23 November 2010

Dr. Bimal Jalan report on Ownership and Governance of Market Infrastructure Institutions

SEBI has put on its website the much anticipated Dr. Bimal Jalan committee report on ‘Ownership and governance of Market Infrastructure Institutions’. The report is at times quite disappointing, particularly since expectations were quite high from one of the most celebrated central bankers of India of all times who chaired the committee. This is an advisory committee and all or some of it does not necessarily have to become the law. I had put in my two bits by writing an open letter in the ET to Dr. Jalan on the issues.

Given below are some of the recommendations followed by my views on the issue:

However, due to the potential conflict of interest in the strong exchange SRO model, the Committee is of the view that SEBI must take a more active role in setting a level playing field with regard to fees, entry, etc. of members of MIIs.
View: Fully agree.

The MII should endeavor to generate reasonable profits in order to be self-sustaining. The MII should levy reasonable charges on its users without abusing its dominant or regulatory position.
View: Very vague recommendation.

The MII should maintain utmost transparency in its operations. The MII on its website should at least make disclosures that are mandated for a listed company.
View: Good recommendation.

Annexure – C & Annexure –D of this report depict the ownership restrictions in select countries and details of ownership of stock exchanges in select countries, respectively. It is seen that the existing shareholding restrictions in India generally are similar to that of most other countries.
View: The committee ought to read the annexure it appends. The annexure clearly shows that India is the only country with a cap on shareholding. All other countries require either disclosure or permission, but all permit going upward to any extent. Not a single country in the annexure has an absolute cap – that is so for a reason. It would be foolish and anti-competitive, as we have seen. The full IOSCO report which they rely on can be found here. http://www.iosco.org/library/pubdocs/pdf/IOSCOPD225.pdf

a) Domestic institutions registered in India having a net worth of 1000 crores or more and falling under the category of:
(i) Public Financial institutions defined under section 4A of the Companies Act, 1956 and with national jurisdiction,
(ii) Banking company as defined under clause (c) of section 5 of the Banking Regulation Act, 1949
may be permitted to be anchor institutional investors for stock exchanges for a period of 10 years from the date of recognition as an AII of the exchange.
View: The anti-competitive (and illegal) MIMPS regulation will get a renewed birth with this very tiny exemption provided by way of a fig leaf – almost exclusively to large banks.

The Committee therefore, recommends that at least 51% of the paid-up equity capital of the clearing corporation should be held by one or more recognised stock exchanges.
View: Micro-management in the name of regulation – and lack of a singular philosophy. If exchanges should have diversified shareholding, why not clearing corporations?

However, the Committee is of the opinion that the integrity of the surveillance mechanism in each entity should be maintained and in the process insulate the market from systemic risks to the extent possible…It is recommended that the holding of stock exchanges in depositories may be restricted to a maximum of 24%.
View: Contradicts the previous para for reasons which are not clear to me. Holdings should either be diversified or not.

The committee feels that trading members bring rich practical experience and the same should be utilized in a manner which doesn’t conflict with governance. Therefore in order to utilize the experience and expertise of trading members in the securities market, an advisory committee shall be constituted by the board of the stock exchange, comprising of trading members.
View: Great suggestion – balances expertise with keeping it at arms length.

Therefore, the Committee is not in favor of permitting listing of MIIs. However, the disclosures and corporate governance requirements of the listing agreement applicable to listed companies shall be made applicable to MIIs too. The information required to be disclosed shall be posted on the website of the MII.
View: Disagree strongly. An exchange like the BSE needs listing for governance and performance pressures. Today, the management is accountable to no shareholder. There is complete divorce of ownership and management, leading to an orphan exchange in the name of 5% shareholding cap.

It is recommended that the net worth requirement for a Clearing Corporation may be fixed at ` 300 crores. The clearing corporation shall meet relevant networth criteria on an ongoing basis.
View: A random number as it is unconnected to the riskiness of the CC. But an improvement over current number.

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. It is pertinent to note that this would be similar to the treatment afforded by the Reserve Bank with respect to new banks.
View: Could not disagree more. This would result in favouritism and license raj. A regulator cannot pick a winner even in an industry where too many players may fragment trades too much.

The category based restrictions for trading members, FII, FDI and cumulative foreign holding will continue as before.
View: Why treat foreigners differently? Can’t we have similar treatment?

Endnote: The report is unnecessarily long – just as is this blog :) It seeks to explain some economics on competition, definition of exchanges, history of exchanges etc.

Disclosure: I have advised MCX-SX which is directly affected by these recommendations.

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