02 December 2008

Cross margining or the end of BSE

SEBI today extended the concept of cross margining to retail from the May 2008 move to introduce cross margining for institutional investors. I have blogged about it previously in August 08:

"The recent introduction of cross margining by SEBI, has almost guaranteed the demise of the (Bombay Stock) 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."

So is this the end of the BSE? While I don't have too much of sympathy for the BSE because they have invited this fate on themselves reflected in their performance and governance, but I do feel bad at having a monopoly exchange - which is a problem - howsoever well the NSE is run currently. A monopoly will behave like a monopolist. Also, a large part of the blame (in the recent past only) rests with the Government which refuses to allow a controlling stake in excess of 15% (5% till a few months back) by a single entity or group - creating a massive governance vacuum in the existing exchanges including BSE and other regional stock exchanges.

PS: I have blogged about the BSE issue previously on 9th August, 26th August and 6th Sept.

Explanation: Cross margining across the cash and derivatives segments means that margins are collected on a portfolio basis. Thus if a person (client) has a short position in futures and a similar long position in equities, the person may have a cancellation of the positions and thus need post no margin. In other words risk is calculated not individually but on a holistic basis - so if a stock goes up and opposing positions are held, one side will move up and the other position will move downwards reducing the risk in the portfolio on a net basis - thus in turn reducing the margins which are needed to be posted. As the BSE has practically no trades in the derivatives market, any person with exposure in both the cash and derivatives market will rationally move to the NSE to trade both the cash and the derivatives positions where he gets such benefits and thus saves money. Note, that the advantage would be eliminated if cross margining is done across exchanges - however, SEBI has not mandated such a move for reasons which are not clear.

Please see my main blog for the full post.

1 comment:

Gaurav Shah said...

4Hi, Sandeep Sir, regular visitor of your blog:
1. This move will help traders who do arbitrage, in that case wont dent BSE's share to that extent.
2. You mentioned that you don't advocate monopolization of exchanges, agreed but then if you try and see the securities that get traded on both the exchanges are same, and if one exchange has better product offering in F&O space, its bound to enjoy a large share of Volume Pie.
For survival either BSE should compete head on with NSE in F&O segment or develop a niche like exchange for Small Caps or for SME's..though sounds imaginary lot of SME's are in need of Risk Capital.
- Gaurav Shah
Batch of 2009 ICFAI BUSINESS SCHOOL ,Hyderabad.