Derivatives trading at risk of shutdown as BSE stops market maker incentives

BSE’s recent move to curtail incentives it paid to the market makers in the derivatives segment for the past many years has put Asia’s oldest exchange in a peculiar situation. 

Data show that BSE’s derivatives trading volumes have declined nearly 90 per cent during the first three months of 2023 compared to what they were till November 2022 and the exchange is staring at a complete shutdown of the segment.

From April, BSE has decided to discontinue its liquidity enhancement scheme (LES) where brokers were paid for market making in the derivatives. 

As per data, BSE recorded average daily turnover (ADT) in derivatives of ₹9,511 crore for the month of January, ₹7,117 crore for February and ₹5,477 crore for March 2023. Comparatively, the BSE had witnessed ADT in derivatives of close to ₹2-lakh crore for the most part of 2022. Already, between January and March trading volumes on the exchange suffered a setback on anticipation that BSE was likely to suspend incentives to the market makers. BSE’s market share in the equity cash and currency derivatives segment has also come under pressure.

Sources in the know said if the incentives for market makers are completely discontinued, it is likely to impact BSE’s overall volumes, as many brokers who received these incentives also have their servers placed in the exchange’s co-location facility.

Co-location based trading

Data shows that co-location based trading generated more than 34 per cent volumes on the BSE. 

BSE’s co-location is run by a third party known as NTT Global, which will have to take a call on how to keep the facility running if there were not many takers, experts said. This comes at a time when BSE’s competitor, the National Stock Exchange, has announced a 33 per cent cut in derivatives transaction charges from April, which could make their offering more attractive to brokers.

Under its new MD and CEO Sundararaman Ramamurthy, who took charge this January, BSE has decided to stop market making incentives in the derivatives market from April. While Ramamurthy may think that it would shore up BSE’s profitability, brokers believe it would severely affect the exchange’s trading volumes.

When contacted, a BSE spokesperson said, “Yes, we are discontinuing LES. At the same time, BSE has introduced several innovations and product differentiation in the past three months since January 2023. BSE introduced 1 paisa tick size in stocks below the value of ₹100 for equities, 10 paise strike intervals in currency options and relaunching Sensex and Bankex derivatives with smaller lot sizes and a unique Friday expiry. These changes seem to be well accepted by the market participants. (Your) question suggests that the withdrawal of LES and the use of Co-location are interrelated. We don’t observe that. Currently, BSE does not charge for trades in the equity derivatives segment.”