January 2021
In the first week of the new year, the Indian market regulator, SEBI, unveiled a discussion paper on reviewing ownership and governance norms in Indian stock exchanges and depositories with a view to facilitate new entrants in the sector (https://tinyurl.com/yxp9cjt6). The proposed changes are quite far-reaching and represent a welcome shift in the regulator’s stance in a sector dominated by a pair of entrenched incumbents.
Exclusive Club
The current state of play is best described in SEBI’s own words: “The Indian securities market has been characterized by dominant level of market concentration by a single entity in the trading and depository space.” The reference here is to the National Stock Exchange of India Limited (NSE), which has a market share (in terms of traded value) in excess of 90% in both the cash and derivatives segments, and a similar overwhelming share in the depository sector (in terms of demat custody value) through the National Securities Depository Limited, an entity promoted by NSE and in which NSE continues to be the single largest shareholder.
The BSE Limited (BSE) was set up several years prior to NSE but was slow to adapt to computerised and electronic trades following the stock market scam of the early nineties, resulting in NSE cornering the lion’s share of the market. As things stand, BSE retains the balance share in the cash and derivatives segments, as well as in the depository sector through Central Depository Services (India) Limited (CDSL), an entity promoted by BSE.
Apart from NSE and BSE, there is no significant trading in equity or equity linked derivatives on any of the other stock exchanges. The regional stock exchanges have all but disappeared from the scene; Multi Commodity Exchange (MCX) has been limited to only commodity derivatives; and there is hardly any trading on the Metropolitan Stock Exchange.
Interestingly, previous measures by SEBI have tended to favour preserving the status-quo rather than introduce genuine competition in the sector. Examples of this include SEBI’s rejection of MCX’s application in 2008 and the resulting long-drawn court proceedings, the recommendations made by the Bimal Jalan committee in 2010 (i.e., which referred to the “natural monopoly” of stock exchanges) and the revamped regulations introduced in 2018 (i.e., which left the ownership limits largely unchanged). While ostensibly the objective was to make sure that stock exchanges had a diversified ownership structure, SEBI’s measures effectively resulted in preventing new players from entering the sector.
A Fresh Approach
As the recent discussion paper indicates, SEBI is now clearly concerned about the existing market concentration leading to abuse of dominant position and institutional tardiness. SEBI is also alert to the need for stock exchanges to constantly innovate, including the adoption of blockchain technology, AI & ML etc. on the lines of the ongoing developments and experiments at stock exchanges in other jurisdictions.
The actual proposals themselves stay true to the stated objectives and recommend an overhaul of the existing ownership norms. While the current regulations dealing with stock exchanges and depositories impose a default 5% ownership limit (with a higher 15% cap for a select category of domestic and foreign institutions), the discussion paper proposes to not have any limit on domestic ownership (i.e., they can own the entire 100%interest) and increase the cap on foreign ownership to 49% from FATF compliant jurisdictions.
The proposals contemplate SEBI approval for only acquisitions in excess of 10%, which is five times higher than the existing 2% threshold. The proposed dilution timeframe of 10 years with respect to promoter holding is also rather generous, though SEBI has invited public inputs on the extent of the reduced shareholding (i.e., whether it should be 51% or 26% in the context of Indian shareholders, and 26% or 15% in the context of overseas shareholders).
While the ownership regime in relation to stock exchange and depositories is proposed to be relaxed, understandably, SEBI has proposed further strengthening the governance framework to ensure enhanced supervision and accountability. The proposed changes in the governance regime include greater representation of public interest directors on various committees and restrictions on the maximum tenure of the MD / CEO of every stock exchange and depository.
Key Implications
Importantly, the proposals do not make a distinction between strategic and financial investors, and provide for the same ownership limits in respect of green field ventures as well as acquisitions of existing entities, with the only caveat being that in case of new ventures, at least 50% of the total ownership should be held by shareholders having more than five years of experience in capital markets or financial services technology.
Given the above, from the perspective of foreign investors, the proposed changes should ideally enable overseas bourses as well as private equity investors to partner with Indian promoters to either set up new stock exchanges or acquire one of the existing exchanges. Having said that, given the intrinsic concentrated nature of the stock exchange business globally, it may well be a case of “too little too late” for new stock exchanges to now emerge and become successful. Therefore realistically, the opportunity for overseas stock exchanges and investors may be limited to acquiring a significant stake in one of the existing stock exchanges.
It is worth noting in this regard that BSE is a listed entity with a dispersed shareholding pattern (https://tinyurl.com/y68nxkya). NSE is as yet unlisted and has several financial investors with sub-5% holdings (see NSE’s shareholding pattern here – https://tinyurl.com/y3ogl9l6). There have been news reports indicating that NSE is preparing itself for a listing.
In relation to secondary purchases, the discussion paper refers to compliance with SEBI’s takeover regulations for share acquisitions of 25% or more, in case of both listed and unlisted stock exchanges. It is unclear how SEBI proposes to enforce an open offer process in the context of unlisted stock exchanges such as NSE. The discussion paper also contemplates SEBI approval for “any merger & acquisition”. Given the separate 10% de-minimis threshold for seeking SEBI approval, we believe that the reference to “acquisition” in this context is a drafting anomaly, and that the intention is for approval to be sought only for mergers (or similar schemes of arrangement) and share acquisitions in excess of the specified threshold.
Looking Ahead
SEBI appears to be keen to ensure competition and innovation amongst stock exchanges and depositories. Unlike previous attempts, the suggested proposals this time around seem to bear a sense of urgency and certainty. In terms of process, the discussion paper is currently pending public feedback, following which the proposals will need to be formally approved by SEBI’s board before the amended regulations are framed and notified.
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This material is for general information only and is not intended to provide legal advice.
For further information, please contact:
Rathin Somnath