MCX Stock Exchange’s court case against the Securities and Exchange Board of India (Sebi) hasn’t come up for hearing yet, but has already achieved one objective. It has highlighted Sebi’s indecision in letting it enter new segments such as equity and debt.
It’s a little over three months since MCX-SX informed Sebi about its compliance with shareholding norms for stock exchanges. There’s some merit in the argument that the regulator should have officially communicated its approval/denial by now, or simply that it needs more time to come to a conclusion. But to be fair to Sebi, it hasn’t been completely indecisive. On the contrary, as reports suggest, it has communicated to MCX-SX verbally that it isn’t comfortable about the manner in which MCX-SX has complied with shareholding norms.
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MCX-SX’s promoters were supposed to cut their stake to 5% to comply with Sebi’s Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognised Exchanges) Regulations, 2006. MCX-SX complied by reducing its share capital and simultaneously issuing warrants against the cancelled shares to its promoters, Financial Technologies (India) Ltd (FTIL) and Multi-Commodity Exchange of India Ltd (MCX). The net result is that FTIL and MCX now hold 5% each in MCX-SX’s issued share capital which, according to them, is in compliance with Sebi’s shareholding norms. But they also hold a large number of warrants which, when converted, would amount to a 68% stake in the expanded share capital. According to reports, Sebi feels that by adopting this form of capital restructuring, MCX-SX has complied with its shareholding norms in letter, but not in spirit.
Since this pertains to approval of a stock exchange, it is a serious issue. As pointed out earlier in this column, a stock exchange cannot be viewed as a normal business venture. This is because, apart from providing a trading platform, it also performs regulatory functions such as market surveillance and compliance by member brokers and investors. Since a stock exchange acts as a quasi-regulator, it’s only fair for Sebi to ask itself questions such as: “If an applicant is itself complying with laws only in letter and not in spirit, how would it respond to the traders and brokers who like to live on the edge of the law? Can issues of market integrity be trusted in the hands of such applicants?”
Sebi’s discomfort about the warrants issue is also understandable. As the name of the shareholding regulation suggests, Sebi’s intent is that the shareholding of a stock exchange should be widespread and public shareholding should increase. It lists the manner in which this objective can be achieved—a) through an offer for sale of shares held by existing shareholders by issuing a prospectus; b) private placement of shares by existing shareholders; c) a fresh placement of shares by the stock exchange; and d) any combination of the above.
The intent of Sebi’s shareholding guidelines is that a stock exchange should attract in more outside investors. The procedure of cancelling shares and issuing warrants to existing shareholders doesn’t achieve this objective. No new investors come in as a result of the restructuring process. On paper, the shareholding, based on the issued share capital, will look widespread. But for all practical purposes, the shareholding pattern is identical to the one prior to the restructuring process.
For this very reason, analysts who track FTIL, a listed company, haven’t altered the manner in which they value the company’s stake in MCX-SX. In a report dated 1 June, Motilal Oswal Securities Ltd, one of the few large brokers that cover this stock, assumes a 44% holding when it values FTIL’s stake in MCX-SX. This was FTIL’s stake in the stock exchange prior to the restructuring process, which was made public in April.
Or, for that matter, consider a situation when a company or a rival exchange wants to take control of MCX-SX. Even if it managed to buy all of the 90% non-promoter holding in the issued share capital, all FTIL and MCX need to do is convert a few of their warrants to thwart the takeover bid. For every 10 shares they hold in the company, the promoters have 217 warrants, each of which can be converted into one share. In practice, of course, no entity can buy a 90% stake, because maximum shareholding even for a financial institution is restricted at 15%. But the above example just shows that even from a “control” perspective, FTIL and MCX are firmly in the saddle thanks to the large number of warrants held by them. To say that they have only a 10% stake misses the full picture.
This is not to say that the warrants structure should be totally unacceptable. MCX-SX’s difficulty in divesting its stake is understandable and Sebi could perhaps consider a time frame by when these warrants would need to be sold to outside investors. But if there is no such time frame, Sebi would have a genuine concern that its desired shareholding pattern may never be adhered to.
Also, the warrants issue is not the only matter in which the spirit of Sebi’s law is being tested. The shareholding guidelines also state that the holding of one entity along with persons acting in concert is to be not more than 5%. In the case of MCX-SX, FTIL and MCX India hold 5% each. Prima facie, FTIL and MCX appear to be persons acting in concert, but it’s quite likely that they are complying with the letter of the law.
In sum, Sebi has quite a few factors to consider and satisfy itself before approving MCX-SX’s application. This needs to be appreciated, as much as the viewpoint that MCX-SX rightfully deserves a formal communication from the regulator on the status of its application.
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