Why the National Stock Exchange should not be listed

It could be a matter of concern that foreign shareholders of the NSE are registered in tax havens such as Mauritius and Cyprus, says Jaimini Bhagwati. 

On 6 July 2016, the National Stock Exchange (NSE) Chairman Ashok Chawla was reported in The Economic Times as having said that “a credible road map has been put in place for listing NSE”.

The same news item mentions that NSE is expecting to file initial public offering (IPO) papers with the Securities and Exchange Board of India (Sebi) in January 2017. This is an alarming development.

The Bimal Jalan Committee on “Review of Ownership and Governance of Market Infrastructure Institutions (MIIs)” submitted its report to then Sebi Chairman C B Bhave in November 2010.

Stock exchanges, depositories and clearing corporations are categorised as MIIs. This Jalan report stated categorically that the committee “is not in favour of permitting listing of MIIs”.

The report also mentioned that the working of MIIs should be reviewed after five years.

Sebi’s website does not provide information on why and how it has considered listing of MIIs. This article examines the considerations, if any, which justify listing of NSE. 

The Harshad Mehta stock market scam was first exposed by Sucheta Dalal in the Times of India in April 1992.

The central government was already concerned about BSE’s monopoly in stock trading and that BSE did not want demutualisation.

In demutualised stock exchanges ownership, management and broker dealerships are segregated from each other.

The government had set up a High-Powered Study Group on Establishment of New Stock Exchanges. This group recommended setting up a new exchange sponsored by government owned financial institutions. 

The NSE was set up accordingly and in April 1993, it was recognised as the first demutualised exchange in India under the Securities Contracts (Regulation) Act.

NSE’s founding shareholders were majority government-owned institutions such as the Life Insurance Corporation of India (LIC), State Bank of India (SBI), IFCI, Infrastructure Development Finance Company (IDFC) and Stock Holding Corporation of India.

Some of the foreign investors are SAIF II SE Investments Mauritius, Aranda Investments Mauritius (which is a wholly owned indirect subsidiary of Singapore-headquartered Temasek Holdings) and GAGIL FDI (Cyprus).

It could be a matter of concern that foreign shareholders of the NSE are registered in tax havens such as Mauritius and Cyprus.

In addition to providing a trading platform for stocks, derivatives and debt instruments stock exchanges also have an important surveillance function.

According to Sebi’s annual report for 2014-2015, 59 per cent of cases relating to market malpractices involved manipulations and price rigging.

We are well aware that insider trading is a practice which is prevalent globally but perhaps to a greater extent in listed Indian family-owned companies.

There are also periodic instances of circular trading in shares of smaller, less well-known companies to drive up their prices artificially.

To that extent, Indian stock exchanges need to be even more vigilant that their counterparts in developed jurisdictions to prevent market manipulation. 

NSE’s first managing director was the widely respected late R H Patil.

He is reported to have commented, in an interview with India Infoline News Service, that there are the following major risks associated with NSE doing an IPO.

Namely, that “NSE shareholders might want to maximise returns whereas NSE was set up with a view to speed up market reforms” and “some of the brokers may corner NSE shares and ask for seats on the Board, which cannot be allowed”.

Patil ably assisted by Ravi Narain and Chitra Ramakrishna enabled the NSE to soon overtake the BSE, till then only major stock exchange, in trading volumes.

The BSE continued for some time to maintain that the practice of “Badla” was a home grown derivative product and also resisted demutualisation.

The NSE had a major role in providing competition, taking the lead in introducing exchange traded derivatives in 2000 and improving probity in Indian capital markets.

As the Jalan Committee report notes, MIIs including stock exchanges are systemically important institutions which have surveillance responsibilities.

In this context, should profit maximisation be part of the mandate of MIIs?

Well, that would be a slippery slope downwards on all issues which have a bearing on NSE’s quasi-regulatory responsibilities.

As for other listed companies, another issue which would arise would be whether capable NSE executives should be offered options on NSE stock.

That would inevitably skew incentives towards raising NSE stock prices.

How would that square up with the unfavourable publicity associated with making wrong-doing by NSE personnel public?

Yet another issue would be whether management compensation should be linked to the performance of NSE stock prices.

Even if so called Chinese walls were to be erected between surveillance and management this is not likely to work well in practice.

Stock exchanges in several developed countries are listed and in most cases these exchanges are listed on themselves.

Such practices are cited as examples for Indian stock exchanges to follow.

In this context, should NSE be listed on NSE? It has to be near impossible to manage the consequent conflicts of interest. Would NSE be comfortable being listed on BSE?

The New York Stock Exchange (NYSE) has been fined periodically by the Securities and Exchange Commission (SEC).

For instance, in September 2012 NYSE was fined $5million for giving proprietary customers advance information on market data before it went to the public.

Again, in May 2014, NYSE was fined $4.5 million for ignoring rules e.g. on how price information is provided to brokers. NYSE is a self-regulating organisation (SRO) and its rules have to be submitted to SEC for approval.

It is not clear how an exchange can be a SRO if it also has to push for profits. 

It appears from media reports that one of the reasons that NSE is considering an IPO is because a few of its existing share-holders want to exit.

To sum up, given the downside risks that is not reason enough for the NSE to do an IPO.

It should be possible to exit at fair valuations even without listing.

The writer is the RBI Chair professor in ICRIER and former joint secretary (capital markets) in the Ministry of Finance. Views are personal.