Informist, Tuesday, Jan 2, 2024
By Rajesh Gajra and Shiladitya Pandit
MUMBAI - The mantra of Sundararaman Ramamurthy, managing director and chief executive officer of BSE Ltd, is to listen to his customers, and he looks to fuse this into his efforts to steer Asia's oldest stock exchange back to its glory days.
Within weeks of taking charge a year ago, Ramamurthy started working by his mantra and took feedback from BSE brokers and traders. It didn't take him time to realise that the risk capital of futures and options investors was not being fully utilised on Fridays. "It was lying fallow," he says.
He says he got a clear sense that they were "able to relate to" the exchange's benchmark index, Sensex, one of the oldest in the continent. This gave him a good measure of confidence to revise the specifications of the derivatives contracts on Sensex, the BSE's benchmark index of top 30 companies.
The move paid off, as Sensex options volume surged. There was enthusiasm at BSE, but that was only the beginning. "Should we be gloating in our glory that we have achieved everything," muses Ramamurthy in an interview with Informist.
"There is a long way to go," he says. For instance, in overcoming its challenges in the cash market segment. Ramamurthy looks to focus on "cracking" the domestic institutional investor segment, one that has provided his exchange only a pittance by way of volumes.
After several years of BSE's decline in the cash market share and failed attempts to get its equity derivatives segment to gain any meaningful traction, the exchange is making steady progress since May, as the notional turnover in its revamped Sensex options has risen substantially since. The BSE's market share in equity derivatives, which was below 1%, is now nearing 5%. The lion's share is held by the over-a-century younger National Stock Exchange.
Taking note of customer feedback, the Ramamurthy-led exchange took a string of steps to boost its business. He says the 150-year-old bourse, which he calls "the new kid on the block" with respect to equity derivatives trading, reduced the lot size of the Sensex and Bankex contracts, and shifted the expiry day to Fridays from Thursdays for the weekly ones in mid-May. Five months later, the Bankex weekly contracts' expiry was moved to Monday from Friday, while the expiry of Sensex contracts kept unchanged. Bankex volumes, however, did not take off like those of Sensex, as investors did not prefer to dabble in bets on two indices on the same day.
Ramamurthy says the exchange's actions were driven by the market. "The changes we made to Sensex options in May are what the market wanted and an empty space which we filled, and which worked."
The average daily equity derivatives turnover of BSE has risen multiple times to 15.23 trln rupees in Apr-Nov from 1.38 trln rupees in the entire financial year ended March. Obviously, the bull-run in the stock market has helped this growth, but BSE's show stands out because its market share in equity derivatives has jumped to 4.98% from 0.89%.
From the feedback he was getting, the managing director realised that F&O investors' risk capital was "not getting well utilised on Fridays..." The two most liquid indices in derivatives--the National Stock Exchange's Nifty 50 and Nifty Bank--expired on Thursdays. If an F&O investor's "directional view did not materialise on Thursday, and if there was a complementing product that expired on Friday, then he could extend it by one day," says Ramamurthy.
Ramamurthy says BSE is not trying to "grab market share" in futures and options. "Competition is good when one is in a position to compete, right?" for around 20 years, BSE had not done anything meaningful in futures and options. "...We are too small to call ourselves as competition."
Ramamurthy says the Sensex and Nifty 50 "complemented each other because they had a 99% co-relation" and the former had the same set of stocks as the latter. The only difference was the "lead and lag effect of the incorporation of the information in the market in the indices", he says. "Sometimes Sensex led and Nifty lagged, sometimes in the other way around, but ultimately the two indices converge."
The managing director says the complementary nature of the two indices also means that Sensex derivatives provide protection to the equity derivatives ecosystem from concentration risk.
In fact, capital market regulator Securities and Exchange Board of India Chairperson Madhabi Puri Buch, has been encouraging collaboration among the stock exchanges.
This has created an impression among market participants and investors that competition between the stock exchanges will decline, and they are not quite happy about it. In order to get better services, they want the BSE and NSE and their clearing corporations to compete with each other.
Ramamurthy, however, sees no conflict between the two sides. "The investors want both exchanges to provide more products, so that they have more avenues for investments... there are areas where we will be able to express their views in the market more efficiently," he says.
CASH - TOUGH NUT
The cash market in equities is where the BSE is not finding it easy to compete. Data for Apr-Nov shows that the BSE's market share in the segment is languishing at around 7% for two years.
Ramamurthy says BSE had significantlt ceded its market share in the past. It made people question whether the exchange would have any meaningful existence if its market share in the cash segment fell below 5%, he says.
The cash market is very important for a stock exchange and raising the market share is not easy. The BSE has not been able to provide anything complementary to the NSE offering in the segment since it is not able to differentiate a product in any way, concedes Ramamurthy. For instance, a share of Tata Consultancy Services is the same whether you trade on one exchange or another, he says. "It becomes difficult to bring a change there."
It is not that BSE has not tried tweaking specifications. For shares trading below 100 rupees, which is the case for around 700 companies, the exchange recently reduced the tick size to 1 paisa from 7 paise. It did yield small results as the impact cost for these shares fell and BSE's market share in these 700 stocks went up to 11% from 9%. "Itihaas gavah hain (history is a witness) that when you change the bid-ask spread, the liquidity improves," says the managing director.
Ramamurthy points to factors that are making it difficult for BSE to boost its cash market volume. "Almost all large brokers have started providing BSE platform for cash equity clients but not all of them have implemented in a way which provides a level playing field," he says. "Some of them have still not given intraday interoperability to their clients. That is, if a client buys in one exchange and sells in another, the broker gets the margin netting by the single clearing corporation which he has opted for, but the benefit is not passed on to the client. So the client lands up with the problem of... twice the margin."
Another issue that the BSE is facing and is "not being able to crack is domestic institutional participation... they are just giving me 4% of their order flow," rues Ramamurthy.
When he met the domestic mutual funds and institutions, some said BSE's cash market order book lacks depth. The order sizes of these investors are big and they were apprehensive whether these would sail through. Institutional investors are liquidity providers because they buy and sell for deliveries, whereas traders are liquidity takers, who buy or sell only to square off as soon as possible at a profit, he says.
Ramamurthy says it might appear that the order book is not deep but after a large order is placed, algorithm-using trading strategies kick in and put in counter orders. Traders don't want to continuously stand in on both sides of large orders for fear of getting hit, but when an institutional large order comes in they take it, says the BSE chief.
For foreign portfolio investors, exchanges do not really matter; they just tell their brokers to get the best price, he says. "But unfortunately, in the secondary market, the contract note comes separate if an investor trades on two exchanges." FPIs want a single contract at a value weighted average price and two contract notes make it impossible for a broker to give them this price. "Their systems are oriented towards managing a single VWAP, so you provide for that, and we will tell our brokers to ensure 100?st price execution and smart data routing, which is not yet happening."
SHAREHOLDER VALUE
BSE is the only listed stock exchange in India, having listed in January 2017. As per the regulatory norms, its shares cannot be listed on its own exchange and has to be listed on another--which in this case is the NSE. Shareholders of BSE have no cause for complaint so far as returns from their investments are concerned. Based on the average price, BSE's shares rose 91% in 2023, 62% in 2022, and 215% in 2021.
At 1010 IST, shares of BSE traded nearly 2% higher at 2,244.20 rupees on the National Stock Exchange.
At a consolidated level, which includes its wholly-owned subsidiaries such as Indian Clearing Corporation, BSE's revenue mix in 2022-23 had 2.41 bln rupees coming in the form of transaction charges, 832 mln rupees from treasury income on clearing and settlement funds, 1.11 bln rupees from other securities services which included its mutual fund subscription and redemption platform for investors, 2.9 bln rupees from corporate services which included listing fees, and 895 mln rupees from other operating income.
In 2022-23, BSE's consolidated revenue from operations rose nearly 10% to 8.16 bln rupees. But the exchange failed to post growth in transaction charges, which while contributing 30% to total consolidated revenue from operations recorded a decline of 7% in 2022-23. Its operating profit too declined 7.4% to 1.97 bln rupees, while the net profit fell 13% to 2.21 bln rupees.
The turnover from transaction charges on equity derivatives has been negligible for a long time, and the BSE also has to pay clearing charges to NSE's clearing corporation for trades on BSE, where the clearing corporation of choice is the competitor's clearing corporation under the clearing interoperability scheme.
In an investor call following the March quarter earnings, Ramamurthy had said BSE will look to increase transaction charges in the derivatives segment if there was an improvement in market share. And he made good on this when the market share in equity derivatives rose sharply from around 1% to nearly 5%.
From Nov 1, the BSE moved to a slab-based fee structure for charges on Sensex options premium turnover from an earlier nominal flat fee of 500 rupees per 10 mln rupees of premium turnover. This is expected to increase transaction charges from F&O segment for the BSE.
Ramamurthy says it takes at least a few years for a derivatives product to mature. "We have seen it earlier in product launches in the equity derivatives market over the last 20 years. Sensex options are at the start of the journey with only six-seven months gone by since the revamp. All indications are there that it will be a mature product but it will take time."
Ramamurthy says he would like to see a few things happening first. Derivatives contracts with expiry more than a week away should see a rise in volume, there should be "a good amount of institutional participation", and there should be "a good balance between futures and options". This is a slow process, he says.
Ramamurthy says FPIs are gradually participating more in Sensex options trades. "Today, we already have 50 FPIs participating in Sensex options, and we are in discussions with more FPIs." BSE's goal, according to Ramamurthy, is to have 250 FPIs actively using Sensex futures and options to hedge their outlook on Indian markets. He is particularly hopeful about FPI participation because they take derivatives hedge for longer-dated contracts like monthly expiries.
The BSE chief is also keen that the number of brokers signed up for F&O membership grows to 400-450 soon from the current 350, and the fact that a chunk of the current members are large and medium-sized does not make him happy. For Sensex and Bankex derivatives products to be stable and all-rounded, the exchange needs the small brokers.
He also does not lose sight of the fact that only 1.5 mln unique client codes (investors) are regularly trading in Sensex and Bankex options. He wants at least 10 times more of them to participate. "There are 7 crore (70 mln) investors whose know-your-client registrations are complete, and 40 mln investors are trading in equity derivatives in India. A larger participation is important because it will get in diverse investors, he says.
Only when all the above factors are met will Ramamurthy think that the products have matured. "I may be right or I may be wrong, but you should be having these features and factors in place when you are talking about the economic significance of a product."
"At the appropriate time, I will levy appropriate charges." This time, according to Ramamurthy, will depend on participation levels and continuous talks with customers. There will be multiple permutations and combinations discussed to get a sense of how much charges can be levied. "There will be noise coming from all quarters. But we listen to the customers' voice, which never misguides."
As a small player in the equity derivatives space, the BSE is cautious of not deterring investors due to high transaction charges, he says. End
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