Demutualisation & Corporatization of Stock Exchanges

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COMPANY LAW - ICORPORATIZATION & DEMUTUALIZATION OF STOCK EXCHANGES IN INDIADate: 16th October 2008

Submitted by: Mayank Jain, Roll # 410, V Sem., B.B.A L.L.B (Hons.)

Submitted to: Mr. Ashish Kumar Srivastav, Principle Faculty, Faculty of Law

NATIONAL LAW UNIVERSITY

RESEARCH METHODOLOGYArea: Corporatization of Stock Exchanges Topic: Corporatization & Demutualization of Stock Exchanges in India. Objectives: 1. To examine the present structure of stock exchanges including those set up as companies and as unincorporated bodies and in this light examine the legal, financial and fiscal issues involved to corporatise and demutualise the stock exchanges, and 2. To look in to the specific steps those need to be taken for implementation. 3. To review and examine the present structure of stock exchanges including those set up as companies and as unincorporated bodies and in this light examine the legal, financial and fiscal issues involved to corporatise and demutualise the stock exchanges, and 4. To recommend the specific steps that need to be taken for implementation, and also to advise on the consolidation and merger of the stock exchanges.

Research Questions: 1. What is the present legal structure of Stock Exchanges in India? 2

2. What is demutualization? 3. How is this process of Corporatization and demutualization to take place? 4. What should be the Structure of the governing boards of stock exchanges and representation of brokers? 5. What are the statutory requirements and legislative changes necessary to give effect to demutualization?

TABLE OF CONTENTS1. Introduction3 2. Existing Structure of Stock Exchanges in India5 3. Models of Demutualization13 4. Recommendations23 5. Conclusion26 6. Bibliography28

INTRODUCTION

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Most of the Stock Exchanges around the world were set up as association of the Trading members. The objective to set up association was aimed to create a formal institution for mutually regulating the securities transactions among the members. Thus, most of the Stock Exchanges were promoted as non-profit organizations. While, the management of the Stock Exchange was generally vested with elected representative(s) of the trading members, executives carried out the day-to-day functioning of the Stock Exchange. However, during last two decades attempts have been made to change the profile of the Stock Exchange by demutualising them and reconstituting them as commercial corporate entities.1 Demutualization of a Stock Exchange entails that it is no longer remains entity for mutual benefit of Trading members but beholds the larger objective of becoming the system with adequate checks for proper mobilization of capital & protecting the interest of investors at large. Corporatisation is a critical enabler that would support the efforts in expanding and strengthening the Indian capital market. While things are becoming more businessoriented, the corporatized Stock Exchanges will improve its flexibility and efficiency in terms of its responsiveness to market needs2. The need for corporatization of Stock Exchanges in India has recently came into lime light after functioning of Mumbai Stock Exchange is alleged to have been manipulated by the some of the Trading members on governing Board of the exchange, which followed by stock markets crash inspite of what was seen as one of the favorable & progressive Union Budget in recent years3.

After the stock scam of March 2001, the Government finally announced that all stock exchanges would have to mandatorily go in for demutualization within a specified

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Dr. K. R. Chandratre et al., Bharats Compendium on SEBI, Capital Issues and Listing, 3rd ed., Vol.1, Sucheta Dalal, Death of Indian Stock Exchanges, Indian Express Newspapers, Delhi, November 252002, Sinha hints at laws for Corporatisation of SES, SEBI: IDBI soon, Indian Express, March 122003.

Bharat Publishing House, New Delhi, 19962 3

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timeframe4. This was aimed at preventing conflict of interests, which arise when stockbrokers are involved in the management of the stock exchanges also. It is in this context it becomes necessary to study the need and impact of Corporatisation of Stock Exchanges and its relevance in Indian context before a clear roadmap could be prepared to take this process forward, for which SEBI constituted a Group under the Chairmanship of Justice M. H. Kania, former Chief Justice of India comprising of eminent personalities, in fields of law, accountancy, finance, company law affairs and taxation to advise SEBI on this matter and to recommend the steps that need to be taken to implement the announcement of the Government.

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Sinha unveils new measures to instill confidence in market, Indian Express Newspapers, March 182002

(Delhi)

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EXISTING STRUCTURE OF THE STOCK EXCHANGE IN INDIAA Stock Exchange is an organized market for purchase and sale of listed Industrial and financial securities. Securities traded on Stock Exchanges include shares and debentures of Public Limited Companies, Government Securities, etc. According to the Securities Contracts (Regulation) Act, 1956, Stock Exchange is an association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing securities5. Section 2 (f) of the above said Act defines recognized stock exchange as a Stock Exchange, which is for the time being recognized by the Central Government under Section 4. SEBI is empowered under Section 4 to grant recognition to Stock Exchanges. In terms of the legal structure, the stock exchanges which are recognized under the Securities Contracts (Regulation) Act in India, can be segregated into two broad groups 20 stock exchanges which were set up as companies, either limited by guarantees or by shares, and the 3 stock exchanges which are functioning as associations of persons (AOP) viz. BSE, ASE and Indore Stock Exchange. The 20 stock exchanges which are companies are: the stock exchanges of Bangalore, Bhubaneswar, Calcutta, Cochin, Coimbatore, Delhi, Gauhati, Hyderabad, Interconnected SE, Jaipur, Ludhiana, Madras, Magadh, Mangalore, NSE, Pune, OTCEI, Saurashtra-Kutch, Uttar Pradesh, and Vadodara. Of these, the stock exchanges of Ahmadabad, Bangalore, BSE, Calcutta, Delhi, Hyderabad, Madhya Pradesh, Madras and Gauhati were given permanent recognition by the Central Government at the time of setting up of these stock exchanges. Apart from NSE, all stock exchanges whether established as corporate bodies or Association of Persons (AOPs), are

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Investment Laws, Stock Exchanges, (Bangalore: National Law School of India University, Distance

Education Department, Master in Business Laws Part II, Course No. 1, Module No. 2 A,)

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non-profit making organizations. 7 stock exchanges are set up as companies limited by shares and the remaining 13 are set up as companies limited by guarantee6. It is thus clear that BSE, ASE and Indore Stock Exchange will have to be both corporatized and demutualised, while of the balance 20 stock exchanges, 18 stock exchanges that are already corporate entities, will only have to be demutualised. Two stock exchanges, NSE and OTCEI, are not only corporatized but also demutualised with segregation of ownership and trading rights of members. Further, NSEIL is a for-profit company and the Board of NSEIL comprises of representatives of shareholders, (some of whom have 100% stock broking subsidiaries) and outside non-shareholder directors. But even these two stock exchanges may if necessary, have to undergo changes in organizational structure consequential to the recommendations of the Group so that a common structural model is adopted by the all the stock exchanges.

TRADITIONAL STRUCTURES OF STOCK EXCHANGESInternationally (as well as nationally), stock exchanges have been the product of circumstance, or of design. These differences in the origins of stock exchanges have tended to lead to differences in perceptions of the role of stock exchanges, and in views about what their relationship with the legal system should be. Stock exchanges have also been subject to limited competition from other firms. Historically, stock exchanges all over the world were mutual organizations owned by and run for the common benefit of their members, with no member taking profits. They were more like "clubs" where the dealers transacted business through the open outcry system.7

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www.sebi.gov.in Kapoor N.D., Business and Economic Laws, Sultan Chand & Sons, New Delhi, 1995

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DEMUTUALIZATIONDemutualization refers to the conversion of an existing non-profit organization into a profits-oriented company. In other words, an association that is mutually owned by members converts itself into an organization that is owned by shareholders. The company can take different shapes and forms, that is, it could be either a listed or unlisted company which may be closely held or publicly held. This process involves the segregation of members' right into distinct segments, viz. ownership rights and trading rights. It changes the relationship between members and the stock exchange. Members while retaining their trading rights acquire ownership rights in the stock exchange, which have a market value, and they also acquire the benefits of limited liability8. The shareholders in a corporatized stock exchange may be a diverse group, as members may decide to retain their shares or to sell them. Demutualization however, does not insulate them from competition. A stock exchange whose management does not effectively work to maintain its position in the market may soon become a takeover target. This term is not restricted only to corporatization of stock exchanges. Any