The market for markets

India now has three stock exchanges (the BSE, the NSE and the USE) with a pan-India footprint and, if SEBI's will does not prevail, one more could be on the way. This suggests that there might be a market for markets; but what determines it? In the case of industries, manufacturing and services, when profits get very big, the big start moving in — if permitted to by the Government. In economics, such markets are called ‘contestable' because they permit free entry. A new firm need not even actually enter a market; the mere possibility that it may do so if the incumbents start making ‘super-normal' profits is enough to keep the latter from becoming too greedy. Who wants more competition? But does this theory apply to exchanges as well? Do they make such huge profits as to attract others into the arena in spite of the high cost of entry? Why are we seeing a proliferation of stock exchanges, especially in these days of intense regulation designed to keep hanky-panky at a minimum to reduce investor risk and where the pickings are probably very thin? What can a new stock exchange offer that entices customers in these days of standardised services and products?

Indeed, given the nature and functions of a stock exchange, a near-monopoly is generally the norm. And communications technology has now made it possible to have a near-monopoly on a national scale, not just at a local level. So one is entitled to ask: why do more firms want to start equity trading? At a simple level the answer — perhaps the only good one – is that they think their business offers few opportunities for growth and they need to diversify into new areas. Some amount of ego may also guide their actions, as when cash-rich firms take a dip in the aviation pool. Their judgement may be flawed but that can become known only later.

Conceptually, though, when large markets generate large profits, they tend to evolve into oligopolies where, even as the No 1 has over half of the market share, the remaining firms have larger shares of the total profit. This makes the return on investment worthwhile. More often than not, the existing structure can be tweaked or leveraged to permit an extension into a new line of business. For instance, a market-place for electronic trading in commodities can well be expanded to permit trading in equity or debt instruments, with a negligible cost of entry, and could well generate decent profits on a very low investment. The keenness of newer players wanting to set up a trading platform for all kinds of financial instruments need not alarm the market regulator. As long as the new entrants bring with them financial strength and an oversight system that guarantees transparency in price discovery, and transactions are settled efficiently, the regulator should welcome competition.