Dragging Bombay's Bourse into the 21st Century

New rules will make it less risky and more transparent

Dilip Bagri's father founded the small brokerage he runs in the Bombay Stock Exchange building on historic Dalal Street. Now, he's not sure how much longer he'll be in business.

What worries Bagri is a sweeping modernization of India's century-old trading system called badla, which combines features of forward and margin trading. The legal but minimally regulated and risky system allows investors to trade stocks with little cash. What's more, they can settle the trade up to five days later--and can pay a fee to delay settlement even longer. The system is fueled by financings from individuals and companies, lured by the high rate of return.

The badla system has long been used by honest brokers but is prone to abuse. Heavy gamblers can lose money for days without the market knowing how much. That's what happened in March on the Calcutta Stock Exchange. Market guru Ketan Parekh and his followers failed to cover their badla-financed positions, and the Indian market went into a tailspin from which it has yet to recover.

BAFFLED. A history of such disasters has prompted the Securities & Exchange Board of India (SEBI) to drag India's securities markets into the modern world. New trading rules and instruments, which go into effect on July 2, will bring India daily settlement, single stock options, and, later, real-time electronic payment and regulated margin trading. Futures and options on the benchmark Sensex and Nifty indexes were launched last year.

But for small dealers like Bagri, who is vice-chairman of the Bombay Stock Exchange Brokers' Forum, the costs of upgrading will be prohibitive. Brokers will have to meet capital adequacy standards and upgrade software. Combined costs could be as high as $100,000. Bagri predicts that baffled investors and dealers will stop trading. "My business could go under," he says, and so could two-thirds of India's estimated 2,000 brokers.

Not everyone laments the end of badla. "We will now be in line with global good practices," says Nagendra Parakh, chief general manager for derivatives and venture capital at India's Securities Board. Settling and paying for trades on the same day limits the damage one person can do.

The upgrade will give foreign and Indian institutional investors, who weren't permitted to use badla, legitimate ways to hedge their bets on individual securities. The reform will also introduce transparency and keep marginal players out of the market. And it will draw more foreign investors, says Khozu Arsiwalla, head of futures and options at J.P. Morgan Chase & Co. in Bombay.

Bombay's local brokers see that as cold comfort. "What happens globally," says Bagri, "is different. We have a separate set of circumstances. There is nothing wrong with the old system." SEBI regulator Nagendra Parakh says the small brokers are panicking unnecessarily: "They'll find other means of arbitrage. Their fears are uncalled for." Other brokers embrace the change. Says Parag Parikh, who runs an advisory and brokerage service in Bombay: "With this system, all the illiteracy of the market will vanish." Confusion at the start of the new trading is a certainty. But the reforms will transform India's exchanges from bazaars to modern bourses.

By Manjeet Kripalani in Bombay

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