In the early 1990s, stock market trading took place through the BSE floor by open outcry. On a good day, BSE members did Rs 400 crore of turnover and earned 2% off buyers and sellers, thus bringing in Rs16 crore per day of revenues. While this was good business for BSE members, if anyone would take two steps back, he would see that the business was a mess. But for any one CEO, it was impossible to shift the business model away from the existing one.
India’s policymakers embarked on an array of reforms. Brokers were forced to unbundle the tariff charged to the customer from the transaction price on the floor. Trading was computerised. Counterparty guarantees came from the clearing corporation that produced safety by limiting leverage. Exchanges were put on a new governance model, featuring a three-way separation between trading members, managers and shareholders of the exchange. The ‘badla’ mechanism was eliminated in favour of derivatives trading.
What was the response of the industry? Mostly, sheer outrage. The firms and their CEOs were finely optimised for playing the old game. In the short run, the reforms disrupted revenues and profits. The BSE virulently protested, saying that market structure is best left to the market (even though no one CEO is able to shift away from the prevailing market structure). In the post-central-planning age of economic liberalisation, it was argued that this was a new level of government intrusion into the affairs of the market. A gifted senior executive director of Sebi, who led the changes, was hounded out.
In the event, the reforms worked out fabulously well. India got a revolution in the stock market. NSE and BSE are now ranked 3rd and 5th, respectively, in the world by number of transactions. The periodic disasters that afflicted the market have ended—we have now enjoyed 9 years without a systemic breakdown. The market is transparent and fair to customers.
Remarkably enough, securities firms have done well through these changes! Brokerage firms now have over 2,00,000 screens spread all across India, and equities trading has gone where it had never gone before. On a good day, NSE and BSE members put together do Rs 1,00,000 crore of turnover—an increase of 250 times. The revenues per transaction have crashed by 20 times. Still, the securities industry takes in revenues of roughly Rs 200 crore a day, which is vastly bigger than the starting point of