Ever since the National Stock Exchange (NSE) came into existence in 1994, it has always been perceived to be one step ahead of its much older rival, BSE, whose origins date all the way back to 1875, making it Asia’s oldest stock exchange.
But, the much-older exchange, which also claims to be the fastest exchange in terms of trading speed of six micro seconds, has pipped NSE on the way to becoming the first publicly-listed stock exchange of India. The initial public offer (IPO) of BSE opens on Monday and shares are being offered in the band of ₹805-806.
If the response to the anchor portion of the offer is anything to go by, then the issue should have a smooth sailing. Prominent institutional investors like Massachusetts Institute of Technology, Goldman Sachs Asset Management, The Washington University, Citigroup, Kuwait Investment Authority Fund, ICICI Prudential Mutual Fund, DSP Blackrock Alternative Investment Fund and Kotak Mutual Fund among others have participated in the offer.
It is a fact that anyone wanting to own a pie in the Indian stock exchange segment cannot ignore BSE.
‘Niche player tag’
“The challenge for the BSE is that it has spent several years honing a ‘comeback’ story but in reality it has struggled to make a breakthrough and goes to market as a niche player,” says Patrick Young of D.V. Advisors, a Europe-based capital markets advisory firm.
“Then again, exchanges per se are at the epicentre of the future of financial markets. There is considerable upside in the exchange model, so even if BSE remains a niche player it can continue to profit, even if it remains in the shadow of the NSE,” adds Mr Young.
Incidentally, for the financial year ended March 31, 2016, BSE reported a net profit of ₹159.15 crore. In FY15 and FY14, the net profit was ₹151.35 crore and ₹159.44 crore, respectively.
While the exchange boasts of a good track record in terms of profit and a cash kitty, there are problem areas for which it has been trying to find solutions for years.
Achilles heel
Equity derivatives is one segment where BSE has been trying to get a foothold for many years now.
“We may not be able to maintain or increase trading in our equity derivatives segment and there is no guarantee that we will be able to compete in this segment with the NSE,” it states in its IPO prospectus.
Since September 2011, BSE has been doing a series of market-making schemes – paying to trade on the BSE – to attract traders to its equity derivatives segment. Between financial year 2012 and fiscal 2016, the exchange spent ₹269 crore as incentives in the market-making scheme.
Still, there was a sharp decline in the equity derivatives segment turnover when the exchange stopped doling out incentives on April 1, 2016. From a high of 20.80 lakh contracts traded in FY15, the number fell to a paltry 954 in the six months ended September 30, 2016.
Interestingly, BSE chief executive officer Ashishkumar Chauhan has, on numerous occasions, said that derivatives are not instruments of capital formation and so the success of an exchange should not be solely measured in terms of derivatives turnover – an obvious jibe at rival NSE that boasts of a near-monopoly in the equity futures and options space.
All is not lost
While it has clearly lost the battle in equity derivatives, it has neatly stolen the show in the SME space.
BSE has more than 160 small and medium enterprises (SMEs) listed on its platform, much higher than NSE that has just more than 30 such entities. Both, BSE and NSE started their SME platform in 2012.
On the mutual fund platform of stock exchanges as well, there are more trades pouring in through the BSE compared to that of the NSE. The older exchange has also been able to create a place for itself in the currency derivatives segment.
While these are obvious successes, it still has to hold on to its pie in the equity segment, where again NSE has grabbed a lion’s share. On an average, BSE sees a daily turnover in the range of ₹2,500 crore and ₹3,000 crore. This is much lower than that of NSE that clocks more than ₹17,000 crore on most days.
The exchange is also betting big on GIFT City, having operationalised its wholly-owned subsidiary India International Exchange (INX), which will function 22 hours a day, five days a week.
Shareholder exits
The IPO of BSE would see some of its prominent shareholders exit the bourse. While more than 300 entities – individuals, brokerages, institutional investors, exchanges – are selling their shares as part of the public issue, Singapore Exchange, Quantum (M) and Atticus Mauritius – among the top 10 shareholders – will completely exit the bourse.
Market participants said that while the complete exit of Singapore Exchange along with that of the partial sell off by global exchange investor Caldwell Holdings Inc. could be looked as a negative, the decision of the Deutsche Boerse to stay invested would be looked upon as a positive factor.
Interestingly, domestic institutional investors like State Bank of India (SBI) and Life Insurance Corporation of India (LIC) have chosen not to sell any shares as part of the public issue. While SBI has a stake of 4.75% in the BSE, LIC owns 4.68%.
Likewise, some of the prominent investors of the NSE are also looking to exit during the public offering of the larger exchange. According to the draft prospectus of the NSE, some of the bigger shareholders that will offer their shares as part of the IPO are Tiger Global, Aranda Investments, Citigroup Strategic Holdings, IDBI Bank, SBI, SAIF Investments, GS Strategic Investments and Norwest Venture Partners.
Incidentally, the public issue of NSE has been in the news for long with its existing investors even writing to the board and senior management of the exchange to expedite its listing process so that there is greater transparency in pricing of shares and exits are facilitated on the stock exchange platform.
“Clearly, NSE is the dominant provider nationally. BSE, while being much older, is still trying to revive its fortunes. BSE has considerable optionality and has come a long way from being the ‘sleepy hollow’ it had become by the mid-1990s when NSE was formed,” said Mr. Young.
Potential in exchanges
There is no doubt that there is potential in the exchange business. The share of equity as a percentage of financial savings in India is only 5% compared with 14% in China, 15% in Brazil, 20% in Indonesia and 42% in USA.
Among the leading listed exchanges of the world like Nasdaq, Intercontinental Exchange, CME Group, London Stock Exchange, Hong Kong Exchange, Singapore Exchange and Deutsche Borse, India’s BSE tops in terms of share of listing fee as part of its overall revenue.
Its EBITDA margins are better than Nasdaq, LSE and Deutsche Borse. Even its profit margins are comparable to LSE and Deutsche Boerse and are better than Nasdaq.
“BSE is not vastly expensive for an emerging market exchange... the biggest risk is not the market but in fact the risk of the clunking fist of the regulatory nexus harming the business through unnecessary intervention,” said Mr. Young.
India has restrictions on the ownership of exchanges. Only a few categories of investors are allowed to hold up to 15% in an exchange and most have to be content at 5%. Interestingly, there are relaxed norms for exchanges located at International Financial Services Centre (IFSC) like GIFT City at Gujarat and BSE is clearly eager to be at the forefront.
BSE may not be the world’s best exchange and may lag in many parameters but it has surely come a long way from the ‘broker’s den’ that it was once known. It is a professionally-managed exchange and has been striving hard to create its own niche in a space that is hugely dominated by its larger rival.
Investors should remember that the exchange business is a good model to look at, especially in a country like India with low equity penetration. Exchanges deliver profits (as has been the case with NSE and BSE) and also have restricted risk during downturns due to the absence of leverage. Also, post-listing, the exchange would enjoy greater flexibility in terms of raising capital, if needed.
