Interoperability: Potential Game Changer for Indian CCPs

India has many stock exchanges, but trading is dominated at two main exchanges – the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). BSE is among the oldest stock exchanges in the world, while NSE was established as part of India’s economic liberalization process in the early 1990s. The NSE was quick to gain market share and now accounts for around two-third of stock trading and most of derivative trading in the country. BSE was slow to react to competition in the early days, but in the last five to six years has taken steps to up its game by making major changes in its technology. Structural issues with the Indian capital market have so far limited its ability to close the gap with NSE. The Indian CCPs that clear exchange trades are owned by the respective exchanges and at present only clear trades executed at the owner exchange. National Securities Clearing Corporation Limited (NSCCL) is the CCP for NSE while Indian Clearing Corporation Limited (ICCL) is the CCP for BSE. Interoperability among CCPs at an investor level is not allowed; i.e., investors can choose which exchange would execute their trades, but cannot choose which CCP would clear them. Therefore, in spite of having multiple players in the clearing space, there is not much competition among the CCPs. The dynamics in the Indian CCP space therefore are largely driven by the competitive developments on the exchange front. The capital market regulator SEBI allowed direct market access in India in 2008 and soon afterwards allowed colocation and smart order routing (SOR). This should ideally allow investors to execute their trades at any exchange of their choice. However, most of the liquidity is concentrated at the NSE due to its dominant position. Furthermore, since almost all of derivative trading takes place at the NSE, investors tend to prefer NSE for their equity trades as well, since that allows them cross-asset margining benefits of clearing trades in different asset classes at the same CCP. Because of this, smart order routing has not picked up in India yet. Thus algo trading reached around 15% in the cash segment in NSE in 2014, but smart order routing was only around 2%. Similarly algo trading was 70% at BSE’s cash segment, but SOR was around 1%. This shows BSE (and its CCP ICCL), with its improved technology and latency capabilities, is attracting a higher share of algo trades but is still unable to capture share in smart order routing, due to unique clearing arrangements in the market. Going forward potential allowing of interoperability promises to be a significant force of change for the Indian CCPs. It would give investors the freedom to choose their CCP, and if they get better latency and pricing from ICCL, they could choose ICCL regardless of BSE’s smaller share in trading volume. SEBI is considering this and is in consultation with a range of market participants. Eventual interoperability may be a boon for BSE and ICCL, allowing it to catch up with the dominant NSE and NSCCL.

Entry Load Ban and its Impact in India

India’s mutual fund sector has traditionally been dominated by investments from the institutional investors, namely banks and financial institutions, non-financial corporates and foreign institutional investors. However, mutual funds are primarily vehicles for retail investments. Retail investments accounted for 51% of India’s mutual fund industry AuM in 2012-13 growing from 43% in 2008-09. While the growth in share may be due to a temporary decline in institutions’ share, retail investments has grown continuously in recent years. More importantly average holding period has gone up in recent years. The practice of charging mandatory entry load was abolished by SEBI to reduce churning, since distributors would encourage investors to prematurely terminate their investments and make new investments as that gave them more commission. Since equity funds earned the highest commission, we analyze the changes in average holding period for equity investments from retail investors. It can be seen that proportion of investments held for over 2 years has gone up, for both retail investors and HNIs. This has come largely at the cost of investments held for between 1 and 2 years. The share of investments held for less than one year has remained more or less same during this time. This is perhaps due to the fact that distributors would typically not ask investors to churn their investments within a year of investment, but afterwards. This trend therefore suggests that the abolition of entry load has indeed resulted in investors holding on to investments for longer duration, and thereby engaging less in churning. holding period We discuss this and other key issues pertaining to the Indian Mutual Fund Industry in a new report.

The State of the Indian Capital Market

There are fundamental problems in the Indian capital market structure, such as lack of liquidity and limited depth and breadth. Many listed securities on stock exchanges are not traded; among the traded securities, not many are traded actively. The market is highly concentrated; a few companies dominate trading at the exchanges. This clearly narrows the breadth of the market, giving rise to liquidity problems for many stocks. Geographic breadth is another problem for Indian markets. Around 80% to 90% of total cash trading and 70% to 80% of mutual fund ownership come from the top 10 cities, with the top two cities (Mumbai and Delhi) accounting for about 60% in each segment.. These shortcomings can be addressed by technology development, better regulations, and focus on financial inclusion. India’s capital market regulator, Securities and Exchange Board of India (SEBI), has been addressing many of these issues. Although the equity market in India is relatively well developed, the debt market is lagging by some distance. The debt market is dominated by government securities. The corporate bond market is very small for a number of reasons, including lack of market infrastructure and adequate regulatory framework, low liquidity, lack of investor interest, etc. Efforts are being made to develop the corporate bond market. Some of the measures include increasing the limit for foreign participation, reducing issuance and transaction costs for corporate bonds, applying similar mark to market accounting requirements for loan and corporate bonds to discourage banks from relying heavily on loans, and setting up a basic framework of credit default swaps on corporate bonds in the country. Some positive results have been observed in recent years, but debt market development will require long-term efforts and commitment. By contrast, India has a healthy exchange-traded derivatives market. India started off with trading in derivatives in the early 2000s, initially allowing trading in index futures (2000) and index options (2001). Options and futures on stocks were allowed in 2001. Since then the product universe has expanded, as has the investor base, resulting in higher volumes and a robust trading platform with sound risk management practices. Index futures and options and stocks futures dominate derivative contracts traded at Indian exchanges. The investor segment is broadly classified into retail and institutional segments. The retail segment brings in the volume, but its trades are essentially low value. A key concern has been this segment’s drop in participation in the secondary market and also in IPOs. This decline began with the crisis in 2008, but the lackluster performance of most IPOs has contributed to what has become an alarming drop. Foreign institutional investors (FIIs) have been a dominant contributor to Indian markets. Since economic reforms started in 1991, India has focused on attracting foreign investment flows by relaxing eligibility conditions for FIIs, relaxing investment limits, and expanding investment instruments. The intermediaries in the market include the exchanges and brokerages. India has 22 stock exchanges registered with SEBI, with over 8,000 registered brokers and over 60,000 registered subbrokers. However, most of the trading takes place at the two major pan-Indian exchanges, National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). NSE is the largest exchange in the country, with around 70% of the equity volumes, while BSE is the second largest. A lot of revamp is happening within exchanges as they turn more competitive to gain market share. Brokers, both domestic and international, are competing in a highly fragmented market. The next wave of growth will probably arise out of technological capabilities, and hence brokerages are trying to outdo each other by providing advanced trading tools like Direct Market Access (DMA) support and algorithmic trading solutions. India has been an early adopter of the various technological changes occurring in the capital markets. With electronic trading picking up along with the adoption of the internet, booming retail equity business evolved in the last 10 years. Surprisingly, due to the market boom and IPO bonanza, retail adoption of technology initially outgrew technology adoption on the institutional side, where voice brokers still played a large part. As foreign participation in the Indian markets picked up, it brought in a rigor and technological requirement essential for international competition leading to adoption of the latest technologies by domestic market participants. A key reason for the success of the Indian capital markets has been the efficiency of SEBI, the capital market regulator. Four regulators control the participants in the securities market. There have been turf wars, and the future might see a super-regulator. India has a good regulatory environment regulating the capital markets, which shielded the economy, to some extent, from larger negative impacts of the global financial crisis and helped it regain its mark quickly afterwards. The regulator has been cautious in expanding the market, and transparency and investor protection have always been high on its agenda. This has sometimes created conflicts with industries as well as among regulators, but it has taken the markets along the right path of development.

Indian exchanges prepare for greater competition

The Indian capital markets regulator, SEBI, is talking reforms as it recently announced a blueprint that is potentially set to increase competition among exchanges. The regulator’s stance on increasing competition and allowing foreign investment in exchanges was closely anticipated in recent months, especially among large global banks. SEBI had to address pressing concerns on attracting foreign investment (Figure indicates the drastic fall in FII inflows into India in 2011) and failing to keep pace with developments in global capital markets. The new move by SEBI has cleared the way for listing of stock exchanges. This decision comes after an expert committee headed by former Reserve Bank Governor Bimal Jalan submitted its report in 2010 on governance and ownership issues relating to market infrastructure institutions. While SEBI has broadly accepted the recommendations, it has gone ahead with the move to allow public listing of exchanges despite the committee recommending against such a move on ‘conflict of interest’ grounds. The blueprint indicates that public holding of exchanges should be at least 51%, while exchange operator, banks and insurance companies are allowed to hold up to 15%. Foreign investors are allowed to hold up to 5%. Exchange operators, however, would not be allowed to list on their own exchanges. SEBI is watching developments in global capital markets closely. The developed markets in US and Europe are far ahead in terms of maturity of market infrastructure, while India is yet to reach a stage where alternative trading venues can compete with incumbent exchanges. The NSE started in 1994 to compete with the then singly dominant exchange, BSE. But ironically the NSE has today itself become what it set out to defeat, accounting for close to 75% of equity volumes. The attention is on regional exchanges to play more aggressively. With an intention to infuse more competition, the regulator has warned that dormant exchanges that are not attracting liquidity would have to be wound up. SEBI has stipulated a minimum annual trading volume of INR 1000 crores for exchanges to continue operating and the same would be reviewed after 3 years. While we see it as a timely warning bell, it is not enough. We have to wait and see how SEBI looks to empower and encourage regional exchanges. The Delhi Stock Exchange has already woken up to the competition by following in the footsteps of LSE in upgrading its IT infrastructure by partnering with MilleniumIT, a technology player which provides ultra-low latency trading solutions. The debate in ongoing in the case of clearing houses and the regulator is expected to come out with its view soon on having a single clearing house versus introducing interoperability. Although it appears that policy challenges facing SEBI are similar to those faced by regulators in developed markets in the past, and despite indications that SEBI is trying to align with developed markets, we should be careful while concluding that the Indian regulator would eventually follow in the footsteps of US and Europe.

The Curious Case of Transaction Taxes

The issue of Financial Transaction Tax (FTT) has come to the fore in the aftermath of the financial crisis. The main motivation behind such a tax is to curb speculative flow of international financial capital. It also has the potential to generate substantial revenue which can be used to fund social development, particularly in developing countries. According to estimates by Bill and Melinda Gates foundation, FTT can raise about $50 bn from G-20 member countries, while according to other estimates FTT can raise $250 bn if a wide range of transactions are included. Implementation of such a tax would also help in monitoring of cross country flows through centralized database; this will also make evasion of such tax difficult. Such a tax to discourage speculation in short term international transactions, also known as Tobin Tax, was proposed by James Tobin in 1972. Opponents of FTT argue that this tax would increase transaction cost thereby reducing efficiency and market liquidity. Moreover, if different countries apply different tax rates, that will result in unwarranted trading volume flows from countries with higher taxes towards countries with favorable tax regime. Needless to say, implementation of such a tax is contingent on agreement reached by the major countries, namely the G20 countries. In September 2011, the European Commission (EC) backed the adoption of an EC proposal to implement FTT in all 27 member-states of the European Union (EU). This tax will be levied on all financial transactions if at least one of the parties involved in the transaction is an EU country. According to this proposal, trading on stocks and bonds will be taxed at 0.1% while derivative trading will be taxed at 0.01%. Individual EU countries may charge higher tax. If approved, this will be effective from 2014 and is estimated to raise $78 bn a year. This proposal has the backing of the two major EU nations, Germany and France, while the United Kingdom (UK) has expressed its reservation over it. British government’s position is that they would back FTT only if it is applied globally; otherwise, it fears, London, a major financial hub, will lose out to New York and Hong Kong in competitiveness. Similarly other countries like U.S., Canada and Australia have also resisted the idea of introducing FTT. Among the emerging nations, Brazil and South Africa have backed the introduction FTT, but India has expressed its reservations against it. India says this tax would be an additional burden on Indian banks which are mandated to set aside significant amount of funds to meet regulatory requirements (i.e., maintain cash reserve ratio and statutory liquidity ratio). India’s position is interesting on two counts. In 2003, India had backed a similar idea to introduce an ‘international levy’ to prevent ‘unstable capital flows’ which ‘can severely disrupt developing economies’. Such a tax was then considered to be ‘an instrument to protect weak economies from the volatility of capital … and to generate valuable developmental resources’. Secondly, in 2004, India itself introduced a similar measure, the Securities Transaction Tax (STT), in its equity and derivative market – this is a tax levied from traders, domestic and foreign, on all transactions that happen in these two market segments. The motivation behind the introduction of STT was pretty similar too, i.e., generating extra tax revenue and protecting market integrity. While it is debatable if this tax has been able to rein in speculation in the markets, it can be safely argued that this has not resulted in significant drying up of liquidity in the markets, as had been originally feared. Additional revenue generated due to this tax contributed to around $1.5bn to the government’s exchequer last year. However, the capital market regulator, the Securities and Exchange Board of India (SEBI), the exchanges, brokers and investors are in favor of abolishing STT. They believe the cost of transaction in India is high; they expect abolition of STT will positively impact the market turnover as lower or no STT would help in higher algorithm trades high frequency traders in driving up trading volumes. SEBI is currently reviewing the impact on the stock market turnover from a possible scrapping of STT and would submit its findings to the Finance Ministry who will take the final call regarding this issue. The Finance Ministry’s capital markets division is said to be in favor of reviewing the STT framework with a view of either scrapping it altogether or in a phased manner, but a final call is unlikely to be taken before the next budget. All these decisions, be it for FTT or STT, effectively come more under the purview of political agents and governments than regulators or technocrats. While the FTT issue is likely to be again discussed in next G20 meeting, decision on STT is likely to be announced by next Indian budget. Hence, their acceptance or rejection will largely depend on the political environment that is to unfold in the next few months.

IPO for Indian Life Insurers

In October 2010, the capital market regulator, Securities and Exchange Board of India (SEBI), approved life insurance companies to issue IPOs. India’s insurance regulator, Insurance Regulatory and Development Authority (IRDA), has been planning to come up with guidelines for IPOs of life insurance companies for quite some time; an announcement is expected within the next few months. Current regulations allow only those insurers that have been in business for at least 10 years to go for an IPO. The government is likely to bring this down to five years; however, a final call is yet to be taken. Another such pending proposal is raising the limit of foreign ownership in a joint venture life insurer to 49% (currently capped at 25%). After an IPO, foreign promoters will have to bring down their stake to ensure Indian promoters hold a majority. An insurer opting for a public offering must also offer at least 25% of the shares to the public. Like any other IPO, pricing of an insurance IPO is an area of concern. This is more so for two reasons. First, insurance is a key sector of the economy with a large number of stakeholders; this sector is being allowed to participate in fund-raising from the capital market for the first time. Therefore, overly optimistic valuation may be detrimental to the sector in the long run. Second, in light of the recent events in Japan, it has become critical that all relevant factors affecting the insurance industry are priced in appropriately. The IRDA is likely to spell out appropriate guidelines regarding valuation accordingly. Insurance IPOs are expected to gain traction in the medium to longer term; however, this will also depend on the evolution of the markets and regulatory landscape. The Indian capital market seems to have hit a roadblock in recent months due to high inflation threatening growth prospects. The insurance sector in particular has been adversely affected. New policy sales by private firms took a hit in 2010, and margins are also under pressure. The Direct Tax Code (DTC), scheduled to implementation in 2012, is another cause for concern. This may remove some tax advantages for certain insurance products and raise the tax burden on insurance companies, which is likely to have an adverse impact on sales and profits. Several private sector insurers, including the likes of ICICI Prudential Life, Reliance Life Insurance, SBI Life Insurance, and HDFC Standard Life, are planning to tap the capital market. However, their expected times of offering may differ. While some may go for IPOs in the very near term, others may wait for some time. For example, Reliance, which has been supporting the reduction of the 10-year operations rule to five years, can be expected to raise money from the public in the short term. On the other hand, SBI Life is not in a hurry and wants to wait and watch as the regulations evolve. So even if IPOs do not pick up in the near term, they are likely to become popular in the medium to longer term.

IPO Pricing Issues in India

One of the most important issues in floating an IPO is the pricing aspect. Different forces, often in conflict with each other, are at play here. Issuers would ideally like to maximize the proceeds from the process. Investors would want the offer to be under priced at best and to be (near) correctly valued at worst. Underwriter gets a portion of capital raised as fee, and they would want to maximize their income. But if an IPO is overpriced, there may not be sufficient demand from the market and as a result the issuer may not be able to sell all the shares it had planned. The reputation of the underwriter is also at stake here. It has been observed from empirical data that historically IPOs have been under priced. However, the trend regarding pricing of IPOs seen in India over the last one year has followed an opposite pattern. It has been observed, 70% of the 55 firms that went for IPO during the period April, 2010 to March, 2011, are trading below their offer price. Moreover, 70% of the same 55 firms traded at premium on their listing days, but price fell on subsequent trading days. This implies only very short term investors have actually benefited from these offerings. This is even more surprising when one considers IPO performance in conjunction with overall market performance. In August 2009 BSE created an IPO index that tracks the value of companies for two years after IPO starting from the third day of trading. The graph shows the movement of this BSE IPO index along with that of the SENSEX. It is noteworthy, while the two moved in tandem initially, they have diverged from each other since September, 2010. Thus while the SENSEX gained over 10% during April 2010 to March 2011, BSE IPO index fell over 15% during the same period. This implies overall market condition is not to be blamed for the poor performance of the newly listed firms. This does not augur well for the markets. Retail investors, most of whom invest with medium to long term objectives and are not very sophisticated or well informed, suffered heavy losses and may lose interest in the IPO segment. The pricing of IPOs has come under scrutiny from a number of market participants and the capital market regulator, Securities and Exchange Board of India (SEBI), has taken note of the situation. In the past SEBI had expressed its displeasure regarding overpricing of IPOs and asked the underwriting banks to be more prudent regarding IPO pricing. Recently SEBI proposed that underwriting banks must disclose to investors the performance and track records of their earlier issues in their prospectus and on website. The regulator is also concerned about hyping of public issues through misleading advertisements and media reports and could propose strict penalty if underwriters are found to be involved in such activities. Moreover, SEBI has expressed its displeasure over investment banks, vying among each other to bag deals, quoting very low fees from issuers, thereby promoting issuer interest above investor interest.

Trends in Indian Mutual Funds since Abolition of Entry Load

The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets. According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened. Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds. In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Quarterly Equity Mutual Fund Sales

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The Securities and Exchange Board of India (SEBI) has undertaken a number of initiatives and brought in new regulations for the mutual fund industry in the last two years, the most important change being the abolition of entry load for selling mutual fund products since August 2009. The effect of this rule change has been widely debated. Some argue the impact of this change has not been significant as fund flows have registered year on year growth in 2009, while others argue that in absence of upfront commission distributors are now less motivated to sell mutual funds. We take a look at quarterly sales data of equity mutual funds to analyze the effect. Sales of euity funds, which constitute a third of industry AuM, is a good proxy to understand retail investor buying behavior, because the retail (including HNI) segment accounts for around 85% of total equity fund assets.

According to data from AMFI, quarterly sales have been steady since the second quarter of 2009, and higher than they were in 2008. However, one needs to decouple the effects of the crisis that hit the markets in 2008. From the figure, one can conclude that though equity fund sales grew after the rule change, they are still far below the trends observed during 2006–2007. The decline in 2008 was due to market conditions, but subsequent recovery has not been commensurate with overall market improvement. Equity fund sales moved in tandem with SENSEX in the pre-2008 period, but post-2008 the gap has widened.

Two points are worth considering here. The crisis of 2008 may have made investors more risk averse. While they were buying heavily during the bull run of 2006-07, post-crisis they have become apprehensive of investing in mutual funds. Another reason for lack of investor participation can be the lower returns generated by the fund managers. A recent study by Standard & Poor’s and CRISIL showed that a majority of actively managed mutual fund schemes in India have underperformed their respective benchmarks over the five-year period ended December 31, 2010. This may have made retail investors shy further away from investing in mutual funds.

In summary, it can be said that the recovery of the Indian mutual fund industry since the crisis of 2008 has not been commensurate with the overall market recovery. The abolition of entry load has had an impact on sales from the retail segment, but it is not the only reason. Failure to outperform benchmark indices is another equally important issue afflicting the industry.

Putting the best foot forward, by choice

The recent City Day organized by SunGard in Mumbai provided interesting insights into India’s equity trading industry. Mr. Damodaran, ex-head of SEBI, the capital market regulator put India’s liberalization and globalization into perspective by pointing out that often in its recent history India has been forced to take actions that are seen to be desirable in hindsight. In 1990-91, it was the precarious forex reserves situation that forced India to open up its economy. Moving on two decades down the line, one hopes that electronic trading in the form of Direct Market Access (DMA), Smart Order Routing (SOR) and algorithmic trading would be something that our capital markets adopt out of choice and because they see the merit in doing so, as opposed to either being forced to do it, or even worse, not doing it at all and facing the possibility of extinction once the global broker-dealers enter the market in a big way. A trend that usually follows the widespread adoption of electronic trading is the concentration of trading, especially in one financial center across a region. In Europe, London happened to be the center that benefited most from the introduction of these technologies. Similarly, markets such as Japan, Korea, Taiwan, Singapore and Hong Kong are adopting high frequency trading in a big way. India cannot afford to be left behind in this context. The same goes for the leading brokerages in the Indian markets. It takes a trading desk between six months to a year to fine-tune its electronic trading capabilities. The longer the delay in getting the buy-in to do so, the lower the chance of success and indeed survival. The buy-side also has to be decisive and quick in its approach. Moving on to some of the other presentations in the event, there were useful inputs given into the issues that are cropping up in terms of the infrastructure for electronic trading. While NSE has a fast matching engine, the rest of the infrastructure has a long way to go. As pointed out, in Indian centers outside Mumbai the contrast between Indian and international capabilities is even more stark and communication networks have been found lacking. Data quality is also something that brokers, especially the smaller ones are struggling with. In this scenario, it is important that India opens up its markets to globally renowned vendors, while at the same time encouraging its local IT firms to also compete in the market. The Indian market is large enough for a number of firms to participate and be able to meet the various requirements for electronic trading.

Equities Trading at Indian Exchanges: Competition Can Wait

MCX-SX, which offers trading in currency futures, had requested to the Securities and Exchange Board of India (SEBI), the capital market regulator, for approval to launch trading in equities, equity derivatives, interest rate futures and other instruments. It was thought that this move would add a new dimension to India’s exchange landscape which is dominated by the two main exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The recently started United Stock Exchange, which commenced its operations in the currency futures segment on 20th September, 2010, recorded on its very first day a turnover more than that of the combined turnover at NSE and MCX, the country’s existing currency trading exchanges. It was anticipated equities trading at MCX, if approved, would also throw up similar competition to the country’s two existing exchanges. In September 2008, MCX-SX was conditionally recognized as stock exchange trading in currency futures by SEBI for a year; recognition was extended in August 2009 for one more year to give MCX more time to comply with requirements. In April, 2010 MCX-SX sought permission seeking approval for trading in segments permitted to BSE and NSE. In July, 2010, MCX-SX filed petition before the Bombay High Court seeking intervention over the delay in approving its application by SEBI; in August 2010, the Bombay High Court asked SEBI to take a final decision on the matter by September 30. On 23rd September, 2010, SEBI rejected the application stating it ‘was not satisfied that it would be in the interest of trade and also in public interest to allow the application’. SEBI’s rejection, as mentioned in its order, was based on a number of issues. Under MIMPS (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges Regulations), no person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent of the equity share capital in a recognized stock exchange. A select class of financial institutions, however, can own up to a maximum of 15% each.
  • MCX-SX is promoted by Multi-Commodity Exchange of India Ltd (MCX) and Financial Technologies India Ltd (FTIL). When MCX-SX was formed, its promoters MCX and FTIL owned 51% and 49%, respectively, which, after divestment, came down to 37% and 33.9%. The promoters in April, 2010 undertook a further financial restructuring to comply with regulations, by reducing their respective shares to 5% each. However, it also issued warrants to MCX and FTIL, which allows the promoters to gradually sell the warrants under favorable market conditions. Under this arrangement, according to SEBI, MCX and FTIL have together now a holding of 71.90% in the shares and warrants issued by the company.
SEBI listed ‘excessive concentration of economic interest in the stock exchange in the hands of the two promoters’ and ‘not being fully compliant with shareholding regulations‘ as reasons for rejection.
  • MCX-SX had submitted that the two promoters did not share a common management, but it (SEBI) found the two entities are operating under a common management. According to SEBI, therefore the share holding of FTIL together with that of MCX (5% each) exceeds the permissible limit of 5% limit of ownership in a stock exchange.
  • SEBI stated that ‘the promoters of MCX-SX and their associates had arrangements with three shareholders of MCX-SX where sale of shares between the parties were based on offers to buy back the shares at or within specified time in the future’. It found such arrangements illegal.
  • In its order SEBI said ‘MCX-SX has been dishonest in its disclosures to SEBI on material information and has failed to fulfil its disclosure and fiduciary responsibilities’ and also it ‘has failed to adhere to fair and reasonable standards of honesty that should be expected of a Stock Exchange’.
MCX-SX may appeal to the Securities Appellate Tribunal (SAT) against the decision, or go for a writ petition in the high court.