Dr. Bimal Jalan committee report on ownership and governance of the Market Infrastructure Institutions

SEBI, in January 2010, had appointed a committee under Dr. Bimal Jalan (former Governor of the Reserve Bank of India) to study and recommend changes on the ownership and governance of the Market Infrastructure Institutions ("MIIs") like stock exchanges, depositaries and clearing corporations. The committee, on November 22, 2010, has submitted its report ("Report") to SEBI and is available here for public comments. The report makes some particularly strong recommendations including not allowing such entities to get listed on stock exchanges.

The Report examines the nature of these institutions and the reasons for such institutions being referred to as MIIs in the light of doctrines like 'Essential Facilities', 'Natural Monopolies', 'Economies of Scale' and emphasizes on the systematic importance of these MIIs for the economy. The report views these MIIs as producers of public good and says that '….. the three MIIs in the securities holding-trading-clearing-settlement chain are engaged in the business of producing a valuable public good for society, which are essentially the price signals produced by a transparent and efficient market mechanism'.

The Report says that it is not possible to sever the regulatory role of the MIIs from their more obvious role of serving as providers of infrastructure of the market and goes on to describe the characteristics and functions of these MIIs emphasizing the following characteristics of such institutions:-

1. In general, MIIs are in the nature of public utilities.
   
2. All of them are vested with regulatory responsibilities, in varying degrees.
   
3. They have systemic importance to the economy.
   

In the above background, the Report highlights the conflict in the 'regulatory role' of these MIIs with their 'economic interests'.

The key recommendations in the Report are the following:

1. Changes to Securities Contracts (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006: The Committee has proposed the replacement of these regulations by a comprehensive set of regulations on the ownership and governance of stock exchange. By way of a transit, the committee recommends changes for the existing provisions of these regulations which inter-alia contains a recommendation that- ' All anchor institutional investors put together shall not hold more than 49% of the total equity capital of an exchange'. Currently depositories, clearing corporations, banks, insurers and public financial institutions are allowed to hold, individually, up to 15% in a stock exchange.

2. Ownership and Control of a MII in another classes of MII: As regards the ownership and control of MII, the committee has proposed the following:

• Clearing Corporations and Depositories may not be allowed to invest in other class of MIIs .
  
• at least 51% of the paid-up equity capital of the Clearing Corporation should be held by one or more recognised Stock Exchanges.
  
• the holding of stock exchanges in depositories may be restricted to a maximum of 24%.
  
• In case of all MIIs, FIIs should be allowed to acquire the shares through off market transactions including through initial allotment, as allowed for any other shareholders, subject to the limits specified by the Government from time to time.
  

3. Governance of MIIs: As regards the governance of MIIs, the committee has proposed the following:

Stock Exchanges:

• no trading /clearing member (irrespective of exchange where he operates) shall be allowed on the board of any of the stock exchange
  
• the number of public interest directors ("PIDs") on the board of a stock exchange shall at least be equal to the number of shareholder directors without trading/ clearing interest.
  

  Clearing Corporations:
  

• the number of PIDs on the board of a clearing corporation shall at least be equal to the number of shareholder directors without trading/clearing interest.
  

  Depositories:
  

• same as prescribed for listed companies under clause 49 of the listing agreement.
  

4. Disclosures by board members of MIIs: All transactions in securities of the board members of the MII and their family have to be disclosed to the board of the MII.

5. Disclosure and corporate governance requirements: The committee recommends that the disclosures and corporate governance requirements of the listing agreement applicable to listed companies shall be made applicable to MIIs too. The information required to be disclosed under the listing agreement should be posted on the website of the MII.

6. Mandatory appointment of Compliance Officers: SEBI has mandated various registered intermediaries and also depositaries to appoint a compliance officer to ensure that the intermediary complies with the rules, regulations, circulars and directives of SEBI. The committee recommends that such appointment should be made mandatory also for the stock exchanges and clearing corporation.

7. No listing of these MIIs: The committee is not in favour of listing of MIIs and observes that- '... MII should not become a vehicle for attracting speculative investments. Further, MIIs being public institutions, any downward movement in its share prices may lead to a loss of credibility and this may be detrimental to the market as a whole'.

8. Networth Requirements: The committee recommends that Stock Exchanges should have a net worth of INR 100 crores at all times. As regards depositories, the SEBI prescribed net worth of INR 100 crores is suggested to be retained with a rider that '…all other investments in related, unrelated/other business shall be excluded while computing the net worth'. For clearing corporation, the committee recommends an ongoing net-worth requirement of INR 300 crores in the form of liquid assets.

Apart from above, a recommendation in the report which may cause significant outcry is putting of a cap on the maximum return that can be earned by MII on its net worth and can be distributed / allocated to its shareholders. The committee observes '…MII being a public utility should endeavor to earn only reasonable profits at par with average earnings of the corporate sector in India'.

It would be interesting to see how much of these recommendations are implemented by the regulator. These recommendations are seen as a disappointment and have been met with criticism (here, here, here and here) on the lines that it would protect the monopolistic market structure and perverse anti-competitive practices by some and prevent new entrants on the stock exchange space. Also, the buzz in media is that the government is unsure of implementing these recommendations.

[The above post has been contributed by Vaibhav Kumar, who is an Associate at the law firm, Desai & Diwanji, Mumbai.]