Demutualization of stock exchange
Demutualization of stock exchange
Tooba Sarbazi
Articles

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.

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.

Their most important characteristic is a very strong and close identity between the owners of the stock exchange and its clients, final consumers of its trading services, because usually, the owners are at the same time its clients, sharing the profits of the company in accordance with the level of their participation in the ownership. Due to the recent years’ technology improvements and competitive environment changes, new opportunities alongside with new threats were created for stock exchanges. As an answer to these new threats stock exchanges began to change their ownership organizational form.

Pakistan’s capital market has seen a number of significant reforms since year 2000 led by the Securities and Exchange Commission of Pakistan (SECP). The reforms were focused on governance, risk management, market development and investor protection with the objective to make the markets fair, efficient, and transparent and enhance its capacity for capital formation.

The SECP as part of its reform process restructured the board of directors of the exchanges with appointment non-broker professional directors however, as self-regulatory organizations the decision making process at the exchange remain inherently conflicted. This is predominantly for the reason that members being owners have sole trading rights and dominant participation in various committees of the exchange which results in bias decision making, jeopardizing the interest of the stakeholders in particular the investors

Stock Exchanges (Corporatization, Demutualization and Integration) Act, 2009 DEMUTUALIZATION COMMITTEE (Section 3)

As defined in Stock Exchanges (Corporatization, Demutualization and

Integration) Bill, 2009:

  • “Corporatization” means the conversion of a stock exchange from a company limited by guarantee to a public company limited by shares;
  • “Demutualization” means the segregation of the majority ownership of a stock exchange from the right to trade on such Stock Exchange;
  • “Integration” means the merger of two or more stock exchanges;

Demutualization is the process through which a member-owned company becomes shareholder-owned; 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.

Pros and Cons of Demutualization:

1) Flexible Governance:

Demutualization results are more flexible governance structure fostering decisive action in response to changes in the business environment. It allows greater Flexibility and access to global markets.

2) Alternative Trading System:

It yields an improved platform in response to potential competitors in the form of alternative trading system. It also facilitates faster and more complete consolidation of stock exchanges to enhance available synergies.

3) More access for Capital investment:

It ensures increased access to resources for capital investment raised by way of equity offerings or private investment.

4) Access to more Resources:

For the stock exchanges, demutualization means access to more resources, which has become very important of late given that they have to invest massively in technology to offer contemporary trading platforms. 5) Globalization:

With globalization the need for entering into a strategic alliance with other exchanges or acquiring other exchanges for growth or even survival has become important. 6) 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.

7) 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. 8) 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.

  • 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. 10) Financial strength: It may hurt a company’s financial strength, because managers may take greater risks to improve profitability.