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Indian Management Studies Journal The Future of Regional Stock Exchanges in India : A Case for Revival N. K. Maheshwary* H. L. Verma** and B. S. Bhatia* • Department of Management. RIMT - Institute of Management & Computer Technology. Mandi Gobindgarh •• Haryana School of Business. Guru Jambheshwar University of Science & Technology, Hisar Abstract The stock exchanges set up regionally were known as the Regional Stock Exchanges (RSEs). The objective of establishing the RSEs was to enable regional companies in the respective geographical locations to raise capital and to help spread the equity cult amongst investors across the length and breadth of the country. However, with the various changes in the capital market micro structure, the scope of operations of the RSEs became limited. The trading in these RSEs had also dwindled over the past several years. At present, there is no trading in these stock exchanges. This paper seeks to dwell upon the strategies & proposes a model seeking revival of the Regional Stock Exchanges in India. A stock exchange in India is recognized by the Central Government under section 4 of Securities Contracts (Regulation) Act, 1956 (SCRA) for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities, after it is satisfied that it would be in the interest of the trade and also in the public interest to grant such recognition. This power to grant recognition to a stock exchange can also be exercised by SEBI. This implies that no entity can act as a stock exchange in India, unless it is recognized as such under this section of

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Page 1: The Future of Regional Stock Exchanges In

IndianManagement

Studies Journal

The Future of Regional Stock Exchanges inIndia : A Case for Revival

N. K. Maheshwary* H. L. Verma** and B. S. Bhatia*• Department of Management. RIMT - Institute of Management &

Computer Technology. Mandi Gobindgarh•• Haryana School of Business. Guru Jambheshwar University

of Science & Technology, Hisar

AbstractThe stock exchanges set up regionally were known as the Regional Stock Exchanges

(RSEs). The objective of establishing the RSEs was to enable regional companies in therespective geographical locations to raise capital and to help spread the equity cult amongstinvestors across the length and breadth of the country. However, with the various changesin the capital market micro structure, the scope of operations of the RSEs became limited.The trading in these RSEs had also dwindled over the past several years. At present, thereis no trading in these stock exchanges.

This paper seeks to dwell upon the strategies & proposes a model seeking revivalof the Regional Stock Exchanges in India.

A stock exchange in India is recognized by the Central Government undersection 4 of Securities Contracts (Regulation) Act, 1956 (SCRA) for the purpose ofassisting, regulating or controlling the business of buying, selling or dealing insecurities, after it is satisfied that it would be in the interest of the trade and alsoin the public interest to grant such recognition. This power to grant recognition toa stock exchange can also be exercised by SEBI. This implies that no entity can actas a stock exchange in India, unless it is recognized as such under this section of

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the SCRA. Over a period of time, stock exchanges came to be set up almost in everyState: These stock exchanges set up regionally were known as the Regional StockExchanges (RSEs). The objective of establishing the RSEs was to enable regionalcompanies in the respective geographical locations to raise capital and to helpspread the equity cult amongst investors across the length and breadth of thecountry.However, with the various changes in the capital market micro structure, thescope of operations of the RSEs became limited. The trading in these RSEs had alsodwindled over the past several years.

The Bombay Stock Exchange (BSE), the Calcutta Stock Exchange(CSE) and the Ahmedabad Stock Exchange (ASE) were set up beforeindependence and recognized in 1956 under the SCRA. Thereafter, 20 otherstock exchanges were set up under the SCRA in various States including theOver the Counter Exchange of India (OTCEI) in 1990 and the National StockExchange (NSE) in 1994.

The concept of RSEs has its genesis when Ministry of Finance,Government of India issued guidelines which stipulated that all then existing listedcompanies were required to be listed on the stock exchange located in an areawhere the registered office or the main works / fixed assets of the company weresituated. When there was little automation and the modern advancedtelecommunication systems were not available; these stock exchanges catered tothe needs of the industry for mobilization and regional allocation of capital andresources and also met the needs of regional investors in the remotest parts ofthe country.

Out of the 22 recognized stock exchanges in India (SEBI has refusedrenewal of recognition to Mangalore Stock Exchange), NSE and BSE account foralmost 100% of the total turnover. As far as RSEs are concerned, except for theCalcutta Stock Exchange (CSE) and the Uttar Pradesh Stock Exchange (UPSE), thereis no trading on any other stock exchange and even on the CSE and UPSE, thebusiness is down to a trickle as may be seen from Table 1.

The financial condition of the RSEs is weak. This state of affairs has beenprevailing for the past several years. The present study indicates that the followingthree factors have been primarily responsible for this :

(a) The advent of automated trading and extension of nationwide reach ofBSE

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Table 1Turnover of the RSEs (Rs. in Crore)

SEslYear 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Bhubaneshwar 0.02 0 0 0 0 0Calcutta 355035 27074 6539 1927 2714 2800Coimbatore 0 0 0 0 0 0Cochin 26 I 0 0 0 0Pune 6171 1150 2 0 0.37 0Vadodara 0.85 10 260 0 0 0Ahmedabad 54035 14644 15482 5044 8 0Uttar Pradesh 24741 13337 14763 13130 5343 1487Jaipur 0 0 0 0 0 0OTCEI 126 4 0.54 16 0.01 0.01Ludhiana 9154 857 0 0 0 0Madras 109 24 38 99 27 5Hyderabad 978 41 5 3 14 97Magadh I 0.0041 I 0.09 0 91Saurashtra Kutch 0 0 0 0 0 0Bangalore 10187 934 0.11 0.1 0 0Delhi 82996 5526 II 3 0 0Gauhati 0 0 0 0 0 0Madhya Pradesh 4 10 0 0 0 0Inter-connected 237 69 24 0.034 0 0

and NSE which offered a large and liquid market to investors across thecountry;

(b) The introduction of uniform rolling settlement from June 2001 in place ofaccount period settlement with varying settlement cycles; and

(c) The abolition of the concept of regional listing.

The NSE was established in 1994 with nationwide electronic tradingterminals. "Subsequently, in 1995, the Stock Exchange, Mumbai (BSE) alsoconverted its manual trading system into a nationwide electronic trading system.

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Between 1995 and 1998, all the remaining stock exchanges also convertedthemselves into electronic exchanges. They, however, did not expand their reach.

This advent of automated trading and advancements in technologyfacilitated the BSE and NSE to expand their reach across the country. At present,both NSE and BSE have their terminals in more than 400 cities. This had animpact on the trading of securities in RSEs.

In the absence of modern telecommunication and automation,listing of securities of companies was always p~rmitted in more than oneexchange. To encourage regional industrial development, the regionalcompanies were compulsorily required to list on the RSE which was closest tothe registered office of the company, in addition to any other stockexchange. In addition, shares listed in exchanges were also allowed to be tradedon other exchanges as a class of "permitted" securities. It was, therefore,common for one company to be listed on BSE (and later on the NSE) as well ason one or more RSEs and also trade on multiple stock exchanges. But theexpansion of the terminals of NSE and BSE across the country provided accessto all investors to two large, liquid and deep national markets in all thesesecurities. Other stock exchanges, thus, found little incentive to simultaneouslyexpand their terminals.

A decline in liquidity and dwindling of business in the RSEs wasinevitable as the RSEs ceased to provide a liquid market in active stocks whichwere also listed on BSEI NSE, the liquidity in the securities of companies whichwere exclusively listed on the RSEs also declined. The cost of membership inBSE and NSE was comparatively higher than in the RSEs and all large brokersin the RSEs obtained membership of BSE or NSE. They had little commercialinterest to continue trading on the RSEs or promoting them. The smallerbrokers were not able to garner sufficient resources to obtain membership ofthe two national exchanges. This, in turn, also led to increase in the numberof inactive members in the RSEs. The business done on the RSEs was adverselyaffected as a result of the cumulative impact ofthese factors. Whatever businesswas left, was mainly on account of varied account period settlement cyclesacross the RSEs which allowed for a product differentiation of sorts among theRSEs.

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2001. The settlement cycles varied from exchange to exchange. Additionally,carry forward transactions or deferral products were permitted on the majorstock exchanges, viz. BSE, NSE, CSE, ASE, DSE and UPSE. Varying accountperiod settlement cycles across exchanges and deferral products gavesufficient incentives to brokers to move positions from one exchange toanother offering arbitrage opportunity. This contributed to the turnover ofthe exchanges.

With the introduction of rolling settlement since June 200 I andabolition of deferral Products followed by the introduction of derivativestrading on the NSE and BSE, the incentive of the brokers to shift positionsfrom one exchange to another was lost. The result was a sudden decline inthe business in CSE, ASE, DSE and UPSE. The business in other RSEs whichonly had a cash market had already declined by then; little that remained alsowithered away.

With the availability of nationwide access to a liquid market, the needfor compulsory listing on the RSEs lost its relevance. Regional listing proved tobe an unnecessary burden in terms of cost to companies which were listed onNSE and BSE. SEBI, therefore, issued the SEBI (Delisting of Securities) Guidelines,2003 which inter-alia did away with the requirement for existing companies toremain listed on any stock exchange merely because they were incorporated ordid business from a region, provided such companies were also listed on eitherof the two national exchanges. Freedom was given to companies to list on astock exchange of their choice. Companies, therefore, chose to remain listed onBSE and NSE and opted for delisting from the RSEs. This resulted in further lossof revenue by way of listing fees for the RSEs.

Consequent to issuance of the SEBI's directive the Government withdrewthe requirement relating to compulsory listing by companies on RSE.

The concept of RSEs was, thus, finally abolished.

The economic relevance and raison d'etre of the institution ofstock exchange lie in its effectiveness in performing successfully two basicfunctions:

(i) to facilitate resource raising from the community for financing corporatesector and government for various activities; and

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(ii) to provide an organized market place for the investors to freely buy andsell securities.The functioning of the stock exchange has, therefore, to be such

as to create a climate conducive to an active primary market (new issuesmarket) and to ensure fair and efficient trading in securities in the secondarymarket (stock exchange) and to establish a harmonious relationship betweenthe two.

In other words, the institution of stock exchange is expected to facilitatethe channelisation of savings especially from the household sector to meet theinvestment requirements of the productive sectors of the economy primarily byensuring a market place, that provides liquidity to capital market instrumentsthrough fair and transparent trading practices.

The responsibility, therefore, to ensure the 'harmonious relationship'between new issues market and secondary market or stock exchange rests withthe functioning of stock exchanges.

Some of the researchers and academicians may argue that NSE has donewell to penetrate the objective of providing transparency and depthness toIndian capital markets but it has been a failure to capitalize and provide theregional capital formation necessary for the growth and development of theregional industry.

Section-I of the paper traces the historical background of the RSEs anddiscusses the present status of the RSEs and the evolution of the Indian securitiesmarket.

Section-II of the paper dwells upon the initiatives taken for the revivalof these RSEs and the subsequent results.

Section-III discusses the proposed theoretical model for revival ofRSEs.The suggestions and recommendations have been collected from various crosssection of the stakeholders including Stock Exchange officials, Stock Brokers,independent experts, investors, researchers etc.

The views of the above have been collected as primary data in the formof a Questionnaire-cum- Interview Schedule.

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Considering that the RSEs had invested substantially in theinfrastructure, which included building, hardware and software for automatedtrading, several initiatives were taken to revive these exchanges so that theinfrastructure could be put to productive use.

The first among them was the setting up of the ICSE platform to regroupthe RSEs to provide a third national market. The ICSE was promoted in 1998 by14 RSEs for providing an additional trading platform where the shares listed onany of these 14 exchanges would be traded. The ICSE was, thus, conceptualizedas a stock exchange to provide a common trading platform to members of allparticipating stock exchanges, mainly with the objective of boosting trade in thesecurities listed on the participating stock exchanges. It was felt that suchtrading across different stock exchanges would generate renewed trading interestamong investors by providing them an opportunity to trade in large number ofshares that were listed on the participating exchanges. But this did not happen.The existing regional order books of the participating exchanges continued. Thisfragmented the order book and thus depleted the liquidity in the shares exclusivelylisted and traded on the RSEs. On account of lack of liquidity, ICSE did notsucceed.

The second effort was to permit the RSEs to set up broking subsidiarieswhich could pool the financial resources of regional brokers and ofthe exchangesand obtain membership of the BSE and NSE. The regional brokers could then actas sub brokers to the subsidiaries (which had registered as brokers) and haveaccess to the markets of BSE and NSE. Even the ICSE set up such a brokingsubsidiary. Though the scheme maintained the purity of the functions of theexchanges, though dysfunctional, most subsidiaries became successful brokersin the market of other exchange(s). Although the subsidiaries were basicallybrokers, there were several differences between them and corporate brokingfirms, primarily because these were subsidiaries of the stock exchanges.

The third effort was when SEBI took the initiative to encourage the BSEand the smaller stock exchanges to set up the BSE IndoNext trading platform asa separate trading platform under the present BOLT trading system of the BSE.It was a joint initiative of the BSE and the Federation ofindian Stock Exchanges

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(FISE) of which 18 RSEs are members. The BSE IndoNext market was intendedto be an SME specific market. The BSE lndoNext trading platform was supposedto be implemented in phases. But it has not yet started.

This study appraises itself of the present status of the RSEs in the lightof the discussions with Exchange officials ofthree RSEs, namely, Delhi, Ludhianaand Jaipur Exchanges. Analysis of the financial conditions of the RSEs and theirsubsidiaries, and of the listing, trading and compliance status of the companieslisted in these RSEs was equally important for a complete appreciation of thepresent conditions of the RSEs and the choices available with the subsidiaries.

The RSEs were established with the objective of providing a regionalmarket for raising capital by companies in the respective regions by garneringregional savings to help achieve a balanced regional development and to spreadthe equity cult among investors in the country. This objective has been fairlyserved by the RSEs for a length of time. But with the advent of modemtelecommunication and information technology and the symbiotic interaction oftechnology and the markets, which facilitated a fundamental transformation ofthe market micro structure, the scope of the RSEs became limited till theyvirtually lost their relevance.

The present study also recognizes that even internationally, and preciselyfor, similar reasons, the RSEs have had a chequered past and over a very shortperiod of time became moribund before the burgeoning growth of the nationalstock exchanges with national and international reach. This prompted a movetowards consolidation of RSEs.

The above situation naturally raises the basic question on the raisond'Stre of the RSEs and their subsidiaries in the present market structure. Whenthis question was posed before the RSEs, it did not evince any convincingresponse. They did not come with any specific viable business plan for therevival of the RSEs except pinning hopes on a future which might be bright. Thestudy also notes that there are certain deeply embedded behavioural issueswhich continue to dominate the mind set of the members of the RSEs and theyseem to be coming in the way of some of the RSEs accepting the reality whichdemands subordination of their individual and independent identity before thelarger interest of the very survival of the R~Es. Indeed, it was this attitudecoupled with the equally uncompromising attitude of the business partnerswhich were responsible for the failure of the various rehabilitatory measurestaken in the past for the revival of the RSEs. Equally, the members of the RSEs,by virtue of their access to national trading platforms through the subsidiary

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route did not find any incentive to trade and promote trading in the RSEs.There have also been serious regulatory concerns from time to time on

the functioning of some of the RSEs. These regulatory concerns had led SEBIto take recourse to the extreme measure of superseding the governing boards ofsome exchanges and even to withdraw the recognition in the case of one RSE.These regulatory concerns still remain in the case of some of the RSEs wherethe members continue to remain recalcitrant and resort to undesirable market andgovernance practices.

Although the RSEs have ceased to perform the basic economic functionfor which they were set up, their continued existence by itself, necessitatesregular on site and off site regulatory monitoring and surveillance. Regulatoryresources are, thus, thinly spread and the attention of the regulator is divertedfrom more emergent issues to grappling with such routine issues which relateto dysfunctional entities.

It is, thus, clear that any solution to the conundrum posed by the RSEsmust encompass all the issues delineated above including the deeply embeddedbehavioural issues. Equally, such solutions must not only be practicable andimplementable but also eschew adhocism and discretion which had informed andalso thwarted some of the past initiatives for revival of the RSEs.

The Proposed Model for Revival of RSEs

The model for revival of the RSEs is discussed under the followingcategories :

• Revival of the RSEs• Restructuring of the subsidiaries of RSEs• For the divestment of the stake of the demutualised / corporatised RSEs• Exit route for the RSEs which desire withdrawal of recognition.

(a) All the RSEs may be given a regulatory mandate to consolidate and forma third stock Exchange, in addition to BSE and NSE.

(b) As some of the RSEs may not be viable and/or interested in theirrevival, region-wise consolidation of RSEs should be facilitated. Anactive market for trading in commodities and foreign Exchange could be

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developed by the stock exchanges region-wise.(c) The IndoNext, which is presently under the aegis of BSE, may be shifted

and given to the "consolidated RSEs" under a unified trading platformand clearing corporation.

(d) RSEs may be encouraged to consider any revival initiatives includingcorporate restructuring by merger with any of the premier stockexchanges subject to mutual agreement.

(e) There is a felt need expressed for an active and liquid market for SMEs.The RSEs may not be able to survive independently in view of thechanged circumstances in the Indian securities market. Therefore, someof the RSEs which are interested, financially sound and compliant withthe regulatory requirements may come together and set up a commontrading platform for such SMEs which have sound financials and viablebusiness strategies.

(f) In addition to providing specific trading platform for SMEs, the RSEsmay be permitted to evolve an active market for marketing structuredfinancial & investment products including mutual funds, insurance plans& other third party products apart from securitized instruments andderivative products.

(g) That RSEs be permitted to diversify into other areas like conductingtraining programmes for participants in capital market, providing servicesto investors, redressing investor complaints by acting as local. forumsof arbitration, distributing mutual fund products, acting as Registrar andTransfer Agents, providing securities lending & borrowing scheme andplaying an advisory role to the SMEs in their need for capital creation.RSEs should be allowed to diversify into other areas of business likecommodity exchange, Foreign exchange or other such suitable businessthrough creation of a special purpose vehicle. They can also be theregional centres for SEBI.

(h) RSEs may be permitted to establish a platform for book building, bothfor initial public offerings (IPOs) and also for delisting of companies.

(i) The members of the RSEs who were also members of the national levelstock exchanges, viz. BSEINSE should not be allowed to be on theBoard of the respective RSEs, as it results in a conflict of interest dueto dual membership and hamper any developmental initiatives for theRSEs.

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(j) OTCEI may be recognised as a national level stock exchange. It may beprovided exclusivity for trading in securities of companies with a paid-up capital below Rs. 20 crore, mutual fund units, privately placedcorporate bonds etc. Post-demutualization, the securities of the BSELtd. should be listed in OTCEI.

Suggestions for the Restructuring of the Subsidiaries of RSEs

(a) Subsidiaries should be considered to be on a par with any other stockbroker, thereby ensuring a level-playing field for all broking entities inall aspects like freedom of appointing franchisees, flexibility inappointment of directors on the board, enrollment of direct clients,executing proprietary trades. For this purpose, most of the exchangeswere willing to fully or partly spin-off the broking subsidiary from theRSE parent as described below.

(b) The RSEs may be mandated to disassociate totally from the subsidiariesand the umbilical cord between the stock exchanges and their subsidiariesmay be snapped. The sub.sidiaries shall be mandated to function asindependent broking entities.

(c) The subsidiaries should be permitted to operate in all areas of businesslike institutional business, margin trading, F&O segment, takingmembership of commodities exchanges etc.

Suggestions for the Divestment of the Stake of the Demutualised andCorporatised RSEs

(a) The scheme of Corporatisation and Demutualization mandates adivestment of at least 51% shareholding from trading members to thepublic or to the strategic investors.

(b) The Regulations to be notified by SEBI on divestment should providefor Foreign Direct investment (FDI) in RSEs, issuance of shares carryingdifferential voting rights, limited exercise of voting rights irrespective ofthe shareholding by an investor etc.

Suggestions for Providing Exit Route for RSEs which Desire Withdrawal ofRecognition

(a) SEBI should come out with clear guidelines providing permission tosuch RSEs which desire to exit the business of functioning as a stockexchange on a voluntary basis, spelling out the modalities for distribution

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of both financial and physical assets.(b) Post-withdrawal of recognition, the surviving entity which becomes a

regular company should be allowed to utilize the infrastructure for anyother business purposes as deemed fit by that entity.

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