Exchange Competition and Market Impact: Currency Derivatives in India

Rivalry among Indian capital market players, including exchanges and regulators, is not new. It was again observed in the currency derivative space recently. Trading in currency derivatives in India began in August, 2009. The National Stock Exchange (NSE) of India was the first player to offer this facility to investors. Two more players, MCX-SX and United Stock Exchange (USE) later entered into this space. Initially NSE was not charging any fees for trading in currency derivative. There were arguments both for and against such policy. NSE’s stand was that such a move was intended to benefit all players (exchange, members and investors) and thereby develop this new market. However, such a stance taken by the first mover and dominant player in the market meant other players were also not able to charge transaction fees in this market. This led MCX-SX to lodge a complaint against NSE to the Competition Commission of India (CCI). In its order, CCI found NSE guilty of abusing its dominant market position. Subsequently NSE introduced transaction charge in the currency derivative segment starting from 22nd August, 2011. According to NSE, while they are challenging the CCI order, they are ‘implementing its direction to levy charges out of respect for the commission’. As a result, transaction charges are being imposed for the first time in the three-year history of this market segment. The NSE would levy transaction charges of up to Rs 1.15 per 100,000 Rs of turnover in the currency future segment. On currency option contracts, members will pay a transaction fee between Rs 30 and Rs 40 on every 100,000 Rs of premium payable. Also, it would levy an advance transaction charge of Rs 50,000 per member per annum and would charge an admission fee of Rs 100,000 from its existing members and Rs 500,000 from others – this would be set off against actual transaction charges payable by the member in the respective financial year. Subsequently, MCX-SX said that it would also levy charges for currency derivative transactions. The third exchange, USE is still considering on levying charges, and hence is the only exchange left which does not impose charges on currency derivatives. Absence of levies and fees was a big contributor to the growth of currency derivative trading in last few years. Besides no transaction charge, this segment is also not charged Securities Transaction Tax (STT), a tax charged on all other transactions. Therefore trading in currency derivatives used to be a much cheaper option and arbitrageurs were attracted to this segment. With the introduction of transaction charges, costs are going to increase and the volumes are likely to be impacted. The results observed so far are very much in accordance with that. Trading volumes at both NSE and MCX-SX, the two exchanges which introduced transaction charges, fell significantly since August 22, while trading volume at USE actually grew marginally. Compared to the period 1st January, 2011- 18th August, 2011, it can be seen from the figure, average daily trading volumes fell by 20% NSE and by 17% at MCX-SX since 22nd August, while it grew by 7% at USE. Similar trend has been seen in case of trading value as well. It must be mentioned here that trading volume in currency options at NSE actually grew by 8% after introduction of transaction charges. This probably indicates the introduction of charges was a deterrent for arbitrage players who are more active in the future segment.

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.