With the growth of the Indian economy the Indian stock exchanges too have witnessed a steep growth trajectory. In keeping with globalization and to compete more successfully, local stock exchanges would like to attract additional and diversified capital. However, the recent Jalan committee report has become a hurdle in that direction and in setting up of newer exchanges by non financial sector participants. The committee is of the view that
i. Anchor Institutional Investors (AII) should be limited to Public Financial Institutions[1] and Banking Company[2] having a net worth of more INR 1,000 crores
ii. for a new entity seeking recognition as a Stock Exchange, AII should be identified from amongst the shareholders holding more than 15% but up to 24% of the equity capital of the exchange
iii. AII should reduce their holding over a 10 year period to a maximum of 15%. The 10 year period will be cumulative for the initial and any subsequent AII
iv. other Stock Exchanges and insurance companies should be allowed equity ownership between 5% and 15%
v. all anchor institutional investors put together should not hold more than 49% of the total equity capital of an exchange
vi. FII should be allowed to acquire shares through off market transactions including initial allotment
vii. to ascertain the holding of an investor in a Stock Exchange (or another Market Infrastructure Institution) the maximum permissible limit should be computed based on the overall direct and indirect, straight and structured investment
viii. given the stable, long term nature of investments required in Stock Exchanges and that listing would bring in conflicts of interest in regulation; Stock Exchanges should not be permitted to list
ix. the maximum return that can be earned on the net worth of a Stock exchange (and other MII) and distributed to shareholders should be capped to ensure that unreasonable profits are not earned
These view points are all valid in varying degrees but, in entirety, at places these views contradict the very concerns that the committee has tried to address.
The analysis presented here is based on:
i. the fact that the Committee views Stock Exchanges as utilities with the objective of providing stable infrastructure for an efficient and well regulated trading market platform at reasonable costs for public consumption
ii. the fact that Stock Markets are no longer geographically restricted
iii. the particular nine recommendations mentioned above
Stability comes from a long term investor ready to commit the significant initial capital and willing to exit at a return without the need to earn a regular return in the short run. To that extent the committee makes a valid point that there has to be minimum net worth of the AII to be able to invest and support the Stock Exchange through its growth phase and there is merit in the proposed 10 year period provided to bring down the AII holding down to a maximum of 15%. This will give the initial AII sufficient time to sell at a reasonable return once the business has stabilized[3]. However, with the capping of the profits and the listing ban the committee seems to have closed the exit for AII. Institutional investors manage monies for third parties who they are accountable to. Their needs to be a justification for them to be investing in equity of an entity that has restricted profit sharing during the tenure of the investment and which at the time of exit might not even find takers. With a risk free rate governed cap[4] on investment there would be better investment opportunities available, maybe even in the debt markets without the risks of an equity investment and probably a more liquid option available. The listing ban further narrows return and exit opportunities for institutional investors. In India, with its shallow investor base, this implication then contradicts the committee’s own views that Stock Exchanges should have a diversified holding. Another contradiction to diversifying holding is restricting the AII to Banking Company and Public Financial Institution, a proposition which in addition loads the risk of investment on the institutions that already bear significant long term risk for the economy(specially in the absence of public corporate debt markets). The ownership as defined by the committee is vague in mentioning a capped 49% cumulative holding by all AII. It is unclear whether this limit is defined at the time of seeking recognition or post the 10-year divestment period. With lack of such clarity, there is also a lack of taking on from global experience.
Global Stock Exchanges have witnessed evolutionary changes in the last decade that have probably outpaced any development in this segment since its considered establishment in 1460 (with the setting up of the Antwerp Stock Exchange)[5]. Historically, world over, exchanges were set up as non-profit organizations by the broker dealers who used the services that the exchanges offered. On 24th September 1996, the Australian Stock Exchange (ASX) became the first exchange to notify its members of its intention to demutualize[6]. Since then there have been a vast number of demutualizations and listings of Stock Exchanges across the world. The World Federation of Exchanges, which has about 70 members, reports that 42% of its members are publicly listed exchanges and another 18% are demutualized. These numbers highlight the fast pace at which the holding structure of global Stock Exchanges has changed in the last 12 years and that even in a deep economic crisis, a wide number of exchanges have managed conflicts and maintained stability despite being listed. The Committee’s concern on conflict resolution is a serious concern, however, one that can be addressed by the regulator. SEBI is a globally respected markets’ regulator with world class surveillance systems. Upon listing the regulatory function should either be moved out from the Stock Exchange to SEBI or the regulatory arm should report to SEBI and not to the Stock Exchange management. Both these models have been successfully adopted by exchanges such as NYSE, LSE, ASX, Deutche Boerse etc. These are exchanges that upon listing have been able to increase their footprint across regions and adopt better policies as integration brought in best practices to the larger organization.
One of the biggest benefits of globalization has been the increase in competition and hence the reduction of the commissions that Stock Exchanges charge. Ultimately that is also the aim of Jalan committee, to have affordable transaction costs for the end user of the Stock Exchanges’ services. In order to ensure this there needs to be competition in the sector which can only happen when the entry barriers are reduced. The report does not lead to that direction. In fact with a restriction on who can be an AII and profit sharing, the entry barriers only increase. The Indian telecom sector is a classic example of how reducing entry barriers benefit the end consumer. It also highlights how a strong regulator can ensure policy formation to protect the interests of the consumers. Thus even if global experience is neglected, domestically we have examples that can aid opening up of the Stock Exchange forum to the benefit of the general public.
While there are significant alterations that can be made to the Committee’s recommendations (in context that was laid at the onset), there are two recommendations which are noteworthy. The first being permitting FII to become equity holders via an initial allocation, this will be a more economical means to invite newer investors leading to diversification. The second is calculating maximum exposure limits using direct and indirect, straight and structured investments; once again this in the true sense will allow more investors to participate and also prevent dominance of any one investor.
There are a number of other recommendations that can be debated. However, in the context of time and criteria laid out it will be sufficient to say that there is a lot more analysis and deliberation required before any ownership recommendation is accepted. If we propose to become a global economy of stature and significance then cautious risk taking will be required as opposed to the conservative crawl that appears in the current form of the report.
[1] Defined under section 4A of the Companies Act 1956
[2] Defined under clause (c) of section 5 of the Banking Regulation Act
[3] This is with the assumption of a new Exchange being set up
[4] As mentioned in the report “The cap may be fixed by SEBI after taking into consideration ‘risk free return’ based on the yield on a 10 year GOI bond and a ‘risk premium’ to account for the risks faced by MIIs including equity risk premium and liquidity risk due to non listing of MIIs.”
[5] The origin of Stock Exchanges is traced back to Antwerp Stock Exchange established in 1460, however, Amsterdam Stock Exchange established in 1602 by the Dutch East India Company is considered the first Stock Exchange in the world as we know it
[6] ASX finally demutualized in 1998
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