Diluting ownership not demutualisation

WITHOUT CONTEMPT

Demutualistion is a constant challenge for regulators worldwide. Segregating ownership and management from stakeholders of an institution is a complicated arena by itself. Matters get even more complicated when regulators do not wish to see any single shareholder hold a substantial interest, as a measure of attaining demutualisation.

In banking, we have a statutory limit of 10 per cent on the voting power that may be exercised by any equity holder. Despite this limit on voting rights, the Reserve Bank of India (RBI) has given itself a veto over any shareholding in excess of 5 per cent across "associated persons" who are members of a bank.

The definition of "associated persons" is borrowed from the tax laws for transfer pricing purposes. Often persons holding shares in a bank find themselves restrained from acquiring more shares because they are technically "associated" with others even if there is no concerted objective.

They also find themselves unsure of whether they are compliant with the law in buying any shares because they have no way of breaching Chinese walls to know if their associated persons are also buying shares at the same time. In fact, the RBI has even gone a step further by unofficially expressing displeasure with common substantial shareholders across banks.

It is against this backdrop that the Securities Contracts (Regulation) (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006 (Regulations), has been notified. The regulations, notified by Sebi, without any public debate over draft regulations, imposes some serious restrictions over public ownership of shares issued by stock exchanges. When stock exchanges get listed on one another, the same compliance problems that plague dealing in bank shares also overwhelm dealing in stock exchange shares.

Nineteen stock exchanges are expected to be affected by the new regulations, and even if only two of them ever go public, life can be fairly rigorous for anyone interested in their shares. Sebi has imposed a prohibition on "direct or indirect" ownership of more than 5 per cent by any person in any stock exchange. The concept of "direct or indirect" ownership, which has been extensively used in the takeover regulations, will tend to bring even pro-rated shareholding within the sweep of the regulations. For instance, if a person were to hold 5 per cent shares in a stock exchange and were to also hold 10 per cent in another company that holds 5 per cent, his holding in the stock exchange could be regarded at 5.5 per cent.

Within this limit, Sebi has imposed further criteria. One would need prior approval of Sebi to hold more than 1 per cent in any stock exchange, and Sebi will consider whether such a person is fit and proper. This 1 per cent limit is not reckoned on a "direct or indirect" basis. The holdings of all "persons acting in concert" would be included within this limit. This is again another concept adopted from the takeover regulations, which covers all persons having a common objective or purpose of acquisition of shares, voting rights or control.

The "fit and proper" criteria in the regulations are vague and range from "financial integrity" to "honesty" and to "good reputation and character". The other disqualifications can also be severe. Apart from the standard disqualifications relatable to insolvency, any person who has been issued a direction not to deal in securities for any period will remain disqualified for three years thereafter.

Sebi has not considered whether it will be relevant to impose such restrictions on shareholders who may themselves have widespread ownership. These regulations have put paid to any stock exchange ever being taken over even by broad-based institutions and companies. For instance, if a stock exchange is substantially owned by a bunch of institutions, which themselves have a broad-based ownership, there ought to be no reason for the exchange to be considered non-compliant.

The National Stock Exchange (NSE) has proven this well. If a broad-based set of investors wants to own the Bombay Stock Exchange and emulate the NSE, there is no reason for a 5 per cent limit to pre-empt such ownership. Similarly, there is no reason why the current ownership of the NSE, which has served the country well, should be disturbed.

Perhaps it is time to remember that demutualisation is only meant to segregate ownership and management from those who are members of the stock exchange, not to ensure that there is no substantial ownership whatsoever over any stock exchange.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

somasekhar@jsalaw.com