What is the Sebi-MCX-SX spat all about ?

MCX-SX, promoted by the Multi Commodity Exchange of India (MCX owned 51% originally) and Financial Technologies India Ltd (FTIL had 49% originally), filed a writ petition in the Bombay High Court in July this year. It said Sebi, the regulator, had delayed giving it a regulatory approval to launch trading in equity, derivatives and interest rate futures. MCX-SX had applied for a licence to start an equity exchange in 2008.

Was Sebi being unfair?

MCX-SX argues that interest rate futures are linked to currency futures, for which it already had a licence, and so it should have got the permission without any problem.

So why didn?t Sebi grant it permission?

On August 2009, Sebi issued a gazette notification saying MCX-SX would get no more products till it became MIMPS-compliant.

What is MIMPS-compliance?

The Manner of Increasing and Maintaining Public Shareholdings in Recognised Stock Exchanges Regulations, 2006 specifies that no single entity can hold more than 5% of the equity in a stock exchange. The idea is to ensure no one person exerts undue control on the exchange. There are certain exceptions to this?entities like stock exchanges, depositories, banks, insurance companies and public financial institutions can hold up to 15% each. This exception was allowed in December 2008.

So why didn?t MCX-SX become MIMPS-compliant?

It claims it is. In 2008, MCX owned 51% of MCX-SX and FTIL owned 49%. FTIL, in turn, owns 31% of MCX and Jignesh Shah owns around 46% of FTIL through various associates. MCX-SX then began approaching banks and other investors and, by April 10, 2010, brought the shareholding of both MCX and FTIL down to 5%. This was done after obtaining approval from the Bombay High Court.

Why wasn?t Sebi satisfied with this?

Sebi told the court it was investigating if there was any buyback agreement with any of the new shareholders. The shareholders include IFCI (13.23%), Union Bank of India (11.5%) and others like Punjab National Bank (PNB) and Infrastructure Leasing & Financial Services (IL&FS). If there is a buyback agreement, this means that the promoters can later increase their shareholdings to more than 5%.

Is there a buyback agreement?

Comfort letters were given to PNB that suggest there is such a relationship. MCX-SX has clarified that the warrants issued by it do not have any voting rights and that such comfort letters are part of any standard investment made by PE investors?investors want to know by when will there be an IPO to allow them an exit route, and what is the exit route and price if there is no IPO. In any case, MCX-SX argues this is infructuous since all the investor companies have passed shareholder resolutions saying they will not buy more than 5% of MCX-SX?s equity. Also, since all shareholding has to be MIMPS-compliant if the exchange has to do business, there are enough checks and balances in place.

Is this fair?

Depends on how you look at it. Sebi believes it can get financially strong exchanges with each promoter holding just 5% of the equity from day one. Most businessmen would tell you it is difficult to get 20 investors to put money in a start-up, which is what the 5% rule boils down to. The general model is to start a firm/project with one or two investors and then divest to the public later ? this also allows promoters to get a value for the risk they?ve taken and the effort to make the business a profitable one. RBI has a ceiling on individual shareholdings (with a cap of 10% on voting rights) but has allowed promoters to set up banks with even higher shareholdings and gives them time to come down to the statutory level. The Insurance Regulatory Development Authority (Irda) also allows promoters a long window to reduce equity; the Forwards Market Commission allows six years.

Is there a date for closure in this case?

The Bombay High Court has directed FTIL (Financial Technologies India) and MCX, the promoters of MCX-SX, to pass a board resolution within 10 days (from Aug 10), to ensure that they would not, at any time, overshoot the 5% maximum limit prescribed under MIMPS regulations. FTIL and MCX say this has been complied with.

The court has given Sebi time till September 30 to decide whether or not MCX-SX can commence trading in equity products. Sebi had earlier told the court that it would require at least six weeks to reach a decision, as it was inquiring into the nature of buyback arrangements. Meanwhile, Sebi renewed MCX-SX?s licence for offering currency futures for one more year. The licence was to expire on September 15.