The starting gun has been fired, and several exchanges are off, hurrying to attract liquidity before their rivals conquer the field. Each exchange believes it has a fighting chance – but is there room for more than one?

Currency derivatives markets are rapidly becoming fertile ground for exchanges in India, as regulators open up the instruments that can be traded.

But as a fierce three-way battle breaks out between the National Stock Exchange, the MCX Stock Exchange and United Stock Exchange, observers reckon that the soil will surely soon be drenched in the blood of two of these combatants.

On April 8, the Competition Commission of India ordered an investigation into allegations by MCX-SX that the NSE had been guilty of predatory pricing. MCX-SX argued that it was a misuse of NSE’s dominant position that the latter waived fees on currency derivatives, a practice that MCX-SX said it could not afford to emulate.

MCX-SX said NSE’s pricing was designed to drive the weaker MCX-SX out of business. NSE is denying the accusation, stating to the CCI that “the fee waiver in the new currency derivative segment … is in the nature of introductory pricing with no intention to eliminate competition”.

Space for all

The NSE declined to discuss the matter with FOW. But a supporter who is close to the exchange’s thinking said there was no reason several exchanges should not coexist in offering currency derivatives. He pointed to there being more than a score of stock exchanges in India and said “there is scope for all” in currency derivatives.

A source at MCX-SX offered a similarly happy view. The USE — which at the end of last month got the official go-ahead from the Securities and Exchange Board of India for currency futures trading — refused to answer whether it was sustainable that three exchanges could share the business, rather than one of the trio winning out by achieving significantly greater liquidity.

USE has a strategic partner in the Bombay Stock Exchange, which has moved out of the way for it by delisting its own, somewhat inactive, FX derivative offerings.

Observers, however, believe that “scope for all” cannot hold true in the burgeoning currency derivatives market, and that the exchanges are sugarcoating harsh realities.

Jamal Mecklai of Mecklai Financial, an Indian consulting company that specialises in treasury risk management, said (before USE officially joined the battlefield): “There will be one winner and one also-ran.”

Currency derivatives were launched in India in August 2008. At first only the dollar/rupee pair was permitted, but at the start of this February came rupee pairs with the euro, yen and pound.

So far, only domestic firms are allowed to participate in the market.

While MCX-SX and NSE were more or less at level pegging on volumes until the beginning of this year, in the first quarter of 2010 MCX-SX has taken the lead. In the rupee-dollar pair, the edge is only slight. MCX-SX had about $62bn of trading in March, while NSE had $58bn.

But in the other currencies, MCX-SX had roughly €5.6bn of trades to NSE’s €2.8bn, £3.5bn to NSE’s £125m, and ¥114bn to NSE’s ¥14.6bn.

The non-dollar volumes are still small, but considering that March was only their second month of trading, they are impressive.
Nearly 42,000 non-dollar contracts were traded daily on NSE and MCX-SX in February, against 265,000 for the dollar/rupee.
For each of the two established players, daily FX turnover is about $3bn a day.
And the spoils at stake are increasing.

Day traders rule

“India is a highly speculative market,” says Mecklai. “The leverage is good, costs are low and most everybody has a view on the currency.

“We look for continued strong growth,” Mecklai adds. “Currently, about 60% to 70% of the market is day traders. There is very little corporate hedging and it is hard to see corporate hedging increase until delivery is permitted.”

Anup Bagchi, executive director at ICICI Securities in Mumbai, is bullish on a broadening of the user base. “Increase in trading volumes and open interest is a reflection of increase in participation in the currency markets,” he says. “Today, the dollar/rupee contract is among the top five contracts traded on the exchanges, implying a growing confidence in the market.”

As Bagchi points out, teaching customers how to use the instruments will play an important role in building the markets, and exchanges are already holding education sessions for members and customers.

But for professional futures players, the next few months could be crucial in determining whether liquidity continues to build at all three exchanges, or whether one starts to emerge as the victor.