The Securities and Exchange Board of India (Sebi) has issued guidelines for stock exchanges in international financial service centres (IFSCs). At first look, this sets the stage for BSE Ltd’s reported 9 January launch at the Gujarat International Finance Tec-City, or GIFT City. Sebi’s rules permit a vast range of products—practically any product that trades on any other global exchange, barring agricultural futures; they give exchanges the freedom to decide on trading hours; and purportedly allow cross-margining between various asset classes.
Earlier, the government announced various tax concessions—transaction taxes and stamp duty won’t be levied in IFSCs, besides which firms operating in them will enjoy a tax holiday.
The moot question is if trading firms will take the bait. More importantly, even if they do, will they just set up servers in GIFT City to establish a presence, or will they set up shop with a full-fledged team? The success of GIFT City, in a true sense, depends on whether top financial market professionals are willing to relocate. As things stand, that still looks like a pipe dream.
Garnering trading volumes, on the other hand, may not be that much of a hurdle. Indian trading firms can potentially fund an IFSC subsidiary to the extent of 400% of their net worth through the overseas direct investment (ODI) route. Of course, unlike IFSCs such as Dubai and Singapore, the paperwork and the number of approvals required is far greater with Indian IFSCs such as GIFT City. But firms may be willing to overlook this, given the chance to be associated with one of the prime minister’s pet projects.
Given the low transaction costs and tax breaks, garnering initial volumes through market-making arrangements should also not be a problem for IFSC exchanges such as the BSE International Exchange. It’s still not clear, however, if trading firms that establish an IFSC presence can use it to trade in overseas markets. Such links would be important for market makers to be able to hedge positions taken in IFSC exchanges. Besides, this will also open up opportunities for arbitrageurs and help build initial liquidity. Likewise, overseas firms that already trade in Indian assets can be natural participants in IFSC exchanges.
But as pointed earlier, all of this can be done without putting in place a full-fledged team in GIFT City. All firms need is servers based in the designated IFSC, and operations can easily be handled remotely. “Expecting top traders and other financial market professionals to set up base in GIFT City is far-fetched, to say the least,” says one hedge fund manager with trades in overseas markets. A senior exchange official says that the government may insist on physical presence, beyond just servers; although, this may work at cross purposes. It may well turn away many firms.
What about the government’s intent of stopping the export of India’s financial markets to centres such as Dubai and Singapore? Does it matter whether market participants move lock, stock and barrel to GIFT City, or is it more important that trading volumes pick up in these Indian centres?
While there is no arguing that exchanges set up in Indian IFSCs can help arrest the export of India’s financial markets, it remains to be seen to what extent they cannibalize India’s own existing markets. If Dubai and Singapore continue to attract volumes on products such as the dollar-rupee and the Nifty because of a stable taxation regime and a better experience with respect to ease of doing business, the IFSC experiment in India would not only end up being a futile one, but rather a dangerous one.
As pointed out earlier in this column, the policy stance must be to correct anomalies in India’s main market, which cause the export of our markets in the first place. The hedge fund manager says one niggling thought among traders is the sanctity of the taxation policy for Indian IFSCs, given the government’s misadventures with retrospective changes to tax policy. Besides, he adds, while the IFSC policy permits various things on paper, it remains to be seen how things work out on the ground.
As such, firms can’t be expected to rush out of other IFSCs in a hurry. In any case, they enjoy similar tax breaks and low transaction costs in other jurisdictions and it looks unlikely that they will shift volumes only because the Indian IFSC is closer to the onshore market for these products.
The move can, in fact, backfire if Indian trading firms gradually shift volumes to IFSCs to take advantage of tax breaks and lower transaction costs. It’s fairly evident that trading volumes veer towards products that have the lowest transaction costs. Among equity derivatives, for instance, options trading accounts for the bulk of trading largely because of lower transaction costs. If this happens, it will also result in revenue leakage for the government.
Besides, decent volumes in IFSCs can well result in policy inaction as far as India’s main markets go. For instance, according to news reports, BSE International Exchange intends to trade dollar-settled single stock futures. Overseas investors may find this to be a far easier means to take an India position, especially when compared with the rigmarole of going through the foreign portfolio investor (FPI) registration process in the main onshore market. In one sense, the business from this overseas investor is retained onshore, and may reduce the urgency for policy action so far as FPI registration norms go.
All told, with the IFSC opportunity drawing nearer, policymakers should remember not to get carried away merely with traded volumes. To say that GIFT City has been truly successful, it should either see a large influx of professionals or, at least, result in a meaningful drop in the share of Dubai and Singapore in dollar-rupee and Nifty contracts.