CHAPTER- III AN OVERVIEW OF INDIAN CAPITAL MARKET

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1 CHAPTER- III AN OVERVIEW OF INDIAN CAPITAL MARKET 3.1 Introduction Capital Market is one of the significant aspects of every financial market. Hence, it is necessary to study its correct meaning. Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business units and corporate are the borrowers in the capital market. Capital market involves various instruments which can be used for financial transactions. Capital market provides long term debt and equity finance for the government and the corporate sector. Capital market can be classified into primary and secondary market. The primary market is a market for new shares, whereas in the secondary market the existing securities are traded. Indian Capital market systems have evolved to be at par with the advanced systems of the world in the last 15 years. Business process, functionality, monitoring / regulating mechanisms, hardware, software etc are all revamped to compete with the global leaders. With the internal systems & monitoring mechanism properly in place, the time is ripe for India to join itself to the global capital market network. At present India stands in the door step of full convertibility of the Indian Rupee in Capital Account, Cross border trading in the securities market is a very bright possibility in the near future. 1 This chapter presents an overview of Indian capital market and its development. 1 Anshinsoft Corp., Case Study Indian Capital Market Overview, Santa Clara, USA, September,

2 3.2 Indian Capital market The capital market consists of primary and secondary markets. The primary market deals with the issue of new instruments by the corporate sector such as equity shares, preference shares and debt instruments. Central and State governments, various public sector industrial units (PSUs), statutory and other authorities such as state electricity boards and port trusts also issue bonds/debt instruments. The primary market in which public issue of securities is made through a prospectus is a retail market and there is no physical location. Offer for subscription to securities is made to investing community. The secondary market or stock exchange is a market for trading and settlement of securities that have already been issued. The investors holding securities sell securities through registered brokers/subbrokers of the stock exchange. Investors who are desirous of buying securities purchase securities through registered broker/sub-broker of the stock exchange. It may have a physical location like a stock exchange or a trading floor. Since 1995, trading in securities is screen-based and Internet-based trading has also made an appearance in India. The secondary market consists of 23 stock exchanges. The secondary market provides a trading place for the securities already issued, to be bought and sold. It also provides liquidity to the initial buyers in the primary market to re-offer the securities to any interested buyer at any price, if mutually accepted. An active secondary market actually promotes the growth of the primary market and capital formation because investors in the primary market are assured of a continuous market and they can liquidate their investments. 66

3 3.3 Structure of Indian Capital Market Broadly the capital market is classified into two categories. They are the Primary market (New Issues Market) and the Secondary market (Existing Old Issues Market). This classification is done on the basis of the nature of the instrument brought in the market. However on the basis of the types of institutions involved in capital market, it can be classified into various categories such as the Government Securities market or Gilt-edged market, Industrial Securities market, Development Financial Institutions (DFIs) and financial intermediaries. All of these components have specific features to mention. The structure of the Indian capital market has its distinct features. These different segments of the capital market help to develop the institution of capital market in many dimensions. The primary market helps to raise fresh capital in the market. In the secondary market, the buying and selling (trading) of capital market instruments takes place. The Figure 3.1 shows the organizational structure of the Indian. 67

4 Figure 3-1 Structure of Indian Capital Market INDIAN CAPITAL MARKET Government Securities (Gilt-Edged Market Industrial Securities Market Development Financial Insitutions (DFIs) Financial Intermediaries Primary Market IFCI Merchant Banks Secondary Market ICICI Mutual Funds SECs Leasing Companies IDBI Venture Capital Companies IIBI Other financial Organisation UTI Source: Vasant Desai, The Indian financial System and development, Himalaya Publishing House, Mumbai, Second revised Edition,

5 1. Government Securities Market: This is also known as the Giltedged market. This refers to the market for government and semi-government securities backed by the Reserve Bank of India. 2. Industrial Securities Market: This is a market for industrial securities i.e. market for shares and debentures of the existing and new corporates firms. Buying and selling of such instruments take place in this market. This market is further classified into two types such as the New Issues Market and the Old Issues Market. In primary market fresh capital is raised by companies by issuing new shares, bonds, units of mutual funds and debentures. This trading takes place through the registered stock exchanges. In India there are three prominent stock exchanges. They are the Bombay Stock Exchange, the National Stock Exchange and Over The Counter Exchange of India. 3. Development Financial Institutions (DFIs): This is yet another important segment of Indian capital market. This comprises various financial institutions. These can be special purpose institutions like IFCI, ICICI, SFCs, IDBI, IIBI, UTI, etc. These financial institutions provide long term finance. 4. Financial Intermediaries: The fourth important segment of the Indian capital market is the financial intermediaries like merchant banking institutions, mutual funds, leasing finance companies, venture capital companies and other financial institutions. 3.4 Capital Market Participants There are several major players in the primary market. These include the merchant bankers, mutual funds, financial institutions, foreign institutional investors (FIIs) and individual investors. In the secondary market, there are the stock exchanges, stock brokers (who are members of the stock exchanges), the mutual funds, financial institutions, foreign institutional investors (FIIs), and individual 69

6 investors. Registrars and Transfer Agents, Custodians and Depositories are capital market intermediaries that provide important infrastructure services for both primary and secondary markets. 3.5 Capital Market Instruments The capital markets are relatively for long term (greater than one year maturity) financial instruments (e.g. bonds and stocks). It is the largest source of funds with long and indefinite maturity for companies and thereby enhances the capital formation in the country. It offers a number of investment avenues to investors. The capital market instruments are the vehicles between the companies and the investors. Stock market is the vehicle and SEBI is the driver. These instruments are of two types namely primary market and secondary market instruments. Apart from derivative instruments, the following are the major mediums of approaching capital markets: Equity Shares Preference Shares Debentures/ Bonds ADRs GDRs Derivatives Stock/ Equity Shares There are two main types of stock: common (also known as "shares" or "equity") and preferred. Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. 70

7 A holder of stock (a shareholder) has a claim to a part of the corporation's assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company's assets Preference Shares Preference share capital means, with reference to any company limited by shares, whether formed before or after the commencement of this Act, that part of the share capital of the company which fulfils both the following requirements, namely:- (a) that as respects dividends, it carries or will carry a preferential right to be paid a fixed amount or an amount calculated at a fixed rate, which may be either free of or subject to income-tax, and (b) that as respect capital, it carries or will-carry, on a winding up or repayment of capital, a preferential right to be repaid the amount of the capital paid-up or deemed to have been paid- up, whether or not there is a preferential right to the payment of either or both of the following amounts, namely.- (i) any money remaining unpaid, in respect of the amounts specified in clause (a), up to the date of the winding up or repayment of capital; and (ii) Any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company. Its main attributes include prior claim on income/assets and redeemability, cumulative dividends and fixed dividends. A preference share may also sometimes be convertible partly/fully into equity shares/debentures at a certain ratio during a specified period. 71

8 3.5.3 Debentures/Bonds A bond is a long-term debt security. It represents debt in that the bond buyer actually lends the face amount to the bond issuer. Since bonds are intended to be bought and sold, all the certificates of a bond issue contain a master loan agreement. This agreement between issuer and investor (or creditor and lender), called the bond indenture or deed of trust, contains all the information in the following: Amount of the Loan Rate of Interest Schedule or Form of Interest Payments Term Call Feature (if any) Refunding American Depository Receipt (ADRs) An American Depository Receipt (ADR) is a negotiable receipt which represents one or more depository shares held by a US custodian bank, which in turn represents underlying shares of non-issuer held by a custodian in the home country. ADR is an attractive investment to US investors willing to invest in securities of non US issuers for following reasons: ADRs provide a means to US investors to trade the non-us company s shares in US dollars ADR is a negotiable receipt (which represents the non US share) issued in US capital market and is traded in dollars. The trading in ADR effectively means trading in underlying shares. ADRs facilitate share transfers. ADRs are negotiable and can be easily transferred among the investors like any other negotiable instrument. The transfer of ADRs automatically transfers the underlying share. 72

9 The transfer of ADRs does not involve any stamp duty and hence the transfer of underlying share does not require any stamp duty. The dividends are paid to the holders of ADRs in U.S. dollars Global Depository Receipts (GDRs) Global Depository Receipts are negotiable certificates with publicly traded equity of the issuer as underlying security. An issue of depository receipts would involve the issuer, issuing agent to a foreign depository. The depository, in turn, issues GDRs to investors evidencing their rights as shareholders. Depository receipts are denominated in foreign currency and are listed on an international exchange such as London or Luxembourg. GDRs enable investors to trade a dollar denominated instrument on an international stock exchange and yet have rights in foreign shares. The principal purpose of the GDR is to provide international investors with local settlement. The issuer issuing the shares has to pay dividends to the depository in the domestic currency. The depository has to then convert the domestic currency into dollars for onward payment to receipt holders. GDRs bear no risk of capital repayment. GDRs are also issued with warrants attached to them. Warrants give the investors an option to get it converted into equity at a later date. Warrants help the issuer to charge some premium on the GDRs sold and it also helps to increase the demand of the GDR issue. The other advantage to the issuer is that it will not have to pay dividends on the warrants till the conversion option is exercised. The disadvantage to the issuer lies in delayed receipt of full proceeds from the issue and in case the conversion option is not exercised the expected proceeds will not be realised. 73

10 3.6 List of Stock Exchanges in India There are 23 stock exchanges in the country, 20 of them being regional ones with allocated areas. Three others set up in the reforms era, viz., National Stock Exchange (NSE) the Over the Counter Exchange of India Limited (OTCEI) and Interconnected Stock Exchange of India Limited (ISE) have mandate to nationwide trading network. The ISE is promoted by 15 regional stock exchanges in the country and has been set up at Mumbai. Table 3.1 List of Stock Exchanges in India Sr. No. Name of the Exchange Valid Up to 1. Ahmadabad Stock Exchange Ltd. Permanent 2. Bangalore Stock Exchange Ltd. Permanent 3. Bhubaneswar Stock Exchange Ltd. 04-Jun Bombay Stock Exchange Ltd. Permanent 5. Calcutta Stock Exchange Ltd. Permanent 6. Cochin Stock Exchange Ltd. 07-Nov Coimbatore Stock Exchange Ltd. Due to pending litigation before the Hon'ble Madras High Court, Coimbatore Stock Exchange Ltd. (CSX) has not filed application for renewal of recognition which expired on However, in terms of order dated of the Hon'ble Court, the right of CSX to apply for renewal shall be subject to further orders of the court and the stock exchange shall not be entitled to oppose the renewal solely on the ground of lapse of time. 17-Sep The Delhi Stock Exchange Ltd., Permanent 9. The Gauhati Stock Exchange Ltd., 30-Apr

11 Sr. No. Name of the Exchange Valid Up to 10. The Hyderabad Stock Exchange Ltd., The Hyderabad Stock Exchange Ltd. (HSE) failed to dilute at least 51% of its equity share capital to public other than shareholders having trading rights on or before the stipulated date i.e. August 28, Consequently, in terms of section 5(2) of the Securities Contracts (Regulation) Act, 1956, the recognition granted to HSE stands withdrawn with effect from August 29, Interconnected Stock Exchange of India Ltd. 17-Nov Jaipur Stock Exchange Ltd. 08-Jan The Ludhiana Stock Exchange Ltd. 27-Apr MCX Stock Exchange Ltd 15-Sep Madhya Pradesh Stock Exchange Ltd Permanent 16. Madras Stock Exchange Ltd. Permanent Magadh Stock Exchange Ltd. 17. "SEBI vide order dated September 3, 2007 refused to renew the recognition granted to Magadh Stock Exchange Ltd." Mangalore Stock Exchange 18. As per Securities Appellete Tribunal order dated October 4, 2006, the Mangalore Stock Exchange is a derecognised Stock Exchange under Section 4 (4) of SCRA 19. National Stock Exchange of India Ltd. Permanent 20. OTC Exchange of India 22-Aug

12 Sr. No. Name of the Exchange Valid Up to 21. Pune Stock Exchange Ltd. 01-Sep-2012 Saurashtra Kutch Stock Exchange Ltd. 22. SEBI vide order dated July 06, 2007 has withdrawn the recognition granted to Saurashtra Kutch Stock Exchange Limited. 23. The Vadodara Stock Exchange Ltd. 03-Jan U.P. Stock Exchange Limited 02-Jun United Stock Exchange of India Limited 21-Mar-2012 Source: * As on June 10, 2011, details of stock exchanges presented in the table. 3.7 Market Regulation It is important to ensure smooth working of capital market, as it is the arena for the players associated with the economic growth of the country. Various laws have been passed from time to time to meet this objective. The financial market in India was highly segmented until the initiation of reforms in on account of a variety of regulations and administered prices including barriers to entry. The reform process was initiated with the establishment of Securities and Exchange Board of India (SEBI). The legislative framework before SEBI came into being consisted of three major Acts governing the capital markets: 1. The Capital Issues Control Act 1947, which restricted access to the securities market and controlled the pricing of issues. 76

13 2. The Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities and disclosures to be made in public issues. 3. The Securities Contracts (Regulation) Act, 1956, SC(R) A which regulates transactions in securities through control over stock exchanges. In addition, a number of other Acts, e.g., the Public Debt Act, 1942, the Income Tax Act, 1961, the Banking Regulation Act, 1949, have substantial bearing on the working of the securities market Capital Issues (Control) Act, 1947 The Act had its origin during the Second World War in 1943 when the objective of the Government was to pre-empt resources to support the War effort. Companies were required to take the Government's approval for tapping household savings. The Act was retained with some modifications as a means of controlling the raising of capital by companies and to ensure that national resources were channeled into proper lines, i.e., for desirable purposes to serve goals and priorities of the government and to protect the interests of investors. Under the Act, any firm wishing to issue securities had to obtain approval from the Central Government, which also determined the amount, type and price of the issue. This Act was repealed and replaced by SEBI Act in Companies Act, 1956 Companies Act, 1956 is a comprehensive legislation covering all aspects of company form of business entity from formation to winding-up. This legislation (amongst other aspects) deals with issue, allotment and transfer of securities and various aspects relating to company management. It provides for standards of disclosure in public issues of capital, particularly in the fields of company management and projects, information about other listed companies under the same management and management perception of risk factors. It also regulates 77

14 underwriting, the use of premium and discounts on issues, rights and bonus issues, substantial acquisitions of shares, payment of interest and dividends, supply of annual report and other information Securities Contracts (Regulation) Act, 1956 The previously self-regulated stock exchanges were brought under statutory regulation through the passage of the SC(R)A, which provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges. This gives the Central Government regulatory jurisdiction over (a) stock exchanges, through a process of recognition and continued supervision, (b) contracts in securities, and (c) listing of securities on stock exchanges. As a condition of recognition, a stock exchange complies with conditions prescribed by Central Government. Organised trading activity in securities in an area takes place on a specified recognised stock exchange. The stock exchanges determine their own listing regulations which have to conform to the minimum listing criteria set out in the Rules. The regulatory jurisdiction on stock exchanges was passed over to SEBI on enactment of SEBI Act in 1992 from Central Government by amending SC(R) Act. 3.8 SEBI and the Regulation of Securities Markets From its inception, SEBI has endeavoured to develop the securities markets and simultaneously set up a benchmark in market regulation. While much of the initial agenda in the early nineties is complete, the task of development and regulation of securities markets is an ongoing process. The work of investor protection and education and development of markets needs to be set in a new context periodically. Following is a brief review of SEBI's achievements in the field of market regulation in the past decade. Streamlining Capital Raising SEBI over time has introduced a number measures aimed at enhancing efficiency and optimizing the cost of raising capital from the securities market. The 78

15 transformation of the primary securities market has been on account of the introduction of the book building route for public issues, margining and proportional allotment for all categories of investors in book-built issues, mandatory IPO grading, qualified institutions placements (QIPs), fast-track issues, Applications Supported by Blocked Accounts (ASBA) and significant reduction in the timeline for rights issues and bonus issues. Reduction in Transaction Costs The growth in the categories of investors in the market has kept pace with the types of products. Transaction costs have come down on account of the reduction in /rationalization of fees, commissions and market impact cost. The transaction cost charged by depositories is the lowest in the world. Broking fees have plummeted in the past decade-and-a-half. The maximum brokerage chargeable by trading member in respect of trades in the equity cash segment can be up to 2.5 per cent of the contract price, inclusive of statutory levies like securities transaction tax, SEBI turnover fee, service tax and stamp duty. However, the actual brokerage charged is as low as 0.10 per cent, suggesting a competitive brokerage industry. Entry load has been abolished for investment in mutual funds. Transparency SEBI's regulatory regime is primarily based on disclosures and transparency. To make the process of price discovery in the primary markets more transparent, SEBI introduced the book building process and mandated necessary disclosures in the offer documents. In the secondary markets, transparency is ensured by introduction of screen-based order matching system which makes the price and volume data instantly available to an investor in the remotest corner of the country. To increase the accessibility of information, SEBI's own activities are immediately put on the website, including the consent orders, quasi-judicial orders and board notes. 79

16 Disclosure-based Regulations The establishment of SEBI ushered disclosure based regulation in the Indian securities market. Companies desiring to raise capital from the securities market through public issues are required to disclose all material information so as to facilitate informed investment decision-making. This mandate applies to companies that propose to list their securities, listed companies and all regulated entities. The legal framework has often been fine-tuned to improve disclosure norms and transparency standards. The report of the Committee on Financial Sector Assessment (CFSA) has noted that all applicable transparency practices are observed in India. Promotion of Market Integrity The surveillance, investigation and enforcement capability of SEBI has been strengthened to deter violation of securities laws. To enhance the efficacy of the surveillance function, SEBI has put in place a comprehensive Integrated Market Surveillance System (IMSS) which generates alerts arising out of unusual market movements. IMSS is also being used to monitor the activities of market participants as well as to issue suitable instructions to stock exchanges and market participants. The supervision and enforcement thus not only complemented the fine-tuned legal framework but ensured better compliance. Processes have been introduced to expeditiously resolve cases of violations by passing quasi-judicial orders, instituting legal proceedings or through the consent process. SEBI keeps a continuous vigil on the activities of the stock exchanges to promote an effective surveillance mechanism and also carries out inspections of the surveillance department of major stock exchanges. Since , SEBI has undertaken 1,359 investigation cases and 1,264 cases investigations have been completed. During , 71 new cases were taken up for investigation and 74 cases were completed. Investor Assistance and Education SEBI has in place a comprehensive mechanism to facilitate redressal of grievances against intermediaries registered by it and against companies whose 80

17 securities are listed or proposed to be listed on stock exchanges. Since its inception, SEBI has resolved 25,46,302 investor grievances 2 amounting to 94 per cent of the total of 27,06,895 investor grievances received. As on March 31, 2010, there were 1, 60,593 pending investor grievances and actions had already been initiated in 1, 22,713 grievances. SEBI has taken several steps to address structural weaknesses in the system to eliminate the root cause of complaints. SEBI has evolved a procedure where class action suits filed by investor associations in respect of violations will be reimbursed the cost of legal action. Investor education has received much attention in the recent past. Adoption of International Standards The legal and regulatory framework governing the Indian securities market complies substantially with the International Organization of Securities Commission's (IOSCO) Principles of Securities Regulation. The assessment of IOSCO Principles as regards regulation of the equity/corporate bond market by the Committee on Financial Sector Assessment (CFSA) has revealed an overall significant level of compliance; out of 30 principles, India is fully compliant on 20, broadly compliant on 8 and partially compliant on the remaining 2. SEBI has implemented a suitable KYC regime in accordance with the recommendations of the Financial Action Task Force (FATF) on money laundering. In addition to its association with IOSCO, SEBI has been actively co-operated with foreign regulators, self-regulatory organisations, international financial institutions, international standards-setting bodies and other international agencies of repute and relevance for the development and regulation of securities markets. Risk Management Various measures have been taken to ensure a prudential market structure. The establishment of central counterparties, introduction of cross-margining for all 2 National Council Of Applied Economic Research, How Households Save and Invest: Evidence from NCAER Household Survey, July, 2011, Sponsored by, SEBI. 81

18 categories of investors, straight-through processing, derivatives trading (including currency futures), short selling, securities lending and borrowing, margining for institutional investors in the equity cash segment, corporates governance norms for listed companies, know your customer (KYC) norms and minimum public float, etc., have brought the Indian securities market at par with the matured markets. Introduction of robust risk management systems have ensured that there should be no defaults in the system even when there are unprecedented movements in the markets caused largely by global factors. After the implementation of these norms, activities in the securities market continued smoothly. The settlement of trades also continued at an uninterrupted pace. Professional Intermediation Intermediaries bridge the gap between investors and issuers in securities markets. Therefore, the way intermediaries deal with their clients influences their trust and willingness to carry out business in the market. In order to enhance the quality of intermediation, SEBI, apart from regulating their activities, has taken several steps to ensure that intermediaries are adequately equipped, both in terms of physical infrastructure as well as professionally qualified staff, to discharge their responsibilities in a professional and cost-effective manner. Trading in Equity Derivatives To provide liquidity to the market and to enable the market to absorb larger shocks, derivatives trading were introduced. To begin with, trading was allowed in June 2000 in index futures contracts based on the S&P CNX Nifty and BSE- 30 (Sensex) index at the NSE and the BSE, respectively. Trading in index options, stock options and futures on individual stocks commenced during June, July and November 2001, respectively. 82

19 Internet Trading SEBI has allowed the use of internet as an order routing system for communicating investors orders to the exchanges through the registered brokers. These brokers should obtain the permission from their respective stock exchanges. In February 2000, NSE became the first exchange in the country to provide web-based access to investors to trade directly on the Exchange followed by BSE in March The orders originating from the PCs of investors are routed through the internet to the trading terminals of the designated brokers with whom they have relations and further to the exchange. After these orders are matched, the transaction is executed and the investors get the confirmation directly on their PCs. Compulsory T+2 Rolling Settlement Rolling settlement was introduced on a voluntary T+5 basis in the demat segment of the stock exchanges on January 15, 1998 to expedite the trading and settlement process and improve the efficiency of the securities market. In , compulsory T+5 rolling settlement were introduced for all scrips listed and traded in any stock exchange in India. The rolling settlement cycle was shortened from T+5 to T+3 with effect from April 1, The clearing and settlement cycle time was further contracted to T+2 with effect from April 1, 2003 for quick settlement and lower settlement risk in the Indian capital market. Exchange Traded Derivatives Contracts on Currency and Interest Rate To make the Indian capital market more efficient, transparent and world class, new products, namely, interest rate futures contracts (June 2003) and futures and options contracts on sectoral indices (August 2003) were introduced. FIIs and Non- Resident Indians (NRIs) were also permitted to invest in all exchange traded derivative contracts. Exchange-traded derivatives contracts on a notional 10-year government bond were allowed for trading. Stock brokers were allowed to trade in commodity derivatives. Based on the recommendation of the RBI SEBI Standing Technical Committee on exchange-traded currency futures, SEBI laid down the 83

20 framework for the launch of exchange-traded currency futures. This included eligibility norms for existing and new exchanges and their clearing corporations/houses, eligibility criteria for members of such exchanges/ clearing corporations/ houses, product design, risk management measures, surveillance mechanisms and other issues pertaining to exchange- traded currency futures. The NSE commenced trading in currency futures on August 29, 2008, the BSE commenced trading on October 1, 2008 and the MCX-SX commenced trading on October 6, Implementation of STP Mandatory processing of all institutional trades executed on the stock exchanges through Straight-Through Processing (STP) was introduced with effect from July 1, This was in continuation of the efforts made by SEBI to ensure interoperability between STP service providers through the setting up of a centralised STP hub. Corporatisation and Demutualisation SEBI envisaged Corporatisation and Demutualisation (C&D) of exchanges to do away with conflicts of interest existing in mutual stock exchanges where ownership, management and trading rested with the same set of people. In order to expedite this, SEBI approved and notified the C&D schemes of 19 stock exchanges during The NSE and OTCEI were already notified as corporatised and demutualised stock exchanges vide the notifications dated March 23, 2005 and September 15, 2005, respectively. Gold Exchange Traded Funds (GETF) Pursuant to the announcement made by the Finance Minister in his Budget Speech for , SEBI (Mutual Funds) Regulations, 1996 was amended to permit mutual funds to introduce GETFs in India subject to certain investment restrictions. 84

21 Dissemination of Filings At the instance of SEBI, the BSE and the NSE jointly launched a common portal ( on January 1, 2007 to disseminate the filings made by companies listed on these exchanges, in terms of the listing agreement. Permanent Account Number (PAN) PAN was made mandatory for all demat accounts pertaining to all categories including minors, trusts, foreign corporates bodies, banks, corporatess, FIIs, and NRIs. SEBI stipulated that PAN would be the sole identification number for all participants in the securities market, irrespective of the amount of transaction with effect from July 2, The objective was to strengthen the Know Your Client (KYC) norms through a single identification. Grading of IPOs It has been made mandatory for IPOs to obtain grading from at least one credit rating agency registered with SEBI. The grading is required to be disclosed in the prospectus, abridged prospectus and in every advertisement for IPOs. Short Selling and Securities Lending and Borrowing (SLB) SEBI specified the broad regulatory framework for short selling by institutional investors and a full-fledged securities lending and borrowing scheme. Accordingly, relevant amendments were made to SEBI (FII) Regulations, 1995 and SEBI (Mutual Funds) Regulations, 1996, enabling FIIs and mutual funds to participate in short selling and SLB. Introduction of Direct Market Access With a view to increase liquidity, bring about greater transparency, lower the impact cost for large orders and reduce the risk of error associated with manual execution of client orders; the facility of Direct Market Access (DMA) was introduced. This facility allows brokers to offer its clients direct access to the 85

22 exchange trading system through the broker's infrastructure without manual intervention by the broker. Cross Margining across Exchange- Traded Equity (Cash) and Exchange- Traded Equity Derivatives (Derivatives) Segments In order to improve the use of capital by market participants, SEBI extended the facility of cross-margining across the cash and derivatives segments to all categories of market participants. To begin with, a spread margin of 25 per cent of the total applicable margin on the eligible offsetting positions is levied in the respective cash and derivatives segments. Transition from DIP Guidelines to ICDR Regulations SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 replaced SEBI (Disclosure and Investor Protection) Guidelines. Extension of Trading Hour Exchanges were allowed to set any trading hours between 9 a.m. and 5 p.m., provided they have in place a risk management system and infrastructure commensurate to the trading hours. Combating Financing of Terrorism During , directions were issued to stock exchanges, depositories and all registered intermediaries to comply with Combating Financing of Terrorism (CFT) under the Unlawful Activities (Prevention) Act, Corporate Debt Market SEBI directed the BSE and the NSE to introduce a trade-reporting platform for corporates bonds in Continuing with the rationalisation of disclosure norms for listing debt issuances, the listing agreement for debt securities was further simplified. All trades in corporates bonds between specified entities, viz., mutual 86

23 funds, foreign institutional investors/ sub-accounts, venture capital funds, foreign venture capital investors, portfolio managers, and RBI regulated entities as specified by the RBI had to be necessarily cleared and settled through the National Securities Clearing Corporation Limited (NSCCL) or the Indian Clearing Corporation Limited (ICCL). The provisions of this circular apply to all corporate bonds traded Over-the- Counter (OTC) or on the debt segment of stock exchanges on or after December 1, Flexibility to Set Expiry Date/Day for Equity Derivatives Flexibility to set the expiry date/ day for equity derivative contracts was allowed to the stock exchanges. Reforms in Mutual Funds Industry In order to empower mutual funds investors through transparency in payment of commission and load structure, entry load was abolished for all mutual fund schemes and investors were allowed to pay commission separately to agents commensurate with the services provided to them by the agent. In order to have parity among all classes of unit holders, it was decided that no distinction among unit holders should be made based on the amount of subscription while charging exit loads. Considering the importance of systems audit in the technology-driven asset management activity, it was decided that mutual funds should have a systems audit conducted by an independent CISA/ CISM-qualified or equivalent auditor. In order to expand the reach of investments in mutual funds, units of mutual fund schemes were permitted to be transacted through registered stock brokers of recognised stock exchanges. Investor Protection and Education Fund For administration of the Investor Protection and Education Fund established by SEBI in 2007, SEBI (Investor Protection and Education Fund) Regulations, 2009 was notified. 87

24 Reduction of Fees Charged by SEBI In order to revise and reduce the fees payable by some intermediaries and market participants viz., custodian of securities, FIIs, FVCI, mutual funds and stock brokers and sub-brokers, SEBI (Payment of Fees) (Amendment) Regulations, 2009 was notified. As a result of these actions by SEBI, there has been a qualitative as well as quantitative transformation of the Indian securities market. New classes of investors, intermediaries and products have emerged and have been growing over the years. Mutual funds, FIIs and venture capital funds, domestic as well as foreign, have become active investors in the Indian stock markets. The role of traditional intermediaries like registrar and transfer agents has been rationalised with dematerialization and the emergence of depositories and depository participants. Regulatory and structural reforms in primary market have resulted in the consolidation of intermediation services in the primary market. A comparison of Indian stock exchanges with major stock exchanges in the world shows that the NSE and the BSE have recorded the highest average annual growth in market capitalisation during the past two decades. 3.9 Leading Stock Exchanges in India The two leading stock exchanges in India are Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). A brief about them is as under: Bombay Stock Exchange Limited It is the oldest stock exchange in Asia with a rich heritage. Popularly known as "BSE", it was established as "The Native Share & Stock Brokers Association" in It is the first stock exchange in the country to obtain permanent recognition in 1956 from the Government of India under the Securities Contracts (Regulation) Act, 1956.The Exchange's pivotal and pre-eminent role in the development of the Indian capital market is widely recognised and its index, SENSEX, is tracked worldwide. 88

25 Earlier an Association of Persons (AOP), the Exchange is now a demutualised and corporatised entity incorporates under the provisions of the Companies Act, 1956, pursuant to the BSE (Corporatisation and Demutualisation) Scheme, 2005 notified by the Securities and Exchange Board of India (SEBI). The Exchange has a nation-wide reach with a presence in 417 cities and towns of India. The systems and processes of the Exchange are designed to safeguard market integrity and enhance transparency in operations. During the year , the trading volumes on the Exchange showed robust growth. The Exchange provides an efficient and transparent market for trading in equity, debt instruments and derivatives. The BSE's On Line Trading System (BOLT) is a proprietary system of the Exchange and is BS certified. The surveillance and clearing & settlement functions of the Exchange are ISO 9001:2000 certified National Stock Exchange NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporates in November 1992 as a tax-paying company unlike other stock exchanges in the country. On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June It uses satellite communication technology to energies participation from around 320 cities spread all over the country. NSE can handle up to 60 Lakhs trades per day in Capital Market segment. 89

26 NSE is one of the largest interactive VSAT based stock exchanges in the world. Today it supports more than 3000 VSATs. The NSE- network is the largest private wide area network in the country and the first extended C- Band VSAT network in the world. Currently more than 9000 users are trading on the real timeonline NSE application. There are over 15 large computer systems which include non-stop fault-tolerant computers and high end UNIX servers, operational under one roof to support the NSE applications. This coupled with the nationwide VSAT network makes NSE the country's largest Information Technology user. The trading intensity of Indian stock exchanges is impressive by world standards. Among the biggest exchanges, measured by the number of trades per calendar year, the National Stock Exchange (NSE) retained rank 3 in all the four years. The Bombay Stock Exchange (BSE) climbed from rank 7 to rank 5 between 2002 and 2003, and has stayed at rank 5 ever since Settlement and Settlement Cycles Settlement refers to the process in which traders who have made purchases make payments while those who have sold shares, deliver them. The exchange ensures that buyers receive their shares either in the physical or the Demat form. Similarly, sellers who have delivered shares to the exchange receive payment for the same. The process of settlement is managed by stock exchanges through Clearing House (CH) entities, formed specifically to ensure that the process of settlement takes place smoothly. SEBI introduced a new settlement cycle known as the 'rolling settlement cycle.' This cycle starts and ends on the same day and the settlement takes place on the 'T+5' day, which is 5 business days from the date of the transaction. Hence, the transaction done on Monday will be settled on the following Monday and the transaction done on Tuesday will be settled on the following Tuesday and so on. Hence, unlike a BSE or NSE weekly settlement cycle, in a rolling settlement cycle, 90

27 the decision has to be made at the conclusion of the trading session, on the same day. Rolling settlement cycles were introduced in both exchanges on January 12, Internationally, most developed countries follow the rolling settlement system. For instance, both the US and the UK follow a rolling settlement (T+3) system, while the German stock exchanges follow a T+2 settlement cycle Clearing Houses Clearing house is an exchange-associated body charged with the function of ensuring (guaranteeing) the financial integrity of each trade. Orders are cleared by means of the clearinghouse acting as the buyer to all sellers and the seller to all buyers. Clearing houses provide a range of services related to the guarantee of contracts, clearance and settlement of trades, and management of risk for their members and associated exchanges Trading Procedures Clients have to open an account with a member of the exchange. When they want to trade in futures, they instruct members to execute orders in their account. The trade details are reported to the clearing house. If a member of the exchange is also a member of clearing house, then he directly deposits the margins with the clearing house. If he is not a member then he should route all transactions through a clearing member for maintaining margins Green Shoe Option Green Shoe Option (GSO) means an option of allocating shares in excess of the shares included in the public issue and operating a post listing stabilizing mechanism, which is granted to a company. In case, an issuer company is making an IPO through book-building mechanism, it can avail of the GSO subject to certain conditions. It shall, in the resolution of the general meeting authorizing the public issue seek authorization agent at the end of the stabilizing period. A lead book runner 91

28 shall be appointed as the stabilizing agent (SA) and shall be responsible for the price stabilization process, if required. The SA shall also enter into an agreement with the promoter who shall lend their shares specifying the maximum number of shares that may be borrowed from the promoters which shall not be more than 15 percent of the total issue size. The allocation of these shares shall be prorate to all the applicants Book Building Process This is a process of offering securities in which bids at various prices from investors through syndicate members and based on bids, demand for the security is assessed and its price discovered. The issue of capital should be 25 Crores and above. Reservation for firm allotment to the extent of the percentage specified in the relevant SEBI guidelines can be made only to promoters, permanent employees of the issuer company and in the case of new company to the permanent employees of the promoting company. It can also be made to shareholders of the promoting companies, in the case of new company and shareholders of group companies in the case of existing company either on a competitive basis or on a firm allotment basis. The issuer company should appoint eligible merchant bankers as book runner(s) and their names should be mentioned in the draft prospectus. The lead merchant banker should act as the lead book runner and the other eligible merchant bankers are termed as co-book runner. The issuer company should compulsorily offer an additional 10% of the issue size offered to the public through the prospectus IPO through Stock Exchange On-Line System (E-IPO) In addition to other requirements for public issue as given in SEBI guidelines wherever applicable, a company proposing to issue capital to public through the online system of the stock exchange for offer of securities has to comply with the additional requirements in this regard. They are applicable to the fixed price issue as well as for the fixed price portion of the book-built issues. The issuing company would have the option to issue securities to public either through the on-line system of the stock exchange or through the existing banking channel. For E-IPO the 92

29 company should enter into agreement with the stock-exchange(s) and the stock exchange would appoint SEBI registered stockbrokers of the stock exchange to accept applications. The brokers and other intermediaries are required to maintain records of (a) orders received, (b) applications received, (c) details of allocation and allotment, (d) details of margin collected and refunded and (e) details of refund of application money Performance of Indian Securities Market during The turnover in the cash market has nearly doubled over the decade while the market capitalization has become eight times the levels that existed in The turnover in the Indian derivatives market has increased from 8,600 Crores in to 3,92,000 Crores in and has surpassed the cash market turnover in India. The resource mobilization in the primary market has increased dramatically, rising six fold between 2000 and Similarly, the resource mobilization through euro issues has increased significantly over the years. Table-3-2 shows the performance in the capital market in terms of certain key indicators. 93

30 Table 3.2 Key performance Indicators of Securities Market ( ) Parameters Compound annual growth Rate( to ) Resource Mobilisation in Primary Market 17.15% Resource Mobilisation through Euro issues 43.89% All India Market Capitalisation 23.15% All India Equity Market Turnover* 19.94% All India Equity Derivatives Turnover % Assets under Management of Mutual Funds Net Investment by Foreign Institutional Investors 18.99% 30.53% Net Investments by Mutual Funds 54.07% Returns on Nifty % * CAGR calculated from to Source: A review of Indian Securities Market, Volume XIII, The performance of the Indian capital market has been impressive with high returns and a high level of investment from both domestic and foreign investors. On the other hand, India s debt market, particularly the corporate bond market is still underdeveloped. Of late, efforts have been made to bring regulatory changes to develop the corporate bond market. However, sustained effort and long-term commitment are needed to realize the true potential of this segment. The growth of India s derivatives market has been significant but needs to develop further in terms of products and investor base. 94

31 Growth of Primary Market Primary market is a place where new securities are bought and sold for the first time. It is also called the New Issues market or the IPO market. In other words the first public offering of equity shares or convertible securities by a company, which is followed by the listing of a company s shares on a stock exchange, is known as an Initial Public Offering (IPO). The Primary market also includes issue of further capital by companies whose shares are already listed on the stock exchange. There are different types of intermediaries operating in the primary market. They play a crucial role in the development of capital market by providing a variety of services. These intermediaries viz., merchant bankers, brokers, bankers to issues, debenture trustees, portfolio managers, registrars to issues and share transfer agents etc., are regulated by SEBI. An efficient primary market is critical for resource mobilisation by corporates to meet their growth and expansion plans. The development of primary markets in India has followed a unique pattern. While the number of issues in the early nineties was very high (more than 1,000), the aggregate resources mobilised was not significant. However, in the first decade of the 21st century the trend gradually reversed; the number of issues remained low (less than 200) but the amount mobilised increased significantly. The only exception to this trend was during when the US was hit by the subprime crisis leading to a global financial crisis and the cascading effect was felt in emerging markets. Where in an amount of 87,029 Crores was mobilised through 124 public and rights issues, the amount mobilised fell to a mere 16,220 Crores through 47 issues in With the gradual waning of the sub-prime crisis in , the market regained confidence and an amount of 57,555 Crores was mobilised through 76 issues (Figure 3.1). 95