Tuesday, January 9, 2018

Excerpts from the book Bulls, Bears and Other Beasts: How BSE scored a self goal

In his book 'Bulls, Bears and Other Beasts', author Santosh Nair presents a fascinating story of how BSE (Bombay Stock Exchange) scored a self goal and allowed unfettered growth of NSE (National Stock Exchange).

The history of this country is replete with antediluvian forces with vested interest hindered the progress of the country by opposing technology and innovation in their areas. Ideology did not matter. Be it communists in West Bengal who opposed computerisation and delayed the economic progress of the state or the 'Bombay Club' of leading industrialists who opposed the opening up of the economy or as the case below shows the brokers and jobbers at Bombay Stock Exchange....

Progress did not matter. Only vested interest mattered..

Read on the case of BSE that opposed computerisation, and how it pushed the exchange back a lot, as told by the author...

---(During the early 90s), there was no dearth of stock exchanges across the country, but BSE was by far the biggest and the most important of them all. It had the maximum number of companies listed on it, and was more liquid compared with its peers. CSE (Calcutta Stock Exchange) came within respectable distance of matching it in terms of liquidity, while Delhi Stock Exchange was a distant third. 

While many retail investors in far-flung towns preferred to transact on BSE, they invariably ended up getting poor prices because their orders would be routes through a chain of sub-brokers to the main broker in Mumbai. Each sub-broker in the chain would charge his commission, with result that brokerages charges alone would amount to 3-4 percent or even higher. Finally whether the investor got a good deal or not depended on how efficient and scrupulous the main broker was. More often than not, the purchase price was marked up closed to the highest price of the day and the selling price closer to the lowest level of the day. Brokers could afford 'take-it-or-leave-it' policy with their retail clients.

This is not to say that BSE did not have progressive minded members. Mahendra Kampani, when he was president of the exchange tried hard to computerise the trading process and convert the open outcry system int a screen-based one. The advantages of electronic trading were twofold. One, liquidity would increase as more investors could simultaneously access the system. This would shrink the spreads dramatically. More importantly, there would be greater transparency about the prices at which shares were actually bought and sold.

---this move would have dented the profitable business of many jobbers and brokers who thrived on the wide spreads and opaque prices resulting from low liquidity. 

--Not surprisingly, Kampani faced huge opposition from the broking community, and the proposal was put in cold storage.

What the broker-jobber lobby did not realize was that in blocking computerisation, they had dealt a crippling blow to BSE, a blow from which the institution would never really recover. 

-- a veteran BSE broker (who had once been a President of the exchange) told me how the exchange's electronic trading plan never got the backing that it should have from the government. In fact, it appeared that some influential people in the government wanted to marginalize BSE.

--- my own view is that (sic) somewhere along the way, BSE broker's lobby had become too powerful for its own good and was beginning to be seen as a challenge to the government. In the late 80s, when former UTI chairman Phervani, tried to get a broking card for a UTI subsidiary, he was denied it. UTI did huge business with the brokers and was aware that it was being regularly fleeced on quite a few transactions. To get around the problem, UTI decided to have its own broking card. But the big boys of Dalal Street would have none of it. One, the brokers who made a living off UTI's deals would lose a big share of the business. Two, giving membership to UTI would lead to similar requests from other institutions too. 

---When SEBI tried to get brokers to register with it for a fee, the proposal was stoutly opposed by brokers and jobbers. They refused to carry out transactions, with the result that BSE had to shut down for a week in April 1992.

Finance minister Manmohan Singh, who visited Bombay during that time, came down to BSE to meet the agitating brokers. Brokers behaved badly with the finance minster, shouting slogans and booing him. This would have piqued the government. A leading exchange of the country holding the government to ransom would have served to drive investors away..

Thus it was that NSE, set up with financial institutions as its principle shareholders, and originally meant to be a trading platform for wholesale debt, was given permission to start and exchange for trading in shares too. It commenced operations in November 1994, overnight changing the rules of the game.

From the first day of its operations, NSE started operations with an electronic trading system. NSE's biggest contribution to the stockbroking industry was the vast new breed of brokers it spawned. Anybody could become an NSE member by paying a (refundable) deposit fee and clearing an exam. 

The introduction of electronic trading rapidly shrank the spreads and dramatically improved liquidity. Liquidity, in turn, attracted more players, making the market even more liquid. No longer the brokers could fleece the investors as prices were transparent. 

In barely eleven months of going live, the NSE nosed past the BSE in terms of daily traded turnover, becoming the top exchange in the country.

That must have hurt...

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