SGX must earn buy-in from foreign markets if it wants their liquidity

The Singapore Exchange's (SGX) recent troubles in India and Malaysia show that a strategy of leveraging another market's liquidity to boost one's own is not an easy one to pull off.

Since its formation in 1999, the modern SGX has always set its sights beyond Singapore's shores. That regional focus is partly born out of necessity - with its relatively small domestic economy, SGX needs to serve more than just Singaporeans and Singapore entities if it means to build a meaningful and relevant market.

Tapping the regional market's vibrancy can happen in a few ways. One is to try to attract companies from the region to list their securities in Singapore. Another is to get investors from the region to trade Singapore-listed securities. Both of those strategies hinge on SGX generating enough liquidity to draw both the buy and sell sides of the market.

A third way is to borrow the liquidity of another market. With derivatives, SGX can offer futures contracts tied to the performance of an offshore stock index, like India's Nifty, China's A50 or Japan's Nikkei. When those markets are volatile, SGX's contracts help the exchange to capture reactions to those movements. For securities, SGX has looked for trading links, such as a trading-and-clearing tie-up with Bursa Malaysia that SGX had hoped would allow investors to clear trades for Malaysian stocks in Singapore.

On the surface, that third strategy sounds great, because it offers SGX a way to have an active market if the Singapore domestic market itself is dry. But the reality is that this avenue has recently proven to be problematic.

India's National Stock Exchange, which owns the Nifty, has stopped supporting SGX's Nifty futures, and both sides are currently embroiled in a legal dispute over the matter.

In Malaysia, newly elected Prime Minister Mahathir Mohamad has indicated that the country will review the trading link and whether it makes sense for Malaysia.

The common thread for both issues is a counterparty that may feel like it is getting shortchanged. Why should SGX get to benefit from the vibrancy of those markets when it does not contribute to those markets?

SGX will have to address those concerns if it wants to continue using this strategy, which it should. It goes without saying that effort must be taken to ensure that the deals bring benefits to both sides. In fact, these deals often do.

But the market operator must also take pains to communicate those benefits to other stakeholders beyond its immediate counterparties. Those stakeholders can include business leaders, local media and politicians. As SGX learnt years ago in its scrapped merger with the Australian exchange, market-related deals do not just have to make sense to get done. They need buy-in from key stakeholders and decision-makers as well.

SGX's troubles in India and Malaysia also reinforce the importance of building the market in an organic and native way. The more your own market is vibrant, active and growing, the less dependent you have to be on the good graces of a competitor. SGX must continue to attract interesting and successful companies to list in Singapore and maintain a quality primary market. It must also continue to foster an active retail trading scene while keeping the sophisticated money invested to ensure a robust secondary market.