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Hard choices for regional exchanges

The regional stock exchanges are on the horns of a painful dilemma.

COINCIDENCE IT might well be but two conflicting messages, one from the Government and the other from the capital market regulator, have placed the 20 regional stock exchanges at the crossroads. Some say they have been pushed to the brink: their extinction, in their view, was inevitable even without the latest developments. Others however see an opportunity for the almost dormant RSEs to `professionalise' and shape up. In due course they can fulfil their original roles and provide liquidity at the regional levels.

Those pessimistic about the future of the RSEs cite recent history. The 1990s have not been the best of times for these exchanges. In November 1994, the National Stock Exchange came into being essentially to function as a much superior alternative and model to the RSEs. The securities scam had ravaged the country's premier Bombay Stock Exchange and in its aftermath it was decided, among other things, to start a new exchange that would be run by professionals (and not by brokers) and would have up-to-date technological capabilities to have an all India reach.

Each of these distinctive characteristics of the NSE was hard to replicate by the other exchanges including the BSE. In less than a year the NSE became the number one exchange in terms of trading volumes. Its all India reach meant that investors even in comparatively remote places could invest in stocks. Other exchanges including the BSE have been trying hard to catch up with the NSE with mixed results.

For the RSEs the process has been painful. The NSE took away their trading volumes. They were forced to invest in technology they could never leverage profitably as the volumes did not justify the huge investments. They have seen even dedicated companies in their region delist. (Amendment to the listing rules has allowed companies to delist from their regional exchanges).

Survival bid hit

The only way they could survive was to latch on to the two principal stock exchanges which they did by floating subsidiaries with membership of NSE/BSE. Brokers of the regional stock exchanges became sub-brokers of BSE/NSE. The value of their membership of the regional exchange might have plummetted but at least they could participate in one or both of the country's leading exchanges. It is this arrangement — life saving as it is — that is under threat after SEBI's new rule which bars sub-brokers from issuing contract notes.

SEBI's motive might be to protect investors. There have been a number of instances of sub-brokers (to regular broker-members) committing malfeasant acts involving contract notes. However the regulatory remedy proposed — to ban all sub-brokers from issuing contract notes — misses the crucial point that there are different types of sub-brokers. The brokers of the regional stock exchanges who have become sub-brokers and deal in NSE/BSE will be hard hit by the blanket rule. That would effectively end whatever chances the RSEs had for surviving.

New opportunity

Ironically the SEBI ruling has come at a time when the Government (through an ordinance) has presented a roadmap to the RSEs to go in for demutualisation and corporatisation. Traditionally the RSEs functioned as mutual societies owned and operated by member brokers. A few of them have already switched to the corporate form. Their action plan now requires them to segregate ownership rights from trading rights. Professionals rather than broker representatives will conduct the affairs of the exchanges. Can the RSEs come together — as has been proposed many times — and transform themselves into the country's third exchange along with the NSE and BSE? That is a tempting thought: few will question the need for increased competition that will give greater choice to investors.

However, in practice it has always been difficult to form a third all India exchange. Despite the current moves to restructure the RSEs there is no guarantee that a demutualised and corporatised exchange by itself will be the recipe for survival and eventual success. On the contrary there are valid reasons to be sceptical. The RSEs in their new form will require a large number of stock market professionals who are a scarce commodity. Besides, an exchange operating for profit may sacrifice regulatory concerns for commercial gains.

In fact one should be extremely wary of pronouncing a judgment on the viability of any particular form of organisation for a stock exchange.

For the RSEs and their stakeholders the painful dilemma continues: restructuring involves considerable expenditure and plenty of pain in adjusting. On top of these there is no guarantee that in their new form they will be a commercial success. And as SEBI's action in banning contract notes issued by sub-brokers shows, there is a basic misunderstanding of the stock markets at the official level.

C. R. L. Narasimhan

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