The good news first. The National Stock Exchange of India (NSE) has zoomed into the top 10 list of global derivatives exchanges, and is ranked ninth based on its 2007 volume of 380 million contracts. Three years ago, NSE stood 17th among global derivatives exchanges, data collated by the Futures Industry Association (FIA) show. Since then, NSE’s volumes have grown at a compound annual growth rate (CAGR) of 72%, while global derivatives volumes increased at an average annual rate of 20%.
The FIA ranking, however, needs to be taken with a pinch of salt as it relies on number of contracts traded. Indian derivatives contracts are amongst the cheapest in the world, with the average size in 2007 being $7,700 (about Rs3 lakh), data collated by the World Federation of Exchanges show.
For perspective, Hong Kong Exchanges and Clearing’s (HKEx) average contract size is over $60,000. So, although HKEx is ranked 26th by volume, in value terms, its derivatives turnover is 80% higher than that of NSE.
Now the bad news. In the list of exchanges complied by FIA, not one competes with NSE. The Bombay Stock Exchange (BSE) doesn’t seem to be part of the association, but in any case, its volumes are not consequential. In 2007, BSE managed volumes of 6 million contracts, leaving NSE with a 98.4% share of the Indian market for equity derivatives.
By contrast, in the US and Europe, where derivatives thrive, a number of large players compete with each other. The chart above shows the top five players include two each from the US and European regions.
Is the Indian equity derivatives market missing anything because of the lack of competition? After all, NSE continues to grow at a fast pace and seems to be placed handsomely in the global league. According to an expert on securities market infrastructure, the Indian market is missing out in least four areas: product innovation, better use of technology, cost cutting and customer satisfaction. One could argue that introducing new products is the purview of the Indian market regulator and that greater competition may not necessarily end in product innovation, unless exchanges have the autonomy to introduce new products.
But greater competition would result in exchanges pushing the regulator for new products to gain more market share. Currently, the market is almost entirely with NSE, and since liquidity pulls liquidity, BSE has had little success even with new product launches.
The surge in volumes on NSE has not been without problems. Brokers warn clients about ’technological risks’, one of them being that the system may not be able to handle the flush of trades in the last half hour of trade.
In a competitive world, brokers and clients would have simply shifted to another exchange. But, given the lack of an option, all exchange members can do is complain gently.
Another consequence of little or no competition is that maximizing customer satisfaction is hardly on the agenda. On the contrary, members say they are faced with arrogance when they want to get their problems resolved.
In a world with greater competition,customers can look forward to better service, new products, lower costs and new measures such as extended trading hours. Markets overall would also benefit through higher volumes and greater efficiency in execution.
How do we get there? To begin with, BSE’s foreign shareholders such as Deutsche Borse and Singapore Exchange need to be given a higher stake and say in the running of the exchange. Deutsche’s combine of Eurex and International Securities Exchange is now a strong number three player in the world, and BSE can leverage its strengths. As long as foreign players are allowed a miniscule 5% in Indian exchanges, little competition can be expected. Besides, BSE could benefit if algorithmic trading, a form of automated trading in which computers execute trade orders based on parameters such as time, price and volume is introduced.
A little over a decade ago, it was BSE that was sitting smug at the number one position in India’s securities market. Competition from NSE, therefore, did wonders to the whole system. Things have now come a full circle. It’s BSE’s turn to give its rival serious competition and remedy the current monopoly.
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