VII. B. Demutualization: PROMOTING STOCK MARKET DEVELOPMENT IN AFRICA

Demutualization can be defined as a change in the legal status, structure and governance of an exchange from a non-profit, protected interest one to a profit oriented.11 The process of demutualization involves a change in ownership structure and a change in legal and organization form. With regards to the ownership structure, members’ seats are monetized and values assigned per seat. Members then either keep or sell shares. Ownership restrictions are placed (for example, 5-10 percent non-controlling stakes) on individuals and groups to prevent potential takeovers by other exchanges. The legal and organizational change normally entails the exchange becoming a typical profit making company with limited liabilities and abiding by company laws.

Demutualization started gaining popularity in the 1990s, due to a number of factors. These include competition among exchanges, need for increased capital, need for good corporate governance in exchanges and the urge to open up ownership of exchanges to public investors (Pirrong, 2000). Between 1999 and 2003, the number of demutualized and public exchanges in the world increased from 10 to 25 (IOSCO, 2005).

Demutualization is expected to solve mutual structure problems by opening up trading rights, admitting new trading partners, and broadening ownership such that the public can invest in exchanges. The absence of these in mutual exchanges tends to breed poor governance structures. In a mutualized exchange, traders and brokers enjoy monopoly power through exclusive rights and access to trading systems, resulting in a protection of vested interests for traders. In a demutualized exchange there is a vote per share and once incentives for equity stakes to nonmembers exists there is separation of powers. Decision making is on ownership structure not trades intermediation. Thus, demutualization induces better corporate governance systems. In addition, undue governmental influence in mutual exchanges in Africa is likely to be absent in demutualized exchanges since appointment of government officials become unnecessary due to the fact that a demutualized exchange is a private company.

Demutualization also increases access to services of the exchange and removes excessive investment costs for fund holders. For instance, brokers usually package non-trade related fees (research, computer systems and IPO access) into institutional traditional commissions often known as “soft commissions” or “bundled commissions” and pass on to clients. With demutualization, fund holders can directly access such information without the use of brokers. Finally, it is also argued that demutualization instills efficiency and better structures in exchanges and results in commercial gains for exchanges (Ryden, 1995).

A major problem with demutualization is that of conflict of interest and regulatory oversight.

Exchanges tend to shy away from taking enforcement actions against their own customers who are a source of income. There is a potential commercialization of services; data and trade information that traditionally is offered freely is now sold. Listing standards and oversight can be compromised by the exchange concerned. To solve these problems selflisting arrangements can be implemented.12 For mutual African stock exchanges, potential conflict of interest could pose huge problems, since current regulatory structures are still undergoing restructuring to meet international standards. In many African countries, the establishment of formal stock exchanges preceded the creation of formal independent securities regulators. However, it could also be argued that perhaps being a private venture, demutualized exchanges could speed up the formation of strong regulatory systems in Africa.

The policy of demutualization should not be of immediate concern to most African exchanges. The reason is that most African exchanges have barely existed for three decades, and are grappling with teething issues of poor infrastructure and illiquidity. Demutualization would, therefore, be more relevant in the medium to long term when the teething issues have been properly managed. Indeed demutualization should be the step after Africans have consolidated gains on improving liquidity problems and strengthening cooperation. For now other African markets can study the JSE to learn from their current experiences as a demutualized exchange. Admittedly the JSE case poses a challenge for advocacy for a regional exchange for SADC. This is because a regional exchange in the SADC in the near future is expected to be demutualized given the current stance of the JSE.

IMF Working Paper African Department Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges Prepared by Charles Amo Yartey and Charles Komla Adjasi August 2007 To learn more about this author, visit International Monetary Fund's Website.

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