Corporatisation and Demutualisation of Stock Exchanges in India

By,

Pawan Janiani (2010146)Piyush Ranjan (2010148)

Contents

Structure of Indian Stock Exchange Mutual Structure of Indian Stock Exchange Drawbacks Prior to Demutualisation Demutualisation and Corporatisation Steps towards Demutualisation Demutualisation of Regional Stock

Exchange Advantages Research and Methodology Challenges We Think..

Structure of Indian Stock Exchanges

BSE the oldest exchange in Asia was established in 1875 as Voluntary ‘not for profit’ un-incorporated association of persons.

Ahmadabad and Indore stock exchanges were other exchanges having similar structure.

The membership of these exchanges entitled the person to be the part owner of the exchange as well as a broker on the exchange.

Structure of Indian Stock Exchanges

All other regional stock exchanges were formed as companies under section 12 of the Companies Act, 1956 as company limited by shares/guarantee, but had a “not for profit” motive.

These exchanges worked like a co-operative society where the share of the company entitled the owner to be the shareholder of the exchange and also gave him a right to act as broker on the exchange.

NSE is a company formed under section 12 of the Companies Act, 1956 with a profit motive.

Mutual Structure of Indian Stock Exchanges

Indian stock exchanges(except NSE and OTCEI) therefore followed a mutual structure where the ownership and management rights of the exchange are bundled with trading rights as a broker and all three are represented by ownership of share of the exchange.

Drawbacks Prior To Demutualisation

The conflict of interests between the owners, the members and the management since all the brokers are managing the exchange together

Investor’s interest was ignored as brokers were manipulating the market for their own advantage

Scams took place in pre-demutualization phase-1992- Harshad Mehta

scam & 2001-Ketan Parekh Scam.

Lack of strict vigilance on the market-No one person or management was there to look after the affair of the exchange.

So Indian market and financial sector felt the need of demutualisation.

Demutualisation- Its Meaning

Demutualisation means “segregation of membership right in a recognised stock exchange into a distinct ownership right through the ownership of shares and distinct trading and/or clearing right of that recognised stock exchange”.

In simpler terms it is a process by which a mutually owned stock exchange is converted into a company owned by shareholders through transforming its existing legal structure into a business entity.

Corporatisation- Its Meaning

In order to demutualise a corporate structure of the exchange is a necessity.

Exchanges like BSE that were not even a corporate entity needed to be converted from “association of persons” to a Company limited by shares.

This process of conversion is termed as “corporatisation”.

Step towards Demutualisation

Board of BSE passed resolution approving “in principle” Corporatisation and Demutualisation way back in 1999

In 2001, Finance minister pledged on the floor of the parliament to demutualise all Indian Exchanges

SEBI appointed Kania committee to look in to the various issues relating to Demutualisation including questions relating to broker ownership

Kania Committee submitted its report to SEBI in August, 2002

Indian Effort Cont…

Kania committee report’s essential recommendations:

Three stakeholders namely shareholders, brokers and investing public to be equally represented.

Disbursal of majority shareholding post demutualisation to non-brokers.

Concept of converting part of reserves of the exchange into deposit from brokers and issuance of shares

Consolidation of exchanges recommended

No Government internationally has claimed any compensation for fiscal benefits given to exchanges prior to demutualisation

Indian Effort Cont…

BSE submitted its duly approved scheme to SEBI in June 2003.

Amendments to Rules and MOA and AOA also submitted in July 2003(based on Kania committee report) to SEBI for approval.

All required amendments in SCRA, Indian Stamp Act and Income Tax Act were then done.

Demutualized Regional Stock Exchanges

Vadodara Stock Exchange Magadh Stock Exchange Jaipur Stock Exchange Ludhiana Stock Exchange Saurashtra Kutch Stock

Exchange Delhi Stock Exchange Bhubaneshwar Stock

Exchange Cochin Stock Exchange Pune Stock Exchange Bangalore Stock Exchange

Ahmedabad Stock Exchange Calcutta Stock Exchange

Madras Stock Exchange Guwahati Stock Exchange

The Stock Exchanges That Hasn’t BeenDemutualised

Coimbatore Stock Exchange

Mangalore Stock Exchange

Meerut Stock Exchange

Uttar Pradesh Stock Exchange

Demutualisation Of Regional StockExchanges

Government asks for demutualisation of regional

stock exchanges in two ways:

Either by becoming trading arms of BSE & NSE, or

Number of regional stock exchange joins hands to make a separate platform

Nine exchanges recently signed an MOU with the National Stock Exchange (NSE) to extend its trading platform on the regional stock exchanges

Advantages Or Reasons For Demutualisation

Rationalized Governance: - The corporate model will enable management to take actions that are in the best interest of customers and the exchange itself. There would be transparency.

Investors Participations: - A demutualised exchange provides both institutional investors and retail investors the opportunity to become

shareholders. Institutional investors require much greater liquidity for block trading.

Competition from Alternate Trading System’s (ATS) and Electronic Communication Networks:- ATS and Electronic Communication Networks provide cheap and efficient access to quoted stocks unlike traditional stocks exchanges. To cope with competition, exchange required funds. While members have limitations in raising funds.

Globalization: - Historically brokers and exchanges were locally focused. Exchanges did not face meaningful competition from exchanges in distance places. Through alliances, exchanges seek to attract more investors by harmonizing distinct trading environment and by offering greater product variety.

Resources for capital investment: - One of the drivers of stock exchange demutualization is screen trading, which has replaced floor trading on most exchanges. Once customers have direct access to screens, exchanges memberships no longer have as much economic value and clearing firms rather than traders become a dominant force in exchange activities.

Research And Methodology

We have used the secondary data information here.

We have taken the six months Bombay Stock Exchange’s index from pre demutualisation and post- demutualisation phase each. All this data are available on the BSE Website.

So the data’s are:- MONTHS B.S.E Indices Nov- 04 6248.43 Dec- 04 6617.15 Jan- 05 6696.31 Feb- 05 6721.08 Mar-05 6954.86 Apr-05 6694.42 May-05 6772.74 Jun-05 7228.21 Jul-05 7708.59 Aug-05 7921.39 Sep-05 8722.17 Oct-05 8821.84 Nov-05 9033.99

So what we analyze from the above graph that the performance of the index gets stable after the month of May, 2005(the BSE was demutualised on 19 May, 2005). The index is quite volatile in pre-demutualisation phase (i.e. before May, 2005).

Now we will look that whether there is any improvement in the turnover of the BSE index because of demutualisation or not?

We have taken the four months turnover (buy & sell figure) from pre- demutualisation and post demutualisation phase each

The data’s are:- MONTHS BUY SELL Jan-05 25663.2 25899.67 Feb-05 28427.63 30895.75 Mar-05 33414.38 38510.1 Apr-05 22636.1 22859.74 May-05 26297.33 27057.4 Jun-05 34275.59 35576.7 Jul-05 38247.85 39624.35 Aug-05 48063.69 49342.17 Sep-05 52561.82 53842.4

So we see that the turnover increases at faster rate after May, 2005. But in the pre-demutualisation phase there is not any fixed trend in the turnover. Sometime the figure is increasing and sometime it is diminishing.

Therefore we can conclude that the performance of the Bombay Stock Exchange has revamped because of demutualisation.

Challenges Of Demutualisation

There will be no changes in the conflict of interest if an exchange is converted from an association of persons into a limited liability company

The same board and the same organizational structure will continue to exist and nothing much will be achieved

The government can not solve the exchange’s management problem by steering the demutualisation process

There have been arguments that demutualisation by itself may not achieve improved governance

We Think………

Though demutualisation is beneficial, many stock exchanges are hesitating to adopt it because they are afraid of loosing their identity

They also have the fear of paying huge tax conversions

This new revolution will become successful when the government will take the necessary steps

This issue has already gained importance at the international level but it needs to be considered more intensely at domestic level

Questions ?

Thank You !