Trouble at the Bombay Stock Exchange

"What's on your mind, if you will allow the overstatement?" Fred Allen

The news about the Chairman of the Bombay Stock Exchange (BSE) quitting (as also another Board member Jamshyd Godrej) was a prelude to the CEO, Rajnikant Patel leaving yesterday or so - see news items on the exit a and b. Jagdish Kapoor the current chairman has asserted according to a news item that the two were not linked and that Patel left for ‘personal reasons’. But another item quoting Rajnikant Patel as saying “One should know when to give up” gives a wholly different picture. Clearly a lot is amiss. On the chopping block seem to be an acquisition of NMCE a commodity exchange and a technical collaboration with Swedish OMX Nordic Exchange for supply of equipment and services. Both are denied by the current Chairman. Whatever…

Rajnikant Patel oversaw some significant though not the best of times for the 133 year old exchange. He took the exchange through a distracting mandatory corporatization and demutualization (C&D) of the exchange. The C&D resulted in a good outcome i.e sale of stakes to Deutsche Börse and Singapore Exchange generating some optimism for an exchange in gradual decline. Though at the regulatory cap of 5% each and no Board seats, there was hardly any salutary effect in terms of improved governance and management. Patel also had the Sensex launched overseas on the US Futures Exchange (formerly Eurex).

At the same time he saw the exchange losing out to the National Stock Exchange steadily. From an approximate even share of the equity markets in 2000, till the launch of the derivatives segment in June 2000 when the BSE for nearly a year overtook the NSE in the derivatives segment, the BSE has consistently trailed the NSE in the cash segment and has been wholly trounced in the derivatives segment.

There has been constant tinkering with the Board of the exchange both before and after demutualisation. The error of this realignment and attempt to improve the exchange by rejigging the Board is deeply flawed. While a Board can impart long term strategy to a company, such rejigging destroys whatever vision is required to gain a competitive advantage. More importantly, it is the management which runs the show and BSE has always had both a weak management structure and ‘event risks’ including various scams and bogey scams. In addition, the Board structure is overly regulated, with the regulator having an overpowering say in the Board composition – though the position is substantially better than SEBI officers sitting on the Board of exchanges, as used to happen at one point of time (RBI continues with this disturbing practice).

My colleague at the institute dean Jayanth R Varma wrote an important paper titled “Regulatory Implications of Monopolies in the Securities Industry”. He said, way back in 2001, that “Reduced competition would remove the single most important driver of capital market modernisation in this country and would create several serious regulatory problems.” We may now be on the cusp of this Armageddon.

The recent introduction of cross margining by SEBI, has almost guaranteed the demise of the exchange in any case. While there is a strong economic rationale for allowing cross margining between the cash and the derivatives segments i.e. treating the risk margining on a basket basis rather than on a gross basis – it is almost certain to move the entire cash volumes to the exchange with the derivatives dominant NSEL (as lower margins would need to be paid at NSEL). Now with the current developments, the end of BSE looks closer than ever. This is very bad news for the investors of the country as a whole and will require a wholly different regulatory structure and closer oversight over the monopoly. The only ray of hope could arise out of a major reform of the regulatory embargo imposed by the regulator on a person not being allowed to hold over 5% (see Reg. 8) of an exchange in the SEBI (MIMPSRSE) Regulations 2006 (don’t ask for the full name). The regulator needs to move it up, say to 26% or 51% or even more while retaining a veto on who can buy over 1% as is currently the case. This would ensure that unsavoury companies do not own/control exchanges. Deutsche Börse or Singapore Exchange managing the BSE are the last hopes of reviving competition – and of course a listing of its shares quickly would ensure accountability to the shareholders of the exchange rather than the impervious Board which is not really appointed by the shareholders and has little to lose were the exchange to collapse.