Brokers' resistance to market reforms

While protecting the genuine demands of brokers, the regulators would do well to encourage transparency and ultimately do what is best in the interest of investors. Merely talking of globalisation is of little use and the sooner the broking community accepts globally accepted trading systems, the better it will be for the markets, says Oommen A. Ninan.

INDIAN STOCK brokers are a worried lot today though they were the market participants who had enjoyed all the benefits of non- transparency in the marketplace till now. For the first time in the history of the Indian capital market, brokers went on a strike en masse - going a step further and joining hands across stock exchanges - which is, in itself, a rare gesture of solidarity.

Now, the broking community is approaching the political bigwigs to bring about a reversal in equity market reforms! And it is quite astonishing that the political leaders have promised to even backtrack on earlier decisions in a phased manner.

It is interesting to look into some of the issues raised by the brokers. Their point of view is that the reforms in the functioning of stock exchanges were taken in undue haste. They argue that the reforms (end of badla trading and introduction of rolling settlement from July 2) were announced and sought to be implemented in a hurry without either taking market participants into confidence or having in place the infrastructure required to support the intended reforms. The brokers argued, ``an attempt to bring about reforms in such a manner would have a lot of negative implications rather than enduring benefits.''

While conceding that some of the reforms announced in March are vital for a healthy capital market, the brokers stuck to their core stand that ``banning of deferral products has taken away one of the most secure and liquid investment options from the retail market.'' They argued, ``As compared to all competing instruments such as bank fixed deposits, mutual fund investments and postal savings schemes, the badla and automated lending and borrowing mechanism (ALBM) systems offered the best return in a secured instrument.''

Strangely, the brokers have been struck by a sudden bout of sympathy for the investing community. ``For no logical reason, the investment avenues have been banned, forcing the investor to settle for low returns and comparatively illiquid financial instruments. Transaction facility on exchange networks, which was so far available easily in all corners of the country, is expected to shrink due to non-availability of the broking business.''

The brokers further lamented that volumes in post badla sessions had dropped by 75 per cent, from about 200 million shares to 50 million shares a day. They argued, ``Indian stock markets have been one of the worst performing markets in the past six months. Banning of badla and ALBM would make the market illiquid and result in erosion of capital. If the country has to look for an engine to provide fuel to the economy, the reforms that have been implemented will have exactly the opposite effect.''

While making out their case, the brokers have also taken up cudgels on behalf of mutual funds. ``Mutual funds have grown in size over the past few years on the strength of vibrant stock markets. Having invested in the market on the assumption of certain liquidity, market size, market participation by various investor groups, the mutual funds are in a Catch-22 situation. Exit is difficult, with high impact costs in an illiquid market. Fresh investment of a large size also is a costly affair. Sudden redemption pressures also cannot be met. If the idea is to have more investors going through the mutual fund route, life cannot be made more difficult for mutual fund mangers by withdrawing the avenues of investment.''

Mutual funds disagree

At this point, one must tune in to the view of a mutual fund manager. Mr. Sanjay Sachdev, Managing Director & CEO of IDBI- Principal Asset Management Co Ltd, said, ``The broker community in our country is quite savvy and are in fact the ones closest to the investor. They have seen the benefits of the changes as well as the pitfalls. We believe significant value can be provided by brokers in these uncertain times. With rolling settlement coming into place, they can no longer take the customers for granted. Thus they are today providing them more value added services.'' According to him, options and futures are one more step forward in the development of the capital market. ``Badla system had encouraged a lot of short term speculation and created artificial volumes. Once options and futures are embraced by the investment community, it will eliminate the inconsistencies that the badla system has created in our market,'' Mr. Sachdev affirmed.

``Markets whether Indian or international have seen changes before and have emerged stronger,'' stated a recent report of Prudential ICICI, another mutual fund. The U.K. markets went through an almost identical experience in 1993-94 when the London Stock Exchange (LSE) migrated from a fortnightly account period settlement to a rolling settlement. Although combined volumes of the shares which make up the FTSE 100 fell from 6.35 billion on March 1, 1994 to 5.13 billion on April 1, 1994, this more than recovered to 7.26 billion by March 1995. Similarly, when most Indian shares shifted to trading on a ``demat'' basis, the initial fall in volumes was followed by an exponential growth. Combined volumes on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) fell from Rs. 3,175 crores on June 29, the last date of the old system, to Rs. 1,399 crores on July 2, the first day of the new system. However, by the very next day - July 3, volumes have to Rs. 2,174 crores.

Interestingly, in Indian stock markets the fall in volumes does not necessarily indicate a fall in real investment. In fact, it was a fall in speculative trading rather than in investments that took place. Indian stock markets traditionally championed the cause of speculative interest. While speculative activity constituted more than 80 per cent of total trading volume, the real investors were only 10 to 20 per cent. However, in developed markets, the reverse holds true and the reforms undertaken in the Indian capital market were able to successfully reverse this unsavoury trend.

On July 23 this year, brokers abstained from trading to protest the imposition of rolling settlement. However, it is unlikely that the regulator would go back on its decision. Instead of seeking a withdrawal of the rolling settlement, they should have instead asked the Securities and Exchange Board of India (SEBI) to put in place market-making products such as stock lending and loans against shares or funding against shares. The blame for forcing the SEBI to introduce rolling settlement before putting in place other facilities associated with that squarely rests with the broking community. It is pointed out that they resisted all changes that sought to create transparency in the system. History has shown that investors, over time, adjust to any new system. It is only a question of getting used to it and then volumes will pick up in the market.

It is also unlikely that the demutualisation or corporatisation of broker-driven exchanges would nullify the malpractices committed by many broking members, especially in the case of the Bombay Stock Exchange and regional stock exchanges. Assuming that these broker members manage to corner shares at the time of corporatisation, they are likely to retain their control of the stock exchanges. The case of National Stock Exchange is entirely different as it is owned by public sector undertakings which have contributed to the building up of infrastructure for the capital market. As in the case of NSE, the Government and the regulator should confine brokers' role to their trading rights, when stock exchanges are demutualised.

It is in fact only the broking community which seems to have a grouse against the new system. Even here the larger market operators seem to have reconciled themselves to the reforms. While protecting the genuine demands of brokers, the regulators would do well to encourage transparency and ultimately do what is best in the interest of investors. Merely talking of globalisation is of little use and the sooner the broking community accepts globally accepted trading systems, the better it will be for the markets.

* * *

What they want

MAJOR RECOMMENDA-TIONS of the broking community to the regulator:

Introduce deferral product in some form to impart liquidity in the market.

Liberalise bank finance to stock brokers and investors.

Create a vibrant derivative market by recognising sub-brokers and not linking member's registration with turnover fees.

Recognise brokers' domain knowledge which is highly desirable for introducing new products and implementing various reforms.

Accountability of regulator is as important as that of any market participant. Bring about clear regulations for the same.

Majority of the reforms like rolling settlement and derivatives require an active electronic fund transfer (EFT) facility. Get RBI to implement as it early as possible.

Find a practical solution to the turnover fees issue. The quantum of fees asked for is far higher than what the margins would permit.

Broker bashing as a matter of routine should stop. The profession should be given the respect it deserves. For a few black sheep, one cannot blame all the brokers all the time.

Closure of business even without proper hearing and in some cases for simple clerical errors is unheard of anywhere in the world.

Demutualisation of stock exchanges.

OAN

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