Indian Exchanges
INDIA RESEARCH The Final Countdown!
June 2009 Nikhil Vora Swati Nangalia
9:54:599:54:59
Sector report
INDIA RESEARCH
8 June 2009 Indian Exchanges BSE Sensex: 14998 The Final Countdown!
A near US$500trn – 10x world’s GDP – is the turnover on global exchanges today! Intrinsically an annuity business, sticky ‘liquidity’ renders the industry quasi- monopolistic where ‘winner takes all’. High operating leverage with EBITDA margins of 60-80% as also limited capital needs, albeit a one-time heavy investment, imply strong cash flows. The nascent Indian exchange landscape is finally evolving from ‘only equity’ into an inclusive blend of asset classes (commodities, forex, power, etc) with underlying physicals warranting a 2.5x growth in industry turnover to US$10trn by FY14. Now demutualized and electronized entities, the compelling business model is bound to translate scale into profitability. With exchanges inherently commanding high strategic valuations (CBOT acquired at 55x earnings; NSE valued at $2.3bn), logical for their risk-free model, we believe it’s time for ‘value creation’ on Indian exchanges. We are BULLISH. Financial Technologies, the only listed player in the space and Asia’s largest exchange conglomerate, is our BIG bet. Business model…flawless: Revenue sustainability (20% CAGR in global volumes for two decades), high operating leverage (60-80% EBITDA margin) and strong cash flows make exchanges a near-perfect business. With liquidity, the key success factor for an exchange, difficult to ‘poach’, entry barriers in the industry are well defined and lend further resilience to the annuity model. Indian exchanges – on a high: Indian exchanges (US$4trn turnover), synonymous to equity markets, are finally coming of age. Inclusion of varied asset classes – commodities, currencies, power, etc – is set to impart scale and depth to the industry. Based on underlying physicals, industry turnover is expected to reach US$10trn by FY14, primarily spear-headed by the nascent but high-potential commodity exchanges (4x from US$1tr currently). Time for value unlock: Having undergone a swift evolution, the demutualized and electronic entities have overcome structural inefficiencies. Catching the eye of global players, the big-ticket sector has garnered high strategic valuations (NSE valued at US$2.3bn, MCX at $1.1bn and BSE at $0.8bn), which is now set to convert into market capitalization. We are bullish. In the listed space, our big bet is Financial Technologies. We recommend Outperformer with a price target of Rs2,000 – a 40% upside from the CMP. Nikhil Vora [email protected] 91-22-66 38 3308 Indian exchanges industry potential Turnover FY09 Size by 5-year CAGR Basis of estimates Swati Nangalia (US$bn) FY14E (%) [email protected] Commodity 1,050 4,184 32 50% discount to global multiple of futures 91-22-66 38 3260 to underlying physical market
Equity 3,042 5,256 12 25% discount to global average for Value
IDFC-SSKI Securities Ltd. traded to GDP 701-702 Tulsiani Chambers, Currency 240 960 32 50% discount to global average of 7th Floor (East Wing), OTC:Exchange derivative markets Nariman Point, Total 4,332 10,400 19 Mumbai 400 021. Fax: 91-22-2204 0282 “For Private Circulation only” “Important disclosures appear at the back of this report”
IDFC - SSKI INDIA
CONTENTS
Investment Argument...... 4 Exchanges: A ‘perfect’ business...... 5 Indian exchanges: A big ticket sector…in a hurry to grow...... 11 Indian exchanges: A US$10trn industry by FY14E...... 13 High strategic value attached to exchanges… ...... 18 …huge market capitalization potential...... 21 Equity Exchanges: ‘Bull’ run...... 23 Indian equity exchanges: From strength to scale...... 23 The future is in ‘futures’...... 26 Competitive landscape: NSE has caged the bull!...... 30 Key growth drivers...... 32 Commodity Exchanges: Midas touch...... 33 India commodities exchanges: A US$4trn opportunity by FY14E…...... 33 …moving towards an organized structure ...... 35 Competitive landscape: MCX has monopoly...... 39 Key growth drivers...... 41 Key concerns...... 41 Forex Exchanges: ‘Appreciation’ certain...... 43 Global forex market: US$3trn daily turnover ...... 43 Indian Forex market: Strengthening...... 45 Exchange Traded Derivatives: US$4trn daily turnover by FY14E ...... 46 OTC forex market in india: US$40bn daily turnover by FY14E ...... 48 Power Exchanges: Lighting up...... 50 Power Trading in india: ‘Bright’ future ...... 50 Power Exchanges: Let there be light ...... 52 Key growth drivers...... 56 Spot Exchanges: Spotted in india...... 57 Indian agri market: Enormous…and inefficient ...... 57 Electronic spot exchanges: The panacea of all evils ...... 58 Competitive landscape ...... 61 Revenue model: High volumes…low value ...... 62 Key growth drivers...... 63 Exchange Ecosystem...... 64 Ecosystem: Pillars of the exchange...... 64 Technology solutions for ‘markets’: Low latency is the rage...... 64 Warehousing and agri credit: Supporting commodity markets ...... 68 Companies ...... 76 Financial Technologies...... 77 Bombay Stock Exchange (BSE) ...... 137 Indiabulls Financial Services (IFSL)...... 142 National Board of Trade (NBOT) ...... 144 National Commodity and Derivatives Exchange (NCDEX)...... 146 National Multi-Commodity Exchange (NMCE)...... 150 National Stock Exchange (NSE)...... 153 Reliance Money ...... 163
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INVESTMENT ARGUMENT Transparency, annuity revenues, high operating leverage and solid entry barriers make exchanges a near-perfect business. With strong secular growth in the underlying market, the US$4trn Indian exchanges industry is headed for 2.5x growth in the next five years to an annual turnover of US$10trn. Almost on par with global peers in terms of corporate structure and sophistication of systems, Indian players are gathering scale, which is bound to translate into profitability (aggregate profit of $200m for NSE and BSE). We believe the industry is now ripe for value creation – validated by the high strategic values ascribed to NSE (valued at $2.3bn), MCX ($1.1bn) and BSE ($0.8bn) by global exchanges. Financial Technologies, Asia’s largest exchange conglomerate as also the only listed entity in the space, is our BIG bet. We recommend Outperformer with a price target of Rs2,000 – a 40% upside from the CMP.
Exhibit 1: Indian Exchange Initiation - Synopsis
A US$10 trillion potential by FY14 (2.5x growth)
Indian Exchanges Commodity markets Equity markets Indian Exchanges Derivatives 3x physical market Value traded to GDP at 70% discount to The ‘undiscovered’ next The ‘undiscovered’ next (global benchmark of 30-40x) global benchmarks BIGBIG thing thing ! ! Currency markets Power Spot markets Potential of US$8bn/day Only 0.05% of short term US$2tr physical market to (currently US$1bn) trading are on exchanges migrate to exchanges
An unparalleled business…
Visibility Sustainability Strong business Annuity income assured Strong business 20% CAGR in volumes over two decades fundamentals…fundamentals… (70% of revenues based on transactions)
Strong entry barriers High operating leverage Capital needs – limited! Stickiness of ‘liquidity’ EBITDA Margins of 60-80% Strong Free Cash Flows creates monopolies
…With high strategic value
US$9.6bn US$7.6bn US$12.2bn …creating…creating value value
US$2.3bn US$1.1bn US$0.8bn
Source: IDFC-SSKI Research
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Exhibit 2: Indian Exchange Initiation - Synopsis
9 Exchanges – CME, NYSE, OMX, LSE, SICOM, Deutsche Bourse, TSX, LME, Global TOCOM, Nord Pool 9 Ecosystem players – Cinnober, Sungard, GL trade, Broker members
9 Exchanges – NSE, BSE, MCX, NCDEX, Reuters, Indiabulls, Reliance, NMCE, Domestic NBOT 9 Ecosystem players – Bullion traders, NBHC, Bloomberg OurOur ground ground research research Regulators / Forward Market Commission (FMC), ICRIER, Futures Industry Association (FIA), Associations World Federation of Exchanges (WFE), World Gold Council
Visits Warehouses, Exchange tours, Agri mandis
9 Evolution cycle of exchanges – electronic, demutualization, listing and consolidation Key analysis 9 Exchange industry dynamics and business model Key analysis 9 Regulatory structure across exchanges in India 9 Underlying markets for every exchange
WhatWhat will will bring bring further further 9 Introduction of options and indices in non-financial asset classes momentum?momentum? 9 Permission for institutional participation on commodity exchanges
9 Regulatory overhang (such as ban on futures trading in farm products) on commodity OurOur apprehensions apprehensions exchanges 9 Commodity transaction tax may impact near term volumes
9 India – the opportunity is big (2.5x growth in the next five years) WeWe are are BULLISH BULLISH 9 Exchanges: A near-perfect business model 9 With inherent value creation potential
9 Largest exchange conglomerate in Asia with 10 exchanges across various asset classes and FinancialFinancial Technologies Technologies – – regions, of which six are currently live OurOur BIG BIG bet!! bet!! 9 Includes MCX – India’s largest commodity exchange (87% share of US$1trn industry) 9 Potential entry of MCX-SX into the US$3trn equity space in India
Source: IDFC-SSKI Research
EXCHANGES: A ‘PERFECT’ BUSINESS Exchanges have been around for centuries, but the business model continues to strengthen with the industry increasingly gaining depth. The global exchange industry has seen a strong 20%+ CAGR in volumes traded over the last two decades reflecting the inherent resilience of these businesses. Sticky liquidity (which imparts quasi-monopolistic nature to the industry), strong annuity income (and thereby sustainability of revenues), transparency, high operating leverage and strong cash flows are hallmarks of these businesses. With such unique characteristics, exchanges emerge as a low risk-high reward business.
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Exhibit 3: A low risk-high reward business
Revenue model – sustainable and visible
Transaction and Clearing Fees Market Data Fees Listing Others
Revenue head Underlying % of total topline 100%
75% Transaction fees Volumes traded 80%+
50% 95% 81% 85% 88% 86% 57% Market data fees Fixed contracts 5% 25%
0% NYSE CME ICE NASDAQ NSE MCX 85% of revenues at zero risk Euronext OMX
Cost structures - Range bound!
Employee Costs Software/Equipment Expenses Cost headings Expense head % of total costs Building operations/Rental General & Admin Others Information Employee 100% 40% maintenance expenses 75% Technology Technology 15% backbone maintenance 50%
Physical 62% Rental costs 10% 25% 47% 49% infrastructure 33% 27% 15% 0% CME ICE NASDAQ NYMEX NSE MCX 65% of costs fixed OMX
High operating leverage – EBITDA margins in the range of 60-80%
(%) EBITDA margins 90 81 83 70 67 68 68 61 63 63 60 57 46
30
0 MCX LSE TSX ASX Nymex NSE CME ICE SGX Hkex NASDAQ OMX
Source: IDFC-SSKI Research
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It’s all about liquidity… Success of exchanges is The primary factor determining the success of an exchange is ‘liquidity’, i.e. volumes purely based on ‘liquidity’, traded on the platform. An exchange, by attracting high participation, is able to offer i.e. efficient trade execution at a minimum impact cost trade execution at a lower impact cost, which in turns drives further liquidity. Thus, participation and liquidity on an exchange are highly interdependent. This also shows that liquidity is critical to success of an exchange and a virtuous spiral that every exchange aims for. Thus, ‘network effect’ determines the survival of exchanges.
Exhibit 4: Liquidity…attracts more liquidity
Larger pool of liquidity
Easier to More Creating the match users network effect orders
Lower bid/ask spread
Source: IDFC-SSKI Research
Liquidity facilitates smooth and orderly price movements for buyers and sellers, and enables market participants to enter and exit the markets quickly and efficiently. With liquidity being the single most crucial success factor for an exchange, it is to some extent artificially induced in the initial years to achieve a minimum critical trading mass. Market intermediaries, or market-makers, form this set of liquidity- inducing participants that give simultaneous buy and sell side quotes to achieve active trading. Over 90% of total traded volumes on exchanges are contributed by such participants. While market making activity is legalized and official globally, India has yet to set its market-making norms.
…which also creates a natural entry barrier
Liquidity rarely migrates Liquidity forms the backbone of any exchange. As observed globally, once volumes but can be acquired gravitate to an exchange, very rarely do they migrate to a different platform. Thus, wholesale, i.e. by liquidity is sticky and creates ‘brand value’ for an exchange. With liquidity almost acquisition/ consolidation impossible to poach, exchanges are a difficult-to-replicate business. Further, in non- financial markets, infungibility of products ensures security of liquidity.
Liquidity on an exchange, by virtue of its nature, creates strong natural dominance of a few players (a quasi-monopolistic situation). In this way, liquidity acts as an effective barrier to competition. Such being the nature of the industry, attracting liquidity through innovation is difficult. In view of this, the global marketplace has undergone two primary structural changes – consolidation and electronization – to ‘acquire’ liquidity.
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Exhibit 5: Structural changes to ‘acquire’ liquidity
Consolidation Acquiring liquidity LIQUIDITY Creates strong entry barriers Improving reach to Electronization enhance liquidity
Source: IDFC-SSKI Research
An annuity income model…sustainable revenues A 20%+ CAGR over two Annuity income (sustainable revenues) is a key characteristic of the business. decades indicates the Exchanges follow a generic business model with well defined revenue streams. inherent resilience in exchanges business Facilitation of trading being the primary business of an exchange, transaction fees form 60-80% of aggregate revenues. Thus, steady underlying average annualized volumes of an exchange impart sustainability to revenues. The 20%+ CAGR in turnover over two decades for global exchanges, a centuries-old industry, point to the inherent resilience of these businesses. Other sources of revenues include sale of market data, listing fees (for equity exchanges), and memberships & related charges.
Exhibit 6: Sustainable business model with definitive revenue streams
Transaction and Clearing Fees Market Data Fees Listing Others
MCX 86%
NSE 95%
LSE 48%
NYSE Euronext 57%
Bursa Malaysia 62%
HKEX 65%
SGX 68%
CME 81%
NYMEX 84%
ICE 85%
CBOE 86%
NASDAQ OMX 88%
0% 25% 50% 75% 100% Source: Companies, IDFC-SSKI Research
Exhibit 7: Key aspects of each revenue stream
Revenue stream Key characteristic Comments
• Indian exchanges charge this fee on total turnover • Charged for every trade facilitated on the platform Transaction fees • Whereas globally fee is charged on number of • Forms 60-80% of total revenues con tracts traded • Quotation data fees for dissemination of market Market data Fees data to subscribers • Indian exchanges yet to monetize this income stream • Primarily provided through third party distributors Listing fees • Income stream for equity exchanges • May be impacted by volatile markets
Membership fees • Charged for admission of members • Primary revenue stream in initial years
Source: IDFC-SSKI Research
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Volumes – steady average amidst peaks and troughs
Volumes, despite market Volume stability is an important criterion as volumes are a key determinant of fluctuations, on an average transaction fees, and thereby exchange revenues. While volumes traded may see some to remain secured variance in line with the external environment, we observe that average volumes on an exchange remain secured. For example, while the year 2008 was dotted with market turbulence and counterparty credit risk was at the peak, global derivative volumes reached a record 17.6bn contracts – a 14% increase over 2007. With average annualized volumes remaining steady (as also traceable on a daily basis) for an exchange, transparency and sustainability of revenues become inherent traits of the business.
Exhibit 8: Average volumes on an uptrend
No. of contracts No. of contracts NYMEX ICE CME CBOE 500 484 2,400 2,250
375 372 373 1,800
295 1,341 268 250 1,200 1,048 215 944 169 787 144 142 620 675 125 600 98 468 284 361
0 0 FY03 FY04 FY05 FY06 FY07 FY03 FY04 FY05 FY06 FY07 Source: Company, IDFC-SSKI Research
High operating leverage While exchanges entail a heavy one-time capex, the business model provides high Operating costs are operating leverage as operating costs are relatively fixed in nature. For an exchange, relatively fixed in nature with limited impact of employee costs are the primary component with software maintenance costs and variation in volumes building maintenance cost/ rental (whether leased or owned) as the other major heads. With costs not affected by variations in trading volumes, exchanges enjoy high operating leverage and earn EBITDA margins in the range of 60-80%, depending on factors such as owned/ leased physical space, technology orientation, etc. For instance, NASDAQ OMX enjoys EBITDA margins of 83%. We believe such nature of the exchanges business increases its value proposition.
Exhibit 9: Operating leverage leading to high EBITDA margins Employee Costs Software/Equipment Expenses Building operations/Rental General & Admin Others EBITDA margins
MCX 27% 46%
NSE 15% 67%
NYMEX 33% 63%
LSE 43% 57%
ICE 62% 68% CME 47% 68% TSX 58% 61% 0% 25% 50% 75% 100% Source: IDFC-SSKI Research
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Interest on float – a bonus! Exchanges can deploy float Exchanges are underwriters of counter-party credit risk and guarantee settlement of (margins to be maintained trades. In order to serve this purpose, exchanges have a robust risk management by members) capital in strategy in place. Exchanges maintain a ‘Settlement Guarantee Fund’ which may be short-term liquid funds used to cover defaults of members. For this, members have to deposit margins with the exchange at the time of admission and also maintain a security deposit. In addition, daily trades are at marked-to-market prices and entail members to maintain margins for the same.
Depending upon the open interest level and other parameters, exchanges deploy the float capital in short-term liquid funds and earn interest on the same. While exchanges are permitted to invest this float available in liquid funds, they cannot use the same to meet any debt obligations they may have.
Strong cash generation ability Capital needs of an In the initial years of an exchange’s lifecycle, capital is needed to be infused in exchange come down with technology and infrastructure as also for inducing liquidity. Based on our interaction age, and then they garner with key global and domestic players, we estimate average investment of US$50m in high cash flows setting up an exchange, though it could vary depending on technology requirement. However, once an exchange is established, the business does not command any major capital investments. In this backdrop, exchanges garner high free cash flows (refer to the following exhibit).
Exhibit 10: Limited ongoing capex… …leading to high free cash flows
FCF/Revenues 2006 2007 (US$ m) 2006 2007 153 (%) 160 49 50 46
120 45 87 40 37 80 37 36
35 33 31 40 11 9 12 30
0 25 CME Nymex ICE CME Nymex ICE Source: IDFC-SSKI Research
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INDIAN EXCHANGES: A BIG TICKET SECTOR…IN A HURRY TO GROW The Indian exchanges industry is coming of age. Traditionally, Indian exchanges were set up as mutually-owned marketplaces where buyers and sellers (who were also collectively the owners) assembled in order to exchange their products. As the entities operated as a not-for-profit utility, there was little incentive to compete. However, taking a cue from global players, Indian exchanges industry has acquired new contours in the last decade or so.
A compressed evolution Global exchanges, in the last two decades, have evolved from being member-owned cycle for Indian exchanges entities into sophisticated business houses (now publicly listed). They have steadily as they had a ready reckoner in global peers completed the four key stages of the evolution cycle – electronization, demutualization, listing and consolidation. With global experiences to draw upon, the leading Indian exchanges in the country (NSE and MCX) were conceived as electronic, demutualized entities – enabling them to fast-track the evolution cycle. Also, older Indian exchanges (BSE and regional exchanges) could initially draw parallels from global exchanges and later jump the evolution curve by taking cues from their more savvy domestic peers. Thus, Indian exchanges have covered the ground in longer strides – which means a compressed evolution cycle for them.
Exhibit 11: Indian exchanges – fast tracking the evolution cycle
Electronic Demutualization Listing Consolidation Global exchanges evolution cycle Profitability & Enhanced reach competitiveness Value unlocking Acquiring liquidity driving liquidity coming to the fore
NCDEX, NMCE
Skipping the first two stages MCX Indian exchanges
NSE
BSE
1994 1995 2005 2009
Source: IDFC-SSKI Research
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Electronization – imparting scale Electronic platforms reduce Enhancing the technology infrastructure is becoming a key focus area for exchanges trading time, and thus across the world in order to reduce transaction time, and thereby attract liquidity. enable higher volumes Traditionally, reduction in execution time of trades has led to increase in volumes. Also, with migration of liquidity not possible across platforms, the imperative to reach a wider audience has led to the evolution of exchanges from pits to electronic screens. Market participants will naturally execute trades through the most liquid venue in order to ensure good execution. In addition, electronic trading allows customers to access multiple exchanges simultaneously with minimal marginal cost, and drastically reduces the cost for an exchange to offer trading of additional securities. Thus, electronic trading allows exchanges to achieve economies of scale.
Exhibit 12: CME – volumes increasing on the back of higher speed Average order volume (m - LHS) Average round trip time (ms - RHS) 250 140 127ms 234mm
200 112
150 84
100 56
50 28 7ms 4mm 0 0 2004 2005 2006 2007 2008 2009 Source: CME Group, IDFC-SSKI Research
Demutualization – profitability taking center-stage Demutualization has The concept of demutualization was introduced in 1993 (with Stockholm Stock converted exchanges into Exchange) and since then, the wave has touched all global markets. Demutualization corporatized entities essentially results in transformation of the exchange from a non-profit utility that is owned by users to a ‘for-profit’ organization held by shareholders. As exchanges demutualize and transform into corporatized, profit-making companies, they are more inclined to explore growth opportunities. We believe the momentum towards increased competition will continue as ownership structure evolves towards an institutional investor base.
Imbibing the key evolutionary parameters – electronization and demutualization, Indian exchanges are well on their way to achieve relevant scale. The US$4trn Indian exchanges sector has witnessed 6-fold growth in the last four years. Thus, transition to the organized sector has triggered growth for the industry.
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INDIAN EXCHANGES: A US$10TRN INDUSTRY BY FY14E The Indian exchanges space is headed for robust growth on the back of improving penetration and structural transition into a more organized industry. Indian exchanges can be categorized into three primary segments – commodities, equities and currency, with power and spot exchanges the other emerging segments. The industry is expected to register 19% CAGR over the next five years to reach a size of US$10trn (in terms of turnover) from US$4trn currently. Taking cognizance of the shorter evolution cycle of the industry, we believe penetration would be achieved over the course of time and hence have appropriately discounted global benchmarks to arrive at this potential (Refer Exhibit below).
Exhibit 13: Potential of the Indian Exchanges industry Segment turnover(US$bn) FY09 Size by FY14E 5-year CAGR Basis of estimates Commodity 1,050 4,184 32% 50% discount to global multiple of futures to underlying physical market Equity 3,042 5,256 12% 25% discount to global average for Value traded to GDP Currency 240 960 32% 50% discount to global average of OTC:Exchange derivative markets Total 4,332 10,400 19% Source: IDFC-SSKI Research
Exhibit 14: The industry will get BIGGER
Commodities Equities Currencies
4,184 960 R 5,256 G A C R 2% R G 1 G A A C C 2% 2% 3 3,042 3
1,050 240
FY09 FY14E FY09 FY14E FY09 FY14E Source: IDFC-SSKI Research
Changing industry contours…commexes to spearhead growth The relatively younger In India, equity exchanges were the first to achieve a structural shift from commodities segment to unorganized to the organized market. With equities being the only available asset lead from the front given a class that could be traded on sophisticated platforms, the segment has registered a strong physical market strong 46% CAGR in turnover over the last 14 years and contributes 70% to the industry turnover. On the contrary, commodity derivative trading on exchanges has commenced only five years ago despite commodities valued at 45% of India’s GDP. With global benchmark of derivative markets at 30-40x the underlying physical market, we believe commodity exchanges (commexes) offer high growth potential. In this backdrop, we expect the share of commodities segment to almost double to 40% of the industry turnover in the next five years.
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Exhibit 15: Share of commexes to increase FY09 FY14E
Currency Currency 6% Commodity 9% 24% Commodity 40%
Equity 51% Equity 70% Source: IDFC-SSKI Research
Commodity markets – the next ‘Midas’ on Indian exchanges Commodities trading on Commodity markets – highly unorganized till about three years ago – are exchanges catching pace; comparatively younger in the Indian context. Interestingly, India is the largest huge scope at 3x physicals market against global consumer of precious metals like gold and silver as also the largest producer of agri average of 30-40x commodities. With turnover on commodity exchanges registering a 40x growth over the last five years, the Indian commodities market is finally rising above structural inefficiencies and attracting relevant participation as also liquidity. MCX, the largest commodity exchange in the country (87% market share in FY09), was ranked World No.1 for silver and No.3 for gold (only after CME and TOCOM) and copper (after LME and SHFE) in terms of number of contracts traded in 2008 (Source: FIA). Commodities are valued at 45% of India’s GDP with the size of the physical commodity market at US$320bn. Globally, commodity derivatives markets are at an average 30-40x the underlying physical market while India currently stands at 3x. Building in the fact that the industry would take time to mature, we have discounted the global average by 50% and expect the turnover to reach US$4trn by FY14.
Exhibit 16: Commodity Exchanges – to gather scale; MCX is the leader
40x growth in the last five years …to grow to US$4tr by FY14 (a 32% CAGR) MCX dominates
Physical Global Indian Total turnover (US$ bn) Potential 1,050 market Benchmark multiple NMCE Others (US$ bn) NCDEX 900 (US$ bn) (x) (x) 0.8% 1.1% 813 10.8% 735 Gold 19.8 60-70 30 594 675 Silver 11.3 60-80 35 396 431 450 Metals 29.4 20-30 10 294
Crude oil 60 20-40 15 900 225 114 Agricultural 26 200 20-30 10 2,000 products MCX 0 87.3% FY04 FY05 FY06 FY07 FY08 FY09 Total 320.5 4,184
Source: IDFC-SSKI Research
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Equities – the bull will remain charged!
Though Indian stock Equity markets have exhibited 46% CAGR over the last 14 years to reach the current exchanges have attained annual turnover of US$3trn. NSE, the country’s largest exchange (93% market share maturity… of equities trading) is ranked 8th in the world among derivative exchanges. Futures & Options have been the key driver of liquidity on equity exchanges and currently contribute 72% to the aggregate volumes. In line with the global average ratio of 3-5x between cash and F&O, turnover in the F&O segment is 3x that of the cash market on Indian bourses.
Exhibit 17: Indian equity exchanges – a snapshot 46% CAGR over last 14 years F&0 – 70% of equity markets NSE – Invincible!
(US$ bn) (US$ bn) CM F&O Debt Indian equity exchanges 3,500 3,042 3500 Market share (FY09)
2,800 2800 93% 2,100 2100
1,400 1400 7% 489 700 15 700
0 Approval 0 awaited FY95 FY03 FY09 FY00 FY03 FY06 FY09
Source: SEBI, IDFC-SSKI Research
However, with regards to global benchmarks of liquidity, Indian bourses seem relatively under-penetrated. Indian equity exchanges are at a 70% discount to the global average of value traded to GDP (average: 177%; India: 64%) and at a 50% discount to the global average of turnover velocity (average: 160%, India: 84%).
…we still see 12% CAGR While under-penetration is evident in the statistics, we have built a 25% discount to over FY09-14 given the global average of value traded to GDP and expect a 12% CAGR in turnover over the under-penetration next five years to US$5.3trn. While NSE’s leadership is indubitable in the near future with its 93% share, upcoming players like MCX-SX (promoted by MCX and Financial Technologies) pose strong competition. MCX-SX has already proved its mettle in the commodities segment.
Exhibit 18: Under-penetration to drive turnover growth
Value traded to GDP at 70% discount Turnover ratio at 50% discount Turnover to reach US$5.3trn by FY14
Turnover ratio (%) (%) Total turnover (US$ bn) 400 372 300 270 6,000 5,256 217 300 225 180 217 207 203 4,500 200 142 3,042 140 131 122 111 150 +=3,000 100 64 84 29 1,537 75 0 1,500 489 LSE BSE NSE Nasdaq
Euronext 0 Tokyo SE UK USA China Japan Singapore India 0 NYSE Group NYSE FY03 FY06 FY09 FY14E Korea Exchange Korea Deutsche Börse Source: World Federation of Exchanges, IDFC-SSKI Research
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Currency derivatives – ‘appreciation’ guaranteed Indian currency derivatives The global foreign exchange market is currently estimated to be ~US$3trn in industry exhibit a 4x turnover per day – making it the largest and the most liquid market. The forex growth potential market can be broadly divided into two segments – cash (OTC – spot, forwards and swaps) and exchange-traded currency futures. The current size of India’s OTC forex market is estimated to be US$33bn in turnover per day, while that of exchange- traded currency derivatives stands at US$1bn a day. Currency derivatives in India are traded on NSE and MCX-SX with both claiming an equal pie in the US$1bn per day industry. Aggregate turnover on these exchanges has grown from US$175m in October 2008 to US$1bn currently.
Our interaction with leading industry participants like Reuters indicates that the OTC market is well on its way to become a US$40bn market in the next five years. Following the global average of 5:1 between OTC and currency derivatives, the potential of the Indian currency derivatives industry is pegged at US$8bn (8x increase from here). In view of the nascent stage of the industry, we have built a 50% discount and estimate the daily turnover to reach US$4bn by FY14.
Exhibit 19: Forex markets in India
Forex Systems
85-90% 50% 60-70% 5% Currency 50% OTC derivative (US$33bn per day) Voice brokers (US$1bn per day) 5%
<1% 30-40%
US$4bn per day US$40bn per day
50% discount to Global average (OTC: Exchange = 5:1)
Source: IDFC-SSKI Research
Energy markets – lighting up Between IEX and PXI, the India’s short-term power market has seen 17% CAGR over FY04-08. Further, the former holds 90%+ of industry has registered an uptick in the last few years with 21BUs of short-term traded volumes of power on exchanges in India power traded in FY08 – a 40% yoy increase (source: CERC). The traded volumes of power have grown from 2.1% of generated capacity in FY04 to 3.2%. Thus, India promises a strong market for power exchanges. Power exchanges in India have been operational for less than a year and are at less than 0.05% of its total power traded.
India currently has two power exchanges operational – Indian Energy Exchange (IEX) and Power Exchange of India (PXI). IEX, promoted by Financial Technologies and PTC India – India’s largest power trader, leads the industry with a 90%+ share.
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Exhibit 20: Power exchanges – the new kids on the block
Traded volumes (BUs - LHS) % of total generation (RHS) 25 3.5
Less than 0.05% of this is on 20 3.0 power exchanges 41.2% 26%
15 2.5
5% 5% 10 2.0
5% 5% 5 1.5 5% 5%
0 1.0 2.8% FY04 FY05 FY06 FY07 FY08 Others Source: CERC, IDFC-SSKI Research
Spot exchanges – ‘spotted’ only in India India has pioneered the India holds a formidable place in the world agricultural commodity production, concept of spot trading in being the 2nd largest producer of key commodities like rice, wheat, sugar, cotton, etc. agri-commodities The strong production base translates into a large physical market of ~US$200bn annually for trading agricultural products. However, the physical agri market in the country has been in dire straits – marked with inefficiencies and stifled due to stringent regulations. In order to address the issues, electronic national level spot exchanges have been introduced – a pioneering concept. These exchanges are still in the incubation phase and while the industry offers enormous potential, we believe regulatory hangovers could stretch their evolution cycle.
Exhibit 21: India – dominant positioning in world agriculture India Rice 2nd largest producer Wheat 2nd largest producer Groundnut 2nd largest producer Castor Seed Largest producer Chilli Largest Producer, consumer, exporter Cotton 2nd largest producer Guarseed Largest producer (90% of world prod) Jeera Largest Producer, consumer, exporter Mentha Oil Largest Producer, exporter Sugar Largest consumer and 2nd largest producer Source: IDFC-SSKI Research
Exhibit 22: India ranking in key agri commodities
Rice/ Paddy % share of country Wheat % share of country Sugarcane % share of country China 29.01 China 17.24 Brazil 32.7 India 21.51 India 11.44 India 20.19 Indonesia 8.57 USA 9.46 China 7.23 Brazil 1.81 Russia 7.43 Thailand 3.42 Japan 1.69 France 5.84 Pakistan 3.21 USA 1.38 Canada 4.5 Mexico 3.63
Source: IDFC-SSKI Research
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HIGH STRATEGIC VALUE ATTACHED TO EXCHANGES… A virtual annuity business with high operating leverage and strong cash flows makes exchanges a unique proposition. Exchanges are businesses built for a lifetime and once established (by garnering liquidity), they become a ‘brand’ with extreme customer stickiness. Such difficult-to-replicate businesses with a fixed opex and limited capital requirement on an ongoing basis are naturally value-accretive. The strength of these businesses is evident in the consolidation taking place in the global exchanges space. With poaching of liquidity extremely difficult, acquisition scores well above innovation. As the risk of entering into a new asset class and failing to attract liquidity in the same is far greater, the global exchanges industry is currently undergoing a wave of consolidation.
Consolidation – ‘acquiring’ liquidity… As liquidity is sticky, With electronic trading opening the door to cross-border trades and demutualization acquiring liquidity is easier through the inorganic route and eventual listing providing access to capital, the global exchanges industry is witnessing an era of consolidation. Consolidation is a natural consequence born of the need for greater liquidity. To acquire liquidity, the largest exchanges have taken to the inorganic route in the last few years. As captured in the exhibit below, the evolution of exchanges in North America substantiates the era of consolidation (through acquisition/ merger) post demutualization and listing.
Exhibit 23: Evolution of exchanges in the North American landscape
10%
25% Acquisition
Demutualisation
2000 2002 2004 2005 2006 2007 2008
Merger
IPO
Source: IDFC-SSKI Research
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The era of consolidation marked the coming together of the largest exchange groups under a single roof. NYSE Group, world’s largest stock exchange, acquired Euronext – the largest European stock exchange (5th largest in the world) – for US$12.2bn in 2006. Further CME, world’s largest exchange group with deep liquidity in bullion, metals and currencies, has acquired Nymex – world’s largest exchange for energy products – for US$7.6bn in 2008. Other key industry consolidations include NASDAQ (America’s largest electronic equity exchange) acquiring Nordic-based OMX to form Nasdaq OMX, and Intercontinental Exchange acquiring NYBOT for US$1.8bn.
Exhibit 24: World’s largest exchange groups coming together – the power of ‘liquidity’
US$7.6bn +
US$9.6bn
Nymex + Comex CME + CBOT
US$12.2bn +
Lisbon Euronext Pacific ++LIFFE +Archipelago +NYSE Exchange N.V Exchange
+ =
+ =
+ =
Source: IDFC-SSKI Research
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…indicative of high strategic value Consolidation happening at Acquisition valuations reflect the value inherent in exchanges. Consolidation in the high PEs of 25-55x and global exchange landscape at P/Es of 25-55x and FCF/ valuation of 1.7-3.6% FCF/ valuation of 1.7-3.6% substantiates the inherently high value. The fact that these investments are purely strategic in nature only further exemplifies the lifetime of such businesses.
Exhibit 25: Consolidation valuations in the international landscape
Acquirer
Target
Valuations (US$bn) 9.6 7.6 12.2
P/E (x) 55.7 34.1 25.5
FCF/Valuation (%) 1.7 3.6 3.4
Source: IDFC-SSKI Research
Indian exchanges – thy time has come NSE valued at $2.3bn, MCX The Indian exchanges industry has exhibited enormous potential and is now at $1.1bn and BSE at approaching final stages of the evolution cycle. Global leaders have evinced keen $0.8bn by world’s leading exchanges interest in the space in the past few years and world’s leading exchanges have acquired stakes in Indian exchanges at high strategic values. NSE garnered an entity valuation of US$2.3bn when NYSE Euronext picked up a 5% stake in the former in 2007. Other prominent stake sales include that of MCX (valued at US$1.1bn), BSE (US$0.8bn) and NCDEX (US$0.5bn). With Indian exchanges now headed towards listing, we believe it is ‘value unlocking’ time for these players.
Exhibit 26: Global exchanges investing into Indian exchanges at high strategic valuations
Value Paid Entity Year Acquirer Target (USD m) Valuation (USD bn)
2008 5% 55.0 1.1
2007 5% 42.7 0.8 Strategic valuations to rub off on listing 2007 5% 42.7 0.8 valuations
2007 5% 115.0 2.3
2006 8% 37.0 0.5
Source: IDFC-SSKI Research
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…HUGE MARKET CAPITALIZATION POTENTIAL The inherent value-accretive nature of exchanges is bound to reflect in their market capitalization. The valuation of listed global exchanges only vindicates our point of view. As shown below, exchanges trade at an average P/E of 19x and EV/ EBITDA of 13x.
Exhibit 27: Global comparables (US$ m) Revenues EBITDA PAT Mkt Cap EV PE (x) PB (x) EV/EBITDA (x) NYSE Euronext 4,775 1,114 580 7,800 9,661 13.3 1.2 8.7 CME Group Inc 2,884 2,016 1,041 22,345 35,026 21.5 1.1 17.4 NASDAQ OMX Group 3,623 851 460 4,493 6,406 10.5 0.9 7.5 Intercontinental Exchange 1,092 718 383 8,721 8,894 22.8 3.8 12.4 Deutsche Bourse 3,462 2,015 1,218 24,120 4,022 13.1 3.8 2.0 Hong Kong Exchange 941 691 666 17,683 16,891 26.9 15.5 24.4 London Stock Exchange 1,015 524 264 3,394 4,321 13.1 1.8 8.3 Bursa Malaysia 91 43 33 1,100 1,018 33.6 5.1 23.4 Average 19.3 4.2 13.0 Source: Bloomberg, IDFC-SSKI Research
The Indian exchanges industry is currently in the ‘strategic value discovery’ phase while inducting global partners. Globally, public listing and consolidation form the final stages of the evolution cycle. In India too, we believe a beginning has been made (with MCX filing for an IPO) and the momentum towards increased competition will continue with ownership structure moving towards an institutional investor base. Importantly, while Indian exchanges are still in a nascent stage in terms of trading penetration, global exchanges have attained deep penetration. Thus, Indian exchanges warrant higher growth than their global counterparts, and hence should fetch higher valuations. Among the key players in the Indian exchange landscape, Financial Technologies and NSE are the largest and have presence across all the segments (as shown below).
Exhibit 28: Key players in the Indian Exchange industry
Commodity Equity Currency Forex Power Spot Technology Ecosystem
Promoted Acquired stake Plans Source: IDFC-SSKI Research
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Financial Technologies and NSE have a parallel business model, as can be seen in the following exhibit. We believe the inherent strength of their portfolio makes them best placed to capture the growth in the industry.
Exhibit 29: Financial Technologies and NSE – a parallel business model Financial NSE Technology
Exchange NSE IT FTIL solutions Technology solutions Trading Omnesys ODIN solutions
Equities NSE MCX-SX
Commodity NCDEX MCX
Exchanges Currency NSE MCX-SX
Power PXI IEX
Spot NCDEX Spot NSEL
Ecosystem Clearing corp NSCCL MCX-SX CCL
Source: IDFC-SSKI Research
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EQUITY EXCHANGES: ‘BULL’ RUN Equity exchanges, the genesis of the organized exchanges sector in India, have witnessed 46% CAGR in turnover over the last 14 years with current annual profits of US$250m. With turnover pegged at US$4trn, equity exchanges form 70% of the Indian exchanges space. Importantly, these exchanges now feature among world’s top 10 derivative exchanges with NSE ranked 8th. However, turnover to GDP is still at a 70% discount to global benchmarks and turnover velocity stands at a 50% discount for Indian equity exchanges. With improving penetration, we expect the sector to register a 12% CAGR in turnover over the next five years to reach US$5.3trn in size by FY14. While NSE remains the invincible leader (93% share) for a decade, competition would escalate with potential entrants like MCX-SX.
INDIAN EQUITY EXCHANGES: FROM STRENGTH TO SCALE Financial markets, or equity exchanges, marked the beginning of the organized exchanges sector in India. Two players – National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are operational in the industry with NSE having a clear monopoly at 93% market share. In FY09, total turnover on equity exchanges stood at US$3trn – 46% CAGR over the last 14 years. Importantly, while liquidity on Indian bourses has been encouraging, India is still at a 70% discount to the global average ratio of value traded to GDP. Thus, we expect turnover to reach US$5.3trn by FY14.
Exhibit 30: Industry turnover increasing… …NSE dominates
Market share Players Total turnover (FY09) (US$ bn) 6,000 5,256 12% CAGR 93%
4,500 3,042 26% CAGR Indian equity 3,000 7% exchanges 47% CAGR 1,537
1,500 489 Approval 0 awaited FY03 FY06 FY09 FY12E
Source: SEBI, IDFC-SSKI Research
Equity markets – 46% CAGR over 14 years… Indian stock exchanges do Equity markets were the first to attain a solid structural base in India, so much so that average daily turnover Indian exchanges industry is synonymous with equity markets. Being the first avenue of $13bn available to participate in trading, equity exchanges have clocked strong volume growth. Total turnover on equity exchanges has witnessed 46% CAGR over the last 14 years to US$3trn. With an average daily turnover of US$15bn, equity exchanges are positioned on a robust growth trajectory.
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Exhibit 31: Total turnover on equity exchanges on a strong growth trajectory
Total turnover (US$ bn) 3,200
2,400
46% CAGR
1,600
800
0 FY95 FY97 FY99 FY01 FY03 FY05 FY07 FY09 Source: SEBI, NSE, BSE
NSE – world’s 8th most liquid derivatives exchange Share of India in total world The stock markets worldwide have grown in size as well as depth over the years. The turnover up from 0.95% in turnover of all markets taken together has grown from US$47.39trn in 2005 to 2006 to 1.12% in 2007 US$98.82trn in 2007. US alone accounted for about 43.12% of worldwide turnover in 2007. The share of India in total world turnover too has increased from 0.95% in 2006 to 1.12% in 2007.
Exhibit 32: India – increasing share of global pie (US $ mn) Market capitalization (end of period) Turnover Country/ Region 2005 2006 2007 2005 2006 2007 Developed Markets 36,183,389 42,916,705 46,300,864 41,693,067 59,258,415 82,455,174 Australia 804,074 1,095,858 1,298,429 616,115 826,285 1,322,822 Japan 4,736,513 4,726,269 4,453,475 4,997,414 6,252,470 6,497,193 UK 3,058,182 3,794,310 3,858,505 4,167,020 4,242,082 10,324,477 USA 16,970,865 19,425,855 19,947,284 21,509,979 33,267,643 42,613,206 All Emerging Markets 7,135,963 10,458,582 18,262,550 5,692,906 8,226,944 16,361,131 China 780,763 2,426,326 6,226,305 586,301 1,635,121 7,791,702 India 553,074 818,879 1,819,101 433,900 638,484 1,107,550 Indonesia 81,428 138,886 211,693 41,900 48,831 112,851 Korea 718,180 835,188 1,123,633 1,202,976 1,340,122 1,974,015 Malaysia 181,236 235,356 325,663 49,976 66,904 150,002 Philippines 40,153 68,382 103,224 6,951 11,243 29,251 Taiwan 515,980 654,858 723,687 716,471 894,553 1,272,432 World Total 43,319,352 53,375,287 64,563,414 47,385,973 67,485,359 98,816,305 US as % of World 39.18 36.39 30.9 45.39 49.3 43.12 India as % of World 1.28 1.53 2.82 0.92 0.95 1.12 Source: S&P Global Stock Market Factbook 2008
th Improving liquidity on Indian equity exchanges has placed them among the top NSE ranked 8 among th world’s largest derivative exchanges in the world in terms of contracts traded. NSE is ranked 8 among the exchanges world’s largest derivative exchanges on the back of its high liquidity in F&O products. In addition, NSE is also ranked 7th among the most actively traded index derivative product among global exchanges.
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Exhibit 33: Top 20 Equity Index Futures & Options Worldwide Top Derivatives Exchanges Worldwide
Rank Contract Jan-Dec 2008 Rank Exchange Jan-Dec 2008 1 Kospi 200 Options, KRX 2,766,474,404 1 CME Group (includes CBOT and Nymex) * 3,277,645,351 2 E-mini S&P 500 Futures, CME 633,889,466 2 Eurex (includes ISE) * 3,172,704,773 3 DJ Euro Stoxx 50 Futures, Eurex 432,298,342 3 Korea Exchange 2,865,482,319 4 DJ Euro Stoxx 50 Options, Eurex 400,931,635 4 NYSE Euronext (incl all EU and US markets) * 1,675,791,242 5 SPDR S&P 500 ETF Options * 321,454,795 5 Chicago Board Options Exchange (incl CFE) * 1,194,516,467 6 Powershares QQQ ETF Options * 221,801,005 6 BM&F Bovespa * 741,889,113 7 S&P CNX Nifty Futures, NSE India 202,390,223 7 Nasdaq OMX Group (incl all EU & US markets) * 722,107,905 8 S&P 500 Options, CBOE 179,019,155 8 National Stock Exchange of India 590,151,288 9 iShares Russell 2000 ETF Options * 151,900,495 9 JSE South Africa 513,584,004 10 S&P CNX Nifty Options, NSE India 150,916,778 10 Dalian Commodity Exchange 313,217,957 Source: IDFC-SSKI Research
…but penetration is still low While turnover on equity exchanges has shown strong growth momentum, the global benchmark of value traded to GDP substantiates under-penetration of equity markets in India. The global average of value traded to GDP for the cash segment stands at 177%, while India’s largest exchange NSE has a value traded to GDP ratio of 64% – a discount of 70% to the global average.
Exhibit 34: Value traded to GDP across world exchanges
400 (%)
300 70% discount to Global Average 200 Global average = 177%
100
0 London Singapore NYSE Korea Euronext Australian Tokyo SE Deutsche TSX Shanghai Nasdaq Borsa NSE BSE SE Exchange Group Exchange SE Group Börse Group SE Italiana Source: World Federation of Exchanges, IDFC-SSKI Research
India’s turnover velocity of Liquidity on stock exchanges is best indicated by turnover velocity – i.e. the ratio of 84% way below 216% total turnover on the exchange to market capitalization. India has a turnover velocity for USA of 84%, sharply lower than 216% for developed markets like USA, for the cash segment. India has the distinction of having the second largest number of listed companies after the US. Thus, Indian stock exchanges have attainted breadth but are yet to attain depth with regards to liquidity across the spectrum of listed companies.
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Exhibit 35: India lagging on turnover ratio among global peers
No. of listed companies Turnover Ratio (%)
300 5130
2588 2nd largest no of listed 225 3844 658 companies after USA
472 150 270 1029 217 1530 4887 180 180 142 75 122 89 84
0 UK USA China Germany Japan Singapore Hongkong India Source: World Federation of Exchanges, IDFC-SSKI Research
The leverage available in the F&O segment over the cash segment places volumes in the former at 3-5x of the cash market volumes globally. In line with this, turnover on F&O segment is 3x that in the cash segment. With F&O intrinsically related to the underlying cash market, which is relatively under-penetrated, we believe the F&O segment also promises strong volume traction.
Equity market turnover – US$5.3trn by FY14E We expect 12% CAGR in While under-penetration across Indian equity exchanges apparent, we have built a Indian stock exchanges 25% discount to global average of value traded to GDP and thus expect turnover on over FY09-14 equity exchanges to increase from US$3trn now to US$5.3trn by FY14.
THE FUTURE IS IN ‘FUTURES’ Evolution of Indian bourses is marked by two crucial events – incorporation of NSE as an electronic demutualized exchange and introduction of F&O products. While the former brought about a structural shift in the industry from pit-based trading to sophisticated system-based trading, the latter has been instrumental in inducing liquidity onto the exchanges.
Industry evolution – to an organized marketplace NSE, a demutualized and Indian stock markets have been the oldest in the Asian sub-continent. Indian equity electronized entity, markets began with the inception of BSE in 1875. However, the industry achieved its triggered industry evolution in 1994 true form in 1994, when the second national exchange NSE was incorporated. While regional exchanges were set up in the interim, NSE was instrumental in changing the dynamics of the stock exchange industry. NSE was incorporated as a demutualized entity (all other exchanges were mutually-owned entities) and was the first exchange to introduce an electronic trading platform. Thus, in order to compete with the new technology platform as also the corporate nature of NSE, BSE migrated to an electronic platform and eventually demutualized in due course.
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Exhibit 36: Evolution of Indian equity exchanges
Amendments to Bombay Stock BSE migrated to Ban on badla Stock and index SCRA for Exchange electronic platform trading options launched demutualization of incorporated Indian exchanges
1875 1995 2001 Jul 2001 2003 1994 1995 June 2000 2001 Nov 2001 2005
National Stock Switch from one Exchange (First Physical shares Index futures week settlement Stock futures Demutualization of electronic to demat form launched to rollover launched BSE demutualized settlement exchange)
Source: IDFC-SSKI Research
BSE, was established in 1875 as a voluntary ‘not for profit’ association of persons. Ahmedabad and Indore Stock Exchanges were the other exchanges set up as a similar structure. The membership of these exchanges entitled the person to be a part owner of, as well as a broker on, the exchange. Thus, Indian stock exchanges followed a mutual structure where the ownership and management rights of the exchange are bundled with trading rights as a broker and all three are represented by ownership of card/ share of the exchange. In 1994, NSE was formed as a company with a profit motive.
Demutualization means “segregation of membership right in a recognized stock exchange into a distinct ownership right through the ownership of shares and distinct trading and/or clearing right of that recognized stock exchange”. In order to demutualise a corporate structure of the exchange is a necessity. Exchanges like BSE that were not even a corporate entity needed to be converted from “association of persons” to a Company limited by shares. This process of conversion is termed as “corporatization”.
In 2001, Finance minister pledged on the floor of the parliament to demutualise all Indian exchanges. By 2003, necessary amendments in SCRA, Indian Stamp Act and Income Tax Act were then done. Among the 23 stock exchanges in India, 18 have corporatized and demutualized.
F&O – the trigger A new beginning was The launch of futures and options (F&O) has been the key trigger for the stock marked with launch of F&O markets in the country. For instance, over the last three years, volumes in the F&O and volumes gravitated segment have grown doubly as fast as that of the cash market – thereby bringing towards NSE Indian bourses closer to the global average ratio of 3-5x between cash and F&O segments. It is important to note that while both NSE and BSE launched F&O at the same time, 99% of the segment liquidity is accounted for by NSE alone. Thus, F&O has been the key factor for NSE taking over BSE – the oldest bourse in Asia.
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Exhibit 37: Turnover on equity exchanges – F&O providing the momentum
CM F&O Debt (US$ bn) 3,200
F&O volumes have grown 2x 2,400 cash segment during FY06-09
1,600
800
0 FY97 FY00 FY03 FY06 FY09 Source: SEBI, IDFC-SSKI Research
History of Futures & Option on Indian bourses The story of modern derivatives in India starts on the financial side of the aisle. In the second half of the 1990s, the NSE proposed that the country should have a financial futures market. However, BSE disagreed and argued that India already had a home-grown, tested and true version of stock futures built on a couple of traditional features of Indian equity markets. The first feature was a week-long settlement period which allowed traders to buy and sell all they wanted and deliver or receive only their net position as of the end of the settlement period. Add to this a unique Indian practice referred to as badla, which allowed traders to roll a net position over to the next settlement period and traders could obtain stock market exposure for days, weeks or even months, without ever having to make or take delivery – very much like a futures contract. In June 2000, both the BSE and NSE launched stock index futures. Index and stock options were approved a year later in July 2001, followed by stock futures in November 2001.
Indian equity markets – the right product mix Equity markets in India are a perfect blend offering four derivative products (index futures, index options, stock futures and stock options) along with the cash and debt market segments. With leverage playing in favour of the F&O segment, volumes here are seen at 3-5x that of the underlying cash market. Further, as the markets develop, the F&O segment begins to drive cash market volumes.
Exhibit 38: Turnover distribution across segments
FY09 turnover distribution Indian Equity Exchanges
Debt Stock options 2% 2% Cash 24% 25% 72% 2% Index options 25% Futures & Cash segment Debt segment Options
Stock Futures Index Futures
Stock futures Stock Options Index Options Index futures 23% 24% Source: IDFC-SSKI Research
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F&O segment contributes 72% to the total US$3trn turnover on equity exchanges with the cash segment accounting for another 25% share. Within the F&O segment, futures clearly dominate with a 64% share while options account for the remaining 36% (based on FY09 turnover). The debt segment contributes a marginal 2% to the overall turnover.
Index futures and options S&P CNX NIFTY accounts F&O on indices account for 48% of the total turnover on equity exchanges. Both for over 99% of all index BSE and NSE offer a broad basket of indices. The BSE has seven listed indices while futures volumes NSE offers 17 listed indices. However, liquidity is visible only on the benchmark indices – Sensex and S&P Nifty. Sensex in India is analogous to Dow Jones in the US while the S&P CNX NIFTY appeals to the professional crowd just as the S&P 500 does in the US. However, looking at the volumes, India is clearly a one-index country with S&P CNX NIFTY accounting for over 99% of all index futures volumes.
Exhibit 39: Key indices available for trading NSE BSE S&P CNX Nifty SENSEX S&P CNX Nifty (Mini) BSE TECk CNX Nifty Junior BSE BANKEX CNX IT BSE OIL & GAS CNX 100 BSE METAL BANK Nifty BSE FMCG Nifty Midcap 50 S&P CNX Defty Source: NSE, BSE
Stock futures and options Stock futures doing well Stock futures on Indian bourses account for 23% of the total and 32% of the F&O but stock options yet to segment turnover. This is despite their poor performance in most parts of the world, capture relevant liquidity and especially in the North America. The huge success of stock futures can be partly attributed to the fact that they were launched at about the same time of elimination of one-week settlement periods and badla. With traders deprived of the traditional synthetic futures, liquidity quickly migrated to stock futures on Indian bourses. On the contrary, stock options have yet to achieve the minimum critical liquidity on Indian bourses. NSE offers trading in 233 stocks in its F&O segment, while BSE offers trading on 327 stocks.
…and robust systems in place Indian stock exchanges Within the Indian exchanges framework, stock exchanges have the most robust regulated by SEBI; sound regulatory systems as also a strong back-end. Indian equity markets are regulated by systems for post-trade the Securities and Exchange Board of India (SEBI). Further, the industry has a sound activities in place system in place for post trade activities – clearing and settlement. NSE and BSE have their own clearing agencies to settle trades executed on the exchange. The clearing and settlement activities of trades on BSE are taken care of by Bank of India (BoI) Share Holding. BoI Share Holding is a subsidiary company of BSE and Bank of India. The National Securities Clearing Corporation Ltd (NSCCL) handles clearing and settlement activities of NSE. NSCCL is a fully-owned subsidiary of NSE.
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Clearing & Settlement Process The clearing process involves determination of what counter-parties owe and which counter-parties are due to receive on the settlement date, and discharge of obligations by settlement thereafter. The clearing and settlement process comprises three main activities – Clearing, Settlement and Risk Management. While stock exchanges provide the platform for trading, the clearing corporation determines the funds and securities obligations of the trading members and ensures that the trade is settled through exchange of obligations. The clearing banks and depositories provide the necessary interface between the custodians/ clearing members for settlement of funds and securities obligations of trading members.
Exhibit 40: Process flow
Exchange
1. Trade details
8. Securities 9. Pay-out NSE BSE Pay-out of funds BSE: BOI NSE: NSCCL Shareholding Clearing bank
Depositories Clearing corporation 6. Securities 7. Pay-in Pay-in of funds
5. Instructions to 2. Affirm trade 3. Download make securities obligations obligation 4. Instructions to available make funds available
Custodian/CMs 10. Confirmation 11.Confirmation through DPs
Source: IDFC-SSKI Research
COMPETITIVE LANDSCAPE: NSE HAS CAGED THE BULL! The Indian equity exchanges industry has migrated from 23 exchanges to a two- player market. The two national exchanges – NSE and BSE – make up the industry, dominated by NSE with a 90%+ market share. While BSE, incorporated in 1875, is the oldest exchange in Asia, it was swiftly taken over by NSE (started operations in 1994), primarily on the back of structural efficiencies.
Exhibit 41: Turnover distribution NSE BSE (US$ bn) 3,200 F&O turnover (FY09) Cash turnover (FY09) BSE 2,400 BSE 1% 26%
1,600
NSE 800 74%
0 NSE FY00 FY03 FY06 FY09 99% Source: NSE, BSE, IDFC-SSKI Research
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Key factors contributing to the success of NSE have been its demutualized structure NSE a dominant force for more than a decade… and the electronic trading platform. On the back of these USPs, NSE was able to bring liquidity to new products (which were launched simultaneously on both exchanges) and thus eventually become the industry leader. BSE was also hit hard by the government-mandated switch in 2001 from one-week settlement sessions to the rolling settlement used in the rest of the world as also a ban on badla trading – a prime liquidity driver for the exchange. Given the quasi-monopolistic nature of the exchange industry, where poaching of liquidity is almost impossible, NSE has sustained its leadership for over a decade.
Exhibit 42: Comparison of NSE and BSE Parameters NSE BSE Year of Establishment 1992 1875 Year of Operations Debt and equities in 1994, Moved from “open outcry” trading to derivatives in 2000 electronic trading in 1995. Derivatives in 2000 Business Model Primarily transaction fees, Primarily transaction fees, typically a percentage of the typically a percentage of the total trading value total trading value Active Market Segments Wholesale debt, equity and Wholesale debt, equity and derivatives derivatives Listed Companies 1,186 4,796 Average Daily Turnover US$12bn US$1bn Settlement Cycle T+2, rolling settlement T+2, rolling settlement Market Model Price/time priority model. Fully automated, Price/time priority model. Fully screen-based trading system; automated, screen based trading system Connectivity VSAT network, connecting 320 cities VSAT network, connecting over 400 cities Source: IDFC-SSKI Research
NSE – secured on ‘futures’ … has ~99% share of the NSE’s monopoly in the equity markets rests purely on liquidity in the F&O segment. F&O segment, on which Arbitrageurs essentially play between the cash and futures markets, and hence rests its dominance liquidity in the F&O segment emerges as a key driver of cash market volumes. While NSE has ~93% share of the overall turnover on equity exchanges, it controls the F&O segment with a whopping 99% share. Index futures and options have been the key driver for NSE’s F&O segment business, making it the world’s 7th largest in terms of number of contracts traded.
Exhibit 43: Turnover in the F&O segment
(US$ bn) NSE BSE 3,000
2,250 99% controlled by NSE
1,500
750
0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: SEBI, IDFC-SSKI Research
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MCX-SX – the commodity bull entering equities! We expect MCX-SX to be a MCX Stock Exchange (MCX-SX), a subsidiary of MCX (India’s No.1 commodities relevant stock exchange exchange) is the third national-level stock exchange in the country. The exchange given its success in commodities and currency currently offers trading of currency derivatives and has a 50% share of the market trading (remaining 50% accrues from NSE’s currency derivatives segment). MCX-SX has filed for permission to launch equity products on its platform and is waiting for an approval from the SEBI. If given approval to enter equities, we expect MCX-SX to swiftly gain a relevant share of the market.
While NSE’s leadership is indubitable (given its 93% share), the success of MCX-SX in the currency derivatives segment as also of MCX in the commodity markets makes us optimistic about the potential entry of the exchange in equities. MCX-SX has outlined a solid plan to enter the equity markets with several differentiating factors. Focus on SMEs, debt and bond segment (highly under-penetrated currently), extension of trading session to evening, etc could help MCX-SX create a strong niche in the Indian equity markets. Most importantly, BSE is a distant No.2 in the Indian equity markets (<7% market share). Globally, every market has seen at least two dominant exchanges in each segment – ensuring arbitrage opportunity and strong participation. Thus, potential to build liquidity on MCX-SX’s equity segment remains strong.
KEY GROWTH DRIVERS New products Innovative derivative India has seen tremendous growth in its derivatives markets. However, product gaps products and higher exist and there is scope to introduce new and innovative derivative products that are participation of FIIs are key currently traded in the rest of the world. These include weather derivatives, volume growth drivers futures/ options, energy derivatives, credit derivatives, etc. Launch of new products, we believe, could bring incremental volumes on the exchanges.
Institutional participation in derivatives markets In the derivatives markets, liquidity for options lags futures liquidity by a wide margin. This can be resolved by having an adequate mass of institutional investors. While banks and mutual funds are major players in the international equity derivatives market, various regulatory and governance problems have kept them at bay in India. In 2007-08, FIIs accounted for 40.36% of the open interest in the derivatives markets, with the share of mutual funds being only 6.03% and proprietary trades accounting for 11.33%. A major part of the open interest was held by “others” including retail investors.
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COMMODITY EXCHANGES: MIDAS TOUCH Leveraging the strong US$320bn physical commodities market (valued at 45% of India’s GDP), Indian commodity derivative exchanges have finally overridden structural inefficiencies and are headed towards growth and scale (40x growth in turnover in the last four years). While global benchmarks of commodity derivative to physicals stand at 30-40x, India is markedly under-penetrated at 3x. On the back of this, we expect commodity exchanges to grow four-fold to US$4trn by FY14 and believe key regulatory reforms (options and intangibles yet to be permitted) would add to momentum. MCX (promoted by FTIL), dominating the space with an 87% market share and now a ‘brand’, is best placed to capitalize on this growth.
INDIA COMMODITIES EXCHANGES: A US$4TRN OPPORTUNITY BY FY14E… The Indian commodities market is finally overcoming structural inefficiencies and attracting relevant liquidity and participation. MCX, the largest commodity exchange in the country (87% market share) is ranked World No.1 for silver and No.3 for gold (only after CME and TOCOM) and copper (after LME and SHFE) in terms of number of contracts traded.
Valued at 45% of GDP, Commodities are valued at 45% of India’s GDP and the size of the country’s physical commodities are a $320bn commodity market stands at US$320bn. Globally, commodity derivatives markets are physicals market in India at an average 30-40x the underlying physical market. However, turnover on Indian commodity derivatives market is only 3x the underlying physical market. With penetration to be attained in the course of time we have built a 50% discount to the average multiple and thus expect the industry turnover to reach US$4trn by FY14.
Exhibit 44: Indian commodity exchanges – the size is getting bigger
Indian The potential commexes India – World opportunity is US$4trn have grown leaders in Gold, by FY14 40x in last Silver, Platinum five years
Source: IDFC-SSKI Research
Indian commodity exchanges – 40x growth over last five years… With 87% market share, The Indian commodity exchanges segment has seen a 40x growth in turnover over MCX by far the segment the last five years with traded values increasing from US$25bn in FY04 to US$1.1trn leader in FY09. Currently, the average value traded on Indian commodity exchanges stands at US$4bn per day. MCX (promoted by Financial Technologies) leads the industry with a dominant 87% share, while its closest competitor NCDEX (promoted by NSE) has an 11% share of the total traded values on exchanges.
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Exhibit 45: Turnover on commexes moving northwards
Total turnover (US$ bn) 1,050 900 813 735
675
431 450
225 114 26 0 FY04 FY05 FY06 FY07 FY08 FY09 Source: IDFC-SSKI Research
...becoming world leaders for silver and gold MCX is world no. 1 in silver Within a short span of five years, Indian commodities exchanges have garnered and no. 3 in gold based on higher volumes (in certain commodities) than the decade-old global leaders. MCX is number of contracts the world’s largest exchange in silver – displacing the largest international metals exchange, COMEX – with 45% higher volumes (in terms of number of contracts). Also, in gold where India is world’s largest consumer, MCX was World No.3 in 2008 with the number of contracts traded only 8% lower than TOCOM (Source: FIA).
Exhibit 46: MCX positioning in the world landscape No of contracts of Gold futures traded in 2008 No of contracts of Silver futures traded in 2008 No of contracts of Copper futures traded in 2008 38.4 12.9 30.0 40.0 14.0
8.9 22.5 30.0 10.5
15.0 20.0 15.2 7.0 14.0
7.5 3.5 10.0
0.0 0.0 0.0 MCX Nymex LME SHFE MCX Nymex Tocom MCX Source: FIA, IDFC-SSKI Research
India’s success in the global landscape reflects the latent demand for commodity derivatives in the country. We believe improving liquidity on global benchmarked commodities would have a rub-off effect across other products on the exchanges and thereby enhance overall liquidity on the platform.
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…and the real potential is pegged at US$4trn India is a commodity-centric economy with commodities valued at 45% of its GDP. In addition, India is the largest consumer of commodities like gold and silver as also the largest production base for various agricultural commodities. We estimate the turnover on commexes to reach US$4trn by FY14 (See exhibit below).
Exhibit 47: Real potential of Indian commodity exchanges industry
Physical market size International benchmark Indian multiple (x) Potential (US$ bn) (US$ bn) (x)
Gold 19.8 60- 70 30 594
Silver 11.3 60- 80 35 396
Metals 29.4 20- 30 10 294
Crude o il 60 20- 40 15 900
Agricultural products 200 20- 30 10 2,000
To tal 320.5 4,184
Source: IDFC-SSKI Research
…MOVING TOWARDS AN ORGANIZED STRUCTURE For decades, Indian commexes have remained shackled in regulations. India’s dominance in agri production makes trading in the same only natural. Thus, primary production regions of key agri commodities developed into trading centers, creating regional commexes. By 2003, there were 21 regional commexes with National Board of Trade (NBOT) in Indore leading the industry with >50% share. However, recurring bans on futures trading and fragmented liquidity across regional exchanges (in the absence of a national platform) suppressed industry growth. India has three national In 2002, the government authorized establishment of national multi-commodity commexes with permission exchanges to facilitate electronic trading of commodity derivatives. This single most for a fourth one, and 19 regional commexes important development marked a new era for Indian commexes. Since then, three national-level commodity exchanges have been set up, namely: Multi-Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX) and National Multi Commodity Exchange (NMCE). Currently, there are 22 commexes in India including the three national-level and 19 regional ones. In addition, Indiabulls – in a JV with MMTC – has received regulatory approval for a fourth national-level commodity exchange.
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Exhibit 48: Commodity exchanges in India
Haryana Commodity Exchange, Bhatinda Om & Oil Exchange Ltd., Bhatinda Hissar
Vijay Beopar Chamber, Muzaffarnagar Bikaner Commodity Exchange, Bikaner Meerut Agro Commodities Exchange, Meerut
Bullion Association, Jaipur Chamber of Commerce, Hapur
Surendranagar Cotton Oil & Rajdhani Oil and Oilseeds Ex., Delhi and Oilseeds Asso., Surendranagar E commodities, Delhi
Rajkot Seeds, Oilseeds & Bullion Merchants Asso. Rajkot
National Multi Commodity Exchange, Ahmedabad The East India Jute & Hessian Exchange, Kolkatta Ahmedabad Commodity Exchange, Ahmedabad Central India Commercial Ex., Gwalior
National Board Of Trade, Indore Multi Commodity Exchange, Mumbai
National Commodity & The Spices & Oilseeds Exchange, Derivative Exchange, Mumbai Sangli
Bombay Commodity Exchange, India Pepper and Spice Trade Mumbai Association, Kochi and East India Cotton Association First Commodity Exchange of India Ltd., Mumbai Ltd., Kochi
E-Sugar India Ltd., Mumbai
Source: FMC
Indian commexes – a new order Participation on Indian Indian commodity exchanges have grown on the back of improving participation commexes improving led facilitated by electronic trading, streamlining of national exchanges (and by electronization, consolidation of liquidity consolidation of liquidity), and regulatory reforms. These developments have given and policy reforms Indian commexes a new structure, making it a true marketplace.
Exhibit 49: Transition towards a true marketplace
A medium to trade A true marketplace
Pit based trading, limiting participation Electronic trading, improving participation
Liquidity fragmented within regional exchanges 98% controlled by top 2 players
Basket of commodities limited to agri Global commodities dominate the basket
Global commodities dominate the basket Regulatory environment opening up to growth
Source: IDFC-SSKI Research
Liquidity now cohesive… National-level exchanges The Indian commodity exchanges landscape is fairly consolidated with MCX and have driven participation, NCDEX controlling 98% of the business. This transition of market share from thereby leading to industry expansion regional to national exchanges took place within three years of setting up of national level commexes, with share of regional exchanges down from 93% in FY03 to 5% in FY06 to 1% currently. However, it is important to note that volumes on regional
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exchanges have sustained and not migrated to national exchanges. Instead, the national exchanges have driven improved participation, which in turn has led to expansion in the industry size.
Exhibit 50: Transition of market share towards national exchanges
MCX NCDEX NMCE NBOT Other regional commex (%) 100 10 19 32 75 49
47 50 87 77 62 25 45 29 1 0 0 2 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: FMC, IDFC-SSKI Research
Inclusion of global While the electronic platform provided by national level exchanges has been a key commodities in the basket factor driving liquidity, the basket of commodities (oriented towards global – a key positive for the commodities) being offered has also played an important role. National-level industry electronic platforms have facilitated uniform price discovery, leading to better transparency and thereby higher participation. This is in sharp contrast to the pit based physical trading in regional commodity exchanges (which is still existent).
In addition, the national-level commodity exchanges are demutualized organizations unlike the regional commodity exchanges that are mutual entities. MCX, NCDEX and NMCE have strong corporate backing, which brings further order to the industry earlier dominated by unorganized players. We believe such consolidation of liquidity is important to create the minimum critical mass of participants.
…and the commodity basket is global Number of tradable A key reason behind the rapid pick-up in commodity trades in the last five years has commodities steadily been the increasing number of commodities being available for trading. Until FY04, increasing; basket trading of only agricultural derivatives on commodity exchanges was permitted. currently at 100… However, with the incorporation of national electronic exchanges, the government has steadily increased the basket of tradable commodities on exchanges. The total number of commodities traded has risen from 15 in FY00 to 100 currently.
Exhibit 51: Increasing no of commodities No. of commodities Major commodities FY00 15 Gur, Castorseed, Pepper, Sacking FY01 21 Gur, Castorseed, Pepper, Sacking, Soy Oil FY02 30 Soy Oil, Gur, Castorseed, Sacking, Cotton. FY03 48 Oil Seed Complexes Gur, Castorseed, Sacking, Pepper FY04 63 Oil Seed Complexes Kapas, Gur, Gold and Silver, Spices FY05 73 Oil Seed Complexes, Pulses, Wheat, Rice, Bullion, Sugar, Spices FY06 92 Oil Seed Complexes, Most of the pulses, Wheat, Rice, Spices, Bullion, Sugar, Crude Oil, Plastic and other metals Source: FMC, IDFC-SSKI Research
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While the number of commodities being traded has increased, there has also been a marked change in the mix of liquidity across commodities. The liquidity pool has migrated from agricultural to global commodities like bullion, energy and metals. The introduction of bullion – gold and silver – has been instrumental in shaping the industry.
…with 88% accounted for In FY04, agricultural commodities contributed 96% to the overall traded values on by non-agri commodities the exchange. Today, bullion is the highest traded commodity and accounts for 55% of the aggregate liquidity on all exchanges. Similarly, crude oil introduced in FY06 has also attracted strong liquidity and currently accounts for 20% of the overall traded values. Thus, global commodities have played a crucial role in developing the commodity derivates space in India. Currently, agricultural commodities contribute just 12% to the aggregate liquidity in the industry.
Exhibit 52: Changing liquidity mix
Gold Silver Energy Metals Agri (%) 100
75 Bullion accounts for 55% and crude oil 20% of overall traded values on Indian 50 commexes
25
0 FY05 FY06 FY07 FY08 FY09 Source: FMC, IDFC-SSKI Research
Among agricultural commodities, guar seed is the most actively traded and accounts for 18% of the trades. Other key agricultural commodities traded are chana, soya oil, jeera and pepper. Also, it is important to note that futures trading in wheat, rice, tur and urad were banned in 2007 because of which volumes in agricultural products have taken a hit. While the ban on rice, tur and urad remain, ban on wheat was revoked in April 2009. Incrementally in May 2009, the government has placed a ban on futures trading in sugar.
Regulatory framework Industry regulated under a Indian commodity derivative markets are regulated under the Forward Contracts 3-tier structure with FMC (Regulation) Act, 1952 (or FCRA Act), which proposes a three-tier regulatory intermediating between the GoI and Commexes structure for the industry. The Government of India is the primary regulator, while Forward Market Commission (FMC) acts as an intermediary between the GoI and the exchanges. Key functions of the FMC include providing limits on speculative open positions, placing price limits for all commodities and providing directives for margin requirements.
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Exhibit 53: Regulatory framework for Indian commexes
Ministry of Consumer Affairs, Food & Public Distribution
Forward Markets Commission (FMC)
Commodity Exchanges
National Exchanges Regional Exchanges
MCX NCDEX NMCE NBOT 18 others
Source: FMC, IDFC-SSKI Research
We met FMC to get its view on the evolution of the country’s commodity derivatives space. The FMC has proposed certain crucial amendments to the FCRA which include introduction of options trading, launch of intangible products (weather derivatives, etc) and demutualization of regional exchanges, which would trigger further growth in the space.
FCRA follows a two-stage process for granting recognition to a new national multi-commodity exchange. First stage: In-principle approval from FMC for which the key criteria is as follows: 1. A public limited company with a minimum authorized equity capital of Rs1bn and a demutualised structure. 2. Shareholding pattern of the exchange should be as under: a) At least 26% should be held by a government entity and Institutional holding to be greater than 20% b) No single shareholder shall be allowed to hold more than 40%. c) Any investor with >26% stake has to bring it down to 26% or below within two years beginning with the 4th year from the date of recognition of the exchange. Second stage: Key guidelines to be executed within a year of receiving in-principle approval Bring paid-up capital of at least Rs1bn as per the proposed equity capital structure. Facilities for online trading with national reach and an efficient clearing and settlement system. Arrange for an efficient delivery mechanism through an adequate network of accredited warehouses. No shareholder shall be allowed to be a trading member of the Exchange.
COMPETITIVE LANDSCAPE: MCX HAS MONOPOLY MCX, NCDEX, NMCE and NBOT are the key commodity exchanges in India. The other exchanges have a regional focus and contribute less than 1% to the total traded volumes. MCX, promoted by Financial Technologies, has been the dominant leader of this industry over the past three years. In FY09, MCX garnered a market of 87% of the total traded value on commodity exchanges.
NCDEX is the second largest exchange in the space in terms of volumes and has a market share of 11% in FY09. Its key shareholders include the NSE, Life Insurance Corporation of India, NABARD, CRISIL and IFFCO. Thus, the top two players control 98% of the commodity derivatives market in India.
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Exhibit 54: Market share of key players
NMCE Others NCDEX 0.8% 1.1% 10.8%
MCX dominates the industry with 87% share…
MCX 87.3% Source: IDFC-SSKI Research
MCX – shining on bullion …on the back of its While MCX and NCDEX were launched at the same time, the key reason for the orientation towards global success of MCX has been its orientation towards global commodities. NCDEX, commodities, particularly bullion… though successful in garnering healthy volumes in agricultural commodities, has seen limited success in global commodities. Further, gold – which accounted for 39% of the overall value traded on exchanges – has been a spectacular success at MCX. One reason for this was the difference in contract specification by the two exchanges. MCX gold contracts were based on 995 purity bar as underlying (which is the primary domestic import standard) while NCDEX contracts were benchmarked to 999 purity. However, NCDEX too has now shifted to contracts with 995 purity.
Exhibit 55: MCX dominating the global commodity basket
MCX Others (%)
100
75
50
25
0 Bullion Metals Energy Agri Source: FMC, IDFC-SSKI Research
New players – to drive participation Indiabulls and Kotak In addition to the three national-level exchanges, a fourth exchange – International waiting in the wings Multi commodity Exchange (IMX) – has received in-principle approval. IMX is a joint venture between Indiabulls Financial Services and MMTC. In addition to this, Kotak Group has also outlined plans to enter this space. With big players like Indiabulls and Kotak coming into this industry, we believe participation – and therefore penetration – would improve and help achieve the US$8trn opportunity.
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KEY GROWTH DRIVERS Options The Indian commodity exchanges are yet to evolve in terms of their product offering. Regulations do no permit option contracts to be traded on the exchange (commodity options contracts have been banned since 1952). Options being a more sophisticated hedging tool than futures attract higher participation. As seen in case of Indian equity exchanges, options contribute 27% to the total industry turnover. Thus, we believe permission to launch options would drive market expansion.
Intangible commodity derivatives New product offerings, The commodities basket permitted to be traded by the GoI has seen a potent increase intangible commodity from 15 in 2000 to 100 commodities currently. However, intangible commodities derivatives… like weather derivative, freight rates, etc are not currently permitted by the government. Guar and chana have seen higher volumes than other agricultural commodities as their production and hence prices are highly dependent on weather conditions. Our discussions with industry participants reveal that speculators use the guar contract as a proxy for weather/ rainfall. While the proposal for the same has been submitted to the government, their introduction would enhance participation from wider sectors which face such risks.
Regulatory developments …and benign policy Government initiatives play an important role in the development of the initiatives are the key commodities industry in India. FMC may also permit mutual funds, FIIs and banks growth drivers to invest in commodity derivatives in India. If allowed, we believe this will result in increased market activity and contribute to the overall growth of the Indian commodities futures market.
KEY CONCERNS While commodity derivatives in India have shown strong growth over the past few years, we believe the following issues/ concerns need to be addressed:
An inefficient back-end Warehousing system For commodity derivatives markets to work efficiently, India needs to have a increasingly moving sophisticated, cost-effective, reliable and convenient warehousing system. Further, towards efficiency independent labs or quality testing centers are required be set up in each region to certify the quality, grade and quantity of commodities so that they are appropriately standardized. To resolve the problem, a Gramin Bhandaran Yojana (Rural Warehousing Plan) has been introduced to construct new rural godowns and expand the existing ones. Large-scale privatization of state warehouses is also being examined (NBHC, by Financial Technologies, is a beginning).
Commodity transaction tax – could prove ‘taxing’ for the industry At present, transactions done on commodity exchanges are not taxed by the government. This is in contrast to equity exchanges, where a Security Transaction Tax (STT) is levied on each transaction. In the Annual Budget for 2008-09, the government has proposed to impose CTT (@0.0017% of the value traded) for trading on commodity exchanges.
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Exhibit 56: Impact of CTT Cost components Present cost Transaction cost after CTT Exchange transaction fees Rs2-3 per Rs100,000 Rs2 per Rs100,000 Service Tax Nil Rs0.25 (@of 12.5% Service Tax) CTT Nil Rs17 per Rs100,000 Total cost Rs2 per Rs100,000 Minimum of Rs19.25 per Rs100,000 Source: IDFC-SSKI Research
CTT tax, if levied, would Levy of this tax would escalate cost of trading on exchanges (as shown in the above significantly increase cost exhibit) and hence may impact volumes significantly. We interacted with key of trading on Indian commexes members of ICRIER, the economic research council, to gauge the impact of the same. Based on our interaction, we understand that this proposal is facing immense resistance from all industry participants as also certain government bodies. Hence, it is unlikely to be implemented in the near term.
Even if implemented, we believe the impact would only be temporary – as has been seen in case of stock exchanges – and that long-term volumes would be sustainable.
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FOREX EXCHANGES: ‘APPRECIATION’ CERTAIN With a daily turnover US$3trn globally, forex trading is the most liquid market in the world. India has a legacy OTC forex market (US$33bn daily turnover today), though exchange traded currency derivatives have been introduced recently (daily turnover of US$1bn). While rupee convertibility stands to be the most important trigger for the Indian forex market, the OTC segment is poised to reach US$40trn and currency derivatives to US$4trn in daily turnover by FY14. NSE and MCX-SX share the currency derivative segment equally (50% each), and hence would be key beneficiaries of the expected 4x growth in the space.
GLOBAL FOREX MARKET: US$3TRN DAILY TURNOVER The global foreign exchange market is estimated to be around US$3trn in turnover per day – making it the largest and the most liquid market in the world. Further, this market is expected to grow to a daily turnover of US$5trn in the next three years (source: FIA). The forex market can be broadly divided into two segments – cash (OTC – spot, forwards and swaps) and exchange-traded currency futures. Currently, spot forex trading volumes account for 31% (US$932bn) of the daily turnover. OTC forex market trading is facilitated online with EBS and Reuters as the largest platform providers in the world.
Exhibit 57: Average daily turnover in cash forex markets (US$ tn) 4.0
3.0 Cash forex world’s largest and most liquid market… 2.0
1.0
0.0 1998 2001 2004 2007 2010E Source: BIS, Celent, IDFC-SSKI Research
…driving penetration in Further, the global ratio of the average size of the OTC to exchange-traded markets is exchange-traded markets 5:1. While the OTC forex market has been prevalent for decades and hence attracts deep liquidity, the exchange traded markets are also witnessing enhanced penetration in the recent years. In 2008, 577m contracts of currency derivatives were traded globally – a 25% increase over the previous year. CME is the world’s largest exchange for currency futures.
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History of Currency Futures The Chicago Mercantile Exchange (CME) created FX futures, the first ever financial futures contracts, in 1972. By creating another type of market in which futures could be traded, CME Currency Futures extended the reach of risk management beyond commodities, which were the main derivative contracts traded at CME until then. Today, CME offers 41 individual FX futures and 31 options contracts on 19 currencies, all of which trade electronically on the exchange’s CME Globex platform. It is the largest regulated marketplace for FX trading.
Traders of CME FX futures are a diverse group that includes multinational corporations, hedge funds, commercial banks, investment banks, financial managers, commodity trading advisors (CTAs), proprietary trading firms, currency overlay managers and individual investors. They trade in order to transact business, hedge against unfavourable changes in currency rates, or to speculate on rate fluctuations.
Participation – dominated by financial institutions The core interbank market Financial institutions have traditionally been the primary participants in the foreign accounts for over 49% of exchange market and thus this market is also called the inter-bank forex market. The the US$932bn spot forex market core interbank market still accounts for over 49% of the spot forex market of US$932bn. Majority of this trading is conducted on two platforms – EBS and Reuters Dealing – and the banks that dominate this market are the principal providers of liquidity across the entire landscape of the forex market.
Exhibit 58: Top 10 currency traders (May-08) Rank Name % share of volume 1 Deutsche Bank 22 2 UBS AG 16 Though the segment is 3 Barclays Capital 9 dominated by banks… 4 Citi 7 5 Royal Bank of Scotland 7 6 JPMorgan 4 7 HSBC 4 8 Lehman Brothers 4 9 Goldman Sachs 3 10 Morgan Stanley 3 Source: Euromoney Survey Results
…non-bank financial However, non-bank financial institutions are also emerging as active participants in institutions too are gaining the foreign exchange market. In the recent years, trading volumes by hedge funds and ground commodity trading advisors have been growing faster than any other segment of the market. This segment contributed 34% to the global spot trading volumes (source: Celent, FIA). This, we believe, imparts exchange-like features to the forex market.
Geographical depth – London accounts for 1/3rd of world volumes In terms of geography, Foreign exchange is a global industry and is clearly impacted by international news European financial centers flow. Therefore, liquidity is skewed towards certain geographies because of the contribute >50% of daily global trading volumes overlapping market timings. For example, European financial centers and London account for more than 50% (London alone accounting for about one-third) of the total daily global trading volumes. Trading volumes in the Asia-Pacific region account for ~21% of the total daily global volumes, while North America has a 22% contribution to the total. The European session overlaps with half of the Asian trading day and half of the North American trading session, which means that market interest – and liquidity – is at the absolute peak during this session.
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Exhibit 59: Distribution of global forex trading turnover
Others, 7%
North America, 22%
Europe, 50%
Asia Pacific, 21% Source: IDFC-SSKI Research, 2004 Survey Results
INDIAN FOREX MARKET: STRENGTHENING India’s OTC market is currently estimated at US$33bn in turnover per day, while the market for exchange-traded currency derivatives stands at US$1bn. Our interaction with leading industry participants like Reuters and IBS Forex indicates that the OTC market is well on its way to attain US$40bn in size in the next five years. Following the global average of 5:1 between OTC and currency derivatives, the potential of the Indian currency derivative industry is pegged at US$8bn (8x growth from here). However in view of the nascent stage of the industry, we expect currency derivatives to reach a US$4bn of daily turnover by FY14.
Exhibit 60: OTC v/s Currency derivatives
Over The Counter (OTC) Currency Market Exchange Traded Currency markets
Size A US$33bn daily market A US$1bn daily market
Regulated No Yes by RBI and SEBI
Key Players Reuters, IBS Forex, CCIL NSE, MCX-SX, BSE
Cross currency forward rate agreements (FRAs) & Products Futures contracts options
No guarantee of counter-party risk elimination and Ensures settlement of contract and dissolves Credit risk settlement of contract default risk
Either both the currencies in the pair traded or on Settlement currency Strictly in Indian Rupee terms a single currency
Self-imposed limits on trading/margin Limits for trading/margin money imposed by Margin requirements by the client intermediary/clearing house
Trades can happen for all dates from 1 to 365 days Monthly contracts for up to 12 monthly Contract lifetime (liquid tenor) as well as upto 5 years (secular contracts from the current date tenor)
Source: IDFC-SSKI Research
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EXCHANGE TRADED DERIVATIVES: US$4TRN DAILY TURNOVER BY FY14E Exchange-traded currency futures are used as a hedge against the risk of rate volatilities in the foreign exchange markets. With regulatory approval of SEBI and RBI in August 2008, currency futures were introduced in India by NSE, MCX-SX and BSE. Within a short span of six months, the average daily turnover in currency futures has reached US$1bn. We expect the industry to reach an average daily turnover of US$4bn by FY14.
Industry overview The Indian currency futures market has registered an impressive 6x growth from US$175m in October 2008 to US$1bn of daily turnover currently.
Exhibit 61: Turnover on currency derivatives platform equally shared
MCX-SX NSE (US$ m) 20,000
51% 15,000
10,000
5,000 49%
0 Nov Dec Jan Feb Mar Source: IDFC-SSKI Research
This US$1bn industry is shared equally by NSE and MCX-SX with each doing an average daily turnover of US$500m. While NSE has been the leading equity exchange in India with a 90% market share, MCX-SX – a subsidiary of MCX – has shown exemplary performance to match that of NSE. Recently, BSE has also launched its currency derivatives segment. In addition, an exchange named called United Stock Exchange of India (USEIL) promoted by Jaypee Group is looking to enter the currency derivatives segment.
Key eligibility criteria of currency futures segment The exchange shall have a balance sheet net worth of at least Rs1bn. The segment should have at least 50 members to start currency derivatives trading. Trading should take place through an online screen-based trading system. The clearing of the currency derivatives market should be done by an independent Clearing Corporation. Key guidelines for existing stock exchanges The trading platform of currency futures should be separate from trading platforms of other segments. Membership of the currency futures segment should be separate from the membership of other segments.
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Exchange traded currency derivatives have attracted wide participation in India. According to the SEBI, 1,030 entities are registered in the nascent currency derivative market as market intermediaries (trading or clearing members) as of December 2008. Of this, NSE is estimated to have 470 members, MCX-SX 403 and BSE 157.
Exhibit 62: Distribution of members
BSE, 15%
According to SEBI, 1,030 entities registered in NSE, 46% currency derivative market as market intermediaries as of December 2008
MCX-SX, 39%
Currently, all futures contracts on MCX-SX are cash settled. There are no physical contracts. The RBI has laid down comprehensive rules to regulate this new market segment.
RBI guidelines Only USD-INR contracts are allowed to be traded. The size of each contract shall be USD 1000. The contracts shall be quoted and settled in Indian Rupees. The maturity of the contracts shall not exceed 12 months. The settlement price shall be the Reserve Bank's Reference Rate on the last trading day.
Economics Currency derivatives exchanges follow the generic exchange business model, and derive revenues primarily from membership and transaction fees. As currency derivatives have been newly introduced in the country, membership does not entail any admission fee. Further, in order to bring liquidity on to the exchange for currency derivatives, transaction fees have been currently waived off by all exchanges. With all the three exchanges generating strong income streams from the main business, they have the wherewithal to survive this period of bleed.
Key growth drivers While the Indian currency futures market has witnessed a phenomenal growth of 6x in a short span of six months, we believe the following factors could further boost trading in this segment:
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Retail participation Entry of retail and FIIs can The key differentiator between OTC and currency futures market is permissibility for grow the market while retail investors to trade on the latter. RBI regulations do not allow retail participation bigger contract sizes could drive participation from in the OTC forex markets. Thus, currency futures have the opportunity to map the institutional investors retail landscape. At the world’s largest currency exchange CME, retail FX accounts for around 20%, or $18bn a day, of the exchange’s global FX business.
Foreign institutional participation As per SEBI rules, FIIs are not permitted to trade on the currency futures segment. We believe a change in regulations to this effect will boost volumes significantly.
Arbitrage not available NSE and MCX-SX – the two leading exchanges offering currency futures trading – are engaged in a litigation on certain issues. Due to this, a single trading terminal cannot include NSE as well as MCX-SX trading screens, thereby limiting arbitrageurs. We believe once this option becomes available to traders, it would positively influence volumes on both the exchanges.
Contract specification The current size of the USD/INR contract traded is US$1000. We believe the contract size is smaller in comparison to the OTC market, and limits participation of larger institutional players. A bigger contract size could enhance liquidity on the exchange.
Increase in exposure While higher exposure As per RBI guidelines, the gross open position of a Trading Member, across all limits would drive contracts, shall not exceed 15% of the total open interest or US$25m, whichever is participation, a wider higher. Also, the gross open position of a Trading Member, which is a bank, across product offering would improve liquidity all contracts, shall not exceed 15% of the total open interest or US$100m, whichever is higher. So, larger exporters and importers may continue to deal in the OTC market, where there is no limit on the hedges. We believe that as the market matures, a revision of exposure limits would facilitate higher participation.
Newer products As per the RBI, only USD/ INR currency pairs are allowed to be traded. With increase in product offering, liquidity would certainly improve.
OTC FOREX MARKET IN INDIA: US$40BN DAILY TURNOVER BY FY14E The Indian OTC foreign exchange industry stands at US$33bn (daily turnover) and is expected to reach US$40bn within the next five years. We interacted with Reuters, the largest player in the Indian OTC segment, to get a sense of the industry dynamics and its potential. From our interaction, we understand that while rupee convertibility would be the key growth trigger for the Indian forex industry.
Market structure – Reuters has monopoly Reuters, with more than The US$33bn inter-bank forex market is divided between system trading and voice 85% share of the systems trading platform, has a brokers. System trading entails trading on an online platform while voice brokers are clear monopoly; CCIL and bank intermediaries that take orders on the phone and execute trades. In India, IBS Forex are other players systems account for 60-70% of the total turnover, and voice brokers the remaining 30-40%.
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Reuters, with more than 85% share of the systems trading platform, has a clear monopoly. Other players include CCIL and IBS Forex – a venture promoted by Financial Technologies, each having around 5% market share. With liquidity being the prime factor for exchanges, it has been tough for new players like IBS Forex to take market share from Reuters.
Exhibit 63: Indian OTC forex market
Systems 85-90%
60-70% 5%
OTC (US$33bn) Voice brokers 5%
30-40%
Source: IDFC-SSKI Research
Around 80% of spot forex Also, in line with global standards, spot forex trading accounts for less than 40% of trading in USD/ INR the OTC market and the remaining is contributed by derivative products like currency pair, with forwards and swaps. Further, 80% of the trading is done in the USD/ INR currency remaining in crosses pair, and the remaining in crosses.
Economics
The business model differs While the OTC market is a virtual exchange facilitating trades between financial from that of a typical institutions, the platform executes bilateral trades with no guarantee of counter-party exchange risk. Thus, the business model differs from that of an exchange.
System providers follow a rental based model, wherein terminals are sold at a fixed monthly rental becoming an annuity for the provider. Currently, Reuters charges a monthly rental ranging between US$2500-4000, depending upon the usage. New entrants like IBS Forex, in a strategy to garner market share, have priced their terminals significantly lower at US$500 per screen. On the contrary, voice brokers charge on the value transacted. This fee is estimated to be in the range of Rs500-1000 per Rs100,000 traded.
Currency convertibility is the key growth driver Currency convertibility to With India achieving currency convertibility, trade in foreign exchange would receive provide a boost to OTC a significant boost. In that case, OTC markets would register much higher growth trading led by higher trade in foreign exchange than the 25% rate currently expected.
“A key driver for forex trading will be the growth of trade and investment in the BRICs—Brazil, Russia, India, and China. Now that Russia’s currency is convertible, and with India and China heading in that direction, the expectation is that the most rapid growth in forex trading will be outside the mature economies of Europe, North America, and Japan.” – FIA
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POWER EXCHANGES: LIGHTING UP Power trading in India is catching pace with traded volumes increasing from 2.1% of total generated power in FY04 to 3.2% currently. In 2008, India traded 21BUs of power – a 40%yoy increase. However, only 0.05% of this is traded on power exchanges as it was introduced just six months ago. With exchanges offering a sophisticated trading mechanism and risk management systems, penetration would naturally improve. Indian Energy Exchange (IEX), promoted by Financial Technologies, leads the space with a 90% share and Power Exchange of India (PXI) is the other player.
POWER TRADING IN INDIA: ‘BRIGHT’ FUTURE Short-term power trading in India has grown by 40% yoy to reach 21BUs in 2008 (15BUs in 2007). This contributed 3.15% to the country’s total power generation capacity. India plans to expand capacity by more than 78 gigawatts by 2012, a >50% rise over the existing capacity. About 15% of this capacity addition is for merchant sale and can be traded through exchanges. However, less than 0.05% of the total power in the country is currently traded on the exchange. We interacted with Nord Pool, world’s first electronic power exchange, to gauge the potential of this industry.
India – trade of power is essential India’s power generation India has a total power generation capacity of 140,000MW, which is targeted to capacity slated to increase reach 218,000MW by 2012. Government entities – both state and central – have by >50% by 2012… been the largest contributors of capacity build-up over the last 10 years (PSUs account for ~89% of the total installed capacity). NTPC is the largest power generator in the country while State Electric Boards (SEBs) are primary distributors with Maharashtra being the largest. Exhibit 64: Generation of power… …Load distribution
500 14 1100 25
400 11.2 880 20
300 8.4 660 15
200 5.6 10 440 (%) share Market Normalized percentage Normalized Market share (%) share Market Normalized percentage Normalized 100 2.8 220 5
0 0 0 0 UP MP A.P. WB Goa Bihar DVC Delhi Kerala Dadar J&K U.P Sikkim Orissa Assam A.P. Punjab Jammu M.P. Daman Tripura NLC NPC Bihar DVC Delhi Manipur Haryana Mizoram Kerala Sikkim Arimacja; NTPC Himachal Nagaland WEST Assam Rajasthan Punjab Karnataka NHPC THDC Jharkhand Orrissa Gujarat NHDC Meghalaya Manipur Chattisgarh Chandigarh Uttaranchal Mizoram Tamil Nadu Tamil HPINJPC Himachal Pnodicherry Nagaland Tripuram Harayana Maharashtra Rajasthan Karnataka NEEPCO Andamna hhatisgarh Arunachal aharashtra ttaranjchal amil Nadu Meghalaya Pharkhand ondicherry C T U P M Source: Power Grid Corporation of India Western and northern India – high demand, low supply …but capacity skewed An important basis for trade of power in India rests in the imbalanced disposition of towards eastern and north- resources (with regards to power) within the country. The eastern region is rich in eastern regions… coal sources and thus pit head based load plants have been set up there. The north- eastern region also holds a lot of hydro power potential. However, the western and northern regions of the country suffer from heavy deficit of such power due to their immense industrial and agricultural load.
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Generation capacity near fuel source creates pockets with surplus/ deficit …which creates pockets Generating companies prefer to set up large scale generating stations at locations near surplus and deficit the source of fuel and transmit power to the load center compared to setting up in power generating stations near each load center. This is primarily because transmission of power is more economical compared to fuel transportation. This creates pockets that are either surplus or deficit in power, making trading of power necessary.
Indian power industry – encouraging short-term markets Steady growth in short- Power in India has traditionally been sold through long-term PPAs (Purchase Power term power trading activity Agreements) between generators and distributors. These contracts essentially work on in the country over the last a cost-plus RoI model, and assure dedicated supply of contracted power. However, few years regulatory changes in the Indian power sector have aided development of a thriving short-term market for trading power. Key regulations include Short Term Open Access (STOA) as also promotion of merchant power plants (MPPs). With the number of participating utilities in STOA increasing steadily, there has been steady growth in the number of short-term power trades.
Exhibit 65: Increasing participants… …Increasing power trading
FY05 FY06 FY06 68 24,000 FY05 64 22526
51 18,000 16641 46 45
34 32 34 12,000
24
17 6,000 3938 5 7 778 0 0 Traders Buyers Sellers Total Participants No of transactions Volume of energy (MU)
Source: Power Grid Corporation of India
Further, MPPs are beginning to gather pace. Unlike typical power plants which are based on long-term PPAs, MPPs compete for customers and play in the spot market. There is no guarantee regarding minimum off take of their output or returns. We believe MPPs offer a huge growth opportunity to utilities, and thereby power exchanges.
Huge potential for power exchanges in India… India’s short-term power market has witnessed 17% CAGR over FY04-08. However, Currently, only 0.05% of the last few years have boosted this industry with India trading 21BUs of short-term total power traded in the country is on exchanges power in FY08 – a growth of 40% over last year (source: CERC). The total traded volumes of power have grown from 2.1% of the total generated capacity in FY04 to 3.2% currently. Thus, India promises a strong market for power exchanges. Power exchanges in India have been operational for less than a year and less than 0.05% of total power traded in the country is currently on exchanges.
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Exhibit 66: Short term traded volumes
Traded volumes (BUs - LHS) % of total generation (RHS) 25 3.5
20 Less than 0.05% of this is 3.0 on Power exchanges 15 2.5
10 2.0
5 1.5
0 1.0 FY04 FY05 FY06 FY07 FY08 Source: CERC
Power Trading Corporation (PTC) is the largest power trader in the country. PTC currently has a market share of 45%+ of this industry. Other key traders include NTPC, Adani, Tata Power, etc.
POWER EXCHANGES: LET THERE BE LIGHT On February 2007, CERC granted approval to set up power exchanges in August 2008, following which two power exchanges have been set up in the country – Indian Energy Exchange (IEX) and Power Exchange of India (PXIL). IEX (promoted by Financial Technologies) registers an average daily volume of 14,500MWh and clearly leads the industry with ~90% share with PXI (a JV between NSE and NCDEX) garnering a daily average volume of ~500MWh. A third exchange, promoted by power major NTPC, NHPC and Tata Consultancy Services, is awaiting regulatory approval.
Exhibit 67: Key players
41.2% 26%
5% 5%
5% 5%
5% 5%
2.8% Others
Source: IDFC-SSKI Research
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Global Power Exchange Industry
Power exchanges work on Power being a region-specific phenomenon, different exchange models has evolved different models worldwide. Nord Pool was the first international commodity exchange for trading in world-wide power set up in 1996. Other key power exchanges are NEMMCO (Australia), NZEM (New Zealand), BETTA (UK) and PJM (USA). Our interaction with global players indicates that this market is fairly closed with little scope for scalability.
We interacted with Nord Pool to get a sense of the industry dynamics and growth drivers. Nord Pool facilitates a physical market (spot trading of electricity) as well as a financial market (derivatives) for power. The total value traded in the physical market on Nord Pool was EUR81.6bn in 2007, while that on the financial market was EUR43.2bn. With a base of 420 members, the exchange has witnessed steady improvement in operational performance.
Exhibit 68: Nord pool trade details …Key financials Nord pool group P&L (Yearly 2003-007) Contracts financial market 2007 (MNOK) Total operating income Net profit after taxes Operating profit Volume (TWh) 1060 400 Value (EUR mill.) 43,202 Number of transactions 108,631 300 Clearing of power contracts 2007 Volume (TWh) 2,369 Value (EUR mill.) 81,645 200 Number of transactions 159,337 100
0 2003 2004 2005 2006 2007 Source: Nord Pool, IDFC-SSKI Research
Indian power exchanges industry IEX, in less than a year, has IEX was the first electronic power exchange launched in India and commenced touched average daily trading on 27 June 2008. In its first month of operations, IEX clocked total volumes volumes of 14,500MWh… of 69,774 megawatt hours (MWh) with daily average volumes of 2,250MWh. Since then, IEX has witnessed strong growth and has touched average daily volumes of 14,500 MWh in less than a year.
On the contrary, PXI has not been able to give stiff competition to IEX. When PXI started operations in October 2008, the concept of power trading on exchanges had already been introduced by IEX. However, in its first month of operations, PXI recorded total volumes of 12,900MWh with daily average volumes of 390MWh.
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Exhibit 69: Average daily volumes on IEX
Avg daily volume
(MWh) 13,624 15,000 12,295
12,500
10,000
6,529
7,500
5,000 Feb Mar Apr Source: IEX, IDFC-SSKI Research
The key difference between the platforms provided by IEX and PXI is the connectivity to members. At PXI, the software system operates on a web platform and members are connected through internet lines with PXI servers housed in Mumbai. In case of IEX, members are provided connectivity through lease lines, which offer enhanced speed.
CERC – Key guidelines for launch of a power exchange De-mutualized form of organization Ring-fencing between ownership, management and participation Computerized trading and clearing system Efficient financial settlement and guarantee system Effective trade information dissemination system The applicant would be required to have adequate knowledge and understanding of the Indian Electricity Grid Code, Open Access Issues, Availability Based Tariff, UI Mechanism, Scheduling Dispatch and Energy Accounting Procedure
Mechanism – day ahead contracts Power exchanges in India operate as day-ahead markets and are operational all days of Trade in power is done the year. Trade in power is done through a double-sided auction market for delivery through a double-sided auction market for delivery on the following day. The bidding process takes place from 10 am to 12 pm daily on the following day when bids and offers from prospective buyers and sellers will be submitted for each hour of the next day (hourly contracts) to the exchange, and the same will be displayed on screens of the trading work stations (TWS). Trades validated by the exchanges are deemed for physical delivery.
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Trades matched by the exchange mechanism are settled at a uniform market clearing price (MCP), and flow of electricity is arranged through the inter-state transmission system (regional grids). Members have to bear the transmission charges and losses in their regional transmission systems. They are also required to bear the system charges, which the power exchange is liable to pay to NLDC (National Load Dispatch Centre) and SLDC (State Load Dispatch Centre). Both IEX and PXI charge membership fee for admission on the exchange. However, transaction fee is currently being charged only by IEX @ Re0.01/KWh traded.
Exhibit 70: Process Flow
Exchange Bid accumulation process determines MCV & (Members enter bids which MCP, & provisional NLDC confirms NLDC sends Exchange issues final are stored in the Central Order obligations of available limit details to obligation certificate Book) members for scheduling concerned RLDCs to members
10.00am 11.00am 12.00pm 12.30pm 1.00pm 2.00pm 3.00pm 4.00pm 5.30pm 6.00pm
NLDC informs exchange list Exchange communicates Exchange submits NLDCs/PLDCs confirm of interfaces on which unconstrained solution to application for the accepted schedule unconstrained flow is NLDC scheduling to NLDC to the exchange required
Source: IDFC-SSKI Research
Determination of MCV and MCP
Purchase Sale
Prices
All purchase bids and sale offers will be 4 aggregated. The aggregate supply and demand
curves will be drawn on Price-Quantity axes. 3 The intersection point of the two curves will give Market Clearing Price (MCP) and Market Clearing Volume (MCV) corresponding to 2 price and quantity. MCP: Rs2.5/KWh
Volume 40 80 120
MCV:60 MW
Thus, the power exchange facilitates trading of power on hourly basis for compulsory delivery on the next day. At the end of the day trading session, hourly delivery of power between members is scheduled for the next day. As per the STOA regulations, power exchanges facilitate collective transactions – through a price discovery process.
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KEY GROWTH DRIVERS Given the growth in power trading in India, we believe power exchanges have a huge potential (currently, only <0.05% of the total traded power is on exchanges). Following are the key growth drivers for the segment:
Longer-term contracts Longer-term contracts, As the power exchange segment is still in its infancy, the CERC permits only day rising capacity at MPPs to ahead trading of power on exchanges. With increasing penetration of this medium, boost power trading on we believe longer-term contracts would be available for trading, which would exchanges significantly boost volumes on exchanges.
Merchant Power Plants With MPPs gathering pace, we see significant momentum for short-term power trading. This we believe will drive volumes on power exchanges.
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SPOT EXCHANGES: SPOTTED IN INDIA India is the world leader in a host of agricultural commodities (2nd largest producer of rice, wheat, sugar and cotton), translating into a US$200bn of physical agri market in the country. However, ‘regulatory ownership’ of the industry has been detrimental to it attaining scale. Capitalizing on this opportunity, a revolutionary concept of electronic spot exchanges have been introduced in India. Pioneered by NSEL (promoted by Financial Technologies), we believe the industry promises immense potential but regulatory hangovers would stretch the evolution cycle.
INDIAN AGRI MARKET: ENORMOUS…AND INEFFICIENT With commodities forming 45% of India’s GDP, the physical market in India is pegged at US$350bn. Further, with India being a dominant producer of key agricultural commodities, trading of agriculture alone is a US$200bn annual market. However, the physical agri market in the country has been in dire straits – filled with inefficiencies and stifled due to stringent regulations. In order to address the issues, electronic national level spot exchanges have been introduced – a pioneering concept in India. These exchanges are still in the incubation phase and while the industry offers enormous potential, we believe regulatory hangovers could stretch their evolution cycle.
A US$200bn physical market for agri… An underlying $200bn India holds a formidable place in the world agricultural commodity production, physical market available being the 2nd largest producer of key commodities like rice, wheat, sugar, cotton, etc. annually for trading in agri commodities The strong production base translates into a large physical market of ~US$200bn annually for trading agricultural products.
Exhibit 71: India – positioning in world agri India Rice 2nd largest producer Wheat 2nd largest producer Groundnut 2nd largest producer Castor Seed Largest producer Chilli Largest Producer, consumer, exporter Cotton 2nd largest producer Guarseed Largest producer (90% of world prod) Jeera Largest producer, consumer, exporter Mentha Oil Largest producer, exporter Sugar Largest consumer and 2nd largest producer Source: IDFC-SSKI Research
Exhibit 72: Contribution to key agri commodities
Rice/ Paddy % share of country Wheat % share of country Sugarcane % share of country China 29.01 China 17.24 Brazil 32.7 India 21.51 India 11.44 India 20.19 Indonesia 8.57 USA 9.46 China 7.23 Brazil 1.81 Russia 7.43 Thailand 3.42 Japan 1.69 France 5.84 Pakistan 3.21 USA 1.38 Canada 4.5 Mexico 3.63
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…But plagued with inefficiencies
Trade mechanism between The current trade mechanism between the farmer and end users is highly farmer and end users is unorganized and driven by intermediaries. This translates into price differentiation highly unorganized and across different regions in the country for the same commodity. Currently, the trade driven by intermediaries… cycle involves two markets – a primary market regulated by the APMC Acts of the respective state government and a secondary market.
Primary markets are small regional-focused areas (typically called mandis), where farmers negotiate prices with traders. These markets are unorganized fragmented markets and as farmers are non-cognizant of prices in other regions, prices are typically commanded by traders. In addition, shortage of adequate storage facilities (warehouses, etc) restrains farmers from stocking the produce to sell it at higher prices at a later stage. Also, while traders have the pricing power, they incur substantial procurement and transportation costs.
…and the system is fraught The trade cycle is completed in the secondary market wherein traders enter into with default risk at every contracts with mill owners/ end users for the procured commodity. With level of the trade cycle commodities not graded to any particular quality standard, issues relating to quality and weight are very common. However, default risk looms large at every level of the trade cycle, which is the key drawback of the entire trade mechanism.
Exhibit 73: Current status of agri markets in India
Primary market • Localized and fragmented • Prices dependant on local demand/supply • Prices in other regions not known Farmer Trader APMC Mandi
Secondary market
• Counter-party default risk Negotiated •Disputes relating to contracts quality, weight, etc Trader Miller/ Exporter/ End user Source: IDFC-SSKI Research
NSEL, India’s first spot ELECTRONIC SPOT EXCHANGES: THE PANACEA OF ALL EVILS exchange, set up by FTIL in association with NAFED In view of the potential underlying market as also the inefficiencies in the system, the concept of a national level spot exchange was pioneered by Financial Technologies – India’s exchange conglomerate – in 2005. Financial Technologies, in a joint venture with NAFED (a government agency engaged in food procurement/ storage), set up the country’s first spot exchange – National Spot Exchange (or NSEL). The potential attracted more players, and today the country has four spot exchanges.
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National-level electronic spot exchanges over-ride the inefficiencies prevalent in the physical market. Products on the exchange are for compulsory delivery only, and hence are identical in purpose to the underlying physical market. While transparency across the system (with access to prices of commodities in all regions) leads to better price discovery, exchanges guarantee counter-party credit risk as well – the most fundamental need of the trade system. In addition, products are quality certified before being traded on the exchange platform, thereby eliminating post-trade related issues.
Exhibit 74: Changing industry dynamics
Spot Exchanges – Structural alignment of India’s physical agri market
Transparency Pan-India prices known on electronic platform
Price discovery Based on national demand/supply
Credit Risk Eliminated as counter party guarantee given
Access Online platform with national reach
Removal of Elimination of middlemen, and identity of trader is undisclosed inefficiencies
Quality assurance Contracts are standardized and backed with quality certification
Value added Spot exchanges provide warehousing and storage facilities services
Source: IDFC-SSKI Research
Improving economics of the industry Farmers get access to spot Electronic spot exchanges are a clear win-win situation for all industry participants exchanges at no extra cost including buyers and sellers. Farmers, the primary sellers, get access to spot exchanges at no extra cost as they do not need to become members of the exchange. Farmers benefit on two main counts – better pricing and warehouse financing. The typical process of the spot exchange system entails farmers taking their produce to exchange- designated warehouses for quality certification. On certification, farmers have an option to store the commodity in the warehouse (storage costs would be charged) for which they are issued a warehouse receipt. Farmers can then avail of temporary financing against their warehouse receipts, and eventually sell the produce on the exchange at an opportune time, and thus benefit from any price escalation.
On the other hand, if farmers choose to sell their produce on the same day, access to prices at all regions in the country enable them to command a reasonable price for the product. Also, being an electronic system, most spot exchanges (like NSEL) have representatives designated at the warehouses which execute the trade on behalf of the farmer.
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Exhibit 75: Win-win situation for all
1. Commodity Exchange warehouse 3. Commodity
Seller Stored
2. Quality Quality checking, certificate weighing
Warehouse receipt financing
Bid price Electronic spot exchange Ask price
Seller Buyer
Trade match Transparent price Saves cost of discovery procurement
Commodity dispatched from warehouse
Source: IDFC-SSKI Research
From the buyers’ point of view, accessibility at low cost forms the key. Buyers have access to prices in all regions in the country with precise contract specifications of the commodities (certified by the exchange). Also, contracts traded on the exchange specify the available locations for delivery (across different states/ regions), enabling buyers to choose contracts based on their requirements. Thus, transparency in the system and savings with regards to procurement costs work in favour of the buyers.
Guaranteed settlement – the key As the exchange has Spot exchanges, like any other exchange system, provide counter-party guarantee in recourse to buyers’ respect of all trades executed on the platform. The exchange collects security deposits deposits, payment is totally secured from its broker members (buyers). Even if the buyer defaults, the exchange makes the payment from its own Settlement Guarantee Fund and subsequently recovers money from the buyer’s deposit. Hence, payment is totally secured. With all contracts mandated for physical delivery, credit risk coverage becomes imperative for the system. This, we believe, is the most important value proposition of spot exchanges vis-à-vis the existing physical market.
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Exhibit 76: Settlement Process
Spot Exchange
Trading (Bid/Ask) Online terminal Online terminal
Matching
Clearing House
Member Broker Member Broker Clearing Bank
Seller Buyer Settlement •Corporate •Farmer •Wholesalers •Importer •Exporters • Co-operatives • Traders •Government Physical Delivery • Governement
Source: IDFC-SSKI Research
An expanding product basket – inclusion of non-agri products The concept now being While the concept of spot exchanges was pioneered around agricultural commodities, extended to bullion, industrial and other it is now being implemented across the commodity basket including bullion and commodities industrial commodities. Regulatory framework – approvals required at the state level Unlike commodity derivative exchanges, spot exchange in the country are not regulated by a separate body. According to the definition laid down by the GoI, any contract designated for delivery within 11 days is considered to be in ‘spot markets’ and is not regulated by the FMC. However, with spot markets in India being a state- specific subject, spot exchanges have to obtain regulatory approvals from the state ministries to designate regions within that state as delivery centers.
COMPETITIVE LANDSCAPE
NSEL, SNX, NCDEX and The concept of electronic pan-India spot exchanges was pioneered by FTIL which NMCE are the four spot setup NSEL in joint venture with leading government agency – NAFED – engaged exchanges at present in food procurement, distribution and storage. While NSEL was earlier focused on mainly agri based commodities, it now includes bullion and industrial commodities.
The potential in the industry also attracted the other national level commodity exchanges in the country – NCDEX. NCDEX launched its spot exchange – NCDEX Spot – in July 2008. Further, NCDEX Spot has entered into an agreement with Riddhi Siddhi Bullion (RSBL), a leading supplier of gold to the domestic market, to establish a nationwide bullion spot exchange.
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Also, Reliance Money – a Reliance ADAG company has also setup a spot exchange called Reliance Spot Exchange Infrastructure in 2008. The exchange is yet to start live operations.
Exhibit 77: Key players
Spot Exchanges
Reliance Spot
Source: IDFC-SSKI Research
Membership and REVENUE MODEL: HIGH VOLUMES…LOW VALUE transaction fees are key sources of revenues for a Primary sources of revenue for spot exchanges are membership fees and transaction spot exchange… fees. Membership fees charged vary across exchanges and also include a one-time security deposit. Contracts on the spot exchange are based on delivery location. Hence, multiple contracts exist for the same commodity. Due to this, turnover per contract is typically significantly low, though aggregate turnover per commodity is healthy.
…but transaction fees are As spot exchanges are still a novel concept in the country, they are yet to achieve the currently negligible except critical liquidity mass, and hence transaction fees are not being charged currently. on castor seed by NSEL However, our interaction with the players indicates that the transaction fees in spot exchanges would be significantly higher than those charged by derivative exchanges. Also, the fees would include transportation/delivery charges as specified in the contract. For instance, NSEL has recently levied transaction charges on castor seed at Rs500 per Rs100,000 traded. Thus, spot exchanges have a strong revenue generation capability.
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KEY GROWTH DRIVERS While the industry exhibits enormous potential, we believe the following growth drivers will aid in capitalizing on the opportunity:
More states opening up
Market to expand as more Currently only few states have given regulatory approval to spot exchanges. These states allow agri spot include Maharashtra, Gujarat, Kerala, Karnataka, etc. We believe as more states open trading and farmers realize up to these markets, penetration will improve. the benefits Awareness creation Spot exchanges are a new concept in the country and aims at reaching the rural markets. Thus, education and awareness about the operations would attract better penetration. NSEL, has adopted innovative methods like sending SMSs to farmers on daily price updates, etc in order to build their interest.
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EXCHANGE ECOSYSTEM Sophisticated systems and streamlined processes are the essence of an exchange marketplace. Imparting these intrinsic qualities to exchanges are two key industries – technology solutions that facilitate trade and warehousing & related processes that deliver efficient post-trade execution mechanisms. While the thirst for faster execution to improve liquidity is influencing the technology industry, inefficient storage conditions (US$25bn of annual losses in agri chain) in the country is boosting the warehousing & ancillary industry.
ECOSYSTEM: PILLARS OF THE EXCHANGE The ecosystem around the exchanges framework plays an important role in supporting the industry’s growth. While the ecosystem is a broad industry, the upcoming and more relevant spaces include technology solutions for exchanges as also warehousing and agri credit finance – that cater to the commodities trading segment (the fastest growth segment).
Exhibit 78: Ecosystem ventures
Exchange ecosystem
Warehousing and agri credit Technology solutions Ecosystem around the financing exchanges framework plays an important role in supporting industry growth For exchanges
For participants
FTIL, Omnesys, Asian CERC NBHC, CWC, SWC, FCI
Source: IDFC-SSKI Research
TECHNOLOGY SOLUTIONS FOR ‘MARKETS’: LOW LATENCY IS THE RAGE The technology solutions industry for markets primarily consists of two segments – one providing the technology for exchanges to run on and the second is to develop trading solutions for clients/ broker members using the exchange. The global industry for the latter alone is estimated to be a US$15bn market.
Trading solutions for We interacted with global players like Euronext, OMX, GL trade, Cinnober, etc to exchange members a gauge the potential of this industry. These players provide technology to both USD15bn global market exchanges as also broker members, and they have created a niche for themselves in certain segments. Euronext, OMX and Cinnober are dominant in developing technology for exchanges, while a different set of players like SunGard, GL Trade and ORC Software focus on developing trading solutions for clients/ broker members.
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Exchange solutions – speed is crucial! Electronic trading has played a vital role in shaping the exchanges industry. Technology crunches Exchanges in USA and UK traditionally developed their own proprietary software to execution time, and thus supports higher volumes meet their technology requirements. With electronic trading catching pace, established electronic exchanges have become formidable technology providers to the financial markets at large. For example, NYSE Euronext and NASDAQ OMX have a dominant presence in providing technology solutions to financial markets. OMX – a Swedish-Finnish Financial Services company operates eight exchanges in the Nordic and Baltic countries and has a technology division developing systems for financial transaction for exchanges. It is now a subsidiary of NASDAQ Group and is a leading exchange solution provider. Today, nearly 40% of the world’s electronic exchanges operate on technology developed by Euronext or OMX.
Exhibit 79: Key clients of OMX Dubai Financial Market Singapore Exchange European Derivatives Exchange Shanghai Stock Exchange International Securities Exchange Tokyo Commodities Exchange Singapore Commodity Exchange Hong Kong Exchanges and Clearing Source: NASDAQ OMX
Enhancing their technology infrastructure is becoming a key focus for exchanges across the world in order to reduce transaction time, and thereby attract more liquidity. Traditionally, reduction in execution time of trades has in most cases led to increase in volumes. The cost for technology solutions for exchanges varies depending on the complexity and specific requirements of the exchange. The latest agreements signed include the Malaysian Derivative Exchange appointing Euronext for technology support at an estimated cost of US$70m. Saudi Exchange is estimated to incur costs to the tune of US$90m for its exchange software from OMX.
Exhibit 80: CME – benefitting from technology …latest transactions
Average order volume (m - LHS) Average round trip time (ms - RHS) 250 234mm 140 127ms Technology Estimated Cost Exchange Provider (US m) 200 112
Malaysian Derivative 150 84 NYSE Euronext 70 Exchange
100 56 Saudi Stock OMX 90 50 28 Market Tadawul 7ms 4mm 0 0 2004 2005 2006 2007 2008 2009
Source: CME Group, IDFC-SSKI Research
Virtual exchanges too add In addition, new concepts such as multi-lateral trading facility (MTF) have been to the market potential invented in European markets, wherein financial institutions come together to form virtual exchanges to facilitate trading. Such concepts further enhance the market potential for technology providers. In order to cater to this rapidly increasing market more efficiently, companies are taking the inorganic route.
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NYSE Euronext acquires Wombat for US$200m NYSE Euronext acquired 100% of Wombat Financial Software (Wombat), a privately held global leader in high-performance financial market data management solutions for $200 million in cash consideration
Snapshot of our interaction with Johan, Partner – Cinnober Private company developing technology solutions for Exchanges and MTFs Key clients include CBOE, LME, American Stock Exchange, Borsa Italiana, HKMEx Follows two different revenue models – one involves a one-time sale of technology backed with an AMC contract, and the other is a revenue sharing agreement with the Exchange. Cost of technology packages for exchanges depends on the complexity and other specifications, and can be as high as US$150m FY08 revenues of 320m Sweden Dollars, with a PAT margin of 20% View MTFs as an upcoming concept in Europe which would broaden the industry CInnober caters to Key competitors – OMX Technologies, Euronext and Chitech
Trading solutions – time the market! Key global players include The biggest market that the wave of electronic trading has created is that of SunGard, Fidessa, Orc technology solutions for clients. Estimated to be a US$15bn market, the trading Software and GL Trade solutions and related market product industry has witnessed strong growth. With increasing penetration of electronic markets, more and more clients are opting for enhanced trading solutions. Key global players include SunGard, Fidessa, Orc Software and GL Trade (now acquired by SunGard).
Exhibit 81: A US$15bn industry BUY SIDE
Order & Execution Date & Info Broker Connectivity PMS / Risk Settlement Management System
Cross asset 3 B$ 2 B$
Front to back Date & Info Order Routing Front Office Middle Office Back Office solutions
Listed equities 2 B$ 5 B$ 0.5 B$ ETD 0.2 B$ 2 B$ FX-Money Mkt 1 B$ Fixed income
Client Connectivity OMS / Market Date & Info Posting / Risk Settlement DMA Connectivity
SELL SIDE
Source: GL Trade, IDFC-SSKI Research
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We interacted with global players to get a sense of the industry. Our sense is that the innate nature of the industry is such that the risk of technology obsolescence makes it imperative for industry participants to continuously improvise and upgrade their systems. With solutions spanning across the entire trading ecosystem and the ongoing advent of enhanced trading methodologies (like algorithm trading, DMA, etc) – scalability in this industry is a given. The strength of this business is apparent in the inherent value attributed to such businesses. For instance, SunGard acquired GL Trade, a global financial software solutions company, for US$585m.
SunGard acquires GL Trade valuing it at US$585m Financial services, higher education and the public sector acquired a majority stake in GL Trade. GL TRADE is a global financial software solutions company, operating in over 50 countries and serving 1,600 clients. It is a leading provider of multi-asset front to back solutions, connectivity and information services.
Key players Key players catering to the exchanges technology industry include Financial Financial Technologies Technologies, Asian CERC, Omnesys and CMC. Financial Technologies dominates dominates the industry with an 85% market share the industry with an 85% market share and has a license base of 320,000 for its trading solutions business. CMC, the technology provider for BSE BOLT (BSE Online trading Terminal) system, was one of the earliest to enter the industry, but has not scaled up the business. Asian CERC – now called Religare Technova – and Omnesys (in which NSE has a significant interest) are the other key players.
Economics – an annuity-backed growth model Trading solutions is an inherent product IPR model, wherein players charge a one- time fee backed with an AMC contract (usually 15% of the one-time fee). Exchange solution providers also charge a one-time set-up cost, which is again backed with an AMC as also software upgradation contract.
Growth drivers The key growth drivers for the technology industry are as follows:
Increasing participation in new exchanges The growth in the Indian exchanges space (from US$4trn currently to US$10trn by FY14) would partly be driven by higher penetration. Higher penetration would imply an increased trading base in the country – thereby providing fillip to the trading solutions industry.
Advanced solutions While penetration of equity markets in India has reached significant levels (64% to GDP), advanced processes such as algorithm trading and DMA are yet to be introduced. Trading on DMA channels is very popular in developed markets like USA where DMA accounts for nearly 18% of the total traded volumes. With respect to algorithm trading, nearly 40% of the volumes traded on NYSE are programmed. We believe the potential opportunity offered by these advanced technologies is immense and would be a key growth driver for the industry.
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WAREHOUSING AND AGRI CREDIT: SUPPORTING COMMODITY MARKETS Warehousing and agricultural credit are primary influential for the Indian agricultural commodities sector, and thereby have a direct influence on exchanges.
Indian agriculture sector – largest…but plagued with inefficiencies Inefficiencies lead to an The agriculture and allied sectors contribute ~19% to the US$1trillion Indian GDP estimated annual loss of and support more than 60% of the country’s 1bn+ population, thereby making it the USD25bn for the agri industry most important element of the Indian economy. About 75% of the population still lives in rural areas and is directly or indirectly engaged in agricultural activities. This number is substantially higher when compared to other developing countries like China, where agriculture contributes only 12% to GDP and employs around 45% of the workforce.
Despite the prominence of agriculture in the Indian economy, the sector is plagued with inefficiencies at every step in the agri value chain. These factors are resulting in losses (estimated at US$25bn annually) as also poor working conditions for farmers (no access to organized finance).
Exhibit 82: Inefficiencies in the agri value chain
Inadequate warehousing I Poor post harvest financing N • ~US$25bn is the estimated losses in E agri supply chain F • Post harvest funding at 3% of total • Post harvest loss of food grain is ~20m agricultural lending tonnes a year = 10.5% of total F production I C I
Lack of marketing infrastructure E Lack of grading infrastructure N C • 7% of foodgrains, 30% of fruits & vegetables and 10% of spices lost I before reaching the market • Less than 10% of rural and APMC E markets have grading facilties • Only 1.3% of fruits & vegetables are S processed, in USA it stands at 80%
Source: IDFC-SSKI Research
Regulatory reforms The Indian government, to address inefficiencies prevalent in the agricultural system, has introduced several measures in the 11th Five Year Plan. Some of these include contract farming, direct marketing, procurement by private players, promotion of post harvest credit by banks, and development of warehousing and grading infrastructure across states. Warehousing (Development and Regulation) Act 2007 The entire value chain of The enactment of the Warehousing (Development and Regulation) Act 2007 agri-production to benefit (WDRA), on 23 September 2007, was an important initiative taken with a view to from the statute ensure that farmers in the country are able to keep their goods in certified warehouses and use warehouses receipts as a negotiable instrument. With the full implementation of WDRA, farmers, traders and processors will now find it easy to take loans from commercial banks against negotiable warehouse receipts. Farmers will benefit
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significantly as they will not have to resort to distress sales when they require money urgently. The entire value chain of agri-production will benefit as the statute will enable the warehouse receipts to be traded within a wide user group as compared to the current scenario.
Reforms in Agricultural Marketing Agri commodities market The GoI has taken a lot of initiatives to deregulate the domestic agricultural moving towards commodities market. The APMC Act was amended to enable farmers to be part of deregulation the sellers’ market and to widen the scope of opportunities being provided to them by trading their goods in mandis. The salient features of the amendments are: Direct Marketing: The amendments allow private players to obtain permission to establish private markets in competition to the markets of APMC; thus ending the long-held monopoly of the state. Contract Farming: Contract farming is defined as a system for production and supply of agricultural or horticultural products under forward contracts between producers/ suppliers and buyers. The amendments also allow contract farming by corporates and enable them to directly tap the agricultural market Terminal Market Complexes (TMCs): TMCs provide multiple options to farmers under one roof to sell their produce through different routes such as electronic auctioning and direct sale to exporters, processors and retail chains
Establishment of the Agricultural Research and Infrastructure Development Fund
Powers given to state governments for exemption of market fee
Setting up of separate markets for special commodities These amendments will help in reducing the number of intermediaries in the overall agri-supply chain. They will induce the much-needed efficiencies in the system and provide better prices for farmers’ produce.
Agri warehousing The farming process from cultivation to final consumption involves a large number of enablers and stakeholders.
Exhibit 83: Agri value chain
Post harvest financing (3% of total agri lending) Pre-harvest financing –Banks/Money lenders Kharif – Apr to Oct Temporary storage/open Rural markets:28,000 Rabi – Oct to June yards Regulated markets: 7,500
Seed Production Fertilizer Cultivation (Kharif: 54% Storage Mandis/markets Rabi: 46%) Farm implement
Farmers get 25-30% of total value paid by Final consumption Storage Agro processing Storage customer
Captive and bonded Local players/exporters Government/ private warehouses warehouses Source: IDFC-SSKI Research
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Subsequent to production, it is critical to ensure that the agricultural produce is stored in an efficient and organized manner to avoid wastages and loss in value. Over US$25bn is estimated to be lost in the agri-supply chain in the absence of efficient and adequate post harvest infrastructure. This is a key reason fueling the need for efficient warehousing.
Agricultural commodities are produced for sale in the market and for consumption by the farmer. After the farmer’s own needs are satisfied, the remaining commodity available for storage is known as “marketable surplus” and the marketable surplus after spoilage, i.e. the commodity available for sale, is known as “marketed surplus”. The need for warehousing stems at the marketable surplus stage, where commodities need to be stored before sale.
The losses in farm produce In India, marketed surplus varies from marketable surplus on account of poor post in India estimated at harvest management. The losses in farm produce in India have been estimated at US$18bn-25bn per annum US$18bn-25bn per annum. The estimated loss includes losses during storage, handling, milling and processing. It is estimated that about 30% of the farm produce is stored in the open, leading to wastage and distress sales. About 12% of the post- harvest stock, worth US$ 22bn, stored in public warehouses gets wasted in the absence of quality storage facilities. The total preventable post-harvest losses of food grains in the commodity value chain are estimated at 20m tonnes a year, which amount to nearly 10.5% of the total production.
Exhibit 84: Marketed surplus
Production of agri commodities US$25bn of annual post harvest losses
Seeds
Utilization Marketable Marketed Spoilage Home by farmer surplu s surplus consumption 60% 40%
Wages in kind
Source: IDFC-SSKI Research
Public sector dominates
CWC provides The total available agri-commodity storage capacity in India is 83.1m tones, which is warehousing facilities at primarily dominated by public sector enterprises holding 71% of the total capacity. centers of national The private space on the other hand is highly fragmented, lacks scale, and is importance unorganized and geographically scattered. Currently, a three-tier system exists in the Indian public sector warehousing infrastructure space. The Central Warehousing Corporation (CWC) provides warehousing facilities at centers of national importance and the State Warehousing Corporations (SWC) and the state governments at centers of states and district level importance.
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Exhibit 85: Distribution of warehouse facilities
CWC Others 12.8% 21.1%
SWC 20.7%
Gramin Bhandharan yojna 24.7% FCI 20.8% Source: IDFC-SSKI Research
The existing storage capacity is pegged at 83.1m tonnes. A shortage of ~38m tonnes The 11th Five Year plan has of capacity as of 2007 calls for additional investment to meet the space shortage. budgeted an investment Further, the additional storage capacity required in 2011-12 is ~28m tonnes. Of this, outlay of US$500m for construction of additional the 11th Five Year plan has budgeted an investment outlay of US$500m for the storage capacity construction of additional storage capacity of 6.67m tonnes. Thus, a shortage of warehousing space of ~59m tonnes remains to be tapped by private players.
Exhibit 86: Warehousing capacity
Upto 2007 Upto 2012
160 28 Shortage of ~59m tonnes 52m tonnes of storage capacity – shortage ample scope for private 120 players 6.7 80 121.1 83.1 40
0 Storage capacity Marketable surplus Source: IDFC-SSKI Research
Key private players Recognizing the need for storage space for agri-commodities, private players have NBHC is the leader in the established their own network of warehouses over the last few years. However, most segment of these players are fragmented and primarily belong to the unorganized sector. Nevertheless, there are a few players like NBHC with pan-India presence and a wide spectrum of service offerings. Other key players in India that offer a variety of logistics-related services across segments include Total Logistics, Indo Arya and Experts Logistics.
Revenue model for warehousing Warehousing service providers charge a fixed fee for storage which varies across commodities.
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Agricultural credit picking up in India…
GoI and RBI initiating Supporting agriculture through timely initiatives and adequate credit flow has been a measures to increase rural longstanding priority for the GoI given agriculture’s significant contributions towards penetration of banks, and employment (57%) and total GDP (18.5%). To accelerate rural infrastructure thus credit flow development, the GoI, together with the RBI, has undertaken a range of initiatives that have resulted in increased rural penetration by banks, and greater agricultural credit flow.
While regional rural banks in India have grown to over 100 in number, rural branches across India have exceeded 30,000 as of March 2006. RRBs and NABARD have helped substantially to increase total credit to agriculture from US$ 7bn in 1996 to over US$ 48bn in 2007.
Exhibit 87: Growing rural credit and bank penetration
Credit outstanding (US$ m - LHS) Branches (nos - RHS) 50,000 60
37,500 45
25,000 30
12,500 15
0 0 FY03 FY04 FY05 FY06 FY07 FY08 Source: IDFC-SSKI Research
Exhibit 88: Increased rural coverage by banking system 1969 2006 Other bank 18 Rural branches 45
Other bank 55
Rural branches 82
Source: IDFC-SSKI Research
…but still a long way to go
A largely untapped rural In spite of the support of the government and other regulatory bodies towards market offers strong increased agricultural credit disbursement, a large section of the rural market remains growth potential untapped, thereby offering tremendous growth potential for such credit. It is estimated that ~40% of Indian farmers still rely on informal credit channels such as moneylenders and commission agents (adatiyas). Additionally, such informal loans are usually obtained at much higher costs; a recent World Bank survey reveals that in certain states, over 44% of rural households had taken informal loans at interest rates as high as 48% p.a. The combination of large price spreads and low price realizations
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subsequently force farmers to borrow more to sustain themselves, thereby ensnaring them in a difficult-to-break debt cycle.
Exhibit 89: Challenges in agri credit flow
• High collateral requirements of banks •KYC norms
Informal credit channel • Increased pressure to sell commodity
High interest Vicious cycle rates Farmer (upto 48% p.a)
Distress sale (upto 50% of marketed surplus)
• Lower price realization • Cannot clear debt obligation
Source: IDFC-SSKI Research
RBI and other banks Agricultural credit may be broadly segregated into pre-harvest and post-harvest loans. looking to shift focus from Pre-harvest loans are disbursed to farmers for the purchase of various inputs such as input-based financing of seeds, fertilizers and farm equipment – that would be used towards land cultivation. agricultural credit towards output-based finance These loans bear a certain degree of risk, given that the agricultural produce is not quantified at the time of disbursement. Such uncertainty and the related risk of non- recovery of debt have been the key factors responsible for banks being reluctant to provide additional agricultural credit In May 2008, the State Bank of India, one of the largest lenders of agricultural credit in India, announced that more than 15% of its total tractor loans of US$ 1.7bn had been classified as NPAs. Such high risk associated with pre-harvest debt has led to collateralization of bank loans, thus excluding the small farmers, most of whom cannot provide the same. On the other hand, post-harvest loans are disbursed against the commodity, and therefore have lower risk associated with them, as the commodity already physically exists at the time of disbursement. Recognizing this, the RBI and other banks have looked to shift focus from input-based financing of agricultural credit towards output-based finance. Post-harvest credit, through pledge financing which facilitates the usage of commodities of graded produce as collateral and warehouse receipts, has gained greater popularity in the recent years as a means to further disseminate credit to the rural sectors with minimal risk impact.
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Exhibit 90: Types of agri credit Criteria Pre-Harvest Credit Post-Harvest Credit Basis Based on borrowers’ credit history, land holding Based on asset quality/ quantity in addition to credit information Key Risks Climate, Productivity, Credit Commodity price fluctuation, Storage (quality and quantity) Due Diligence Difficult to conduct; can lead to fraud Relatively easy as it based on collateral (commodity); proper quality checks need to be ensured Non Performing Assets (NPAs) High Low to negligible Recovery No pledge; extremely difficult Pledge on collateral; easy to recover Source: IDFC-SSKI Research
Warehouse Receipt Financing – the way out While commonly used as a means of agri-funding in more developed countries, WRF is still in its nascent stage in India. Among the various banks involved in WRF, State Bank of India is the leading provider among Public Sector banks (estimated portfolio of US$1.9bn) while HDFC Bank (US$ 1.2bn) and ICICI Bank (US$ 0.5bn) lead among private sector banks.
Warehouse Receipts are documents issued by warehouses/ storage facility providers to depositors against the commodities deposited in the warehouses, for which the warehouse facility provider is the bailee. In addition to certifying the type of commodity deposited, these receipts may also be used as reliable indicators of the quality and quantity of the commodity deposited. Warehouse Receipts may be non-negotiable or negotiable. If they are negotiable, they may be transferred by endorsement and delivery. The original depositor or the holder in due course (transferee) can claim the commodities from the warehouse. Warehouse Receipts may also be subsequently pledged to secure financing from banks using the underlying commodity at the warehouse as collateral, a financing mechanism commonly referred to as Warehouse Receipts Financing (WRF).
Warehouse Receipts Financing – process flow
Farmers can pledge Post-harvest, the farmer deposits his agricultural produce with the warehouse, which Warehouse Receipt to will be inspected to ensure proper quality and quantity of the same. Typically, such obtain a loan from the bank inspection is done by independent third party supervisors known as Collateral Managers, although certain warehouse corporations have in-house capabilities to perform these functions. Once the Collateral Manager is satisfied with the commodity, the farmer will be issued a Warehouse Receipt, which will contain details on both quality and quantity of the commodity deposited.
The farmer may then pledge this Warehouse Receipt to obtain a loan from the bank. Subsequent to issue of the loan, the warehouse holds commodities on behalf of the concerned bank. At a later stage, when the farmer agrees to sell his commodities to a processor (third party), the processor approaches the bank and pays off the loan amount as well as the interest accrued. The balance amount (difference between selling price and loan amount) is settled with the farmer separately. The bank on receipt of payment releases the WR in favour of the processor, who then proceeds to instruct the warehouse on where to deliver the same.
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Exhibit 91: Warehouse receipt financing process flow
1. Deposits commodity Warehouse
2. Warehouse 9. Rece ive s commodity receipt dispatch
7. Balance amount Farmer Processor 5. Commodity sold
6. Loan + Interest on 4. Loan disbursed behalf of farmer
Bank 3. Loan against 8. Releases warehouse commodity receipt Source: IDFC-SSKI Research
Revenue model Collateral Managers retain The revenue model for Collateral Managers differs from their service offering and is a small percentage of based on various factors such as in-house warehousing capability, quality assurance interest rate charged on loans as income facilities, etc. However, the generic income stream for most Collateral Managers comes from retaining a small percentage of the interest rate charged on loans as income. This is usually between 0.75% and 1% of the total loan amount outstanding per annum. Further, if the collateral managers have warehousing and quality assurance facilities, then additional income from providing these services is generated.
Key players Key Collateral Managers in the country include NBHC (promoted by Financial Technologies), NCMSL (promoted by NCDEX), Amin Controllers and Geo-Chem (international presence).
Exhibit 92: Key players
National Bulk Handling • NBHC supervises 390 warehouses with 1.3mn MT storage capacity Corporation (NBHC) • One stop solution provider in warehousing and related activities, including procurement, storage, quality inspection, pest management and collateral management services • Provides collateral management services for more than 4.5mn MT of commodities spread across 3,500 storage facilities • Facilitated CM funding of over US$ 1bn for more than 90 commodities National Collateral Management • Promoted by the NCDEX, Indian Farmer Fertilizer Cooperative Limited (IFFCO) and various Services Ltd (NCMSL) Indian banks • Incorporated in 2004, NCMSL provide a range of services including procurement, collateral management accredits warehouses to ensure that they meet acceptable quality standards. Dr. Amin Controllers Pvt. Ltd. • Specialize in agro-commodity inspections, consumer products, marine and insurance surveys, Collateral and Stock Management and Laboratory Testing assignments • Conducts due diligence on behalf of banks to facilitate commodity financing. • Services include Warehouse inspections, stock audits and evaluation and design of commodity inventory systems Institutions Geo-chem • Spread across 17 countries, with more than 2,000 experienced and qualified personnel • Strong presence in the Indian Sub-continent, Middle East, African Countries and South Asia with regional headquarters in Mumbai, Dubai and Singapore • Conduct Collateral Management services for various agri-commodities including pulses, sugar, cotton, oil seeds and grains Source: IDFC-SSKI Research
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COMPANIES
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IDFC-SSKI INDIA Initiating coverage Rs1410 Financial Technologies OUTPERFORMER
Billion dollar ‘baby’! Mkt Cap: Rs64.7bn; US$1.4bn 8 June 2009 Vision, execution and ability to reinvest capital have impelled the evolution of BSE Sensex: 14998 Financial Technologies (FTIL) from India’s leading exchange solutions provider to Asia’s largest exchange conglomerate. The ‘only’ gateway to the potential US$10trn Indian exchanges space, FTIL has captured 87% of the commodity markets through MCX and given taut competition to equity incumbent NSE in currencies through MCX-SX (49% share). Besides pioneering niche models in power and spot, five international exchanges have been set up in potentially Stock data under-penetrated regions. FTIL is now ready to take the battle to NSE and BSE’s Reuters FITE.BO turf in equity trading (NSE+BSE profits at Rs11bn). While aggression and growth Bloomberg FTECH IN are second nature to FTIL, ability to re-deploy capital (32% divested in MCX at a 1-yr high/low (Rs) 1900/382.35 valuation US$1.1bn; 18% divested in MCX-SX at US$284m) in value creating 1-yr avg daily volumes (m) 0.33 businesses imparts conviction to its growth longevity. We like the ‘urgency’ in Free Float (%) 54.4 FTIL’s business trajectory and initiate coverage with an Outperformer. An annuity play in the US$10trn opportunity space: The transition from a license sale business to an annuity model marks the scale up of FTIL. India’s leading exchange solutions provider (350,000 licenses sold; 85% share), FTIL has extended Price performance the strong domain expertise to the ‘fundamentally-perfect’ exchanges business and 120 Financial Technologies Sensex created MCX with 87% share of Indian commodity space. 95
70 Risk appetite, execution, monetization and growth: The ‘urgency’ to replicate the
45 success of MCX has steered FTIL to become Asia’s largest exchange conglomerate
20 with 10 exchanges across segments/ geographies as also six eco-ventures. We like the execution success in its core technology products business, MCX, NBHC Jun-08 Jun-09 Feb-09 Apr-09 Oct-08 Aug-08 Dec-08 (warehousing) as also MCX-SX (currency derivatives). Ability to monetize is evident from partial divestiture in DGCX and capability to fund growth is reflected in the recent value unlock in MCX-SX. The way to value – SoTP; target price of Rs2,000: FTIL is a compelling business Performance (%) proposition, a gateway to participate in a model with strong technology domain, 3-mth 6-mth 1-yr 3-yr annuity in a high-growth environment, spanning various geographies (Singapore, FT 232.0 184.2 (8.9) (0.2) Bahrain, Africa, Mauritius and India) as also segments (commodities, equities, Sensex 84.2 68.5 (4.2) 50.4 currencies, power, spot, etc). We initiate coverage on FTIL with Outperformer and SoTP-based target price of Rs2,000 – 40% upside from the current levels. SoTP Valuation Entity Basis of Resulting entity FTIL Resultant value
valuation value (Rs bn) stake (%) for FT (Rs bn) Nikhil Vora FT Core Business 15x FY11 earnings 23.9 100 23.9 [email protected] MCX 25x FY11 earnings 45.4 31.20 14.2 91-22-66 38 3308 NBHC 20x FY11 earnings 8.9 86.2 7.7 MCX-SX 2x strategic valuation 27.0 53.1 14.3 Swati Nangalia Invested capital in group cos 2.5x inv cap 24.2 100 24.2 [email protected] Cash and Other investments 1x investments 7.7 100 7.7 91-22-66 38 3260 Total 92.2 Per share value 2,000
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CONTENTS
Investment Argument...... 79 FTIL: A neat ensemble of vision, execution and risk appetite ...... 79 The genesis: Technology is in its blood! ...... 80 The one ‘BIG’ move – MCX ...... 82 Execution success stoking risk appetite...... 83 MCX-SX: Looking to conquer the largest exchange space in india ...... 85 Key risks ...... 86 The way to value FTIL: Sum-of-parts ...... 86 Solutions Business: Eternal Bubble...... 88 Technology solutions for ‘markets’: Low latency is the rage...... 88 Trading solutions: Time the market...... 88 Exchange solutions: Speed is crucial ...... 91 Competitive landscape ...... 92 Key concerns...... 92 Financial analysis ...... 93 Exchanges Business: A new beginning...... 95 FTIL: An exchange behemoth...... 95 MCX: Flawless success ...... 96 MCX-SX: The next big thing...... 104 DGCX: Oil not liquid! ...... 109 IEX: ‘Power’ed to deliver ...... 111 IBS Forex: ‘Appreciation’ difficult!...... 113 NSEL: World’s first electronic spot exchange...... 115 International exchange ventures ...... 118 Ecosystem Ventures...... 120 Business Overview ...... 120 NBHC: Warehousing exchanges...... 120 Atom: Explosive growth ahead ...... 128 Tickerplant: Ticking towards growth ...... 131 Other ecosystem ventures...... 132
Valuations & View ...... 133 Management Structure...... 134
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INVESTMENT ARGUMENT FTIL has an impressive evolution cycle – from being India’s largest exchange technology provider (85% market share), it has evolved into Asia’s largest exchange conglomerate with 10 exchanges (five international) and six ecosystem ventures. The only listed gateway to the potential US$10trn Indian exchanges space, FTIL has established leadership in the commodity markets through MCX (87% market share) and given tough competition (49% share) to equity incumbent NSE in currencies. Besides, it has pioneered niche models in power and spot. The exchange behemoth is now looking to capture a pie in the Indian equity markets. While aggression and growth are inherent in FTIL, ability to redeploy capital accrued from these businesses (32% stake divested in MCX at entity valuation of US$1.1bn and 18% stake divested in MCX-SX at entity valuation of US$0.3bn) as also strategically staggering its growth over the next few years induce high conviction in the company. Recommend Outperformer with a target price of Rs2,000.
FTIL: A NEAT ENSEMBLE OF VISION, EXECUTION AND RISK APPETITE A technology solution for Two entrepreneurs – Jignesh Shah and Dewang Neralla, equipped with strong exchanges marked the domain expertise, ventured into creating solutions for ‘markets’ and established FTIL beginning of FTIL in 1995. Being an IPR product licensing business, the business model assured annuity income backed with strong growth. Thus, technology and building ‘annuity’ business formed the genesis of FTIL. Leveraging on these core attributes, FTIL has successfully broadbased its business model to create a ‘virtuous spiral’.
Exhibit 1: Business Model – a ‘virtuous’ spiral
Solutions business VISION Fueling growth in (Annuity backed One ‘big step’ core business IPR model) backed by strong domain expertise
International MCX India’s largest EXECUTION Exchanges commex (in potential (87% share of untapped US$1trn space) geographies) Management Wherewithal bandwidth to go global RISK APPETITE (Jignesh Shah, Dewang Neralla)
Ecosystem Capital ventures (32% divested in (Piggyriding MCX at entity ABILITY TO exchange industry valuation of MONETIZE growth) US$1.1bn)
Domestic Ability to re- Exchanges MCX-SX invest capital (addressing the ABILITY TO (Currency & potential entire US$10trn RE-INVEST equity) potential) Valued at US$284m
Source: IDFC-SSKI Research
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Multi-Commodity Exchange (MCX) marked the entry of FTIL in the exchanges FTIL the largest exchange conglomerate in Asia space in 2003. Over the last five years, FTIL has set up 10 exchanges as also six ecosystem ventures – making it the largest exchange conglomerate in Asia. Six of the exchanges cater to the US$4trn domestic market (expected to reach US$10trn by FY14) across different asset classes. FTIL has strived for a balanced mix covering commodities (MCX – India’s largest with 87% market share), currency (MCX-SX; 49% market share), forex, energy, agri and potentially equities (approval awaited). The remaining five exchanges are international multi-asset derivative exchanges in different geographies spanning Africa to Asia. The ecosystem ventures have been built around the domestic exchange framework and cater to spaces like warehousing, clearing, information dissemination, mobile trading, etc.
Exhibit 2: Business overview
Core Business Exchanges Ecosystem Ventures
Trading Solutions Exchange Solutions Domestic International
Source: Company, IDFC-SSKI Research
THE GENESIS: TECHNOLOGY IS IN ITS BLOOD! Products offered across Leveraging on their domain knowledge, the two entrepreneurs developed a strong the exchange technology product portfolio addressing the entire value chain of technology solutions in the value chain – exchanges as well as participants exchanges space (refer to the following exhibit). The domestic exchanges industry has seen a sharp growth in the number of participants. Broker members in the cash segment alone has gone up from 202 in 1994 to 44,074 currently. Thus, the increasing penetration of Indian equity markets (46% CAGR in turnover since 1994) has helped FTIL sustain strong growth momentum in its brokerage solutions business with 20x increase in number of licenses sold in the last four years.
FTIL today has an 85% share of the industry with its flagship product ODIN (trading terminal application) present across 860+ brokerage houses and implementing over 350,000 applications.
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Exhibit 3: FTIL’s technology solutions portfolio
Exchange Solutions Brokerage Solutions
Back Office Front Office Front Office Back Office
Clearing & Order Matching Trader Work Accounting & Settlement Engine Station (TWS) Settlement
Portfolio based Risk Online trading Online risk Management Engine system management
Inter-bank Forex Internet / VSATLease / Line Mobile based Messaging Dealing System trading solution
Source: Company, IDFC-SSKI Research
FTIL is a vendor for its With regards exchange solutions, FTIL is engaged in creating the technology group exchange ventures infrastructure for its own group exchanges. Of the six exchanges currently live, five run on FTIL technology (IEX runs on a platform provided by OMX). Further, technology for the remaining four exchanges – namely SMX, GBOT, BFX and BA, which are scheduled to go live over the next two years – is also being provided by FTIL.
An annuity-backed growth engine For trading solutions, By virtue of being an IPR based product licensing business, FTIL receives a one-time revenue mix from new fee on sale of products which is backed by an annual maintenance contract (AMC). license sales and AMC For brokerage solutions, the pricing model is varied across clients depending upon is 50:50 the volume/ usage and may entail a one-time sale or a lease model. An ODIN license, at an average, costs Rs10,000. This is backed with an AMC which is generally 15% of the one-time fee. In the brokerage solutions segment, the estimated mix in revenue between new license sales and AMC is 50:50, reflecting the inherent sustainability of the business model. While increasing penetration across the Indian exchange We expect 17% CAGR in landscape would be the primary driver for this segment, international exchanges set revenues over FY08-11 for trading solutions up by the group would open up cross-selling opportunities for FTIL in these markets. Thus, we expect this segment to register 17% CAGR in revenues over FY08-11.
While the brokerage solutions business is volume-driven, the exchanges solutions business is value-driven. The initial set-up costs for exchange solutions fall in the range of US$10m-20m and ongoing annual upgradation and maintenance costs form 10-15% of this one-time fee. With five exchanges already running live on FTIL software and four more in the pipeline, sustained income flow is assured for FTIL. With new exchanges providing impetus, Also, inclusion of new asset classes on existing exchanges would entail new exchange solutions to applications, which would again bring a one-time fee backed with annuity. While clock 70% CAGR over two exchanges (MCX-SX and NSEL) went live in FY09, the remaining four are FY08-11 expected to go live within the next two years. With the segment promising strong growth in the coming years, we expect 70% CAGR in this business over FY08-11.
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THE ONE ‘BIG’ MOVE – MCX
MCX to sustain leadership After almost a decade of understanding the business, FTIL drew on the strength of its position, albiet marginal solid core business and on the back of domain expertise, broadbased the opportunity slippage in market share landscape by venturing into exchanges. FTIL established MCX, its first exchange, possible with an initial investment of US$5m in 2003. Today, MCX is India’s largest commodity exchange with an 87% market share of the US$1trn industry (US$4trn by FY14E). While increasing competition may result in marginal slippage in market share for MCX, we see the exchange well-positioned to sustain its leadership position, and thereby capture the largest pie of the incremental market as well.
Exhibit 4: MCX dominating the high growth industry
…to grow to US$4tr by FY14 (a 32% CAGR) MCX dominates
Physical Global Indian Potential FY09 market Benchmark multiple (US$ bn) (US$ bn) (x) (x) NMCE Others NCDEX 0.8% 1.1% Gold 19.8 60-70 30 594 10.8%
Silver 11.3 60-80 35 396
Metals 29.4 20-30 10 294
Crude oil 60 20-40 15 900
Agricultural 200 20-30 10 2,000 products MCX Total 320.5 4,184 87.3%
Source: IDFC-SSKI Research Business model – sustainable and high operating leverage… Sustainable revenues with Strong annuity income (and thereby sustainability of revenues), transparency, high EBITDA Margins of 40%+ operating leverage and strong cash flows are hallmarks of the exchanges business, and MCX is no exception. Deriving 80%+ of its revenues from turnover on the exchange, which in turn is expected to register 35% CAGR over the next two years, the model promises robust growth ahead. While EBITDA margins of MCX are pegged at 40%+, earnings momentum would get a further boost from the incremental income stream in the form of interest on float (margin deposits in the exchange). The quantum of other income is based on various factors including open interest, etc and is typically 30-35% of revenues.
Exhibit 5: A flawless business model
Transaction fees 82% of revenues 35% CAGR in turnover over next 2 yrs
Operating expenses 17% CAGR over next two years Range bound
Annuity income with high operating EBITDA Margins 40%+ leverage Other income 30-35% of revenues (interest on margin deposits, etc)
PAT Margin 45%+
Source: IDFC-SSKI Research
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We expect MCX to garner MCX is estimated to have garnered revenues of Rs1.7bn and net profit of Rs947m in a net profit of Rs1.8bn FY08. The net profit is inclusive of Rs350m of capital gains arising from divestment in FY11 in DGCX. We expect MCX to garner a net profit of Rs1.8bn by FY11 – a 40% CAGR over FY08-11 (not considering capital gains).
…and the ‘brand’ is creating ‘value’ A 32% stake in MCX MCX has created a franchise for FTIL in the exchanges space, and its success has divested at an entity been the beginning of a new era for FTIL. Given the strong growth potential offered valuation of US$1.1bn by the Indian commodity exchange landscape, global players have evinced interest in the exchange. FTIL has divested a 32% stake in MCX so far at an entity valuation of US$1.1bn to key strategic and financial investors including NYSE Euronext.
EXECUTION SUCCESS STOKING RISK APPETITE Success of MCX turned into a strong growth curve for FTIL as the company attained the much-needed domain expertise as also capital (with stake divestment) to scale up. On the back of strong management bandwidth and focused vision, FTIL has tactfully re-deployed the accrued capital by replicating the near-perfect exchanges business. Today, FTIL has an inclusive portfolio of 10 exchanges (five domestic and five international brands) and six ecosystem ventures (refer exhibit 7). With regards to international ventures, FTIL has strategically selected geographies which have a strong underlying trading market but are yet to evolve in the derivatives trading arena – especially non-financial instruments.
Thus, FTIL addresses the entire value chain in the exchanges space as also all the different segments within the exchanges space. FTIL has emerged as the first company in the world with such an inclusive portfolio.
Exhibit 6: Addressing the entire value chain
Technology Commodity Stock Power Forex Information Mobile Spot exchange & solutions Exchange Exchange Exchange trading dissemination payments Warehousing
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Exhibit 7: Business Overview
Description Potential Strengths Growth drivers
Domestic
• Introduction of options • US$4trillion by FY14 - a 4x • Largest player in India Commodity Exchange •New products MCX growth with 85% market share • Increase in penetration
• US$1bn by FY14 - 3x growth for Stock Exchange (currently • Rupee convertibility currencies • 49% market share against MCX-SX only offering currency • Potential to move into • US$5.2tr in for equity markets equity mammoth NSE derivatives) equities by FY14
• Only 0.05% of short term traded IEX Energy Exchange • Largest player in India • Improving penetration power on exchanges
• US$320bn physical market in NSEL Spot Exchange • Largest player in India • Improving penetration India E X IBS Forex Forex trading platform • US$33bn of daily turnover • 3rd largest player in India • Rupee convertibility C H A International N • First intl multi- G Intl commodities derivative • World's largest physical market DGCX commodity derivative • Improving penetration E exchange in Dubai for energy and precious metals S exchange • World's 8th largest OTC • Strong management team Intl multi-asset derivative derivative market SMX - CEO is ex-director of • Improving penetration exchange in Singapore • Developed equity markets with Nymex Asia 722 listed companies
Pan-African derivatives • African rich in mineral resources • First exchange in the GBOT • Increase in participation exchange in Mauritius thus strong physical market region
• Commodity and financial • First exchange in the Multi-asset derivative instruments industry in Africa BFX region • Increase in participation exchange in Bahrain • Time zone between London & • Multi-asset offering Tokyo
• Africa rich in mineral resources Pan-African spot and • First exchange in the Boursa Africa thus offers a strong physical • Increase in participation derivatives exchange region market
Warehousing and collateral • Agri-commodity warehousing • Largest private player • Increasing rural NBHC E management industry with Pan-India presence penetration C Mobile payments • Successful adoption of O Atom • Credit card base of 40m by 2010 • Largest player in India S application technology Y • Financial industry accessing Tickerplant Information dissemination • Access through internet • Product acceptance S market data T E Across knowledge and risk M Others management, credit • New spaces • Pioneer •Building scale market
Source: Company, IDFC-SSKI Research
All the five domestic exchanges are currently live, with MCX-SX, IEX and NSEL having gone live in FY09. With these ventures still to complete one full year of operations, they do not charge transaction charges for trading and thus are yet to contribute to overall revenues. Among the international ventures, only DGCX is currently live. While DGCX is yet to garner deep liquidity (6,500 contracts traded daily), the inherent value creation ability of exchanges as also FTIL’s ability to monetize led to a part divestment in DGCX at an entity valuation of US$625m (5% divested to financial investors). Of the remaining exchanges, SMX and GBOT are expected to go live in 2009 while BFX and BA would be operational in 2010. Among
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the ecosystem ventures, NBHC has garnered relevant scale and has started contributing to FTIL’s profitability. However, the remaining ventures are still in the incubation stage.
MCX-SX: LOOKING TO CONQUER THE LARGEST EXCHANGE SPACE IN INDIA MCX-SX awaiting Fifteen years after the launch of NSE, India has a new stock exchange – MCX-SX, regulatory approval for jointly promoted by FTIL (49%) and MCX (51%). Trading in currency derivatives, entry into equity trading MCX-SX – with a 49% market share – is neck-to-neck with the equity incumbent NSE. MCX-SX is now targeting the equity markets and is awaiting regulatory approval for launching equity products on the stock exchange. The US$3trn Indian equity exchanges space is estimated to have made a profit of US$200m in FY09, wherein BSE holds on-fourth of the profit with its 7% share!
18% stake divested at an Regulations in India mandate a particular ownership structure for stock exchanges entity valuation of wherein promoter ownership is to be limited to a maximum of 15% within a US$284m stipulated time of start of operations. To align to the mandate, MCX-SX has recently divested an 18% stake to leading Indian banks (including Union Bank of India, Bank of India) at an entity valuation of US$284m. Previously, leading stock exchanges like NSE and BSE have garnered high strategic valuations of US$2.3bn and US$0.8m respectively. Thus, entry into equities would only add to the inherent value creation potential of MCX-SX.
Exhibit 8: MCX-SX waiting to enter the equity markets
Market share Profits Last valuation Players (FY09) (US$ m) (US$ bn)
93% 150 2.3
Indian equity 7% 50 0.8 exchanges
Approval awaited 0.3
Source: IDFC-SSKI Research
We expect MCX-SX to While NSE’s leadership is indubitable (given its 93% share), the success of MCX-SX emerge as a relevant stock in the currency derivatives segment as also of MCX in the commodity markets makes exchange us optimistic about the potential entry of the exchange in equities. Our interaction with the management indicates that MCX-SX has outlined a solid plan to capture a share of the equity markets on the back of several differentiating factors. Focus on SMEs, debt and bond segment (highly under-penetrated currently), extension of trading session to evening, etc could help MCX-SX create a strong niche in the Indian equity markets. More importantly, BSE is a distant No.2 in the Indian equity markets with less than 7% market share. Globally, every market has seen at least two dominant exchanges in every segment – ensuring arbitrage opportunity and strong participation. Thus, potential to build liquidity on MCX-SX’s equity segment remains strong.
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KEY RISKS Case with NSE – the big fight! Ongoing litigation with NSE has put FTIL on a watch list with allegations of bugs in its software solutions. NSE may impact FTIL The litigation process is on and KPMG has been chosen as an independent auditor for the same. However, the case does not exempt FTIL from being a vendor for NSE and hence the direct impact on FTIL’s business is mitigated. FTIL competes with NSE across various segments of the Indian exchanges space, which implies clash of business interest.
Exhibit 9: NSE v/s FTIL NSE FTIL Technology NOW, NSEIT, Omnesys ODIN Stock exchange Equity, F&O and currency Currency Commodity exchange NCDEX MCX Power exchange PXI IEX Overseas exchange None 5 exchanges Source: IDFC-SSKI Research
Execution risk Execution to be key Over the next two years, all four international exchange ventures of FTIL would monitorable for become operational. While these ventures promise high growth potential, they carry international ventures the risk of not attaining success being virgin spaces. Further, FTIL’s core technology business is also highly dependent on the success of these exchanges and would thereby be impacted in case these ventures do not pick up. While success of MCX and MCX- SX imparts confidence in the management’s execution ability, deliverance for the new ventures remain to be a key monitorable.
THE WAY TO VALUE FTIL: SUM-OF-PARTS We have valued FTIL We have valued FTIL based on SoTP. Core businesses which include the technology based on SOTP business, MCX and NBHC have been valued based on their operational performance. We have valued the technology business at 15x FY11E earnings, MCX at 25x FY11E earnings (resulting into an entity valuation of US$0.9bn which at a 20% discount to its strategic value) and NBHC at 20x FY11E earnings.
MCX-SX has recently divested an 18% stake to Indian banks at an entity valuation of US$284m. With MCX-SX’s potential entry into equities as also in view of the fact that the divestment has been done to Indian banks, we believe MCX-SX’s fair value is pegged at 2x the current divestment valuation.
We arrive at a per share Further, FTIL is estimated to have an invested capital of Rs9.6bn by FY11 across the value of Rs2,000 for FTIL remaining eight exchange ventures (three domestic and five international, of which DGCX was valued at US$625m by financial investors) and five ecosytem ventures. With an assumption that at least two of these eight ventures would establish success, we have valued the invested capital at 2.5x. In addition, FTIL is expected to have Rs7.7bn of net cash on books in FY11. Thus, we arrive at an aggregate entity valuation of US$1.9bn for FTIL, which translates into a per share value of Rs2,000.
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Exhibit 10: SOTP Entity Basis of Resulting entity FTIL Resultant value valuation value (Rs bn) stake (%) for FT (Rs bn) FT Core Business 15x FY11 earnings 23.9 100 23.9 MCX 25x FY11 earnings 45.4 31.20 14.2 NBHC 20x FY11 earnings 8.9 86.2 7.7 MCX-SX 2x strategic valuation 27.0 53.1 14.3 Invested capital in group cos 2.5x inv cap 24.2 100 24.2 Cash and Other investments 1x inv 7.7 100 7.7 Total 92.2 Per share value 2,000 Source: IDFC-SSKI Research
Exhibit 11: Corporate structure
Jignesh Shah & Family
46.6%
100% Financial Technology (Core exchange solutions business) FT Mauritius
Exchanges Ecosystem Others
20% 51% 66.2% NSE 31.2% 5% NBHC (Rs1.25bn) MCX DGCX DMCC (Rs130m) 19% 100% Tickerplant 42% DSE, Vadodara 18.0% Investors (Rs400m) Indian 5% (Rs160m) Banks 100% 40.0% SMX 100% FTKMC MCX-SX (Rs1bn) (Rs40m) 26.0% 99.9% PTC India CSML IEX GBOT 100% (Rs50m) 41.2% (Rs110m) (Rs1.1bn) 100% 32.0% Riskraft Investors (Rs50m) 99.9% NSEL BFX 100% 99.4% Atom (Rs160m) (Rs760m) (Rs60m) 76.0% IBS Forex 60% 23% BA (Rs30m) MCX-SX CCL 26%
51% Source: IDFC-SSKI Research; Note: Figures in brackets indicate capital employed currently.
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SOLUTIONS BUSINESS: ETERNAL BUBBLE FTIL’s genesis lies in the technology solutions business. Addressing the entire value chain of exchange solutions, FTIL has created a unique niche for itself and thereby dominates the domestic industry with an 85% market share. The business model provides strong annuity backing with FTIL having sold 350,000 licenses of ODIN (flagship model for traders). With trading penetration being the key growth driver for the Indian exchanges industry, it would provide leverage to the resilient model of FTIL. We expect this business to garner revenues of Rs3.7bn and net profit of Rs1.6bn in FY11.
TECHNOLOGY SOLUTIONS FOR ‘MARKETS’: LOW LATENCY IS THE RAGE FTIL addresses the entire The financial services solutions industry broadly comprises two different segments – value chain in the categorized on the basis of the end users being market participants or the exchange exchange solution space marketplace itself. The technology solutions industry for market participants is estimated to be a US$15bn industry globally. On the other hand, exchanges – in the race to attract higher liquidity – are consistently improvising their existing technology framework. FTIL is uniquely placed in the industry as it addresses the entire value chain with a wide product offering including front office and back office software for exchanges as well as brokers.
Exhibit 12: FTIL addressing the entire value chain
Exchange Solutions Brokerage Solutions
Back Office Front Office Front Office Back Office
Clearing & Order Matching Trader Work Accounting & Settlement Engine Station (TWS) Settlement
Portfolio based Risk Online trading Online risk Management Engine system management
Inter-bank Forex Internet/ VSAT / Lease Line Mobile based Messaging Dealing System trading solution
Source: Company, IDFC-SSKI Research
TRADING SOLUTIONS: TIME THE MARKET
Trading solutions for The biggest market that the wave of electronic trading has created is that of participants is a US$15bn technology solutions for clients. Estimated to be a US$15bn industry globally, the global industry trading solutions and related market product industry has witnessed strong growth. With deepening penetration of electronic markets, an increasing number of clients are opting for enhanced trading solutions. Key global players include SunGard, Fidessa, Orc Software and GL Trade (now acquired by SunGard).
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Exhibit 13: Trading solutions – a US$15bn global industry BUY SIDE
Order & Execution Date & Info Broker Connectivity PMS / Risk Settlement Management System
Cross asset 3 B$ 2 B$
Front to back Date & Info Order Routing Front Office Middle Office Back Office solutions
Listed equities 2 B$ 5 B$ 0.5 B$ ETD 0.2 B$ 2 B$ FX-Money Mkt 1 B$ Fixed income
Client Connectivity OMS / Market Date & Info Posting / Risk Settlement DMA Connectivity
SELL SIDE
Source: GL Trade, IDFC-SSKI Research
We interacted with global players to understand the intricacies of the industry. Our sense is that the risk of technology obsolescence is innate to the industry and the ongoing advent of enhanced trading methodologies (like algorithm trading, DMA, etc) makes it imperative for industry participants to continuously improvise and upgrade their systems. The advent of electronization on Indian exchanges took place with the incorporation of the National Stock Exchange (NSE).
FTIL – strong leadership… FTIL’s ODIN a huge With NSE changing the dynamics of equity markets by taking trading terminals to success as it allows brokers, FTIL was the first in India to recognize the strong potential for market brokers to customize their intermediaries. While exchanges provide their own software, they do not allow clients trading screens to customize the home screen. FTIL launched its first product ODIN – a front office solution which let brokers customize their interfaces with stock exchanges and execute market trades from their terminals. Today, FTIL holds an impressive 85%+ share of the Indian financial services software solutions industry.
…in a growing market With deeper penetration of The domestic industry has seen sharp growth in the number of participants in the equity trading, 67% CAGR exchanges industry. In the last 14 years, number of brokers in the cash segment alone in FTIL’s IPR product has gone up from 202 in 1994 to 44,074 currently. The increasing penetration of licensing business over last four years Indian equity markets (40% CAGR in turnover since 1994) has helped FTIL sustain strong growth momentum in its IPR product licensing business with a 67% CAGR over FY04-08. With 860+ brokerage clients, FTIL has sold nearly 350,000 licenses of its flagship product ODIN (a trading workstation).
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Exhibit 14: Cash segment brokers– 47% CAGR over last 14 years… …and 46% CAGR in turnover
(nos) (US$ bn) Sub-Brokers(Cash Segment) Cash market turnover 50,000 1,200
37,500 900
25,000 600
12,500 300
0 0 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08
Source: SEBI Handbook
Product licensing – an annuity-backed business model ODIN typically sells at By virtue of being a product licensing business, FTIL receives a one-time fee on sale Rs10,000 with AMC at 15% of products which is backed with an AMC. The AMC charges are 15% of the of the product cost product cost, thereby assuring an annuity income flow for the company. The pricing model for brokerages is varied across clients depending upon the volume/ usage. Thus, the license may be sold for a one-time fee or may follow a lease model. An ODIN license has an average cost of Rs10,000.
Key growth drivers The following would impart further impetus to FTIL’s core business:
Increasing participation in new exchanges Increasing broker FTIL has set up 10 different exchanges, of which six are operational and the participation to drive remaining are due to go live in the next two years. Of the six operational ones, three growth in trading solutions business exchanges have gone live only in 2008, and hence are yet to reach full-scale operations. We believe that as business on these exchanges gains momentum, the participation would increase (in terms of broker members) and thus boost revenues for the company.
International markets As FTIL’s international FTIL currently caters primarily to the domestic industry. However, launch of ventures gain traction, exchange ventures in international markets of Dubai, Singapore, Malaysia, etc would higher visibility to boost solutions business enhance visibility for the company and open up cross-selling opportunity in these markets. Globally too, Euronext and OMX achieved success in the technology solutions segment on the back of their exchanges. Hence, with increasing noise value of FTIL’s exchange ventures, we see the company well-equipped to tap the potential market outside India.
Advanced solutions Introduction of new equity While penetration of equity markets in India has reached significant levels (64% to products would drive the GDP), advanced processes such as algorithm trading and DMA are yet to be need for advanced technology solutions introduced. Trading on DMA channels is very popular in developed markets of USA where DMA accounts for nearly 18% of the total traded volumes. With respect to algorithm trading, nearly 40% of the volumes traded on NYSE are programmed. We believe the potential opportunity offered by these advanced technologies is immense
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and would be a key growth driver for FTIL in a few years, as the Indian market evolves further.
Exhibit 15: US DMA equities volume growth (2002-10)
Shares (bn) Direct access volume growth 400
300
200
100
0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E Source: Celent, World Federation of Exchanges
EXCHANGE SOLUTIONS: SPEED IS CRUCIAL Electronic trading has played a vital role in shaping the exchanges industry. Exchanges in USA and UK traditionally developed own proprietary software to meet their technology requirements. With electronic trading catching pace, established electronic exchanges have become formidable technology providers to the financial markets at large. For example, NYSE Euronext and NASDAQ OMX have a dominant presence in providing technology solutions to financial markets. Today, nearly 40% of the world’s electronic exchanges operate on technology developed by Euronext or OMX.
Technology solutions help Enhancing the technology infrastructure is becoming a key focus for exchanges across reduce transaction time, the world in order to reduce transaction time, and thereby attract more liquidity. and thus enable higher volumes Traditionally, reduction in execution time of trades has mostly led to higher volumes. The cost of technology solutions for exchanges varies depending on the complexity and specific requirements of the exchange. The latest agreements signed include the Malaysian Derivative Exchange appointing Euronext for technology support at an estimated cost of US$70m. Saudi Exchange is estimated to have incurred costs to the tune of US$90m for its exchange software from OMX.
Exhibit 16: CME– faster execution improving volumes …Latest contracts for exchange solutions
Average order volume (m - LHS) Average round trip time (ms - RHS) 250 234mm 140 127ms Technology Estimated Cost Exchange Provider (US m) 200 112
Malaysian Derivative 150 84 NYSE Euronext 70 Exchange
100 56 Saudi Stock OMX 90 50 28 Market Tadawul 7ms 4mm 0 0 2004 2005 2006 2007 2008 2009 Source: CME Group
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FTIL – supporting its group ventures We expect substantial With respect to its exchange solutions business, FTIL provides software for its group demand for technology exchange ventures. The initial set-up costs for exchange solutions fall in the range of solutions from in-house ventures US$10m-20m and ongoing annual upgradation and maintenance costs form 10-15% of this one-time fee. With five exchanges already running live on FTIL software and four more in the pipeline, sustained income flow is assured for FTIL. Also, inclusion of new asset classes on existing exchanges would entail new applications, which would again bring a one-time fee backed with annuity. While two exchanges (MCX-SX and NSEL) went live in FY09, the remaining four are expected to go live within the next two years, thereby promising strong growth for the segment. Thus, we expect 70% CAGR in segment revenues over FY08-11.
COMPETITIVE LANDSCAPE
Religare Technovo and Electronic trading was introduced in India by NSE, which developed its technology NSE IT are FTIL’s key in-house (by NSE IT – its technology-focused subsidiary). In order to survive the competitors in the space onslaught of electronic platform, BSE too contracted CMC to develop its online trading system – BOLT (BSE Online Trading Terminal), operational since 1995. However, FTIL is the clear market leader in the Indian market for with a dominating 85%+ market share. Other key players in the industry include Asian CERC (name changed to Religare Technovo Global Solutions) and NSE IT. Given FTIL’s reach across 860+ clients and a robust network formed through its exchange ventures, we believe FTIL is well positioned to sustain its lead.
KEY CONCERNS While we are fairly comfortable with FTIL’s solutions business model, direct exposure to the exchanges marketplace and the ongoing litigation with NSE are two key concerns.
Exposure to markets Revenues linked to market As FTIL’s product offerings are directly related to markets, the business is exposed to conditions, though a solid market choppiness. Sale of new licenses for brokers would see a slowdown in difficult base of 350,000 clients for ODIN provides comfort markets and hence impact revenues. However, we derive comfort from the fact that FTIL has an existing license base of 350,000 clients, which brings an annuity revenue stream. Further, contribution of revenues from exchange solutions is expected to remain healthy and overall revenues would not be significantly impacted in times of volatility.
Case with NSE – the big fight! Ongoing litigation with NSE has put FTIL on a watch list with allegations of bugs in its software solutions. NSE may potentially The litigation process is on and KPMG has been chosen as an independent auditor impact solutions business for the same. However, the case does not exempt FTIL from being a vendor for NSE and hence the direct impact on FTIL’s business is mitigated. FTIL competes with NSE across various segments of the Indian exchanges space, which implies clash of business interest.
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Exhibit 17: NSE v/s FTIL NSE FTIL Technology NOW, NSEIT, Omnesys ODIN Stock exchange Equity, F&O and currency Currency Commodity futures NCDEX MCX Power trading PXI IEX Overseas exchange None 5 exchanges Source: IDFC-SSKI Research
FINANCIAL ANALYSIS FTIL’s core technology solutions business has shown a healthy 26% CAGR over FY06-08. The strong base of 350,000 licenses in trading solutions would generate a consistent annuity income, while inception of new exchanges will fuel exchange solution revenues. We expect FTIL’s standalone business to garner revenues of Rs3.7bn and net profit of Rs1.6bn in FY11.
Strong traction in revenues – 39% CAGR over FY08-11E… Exchange solutions to In FY08, FTIL garnered revenues of Rs940m from trading solutions on the back of a drive revenue growth 95% increase in license sales. Thus, the strong license base of 350,000 would generate 17% revenue CAGR in trading solutions over FY08-11E. With regards exchange solutions, FTIL garnered revenues of Rs433m in FY08 as only MCX and DGCX were operational till then. However, with three new exchanges (MCX-SX, NSEL and IEX) having gone live in FY09 and two exchanges scheduled to go live each year for the next two years, this segment would witness strong momentum. We expect exchange solutions to register a 70% CAGR over FY08-11. Thus, we anticipate the core business to generate aggregate revenues of Rs3.7bn in FY11. Overall, we expect the division to register 39% CAGR over FY08-11.
Exhibit 18: Revenue growth to remain strong… …exchange solutions to contribute a higher share
Total revenues IPR based licenseS Exchange Solutions Sales of trading goods (Rs m) (%) 4,500 100 3,872 3,750 3,433 2,919 75 3,000
2,250 50 1,432 1,500 899 1,023 25 750
0 0 FY06 FY07 FY08 FY09E FY10E FY11E FY06 FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
…leading to margin expansion We expect EBITDA margin With a fixed cost structure, margins in the business are sensitive to growth in of 45% in FY11 revenues. Thus, the robust growth in revenues would lead to margin expansion. We expect EBITDA margins to improve from 32.6% in FY08 to 45% in FY11E.
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Exhibit 19: Margins to expand
EBITDA (Rs m - LHS) Margins (% - RHS) 1,800 70 1,666 65 1,422 1,350 60 1,173
900 50 45 581 44 42 450 434 449 43 40
33
0 30 FY06 FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
Net profit to register a 24% CAGR over FY08-11E We expect net profit of FTIL garnered a net profit of Rs838m from operations in FY08. Additionally, Rs1.6bn in FY11 divestment of a 27% stake in MCX resulted in capital gains of Rs11.2bn and Rs2.1bn in FY08. Interest accrued on this capital resulted in FTIL garnering Rs935m of other income in FY08. Also, a further 5% stake sale in MCX in FY09 has brought in incremental capital inflow of Rs2.1bn with another Rs1.2bn likely to accrue from divestment in MCX-SX in FY10. With FTIL tactfully deploying accrued capital into potential businesses, quantum of interest income would decline. We expect a 24% CAGR in operational profits over FY08-11. Thus, we expect the core business to generate net profit of Rs1.6bn in FY11.
Exhibit 20: Profits to increase steadily* PBT (Rs m) 2,387 2,500 2,102
2,000 1,823
1,500 1,251 1,168
1,000 631
500
0 FY06 FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research (*PBT given to exclude capital gains)
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EXCHANGES BUSINESS: A NEW BEGINNING FTIL ventured into exchanges by setting up MCX, the biggest success for the company so far. Dominating the US$1trn commodity exchanges space with 87% market share, value accretion from MCX (32% stake divested at an entity valuation of US$1.1bn) provided the wherewithal to FTIL to broadbase its opportunity landscape. On the back of strong management bandwidth and ability to redeploy capital, FTIL has replicated the near-perfect exchanges model to become Asia’s largest exchange conglomerate (10 exchanges across different asset classes and geographies). While MCX offers high earnings visibility, new exchanges are gathering scale – which would eventually translate into profitability. With MCX proving its mettle, MCX-SX (India’s third stock exchange) stands to be FTIL’s big bet as it promises high value creation potential (18% to be divested at US$0.3bn), thereby providing a near-term trigger.
FTIL: AN EXCHANGE BEHEMOTH FTIL started its journey in the exchanges space by setting up MCX – a national-level commodity exchange – in 2003. Success of MCX turned into a passionate growth curve for FTIL as the company attained the much-needed domain expertise as also capital (32% stake in MCX divested at an entity valuation of US$1.1bn) to scale up. Today, FTIL has an inclusive portfolio of five domestic brands and five international exchanges, making it the largest exchange conglomerate in Asia.
Exhibit 21: Overview of exchange ventures
FTIL Date of No of Liquidity Exchange Description Location Holding Commencement members per day (%)
India's largest commodity exchange India 31.2 Nov, 2003 1900 US$3.5bn
6500+ Leading derivatives exchange in Middle East Dubai 39.0 Nov, 2005 221 contracts
14500 India’s first power exchange India 41.2 Oct, 2008 403 MWh
India's third stock exchange (currently trading India 40.0 June, 2008 52 US$500m in currencies only)
India's No.3 online inter bank trading platform India 76.0 June, 2002 26 ~US$1.6bn
First pan India electronic spot exchange India 99.9 Oct, 2008 285 Rs63m
Targeted to go live International commodity derivatives exchange Singapore 100.0 - - in 2009
Targeted to go live First Pan African derivatives exchange Mauritius 100.0 - - in 2009
Targeted to go live Multi-asset derivatives exchange in Bahrain Bahrain 100.0 - - in 2010
First pan African spot and derivatives multi- Targeted to go live Africa 60.0 - - asset exchange in 2010
Source: Company, IDFC-SSKI Research
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MCX: FLAWLESS SUCCESS Capitalizing on strong domain expertise, FTIL forward-integrated its technology business and ventured into exchanges by establishing MCX in 2003. MCX is a national-level multi-commodity exchange, established as a demutualized and electronic entity. Today, MCX leads the US$1trn commodity exchanges industry with an impressive 87% market share.
MCX – the commodity bull! MCX’s strong dominance The Indian commodity derivatives sector promises 4x growth from a turnover of in commodities trading to US$1trn to US$4tr in the next five years. With an 87% market share of this segment, enable it to capitalize on MCX is the best placed among peers to capitalize on this humongous opportunity. the 4x growth potential MCX has witnessed rapid growth in membership on its exchange from 843 in FY05 a 1,900+ members. Of this, we believe 600 are active members trading on a daily basis. The fact that liquidity is sticky for exchanges supports our view that MCX would sustain dominance in the rapidly growing industry.
Exhibit 22: MCX best placed to capitalize on the growth
…to grow to US$4tr by FY14 (a 32% CAGR) MCX dominates
Physical Global Indian Potential FY09 market Benchmark multiple (US$ bn) (US$ bn) (x) (x) NMCE Others NCDEX 0.8% 1.1% Gold 19.8 60-70 30 594 10.8%
Silver 11.3 60-80 35 396
Metals 29.4 20-30 10 294
Crude oil 60 20-40 15 900
Agricultural 200 20-30 10 2,000 products MCX Total 320.5 4,184 87.3%
Source: IDFC-SSKI Research
MCX – liquidity is Golden! MCX has emerged as a Participation in the Indian commodities exchange industry is restricted to domestic leading world player in players. Despite this, MCX has managed to establish a strong presence on the global bullion trading stage. MCX is world’s largest exchange in silver – displacing the largest international metals exchange, COMEX – with 45% higher volumes (in terms of number of contracts). Also, in gold where India is the world’s largest consumer, MCX is world No.3 with the number of contracts traded only 8% lower than the leader TOCOM (Source: FIA). Clearly, bullion has been the key success factor for MCX. (Note: Globally ‘number of contracts’ traded is the key metric to rank exchanges and it does not take into consideration the contract size, which for Indian exchanges is much lower than for international players.)
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Exhibit 23: MCX taking on international exchanges No of contracts of Gold futures traded in 2008 No of contracts of Silver futures traded in 2008 No of contracts of Copper futures traded in 2008 38.4 12.9 30.0 40.0 14.0
8.9 22.5 30.0 10.5
15.0 20.0 15.2 7.0 14.0
7.5 10.0 3.5
0.0 0.0 0.0 LME SHFE MCX MCX Nymex Nymex Tocom MCX Source: FIA, IDFC-SSKI Research
MCX’s dual strategy of offering a differentiated portfolio of products inclined towards global commodities and inducting relevant public sector players through equity participation in the exchange has enabled it to establish itself as the leader.
Exhibit 24: Key drivers of liquidity on MCX
Public sector participation in Focus on global Alliances with domestic trade the form of equity ++commodities associations
Liquidity
Source: IDFC-SSKI Research
MCX’s strategic focus on MCX, since inception, has rightly emphasized on global commodities, while the global commodities, vis-à- other two national exchanges – NCDEX and NMCE – focus on agri commodities in vis agri commodities for their effort to tap the Indian potential. With global commodities providing a good Indian peers, has paid off benchmark in terms of price, participation in these commodities has been far superior. This has helped MCX achieve liquidity – the single most important success factor for an exchange. Once MCX was able to attract liquidity in certain commodities, the network effect had a rub-off effect on other commodities. Thus, MCX steadily took market share off competitors and currently leads with a dominating 87% share.
Exhibit 25: Industry turnover moving towards global commodities… …improving market share for MCX Gold Silver Energy Metals Agri MCX NCDEX NMCE Others (%) 100% 100
75% 75
50% 50 87.3 76.9 62.4 25% 25 44.6 28.9
0% 0 FY05 FY06 FY07 FY08 FY09 FY05 FY06 FY07 FY08 FY09 Source: FMC, MCX, IDFC-SSKI Research
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Strong product portfolio… A well-diversified MCX has developed an impressive product portfolio with offerings across commodities basket commodities like bullion, metals, agri, energy, etc. Over the years, MCX has steadily comprising 55 products is MCX’s key strength expanded its commodity listings and offers trading in 55 commodities (from 15 in FY04). MCX has been the pioneer in various commodity listings like steel, crude oil and plastics. Further, in a strategic alliance with Chicago Climate Exchange, MCX has also launched carbon credits in India. In addition, MCX has devised contract specifications to cater to the domestic industry. Contract sizes are small and thus attract participation from a wider section of traders.
With higher liquidity, MCX While MCX offers a broad portfolio of commodities, gold is the highest traded well-placed to launch new commodity on the exchange and contributes 46% of the total traded value on the products exchange. Energy futures, mainly crude oil futures, are the second most liquid commodity contributing 22% to the total traded value on the exchange. We believe liquidity on the exchange is well distributed across commodities, which enhances MCX’s ability to launch new products.
Exhibit 26: Turnover distribution of MCX for FY09
% of total traded value
Agri, 1% Metals, 13%
Gold, 46%
Energy, 22%
Silver, 18% Source: Company, IDFC-SSKI Research
Indices – potential restricted by regulations Favourable policy on MCX has launched various indices on its exchange, providing a holistic view of trading in commodity commodities in certain baskets. In June 2005, the company launched MCX- indices can be a big growth trigger COMDEX (India’s first composite commodity futures price index) along with three group indices – MCX Agri, MCX Metal and MCX Energy. In addition, three rain indices, RAINDEXMUM (Mumbai), and RAINDEXIND (Indore), RAINDEXJAI (Jaipur) have also been launched – to track the progress of monsoon rains in the respective geographic location. Traditionally, indices serve as an excellent hedging tool, mitigating risk across a basket of commodities. However, commodity indices are not open to trading currently. We believe relaxation of this regulatory restriction could be a potential growth driver for MCX.
…an efficient back-end MCX’s operations MCX has an in-house clearing house which manages the daily MTM settlement as supported by 48 well as final settlement of all contracts including cash settlement and physical delivery warehouses across 21 locations of commodities. MCX has approved 13 clearing banks to support electronic funds transfer for settlement purposes and 48 exchange-designated warehouses across 21 locations to support the physical delivery of commodities.
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Physical delivery When a contract enters into a delivery period towards the end of its life cycle, which is typically five days before the expiration of the contract, a tender period margin is imposed. Such margin is imposed on members having open positions and is calculated according to a rate which varies according to the type of commodity. When a buyer pays money for the delivery allocated, the position is treated as settled and the tender/ delivery period margin is exempted. The matching of positions for the physical delivery of the underlying commodities is done according to contract specifications. Unmatched positions are settled in cash at the Due Date Rate. Cash settlement of the contract is done the day after the contract expiry date.
Exhibit 27: Process flow
Designated warehouse
5 . W ty ith di d o ra mm wa co l it of os co ep m D m 1. od ity
3. Pay out of funds 4. Commodity payout
Seller Delivery & Buyer settlement 1. Intent to give delivery 2. Pay in of funds
Source: Company, IDFC-SSKI Research
Physical delivery of the underlying commodity can be specified in futures in one of the three ways:
Seller’s Option: Physical delivery of the underlying commodity is affected if the seller having short open positions indicates an intention to deliver the goods. Otherwise, all open positions for the commodity on the expiry date of the contract are closed out at the price which is calculated by way of taking the weighted average of the spot market prices of the commodity over the last day, three days or five days of the contract expiry date, depending on the contract specifications and no penalties are imposed.
Compulsory Delivery: For a contract which has compulsory delivery option, a seller having an open position on the expiry date of the contract must deliver the underlying commodity on the working day after the expiry date. Penalties are imposed for non-delivery of the commodity at rates indicated in the contract specification. Similarly, buyers should compulsorily take delivery of such commodities, failing which they too will be charged a penalty for such default as indicated in the contract specification.
Both (Buyer’s and Seller’s) Option: Physical delivery of the underlying commodity will be affected only when both the buyer and seller give their consent to take and give delivery. Any remaining unmatched quantity of underlying goods and any open positions for which delivery intentions were not made will be closed out without the imposition of any penalty.
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Key growth drivers While MCX is on the path of strong growth traction, we believe the following developments would provide further growth impetus:
Introduction of Options Permission to launch Indian commodity exchanges are yet to evolve in terms of their product offering. options to drive turnover Regulations do no permit option contracts to be traded on the exchange. Options on commexes being a more sophisticated hedging tool than futures, they attract good participation. As seen on Indian equity exchanges, options contribute 27% to the total industry turnover. Thus, we believe permission to launch options would drive turnover growth of the industry and MCX, being the largest player, would derive maximum benefit.
Advanced products Addition of intangible Intangible commodities like weather derivatives, freight rates, etc are currently not commodities to permitted permitted by the government. Proposal for the same has been submitted to the basket would benefit MCX government and their introduction would enhance participation from wider sectors which face such risks. With its strong liquidity base, we believe MCX would be the best placed to attract participation in new products.
Institutional participation Participation of MFs, FIIs Government initiatives play an important role in development of the commodities and banks on commexes industry in India. FMC may also permit mutual funds, FIIs and banks to invest in to boost market activity commodity derivatives in India. If allowed, we believe this will result in increased market activity and contribute to overall growth of the Indian commodities futures market.
Key risks MCX has a strong business model and is well positioned to capitalize on the US$4trn potential of the Indian commodity exchanges sector. However, the following issues concern us:
Credit risk of members Though risk mitigation The clearing house of MCX guarantees the settlement of trading done through the systems are in place, exchange. As a result, MCX is exposed to credit risk of members. Thus, any defaults defaults by trading by trading members could adversely impact MCX. While such a potential hangover members could adversely impact MCX exists for all exchanges, defaults of such nature all well handled by a good risk mitigation system – through margins. We believe MCX has sound systems and measures in place to cover default and maintain liquidity. Since inception, MCX has not had a single default.
Change in regulations Policy interference could The commodity futures exchange industry is regulated by the FMC and the Ministry disrupt business, but risk of Consumer Affairs. The FMC has, from time to time, placed a ban on certain agri higher in agri commodities commodities. Such restrictions could have a materially adverse impact on volumes, and thereby profitability, of MCX. However, MCX has only 5% of its turnover from agricultural products. Thus, we believe MCX is well positioned in this uncertain regulatory environment – in contrast to its competitor NCDEX which is highly dependant on agri commodities (95% of its volumes).
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40% of MCX volumes accrue from top 10 members Client concentration risk MCX derives a significant portion of revenues from a limited number of members, looms large, though and this dependence has only been increasing. The top 10 members accounted for receding with higher 40%+ of the total turnover in FY08 in comparison to 30% in FY06. The loss of these penetration members or any decrease in their volume of trades may adversely impact revenues and profitability. However, as penetration in the industry improves, we believe participation on MCX would get balanced.
Increasing competition Competition is bound to Corporate groups like Indiabulls and Kotak are looking for a potential entry in the escalate with entry of big Indian commodity exchanges space. Indiabulls has already attained the license for the corporates in the space same and is targeting to launch its exchange in 2010. With such big corporates entering the industry, market share of MCX could be impacted. However, we believe the industry size would only increase with competition and as liquidity rests with MCX, its leadership would be maintained.
Capital structure FTIL holds a 31.2% stake in MCX, with the remaining owned by key strategic and financial investors.
Exhibit 28: Shareholding pattern Name % shareholding FTIL holds a 31.2% stake FTIL 31.2 in MCX FID Funds (Mauritius) 9.2 State Bank of India 5.3 Citigroup Strategic Holdings 5.0 Merrill Lynch Holdings 5.0 IL & FS Trust Company 5.0 NYSE Euronext 5.0 Corporation Bank 3.6 NABARD 3.2 ICICI Trusteeship Service 3.1 Passport India Investments 3.0 NSE 2.5 GLG Financial Fund 2.0 BCCL 1.9 Source: MCX, IDFC-SSKI Research
Financial analysis We expect MCX to register 28% revenue CAGR over FY08-11E. With operating leverage coming into play, EBITDA margins are expected to improve from 28% in FY08 to 49% in FY11, driving a 40% CAGR in net profit over the period.
Revenues – Rs3.6bn in FY11E (28% CAGR over FY08-11E) Primary sources of revenue for MCX are transaction fees, membership fees (new admission as well as annual renewal) and terminal charges.
A. Transaction fees – 80% of overall revenues Transaction fees charged MCX charges transaction fees to members for the execution of trades. Both buyers to both buyers and sellers and sellers are charged transaction fees. The fee charged to a member in any month
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depends on the average daily turnover generated by the member in the previous month and is charged in various slabs (as shown below). We expect MCX to garner a 39% CAGR in turnover over FY08-11. However, in view of competition as also entry of new participants in commodity markets (and thereby trading a lower turnover), we believe average transaction fees would decline going forward. Thus, we expect 34% CAGR in transaction revenues over FY08-11.
Exhibit 29: Transaction fees charged in slabs… …steady growth in revenues from transaction fees
Total transaction fees (Rs m - LHS) Total value traded (Rs bn - RHS) 3,500 90,000 Average Daily turnover Transaction Fee 3,268
Rs.4 per Rs.100,000 of 2,800 72,000 Up to Rs.200 million 2,452 turnover 2,100 54,000 On incremental volume above Rs.200 Rs.3 per Rs.100,000 of 1,862 million up to Rs.1,000 million turnover 1,400 1,362 36,000 On incremental volume above Rs.2 per Rs.100,000 1,103 Rs.1,000 million to Rs.3000 million of turnover 18,000 700 532 On incremental volume above Rs.1 per Rs.100,000 53 Rs.3000 million of turnover 0 0 FY05 FY06 FY07 FY08E FY09E FY10E FY11E Source: MCX, IDFC-SSKI Research
B. Membership admission fees Rapid growth in MCX has witnessed rapid growth in membership on its exchange from 843 members membership base in FY05 a 1,900+ membership base. MCX has outlined four different categories of membership based on the rights available. All members are entitled to pay a one-time admission fee as well annual subscription charges. MCX has progressively increased the amount of admission fees charged to members (refer exhibit below). With MCX having established a sound membership base over the past five years, we believe it would witness marginal additions in membership going forward.
Exhibit 30: Membership charges being increased progressively (Rs m) As of Dec-03 to Sept-04 to July-05 to May-06 to May-07 Nov-03 Sept-04 July-05 Apr-06 Apr-07 till date TCM –Non Deposit Based 0.25 0.35 0.5 0.75 1.0 2.0 TCM – Deposit Based - - - 0.375 0.5 1.0 ITCM 0.5 0.5 1.0 0.75 1.0 2.5 PCM - - - - - 1.0 Nov-03 to Apr-05 to July-07 Mar-05 July-07 till date TM 0.1 0.25 0.75 Source: MCX, IDFC-SSKI Research
MCX expected to clock We expect MCX to garner revenues of Rs3.6bn in FY11 – a 28% CAGR over FY08- revenues of Rs3.6bn in FY11 11. Of this, Rs3.3bn or 90% is estimated to be contributed by transaction fees in FY11.
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Exhibit 31: Growth in turnover driving revenues Total Revenues (Rs m - LHS) Total Value Traded (Rs bn - RHS) 4,000 90,000 3,617
3,000 2,827 67,500
2,282 2,000 45,000 1,656 1,738
1,000 900 22,500
298 42 0 0 FY04 FY05 FY06 FY07 FY08E FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
EBITDA margins – improving on the back of high operating leverage
We expect EBITDA As operations of MCX started picking up, its fixed cost base increased, which meant margins of 49% in FY11 margin contraction from 61% in FY06 to 28% in FY08. However, MCX has now attained the base level liquidity and operating expenses would be range-bound. This would allow the high operating leverage inherent to the exchange business to play out. We expect MCX to attain EBITDA of 49% in FY11.
Exhibit 32: Margins to expand EBITDA (Rs m - LHS) Margins (% - RHS) 2,000 65 61 1,772 59 1,500 55 1,272
49 1,000 970 45 935 45 41 546 500 487 35
28 0 25 FY06 FY07 FY08E FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
Other income – icing on the cake Margin money invested in MCX collects margins from members for all open positions on the exchange, which is debt-based mutual fund then invested in debt-based mutual fund schemes and bank fixed deposits. In FY08, schemes and bank fixed deposits MCX garnered other income of Rs652m. The income earned on investments is partially affected by the value of open interest positions on the exchange, and thereby the turnover. With turnover following a strong growth trajectory, we expect MCX to garner other income of Rs1.2bn in FY11.
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Exhibit 33: Other income increasing on the back of rising turnover Non-operational income (Rs m - LHS) Total Value Traded (Rs tr - RHS) 1,200 1174 90.0
84 978 900 67.5 815 62 652 600 45.0 46 408 31 300 22.5 23 144 10 0 0.0 FY06 FY07 FY08E FY09E FY10E FY11E Source: MCX, IDFC-SSKI Research
PAT – 40% CAGR over FY08-11E We expect net profit of We expect MCX to attain net profit of Rs1.8bn in FY11 – a 40% CAGR over FY08- Rs1.8bn for MCX in FY11… 11. Additionally, divestments in MCX-SX would result in capital gains of Rs1.2bn in FY10.
Exhibit 34: Profits rising steadily PBT (Rs m) 3,000 2,711
2,500 2,043 2,000 1,562
1,500 1,281 995 1,000 632
500 FY06 FY07 FY08 FY09E FY10E FY11E Source: MCX, IDFC-SSKI Research (Note: PBT has been shown to exclude capital gains)
MCX-SX: THE NEXT BIG THING
MCX-SX awaiting Fifteen years after the launch of NSE, India has a new stock exchange – MCX-SX, regulatory approval for jointly promoted by FTIL (49%) and MCX (51%). Currently trading in currency entry into equity trading derivatives (US$1bn of daily value traded), MCX-SX is neck-to-neck with the decade-old leader NSE. Waiting for SEBI approval to launch trading in equities (where the top two players make $200m in profits annually), we expect MCX-SX to be the next big thing for FTIL. The stock exchange, we believe, will draw strength from the proven success of MCX.
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18% stake divested at Regulations in India mandate a particular ownership structure to be attained by stock entity valuation of exchanges within a stipulated time of commencing operations. These regulations US$284m limit promoter entity holding to 15%. On the back of this, MCX-SX has recently divested an 18% stake at an entity valuation of US$284m to leading Indian banks.
Currency derivatives – a US$1trn opportunity in India by FY14 OTC market set to do Currency futures were introduced in India in August 2008 and within a short span of US$40bn in daily turnover six months, the average daily turnover in currency futures has reached US$1bn. The in the next five years OTC forex market in India is pegged at US$33bn currently. Our interaction with leading industry participants indicates that the OTC market is well on its way to become a US$40bn market in the next five years. Following the global average of 5:1 between OTC and currency derivatives, the potential of the Indian currency derivatives industry is pegged at US$8bn (8x increase from here). In view of the nascent stage of the industry, we estimate the daily turnover to reach US$4bn by FY14.
Exhibit 35: Currency derivatives – a potential US$4bn daily turnover by FY14E
Forex
50%
Currency 50% OTC derivative (US$33bn per day) (US$1bn per day)
<1%
US$4bn per day US$40bn per day
50% discount to Global average (OTC: Exchange = 5:1)
Source: IDFC-SSKI Research
MCX-SX – keeping the franchise alive MCX-SX neck-to-neck with MCX-SX went live on 7 October 2008 and has demonstrated strong growth traction equity mammoth NSE in in the currency derivatives segment with daily turnover growing 8x from US$65m in the currency segment October 2008 to US$512m currently. The primary competitor for MCX-SX is India’s largest stock exchange – NSE. Today, both MCX-SX and NSE share an equal pie of the currency derivative market turnover. We believe this is commendable for MCX-SX given NSE’s long standing leadership in equities.
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Exhibit 36: 8x growth in daily turnover on MCX-SX
Average daily turnover (US$ m)
600 512.0
450 338.9
244.2 300 218.4 167.9
150
0 Nov Dec Jan Feb Mar Source: IDFC-SSKI Research
Business still in investment phase With currency derivatives being newly introduced in the country, membership to the segment does not entail any admission fee. MCX-SX is estimated to have garnered a membership base of over 400+, with an additional 450 applications in process. In order to bring liquidity onto the exchange for currency derivatives, transaction fees have been currently waived off by all exchanges. Thus, revenues from transaction fees are yet to start accruing in MCX-SX. However, given the strong growth in liquidity on the exchange, we anticipate MCX-SX to begin charging transaction fees in FY10.
Growth drivers for currency segment While the Indian currency futures market has witnessed phenomenal growth of 6x in a short span of six months, we believe the following could further boost trading in this segment:
Retail participation Retail participation is a big The key differentiator between OTC and currency futures market is permissibility for potential opportunity retail investors to trade on the latter. RBI regulations do not allow retail participation in the OTC forex markets. Thus, currency futures have the opportunity to map the retail landscape. At the world’s largest currency exchange CME, retail FX accounts for around 20%, or $18bn a day, of the exchange’s global FX business.
Foreign Institutional Participation As per SEBI rules, FIIs are not permitted to trade in the currency futures segment. We believe a change in regulations to this effect will boost volumes significantly.
Arbitrage not available Once arbitrageurs get NSE and MCX-SX, the two leading exchanges providing currency futures, are access to a single terminal litigating on certain issues. Due to this, a single trading terminal cannot include NSE for both NSE and MCX-SX, volumes would increase as well as MCX-SX trading screens, thereby limiting arbitrageurs. We believe once this option becomes available to traders, it would positively influence volumes on both the exchanges.
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Contract specification Currently, the size of the USD/INR contract traded stands at US$1000. We believe the relatively small contract size in comparison to the OTC market limits participation of larger institutional players. A bigger contract size could attract better liquidity on the exchange.
Increase in exposure As per RBI guidelines, the gross open position of a trading member, across all contracts, cannot exceed 15% of the total open interest or US$25m, whichever is higher. Also, the gross open position of a trading member, which is a bank, across all contracts, shall not exceed 15% of the total open interest or US$100m, whichever is higher. So, larger exporters and importers may continue to deal in the OTC market, where there is no limit on the hedges. We believe that as this market matures, a revision of exposure limits would attract better participation.
Newer products New product offerings to As per RBI, only USD/INR currency pairs are allowed to be traded. With add to liquidity incremental product offerings, liquidity would certainly improve.
Equity markets – the BIG opportunity! MCX-SX awaiting Subsequent to capturing an impressive 49% share of the newly launched currency regulatory approval for derivatives segment in India, MCX-SX is now gearing to target the equity markets in launching equity products the country. MCX-SX is awaiting regulatory approval for launching equity products on the stock exchange.
Current size of the Indian equity markets stands at US$3trillion in terms of annual turnover and the industry profits are estimated to be at US$200m for FY09. Two players – NSE and BSE – control the industry, and NSE has a clear monopoly with a market share of 93%. Further, Indian bourses have garnered high strategic valuations with the latest stake sale on NSE and BSE being done at entity valuations of US$2.3bn and US$0.8m respectively. MCX-SX also has recently divested an 18% stake at an entity valuation of US$0.3bn.
Exhibit 37: MCX-SX waiting to capitalize on the strong growth
Turnover to reach US$5.3trn by FY14 Profits Last valuation Total turnover Market share (US $ bn) Players (FY09) (US$ m) (US$ bn) 6,000 5,256 93% 150 2.3
4,500
3,042 Indian equity 7% 50 0.8 3,000 exchanges
1,537 1,500 489 Approval awaited 0.3
0 FY03 FY06 FY09 FY14E Source: IDFC-SSKI Research
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With a weak no. 2 player, While NSE’s leadership is indubitable (given its 93% share), the success of MCX-SX MCX-SX stands a good in the currency derivatives segment as also of MCX in the commodity markets makes chance to be a leader us optimistic about the potential entry of the exchange in equities. Our interaction with the management indicates that MCX-SX has outlined a solid plan to enter the equity markets with several differentiating factors. Focus on SMEs, debt and bond segment (highly under-penetrated currently), extension of trading session to evening, etc could help MCX-SX create a strong niche in the Indian equity markets. Further, with MCX-SX offering membership at optimized rates, against the high membership charges levied by NSE and BSE, incremental industry participation would migrate towards it.
More importantly, with BSE being a distant No.2 in the Indian equity markets (<7% market share) and MCX a formidable player in the commodities market (leads with 87% market share), we believe MSX-SX has all the ingredients to capture a sizable portion of equity markets in the country.
MCX-SX – valued at US$284m A single entity’s stake in MCX-SX is registered as a stock exchange. SEBI, the regulatory body for stock an exchange mandated to exchanges in India, mandates an ownership structure wherein an individual entity’s come down to 15% stake cannot exceed 15% in an exchange. This ownership structure has to be attained within a stipulated period of start of operations. MCX-SX, which started operation in October 2008, is jointly held by MCX (51%) and FTIL (49%). MCX-SX has recently divested an 18% stake to leading banks, including Union Bank of India and Bank of India, at an entity valuation of US$284m.
Key concerns We believe MCX-SX’s entry into the equity markets could be a key trigger for the exchange. However, the following issues pose a risk:
Limited liquidity – a third stock exchange We see high potential for Equity exchanges have been in existence in India for decades and the market is a clear MCX-SX to build liquidity duopoly between NSE and BSE. Thus, liquidity on the third stock exchange, MCX- in the equity segment SX, may seem difficult to accrue. However, given BSE’s struggle in the F&O segment (<1% share), participation in the same has been limited. Globally, every market has seen at least two dominant exchanges in each segment – ensuring arbitrage opportunity and strong participation. Thus, potential to build liquidity on MCX- SX’s equity segment remains strong.
Companies listing on a third stock exchange MCX-SX may lower net With companies already listed on NSE and BSE, there may be no incentive for them worth requirements or to list on MCX-SX. However, we believe liquidity on MCX-SX would be a key driver offer other such measures to attract listing for corporates to list on the exchange. Also, our interaction with the management suggests that the exchange has an innovative strategy in place (such as lower net worth requirements for raising capital, etc), which would be a good incentive for corporates to list on MCX-SX.
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DGCX: OIL NOT LIQUID! Buoyed by the success of MCX, FTIL ventured into one of the world’s largest areas of financial liquidity – Dubai. FTIL joined hands with the Dubai government and set up the first commodity derivatives exchange in the Middle East called the Dubai Gold & Commodities Exchange (DGCX). While trading on the exchange started in November 2005, average daily volumes on the exchange are currently at 6,500+ contracts. Thus, we believe the exchange is yet to garner deep liquidity and thereby reap profits.
With the Dubai market exhibiting strong potential in the underlying physical market for gold and energy products, as also the success of MCX rubbing off on DGCX, the exchange was last valued at US$650m by financial investors who have a 5% stake in the exchange.
DGCX – right market and right participation DGCX, the first commodity In order to tap the potential in the Dubai commodities market, FTIL joined hands derivatives exchange in with the Dubai government to set up a commodity exchange. While being a free Middle East, to have first mover advantage trade zone with a 50-year tax holiday, Dubai’s huge physical market (US$30bn in gold alone) has been a key driver to address the commodity sector in the region. Thus, FTIL – in a joint venture with DMCC (Dubai Multi Commodities Centre, a strategic initiative by the Dubai government) and MCX – set up the first commodity derivatives exchange in Middle East called the Dubai Gold & Commodities Exchange (DGCX). It is regulated by the Emirates Securities & Commodities Authority (ESCA).
Exhibit 38: Key shareholders
51% 39% 5% 5%
Financial investors
Source: Company, IDFC-SSKI Research
Dubai the third largest DGCX is a demutualized entity and the first international exchange to offer trading global re-export hub after facilities between the time zones of Europe and Far East. Further, the potential of the Hong Kong and Singapore underlying physical market, especially for commodities like energy and precious metals, made trading in derivatives in the region only logical. Dubai is also the third largest global re-export hub after Hong Kong and Singapore.
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Exhibit 39: Physical market for gold in Dubai
Total Value (US$ millions) 35,000
29069 26,250
19001 17,500 14748
10175 10730 8,750 4522 4565 5843
0 2001 2002 2003 2004 2005 2006 2007 2008 Source: DMCC, IDFC-SSKI Research
Strategic product offering…but liquidity still not deep DGCX offers derivative Product offering on an exchange forms a key driver of liquidity on the platform. On trading in precious metals, the back of this, DGCX focuses on products which are of relevance in the underlying energy, steel and currencies physical market. DGCX offers derivative trading in commodities such as precious metals, energy, steel and currencies. DGCX was started only with gold contracts and the exchange did not attract liquidity in the initial period, at least to the potential that was envisaged with the Dubai market. Thus, DGCX could not replicate the success of MCX for FTIL. The success of MCX can be partly attributed to the regulations in India that do not allow exposure to international commodity exchanges. Thus, MCX was a perfect opportunity to tap the latent domestic demand. In contrast, Dubai is a free trade zone, and thus the domestic commodity derivatives industry of the region already had access to global markets.
DGCX registered a 66% However, DGCX has gradually increased its product offerings over the years and has jump in volumes in CY08 seen a steady increase in turnover to reach 1.15m contracts in CY08 – a 66% yoy increase. Total traded value stood at US$57.5bn for CY08.
Exhibit 40: Turnover on DGCX Number of contracts (LHS) Value (m $ - RHS) 1,400,000 70,000
1,050,000 52,500
700,000 35,000
350,000 17,500
0 0 2006 2007 2008 Source: Company, IDFC-SSKI Research
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Revenue model In line with the exchanges business model, the initial years saw membership fees as the only revenue contributor. In three years since inception, DGCX has garnered a membership base of 221 members. Transaction fees – based on contract volumes Transaction fees charged DGCX did not charge transaction fees for the first two years of its lifespan in order to on all contracts, except induce the base liquidity. While in the beginning, fees were levied only for gold steel and crude oil contracts, all contracts (except steel and crude oil) have been charged from July 2008. DGCX follows the global method of charging transaction fees on the number of contracts (unlike in India were it is charged on the value traded). The exhibit below specifies the transaction charges levied per contract per side:
Exhibit 41: Transaction charges Particulars (US$) Regular Day Trade (Intra-day) Trade fee 0.55 0.25 Clearing fee 0.10 Source: DGCX, IDFC-SSKI Research
Key growth drivers Introduction of new and While DGCX has not seen sharp growth with regards volumes on the exchange, our relevant products to be a interaction with the management indicates that liquidity would come with launch of key growth driver new products like crude oil, etc.
Key risks Execution remains the DGCX has yet to prove its execution ability by attracting liquidity, and thus better key risk participation. Further, Dubai Mercantile Exchange (DME) is emerging as a strong competitor for DGCX. While earlier DME facilitated trading in only Oman crude oil, it is now planning to get into commodities like bullion. However, we believe DGCX would continue to dominate as bullion forms the strength of the exchange (3,200 contracts of gold traded daily on DGCX).
Financials and valuations In CY07, DGCX is estimated to have attained a top line of US$2.5m and incurred losses to the tune of US$6.7m. While the exchange is yet to be an operational success, FTIL has tactfully monetized the venture by divesting a 5% stake sale to financial investors. This transaction valued the exchange at US$625m.
IEX: ‘POWER’ED TO DELIVER Indian Energy Exchange (IEX) is India’s first-ever nationwide, automated and online electricity trading platform. It is a joint venture between FTIL, Power Trading Corporation of India (PTC) and six other partners. The exchange currently does an average daily turnover of 14,500MWh (megawatt hours).
Power exchanges in India – high potential
Less than 0.05% of total Short-term power trading in India has reached 21BUs in 2008 from 15BUs in 2007 – a power traded in India is 40% increase. This contributed 3.15% to India’s total power generation. However, less on exchanges than 0.05% of the total power currently traded in the country is done on exchanges. Thus, penetration would be a key driver of volumes on the power exchanges.
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Exhibit 42: Power exchanges– high potential
Traded volumes (BUs - LHS) % of total generation (RHS) 25 3.5
20 Less than 0.05% of this is 3.0 on Power exchanges 15 2.5
10 2.0
5 1.5
0 1.0 FY04 FY05 FY06 FY07 FY08 Source: CERC
IEX – the leader… IEX has strong pedigree in IEX, the first pan-India spot electronic power exchange, commenced trading on 27 FTIL and PTC – India’s June 2008. IEX is a joint venture between FTIL (a 41.2% stake), PTC India (the largest power trader largest power trader in the country with a 45% market share) and seven other partners. Thus, IEX demonstrates sound ability to attract participation from the energy and infrastructure field. This, we believe, will prove important to induce liquidity onto the platform. In addition, FTIL has partnered with OMX (global leader in exchange technology) for securing the technology infrastructure of IEX.
Exhibit 43: IEX garnering steady growth Avg daily volume (MWh)
13,624 41.2% 26% 15,000 12,295
12,500
5% 5% 10,000
5% 5% 6,529
7,500 5% 5%
2.8% 5,000 Others Feb Mar Apr Source: IDFC-SSKI Research
Average daily volumes of IEX offers day ahead contracts of power, for which trading is done through a double- 14,500MWh on IEX sided auction process. Trades validated by the exchanges are deemed for physical delivery on the following day. In its first month of operations, IEX clocked total volumes of 69,774MWh with a daily average volume of 2,250MWh. Since then, IEX has witnessed strong growth and in less than a year reached average daily volumes of 14,500MWh.
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Business model IEX derives its revenues from two key sources – membership fees and transaction fees. IEX currently charges a transaction fee of Re0.01/KWh traded. IEX has a total membership base of 58 brokers. Membership fees vary across different categories, as shown below:
Exhibit 44: Membership charges (Rs m) Trading Member Trading and Self- Trading-cum- Clearing Member Clearing Member Membership fees vary One-time Fee 0.5 1.0 1.0 across categories Annual Fee 0.1 0.25 0.25 Interest-free Security Deposit 1.0 2.5 4.0 Processing Fee 0.005 0.005 0.005 Net worth Criteria 15 15 15 Source: Company, IDFC-SSKI Research
Growth drivers Penetration (only <0.05% of total traded power is on exchanges) on power exchanges stands to be the single most important growth driver for the leader, IEX. In addition, regulatory reforms such as permission of longer-term contracts (currently only day ahead allowed) would provide further impetus. Also, incremental merchant power plants, which cater to the short-term power market and Ultra Mega Power Plants (of which 15% would be available for short-term trading), would significantly widen the scope of the industry.
IBS FOREX: ‘APPRECIATION’ DIFFICULT! FTIL launched its inter-bank foreign exchange trading platform, IBS Forex, in June 2002. While the Indian inter-bank forex industry is huge and garners a daily turnover of US$33bn per day, the market is dominated by Reuters – the world leader in forex trading. Thus, IBS Forex has managed to get only 5% share of the market. Further, rupee convertibility stands to be the most important trigger for the Indian forex industry. With industry dynamics improving on the back of this, IBS Forex can potentially garner a share of the incremental market.
Potential is huge – US$33bn daily turnover OTC forex industry The Indian OTC foreign exchange industry stands at US$33bn (daily turnover) and expected to reach $40bn in is expected to reach US$40bn within the next five years. The US$33bn inter-bank daily turnover by FY14 from $33bn forex market is divided between system trading and voice brokers. System trading entails trading on an online platform while voice brokers are bank intermediaries that take orders on the phone and execute trades. In India, systems account for 60-70% of the total turnover, and voice brokers hold the remaining 30-40%.
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But Reuters dominates
Reuters has >85% share of The Indian inter-bank foreign exchange platform is dominated by Reuters having an the systems trading over 85% share of the systems trading platform. Also, in addition to IBS Forex, one platform more player has recently entered the industry – Clearing Corporation of India (CCIL). Both IBS Forex and CCIL have ~5% market share each of the system trading platform. With liquidity being the prime factor for exchanges, it has been tough for new players like IBS Forex to take market share away from Reuters.
Exhibit 45: India OTC forex market
Systems 85-90%
60-70% 5%
OTC (US$33bn) Voice brokers 5%
30-40%
Source: IDFC-SSKI Research
Also, in line with global standards, the spot forex trading accounts for less than 40% of the OTC market and the remaining is contributed by derivative products like forwards and swaps. Further, 80% of the trading is done in the USD/INR currency pair, and the remaining in crosses.
IBS Forex – striving for a pie of the market IBS Forex offers an on-line The platform provided by IBS Forex is called FX-Direct. It offers an on-line, real spot and forward trading in USD/ INR time, anonymous deal matching system for spot and forward trading in the USD/INR for the inter-bank forex market in India. In addition, it has a negotiated dealing system for one-to-one trades in any currency pair. IBS will also be offering a similar platform for trading in USD/INR Options and other derivatives. IBS currently has 26 banks as clients.
Exhibit 46: Key clients of IEX Bank of Baroda Bank of India Bank of Maharashtra Central Bank of India Canara Bank Corporation Bank Punjab National Bank State Bank of India State Bank of Indore State Bank of Hyderabad State Bank of Patiala State Bank of Travancore Syndicate Bank UCO Bank Union Bank of India ICICI Bank HDFC Bank Karnataka Bank IDBI Bank Bank of Bahrain & Kuwait UTI Bank Citibank American Express Bank BNP Paribas Source: Company, IDFC-SSKI Research
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Business model IBS Forex follows a rental based model, wherein terminals are sold at a fixed monthly rental of ~US$500, thereby becoming an annuity income stream. IBS Forex is estimated to have sold 80-100 terminals till date and FTIL is estimated to have committed a total capital of Rs30m in this venture.
Growth drivers Currency convertibility to We believe currency convertibility will be a key trigger for the inter-bank forex be a major boost for inter- industry as a whole. Thus, while Reuters dominates currently, there exists a potential bank forex industry for IBS Forex to gain market share of the incremental pie. Further, IBS Forex has a limited product offering in USD/INR currency pair and does not offer options yet. This is in contrast with Reuters which provides a broader offering of currencies and products. Thus, evolution in product offering would also prove to be beneficial for IBS Forex.
NSEL: WORLD’S FIRST ELECTRONIC SPOT EXCHANGE FTIL pioneered the concept of an electronic spot exchange by setting up the National Spot Exchange (NSEL) in a joint venture with NAFED (National Agricultural Cooperative Marketing Federation – a government agency) in 2005. We met Anjani Sinha, the MD and CEO of NSEL, to gauge the potential of this venture.
NSEL offers trading in agri The exchange started live operations in mid-2008 and currently offers trading in agri commodities and bullion; commodities and bullion, and is soon launching industrial products. In addition, industrial products to be launched soon NSEL has diversified its business model and entered into procurement of certain commodities like cotton. FTIL is estimated to have committed a capex of Rs160m in NSEL and the exchange is expected to turn profitable in FY10.
Spot exchanges – an India-centric model With commodities valued at 45% of India’s GDP, the physical market in India is pegged at US$320bn. Further, with India being a dominant producer of key agricultural commodities, trading of agriculture in itself is a US$200bn annual market. However, the physical agri market in the country has been in dire straits as it is marked with inefficiencies and shackled by stringent regulations.
Exhibit 47: Enormous potential… …but inefficiencies
India Primary market • Localized and fragmented Rice 2nd largest producer • Prices dependant on local demand/supply Wheat 2nd largest producer • Prices in other regions not Groundnut 2nd largest producer known Farmer Trader Castor Seed Largest producer APMC Mandi Chilli Largest Producer, consumer, exporter
Cotton 2nd largest producer Secondary market Guarseed Largest producer (90% of world prod) • Counter-party default risk Jeera Largest Producer, consumer, exporter Negotiated •Disputes relating to Mentha Oil Largest Producer, exporter contracts quality, weight, etc Sugar Largest consumer and 2nd largest Trader Miller/ Exporter/ producer End user Source: IDFC-SSKI Research
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Electronic spot exchanges over-ride the inefficiencies prevalent in the underlying Spot exchanges offer better price discovery, physical market. Products on the exchange are for compulsory delivery only, and counter-party credit risk hence are identical in purpose to the underlying physical market. While the and quality certification transparency across the system (with access to prices of commodities in all regions) leads to better price discovery, exchanges guarantee counter-party credit risk, the most fundamental need of the trade system. In addition, products are quality certified before being traded on the exchange platform, thereby eliminating post-trade related issues.
NSEL – the pioneer NSEL is the first national level electronic spot exchange in the country and is a pioneering concept in the world. The exchange was incorporated in 2005 as a JV between FTIL and NAFED. Initial capital infused in the exchange is estimated to be to the tune of Rs160m. The exchange started its membership drive in June 2008, and subsequently went live in October 2008.
NSEL offers 31 contracts With spot exchanges regulated by state APMCs, regulatory approvals are required to including contracts on base delivery locations in the respective states. NSEL has got regulatory approvals in same commodity at different delivery locations seven states – Bihar, Gujarat, Maharashtra, Karnataka, Rajasthan, Andhra Pradesh and West Bengal. NSEL offers only delivery based contracts for key agricultural commodities and bullion. Currently, NSEL offers 31 contracts which include contracts on the same commodity but at different delivery locations. The exchange plans to launch gold contracts in 40 different locations within the next six months.
Exhibit 48: Product portfolio Products Cereals Maize Pulses Tur Wheat Yellow peas Oilseeds Castor seed Urad Soyabean Channa Fibers Cotton bales Plantation Rubber Spices Cumin seed Arecanut Black pepper Others Guar seed Cardamom Bullion Gold Silver Source: Company, IDFC-SSKI Research
With 265 members, NSEL Trading on the exchange is facilitated electronically through the NEST system, which does average daily is provided by FTIL. The exchange currently has a membership base of 265 brokers turnover of Rs63m and garners an average daily turnover of Rs63m. The client base includes corporates like Jayant Oil, MMTC, PFC, etc as also bullion dealers. NSEL guarantees counter- party credit risk and has an efficient clearing and settlement back-end.
New avenues – procurement NSEL procures Many agricultural commodities are procured by NAFED and finally traded on the commodities on behalf of exchange. For instance, NAFED does procurement of cotton which is followed by NAFED at a 2% margin on the total turnover pressing and ginning to transform it to cotton bales and then traded on NSEL. Expanding its business model beyond the spot exchange framework, NSEL entered into an agreement with NAFED in January 2008 for physical procurement of cotton. The agreement entailed procurement of cotton in Andhra Pradesh and NSEL further undertook the ginning and pressing process. Within three months (Jan-Mar), NSEL
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did an aggregate procurement valued at Rs2.05bn. As per the agreement, NSEL received a 2% margin on the total turnover. Our interaction with the management indicates that it is open to such procurement contracts and this would form a sustainable revenue source for NSEL.
Business model Currently no transaction NSEL derives its revenues from two primary sources – exchange-based revenues and fees levied, but indicated procurement fees. Exchange related revenues include transaction fees charged on the to be much higher than for traded value, membership fees (includes a one-time fees followed by annual derivatives products subscription fees) and storage fees. While the exchange currently does not levy a transaction fee on all commodities, charges are estimated to be significantly higher than in the derivatives market. For instance, for castor seed, NSEL plans to charge Rs300 per Rs100,000 traded on the exchange.
Membership fees vary across categories and NSEL currently has a base of 265 members. The various categories of members and their corresponding fee requirements are as follows:
Exhibit 49: Membership fee (Rs) TCM ITCM PCM TM Membership fees varies Membership Admission Fee 7,50,000 10,00,000 10,00,000 1,00,000 based on the category Application Processing fee 5,000 5,000 5,000 5,000 Annual Subscription Fee 25,000 50,000 50,000 10,000 Source: Company, IDFC-SSKI Research
Procurement revenues are linked to the total value procured. As per the agreement with NAFED, NSEL receives 2% of the total procurement turnover. On the basis of this, NSEL is estimated to have earned Rs40m in FY09 from procurement services.
NSEL charges storage The third source of revenues for NSEL from the exchange is storage fees charged for fees for commodities commodities deposited in exchange-designated warehouses. NSEL undertakes quality stored in exchnage- designated warehouses certification for the respective commodities and stores it until it is traded. For this, NSEL charges storage and wartage charges which is estimated at Rs100 per kg.
Key financials NSEL was incorporated in 2005 with an initial investment of Rs160m from FTIL and the exchange went live in October 2008. During this period, the exchange accumulated losses to the tune of Rs100m. While the exchange does not levy transaction fees currently, revenues from membership admission, storage as also procurement revenues were achieved in FY09. NSEL is expected to start levying transaction charges from FY10.
Growth drivers While the industry exhibits enormous potential, we believe the following growth drivers will aid the exchange in capitalizing on the opportunity:
More states opening up As more states allow spot Currently, only a few states have given regulatory approval to spot exchanges. These exchanges, we expect the include Maharashtra, Gujarat, Kerala, Karnataka, etc. We believe as more states open market to expand up to these markets, penetration will improve.
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Awareness creation Spot exchanges are a new concept in the country and aim at reaching the rural markets. Thus, education and awareness about the operations would attract better penetration. NSEL has adopted innovative methods like sending SMSs to farmers on daily price updates, etc in order to build their interest.
INTERNATIONAL EXCHANGE VENTURES In addition to the already live exchanges, FTIL has laid down a sound execution plan for the next two years to launch four international exchanges –SMX, GBOT, BFX and Bourse Africa. The regions for setting up international exchanges have been strategically selected to include countries which are relatively under-penetrated in commodity derivatives but have a dominant trading base in other products. While execution would be the key monitorable, the management is extremely optimistic about these ventures.
Singapore Mercantile Exchange (SMX) – a potential trigger! FTIL entering Singapore, FTIL has outlined plans to enter the Singapore market and is setting up an world’s eighth largest OTC international commodity derivatives exchange in the region – Singapore Mercantile derivatives and third largest oil trading centre Exchange (SMX). FTIL has already received the necessary regulatory approval from the Singapore government, and SMX is expected to go live in 2009.
Singapore is the eighth largest OTC derivatives centre in the world, and the third largest oil trading centre after New York and London. Further, the region has a fairly developed equity market with a total of 722 companies listed on the SGX. While the Singapore market exhibits a strong trading culture, the region is fairly under- penetrated with regards commodity derivatives. There is only one dominant commodity exchange – SICOM, which has been able to garner healthy liquidity only in rubber.
Exhibit 50: Potential in Singapore
8th largest OTC derivative market
Singapore – Potential BUT, Under- 3rd largest oil trading centre looks good penetrated commodity derivatives markets Active equity market – 722 companies listed
Source: IDFC-SSKI Research
SMX, a multi-commodities FTIL aims to capitalize on this opportunity through SMX, its 100% owned exchange, expected to go subsidiary. The exchange is expected to go live in this calendar year and would be a live in 2009 multi-asset class international exchange. It would operate an electronic trading platform for trading in futures and options contracts across a range of commodities. Key commodities include precious metals, base metals, energy products and agriculture commodities. Further, SMXCC – a wholly-owned clearing corporation of SMX – would stand as central counter party for all trades executed on the exchange.
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An international multi-asset exchange catering to Asian time zone between Tokyo and London, SMX promises strong potential. Also, SMX has a strong management team in place. The CEO, Thomas McMahon, was earlier heading the Hong Kong Mercantile Exchange and is a former director of Nymex Asia. While the potential looks promising, we believe execution would be the key monitorable.
GBOT GBOT, another commex In a move to tap the African continent, FTIL has set up an exchange – Global Board for futures trading in of Trade (GBOT) – in Mauritius, a 100% owned subsidiary. FTIL is estimated to African continent, to go live in 2009 have made an aggregate capital commitment of Rs1.1bn for this venture. GBOT is licensed by the Financial Services Commission (FSC), the regulator for non-bank financial services sector in Mauritius for initiating futures trading in commodities. GBOT will be the first pan-African derivatives exchange and a gateway to serve the African continent. GBOT is expected to go live in 2009. The exchange plans to offer a wide product offering across metals, energy and agri commodities in addition to intangibles like freight rates, etc.
Exhibit 51: Proposed product offering Category Commodities Precious Metals Gold, silver and platinum Base Metals Aluminum, copper, nickel and zinc Energy Crude and ATF Agricultural Sugar and coffee Others Carbon credits and shipping freights (wet and dry) Source: GBOT, IDFC-SSKI Research
Bahrain Financial Exchange (BFX) BFX a composite Bahrain Financial Exchange (BFX; 100% owned by FTIL) is an international international exchange in exchange dealing in multiple asset classes. BFX is a composite international exchange the time-zone between London and Tokyo in the time-zone between London and Tokyo. BFX will be regulated by the Central Bank of Bahrain and will have its own clearing corporation and depository agency. Products expected to be traded on the exchange include stocks, bonds, Shariah Compliant Financial Instruments, currencies and derivatives. The exchange is expected to go live in 2010, and FTIL is estimated to have made a capital investment of ~Rs750m for BFX.
Bourse Africa – hub-and-spoke model Bourse Africa the first Bourse Africa, (60% owned by FTIL) would be the first pan-African spot and pan-African spot and derivatives multi-asset exchange. The exchange plans to offer multi-asset class trading derivatives multi-asset in commodities, currencies, bonds and diamonds. Proposed commodities include exchange precious and base metals, agricultural commodities, energy products and minerals. The exchange comes under the regulatory framework of the Non-Bank Financial Institutions Regulatory Authority.
Our interaction with the management indicates that the exchange plans to achieve a Pan-Africa presence by implementing a hub-and-spoke model. The central hub would be located in Botswana and it would connect to all key countries in Africa. With Botswana as the hub, it would be easier for FTIL to get through the regulatory system instead of dealing with regulators across different countries in Africa. The exchange is targeted to go live in 2010.
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ECOSYSTEM VENTURES Gaining further depth in the Indian exchanges industry, FTIL has floated a host of ecosystem ventures to cater to spaces including warehousing, real-time information dissemination, mobile payments, etc. While most of these ventures are still in the incubation stage, NBHC is established as the largest private sector warehouse player and is expected to be a strong growth driver for FTIL. In FY11, we expect NBHC to garner revenues of Rs1.8bn (52% CAGR over FY08-11E) and net profit of Rs449m (148% CAGR).
BUSINESS OVERVIEW NBHC, agri commodity With the Indian exchanges industry poised to register 19% CAGR over the next five warehousing and years, FTIL saw merit in developing an ecosystem around this to piggy-ride the financing venture to be a key growth driver for FTIL growth potential. Further, in view of the nascent commodity markets in the country over FY09-11 as also inefficiencies surrounding the agri segment, FTIL ventured into agri commodity warehousing and financing in 2005 with its subsidiary called NBHC. With strong execution capability, NBHC has established itself as the largest private player in the industry and is a key growth driver for FTIL. In addition to warehousing, FTIL has also ventured into niche segments like real-time market dissemination systems, mobile payments, training services, etc. However, these ventures are still in the incubation stage and execution will be the key monitorable.
Exhibit 52: Ecosystem ventures Entity Description NBHC Warehousing, collateral management, procurement services Atom Mobile payment applications Tickerplant Market information dissemination systems FTKMC Knowledge management company offering training services CMSL Services to the credit market in the country Source: IDFC-SSKI Research
NBHC: WAREHOUSING EXCHANGES NBHC, established in April 2005, was primarily set up with the objective to service the warehousing and quality assurance needs of MCX. However, the opportunity is this space enabled NBHC to broad-base its business model to include various aspects of the warehousing industry as also cover a broader clientele including farmers, traders, corporates and exchanges.
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Exhibit 53: NBHC – Business model
Warehousing services Collateral management
Storage facilities Warehouse receipt financing Quality assurance Pest management
Procurement service Other value added services
Procurement of wheat and Warehousing audit and paddy on behalf of FCI accreditation Commodity valuation services
Source: IDFC-SSKI Research
NBHC an end-to-end Today, NBHC has established itself as an end-to-end provider of warehousing related provider of warehousing services and generates revenues by providing a suite of value-added services under related services various brands. Revenues are primarily derived from professional warehousing services (including pest management services), collateral management and other value added services. Additionally, NBHC also generates revenues through procurement activity for commodities, which is conducted on behalf of the FCI.
Exhibit 54: Revenue model across segments
Services Market Segment Revenue model
Storage charges, fumigation and spraying Farmers, traders, corporates, processors Warehousing services charges, quality testing and certification and commodity exchanges charges
Collateral Farmers, traders, corporates, processors Service provider charges, collateral Management and commodity exchanges mgmt fees
Commodity Government Agencies, FCI, NAFED,etc Procurement charges procurement
Trade consultancy, support fees and Value added services Banks, corporates, processors and traders commision
Source: Company, IDFC-SSKI Research
Agri-warehousing: Capitalizing on inefficiencies The agriculture and allied sectors contribute ~19% to the US$1trn Indian GDP and supports more than 60% of the country’s 1bn+ population, thereby making it the most important element of the Indian economy. The losses in farm produce in India have been estimated at US$18bn-25bn per annum. The total available agri- commodity storage capacity in India is 83.1m tonnes, which is primarily dominated by public sector enterprises holding 71% of the total capacity. Further, the additional storage capacity required in 2011-12 is approximately 28m tonnes. While the 11th 5- year plan has budgeted an investment outlay of US$500m for the construction of
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additional storage capacity of 6.67m tonnes, ~59m tonnes of warehousing space would still be required – a lucrative opportunity which is up for grabs for private players.
Exhibit 55: Shortage in capacity
Upto 2007 Upto 2012
160 28 Shortage of ~59m tonnes 52m tonnes of storage capacity – shortage ample scope for private 120 players 6.7 80 121.1 83.1 40
0 Storage capacity Marketable surplus Source: IDFC-SSKI Research
NBHC – the largest private player NBHC manages 390+ NBHC has established itself as one of the largest private sector warehousing warehouses across India companies in India. NBHC started operations with a single warehouse facility in with 1.3m tonnes capacity Unjha in Gujarat (in 2005) having a total capacity of 4,340 tonnes. Today, NBHC manages a total of 390+ warehouses across India with 1.3m tonnes of capacity.
Exhibit 56: Capacity build-up of NBHC warehouses (2005-2008)
No of warehouses (LHS) Capacity ('000 MT - RHS) 800 2000
600 1500
400 1000
200 500
0 0 April, 2006 April, 2007 April, 2008 June, 2008 Source: Company, IDFC-SSKI Research
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Exhibit 57: Regional location of warehouse (as at 30 June 2008)
Source: Company datasheet
Storage available for 45 NBHC offers facilities to store more than 45 commodities in its warehouses, based commodities; 51% on the requirements of its clients. Among these, wheat is the most dominant accounted for by wheat… commodity, accounting for over 51% of the total storage capacity. Other commodities ranking among the top 10 commodities stored at NBHC warehouses include maize, soyabean and paddy.
Business model NBHC does not currently own any warehouse. NBHC primarily has two business models for conducting its warehousing operations, namely Leased Warehouse Model and Franchised Warehouse Model.
Exhibit 58: Warehousing business model
Franchised Warehouse Model Criteria Criteria Leased Warehouse Model NBHC-controlled Franchisee-controlled
Responsibility Conducted by Franchisee staff under the Con ducte d by N BHC staff Conducted by NBHC staff for operations supervision of NBHC
100% managed by NBHC, Managed by NBHC, but Control of which has complete control franchisee retains the right to Control rests with franchisee, under effective Commodity flow of all warehousing allow depositors to store oversight of NBHC activities at all times commodities at the warehouses
All expenses are borne by Manpower costs are borne by the franchisee, Expenses All expenses are borne by NBHC NBHC operational expenses are borne by NBHC
Income streams Storage Revenue Share in Storage Revenue Franchisee fee , Share in Storage Revenue
Revenue- NBHC retains 100% of Revenue-sharing is based on Revenue-sharing is based on sharing revenues contracts/agreements contracts/agreements
Source: Company, IDFC-SSKI Research
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Key clients NBHC provides professional warehousing services to a wide range of customers, including farmers, traders, corporates (both Indian and MNCs) and commodity exchanges. In FY06, the company began catering to corporate clients with the storage of soyabean with ITC as its first corporate client. As on 30 June 2008, retail clients (consisting of farmers and traders) accounted for 39% of the total leased warehousing capacity utilization, while corporate clients accounted for 49%.
Exhibit 59: Customer Segmentation
Unutilized capacity 12% Farmers and traders account for 39% and corporates 49% of total Corporate leased warehousing 49% capacity utilization
Retail 39% Source: Company, IDFC-SSKI Research
Warehouse receipt financing – safe credit While commonly used as a means of agri-funding in more developed countries, WRF is still in its nascent stage in India. Among the various banks involved in WRF, State Bank of India is the leading provider among public sector banks (estimated portfolio of US$1.9bn) while HDFC Bank (US$ 1.2bn) and ICICI Bank (US$ 0.5bn) lead among private sector banks.
NBHC – taking ‘credit’ of the nascent industry NBHC has facilitated over Recognizing the shortage of independent professional Collateral Managers in the 55,000 WRF transactions country and the tremendous opportunity therein, NBHC decided to leverage its to date worth US$ 1.2bn warehousing knowledge and entered into its first Collateral Management (CM) agreement with Kotak Mahindra Bank in April 2006. Since then, NBHC has rapidly increased the reach of its Collateral Management business to become one of the country’s largest private sector players with a network of 24 banks, managing over 3,500 storage facilities across India and having total assets under management of over 4.5m tonnes. Additionally, the company has facilitated over 55,000 Warehouse Receipts Financing (WRF) transactions to date worth over US$ 1.2bn, with an asset base of over US$ 1.6bn.
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Exhibit 60: Warehousing Receipts issued and funding facilitated
WR issued (LHS) Amount funded (US$ m- RHS) 40000 4000 3,463
30000 3000
34,239 20000 2000
1,194
10000 1000 700 12,965 2.6 7,117 70 0 0 FY06 FY07 FY08 H1FY09 Source: IDFC-SSKI Research
Business model NBHC provides its collateral management services under the brand name NBHC Cecure. Cecure has two business models for providing CM services, namely Service Provider Business Model and Collateral Management. In FY09, NBHC is estimated to have garnered revenues to the tune of Rs274m from collateral management.
Exhibit 61: Business Model
No. Criteria Collateral Management Business Model Service Provider Business Model
Banks approach NBHC for Collateral Management Farmers and traders (Depositors) approach NBHC.NBHC Client Origination services for depositors who have already applied to does a due diligence and enables the Depositors to get the banks for credit credit from the banks.
Commodities deposited in NBHC warehouses – leased or Commodities deposited in third-party warehouses or Place of Deposit franchisee, or third party warehouses that subsequently own warehouse of borrower ente r into an agreeme nt with NBHC
Conducted by NBHC, since it knows the depositors and was Due Diligence Conducted by banks; KYC burden rests with banks responsible for bringing them to the banks
Differential interest rate (0.75%-1% ) paid by banks and Average fixed charge paid by banks per month by Revenu e average per borrower per month charges c. US$ 240 ( or location c.US$600 ( or INR 25,000/-) INR 10,000/)
Source: Company, IDFC-SSKI Research
Procurement – playing pseudo government Backward integrating the warehouse business model, NBHC ventured into procurement of wheat and paddy on behalf of FCI. The total quantity of paddy and wheat procured has increased from 18,862 tonnes in FY07 to 656,827 tonnes in FY08. NBHC has made significant progress in procurement activities since 2006, both in terms of quantity procured and the geographical area covered. The shift in the coverage of NBHC in procurement activities between FY07 and FY08 is shown below.
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Exhibit 62: Procurement reach
Jammu & Kashmir Jammu & Kashmir
Himchal Pradesh Himchal Pradesh
Punjab Punjab Uttarakhand Uttarakhand North East Haryana North East Haryana
Assam Assam Rajasthan Uttar Pradesh Rajasthan Uttar Pradesh
Bihar Bihar
Jharkhand Jharkhand Gujarat Gujarat Madhya Pradesh West Bengal Madhya Pradesh West Bengal
Chattisgarh Chattisgarh Orissa Orissa Maharashtra Maharashtra
Andhra Pradesh Andhra Pradesh
Karnataka Karnataka
Tamilnadu Tamilnadu Kerala Kerala
Source: Company, IDFC-SSKI Research
Business model Before the start of every procurement season, FCI marks up the MSP by a defined percentage of incidentals and reimburses the same to the government procurement agencies. There are a number of incidentals in the procurement chain, including the cost of gunnies, labor charge, transportation & logistics, adatiyas commissions, Mandi Tax, Agricultural Tax, Educational Cess and other applicable miscellaneous expenses. NBHC economizes on all aspects of the cost other than the taxes and cess, which are fixed costs. It has tie-ups with the local adatiyas, village level aggregators and rice millers and manages to reduce costs on account of assured volume of business throughout the procurement season. A percentage savings in cost directly adds to the profit of procurement operations.
NBHC to limit government Our interaction with the management indicates that going forward NBHC would procurement activities limit procurement activities for the government. While NBHC is estimated to have going forward garnered Rs187m in procurement revenues in FY09, we have not accrued for revenues from this segment going forward.
Financial analysis We expect NBHC to register 52% CAGR in revenues over FY08-11. EBITDA margins are expected to improve to 36% in FY11 (from -1% in FY08), driving a 148% CAGR in net profit over FY08-11.
Revenues – 52% CAGR over FY08-11E NBHC expected to garner NBHC garnered revenues of Rs530m in FY08. Strong traction is expected in all revenues of Rs1.8bn in business segments and we expect overall revenues to increase to Rs1.8bn in FY11 – FY11 52% CAGR FY08-11.
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Exhibit 63: Strong traction in revenues Revenues (Rs m) 2,000 1,849
1,500 1,297
1,000 857
529 500 128
0 FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
EBITDA margins – significant improvement ahead Strong top line growth to The strong growth in top line would translate into margin expansion for NBHC translate into margin from -1% in FY08 to 36% in FY11. Thus, we expect NBHC to garner an EBITDA expansion of Rs669m in FY11.
Exhibit 64: EBITDA margins to improve EBITDA (Rs m - LHS) Margins (% - RHS) 900 40 36
675 669 32 28
450 24 21 341
225 16
10 10 0 8 -14 -3
-225 0 0% FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
Net profit – Rs450m by FY11E 148% CAGR in profts over Improvement in margins would flow to profitability. We expect a net profit of FY08-11E Rs450m in FY11 – a 148% CAGR over FY08-11.
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Exhibit 65: Net profits to increase sharply (Rs m) 450 Net profits 449
350
250 241
150 102
50 30
-50 -9 FY07 FY08 FY09E FY10E FY11E Source: Company, IDFC-SSKI Research
ATOM: EXPLOSIVE GROWTH AHEAD Atom Technologies was incorporated in 2006 and FTIL currently has an 88% stake in the same. Atom started as a pure mobile payments service provider and has now broad-based its service offering to include micro-finance and IVR related transactions. The primary target audience of Atom is the credit card industry in the country as its payment applications are alternatives for credit card payments. The credit card base in India is estimated to stand at 26m and is expected to increase to 40m by 2010.
Atom Technologies – ‘product’ive Atom Technologies offers Focusing on the use of technology in the mobile transactions ecosystem, Atom four products – Atom, Technologies has created multiple products and services for mobile payments, mobile Atom IVR, Atom Seva and banking for the unbanked, IVR based payments and mobile based service Atom OTP distribution framework. Atom has filed for patents for the same, for which approval is pending. Currently, Atom Technologies offers four products – Atom, Atom IVR, Atom Seva and Atom OTP.
Exhibit 66: Products portfolio Product Description Atom Mobile payment application Atom IVR Credit card payment through IVR Atom Seva Micro-finance Atom OTP Second factor authentication system Source: Company, IDFC-SSKI Research
Atom – the ongoing buzz Atom allows customers to Atom is a mobile payment application which enables multiple banks as well as make remote and counter merchants to be available on a common platform, thereby allowing a bank’s customer payments from mobile to make payments across the merchant population. Banks enter into an agreement phones without disclosing critical card details with Atom to utilize the mobile payment facility and in turn induce merchants for the same. Atom provides merchants with the utility required to facilitate the transaction.
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Currently, Atom is being implemented at a host of merchants across movie theaters, restaurants, hotels, etc.
Atom allows customers to make remote as well as counter payments from their mobile phones without disclosing critical card details. All transactions are authorized by a PIN and encrypted ‘end-to-end’, providing maximum security. Further, a customer can store up to 16 credit cards on a single application.
Exhibit 67: Process flow
Download Atom Customer purchases Gives his/her mobile Create an Atom PIN software on mobile required entity number
Customer makes payment Merchant sends payment request
Payment Selects card Enters PIN – Enters Enters Atom request recd payment customer PIN confirmed mobile no.
Payment receipts
Customer Merchant receipt receipt Source: IDFC-SSKI Research
Revenue model – transaction based Atom, being the facilitator of the mobile payment transaction, gets a per cent share of the transaction value traded from the respective bank. In turn, Atom has to pay a fee to the telecom service provider. At the net level, we estimate Atom to earn 0.25-0.5% of the total transaction value executed.
Key competitors Paymate is key competitor The other key player in the industry offering mobile payment facilities is Paymate. to FTIL’s Atom We interacted with Paymate to understand the difference in the two product offerings. Paymate offers only remote payment facility and allows only a single bank card to be accessed through its software. In contrast, Atom offers remote as well as
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counter payment facility and provides the option to pay through 16 different bank credit cards. These, we believe, are the key differentiators for the Atom platform.
Atom IVR – voicing growth Atom IVR is estimated to Atom IVR is a simple, secure and reliable payment solution based on interactive voice have a base of 60+ clients response (IVR) technology. Atom IVR makes it possible to make payment over the phone without revealing critical credit card data, as the customer care executive does not participate in the process of receiving payment or entering the credit card details while using the IVR system (interaction happens between the system and the customer).
Atom IVR enables transactions on the phone, be it a movie ticket, airline ticket, leisure tours, day to day shopping, home delivery, car servicing, magazine subscription and many more with real time validation and authorization, over secure links. Atom IVR is estimated to have a base of 60+ clients and facilitated transaction of aggregate value Rs1.6bn on 30 December 2008.
Exhibit 68: Transaction values on an uptrend …and so are transaction volumes
Transanction values (Rs m) Transaction volumes 1628 711,569 1800 800,000
1350 600,000 453,687 822 900 400,000 272,587 472 153,591 299 450 200,000
0 0 31 Mar 08 30-Jun-08 30-Sep-08 30-Dec-08 31 Mar 08 30-Jun-08 30-Sep-08 30-Dec-08
Atom Sewa - Technology@Financial Inclusion The platform facilitates Atom Sewa is a mobile micro-banking platform for banks and MFIs (Micro Finance agents to use their mobile Institutions) to provide technology enabled financial inclusion services. The platform phones as point of facilitates agents to use their mobile phones as point of transaction devices. Atom transaction devices Sewa comes with its banking correspondent and facilitator model to reach out to the end users. The software also provides local language support for receipts as well as voice intimation specially targeted at population understanding only the local language.
The project is in pilot testing phase. Atom has tied up with various financial institutions for the same. Some key tie-ups include the one with Sahayata MFI for mobile based application to enable the latter to disburse loans and collect installments, and with LIC to act as its nodal agency for selling its Micro Insurance product. Among banks, Atom has tied up with HDFC Bank as also created an application for the field force automation of ICICI Lombard.
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Key financials FTIL has committed an estimated capex of Rs60m to develop the different Atom platforms. The company has around 80 employees engaged in developing and maintaining the software.
TICKERPLANT: TICKING TOWARDS GROWTH TickerPlant is a global content provider for real-time dissemination of all types of financial and business critical data. Tickerplant caters to all segments of the financial markets including corporates, banks, broking houses, media, HNIs, etc. Key clients include Axis Bank, IDBI, DCB, Times of India, GE Shipping, Thomas Cook, Tata Communications, Yahoo, Reliance Capital, etc.
Tickerplant offers its facilities on two platforms – internet and mobile, and charges a monthly subscription fee for its services.
Exhibit 69: Revenue Model Product Clients Revenue model Marketviews terminals Corporates, Brokers, Banks, HNIs Subscription fees Marketview Mobile Mobile user population Subscription fees Data feeds Business Channels, financial portals Subscription fees Ticker boards Market regulators, commodity exchanges Hardware, software costs, installation, maintenance fees Source: Company, IDFC-SSKI Research
Mobile Application Tickerplant offers three categories in the mobile based application services, namely Platinum, Gold and Silver. Platinum and gold users receive live feed from exchanges while the feed is delayed by 30 seconds for silver users. Tickerplant is estimated to charge Rs500 per month for each segment which includes BSE CM, BSE F&O, NSE CM and NSE F&O, while silver users are charged Rs2,400 per year for three segments.
Tickerplant is estimated to have sold 3000+ Platinum and Gold applications (launched a year ago) and 2,000+ Silver applications (launched six month ago).
Terminal Application
Tickerplant estimated to The terminal application gives access to newsfeeds via the internet. Tickerplant is charge Rs20,000 per estimated to charge Rs20,000 per month for all the segments for the terminal month for terminal application. Other players in this space include Bloomberg and Reuters. However, application their terminal application can be accessed only on the local area network. Thus, Tickerplant provides easier accessibility through the internet.
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OTHER ECOSYSTEM VENTURES
CMSL is a business Other ecosystem ventures of FTIL include FTKMC, CMSL and Ace. FTKMC (FT focused on Indian credit Knowledge Management Company) – a 100% subsidiary of FTIL – is its knowledge markets and ACE a major hub offering short-term and long-term training and certification programs. The credit support company company also provides consultancy and advisory services in commodities and financial markets. FTKMC has franchisee at 10 places as well as a tie-up with APTECH in 11 cities.
CMSL (Credit Market Services), a business focused on the credit markets in India, is also in the pipeline. CMSL aims to become India’s first and leading provider in transforming the current illiquid credit market into a developed credit market by offering appropriate prudential, regulatory, supervisory, and business strategy framework.
In October 2008, FTIL acquired a significant equity stake in ACE (Audit Control & Expertise Global) – one of world’s major credit support companies, and a market leader in providing inspection, monitoring and collateral management services. Since its inception in 1996, ACE has provided credit support services for commodity values in excess of US$40bn to more than 150 financial institutions, and trading companies in more than 75 countries. ACE employs directly or through agency arrangements over 1,220 inspectors and managers operating in 32 offices in 28 countries.
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VALUATIONS & VIEW FTIL is a compelling business proposition which gives investors an ability to participate in a model that endemically has a strong technology domain, an annuity in a high-growth environment, spanning various geographies (Singapore, Bahrain, Africa, Mauritius and India) as also segments (Commodities, Equities, Currencies, Power, Spot, etc). We initiate coverage on FTIL with an SoTP-based valuation, which gives us a target price of Rs2000 – an upside of ~40% from the current levels. Core businesses valued on operational performance We have valued FTIL We have valued FTIL based on SoTP. Core businesses which include the technology based on SOTP business, MCX and NBHC have been valued based on their operational performance. We have valued the technology business at 15x FY11E earnings, MCX at 25x FY11E earnings (resulting into an entity valuation of US$0.9bn which at a 20% discount to its strategic value) and NBHC at 20x FY11E earnings.
MCX-SX valued on strategic value MCX-SX has recently divested an 18% stake to Indian banks at an entity valuation of US$284m. With MCX-SX’s potential entry into equities as also in view of the fact that the divestment has been done to Indian banks, we believe MCX-SX’s fair value is pegged at 2x the current divestment valuation.
Other ventures valued on invested capital Further, FTIL is estimated to have an invested capital of Rs9.6bn by FY11 across the remaining eight exchange ventures (three domestic and five international, of which DGCX was valued at US$625m by financial investors) and five ecosytem ventures. With an assumption that at least two of these eight ventures would establish success, we have valued the invested capital at 2.5x. In addition, FTIL is expected to have Rs7.7bn of net cash on books in FY11.
Target price is Rs2,000 Thus, we arrive at an aggregate entity valuation of US$1.9bn for FTIL, which translates into a per share value of Rs2,000. Recommend Outperformer.
Exhibit 70: SOTP We arrive at a per share value of Rs2,000 for FTIL Entity Basis of Resulting entity FTIL Resultant value valuation value (Rs bn) stake (%) for FT (Rs bn) FT Core Business 15x FY11 earnings 23.9 100 23.9 MCX 25x FY11 earnings 45.4 31.20 14.2 NBHC 20x FY11 earnings 8.9 86.2 7.7 MCX-SX 2x strategic valuation 27.0 53.1 14.3 Invested capital in group cos 2.5x inv cap 24.2 100 24.2 Cash and Other investments 1x inv 7.7 100 7.7 Total 92.2 Per share value 2,000 Source: IDFC-SSKI Research
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MANAGEMENT STRUCTURE Two entrepreneurs – Jignesh Shah and Dewang Neralla, established FTIL in 1995 as a technology solution provider. The evolution of FTIL from a technology solutions company to Asia’s largest exchange conglomerate today has been on the back of a strong management team. With eminent industry professionals on their advisory board as also highly experienced professionals heading their group ventures, FTIL is well placed to garner execution success across its ventures.
Exhibit 71: Management profile Name Designation Background Leadership Team Jignesh Shah Chairman and Group CEO Founder of Asia's largest exchange conglomerate Dewang Neralla Director - Technology Formerly deputy manager, Trading division of BSE V Hariharan Director - Strategy Formerly Assistant Vice-president, NSE Shreekant Javalgekar Director - Finance Formerly India Advisor, NexGen Fin Soln, Singapore Group Ventures Joseph Massey MD & CEO, MCX 20yrs of experience with LIC, RBI, SHCIL Lamon Rutten Joint MD, MCX Previously Chief Finance, UNCTAD Anjani Sinha MD & CEO, NSEL Former Executive director of Ahmedabad Malcolm Morris CEO, DGCX Former Head of business development of LIFFE (NYSE Euronext) Framroze Pochara Director, SMX Former Vice President - Operations, NSE John Mathias CBO, SMX Former director of Financial F&O , Merrill Lynch Anil Choudhary MD & CEO, NBHC 23 yrs of experience in banking U. Venkataraman CEO, MCX-SX Former head of treasury, IDBI Craig Hewett Chief Business Officer, BFX Former deputy commercial director, LME Joseph Bosco DMD & COO, GBOT Former MD & CEO of OTCEI Jayant Deo MD & CEO, IEX Chairman of Energy sub-committee of Maharashtra Ganesh Rao CEO, IBS Forex 25yrs of experience in banking focused on forex trading Advisory Board P.G Kakodkar Board of Director, FTIL & MCX Advisor to Societe Generale - India, Former Chairman of SEBI Narayanan Vaghul Chairman - Independent Advisory Board Chairman of ICICI Bank, Former Chairman and MD of BOI G.N. Bajpai Member - Advisory Board, FTIL Former SEBI Chairman, Former Chairman of LIC of India Dr. S. Narayan Member - Advisory Board, FTIL Former Economic Advisor to PM Kiran Karnik Member - Advisory Board, FTIL Former President of NASSCOM Venkat Chakry Chairman, MCX Ex-chairman of FMC, Ex-secretary to CM of Maharshtra Vepa Kamesam Director, MCX-SX Former Deputy Governor of RBI A.V. Rajwade Member - Advisory Board, MCX-SX Former Director, CRISIL Myron Scholes Member - Advisory Board, SMX Winner of Nobel Memorial Prize in Economics Ang Swee Tian Chairman, SMX Former President of Singapore Exchange (SGX) Source: Company
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Income statement Key ratios Year to Mar 31 (Rs m) FY07 FY08 FY09E FY10E FY11E Year to Mar 31 FY07 FY08 FY09E FY10E FY11E Net sales 988 1,376 2,802 3,295 3,717 EBITDA margin (%) 43.9 32.6 41.9 43.2 44.8 % growth 10.0 39.2 103.7 17.6 12.8 EBIT margin (%) 42.3 30.9 39.3 39.2 40.9 Operating expenses 555 927 1,629 1,873 2,051 PAT margin (%) 100.1 698.8 109.1 72.2 43.0 EBITDA 434 449 1,173 1,422 1,666 RoE (%) 56.6 115.3 19.1 13.0 8.1 % change (25.3) 3.5 161.4 21.3 17.1 RoCE (%) 10.0 3.3 5.4 5.7 6.3 Other income 753 935 723 809 865 Gearing (x) 2.2 0.3 0.2 0.2 0.2 Net interest (3) (109) - - - Depreciation 15 24 72 129 145 Pre-tax profit 1,168 12,415 3,891 3,317 2,387 Valuations Deferred tax - - - - - Current tax 179 2,803 833 937 788 Year to Mar 31 FY07 FY08 FY09E FY10E FY11E Profit after tax* 990 9,612 3,058 2,380 1,599 Reported EPS (Rs) 22.1 209.5 66.6 51.9 34.8 Non-recurring items (16) - - - - Adj. EPS (Rs) 22.4 209.5 66.6 51.9 34.8 Net profit after PE (x) 62.8 6.7 21.2 27.2 40.5 non-recurring items 973 9,612 3,058 2,380 1,599 Price/ Book (x) 31.3 4.4 3.7 3.4 3.2 % change 95.2 887.5 (68.2) (22.2) (32.8) EV/ Net sales (x) 65.5 47.4 23.0 19.7 17.8 *Includes project divestment income EV/ EBITDA (x) 149.2 145.2 55.0 45.7 39.8 Balance sheet EV/ CE (x) 9.8 3.4 3.0 2.8 2.7
As on Mar 31 (Rs m) FY07 FY08 FY09E FY10E FY11E Paid-up capital 88 92 92 92 92 Shareholding pattern Reserves & surplus 1,898 14,602 17,247 19,198 20,313 Total shareholders' equity 1,987 14,694 17,339 19,290 20,405 Public & Others Total current liabilities 492 601 720 752 859 Foreign 16.8% Total debt 4,344 3,995 3,520 3,520 3,520 27.2% Other non-current liabilities 254 667 667 667 667 Total liabilities 5,090 5,262 4,906 4,938 5,045 Total equity & liabilities 7,077 19,956 22,245 24,228 25,450 Net fixed assets 691 2,073 2,478 2,821 3,206 Institutions 6.8% Investments 4,144 13,743 14,989 16,989 18,989 Non Promoter Promoters Total current assets 2,234 4,129 4,778 4,419 3,255 Corporate Holding 45.6% Deferred tax assets 9 11 - - 1 3.6% Working capital 1,742 3,528 4,058 3,666 2,396 As of March 09 Total assets 7,077 19,956 22,245 24,228 25,451
Cash flow statement Year to Mar 31 (Rs m) FY07 FY08 FY09E FY10E FY11E Pre-tax profit 1,168 12,415 3,891 3,317 2,387 Depreciation 15 24 72 129 145 Chg in working capital 34 331 (328) (80) 9 Total tax paid (179) (2,803) (833) (937) (788) Operating cash inflow 1,039 9,967 2,802 2,430 1,752 Capital expenditure (612) (1,401) (400) (400) (401) Free cash flow (a+b) 427 8,566 2,402 2,030 1,351 Chg in investments (2,541) (9,599) (1,246) (2,000) (2,000) Debt raised/ (repaid) 4,344 (350) (475) - - Capital raised/ (repaid) (117) 4,166 - - - Dividend (incl. tax) (409) (1,071) (429) (429) (483) Net chg in cash 1,704 1,712 252 (400) (1,132)
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Bombay Stock Exchange (BSE) NOT LISTED Yet to ‘own’ liquidity!
The Bombay Stock Exchange (BSE), established in 1875, is the oldest exchange in Asia. However, structural inefficiencies with regards ownership structure as also physical trading platform led to BSE losing grip on the industry, reflective in its declining market share (down from 89% in 1995 to 7% currently). In addition, slow pick- up in the largest segment of the indutry – F&O (72% of industry turnover) – further added to its woes. Taking cue from NSE’s sophisticated platform and corporatized structure, BSE is now a demutualized and electronic exchange. The demutualization process culminated into two leading world exchanges – Deutsche Bourse and Singapore Exchange – acquiring 5% stake each in BSE at US$42.7m, valuing the entity at US$0.8bn. However, while structural inefficiencies have been addressed, we believe BSE has a big task at hand as NSE leads the industry with a 90% market share and liquidity is inherently sticky. Asia’s oldest exchange… The BSE was established in 1875 is Asia’s oldest exchange. It migrated from the open outcry system to an online screen- based order-driven trading system in 1995. While it was incorporated as an Association of Persons (AOP), BSE is now a corporatized and demutualised entity. The largest shareholders of BSE include strategic investors – Deutsche Bourse and Singapore Exchange, each owing ~5% stake in the same.
Exhibit 1: Top five shareholders Shareholder % owned Deutsche Bourse AG 4.95 Singapore Exchange 4.95 SBI 4.95 LIC 4.95 Dubai Financial LLC 3.96 Source: Company
…But the bull has been overtaken As BSE was the oldest and the only national-level exchange in India until 1993, it enjoyed dominant leadership with an over 90% market share. The remaining was shared by regional exchanges. However, the incorporation of NSE, the second national-level exchange in 1993, changed the industry dynamics. It marked the shift of the industry to an organized sophisticated market. Thus, BSE – due to its legacy structure – started conceding market share to NSE with its share declining from 89% in 1995 to 7% currently. Key structural differences included BSE’s mutual-ownership structure and its physical trading platform. In addition to these drawbacks, BSE was also not a strong proponent of F&O – a segment that today forms 72% of the industry turnover.
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Exhibit 2: BSE losing market share to NSE
NSE BSE (%) 100 13 10 10 7 27 37 36 75
89 50 87 90 90 93 73 63 64 25
11 0 FY95 FY97 FY99 FY01 FY03 FY05 FY07 FY09
Ownership structure – not-for-profit BSE was established in 1875 as a voluntary ‘not-for-profit’ un-incorporated association of persons. The membership entitled the person to be a part owner of, as well as a broker on, the exchange. Such a mutually-owned structure inhibited the competitiveness as also policy decisions on the exchange. In 1993, NSE was established as a demutualized entity wherein ownership/ membership was distinct from trading rights. Such a corporatized structure enabled NSE to make stronger policy decisions and progress in a more focused manner. Taking a cue from NSE, BSE finally attained corporatization and demutualization in 2003.
Open outcry trading – limiting accessibility BSE facilitated trading in pits following the open outcry system for trading. This limited accessibility as to trade, physical presence was mandatory at the exchange. Subsequently, NSE was established as an electronic exchange facilitating nationwide trading on an electronic platform. Thus, NSE stretched its reach over a wider audience, improving participation and thereby liquidity. Taking learning from this, BSE migrated to an electronic platform in 1995 by launching BOLT (BSE Online Trading System) with CMC as its technology provider.
F&O – did not envision the ‘future’ NSE, since the start, was a strong proponent of financial futures market in the country. However, the BSE disagreed and argued that India already had a home-grown, tested and true version of stock futures built on a couple of traditional features of Indian equity markets. The first feature was a week-long settlement period which allowed traders to buy and sell all they wanted and deliver or receive only their net position as of the end of the settlement period. Add to this a unique Indian practice referred to as badla, which allowed traders to roll a net position over to the next settlement period and traders could obtain stock market exposure for days, weeks or even months, without ever having to make or take delivery, very much like a futures contract.
Financial futures were permitted by the GoI in 2001. BSE’s lag and lack of pro-activeness towards the F&O segment led to liquidity migrating wholesale to NSE. Today, F&O forms 72% of the total turnover on Indian equity exchanges and NSE has a 99% share of this segment. Thus, success in F&O has been the most important reason behind NSE’s takeover of BSE.
Business Overview With the inability to garner liquidity in F&O segment, the distribution of turnover on BSE is skewed towards the cash segment (98% of its total turnover) in FY09. While global benchmarks indicate that volumes on financial derivatives are 3-5x those in the underlying cash market, BSE is an exception. With the cash segment being the underlying for the F&O segment, liquidity in the latter is bound to bring liquidity in the cash segment as well. While BSE has not been
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Cash turnover on BSE has registered a 20% CAGR over the last five years. In aggregate, BSE registered an annual turnover of US$222bn in FY09.
Exhibit 3: Cash segment the survivor… …forms 99% of overall turnover
(US$ bn) F&O CM Aggregate F&O 400 1%
300
200
100
CM 0 99% FY04 FY05 FY06 FY07 FY08 FY09
Source: IDFC-SSKI Research
Revenue model Primary sources of revenue for BSE include transaction fees, listing fees and membership fees. As exchanges progress towards maturity, income from transaction fees begins to dominate the mix while those from membership fees drops as a percent of total revenues. In addition, listing fees are dependent on the market conditions as stable markets attract higher fund raising issues. In FY08, transaction fees contributed 71% to the total operational income (excluding income/ interest from investments or income from penalties) which stood at Rs1.5bn – a growth of 56% over FY07.
Exhibit 4: Revenue breakup
FY08 Listing fees 26.9%
Processing fees 0.6%
Membership fees 1.4% Transaction fees 71.1% Source: Company, IDFC-SSKI Research
Transaction charges BSE charges a fixed fee for every transaction facilitated on the exchange. BSE has a differential fee structure across its cash and F&O segments and the dependence on this turnover is high. In the cash segment, charges are placed at 0.0035% of turnover (Rs3.50 per Rs100,000 of turnover), while for derivatives it is at 0.00025% of turnover (Re0.25 per Rs100,000 of turnover).
Listing Being an equity exchange, BSE generates income from listing fees in the case of IPOs, FPOs, QIPs, etc. BSE has a total of 4,887 companies listed, which is the second largest base in the world after USA. BSE charges an initial listing fee
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which is backed by an annual charge. While the initial charge is fixed at Rs20,000, the annual charges are based on the respective company’s capital base and varies from Rs10,000 to as high as Rs30,000 per year. In FY08, BSE garnered Rs159m as listing fees and Rs167m as book building fees.
Exhibit 5: No. of companies listed… …Listing fees charged No of cos listed 5,853 5,815 5,782 Listing (Rs) 6000 5,603 5,528 Initial Listing Fees 20,000 4,887 4,781 Annual Listing Fees 4500 (i) Companies with listed capital up to Rs50m 10,000 (ii) Above Rs50m and up to Rs100 15,000 (iii) Above Rs100m and up to Rs200 30,000 3000
1500
0 FY96 FY98 FY00 FY02 FY04 FY06 FY08 Source: IDFC-SSKI Research
Membership admission With BSE being existent for over a decade now, new member admission has been relatively subdued. BSE has a membership base of 2000+ members. In FY08, BSE garnered subscription revenues of Rs21m.
Future outlook While the last few years have been a struggle for BSE in the wake of its structural inefficiencies the way forward looks more promising. BSE is now a demutualized electronic exchange and is trying innovative methods (such as market making) to drive liquidity on its F&O platform. Further, the exchange is upgrading its technology platform and has contracted OMX – the world’s leading technology provider – for the same. With regards to its business domain, BSE has ventured into currency derivatives. However, liquidity is yet to pick up in this segment.
Another important development has been towards its management structure. BSE did not have a CEO for the past nine months after Rajnikanth Patel resigned from the operations. This, we believe, further limited the focus and business decisions of BSE. However, the company has recently recruited Madhu Kannan for the post of MD and CEO. Prior to his appointment, Mr. Kannan was a managing director (corporate strategy) with Bank of America-Merrill Lynch based in New York. He also held various senior roles across businesses at the NYSE Euronext. Thus, we believe, can potentially drive a revival in BSE’s fortunes.
Financials and valuations In FY08, total operating revenues stood at Rs2.2bn (a 52% yoy increase) while aggregate other income on investments almost doubled to Rs2bn on the back of strong trading activities. Thus, net profit came at Rs1.8bn – a 97% yoy increase.
Further, BSE has been able to garner a high strategic valuation. In 2007, the two leading global exchanges – Deutsche Bourse and Singapore Exchange – acquired a 5% stake each in BSE at US$42.7m, thus ascribing a total entity valuation of US$0.8bn to BSE.
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Exhibit 6: Key Financials (Rs m) FY07 FY08 Revenues: Transaction charges 665.6 1099.1 Listing Fees 302.4 415.4 Operational charges 357.2 483.9 Membership fees 20.1 21.8 Penalties & Fines 64.4 106.37 Processing fees 6.4 9.7 Training institute 36.3 65.3 Total revenues 1452.4 2201.6 Expenditure: Technology expenses 402.3 517.75 Employee costs 328.7 329.3 Admin expenses 503.9 1089.8 Other Expenditure 13.4 42.7 Total Expenditure 1248.3 1979.5 EBITDA 204.1 222.0 Depreciation 230.1 257.0 Other income: Income from investments 805.73 1751.8 Other non-operational income 221.9 251.1 PBT 1001.63 1967.92 Exceptional item 0 32.5 Tax 93.2 210.5 PAT 908.4 1789.9 Source: Company
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Indiabulls Financial Services (IFSL) UNRATED Venturing with the right partner
Indiabulls Financial Services (IFSL), part of the Indiabulls Group, forayed into the US$1trillion Indian commodity exchange space in 2008. We met Ajit Mittal, president of Indiabulls Group, to gauge the potential of the exchange venture. IFSL has established India’s 4th national-level multi-commodity exchange called IMX (or International Multi-Commodity Exchange) in a joint venture with MMTC – the country largest commodity trading company. We believe MMTC’s domain expertise and industry network will aid in inducing liquidity on the exchange, while IFSL’s retail presence would bring added participation. Having contracted MIT for the exchange technology platform, IMX is targetted to go live by end of June 2009. Company background Indiabulls Financial Services (IFSL) is an integrated financial services provider disseminating providing Consumer Finance, Housing Finance, Commercial Loans, Life Insurance, Asset Management and Advisory services. It is a part of the US$2bn Indiabulls Group which has business interests in Real Estate, Infrastructure, Financial Services, Retail, Multiplex and Power sectors. In Q3FY09, the company made a foray into the Indian commodity exchange space. The company, in partnership with MMTC – the largest commodity trading company in India, is setting up Multi- Commodity Exchange (IMX), India’s 4th Multi-Commodities Exchange.
International Multi-Commodity Exchange (IMX) – Corporate structure IMX was promoted as a joint venture between IFSL and MMTC. Indiabulls held a 74% stake in IMX while MMTC owned the remaining 26%. However, with Indian regulations limiting ownership of a single entity in a commodity exchange to 40%, Indiabulls subsequently inducted other strategic partners and brought down its stake to 40%. Thus, in addition to Indiabulls and MMTC, there are four others partners namely Yes Bank, HDFC Bank, Indian Potash and a small trading firm.
Exhibit 7: Corporate Structure
International Multi-Commodity Exchange (IMX)
~40% 26% ~34%
Indiabulls Financial MMTC Services Yes Bank
HDFC Bank
Indian Potash
Small Trading firm
Source: IDFC-SSKI Research
MMTC – high strategic value! Established in 1963, MMTC is a leading international trading company with a turnover of over US$ 5 billion. Its vast international trade network, which includes a wholly-owned international subsidiary in Singapore, spans almost all countries in Asia, Europe, Africa, Oceania and Americas, giving MMTC global market coverage. MMTC, the largest non-oil importer in India, is the largest importer of gold and silver in the Indian sub-continent, handling about 100
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Target to go live by June-end Indiabulls and MMTC are working closely to operationlize IMX. The recruitment drive has started and the exchange expects to go live by June 2009, subject to regulatory approvals. The contract for implementing the technology platform has been awarded to Millennium Information Technology (MIT), a leading international exchange services provider in USA. Millennium has implemented the technology platform at more than a dozen exchanges worldwide, including AMEX and Icap of USA.
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National Board of Trade (NBOT) NOT LISTED Largest regional commodity exchange
The National Board of Trade (NBOT) is a regional commodity futures exchange based in Indore, capitalizing on the region’s strong underlying physical market for Soybean (Madhya Pradesh accounts for 60% of India’s production). While NBOT is the erstwhile leader of the Indian commodity exchange space (52% market share in FY03), launch of the three national-level exchanges in 2003 changed the opportunity landscape of the industry with inclusion of global commodities for trading on exchanges and increased national reach. Nevertheless, NBOT has registered a 3x growth in turonver since then (US$19bn annual turnover in FY08 from US$6.6bn in FY03), thereby sustaining its dominance in the regional commodity exchange landscape (albiet <1% of the Indian industry). Company background National Board of Trade (NBOT) was incorporated as a commodity futures exchange in Indore and commenced trading in 2000 and currently garners daily volumes of ~60,000 tonnes in Soya oil. With Madhya Pradesh accounting for ~60% of India’s production of Soybean, Indore emerged as an important terminal market for trading in the commodity. The strong physical market resulted in NBOT garnering healthy volumes in its futures segment. Thus, while NBOT was a regional exchange, it dominated the Indian commodity exchange landsacpe with a 52% market share in FY03. However, introduction of the three national level commodity exchanges in the country in 2003 changed the opportunity landscape of the Indian commodity exchange industry.
Regional focus chipping at market share…but turnover growth still robust (3x in last six years) With increasing penetration of commodity derivative markets in the country, and thereby increased turnover on national commexes, NBOT has lost its dominance in the space. However, it is important to note that these national level commexes increased the overall industry size by introduction of global commodities (like bullion, energy, etc) and hence did not directly impact volumes on regional exchanges. Thus, while market share of NBOT has decreased to sub 1% from 50%+ over the last six years, turnover on the exchange has increased 3x over the same period. In FY08, NBOT registered an annual turnover of US$19bn, making it the largest regional exchange in the country.
Exhibit 8: NBOT losing market share to national exchanges… …but turnover growth still sustained
(%) MCX NCDEX NMCE NBOT Other regional commex NBOT (Turnover in US$bn) 100 20.0 10 19 32 75 49 15.0
50 47 87 10.0 77 62 25 45 5.0 29 1 0 2 FY03 FY04 FY05 FY06 FY07 FY08 FY09 0.0 FY03 FY04 FY05 FY06 FY07 FY08
Source: FMC, IDFC-SSKI Research
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Business overview Key commodities in which NBOT offers futures trading include Soybean (seed, oil and cake), Rape/ Mustard (seed, oil and cake), RBD Palmolein, Crude Palm Oil, CPO Refined and Crude Palmolein. The Exchange has 119 business members from all over India, of which almost 70% are active. The business members represent various categories, viz. growers, processors, traders, brokers, importers-exporters and banker. The distribution of the membership base and fees charged by NBOT is as follows:
Exhibit 9: Membership charges Type of Member Entrance Fee (Rs.) Security Deposit (Rs) Trade Guarantee Fund (Rs) No of members TM 100,000 150,000 15,000 56 TCM 300,000 400,000 60,000 62 ICM 1,500,000 3,500,000 350,000 1 Source: IDFC-SSKI Research
The exchange operates on outcry system for trading. All the post trading activities are fully automated (which includes margining). The trades executed in the ring are confirmed only after the margins are debited and limits are checked. NBOT implemented an Online Trading platform in April 2006 which is operational within 60kms of the radius of Indore City. The exchange has already launched nationwide online trading platform developed by CMC Limited in April 2008.
Future outlook With Indore being an important terminal for Soybean trade, we believe NBOT would remain a dominant player among regional exchanges. Thus, if the Indian commodity exchange space moves towards consolidation (currently there are 19 regional exchanges), we believe NBOT would be the most attractive player in the regional domain.
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National Commodity & Derivatives Exchange (NCDEX) NOT LISTED Agri focused!
The National Commodity and Derivatives Exchange (NCDEX) is India’s 2nd largest commodities exchange with an annual turnover of US$107bn and a 10% share of the market. It has a balanced mixed of public and institutional ownership (46% and 54% respectively) with NSE, LIC and NABARD as the largest stakeholders (15% stake each). In addition, Intercontinental Exchange (ICE), America’s leading exchange group, acquired an 8% stake in NCDEX in 2006 – thereby valuing the entity at US$37m. We met the management to get an update on its business operations and future plans. NCDEX has positioned itself as an agri-focused exchange (95% of turnover from agri commodities) and is thus materially exposed to bans/ suspensions by the government as these have a major bearing on volumes. While the regulatory hangover with respect to restrictions on trading will remain, NCDEX has broad based its product portfolio (54 commodities) and is also moving into newer avenues such as spot exchange, warehousing, etc to drive future growth.
COMPANY BACKGROUND The National Commodities and Derivatives Exchange (NCDEX) was incorporated in 2003 as a demutualized electronic commodities exchange. It is one of three commodity exchanges in the country (other than MCX and NMCE) recognized as a ‘national-level’ exchanges. The exchange has nine institutional shareholders with the public sector holding a 46% share, providing a suitable balance in the shareholding pattern. The top three shareholders of the exchange are NSE, LIC and NABARD – each having a 15% stake.
Exhibit 10: Corporate Structure
Public sector 46%
Other institutions 54%
Source: IDFC-SSKI Research
NCDEX: FIGHTING THE AGRI-WAR NCDEX is currently the second largest commodities exchange in India with an annual turnover of US$107bn in FY09. However, NCDEX has been conceding market share to its strongest competitor – MCX. The market share of NCDEX is down from 60% in FY05 to 10% currently. The loss of market share is primarily attributable to its positioning as an agricultural commodity-focused exchange.
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NCDEX currently garners 95%+ of its turnover from agricultural commodities. However, it is important to note that agri commodity trading contributes only 12% to the aggregate turnover in the industry. This has been on the back of increased penetration of global commodities which offer better visibility with regards prices as they are benchmarked to the global exchanges. Thus, with increasing share of non-agri commodities in the total industry turnover, NCDEX being agri focused started to lose market share (refer exhibit below).
Exhibit 11: Increasing share of bullion trading in the industry ….Decreasing market share of NCDEX
Agricultural Metals Energy Bullion MCX NCDEX NMCE (%) (%) 3 100 100 2 10 20 31 35 42 33 47 75 75 57 52 60 8 1 12 50 96 6 50 88 11 80 68 22 20 64 55 25 25 47 36 12 37 23 5 12 9 0 0 FY04 FY05 FY06 FY07 FY08 FY09 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: IDFC-SSKI Research
Another key reason for the decline in market share is the limited liquidity NCDEX has been able to garner in global commodities like gold. When gold contracts were launched on NCDEX, contract specifications were benchmarked to global commodity exchanges with the underlying being 999-purity. However, India – the largest consumer of gold in the world – follows 995-purity as the primary domestic import standard, which was also used as a benchmark for MCX contracts. This, we believe, led to migration of liquidity towards MCX for gold, which currently forms 39% of the total turnover in the industry.
Bans/ Suspensions – the bane of the industry With the underlying for agri commodities directly related to the domestic economy, there have been many regulatory issues regarding speculation in the same being a potential cause for inflation. This has led to the FMC placing a ban/ suspension on various commodities from time to time. NCDEX garners over 95% of its turnover from agricultural commodities. Thus, turnover on the exchange has been severely hit by these regulatory roadblocks. For instance, Chana was suspended for trading by the FMC for nine months in 2008. For NCDEX, Chana was a major contributor to its turnover, forming 23% of the total in FY07. Thus, while turnover on NCDEX registered a robust 109% CAGR over FY05-07, such restrictions have led to a decline in turnover in the last two years.
Exhibit 12: Timeline of ban on agri commodities… …impacting turnover
NCDEX Annual turnover Government bans/suspension on agri commodity trading (US$bn) 250 233 213 2007 Wheat, Rice, Tur, Urad banned from trading 200 May 2008 Suspension on rubber, potato, soyoil, Chana 155 150 Dec 2008 Suspension revoked on rubber, otato, soyoil, Chana 107 100 Apr 2009 Ban of wheat revoked 53 50 May 2009 Sugar futures banned
Ban of Rice, tur, urad, sugar still remains 0 FY05 FY06 FY07 FY08 FY09
Source: IDFC-SSKI Research
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BUSINESS OVERVIEW NCDEX currently does an average daily turnover of ~US$520m and offers trading in 54 commodities. However, the top 9 commodities contribute 91% to the turnover. Thus, NCDEX is yet to achieve the minimum critical liquidity across its commodities basket. The exchange has a membership base of 900 brokers and is estimated to have reached 20,000 terminals. Further, NCDEX has a tie-up with 55 depository participants and 13 clearing banks in order to execute post trade related operations efficiently.
Exhibit 13: Product portfolio ….Contribution from each
Products Others Barley Cotton Maize Rice Pepper 7% Brent Crude Oil Cotton Seed Oilcake Mentha Oil Rubber Jeera 3% Refined Soya Oil 3% 17% Bullion (Gold & Silver) Furnance Oil Mild Steel Ingots Sesame Seeds Sugar 7% Cashew Groundnut Expeller Mustard Seed Soy Oil Oil Chana 9% Castor Seed Groundnuts (in shell) Oils and Oil Seeds SoyBean Guar Seeds Chana Guar seed and Pepper Sugar 15% Guar Gum Chilli Gur Polymer Turmeric Turmeric 12% Copper Jeera Potato Wheat Rape/Mustard Seed Soyabean Seeds 15% Coriander Jute Rapeseed-Mustard 12% Seed Oilcake
Source: IDFC-SSKI Research
Transaction fees reduction – a move to revive volumes! NCDEX charges transaction fees in four different slabs as directed by the FMC. However, the exchange put up a proposal in January 2009 to bring down the transaction fees in a bid to boost its sagging turnover. NCDEX proposes to charge a uniform charge of Rs3 per Rs100,000 of the total value of all trades in all commodities from 10 a.m. to 5 p.m., while reduce the charges to Re0.05 per Rs100,000 of value of all trades in the second session starting 5 p.m. to 11 p.m. The reduction in transaction charges is targeted at attracting trading volumes, especially in the metals segment, which are largely traded after 5 p.m. given the information flow from international markets. However, the FMC has rejected this proposal and NCDEX has moved the Supreme Court against the regulator for the same.
In view of the fact that MCX has deep liquidity in the metals segment (99% control over bullion) as also the stickiness in the business where poaching of liquidity is extremely difficult, we believe that reduction in transaction charges would not materially influence volumes on NCDEX.
Exhibit 14: Transaction fees charged
Average daily turnover Rate charged/per lakh (Rs) Up to Rs500m 4 Proposed uniform charges of Above Rs500m and up to Rs1.5bn 3 Rs3/lakh from 10am-5pm while Above Rs1.5bn and up to Rs3.0bn 2 5paise in the evening session On incremental volume above Rs3bn 1 Source: IDFC-SSKI Research
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FUTURE OUTLOOK Growth drivers NCDEX Spot Exchange NCDEX has incorporated a wholly-owned subsidiary called NCDEX Spot to cater to the spot exchange industry in India. NCDEX Spot is expected to start operations in four states namely Maharashtra, Karnataka, Kerala and Bihar as these states do not require a license to trade in agricultural commodities. NCDEX is estimated to have invested Rs0.5m in the exchange. While the spot market offers huge potential, the exchange is yet to deliver in terms of execution.
Warehousing services In order to cater to the agri warehouse as also collateral management industry in the country, NCDEX has established a separate associate company called National Collateral Management Services (NCMSL). Within two years of operations, NCMSL has reached an aggregate capacity of over 1m tonnes and provides services like grading and assaying through reputed agencies accredited for the purpose. NCMSL has facilitated finance against commodities of about Rs4bn as on 31 March 2007 and Rs6bn as on 15 March 2008.
In addition, NCMSL also does procurement on behalf of FCI. In FY07, the company procured 0.7m tonnes of paddy from various states covering around 92,000 farmers and 3,980 tonnes of wheat from 360 farmers. In FY08, ~0.6m tonnes of paddy were procured from various states from around 68,000 farmers. We believe this venture could be a potential growth driver for NCDEX.
Concerns Turnover on NCDEX is primarily linked to agricultural commodities which contribute over 95% to the aggregate volumes. Thus, the bans /suspensions placed by FMC from time to time on specific agricultural commodities impart an element of volatility in turnover growth on NCDEX. While the FMC has revoked the ban on wheat just recently, it has placed a new ban on sugar trading. Such sudden regulatory impositions would adversely affect turnover on NCDEX.
Financials and valuations NCDEX is estimated to have garnered revenues of Rs967m and profits of Rs50m in FY08 with cash on books believed to be at Rs3.7bn. Further in 2006, Intercontinental Exchange (ICE), USA – one of the largest exchanges in the world – acquired an 8% stake at US$37m. ICE acquired the stake from ICICI Bank, ascribing an entity valuation of US$500m to NCDEX.
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National Multi-Commodity Exchange (NMCE) NOT LISTED Yet to ‘deliver’!
National Multi-Commodity Exchange (NMCE) is a national-level, demutualized electronic exchange promoted by Neptune Overseas – a government recognized export house – and key Indian public sector institutions like CWC, PNB, NAFED, etc. In 2008, Reliance Money acquired a 10% stake in the exchange and is looking to extend its ownership to 26% (awaiting regulatory approval). On the business front, NMCE has its strategic focus on delivery- based trading (<5% of aggregate industry turnover) as also domestic agri-commodities (12%). This, however, has limited its exposure in the industry, which has led to a decline in market share from 96% in FY04 to 1.2% in FY09. We interacted with Anil Mishra, CEO, to get an update on the business operations and future developments. In order to revive volumes on the exchange, NMCE has taken crucial steps like improvising its product basket and extending the trading window to evening sessions. On the back of these developments, turnover on the exchange has increased to US$12bn in FY09 - a 142% yoy jump. However, we believe sustainability of growth would be the key monitorable. Company background NMCE was the first national-level exchange in India and started operations on 26 November 2002. It has been promoted by Neptune Overseas, a government recognized export house, and a host of public sector companies. In 2008, Reliance Money signed an agreement to acquire a 26% stake in NMCE. However, regulatory approval could be obtained only for a 10% stake, which Reliance Money acquired at an estimated Rs100m. Reliance Money is still in the process of enhancing its stake to 26% and we believe would subsequently gain management control. Our interaction with the management also indicates a potential divestment by Neptune Overseas to other strategic investors.
Exhibit 15: Corporate Structure
National Multi-commodity exchange
24.4% 21.9% Neptune Overseas Anil Singhania
23.4% Central Warehouse 10.0% Reliance Money Corporation
9.3% Punjab National 4.5% NAFED Bank
6.3% Gujarat Agro 0.2% Kailash Gupta Industries
Source: IDFC-SSKI Research
Declining market share…a cause for concern NMCE, being the first national-level exchange in India, garnered an 86% share of the industry in FY04. However, over the last few years the exchange has lost market to its two national peers – MCX and NMCE, and currently controls only 1.2% of the industry (US$12bn of turnover in FY09). The primary factors responsible for this decline in share are the positioning of the exchange as a delivery-based commodity trading platform and focus on agricultural commodities – share of which has been reducing in the overall industry turnover.
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Exhibit 16: NMCE – The erstwhile leader… …now has 1% share
FY04 FY09
MCX NMCE NCDEX 9% NCDEX 1% 10% 5%
NMCE MCX 86% 89%
Source: IDFC-SSKI Research
Focus on delivery-based contracts NMCE, since inception, has positioned itself as an exchange for the purpose of seamless hedging and has maintained a stringent policy to demand compulsory delivery. This is in contrast to the other two national exchanges (MCX and NCDEX) which charge a penalty on failure of delivery for open contracts at expiry. In adition, NMCE pinoeered contracts for which delivery can be forced by the buyer or seller. This has been well accepted by FMC, which has mandated the same policy for agri commodities on MCX and NMCE which run contracts on sellers’ option. While this strategy of NMCE has been in the interest of farmers/ hedgers, we believe it has limited the its target market as pure speculators have migrated to other exchanges due to the threat of delivery. Currently, 95%+ turnover on the exchanges does not result into delivery, which implies that NMCE is not catering to the larger pie.
Focus on agri-commodities NMCE’s product offering is built around agricultural commodities with 90% of its turnover accruing from agri this class. This comes as a natural extension to its strategy of focusing on delivery-based contracts. While only agricultural commodities were permitted to be traded until FY04, the government has liberalized its policies over the last few years to include global commdities like bullion, energy, etc in the product basket. Global commodities offer better price transparency as they are benchmarked on global prices (and hence attract higher liquidity) as against agricultural commodities where price discovery is difficult because of the fragmented physical market in the country. In addition to this, bans and suspension by the government have further hurt trading in agri commodities. Thus, share of turnover of agri commodities has decreased to 12% in FY09 as against 96% in FY04, which has meant a big dent in NMCE’s market share.
Exhibit 17: NMCE – Only 11% of turnover from non-agri… …while industry turnover is skewed towards non-agri
FY09 Non-agri Sack 11% 19% Agricultural 12% Other agri Metals 17% 12%
Mustard seed Coffee Robusta 17% Bullion 5% 56% Copra Energy 20% 8% Isabgul seed Guar Seed 11% 12%
Source: IDFC-SSKI Research
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NMCE – focused on revival In order to improve its presence in the industry, NMCE has brought about key changes in its operations. Since September 2008, NMCE has increased its trading window by starting an evening session and launching international commodities such as coffee, bullion and metals. Also, the exchange has been consistently improvising its product basket which has increased from eight commodities in FY03 to 23 currently. On the back of these developments as also the increasing penetration of commodity markets in the country, the exchange is seeing a revival in turnover. In FY09, NMCE registered a turnover of US$12bn – a jump of 142% yoy. Further, the exchange has a near 100% market share in rubber with a turnover of US$196m in the same as also leads the market for products like coffee, cotton, etc.
Business Model Membership fees and transaction fees form key revenue sources for NMCE. The exchange has seen a steady increase in its membership base – from 41 brokers in FY03 to the current 301. Membership charges vary with the type of membership, as shown below:
Exhibit 18: Membership fees …Transaction charges
Fee Structure Professional/ Trading cum Trading Average daily turnover Rate per lac (Rs) (Rs m) Institutional Clearing Member Member Up to Rs500m 4 Above Rs500m and up to Rs1.5bn 3 Clearing Member Above Rs1.5bn and up to Rs3.0bn 2 Admission Fees 0.25 0.1 0.025 On incremental volume above Rs3.0bn 1 Initial Base Capital(Refundable After the min lock in period) 0.5 0.1 0 Trade Guarantee Fund 0 0.1 0 Additional Base Capital (In form of Collaterals) 1.5 1.0 0 Annual Subscription charges 0.05 0.02 0.005 Net worth Criteria 250 5.0 0.5 Source: Company, IDFC-SSKI Research
Transaction charges on NMCE are distributed over four slabs (as directed by FMC) on the basis of average daily turnover. However, turnover on NMCE has not followed a steady trend, partly attributable to the ban/ suspensions by FMC. In FY07, NMCE registered the highest turnover as the exchange added 11 new products in that year. However, post that turnover has been impacted partly due to the ban/ suspension by FMC as also improvisation of product offering by NMCE (product portfolio rationalized from 35 in FY07 to 24 in FY08). NMCE is estimated to have garnered revenues of Rs81m and profits of Rs31m in FY07.
Exhibit 19: Steady increase in membership base …Turnover lopsided on the back of bans/suspensions
No of members (US$ bn) Turnover 350 25.0 22.6 301
280 20.0
207 210 15.0 12.3 150 140 10.0
4.8 5.1 52 5.0 3.7 70 41 48 49 2.8 0.9 0.0 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY03 FY04 FY05 FY06 FY07 FY08 FY09
Source: IDFC-SSKI Research
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National Stock Exchange (NSE) NOT LISTED The equity bull!
National Stock Exchange (NSE) dominates the US$4trillion Indian exchange landscape with a 65% share of the industry. Established in 1994, NSE is the country’s first demutualized exchange and the pioneer of electronic trading in the country. We met Ravichandran – Director, NSE to take an update on the business operations. While NSE’s sound corporate structure imparts execution efficiency, strategic focus on the financial derivatives (F&O) segment has been the cornerstone of NSE’s journey to the current 90% share of the Indian equity market (99% share of the F&O segment). Ranked as 7th largest derivatives exchange in the world (in terms of contracts traded), NSE reported gross reveneus of Rs10.4bn and profits of Rs5.2bn in FY08. Strong earnings capability and leadership in the Indian exchange industry has translated into a high strategic value for NSE with NYSE Euronext acquiring a 5% stake for US$115m, ascribing an entity valuation of US$2.3bn. While the expected 12% CAGR in turnover over the next five years in Indian equity markets would maintain NSE’s growth momentum, its leadership (51% share) in the newly launched currency derivatives segment (US$240bn industry expected to grow 4x by FY14) would provide further growth impetus.
ESTABLISHED LEADERSHIP The current size of the Indian exchange space is pegged at US$4trillion in terms of annual turnover. With equity exchanges being the genesis of the organized exchange sector in India, their size in the industry is the largest, contributing 70% to the total turnover. NSE leads the equity exchange industry in the country with a dominating 93% share of the total turnover, thereby holding a dominant 65% of the Indian exchange space.
Exhibit 20: NSE – The largest player in the Indian exchange space
Current Size (US$bn) % share
Commodity 1,050 24% National Stock Equity 3,042 70% Exchange – 93% share of equity markets Currency 240 6% Total 4,332 100%
65% share of the Indian Exchange space 65% share of the Indian Exchange space
Source: IDFC-SSKI Research
NSE – world’s 8th largest derivatives exchange The success of NSE is evident in its positioning on the global exchange landscape. NSE is ranked 8th among the world’s largest derivative exchanges in terms of contracts traded. Derivative exchanges ranked include all exchanges across the globe offering derivative products irrespective of the underlying which includes commodities, equities, etc. NSE, being present solely in the equity segments, has managed to garner this position on the back of deep liquidity in its F&O segment. In addition, NSE is also ranked 7th among the most actively traded index derivative products among global exchanges.
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Exhibit 21: Top 20 Equity Index Futures & Options Worldwide Top Derivatives Exchanges Worldwide
Rank Contract Jan-Dec 2008 Rank Exchange Jan-Dec 2008 1 Kospi 200 Options, KRX 2,766,474,404 1 CME Group (includes CBOT and Nymex) * 3,277,645,351 2 E-mini S&P 500 Futures, CME 633,889,466 2 Eurex (includes ISE) * 3,172,704,773 3 DJ Euro Stoxx 50 Futures, Eurex 432,298,342 3 Korea Exchange 2,865,482,319 4 DJ Euro Stoxx 50 Options, Eurex 400,931,635 4 NYSE Euronext (incl all EU and US markets) * 1,675,791,242 5 SPDR S&P 500 ETF Options * 321,454,795 5 Chicago Board Options Exchange (incl CFE) * 1,194,516,467 6 Powershares QQQ ETF Options * 221,801,005 6 BM&F Bovespa * 741,889,113 7 S&P CNX Nifty Futures, NSE India 202,390,223 7 Nasdaq OMX Group (incl all EU and US markets) * 722,107,905 8 S&P 500 Options, CBOE 179,019,155 8 National Stock Exchange of India 590,151,288 9 iShares Russell 2000 ETF Options * 151,900,495 9 JSE South Africa 513,584,004 10 S&P CNX Nifty Options, NSE India 150,916,778 10 Dalian Commodity Exchange 313,217,957 Source: World Federation of Exchanges
NSE: STRUCTURED JOURNEY TO LEADERSHIP NSE started operations in 1994 and has been instrumental in changing the contours of the Indian equity exchange industry. Swiftly over-taking Asia’s oldest equity exchange – Bombay Stock Exchange – within a year, NSE is today the dominant leader of the industry with a 90% market share. The primary reasons attributable to NSE’s success over the older bourse are its corporate structure, advanced trading platform and product offering.
Exhibit 22: Key attributes for NSE taking over Asia’s oldest exchange
NSE’s win over BSE
Platform Structure Products
NSE commenced NSE established as the Strong focus on attaining electronic trading in country’s first liquidity in F&O equity markets demutualized exchange
Source: IDFC-SSKI Research
NSE – India’s first demutualized exchange NSE is the first de-mutualised stock exchanges in the country, where the ownership and management of the exchange is completely divorced from the right to trade on it. From day one, NSE has adopted the form of a demutualised exchange – the ownership, management and trading is in the hands of three different sets of people. NSE is owned by a set of leading financial institutions, banks, insurance companies and other financial intermediaries and is managed by professionals, who do not directly or indirectly trade on the exchange. This has completely eliminated any conflict of interest and helped NSE in aggressively pursuing policies and practices within a public interest framework.
On the other hand, BSE till 2005 followed a mutual structure with the ownership and trading rights in the hands of members. This difference in the structural orientation between the bourses was instrumental in bringing success to NSE.
Technology – pioneer of electronic trading NSE introduced electronic trading in the Indian exchanges space. Until then, BSE followed the open outcry trading method wherein members collected in a pit and executed orders by word of mouth. With electronic trading, NSE brought about sophistication in the trading system, providing enhanced access and thereby increasing participation. This was a key driver of liquidity on NSE. Taking cue from the success of NSE, BSE too migrated to the electronic platform in 1995.
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NSE – realizing the future in ‘futures’! NSE, since the start, was a strong proponent of financial futures market in the country. However, BSE disagreed and argued that India already had a home-grown, tested and true version of stock futures built on a couple of traditional features of Indian equity markets. The first feature was a week-long settlement period which allowed traders to buy and sell all they wanted and deliver or receive only their net position as of the end of the settlement period. Along with a unique Indian practice referred to as badla, which allowed traders to roll a net position over to the next settlement period, traders could obtain stock market exposure for days, weeks or even months, without ever having to make or take delivery, very much like a futures contract.
Financial futures were admitted by the GoI in 2001. NSE – sensing the potential in the industry – was pro-active in launching contracts and on the back of its strong membership base garnered strong liquidity in its F&O segment. Today F&O forms 72% of the total turnover on Indian equity exchanges and NSE has a 99% share of this segment. Thus, success in F&O has been the most important reason behind NSE overtaking BSE.
NSE – established leadership across all equity market segments The US$3trillion equity markets in the country are a perfect blend of four derivative products (index futures and options, stock futures and options) along with the cash and debt market segments. With leverage playing in favour of F&O, volumes in the F&O segment are seen at 3-5x that of the underlying cash market. Futures and options (F&O) contribute 72% to the total US$3trillion turnover on equity exchanges while the cash segment accounts for 25% of the total turnover. Both the key players – NSE and BSE – are present across all these segments. However, NSE clearly dominates across segments, with the highest gap in F&O segment where NSE has a 99% market share.
Exhibit 23: Industry turnover distribution… …NSE leads across all segments
Indian Equity Exchanges
Avg of FY08 & NSE BSE 25% 72% 2% FY09 Futures & Cash segment Debt segment Options Cash Market 70% 30%
Stock Futures Index Futures F&O 99% 1%
Stock Options Index Options
Source: IDFC-SSKI Research
NSE has established a strong membership base across all segments and has a total membership base of 1,075 brokers. Further, NSE offers a total of 28,268 contracts across different segments. Increasing participation as also depth in trading has led to a strong 70% CAGR in turnover on NSE over the last 14 years. In FY09, NSE recorded an annual turnover of US$2.8trillion - a 17% dip with respect to the previous year (total turnover stood at US$3.3trillion in FY08), attributable to bad market conditions. Also, the average daily traded value on NSE stands at US$12trillion.
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Exhibit 24: Segment wise increase in turnover CM F&O Debt 3500
2800 Segments No. of Members No. of Securities/ Contracts Available 2100 CM 1,069 1,236 WDM 62 3,566 1400 F&O 942 23,466 Total 1,075 28,268 700
0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: IDFC-SSKI Research
Distribution of turnover on NSE is skewed towards the F&O segment, with the segment having contributed 78% to the total turnover in FY09. The cash segment contributed 20% to the aggregate turnover. This is in line with global standards where volumes on financial derivatives are 3-5x those in the underlying cash market. NSE has seen strong growth in turnover across the cash and F&O segments, with cash turnover registering a 20% CAGR over the last five years and F&O a 39% CAGR. Thus, F&O stands to be the key driver for NSE.
Currency derivatives – potential future driver! In addition to the equity segments, NSE ventured into currency derivatives in September 2008. NSE holds a 51% share of the newly introduced currency derivatives market, with the remaining 49% held by MCX-SX (promoted by MCX and Financial Technologies). NSE does an average daily turnover of ~US$550m in this segment. With this segment still being nascent, NSE does not charge any fees for trading on the same and hence it does not contribute to profitability.
Exhibit 25: Currency derivatives turnover increasing steadily… …NSE leads with 51% market share
Average daily turnover (US$ m) MCX-SX 600 535 49% NSE 450 51% 334
300 240 218 177
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0 Nov Dec Jan Feb Mar Source: IDFC-SSKI Research
REVENUE MODEL Primary sources of revenue for NSE include transaction fees, listing fees and membership fees. As exchange progress towards maturity, income from transaction fees begins to dominate while that from membership fees drops as a percent of total revenues. In addition, listing fees are dependent on the market conditions as stable markets attract higher fund raising issues. In FY08, transaction fees contributed 95% to NSE’s total operational income (excluding income/ interest from investments or other income), which stood at Rs7.8bn – a 79% rise over FY07.
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Exhibit 26: Revenue model
FY08
Book building Fees 2% Listing Fees Annual Subscription 1% 1%
Transaction Charges 96% Source: Company, IDFC-SSKI Research
Transaction charges NSE charges fees a fixed fee for every transaction facilitated on the exchange. Clients are charged fees in three brackets – brokerage charges, transaction charges and securities transaction tax (or STT). Of this, the brokerage fess is at the discretion of the broker member (NSE sets the upper limit for the same) and is retained by him. The transaction fees and STT are retained by NSE. NSE has a differential fee structure across its cash and F&O segment and is dependant on the turnover. The charges for the segments as charged by NSE are outlined below:
Exhibit 27: Trading charges Charges CM F&O Brokerage Charges Max fixed at 2.5% of value traded Max fixed at 2.5% of value traded/notional value Transaction charges 0.0035% of turnover Futures - 0.002% of turnover (subject to min Rs1lakh per year) Options - 0.05% of the premium value Securities transaction tax (delivery based) 0.125% of turnover Securities transaction tax (non-delivery based) 0.025% of turnover 0.017% of turnover (payable only by seller) Source: Company, IDFC-SSKI Research
In FY08, revenues from transaction fees stood at Rs7.4trillion – an 80% increase yoy. With NSE leading the Indian equity exchange space, which is expected to register a 16% CAGR in turnover over the next five years, we believe NSE would continue to report healthy growth in transaction fees. Also, NSE does not levy a transaction fee in its currency derivatives business. With the segment garnering a healthy daily turnover of US$550m, levying of transaction charges in the near future would boost NSE revenues.
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Listing Being an equity exchange, NSE generates income from listing fees in the case of IPOs, FPOs, QIPs, etc. The number of companies listed on NSE has increased from 135 in 1995 to 1,432 currently. NSE charges an initial listing fee which is backed by an annual charge. While the initial charge is fixed at Rs25,000 the annual charges are based on the respective company’s capital base and varies from Rs10,000 to as high as Rs375,000 per year. In FY08, NSE garnered Rs108m in listing fees and Rs194m as book building fees.
Exhibit 28: Listing charges by NSE Listing Fees Amount(Rs) Initial Listing Fees 25,000 Annual Listing Fees (based on paid up share, bond and/ or debenture and/or debt capital, etc.) a) Up to Rs10m 10,000 b) Above Rs10m and up to Rs50m 15,000 c) Above Rs50m and up to Rs100m 25,000 d) Above Rs100m and up to Rs200m 45,000 e) Above Rs200m and up to Rs300m 70,000 f) Above Rs300m and up to Rs400m 75,000 g) Above Rs400m and up to Rs500m 80,000 h) Above Rs500m and up to Rs1bn 130,000 i) Above Rs1bn and up to Rs1.5bn 150,000 j) Above Rs1.5bn and up to Rs2.0bn 180,000 k) Above Rs2.0bn and up to Rs2.5bn 205,000 l) Above Rs2.5bn and up to Rs3.0bn 230,000 m) Above Rs3.0bn and up to Rs3.5bn 255,000 n) Above Rs3.5bn and up to Rs4.0bn 280,000 o) Above Rs4.0bn and up to Rs4.5bn 325,000 p) Above Rs4.5bn and up to Rs5.0bn 375,000 Source: Company, IDFC-SSKI Research
Exhibit 29: Listed base …FY08 listing fees
No of cos listed 1600 1,432 Particulars No of issues Amount raised 1,381 1,228 (For FY08) (US$ bn) 1200 1,069 Public Issues 77 15.6 970 909 IPOs 74 10.5 785 793 818 FPOs 3 5.2 800 720 612 648 Rights Issues 14 3.4 550 422 QIP 33 6.1 400 Preferential Allotment 174 6.1 135 Total 298 31.1
0 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09
Source: IDFC-SSKI Research
Membership admission fees With NSE being operational for over a decade now, new member admissions have been relatively subdued. NSE has added ~100 members over the last eight years. Current membership base stands at 1,075 brokers spread across cash (1,069 members), F&O (942) and debt segments. In addition, NSE is estimated to have an estimated base of 470 members in the currency derivatives segment. In FY08, NSE garnered subscription revenues of Rs95m.
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Exhibit 30: Increasing Membership base …eligibility criteria for membership
WDM Segment CM Segment F&O segment (Rs m) CM and CM and WDM CM, WDM 2,500 1,075 F&O WDM and F&O 1,009 Paid-up capital 3 3 3 3 2,000 940 891 Net Worth 10 20 20 20 936 895 874 980 1,500 Interest Free Security Deposit 12.5 25 15 27.5 1,000 Collateral Security Deposit (CSD) 2.5 2.5 Nil 2.5 500 Annual Subscription 0.1 0.2 0.1 0.2
0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08
Source: IDFC-SSKI Research
GROUP STRUCTURE NSE was given recognition as a stock exchange in April 1993 and started operations in June 1994, with trading on the Wholesale Debt Market Segment. Subsequently, it launched Capital Market Segment in November 1994 as a trading platform for equities and the Futures and Options segment in June 2000 for various derivative instruments. NSE has over the years developed in-house capabilities across the entire exchange framework including technology, clearing & settlement, depository facility, etc.
Exhibit 31: Corporate timeline
Setting up of National Commencement of Establishment of NSCCL, Securities Depository Derivatives Trading (Index the first Clearing Limited, first depository in Futures) Corporation India, co-promoted by NSE Launch of Currency Commencement of Commencement of Derivatives Wholesale Debt Launch of CNX Setting up trading in Futures on Incorporation clearing and settlement Market segment Nifty Junior of NSE.IT Individual Securities goes live by NSCCL
Nov-92 Apr-95 Nov-96 Dec-96 Oct-99 Jun-01 Nov-01 Aug-08 Apr-96 Jun-94 Nov-94 Apr-93 Oct-95 Apr-96 Dec-96 May-96 Jun-00 Jun-01 Jun-03
Capital Market Recognition Became largest Launch of Commencement of Commencement Commencement of (Equities) Promotion of Launch of as a stock stock exchange S&P CNX trading/settlement of Derivatives trading in Options segment goes joint venture, Interest Rate exchange in the country Nifty in dematerialised Trading (Index on Individual live India Index Futures securities Services & Futures) Securities Products Limited (IISL)
Source: IDFC-SSKI Research
In order to cater to the different aspects of the exchange framework, NSE has created separate entities which include NSCCL, NSE.IT and NCCL – all being 100% owned subsidiaries. In addition, NSE has set up a host of joint ventures such as NSDL, IISL and PXI with leading institutions/ exchanges.
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Exhibit 32: Group Structure
National Stock Exchange
JV between NSE Securities Clearing Corporation 100% subsidiary Provides indices and index services and CRISIL NSCCL IISL
Promoted by Securities Depository NSE, UTI and National level commodity exchange 15% stake owned NSDL IDBI NCDEX
Technology arm 100% subsidiary Commodity Clearing Corporation 100% subsidiary NSETECH NCCL
JV between NSE Online trading system (NEAT) provider 100% subsidiary National level power exchange and NCDEX NSE.IT PXI
Source: Company, IDFC-SSKI Research
NSCCL – clearing and settlement National Securities Clearing Corporation (NSCCL), a wholly-owned subsidiary of NSE, was set up in August 1995. It was the first clearing corporation in the country to provide settlement guarantee that revolutionized the entire concept of settlement system in India. It commenced clearing operations in April 1996. It carries out clearing and settlement of the trades executed in the equities and derivatives segments of NSE. It assumes the counter-party risk of each member and guarantees financial settlement. It has tied up with 13 Clearing Banks, viz Canara Bank, Citibank N.A, HSBC, HDFC Bank, IndusInd Bank, ICICI Bank, Kotak Mahindra Bank, Axis Bank, Bank of India, IDBI Bank, Standard Chartered Bank, State Bank of India and Union Bank of India, for funds settlement while it has direct connectivity with depositories for settlement of securities.
Exhibit 33: Clearing and settlement process flow
Exchange
1. Trade details
8. Securities 9. Pay-out Pay-out of funds NSE: NSCCL Clearing bank
Depositories Clearing corporation 6. Securities 7. Pay-in Pay-in of funds
5. Instructions to 2. Affirm trade 3. Download make securities obligations obligation 4. Instructions to available make funds available
Custodian/CMs 10. Confirmation 11.Confirmation through DPs Source: Company, IDFC-SSKI Research
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In FY08, NSCCL garnered a total income of Rs3.7bn and profits of Rs2.6bn. Of the total income, Rs732m accrued from clearing and settlement charges which was levied to NSE.
Others key entities NSDL – the demat magic! Prior to trading in a dematerialized environment, settlement of trades required moving the securities physically from the seller to the ultimate buyer, through the seller’s broker and buyer’s broker, which involved a lot of time and the risk of delay somewhere along the chain. Further, the system of transfer of ownership was grossly inefficient as every transfer involved physical movement of paper to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. To obviate these problems, NSE promoted dematerialization of securities in association with UTI and IDBI, and set up the first depository in India called the “National Securities Depository” (NSDL).
NSE.IT – Technology NSE.IT, a 100% technology subsidiary of NSE, was incorporated in October 1999 to provide thrust to NSE’s technology edge Amongst various products launched by NSE.IT are NEAT XS, a Computer-To-Computer Link (CTCL) order routing system, NEAT iXS, an internet trading system and Probos – a professional broker’s back office system.
IISL – indices India Index Services and Products (IISL), a joint venture of CRISIL and NSE, was set up in May 1998 to provide indices and index services. It has a licensing and marketing agreement with Standard and Poor’s (S&P), the world’s leading provider of investible equity indices, for co-branding equity indices. IISL has developed various index based derivatives on NSE and on the Singapore Exchange (SNX Nifty index is traded on Singapore Exchange).
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FINANCIALS & VALUATIONS In FY08, standalone operational revenues of NSE stood at Rs7.8bn while gross revenues including interest/ investment income stood at Rs10.4bn. Aggregate operating expenditure stood at Rs2.6bn resulting in EBITDA margins of 67% with net profit of Rs5.2bn. In addition, in 2007 NYSE Euronext – world’s largest securities exchange – acquired a 5% stake in NSE at US$115m, thus ascribing a total entity valuation of US$2.3bn to NSE.
Exhibit 34: Key Financials Income FY07 FY08 Transaction Charges 4136 7462 Annual Subscription 57 95 Book building Fees 106 194 Listing Fees 98 108 Operational Revenues 4396 7858 Expenditure: Operating, Administration & other expenses 1101 1472 Clearing & settlement charges 451 732 Payments to and provision for employees 269 394 Total 1821 2599 EBITDA 2575 5259 Margins 59% 67% Depreciation (Refer Note no.1d) 300 439 Non-operational income Operational Expenses Recovery 479 475 Interest Income 225 201 Other Investment Income 580 1149 Other Income 555 703 Add: Profit on shares bought back by a subsidiary 649 PBT 4764 7348 Tax 1215 2135 PAT 3549 5213 Source: IDFC-SSKI Research
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Reliance Money NOT LISTED Testing new shores!
In a move to tap the potential in the exchanges indsutry as also forward-integrate its brokerage business, Reliance Money has acuired a 10% stake in NMCE (3rd largest National level commdity exchange). With the intention to further broadbase its exposure in the Indian exchanges industry, Reliance Money has taken on board Rajnikant Patel (ex-MD and CEO of BSE) as President of its exchanges business. Based our meeting with Mr Patel, we gauge that Reliance is focusing on the spot exchange framework in India. In this regard, Reliance has already launched a Spot Exchange (Reliance Spot Exchange Infrastructure; RSEI – a 100% owned subsidiary). Incrementally, Reliance Money has also ventured into the international exchange landscape by acquiring a 15% stake in HKMEx and is looking to acuire a majority stake in the Nigerain Exchange. While the exchange business of Reliance Money demonstrates strong potential, all its ventures are still in the incubation stage and thus yet to deliver in terms of execution. Company background Reliance Money, promoted by Anil Dhirubhai Ambani Group (ADAG), is India’s leading financial brokerage house with over 10,000 outlets in 5,165 locations. Forward integrating and broadbasing its brokerage business, Reliance Money has ventured into the exchange business in October 2008 by acquiring a 10% stake in NMCE –India’s third largest national-level commodity exchange. Since then, Reliance Money has increased its exposure in exchanges in India as well internationally.
Exhibit 35: Corporate Timeline
Feb 2008 • Expresses intent to setup a stock exchange for SME sector
July 2008 • Initiates talks to acquire 26% stake in NMCE
August 2008 • Sets up a spot exchange
• Acquired 10% stake in NMCE October 2008 • Acquired 15% stake in Hong Kong Mercantile Exchange
• Negotiates acquiring majority stake in upcoming exchange in November 2008 Nigeria
Source: IDFC-SSKI Research
Business overview With regards to exchange ventures, Reliance Money has interests across four domestic exchanges and two international exchanges. All these exchanges are non-financial derivative exchanges and primarily cater to the commdities markets.
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Exhibit 36: Business overview
Reliance Money
International Domestic
Hong Kong Mercantile Exchange National Multi-Commodity (15% stake) Exchange (10% stake)
Nigeria Exchange Reliance Spot Exchange
Stock exchange for SME
Source: IDFC-SSKI Research
Domestic exchange ventures In the domestic landscape, Reliance Money has interests across two exchange ventures which include India’s thrid largest national commodity exchange and a spot exchange. In addition, Reliance Money has expressed its intention to launch a stock exchange for the SME space in February 2009 and is scouting for partners.
Stake in NMCE – entry into the US$1tr Indian commodity exchange industry The National Multi-Commodity Exchange (NMCE) based in Ahmedabad is the country’s third largest national level electronic commodity exchange. In view of the potential offered by India’s commodity derivatives market, Reliance Money strategized to enter the industry and tied up with NMCE in July 2008 to acquire a 26% stake in the exchange. After receiving permission from the regultory authority (FMC), Reliance Money acquired a 10% stake in NMCE in October 2008. The transanction is estiamted to have been effected at Rs100m.
NMCE has a market share of <1% of the Indian commodity exchange space and registered an annual turnover of US$12bn in FY09. Reliance Money is looking to increase its stake to 26% in NMCE and subsequently gain management control in the same.
Spot Exchange – the big bet! Reliance Money has set up the third Spot Exchange in the country and has created an SPV called Reliance Spot Exchange Infrastructure (RSEI) for this purpose. In April 2009, the exchange has commenced trial runs for both agricultural and non-agricultural products, and is targetting to start live trading in the next few months. The exchange has a 50-member team running mock trades with a focus group in Punjab for non-farm goods and in the agricultural mandi (wholesale market) at Vashi, a Mumbai suburb. Spot Exchanges come under the purview of State APMCs. So far the exchange has secured trading approvals only in Rajasthan and Gujarat, but will need it in important agricultural markets such as Uttar Pradesh, Maharashtra, Karnataka, West Bengal, Punjab and Haryana to be nationally relevant for APMC products.
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Exhibit 37: Spot Exchange
Status Trial runs begun in April 2009
APMC Approvals Gujarat and Rajasthan
Agricultural : Sugar, tea, cashew and cloves Key commodities Industrial: Steel, copper, steel scrap
JV with Singapore based warehousing company for supply chian Other initiatives management
Source: IDFC-SSKI Research
Further, the exchange is strategizing to start with non-APMC products in order to prevent any further delay. It is estimated that 40% of farm commodities are outside the purview of the APMC. Key products to be launched by the exchange include sugar, tea, cashew and cloves in the agriculture segment and steel, copper, steel scrap on the industrial products front.
In addition, Reliance Money has formed an equal stake joint venture with Singapore-based warehousing and handling company CWT Commodities Pte Ltd in January 2009 for supply-chain management, particularly for perishable commodities. The firm plans to set up 20-odd exchange centres in its first year in places such as Ludhiana, Unjha (in Gujarat), Mumbai, Delhi, Kolkata, Chennai, Kochi, and Chikmagalur and Kushalnagar (both in Karnataka), among others.
International interest in exchanges In October 2008, Reliance Money acquired a 15% stake in Hong Kong Mercantile Exchange (HKMEx). With this holding, Reliance Money becomes the second-largest shareholder in the commodity exchange and will have a board membership. HKMEx is yet to start live trading and plans to offer futures, OTC futures and options on underlying on- exchange products.
In addition, Reliance Money is in talks for acquiring a majority stake in a new exchange in Nigeria, which will offer commodity and currency contracts to begin with and may evolve into a full fledged trading exchange going forward.
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Analyst Sector/Industry/Coverage E-mail Tel. +91-22-6638 3300 Pathik Gandotra Head of Research; Financials, Strategy [email protected] 91-22-6638 3304 Shirish Rane Construction, Power, Cement [email protected] 91-22-6638 3313 Nikhil Vora FMCG, Media, Retailing, Mid Caps, Education, Exchanges [email protected] 91-22-6638 3308 Ramnath S Automobiles, Auto ancillaries, Real Estate [email protected] 91-22-6638 3380 Nitin Agarwal Pharmaceuticals [email protected] 91-22-6638 3395 Chirag Shah Metals & Mining, Pipes, Textiles [email protected] 91-22-6638 3306 Bhoomika Nair Logistics, Engineering, Power [email protected] 91-22-6638 3337 Hitesh Shah, CFA IT Services [email protected] 91-22-6638 3358 Bhushan Gajaria FMCG, Retailing, Media, Mid Caps [email protected] 91-22-6638 3367 Ashish Shah Construction, Power, Cement [email protected] 91-22-6638 3371 Salil Desai Construction, Power, Cement [email protected] 91-22-6638 3373 Ritesh Shah Metals & Mining, Pipes, Textiles [email protected] 91-22-6638 3376 Neha Agrawal Financials [email protected] 91-22-6638 3237 Swati Nangalia Mid Caps, Media, Exchanges [email protected] 91-22-6638 3260 Sameer Bhise Strategy, Pharmaceuticals [email protected] 91-22-6638 3390 Shweta Dewan Mid Caps, Education, FMCG [email protected] 91-22-6638 3290 Nikhil Salvi Cement, Construction [email protected] 91-22-6638 3239 Rajeev Desai Real Estate [email protected] 91-22-6638 3231 Chinmaya Garg Financials [email protected] 91-22-6638 3325 Aniket Mhatre Automobiles, Auto ancillaries [email protected] 91-22-6638 3311 Probal Sen Oil & Gas [email protected] 91-22-6638 3238 Rupesh Sonawale Database Analyst [email protected] 91-22-6638 3382 Dharmesh Bhatt Technical Analyst [email protected] 91-22-6638 3392 Equity Sales/Dealing Designation E-mail Tel. +91-22-6638 3300 Naishadh Paleja MD, CEO [email protected] 91-22-6638 3211 Paresh Shah MD, Dealing [email protected] 91-22-6638 3341 Vishal Purohit MD, Sales [email protected] 91-22-6638 3212 Nikhil Gholani MD, Sales [email protected] 91-22-6638 3363 Sanjay Panicker Director, Sales [email protected] 91-22-6638 3368 V Navin Roy Director, Sales [email protected] 91-22-6638 3370 Suchit Sehgal AVP, Sales [email protected] 91-22-6638 3247 Pawan Sharma MD, Derivatives [email protected] 91-22-6638 3213 Dipesh Shah Director, Derivatives [email protected] 91-22-6638 3245 Jignesh Shah AVP, Derivatives [email protected] 91 22 6638 3321 Sunil Pandit Director, Sales trading [email protected] 91-22-6638 3299 Mukesh Chaturvedi SVP, Sales trading [email protected] 91-22-6638 3298 Viren Sompura VP, Sales trading [email protected] 91-22-6638 3277 Rajashekhar Hiremath VP, Sales trading [email protected] 91-22-6638 3243
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