Fledgling Indian bourse MCX-SX is likely to struggle to attract foreign broker-dealers as members and to challenge National Stock Exchange dominance after being ordered to improve governance by the regulator.

Last week the Securities and Exchange Board of India (Sebi) granted MCX-SX a one-year extension of its exchange status from September 16, on condition that it sets up an independent committee to scrutinise its financing and management. Such a move is unprecedented, says an analyst at a foreign broker-dealer.

MCX-SX went live in February and trades stocks as well as currency derivatives and bonds. It is backed by Financial Technologies – an exchange technology provider and shareholder in nine commodity exchanges, including Indian bourse National Spot Exchange Ltd (NSEL).

Industry players say MCX-SX is suffering collateral damage following a recent default by NSEL. (Last month the latter suspended trading in almost all its contracts and defaulted on its payment to certain investors, amid investigations by Indian regulators about the group allowing trading in forward contracts by members who could not deliver the underlying commodities.)

MCX-SX has 528 members in its cash trading segment and 849 members in its currency derivatives segment, but only a handful are foreign broker-dealers, such as Bank of America and Citi.

Industry players say Sebi would not want to be seen stepping in and tell an exchange how to operate. The fact that it has done so underlines the message that the regulator wants Financial Technologies to “clean up its act”.

The unnamed analyst says his team has been monitoring MCX-SX for a couple of years. With the recent warning from Sebi, and considering the recent defaults by NSEL, there has been more reticence from industry players about participating in an exchange that is an affiliate of the NSEL.   

“We are not in a hurry to join MCX-SX as members,” he says. “We need to get more clarity about their market volume and market share to determine that they have a decent amount of liquidity. More importantly, we also need to know that they have a clearing structure whose risk management and governance are credible.”

Industry players also cite as a concern the fact that both MCX-SX and NSEL have similar member profiles, with small brokers and speculative trading firms accounting for the bulk of members.

Another brokerage executive says: “You don’t know what else could trigger a similar payments crisis on MCX-SX, considering the profile of the participants. This would keep larger financial institutions away at least for a while.”

MCX-SX data shows that in August it had a 39% market share in currency futures and options, with average daily turnover across both segments at Rs11,650.35 crore ($1.8 billion), and average daily volume of 1.77 million lots.

Comparable daily average volume is not available for the National Stock Exchange (NSE), the biggest exchange in the country; but MCX-SX says NSE had 57.11% share of the market that month. In August, NSE traded Rs340,807.5 crore. Divided by 22 trading days that month, that works out at a daily average of Rs15,491.25 crore.

But many local brokers see MCX-SX’s one-year extension as a positive, as they had been speculating that Sebi would decide to remove its licence, says Nithin Kamath, founder of an online trading brokerage Zerodha in Bangalore.

Yet the NSEL debacle has come at a bad time for India, he admits. Amid a broad emerging market sell-off, the rupee has lost 15% against the dollar year-to-date, and foreign institutional investors pulled $902.5 million out of Indian stocks in August and $1.02 billion in July, Sebi data shows.  

“India has seen the worst three years in brokerage business, as retail investors retreated from stock trading amid the ongoing market volatility,” says Kamath. “It has not been a good time for the exchange business either.”