2012

Demutualization of stock exchange

Muqadambutt 11476 Shaheen tariq (11780) Shahzad ghani (9955)

HISTORY: The demutualization of stock exchanges is a recent new phenomenon in the economic world with a history of approximately 20 years, meaning that till the early 1990s, most of world stock exchanges were non-profit, mutual organizations with monopoly power, owned by their members. In 1993, the Stockholm Stock Exchange became the first exchange to demutualize. It was followed by several others,including the Helsinki Stock Exchange in 1995, the Copenhagen Exchange in 1996, the Amsterdam Exchange in 1997, the Australian Exchange in 1998,and the Toronto, Hong Kong, and London Stock Exchanges in 2000. DEMULTUALIZATION: Demutualization is the process through which a member-owned company becomes shareholderowned; frequently this is a step toward the initial public offering (IPO) of a company. Insurance companies often have the word "mutual" in their name, when they are mutually owned by their policy holders as a group. Generally, policy holders are offered either shares or money in exchange for their ownership rights. Because shares can be traded or sold - in contrast to ownership rights, which can -not - demutualization increases the possibility of profit for those involved, and tends also to benefit the economy. For example, following a demutualization process that began in 1996, the Australian Stock Exchange issued shares to the public and began listing on its own exchange in 1998. . Worldwide, stock exchanges have offered another striking example of the trend towards demutualization, as the London Stock Exchange (LSE), New York Stock Exchange (NYSE), Toronto Stock Exchange (TSE) and most other exchanges across the globe have either recently converted, are currently in the process, or are considering demutualization Demutualised exchange different from a mutual exchange in following way:In a mutual exchange, the three functions of ownership, management and trading are concentrated into a single Group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. This at times can lead to conflicts of interest in decision making. A demutualised exchange, on the other hand, has all these three functions clearly segregated, i.e. the ownership, management and trading are in separate hands.
THE PROCESS

As stated earlier, demutualization is the process of converting a non-profit, mutually owned organization to a for-profit, investor-owned corporation. The members of mutually owned exchangesthat is,broker-dealers with seats on the exchangeare also its owners, with all the voting rights conferred by ownership.3 In contrast, a demutualized exchange is a limited liability company owned by its shareholders.Trading rights and ownership can be separated;shareholders provide capital to the exchange and receive profits, but they need not conduct trading on the exchange. And as discussed later, although demutualized exchanges will continue to provide

many if not most of the same services, they will have different governance structures in which outside shareholders are represented by boards of directors.After demutualization, brokers would not have 100 percent ownership because the general public and strategic investors would also now be able to obtain major shareholding of the stock exchanges, which would be turned into companies.
SALIENT FEATURES:

The status of the stock exchanges would thus be changed from limited by guarantee to the public limited company that will be listed on the stock exchanges.Composition of the board of directors will also be changed, bringing a balance among the interests of different stakeholders in the corporate and governance structure of a stock exchange. Conflict of interest will also end in demutualized exchanges as the management, board and shareholders will become independent

Disadvantages of Demutualization:
1. Expensive: A large company can easily spend tens (or even hundreds) of millions of dollars on the professional services needed to go through the process. One costly task is figuring out how to allocate the company's surplus among the individual policyholders. Ongoing administration is also expensive, because the company is likely to have many small shareholders. 2. Time consuming: It can take 18 to 24 months from start to finish. During this time, management's attention is distracted from other operational duties. 3. Litigation: It may lead to litigation or at least to perceptions of unfairness. Some groups of policyholders may object to the company's allocation method. For example, the owners of nonparticipating cash value policies, such as universal life, may wonder why they receive less than the owners of participating whole life policies. Policyholders who receive cash or policy enhancements may object to a valuation that is based on a below-book-value IPO price. Litigation can be costly and time consuming, and it can also damage a company's reputation. 4. Existing policies: It may hurt the performance of existing policies, through lower dividends, interest rates, and other factors. Although every demutualization plan tries to address this risk, there is no assurance that the solutions will work. Shareholders want their stock to perform well, and policyholders want their policies to perform well, and that inherent conflict can't be avoided. Based on unconfirmed anecdotes, it appears that the risk of dividend cuts is much greater for small policies. 5. Financial strength: It may hurt a company's financial strength, because managers may take greater risks to improve profitability. Some companies may find that the cultural leap from mutual to stock was too sudden, like jumping into a pool before you have learned how to swim. The mistakes they make as they try to build a competitive organization may be costly. Early missteps may also depress the company's stock and create long-term credibility problems with the investment community. 6. Process costs: It usually forces management to issue stock to policyholders even if conditions are

temporarily unfavorable, although some state laws may provide more flexibility. An immediate IPO is usually needed to recover the costs incurred in the demutualization process. There may also be selling pressure immediately after issue if many small shareholders choose to unload their shares. 7. Takeover: It creates the opportunity for the company to be taken over. A takeover may or may not benefit policyholders, but it is likely to be unsettling until more information is known. 8. Mutuality: It eliminates any flicker of mutuality. The company becomes a stock company, managed for the primary benefit of shareholders. In the past, most policyholders have sold their stock to institutional shareholders within the first year after demutualization. MOTIVES FOR DEMUTUALIZATION There are two main forces driving stock exchanges to demutualize: (1) increased global competition and (2) advances in technology Global Competition: Competition among the exchanges and with electronic communications networks (ECNs) has increased, and not just at the national level, but at the regional and global levels as well. In the new environment, exchanges are no longer monopolies but must now be run as efficient business enterprises. Heightened competition has thus been a major factor in decisions to demutualize. Advance in Technology: Technology Major changes in the structure and operations of stock exchanges have generally coincided with breakthroughs in communication and data processing technologies. Prime examples are the emergence of telegraph technology, which helped the NYSE establish its dominance in the late 19th century, and the advances in network technology that led the way to the development of Nasdaq in the 1980s. More recent technological improvements have enabled the development of the continuous electronic auction market in Europe. Continuous auction systems are trading systems that allow automatic execution of matching buy and sell orders.

Structure of Demutualization: The following key issues are addressed in structured of demutualization of stock exchange. 1) Corporate governance: a stock exchange establishes sound corporate governance of its activities, and this affects listed companies. Board appointments, board representation, board committees, share dealing rules for directors and managers, continuous disclosure procedures, as well as accountability and transparency of supervisory decision are reviews and reported. 2) Risk Management: risks and inevitable in any business, but can be monitored and managed to a reasonable extent. A stock exchange board established the framework for management risks, which generally emanated from current operation and new project are continuously identified and addressed 3) Ownership: the ownership structure of a demutualized stock exchange will go a long way in determining its mode of operations. Issues such as target investors, foreign ownership limit, percentage limits etc are addressed. 4) Financial management: a demutualized stock exchange is solely for profit making. As such strategies on how to meet up with investors expectation with respect to return on investment are considered. Issues such as sources of funds, dividend policy and financial governance are also addressed.

Demutualization in Pakistan: Presently the Pakistani stock exchanges are operating as non-profit companies with a mutualized structure wherein the members have the ownership as well as trading rights. This structure inherently creates conflict of interest as members predominantly control the affairs of the stock exchange which results in lack of transparency in the operations of the stock exchange and compromises investors interest. Also, due to lack of resources our exchanges have not been able to grow to the expectations of investors as trading activity is mostly concentrated in three buildings of these exchanges with the dominant share going to the Karachi Stock Exchange. Corporatization and demutualisation of stock exchanges would entail converting the stock exchanges structure from non-profit, mutually owned organizations to for-profit entities owned by shareholders. Demutualization would result in enhanced governance and transparency at the stock exchanges and greater balance between interests of various stakeholders by clear segregation of commercial and regulatory functions and separation of trading rights and ownership rights. Demutualization will assist in expansion of market outreach, resulting in larger number of investors, improved liquidity and better price discovery. A demutualized stock exchange will be in a better position to attract international strategic partners and good quality issuers. Demutualization will also facilitate consolidation of brokers leading to financially strong entities. Demutualization is a well-established global trend and almost all stock exchanges worldwide operate in a demutualised set up. The passing of this law is a momentous accomplishment 2 which will bring the Pakistani capital market on par with other international jurisdictions like India, Malaysia, Singapore, USA, UK, Australia, Hong Kong, Turkey etc. Explaining the salient features of the Bill on 28th March, 2012, the SECP Chairman, Muhammad Ali said that the Demutualization of stock exchanges would end the reign of the stock market brokers by segregating the ownership and trading rights at the bourses. After demutualization, brokers would not have 100 percent ownership because the general public and strategic investors would also now be able to obtain major shareholding of the stock exchanges, which would be turned into companies. The status of the stock exchanges would thus be changed from limited by guarantee to the public limited company that will be listed on the stock exchanges. Composition of the board of directors will also be changed, bringing a balance among the interests of different stakeholders in the corporate and governance structure of a stock exchange. Conflict of interest will also end in demutualized exchanges as the management, board and shareholders will become independent and out of 10 directors, six directors will be nominated by the SECP from the private sector whereas the remaining four directors would be elected. An investment bank of international repute would be appointed for the evaluation of the stock exchanges and after Demutualization, the only way to increase the value of shares would be increasing profitability of the stock exchanges