Chekov’s The Cherry Orchard and some of our stock exchanges have much in common. In The Cherry Orchard, the property of Madame Ranevsky, an aristocratic Russian lady, is about to be auctioned to pay the mortgage dues. Lopakhin, a former serf, who has agreed to buy the property, suggests various options to save the estate, but the options include the proposal to raze the cherry orchard which is a part of the estate. Madame Ranevsky and her family are so fond of and deeply attached to the cherry orchard that they cannot bear to see it being razed. She cries out in desperation “Don’t you see? I was born here, my father and mother lived here, and my grandfather; I loved this house; without the cherry orchard my life has no meaning for me, and if it must be sold, then for heaven’s sake, sell me too!” In the end, she could not save the property, because of the fondness for the cherry orchard. Surprisingly, however, when the inevitable happened, the various members of the family readjusted themselves well and began to lead their own lives.
A close examination of the micro structure of our equity market suggests that some of our stock exchanges have become cherry orchards, or are on the verge of becoming one; we are seeing this happen but, like Madame Ranevsky, are reluctant to take timely and corrective steps, which may even include “razing the cherry orchard” — winding up the stock exchanges or merging them.
Let us investigate the issue a little more deeply. A congenital rather than acquired, idiosyncratic feature of the micro structure of our stock market is that the same security is permitted to be simultaneously listed and traded in more than one stock exchange. Our stock market also has the unique distinction of having the maximum number of stock exchanges in the world, registered with the market regulator — 22 to be precise. Of these, trading used to take place in four stock exchanges, the Bombay Stock Exchange (BSE), the National Stock Exchange (NSE), the Calcutta Stock Exchange (CSE) and the Uttar Pradesh Stock Exchange (UPSE). But from 2005-06, trading in the CSE and the UPSE trickled to driblets, while the share of cash market trading volume of the BSE began to decline rapidly. There has been no trading in the remaining stock exchanges for the past five years. All the stock exchanges have been demutualised. Demutualisation offers a possibility of winding up and the proceeds of the winding up could be large because of the prime property these stock exchanges stand on. But winding up is unlikely to happen, because none of the stock exchanges would be agreeable to pay taxes on the proceeds of the winding up, and neither will the government agree to let go a few hundred crore of taxes.
Trading volumes in active stock exchanges in India (Rs crore)
The precise economic rationale for the legal existence of a stock exchange which has no trading in securities is not strikingly apparent. These exchanges, of course, serve a social cause. They provide employment in a small measure and livelihood to a number of brokers who can trade as sub-brokers through these exchanges as these have acquired memberships of the BSE and the NSE. This was a very innovative and a “politically correct” mechanism which was allowed several years ago when the business of the stock exchanges showed signs of dwindling rapidly. But the mechanism was intended only to be a lifeline for the members of the regional stock exchanges. A lifeline is only a one-time measure; it could not have been the long-term solution for survival.
There was a time when multiple regional stock exchanges and multiple listing made economic sense, especially in the days prior to mobile telephony and Tim Berner Lee’s World Wide Web. The government policy of wide dispersal of industrialisation and spreading the equity cult required this, so that investors could easily access a stock exchange. But the NSE was a disruptive innovation in India. It became a game-changer and redefined stock markets. The BSE realised the benefits of automation very late and strongly resisted the change, like Madame Ranevsky. It had to be persuaded and forced to change. That was when the BSE began to lose its leadership.
In stock markets, liquidity and depth are important. This means that there should be a large number of buyers and sellers to trade and a large number of stocks to buy and sell. If the products available on one stock exchange do not have different features and benefits from that offered by competition, it will not attract a large number of buyers and sellers. Varying account settlement periods, which existed across stock exchanges for a long time, and the availability of badla in some of the major stock exchanges provided the much-needed product differentiation. So, multiple stock exchanges worked even in an electronic trading environment. But with the introduction of rolling settlement in 2001, and with the derivatives replacing the age-old badla, the differentiation was lost and so was the economic relevance of multiple stock exchanges. There was no differentiation between products or services across stock exchanges, and only the stock exchange which could offer a more efficient and large market was destined to survive. It was inevitable that the weak exchanges would become weaker. Besides, by trading in the same stocks, these exchanges fragmented the cash market, let alone gain leadership positions. Fragmentation makes markets less efficient.
It is not the case that dual listing or multiple listing or multiple stock exchanges do not exist in other countries. But where these exist, and have been successful, the markets are characteristically different — they enabled product differentiation. This has been true in the case of Nasdaq for example, which launched a successful dual-listing programme in 2004 to offer companies an opportunity to experience Nasdaq’s market performance first-hand without disruption.
It is often said that monopoly in financial services is not desirable. There cannot be any two opinions about this. But, competition must be among equals. David was able to slew Goliath with a sling; but then one needs to be a David first and David was no ordinary kid. Competition is also a matter of business strategy, one which can help forget the past and fold in the future. It is business strategy which can provide leadership. Business strategy does not lie in the weaker player taking a unilateral action when a responsible, concerted decision is called for. Such actions would only provoke the stronger player to join competition.
If one efficient stock exchange is beneficial for our market, and if it provides more depth and liquidity, then we should work towards this goal. This will not be easily achieved. Financial markets always develop entrenched interests, which will appear like Banquo’s ghost (Macbeth). There will be apprehensions associated with a monopoly. But these can be easily addressed by regulatory fiat and stricter governance and monitoring norms. However, we need not close the door to future of competition.
All figures are from the November issue of the Sebi Bulletin. The author is a former executive director of Sebi and is currently associated with the Global Corporate Governance Forum of the International Finance Corporation and the World Bank.
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