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It's BSE vs NSE. And the winner is...
Prasad Sangameshwaran & Mobis Philipose
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September 14, 2005

"We think it will become a shopping arcade," says the chairman of a large stock broking house, only half-joking. He is referring not to the possible fate of his run-down office building, but to that of a pearl white edifice a few blocks away.

The Bombay Stock Exchange building in downtown Mumbai is hardly mall material. So is it just sour grapes now that the bourse is no longer managed by brokers?

Last month, the BSE transformed into a corporate entity, along the lines of arch-rival National Stock Exchange, where the ownership and management of the exchange are completely separated from the trading rights. It's even changed its name -- BSE Ltd.

The Sensex journey: 1000 to 8000!

The shift in the balance of power is an issue, but what's more worrying to this broker -- and several others like him -- is BSE's declining market share.

At present, not counting regional exchanges, BSE has under 12 per cent share across the cash and derivatives segments of equity markets, down from nearly 45 per cent in 2000 (source: Business Standard Research Bureau, BSRB). When BSE loses, the NSE gains.

You want proof? Compare the trading volumes of just one scrip listed on both the NSE and BSE. On September 2, 2005, 26,000 shares of Bajaj Auto [Get Quote] were traded on BSE; on NSE, volumes were 50 times higher, at 14 lakh (1.4 million) shares. "NSE's liquidity is better. BSE is beyond repair," continues the broker.

Of course, they're not all Cassandras. There are some brokers who believe it's too soon to write off BSE. Prominent among them are Anand Rathi and Deena Mehta, former presidents of BSE.

What brokers want

Why are Indian markets rising?

"BSE has inherent advantages: its history, larger scrip base and a stronger brand," says Rathi, chairman, Anand Rathi Securities. Adds Mehta, managing director, Asit C Mehta Investment Intermediates, "Corporatisation will improve internal management systems and investor relations, and benefit companies that list on BSE."

That's the big picture, but the essential question remains: why have BSE's trading volumes shifted to the NSE? It's a chicken-and-egg situation.

Brokers point to the superior bid-ask spreads on the NSE (the difference between buy and sell rates at any given point on an exchange) as the reason for higher trading volumes. And what causes better bid-ask spreads? Larger trading volumes.

Let's return to the Bajaj Auto example to illustrate this point. Towards close of trading on Friday, the difference between the best buy quote and the best sell quote for Bajaj Auto on the NSE was just 50 paise. (Buy: Rs 1,499, Sell: Rs 1,499.50). On BSE, however, the difference was as high as Rs 2.80 (Buy: Rs 1,502, Sell: Rs 1,504.80).

Given that higher bid-ask spreads entail higher costs while executing large orders and spreads on the NSE are finer, it's the obvious choice for investors. As a broker says, "Liquidity breeds liquidity."

How you can still make money in stocks

More investors also means the NSE has been more open to different avenues of investment -- derivatives, for instance. While regulations hampered BSE and restricted its operations mainly to Mumbai, the NSE spread its footprint across the country, reaching out to a wider, potentially hungry investing audience.

But blaming regulations would be the easy way out; there's no denying BSE was criminally slow in taking advantage of its enormous brand equity. The Sensex (BSE's 30-share sensitive index) is far better recognised than the NSE's 50-share index, S&P CNX Nifty.

When index futures were launched in June 2000, BSE lost out on a great opportunity to hawk it as a branded product -- of course, poor margins and inadequate support from brokers didn't help.

"The goodwill of the Sensex couldn't be exploited," points out a former NSE executive. Other BSE product launches such as weekly options haven't been particularly successful, either.

At present, BSE is almost non-existent in the derivatives space, with a market share of less than 0.1 per cent. In contrast, derivatives form more than 70 per cent of NSE's turnover.

Do's and don'ts for small investors

Even in global stock markets the derivatives segment is five times the size of the cash segment. "We will be relaunching our products to be in the derivatives space," says Rajnikant Patel, CEO, BSE.

Will that be enough?

For starters, BSE accepts the need to attract a larger base of investors (in effect, greater liquidity) into its exchange. "The key to BSE's success is in finding the right strategic partner," says Ajit Surana, MD, Dimensional Securities.

Why will a strategic partner help? Hypothetically, if a large private sector bank picks up a strategic stake in BSE, it could give the exchange access to a large distribution network and promote new products like derivatives. The strategic investor could also be a market maker (providing buy and sell quotes at any given time).

Is that likely to happen? Patel flashes a wait-and-watch smile. He says BSE is in talks with merchant bankers and management consultants to decide the future course for the bourse.

Still, a decision has to be taken soon because BSE's member brokers, who now control 100 per cent of the exchange's shareholding, have to offload 51 per cent within the next year. That can happen either by roping in a strategic partner, through an IPO or a combination of the two.

In the meantime, BSE has been trying to increase liquidity flow for its large base of small and mid cap stock (these stocks form nearly 30 per cent of BSE's offering, compared to 17 per cent in the NSE).

In January 2005, a joint effort by BSE and the Federation of Indian Stock Exchanges to create a national trading platform for small and medium enterprises, BSE Indonext, was launched.

With this, SMEs can raise capital and trade through BSE Online Trading and BSE's web trading system, WEBX. According to BSRB, this has helped increase the liquidity of small and mid capital stocks. Indonext now accounts for 11 per cent of BSE's turnover.

Revenue streams

But BSE can't afford to be content with just new products or services. World over, data dissemination is big business for stock exchanges: Patel estimates that 30 to 40 per cent of the income of exchanges like Nasdaq and NYSE is from vending data. For BSE, it's a measly 4 per cent. The potential for growth, then, is immense.

After all, BSE has a lot to offer: apart from a larger base of listed companies -- 8,500 compared to NSE's 860-odd stocks -- BSE also has historical perspective, 130 years compared to the decade-old NSE.

But that's on paper. In the real world, market watchers dismiss the plan. Says the ex-NSE executive, "India is not hungry for information as the West. Selling data is like a daydream." Brokers aren't too impressed either. "Why would anybody pay for BSE data, if NSE provides it free of cost?" asks a broker. And there's also the issue that BSE's historical perspective may not be as much of a hot seller as it believes: demand is more for live data feeds, not vast historical data.

And if revenue from data dispensing seems futuristic, it's actually a little late in the day for other sources like selling trading platforms. Globally, stock exchanges like the Swedish OM have supplied their platforms to a dozen exchanges across the world.

Instead of adopting a similar strategy, BSE has actually lost out on some vital opportunities. For instance, at various points in time, officials from Kuwait, Dubai, Oman and Muscat have visited BSE to study the working of the exchange.

Nothing came of their visits, though, and even Patel agrees that it may now be some time before the replacement market takes off: the market for trading platforms is saturated at present. Still, he's not given up hope. "There is a big opportunity in supplying the support software to existing trading systems," Patel says.

Room for two?

Is the Indian market big enough for two bourses? "Stock exchanges are a natural monopoly," says a broker. In most countries, the norm is one exchange for one product. "In the next 10 years, there will be only one stock exchange in India. Consolidation is the name of the game," says the chairman of a leading financial services multi-national. Does this mean BSE's days are numbered?

Doubtful. The theory has its holes, after all. First, the Indian financial structure supports the rule of two -- two depositories, two commodities exchanges and so on. As Patel points out, "Arbitrage accounts for about 30 per cent of volumes and brings in efficiency to the markets."

With just one exchange, these volumes will disappear and affect the overall liquidity of the market. Brokers add that two exchanges helps customers get better service and competitive rates.

The take out? It's too early to write off BSE. A decade from now, when people go shopping at BSE building, it will most likely still be for shares.

Advantage NSE

In retrospect, the launch of derivatives in 2000 choked the Bombay Stock Exchange. True, the country's oldest exchange had already been dethroned in the equity markets after the November 1994 entry of the National Stock Exchange. But it had still managed to retain a respectable 45 per cent market share.

The landscape changed with the launch of derivatives. The BSE has lost market share to the NSE every year since then. Even in the cash segment of equity markets, the BSE slipped from 45 per cent in 2000 to under 32 per cent at present.

Also, for the BSE, the lack of trading in the derivatives segment meant arbitrage volume between the cash and derivatives segment were absent.

Brokers point out that a large chunk of the BSE's current cash market turnover comes from arbitrage between the BSE and the NSE and from small and medium sized stocks that are not listed on the NSE.

Almost 50 per cent of its cash market turnover comes from stocks that are outside the "A" group of stocks, which includes the top 206 stocks listed on the exchange. On the other hand, the NSE's top 100 stocks alone account for nearly 80 per cent of its cash segment's turnover, indicating that the NSE is clearly the preferred destination for trading in the top stocks.

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