Role of Stock exchange in Corporate Governance

Introduction.

Corporate Sectors want a wide market for trading of securities. The investors want liquidity for their investments. The securities which they hold should easily be sold when they need cash. Thus, there should be a place where the securities may be purchased and sold. Stock exchange provides such a place where securities of different companies can be purchased and sold. Stock exchange is a body of persons, whether incorporated or not formed with a view to hold, regulate and control the business of buying and selling securities. Stock exchanges provide services to the investors, corporate sectors and also to the society.[1]

This project is concerned with the role of Stock exchanges in Corporate Governance. Role of exchanges in Corporate Governance has been listing and disclosure standards and monitoring compliance. Demutualization has raised issues on the role of exchanges. After demutualization the role of stock exchanges in Corporate Governance has changed. This project focuses on the impact of demutualization of stock exchanges on Corporate Governance. The project is structured in following manner. Chapter-I describes the concept of stock exchange. Chapter-II is role of stock exchange in Corporate Governance. This chapter deals with the traditional role of stock exchanges that was listing, disclosure standards and monitoring compliances. Chapter-III is impact of Demutualization of stock exchanges in Corporate Governance. This chapter deals with the changing scenario of the stock market and also corporate Governance after demutualization of exchanges. Chapter-IV deals with the Role of SEBI  in case exchanges failing short of its disclosure requirements.

Statement of the problem

Historically if we see stock exchanges™ role was mostly limited to issuing rules and clarifying aspects of existing frameworks. Stock exchanges were assigned the role of monitoring the compliance with legislation and securities regulations. Since the promulgation of OECD Principles of Corporate Governance, stock exchange has contributed to the development of Corporate Governance. It provided new market for securities, increased goodwill of the company, helped in the growth of the Companies. Recently we find stock Exchange have demutualised and in most cases become listed and now stock exchanges have become engaged in intensified competition and are refashioning them to meet the challenge. Thus, this is how the role of stock exchange is changing towards capital market and corporate governance.

Overview of the literature.

The researcher has referred an Article on the ˜Role of Stock exchanges in Corporate Governance™ by Hans Christianen and Alissa Koldertsova to get the clear idea of the role of stock exchanges.

Another Article on ˜demutualization of stock exchanges™ by L.C Gupta is followed to understand the effect of demutualization of stock exchanges.

An Article ˜Issues in Demutualization of exchanges™ by R. Ramaseshan is referred for the getting the clear idea about the issues raise after demutualization of the exchanges.

An Article by Herbert Smith on ˜Stock Exchange Demutualization™ is followed to understand the impact of stock exchange demutualization on Corporate Governance, the changing role of stock exchanges in the changing scenario of different countries.

A book on Commerce by R.K Sharma (2005) is also followed as it deals with the services provided by Stock exchanges to the Corporate Sectors.

Objective of the project.

The objective of the project is:-

1)      To trace the traditional role of stock exchanges in Corporate Governance.

2)      To examine the impact on the role of stock exchanges in Corporate Governance after it is demutualised.

3)      To analyze impact of demutualization of stock exchanges in different countries on Corporate Governance.

Research Questions

1)      What were the traditional roles of stock exchanges in Corporate Governance?

2)      What is the impact of demutualization on the role of Stock exchanges on the Corporate Governance?

3)      What is the role of SEBI in case the stock exchanges fails to meet the disclosure requirements?

Chapter-I

Stock Exchange.

Stock exchanges are organized and regulated markets for various securities issued by corporate sector and other institutions. The stock exchange enables free purchase and sale of securities as commodity exchanges allow trading in commodities. Stock exchanges provide a platform for the buyers and sellers to purchase and sell of their stocks.[2]Stock exchanges itself does not own shares. Instead it acts like market where stock buyers connect with their stock sellers. Stock can be traded in any stock exchanges like BSE and NSE of India. Though the meaning of stock exchange is explained but it is pertinent to know the history of stock exchanges.[3]

In this Article, the birth of stock exchange will be focused. Indian stock market is marked to be one of the oldest stock market in Asia. It dates back to the close of 18^th century when East India Company used to transact loan securities. In 1830s trading of corporate stocks and shares took place in Bank and cotton press first in Bombay. An informal group of 22 stock brokers started trading stocks under a banyan tree opposite Town Hall of Bombay each investing princely amount of Rupee 1. In 1860 the exchange flourished with 60 brokers. The share mania in India started when the American war broke and the cotton supply from U.S to Europe stopped. Further brokers increased to 250. The informal group of stockbrokers organized themselves as the Native Share and stock brokers association which in 1875 formally organized as the Bombay Stock Exchange[4].

The primary function of an exchange is to help provide liquidity; in other words, to give sellers a place to liquidate their share holdings. Stocks first become available on an exchange after a company conducts its initial public offering (IPO). In an IPO, a company sells shares to an initial set of public shareholders (the primary market). After the IPO “floats” shares into the hands of public shareholders, these shares can be sold and purchased on an exchange (the secondary market).[5]
The exchange tracks the flow of orders for each stock, and this flow of supply and demand sets the stock price. Depending on the type of brokerage account you have, you may be able to view this flow of price action. For example, if you see that the “bid price” on a stock is $40, this means somebody is telling the exchange that he or she is willing to buy the stock for $40. At the same time you might see that the “ask price” is $41, which means somebody else is willing to sell the stock for $41. The difference between the two is the bid-ask spread.[6]

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers’ market linking buyers and sellers. Before explaining further it is need to understand the difference between primary market and secondary market.[7]

Definition

Section 2(j) Securities Contract (Regulation) Act,1956, stock exchange means”

(a) any body of individuals, whether incorporated or not, constituted before

corporatisation and demutualisation under sections 4A and 4B, or

(b) a body corporate incorporated under the Companies Act, 1956 (1 of 1956)

whether under a scheme of corporatisation and demutualisation or

Otherwise, for the purpose of assisting, regulating or controlling the business of buying,

Selling or dealing in securities.

According to this definitions stock exchange allows trading in securities under certain rules and regulations.

Actually investors want liquidity for their investments. The securities which they hold easily be sold when they need cash. Similarly there are others who want to invest in new securities. There should be a place where the securities may be purchased and sold. Stock exchange provides such a place where securities of different companies can be purchased and sold. Stock exchanges are organised and regulated markets for various securities issued by corporate sectors and other institutions. The stock exchanges enable free purchase and sale of securities as commodity exchanges allow trading in commodities[8].

Characteristics of stock exchanges

1)      It is a place where securities are purchased and sold.

2)      The trading in an exchange is strictly regulated and rules and regulations prescribed for various transactions.

3)      Both genuine investors and speculators buy and sell shares.

4)      The securities of corporations, trust, governments, municipal corporations, etc.are allowed to be dealt at stock exchanges.

5)      Stcok exchanges are usually established at joint stock companies.

6)      The transactions take place between the members or their authorised agents.

7)      The securities are listed at stock exchange in a systematic manner and only these are traded.

8)      The stock exchanges are managed by the board of directors elected by shareholders.

9)      The exchanges are run as per certain rules and bye-laws decided earlier.[9]

 SEBI™s role in a stock exchange.

The securities and Exchange Board of India (SEBI) Act, 1992 was passed by Central Government for establishing a Board to protect the interests of investors in securities and to promote the development of and to regulate, the securities market and for matters connected therewith or incidental thereto.[10]

Every stock exchange needs recognition from the central Government. Any stock exchange, which is desirous of being recognized, may make an application to the central government. The application should be accompanied by a copy of the bye-laws of the stock exchange for the regulation and control of contracts and a copy of the rules relating in general to the constitution of the stock exchange. If the central Government is satisfied that bye-laws of the exchange ensure fair dealing and protect investors; stock exchange is willing to comply by other conditions which the Central Government imposes and it is in the interest of trade and public to grant recognition, it may recognize the stock exchange.

 

Stock exchanges provide services not only to the investors but also to the corporate sectors.[11]

Chapter-II

Role of Stock Exchange in Corporate Governance.

Corporate Governance is a term that refers broadly to the rules, process or laws by which business are operated, regulated and controlled. The term can refer to internal factors defined by the officers, stockholders or constitution of a corporation as well as to external forces such as consumer groups, clients and government regulations.[12] Historically the main direct contribution of exchanges has established themselves as promoters of corporate Governance recommendations for listed companies. Demutualization and the Corporatization have changed the role of stock exchanges in Corporate Governance. [13]

SEBI committee defined the objective of corporate governance as the maximization of shareholders™ wealth keeping in mind the interests of the other stakeholders.

it Traditional Role of stock exchanges.

The regulating functions of stock exchanges were in the past mostly limited to issuing rule and clarifying aspects of existing frameworks. The standard-setting role of stock exchanges was essentially exercised through the issuance of listing, ongoing disclosure, maintenance and de-listing requirements. On the enforcement side stock exchanges have shared their regulatory function with the capital market supervisory agencies. Stock exchanges were also assigned the role of monitoring the compliance with the legislation and subsidiary regulation[14].

1)      Stock exchanges provide new market for securities. The securities can be listed and then traded at the exchanges. It provides an opportunity to companies to raise funds for capital issues[15].

2)      It increases goodwill to the company. The securities are listed only after the scrutiny of financial positions of a company.[16]

3)      Stock exchanges provide ready market for the purchase and rate of securities. Besides new companies the existing companies also need to issue shares at the time of expansion.

4)      Those who invest in shares are confident of getting a ready market for their securities. The exchange provides liquidity to securities. When investors are not sure of getting ready market for their shares then they will hesitate to invest.

5)      The corporate sector can get information regarding trends of investment, investors, choice and priorities etc., from stock exchanges on regular basis. On the basis of this information, companies can plan their future issues.[17]

Stock exchanges act as medium for capital formation in the country. It helps in creating the habit of savings among people. People can invest their savings in corporate and government securities. Small savings of large number of people help in capital formation in the country. Companies can sell their shares through stock exchanges. Stock exchanges provide a platform to the companies for raising additional funds. An exchange allows the trading of listed securities only. While getting the shares listed on an exchange, a company is required to follow certain guidelines for protecting the interests of shareholders. While following the guidelines of the exchange, the management of the company is also regulated.[18]

SSBI committee defined the objective of corporate governance as the maximization of shareholders™ wealth keeping in mind the interests of the other stakeholders. However, we must also ensure that the interests of otherChacha shareholders are not getting affected in the process.EBISEBI committee defined the objective of corporate governance as the

Chapter-III

Impact of Demutualization and Corporatization of stock Exchanges in Corporate Governance.

Historically, stock exchanges, were owned, controlled and managed by a set of brokers. They set the rules and regulations which they were expected to follow. This led to a conflict of interest. In case of disputes, integrity of the stock exchanges suffered. NSE, however, was set up with a pure demutualised governance structure i.e., ownership, management and trading rights were distributed between three different set of entities. NSE™s ownership vested in the hands of banks, insurance companies, financial institutions, its management was drawn from the professionals and brokers were offered trading rights on the exchange. This separation of ownership, management and trading rights eliminated conflict of interest and provided transparency in operations. Currently all the stock exchanges in India have a demutualised set up.[19]

Demutualization

Demutualization means restructuring the stock exchange and changing it from a nonprofit organization mutually owned organization by its members into a profitable company owned by various entities including the public. The shares of the exchange can then be distributed among members, financial institutions and the public. Done properly, a change in the status of the

Exchange could provide the needed capital to build the marketplace, lower costs to members and better serve investors.[20]

Now the members of it are its shareholders. It has become a publicly traded company. When stock exchanges go for public it is demutualization.

Corporatization.

Corporatization means stock exchange should be organized as a company. The idea is to separate ownership, management and trading rights from each other. [21]

It is not necessary that any stock exchange which is corporatized is also demutualized. There are still some stock exchanges like Calcutta Stock exchange, Bhubaneswar stock exchange, Bangalore Stock exchange etc., out of 20, 18 stock exchanges are corporate entities and need to be demutualized that it must be converted into profit-making organization.[22]

Corporatization and Demutualization of Stock exchanges.

According to section 2 (aa) of the Securities Contract and regulation Act, 1956 Corporatization means corporatization means the succession of a recognized stock exchange, being a body of individuals or a society registered under the Societies Registration Act, 1860 (21 of 1860), by another stock exchange, being a company incorporated for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities carried on by such individuals or society;

According Sections 2 (ab) of the SCRA, 1956 demutualization means the segregation of ownership and management from the trading rights of the members of a recognized stock exchange in accordance with a scheme approved by the Securities and Exchange Board of India;]

According to section 4A of the SCRA, 1956 on and from the appointed date all recognized stock exchanges who are not corporatized and demutualised before the appointed date shall be corporatized and demutualised as per the provisions contained in section 4B. Appointed date shall be fixed by the SEBI by issuing a notification in official Gazette and SEBI can fix different appointed date for different recognized stock exchanges.

SEBI can extend the date for corporatization and demutualization of an exchange, if a particular stock exchange could not convert on or after the appointed date for sufficient cause[23].

Change in the role of stock exchanges after being demutualised.

Over the past 15years, the exchange industry is continuously changing. Exchanges have demutualised and in most cases become listed. A precursor to most of the recent structural changes in the stock exchange industry has been the process of demutualization. The listing of stock exchanges, perhaps even more than their demutualization, has transformed their business model. Demutualization has changed the ownership of stock exchanges, significant ownership stakes were often retained by previous member firms. The fundamental governance structure of exchanges was not significantly impacted. But self-listing and the subsequent dispersion of ownership of exchanges have finally divorced their interests from those of broker dealers. While competition among stock exchanges is not new, it has intensified in recent years in various areas of exchange activities, including trading, listing and settlement. In addition to the obvious effects of demutualization and listing of exchanges, a rapid improvement in information technology and the creation of innovative financial instruments have also been among the key factors. Moreover the scope of competition has broadened from the national to the international level. While earlier there was only among the domestic level now it has increased to international level. [24]

With regard to the functioning of securities market competition between exchanges can produce conflicting results. On the one hand, greater liquidity may be generated due to enhanced inter-market competition. On the other, insofar as competition may result in trading fragmentation, concerns regarding market transparency and indeed financial stability of exchanges emerge, since illiquid markets tend to be less resilient in periods of volatility.[25]

Concerning the ability of stock exchanges to enhance corporate governance of listed companies, competition between stock exchanges, in the absence of minimum standards set by the regulators (or weak enforcement of such standards), raises concerns. The incentives faced by exchanges to establish and maintain high regulatory standards might weaken as they weigh the risk of deterring listings altogether or losing them to competing market places. This risk may be exacerbated by the pressures a demutualised exchange is subject to from its shareholders to give top priority to maximizing profitability.[26]

As the stock exchange has itself turned into Business Corporation, in some jurisdictions its regulation function has been removed.[27]

Chapter-IV

Role of SEBI in case Exchanges™ failure.

Whenever investors want to invest in a company it needs to get information about the company. One can search the information of the company in its website or for more convenient information its can search in the stock exchanges™ website where the company is listed.[28]

A company is bound to keep update the stock exchange as part of its listing agreement, information regarding annual reports, quarterly financial information, shareholding patterns and corporate governance compliance reports[29].

The company also has to update the exchange on any event that can impact its financial performance or stock price. If a company fails to do so, then the stock exchange can take action against it.[30]

SEBI has also pointed out that not only companies but sometimes even stock exchanges fails short of adequate monitoring disclosure compliances. Now Stock Exchanges are also profit making institutions with commercial operations.[31]

Very recently measures have been introduced by SEBI:-

Stock exchanges have been asked to compare information filed on shareholding pattern with that in the previous quarter and to find out whether the disclosures comply with the existing regulations, such as those on insider trading.

They have to keep themselves informed on media updates on companies to check whether the information has also been filed with them. Besides, separate cells have to be set up for monitoring company disclosures.

While stock exchanges have been pursuing companies in case of unsatisfactory disclosures, what has been missing so far is an effective follow-up process. This is now set to change, as a detailed follow-up procedure has been laid out.[32]

Deadlines have been set for exchanges to seek information and for companies to respond to the queries raised. What™s more, correspondence between the two has to be put up on the stock exchange Web site.

Also, SEBI has to be kept regularly updated (through an ˜exception report™) on defaulting companies and also on the action taken by the stock exchange concerned.

While these are steps in the right direction, given that stock exchanges are profit-making entities with commercial operations (besides a regulatory role) to be taken care of, one will have to wait and see how all this will be accomplished.[33]

According section 7 of the Securities Contract and regulation Act 1956, every stock exchange is shall furnish the Central Government with a copy of the annual reports and such annual reports shall contain the entire requirement as may be prescribed.[34]

According Section 8(2) of the Securities Contract and Regulation Act 1956, If any recognized stock exchange fails or neglects to comply with any order made by the Central Government within the period specified therein, the Central Government may make the rules for, or amend the rules made by, the recognized stock exchange, either in the form proposed in the order or with such modifications thereof as may be agreed to between the stock exchange and the Central Government.[35]

According to section 8(A) of the Securities Contract and Regulation Act 1956 the stock may with the prior approval of the SEBI transfer the duties and the duties and function of a clearing house to a corporation being a company registered under the Companies Act, 1956.[36]

These are the laws that are framed under SCRA in case any stock exchanges fail to meet its requirements these measures can be adopted.

Secion 11.3(c) of the SEBI Act 1992 provides that it shall be the duty of the Board to protect the interest of the investors in securities and to promote the development of and to regulate the market securities as it thinks fit. It empowers the board to regulate the business in stock exchange and to regulate the working of the stock brokers, sub-brokers, share transfer agents etc.[37]

Section 11.3(d) of the SEBI Act 1992 states that as all Stock Exchanges are required to be registered with SEBI under the provisions of the Act, under Section 12 of the SEBI Act all the stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deed, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and such other intermediary who may be associated with the Securities Markets are obliged to register with the Board and the Board has the power to suspend or cancel such registration. The Board is bound by the directions given by the Central Government from time to time on questions of policy and the Central Government has the right to supersede the Board. The Board is also obliged to submit a report to the Central Government every year, giving true and full account of its activities, policies and programmers. Any one aggrieved by the Board’s decision is entitled to appeal to the Central Government.[38]

 

Chapter-V

Suggestions and Conclusion.

Thus from the above discussions an inference can be drawn that Stock exchanges play a very important role in the corporate governance but recently the role of it has changed.  Corporatization of Stock Exchange has no adverse effect on Corporate Governance as separation of ownership, management will cause efficiency. But profit motive of stock exchange after being demutualised may somehow affect the performance of the stock exchange in corporate governance as now it itself has become a company. There are different opinions on the performance of stock exchanges after it is demutualized. Some says that intense competition may increase the skill of the performance of stock exchange. Some other™s view is that because of profit motive it may however have adverse effect on the stock exchange. This project has commented on the main issues that present themselves when exchanges consider what is to be the exchange™s most appropriate structure post-demutualization, including:-

1)      Corporate governance issues, such as what should be the composition of the board, whether the board should establish committees, and what share-dealing rules and policies should be introduced for the exchange™s own directors and managers.[39]

2)      Competition has increased among the stock exchanges.[40]

3) Stock exchanges now face competition from Alternative Trading System. Investors are getting Traditional functions of the stock exchange became available from other sources and made investors seek the means that can provide liquidity more efficiently.[41]

The discussion highlights a variety of issues that need to be addressed in order to maximize the benefits to be gained from demutualization. It is unlikely that one set of solutions will suit all

Exchanges. Each exchange will need to consider these and other issues in the light of its own particular environment.

However, some laws are implemented like SCRA, SEBI ACT 1992, which shall protect the interest of the investors as well as other corporate sectors which are listed in the stock exchanges for selling of its shares.

SEBI plays a very important role to regulate the securities market.  SEBI regulates the securities market and gives guidelines to the stock exchanges and thuss protect the interest of the investors.

Some issues that should be taken into consideration are as follows:-

The mangement of the stock exchnage must be made strong.

Corporatisation and demutualisation of stock exchanges are complex subjects and involve a number of legal, accounting, Companies Act and tax issues. These issues would need careful examination, before a clear roadmap could be prepared to take this process forward. SEBI felt that it would be desirable to appoint a Group comprising of eminent personalities, in fields of law, accountancy, finance, company law affairs and taxation to advise SEBI on this matter and to recommend the steps that need to be taken to implement the announcement of the Finance Minister.

It is also felt that there is need to change some of the Acts such as Income Tax Act,  so that the past profits of an stock exchange which were not taxed when it had the character of a not for profit entity should not be taxed when its character changes.

Thus, these are some of the issues that should be taken into consideration.

 Bibliography

Books.                                              

1. Sharma R.K. and Shashi K.Gupta, Structure of Commerce, (2005)

Articles

1. Tejpal.N History and evolution of stock exchanges in India, shodhganga(2011)shodhganga.inflibnet.ac.in
2. Harper David, Getting to know the stock exchange,investopedia(22   September2013)http://www.ivestopedia.com
3. Investopedia Staff,Stock basics how stocks trade?, Investopedia.www.invetopedia.com

4. Rouse.M, Corporate Governance, Tech Target,(January2008),searchfinancialsecurity.tachtarget.com

5. .Christaniansen Hans and Alissa Koldertsova, Role of stock exchange in Corporate Governance,OECD(2008),http://www.oecd.org

6.Arwa M. Morsy ,The impact of demutualization on the performance of stock exchanges, MSM,(2007),http://www.msm.com

7.Secondary Market Department, Corporatization and Demutualization of stock Exchange,(30 January 2003), www.sebi.gov.in

8.Akhtar Shamshad, Demutualization of stock exchanges, Problems, Solutions and case studies, Director,Governance, Finance and Trade, East and Central Asia Department, Asian Development Bank, At 83,(2002)http://www.set.org.com

Statutes

1.      Securities Regulation and Contract Act, 1952

1. Securities and Exchange Board of India Act, 1992.