India's Battle Of The Bourses

A new exchange drags the markets into the 20th century

To get a real rise out of M.C. Damani, president of the Bombay Stock Exchange, all you need to do is mention the rival National Stock Exchange. The NSE, launched by a group of Indian financial institutions less than two years ago and located at the other end of town, has been steadily grabbing business from the 111-year-old BSE, Asia's oldest stock exchange. Damani says the reason is regulatory favoritism.

"The government of India has been partial to the NSE," he fumes. But his archenemy, NSE Managing Director R.H. Patil, thinks that explanation is just sour grapes. "In 18 months, we have two and a half times the BSE's trading volume. They are shattered," he says, laughing.

FIRST TASTE. The battle of the bourses is reshaping India's financial scene. When the NSE introduced computerized trading at its startup in November, 1994, the country got its first taste of how a modern market system works. Abandoning its traditional open-outcry system, the BSE followed suit in 1995. Automation improved transparency, which in turn has lowered buy-sell spreads and brokerage fees. After some election-year jitters early in the summer, trading volume is on the upswing. Most important, the rivalry has focused attention on the remaining inefficiencies in the market. If these are addressed, India could join the club of the world's advanced stock markets in just a few more years, attracting billions in foreign investment that India badly needs.

For investors, the new competition has been a boon. The BSE, commonly called the "share bazaar," formerly did 90% of all India's stock transactions, with the rest divided among 21 regional exchanges. Investors in distant towns who wanted to buy a BSE-listed blue chip had to pay hefty fees to "sub-brokers," who then transacted with authorized BSE members in Bombay.

A week later, maybe, the trade was made, at a price fixed by the two brokers--usually somewhat higher than the quoted price. Fraud was rampant. Penalties were light, and influential members of the BSE ignored them entirely. "The investor really lost out," says Samir Barua, professor of capital markets at the respected Indian Institute of Management in Ahmedabad.

The NSE has taken direct aim at such practices. Computerized trading has narrowed spreads by 75%, and brokerage fees have been halved. Trades are executed within minutes. The NSE also has far more stringent listing requirements than the BSE. Its 940 members trade in the top 1,400 stocks that make up 93% of India's total market capitalization, while the BSE lists those plus 5,000 much smaller companies. The new exchange saves money for brokers, too. Membership on the NSE costs just $215,000 in a refundable deposit. Seats on the BSE, which last year sold for more than $1 million, are now going begging at half that price.

The good news for investors has a downside, however. Greater efficiency at the BSE and NSE threaten to make the regional markets obsolete. For years, the regional exchanges, with a mostly retail clientele, listed small local stocks ignored by the BSE. Now, there are 900 NSE terminals in 47 cities. So, for example, the Madras Stock Exchange, which used to trade $3.5 million worth of shares a day, now does half that volume.

Things could get even worse for the local exchanges. Damani claims that the BSE can compete fairly with the upstart only if it gets permission to go national with Bolt, a proprietary online system that would let sub-brokers around the country trade BSE-listed stocks. Damani says that Bolt would double the number of BSE terminals in the country to 3,000 within six months. It does not worry him that the regional exchanges would probably lose their business.

But it does worry the Securities & Exchange Board of India, the BSE's regulator. Says Executive Director O.P. Gahrotra: "Our stock exchanges are going through a very, very difficult period. Bolt is not being approved precisely because of the perception that the small exchanges will die." SEBI is waiting for the regional exchanges to come up with a plan to merge or form a regional trading grid.

The market needs other reforms, as well. For one thing, computerization has done nothing to speed up share delivery. Back offices are piled high with stock certificates waiting to be processed. Typically, delivery averages 10 days, but actually transferring ownership, after which the new bearer can collect dividends, can take up to a year. Theft of share certificates in transit is common. The NSE has been pushing for the establishment of an electronic depository. Patil hopes it will be operational by yearend, eliminating the paper nightmare and removing one of the biggest hurdles to investing in India.

FIGHTING HARD. Another problem is that transparency is still limited. The Indian market is dominated by domestic and foreign financial institutions, which trade in large volumes and prefer to keep their orders confidential. So nearly half their orders are executed on the telephone, with prices negotiated privately between brokers. Typically, big blocks of stock command premiums over the market price. Such trades must be reported to the BSE, but the exchange does not publicly quote the price at all. Again playing the role of reformer, the NSE requires trades of more than $286,000 to be approved, presumably to monitor any price-fixing.


The NSE is also taking the lead with plans to develop equity futures and options and introduce index-based derivatives. But the BSE has tradition on its side and is fighting hard. Mahesh Gandhi, former portfolio manager for the Unit Trust of India's $155 million India Growth Fund and now an independent investment adviser, has a theory. If the regional exchanges decide to merge with either the NSE or the BSE, he says, "what would emerge is a classical New York Stock Exchange and American Stock Exchange system. It'll be a hugely different market two years from now." The NSE has already shown how much can change in two years.

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