1. Muhammad Hassan Jamal Malik. 2. Shakeel Ahmed. 3. Muhammad Asif Khan 4.

Nabil Ali Nasiruddin

Reg # 11341 Reg # 10758 Reg # 8460 Reg # 05820

Course: Financial Markets and Institutions Day: Sunday 4:00- 7:00

Submitted to:

Mr. Ali Saeed

Demutualization of Stock Exchange

Table of Contents Executive Summary 1 Introduction 2 background and history 3 motives of dematulizaiotn 4 benefits of demutualizaiotn 5performance before and after demutualization 6 list of demutualzed stock exchange 7 List of References

Executive summary: This is an informatory report about the demutualization of stock exchange. The objective of this report is to study about demutualization of stock exchange and also the impact predemutualization and post on the performance of stock exchange in Pakistan. In fact, the role of capital market is very important as channel between saver to investor that enhance the income, employment opportunities, and help to growth of economy as whole. globally, it is now possible for savers and investors to move more efficient market due advancement of technology that make better communication channels as fast and efficient beyond the boundaries. Intense competitions among exchanges, and alternative trading systems led many countries toward demutualization around the world. In Asian countries development and integration of exchanges is emerged. In Pakistan SEC Initiated to demutualize its exchanges like KSE,LSE,and ISE Demutualization is critical in ensuring that the exchanges truly and fairly represents the interests of all stakeholders and thus perform its true function as an engine of economic growth. Demutualization of stock exchanges will not only promote greater transparency and stock market efficiency but also help in dispelling the perception that the stock exchanges are merely clubs, serving the interests of their members. The SECP is vigorously pursuing the process of Demutualization and Corporatization of the stock exchanges. The Stock Exchanges (Corporatization, Demutualization and Integration) Act, 2009 drafted in co-ordination with the relevant stakeholders was approved by the National Assembly in October 2009 however; the same could not be taken up by the Senate and is awaiting promulgation. Therefore in order to ensure smooth transformation and bring our exchanges and markets at par with international jurisdictions it is vital that the Demutualization law is enacted on priority.

List of demutualized stock exchange

STOCK EXCHANGE TSE Legal Form TSE was demutualized on 1 November 2001 Legal Status: Company SGX was demutualized in December 1999 Legal Status: Company (for profit). HKEx was demutualized in March 2000 Legal Status: Company (for profit) ASX was demutualized on 13 October 1998 Legal Status: Company (for profit) PSE was demutualized in August 2001 Legal Status: Company LSE demutualized in 2000 Legal status : Company for profit Deutsche Brse demutualized in 2001 Legal status : Company for profit Demutualized in 2000 Legal Status: Company (for profit) Demutualized in 2000 Legal Status: Company (for profit) Demutualized in 2000 Legal Status: Company (for profit) Demutualized in 2006 Legal Status: Company (for profit) Listing Status Not listed (plans to list in FY2005)

SGX

SGX

On 23 November 2000, the Company was admitted for listing of SGX-ST. SGX became a public-listed company with 1,000,000,000 ordinary shares outstanding. Listed

ASX

PSE

ASX was listed on its own exchange on 14 October 1998. When ASX shares were quoted on 14 October 1998, they closed at A$4.25; sub-sequently they rose as high as A$16 by 16 March 1999. Not Listed

LSE

In july 2001 LSE became Listed in its own market In Feb 2001 Deutsche Brse completed its Public Offering.

Deutsche Brse

Euronext

Became listed in july 2001

Chicago Mercantile Exchange Nasdaq

Became listed in Dec, 2002

Became listed in Feb, 2005

NYSE

Became listed in Mar. 2006

Performance Pre and post demutualization of stock exchanges

Net operating income symbol ASX SGX HKEx TSE PSE demutualization date (13-OCT-1989) (1 -DEC- 1999) (6 -Mar 2000) (1- Nov 2001) (8- Aug 2001) H$ 557(1999) Y3250(2001) P72.9(2000) before A $26.4( (1998) after Net income before(1998) after A$51.0(2001) S$60.9(2002) H$521(1999) H$ 740(2001) Y2152(2001) Y2826(2002) P70.1(2000) P18.3(2001)

A&74.4(2001) A$16.7 S$64.0(2002) 882(2001) Y1308(2002) P17.3(2001)

Key success of demutualize stock exchange around the world

Over 70 per cent of the world's stock market capitalization are comprised of publiclylisted exchanges Performance of TSX and Australian Stock Exchange post IPO excellent Demutualization in emerging markets differs significantly from developed markets. An increasing number of stock exchanges have joined the trend towards demutualization, which involves the conversion of an exchange from a not-for-profit member owned organization to a for-profit shareholder owned corporation. Demutualized stock exchanges (DEs) include the Toronto Stock Exchange (TSX), the Australian Stock Exchange (ASX) and, recently, the New York Stock Exchange (NYSE). Demutualization can be a source of significant market capitalization. At the end of 2004, the total stock market capitalization of the worlds exchanges was $37.2 trillion a figure that excludes the value added by the recent demutualization of the NYSE. With the addition of the NYSE as a publicly traded company on March 8, 2006, presently over 70 per cent of the worlds total stock market capitalization is comprised of publicly-listed exchanges. However, a small but significant portion of exchanges, accounting for 18 per cent of worlds total stock market capitalization, have demutualized but not listed their shares. This bulletin broadly reviews certain common features of DEs and provides an overview of relevant issues regarding stock exchange demutualization. It focuses primarily on demutualization in the context of developed markets, but briefly considers how the process has functioned in emerging markets. The challenges of demutualization in an emerging markets context have thus far been met with mixed success. While certain DEs in emerging markets, such as the Bursa Malaysia have generated long-run returns in the 26% range, others, such as the Philippine stock market, have been less than successful, reporting a first day trading return of more than 120%, but failing to realize durable profitability, positing negative returns of close to

74% as of September 30, 2005. That said, the Emerging Markets Committee of the International Organization of Securities Commissions has stated that it is too early to assess the benefits of demutualization in an emerging markets context, as insufficient time has passed since the various demutualization exercises were initiated. Since this is the case, it is likely that there will be considerable debate on this topic as time passes and additional information is made available.

HISTORY OF DEMUTUALIZATION
Demutualization refers to the process of changing the ownership structure of a member-owned (or mutually-owned) financial institution into a shareholder-owned corporation. The first stock exchange to demutualize was the Stockholm Stock Exchange in 1993. Several other exchanges followed Stockholms lead: the Australian Stock Exchange (ASX), Toronto Stock Exchange (TSE), Singapore Stock Exchange and Hong Kong Stock and Futures Exchanges among them. In December 1998, the Securities and Exchange Commission (SEC) in the United States determined that a stock exchange could be registered with the SEC and operated on a for-profit basis. High-profile demutualizations amongst securities-trading exchanges such as the NYSE and the CME are best known but demutualization has also become common among life insurers and building societies. Financial institutions that demutualize receive large influxes of capital from their new owners plus easier access to future capital through the financial markets and so is common amongst mutually-owned institutions that need to invest in growth to compete. Life insurers were amongst the earliest pioneers of demutualization but the 1980s and 1990s saw a wave first among building societies and then producer co-operatives and trading exchanges. The 20-year push for demutualization by member-held public trading co-operatives is now being felt in some of the investing world's frontier markets.

What is demutualization?
It is the process of converting a non-profit, mutually owned organization to a for-profit, investor-owned corporation. Although, demutualized exchanges will continue to provide many if not most of the services, they will have different governance structures in which outside shareholders are represented by boards of directors.

Strict definition is

The transition from a mutual company, in which here are no shares and every member has one vote, to a company limited by shares and one vote per share.

Can also imply

The process by which a company converts to a more usual economic model; or A company where the link between the membership in the exchange company or ownership of a share in it, is broken

A common entity.
The transformation of an exchange from an entity owned by its members into a for profit, shareholder-owned company

Why demutualize? Governance

Demutualization is considered for revamping and separating ownership control from management control in stock exchanges

Commercial
Internationally, demutualization has been adopted by exchanges more for resources generation to meet rising capital requirement and less for better corporate governance.

Commercial Benefits of Demutualization:

Potential for realization of shareholder value for members Commercial criteria for decision making Enhanced ability to increase revenue Ability to reduce combined costs Spreading of ownership risk Greater access to capital Market discipline on management POSSIBLY A PROFITABLE SE!!!!

The Merits of a Public Stock Exchange

Consolidation of bourses and clearing houses within a single entity would bring economies in terms of operational efficiencies, savings in infrastructure investments and financial strength Public listing of shares of the exchange would enable it to raise funds from the market subjecting it to transparency, accountability and market discipline Demutualization would ensure that exchange would not work in the interest of members only, but also be responsive to market participants

A public exchange would make it possible to infuse professional mangement

Where is the Intrinsic Value?

A membership seat value is derived from its components The value of the ownership right Value of the trading right (the current market price of the set value of ownership right)

Issues Related to Valuation:

Different exchange will have different values for the trading rights Similarly with ownership value but this is easier to price

Demutualization Tends to Lower the Value of Trading Rights:

The potential to increase the number of trading rights can cause dilution in natural share In a demutualised exchange, the drive for profit increase both the scope and the intensity of conflicts Moving to a for-profit enterprise may allow the exchange to enter into new businesses, thereby increasing the opportunities for conflicts between its regulatory role and those as a competitor in the market place Operating costs for members will increase (annual fees, charges for services, etc.) The scope of conflict between a corporatised KSE and the trading interests of members could swell

Cost Cutting Can Only Be Achieved Through Mergers:

Remove duplication of management, administration, I.T. and other costs of the exchanges Have a single clearing house so that NCSS makes commercial sense Better still, merge with the CDC and remove costs further (communication, I.T. etc.)

Regulatory Structure:
The benefits of additional resources and independent and professional governance can be balanced by an efficient regulatory structure

Appointment of public representatives: appointed nominees from other regulatory organizations in related professions (Accounting, Law, etc.) have little or no commercial stake in the business. Regulation & profitability: regulatory decisions should be evaluated from the dimension of its impact on the share value or profitability or turnover of the exchange. Maximum limit: No broker to own more than 5% of an exchange Shareholding and exit price: Trading rights should initially be tradable and an embargo on issuance of new trading rights. New shareholders should be introduced through subscription or merger and should replace nominees on the board

Revenue enhancement-burden must be shared:

Charges to brokers will rise Annual listing fees should raise very substantially say PKR 1 Million Steep rise in data charges to external third parties New product lines leveraging the existing infrastructure

Motives for Demutualization: Global Competition

Competition among the exchanges and with electronic communications networks (ECNs) has Increased, and not just at the national level, but at the regional and global levels as well. In the new environment, exchanges are no longer monopolies but must now be run as efficient business enterprises. Heightened competition has thus been a major factor in decisions to demutualize.

Technology
Major changes in the structure and operations of stock exchanges have generally coincided with breakthroughs in communication and data processing technologies. Prime examples are the emergence of telegraph technology, which helped the NYSE establish its dominance in the late 19th century, and the advances in network technology that led the way to the development of Nasdaq in the 1980s. More recent technological improvements have enabled the development of the continuous electronic auction market in Europe. Continuous auction systems are trading systems that allow automatic execution of matching buy and sell orders. At present, all the European stock exchanges operate some version of this continuous electronic trading system.

TYPES OF DEMUTUALIZATION
There are three general methods in which an organization might demutualizes 1. Full demutualization 2. Sponsored demutualization 3. Mutual holding company (MHC)

In a Full demutualization the mutual completely converts to a stock company, and passes on its own (newly issued) stock, cash, and/or policy credits to the members or policyholders. No attempt is made to preserve mutuality in any form. A Sponsored demutualization is similar; the mutual is fully demutualized and its policyholders or members are compensated. The difference is that the mutuality is essentially bought by a stock corporation. Instead of receiving stock in the formerly mutual company, stock in the new parent company is granted instead.

A Mutual holding company is a hybrid concept, part stock company and part mutual company. Technically, the members still own over 50% of the company as a whole. Because of this, they are generally not significantly compensated for what would otherwise be viewed as loss of property. The core participants are isolated into a special segment of the company, still viewed as "mutual". The rest is a stock company. This part of the business might be publicly traded or held as a wholly owned subsidiary until such time that the organization should choose to go public.

Mutual holding companies are not allowed in New York where attempts by mutual insurance to pass permissible legislation failed. Opponents of mutual insurance holding companies referred to the establishment of mutual holding companies in New York as Legalized Theft. Some MHC demutualizations have been planned as the first of a two-stage process. The second stage would be full demutualization once the transition pains into MHC status are complete. In other cases, the MHC is the final stage. Note that some mutual companies, such as Nationwide Mutual Insurance Company and the MassMutual, own stock companies and are listed on a stock exchange. These are not MHCs, however; they are simply mutual companies which have majority control over one or more stock companies. Other mutual companies may own some of another company's stock, but as simply an asset, not something they actually control. Finally, many mutual companies, including Nationwide and MassMutual, have wholly owned subsidiaries. The subsidiaries may technically be stock companies, but the mutual owns all the stock. For example, the New York Life Insurance and Annuity Corporation (NYLIAC) is a wholly owned subsidiary of the New York Life Insurance Company (NYLIC). A person may purchase an insurance policy from either company, but only those who own participating policies from NYLIC are mutual members. Other policyholders are customers.

ROLE OF SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN

Under capital market restructuring reforms program, funded by the international donor agencies, the Securities and Exchange Commission of Pakistan (SECP) has taken various measures. All these steps are aimed at making the local market efficient and transparent to protect the interest of all the stakeholders. Yet another step in this direction is aimed at demutualization of local stock exchanges. Like all other initiatives taken in the past, the broker's community may not like the move.

DEMUTUALIZATION IN PAKISTAN
The demutualization process in Pakistan has been initiated by the Federal Government as part of the capital market reforms package introduced by Asian Development Bank (ADB). Securities and Exchange Commission of Pakistan (SECP) then constituted a committee to submit a detailed report regarding the demutualization of stock exchanges of Pakistan. This committee suggested two models for the process; Fully Integrated and Demutualized Exchange (FIDE) and National Exchange (NE). The authorities regarding demutualization of exchanges have decided to demutualize the exchanges without going into integration. However, the process of demutualization will start when the bill for demutualization and integration of stock exchanges gets the approval of senate. Whenever this bill gets the approval this will become a law after that exchanges will be given time of 3 months to convert into a demutualized exchange. The action plan for this process is already chalked out. Islamabad and Lahore stock exchanges have hired consulting firm to pursue objective of uniform valuation on the same parameters and terms. Both the exchanges have also developed a Joint Demutualization and Integration Committee (JIDC) to look after the process. Stock exchanges of Pakistan have decided to form three individual demutualized exchanges because KSE is far bigger than the other two exchanges and it wants to stay away from an integrated stock exchange. For an exchange to get demutualized a 5 year business plan would be required. After demutualization following changes will take place according to Stock Exchanges (Corporatization, Demutualization and Integration) Ordinance 2007: (1) Legal status of the stock exchanges shall be changed from company limited by guarantee to a public company limited by shares. (2) The majority ownership shall be segregated from the right to trade on the stock exchange. (3) Shareholdings of the stock exchanges will be as under: a) Initial Shareholders: 40% b) Strategic Investors/Local financial Institutions 40% c) General Public 20% (4) The initial shareholders (the members) will be issued shares for consideration other than cash.

(5) The Composition of the Board of Directors shall be: Total Number of Directors: 10 (Initial Shareholders Directors 4, Nominee Directors 6) (6) There will be TRE Certificate Holders (trading rights entitlement holders) instead of members. (7) Upon re-registration as company limited by shares, the existing directors of the exchange shall cease to hold the directorship and will be replaced by the first directors. (8) Within 30 days of demutualization the exchange shall hold elections in respect of its nominated directors. The Commissions nominee directors shall continue to hold their office. (9) The Chairman of the Board shall always be from amongst the directors not representing the TRE certificate holders. (10) Upon change of legal status of the exchange, the liability of every member as guarantor shall stand extinguished. (11) The strategic investors and financial institutions could sell their shares only to other strategic investors and financial institutions with the permission of the Commission. (12) A financial institution could not purchase further shares from the public except from any financial institution with the prior permission of the Commission. (13) The stock exchange shall be listed on itself. However, its listing shall be managed and administered by the Commission. (14) A stock exchange shall not issue new TRE certificates to any person until 30th June 2010 unless 2/3 majority of its TRE certificate holders shall decide otherwise. (15) After July1, 2010 till December 31, 2019, a stock exchange shall offer 15 TRE certificates each year and after 2019, there will be no restriction on the issuance of further certificates. (16) Exchanges could integrate with each other without the involvement of the court of law. (17) The stock exchange shall not sell its immovable assets at the date of incorporation without prior approval of the Commission. (18) The Commission shall have powers to impose penalties up to Rs.20 million on the stock exchange including its suspension and cancellation of registration, penalty of maximum amount of Rs.1 million on any director, shareholder, TRE holder or committee member in case of any violation of the Ordinance.

The demutualized exchange is jointly owned by six shareholders, including National Bank of Pakistan, Karachi Stock Exchange, Lahore Stock Exchange, Islamabad Stock Exchange, PakKuwait Investment Company and Zarai Taraqiati Bank. Shareholdings of each of these stakeholders are presented in the table below: The board of directors of the institution includes 13 members, of which 6 represent each of the shareholding institutions, 6 are independent directors appointed by the Securities and Exchange Commission of Pakistan (SECP), while the chief executive of PMEX is the thirteenth director. The functioning of the exchange is regulated by the SECP; while other relevant legislations pertaining to the PMEX include Commodity Exchange and Futures Contract Rules 2005 as well as internal regulations. At present, the exchange has 313 members and 120 registered brokers, of whom 42 are currently active.

POTENTIAL BENEFITS OF DEMUTUALIZATION

In the case of Pakistan, the demutualization of stock exchanges can yield benefits. After demutualization the stock exchanges can improve in corporate governance. The de linkage between the ownership and management will channelize the efforts for the betterment of the exchanges. Management will do their best to improve the policies and matter of the exchange in order to show the progress. Better policies and enhanced benefits will attract the prospective people to apply. On the other hand owners will hire such efficient group of people who can perform well as part of their management team. Demutualization can facilitate access to better economic and human capital. The process will help them to raise capital from sources other than ones which were previously available like they can get money from institutional and individual investors. Demutualization will also increase pressure for growth and development. When a stock exchange demutualizes it becomes a company limited by shares which has to earn profit. Now the stock exchange has to compete with all the other companies to develop a reputation in the market. Moreover, its shares will be listed along with the other companies and to increase the value of the shares, exchanges have to be vigilant and efficient to grab the upcoming opportunities. As far as KSE is considered it has the positive repo which can help to

improve the position of the exchange when it will demutualize. Whereas the other two exchanges, ISE and LSE have to really work hard to cope with the fierce competition in market. There is a possibility of going for an international alliance since stock exchanges in Pakistan (Especially KSE) has performed well in last decade or so. Merger is another option as it will increase and improve the creditability and enhance the domain of operations. Overall income of the demutualized exchanges will increase.

IMPLICATIONS OF DEMUTUALIZATION
Demutualization is a complex process and the biggest challenge is the development of an appropriate regulatory framework which not only looks after the demutualization process but also post demutualization developments. Although stock exchanges have decided to make two separate departments that is regulatory and commercial to reduce issues but that would be after demutualization process. Conflict of interest can be another problem which demutualized exchanges of Pakistan can face because after demutualization ownership will be transferred to non members from members (SECP, 2004). In the present scenario members are the owners and they take decisions in their own best interest. In a demutualized exchange management takes the decision and in this situation an agency problem can arise between management and the owners or shareholders. Delegation of authority to the management which is separate from the owners is another issue. There is a possibility that management pursues personal goals rather than corporate goals. Stock exchanges have to bear agency cost as a result of demutualization. Risk could be another challenge for demutualized exchanges. Investors may be reluctant to invest in a for profit exchange because of the economic conditions of the country. Lenders may not lend the capital sufficient enough to run the business properly. Share prices of stock exchange can be undervalued. These factors can haunt the investors or the authorities. Another problem can be the selection of an appropriate bench mark for pre and post demutualization process.

Conclusion
Global competition and advances in technology costs are causing stock exchanges around the world to examine their business models and become more entrepreneurial. Many exchanges have responded by demutualizing, which is bringing about major shifts in ownership and corporate governance structure. By converting member-owned, non-profit organizations into profit-driven investor-owned corporations, demutualization will give exchanges access to capital that can be used both for investment in new technology and for participation in the ongoing consolidation of the industry. In the process of providing the exchanges with capital, demutualization is also expected to strengthen the corporate governance of the exchanges. Therefore in order to ensure smooth transformation and bring our exchanges and markets at par with international jurisdictions it is vital that the Demutualization law is enacted on priority.