After the success of the National Stock Exchange (NSE), the failure of the OTC Exchange (OTCEI) and the fruitless attempt to interconnect regional exchanges, the Indonext project, led by the Bombay Stock Exchange (BSE), is an interesting new initiative in the Indian capital market. In terms of size, Indonext will start as a small operation. Even its promoters do not expect the turnover to cross a few hundred crores a day, unless the market surprises them. But in a stock market rally, where mid-cap companies have shown tremendous strength for the first time, there is a clear market for good small capital companies that are desperately seeking to list their shares and to grow by raising public funds.
The M. R. Mayya Committee originally proposed Indonext and it was to be set up by the Inter-Connected Stock Exchanges of India (ICSEI). But its present structure as a separate trading platform on the BSE probably gives it a much better chance of success. The ICSEI originally wanted to start Indonext but the cost and viability were a problem for the exchange. With the BSE providing the trading platform, it also takes over the financial burden of listing, supervision and surveillance. And the 7,000 odd broker members of the Federation of Indian Stock Exchanges (FISE), who are partners in the Indonext experiment, would help generate liquidity by expanding its geographical reach.
The BSE proposal to give ‘limited trading access’ to regional stock exchange members for trading on Indonext is also a better alternative to a new exchange. That’s because the BSE alone lists over 5,600 small and mid-cap stocks that may not be willing to transfer to a new exchange. The regional bourse and the ICSEI get to participate in the management through a 50 per cent governing council which will frame the rules for trading and supervision and oversee its functioning. Indonext proposes to list companies with a capital of Rs three to ten crore after a weeding out process.
Eligible stocks would include B1 and B2 list companies (but not Z category scrips) and several regional stocks. In order to create a platform for good quality small scrips, the BSE has initially relaxed its listing guidelines, but will revert to its entry barrier of Rs 10 crore capital once Indonext takes off, says a top BSE source. Out of over 9,000 companies listed on all Indian stock exchanges, it is expected that at least 2,000 odd well-managed small-cap companies would be eligible for trading on Indonext.
Indonext plans to facilitate liquidity in these stocks through a separate trading structure. A source connected with the project says, ‘‘Although Indonext will have a common order book, it cannot succeed in a pure order driven structure. Liquidity will have to be enhanced though market making or a Nasdaq type single call auction.’’ But market makers will show interest and commit capital for trading only if the Indonext companies are perceived to have a future.
What then is the future for Indonext? Despite the correction in stock prices over the last week, investment bankers predict that a 7 per cent plus growth of the economy would attract double the level of foreign investment into India as this year. Much of this new investment will be absorbed by IPOs (initial public offerings) of existing companies and divestment of government equity in public sector undertakings and banks. But a boom in the primary and secondary markets will have a rub-off effect on small-cap stocks too. If, even a part of the investment (not necessarily foreign) moves into the Indonext companies, the small-cap market could easily boom into a viable investment alternative for retail investors. But its success will depend entirely on the quality of its regulation and supervision.
At the first whiff of scandal, investors will shun the segment and kill the experiment. It will be up to Indonext’s governing council and the Securities and Exchange Board of India (Sebi) to ensure impartial regulation, ruthless supervision and adequate disclosure. Since supervision cannot be decentralised, the job will have to be done by the BSE, but its history of broker interference in administrative decision makes this a real worry.
Indonext’s complicated structure will make the task even more difficult. Although free ‘limited access’ to regional stock exchange members sounds like an excellent idea in theory, it will work only if the members are kept in line and do not indulge in price manipulation and ramping of shares which is much easier in smaller companies which have low floating stock. The BSE cannot leave this job to the management of nearly defunct regional bourse; it will have to stretch its infrastructure and exert control. The Central Listing Authority (CLA) may also have to consider special treatment to Indonext stocks to ensure that listing and disclosure guidelines are stringent but also adequately flexible.
Supervision of Indonext will also be a challenge for Sebi. Although the idea of a common platform for members of 18 bourse sounds interesting, it is a regulators’ nightmare. Of its 18 members, 11 bourse had zero turnover in the past year and are virtually defunct. In fact, if one excludes the BSE and the NSE, the 21 regional exchanges accounted for under four per cent of the total trading turnover in 2002. So, if enhancing liquidity is an important objective, Indonext could consider granting ‘limited trading access’ to NSE members also for a fee. This will help the BSE earn some money for creating Indonext and enhance its market reach.
Although Indonext is a small project with large ambitions, it seems to have a better chance of success than experiments such as the OTCEI or even ICSEI. While Sebi must indeed give this experiment a chance, with adequate checks and balances, it must simultaneously encourage the regional stock exchanges to close down their unviable individual operations instead of using Indonext as a last ditch effort to avoid the inevitable. -- Sucheta Dalal