India, the next frontier?

Do the reports of alliance talks between the BSE and the London Stock Exchange indicate that global consolidation of equity and commodity exchanges has reached Indian stock markets as well?

With the rapid expansion of Indian equities and commodities markets over the last decade, it was only a matter of time before large foreign stock and commodity exchanges started looking at the country as an attractive market, which would offer significant potential for growth. After a wave of major consolidation and alliance moves involving some of the largest global exchanges, reports are now speculating on global players eyeing alliances with major Indian exchanges.

The Bombay Stock Exchange (BSE) is in talks to form an alliance with the London Stock Exchange (LSE), according to unconfirmed reports in the British financial media. The nature of a possible alliance is not yet clear, though it is speculated that it would be an operational alliance — without any financial commitments — to begin with.

Set up in 1875, BSE is Asia's oldest exchange. After functioning as an association of member-brokers for well over a century, the BSE has been converted into a company recently. Trading rights have been separated from ownership, by granting trading memberships to all brokers.

All former members of the association have been issued equity shares in the new company. The BSE is planning an IPO in the future to raise additional capital to finance its expansion plans.

Though the oldest exchange in India, the BSE had lost its market leadership to the National Stock Exchange (NSE) in the '90s. The NSE, promoted by leading banks like SBI and ICICI Bank besides financial institutions like LIC, was more professional and transparent and had tougher listing and disclosure norms. Though the BSE has taken a wide range of steps to improve transparency and investor confidence, it still has some way to go.

Global consolidation
Major stock exchanges across the globe have been trying to expand their geographical presence through acquisitions and alliances. US based exchanges, for instance, are looking at exchanges based in Europe to escape the strict regulation laws in the US.

The Sarbanes-Oxley Act and other financial regulation in the US, introduced after major corporate scandals, demand very tough disclosure standards from listed companies and their senior executives. This has made listing in US exchanges relatively unattractive for overseas companies. In Europe, the regulation of listed companies is comparatively more lenient.

The NYSE Group, which operates the New York Stock Exchange, had recently acquired the European electronic exchange Euronext for around $10 billion after a bidding war with rival European exchange Deutsche Boerse. Euronext operates electronic equities exchanges in Paris, Amsterdam and Brussels and a futures and derivatives exchange in London.

LSE, the preferred exchange in Europe for overseas companies, itself has been gripped by rumours of a possible takeover for quite some time now. The LSE stock had rallied last week on expectations of a renewed bid by NASDAQ to acquire majority control. The rumoured offer price is between 1400 pence to 1500 pence as against Friday's closing price of 1294 pence. NASDAQ currently holds around 25 per cent of LSE Group.

NASDAQ had earlier made an over $4-billion bid to acquire LSE, but had to eventually settle for a minority stake. The LSE board resisted the bid, arguing that the offer price was too low. Ever since, NASDAQ has maintained that it is not planning to acquire majority control in the short to medium term and would instead focus on an operational alliance with LSE. But most analysts reckon that it is only a matter of time before the two exchanges merge, unless another large exchange makes a higher bid for LSE.

Both Deutsche Boerse and NYSE were earlier interested in LSE. Though NYSE may not be too keen for another acquisition, Deutsche Boerse would certainly be very interested in LSE to strengthen its presence in Europe and ward-off American rivals.

LSE is also holding alliance talks with the Tokyo Stock Exchange (TSE) — Asia's largest stock exchange. Last week, TSE has confirmed that it is in alliance talks with LSE, which might include cross-listing, development of trading systems and platforms and exchanges for start-up companies. However, the exchanges are not considering a capital alliance — involving stake acquisitions - at present.

TSE had announced earlier that it is in talks with NYSE for a capital alliance. NYSE and TSE are the world's two largest exchanges and a merger would create a global giant which would dominate in the US and Asia with a very strong presence in Europe through Euronext. If talks succeed, the alliance is expected to happen by 2009.

The consolidation wave is sweeping commodity exchanges as well. Last month, the Chicago Mercantile Exchange had announced the acquisition of Chicago Board of Trade in an $8-billion deal. The combined entity with a market value of around $25 billion would be the largest commodity derivatives exchange globally with trading volume of more than 9-million contracts daily — easily surpassing its European rivals.

The Indian attraction
India is expected to become a very attractive destination for global stock and commodity exchanges in future. The country has one of the best-regulated and most transparent stock markets among all emerging markets. Trading in commodities has also seen spectacular growth in recent years and commodity-trading volumes are expected to overtake stock market volumes within a decade.

Unlike other emerging markets like China and Russia, India's economic growth is being driven by the strong private corporate sector. Many of these companies are truly competitive globally and have big global ambitions. It is very likely that some of the large Indian companies would emerge as among the most valuable listed companies globally over the next couple of decades.

Despite the robust growth and visibility of the domestic private sector, the number of Indian investors with equity exposure is low – even when compared to other emerging markets. As the Indian economy is going through its best ever growth phase, the exposure to equity markets among domestic investors is bound to grow. This would offer tremendous opportunities for stock exchanges and intermediaries to expand their business volumes.

With its diverse climate, the country produces most of the agricultural commodities and is also blessed with good reserves of minerals. Because of low economic growth rates, consumption has been low for the past many decades. But as consumption increases and markets for these commodities mature, trading volumes in commodity derivatives would also increase tremendously.

Domestic commodity exchanges like NCDEX and MCX set up over the last few years have expanded at a rapid pace and it is only a matter of time before some of the global commodity exchanges make their entry into the country. Large overseas financial investors have picked up sizeable stakes in both the leading domestic commodity exchanges recently.

Government policy
As can be expected, the government and market regulator are not very keen to have foreign investors with majority or large strategic stakes in domestic stock and commodity exchanges. The issue has attracted considerable attention in recent months as the BSE became corporatised and announced its IPO and stake sale plans.

Current government thinking is to limit total investments by foreign investors in stock and commodity exchanges to 49 per cent. The finance ministry is expected to come out with a formal policy announcement before the end of this year. The policy is also expected to limit the total shareholding of broker-shareholders to 49 per cent.

SEBI is expected to announce detailed norms and guidelines regarding the shareholding pattern of domestic exchanges. It is expected that foreign strategic investors, including foreign stock exchanges, would be allowed to hold only up to 5 per cent stake individually in an exchange. Collectively, the total shareholding of overseas investors would not be allowed to exceed 49 per cent. In the case of domestic strategic investors and financial institutions, individual holdings of up to 26 per cent may be allowed.

However, it is expected that these policies would be further liberalised in future to allow increased foreign ownership in domestic exchanges. By then, many large global players would have established their alliances with the leading domestic exchanges.