June 27, 2011

When Investor Trust Goes Awry

Chitra Ramkrishna, joint managing director of the National Stock Exchange of India, describes the formation of a stock exchange that catered to investors, not brokers.

Sharon Kahn
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Two decades ago, India’s stock exchanges were of the brokers, by the brokers, and for the brokers, said Chitra Ramkrishna, joint managing director, National Stock Exchange of India (NSE).

“Being a closed system, new brokers could not come in. Risk management was not a priority,” she noted at the Nand and Jeet Khemka Distinguished Speakers Forum in May, sponsored by The Chazen Institute of International Business. “Numbers were nonexistent and dealings opaque, so shareholders could not know what they were buying. Settlement meant you could put in an order and get shares in a month — or not at all. Hassles and costs outside Bombay made trading from anywhere else in the country prohibitive. Fees often surpassed 2 percent of total brokerage costs.”

But in 1991, a government-sponsored committee recommended starting a new stock exchange, the NSE, from scratch. “Liquidity begets liquidity,” said Ramkrishna, a member of the five-person founding team. “The more trading you generate, the more business you get. With that in mind, we decided we needed a 60 percent market share the first year to be successful.”

The three guiding principles of the new exchange were vital to attracting investors new to trading. And they’re still relevant today to any company struggling to gain consumer confidence.

1. Maintain integrity

The founding team chose a demutualized structure, which divorced ownership from management. Brokerage firms were banned entirely from owning a stake. Instead, capital to launch the exchange came from a consortium of government and private Indian banks. (In 2007, NYSE Euronext, Goldman Sachs, General Atlantic Partners, and Softbank Asian Infrastructure Fund also bought 5 percent shares.)

Other decisions were made to shore up the exchange’s integrity — even where that meant forgoing profits, Ramkrishna said. For example, although regulation is a cost center, the NSE increased oversight, especially against brokers, who remained the prime contributor to revenues. “But that approach helped build confidence and volume,” she said.

2. Create transparency

Rather than the fog that surrounded trades at other exchanges in India, data on trading activities at the NSE would be readily available. And, rather than set data up as a profit center, most of it is free. “Because we wanted open access, we had no choice but to opt for technology,” said Ramkrishna. As a result, the NSE launched the National Securities Clearing Corporation. as a wholly owned subsidiary, ensuring that orders and processes were visible and that trading ran at international speed.

3. Aim to benefit all stakeholders

Risk management guidelines were put in place to protect listed companies and shareholders. To widen the trading base, “We became a telecom company before becoming an exchange, so our satellite feed could reach all of India,” said Ramkrishna. The NSE set up investment seminars across the country to raise basic financial literacy and enlarge the size of the shareholder pool.

The NSE was immediately successful, garnering a 70 percent market share in equity trading in its first year of operation. Today, it calls itself the ninth largest stock exchange in the world by market capitalization and the largest in India by daily turnover and number of trades, for both equities and derivative trading. As broker competition increased, fees shrank, now amounting to under 0.25 percent of a trade.

“Profits came from the beginning,” said Ramkrishna. “We paid shareholders a dividend the first year. Today, the NSE has become one of the 50 most profitable companies in India.”

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