Governance of the demutualized stock exchanges

In the past, in almost all the stock exchanges, the broker members of the governing boards have been critical in the governance of the stock exchanges. The reconstitution of the governing boards of the stock exchanges by SEBI, which reduced the broker representation on these boards to 50%, had helped in making the boards more independent and minimized the influence of brokers. However, in most stock exchanges on account of the brokers retaining posts of the officer bearers of the stock exchanges till recently viz. president, vice-president and treasurer, they continued to play a dominant role in the management of the stock exchange. The fall-out of this practice has been that most stock exchanges have failed to develop good corporate governance practices and strong management teams. This has not only been a perception but also a reality in most stock exchanges. Conflicts of interest have bedeviled the operations of the stock exchanges in the past to the detriment of the securities market. If the stock exchanges are to function in a modern competitive environment these deficiencies would have to be removed and they would have to adhere to the high standards of corporate governance. Indeed this is one of the objectives to be achieved through this entire exercise of demutualization of the stock exchanges.

The steps taken by SEBI recently to strengthen the governance of the stock exchanges and to remove the conflicts of interest. As directed by SEBI, the brokers are not allowed to hold the posts of president, vice president, treasurer or act as office bearers. Besides, pursuant to this directive the brokers have stepped down from these posts in almost all the stock exchanges. However there is a need to further strengthen the present governance structure to compliment the demutualization exercise so that the purpose of demutualization could be fruitfully served.

Divergent views have been expressed on the issue of broker representation on the governing boards of stock exchanges. The case for broker representation has been made by almost all stock exchanges and brokers’ association. Their argument is that the brokers are major stakeholders in a stock exchange and they are affected by the manner in which an stock exchange functions. They also have the experience and knowledge of the market and therefore should have some representation on the governing boards of the stock exchanges. Besides, the demutualised corporatised structure envisages that brokers could continue to be shareholders and as such be eligible to be elected on the boards as directors. The investors’ association has made the case for not giving any representation to the brokers. The argument against broker representation is one of conflict of interest and the possibility of interference and exercising influence in the functioning of the stock exchange. The investors’ association have felt that in a sense the presence of brokers on the governing boards affects the independence of the executives of the stock exchange who may be answerable to the very persons whose actions they are expected to control.

However in the newly constituted demutualised stock exchange, there would and should be three major stakeholders – the shareholders, the brokers and the investing public through the regulatory body. It was important that all the three stakeholders are represented equally on the governing boards of the stock exchanges. The representation of the brokers on the governing boards of stock exchanges is desirable since the stock exchange would benefit from their expertise and experience about the working of the stock exchange. It is expected that the 2/3rd of the board being non-brokers should be able to provide the driving force behind the management of the stock exchange. But in no case should the stock exchange have more than 1/3rd broker representations on its governing board.

According to the Kania Committee report,

  • The three stakeholders viz. shareholders, brokers and investing public through the regulatory body should be equally represented on the governing board of the demutualised stock exchange;
  • There should be specific vacancies on the board for each group of stakeholders;
  • The shareholders’ representatives should not be functioning brokers;
  • The brokers representatives would be elected by the shareholders from among the brokers of the stock exchange;
  • The representatives of the investing public would be nominated by SEBI from among a panel comprising of academics, professionals, industry representatives, public figures and investors association, none of whom should have any interest in any broking firm;
  • Adequate disclosures about the background of the directors of the board should be provided to the shareholders at the annual general meetings and the annual reports;
  • The relevant provisions of the Companies Act will govern the maximum number of directors on the board. 1956; and
  • Current restrictions on the tenure of broker directors should continue.

In most of the demutualised stock exchanges abroad, and even in non-demutualised stock exchange such as NYSE and NASDAQ, brokers are represented on the governing boards. In NYSE for example there are 4 broker members, 12 are providers of financial services, 8 are from financial institutions, 2 are CEOs of large corporates, 2 are representatives of investing association and 4 are retired public servants who held important administrative offices.