The National Stock Exchange (NSE)came into existence five years ago to offer investors a transparent and efficient system to trade. NSE has lived up to its mandate and provided investors an alternate to the Bombay Stock Exchange. Dr. R H Patil, was handpicked to head NSE when it was floated as a part of capital markets reforms. Dr. Patil spoke to R. Venkataraman and Tushar Pania of India Infoline and shared his views on the evolution of NSE, its achievements and future plans. Dr. R H Patil started his career as a faculty member in the Post-graduate Department of Economics, University of Bombay. He joined the Reserve Bank of India in the erstwhile Economics Department. From there, he moved on to Industrial Development Bank of India (IDBI) and was a senior Executive Director, loan operations and treasury. He was hand picked to head the NSE and is the architect of its success.
NSE is today a five year old organization. Looking back, are you satisfied by its progress?
We are ourselves amazed at the success of the NSE. We did not anticipate that it would grow so fast. When the NSE was started, I was often asked how long would it take to reach the turnover level of BSE and my standard reply was five years. But we achieved that in the very first year. We had, for example, targeted to reach 200 cities eventually, but we are already in 276 cities and the rate at which we are growing, we will soon have a presence in over 500 towns.
NSE was started as a company instead of a trust or an association that could have given us tax breaks. We demutualized the exchange, ie the exchange was not owned by brokers, but run as a business proposition and which functions with a profit motive. Today New York Stock Exchange (NYSE) and London Stock Exchange (LSE) are demutalizing themselves, so we were somewhat ahead of our time. It also ensures that there is a high degree of corporate discipline and we have the responsibility of satisfying our shareholders (by paying them dividend) and our customers (investors) by giving them good service. Today we may be a costly exchange but we ensure that our service is better.
Why did OTCEI fail whereas the NSE has been a very big success?
OTCEI was designed differently. It was set up to give the financial institutions an exit route for their venture capital investments. These companies typically have a small capital and are not permitted to be listed on the bigger exchanges, hence the need for a smaller exchange. They had decided on market making as the only route for the market. As long as the markets are nascent this approach works but for matured markets this is not the right solution. I for one, am a firm believer in giving the market what it wants, while ensuring that the markets are safe.
Today the screen acts as the independent market maker. Besides with the market-maker, spreads used to be 1-1.5% while with the screen spreads have fallen to less than 0.5%. To conclude, OTCEI had a number of restrictions which made players reluctant to trade.
Ever since NSE was launched, it has been talked about as a rival to the BSE. After five years where do you stand vis a vis the BSE?
NSE was started with the basic aim of reforming capital markets and I am proud to say that we have achieved our targets. The turnover of NSE has been consistently higher than that of BSE, and on some days it is almost 2.5 times that of BSE. Of late, the gap has narrowed but this is due to huge quantum of badla transactions taking place on the BSE, which is a temporary phenomenon.
NSE has always been a leader in exchange related innovations. It is just a matter of time before rolling settlement is introduced. NSE was the first to talk about derivatives in 1996. At that point every one said that there was no need to introduce derivatives in India, but at least we started an intellectual debate in the country about this issue.
Do you perceive the inter-connect stock exchange will be a threat to NSE?
The Inter-connect stock exchange is a very good idea but a bit too late. Already we facilitate trade in regional scrips. Some companies are getting delisted from regional exchanges as the NSE gives them a national presence. Though Bombay accounts for 60% of trades on NSE, in the last few months we are seeing an increasing number of trades in other regions with exchanges. It shows that investors in those cities prefer to trade in local companies on the NSE.
NSE has been in forefront of innovation and automation. What are your plans now?
When we started, we had decided to go for a short settlement cycle where a trade is settled within 10 days of executing. This was at a time when the settlement on BSE used to take more than three weeks. When we said we will have weekly settlement many skeptics said ?you cannot do it?. However we were firm and said not only can we do it we can even handle high volumes. After we introduced weekly settlement, BSE too followed suit. We were the first to introduce weekly margins and mark-to-market margins and exposure limits. We had real time exposure limit which is indicated on the broker's screen and the moment a member exceeds his limit the terminal is automatically disabled.
The NSE is based on a competitive system where there are no entry or exit barriers. Membership is open to everyone and a member has an option to leave when he wants and his deposit is returned. The NSE has allowed members from different parts of the country, while BSE continues restrict them only to Bombay. All the terminals outside Bombay function as "sub-brokers" of BSE members.
The philosophy behind this is that the market should not be identified with geography. Anyone, anywhere should be in a position to access the market. Now we want to go global and we have also received regulatory approvals to expand our terminals abroad. We undertook a survey of our members and found that many of them are interested in setting up terminals abroad. The result of the survey was quite interesting. Some 68 members were willing to set up 81 terminals in four cities of UAE, 47 members wanted to set up 61 terminals in 16 American cities and so on.
Why are "deliveries" on the NSE low?
What is a market? In my opinion, a market is a place where price discovery occurs. Price reflects all available information and that happens as different people absorb information at different times and react differently. The price discovery process is an iterative. Delivery is an irrelevant issue. Whether trades actually result in delivery or not is not the market's concern. World over those who trade are not necessarily the final consumers of the product. What the exchange is responsible is that those who trade must by law settle.
What are your plans for Futures trading?
In a world where present and future markets are inter-related, we just cannot have only a cash market. We are not a vegetable economy which deals only in perishable goods but one where there is co-relation between present and future, if not there will be chaos. And the link is interest rates. We require equity derivatives, forex derivatives and even for the government debt paper.
We are ready and awaiting necessary regulatory changes. It was to be taken up in the last session of the Parliament but the house was dissolved. I expect that futures should commence in India by the second quarter of next year.
Will Internet based trading ever take place in India?
The next step is Internet trading. As long as it works in a way where the investor enters the order through a broker, who authorizes it, we have no problems. However there can be no deals without the involvement of broker or exchange as there will be then no one to guarantee trade. We are ready for Internet broking, but for infrastructure issues.
I am in favor of the way it is done in US where the investors come into the system through a broker. The trade takes place on the exchange and the broker validates it. SEBI has already appointed a working group to look into the issue.
Are you taking any steps to ensure that companies make more disclosures?
Before we permit a company to be listed, we evaluate the background of the company and check the promoter's track record and other issues and only list those companies who meet our standards. We also had a number of permitted securities listed on the exchange and stopped trading in few of them where we were not comfortable. However since we cannot delist a company, we have to be very careful when we permit them to be listed in the first place.
The problem started a few years ago when the exchanges started listing all and sundry companies with a view to earn increased listing fees. Today NSE?s contribution from listing is only 1-1.5% of total income and a major part of comes from transaction fees which is paid by the user for using the facility of the exchange to trade. Until SEBI and Company Law Board make requisite changes, nothing much can be done about increasing disclosure.
Are you proposing an IPO on the lines of NYSE?
The Australian stock exchange recently went public and is listed on itself. It is a radical concept in Indian context and I think the idea is before time. Also the shareholders of NSE, feel that there are many social mandates which NSE has to fulfill so there is no urgency to go public.
There are two risks of NSE going for an IPO at this point of time. The shareholders of NSE might want to maximize returns whereas NSE was set up with a view to speed market reform. We are still concerned that some of the brokers may corner shares of NSE and ask for seats on the board, which cannot be allowed.