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Before we decide whether the National Stock Exchange of India Ltd (NSE) should

list, it is important to understand the nature of the beast, the underlying asset. The
business of Indias largest exchange, formed two decades ago, is unlike any of the
companies that list on it, barring banks. In all other companies, the profits and losses
are limited to one firm, its clients and shareholders. But NSE, like the Bombay Stock
Exchange, provides a critical financial market infrastructure and the business needs
to be seen from two sides profits and compliance. The critical differentiator here is
regulatory oversight the company has been outsourced and entrusted with. Any
compromise here would reflect not only on NSE but on all the 1,600-plus companies
listed on it.< Global private equity investors including SAIF Partners, Actis, General
Atlantic, IDFC, NVP, Tiger Global, Temasek Holdings, and Beacon India that hold a
28 per cent stake in NSE are reportedly unhappy that the exchange is refusing to
either list or pay higher dividend. This, they say, goes against the collective interest
of its shareholders. They are seeking an exit from NSE by getting the company to
list. What they need to understand and probably do is the potential conflicts of
interest that can arise out of taking NSE public. On the other side, not all NSE
investors are seeking a listing. The two largest shareholders, Life Insurance
Corporation, and IDBI Bank that hold a 15.5 per cent stake in the exchange, are
comfortable staying unlisted. The question of listing does not arise at all, an LIC
executive told The Economic Times. Of course, the fact that these are public sector
entities helps shape this outlook.
Investing in companies that run critical financial infrastructure, such as stock
exchanges, credit rating agencies, clearing corporations and depositories, carries a
risk of public policy. Any large investor should know that when the government
outsources its first line of regulatory and supervisory functions to a private firm like
the NSE, the responsibility to serve that function goes more than mere compliance.
A compromise here would impact not just one entity and its shareholders; it affects
thousands of companies, millions of investors. The potential risk of abusing this
regulatory and supervisory function in the quest for profit becomes higher when such
a company gets listed. This higher risk comes in two ways. A listed firms returns to
investors is more than mere increased profits a Re 1 of net profit translates into
Rs 20 in the value of the firm that would trade at a PE multiple of 20. So, the
pressure from investors can hang like a golden sword on the heads of managers.
Second, if managers themselves become participants in those returns through stock
options, the high-powered incentives have the potential to bite regulatory
requirements twice over. There are many ways an exchange can compromise its
regulatory function. The market value of a valuation-focussed exchange rises with
increased turnover, so encouraging fake circular transactions would help raise
valuation. Or a large securities firm with malpractice at heart could go regulatory
shopping and threaten to shift to another exchange if enforcement is too strong. Or
conversely, if a firm is diverting business to a rival exchange, it could harass the firm
through inspections. And so on. One way out would be to segregate the regulatory
functions of an exchange from the profits it makes. This can be done by hiving off the

regulatory arm and turning it into a not-for-profit organisation, an SRO (selfregulatory organisation) for instance, with clear regulatory compliance expectations
from its management. Perhaps an SRO formed by association of exchanges with
regulatory oversight by Securities and Exchange Board of India (SEBI) might work.
The problem here is that, from the Medical Council of India to the Institute of
Chartered Accountants of India, the state of SROs in India leaves a lot to be desired.
The other way would be to transfer the regulatory function back to the government or
regulator SEBI. But that would turn the entire structure of outsourcing the regulatory
work to a private firm on its head. Given the rather weak governance capacity,
dealing with a single entity would be a better option for SEBI to deliver regulatory
compliance. The process of listing stock exchanges began with their
demutualisation, a process that transformed them into profit-making, investor-driven
corporations from non-profits, members-owned organisations Stockholm Stock
Exchange in 1993, Helsinki Stock Exchange in 1995, Copenhagen Exchange in
1996, Amsterdam Exchange in 1997, Australian Exchange in 1998 and Toronto,
Hong Kong and London exchanges in 2000. Following the securities scam of mid1990s, the Bombay Stock Exchange was formally demutualised in 2007, while NSE,
created in 1993, was born demutualised. Listings followed Australia in 1998, Hong
Kong in 2000, London in 2001, New York in 2006, and Moscow earlier this year. But
applying the demutualisation trend to listing may neither be in so straight a line, nor
so easy to accomplish. While SEBI has allowed bourses to go public with their
shares on exchanges other than themselves through a June 2012 notification, the
reporting line of the compliance officer to the board of the exchange may not be such
a great idea. Further, even if the oversight committees are chaired by public interest
directors, their efficacy and effectiveness when functioning within the same corporate
structure as the rest of the organisation is unproven. The regulatory function a
clear public good that needs public scrutiny and control needs to be completely
isolated from the profit-generating part of the exchange. I believe SEBI needs to do
some more work on this front. Until then, NSE should not list. Threats or noises
made by some of its investors seeking an exit cant overrule market safety and
regulatory sanctity. Only once this potential conflict of interest is resolved and we are
assured that the regulatory compliance is in safe hands, should the NSE board give
these voices of listing a hearing.
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