Sunday, July 15, 2012

The MCX Equity Exchange : Can it make a mark ?

Yesterday, MCX got a permission to start an equity exchange, sounds good as it will add to product list which can be traded, but can we make a list of what may or may not happen after this development.

It makes me think that with a long history of being an oldest exchange, if BSE is struggling with volumes, how would new exchange garner volumes. BSE generates volumes in derivatives only because of LEIPS (Liquidity enhancement program), where the traders are compensated for the statutory cost else there is no volumes in derivatives exchange

Then how can MCX make its mark ?

a) MCX intends to replicate success of MCX commodities and to some extent Currencies in Equities, but we must know that i) MCX & NCDEX started trading at around the same time, when neither had lead nor volumes.ii) Today MCX has volumes but if we dissect the volumes, they are mostly speculative and only in Metals, where delivery in very miniscule, whereas NCDEX commands higher volumes in Agri Products and huge quantities are marked for deliveries. iii) There is miniscule institutional participation in MCX whereas Big Trading houses and Many MNC procure through NCDEX. 

In Equities , to garner volumes you need the participation of Retail Investors, Traders, Prop Desk and also Institutions, but if we look at the above instance Institutions don't trade on MCX. It needs to be seen, How can MCX get institutional investors on board.

b) The biggest advantage of MCX, is that it has trading software and the required domain expertise in creating a back-end of trading in place. Thanks to support of its parent Financial Technologies. ODIN software (A front-end software for trading) was the only player until before some time, but now there are many other software vendors, but its still the leader.

c) I am also concerned about the risk management and work ethics in MCX, They need to come out with strong risk Management and strict code of secrecy and work ethics of its employees.

What can MCX do to make a mark ?

I believe that MCX  will have to differentiate their products to attract more players and different breed of players.

a) The first and foremost is they should try with delivery based Stock futures and options : There is a strong demand for delivery based derivatives in Indian market, but NSE is reluctant to introduce this as there is a fear of loss in volumes and NSE trading structure for cash and derivatives segment is different as such that they cannot introduce deliver based derivatives, whereas IF MCX goes on lines of Clearing members and Trading Members for equity brokers also, they will be able to introduce delivery based derivatives.

Incidentally all institutions are for delivery based derivatives and this is an opportunity that MCX can grab, because if Big breed of Institutions trade in MCX, then others are there to follow.

The Basic rational is Institutions have to run VWAP on Expiration day to close their positions and they expect volumes for VWAP, which they get only in NSE as of now, but if the stock futures are delivery based, they need not worry about the delivery, but volumes will follow as stocks will be marked for delivery.

b) In the same manner , they can trade in American options instead of European option and institutions would be a  more comfortable in such trades and it will also create sophisticated arbitrages opportunities for complex trades, which they will love.

c) The biggest obstacle wold be INDEX, It will have to create its own INDEX to trade, but they have opportunity like they can also introduce trading in MSCI index and other such index, which are maintained by big institutions and tracked by foreign investors.

d) SEBI guidelines for Derivatives market  mandates the structure of Trading Member and Clearing Member, such structure in Equities will also help MCX to garner its long list of small brokers and avoid Risk Management issues.

MCX will also have to overcome some regulatory issues like :

a) SEBI may move to supreme court for a stay in ruling, further increasing the waiting period.
b) SAT has mandated to reduce their stake in MCX below 10% in 18 months, which will impact its valuations.

Looking forward, we can look at MCX equities exchange as an opportunity for different class of investors and to satisfy their investment needs.

I welcome your critical comments and suggestions


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