Liquidity Enhancement Scheme: Needed For A Healthy Market

SEBI’s decision to allow the Liquidity Enhancement Scheme is a good move in the transparent and healthy development of the market. There is a need to extend this further into the future in order to avoid malpractices and disruption in the markets says Shailendra Lotlikar.

In 2011, SEBI had initiated a new scheme which paved the way for enhancing liquidity in the equity markets. The equity derivatives related liquidity enhancement scheme allowed for a payment to market makers, general traders, dealers, investors for trading on an exchange. Both the NSE and the BSE have taken advantage of the liquidity enhancement scheme albeit with a varying degrees of success. The NSE tried the scheme and closed it after a few months. 

The BSE has had a better success rate ever since it launched the scheme in late 2011. From zero, its trading volume in derivatives segment went up so much that today it commands nearly 20 per cent of the market share. In this period of resurgence, the BSE also became the third largest exchange in the world in index options trading. 

The BSE’s experience and success actually portrays how a clean, regulator approved, transparent and non-discretionary incentive scheme could lead to a very liquid order book and successful derivatives contracts.

BSE’s success seems to have encouraged SEBI to allow the scheme to be operated by MCX SX which has recently commenced its equity trading platform. Probably the intent of letting MCX-SX use the scheme was to let it get a level playing field to compete with the largely established exchanges. MCX – SX also got an approval for the Derivatives scheme and while its equity scheme does not seem to have got a traction yet, the equity futures volume on the MCX – SX have gone up to more than Rs 400 crore as on March 6, 2013 - a commendable feat for a new entrant. 

The BSE and the NSE are perhaps not yet worried over this. The NSE has been doing more than Rs 150000 crore of daily volumes in the derivatives segment while the BSE has been doing in excess of Rs 60000 crore in the recent past. The power that the liquidity enhancement scheme has when implemented in a transparent manner has already been shown by the BSE and now by the MCX SX in their derivatives markets. It however remains to be seen, how the MCX SX will be able to tweak the equity liquidity enhancement scheme to gain more volumes in that segment. 

MCX-SX is yet to launch its index and therefore Index futures. Both the BSE and MCX-SX seem to have sufficient funds to provide in excess of Rs 50 crore per year as per the SEBI regulations, though MCX-SX seems to have a much smaller balance sheet. The BSE has already spent more than Rs 120 crore over the past two years and plans to spend another Rs 75 to Rs 100 crore per year for the next two to three years. 

MCX SX will presumably spend large sums. One good thing about a transparent system like this for attracting volumes is that, it provides a complete account of who gets how much, on what basis etc. the information is available on exchange website as mandated by SEBI regulations. If these schemes were to be removed, the incentivisation will move to the darker corners of the markets leaving room for malpractices as seen in the earlier days and stages of the commodities markets development. Overall stock markets have been doing better in terms of oversight due to SEBI’s insistence on transparency and level playing field. Even the new exchange is being given a fair chance to attract liquidity by paying money for order flow and liquidity in a transparent way which seems to be succeeding for MCX SX. We hope the scheme continues in its right earnest so as to aid in the healthy development of the market.