Demutualization is coined from the word “Mutual”. A mutual organization is an association set up by members to satisfy their narrow interest or to serve public interest under a charter.
They are generally not-for-profit entities in which members are also their customers. Stock exchanges began as private clubs that eventually adopted formal structures by granting seat to members, which entitled them to trade on the floor of the exchange, and right to vote on the exchange’s affairs. Members were prohibited from trading with non members, a kind of monopoly that is no longer tenable in today’s competitive economies.
Under the traditional mutual model, exchanges earn revenue through membership dues, trading fees charged to members on every transaction, initial and annual listing fees charged to listed companies, sale of data and other information to members and the public. Homogeneity of members lent itself to the mutual association model when market operators were bound by same commission rate and other execution conditions.
The mutual society model was the traditional way of organizing stock exchanges until 1990s when the forces of liberalization and globalization ushered in drastic changes to the global financial landscape. One of such changes was the departure from mutually organized stock exchanges to demutualized exchanges.
Demutualization is the term used to describe the transition of a stock exchange from a mutual association of exchange members, operating on a not-for-profit basis to a limited liability company, operating for profit and accountable to shareholders. Demutualization in its many forms has become a widespread phenomenon globally since 1993, when the Stockholm Stock Exchange blazed the trail as the first exchange to demutualize. Several other renowned stock exchanges like Amsterdam, London, Deutsche, Paris, Hong Kong, Toronto, Chicago, NASDAQ, etc followed suit in quick successions. After several years of resisting the domino effect, the highly revered New York Stock Exchange that was established in 1792 succumbed to the inevitable and demutualized in 2006. Africa has also had its fair share of demutualization. Johannesburg, Nairobi, Mauritius, Seychelles, Rwandan, Casablanca and BRVM, Stock Exchanges in Africa are demutualized.
With passage of the Demutualization Act by the National Assembly, and approvals by SEC and CAC, The Nigerian Stock Exchange (NSE) has become the latest exchange to be demutualized. The NSE was was established by an Act of Parliament in 1960 as a mutual, not-for-profit organization, limited by guarantee of its members. For sixty years of existence, it has functioned as a charitable organization, consisting of members but not owners. Its surplus income was not distributable but retained. The situation has now changed because of its new corporate status. It can now make profit, distribute same to shareholders and also pay corporate income tax.
The journey to demutualization started around 2009, during the tenure of Oba Otudeko as President and Professor Ndi Okereke-Onyiuke as Director General of The NSE. The decision was made in 2009 or thereabout by the Council of The NSE at a special retreat in South Africa. Soon after that retreat, the Council of The NSE descended into a brutal power struggle which many believed was attributable to the jostling between contending principalities for ownership of the proposed demutualized Exchange. Twelve years after the idea was muted, the demutualization has crystallized without any of the contending adversaries hijacking ownership of the exchange. Actualization of the NSE demutualization without any rancour is a remarkable event and a watershed in its anal of history.
Demutualization of exchanges decouple membership (and voting rights) from the right of access to trading. Without demutualization, an exchange continues to be an extension of the interest of its mutual members. When those interests start to divert and are no more common, innovation and competitiveness are impeded. Demutualization depersonalizes those interests by altering the governance structure of the exchange although, its operations and services may remain the same. Demutualization can rid an exchange of corrupt self regulation as evidenced by the credibility crisis that rocked The NSE between 2005 and 2009, and spur governance beyond the narrow interest of members. It can move the capital market beyond the narrow interest of members by creating a more market oriented exchange. The exchange may still be regarded as serving a public function and may act as a Self Regulating Organization (SRO). However, access to trading becomes a matter of contract with the exchange with brokers and dealers simply signing in as users or participants.
Several changes in the capital market necessitate demutualization. Internationalization of financial services continue to breakdown the traditional structures that favour local intermediaries which large global financial institutions have less stake in. The logic of the traditional member-run stock exchange has now been eroded and the business goals of exchanges have changed. Exchanges are increasingly becoming technology and liquidity providers, requiring expertise, skills and ingenuity that may be much different from those endowed by only situating around brokerage business.
Demutualization has mainly been driven by business considerations rather than regulatory concerns. It has been looked at as a means of meeting developmental and competitive challenges and even to address failure to carry out credible operations. Due to growing liberalization and deregulation of economies, several areas of monopoly are being opened up to competition. As a result, many securities exchanges are springing up in local markets, causing widespread competition. Due to competition among exchanges, attracting listings has drastically changed in dynamics. Globalization has also heightened global competition among exchanges across borders. Disruption by Fintech has broken down barriers to shifting of liquidity between exchanges worldwide, online and realtime, taking competition for liquidity to unprecedented levels. One response to these increasing competition, particularly across borders from large exchanges that draw listings and trading globally, has been the formation of strategic alliances and mergers between smaller exchanges. For example, Euronext Exchange which is an alliance between Paris, Amsterdam and Brussels, enables them to compete effectively against London and Deutsche Stock Exchanges. Demutualization made it possible. This is a possibility that was hitherto not available to the NSE. The NSE is now open to alliances, merger and acquisition from interested parties worldwide under well defined and quantifiable value exchange rate.
An important reason for demutualization to corporate organization is to unlock more avenues for capital mobilization, to finance operations and strategic plans. Beyond the traditional sources of funding itself, the NSE has unlimited access now to mobilizing funds from the investing public worldwide through issuance of its own securities. Demutualization leads to capital raising flexibility. The NSE can also now maximize its profits by commercialization of its services in line with what the market can bear. This expected enhancement in financial status will enable the NSE to continuously upscale in every ramification.
There are several models of demutualization. In some instances, limitations are imposed by law on the maximum ownership stake a shareholder can have in the demutualized entity. The Demutualization Act of The Nigerian Stock Exchange, together with the rules of SEC puts this at 5%. Demutualization may also be partial where the shares of the emergent company are held privately by erstwhile mutual members. However, demutualization of the NSE is full because its holding company will be listed and publicly traded. Any investor can buy the shares of The Nigerian Stock Exchange Plc after listing in due course.
Demutualization creates special corporate governance needs due to the public interest responsibilities of stock exchanges, and their position in the financial structure of economies. As exchanges become demutualized, their regulatory role becomes more difficult and yet, the advantages of self regulation are not easily discarded. Demutualization will not erode the standards for participants and issuers, nor the enforcement of those standards, despite need to achieve competitive edge. A new dilemma is also introduced into the equation by virtue of being a regulator and an issuer, if the demutualized exchange is also listed on its exchange for trading. To forestall any conflict of interest that may arise, the NSE has established an independent regulatory company to regulate its market dispassionately. This should elicit issuers’ and investors’ confidence in the NSE, notwithstanding its new conflicting roles in the capital market.
While demutualization is seen as a cure for the crippling self interest attendant to mutual organizations, the transformation can lead to sacrifice of ethics and professionalism (which are hallmark of fraternities) at the alters of commercial expediences. This will challenge stakeholders to balance the public interest role of the exchange with its commercial goals. Since the investing public will be controllers of the governance of the emerging stock exchange group, shareholders will certainly ensure that the standards of corporate disclosure, transparency, trust and integrity expected from public quotation, remains the hallmark of the new entity. The Nigerian Stock Exchange Plc by virtue of its listing will definitely add to the profitable, safe and liquid investment outlets in the capital market in which investors can deepen their investment choices.
DAVID Adonri is the Managing Director of Highcap Securities Limited