India's Exchanges at a Crossroads: From Utilities to Innovation Hubs

India's stock exchanges, while globally competitive in operational efficiency, are being held back by outdated regulations designed for utility-like functions. A potential shift by the Securities and Exchange Board of India (SEBI) could transform them into innovation-driven ecosystems, vital for India's financial market evolution.

The Utility Mindset Hinders Growth

For decades, Indian exchanges and clearing corporations have been viewed as Market Infrastructure Institutions (MIIs) focused on public purpose like fair access and stability. This utility framework, crucial when markets were fragile, now restricts their ability to compete in a digital global economy.

• Current rules limit MIIs' investment in new technologies or overseas ventures.
• Strategic collaborations and product development face complex approval layers.
• Compensation structures resemble public utilities, not fast-paced tech firms, stifling talent.
• This results in exchanges being operationally world-class but innovation-poor, failing to leverage their potential in product and ecosystem development.

Global Peers Embrace Ecosystems

Exchanges worldwide have evolved beyond mere facilitators to become market architects and technology integrators.

• Nasdaq now derives nearly 70% of its revenue from data, analytics, and software services.
• CME Group integrates futures, options, and OTC clearing with advanced data and AI risk analytics.
• Hong Kong Exchanges and Clearing (HKEX) and Singapore Exchange (SGX) act as regional hubs for capital, commodities, and carbon markets.

SEBI's Crossroads: Differentiating Functions

The Securities and Exchange Board of India (SEBI) is at a critical juncture, needing to distinguish between core and adjacent functions.

• Core functions like market access, trading integrity, clearing, and investor protection require tight regulation.
• Adjacent functions, including data analytics, technology innovation, product development, and global connectivity, could operate under a lighter, outcome-based supervision.
• This is not deregulation, but "re-regulation for innovation"—setting boundaries to protect public interest while allowing MIIs to invest and experiment.

Building the Exchange Ecosystem

An ecosystem-oriented exchange plays multiple roles, fostering broader market development.

• Market Architect: Designs new instruments like electricity contracts, carbon credits, and weather derivatives.
• Technology Integrator: Provides APIs and AI/ML analytics for brokers and fintechs.
• Data & Intelligence Hub: Curates anonymised trading and risk data for insights.
• Global Connector: Links regional markets, facilitating offshore flows via hubs like GIFT City.

Re-imagining Oversight for Innovation

A new compact between MIIs and SEBI could be built on three pillars:

• Outcome-Based Regulation: Shift from pre-approval to post-facto supervision focused on measurable results like transparency and investor welfare.
• Tiered Governance: Separate core "utility" functions from "innovation" functions with appropriate safeguards.
• Incentive Alignment: Allow innovation-linked revenues that demonstrably improve market efficiency or access, such as SME liquidity products.

The Peril of Inertia

Failing to adapt risks India having highly advanced markets governed by outdated logic, with innovation migrating to unregulated fintechs and offshore venues.

• Creative market designs, like fractional investing or social trading, are emerging outside formal exchange infrastructure.
• Without recalibration, India could face incumbents burdened by compliance while disruptors innovate freely.

Pathways to Modernization

The solution lies in differentiated regulation, not deregulation, with SEBI acting as an enabler.

• MII Innovation Sandbox: Allow joint piloting of new ideas by exchanges and fintechs under relaxed norms.
• Innovation Carve-outs: Create specific innovation zones within exchange rules, supervised by enhanced disclosures.
• R&D Consortia: Encourage public-private partnerships for market technology, AI surveillance, and analytics.

Impact

• This shift could significantly enhance market efficiency, introduce new investment products, attract more participants, and boost India's global standing in financial innovation. It allows exchanges to adapt to evolving digital finance landscapes and prevents innovation from moving to less regulated spaces.
• Impact Rating: 8

Difficult Terms Explained

• Market Infrastructure Institutions (MIIs): Entities like stock exchanges and clearing corporations that provide the essential services for financial markets to function smoothly and safely.
• SEBI: Securities and Exchange Board of India, the primary regulator of the securities market in India.
• APIs: Application Programming Interfaces; sets of rules that allow different software applications to communicate with each other.
• AI/ML: Artificial Intelligence / Machine Learning; computer systems capable of performing tasks that typically require human intelligence, such as learning and problem-solving.
• EGRs: Electronic Gold Receipts; a negotiable instrument representing ownership of underlying gold.
• GIFT City: Gujarat International Finance Tec-City, India's first operational smart city and International Financial Services Centre (IFSC).
• ESG: Environmental, Social, and Governance; a set of standards for a company's operations that socially conscious investors use to screen potential investments.