The Technology Lifeline
The main worry of the regional exchanges was that business from their centres would shift to the NSE. At that time, however, barring NSE and BSE, no SE
had automated its trading process. The perceived threat from NSE has since led to
rapid-fire announcements, decisions and actions. The most prominent among them has been the demand (now approved) of the BSE to expand its on-line trading (BOLT) system outside Mumbai.
Most of these fears about the threat of NSE and the BSE have been unfounded. The reality is that those stock exchanges that worked on automating their trading process and thereafter went on-line, have found a sea-change in their members interest. Consequently, instead of declining, the volumes on these SEs have gone up substantially. And, those providing additional information-services using latest available technological tools and services have been more successful in retaining their competitive edge, even over the NSE.
The magic of IT
A case in point of how information technology (IT) helped rejuvenate a service provider in a competitive arena, is the Bangalore Stock Exchange (BgSE). Trading on the BgSE went on-line on July 29 this year. The bar graph given alongside brings out how the average daily turnover shot up from Rs 6.64 crore in April to Rs 20.70 crore in October as a result of screen-based trading. Having decided to introduce automated trading way back in January 1995, BgSEs screen-based trading project, given to Tata Consultancy Services, gathered momentum only after November 1995.
But, it is not just the provision of on-line trading that matters. The efficiency of the settlement system and the arbitration mechanism are the other two main critical factors. Then, brokers and investors are particularly interested in the availability of real-time information of order prices of mainline SEs as well. All this goes a long way in improving liquidity.
Says Ajay Shah, assistant professor, Indira Gandhi Institute of Development Research, The stock market is a manufacturer of a commodity which is called liquidity. I would view exchanges as competitive firms producing a number of closely-related services such as liquidity, post-trade handling and dispute resolution which attract investors and lead to the valuation of traded instruments.
Adds Ramachandra, executive director, BgSE, After availing the on-line trading and efficient settlements, the local broker can increase his competitive edge through better services like making NSE and BSE prices available to his clients along with the help of stock market information providers like Knight-Ridder. And, if the local broker also has a NSE membership he can develop a software for integrating both the terminals and thereby provide a single-shop window to his institutional or retail clientele.
The BgSE gives an option to its member-brokers to integrate Knight-Ridders market software with their BEST (BgSE Electronic Securities Trading) terminals. This gives brokers access to real-time prices of the NSE and BSE on their screens itself. Moreover, the technical analysis tool available in Knight-Ridder package has brought about an awareness among the BgSE brokers.
A similar situation is developing on a still smaller regional SE, the Mangalore Stock Exchange (MgSE). It went live on September 9 and trading volumes immediately jumped. From a level of just Rs 10 lakh the average daily turnover on the MgSE is currently hovering at Rs 1.50 crore (touching Rs 1.81 crore on October 24). This translates into a massive fifteen-fold increase in volumes.
Again, since MgSE has tied up with DART-Dow Jones to provide real-time prices of NSE and BSE, its brokers have, no doubt, taken to it in no time. Says Gopal Chhetri, manager (operations), MgSE, We have definitely seen an increased trading interest by our members. The member looks at the real-time NSE or BSE price, but prefers to execute trades through our MOST (Mangalore Online Securities Trading) system. These add-ons are indeed motivating factors for our members to trade more actively.
The new reality
As the myth of NSE affecting volumes on other SEs continues to explode in the face of the proponents of doom, the new reality of competition is gradually dawning on the stock exchanges including the regulatory body for capital market, the Securities and Exchange Board of India (Sebi). There is no doubt in anyones mind that the stock exchanges have to work out their own strategies to make it successfully into the 21st century, says a broker.
Shah feels the regulator can help by making entry barriers low. To the extent that new markets can be easily started (even by private, profit-making companies), it enables and fosters competition, which is good for the customer and for the country. A hectic pace of entry and exit would be a very reassuring symptom that the industry is in a state of good health. Shah also pinpoints a well-suited regulatory agenda to be limited to defining bare-minimum health-safety-environment requirements and ensuring systemic integrity.
In its board meeting held on October 29, Sebi cleared BSEs application to expand its BOLT terminals nationwide. It also laid down two pre-conditions for SEs wanting to expand their networks to other cities. These are a legal guarantee of trades, and a surveillance system and arbitration mechanism that will cover the outstation terminals adequately. However, while granting in-principle approval to the BOLT expansion, Sebi admitted that it had not taken into consideration BSEs track record and current status in these areas and that it would analyse the information now.
One more expansion proposal, pending with Sebi, is that of the Delhi Stock Exchange (DSE). Says Arjun Kapur, a member and former president, DSE, We had applied to Sebi for an in-principle approval to expand our DOLT terminals. We feel we are ready to meet whatever infrastructural criteria like systems capability, capital adequacy, monitoring systems and arbitration mechanism that Sebi puts forth. The DSE also intends to allow its members set up terminals in Mumbai just like the BSE brokers intend to come to Delhi.
The BgSE also hopes to increase its presence to interior areas of Karnataka like Mysore, Hubli, Hassan, Kolar. Says Ramachandra, Our current focus is to go the areas in our state where no stock exchange
facilities exist today. BgSE members, at present, operate on a Local Area Network in one premise and very soon, will also be able to trade in a Wide Area Network. For expansion to other areas in the state, according to Ramachandra, the exchange is contemplating using either ICNET or VSAT technology and the cost-benefit analysis is on.
Given this scenario where the regional SEs are beefing themselves up to sustain the profitability of their members, what are the plans of the NSE that prompted all the action in the first place? With over 975 NEAT terminals already spread across 45 cities,
R H Patil, managing director, NSE says: We have got the DoT approval for an additional 9 Mhz of band-width on the satellite, whereby we can install 1,000 more terminals and increase our presence to over 80 cities by the middle of 1997. Looking at NSEs stupendous reach across the country, the other SEs, would no doubt be on their toes.
Importance of arbitrage
There is a fear that with SEs spreading to each others domain, the entire market will get fragmented. It is also feared that the price discovery will get distorted. IGIDRs Shah is keen to assuage such fears. In my opinion, if you are a small exchange trying to compete with a big exchange, then arbitrage is a critical ingredient of your strategy. Shah explains that a small exchange, by definition, lacks the market depth to offer investors good prices, as a result of which they divert their orders to big exchanges.
The opposing force to this, according to Shah, is arbitrage. Through arbitrage, prices on the small exchanges will tend to become equal to prices on the big ones. This will generate a good price to an order, no matter where it is placed. Arbitrage generates price priority for all orders, regardless of where they are placed. Hence, arbitrage is a great weapon for a small exchange to come up to the quality of execution of a big exchange. Large brokerage firms can particularly take advantage of multiple memberships and utilise arbitraging skills to rake in revenue in these times of dwindling clientele business for the brokers.
Finally, the country is witnessing a rapid development of the stock market with most SEs gearing up to face the challenges. The time is not far when a broker having multiple membership, will have five or six different SEs trading terminals, or even further all these integrated in one terminal across different windows, and all this in a single office. Of course, there is no need to shed tears if the inefficient SEs die a natural death. After all, that is the dictum of the market.