Sunday, August 15, 2010

NSE to form Global Alliances

The recent deal between NSE and LSE to work out a joint venture and allow CNX Nifty and FTSE 100 to be traded on each other’s exchange is of great strategic significance. With such a deal in place, CNX Nifty, will become a globally traded contract and NSE will be able to offer a basket of top traded global indices. This move is expected to benefit both the exchanges and the investor community and seems to emerge out of a strong economic logic. The landscape in which stock markets have operated globally are fast changing. With advancement in IT services and almost negligible marginal costs involved in executing trades, the traditional parameters for judging a stock exchange’s competency are fast losing ground.

Typically, stock exchanges earn revenues from member subscriptions, fees from listing, trading, clearing and settlement services and charges for providing company news, quote and trading data. But with negligible marginal costs involved with each of these activities, the associated margins have dwindled significantly. Therefore, the economic viability of any exchange to a large extent is determined by the volumes of trade being transacted through it. The traded volumes in turn are dependent on the reach and liquidity offered by the stock exchange. In stock markets, liquidity breeds liquidity. Because of higher liquidity, the bid-ask spreads (the difference between the best buy and best sell prices of any scrip) become lower, which brings down the transaction costs for brokers. Because of lower transaction costs more brokers trade on the exchange, increasing the liquidity again.

Given the changing nature of the market forces, a strong case is set out for alliances among the stock exchanges. Alliances among stock exchanges will provide them with a positive network externality as a wider network would result in greater liquidity. With a wider network in place, more traders are expected to trade on that network as an order being sent out by them is more likely to get executed if there are others sending out their orders on the same network. Therefore, a network with a large order flow will attract more orders.

Apart from the strategic interests of the exchanges, such a tie-up will also benefit the investors. Traditionally, the high trading costs have limited Indian investors from taking positions in foreign stocks. The tie-ups between Indian and foreign stock exchanges are likely to make it easier for Indian investors to invest in foreign stocks.

The success of this deal is expected to set the path for future global tie-ups of Indian exchanges and provide synergies from other tie-ups of foreign exchanges. These tie-ups will add to the reach of the Indian stock exchanges and enable them to provide a wide range of trading options.

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