Sucheta Dalal :Will change mean progress or confusion? (11 February 2002)
Sucheta Dalal

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Will change mean progress or confusion? (11 February 2002)  

A couple of weeks ago, the Securities and Exchange Board of India chairman, D R Mehta, told this newspaper how he had presided over a paradigm shift in the Indian capital market. He spoke of how the secondary market in India has transformed itself from a backward system, fraught with broker-defaults, unlimited counter-party risk, bad deliveries, frequent market closures and poor price-discovery to a fully automated system, on par with world’s best.

In under ten years, we have automated trading, expanded the direct reach of major stock exchanges to over 400 centres, dematerialised shares, eliminated counter-party risk, moved to rolling settlements and introduced derivatives trading. If anything, the capital market is held back only by the Reserve Bank of India’s failure to introduce electronic transfer of funds which has prevented faster settlement of trades.

At the same time, there has been a significant change in the distribution of trading. While trading volumes have soared dramatically, most of India’s 23 stock exchanges have become redundant. The National Stock Exchange now accounts for 65 per cent of trading volumes nationwide while the Bombay Stock Exchange accounts for another 33 per cent of the business. All other bourses, including Kolkata, Delhi and Ahmedabad, may close down eventually. However, as efficient and vibrant may the secondary market be, the primary market is moribund, the debt market disorganised and supervision is lacking. Is this the shape of the future?

The future would depend on several factors. The quality of supervision is dependent on who is appointed to head Sebi in the coming years. This decision depends on whether policymakers understand the long-term damage caused to the capital market by frequent scams and poor supervision, or the need to correct it. A study conducted by Dr L C Gupta of the Society for Capital Market Research and Development shows that the number of investors is stagnating at two crore since 1997. The study points out that investors perceive the primary capital market as far riskier than the secondary market. Both these factors have a long-term impact on the role of the capital market in raising public funds. Industry houses may want to consider these facts before lobbying for a “soft” or “market-friendly” Sebi chairman.

As far as the NSE is concerned, technology changes that took the secondary market to a new level of sophistication will probably continue to create significant changes. At a recent seminar in Pune, Dr R H Patil, former managing director of the NSE, outlined some interesting changes that he foresaw in the coming years. Dr Patil believes that the growth of Internet trading will take the stock exchange to the desks of ordinary investors. Also, global competition, cross-border listing of securities and the demand by Indian investors to access overseas markets will force the bourses to face up to international competition and create cross-border payment and securities settlement systems. The possibility of ‘straight through’ processing of transactions will also change the nature of business. This envisages that a purchase transaction will simultaneously be communicated to the buyer’s bank to pre-empt funds for payment and a sale transaction to his depository account to block the shares for delivery, eliminating trading risk and allowing investors (individual as well as institutional) to operate without going through brokers.

Dr Patil himself is spearheading the RBI’s attempt to change the face of the debt market through the Negotiated Dealing System and the Clearing Corporation of India Ltd. This effort, however, raises several uncomfortable questions. Given Dr Patil’s track record, the NDS will fulfil its core objective of eliminating asymmetry of information between investors (mainly banks) and intermediaries and providing an efficient and transparent trading platform for debt instruments. The NDS will allow dealers to execute trades in the computer-matching mode or in the chat mode to negotiate deals on the system itself. It will reduce risk through restricted access. For instance, it aims to ensure that the call money market is purely an institutional market open only to AAA rated banks and not for weak ones. All others will have to access their funds requirement through the repo market.

But is the RBI’s decision to set up its own trading platform, outside the supervisory purview of the Sebi, beneficial for the market? The RBI has a terrible record of supervision, is poor in transparency, and intolerant of criticism. This does not make it an ideal supervisor. Secondly, the NDS re-creates what was easily possible within the NSE’s wholesale debt market system. The only apparent reason for creating another platform is that the RBI wants to keep the debt market pristine and pure — unsullied by existing bourses and the influence of brokers. In fact, the NDS aims at eliminating brokers altogether. It is a closed market exclusively for the institutions and primary dealers, all operating under the eagle eye of the RBI where information available on the trading screen will substitute the expertise of brokers in matching buyers and sellers.

Will it work? It is too early to tell but the attitude is in line with the RBI’s long time allergy for brokers. Remember how it eliminated brokers from call money deals in early 90s? Banks continued to use brokers and found shadier ways to compensate them. Another issue that remains unclear is whether the NDS will be registered as an exchange under the Securities and Contracts Regulation Act, or will the laws be amended to give it special status to operate without brokers. Finally, one always understood that reform in the debt market would aim to expand the market and allow some retail participation in it. The NDS, however, is an exclusive club open only to those entities which have an SGL and current account in the RBI. A few other large corporates, NBFCs and funds will be given ‘guest membership’ through a large bank, but only for a limited access.

Clearly, the future of Indian capital market is full of contradictory signals: dying regional exchanges and an avant garde debt market system without brokers; vibrant secondary market and comatose primary market; nationwide access to electronic trading and poor supervision. Do they add up to progress or confusion?

-- Sucheta Dalal