The Secondary Market
This chapter will enable you to develop an understanding of the following:
Functions of the secondary market
Post-reforms stock market scenario
Organisation structure of stock exchanges
Listing of securities, trading and settlement arrangements
Stock market index
Stock exchanges such as the Bombay Stock Exchange, the National Stock Exchange, the Over The Counter Exchange of India, the Inter-connected Stock Exchange of India, the Indonext and Regional Stock Exchanges
Measures to boost liquidity in the secondary market: Investment by FIIs, buy back of shares, market making system, rolling settlement and margin trading
Impact of reforms and measures on secondary market activities
The secondary market is a market in which existing securities are resold or traded. This market is also known as the stock market. In India the secondary market consists of recognised stock exchanges operating under rules, by-laws and regulations duly approved by the government. These stock exchanges constitute an organised market where securities issued by the central and state governments, public bodies, and joint-stock companies are traded. A stock exchange is defined under Section 2(3) of the Securities Contracts (Regulation) Act, 1956, ‘as any body of individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities’.
Functions of the Secondary Market
To facilitate liquidity and marketability of the outstanding equity and debt instruments.
To contribute to economic growth through allocation of funds to the most efficient channel through the process of disinvestment to reinvestment.
To provide instant valuation of securities caused by changes in the internal environment (company-wide and industry-wide factors). Such valuation facilitates the measurement of the cost of capital and the rate of return of the economic entities at the micro level.
To ensure a measure of safety and fair dealing to protect investors' interests.
To induce companies to improve performance since the market price at the stock exchanges reflects the performance and this market price is readily available to investors.
Development of the Stock Market in India
The origin of the stock market in India dates back to the end of the eighteenth century when long-term negotiable securities were first issued. The real beginning, however, occurred in the middle of the nineteenth century, after the enactment of the Companies Act in 1850 which introduced the feature of limited liability, and generated investor interest in corporate securities.
The Native Share and Stock Brokers’ Association, now known as the Bombay Stock Exchange (BSE) was formed in Bombay (now Mumbai) in 1875. This was followed by the formation of association/exchanges in Ahmedabad in 1894, Calcutta (now Kolkata) in 1908, and Madras (now Chennai) in 1937. In order to promote the orderly development of the stock market, the central government introduced a comprehensive legislation called the Securities Contracts (Regulation) Act, 1956.
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960s. In 1961, there were 1,203 listed companies across the various stock exchanges of the country. Of these, 576 were listed on the CSE and 297 on the BSE. However, during the later half of the 1960s, the relative importance of the CSE declined while that of the BSE increased sharply.
Table 8.1 below shows the phenomenal growth in the operations of the stock markets in India till the nineties.
Till the early 1990s, the Indian secondary market comprised regional stock exchanges with the BSE heading the list. The Indian stock market was plagued with many limitations, such as the following.
TABLE 8.1 Pattern of Growth of Stock Exchanges
Note: * relates to the BSE, ** relates to the BSE and the NSE.
Source: SEBI, Annual Report, various issues.
Uncertainty of execution prices.
Uncertain delivery and settlement periods.
Front running, trading ahead of a client based on knowledge of the client order.
Lack of transparency.
High transaction costs.
Absence of risk management.
Systemic failure of the entire market and market closures due to scams.
Club mentality of brokers.
Kerb trading—private off-market deals.
POST-REFORMS MARKET SCENARIO
After the initiation of reforms in 1991, the Indian secondary market now has a four-tier form as follows:
Regional stock exchanges
The National Stock Exchanges (BSE and NSE)
The Over the Counter Exchange of India (OTCEI)
The Inter-Connected Stock Exchange of India (ISE)
The NSE was set up in 1994. It was the first modern stock exchange to bring in new technology, new trading practices, new institutions and new products. The OTCEI was set up in 1992 as a stock exchange, providing small- and medium-sized companies the means to generate capital.
In all, there are, at present, 21 stock exchanges in India—15 regional stock exchanges, the BSE, the NSE, the OTCEI and the Interconnected Stock Exchange (ISE) of India. The ISE is a stock exchange of stock exchanges. The 15 regional stock exchanges are located at Ahmedabad, Bangalore, Bhuvaneshwar, Kolkata, Cochin, Coimbatore, Delhi, Guwahati, Indore, Jaipur, Kanpur, Ludhiana, Chennai, Pune and Vadodara. They operate under the rules and by laws and regulations approved by the government and the SEBI.
The MCX Stock Exchange (MCX-SX) was granted recognition on September 16, 2008 by the SEBI. The United Stock Exchange of India Limited (USE) is the latest entrant in the stock markets. It commenced operations in July 2010. It is the fourth currency futures exchange after BSE, NSE and MCX-SX. All 21 Indian public sector banks, leading private sector banks, public sector undertaking and corporates are shareholders of the exchange.
Table 8.2 shows the secondary market structure in India.
Regulation of Stock Exchanges
The stock markets in India are regulated by the central government under the Securities Contracts (Regulation) Act, 1956, which provides for the recognition of stock exchanges, supervision and control of recognised stock exchanges, regulation of contracts in securities, listing of securities, transfer of securities and many other related functions. The Securities and Exchange Board of India Act, 1992, provides for the establishment of the Securities and Exchange Board of India (SEBI) to protect investors’ interest in securities and promote and regulate the securities market.
TABLE 8.2 Secondary-market Structure
Source: SEBI Bulletin, September 2009.
ORGANISATION, MANAGEMENT AND MEMBERSHIP OF STOCK EXCHANGES
The organisational forms of the various recognised stock exchanges in India were as follows:
|(i) Bombay, Ahmedabad and Indore||Voluntary non-profit-making association of persons|
|(ii) Kolkata, Delhi, Bangalore, Cochin, Kanpur, Guwahati, Ludhiana and Chennai||Public limited company|
|(iii) Coimbatore and Pune||Company limited by guarantee|
|(iv) The Over the Counter Exchange of India||A company under Section 25 of the Companies Act, 1956|
The regional stock exchanges were managed by a governing body consisting of elected and nominated members. The trading members, who provide broking services, owned, controlled and managed the exchanges. The governing body was vested with wide-ranging powers to elect office-bearers, set up committees, admit and expel members, manage properties and finances of the exchange, resolve disputes and conduct day-to-day affairs of the exchange.
The OTCEI and the NSE are demutualised exchanges wherein the ownership and management of the exchange are separated from the right to trade on exchange. The National Stock Exchange was the only tax-paying company incorporated under the Companies Act and promoted by leading financial institutions and banks.
Brokers are members of the stock exchange. They enter trades either on their own account or on behalf of their clients. They are given a certificate of registration by the SEBI and they have to comply with the prescribed code of conduct. Over a period of time, many brokers with proprietary and partnership firms have converted themselves into corporate entities. Both NSE as well as OTCEI have laid down strict standards for the admission of members, which relate to capital adequacy, track record, education, experience and so on, to ensure quality broking services.
Brokers are important intermediaries in the stock markets as they bring buyers and sellers together, and aid in price discovery. There are three classes of brokers, namely, proprietary, partnership and corporate. In the old exchanges, most of the brokers are proprietary in nature, whereas in the new exchanges, they are corporate members. Several structural changes have taken place in the Indian broking industry over the past few years. Consolidation and reconstructuring have assumed considerable importance in this segment. As on March 31, 2010, there were 9,772 brokers and 4,424 brokers in the cash segment registered with the SEBI. The CSE has the highest number of brokers followed by the NSE, the OTCEI and the BSE.
A stock broker is required to pay an annual registration fee of Rs. 5,000, if his turnover per year does not exceed Rs. 1 crore. If it does, he has to pay Rs. 5,000 plus one-hundredth of 1% of the turnover in excess of Rs. 1 crore. About 5 years from the date of initial registration, he has to pay Rs. 5,000 for a block of 5 financial years. The exchange also levies transaction charges.
The brokerage on transactions varies from broker to broker. The maximum brokerage that can be levied is 2.5% of the contract price, exclusive of statutory levies such as SEBI-turnover fee, service tax and stamp duty. He is also required to pay the exchange, the transaction charges at the rate of 0.0035% (Rs. 3.5 per Rs. 1 lakh) of the turnover. Trading members are also required to pay securities-transaction tax (STT) on all delivery-based transaction, at the rate of 0.125% (payable by both buyer as well as seller), and, in case of non-delivery transactions, at the rate of 0.025%, for equities payable by the seller alone). Stamp duties are also payable by him as per the rates prescribed by the relevant states.
Brokers can now offer direct market-access (DMA) facility to institutional clients that allow clients a direct access to the exchange-trading system, through the broker's infrastructure, without any manual intervention by the broker. This enables brokers to have a direct control of clients over orders, faster execution of client orders, reduced risk of errors associated with manual-order entry, greater transparency, increased liquidity, lower-impact costs for large orders, better audit trails and better use of hedging and arbitrage opportunities through the use of decision-support tools/algorithms for trading.
Consolidation is taking place in the broking industry. Small brokerages are shutting shop as the big broking entities have cornered a big chunk of the broking business.
Separation of ownership rights and trading rights
Stock exchange is a corporate tax paying entity
Safeguards the interest of investors
Brings out greater transparency in the functioning of the stock exchanges
Demutualisation of Stock Exchanges
All the stock exchanges in India, except the NSE and the OTCEI, were broker-owned and broker-controlled. In other words, it was the brokers who traded, collectively owned and managed these exchanges. The ownership and managerial rights of the brokers often led to a conflict of interests, wherein the interest of brokers was preserved over those of the investors. Instances of price rigging, recurring payment crisis on stock exchanges and misuse of official position by office bearers, have been unearthed in the last few years. As a result, both rolling settlement as well as demutualisation of stock exchanges were announced to preserve their integrity.
Demutualisation is the process by which any member-owned organisation can become a shareholder-owned company. Such a company could either be listed on a stock exchange or be closely held by its shareholders.
Stock exchanges in India were either Section-25 companies under the Companies Act or an association of persons. Hence, stock exchanges were exempt from all taxes. The NSE, the OTCEI and the ICSE were set up as demutualised stock exchanges. The NSE was set up as a demutualised entity and is owned by financial institutions. Although the ISE was set up as demutualised, it was not a profit-making organisation, which means that even if the profit gets generated, it cannot be distributed among owners, like in the NSE. Like the ISE, the OTCEI has been set up with a not-for-profit motive. It was the first demutualised exchange in the country, set up with a share capital of Rs. 10 crores and promoted by prominent Indian financial institutions. Table 8.3 provides a comparison of the NSE model and international models of demutualised exchanges.
Through demutualisation, a stock exchange becomes a corporate entity, changing from a non-profit-making company to a profit- and tax-paying company. Demutualisation separates the ownership and control of stock exchanges from the trading rights of its members. This reduces the conflict of interest between the exchange and the brokers and the chances of brokers using the stock exchanges for personal gains. With demutualisation, stock exchanges have access to more funds for investment in technology, mergers with and acquisition of other exchanges, and for strategic alliances with other exchanges. Members of the stock exchange also benefit by demutualisation as their assets become liquid and they get a share of the profits made by the exchange through dividends. Demutualisation makes operations of the stock exchange transparent, which facilitates better governance.
Demutualisation process is similar to a company-going public—owners will be given equity shares. The exchange offers equity capital, either through dilution of existing promoters stake or by the fresh issue of capital. The process seeks to give majority control (51%) of the exchange to investors who do not have trading rights. This is to allow a better regulation of the exchange. Once listed as a public company, the exchange will be governed by the corporate-governance codes to ensure transparency.
There has been a global trend towards demutualisation, wherein 17 stock exchanges including NASDAQ, and those of Australia, Singapore, Hong Kong, London and Tokyo have already been demutualised, and another 15 are in the process of demutualisation. The Amsterdam and Australian Stock Exchanges have become publicly listed companies. In Asia, the Singapore Stock Exchange (SGX) and the Singapore Monetary Exchange have merged.
In November 2002, SEBI approved the uniform model of corporatisation and demutualisation of stock exchanges, recommended by the Kania Committee. The committee recommended that stock exchanges in India, which were set up as associations of persons, should be converted into companies, limited by shares. The three stakeholders of the exchange—the shareholders, brokers and the investing public—should equally represent the board. The trading and ownership rights, currently coded in the broker's membership card, should be separated. A broker will get trading rights after paying a certain fee, fixed by the exchange. The ownership right, however, will reside with the shareholders of the corporatised exchange. The shares of an exchange can also be listed on other exchanges.
The Securities Contracts (Regulation) Act was amended on October 12, 2004, through an ordinance, making it compulsory for the exchanges to convert into corporate entities and delink their broker members from the management. The ordinance restricts brokers' representation in the governing-body board of stock exchanges to 25%. It also reduces their shareholding in the exchange to 49% from the existing 100%.
Moreover, 51% of the stake of an exchange should be held by the public, other than shareholders having trading rights. Brokers' trading rights will be distinct from their ownership and management right in all exchanges. The segregation is expected to safeguard the interest of investors and bring about a greater transparency and efficiency of stock exchanges. The ordinance also allows inter-exchange trading among brokers, which would promote a trading platform for small- and mid-cap companies.
With corporatisation, the assets owned by the exchanges become the personal property of the brokers. Brokers demanded a one-time exemption from all taxes, including capital-gain tax in respect of all the property of the exchange. The budget for 2003–04 announced an exemption from the payment of capital-gain tax for exchanges on corporatisation.
In order to speed up the process of demutualisation and corporatisation of stock exchanges, the finance minister in the Finance Budget 2005–06, announced a one-time exemption from the stamp duty that is payable on transfer of assets.
The SEBI made it mandatory for stock exchanges to dilute 51% ownership in favour of public. In India, three stock exchanges—the Bombay Stock Exchange (BSE), the Ahmedabad Stock Exchange (ASE) and the Madhya Pradesh Stock Exchange (MPSE), did not have a corporate structure as they functioned as associations of persons. They were first corporatised and then demutualised. The BSE completed the process of demutualisation in June 2007.
Box 8.1 NASDAQ
The National Association of Securities Dealers (NASD) demutualised the NASDAQ stock exchange in the year 2000 by way of a two-phase private placement of shares to dilute the stake of NASD in Nasdaq to 27 per cent. It raised a total of USD 516 million in the first phase and later raised another USD 240 million by offering convertible debentures in a private offering which could be converted to a 9.8 per cent stake in Nasdaq. Today, the exchange has over 2,900 investors.
Source: Capital market.
TABLE 8.3 Comparison of the NSE Model and International Models of Demutualised Stock Exchanges
|Comparators||International Model||NSE Model|
|For Profit/Not-for-profit Ownership Structure||For Profit Company Owned by shareholders which includes brokers||Owned by shareholders which are financial institutions which also have broking firm as subsidiaries|
|Listing||Several stock exchanges are listed on themselves after initial public offer.||Not a listed company. No Initial public offer made.|
|Ceilings on Shareholding||Mostly 5% of voting rights for a single shareholder||No ceiling|
|Segregation of Ownership, Trading Rights and Management||These are segregated. To become a member of the demutualised stock exchange, it is not necessary to own a share in the company. Thus, members may or may not be shareholders and members who own shares may sell off their trading rights and all shareholders are not necessarily members||These are segregated. The trading rights and ownership are segregated. The broking firms are not shareholders|
|Board Structure||The governing board comprises directors who are elected by shareholders. Some of the directors are brokers but majority do not have a stock-broking background||The board comprises representatives of shareholders, academics, chartered accountants, and legal experts. Of these, three directors are nominated by the SEBI and three directors are public representatives approved by the SEBI|
|Fiscal Benefits||As mutual entities, stock exchanges enjoyed fiscal benefits prior to demutualisation, but when converted into for-profit companies these are taxed||The NSE was set up as a demutualised for-profit company and is taxed. So the question of fiscal benefit prior to demutualisation does not arise|
|Transfer of Assets||Assets were transferred from the mutual entity to the for-profit demutualised company and shares were given to the members in lieu of the ownership in the old entity. There was no cash consideration paid. Since an Initial Public Offer (IPO) was also made in many cases, the valuation of the shares were done by the market and no separate valuation exercise was required as for example in the case of the LSE where a bonus issue was made||The question of transfer of assets did not arise because the NSE was set up by the institutions as a demutualised company itself|
|Enactment of Legislation to Give Effect to Demutualisation||In several countries, a separate legislation was necessary as in the case of Australia, Hong Kong, Toronto and Singapore. In several others, no legislation was necessary as in the case of the UK||Not applicable as the NSE was set up as a demutualised company|
Source: Report of the SEBI Group on Corporatisation and Demutualisation of Stock Exchanges.
All stock exchanges except the Coimbatore Stock Exchange have completed their corporatisation and demutualisation process, and are functioning as for-profit companies, limited by shares, and at least 51% of their equity-share capital is held by public other than shareholders having trading rights therein. Various investors like public-sector banks, public-sector insurance companies, public-sector undertakings (PSUs), industrial-development corporations, corporates and individuals have subscribed to the equity-share capital of the stock exchanges.
In view of the special nature of stock exchanges, the SEBI laid out norms in regard to the shareholding pattern, for recognised stock exchanges in respect of which the scheme for corporatisation or demutualisation has been approved by the Board under Section 4B of the Act.
- The minimum stake of a single shareholder in a recognised stock exchange, directly or indirectly, cannot exceed 5% of the total equity, and that at least 51% of the total equity in such exchanges should be held by public. The holding limit of a single shareholder was enhanced to 15% in respect of six categories of shareholders, which are public financial institutions, stock exchanges, depositories, clearing corporations, banks and insurance companies.
- Any shareholder holding more than 1% of the exchange's total equity cannot hike the stake, post-implementation of these norms.
- No shareholder having trading rights in a recognised stock exchange shall, prior to issuance of the confirmation under Regulation 7, transfer his shares in such recognised stock exchange to any person otherwise than in accordance with Chapter II.
- The private placement would be in line with the rules in the Companies Act.
These norms prevent any single entity from acquiring a substantial stake and, say, in the functioning of stock exchanges. Also, they enable foreign investors to acquire shares in stock exchanges and encourage competition among exchanges. The government has permitted 49% (26% by FDI and 23% by FII) foreign investment in stock exchanges. Strategic investments in stock exchanges are required for the revival and growth of stock exchanges, so that they can compete globally. SGX and Deutsche Börse AG hold 5% stake each in the BSE. In NSE, entities such as the NYSE Group, Goldman Sachs, General Atlantic and Softbank Asian Infrastructure Fund have a stake of 5% each.
Listing of Securities
Unlocks the value of the company
Creates wealth effect
LISTING OF SECURITIES
A company has to list its securities on the exchange so that they are available for trading. A company can seek listing on more than one stock exchange. Earlier, it was compulsory to list on the regional stock exchange that is nearest to its registered office, but now it is not mandatory. A security listed on one exchange is permitted for trading on the other.
A company seeking listing of its securities on the stock exchange is required to file an application, in the prescribed form, with the Exchange before issue of Prospectus by the company, where the securities are issued by way of a prospectus or before issue of Offer for Sale, where the securities are issued by way of an offer for sale. The prospectus should state the names of the stock exchanges, where the securities are proposed to be listed. It has to enter into a listing agreement with the stock exchange. As per Section 73 of the Companies Act, 1956, a company seeking listing of its securities on a stock exchange is required to submit a letter of application to all the stock exchanges where it proposes to have its securities listed, before filing the prospectus with the registrar of companies. Section 21 of the Securities Contract (Regulation) Act, 1956, deals with the listing of the public companies. Section 19 of the Securities Contract (Regulation) Rules, 1957, deals with the requirements and documents to be submitted with respect to the listing of securities on a recognised stock exchange. The documents that need to be submitted are: Memorandum and articles of association and, in case of a debenture issue, a copy of the trust deed, prospectus or statements in lieu of prospectus, offers for sale and circulars or advertisements offering any securities for subscription or sale during the last 5 years, balance sheets and audited accounts for the last 5 years, or in the case of new companies, for such shorter period for which accounts have been made up; a statement showing dividends and cash bonuses, if any, paid during the last 10 years (or such shorter period as the company has been in existence, whether as a private or public company) and dividends or interest in arrears, if any; certified copies of agreements or other documents relating to arrangements with or between vendors and/or promoters, underwriters and sub-underwriters, and brokers and sub-brokers; a statement containing particulars of the dates of, and parties to all material contracts, agreements (including agreements for technical advice and collaboration), concessions and similar other documents (except those entered into in the ordinary course of business carried on or intended to be carried on by the company), together with a brief description of the terms, subject matter and general nature of the documents; a brief history of the company since its incorporation giving details of its activities including any reorganisation, reconstruction or amalgamation, changes in its capital structure (authorised, issued and subscribed) and debenture borrowings, if any; particulars of shares and debentures issued (i) for consideration other than cash, whether in whole or part, (ii) at a premium or discount or (iii) in pursuance of an option; and a statement containing particulars of any commission, brokerage, discount or other special terms including an option for the issue of any kind of the securities granted to any person. The SEBI issues guidelines/circulars prescribing certain norms to be included in the listing agreement and to be complied by the companies.
In case the exchange does not admit the company's securities for listing, the company cannot proceed with the allotment of shares. However, the company may file an appeal before SEBI under Section 22 of Securities Contract (Regulation) Act, 1956 (SCRA, 1956), and also to the Securities Appellate Tribunal (SAT).
A company delisted by a stock exchange and seeking relisting at the same exchange is required to make a fresh public offer and comply with the extant guidelines of the exchange. Provisions in the listing agreement attempt to ensure liquidity and investor protection in the stock market. There were 5,900 securities listed on exchanges and around 6,94,000 unlisted companies in India at the end of March 2009. Unlisted companies follow provisions under the Companies Act which are less stringent. Because the compliance cost of listing are high, companies do not prefer to get listed on the stock exchanges. The compliance costs for listed companies include expenses for carrying out legal formalities, costs for communicating quarterly and annual financial reports to shareholders, printing and posting costs of reports, listing fee to the exchanges and reporting board decisions to exchanges.
A company can seek listing if at least 10% of the securities, subject to a minimum of 20-lakh securities, have been offered to the public for subscription. In addition, the size of the net offer to the public (i.e., the offer price multiplied by the number of securities offered to the public, excluding reservations, firm allotment and promoters' contribution) is not less than Rs. 100 crores and the issue is made only through book-building method with 60% of the issue size allocated to the qualified institutional buyers (QIBs). Alternatively, a company has to offer at least 25% of the securities to the general public.
A company needs to obtain ‘in-principle’ approval for listing from the exchanges having nationwide trading terminals where it is listed, before issuing further shares or securities. Where the company is not listed on any exchange having nationwide trading terminals, it needs to obtain such ‘in-principle’ approval from all the exchanges in which it is listed before issuing further shares or securities. Moreover, the equity-listing agreement has been amended to prohibit listed companies from issuing shares with superior rights as to voting or dividend vis-à-vis the rights on the equity shares that are already listed.
The basic norms for listing of securities are uniform for all exchanges. They are specified in the listing agreement entered into between the company and the concerned exchange and their compliance is monitored by the exchanges. The stock exchanges levy annual listing fees from the listed companies; this constitutes their major source of income.
The following eligibility criteria have been prescribed effective August 1, 2006 for listing of companies on BSE, through Initial Public Offerings (IPOs) and Follow-on Public Offerings (FPOs):
Companies have been classified as large-cap companies and small-cap companies. A large-cap company is a company with a minimum issue size of Rs. 10 crores and market capitalisation of not less than Rs. 25 crores. A small-cap company is a company other than a large-cap company.
- In respect of Large-Cap Companies: The minimum post-issue paid-up capital of the applicant company shall be Rs. 3 crores; issue size shall be Rs. 10 crores; and the market capitalisation of the company shall be Rs. 25 crores (market capitalisation shall be calculated by multiplying the post-issue paid-up number of equity shares with the issue price).
- In respect of Small-Cap Companies: The minimum post-issue paid-up capital of the Company shall be Rs. 3 crores; the issue size shall be Rs. 3 crores; the market capitalisation of the Company shall be Rs. 5 crores; the income/turnover of the Company shall be Rs. 3 crores in each of the preceding three 12-month period; and number of public shareholders after the issue shall be 1,000. A due diligence study may be conducted by an independent team of Chartered Accountants or Merchant Bankers appointed by BSE, the cost of which will be borne by the company. The requirement of a due diligence study may be waived if a financial institution or a scheduled commercial bank has appraised the project in the preceding 12 months.
The BSE issued new listing norms in August 2002 for companies listed on other exchanges and seeking listing on the BSE. These companies should have a minimum issued and paid-up equity capital of Rs. 3 crores, minimum net worth of Rs. 20 crores, profit-making track record of 3 years, minimum market cap at two times its paid-up capital, and a dividend track record for three consecutive years with a minimum dividend of at least 10%. Besides, there should be a two-year track record of being listed on a regional exchange. At least 25% of the issued capital should be with a non-promoter and no single shareholder should hold more than 0.5% of the capital.
After a security is issued to the public and listed on a stock exchange, the issuing company has to make continuous disclosures relating to financial results, material information which would have a bearing on the performance of the company, and information in the form of a statement on the actual utilisation of funds and actual profitability as against the projected utilisation of funds and projected profitability, on a quarterly basis to the stock exchanges. To improve transparency, the SEBI made it mandatory for listed companies to provide their half-yearly results and disclose their balance sheets—audited or un-audited—every 6 months to the stock exchanges. Listed companies will also be permitted to submit accounts under the international financial reporting standards (IFRS), which calls for greater disclosures.
The SEBI issued new norms for listing and raising of funds by small and medium enterprises (SMEs) on November 9, 2009. According to the norms, Companies listed on the SME exchanges would be exempted from the eligibility norms applicable for IPOs and FPOs prescribed in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR). SEBI has prescribed a minimum IPO application size of Rs. 1 lakh in order to have informed, financially sound and well-researched investors with a certain risk-taking ability. The minimum trading lot under the SME platform would be Rs1 lakh. For listing on the main boards of NSE and BSE, an upper limit of Rs. 25 crores paid-up capital has been prescribed for a company wanting to be listed on the SME platform/exchange and having a minimum paid-up capital of Rs. 10 crores. In other words, Rs. 25 crores would be the maximum capital permissible to be raised under the SME platform. If the paid-up capital is more than Rs. 25 crores, trading will be on the main platform. The entire public offer of small and medium companies will have to be underwritten. The offer document will have to be filed with SEBI and the exchange. No observations would be issued by SEBI on the offer documents filed by the merchant bankers.
An exchange can take some disciplinary actions, including suspension/delisting of securities if a company fails to comply with the requirements. Delisting of securities means removal of securities of a listed company from the stock exchange where it was registered. As a result of this, the company ceases to be traded at that stock exchange. There are two methods for delisting: compulsory and voluntary.
A stock exchange may compulsorily delist the shares of a listed company under certain circumstances such as non-compliance with the listing agreement for a minimum period of 6 months, failure to maintain the minimum trading level of shares on the exchange, insider trading, manipulation of share prices, unfair market practices by promoters/directors, inability to meet current debt obligations or to adequately finance operations due to sickness, or has not paid interest on debentures for the last 2–3 years, or has become defunct, or there are no employees, or liquidator appointed. Under compulsory delisting, the promoter of the company shall be liable to compensate the shareholders of the company by paying them the fair value of the securities held by them and acquiring their securities, subject to their option to remain security holders with the company. In such a case, there is no provision for an exit route for the shareholders except that the stock exchanges would allow trading in the securities under the permitted category for a period of 1 year after delisting.
The SEBI has issued the delisting guidelines for voluntary delisting from any stock exchange other than the regional stock exchange. The companies need to obtain prior approval of the holders of the securities sought to be delisted, by a special resolution at a General Meeting of the company. The shareholders will be provided with an exit opportunity by the promoters or those who are in the control of the management.
Companies can get delisted from all stock exchanges following the substantial acquisition of shares. The regulations state that if the public shareholding goes down to 10% or less of the voting capital of the company, the acquirer making the offer, has the option to buy the outstanding shares from the remaining shareholders at the same offer price. However, under the existing SEBI takeover code, the exit price is based on the average of the preceding 26-week high and low prices.
An exit-price mechanism called ‘reverse book-building method’ is used to arrive at the price at which the shares will be bought from the shareholders. However, an exit opportunity need not be given in cases where securities continue to be listed in a stock exchange having nationwide trading terminals.
Dual Listing of shares of companies is not allowed in India. Dual Listing allows a company to be listed on stock exchanges of two countries. This enables an investor to buy/sell shares in one country and sell/buy them in another country where they are listed. For example, Royal Dutch Shell and Unilever are listed on the stock exchanges of the United Kingdom and the Netherlands, and Rio Tinto Group is listed on the stock exchanges of Australia and the United Kingdom. Dual Listing is required when two companies in two countries enter into an agreement to operate their businesses as if they were a single enterprise (without an outright merger), while retaining their separate legal entity and the existing stock exchange listings. Bharti Airtel and the South Africa-based Telco, MTN sought dual listing of their shares where Bharti shares could be listed on the Johannesburg Stock Exchange and MTN on NSE or BSE. But the Indian government policy does not allow dual listing. There are many issues which need to be resolved to enable dual listing. Domestic trading in shares denominated in foreign currency is not permitted; and to enable this, the Foreign Exchange Management Act and the Companies Act need to be amended. Moreover, the Indian rupee needs to be fully convertible. In addition, the domestic company's and the foreign company's composition of Boards should be identical and the stock exchanges of both the countries should have similar rules and regulations.
Central Listing Authority
The listing fees constitutes the major source of income of stock exchanges. The greater the number of companies listed on an exchange, the higher their listing fees. To attract companies to get listed, exchanges are tempted to ease listing standards. Moreover, listing requirements vary from one exchange to another. This results in issuers wasting resources to comply with listing requirements of a number of exchanges simultaneously. Hence, a conflict of interest arises when stock exchanges regulate the companies that contribute to their revenues through listing fees. This conflict may become more serious in the near future as the process of demutualisation of stock exchanges is underway. With demutualisation, the core objective of stock exchanges would be profit maximisation; this would lead to further dilution in listing requirements to maintain or increase listing fees.
To resolve these issues, a central listing authority is needed in the country who would not only frame listing regulations but also take on the task of ensuring compliance of listing requirements. In the UK, the London Stock Exchange (LSE) takes care of trading while a listing authority takes care of the listing activity. The government has proposed the introduction of a Central Listing Authority (CLA). The CLA would regulate prelisting procedures including clearing of prospectus. It would also apply post-listing measures to monitor the purpose for which funds are used. This would prevent diversion of funds for alternate use. In the pre-liberalisation era, the Controller of Capital Issues (CCI) monitored the pricing of issues as well as the end use of funds by companies.
Under the proposed structure, the regional listing of shares will continue and the stock exchange would be responsible for monitoring violations of listing agreement. Merchant bankers would be responsible for disclosures made in the prospectus. The department of company affairs would, as usual, regulate unlisted companies.
To make corporates more accountable for their actions and to prevent any further scandals, the SEBI has set up the CLA for which it has spelled out norms.
The SEBI (Central Listing Authority) Regulations, 2003
These regulations were notified on August 22, 2003 and are stated below:
Before making an issue of securities, and before making an application to the stock exchange for listing of its securities, the issuer must obtain a letter precedent to listing from the CLA. The applicant shall also specify the exchange or the exchanges where the applicant is desirous of listing its securities.
The draft offer document will be filed only with the CLA. The SEBI may offer its observations, if any, to the CLA.
The CLA may call for information from the stock exchanges and the intermediaries in connection with the processing of the applications for letter precedent to listing.
The CLA may impose conditions while granting the letter precedent to listing and also lay down further conditions subsequent to the grant of the letter. The letter is to be valid for 90 days, by which time the subscription list for public and rights issues should have opened and in the case of other kinds of issues the securities should have been listed on the stock exchanges. Subject to certain conditions, the CLA may, in its discretion, extend the validity period of the letter precedent to listing.
The CLA may withdraw the letter precedent to listing after giving an opportunity of being heard to the applicant in the following circumstances.
Where the applicant changes the terminal conditions of the issue or where any material development has taken place which has a bearing on the issue.
Where the applicant has either suppressed material facts or misrepresented the facts in its application to the CLA.
Where the applicant has failed to comply with the conditions imposed by the CLA.
Where the CLA is of the opinion that withdrawal of the letter precedent to listing is in the larger interests of the investors and the securities markets.
Against decision of the CLA, an appeal may be filed before the SAT.
The CLA shall be entitled to withdraw the letter precedent to listing if and only if the securities have not been listed and in case they have been listed, then CLA shall inform the SEBI and the stock exchanges for taking such steps as may be deemed fit including delisting of the securities.
Regulation 17 provides that in the extent of non-compliance with any of the CLA regulations or any of the terms of the listing agreement or in the event of any failure on part of the applicant to furnish the required information to the CLA, the same shall be punishable with penalty as specified in Section 15A or Section 15B of the SEBI Act, 1992.
Regulation 2 (1)(h) of the SEBI (CLA) Regulations, 2003 defines a ‘letter precedent to listing’ to mean a letter issued by the CLA under Regulation 12 permitting the applicant to make a listing application to any exchange including an application for re-listing and listing of an already listed security at an exchange other than the exchange where it is presently listed.
The SEBI provides operational and functional support to the CLA in matters relating to appointment of the CEO and providing infrastructure and manpower to the CLA as and when required.
The CLA is headed by Shri M. N. Venkatachalaiah, former Chief Justice of India. The aim of the CLA is to ensure uniform and standard practices for listing the securities on stock exchanges.
Risk Management to be shifted below Central Listing Authority, and Trading rules and regulations below risk management. Then circuit breakers and then trading arrangements.
The SEBI has laid down risk management policies to mitigate market, operational and systemic risks. Designing effective risk management policies leads to enhancement of investor protection and market development.
On the instructions of the SEBI, the stock exchanges have developed a comprehensive risk management system to promote a safe and efficient market. Stock exchanges have laid down trading rules and regulations for broker-members, set up market surveillance systems to curb excess volatility, created trade/settlement guarantee fund to ensure timely settlements even if a member defaults to deliver securities or pay cash, and set up a clearing corporation to guarantee financial settlement of all trades and thereby reduce credit risk in the settlement system. The Clearing Corporation matches the transactions, reconciles sales and purchases and daily settlements. It is also responsible for the risk management of its members and conducts inspection and surveillance. It also collects margins and capital from members and monitors their net worth requirement. Its major role is to ensure the fulfilment of every contract either by becoming a counter-party itself to every trade or by guaranteeing the performance of all trades. This risk management system was absent in the pre-reforms period and the setting up of the system is one of the landmark achievements of financial market reforms.
Trading Rules and Regulations
Strict rules and regulations have been framed to prevent unfair trading practices and insider trading. The trading rules relate to the margin system, intra-day trading limit and exposure limit. Brokers are levied various types of margins such as daily margins, mark-to-market margins, ad hoc margins and volatility margins to check price volatility.
Stock exchanges impose different types of margins on brokers for individual stocks, depending on the exposures taken by these brokers in these stocks, both on a proprietary basis and on behalf of clients, vis-à-vis the overall market exposure in the scrips. Several of these margins are paid upfront by brokers.
These margins are collected to prevent operators from taking market positions in excess of their buying capacities and are used to settle dues to the exchange/clearing corporation/traders in the event of any fund shortage faced by the broker. The margins vary from operator to operator depending on the size of the positions taken in the market. There is a real-time monitoring of the intra-day trading limits and gross exposure limits by the stock exchanges. There is an automatic deactivation of trading terminals in case of breach of exposure limits. The collection of margins from institutional clients is on T + 1 basis.
As a large section of the market makes margin payments by routing trades through brokers who pay lower margins, the SEBI stipulated that the stock brokers/sub-brokers of one exchange cannot deal with the brokers/sub-brokers of the same exchange either for proprietary trading or for trading on behalf of the clients without prior permission. It has also stipulated that a stock broker/sub-broker of an exchange can deal with only one broker/sub-broker of another exchange for proprietary trading offer, intimating the names of such stock broker/sub-broker to his parent stock exchange.
If the markets become volatile, the exchanges impose different types of margins such as value-at-risk (VaR) to minimise the risk of default by either counter-party. The system of collecting margins is devised in such a manner that higher exposures attract higher margins. Besides the normal margin, scrips with unusually high trading volumes attract special margins or a special ad hoc margin to keep defaults at bay.
The SEBI has shifted the margining system from net basis to gross basis (sale and purchase) with effect from September 3, 2001, and introduced a 99% VaR-based margin for all scrips in the compulsory rolling system with effect from July 2, 2001. VaR measures the worst-expected potential loss from an unlikely adverse event in a normal, everyday market environment. Prior to VaR, trade positions were reported at book value only and no considerations were made for market changes. This margin is kept in a manner that covers price movements for more than 99% of the time. Usually, three sigma (standard deviation) is used for the measurement.
The intra-day trading limits, that is, limit to volume is specified and no broker's trading volume can exceed this limit. If a broker wishes to exceed the limit he has to deposit the additional capital with the exchange. The upper limit for the gross exposure of a broker is fixed at 20 times his capital to ensure market safety. Besides these, there are capital adequacy norms for members, indemnity insurance and online-position monitoring by exchanges.
To ensure fair trading practices, the SEBI has formulated Insider Trading Regulations prohibiting insider trading by making it a criminal offence. To enhance transparency of the takeover process and to protect the interests of the minority shareholders, there are now separate regulations relating to acquisitions and takeovers.
To contain the excessive volatility in prices, the SEBI introduced, in 1995, scripwise daily circuit breakers/price bands. The circuit breakers bring about a halt/suspension in trading, automatically for a specified period, if the market prices vary unusually on either side, that is, move out of a pre-specified band. Circuit breakers do not halt trading but no order is permitted if it falls out of the specified price range.
Circuit breakers allow participants to gather new information and assess the situation. This helps in controlling the panic. It helps exchange-clearing houses to monitor their members. However, the introduction of circuit breakers precipitates matters during volatile moves and leads to chaos as participants rush to execute their orders before an anticipated trading halt.
In the United States, the system of circuit breakers was introduced in 1987 to halt a sharp fall in share prices. In India, circuit breakers are used to halt both sharply rising as well as declining prices. Price bands, which were originally fixed at 8%, were relaxed in case of 100 scrips in January 2000, when a further variation of 4% in the scrip beyond 8% was allowed after a cooling-off period of 30 minutes. In June 2000, the price band was relaxed by 8% from 4% in case of scrips under rolling settlement. These price bands were removed for all stocks in the rolling mode from July 2, 2001, and for the entire market from January 2, 2002. An index-based, market-wide circuit-breaker system at three stages of the index movement, either way at 10%, 15% and 20% is now applied. To enhance safety, individual scripwise price bands of 20% either way have been prescribed for all securities except those available for trading in the derivatives segment, and new listings.
Box 8.2 Index-wide Circuit Breakers
The BSE and the NSE implement the index-based market-wide circuit breaker system on a quarterly basis. The market-wide circuit breakers would be triggered by movement of either the Sensex or the NSE S&P CNX Nifty whichever is breached earlier.
In case of a 10 per cent movement of either of these indices, there would be a one-hour market halt if the movement takes place before 1 p.m. In case, the movement takes place at or after 1 p.m. but before 2:30 p.m., there will be a trading halt for one-half hour. In case the movement takes place at or after 2.30 p.m., there will be no trading halt at the 10 per cent level and the market will continue trading.
In case of a 15 per cent movement of either index, there will be a two-hour market halt if the movement takes place before 1 p.m. If the 15 per cent trigger is reached on or after 1 p.m. but before 2 p.m., there will be a one-hour halt. If the 15 per cent trigger is reached on or after 2 p.m. the trading will halt for the remainder of the day.
In case of a 20 per cent movement of the index, the trading will be halted for the remainder of the day.
The percentages are calculated on the closing index value of the quarter. These percentages are translated into absolute points of index variations (rounded off to the nearest 25 points in case of the Sensex and 10 points in case of the Nifty). At the end of each quarter, these absolute points of index variations are revised and made applicable for the next quarter.
As an additional measure of safety, individual scrip-wise price bands have been fixed by the NSE as below:
Daily price bands of 2% (either way) on a set of specified securities
Daily price bands of 5% (either way) on a set of specified securities
Daily price banks of 10% (either way) on specified securities
Price bands of 20% (either way) on all remaining securities (including debentures, warrants, preference shares etc. which are traded on CM segment of NSE),
No price bands are applicable on: scrips on which derivative products are available or scrips included in indices on which derivatives products are available.
Source: NSE, Factbook 2008
For the first time since their introduction in July 2001, the Sensex and Nifty attracted the index-wide circuit filters and trading on BSE and NSE was halted two times (for a total of 3 hours) on May 17, 2004. Monday, May 17, witnessed the biggest intra-day fall (842.37 points or 17.59%) and the second-biggest, single-day fall (564.71 points or 11.14%) of the Sensex. The market reacted adversely to the statements of some leaders of the new Congress-led United Progressive Alliance (UPA) government regarding policy matters including disinvestment in the PSUs, liberalisation of foreign-direct investment (FDI) norms and the sale of non-performing assets by banks and financial institutions. On November 26, 2008, markets hit lower circuits on the news of global financial crisis. For the first time on Monday, May 18, 2009, markets hit two upper circuits (first circuit at over 10% and the next at 20%) when a clear mandate for the Congress-led UPA was announced. May 18, 2009 was the reverse of May 17, 2004. Trading was halted within seconds of opening of the markets when the 30-share Sensex surged 14.70% or 1,789.88 points to 13,963.30 and the 50-unit S&P CNX Nifty gained 531.65 points or 14.48% to 4203.30.
Electronic Trading Systems
Increases information efficiency
Increases operational efficiency
Improves depth and liquidity of the market
Provides a single trading platform
The open outcry system, prevalent a few years ago on regional stock exchanges, has been replaced by an online, screen-based electronic trading system. The NSE and the OTCEI had adopted screen-based trading right from inception. With almost all the exchanges going electronic, trading has shifted from the floor to the brokers' office where trades are executed through a computer terminal. All stock exchanges together have 8,000 terminals spread across the country. In a screen-based trading system, a member can feed into the computer the number of securities and the prices at which he would like to transact and the transaction is executed as soon as it finds a matching order from a counter party. The electronic trading system is superior to the open outcry system of the past. It ensures transparency, as it enables participants see the full market during real time. It increases information efficiency by allowing a faster incorporation of price-sensitive information into prevailing prices and thereby helps in an efficient price discovery. This also results in the operational efficiency as there is a reduction in time, cost, risk of error, and fraud and elimination of a chain of brokers and jobbers, which result in low transaction costs. This system has enabled a large number of participants, in every part of the country, to trade in full anonymity with one another simultaneously, thereby improving the depth and liquidity of the market. This has led to the integration of different trading centres spread all over the country into a single trading platform.
The SEBI has permitted the setting up of trading terminals abroad as well as Internet trading. Now, investors in any part of the world can route the order through the Internet for trading in Indian scrips. Internet trading is more cost effective than using trading terminals.
There are two types of trading systems—order-driven trading system and quote-driven trading system. In the order-driven system, orders from all over the country are entered into an electronic system and matched directly and continuously without the involvement of a jobber or a market maker. In the quote-driven system, there are market makers who continuously offer two-way quotes—buy-and-sell quotes—and are willing to buy and sell any quantity. The BSE provides both these systems while the NSE provides only the order-driven system.
There are two types of orders: limit orders and market orders. Limit orders are those trades which will be only executed at the price specified by the investor. Usually, retail investors and fund houses place limit orders. Market orders are those trades which are executed at the latest quoted bid or offer price on the trading screen.
There are certain orders (buy or sell) which already exist in the trade book at the time of trade matching which are known as passive orders. While active orders are incoming orders that are matched against the passive orders, stock exchanges charge different transaction fees for both passive and active orders.
The SEBI allowed trading members (Brokers) to offer Direct Market Access (DMA) to institutional clients such as foreign institutional investors (FIIs), mutual funds and insurance companies in April 2008. These institutional clients can directly execute their buy-and-sell orders without any manual intervention by their brokers. The benefits of DMA are:
- It prevents the practice of front-running by brokers who are trading ahead of the client based on the knowledge of the client order. Brokers profit from the price changes which take place when large institutional orders are placed. With DMA, the secrecy of the orders can be maintained as the orders are routed directly through the computer system.
- It enables a faster execution of orders with a minimal risk of errors from the manual order entry.
- It reduces malpractices and price manipulation, enhances transparency and increases liquidity as the orders are visible to the entire market rather than to a particular person/group.
- It results in lower impact costs for large orders. Moreover, institutional client can break large orders into smaller ones, thereby reducing the bid-ask spread. In addition, it results in saving, in the form of low brokerage charges.
- It enables algorithmic trading wherein the traders instal computers running complex mathematical algorithms and place buy-and-sell orders automatically in the trading system through DMA. Algorithmic trading or program trading is a software program built on certain mathematical models, which enables traders to detect an arbitrage opportunity between the cash and the futures market and place orders on exchanges in real time. It enhances efficiency in trading, reduces transaction costs and prevents information leakage. Foreign broking firms such as Merrill Lynch, Goldman Sachs, JPMorgan, Citigroup and Credit Suisse offer these trading services.
Algorithmic trading is popular in developed countries but it has not taken off in a big way in India because of lack of liquidity beyond the top 15–20 actively traded scrips and both the exchanges' systems not being equipped to handle very heavy orders of trades, when the market is unusually active.
Trading and Settlement
After the reforms, the trading-and-settlement cycle was trimmed from 14 days to 7 days. Later on, securities were traded and settled under a uniform weekly-settlement cycle. In a trading cycle, trades accumulated till the end of a specified period and the positions were settled in the form of payment of cash and delivery of securities. The carry-forward system prevailed for a long period at stock exchanges, as it increased the volume of trading and thereby added to the liquidity of the system. However, it also increased the speculation which, in turn, increased the volatility in prices and defaults by brokers, thereby impeding the price-discovery process. Hence, an alternative system called ‘rolling settlement’ was introduced in a phased manner.
Under the T + 5 basis rolling-settlement system, the trading cycle comprises 1 day and transactions in these securities are settled 5 days after the trade date. The rolling settlement on a T + 5 basis was introduced in 10 scrips in January 2000, extended to another 153 scrips in May 2000 and then to 414 securities in July 2001; and thereafter, all scrips were covered under this system. From April 2002, the rolling settlement was on a T + 3 basis but since April 2003 it is on a T + 2 basis (transactions in securities are settled 2 days after the trade date). Effective implementation and success of the rolling settlement requires electronic fund-transfer facility and dematerialisation.
Dematerialisation of Securities
To eliminate various problems such as theft, fake/forged transfers, transfer delays and the paperwork associated with physical certificates, an electronic book entry form of holding and transferring securities has been introduced. Investors have the option to hold securities in either physical or dematerialised form. In order to expedite the process of dematerialisation, the SEBI has mandated the compulsory settlement of trade in demat form in certain select scrips. Securities issued through an IPO can be settled only in a dematerialised form. Henceforth, all IPOs will be issued in the dematerialised form. Two depositories—the National Securities Depository Limited (NSDL) and the Central Depository Service Limited (CDSL)—offer trading facility in the dematerialised form. The dematerialisation process is almost complete and more than 99% of the turnover settled by delivery is in the dematerialised form.
Steps involved in online trading
- An investor/trader needs to sign the ‘member–client agreement’ if dealing directly with a broker or a ‘broker–sub-broker–client tripartite agreement’ if dealing with a sub-broker in order to execute trades on his behalf from time to time. An investor/trader has also to furnish details such as permanent account number (PAN), which has been made mandatory for all the investors participating in the securities market;, his name, date of birth, photograph, address, educational qualifications, occupation, residential status (Resident Indian/NRI/others); bank and depository account details; and if registered with any other broker, then the name of that broker and the concerned stock exchange and the Client Code Number in the client registration form. All brokers have been mandated to use the unique client code that is linked to the PAN details of the respective client, which will act as an exclusive identification for the client. The broker opens a trading account in the name of the investor for maintenance of transactions executed, while buying and selling the securities.
- An investor has to open a Beneficial Owner Account (BO Account)/Demat Account with a depository participant in his name for the purpose of holding and transferring securities. He also has to open a bank account which is used for debiting or crediting money for trading in the securities market.
- Investor/trader who wants to trade places order with a broker to buy/sell the required quantity of specified securities.
- The order is matched at the best price based on the price–time priority.
- The order which is executed electronically is communicated to the broker's terminal.
- The broker issues the trade confirmation slip to the investor/trader.
- The broker issues contract note to the investor/trader within 24 hours of trade execution. A contract note is a confirmation of trades done on a particular day on behalf of the client by the broker. It imposes a legally enforceable relationship between the client and the broker with respect to purchase/sale and settlement of trades. It also helps to settle disputes/claims between the investor and the broker.
The stock exchanges assign a Unique Order Code Number to each transaction, and once the order is executed, this order code number is printed on the contract note. The time when the investor/trader has placed the order and the time of execution of the order have to be mentioned in the contract note.
- The payment for the shares purchased or delivery of shares in case of sale of shares is required to be done prior to the pay-in date for the relevant settlement.
- Pay-in of funds and securities take place before T + 2 day as the settlement cycle is on T + 2 rolling-settlement basis, w.e.f. April 1, 2003. Pay-in day is the day when the broker shall make payment or delivery of securities to the exchange.
- Pay-out of funds and securities take place on T + 2 day. Pay-out day is the day when the exchange makes payment or delivery of securities to the broker. The broker makes payment to the investor/trader within 24 hours of the payout.
- The investor/trader can get direct delivery of shares in his beneficial owner account. To avail this facility, he has to give details of his beneficial owner account and the DP-ID of his Depository Participant (DP) to his broker along with the standing instructions for ‘Delivery-In’ to his DP for accepting shares in his beneficial owner account. After the receipt of these instructions, the clearing corporation/clearing house sends pay-out instructions to the depositories and the investor/trader receives pay-out of securities directly into his beneficial owner account.
- In case of short or bad (non) delivery of funds/securities, an auction of securities on the pay-in day is held to settle the delivery. The Exchange purchases the required quantity in the Auction Market and delivers them to the buying trading member. The shortages are met through auction process and the difference in price indicated in the contract note and the price received through auction is paid by the member in the Exchange, which is then liable to be recovered from the client. Auction ensures that the buying trading member receives the securities. The Exchange purchases the requisite quantity in auction market and gives them to the buying trading member. Auction price applicable is previous day's close price.
In case the shares could not be bought in the auction, the transaction is closed out as per SEBI guidelines. The guidelines stipulate that the close-out price will be the highest price recorded in that scrip on the exchange in the settlement in which the concerned contract was entered into and up to the date of auction/close out or 20% above the official closing price on the exchange on the day on which auction offers are called for (and in the event of there being no such closing price on that day, then the previous day's closing price), whichever is higher.
Internet trading in India made its debut in April 2000. Through this means of trading, investors can buy and sell shares online through the Internet.
To start Internet trading, an investor has to register himself with a broker offering online services. He has to open a bank account as well as a demat account with the broker. The broker is responsible for the risk management of his clients. The orders get logged directly on the trading platforms within the assigned limits designated by the broker to the clients. Even if the client order exceeds the assigned limits, the order gets re-routed to the broker's server for authorisation or rejection. The broker can change the parameters on-line. His software allows real time market information display, client information display, bank account management, and a transaction history display.
Box 8.3 To Trade Online Using e-broking Facility
Register yourself with the online trading portals listed on the site.
You must be a registered iconnect user.
On placing an order for buy/sell of securities through the listed, online trading portal, click on ‘Pay Through’—Bank listed on the
online portal which will direct you to a login screen of your account.
Once the details of your Login ID and password are entered, you are required to verify the transaction details and confirm the
transaction by entering your transaction ID and password. An email confirmation will follow regarding the status of your transaction once your order is executed.
Your account status will be updated on a real time basis.
Source: Business Today, February 13, 2005.
In April 2000, the market was bullish and a large number of players ventured into online (Internet) trading. As many as 79 members took permission for Internet trading. However, after the Ketan Parekh scam, barely 10 members remained online. The market is dominated by ICICI Direct.com with a market share of about 50 per cent and India bulls.com with a market share of 26 per cent.
ICICI has emerged as a market leader because it can provide strong connectivity between the trading account, demat account, and bank accounts. Moreover, ICICI's huge off-line presence in various financial services segments and penetration aids in drawing as well as servicing customers. ICICI Direct leads the pack with 1,70,000 trading customers. It executes an average of 1,600 trades a day; this puts it in the same league as the tenth largest online brokerage in the US. Sharekhan.com and 5 paise.com have faded away while Kotak Street.com and HDFC Securities are hanging on.
Around 44 lakh investors had registered to trade online as on March 31, 2008. There has been a sharp increase in volumes after the rolling settlement was introduced. The online trading volumes rose from Rs. 7,288 crore in 2000–01 on the National Stock Exchange to Rs. 6,68,399 crore in 2007–08. Around 11.68 per cent of the total trading volume was routed and executed through internet during 2007–08.
Online trading has driven down the transaction costs substantially and increased the liquidity options available to an investor to enter or exit from the stock at his own wish. The Internet has provided a wide range of information to the investor which has enabled him to take calculated risks.
The US has the largest number of cyber investors—approximately 15 million. Online trading has grown tremendously in the US where roughly 40 per cent of retail stock brokerage business is conducted through the Internet. Schwab, a US-based company, is the world's largest discount and web brokerage firm with 5.8 million investor accounts holding more than USD 500 billion in assets.
Compare this with Indian online trading statistics. Online trading represents about 18 per cent of the total traded volumes on the NSE and the BSE.
The stumbling blocks for such low online trading volumes are as follows.
- Erratic bandwidth and erratic net connectivity coupled with low personal computer (PC) penetration.
- Low security and inadequate cyber laws.
- Lack of automation in the banking sector especially among public sector banks. Not many banks offer online transaction of money.
- Incremental and ongoing investment in technology and brand building are required. This is owing to lack of funding for Internet-based business.
- Stipulation from the SEBI—Know Your Customer (KYC)—which requires that companies actually meet their customers before allowing them to trade on their site. This requires a large off-line structure which most of the companies do not have.
- A big time lag of 5–10 minutes between the placing of an order and its execution. The high volatility prevailing in the market leads to fluctuations in prices.
- High cost of transactions as online brokers charge brokerage as steep as 0.20–0.25 per cent for non-delivery based transaction and between 0.50–0.75 per cent for delivery based transaction.
- Absence of streaming data on the investor's computer. The broker gets streaming data on his computer while the client does not. Clients get a browser-based web application which works on a request reply model, most suited for document presentation,
- An online investor pays more margin for trading than the off-line investor and his funds are also tied up for more trading days.
- The high development, acquisition, maintenance and service costs. The cost of servicing one internet client may range between Rs. 5,000 to Rs. 8,000 annually.
There is great potential for the growth of Internet trading in India. What is required is a regulatory authority to control this market; availability of high bandwidth, and an online infrastructure. Investor interest in Internet trading has to be sustained and this requires innovations and new products. Broking firms should devise distinct marketing and service strategies.
Functions of an Index
To serve as a barometer of the equity market
To serve as a benchmark for portfolio of stocks
To serve as underlying for futures and options contracts
STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall market sentiment through a set of stocks that are representative of the market. The stock market index is a barometer of market behaviour. It reflects market direction and indicates day-to-day fluctuations in stock prices. The market index reflects expectations about the behaviour of the economy as a whole. It is a precursor of economic cycles. The function of a stock index is to provide investors with information regarding the average share price in the market. A well-constructed index captures the overall behaviour of the market and represents the return obtained by a typical portfolio investing in the market. An ideal index must represent changes in the prices of scrips and reflect price movements of typical shares for better market representation. Stock index is a barometer of a nation's economic health as market prices reflect expectations about the economy's performance. Stock markets tend to be buoyant when the economy is expected to do well. The bell wether Sensex, if it touches the psychologically golden 15,000 mark, indicates that the country's fnancial and economic growth is surging ahead.
Stock indices are termed as leading economic indicators as they indicate what is going to happen in the economy in the future. The returns generated in the stock market are based on future expectations. The future streams of expected returns from the companies are discounted to arrive at their present value known as market price.
A good market index incorporates a set of scrips which have high market capitalisation and high liquidity. Market capitalisation is the sum of the market value of all the stocks included in the index. The market value is derived by multiplying the price of the share by the number of equity shares out-standing. Liquidity is reflected in the ability to buy or sell a scrip at a price close to the current market price. In other words, the bid–ask spread is minimum.
The index on a day is calculated as the percentage of the aggregate market value of the set of scrips incorporated in the index on that day to the average market value of the same scrips during the base period. For example, the BSE Sensex is a weighted average of prices of 30 select stocks and S&P CNX Nifty of 50 select stocks.
Categories of Holding Excluded from the Definition of Free-float
Holdings by founders/directors/acquirers/bodies with controlling interest.
Government hold-ing as promoter/acquirer
Holdings through the FDI route
Strategic stakes by private corporate bodies/individuals
Crossholdings by associate/group companies
Equity held by Employee Welfare Trusts
Methodologies for Calculating the Index
Market Capitalisation Weighted
- Full market capitalisation method: In this method, the number of shares outstanding multiplied by the market price of a company's share determines the scrip's weightage in the index. The shares with the highest market capitalisation would have a higher weightage and would be most influential in this type of index. Examples: S&P 500 Index in USA and S&P CNX Nifty in India.
- Free-float market capitalisation method: Free-float is the percentage of shares that are freely available for purchase in the markets. It excludes strategic investments in a company such as the stake held by government, controlling shareholders and their families, the company's management, restricted shares due to IPO regulations, and shares locked under the employee stock ownership plan. In this methodology, the weight of a scrip is based on the free-float market capitalisation. Free-float market capitalisation reflects the investible market capitalisation which may be much less than the total. Closely held companies would have a much lower weightage and companies with high free-float, i.e., higher investible shares, would be rewarded. Companies which provide high shareholder value but have less free-float would be marginalised.
Free-float market capitalisation method is superior to full market capitalisation method in several ways.
- Free-float is rational in the sense that it factors in the constituent shares to the extent they are available for trading in the market. For instance, ONGC has a free-float of less than 15 per cent and hence it has a weight of under 5 per cent in the free-float weighted sensex.
- The free-float methodology helps in designing a broad-base index wherein the concentration of top few companies and their influence on index movement is reduced. It avoids the undue inf uence of closely held large capitalisation stocks on the index movement and prices.
- An index-based on free-float methodology, is useful to active fund managers as it enables them to benchmark their fund returns vis-a-vis an investible index.
- It avoids multiple counting of company shares through cross holding.
Passive investing (index investing) in the developed market is around 10 per cent. The free-float index helps fund managers in better tracking and replication as the weight of scrips in the index is based on their float available in the market, which helps them in investing in those scrips. The free-float methodology has become popular the world over. Since June 2001, the entire range of FTSE (Financial Time Stock Exchange) indices are fully free-float adjusted. S&P's indices around the world are free-float. All Dow Jones indices except Dow Jones Industrial Average are free-float adjusted.
The BSE has taken a lead on free-floating the indices. It made a beginning by launching on July 11, 2001, the country's first free-float index, ‘BSE-TECK Index,’ an index for technology, entertainment, communication, and other knowledge-based sectors. The BSE has introduced this methodology in the case of the BSE sensex since September 1, 2003. Now the BSE sensex is a free-float sensex.
Reflects investible market capitalisation
Avoids influence of few companies on index movement
Helps active fund managers to benchmark their returns
Helps passive fund managers in tracking and replicating
Free-float Factors The BSE has adopted the international practice of assigning a free-float factor to each company. Free-float factors are assigned according to a banding structure consisting of ten bands into which each company falls, based on its percentage of shares in free-float. The banding structure means that the actual free-float of a company is not taken as it is but rounded off to the higher multiple of 5 or 10 depending upon the banding structure adopted. The exact free-float of a company is rounded-off to the higher multiple of 10. For example, if the free-float factor of a company is, say, 16 per cent, a free-float factor of 0.2, i.e., 20 per cent is applied. If the free-float factor changes, adjustment to the index is made only if the new free-float crosses either the lower band or the higher band by 2 percentage points. The free-float factor is then multiplied with the full market capitalisation of the company to arrive at the free-float capitalisation. Based on the percentage of a company's free-float capitalisation to the total free-float capitalisation of the sensex, weights are assigned to each company.
In order to reduce the frequency of index adjustments arising out of a change in free-float of a company, the BSE refined the banding structure and increased the number of bands from 10 to 20. In the 20 band system, a company having a free-float of 60.1 per cent would be assigned a free-float factor of 0.65 and another company having a free-float of 67 per cent would be assigned a free-float factor of 0.7. A Free-float factor of say 0.55 means that only 55 per cent of the market capitalisation of the company will be considered for index calculation.
- Modified capitalisation weighted: This method seeks to limit the influence of the largest stocks in the index which otherwise would dominate the entire index. This method sets a limit on the percentage weight of the largest stock or a group of stocks. The NASDAQ-100 Index is calculated by using this method.
Price Weighted Index In this method, the price of each stock in the index is summed up which is then equated to an index starting value. An arbitrary date is set as the base and the Laspeyre's Price Index which measures price changes against a fixed base period quantity weight is used. In case of a stock-split, the market price of the stock falls and this results in less weightage in the index. The Dow Jones Industrial Average and Nikkie 225 are price-weighted indices.
Equal Weighting In this method, each stock's percentage weight in the index is equal and hence, all stocks have an equal influence on the index movement. The value line index at Kansas City Board of Trade (KCBT) is an equal weighted index.
Global Stock Market Indices
The Dow Jones lndustrial Average It is the most widely watched and quoted index because of its long existence. The Dow has 30 constituents and it follows the methodology of price-based weightage. Changes to stocks included in the Dow are infrequent: three stocks were added/dropped in 1991, four in 1997, and four in 1999. The addition of Microsoft and Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30.
The Nasdaq Composite Index This index is the market capitalisation weightages of prices for all the stocks listed in the Nasdaq stock market. The Nasdaq Composite began on February 8, 1971, with a base of 100.
The Nasdaq 100 Index Nasdaq 100 comprises the largest computer, software and telecom stocks by market capitalisation on the Nasdaq. For a company to be included in the Nasdaq 100, it must have a minimum average trading volume of 1,00,000 shares per day and must have been trading on a major exchange for at least a year or two.
The S&P 500 Index This index comprises 500 biggest publicly traded companies in the US by market capitalisation. Most money managers treat the S&P 500 as a proxy for the US stock market. The S&P 500 tries to cover all major areas of the US economy. To be included, a company must be profitable, the prospective company must not be closely held (at least 50 per cent of its stock should be public) and must have a large trading volume for its shares (not less than a third of its total shares).
The FTSE 100 The FTSE 100 consists of the largest 100 companies by full market value listed on the London Stock Exchange. The FTSE 100 is the benchmark index to indicate the performance of the European market. It is a market-capitalisation-weighted index that also considers the free-float weightages of individual stocks before including them in the index.
The MSCI Indices Include the MSCI EAFE (Europe, Australasia, and Far East), MSCI Europe, MSCI World, MSCI (EMF), and MSCI Pacific Basin Indices.
The MSCI World Index is a free-float adjusted market capitalisation index that is designed to measure global developed market equity performance. As of April 2002, the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Singapore, Portugal, Spain, Sweden, Switzerland, the United Kingdom and the United States.
The MSCI EAFE Index is a free-float market capitalisation index that is designed to measure developed market equity performance. As of April 2002, it consisted of 21 developed market country indices, excluding the US and Canada.
The MSCI EMF (Emerging Markets Free) Index is a free-float adjusted market capitalisation index that is designed to measure equity performance in the global emerging markets. As of April 2002, the MSCI EMF Index consisted of the following 26 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, the Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey and Venezuela.
S&P CNX Nifty
Major Indices in India
There are two major indices in India: BSE Sensex and NSE Nifty. The BSE Sensitive Index of equity share prices was launched in 1986. It comprises 30 shares and its base year is 1978–79. The major criterion for selection of a scrip in the Sensex is large market capitalisation. Besides this criterion, other criteria like listed history, track record, industry/sector representation, number of trades, average value of shares traded per day as a percentage of total number of outstanding shares, are considered for inclusion in the Sensex. The scrip selection is also based on a balanced representation of the industry, leadership position in the industry, continuous dividend-paying record, and track record of promoters. Since its beginning in 1986, it was revised for the first time on the 50th Independence Day, August 15, 1997, by replacing 15 scrips. During this revamp, the scrips of banks and financial institutions with a weightage of 14.6 per cent were included on the index for the first time. It was revised again in October 1998 to replace some old economy stocks such as Arvind Mills, Great Eastern Shipping, Steel Authority of India, and IPCL with some new economy stocks such as Infosys, NIIT, Castrol, and Novatris. The sensex was revamped again on March 11, 2000, which came into effect on April 10. Certain scrips, such as Indian Hotels, IDBI, Tata Chemicals, and Tata Power were replaced by Satyam Computers, Zee Telefilms, Dr Reddy's Laboratories, and Reliance Petroleum. The new economy stocks now have a 50 per cent weightage in the index. The BSE Sensex was revised again on January 7, 2002, when the motorcycle major Hero Honda Motors displaced Mahindra and Mahindra and HCL Technologies displaced NIIT. The BSE included the MUL scrip in place of L&T Ltd from May 19, 2004. On July 7, 2007, Mahindra and Mahindra displaced Hero Honda Motors. On July 28, 2008, Ambuja Cement Ltd and Cipla Ltd were replaced by Sterlite Industries Ltd and Tata Power Company Ltd. The Sun Pharmaceutical Industries replaced Satyam Computers on January 12, 2009. The recent revamp was on June 29, 2009 when Ranbaxy Laboratories was replaced by Hero Honda Motors. The index constituents were revised by the BSE 20 times between January 1, 1986 and June 30, 2009. Today, only eight of the original club of 30 remain, the others have been supplanted by companies whose scrips are far more indicative of the happenings in the market.
The Reliance Industries Ltd (RIL) has the highest weightage of 13.75% in index market capitalisation, followed by Infosys Technologies Ltd with 9.5%, and ICICI Bank Ltd with 7.58%. The BSE Sensex represents 44% of the BSE market capitalisation and 14 most-important listed and traded sectors. The BSE Sensex scrips, on average, account for 52% of the trading volumes on a daily basis and 35% of total trades executed on the exchange.
Impact cost is the cost of executing a transaction on a stock exchange. It varies with the size of the transaction
Another index which has become very popular in a short span of time is the S&P CNX NIFTY. The NSE began equity trading in November 1994, and its volumes surpassed that of the BSE in a very short span of time. The NSE and CRISIL undertook a joint venture, wherein they jointly promoted India Index Services and Products, a specialised organisation to provide stock index services. This organisation developed scientifically devised indices of stock prices in the NSE in technical partnership with Standard and Poor (S&P). The NSE introduced this index to reflect the market movements more accurately, provide fund managers with a benchmark for measuring portfolio performance and develop a reference rate for introducing index-based derivative products. The S&P CNX Nifty launched on July 8, 1996, comprises 50 scrips which are selected on the basis of low impact cost, high liquidity and market capitalisation. The impact cost is the percentage marking from the (bid+ask)/2 suffered in executing a transaction. The ‘Bid’ is the buyer's price—the price at which there is a ready buyer for the stock which he intends to sell. The ‘Ask’ (or offer) is the price at which there is a seller ready to sell his stock and this is the price the buyer needs to know when he is buying a stock.
Lower the impact cost, higher the liquidity of a stock and vice versa. Suppose a scrip trades at a bid price of Rs. 99 and an asking price of Rs. 101, the ideal price is Rs. 100. If a buy order for 1,000 shares goes through at Rs. 102, then the market impact cost is 2%. If a buy order for 2,000 shares goes through at Rs. 104, then the market impact cost at 2,000 shares is 4%. For a stock to be included in the S&P CNX Nifty, it must trade in the total portfolio of Rs. 2 crores at an impact cost of less than 1.5 per cent on 85% of the trading days. Nifty represents about 44% of the total market capitalisation on the NSE. The S&P CNX Nifty is a widely used indicator. Index funds and index futures and options, launched at the NSE, are based on the S&P CNX Nifty.
Both BSE as well as the NSE use the weighted average method of averaging whereby each stock is given a weight in proportion to its market capitalisation. Suppose an index contains two stocks, A and B. If A has a market capitalisation of Rs. 3,000 crores and B has a market capitalisation of Rs. 1,000 crores, then a 75 % weightage is attached to the movements in A and a 25% weightage to the movements in B.
Besides these two indices, the other popular indices are the Economic Times Ordinary Share Price Index, Financial Express Ordinary Price Index and the RBI Index of Security Prices. These indices comprise 72, 100, and 338 scrips, respectively. The major regional stock exchanges such as Kolkata, Chennai, Delhi and Ahmedabad have their own indices. The other major indices are the OTCEI index, the CMIE (Centre for Monitoring Indian Economy) index, the CRISIL CNX indices (mid-cap 200, PSE index, IT index and MNC index) and the Business Line (all India) Index.
The Bombay Stock Exchange
Trading in securities has been in vogue in India for a little over 200 years. Trading in securities dates back to 1793, most of them being transactions in loan securities of the East India Company. Rampant speculation was a common feature even during those times. The broking community prospered as there was a rise in prices which led to a share mania during 1861–65. This bubble burst in 1865 when the American Civil War ended. The brokers realised that investor confidence in the securities market could be sustained only by organising themselves into a regulated body with defined rules and regulations. This realisation resulted in formation of ‘The Native Share and Stock Brokers’ Association,’ which later came to be known as the Bombay Stock Exchange (BSE). In 1875, these brokers assembled at a place now called Dalal Street. The BSE was set up as a voluntary, non-profit-making association of broker members. It emerged as a premier stock exchange after the 1960s. The increased pace of industrialisation caused by the two world wars, protection to the domestic industry and the government's fiscal policies aided the growth of new issues, which, in turn, helped the BSE to prosper. The BSE dominated the Indian capital market by accounting for more than 60% of the all-India turnover.
Until 1992, the BSE operated like a closed club of select members. With the securities scam outburst in 1992 and the SEBI taking over the reins of the stock market, the BSE had to bring about changes in its operational policies. Until March 1995, the BSE had an open outcry system of trading. However, when faced with a stiff competition from the NSE, the country's first modern, computerised and professionally managed stock exchange set up in 1994, the BSE had to change its system of trading and operations. On March 14, 1995, the BSE turned to electronic trading whereby the brokers trade using computers. This system is known as the BSE On-line Trading System (BOLT). Screen-based trading was initially confined to 818 major scrips. Trading in all the 5,000 scrips of the BSE was transferred to BOLT on July 3, 1995. The introduction of BOLT helped in improving trading volumes, significantly reducing the spread between buy-and-sell orders, better trading in odd-lot shares, fixed-income instruments and dealings in the renunciation of rights shares.
In 1995, BOLT was limited to Mumbai, whereas the NSE was operating at the national level. As a result, the BSE was losing countrywide business. The BSE, therefore, submitted a proposal for allowing the installation of terminals connected to BOLT in centres outside Mumbai. After rejecting the proposal four times, on October 29, 1996, the SEBI finally allowed the BSE to use its BOLT system nationwide.
Today, BOLT is spread over 330 cities with 15,471 TWSs (trader work stations). Later, the BSE set up a central depository system to dematerialise shares and promote demat trading.
Carry Forward Deals, or Badla
The carry forward system, or badla, was a unique feature of Indian stock exchanges, particularly of the BSE. Badla was a unique selling proposition of the BSE. Badla provided the facility for carrying forward the transaction from one settlement to another. In simple terms, it was the postponement of the delivery of or payment for the purchase of securities from one settlement period to another. This facility of carry forward provided liquidity and breadth to the market. It was invented in the BSE and other exchanges copied the mechanism as it facilitated share financing, share lending, and carry forward simultaneously. It was a stock lending facility (since shares were needed to postpone a sell position) as well as a money market operation (since finance was needed to postpone a buy decision). By bringing in outside money to fund the carry forward of the long positions, badla acted as a bridge between the money market and the stock market. This system also helped in moderating extreme movement of stock prices, as it facilitated short selling in a rising market and long purchases in a declining market. It acted as a risk-hedging instrument wherein an investor could hedge against a likely fall or rise in prices by selling or buying in a carry forward market.
Badla is the postponement of the delivery of or payment for the purchase of securities from one settlement period to another
Badla was allowed in the specified group of shares of the BSE. This specified group was also known as the forward group as one could buy or sell shares in it without physical delivery. The carry forward session (badla session) was held on every Saturday at the BSE.
A contract for current settlement could be executed in any of the following three ways.
- Delivery against a sale contract given and delivery against a purchase contract received, and payment received/made at the contract rate.
- Squaring off of transactions wherein a reverse transaction of either buying or selling of shares squared up with the earlier outstanding position and the difference in prices settled.
- A contract in respect of which delivery was given or taken and which was not offset by an opposite transaction during the settlement period, could be carried forward to the next settlement period at the making up price, i.e. the closing quotation on the last trading day and the difference between the contract rate and the making up price settled. This postponement of the delivery of or payment for the purchase of securities from one settlement period to another was referred to as carry forward.
Badla involved four parties: the long buyer—a buy position in a stock without the capacity to take delivery of the same, the short seller—a sell position without having the delivery in hand, the financier and the stock lender.
Types of Badla Transactions
Vyaj badla known as mandi badla
Teji badla known as mal badla
If the quantum of delivery sales exceeded the quantum of delivery purchases, financiers known as vyaj badlawala came forward to assist in completing the deal, took delivery in the current settlement, made the delivery in the next settlement to the buyers and, by doing so, helped in carrying forward the transaction. The difference between the current settlement rate and the sale rate for the next settlement which they received was the interest charges known as seedha badla and the transaction was known as vyaj or mandi badla. If the quantum of delivery purchases exceeded the quantum of delivery sales, share financiers known as teji badlawala would give delivery in the current settlement to the buyers at the settlement rate and take the delivery back in the next settlement from the seller at lower sale rates. The difference between the two rates earned by them was known as ‘backwardation’ or ulta badla and the transaction was known as mal badla or teji badla.
Badla charges were market-determined and varied from scrip to scrip and from settlement to settlement. Badla rates ranged from 15 per cent to 36 per cent on a yearly basis. The SEBI banned badla charges for carry forward sales (short position) if the net carry forward buy (long) positions exceeded short positions. If the market was overbought (net long), there would be more demand for funds and the carry forward rates would be high; the reverse would be true when the market was oversold (net short). An oversold market would result in high demand for securities and the stock lender would get returns.
These transactions were completely hedged and stock exchanges guaranteed settlements and conducted auctions of shares in case of defaults. However, these guarantees were not available in unofficial or parallel badla markets which existed in Kolkata and Mumbai. Kolkata had a 90 per cent unofficial badla market and as a result, it had to undergo a payment crisis in 2001.
Badla, or the carry forward facility, was quite popular, accounting for nearly 90 per cent of the trade at all stock exchanges.
The badla system contributed to the increase in the volume of the trading activity at the BSE as it facilitated brokers to carry forward their positions and leverage. Moreover, as badla financiers were earning higher returns through this mechanism, they were lending a larger amount of funds, leading to an increase in trading activity. Badla along with other factors such as increased network, boom periods, and increased participation by retail investors was instrumental in the increase of volume of trading activity from Rs. 500 crore in 1991–92 to Rs. 9,000 crore in 2000. Badla was also a vehicle of speculation.
The 135-year-old badla system was banned in 1993 by the SEBI as it led to excessive speculation and increased market risk. It was also uncontrolled and unregulated which enhanced market risk and the prices of scrips could be manipulated under badla as brokers could easily corner liquid stocks. Moreover, brokers evaded margins and manipulated badla rates. Following the ban, however there was a steep decline in the volumes in the specified group following the ban. Therefore, it was revived and resumed again on the BSE in January 1996 on the recommendations of the G. S. Patel Committee. Later, in March 1997, the SEBI constituted the J. R. Varma Committee to review the revised carry forward system. The committee recommended a modified carry forward system (MCFS) which was accepted by the SEBI.
The MCFS was replaced by another carry forward mechanism—Borrowing and Lending of Securities Scheme (BLESS)—on January 27, 2001. This scheme was similar to Automatic Lending and Borrowing Mechanism (ALBM) of the NSE. The difference between ALBM/BLESS and badla was that while under ALBM/BLESS one could withdraw the securities financed by paying a small margin of 15 per cent to 20 per cent, under badla, securities were kept with the clearing house and could not be withdrawn. Due to the facility of withdrawal of securities under BLESS/ALBM, a broker could create an exposure seven to eight times the amount invested in these deferral products.
In March 2001, after the Ketan Parekh scam came to light and the payment crisis in the Kolkata Stock Exchange, the SEBI completely banned badla and all deferral products—ALBM and BLESS—from July 2001. With this ban again, the volume of trading on BSE slumped from an average daily turnover of Rs. 5,220 crore in May 2001 to around Rs. 700 crore in July 2001—a decline of more than 70 per cent in a period of two months. This old system has been replaced by a new system—rolling settlement.
Before badla was resumed in 1996, there were only two categories of securities listed on the BSE—the specified group of shares comprising the securities in which carry forward deals were allowed and the cash group shares in which no carry forward deals were permitted. Later, it was observed that the facility of carry forward was not being used in all the 94 scrips in the specified group. Hence, after badla was resumed, the size of the specified group was reduced to 32 scrips on April 3, 1996.
The BSE later decided to regroup the existing A and B group shares into three categories.
A Group This group consists of large turnover and high floating stock, with large market capitalisation. In other words, scrips included in this group are blue-chip companies. Carry-forward deals and weekly settlement were allowed in this group. At present, there are 150 scrips in this group.
B1 Group This group includes scrips of quality companies with an equity above Rs. 3 crores, with high growth potential and trading frequency. No carry-forward facility was allowed in this group. As on 12 December 2009, there were 205 scrips in this group.
B2 Group This group of scrips were just like those of B1 but with a fortnightly settlement. However, in September 1996, the BSE introduced a weekly settlement for all scrips listed on the exchange, thus doing away with the distinction between the B1 and B2 groups. This group consists of low trading volume scrips, with an equity below Rs. 3 crores, and surveillance measures initiated against most of them for suspected price manipulations.
Both B1 and B2 groups have been merged into one group known as B Group since April 1, 2008. All companies not included in group ‘A’, ‘S’ or ‘Z’ are clubbed under this category.
Subsequently, a Z group was introduced in 1999 with scrips of companies that do not meet the rules, regulations and stipulations laid down by the exchange. It is a buyer-beware company. There are some 300 scrips in the group. The companies that failed on a frequent basis to disclose quarterly results, to address investor grievances and make an arrangement with depositories to demat shares or even pay the exchange-listing fees are transferred by the exchange to this category. All Z-category stocks result in deliveries. The trading is on a trade-to-trade basis and no squaring up is permitted in intra-day trading as in other groups. The exchange authorities review their performance on a regular basis; and if a company satisfies the requirement, it is reverted back to its original group. As on December 12, 2009, there were 2,376 scrips in this group.
A new F group pertaining to the debt-market segment and G group pertaining to the government-securities market was started with effect from September 9, 1996.
The BSE set up the BSE INDONext market as a separate trading market on January 7, 2005 on its BOLT system as S group. As on December 12, 2009, there were 481 scrips in this group.
The scrips are transferred on a trade-to-trade basis from the regular segment to T group. Settlement of trades is done on the basis of gross obligations for the day. No netting is allowed and every trade is settled separately. As on December 12, 2009, there were 623 scrips in this group.
Scrips in the BSE-Indonext segment S, which are settled on a trade-to-trade basis as a surveillance measure, are transferred to the TS group. As on December 12, 2009, there were 52 scrips in this group.
There were 4,955 companies and 7,887 scrips were listed on BSE till November 2009.
The first index launched by BSE was the BSE Sensitive Index (Sensex) in 1986. Since then, in the last 15 years, it has launche d 13 more indices. The BSE Sensex of equity-share prices was launched with the base year of 1978–79. It comprises 30 scrips. The BSE Sensex was followed by the BSE National in 1989.
This is a broader index comprising 100 scrips. The BSE introduced two new indices during 1993–94—the BSE 200 and the Dollex. The BSE 200 reflects the movements in the shares of 200 selected companies from its specified and non-specified lists. The Dollex is a dollar version of the BSE 200, which has 1989–90 as its base year. The BSE Dollex indices are Dollex 30, 100 and 200. The BSE introduced five sectoral indices from August 1999—the BSE IT Index, the BSE Capital Goods Index, the BSE FMCG Index, the BSE Health Care Index and the BSE Consumer Durables Index. In 2001, the BSE launched the BSE-PSU Index Dollex-30 and the BSE-Tech Index. Market capitalisation of all the indices is a free-float market capitalisation except for BSE-PSU Index. Subsequently, it introduced seven new sectoral indices which include auto, bank, metal, oil and gas, power, realty and tech. The other major indices introduced are small cap, midcap, BSE100, BSE 500 and BSE IPO.
Box 8.4 Scrips Comprising the Sensex and their Free-float Factors
Sensex Moves in the 1990s
Gigantic Drops of the Sensex in a Day Of the eight major falls of Sensex in a day, three can be attributed to political developments and the rest to scams. Political stability and scams have, to a large extent, influenced the market investor sentiments—domestic and international.
|April 28, 1992||
|Harshad Mehta Involved in a Scam|
|May 12, 1992||
|Full Effect of the Scam|
|May 9, 1992||
|National Housing Bank Involved in a Scam|
|March 31, 1997||
|Congress Withdraws Support to Deve Gowda's Government|
|April 17, 1999||
|Vajpayee's Government Falls|
|April 04, 2000||
|Dotcom Bubble Bursts|
|May 17, 2004||
|Defeat of the BJP-led NDA Government|
|October 24, 2008||
|Sub Prime Crisis and Global Meltdown|
Bull Rally On October 17, 2003, the BSE Sensex closed at 4,930.53. This was the fastest rally of 2,006 points in the last decade. This 2,006-point rally came in 123 trading days, since April 25, 2003, when the Sensex was 2,924.12 points. However, the fastest rally, outside the current decade, was during the Harshad Mehta Scam when the Sensex gained 2,193 points in 31 trading days between February 7, and April 2, 1992. The biggest bull run was inspired by ‘Big Bull’ Harshad Mehta and expectations of foreign money coming into the local equity market. The Sensex moved up by 127% from 1,885 to 4,285 levels.
The second 1,150-plus point rally during March–August 2003 in the equity market was the largest half-year rally in more than a decade. The BSE Sensex then registered the biggest post-reform gain—a record rise of 83.37% during the year 2003–04. Unlike some previous rallies, this rally was a broad-based one, not driven by a few scrips of one or two sectors. Investors holding a diversified portfolio recorded an all-round gain. Moreover, there was also a considerable amount of FII interest in the Indian markets.
Between the last week of October 2004 and end-March 2005, a strong rally pushed the BSE Sensex to a historic high of 6,915.06 on March 8, 2005. Strong macroeconomic fundamentals, renewed buying interests by FIIs, an acceleration in the industrial activity, an improved financial performance of Indian companies, a moderation of domestic inflation, an easing of international crude-oil prices, an unprecedented pick-upon in bank credit and policy initiatives relating to the FDI in telecom and construction sections contributed to the upsurge in the Sensex.
The Sensex crossed the 8,000 level—a historic high on September 8, 2005. The Sensex closed on that day at 8,053—a rise of 106 points. The BSE Sensex crossed the 5-digit mark on February 6, 2006 when it touched 10,122. It touched 12,000 on April 20, 2006 and 12,671 on May 11, 2006, but it went into a free fall after May 12, 2006, lost 30% over a month, touched bottom at 8,799 on June 14, 2006 and drove investors into a panic.
The Sensex touched 11,015 on August 8, 2006 and 12,010 on September 15, 2006. It crossed the 13,000 mark on October 30, 2006 when the index rallied 117 points to close at 13,024. Investors' wealth in the 30 Sensex companies, measured in terms of the cumulative market value of these firms, soared to over Rs. 16,50,000 crores, from about Rs. 15,00,000 crores on April 20, 2006. Total investor wealth soared to over 34,00,000 crores on October 30, 2006. Strong economic growth, robust corporate results, a stable rupee, inflation and interest rates, lower crude-oil prices and high FII investment gave a fillip to market sentiments which drove the Sensex to amazing heights.
In 2006, the Sensex joined a select club of global indices such as the Dow Jones Industrial Average, the Nikkei and Hong Kong's Hang Seng which had crossed the 10,000 mark. India became the first BRIC country to join an exclusive club of developed markets whose market capitalisation of companies listed on the stock exchanges exceeds the GDP. A comparison of the market capitalisation with GDP is primarily made to assess the valuation levels of the markets. The total listed market capitalisation touched Rs. 34 lakh crores on October 16, 2006 exceeding the GDP figure of around Rs. 32 lakh crores during the financial year 2006.
The Sensex touched an all-time high of 21,206.77 on January 10, 2008, but then started declining on account of adverse global developments. Since the second quarter of 2009, the Sensex has been rising on account of improvements in the global financial markets scenario.
The BSE Sensex (Average) movements are shown in Figure 8.1.
Trends in Turnover on the BSE
The annual turnover, market capitalisation and the BSE Sensex increased sharply by 99 per cent in 1991–92 (Table 8.4). Share markets were unprecedentedly buoyant due to the liberalisation measures announced by the government to attract investments. Some important proposals announced in the Union Budget of 1992–93, such as the abolition of wealth tax on financial assets, abolition of the office of the CCI, free pricing era, and permission for Indian companies to raise funds abroad triggered volumes on the BSE. Irregularities in the securities transactions of banks and financial institutions also added to the speculative pressure in the stock markets. These irregularities were detected in 1992–93 when the scam broke out which -led to the streamlining of stock market operations by the BSE authorities, sharply reducing the turnover. In 1996–97, the turnover at BSE rose by 148 per cent. Badla was revived, which led to a massive rise in the turnover in the specified group of shares. Moreover, the extension of trading terminals outside Mumbai in September 1997 and rapid progress in trading in demat paperless form were some of the reasons for an increase in the turnover witnessed from 1996–97 to 1998–99.
During 1999–2000, the BSE turnover witnessed a sharp increase of 119 per cent. The market was driven by large FII inflows, improved corporate performance, sound macro-economic fundamentals, and upgrading of India's international credit ratings from stable to positive by international credit rating agencies. In 2000–01, the increase in turnover was 46 per cent. This was due to a slowdown in FII inflows, large sell-offs of new economy stocks on Nasdaq, an increase in international oil prices, payment crises at some stock exchanges, and liquidity problems with some cooperative banks.
Figure 8.1 BSE Sensex (Average)
The average share of A group in total volumes from 1990–91 to 1993–94 was around 78 per cent. In 1994–95, there was a sharp fall in its percentage as the SEBI banned badla in A group shares. Then, with the resumption of badla in January 1996, the proportion of A group increased. Moreover, in 1995–96, even though the number of companies in A group was reduced sharply from 94 to 32, the group's share in total volumes increased. This shows a very high concentration of a handful of companies in trading volumes at the exchange.
The number of listed companies rose from 2,471 in 1990–91 to 9,413 in 2002–03. However, the number of listed companies declined to 4,955 till November 2009, on account of delisting of securities. The market capitalisation is an indicator of the addition to the wealth of share owners. Its increase is a function of price change and supply change coming from new issues. In the first year of economic reforms, market capitalisation increased by 256%. This was the result of an increase in share prices due to an announcement of liberalisation measures and the listing of six PSU stocks for the first time on the stock exchange. In the subsequent year, 1992–93, market capitalisation declined due to irregularities in securities transactions. Share prices firmed up again in 1993–94 due to an increased flow of foreign funds, increased investor interest and speculative trading.
The secondary market turned distinctly depressed thereafter, as the BSE Sensex lost as many as 1382.30 points by March 31, 1995. In 1996–97, 1998–99, and 2000–01, even though the turnover increased, the market capitalisation declined. This indicated that the positive impact of wealth on consumption demand was lacking. The decline in market capitalisation was a result of decline in the new economy share prices and large sell-offs in the global market, news about financial status of US-64, payment crises at some stock exchanges and withdrawal of deferral products including badla. The secondary market turnover declined sharply both at the BSE and the NSE in 2001–02. Global recessionary conditions, international disturbances, and domestic industrial slowdown accounted for this sharp decline. The BSE Sensex touched the 2,600 mark on September 21, 2001 when terrorists attacked US cities. This 2,600 mark was an all-time, eight-year low, the lowest since September 8, 1993. BSE market capitalisation jumped to Rs. 17.5 lakh crores in March 2004, and India joined the US$400-billion Asian elite club. On October 30, 2006, the Sensex joined a select club of global indices which have crossed the 10,000 mark and continued to trade above that mark. The BSE Sensex touched an all-time high of 21,207 on January 10, 2008, but declined sharply thereafter on account of global financial turmoil. The impact of the sub-prime crisis and the turbulence in the global financial markets were felt on the stock markets in India. The depressed conditions in the domestic and global markets led to a steep fall in the Sensex by 60.9% and it touched a new low of 8,110.10 on March 9, 2009. The volatility of the BSE Sensex increased, the market capitalisation fell and the price–earning (P/E) ratio declined significantly. With improvements in the global liquidity and global financial markets, there has been an upward trend in the Sensex since the second quarter of 2009. The FIIs returned to the Indian markets and large purchases by them raised the BSE Sensex to 17,000 mark in November 2009. Moreover, the unexpected, good, corporate-earning announcements improved the market sentiments and investor confidence (Table 8.4).
TABLE 8.4 Important Indicators of the Stock Exchange, Mumbai
Note: Figures in brackets are percentage variations over the previous year.
N.A.: Not Available.
Source: The Stock Exchange, Mumbai.
The P/E ratio is the market price of a share divided by the earnings per share. It signifies the price being paid by the buyer of equities for each rupee of annual earnings, whether distributed as dividends or retained in the company. A company's P/E ratio is crucial for judging whether the prevailing market price of a share is reasonable. The P/E ratio of the index is the market capitalisation of the 30 companies in the Sensex, divided by their earnings or net profits. A market's P/E ratio is an important indicator of the general state of the share market. Markets decide the P/E ratio based on a company's expected growth in earnings. Hence, when the expectation of growth increases and confidence shoots up, the scrip gains. One of the highest P/E levels was witnessed in April 1992, when the Sensex had a P/E of 56. In November 1994 it was 39, in July 1999 it was 17.51, in June 2000 it was 22.4 and in September 2003 it was 15.55. In November 2004, the stocks of Indian companies were quoted at 13 times their earnings. A declining trend was witnessed in P/E ratios due to lack of free-float, rising fiscal deficit, and a substantial rise in recent years in earnings of corporates. A similar trend was observed in the price–book-value ratio. The annualised yield based on 30 scrips included in the Sensex was the highest at 1.82% in 1998–99 and declined in the subsequent years and again increased to 2.0 in 2001–02. The price–earning ratio of the 30 scrips increased during the years 2005–06, 2006–07 and 2007–08, but declined during 2008–09. A similar trend was noticed in the price–book-value ratio.
Box 8.5 Price–to-book Value Ratio
Price-to-book value (P/BV) is the ratio of market price of a company's share over the book value of its equity, or the net worth. The net worth is the value of company's assets expressed in the balance sheet, i.e., the difference between the book value of assets and book value of its liabilities. The P/BV ratio offers a simple approach to find undervalued stocks. If a stock is trading for less than its book value, or has a P/BV ratio of less than 1, it means the investors perceive the company's assets as overstated or that the company is earning a low return on assets. This ratio may not always be a reliable guide for picking under valued stocks on account of various reasons: book value of an asset may not help when assets are ageing or the earnings power of the assets increase or decrease; book value can be changed by increasing or lowering the cash reserves; and this ratio is of less value to companies in the services sector with few tangible assets.
TABLE 8.5 Top 50 Companies by Market Capitalisation and Turnover at BSE and NSE (Rs. in Crores)
Note: FMCG: Fast moving consumer goods such as food, beverages and personal products.
IT: Information Technology.
Source: BSE, NSE, RBI, Report on Currency and Finance and various issues.
Table 8.5 reflects the significant changes in the relative importance of various companies. Traditionally, manufacturing companies such as cements and steel and the financial-services sector constituted the bulk of market capitalisation and of the turnover at the stock exchanges. However, in recent years, the relative importance of the traditional sectors has declined, while that of information technology (IT), pharmaceuticals and FMCG sectors has increased.
This change was a result of the government policy, which lifted the controls on the private sector and then opened up the economy to foreign companies. Hence, many capital-intensive industries such as steel, fertilisers and chemicals, which worked well in a closed economy, could not withstand the international competition. Moreover, new companies and businesses emerged which offered good returns.
The oldest stock exchange of India faced rough weather when the National Stock Exchange (NSE) was set up in 1994. It was opined that the BSE would not be in a position to face stiff competition from this new and modern stock exchange. However, the BSE revamped its operations quickly, adopted modern technology, and gave tough competition to the NSE. This competition among the exchanges has made the Indian capital market more mature.
The BSE is still in the process of reforming itself. The involvement of BSE brokers and its elected members in a series of scams has affected its image and small and institutional investors have more or less lost faith in it. It completed the process of demutualisation and corporatisation in May 2007. The Singapore stock exchange (SGX) and the Deutsche Borse (DB) are BSE's strategic partners holding 5 per cent stake each in the exchange. They have a combined investment of Rs. 380 crore at Rs. 5200 per share.
The BSE's network outside Mumbai has not expanded significantly. The BSE lacks in liquidity and needs to draw in more players like market makers to create liquidity. The BSE and NSE had commenced derivatives trading in 2000 but NSE dominates the derivatives market. Thus, BSE needs to revamp its strategic plan to compete with NSE.
THE NATIONAL STOCK EXCHANGE OF INDIA
The stock markets witnessed many institutional changes in the 1990s. One of them was the establishment of the NSE, a modern stock exchange which brought with it the best global practices.
The NSE was incorporated in November 1992 with the following objectives.
To establish a nationwide trading facility for equities, debt instruments, and hybrids.
To ensure all investors all over the country equal access through an appropriate communication network.
To provide a fair, efficient, and transparent securities market to investors through an electronic trading system.
To enable shorter settlement cycles and book-entry settlement system.
To meet the current international standards of securities markets.
The Pherwani Committee, which mooted the setting up of the NSE, wanted different trading floors linked through a technologically backed, automated network thereby creating an exchange with a national network. However, instead of providing a common platform for all regional stock exchanges, the NSE is competing with the BSE, thus creating a problem of survival for other exchanges.
The NSE, unlike other Indian stock exchanges, is a tax-paying company incorporated under the Companies Act, 1956. It has been promoted by leading financial institutions and banks to provide automated and modern facilities for trading, clearing and settlement of securities in a transparent, fair and open manner and with countrywide access.
The exchange is professionally managed in that the ownership and the management of the NSE are completely separated from the right to trade on the exchange. In order to upgrade the professional standards of the market intermediaries, the exchange lays stress on factors such as capital adequacy, corporate structure, track record and educational experience.
NSE's membership is always on tap and anyone who meets the eligibility criteria such as cash deposits and high net worth can become a member. A member, who wants to quit business, can do so freely and refund deposits after meeting all liabilities. The Exchange had 1,227 members as at end March 2009 and a large majority (88.59%) of them were corporate members, and the remaining, individuals, firms and banks.
NSE members are connected to the Exchange from their work stations to the central computer located at the exchange through a satellite using VSATs (very small aperture terminals). The NSE has installed over 2,648 VSATs in over 201 cities across the country. Members can place orders from their office and extend connectivity to clients through their computer-to-computer-link (CTCL) facility outside their premises. Registered dealers of the members have remote trading terminals at their offices and they trade electronically on the ‘NSE–NEAT’ trading system through the CTCL server installed at the members’ office. Through this facility, members can have a total control over their network and can closely monitor the orders placed by their registered dealers/branches.
The NSE was granted recognition as a stock exchange in April 1993 and it started operations with the wholesale debt market (WDM) segment in June 1994. It started equity trading in November 1994 and, in a short span of 1 year, surpassed the volume at the BSE, the largest stock exchange in the country. The NSE is the only stock exchange in the world to get to the first place in the country in the very first year of its operations.
The NSE offers a trading platform for a wide range of products for multiple markets, including equity shares; warrants; exchange-traded funds (ETF); mutual funds; debt instruments including corporate debt, central and state government securities, treasury bills, commercial paper and certificate of deposits; derivatives like index futures and options, stock futures and options and currency futures. The Exchange provides trading in four different segments, namely, Wholesale Debt Market (WDM) segment, Capital Market (CM) segment, Futures & Options (F&O) segment and the Currency Derivatives (CD) segment. Table 8.6 captures the record number of trades and daily turnover in all the five segments of NSE.
There are more than 1,400 companies listed in the Capital Market and more than 95% of these are actively traded.
The NSE introduced, for the first time in India, fully automated, screen-based trading, eliminating the need for physicaltrading floors. This screen-based trading was the first to go live in the world through satellite communication.
The NSE developed a system of managing the primary issues through screen-based automated trading system.
The NSE offers its nationwide network for conducting online IPOs through the book-building process. It operates a fully automated, screen-based, bidding system called NEAT IPO that enables the trading members to enter bids directly from their offices through a sophisticated telecommunication network.
The NSE developed a new trading application, NOW, or ‘NEAT on Web’ in May 2008. This platform allows the trading members to connect to the Exchange through the Internet, and has resulted in a significant reduction in both access cost as well as turnaround time for providing access.
The NSE is the first stock exchange to help promote institutional infrastructure of the capital market.
The NSE set up the National Securities Clearing Corporation Limited (NSCCL)—the first clearing corporation in the country, to provide settlement guarantee. To promote dematerialisation of securities, it jointly set up with the erstwhile UTI and the IDBI, the National Securities Depository Limited (NSDL)—the first depository in India.
The NSE set up India Index Services and Products Limited (IISL), a joint venture of CRISIL and NSE, in May 1998, to provide indices and index services. IISL is India's first specialised company focusing upon the index as a core product and maintains over 96 equity indices comprising broad-based, benchmark indices, sectoral indices and customised indices.
The NSE's IT set-up is larger than that of any company in the country. It has a state-of-the-art client-server application. The NSE was the first exchange to grant permission to brokers for Internet trading.
TABLE 8.6 NSE—At a Glance
The NSE incorporated a separate entity—NSE IT Ltd in October 1999, to service the securities industry in addition to the management of IT requirements of the NSE. It also set up NSE Infotech Services Ltd to focus on IT. It caters to the IT needs of NSE and all its group companies exclusively. The data and infovending products of the NSE are provided through a separate company DotEx International Ltd, a wholly owned subsidiary of the NSE.
The commodity exchange platform—NCDEX—was jointly set up by the NSE with financial institutions. In order to provide clearing-and-settlement services to NCDEX, it promoted a company—National Commodity Clearing Limited (NCCL) in 2006. In 2008, it set up a national-level electricity exchange—Power Exchange India (PXI) Ltd, again the first of its kind in the country.
The NSE is ranked third in terms of number of equity shares traded and is the eighth largest derivatives exchange in the world.
Membership Pattern on the NSE
The management of the NSE is in the hands of professionals, as distinct from the trading members, to avoid any conflict of interest. If the applicant is an individual/partnership firm/corporate, then the individual/at least two partners of the applicant firm/at least two directors of the applicant corporate must be graduates, possess at least 2-year experience in securities market, not debarred by the SEBI and not engaged in any fund-based activity. A trading member is admitted to any of the following combinations of market segments: (a) wholesale debt market (WDM) segment, (b) capital market (CM) and the futures and options (F&O) segments, (c) CM segment and the WDM segment or (d) all the three segments (refer Table 8.7).
|April 1993||Recognition as a stock exchange.|
|June 1994||WDM segment goes live.|
|November 1994||CM segment goes live through VSAT.|
|March 1995||Establishment of Investor Grievance Cell.|
|April 1995||Establishment of NSCCL, the first Clearing Corporation.|
|July 1995||Establishment of Investor Protection Fund.|
|October 1995||Became the largest stock exchange in the country.|
|April 1996||Commencement of clearing and settlement by NSCCL.|
|April 1996||Launch of S&P CNX Nifty.|
|June 1996||Establishment of Settlement Guarantee Fund.|
|November 1996||Setting up of National Securities Depository Ltd, the first depository in India, co-promoted by NSE.|
|November 1996||‘Best IT Usage’ award by Computer Society of India.|
|December 1996||Commencement of trading/settlement in dematerialised securities.|
|December 1996||Dataquest award for ‘Top IT User.’|
|December 1996||Launch of CNX Nifty Junior.|
|November 1997||‘Best IT Usage’ award by Computer Society of India.|
|May 1998||Promotion of joint venture, India Index Services & Products Limited (IISL) (along with CRISIL) for index services.|
|May 1998||Launch of NSE's Web-site: www.nseindia.com.|
|July 1998||Launch of ‘NSE's Certification Programme in Financial Markets.’ (NCFM).|
|August 1998||‘CYBER CORPORATE OF THE YEAR 1998’ award.|
|April 1999||‘CHIP Web Award’ by CHIP magazine.|
|October 1999||Setting up of NSE. IT Ltd.|
|January 2000||Launch of NSE Research Initiative.|
|February 2000||Internet Trading in CM segment.|
|June 2000||Commencement of Derivatives Trading (in Index Futures).|
|September 2000||Launch of Zero Coupon Yield Curve.|
|June 2001||Commencement of Trading in Index Options.|
|July 2001||Commencement of Trading in Options on Individual Securities.|
|November 2001||Commencement of Trading in Futures on Individual Securities.|
|December 2001||Launch of NSE VAR for Government Securities.|
|January 2002||Launch of Exchange Traded Funds (ETFs).|
|May 2002||NSE wins the Wharton–Infosys Business Transformation award in the organisation-wide transformation category.|
|October 2002||Launch of Government Securities Index.|
|January 2003||Launch of Retail Debt of Government Securities.|
|June 2003||Launch of Exchange Traded Interest Rate derivatives on Notional 91-day T-bills and Notional 10-year bonds.|
|August 2003||Launch of Futures and Options on CNX IT Index.|
|June 2004||Launch of STP Interoperability.|
|August 2004||Launch of NSE electronic interface for listed companies.|
|March 2005||‘India Innovation Award’ by EMPI Business School, New Delhi.|
|June 2005||Launch of Futures & Options on BANK Nifty Index.|
|August 2006||Setting up of NSE Infotech Services Ltd.|
|December 2006||‘Derivative Exchange of the Year,’ by Asia Risk magazine.|
|January 2007||Launch of NSE–CNBC TV 18 media centre.|
|March 2007||NSE, CRISIL announce launch of India Bond Watch.com|
|March 2007||Launch of Gold BeES—Exchange Traded Fund (ETF).(First Gold ETF).|
|June 2007||Launch of Futures & Options on CNX 100 and CNX Nifty Junior contracts.|
|October 2007||Launch of Futures & Options on Nifty Midcap 50.|
|January 2008||Launch of Mini Nifty derivative contracts.|
|March 2008||Launch of long-term option contracts on S&P CNX Nifty Index.|
|May 2008||Launch of NOW or ‘NEAT on Web’ platform.|
|April 2008||Launch of DMA|
|April 2008||Launch of Securities Lending & Borrowing Scheme.|
|April 2008||Launch of India VIX—The Volatility Index.|
|June 2008||Setting up of Power Exchange India Ltd.|
|August 2008||Launch of Currency Derivatives for the first time in India, currency futures are traded on a stock-exchange platform.|
|October 2008||Operationalisation of Power Exchange India Ltd. It provides a common electronic platform for trading of electricity.|
|August 2009||Launch of Interest Rate Futures.|
|November 2009||Launch of Mutual Fund Service System.|
TABLE 8.7 Distribution of SEBI Registered Trading Members on NSE as on March 31, 2009
CM = Capital Market, WDM = Wholesale Debt Market, F&O = Futures & Options, PCM=Professional Clearing Members, CD = Currency Derivatives
The NSE Fifty was rechristened as the S&P CNX Nifty on July 28, 1998. This index is widely used as it reflects the state of the market sentiments for 50 highly liquid scrips. The base period for the S&P CNX Nifty is November 3, 1995. The S&P CNX Nifty is computed using a float-adjusted, market capitalisation-weighted methodology. It accounts for 58.64% of the total market capitalisation of CM segment of NSE and 51.39% of the traded value of all the stocks on the NSE as at end-March 2008. It is used as a benchmarking fund portfolios, index-based derivatives and index funds.
The CNX Nifty Junior is a mid-cap index introduced in January 1997 to cater to the growth companies in the economy. The base period is November 3, 1996. Companies include those which are traded with an impact cost of less than 2.5% on 85% of the trading days. It accounts for 9.60% of the market capitalisation of CM segment of NSE as at end-March 2008.
A new index called the S&P CNX Defty (dollar-denominated S&P CNX Nifty) was introduced on November 26, 1997. It shows returns on the S&P CNX Nifty index in dollar terms. The S&P CNX Defty serves as a performance indicator to FIIs, offshore funds and others. It is also used as an effective tool for hedging Indian equity exposure. This new index is available online.
The other popular indices are the Nifty mid-cap 50, the CNX mid-cap 50, the S&P CNX Sectoral Indices, such as IT, Bank, FMCG, Public Sector Enterprises (PSE), MNC, Services, Energy, Pharma, Infrastructure, PSU Bank and Realty.
NSE launched on January 29, 2008 an environment, social and corporate governing (ESG) index, the first of its kind, to measure practices based on quantitative as opposed to subjective factors.
These indices are maintained, monitored and updated by India Index Services and Products Limited (IISL). A joint venture between the NSE and CRISIL, IISL is the only specialised organisation in the country to provide stock-index services. It introduced the country's first infotech, sector-specific index in September 1998.
Functions of NSCCL
Clears all trades
Determines obligations of members
Arranges for pay-in and pay-out of funds/securities
Processes for shortages in funds/securities
Collects and maintains margins/collateral/base capital/other funds
Counter party to all settlement obligations of the members
National Securities Clearing Corporation Limited
In April 1995, the NSE set up the National Securities Clearing Corporation Limited (NSCCL), a wholly owned subsidiary, to undertake clearing and settlement at the exchange. It commenced operations from April 1996. It operates with a well-defined settlement cycle, aggregates trades over a trading period, nets the positions to determine the liabilities of the members, and ensures movement of funds and securities to meet respective liabilities. Its central functions are clearing and settlement of trades and risk management.
The NSCCL assumes the counter-party risk of each member and guarantees settlement. Settlement guarantee is a guarantee provided by the clearing corporation for the settlement of all trades even if a party defaults to deliver securities or pay cash. The NSCCL started the settlement guarantee fund for the capital market in June 1996 with an initial corpus of Rs. 300 crore (Table 8.9). This fund stood at Rs. 2,700 crore at the end of March 2006. It cushions itself from any residual risk. Members contribute to this fund which is utilised for the successful completion of settlement. A separate settlement guarantee fund (SGF) is maintained for the futures and options (F&O) segment.
There are four entities linked with the Clearing Corporation (NSCCL) in the clearing and settlement process.
Custodian/Clearing members: Clearing members have to make available funds and/or securities in the designated accounts with clearing bank/depositories to meet their obligations on the settlement date. Custodian is a clearing member but not a trading member. They settle trades assigned to them by trading members. The NSCCL notifies the relevant trade details to custodians on the trade day who affirm back. If a custodian confirms to settle that trade, he is assigned that particular obligation by the NSCCL. There are 11 custodians empanelled with the NSCCL.
Clearing banks: They are a key link between the clearing members and clearing corporation. Every clearing member is required to open a dedicated clearing account with one of the designated clearing banks. The NSCCL, in association with clearing banks, provides working capital funding to clearing members. A clearing bank has to enter into an agreement with the NSCCL and the clearing member and open clearing accounts with depositories. The clearing member has to approach its bank, which would extend the funding requirements in consultation with the NSCCL.
Depositories: They hold securities in dematerialised form for the investors in their beneficiary accounts. Every clearing member is required to maintain a clearing pool account with the depositories. The depository runs on electronic file to transfer securities from accounts of the custodians/clearing member to that of the NSCCL and vice versa.
Professional Clearing Members (PCMs): They are a special category of members with clearing rights but with no trading rights and who perform functions similar to those of custodians. PCMs clear and settle trade for their clients who may be individuals or institutions.
The NSCCL carries out the clearing and settlement process with the help of clearing banks and depositories which results in an actual movement of funds and securities on the prescribed pay-in and pay-out day.
NSCCL Products and Services
Clearing and settlement
Direct payment to clients
Constituent SGL account
Mutual fund service system
The clearing members bring in the securities in designated accounts with the two depositories—the CM pool account in the case of the NSDL and designated settlement accounts in the case of the CDSL and funds in the designated accounts with clearing banks. The clearing banks, on receiving electronic instructions from the NSCCL, debit accounts of clearing banks and credit accounts of the clearing corporation. This is termed as pay-in of funds and securities (Table 8.8).
The NSCCL, after providing for shortages of funds/securities, sends electronic instructions to the depositors/clearing banks to credit accounts of clearing members and debit accounts of the clearing corporation. Thus, the settlement cycle is complete once the pay-out of funds and securities is done.
The NSCCL imposes stringent margin requirements as part of its risk containment measures. For imposing margins, the stocks are categorised as follows:
TABLE 8.8 Settlement Cycle at NSCCL
|Activity||T + 2 Rolling System (From April 1, 2003)|
|Trading||T (Trade Details from Exchange to NSCCL)|
|Custodial Confirmation||T + 1 (Custodians/Clearing Members (CMs) Confirm the Trade)|
|Determination of Obligation||T + 1 (NSCCL Determines Obligations and Gives Pay-in Advice for Funds/Securities to Clearing Banks and Depositories, Respectively.|
|Securities/Funds Pay-in||T + 2 (NSCCL Advises Depository and Clearing Banks to Debit Pool Account of Custodians/Clearing Members (CMs) and Credit its Account)|
|Securities/Funds Pay-out||T + 2 (NSCCL Advises Depository and Clearing Banks to Credit Pool Account of Custodians/CMs and Debit Its Account)|
|(Depository Informs Custodians/CMs through DPs)|
|(Clearing Banks Inform Custodians/CMs)|
|Valuation Debit||T + 2|
|Auction||T + 3|
|Bad-delivery Reporting||T + 4|
|Auction Pay-in/Pay-out||T + 5|
|Close-out||T + 5|
|Rectified Bad-Delivery Pay-in/Pay-out||T + 6|
|Re-bad-delivery Reporting||T + 8|
|Close-out of Re-bad Delivery||T + 9|
TABLE 8.9 Settlement Statistics—National Securities Clearing Corporation Limited
- The stocks, which have traded atleast 80 per cent of the days during the previous 18 months, shall constitute Group I and Group II.
- Out of the scrips identified above, those having a mean impact cost of less than or equal to one per cent shall be under Group I and the scrips where the impact cost is more than one, shall be under Group II.
- The remaining stocks shall be under Group III.
- The impact cost shall be calculated on the 15th of each month on a rolling basis considering the order book snapshots of the previous six months. On the basis of the calculated impact cost, the scrip shall move from one group to another group from the 1st of the next month. The impact cost is required to be calculated for an order value of Rs. 1 lakh.
The daily margin is the the sum of mark to market margin (MTM margin) and value at risk-based margin (VaR-based margin). The VaR margin is applicable for all securities in rolling settlement.
For the securities listed in Group I, scripwise daily volatility is calculated using the exponentially weighted moving average which is 3.5 times the volatility. For the securities listed in Group II, the VaR margin is higher of scrip VaR (3.5 δ) or three times the index VaR and it is scaled up by root 3. For the securities listed in Group III, the VaR margin is equal to five times the index VaR and scaled up by square root of 3. The VaR margin rate for a security constitute the following.
The index VaR would be the higher of the daily Index VaR based on the S&P CNX Nifty or the BSE Sensex. The index VaR would be subject to a minimum of 5 per cent.
An additional VaR margin of 6 per cent as specified by the SEBI.
The NSCCL may stipulate security specific margins for the securities from time to time.
The mark to market margin is calculated on the basis of a notional loss which the member would incur in case the cumulative net outstanding position of the member in all securities, at the end of the relevant day were closed out at the closing price of the securities as announced at the end of the day by the NSE. Mark to market margin is calculated by marking each transaction in a scrip to the closing price of the scrip at the end of trading. In case the security has not been traded on a particular day, the latest available closing price at the NSE is considered as the closing price. In the event of the net outstanding position of a member in any security being nil, the difference between the buy and sell values would be considered as notional loss for the purpose of calculating the mark to market margin payable. MTM profit/loss across different securities within the same settlement is set off to determine the MTM less for a settlement. Such MTM losses for settlements are computed at client level.
The NSCCL has introduced the facility of direct payment to clients' account on both the depositories—the NSDL and the CDSL. Based on the information received from members, the NSCCL sends pay-out instructions to the depositories which enables the clients to receive the pay-out directly into their accounts on pay-out day.
The NSCCL also offers constituent subsidiary general ledger (CSGL) facilities to investors in government securities. SGL is a facility provided by the RBI to large banks and financial institutions to hold their investments in government securities in the electronic book entry form. The securities held in SGL can be settled through a delivery-versus payment (DVP) mechanism which ensures simultaneous movement of funds and securities.
Mutual Fund Service System (MFSS) is a facility provided by the NSCCL to investors for transacting in dematerialised units of open-ended schemes of mutual funds. The objective is to provide to the investor a one-stop shop for transacting in financial products. MFSS addresses the need for a common platform for sale and repurchase of units of schemes managed by various funds. The exchange, with its extensive network covering around 400 cities and towns across the country, offers a mechanism for electronic online collection of orders from the market and the Clearing Corporation acts as a central agency for the clearing and settlement of all orders. The transactions are not covered by settlement guarantee.
The NSCCL was permitted to operate a stock lending/borrowing scheme from July 1998. The NSE and the NSCCL commenced the automated lending and borrowing mechanism (ALBM) for lending and borrowing of securities from February 10, 1999. The ALBM facilitated borrowing/lending of securities/funds at market-determined rates to meet immediate settlement requirements or payment obligations at a reasonable cost and low risk. The ALBM was NSE's answer to BSE's badla. The ALBM was restricted to only the S&P CNX Nifty and the CNX Nifty Junior Index securities. Badla was supposed to be a pure financing mechanism while ALBM was a security lending and borrowing mechanism. The trades in the ALBM segment were guaranteed by the settlement fund of the NSE. This deferral product has been banned by the SEBI along with other deferral products from July 2001.