Demutualisation: The need for market diversification

Director and chief economist at the Hambros Fund Management Ian Beauchamp was quoted in the 'Treasury in Wisdom' as saying: "The first move of being defensive is to diversify. As markets become more and more global, that becomes increasingly difficult."
The observation is very relevant for Bangladesh's stock market that is undergoing reforms including demutualisation of its stock exchanges, which is associated with some risks in the global perspective. So, it is very important to ascertain how far demutualisation of bourses will work as far as the present state of Bangladesh's stock market is concerned as it is not so diversified.
Most of the stock exchanges including those in developed and developing countries have turned to demutualisation, which is now a buzzword in the modern finance world. Most of them have completed the process while many others are still implementing it. After the stock market crash in 2010-11, Bangladesh also felt the necessity of demutualisation and already started implementing it which will take three years. But many cast doubts about its efficacy as the stock market in Bangladesh is not that diversified.
In developed countries, their stock markets have undergone demutualisation alongside introduction of key market instruments including derivatives and hedge products, private equity market, strong bond market, commodity exchanges and so on. They have also adopted the international financial reporting standard. But in Bangladesh, we are far off the mark.
Whether demutualisation is the eventual remedial measure that can make the stock market in Bangladesh sustainable is a matter of debate. There are people on both sides of the divide who have very strong feelings. Some say there is no guarantee that demutualisation of the stock exchanges will make everything alright and no stock market crash will happen again. Obviously, demutualisation has some positive aspects. But it cannot be the ultimate solution to any stock market debacle unless the other key market instruments are there.
As the concept of demutualisation is new in Bangladesh, we have to wait for a few years to evaluate its efficacy. The government deserves thanks for coming up with a positive mindset. As the ball of demutualisation has started rolling, now what remains to be seen is how the market functions in the preliminary phase. Changes in the mindset of those at the helm of the exchanges and the attitude of other key market players are crucial for further development. So, for successful implementation of the process, other remedial issues and risk factors should also be taken into account.
The authorities in Bangladesh's capital market and the government have initiated the demutualisation process as part of the share market reforms agenda. The benefits include better corporate governance, access to economic and human capital, and an increase in listings and international alliances. However, there are some challenges also. These include regulatory framework, conflict of interest, ownership structure issues and agency cost. All these factors should be kept in mind if we want to complete the demutualisation process effectively.   
"We enjoy the process far more than the proceeds." By saying this, a renowned American business magnate, investor, stock market guru and philanthropist might have attempted to convince us about the importance of proper enforcement of any market-related strategy like demutualisation.
However, various policies have been adopted by the stock market regulating authorities for capital market development on different occasions. Very few of the measures have been supported on a sustainable basis.
Today's demutualisation of stock exchanges is a very useful remedial measure. The capital market in Bangladesh has adopted the demutualisation process for making the share market sustainable on a long-term basis.
The capital market already experienced two massive debacles. The first market plunge happened in 1996 when a spurt of foreign investments in the market was greeted with withdrawal of the lock-in system leaving at risk the small investors doing paper-based trading at the kerb market.
What is interesting to note is that after the 1996 stock market debacle, the authorities in Bangladesh's capital market adopted a lot of market-friendly policies like automated trading, dematerialisation of securities and a strong software surveillance system, but those failed to avert the second big market crash of the fiscal year 2010-11.
This time experts blamed the market infrastructure system for the debacle. They identified the lack of transparency and accountability, inaction of the market regulators and lack of coordination among themselves, greed of the market players, both small and big, lack of diversified market instruments and lack of political will as the main factors behind the second stock market crash. Market experts suggested separating management of stock exchanges from their ownership. Subsequently (in 2011) the capital market probe committee, headed by former Krishi Bank chairman Ibrahim Khaled, strongly recommended demutualisation of the stock exchanges to improve market performance and management and ensure  transparency and accountability inside the stock market.
Intrinsically, demutualisation is the contemporary issue in the world capital market and it requires exceptional infrastructural development. This means dynamic and efficient technological advancement. Essentially, futures exchanges similarly have been buffeted by technological changes and the global competition. One important response to these challenges is demutualisation.
Mostly, demutualisation is the mechanism (or strategy) of transforming a member-owned stock exchange into a shareholder-owned company, which could be listed with a stock exchange. The aim of segregation of management from ownership is expected to establish transparency and accountability inside the stock market. Demutualisation also guarantees one vote per share instead of one-vote one-member. Moreover, another crucial aspect of demutualisation is to bring good governance through segregation of ownership from management. Keeping the international capital market trend and the prospective benefit of demutualisation in mind, the Jatiya Sangsad passed the Demutualisation Act-2013 and the Exchange Demutualisation Act-2013. The laws were published in the Bangladesh Gazette on May 2, 2013.
The first stock exchange to embrace demutualisation was the Stockholm stock exchange in 1993. Today, all major stock exchanges around the world such as exchanges in India, Malaysia, Hong Kong, Singapore, Japan, Germany, Australia, the USA, the UK etc are operating as demutualised exchanges.
However, though it is a global practice, demutualisation has its drawbacks and risks. It is not the ultimate solution and it cannot stop stock market manipulation overnight. The timeframe for its implementation is important. It all depends on how we use the given mechanism.
When the demutualisation is gaining popularity across the globe, there is no doubt that Bangladesh's capital market has ushered in a new era by undertaking its project for introducing the global capital market standard. No other exchange in the world saw two market crashes as happened in Bangladesh within less than two decades. The market here not only saw two big crashes but also faced a severe confidence crisis. Experts believe that if we get rid of the traditional system of stock market workings, then sustainable development will be possible. Demutualisation can be the best option in that direction if we want to ensure sustainable development of the stock market and restore investor confidence.
The demutualisation process meets challenges on development and competition fronts and even addresses failure to conduct credible operations. It cannot be said that all of the demutualised exchanges in different countries have been fully successful. We can learn lessons from those that are yet to achieve their objectives. The cues from them can guide us on the path of demutualisation. The authorities must assess the impact of the changes in regulatory structure after demutualisation. The authority must assess beforehand how much viable the regulatory structure change is. With the bourses' move toward full demutualisation, the regulatory role of the exchanges will become more difficult and they should be prepared for handling things in the changed perspective. If the regulatory structure is flawed, the benefit of demutualisation will remain elusive. New issues will arise as a result of demutualisation including direct investors' access to exchanges, global alliances and cross-border ownership.
Nevertheless, there is an immense scope for the market to benefit from demutualisation provided there is the proper product diversification and technological advancement.
The infrastructural deficiency and confidence crisis are very terrible problems facing our share market. The BSEC (Bangladesh Securities and Exchange Commission), the MoF (Ministry of Finance) and other stock market related authorities should try their best to found a sustainable capital market. In this case, demutualisation of stock exchanges is really a great challenge. For successful implementation of it the stock market authorities and other financial institutions should come forward with proper steps.
The writer is a financial market analyst and Young Professional at BRAC International. He authored the book 'Bangladesh Stock Market: Looking ahead after two big crashes'. The opinions expressed here are not necessarily shared by the organisation he works for. toufique2010@gmail.com