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The recent unanimous decision by members of the Nigerian Stock Exchange (NSE) to transform from a mutually-owned (for the benefit of its members) exchange to a for-profit company is a strong statement of intent that the NSE's management and members are unwavering in their drive to actualise the NSE's vision “To be Africa's foremost securities exchange driven by regulation, efficiency, liquidity and innovation.” On completion of the demutualisation process, the NSE will join the growing list of demutualised exchanges in Africa and across the world.  
    
The Demutualisation of Exchanges (DOE) is not a new trend. The first DOE took place in 1993 when the Stockholm Stock Exchange demutualised. DOE has been mainly driven by its tangible benefits such as access to capital and a more flexible governance structure that enhances resolute actions in response to changes in the business environment. In Africa, this has also been driven by the desire to transfer stock exchanges from state ownership to private sector ownership.

Notwithstanding the positive benefits of demutualisation, DOE will throw up a number of conflicts of interest (COI) that the NSE must address, as part of the demutualisation process, to protect and preserve the integrity of the market and increase investor confidence. The COIs are essentially two-fold:
1.    The conflict of interest arising from the NSE's role as a regulatory organisation responsible for the oversight of trading and listing on the exchange as well as its commercial activities as a for-profit company; and
2.    The conflict of interest that will arise in the event the NSE decides to list on the Exchange i.e. self-listing.  
    
These challenges are, however, not peculiar to the NSE as leading demutualised exchanges have encountered and addressed them. It must also be stated from the outset that, to a large extent, the Securities and Exchange Commission of Nigeria (SEC) Rules for Demutualization of Securities Exchanges in Nigeria have addressed squarely the ownership and corporate governance issues.

The Rules restrict a single individual or entity from holding no more than 5%, of the equity or voting rights of the exchange. Additionally, members of a stakeholder group cannot hold more than 40% in aggregate of the equity of the exchange. The requirement that at least one-third of the Board of Directors of the NSE should be independent also addresses the corporate governance issue.

So how should the NSE address the challenge of regulating the market whilst also trying to be a profitable enterprise in the same market it regulates? From our review of how leading demutualised exchanges in the USA, Europe, Asia and Africa dealt with this issue, there are two principal methods for resolving the conflict. They are as follows:
1.     Separation of the exchanges' regulatory responsibilities from the listing and trading business by creating a separate regulatory body that is not accountable to the exchange (also known as the Separation Model). This is the approach adopted by the New York Stock Exchange and the London Stock Exchange.
2.     Retention of the exchanges' regulatory power alongside its listing and trading business but with additional safeguards to ensure that the exchange exercises its regulatory powers fairly. The additional safeguards include oversight by an independent body or a supervisory ministry; restriction on the percentage shareholding by any one single entity in the exchange. (This is also known as the Integrated Model.)  This is the approach adopted by the Johannesburg Stock Exchange, the Singapore Stock Exchange and the Hong Kong Stock Exchange.
    
We recommend that to effectively and transparently manage the conflicts of interest between its regulatory function and profit-making activity, the NSE, on or before its demutualisation, should adopt the separation model through the creation of a new regulatory organisation, to be called the Nigerian Stock Exchange Regulatory Organisation (NSEREG) within – but independent of – the NSE.  The new regulator's independence would be assured by having a separate governance structure and funding arrangement.

NSEREG's responsibilities would include 'Conduct and Prudential Regulation' of NSE Dealing Members (and equivalent on demutualisation) and enforcement of listing rules, among other responsibilities.

Our recommendation takes into consideration the current regulatory framework of the Nigerian Capital Market and is also closely aligned with best practice in corporate governance and the management of conflicts of interest.
    
OpenSpaces Compliance Consultants Limited is a London-based financial services regulation and compliance consultancy firm (www.openspacesltd.com)
    
Editor's Note
This article is an abridged version of a whitepaper: 'An insight on the regulatory issues arising from the demutualisation of the Nigerian Stock Exchange' produced by OpenSpaces Compliance Consultants Limited. The full version of the whitepaper can be obtained at – www.openspacesltd.com/insight