Sensex has the mindshare, Nifty has the market share

The Bombay Stock Exchange is an heritage of Indian capitalism. But over the years the structure has been damaged so much it needs a serious restoration. Ironically, it is looking for regulatory help to tide over the current crisis and institutional support to reinvent itself. By all counts, the 15 year old National Stock Exchange has over taken the 133 year old BSE and is leaps ahead of its competitor. Sensex, the 30-share BSE Sensitive Index and the 36-storey Jeejeebhoy Towers are the towering symbols of Indian capital markets. But the market share is with Nifty and all action is in the derivatives segment of the NSE.  

The brand BSE seemed to be doing well and the business on the revival path, when the exchange successfully got a valuation close to a $ 1 billion last year. Though rival NSE roped in the largest international exchange NYSE-Euronext as its shareholder, BSE

brought in some of the big names, if not biggest in terms of business as its shareholders – the Deutsche Boerse and Singapore Stock Exchange. It met the deadline set by the regulator to demutalise and bring down the broker shareholding to less than 50 per cent. But some of the current problems of BSE are attributed to the concentration of all its energies towards the demutualization exercise. "Demutualisation is not an end in itself. The management failed to improve the business especially in the derivatives business," blames the non executive chairman Jagdish Capoor.

It was the exit of Shekar Datta as the chairman of BSE in May and the re-election of Capoor as the chairman that stirred the nest. Award of technology platform revamp contract to the Nordic exchange OMX was the centre of controversy that involved Datta as well former CEO Rajnikant Patel. WhilePatel insists that the exchange went ahead with the OMX deal only with the board approval and a due diligence by an independent consultant, the deal itself is as good as dead and the exchange is likely to lose the advances paid. l and a due diligence by an independent consultant, the deal itself is as good as dead and the exchange is likely to lose the advances paid. "The management has  powers to approve only transaction up to a limit of Rs 25 lakhs, for every deal above that board approval is required," saidPatel. While Patel accuses the board of micro managing the affairs and lack of trust in the management, the board in retrospect has questioned the OMX as well as other decisions taken by Patelthough officially no questions were raised by the board or charges levied against the management. Technology definitely is a weak point for BSE as every market participant would vouch for the superiority of NSE's systems. Set back on the OMX deal puts BSE's drive towards creating a scalable and unified platform by several months if not more.

Though BSE started derivatives trading a day ahead of NSE, trading in futures and options has miserably failed. Initially it was the BSE brokers reluctance to move towards derivatives and their longing for the long shelved badla trading that reason for derivatives not taking off at BSE. At a time when derivatives was introduced BSE also had other administrative issues to tackle – yet another scandal of sorts lead to change of guard at BSE and it took couple years for it to move towards a new management structure. It moved away from broker managed exchange to professionally managed exchange. BSE by the end of 2007 was an entity on par with NSE in terms of management and processes, but not everyone would agree to that. Former managing director of R.H.Patil said he still has a problem with BSE as it continues to house the brokers and the management, executives under the same roof. "As long as the brokers are sitting in the same building there is a problem," he said.

With just three broker members on the board and having lost control of majority shareholding brokers insist there is no interference. Yet, as one instance suggests, most members are reluctant to change.BSE at some point came up with a proposal to have a new administrative building at a cost of Rs 200 crore and sources said there was even an in principle approval from the Maharashtra government to grant them a plot at Bandra Kurla Complex. Section of brokers are blamed for scuttling the project. This is a mindset issue, say insiders.

"Why should we have members on the board? Even if they have to be there let them be a system of nomination instead of an election," says Patel. His contention is that NSE even without any brokers on the panel has been able to run well and bring out various products and run them successfully. Even asPatel is accused of having wasted money on a market making system in the derivatives segment, he blames the members for not having taken advantage of products which they got exclusively. "We managed to get weekly stock options exclusively and also the corporate bond trading platform. But not a single trade happened," said Patel. It is the exchange that is the loser in this infighting and no one else stands to lose.

With the money BSE members got out of the sale of shares last years, many who have been active have opted to take NSE membership. BSE still has a large number of shares that are not traded on NSE. But those shares are typically mid to small cap and that cannot make a big difference to the exchanges' volumes are revenue. NSE has also gone a step ahead towards presenting an integrated web platform ut may be some professional help is near as representatives of SGX and DB join the BSEboard. to its members and their clients through its latest product launch NOW. Demonstrating the platform where clients can directly log in and trade on products listed on NSE, NSE derivatives, currency futures and products on commodities exchange NCDEX, the NSE official said they want to put even BSE's products there on the list. "We know the markets and we are talking to BSE," said the NSE official in charge of the product.  

BSE has to soon take its products international, generate larger business out of its indices and other data products and also get products other than equity. Deutsche Boerse has exclusive license to marketBSE data products and for the financial year 2008 the exchange derived close to 8 per cent revenue out of it. It had licensed Sensex for launch of an ETF on Hong Kong stock exchange and has been doing decent volume. But Nifty became the most successful Indian capital market export, as Nifty futures trading on Singapore stock exchange soared. For whatever reasons, BSE took Sensex futures to a little known US exchange, despite enlisting SGX as a shareholder. "Sensex brand has to be reinforced and it has to become a tradable product quickly. Lux is an established product. But they keep reinventing it," says Patel. "Sensex brand has to be reinforced and it has to become a tradable product quickly. Lux is an established product. But they keep reinventing it," says Patel.

BSE also needs some regulatory support here. The issue of cross margining has already threatened its business volumes and if it is to extended beyond its current coverage BSE would suffer. Allowing investors to maintain margins only once, when they take a position on the underlying and hedge for it on the derivatives segment has moved trading volumes in those stocks to NSE. Every time a stock is introduced into the derivative segment BSE witnesses fall in trading volumes. "It is not true that BSEdoes not have liquidity. There are times we do trades much quickly on BSE," says Deena Mehta, a member and former president of the exchange. She feels BSE instead of getting into this fight over derivatives volume should use its franchise, goodwill and network to offer one stop financial platform for investors, making it a supermarket of financial products. Capoor feels that is only a partial solution and building derivatives is a key element for him to arrest to arrest erosion of business.

Derivatives is definitely a key element and canvassing business is crucial as competition is getting intense among exchanges with the launch of currency futures. Regulators are also working on interest rate derivatives and introduction of it is only a few months away. But who is going to drive BSE into this new terrain? At present it is functioning with an active CEO. There is no single promoter/owner to effectively oversee the exchange runs efficiently and turns profits for shareholders. The regulatory help in terms of hiking the cap on single holding in stock exchanges from 5 to 15 per cent should be a blessing for BSE. Though the FDI policy may prevent foreign entities from hiking their stake beyond 5 per cent, Indian institutions can come in as a higher stakeholder control. That may be a long way to go under current market conditions. But may be some ut may be some professional help is near as representatives of SGX and DB join the BSE board.

If the government created NSE to keep BSE under check, and regulators supported it, it is the same regulators who would justify the continued existence of BSE. No one wants a monopoly if it is an institutional monopoly like NSE. But BSE is only wasting away its chance by not making most of the situation. It lost out on a crucial segment of commodities by letting go of the deal with Ahmedabad based NMCE. Scuttling of the deal by vested interests is very much suspect, but no one has gone on record about it. It is one of those serious charges against Patel, though legally or otherwise it cannot be help up against him – that he took a board seat on NMCE even while BSE was negotiating a stake. Though BSE said it would create its own commodities platform, the government now doesn't seem to be in a mood to give any more licenses beyond the already approved 4 national commodities exchanges. While Patel accuses the board of not having faith in the management and forcing too many board meetings, he clearly has not kept corporate governance in mind while jumping on to NMCE board.

P.S.This is something I wrote in 2008, but never published. Since, my idea has been vindicated by a recent story of an ex-colleague that BSE is on a revival path wanted to archive this piece.