Re: [nukkad] Indian Stock Market : Continued.

["Indian Rediff" <>]

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Dear Vishwas and Nukkadites,

Vishwas wrote two very strong e-mails venting his frustrations about the Capital markets in India. I feel that there needs to be apoint by point response to this. Especially since Financial markets are close to my heart (but not to my wallet - but that is a different story).

Please see my responses interspersed with Vishwas' original comments (I have taken the liberty to delete unnecessary portions of the message). I will be comparing the proposals with the US financial markets - arguably the most advanced in the world (except for forex):

-----Original Message-----
From: Vishwas Patil <vishas_patil@yahoo.com>
Date: 23 Jul 2001 19:10:47 -0000
To: Nukkad <nukkad-list@mumbai-central.com>
Subject: [nukkad] Indian Stock Market (both parts combined)

<letter one>

<deletia>
> 1) The rolling settlement method proposed by the
> Executive Director of SEBI, Mr. C.B. Bhave (I may be
> wrong here for Mr. Bhave's post!!! if so then I
> request u to kindly ignore it, n give more importance
> to the THEME), in the most "VOLATILE!! 500 SCRIPTS"
> for the stock markets shud be implemented. 

I couldn't agree more with this sentiment. The rollign settlement is an international standard and we need to get on par with international markets if we hope to have SOME standing in the financial world. However, I would also recomment aht along with rolling settlements, a good and simple mechanism by which stocks can be borrowed (for short-selling) be also implemented - much like the DTC mechanism prevalent in the US. Along with the ability to short-sell, the RBI/SEBI should implement the concept of margin (in the US this is 50% of the value of the holdings) calls so that people canot simply revert back to old badla mechanism with the help of the borrowing/short-selling capabilities.

> 2) A stock broker's "REALISTIC" job is to provide the
> "BROKERAGE SERVICES" to the "INVESTORS", so all the
> Stock Brokers shud be prevented from acting as
> "POTENTIAL INVESTORS OR RATHER MARKET MOVERS!!!".

I disagree with this. A broker is there to do two things. On the one side he is supposed to provide services to the customer. On the other side, he is SUPPOSED to provide liquidity in the market place. The dual face of the broker is also called the agent/dealer duality. If all trading in the US (for example) were restricted to institutional and investor trades, volumes in this, the most advanced equities market in the world would PLUMMET. 

One thing that is grossly misunderstood by people is the harm caused by volumes plummeting. When volumes go down, liquidity goes down. When liquidity goes down that means there are fewer buyers and sellers available for each trade. As soon as this happens, the buyers and sellers start to raise/lower their prices thus increasing the spread. The spread is the difference between the price at which you can buy 100 shares of a scrip minus the price at which you can sell 100 shares of the SAME scrip at any given moment. When spreads increase, investors get deals that are not good. Let me clarify this with an example. If I were to go to the market (NYSE) right now and get a quote i=on IBM (one fo the most liquid shares on the NYSE), I would get a response as follows:
Last trade = 104.60, Bid = 104.59 Ask = 104.70, High 104.76, Low 104.23 (volume so far 0.654 million)
The spread in this case is 104.70 - 104.59 = 0.11 cents. For a stock as highly priced as IBM, this works out to 0.105% of the stock price (last trade in this case)
Let us run the same exercise for LU (currently one with the highest volume on the NYSE - because of the announcement of the 20,000 job cuts) 
Last trade 6.75, Bid = 6.74, Ask = 6.75, High = 7.00, Low = 6.65 (volume so far 10 million shares)
The spread here is 6.75 - 6.75 = 0.01 cents. For Lucent this works out to 0.148%

Thus you can see that the spread is quite narrow and works to the advantage of the investor with higher liquidity. Now if you were to go back just a few months and look at prices for these securities, the minimum increment in which the stocks prices could jump was usually 1/16 (0.0625 cents). Thus the spread would usually be 0.0625 cents. You can clearly see the effect this has on the poor investor. In the case of Lucent, he will definitely lose. 

The point to all this is that if the spread narrows, the investor wins. If the broker is NOT allowed to make markets, spreads will widen and the investor will lose. After all, the broker has to make money SOMEWHERE no? If he is forced to provide narrow spreads AND has to make a living, he will be forced to abandon the latter and cease to help the investor.

As was pointed out by Nitin Goyal, liquidity IS important - otherwise you will get nothing for investors.

> 3) A stock broker is "ALLOWED TO PURCHASE THE SHARES
> OF ANY COMPANY IF N ONLY IF HE HAS AN IMMEDIATE
> POTENTIAL TO PAY THE AMOUNT OF THE TRANSACTION N
> PICK-UP THE DELIVERY AT THE TIME OF THE TRANSACTION
> ITSELF, ALSO HE SHUD BE ALLOWED TO SELL THE SHARES OF
> ANY COMPANY IF N ONLY IF HE HAS A PHYSICAL DELIVERY ON
> HIS OWN NAME, OF THE SHARES, TO BE GIVEN TO THE BUYING
> PARTY AT THE TIME OF THE TRANSACTION ITSELF".

On this point again, I would have to partially agree. Yes indeed - the broker MUST be able to put up the money. But I would argue that there is no REAL need for 100% margin requirement. In the US this margin requirement has be 50% for quite a long time. Let me explain how this works. If I wanted to buy IBM stock on MARGIN, I would have to provide only 50% of the price of the 100 shares( say) of IBM that I wish to buy. In this case (using the above prices) I would have to provide 104.60 * 100 = $10,460 if I wanted to buy this in my CASH account. However, in my mrgin account, I would need to put up just half of that = $5,230. Please note that at any brokerage, every account that wants to trade in margin needs to sign a separate agreement stating that they understand the mechanics of margin accounts and the need to provide money in case of margin calls. Also note that trading on margin is a VERY risky proposition and should be left to those who fully understand this. 

How does this benefit anyone? Well, let me see. The customer needs to put up just 5230. The remaining 5230 is borrowed against the 100 shares from the broker himself. The broker gets to LEND 5230, charges interest at the broker-call rate (usually somewhere around the prime rate +/- a few points). The broker ALSO gets to LEND those shares into the market to ANYONE that may be willing to BORROW the shares (usually to sell the shares SHORT). The broker also makes money on that side of the transaction by charging the borrower interest. The BORROWER of the shares also gets to place HIS bets that the shares are expectd to go down (for whatever reason - whether it be to hedge a position that he may already have or just bet against the security). So far, it looks like everyone has come out a winner.

If you will note, this also provides liquidity by allowing the pruchased shares to be immediately turned around and sold. Selling securities short is NOT an unhealthy practise - provided it is kept in rein.  IN the US, if you seel something SHORT, you have to BORROW it in order to have it ready for settlement purposes. In case the BORROWED shares are called away (e.g., the original margin customer may have SOLD his shares), your broker will re-borrow it from a different source. Borrowing interest rates vary widely and depend on demand and supply of securities.

> 
> 4) The overdraft issued by the Banks to any stock
> broker to "COMPLETE" his/her transactions in a
> "PARTICULAR SETTLEMENT", shud be limited to the
> "MAXIMUM OF 0.1%" of the "NET WORTH" of the stock
> broker.
> 

This overdraft (or margin percentage) is addressed by the margin requirement I have written about above.

> 5) The mutual fund companies, the big investors in the
> stock market, domestic institutional investors,
> foreign institutional investors shud not be allowed to
> have a "ONE N ONLY ONE PARTICULAR" broker for all
> their transactions. Also they must not have thier own
> brokerage firm to handle their all transactions. If
> they want to act as an "INVESTOR" in the stock market,
> then they must act like that only, they must not act
> as "BROKERS", then. 

I do not see the logic in this statement. It is quite possible AND acceptable for an institutional investor to also have his/her own brokerage in order to get the best prices in the market place. The only thing is this brokerage must be a distinct institution that deals with other broker/dealers on an equal basis. The Institutional investor that owns this brokerage must NOT be allowed to treat the brokerage as his own fiefdom.

> 6) Their all transactions in the stock market shud be
> done by "A GOVERNMENT REGULATORY AUTHORITY WHICH WILL
> BE UNDER SEBI". By this way the "MONOPOLY" of the
> stock brokers' community in the stock market will be
> substantially curtailed n our government will also get
> an additional revenue from the brokerage of such
> transactions. If this is done then according to the
> fair estimates as per report of SEBI, presented to the
> Union Finance Ministry of India, by Mr. Raje, Chief
> Financial Officer of SEBI, (Once again I may be wrong
> here for Mr. Raje's post!!! if so then once again I
> request u to kindly ignore it, n give more importance
> to the THEME), our government can get a revenue of
> around 1bn US$ every yr.
> 

I am assuming that the above statement is calling for the set up of a separate body to do trading on behalf of the Institutional investors. This is plain nonsense. The government has no business getting into managing portfolios and trading. The government's job is to provide the rules and strictly enforce them.

> The following opinion is my personal opinion, which I
> made by seeing the "BROKERS COMMUNITY" very closely
> for a decade. 
> 
> 7) Finally, the tremendous "GREED FOR MONEY" kinda
> attitude of the brokers community n their habit to
> "EARN MONEY BY ANY ILLEGAL MEANS", shud be given up by
> the stock brokers' community, but I don't think that
> this is possible coz that community is so much deeply
> habituated for earning money thru fradulant activities
> that this is not possible for them. Fraud is in their
> blood n in their "ENTIRE COMMUNITY".
> 

Earning money is NOT a sin. If it were not for the free ability to earn money, the world would be under communists. And as we all know, communism is dead. We should leave regional chauvinism and jingoism out of this discussion of financial markets.

<letter two> 

> As everybody knows that the brokers community is on
> strike over the issue of the introduction of rolling
> settlement in the stockmarket.
> Please read the following article: 
> NSE striking brokers demand word with Govt., SEBI
> at the following URL:
>  <A HREF="http://www.mumbai-central.com/grapevine/today.html#12" TARGET="_new"><FONT COLOR="BLUE">http://www.mumbai-central.com/grapevine/today.html#12</FONT></A>
> In this article it is clearly stated as follows :
> Pointing out that NSE daily volume had fallen to Rs
> 1,000 crore from a high of Rs 15,000 crore and in BSE
> it had gone down to Rs 500 crore from a higher figure
> of Rs 5,000 crore,
> This proves that my earlier point that "THE
> TRANSACTIONS WORTH AROUND 9/10TH OF THE TOTAL VOLUME
> ON BOURSES WERE MADE BY THE BROKERS COMMUNITY, WHICH
> WERE FISCTIOUS AND ONLY 1/10TH OF THE TRANASCTIONS
> FROM THE TOTAL VOLUME ON BOURSES WERE DONE BY GENUINE
> INVESTORS. IT MEANS THAT BROKERS COMMUNITY WAS PLAYING
> A ROLE OF MARKET MOVERS".
> Further it is said as follows:
> On tunover tax on Bhatt committee's recommendations,
> he said, there should be review of tax, if possible by
> the same person, since the brokerage had gone down
> "significantly" and brokers were "willing to negotiate
> with SEBI on the issue". 
> This is a very good news for the investors' community
> since their grievances against the brokers community r
> indeed taken very seriously by the govt. and SEBI.  
> Now govt. and SEBI shud not bow-down in front of the
> brokers community n they shud push thru the implement
> of the method of rolling settlement into the market.
> If this happens then good days r not far for the
> "GENUINE INVESTORS COMMUNITY N HEALTHY INDIAN STOCK
> MARKET N HEALTHY INDIAN ECONOMY".

Once again - it is the DUTY of the broker community to act as MARKET MAKERS. Unfortunately, in India they also act as MARKET MOVERS (as pointed out by Vishwas). SEBI should put in place processes so that ALL transactions are completely traceable and every allegation of insider trading should be quickly traced to its roots. ALL phone calls made by brokers and thier agents MUST be recorded (standard practise in the US). By default, if traces of trades point to a group of brokerages or brokers as being responsible for insider trades, the onus should be on THEM to prove that their trades were NOT insider trades. They brokerages/brokers will AUTOMATICALLY enforce recording of their own phone calls so that they can cover their a**es. i.e, if the brokers/brokerages are able to show by means of order tickets and phone calls and web based order tickets that their trades originated BECAUSE of investors' requests, and these investors are verified to be genuine bona-fide investors (not individuals with insider contacts) then the brokerages will automatically be let off the hook.

> 
> Vishwas,


Indian©

I hope you don't get bored reading about this :-)
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