People find it easier to identify defining moments in history with a face. And I have the good fortune of being that for the National Stock Exchange (NSE). I was fully involved with the setting up of NSE right from day one and was also its MD and CEO for the first seven formative years. However, like the proverbial iceberg, that is only 10% of the story. The other 90% is about how time conspired to make things happen despite a lot of behind-the-scene machination. The story of NSE is one of going against the grain; it is also a story of underestimation, opposition, serendipity and fortitude.
As they say, one has to begin at the beginning. So let me begin my story by drawing your attention to the major disaster that struck the Indian financial system during 1991-92. It shook the stock market to its very foundation. It was in this context that there was a sense of urgency to bring about necessary reforms in the area of capital markets so that such serious mishaps do not recur. Since the governance of the stock exchanges was very poor, something more in the nature of a new, model stock exchange was needed so that its competitive pressure would force other stock exchanges to reform themselves. The Government of India agreed to support the lead taken by IDBI to set up such a modern stock exchange.
Whole new world
When I was in charge of treasury at IDBI, the late SS Nadkarni, who was chairman during that time, took a leap of faith and assigned me to oversee the NSE project. During my interaction with the team and the consultants, I found the whole thing both very interesting and challenging. That’s why I moved full-time to the NSE. Quick availability of leased lines was a problem in those days as there was no competition to BSNL or MTNL and given the state of telecom infrastructure it would have been practically impossible to establish NSE’s nationwide trading network.
Satellite communication seemed the best option but until then nobody had used it to run an exchange. I don’t think anybody took us seriously as we went about trying to meet our deadline. This included the department of telecommunications (DoT) as well. They were, perhaps, under the impression that we would not be able to operationalise such a complex project as no other sophisticated satellite-based communication system had gone live in India until then.
DoT wanted to be sure that our setup in Mumbai did not interfere with any other telecom system. If it did, then we would have to shift our mother-dish antenna to the outskirts of Pune. But everything worked extremely fine despite the fact that our extended C-band system was not thoroughly tested before we put it into live operation. It was almost a miracle that our VSAT system did not face any glitches as most such complex systems normally do. This convinced me that if you are well-intentioned there is a higher force up that helps you.
In hindsight, NSE’s choice to go in for its own captive VSAT network proved to be a very wise decision. A highly reliable telecom link put NSE way ahead of all its competitors and helped trading volume grow almost exponentially. In fact, many of the decisions that we took were bold decisions in the sense that it never occurred to us that some of them may not succeed. Others however were more than sure that we will not succeed; some even went out of their way to see that we do not succeed. Ours was an open architecture; anybody could get a membership by paying a deposit. This democratic approach totally unnerved the existing brokers. For them, it was a family business and into this fiefdom we were letting in bankers, chartered accountants, cost accountants and so on. I remember a meeting attended by the former BSE president and chairman of broking firm DSP.
When I was at IDBI it used to borrow foreign currency loans periodically for on-lending to projects. Hemendra Kothari had come in that connection to IDBI. Over lunch, he expressed his displeasure to Nadkarni about the NSE idea. In his own style, Nadkarni told him, “Hemendra, this is my lunch; you shouldn’t tell me what I should do and what I should not.” Fascinatingly, when we opened up NSE’s debt membership DSP was among the first to become a member and the first to trade. When someone asked Kothari about it, he said, “Well, it is business.” But the main BSE brokers stayed away even from the NSE equity segment for a long time. Some got their family members to apply but a lot of our early members were the first-generation stock brokers.
The other big decision was whether to choose the BSE model of jobbers or direct matching of orders. We weighed the pros and cons and ultimately decided that the anonymous order matching system was the best, although many Exchanges had a quote-driven system. It was widely believed that computerised trading would not succeed in a country like India where computer literacy was quite poor, especially among the stock market fraternity. In a way, we were also worried about the difficulties of enticing the brokers into the fold of NSE.
Hence, we planned to provide training in computerised trading to our members before we actually commenced formal trading on NSE. We estimated that it will require at least three full days’ training for each dealer. After the training started we were in for a major surprise. Most of the dealers at these training courses took just about two hours to learn all the tricks of the trade and became quite proficient in computerised trading. In June 1994, we started trading in government securities and in November we started trading in equities. In the first few months there was hardly any trade happening. It was about ₹6 to 8 crore per day in the equities as well as debt segment.
The ironic part is people did not congratulate us after we successfully went online. At the most there was a grudging acceptance of what we had achieved. I remember prominent investment banker Vallabh Bhanshali telling me, “Mr Patil, with due respect to you, this experiment has worked only because of you and your team, but what about continuity? For that, only the BSE model is good enough.” The complacency of regional exchanges got a severe jolt as NSE started eating into a big chunk of BSE’s order flow that used to originate from the rest of the country.
As NSE’s trading volumes started spurting, all the regional exchanges started putting pressure on the regulator, not to permit spread of NSE to centres where the regional stock exchanges were located. Not only Indian institutions but even foreign institutions at times questioned the credibility of our systems. I can recall an interesting case about a large foreign brokerage firm who was a big trading member of the NSE. One day, the CEO of that firm came to us complaining about the leakage of information about their trades. After a through scrutiny about all possible sources of leakage we came to know that their telephone lines were being tapped and that’s how their overseas orders were no longer private.
Among the key decisions that we took, keeping ownership and management separate perhaps was the most important one. To talk about demutualisation might be in fashion today, but for the NSE, demutualisation was built into its fabric.
In other parts of the world demutualisation has meant converting the mutualised exchange into a corporate entity, with trading members having both ownership rights as also representation on the board of the company. A true demutualisation is one in which ownership and management of an exchange is totally separate from members’ trading rights in the exchange. The problem with a broker-owned and managed exchange is like playing a cricket match where the players also act as umpires by turn. Such a game will never have impartial umpiring since each umpire’s decisions will be biased because of the conflict of interests he faces.
That’s why we were clear right from the beginning that neither market participants nor professionals running it will have ownership but only institutions will. We also followed a strict rule-based approach and these rules were cast not by us but a cross-section of experts. The principle was that, going forward if there was any deficiency found in any rule, the rule will be changed but applied prospectively. If one applied it retrospectively there could be scope for undue favours.
Here I must point out that tremendous pressure was brought to bear on NSE from highly powerful quarters to have broker members on its board. Very ingenious arguments were put forth in justification of having brokers on the board of NSE. It was said just as we cannot have bar councils without lawyers on the bar or medical councils without doctors as its members how can we have stock exchanges without stock brokers on their boards? Although NSE’s trading members were fully aware that NSE’s trading membership does not grant them any rights to its board membership they also started an agitation to have board representation. They were being instigated by those putting forth bar/medical council arguments as also broker activists from other exchanges. However, NSE’s board stood firm and refused to yield to pressure.
In the NSE, when we introduced the settlement guarantee, the idea was to allow everybody to trade without settlement risk. But an exchange could go bankrupt guaranteeing settlements, in case an extremely volatile market depleted its guarantee fund. So, we decided to set up a wholly-owned subsidiary called National Securities Clearing Corporation (NSCCL) for this purpose. The major advantage of NSE owning the NSCCL is that there is seamless integration of the two most important functions of trading and settlement with full guarantee.
Given the speculative instincts that dominate market players in India, NSCCL introduced some of the most stringent regulations for its members. To track member positions, NSCCL developed unique software which tracks each member’s aggregate trading exposure on real time basis. The software has the capability of not only informing the member his exposure position on a real time basis but also disconnect all his trading terminals the moment he crosses the limit granted to him on the basis of the deposits made with NSE/NSCCL.
The biggest problem we faced after volumes increased rapidly was delivery of fake certificates and forged documents. I remember that at one stage almost 40 people were engaged in detecting fake certificates before accepting shares for settlement. As the volume of trading increased exponentially and spread across India we had another problem. Share certificates were coming from all over the country and many brokers found it very expensive to send them on their own account. Since it was impossible to cope, we decided to move towards paperless trading through National Securities Depository (NSDL). The speed with which this was implemented can be seen from the fact that the depository was ready in November 1996; just two years after NSE went live.
The NSE experience also left me very thick skinned for my next adventure at the Clearing Corporation of India. If the NSE had failed, people would have said all sorts of things. In fact, many were waiting. Unfortunately for them, the waiting has been infinite. If the broker managed BSE had functioned well, maybe the NSE would have never come up. After the NSE was set up, the atmosphere changed. The broker-owned and managed exchanges started worrying more about the competitive threat that NSE posed to their business and how they should meet investors’ minimum demands so that they did not lose out completely to NSE.
When I look back, I still wonder whether it is indeed me who has travelled through what has been achieved. The NSE in the beginning used to see 1,000 trades a day, now it does 6-7 million trades a day and capability is being put in place that can handle 50 million trades a day. If I had stayed around at IDBI, I could have well retired there as managing director. Moving over to NSE from IDBI was a judgement call on my part, but one which had Nadkarni’s blessings. At that time, nobody, including me, was sure whether NSE would succeed. In fact, many people said I was a fool. But my own feeling was that, once you retire from IDBI, who remembers you? So I decided that it does not matter whether or not I succeed in setting up NSE. My grandfather used to say, “If you make a whistle out of a carrot, then it is good if it plays and if it does not, you can always eat it.”