Maintaining Vibrant Competition Among Exchanges – A Key Driver of the Rapid Development of the Indian Financial Markets

The exercise of market power
How does one ensure that a dominant exchange does not abuse its market power to create an unlevel playing field for its competition?
First, you must be able to distinguish between fair competition and other behavior which crosses some kind of regulatory threshold. This is admittedly not a trivial job for a regulator. It requires expertise in microeconomics, regulation of firms with significant network externalities, anti-monopoly laws, etc. Are the practices noted above in violation of any specific rules or regulations? I am not a securities lawyer. But ever since I started my career on Wall Street, I have been a believer in the“smell test.” If something doesn’t pass that test, you don’t do it.
Because a large percentage of activity in securities markets is often dominated by less than ten or twenty firms, resistance to the abuse of market power by an exchange can often be orchestrated by a combination of regulatory action and collective action by major market participants. For many years, for example (until 2000 when the rule was finally fully revoked), the NYSE tried to prevent its members from trading NYSE-listed stocks in the OTC market through something called Rule 390. The ability to impose such a rule – in the absence of regulatory intervention – is directly proportional to an exchange’s market power. If a smaller market with 10% market share had tried to do so, customers will simply stop being members of that exchange. If a dominant market with 95% market share does so, it is difficult for a customer to leave.
NSE’s policies on algo trading and co-location noted above are tolerated by firms because of NSE’s tremendous market power. In the end, Rule 390 was abolished because the largest member firms objected to it and convinced the SEC that what was positioned as an investor protection rule was actually anti-competitive. Similarly, I believe that only when Indian market participants find their collective courage and voice, will NSE’s policies change and will the drift toward increasing monopoly power be halted.
Where do we go from here?
Robust competition will be an essential driver of financial market development in India in the next decade. I believe that regulatory authorities in India will increasingly turn their attention to issues of regulating competition in order to more effectively achieve their twin goals of investor protection and market development.
But preserving competition in a market is a bit like preserving liberty. As Andrew Jackson put it: “. . . eternal vigilance by the people is the price of liberty, and . . . you must pay the price if you wish to secure the blessing.”
Beyond the role of the regulators, who must be vigilant and intelligent in preserving a competitive environment, there is also the important role of market participants. For in the end, if a dominant exchange engages in market practices that are detrimental to the development of the market and harmful to the preservation of a competitive environment, market participants cannot be passive. As Edmund Burke said: “The only thing necessary for the triumph of evil is for good men to do nothing.” If we, as market participants, want Indian financial markets to flourish and attain their potential over the next decade, we must be willing to speak up when we see practices that are harmful to the preservation of a competitive environment and the development of the market.
The views expressed by the author in this article are personal.