TABLE OF CONTENTS
Abbreviations. 2
1..... Introduction. 3
1.1 An Introduction to Demutualization of Stock Exchanges. 3
1.2 Objective. 4
1.3 Scope. 5
1.4 Problem Statement 5
1.5 Hypotheses. 5
1.6 Methodology. 5
1.7 Data Collection Procedures. 6
2..... Both
Sides of the Fence. 7
2.1 One side of the fence: Why do we need Demutualization?. 7
2.2 Other side of the fence: Problems with demutualization?. 11
2.3 Regulatory Challenges for Deregulated Exchanges. 12
2.4 Demutualization: Opposing Views. 13
3..... Examples
of Successful Demutualization Attempts. 15
3.1 Demutualization Process. 15
3.2 History of Demutualization. 16
3.3 Growing Trend in Demutualization. 17
3.4 BCG Model 17
3.5 The Australian Stock Exchange: A Success Story. 18
4..... An
Overview of Pakistani Stock Market 21
4.1 Major Issues. 21
5..... Prospects
for Demutualization in Pakistani Exchanges. 25
5.1 Proposed Benefits. 25
5.2 Impact of Demutualization on the Institutional Investor 26
5.3 Major Challenges. 27
5.4 Conflict of interest 27
6..... CONCLUSION.. 28
7..... Bibliography. 29
Abbreviations
ATS: Alternative Trading System is an electronic system
that can bring together potential buyers and sellers of securities, and which
may disinter mediate the traditional broker's role in trading.
ECN: Electronic Communications Networks is an ATS
that has registered with the SEC as either a broker or an exchange.
SRO: A self-regulatory organization is an organization that exercises some
degree of regulatory authority over an industry or profession.
KSE: Karachi
Stock Exchange Pakistan's
largest and oldest stock exchange, with many Pakistani as well as overseas
listings. KSE is the biggest and most liquid exchange in Pakistan and in 2002 it was declared as
the “Best Performing Stock Market of the World” by “Business Week”.
NSE: National Stock Exchange of India is
the largest stock exchange in terms daily turnover and number of trades, for
both equities and derivative trading. It is mutually-owned by a set of leading
financial institutions, banks, insurance companies and other financial
intermediaries in India
but its ownership and management operate as separate entities
CDS: Central Depository System is an
Electronic Book Entry System to record and maintain securities and to register
their transfer. In CDS, ownership will be changed without physical movements of
securities or execution of transfer deeds. The ownership will be transferred as
soon as securities move from one account to another.
1
Introduction
1.1
An Introduction to Demutualization
of Stock Exchanges
1.1.1
Overview of Roles and Structure of
Stock Exchanges
Stock exchanges
anywhere in the world provide a platform for investors and capital raisers to
come together and get what they want. They assist in trading of stocks and
bonds. Apart from that, it can be viewed as a liquidity providing platform. For
this purpose, the stock exchange has to have a set of rules that will govern
the execution and clearing of trade. Some of the responsibilities of a stock
exchange are also enforcing standard rules to reduce transaction costs and monitoring
of the trading to prevent manipulations like insider trading.
Stock exchanges
have traditionally been acting as a club of brokers or members. These members
enjoyed:
Ownership rights
Decision making rights (1 member 1vote)
Trading rights
Traditionally,
the exchange has been a guarantee limited company, which means that a certain
group of individuals came together and formed the stock exchange; and put the
guarantee that they will contribute their share of the guarantee if the
exchange fails to run smoothly as desired and will be liquidated thus.
Nowadays,
exchanges in the world are moving towards demutualization- a process which
alters the structure of an exchange.
1.1.2
Demutualization: Definition,
Concept and Significance
Demutualization
converts a guarantee limited company into a company limited by stocks as other
listed companies on the exchange. It demutualizes a
currently mutual exchange with one vote
one member into a one vote per share.
It changes the decision making structure from “consensus based” to “majority
based”.
Thus, the
exchange would become a profit oriented company rather than the existing
not-for-profit orientation. Traditionally, the exchange gave trading rights to
owners of the exchange. Demutualization would separate trading rights from
ownership.
So, the concept
can be summarized as:
Making the exchange a profit oriented company
Making the company a public limited company that is
able to generate funds for itself like others, rather than be limited by
the guarantee contributed by the members
Separating ownership from trade
Making decision making majority based rather than
consensus based
The significance
of this process comes into play when one looks at the current discrepancies in
the prevailing working of the stock exchange. Exchanges are not considered to
be very efficient in maintaining transparency and have not been able,
specifically in countries like Pakistan,
to prevent insider trading. Their growth is also a major issue. There are
points of view which enforce that this not-for-profit orientation of the
exchanges has rendered them stagnant because they have limited access to
capital this way. They also say that this mutual nature of the exchange leaves
it nowhere in the competition when it comes to other trading systems. Supporters
of the demutualization process have also said that it will eliminate conflicts
of interest in decision making because now the owners will not be the managers
themselves. Also, the regulators and players will have clearly defined roles
according to them.
