Harvard Case - The Bombay Stock Exchange: Liquidity Enhancement Incentive Programmes
"The Bombay Stock Exchange: Liquidity Enhancement Incentive Programmes" Harvard business case study is written by Nupur Pavan Bang, Khemchand H. Sakaldeepi, Ramabhadran S. Thirumalai. It deals with the challenges in the field of Finance. The case study is 16 page(s) long and it was first published on : Dec 13, 2016
At Fern Fort University, we recommend a multi-pronged approach to enhance liquidity at the Bombay Stock Exchange (BSE). This involves a combination of financial incentives, structural reforms, and strategic partnerships to attract new investors and encourage existing ones to participate more actively.
2. Background
The BSE, established in 1875, is one of the oldest stock exchanges in Asia. However, it faced challenges in the early 2000s, including low trading volumes, limited investor participation, and a lack of transparency. To address these issues, the BSE implemented a series of liquidity enhancement incentive programs (LEIPs). The case study focuses on the effectiveness of these programs and explores the challenges faced by the BSE in attracting foreign investors.
The main protagonists in the case study are the BSE management, who are responsible for designing and implementing the LEIPs, and the various stakeholders, including investors, brokers, and regulators, who are impacted by these programs.
3. Analysis of the Case Study
We can analyze the case study using the framework of Financial Markets and Investment Management. This framework helps to understand the factors influencing liquidity in the stock market, the role of incentives in attracting investors, and the impact of regulatory changes on market behavior.
Key Considerations:
- Liquidity: The case highlights the importance of liquidity in a stock market. High liquidity ensures efficient price discovery, reduces transaction costs, and attracts more investors.
- Incentive Programs: The LEIPs implemented by the BSE aimed to increase trading volumes and attract new investors. These included reduced brokerage fees, tax benefits, and other financial incentives.
- Regulatory Environment: The regulatory environment plays a crucial role in attracting foreign investors. Factors like transparency, corporate governance, and investor protection are crucial for building confidence in the market.
- Market Structure: The BSE's market structure, including the trading platform and settlement mechanisms, also influences liquidity.
Analysis of LEIPs:
The LEIPs were successful in increasing trading volumes and attracting new investors in the short term. However, the case study also highlights challenges in attracting foreign investors. These challenges include:
- Lack of transparency: Foreign investors often perceive emerging markets like India as lacking transparency and having weak corporate governance.
- Regulatory hurdles: Complex regulations and bureaucratic procedures can deter foreign investors.
- Currency risk: Fluctuations in the Indian Rupee can pose significant risk to foreign investors.
- Competition: The BSE faces competition from other emerging markets and established stock exchanges globally.
4. Recommendations
To address these challenges and further enhance liquidity at the BSE, we recommend the following:
- Strengthening Transparency and Corporate Governance: The BSE should focus on improving transparency and corporate governance standards. This includes stricter regulations on corporate disclosure, independent audits, and shareholder rights.
- Simplifying Regulatory Procedures: The BSE should work with the government to simplify regulatory procedures and reduce bureaucratic hurdles for foreign investors. This could involve streamlining the process for foreign investment approvals and providing clear guidelines for compliance.
- Hedging Currency Risk: The BSE should encourage the use of hedging instruments to mitigate currency risk for foreign investors. This could include providing access to derivatives markets and promoting the use of currency swaps.
- Strategic Partnerships: The BSE should explore strategic partnerships with global exchanges and financial institutions to enhance its reach and attract foreign investors. This could involve joint ventures, cross-listings, and technology sharing.
- Marketing and Outreach: The BSE should invest in marketing and outreach programs to promote itself to foreign investors. This could include targeted advertising, conferences, and roadshows.
- Developing a Strong Financial Strategy: The BSE should develop a strong financial strategy that focuses on attracting long-term investors. This could involve offering incentives for long-term investments, promoting dividend payouts, and creating a favorable tax environment for investors.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: The recommendations align with the BSE's mission to provide a fair, transparent, and efficient platform for trading securities.
- External Customers and Internal Clients: The recommendations address the needs of both foreign and domestic investors, as well as brokers and other market participants.
- Competitors: The recommendations help the BSE to remain competitive in the global market by attracting foreign investors and improving its overall attractiveness.
- Attractiveness: The recommendations are expected to increase the BSE's attractiveness to investors, leading to higher trading volumes and increased market capitalization.
6. Conclusion
The BSE has made significant progress in enhancing liquidity through its LEIPs. However, attracting foreign investors requires a multi-faceted approach that addresses concerns related to transparency, regulation, currency risk, and competition. By implementing the recommendations outlined above, the BSE can create a more attractive investment environment, enhance its liquidity, and solidify its position as a leading stock exchange in Asia.
7. Discussion
Other Alternatives:
- Mergers and Acquisitions: The BSE could consider merging with or acquiring another exchange to expand its reach and market share.
- Focusing on Specific Sectors: The BSE could focus on attracting investors in specific sectors, such as technology or healthcare, where there is high growth potential.
Risks and Key Assumptions:
- Implementation Challenges: Implementing the recommendations requires significant effort and coordination among various stakeholders.
- Regulatory Uncertainty: Changes in government policy or regulations could impact the effectiveness of the recommendations.
- Market Volatility: The global financial markets are subject to volatility, which could impact investor sentiment and trading volumes.
8. Next Steps
- Develop a detailed implementation plan: This plan should outline the specific actions, timelines, and resources required to implement each recommendation.
- Engage stakeholders: The BSE should engage with key stakeholders, including investors, brokers, regulators, and government officials, to gain their support and input.
- Monitor progress: The BSE should regularly monitor the progress of the implementation plan and adjust its strategy as needed.
By taking these steps, the BSE can continue to enhance its liquidity and position itself for long-term growth and success.
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Case Description
In 2013, the chief business officer at the Bombay Stock Exchange needed to prepare a recommendation on whether to pursue liquidity enhancement schemes in the equity cash market. The Bombay Stock Exchange, the oldest stock exchange in Asia, had held a monopoly in India until 1994, when the National Stock Exchange was launched. When derivatives were introduced to the Indian stock exchanges in 2000, the Bombay Stock Exchange had been unprepared, and the National Stock Exchange soon captured the entire derivatives market. In 2011, the Securities and Exchange Board of India approved the introduction of the Liquidity Enhancement Incentive Programmes on illiquid securities in the derivatives segment. The Bombay Stock Exchange then introduced the incentives for various illiquid products in the derivatives segment, but lost profit as a result of the incentives it paid out. Had the Liquidity Enhancement Incentive Programmes improved liquidity in the derivatives segment? Was it worth sacrificing profit to gain liquidity and market share? The chief business officer needed to address the long-term benefits of liquidity enhancement schemes and the merits of introducing such schemes to the Bombay Stock Exchange's equity cash market.
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