Yes, well-capitalised institutions will inspire confidence and encourage stability, but what signals would India be sending to the global investment community?
Professor of Finance, Indian School of Business, Hyderabad
The recommendation of the Bimal Jalan committee that only well capitalised banks and financial institutions (FIs) be allowed to be anchor investors in stock exchanges has attracted the criticism of being anti-competitive. That is hardly surprising since any restriction, is, in a way, a barrier to free entry, the celebrated insurer of competitive markets. But the prescription is well grounded in reason.
First, exchanges – profitable or not – are more like telephone networks than like stand-alone profit-maximising firms. They derive value from connecting more investors so as to provide the best prices. They enjoy network externalities or increasing returns to scale. Economics 101 tells us that competition just cannot handle the latter situation in which the optimum solution may well be a monopoly. Thus, restricting competition here may actually enhance rather than diminish welfare.
But of course monopolies – natural or otherwise – have their problems. The Bombay Stock Exchange (BSE), the oldest bourse in Asia, provided a great example of that in the 1990s when the National Stock Exchange (NSE) made its appearance. Demutualisation – the changeover of exchanges from self-regulated broker clubs to regulated entities with separation of ownership from trading rights – ensued, dramatically improving investor protection, transparency and efficiency. Though it was a global trend in the 1990s, one can well argue that demutualisation would not have happened in India without the salutary competition from the NSE. So why should it be different now?
Because while the benefits of demutualisation are well recognised the world over, the exchange ownership effects are less clear. In any case, with the Securities and Exchange Board of India (Sebi) firmly ensconced as a market regulator today and Indian bourses providing world-class efficiency – ask IOSCO or other international agencies – the environment today is vastly different. If NSE slackens tomorrow on any of the observable indicators, Sebi can pull it up.
But why “anchor investors” in the first place and why the restriction of the privilege to banks and FIs? Here, too, the committee is on firm ground. The last thing needed is a mad scramble into the “exchange business” and then a painful industry consolidation with failing bourses. Though change may well be the only constant in life, when it comes to exchanges, stability is a critical virtue.
Hence the need to ensure that a promoter of an exchange is a serious entity with deep enough pockets to inspire the confidence of other players as well as credibly absorb the potentially vast risks associated with the business. Expertise in financial business is another important criterion. While each industry is unique, financial businesses differ more from non-financial businesses in the risks they entail and the degree to which they depend on public confidence for survival. Of course, none of this is to guarantee that an exchange floated by an FI would never run into problems or that one started by a deep-pocket non-financial business cannot function successfully. We are only talking about probabilities and beliefs, the only instruments at the disposal of policy makers. There is also the example from around the world. Whether by regulation or by history, major exchanges worldwide are supported by banks and FIs rather than non-financial businesses.
It is also important to realise that the committee recommends the anchor investors only as a temporary arrangement. The final state visualised involves widespread shareholding.
The debate over the restriction on anchor shareholding to banks and FIs boils down to balancing the freedom of every individual and group to pursue any business it wants with society’s need for reliability and stability in the critical institutions that uphold the very system that sustains free enterprise in the first place. In the wake of one of history’s worst financial crises, there is unlikely to be much contention over which of the two should get priority.
Although competition is a most desirable attribute, its effects are not universally and exclusively positive. When it comes to the very pillars of the capitalist system, it is ironic but beyond doubt that both the hallowed system of free enterprise as well as the economy are better served by adopting a higher threshold of entry rather than by an indiscriminate opening up of the field to a free brawl of everyone interested.
Prakash G Apte
Professor, Indian Institute of Management, Bangalore
First, what will be the answer to approximately Rs 10,000 crore invested in the shares of the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) by the global best and other investors? They have bought the original shares of both these exchanges and facilitated the demutualisation process based on the well-researched and deliberated Kania committee report.
Second, what kind of signal will the global investing community get on the investments in 10 regional stock exchanges and two new entrants? It is only after answering these two questions that we should address the topic of this debate.
When the Bimal Jalan committee report is closing the most transparent and scientific exit door and capping the profit to government security yield, the thought that should occur to us is: would any bank or financial institution (FI) like to become an anchor investor in such circumstances? When 90 per cent of the investment value in these exchanges has been eroded, which investor would like to be an anchor investor?
Globally, the banking, financial services and insurance (BFSI) sector is becoming an allied technology business. The first slide of the New York Stock Exchange (NYSE) corporate presentation says it is a technology company first and it runs an exchange domain business. Nasdaq merged with technology company OMX to create Nasdaq-OMX, anchoring a new avatar. It was the same case when Instinet (a Reuter’s info-vending company) gained a majority stake in NYSE. Many other global exchanges have followed a similar pattern.
In today’s competitive environment, when transnational consolidation and M&A strategies are being adopted, should we restrict the anchor investor to banks and FIs? If you study NYSE acquiring Euronext or Singapore Exchange acquiring the Australian Exchange, these are real examples of activities aimed at global financial centres leadership.
Going by the Jalan committee report, our exchanges will go back to being worse than mutual associations of members dependent on funding from members. When the world of exchanges is becoming globally benchmarked, why are we pushing ours towards “cottage industry status” and stifling their ability to grow in a globally competitive environment?
Exchanges in Africa, Malaysia and Dubai are listed entities, let alone those in the Americas, Europe, Singapore, Hong Kong, Tokyo and Australia. Given this, I would like to question the rationale for not allowing exchanges to list.
Which bank or anchor investor will anchor an exchange when there is no exit route? Without listing, which anchor investor will ensure strict corporate governance and shareholder scrutiny that form the basis of investments? BSE and MCX-SX have gone public with their view that they support listing for better corporate governance and transparent exit options for investors. Whereas NSE has cleverly opposed listing by giving the front line regulator story, which is not even cited by countries behind India or even those ahead of the country in the list of developed financial capital markets. In such a situation, even the earlier Industrial Development Bank of India in its development financial institution role will not become anchor investor today.
The government has realised the importance of having an autonomous regulator rather than a department of any ministry. Disallowing listing will dry up funding for state-of-the art exchanges. Does one presume that anchor investors being limited to banks and FIs should continue to bear the brunt of investments without getting options to exit or realise a return on investments through listing? The Jalan committee has forgotten these fundamentals, in serving the sole purpose that only perpetuates a monopoly.
The moot point is: by imposing ownership restrictions, cap on profit, disallowing listing, no stock options and no variable pay for exchange executives are restrictive ways of ensuring that exchanges do not make supernormal profits. That objective can be easily achieved by allowing healthy competition and a conducive environment for competition. And currently, with the lack of competition, there is a glaring case of an incumbent exchange along with all the things that the Jalan committee wants to prevent.