Sucheta Dalal :Will Cross Margins Kill the Bombay Stock Exchange?
Sucheta Dalal

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Will Cross Margins Kill the Bombay Stock Exchange?  

May 10, 2008

Will Cross Margining Kill BSE?



By Sucheta Dalal


Cross margins across the cash and derivatives segment is great news for investors – apart from reducing margin requirements it could cut investors’ trauma at times when a sharp fall in prices creates mayhem in the market.

But, this positive move by the Securities and Exchange Board of India (SEBI) could easily be the death knell of the 135-year old Bombay Stock Exchange (BSE). How would this happen?

In the past few weeks, Chairman C B Bhave has introduced a number of policy measures that tighten some margin requirements and relax others. For instance, institutional investors have been brought on par with retail ones by asking them to pay margins on a T+1 basis. This forces them to bring in their money upfront – a fact that has made foreign institutional investors (especially those with a high churn rate and more short term outlook to investment) as well as their custodians (who lose income on float funds) unhappy and claim that it will increase transactions costs.

On the other hand, SEBI has allowed them Direct Market Access (DMA) through brokers’ infrastructure, eliminating the possibility of front running on their stocks by these entities. Also, as SEBI’s circular says, it will permit faster access, lower impact cost and lesser errors.

SEBI has also introduced cross margining across the equity and derivatives segment. This helps all investors who trade in cash and derivatives. For them, margin payment is significantly rationalised and it also reduces transaction costs. Consequently, investors are happy with the cross-margin move, but it would mean that the BSE, which has no derivatives business to speak of could end up a big loser. The BSE has had almost a decade in which to grow and nurture the derivatives business, but has made little headway. The NSE meanwhile has a natural monopoly in the derivatives segment and a strong cash market as well. Naturally, much of the big institutional business will shift to the National Stock Exchange (NSE), further strengthening its monopoly

Once that begins to happen, the Pareto principle (or the 80:20 principle) kicks in and the BSE will quickly lose its relevance.


Is SEBI against the BSE?

The best was to find out is to ask the regulator. We spoke to SEBI Chairman C.B.Bhave, who said that the decision, as usual, was taken after discussions with both national exchanges and the BSE did not raise any objection or express fears of losing business. In fact, Mr.Rajnikant Patel, CEO of the BSE has still not responded to our query about the impact on the bourse. Mr.Bhave was emphatic that SEBI was not in favour of a NSE monopoly. He said, SEBI will have to examine ways to strengthen the management and ownership structure of the BSE to figure out how to make it an effective competitor to the NSE. This may mean some significant policy changes in the near future.

So far, the BSE has merely rushed to emulate the NSE, often without success. We learn from reliable sources that despite the appearance of a professional board of directors, there is considerable friction between some BSE board members and its CEO Mr.Patel, who had even offered to resign in the recent past. He is understood to have told the Finance Minister as well as key investors that he suspects a management coup by one of his senior officials. With all these goings-on, foreign institutional investors led by the Deutsche Bourse, who acquired a stake in the BSE are also disappointed with their investment. It is not clear whether the very eminent public representatives on the BSE board have played their anticipated role in pushing the exchange to set its house in order. The Finance Ministry is also worried about the BSE’s future and is in favour of taking such measures as required to strengthen its management structure. Some of these issues were to be discussed at the SEBI board meeting on 13th May 2008.  

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-- Sucheta Dalal