2061 – A capital market’s odyssey

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As they say, the past was a different country. The future looks even more fascinating and full of possibilities.

In this article, an effort is being made to look at the history and the trend of developments in the world of capital markets and to make an attempt at extrapolating the results to arrive at a picture of how Indian markets would look like in the year 2061.

As per Investopedia, capital markets are “markets in which individuals and institutions trade financial securities. Organizations/institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. Thus, this type of market is composed of both the primary and secondary markets.”

Financial securities are essentially a way to connect the ‘present’ with the ‘future’ – using ‘trust’. Trust, in essence, is intangible and ephemeral. It is very fragile. To a large extent, it is also a function of the society we live in. The norms, mores, technical capabilities and institutions in a society all have a role to play in maintaining and enhancing this ‘trust’. Dysfunctional societies do not support vibrant financial markets.

Mankind has been making investments in capital markets for millennia in some way or another. The first set of organized lenders in Egypt and other places several millennia back were large religious establishments. It is not surprising given the fact that, even thousands of years back, religious establishments were adept at dealing with connecting the present with the future (even beyond death and in next lives) and knew how uncertainty plays a role in human lives and how to make more money by connecting the present with the future.

A question arises as to whether by 2061, will the future become certain?

If the future becomes certain, will there be a need to differentiate between two investment opportunities? Since we will know with complete certainty the outcome of an investment event (default, repayment, interest payments, yield curve across the duration, returns from competing instruments etc.), will there be a need for capital markets? Since the entire future will be known for everyone and for the smallest to the longest duration of time, there will be no uncertainty and hence no need to invest.

However, it will perhaps be a boring life.

Hope, by 2061, uncertainty will still persist especially about the future. Perhaps, even beyond.

Capital markets therefore will still exist in 2061, perhaps even beyond.

Sub-millisecond response time is no longer aspirational but a reality. By 2061, we might be in picosecond response time.

An investor investing in a financial security is expecting the money to come back with returns in the future. This is called ‘risk free return’ in investment parlance. Usually investments in sovereign securities within the same country are considered risk free in nature. Modern ‘fiat money’ allows only the sovereign to print money. Hence, theoretically the sovereign can always print money and give the same to the lender. However if ‘printing of money’ creates hyperinflation, then society may not find it acceptable. Any other investment – in debt, equity, derivatives – therefore has a finite risk associated with it. Risk, in some sense, is a function of time. The longer the maturity of the investment (when the original money is supposed to be returned by the borrower), the more the risk. Methods to identify, measure and manage these different types of risks have evolved over a period resulting in very sophisticated models. By 2061, even more fancy models may be developed. However the unknown unknowns and known unknowns in Donald Rumsfeld’s world would not have been captured even by then. Models would be even more accurate than what they are today. However the incremental value addition from here to 2061 in the model creation industry for risk management may still keep out a large delta that will continue to provide employment opportunities for many IIM graduates even in 2061.

There are 3 important features of a capital market that we can discuss here:

1.Transaction processing and price signaling

Transaction processing is what makes a market look like a market. However the prime function of a market surprisingly is not transaction processing, but is price signaling. Squeaky clean price (not manipulated) is what one expects from a well-functioning market – indeed it is the obligation of a market to provide one. Transaction processing is a means to achieve that end. If a market has a great way to process transactions but does not worry about the manipulations, then that market might not survive for long.

Over the last 20 years, Indian markets have seen a great move towards automating transaction processing. From floor-based markets in 1994, we have screen-based markets now. We have set up even risk management and settlement guarantee organizations called Clearing Corporations, and depository institutions which keep stocks in dematerialized format like banks keep money in bits and bytes for you. Connectivity to banks has improved and surveillance mechanisms have become real time. Mobile trading, web trading, algorithmic trading, etc. have become commonplace. Sub-millisecond response time is no longer aspirational but a reality. By 2061, we might be in picosecond response time. We might be using algorithms which take into account each and every part of economic and social data to predict the future and still might fail.

In last 3 years, BSE response time has reduced from 300 milliseconds to 10 milliseconds and number of orders has gone up from 75 lakh per day to 11 crore per day.

Cost of transactions and post-transaction activities in the Indian market have come down by 99% in the last 20 years. However volumes in the market have gone up by 1000 times or even more.

By 2061, transaction cost may come down by a further 99% or more but transaction volumes will increase manifold. Market participants will also figure out new ways of making money. We will witness many innovative business models. We will witness a transformation in the way business is conducted in this sector.

In last 3 years, BSE response time has reduced from 300 milliseconds to 10 milliseconds and number of orders has gone up from 75 lakh per day to 11 crore per day. In Indian capital markets, the current working day lasts 6 hours and 15 minutes. BSE plans to change in the near future to a system that will have a response time of 100 microseconds and can take 3 crore orders in a minute. The trading day might last practically 24 hours by 2061 which is currently the case in many other countries. In Indian commodities markets, trading takes place daily till 11pm or beyond.

By 2061, microsecond might be too slow. However for people who invest for the long term, the pursuit of speed may not be very important. They may want to worry about identifying the right companies and business ideas to invest in, like today.

Capital formation will continue to remain the key touchstone of the effectiveness of capital markets and not necessarily at what speed the markets are able to transact. For that reason alone, corporate governance becomes an important aspect to discuss even in 2061.

In India, today only 1.5% of the people invest in capital markets. The returns derived from the non-regulated, non-matured asset classes have far outperformed the capital market returns in last few years. A similar trend, on a comparatively smaller scale, was witnessed in all developed markets as well. Sooner or later, as those alternative asset classes mature, or undergo correction, or generally reach peak prices, investors will once again turn to the capital markets for capital formation and capital appreciation.

With the investor awareness programs and other initiatives undertaken by SEBI, BSE, etc., the market size in terms of number of market participants has been growing at a steady pace and is expected to accelerate once the high returns currently offered by alternate asset classes dry up. Government initiatives like the recently launched Rajiv Gandhi Equity Savings Scheme will help attract new investors. By 2061, we can expect a large part of the population to be actively trading and investing in capital markets as financial literacy and awareness increases across the country across classes.

By 2061, we can expect a large part of the population to be actively trading and investing in capital markets as financial literacy and awareness increases across the country, across classes.

Due to the lower cost of creating faster and better technology, many more exchanges might come up. Many more transaction processing platforms may come up. They need to be interconnected in a variety of ways with existing systems and systems that are expected to come up. Regulators will have their hands full in coping with newer technologies, newer instruments and newer challenges of corporate governance. The pace of change in regulations that has seen tremendous acceleration in last 5 years will accelerate even further. Many more regulators may come up time and again and perhaps, may get merged in each other again and again. USA, UK and several other countries are going through this creation and destruction process of regulators over last decade.

There will probably be full capital account convertibility making it possible for any investor in any part of the world to trade in a security in India at any time of the day on any day.

Markets will become safer. Already we see a trend where regulators and markets across the world are moving towards a centrally cleared model. Central Counter Parties (CCPs), with their collateral-based trading limits model and client collateral segregation, will make the capital markets virtually immune or less sensitive to the risks of defaults, market volatility and other similar risk factors. We can expect this trend to continue to its logical conclusion and by 2061, all products and assets will work on a centrally cleared model. The banking and payment system will evolve to cater to the need of real-time 24×7 payment systems and gateways through mobiles. There will probably be full capital account convertibility making it possible for any investor in any part of the world to trade in a security in India at any time of the day on any day.

Automation of trading, clearing and banking systems has already happened. The small degree of manual intervention in these financial infrastructure units will also get completely automated by 2061. The main system will be automated, the near Disaster Recovery (DR) system will be automated and the far DR system will be automated. We will probably even have DR systems which are situated in different continents on different continental and oceanic plates.

Connectivity across the globe has already been discussed. Economic activities might be even more tightly integrated looking at a time horizon of 50 years. Cooperation across countries in terms of money laundering, terrorist financing, financial misdemeanor, etc. may increase. It will ensure that there is no safe haven for crooks to run away to.

At the same time perhaps, a Japanese housewife will be investing in a handicraft unit in Jaisalmer using BSE’s Micro Stock Platform with complete confidence that her money is safe and is used for the purpose she is investing in.

2. Corporate governance

In capital markets, a person invests with the ‘trust’ that he is investing in the business as a partner or a lender. He may be willing to face the losses if his investment calculation goes wrong. However, he will feel cheated if his identification of the business idea is correct but the system allows promoters to not share the riches with other investors and only losses are shared with the other shareholders; or if the company does not return the money when the bond matures despite the company having sufficient money.

Corporate governance, faster and fair legal system, etc. will continue to remain important for the capital markets as they are today. They will become perhaps more relevant. The performance of the Indian corporate sector is directly linked to the investor confidence in the corporate governance practices followed. Companies which take leadership in corporate governance norms are richly rewarded by investors.

Companies were earlier required to give annual results which have now been made quarterly. In the future, it is possible that companies may be required to provide details at shorter durations, maybe even on a real-time basis or perhaps not – for strategic and competitive reasons.

3. Need for capital and new instruments

Current Indian demographics and even future Indian demographics suggest that India will continue to be a large and fast-growing economy till 2061 and beyond.

Currently, more than 50% of the Indian population is aged below 25. On the other hand, less than 1.5% of the Indian population has invested in capital markets. Given the formation of nuclear families and rapid urbanization expected to take place, it is natural for this young workforce to invest in financial instruments for their old age pension, children’s education, health care, etc. Whether they invest in financial instruments by investing in stock markets directly or investing through intermediaries such as mutual funds, insurance companies, pension funds, etc. remains to be seen. A safe guess would be that they will continue to invest directly as well as indirectly. They will have, perhaps, many more choices of instruments and companies to invest in. Derivatives which were not available till 2001 in India have become a part of life in 2013 with index futures, index options, stock futures, stock options, currency futures, currency options, foreign index futures and options, etc. being available to and widely traded by investors. Many more sophisticated instruments might become available.

While trading will continue to be an integral part of capital markets, so will investing. Indian debt market, which has remained dormant for too long, can get a new wind and follow the success achieved by similar products worldwide. And it cannot be any sooner. As per current estimates, India needs to invest US $1 trillion in infrastructure till 2020. If we estimate the total need for the capital till 2061, it could run into several tens of trillion US dollars. While part of this capital requirement will be funded by the Government, a major part will come from investors, both from within India as well as from abroad, in the form of investment in infrastructure debt or investment in equity of infrastructure-based companies or through project-based financing.

The role of the investor in creating institutions like Birla, Reliance, Tata or the younger institutions like Infosys and TCS cannot be overemphasized. The same investors will play a big role in developing the infrastructure in India to help make India into a global power and a services and manufacturing leader 50 years hence.