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Ramachandra

Can the regional stock exchanges shake off their lethargy and get back into the ring?

REGIONAL stock exchanges (RSEs) are in the news again. A few southern RSEs are planning to form Indonext, a new exchange likely to be in line with the recommendations of the SEBI-appointed M. R. Mayya Committee, set up to suggest consolidation of Indian stock exchanges on the lines of "Euronext".

These RSEs are planning to start a national-level trading platform, supplementing the NSE and the BSE — the so-called national exchanges. One proposal is that of placing all the shares listed exclusively on the RSEs on a common order book.

The members of all the participating exchanges will trade on this common order book. Regional exchanges have lost their relevance as far as liquidity is concerned. The combined turnover of 21 regional exchanges (barring the NSE and the BSE) was a mere 3.84 per cent of the total during April 2002 to February 2003.

Of these, 11 exchanges recorded nil turnover, virtually closing their own trading segment. To ensure their members' survival, some of these exchanges have formed subsidiaries and have taken membership with the national exchanges. Effectively, the orders received by the members are sent to either the BSE or the NSE.

The liquidity of securities listed on the exchanges is an issue that needs attention. Trading in the premier stock exchanges is concentrated in a few companies, particularly those in the IT sector. In 2001-02, 50 of the 990 companies listed on the NSE contributed to 91.56 per cent of the turnover. Of this, 66.58 per cent came from IT companies alone. Another 50 companies contributed 3.45 per cent of the turnover, leaving the remaining 890 companies making up a mere 4.09 per cent of the turnover.

As regards the BSE, during April 2002 to February 2003 only 2,658 securities of the 5,659 eligible ones were traded at least once. The corresponding figures for the NSE were 897 and 925 respectively. The NSE figures are better because the number of securities listed are far lower than that on the BSE. The liquidity of the securities outside the `Top 100' is very poor. If one considers paid-up capital, the turnover of companies with less than Rs 20-crore capital would be even worse.

Would Indonext be a viable alternative for low-cap, illiquid securities held by a large number of small investors? To bring liquidity to these securities, a structural change in the marketplace is required. Illiquid securities cannot be dealt with in order-based trading systems.

These securities need market-makers who are willing to make the market for a spread. The Mayya Committee has rightly highlighted the need to provide alternative methods of trading for these stocks, such as the Market Maker Model of Nasdaq, single call auction, and so on. The market-makers need to commit their capital for this purpose. For bringing in such capital, there should be commercial viability for these participants.

The attempt by the RSEs at providing an alternative trading platform to the NSE/BSE is not new. The last such attempt was the formation of the Interconnected Stock Exchange of India (ISEI) by 15 RSEs. The RSE members wanted their own platform to trade in the liquid stocks being traded on the NSE/BSE, which would provide them a larger order book. But when the moment of reckoning arrived, many of the RSE promoters simply failed to close their trading systems and consolidate their order books. This time round, though, such things cannot happen, because none of the RSEs has any significant order book.

Today, neither the NSE nor the BSE has any exclusive trading privileges. Both these exchanges allow trading in the same securities. The NSE lists securities of 818 companies and, under the permitted category, allows trading in the securities of another 107 companies. For the 11-month period up to February 2003, the NSE turnover, at Rs 5,75,434.50 crore, was 63.66 per cent of the total. The BSE lists the securities of 5,647 companies and allows trading in 12 more companies under the permitted category. But the BSE turnover was Rs 2,93,808.50 crore, 32.5 per cent of the total.

Despite a large number of listed companies and national reach, the BSE is unable to provide much-needed liquidity to securities beyond the `Top 100'. This is despite the BSE being oldest exchange and providing a hybrid system of trading, by allowing quotes-based entry.

Indonext is likely to request SEBI for an exclusive listing privilege for companies having paid-up capital of less than Rs 20 crore. As on March 2002, there were 9,644 listed companies, with none of them eligible for listing on the NSE/BSE. It is estimated that at least 25 per cent of these have a paid-up capital of less than Rs 20 crore.

Considering this, Indonext should be the trading venue for over 2,000 small-cap stocks. With an average listing fee of Rs 15,000 per company, Indonext should be able to generate Rs 3 crore a year from this source.

Till recently, the RSEs had the privilege of companies applying for listing with them, thanks to the requirement of primary listing in the exchange of the region. The Government has amended this rule, giving companies the choice of listing their securities on any exchange. Hence, multiple listing — that is, listing in one primary regional exchange and one national exchange — is no longer required of companies.

However, the regional exchanges already have a wide number of such primary listing which they are likely to lose. However, Indonext would be an ideal platform for trading in securities which are primarily listed on the RSEs and having a paid-up capital of less than Rs 20 crore.

However, companies which are already listed on the NSE/BSE (with paid-up capital of Rs 10 crore and above) may not opt for Indonext until there is liquidity in this market.

With the recent changes to the primary listing rules, RSEs have lost the exclusive privilege of levying listing fees from these companies. With the changed rules, RSEs will be left with companies which are not eligible to be listed on the NSE/BSE, that is, those with paid-up capital of up to Rs 10 crore.

With request for exclusive listing rights for companies up to Rs 20-crore paid-up capital, the RSEs are likely to enhance the size of their potential market of listed companies.

European markets do not have common jurisdiction for regulating listed companies. The Euronext model provides listed companies the advantage of jurisdiction of choice, that is, where they want the securities to be listed. However, the RSEs under the Indonext model would not have such preference of jurisdiction, as all the companies are subject to the same jurisdiction.

Small-cap stocks need a large number of intermediaries to buy and sell the stocks. It is envisaged that most of the RSE members would get trading privilege on the Indonext. Whether the large number of RSE members would provide much-needed liquidity in this market is not certain, as many of them are currently inactive.

The only enabler for them to trade on the Indonext is the promise of transfer of their current base minimum capital from the RSEs to Indonext to provide trading privilege.

Indonext would also need participants who can build portfolios and make a market in illiquid stocks. Such market-makers need more capital. The ultimate test for the exchange lies in providing liquidity and building investor confidence in the system.

If liquidity is provided, it will attract more number of players which, in turn, would improve liquidity.

Clearing and settlement and risk management are important aspects for an efficient market, and these would need to be centralised. Some RSEs may want these to be in their control.

The RSEs promoting this exchange and moving their securities to this market would contribute part of their listing fees to this exchange as funding. As per regulatory prescription, any new exchange should be a de-mutualised exchange. Therefore, it should also be commercially viable.

Commercial viability of the exchange should not depend on the funding by the mutualised RSEs. Why not the collective leadership of the RSEs consider merging the RSEs to form the Indonext and pool-in their strengths? This would enable them to make optimum use of collective resources and bring in economies of scale in their operations.

A de-mutualised Indonext, formed by merging the RSEs, would probably be more commercially viable than the independently de-mutualised RSEs. However, there are very few examples of management of the RSEs showing such courage and pragmatism.

The ISEI, promoted by the RSEs, did not take off mainly because the participating exchanges dithered in putting their might together to protect their own trading books, which they have now lost.

It would not be inappropriate to suggest that the ISEI itself could be transformed into Indonext. The RSEs could bring in the necessary changes to the structure of this exchange to fulfil the Indonext vision.

Small-cap companies need their securities to be liquid to attract shareholders. Again, investors need performing companies whose securities are liquid. Will Indonext provide this much-needed liquidity to companies and investors? Indonext needs to be planned well to meet this test.

Computerised trading systems can only bring transparency to the trading system, not liquidity. A case in point is the RSEs, all of which, though computerised, are almost defunct.

(The author, a principal consultant, Tata Consultancy Services, Chennai, was executive director of the Bangalore Stock Exchange.)

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