The Bombay Stock Exchange: Liquidity Enhancement Incentive Programmes

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.

This case is appropriate for an undergraduate or graduate course on security markets, with a specific focus on market liquidity and market structure. It may also be used in an undergraduate or graduate course on competitive strategy to illustrate how incentives can change competition, especially across two almost identical products: the National Stock Exchange’s Nifty Index and the Bombay Stock Exchange’s 100 Index. This case provides an alternative scenario to order-driven markets, whereby a stock exchange is able to significantly improve liquidity by incentivizing traders to participate in its derivatives market. The case can also be used to revisit the basic terminologies in derivatives and the unique features of the Indian stock market. After completion of the case, students will be able to<br><ul><li>debate the importance of liquidity and how stock exchanges compete for liquidity;</li><li>compare the purchase order concept prevalent in the United States with the liquidity incentives schemes introduced in India;</li><li>analyze how liquidity incentive schemes can be used for the benefit of the entire securities market; and</li><li>understand the basic terminology of derivatives and the unique features of Indian stock markets.</li></ul>

• Liquidity, payment for order, exchanges, market microstructure