`We have created an ethos of innovative products' -- Mr Ravi Narain, Managing Director, National Stock Exchange

Deeptha Rajkumar

The National Stock Exchange Managing Director, Mr Ravi Narain, discusses with Business Line the stock exchange's future from the perspective of expansion, new policies and services, and the pressing issues that need to be addressed.

Excerpts from the interview:

What do you foresee for the market from the systems, trading and infrastructure points of view?

In terms of infrastructure, enormous reforms have already taken place. Reforms in the securities market outstrip those in other areas. However, we all recognise that some part of the agenda still remains.

The key ones are the rolling settlement and CNS. The other bit involves taking the entire system -- trading, settlement and margining -- to the gross client level, where SEBI has just made client IDs mandatory. This has to be worked into the system.

Another important factor is the integration of the payments system, to be considered from the infrastructure side. Once all these three issues are factored in, the infrastructure side reforms should be complete.

In terms of trading, the systems are fairly comfortable. They are modular. For instance, at the NSE we can do one million trades a day, and soon, two million trades. At that point it is modular. So, from two to four is trivial.

Five years from now, in terms of structure, where do you see the market heading?

There are likely to be profound changes in the market structure. The stock exchange will no longer remain just a stock exchange. Historically, each part of the financial services sector had its own segregated, virtually captive distribution network. The primary market had one distribution network, the secondary market another, LIC and other insurance companies had a third, the mutual funds a fourth and so on. There will be a convergence... actually there already is a convergence of financial services and products around these distribution networks, and the various distribution networks will compete with one another on service, innovation, price and more.

So, the NSE distribution system, which today encompasses 4,000 VSATs and 10,000 terminals in 400 cities, is a very compelling network as a distributor of financial products and services. What we are trying to do is bring as many products and services into our distribution network so that member brokers essentially become money managers of choice for investors, and money management can happen in a variety of ways. That is the broad vision.

We started with the secondary market, expanded to the IPOs, then the mutual funds, derivatives and so on. The question is whether to be restricted to only those products that have an element of price discovery, those products where there is a lower element of price discovery, or the provision of pure cash versus services products. The evolution of the process is interesting. In five years, this process will have been clearly defined and fiercely competitive.

Where do you see the NSE in all this?

We believe that the NSE has created a powerful network exactly on the lines we have been talking about. But more than the distribution network we have created an ethos of innovative products. So we are able to give more products and services that can take advantage of this distribution network. We can offer superior risk management services to enable these products and services be settled in a framework where systemic risk is not an issue. We can offer an element of brand trust where the market perceives us as a truly neutral entity that can all market constituents. So with these three facets we hope to keep pushing forward.

What are the three areas that you feel require some action?

Clearly, derivatives is one. Today, the market perceives derivatives as just one more product. It fails to realise that with the prices becoming more and more liberalised, it offers a large amount of price risk. Once that becomes more obvious, then the use of derivatives is the only way to go. So that has to be factored in. To some extent it is an education issue. We have to continue with our roadshows. We already do 50 a year, 3-4 a month. At some point a trigger will come where all this education awareness will pay off.

So, our belief is that derivatives are important not just as one more product that will bring in business to the exchange, which of course it must. But in a systemic sense it is going to ensure huge pay-offs to the market in these volatile, free-price environment. That is the trigger we are waiting for.

As an adjunct, we are going to keep pushing for lending borrowing products. That will pay off when the rolling settlement comes in. So, it is a bit of the chicken-and-egg situation right now. While the ALBM is doing remarkably well, more lending/borrowing products are needed.

On the payment side, once we see a more integrated payment mechanism we will see a lot more products spinning off from there. This will again facilitate the entire issue of risk management kind of close awareness system.

Given the high cost structure and the absence of fool-proof systems, do you think Internet trading will ever take off in a big way? What are the missing links, if any?

The most obvious missing links in Internet trading are the number of Net connects and the bandwidth. But this is improving fast. We presume that every quarter the number of Net connects and bandwidth is expanding. Now that the Net is available on cable, we are looking at every home as a potential Net connect. So the last thing on our mind is the Internet. It is going to take off in an unimaginably big way. However, we have to concentrate on the payment gateway. In a sense, it makes the whole link more attractive.

Security systems are now part of our life, now that we have made everything electronic from order flow, to trade, to clearing to risk management. There are people out there right now trying to access the system. Hence, security is part of our life. We will continuously worry about the next secure layer and the next risk management system.

We also have to assume that the crooks will be a step ahead of us and make checks and balances a part of our life. It cannot be that we need one security system. We need secure layers that get more and more complex. Right now the process has started and the volumes are low. So, in a sense, it will move together. Fortunately, we have not been hit so far by any large electronic scam. But we do need to keep it in mind and be well-equipped to handle such a situation.

What should the NSE do to maintain its leadership?

We need to continue thinking of product innovations. As the gamut of products and services we can operate in expands, we have a greater role to play. We must continue to use that to improve on services to the market place. Everything else is secondary. And we must take our member brokers with us. It is not enough for the exchange to think two steps ahead. The member-brokers should be in a position to take those to the ultimate customer. And so we must be equipped to handhold in terms of technology and business skills, both of which are fairly critical.

Are you happy with the measures taken by stock exchanges on the surveillance and enforcement fronts?

The whole issue of continuing disclosure by corporates needs a serious review by everyone. It is not something we can track on our own. In this case, we need the chambers to discuss the issues involved. While there is some sense of what needs to be disclosed, the other issues are unclear. For instance, the timing of the disclosure is completely unclear. And I have some kind of an empathy with corporates regarding this. Disclosures must be made when plans are being firmed up. At this point nobody knows what to do. If it is released too early, there could be possibilities of being accused of releasing information to manipulate share prices. Either way it is a tough act.

Do you feel that insider and informed trading ahead of key corporate action is rampant today? Nothing seems to be happening to deter such trends...Material event disclosures and client IDs are necessary to crack front-running and insider-trading. With the two, we would have seriously dented insider-trading and front-running. SEBI has taken a remarkably bold step of making client ID mandatory. The next step would be to streamline the system of so that it becomes a standard requirement.

Continuing on the same theme, do you feel analyst meets and implications for price formation and trading levels should be banned?

Whether it should be banned or not is a tricky issue, but selective disclosure do not help.

Do you think the trading cost structure will come down further?

Trading cost will come down but over a period. So as and when there are substantial investments in infrastructure, it need not come down immediately. And yet if you look at it, we invest substantially in technology every single year and every single year we have bought down cost. In fact, last year we brought it down twice. So, it is not something we should worry about. And to the extent that historically the poor state of the securities market infrastructure used to eat up a large part of the returns, it is seeing very substantial returns from that segment.

However, the market continues to see the financial charges as a big part of the cost. They are not. The biggest part continues to be the risk and risk is declining faster than the financial charges are and that is where the big gains are and will always be.

After Dr Patil, do you think you have a difficult act to follow?

It is bound to be. But the exchange must go wherever it has to go. We must continue to deliver service. Whatever highs and lows we achieve in the process happens. We must have a very clear vision of what we have to do.

How do you view the competitive environment (alliances and mergers) that are taking place among stock exchanges at the global level?

Everyone believes that a consolidation of this industry is inevitable. But the form and manner in which the consolidation is to take place is still not clear. So, our view is that we must continue our dialogues with exchanges and clearing and settlement agencies of the world. This is essential to understand where they are coming from, what is the global industry structure they visualise and where we fit in. For example, the kind of financial products around a distribution network that we just spoke of is yet to be seen or articulated overseas. But I am sure it will happen there as well.

What they are looking at is consolidation of exchanges to lower the cost of overall infrastructure to make them more competitive, and trying to build a global time-zone book for key stocks that have trading interests around the world. The latter is not of immediate interest to us. And the former is not an issue at the moment. But, obviously, they will become issues at one point. Having said that, I believe there is something very important and unique about India which differentiates us from other emerging markets.

We also have a huge domestic retail market. For the first time companies are emerging which are beginning to look of global size. Five years from today, if we have 50 of these, we will be in a very interesting position in the global environment.

Today, we need to be aware of key platforms and interfaces that people are developing. But as this is more of a technical question, it is easily handled. However, we do not know what happens beyond that -- whether exchanges consolidate with one another or with clearing houses. These are not obvious now.

Many of our companies are looking at overseas listing. Initially it was important for a variety of reasons. But this is a development we need to watch for, to see how we can help in the process without exporting our entire market.

The key is obviously not to be restrictive but figure out a way in which we can play a global role. MoUs are a way of understanding each other. So, I think it is time for all of us collectively to worry about the structure of the industry, from the point of view of global positioning. A series of small incremental steps is a better way of going global than to flounder with large consolidations and mergers.

In India a different kind of consolidation is taking place -- of the order book. While the exchanges are not consolidating as organisational entities, the order books are consolidating very rapidly. All the RSEs are tapping into the NSE's order book. It is a strange structure but India very often has its own solutions, own answers.

What areas could the regulatory environment improve?

A couple of interesting views are surfacing. For instance, some market participants feel there is too much speculative trading. That worries me because it begs many issues. Speculative trading is still unclear to me. In an environment where there is physical delivery, one could define not having taken physical delivery as speculative. In a demat environment, it is not clear what is speculative trading.

Frankly, if an investor chooses to put money into securities it is speculative. If I was not speculative I would put my money in a fixed-income instrument. Thus, it seems the duration of the investment is getting shorter and that investors are going through their portfolios faster than they used to historically.

Does that seem unfair in an environment where the entire Indian economy is going through rapid restructuring. Where banks and institutions are themselves not comfortable with utilising the full amount of money they are allowed to put into equities because they themselves are not sure of the valuations of the company. Where a company which was a bluechip could rapidly turn into a less than solid share. Is it surprising that investment horizons are getting shorter and shorter.

All we need to do is look at the environment and recognise that the Indian economy is going through a transition phase. In this phase, I could rapidly get trapped into a portfolio which has seen a decline in value. It is an obvious consequence of the valuations we are looking at. We need to understand, rather than say, it is unhealthy or undesirable. Because this is something that can correct itself. I think we are doing a disservice by not recognising this.

It is an obvious outcome of the uncertain valuations of our companies. And when something is uncertain we tend to react in a predictable way. I think people are being wise and sensible in shortening their investment horizon. It will work itself once these valuations look to be settling down. Whether they settle down in two years or five is an ongoing process. The investor is at the tailend of it.

Obviously the regulator will continue to push the system towards a direction where there is less systemic risk, more integrity and fair play in market transactions and transparency and efficiency of system. That is what it has been doing.