Trading in India The Status Quo Anshuman Jaswal Senior Analyst, Celent
Roadmap Brief look at equity, bond and derivative markets Level of electronic trading DMA and Algorithmic trading Industry evolution Regulatory practices
Market Overview
Cash Equity Cash Equity Turnover and FII Rs. Billion 7000 6000 5000 4000 3000 2000 1000 0 Jan- 05 Jul-05 Jan- 06 Jul-06 Jan- 07 Jul-07 Jan- 08 Jul-08 Jan- 09 Jul-09 Jan- 10 300 250 200 150 100 50 0-50 -100-150 -200 Rs. Billion Equity FII Equity indices reached two year highs in end-march 10 Cumulative Equity FII in 2009 was higher than in 2007 (Rs. 834 billion vs. Rs. 715 billion)
Government Bonds Government Bonds Secondary Market Turnover 7000 Proportion of G-Secs in trading 6000 book of leading FIs is low Rs. Billion 5000 4000 3000 2000 1000 Turnover lower when yields rise, indicating long only investors are dominant Main reason: Much of the investment by banks in government securities is part of 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 the mandated SLR requirement and is held to maturity to avoid the mark-to-market risk
Corporate Bonds Impact of the financial crisis Corporate bond market: Turnover Sharp increase in the spreads on corporate bonds 6 Decline in the turnover after Rs. Billion 5 4 3 2 1 - Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 August 2008 Risk spread on corporate bonds declined significantly by the end of Q4 of 2008-09 Improvement in volumes Introduction of CDS Regulatory and institutional barriers: Stamp duty varies depending on state and type of investor Product standardization required Centralized database needed Bankruptcy norms
Equity Derivatives NSE Equity Derivatives: Turnover Rs. Billion 20,000 15,000 10,000 5,000 - Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Nifty Index Options and Index Futures are among top 10 index derivatives worldwide
Comparison of Equity Derivatives Comparison of Equity Derivatives Turnover 12000 10000 Rs. Billion 8000 6000 4000 2000 0 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Index Futures Stock Futures Index Options Stock Options
Currency Futures Rs. Billion 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - Sep-08 Oct-08 Oct-08 Currency Futures: Turnover Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Currency futures were introduced in NSE and MCX- SX in August and October 2008 US$-Rupee futures contracts at NSE and MCX-SX are the top 2 forex futures contracts globally Contracts are cash settled Do not require proof of any underlying that needs hedging Market is driven largely by intra-day activity
Commodity Futures Commodities Futures Turnover 8000 7000 6000 5000 4000 3000 2000 1000 0 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 Rs. Billion MCX has 6 contracts in top 20 metals futures and options contracts globally 2 contracts in top 20 energy futures and options contracts
Interest Rate Futures Rs. Billion 16 14 12 10 8 6 4 2 - Interest Rate Futures: Turnover Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Interest rate swaps and forward rate agreements introduced in 1999 IRS attracted significant liquidity Turnover in interest rate futures at very low levels RBI in discussions with market participants to try and revive the market
Electronic Trading
Retail Cash Equity Share of Electronic Trading in Retail Equity market 30% 25% 20% % 15% 10% 5% 0% 2003 2006 2009 2010 2012E
DMA Share of DMA in Institutional Equities 40% % market share 30% 20% 10% 0% 2008 2009 2010 2011 2012 2015
Main Issues
Points of Discussion DMA- more one touch than direct Physical infrastructure for algorithmic trading Co-location Higher compliance costs driving consolidation A volume game: automation and commissions Benefit of longer trading hours Standardization required Technology integrating front and back-office
DMA FIIs driving change Greater acceptance among DIIs, especially top MFs Still mainly low-touch Restrictions on direct DMA Even low-touch has improved level of automation Less manpower required Costs of trading lowered Foreign and Tier I domestic brokerages geared up Tier II in process of adopting technology
Algorithmic Trading Accepted as the future of institutional trading Infrastructure a barrier in short term Vital market data speed is improved Latency reduced, matching engines faster Low-touch DMA prevents algorithmic trading Pre-order risk management also a factor - affects latency Regulation slowing adoption - only white box for now Low incentive to foreign brokerages to bring developed algorithms to India Need to refine algorithms for local markets Local brokerages and vendors still developing capabilities
Cost of Trading By global comparison, Indian markets are: Costly in terms of exchange fees Market data and clearing is much cheaper Automation beneficial to buy-side Post-trade processing has improved Reducing revenues of sell-side: volume game
Higher Compliance Costs SEBI and exchanges requirements tough on brokers Smaller brokers struggling to cope Consolidation inevitable Need to take smaller brokers resources into account Provide IT support Standardization of procedures across exchanges required
International standard India late adopter Co-location Overall latency needs to be reduced for co-location to be meaningful
Longer Trading Hours Benefits still not conclusive Further extension expected Greater pressure on post-trade processing Smaller players will find it difficult to bear costs Where does it end? Need for debate
Importance of Standardization Number of exchanges rising Each with own certification impacting costs Standardization required going forward More cooperation between exchanges - finding common ground
Technology Front and back-office working together in realtime Advantageous for IT vendors which cater to both front and back-office Global and local systems also closer
Clearing Houses Clearing houses like silos Need to cover multiple assets across exchanges Wider coverage will drive innovation and reduce costs
High market impact Block Deals Operationally difficult to execute for institutional investors Dark pools beneficial but not probable Regulator needs to address issue
Relationships Still Matter Domestic institutional brokerages recruited from foreign counterparts to increase marketshare Reverse flow also seen Expected to continue as a factor despite automation
Regulatory Overlaps Securities and Exchange Board of India is the main capital market regulator Overlap of its domain with: Insurance regulator, IRDA (e.g., unit linked insurance plans) Central bank, RBI (e.g., FII limits, currency and interest rate futures, investment banks) Provident fund regulator, PFRDA (e.g., NSDL) FMC (commodity markets) High Level Coordination Committee (HLCC) on capital markets not deemed successful Financial Stability and Development Council (FSDC)
Thank You ajaswal@celent.com