History of Indian Capital Market
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History of Indian Capital Market Evolution Indian Stock Market is one of the oldest in Asia. Its history dates back to nearly 200 years ago. The earliest records of security dealings in India are meager and obscure. The East India Company was the dominant institution in those days and business in its loan securities used to be transacted towards the close of the eighteenth century. By 1830's business on corporate stocks and shares in Bank and Cotton presses took place in Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers recognized by banks and merchants during 1840 and 1850. The 1850's witnessed a rapid development of commercial enterprise and brokerage business attracted many men into the field and by 1860 the number of brokers increased into 60. In 1860-61 the American Civil War broke out and cotton supply from United States of Europe was stopped; thus, the 'Share Mania' in India begun. The number of brokers increased to about 200 to 250. However, at the end of the American Civil War, in 1865, a disastrous slump began (for example, Bank of Bombay Share which had touched Rs 2850 could only be sold at Rs. 87). At the end of the American Civil War, the brokers who thrived out of Civil War in 1874, found a place in a street (now appropriately called as Dalal Street) where they would conveniently assemble and transact business. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as " The Stock Exchange "). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated. Other leading cities in stock market operations
Transcript of History of Indian Capital Market
History of Indian Capital Market
Evolution
Indian Stock Market is one of the oldest in Asia. Its history dates back to nearly 200 years ago. The earliest records of security dealings in India are meager and obscure. The East India Company was the dominant institution in those days and business in its loan securities used to be transacted towards the close of the eighteenth century.
By 1830's business on corporate stocks and shares in Bank and Cotton presses took place in Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers recognized by banks and merchants during 1840 and 1850.
The 1850's witnessed a rapid development of commercial enterprise and brokerage business attracted many men into the field and by 1860 the number of brokers increased into 60.
In 1860-61 the American Civil War broke out and cotton supply from United States of Europe was stopped; thus, the 'Share Mania' in India begun. The number of brokers increased to about 200 to 250. However, at the end of the American Civil War, in 1865, a disastrous slump began (for example, Bank of Bombay Share which had touched Rs 2850 could only be sold at Rs. 87).
At the end of the American Civil War, the brokers who thrived out of Civil War in 1874, found a place in a street (now appropriately called as Dalal Street) where they would conveniently assemble and transact business. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as " The Stock Exchange "). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated.
Other leading cities in stock market operations
Ahmedabad gained importance next to Bombay with respect to cotton textile industry. After 1880, many mills originated from Ahmedabad and rapidly forged ahead. As new mills were floated, the need for a Stock Exchange at Ahmedabad was realized and in 1894 the brokers formed "The Ahmedabad Share and Stock Brokers' Association".
What the cotton textile industry was to Bombay and Ahmedabad, the jute industry was to Calcutta. Also tea and coal industries were the other major
industrial groups in Calcutta. After the Share Mania in 1861-65, in the 1870's there was a sharp boom in jute shares, which was followed by a boom in tea shares in the 1880's and 1890's; and a coal boom between 1904 and 1908. On June 1908, some leading brokers formed "The Calcutta Stock Exchange Association".
In the beginning of the twentieth century, the industrial revolution was on the way in India with the Swadeshi Movement; and with the inauguration of the Tata Iron and Steel Company Limited in 1907, an important stage in industrial advancement under Indian enterprise was reached.
Indian cotton and jute textiles, steel, sugar, paper and flour mills and all companies generally enjoyed phenomenal prosperity, due to the First World War.
In 1920, the then demure city of Madras had the maiden thrill of a stock exchange functioning in its midst, under the name and style of "The Madras Stock Exchange" with 100 members. However, when boom faded, the number of members stood reduced from 100 to 3, by 1923, and so it went out of existence.
In 1935, the stock market activity improved, especially in South India where there was a rapid increase in the number of textile mills and many plantation companies were floated. In 1937, a stock exchange was once again organized in Madras - Madras Stock Exchange Association (Pvt) Limited. (In 1957 the name was changed to Madras Stock Exchange Limited).
Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with the Punjab Stock Exchange Limited, which was incorporated in 1936.
Indian Stock Exchanges - An Umbrella Growth
The Second World War broke out in 1939. It gave a sharp boom which was followed by a slump. But, in 1943, the situation changed radically, when India was fully mobilized as a supply base.
On account of the restrictive controls on cotton, bullion, seeds and other commodities, those dealing in them found in the stock market as the only outlet for their activities. They were anxious to join the trade and their number was swelled by numerous others. Many new associations were constituted for the purpose and Stock Exchanges in all parts of the country were floated.
The Uttar Pradesh Stock Exchange Limited (1940), Nagpur Stock Exchange Limited (1940) and Hyderabad Stock Exchange Limited (1944) were incorporated.
In Delhi two stock exchanges - Delhi Stock and Share Brokers' Association Limited and the Delhi Stocks and Shares Exchange Limited - were floated and later in June 1947, amalgamated into the Delhi Stock Exchange Association Limited.
Post-independence Scenario
Most of the exchanges suffered almost a total eclipse during depression. Lahore Exchange was closed during partition of the country and later migrated to Delhi and merged with Delhi Stock Exchange.
Bangalore Stock Exchange Limited was registered in 1957 and recognized in 1963.
Most of the other exchanges languished till 1957 when they applied to the Central Government for recognition under the Securities Contracts (Regulation) Act, 1956. Only Bombay, Calcutta, Madras, Ahmedabad, Delhi, Hyderabad and Indore, the well established exchanges, were recognized under the Act. Some of the members of the other Associations were required to be admitted by the recognized stock exchanges on a concessional basis, but acting on the principle of unitary control, all these pseudo stock exchanges were refused recognition by the Government of India and they thereupon ceased to function.
Thus, during early sixties there were eight recognized stock exchanges in India (mentioned above). The number virtually remained unchanged, for nearly two decades. During eighties, however, many stock exchanges were established: Cochin Stock Exchange (1980), Uttar Pradesh Stock Exchange Association Limited (at Kanpur, 1982), and Pune Stock Exchange Limited (1982), Ludhiana Stock Exchange Association Limited (1983), Gauhati Stock Exchange Limited (1984), Kanara Stock Exchange Limited (at Mangalore, 1985), Magadh Stock Exchange Association (at Patna, 1986), Jaipur Stock Exchange Limited (1989), Bhubaneswar Stock Exchange Association Limited (1989), Saurashtra Kutch Stock Exchange Limited (at Rajkot, 1989), Vadodara Stock Exchange Limited (at Baroda, 1990) and recently established exchanges - Coimbatore and Meerut. Thus, at present, there are totally twenty one recognized stock exchanges in India excluding the Over The Counter Exchange of India Limited (OTCEI) and the National Stock Exchange of India Limited (NSEIL).
The Table given below portrays the overall growth pattern of Indian stock markets since independence. It is quite evident from the Table that Indian stock markets have not only grown just in number of exchanges, but also in number of listed companies and in capital of listed companies. The remarkable growth after 1985 can be clearly seen from the Table, and this was due to the favouring government policies towards security market industry.
Growth Pattern of the Indian Stock Market
Sl.No. As on 31stDecember
1946
1961
1971
1975
1980
1985
1991
1995
1 No. ofStock Exchanges
7 7 8 8 9 14 20 22
2 No. of Listed Cos.
1125 1203 1599 1552 2265 4344 6229 8593
3 No. of StockIssues of Listed Cos.
1506 2111 2838 3230 3697 6174 8967 11784
4 Capital of ListedCos. (Cr. Rs.)
270 753 1812 2614 3973 9723 32041 59583
5 Market value ofCapital of ListedCos. (Cr. Rs.)
971 1292 2675 3273 6750 25302 110279 478121
6 Capital perListed Cos. (4/2)(Lakh Rs.)
24 63 113 168 175 224 514 693
7
Market Value ofCapital per ListedCos. (Lakh Rs.)(5/2)
86 107 167 211 298 582 1770 5564
8
Appreciated value of Capital perListed Cos. (Lak Rs.)
358 170 148 126 170 260 344 803
Source : Various issues of the Stock Exchange Official Directory, Vol.2 (9) (iii), Bombay Stock Exchange, Bombay.
Scam in capital market
What is Scam?
A scam is an attempt to defraud a person or a group by gaining their confidence. The person who is victimize of the scam is known as mark. and
the trickster (i.e. the person who has committed this scam is called a confidence man or con man. Confidence men or women exploit human characteristics and emotions such as greed, dishonesty and exploit individuals from all walks of life. For many years Indian Capital market has been damaged badly by numerous scams. Some of he major scams are enumerated below:
Harshad Mehta Scam 1992:
He was known as the 'Big Bull'. However, his bull run did not last too long.
He triggered a rise in the Bombay Stock Exchange in the year 1992 by trading in shares at a premium across many segments.
Taking advantages of the loopholes in the banking system, Harshad and his associates triggered a securities scam diverting funds to the tune of Rs 4000 crore (Rs 40 billion) from the banks to stockbrokers between April 1991 to May 1992.
Harshad Mehta worked with the New India Assurance Company before he moved ahead to try his luck in the stock markets. Mehta soon mastered the tricks of the trade and set out on dangerous game plan.
Mehta has siphoned off huge sums of money from several banks and millions of investors were conned in the process. His scam was exposed, the markets crashed and he was arrested and banned for life from trading in the stock markets.
He was later charged with 72 criminal offences.
A Special Court also sentenced Sudhir Mehta, Harshad Mehta's brother, and six others, including four bank officials, to rigorous imprisonment (RI) ranging from 1 year to 10 years on the charge of duping State Bank of India to the tune of Rs 600 crore (Rs 6 billion) in connection with the securities scam that rocked the financial markets in 1992. He died in 2002 with many litigations still pending against him.
Ketan Parekh
Ketan Parekh followed Harshad Mehta's footsteps to swindle crores of rupees from banks. A chartered accountant he used to run a family business, NH Securities.Ketan however had bigger plans in mind. He targetted smaller
exchanges like the Allahabad Stock Exchange and the Calcutta Stock Exchange, and bought shares in fictitious names.
His dealings revolved around shares of ten companies like Himachal Futuristic, Global Tele-Systems, SSI Ltd, DSQ Software, Zee Telefilms, Silverline, Pentamedia Graphics and Satyam Computer (K-10 scrips).
Ketan borrowed Rs 250 crore from Global Trust Bank to fuel his ambitions. Ketan alongwith his associates also managed to get Rs 1,000 crore from the Madhavpura Mercantile Co-operative Bank.
According to RBI regulations, a broker is allowed a loan of only Rs 15 crore (Rs 150 million). There was evidence of price rigging in the scrips of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek Infosys and Padmini Polymer.
C R Bhansali
The Bhansali scam resulted in a loss of over Rs 1,200 crore (Rs 12 billion). He first launched the finance company CRB Capital Markets, followed by CRB Mutual Fund and CRB Share Custodial Services. He ruled like a financial wizard 1992 to 1996 collecting money from the public through fixed deposits, bonds and debentures. The money was transferred to companies that never existed. CRB Capital Markets raised a whopping Rs 176 crore in three years. In 1994 CRB Mutual Funds raised Rs 230 crore and Rs 180 crore came via fixed deposits. Bhansali also succeeded to to raise about Rs 900 crore from the markets. However, his good days did not last long, after 1995 he received several jolts. Bhansali tried borrowing more money from the market. This led to a financial crisis. It became difficult for Bhansali to sustain himself. The Reserve Bank of India (RBI) refused banking status to CRB and he was in the dock. SBI was one of the banks to be hit by his huge defaults.
IPO Scam
The Securities and Exchange Board of India barred 24 key operators, including Indiabulls and Karvy Stock Broking, from operating in the stock market and banned 12 depository participants from opening fresh accounts for their involvement in the Initial Public Offer scam. It also banned 85 financiers from capital market activities.Suzlon Energy Ltd's Rs 1,496.34 crore (Rs 14.963 billion) public issue (September 23-29, 2005). The retail portion was oversubscribed 6.04 times
and the non-institutional portion was oversubscribed 40.27 times. Key operators used 21,692 fictitious accounts to corner 323,023 shares representing 3.74 per cent of the total number of shares allotted to retail individual investors. Jet Airways's Rs 1,899.3 crore (Rs 18.993 billion) public offer (Feb 18-24, 2005). The retail portion was subscribed 2.99 times and the non-institutional portion by 12.5 times. Key operators used 1186 fake accounts for cornering 20,901 shares repersenting 0.52 per cent of the total number of shares allotted to retail investors. National Thermal Power Corporation Ltd's Rs 5,368.14 crore (Rs 53.681 billion) IPO (Oct 7-14, 2004). The retail portion was oversubscribed 3.73 times and the non-institutional portion by 11.93 times. Key operators used a total of 12,853 afferent accounts for cornering 2,750,730 shares representing 1.3 per cent of the total number of shares allotted to retail investors. Tata Consultancy Services's Rs 4,713.47 crore (Rs 47.134 billion) public offer (Aug 19-23, 2004). The retail portion was oversubscribed 2.86 times and the non-institutional portion by 19.15 times. Key operators used 14,619 'benami' accounts to corner 261,294 shares representing 2.09 per cent of the total shares allotted to retail individual investors. Patni Computer System Ltd's Rs 430.65 crore (Rs 4.306 billion) public issue (Jan 27-Feb 5 2004). The retail portion was oversubscribed 9.36 times and the non-institutional portion by 39.22 times. A lone key operator used 2541 afferent account for cornering 127,050 shares representing 2.71 per cent of the total number of shares allotted to retail investors.
Reforms in the Capital Market: In order to protect capital market from being vitiated by scams and other malpractices Government of India formulated a governing body, which is known as Security Exchange Board of India (SEBI). The SEBI came into being in 1992 as an agency to protect the interest of investors in securities and to promote a transparent and strong regulatory structure for the efficient functioning of the capital market. Intermediaries including merchant bankers, brokers, portfolio managers, mutual funds etc were brought under SEBI regulations. The responsibilities and obligations of the intermediaries towards investors were specified by SEBI. SEBI deals with all aspects of capital market, VIz; entry to act as member/dealer, merchant banker, MF and venture capital markets. The Government of India has concurrently delegated to SEBI some of the powers under Securities Contracts (Regulation) Act, including recognition of new stock exchanges, withdrawal of recognition, making/amending the rules regarding voting rights, appeal against refusal by stock exchanges to list securities etc. SEBI has also introduced a system of approval of market makers based upon recommendations of stock exchanges.
The setup of Over The Counter Exchange of India (OTCEI) in 1992 has immensely help the investors in many ways. OTCEI is recognized as a stock exchange under Sec 4 of the Securities Contract (Regulation) Act 1956 and is registered as a company under sec 25 of the Indian Companies Act 1956. It has helped the corporate sectors in many ways. 1) Unlisted companies, closely held companies can get a boost to go to public. 2) Raising of funds through capital markets is easy . 3) Cost is less. Wasteful expenditure in terms of elaborate publicity campaigns, printing and mailing is avoided. 3) Instrument is priced fairly. 4) Management stability is ensured. Only a minimum of 20% equity need be offered to the public. For the investors; investment in capital market instrument becomes simple and quick. No Need to block the funds for 3-4 months. The vast network will ensure that stock exchange is virtually taken to street corners. Simplified access to the capital market. Whole process becomes easy. Walk-in, invest or disinvest. The Investor knows exactly the price at which he is buying or selling.
Setting up of Inter-connected Stock Exchange of India (ISE) on 26the Feb 1999 has several distinctive aspects. It is exchange of exchanges and members of all exchanges and members of all exchanges participate in ISE. Cost of trading is kept low for a member stock exchange. ISE is a professionally managed exchange, with state-of-the art computer and communication systems. It provides a highly automated trading system with clearing and settlement facilities directly open to all the registered traders of participating exchanges on an equal footing regardless of the location of the participating exchange and of the status of the exchange in terms of turnover, financial strength.
The trading on the stock exchanges in India used to take place through open outcry without use of information technology for immediate matching or recording of trades. This was time consuming and inefficient. This imposed limits on trading volumes and efficiency. In order to provide efficiency, liquidity and transparency, NSE introduced a nationwide, on-line, fully-automated screen based trading system (SBTS) where a member can punch into the computer the quantities of a security and the price at which he would like to transact, and the transaction is executed as soon as a matching sale or buy order from a counter party is found. National Stock Exchange is the first exchange in the world to use satellite communication technology for trading. Its trading system, called National Exchange for Automated Trading (NEAT), is a state –of- the- art client server based application.
Setting up of depository is another important aspect towards reforms in capital market. It facilitates transfers of securities between accounts on the instruction of the account holder. It also facilitates transfers of ownership without handling the securities physically and also safe keeping of shares. There are two depositories in India which provide dematerialization of securities. The National Securities Depository Limited (NSDL) and Central
Securities Depository Limited (CSDL). All these facilities has technological development has really provided the capital market a new dimension for trading in capital assets and mobilization of idle funds into the market for entrepreneurial growth and economic development.
Primary Market:
Primary market is a place that provides the channel for sale of new securities. Primary market provides opportunity to issuers of securities; Government as well as corporate, to raise resources to meet their requirements of investment and/or discharge some obligation. They may issue the securities at face Value, or at a discount/premium and these securities may take a variety of forms such as equity, debt etc. They may issue the securities in domestic market and /or international market.
Most companies are usually started privately by their promoters. However, the promoters’ capital and the borrowings from banks and financial institutions may not be sufficient for setting up or running the business over a long term. So companies invite the public to contribute towards the equity and issue shares to individual investors. The way to invite share capital from the public is through a ‘Public issue’; simply stated, public issue is an offer to the public to subscribe to the share capital of a company. One this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid down by SEBI.
Kinds of issues:
Primarily, issues can be classified as a Public, Rights or Preferential issues ( also known as private placements). While public and rights issues involve a detailed procedure, private placements or preferential issues are relatively simpler. The classification of issues is illustrated below:
Initial Public Offer (IPO): When an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public, it is known as Initial Public Offer (IPO). This paves way for listing and trading of the issuer’s securities. It is basically selling of securities to the public in the primary market. It is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. The sale of securities can either through book building or through normal public issue.
Follow on Public offering (Further Issue): When an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document it is known as Follow on Public offering.
Preferential issue: Is an issue of shares or of convertible securities by listed companies to a select group of persons under Sec 81 of the companies Act, 1956 which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital. The issuer company has to comply with the companies Act and the requirements contained in the chapter pertaining to preferential allotment in SEBI guidelines which inter-alia include pricing, disclosures in notice etc.
What is issue price?
The price at which a company’s shares are offered initially in the primary market is called as the issue price. When they begin to be traded, the market price may be above or below the issue price.
Free Pricing:
Indian primary market ushered in an era of free pricing in 1992. Following this, the guidelines have provided that the issuer in consultation with Merchant Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI does not play any role in price fixation. The company and merchant banker are however required to give full disclosures of the parameters which they had considered while deciding the issue price. There are two types of issues, one where company and Lead Merchant banker fix a price (called fixed price) and other, where the company and the Lead manager (LM) stipulate a floor price or a price band and leave it to market forces to determine the final price (price discovery through book building process).
Price discovery through ‘Book Building Process’
Book Building is basically a process used in IPOs for efficient price discovery. It is a mechanism where, during the period for which the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The offer price is determined after the bid closing date. The basic difference between the offer of shares through book building and offer of shares through normal public issue is that, price at which securities will be allotted is not known in case of offer of shares through Book Building while in case of offer of shares through normal public issue, price is known in advance to investor. Under Book Building, investors bid for shares at the floor price or above and after the closure of the book building process the price is determined for allotment of shares. In case of Book Building, the
demand can be known everyday as the book is being built. But in case of the public issue the demand is known at the close of the issue.
Cut-Off - Price:
In a Book Building issue, the issuer is required to indicate either the price band or a floor price in the prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called “Cut-Off – Price”. The issuer and the lead manager decide this after considering the book and the investors’ appetite for the stock.
Floor Price: It is the minimum price at which bids can be made. For ex: if the bids are made at minimum of Rs 20 per share it is known as floor price.
Price Band in Book Building: The prospectus may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20%. In other words, it means that the cap should not be more than 120% of the floor price. The price band have a revision and such a revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing a press release and also indicating the change on the relevant website and the terminals of the trading members participating in the book building process. In case the price band is revised, the bidding period shall be extended for a further period of three days, subject to the total bidding period not exceeding ten days. It is understood that the regulatory mechanism does not play a role in setting the price for issues. It is up to the company to decide on the price or the price band, in consultation with Merchant Bankers. The book for bid during Book Building process should remain open for a minimum of 3 days. As per SEBI norms, only electronically linked transparent facility is allowed to be used in case of book building.
As per SEBI guidelines, the basis of allotment should be completed with 15 days from the issue close date. As soon as the basis of allotment is completed, within 2 working days the details of credit to demat account /allotment advice and dispatch of refund order needs to be completed. So an investor should know in about 15 days time from the closure of issue, whether shares are allotted to him or not. It generally takes around 3 weeks after to get the shares listed after the closure of the book built issue.
Private Placements:
When an issue is made to a select set of people, it is called private placement. As per Companies Act, 1956, an issue becomes public if it results in allotment to 50 persons or more. This means an issue can be privately placed where an allotment is made to less than 50 persons.
Principal steps of Private Placement:
Private placement may be done in respect of equity shares, preference shares, bonds and debentures. Generally, the private placement of bonds and debentures is very popular. The private placement involves the following steps:
i) Terms and Conditions: The terms and conditions of the issue like the value of the instrument, maturity period, yield rate, issue and redemption details etc. should be clearly laid down and the instrument should be structured accordingly.
ii) Credit Rating: It is mandatory to obtain credit rating from a recognized credit rating agency that will evaluate the various aspects concerned with the instrument and give proper rating.
iii) Confidential information Memorandum (CIM): Just like the offer document in the case of shares, this document contains all details about the company and the instrument. An investor can have a thorough knowledge about the issue by going through this document.
iv) Trustees to the Issue: The next step is to appoint trustees to the issue to protect the interest of investors. Generally, banks or other financial institutions may be appointed as trustees.
v) Pre-launching formality: Just one or two days before the launching date, the CIM is sent to the prospective investors inviting them to subscribe to the issue.
vi) Pricing the Issue: Sometimes pre-marketing campaign may be conducted by the issue houses to ascertain the investors towards private placement and the probable prices. Since book building method is adopted by many companies, this campaigns not generally resorted to.
vii) Post- issue Steps: After the closing of the issue expires, a decision is taken on allotment and the certificates are issued. Over subscriptions are refunded. The details of the issue are sent to the stock exchange concerned where it is likely to be listed.
The above steps are followed for shares also except the fact that the terms and conditions of issue, it modalities etc. are decided by the shareholders at their meeting and there is no need to appoint trustees.
Secondary Market:
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Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets.
For general investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company, secondary equity markets serve as a monitoring and control conduit-by facilitating value-enhancing control activities, enabling implementation incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions. The difference between primary and secondary market is that tin the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading venue in which already existing/pre-issued securities are traded among investors. Secondary market could be either auction or dealer market. While stock exchange is the part of auction market, over-the –Counter (OTC) is a part of the dealer market.
Organization of Stock Exchange:
Stock exchanges are the important ingredient of the capital market. They are the citadel of capital and fortress of finance. They are the theaters of trading in securities and as such they assist and control the buying and selling of securities. The stock exchanges in India, under the overall supervision of the regulatory authority, the Securities and Exchange Board of India (SEBI), provide a trading platform, where buyers and sellers can meet to transact in securities. The trading platform provided by NSE is an electronic one and there is no need for buyers and sellers to meet at a physical location to trade. They can trade through the computerized trading screens available with the NSE trading members or the internet based trading facility provided by the trading members of NSE.
Demutualization of stock exchanges: Demutualization refers to the legal structure of an exchange whereby the ownership, the management and trading rights at the exchange are segregated from one another. In mutual exchange, the three functions of ownership, management and trading are concentrated into a single group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. This at time can lead to conflicts of interest in decision making. A demutualized exchange, on the other hand, has all these three functions clearly segregated,, i.e. the ownership, management and trading are in separate hands.
Currently, two stock exchanges in India, the National Stock Exchange (NSE) and Over the Counter Exchange of India (OTCEI) are demutualized.
Stock Brokers: A stock broker is a member of a recognized stock exchange who buys, sells or deals in securities. A certificate of registration from the SEBI is mandatory to act as a broker. The SEBI is empowered to impose conditions while granting the certificate. As a member of a stock exchange, the stockbroker will have to abide by its rules, regulations and bye-laws, pay the prescribed fee and take adequate steps for redressal of investors’ grievances within one month of the receipt of the complaint and keep the SEBI informed about the number, nature and other particulars of such complaints.
A broker seeking registration with the SEBI has to apply through the stock exchange of which he is a member. The application must be forwarded by the exchange to the SEBI within 30 days from the date of receipt. Every registered broker has to pay the SEBI a specified registration fee based on the annual turnover, that is, the aggregate of the sale and purchase prices of securities received and receivable by the stock broker during any financial year, on his own account as well as on account of his clients. For an annual turnover up to Rs 1 crore, a sum of Rs 5,000 is to be paid as fee to the SEBI. For an annual turnover in excess of Rs 1 crore, the registration fee is Rs 5,000 plus one hundredth of one percent of the turnover in excess of Rs 1 crore for each financial year.
Sub-Brokers: A sub-broker acts on behalf of a stock broker as an agent or otherwise for assisting investors in buying, selling or dealing in securities through such brokers, but he is not a member of a stock exchange. To act as a sub-broker, a certificate of registration from the SEBI is required. It grants a registration certificate to a sub-broker subject to the condition that he i) pays the prescribed fee, ii) takes adequate steps for redressal of investor grievances within one month of the receipt of the complaint and keeps the SEBI informed about the number nature and other particulars of the complaints and iii) is authorized in writing by a broker for affiliation in buying, selling or dealing in securities. According to SEBI regulations currently in force, a sub-broker is required to submit along with the application 1) a recommendation from a stock broker with whom he will be affiliated and 2) two references including one from his banker.
A trading member is a member of derivative exchange/derivative segment of a stock exchange who settle the trade in the clearing corporation or clearing house (i.e. clearing corporation / house of a recognized stock exchange to clear and settle trades in securities) through a clearing member (i.e. a member of a clearing corporation/house of the derivative
exchange/derivative segment of a stock exchange who may clear and settle transaction in securities). A self clearing member means a member of a clearing corporation house (CC/CH) who may clear and settle transactions on its own account or on account of its clients only. He cannot clear/settle transactions in securities for any other trading member(s). An application for registration with the SEBI by a trading member, clearing or self clearing member should be routed through the concerned derivative exchange/derivative segment of a stock exchange and the CC/CH respectively, who would forward it to the SEBI within 30 days from the date of its receipt. A clearing member should pay a fee of Rs 20,000 every year, along with the application for registration for the first financial year (Apr 1-Mar 31) and before June 1 for subsequent financial years. A trading member should pay every year i) Rs. 10,000 for each financial year if the annual turnover is up to five hundred crore rupees and ii) Rs 10,000 plus ten paisa peer Rs. 100,000 for annual turnover in excess of rupees five hundred crore.
Management of Stock Exchanges:
The recognized stock exchanges are managed by “Governing Boards” . The governing boards consist of elected member directors from stock broker members, public representatives and government nominees nominated by the SEBI. The government has also powers to nominate President and Vice-Presidents of stock exchanges and to approve the appointment of the Chief Executive and public representatives. The major stock exchanges are managed by the Chief Executive Director and the smaller stock exchanges are under the control of a Secretary.
The Governing Boards have wide powers such as:
1) Selection of office bearers and setting up of committees like Listing Committee, Arbitration Committee, Defaulter’s committee etc.
2) Admission and expulsion of members
3) Management of the properties and finances of the exchange
4) Framing and interpretation of rules, bye-laws etc. for the regulation of stock exchange
5) Adjudication of disputes among members or outsiders
6) Management of the affairs of the exchange in the best interest of the investors and public interest.
Membership:
To become a member of a recognized stock exchange, a person must possess the following qualifications:
i) He should be a citizen of India,
ii) He should not be less than 21 years of age
iii) He should not have been adjudged bankrupt or insolvent
iv) He should not have been convicted for an offence involving fraud or dishonesty
v) He should not be engaged in any other business except dealing in securities
vi) He should not have been expelled by any other stock exchange or declared a defaulter by any other stock exchange.
Apart from individuals, a company is also eligible to become a member provided it satisfies the conditions imposed by the stock exchange concerned.
Listing:
Listing of securities means that the securities are admitted for trading on a recognized stock exchange. Transactions in the securities of any company cannot be conducted on a stock exchange unless they are listed by them. Listing is compulsory for those companies which intend to offer shares/debentures to the public for subscription by means of issuing prospectus.
The listed shares are generally divided into two categories namely i) Group A shares (Specified shares or cleared securities). Ii) Group B shares (Non-specified shares or non-cleared securities). Group A shares represent large and well established companies having a broad investor base. These shares are actively traded. Naturally these shares attract a lot of speculative multiples. These facilities are not available to Group B shares. However, shares can be moved from Group B to Group A and vice-versa depending upon the criteria for shifting. For instance, the Bombay Stock Exchange has laid down several criteria for shifting shares from Group B to Group A, such as, an equity base of Rs. 10 crores, a market capitalization of Rs. 25-30 corres, a public holding of 35to 40 percent , a shareholding population of 15,000 to 20,000, good dividend paying status etc. Group B2 shares are again divided into B1 and B shares on the Bombay Stock exchange. B1
shares represent well traded scrips among the B Group and they have weekly settlement.
Listing Procedure:
Listing enables a company to include its securities in the official list of one or more recognized stock exchanges for the purpose of trading. A company which requires its securities to be listed must comply with the following formalities:
The company concerned must apply in the prescribed form along with the following documents and details:
i) Certified copies of Memorandum and Articles of Association, Prospectus or Statement in lieu of Prospectus, Underwriting agreements, agreements with vendors and promoters etc.
ii) Specimen copies of shares and debenture certificates, letter of call, allotment, acceptance and renunciation.
iii) Copies of balance sheets and audited accounts for the last 5 years.
iv) Copies of balance sheets and audited accounts for the last 5 years.
V) Certified copies of agreements with managerial personnel.
vi) Particulars of dividends and bonuses paid during the last 10 years.
vii) A statement showing dividends or interest in arrears if any.
viii) A brief history of the company since its incorporation, giving details of its activities.
viii) A brief history of the company since its incorporation, giving details of its activities.
ix) particulars regarding its capital structure.
X) particulars of shares and debentures for which permission to deal is applied for and their issue.
xi) A statement showing the distribution of shares along with a list of highest 10 holders of each class or kind of securities of the company stating the number of securities held by them.
xii) Particulars of shares forfeited.
Xiii) Certified copies of agreements if any with the Industrial Finance Corporation, ICICI etc.
xiv) Listing agreement with the necessary initial and annual listing fee.
Criteria for Listing:
A company which desires its securities to be listed on a recognized stock exchange must satisfy the following conditions:
i) At least 60% of each class of securities issued must be offered to the public for subscription and the minimum issued capital should be Rs. 3 crores.
ii) The minimum public offer for subscription must be at least 25% of each issue and it must be offered through advertisement in newspapers at least for a period of 2 days.
iii) The company should be of a fair size having broad based capital structure and public interest in its securities.
iv) There must be at least 10 public shareholders for every Rs. 1 lakh capital in the form of fresh issue of shares and it is 20 in the case of subsequent issue of shares. This criterion is different for investment companies.
V) A company having more than Rs. 5 crore paid up capital must list its securities on more than one stock exchange. Listing on the regional stock exchange is compulsory.
vi) The company must pay interest on the excess application money received at the rates ranging between 4% and 15% depending on the delay beyond 10 weeks from the date of closure of the subscription list.
vii) The Articles of Association of the company must provide for the following:
a) A common form of transfer shall be sued.
b) Fully paid shares will be completely free from lien.
c) Partly paid up shares will be subject to lien only to the extent of call money due at a fixed time.
d) Calls in advance carry only interest5 and not dividend rights.
e) Unclaimed dividends shall not be forfeited before the claims become time barred.
f) The right to call shares shall be given only after the necessary sanction by the general body meeting.
g) Transfer of shares shall be registered within 30 days of deposit of request and the balance certificates shall be issued within the same period.
viii) The existing companies must adhere to the ceiling in expenditure of public issues.
ix) A certificate to the effect that shares from promoter’s quota are not sold or transferred for a period of 3 years must be submitted.
A company whose securities have been listed on a stock exchange has to perform certain obligations also. Some of the important obligations have been given hereunder:
The company must compulsorily notify the stock exchange:
i) The date of the board meeting at which the declaration of recommendation of dividend or the issue of right or bonus shares will be considered.
Ii) Any change in the company’s directorate or managerial personnel by death, resignation, removal or otherwise.
iii) Any issue of new shares, rights shares or otherwise as well as the issue of any privileges or bonuses to members, even before they are intimated to share holders.
iv) Any change in the company’s capital structure.
v) Any material change in the general character or nature of the company’s business.
vi) Any re-issue of forfeited securities or the issue of any other securities held in reserve for future issue.
vii) Any action which will result in the redemption, cancellation or retirement of any securities listed on the stock exchange.
viii) Any intention to make a drawing of listed securities.
ix) Any other information necessary to enable the shareholders to appraise the company’s position so as to avoid the establishment of a false market in the shares of the company.
X) In addition to the above, the company has to forward to the stock exchange:
a) Copies of all notices and circulars sent to the shareholders including the proceedings of ordinary and extraordinary general meetings.
b) Certified copies of all resolutions passed by the company as soon as such resolutions become effective
c) Copies of statutory and annual reports and annual audited accounts as soon as they are issued and the director’s report.
d) Annual return of at least 10 principal holders of each class of security of the company.
Advantages of Listing;
1) Facilitates Buying and Selling Securities:
Listing paves way for easy buying and selling of securities. Constant marketing facilities are assured for listed securities.
2) Ensures Liquidity
The prices of listed securities are quoted daily in the market. Hence, securities can be converted into cash readily at quoted prices and thus listing ensures liquidity.
3) Offers Wide Publicity
Listed securities give wide publicity to the companies concerned. It is so because the names of listed companies are frequently mentioned in stock market reports, T.V., Newspapers, Radio etc. This has an advertisng effect for such companies and this will automatically widen the market for their securities.
4) Assures Finance
The very fact that a security is listed in a recognized stock exchange adds to the prestige of that company and it enables the company to raise the necessary finance by the issue of such securities expeditiously.
5) Enables Borrowing
Listed securities are preferred as collateral securities by commercial banks and other lending institutions because they are rated high in market quotations and there is a ready market for them also. Thus borrowings are made easier against the securities of the listed companies.
6) Protects Investors
Listing companies have to necessarily submit themselves to the various regulatory measures by disclosing vital information about their assets, capital structure, profits, dividend policy allotment procedure, bonuses etc. Hence, listing aims at protecting the interest of investors to a greater extent.
Trading in Stock Exchange:
The stock exchange operations at floor level are highly technical in nature. Non-members are not permitted to enter into the stock market. Hence, various stages have to be completed in executing a transaction at stock exchange. The steps involved in the method of trading are given below:
i) Choice of a Broker: The prospective investor who wants to buy shares or the investor who wants to sell his shares cannot enter into the hall of the exchange and transact business. They have to act through only member brokers. They can also appoint their bankers for this purpose. After choosing the broker, one has to find out whether the broker is willing to transact business on his behalf. Generally, the brokers demand a letter of introduction or a reference from a respectable party like Notary Public. Only when he is satisfied with the financial position of the party, he will be willing to act on behalf of him.
ii) Placement of Order: The next step is the placing of order for the purchase or sale of securities with the broker. The order is usually placed by telegram, telephone, letter, fax etc. or in person. To avoid delay, it is placed generally over the phone. To reduce the cost also, it is placed in abbreviations, i.e., “ Buy 100 SBI @ Rs 156”. The orders may take any one of the following forms:
a) At Best order: It is an order which does not specify any specific price. It must be executed immediately at the best possible price. The client may also fix a time frame within which the order has to be executed. E.g. “Buy 100 Essar oil at best”.
b) Limit Order: It is an order for the purchase or sale of securities at a fixed price specified by the client. E.g. “ Sell 100 TISCO @ Rs 250.
c) Immediate or Cancel order: It is an order for the purchase or sale of securities immediately at the quoted prices. If the order could not be executed at the quoted prices immediately, it should be treated as cancelled e.g. “ Buy TISCO @ RS. 250 immediate”.
d) Discretionary order: It is an order to buy or sell shares at whatever price the broker thinks reasonable. This is possible only when the client has complete faith on the broker.
e) Limited discretionary Order: It is an order to buy or sell securities within a specified price range and/ or within the given time period as per the best judgment of the broker.
f) Open Order: It is an order to buy or sell without fixing any time limit or price limit on the execution of the order. It is similar to discretionary order.
g) Stop Loss Order: It is an order to sell as soon as the price falls up to a particular level or to buy when the price rises up to a specified level. This is mainly to protect the clients against a heavy fall or rise in prices so that they may not suffer more than the pre-specified amount.
On receiving the orders, they are first recorded in a rough memo book and then they are transferred to the ‘Order Book’.
ii) Execution of Orders
Big brokers transact their business through their authorized clerks. Small ones carry out their business personally. Orders are executed in the Trading ring of a stock exchange which works from 12 noon to 2 pm. on all working days from Monday to Friday and a special one hour session on Saturday. Trading outside the trading hours is called ‘Kerb dealings’.
The floor of the stock exchange is divided into a number of markets (pits) according to the nature of security dealt in. The authorized clerks/broker goes to the pit and the jobbers offer two-way quotes for the scrips they deal in. They act as market makers and provide liquidity to the market. The Bombay Stock Exchange has introduced screen-based trading from March, 1995, called BLOT (BSE on Line Trading). It has been designed to get the best bids and offers from the jobber’s book as well as the best buy and sell orders from the order book. If the quotation is not acceptable to the broker, he may make a counter bid/offer. Ultimately the bargain may be closed at a price mutually acceptable to both the parties. In case the quotation is not acceptable to him, the broker may go to another dealer and make a bargain.
Once the transaction is finalized, the details are recorded in a rough note book. Souda Block Books or confirmation memos are provided by the stock exchange. The details are recorded in these books also. The prices at which different scrips are traded on a particular day are published on the next day in the News papers. An authorized representative of the stock exchange is also present in the hall to supervise the trading.
Contract Note
Contract Note is a confirmation of trades done on a particular day on behalf of the client by a trading member. It imposes a legally enforceable of the client by a trading member. It imposes a legally enforceable relationship between the client and the trading member with respect to purchase/sale and settlement of trades/ It also helps to settle disputes/claims between the investor and the trading member. It is a prerequisite for filling a complaint or arbitration proceeding against the trading member in case of a dispute. A valid contract note should be in the prescribed form, contain the details of trades, stamped with requisite value and duly signed by the authorized signatory. Contract notes are kept in duplicate, the trading member and the client should keep one copy each. After verifying the details contained therein, the client keeps one copy and returns the second copy to the trading member duly acknowledge by him.
The maximum brokerage that can be charged by a broker from his clients as commission cannot be more than 2.5% of the value mentioned in the respective purchase or sale note.
Screen Based Trading
The trading on stock exchanges in India used to take place through open outcry without use of information technology for immediate matching or recording of trades/ This was time consuming and inefficient. This imposed limits on trading volumes and efficiency. In order to provide efficiency, liquidity and transparency, NSE introduced a nationwide, on-line, fully-automated Screen Based Trading System (SBTS) where a member can punch into the computer the quantities of a security and the price at which he would like to transact, and the transaction is executed as soon as a matching sale or buy order from a counter party is found.
NSE is the first exchange in the world to use satellite communication technology for trading. Its trading system, called National Exchange for Automated Trading (NEAT), is a state of-the-art client server based application. At the server end all trading information is stored in an in-memory database to achieve minimum response time and maximum system availability for users. It has uptime record of 99.7%. For all trades entered into NEAT system, there is uniform response time of less than one second.
Today India can boast that almost 100% trading take place through electronic order matching. Technology was used to carry the trading platform from the trading hall of stock exchanges to the premises of brokers. NSE carried the trading platform further to the PCs at the residence of investors through the Internet and to handheld devices through WAP for convenience of mobile investors. This made a huge difference in terms of equal access to investors in a geographically vast country like India. NSE has main computer which is connected through Very Small Aperture Terminal (VSAT) installed at its office. The main computer runs on a fault tolerant STRATUS mainframe computer at the Exchange. Brokers have terminals installed at their premises which are connected through VSATs/leased lines/modems.
An investor informs a broker to place an order on his behalf. The broker enters the order through his PC, which runs under Windows NT and sends signal to the satellite vai VSAT/leased line/modem. The signal is directed to mainframe computer at NSE via VSAT at NSE’s office. A message relating to the order activity is broadcast to the respective member. The order confirmation message is immediately displayed on the PC of the broker. This order matches with the existing passive order(s), otherwise it waits for the active orders to enter the system. On order matching, a message is broadcast to the respective member.
The trading system operates on a strict price time priority. All orders received on the system are sorted with the best priced order getting the first priority for matching i.e. the best buy orders match with the best sell order. Similar priced orders are sorted on tie priority basis, i.e. the one that came in early gets priority over the later one. Orders are matched automatically by the computer keeping the system transparent, objective and fair. Where an order does not find a match, it remains in the system and is displayed to the whole market, till a fresh order comes in or the earlier order is cancelled or modified. The trading system provides tremendous flexibility to the users in terms of kinds of orders that can be placed on the system. Several time-related (good till cancelled, good till day, immediate or cancel), price-related (buy/sell limit and stop loss orders) or volume related( all or none, minimum fill, etc) conditions can be easily built into an order. The trading system also provides complete market information on-line. The market screens at any point of time provide complete information on total order depth in a security, the five best buys and sells available in the market, the quantity traded during the day in that security, the high and the low, the last traded price, etc. Investors can also know the fate of the orders almost as soon as they are placed with the trading members. Thus the NEAT system provides an Open Electronic consolidated Limit Order Book (OECLOB). Limit orders are orders to buy or sell shares at a stated quantity and stated price. If the price quantity conditions do not match, the limit order will not be executed. The term “limit order book” refers to the fact that only limit orders are stored in
the book and all market orders are crossed against the limit orders sitting in the book. Since the order book is visible to all market participants, it is termed as an ‘Open Book’.
Thus the NEAT system supports an order driven market, wherein orders match on the basis of time and price priority. All quantity fields are in units and prices are quoted in Indian Rupees. The regular lot size and tick size for various securities traded is notified by the Exchange from time to time.
Clearing and settlement mechanism
The clearing and settlement mechanism in Indian securities market has witnessed significant changes and several innovations during the last decade. These include use of the state-of –art information technology, emergence of clearing corporations to assume counterparty risk, shorter settlement cycle, dematerialization and electronic transfer of securities, fine tuned risk management system etc.
Till recently, the stock exchanges in India were following a system of account period settlement for cash market transaction. T+2 rolling settlement has now been introduced for all securities. The members receive the funds/securities in accordance with the pay-in- pay-out schedules notified by the respective exchanges. Given the growing volume of trades and market volatility, the time gap between trading and settlement gives rise to settlement risk. In recognition of this, the exchanges and clearing corporation employ risk management practices to ensure timely settlement of trades. Due to setting up of the Clearing Corporation, the market has full confidence that settlements will take place on time and will be completed irrespective of possible default by isolated trading members. Movement of securities has become almost instantaneous in the dematerialized environment. Two depositories viz National Securities Depositories LTD. (NSDL)and Central Securities Depositories Ltd (CSDL) provide electronic transfer of securities and more than 99% of turnover is settled in dematerialized form. The obligation of members is down loaded to members/custodians by the clearing agency. The members /custodian make available the required securities in their pool of accounts with depository participants (DPs) by the prescribed pay-in time for securities. The depository transfers the securities from the pool accounts of members/custodians to the settlement account of the clearing agency. As per the schedule determined by the clearing agency, the securities are transferred on the pay-out day by the depository from the settlement account of the clearing agency to the pool accounts of members /custodians. The pay-in pay-out of securities is effected on the same day for all settlements. Select banks have been empanelled by clearing agency for
electronic transfer of funds. The members are required to maintain accounts with any of these banks. The members are informed electronically of their pay-in day. The clearing agency forwards funds obligations file to clearing banks by the prescribed pay-in day. The clearing agency forwards funds obligations file to clearing banks, which in turn, debit the accounts of members and credit the account of the clearing agency. In some cases, the clearing agency runs an electronic file to debit members, accounts with clearing banks and credit its own account. On pay-out day, the funds are transferred by the clearing banks from the account of the clearing agency to the accounts of members as per the member’s obligations. In the T+2 rolling settlement, the pay-in and pay-out of funds as well as securities take place 2 working days after the trade date.
Transaction Cycle: A person holding assets (securities/funds), either to meet his liquidity needs or to reshuffle his holdings in response to changes in his perception about risk and return of the assets, decides to buy or sell the securities. He selects a broker and instructs him to place but/sell order on an exchange. The order is converted to a trade as soon as it finds a matching sell/but order. At the end of the trade cycle, the trades are netted to determine the obligations of the trading members to deliver securities/funds as per settlement schedule. Buyer/seller delivers funds/securities and receives securities/ funds and acquires ownership of the securities.
Settlement Process:
While NSE provides a platform for trading to its trading members, the National Securities Clearing Corporation Ltd. (NSCCL), determines the funds /securities obligations of the trading members and ensures that the trading members meet their obligations. NSCL becomes the legal counterparty to the net settlement obligations of every member. This principle is called “novation” and NSCCL is obligated to meet al settlement obligations, regardless of member defaults, without any discretion. Once a member fails on any obligations, NSCCL immediately cuts off trading and initiates recovery. The clearing banks and depositories provide the necessary interface between the custodians/ clearing members (who clear for the trading members or their own transactions) for settlement of funds /securities obligations of trading members. The core procedures involved in the settlement process are:
1) Determination of obligation: NSCCL determines what counter-parties owe, and what counter parties are due to receive on the settlement date. The NSCCL interposes itself as a central counterparty between the counterparties to trade and nets the positions so that a member has security wise net obligation to receive or deliver a security and has to either pay or receive funds.
2) Pay-in of Funds and Securities: The members bring in their funds/securities to NSCCL. They make available required securities in designated accounts with the depositories by the prescribed pay-in time. The depositories move the securities available in the accounts of members to the account of the NSCCL. Likewise members with funds obligations make available required funds in the designated accounts with clearing banks by the prescribed pay-in time. The NSCCL sends electronic instructions o the clearing banks to debit member’s accounts to the extent of payment obligations. The banks process the instructions, debit accounts of members and credit accounts of the NSCCL.
3) Pay-out of funds and Securities: After processing for shortages of funds/ securities and arranging for movement of funds from surplus banks to deficit banks through RBI clearing, the NSCCL sends electronic instructions to the depositories/ clearing banks to release pay-out of securities/funds. The depositories and clearing banks debit accounts of NSCCL, and credit settlement accounts of members. Settlement is complete upon release of pay-out of funds and securities to custodians/members.
4) Risk management: A sound risk management system is integral to an efficient settlement system. NSCCL has put in place a comprehensive risk management system, which is constantly monitored and upgraded to pre-empt market failures. It monitors the track record and performance of members and their net worth; undertakes on-line monitoring of members’ positions and exposure in the market collects margins from members and automatically disabled embers if the limits are breached.
Settlement Agencies:
The NSCCL, with the help of clearing members, custodians, clearing banks and depositories settles the trades executed on exchanges. The roles of each of these entities are explained below:
a) NSCCL: The CL is responsible for post-trade activities of a stock exchange. Clearing and settlement of trades and risk management are it s central functions. It clears all trades, determines obligations of members, arranges for pay-in of funds/ securities, receives funds/ securities, processes for shortages in funds/ securities, arranges for pay-out of funds / securities to members, guarantees settlement, and collects and maintains margins/collateral/base capital/other funds.
b) Clearing members: They are responsible for settling their obligations as determined by the NSCCL. They have to make available funds and/ or securities in the designated accounts with clearing bank/ depository
participant, as the case may be to meet their obligations on the settlement day. In the capital market segment, all trading members of the Exchange are required to become the clearing member of the clearing corporation.
c) Custodians: A custodian is a person who holds for safe keeping the documentary evidence of the title to property belonging like share certificates, etc. The title to the custodian’s property remains vested with the original holder, or in their nominee(S), or custodian trustee, as the case may be. In NSCCL, custodian is a clearing member but not a trading member. He settles trades assigned to him by trading members. He is required to confirm whether he is going to settle a particular trade or not. If it is confirmed, the NSCCL, assigns that obligation to that custodian and the custodian is required to settle it on the settlement day. If the custodian rejects the trade, the obligation is assigned back to the trading/clearing member.
d) Clearing banks: Clearing banks are a key link between the clearing members and NSCCL for funds settlement. Every clearing member is required to open a dedicated settlement account with one of the clearing banks. Based on hi obligation as determined through clearing, the clearing member makes funds available in the clearing account for the pay-in and receives funds in case of a pay-out. Multiple clearing banks provide advantages of competitive forces, facilitates introduction of new products Viz. working capital funding, anywhere banking facilities, the option to members to settle funds through a bank, which provides the maximum services suitable to the member.
e) Depositories: A depository is an entity where the securities of an investor are held in electronic form. The person who holds a demat account is a beneficiary owner. In case of a joint account, the account holders will be beneficiary holders of that joint account. Depositories help in the settlement of the dematerialized securities. Each custodian/ clearing member is required to maintain a clearing pool account with the depositories. He is required to make available the required securities in the designated account on settlement day. The depository runs an electronic file to transfer the securities from accounts of the custodians/ clearing member to that of NSCCL. As per the schedule of allocation of securities determined by the NSCCL, the depositories transfer the securities on the pay-out day from the account of the NSCCL to those of members/ custodians.
f) Professional Clearing Member (PCM): NSCCL admits special category of members namely professional clearing members. Professional Clearing Member (PCM) may clear and settle trades executed for their clients ( individuals, institutions etc). In such an event, the functions and responsibilities of the PCM would be similar to custodians. PCMs may also undertake clearing and settlement responsibility for trading members. In such a case, the PCM would settle the trades carried out by the trading
members connected to them. The onus for settling the trade would be thus on the PCM has no trading rights but has only clearing rights, i.e. he just clears the trades of hi associate trading members and institutional clients.
Bombay Stock Exchange (BSE):
BSE On-line Trading (BLOT): It is a system that provides a quote driven automated trading facility to members of exchange working on direct connection to broker office and through telephone lead lines. It stands for Bombay Stock Exchange on line Trading and currently supports those members who have offices in the vicinity of BSE. BLOT is different from NEAT ( a system which help NSE brokers to trade directly from their offices anywhere in the country through satellite based telecommunication network), which is order driven while bolt is quote driven system.
The Bombay Stock Exchange (BSE) Sensitive Index or the SENSEX is the barometer of the country’s stock markets. It was created in January 1986 by the BSE using 1978-79 as the base year. Its movements are based on highs and lows in the weighted market capitalization of 30 shares that were chosen for their sensitivity. (Market capitalization = outstanding equity shares * current market price).
For certification of the index,, the price of the company’s share in the index is weighted by the number of its shares, so that each scrip’s influence is in proportion to its market importance. The index is calculated as the ratio of the aggregate market capitalization of the equity shares of all the sensex companies on the given day to the total market capitalization of the equity shares of the same companies during the base period multiplied by 100. The same method is employed by S&P 500, DJIA (DOW Jones Industrial Average) and Hong Kong’s Hang Seng.
BSE National Index (Natex):
The BSE National Index of Equity Prices was constructed by the BSE in January 1989 using 1983-84 as the base year. It is based on market capitalization of 100 scrips.
National Stock Exchange of India (NSE):
The high-powered committee on the establishment of new stock exchanges headed by M.J. Pherwani, former UTI chairman, first mooted the idea of a National Stock Exchange (NSE) in June 1991. The committee identified the
following weakness in the Indian Stock markets. The establishment of National Stock Exchange (NSE) is a step to overcome the deficiencies of the existing stock market and to bring Indian financial markets in line with international markets.
The National Stock Exchange of India (NSE) was incorporated in November 1992 with an equity capital of Rs. 25 crores and promoted by IDBI, ICICI,LIC, GIC and its subsidiaries, State Bank Of India and SBI Capital Markets Ltd.
Objectives
1. To establish nation wide trading facility for equities, debts and hybrids.2. To facilitate equal access to investors across the country.3. To provide fairness, efficiency and transparency to the securities
trading.4. To enable shorter settlement cycles.5. To meet international securities market standard.
Features of NSE
1. The NSE employs a fully automated screen based trading system. Investors can trade from 400 cities on a real time basis.
2. It has three segments: The capital market segment, wholesale debt market segment and derivatives market. The capital market segment covers equities, convertible debentures and retail trade in debt instruments like non-convertible debentures. Securities of medium and large companies with nationwide investor base, including securities traded on other stock exchanges are traded in NSE through trading members.
3. The NSE market is a fully automated screen based environment. There is no trading floor as is prevalent in the traditional stock exchanges.
4. The market operates with all participants stationed at their offices and making use of their computer terminals, to receive market information, to enter orders and to execute trade. Through 1777satellite dishes there are 3000 computer terminals connected to NSE.
5. The trading members in the capital market segment are connected to the central computer in Bombay through a satellite link-up using VSATs (Very Small Aperture Terminals). The trading members in the whole sale debt market segment are linked, through dedicated high speed lines, to the central computer at Mumbai.
6. The NSE has opted for an order driven system. The system provides enormous flexibility to trading members. A trading member can place various conditions on the order in terms of price, time or size. When an order is placed by a trading member, an order confirmation slip is generated. All orders received are stared in price and time priority. The computer system automatically searches for a match and no sooner to the same is found, the deal is struck. If it does not find a match immediately as may happen in the case of less liquid securities, the order is kept pending in the computer unless specified otherwise by the trading member.
7. When a trade takes place, a trade confirmation slip is printed at the trading member’s work station. It gives details like price, quantity, code number of the party and so on.
8. The identity of the trading, member is not revealed to others when he places an order or when his pending orders are delayed. Hence large order can be placed in NSE without the fear of influencing the market sentiment.
9. On the eight day of trading, each member gets a statement showing his net position, the amount of cash he has to transfer to the clearing bank and the securities he has to deliver to the clearing house.
10. Members are required to deliver securities and cash by the thirteenth and fourteenth day, respectively. The fifteenth day is the pay-out day.
11. The automated trade matching system secures the best price available in the market to the investor. The trading member can transact a high volume of business efficiently.
NSE and Wholesale Debt Market (WDM)
Prior to the commencement of trading in WDM segment of NSE, the only trading mechanism available in the debt market was the telephone market. NSE provided for the first time in the country, an online, automated trading facility across a wide range of debt instruments.
The trading system of the exchange known as NEAT (National Exchange for Automated Trading) is fully automated, screen based trading, system that enables members across the country to trade simultaneously with enormous easy and efficiency.
WDM segment provides trading facilities for a variety of debt instrument. Initially Government securities, Treasury Bills and Bonds issued by public sector undertakings were made available for trading. This range has been
widened to include non-traditional instruments like floating Rate Bonds, Zero Coupon Bonds, Index Bonds, Commercial Papers, Certificate of Deposits, Corporate Debentures, State Government Loans, bonds Issued by Financial Institutions, Units of Mutual funds and Securitiezed debt.
In order to enable investors like Provident Fund, Trust, NBFCs and other high net worth investors to deal in debt instruments, the exchange has introduced a small book let facility where an order of minimum of Rs. 1 lakh can be placed on the trading system of the exchange.
The volume of trade in NSE has increased multifold in the last four years. NSE is the largest exchange in the world next to NASDAQ and NYSE. There are 50,700 terminals across 1500 locations in India. 90% of capital market volumes routed through NSC. NSE is the world’s fourth largest exchange in terms of trade in equity.
NSE has set up a wholly owned subsidiary- National Securities Clearing Corporation that takes up the responsibility of settlement by opening guarantee. There is seamless integration of trading and settlement with full guarantee which protects the interest of investors fully. It commenced clearing operation in April 1996. NSE has worked out a unique facility for achieving quantum improvement in the process of primary issues. The exchange is proposing to provide a facility for issue of securities for time bound Initial Public offerings (IPO) and perpetual IPO.
Over The Counter Exchange Of India (OTCEI);
The market where second hand securities are bought and sold is referred to as the stock market. Present, the stock market consists of 23 regional stock exchanges and two national stock exchanges known as the National Stock Exchange (NSE) and the Over the Counter Exchange of India (OTCEI)
The OTCEI was incorporated in 1990 as a company under the Companies Act, 1952. It became fully operational on September 1992, with opening of a counter in Bombay. The OTCEI is recognized by the Government of India as a recognized stock exchange under section 4 of the Securities Control Regulation Act, 1956.
Features of the OTCEI
1. It is a national computerized exchange.
2. As opposed to the traditional ring in the stock exchange, the trading will be screen based. Transactions would take place through satellite communication telephone lines.
3. Trading on the OTCEI takes place through a net work of computers of OTC dealers located at different places within the same city and even across cities. These computers allow dealers to quote, query and transact through a central OTC computer, using the telecommunication links.
4. Small and medium sized companies with a paid up capital between Rs. 30 lakhs and Rs. 10 crores may be enlisted on the OTCEI. The maximum limit has now been raised to Rs. 25 crores.
5. OTCEI deals in equity shares, preference shares, bonds, debentures and warrants.
6. A company which is listed on any other recognized stock exchange in India is not permitted simultaneously for listing on OTCEI.
7. The minimum offer should be 40% of the issued capital or Rs. 20 lakh worth of shares in face value, which ever is higher.
The OTCEI has been promoted by all India financial institutions namely, UTI, ICICI, IDBI, IFCI, LIC, GIC, SBI Capital markets and can Bank Financial Services Ltd. The top executives of the promoters are on the Board of Directors of the OTCEI. The operations are supervised by SEBI and the Government of India.
Participants in OTCEI Market
The various participants in the OTCEI are:
1. Members and Dealers appointed BY OTCEI: These members and dealers appointed by the OTCEI may act as brokers and serve as market makers. Market making is a process of making two way quotes, i.e. buy as well as sell quotes for the same scrip by the sponsor. The maximum permissible spread between the buy and sell is 10%. Compulsory market making has to be undertaken by the sponsor of the scrips for a minimum period of 18 months from the date of public trading. At the end of 18 months, the sponsor may withdraw from market making functions, provided an alternate compulsory market maker has been assigned for the scrip. The member of OTCEI may be an institution, a banking subsidiary, a merchant bank or a finance company approved by SEBI.
2. Companies, whose securities are listed on OTCEI: Every company desirous of listing would have to get sponsored by a member of the OTCEI.
3. Investors who trade in the OTCEI
4. Registrar who:
a) Keeps custody of share certificates.b) Maintains Register of Members.
5. Settlement Bank : It clears the payment between countries.
6. SEBI and Government which exercises an overall supervision on
OTCEI.
Trading in OTC Exchange
Every investor is required to register with OTC prior to trading. The investor registration is required to be done only once and is valid for trading on any OTC counter in the country and in any scrip. The registration is, at present, done free of cost. The purpose of investor registration is to facilitate computerized trading.
For buying and selling shares on OTC, an investor needs the INVEST OTC CARD which can be obtained from any OTC counter free of any charge just on filling the application form.
Steps involve in Buying /Selling Scrips
1. Walk into any convenient OTC counter. 2. The PTI OTC Scan at each dealer’s counter continuously displays the
best buy and sell quotes offered by market makers and also all other market related information.
All quotes and transactions are entered in the Central OTC computer which can be accessed by any dealer’s computer, through telephone lines with modem.
3. See the price of shares on the PTI OTC scan at the counter.4. Decided to buy/ sell5. Ask counter operator to deal on your behalf.6. Deal gets confirmed automatically at the best price7. In case of buying
a. draw cheques for paymentb. get the Counter Receipt (CR). The CR is tradable and contains all
information which appears on a share certificate.c. Return CR when cheque is cleared.d. Collect final CR within 7 days.
8. In case of selling:
a. give CR and Transfer Deed (TD) to counter.b. Receive sales confirmation Slip.c. Return when CR and TD cleared and collect cheque.
The OTCEI’s unique depository system enables convenient and faster settlement for investors. The OTCEI’s depositors transfer delivery electronically to the purchaser as soon as the trade is completed.
The OTC Exchange offers a whole lot of investor services, namely-
i. Splitting/ Consolidation of PCRs (Counter Receipt)ii. Transfer/ nominationiii. Change in joint holder’s namesiv. Exchange of PCR for share certificate and vice-versa.
The OTC counter is truly a single window for investments. For each of the above services requested by investors, an Application Acknowledgement Slip (AAS) will be issued, nominal service charges may be levied and the services will be completed within reasonable time specified by OTCEI.
Listing on OTC Exchange
The OTC Exchange can list companies with issued capital from Rs. 30 lakhs up to Rs. 25 crores. The eligibility for listing are:
i) The issue size should be minimum of Rs. 20 lakhs or 25% of the paid up capital, whichever is higher.
ii) Companies engaged in hire purchase / finance/ leasing, amusement parks, etc, shall not be eligible for listing on the OTC exchange.
iii) Companies covered under the MRTP/FEMA may be listed on OTC Exchange if they satisfy listing guidelines as on other recognized stock exchanges.
iv) The minimum number of counters for collection of application forms for issues of securities shall be four.
i) The company will pay one time listing fee of Rs. 6,000 and annual listing fee of Rs. 0.05% of their paid-up capital in case of equity shares and 0.05% of the gross amount issued in case of any other security.
Recent Development in the secondary market along with measures to infuse liquidity
Many steps have been taken in recent years to reform the secondary market so that it may function efficiently and effectively. Steps are also being taken to broaden the market and make it function with greater degree of transparency and in the best interest of investors. Some of the developments in this direction are the following:
1) Regulation of Intermediaries: To improve the functioning of intermediaries in the capital market, strict control is being exercised on them by SEBI. The intermediaries such as merchant bankers, underwriters, brokers, sub-brokers, bankers to the issue etc. must be registered with the SEBI. It is proposed that the registration should be subject to renewal from time to time instead of making it a permanent one. SEBI has powers to suspend them after conducting an enquiry. It is also planning to conduct examinations for them. To improve their financial adequacy, capital adequacy norms have been fixed. Brokers are expected to maintain a minimum capital of Rs. 5 lakhs in major exchanges and Rs. 2 lakh in minor exchanges. Again they have to keep a minimum net worth of 8% of annual turnover.
2) Change in the management Structure: In the early periods, the boards of stock exchanges were dominated by brokers whose decisions were not fair and transparent. The SEBI now requires that 50 per cent of the directors must be non-broker directors or Government Representatives. Further, it is obligatory that a non-broker professional shall be appointed as the Executive Director.
3) Insistence of quality Securities: For efficient and active functioning of a stock exchange, quality securities are absolutely essential. Realizing this fact, the SEBI has announced recently revised norms for companies accessing the capital market so that only quality securities are listed and traded in stock exchange. For instance dividend payment condition ( dividend payment for at least 3 years out of the immediately preceding 5 years of issue) has been laid down for companies to go for public issue. Again, participation of financial institutions in the capital is essential for entry into the capital market. These measures ensure that only quality securities enter into the market.
4) Prohibition of Insider Trading: Insiders can easily enter into manipulative dealings against the interest of the public on the basis of any unpublished price sensitive information available to them because of their position in the company. Now, there is a ban on insider trading and hence, an insider is prevented from dealing in securities of any listed company on the basis of any unpublished price sensitive information.
Now, SEBI (Insider Trading) Amendment Regulations, 2002 have been formed giving more powers to SEBI to curb insider trading. The Government now seems to think that defining insider trading in the SEBI Act itself will make it more strongly enforceable in a court of law.
5) Transparency of Accounting Practices: To ensure correct pricing mechanism and wider participation, all attempts are being taken to achieve transparency in trading and accounting procedure. Brokers are asked to show their prices, brokerage, service tax etc. separately in the contract notes and their accounts. Of course the service tax is collected from the clients and paid to the Government.
6) Strict Supervision of Stock Operations: The Ministry of Finance and the SEBI supervise the operations in stock exchanges very strictly. The SEBI monitors the operations of stock exchanges very closely with a view to ensuring that the dealings are conducted in the best interest of the overall financial environment in the country in general and the investors in particular. Strict rules have been framed with regard to recognition of stock exchanges, membership, management, maintenance of accounts etc. Further, stock exchanges have been asked to subject the broker accounts to better inspection and audit. Some times, the SEBI itself
organizes such inspection of broker firms and their accounts. Again, stock exchanges are inspected by the officers of the SEBI from time to time. Any violation of rules and regulations involves penalties immediately.
7) Prevention of Price Rigging: Greater powers have been given to SEBI (Prohibition of fraudulent and unfair trade practices relating to security markets). Regulations, 1995 to curb price rigging. In fact the SEBI exercised its powers in 1996 for the first time by issuing show-cause notices to the various parties-promoters, brokers and clients involved in price rigging. Further, certain procedural changes have been planned in the auction route to curb price rigging. Thus all efforts are being taken to protect the interest of genuine investors.
8) Encouragement of market making: There is greater transparency in the dealings of market makers and the securities with market makers command higher level of liquidity. Market makers offer two-way quotations one for purchase price and the other for sale price in respect of the same security. They have to comply with many rules and regulations strictly with regard to minimum number of scrips for market making, timely payment of market makings, adequate financial strength, adequate turnover etc. Hence, market making has been made compulsory on OTCEI at least for a period of 18 months from the date of opening of the offer by the sponsors or designated member.
9) Discouragement of Price manipulations: SEBI is taking all steps to prevent price manipulations in all stock exchanges. It has instructed all stock exchanges to keep special margins in addition to the normal ones on the scrips which are subject to wide price fluctuations. The SEBI itself insists upon a special margin of 25% or more (in addition to the regular margin) on purchases of scrips which are subject to sharp rise in price. This margin money should be retained by the stock exchange concerned for a period of one to 3 months. All Stock exchanges have been directed to suspend trading in scrip in case any one of the stock exchanges suspends trading in that scrip for more than a day due to price manipulation or fluctuation. Suspension of trading in scrip can be done indefinitely in concurrence with the SEBI.
10) Protection of Investors’ Interest: Much importance is given to protect the interest of investors by instructing the exchanges to take timely action for the redressal of their grievances. For this purpose, the SEBI issues “ Investors Guidance Services” to guide and educate the investors about grievances and remedies available apart from giving information about various investment avenues, their merits, tax benefits available, illegal transactions etc. Disciplinary Action Committee have
been set up in each stock exchange to take up the complaints against companies, brokers etc.
11) Free Pricing of Securities: A new era in the capital market has begun with the process liberalization started from June 1991 onwards. In May 1992, the Capital Issues Control Act was abolished and the functions of the Controller of Capital issues were entrusted to SEBI. Now, any company is free to enter the capital market to raise the necessary capital at any price that it wants. Thus, a new era of free capital market has ushered in.
Very recently, the SEBI has permitted companies to issue shares below the face value of Rs. 10 and liberalized the norms for initial public offerings. This is mainly permit companies with intrinsic value of shares below Rs. 10 to tap the market at a low price. Even existing companies can split up their shares accordingly.
12) Freeing of Interest Rates: Interest rates on debentures and on PSU bonds were freed in August 1991 with a view to raising funds from the capital market at attractive rates depending on the credit rating. Companies can now offer any rate to the public and mobilize the savings.
13) Setting up of Credit Rating Agencies: Credit rating agencies have been set up for awarding credit rating to the money market instruments, debt instruments, and deposits and even to equity shares also. Now, all debt instruments must be compulsorily credit rated by a credit rating agency so that the investing public may not be deceived by financially unsound companies. It is a healthy trend towards a developed capital market.
14) Introduction of Electronic Trading: The OTCEI has started its trading operations through the electronic trading system in January 1995, called BOLY. Again, NSE went over to screen based trading with a national network. Under this system, investment counters can be spread throughout the country under the electronic network. The buyers and sellers living apart from each other can trade in corporate securities through electronic media and through telephone/ teller/ computer in the case of OTC. Hence, there is a national market with no physical location, no trading ring , no stock exchange building, no hustle, and bustle scenes etc.
15) Establishment of OTC/OTCEI/ NSE: Investors have to face many ordeals in the conventional stock exchanges/ Delays in refunding application money, issuing of allotment letters, posting of share certificates are quite common. Trading in new issues prior to formal listing of such issues is also prevalent. Rigging up of prices before flotation of
new issues, manipulations of high premium on new issues are also rampant. To overcome many of such defects, OTC/OTCEI and NSE have been established. The scope for manipulations, speculations and malpractices is very less if trading is shifted to OTC/OTCEI etc.
16) Introduction of Depository System: To avoid bad delivery, forgery, theft delay in settlement and to speed up the transfer of securities, the depository system has been approved by the Parliament on July 23, 1996. A depository is an organization where the securities of a shareholder are held in the electronic form through a process of dematerialization. The investor has to simply open an account with the depository through a depository participant. The account will be credit with the purchase of securities and debited with the sale of securities. There is no physical transfer of shares. Everything is done through electronic media. The depository system facilitates investors to hold securities in the electronic form rather than in physical form. Since the operations are computer linked, they are transparent, speedier, less speculative and cost effective.
17) Buy back of Shares: With a view to arresting heavy fluctuations in the prices of shares and to adjusting the demand and supply of shares in the market companies have been permitted to buy back their own shares. It is hoped that idle cash in the hands of one company will be channeled to another company having a pressing need and further it will be used to correct the valuation of their stock. However, the cash employed in buy back at the cost of investment plans could turn out to be costly affair in the long run.
18) Disinvestment of Shares of Public Sector Units: To bring down the Govt holding and to push up the privatization process, the disinvestment programme has been implemented. This would also activate the capital market by increasing the availability of number of shares in the market for trading. A disinvestment Commission has been established for this purpose. In spite of the steps taken, only 10% of the Government’s disinvestment target has been achieved in the last 3 years. To speed up the process of disinvestment, the Ministry of Finance has proposed to set up a special purpose vehicle (similar to one available in the case of mutual funds). Its sole objective would be to hold and sell public enterprise equity until government ownership falls to 49% in each Public Sector Enterprise.
19) Starting of Self Regulatory Organisations (SROs): The SEBI is encouraging the SCRA, SEBI ACT, Rules, Regulations and Guidelines issued by the Government from time to time. This would reduce the work of the regulatory authorities. For this purpose, the SEBI is encouraging the various market intermediaries like merchant bankers, stock brokers,
underwriters, mutual funds etc. to start organizing themselves into SROs and to recognition from the SEBI. For, instance, the SEBI has granted recognition to the SRO of merchant bankers registered as the Association of Merchant Bankers of India (AMBI). In all there are three SROs which have been formed in India by Various market participants. The other two are i) Association of Mutual Funds of India (AMFI). Ii) Registrars of Association of India (RAI).
20) Stock Watch system: The SEBI is contemplating to introduce a New Stock Watch System to trace out the source of undesirable trading if any in the market. The Stock Watch system simply works as a mathematical model which keeps a constant watch on the market movement. When the model is activated, certain parameters are put to work at once. It would bring to light automatically the scrips which are under alert. This alert list divides the scrips into three categories such as least bothersome, bothersome and more bothersome indicating blue, yellow and red signals respectively. The process would facilitate an immediate audit of the scrips put under alert so that undesirable alert so that undesirable trading and the players who do it can be traced out. This would go a long way in developing a healthy capital market.
21) Setting up of National Market System (NMS): On the recommendation of the Pherwani Committee the Government has initiated steps for setting up of NMS. The committee recommended that there should be three tiers, namely: i) Principal or Big Stock Exchanges like Mumbai, Kolkata etc. forming the first tier; ii) Regional Stock Exchanges like those in major state capitals forming the second tier; iii) Additional trading floors sponsored or managed by either Principal or Regional Stock Exchanges forming the third tier. The NMS would facilitate electronic trading and settlement throughout the country on the basis of standard prices and fixed margin of service charges / commission for the broker.
22) Trading in Derivatives: Dr. L.C. Gupta Committee which had gone into the question of introduction of derivative trading, has recommended introducing trading in Index futures to start with and then trading in options. BY-Laws have already been framed by the NSE and BSE based on the recommendation of the Committee. Trading in derivatives has been introduced by bringing necessary amendment to the Securities Contract Regulation Act. Recently, mutual funds have also been permitted to trade in derivatives. These measures would make the capital market active.
23) Reserve Bank of India’s measures: The RBI is also taking measures to revive the capital market which is undergoing a period of sluggishness. It has permitted commercial banks to invest up to 5 percent of their incremental deposits in ordinary shares of the corporate sector including
PSUs. Again, banks are allowed to extend loans to corporate against shares held by them so as to enable them to meet promoters’ contribution to the equity in new companies. The RBI has also increased the ceiling for bank’s advances to individuals against shares and debentures. Further, financial institutions have been allowed to purchase and sell Treasury Bills.
24) Stock Lending Mechanism: To make the capital market active by putting idle stocks to work, another innovative mechanism viz; Stock Lending Scheme has been introduced by the SEBI. Though the scheme was approved in 1997, it was put into action only on February 10, 1999. the National Securities Clearing Corporation Limited (NSCCL) is the first Approved Intermediary (IA) to implement the scheme. The scheme introduced by the NSCCL is known as ‘Automated Lending and Borrowing Mechanism’ (ALBM).
25) Union Budget measures to infuse liquidity: The Govt of India is also taking many initiatives to develop the capital market. Union Budget of 2006-2007 contains many measures for the development of our capital market. Some of the important measures are:
Limit on FII investment in government securities to be increased from $ 1.75 billion to $ 2 billion.
Limit on FII in corporate debt to be increased from $ 0.5 billion to $ 1.5 billion.
Ceiling on aggregate investment by mutual funds in overseas instruments to be raised from $1 billion to $2 billion with removal of requirement of 10 per cent reciprocal shareholding.
26) Rolling settlement: In July 2001, SEBI , made rolling settlement on T+ 5 cycle compulsory in 414 stocks and the rest of the stocks should follow it from January 2002. But now T+2 rolling settlement has been introduced for all securities. It means that transactions on a stock exchange have to be settled 2 days after the trade day. He time gap between trading and settlement given rise to settlement risk. To overcome this risk, risk management practices are being adopted by stock exchanges and clearing corporations. Exchanges provide counter-party guarantee must set up trade guarantee funds as per the advice of the SEBI.
Internet Trading:
SEBI Committee has approved the use of Internet as an Order routing System (ORS) for communicating clients’ orders to the exchanges through brokers. ORS enables investors to place orders with his broker and have control over the information and quotes and to hit the quote on an on-line basis. Once the broker’s system receives the order, it checks the authenticity of the client electronically and then routes the order to the appropriate exchange for execution. On execution of the order, it is confirmed on real time basis. Investor receives reports on margin requirement, payments and delivery obligations through the system. His ledger and portfolio account get updated online. NSE launched internet trading in early February 2000. It is the first stock exchange in the country to provide web-based access to investors to trade directly on the exchange. The order originating from the PCs of the investors are routed through the Internet to the trading terminals of the designated brokers with whom they are connected and further to the exchange for trade execution. Soon after these orders get matched and result into trades, the investors get confirmation about them on their PCs through the same internet route.
Unit IV Debt Market:
Introduction: The debt market is any market situation where trading debt instruments take place. Examples of debt instruments include mortgages, promissory notes, bonds, and Certificates of Deposit. A debt market establishes a structured environment where these types of debt can be traded with ease between interested parties.
The debt market often goes by other names, based on the types of debt instruments that are traded. In the event that the market deals mainly with the trading of municipal and corporate bond issues, the debt market may be known as a bond market. If mortgages and notes are the main focus of the trading, the debt market may be known as a credit market. When fixed rates are connected with the debt instruments, the market may be known as a fixed income market.
History of Indian Debt Market
The debt is one of the most critical components in the financial system of any economy and acts as the fulcrum of a modern financial system.
The Indian debt market has traditionally been a wholesale market with participation restricted to few institutional players – mainly banks. The banks were the major participants in the government securities market due to statutory requirements. The turnover in the debt market too was quite low a few hundred crores till the early 1990s. The debt market was fairly underdeveloped due to the administrated interest rate regime and the availability of investment avenues which gave a higher rate of return to investors.
In the early 1990s, the government needed a large amount of money for investment in development and infrastructure projects. The government realized the need of a vibrant, efficient and healthy debt market and undertook reform measures. The Reserve Bank put in substantial efforts to develop the government securities market but its two segments, the private corporate debt market and public sector undertaking bond market, have not yet fully developed in terms of volume and liquidity.
It is debt market which can provide returns commensurate to the risk, a variety of instruments to match the risk and liquidity preferences of investors, greater safety and lower volatility. Hence the debt market has a lot of potential for growth in the future. The debt market is critical to the development of a developing country like India which requires a large amount of capital for achieving industrial and infrastructure growth.
Regulation of Debt Market: The Reserve Bank of India regulates the government securities market and money market while the corporate debt market comes under the purview of the Securities Exchange and Board of India (SEBI).
In order to promote an orderly development of the market, the government issued a notification on March 2, 2000 delineating the areas of responsibility between the Reserve Bank and SEBI. The contracts for sale and purchase of government securities, gold related securities, Money market securities and securities derived from these securities and ready forward contracts in debt securities shall be regulated by the Reserve Bank. Such contracts, if executed on the stock exchanges shall, however, be regulated by SEBI in manner that is consistent with the guidelines issued by the Reserve Bank. The total size of the Indian debt market is currently estimated to be in the range of US $92 billion to US $100 billion. India’s debt market accounts for approximately 30 percent of its GDP. The Indian bond market measured by the estimated value of bonds outstanding is next only to the Japanese and Korean bond markets in Asia. The Indian debt market, in terms of volume, is larger than the equity market. In terms of daily settled deal, the debt and the
forex markets market currently (2001-02) command a volume of Rs 25,000 crore against a meager Rs 1,200 crore in the equity markets (including equity derivatives). In the post reforms era, a fairly well segmented debt market has emerged comprising:
1. Private corporate debt market2. Public sector undertaking bond market and3. Government securities market
The government securities market accounts for more than 90 percent of the turnover in the debt market. It constitutes the principal segment of the debt market.
Primary and Secondary Market Segment
The debt market has two interdependent and inseparable segments: the primary and the secondary market. The primary market provides the channel for creation of new securities through issuance of financial instruments by public companies as well as Governments and Govt agencies and bodies where as the secondary market helps the holders of these financial instruments to sale for existing from the investment. The price signals, which subsume all information about the issuer and his business including associated risk, generated in the secondary market, help the primary market in allocation of funds. The primary market issuance is done either through public issues or private placement. A public issue does not limit any entity in investment while in private placement; the issuance is done to selected group of people. In terms of Companies Act 1956, an issue becomes public if it results in allotment to more than 50 persons. This means an issue resulting in allotment to less than 50 persons. This means an issue resulting in allotment to less than 50 persons is private placement. There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity instruments (share, debentures etc), while the governments (Central and State Governments) issue debt securities (debt securities and treasury bills).
The secondary market enables participants who hold securities to adjust their holdings in response to changes in their assessment of risk and return. They also sell securities for cash to meet their liquidity needs. The exchanges do not provide facility for spot trades in a strict sense. Closet to spot market is the cash market in exchanges where settlement takes place after some time. Trades taking place over a trading cycle (one day under rolling settlement) are settled together after a certain time. All the 23 stock exchanges in the country provide facilities for trading of corporate securities. Trades executed on NSE only are cleared and settled by a clearing corporation which provides novation and settlement guarantee. Nearly 100% of the trades in capital market segment are settled through demat delivery.
NSE also provides a formal trading platform for trading of a wide range of debt securities including government securities in both retail and wholesale mode.
Corporate Debt Market
The corporate debt market refers to funds raised by corporate through instruments such as debentures, bonds and other long-term debt instruments. It also includes money secured from derivative instruments such as futures, options and swaps. The corporate bond market acts instruments to channelise people’s saving into productive investments so as to bring about economic growth. The balanced funds offered by mut6ual fund companies invest part of money in corporate bonds, which cause the major growth of corporate bond market in India. To make debt market more popular, SEBI has recently drafted proposals that make it easier for companies to make a public issue of debt through the primary markets. A company needs funds for projects with long term gestation period. Commercial banks are generally not willing to finance such projects. For such projects, corporate bond market facilitates financing through issue of bonds, with long term maturity period, to the public. For a company, money raised through bonds doesn’t require funds at a lower cost. For the investors, unlike traditional bank deposits, there exists an opportunity to benefit from bond price movements as interest rates change.
For the market as a whole, the existence for transparency will help reduce to a great extent, the inherent risk related to the exposure. Globally, bond markets are many more times the size of equity markets. In India, although the debt market as a whole is bigger than the equity market, more than 80 per cent of it is dominated by government securities. This anomaly can partly be attributed to the presence of development financial institutions such as ICIVI, IFCI, IDBI, which readily provide them long-term finance, limiting the need for a full-fledged bond market. Besides, illiquidity, strict regulatory requirements, ceiling on exposure by insurance companies and FIIs and credit rating have crippled the growth of bond market in India. So far majority of the companies have resorted to private placement of bonds instead of going to primary market.
Government Securities Market
The government debt presents under two broad heads- internal and external. Internal borrowings constitute bulk of the debt, forming almost 97% of the total debt. Internal debt includes loans raised by the government in the open market, special securities issued to RBI , rupee securities (non-interest bearing issued to international institutions such as IMF and World Bank, treasury bills issued to state governments, commercial banks and other parties. The debt of the government also includes others like the
outstanding against small saving schemes, provident funds, deposits under special deposit schemes and reserve funds of departmental undertakings.
The government bonds currently dominate the domestic bond market. They account for two thirds of the total outstanding debt and 97% of secondary trade. On increasing FII investment in the corporate bond market, there is a need for a vibrant corporate bond market. The present major hurdle in the corporate bond market is due to different rates of stamp duty charged by the state governments. Now, a committee of finance ministers is empowered to consider uniform stamp duty on corporate bonds as it would only enhance the revenues of the states. The Government is also proposing to introduce repo in corporate bonds. Repos would allow investors to recycle illiquid corporate bonds and then borrow, which in turn would improve liquidity.
Trading System in Debt Market
The debt raised from the primary markets is predominantly of government securities on account of borrowing by the Central Government. The other debt instruments constitute a very small percentage of the entire debt market. The debt market in India has not developed as much as the equity market. There is no trading floor where brokers bid and offer debt securities. There is no standardized market lot for purchase and sale of such securities. There is no settlement of transactions by an exchange. The brokers/traders in the debt market negotiate the deal privately and the deal is struck. This deal is completed by the two parties to the deal. The debt market in India is still not as transparent as the equity market. The predominant security in the debt market is Government securities. The debt instruments of corporate, financial institutions and banks constitute a tiny portion of entire debt market.
Negotiated Dealing System (NDS): The Negotiated Dealing System (NDS) supports transaction in government bonds, repos, call money commercial paper, certificate of deposit and interest rate derivatives. NDS will facilitate submission of bids for auctions of government securities. It will facilitate dissemination of information relating to primary issuance through auction/sale on tap and underwriting apart from secondary market. NDS facilitates are screen based negotiated dealing for secondary market transaction in government securities. It is an electronic platform for facilitating dealing in Government securities and money market instruments. NDS will facilitate electronic submission of bids/ application by members and provides a seamless interface to Securities Settlement System (SSS) of Public Debt Office, RBI. All outright and Repo transactions in treasury bills and dated securities are settled through NDS.
Electronic Trading System (ETS): Bids, offers and quantities are displayed on a screen in descending/ascending order of price to buy/sell. The trader enters his order to buy/sell, quantity and price. If the order is within the live range of buy/sell prices and quantity, it will be executed instantaneously.
Over-The-Counter (OTC)- Deals are struck with counter parties on phone and the same is later confirmed in writing. Forex trading is not centralized on an exchange, as in the case of stocks and futures markets. The forex market is considered an over the counter (OTC) or inter bank market, since transactions are conducted between two counterparties over telephone or via and electronic network.
Wholesale Debt Market of NSE :
The trading system of NSE provides two forms of market for wholesale trade of debt instruments: a) Continuous market, and b) Negotiated market.
Continuous Market: The buyer and seller in a continuous market do not know each other and they put their best buy/ sell orders, which are stored in order book with price/time priority. If order matches, it results into a trade transaction. The trades are settled directly between participants, who take an exposure to the settlement risk attached to any unknown counterparty. A trade does not take place if both the buy/sell participants do not invoke the counterparty exposure limit in the trading system.
Negotiated Market: In negotiated market, the trades are normally decided by the seller and the buyer outside NSE and reported to NSE through broker. The deals are negotiated or structured outside the exchange are disclosed to the market through the trading system. As the buyers and sellers know each other and have agreed to trade, no counterparty exposure limit needs to be invoked. The wholesale debt market segment of the NSE is a facility of institutions including subsidiaries of banks engaged in financial services and corporate bond including companies to enter into high value transactions in instruments such as public sector undertakings bonds, treasury bills, government securities, commercial papers, certificate of deposits, floating yield bonds. Members on the wholesale debt market segment can trade on their own behalf or their clients. NSE trading system facilitates making of two ways quotes in a highly flexible manner. The high net worth corporate members of the wholesale debt market segment would be able to make such two way quotes in the retail market and any excesses or shortages in holding of their debt stock, they would be able to make good by having access to the wholesale debt market.
National Electronic Funds Transfer System: The National Electronic Funds Transfer (NEFT) system was introduced in November, 2005 as a secure, nationwide retail electronic payment system to facilitate funds transfer by
banks customers. There are six settlement cycles every day that enable funds transfer to the beneficiaries’ account within two hours- as against conventional methods of sending money by drafts or cheques where it could take days or weeks.
E-Platform for Corporate Debt Trading: India’s first live corporate debt trade facilitating platform called ‘Dome’ has been launched by Derivium Capital and Securities Pvt. Ltd. A web-based platform, ‘Dome’ in its launch phase is a live corporate debt market and other debt market reporting system. The purpose of the platform is to increase transparency and faster dissemination of market information, quotes and trade levels. The platform provides information for markets including special Government securities such as oil bonds, food bonds and fertilizer bonds; bank CDs, corporate CP and short-term NCDs; institutional and corporate bonds; interest rate swaps and primary placements of bank CD, corporate CP and bonds.
The platform will soon introduce in a phased manner new features such as complete database of rating-wise market levels for analysis, research and decision-making with a market history; and working price/yield calculators for all the listed bonds (including complete cash flows). Operating as an institutional intermediary, Derivium Capital has played a leading role in the development of the country’s corporate debt and derivatives market. The ‘Dome’ platform has clearance from Securities and Exchange Board of India.
Net of Trades in Government Securities: In a move to develop the debt market and create a level playing field for mutual funds which trade in government securities, the Securities and Exchange Board of India (SEBI) has allowed netting of trades to Mutual funds in the G-Sec market. SEBI allow MFs to sell G-Secs contracted for purchase in DVP III mode in accordance with the guidelines issued by Reserve Bank of India (RBI) in this regard. Under the DVP III mode of settlement, it is possible to sell government securities, already contracted for purchase without taking delivery provided the transaction is guaranteed by an approved central counterparty. Clearing Corporation of India Ltd. (CCIL). Mutual funds cannot now sell such securities contracted for purchase as they are required under SEBI regulations to take the actual physical delivery.
RBI Facilities in Government Debt Market:
The RBI provides liquidity support and other facilities, such as, SGL and current accounts, transfer of funds through the RBI’s remittance facility scheme and access to call money market to dedicated gilt funds. These4 facilities are provided to encourage gilt funds to create a wider investor base
for government securities market. The facilities provided to gilt funds include:
Liquidity Support: The objective of extending liquidity support to dedicated gilt funds is to support short-term liquidity requirements of such mutual funds. The RBI provides liquidity support to gilt funds by way of reverse repurchase agreements (reverse repos). Reverse repos are done in Government of India dates securities eligible for repo transactions and treasury bills of all maturities. The quantum of liquidity support on any day is up to 20 percent of the outstanding stock of government securities, including treasury bills, held by the gilt funds as at the end of the previous working day.
SGL and Current Account: The RBI opens one Subsidiary General Ledger (SGL) account and one current account for gilt funds own transactions at all centers of the RBI wherever desired by the gilt funds.
Funds Transfer Facility: The gilt funds are given the facility of fund transfer from one center to another under the remittance facility scheme of RBI. The gilt funds are also given the facility of clearing of cheques arising out of government securities transactions, tendered at the Reserve Bank Counters.
Access to Call market: Gilt funds can access the call money market as lenders.
Ready Forwards: The RBI will also recommend to the Government of India to permit the gilt funds to undertake ready forward transactions in Government securities market.
Reforms in Government Securities Market
A move towards globalization of Indian financial system has brought the following reforms in Government securities market:
a) Administered interest rates on Government securities were replaced by an auction system.
b) Automatic monetization of fiscal deficit through the issue of ad hoc treasury bills was phased out.
c) Primary dealers were introduced as market makers in the Government securities market.
d) For ensuring transparency in the trading of Government securities Delivery versus Pay (DvP) Settlement System was introduced.
e) Repurchase agreements (repo ) was introduced as a toll of short-term liquidity adjustment. Subsequently, the liquidity adjustment facility (LAF) was introduced. LAF operates through repo and reverse repo auctions to set up a corridor for short-term interest rate. LAF has emerged as the tool for both liquidity management and also signaling device for interest rates in the overn9ght market.
f) market Stabilization Schemes (MSS) has been introduced, which has expanded the instruments available to the Reserve Bank for arranging the surplus liquidity in the system.
g) 91-day treasury bill was introduced for managing liquidity and benchmarking.
h) Zero coupon bonds, floating rate bonds, capital indexed bonds were issued and exchange traded interest rate futures were introduced.
i) OTC interest rat derivatives like IRS/ FRAs were introduced.
j) FIIs were allowed to invest in Government Securities subject to certain limits.
k) Introduction of automate screen-based trading in Government securities through negotiated dealing system (NDS).
l) Risk-free payments and settlement system in Government securities was introduced through Clearing Corporation of India Ltd. (CCIL).
m) The Real Time Gross Settlement (RTGS) system was introduced.
n) Non-banks are permitted to participate in repo market.
o) The trading on Government securities was permitted in the stock exchanges for promoting retailing in such securities.
