Jalan Report a damp squib – II
Deena Mehta 21 December 2010

The proposed rules regarding compensation to exchange executives are flawed, as are the rules for listing of exchanges and restricting their profits, and the powers to SEBI to regulate market infrastructure institutions

Compensation for executives: The Bimal Jalan Committee report on ownership and governance of market infrastructure envisages that the key executives will not have any variable component in their remuneration. The report states that the remuneration should be determined after giving due regard to industry standards. If we go by industry standards, most of the corporate world has a fixed as well as a variable component. In fact, all high-paid executives do have a large variable component so that the burden of the salary on the organisation is not very high and some minimum performance and accountability is assured.

The National Stock Exchange (NSE) has a fixed remuneration package, whereas the Bombay Stock Exchange (BSE) has a fixed-cum-variable remuneration package. The reasons are obvious. The BSE top management team was hired at a time when it was necessary to get high-class performance to increase the BSE market share. The top management on the NSE on the other hand has grown with the organisation and though there were challenges, the pressures to revive a sagging exchange were different.

There is no reason given by the committee on why the variable component should not be there. Favouring a particular model indicates a bias, more so when the reasons of such recommendation are contrary to its own views on market salaries.

Listing of exchanges: The Jalan Committee has raised the issue of the conflict arising out of self-listing of shares. Instead of thinking of a solution, such as monitoring by the Securities and Exchange Board of India (SEBI) or a separate cell within the exchange to monitor listing norms, it has recommended that listing is not advisable. In a bizarre comparison, the Jalan Committee states that the share price of the exchange would impact the credibility of the exchange. I am sure that the buyers of Colgate toothpaste are least bothered about share prices of Colgate. Everybody who is connected with the stock market understands that the price of the stock has no connection with the credibility of an organisation, but it has more to do with the demand supply of shares in the short term and financial performance and thereby its credibility in the long term.

The government is pushing very hard to promote financial inclusion and make available the prosperity in the share market to all Indian citizens. A statement of this kind is very saddening. This implies a general impression that most companies in the country are vehicles of speculative investments. The committee does not address the issue of current shareholders of the stock exchanges whose exit route would be sealed by its recommendations, if these proposals are accepted. It was always envisaged that stock exchange shares would be listed and the BSE delayed filing of the prospectus following the setting up of this committee. The modalities of listing are necessary, rather than question the very idea of listing. The question is how and where to list and not whether to list.

Market infrastructure institutions (MIIs) to generate only reasonable profit: The Jalan Committee recommends that there should be a cap on profitability of the exchanges and other MIIs. Any profit earned over and above the prescribed return on net worth shall be transferred to the Investor Protection Fund (IPF) or Settlement Guarantee Fund (SGF), as the case may be.

The profitability of exchanges and clearing corporations are essentially from three sources: transaction charge, penalty collected from members, and income earned on treasury operations of the funds deposited by brokers as margins. Hence, pragmatically speaking, the Committee should have recommended payment of interest on the broker's funds and reduction in transaction charges. Transferring funds to IPF or SGF fund serves nobody's purpose since there have been no broker defaults in recent times and investor claims are hardly made to the IPF. In the absence of default, again the SGF fund is hardly used. Hence, there will only be further interest accumulation to these funds.

It would be more advisable to reduce the cost of transaction, which is in the interest of every investor. Our markets are also over-margined and due to general ignorance of the risk associated with the stock markets, exchanges have got away with excessive margining. There is a strong case to rationalise the margin structures. Reduction in transaction charges, payment of interest on margins and rationalisation of margins, will automatically cap the exchange profits.

Powers to SEBI in matters relating to MIIs: The Committee is of the view that SEBI should have the discretion to limit the number of MIIs operating in the market, in the interest of the market and in public interest. Instead of limiting the MIIs, it would be desirable to set up countrywide investor participation benchmarks and permit exchanges once the benchmarks are reached. For example, another depository can come up when the combined beneficial owners of the current depositories are say 5 crore. This would link the infrastructure to the demand in the economy. To sum up, instead of putting discretion with SEBI, it is desirable to have performance benchmarks so that basic principles of equity and democracy are prevailed upon. There should also be a provision to close MIIs by SEBI if they fail to reach minimum benchmarks in terms of membership, turnover, etc. This would ensure that price wars indulged in by new exchanges are not just entry strategies but a long-term strategy for survival is in place. Such a condition will in fact accentuate the price wars as there is a time limit to achieve the benchmarks! There is an opinion that every entity interested in setting up an exchange should be allowed to do so. Let the market forces decide whether the exchange should continue operations. Unfortunately, our markets lack depth in terms of the number of participants who use exchange services. Competing on price only leads to attracting speculators who are extremely cost conscious. Wastages in terms of computer systems, networks, office buildings, and so on, are evident in the regional exchanges. Interconnected Stock Exchange (ISE) was promoted by all regional exchanges to trade on the BSE and the NSE and then they directly became members of the BSE and the NSE through their subsidiaries. The infrastructure was wasted. Now ISE is trying to survive like any other broking house.

To conclude, all issues arising from demutualisation and regulation of MIIs should have been addressed before allowing stock exchanges to demutualise. Unfortunately, the Jalan Committee report is a non-starter and in fact, regressive in its ideas. It appears biased in favour of a particular exchange and does not address the problems. It is not bold in taking a stand that exchanges are utilities. Half-hearted attempts at restricting top management remuneration, a cap on income and not listing the shares is an attempt to give a colour of socialism to the stock exchanges. Socialism per se is not bad.

A bold stand is required to call the exchanges as public utilities and bring down the cost of transaction and spend money on the development and penetration of the capital market throughout the country.

(This is the second and concluding part of a critique by Deena Mehta on the Bimal Jalan Committee Report. In the first part, 'Jalan Report a damp squib - I', published on Monday, Mrs Mehta wrote that the shareholding proposals of the Committee for market infrastructure institutions are biased and not justified and that the report sidetracks corporate governance issues and the developmental role of stock exchanges. Deena Mehta is managing director of Asit C Mehta Investment Intermediates Ltd. She is one of the three trading member directors on the board of the Bombay Stock Exchange. To read the first part click http://www.moneylife.in/article/72/12497.html)

1 decade ago
What is existing law on listing by Exchanges?

(1) The Corporatisation and demutualisation (C&D) scheme of BSE as notified by SEBI states regarding listing as under:

"6. Listing of Shares of Bombay Stock Exchange Limited
Bombay Stock Exchange Limited may at any time list its securities on any recognized stock exchange."

(2) AS we all know, C&D scheme is a statutory order. See Section 4B of the SCR Act.
"4B (4) Where the scheme is approved under sub-section (2), the scheme so approved shall be published

(b) .............and upon such publication, notwithstanding anything to the contrary contained in this Act or any other law for the time being in force or any agreement, award, judgment, decree or other instrument for the time being in force, the scheme shall have effect and be binding on all persons and authorities including all members, creditors, depositors and employees of the recognised stock exchange and on all persons having any contract, right, power, obligation or liability with, against, over, to, or in connection with, the recognised stock exchange or its members."

(3) Section 4B (8) makes it mandatory for the exchanges to go public. See the language:

"(8) Every recognised stock exchange, in respect of which the scheme for corporatization or demutualisation has been approved under sub-section (2), shall, either by fresh issue of equity shares to the public or in any other manner as may be specified by the regulations made by the Securities and Exchange Board of India, ensure that at least fifty-one per cent of its equity share capital is held, within twelve months from the date of publication of the order under sub-section (7), by the public other than shareholders having trading rights:"

The phrase " shall, ...by fresh issue of equity shares to the public" does not give any other meaning but mandatory listing of its securities by an exchange.

(4) Regulation 4 of the most debated SECURITIES CONTRACTS (REGULATION) (MANNER OF INCREASING AND MAINTAINING PUBLIC SHAREHOLDING IN RECOGNISED STOCK EXCHANGES) REGULATIONS, 2006 ( MIMPS Regulations) also provide for listing. See the following extract of the regulation.

“Manner of increasing the public shareholding

4. Subject to the provisions of sub-section (8) of section 4B of the Act and the scheme, the recognised stock exchange shall ensure that at least fifty-one percent of its equity share capital is held by the public, either by fresh issue of equity shares to the public through issue of prospectus or in the following manner: -

(a) offer for sale, by issue of prospectus, of shares held by shareholders having trading rights therein;”

The above regulation makes it a vested right for the shareholders of the Exchanges to go public.

It is strange why Bimal jalan tried to reinvent the wheel and why SEBI supported it publicly.

Entire intelligentsia in India has already debunked the report. Thanks to the untiring efforts of likes of Sucheta.
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