Finally, competition in equity derivatives

Finally, competition in equity derivatives

This is unlike the situation in the exchange’s mainstay equity derivatives business, where it now enjoys a market share of nearly 100%. In the past few months, BSE’s volumes have fallen to nearly zero. In June, just one Sensex futures contract was traded, compared with 39 in May, 113 in April and 294 in March. In March 2008, 790,000 index futures contracts had changed hands on BSE. Even though the year-ago numbers look high, they pale in comparison with NSE’s index futures volumes of 156.9 million contracts during the same period.

Also read Mobis Philipose’s earlier columns

Statistically, NSE has moved a few percentage points ahead in the past year in terms of market share, but there was never any doubt that the equity derivatives market has always been a monopoly. To tackle this, BSE recently inducted a new CEO, Madhu Kannan, who in turn announced the induction of three market professionals with wide experience. James E. Shapiro, who will be head of market development, has spent 16 years at New York Stock Exchange, or NYSE. Sayee Srinivasan, who has been hired as head of product strategy, has spent at least 10 years in product development across asset classes, most of this at the world’s largest exchange, Chicago Mercantile Exchange.

Will the induction of a new CEO and an experienced set of professionals at BSE change the monopoly situation in the equity derivatives space? Well, many sensible people, including the exchange’s board of directors and those who have joined the exchange, seem to think so. But at the same time, there are detractors as well. The equity derivatives market is now well established, with daily volumes of at least Rs50,000 crore and to pull liquidity out to another platform would be quite a challenge. According to an expert, the switching cost is way too high for market participants to consider trading on a new platform.

Of course, it’s not impossible. Bats Exchange, a relatively new entrant in the US exchange space, has quickly moved to the No. 3 position among US equity exchanges by attracting users of established exchanges. One simple strategy that could work is to get large brokers to act as market makers and provide two-way quotes. If some market participants find these quotes useful and hit them, this would result in a gradual build-up in liquidity. In order to build initial liquidity, Bats paid Nasdaq and NYSE traders to redirect orders of securities listed on the two exchanges. Of course, it also helped that US Securities and Exchange Commission rules made it easier for marketplaces to compete for trade since 2006, and Joe Ratterman, CEO of Bats Exchange, has been quoted by Bloomberg as saying that traders want to foster that rivalry by distributing their business to multiple venues.

In India, too, traders would love to see the monopoly status of NSE broken, but given the large importance of liquidity, they would understandably go slow on shifting orders. For the majority, this would happen only when they see reasonable bid-ask spreads on a rival venue, and the experience of having their trades executed at a comparable price.

Talking of rival venues, MCX-SX is likely to pose a greater threat thanks to its monopoly situation in front-end trading technology. It is estimated to have a market share of at least 80% in the front-end technology space, and if it can seamlessly integrate its front-end offering with the exchange operations (that is when it gets approval from the Securities and Exchange Board of India), its offering could be rather lucrative for traders. In the midst of all this, the Delhi Stock Exchange has announced its plans to relaunch operations and lure north-based member brokers. All put together, NSE will soon be fighting battles on various fronts.

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