The long-drawn stand-off between the Securities and Exchange Board of India (SEBI) and MCX-SX regarding the grant of an equity trading licence could soon draw to a close. The Bombay High Court ruled in favour of the exchange last week, and asked SEBI to re-examine the case.
This litigation is significant for the Indian stock market investors, as it could mean that another large player will enter a space dominated by the Bombay Stock Exchange and the National Stock Exchange. The latter currently has a share of more than 80 per cent in equity volumes.
The entry of a third player could benefit equity investors, as exchanges vie for market share. This could result in an improvement in transaction costs, speed and overall trading experience. Penetration of equity investments can also get a leg-up, as the exchanges attempt to reach out to every corner of the country. The fillip that equity trading received after the entry of professionally-managed and technologically-savvy NSE is a case in point.
HISTORY
SEBI had asked MCX-SX to comply with the MIMPS regulations (Manner of Increasing and Maintaining Public Shareholding) as a pre-condition to giving permission for launching an equity platform. This regulation stipulates a shareholding cap of 5 per cent on all residents besides stock exchanges, depositories, clearing corporations, banking companies and public financial institutions.
The two promoters of this exchange initially divested their stakes to PNB, IFCI, IL&FS, as well as 18 banks. Buyback arrangements were also executed with the first three that gave them an option to sell the shares again to the promoters at a premium.
A capital reduction plan was implemented to further help promoters bring down their stake to 5 per cent. Under this plan, 119.66 crore equity shares were cancelled. Of this, 61.71 crore shares were owned by MCX, 56.24 crore by FTIL, and the rest by IL&FS. The exchange then issued warrants of equivalent amount to the three shareholders that included the option to convert into equity shares at a later date.
THE CONTENTION
SEBI rejected MCX-SX's application on the grounds of concentration of economic interest in the hands of a few, the warrants and buyback arrangements being illegal, and persons acting in concert holding more than the minimum cap laid down by MIMPS. Shorn of legalese, SEBI's main contention was that though the promoters held only 5 per cent each of the share capital, if the warrants (that have rights to shares attached) are taken into account, they own more than 70 per cent of the exchange.
This went against the principle behind MIMPS regulation that seeks to make sure that the shareholding in a stock exchange is diversified. Some would argue that the arrangement met most legal requirements, and that it was alright in letter. But SEBI wasn't comfortable with the spirit, or the implications of the arrangement.
The court agreed with SEBI that non-disclosure of the buyback arrangement was wrong. It has also concurred with SEBI's right to demand compliance with MIMPS regulation, despite the exchange being already demutualised. But the court put forward counterpoints to the legality of warrants and buyback arrangement, the issue of persons acting in concert (PAC) and so on.
There are a couple of loose ends that SEBI can still fall back on. The Court has not considered the issue that options not issued on the floor of an exchange are illegal since it did not form part of the original show-cause notice given by SEBI. The takeover code contains definition of persons deemed to be acting in concert that can be applied to MCX and FTIL.
UNDERTAKINGS
The point on which SEBI seems to have been on unsteady ground is in not recognising the undertaking that the two promoters gave to the Bombay High Court. MCX and FTIL have given two undertakings to the Court. In the first one, given at the time the scheme of capital reduction was approved by the court, the promoters had promised that even if the warrants were exercised, they would make sure that their stake didn't exceed 5 per cent.
Further, in the course of the hearing of the recent case, the promoters gave another undertaking before the court that they would bring down their joint stake in MCX-SX to 5 per cent. This effectively nullifies the PAC contention.
These undertakings imply that the warrants held by promoters are part of a temporary arrangement. The promoters will hold on to them till they find buyers to whom these can be divested. There is no way they can exercise the right to convert them into shares without shooting past the MIMPS regulation's ceiling. If they did so, SEBI would then be justified in cancelling their trading registration.
PROMOTER HOLDING
The question that this litigation raises is if the maximum limits for promoter holdings in exchanges aren't too stringent. SEBI's perseverance, for the stake to be brought down before licence was granted, also went against the practice followed by both the commodities market regulator, Forward Markets Commission (FOMC) and the RBI.
The RBI allows new private banks 12 years from the date of licensing to bring down the promoters' stake to 15 per cent. FOMC, too, allows time to promoters of commodities exchanges to reduce stake to 26 per cent after the exchange has begun operations. The Ministry of Finance needs to ensure uniformity in the norms followed by various regulators.
FINAL WORD
The final word hasn't been said in this case yet. SEBI has been asked by the court to give a fresh ruling based on the earlier submission of MCX-SX made in April 2010. The regulator will now need to keep in mind the court's view on various aspects and the undertaking given by promoters while giving a fresh ruling.
There are many courses that the market regulator can adopt. It can appeal to the Supreme Court against the High Court order, it can once again reject the application on fresh grounds, or it can grant permission, perhaps, with the injunction that the promoters divest their warrants within a specified period.
Since only 30 days are given to the regulator to give its ruling, it may miss the opportunity of getting a direction from Supreme Court in that period. There could be more legal wrangling, appeals, reviews and so on. It is only hoped that the ultimate decision turns out to be in the interest of the section that matters the most — the investor.