‘After the NSE deal, everybody wants an Aishwarya Rai kind of valuation, but it is not going to happen,” says a market participant in typically colourful market-speak. Notwith-standing the Bollywood allusion, what he says is perfectly true. Restrictive ownership and irrational fears are killing the prospects of appropriate valuation as well as the growth and globalisation of Indian bourses.
The New York Stock Exchange’s (NYSE) acquisition of a 5% stake in the National Stock Exchange (NSE) for a fancy price seemed to signal the first baby step towards Indian markets making their global debut; but it seems set to remain a one-off deal. Although NSE’s high profitability and operating margin of 53% is attractive, NYSE’s valuation of its 5% stake seems based on the expectation that a foot in the door is a step towards a significant strategic investment when regulations permit it.
Unfortunately, for all others, the 5% cap on individual ownership is turning off potential strategic investors. This is likely to jeopardise the transformation of India’s many regional bourses, as well as the development of a much-needed market for Small and Medium Enterprises (SMEs). In March 2006, the Ananthraman Committee had recommended permitting strategic investment in bourses of upto 26%. But this has been negated by the 5% cap. The regulator is correctly worried that without a cap on individual share ownership in the formerly broker-owned bourses, a situation could arise where a savvy but dubious market operator would buy out the individual brokers and acquire control over the bourse. But why throw out the baby with the bathwater? Instead of a blanket 5% individual limit, Sebi could have made an exception for strategic investment by a recognised bourse—domestic or international—with the specific prior approval of the regulator.
In any case, the Securities Contracts Regulation Act allows the central government, and by delegation the market regulator, enormous powers to make or amend bylaws of stock exchanges, supersede their governing body, suspend their business or even issue directions. All these powers can be effectively used to ensure that demutualised and listed stock exchanges is not taken over by a cabal of brokers acting in concert or by a corporate entity. Instead, Sebi’s cap at 5% seems strangely contradictory to the global trend of trans-border consolidation of bourses in line with the NYSE-Euronext or Nasdaq-LSE deals. Moreover, the foreign equity ownership in the new multi-commodity bourses is significantly higher than 5%; so is the individual holding of several institutional investors of the NSE.
The Bombay Stock Exchange (BSE) has been badly hit by the Sebi decision, especially since it is working against the clock to complete its corporatisation process by May 19, 2007. The 5% ownership restriction will hurt its valuation, put it at a competitive disadvantage and widen the gap with the NSE.
On the other hand, a strategic partnership with a leading global exchange could have rejuvenated the BSE, activated its derivatives and debt segments and rekindled competition between the two bourses. This could have led to innovation and lower transaction charges, which would benefit both investors and listed companies. The BSE could also do with help in reassessing its infrastructure. Sources say that unless the BSE thinks ahead, the cost of maintaining and expanding its Tandem Computer-based system could eat into its profitability over the years. Since the BSE is also keen on being listed, public scrutiny may have enhanced transparency and performance.
The irony is that under the chairmanship of M Damodaran, Sebi had taken several steps to give the BSE a competitive edge. For instance, it chose the BSE as the reporting exchange for debt market trades. But the 5% rule has against tilted the balance hugely in NSE’s favour.
The problem is not limited to the BSE. Regional exchanges also hoped to bring in strategic partners at attractive valuations and transform themselves into specialised bourses that would explore new niches such as the SME segment. Such initiatives will now be put on the backburner, leaving the regional exchanges to languish without business or clinging to the national bourses for survival.