BackRise in proprietary trading hints at limited FII interest
As per latest Sebi data, proprietary trading made up 52% of the total derivatives turnover on NSE and 84% on BSE in June-September 2014
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Mumbai: Brokers trading with their own money are dominating India’s growing derivatives market, indicating limited participation from institutional and foreign investors.
In a year in which derivatives turnover rose, the share of so-called proprietary trading where brokers do not use client funds increased, thanks to factors like a market making scheme offered by BSE.
As per the latest Securities and Exchange Board of India (Sebi) data available, proprietary trading made up 52% of the total derivatives turnover on the National Stock Exchange of India Ltd (NSE) in June-September 2014. On BSE, it was as high as 84% in the same period.
The derivatives segment—also known as futures and options (F&O)—of India’s two leading exchanges is much larger than the equity segment, with average daily turnover of ₹ 3-5 trillion. The daily average turnover in the equity segment is approximately ₹ 25,000 crore, with NSE accounting for 70% of the pie.
The Sebi data also makes it clear that other entities, including foreign institutional investors (FIIs) who are significant drivers of equity markets, do not play a similarly significant role in the derivatives segment.
In NSE’s derivatives segment, trading by clients and FIIs accounted for only 37% and 11%, respectively, during July-September, Sebi data showed.
An NSE official said the exchange has a very diversified set of investors in the derivatives segment with good amount of participation from corporates, high net-worth individuals, domestic institutions and FIIs with the high open interest signifying usage of the products for hedging purposes and in long-term investor interests.
Sebi pegs the share of clients on BSE’s derivatives segment at 16%, with no specific mention of FIIs. “BSE is running a liquidity enhancement scheme (LES) for equity derivatives, wherein majority of the participants are BSE trading members leading to high proprietary trading at BSE," noted the Sebi paper.
To be sure, proprietary activity dominates the derivatives market globally as well, say market experts.
“Overall, the industry standard tends to be that 65-70% of exchange trading in derivatives is proprietary short-term speculation enabling a minority of trades, which enable risk transfer and hedging for end users," says Patrick L. Young, executive director at DV Advisors, a Europe-based capital markets advisory firm.
While proprietary trading has always been the largest part of derivatives markets, its dominance seems to have only increased over time.
During the period between March and May 2014, proprietary trading accounted for 48% and 92% of the total F&O turnover on NSE and BSE, respectively. Between December 2013 and February, the shares were 49% and 77% on NSE and BSE, respectively. In sharp contrast to their activity in the equity segment, the share of FIIs in F&O has been uniformly 12-15% as per Sebi data.
Arun Kejriwal, director of Kejriwal Research and Investment Services Pvt. Ltd, says the proprietary activity of brokerages includes the arbitrage desk and the participatory note business.
“The arbitrage desk would normally have positions which are hedged in terms of matching contracts either in time or value. The p-note transactions would typically be one-sided," he says.
P-note business, however, is limited to top foreign brokerages and a few large domestic brokers.
Among the two exchanges, the skew towards proprietary trading is more pronounced at BSE. The recent past has seen BSE clocking significant volumes in F&O segment on the back of a market making scheme wherein members get financial incentives for trading. In December, BSE’s share in the total F&O turnover has been approximately 25%.
Responding to an email from Mint, a BSE spokesperson said its F&O segment sees trading from nearly 30,000 unique permanent account numbers (PANs) every month.
While BSE has been clocking impressive volumes in its F&O segment, the open interest or the number of outstanding contracts is still low compared with that of NSE. A relatively low open interest-volume ratio indicates a higher dependence on day traders who close their positions by the end of the day.
On 19 December, the F&O turnover on BSE was ₹ 1.71 trillion with 4.27 million contracts and an open interest value of ₹ 963 crore. On the other hand, NSE’s volume was ₹ 3.29 trillion with 14 million contracts and an open interest value of ₹ 2.65 trillion.
“Encouraging liquidity is one thing, paying for trades, which are otherwise uneconomic, is entirely something different and I think the exchange industry world-wide needs to consider this issue," says Young, highlighting the case of Nasdaq’s NLX platform, which offers both short-term and long-term derivative products, and has been building volume solely based on market making schemes.
Interestingly, MCX Stock Exchange, which had a sizeable F&O business till a few months ago, saw clients registering 75% of the turnover between December 2013 and February 2014, as per Sebi data. Only the balance 25% was by trading members on proprietary account.
India ranks highest among global exchanges in terms of turnover in F&O as the contract value in India is at least 20 times smaller than that of overseas bourses, said the BSE spokesperson.
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