Demutualization of Stock Exchanges

DEMUTUALIZATION OF rootage varyS PROBLEMS, SOLUTIONS AND CASE STUDIES Edited by SHAMSHAD AKHTAR music director, Governance, Finance and barter Division, eastward and substitution Asia Department, Asian information beach Asian discipline bound 2002 All reforms reserved. The views express in this disk be those of the authors and do not necessarily reflect the views and policies of the Asian breeding Bank, or its table of Governors or the governments they represent. The Asian Development Bank does not guarantee the accuracy of the data include in this prevalentation and accepts no responsibility for some(prenominal) consequences for their use.Use of the term country does not imply whatever judgment by the authors or the Asian Development Bank as to the licit or some different(prenominal) status of any territorial entity. ISBN 971-561-475-2 habitualation live persuade No. 100602 Published and printed by the Asian Development Bank P Box 789, 0980 Manila, Filipinos . O. CONTENTS Foreword Principal Authors Abbreviations xiii xv xxi plowshare I ISSUES INVOLVED IN parenthood EXCHANGE DEMUTUALIZATION 1 De commonization of Asian inventory transmutes precise Issues and Ch bo whereforeges by Shamshad Akhtar 1. 1 1. 2 1. 3 1. 4 1. 5 1. 6 1. 7 1. founding Demutualization Its Definition, Size and importee Motivation and driving Factors for Demutualization From interdependency to Demutualization of diversify Benefits of Demutualization of alternates Regulatory Oversight Challenges and Responses for Demutualized transfer mo remunerationary Vi office of Demutualized replacement conclusion 3 3 4 5 8 12 19 25 29 2 2. 1 2. 2 2. 3 2. 4 2. 5 2. 6 Background Information on Demutualization by Pamela S. Hughes Introduction What Demutualization Means The Reasons to Demutualize The Models An Update Since Demutualization Conclusion 33 33 33 36 40 43 47Demutualization of convey(a) certificate shiftsProblems, Solutions and baptistery Studies mak e upendum 1 The Models 48 3 Motivations, Mechanics and Models for rally Demutualizations in the get together States by Roberta S. Karmel 3. 1 3. 2 3. 3 3. 4 Overview Reasons for Demutualization How Demutualization is Accomplished Post-Demutualization Models 59 59 61 65 70 4 The body structure of a Demutualized transmute The Critical Issues by David Holthouse 4. 1 4. 2 4. 3 4. 4 4. 5 4. 6 4. 7 Introduction will power bodied Governance Access indemnifys seek Management pecuniary Management Conclusion 73 73 73 77 80 81 82 83 Demutualization of interchanges The Conflicts of pursuit (Hong Kong) by William Pearson 5. 1 5. 2 5. 3 5. 4 5. 5 5. 6 5. 7 Structure of alters Regulatory Role and Self- economy Public insurance Objectives of telephone line wiliness place command wherefore Should Demutualization Require a Reassessment of SRO Functions? What Responses are Being Developed to Deal with These Problems? Conclusion Hong Kongs mannikin Listing of HKEx and the Framework for Dealing with Conflicts of hobby 85 85 88 91 92 95 99 100 iv Contents adjunct Hong Kong swops and modify hold in Reinforcing Hong Kongs Position as a Global Financial CentreA Policy Paper 2 Memorandum of appreciation for the Listing of HKEx on SEHK 3 Section 13 of the changes and illumination Houses (Merger) Ordinance 4 Chapter 38 of the Rules regime the Listing of Securities on the stress transpositions of Hong Kong Limited 5 Procedures to Deal with Conflicts of Interest 105 114 131 APPENDIX APPENDIX APPENDIX 133 138 APPENDIX 6 Demutualization of ExchangesThe Conflicts of Interest (An Australian Perspective) by David Holthouse 6. 6. 2 6. 3 6. 4 6. 5 6. 6 6. 7 6. 8 6. 9 Introduction Background to Conflicts An Exchanges Listing Regulation of Other Listings Supervision of Intermediaries Profit Motive versus Supervisory Function Public Interest versus the Exchanges Commercial Interest forward-looking clientele Lines Conclusion 145 145 146 148 149 149 150 152 153 15 4 7 Demutualization of ExchangesThe Conflicts of Interest (The Australian Regulators Experience) by Claire G rosebush 7. 1 7. 2 7. 3 Introduction Self-Listing Other Conflicts 157 157 157 one hundred sixty vDemutualization of timeworn ExchangesProblems, Solutions and Case Studies 8 8. 1 8. 2 8. 3 Regulation of a Demutualized Exchange (Canada) by Pamela S. Hughes Introduction Role of an Exchange Self-Regulation and Government Oversight SRO Conflicts of Interest Supervision of Listings Self-Listing Managing Conflicts of Interest Prudential Regulation mete outholders Directors and policemans Memoranda of beneathstanding Conclusion 163 163 165 165 169 171 171 172 172 173 175 175 176 8. 4. 8. 5 8. 6 8. 7 8. 8 8. 9 8. 10 8. 11 8. 12 9 9. 1 9. 2 9. 3 9. 4Regulation of a Demutualized Exchange ( uppercase of capital of capital of Singapore) by Lee Boon Ngiap Background Regulatory Issues Arising from Demutualization The Regulatory Relationship between the pecuniary Authority of Singapore a nd post Exchange of Singapore Conclusion 177 177 178 179 183 10 Regulation of a Demutualized Derivatives Exchange (United States) by Natalie A. placeman 185 185 186 190 192 195 Introduction A New Framework Exchange Oversight Regulatory Issues raise(a) by Demutualization Conclusion 10. 1 10. 2 10. 3 10. 4 10. 5 vi Contents APPENDIX APPENDIX APPENDIX Designated Contract marts for Regulated US Derivatives Exchanges 2 Registered Derivatives Transaction Execution Facilities 3 The CFTC commercialise Surveillance Program 196 202 205 11 Regulation of Demutualized Exchanges (Australia) by Claire Grose 213 213 214 214 215 215 217 Legislative Framework Australian Securities and Investment missionary stations (ASIC) Powers Supervision by Market Operators Memoranda of Understanding (MOUs) Changes Due to Demutualization New Legislation 11. 1 11. 2 11. 3 11. 4 11. 5 11. 6 PART II DEMUTUALIZATION CASE STUDIES 2 Australian Stock ExchangeThe Conversion to a Demutualized Exchange ASXs Experie nce by David Holthouse 12. 1 12. 2 12. 3 12. 4 12. 5 12. 6 12. 7 12. 8 12. 9 Introduction Background to Australian Stock Exchanges Demutualization Obtaining Member Approval Mechanism Used for Conversion Changes to the federations justness The Demutualization deal Memorandum of Understanding (MOU) with ASIC Demutualization and Listing Outcomes Subsequent Supervisory Development ASX Supervisory Review Pty Limited 221 221 222 223 224 225 226 228 229 230 ii Demutualization of Stock ExchangesProblems, Solutions and Case Studies 12. 10 Changes in ASXs Focus and Activities 12. 11 Conclusion 231 233 13 Hong Kong Exchanges and elucidation Limited Demutualization, Merger and Listing The Hong Kong Exchanges Experience by jurisprudencerence Fok 235 235 236 238 239 242 246 Introduction Pre-Merger Period Two Exchanges and Three clarification Houses Merger and Proposal Reasons For the Merger Market Reform Conclusion 13. 1 13. 2 13. 3 13. 4 13. 5 13. 6 14Hong Kong Securities and Futures guar dianship The Conversion to a Demutualized Exchange The Hong Kong Regulators Experience by William Pearson 247 247 250 255 258 258 The Need for Reform The Reform Process Rationalized Market Regulation Implementing Legislation Exchanges and Clearing Houses (Merger) Ordinance severalise Issues Arising from Hong Kongs Experience with Demutualization 1 Summary of the Exchanges and Clearing Houses (Merger) Ordinance 14. 1 14. 2 14. 3 14. 4 14. 5 APPENDIX 261 15Singapore Stock ExchangeDemutualization and Listing of the Singapore Exchange Limited by Alan Shaw 265 265 Introduction 15. 1 viii Contents 15. 2 15. 3 15. 4 15. 5 15. 6 15. 7 15. 8 15. 9 Drivers for Change The Rationale for Demutualization and Merger Impact of Demutualization The Merger Act The Process of Demutualization The Singapore Exchanges Initial Public Offer The Structure of Singapore Exchange The Governance of Singapore Exchange Listing and Conflict of Interest 265 267 269 270 271 272 274 276 279 281 5. 10 Conclusion APPE NDIX 1 Procedures to Deal with Conflicts of Interest 16 Toronto Stock ExchangeFrom Toronto Stock Exchange to TSE Inc. Torontos Experience with Demutualization by Timothy Baikie 283 283 283 286 291 292 296 298 298 Introduction An Overview of the Toronto Stock Exchange (TSE) The Development of Mutual Exchanges Consolidation, Globalization and New Competition The Demutualization Decision Market Regulation by a Demutualized Exchange Next Steps Conclusion 16. 1 16. 2 16. 16. 4 16. 5 16. 6 16. 7 16. 8 17 Demutualization of the Philippine Stock Exchange by Maria Larrie Alinsunurin 299 299 ccc 300 301 304 307 Introduction Ownership Structure of the Stock Exchange Upon Demutualization traffic Rights Corporate Governance vocation of the Exchange Statutory Regulatory Role 17. 1 17. 2 17. 3 17. 4 17. 5 17. 6 ix Demutualization of Stock ExchangesProblems, Solutions and Case Studies PART third expression OF MUTUAL EXCHANGES 18 The Colombo Stock Exchange (Sri Lanka) y Rajeeva Bandaranaike 18 . 1 18. 2 18. 3 18. 4 18. 5 18. 6 18. 7 18. 8 18. 9 Ownership Structure Listing Data Corporate Governance Business of the Exchange The Vision, Mission and Corporate Strategy concern Rights Regulatory Framework Self-Regulation Statutory Regulatory Role 313 313 314 314 315 316 317 317 317 319 320 321 321 18. 10 Investor Protection 18. 11 Funding of the Colombo Stock Exchange 18. 12 Stock Exchange Seeks to Demutualize 19 The Kuala Lumpur Stock Exchange (Malaysia) y Securities Commission (Malaysia) 323 323 323 324 324 325 326 327 329 329 Introduction Ownership Structure of the KLSE Listing Data Corporate Governance Business of the Exchange Trading Rights Risk Management and Supervisory Issues Statutory Regulatory Role Stock Exchange desire to Demutualize 19. 1 19. 2 19. 3 19. 4 19. 5 19. 6 19. 7 19. 8 19. 9 x Contents 20 The Shanghai and Shenzen Exchanges Business Operation, Governance Structure, and Regulatory Function (Peoples republic of China) by Feng Wei 331 331 332 333 335 337 Overview Business Operation Governance Structure Regulatory Function Outlook on Demutualization 0. 1 20. 2 20. 3 20. 4 20. 5 21 The Taiwan Stock Exchange (Taipei,China) by Wanpo (Mina) Wang 341 341 342 342 343 344 344 347 347 Ownership Structure of Taiwan Stock Exchange Corporation Listing Data Corporate Governance Business of the Exchange Trading Rights Risk Management Statutory Regulatory Role Stock Exchange Seeking to Demutualize 21. 1 21. 2 21. 3 21. 4 21. 5 21. 6 21. 7 21. 8 22 online geological formational and Regulatory Structure of The Stock Exchange (Thailand) by Klao Sanasen 349 349 352 Thai working capital Market Structure The Stock Exchange of Thailand 2. 1 22. 2 xi Contents FOREWORD Demutualization of a parenthood primal is entire go by which a non-profit member-owned mutual organization is transformed into a forprofit shareholder tidy sum. Exchanges approximately the world require been demutualizing because of supranational competition and scientific challen ges to traditional modes of trading securities. The change of a stock qualify from a member-owned organization to a for-profit shareholder corporation triggers a act of questions about restrictive oversight.When a demutualized permute is listed on its own gore, some restrictive oversight pick outs to be transferred to a government regulator. In many countries, demutualization of the major national stock commute has been accompanied by customary securities regulatory reform. This disc grew out of a convention on Demutualization of Stock Exchanges held in Manila on 13-14 exalted 2001 organized under the APEC Financial Regulators Training Initiative sponsored by the Asian Development Bank.The conference focused on create greater understanding of demutualization by discussing the general problems it engenders and how these might be solved, developing common themes and lessons from case studies and also seeing how different countries have evolved different approaches to dem utualization. This book is divided into threesome parts. grapheme I, consisting of Chapters 1-11, discuss various dimensions and issues involved in the sue of stock fill in demutualization.Chapters 1-3 give a broad overview of the reasons for demutualization, the slender issues and challenges, the decision-making process relating to demutualization and the possible models stock exchanges may choose, including that of a clubbyly owned for-profit corporation and that of a publicly held association listed on the exchanges own mesa. Chapter 4 bewilders forth the critical issues an exchange and its regulator essential confront in connection with the demutualization process from the vantage point of a particular jurisdictionAustralia.Chapters 5-7 discuss the conflicts of kindle raised by an exchanges demutualization and then Chapters 8-11 set forth how regulators in Canada, Singapore, the United States and Australia attempted to deal with some of these conflicts through comma ndment. Part II of this book is a series of case studies. Chapters 12-17 discuss the demutualization experience in Australia, Hong Kong, Singapore, xiii Demutualization of Stock ExchangesProblems, Solutions and Case Studies Toronto and the Philippines.Part III of this book provides information about jurisdictions that have not demutualized their exchanges. Chapters 18-22 discuss the Colombo, Kuala Lumpur, Shanghai and Shenzen, Taiwan and Thailand exchanges. Chapters 1-16 were submitted as document by professionals who presented papers at the conference. Chapters 17-22 were submitted by participants in the conference who were not presenters. This conference was coordinated by the Finance and Industry Division (East) of ADB under the overall guidance and supervision of Ms.Shamshad Akhtar, Director, Governance, Finance and Trade, East and Central Asia Department. Special thanks are due to the various contributors as well as the organizers. The book has been modify by Ms. Akhtar. Ms. Roberta Karmel, Professor of police force at Brooklyn Law School, was engaged to integrate the conference materials and provide bran- briskspaper column advice. R. Jane Lee, a student at Brooklyn Law School supported the compilation of this book. Mr. Lyle Raquipiso coordinated the publication of this book and Ms. Nancy Bustamante provided administrative support. Geert H.P van der Linden . B. Director General East and Central Asia Department Asian Development Bank xiv Contents PRINCIPAL AUTHORS SHAMSHAD AKHTAR is Director, Governance, Finance and Trade Division of the Asian Development Banks (ADBs) East and Central Asia Department. She oversees ADBs financial commercialize operations in the Peoples Republic of China, Mongolia and the Central Asian Republics, including SME, microfinance and forward-looking(prenominal) rural market financial mediation organization and private vault of heaven assessment work and contend liberalization and facilitation.Concurrent to holding othe r portfolio from 1998-2001, she was head of ADB Secretariat for Asia peaceful Economic Cooperation, leaders the insurance dialogue and preparation of all papers/ documents for this forum, involving interactions with Finance Ministers and Central Bank Governors and their Deputies. Before connector ADB in 1990, she worked as Economist in the World Bank in the 1980s, and precedent to that, in Pakistans Planning Agency. She obtained a B. A. in Economics and M. Sc. in Economics from Islamabad, an M. A. n Development Economics from University of Sussex in the United Kingdom (UK), and a Ph. D. in Economics also from UK. She had her post-doctoral fellowship as a Fulb justly scholar and was visiting fellow at the Department of Economics, Harvard University in 1987. Ms. Akhtar has presented numerous papers on economics and finance in international conferences. TIMOTHY BAIKIE is Director, Global Market Initiatives at the Toronto Stock Exchange and is amenable for analyzing market structur e issues from a broad, strategical standpoint, including the market model for the Global Equity Market (GEM).Previously, he was Special Counsel, Market Regulation and Director of the Regulatory and Market Policy Division of the Exchange, which is responsible for policy and rule development for the equities and derivatives market. He has spoken at numerous conferences on market convention, market structure and corporate governance issues and was a member of the Advisory Board for the 1999 Canadian Corporate/Securities Law Moot Court Competition. He received a B. A. from York University (Glendon College), an LL. B. and a B. C. L. from McGill University and an LL. M. rom the University of Illinois at Urbana-Champaign. He was called to the Ontario mensuration in 1987. LAWRENCE FOK is the Deputy Chief Operating Officer of Hong Kong Exchanges and Clearing Limited and the Chief executive of the Stock Exchange. Mr. Fok joined the Stock Exchange in February 1992 and was xv Demutualization of Stock ExchangesProblems, Solutions and Case Studies ordained Executive Director of the Listing Division in February 1997 and Senior Executive Director of its Regulatory Affairs Group in November 1998. Mr. Fok has over 19 old age of experience in financial improvements and securities regulatory work.Before joining the Stock Exchange he worked for the Securities and Futures Commission, the Office of the Commissioner for Securities and Commodities Trading of the Hong Kong Government and other private organisations in areas of corporate finance advisory work, securities dealing, venture chief city investment, mainland China trade and investment focus. CLAIRE GROSE is Special Counsel, Regulatory Policy beginning at the Australian Securities and Investments Commission (ASIC). For two years prior to July 2001, she held the position of ASICs Director, National Markets Unit.Before joining ASIC in January 1999, Ms. Grose was a senior partner in the national Australian law firm Fre ehill Hillingdale & Page, specialising in corporations and securities law. She has more(prenominal) than 20 years experience as a corporate lawyer and played a major part in developing changes to the Corporations Law in Australia in her role as a member of the Corporations Law Simplification Task Force from October 1993 to March 1997. DAVID HOLTHOUSE is National jitney, transnational Affairs, at the Australian Stock Exchange (ASX), which he joined in February 1996.His responsibilities include fostering golf links with governments, occupationes and market participants to catch that ASX has a role in shaping the regional capital market environment, coordinating ASXs international activities to ensure strategic fit, identifying cross-border inclination opportunities where ASX derriere add value, and providing an sound protocol service on behalf of the Exchange. He has been a member of the Working Committee of the East Asian and Oceanian Stock Exchanges confederacy (EAOSEF) since 1997 and is currently the compacts Working Committee Chairman.A key activity of the Committee during this time has been the facilitation of cross-border trading. He was formerly a career naval officer, retiring as a Rear Admiral in 1993. He is a member of the governing bodies of a number of professional and charitable organisations, and a Graduate of the Australian form of smart set Directors. He is a hired Professional Engineer, and a Fellow of some(prenominal) the build of Engineers Australia and the shew of Marine Engineers (UK). He was appointed as an Officer in the Order of Australia in 1991. xviPrincipal Authors PAMELA S. HUGHES is a securities law partner at Blake, Cassels & Graydon LLP in Toronto. Her practice focuses on international corporate finance and mergers and acquisitions dealings and advice regarding capital market regulatory reform. Ms. Hughes is a member of the team of lawyers from Blake, Cassels & Graydon involved in the ongoing Ontario Securities Commis sion (OSC) Policy Reformulation Project which commenced in 1995. Prior to February 1, 1995, Ms. Hughes was Director of the Capital Markets/ internationalistic Markets Branch of the OSC.Ms. Hughes has also taught international securities regulation in the LL. M. programme at Osgoode Hall and the LL. B. programme at the University of Toronto, and was a contributing editor to coupling Ameri mickle Corporate Lawyer. Ms. Hughes updated the chapter on Philippines securities law in International Securities Regulation Pacific Rim, Volumes I and II (New York Oceana) released in 2000. In 2000, Ms. Hughes was nominated by the federal Department of Finance to the financial services peal for dispute resolution under the North American Free Trade Agreement.ROBERTA S. KARMEL is a Professor of Law and Co-Director of the Center for the Study of International Business Law at Brooklyn Law School and Of Counsel to the law firm of Kelley Drye & Warren LLP In addition, she is a . director of the Kemper Insurance Companies. She was a Commissioner of the Securities and Exchange Commission from 1977-80, and a public director of the New York Stock Exchange, Inc. from 1983-89. She received a B. A. cum laude from Radcliffe College in 1959 and an LL. B. cum laude from New York University School of Law in 1962.Professor Karmel is the author of over 30 articles in legal journals, and writes a fifty-fifty column on securities regulation for the New York Law Journal. Her book entitled Regulation by criminal prosecution The Securities and Exchange Commission vs. Corporate America was published by Simon and Schuster in 1982. LEE BOON NGIAP heads the securities regulatory policy function in Monetary Authority of Singapore (MAS). His division is responsible for regulatory manikin development, policy coordination and market analysis of the securities, futures and asset management industries in Singapore.Prior to taking up his responsibility in the Securities and Futures Department, Mr. Lee was the Representative in the MAS office in capital of the United Kingdom, responsible for spearheading the promotion of Singapore as an loving place for UK and European financial institutions to invest and set up operations. Mr. Lee joined MAS in 1986 and worked in several departments before joining the Markets and Investment Department, where he rose to become a Senior aid Director in the Monetary Management Division. xvii Demutualization of Stock ExchangesProblems, Solutions and Case StudiesThere his responsibilities included the conduct of Singapores exchange rate and monetary policies, and management and evaluation of the foreign exchange exposures of public firmament entities. He holds an honours degree in Civil Engineering from the National University of Singapore and is a Chartered Financial Analyst. NATALIE A. MARKMAN is Counsel to Commissioner Thomas J. Erickson of the US Commodity Futures Trading Commission. She provides legal counsel and analyzes such policy issues as th ose created by derivatives market deregulation, electronic trading, and exchange demutualization.Ms. Markman reviews and evaluates all documents submitted by staff for Commission approval, including exchange designations, contract and rule approvals, rulemakings, opinions, and enforcement actions. Previously, she served as Special Counsel in the Commissions Office of International Affairs, as an Attorney-Advisor in the Office of the Chief Counsel of the Commissions Division of Trading and Markets, and as an Attorney-Advisor to Commission Administrative Law Judge George H. Painter. Ms.Markman also was a Teaching Fellow for the Foundations of American Law and Legal Education program at the Georgetown University Law Center, where she received her J. D. degree in 1993. WILLIAM PEARSON is Director in the Corporate Finance Division of the Securities and Futures Commission (SFC) in Hong Kong. He is responsible for assisting in formulating policies for the effective regulation of listed com panies and the securities markets. Daily work involves monitoring and regulating corporate activities of publicly listed companies, overseeing the Stock Exchange in its listing related functions, nd approving byeings of shares and debentures to the public by non-listed companies. Mr. Pearson joined the SFC as a Senior Manager in the Corporate Finance Division in 1998. Prior to that he spent nine years as a lawyer with Norton Rose, a London law firm, practicing in the areas of corporate finance and M&A. He graduated as a lawyer from Kings College, London in 1987. ALAN JOSEPH SHAW is Executive Vice-President of the Singapore Exchange Limited, Head of Risk Management and Regulation.Previously, from 1991-2000, he was National Manager, Supervision of the Australian Stock Exchange Limited, Melbourne. He was educated at the University of Melbourne, from which he received a Bachelor of Laws in 1979, a Graduate Diploma of Public Policy in 1988, and a Master of Arts in Public Policy in 1994. From 1980-91, he served as a Principal xviii Principal Authors Legal Officer for the National Companies and Securities Commission, as a Judges Associate, and as a Barrister. He has authored a number of articles on ships company law. xix Abbreviations ABBREVIATIONSAmex APEC Archipelago Archipelago Exchange ASIC ASTC ASX ATS BOT CATS CBA CBI CBOT CCASS CDNX CDS CFE CFTC CGE CME CMP CNS CSE CSRC DTF EBOT ECM ECN Australian Securities and Investments Commission Australian s apexpage and Transfer Corporation Pty Ltd Australian Stock Exchange alternative trading clay Bank of Thailand ready reckoner assisted trading system Colombo Brokers Association Canadian-based interlisted issuer Chicago Board of Trade Central Clearing and Settlement ashes Canadian Venture Exchange Central down payment System communication front-end system Commodity Futures Trading Commission Committee on the Governance of the Exchanges Chicago Mercantile Exchange Capital Market Masterplan Continuous Net Settlem ent Colombo Stock Exchange China Securities Regulatory Commission derivatives transaction execution facility exempt board of trade exempt commercial market electronic communications network American Stock Exchange Asia Pacific Economic Cooperation Archipelago Holdings, LLC Archipelago Exchange, LLC xxi Demutualization of Stock ExchangesProblems, Solutions and Case Studies ETF ETP FCM FIBV GEM HIBOR HKCC HKEC HKEx HKFE HKFECC HKSCC IDA IISL IMM IOM IOSCO IPO KLSE KULBER LFX LSE MAS MCD MDEX ME MESDAQ MkSE MMCD MOF MOU MSE xchange traded fund equity trading permit futures commission merchant International alliance of Stock Exchanges Growth and Emerging Market Hong Kong Interbank Offered Rate HKFE Clearing Company Hong Kong Exchanges and Clearing Hong Kong Exchanges and Clearing Limited Hong Kong Futures Exchange Limited HKFE Clearing Corporation Limited Hong Kong Securities Clearing Company Investment Dealers Association India baron serve & Products Limited International Monetary M arket Index and Option Market International Organization of Securities Commissions Initial Public Offer Kuala Lumpur Stock Exchange KLSE-Bernama Real-Time Information Services Labuan International Financial Exchange London Stock Exchange Plc Monetary Authority of Singapore Malaysian Central Depository Malaysia Derivatives Exchange Montreal Exchange Malaysian Exchange of Securities Dealing and Automated Quotation Bhd Makati Stock Exchange Mark to Market Collateral Deposit Ministry of Finance memorandum of understanding Manila Stock Exchange xxii Abbreviations MSRS NASD NASDAQ NASDR NSE NYSE OECD OM OSC OTC PCX PCX PCX Holdings PCXE PSE REC RIIAM SAFE SC SCA SCANS SCCP SCORE SCH SEA SEC SEHK SEL SEOCH SES SET Malaysian Share Registration Services National Association of Securities Dealers, Inc. NASDAQ Stock Market, Inc. NASD Regulation, Inc. National Stock Exchange of India New York Stock Exchange Organisation for Economic Co-operation and Development OM Gruppen AB Ontario Securities Commission over-the-counter Pacific Exchange PCX Equities, Inc. PCX Holdings, Inc.PCX Equities, Inc. Philippine Stock Exchange, Inc. recognized exchange controller Research Institute of Investment Analysts Malaysia South Asian Federation of Exchanges Securities Commission Securities Commission Act 1993 Securities Clearing Automated Network Services Sdn Bhd Securities Clearing Corporation of the Philippines System on Computerised Order Routing and Execution Securities Clearing House Securities and Exchange Act of 1992 Securities and Exchange Commission The Stock Exchange of Hong Kong Limited Taiwanese Securities and Exchange Law SEHK Options Clearing House Limited Stock Exchange of Singapore Stock Exchange of Thailand xxiiiDemutualization of Stock ExchangesProblems, Solutions and Case Studies SFA SFC SFE SGX SGX-ST SIA SIIS SIMEX SIPF SME SRC SRO STAMP TBDC TSD TSE TSE RS TSE TSEC TSI Securities and Futures Act Securities and Future Commission SFE Corporation Limited (formally k pro mptlyn as Sydney Futures Exchange Limited) Singapore Exchange Limited Singapore Exchange Securities Trading Ltd Securities Industry Act 1983 Special Isolated Immediate Settlement Singapore International Monetary Exchange Limited Securities Investors Protection Fund Small Medium Enterprise Board Securities Regulation Code Self-regulatory organization standard message protocol Thai Bond Dealing Center Thailand Securities Depository Co. , Ltd.The Toronto Stock Exchange TSE regulatory services Tokyo Stock Exchange Taiwan Stock Exchange Corporation Thailand Securities Institute xxiv PART I Issues elusive in Stock Exchange Demutualization Demutualization of Asian Stock ExchangesCritical Issues and Challenges 1 Demutualization of Asian Stock Exchanges Critical Issues and Challenges Shamshad Akhtar 1 1. 1 Introduction Stock exchanges allow a host of services to listing companies. These include (i) liquidity, (ii) execution of services, (iii) signaling function for listed companies, (iv) m onitoring of trading to block manipulation and insider trading, (v) standard rules to reduce transaction lives, and (vi) clearing of buy and order transactions.Traditionally, stock exchanges operating as a club of brokers offered these services as monopoly operators serving bangingly under a mutual governance structure. The members of the club bonked rights of possession, decision-making (one member, one vote), and trading. Value enhancement of the exchange was achieved by restricting access. Stock exchanges are now increasingly changing their affair model and restructuring themselves across the world due to the simultaneous convergence of a number of powerful developments. The most notable of these has been the (i) rapid advancement and innovation 1 Director, Governance, Finance and Trade, East and Central Asia Department, Asian Development Bank. 3 Part I Issues entangled in Stock Exchange Demutualization n technology that has facilitated alternative trading systems (ATS) inc luding electronic communication networks (ECNs) and (ii) growing market competition and consolidation as well as globalization induced partly by cross-border listing and portfolio flows, etc. together these developments have eroded the significance of physical national stock exchanges and their trading floors. Consequently, across the globe stock exchanges are now rethinking their business strategy and model in order to find ways of how reward up to survive. In the process, exchanges have evolved towards rude(a) corporate, legal and business models to strengthen governance and face the competition.This process of innovation from members associations into for-profit corporations is referred to as demutualization. There is a great need to distill lessons from the rapidly evolving experience with demutualization and synthesize both the normative and positive aspects of this exciting and relatively new structure so that developing countries can take advantage of it. This paper, th erefore, aims to provide basic perspectives and dimensions of demutualization based on a review of literature and experience. In the process it explains (i) What is demutualization and how significant has it been? (ii) What factors have been driving the demutualization of exchanges? iii) What self-control, legal and strategic approaches are being adopted in the process of demutualization? (iv) What are the principal benefits of demutualization? (v) What regulatory challenges and responses does a demutualized exchange face? (vi) Have the demutualized exchanges been financially viable? 1. 2 Demutualization Its Definition, Size and Significance Demutualization, in the strictest sense, refers to the change in legal status of the exchange from a mutual association with one vote per member (and possibly consensus-based decision making), into a company special by shares, with one vote per share (with majority-based decision making).Demutualization makes sense if it induces a change in th e exchanges objective from managing the interests of a closed 4 Demutualization of Asian Stock ExchangesCritical Issues and Challenges member-based organization with a central focus on providing services for the benefit primarily of the members/brokers and keeping costs and investments circumscribeed to financing concur by members, into a company set up with the objective of maximizing the value of the equity shares by focusing on generating profits from servicing the demands of their customers (brokers and investors) in a combative manner. The number of exchanges that have privatized or listed has been increasing since the Stockholm Stock Exchange demutualized in 1993.In 1999, 11 stock exchanges had been privatized or listed and this number rose to 21 by primaeval 2002, with several other exchanges either considering demutualization or already having stated their function to do so. Of the World Federation of Stock Exchanges-formerly the International Federation of Stock Exchan ges (FIBV)-member exchanges, around 52% of stock market capitalization is broadsideed for by demutualized exchanges. In Asia, demutualized stock exchanges including the Tokyo Stock Exchange now account for 76 % of the regions market capitalization (Figures 1. 1 and 1. 2). Figure 1. 1. Market Capitalization FIBV Stock Exchanges (2001) Figure 1. 2. Market Capitalization Stock Exchanges in Asia (2001) Demutualized 52%Not demutualized 48% Demutualized 76% Not demutualized 24% reference work International Federation of Stock Exchanges (FIBV) Source International Federation of Stock Exchanges (FIBV) 1. 3 Motivation and Driving Factors for Demutualization Today, exchanges are no longer the sole primary and secondary market makers or the sole service providers of trade execution, signaling or other activities. This is largely because of the widespread proliferation of ATS and ECNs that have been supported by technological revolution and introduction of high capacity hardware, software pac kages and Internet facilities. ATS/ECNs have allowed economical and effective co-ordinated 5Part I Issues Involved in Stock Exchange Demutualization of the buy and sell orders of customers at lower transaction costs, composition offering price transparency, trader anonymity and extended trading hours. Large global brokers are able to price-match within their own order-stock and only report the net position as a trade to the exchange ( indeed avoiding transaction costs). Given the competitive edge, the market share of the ECNs has grown. In 2002, ECNs have accounted for 45% of NASDAQ shares traded (compared to 25. 5% in 1999) although they only accounted for about 5% of the listed shares traded. Of the several ECNs, Island ECN alone accounted for 32% of the ECNs market share.Instinet makes up another 29%, ArcaEx 27. 2% (formed through the merger of Archipelago and REDIBook), Bloomberg Tradebook 6. 3% and Brut ECN 5. 3%. The rest is accounted by other networks. 2 Having attracted s ubstantial trading, ECNs are also entering into strategic alliances or tie ups with other exchanges or are offering services such as quotes and listing shares to foster raise revenues. The growing competitive pressure has also triggered a wave of restructuring and mergers and alliances among securities markets to maximize economies of scale, accessibility and market reach, while providing global trade facilities through around the clock trading.For instance (i) Euronext was established by the merger of former national exchanges in France, the Netherlands, Belgium and Portugal and the integrated equity trading markets of the northern-European countries of Sweden, Finland, Denmark and Norway (ii) in the derivatives markets, a/c/e, the trading platform of Eurex and Chicago Board of Trade (CBOT), and Globex (Chicago Mercantile Exchange, Liffe, Singapore and others), have already formed global alliances with participants from all time zones, thus creating 24 hour trading markets and (ii i) NASDAQ has developed global alliances/interconnections to attract more liquidity for the United States and regional securities markets. NASDAQ has structured agreements with Europe, Japan, Hong Kong and Canada and is positioned for connatural arrangements with China, Latin America and Middle East. In Asia, several exchanges have trading links and dual-listing agreements with the United States-based NASDAQ. 2 Global Finance Staff Research. 2002. National Association of Securities Dealers (NASD). JP Morgan, H. 6 Demutualization of Asian Stock ExchangesCritical Issues and Challenges The market integration has encouraged a process of disintermediation.With the emergence of new structures, there is no need for formal floors of stock exchanges or financial market intermediaries and participants, as they do not add value (to match the cost) to trading of securities. Exchanges with low market capitalization and weak trading volumes have had to particularly re-examine their operations a nd organizations with the view to increasing their competitive offering and price mix to minimize further diversion of trading volumes. Summarizing the emerging issues, a recent World Bank study3 concluded that Powerful trends of internationalization and migration of order flow are putting pressures on stock exchanges around the world. For some exchanges, already more than half of trading and listing has migrated offshore Migration makes it difficult for countries to sustain a full-fledged local stock exchange.As trading volumes further decrease, financing the fixed smash-up of maintaining market oversight, clearing and settlement systems, and generating enough business for local investment banks, business relationship firms, and other support services will become even harder, in particular for humbleder emerging markets. The trend towards increased migration will thus make it more difficult for small exchanges to survive. page 18 In order to survive in this environment, excha nges need to diversify and move towards commercially oriented business practices with greater focus on improving efficiency, accessibility and ease of use of their systems. Since exchanges have higher overhead costs (as compared toECNs) due to (among other things) cost of building and facilities, they need to strive harder to achieve profitability and economies of scale, while offering competitive services and fees compatible to those being provided by the ECNs. These considerations have driven exchanges to consider alliances and consolidation. By merging two exchanges, the exchange can multiply the volume at the same overhead cost (provided cost cutting synergies are fully explored). It can thus offer to the investors and brokers more listed securities for trading on the same platform. There are forecasts available that indicate that by 2010, there will be few than five major stock exchanges and, perhaps two or three of these will be on the whole electronic marketswhich have not yet been established. 4 3 4 Claessens, Stijn, et. l. 2002. Explaining the Migration of Stocks from Exchanges in Emerging Economies to International Centers. World Bank Working Paper No. 2816. Young, Patrick. 1999. Capital Market Revolution The Future of Markets in an Online World. Harlow Financial Times. 7 Part I Issues Involved in Stock Exchange Demutualization 1. 4 From Mutuality to Demutualization of Exchange The transformation of exchanges from mutual to demutualized structure involves two key features (i) a change in the ownership structure, and (ii) a change in legal as well as organizational form. Both need to be accompanied by adequate safeguards to ensure appropriate governance.Depending on the nature of ownership and legal forms adopted, the demutualized exchangegiven their corporate model and facing growing competitive pressureslends itself to focusing on evolving strategic positioning which, depending on a number of conditions, could involve greater market consolidation , vertical integration and convergence diversification. 1. 4. 1 Ownership Structure The transformation from the mutual member-based to demutualized exchange involves issues of transferability of ownership from members to nonmembers. There are various ways that dilution of membership can be achieved. Sequentially, it involves conversion of active member seats by monetizing these and assignment a certain value per seat.Once the valuation is done, the members can opt to convert their membership to share ownership or to sell off their interest to nonmembers. In most cases of demutualization of exchange, members have opted to retain their share ownership. A listing of equity shares in the exchange facilitates the unlocking of the members equity and buy out of the interest of the traders, while leading to the monetization of the value of the members seats. An entity with freely transferable shares, rather than membership rights, can form equity-swap-based strategic alliances or merger s with other exchanges, domestically or in other countries or time zones. such(prenominal) alliances are stronger and offer greater credibility than pure cooperation agreements.To avoid stock exchanges operating in special or contain interests, securities regulators often place restriction on ownership by one holder or a group of holders to non-controlling stakes of 5-10%. Limits on ownership stakes could affect potential take-over by other exchanges. Such take-overs could have merit in terms of efficiency and economies of scale of the market oddly where more efficient participants acquire inefficient ones. Recognizing the synergies of take-overs, most demutualized exchanges have provisions in place to allow other 8 Demutualization of Asian Stock ExchangesCritical Issues and Challenges exchanges, or technology partners, the possibility of acquiring or swapping strategic stakes.The hesitation to relinquish control to strategic partners or owners remains however one reason why non- equity, swapbased reconciling alliances have been more prolific in the exchange industry. 5 Indeed, several hostile take-over attempts (including OM Gruppens moves to acquire the London Stock Exchange in 2000, and the bidding war for Sydney Futures Exchange by Australian Stock Exchange and Computershare in 1999) have failed due to the voting strength still exerted by the brokers (Table 1. 1). 1. 4. 2 Legal and Company Structure Most stock exchanges are registered as private limited companies with a paid-up capital base, while others operate as member associations or cooperative arrangements.At the end of 2000, FIBV statistics indicates that 90% of its member exchanges, accounting for 60% of market capitalization, were private limited companies. Almost 46% of these were legal company exchanges with inside ownership. most 25% (accounting for 21% of market capitalization) of the exchanges had been privatized, 13% (accounting for 8% of market capitalization) were registered as listed companies6 and the remaining 17% had other types of statuswith some being state-owned or semi-public entities (such as the Shenzhen and Shanghai Stock Exchanges (SZSE and SHSE). As evident in Table 1. 2, in Asia, with the exception of SZSE and SHSE, most of the exchanges are legal entities registered as private limited companies.So far, five exchanges in Asia have been fully demutualized, with three of these listed on their own exchange, and another two have inform plans to demutualize in 2003. The legal structure for the demutualized exchange is based on considerations similar to that for any profit-making company including decisions on number of shareholders (partnership vs. corporation), voting procedures, limitation of liability (liability limited to equity invested vs. joint and several liability for all debts), accounting and reporting requirements (based on taxation laws and on partners/shareholders access to information of the company) and distribution of dividends (re-inve stment 5 6Interestingly, this is similar to another rapidly globalizing industry with national quasimonopolistic companiesthe airline industryin which global cooperation alliances have be very weighty for customer retention. Notably half (of six) of the exchanges that have listed themselves are in Asia. 9 Part I Issues Involved in Stock Exchange Demutualization Table 1. 1. Asian Stock Exchanges Shareholding Structure SHAREHOLDING border Australian Stock Exchange (ASX) Initially uttermost shareholding limit was 5%, but the Financial Services Reform Act raised this to 15% in March 2002. Higher shareholding can be allowed if it is in national interest subject to approval of the Minister for Financial Services and Regulation.Singapore Exchange Limited (SGX) utmost shareholding limit is 5% and can be higher if approved by the Monetary Authority of Singapore (MAS). In 2001, MAS announced that, with its approval, strategic investors and fund managers who invest pools of consumer funds could acquire up to 10% of share-holding. SHAREHOLDING STRUCTURE As of June 2001, issued and paid-up capital of ASX amounted to A$106,282,000. After listing, ASXs shareholders rose from 606 to 16,313. Besides individual investors, the large domestic and international fund managers subscribe to ASX equity including Chase Manhattan Nominees Ltd. whose holding is 6. 9%, National Nominees Ltd. 3. 5%, followed by AMP Life Ltd. (2. %), Westpac Custodian Nominees Pty. Ltd. (2. 11%) and Citicorp Nominees Pty. Ltd. (2. 07%). The top 20 shareholders account for 27. 3% of issued capital. SGX has authentic share capital of S$1,000,000,00. As of August 2001, its issued and paid-up capital stood at S$10,000,000. The top shareholders include SEL Holdings Pte. Ltd with 25% of fit shares (but owing to the restrictions in the exercise of votes attached to shares, SEL is not regarded as a substantial shareholder), Raffles Nominee Pte. Ltd. (12. 9%), followed by DBS Nominees Pte. Ltd. (9. 9%), Overs eas-Chinese Bank Nominees Ltd. (5. 3%) and HSBC Singapore Ltd. and Citibank Singapore (each over 4. %), and others with significant stake in the range of 0. 60-2%. The top 20 shareholders account for 77. 8% of total shares. Out of the shares issued to SEL, the Company made an Initial Public Offer (IPO) and a private placement. The IPO raised S$470 million. Consequently, the issued and fully paid share capital of SGX increased from S$61,670 as at 30 June 2000 to S$10 million as at 16 November 2000. HKEx has authorized share capital of HK$2,000,000,000. As of declination 2001, issued and fully paid capital amount to HK$1,040,664,846. As of March 2002, the two Central Clearing and Settlement System (CCASS) Participants held 28. 8%, and 12. 1% of HKExs issued share capital.SFC granted approval to these two entities as minority controllers of HKEx on the basis that the shares are held in custody for their clients. Hong Kong Exchanges and Clearing Limited (HKEx) Maximum shareholding limi t is 5%. The Securities and Futures Commission (SFC), in consultation with the Finance Secretary, may give approval to a soulfulness to hold more than 5% where it can be demonstrated to be in the interest of the public or the investing public. Philippine Stock Exchange (PSE) The Securities Regulation Code imposes a 5% maximum shareholding limit for individuals and individual companies and 20% for industry or business groups. The demutualized PSE has an authorized capital stock of P36. million, with subscribed and fully paid-up capital base of P9. 2 million representing a portion of the members total office of P286. 6 million as of 31 December 2000. Each of the 184 member-brokers was granted 50,000 common shares of the new PSE at a par value of P1. 00 per share. The remaining members contribution of P277. 4 million will be schedule under additional paid-in surplus. Prior to demutualization, TSE had a capital of Y11,500 million. After demutualization, TSE raised it to Y22,874 milli on by payoff 2,300,000 shares for equal allotment to its members. The total number of authorized shares after demutualization is 9,200,000. TSE now has 114 shareholders.Tokyo Stock Exchange (TSE) Under the Securities and Exchange Law, there is a 5% maximum shareholding limit. Source Stock Exchanges. Latest Annual Reports 10 Demutualization of Asian Stock ExchangesCritical Issues and Challenges Table 1. 2. Asian Stock Exchanges Legal and Corporate Structure 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). Singapore Exchange Securities Trading Limited (SGX-ST), the stock exchange, is a wholly-owned subordinate word of SGX. HKEx was demutualized in March 2000 Legal Status Company (for profit) with the Stock Exchange of Hong Kong Limited (SEHK) set up as a wholly- owned subsidiary of HKEx.ASX was demutualized on 13 October 1998 Legal Status Company (for profit) list STATU S Not listed (plans to list in FY2005) 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. HKEx Listed ASX 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. By the end of 1999, they traded at a range of A$10 to A$11, valuing the company at between A$1 billion and A$1. 1 billion. Not Listed PSE PSE was demutualized in August 2001 Legal Status CompanySource Stock Exchanges. Latest Annual Reports involve vs. distribution to partners, taxation). In most jurisdictions, a limited liability company has been observed to be the traditional and preferred option for profit-making ventures involving more than a close group of partners. The methods for transforming an association into a limited liability company varies between jurisdictions, but in principle, t he existing members agree to transfer the assets and operations of their association to a newly formed company, in exchange for shares in that new company. 11 Part I Issues Involved in Stock Exchange Demutualization 1. 5 Benefits of Demutualization of Exchanges 1. 5. Improvements in Corporate Governance Exchanges, when run as mutual associations, clubs and cooperatives of traders and brokers allow members exclusive rights of access to trading systems and platforms. Operating under this mutual structure, exchanges enjoyed quasi or full monopoly on trading and they derived profits from the intermediation of nonmember transactions. Since members under the mutual structure were owners of the exchange, they imposed rights to trading and disallowed direct access to the trading floor to any outsiders. Brokers inadvertently resisted changes if these entailed additional costs, loss of revenue or competitive threat.This resistance eventually impeded the ability of the company to react quickly to a rapidly changing market environment. Also, in some developing countries if the exchanges enjoyed a legal or decreed national monopoly, government-appointed officials and stakeholder representatives were often represented on the board. While in the short-run such appointments may have proved conducive to mitigating entrenched vested interests, in the long-run these can prove counter productive leading to unhealthy government interference. With the changing economics of automated auction off trading and its easy access electronically, the economics of member-cum-trading floor based exchanges has lost its merit.As a result, it has generated pressures to replace the antique reliance on one member, one vote and the committee-based decision structure where control is vested with the interest groups that have exclusive rights of intermediation at exchange. Under demutualization, there is increased acceptance to separation of ownership from membership that automatically provides tra ding rights. This segregation processs introduce effective corporate governance if (i) there are attach to improvements in the incentive structure,7 which allow the exchanges to sell their equity stakes to nonmembers and outsiders, (ii) decision making is based on this new ownership structure (not on rights of intermediation), and (iii) when there is an effective oversight of a governing board and a company structure. 7 Steill Ben 2002.Changes in the Ownership and Governance of Securities Exchanges Causes and Consequence. In Brookings-Wharton Papers on Financial Services. Washington D. C. Brooking Institution Press. 12 Demutualization of Asian Stock ExchangesCritical Issues and Challenges Since under demutualization the economic ownership of the exchange is separated from trading membership, it is not appropriate that interest groups (such as the trading members) have exclusive empowerment over the decisions of exchange. After demutualization, some exchanges have granted less th an 50% of the voting rights to the broker members on the board of the exchange (see Table 1. 3).To gradually decrease broker influence on the board, the exchanges have appointed independent directors or directors that are nontrading owners. After demutualization, the appointment of government appointed officials (a common feature of exchanges in developing economies) has by and large been viewed as controversial given that the demutualized exchange is a private sector company operating in a competitive environment. In environments where broker influences are often daunting, the continue role of the representative(s) of the securities regulator can support the transition of exchange till such time as the regulation is changed to allow the exchanges to operate in a fully competitive manner.Besides appropriate board representation, it is important that the management of the exchange is fully qualified and motivated to act not only in the high hat interests of the shareholders, but als o to conduct the business in a prudent manner so as not to disrupt the orderly and fair trading in the capital markets. To ensure that this public interest is satisfied, fit-and-proper screening of the board and management, similar to tests put in place in the banking regulations of many jurisdictions, could be undertaken. The management should be accountable to the board, which would determine managements appointment and remuneration, supervise the strategic direction and audit the financial and available results, including risk management, and if needed, effect the removal of management.To ensure the effective supervision and auditing of management, it would seem prudent to ensure that a majority of board members are truly independent directors. To remain competitive, a stock exchange must follow international best practices in ethics and procedures. This is necessary in order to ensure that institutional investors do not shift their investments to other alternatives perceived to be more fair or secure. Therefore, it is in the profit-motivated exchanges best interest to ensure fair and transparent practices and, as such, good corporate governance needs to be an integral part of the exchange once it is driven by the profit motive. 13Part I Issues Involved in Stock Exchange Demutualization Table 1. 3. Asian Stock Exchanges Board Representation STOCK EXCHANGE ASX BOARD REPRESENTATION/COMPOSITION 9 member board of directors. Of ASXs 9 directors, 4 are ASX Members/ Affiliates. 11 member board of directors. Of SGX 11 directors, 4 represent broker interests. SGX plans to broaden membership base by attracting new international members both global and regional securities houses. In addition, SGX will be introducing a new membership structure that allows new and existing members to choose between trading-only membership or clearing-only membership or both trading and clearing membership. Central Depository Pte. CDP) clearing rules have been revised to incorporate the memory access requirements and expect to launch the new membership structure in the third quarter of 2002. The board comprises 8 Public Interest Directors appointed by the Financial Secretary to represent public and market interests, 6 Directors elected by shareholders, and the Chief Executive of HKEx who is an ex-officio board member. Pursuant to the Exchanges and Clearing Houses (Merger) Ordinance, the number of Public Interest Directors will be reduced to no more than the number of elected Directors immediately following the yearbook general meeting of HKEx in 2003. 51% of the board (8 of 15 directors) should be independent. 11 member board of directors, of whom 6 are outside directors. SGX HKEx PSE TSESource Stock Exchanges. Latest Annual Reports 1. 5. 2 Opening Up of Trading Rights of Exchanges Consistent with the for-profit motive, the demutualized exchanges in Asia have included provisions to admit new trading partners (Table 1. 4) and permitted eligible applicants (new cu stomers) open commercial access to the services of exchange. Some exchanges, however, adopted a moratarium period on the proceeds of new trading rights. If share ownership were a requirement for trading membership, it would be relatively easy for existing members to protect their market share by refusing to sell existing or issue any new shares, thus barring new entrants.If new shares can only be issued to the active trading members, then the public, financial institutions, institutional investors and others would generally not be able to invest. The question of a broader ownership 14 Demutualization of Asian Stock ExchangesCritical Issues and Challenges Table 1. 4. Asian Stock Exchanges Trading Rights and Dividend for Profit-Seeking STOCK EXCHANGE ASX occupation RIGHTS Trading rights may be acquired through application with ASX or from an existing Participant. Trading rights have to be acquired through application with SGX, as these cannot be secured through transfer from an exi sting member. In July 2000, SGX opened the securities market to new members, and five new member firms joined in 2000.SGX also changed its rules to allow a item-by-item legal entity to be a member firm in each of the securities and derivatives markets thereby furthering their members opportunities to trade in both markets. Access to the markets may be obtained through acquisition of trading rights from existing members of the exchanges and from HKEx after the breathing out of a two-year moratorium on March 2002. Trading rights issued by HKEx (other than those automatically conferred to the exchange shareholders on the effective date) will not be transferable. For a further period of 2 years thereafter, no new trading rights will be issued for less than HK$3. 0 million per Stock Exchange Trading Right or for less than HK$1. 5 million per Futures Exchange Trading Right.An entity may acquire trading right from an existing trading participant (with approval of TSE), or through applica tion with TSE. Trading right can be acquired through purchase from an existing trading participant. PSE temporarily imposed a moratorium on the issuance of new trading rights and limits it to its present number of 184, transferable for an unlimited period of time. PAYOUT RATIO 70% of net profit after tax. 85% SGX HKEx 46% TSE n. a. PSE n. a. Source Stock Exchanges. Latest Annual Reports base of the exchange (as a public listed company) is critical in situations where exchanges need to raise funds for future investments. Broader ownership would help avoid potentially large swings in the value based on the trading of a limited number of shares only.With share ownership separated from the right to trade, the question of the compensation of existing trading members arises especially since trading rights are granted freely to new members when the existing 15 Part I Issues Involved in Stock Exchange Demutualization members had to acquire their trading memberships. If existing shareholders continue to retain their shares, then they would enjoy the trading rights granted to the shareholders and there would be no need to compensate them for trading rights. This is argued largely because for both the old and new shareholders, the economic value that the shares now represent would always be inclusive of the right to trade provided such rights have been granted.In order for shares to have economic value, there must be an anticipation of dividends, at some point in the future. The introduction of a dividend policy (which does not exist in mutual exchanges), coupled with a listing of the shares, thus transfers the value of stock exchange share ownership from the right to trade, to the right to receive dividends and trade the shares (see Table 1. 4). These factors should in theory minimize the resistance to the demutualization of exchanges by the brokers. However, a moratorium (limited in time) on the granting of new trading rights has often been introduced to lessen the co mpetitive impact on smaller brokers. 1. 5. Restructuring and Alliances of Exchanges After being demutualized, most exchanges have revisited their commercial strategy to improve viability and enhance business prospects. Exchanges have opted to (i) consolidate, merge and/or integrate their domestic markets (ii) build alliances by establishing cross-border linkages with other exchanges within or outside the region and (iii) merge with other exchangesa phenomena more predominant thus far in Europe. In Asia, the exchanges have by and large opted thus far for (i) and (ii). Emphasis has been largely to re-group businesses to broaden the markets, offer issuers and investors better distribution networks and improved liquidity.Predominant in-country mergers or restructuring have taken place in Singapore, Hong Kong, Australia and Japan, and in early 2002, the Kuala Lumpur Stock Exchange (KLSE) merged with MESDAQ (Table 1. 5). In-country restructuring of exchanges has involved (i) Merger of two or more exchanges into a undivided viable nationallevel company, which would be of sufficient scale to be an interesting partner for other (foreign) exchanges, and as a listed company for investors to consider. While these mergers lead to 16 Demutualization of Asian Stock ExchangesCritical Issues and Challenges Table 1. 5. Asian Exchanges Mergers and Alliances STOCK EXCHANGE TSE MERGERS PRIOR TO DEMUTUALIZATION Hiroshima and Niigata Stock Exchanges merged with the TSE in March 2000. ALLIANCES W