DEMUTUALIZATION OF BOURSES
An Obligatory Fast Track deed
MARIAM NASIR, Manager Research
Apr 23 - 29, 2007
The term demutualization describes the process by which mutual organizations or companies convert themselves to for-profit (or profit-making) public companies which distribute profits to their shareholders in the form of dividends. Demutualization usually involves the sale or reorganization of a mutual, by its members, to or into a non-mutual company whose shares can be traded on a stock market. This maneuver generally improves the company's access to investment capital, and so increases its value as a viable business. As a result of demutualization, members usually receive a windfall payout. This payout usually takes the form of shares in the successor company, a cash payment, or a mixture of both. At demutualization, the restricted ownership rights of members are either dissolved or replaced by more conventional stock ownership and voting rights in the surviving company.
HISTORY OF DEMUTUALIZATION
The transformation of exchanges from mutual to demutualized structure involves two key features: (I) a change in the ownership structure, and (II) a change in legal as well as organizational form. Both need to be accompanied by adequate safeguards to ensure appropriate governance. Since the beginning of the 90's several stock exchanges have demutualized, i.e. they become for profit companies and opened ownership to outside investors. In addition, a growing number of exchanges have introduced shares of their companies on the stock market they operate- a process called self-listing- emphasizing at the same time the for-profit and public nature of the activity. The number of exchanges that have privatized or listed has been increasing since the Stockholm Stock Exchange demutualized in 1993. In 1999, 11 stock exchanges had been privatized or listed and this number is increasing with several other exchanges either considering demutualization or already having stated their intention to do so. There are various benefits of demutualization, some are: improvements in corporate governance, opening up of trading rights of exchanges and restructuring and alliances of exchanges etc.
DEMUTUALIZATION OF STOCK EXCHANGES OF PAKISTAN
The SECP set up a committee of local and international experts on demutualization of stock exchanges in the country. The committee submitted its report to the SECP in the year 2004. The committee recommended demutualization and integration of existing exchanges through special legislation. Alternatively, the committee recommended that a new stock exchange sponsored by banks/financial institutions should become a National Exchange whether or not the existing stock exchanges merge into it. SECP is vigorously pursuing the process of demutualization. But the pace of this risk management system is quite slow. Ever since the process of demutualization has taken hold, the captains of the Karachi bourse have taken a backseat, kept themselves aloof and placed their underlings to negotiate the demutualization scheme with SECP. The board needs people with deep understanding of the market and having legal background also to guide its management in the regulatory changes required. Secondly, it is difficult for directors without a proper grounding in financial sector to fully understand the risk management sought by the SECP and back it with technology and a well-defined system in line with the relevant regulations. It is only the stakeholders whose bread and butter comes from the market, who can install a competent management in place, lay down the right policy guidelines, set realistic targets and hold the management accountable. Demutualization is part of SECP's integral efforts to strengthen professionalism in its business operations, maximize transparency, reinforce competitive position globally, and optimize financial performance. By now SECP and KSE as per agreement has decided to demutualize the exchange by end December 2007. For that purpose the valuation of the exchange is to carried out by an international investment banker i.e. by a globally renowned consultant the appointment of which is now imminent. The next step is the corporatization, whereby KSE, presently a company limited by guarantee, will be converted in to a company limited by shares and 100% of its shares will be issued to its members. Subsequently, the members would be required to disinvest 40% of their shareholding to financial institutions and 20% to general public by having the exchange listed locally and globally.
The Securities and Exchange Commission of Pakistan (SECP) has approved the Unified Trading System (UTS) of Islamabad Stock Exchange (ISE) and Lahore Stock Exchange (LSE), which would become operational from April 30, 2007. This is the first initiative by any of the stock markets in Pakistan to link together their trading systems whereby members of both exchanges would be able to trade from a single platform. The system would enable both ISE and LSE to retain much of the trading volume within this common trading system, which at the moment is shifted to Karachi Stock Exchange. The UTS would bring more transparency in the trading system of both exchanges. With the inception of UTS, it is expected that a healthy state of competition would occur as a result thereof, and the securities market of the country, particularly LSE and ISE, would progress.
The agreement between the SECP and KSE members to demutualize the exchange by end December 2007 with the establishment of milestones is too long a period. Uncertainty is certainly not in the interest of the market. A board comprising of stakeholders with investment in the exchange and having the desire to profit from this business, needs to be put in place at the earliest.