Not the best recipe

Not the best recipe

SEBI's Jalan Committee recommendations will perpetuate the monopoly of the National Stock Exchange, argues Joseph Massey.

In India, industry and investors, who raise and deploy capital in our capital markets, currently have to grapple with an undeveloped market. Consider this: 80 per cent of the trading is still confined to the Top 100 companies, 50 per cent of the trading business is with the Top 25 members, and 80 per cent of the market is restricted to the four metros.

There are other problems. There is excessive dependence on foreign institutional investors, or FIIs, in the cash market, low retail participation, low delivery-based business and absence of instruments such as corporate bonds, interest rate futures and equity in small and medium enterprises, or SMEs. The Bimal Jalan Committee (BJC), set up by the Securities and Exchange Board of India, or SEBI, the stock market regulator, on the governance of market infrastructure institutions, misses the opportunity to usher in any change as we enter a new decade with global attention on India. SEBI Chairman C.B. Bhave's comments in support of the committee report is equivalent to pronouncement of judgment even before the hearing. This reflects lack of jurisprudence. Let me explain the major shortcomings in the proposals.

 Massey's take

  • The Jalan Committee has missed the opportunity to broadbase the Indian equity markets
  • The Committee appears to see merit in the NSE model by rejecting better global models
  • If exchanges are not allowed to list, it will dry up sources of capital for new exchanges
  • The defi nition of 'anchor promoter' should be broadened to allow non-fi nancial corporates to establish exchanges
  • The shareholding of clearing corporations and depositories must be diversified
  • The Committee's composition also leaves a lot to be desired

The committee has committed several oversights. One of the biggest, a cause of anguish to the industry, is that the chairman did not meet many stakeholders; only its sub-committee did. On most issues, the BJC has seen merit in the National Stock Exchange, or NSE, model by rejecting better global models and has ensured that capital raising is made more difficult for existing or new exchanges, hence perpetuating the NSE model and monopoly.

The BJC recommendation that exchanges should not be allowed to list is bad in law as investors have already invested Rs 10,000 crore in various stock exchanges based on the recommendations of the Kania Committee and the scheme of demutualisation. This recommendation, if implemented, will dry up all sources of capital available to the exchanges. No new exchange will ever be set up.

While Rs 100 crore is the minimum capital requirement, the actual capital needs of an exchange could be Rs 1,000 crore and nobody would invest this kind of funds with the proposed restrictions. Also, the argument that listing exchanges will lead to a conflict of interest as they are frontline regulators has no logic as this does not hold true for other utility sectors like telecom, banking, aviation, and insurance.

The recommendation that any excess profit over a fixed return on net worth will have to be transferred to the settlement guarantee fund/investors' protection fund, is a retrograde one. It will favour the existing monopoly player who has a larger net worth, and, therefore, is entitled to retain more profit than a new exchange with lower net worth.

It is also interesting to note that the Jalan report has suggested the ownership limits of domestic public financial institutions and banks (private and public) be increased from 15 per cent to 24 per cent by introducing the concept of 'anchor investors'. The BJC recommends that only banks and financial institutions can be anchor investors and prevents other eligible corporates from being anchor promoters, who could add great value and prevent conflicts. The definition of an anchor promoter should ideally be further widened to allow non-financial companies to establish exchanges.

Globally, the non-banking financial companies, or NBFCs, and technology companies establish new generation exchanges, which promote product differentiation, innovation, new technologies, and ultimately capital market development.

The committee has categorised stock exchanges, clearing corporations and depositories as market infrastructure institutions, but suggests differential treatment to their shareholding structures. It has recommended a maximum of five per cent shareholding in a stock exchange, 24 per cent shareholding in a depository, and 100 per cent shareholding in a clearing corporation for any investor.

Ideally, as a clearing corporation and a depository carry more risk, their shareholding should have been more dispersed. The committee's composition has also left a lot to be desired. Of the BJC's seven members, four are from SEBI, its board or its affiliate organisations. The Kania Committee, which recommended demutualisation, had no SEBI-related officials.

Tata Sons, the promoter of TCS - the largest technology provider to NSE, NSDL, and NSCCL - has one member. One of the members is a promoter who runs a new private bank, mutual fund, and brokerage house. So, I believe there is a conflict of interest, given the BJC's recommendation on ownership limits.

While SEBI has been transparent enough to upload the agenda on its web site, it is surprising to note that it has withheld the feedback of several respondents to the committee report. RBI uploads such comments received on banking licences and it is an accepted global best practice.

To my mind, the uproar in the financial community over the BJC report is justified since it is taking India's financial sector backwards. The recommendations are promonopoly, anti-growth, and hence anti-market development.

The author is the MD & CEO, MCX-SX