A committee of experts under the chairmanship of former Reserve Bank of India Governor Bimal Jalan and comprising seasoned capital market and finance professionals was asked to review the ownership and working of market infrastructure institutions.

Its report, submitted to the Securities and Exchange Board of India recently, effectively raises the bar for existing institutions and prospective entrants.

They will have to comply with much higher standards of capital adequacy and governance than what they obtain now.

The three market infrastructure institutions are: stock exchanges, clearing corporations and depositories.

Understandably, it is the stock exchanges that have received the maximum attention from the committee.

In the reform era, it is the stock exchanges that have seen the most visible transformation. They have also attracted the maximum regulation.

The other two, though playing a vital role in the capital market edifice, are in a sense adjunct to the stock exchanges.

There is another topical reason why the committee's recommendations on stock exchanges have attracted so much interest.

There have been plans by newer players to start an exchange. An attempt by MCX, a commodities exchange, to start a stock exchange has been thwarted by the regulator. If the panel's recommendations are accepted, the doors will be practically shut for many new parties.

Net worth

The committee report has, as its core recommendation, the provision that only banks, insurance companies and domestic public financial institutions with a net worth of Rs.1,000 crore be anchor investors in a stock exchange, a position analogous to but not identical with promoters. The panel wants a widespread dispersal of shareholding in a stock exchange.

These two provisions — of allowing only well capitalised parties as anchor investors and ensuring a dispersal of shareholding — are deemed necessary for the proper functioning of an exchange. They also rule out control by any one party. An anchor investor can hold 24 per cent of the share capital but should bring it down to 15 per cent within ten years.

Another key suggestion having a bearing on the balance-sheet of a stock exchange is to include off and on balance sheet expenses while calculating the limits to shareholding in a stock exchange. Stock exchanges will not be allowed to list. This important provision should put an end to all controversies that will arise if stock exchanges list with one another. Perhaps even more significantly the provision reinforces what seems to be the thrust of the committee's recommendation: that the business of a stock exchange should neither yield large profits nor be a magnet for speculative capital.

Critics point out that the denial of permission to list will reduce the number of exit options.

Investors will be essentially holding on to non-traded securities. Foreign participation in a stock exchange and other market infrastructure institutions is capped at 49 per cent (FDI at 26 per cent and FII at 23 per cent).

Other restrictions

There are other restrictions as well. They clearly underline the committee's intention to maintain the ‘demutualised' character of the exchanges.

For instance, no trading member will be allowed to be on the board of stock exchanges except in the case of the advisory committees that deal with technology and other matters not directly connected to regulation.

In the past decade, stock exchanges in India, which functioned as mutual associations of brokers, were asked by the regulator to convert into demutualised entities and keep the trading, ownership and management functions completely segregated.

Stock exchanges and other market infrastructure institutions should be made to follow the disclosure and governance requirements of the listing agreement applicable to listed companies. The compensation packages of senior stock exchanges will be kept on a leash.

Finally, the committee says that when a related business of a market infrastructure institution delivers a service to another market infrastructure institution, it should be ensured that there is equal, unrestricted, transparent and fair access to all without any bias towards its affiliated entity.

To foster co-operation

The aim is to foster co-operation and the entity should not try to use its monopoly position to earn ‘super normal' profits that are drastically higher than average industry earnings in India. Excess profits should be used for investor protection and settlements.

The implications are: (1) Based on the committee's report there will not be a rush for starting new exchanges. The barriers have been set high and the returns capped; and (2) the report realises that there will not be an increase in competition.

The question is whether it will be disadvantageous to the consumer (investor).

It is a moot point whether unfettered competition among exchanges is to be endorsed at all and whether it will deliver all the presumed benefits.

When it concerns market infrastructure institutions, there cannot be too many players competing for the same business.

But it is the role of the stock exchange as a regulator that has made the committee pitch for high entry level norms and lay down stringent rules of governance.

Major stock exchanges around the world have, realising this unique characteristic of a modern stock exchange, ensured that their surveillance and other regulatory functions are not downplayed in a competitive environment.

Anticipating criticism that its report will not help foster competition, the committee has suggested that market infrastructure institutions should reduce charges and pass on the benefits to all their users.