Of archaic norms and fettered bourses

Consolidation is sweeping across exchanges worldwide. Interesting developments are taking place in global commodity and stock exchanges - in both the cash and the derivative segments.

India is set to benefit from these developments.

But, the government and the regulators seem to be taking a myopic view by putting restrictions. In some cases, restrictions are reflective of the old ideologies.

In 2005 and 2006 at least seven deals each were struck, leading to a consolidation in the global exchanges.

This is happening in two ways - through mergers and acquisitions (M&As) and through mutual cooperation, such as cross-selling of products and so on.

CME acquiring CBOT, Nasdaq buying out more than 28 per cent of the stake in the LSE are some of the significant transactions in the last two years.

Consolidation is speedier in the USA and Europe, while in Asia, exchanges are still considered as 'national preserves'. India is following the Asian example of restricting investment of single entities in stock exchanges, thereby restricting the benefits of strategic investments.

The stock exchanges of Hong Kong and South Korea have a 5 per cent cap for each single investor. The Singapore exchange has restricted the investment limit to 10 per cent for individual entities.

India recently decided to have a 5 per cent cap for each single investor in the newly demutualised stock exchanges, including the BSE, the oldest and the biggest.

The BSE had announced its intention for IPO and dilution of its equity in favour of strategic investors. However, the cap on investment has dented the BSE's plans.

The growth potential in the Indian market may favour the BSE to get investments from big players when it dilutes equity. But, it will not get the premium associated with strategic stake. It is not money alone, but the strategic investor, which helps in increasing the market share.

The BSE needs support for increasing its share in the derivative segment. Its Sensex is patented in the US and is considered as a benchmark for the Indian equity markets. Any high-profile strategic investor would certainly have added value to this.

If Mumbai has to emerge as a global financial hub, foreign companies must come here for listing, participate in fund-raising and shifting their base to Mumbai is necessary. This can only be a reality when our exchanges are vibrant and globally competitive.

The ailing Calcutta Stock Exchange (CSE) has found help in the MCX, which can bail it out. But the 5 per cent cap will make it very difficult for the CSE to get the deal through.

With the Indian companies on an aggressive buying spree abroad, the scope for cross-listing of companies is enormous. But, this can be expedited only when our exchanges match their peers globally. Besides, regulatory restrictions are barriers for exchanges to participate in overseas bids.

The barriers also deprive them from M&A premiums. This is not the case only in India. It is an Asian phenomenon. Exchanges, such as the MCX, are among a few exceptions to this phenomenon.

The 5 per cent cap has raised new issues. If the restrictions are applicable to the newly demutualised exchanges, then the NSE is already demutualised and the cap will apply to it too.

The NSE is demutualised so far as keeping trading and ownership rights separate. But, there is no direct public participation in it. So, the playing field is not levelled for the NSE, the BSE and the other exchanges. In this context, there is a need for more clarity as regards public shareholding and other issues.

Setting an exchange is also emerging as a lucrative business proposition in the country. Two of the new-age commodity futures exchanges - the MCX and the Ncdex - have been set up by entrepreneurs. The time is now ripe to look at exchanges from the profitability angle. This is already happening the world over.

The valuation of several US exchanges have become high, owing to the M&A premiums attached to them, as they are either targets or acquirers. But, barriers to participating in M&As deprive investors from getting the full value of their investments.

The US exchanges have high P/E multiples of around 40 as against those of European exchanges at 23 and Asian exchanges at 30. The US exchanges are hence expected to play a big role as consolidators.

See how consolidation in global exchanges is changing the world. The two high-profile mergers of the CME-CBOT and the ICE-NYBOT have redefined the US futures market. The emergence of Chicago as a dominant liquidity pool for futures trade has increased the urgency of the NYSE to acquire the Euronext.

The CME-CBOT merger makes it the largest futures market in the world with a market share of 17.8 per cent. Meanwhile, seven major European investment banks are also planning high-speed trading system with tariffs far below those of the LSE, the Euronext and the Deutsche Borse.

The 5 per cent cap for single-entity investment in the newly demutualised exchanges should be seen in this perspective.

Even if a foreign bourse acquires a major share in a domestic exchange, it is certain that it will add value to the market, as the foreign exchanges are better regulated by stronger regulators.

The fear of foreign bourses taking over Indian exchanges can be addressed in many other ways, as it is done in the case of FDI in print media. India has allowed 74 per cent FDI in the telecom sector despite the fear related to national security. In fact, the fear is proving to be a myth.

So, there can be more liberal rules for investment in exchanges and the present or future investors should not be deprived of the benefits of capital appreciation in the fast consolidating global exchanges.

The government should consider a liberal limit for strategic investors in exchanges and can approve them on a case-by-case basis.

It should be kept in mind that running an exchange requires specialised skills and commitment from promoters. If outside investors fulfil these criteria, then India should welcome them.