Bulls, Bears and Other Beasts Read online

  It was not just the institutional brokers who were fattening themselves at the expense of their foreign clients; jobbers too had a field day quoting outrageous spreads. Because it was an open outcry system, FIIs wanting to buy stocks beyond the top ten most actively traded ones were forced to accept the terms of the jobbers in those stocks. Electronic screen-based trading, introduced by NSE towards the end of 1994, would end some of the malpractices, but not all of them.

  As for the two sharp-witted dealers, they endeared themselves to dance girls in the Topaz bar by generously lavishing crisp tenners on them. Each of them is known to have at times blown up as much as Rs 5 lakh in a single night on their favourite girls. Back in the early 1990s, Rs 5 lakh went a really long way. News of their extravagance soon reached the ears of their employers, and the duo had to tone down their wild ways. In another six years, Rs 5 lakh would look like loose change when a few brokers from Calcutta went berserk over the girls.

  11

  Winds of Change

  Foreign fund houses may have been ripped off in the initial days, but the unscrupulous fund managers among them had a fabulous time personally, being wined, dined and fawned upon by brokers eager for business. Some of the big brokerages regularly hosted barge parties off the Gateway of India for their FII clients, and even organized striptease shows.

  NSE’s arrival on the scene as a competitor to the BSE dramatically changed the way business was transacted. There was no dearth of stock exchanges across the country at that point, but BSE was by far the biggest and most important of them all. It had the maximum number of companies listed on it, and was more liquid compared with its peers. CSE came within respectable distance of matching it in terms of liquidity, while the Delhi Stock Exchange was a distant third.

  While many retail investors in far-flung towns preferred to transact on BSE, they invariably ended up getting poor prices because their orders would be routed through a chain of sub-brokers to the main broker in Mumbai. Each sub-broker in the chain would charge his commission, with the result that brokerage charges alone would amount to 3-4 per cent or even higher. Finally, whether the investor got a good deal or not depended on how efficient and scrupulous the main broker was. More often than not, the purchase price was marked up closer to the highest price of the day and the selling price closer to the lowest level of the day. Brokers could afford a ‘take-it-or-leave-it’ policy with their retail clients, fully aware they could not be assured of reliable prices or good service even if they were to take their business elsewhere.

  This is not to say that BSE did not have any progressive-minded members. Mahendra Kampani, when he was president of the exchange, tried hard to computerize the trading process and convert the open outcry system into a screen-based one. With screen-based trading, brokers could put in their orders on a trading terminal from the comfort of their offices. The advantages of electronic trading were twofold. One, liquidity would increase as more investors could simultaneously access the system. This would shrink the spreads (difference between the buy and sell quotes) dramatically. More importantly, there would be greater transparency about the prices at which shares were actually sold or bought.

  The move would have been beneficial for investors, but it would have also dented the profitable businesses of many jobbers and brokers who thrived on the wide spreads and opaque prices resulting from low liquidity. In fact, the majority of the jobbers would have been rendered redundant. Not surprisingly, Kampani faced huge opposition from the broking community, and the proposal was put in cold storage.

  What the broker-jobber lobby did not realize was that in blocking computerization, they had dealt a crippling blow to BSE, a blow from which the institution would never really recover. Had BSE opted for computerization at that stage, NSE would have had to work harder to snatch market share from it. I cannot say for sure if BSE would have been ahead of NSE had it computerized its systems earlier, because the BSE continued to score self-goals even after the NSE had started nibbling away at its lunch.

  Years later, when I met up with a veteran BSE broker who had once been a president of the bourse, he told me how the exchange’s electronic trading plan never got the backing it should have from the government. In fact, it appeared as though some influential people in the government had resolved to marginalize BSE.

  My own view, which many old-timers also agree with, is that somewhere along the way, the BSE brokers’ lobby had become too powerful for its own good and was beginning to be seen as a challenge to the government. In the late 1980s, when former UTI chairman Manohar Pherwani – the original Big Bull of the Indian stock market – tried to get a broking card for a UTI subsidiary, he was denied it. UTI did huge business with the brokers and was aware that it was being regularly fleeced on quite a few transactions. Large deals would be leaked and the prices it got on many trades were far from satisfactory. To get around the problem, UTI decided to have its own broking card. But the big boys of Dalal Street would have none of it. One, the brokers who made a living off UTI’s deals would lose a big share of the business. Two, giving membership to UTI would lead to similar requests from other institutions too. It is said that Pherwani was incensed, but there was little he could do. Some other institutions too tried requesting for membership, but they too were snubbed.

  When the newly established SEBI tried to get brokers to register with it for a fee, the proposal was stoutly opposed by brokers and jobbers. They refused to carry out transactions, with the result that BSE had to be shut for a week in April 1992.

  Finance Minister Manmohan Singh, who visited Bombay during that time, came down to BSE to meet the agitating brokers. I was told by friends that the brokers behaved badly with the finance minister, shouting slogans and booing him. This must have piqued the government, which was in the midst of rolling out the red carpet to foreign investors to get them to invest in the stock market. The leading exchange of the country holding the government to ransom would have only served to drive the investors away.

  Thus it was that NSE, set up with financial institutions as its principal shareholders, and originally meant to be a trading platform for wholesale debt, was given permission to start an exchange for trading in shares too. It commenced operations in November 1994, overnight changing the rules of the game. Incumbents like BSE had no choice but to follow suit or risk becoming obsolete.

  While their core business was the same – bringing together buyers and sellers of shares – there was a marked difference between the business models of NSE and BSE. From the first day of its operations, NSE started operations with an electronic trading system. It would take a few more months for BSE’s computerized system to become operational. NSE followed a weekly settlement cycle, just like BSE, but unlike on BSE, trades on NSE could not be carried forward. On settlement day, trades had to be either squared up or settled.

  The ever-ingenious brokers found a way to circumvent this hurdle too. The NSE followed a Wednesday-to-Tuesday settlement cycle while the BSE followed a Monday-to-Friday settlement cycle. Towards the close of trading hours on Monday, or early on in the session on Tuesday, brokers would ‘shift’ their positions from the NSE to the BSE. They would do this by closing their outstanding positions on the NSE, and taking up similars position on the BSE. On Wednesday morning, they would shift their positions back to the NSE by closing out their positions on the BSE and taking fresh positions on the NSE. In this way, they could keep carrying forward their trades on the NSE even though it did not have a formal carry-forward mechanism.

  The NSE was run by professionals and did not have even a single broker member on its board. In comparison, the BSE’s governing board was packed with brokers, and the officials in charge of operations complained of frequent interference by influential brokers. Above all, the NSE’s big advantage over the BSE was its pan-India reach, offering services across the country. The BSE had to wait for some months before it could expand beyond Bombay. That head start made quite a difference, as the NSE had already made a ma
rk for itself in many of the smaller towns by the time the BSE came calling.

  NSE’s biggest contribution to the stockbroking industry was the vast new breed of brokers it spawned. Anybody could become an NSE member by paying a deposit fee and clearing an exam. The day the member wanted to opt out, his deposit would be returned. The closed club culture of the BSE only worked to the advantage of the NSE. The number of membership seats, or cards, as they were called, on BSE was limited. Anybody aspiring to become a member had to buy a card from an existing member. This arrangement helped keep the price of the membership card very high because there were very few sellers. At the peak of the rush for BSE membership, ING Barings bought a seat for a whopping Rs 4 crore. Never was a BSE card sold for anywhere close to that price ever again.

  The BSE brokers found the deposit concept of membership laughable, as did the brokers on the Calcutta and Delhi bourses. For the many aspiring brokers who were kept out by the powerful broker lobbies of the Bombay, Calcutta and Delhi Stock Exchanges, the NSE was the answer to their dreams. As for investors, they had been at the mercy of the whims of the brokers in the big city, and stood to benefit hugely.

  As much as they derided the NSE in public, many of the large the BSE brokers privately applied for membership on the NSE. They wanted to hedge their positions. They were convinced that the NSE would flop, but just in case it did well they did not want to lose out on clients.

  Electronic trading was a grand concept, but there were plenty of operational issues. For instance, if the broker was located in Mumbai, it was easy to have a leased line connecting him to the exchange’s trading system. But it was not possible to drag leased line cables to other parts of the country. The NSE solved this by offering a satellite network to help brokers in other states and the far-flung corners of Mumbai city to connect to its trading system. In effect, the NSE had to start as a telecom company, hooking a stock trading platform to its telecom network!

  The NSE’s debt market segment went live in June 1994, before its equity segment did. By November that year, the equity segment was operational too. The introduction of electronic trading rapidly shrank the spreads and dramatically improved liquidity. Liquidity, in turn, attracted more players, making the market even more liquid. No longer could brokers fleece investors as the prices were out there for all to see. Collection of daily margins and limits on positions that brokers could take up, helped in risk management.

  Before the NSE’s arrival, the BSE used to be closed for trading from Christmas day up to the day after New Year’s day. Not wanting to risk losing business to its rival, BSE decided to do away with the week-long break.

  The screen-based system made the whole trading process faceless. Buyers and sellers no longer knew who was on the opposite side of their trades. When trading used to take place in the stock exchange ring, brokers and jobbers could choose whom they wanted to deal with. The community being a small one, everybody knew everybody else by face and name, even if not personally. Brokers would avoid counterparties whom they suspected of bad faith or of not being financially sound to be able to honour commitments. In the ring, I would avoid AS and PS like the plague. But on the screen, there was no way of saying if I was buying from or selling to them.

  With BSE too going electronic, many jobbers saw their income drop sharply. Once the kings of certain counters, quite a few of them had to hire themselves out as arbitrage dealers to brokers. Seated in front of two trading terminals – one of the BSE and the other of the NSE – these jobbers would try to profit from the brief price differentials on scrips on the two exchanges. They would buy on the exchange where a stock was quoting cheap and promptly sell on the exchange where it was quoting a few paise higher. This called for lightning reflexes and for constantly prowling the screens for opportunities. One advantage with the trading terminals over jobbing in the ring was the ease with which one could keep track of one’s positions. At one tap of a key or a click of the mouse, you could know your trading positions down to the last share. But the new format was unexciting in other ways. No longer could you look into the eyes of the counterparty and give a quote based on what you thought he was likely to do. Worse still, you could be beaten by somebody who lacked a genuine understanding of the market, but who simply knew how to work the keyboard faster.

  While many jobbers were marginalized in the new system, there were also those who adapted and thrived. Needless to say, yours truly was one among them. And, while electronic trading did make many stocks much more liquid, there were limitations. Large orders could still not be put on the screen because it would drive the prices sharply higher or lower, as the entire market could see them. A large buy order would instantly send the stock price soaring as sellers would seek a higher rate; and if there was a large sell order, buyers would quote very low.

  The skill lay in negotiating deals for large blocks beforehand with a potential buyer or seller, and then putting the deal through on the screen. That was where people like GB and, in all humility, I, had an edge over those who only knew how to work the keyboard of their trading terminals.

  While electronic trading did away with certain malpractices, it created a few others in the bargain. A group of brokers would get together and trade in a stock among themselves to give an impression of heavy volumes. If five brokers traded 10,000 shares between themselves five times, it would appear that 2.5 lakh shares had been traded. Just creating volumes would not help; the price would have to be pushed up too. So each member of the cartel would sell to the next member of the chain at a slightly higher price.

  A member of the syndicate would then spread the word that some big investors had taken a liking for the stock. Within no time, retail investors and day traders would rush in to make a quick buck, and the next 2.5 lakh shares would constitute genuine trading volumes. In the mêlée, the members of the syndicate would quietly unload their positions for a tidy profit and head to the next counter.

  In barely eleven months of going live, the NSE nosed past BSE in terms of daily traded turnover, becoming the top exchange in the country. Even the NSE was surprised at the speed with which this happened. As for the veteran brokers on BSE, this was a mighty blow to their egos, especially for those who kept ridiculing the NSE even as it was narrowing the gap with BSE. But it hurt their pockets little, since many of them had already bought memberships on the NSE.

  From 1994 till mid-1995, the price of the the BSE membership card kept rising, thanks to demand from foreign investment banks that wanted to start broking operations in India. While membership on the NSE was far cheaper, foreign firms were keen on being members on both exchanges.

  The arrival of foreign brokerages also led to a huge demand for analysts tracking equities and the economy. By 1994, quite a few domestic brokerages catering to institutional investors had begun hiring analysts to offer research services in addition to executing transactions. Most of the analysts had been roped in from the term-lending institutions, where they used to make project analysis reports.

  The domestic brokerages were paying them a good salary, considering most of them were chartered accountants and MBAs. But overnight, foreign broking firms upended the wage structure of the industry by offering these analysts three to four times their existing salaries. It was a typical Godfather kind of offer that most analysts found hard to refuse.

  Domestic brokerages were furious, but could not afford to compete with their foreign rivals on salaries. From 1994 onwards, Morgan Stanley, Merrill Lynch, Barclays De Zoete Wedd (BZW), National Westminster (NatWest), Indo Suez WI Carr, Hoare Govett, Credit Lyonnais (later CLSA) ABN Amro, Peregrine, Jardine Fleming, Socgen Crosby, HSBC (in partnership with Batlivala & Karani for a long time), ING Barings, UBS, Credit Suisse First Boston, Caspian, Cazenove, were among the firms that went on to set up shop in India. The aftermath of the Asian currency crisis of 1997 would see many of them retreat from India, and the dotcom bust of 2001 would claim some more casualties.

  Some of the big names chose to dip their
toes in the perilous waters of Indian stock broking, hand-held by some of the leading domestic names. Merrill Lynch chose DS Purbhoodas as its partner, Morgan Stanley allied with JM Financial, and Goldman Sachs teamed up with Kotak Securities. All the marriages would dissolve over the next decade or so.

  The arrival of FIIs improved India’s standing in the global markets. It was way down in the pecking order, but had finally got noticed. However, while trading volumes had improved considerably, thanks to electronic trading, there was still not enough liquidity for FIIs to trade in large lots.

  The market hierarchy also changed with the entry of FIIs. Once the undisputed king of the Indian stock market, the Unit Trust of India could no longer impact prices or sentiment the way it used to. The same brokers who would queue up for hours at the UTI headquarters were now trying hard to ingratiate themselves with the new masters of the game – the FIIs. Brokers and jobbers were obsessed with what the FIIs were up to, just as they had been trying to sniff out UTI’s deals till a few months ago.

  12

  Money for Jam

  With FIIs scaling up their operations in India, the frenzy in the primary market showed no signs of abating. Retail investors regained their love for the stock market, but the quality of companies seeking to raise money was rapidly going from bad to worse. Fly-by-night merchant bankers helped shady promoters raise money for projects that existed only on paper. Eventually, many of the companies and their promoters would simply vanish, never to be heard of again.