Risky convergence

The Securities and Exchange Board of India (Sebi) has cleared in principle the convergence of financial exchanges, allowing the same exchange to offer products in the equity, commodity derivatives, debt and currency segments. There is a two-phase timeline and Sebi envisages the launch of converged trading by “universal exchanges” from October this year. This clearance will enable the BSE and the National Stock Exchange (NSE) to launch commodity derivatives trading and enable the Multi Commodity Exchange of India (MCX) and the National Commodity and Derivatives Exchange (NCDEX) to move into the equity segments. Detailed guidelines are yet to be issued, but new products will only be introduced with Sebi’s approval. This was always on the cards after the Forward Markets Commission was merged with Sebi to create a single regulator. The first phase will involve integration at the intermediary level, while the second phase will enable an exchange to offer products across equity, equity derivatives, commodity derivatives, currency derivatives, interest rate futures and other debt instruments. The regulator has said all necessary steps for the first phase had been taken and brokers could offer all products in an integrated way. The multiple regulatory details will now be reviewed and tweaked.

In theory, this move should enhance competition across all categories, thus creating deeper markets with lower spreads and exchange fees. It should offer greater convenience, in that traders will be able to trade all asset categories from a single account. It may also lead to consolidation — cross-holding norms will have to be reviewed in case mergers between exchanges appear attractive. The NSE and the BSE offer equity and equity derivatives, while the MCX and the NCDEX specialise in commodity derivatives. Foreign exchange (forex) is traded at both the NSE and the MCX. Though traditional exchanges specialise in one asset class — for example, the New York Stock Exchange (NYSE) trades equity and equity derivatives, while Chicago Board of Trade and its subsidiary, Chicago Mercantile Exchange, specialise in commodities and commodity derivatives — modern exchanges like Singapore’s SGX and Dubai’s DGCX do offer a wide range of asset classes. Both these exchanges also offer futures on Indian indices and both intend to offer Indian single-stock futures. Given their long trading hours, this enables traders to respond instantly to events at odd hours. Singapore and Dubai could be formidable competitors. Indian exchanges will find it easier to compete if they are also present in multiple segments. This might help in preventing exporting our markets.

However, risk management across asset classes will be the big new challenge, given the significant differences between commodities and equities. Margins for futures on different commodities underlying are different, contract tenures are different, and margins change on a seasonal basis for agricultural commodities. Commodity futures can involve physical delivery although most Indian commodity futures are cash-settled, with delivery only in gold and silver. Besides, agro-commodities have discontinuous production. Commodity exchanges also remain open for very long hours, since many commodities track global prices. Forex segments should ideally be open 24x7 because prices change continuously. If the NSE and the BSE do start offering commodity derivatives segments, they will have to keep those segments open for longer hours. Extensive review and modification of margining systems and trading platforms will be required. Similarly, if the MCX steps into equity and equity derivatives, it will need to review its risk-management systems. Overall, this is a progressive move but the details of implementation will be crucial.