| Two articles last month addressed the subject of commodity exchanges. "Listed exchanges pose unique problems" by Ajay Shah (May 17), questioned the supposed pitfalls of the Multi Commodity Exchange (MCX) going public, in terms of governance issues, whereas "Heads up on commodities" by R Ravimohan (May 19) lauded the other commodity exchange, NCDEX, as if it's the only exchange in existence and singly responsible for the growth of the commodity futures market. Both authors failed to disclose that they are directors on the board of the NCDEX. Surely Shah, whilst expounding on conflicts of interest, should have been forthright about his own conflicts. Ravimohan a proponent of corporate governance, should likewise have disclosed his own interests. Whilst Ravimohan, for whom I have the highest personal regard, might be merely faulted for adequate disclosures while promoting the NCDEX, Shah does not seem to be aware that the Securities and Exchange Board of India (Sebi), which is the authority in this matter, has already come out with an Anantharaman committee report on allowing exchanges to list, rather self-list, which is an extension of the landmark work done in 2002 by the Kania committee on demutualisation of exchanges. Hence Shah's article is on a subject which has already become a non-issue. |
| Shah believes that an exchange should be "demutualised" and managed by managers with no financial interest other than their salary, for it's presumed that "protecting their reputations" would be their sole motivation in running the exchange. "Demutualisation" in the exchange business means that trading rights and ownership rights on/of an exchange are separate, and acquisition of one does not guarantee the other. Such a model is the opposite of a mutual association (Section 25 companies in earlier days), which were owned by members, were "not for profit" and always had the problem of raising resources, whether equity or debt. The only source of income was the sale of membership rights, which also gave an ownership stake in the exchange. The failure of such a model gave rise to the NSE, MCX, NCDEX... as corporate, exchange, limited company, "for profit" entities regulated by Sebi and the Forward Markets Commission (FMC). |
| A practical example to explain demutualisation is ICICI Bank, which is a co-promoter of the NSE, has a place on its board, and is also listed on the NSE. Its broking subsidiaries ICICI Direct.com and ICICI Securities have acquired broking rights on the NSE. The part ownership of the NSE has not given any benefits to ICICI Bank in obtaining broking rights. In short, both the rights are unrelated arrangements. |
| Equity owners of exchanges are aware that the long-term value of an exchange rises only if it delivers a neutral trading platform that traders trust. A biased exchange policy can destroy confidence. Who loses? The exchange's equity owners. And what about professional managers? If anything goes wrong, they can switch to another job. Equity owners/promoters, in contrast, have a greater stake in the success of the business, which is guaranteed by benchmarking an exchange to global standards of neutrality, professionalism and above all credibility. |
| Let's talk specifics. There have been numerous allegations of misconduct by some professionals at the NCDEX, from the guar gum episode to arbitrary margin changes on pulses to open non-compliance with directives by the FMC. I do not know whether these allegations are true. These instances have, however, forced the FMC to issue warnings to the NCDEX. Shah should ask the FMC which model has worked better. |
| Shah enumerates hypothetical instances of expected "promoter behaviour". Let me mention just one. He believes that if a broker gives business to another exchange, the first exchange may "inflict punishment" on such an "erring" member. Perhaps he believes that exchanges rough up those who dare deal with other exchanges. Can he please study the reaction of the BSE when the NSE was set up, and whether any such instance transpired? |
| Shah's arguments are predicated on the assumption that salaried employees would act responsibly. But haven't there been numerous examples of BSE officials being dismissed by Sebi for misusing insider information? Shah also alleges that, owing to a hypothetical "monopoly status" of exchanges, member brokers will be "herded" to buy software from their sister concerns in an attempt to earn "monopoly rent". He ignores the fact that when the NSE started its software company, NSE.IT, it never coerced brokers to buy its trading terminals and, indeed, encouraged other software companies, by opening up its Application Protocol Interfaces (APIs) to develop independent software programmes for brokers. The same is the case with Financial Technologies, the promoter of MCX, which is the largest software supplier for trading terminals to its own as well as to NCDEX brokers, and supplies trading terminals to members of the NCDEX. A software company's goal would be to sell is products, whereas an exchange's goal would be to encourage any software interface which would help enhance volumes. As it happens, NSE.IT is also an empanelled software vendor for MCX. Globally, the Stockholm exchange is owned by O&M, an IT company, and an example of professionalism and strict governance. |
| To suit the facts to his argument, Shah sees no problem with ICICI Bank being a founder/promoter of the NCDEX since a higher dividend from the NCDEX would be "small change" for the bank. By deduction, therefore, large entities can be shareholders of exchanges whereas smaller ones cannot! This points to another problem: our system easily forgives infractions by established "business houses" and by "institutions" but do not hesitate to criticise budding entrepreneurs. In the 1990s, our established institutions promoted the "Over the Counter" (OTC) Exchange, which failed. Today, the OTC's predominant revenue is interest income on deposits from members. The institutional shareholders were never held to blame, being, after all, institutions! A similar mishap in the private sector would result in banning of the promoters from the capital market. An ICICI subsidiary would be accepted on an ICICI-promoted exchange, but a broking subsidiary of Financial Technologies (being a member of MCX) would never be accepted. We are a society driven by capitalist dreams, but with a socialist bent of mind. |
| An exchange company is like any other infrastructure project, and will approach the capital markets or banks for raising resources. All the examples Shah has used in his article hold equally good for a listed company in the banking/energy/telecom sectors and for their respective CEOs. While they function as corporates, they are regulated by their respective regulators and carry out the same extent of critical operations for the public good. Going by Shah's argument, should these institutions also be barred from listing? Wouldn't listing encourage these corporates to perform and deliver shareholder value? With an added regulator in the form of Sebi? Shah's arguments are selective, and he ignores the broader canvass of the government encouraging more sectors to face the rigours of the market. |
| Should capital convertibility come about, cross border transactions would become a reality. Transactions will naturally flow towards those exchanges offering global efficiencies. The government and our opinion makers should encourage our exchanges to prepare for that day (in the footsteps of the NYSE, NASDAQ, CME, CBOT, LSE and Deutsche), which will surely come. The author is a director of Business Standard Ltd, and a director as well as shareholder of Financial Technologies, which has promoted MCX |
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