The exchange could do with the extra money, as its operations are in a steady decline for the past decade or more. While the cash segment (in market parlance, or the regular equity segment in common parlance) has increased, most of the increase has been because the size of the pie has increased since 2000. The three-year record is more sobering; it fell every year, to record a turnover of R11 lakh crore versus its rival NSEs R330 lakh crore, according to Sebi statistics. With India becoming the flavour of the past decade, the turnover of exchanges met with explosive growth. Hidden in the growth was the slow and steady relative decline of the BSE. Far more abrupt was the decline in the volumes of the derivatives segment. These volumes had nothing to hide behind. Launched in 2000, derivatives volumes surpassed the only other competitor NSE for a few months. Then they virtually fell off a cliff. Today, they are virtually absent in the segment. Given the much larger size of the derivatives market, the BSEs overall market share is 3% now. Among the many well-wishers of the exchange, there has been steady support. Unfortunately that hasnt been enough.
While it is clear that in the initial few years after NSE came into play, BSE was ill-prepared for the efficiency, independent management and the clear technological lead provided by the NSE. Many subsequently blamed the bias of Sebi towards NSE. This was probably untrue. Sebi stood for much of what NSE stood for, rather than for NSE itself. There were some delays, which are normal in any regulatory approval, for instance, granting BSE a nationwide terminal tag, which would have helped it spread quickly.
The second stage was in the early 2000s, which saw the launch of equity derivatives on both the leading exchanges. The lead which NSE had shown in trading in the cash segment led to a complete rout of its rival in the derivatives space described above.
The third phase was the attempt of the BSE board to get new management in place and give the institution a management makeover. They appointed Madhu Kannan, who had a senior role at the NYSE, and a team of international experts, around 3 years ago. Just before the appointment was a phase of disputes between the board members of the exchange and some board members and the CEO. This pre-third phase did no favours to an already ailing exchange. With two drivers in the seat, the car didnt really rally anywhere in particular. In addition, Parliaments mandate to demutualise focused energy on that task and made the exchange have distinct classes of shareholders, brokers and managers. Finally, in this phase, Sebi wrongly imposed an ownership cap of 5% on any person to own shares of a stock exchange. This continues till today and is a huge problem as I will discuss below.
This phase was full of hope of reform. Brokers who received shares of the exchange in lieu of the fractured ownership and trading rights briefly traded shares of the BSE at huge premiums. International investors like Deutsche Boerse and others, despondent about the 5% cap, saw a ray of light.
New investors like George Soros saw merit in investing in the exchange. Despite the best efforts of the A-star team, BSE continued to struggle. It invested quixotically (15%) in a currency exchange, the United Stock Exchange, thereby outsourcing its exchange function in currency derivatives for a 15% share in the returns. The problems in this phase were a) the 5% limit on ownership, which meant that anyone who wanted to invest in BSE and give it a competitive advantage was unable to take control of BSE and give it a makeover, b) because the shareholders had been so emasculated, the management felt directionless with a board that drew no power from the shareholders, and c) there was no competitive advantage BSE had. There was nothing, nothing at all that BSE could do, which NSE couldnt replicate in 24 hours with more technology, more money and with a history of far deeper markets in an industry where liquidity breeds more liquidity. Finally, d) there existed a policy vacuum with respect to whether Sebi stood for listing of exchanges or not, further muddied by the Jalan Committee report, which made recommendations without even reading the annexures attached by them to the Committee report. This cloud thankfully lifted a few days ago.
If you ask what the future of BSE is, I only have a crystal ball that can see imprecisely. In addition, my crystal ball shows a dire future unless the stars align differently than they currently do. As we have seen, a good management team is a necessary but not sufficient condition for the positive future of BSE. The new team must be well-grounded in the realities of the Indian market and leverage the still-continuing goodwill of its members, negotiate with the sometimes tricky labour relations and work with the Board without allowing the Board to also sit in the drivers seat. Second, the 5% ownership cap must be removed by Sebi for the sake of a healthy competitive marketat least for a few years. This will enable BSE to tie up with an NYSE or equivalent who will own a chunkier stake in the exchange in return for a competitive advantage. Of course, competition has not historically been BSEs strong suite. Third, the exchange must list immediately, irrespective of the valuation it would command today.
This will give the exchange direction and accountability. Shareholders, where brokers have a limited say, would decide on the direction of the exchange. The management will come out with disclosures, explanations and accountability to its shareholders, not to talk of performance measurement. Similarly, the board, too, would be elected largely by the shareholders with some public interest directors. These are somewhat naive and simplistic suggestions, as they dont answer the key question. What is BSEs competitive advantage Can it do something that its rivals cannot duplicate immediately and more effectively. Here, the answer is hard, very hard. And only a visionary can answer it. Fortunately, with the other three conditions met, this will be achievable, though with difficulty and a lot of luck.
The author is founder, Finsec Law Advisors