Exchange Competition and Market Impact: Currency Derivatives in India
19 October 2011
Rivalry among Indian capital market players, including exchanges and regulators, is not new. It was again observed in the currency derivative space recently. Trading in currency derivatives in India began in August, 2009. The National Stock Exchange (NSE) of India was the first player to offer this facility to investors. Two more players, MCX-SX and United Stock Exchange (USE) later entered into this space. Initially NSE was not charging any fees for trading in currency derivative. There were arguments both for and against such policy. NSE’s stand was that such a move was intended to benefit all players (exchange, members and investors) and thereby develop this new market. However, such a stance taken by the first mover and dominant player in the market meant other players were also not able to charge transaction fees in this market. This led MCX-SX to lodge a complaint against NSE to the Competition Commission of India (CCI). In its order, CCI found NSE guilty of abusing its dominant market position. Subsequently NSE introduced transaction charge in the currency derivative segment starting from 22nd August, 2011. According to NSE, while they are challenging the CCI order, they are ‘implementing its direction to levy charges out of respect for the commission’. As a result, transaction charges are being imposed for the first time in the three-year history of this market segment. The NSE would levy transaction charges of up to Rs 1.15 per 100,000 Rs of turnover in the currency future segment. On currency option contracts, members will pay a transaction fee between Rs 30 and Rs 40 on every 100,000 Rs of premium payable. Also, it would levy an advance transaction charge of Rs 50,000 per member per annum and would charge an admission fee of Rs 100,000 from its existing members and Rs 500,000 from others – this would be set off against actual transaction charges payable by the member in the respective financial year. Subsequently, MCX-SX said that it would also levy charges for currency derivative transactions. The third exchange, USE is still considering on levying charges, and hence is the only exchange left which does not impose charges on currency derivatives. Absence of levies and fees was a big contributor to the growth of currency derivative trading in last few years. Besides no transaction charge, this segment is also not charged Securities Transaction Tax (STT), a tax charged on all other transactions. Therefore trading in currency derivatives used to be a much cheaper option and arbitrageurs were attracted to this segment. With the introduction of transaction charges, costs are going to increase and the volumes are likely to be impacted. The results observed so far are very much in accordance with that. Trading volumes at both NSE and MCX-SX, the two exchanges which introduced transaction charges, fell significantly since August 22, while trading volume at USE actually grew marginally. Compared to the period 1st January, 2011- 18th August, 2011, it can be seen from the figure, average daily trading volumes fell by 20% NSE and by 17% at MCX-SX since 22nd August, while it grew by 7% at USE. Similar trend has been seen in case of trading value as well. It must be mentioned here that trading volume in currency options at NSE actually grew by 8% after introduction of transaction charges. This probably indicates the introduction of charges was a deterrent for arbitrage players who are more active in the future segment.