Mumbai: Lobbying and counter-lobbying by exchanges has intensified recently as they try to influence the government’s stand on regulation of market infrastructure institutions.
Recommendations made to a 15-member committee appointed by the ministry of company affairs (MCA) to look into the regulatory framework indicate that exchanges as well as industry lobbies have advocated listing of exchanges.
However, it appears there is a lack of consensus so far on nearly everything else. Mint has reviewed some of the recommendations made to the ministry.
The committee includes representative from four exchanges: National Stock Exchange (NSE), Bombay Stock Exchange (BSE), United Stock Exchange (USE) and MCX Stock Exchange (MCX-SX); two depositories: National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL); as well as industry lobbies Confederation of Indian Industry (CII), Federation of Indian Chambers of Commerce and Industry (Ficci) and Associated Chambers of Commerce and Industry of India (Assocham).
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The three issues on which the ministry sought recommendations are: listing of exchanges, segregation of commercial and regulatory functions of an exchange, and shareholding pattern of exchanges.
A panel headed by former Reserve Bank of India (RBI) governor, Bimal Jalan, which was appointed by the Securities and Exchanges Board of India (Sebi) to review ownership and governance norms of market infrastructure institutions, submitted its recommendations on these issues to Sebi in November 2010.
Exchanges, clearing corporations and depositories are classified as market infrastructure institutions.
The Jalan committee’s recommendations came under criticism for being out of sync with the spirit of liberalization and for promoting stability at the cost of competition. The committee advocated, among other things, a bar on listing of exchanges till five years, restricting ownership of a single promoter up to 5% and cap on profits and variable pay for exchange executives.
The Jalan committee took the view that additional restrictions need to be imposed on stock exchanges as they offer a public good and act as regulators of their members. All exchanges other than NSE opposed the recommendations and have been lobbying for a relook. Sebi has deferred its decision till it gets the government’s views.
MCA and the ministry of finance, both of which have representatives on the Sebi board, are examining the issue, although it is only the MCA that has formed a formal committee to seek inputs from stakeholders.
If initial indications are anything to go by, most stakeholders are advocating a burial to most of Jalan’s recommendations.
In the first committee meeting on 23 May, there was a broad consensus that exchanges should be allowed to list. But opinions vary on whether there should be segregation of regulatory and commercial arms of an exchange to avoid conflict of interest before or after listing the exchange, on the best model for achieving segregation as well as on shareholding norms, with many committee members stressing the need for higher promoter stake in the early stages of an exchange.
The conflict of interest in an exchange’s role arises on two counts. One, in case an exchange self-lists, it will be regulating its own compliance norms, leading to fears that there might be abuses. Second, there is a concern that after listing, a stock exchange may lower regulatory standards as a result of focus on profits and valuations.
The first concern can be allayed if there is cross-listing, which means exchanges list on other exchanges, a USE official said. “There are various global models that can be taken up. Some exchanges have given up the right to regulate their own stock while others have set up conflict management committees,” he said.
The second concern has become a bone of contention with rival exchanges MCX-SX and NSE trying to score brownie points at each other’s expense.
“I do not see how there would be a conflict of interest only if a stock exchange lists. If NSE could function as a for-profit entity without any conflict of interest, what prevents other stock exchanges from doing so?” asked Joseph Massey, managing director and chief executive officer, MCX-SX. “These pre-requisites for listing and restrictions on promoter shareholding only serve as entry barriers that benefit NSE but come in the way of new exchanges, which need to raise capital to grow.”
An NSE spokesperson declined comment. An official at the bourse, who refused to be identified, said the conflict of interest exists even now, but it would exacerbate after listing as the management’s key focus would be on maximizing valuations of the company’s stock.
The official cited above argued that while NSE has always worked within established rules, MCX-SX has flouted norms in the past and is now trying to bend rules to suit its interests.
MCX-SX has faced Sebi’s ire over share-holding norms. Sebi has said that the manner in which the promoters brought down their stake in MCX-SX violates its regulations. MCX-SX has filed a writ petition against the Sebi order and the case is pending with the Bombay high court.
Several members of the committee have, in their submissions, recognized there is a conflict of interest between the regulatory and commercial arms of an exchange. Several members have suggested that an independent self-regulatory model, in which all exchanges are members, may be adopted over the course of time.
Almost all sections of the market agree that there is a conflict of interest, said Prithvi Haldea, chairman of primary market tracker, Prime Database.
Different countries have tried to address this issue in different ways. “We need to debate which model would work best in Indian conditions, what are its merits and take cognizance of the demerits and ways to handle the same,” said Haldea.
Two of the three trade bodies, CII and Ficci, have argued that exchanges should be allowed to list immediately, citing the need for competition, although they acknowledge a conflict of interest between the regulatory and commercial roles. According to them, the issue of conflict can be resolved over time.
CII, Ficci, Assocham and MCX-SX have all cited the example of RBI and Forward Markets Commission (FMC) to highlight how other regulators have allowed higher levels of promoter stakes to banks and commodity exchanges respectively, in the early stages of the business, to allow competition. They point out that Sebi’s ownership guidelines are restrictive.
However, FMC also has a restrictive clause in its guidelines for commodity exchanges: a stock exchange’s shareholding in a commodity exchange cannot exceed 5%.
Some kind of relaxation of ownership is essential for enhanced competition, said B.B. Chakrabarti, professor of finance at the Indian Institute of Management, Calcutta.
To address the issue of conflict of interest and financial stability, Chakrabarti and his colleague, Mritiunjoy Mohanty, have argued for a single clearing competition for all stocks, similar to the one in the Indian debt market, in a March article in the Economic and Political Weekly.
“If you are not able to trust the promoters of stock exchanges, instead of imposing diversified ownership norms, you can separate the part where most of the money is, which is clearing,” Chakrabarti said. Such an arrangement will allow stock exchanges to compete based on trading platform and products they offer and lower the margin requirements for brokers considerably.
However, given that each exchange is busy in pushing its own vested interest, interest of market participants is not receiving due attention, said a member of the MCA committee on condition of anonymity.
It is not surprising to see a second round of deliberations on these issues, given that Jalan’s report seemed to go against the grain of liberalization, said Rajesh Chakrabarti, professor of finance at Indian School of Business, Hyderabad. “However, government and the regulator would need to balance competition with financial stability,” said Chakrabarti.
Mint’s publisher HT Media Ltd has 0.2% stake in MCX, the promoters of MCX-SX.
Sangeeta Singh in New Delhi contributed to this story.
Graphic by Yogesh Kumar/Mint