SEBI’s decision on Jalan Committee: Neither socialist nor capitalist and therefore unworkable  

April 3, 2012

SEBI tweaks Bimal Jalan Committee Report and makes a mess of it. The new rules may favour NSE management but the investors of NSE, BSE and aspirant MCX-SX feel let down

Sucheta Dalal

The Securities and Exchange Board of India (SEBI) has virtually junked the Bimal Jalan Committee report on key issues, without saying so. In the process, it has pushed the exchanges into a scenario where they are neither in a socialist regime (they were not-for-profit, members-only associations before demutualisation) nor fully capitalist institutions chasing profits and innovation. The hybrid model will be unworkable and like SEBI's other measures, will have the unintended consequence of slowing down change.

Ironically, while SEBI has scrapped the Jalan Committee's recommendation not to permit listing for five years, it has, in fact, ensured that the bourses are no longer attractive investments either to retail investor or institutions. Under the new rules, the stock exchanges will be mandated to transfer 25% of their profits to the Settlement Guarantee Fund (SGF) of the clearing corporation to meet contingencies and 'black swan' events. How will investors react to this? Investors invest in companies on the assumption that its management and employees will strive to maximise profits for shareholders and that their effort will be fully reflected in the stock price discovered through fair trading on the bourses. But with 25% of the profits forced to be stashed away in a SGF, would investors still be interested in exchanges and listed entities? The answer lies in the fact that the Bombay Stock Exchange (BSE) has not issued any press release expressing delight at SEBI's recommendations. The idea exposes how bureaucrats and bankers sitting on the SEBI board are clueless about the basic philosophy and mechanics of a joint stock company.

Even if the BSE and its members manage to get it listed under the new rules, valuation is hardly likely to be attractive since it will only be based on 75% of the earning potential. This will also mean that if the BSE is listed at all, it will be fully focussed on maximising revenues by working in the interest of pattern traders, speculators, algorithm traders and other high volume operators. This is already distorting price discovery, affecting retail investor who hopes for short term gains and even mutual funds in getting the best price.

Most importantly, SGF is a critical part of maintaining stability of exchange operations. Why should it be funded out profits which will fluctuate from year to year? And if MCX-SX is allowed to launch its equities segment, it may not even be profitable. Will it then not need to contribute to a Settlement Guarantee Fund? Clearly, SEBI has not thought of the implications. What is also not clear is what happens to the current mechanism of SGF, where clearing members contribute. Will this be disbanded?

As for the NSE (National Stock Exchange), it has always been reluctant to get listed even though it has accepted large institutional investors and even individuals as shareholders. With the NSE's 'professional' top management already having wangled salaries that are among the highest in the corporate world, it would hardly want to be in a situation where this pay is directly linked to performance. The near monopoly bourse is now in a happy position-even if its lists its shares, in order to provide a "market determined" exit route to investors, it can always blame the SEBI for undermining its valuation.

The irony is that SEBI has taken the bourses, which are essentially market utilities providing an efficient trading platform, and left them in a vague space that is neither a capitalist venture, focused on the bottomline, nor a not-for-profit association that bourses were in the past. NSE chairman Dr Vijay Kelkar repeatedly refers to the bourses as utilities, although the NSE itself is a hugely profitable monopoly paying top salaries to its senior management.

SEBI's attitude is probably the outcome of blindly aping the failed American model and not having the vision and depth of understanding to work on a model that suits the Indian market. The SEBI board has retained the Bimal Jalan Committee's recommendation to cap variable pay, make it payable after three years and bar stock options. But we understand that this too will only affect the BSE, not the NSE.

As for future competition, SEBI rules as cleared on Monday (2 April 2012) make the business unattractive for MCX-SX, which was seen as a potential threat to NSE's monopoly. We also learn that the battle over the permission to permit it to start equity trading is far from over. SEBI, says sources, seems all set to appeal to the Supreme Court against the Bombay High Court verdict, essentially to avoid controversy or allegations that it is favouring MCX-SX.

The upshot is that neither brokers (stakeholders in the BSE which has got de-mutualised) nor bourses are happy with SEBI's new set of rules for stock exchanges. Another expert source told us, "The new rules spelt out by SEBI will make exchanges more bureaucratic and mechanical. They will go back to being a utility without room for innovation or competition".  The consequence, he says, will be the inability to attract management talent.

A leading broker could not hide his disappointment. He says, "Demutualisation of bourses was the first mistake. But we are now hoping that the exchange can get listed and we can extract some value out of our membership at a time when investors seem enthusiastic about bourses after MCX's successful listing".

He is also angry at the decision to keep brokers out of the governing board.  He says, "We are tired of being treated as non-trustworthy". However, this decision is prompted by the need to avoid conflict of interest issues that could arise if brokers were on the board and exerted influence over office bearers.

SEBI's policy on Market Infrastructure Institutions (MIIs) released on Monday says, "The stock exchanges will have diversified ownership and no single investor will be allowed to hold more than 5% except the Stock Exchange, Depository, Insurance Company, Banking Company or public financial institution which may hold up to 15%". But it will be interesting to see who lines up to acquire the shareholding and at what valuation given, the peculiar hybrid SEBI has created.

(Additional reporting by Aditya Govindaraj)