Bare-knuckled bourses armoured for battle

New deals and initiatives are underway at the stock exchanges as they hunker down for a fight to the finish. Now that MCX-SX, promoted by Financial Technologies group, has begun its membership drive to go live with equity and debt market trading from the coming Diwali, the price war among India's bourses has begun. If not a radical change, the stock exchange landscape is set for a major transformation.

A little retrospective on the stock exchange business in India should be pertinent to start with before dwelling further on the impending battle royale of the bourses. India is home to the Bombay Stock Exchange (BSE), the oldest stock exchange in Asia, a 137-year-old institution earlier known as 'The Native Share & Stock Brokers Association'. Then, comes the second oldest bourse in the country, the Delhi Stock Exchange, established in 1947. These two bourses were completely overshadowed by a new entrant, the National Stock Exchange (NSE), in 1992.

Circa 2012, and NSE has amassed an 80 per cent market share in the cash equities segment, while BSE accounts for just over 18 per cent and regional stock exchanges (RSEs) for the remainder.

The concern aired by some market participants on D-Street is that NSE is becoming too dominant as its early innovations like order driven trading and central counter-party clearing (CCP) which drove down costs for participants are no longer subject to competition and the fees now appear too high given its current state of technology. Some even say that the so-called "child of competition" -- when it took on the mighty BSE -- has now become the incumbent.

As competition hots up in the equity markets, could things change for better? For starts, MCX-SX has conceptualised a lower deposit structure and net worth requirement for its members than NSE and also forked out discount schemes for those from rural areas and professionals such as accountants and MBAs.

Apart from MCX-SX as a counterpoint to NSE and BSE, the country's second oldest bourse DSE -- virtually dormant in the last few years -- is undergoing a rebirth of sorts and teaming up with the London Stock Exchange (LSE) to set up a trading venue in Mumbai.

This trading house will run on technology provided by LSE subsidiary MilleniumIT, considered the fastest trading platform in the world. It's a system which runs LSE's equity markets at an average round trip latency of about 100 microseconds on high throughput, and will bring India technologically on par with leading edge exchanges of the West.
As four national exchanges vie for market share, there is bound to be intense competition which will likely drive down trading costs, lead to better products and improve trading speeds.

That would be good news for stakeholders and investors. Under the MCX-SX scheme, a broker will have to shell out nearly 80 per cent less, Rs 25 lakh as compared to NSE's Rs 1.5 crore, during the offer period to become a trading member.

Winner take all

Needless to say, higher membership requirement was earlier a major entry barrier to becoming a stock broker. So much so, that BSE made attempts to reduce costs by slashing deposits 90 per cent in 2010. However, MCX-SX has priced itself higher than BSE and positioned itself as a premium bourse. Experts, though, feel that pricing need not matter if MCX-SX can give its members a good amount of liquidity in the wholesale debt market and interest rate futures segment along with equity.

One school of thought is sceptical over chances of all four exchanges surviving the fight for supremacy. They foresee a period of intense competition followed by eventual consolidation to the extent of some exchanges exiting the game altogether. According to Raamdeo Agrawal, Joint Managing Director, Motilal Oswal Financial Services, "The exchange business is a winner-take-all game. I do not know which of the four will win the game; one has to finish off the others to survive."

Hirander Misra, one of Chi-X Europe's co-founders and currently shaping DSE's strategy in India, in an article published in Automated Trader's Q4 2012 edition takes a look at prospects for other exchanges challenging NSE: "What has happened in India over the last 20 years with the NSE becoming dominant would be equivalent to the LSE being superseded in a big way by a new entrant, whereas data over the last 12 months suggests that we have reached a point of equilibrium in terms of European market share distribution. If anything, LSE has gained some market share."

Misra, who is set to take over as DSE CEO subject to Sebi clearance -- was Chi-X's chief operating officer when it was launched in 2007 and helped it become the second largest exchange in Europe behind LSE before he quit in 2010.

He points out that even in the US when NYSE's market share was eroded, the market ended up in an oligopolistic framework with a number of players holding decent market shares (NASDAQ, Bats and Direct Edge today), rather than a single dominant force. “A theory is that once competition took hold in the West, it resulted in more innovation even from incumbents, with lower fees and tighter spreads. That in turn led to demand for more such competition."

BSE had seen improvements during the tenure of Madhu Kannan -- who recently quit to pursue other opportunities -- as its chief executive. But it could not reverse the slump in its market share which has dropped from 25 per cent last year to 18 per cent levels. Even with a 6 per cent market share, BSE challenged NSE's monopoly on equity derivatives but at the cost of paying market makers a part of its liquidity incentive scheme. It has not addressed the core issue of its BOLT (BSE Online Trading System) which is outdated, analysts say.

On the contrary, Jignesh Shah led MCX-FTIL's group's ambitions are grand. It has taken NSE and market regulator SEBI head-on in court battles. MCX-SX forced NSE to start imposing transaction charges in currency derivatives after lodging a complaint with anti-trust watchdog Competition Commission of India (CCI). It holds a roughly similar share as NSE in the currency futures segment, though lagging behind in terms of open interest.

Shah, known as a control freak in market circles, delves into every minute detail of a plan. This time round, analysts say that instead of relying on members of existing bourses to shift their volumes to MCX-SX, Shah's team will extend its reach beyond the current pool of brokers, traders and investors.

Though domestic bourses have done well to improve their governance and risk management systems, they have failed to attract more people with disposable income hoarded in fixed deposits, real estate and gold. MCX-SX will target them on the underlying theme: 'Better to expand the market than to nibble at the same pie'. So, Shah will definitely pursue the route -- seen as a risky and previously failed ploy -- of regional stock exchanges (RSEs), 15 of which have more or less become redundant with the rise of NSE, and later BSE.

Attempts like the Inter-Connected Stock Exchange and BSE's Indo Next tried to create a common network but failed because the order books remained fragmented and each RSE pulled in a different direction. But Shah will rely on Joseph Massey, current MD & CEO of the new stock exchange, to convince the trading community of the need to revive the RSE network for building further volumes.

As the bourses join the war, the market stands to gain. India has seen a sharp rise in electronic trades and high-frequency trading through co-located servers placed on the exchange floor to take advantage of low latency and algorithmic trading -- which means that computer programs decide the timing, locating, pricing or volumes of orders. Electronic and high-frequency trades account for nearly one-third of NSE’s turnover, as per latest data.

Challenges of scale

To what extent old exchanges could upgrade their techology to compete with the newer ones may elude a clear cut answer now, but the speed wars between bourses will fragment the market and yet have its benefits as well, says Rajesh Dedhia, Director, Vantage Institute of Finance Markets, an arm of BSE-listed Vantage Corporate Services.
Sceptics say that there are very few untapped markets and new exchanges are unlikely to suddenly develop traditional advantages of scale over incumbents. Of the 30 million taxpayers in India, 13 million invest through the bourses, said a NSE spokesperson. NSE has built a network of 200,000 terminals across the country, nearly 60 per cent of which are located in Tier II and Tier III towns.

Both DSE and MCX-SX plan to launch new products and offer new avenues for investing in multiple asset classes, though neither have revealed details. Some of the plans will depend on regulatory approvals, while there are several innovations possible within existing regulatory constraints, analysts said. “Not all experiments succeed but if one clicks in a big way, then it will lead to a paradigm shift,” says an analyst, pointing out how people who were used to a 30-unit Sensex for a long time were receptive when NSE innovated with a basket of 50 stocks or the 'Nifty'. "Such shifts can only happen with competition," he said.

Given that only 1 per cent of the Indian population trades in equities and the government wants this to increase to 10 per cent in the next five years, there will be a degree of consolidation, says DSE's Misra. And, those emerging unscathed could be in a position to mount a serious challenge to NSE's supremacy. Watch this space.