Sebi Should Clarify Stand On Unlisted Cos Taking Over Existing SEs

To make the stock exchanges (SEs) and depository business more competitive, the capital market regulator Securities and Exchange Board of India (Sebi) has made the radical recommendation in its discussion paper on the subject. One of the proposals put forward by the Sebi in its discussion paper is about allowing unlisted companies/entities to take over existing SEs and depositories but these companies/entities should comply with Sebi’s takeover regulations.  

Terming this as a curious proposal, Anand Lakra, Partner at J Sagar Associates, a leading corporate law firm said, “Given the obvious differences between listed and unlisted companies, it would do well for Sebi to provide clarity on this (issue)”.

Welcoming the proposal to permits any person to start a business of an SE or a depository business with 100 per cent ownership or even acquire 100 per cent of an existing stock exchange or a depository, “a welcome move, as it encourages competition in duopolistic markets by lowering the entry barriers”, said Lakra.

Until now the ownership ceiling was 5 per cent and 15 per cent for an individual and an entity, respectively, in such institutions which Sebi calls as Market Infrastructure Institutions (MIIs).

Earlier this week, Sebi proposed to ease ownership norms for entities that plan to start new stock exchanges in India, a move that may end the 16-year-long dominance of the National Stock Exchange (NSE) and allow entry of foreign exchanges and lower the trading costs for investors.

Sebi has asked all the stakeholders in the business to express their views on the paper and send their opinion by February 5, so that it can collate all the views and present before its board at the earliest to take a final decision on the issue.

Currently, three SEs are operating in India, they include NSE, BSE and Metropolitan Stock Exchange, with NSE being the largest in terms of trade volumes both in cash and derivatives segments. Though BSE is Asia’s oldest bourse, almost all equity derivatives business in the country happens on NSE’s trading platform. NSE is the world’s largest derivatives stock exchange.

The reason behind the NSE cornering most of the trading volume and turnover is its better and effective use of technology and lack of ownership issue, which was the main obstacle for BSE, Asia’s oldest stock exchange.

NSE may be dominating the Indian SE space, but it has also faced several issues related to technical problems, causing unexpected trading disruptions and investors suffering for no fault of theirs. NSE is also facing Sebi.s investigation in the case of preferential access given to certain market players to its algorithmic trading terminals. This is precisely the reason why NSE’s initial public offering (IPO) has been delayed.

Sebi in its discussion paper said, “The Indian securities market has witnessed dominance in trading and depository space, raising concerns on the possibility of excessive concentration and institutional tardiness in quickly responding to the changing market dynamics which may have an adverse bearing on efficiency in trading, record-keeping, supervision and risk management practices".

A review is crucial to facilitate new entrants to set up stock exchanges or depositories, Sebi said.

The proposals, if implemented, will allow foreign exchanges to enter India either through joint ventures with a new domestic entity or through mergers with existing stock exchanges. The proposed norms will also allow new companies to acquire existing exchanges or facilitate mergers of existing exchanges and depositories.

This will increase competition, which in turn will lower the costs of trading for investors, attract more investors into the equity market, and lower the membership and clearing fees for brokers and other trading members. For setting up a new exchange, the promoter may hold up to 100 per cent stake initially and then lower it to either 51 per cent or 26 per cent within the next 10 years.

If the promoter of such a new exchange or a depository launching or entering in India is a foreign entity, it may hold up to 49 per cent, to begin with. This can be brought down to either 26 per cent or 15 per cent within 10 years, Sebi proposed.

At present, Sebi norms mandate exchanges to maintain a 51 per cent shareholding by the public and a total of 49 per cent holding by trading members, associates and agents. Foreign entities are allowed to hold up to 15 per cent in domestic stock exchanges.

Sebi said any person (domestic or foreign), other than the promoter, may acquire up to 25 per cent holding in an exchange or depository.

Also, at least 50 per cent of the ownership of the exchange or the depository has to be held by entities who have an experience of at least five years in areas of capital markets or technology related to financial services, Sebi proposed.

In case of an existing exchange or a depository, any entity may acquire up to 100 per cent shareholding and lower its holding 51 per cent or 26 per cent in 10 years, Sebi said.

However, for an acquisition of more than 25 per cent stake, prior Sebi approval will be required.

In such cases of acquisition, if the new promoter is a foreign entity, it may hold up to 49 per cent, which can be brought down to 26 per cent or 15 per cent in 10 years, Sebi said.

The regulator said that another dominant trend shaping the exchange and depository landscape is the emergence of new technologies such as distributed ledger technology, artificial intelligence and machine learning.

“Several new fintech or tech-fin players have emerged in trading space in various jurisdictions, who are increasingly deploying these disruptive technologies and challenging the traditional functioning of stock exchanges and depositories (collectively termed as market infrastructure institutions, or MIIs)," said Sebi.

“A need is, therefore, being felt to forge a competitive landscape in MIIs’ space by facilitating new players, who may like to challenge other MIIs in their already established domain, to set up MIIs or merge and acquire the existing entities," Sebi said. The existing norms not only inhibit entry of new players but also restrict the acquisition of existing exchanges and depositories, especially due to a default pre-condition of dispersed shareholding at the initial stage itself, which limits the upside gains for a potential entrant arising out of entrepreneurial capital.