DEMUTUALIZATION OF STOCK EXCHANGES PROBLEMS, SOLUTIONS AND CASE STUDIES Edited by SHAMSHAD AKHTAR Director, Governance, Finance and Trade Division, East and Central Asia Department, Asian Development Bank © Asian Development Bank 2002 All rights reserved. The views expressed in this book are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Governors or the governments they represent. The Asian Development Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequences for their use. Use of the term “country” does not imply any judgment by the authors or the Asian Development Bank as to the legal or other status of any territorial entity. ISBN 971-561-475-2 Publication Stock No. 100602 Published and printed by the Asian Development Bank P.O. Box 789, 0980 Manila, Philippines CONTENTS Foreword xiii Principal Authors xv Abbreviations xxi PART I : ISSUES INVOLVED IN STOCK EXCHANGE DEMUTUALIZATION 1 Demutualization of Asian Stock Exchanges— Critical Issues and Challenges by Shamshad Akhtar 3 1.1 Introduction 3 1.2 Demutualization: Its Definition, Size and Significance 4 1.3 Motivation and Driving Factors for Demutualization 5 1.4 From Mutuality to Demutualization of Exchange 8 1.5 Benefits of Demutualization of Exchanges 12 1.6 Regulatory Oversight: Challenges and Responses for Demutualized Exchange 19 1.7 Financial Viability of Demutualized Exchange 25 1.8 Conclusion 29 2 Background Information on Demutualization by Pamela S. Hughes 33 2.1 Introduction 33 2.2 What Demutualization Means 33 2.3 The Reasons to Demutualize 36 2.4 The Models 40 2.5 An Update Since Demutualization 43 2.6 Conclusion 47 Demutualization of Stock Exchanges—Problems, Solutions and Case Studies APPENDIX 1 : The Models 48 3 Motivations, Mechanics and Models for Exchange Demutualizations in the United States by Roberta S. Karmel 59 3.1 Overview 59 3.2 Reasons for Demutualization 61 3.3 How Demutualization is Accomplished 65 3.4 Post-Demutualization Models 70 4 The Structure of a Demutualized Exchange— The Critical Issues by David Holthouse 73 4.1 Introduction 73 4.2 Ownership 73 4.3 Corporate Governance 77 4.4 Access Rights 80 4.5 Risk Management 81 4.6 Financial Management 82 4.7 Conclusion 83 5 Demutualization of Exchanges— The Conflicts of Interest (Hong Kong) by William Pearson 85 5.1 Structure of Exchanges 85 5.2 Regulatory Role and Self-Regulation 88 5.3 Public Policy Objectives of Stock Market Regulation 91 5.4 Why Should Demutualization Require a Reassessment of SRO Functions? 92 5.5 What Responses are Being Developed to Deal with These Problems? 95 5.6 Conclusion 99 5.7 Hong Kong’s Framework: Listing of HKEx and the Framework for Dealing with Conflicts of Interest 100 iv Contents APPENDIX 1 : Hong Kong Exchanges and Clearing Limited: Reinforcing Hong Kong’s Position as a Global Financial Centre—A Policy Paper 105 APPENDIX 2 : Memorandum of Understanding for the Listing of HKEx on SEHK 114 APPENDIX 3 : Section 13 of the Exchanges and Clearing Houses (Merger) Ordinance 131 APPENDIX 4 : Chapter 38 of the Rules Governing the Listing of Securities on the Stock Exchanges of Hong Kong Limited 133 APPENDIX 5 : Procedures to Deal with Conflicts of Interest 138 6 Demutualization of Exchanges—The Conflicts of Interest (An Australian Perspective) by David Holthouse 145 6.1 Introduction 145 6.2 Background to Conflicts 146 6.3 An Exchange’s Listing 148 6.4 Regulation of Other Listings 149 6.5 Supervision of Intermediaries 149 6.6 Profit Motive versus Supervisory Function 150 6.7 Public Interest versus the Exchange’s Commercial Interest 152 6.8 New Business Lines 153 6.9 Conclusion 154 7 Demutualization of Exchanges—The Conflicts of Interest (The Australian Regulator’s Experience) by Claire Grose 157 7.1 Introduction 157 7.2 Self-Listing 157 7.3 Other Conflicts 160 v Demutualization of Stock Exchanges—Problems, Solutions and Case Studies 8 Regulation of a Demutualized Exchange (Canada) by Pamela S. Hughes 163 8.1 Introduction 163 8.2 Role of an Exchange 165 8.3 Self-Regulation and Government Oversight 165 8.4. SRO Conflicts of Interest 169 8.5 Supervision of Listings 171 8.6 Self-Listing 171 8.7 Managing Conflicts of Interest 172 8.8 Prudential Regulation 172 8.9 Shareholders 173 8.10 Directors and Officers 175 8.11 Memoranda of Understanding 175 8.12 Conclusion 176 9 Regulation of a Demutualized Exchange (Singapore) by Lee Boon Ngiap 177 9.1 Background 177 9.2 Regulatory Issues Arising from Demutualization 178 9.3 The Regulatory Relationship between the Monetary Authority of Singapore and Stock Exchange of Singapore 179 9.4 Conclusion 183 10 Regulation of a Demutualized Derivatives Exchange (United States) by Natalie A. Markman 185 10.1 Introduction 185 10.2 A New Framework 186 10.3 Exchange Oversight 190 10.4 Regulatory Issues Raised by Demutualization 192 10.5 Conclusion 195 vi Contents APPENDIX 1 : Designated Contract Markets for Regulated US Derivatives Exchanges 196 APPENDIX 2 : Registered Derivatives Transaction Execution Facilities 202 APPENDIX 3 : The CFTC Market Surveillance Program 205 11 Regulation of Demutualized Exchanges (Australia) by Claire Grose 213 11.1 Legislative Framework 213 11.2 Australian Securities and Investment Commission’s (ASIC) Powers 214 11.3 Supervision by Market Operators 214 11.4 Memoranda of Understanding (MOUs) 215 11.5 Changes Due to Demutualization 215 11.6 New Legislation 217 PART II: DEMUTUALIZATION CASE STUDIES 12 Australian Stock Exchange—The Conversion to a Demutualized Exchange: ASX’s Experience by David Holthouse 221 12.1 Introduction 221 12.2 Background to Australian Stock Exchange’s Demutualization 222 12.3 Obtaining Member Approval 223 12.4 Mechanism Used for Conversion 224 12.5 Changes to the Corporations Law 225 12.6 The Demutualization Process 226 12.7 Memorandum of Understanding (MOU) with ASIC 228 12.8 Demutualization and Listing Outcomes 229 12.9 Subsequent Supervisory Development: ASX Supervisory Review Pty Limited 230 vii Demutualization of Stock Exchanges—Problems, Solutions and Case Studies 12.10 Changes in ASX’s Focus and Activities 231 12.11 Conclusion 233 13 Hong Kong Exchanges and Clearing Limited— Demutualization, Merger and Listing: The Hong Kong Exchanges’ Experience by Lawrence Fok 235 13.1 Introduction 235 13.2 Pre-Merger Period: Two Exchanges and Three Clearing Houses 236 13.3 Merger and Proposal 238 13.4 Reasons For the Merger 239 13.5 Market Reform 242 13.6 Conclusion 246 14 Hong Kong Securities and Futures Commission— The Conversion to a Demutualized Exchange: The Hong Kong Regulator’s Experience by William Pearson 247 14.1 The Need for Reform 247 14.2 The Reform Process 250 14.3 Rationalized Market Regulation 255 14.4 Implementing Legislation: Exchanges and Clearing Houses (Merger) Ordinance 258 14.5 Key Issues Arising from Hong Kong’s Experience with Demutualization 258 APPENDIX 1 : Summary of the Exchanges and Clearing Houses (Merger) Ordinance 261 15 Singapore Stock Exchange—Demutualization and Listing of the Singapore Exchange Limited by Alan Shaw 265 15.1 Introduction 265 viii Contents 15.2 Drivers for Change: The Rationale for Demutualization and Merger 265 15.3 Impact of Demutualization 267 15.4 The Merger Act 269 15.5 The Process of Demutualization 270 15.6 The Singapore Exchange’s Initial Public Offer 271 15.7 The Structure of Singapore Exchange 272 15.8 The Governance of Singapore Exchange 274 15.9 Listing and Conflict of Interest 276 15.10 Conclusion 279 APPENDIX 1: Procedures to Deal with Conflicts of Interest 281 16 Toronto Stock Exchange—From Toronto Stock Exchange to TSE Inc.: Toronto’s Experience with Demutualization by Timothy Baikie 283 16.1 Introduction 283 16.2 An Overview of the Toronto Stock Exchange (TSE) 283 16.3 The Development of Mutual Exchanges 286 16.4 Consolidation, Globalization and New Competition 291 16.5 The Demutualization Decision 292 16.6 Market Regulation by a Demutualized Exchange 296 16.7 Next Steps 298 16.8 Conclusion 298 17 Demutualization of the Philippine Stock Exchange by Maria Larrie Alinsunurin 299 17.1 Introduction 299 17.2 Ownership Structure of the Stock Exchange Upon Demutualization 300 17.3 Trading Rights 300 17.4 Corporate Governance 301 17.5 Business of the Exchange 304 17.6 Statutory Regulatory Role 307 ix Demutualization of Stock Exchanges—Problems, Solutions and Case Studies PART III: STRUCTURE OF MUTUAL EXCHANGES 18 The Colombo Stock Exchange (Sri Lanka) by Rajeeva Bandaranaike 313 18.1 Ownership Structure 313 18.2 Listing Data 314 18.3 Corporate Governance 314 18.4 Business of the Exchange 315 18.5 The Vision, Mission and Corporate Strategy 316 18.6 Trading Rights 317 18.7 Regulatory Framework 317 18.8 Self-Regulation 317 18.9 Statutory Regulatory Role 319 18.10 Investor Protection 320 18.11 Funding of the Colombo Stock Exchange 321 18.12 Stock Exchange Seeks to Demutualize 321 19 The Kuala Lumpur Stock Exchange (Malaysia) by Securities Commission (Malaysia) 323 19.1 Introduction 323 19.2 Ownership Structure of the KLSE 323 19.3 Listing Data 324 19.4 Corporate Governance 324 19.5 Business of the Exchange 325 19.6 Trading Rights 326 19.7 Risk Management and Supervisory Issues 327 19.8 Statutory Regulatory Role 329 19.9 Stock Exchange Seeking to Demutualize 329 x