Jamal Mecklai: 'We want brokers ...'

MARKET MANIAC

Last Sunday, I had a wonderful dream where the entire 18th floor of the Reserve Bank was turned into a Bollywood set, with all the most senior officers kicking up their heels and dancing (a little out of step) to "It's the time to disco" and singing along (a little out of tune) to the song "We want Billy" from the Hollywood musical "Chicago", except that they were singing "We want brokers."

It was a lovely dream and I didn't really think anything of it, except to enjoy the fact that the RBI had such a large number of smart, attractive women""good dancers, too""in high places. And I also remember remembering my dear, departed father-in-law, who had taught me that when you say "attractive woman" you are being redundant""all women are beautiful.

So, I woke up with a smile in my heart, reached for my morning tea and paper and read, to my amazement the finance ministry will meet on Monday to consider the introduction of screen-based dealing in government securities, which will banish brokers and end the telephone market.

I rubbed my eyes and reread it.

Surely it was a mistake. Banish brokers? End the telephone market? Such extravagant micro-management! Surely that's not the finance ministry's job?

And in any case, what does the finance ministry really know about financial markets? About what makes markets work? I remember some eight or ten years ago when a senior functionary of the finance ministry had attended a closed-door meeting in Bombay, where he had asked the marketwallahs present""all of whom had been clamouring for a deregulation of the debt markets to increase liquidity""as to why greater liquidity was in the government's interests.

We were all aghast as we patiently explained to him that since the government was the largest user of the debt markets, higher liquidity would mean (a) better prices for the placement of government debt, (b) narrower spreads, which would further reduce costs for the issuer, and (c) less risk for investors, which would""again""improve the costs for the issuer.

And here we are, once again, with the finance ministry proposing something that will undercut its own positioning. Granted that technology has taken giant strides in the intervening years.

Granted that technology has enhanced efficiencies and reduced costs in virtually every market it has come to. But in every case, technology has worked synchronously with brokerages.

The first market to introduce technology was the global forex market. Reuters introduced its dealing system in the early 1980s""that's over 20 years ago. At that time, the global forex market was trading about $250 billion a day, virtually all of which was intermediated by voice brokers in a telephone market.

Today, the global forex market trades some $2 trillion a day, the vast bulk of which (around 90 per cent) goes through one of a range of electronic trading platforms. The balance is intermediated by brokers, who offer a combination of voice and electronic services.

Significantly, this 90/10 ratio shifts""and sometimes dramatically""in favour of brokers, whenever volatility spikes. At such times, brokers offer value that technology cannot. And this is in the most liquid and most highly commoditised market in the world.

Most global equity markets""including Indian markets""have become more or less totally electronic. However, here brokers still drive the markets, intermediating between the clients and the now-electronic price discovery mechanism.

Debt, commodity and derivative markets have been the least translatable into technology, at least thus far. This is because these markets are either less liquid or less commoditised""i.e. the products traded are more complex.

In other words, these are markets where information is not uniformly distributed or uniformly valuable""these are environments where brokers add the most value.

No wonder then that, even as technology has taken its share of these markets, brokers""again, many of them offering a combination of voice/telephone and electronic services""retain significant market volumes.

The government's (or the RBI's) attempt to push technology is laudable""and full marks to CCIL for its pioneering development work. However, the attempt to push brokers aside is both laughable""because it will fail""and tragic""because it speaks a mindset that is mired in the past.

That closed mindset is""supposedly""borne out of experiences over the past 40 or 50 years, where one scam after another in one market after another was precipitated by collusion between brokers and financial institutions. In the early days, the response was: if we eliminate brokers, we won't have scams.

An equally logical response would be: if we eliminate financial institutions, we won't have scams. Of course, in that case, you wouldn't have a market either.

But what the regulators don't understand is that if you don't have brokers you may have a market""one person buying and one person selling does constitute a market""but market development will be very slow and, worse, what market you do have will be heavily skewed in favour of the larger (or more aggressive) players.

The interest-rate-swap market provides an excellent case in point""while volumes have grown reasonably well (although they could be easily 5 to 10 times as high with proper market development), the market remains divided between a handful of market makers (mostly foreign and some private banks) and a modest number of players who remain disadvantaged price takers.

Let me close my eyes and look for that dream again.

jamal@mecklai.com

(The author is CEO of Mecklai Financial)