Stock Exchanges: Behind the Ruse of Demutualising

We are witnessing a second stock market crisis in a period of less than three years, a far more serious one than the first. The government set up SEBI in 1988 expecting that it would give a clear direction as to how the equity markets could be reformed. Manmohan Singh had realised that day-to-day regulation of the stock exchanges could not be done from the finance ministry and therefore he gave statutory powers to SEBI which had till then been denied to it. He also took the bold decision to encourage select public institutions to set up the National Stock Exchange (NSE) as an ordinary limited liability company under the Companies Act, 1956. NSE is as a result subject to corporate tax on its profits and dividend tax on the profits distributed to its shareholders. Other stock exchanges in the country are exempt from all taxes because they are supposed to be charitable institutions! In all the crises that have hit the stock markets after it was set up, the NSE is the only exchange which has consistently emerged unscathed.

The NSE has brought about significant reforms in the markets and introduced several new risk management and risk containment practices. The clearing corporation with a large settlement guarantee fund is intended to weather all settlement difficulties and crises as it acts as a central counter-party for all settlements. The SEBI, for reasons not clearly known, had shown, until recently, scant interest in NSE’s clearing corporation model and did not ask other exchanges to opt for a similar mechanism. After the recent severe crisis hit the markets SEBI issued an overnight directive to all exchanges to adopt the NSE model. According to market observers, SEBI’s lack of interest in bringing about the necessary reforms in this area was largely due to the unwillingness of the broker-controlled exchanges to accept the NSE model as it hurt the ego of the broker community. Similarly, SEBI did not show much keenness to introduce rolling settlements so far mainly because brokers did not want the badla trade to end. As market players know, the badla trading system would lose all its charm once rolling settlements are introduced. It is not possible to manipulate trading patterns and stock prices or do front running without the help of badla trading under a regime of a weekly trading/settlement cycle.