The third stock exchange

Expand market reach via better surveillance and innovation

The big smile on the faces of MCX-SX brass all through Saturday late afternoon was understandable, as the inauguration of India’s third national stock exchange took place after a very long and hard battle. They made all the right noises — that they were in no hurry to garner market share by undercutting competitors, but would focus on expanding market reach, quality investor services and innovative products to drive liquidity. These are precisely the things that are required to counter the argument that India didn’t exactly need another stock exchange, as market fragmentation results in loss of liquidity for all exchanges and a new stock exchange per se does not necessarily create new sets of investors and issuers of capital.

However, the arguments in favour of a third exchange are compelling. After all, the stock exchange business, for all its jargon-riddled, acronym-happy complexity, has one primary objective: trading should not be concentrated only in a few hands and should reach the millions of people in India’s hinterlands. In that context, despite their pioneering work, India’s two national stock exchanges have been found wanting. According to a survey by the National Council of Applied Economic Research, just 1.3 per cent of India’s 1.24 billion population participates in equity trading, compared with 9.4 per cent in China, 18 per cent in the UK and 41 per cent in Australia. The reason for this is obvious: trading has been concentrated mainly in the top five cities that account for 85 per cent of the total turnover of the cash segment on the National Stock Exchange, or NSE. The top 100 scrips have contributed to 76 per cent of the turnover in NSE’s cash segment and 61 per cent in the Bombay Stock Exchange’s cash segment in the current financial year so far. And 90 per cent of volumes in the equity cash market are proprietary in nature and done by only 573 proprietary traders, indicating concentration of trading in only a few hands. Besides, genuine competition is missing since NSE controls more than 85 per cent of the nation’s equity derivatives market and handles 75 per cent of the stock trades.

MCX-SX would justify its existence only if it can remove some of these anomalies through prudent market practices and raising the bar on surveillance. Also, the cash market, where genuine investors buy or sell shares in companies for their long-term prospects, accounts for just five per cent of traded volumes. MCX-SX has already talked about its focus on a robust cash market and it is to be hoped that the new exchange will walk the talk on this, instead of trying to build volumes by launching newer derivative contracts with hefty incentives. The birth of a new stock exchange after 19 years will be truly worth its while if it can prompt the entire exchange space in India to improve investor confidence through introduction of innovative products, reduction of transaction costs, and superior services.