Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Exchange investors in India hit by regulatory risk

Investors in Indian exchanges have been hit by significant regulatory risks this year

Investors in Indian exchanges have been hit by significant regulatory risks this year. Shares of the country’s only listed exchange, Multi Commodity Exchange of India Ltd (MCX), have halved in the year till date. Not that investors hadn’t been warned—the company’s initial public offering (IPO) prospectus had mentioned regulatory risks in at least three different places among its risk factors.

One of them pertained to changes in taxation policy. Earlier this year, the finance minister announced that trading in non-agricultural commodities will attract a commodity transaction tax (CTT). Most of MCX’s commodity volumes come from this segment, and the new tax, effective 1 July, has resulted in a drop of about 43% in its average daily turnover. Unless the exchange hikes transaction charges and/or reduces costs, and if all other factors remaining the same, profits could more than halve. Transaction charges account for about 80% of the exchange’s total revenue. Just a week after CTT was implemented, the central bank and the Securities and Exchange Board of India (Sebi) imposed major restrictions on the currency derivatives market to protect the rupee. Turnover of the segment has more than halved on the MCX Stock Exchange and has fallen by an even greater degree on the National Stock Exchange. MCX holds a 38% economic interest in MCX-SX—it is required to sell a 33% stake held in the form of warrants in roughly another two years’ time to comply with Sebi’s regulations. The huge hit on the exchange’s mainstay currency derivatives business will hardly help in the attempt to find investors. While MCX-SX has launched equity cash and derivatives trading earlier this year, those segments are likely to take some time before contributing meaningfully to revenue and profit. Currently, the exchange is paying incentives to trading members to build liquidity.

Investors’ aversion to the exchange business is also reflected in shares of Financial Technologies (India) Ltd, which owns stakes in MCX, MCX-SX and a number of other exchanges. Its shares have fallen by 48% this year, and by about a fifth in the past week. Apart from the impact on the commodity derivatives business and the currency derivatives business, Financial Technologies investors have also had to worry about a sanction from the department of consumer affairs on its commodity spot exchange, National Spot Exchange Ltd (NSEL). The exchange has been asked not to launch new contracts until there is a new regulatory framework for the segment.

The exchange’s turnover has fallen from well over 1,000 crore until last month, to between 400 crore and 500 crore last week. In the 2011-12 financial year, NSEL was Financial Technologies’ most profitable subsidiary with a net profit of 25.6 crore and accounted for almost 10% of the company’s consolidated net profit.

In the midst of all this, the government has enabled foreign investment in commodity exchanges and stock exchanges under the automatic route. In the above backdrop, it’s quite likely that existing foreign investors will look to exit their investments. Also, while none of BSE Ltd’s business segments have been impacted by the above measures, all this can affect sentiment for its proposed IPO.

As pointed out above, National Stock Exchange has been the worst hit because of the measures in the currency derivatives segment, since it was leading both with respect to turnover and open interest. The equity segment has been spared this year, and has even gained to some extent with the securities transaction tax (STT) being lowered marginally in this year’s budget. But this segment has taken hits in previous years, when STT was first introduced and when state governments implemented/increased stamp duty on stock market trading. All told, investors in Indian exchanges should be prepared for regulatory risks. The saving grace, however, is that with the exception of the currency derivatives market, where the impact has been extreme, traders have adjusted to most other situations. For instance, while volumes have dropped sharply after the introduction of CTT, turnover is still at fairly healthily levels.

According to the promoter of a leading brokerage, commodity traders and arbitrageurs have gotten used to the higher trading costs and have adjusted to lower return expectations. The sharp drop in the share prices of listed exchange plays shows that investors have made similar adjustments as well.

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