Unit I Introduction to Securities Market in India

Unit – I Introduction to Securities Market in India Presented by A. Musthaffa, MBA, M. Phill, (Ph. D), Assistant Professor, K. S. R. School of Management, K. S. R College of Technology, Tiruchengode.

Securities Market • A Market is a place used for buying and selling of Goods, similarly the Financial assets transferred are corporate securities and Govt. securities, the Mechanism of transfer is known as ‘Securities Market’. • In the securities markets, organizational innovation has been witnessed with corporatisation and demutualization of all the stock exchanges; institutional innovations in the form of emergence of regulators, self regulatory organizations and clearing corporations and more recently, market innovations through a short selling and securities lending and Borrowing Scheme, Direct Market Scheme, addressing of the legal, regulatory, tax and market design issues in the development of the corporate bond in the country, provisions for legal frame work for trading of securitized debt, quicker procedures for registration and operation by FII’s making PAN as the sole identification number for all transactions in securities market and new derivative products such as currency futures.

Market Segments • The Securities Market has two interdependent and inseparable segments, the New Issues (Primary) market and the Stock (Secondary) Market. • The primary Market provides the channel for creation and sale of new securities, while the Secondary Market deal in Securities Previously Issued. • The securities issued in the primary market are issued by Public Limited Companies or by Govt. agencies. • The capital of market are mobilized either through Public Issue or through private placement route. • It is a Public issue if anybody and everybody can subscribe, Where as if the issue is available made available to a selected group of persons, it is termed as Private Placement.

Market Segments • There are two major types of issuers of securities, the corporate entities who issue mainly debt and equity instruments and the Govt. (central as well as state) who issue debt securities( dated securities and treasury bills). • The secondary market enables participants who hold securities to adjust their holdings in response to change in their assessment of risks and returns. • Primary market the New issue and they are traded in stock exchange. • The secondary Market trades through Two mediums, Namely i) OTC & ii) Exchange traded.

Market Segments • OTC markets are informal markets where trades are negotiated. • Most of the trades in Govt. Securities are in the OTC Market. • All spot trades where securities are traded for immediate delivery and payment take place in the OTC Market. • The Exchanges in India follow a systematic settlement period. • The trading cycle (day = T) are settled together after a certain time (T+2 day). • The Trades executed on Exchanges are cleared and settled by a clearing corporation. • The clearing corporation acts as a counterparty and guarantees settlement.

Market Segments- International Scenario. • A variant of the secondary market is the forward market, where securities are traded for future delivery and payment. • A variant of the forward market is futures and options market. • Presently only two exchanges NSE & BSE provides trading in the futures & options. • India has the second largest number of listed companies after the USA. • As per Standard and Poor’s Fact Book 2007, India ranked 8 th in terms of Market Capitalization and 15 th in terms of Turnover Ratio as of December 2007.

International Comparison: End December 2007. Particu USA lars No. of. Compa nies 5, 130 Market Capital 19, 947 isation( US $ bn Market Capital 149. 01 isation Ratio( UK Japan Germ Sing Hong China India any apore Kong 2, 588 3, 844 658 472 1, 029 1, 530 4, 887 3, 859 4, 453 2, 106 353 1, 163 6, 226 1, 819 157. 13 90. 25 69. 43 274. 583. 8 237. 5 200. 0 41 9 6 9

International Comparison: End December 2007. Particular USA s Turnover ( US $ 42, 61 bn) 3 Turnover Ratio 216. 5 UK Japan Germ Sing Hong China India any apore Kong 10, 324 6, 497 3, 363 384 917 7, 792 1, 108 270. 1 141. 6 179. 7 122 89. 1 180. 1 84

Market Concentration in the World Index as on End 2007 Market Index Stock Share of Total Market Capitalization 10 largest index stock’s share of Total Market Capitalization Japan 73. 9 14. 8 Singapore 63. 4 32. 8 France 60. 4 29. 7 Germany 71. 1 41. 8

Market Concentration in the World Index as on End 2007 Market Index Stock Share of Total 10 largest index Market Capitalization stock’s share of Total Market Capitalization US 78. 1 12. 4 UK 89. 7 36. 0 India 77. 5 26. 8

Key Strengths of Indian Security Markets. • • • Automated Trading System. Wide Range of Products Integrated Platform for trading in both cash and derivatives. 4000 Corporate Brokers SEBI is Independent and Effective Regulator Trading Mechanism Settlement Cycles Risk Management NSE & BSE

Regulatory Framework • The five main Acts governing the securities markets are (a) the SEBI Act, 1992; (b) the Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to issuance, allotment and transfer of securities, and disclosures to be made in Public Issues; © the Securities Contract Regulation Act, 1956, which provides for regulation of transactions in securities through control over stock Exchanges, (d) the Depositories Act, 1996, which provides for electronic maintenance and transfer of ownership of demat shares and, (e) Prevention of Monetary Laundering Act, 2002.

Legislations • Capital Issues (Control) Act, 1947 – The Act was passed during the war time in 1943, the objective of the Act was to channel resources to support the war effort. Control the raising of capital by companies and to ensure that national sources were channeled into proper lines. – Under the Act, any firm wishing to issue securities had to obtain approval from the central Govt. , which also determined the amount type and price of the issue. As part of the liberalization process, the Act was repealed in 1992 paving way for market determined allocation of resources.

Legislations • SEBI Act, 1992: – The SEBI Act, 1992 was enacted to empower SEBI with statutory powers for (a) Protecting the interests of investor in securities, (b) Promoting the development of the securities market, © regulating the securities market – Its regulatory jurisdiction extends over corporate in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with securities market. – To conduct enquiries, audits and inspection of all concerned and adjudicate offences under the Act. SEBI has power to register and regulate all market intermediaries and also to penalize them in case of violations of the Act. SEBI has full autonomy and authority to regulate and develop an orderly securities market.

Legislations • Securities Contract (Regulation Act), 1956 – This Act provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and aims to prevent undesirable transactions in securities. It gives central Govt. regulatory jurisdiction over the following activities. (a) Stock Exchanges through a process of recognition and continued supervision, (b) Contracts in securities © Listing of Securities on Stock Exchanges. – Organized trading activity in securities takes place on a specified recognized stock exchange, and determine their own listing regulations which have to conform to the minimum listing criteria set out in the rules.

Legislations • Depositories Act, 1996 – The Depositories Act, 1996 provides for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security by making securities of Public Limited Companies freely transferable subject to certain exceptions, dematerializing the securities in the depository mode and providing for maintenance of ownership records in a book entry form.

Legislations • Companies Act, 1956 – Companies Act deals with Issue, allotment and transfer of securities and various aspects relating to company management. – This Act provides for standard 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 underwriting, the premium and discount on issues, rights and bonus issues, payment of interest and dividends, supply of annual report and other information.

Legislations • Prevention of Money Laundering Act, 2002 – The Primary Objective of the Act is to prevent money – laundering. – To provide for confiscation of property derived from or involved in money – laundering. – The term money – laundering is defined as whoever acquires, owns, possess or transfers any proceeds of crime; or knowingly enters into any transaction which is related to proceeds of crime either directly or indirectly or conceals or aids in the concealment of the proceeds or gains of crime within India or outside India commits the offence of laundering.

Types of Securities. • Corporate Securities. • BONDS – A bond is a long-term loan issued in the form of a negotiable security by a corporation, government, or government agency. Bonds are loans from the bondholder (buyer) to the issuer (seller). A bond is a promise by the issuer to pay back the amount loaned to it (called principal) plus an agreed to amount of interest on or before a stated date. – The interest may be paid periodically during the life of the loan or all at once when the loan is paid back. Bonds are also called fixed income instruments, because the amount of income that the bond will generate is fixed by the stated interest rate of the bond. The date when the loan becomes due is called the maturity date of the bond.

Types of Bonds • • • • coupon bonds Bearer and Registered Bonds General Obligation and Revenue Bonds Treasury/Government Notes Treasury/Government Bills Participating Bonds Convertible Bonds Zero Coupon Bonds High Yield (Junk) Bonds Warrant Bonds or Bonds with Warrants Indexed Bonds, Sinking Bond Funds, Commercial Paper Mortgage backed securities

Types of Securities. • EQUITIES – The principal focus of securities regulation is on the equities market because it attracts much more interest from the general public which are usually less sophisticated than professional or institutional investors. This market trades shares of common stocks issued by corporations

Types of EQUITIES. • • • Common Stock Preferred Stock Par Value Book Value Classes of Stock Splits Dividends Ex-Dividend DRIPS Treasury Stock Depository Receipts

Types of Securities. • COMMODITIES – A commodity is not technically a security, but the contract to buy or sell the commodity is a security. Because it is the contracts to buy or sell that are being traded, investors deal with these securities without ever seeing the commodity that is the subject of the contract. The commodities market involves the purchase or sale of products such as oil, gold, silver, copper, and many agricultural product. – Currency markets have become the ultimate commodity markets with worldwide influence. Interest rates and specific stock indexes are two other of the most recently introduced subjects of commodity contracts.

Types of Securities. • DERIVATIVES – The word derivative means taken from something else. In securities, it usually means taken from a direct security such as a bond or stock. These securities are direct obligations or investments. Everything else is derived from one of these instruments. Financial products that were once called “hedging instruments” are now called derivatives but are still widely used for the purpose of hedging.

Types of Derivatives • Forward contract • Futures • Options – Call option – Put option • Swaps – Interest Rate Swaps – Currency Swaps – Credit Default Swaps

Types of Securities • ISLAMIC INVESTING PRINCIPLES – Halal –Islamic and approved – Haram - non-Islamic and prohibited • The Islamic Capital Market is similar to conventional capital markets and is represented by both equity and bond markets. Fundamental to Islamic capital market operation, is that all financial transactions must conform with the Syariah principles. The main prohibited (haram) actions under the Syariah principals are riba and gharar. • Riba means literally an increase or addition. Technically, in a loan transaction, it denotes any increase or advantage obtained by the lender as a condition of the loan. It is generally interpreted to mean that interest cannot be charged on loans. It also means that in practice rather than charging interest on loans, the investor takes a share in the profits, if any, and is liable for any losses. The activity therefore involves investing not lending and is more similar to the German, Japanese and Spanish banking systems rather than the British or American systems.

Types of Securities • With Islamic investments, therefore, interest is converted into capital gains. Profit and loss sharing, with the profit sharing ratio predetermined, is Hallal. Under the Syariah principals, then, zerocoupon or discount bonds are approved, since these instruments forgo interest and take any profits in the form of capital gains. Any equity or derivative would also seem to be approved since they are profit sharing instruments and not interest paying. • Gharar denotes deception, uncertainty or ambiguity and generally refers to the existence of an element of deception in the trade or exchange through ignorance of the goods or the price through faulty description of the goods Another principle of Islamic investing is governed by the Quran that distinguishes between interest and trade. This principle urges Muslims to receive only the principal sum loaned and the principal should only be taken back subject to the ability of the borrower to repay it. The distinction between interest and trade allows various Islamic financial instruments to “mark up” deferred payments or early payment discounts, trade financing commissions and leasing transactions Less clear is what is meant by “ability to repay” and what triggers such an inability.

Types of Securities • Islamic loans are, therefore, a good deal more risky than conventional interest bearing securitized loans. Islamic investments exclude tobacco, alcohol, gaming and other undesirable sectors. These investments, therefore, are similar to what in the West is known as “socially conscience” or “ethical” investments. Many Western collective investment schemes are operated under these principles.

ISLAMIC INVESTMENT BANKING TERMS • Islamic borrowers are reluctant to give away a share in the profits of their enterprise and therefore Islamic banking takes the form of a “mark-up” rather than profit sharing. The mark up method is favored because it is simple in design, profitable in return and its short-term nature is ideal for managing liquidity in a market with little or no inter-bank facility. • Al-Wadiah Yad Dhamanah (safekeeping with guarantee) refers to goods and deposits that have been deposited with another person who is not the owner for safekeeping. Wadiah is a trust and the depository becomes the guarantor who guarantees repayment of the whole amount of the deposit or any part thereof outstanding in the account of the depositors when demanded. The depositors are not entitled to any share of the profits but the depository may provide returns as a gift

ISLAMIC INVESTMENT BANKING TERMS • Bai ‘al-Istijar refers to an agreement between the client and the supplier, whereby, the supplier agrees to supply a product on an ongoing basis at an agreed price and on the basis of an agreed mode of payment • Bai ‘al salam involves the advance payment for goods to be delivered later. There is no sale unless goods exist at the time of the deal or are defined and a date is fixed. At first glance this looks like a commodities future except that the parties cannot reserve the option of rescinding the contract. If the product is defective on delivery there is redress. This is typically used to fund agricultural production to help a farmer buy seed.

ISLAMIC INVESTMENT BANKING TERMS • Ijara is the Islamic form of leasing. The bank buys machinery or other equipment and leases it out under installment plans. As with western leasing there may be an option to buy the goods built into the contract. Ijara wa iqtina is renting then purchasing at the end of the contract. • Istisna is a contract for the acquisition of goods by specific order where the price is paid progressively in accordance with the progress of job completion. This is used, for example, in the construction of a house where payments made to the builder or the developer are made according to the stages of work completed.

ISLAMIC INVESTMENT BANKING TERMS • Murabahah is cost-plus financing. The bank finances the purchase of an asset by buying it on behalf of its client. The bank then adds a “mark-up” in its sale price to its client who pays for it on an installment basis. The bank stands in between the buyer and the seller and is liable if anything goes wrong. There is thus some sort of guarantee with respect to the quality of the goods provided. Title to the goods financed may pass tothe client at the outset or on a deferred basis. • Mudharabah/Muqaradhah is trust financing and is similar to a loan, except that there is no interest paid and the principal is at risk. The lenders/investors (rabb al-mals) “invest” through a (mudarib) who manages the project. Profits are shared on a pre-agreed basis, but losses are born only by the rabb al-mals, or investors. The rabb almals have no control over the management of the project

ISLAMIC INVESTMENT BANKING TERMS • Musyaraka is financing through equity participation in a partnership. Here the partners or shareholders use their capital through a joint venture. Profits are split between the shareholders according to some agreed to formula linked to the investment ratio. The ratio takes into account the resources contributed by each party, not just financial but also experience and expertise. Losses are shared strictly on the basis of equity participation. Management of the project may be carried out by either, both or only one of the parties.

Recent initiatives and developments in Indian Securities Markets Introduction of Application Supported by Blocked Amount (ASBA) (April 2008) SEBI introduced the Application Supported by Blocked Amount (ASBA) as a new mode of payment in public issues. In this kind of mechanism the application money remains blocked in the bank account of the applicant till the allotment is finalized. Direct Market Access (April 2008) Direct Market Access facility was introduced for institutional investors in April 2008 by SEBI

Recent initiatives and developments in Indian Securities Markets Margining of Institutional In an Endeavour to strengthen the risk management framework, margining for Trades in Cash Market institutional trades was made mandatory by (May 2008) SEBI. Corporate Debt Market Initiatives (May 2008 and June 2008 • Notification of Listing of Securitized Debt Instruments Regulations in May 2008. • Notification of Issue and Listing of Debt Securities Regulations in June 2008.

Recent initiatives and developments in Indian Securities Markets Reduction in time for Rights Issues (2009) To eliminate risks faced by issuers and investors and to enable listed companies to raise funds from its shareholders, time taken for completion of rights issues was reduced from 16 weeks to 6 weeks. Disclosure of Pledged Shares by Promoters/ Promoter Group in Listed Companies January 2009 Clause 35 and Clause 41 of listing agreement was amended to provide for disclosure of details of shares held by promoters and promoter group entities in listed companies which are pledged.

Recent initiatives and developments in Indian Securities Markets New provisions introduced in Clause 49 to enhance Corporate Governance standards for listed companies To enhance the standards of corporate governance, new provisions were included in clause 49 of listing agreement. These requirements were: (i) Having at least one-half of the board as non-independent directors if the non executive chairman of the company is a promoter or is related to promoters or persons occupying management positions. (ii) Minimum age limit of 21 years for independent directors.

Recent initiatives and developments in Indian Securities Markets New provisions introduced in Clause 49 to enhance Corporate Governance standards for listed companies (iii) Specifying the maximum time gap i. e. 180 days between the retirement and resignation of an independent director and appointment of another independent director in his place (iv) Requiring the listed companies to disclose the inter-se relationship between the directors in the filing made with stock exchanges.

Recent initiatives and developments in Indian Securities Markets Changes in SLB Scheme The Securities Lending and Borrowing (SLB) Scheme was introduced in April (October 2009) 2008 and various modifications were made pursuant to the feedback received from market participants. These modifications include increasing the tenure and duration of SLB sessions, allowing margins in cash and cash equivalent form for SLB and providing clarification for dealing with corporate actions.

Recent initiatives and developments in Indian Securities Markets Launch of Currency Futures (August 2008) Currency Futures were launched on USDINR pair in India in August 2008 by NSE, and in October 2008 by BSE and MCX. Removal of quantitative restrictions imposed on the Overseas Derivatives Instruments (ODIs) for FII (October 2008) The quantitative restrictions imposed on the ODI issuance capabilities and restrictions on ODI were removed from October 7, 2008. SEBI issued a disapproval note on the activity of FIIs which had the effect of lending of shares abroad in an OTC market, an activity which was not allowed onshore

Recent initiatives and developments in Indian Securities Markets Exit Option to Regional Stock Exchanges (RSEs) December 2008 SEBI put in place broad guidelines for exit option for RSEs whose recognition was withdrawn/ refused by SEBI or for RSEs who wanted to surrender their recognition Listing of Close-ended Listing of close-ended schemes launched schemes for Mutual Funds on or after December 12, 2008 along with daily computation of NAV was made (December 2008) compulsory.

Recent initiatives and developments in Indian Securities Markets Launch of IRFs (August 2009) SEBI permitted NSE to launch Interest Rate Futures on August 31, 2009. Issue of Capital and Disclosure Requirements (ICDR) Regulations 2009 September 2009 In September 2009, the SEBI issued Issue of Capital and disclosure requirements (ICDR) Regulations 2009 replacing the Disclosure and Investor Protection (DIP) Guidelines 2000. ICDR would govern all disclosure norms regarding securities and no changes to this can now be made without the consent of SEBI.

Role of NSE in Indian Securities Market • In Union of India Vs. Allied International Products Ltd. 1971) 41 Comp Case 127 SC]: (1970) 3 SCC 5941), the Supreme Court of India has enunciated the role of the Stock Exchanges in these words: • “A Stock Exchange fulfills a vital function in the economic development of a nation: its main function is to ‘liquify’ capital by enabling a person who has invested money in, say a factory or railway, to convert it into cash by disposing off his shares in the Investment in Joint stock companies is attractive to the public, because the value of the shares is announced day after day in the stock exchanges, and shares quoted on the exchanges are capable of almost immediate conversion into money. In modern days a company stands little chance of inducing the public to subscribe to its capital, unless its shares are quoted in an approved stock exchange. All public companies are anxious to obtain permission from reputed exchanges for securing quotations of their shares and the management of a company is anxious to inform the investing public that the shares of the company will be quoted on the stock exchange”.

Role of NSE in Indian Securities Market The stock exchange is really an essential pillar of the private sector corporate economy. It discharges three essential functions: • First, the stock exchange provides a market place for purchase and sale of securities viz. shares, bonds, debentures etc. It, therefore, ensures the free transferability of securities which is the essential basis for the joint stock enterprise system. • Secondly, the stock exchange provides the linkage between the savings in the household sector and the investment in the corporate economy. It mobilizes savings, channelises them as securities into these enterprises which are favored by the investors on the basis of such criteria as future growth prospects, good returns and appreciation of capital.

Role of NSE in Indian Securities Market • Thirdly, by providing a market quotation of the prices of shares and bonds- a sort of collective judgment simultaneously reached by many buyers and sellers in the market- the stock exchange serves the role of a barometer, not only of the state of health of individual companies, but also of the nation’s economy as a whole. • NSE was given recognition as a stock exchange in April 1993.

Objectives of NSE 1. 2. 3. 4. 5. To establish a nationwide trading facility for all types of securities. To ensure equal access to all investors all over the country through an appropriate communication network. To provide a fair, efficient and transparent securities market using electronic trading system. To enable a shorter settlement cycles and book entry settlements and To meet the international benchmarks and standards

Role of NSE in Indian Securities Market • NSE has set up infrastructure that serves as a role model for the securities industry in terms of trading systems, clearing and settlement practices and procedures. The standards set by NSE in terms of market practices, products, technology and service standards have become industry benchmarks and are being replicated by other market participants. • It provides screen-based automated trading system with a high degree of transparency and equal access to investors irrespective of geographical location. The high level of information dissemination through on-line system has helped in integrating retail investors on a nation-wide basis.

Role of NSE in Indian Securities Market • The Exchange currently operates four market segments, namely Capital Market Segment, Wholesale Debt Market Segment, Futures an Options segment and the Currency Derivatives Segment. • NSE has been playing the role of a catalytic agent in reforming the market in terms of microstructure and market practices. Right from its inception, the exchange has adopted the purest form of demutualised set up whereby the ownership, management and trading rights are in the hands of three different sets of people. • It has helped in shifting the trading platform from the trading hall in the premises of the exchange to the computer terminals at the premises of the trading members located country-wide and subsequently to the personal computers in the homes of investors.

Role of NSE in Indian Securities Market • Settlement risks have been eliminated with NSE’s innovative endeavors in the area of clearing and settlement viz. , reduction of settlement cycle, professionalisation of the trading members, finetuned risk management system, dematerialization and electronic transfer of securities and establishment of clearing corporation. • NSE today uses the state-of-art information technology to provide an efficient and transparent trading, clearing and settlement mechanism. • NSE provides a trading platform for of all types of securities-equity and debt, corporate government and derivatives.

Role of NSE in Indian Securities Market • On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, it commenced operations in the Wholesale Debt Market (WDM) segment in June 1994, in the Capital Market (CM) segment in November 1994, in Futures & Options (F&O) segment in June 2000 and Currency Derivatives Segment (CDS) in August 2008. The Exchange started providing trading in retail debt of Government Securities in January 2003. 1. Wholesale Debt Market This segment provides the trading platform for trading of a wide range of debt securities. Its product, which is now disseminated jointly with FIMMDA, the FIMMDA NSE MIBID/MIBOR is used as a benchmark rate for majority of deals struck for Interest Rate Swaps, Forwards Rate Agreements, Floating Rate Debentures and Term Deposits in the country.

Role of NSE in Indian Securities Market 2. NSEs Capital Market This segment offers a fully automated screen based trading system, known as the National Exchange for Automated Trading (NEAT) system, which operates on a strict price/time priority. It enables members from across the country to trade simultaneously with enormous ease and efficiency. 3. NSEs Futures & Options This segment provides trading of a wide range of derivatives like Index Futures, Index Options, Stock Options and Stock Futures. 4. NSEs Currency Derivatives This segment provides trading on currency futures contracts on the USD-INR and other currency pairs which commenced on August 29, 2008 and interest rate futures were allowed for trading in this segment on August 31, 2009

Role of NSE in Indian Securities Market • Technology and Application Systems in NSE chose to harness technology in creating a new market design. It believes that technology provides the necessary impetus for the organization to retain its competitive edge and ensure timeliness and satisfaction in customer service. NSE is the first exchange in the world to use satellite communication technology for trading. It uses satellite communication technology to energize participation from about 2648 VSATs from nearly 201 cities spread all over the country.