MCX Stock Exchange’s equity and equity derivatives segments were expected to have a slow start but volumes on the first day of trading turned out to be even lower than anticipated. Shares worth less than Rs.1 crore traded in the cash equity segment and turnover in the equity derivatives segment amounted to Rs.11.8 crore, a fraction of the trading levels on the National Stock Exchange (NSE) and BSE Ltd. Of course, this is far better than the big-bang launch of United Stock Exchange’s (USE) currency derivatives segment in 2010, when the new exchange reported a market share of over 53% in the near-month dollar-rupee futures contract on the first day of trade, propped up by artificial volumes. USE now has a negligible share in the currency derivatives market.
It takes times to build liquidity on new products and new exchanges. This has been the experience even in Indian markets in most products. It was months before volumes reached reasonable levels when NSE cash equities segment was launched in the mid-1990s. Later, when the exchange launched index derivatives, it was a long time before the contracts became liquid. In fact, traders first warmed up to single stock futures, even though they were launched much later than index futures and options. This was because the single stock product was very similar to the existing cash equities products, with some of its features resembling the badla market, which most market participants were familiar with. In this backdrop, it is also good to remember the age-old principle stated in the Bible that “small beginnings should not be despised”.
Even so, it must be stated that MCX-SX needs to do a lot more to garner share in equities trading. While the slow start is not a big worry, the exchange’s investors should be worried that it hasn’t yet offered any compelling proposition for traders to get active on its equities platform.
World-over, exchanges have captured share either by significantly reducing trading costs, providing meaningful incentives to volume providers, launching innovative products, or by disrupting the market because of superior use of technology. Trading in bund futures, for instance, tipped completely to the electronic trading platform of Eurex, owned by Deutche Börse, from LIFFE, which then operated a floor-based open-outcry system of trading. There’s nothing to suggest, at least with the facts available, that MCX-SX can offer superior technology compared with NSE, which thanks to its huge cash flows continues to make large investments in building infrastructure and capabilities.
And while MCX-SX’s transaction fees are currently about half that of NSE’s, it must be noted that exchange fees account for a small fraction of total trading costs. After accounting for securities transaction tax (STT) and stamp duty, the actual reduction in trading cost is much less than 10% for futures contracts. For delivery trades in the cash market, the reduction is almost negligible, because of a much higher STT. For the same reason, incentivizing trading members to provide liquidity and make markets is a very expensive proposition. Exchanges need to pay brokers incentives that cover the high statutory levies and then some more to keep interest alive. So while it’s good to see that the Securities and Exchange Board of India is doing its bit to promote competition by allowing market making schemes in the cash segment just before MCX-SX’s launch, it remains to be seen if this will be of much use because of the high statutory levies involved. As pointed out in this column before, the finance ministry needs to do its bit by removing STT entirely, which financial economists say is a bad tax. But until this tax remains, garnering share will always be an uphill task.
Coming to innovation, the products MCX-SX has launched so far are essentially clones of what is already available, and there’s little reason for traders to shift from products that are already very liquid. The exchange has listed stocks that are already available on both NSE and BSE and has launched an index, SX40, which is made of 40 stocks. The Sensex, which has 30 stocks, and the Nifty, which has 50 stocks, are themselves highly correlated. SX40 has 37 stocks that are common with the Nifty and is likely to be much more correlated. As one market expert points out, it may be have been good for MCX-SX to launch contracts on MSCI indices, which are already tracked by many institutional investors, rather than launch an index that is very similar to existing ones.
A number of market participants are confident that MCX-SX will succeed in the long term, pointing to the large volumes in the commodity derivatives exchange run by parent company Multi-Commodity Exchange of India Ltd, and the healthy volumes in the currency derivatives segment run by MCX-SX. But these markets have many differences from the equities market. The latter has a much larger institutional presence and attracts higher statutory levies. The new exchange will have to work hard at innovating, providing better technology, and hope for the removal of STT.
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