7/29/2019 10.Articles SGX NSE[1]

1/4

NSE vs. SGX vs. BSE

One of the most interesting features of the global securities markets in the late

1980s and early 1990s was the battle which took place between Singapore andJapan on the question who would dominate futures trading on the Japanese stockmarket index.

Index derivatives are purely cash settled; there is no physical settlement involvingshares. Hence, an exchange anywhere in the world can trade index derivatives using

any index, regardless of capital controls or the lack of connectivity to the depository.This is in contrast with trading shares, where a foreign exchange is unable to

compete with an Indian exchange without access to settlement at NSDL.

The Singapore International Monetary Exchange (SIMEX) commenced trading on theNikkei 225 index futures on 3 September 1986. Prior to this, in 1985, the index

futures had started trading at the Chicago Mercantile Exchange (CME). At the time,

Japanese regulators were dithering about whether or how index derivatives shouldtrade. The Japanese regulators were fearful of cash settlement. They first permitted

a physically settled index on the Kabusaki 50. This was the world's only attempt at aphysically settled index derivatives product, and it failed. On 3 September 1988,

exactly two years after SIMEX got started, cash--settled Nikkei 225 futures startedtrading at Osaka.

In the early days, Osaka and Chicago dominated the market, while SIMEX struggledalong. In 1991, the regulators of Japan did SIMEX a great favour. Osaka raised

margin requirements (from 9% on 23 August 1990 to 20% on 31 Jan 1991) whileSIMEX cut margin requirements (going from 12% on 30 July 1990 to 9.5% on 31 Jan

1991). As of early 1992, the margin required at Osaka was 30% while SIMEX was at

14.2%. In addition, brokerage fees and transaction charges at SIMEX were lower.Within a matter of weeks, the Nikkei 225 market started moving to SIMEX, withvolumes going from 4,000 to 20,000 contracts a day.

This led to a remarkable situation where a flourishing market for the Japanese index

futures was to be found in Singapore. This lasted all the way to the late 1990s, whenJapan started remedying these problems and the market significantly moved back to

Japan.

What about India? The Singapore economy is too small to sustain a serious financialmarket, so Singapore's future lies in being an international financial centre. The

Nikkei 225 product did a world of good for trading at SIMEX, and for the positioning

of Singapore as a centre for international finance. With this market fading away,Singapore needed to look for a country with a large economy and a good chance offinding incompetent regulators.

The natural choice for this is the Indian stock market index and the dollar-rupeeexchange rate. On both these, SIMEX can easily do cash--settled derivatives without

requiring any cooperation from Indian authorities. Both these products haveregulators in India with a conservative track-record. Hence, SIMEX, now in its new

incarnation as SGX, looked at the field, which consists of the NSE-50 index, the BSE

7/29/2019 10.Articles SGX NSE[1]

2/4

Sensex, and the Morgan Stanley, IFC and Barings indexes. They needed to choosethe index which had the best chance of winning the domestic index derivatives

market, so they picked Nifty. The Nifty futures started trading at NSE in June, and onSGX in September.

There are a few important differences between the Nifty product in Singapore versus

that on NSE:

The SGX product is denominated in dollars; i.e. it is a futures on Defty, not

Nifty. This means that a foreign portfolio or FDI investor directly getscurrency protection when he uses the SGX product for hedging. In the case of

Nifty futures, this foreign investor would need to combine a position on the

Nifty futures with a position on the dollar-rupee forward market.

Foreign investors face a variety of hurdles in accessing the Nifty futures or the

dollar-rupee forward market. The SGX product is unencumbered.

SGX will soon move on to options, while India's regulators are still

"evaluating" how and when options trading will start.

The margins at SGX are lower than those found at NSE.

NSE now faces the battle of its life. SGX is a competitor with technology, branding,proven track record of high ethical standards, and managerial capability that equals

or exceeds that of NSE. NSE is constrained by the speed at which India's regulatorsallow derivatives trading to grow, and by the speed at which India's securities firms

plunge into derivatives trading. However, NSE has one great edge: monopolisticaccess to the great Indian retail market. India's remarkable equity market liqudity is

dominated by retail trading, and until capital account convertibility comes about, thisinvestor base cannot go to SGX. This edge will fade away as India moves towards

capital account convertibility, but it will take a while for SGX terminals to be asprevalent in rural Andhra Pradesh as NSE terminals.

These developments open up one new market: arbitrage between Nifty at SGX andNifty at NSE. As mentioned above, there is one catch in this arbitrage, which is thecurrency. Hence, arbitrageurs will fall into two groups: (a) those who use the dollar-

rupee forward market that prevails in Hong Kong or Singapore, or (b) those who arepermitted to engage in forward transactions on the dollar-rupee forward market in

India under existing RBI regulations.

What does this mean for the BSE? The BSE suffers from several problems. The firstis a weak product, the BSE Sensex, which delivers inferior hedging effectiveness and

higher impact cost. The BSE spent many years engaging in political lobbying to blockindex derivatives. In this period, NSE has become strongly associated with the idea

of derivatives. In this period, NSE also got a head start on systems, procedures andproduct design. The NSE is the largest equity market, a fact which hurts the extent

to which futures on the BSE Sensex can obtain efficiency. Finally, the BSE will besidelined in the arbitrage activities between Singapore and NSE.

The BSE Sensex has greater mind--share amongst the less sophisticated part of themarket. Hence, the more knowledgeable users will initially converge on Nifty, and

then there could be a catch--up for BSE as the less-knowledgeable participants comeinto the market.

7/29/2019 10.Articles SGX NSE[1]

3/4

This will be an interesting horse race. The score so far is : Nifty futures are at Rs.9crore a day at NSE and Rs.7 crore a day at SGX. BSE Sensex futures are at roughly

Rs.6 crore a day. International investors and NRIs, with an interest in hedging Indiarisk, already know about derivatives; they will quickly start using the SGX products.

The question is about Indian retail: how quickly with India's securities firms andretail investors get comfortable with using index derivatives?

I believe that this is only a question ofwhen and not whether. India's retail users willswitch from stock trading to derivatives trading, and when this happens, India will

own the Indian index futures market. How fast this happens significantly depends onhow fast India moves on a variety of policy questions on the spot and derivatives

markets. Until these questions are resolved, I think it is quite possible to see SGXpulling ahead of NSE.

7/29/2019 10.Articles SGX NSE[1]

4/4