Corporate Governance

The Role of Stock Exchanges in Corporate Governance: Demutualisation and the Retention of Regulatory Responsibility (Part 3)

By J. Robert Brown

We are discussing The Role of Stock Exchanges in Corporate Governance, a report issued by the OECD. The precise role of stock exchanges in the regulatory process has been an often discussed issue.  Demutualisation and the conversion to for-profit companies has, however, raised the importance of the discussion to a new level.

Demutualisation occurred for the first time in Sweden with the Stockholm stock exchange converting to a for-profit corporation in 1993.  The exchanges in the OECD have all more or less demutualised, although three, Warsaw, Tokyo and the Swiss exchanges, have not yet listed.  The trend for the rest of the world?  "Exchanges outside the OECD area, including regions such as South America and the Middle East, have only recently begun to demonstrate an interest in demutualisation."  In other words, exchanges as "for profit" companies will eventually become the global norm.

Demutualisation changes the focus of an exchange.  Brokers as owners cease to be the main concern, replaced by shareholders who want profit maximization.  "Self-listing and the subsequent dispersion of ownership of exchanges have finally divorced their interests from those of broker dealers. As a result, exchanges started to face multiple constituencies with diverging motivations, putting a further pressure on them to satisfy multiple demands."

At the same time, the need to profit maximize creates a potential conflict with the regulatory mission of the exchange.  In some countries, the conflict has been deemed irreconcilable and the regulatory functions taken away from the exchange.

• An obvious illustration of this model is the United Kingdom, where, following the demutualisation of the LSE, the listing responsibilities were transferred to the FSA (FSA Listing Authority) that is now responsible for listing and aspects of enforcement. The FSA may also modify listing or disclosure rules, or suspend trading of a financial instrument. In a slightly different model adopted in Canada, the TSX, upon approval by the OSC, has contracted market surveillance functions to the Investment Industry Regulatory Association of Canada (IIROC).27 These measures have been aimed to address not only the conflicts of interest related to self-listing, but also to conflicts of interest related to issuer regulation.

The approach, however, has been the exception rather than the rule.  As the study notes:  "The resultant competitive advantage would help explain why exchanges have rigorously defended their prerogative to maintain the regulatory function, introducing a variety of mechanisms to address the potential conflicts of interests that arise with respect to self- and issuer oversight."  In other words, in a for-profit universe, the exchanges see control over the regulatory function as a competitive advantage.

Full post as published by The Race to the Bottom on September 14, 2009 (boomark / email).