Mumbai: At a recent technology conference in Mumbai, James Shapiro, marketing head of Bombay Stock Exchange (BSE), Asia’s oldest bourse, alleged that its younger rival National Stock Exchange (NSE) had been trying to stifle competition by illegally blocking its algorithm customers from accessing trades at BSE.
According to Shapiro, NSE had prescribed an approval process for algorithms that can be used by investors and traders, but this approval process was “painful” and “slow” and it blocked algorithms that can send orders to BSE.
Market moves: Madhu Kannan, chief executive of BSE. Abhijit Bhatlekar/Mint
Algorithmic models use complex mathematical relationships among several technical, economic and fundamental parameters for investment recommendations. Though these models were available earlier, the launch of direct market access in 2008, a facility wherein trades could be routed directly from a client’s system without any human intervention at the broker’s end, has reduced the execution time and increased the viability of algorithmic trades.
NSE vice-president R. Nandakumar was present at the event, but chose not to respond to Shapiro’s allegation.
An NSE official, on the condition of anonymity, said BSE had not co-operated when asked for some details on security standards. But BSE is not ready to buy this argument. “NSE is in the same class with us. How can they play the teacher and set the rules?” asked a senior BSE official, who also did not want to be named.
Algorithm trading is one of the many skirmishes between the two exchanges since 37-year-old Madhu Kannan took over the reins at BSE as its youngest chief executive in May.
The latest is over the extension of trading hours. BSE first forced NSE to extend trade timings by announcing a 10-minute extension—saying it would start trade at 9.45am instead of 9.55am. NSE, which until then had maintained that it would not extend timings without a consensus among its members, decided to start trading at 9am.
BSE followed suit, and the capital market regulator had to step in to sooth the frayed nerves of the broking community that was not prepared for this and forge a truce between the two exchanges that were scrapping like kids.
“Thank god, you’re at least calling us a kid. Till now, people used to think of NSE as a teenager and BSE its pet dog, which follows NSE wherever it goes,” said a BSE executive.
Their rivalry has now entered a new phase. From being a weak, old player that had nothing much to show except history and was losing market share continuously, BSE is now trying to match its younger rival at every step. As a close watcher of the fight said, by any yardstick, it’s guerrilla warfare. BSE is following hit-and-run tactics, the objective being to keep NSE on its toes.
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“We need to wait and watch to see who will emerge winner. From a policy point of view, competition is desirable in any sphere of economic activity,” said J.R. Verma, a professor at the Indian Institute of Management, Ahmedabad, who has a close association with the capital market regulator as part of various committees.
The broking community endorses this. “Competition is always good. If BSE is kept stifled, NSE will emerge as the winner, which may result in an end of initiatives at NSE in the absence of any rival exchange,” says Raamdeo Agrawal, managing director, Motilal Oswal Financial Services Ltd, a listed domestic brokerage.
Given its brand equity, distribution strengths and improved technology, BSE is now well positioned to compete with NSE.
Rahul Saraogi, managing director, Atyant Capital Advisors Pvt. Ltd, an algorithmic fund, said the “monopolistic situation needs to be shaken up”.
On algorithm trading, Saraogi said: “From being innovators, the exchanges have become creators of hurdles. They are not behaving like a facilitator. One should allow multiple platforms to co-exist.”
Co-location is the next innovation that NSE is driving. Through this facility, NSE will enable its customers to physically keep their servers near the trading engine of the exchange. This will reduce latency, the time delay in data being transmitted from the exchange server to that of the member broker as well as the time taken for a member’s order to reach the exchange’s system.
Low latency is critical for algorithmic trading and exchanges—brokers and traders worldwide are investing millions of dollars to enhance trading efficiency.
Taking stock: Ravi Narain, chief executive of National Stock Exchange.Jonathan Fickies/Bloomberg
NSE has offered co-location facilities to its members who can set up automated trading systems on the exchange’s premises.
An NSE official, in a recent presentation to the media, said the exchange is geared up to provide co-location facilities to its clients. The new facility may become operational by mid-January. Though BSE is technologically ready to launch co-location facilities, it would not help the exchange much unless it manages to create liquidity in its near-zero derivatives market.
BSE is trying hard to make inroads into NSE’s virtual monopoly in the derivatives segment.
Indian exchanges offer four derivative products—index futures, index options, stock futures and stock options—along with the cash and debt-market segments. The volumes in derivatives segments are a multiple of the underlying cash market.
NSE offers trading in 233 stocks in its futures and options, or F&O, segment, and BSE offers trading in 327 stocks.
The average daily turnover in the cash segment at both exchanges in November stood at Rs21,481 crore. The derivatives trades were four times larger—Rs83,090 crore.
BSE’s trading volume in the derivatives segment is almost zero and even though it accounts for about one-fourth of spot trading, its overall market share is around 7%.
BSE is trying to generate volume in derivatives trade through the introduction of a new expiry cycle for its derivative contracts. The new contracts came into being on 18 December.
The mid-month expiry is an attempt to differentiate from NSE’s contracts that end in the last week of every month.
According to Agrawal of Motilal Oswal, BSE for the first time has started offering differentiated products. These will increase arbitrage opportunities for investors.
Though the underlying asset (equity) will be identical, the difference in the expiry cycle would result in variations in pricing. One of the factors that determines the price of a futures contract is the time till expiry, and a shorter/longer time till expiry will result in an increase/fall in the fair value of the contract. This difference in prices will create trading opportunities, points out Sayee Srinivasan, head of product strategy at BSE.
Srinivasan and Shapiro are two of the eight-member crack team at BSE under Kannan that has been working continuously to put the 124-year-old bourse’s house in order.
On the other hand, NSE has been driven by its managing director and chief executive Ravi Narain and his deputy Chitra Ramakrishna for about a decade now. Both of them have been with NSE since its inception.
BSE is also paring transaction charges for derivatives trading from next week. “This new pricing scheme is designed to improve depth and liquidity in the BSE equity derivatives segment,” a BSE statement said. NSE is yet to react to this.
However, on a previous occasion, NSE took the lead and BSE followed it in cutting transaction changes. On 1 October, NSE lowered transaction fees by nearly 10% in the cash as well as derivatives segments. It reduced the charges for the cash segment from Rs3.50 per Rs1 lakh traded to Rs3-3.25. In the F&O segment, it reduced charges from Rs2 per Rs1 lakh of traded value to Rs1.75-1.90.
A week later, BSE reduced transaction fees for the cash segment and introduced differential rates. It trimmed the charges from Rs3.50 per Rs1 lakh of trade to Rs2.25 for passive orders. For active orders, the reduction was less—from Rs3.50 per lakh to Rs3.25.
Passive orders are defined as those already existing in the order book at the time of trade, while active ones are fresh orders for buying or selling of stocks.
BSE’s desperation to ramp up the non-existent derivatives trade on its platform is to be seen in the context of the so-called cross-margining facility that the Indian capital market regulator introduced in 2008.
An investor or trader can utilize the margins already paid in the derivatives market to meet the margin requirements in the cash segment. Many investors have shifted their trades from BSE to NSE to make efficient use of their margin capital, and this has started eating into BSE’s cash segment market share.
From being at around 30% in April 2008, it dropped to 24.4% in November 2009. If it declines further and drops below 20%, that will deliver a body blow to the exchange as existing traders may withdraw as liquidity dries up.
By attracting a higher volume of trading, an exchange is able to cut transaction costs and this, in turn, drives liquidity, its lifeline. Thus, higher participation by the brokers in trading and liquidity on an exchange are interdependent. NSE’s monopoly in the equity markets rests purely on liquidity in the F&O segment.
Arbitrageurs play between the cash and futures markets, and hence liquidity in the F&O segment emerges as the key to drive cash market volumes, said IDFC SSKI Securities Ltd analysts Nikhil Vora and Swati Nangalia in a June report on Indian exchanges.
While NSE has about 93% share of the overall turnover on equity exchanges, it controls the F&O segment with a 99% share. Index futures and options have been the key driver for NSE’s F&O segment business, making it the world’s seventh largest in terms of number of contracts traded.
So the fulcrum of Kannan’s strategy is not to lose market share any more and raise it any which way he can.
“Without volumes there is no liquidity, and without liquidity there is no volume. This is a serious thing. Unless you fix this, you are not going to get anywhere as any step you take can be quickly replicated by the other exchange,” says V.K. Sharma, head of private broking and wealth management at Mumbai-based brokerage HDFC Securities Ltd.
Product developments and price war should not be seen in isolation. There are fights for the supremacy on the front end, too. The stock exchanges have an ownership in or an affiliation to a front-end trading solutions provider and so they are involved in not only providing exchange services, but also distribution of these services.
In developed markets, distribution is done by third-party providers.
In 2008, NSE put ODIN, the front-end system produced by Jignesh Shah-promoted Financial Technologies (India) Ltd, or FTIL, on its watchlist for alleged security issues.
Even as FTIL dragged the exchange to court, NSE began ramping up its capabilities in the front-end space by buying a stake in Omnesys Technologies Pvt. Ltd, which not only distributes its own products but has helped NSE develop an Internet-based solution called NOW (NSE on the Web).
However, ODIN still remains the most used front-end platform as it has licences for BSE and NSE equity and derivatives as well as products of MCX Stock Exchange, the new stock exchange promoted by FTIL and Multi Commodity Exchange of India Ltd.
BSE’s new management sees the front-end as a key element in its strategy to rebuild the exchange. It bought front-end company Marketplace Technologies Pvt. Ltd, which already had the licence to access NSE feeds. This put it in a unique position as the only front-end provider which has all exchange-traded products, including MCX-SX and NSE currency derivatives though its market share is small.
In fact, barring NOW, each of the front-end trading solutions distributes feeds of not only their promoter/subsidiary exchange, but also those of rival exchanges. This could result in a potential conflict of interest. The solution provider could discriminate against competitors when disseminating market data. Stale data can put off broker members who would then shift their volumes to the exchange the trading solutions provider is supporting.
In April, BSE’s then chief operating officer M.L. Soneji had given in-principle approval to explore the possibility of making BSE data feeds available on the NOW platform. But BSE’s new management does not seem to be keen on taking this forward.
There are other areas where the exchanges are competing fiercely. Though BSE was a relative late starter in trading of mutual fund units, it could attract more funds than NSE. On the first day itself, the trading volume was 10 times higher. While NSE platform MFSS attracted volumes worth Rs77 lakh, BSE’s Star MF clocked trades of Rs8 crore.
Both exchanges have been wooing regional exchanges to add to their reach and collect new members. In 2007, BSE inked a platform-sharing agreement with the Calcutta Stock Exchange, which enabled it to access the member base in eastern India. In November, NSE entered into an agreement to allow the members of Chennai-based Madras Stock Exchange to trade in the cash and derivatives segments.
In its new-found aggression, BSE has also become more vocal at meetings with the Indian capital market regulator. According to an official of the Securities and Exchange Board of India (Sebi), from being a follower of whatever NSE does, BSE now contributes a lot more during joint consultative meetings.
BSE was established in 1875 as a voluntary and not-for-profit association of persons. The members were part owners, and it followed a mutual structure where the ownership and management rights of the exchange were bundled with trading rights as a broker.
In 2007, it was demutualized as part of the government initiative to release the exchanges from the clutches of vested interests and run them as corporate entities. Twenty one strategic and financial investors including Deutsche Borse, Singapore Exchange Ltd, Life Insurance Corp. of India and State Bank of India and the Aditya Birla Group have picked up a 51% stake in BSE.
Deutsche Borse and Singapore Exchange picked up 5% each for Rs189 crore at Rs5,200 per share, valuing BSE at $1 billion (Rs4,690 crore).
In 2007, New York Stock Exchange, SAIF Partners, Goldman Sachs Group Inc. and General Atlantic Llc picked up a 5% stake each, valuing the exchange at about $2.5 billion. Subsequently, Hero Honda Motors Ltd, Srei Infrastructure Finance Ltd and Norwest Venture Partners have picked up small stakes in the exchange.
“Key factors contributing to the success of NSE have been its demutualized structure and the electronic trading platform. On the back of these USPs, NSE was able to bring liquidity to new products (which were launched simultaneously on both exchanges) and thus eventually become the industry leader,” the IDFC SSKI Securities report said.
“BSE was also hit hard by the government-mandated switch in 2001 from one-week settlement sessions to the rolling settlement used in the rest of the world as also a ban on badla trading—a prime liquidity driver for the exchange. Given the quasi-monopolistic nature of the exchange industry, where poaching of liquidity is almost impossible, NSE has sustained its leadership for over a decade,” it says.
Now for the first time, NSE seems to be facing a semblance of competition and reacting. Competition for higher volumes and liquidity will intensify when MCX-SX starts equity trading. It has been trading currency derivatives since October 2008, and Sebi is expected to allow it to offer equity trading after it fulfils ownership norms. The old war will continue to be fought on newer fronts.
Graphics by Sandeep Bhatnagar/Mint