TRANSFORMATION OF INDIAN CAPITAL MARKET

Dr. R H Patil*

Most of you certainly remember Mr

Nadkarni as an outstanding development
banker who made a significant impact on
the then existing two most important
development banks of our country, viz.,
IDBI and ICICI. He was the first Indian
development banker to become Chairman
of the World Federation of Development
Banks. Although by training he was an
engineer he became an astute development
banker par excellence. During my service at
IDBI stretching over nearly two decades, I
observed that several of my colleagues with
basic engineering degrees turned out to be
very good development bankers. Since
development banking is essentially project
lending, engineers enjoy a special advantage
as they could understand the technical side
of the project very well. For a person of very
high calibre like Mr Nadkarni learning that
bit of accountancy for analysing cash flow
and profitability projections was not at all a
difficult thing. What I admired most in Mr
Nadkarni was not only his technical
capabilities as a development banker, but
also his very strong common sense and
extraordinary talent to judge men he came in
contact with and assess relative strengths and
weaknesses. He never believed in quarrelling

th

with his tools. When he joined IDBI in 1985

it was not in a very good shape. But by the
time he left, it was considered to be a very
sound and client friendly institution. All
this he could do by relying on the same staff
of IDBI thereby proving that the real key to
achieving desired results is to put the right
people for the right jobs. He was clear that in
a public sector institution like IDBI, it was
eminently possible to achieve desired results
without resorting to hire-and-fire policies or
promoting people out of turn as both these
eventually turn out to be highly counter
productive.
In so far as my active professional life is
concerned, he was the most important
person who has influenced me in so many
important ways. It was a great and rewarding
experience to work with him. He was
absolutely clear in his thinking and a rare
individual with the highest personal and
professional integrity. Anybody working
with him felt fearless as Mr Nadkarni would
never let down a person once he delegated
important and delicate tasks, some of which
might end up producing unpalatable results.
Those who have worked in public sector
institutions/banks know very well that
personal zeal and initiative in taking bold

The current article is the replica of the 6 S S Nadkarni Lecture delivered on June 11, 2005.
*Dr. Patil is currently Chairman, CCIL.

decisions with all the good intentions is

rather too risky if your boss does not come to
your rescue when you are in trouble.
He used to read a lot, both literature and
serious writings. Bird watching was one of
his fond hobbies. He used to enjoy company
of literary people. He liked reading business
journals and books on economics. I was on
several occasions, amazed at his grasp of
serious economics and policy matters. Once
I did ask him about the secret. He told me
that he had, over a length of time, fully
digested Prof. Samuelsons outstanding
textbook on economics. As some of you
know several engineers in their later life
became serious academic economists in the
US and some of them have even won Nobel
Prize in economics. It was therefore not a
great wonder that Nadkarni through sheer
perseverance had got a good grasp on
economics, as he was an engineer with an
extraordinary clear and a highly practical
mind.
The Government did recognise his great
contributions to the areas of industrial
development and banking by conferring on
him Padma Bhushan in 1990. If I am not
wrong, he was the first banker to receive this
great recognition. Most of you also know
him as the first chairman of National Stock
Exchange (NSE) when it was set up as
company with limited liability in 1993. I was
particularly happy that a person of his
eminence agreed to become chairman of
NSE and guide its destiny in the early years.

However, he remained with NSE as its

chairman just for about a year or so. The
Government wanted him to take up a much
bigger challenge and appointed him as
chairman of SEBI in 1994. But during the
first crucial year his guidance and
Himalayan support helped us to crystallise
NSEs design and architecture as the most
modern exchange of the world. He was
particularly firm on the idea that NSE
should not seek tax exemption of any kind
and that it should function as a commercial
entity without depending on crutches/doles
of any kind from the government or its
promoter institutions. He favoured the idea
of NSE as a commercial tax paying entity for
one more reason. The structure of an
ordinary tax paying company provides all
the freedom to take quick entrepreneurial
decisions. Its operations and decision
making processes are not constrained by the
provisions of a Section 24 company or a tax
exempt charitable institution. I could go on
and on talking about Mr Nadkarni. But let
me now turn to the main theme of my talk,
viz., Rapid Transformation of the Indian
Capital Market.
Introduction
Today there is not much disagreement if
anyone makes a statement that Indian
capital markets have witnessed radical
transformation during the short period of a
decade. There is hardly any country in the
world which has witnessed such massive
changes in its capital market during such a

short period. If you permit me to use a

phrase from anthropology I would say that
the state of the Indian capital market around
the early 1990s was akin to the Stone Age, a
phrase used merely to indicate its primitive
stage. During the early part of the 1990s,
ranking of the Indian capital market with
reference to the standard global indices
relating to efficiency, safety, market
integrity, etc was not at all flattering. With
reference to the risk indices in particular, the
Indian capital market was regarded as one of
the worst, as it figured almost at the bottom
of the league. The same was the case in regard
to its efficiency levels in trading and
settlement systems. Strangely, not many
people appeared to be bothered about the
dismal state of our capital markets. As we are
all accustomed to find India figuring in the
bottom league in regard to so many other
indicators of development such as per capita
income, nutritional standards, health
amenities to citizens, literacy levels, etc we
did not feel sorry to note that the Indian
capital market was also ranked at the bottom
of the global ranking sheet.
Interestingly, however, the same cannot be
said about the current state of the Indian
capital markets. From the viewpoint of both
adoption of sophisticated information
technology tools in trading and settlement
mechanisms as also efficiency of capital
markets, not only is India ranked in the top
league but it is also considered to be way
ahead of many developed country capital
markets. Even at the risk of being dubbed as

personally biased, I would affirm that the

National Stock Exchange (NSE) has been
largely responsible for significantly
upgrading the Indian capital markets to the
best global standards. I would be the last
person not to agree with the proposition that
the Government and SEBI have also played
very crucial role in this transformation
process. But there is a limit to what can be
a c h i e v e d m e re l y t h ro u g h o ff i c i a l
interventions or directives. It may be
recalled that Government did seriously try
to bring about several desirable reforms in
the capital markets in response to the
recommendations of the 1985 G S Patel
Committee Report. But it was not possible
to make much progress in the desired
direction as the stock exchange community
was not receptive even to the marginal set of
reforms. What is even stranger, the powerful
broker community started talking about
their own fundamental rights to do business
as they thought fit, although it may not
always be in the interests of the markets and
the investor community.
But after the NSE was set up the entire
atmosphere changed. The broker owned and
managed exchanges started worrying more
about the competitive threat that NSE posed
to their business and how they should meet
investors minimum demands so that they
did not lose out completely to NSE. All these
exchanges became more receptive to what
the Government and SEBI were telling about
adopting clean business practices. NSE, in
that sense, strengthened the hands of the

authorities in making the other exchanges

conscious of their social responsibilities. I
have therefore decided to talk more about
NSE today, both with a request to you all to
retrospect on what NSE has been able to
achieve in about a decade but also to share
with you the travails it had to go through in
the process.
How is it that the Indian capital market
which was considered to be one of the most
inefficient and risky markets, got
transformed into one of the best and the
safest in such a short period of time? There
appear no parallels to this in any part of the
world. In several countries capital markets
have improved in terms of quality and
efficiency continually over several decades
before they could be bracketed with the top
league of the best capital markets of the
world. To the best of my knowledge no other
country even in the developed part of the
world has been able to witness such a
quantum jump in the quality and efficiency
of its capital markets in a short period viz., a
decade. Hence, a detailed study of
transformation of the Indian capital
markets during the last decade will certainly
prove to be a fascinating story. In my talk
today I do not have the ambition of
presenting a very detailed study before you.
All that I am planning to do is to give a birds
eye view of the developments in the Indian
capital markets as I have seen them from
close quarters as I was fully involved with the
setting up of NSE right from day one and
was also its MD and CEO for the first seven

formative years. It is my humble claim that

NSE has been the most important catalyser
of the radical transformation of the Indian
capital market during the last decade. Hence
I consider myself to be one of those few most
fortunate people who could
witness/participate in the unfolding of this
fascinating story from the central place
where most of the catalytic activity took
place. Before I turn to that story let me, with
all sincerity and utmost humility, seek your
forgiveness if I am forced to become
autobiographical on too many occasions
during my presentation since I participated
actively in this major experiment which has
fortunately become so successful.
Let me begin my story by drawing your
attention to the major disaster that struck
the Indian financial system during 1991-92.
It shook the stock market to its very
foundations. During this scam, several
banksboth, small and big, foreign and
Indian, and public sector as well as private
sectorlost a huge amount of money. Very
strangely many stock brokers prefer to refer
to this disaster as a banking scam, as if the
broker community did not have any role in
perpetrating this scam. The real truth was
that money was siphoned off from the
banking system by the stock brokers through
many devious ways. The equity prices were
hugely manipulated by several prominent
brokers with the help of the money diverted
from the banking system. Although brokers
used to issue their contract notes, their
concerned stock exchanges did not bother to

have regulatory surveillance on these

transactions. There is hardly any doubt or
dispute about the proposition that the stock
brokers were the kingpins of the major fraud
that shook the financial system and the
capital markets. It was in this context that
urgency was felt to bring about necessary
reforms in the area of capital markets so that
such serious mishaps do not recur. This
prompted GoI to delegate powers to SEBI
under the Securities Contracts (Regulations)
Act, 1956 and later to enact a special
legislation called SEBI Act. But it was soon
realised that merely empowering SEBI with
more powers was not enough. Since the
governance of the stock exchanges was very
poor, something more in the nature of
setting up of a new model stock exchange
was needed, so that its competitive pressure
would force other stock exchanges to reform
themselves. GoI agreed to bless/support the
lead taken by IDBI to set up such a modern
stock exchange that would help in
introducing in India, the best international
practices, both in the areas of trading and
settlement.
It is worth noting in this context that, in the
initial stages, there was not much
enthusiasm in favour of setting up of a new
stock exchange even among the influential
official circles. There was some scepticism as
whether there is any need for such an
exchange that would compete with the
broker-owned-dominated stock exchanges.
It was widely believed that the right course of
action should be that SEBI should crack its

regulatory whip. It was hoped that this

would ensure good corporate governance
among the stock exchanges, make markets to
function more efficiently and protect
investors interests. The then chairman of
SEBI Mr G V Ramakrishna did act tough to
make stock exchanges to fall in line. But the
well entrenched brokers were in no mood to
listen to wise counsel. Prominent broker
associations as also some of the stock
exchanges were almost on a collision course
with the market regulator. Militant brokers
were more concerned with their own
fundamental rights to conduct their
business on lines which they considered to
be appropriate rather than being unduly
bothered about the rights of investors for
fair play and justice. Soon it became
abundantly clear that, in the absence of
competitive pressure from a well
functioning and professionally managed
stock exchange, market standards cannot be
significantly improved.
The second point that needs to be noted is
that the National Stock Exchange as it has
now emerged was not the one to which we
find a reference in Pherwani Committee.
The concept of the stock exchange given in
Pherwani Committee was quite a timid one.
The NSE as proposed by the Pherwani
Committee was primarily meant for creating
a corporate debt market as also create
liquidity in mid-range stocks that lacked
liquidity on the main stock exchanges like
the BSE. Foreseeing the opposition such
proposal would meet with from BSE and the

powerful broker lobby, the Pherwani

Committee had suggested that such a stock
exchange should be set up in New Bombay.
Despite the fact that the NSE as
recommended by the Pherwani Committee
would have posed hardly any threat to the
strongly entrenched BSE and other
exchanges, there was tremendous opposition
to the very idea of an exchange with different
feathers. At that time the broker community
was having a strong conviction that the area
of stock exchanges was their exclusive
preserve and that they would not like any
one else to trespass in their territory.
It was certainly a difficult journey as we faced
several difficulties, often from quarters
which should have, in the fitness of things,
supported us in our difficult task. My
intention today is to share with you an
insiders story so as to dispel the wrong
impression that some people have that it was
a cakewalk for us. It is also my desire to
emphasise that the changes that NSE has
been able to bring about may appear to be
irreversible; but it need not necessarily be so.
History of our civilisation is replete with
examples that human beings are accustomed
to behave in a pendulum like fashion. Often
we do not learn from history; hence we are
warned by philosophers that we are often
condemned to repeat it. But that has never
deterred many especially the selfish and
short sighted people not to roll back the
progress that has already been achieved.
Hence we are often reminded that price of
freedom is eternal vigil. If we are keen that

our journey on the path of capital market

reform is not slowed down or that the reform
process does not get reversed we should
remain ever watchful of the games that the
detractors play. We should try to see through
the clever games which a number of
powerful market operators repeatedly play
to achieve their selfish objectives.
NSE as a trend setter
The anonymous order matching system
adopted by NSE is perhaps one of the best in
the world. The NYSE for example would
have remained free from the bad name that
the floor specialists brought to NYSE had it
adopted NSEs automated trading system. In
terms of geographical reach of the real time
trading facilities to the nooks and corners of
the country, the Indian capital market is way
ahead of most of the global capital markets.
Investors can trade from close to 400
cities/towns across the length and breadth of
the country on a real time basis. Today,
investors in distant parts of the country feel
happy that they enjoy parity with investors
located in Mumbai as they also have the
same type of access to the best prices as are
available to investors in Mumbai. With T+2
settlement systems, India is well ahead of
even the sophisticated markets like that of
the US or UK, where equity trades are still
settled on T+3 bases. Before NSE came into
existence the country was not even aware of
the ironclad settlement guarantee for all the
trades done on an exchange. NSE is the only
exchange in the country which has set up a

Clearing Corporation, which acts as the

Central Counter Party guaranteeing all
settlements.
NSE happens to be the first truly
demutualised stock exchange of the world; it
has completely resolved the conflicts of
interest issues that arise when brokers are in
control of the boards of the stock exchanges.
NSE represents a basic paradigm shift as the
ownership and management of the exchange
have been fully separated from the trading
rights. NSE is owned by a set of premier
financial institutions/banks and is managed
by professionals who do not trade directly or
indirectly on the exchange. NSE is the only
stock exchange in the country which decided
not to seek exemption from corporate tax
which all other stock exchanges in the
country routinely enjoy. NSE has been
paying sizable corporate taxes every year
right from the first year of its operation.
NSE believes in the philosophy of a fully
competitive system in so far as its trading
membership is concerned. There are no
entry or exit barriers with regard to NSE
membership. Since NSE does not arbitrarily
limit as to how many members it will admit
in any of its trading segments, any eligible
corporate or non-corporate entity can aspire
to become its trading member by paying the
required security deposits and meeting other
n o rm a l m e m b e r s h i p re q u i re m e n t s .
Similarly, its members are also to free to exit
later if they find that they have other more
profitable business opportunities; such

exiting members can seek refund of all the

membership deposits kept with NSE once
they meet the dues of the exchange and their
clients.
NSEs Architectural Design
I still vividly recall the meeting in the
Ministry of Finance, GoI, which was
convened by Mr Montek Singh Ahluwalia in
August 1992. The other participants at that
meeting were Mr G V Ramkrishna, Mr S S
Nadkarni, Dr P J Nayak, and myself. After
listening to the proposal for setting up of a
state-of-the-art NSE, government gave the
mandate to IDBI to set it up. Mr Nadkarni
knew my deep interest in the capital market
area as I had come in contact with him very
closely earlier even before he became
Chairman of IDBI during the deliberations
and drafting of the G S Patel Committee
Report on Capital Market. He therefore
asked me to take up the responsibility of
setting up the brand new stock exchange.
Being a visionary he was not in favour of one
more ordinary stock exchange that would
end up merely being counted as one more
also ran category stock exchange. He was
clear in his mind that the new stock
exchange should make perceptible
difference in the way the capital market
functioned in India. Typical of him, he gave
me not only full freedom to prepare and
finalise its architectural design he also did
not raise many questions at the way we were
planning for large capital expenditure in
software, mainframe computers, and the

satellite communication system. Without

his full support and understanding it would
have been an impossible task to implement
the grand NSE project that has made such a
huge difference to the quality, efficiency and
dynamism of the Indian capital markets.
In retrospect, it turned out to be a great
opportunity for me. In the absence of a life
time opportunity like NSE I would have
ended my career as one more finance sector
professional who retired in the routine
course when he reached the pre-determined
chronological age of retirement. Quickly, I
set up a small core group of five people
headed by a very competent team leader
Mr Ravi Narain. The other team members
were Ms Chitra Ramkrishna, Mr Raghavan
Putran, Mr K Kumar and Mr Ashish
Chavan. It was an inter-disciplinary group
with its members representing various
disciplines such as management, economics,
accountancy and engineering. After a lot of
deliberations among ourselves we came to
the conclusion that we should engage a
global consultant to guide us in this area.
Our search finally ended up with appointing
a Hong Kong based consultant called
International Securities Consultants to
suggest a business model for NSE. We felt
that before we crystallise our architectural
design for the purpose of stock exchange we
should have some idea as to how some of the
best stock exchanges in the world
functioned. Some of the core group
members undertook a study tour of stock
exchanges of Asia (Australia, Bangkok and

Hong Kong,) Europe (London, Paris,)

America (NYSE & NASDAQ, Vancouver).
Our study visits as also our extensive
discussions with the consultants convinced
us that an eclectic approach should be
adopted so that we incorporated in the
conceptual design of the new stock exchange
the best features that we found in different
exchanges of the world. NSE thus
incorporates today the feature of big board
of NYSE dealing mainly in very large stocks
that will be widely known across the length
and breadth of a vast country like ours,
nationwide presence of trading terminals on
the pattern of NASDAQ, computerised
order-driven trading system of the type of
Paris bourse or Vancouver which is free from
the manipulative behaviour of the market
makers or specialists, and settlement
guarantee system of the Chicagos futures
exchanges.
We also needed a communication
technology that would help us to connect
trading terminals of our members to the
exchange computers. In this area we
borrowed the idea of the nationwide
department stores of USA, which rely on
their captive satellite communication
network for executing instantaneously cash
settlements. There was also another strong
reason for choosing satellite-based
communication technology (SBCT) in our
context. When NSE was being set up, the
terrestrial communication system provided
by BSNL would not have provided a fault
tolerant, time critical, and high bandwidth

communication link between NSE and its

members. Even within Mumbai city
broadband telecommunication links were
not highly reliable, besides the fact that they
were relatively more expensive. For example,
in Mumbai an end-to-end 64 kbps leased line
from MTNL was costing NSE members
almost Rs 2 lakh per annum whereas NSEs
highly reliable satellite link costed around
half of that amount. Secondly, quick
availability of leased lines was also a problem
in those days as there was no competition to
the BSNL or the MTNL. In retrospect NSEs
choice to go in for its own captive VSAT
network proved to be a very wise decision.
Such a highly reliable telecom link that
enabled NSE to establish links with its
rapidly expanding member community with
a minimum time lag put NSE way ahead of
all its competitors. This was perhaps one of
the most important reasons which helped
NSEs trading volumes to grow almost
exponentially. Secondly, given the state of
the terrestrial telecom infrastructure of
BSNL and MTNL when NSE started its
operations in 1994 it would have been
practically impossible to establish NSEs
nationwide trading network, connecting
such far off places like Srinagar, Johrat
(Assam), Nagercoil (Tamil Nadu), Nainital
(Uttaranchal), and Salasar (Rajasthan).
Pangs of Birth
The NSE proposal was met with tremendous
hostility. Broker community was up in arms
against any such idea for the simple reason

that it was against their interests. They

sincerely believed in the concept of
mutuality of a stock exchange and were dead
sure that only brokers should own and
manage a stock exchange. They could sell
such an idea to the lay people as global
history of the stock exchanges supported
their contention. All over the world almost
all the stock exchanges are broker owned and
managed. Even in India the history not only
was in their favour but that the spirit of
SCRA was also in sympathy of their
contention. The SCRA defines the stock
exchange as follows:
stock exchange means any body of
individuals, whether incorporated or not,
constituted for the purpose of assisting,
regulating or controlling the business of
buying, selling or dealing in securities
The second objection of theirs was that NSE
was given a mandate to spread to all the parts
of the country whereas then existing stock
exchanges were permitted to operate within a
strictly defined narrow geographical
territory. The area in which a stock exchange
could operate, most of the time, was coterminus with city limits where the
particular exchange was set up. For example,
the area of operation of BSE was confined to
municipal limits of Mumbai and that of
DSE to Delhi. The design accepted by the
authorities at that time was to divide the
country into geographically noncompetitive securities markets; in other
words the then accepted policy frame was to

create geographical monopolies for

respective stock exchanges and to protect
them from competition with other stock
exchanges. With the arrival of NSE with a
mandate to operate in all parts of the
country the monopoly status of all the stock
exchanges came to an end abruptly. The
smaller stock exchanges were particularly
worried that they would have to compete
with the proposed exchange which was
backed by powerful financial institutions of
the country.
They also took a great objection to the
proposition that NSE would enter in a big
way into the equity segment by setting up
computerised trading facilities in equities all
over the country. The broker community
were under the wrong impression that we
were implementing NSE as was conceived in
the Pherwani Committee Report. However,
our design of NSE was radically different.
All that we borrowed from Pherwani
Committee Report was the attractive name
of National Stock Exchange for the
proposed stock exchange. The broker
community therefore accused us that we
were going beyond our charter which
according to them was merely setting up of
an exchange for trading in debt instruments.
Advantages of Misconceptions
In retrospect, I must confess that several
such and similar misconceptions about NSE
did help us in many ways. Brokers used to
refer to NSE as a Sarkari exchange as it was
being set up by people with a public sector

background and most of its promoters were,

directly or indirectly, government owned
institutions/banks. Since the record of
public sector entities in regard to either
efficiency and customer-friendliness has not
all along been particularly flattering it was
felt that a Sarkari exchange would be no
match to well entrenched stock exchanges
like BSE. The critics also used to be quite
unflattering about the team that was
identified to set up NSE. They were sure that
the sarkari babus will never be able to
understand complexities of a stock
exchange. The economists in this compact
team came in for special ridicule.
Economists, even today, are considered by
many to be woolly thinkers and are not
thought to be good at implementing
complex projects and least effective in
managing market oriented business
enterprises. According to majority of the
market observers all the important factors
that are crucial for ensuring success of any
out of the way new ventures were absent both
in regard to ownership and the management
structure of NSE. Thus, there were several
factors that weighed heavily against NSE
offering any competition worth the name to
the broker managed large stock exchange
like BSE. There were also other equally
weighty reasons which were being cited as to
why NSE would not become an exchange of
any consequence.
It was then very widely believed that
computerised trading would not succeed
especially in a country like India where

computer literacy was quite poor, especially

among the stock market fraternity. When
NSE was being set up, most of the people
who took up broking activity were not only
not very well educated community but that
most of them had not even touched the
computer key board. In view of this it would
be very difficult to attract truly business
savvy brokers into NSEs fold as they would
detest computerised trading systems. It was
widely believed that computerised trading
requires highly complex computer skills and
those who have such skills are unlikely to be
good brokers. In a way, we were also worried
about the difficulties of enticing the broker
community into the fold of NSE. Hence we
p l a n n e d t o p ro v i d e t r a i n i n g i n
computerised trading to our members
before we actually commenced our formal
trading on the NSE. We set up trading floors
in NSEs office premises by setting up a
Local Area Network (LAN) where members
could be actually trained to do computer
trading. We estimated that it will require at
least three full days training for each dealer.
Our LAN could accommodate almost 100
dealers at any point of time. After the
training started we were in for a major
surprise. Most of the dealers at these training
courses took just about two hours to learn all
the tricks of the trade and became quite
proficient in the computerised trading
system. The main reason for dealers learning
the skills fast was due to the high quality
trading software that we had procured from a
foreign software company and the

subsequent improvements/modifications/
customisation done by Tata Consultancy
Services (TCS), our main software vendor at
NSE. The trading software had kept all the
complexities at the host computers at NSE
and the dealer terminal or front-end was kept
as simple and user friendly as possible.
As a matter of fact, all the drawbacks that
were perceived by the critics of NSE to be in
the NSE project did help in many ways. The
broker-perceived weaknesses of NSE project
helped us a great deal in minimising the
extent of actual opposition that NSE faced
particularly from the powerful broker
community. Since NSE was considered to be
a venture which, according to many
traditional brokers, was certain to end up as
major disaster the broker community did
not feel as much threatened as it was trying
to make out through periodic virulent
attacks on NSE. The frequent derogatory
remarks that we used to hear from most of
the critics was that the IDBI led consortium
was wasting public money on the NSE
venture which, according to them, was
doomed to be a failure.
NSE as Market Reformer
A. The Concept of a Demutualised
Exchange
The NSE brand of demutuality is perhaps
unique in the world as it aims at a total
separation of exchange ownership and
management from the trading rights of
members. In other parts of the world

demutualisation has meant converting the

mutualised exchange into a corporate entity,
with trading members having both
ownership rights as also representation on
the board of the company. Australia was the
first country where a mutualised exchange
got transformed into a demutualised
corporate body in the latter half of 1990s. In
the Australian demutualisation case, brokers
still have a strong voice in management as
their shareholding in the exchange company
continues to be sizable. A true
demutualsation is one in which ownership
and management of an exchange are totally
separate from members trading rights in the
exchange. The problem with a broker owned
and managed exchange is like playing a
cricket match where the players also act as
umpires by turn. Such a game will never have
umpiring being done impartially since each
umpires decisions will be biased because of
the conflicts of interests he faces. In a broker
dominated exchange all the office bearers
such as the president, vice-president/s,
treasurer, and other board members are all
elected by the general body of members who
are trading members. It is also obvious that,
once you resort to election as a method for
choosing office bearers of the exchange,
group politics is bound to emerge. Members
in such an exchange do not seek board
positions for altruistic reasons but to enjoy
the advantages that accrue to the office
bearers. Hence desire to win an election
becomes a strong motivation for protecting
self and/or group interests. As office bearers

of an exchange continue to remain active in

their own day-to-day brokerage business
there is always a temptation to misuse their
official position to have access to
information about other members market
position in different stocks. It is not possible
to prevent all such malpractices unless all the
office bearers in control of the affairs of an
exchange are not its trading members.
This argument is sometimes countered by
pointing out that a number of chief/senior
executives of brokerage firms also sit on the
board of NYSE. It is further argued that if
that is considered to be reasonable in the case
of NYSEa premier stock exchange of the
world, what is wrong in having brokers
on boards the Indian stock exchanges? The
major point that should be noted in this
context is that the senior member
representatives on the board of NYSE are not
only very far removed from the normal
trading desks of their firms but that they
scrupulously avoid having any contact even
remotely with all those departments which
are involved in the actual exchange activity.
In spite the self discipline observed by NYSE
board members there has been frequent
criticism about the influence of powerful
trading members on the management
quality of functioning of NYSE. Recently,
there has been intense criticism about the
detrimental influence of the floor specialists
on the price discovery process of NYSE and
the role of powerful NYSE members firms in
this.

As of now there is hardly any disagreement

in our country on the necessity of having
demutualised stock exchanges. After the
stock exchange crisis in 2001 the
government announced that
demutualisation will be made mandatory.
However, actual move in that direction has
got considerably delayed. The main
difficulty that arose in this area is about the
beneficial ownership of the property that
belonged to the exchanges after they got
demutualised. Many people including me
have argued that most of the property that
the exchanges had accumulated has been due
to the favours passed on by the government
to the exchanges. They were exempt from all
types taxes besides the fact that the land on
which the buildings of most of the stock
exchanges were constructed was given at
almost throwaway prices to the exchanges.
Since the exchange was considered to be a
public utility it enjoyed so many other
benefits including listing fees that are to be
paid by the listed companies. Recently SEBI
has come out with a broad demutualisation
scheme for the exchanges where brokers will
have 49% of the share capital of the new
exchange company and broker
representation on the governing board will
be to the extent of 25 % of the total. It should
be noted in this context that this scheme of
demutualization is materially different from
that of NSE. Hence one is not fully sure as to
what this will mean in reality to the quality
of governance and resolution of the issues
relating to conflicts of interests as noted

above with broker members sitting on the

boards of the stock exchanges. There is also
one more puzzle that needs to be noted in
this context. In re sponse to the
recommendations of a SEBI Committee on
uniform set of Rules and Bye-laws to be
adopted by the stock exchanges, SEBI came
out with a circular in December 2001
mandating a model set of rules applicable to
all exchanges uniformly including the
demutualised exchanges like NSE and
OTCEI without realising that many of the
clauses in the model rules are actually not
only contrary to the principle of
demutualisation but also that they negate
some of the best practices already adopted by
the demutualised exchanges. These new
model rules are still in the process of being
adopted by all the exchanges. There are
therefore two important points that need to
be noted in this context. Firstly, since SEBI
now wants all the exchanges to be
demutualised, will it still insist on adoption
of rules that negate the basic principles and
practices adopted by exchanges like NSE?
Secondly, is it desirable that we should get
back to a philosophy of forcing a common
set of rules which, often are worked out on
the principle of least common
denominator? One would say that ideally it
would be desirable to prescribe minimum
standards/rules that all the stock exchanges
should adopt so that more dynamic among
them have incentives to move faster in the
right direction.
Before I turn to NSEs attempt to set up a

nationwide exchange let me draw your

attention to the tremendous pressure that
was brought to bear on NSE from highly
powerful quarters to have broker members
on its board. Very ingenious arguments were
being put forth in justification of having
brokers on the board of NSE. It was said that
just as we cannot have bar councils without
lawyers on the bar or medical councils
without doctors as its members how can we
have stock exchanges without stock brokers
on their boards? The major point that was
missed all along was that bar councils or
medical councils are like clubs of their own
members and they are not on par with stock
exchanges which are granted recognition by
the regulator so that they scrupulously
follow a code discipline, protect integrity of
the market and fully protect investors
interests. Common citizen do not deal with
the bar councils or the medical councils in
the same fashion that investors deal with the
stock exchanges. Hence it is meaningless to
compare bar councils or medical councils
with stock exchanges. Although NSEs
trading members were fully aware that NSEs
trading membership does not grant them
any rights to its board membership they also
started an agitation to have board
representation. They were being instigated
by those putting forth bar/medical council
arguments as also broker activists from other
exchanges. However, NSEs board stood
firm on this issue and refused to yield to
pressures of the vested interest groups.

B. Concept of nationwide exchange

When NSE got its recognition as a stock
exchange these powers were being exercised
by the Ministry of Finance, GoI. When NSE
was given a clear mandate that permitted it
to extend its operations to all the parts of the
country it was not clear to the stock
exchange community as to how we would be
able to implement such a difficult project.
Hence most of them felt that this
nationwide trading mandate would remain
merely on paper. It is possible for this reason
that most of the regional stock exchanges
were not worried in the beginning that NSE
would ever compete with them for business.
With the resounding success of NSEs order
driven anonymous computerised trading
system, which rode a highly reliable satellite
communication system, all the stock
exchanges got very much worried about its
competitive threat. BSE also got more
worried as we started eating in a big way into
its order flow that used to originate from the
rest of the country. As NSEs trading
volumes started spurting all the stock
exchanges started putting pressure on the
regulator not to permit spread of NSE to
centres where the regional stock exchanges
were located. We from the NSE took a stand
that since NSE had been given a mandate to
spread its trading network to provide real
time and equal access to investors spread
across the length and breadth of the country
we cannot stop our drive of going to newer
and newer places where investors existed.

This became a highly contentious policy

issue; hence it had to be finally referred to
the Government as the original mandate to
NSE for nationwide trading was given by the
Government itself. Government was
requested to review the policy in regard to
NSE so that it is also obliged to seek
appropriate approvals for all its future plans
to expand its network to new geographical
locations. The logic was that since other
exchanges had to obtain approval before
spreading their trading terminals to
locations outside their licensed areas NSE
should also be subjected to the same rule.
However, we from the NSE were vocal that
the ban put on other exchanges from
spreading to locations outside their preapproved areas of operations should be
removed so that all the recognised exchanges
freely spread their operations to places of
their choice. Since NSE was conceived from
the beginning as a model exchange to
significantly upgrade capital markets of the
country and put competitive pressure on the
existing exchanges to reform themselves, it
was not necessary to set up different NSE
type model exchanges in all places where the
stock exchanges already existed. The
technology adopted by NSE facilitates
spreading its trading network to all the parts
of the country; therefore it is a cost effective
option to provide exchange infrastructure
rather than duplicating NSE model in
different cities and towns. The NSE model
discards the archaic then prevailing capital
market concept which identified a market

with a particular geographical location.

Prior to NSE the capital market of the
country was divided into isolated markets
which were identified with the cities of their
location viz., BSE in Mumbai, DSE in Delhi,
etc. When the policy about NSEs expansion
was being reviewed NSE had put on hold its
expansion plans. However, it did not take
much time for the Government to reaffirm
its earlier decision that NSE should be
allowed to spread its trading network
without any hindrance to all the parts of the
country.
C. Settlement guarantee
The concept of a settlement guarantee as
NSE currently operates was almost
unknown in India until 1995. Interestingly
the SCRA also does not talk much about
settlement of trades done on the exchanges
except mentioning that the exchanges can
set up their own clearing houses. We realised
this was one area where a major reform was
overdue. Our review of global practices
indicated that even some of the major stock
exchanges like NYSE, NASDAQ, and LSE,
did not have their own clearing and
settlement infrastructure/entities. But this
model was not found to be suitable for the
Indian conditions as there are even today no
such independent clearing corporations that
would take responsibility of settlement by
offering settlement guarantee. NSE decided
to set up a wholly owned subsidiary called
National Securities Clearing Corporation of
India Ltd (NSCCL) for this purpose. The

main idea behind setting up a separate legal

entity for handling clearing and settlement
is that such an activity is a commercially
risky proposition. A clearing corporation
may face the prospects of bankruptcy in
extremely volatile market conditions if the
margin money and other funds on the basis
of which settlement guarantee is extended to
the clearing members is not adequate to
cover the risks that emanate if some of the
clearing members become bankrupt and the
guarantee fund is not enough to complete
the settlement. From an overall point of view
an exchange is considered to be a public
entity which should not ever face the
prospects of bankruptcy. Hence there is
justification to segregate the clearing and
settlement activity by entrusting it to
another corporate entity and not make it
part of exchange activity.
Given the speculative instincts that
dominate market players in India NSCCL
introduced some of the most stringent
regulations for its members. The mechanism
of upfront or initial margins was introduced
by NSCCL right from day one in a different
garb. Each member was given trading
exposure limits (net in each stock and gross
across all the securities) based on the
deposits that the member placed with NSE
plus NSCCL. To begin with the net exposure
ratio was fixed at 10, meaning thereby that
no member can have, at any point of time, an
aggregate exposure of more than 10 times his
deposits. If a member deposits say Rs 2 crores
he can trade within an exposure limit of Rs.

20 crores. To track member positions

NSCCL developed unique software which
tracks each members aggregate trading
exposure on a real time basis. The software
has the capability of not only informing the
member his exposure position on a real time
basis but also disconnect all his trading
terminals the moment he crosses the limit
granted to him on the basis of the deposits
made with NSE/NSCCL. The NSCCL has
been making variations in the exposure ratio
depending on the market conditions. Later
NSE calculated security - wise margins based
on the volatility to which different stocks are
subject to. As of now it would be no
exaggeration that India has one of the most
sophisticated system implement a scientific
margining mechanism but that it is one of
the few countries that has built strong
capabilities to deny trading connectivity to
members that exceed their exposure limits
on a real time basis.
When NSCCL introduced the concept of
settlement guarantee fund for smoothly
managing the settlements there was lot of
misunderstanding about the whole thing. It
is very rarely that in each settlement all the
pay-ins are made fully by the members.
Temporary shortages of either funds or
securities can happen for various reasons
given the fact that members/investors trade
from nearly 400 places across the country.
For example, a member may find that his
client could not remit funds in time for the
member to complete the pay-in before the
predetermined time. In some cases investors

may not be able to give delivery of shares to

the members in time if the members
maintain their depository account with
some other depository participant. It is also
possible that a client of a broker or the
broker himself has traded excessively and is
not in a position to honour his obligations
to the clearing corporation. In this context it
should be noted that just because all the payins have not come forth the settlement
should be aborted. In all such cases of
shortages the NSCCL which acts as the
central counter-party for the whole
settlement process steps in and completes
the settlement. If there is a shortage of funds,
the settlement guarantee fund is used to
complete settlement. If there are security
shortages NSCCL procures the shares by
buying them through an auction or
borrowing the securities as recently
permitted by SEBI. Later the NSCCL
recovers the dues from the members who are
short in deliveries and also levies fines for
not having made the required pay-in in time.
It is only when the concerned member fails
to pay up his dues to the NSCCL within the
time frame stipulated by it that the
procedure for declaring him defaulter kicks
in.
In the beginning when this system was
introduced there was a great deal of
misunderstanding about it. Some even
unfairly and maliciously accused NSCCL as
encouraging speculation by funding
settlement shortages. All those who are
familiar with goings on in the BSE before it

also set up its own settlement guarantee fund

for managing settlements smoothly will
agree that the settlement guarantee
mechanism introduced by NSCCL for the
first time in India is the right one. During
the period before BSE put up its form of
settlement guarantee it had to shut down the
exchange for three days for a settlement
default by a member of a relatively small
amount. Settlement guarantee fund helps to
fund settlement shortages as a bridging
mechanism so that the settlement goes
though smoothly and there are no cascading
defaults. During its existence so far NSCCL
has been able to manage all the settlements
on time with the help of the settlement
guarantee fund even when there were large
pay-in shortfalls. In most of these cases
NSCCL has been able to recover later the
pay-in shortfalls from the members. In all
those cases where members failed to meet
their obligations to the NSCCL, even after
they were given reasonable time to make
good their shortfalls, such members were
declared as defaulters and the shortfalls were
met out of the incomes NSCCL earns by way
of interest on settlement guarantee fund as
also the small fees it collects from the
members as settlement charges. As of today,
the concepts of the settlement guarantee
fund and guaranteed settlements have
become accepted folklore in our capital
markets. But it should not be forgotten that
when we introduced them for the first time
in the country, we had to face lot of
malicious criticism from the market players

and hostility from unexpected quarters.

Some market players even went to the extent
of spreading falsehood that IDBI was
continually funding all such shortages and
that NSCCL losses were being covered by
IDBI as it had promoted NSE.
NSE: Third largest exchange
In terms of the number of transactions NSE
today is ranked as the third largest exchange
in the world, next only to NASDAQ and
NYSE. How did NSE come to occupy this
position in its short history of a decade? It
has also been able to establish another major
landmark. It is the first stock exchange in the
world to cross the turnover of an already well
entrenched stock exchange in its own
country, viz., BSE in a very short period of
one year. It is worth noting in this context
that the initial run for the NSE was not at all
that smooth. During first few months of its
existence its trading turnover was quite
modest, often less than Rs. 10 crores a day. It
appears that the investors as also our
members were testing our systems and our
management capabilities. When they saw
that all the settlements were being completed
absolutely in time without any hitches they
started developing confidence in us. As our
rules and regulations were absolutely
transparent and once investors started
seeing prices and quantities in different
stocks on a real time basis at all places where
our terminals were located they came to
recognise a major difference between NSE
and all other exchanges. As NSE volumes
started growing the prices reflected on its

screen became a benchmark for all other

exchanges including BSE. It did not require
much time for NSE to establish its
leadership in the market. Another
interesting thing that is worth noting is the
composition of its investor class when it
emerged as the largest stock exchange of the
country. At that time more than 90% of the
value of trading was accounted for by noninstitutional or retail investors. Strangely
even most of the promoters of NSE were not
trading on NSE. That is why I consider that
institutional investors are less market savvy
and laggards as compared to retail investors.
Although the institutional investors
holdings have grown quite rapidly during
the last decade the retail investors continue
to be the backbone of our equity markets.
Given the fact NSE enjoys maximum trust of
the retail investor community and it will
continue to grow both in terms of trading
volumes as also in terms of market share.
Sizable institutional orders are still said to be
going to BSE for a very strange reason. Since
its order book position at most of the time
during the trading hours is reported to be
thin institutions prefer to execute their
negotiated deals on the BSE. As per SEBI
rules the trades have to be matched on the
trading screen of an exchange. If the
institutions place their orders on the NSEs
trading screen they run the risk of their
orders getting matched with other orders
since there is considerable order depth on
the NSE screen during almost the entire
trading hours. Therefore for concluding 1-2-

3 type of deals the institutional investors

prefer BSE screen in view of its shallow order
book position. Indirectly this is a tribute to
the NSE as those who trade on it can end up
having more efficient order execution.
Real Life Experiment
It is not widely recognised that the success of
NSE throws up some important lessons even
to the academic minded people. As you all
know while it is possible to conduct
experiments to test validity or otherwise of a
hypothesis it is next to impossible to
conduct similar experiments to prove one
way or the other economic
laws/propositions. Elementary text books
on economics tell us that as price of a
commodity falls, demand for it increases, or
vice versa. It is difficult, however, to simulate
such exercises/situations in real life and
draw any conclusions; demand for any
commodity in real life situations is subject
to many other factors other than merely
movement in prices. That is why the
economists always state their proposition
with the usual qualification that other
things being the same a fall in price leads
to a rise in demand. In short, most of the
economic or business propositions are also
not amenable to real life experiments.
There has been a long standing debate as to
whether an order-driven trading system is
superior to a quote-driven or jobber-driven
trading system. Even in the US there is a
strong lobby which maintains that a
jobber/specialist driven trading system is far

superior to the automated anonymous order

driven trading system. On the NYSE, for
example, the specialists or the jobbers have
such a strong clout that despite the exposure
of misdeeds of several powerful specialists
the Securities Exchange Commission (SEC)
could not succeed in forcing a change in
favour of an anonymous computerised
trading system. All that the SEC could do
was to levy hefty fines on the specialists who
had gained at the expense of the investor
community.
In India, after NSE scored a conclusive lead
over BSE in terms of trading volumes, we
have been able to settle the debate in favour
of the order-driven trading system. It may be
recalled that before NSE came on the scene,
jobbers used to rule the roost on BSE, which
accounted for almost 70% of the trading
volume on all the stock exchanges in the
country at that point of time. All the capital
market experts in our country were fully
convinced that success of a stock exchange
was directly related to the activity level of
jobbers who act as market makers
continuously by giving two-way quotes for
stocks of their choice. In such a trading
system the jobbers are supposed to be aiding
the price discovery process for different
stocks. The argument goes on to maintain
that the jobber are more efficient in the price
discovery process as they know better the
pulse of the market, given the fact that most
of the buy/sell orders pass through them.
Equally strong are the arguments on the side
of the order driven trading system. In an

order-driven trading system buyers and

sellers, without the assistance of any
intermediary like a jobber/specialist,
directly decide as to the prices that are
acceptable to them. Once buyers/sellers
place their limit orders on an anonymous
transparent trading screen the entire
investor community comes to know the state
of the market on a real time basis. This helps
other investors to reassess their trading
strategies and thus, through an iterative
process, the market is able to arrive at an
efficient price discovery process. The
buyers/sellers who place limit orders do not
run the same risk as jobbers do. Since a
jobber has limited resources of his own and
since his demand and supply for stocks is a
derived demand his willingness and ability
to bear risks is far more limited. In a
turbulent market the jobbers stop giving two
way quotes while in an order driven trading
system trade can still take place as there
would be some investors who are willing to
enter or exit market at prices acceptable to
them.
NSE introduced its order-driven trading
system during a period when the ruling deity
was the jobber-driven trading system on the
BSE. The jobbers on the BSE had almost full
control on all the trading that took place on
the floor to such an extent that even the big
brokerage firms were afraid of them. In one
instance, when a big brokerage firm rubbed
an important jobber slightly on the wrong
side, that jobber refused to have any dealing
with the concerned brokerage firm. Since the

jobber had almost a monopolist position in

several less actively traded stocks the big
brokerage firm had to tender apologies
before the jobber agreed to deal with it.
Jobbers had come to assume a unique
position on the trading floor of BSE. This
led many market observers to conclude that
an exchange cannot function unless there
are jobbers for most of the stocks including
even the highly liquid stocks. When NSE
decided to do away with the jobbing system
and opt in favour of the order-driven trading
system a number of close observers of the
market predicted that NSE would fail to take
off as an exchange given the fact that such a
trading system did not have any chance of
winning. But we did not share this view as we
were fully convinced about the advantages of
an order-driven trading system, especially
for stocks with relatively large market
capitalisation.
As if to bear out the prediction of these
market observers, NSE trading volumes
remained very modest during the first four
to five months. Even during the second
month of its operations NSEs trading
volumes were less than Rs 10 crores a day.
Although we were quite concerned about
this we decided to give a full try out to the
system that was quite new to the country.
Interestingly however, after a couple months
unexpected things started to happen. From
the fifth month onwards, volumes started
growing almost exponentially. During the
sixth month in particular the daily trading
volume was often in excess of Rs 200 crores.

On a day when the volume crossed Rs 260

cores calls started coming from the
regulators office as to whether the things
were under control and whether there would
be settlement troubles. There was nothing
much to worry as all our members had
maintained hefty membership deposits in
relations to the trading volumes of those
days. If any member failed to honour his
delivery obligations we had the freedom to
close out his position and use his
membership deposit to meet his losses. The
standard procedure adopted at NSE from
day one was to deny access to his trading
terminals until he brought in fresh deposits
to meet the exchange requirements.
Our quick analysis as to how the trading
volumes started growing so fast at that time
yielded an interesting result. Many of the
BSE brokers who had also taken up NSE
membership started doing arbitrage trading
in a big way. They would buy on NSE and sell
simultaneously on the BSE, and vice versa.
Since they were benefiting from price
differentials on the two exchanges they were
in a safe position so long as deliveries did
materialise. As NSE started expanding its
trading network to other major cities where
regional exchanges were located arbitrage
trading further picked up between NSE on
the one side and the regional exchanges on
the other. Thus the spread of NSE benefited
all the exchanges as their volumes grew fast
because of arbitrage between NSE and all
other exchanges. In this context it is worth
recalling the hostile reaction of most of the

regional exchanges when the regulator made

a proposal to have uniform trading cycles on
all the exchanges. The regional exchanges
argued that they will have to shut down their
operations if uniform trading cycles are
introduced. Different trading cycles were
also helping stock brokers and speculative
investors to transfer their open positions
from one exchange to the other without
much of a trouble. It was possible for
somebody to carry on open positions in
their stocks indefinitely so long as they were
willing to pay margins of the stock
exchanges where they maintained open
positions. All the major market operators
who benefited from differing trading cycles
of different exchanges became a major
stumbling block in the introduction of
rolling settlements.
When BSE introduced its version of
computerised trading it had opted in favour
system that favoured jobbers at the cost of
non-jobbing members. The order matching
algorithm was designed on BSE in such a
way that, at a given price for a stock, orders
would match on priority with those of the
jobbers orders. For example, if a order for
sale for a stock at a given price is placed on
the screen and there are two match-worthy
buy orders at the same price, then the sale
order would match on priority with jobbers
buy order. When brokers who were members
of NSE and BSE started evaluating relative
advantages of the two trading systems most
of them realised that NSEs trading system
was more market friendly as it did not create

any class distinctions and treated all on par.

Several BSE brokers started working around
their own trading system so that BSE trading
system almost got converted into an orderdriven trading system.
Depository with dematerialisation
As NSE spread across the country it faced
serious problems related to the paper-based
settlement system. The first set of problems
related to transport of share certificates to
the central clearing location in Mumbai.
Since NSE decided to shorten the settlement
period it introduced a weekly settlement
system as against BSEs fortnightly
settlement. Shortening of the settlement
period along with the responsibility of
clearing settlement of the net obligations
during the next week put excessive burden
on NSE. The pay-ins of securities from all
over the country at Mumbai and thereafter
re-dispatch of pay-outs at all the relevant
locations in a weeks time created lot of
difficulties for its members. NSE therefore
decided to offer a helping hand to its
members. It made arrangements to receive
all the pay-ins at four major metros, viz.,
Mumbai, Delhi, Kolkata, and Chennai and
also make payouts from these four metros.
At its own expense NSE used to ship by air
all the securities pay-ins from the other
metros to the central location in Mumbai
and reship by air the pay-outs to the other
metros. On many occasions NSE had to
airship share certificates weighing more than
four tonnes a week each way at its own

expense. The paper based system posed other

far more serious problems. Several antisocial elements tried to take advantage of the
system by introducing fake and fraudulent
securities and transfer forms that
accompanied them. To deal with problem of
fake certificates NSE, with the assistance
registrars and transfer agents of the
companies, launched a system of scrutiny of
the documents before they are accepted as
pay-ins. Despite all this NSCCL as also
several members suffered loss due to the
massive nature of this problem.
NSE therefore took in serious earnest the
task of setting up a depository where
ownership records would be maintained in
the dematerialised form. The speed with
which this task was also implemented could
be noted from the fact that the depository
went live in November 1996, just two years
after NSE went live in November 1994. It
was a great encouragement and relief for us
when Mr Bhave agreed to take up the
responsibility as the first MD and CEO of
the depository in the early part of 1996. He
has done a wonderful job at the depository
and taken it to great heights. NSDL therefore
continues to be the most preferred
depository of the country by the investor
community. In this context it is worth
remembering that despite the obvious
advantages of a depository there were some
people who were not in favour of the
depository. These were the people who could
benefit from badla trading in paper-based
environment. The true motives of some of

these people got exposed during the 1998

stock market debacle when it was found that
physical share certificates were being
misused in the badla trading. If depository
movement has become a resounding success
in India in such a short period of time it is a
tribute to both the Government and the
SEBI for consciously pushing the capital
market players in that direction. The Indian
depository is unique in the world in one
respect; it is, perhaps, the only depository to
have full data on investor holdings, which
gets updated continually. The investors are
therefore better protected from problems
that may arise due to intentional or
unintentional activities of the depository
participants which are in the investors
interest. The success of a dematerislised
depository has also helped to usher in an era
of rolling settlement. In a period of less than
four years the Indian capital markets could
make a transition from a weekly account
period settlement first to T+5 settlement,
then to T+3 settlement and finally to T+2
settlement. India is one of the very few
countries globally to have adopted T+2
settlement system. It would have been
simply impossible to think of rolling
settlement if depository movement had not
caught on in such a short period of time.
India is one of the very few countries where
the depository movement has become such a
market-wide success.
Futures & Options launched
Despite the advice to the contrary even from

many of our well wishers we decided not to

introduce badla trading system on the NSE.
Some had favoured NSE introducing badla
trading as they felt that we would be able to
manage it more efficiently and in a
transparent fashion. The main reason why
we did not favour badla trading is that it is a
hybrid product which muddies up the price
discovery process as badla is a mix of the cash
and the futures market. Badla grew rapidly in
the Indian market after the forward trading
was banned in the 1960s because of the
excessive speculation that it was leading to.
Badla provided an escape route to the active
market players; it gained in popularity with
speculators as also many financiers who
wanted to deploy their funds in a profitable
way. The badla trading system also became a
conduit for deployment of unaccounted
money for traders in many areas including
diamond trading. Authorities had
periodically expressed their unhappiness
with several unhealthy practices adopted in
badla trading. Hence it was banned a
number of times when the markets got
excessively heated up. During the mid1990s SEBI lifted its ban by stipulating
some stringent conditions on badla trading.
BSE found that it would take considerable
effort on its part to develop software that
could ensure that SEBI conditionalities were
met. When BSE could not introduce
modified badla quickly some of the more
disciplined and professional minded ardent
supporters of badla approached me with a
request to introduce modified badla on NSE

because, according to them, NSE would be

quick and more efficient in introducing the
modified badla, given its proven capabilities
to develop good software. But since NSE was
not keen to compete with BSE for its own
sake or to capture larger market share by
adopting any means, I was not tempted to
accept the proposal. It was my strong
conviction that badla might have served
some purpose at a time when the
Government had banned abruptly forward
trading. But it had outlived its utility and
should therefore be phased out and in its
place we should have futures and options.
Because of this view of mine I had become a
much disliked person among the badla
supporters as also some of the important
people in official circles. Right from day one
of NSE I was keen that India should graduate
into the globally accepted most efficient
form of futures trading viz., options and
futures; hence our efforts were, at that time,
concentrated on getting SEBI approval for
the futures and options. Being a totally new
product it did take us quite some time to get
the futures trading duly approved. Major
part of the difficulty that we faced was on
account of the powerful badla lobby which
strongly opposed introduction of futures in
the Indian markets. The main worry of the
badla lobby was that, once futures were
introduced in India, badla would become
less attractive.

futures one day prior to that of NSE. But

that has not helped BSE in any way as could
be noted from the fact that futures have not
taken off at BSE. As of today more than 99%
of the futures trading in the country
happens to be on the NSE. One need not put
in great efforts to find out as to why BSE has
lost to NSE in the futures game. The reason
for this is simple. When NSE was
concentrating its efforts on building its inhouse expertise, developing the trading and
settlement software, and spread of the
message of futures countrywide through
large number of investor seminars, BSE was
emotionally pleading the case of badla even
in foreign countries. As a result, it lost a great
deal in terms of getting seriously prepared
for the introduction of a relatively more
complex options and futures trading. Once
having lost the lead in this area it has become
more difficult for BSE to attract investors to
its futures segment. During 2000-01 the
market witnessed exceedingly high
speculative activity on the exchanges, aided
by badla with diluted standards and interexchange position shifting. This led to a
market crash forcing Government to ban
badla and announcing introduction of
rolling settlements. My worst fears about the
highly risky nature of badla trading were
proved to be correct and our decision not to
introduce it at any cost also proved to be the
right one.

After a great deal of efforts, futures were

allowed to be introduced. However, BSE
managed to score over NSE by launching

Concluding remarks
I think I have rambled at length during the

last 45 minutes or so. I am sure you will be in

a mood to forgive me if you kindly
remember the fact that it is difficult to avoid
temptation for rambling when one is
personally involved in the subject matter
itself. It is difficult not becoming passionate
about certain matters which you consider to
be important whereas some others may not
necessarily think on similar lines. I recall
listening to the talk of a capital market
expert from the academic world about the
reforms that got introduced in the Indian
capital market after NSE was set up. I am not
sure as to what was his intention in belittling
all that NSE had done in a relatively short
period of time. The main thrust of his
argument was that it was easy to modernise
any capital market if you have access to
adequate financial resources to put up
powerful computers with state-of-the-art
software and good communication system
to establish links among the brokers, the
stock exchange and the investor community.
He was also arguing that clearing and
settlement efficiency and risk management
capabilities of a stock exchange are all

dependent on deployment of efficient

software and systems. He gave hardly any
credit to the quality of management of an
exchange or to put it figuratively, the men
behind the machines. If you go along with
the argument of this expert you would be
hard put to explain as to why BSE could not
do, in the first instance, all that NSE was able
to do. BSE was not short of financial
resources; it had all the means to put up the
most powerful computers, acquire the
necessary software, and communication
systems. If BSE had the will to reform itself
there would have been no need to set up
NSE. Strangely, even today when we hear
discussion on the Indian capital markets we
do not hear much about the importance of
the motivations of men that are in charge
of exchange management. Until the
arrival of NSE on the scene the reforms were
delayed mainly because of the absence of
desire or drive on the part of the men in
charge at the stock exchanges to bring about
the required changes with single-mindedness
of purpose.