Why Demutualization of Stock Exchanges?

Globally, capital markets play a crucial role in mobilising domestic resources and channelling them efficiently to productive uses, thus raising national productivity. The level of capital market development is an important determinant of level of savings, efficiency of investment and ultimately rate of economic growth.
Pakistan's capital markets have seen a number of significant reforms since year 2000. These reforms were led by the Securities and Exchange Commission of Pakistan (SECP) - the apex regulator of capital market. The reforms were focused on governance, risk management, market development and investor protection. The underlying objective of these reforms has been to make the markets fair, efficient, and transparent and enhance their capacity for capital formation. There is a general agreement that because of these reforms capital markets are a much better place than they were prior to 2000. However, despite all of these reforms it is felt that there is a lot more that needs to be done to ensure that capital markets in Pakistan are integrated with the rest of the economy and provide much easier access for issuers and investors both for equity and debt and serve as true venues of capital formation. Therefore, the years to come are likely to see major structural reforms in the capital markets such as Demutualization of stock exchanges.
Demutualization of stock exchanges essentially refers to the process of converting a non-profit, mutually owned organisation to a for-profit entity owned by the shareholders. The process involves not only Corporatization, which is conversion of a stock exchange limited by guarantee into one limited by shares but also segregates ownership and trading rights.
Historically stock exchanges all over the world were mutual organisations owned by their members for the common benefits of the members however; members were not allowed to take any profit. In recent years, though, technological change, globalisation, growing competition and concern for investors' interests all put increasing emphasis on the need for stock exchanges to be cost-efficient, transparent and more widely accountable. Today all major regional and international stock exchanges are demutualized which include jurisdiction like India, Malaysia, Singapore, Japan, Australia, the USA, UK etc.
All the three stock exchanges presently operational in Pakistan namely Karachi Stock Exchange, Lahore Stock Exchange and Islamabad Stock Exchange posses mutualized structures. As there is no separation of trading rights and ownership there is a perception that market is not transparent. Due to lack of resources the exchanges have to provide trading terminals in many cities, which currently have no direct access to the market. As the market would move into cyber space, the exchanges will have to become geographically neutral. However, expansion of market demands additional capital for investment in technological infrastructure and professional human. not been able to grow to the expectations of investors as trading activity today is concentrated in three buildings of these exchanges with the dominant share going to the Karachi Stock Exchange. Our exchange need to invest large sums in its technological infrastructure to provide trading terminals in many cities, which currently have no direct access to the market. As the market would move into cyber space, the exchanges will have to become geographically neutral. However, expansion of market demands additional capital for investment in technological infrastructure and professional human.
The expansion of market outreach will also result in much larger number of investors in the stock markets and turnover of shares. Greater competition among brokers, broader participation by investors, and rising turnover shall improve liquidity and price discovery without a parallel increase in trading costs. The increasing number of investors shall increase public stake in the market, which will call for additional measures for improved investor protection and corporate governance.
Although, the SECP as part of its reform process restructured the board of directors of the exchanges with appointment non-broker professional directors however, as self-regulatory organisations the decision making process at the exchange still needs to be ant participation in various committees of the exchange may take decisions favouring the interests of broker members over those of the investing public. This compromises the very principle of self regulation which results in adequate enforcement of rules and regulations.
Demutualization would lessen the conflicts compared to a self-regulatory organisation with a mutualized structure. It leads to improvement in the governance structure, segregation of regulatory functions from commercial functions and separation of trading rights and ownership rights. Demutualization/ Corporatization would also assist in attracting international strategic partners and good quality issuers. As such institutional investors prefer to invest in markets where the exchange demonstrates strong corporate governance, market surveillance and enforcement in the belief that such markets are less likely to experience endemic market speculation and manipulation or be threatened by systemic failure. Thus strong regulatory mechanism instituted by an exchange actually supports the reputation of the exchange.
Demutualization serves in the interest of all stakeholders including the broking community who stand to gain from increased market liquidity that comes from better governance of the exchange and improved reputation. Strategic alliances and straight-through trading linkages will also boost market liquidity for our capital market and assist in enhancing outreach which is presently limited with a narrow investor base.
Demutualization is critical in ensuring that the exchanges truly and fairly represents the interests of all stakeholders and thus perform its true function as an engine of economic growth. Demutualization of stock exchanges will not only promote greater transparency and stock market efficiency but also help in dispelling the perception that the stock exchanges are merely clubs, serving the interests of their members.
The SECP is vigorously pursuing the process of Demutualization and Corporatization of the stock exchanges. The Stock Exchanges (Corporatization, Demutualization and Integration) Act, 2009 drafted in co-ordination with the relevant stakeholders was approved by the National Assembly in October 2009 however; the same could not be taken up by the Senate and is awaiting promulgation. Therefore in order to ensure smooth transformation and bring our exchanges and markets at par with international jurisdictions it is vital that the Demutualization law is enacted on priority.