Changing how it is always done – exchange, agriculture and AMC

Letter # 36, 9 April 2021

“The NSE will only result in fragmenting the existing market, which will lead to less competition and greater volatility,” said the then president of the Bombay Stock Exchange (BSE) in September 1991 (1). In June 1991, a committee headed by Mr. Pherwani had recommended, among other things, that a new stock exchange be promoted as a ‘model exchange’ which would provide access to investors from across the country on an equal footing (2). BSE, at the time, was the largest exchange accounting for 70% of all transactions in India, but had multiple issues—fake certificates, broker defaults, counterparty risks, low liquidity, delayed settlements, antiquated trading platform and frequent closures.

At the root of the problem was the exchange’s bundled structure (ownership, management and trading), controlled by the broker coterie, that created unusually high entry barriers and thwarted all attempts of automating the exchange fearing that the transparency would end their dominance (3).

The NSE was set up in 1992, but BSE continued to believe that brokers, and not technology, is central to operations of the exchange. Even the protests around the creation of a new exchange were rather muted, as most participants had expected NSE to fail. Under the leadership of Mr. Nadkarni and Dr. Patil, NSE linked trading terminals across India using the V-SAT technology and introduced electronic matching system (4). Trading at NSE took off in 1994 (amid high suspicion), but was slow to begin. However, once it started processing weekly settlements (unheard of at that time) with relative ease, volumes started rising. Within just a year of launch, NSE had beaten the champion at its game and started reporting a higher turnover than BSE. BSE’s own members now started taking NSE memberships. Technology had changed the game and incumbents did not see that coming.

Fast forward a few decades to now, and we find another resistance to adoption of technology. Last week, India’s Food and Public Distribution minister Piyush Goyal wrote a letter to the Punjab government asking it to finally (after years of cajoling) implement central guidelines for e-payment of minimum support price directly into farmers’ accounts for the upcoming rabi season (5).

The Public Finance Management System (PFMS) was launched in 2009 as a platform to track funds released under Plan expenditure of central government. By 2012, the central government started direct payment of MSP to farmers, and by 2013, the PFMS was put in use for all direct benefit transfers (DBT) from the central government. By 2017, PFMS was made mandatory for all central government schemes. Andhra Pradesh, Bihar, Rajasthan, Telangana and Haryana integrated land records (with some exceptions for Haryana), set up own procurement portals and started e-transferring the money to farmers. Punjab, on the other hand, continued to pay farmers through middlemen (arhathiya) who facilitate the transaction in marketplace (mandis). Given that Punjab was among the first few states to ensure bank accounts for all households under the Pradhan Mantri Jan Dhan Yojana, it is apparently the fear of moving to a new system and control of a few vested interests that seems to be holding the process back (6).

Coming closer home, technology appears all set to disrupt the asset management industry as well. The mutual fund industry has done a fabulous job of expanding the equity culture in India over the past two decades. With targeted marketing and strong distribution, assets under management have increased multiple folds and the mutual fund industry has taken the product to India’s masses (with 85m retail investors with average ticket size of just INR69,000 per account (8)). However, a cursory glance (7) indicates that seven of the 10 largest asset management companies in India have banking parentage. Wide-spread banking reach and brand equity of the parent enable them to create a distribution network that reaches far into India’s hinterland.  On occasions, that has also implied that the distribution (marketing and sales) has taken precedence at the cost of product (ability to generate superior returns in a consistent fashion). In most categories, alternative asset managers (AIF and PMS) seem to be displaying a superior product slate (better risk-adjusted returns), but lack the distribution (hinterland roots and ubiquitous brand) and a higher ticket size has so far prevented their large-scale asset accretion (relative to mutual funds). With democratization of data and information availability easing, on incremental basis, a superior product could start having a much stronger ‘pull’ compared to a weakening distribution ‘push’. A level-playing field on taxation could just accelerate the process much faster.

In conclusion, the pace of technology-driven change often surprises us with its speed and leaves a lot of ‘once immensely powerful’ systems in its wake. NSE transformed the game with weekly settlements and today, the system happily settles trades on the same day effortlessly. Similarly, technology changed how corruption was tackled with DBT. Changes are now upon us in the asset management industry. A lot more alternative managers will come about, and the industry, which has grown multi-fold over the past few years might come to be the mainstay in some categories (wealth above certain threshold). Moats around the mutual fund industry (viz. brand and taxation) might prove inadequate in face of technology and data democratization that could change how distribution is handled in India going forward.

Notes:
(1) Ego clash – Economy News – Issue Date: Sep 30, 1991 (indiatoday.in)
(2) High_Powered_Study_Group_On_Establish_Of_New_Stock_Exchanges.pdf (mstatic.in)
(3) Sucheta Dalal on the NSE. (goodnewsindia.com)
(4) RH Patil: The man who revolutionized Indian stock market – The Economic Times (indiatimes.com)
(5) Ensure e-payment of MSP directly into farmers’ accounts: Piyush Goyal to Amarinder Singh | India News,The Indian Express
(6) Amarinder Vs Goyal On Direct Payments To Farmers: In No Possible Scenario Do The Arhatiyas Gain Anything (swarajyamag.com)
(7) 10 Biggest AMCs in India – Asset Management Companies List 2020! (tradebrains.in)
(8) FolioandTicketSize.pdf (amfiindia.com)

This letter was originally published here: Changing how it is always done – exchange, agriculture, and AMC – cnbctv18.com

Disclaimers:
Information in this letter is not intended to be, nor should it be construed as investment, tax or legal advice, or an offer to sell, or a solicitation of any offer to make investments with Buoyant Capital. Prospective investors should rely solely on Disclosure Document filed with SEBI. Any description involving investment examples, statistical analysis or investment strategies are provided for illustration purposes only – and will not apply in all situations and may be changed at the discretion of principal officer. Certain information has been provided and/or based on third-party sources and although believed to be reliable, has not been independently verified; the investment managers make no express warranty as to its completeness or accuracy, nor can it accept responsibility for errors appearing herein.

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