SEBI Order on MCX Stock Exchange

SEBI has issued a detailed order rejecting the application of MCX-SX to commence trading in several exchange segments. SEBI’s conclusion is based on a legal analysis (a fairly intensive one for a regulator) of various issues as well its assessment of whether the applicant is a ‘fit and proper’ for the grant of a licence.

In September 2008, MCX-SX had been recognized as a stock exchange by SEBI with the condition that the promoters need to dilute their stake within a year’s time. When MCX-SX was formed, its promoters MCX and FTIL owned 51% and 49%, respectively, in it. Their stake came down to 37% and 33.9%, respectively, after the divestment of shares.

The firm got an extension of another year when the deadline for divestment lapsed last September. When SEBI renewed its recognition of MCX-SX as a stock exchange, it inserted a new condition that the bourse won’t be eligible to introduce any new class of contracts until shareholding norms are complied with.

This new condition, says the exchange, made it more difficult for it to find new investors, since such entities were willing to invest only after the bourse received approvals for operating in other segments. But SEBI would give approval for new segments only after the promoter stake was diluted. Given this challenge, the bourse had to resort to an unconventional method of capital restructuring, it said.

According to the capital restructuring exercise approved by the Bombay high court, the holdings of all shareholders came within permissible limits. However, the bourse issued 617.1 million warrants to MCX and 562.5 million warrants to FTIL. This arrangement allowed the promoters to gradually sell the warrants when the markets were conducive and valuations were agreeable. When the warrants are converted into equity shares by outside shareholders, the bourse’s equity base will expand and the promoters’ stake will fall below the 5% limit depending on the extent of conversion. The promoters can then convert warrants still in their possession into shares to keep their stake at 5%.

After getting court approval for this exercise, MCX-SX had written to SEBI on 7 April seeking to trade in new products. SEBIs Thursday order disposed of this application.

The reasons for SEBI’s conclusion have been summarised in the order as follows:

a. The concentration of economic interest in a recognised stock exchange in the hands of two promoters is not in the interest of a well-regulated securities market.

b. The Applicant is not fully compliant with the MIMPS Regulations as substitution of shares by warrants is an attempt to work around the requirements of Regulation 8 of the same and the same is not a mode recognised as falling within the scope of the said Regulations.

c. The Applicant has been dishonest in withholding material information on arrangements regarding the ownership of shares of its shareholders and therefore has not adhered to fair and reasonable standards of honesty that should be expected of a recognised Stock Exchange.

d. The Applicant has failed to ensure compliance with Regulation 8 of the MIMPS Regulations as its two promoters (FTIL and MCX) are persons acting in concert and cannot hold more than 5% in the equity shares of a recognised stock exchange.

e. The Applicant is instrumental to buyback transactions that are illegal under the SCR Act and cannot be considered to have adhered to fair and reasonable standards of integrity that should be expected of a recognised Stock Exchange.

The issue is quite likely to go up in appeal. The exchange has the option to either take it up with Securities Appellate Tribunal (SAT) or go for a writ petition in the high court. The order suffers from a fundamental defect. The MIMPS regulations apply only to exchanges which are not corporatized and demutualised. They did not apply to the NSE and to the OTCEI, they do not apply to MCX-SX also.