ION Markets’ Sandeep Sabnani, head of equities product strategy and growth, and Chris Brown, thought leadership content specialist, question what lies ahead for the Indian capital market
India is on the move and it is moving fast. That is what Prime Minister Narendra Modi said recently as he reiterated his aim to make the country the world’s third largest economic power if he wins a third term in the upcoming elections.
The momentum and numbers appear to agree with his optimism.
With the IMF expecting India’s economy to grow 6.5 per cent this year, an unprecedented wave of digital adoption could open up financial markets to millions. With US$130 billion in planned infrastructure spending, and a comparatively young population, there is an upbeat feeling about the world’s most populous nation.
Foreigners and locals alike are buying into the country’s growth story in increasing numbers.
The National Stock Exchange of India (NSE), which recently overtook Hong Kong as the fourth largest in the world, has doubled in value in four years, surpassing a market capitalisation of US$4 trillion at the end of 2023. And India is outpacing China in IPOs, according to ION Analytics and Dealogic data.
Brokerages have reaped the rewards of this exponential growth, generating FY2023 revenue of 382 Indian Rupees (US$4.6 billion), while shifting from a transaction-based trading model to a fee-based one, and expanding the services they offer.
But the heavy demand, increased competition from discount brokers, and regulatory changes have created challenges as well as opportunities.
Technology has addressed some of the obstacles and will continue to do so as the industry seeks to tap India’s full potential.
The India Stack: Kicking off a retail revolution
A fast growing economy, higher disposable incomes, and a unique digital architecture called the India Stack, have made it easier for millions to invest in shares for the first time.
This infrastructure has been “revolutionising access to finance”, according to the IMF. It has given swathes of the population digital IDs (Aadhaar) for the first time, thereby widening access to banking and digital wallets.
A fundamental component of this technological stack is the Unified Payment Interface (UPI).
This interoperable system on which banks and nonbanks can build apps, allows the fast, cheap, and seamless transfer of payment orders between individuals, companies, and government institutions. People with smartphones have the world at their fingertips.
The UPI has gone from strength to strength in services offered.
In 2022/23 alone, during a period of market volatility, people in India opened almost 25 million demat accounts, which are required to buy and sell shares. The number of demat accounts increased five-fold between 2014 and 2023, while the number of active NSE clients grew nine-fold.
For retail investors, the infrastructure already dominates IPO applications, and India’s National Payments Corporation of India is taking it a step further. In collaboration with clearing houses and brokerages, it recently began pilot-testing a UPI for the secondary market.
Given how the India Stack is facilitating investment opportunities for retail investors, demand for equities is set to continue, adding to the pressure on intermediaries operating in India’s capital markets.
Soaring passive investment pushes tech case
At the end of November 2023, the Indian ETF industry had 190 ETFs and assets of US$73 billion (versus US$36 billion four years earlier), according to London-based research organisation ETFI. Regulatory changes have helped the growth of ETFs in India, where the 10-year compound annual growth rate is 45.9 per cent.
Retail demand for shares, ETFs, and even derivatives has led brokers to invest in more low-touch trading software and integrated solutions. With retail customers expecting easy to use trading applications on their smartphones, operators must have systems in place to ensure their internal processes are automated as much as possible to handle increased traffic and trade orders efficiently.
Traditional full-service brokerages (FSBs) have had to adapt amid competition from innovative discount and Robo brokers. FSBs need to continue diversifying and offer a whole range of financial services, in addition to producing the traditional, human-intensive research that is important for institutional clients.
New entrants tend to charge zero, flat, or discounted brokerage fees. The new-aged platforms are efficient, algo-driven, and robust.
According to ICICI research: “In the past few years, the cost structure and operational efficiency of brokerages has improved amid higher utilisation of technology.”
Evolving regulations, evolving risk
In addition to more intense competition and higher demand, market participants must be prepared for frequent regulatory changes. The scenario reinforces the need for a more holistic approach to technology and the role it can play in managing risk and compliance.
Foreign Portfolio Investors (FPIs), which “help deepen the Indian capital markets for listed securities, bonds, derivatives” according to PWC, face several challenges — from a complex and changeable regulatory framework governing their investments, to differing tax regimes depending on the security and FPI category.
In 2021/22, new SEBI rules on intraday trading came into full force after a phased approach, in what The Economic Times called a “tectonic shift”. Rather than collecting minimum margins at the end of the day from clients for leveraged positions, brokers are obliged to collect them upfront. Moreover, clearing houses must ensure that minimum margins are maintained throughout the session, and brokers face penalties if leverage surpasses specified parameters.
Market participants also have to deal with shorter settlement periods for trades, which from 2023 in India must be wrapped within 24 hours (T+1). The US, is of course also moving to this compressed time regime in May. India is already planning to shift to same-day settlement (T+0) and then instant settlement.
For cross-border trades, the situation is more complicated, and T+1 and T+0 leads to more expensive pre-funding.
Making investment more attractive
Authorities have undertaken reforms to make investment easier. These include single-window clearances, simplified approvals, tax changes, broadening the parameters of what financial investors can put their money in, and recategorising FPIs.
Making the country a global financial centre, a technology superpower, and luring more foreign direct investment and money from wealthy non-resident Indians are government priorities.
One project that encapsulates this drive is GIFT City (Gujarat International Finance Tec-City) in Gandhinagar, western India.
Its inception dates back to 2008 when Prime Minister Modi was chief minister of the state of Gujarat, and it aims to establish a technology and financial hub to compete with Singapore and Dubai.
To encourage funds and capital markets firms to open offices in GIFT City’s International Financial Services Center (IFSC), the government established tax incentives and a unique financial authority (the IFSCA), which has a holistic, inter-regulatory vision.
The project is growing and last year an agreement was struck whereby US$7.5 billion in derivatives trading shifted from Singapore to GIFT City.
Tech is the answer
Nevertheless, GIFT City aside, regulatory pressures and changes can be immense for firms in capital markets, and any efficiencies in internal processes must be ironed out to save costs in the long term. More automation will reduce the risk of human error and trades falling through, which can be costly. This is essential for market participants as momentum builds for equities and passive investment strategies such as ETFs among India’s growing middle classes, and as the country continues its drive to lure more foreign investors.
Brokers who work with multiple systems or legacy infrastructure will struggle to manage the complexity of markets, both locally and abroad. Those who leverage integrated trading solutions to streamline workflows, from order and execution to settlement, and manage risk and compliance will have a competitive advantage.
As financial literacy and smartphone use expand, and if economic growth can bring prosperity to many more Indians, then capital markets need to be prepared to scale. Investment in cloud-based technology will be critical in order to tap this potential.
