Home / Companies / Will United Stock Exchange merge with MCX-SX?

Mumbai: United Stock Exchange (USE), the money-losing new stock exchange, could be trying to find a way out by merging with another exchange, with one potential candidate being MCX Stock Exchange Ltd (MCX-SX), with which it has started preliminary talks, according to two people familiar with the development, who asked not to be named.

Both exchanges denied they were in talks.

Arindam Saha, director of business development at USE, said the exchange is not aware of any such development and has not received any such communication from the other exchange. “At this point, we do not want to comment on market rumours, if any."

An MCX-SX spokesperson said, “There is no informal discussion or development regarding merger of businesses between USE and our stock exchange. Hence the possibility of formal discussion on the merger and other related formalities does not arise."

To be sure, a merger would make sense, not just for USE, but also for MCX-SX, promoted by Financial Technologies (India) Ltd (FTIL). MCX-SX has so far failed to gain enough volume in equity trading and the currency derivatives trading volume too has fallen steeply. The monthly average turnover in currency derivatives has plunged 72% since April to 4,284.46 crore in December after the Reserve Bank of India in July prohibited banks from proprietary trading in currency derivatives with an aim to arrest the rupee decline. India’s capital markets regulator Securities and Exchange Board of India (Sebi) will begin hearing FTIL’s case on why it should not be restrained from holding stake in any stock exchange or clearing corporation on 13 January. This follows in the wake of a crisis at the FTIL-promoted commodity exchange National Spot Exchange Ltd.

Both USE and MCX-SX face similar challenges, added the two people cited above: an uncertain future on market-making and liquidity, low trading volumes, reducing shareholders’ fund value, and a race against time to comply with the net worth norms stipulated by the markets regulator.

Sebi stipulates that the net worth of an exchange should be at least 100 crore at any time.

Since its inception in 2010, USE has struggled to build volumes in the only segment in which it operates, currency derivatives, and extend its product range to equity, equity derivatives and other exchange-traded products to become a full-fledged stock exchange. Its turnover is low and it has been posting losses. The average daily volume in currency derivatives has fallen 7% since April to 873.85 crore in December in 2013.

“The exchange wants to enter trading in equity and debt securities, for which it needs additional money, which the shareholders are not keen to provide at the moment," said one of the two persons mentioned above.

MCX-SX managed to secure a licence to trade in equities and all other exchange-traded products after a long legal tussle with Sebi. However, its inability to build trading volumes and the happenings at NSEL have made investors uneasy. Market conditions do not appear to be conducive for a share sale. As a result, the exchange may find it difficult to raise more capital.

Both USE and MCX-SX have capital at the moment but their losses are eroding their net worth.

MCX-SX exchange has a new board in place, an effort aimed at sequestering it from the happenings at NSEL, but it will take some time to rebuild investors’ confidence, and a merger will help that cause, according to the former head of Asia’s oldest stock exchange BSE.

“Shareholders’ faith in the merged entity would increase as they will find it to be more sustainable. Most of the investors in these exchanges have institutional base. These investors would feel more comfortable dealing with strong merged entity, said Rajnikant Patel.

After the board overhaul at MCX-SX, USE’s chief operating officer and managing director Saurabh Sarkar has been chosen as MCX-SX’s new managing director and CEO. Sarkar had headed USE operations for about 18 months.

Products, volumes and liquidity

A merger, if it happens, may result in an increase in trading volumes in the currency derivatives market. In equity trading, USE is absent and MCX-SX has very small volumes. The emphasis isn’t necessarily on equity, said the first person. He pointed out that the range of products traded on exchanges has grown.

The combined entity may not see an immediate spurt in volumes but it will have extra cash to use for market-making and liquidity enhancement schemes, expand its product range, or invest in inorganic growth, without worrying about depletion in net worth. The merged entity, with the present balance sheet, will have cash and bank balances of about 350 crore which will allow it to experiment with new products and schemes to compete with older rivals National Stock Exchange and BSE.

In August, USE’s advisory committee recommended the exchange to consider inorganic growth to strengthen its net worth, statutory funds, liquidity and reach. USE’s board agreed to the proposal and authorized the management to explore feasibility of mergers with regional stock exchanges and to present a detailed proposal for its consideration.

Net worth

According to the latest balance sheets of the two exchanges filed at the end of September, MCX-SX had a net worth of 185.83 crore and USE, 118.7 crore.

With increasing expenditure quarter-on-quarter, it could be difficult for MCX-SX to keep its net worth at this level. MCX-SX’s expenditures have shot up from 32.31 crore in the September quarter of 2012 to 88 crore at the end of September 2013, primarily due to high advertisement and promotion expenses, operating expenses, and unspecified other expenses. The exchange spent 41.37 crore on technology.

Its half-yearly losses jumped to 89 crore in the September 2013 quarter from 10 crore in September 2012.

The exchange, in its 2012-13 annual report, mentioned that according to regulations, it has to increase the net worth of its subsidiary, MCX-SX Clearing Corp. Ltd, to 300 crore and admitted that raising the requisite funds would be challenging.

USE too has seen its losses mounting. Its loss for the half year ended September 2013 widened to about 9 crore from 3 crore in the previous year.

Though the exchange has been able to control some costs, its limited product range and low liquidity in existing trades will make it difficult for USE to keep its net worth at required levels—unless the promoters pump in more money or the volume of trades sees a dramatic rise.

Patel added that though losses have eroded the capital base of the two exchanges, a merger will make it easy for the resulting entity to meet the minimum net worth requirement laid down by Sebi.

Both the exchanges have a wide shareholder base, mostly banks. MCX-SX has 22 major shareholders, of which 17 are banks. Similarly, 15 of USE’s 26 major shareholders (those with at least 1% stake) are banks. At least 11 of these banks are shareholders in both exchanges.

Jaypee Capital Services Ltd’s managing director Gaurav Arora founded USE, originally with a no-compete pact with BSE on product offerings. Jaypee later reduced its holding to 2.91% and the no-compete agreement is likely to end soon, which will make USE and BSE independent of each other and legally allow USE to enter trading in equities and debt products such as corporate bonds.

BSE continues to hold 15% in USE and has a seat on the board, but recent developments have made USE a competitor of BSE.

If a merger does happen, it will likely be through a share-swap, making the deal tricky. FTIL and MCX, the two promoters of MCX-SX, have to lower their shareholding in the exchange as directed by Sebi.

Initially, the two promoters were ordered to bring down their combined holding to 5% in the bourse, as stipulated by Sebi’s norms. The effective combined holding of FTIL and MCX in the exchange is about 71%.

A merger will also remove the cloud over MCX-SX, said the CEO of a brokerage and finance company.

“A merger will definitely boost investor confidence as it will bring in a new management and board members. It is also necessary for somebody who is distinguished, and has impeccable integrity to be selected as the chairman," said Nirmal Jain, chairman of India Infoline Ltd. Jain is one of those affected by the settlement crisis at NSEL.

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