Corporatisation and Demutualisation of

Stock Exchanges
I. What is Corporatis- demutualisation.
ation and Demutuali- As per SCRA, all RSEs, which are not corporatised
sation? and demutualised, have to be corporatised and
Corporatisation and demutualised by an appointed date as may be specified
Demutualisation by SEBI. Different appointed dates may be specified
(C&D) is a process to for different exchanges. The exchanges shall be
change the organizat- corporatised and demutualised in terms of a scheme
ional structure of the for C&D submitted by the exchanges and approved by
stock exchanges from SEBI. The exchanges which are already corporatised
non-corporate mutual and demutualised are not required to submit the
form to corporate scheme for C&D to SEBI.
demutual form where
the ownership / II. Why Corporatisation and Demutualisation?
management rights The exchanges frame and enforce rules, which may not
M.S.Sahoo and trading rights are always, further the public interest (interests of investors
Chief General Manager segregated. These and the society) and the private interest (interests of
Securities & Exchange Board of rights may be held and trading members) simultaneously. Theoretically public
India exercised by the same interest gets precedence in a demutualised exchange
or different sets of people depending on the objectives while private interest gets precedence in a mutual
of the C&D. exchange in the formulation and implementation of
As defined in the Securities Contracts (Regulation) the rules. In a mutual exchange, the trading members
Act, 1956 (SCRA), ‘corporatisation’ means the succession elect their representatives to regulate the activities of
of a recognised stock exchange (RSE), being a body of the exchange, including their own activities. As a
individuals or a society registered under the Societies result, in case of a dispute between trading members
Registration Act, 1860, by another stock exchange, being a and the investors, investors’ interests may not always
company incorporated for the purpose of assisting, regulating receive the same utmost objective treatment. The
or controlling the business of buying, selling or dealing in regulatory and public interest roles of the exchange
securities carried on by such individuals or society. This may give way to private interests of the elected
requires incorporation of a company with the main directors. As the self sometimes may get precedence
objective of succeeding a RSE, which is a body of over regulation, mutual exchanges generally do not
individuals or a society. The provisions relating to offer an effective model for self-regulatory
issue of shares, rights of shareholders, holding of organisations. On realising the limitations of the mutual
equity capital by non-trading members, etc. in the structure and discovering the advantages of the
SCRA make it clear that the company needs to be a demutual structure, the stock exchanges all over the
company limited by shares. Hence if the RSE is already world are reorganising themselves as commercial
a company, it does not require to be corporatised. It entities and undergoing a process of demutualisation.
may, however, change the corporate structure to that This is not to say that the demutual structure is definitely
of a company limited by shares. a superior model for stock exchanges.
As per SCRA, ‘demutualisation’ means the segregation The limitations of a mutual structure has been realised
of ownership and management from the trading rights of the time and again by the exchanges and the regulators in
members of a RSE in accordance with a scheme approved by India. The High Powered Committee on Stock Exchange
SEBI. The demutualisation, thus, intends to segregate Reforms in early 1980s, the High Powered Study Group
the ownership and management rights from trading on Establishment of New Stock Exchanges in early
(including clearing) rights. This does not propose that 1990s and the Group on Corporatisation and
one set of people will have only ownership and Demutualisation of Stock Exchanges in early 2000s
management rights and another set of people will have observed that most stock exchanges had failed to
only trading rights. The same set of people may have develop good corporate governance practices and
both the rights simultaneously, but these must be strong management teams and the conflicts of interests
clearly identifiable and severable. Each of these rights had bedeviled the operations of the stock exchanges in
can be acquired, exercised and extinguished separately. the past to the detriment of the securities market.
This is in contrast to the current membership rights Reforms, therefore, initially focused on reducing the
which camouflage both the rights and can not be dealt dominance of trading members in the management of
with separately. The exchanges where these rights are stock exchanges by prescribing the composition of
not segregated will have to undergo the process of governing council and strengthening the position of
executive director. This did not materially alter the Budget 2001-02: The Income Tax Act, 1961 was
situation. The exchanges continued to witness different amended to provide that any transfer of capital asset
types of crises from time to time. The post-mortem of from an association of persons or body of individuals
these has generally revealed complicity of elected to a company in the course of corporatisation (‘and
directors. The investigations into the massive rigging demutualisation’ added in 2002-03) of a RSE shall not
in prices of certain scrips during May-June 1998 revealed be regarded as transfer for the purposes of capital
a number of systemic deficiencies including the gains tax.
composition of governing councils. Before these Budget 2002-03: The process of demutualisation would
systemic improvements could be effected, the market be completed during the course of the year to implement
witnessed a major misconduct in early 2001 involving the decision to separate ownership, management and
some trading members and the banking system. These operation of the stock exchanges.
led to the inevitable conclusion that the quality of November 2002: The Group on C&D of Stock
trading members-managed exchanges is far from Exchanges under the Chairmanship of Justice M. H.
satisfactory. Kania for advising SEBI on C&D of stock exchanges
In order to reduce the dominance of trading members and to recommend the steps that need to be taken to
in the ownership and management, it was considered implement the same submitted its Report to SEBI on
necessary to restrict their ownership and management August 28, 2002. SEBI Board broadly accepted the
rights without affecting their rights to trade. Such recommendations of the Group.
restriction is possible only if these rights are segregated December 2002: The Joint Parliamentary Committee
by demutualisation. Such segregation is possible only on the stock market scam and matters relating thereto
if the exchange is corporatised. The corporatisation recommended that the process of corporatisation and
creates two types of members, namely shareholder demutualization should be expedited and underlined
members and trading members. The existing trading the necessity for early implementation of C&D of stock
members of the exchange are granted shareholding exchanges. The Government, in its action taken report
rights of the company and trading rights on the laid before both the Houses of Parliament, assured that
Exchange. The ownership and management rights legislative amendments to give effect to this
associated with shareholding are restricted in case of recommendation will be made.
trading members. Thus corporatisation is a necessary Budget 2003-04: To enable corporatisation, the budget
condition for demutualisation and demutalisation is a proposed amendments to the SCRA in the same Session
necessary condition for restriction on ownership and of the Parliament. It amended the Income Tax Act, 1961
management rights of the trading members. Hence the to provide that any transfer of capital asset, being a
non-corporate exchanges need to be corporatised and membership right held by a member of a stock exchange
demutualised, while corporate exchanges need to be for acquisition of shares and trading or clearing rights,
demutualised. shall not be regarded as transfer for the purposes of
The “Statement of Objects and Reasons (SOR)” capital gains tax.
appended to the Securities Laws (Amendment) Bill September 2003: The Securities Laws (Amendment)
2004 (subsequently converted to the Securities Laws Bill, 2003 was introduced in Lok Sabha to amend the
(Amendment) Act, 2004), stated: Although the SCRA SCRA to provide for C&D. The Bill was referred to the
aims to prevent undesirable transactions in securities by Standing Committee on Finance. However, the Bill
regulating the business of dealing therein, the existing lapsed with the dissolution of the Lok Sabha.
mutual structure of stock exchanges (except two exchanges) October 12, 2004: The Securities Laws (Amendment)
failed to address the conflict of interests on stock exchanges. Ordinance, 2004 was promulgated to amend the SCRA
It amended the SCRA to mandate structural to facilitate the C&D of exchanges.
transformation of the exchanges from mutual January 07, 2005: The Securities Laws (Amendment)
organization form to a demutualised form by an Act, 2004 was enacted which replaced the Securities
appointed date. It also stated: Since demutualisation Laws (Amendment) Ordinance, 2004.
separates ownership, voting rights and management from Budget 2005-06: In order to facilitate corporatisation /
the right of access to trading, it is imperative that the change of corporate structure without attracting stamp
representation of trading members in board of directors of duty, the Indian Stamp Act, 1899 was amended to
stock exchanges is either not permitted at all or kept to a grant a one-time exemption from stamp duty on the
minimum. notional transfer of assets of the exchanges in connection
with corporatisation and/or demutualisation of an
III. Preparatory Steps exchange pursuant to a scheme approved by SEBI.
March 2001: While responding to a calling attention 2001-2005: All parties concerned such as Government,
motion by the Leader of the Opposition on extreme SEBI, Exchanges and Brokers debated over various
volatility in stock markets, the Finance Minister approaches to C&D to evolve the most suitable model
proposed corporatisation of stock exchanges by which in the Indian context.
ownership, management, and trading membership
would be segregated from each other.
IV. Securities Laws (Amendment) Act, 2004 a. Acquisition (initial and subsequent), transfer
The Act made it mandatory that all stock exchanges, if and extinguishment of ownership rights,
not corporatised and demutualised, shall be b. Acquisition (initial and subsequent), transfer
corporatised and demutualised on and from the and extinguishment of trading rights, and
appointed date so notified in the official gazette by c. Management of the stock exchanges.
SEBI. It obligated the non-corporate and mutual
exchanges to submit, within such time as may be a. Ownership Rights: Through the process of C&D,
specified by SEBI, a scheme for C&D to SEBI for its the exchanges would have the structure of a company
approval. The scheme should provide for issue of limited by shares. Hence the ownership rights shall be
shares and provision for trading rights, restriction on represented by the equity shares and such shares shall
voting rights, and transfer of property, business and be acquired, transferred or extinguished in the manner
employees etc. SEBI may approve the scheme with or prescribed in the Companies Act, 1956, unless it is
without modification if it is satisfied that it is in the provided differently in the scheme. The scheme may
interest of trade and also in the public interest. If a provide a different manner only if it justified in the
scheme is approved, it shall be published immediately public interest or in the interest of trade. While these
by SEBI in the official gazette and by the Exchange in can be left to the Companies Act, 1956, the scheme
two newspapers. On such publication, the scheme needs to provide as to who would be the initial
shall have effect and shall be binding on all persons and shareholders, because on the day one these shareholders
authorities. SEBI shall not approve any scheme of C&D will be indirect owners of the assets of the company
if the issue of shares for a lawful consideration or and can sell the shares to realize the so far unlocked
provision of trading rights in lieu of membership cards value of the exchange. While the SCRA does not
of the members of an exchange or payment of dividend directly specify who would be the initial shareholders,
to members is proposed out of any reserves or assets of the provision relating to contents of the scheme and the
the exchange. While approving the scheme, it may, by holding of equity by non-trading members within 12
order, restrict (a) voting rights of the broker months indicate that only the existing membership
shareholders, (b) the rights of shareholders or brokers card holders would become initial shareholders. In
to appoint the representatives on governing board of case the exchange is an association of persons, the
the Exchange, and (c) the maximum number of broker members (membership card holders who have both
directors on the governing board, which shall not trading right and management right) of the exchange
exceed one fourth of the total strength of the governing will become shareholders initially. The limited trading
board. Such order shall be published in the official members who do not have management right will not
gazette. Within 12 months of such publication, the become initial shareholders. In case the exchange is a
stock exchange concerned shall, either by fresh issue of company limited by guarantee, the trading members
equity shares to the public or in any other manner, as will become initial shareholders. In case the exchange
may be specified by the regulations made by SEBI, is already a company limited by shares, no shares will
ensure that at least 51% of its equity shares is held by be issued at the time of C&D. The membership card
public other than shareholders having trading rights. holders will be entitled to shares in proportion to the
SEBI may extend this period by another 12 months in number of membership cards held by them in the
public interest. SEBI may reject a scheme if it is satisfied exchange and they will pay for the shares in cash only.
that it would not be in the interest of trade and also in Since the allotment of the initial shares will be made
the public interest, after giving a reasonable opportunity only to the identified people, and all will get equal
of hearing to all the persons and the exchange concerned. number of shares and the process of C&D needs to be
Any person aggrieved by an order of SEBI approving completed in a time bound manner, such initial
/ rejecting the scheme can prefer an appeal before the allotment may not be considered as being an invitation
Securities Appellate Tribunal. If an exchange is not to offer, offer, issue or allotment to the public.
corporatised and demutualised or fails to submit a
scheme for the same or the scheme is rejected by SEBI, b. Trading Rights
the recognition granted to such exchange shall stand The objective of C&D is to segregate the trading rights
withdrawn. The central government shall notify such and ownership / management rights associated with
withdrawal of recognition in the official gazette. the membership cards. The holders of membership
cards need to be given shares in lieu of their ownership
V. Three Pillars of C&D / management rights and given trading membership
As stated in the SOR, the C&D aims to address the in lieu of trading rights. Any other person who is
conflict of interest. The strategy envisaged is segregation having only trading rights (like limited trading member
of trading rights and ownership/management rights or trading member on derivative segment) needs to be
and restricting the ownership and management rights granted trading membership. Hence all existing trading
of the trading members. This essentially means that the members of the exchange shall become trading
C&D scheme must deal with the following three major members of the respective segments of the
aspects: demutualised exchange initially. All trading members,
whether they were membership card holders or limited z The membership cardholders of the BSE shall
trading members of the mutual exchange, shall have become initial shareholders of BSE Ltd. which
similar rights and privileges, as the membership card shall ensure that at least 51% of its equity shares are
holders have been granted shares in lieu of their held by public other than shareholders having
ownership right. Thereafter, acquisition, transfer and trading rights within 12 months.
extinguishment of trading rights will be governed by z No shareholder, who is a trading member, shall
the bye-laws of the exchanges in compliance with the have voting rights (taken together with voting
securities laws. A person desirous of becoming a trading rights held by him and by persons acting in concert
member at any time would be admitted if he complies with him) exceeding 5% of the voting rights in BSE
with the requirements and brings in specified fees and Ltd.
deposits and the exchange will have no limitation on z The Governing Board of BSE Ltd. shall be so
the number of trading members. Similarly, a trading constituted that the representatives of the trading
member wanting to exit the system would do so by members do not exceed one-fourth of the its total
surrendering his trading membership as per prescribed strength and the remaining directors shall be are
procedure and get back his refundable deposits from appointed in the manner as may be specified by
the exchange. While trading members may sell / SEBI from time to time.
transfer trading right in the market, they would also z The membership card holders, limited trading
have an option to surrender the same to the exchange. members and trading members of derivative
This would ensure free entry and exit of trading segment shall be trading members of the respective
members. In order to ensure that the trading rights and segments of BSE Ltd. initially.
management / ownership rights remain segregated, it z After C&D, there will be only one class of trading
shall not be necessary for a person to acquire trading members with similar rights and privileges and
rights and ownership rights together. uniform standards shall be followed in terms of
capital adequacy, deposits, fees, etc while admitting
C. Management any person as a trading member or accepting his
The objective of C&D is to reduce the influence of surrender.
trading members in the ownership and management z The trading members shall clear and settle trades
of the exchange. The influence needs to be reduced in till the clearing and settlement functions are
the general body and in the governing body. Though transferred to a clearing corporation which shall
the trading members would be exclusive shareholders happen within one year.
initially, the SCRA requires the exchange to ensure z BSE Ltd. shall ensure that the existing assets and
that, either by fresh issue of equity shares to the public reserves transferred from BSE are utilised only for
or in any other manner as may be specified by SEBI, at the operations of the corporatised and
least 51% of its equity shares are held by public other demutualised exchange.
than shareholders having trading rights. In order to
ensure that no trading member has undue influence in VI. Next Steps
the general body, the scheme may restrict the voting It is expected that the principles underlying the BSE
right of those shareholders who are trading members (C&D) Scheme, 2005 will be applied while approving
of the exchange. The SCRA also requires that the the C&D schemes submitted by other exchanges. With
representation of trading members does not exceed approval of these schemes and their successful
one-fourth of the total strength of the governing body. implementation, all the exchanges in the country will
The balance three fourth of the governing body may be be corporatised and demutualised, which would
constituted in the manner as may be prescribed by constitute a very important institutional reform in the
SEBI from time to time depending on the changing securities market in India.
circumstances. The approved C&D scheme provides that the
representatives of trading members shall not exceed
VI. BSE (C&D) Scheme, 2005 one fourth of the total strength of the governing body.
Vide notification dated 20th May, 2005, SEBI has The balance will be composed in the manner as may be
approved the BSE (C&D) Scheme, 2005 with certain specified by SEBI from time to time. Hence SEBI needs
modifications. The broad features of the scheme are as to issue the guidelines to govern composition and
follows: appointment of balance two third directors and the
z A for-profit company limited by shares under exchanges need to compose the boards accordingly.
section 12 of the Companies Act, 1956, in the name The scheme requires the exchanges to ensure that the
and style of Bombay Stock Exchange Limited (BSE non-trading members hold at least 51% of equity in the
Ltd.) shall be incorporated to succeed BSE. manner prescribed in the Regulations to be framed by
z The ownership and management rights and trading SEBI. Hence SEBI needs to frame Regulations to provide
rights associated with membership cards of the for the manner of increasing shareholding of non-
BSE shall be segregated. trading members on the exchange and the exchanges
need to do so in compliance with the Regulations. The
scheme also requires that the clearing and settlement will seek recognition from SEBI in terms of the said
functions will be transferred to a recognized clearing Rules and the exchanges will transfer the clearing and
corporation. This requires Government / SEBI to lay settlement functions to such recognized clearing
down a regulatory framework for governance of corporations. Only after these are completed, the
clearing corporations through the Securities Contracts process of C&D of the exchanges shall be complete.
(Regulation) Rules, 1957. The clearing corporations

1 Chief General Manager, SEBI. The views expressed in this paper are of the author and not necessarily of his employer.