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THE BOMBAY STOCK EXCHANGE: LIQUIDITY ENHANCEMENT INCENTIVE PROGRAMMES

Nupur Pavan Bang, Khemchand H. Sakaldeepi, and Ramabhadran S. Thirumalai wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com.

On a hot day in April 2013, V. Balasubramaniam, the chief business officer of the Bombay Stock Exchange (BSE), sat in his office on the 27th floor of the iconic 28-storey Phiroze Jeejeebhoy Towers on Dalal Street that housed the BSE. He was preparing a note on whether the BSE, after its foray into liquidity enhancement schemes in the derivatives market, should also take up similar schemes in the equity cash market.

THE BOMBAY STOCK EXCHANGE

In the 1850s, a few stockbrokers gathered under a banyan tree in Bombay to trade in stocks.1 The location of these meetings changed frequently, as the number of brokers increased. In 1875, the gathering morphed into The Native Share & Stock Brokers Association and was eventually renamed the Bombay Stock Exchange Ltd. and moved into Phiroze Jeejeebhoy Towers on Dalal Street.2 Historically an open outcry, floor-trading exchange, the BSE started publishing the Bombay Stock Exchange Sensitive Index in 1986.3 Widely known simply as the SENSEX, this free-float, market-weighted stock market index included 30 well-established and financially sound companies that were listed on the Bombay Stock Exchange. The BSE was a virtual monopoly until 1992, when the establishment of the National Stock Exchange of India (NSE) severely affected the BSE’s market share and compelled the introduction of an electronic trading system in 1995.

THE NATIONAL STOCK EXCHANGE

The NSE was set up in 1992 by leading government-promoted financial institutions at the behest of the Government of India, to bring transparency to the markets. The capital market (i.e., the equities, or “cash”) segment of the NSE commenced operations in November 1994. The NSE set up its own index of 50 companies, which came to be known as NIFTY.

1 Bombay Stock Exchange, “Heritage,” accessed February 17, 2016, www.bseindia.com/static/about/heritage.aspx. 2 Ibid. 3 Ibid.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 2 9B16N071 THE BSE’S TRYST WITH DERIVATIVES In 2013, India was the world’s largest democracy, the second most populous country, the fourth largest economy by purchasing power parity, and the seventh largest country by area. The name of the country brought to mind many things—spiritual pilgrimages; bad roads; vibrant fabrics; the Taj Mahal; and the land of software developers, engineers, and outsourcing. India had finally broken away from the painfully dated image of a country that was synonymous with finding elephants and camels on the streets to a newer one of being the land of information technology professionals.4 Indeed, the software and services industry had pushed the growth rates from the sluggish “Nehruvian” 3.5 per cent rate of growth5 to averaging a robust annual gross domestic product growth rate of 7.73 per cent over the decade from 2002 to 2011.6 Stock markets had always played a pivotal role in any economy because they provided a platform for businesses to raise capital and for investors to trade in financial securities. For this reason, a country’s stock market needed to be robust and liquid—and India was no different. Its growing economy resulted in an unprecedented increase in the variety and number of financial products and services in the market. The NSE was established in 1992 and started operations in 1994 (see Exhibit 1).7 Predictably, the NSE, which had online trading facilities from day one, slowly started reducing the BSE’s monopoly in the equities segment (see Exhibit 2). As a strategy to innovate and offer new products, the NSE soon started insisting on the need for derivatives. The BSE was accustomed to badla trading,8 and hence, opposed derivatives. The NSE was of the view that both badla and derivatives could coexist; however, it highlighted that badla did not allow investors to hedge for a specific time and offered no options. Also, every 15 days, the carrying costs would change, and the investors would not know the carrying costs for the next three months. Derivatives were finally introduced in 2000; and in 2001, following a major scam on the stock exchanges,9 the badla system was banned. The BSE had not been prepared for this move. Although derivatives were introduced simultaneously on both the NSE and the BSE, the NSE soon captured more than 99 per cent of the trades in the derivatives segment. What had been the largest stock exchange in the country for years had been relegated to a distant second (see Exhibit 3). The Multi-Commodity Exchange Stock Exchange (MCX-SX),10 the newest competitor in the arena, had also made its intentions clear from the beginning. It planned to seize the opportunity and was determined 4 Mark Kobayashi-Hillary, Outsourcing to India: The Offshore Advantage (New York, NY: Springer-Verlag, 2005), 1–3. 5 The growth rates in the 1950s and 1960s were referred to as being Nehruvian, as they were believed to have been the outcome of the policies of India’s first prime minister, Jawaharlal Nehru. 6 Calculated by the authors using data from The World Bank Group, “World Development Indicators,” accessed May 16, 2013, http://data.worldbank.org/data-catalog/world-development-indicators. 7 The National Stock Exchange of India Ltd., “History & Milestones,” accessed August 12, 2016, www.nseindia.com/global/content/about_us/history_milestones.htm. 8 The ingenious and innovative badla trading had been introduced to increase liquidity in the Indian secondary markets. It allowed the trading of single stocks on margin and the carrying forward of positions to the next settlement cycle, effectively allowing the position to be carried indefinitely. This approach essentially meant that all transactions would be settled (i.e., the delivery of shares and the payment of cash) in the future, which is similar to a forward or a futures transaction. The Securities and Exchange Board of India banned the badla system in 1993; however, because of complaints from foreign investors, it was reintroduced in 1996. 9 From 1999 to 2001, Ketan Parekh, a stockbroker from Mumbai, was instrumental in the manipulation of stock prices through circular trading. For more information, see The Ketan Parekh Scam, accessed August 12, 2016, http://mba.mit.asia/waves- 2014/Case-study-on-ketan-scam.pdf. 10 The MCX-SX was India’s third and newest national-level stock exchange. On July 11, 2012, the Securities and Exchange Board of India granted it permission to offer a trading platform for equities and futures.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 3 9B16N071 to be successful. Shortly after the MCX-SX received permission to deal in equities and futures from the Securities and Exchange Board of India (SEBI), Jignesh Shah, the vice-chairman of the MCX-SX, was quoted as having joked with his colleagues that the BSE was no competition and that it was “only moving closer to a museum.”11 The BSE had clearly missed a big opportunity. Slowly, the BSE’s market share in the cash segment began to slip away, as most traders preferred to trade both derivatives and equities on the same exchange. By March 2012, the NSE accounted for approximately 80 per cent of the turnover in the cash market (see Exhibit 2). As noted by the BSE’s managing director and chief executive officer, Ashish Kumar Chauhan, “From 2000 to 2012, in 12 years’ time, derivatives have become 10 times the size of the cash segment. BSE was in a sense only in equities. So now we have 20 per cent market share of a market which is only 10 per cent of the total.” LIQUIDITY ENHANCEMENT INCENTIVE PROGRAMMES Liquidity was an important attribute of any exchange. Liquidity helped in the formation of better prices by increasing the stock market’s depth (i.e., increasing the volume of trades). Liquidity was essential, both to make markets more efficient and to reduce arbitrage opportunities. Once a market offered such an environment, investors were better able to manage risks and to make informed decisions for trade execution. A positive relationship existed between trading activity and liquidity. Overall, a market with good liquidity created an ecosystem where trading activity could flourish, which could have only positive effects. Similarly, the lack of liquidity led to high trading costs and took time for order execution. Globally, incentives for order flow had been used successfully by such exchanges as the Cincinnati Stock Exchange when it took on its rival, the New York Stock Exchange, and by the Bats Chi-X Europe when it took on the London Stock Exchange. Other exchanges had also implemented various schemes from time to time in an effort to improve liquidity in illiquid or new products. For example, in 2007, the Hong Kong Stock Exchange gave incentives to market makers by way of discounts and fee waivers, in exchange for trading in their stock and index futures and options segment. In 2009, the Tokyo Stock Exchange offered similar waivers and discounts. The merits and demerits of such arrangements had long been a matter of debate. To enable the Indian stock exchanges to improve liquidity in illiquid securities, the SEBI, in a circular issued in June 2011, permitted stock exchanges to introduce Liquidity Enhancement Schemes for illiquid securities in their equity derivatives segment, which were similar to the payments for order-flow arrangements globally.12 However, unlike in other jurisdictions, the SEBI mandated that the program should be objective, transparent, non-discretionary, and should provide continuous disclosures on the stock exchange’s website. The approval of Liquidity Enhancement Schemes meant that stock exchanges could now incentivize market participants to trade in the illiquid segments of their product offerings. For the BSE, it meant that it could pay market participants directly to trade in its equity derivatives segment. Because liquidity was an important driving force behind the success of any stock market, the BSE took advantage of this opportunity to secure its future by launching a series of Liquidity Enhancement Incentive Programmes (LEIPs) with the

11 Anand Adhikari and Manu Kaushik, “The Importance of Being Jignesh,” Business Today, August 5, 2012, accessed May 28, 2013, http://businesstoday.intoday.in/story/jignesh-shah-mcx-sx-equities-trading/1/186185.html. 12 Due to regulatory challenges in India, it took SEBI two years to permit these incentive programs; SEBI Circular CIR/MRD/DP/05/2013, February 8, 2013, accessed April 2, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1360335401597.pdf.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 4 9B16N071 goal of creating lasting, self-sustaining liquidity in the BSE’s Futures & Options Segment (see Exhibit 4).13 Chauhan commented:

The way it works, it’s like you open a new store, you give a minor discount. People start coming to your store. They figure out that the earlier store and the new store both have similar products. Initially they start coming because of the discount. Later on it becomes a way of life for them. They continue to come even if the discount is removed.

LEIPs began in beta-test mode in September 2011, and had evolved to its ninth stage in February 2013.14 The exchange made certain revisions during some of the phases based on its budget and certain policy changes in line with its objectives.15 OVERVIEW OF THE BSE’S LEIPS In line with the SEBI’s guidelines, the LEIPs introduced by the BSE included the following notable features: 1) The program required members of the BSE to first register either as general market participants (GMPs) or as market makers (MMs), so that they could be compensated accordingly. MMs were obliged to provide continuous two-way quotations and were paid higher incentives than the GMPs; 2) Once the participants registered, they were required to trade a minimum number of times to be eligible for the incentives. The incentives to be paid were computed by the exchange on a daily basis. The computations were on a pro rata basis, as the BSE had imposed upper limits on the amount that could be paid out as incentives for different products. The accumulated incentives were later paid as cash transfers to the participants’ accounts; 3) The incentives were rolled out in a phased manner, targeting products offered by the BSE (see Exhibit 5). Each phase had an incentive maximum (see Exhibits 6 and 7); and 4) The participants were provided with four types of incentives: (1) volume-based cash incentives; (2) lower transaction fees; (3) open-interest cash incentives; and (4) obligation-based cash incentives. UNIQUE LEIPS FEATURES LEIPs-I (BETA) was for members to test their end-to-end quoting, trading, and clearing systems. The payout per trade was limited to a maximum of 10 contracts. Incentives were payable only for current-month expiration futures, and for options contracts and near-month expiration contracts (during the rollover period) on the SENSEX and the underlying 30 SENSEX stocks.16 Each member was entitled to a payment of at least ₹5,00017 (₹2,500 in futures plus ₹2,500 in options) daily under the volume-based cash incentives program, even if the daily ceilings were exceeded. The calculations were based on payout rates. Under LEIPs-II, the maximum payout was limited to 10 contracts per trade for futures and 200 contracts per trade for options. LEIPs-II issued incentives totalling ₹1.02 billion, or ₹170 million every month, for all participating members. Under the program, MMs were incentivized at higher-volume incentive rates than were the GMPs. The daily volume on which incentives would be paid out was limited to ₹12 billion for futures turnover and ₹2.10 billion for options premium values.

13 Bombay Stock Exchange, “About LEIPs,” accessed March 20, 2013, www.bseindia.com/markets/Derivatives/DeriReports /about_LEIPS.aspx. 14 With respect to information available as on March 20, 2013. 15 Bombay Stock Exchange, “About LEIPs,” op. cit. 16 Current-month expiration referred to contracts that were expiring in the current month; near-month expiration referred to contracts that were expiring in the next month. 17 ₹ = INR = Indian rupee; all currency amounts are in Indian rupees unless otherwise specified; US$1 = ₹54.35 on March 31, 2013.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 5 9B16N071 The exchange decided to run a separate LEIP for its options sub-segment to encourage greater participation. LEIPs-III focused on options on the SENSEX with a current-month expiry cycle, to help develop the SENSEX options market. LEIPs-III envisaged the MMs as having a continuous quoting obligation with specified size and spread in SENSEX options contracts. The program defined two levels of market making. Level-1 quote obligations were similar to the market maker obligations in the prevailing LEIP. In addition, the market maker could also maintain Level-2 quote obligations, wherein the market maker was required to make markets with tighter spreads for 95 per cent of the trading time. The intention was to create a very deep and tight order book in the SENSEX options contracts. The market makers fulfilling the Level-2 quote obligations were entitled to receive up to ₹200,000 a day. LEIPs-IV focused on futures contracts on the SENSEX and BANKEX.18 According to the BSE, under LEIPs-III, nearly 90 per cent of the turnover was based on a non-incentivized volume. Under LEIPs-IV, however, 100 per cent of the turnover was due to incentivized volumes.19 The fifth program focused on single-stock futures and options contracts on eight stocks: State Bank of India, Reliance Industries Limited, ICICI Bank Limited, Tata Steel Limited, Tata Motors Limited, Infosys Technologies Limited, Larsen & Toubro Limited, and Axis Bank Limited. The program incentivized both MMs and GMPs by offering cash payments for their participation. LEIPs-VI focused on futures and options contracts on the BSE-100 Index. The BSE-100 Index was launched to compete against the NSE’s popular NIFTY 50-company index. The BSE-100 Index’s performance had a 99.4 per cent correlation with the NIFTY.20 LEIPs-VII focused on options contracts on the BSE SENSEX and incentivized both MMs and GMPs by offering cash payments for their participation. It envisaged the MMs as having a continuous quoting obligation with a specified size and spread in the BSE SENSEX options contracts. LEIPs-VIII and -IX focused on futures contracts on the 30 stocks that formed the SENSEX. Apart from the LEIPs, the BSE also started a special scheme on September 12, 2012, whereby it directly incentivized retail clients and trading members for bringing in more retail participation in its derivatives segment. The exchange paid an amount of ₹100 as a one-time incentive to a customer who traded for the first time on the BSE’s derivatives segment, the trading members were paid incentives based on the number of retail clients that traded through them (see Exhibit 8). All these measures had the effect of increasing the BSE’s market share in the derivatives segment, which increased to approximately 20 per cent by December 2013, but, owing to the incentives paid out, profitability declined.

18 BANKEX was an index of the leading banking sector stocks listed on the BSE. 19 Ashish Rukhaiyar, “Small Brokers Make It Big on BSE F&O Segment as Long-Term Players Missing,” The Indian Express, August 8, 2012, accessed September 24, 2012, www.indianexpress.com/news/small-brokers-make-it-big-on-bse-f-o- segment-as-longterm-players-missing/985272/. 20 Palak Shah, “BSE-100 Derivatives to Take on Nifty-50,” Business Standard, July 25, 2012, accessed May 16, 2013, www.business-standard.com/article/markets/bse-100-derivatives-to-take-on-nifty-50-112072500051_1.html.

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Page 6 9B16N071 LEIPS IN THE CASH SEGMENT In February 2013, the SEBI issued a circular that allowed exchanges to introduce liquidity enhancement schemes in the cash segment.21 This option seemed to be an opportunity to gain market share in the equity segment, similar to what the BSE had done in the derivatives segment. Balasubramaniam turned his attention to a pile of newspaper reports and the quarterly financial statements of the BSE for financial years (FY) 2011/12 and FY 2012/13. The first newspaper article’s headline screamed: Derivatives liquidity enhancement programme takes toll on BSE profit.22 The article said that although many debated the usefulness of the liquidity enhancement scheme, which the BSE had introduced to boost investor participation in its derivatives segment, the scheme had inflicted a negative impact on the exchange’s financial performance. It added that the BSE had witnessed a sharp decline in its profitability since the December 2011 quarter, when it had started accounting for the costs related to LEIPs. A quick glance at the BSE’s quarterly income statements (see Exhibit 9) confirmed this decline. Market share or profitability was the dilemma. A lower market share would mean reduced liquidity (see Exhibit 10). Reduced liquidity, in turn, would mean even lower market share. It was a vicious cycle. THE DILEMMA There was no doubt in Balasubramaniam’s mind that the LEIPs had succeeded in helping the BSE gain some market share from the NSE. The average daily value traded on the BSE’s equity derivatives segment stood at ₹13.95 million in September 2011 when the LEIPs were introduced. By December 2012, the average daily value traded had increased multi-fold to ₹450 billion (see Exhibit 11).23 The incentive structure under the LEIPs had an upper limit on the traded volumes that were incentivized. However, the volumes were 21 times the upper limit, showing clearly that market participants had realized other benefits from trading on the BSE’s derivatives segment (see Exhibit 7). The BSE’s market share in the derivatives segment had increased from close to 0 per cent in September 2011 to 18.5 per cent by the end of FY 2012/13 (see Exhibit 12). Did an increased market share indicate better liquidity? According to data from the BSE, the top volume generators in its derivatives segment were mostly the proprietary desks of small brokerages, which on average, accounted for 80 per cent of the trades in this segment. There was negligible participation from financial institutions, such as mutual fund companies and insurance companies, which were generally long-term players (see Exhibits 13 and 14). As the newspapers had rightly pointed out, the BSE’s profitability, as measured by profit before tax, had experienced a sharp decline, owing to the incentives paid out to enhance liquidity. The expenditures under the LEIPs were listed under “Exceptional Items” in the BSE’s financial statements. The BSE’s operating income had increased soon after the LEIPs were introduced, but had fallen to pre-LEIPs levels after FY

21 SEBI Circular CIR/MRD/DP/05/2013 dated February 8, 2013, accessed April 2, 2013, www.sebi.gov.in/cms/sebi_data /attachdocs/1360335401597.pdf. 22 Devangi Gandhi, “Derivatives Liquidity Enhancement Programme Takes Toll on BSE Profit,” Financial Express, August 10, 2012, accessed September 24, 2012, www.financialexpress.com/news/derivatives-liquidity-enhancement-programme-takes- toll-on-bse-profit/986414/1. 23 Securities and Exchange Board of India, Handbook of Statistics on Indian Securities Markets, 2012, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1389094067302.pdf.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 7 9B16N071 2011/12 (see Exhibit 15). It would also be a challenge to convince the BSE’s more than 8,000 shareholders of the benefits of the LEIPs. Had liquidity improved at the BSE due to the LEIPs? Could profitability be sacrificed for market share and liquidity? Would it be wise to implement similar schemes in the cash segment? Balasubramaniam had hoped to make a convincing argument to the board, by presenting facts, figures, and research to convince them of both the long-term benefits of the LEIPs and the merits of introducing the LEIPs to the BSE’s cash segment. He realized it would take more than just increased market share numbers to convince the board to introduce liquidity enhancement schemes in the cash segment.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 8 9B16N071

EXHIBIT 1: COMPARISON OF THE BOMBAY STOCK EXCHANGE AND THE NATIONAL STOCK EXCHANGE

Comparison Bombay Stock Exchange National Stock Exchange Inception Date 1875 1992 Headquarters Mumbai, India Mumbai, India Market Timings 09:15 to 15:30 (+5.5 hours GMT) 09:15 to 15:30 (+5.5 hours GMT) Demutualized Yes—in 2007 Yes—Since inception Trading Mechanism Mixed: Mainly order driven, market

making for illiquid securities Order driven

Settlement Cycle T+2 rolling settlement T+2 rolling settlement Major Index SENSEX (30 stocks) S&P CNX Nifty (50 stocks)

Note: GMT = Greenwich Mean Time; T+2 = the second working day after a trade; SENSEX = The Bombay Stock Exchange’s Sensitive Index; S&P CNX Nifty = The National Stock Exchange’s benchmark stock market index. Source: Compiled by the authors from the Bombay Stock Exchange website, accessed March 4, 2013, www.bseindia.com; and the National Stock Exchange website, accessed March 4, 2013, www.nseindia.com.

EXHIBIT 2: COMPARISON BETWEEN THE OPERATIONS OF THE BOMBAY STOCK EXCHANGE AND THE NATIONAL STOCK EXCHANGE IN THE CASH SEGMENT, 2000/01 TO 2011/12

Number of Companies

Listed

Annual Average of Benchmark

Index

Annual Average of Market

Capitalization (₹ trillions)

Turnover in Cash Segment (₹ trillions)

Year BSE NSE BSE

Sensex NSE Nifty

BSE NSE BSE NSE

BSE Share as % of

Total (BSE + NSE)

2000/01 5,869 785 4,270 1,335 5.72 6.58 10.00 13.40 42.74

2001/02 5,782 793 3,332 1,077 6.12 6.37 3.07 5.13 37.46

2002/03 5,650 818 3,206 1,037 5.72 5.37 3.14 6.18 33.70

2003/04 5,528 909 4,492 1,428 12.01 11.21 5.03 11.00 31.37

2004/05 4,731 970 5,741 1,805 16.98 15.86 5.19 11.40 31.27

2005/06 4,781 1,069 8,280 2,513 30.22 28.13 8.16 15.70 34.21

2006/07 4,821 1,228 12,277 3,572 35.45 33.67 9.56 19.45 32.96

2007/08 4,887 1,381 16,569 4,897 51.38 48.58 15.79 35.51 30.78

2008/09 4,929 1,432 12,366 3,731 30.86 28.96 11.00 27.52 28.56

2009/10 4,975 1,470 15,585 4,658 61.66 60.09 13.79 41.38 24.99

2010/11 5,067 1,574 18,605 5,584 68.39 67.03 11.05 35.77 23.60

2011/12 5,133 1,646 17,423 5,243 62.15 60.97 6.67 28.11 19.18 Note: BSE = Bombay Stock Exchange; NSE = National Stock Exchange; US$1 = ₹46.56 on April 01, 2001 and US$1 = ₹ 50.88 on April 1, 2012. Source: Compiled by the authors using data from the Securities and Exchange Board of India, Handbook of Statistics on Indian Securities Markets, 2012, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1389094067302.pdf.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 9 9B16N071

EXHIBIT 3: COMPARISON BETWEEN THE OPERATIONS OF THE BOMBAY STOCK EXCHANGE AND THE NATIONAL STOCK EXCHANGE IN THE EQUITY DERIVATIVES SEGMENT,

2000/01 TO 2011/12

Turnover (₹ billions) No. of Contracts

BSE as a % of Total (BSE + NSE)

Year BSE NSE BSE NSE Turnover No. of

contracts 2001/02 19.26 1,019.25 105,023 4,196,873 1.85 2.44

2002/03 24.78 4,398.66 138,011 16,768,909 0.56 0.82

2003/04 120.74 21,304.47 382,258 56,875,995 0.56 0.67

2004/05 161.12 25,470.53 531,719 77,017,185 0.63 0.69

2005/06 0.09 48,242.51 203 157,619,271 0.00 0.00

2006/07 590.06 73,562.70 1,781,220 216,883,573 0.80 0.81

2007/08 2,423.08 130,904.77 7,453,371 425,013,200 1.82 1.72

2008/09 117.75 110,104.82 496,502 657,390,497 0.11 0.08

2009/10 2.34 176,636.65 9,026 679,293,922 0.00 0.00

2010/11 1.54 292,482.21 5,623 1,034,212,062 0.00 0.00

2011/12 8,084.76 313,497.32 32,222,825 1,205,045,464 2.51 2.60 Note: US$1 = ₹46.56 on April 1, 2001 and US$1 = ₹50.88 on April 01, 2012. The FY 2011/12 figures include the increase in market share due to the introduction of Liquidity Enhancement Incentive Programmes. Source: Compiled by the authors using data from the Securities and Exchange Board of India, Handbook of Statistics on Indian Securities Markets, 2012, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1389094067302.pdf. EXHIBIT 4: START AND END DATES OF THE BOMBAY STOCK EXCHANGE’S VARIOUS LIQUIDITY

ENHANCEMENT INCENTIVE PROGRAMMES

LEIP Start Date End Date Period

I Sept. 28, 2011 Oct. 25, 2011 27 days

II Oct. 26, 2011 Apr. 25, 2012 6 months

III Feb. 1, 2012 July 31, 2012 6 months

IV May 2, 2012 Nov. 1, 2012 6 months

V Aug. 1, 2012 Jan. 7, 2013 5 months

VI Aug. 1, 2012 Jan. 31, 2013 6 months

VII Oct. 29, 2012 Apr. 29, 2013 6 months

VIII Jan. 16, 2013 July 15, 2013 6 months

IX Feb. 1, 2013 July 31, 2013 6 months

Note: LEIPs = Liquidity Enhancement Incentive Programmes. Source: Compiled by the authors using data from Bombay Stock Exchange, “About LEIPS,” accessed March 20, 2013, www.bseindia.com/markets/Derivatives/DeriReports/about_LEIPS.aspx.

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Page 10 9B16N071

EXHIBIT 5: THE DIFFERENT PHASES OF THE LIQUIDITY ENHANCEMENT INCENTIVE PROGRAMMES AND THE PRODUCTS TARGETED

Note: F&O = futures and options Source: Compiled by the authors using data from Bombay Stock Exchange, “About LEIPS,” accessed March 20, 2013, www.bseindia.com/markets/Derivatives/DeriReports/about_LEIPS.aspx.

EXHIBIT 6: DERIVATIVE-INCENTIVE CEILING VERSUS THE MAXIMUM VALUE OF VOLUME TRADED

LEIPs Derivative Incentive Ceiling

(₹ millions) for Traded Volumes Derivative Incentive

Ceiling (₹ millions) for Traded Volumes

Maximum Value of Volume Traded

(₹ millions) Futures Options

I 4,000 4,000 8,000 5,460

II 10,000 5,000 15,000 537,650

III N/A 51,000 51,000 1,089,330

IV 12,000 N/A 12,000 1,089,330

V 1,600 1,600 3,200 1,722,780

VI 2,075 N/A 2,075 1,722,780

VII N/A 19,950 19,950 716,610

VIII 30,000 N/A 30,000 716,610

IX 2,075 N/A 2,075 196,800 Note: LEIPs = Liquidity Enhancement Incentive Programmes; US$1 = ₹ 48.94 on September 28, 2011 and ₹ 53.21 on February 1, 2013; N/A = not applicable. Source: Compiled by the authors using data from Bombay Stock Exchange website, “About LEIPs,” accessed March 21, 2013, www.bseindia.com/markets/Derivatives/DeriReports/about_LEIPS.aspx.

III

VII

VIII

LEIPS Timeline

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Page 11 9B16N071

EXHIBIT 7: DERIVATIVES INCENTIVE CEILING VERSUS THE MAXIMUM VALUE OF VOLUME TRADED

Note: US$1 = ₹ 48.94 on September 28, 2011 and ₹ 53.21 on February 1, 2013 Source: Graph created by the authors using data from Bombay Stock Exchange, “About LEIPS,” accessed March 21, 2013, www.bseindia.com/markets/Derivatives/DeriReports/about_LEIPS.aspx.

EXHIBIT 8: THE BOMBAY STOCK EXCHANGE’S SAMPLE INCENTIVE SCHEME FOR RETAIL PARTICIPATION

Number of clients who traded on the BSE Derivatives Segment, from September 12 to September 30, 2012

Incentive amount

(₹) 0–599 0 600–1,499 120,000 1,500–2,999 240,000 3,000–4,499 360,000 4,500–5,999 480,000 6,000 and above 600,000

Note: BSE = The Bombay Stock Exchange; US$1 = ₹ 55.21 on September 12, 2012; The bands and the actual amounts may have changed, due to subsequent revisions by the Bombay Stock Exchange. Source: The Bombay Stock Exchange, “Notice No. 20120907-27: Incentive Program for Increasing Retail Participation in BSE Derivatives Segment—Revision for the Month of September, 2012,” accessed May 10, 2013, www.bseindia.com/markets/MarketInfo/DispNoticesNCirculars.aspx.

‐

10,000

20,000

30,000

40,000

50,000

60,000

400

200,400

400,400

600,400

800,400

1,000,400

1,200,400

1,400,400

1,600,400

1,800,400

2,000,400

I II III IV V VI VII VIII IX

D e ri v a

v e I n ce n

v e C e il in g ( ₹ m

il li o n s) f o r

T ra d e d V o lu m e s

M a x im

u m V a lu e o f V o lu m e T ra d e d

(₹ m

il li o n s)

LEIPs phases

Maximum Value of Volume Traded (₹ millions)

Deriva ve Incen ve Ceiling (₹ millions) for Traded Volumes

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Page 12 9B16N071

EXHIBIT 9: THE BOMBAY STOCK EXCHANGE’S QUARTERLY INCOME STATEMENTS, JUNE 2011 TO SEPTEMBER 2012

Particulars (₹ millions)

For the Quarter Ended June 30, 2011

For the Quarter Ended Sept. 30, 2011

For the Quarter Ended Dec. 31, 2011

For the Quarter Ended March 31, 2012

For the Quarter Ended June 30, 2012

For the Quarter Ended Sept. 30, 2012

Income

Operating Income 1,386.71 1,256.63 1,291.20 1,525.60 1,253.40 1,205.40

Other Income 68.60 78.41 72.20 104.90 110.20 129.70

Total Income 1,455.31 1,335.03 1,363.40 1,630.50 1,363.60 1,335.10

Expenditure

Employee Costs 196.83 195.77 195.07 183.60 201.90 195.80

Computer Technology-Related Expenses

117.85 139.89 173.70 181.30 194.50 135.10

Administration and Other Expenses

156.51 183.28 163.11 243.40 165.80 186.80

Depreciation 80.20 82.37 89.00 89.10 61.10 82.40

Total Expenditure 551.39 601.32 620.88 697.40 623.30 600.10

Profit before LEIPs 903.92 733.72 742.52 933.10 740.30 735.00

Interest 3.72 2.73 2.98 4.20 18.30 2.80

Exceptional Items/LEIPs 186.64 416.90 410.20 1.30

Profit before Tax 900.19 730.99 552.90 512.00 311.80 730.90

Tax Expenses 258.55 171.78 136.62 75.60 75.70 171.70

Net Profit for the Period 641.64 559.21 416.29 436.40 236.10 559.20

Less: Minority Interest 73.29 57.95 69.25 67.60 65.80 57.90

Add: Share of Profit of Associate (Net)

0.00 –5.70 1.60 –1.90

Profit after Tax and Share of Associate

568.35 501.25 341.34 370.40 168.40 501.30

Paid Up Equity Capital (Face Value Per Share ₹ 1 Each)

103.41 103.54 103.50 103.50 103.50

Basic EPS After Extraordinary Item (Not Annualised)

4.67 4.34 2.69 3.50 0.87 4.74

Diluted EPS After Extraordinary Item (Not Annualized)

4.67 4.34 2.69 3.50 0.81 4.74

Note: US$1 = ₹ 44.59 on June 30, 2011 and ₹ 52.84 on September 30, 2012; LEIPs = Liquidity Enhancement Incentive Programmes; EPS = earnings per share Source: The Bombay Stock Exchange, “Financials Historical,” accessed March 4, 2013, www.bseindia.com/static/about/financials.aspx.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 13 9B16N071

EXHIBIT 10: LIQUIDITY RATIOS ON THE BOMBAY STOCK EXCHANGE AND THE NATIONAL STOCK EXCHANGE

Year Turnover Ratio Traded Value Ratio

BSE NSE BSE NSE

2000/01 175 203.6 47.9 64.1

2001/02 50.2 80.6 13.5 22.6

2002/03 54.9 115.1 12.7 25.1

2003/04 41.9 98.1 18.2 39.8

2004/05 30.5 71.9 16 35.2

2005/06 27 55.8 22.1 42.5

2006/07 27 57.8 22.3 45.3

2007/08 30.7 73.1 31.7 71.2

2008/09 35.6 95 19.7 49.3

2009/10 22.4 68.9 21 63.2

2010/11 16.2 53.4 15.2 49.2

2011/12 10.7 46.1 8 33.6

2012/13* 5.9 29.2 4.3 20.9 Note: BSE = Bombay Stock Exchange; NSE = National Stock Exchange; Data for 2010/11 and 2011/12 have been revised (at 2004/05 prices); Turnover Ratio = (Turnover ÷ Market Capitalization); Traded Value Ratio = (Turnover ÷ Gross Domestic Product [GDP]); *Advance estimate of GDP at market prices for 2012/13 (at 2004/05 prices) is considered. Source: Securities and Exchange Board of India, Handbook of Statistics on Indian Securities Markets, 2012, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1389094067302.pdf.

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 14 9B16N071 EXHIBIT 11: NOTIONAL VALUE TRADED IN THE EQUITY DERIVATIVES SEGMENT BEFORE AND

AFTER THE INTRODUCTION OF THE LIQUIDITY ENHANCEMENT INCENTIVE PROGRAMMES (IN ₹ BILLIONS)

Note: US$1 = ₹ 40.73 on June 25, 2007 and US$1 = ₹ 50.78 on March 28, 2013; LEIPs = Liquidity Enhancement Incentive Programmes. Source: Graph created by the authors using data from Bombay Stock Exchange, “Day Wise Market Summary,” accessed May 12, 2013, www.bseindia.com/markets/Derivatives/DeriReports/DeriArchiveSum.aspx.

‐

200

400

600

800

1,000

1,200

1,400

1,600

1,800

25‐Jun‐07 06‐Nov‐08 21‐Mar‐10 03‐Aug‐11 15‐Dec‐12

N O T IO N A L V A LU

E T R A D E D I N T H E E Q U IT Y

D E R IV A T IV E S S E G M E N T ( ₹ B IL LI O N S )

Period

Before LEIPs After LEIPs

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 15 9B16N071 EXHIBIT 12: MARKET SHARE OF THE BOMBAY STOCK EXCHANGE AND THE NATIONAL STOCK

EXCHANGE (BASED ON THE ANNUAL NOTIONAL VALUE TRADED)

Note: US$1 = ₹46.56 on April 1, 2001 and US$1 = ₹ 54.29 on April 1, 2013; LEIPs = Liquidity Enhancement Incentive Programmes Source: Graph created by the authors using data from Securities and Exchange Board of India, Handbook of Statistics on the Indian Securities Market, 2009, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1288678534212.pdf; and Handbook of Statistics on the Indian Securities Market, 2013, accessed May 16, 2013, www.sebi.gov.in/cms/sebi_data/attachdocs/1404362427338.pdf.

EXHIBIT 13: BOMBAY STOCK EXCHANGE’S TRADER CLASSIFICATIONS FOR SELL TRADES

Note: FII = foreign institutional investors; the share of Mutual Funds and FIIs is negligible. Source: Graph created by the authors using data from Bombay Stock Exchange, “Investor Categorywise Turnover,” accessed May 5, 2013, www.bseindia.com/markets/Derivatives/DeriReports/InvCatTurnArchive.aspx.

‐

100

150

200

250

300

350

400 ₹ T ri ll io n s

BSE NSE

Before LEIPs After LEIPs

18.5%

2.5%

20%

40%

60%

80%

100%

2 0 ‐F e b ‐1 3

2 2 ‐F e b ‐1 3

2 4 ‐F e b ‐1 3

2 6 ‐F e b ‐1 3

2 8 ‐F e b ‐1 3

0 2 ‐M

a r‐ 1 3

0 4 ‐M

a r‐ 1 3

0 6 ‐M

a r‐ 1 3

0 8 ‐M

a r‐ 1 3

1 0 ‐M

a r‐ 1 3

1 2 ‐M

a r‐ 1 3

1 4 ‐M

a r‐ 1 3

1 6 ‐M

a r‐ 1 3

1 8 ‐M

a r‐ 1 3

2 0 ‐M

a r‐ 1 3

2 2 ‐M

a r‐ 1 3

2 4 ‐M

a r‐ 1 3

2 6 ‐M

a r‐ 1 3

% T ra d e s

Period

Mutual Funds FII Proprietary Traders Others

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.

Page 16 9B16N071

EXHIBIT 14: BOMBAY STOCK EXCHANGE’S TRADER CLASSIFICATION FOR BUY TRADES

EXHIBIT 15: TRENDS IN LIQUIDITY ENHANCEMENT IINCENTIVE PROGRAMMES OUTFLOWS AND PROFIT BEFORE TAX

Note: US$1 = US$1 = ₹ 44.59 on June 30, 2011 and ₹ 52.84 on September 30, 2012; QE = quarterly earnings; PBT = profit before taxes; LEIPs = Liquidity Enhancement Incentive Programmes Source: Graph created by the authors using data from Bombay Stock Exchange, “Financials Historical,” accessed January 4, 2013, www.bseindia.com/static/about/financials.aspx?expandable=2; and “About LEIPs,” accessed March 21, 2013, www.bseindia.com/markets/Derivatives/DeriReports/about_LEIPS.aspx.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

100%

% T ra d e s

Period

Mutual Funds FII Proprietary Traders Others

(200) ‐

200 400 600 800

1,000 1,200 1,400 1,600 1,800

QE 30.06.2011

QE 30.09.2011

QE 31.12.2011

QE 31.03.2012

QE 30.06.2012

QE 30.09.2012

QE 31.12.2012

₹ m il li o n s

Operating Income PBT LEIPS

Net Profit Linear (PBT) Linear (LEIPS)

This document is authorized for use only by Marie Constant in FIN-670-Q1360 Option Analysis & Fin Deriv 21TW1 at Southern New Hampshire University, 2021.