Equities Trading at Indian Exchanges: Competition Can Wait

MCX-SX, which offers trading in currency futures, had requested to the Securities and Exchange Board of India (SEBI), the capital market regulator, for approval to launch trading in equities, equity derivatives, interest rate futures and other instruments. It was thought that this move would add a new dimension to India’s exchange landscape which is dominated by the two main exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The recently started United Stock Exchange, which commenced its operations in the currency futures segment on 20th September, 2010, recorded on its very first day a turnover more than that of the combined turnover at NSE and MCX, the country’s existing currency trading exchanges. It was anticipated equities trading at MCX, if approved, would also throw up similar competition to the country’s two existing exchanges. In September 2008, MCX-SX was conditionally recognized as stock exchange trading in currency futures by SEBI for a year; recognition was extended in August 2009 for one more year to give MCX more time to comply with requirements. In April, 2010 MCX-SX sought permission seeking approval for trading in segments permitted to BSE and NSE. In July, 2010, MCX-SX filed petition before the Bombay High Court seeking intervention over the delay in approving its application by SEBI; in August 2010, the Bombay High Court asked SEBI to take a final decision on the matter by September 30. On 23rd September, 2010, SEBI rejected the application stating it ‘was not satisfied that it would be in the interest of trade and also in public interest to allow the application’. SEBI’s rejection, as mentioned in its order, was based on a number of issues. Under MIMPS (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges Regulations), no person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent of the equity share capital in a recognized stock exchange. A select class of financial institutions, however, can own up to a maximum of 15% each.
  • MCX-SX is promoted by Multi-Commodity Exchange of India Ltd (MCX) and Financial Technologies India Ltd (FTIL). When MCX-SX was formed, its promoters MCX and FTIL owned 51% and 49%, respectively, which, after divestment, came down to 37% and 33.9%. The promoters in April, 2010 undertook a further financial restructuring to comply with regulations, by reducing their respective shares to 5% each. However, it also issued warrants to MCX and FTIL, which allows the promoters to gradually sell the warrants under favorable market conditions. Under this arrangement, according to SEBI, MCX and FTIL have together now a holding of 71.90% in the shares and warrants issued by the company.
SEBI listed ‘excessive concentration of economic interest in the stock exchange in the hands of the two promoters’ and ‘not being fully compliant with shareholding regulations‘ as reasons for rejection.
  • MCX-SX had submitted that the two promoters did not share a common management, but it (SEBI) found the two entities are operating under a common management. According to SEBI, therefore the share holding of FTIL together with that of MCX (5% each) exceeds the permissible limit of 5% limit of ownership in a stock exchange.
  • SEBI stated that ‘the promoters of MCX-SX and their associates had arrangements with three shareholders of MCX-SX where sale of shares between the parties were based on offers to buy back the shares at or within specified time in the future’. It found such arrangements illegal.
  • In its order SEBI said ‘MCX-SX has been dishonest in its disclosures to SEBI on material information and has failed to fulfil its disclosure and fiduciary responsibilities’ and also it ‘has failed to adhere to fair and reasonable standards of honesty that should be expected of a Stock Exchange’.
MCX-SX may appeal to the Securities Appellate Tribunal (SAT) against the decision, or go for a writ petition in the high court.

Exchange Trading of Mutual Funds in India

In the last year and a half, the Securities and Exchange Board of India (SEBI) has taken a number of steps to develop the mutual funds industry in India. One significant move in this direction has been allowing trading of mutual funds at the country’s stock exchanges. After studying the feasibility of doing this in 2009, SEBI approved mutual fund transactions through stock exchanges in November last year. This was done to extend the convenience of the secondary market infrastructure to mutual fund investors who could earlier invest in funds only through the existing distributor/agent channel. India’s exchanges with a large number of trading terminals connected through numerous Lease Lines and VSAT terminals can reach investors in over 400 cities. Besides reach, exchange trading offers number of other benefits too: opportunity to invest in multiple asset class through a single (demat) account, aggregation of entire portfolio in a single place enabling easy monitoring and more efficient investment decision making, reduction of paper work and errors etc. Also the exchanges’ existing delivery vs payment process offers de-risking of settlement process and increases transparency. Following SEBI’s approval, the two Indian Exchanges, the National Stock Exchange of India (NSE) and the Bombay Stock Exchange (BSE) started trading in mutual funds in November-December, 2009 (NSE: Mutual Fund Service System, BSE: StAR MF). Under the current arrangements investors would be able to deal in Mutual funds that have signed up with the exchanges and in the schemes which the fund houses have permitted to be traded at the exchanges. Out of 40 Asset Management Companies, around 20-22 have signed up with the two exchanges so far. SEBI is planning to make listing of all schemes mandatory. A look at the figures (see graph below) reveals this new channel for investing in mutual funds has not been very popular among investors yet. It can be noted in this context, average daily transaction value (sales+redemptions) for the overall industry during May-July, 2010, had been around 690 bn Rs, which makes exchange trading around 0.3% of total trading during the same period. The occasional jump (July) in trading value is more because of market fluctuations than investors’ preference for exchange trading: Industry Assets Under Management went down by 10% in July as compared to May, as a result subscription went up. Though it has to be acknowledged that of late, there has been a push from the fund houses to encourage investors to take the exchange route. However, these are still early days for this new system. Moreover, since removal of entry load (distribution fee charged by agents to investors) in August, 2009, the industry has been in a state of flux with agents now focusing more on selling insurance products which have high distribution fees. To overcome this problem the fund houses have been trying a number of new distribution models in last one year for attracting new investors; but a clear pattern is yet to emerge. It can be argued with more investor education and awareness about the new technology channels and SEBI’s continuous push, exchange trading of mutual funds is likely to pick up in the future. Banks are a big player in mutual funds and the regulators’ urging banks to transact through exchanges may be one step towards achieving this. Another recent phenomenon is that many brokerages are placing orders through exchanges in the recent months. These all hold good promise for this new channel, however, its long term impacts are yet to be seen.