The optimal market structure and the governance and regulatory status of a securities exchange are among the burning issues of the day. Despite the long history (1) and importance (2) of the exchange, there has been little study of it until recently. The Securities Exchange Act of 1934 ("Exchange Act") was content to define an exchange as "generally understood." (3) Despite the existence of different organizational designs, (4) there has been a general understanding of the term in the English-speaking world: a securities exchange is an organization owned and operated by intermediaries for the trading of securities. However, developments in the market beginning in the 1960s and rising to a crescendo in the 1990s compelled an examination of this general understanding. Out of the ensuing debate grew a recognition that ownership by intermediaries is not necessary and may be undesirable. When the Securities and Exchange Commission (SEC) finally grappled with the issue by compulsion of the court in 1990, (5) it understood the term "exchange" in the context of the Exchange Act to mean an institution
with the fundamental characteristic of centralizing trading and providing
purchasers and sellers, by its design (whether through trading rules,
operational procedures or business incentives), buy and sell quotations on
a regular or continuous basis so that those purchasers and sellers have a
reasonable expectation that they can regularly execute their orders at
those price quotations. (6)
Conspicuously omitted from the definition is intermediary-ownership, i.e., the mutual form of organization. (7) However, the road from recognizing that mutuals are unnecessary for designing the proper governance and regulatory structure is long and difficult. The New York Stock Exchange (NYSE), the National Association of Securities Dealers, Inc. (NASD), and the SEC are now exploring this path. Given the high stakes involved, both public and private, a vigorous debate is expected.
In Hong Kong, the Financial Secretary announced in his budget speech (8) on March 3, 1999 that the two organized securities exchanges of Hong Kong must "demutualize" (9) and merge. In about six months, his will was done: the members of both exchanges voted in favor of his plan. (10) Legislation followed in February 2000. (11) In June 2000, the merged exchange was listed on its own market. (12)
Although the stage had been set in the 1960s and the concept sown in articles published in the United States in the late 1960s and early 1970s, (13) there has not been any evaluation of the merits of demutualization except at a highly theoretical level. A European commentator has observed that "rampant enthusiasm" on the part of exchanges to go public was "devoid of any theory about efficient corporate governance." (14) This is an apt description of the process in Hong Kong. This Article applies the theory of demutualization to the circumstances of Hong Kong and questions its merits. It is hoped that the analysis can be generalized to provide insights into the translation of an economic model into reality and the grafting of "first world" structures to "third world" trunks.
This Article is organized as follows. Part II critically examines the result of demutualization in Hong Kong measured against the theory and international practice of demutualization and against its own claims. Part III considers the consequences of demutualization and Part IV concludes with observations on the moral of the story.
II. THE MERITS OF DEMUTUALIZATION OF ORGANIZED SECURITIES EXCHANGES IN HONG KONG
In Hong Kong, both the cash and futures exchanges have been demutualized. Because both exchanges are subject to the same governance and regulatory structure involving the same issues, this Part will focus on the cash exchange. After a brief introduction of the Hong Kong exchanges and clearing houses and the process of demutualization, this Part will analyze the purpose and effect of demutualization in Hong Kong against the theory and international practice of demutualization and against the proponent's own claims. …