How do you see the exchange space panning out in the near future As there are already two national level exchanges, how do you justify the need for a third exchange
A full-fledged capital market is the need of the hour for India. Globally, if you look at any developed economy, equity constitutes only 13% of the capital market and other asset classesdebt, corporate and government bonds, interest rate futures, currency, SME, etcconstitute the remaining 87% of the market. While everyone says that we have two national-level exchanges, I think not much has been done to develop this 87% of the market segment, which, in a way, remains unexplored. Here, I want to explicitly state that the government, regulator and the policymakers have done enough and everything to develop the capital market, more so during the last 10 years. Sebi, as a regulator, has created a very conducive environment for 360-degree development of our markets. It is important for the exchanges to play the developmental role and invest in research, training and education to get the best outcomes from the capital markets. In addition, exchanges should also provide the right feedback to the regulators and policymakers on a continuous basis, to evolve right course of direction and growth. This will enable the exchange industry to meet the government objective of inclusive growth.
Exchanges which claim to have achieved nirvana appear to be contented that they have achieved everything required, but they are not acknowledging their severe shortcomings, wherein 80% of the volumes belong to equity derivatives and not much capital formation or bond market development is taking place. This leaves a huge responsibility available to the new exchanges, to take up the agenda of all-round market development.
The US has a fully developed capital market system with 10 exchanges and 76 alternate trading systems for a population of 300 million people. India has a population of 1.2 billion and perhaps more listed companies than the US, but we have only two exchanges. In the US, 40-45% of the population is connected with the capital market whereas this number is less than 2% in India. Moreover, the need for raising risk capital, growth capital, debt capital for infrastructure development and for hedging risks in interest rates, currencies, commodities and equities has never been stronger than it is today. Nowhere in the world has infrastructure financing or corporate expansion happened on the back of equity funding alone. To conclude, there is huge potential open to a third exchange. And unlike others, we are committed to taking responsibility and seeing this as a great opportunity for market development.
You have mentioned the role of exchanges in contributing to research and policymaking. Can you elaborate
Rather than giving the right feedback to decision-makers, exchanges are driving the corporate competitive agenda. Unfortunately, this has taken priority over the national interest. For example, on the suggestion of taxes on hedging transactions, a senior executive of an exchange has suggested that all hedging transactions such as commodity, currency and interest rate derivatives transactions should be taxed. It is surprising that instead of highlighting the need for removing the securities transaction tax on the equity hedging function (F&O), they have suggested that the transaction tax should be imposed on commodity, forex, interest rate derivatives and all hedging functions as they claim this difference has led volumes to shift from the capital market to the commodity market. This is a total misrepresentation, as large volumes in the equity market are done by banks, mutual funds and FIIs which are not allowed to participate in commodity markets. This is akin to the cement industry which has problem specific to it saying that the solution should be applied to the steel industry as well, which is not logical. Hedging products should not be taxed, otherwise volumes might get shifted to unregulated segments such as dabba trading.
How do you see trading costs coming down due to the entry of more exchanges
Competition is the biggest leveller. Competition in sectors such as telecom, airlines, banking and insurance has not only led to cost-reduction but also spurred product innovation and expansion of these markets. If you look at the balance sheets of some of the exchanges in India, they are operating at over 70% EBITDA margins and this is the primary reason why they do not want any competition. As there is no competition, they do not see a necessity for lowering margins. They also do not feel the need to develop the market or invest in financial education and training in regional languages. Their argument is that the exchange fee constitutes a very small percentage of the trading cost. However, this is no justification for not lowering costs.
In our case, we have brought down the main component of transaction charges. We announced 35-50% lower costs than other exchanges and we are sure there is still room for us to work on a healthy financial balance sheet, with sufficient margins. Our announcement for cost reductions were immediately followed by other exchanges and the record membership that we received reflects the endorsement of our pricing. It is wrong to say that lower costs will reduce the rigour of regulation as regulatory standards evolved by Sebi are common for all, complied with by all and strictly enforced across.
You seem quite focused on the non-equity segment like corporate bonds. It seems exchanges have not done their part to develop this market though the policies are in place. How do you plan to execute your strategy
Though the regulator and policymakers have given all the support and requisite policy framework for development of the bond markets in India, the exchanges have overly focused on delta trading and cash-settled products. We have a unique strategy in place for the bond markets. The whole market for bonds has been designed for only AAA-rated companies that have many avenues to raise capital, including banks. But what about companies rated below AAA A market has to be created for such entities, for which a different market structure needs to be designed. You cannot just copy the equity structure and present it for the bond segment. There is a huge scope for retail participation in the bond segment. Retail investors need to be told about three parameters: credibility, liquidity and clarity on the downside risk. If exchanges are able to cater to these things, we will surely see the emergence of an active bond market. We will get that broker-member network in place for bonds with adequate training and requisite skill sets. Look at LIC and how they have gained owing to their large agent network. So, you have to create the right product and educate investors.
The recent flash crash brought to the fore issues related to co-location and absence of robust risk mechanisms and surveillance measures at the exchange level. Regulators and exchanges are working together to plug this gap. What are your views
The issue here is not whats good or bad about co-location. The challenge concerns the competence and capability of the exchanges to have proper control, on which I have several concerns and doubts. If you cant handle the speed of execution in 10 milliseconds, it is better that you dont do it at all. The basic purpose and principle of technology is to provide a level playing field whereas co-location differentiates between the big and the small traders and investors. Just aping the emerging technology models of western market exchangeswhich are still under review and assessmentdoes not serve the the priorities of a developing market like India, where the fundamental focus of any exchange is not just promoting delta trading but contributing to the crucial and critical capital market formation. The recent episode of a market crash in India, where an order sent by a dealer went wrong and brought the market to an abrupt halt, shows that the exchange which claims it had achieved the speed of light in execution was not able to handle a single erroneous trade, was not able to amply demonstrate proper checks and balances before the order execution and, above all, was able to evade responsibility by saying that its systems are fine and dont need any improvement. Such an attitude is a matter of grave concern to the capital market community as a whole; erring stock exchanges should be made responsible and accountable. If an exchange that claims to have achieved the ultimate in technology does not have a system that can check and stop a wrong order, it appears like a novice in the exchange industry. Technology is meant to enhance the quality of the market in terms of speed and integrity. But if it is not handled properly, this would lead to serious distrust among domestic and foreign investors.