Demutualization of Stock Exchanges

Demutualization of Stock ExchangesWith special reference of Pakistan

Mutualization

Mutualization is the process by which a joint stock company changes legal form to a mutual organization or a cooperative, so that the majority of the stock is owned by employees or customers.

A mutual exists with the purpose of raising funds (or money), from its membership or customers (collectively called its members), which can then be used to provide common services to all members of the organization or society.A mutual is therefore owned by, and run for the benefit of, its members - it has no external shareholders to pay in the form of dividends, and as such does not usually seek to maximize and make large profits or capital gains.

The process of converting exchanges from nonprofit, member-owned organizations to for-profit, investor-owned corporations.

What is Demutualization?

Corporatization and IPO of the stock exchange

Cont.…

This process is defined by Fabio Chaddad (Chaddad, 2003) (p.1) as:

"Conversion, increasingly known as demutualization, refers to

changes in the ownership structure of user owned and controlled

organizations from a cooperative (or mutual) to a for-profit,

proprietary organization."

Reasons for Demutualization

Information Technology

Globalization

Globally, Stock exchanges have undergone transformation. Advancement in communication technology and globalization have made it possible for investors and issuers to move to more efficient capital markets, even if these are located outside the geographical boundaries of their country.

Competition among exchanges and alternative trading systems has led to integration and demutualization in many countries. Now countries in Asia are developing their capital market through demutualization and integration.

Problems faced byStock Exchanges.

Despite economic growth in the country, companies are not seeking listing at exchange and little formation of capital is taking place through stock exchanges.

Issuers do not appear to have confidence in stock exchanges and see minimal value addition in listing.

Investor base is small. Percentage of adult population that own shares is less than 1%.

Growth in mutual funds has not led to increase in number of investors. The number of shareholders in listed companies has practically remained stagnant despite the Bullish sentiments in the market.

Investors are vulnerable to different forms of market abuse. Market remains rife with allegations of price manipulation, front running, insider trading and blank selling.

Exchanges are financially weak.Speculative activity dominates the trading and liquidity is

highly concentrated.A mutual structure and fragmented market are at the heart

of problems faced by stock market. A mutual structure allows control of exchange by one stakeholders “Brokers”, fragmentation of market place has added to cost inefficiencies for all stakeholders.

Benefits of Demutualization

Rationalized Governance. Investor Participation. Globalization. Resources of Capital Investment. Profit motive for growth and development. Great ability to attract listing. Removal of barrier of entry for new broker. Unlocking of value of membership card. Domestic and international recognition. Ability to make international alliance.

Demutualization Process

Legal and Company Structure

Ownership Structure

Ownership structure

• Dilution of membership by valuation of member seats.

Legal and Company Structure

• Public Limited & profit-making corporation

Factors of Demutualizatio

n

Internal Factors

External Factors

History of Demutualization

First demutualized SE : Stockholm Stock Exchange (SSE), 1993, Sweden

Helsinki Stock Exchange, 1995Copenhagen Exchange, 1996Amsterdam Exchange, 1997Australian Exchange, 1998Toronto, Hong Kong, London SE, 2000 Pakistan 2012

Cont.…In developed countries demutualization was motivated primarily by the need to compete with exchanges, both conventional exchanges and alternative trading systems like electronic communication networks(ECN). In some countries such as Australia, USA,UK demutualization was largely voluntary and regulator and the Govt.merely facilitate the process. Demutualization is now well establish global trend. The structure reflects recognition of the fact that from governance point of view demutualization structure is preferable.

Demutualization in Pakistan

Initiated by Federal Govt.

SECP’s Expert Committee on Demutualization and Integration/Transformation of Stock Exchanges

Demutualization without Integration

Three individual demutualized SE’s• KSE, LSE, ISE

Cont.….

A demutualized exchange can specialize in one or a combination of the followings:-

Regular/ cash market i.e. T+3 Derivatives Debt instruments Over the counter(OTC)market for small cap.

Integration of stock exchanges

Integration mean consolidation of the three stock exchanges through merger. During the consultative process, the Committee has found that most of the stakeholders are of the view the existence of multiple stock exchanges in Pakistan is a core problem. The stakeholders in favor of integration of stock exchange have put forward a number of arguments.

Significant member are common in three S.E Single geographically neutral clearing house (NCCL) & CDC All three exchanges are public companies limited by guarantee.

KSE as individual demutualized SE.

LSE and ISE as integrated SE

Merger with CDC & NCCP

Better Understanding to resolve Agency Problems