Capital markets boom
Thanks to this increasingly sophisticated financial workforce, as well as a generally liberal regulatory policy over the last few years, the Indian capital markets are maturing rapidly. Although the equities market is currently lagging as a result of the global economic downturn combined with high inflation-a recent Financial Times article rates India’s equities market as the worst performing for a large emerging market-derivatives trading is now big business. India has one of the largest single stock futures markets in the world-just four years after it was introduced. A new power exchange was recently launched and a formal mechanism for trading currency futures was expected to be up and running by the beginning of this month.
Foreign participation in Indian markets has grown steadily over several years and shows no signs of abating, and regulatory changes mean that domestic brokerage firms are starting to enjoy a larger slice of the business. In the past, foreign buy-side participants that wanted to trade securities in India had to do so via participatory notes-also known as P-notes-which were mostly distributed by international tier-one brokers, who would buy and sell shares on behalf of the foreign player. Typically, international buy-side firms went with international brokers that had offices in Mumbai, and the local brokers didn’t see much benefit from the foreign investment in their country, says Nelson Cheng, business development manager for the Asia-Pacific region at trading systems provider Fidessa.
However, this dynamic is changing. Foreign firms wanting to participate in the Indian market must now register as Foreign Institutional Investors (FIIs), and this has opened up a lot of opportunity for local brokers, according to Cheng. “Once you qualify as an FII you can go to local brokers as well as international brokers to get access to the market,” he says.
Indian brokers need FIX connectivity to attract international order flow and many have made significant investments in FIX networks and order management systems (OMSes). Financial Technologies (FT), an Indian trading and exchange technology provider, saw 95 percent year-on-year growth in the number of trading licenses for its Odin OMS, from 164,000 in March 2007 to over 320,000 in March 2008.
Surprise DMA Introduction
This year, new regulatory changes are opening up the markets even more for foreign participation. The Securities and Exchange Board of India (SEBI) announced in April that it would allow the introduction of direct market access (DMA) for equities, futures and options, and about a dozen brokerages in India launched this service with a few clients this summer. Vendors are also busy-FT recently launched DMA Live!, its direct market access solution, providing international market connectivity to over 80 percent of the domestic brokerages.
Boston-based research and analysis firm Celent estimates that between 40 and 50 brokerage firms and around 80 domestic and foreign buy-side firms will use the DMA channel by 2010.
The possibility of DMA in India had been widely discussed, but nonetheless it came as a surprise to many market participants when the SEBI announced that DMA would be permitted from April this year. “The general consensus in the market was that DMA in its entirety would still be at least 18 months to 24 months away,” says Athul Kudva, director at Indian trading technology provider Omnesys. “If you look at January and February, the markets were booming and generally the regulators are wary of opening the doors for such things when the markets are booming,” he says. One-touch DMA, requiring manual intervention from the broker, had already been permitted for some months.
DMA traffic accounts for 15 percent to 18 percent of total trading volumes in the US and 8 percent in Europe, and these numbers are growing fast, according to a Celent report, Impact of Direct Market Access in India, by senior analyst Sandeep Hebbar. In these developed markets, DMA adoption has helped drive down costs, provide better execution quality, better market and liquidity aggregation and better compliance with regulations, according to the report. Emerging markets regulators and participants have seen the effects that electronic and algorithmic trading have had on the developed world’s markets and are keen to reap some of the benefits for themselves.
India is not alone-DMA is also currently being introduced in Brazil, Chile, Mexico and Columbia. This is made possible by the widespread adoption of the FIX protocol over the last two years, says David Meredith, CTO at Marco Polo. As well as providing FIX network connectivity to emerging markets, Marco Polo provides gateway technology to the exchanges themselves, enabling emerging markets participants to be up and running relatively fast. “Developed markets took a long time to adopt DMA, but because clients in those developed markets are now very used to FIX, we’re seeing very high demand in emerging markets from day one,” he says.
Exchanges Respond
Industry insiders expect trading volumes to surge within the next year or two as a result of DMA, and firms and exchanges are working fast to make sure their systems are ready to handle the additional traffic.
The National Stock Exchange of India (NSE) is currently migrating from an x.25 network to a TCP/IP network in order to offer faster market data updates. The NSE does not currently distribute market data on a tick-by-tick basis, but sends snapshots of its order book to trading participants at regular intervals. “Depending on the liquidity of the securities, market data is sent every two to three seconds or even every six to seven seconds,” says Omnesys’ Kudva. The existing x.25 network distributes data at 128 kilobits per second (kbps). The new TCP/IP network, scheduled to go live on Oct. 31, will transfer information at a rate of 2 megabits per second (Mbps).
Latency can be a major issue in India, where market data delays have been known to reach 30 minutes during trading peaks. “A couple of months ago, we had a pressure scenario on the expiration date, and the system got so jammed up that even after the close of the market we were still getting the confirmations from our trades,” says Centrum’s Shah. With such delays, traders run the risk of buying or selling securities at an inaccurate price. “The exchanges needed to improve their infrastructure completely-they have realized this and are working on it,” Shah says.
While both types of networks are constrained by the speed of light, the new IP network will be able to process a much larger number of orders simultaneously, resulting in fewer network jams, says Frédéric Ponzo, managing director of Net2S, a Paris-headquartered capital markets technology consulting firm. Although in an IP network latency for a single order is increased because of the need for firewalls-x.25 networks do not require them-the additional bandwidth means that for a basket of 20 orders, network latency is reduced by a factor of six, Ponzo says.
Not to be outdone, the Bombay Stock Exchange (BSE) recently announced a deal with Transaction Network Services (TNS), which will allow international brokers to participate on the exchange more easily via TNS’ secure trading extranet. Previously, access to the BSE for trading and market data was limited to participants that had set up offices in India, which were typically connected to the exchange via leased lines. The exchange hopes the new setup will reduce the number of network management issues faced by the BSE and its customers, according to exchange officials.
Both the BSE and the NSE have seen tie-ups with overseas exchanges. BSE signed a technology agreement with Nasdaq OMX Group in January this year and NYSE Euronext bought a 5 percent stake in the NSE in March.
The Volume Explosion
Even before the rise of DMA, trading volumes had increased dramatically over the last few years, putting a strain on the exchanges’ existing infrastructures. Foreign participation, a growing retail segment, the dematerialization of shares, the reduction of transaction costs for some securities, the successful introduction of stock lending and borrowing as well as single stock futures and options trading have all played a role in increasing volumes, sources say. Combined daily trading volumes on the BSE, the NSE and the NSE futures and options exchanges hit a peak one-day high of $34.49 billion in October last year, up from $1.8 billion just five years ago. The current global economic downtown resulting from the sub-prime mortgage fiasco means that volumes are down-$14.5 billion on Aug. 13-but most industry participants are confident the markets will bounce back.
Source: Waters Online, By Emily Fraser, 01.09.2008
