Demutualisation and sound corporate governance

The four-member investigation committee on the recent stock market crash already submitted its report to the finance minister suggesting some recommendations to improve transparency in the operation of the nation's two stock exchanges: Dhaka Stock Exchange (DSE), and, Chittagong Stock Exchange (CSE). One of the recommendations is to demutualization of the two stock exchanges. The committee was headed by Khondkar Ibrahim Khalid, Chairman, Bangladesh Krishi Bank and former Deputy Governor of Bangladesh Bank (BB). Other members of the committee are Dr. Taufic Ahmad Choudhury, Director General of Bangladesh Institute of Bank Management (BIBM), Abdul Bari, ex-president of Institute of Chartered Accountants of Bangladesh (ICAB) while Nihat Kabir acted in the committee as legal expert. The members are highly experienced and possess authority on the capital market. The investigation report revealed the alleged manipulation of the market operation through issuing of illegal placement and preference shares, loan settlement through shares, asset re-evaluation, share split, and a series of ill-motive transactions. In addition, the report is thoroughly well-researched in nature because of its directives. They came up with a number of recommendations for our capital market. An important recommendation made by the committee is overhauling of the Securities and Exchange Commission. But the recommendations they put most emphasis on is the demutualisation of stock exchanges. Demutualisation is related with the organisational structure of stock exchange. Currently, our stock exchanges are non-profit cooperative organisations, owned by the exchange members who are usually stockbrokers. They do not distribute earnings as dividend. Rather, any profits are returned to members in the form of lower trading costs or access fees and investment for growth. These types of mutual association models have several disadvantages which can be listed as follows: l Decision making takes time. The exchange becomes unable to respond promptly and decisively to changes in the market; l Ownership and trading privileges rest with the same group of people which allows them to interfere in exchange policies with an ill motive for maximising self-interest; l Ownership is limited to only brokers & dealers. Institutional investors or fund managers cannot take part in ownership; and l Lack of competitiveness and dynamism in terms of fees and quality of services. Demutualisation could help us to overcome these shortcomings. Demutualisation of a stock exchange is entire process by which a non-profit member-owned mutual organisation is transformed into a for-profit shareholder corporation. Demutualisation breaks the mutual cooperation structure into three separate groups; the owners, the board of directors and the customers. Like corporations, the owners or shareholders vest decision-making power in a board of directors who are subject to election and removal by shareholders and this power is exercised on a day-to day basis by the management of the corporation. The members who have the supreme command in a mutual association model are just customers in a demutualised stock exchange. The owners will receive dividends from the profits of the stock exchange. The concept of the demutualisation was well discussed in 1993 and in the same year, the Stockholm Stock Exchange became the first exchange to demutualise. Since then, exchanges around the world have been demutualising, the London Stock Exchange in 1995, the Toronto Stock Exchange in 1999, the Tokyo Stock Exchange in 2001. The change of a stock exchange from a member-owned organisation to a for-profit shareholder corporation results in a number of benefits. It increases overall value by increasing revenues, reducing transactions and other costs. A demutualised exchange operates in a more customer-focused manner and is able to respond more easily and quickly to changes in the business environment and meet competitive challenges. Furthermore, separation of management from ownership means members could no longer maximise self-profits but, instead, they will be driven to maximise the overall value. Demutualisation will also allow an exchange to go public and raise capital for productive investment by listing its shares. It can even merge with another (e.g., merger of NYSE & Euronext in 2007). Today, all of the 10 largest international exchanges in the world are demutualised in an attempt to reap all these benefits. In Bangladesh, until now, good corporate governance is very much neglected and hardly practiced by enterprises. But ensuring good corporate governance in stock exchanges could help us from a lot of troubles. Looking back the stock market debacles in 1996 and 2010, it has been clear to all of us that stock market members are practicing very poor corporate governance. The investigation committee identified heavy weight corporates, politicians, officials of securities regulatory body, stakeholders and renowned individuals are involved in the market crash. Some members of DSE board of directors were also involved, it was learnt. To bring a change in this scenario the stock exchanges need to be demutualised. Demutualisation will ensure sound corporate governance, reduce unauthorised influences by members and bring operational efficiency. We need transparency in the management of the market. It needs to be mentioned here that, demutualisation doesn't guarantee good corporate regulations. However, as it separates owners from managers, agency management system provides a more transparent organisation structure than previous self regulated organisations. One way to ensure good corporate regulation can be setting up a separate entity to conduct regulatory functions. In US, Nasdaq took this approach and established two subsidiaries: NASD Regulation Inc. (NASDR), which was the regulatory arm, and the Nasdaq Stock Market, the commercial trading arm. The exchange can also outsource its regulatory functions to a completely independent third party. In many countries, demutualisation of the major national stock exchange has been accompanied by general securities regulatory reform. Bangladesh has started its way to demutualise the stock markets. The present government is determined to complete the demutualisation process within its tenure. Recent delegates from IMF also stated demutualisation as a pre-condition for its sanction of $1 billion loan. On February 02, 2011, the DSE formed a 10-member committee in this regard conferring the Term of Reference of reviewing the process maintained for demutualisation of Asian stock exchanges. Based on their opinion the demutualisation process for both stock exchanges of Bangladesh will be initiated. Demutualisation requires doing the valuations, structures, laws and governance which is very time-consuming. We may wait for next couple of years to complete the process. The writers Qazi Musaddeq Ahmad E-mail:musaddeq@mindspringbd.com is a research analyst, and Md. Mizanoor Rahman E-mail:mizan2006@yahoo.com is an Asstt Professor of Finance and Banking in the Bangladesh Open University