Spare a thought for United Stock Exchange (USE), which is set to launch currency futures trading, after having finally received approval from the Securities and Exchange Board of India (Sebi).
Based on reported turnover for March, the incumbents, MCX Stock Exchange (MCX-SX) and National Sock Exchange (NSE), have created extremely liquid markets with average daily turnover of $4 billion (Rs17,880 crore) and $3.1 billion, respectively.
Capturing share from liquid venues is always tough, but USE’s task will be more difficult for two reasons. First, USE can’t compete on price, since both MCX-SX and NSE charge zero fees in currency futures. Besides, it cannot differentiate much because various features of the product such as design and market timing are determined by Sebi.
On pricing, MCX-SX has already approached the Competition Commission of India with a charge of “predatory pricing” against NSE. The charge is that it can afford to keep waiving fees in the currency derivatives segment till competition is killed, since it runs a highly profitable equity derivatives business, thanks to a monopoly position.
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Unless there is a directive from the commission to charge fees, it looks like new exchanges would need to have deep pockets to keep going. One advantage is that the majority of the cost of an exchange is borne upfront and variable costs are small.
But in any case, investors in start-up exchanges such as MCX-SX and USE may need to accept that revenues and profit may flow in only in the long run. This could act as an entry barrier to new competition.
This column had argued late last year that it’s best left to the commission to resolve the issue on pricing. Meanwhile, start-up exchanges would just have to work on building liquidity on their trading venues and wait for the day when they can start charging trading fees. Of course, the situation wouldn’t be as bad when one takes into consideration the likely entry of these players into other segments such as equity derivatives and interest rate derivatives.
Sebi’s stance seems to be that permission for other derivatives segments will be given when shareholding norms are met. Both MCX-SX and USE have been working on this and it would be fair to assume that they would get permission to trade in the other segments at some point.
They could meaningfully compete in the equity derivatives segment on price and if, like in the rest of the world, interest rate derivatives turn out to be the biggest market segment, the competitive landscape would look very different. Of course, returns would likely be visible only in the long run.
What could the regulator do to foster competition in the stock exchange space? This column has previously argued that exchanges need to be given freedom with product innovation. This is not to say that this is the definitive solution, but it would certainly help in more effective competition.
If there’s one major regulatory change that would foster greater competition in India, it would be to remove current ownership restrictions for stock exchanges. Competition from the likes of Chicago Mercantile Exchange, New York Stock Exchange and Euronext will be extremely healthy for the Indian markets.
But such players won’t be interested in entering the markets only with a 5% stake. The terms of reference of the Bimal Jalan committee set up by Sebi includes a review of the ownership structure of stock exchanges. One hopes that the current ownership restrictions are revisited, since they are an impediment to credible competition in the exchange space.
Of course, there is also the issue of the governance role of stock exchanges and that it should not be compromised in the pursuit of greater competition. But there are ways to address the issue of governance while at the same time provide room for greater participation by global exchanges and large institutions to set up new trading platforms in the country.
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