Fair exchange? New stock exchanges may not thrive: Financial Express 14th January 2021

 

New players may bring in technology, but may not be able to accomplish much on marketing, especially when confronting well-established players

The Mumbai-Pune expressway would probably be one of the first such passage for commuters on this route. Everybody agrees that it is a great road to drive on. The alternative route is the old Pune road, which charges a lower toll than the expressway. The toll on the expressway is Rs 270 for a car. Is this the right toll? One does not know, as it is a monopoly and the charges could sound arbitrary. Thus, a better approach would be to have multiple expressways that will ensure fair-play and correct price discovery. Unfortunately, there is no way to have 2-4 expressways on the same route, it costs money and space, and ideally, the government would like to deploy the funds to other routes. This is the problem with infrastructure.

How about financial infrastructure? Here, the cost of entry is regulation and technology. Sebi has recently addressed the first for the segment of financial infrastructure it regulates, by opening the gate to have more players in the market. The rationale is that there will be more competition and greater leverage of technology if there are more stock exchanges. The guidelines on ownership pattern of exchanges and depositories have been put out for discussion. Sebi points out that there are several cases of fintech players bringing in disruptive technologies and challenging the existing players, thus, adding value. If this were so, then there is a strong case from the point of view of the trading business to get more players. Unlike physical infrastructure, where there are logistical issues, the same does not hold for financial infrastructure.

The logic behind having more players in any field is compelling because it fosters competition and customers gain with lower cost and comfort of transacting. Therefore, there can be no argument, from the regulatory perspective. of stopping more players in the arena. The point of contention, however, is whether this will work.

There can be more players interested in joining the bandwagon, but the broader question is whether they will succeed. Bringing in technology in a well-established market is one thing, but using it to wean away customers from existing well-entrenched players is quite a challenge. Hence, it is interesting to see how the case of new players has worked in these markets.

If one looks at the history of stock exchanges, the BSE and regional stock exchanges (23 at one point of time) were the only ones before the NSE came along. NSE came as a breath of fresh air in 1992, with a professional structure and open membership. The point of differentiation was technology. This was also the time when the system went into the dematerialisation mode post-1996 with the establishment of NSDL, and later CDSL, in 1999. This brought about a sea change in the business.

However, BSE was slower to respond, and NSE was able to take a comfortable lead in both the cash and derivatives segment. As of FY20, in the cash segment, NSE clocked total business of Rs 90 lakh crore, compared with BSE’s Rs 6.6 lakh crore. The latest entrant, MSEI, had volumes of just Rs 28 crore. Quite clearly, liquidity is concentrated in two exchanges, with the dominant one being way ahead. The quirk of markets is that liquidity brings in more liquidity, and hence any new player has to face a challenge in the market.

The forex derivatives market was established to provide a vibrant hedging platform for companies with forex exposure. Three exchanges are active here, but again the picture is lopsided. In FY20, NSE clocked volumes of Rs 96 lakh crore in the F&O segment, while BSE had Rs 68 lakh crore. MSEI managed just Rs 45,000 crore. Therefore, the first-mover advantage remains with the protagonists, and new players find it a struggle.

The commodity market is another example of such concentration. The commodity futures market was opened in 2003 when MCX and NCDEX were established. Both exchanges came in when there were regional exchanges (22 at one point of time) of which one got converted to a national level multi-commodity exchange. Seventeen years down the line, the regional exchanges have closed down, and there are only three of them left. Their level of volumes is so disparate. MCX had volumes of Rs 84 lakh crore in FY20 specialising in metals, bullion and energy, while NCDEX, with substantially lower volumes (Rs 4.4 lakh crore), is considered more of an agricultural exchange. In fact, volumes in the agricultural products segment are just 5% of the non-agricultural products.

ICEX remains a fringe player, with the business of just Rs 40,000 crore. There have also been new exchanges which had to shut shop due to the non-viability of their business model (ACE Derivatives and Commodity Exchange and Universal Commodity exchange).

Interestingly, both BSE and NSE have opened their commodity wings. However, in terms of business generated, they have minimal exposure at Rs 46,000 crore and Rs 6,300 crore, respectively. It has been observed in all countries that there tends to be a concentration in liquidity in commodities in specific exchanges which once established is hard to shake off. The monopolisation increases over time. This has also been witnessed in overseas markets and is not specific to India. In the case of NSE and BSE, which are well-established stock exchanges, diversification is an idea which will not affect the company as the main area of equities continues to tick. A new player will be extremely disadvantaged in such a setting.

The positions of the two depositories tells a similar tale. NSDL had around 21 million accounts as of November 2020 whereas CDSL had 28 million. The total dematerialised value of companies with these two depositories was Rs 160 lakh crore and Rs 16 lakh crore, respectively—CDSL is just 10% of NSDL. With such dominance of the two players, can there be a meaningful business for new participants even if they possess superior technology, which reduces costs and provides a better experience? The answer is probably a no because even if incrementally there could be some movement, it is unlikely for existing customers to shift to another service provider.

The idea to bring in more players to avoid concentration is in the right spirit as it is possible that customers are not getting a fair value for their participation on the exchanges or dealing with depositories. There could be interest in such new enterprises as the response to any regulatory change is often met with enthusiasm. The broader question is whether or not these new companies have the wherewithal to pull the enterprise as it could take even a decade to break-even.

The temptation to withdraw cannot be ruled out. The banking experience has been mixed in the last two and half decades. Those players in the fintech space may have the right model, but may not be able to accomplish much on marketing, especially when confronting well-established players and could just be looking to sell at a good valuation. This is something which has to be kept in mind when granting licences.