ASSIGNMENT ON

Demutualisation of Indian stock market.

ASSIGNMENT PREPARD BY SHANKAR KUMAR SINGH -07F042.SOHINI SAMANTA -07F044. SOUMYA TRIPATHI -07F046. SUBHOJIT DAS -07F048.

UNDER THE GUIDANCE OF PROF (Dr.). S. DEV

INSTITUTE OF MANAGEMENT AND INFORMATION SCIENCEBHUBANESWAR

CONTENTS

Ø EXECUTIVE SUMMARY 1

Ø INTRODUCTION 2

Ø DEMUTUALISATION 3

Ø ADVANTAGES OF DEMUTUALISATION 4

Ø STOCK EXCHANGE BOARD OF INDIA’S GUIDELINES 5

Ø THEORITICAL FRAMEWORK 6

Ø M.H.KANAI COMMITTEE 8

Ø DEMUTUALISATION OF REGIONAL STOCK

EXCHANGE 9

Ø PROCESS OF DEMUTUALISATION 10

Ø RESARCH AND METHODOLOGY 11

Ø CHALLENGES OF DEMUTUALISATION 13

Ø CONCLUSION 14

Ø REFERENCES 15

INTRODUCTION

Earlier the stock exchanges in India are formed as association of stock brokers. Stock exchanges were mutual organizations that were managed by members in a single city with a huge dealer population. They were registered as what is known as section 25 companies or as not-for-profit organization. Organizational profit making was never the motive; the exchanges required funds only the extent of meeting its expenses. Any surplus made by the exchange resulted in reduced access fees for members. Though outside professionals have been appointed to research wings and to positions such as executive directors, in practice, the exchanges have been run by broker-members elected representatives.The members, who provide brokerage services also own, control and manage the exchange. DRAWBACKS:-

1) The conflict of interests between the owners, the members and the management - since all the brokers are managing the exchange together then such conflict is advent to happen.

2) Brokers were manipulating the market for their advantage- That is investor’s interest was ignored.3) Scams took place in pre-demutualization phase-1992-

Harshad Mehta scam & 2001-Ketan Parekh Scam4) Lack of strict vigilance on the market-No one person or

management was there to look after the affair of the exchange.

So Indian market and financial sector felt the need of demutualization.

WHAT IS DEMUTUALISATION?

Demutualization means converting a “not for profit" organization into a “for profit”organization.It implies that a mutually owned association is converted into a company owned by shareholders. BSE is converted into BSE LTD.In other words transforming the legal structure, of an exchange form to a business corporation form is referred to a demutualization.The ownership, management and trading is separated and are in different hands.They are clearly separated like a commercial entity. The management of the exchange is separated from the shareholders and the brokers.The Stockholm Stock Exchange was the first stock exchange to be demutualised. It is a Swedish based stock exchange.

ADVANTAGES OF DEMUTUALISATION.

ADVANTAGES OR REASONS FOR DEMUTUALISATION

1) Rationalized Governance: - The corporate model will enable management to take actions that are in the best interest of customers and the exchange itself. There would be transparency.

2) Investors Participations: - A demutualised exchange affords both institutional investors and retail investors the opportunity to become shareholders. Institutional investors require much greater liquidity for block trading.

3) Competition from Alternate Trading System’s (ATS) and Electronic Communication Networks:- ATS and Electronic Communication Networks provide cheap and efficient access to quoted stocks unlike traditional stocks exchanges. To cope with competition, exchange required funds. While members owned have limitations in raising funds.

4) Globalization: - Historically brokers and exchanges were locally focused. Exchanges did not face meaningful competition from exchanges in distance places. Through alliances, exchanges seek to attract more investors by harmonizing distinct trading environment and by offering greater product variety.5) Resources for capital investment: - One of the drivers of stock exchange demutualization is screen trading, which has which has replaced floor trading on most exchanges. Once customers have direct access to screens, exchanges memberships no longer have as much economic value and clearing firms rather than traders become a dominant force in exchange activities.

SEBI’s GUIDELINES

SEBI issued its guideline on 31- 11- 2006 for investment in stock exchanges in India. Under this guidelines, shareholdings of tradingMembers have to be brought down to 49% which can be either by divestment or additional equity capital to be issued to make the shareholding of existing trading members to 49%. Therefore, it can be way of1) Offer for sale by prospector by existing trading members2) Placement of shares of shareholders having trading rights to such persons or institutions may be short listed by the exchange with the approval of SEBI.3) Issue of equity shares on private placement basis by the stock exchange to any person or group of persons not having trading rights subject to approval of SEBI.

LIMITATIONS BY SEBI.

• No person shall directly or indirectly acquire or hold more than 5% in the paid up capital.

• No person shall either individually or together with persons in concert with him acquire and or hold more than 1% of the paid up capital.

• Foreign investment up to 49% will be allowed in stock exchanges with a separate FDI cap of 26% and FII cap of 23%.

• No FII shall seek and get representation on the Board of Directors of stock exchanges. No foreign investor including persons acting in concert will hold more than 5% of the equity in the exchange.

THEORITICAL FRAMEWORK. In this theoretical framework we have taken three models of

demutualization from the Indian stock market. The models are of Bombay Stock Exchange, National Stock Exchange and National

Commodity and Derivative Exchanges Limited. DEMUTUALISATION OF BSE.

The Bombay stock exchange. Asia’s oldest stock exchange with 131 year old history. It was handled by 790 brokers.

It was corporatised on 19 May 2005.The process of converting these exchanges into incorporated companies is called corporatization. Around 51% stakes of 790 brokers were offloaded to 21 investors. Like SBI, LIC, Aditya Birla Group, beside Deutsche Brose and Singapore Exchange’s.

• 19 investors (like SBI, LIC, Aditya Birla and so on) have picked up 41% stake.

• 10% by Deutsche Borse and Singapore Exchange. Each group has picked up 5 % stake for Rs. 189 crore each.

DEMUTUALISATION OF NSE:

The National Stock Exchange was formed in November 1992 as a tax paying company. Unlike other stock exchanges in the country. From day one, NSE has adopted the form of a demutualized exchange’s. It is owned by a set of leading financial institutions like banks, insurance companies and other financial intermediaries and is managed by professionals, who do not directly or indirectly trade on the exchange.The promoters of the NSE are like: –Industrial Development Bank of India Limited. Industrial Finance Corporation of India Limited.National Insurance Company Limited.Infrastructure Development Finance Company Limited. And so on.

DEMUTUALISATION OF NCDEX. National Commodity & Derivatives Exchange Limited, isa public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It commenced its operations on December 15, 2003. NCDEX currently facilitates trading of 57 commodities.

NCDEX is a national-level, technology driven de-mutualised on-line commodity exchange with an independent Board of Directors and professional management - both not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. The promoters and its shares can be known through the pie chart given below.

COMMITTEE FORMED FOR SUGGESTIONS:-

A group was constitute by SEBI to advise on the matter of corporatization and demutualization of exchanges under the chairmanship of Justice M K Kania, former chief justice of India which has suggested some steps for implementing the demutualisation concept in the Indian stock market.

The group formed to view the corporatization and demutualization of stock exchanges submitted its report on August 28, 2002 and made the following silent observations and recommendation:-

1) Stock Exchanges are converted into companies limited by shares from associations of persons/companies limited by guarantee.

2) Amendment is made to the Income Tax Act 1961, so that past accumulated profits of the stock exchanges are not subject to tax.

3) Amendment would also be required in the Indian Stamp Act 1899 and Sales Tax law to allow a tax- free transfer of assets from the old entity to the demutualized new entity.

4) The system of permission to trade on the basis of ownership of a trading card is replaced by a system where money is deposited to obtain trading rights.

5) Shareholders, brokers and investing publics are equally represented on the governing board of the demutualized exchanges.

6) A uniform model for corporatization and demutualization would have to be adopted by all stock exchanges.

7) The merger of stock exchanges is a commercial decision that would be left to stock exchanges.

DEMUTUALIZATION OF REGIONAL STOCK EXCHANGES.

Government asks for demutualisation of regional stock exchanges in two ways:-

1) Either by becoming trading arms of BSE & NSE, or

2) no. of regional stock exchange joins hands to make a separate platform.

Nine exchanges recently signed an MOU with the National Stock Exchange (NSE) to extend its trading platform on the regional stock exchanges.

THE REGIONAL STOCK EXCHANDES THAT HAS BEEN DEMUTUALIZED ARE:-

Vadodara Stock Exchange Magadh Stock Exchange

Jaipur Stock Exchange Ludhiana Stock Exchange

Saurashtra Kutch Stock Exchange Delhi Stock Exchange

Bhubaneshwar Stock Exchange Cochin Stock Exchange

Inter Connected Stock Exchange Pune Stock Exchange

Bangalore Stock Exchange Ahmedabad Stock Exchange

Calcutta Stock Exchange Madras Stock Exchange

Madhya Pradesh Stock Exchange Gauhati Stock Exchange

Hyderabad Stock Exchange.

THE STOCK EXCHANGES THAT HAS NOT BEEN DEMUTUALIZED.

Coimbatore Stock Exchange.

Mangalore Stock Exchange .

Meerut Stock Exchange .

Uttar Pradesh Stock Exchange.

PROCESS OF DEMUTUALISATION:-All the assets are valued by the exchange, which includes the value of seats. A total value is founded and divided into shares, which are offered to the public. Then the stock exchange lists the shares. The members of the exchange will get the payment for their seats from the funds available through the sale of shares. The goal of demutualization is corporate structure which offers the management greater flexibility. Demutualization helps to respond to changes in a better way and it also provides the company to spin-off its subsidiaries, get into mergers and acquisitions, raise funds, etc.Membership cardholders of the exchange will be the shareholders of the exchange initially. There would be only a single class of trading members having the same rights and privileges. If any person is admitted as a trading member then uniform standards will be followed in terms of capital adequacy, deposits, fees, etc.In the governing board of any demutualized exchange, the representatives will not exceed one-fourth of the total strength of board. The public, apart from the shareholders who have the trading rights, will hold at least 51% of its equity shares. The trades are being cleared and settled by the trading members until the clearing and settlement functions can passed on to a recognized clearing corporation which might take place within two years. The corporatized and demutualized exchange will initially use the existing assets and reserves transferred from the previous exchange. The government transfers the surplus funds built in the process of demutualization to the consolidated fund of India. It also has the option of using such funds to acquire capital assets or to develop the market. Demutualization avoids conflict of interests between the owners, the members and the management.

RESARCH AND METHODOLOGY. We have used the secondary data information here. We have taken the six months Bombay Stock Exchange’s index from pre- demutualisation and post- demutualisation phase each. All this data are available on the BSE. Website. So the data’s are:-

MONTHS B.S.E Indices

Nov- 04  6248.43

Dec- 04  6617.15

Jan- 05  6696.31

Feb- 05  6721.08

Mar-05 6954.86

Apr-05 6694.42

May-05 6772.74

Jun-05 7228.21

Jul-05 7708.59

Aug-05 7921.39

Sep-05 8722.17

Oct-05 8821.84

Nov- 05  9033.99

Now we are going to draw the line graph with the aid of above data’s

So what we analyze from the above graph that the performance of the index gets stable after the month of May, 2005(the BSE was demutualised on 19 May, 2005). The index is quite volatile in pre-demutualisation phase (i.e. before May, 2005). Now we will look that whether there is any improvement in the turnover of the BSE index because of demutualisation or not? We have taken the four months turnover (buys & sells figure) from pre- demutualisation and post- demutualisation phase each. The data’s are:-

MONTHS BUY SELLS

B.S.E Indicies

0100020003000400050006000700080009000

10000

B.S.E Indicies

Jan-05 25663.2 25899.67Feburary2005 28427.63 30895.75

Mar-05 33414.38 38510.1Apr-05 22636.1 22859.74May-05 26297.33 27057.4Jun-05 34275.59 35576.7Jul-05 38247.85 39624.35Aug-05 48063.69 49342.17Sep-05 52561.82 53842.46

Now we are going to draw the bar graph with the aid of above data’s

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So we see that the turnover increases at faster rate after May, 2005. But in the pre-demutualisation phase there is not any fixed trend in the turnover. Sometime the figure is increasing and sometime it is diminishing.

Therefore we can conclude that the performance of the Bombay Stock Exchange has revamped because of demutualisation.

CHALLENGES OF DEMUTUALISATION. Demutualization is not enough for obtaining a franchisee agreement though it is a necessary condition. There will be no

changes in the conflict of interest if an exchange is converted from an association of persons into a limited liability company. The same board and the same organizational structure will continue to exist and nothing much will be achieved. The government can not solve the exchange’s management problem by steering the demutualization process. There have been arguments that demutualization by itself may not achieve improved governance.

CONCLUSION.

If stock exchanges are of self regulatory nature then they find ways to profit making objectives. The stock exchanges have the option

of setting up separate entity within the stock exchanges defining the regulatory powers. Though demutualization is beneficial, many stock exchanges are hesitating to adopt it because they are afraid of loosing their identity. They also have the fear of paying huge tax conversions. This new revolution will become successful when the government will take the necessary steps. This issue has already gained importance at the international but it needs to be considered more intensely at domestic level.

REFERENCES.The sources from where we have availed the information mentioned above are:-

• ICFAI Journals of 2005.• Financial market & services, By Gordon & Natarajan.• www.livemint.com• nseindia.com

• Bseindia.com