How NSE made shares less risky

Brokers who would front-run your trades; extended waiting period to get your shares;
cumbersome paper certificates the National Stock Exchange has changed all these. Think the
stock market is a minefield? Well, you probably werent trading in it 20 years ago. Can you
imagine paying in advance for your shares and waiting with bated breath for a month to receive
them? Or signing a truckload of transfer deeds to get shares registered in your name? Or never
knowing the current price of the stock and always buying it at the days high? Well, this is how
stock trading used to be before the National Stock Exchange (NSE) burst upon the scene in 1993.
NSEs biggest contribution to the market was the democracy it ushered into stock trading. By
linking up trading centers across the country through V-SAT terminals, it made sure that a small
investor sitting in Ranchi had the same opportunity to trade as the fat-cat at Fort, Mumbai.
Electronic trading replaced the system of ring trading prevalent on the BSE, where only a select
coterie of brokers, through open outcry, could trade on the exchange floor. Costs were sky-high
too, with a BSE membership card costing over a crore and brokerage fees at 1-2 per cent of the
transaction value. Contrast that with the 10 paise brokerage deals you get today! On the BSE,
investors wanting to buy or sell a stock had no ticker tape to rely on. They went by quotes
provided by the broker, who in turn had to rely on his man in the trading ring to call and give
him the latest quote.
You had to call the broker a day in advance and tell him the price you want. The next day he
would go to the exchange and see what other brokers had to offer. As there was no mobile
connectivity then, he would take a call on your behalf and close the deal. So, you never knew if
he got the best price for you. Brokers usually gypped clients. If you placed an order for 10,000
shares, the broker would front-run it with 1,000 shares of his own and your shares would be
always bought at the days high!
NSEs system of screen-based trading with an electronic order matching system changed all this.
NSEs biggest contribution was transparency one nation-wide order book that everyone could
see, from the small investor to the big institution. When the order book became public, poof went
the advantage that the big guys had over ordinary folk. Orders were matched on price-time
priority by the computer; the first trader to punch in his order got the best price. Today, traders
can even ask the exchange for a volume-weighted average price (VWAP) to check exactly how
much the trade price deviated from the days trends.
The electronic order book dislodged many jobbers from the market too, reducing price
differentials between exchanges. Earlier, the same share used to trade at very different rates
across regional exchanges. Brokers pocketed the difference and hardly anything came to
investors, as they were clueless about what happens on the exchange floor. But once NSE came
in and trades went electronic, there was a single order book for the whole country and a single
price for every stock. If small investors had a difficult time placing an order, that was just the
beginning of their troubles. After paying in full for the shares, sometimes you would still not
receive them because of bad delivery or the other guy reneging on his trades.

Ajay Menon, Chief Operating Officer, Motilal Oswal Securities, recalls, The biggest change
that NSE ushered into the markets was a good settlement system. Earlier, one had to cope with
bad deliveries, defaults and all sorts of problems. Settlement used to take 10-12 days; the shares
would reach us only through brokers. When I was a sub-broker, I saw cases of fake share
certificates too.
Then, there was the problem of bad deliveries. Institutions which traded in lakhs of shares used
to receive hundreds of transfer deeds. They had to be signed and the signature had to tally with
that in the companys books for the trade to be settled. If signatures on a single certificate didnt
match, the trade was invalidated. Dematerialization of shares was the answer to this. The
Depositories Act was enacted by the government in 1996 and NSE, IDBI and UTI jointly set up
the NSDL an entity that held and transferred shares in electronic form. This did away with the
problems of physical certificates.
But the one problem that remained was counter-party risk. Remembering his early days in the
market, Leopaul George, who started his career in 1992 with a regional stock exchange and now
heads an investment company, says Then there was always the fear of not receiving shares
against payments for stocks, this deterred many from investing large sums in the market. I have
seen many people lose big money in the Calcutta Stock Exchange payment crisis.
Observing that Demat alone wasnt doing the job, the NSE set up the National Securities
Clearing Corporation Ltd (NSCCL) in April 1996, to act as counter-party to each trade. NSCCL
was given the responsibility of guaranteeing full financial settlement and maintained the
exchanges settlement guarantee fund. The recent National Spot Exchange crisis tells us just how
easily counter-party risk can bring down an exchange. By putting up an electronic order
matching system, the NSE had ensured faster price discovery than ever before, but there was still
a high incidence of circular trading and manipulation.
This created the need for a surveillance mechanism a system that could monitor open
positions of members constantly. The NSE built a strong technology-based surveillance system
for its capital market segment as early as 1998, to detect aberrant trades and take action against
the member. Risk containment measures such as capital adequacy requirements for members,
margin requirements for clients and immediate disablement of member log-in if certain limits
were breached, were first-of-their-kind in India in the 1990s.
Yes, after this long story, we can hear your dissent. But are you saying the Indian stock market
is safe for the retail investor? Look at the wild swings in the indices, insider trading, volumes
shifting to derivatives.what is the NSE doing about all of that? Well, Indias largest stock
exchange and its stock market regulator SEBI are both only 20 years old. Give them time and
they may yet deliver on their original promise to the small investor.
(News Article: Business Line 21/12/2013)