An Integrated Future Of Stock Exchanges

Regulatory board SEBI’s much awaited plan to have a unified regime for stock exchanges finally materialised in October 2018. Last December, it had announced its plan to create a single window regime for the stock exchanges, thereby allowing them to trade in commodities derivatives. For which, SEBI had charted clear plans to smoothly integrate the exchanges in two phases.  In the first phase, it had proposed to have integration at the intermediary level. And in phase-II, necessary steps were to be taken to enable a single exchange to operate across various commodity segments.

On October 1, 2018, BSE achieved huge milestone by commencing trading in commodity derivatives in delivery based futures contracts starting with gold (one kg) and silver (30 kg). Whereas, NSE started its trading on October 12, after the year entered auspicious ‘Matri-Paksh’, with gold (one Kg), silver (30 Kg) as well as gold mini (100 gms) to attract small investors. Both the bourses had planned to offer derivative contracts only in non-agriculture commodities, followed by agricultural commodities later on. Let us take detailed look at how this move will impact all the players across markets:

Higher Price Efficiency

Market experts feel that starting a unified exchange is a rational and logical move, which would improve participation and trading volumes in the commodity markets. “Investors would also be able to trade in multiple asset classes at a single trading venue on NSE resulting in capital efficiency. The nationwide trading facility will be the backbone of a robust clearing mechanism, and it would be beneficial for the market participants,” stated Vikram Limaye, MD and CEO, NSE. In addition, the newly-added volumes and increased depth would enable the corporates to hedge their exposure with higher price efficiency at a lower cost.

“BSE firmly believes that its commodity derivatives platform will help in efficient price discovery, reduction in timelines, cost-effective, user-friendly, robust risk management system and wider market penetration,” explained BSE in its circular.  For the government and SEBI, it becomes easier to regulate and monitor all the segments under a single window. Vikas Vaid, head Partner (Business Development), Prabhudas Lilladher, said, “With SEBI now being the common regulator, synergies and experiences of both the stock markets can be used to bring the right laws required for improving market depth significantly.”

Need Of Compliance

In terms of innovation of products, there lies a huge opportunity for  the exchanges to build a simpler trade platform across segments  for their investors.  However, for doing so, a good framework is crucial. “The exchange has to build risk and compliance environment and such a framework is important as most exchanges are domain specific. For example, BSE and NSE are equity domains and MCX and NCDEX are commodity domains. All the exchanges have their own advantages in terms of operations,” commented B. Gopkumar, Executive Director and CEO, Reliance Securities.

Seamless Interface  For Investors

With the move in place, the investors will have multiple interfaces to trade with a single market under one click. Vaid added,  “With common platforms, investors and traders will be able to use their funds in equity as well as commodity market without having to maintain funds separately for each of the exchanges. This is a huge milestone for the commodity markets.” The integration gives the opportunity to an investor to look at the holistic picture in terms of the correlation between the commodities and its stocks. Also, an integrated platform will help the investors to track the markets more efficiently as well as take benefits of the opportunities that arise in the markets easily.

Vaid pointed out, “Some commodities (bullion) are a natural hedge to equity markets, a few have positive correlation with stocks (metals) and others have indirect correlation and effects with them (oil, sugar, cotton, rubber). The investors and traders will be able to take benefit of such opportunities through a single click.” On the basis of that, investors can trade better and take faster decisions.  “A single market option would enable them to optimally utilise their capital across all asset classes and also create much more dynamic opportunities with a mixture of asset classes in their portfolio,” said Ajay Menon, MD and CEO, Broking and Distribution, Motilal Oswal Financial Services.

Simpler Risk Management For Stockbrokers 

For brokers believing that the universal exchange was formed to serve their needs - that aspect had already been taken care of and addressed last year by SEBI. The unification process for brokers happened last year when on September 21, 2017, SEBI allowed the integration of stock and commodity brokers. Now stockbrokers can deal in commodities and stocks under a single entity.  SEBI has allowed fungibility of funds between commodity and the stock markets; provided that an individual investor is serviced by the same stockbroker.

Further to aid the integration process, SEBI also decided that a stockbroker can transfer a client’s account to another stockbroker but with his consent. Vaid further added, “From the broker’s and companies perspective, risk management becomes simpler as all limits will become fungible across segments. Operation costs in terms of different exchange fees, software, audits and fund management will become a lot simpler and easier for allowing the brokers to invest more of their funds for improving customer experience.”

Competition Intensifies

There is an old saying that competition always brings out the best in people. That holds true with regards to investors too. Good competition will boost the growth of the commodity market. BSE in a quest to boost the volume growth as well as to increase the investors’ participation has decided to waive off the transaction charges for the first year in the commodities market operations. Similarly, NSE has decided to waive off the transaction charges for the next three months.  “Reduction of transaction fees will give rise to arbitrage opportunities to create liquidity and volumes exchanges will bring commodity contracts which are being demanded by markets since long – diesel and petrol contracts for example,” highlighted Vaid. 

Creating Robust Infrastructure 

Building a good infrastructure is always challenging and it takes time. That said, for the exchanges, it is a challenge as well as an opportunity to build and integrate new segments along with the existing ones. “For the traditional equity exchanges, the biggest challenge would be to deal with deliveries, basically managing quality and quantity to ensure good deliveries. Creating that infrastructure is costly and challenging,” Menon further said.

Challenges For the Commodity Market

From an exchange perspective, it will take them time to build their own segments because they work in terms of volume and depth of the market. Gopkumar said, “If you look at NSE, it commands almost 96 per cent of total volume in equities. MCX command almost 91 per cent in the commodity market. So there are monopolies and to create another segment will take time.” Building the volume would definitely take some for these exchanges.

Vaid added, “Initially some challenges may occur as the commodity has a longer market timeframe and exchanges will have to modify their back office processing to inculcate the commodity market.” Above all, a vibrant commodity market is also a necessity for economic growth and prosperity. Though at present, one cannot compare equities and commodities market on a single level playing field. “Today the commodities volumes are not that large as compared to the equity market. But globally, commodity markets are three times bigger than the equity markets,” opined Gopkumar.

On the whole, if market experts are to be believed, the next two-three years would be a large opportunity in terms of expansion. Currently, MCX which holds a de-facto monopoly in commodities trading has 91.4 per cent market share in terms of the value of commodity futures contracts traded as on the first half of the Financial Year 2019.

And it is just a matter of time before the stock exchanges fairly establish themselves at that level. However, they need time to put this concept in place. All in all, the launch of the unified exchange regime will definitely create innovative products benefiting investors and strengthening the market base.  

himali@outlookindia.com