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Room for the third exchange

Rachna M. Koppikar     May 18, 2009

The only disadvantage of being a monopoly player is that there is nobody around to tell you so. Until a Johnniecome-lately strides into town and begins chipping away at that dominance. For the National Stock Exchange (NSE), which controls close to three-fourths of the share of the cash market in stock trading, and reigns supreme in the derivates segment, has consigned the 133-year-old Bombay Stock Exchange (BSE) to a distant #2 place, in what is essentially a two-horse race. Not for much longer, however.

The new kid on the trading block that’s set to launch an equity and derivates platform is from Financial Technologies (FT), which currently has in its stable India’s largest commodity futures exchange, the Multi-Commodity Exchange (MCX). The new exchange will be under the umbrella of MCX-Sx which currently runs the currency futures trading platform of MCX. It also plans to start an exchange for small & medium enterprises (SMEs). MCX is awaiting a go-ahead from the Securities & Exchange Board of India (SEBI).

While MCX is keeping its cards close to its chest, it wants to build on the existing market inefficiencies and its vast distribution network in the hinterland. But then, what can MCX-Sx offer that the NSE isn’t already providing? Explains Joseph Massey, CEO, MCX: “Today, 90 per cent of the business of exchanges is from the four metros, the top 100 companies account for 95 per cent of trading and less than 5 per cent of Indians invest in stocks. These are skewed numbers.”

It’s in those numbers that rests the MCX’s competitive edge, which has a geographical spread across over 650 cities, as against the NSE’s 1,500 cities. “Our strength lies in our decentralised distribution as we created markets in non-urban centres and included participants at taluka or district levels (in the commodity exchange),” adds Massey. In addition, MCX hopes to introduce innovative products, and invest in investor education through parent company FT; the latter will take on NSE’s stock market certification programme.

In many ways, MCX is hoping to do to the NSE what the NSE did to the BSE after its launch in 1994. At that time, the BSE ruled the roost with its indigenous badla (forward trading) system. The NSE came into existence with a different ownership model and it marched ahead. Eventually, badla was abolished, and the BSE—then largely seen as a cosy cartel of brokers—rapidly lost ground, with the NSE pulling ahead of the exchange on Dalal Street in the second year itself. Despite launching the derivates in 2000, the BSE could never regain lost ground, with stock market scams along the way not helping its case. Eventually, the exchange moved away from broker control, but the lack of management continuity has ensured it is no serious threat to the NSE any more.

But it isn’t giving up, yet. BSE Chief Operating Officer M.L Soneji is trying to drive the exchange by beefing up its technology, systems and processes. “We will be more competitive if we equip ourselves with advanced technology,” says Soneji. The BSE plans to re-launch Sensex futures, and then hopes to take this to the Singapore Stock Exchange or the Deutsche-Borse, its strategic partners with a 5 per cent stake. Also, BSE has short-listed a few names for the CEO slot: At the time of writing, Madhu Kannan, Managing Director at Bank of America-Merrill Lynch and a former employee of the New York Stock Exchange (NYSE), was in the race for the post.

MCX: The threat in the making

  • MCX plans to launch a stock exchange
  • It will go beyond the metros, which account for 90 per cent of business today
  • Will include participants from the district and taluka levels
  • Will introduce innovative products & focus on investor education in non-urban areas

BSE's comeback bid

  • Cooperate closely with strategic partners Deutsche-Borse and Singapore Stock Exchange for technology enhancement
  • Re-launch Sensex futures on a new trading platform and list them on Deutsche-Borse or SGX in future
  • Explore opportunities for BSE-listed companies to get listed on exchanges of its strategic partners

The NSE's counter-attack

  • Improve its technology platform at front-end and back-end
  • Strengthen position in IT solutions.Launched now, a trading software to beat ODIN of FT
  • Adopt a more broker-friendly approach
  • Launched an online interface for investors to lodge complaints against brokers

Rather than battling MCX, the BSE could seek to ally with the private sector player; this would suit MCX too in its objective of toppling the market leader. Soneji refuses to comment on speculation that MCX and the BSE could form an alliance to share their trading platforms, although Massey says he is open to collaborations. MCX’s depth in derivates could also help revive the BSE’s moribund derivatives business.

The NSE, for its part, won’t be taking the MCX threat lightly. It’s already witnessed what Shah’s exchange has done in commodities trading, where the MCX has raced ahead of the NCDEX, which is copromoted by the NSE (along with the Life Insurance Corporation and Punjab National Bank) in trading turnover.

To be sure, the NSE and MCX are no strangers on the battlefield, on many fronts. Last August, for instance, the NSE got the go-ahead for a currency exchange platform; within a month MCX went live with its currency platform. Both exchanges tried to out-do each other by charging trading members minimal fee. The two players currently share the total currency futures trading volumes between themselves.

R.H. Patil, Ex-Managing Director, NSE
R.H. Patil, Ex-Managing Director, NSE
The NSE fired another salvo when in December 2008 it put FT— its trading software vendor—on a watchlist, citing performance issues. Even as both companies slapped legal notices on each other, NSE launched its internally-developed trading software NOW which competes with FT’s ODIN. While NOW is being installed in brokers’ offices without any charge, it allows access to all trading platforms of the NSE but doesn’t include the BSE and MCX trading platforms. The NSE and MCX are now slugging it out in courts over the matter. The NSE didn’t respond to repeated e-mail and interview requests sent by Business Today.

A section of brokers points out that the NSE might have just become a victim of its monopoly—its functioning is bureaucratic, complacent, and opaque, what with decisions taken in isolation without taking the market participants into confidence. “We know that NSE employees are overworked as each one of them handles the work of three.

But access and communication with them is a long-drawn process as junior employees simply don’t allow access to their seniors,” says the head of institutional equities at a Mumbai-based broking firm. A CEO of a large brokerage firm recalls the harrowing experience of getting NSE membership a few years ago. “Their attitude was like I am the boss and I am the best,” says the CEO, on the condition of anonymity.

Robert Kent, Executive VP, NYSE Euronext
Robert Kent, Executive VP, NYSE Euronext
“The decision-making is completely in the hands of top management and brokers get involved only when there is some payment crisis during steep market declines or any connectivity-related problems,” he adds.

Former NSE employees point out that during the tenure of first managing director R.H. Patil, employees were consulted over the key issues, which doesn’t happen anymore. Today, the NSE is believed to have included a non-compete clause in its agreement with employees, as 5-6 of them have joined MCX.

Industry watchers, however, say the broker-unfriendly image is a result of an unwritten rule etched when the NSE was founded: Never cosy up to brokers. This was seen as a key differentiator from the broker-led BSE model. In hindsight, that strategy has paid. “The management of the NSE has made conscious efforts to be not seen as an exchange which gives into broker demands. So far, this helped them remain in good books of the Finance Ministry and the market regulator, SEBI, and aided in getting quick approvals,” points out a former member of the BSE.

Will those good books now once again come to the NSE’s rescue? There is a buzz that the government and the regulator may not feel the need for another exchange. A senior SEBI official who didn’t want to be named, rubbishes such rumours. “We are neither against competition nor do we intend to create hurdles in encouraging competition. If players are not able to compete on their own, there is little we can do.”

One advocate of more competition is none other than NSE’s founding member Patil. “It’s a fact that for a long time we didn’t have a strong player with an organisational capability to take on the NSE. Competition is good for the system and I won’t be surprised if the third exchange comes up,” says Patil, now Chairman of Clearing Corporation of India. “A third exchange would make sense if it’s able to provide better trading ideas, encourage structured products and provide a market making facility,” adds Deven Choksey, Managing Director, K.R. Choksey Securities.

M.L Soneji, COO, BSE
M.L Soneji, COO, BSE
The turf war between exchanges will take another leap if foreign exchanges are allowed to hold more than 5 per cent stake in the local exchanges. In 2007, NYSE Euronext invested in NSE and MCX and BSE got Singapore Stock Exchange and Deutsche-Borse on its board. Over the past few years, the NYSE Euronext and Nasdaq have strengthened their reach outside America with a string of acquisitions of trading software providers, alternative exchanges and local exchanges. Result? NYSE Euronext controls 40 per cent of the world’s equity trading volumes.

Such consolidation may be premature in India, but you can’t rule it out. NYSE Euronext, for one, is testing the waters. Robert Kent, Executive Vice President and Head of International Listings at NYSE Euronext, says the exchange is willing to work with both NSE and MCX. That adds another dimension to the NSE vs MCX slugfest. Not only will the winner be crowned India’s biggest and best exchange, it could also get a chance to tie an exclusive knot with the world’s most global bourse.

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