Its revenue model is seriously flawed; and the more it transacts, the more money it will burn

In another bizarre example of how bourses are regulated and promoted in India, the United Stock Exchange (USE), India's fourth currency derivatives exchange cornered 52% market share on debut day (according to advertisements released by the exchange). Its turnover surpassed that of the National Stock Exchange (NSE) as well as the market leader MCX-SX on the very first day. Contrast this with the fact that the Bombay Stock Exchange (BSE), which now has a 15% stake in USE, had set up and shut down its own currency-derivatives market in a couple of months and you wonder what is going on.

Trading in currency derivatives is jointly regulated by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). They inaugurated a record three bourses in just a month and have now jointly inaugurated a fourth to replace the BSE's currency segment which shut down. Yet, the regulators have not found it necessary to look at a simple issue - what is the revenue model for these bourses, especially the third one?

It may be recalled that MCX-SX has dragged the NSE to the Competition Commission on the grounds that it is losing a large amount of money because NSE has chosen an anti-competitive strategy of not charging a transaction fee. In effect, the equity segment subsidises the currency derivatives. MCX-SX, a market leader, says that it is forced to do the same and is incurring heavy losses. In fact, both NSE and MCX-SX would have lost crores, based on their trading volumes. Since the regulator stipulates a Rs 100 crore continuous net worth requirement, it requires constant topping up of capital.

Into this scenario enters the trailblazing USE, which is backed by a number of banks and institutions, but has no other bourse to subsidise it. On day one, it makes news by cornering a 52% market share but also does not impose a transaction fee. So do the math: a higher market share would only mean a faster burn of its money.

Our question is, aren't the regulators - RBI and SEBI - required to check the business model of a bourse when they permit a fourth exchange to start operations while a case of anti-competition practices is already pending?

We asked SEBI and the RBI for a response. We also asked about the fact that a single substantial shareholder of the exchange Jaypee Capital reportedly accounted for over 80% of the turnover on debut. SEBI responded saying that it has left "pricing" to the bourses and cannot comment. On the turnover by a single broker, it said, it will collect and analyse the data before responding. Apparently, what is common knowledge in the market is unknown to the regulator even after such an astounding, record-making debut by an exchange.

How serious is this issue? Let's compare it with the two existing bourses operating in the currency derivatives space. According to sources, MCX-SX is sitting on a loss of around Rs110 crore. In one of its lawsuits, it has said that it is losing Rs5 crore a month. The exchange had a net worth of Rs314 crore as of 31 March 2010, meaning a third of it has already been eroded. The loss incurred by the NSE would also be in the region of Rs110 crore.

The USE on the other hand has a capital of Rs150 crore. If it incurs the same costs as MCX-SX and the NSE, it would lose around Rs25-30 crore by 31 March 2011 and the net-worth would be eroded to that extent at least. However, if USE continues to record twice the turnover of NSE and MCX-SX combined, its losses will be that much higher. Will its shareholders top up the capital to pay for this?

USE reported a turnover of Rs45,485 crore on debut day, compared to a combined turnover of Rs42,000 crore by NSE and MCX-SX. Apart from the BSE, its other shareholders are Jaypee Capital, Riddhi Siddhi Bullion, MMTC and India Potash and around 26 banks. Many of the banks are also shareholders of the NSE and MCX-SX.

According to market sources, a single trader, Jaypee Capital, who is also a significant stakeholder accounted for over 80% of the trading volumes. Concentration of trading among the top 10 traders is also very high on the two existing bourses, but significantly, the USE did not eat into the turnover of the other two bourses, but generated an all new market. Surely this is something that the RBI and SEBI need to examine in detail.

Interestingly, while inaugurating the exchange, RBI deputy governor Shyamala Gopinath compared bourses to "public utilities". It is interesting that SEBI, which has been mandating and standardising fees and often raising them substantially (arbitration fees) charged by bourses in the equity segment, has not found it necessary to recommend that they charge even a minimum transaction fee for their survival in the currency derivatives segment. It is exactly why MCX-SX has gone to the competition commission alleging bias and favouritism on the part of the market regulator. But such double standards in dealing with issues and cases has been the hallmark of SEBI regulation in the current dispensation. At the time of going to press, we are awaiting USE's response to our query on its revenue model.