Monday, November 20, 2006

Demutualization of stock exchanges

We keep hearing about demutualization from time to time in papers. What exactly is demutualization? And is it good or is it bad?

Before we undertand what it means, let us first of all understand that stock exchanges in India are formed as associations of stock brokers. All these associations are supposed to be not-for-profit mutual entities. They are supposed to manage their own affairs with government never interfering with their internal functioning while laying down the broad rules of the game in which the stock market game can be played. This has perpetuated a strong control over the stock markets by the brokers.

But this is not the way stock exchanges operate in developed coutries. Hence the need for demutualization was felt as a reform measure in government circles. This is supposed to end the monopoly of the stock brokers. This was sought to be achieved through the transformation of the constitution of the exchanges into for-profit public limited companies. The demutualization in UK was not as a result of government mandate but of brokers’ own volition.

The demutualization of the stock exchanges in India has these noteworthy features:

  1. The representation of the brokers on the governing boards of each of the stock exchanges is restricted to a maximum of a fourth of the board’s strength, the rest being appointed in the manner specified by SEBI (Securities & Exchange Board of India).
  2. The aggregate shareholding of broker-shareholders is limited to a maximum of 49% of the stock exchange’s equity capital.
  3. A minimum of 51% of the equity capital is to be held at all times by public other than broker-shareholders.
  4. No broker-shareholder is allowed to have more than 5% voting rights.

Demutualization is supposed to bring in more efficiency to the management of the markets. With the public holding a major share in the equity capital of the stock exchanges, the brokers are expected to be in a less powerful position to manipulate the stock exchanges.

There is an excellent piece on demutualization covered by ET in the classroom at: