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The killing of competition

The Jalan report’s control-era conclusions on stock-exchange ownership need to be thoroughly debated before being even marginally accepted.

Written by Surjit S Bhalla |
December 2, 2010 2:56:21 am

The government of India has officially proclaimed a target of 10 per cent GDP growth for India. If this is to be achieved,successful financial intermediation is a critical necessity. Recognising this,we at Oxus Investments have embarked on a major work programme related to India’s financial markets. The hope is that via intensive research on both our own and international capital markets,one can arrive at a set of guidelines and policies for India to achieve its goal and destiny.

There are parallel forces in government trying similar things. Towards this end,the major financial markets regulator,Sebi,set up a blue-ribbon committee to study the question of the “ownership and governance of market infrastructure institutions in India.” This committee was chaired by Bimal Jalan,a former RBI governor,and contained the following distinguished individuals: K.P. Krishnan,secretary of the PM’s Economic Advisory Council; Kishore Chaukar,managing director of Tata Industries; the banker Uday Kotak; G. Sethu,of the National Institute of Securities Markets and K.M. Abraham,a whole-time member of Sebi. The Jalan committee has just issued its report. It contains recommendations on how many stock exchanges there should be in the country — the fewer the better; on ownership of stock exchanges — no more than 26 per cent for a financial institution; on profits of the stock exchanges — they should be limited and controlled; on listing of stock exchanges — no,they should not be submitted to the normal corporate governance practices that a listing enables.

The importance of the report is immense and the report correctly calls for a national debate on its recommendations. This article is a humble submission towards the debate as is a detailed paper entitled ‘Stock Exchange Ownership in India: Rules,Regulation and Policy’ available online.

In two words,the Jalan report is deeply disappointing. The first,and most major disappointment,is with the fact that this weighty report,written by experts,does not have any analysis. It has assertions,and recommendations,but no hypotheses,or analyses,or investigations. Interestingly,the RBI issued its own paper on a similar subject some time back. The RBI report had to do with the ownership of banks,and the Jalan committee dealt with the ownership of stock exchanges and related institutions (depositories and clearing corporations). The RBI report was written by internal staff; the Jalan report by blue-chip experts.

The mandates of RBI and Sebi were identical — to have a national debate. Anyone interested in the issues,and especially policymakers,must read both reports. The RBI report,on every issue,presents the pros and cons,the reasoning,and hesitates about reaching any conclusion. But it does provide evidence on the issues. The Jalan committee (and Jalan was one of the finest RBI governors) hesitates to provide hypotheses or evidence. But it does make conclusions.

On the important issue of ownership,this is what the two reports have to say. For a commercial bank,the RBI is willing to entertain the possibility of even industrial houses owning a bank,and requires a minimum of 40 per cent ownership by a single investor. One of the points made in my above-cited paper is that a bank and a stock exchange are comparable and that rules and regulations pertaining to a bank should be more stringent than rules and regulations pertaining to a stock exchange. But the Jalan report thinks otherwise. Instead,for reasons that the Jalan report does not make clear,it anoints a stock exchange with a halo of public service. According to the report,a stock exchange is a national utility,and apparently not a market where simple price discovery takes place of stocks and firms. It is a national treasure to be run by the government and its profits curtailed!

The reasoning of the Jalan report is as follows. “The motivation of the owners of MIIs (market infrastructure institutions) should be to make only reasonable profits… There should be predominance of desire on the part of the shareholders of an MII to play an institutional role rather than seeking commercial gains in the short/long run. Given the importance of the MIIs as components of social infrastructure,national interest should be safeguarded in specifying ownership/management control.” (Emphasis added.)

The Jalan report reaches several other controversial conclusions. Not only are stock exchanges believed to be a national treasure,but so much so that the salaries of management and the profits of the firm need to be capped. Further,the national treasure does not need to list itself so that corporate governance can be enforced. So stock exchanges should not be listed — this when most stock markets in the world today are listed,and none have reported problems with the listing.

In addition,in the Jalan report,there is a more than surprising distrust of the marketplace. For example,the need for competition is paid lip service to — but it believes that the “entry of a large number of stock exchanges will fragment liquidity to such an extent that this might stifle growth and innovation in the process. Also,too frequent exits of stock exchanges will jeopardise the interests of the investors and disrupt the stability of the markets themselves. Further,technology has altered the marketplace so much that the need for multiple stock exchanges has been reduced largely.”

The reason I have quoted at length from the report is so that the reader’s appetite is whetted and she can download the report from the SEBI website and read it at leisure. From my side,I found the report more than strange. It belongs to a different era,an era of controls when government knew better. That stock market exchanges are a national treasure to be controlled and run by bureaucrats is antithetical,I think,to most notions of financial markets,corporate governance and efficiency. But the Jalan report does provide a useful service — it will engineer the debate that it so keenly seeks and that India desperately needs.

 

The writer is chairman of Oxus Investments,an emerging market advisory and fund management firm

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