A stock exchange, in its basic business framework, is structurally similar to a toll bridge, which provides much-needed access to capital markets, in which financial dealings, such as deals in equity, cash and F&O (Futures and options), are conducted. Such analogy is relevant as it was mentioned by Warren Buffett, according to whom it is a great thing to own a toll in an inflationary world as the initial investment to be made is built in and needs few replenishments.
The Indian stock exchange ecosystem is an illustration of this strong, highly lucrative paradigm, with the recent soaring growth largely provided by a “Retail Revolution” and consequent hyper-concentration in the derivatives market. This analysis will break down the existing market structure, expose the near-perfect market unit economics that have produced colossal profitability, and critically evaluate how new, specific regulatory actions are setting the future growth, competition, and revenue diversification.
The Current Landscape
The Indian capital market had its roots in the 1850s as it began informally under a Banyan tree. The market later on took a different shape, which resulted in the establishment of the Native Shares and Stock Brokers Association in 1875. But the paradigm shift came in the early nineties after a huge security scam had revealed a lot of market manipulation, laxity in regulations and inefficiencies in systems that were inherent in the old system of trading, which was manual and an open outcry system. This crisis led to the establishment of the National Stock Exchange (NSE) in 1992, which started operating in 1994, but most significantly, without a physical trading floor, through nationwide electronic connectivity.
The present environment is characterised by the Retail Revolution that started in 2020, which is a structural inflexion point of the exchanges. This tremendous increase in participation was enabled by three important factors, namely, the virtualizing of KYC by SEBI, which opened the market by creating a seamless online process of demat account opening; the introduction of discount brokers who charged much lower fees than the previous brokers, making market entry cheap; and the presence of the COVID-19 lockdown, which gave people time to interact with the markets. As a result, discount brokers are currently in control of almost two out of three market shares; the overall number of demat accounts is up more or less five times that of FY20.
The difference in the revenues among the key players is enormous in terms of scale. It is estimated that NSE will have top-line revenue of around 17,000 crores in FY25, as compared to around 2,000 crores of BSE. In exchanges, the cash and the F&O trades apply the trade facilitation as the primary source of revenue, which comprises up to 70 and 80 per cent of the total revenue, respectively. Some of the services offered to generate ancillary revenues include co-location, listing fees and investment income as a result of margin deposits.
Core Analysis & Argument Development
The main thesis is that the high profitability and explosive growth of Indian exchanges are inherently associated with the handful and exclusive unit economics of the derivatives part, a format that is currently undergoing intentional regulatory recalibration.
Derivatives have turned out to be the main driver of growth. The notional Average Daily Turnover (ADTO) in the industry recorded a brutal 10-year Compound Annual Growth rate (CAGR) of approximately 66% as it increased to ₹420 crores per day in FY25. More importantly, exchange revenue depends upon traded premiums rather than the overall notional exposure. The take rate of NSE is around ₹35 per ₹1 lakh of traded premium.
There has been an illustrated fundamental change that has taken place in the trading behaviour, which is realised by the drop in the Premium to Notional Ratio, previously being around 50-55 basis points before FY21, and today the ratio stands at roughly 17-18 basis points. This loss can be clearly attributed to the fact that the retail investors are opting more towards lower-duration contracts as they provide maximum notional exposure at the lowest premium.
The result of this dynamic was that concentration of volumes was tremendous: weekly index options comprised approximately 70% of the total volumes in the industry in FY24. Moreover, liquidity in weekly options is dominant in the short-term run, where 50 to 60 per cent of the volume is on zero-day and one-day options.
The density and the possible dangers of such a structure prompted the SEBI Circular of October 2024, which made a major inflexion point. This circular brought in two drastic changes:
Product Rationalisation: Exchanges were also required to sell only one weekly index expiry. NSE, which had hitherto controlled all five trading days in distinctive expiry contracts, had to reduce or abolish four of its weekly options. This gave vital white space in the trading week. This was seized by BSE, whose option market share has increased exponentially from an initial 3% in FY24 to the current 23%.
Greater Contract Size (Lot Size): SEBI has increased the minimum notional exposure needed on index derivatives considerably, by increasing it to ₹15 lakh, which was previously ₹5 lakh. In agreements such as Sensex, this necessitated doubling of the lot size to 20 options, leading to the minimum size of the contract being around ₹17 lakhs. This was an effective tripling of the minimum premium level, which swamped out individual traders at the bottom of the trading pyramid who cannot pay the increased premiums.
The Road Ahead & Strategic Implications
To investors, the forward perspectives can be defined by the recurring regulatory scrutiny and requirement to diversify. The excessive reliance of the market on speculative retail trading cannot be maintained in terms of governance, as the SEBI data reveal that 93% of individual traders made a loss in FY24, and an overall loss of ₹75,000 crores. Moreover, 75% of the individuals who had made losses in the last two years were trading and losing in FY24, indicating progressive and high-risk behaviour. This indicates that the regulators might implement additional regulations or additional curbing, of weekly derivatives to ensure that markets are honest.
The regulatory environment has introduced changes in the competitive environment, which is intentional on its part. BSE has had a competitive push to take up much of the options markets by the rationalisation of weekly expiries. It is probable that many regulatory measures in the future, including any possible changes in the contract regulations or the exposure threshold, will shift the market volumes and liquidity, which could prove to be a challenge to NSE in taking over the entire history of market domination.
One of the major strategic implications is based on the global revenue mix disparity. The Indian exchanges largely depend on the revenue from transactions (70-80%). The larger international competitors, in turn, such as the London Stock Exchange Group (LSEG) and Intercontinental Exchange (ICE), obtain significant shares of their revenues (45% -70%) out of Tech and Data Services. In the case of LSEG, it owns Refinitiv, which is the source of a significant portion of its data revenues. The data and technology-enhanced annuities are one of the opportunities that Indian exchanges need to grow in the future, as core volumes of transactions may be limited by regulations.
Although the cash and mutual fund order platforms (such as that of BSE, STAR MF, where orders increased six-fold over five years) are increasing, they are not charged on an ad valorem basis but on a per-order basis (say ₹3-₹3.5), and thus fail to completely offset the decreases in the high-margin derivatives volume.
Finally, volumes have decreased after the SEBI circular, but the basic toll bridge structure of the market is extremely secure with substantial entry barriers and better unit economics, which have ensured high profitability, despite the market adjusting to more restrictive governance.
Conclusion
The Indian stock exchanges have developed a highly lucrative value addition of a lucrative and extremely profitable business model of a toll bridge through the retail revolution, and the power of high-margin derivatives trading. Underlying this structural dominance are strategic subsidiary structures, which translate into some of the best contribution margins of close to 99% in the major trading segments.
The main question that investors face is whether the exchanges can shift to the diversified data and tech-based revenue models that are used in the rest of the world, or whether their valuation will always remain the capacity to navigate and make money out of an increasingly speculative derivatives market, which is increasingly being regulated to restrain the excesses of the retail revolution.