BackMark to Market | What drives volumes on BSE?
Trends in bourse’s derivatives volumes change dramatically whenever it tweaks its incentive rules
Premium(Abhijit Bhatlekar/Mint)
BSE’s equity derivatives volumes have declined by around 70% after it tweaked the rules for its market-making incentive scheme last week. The segment’s turnover has averaged ₹ 11,800 crore since the changes were made effective on September compared with a daily average of ₹ 42,750 crore in the preceding month.
This has happened mainly because the exchange tightened the obligations of its market-makers, by reducing the permissible spread for the two-way quotes they provide. On one hand, this shows that the exchange’s volumes are largely dependent on the incentives it doles out. This is evident from the large drop in volumes when the incentive structure was modified. But not all hope is lost.
According to a BSE broker who isn’t active in the exchange’s derivatives segment, the narrow spreads make a compelling trading case, even if one were to keep incentives out of the picture. He adds that in some near-month contracts, the spreads are even narrower than those on the comparable National Stock Exchange (NSE) products. Besides, trading costs even without accounting for incentives are lower compared with NSE. He admits, however, that there’s barely any non-incentive-linked volumes on the exchange currently.
Needless to say, the task is cut out for BSE. It can’t run an incentive programme, at least in the current form, for a long time. Before the exchange starts withdrawing/reducing incentives, non-incentive-linked volumes need to rise to meaningful levels. Else, when market-making activity reduces, spreads will widen to such an extent that genuine traders will find little reason to continue trading.
BSE has been running its incentive programme for nearly a year now, and while reported volumes have been impressive, most of this is from proprietary desks looking to rake in incentives. Exchange officials disagree that most of the volumes are linked to its incentives, citing that its trading members have been willing to bear securities transaction taxes, the financial cost of posting margins as well as the cost of setting up infrastructure to trade on its platform.
Be that as it may, trends in the exchange’s derivatives volumes have changed dramatically whenever it has tweaked its incentive rules. In August, the exchange stopped incentivizing trades on Sensex options and shifted focus to the BSE-100 index. Overnight, volumes shifted to BSE-100 contracts. On Tuesday, BSE-100 options accounted for 99.2% of the total options volumes on the exchange, and volumes on Sensex options amounted to merely 0.01% of turnover. Even the large drop in volumes since last week shows that existing traders are sensitive to the incentive structure. Why else would volumes fall to less than one-third when the new market-making rules became effective? With MCX-SX now gearing up for a launch with relatively low trading fees as well, BSE needs to work doubly hard to get non-incentive-linked trading on board.
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