Opinion The hand of the regulator

It is a stock exchange promoted by MCX and Financial Technologies India Ltd (FTIL). While MCX is a commodity exchange,where commodities like gold are traded,FTIL is a company which provides software for stock exchanges and brokers who trade on them.

What is the crux of Sebi’s order against MCX-SX?

Sebi’s argument is that everyone should comply with the rules (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges,or MIMPS) which say that nobody can own more than 5 per cent. While the promoters had attempted to do this by reducing the stock exchange’s equity,Sebi says this was actually a fudge.

How so?

They exchanged part of the stock exchange’s equity against ‘warrants’ which they could convert into shares later. This allowed them to reduce their shareholding to 5 per cent. But since the warrants can be converted to shares,this allows them to later hold more than 5 per cent of the exchange.

How can they do so when MIMPS doesn’t allow any one person to hold more than 5 per cent?

They can if,and when,the MIMPS rules are changed.

Why is it important to cap equity ownership at 5 per cent?

Stock exchanges are privy to sensitive information and also serve as the check on malpractices. So the argument is that a 5 per cent cap divorces ownership from management and that’s good. So let’s say a broker doesn’t have enough “margin money” to deposit with an exchange to be allowed to buy shares. The greater the value of shares,the greater the margin money. One argument,not made by Sebi,is that a promoter-run exchange may allow the broker to deposit the margin money later instead of cutting off his trading terminal. Several such possibilities are cited.

So this can happen only in promoter-run exchanges?

Theoretically,they can happen anywhere but one argument is: separating ownership from management,as in the NSE,reduces this possibility since the MD of the exchange has no ownership stake. The converse argument is that it is only when a promoter owns more of a stock exchange does he make the extra effort to make it grow.

So is the only check against malpractice the integrity of the person selected to be MD?

Integrity helps,though it is unfair to assume a promoter-run exchange’s MD won’t have integrity. More important,Sebi,for instance,gets 24×7 information online on what’s happening in an exchange. In any case,most of these functions are driven by computer programmes which make it difficult to actually favour one or two sets of brokers.

But even if you assume the stock exchange — promoter- or professionally-run — allows a broker some leeway in depositing margin money,Sebi will know immediately. In fact,Sebi also has data on different exchanges and even from depositories. So,it can track if someone is selling on one exchange and buying on the other; it can track if stock exchanges are using information on what brokers are buying or selling; whether price-sensitive information is being uploaded with a delay,and so on. Also,given how the bulk of trading is by institutional investors,favouring one or two brokers seems a suicidal game.

Is the order good in law?

Former Sebi member J.R. Varma argues that stock exchanges cannot and should not be seen as the first frontier of regulation once the clearing or regulatory function is outsourced. He says stock exchanges are like a shopping mall where brokers buy and sell. In other words,don’t load regulatory functions on an exchange. Former Sebi executive director Sandeep Parekh,currently running Finsec Law Advisors,argues that MIMPS doesn’t even apply to stock exhanges like MCX-SX which are demutualised and corporatised. In other words,the order is bad in law.

Does every regulator enforce the 5 per cent rule?

Not at all. The RBI says bank promoters must have a minimum of 40 per cent,and allows six years to reach this level in case the promoter has a higher shareholding; the commodity regulator allows 26 per cent,and the insurance regulator allows even 100 per cent.

But aren’t stock exchanges more risky than banks,given the volume of transactions in them?

There is little doubt stock exhanges are a source of risk and a badly-run exchange hugely intensifies financial risk. But so does a bank. And even conservative regulators like the RBI think a promoter with a 40 per cent stake can do no harm.

sunil.jain@expressindia.com