NSE/BSE refusing to share data with SGX - tilting at windmills, but not end of the world

This was published on the 24th of Feb, 2018 in DNA

Earlier this month, the three largest stock exchanges in the country — National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and the new Metropolitan Stock Exchange (MSE) — agreed to stop sharing data with overseas stock exchanges that offer derivative contracts linked to popular Indian indices and stocks. As soon as the news hit the wires, the predictable responses came out like the proverbial ants out of the woodworks — it’s anti-competitive, a policy self-goal, protectionist. MSCI, the popular global index-provider, even darkly hinted at a possible cut in India’s weightage in its global benchmark indices.

The fact though is, from the perspective of the Indian stock exchanges, this was a perfectly sensible competitive move. It made so much sense that two intensely competitive companies — NSE and BSE fight a bruising battle for market share and market access — came together on this issue. This move is simply a way for Indian bourses to protect their own market share from a steady haemorrhage. The rationale is pretty simple.

NSE, BSE today share, with a range of offshore stock exchanges, price feeds and index brands for stocks and popular benchmark indices listed on their platforms. These offshore bourses — primarily in Singapore, Dubai and Hong Kong — in turn use the price feeds and brands to float their own India products — SGX Nifty for example. Over the last few years, a significant amount of incremental trading on Indian indices have moved to these offshore platforms. Reasons are manifold, lower taxes for one — Singapore/Hong Kong/Dubai do not have taxes on capital gains made out of derivative contracts, unlike India. Severe restrictions in India on Participatory Notes (P-Notes), a popular instrument used by a variety of foreign investors to take equity exposures are a second. Above all, there is also the ease of regulatory environment, where many of these offshore markets are considered better than India. The proverbial last straw in the camel’s back was the launch of 50 Indian single stock futures by SGX earlier this month.

NSE and BSE came together to essentially use the nuclear option, ie, access to price feeds. Sans access to price feeds (as also brand rights to the popular indices, though that is a smaller issue), the ability of traders on the SGX (or any other offshore exchange) platform to efficiently price Indian underlying products is severely impaired. It also required both BSE and NSE to cooperate on the issue, as restriction by only one of the two would keep the window of price feeds open from the other, and defeat the purpose altogether. In other words, it’s a question of pure self-interest in a competitive market, where offshore exchanges like SGX were actively competing with BSE/NSE for market share. Nothing “protectionist” about it at all. The fact that SGX’s own share price fell 9 per cent on the day the announcement by BSE/NSE came partially reflects the competitive impact of this move.

How does this play out now for markets and its shape? In the short run, there’s unlikely to be any great impact. India hasn’t put physical controls over foreign access to Indian stock markets. India’s attractiveness as an investment destination too doesn’t change, one way or another, by the decision of local exchanges to either share or not share price feeds with their overseas counterparts. If investors and investment themes do not materially change, chances of index providers cutting India weightages are extremely remote too.

In the slightly longer run though, this would likely be a case of delaying the inevitable. The case of currency trading is illustrative in this respect. USDINR, the most popular currency pair traded on India, are traded both in India as well as offshore (in what is called the NDF — Non Deliverable Forward — market). Volumes in the NDF market are over twice the volumes traded onshore in India. This, despite the fact that the NDF market has structural limitations in the form of inability to “physically settle” trades, given that INR is not a convertible currency. Reasons are all familiar, and similar to the ones described for stocks above. Now, currency markets are largely OTC (Over The Counter — bilateral deals struck on the phone/computer network by two traders), and not exchange-traded, and hence do not require proprietary price feeds from an exchange, unlike equities. As a result, offshore traders cannot replicate the same model easily for equities.

There is also the additional factor of India’s own IFSC (International Financial Services Centre), in GIFT City, Gujarat. There’s been a huge amount of regulatory nudge to shift offshore trades there from overseas exchanges.

However, financial innovation typically tends to trump physical barriers. While its more difficult to price offshore-listed Indian derivatives sans data from NSE/BSE, its not impossible. There would be smart structures/traders/algorithm-writers at work to develop new models to obviate the issue. Given the experience worldwide,  especially on USDINR case, it is a problem that doesn’t seem immune to being cracked. On IFSC, while taxes are somewhat lower compared to onshore exchanges, the issues around acceptability, ecosystem and market depth are still open questions for foreign investors to move serious volumes, yet.

Net-net, while the popular narrative around protectionism is widely misplaced, and this buys some time for India’s local exchanges, this is likely to look a bit more of Don Quixote than Napoleon in the longer run!

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Bitcoin as currency - closer than we think

This article was published in the DNA op-ed page on 24th Jan, 2018

Bitcoin has assumed cult proportions, and naysayers in both financial markets (through their dire warnings of a Dutch Tulip redux) and global governments (through pre-emptive executive actions) have not really been able to fully dampen the enthusiasm of cult-followers. The real question though is if Bitcoin would be ever able to transcend its cult-status into its promised nirvana, ie, an alternative global currency. Prospects of that happening, while enormous challenges remain, are perhaps not the in “not in my lifetime” domain. Why? Let us examine the key hot buttons — demand and supply considerations of an alternative global currency. 

Starting with demand — is there a demand for an alternative global currency? This is an easy answer — it is a loud, unambiguous YES. There are multiple intellectual convincing and politically powerful support for Bitcoins as an alternate currency. 

First, the current international financial system is predicated on the status of US Dollar (USD) as the de facto reserve currency. Bulk of trade settlements, capital flows and money transfers happen in USD — giving the US government supranational powers to regulate the international financial system. Along with USD as the reserve currency, the entire global financial architecture is run by financial institutions around US rules. This gives enormous political powers to the US government — it can (and has) try to influence behaviour of people, corporations, even countries, by sanctioning their access to the global financial system. States at the receiving end of such action — Russia, Iran, Venezuela come immediately in recent memory — have enormous interest in breaking out of the straightjacket of USD. Bitcoin, where custody, transfer and trust are ensured by a disaggregated, decentralized protocol (rather than US laws), reduces the leverage of sanctions today that US government has. 

Second, the crisis of confidence in the traditional monetary regime. Under the traditional monetary policy, new money is primarily created by “fiat”, or by central banks (representing their respective sovereign governments) printing money. Post the global financial crisis in 2008, central banks around the world used this power to print very large sums of money (popularly described as Quantitative Easing), with the objective to keeping interest rates low, finance government buy-outs of toxic financial assets, and give a general “monetary boost” to a crisis-hit global economy. In some parts, it worked. But it also left in its wake a crisis of confidence with a section of thought-leaders  — as currency as an asset was seen to have been devalued by printing such large amounts, opening up possibilities of run-away inflation in the future. 

Next, what about supply? Is Bitcoin (and the whole family of cryptocurrencies at large) geared up to become an alternative form of money? Any form of money has two features — as a medium of exchange and as a store of value. At an overarching level, money also has to support business cycles in the real economy. 

As a medium of exchange, Bitcoin (and cryptocurrencies in general) shows the maximum promise — as a decentralised, public architecture — since money transfers can be done faster, cheaper and without taking credit risk on various intermediaries along the chain. A typical international wire transfer today navigates its way through multiple banks, clearing houses, custodians and transfer protocols (like SWIFT) — takes several days, with the only beneficiary being the intermediary banks making money out of the idle float. Cryptocurrencies like Litecoin can do the transfer in minutes, and cost virtually nothing.  

The real issue with Bitcoin today though, is as a store of value. Rather, as a “stable” store of value. Volatility in Bitcoins today is very high, 20-25 times the volatility of stocks. Now, no one would generally like to be paid in a form of money that can be worth 15 per cent more (or less) the day after. Part of this is growing up pangs, Bitcoins do not have the normal full suite of financial products underlying the asset — most financial assets that do not have well-traded option contracts tend to be non-ergodic (in simple terms, subject to massive blow-ups). Recently, mainstream exchanges like Chicago Board of Trade and Chicago Mercantile Exchange started offering futures contracts on Bitcoins. Its not enough, futures contracts, sans a large, liquid options market, will not bring volatility down markedly. The point though is, this is just the beginning. Moore’s Law in financial market innovation will kick-in at some stage, especially with mainstream financial market participation increasing, and newer derivative instruments would start trading off Bitcoin underlyings. However, this is the toughest condition for Bitcoin to achieve for it to become a form of money. 

Which brings us to the last issue, does Bitcoin lend itself to viable monetary policy formulation, one that can support the real economy? The first objection would be in terms of its finite quantity – Bitcoin is limited to 21 million. In times of economic downturn, it limits the ability of governments to expand the money supply to tackle the same. This isn’t as such a difficult problem, as Bitcoin is but one of many cryptocurrencies, there are many more (like Litecoin, Dash etc).  

The bigger issue, though, is around the power of the State associated with money. Fiat money today is printed by governments, it’s a sovereign obligation. How would states react to a new architecture stripping that power away? 

Philosophically, this would be the biggest supply-side question that Bitcoin has to answer. Good news (for Bitcoin fans), is that there is a modern precedent. About 500 million citizens in dozens of States, gave up their sovereignty to print money to a common shared pool — the European Monetary Union, on January 1, 1999 — giving birth to Euro. Some of the objectives of the Euro are not very dissimilar to the demand-side arguments for Bitcoin. In a nutshell, it has happened before! While the obstacles are many, so it would seem are the arguments in favour of Bitcoin. How the cookie crumbles would be an interesting story of our lifetime!

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