The risks of demutualisation

'Quinine is used to cure malaria. But, who is going to cure Quinine?' Remember the philosopher-writer of the last century Syed Muztaba Ali mockingly mentioning this hard truth? I recall it as I observe the demutualisation process of the stock exchanges of the country.
The finance minister in his usual bold voice a year ago stated his prescription for our sick markets.  The "medicine" he prescribed has been the demutualisation of the stock exchanges.  The word 'demutualisation' is not available in a standard dictionary.  The meaning was not clear even to almost all of us in the market. The complicated pronunciation of the word by Bengali tongue further made us jittery. However, we have all been determined and eager to try anything and everything to cure (once again after 1996) the market that suffered from internal blows. Any known and unknown medicine and surgery would do the needful for us. Side effects are not the issue for an emergency patient.
Demutualisation has become a buzzword worldwide in the reforms of the stock exchanges in the last two decades.  Most of the bourses, if not all, are responding to the miraculous development of information and communication technology.  With this miracle, the "club" of stock brokers started to fall apart.  The market places have become spaces which are said to be now "geographically neutral". Access to markets, especially share market is now just a click away. Computer replaced the order book; Internet substituted investors' runner to brokers, and robust electronic trading system of the exchanges poses threats to the very profession of brokers -- the middlemen. Although the affluent brokers and dealers so far have kept their jobs, the threats continue to rise.  The institutions so far remain unbeatable are advisory firms, margin loan lenders and asset management companies.
In this scenario, members of "stock exchange clubs" recognising the irreversible progress of technology prudently convert bourses into profit- yielding technology company.  The coterie of brokers renounces their power to make regulations for their own operation and business in the markets.  In lieu of the exclusive club membership, now the businessmen either become profit-taking owner of the bourse or choose to hold trading right.  The trading right certificate holders act as brokers and dealers for themselves and their clients.  The process termed as DEMUTUALISATION, often defined in a simplified manner, as the process of separation of trading right and ownership.
The process, if we number the major changes, involves are:
1.    Transformation of bourses from non-profit nature into profit distributing corporate entity
2.    The Governing board of directors of bourses comprises of experts and independent brokers
3.    The power of the bourses to frame trading regulation  are reduced heavily
4.    The regulator, in our case the Bangladesh Securities & Exchange Commission (BSEC) takes larger responsibility to regulate
5.    The technology, that is the trading system and the network requires to be robust and broad to incorporate risk management system
6.    Now, in the current form of mutualised form of stock exchange, for a trading right the prime (and sometime lone) requirement is money.  A huge amount is required to buy a seat in the club.  In a demutualised setting, money required for trading will mainly be linked with trade volume and risks embedded to it.  A prime requirement for the trading right holders will be education -- proven skill to serve investors and trader efficiently, effectively, transparently and most importantly in a managed risk environment.  Brokers will be obliged to pass examination, systematised by the regulators.  
Now, having cited the obvious changes through demutualisation, we can see, what could be called by academics popularly as a paradigm shift.  The whole business model of stock market should be shaken by a revolution. Finance minister very rightly said that it is a medicine.  But is the medicine itself safe?  Is there any side effect?
The dangerous side effects, vis-à-vis the transformations mentioned above should be known to us:
1.    Stock Exchange is an organisation for public service. By the word "public", I don't mean the government.  But in true sense the members of the public and private institutional entities as well who invest and trade in stocks, shares and other securities.  When the owners of the exchange are out there for making personal profit, the noble objective faces threat.  You can say that the current scenario is no better than that.  Brokers look after their profit is a non-monetary way now.  After the demutualisation, the profiteers will be running overtly after profit in money terms directly and openly.  So the medicine will only change the superficial symptom.  Not the inherent disease.
2.    We are excited about the bourse board with majority of Independent directors. The greatest risk of demutualisation in fact lies in this "independence".  The stockbroker nurtured the stock exchange as their own baby, regardless of profit. They made money by attending investors-traders.  Everything happened on the stock exchange for them.  Stock exchange has been their home and temple.  Now the independent directors come in as nurse.  Paid by number of hours of their services, do we really expect the same love and care for the exchanges?  This love and sense of responsibility cannot be measured by a cardinal scale.  But on an ordinal scale, comparing to a broker-member of the exchange, the traits of the independent directors may be significantly low.  The risk of independent director was very well exemplified in our nationalised banks.  All directors of the Sonali Bank remained "independent". They may have lost jobs after a major loan scam, but not taken to task for their inefficiency or negligence.  They denied their involvement and that denial has been cowardly accepted. Can we ensure inclusion of responsibility shouldering directors in the stock exchanges who are at the same time skilled, experienced and resilient? Unlike those in Sonali Bank, stock exchange must not be left as nobody's baby in the "holy" name of demutualisation.
3.    The power of the bourse, instead of centralised in the hand of brokers, will be divided in three groups -- profit seeking owners, board led by independent directors and professional management.  In the mutualised form, the exchange suffered from group dictatorship of the brokers.  Now we will face the risk of imbalance and conflict between these three distinct bodies.  Balancing of power is a puzzling task.  Who is going to lead address this challenge?
4.    The BSEC has many challenges.  In the recent years we have seen a significant improvement.  Nevertheless, BSEC still has a long way to go.  It is yet to be up-graded from Appendix B to Appendix A in the member list of International Organisation of Securities Commissions (IOSCO). Although expected this promotion soon, we know that BSEC is tremendously understaffed. We know about the revised organogram, new recruitment and training.  However, we have not yet given BSEC its due respect and power.  Established in 1993, SEC faced the hurdle of defying DSE members.  Driving stock exchanges on a track was a hectic task. After demutualisation, again when BSEC has to be in the driving seat and change to a higher gear, the risk of unadjusted four parts of the vehicle may not respond properly on the high way.  At least in the beginning, the need for a fine-tuning of independent new board, the trading of right holders, owners and management may be felt painfully.
5.    The technology will be the prime factor in a demutualised exchange.  The business will be totally technology-based. An integrated technology for high speed trading, clearing and settlement and risk management is absent as of now.  There are no effective disaster recovery centres. Will the new owners be interested to invest for a massive up-gradation of technology?  They will naturally be more inclined to take off money from the treasury of the exchanges as dividend. It is a high risk.
6.    Education and skill development for the brokers and their authorised representatives will require a massive operation and investment.  There are more than 1000 persons now to be trained and passed through a standard examination.  When trading rights will be offered to all, we will need a full-bodied training and exam system, failing which the expected benefits of tonic called demutualisation may not be available. The fundamental risk is that our market participants are still averse to education.
The demutualisation is required. It is something overdue. The scheme prepared by the exchanges themselves demonstrates a roadmap for development. However, we must be aware of the risk associated with it. We must remember the adage of Syed Muztaba Ali.  'Quinine will cure malaria.  However, who will cure the effects of quinine?'
The writer is Chairman & MD of Alliance Capital Limited and can be reached at [email protected].
The observations and opinion expressed in this column are totally of the writer. It does not represent or reflect policy and view of any organisation the writer is working for or with.