Understanding India's Stock Exchanges

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India has one of the oldest equity markets in Asia and one of the most technically modern, and the gap between those two statements is the story of the last thirty years. Share trading in Bombay dates to the middle of the nineteenth century, when brokers gathered under a banyan tree near the town hall and speculated on cotton during the American Civil War boom. In 1875 they organised themselves formally as the Native Share and Stock Brokers Association, the body that became the Bombay Stock Exchange and, later, simply BSE. It is the oldest exchange in Asia, and its tower on Dalal Street is still the physical image most people associate with Indian finance. For more than a century it operated as a closed club: membership was held by individuals and families, trading was by open outcry on a floor, settlement was fortnightly, and shares changed hands as physical paper certificates that had to be transferred by the company registrar.

That system produced two chronic problems. Prices were opaque to anyone not on the floor, so brokers could and did trade against their own clients. And settlement was slow and unreliable, with bad deliveries, forged certificates and lost paper an ordinary hazard of investing. Regional exchanges multiplied to serve local companies, at Ahmedabad from 1894, Calcutta from 1908, Madras, Delhi, Bangalore, Hyderabad and a dozen more, each with its own rules and its own liquidity problems.

The reforms that rebuilt the market

Two shocks forced change. The first was regulatory catch up. The Securities and Exchange Board of India was set up as an administrative body in 1988 and given statutory powers by the SEBI Act of 1992, becoming the market regulator with authority to register intermediaries, make regulations and investigate. The second was a scandal. In 1992 a large scale securities fraud came to light in which a leading broker had used the interbank market in government securities, and in particular the loosely controlled paperwork of bank receipts, to divert bank funds into share purchases, driving the index up dramatically before it collapsed. The affair discredited the existing market structure and gave reformers the political cover they needed.

The response was the National Stock Exchange, incorporated in 1992 and starting trading in 1994, first in wholesale debt and then in equities from November of that year. It was deliberately designed to be everything the old exchanges were not. It was promoted by financial institutions rather than owned by its brokers, so ownership and trading membership were separated from the start, a structure known as demutualisation that the BSE adopted only later. It had no trading floor: orders were matched by computer on a fully electronic, anonymous, price and time priority order book, with terminals connected across the country by satellite so that a broker in Coimbatore saw the same screen as one in Mumbai. Competition worked quickly. The BSE electronified, spreads narrowed, and trading concentrated in the two national exchanges while the regional exchanges withered. Under a SEBI exit policy, most of them formally closed between 2014 and 2017.

Settlement was rebuilt in parallel. The Depositories Act of 1996 allowed shares to be held in electronic form, and the National Securities Depository, set up in 1996, and Central Depository Services, in 1999, dematerialised the paper. Rolling settlement replaced the old account period, moving to delivery two days after the trade in 2003 and then to the next day in a phased transition completed in early 2023, with optional same day settlement introduced after that. India was among the first large markets to make that move. Central counterparty clearing corporations now stand between buyer and seller so that no participant carries the credit risk of another.

What the market looks like now

The two benchmark indices are the BSE Sensex, a thirty company index with its base set in the financial year 1978 to 1979 at one hundred, and the Nifty 50, launched by the National Stock Exchange with a base date in November 1995 at one thousand. Both are free float market capitalisation weighted and both are dominated by financials, information technology, energy and consumer companies. Derivatives arrived in 2000 with index futures and expanded to index options, then stock futures and options, and India has since become the largest market in the world by number of derivative contracts traded, driven overwhelmingly by short dated index options bought by retail traders. That statistic is a genuine source of regulatory anxiety rather than pride, and SEBI has published studies indicating that the large majority of individual traders in that segment lose money, prompting successive tightening of contract sizes and expiry schedules.

Foreign portfolio investors have been permitted since 1992 and are now a decisive marginal buyer, which is why Indian equities react to United States interest rate decisions. Domestic participation has grown even faster. Systematic investment plans into mutual funds, in which households commit a fixed monthly sum, have created a large and relatively stable domestic flow that has repeatedly absorbed foreign selling. The number of demat accounts has risen into the hundreds of millions, though the number of accounts substantially exceeds the number of active investors.

The market has not outgrown scandal. A stock market operator manipulated prices through circular trading and bank funding in 2001. A commodity spot exchange collapsed in 2013 with large unpaid dues, leading to the merger of the separate commodity regulator into SEBI in 2015. And a long running controversy over preferential access to the National Stock Exchange's servers by certain algorithmic trading firms led to penalties and to the resignation and later arrest of senior exchange executives. Each episode has tightened the rules further.

Two structural developments are worth watching. The first is the International Financial Services Centre at GIFT City in Gujarat, where exchanges operate in foreign currency under a separate regulator, designed to bring back offshore trading in Indian linked products. The second is the sheer breadth of new listings: India has recently led the world in the number of initial public offerings in some years, including a long tail of small and medium enterprise listings whose valuations and disclosure quality regulators have publicly questioned. An exchange system that thirty years ago could not reliably deliver a share certificate now settles in a day; whether its investor protection has kept pace with its plumbing is the open question.

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