'Profit capping ideas for stock exchanges infirm, short-sighted'

The National Stock Exchange (NSE) has rapped proposals to cap profits of the exchanges.

Its chairman, Vijay Kelkar, has said such profit capping would have many adverse implications and destroys incentives for an exchange.

Here recently for the R Venkataraman Endowment Lecture 2011, he said at times it is argued that NSE's profitability is excessively high. This isn’t true, as it belongs to an industry characterised by relatively large fixed costs and very low — close to zero — marginal costs, he said.

Both these resulted from the use of technologies that involve high capital costs. This makes gross margin an inappropriate indicator of profitability for the purpose of comparison with other enterprises. A more appropriate indicator of profitability is the return, he argued.

“When compared globally on the basis of return on net worth, NSE is well bracketed – nowhere close to the extremes and, domestically, there are many firms that typically have return on net worth higher than NSE's (25 per cent)”.

He noted 2010 data show that of the top 100 profit-making firms in India, as many as 37 made a higher return on net worth. These were from capital and technology-intensive industries such as automobiles, information technology and pharmaceuticals. The profit performance of other major Indian stock exchanges is also not too different. In other words, there is no evidence of excessive profits made by our exchanges.

“Hence, any proposal to cap profits of exchanges may not be entirely justified. Further, profit capping has many adverse implications. It destroys incentives for an exchange to reduce costs and productivity optimisation. This I have seen happening with industries that were governed by an administered price regime and exchanges will be no exception,” said Kelkar.

On market dominance, he said while most emerging markets had only one monopoly exchange. India had competing exchanged for decades. Further, as liquidity begets liquidity in the sector, it is natural to expect that the more efficient exchange in any given asset class would attract the bulk of the liquidity, making it emerge a strong player in the asset class.

Thus, while NSE is strong in the equity derivatives market, MCX is a significant player in the energy and metal space, NCDEX in the agricultural space and so on.

He further said in the case of Indian securities, the market here was not the only one where the underlying propduct was traded.

These are also traded abroad on other exchanges. In other words, Indian exchanges, despite their strong local presence, face global competition in the case of many securities. This feature is not widely recgonised, said Kelkar.