Mumbai: MCX Stock Exchange Ltd (MCX-SX), embroiled in a legal tussle with India’s market regulator, could face another hurdle in its attempt to get a licence for equity trading.

The issue came to light after Sebi issued a show-cause notice to another exchange, the United Stock Exchange of India Ltd (USE), over similar issues recently.

Trading members have a 49.75% stake in USE and account for more than a quarter of the governing board, another alleged violation of Sebi’s rules.

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The MCX stock exchange is tangled in another tussle with Sebi, which is objecting to its so many if its shareholders having trading rights on the exchange’s currency derivatives platform.

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Sebi had found MCX-SX non-compliant with ownership norms in 2010.

It objected to the manner in which Multi Commodity Exchange of India Ltd (MCX) and Financial Technologies (India) Ltd (FTIL) pared their stakes in the exchange by issuing warrants to banks and financial institutions, and found them acting in concert. MCX-SX filed a writ petition against the order. The Bombay high court has reserved its judgement on the case.

Sebi said the promoters hold stakes of roughly 72%, including economic interest, but MCX-SX said the two hold just 5% each and the rest of the shareholding vests with banks and other financial institutions who own the warrants.

The promoters of the exchange—MCX and FTIL, which originally held 51% and 49%, respectively—lowered their shareholding by divesting 16% to financial institutions and later issuing warrants to the extent that they held 5% each.

However, MCX-SX’s claims and the data on ownership available on its website suggest a different scenario as trading members account for roughly 83% shareholding.

Since a large part of MCX-SX’s stake is divided among banks and financial institutions, most of whom trade currency derivatives on the bourse, the stake of shareholders with trading rights is higher than in other exchanges.

This issue has not been flagged in the court case between Sebi and MCX-SX, but could assume importance in case the Bombay high court quashes Sebi’s order and upholds MCX-SX’s claims, a person with direct knowledge of the matter said on condition of anonymity.

“If Sebi’s interpretation is dismissed by the court, then the issue of shareholders with trading rights becomes relevant, going by MCX-SX’s submissions in court,” the person added.

MCX-SX spokesman Setu Shah declined comment for the story.

In an emailed statement, Shah said: “We have observed in the past and officially complained to the highest authorities in Mint, including the editor and the Mint ethics committee, about stories pursued by your newspaper on issues that are being heard in the court of law, with the ulterior motive to drive our competitor’s agenda or cause us harm by trying to opine on the judicial process. Unfortunately our complaints have gone unheard and we have never got a written reply or were even granted a meeting with the editor or the ethics committee on these serious issues we raised.

“It has now become a pattern with Mint to pursue stories that are sensitive to MCX-SX or are on matters that are sub-judice. In recent instance even after our detailed official replies to your questions us or to our promoting companies, either you have not taken the complete reply or have scrapped the story altogether since our replies may have derailed your hidden agenda. As for your current questions on our shareholding, we would like to reiterate that these matters are sub-judice and may lead to opining on the legal process. Hence, we will not like to comment as your queries are advocating points that are to be decided in the court of law,” the statement added.

The Business Standard reported on 2 February that Sebi had served a show-cause notice to USE asking it to lower the representation of trading members on its board. A USE spokesperson declined to comment for this story.

A board member of the exchange, who declined to be identified, confirmed the move and said USE will pare the representation of trading members below 25% by either expanding the size of the board or removing one of the two trading members.

The bourse will also bring down the shareholding of trading members below 49% by making non-trading members infuse more capital, thereby diluting the stake of members with trading rights.

Federal Bank Ltd and Jaypee Group are the two shareholders with trading rights on the USE board, reduced to six members after the resignation of the managing director in October.

The manner of increasing and maintaining public shareholding in recognized stock exchanges (Mimps) regulations issued by Sebi require trading members, including their associates, to cumulatively hold less than or equal to 49% stake. Also, the governing boards of these exchanges should not have more than 25% representation of trading members.

When the Mimps regulations were issued in 2008, regulators did not think of banks as trading members as at that time exchange-traded currency derivatives had not been introduced, the USE board member said.

Grey area

This appears to be a grey area in stock exchange regulations, with legal experts differing on how the law will apply in the case of shareholders who are not trading stocks, but trade on the currency derivatives platform.

“Technically, it may be correct for Sebi to say that if the proportion of shareholders with trading rights (or associates having trading rights) exceeds 49%, then it is a violation of Sebi’s rules for stock exchanges even if those shareholders are not trading stocks, but are on a different platform (such as currency derivatives),” said Siddharth Shah, partner at Nishith Desai Associates, a Mumbai-based law firm.

“However, if you look at the spirit of the law, then the intention is to ensure that members who trade stocks do not exercise control over a stock exchange. In the case of USE or MCX-SX, it is not obvious that shareholders who trade currency derivatives will automatically have trading rights in the equity platform and if the governance structure for each of the platforms can be differentiated,” he added.

Not everyone agrees. “If you look at Mimps regulations together with the demutualization scheme for exchanges, then it is evident that the intent has been to separate those owning the exchange from those using the exchange, regardless of the segment in which they are trading,” said a former Sebi executive, who declined to be named.

The demutualization scheme was intended to corporatize exchanges and separate ownership from trading interest.

The Sebi official who handles such issues declined to comment.

“We must keep in mind that exchanges are front line regulators and it has always been Sebi’s intention to ensure that entities regulated by exchanges do not have dominant control over the exchange,” said the former Sebi official cited above.

Shah of Nishith Desai commented that this was a grey area and Sebi should clarify the issue or amend the relevant sections of the law to make the position clear.

While BSE Ltd has roughly 43% of its shareholders as trading members, the National Stock Exchange of India Ltd refused to divulge the shareholding pattern, but its spokesperson said it was compliant with all provisions of Mimps.

The impact on MCX-SX will be known only after the Bombay high court announces its verdict on the case between the bourse and Sebi.

MCX and FTIL had pledged to restrict their combined holding in the bourse to 5% at the final hearing of the case on 25 November and agreed to give an undertaking to this effect.

Sebi counsel Darius Khambatta argued that the regulator cannot decide merely on the basis of such an undertaking. “We have to consider the cumulative developments so far before reconsidering their application,” he said, referring to the regulator’s discomfort about the methods adopted by the exchange to comply with Mimps.

In September 2010, it said MCX-SX was not “fit and proper” to conduct the business of a full-fledged stock exchange.

Although the matter continues to be sub judice, Sebi on 14 September granted a conditional extension to MCX-SX’s licence to trade in currency derivatives, while issuing a show-cause notice asking why a renewal should not be denied.

While the regulator has not allowed equity trading by MCX-SX, it has been offering currency derivatives trading since 2008.

HT Media Ltd owns 0.2% stake in MCX, the promoter of MCX-SX.

Editor’s note: MCX has never complained to the ethics committee of Mint. Its executives, in meetings with me, have conveyed their displeasure with Mint’s stories (belying the spokesperson’s claims about letters being written and meetings not being granted), but these have had more to do with allegations about the stories being motivated rather than factual inaccuracies.

Anirudh Laskar and Khushboo Narayan contributed to this story.

pramit.b@livemint.com