Regulatory arbitrage is not good for any financial sector: Ravi Narain

Interview with Non-Executive Vice-Chairman, NSE

Ravi Narain, 58, retired as the managing director of the National Stock Exchange from April 1 and has taken on the new role of non-executive vice-chairman. In an interview with Shyamal Majumdar and Nishanth Vasudevan, Narain speaks about life after NSE and the road ahead for the stock exchange. Excerpts:

You talked about derivatives as an inflection point in your career. But, after the introduction of derivatives, there has been no major product innovation or launch. Is it because regulations are too restrictive?
If you think very carefully, derivative is a very large universe and not a product as such. Derivative is a field and if you look at it from that sense, product innovations have happened. It started with single stock futures, then we brought in index products and then there were options. Then, we moved across asset classes to currency derivatives. So, the product evolution has been reasonable every few years. Is that enough? That's a separate question altogether. In the case of India Vix (volatility index), it can be said that the product exists. We disseminate real-time continuous information for Vix. But, if you ask me where the tradable product is, it has not been launched yet.

The minute Sebi gives us approval, we will launch it. So, there is a product cycle in every market when the idea is conceived, tested and then its taken to the regulator, which cannot approve a product without understanding the consequences of that especially if it can lead to systemic risks. So, this product cycle issue has to be respected.

Is the shift in Nifty futures activity from India to Singapore a big worry for you?
Yes, of course, it does. In the financial sector, nothing is worse than regulatory arbitrage. It can be regulatory arbitrage across geographies as you have mentioned or across products, as we have seen between insurance and mutual fund products or across asset classes. Any form of regulatory arbitrage is not good for any financial sector, particularly ours. We need to be very watchful about regulatory arbitrage, anticipate it and take timely action.

Is the recent move to cut STT on equity futures good enough to bring back volumes from Singapore?
Well, its never any one thing. One tries to do all actions in a comprehensive way which will ultimately matter. The transaction tax is just one component of that. But, if you look at what the government and Sebi have been doing, there have been a number of steps, including reviewing all the plumbing bottlenecks one after the other, so that the ease to access the market is as good as any other market in the world.

But, isn't the cost structure for Indian markets still a concern?

Yes, it is high and all of these pieces that we are discussing is the way to lower it. Steadily, as we keep cleaning up, the cost of business will get lowered. The key is to have one eye firmly positioned on this at all times and one of the key announcements in the Finance Minister's budget which got relatively less attention was the standing council to look at the comparative position of India's markets. Its an important announcement and it shows the finance minister is clearly focused on the importance of this subject.

You recently mentioned about the importance of tie-ups with foreign exchanges for growth. Could you throw some light on this?

From very early days, I have not been bullish on these M&A type of activities in exchanges globally. I always felt that culturally to bring two exchanges closer is not a modest exercise. And the minute we move away from the developed world to emerging markets, the cultural and DNA issue becomes even more complicated because here the market definitely has elements of flying the flag, bit like the airline analogy. So, it is a lot more complex to carry out an M&A activity. I used to think that in the context of emerging markets. It has been reinforced by the problems encountered by Singapore and Australia.

Second, wherever they become feasible and attractive is where there is a huge scope for cost cutting which can be a one-time affair. So, the sustainable strategy internationally has to be product alliance because then one party is not getting threatened by another. Today one emerging market cannot march into another and say Iam taking over you.Of course, one can do joint ventures. That to my mind is a product alliance

Have you got into any joint ventures?
We have started looking at it. Our early focus was on building our footprint within India. Now, we have enough benchmark experience that we have what It takes to build a retail market and sophisticated range of products with a technology at a fraction of the cost. So, now we think we have a very strong value proposition to expand outside India. We have open ourselves to looking at and engaging in interesting conversations.

Will joint ventures only be in emerging markets?
There is no deliberate strategy to restrict oneself to emerging markets. But, there will some natural advantage to look at that direction more so because the developed economies are not doing particularly well at the moment.

Is Africa an option for NSE?
We are very open in terms of geographies. One key difference in our approach is that we are very strong believers in partnerships. So, it's a lot about where we fell partnerships will be fruitful.

So, are you open to a minority stake as well?
Absolutely. We have no issues with getting minority or majority holdings but it should be a successful partnership to build a market. And its not the exchange, by the way. Very often, what happens outside India will be partnership to build the eco system around the exchange. Very often it is more interesting that the trading order matching system which has rapidly become a commodity globally. So, it's the clearing settlement, risk management, index business, database, ETF products for a retail market. So, there are a lot of interesting initiatives available offshore.

India was an underserved market 20 years ago and continues to remain one even today.
Absolutely, but here my view has been a little different. It's a fact that the proportion of household financial savings which end up in the equity market is 6-8 percent. Obviously, we would like this to be 50-60 percent. When a very large portion of the Indian population do not have a bank account, that is not the target universe. The key to raise this proportion to 50-60 percent is to increase retirement savings and not exhortation and marketing to individual households. If we push a household which predominantly invests in NSC or other deposits to invest in stocks, Iam afraid this could result in mis-selling. So, the key to correct this is to reform EPFO which is a burning need at the moment and on the other side is to grow the NPS, which is a very nice modern apparatus tailor-made for this purpose. So, the challenge is how a big chunk of the EPFO corpus can be shifted to NPS.

NSE has drawn a fair bit of flak on the co-location server facility issue. Critics say it favours a few.
The issue that has been looked at, not just in India but also globally is not so much of co-location HFT (high frequency trading). That is where the issue of order-to-trade ratio comes into play. By definition, HFT incorporates algorithms and of course a machine will be able to do much more than a human can. More interestingly, what is a strong economic case for a high order-to-trade ratio. If you look at the options market, unlike the cash equities and futures market, the options market has a number of strike prices. Now, you can argue that you are happy with liquidity being concentrated in a few areas, but if you want the entire market to be liquid, people should be able to put in orders and change them frequently. When algos and HFT deploy that, they bring enormous liquidity into the market. And absence of liquidity would sound the death knell to that market. Even the Bank of England has put out actual studies and work which says that visible quantifiable benefits have emerged from HFTs and algorithmic trading. There are risks to HFT like with any machine. The key is can we build enough checks and balances into HFT so they don't result in systemic risks. It is a continuous process. We can never turn back the march of technology.

NSE has not been the preferred designated exchange for offer for sales (OFS). What are the reasons?
I don't have a decisive statement to make on this. But, if you look at the statistics of the business activity in the OFS space, we are still the preferred exchange. If your focus is on designating a particular exchange, that can be a function of many things. Where is the business happening is what you must be focusing on. What Iam saying is it is fine for a designated exchange to be x, but if the business is happening at y, that's a fairly telling story.

When will the much-awaited NSE listing happen?
We are still very much in the midst of complying with the Sebi framework for listing. As and when that is complete, the board will apply its mind into the issue of listing. The board has not even applied its mind to the listing issue. So, it is still a bit premature.