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P/2 W P/2/2011

NSE WORKING PAPER
Cost of Trading in Stock Exchanges: a Perspective

Nirmal Mohanty

November 2011
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NSE Working Paper
Cost of Trading in Stock Exchanges: a Perspective
Prepared by Nirmal Mohanty1

November 2011

Abstract

This paper attempts to make a case for Securities Transaction Tax (STT) rationalization. The paper finds, that of the three major components of cost of trading viz. user charges (brokerage fees, exchange transaction charges and DP chargers), impact cost and statutory levies (STT, service tax on brokerage, stamp duty etc.), the user charges and the impact cost have been falling over the years due to rising competition and technology. This has led to a decline in India’s cost of trading, though it remains high relative to other emerging economies such as Brazil and Russia primarily due to high STT levels. The paper advocates that India’s STT regime should be reviewed because of negligible revenue collection by Government from the STT and also because high STT reduces trading volumes, slows prices discovery, increases businesses’ cost of capital and impairs the competitiveness of domestic financial markets, given the increased cross border mobility of capital.

Vice President, National Stock Exchange of India Ltd. The article has been published earlier in the FICCI Banking and Finance Digest, June 2011. The views expressed in the paper are those of the author and not necessarily of the National Stock Exchange of India Ltd. The author can be contacted at nmohanty@nse.co.in. 2

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Cost of Trading in Stock Exchanges: a Perspective

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Introduction

In India, capital markets have been playing an increasingly important role, determining the pace and pattern of economic growth and the stock exchanges are a vital institution of the capital markets. As an important intermediary in the capital market, a stock exchange provides an organized marketplace for transparent price discovery, where trading members (brokers) use a trading platform, typically an electronic one, to trade in securities such as equities or bonds either on behalf of their clients or on their own account. When a party trades with another on a stock exchange, he not only pays or receives the price (at the time of trading) of the securities he buys or sells, but also incurs certain additional costs. These additional costs are called costs of trading. Costs of trading in an exchange have an important bearing on the efficiency of the capital market and hence, call for a critical examination. Why are costs of trading an important parameter to monitor and control? In a globalized world, capital moves not only in response to competing monetary policies, but also to competing securities markets. Inefficient financial systems are therefore likely to be increasingly penalized. Besides, high trading costs of securities distort the allocation of investible resources to securities vis-à-vis other assets. It also increases the cost of capital. By making it more expensive to exit, trading costs add to the liquidity risk and induce investors to ask for higher risk premium, implying a higher cost of capital. The aim of this paper is to critically examine the sources of the costs of trading on an exchange in the Indian context, analyze the trends and identify and discuss the emerging issues.

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Composition of trading costs in India

Investors/ traders incur trading costs that can be broadly classified into three main categories: (i) user charges, (ii) statutory levies and (iii) impact costs.

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User charges An investor/trader is required to pay user charges in return for the facility to use the infrastructure of three separate entities: brokers, stock exchanges and depository service providers; the charges made by these entities are brokerage fees, exchange transaction charges and depository charges respectively. The exchange transaction fee also includes the costs of clearing and settlement, undertaken...
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