Financial Derivatives

Pravin Wakle EPGDBM110315 Sowmya Krishnan EPGDBM110320

[ASSIGNMENT ]
This Assignment is to deal with two question 1) why derivatives trading volume is Higher in NSE compared to BSE. 2) impact of growth of the financial derivatives on the Indian financial system.

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[ASSIGNMENT ]

1 Derivatives trading volume is Higher in NSE compared to BSE

BSE introduced derivative trading in June 2000, around the same time as the NSE. But, NSE was able to garner larger share in derivatives as traders already using its nation-wide online terminals easily switched to derivative trading on the same.
Launched in the year 2000, BSE derivatives volumes surpassed the only other competitor NSE for a few months. Then they virtually fell off a cliff. Given the much larger size of the derivatives market, the BSEs overall market share is 3% now. Of the many well wishers of the exchange, there has been steady support. Unfortunately that hasn't been enough.

1.1 NSE & BSE growth from 2000

Figure 1.7 shows the time-series of NSE and BSE turnover. This graph is in log scale. Straight line segments in such graphs correspond to of constant percentage compound growth rate. This suggests that NSE has had a phase of meteoric and steady growth from May 2001 onwards.

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As has taken place with competing derivatives markets elsewhere in the world, there was substantial competition in the early days of the market. However, once NSE obtained some critical mass, BSE turnover substantially faded away. Today NSE has become the clearly dominant market trading equity derivatives in India.

1.2 Initial Hiccups:

While clearly, the initial few years after the NSE came into play, BSE was ill prepared for the efficiency, independent management and the clear technological lead provided by the NSE. Some was subsequently blamed by many on the bias of SEBI towards NSE. This was probably untrue. SEBI stood for much of what NSE stood for rather the NSE itself. There were some delays which are normal in any regulatory approval for instance granting BSE a nationwide terminal tag, which would have helped it spread quickly. The second stage was the early 2000s which saw the launch of equity derivatives on both the leading exchanges. The lead which NSE had shown in trading in the cash segment led to a complete rout of its rival in the derivatives space described above.

1.3 New Management and trading volume

The third phase was the attempt of the BSE board to get new management in place and give the institution a managmenet makeover. They appointed Madhu Kannan who had a senior role at the NYSE and a team of international experts around 3 years back. Just before the appointment was a phase of a disputes between the board members of the exchange and some board members and the CEO. This pre third phase did no favour to an already ailing exchange. With two drivers in the seat, the car didn't really rally anywhere in particular. In addition, the parliament's mandate to demutualise focused energy on that task which made the exchange to have distinct classes of shareholders, brokers and managers. Finally, in

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this phase SEBI wrongly imposed an ownership cap of 5% on any person to own shares of a stock exchange. This continues till today and is a huge problem . This phase was full of hope of reform. Brokers who received shares of the exchange in lieu of the fractured ownership and trading rights briefly traded shares of the BSE at huge premiums. International investors like Deutsche Boerse and others, despondent about the 5% cap, saw a ray of light. New investors like George Soros saw merit in investing in the exchange. Despite the best efforts of the A star team, BSE continued to struggle. It invested quixotically (15%) in a currency exchange, the United Stock Exchange thereby outsourcing its exchange function in currency derivatives for a 15% share in the returns. The problems in this phase were a) the 5% limit on ownership, which meant that anyone who wanted to invest in BSE and give it a competitive advantage was unable to take control of BSE and give it a makeover b) because the shareholders had been so emasculated, the management felt directionless with a Board which drew no power from the shareholders. c) There was no competitive advantage the BSE had. There was nothing, nothing at all which BSE could do, which NSE couldn't replicate in 24 hours with more technology, more money and with a history of far deeper markets in an industry where liquidity breeds more liquidity. d) there existed a policy vacuum with respect to whether SEBI stood for listing of exchanges or not, further muddied by the Jalan Committee report which made recommendations without even reading the annexures attached by them to the Committee report. This cloud has thankfully lifted a few days back.

Reference: http://spparekh.blogspot.in/2012/04/future-of-bse.html

http://iief.com/Research/CHAP1.PDF