demutualisation of stock exchanges
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8/3/2019 Demutualisation of Stock Exchanges
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Demutualisation of Stock
Exchanges
SAPM | Section A | Group 2
Abhishek Sinha | Manish Yadav | Manu Gupt |Nishant Hingu | Roshan Tirkey | Vijay KumarSiddi
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DEMUTUALIZATION –
ROLE &DEFINITION
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Capital Markets and Exchanges
• Capital markets channel the savings of an economy intoinvestments
• Stock exchanges create an organized market whereissuers and investors are brought together
• Demutualization:• conversion of an exchange from a not-for-profit member
owned organization
• to a for-profit shareholder owned corporation
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Organizational Structure differences
• Role and powers of the exchange’s Board of Directors
• Influence of external bodies and public interestrepresentatives
• Legal and regulatory frameworks
• Degree of oversight of each exchange by Govt.
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Traditional Exchanges
• Mutual associations owned by their members• Co-operative governance: close identity between owners
and direct users of its trading services
• Democratic: one-member one-vote
• Ownership rights not freely tradeable or exchangeable• Forfeited on the cessation of membership
• Non-profit objective and prohibit the distribution ofsurpluses
• Seldom able to raise capital from anyone other than theirmembers
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Demutualized Exchange “DE”
• Corporations with share capital which are listed publiclytraded
• 3 principal groups: owners, decision-makers, customers
• Shareholders vest decision-making power in board of
directors• Voting rights of shareholders are proportionate to their
economic interest in the corporation
• Owners with greater economic interests are more
capable of influencing decision making• Separate ownership rights from trading privileges
• Able to raise new capital from a variety of sources
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Post-demutualization structure
• Remained private corporations• Public corporations by listing their stock
• Subsidiaries of publicly traded holding companies
• Some have limited the tradeablity of their shares post-
public listing• Most have imposed share ownership restrictions
• Appropriateness of each structure is dependent on thecircumstances
• However, most of the benefits are associated with thepublicly listed demutualized exchange with freely tradableshares
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Process of Demutualization
• Process of continuing an organization from its mutualownership structure to a share ownership structure
• Obtaining the appropriate regulatory and governmentalconsents
• Converting membership rights into shares• Public issuance and listing of the exchange
• Immediate or eventual freely tradeable shares
• DE’s governance structure rests the ultimate control of
the exchange in the hands of its shareholders
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Historical Evolution of Exchanges
• Stockholm Stock Exchange, was the first major exchangeto demutualize in 1993
• Singapore Exchange Limited (“SGX”) was Asia-Pacific'sfirst, in 2000
• LSE, Deutsche Borse and Euronext, NYSE, NASDAQ• 70% of the world’s stock market capitalization is of
publicly-listed exchanges
• 18% have demutualized but not listed their shares
• All of the largest stock exchanges have demutualizedand listed their shares in the last decade
• Similar pattern is for the largest derivatives exchanges
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Reasons to Demutualize:RationalizedGovernance
• NSE model: Consensus decision making is slow• Exchange unable to respond quickly and decisively to
changes
• Floor community had significant power over decision
making• Whereas, Bulk Business driven by Institutional Investors,
expecting lowest cost and efficient execution of trades
• Cost and efficiency threatens profits of the floor
community and makes it difficult to implement changes
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Reasons to Demutualize: RationalizedGovernance
• DE model: Bottom-line focussed, capable of actingdecisively and rapidly
• Management to take actions in the best interests of the
exchange and its shareholders
• Greater degree of transparency and accountancy toshareholders and thus better corporate governance
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Reasons to Demutualize: InvestorParticipation
• Stakeholders: Participating organizations, listedcompanies, and institutional and retail investors
• A DE affords both institutional investors and retail
investors the opportunity to become shareholders
• A DE will have greater flexibility to accommodate theneeds of the now more powerful institutional investors
(who have high liquidity and block trading preferences)
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Reasons to Demutualize: Competition fromATSs and Upstairs Trading
• Alternative trading systems (“ATSs”): ATSs are privately operated
computerized systems centralizing and matching buy and sell ordersand providing post-trade information
• Maintained by a third party who also serves a limited regulatoryfunction by imposing requirements on each subscriber
• Upstairs trading: Broker-dealers adopting internal systems toautomate the firm’s execution of customer orders
• When a stock exchange member matches customer orders againstother customer orders or against its own inventory position within thefirm, rather than exposing the order to auction on the exchange
• A DE will be more capable of remaining competitive in terms of price,variety and quality of their services than the exchanges organizedpursuant to the NSE model
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Reasons to Demutualize: Globalization
• More mobile as issuers and investors are more readilyable to access foreign capital markets
• Locality and nationality has become less of a defining
characteristic of capital
• Exchanges that once were isolated find themselves inintense competition with global rivals
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Reasons to Demutualize: Consolidation
• Strategic alliances and consolidations are impactingcapital markets and exchanges
• Mergers among stock and derivative exchanges havecreated super-exchanges
• Exchanges have to expand their capabilities• Consolidation process will be greatly facilitated by the DE
structure with publicly traded shares
• Greater incentive for exchanges to seek revenue and
cost-saving synergies• DEs makes for easier execution of such strategies
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Reasons to Demutualize: Resources forCapital Investment
• Capital raised from an IPO or private investment and aheightened awareness of accountability to stakeholders
• DE should have both the incentive and the resources to
invest in the competitiveness of its information systemsconsiderable capital investment was required to buy-outthe interests of the traders and to modernize theinformation systems of exchanges
• Demutualization was an efficient and rational means ofinfusing additional capital inorder to finance bothactivities
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REGULATION OF ADEMUTUALIZED EXCHANGE
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The Need for Regulation
• Regulation is necessary to address the inefficienciesgenerated by economic activity
• 3 main objectives of securities regulation asexpressed by the International Organization ofSecurities Commissions (“IOSCO”) are:a. the protection of investors
b. the creation and maintenance of fair, efficient and transparent markets;and
c. the reduction of systemic risk
• Regulation aims toa. reduce the risk of failure of market intermediaries,
b. seeks to reduce the impact of that failure, and
c. isolates the risk to the failing institution
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Self-regulatory Organizations (“SRO”)
• Org that exercises some degree of regulatory authority over marketparticipants
• Adv. of a Govt. regulator delegating responsibility to SROs are:
a. the ability to utilize industry expertise;
b. the potential for higher standards than may be imposed by law;
c. greater flexibility and responsiveness
• Dis-adv. of a Govt. regulator delegating responsibility to SROs are:
a. operational failures resulting from lack of resources or commitment;
b. anti-competitive behaviour, such as entry barriers and sub-optimal marketstructure, which favours the interests of members over those of investors
c. heightened possibility of “regulatory capture”
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Demutualization, Self-regulation andConflicts of Interest
Issues
• Management will be too preoccupied with profits and business
• Duplicative costs of creating multiple SROs
• If for-profit exchange enters into new businesses, it increases itsopportunities for conflict
Response from DEs• Divided their business from their regulatory branch ensuring
independence of SROs
• Mechanisms to ensure sufficient disclosure by the SRO of theirregulatory duties
• Limits on the level of ownership of the exchange
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DEMUTUALIZATION OFINDIAN STOCK EXCHANGES
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Demutualization of Indian Stock Exchanges
• Stock exchanges formed as association of stock brokers
• Mutual organizations managed within a single city with ahuge dealer population
• Registered as section 25 companies
• Exchanges required funds only the extent of meeting itsexpenses
• Any surplus made by the exchange resulted in reducedaccess fees for members
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SEBI’s Guidelines
• Issued guidelines on 13 November,2006 for investment in stock
exchanges in India
• Under the guidelines, shareholding of trading members has to bebrought down to 49% .This can be done by either-
• Offer for sales by prospectus by existing trading members havingownership shares
• Placement of shares of shareholders having trading rights to suchpersons or institutions as may be shortlisted by the exchange withthe approval of SEBI
• Issue of equity shares on private placement basis by the stock
exchange to any person or group of persons not having trading rightssubject to approval of SEBI
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Limitations by SEBI
• No person shall directly or indirectly acquire or hold morethan 5% in the paid up capital
• Foreign investments up to 49% will be allowed inexchanges with a separate cap on FDI of 26% and FII of23%
• No FII shall seek and get representation on the Board of
Directors of stock exchanges
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Demutualization of BSE
• Asia’s oldest stock exchange.131 Year old history
• Corporatized on May 19,2005
• Around 51% stake of 790 brokers were offloaded to 21investors(SBI,LIC,AB Group, Singapore Exchange,Deutsche Borse etc.)
• 19 investors have picked up 41% stake
• 10% stake was picked by Singapore Exchange anddeutsche Borse
• Share price of INR 200,• Total capital raised: INR 189 Crore
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Process of Demutualization
• All the assets are valued by the exchange which includethe value of seats
• Then the total value was founded and divided into shares
• Shares offered to public
• Members of the exchange will get the payment of theirseats through funds available through sale
• If any person is admitted as trading member then uniformstandards will be followed in terms of capital adequacydeposit fees
• The public apart from shareholder who have trading rightwill hold atleast 51% of its equity shares
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Demutualization of NSE
• Formed in November 1992 as a tax paying company
• Owned by a set of leading financial institutions i.e.
I. Industrial development Bank of India LimitedII. Industrial Finance corporation of India Limited
III. National Insurance Company Limited
IV. Infrastructure Development finance Company Limited
D t li ti f R i l St k
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Demutualization of Regional StockExchanges
• Government asks for demutualization of regional stock exchanges in
2 ways:
Either by trading arms of BSE & NSE
or
No of regional stock exchanges join hands to make a separate platform
• 9 Exchanges recently signed an MOU with NSE to extend its tradingplatform on regional stock exchanges
• Out of 21 stock exchanges ,17 are now demutualized
• Stock exchanges still not demutualized are:
– Coimbatore Stock Exchange – Mangalore Stock Exchange
– Meerut Stock Exchange
– UP Stock Exchange
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