In the modern era of globalization and free trade, politically motivated protectionism and trade wars are largely a thing of the past. But when they do occur, they raise eyebrows. And while US President Donald Trump’s looming trade war with China has garnered more headlines, India’s recent decision to chaperone its domestic exchanges’ trading revenues by banning the use of their index data for creating derivatives listed on overseas markets could have far-reaching implications for exchanges and index providers.
On February 9, India’s market regulator the Securities and Exchange Board of India (Sebi) asked the National Stock Exchange of India (NSE), the Bombay Stock Exchange (BSE) and the Metropolitan Stock Exchange of India (MSEI), to terminate their existing market data licensing agreements with foreign partners.
The news triggered the biggest intraday plunge—about 8.75 percent to a 52-week low of S$7.20 ($5.49)—since November 2008 in the share price of the Singapore Exchange (SGX), which lists futures based on NSE’s Nifty 50 Index.
SGX quickly reassured market participants that trading for its entire India suite of products will continue to operate as usual—at least until August, when the notice period agreed with NSE runs out, ending almost 18 years of NSE sharing Indian securities data and licensing Nifty products.
India’s main grouse with having its market data licensed to foreign exchanges and other data providers was that liquidity in Indian markets was flowing away to foreign jurisdictions like Singapore.
“It is observed that for various reasons the volumes in derivatives trading based on Indian securities including indices have reached large proportions in some of the foreign jurisdictions, resulting in migration of liquidity from India, which is not in the best interest of Indian markets,” said the Indian exchanges in a joint statement in February.
India’s move may have been in response to SGX’s decision to introduce single-stock future contracts on the top 50 Indian stocks on February 5, an initiative that the NSE had sought to delay. NSE CEO Vikram Limaye previously said the SGX’s move would shift liquidity away from India.
According to Indian business news website Livemint, trading on SGX accounts for about 40 percent of Nifty futures turnover and about 70 percent of open interest in the contracts.
India’s move to retract its data licenses from foreign exchanges and other data providers received harsh feedback from index provider MSCI, which suggested that the move might result in MSCI lowering India’s weighting in its indexes, or changing the country’s classification in its suite of products.
“MSCI strongly suggests the Indian exchanges and their regulator Sebi reconsider this ‘unprecedented anti-competitive action’ before it leads to any unnecessary disruptions in trading or a potential change in market classification of the Indian market in the MSCI indexes,” MSCI officials said in a statement, declining to comment further.
Posturing for Pay?
Thomas J. Monaco, managing partner at boutique research firm Silver Point, says he believes that the Indian authorities will reissue the data licenses to the SGX, although it might take a while for the issue to be resolved, and SGX may end up paying more for the data than it did under the previous agreement.
“I think they will, because the SGX and the Indian authorities have spent an awful lot of time trying to figure out how to build futures contracts,” he says. “My guess is, it’ll just be a higher fee at the end of the day, and SGX will pass it along to anyone making transactions on the contract.”
But that’s the best case scenario: If the current situation doesn’t change by August, contracts like the SGX Nifty 50 Futures Index will cease to exist.
In the event that the SGX can no longer list Nifty 50 contracts, Monaco says there is no reason to own SGX shares. “There’s no reason to own SGX if that’s the case because there is no growth. The Nifty 50 is the only product, in my personal opinion, that’s exhibiting a fair amount of growth outside of SGX’s FTSE China 50 UCITS ETF. The equivalent on HKEx—the CSOP FTSE China A50 ETF—means it is in direct competition with the SGX,” he says.
SGX says it will launch a successor product to its SGX Nifty family before August that will give market participants the same ability to invest and maintain their risk exposure to the Indian capital markets. Market participants would be able to seamlessly transition to the new products before the expiration of SGX’s license agreement with the NSE.
The SGX is also continuing to work with the NSE to develop a link that will allow market participants to trade on NSE’s International Exchange at the Gujarat International Finance Tec-City (GIFT City). SGX, Sebi, and the three Indian Exchanges were not available for comment.
The question remains how SGX would be able to potentially list similar products without the data from its Indian counterparts. Stephane Loiseau, managing director, head of cash equities and global execution services for Asia-Pacific (APAC) at Societe Generale (SocGen), tells Inside Data Management that generally, licensing agreements are quite comprehensive and cover all types of scenarios, including usage of data that is made available from other sources.
“Market data is quite a proprietary product for an exchange so they have quite a bit of control on this. Also, you can imagine that a derivative product needs real-time prices, so you won’t be able to do it with end-of-day data,” he says. Technically, it is possible to create a derivative product using end-of-day data, but practically, it is unlikely that it will be a successful product if it can’t rely on real-time data, particularly for the purposes of investors, traders and also market makers, Loiseau adds.
However, Michael Wu, senior equity analyst at Morningstar Investment Management Asia, says SGX has told him that it can use end-of-day data to launch similar products. “They can launch a product whereby the pricing is set by market participants. It could be something like a contract-for-difference (CFD) but linked to a certain underlying index or item where you can get that price point at the end of the day,” he says, noting that the exchange did not specifically reference CFDs. “It doesn’t need real-time data, and that’s how the CFD works. Because it could be an underlying share that the provider has but the price is set by the market participants. In that logic, that works and doesn’t need real-time data to be applied.”
Meanwhile, Lyndon Chao, managing director for APAC equities and post trade at the Asia Securities Industry Financial Markets Association (Asifma), and a 26-year veteran of Morgan Stanley, says he expects SGX to figure something out. “It may be that they have a product that introduces a higher tracking error but it’s significantly cheaper and more convenient to use alternative products to continue the way they’re operating.”
Morningstar’s Wu says that if SGX ends up launching a similar product using a reference price that does not require a subscription to NSE data, then investors may still choose to trade on SGX, and liquidity would not return to India’s domestic markets.
Liquidity in Motion
This wouldn’t help India achieve its stated aim of returning liquidity to its national stock exchanges, so whether—and to what extent—the decision to pull the plug on data licenses with foreign exchanges and data providers will affect the industry remains to be seen.
“There are really two products that people are interested in for this debate,” Loiseau says. “There’s the Nifty 50 Futures index that are traded in Singapore, and the other one is the MSCI India Index, which is also a futures contract traded elsewhere—not only in Singapore but also in Europe and US. It’s important to distinguish the two because they both have reasonably different functions,” he says.
Loiseau says one could argue that the Nifty 50 is mostly a trading tool, while the MSCI India Index is seen more by experts as an investment product. “It’s a product that is mostly used by institutional asset managers as a way to get exposure to the Indian market. Therefore, you could argue that if this product becomes unavailable in August and is not replaced by an equivalent product, liquidity won’t necessarily go back to India,” he says, adding that much of the turnover in the MSCI India Index’s underlying equities is driven by banks trading stocks to hedge their exposure to the index. “If that product doesn’t exist anymore, then the need to hedge that product doesn’t exist anymore, so we can assume that the underlying liquidity in the India stock market would also disappear.”
Besides providing a hedging tool for underlying equities markets, there are other good reasons for licensing offshore derivative contracts. For example, having an offshore derivative increases the attractiveness of the underlying market, Wu says. One reason India offshore derivatives have become popular is that setting up a foreign portfolio investment (FPI) or identification to trade in India can be a cumbersome process, Asifma’s Chao adds.
“People in the industry say it takes several months—between three to six months, on average—to get an FPI registered in India. So those who wish to get exposure have found it convenient to tap into offshore channels. Historically, broker-dealers have been able to issue participatory notes (P-notes) to provide investors with easy access to Indian markets, but since July of last year, P-notes have faced heightened regulatory restriction—so much so that the market barely exists anymore,” Chao says.
P-notes were issued by registered FPIs to overseas investors looking to participate in the Indian stock market without registering themselves directly. Last year, Sebi took measures to discourage the misuse of P-notes, including levying a fee of $1,000 on each instrument to check for misuse, such as channeling black market money.
This, among other factors, has caused foreign investors to shift their trading activity to offshore derivatives on foreign exchanges like SGX, which has been gaining significant market share of the Nifty 50 Index Futures.
“It’s very clear that Singapore shifted quite a lot of liquidity away from India on the SGX. They’ve offered a simpler product, which is easier for foreign investors to access, and is also probably cheaper. There are fewer tax issues to deal with, so it has become competitive. I’m not sure how the new restrictions will play out in the end for India, if this will really achieve the objective… to migrate the flows [back] onshore,” Chao says.
Sebi has recognized the FPI registration challenge and has previously said it will take steps to improve and simplify the registration process—though observers say streamlining it down to a matter of days is “very optimistic.”
While some investors do already have FPIs or the necessary IDs to trade in India, other investors who have historically preferred to trade offshore might not want to go through the hassle of the registration process. “If offshore channels continue to get cut off, that could impact investment into India,” Chao adds.
A key factor in the ultimate impact of the index licensing decision is not where the derivative contracts trade, but who the users of the affected products are and why they use them: whether for speculative trading, risk management, or as a longer-term investment product providing investors with exposure to Indian markets.
“It’s difficult to know for sure the divide between the different types of investors because there is no data that can help quantify in an accurate way why investors are using the different products. It’s reasonably accepted that on one side you’ve got risk managers, and on the other side investors, and those two categories won’t be impacted in the same way by the license decision,” Loiseau says.
A senior bank executive, who requested anonymity, says the Indian exchanges are the ones that have the most to lose on this decision because the derivatives are linked to underlying stocks that only trade in India. “As much as you understand the strategy to bring this derivative liquidity back onshore, it also has an underlying component, which has its own liquidity onshore,” the executive says.
But withdrawing India’s data won’t necessarily even end offshore derivatives trading, let alone migrate liquidity back to India. SGX, for example, is already planning new India-based derivatives to protect its share of this market, and announced on April 11 that it will list new India equity derivative products in June 2018 to allow traders to transition their current India risk management exposures. These new products will be in addition to the existing India single stock futures launched in February, despite NSE’s concerns that it will take liquidity away from India’s domestic market.
“While implementation is not feasible before expiry of the license agreement with NSE, SGX remains committed to engagements with NSE and other relevant stakeholders in India toward a collaboration in GIFT City,” SGX says in a statement.
Exchange officials were not available for further comment about how it will launch these new India equity derivative products, or where it will source the data needed to create them, but Michael Syn, head of derivatives at SGX, said in a statement on April 11 that “SGX has worked hard over the past two decades to promote the development and internationalization of India’s capital markets. We are still exploring a solution that would bring the liquid international market directly into GIFT City, in a way that meets our clients’ regulatory requirements while growing the overall market. In the meantime, we will continue with our new India equity derivative products, which international portfolio investors need to maintain exposure to India.”
Most industry observers say it’s unlikely that other exchanges will follow in India’s footsteps. India presented a specifically unique situation, says the senior bank executive. “The fact that it had two big listed future contracts trading outside of India that represented a significant portion of liquidity of that particular market, and the fact that we had the situation with the licensing agreement—I think it’s unlikely that it will be replicated elsewhere,” he adds.
Sources generally agree that other exchanges will not follow India’s example because the action does not benefit the underlying markets.
“If anything, financial and trade integration within the region is deepening. Asian markets used to be highly correlated with movements in US stock markets, but that is weakening as intra-regional portfolio flows grow,” says Sharmila Whelan, deputy chief economist at Hong Kong-based independent research provider Asianomics, noting that politically motivated protectionist initiatives can be traced to Indian Prime Minister Narendra Modi, who faces elections next year.
“Things like the long-term capital gains tax on foreign investors and the recent 10 percent import tax on key smartphone components… are really about accelerating the ‘Made in India’ agenda that Modi has,” Whelan says, adding that the index move worryingly comes at a time when investors are already nervous about India, fiscal slippage, public sector bank bad loans, and its widening deficit. “So while there is a protectionist element to India’s decision [to cut off data licenses], there’s more going on: It’s about elections, trying to take back control, trying to grow the domestic market—be it the financial market or pushing the ‘Made in India’ brand.”
But Asifma’s Chao says any protectionist approach is bad for markets. “Money doesn’t like to be constricted or restricted. Money likes to flow freely. If—as it flows across borders—it runs into barriers, it just breaks up the liquidity and makes it harder to flow. The cost of trading would go up, and for a lot of these passive ETFs—given that the fees they charge have now gotten so low—if it becomes more expensive to trade certain markets because of the increasing barriers, then those fees to customers might go up and may attract fewer investors to participate. So the overall activity might slow down,” he says.
However, Silver Point’s Monaco suggests an alternative theory for India’s index decision: that the move is not protectionist but—reflecting the growth of trading in the SGX contracts—is rather a ploy to extract higher license fees from SGX, in line with trading levels. “I think the end result will be higher fees,” he says, adding that the negative reaction from other markets may deter India from pursuing protectionist measures in the future.
It remains to be seen how exactly India’s decision to pull back the data licenses will truly impact liquidity in its home market and whether the decision will curry favor with foreign investors, or cool their appetite for exposure to India. But one thing is clear: a data takeaway may be food for thought, but may prove hard to digest.
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