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A requiem for Regional SEs

Advent of NSE and BSE has led to a sharp fall in their trading volumes

A RECENT report of the committee set up by the Securities and Exchange Board of India has large meanings for the regional stock exchanges (RSEs). In a broad sense the report might as well be their requiem; so complete has been their marginalisation in recent times that it seems pointless to persist with them as business entities that had once catered to a captive clientele.

The advent of the National Stock Exchange in 1994 and the extension of trading terminals by the Bombay Stock Exchange across the country deprived the RSEs of clients. Investors could now access the country's two principal exchanges and trade on a vastly superior platform that gives them substantial liquidity. On the other side, many companies once statutorily required to list their shares with the regional stock exchanges, see no point in having to comply with the requirements of multiple stock exchanges. Many of them have been delisting from the RSEs after the rules were suitably amended in 2003.

Two factors — abundant choice for investors to trade on the NSE and the BSE and large scale delisting by companies — are behind the sharp decline in trading volumes on the RSEs. In 2000-01, the RSEs had collectively reported a turnover of more than Rs. 5,43,000 crore. Today most of them are in a moribund state with negligible business to show.

However, the sharp fall in business has not stood in the way of some RSEs acquiring notoriety. There have been a number of malfeasant acts committed at the level of RSEs and it was again found that their traditional organization structures and quality of management were inadequate to deter such acts. There is a clear global trend in favour of bigger stock exchanges. Capital markets bigger than India's have witnessed rapid consolidation, with the smaller exchanges being gobbled up or simply withering away.

In India too, the movement has been in that direction although it has not been easy to discard the idea of regional exchanges. In less than two and a half decades the perception of RSEs has changed dramatically. Until the 1990s, official policy had been to promote more regional exchanges, in order to spread the equity habit to every nook and corner of the country.

Feeble bid for relevance

There have been attempts to find viable methods to help the RSEs remain relevant. Members (brokers) of some exchanges gained access to the trading terminals of BSE and NSE through an indirect route. The stock exchanges concerned floated subsidiaries to acquire corporate memberships of the two principal exchanges. Brokers of regional exchanges became members of the subsidiaries, effectively becoming sub-brokers of the BSE/NSE.

While that kept those exchanges alive, it was felt necessary to deal with the structural inadequacies of RSEs. Last October, following extensive discussions, regional stock exchanges were forced to undergo a makeover when the SEBI unveiled a roadmap for them to "demutualise and corporatise.'' Such expressions may be inelegant but have a strong reformist message. It meant a fundamental change in the structure of the exchanges. Despite sweeping changes in the capital market, they had continued to function as associations of persons.

Especially anachronistic was their ownership and management structure: brokers (who alone could be members) held all the shares in regional exchanges and controlled their management. That there was scope for a potential conflict of interest was obvious to all. The BSE, the country's oldest stock exchange, also suffered from those inadequacies. (But it reorganised itself to become the Bombay Stock Exchange Ltd). Eighteen RSEs were then asked to change over to a corporate and demutualised form. It is against this backdrop that the latest SEBI committee's report has to be viewed.

On the premise that neither the interests of the public nor those of the trade are served by keeping alive an exchange that does not have the potential for survival, is keen to exit, or has become a regulatory burden, the report has made its important recommendations.

RSEs can be divided into three categories: (1) Those that do not want to continue. They should be allowed an exit option. The SEBI can withdraw recognition of such exchanges upon specific requests being made; (2) Exchanges that have become notorious for their rank indiscipline. They should have their recognition compulsorily withdrawn; (3) Exchanges that have a potential and willingness to continue with alternative trading platforms. These can be allowed to do so. Withdrawal of recognition of the first two categories will help cleanse the system and reduce regulatory hazards to investors and various agencies.

The report has tried to address the key question of the distribution of assets of exchanges whose recognition has been or will be withdrawn.

C. R. L. NARASIMHAN

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