Vote against the listing of stock exchanges - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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30 DECEMBER 2010

Every once in a while, there is a legislation that comes out which can fundamentally change the landscape for investors in the growing Indian stock markets. And sometimes it creeps in silently, with little fanfare.

In the early 1990's, the rules allowing Foreign Institutional Investors (FII's) was born. Today foreign investors have a stronger role in determining the direction of share prices than local investors. Much of this is due to the introduction of P-Notes by which "un-registered" foreign investors can access the Indian capital markets. A slight, silent twist to a regulation that was originally intended to allow long term capital to finance India's long term economic growth has now exposed India's stock markets to the minute-by-minute changes in sentiment of short-term obsessed gamblers head quartered in Connecticut, London, Geneva, and Hong Kong. Foreign investors trade about Rs 7,000 crore of stocks every day in India, and actually pay for and keep about Rs 400 crore - a delivery/trade ratio of about 6%.

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In the mid-1990's the Bombay Stock Exchange, the Calcutta Stock Exchange, the Delhi Stock Exchange and other minor stock exchanges were more focused on what was good for the brokers and the operators they worked with, rather than what was good for investors. Indeed, with their opaque pricing systems and devotion to maximise their commissions on any trade, brokers were branded as "crooks" by those in the know. SEBI tried to change this by insisting on greater transparency. After being ignored by the BSE, the National Stock Exchange was born - amidst a lot of noise and protests from the BSE, CSE, and DSE. Today, brokerage commissions are 90% lower than what they were in 1994 and there is more transparency on the prices at which investors transact.

In August 2009, the rule banning mutual funds from paying front end commissions was put in place - after repeated warnings from SEBI to the mutual fund community and to their distribution partners to do what was in the best interest of investors fell on deaf ears. As with recent practice, SEBI invited responses from the public. It was flooded with letters and emails from the mutual funds (with the exception of Quantum Mutual Fund) and their distributors saying the ban should not be out in place. Better sense prevailed and SEBI imposed the ban and began the forced clean-up of a dirty industry. There was a lot of noise at that time, too.

In June 2010, a committee set up by SEBI recommended the raising of the minimum net worth of Asset Management Companies (those entities that manage the money in the mutual funds) from the existing Rs 10 crore to Rs 50 crore. Again, the larger firms in the industry - who wanted to shut down the small firms (like Quantum Mutual Fund) and keep out the competition - were vocal in their support. Seeing no logic in asking a lawyer, an auditor, a doctor, or a fund manager - all professionals who offer a service - for a minimum net worth requirement, Quantum Mutual Fund opposed this proposal. This proposed raising of the minimum net worth from Rs 10 crore to Rs 50 crore, we wrote, was a move to block competition and devoid of any logic. We made a lot of noise in what was a silently attempted coup.

Over the past decade, SEBI has followed the wonderful practice of setting up committees, getting a report, placing the report on their web site (www.SEBI.gov.in) and then inviting feedback from the general public before taking a final decision.

The setting up of the committee is, in itself, not a guarantee that everything the committee says will be accepted. Sebi wants views from "experts" - and then the views on those views - before it makes a decision. A fantastic process. But sometimes we, the people, are too caught up in our daily grind to focus on these issues. A bit like our fight against the corrupt politicians and their business partners, whether "new age" or "old age" industrialists, who continue to racketeer with our total knowledge. We yell, we scream, and then we use the voting day as our vacation day.

Let's not make that same mistake with the issue of whether stocks exchanges should be listed or not.
And the good news is that, even while we are on holiday on New Year's Eve, we can send in our vote electronically - via email.

The role of a stock exchange
Now, the Bimal Jalan Committee set up by SEBI to "Review the ownership and governance of market infrastructure institutions" has submitted a report (please see www.SEBI.gov.in ) which recommended that stock and commodity exchanges should not be listed. And those profits should be "reasonable".

While making its recommendations, the committee noted:

  1. in a growing market, changes are inevitable
  2. but changes need to be calibrated
  3. because the financial crises nearly toppled the global economy, many assumptions we held about the stability of various "solid" financial institutions have been subject to re-examination
  4. any Market Infrastructure Institution (MII, such as a stock exchange, depositories, or a clearing corporation) which can cause a global or national meltdown should be owned in such strong hands that it will not act as a source of a problem but, because of its ownership in these strong hands, will act as a buffer and stop the problem.
The Jalan Report then goes on to define whether these institutions should be classified as "infrastructure" and concludes that MIIs, such as a stock exchange:
  1. offer a public good (they bring those investors with extra savings in touch with those who need capital to grow a business),
  2. exist as an essential service (imagine if there was no exchange open to trade your shares!),
  3. have a "natural monopoly" (once a share is listed on the BSE and the NSE, will you switch over to trading that share on a stock exchange run by Ajit Dayal, no matter how much you trust me?)
The Jalan report also notes that, in addition to providing an electronic platform for listing and trading, the stock exchanges also act as first-stop regulators since they regulate:
  1. the companies that issue shares,
  2. the member brokers,
  3. the traders and trading mechanisms,
  4. the introduction of new products, and
  5. the protection of investors.
All of these regulations provide the comfort to investors that there is a fair platform on which they can trust their savings.
And then there is SEBI in its present version 2.0 which ensures that the rules written by the SEBI of the 1990's are being followed. SEBI oversees what the exchanges - and other market participants - do.

Keeping in mind that a previous committee, the Kania Committee in 2002, had suggested that stock exchanges should be listed, the Jalan Committee - created in the backdrop of the financial crises which hit the world (and India) just 26 months ago - recommends that:
  1. profits of stock exchanges, since they are a public utility, should be capped and be on par "with average earnings of corporate sector in India".
  2. stock exchanges should not be listed and that this recommendation should be reviewed after 5 years.
The rogues are back!
The reaction to this recommendation has been violent.

Dr. Ashok Desai, a respected economist and ex-Ministry of Finance, was asked by ET Now to give this report a score on a scale of 1 to 10. He gave it a minus 10 and said, "too many restrictions will not get any entrepreneurs but rogues in this business. With Jalan's formula only rogues will get into the exchange business."

Pradip Shah, Chairman of the Capital Market Committee of the Indian Merchants Chamber said, "Committee has gone by the universal truth that individuals can do wrong and assumed they will. Society at large is right to expect that Policymakers to assume that most people do the right thing and devise policies to correct the wrong doing, rather than assume that people will do the wrong thing and devise policies accordingly."

And there are others...but the point is that the free-market capitalists as represented by IMC, Assocham, the private equity funds (who are investors in these exchanges and are hoping for an IPO), and every free-profit individual out there is up in arms. India is regressing, they rage.
This is license raj.
This will lead to inefficiencies.
Only rogues will enter this business.

But maybe the rogues are already in the business?
And the Jalan Report is trying to weed them out.

How many of you believe that "individuals in the field of finance can do no wrong"?
Yes, just a few hands up there.

And how many of you believe that "individuals in the field of finance are out to get you one way or another"?
Yes, I see many hands up there raised in agreement.

Universal truth: we steal your wallet!
Yes, it is a universal truth - the people in finance are generally out to get you.
And laws must be written around this universal truth!
Goldman Sachs has been described by many as a mafia, as a scorpion with tentacles that is out to suck every cent in your pocket. Goldman attracts the most criticism because it is the face of the money machines that dominate US policy making.
That culture of Wall Street firms has found its way to India.
India has "liberalised". Radia is a lobbyist and rather than banning "lobbying" we want to find ways to legalise it! The Political Action Committees (PAC) in USA are legal pools of money that back governments and bureaucrats to make a few people rich at the cost of many.

But, first, the negative connotation to being called a "public good".
There is this media campaign that "public sector" is a failure and "private sector" is successful. "Liberalisation" is equated as giving more control to the private sector and "for-unlimited-profit" motives are chanted as the Holy Grail to India's development.
I question that.

Enron was a private sector firm, and it went bust.
So was WorldCom.
All the NASDAQ bubble companies were private sector and went bust.
And, yes, all those financial geniuses who blew up the world (Bear Stearns, Citi, Goldman, Lehman, Morgan Stanley to name a few) were all private sector.

Closer to home we had Satyam and Global Trust Bank - and many others who still exist out there who are "successful". But one day these emperors will have no clothes and be bared for what they are.

Did I hear you say "telecom in India was successful after it was privatised"?

MTNL was being built as a great company and the DoT under Sam Pitroda had built local exchanges that challenged the multinationals like Siemens and Alcatel. Sukh Ram, the telecom minister, was found with a sack full of cash in his house in
1996 - no one knows why he got the cash.
But I note that private sector telecom took off after that.

IPCL was a good company and then sold off to Reliance.
Maruti was a PSU and then a majority given to Suzuki.
BHEL still fights the multinationals and builds great power equipment.
At the time of the financial crisis where did you place your money: in State Bank of India or in ICICI Bank?

There is nothing to suggest that the PSUs are bad.
There is a lot to suggest that PSUs with political influence can be disasters.
No doubt about that.
Like an Air India.
And there is a lot to suggest that the telecom industry has grown because a few private people knew how to get spectrum allocated. A "public" connection was used to make a "private" profit.

And sure, the private airlines have given us more flights and sweeter smiles.
But note that the government bailed them out when oil prices were surging and the world was collapsing in 2008 and now these airlines don't want to listen to your complaints about high air fares. After all, they are not a public good. They are private sector: come running to the government when you need help and get back to maximising profit when times are good.

Just like the mutual fund houses who went to the RBI for a Rs. 20,000 crore bail out after Lehman went bust but allowed all their CEOs to keep their bonuses from selling you FMP's.

Unlike Deepak Parekh, I don't believe that the established industrial houses are necessarily more honest than the "new age" ones.

And unlike many in the financial services industry, I don't believe that we as a community should be given a free hand to do what we want. Imagine the power we would have if we had a third, free hand to pick your pocket!

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The profits of power companies are regulated
In addition to the fact that monopoly does not mean PSU, does not mean bad service, there is the other aspect of providing a public good: how much money can you make?
And who will buy shares of a regulated entity, the existing investors ask.

So, Tata Power is a regulated entity and it cannot earn more than 15.5% RoE on the regulated businesses plus some efficiency returns and the bidding for the Ultra Mega Power Plants was on the basis of the lowest cost bidder winning the mandate - so, presumably, the lowest profit target won the mandate.

Yet we buy the stock.

We also buy telecom stocks in the market knowing fully well that the regulator can change tariff rates if they feel that profits are too high.

So, what is so odd about the stock exchange having regulated profits? Linked to some kind of average to corporate India, or to a risk-free rate of a government bond?

Aha, the problem is that there are many financial investors and PE funds that had made investments in stock exchanges with a view that they will list.
And, on listing, they will make a great profit if they could sell a business with unregulated profits.
But now there is no listing at least for the next 5 years.

And a great profit from a listing would have meant a great personal bonus.
The Jalan Report has threatened that.
And the rogues are upset that now there is no listing.
But you promised we could list these exchanges, they scream.
Tough luck: we all make investments and tax rates may change, the environment changes, these are some of the risks we take.
When we launched Quantum Mutual Funds, we assumed that the distribution channels would work for investors and introduce our disciplined research and investment process to their clients.
What a wrong assumption!

Yes, those who are "stuck" as existing shareholders can sell their investment to a State Bank of India and to any other non-rogue who will buy them for the 100 years of guaranteed profits such a monopoly can generate.
I will buy it - even if it is never listed. And maybe readers of the Honest Truth would like to buy it, too.
Let's discuss the price.

And Jalan is not saying "no listing forever" - all he is saying is let's review this in five years.
But 5 years is a lifetime for a quarterly-oriented financial investor.
Though 5 years is but the blink of an eye for an economy trying to build a capital market to support India's funding needs for the next twenty years.
But people with a long term view are in short supply; the rogues are in abundant supply. The rogues and mafia are pitching big time in the very buyable Indian media space with guest columns and interviews (don't forget the role of the journalists in the Radia tapes as they supposedly look for their scoops!)

So, please send in your email to SEBI
The focus on profit maximisation and the power of the financial firms is what caused the great bust in 2008.
The bust is not over - it has been swept under the carpet by a flood of money from Helicopter Ben.
The financial firms have been bailed out by their friends in the US governments.
The SEC was sleeping on the job for much of this past decade.
The Fed is lulling the US public into a dream world of a recovery.

But India was lucky to have the RBI and SEBI - the RBI under Dr Reddy refused to surrender India as the playground for the great financial jugglery. Unlike the local politician who signs away a community garden plot to a real estate developer for a private profit motive, Dr. Reddy told the derivative geniuses to stay out.

With reference to the Jalan report, Mr. Bhave, SEBI Chairman, has said, "Profit maximisation for market infrastructure institutions will not be encouraged. Proper mechanisms need to be put in place to discourage profit maximisation."

As the Jalan report concludes, "The stock market is evolving and a review (after 5 years) may be inevitable in the light of new technological developments....it would be desirable to keep a close watch on the working of the MII so that gains from the well-tuned markets results in the growth of the real economy and maintenance of financial stability."

So, email your views to RajeshKD@sebi.gov.in by December 31, 2010.
This is the email I plan to send in the suggested format, along with this Honest Truth:

S. No. Recommendation of the Committee Comment with rationale
1 Para 5.3 MIIs to generate only reasonable profits Yes, I agree. MIIs provide a public good and must earn a reasonable profit for that service
2 Para 5.1 Listing Yes, I agree MIIs should not list as yet since listing may confuse the objective of shareholders to maximise short term returns v/s the need to provide a stable stock exchange that provides a long term, public good of matching savers with the users of capital.

And to prove that this rogue has no bias against any particular financial intermediary, I wish that SEBI appoints a committee to review the workings of the entire financial services sector and put in place a cap on salaries and bonuses that get paid to all of us in this "business". After all, it is time that those in the financial services industry really began focusing on the public good rather than our private pockets.


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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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27 Responses to "Vote against the listing of stock exchanges"

Maaran

Jan 19, 2011

"The focus on profit maximisation and the power of the financial firms is what caused the great bust in 2008." - It is the intervention of Govt in Housing markets in creating Fannie Mae, Freddie Mac and Fed artificially keeping interest rates lower than inflation. Don't blame the markets. Blame the regulators & the govt.

When the regulators cause a crisis, how do you propose to recover - more regulation? - Defies logic.

People competent at finding good companies to invest may be completely ignorant in the matters of economics. This edition of "honest truth" is anything but the truth.

The author is only spreading his ignorance on economics.

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Nishant

Jan 12, 2011

Do not list stock exchanges......Just dont'

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K.Parameswara Iyer

Jan 7, 2011

I feel that it is not advisable as yet to list stock exchanges in India

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K.Parameswara Iyer

Jan 7, 2011

I vote against the listing of stock exchanges

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Prashant

Jan 6, 2011

I differ.
Hasn't competition in automobile industry, car industry, telecoms have by themselves put check on pricing. There can be regulator like SEBI on private exchanges. Many private exchanges competing head-on under good regulator (SEBI like) would be a good solution than restricting them from making profits, capping their profits, or simply not allowing them to go public etc.

Many places in world (US, Singapore) have private exchanges..

-- Some Digression
On an aside, US made policy mistake (great blunder) in housing loans, poor banking regulation. They are paying price for it. But you must also praise US for its quick decision making, trying out all options, etc. US has some great private stock exchanges, business policies, work environment..

Compare MFI interest rates of 50+% to poor people vis-a-vis US Govt attempt to help SMEs with 7-9% loans in these tough times. I am sure US would come back to be a great business nation by end of this decade (as Warrent Buffet says).


Don't keep blaming to Fed's QE program all the times. Exception measures are required in exceptions time. Compare again those things with Indian Govt's subsidy program and tell us who is eventual winner.

You have to occassionly go out of economic text book and get things right which are fully broken. US economy was on verge of collapse in 2008. Now it has large debt and debt reduction is next US challenge. In history US did have 100% public debt to its GDP and it resolved that problem.

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v.shiva

Jan 5, 2011

i agree with you that these commercial motives have put us to various scams that we are into. why highly educated populase do not wish to give a call for your good cause
this is the curse in our country.
keep it up

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bishnupanda

Jan 3, 2011

Sir
Plese advise about unlisted companies like SESA INDUSTRIES of sesa goa.at what pricw should i sell?I have 100 got @ 10 rupees and getting offer of 1000 by a postal news letter of a bombay broker.similar offers have come for JULUNDER MOTOY.
shares as investor

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Srini

Jan 3, 2011

It's a right step.
I think the mistake happened earlier - when the Exchanges - were made to feel that they can list. So they good all those "wonderful" shareholders who picked up stakes trying to make a killing.
Now this recommendation from Jalan will kill that.
So that's the unfortunate situation.

Despite all this I feel we should NOT list the SE.
If people want to list SE - it should be such that no one holds more than a very small fraction of a percentage. More like a mutual co.

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Madhav

Jan 3, 2011

In India with such weak inconsistent regulatory authority which at most of the times is easily influenced by political/business considerations SE's should not be listed to avoid the conflict of short term gains against long term stability we need. However more exchanges should be allowed under a strong regulatory mechanism to encourage competition (may be they can treated like utilities for returns). MTNL may not be a good example but many a PSU has been run to ground by political interference rather than managerial incompetency. A relatively free hand for PSU does work - most of the PSU banks do compete well against the "fee for talking to you" private sector banks! They may not have the ambiance of private sector by many customers don't want to pay through their nose for the service. Again we don't need PSU's running hotels, restaurants, textile etc - a few PSU's in banking/financial/insurance, defence/industrial/oil with no budgetary support and total freedom for private sector to enter. Let us have PSU's & private sector compete on equal footing & get the best for the final customer.

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Regular Reader

Jan 3, 2011

I see you have very strong views. But there's no question that private sector has been good for overall development. It runs on greed and you can always bank on people's greed for efficient utilization of resources rather than common good.

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