Report of the Group on

Corporatisation & Demutualisation of Stock Exchanges

1. Introduction

The Government had announced its proposal to corporatise the stock exchanges by which
ownership, management and trading rights would be segregated from each other and
legislative changes, if required, would be proposed accordingly to give effect to the
corporatisation of stock exchanges. The Finance Minister has also emphasized in his
Budget Speech for the year 2002-03 that this process would be completed during the
course of the year to implement the decision to separate ownership, management and
operation of the stock exchanges.

Corporatisation and demutualisation of stock exchanges are complex subjects and involve
a number of legal, accounting, Companies Act and tax issues. These issues would need
careful examination, before a clear roadmap could be prepared to take this process
forward. SEBI felt that it would be desirable to appoint a Group comprising of eminent
personalities, in fields of law, accountancy, finance, company law affairs and taxation to
advise SEBI on this matter and to recommend the steps that need to be taken to implement
the announcement of the Finance Minister.

2. Constitution of the Group

Accordingly, SEBI, by order of Chairman, Shri G N Bajpai has constituted a Group under
the Chairmanship of Justice M. H. Kania, former Chief Justice of India with the following
members:

i. Justice M. N. Chandurkar – former Chief Justice of the Bombay High Court and the
Madras High Court.
ii. Shri Y. H. Malegam, Chartered Accountant and Managing Partner, S.B. Billimoria &
Co.
iii. Shri Hemendra Kothari, Chairman, DSP Merrill Lynch and former President of BSE.
iv. Shri Nimesh Kampani*, Chairman, JM Morgan Stanley.
v. Shri G. Anantharaman, Chief Commissioner of Income Tax (IV), Mumbai.
vi. Shri Rajiv Mehrishi, Joint Secretary, Dept. of Company Affairs.

*
Shri Nimesh Kampani later on expressed that as he was not keeping well he would
not be able to attend the meetings of the Group for some time and hence would not
be able to continue as a member of the Group. His resignation was accepted.

3. Terms of reference
 The terms of reference of this Group were as under:

i. to review and examine the present structure of stock exchanges including those set
up as companies and as unincorporated bodies and in this light examine the legal,
financial and fiscal issues involved to corporatise and demutualise the stock
exchanges, and
ii. to recommend the specific steps that need to be taken for implementation, and also
iii. to advise on the consolidation and merger of the stock exchanges.

The Group may during the deliberations call and hear the views of other legal
experts, stock exchanges and other market participants etc. The Group would
submit its report within two months from the date of its first meeting. The date of
submission of the report was further extended till August 31, 2002.

4. Recommendations

The recommendations of the Group are as follows:

i) a) the stock exchanges which are set up as association of persons and
those which are set up as companies limited by guarantee be converted
into companies limited by shares;

b) a common model for corporatisation and demutualisation be adopted for

all stock exchanges; and

c) the clause (j) of section 2 of SCRA be amended to mean that the stock
exchanges could be companies incorporated under the companies act. The
present provisions under clause (j) of section of 2 of SCRA defines stock
exchanges to "mean any body of individuals, whether incorporated or not,
constituted for the purpose of assisting regulating or controlling the
business of buying, selling or dealing in securities". This clause would need
to be amended to provide that a stock exchange should be a company
incorporated under the Companies Act. (Para 9.4)

ii. a) as corporatisation and demutualisation of a stock exchange is

essentially a conversion from a not-for profit entity to a for-profit
company, and would result in a distribution of assets, the Income Tax
Act should be amended if necessary, so that the past profits of an
stock exchange which were not taxed when it had the character of a
not for profit entity should not be taxed when its character changes. In
other words, the accumulated reserves of the stock exchange as on the day
of corporatisation should not be taxed. However, there would be no
objection to taxation of these reserves, in the hands of the shareholders
when these are distributed to shareholders as dividend at the net applicable
tax rate; equally all future profits of the stock exchange after it becomes a
for profit company may be taxed;

b) notwithstanding any provision, judgment or order to the contrary or

inconsistent therewith, a statutory provision should be made in the Income
Tax Act, so that the issue of shares and trading rights in lieu of the card
should not be regarded as transfer within the meaning of Section 47(xiii) of
the Income Tax Act. The byelaws, rules and articles of a stock
exchange should be amended to provide for the allotment of shares
and trading rights to its members upon corporatisation (in applicable
stock exchanges) and upon demutualisation;

c) necessary provisions should also be made in the Indian Stamp Act and
the Sales Tax laws to exempt from stamp duty and sales tax, the
transfer of the assets from the mutual stock exchange and the
issuance of shares by the new demutualised for-profit company,
formed pursuant to an approved scheme of demutualisation; and that

d) as only the schemes for demutualisation approved by SEBI will qualify for
the exemptions under the Income Tax Act, the Indian Stamp Act and the
Sales tax Act, each stock exchange would be required to submit a scheme
drawn on the lines of these recommendations to SEBI for approval. (Para
9.18)

iii. a) the trading card system be replaced by the deposit system

wherein the money deposited by the member to obtain trading rights
only, be considered as deposit with the stock exchange for trading purpose.
While the Group favors the deposit system, it would like to leave the choice
of adopting either the card or the deposit system to the exchanges; and

b) the procedures to be adopted if the deposit system is accepted by an

exchange for the purpose of segregation of the trading rights and
ownership, may be as detailed in Para 9.21 of the main Report. (Para 9.21)

iv. a) the three stakeholders viz. shareholders, brokers and investing

public through the regulatory body should be equally represented on
the governing board of the demutualised exchange;

b) there should be specific vacancies on the board for each group of

stakeholders;

c) the shareholders’ representatives should not be functioning brokers;

d) the brokers representatives would be elected by the shareholders from

among the brokers of the exchange;

e) the representatives of the investing public would be nominated by SEBI

from among a panel comprising of academics, professionals, industry
representatives, public figures and investor associations, non of who should
have any interest in any broking firm;

f) 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;

g) the maximum number of directors on the board will be governed by the

relevant provisions of the Companies Act. 1956; and

h) current restrictions on the tenure of broker directors should continue.

v. a) the roles and hence the posts of the Chairman and Chief
Executive should be segregated. The Chairman should be a person who
has considerable knowledge and experience of the functioning of the stock
exchanges and the capital market;

b) the Chairman of the Board should not be a practicing broker;

c) the demutualised stock exchanges should follow the relevant norms

of corporate governance applicable to listed companies in particular, the
constitution of the audit committee, standards of financial disclosure
and accounting standards, disclosures in the annual reports,
disclosures to shareholders and management systems and procedures;

d) the exchange must appoint a CEO who shall be responsible for the day
to day functioning of the exchange. The CEO would be solely responsible
for the day to day functioning of the exchange which would also include
compliance with various regulations and risk management practices;

e) it would be optional for the exchange to appoint a CFO in addition to the

CEO; and

f) the board should not constitute any committee whose effect would be to
dilute the independence of the CEO of the exchange and the day to day
functioning of the exchange. (Para 9.29)

vi. No specific form of dispersal need be prescribed but there should be a

time limit prescribed, say three years which can be extended by a further
maximum period of 2 years with the approval of SEBI, within which at least
51% of the shares would be held by non-trading members of the stock
exchange. (Para 9.30)
vii. It would be desirable for the demutualised exchanges to list its shares
on itself or on any other exchange. However, this may not be made
mandatory; in case the exchange is listed the monitoring of its listing
conditions should be left to the Central Listing Authority or SEBI following
the pattern obtained in UK and Australia where the market regulators viz.
FSA and ASIC supervise the listing. (Para 9.31)
viii. There should be a ceiling of 5% of the voting rights which can be
exercised by a single entity or groups of related entities, irrespective of the
size of ownership of the shares. (Para 9.32)
ix. The relevant provisions of the Securities Contract (Regulations)
Act, 1956, the Income Tax Act, 1961 and the Indian Stamps Act, 1899
be amended to facilitate corporatisation and demutualisation of the
exchanges and to grant fiscal exemptions to encourage this process.
(Para 9.45)
x. On the relevance of the regional stock exchanges, the Group felt that the
concept of regional stock exchanges needs to be abolished. (Para 9.39)
xi. On the issue of alternative use of the existing infrastructure facility of the
stock exchanges, the Group was of the view that that some of the stock
exchanges could explore the possibility of merger on the lines of Euronext.
The Group does not recommend any specific route as being mandatory as
the choice should be dictated on commercial considerations. The Group
however feels that it would be in national interest that the infrastructure
available with the stock exchanges be put to best economic use. In case the
stock exchanges adopt the Euronext model, SEBI will have to work out the
eligibility criteria for the brokers, model rules and bye-laws for such an stock
exchange, the risk containment measures, and the listing guidelines. (Para
9.43)
xii. In sum, the Group is of the view that -

a) a uniform model for corporatisation and demutualisation would

have to be adopted by all the stock exchanges. This model should not
be made applicable selectively only for a few stock exchanges;

b) if the recommendations are adopted and suitable legislative changes

carried out to implement the recommendations, the stock exchanges will be
required to submit a scheme of demutualisation to SEBI by an appointed
date, and non-compliance in this regard would result in lapse of recognition
granted to an existing stock exchange, whether permanent or temporary;

c) merger of stock exchanges, before or after demutualisation is a

commercial decision and the choice should be left to the concerned stock
exchanges and it is not within the purview of the Group to recommend a
specific course of action. However, the Group strongly feels that
corporatisation and demutualisation will facilitate the process of
consolidation of stock exchanges; and

d) while the Group does not wish to recommend measures which may
provide an exit route to the members of the stock exchanges, any stock
exchange which fails to comply with the requirement of corporatisation and
demutualisation by the appointed date and is accordingly derecognised, will
have to distribute its assets in accordance with the provisions of the
respective articles/ rules of the stock exchange and the relevant tax laws
shall become applicable. (Para 9.44)