Report of the Committee on Governance of the Exchanges

18 Jan 1999

EXECUTIVE SUMMARY

Strategic Imperatives

Global forces at work today are changing the rules of the performance game for exchanges. Exchanges face increasing global competition from existing and new players. These include proprietary trading systems that are executing trades between large participants at low cost and bypassing exchanges. Investors are becoming more sophisticated, demanding the facility to execute trades directly and requiring convenient and low-cost access to a wide variety of cash and derivative instruments. For exchanges, there is an increasing premium on efficiency, innovation and the continuous pursuit of new value-adding opportunities.

The SES and SIMEX have done well. The SES has played an integral role in developing Singapore's capital market, and has maintained high prudential standards that have enabled it to weather the Asian economic turmoil. It has been a leader in exchange technology in Asia. SIMEX is the most international derivatives exchange in the Asia-Pacific, offering the broadest range of Asian and global products. It has the second-largest volume of financial futures trading among exchanges in the Asia-Pacific, next to the Korean Stock Exchange, and is growing rapidly.

Going forward, Singapore's exchanges need to re-assess their strategies within an increasingly globalised and competitive exchanges environment, and meet the challenges of new investor demands. They should position themselves as leading international exchanges for the trading of Asian products, and the trading of global products in Asia.

To do so, the exchanges require improved ownership and governance structures, enabling them to be driven as business entities in their own right. They will also enhance their business capabilities by joining strengths, consolidating their resources, and developing synergies between the cash and derivative markets.

Demutualisation and Integration of SES and SIMEX

The Committee assessed several models of exchange governance for Singapore's exchanges, and studied the experience and trends in governance of other international exchanges. It recommends that SES and SIMEX be demutualised to separate ownership from participation in the exchanges, and integrated into a single corporate entity. The Committee was of the view that this would best position the exchanges to develop new business opportunities, and provide maximum incentive for owners and management to strive for competitive advantage and operational efficiencies.

The new integrated entity should be a for-profit, privately-held stock company with a single pool of owners at the holding company level. The new entity should aim for a public listing within about 5 years, providing an added incentive for owners to ensure its success.

Ownership of the New Integrated Exchange

The Committee recommends that existing SES members and SIMEX clearing and non-clearing seat-holding members (both individual and corporate) be allocated shares in the new entity, in recognition of their contributions to the development of SES and SIMEX and to encourage their commitment to the new enterprise.

The Committee recommends that the allocation of shares to SES and SIMEX members be based on slight discounts to the imputed value of SES and SIMEX seats/shares currently. The discounts recognise the fact that seat values would have declined dramatically under the status quo, once commissions are liberalised and access to the exchanges opened up. Specifically, it is recommended that:

• Each of SES' 33 members receive S$6 million worth of shares in the new entity. This is about 15% lower than the estimated current market value of S$7 million for an SES seat.
   

• SIMEX members receive S$115,000 worth of shares in the new entity for each SIMEX share owned, and S$170,000 worth of shares in the new entity for each SIMEX seat owned. These correspond to seat and share values which are about 11% lower than the average for 1998. The discount of 11% applied to SIMEX seat values is lower than the 15% discount applied above to SES seat values, since SIMEX's seat and share prices better reflect fair market value.
   

At preliminary valuations of S$600-800 million for the combined entity, the recommended allocations translate into a 40%-50% combined shareholding for existing SES and SIMEX members. To broaden the shareholding base, the Committee recommends that the remaining shares of the integrated exchange be sold to new investors. A financial advisor will need to be appointed to value the new entity and price the shares fairly.

The Committee believes that the new exchange's success is dependent on the continued commitment of existing members. At the same time, it will be important to balance broker interests with broader financial sector and strategic interests. The Committee recommends that the aggregate broker shareholding should be subjected to a ceiling of 75% and a floor of 33% of the new entity.

Until the new exchange is publicly listed, owners should be allowed to trade their shares privately. The ceiling and floor on aggregate broker ownership should remain until the IPO.

To ensure that the shareholder base is adequately diversified any shareholding of more than 5% in the integrated exchange should require MAS approval.

The Committee recommends that a pool of strategic investors, including local financial institutions and other institutions with long-term interest in Singapore's financial centre be invited to take significant stakes in the new entity. Strategic investors may be allowed to go beyond 5%, but MAS approval should also be required for holdings in excess of 10%.

The Committee proposes that proceeds from the sale of shares to new investors be placed in a new Financial Sector Development Fund, to be used to enhance the development of skills and capabilities in Singapore's financial sector as a whole.

Organisation and Decision-Making in the Integrated Exchange

To realise the full benefits of integration, the Committee's view is that the combined exchange should over time be organised functionally as separate wholly-owned subsidiaries for trading, clearing, depository and IT systems services under a common parent holding company. In particular:

• SES and SIMEX trading operations will initially remain separate subsidiaries and legal entities. Eventually, they may share a common trading engine when an integrated engine becomes operationally available, and merge into a single trading subsidiary.
   

• Existing SES and SIMEX clearing functions could initially remain status quo, but looking ahead a stand-alone clearing subsidiary should be considered to facilitate cross-margining and enable more efficient use of collateral. The stand-alone clearing subsidiary could also pool resources and consider expanding into clearing services for the OTC and debt markets.
   

• No change is initially envisaged to SIMEX's Common Bond system. SIMEX Clearing members should continue to earn clearing commissions and be adequately represented in the new entity's decision-making mechanism on admission of new clearing members.
   

Suitable "corporate veils" should be put in place to shield the holding company from subsidiary companies' legal liabilities and to prevent loss-migration between subsidiary companies.

The Committee feels that the decision-making mechanism of the combined entity should ensure a diversity of financial sector interests. It should also accord the exchange's top management considerable flexibility in operations. In particular:

• To balance broker and broader capital market participant perspectives, brokers should not comprise more than half of the Board, which is envisaged to comprise 10 to 12 members. A minimum of two and up to four MAS-approved independent directors should be appointed, including the non-executive Board Chairman, to ensure balanced representation of interests favouring long-term financial centre development.
   

• The Board of Directors should have primary responsibilities of providing strategic directions and appointing management executives. The top management of the new entity (Executive Committee - EXCO) should be responsible for operational decisions, business development and strategy formulation. The EXCO should include existing SES and SIMEX top management, who will remain key members of the new top management team.
   

Regulatory Issues

The Committee proposes that in line with the SESRC's recommendation that full liberalisation of the brokerage industry take place within 5 years, open access to the new integrated exchange should be phased in over 3 years. Completely open access should be in place by Jan 2002, by which time participation in the exchange would be fully divorced from ownership of the exchange.

The Committee also noted that MAS' regulatory framework and the exchanges' current bye-laws and regulations will need to be reviewed:

• In the short term, existing statutory legislation and the exchanges' bye-laws will need to be amended to account for the demutualisation of the exchanges. New provisions will also need to be enacted to enable MAS to regulate the new holding entity.
   

• In the longer term, a more thorough review of the regulatory framework will need to be undertaken to:

  • study if MAS' role in overseeing the new, for-profit exchange will need to be enhanced to ensure that there is no relaxation of current regulatory standards. There is also a need to clearly delineate in legislation respective regulatory functions of MAS and the exchange; and  

  • study whether there should be a merging of current securities and futures legislation into a single "omnibus" legislation, to anticipate features such as common licensing for intermediaries operating in both markets, a shared trading platform for cash and derivatives, increased trading of hybrid cash-derivatives products and an integrated clearing house for both cash and derivatives clearing. 

  
   

This report can be downloaded in full in PDF format and viewed and printed with Adobe's Acrobat^(TM)Reader.
 (PDF, 84.6KB)