Don't fix it

When the National Stock Exchange and Bombay Stock Exchange became nationwide exchanges, the exchange business was changed forever. Suddenly, an exchange no longer had a little monopoly by being the only game in town. Trading volume in regional stock exchanges (RSEs) dropped from Rs 543,800 crore in 2000-01 to nothing in 2005-06. Sharp changes in market share are the hallmark of a competitive market economy. The rapid demise of RSEs is particularly noteworthy, given the involvement of local politicians in various exchanges, who made all manner of attempts at manipulating policies to help RSEs. The most important policy milestone was in 2003, with the removal of the "regional listing" requirement by Sebi and the ministry of finance, which used to force companies to feed listing revenues to defunct RSEs.

RSEs that had management depth re-invented themselves as brokerage firms. They took NSE and BSE memberships and quietly abandoned the idea of being an exchange. This worked well for all parties. The genuine trading talent, physical infrastructure and human networks of local exchange members feed the ocean of liquidity of the NSE and BSE. Members are happy because they have a livelihood and have not wasted resources. The NSE and BSE are happy because they have orders. Sebi is happy because the headaches of regulating RSEs are absent. Customers of these members are happy because their orders are executed on superior platforms (NSE/BSE) where liquidity and regulation are both better.

This pleasant situation could be undone by the recent Sebi report on RSEs. This endorses the "BSE Proposal" where an RSE would subsume itself into the BSE, and members would trade spot and derivatives on the BSE. The Sebi report then takes a big leap, away from the issue of RSEs, to the issue of competition between the NSE and BSE. Sebi feels that because the BSE is smaller than the NSE, it needs to be supported. Hence, it is proposed that as part of this deal, RSE-brokerage firms would be prohibited from trading on NSE. This could shift perhaps 10 per cent of business away from the NSE to the BSE ""a huge change in a competitive marketplace.

In the late 1990s, Sebi repeatedly strayed into supporting the BSE in competing against the NSE. The resumption of this stance, in the unlikely context of a committee report on RSEs, is surprising. The core dharma of a regulator has to be competition. The regulator must not be a caring mother drawn from a socialist utopia, giving a helping hand to firms that are doing badly. The regulator must simply enforce competition. Whether MTNL is doing well or badly, the job of Trai is to foster competition in the telecom market. The Sebi committee has displayed a profound lack of understanding of regulation and competition. A Sebi order that prohibits RSE-brokerage firms from doing business on NSE would be profoundly anti-competitive. The RSEs are not a problem for the Indian securities market. The present solution, where all RSEs are effectively dead, and existing assets have been channelled into RSE-brokerage firms with memberships on NSE and BSE, is an excellent one for the Indian economy. It ain't broke, so don't fix it.