Latin American Capital Markets

DEMUTUALIZATION OF EXCHANGES 271interest responsibilities.Traditionally, exchanges have engaged in self-regulation, whichgenerally is more efficient and cost-effective than government regulation. In addition,self-regulation involves those subject to regulation as participants in the regulatoryprocess, making the imposition of regulatory controls more palatable. Whether thechange from a nonprofit mutual form of organization to a for-profit corporate formmakes self-regulation more problematic is an interesting question, which can be brokendown into a number of issues. First, what conflicts of interest are created or increasedwhere a for-profit entity also performs exchange regulatory functions, especiallysecurities listing, secondary market regulation, and member regulation? Second,is there a need to impose a special regime on exchanges to protect the public interest,such as particular corporate governance arrangements or rules with respect toshare ownership? Third, will a for-profit exchange be run with more regard for its financialviability than its regulatory effectiveness?Although demutualization raises these issues, the answers become evenmore difficult when an exchange makes a public offering of securities and then selflistson its own board. Although the decisions to demutualize and go public are separate,most exchanges that have demutualized contemplate a public offering at anappropriate future time. Therefore, as an exchange considers whether to demutualize,the government regulator dealing with the problems that the transaction entailsshould probably look ahead to the exchange becoming a public company in resolvingthe regulatory problems involved.Different jurisdictions have approached these issues from the perspective oftheir own legal, regulatory, and corporate finance systems. IOSCO tries to identifycommon approaches. It considers the corporate governance requirements mandatinthe appointment of public directors—that is, directors who are not engaged in the securities business—and the public good of an exchange, not merely the good of membersor stockholders (IOSCO 2000). Such public directors can help solve conflict ofinterest problems and ensure the fair and efficient functioning of the exchange. Exchangeshave a public interest responsibility because they provide liquidity and pricediscovery facilities to aid capital formation. In a demutualized environment, IOSCO(2000) suggests evaluating the need for some greater regulatory oversight of exchangemanagers. Furthermore, consideration needs to be given to placing restrictionton who may become shareholders and who may control exchanges as shareholdertThe funding of the regulatory activities of a demutualized exchange is animportant public interest concern. In particular the demutualization process shouldpay attention to cross-subsidization of for-profit activities using cash flows from regulatoryactivities, uneconomic pricing, allocation of regulatory costs, and financial viabil-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub