Demutualization refers to the conversion of an existing non-profit organization into a profits-oriented company. In other words, an association that is mutually owned by members converts itself into an organization that is owned by shareholders. The company can take different shapes and forms, that is, it could be either a listed or unlisted company which may be closely held or publicly held.
Demutualization of stock exchanges involves the segregation of members’ right into distinct segments, viz. ownership rights and trading rights. It changes the relationship between members and the stock exchange. Members while retaining their trading rights acquire ownership rights in the stock exchange, which have a market value, and they also acquire the benefits of limited liability. The shareholders in a corporatized stock exchange may be a diverse group, as members may decide to retain their shares or to sell them. Demutualization however, does not insulate them from competition. A stock exchange whose management does not effectively work to maintain its position in the market may soon become a take-over target.
This term is not restricted only to corporatization of stock exchanges. Any organization that is a non-profit body (which is not the same as loss-making), and is not distributing its profits to owner-members but retains the same to develop infrastructure of the organization, can demutualise.
Thus recapitulating once again Demutualization refers to the transition process of an exchange from a “mutually-owned” association to a company “owned by shareholders”. In other words, transforming the legal structure of an exchange from a mutual form to a business corporation form is referred to as demutualization. The above, in effect means that after demutualization, the ownership, the management and the trading rights at the exchange are segregated from one another.
A demutualised exchange is way different from a mutual exchange; the three functions of ownership, management and trading are intervened into a single Group in a mutual exchange. The broker members of the exchange over here are both the owners and the traders on the exchange and they further manage the exchange as well. A demutualised exchange has all these three functions clearly segregated.
SEBI had formed a Group on Corporatisation and Demutualization of Stock Exchanges under the Chairmanship of Justice M H Kania, former Chief Justice of India, for advising SEBI on corporatization and demutualization of exchanges and to recommend the steps that need to be taken to implement the same. The Group submitted its Report to SEBI on August 28, 2002. SEBI has taken up with Central Government to amend the SC(R) A to affect Corporatisation and Demutualization.
Advantages of Demutualization:
- Rationalized Governance: The corporate model will enable management to take actions that are in the best interest of customers and the exchange itself. There would be transparency.
- Investors Participations: A demutualised exchange affords both institutional investors and retail investors the opportunity to become shareholders. Institutional investors require much greater liquidity for block trading.
- Competition from Alternate Trading System’s (ATS) and Electronic Communication Networks: ATS and Electronic Communication Networks provide cheap and efficient access to quoted stocks unlike traditional stocks exchanges. To cope with competition, exchange required funds. While members owned have limitations in raising funds.
- Globalization: Historically brokers and exchanges were locally focused. Exchanges did not face meaningful competition from exchanges in distance places. Through alliances, exchanges seek to attract more investors by harmonizing distinct trading environment and by offering greater product variety.
- Resources for capital investment: One of the drivers of stock exchange demutualization is screen trading, which has which has replaced floor trading on most exchanges. Once customers have direct access to screens, exchanges memberships no longer have as much economic value and clearing firms rather than traders become a dominant force in exchange activities.