As was not predicted but as could have wisely been anticipated, such an exchange was bound to fail.
Causes for Failure
The OTCEI has failed because of two major reasons. One, none of the participants in the OTCEI market have made any significant gains. Issuers have found that marketing their issues on the OTCEI is not easy. Neither does listing give them any publicity. Some of the prospective issuers have, therefore, chosen the path of inflating their capital and seeking listing on a regular stock exchange. Investors have hardly had any worthwhile returns from OTCEI shares, with a few exceptions. The OTCEI Composite Index, which had peaked at around 380 in October 1994, is currently just around 100.
The intermediaries, be they members or dealers, have also failed to make any major gains, while the responsibilities cast on them in terms of sponsorships and market making with low spreads have proved to be exacting. Most of them enrolled themselves to become stockbrokers as the dealership was available quite easily and rather cheaply, compared to the membership of other stock exchanges.
Secondly, the procedure of trading and settlement on the OTCEI is quite cumbersome, with registration requirements proving to be a deterrent for investors and the T+3 continuous settlement programme casting, as pointed out by Dave Committee, an onerous responsibility on the support systems such as custodians, clearing houses and banks apart from the back offices of dealers.
Several of the 16 prescriptions given by the Dave Committee to resuscitate the OTCEI are no doubt relevant. Important among them are listing of companies which do not meet the Sebi criterion of a three-year dividend paying record; shifting of the rolling settlement system from T+3 to T+5 in respect of listed securities; and permitting weekly netting of trades in the place of daily netting in permitted securities. Also in the same category are other suggestions, like a more active role for promoter institutions who are to institute a dedicated fund of Rs 50 crore-100 crore for investment in fundamentally strong OTCEI listed stocks and underwriting OTCEI issues; upgradation of technology; etc.
However, the recommendation that all companies which do not fulfill the criterion of having at least five public shareholders for every Rs 1 lakh net capital offer made to the public be given the option to seek listing on the OTCEI is not proper. It is actually the Sebi guideline that needs modification, as it has to be harmon-ised with the guideline relating to allotment of shares on a proportionate basis. The related recommendation that companies which are being delisted from other stock exchanges for reasons other than absence of trading, be permitted to be enlisted on the OTCEI on an order based system in a separate listed companies category is not in good taste. The OTCEI can not certainly be treated as a dumping ground. Such companies should be listed on the OTCEI if and only if delisting is due to the low level of capital of the companies.
The recommendation of the Committee to remove the upper limit of Rs 25 crore for listing on the OTCEI, goes beyond the objective for which the exchange was set up. The recommendation to allow equity shares of unli-sted companies to be traded on the OTCEI, with lesser disclosure of information is frau-ght with serious consequences, like manipulation and insider trading, with no punitive provisions as these will be beyond the purview of Sebi. It is, therefore, necessary to provide suitable safeguards against malpractices before permitting trading in such shares. The most unwarranted recommendation of the Committee is the introduction of instruments like futures and options, forward contracts on stocks, other forms of forward transactions, stock lending, etc. These are highly complex instrume-nts which call for a well-planned and fully guarded system for operation. In mo-st of the advanced markets, there are separate organisations conducting tra-ding in these instruments. The OTCEI is, to say the least, just not the exchange for these instruments.
The whole focus of the recommendations of Dave Committee is to ensure that somehow or other, OTCEI survives, no matter what it does in the process. The issue really is not whether or not OTCEI survives but whether or not the primary objective for which OTCEI was set up - enabling small and medium-sized companies to raise resources - is achieved. If this objective is not achieved, the attempt should be to ascertain the reasons for that and to make a set of recommendations to achieve the objective. If Dave Committees recommendations are fully accepted and implemented, it could well be that the exchange booms, but the primary objective of the exchange is lost.
In several countries in the world, sustained efforts are made to foster the second tier market to cater to the needs of small companies. In the US, the Over-The Counter (OTC) market regulated by the National Association of Securities Dealers (NASD) has been functioning for a long time. This has been a prime market for new and growing companies. NASD introduced in 1971 an electronic quotations system called the National Association of Securities Dealers Automatic Quotations (NASDAQ) with prescribed listing norms. While there over 50,000 stocks and bonds traded on the OTC market, NASDAQ has about 5,000 listed securities.
In the UK, the Unlisted Securities Market was set up in November 1980 to cater to the needs of small companies. Subsequently, a Third Market was also established for still smaller companies. As both these attempts failed to evoke adequate interest, in June 1995, the London Stock Exchange itself established the Alternate Investment Market as a second-tier exchange to provide small, young and growing companies a vehicle to raise capital and a trading facility under its supervision. The Alternative Investment Market has proved to be a success in a short time.
There can be no two opinions on the question that the OTCEI must succeed but it has to achieve the objectives for which it was set up. Apart from the several useful constructive suggestions made by the Dave committee, which are in line with these objectives, there are four other thrust areas needing concentration of efforts. First, the OTCEI has not been marketed properly. Aggressive marketing efforts to educate both entrepreneurs and investors are needed.
Secondly, Sebi regulations relating to take over of companies should not be made applicable to the OTCEI companies for a period of at least 10 years from the date of listing on the exchange. Several of the professionally qualified and technically sound but financially weak entrepreneurs dread these provisions. Thirdly, market makers need to be funded liberally, preferably at a confessional rate, by the banking system. Finally, and most importantly, the attempts made hitherto to create a model exchange with delivery-based transactions and without short sales should be given up. Liquidity - coupled, of course, with safety - is the sine qua non of a successful stock exchange, and any regulation that restricts liquidity restricts the market itself. One hopes that sane counsel will prevail and the OTCEI will emerge as the stock exchange for small and medium-sized companies starved of funds today.
(The author is former executive director of the Bombay Stock Exchange)