Rajrishi Singhal: BSE IPO: What a long, strange trip it's been

Once upon a time it was a closed club, riddled with risks and scams but steadfast in its opposition to any public scrutiny. Today, that same organisation is preparing for a public issue, opening up its portals and books for everybody to inspect and comment. What a long, strange trip it's been for BSE Ltd.

Next in line is the National Stock Exchange of India Ltd, or NSE Ltd, looking to raise R10,000 crore. Once NSE is also listed, the country's two largest stock exchanges will join an exclusive global club. While NSE is the country's youngest stock exchange (gaining recognition as stock exchange only in 1993), BSE's long arc of history stretches back to 1875.

So, why should a stock exchange go public? For one, most other stock exchanges in the world are also going public. This is not a passing fad but a change necessitated by increasing competition between exchanges, growing sophistication in technology and a need to keep costs under control. Companies with global operations are not restricted to listing their stocks on only home country exchanges; they prefer to raise capital from markets anywhere in the globe where listing and compliance costs are low, investor response is good and there is sufficient liquidity available for efficient price discovery. Going public allowed exchanges to shake off their legacy structures and offer competitive services to clients.

The typical journey for most stock exchanges comprises three phases. In the first phase, most exchanges were member-owned - trading members doubled up as the exchange management. This introduced myriad distortions, with the clubby membership structure fostering high costs, inefficiency and fraud.

The second stage was demutualisation (with the Stockholm Stock Exchange being the first to demutualise in 1993), under which the legal status of exchanges changed to joint stock companies where members and investors were allotted shares in the new company. For instance, after BSE's demutualisation in 2005, Singapore Exchange and Deutsch Borse bought 5% each in the newly formed company. Pre-IPO, BSE has 9,542 shareholders, with trading members owning 43.5%.

Even demutualisation proved bothersome due to irreconcilable differences between interests of exchange shareholders (who want to maximise profits) and investors (who come to trade on the exchange). This has led to a clamour for exchanges listing their shares, the third stage. Hence, the last 20 years, beginning with the deregulation trend of the early 1990s, have seen a large number of exchanges going public.

How this will pan out is still too early to say. But, competition is forcing consolidation among exchanges; going public empowers exchanges with a new currency: they can offer their own stock, instead of hard cash, to shareholders of other exchanges they wish to acquire. For the moment, though, Indian exchanges are ring-fenced with regulation that limits foreign shareholding to 49%.

Regulation also prohibits any Indian individual from holding more than 5% in a stock exchange to avoid undue concentration of power. In fact, anybody acquiring more than 2% has to seek Sebi approval.

Stock exchanges typically have three to four revenue sources: listing fees, transaction fees levied on each deal, post-trade service levies (like clearing and settlement), subscription fee from data services (including training programmes) and technology services. Exchanges usually offer a risk-adjusted, annuity kind of business that is stable, sustainable and predictable. The upside is the low capital markets penetration in India and the spacious headroom available for expanding business.

But BSE is already under some stress: rival NSE has a lion's share of trading volumes, in both the equity cash and derivative segments, even though BSE leads in number of companies listed. The risk from new exchanges further chipping away at BSE's market share also exists. That's in the future. For the moment, investors have found BSE's shares attractive: the exchange's initial public offer got over-subscribed by 51 times. The public offer received bids for 55,08,50,616 shares against 1,07,99,039 shares on offer.

Interestingly, the sale proceeds from the current issue - maximum of R1,244 crore - will not accrue to BSE but to existing shareholders selling their shares to the public.
What's even more interesting is that BSE will be listed on rival exchange NSE and vice versa. This follows SEBI's policy of not allowing self-listing for exchanges.

There was a bit of concern about this initially. Each exchange will have to comply with full disclosure of all price-sensitive information on the other exchange, triggering panic attacks that strategic information will no longer remain confidential. However, SEBI has not relented. The final consequences of listing stock exchanges will be known only after both BSE and NSE list on each other's exchanges and from the subsequent trading volumes. Yet, the historic trajectory of India's capital markets and its implications are inescapable.

The author is a Mumbai-based consultant and former editor of The Economic Times Send your feedback to mailbag@mid-day.com