Testing times for the regulator: Financial Express 21st February 2012

The MCX IPO is an important development not just because it will be one of the bigger ones that will hopefully lift the market but also because it spurs debate on the public issue of a company that comes under what is called financial infrastructure. This has been discussed at length when the Jalan committee commented on the same with respect to stock exchanges in 2010. This would probably be a precursor to the listing of other exchanges, including stock exchanges, which can possibly provide some buoyancy to the respective markets.

To begin with, it should be stated that in a free market economy everything should be permitted and in case there are any apprehensions, they should be addressed through regulation rather than prohibition. If regulation is in place and the regulator is strong enough, then it should not really matter whether it is a stock exchange or a manufacturing company that is getting listed. There are global examples of listing of exchanges—the CME group, Intercontinental Exchange, NYSE Euronext and London Stock Exchange. The last two are listed on themselves. But it is nonetheless necessary to visit the debate once more.

Let us look at the more conservative set of arguments against such listing. Financial infrastructure companies serve a broader goal of public service for society and hence should not be motivated by profit as they are public goods. Once listed, their goal would be to maximise profits for the shareholders and for better valuation, which can lead to a conflict of interest with their own rules and regulations. Rules may be compromised to appease brokers and regulation may be flouted. This is but natural because when the idea is to increase profits that are also linked to the ESOPs offered to managers, then there is an attempt to be lenient.

They could also misuse their oligopolistic power to charge higher prices, which can then distort the market. The process of price discovery itself could, hence, be in danger in case there is insider trading, which can be perpetrated to increase business. Besides, since such business is typically a closed supplier group, entrepreneurs could come in, increase valuation and then exit, thus leaving behind weaker institutions as there is less commitment to the enterprise. Last, the existence of a dicey troika of owner, manager and broker, where each one is dependent on the other, sows the seeds for impropriety.

These arguments can actually be countered quite forcefully with the following. Does not this hold for any enterprise in any field? Second, if exchanges are financial infrastructure, then aren’t banks also the same? Don’t banks use public money (which exchanges do not) and, hence, carry greater risk at the bourse than the exchanges? Third, exchanges are not really public goods since those who use it make money and the promoter puts his own money to create it, unlike a public good where the government spends and everyone benefits. Fourth, even public sector companies are listed which are owned by the government, in which case the same should be permitted for exchanges. Also the government is earning a lot from disinvestment by virtue of this listing. Why not exchanges? Fifth, on the issue of the troika of relationships, it can be addressed by laying down prerequisites for such listings. This leads to the final counter-argument where the clue really is regulation. Exchanges should be allowed to list only if the regulator is strong and can ensure that the rules of the game are observed. All the issues raised earlier can be addressed by the FMC for MCX and Sebi for any stock exchange that could get listed in course of time.

Today there are various rules set for shareholding pattern and, to ensure interest in the project, there can be a minimum holding time period before divestment can be done. Further, market watch and surveillance has to become more important at both the exchange and regulator levels to ensure that trading takes place in an orderly manner. Also, broker dealings have to be examined even more closely in the commodity market by the FMC as well as Sebi once the listing takes place because any information or news on wrongdoing can create havoc in both the commodity and stock markets. The onus or test is really on regulation once such a listing takes place. Such listing, however, has not really created problems elsewhere in the world, and hence there is reason to believe that it should be similar here too.

Therefore, the listing of MCX is going to set the tone for more advanced versions of financial liberalisation where systems will be tested as this will logically provide opportunities for stock exchanges. The commodity market is relatively larger in terms of the number of players though, admittedly, it is still dominated by around 3-4 entities which is still more than the stock market. The FMC will have a job on its hand from now onwards and, going by its past record, can be depended on to ensure that trading is orderly, considering that in the last eight years or so ever since such trading was resurrected there has not been any trouble in this market, which tells a lot on its performance.