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Home >Opinion >Ironies behind Kotak Mahindra Bank’s run-in with FMC

Kotak Mahindra Bank Ltd’s attempt to have a seat on the board of Multi Commodity Exchange of India Ltd has come to nought, at least for the time being. Regulator Forward Markets Commission (FMC) had concerns about a conflict of interest, and late last week the company withdrew its nomination for the seat.

Kotak’s run-in with the regulator is full of ironies. For instance, its 15% stake in the exchange makes it the largest shareholder, but some investors with much lower ownership have a board seat.

The most interesting part about the dispute, however, is the bank’s founder, Uday Kotak, may have had a role to play in the drafting of the very rules that FMC is using to argue its case. FMC’s main concern relates to the association between the company and Kotak Commodity Services Ltd, a firm that trades actively on MCX. Its rules state: “No trading member or clearing member or their associates and agents shall be on the board (of an exchange)."

Kotak Commodity isn’t directly related to Kotak Mahindra Bank. But the trading firm’s chairman, Suresh Kotak, is Uday Kotak’s father. Kotak Mahindra Bank evidently doesn’t view Kotak Commodity as an associate or a related party, and according to a report in The Economic Times, its nomination included a legal opinion on this matter.

FMC, on the other hand, believes that the two companies are related. While this can be debated, it’s interesting to note that the rule denying trading firms representation on the board of exchanges finds its origin in the recommendations of the Bimal Jalan committee. The committee was formed to recommend norms for ownership and governance of stock exchanges regulated by the Securities and Exchange Board of India (Sebi). The report had received immense criticism, although some of it was misguided (http://bit.ly/1yZt12k). But naysayers of the committee’s report would now view Kotak’s predicament as a delicious irony—Uday Kotak was part of that committee. Of course, this is not to say that he was behind or is associated with some of the stringent rules that were eventually framed, based on the committee’s recommendations.

Sebi first issued new rules based on the recommendations in 2012. FMC, after it was brought under the jurisdiction of the finance ministry in 2013, later issued its own rules, most of which, including the above-mentioned one on trading member representation on boards found its roots in the Jalan report.

Apart from pointing out its rules on board representation, a person, who declined to be named, at the regulator says it is only using the same yardstick it had applied to National Commodity and Derivatives Exchange a few years ago. This was when Jaypee Capital Ltd, a trading firm, had bought a stake in the exchange and the regulator had concerns about another firm owned by a relative trading on NCDEX.

Having said all this, even if the regulator is on firm ground in interpreting its rules, the irony is that this could work against the regulator’s objective of having a flourishing commodities futures market. FMC did brilliantly well to put a hedge around MCX soon after the National Spot Exchange Ltd scam. It also ensured that the troubled Financial Technologies (India) Ltd group sold its entire stake and that the functioning of MCX continued smoothly, without any concerns about settlements or siphoning off of funds.

It’s unfortunate, however, that a large shareholder such as Kotak can’t have a say in the management of the exchange. While it’s true that there may be a conflict of interest—perceived or otherwise—regulators must find a way out soon to address these conflicts. As it is, FMC’s new rules on ownership of exchanges had drastically reduced the number of companies that could buy a 15% stake in the exchange. Among the rare firms that could end up buying the stake, Kotak is forced to sit out of the board.

As pointed out in this column on numerous occasions, the exchange space is in desperate need of reform on ownership and governance norms. In the stock exchange industry, BSE Ltd is stuck with its initial public offering proposal for some of these same reasons.

Since it’s clear that policymakers are worried about regulatory functions of exchanges being compromised, they should make plans to move these functions out of exchanges. Some functions such as listing and surveillance can even be housed within the regulator. Else, regulatory functions can be moved to a non-profit organization, akin to the model adopted in some developed markets. Exchanges can then focus on their products and services and have freedom on decisions such as board representation and listing. The non-profit organization that performs the regulatory roles can report directly to the market regulator. This way, concerns about “conflicts of interest" can be taken care of.

While Kotak may have backed off and BSE may still be patiently waiting in the wings as far as its IPO plans go, policymakers should realize that these numerous run-ins they’re having with market participants will work against the long-term health of the markets they oversee.

In that lies the biggest irony of this dispute—FMC may have won the battle of its rules being upheld; but in the process, the markets have lost.

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