Secondary Markets in India

Types of Financial Markets• The financial markets can broadly be divided into money

and capital market.• Money Market: Money market is a market for debt

securities that pay off in the short term usually less than one year; for example the market for 90-days treasury bills. This market encompasses the trading and issuance of short term non equity debt instruments including treasury bills, commercial papers, bankers acceptance, certificates of deposits, etc.

• Capital Market: Capital market is a market for long-term debt and equity shares. In this market, the capital funds comprising of both equity and debt are issued and traded. This also includes private placement sources of debt and equity as well as organized markets like stock exchanges. Capital market can be further divided into primary and secondary markets.

Secondary Market

• Secondary Market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets.

• For the general investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company, secondary equity markets serve as a monitoring and control conduit—by facilitating value-enhancing control activities, enabling implementation of incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions.

Difference between Primary & Secondary Markets

• In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading avenue in which already existing/pre- issued securities are traded amongst investors. Secondary market could be either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.

Role of SEBI

• The SEBI is the regulatory authority established under Section 3 of SEBI Act 1992 to protect the interests of the investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith and incidental thereto.

Stock Exchanges in India

• There are 19 recognised stock exchanges in India. However, the main business is with NSE and BSE.

• It is important that while structuring stock exchanges, all the three main functions, viz. ownership, management and trading are clearly segregated. In India this has been ensured by SEBI.

Trading in Corporate Bonds

• The term Corporate Bonds includes all debt securities issued by institutions such as Banks, Public Sector Undertakings, Municipal Corporations, bodies corporate and companies having a tenure of more than 365 days. Such an issue of bonds, if offered to the public, shall be required to comply with the SEBI (Disclosure and Investor Protection Guidelines), 2000. Also, a private placement of corporate bonds made by a listed company shall be required to comply with provisions contained in SEBI Circulars in this regard.

• The SEBI Circulars dated September 30, 2003 and December 22, 2003 have laid out norms pertaining to the disclosure norms on issuance of such securities, which include compliance with Chapter VI of the SEBI (Disclosure and Investor Protection) Guidelines, 2000, Companies Act, 1956, listing agreement for debentures with the stock exchanges, rating to be obtained from a Credit Rating Agency registered with SEBI, requirement for appointing a debenture trustee registered with SEBI, mandatory trading in dematerialized form, etc.

Trading in Corporate Bonds

• BSE and NSE have launched an order driven trade matching platform which retains essential features of OTC market where trades are executed through brokers. OTC trades however continue to be reported on the exchange reporting platforms. In order to encourage wider participation, the lot size for trading in bonds has been reduced to Rs.1 lakh.

Primary Dealer System

• A system of primary dealers (PDs) was introduced in 1996 to strengthen the government securities market infrastructure and to make it more liquid and broad based.

• In order to enable PDs to perform their role effectively, the RBI has cast certain obligations upon them, which include an annual minimum bidding for dated securities and treasury bills with a minimum success ratio and commitment to underwrite the shortfall (gap) between the subscribed/ accepted amount and the notified amount.

Role of Brokers/ Sub-brokers• A broker is a member of a recognized stock exchange,

who is permitted to do trade on the screen-based trading system of different stock exchanges. He is enrolled as a member with the concerned exchange and is registered with SEBI.

• A sub broker is a person who is registered with SEBI as such and is affiliated to a member of a recognized stock exchange.

• For the purpose of engaging a broker to execute trades on the investor’s behalf from time to time, details of the investor have to be furnished for enabling the broker to maintain client registration form. The investor has to sign the “Member - Client agreement” if dealing directly with a broker. In case the investor is dealing through a sub-broker then she will have to sign a ”Broker - Sub broker - Client Tripartite Agreement”.

Selecting a Broker

• Brokers differ enormously by size and type of clientele.

• Some brokers concentrate on institutions while others specialise in dealing with individuals.

• Some brokers do their own analysis, while others depend upon second-hand analysis.

• Fees usually vary depending upon type and size of business, negotiating capacity of client, etc.

• Commission levels have declined in recent years on account of competition

Charges Incurred by Investors

• The maximum brokerage that can be charged by a broker has been specified in the Stock Exchange Regulations and hence, it may differ across various exchanges. As per the BSE & NSE Bye Laws, a broker cannot charge more than 2.5% brokerage from his clients.

• Securities Transaction Tax (STT) is a tax being levied on all transactions done on the stock exchanges at rates prescribed by the Central Government from time to time. Pursuant to the enactment of the Finance (No.2) Act, 2004, the Government of India notified the Securities Transaction Tax Rules, 2004 and STT came into effect from October 1, 2004.

Process of Online Trading

• The normal course of online trading in the Indian market context is placed below:

• Step 1: Investor / trader decides to trade• Step 2: Places order with a broker to buy / sell the required quantity

of respective securities• Step 3: Best priced order matches based on price-time priority• Step 4: Order execution is electronically communicated to the

broker’s terminal• Step 5: Trade confirmation slip issued to the investor / trader by the

broker• Step 6: Within 24 hours of trade execution, contract note is issued

to the investor / trader by the broker• Step 7: Pay-in of funds and securities before T+2 day• Step 8: Pay-out of funds and securities on T+2 day• In case of short or bad delivery of funds / securities, the exchange

orders for an auction to settle the delivery. If the shares could not be bought in the auction, the transaction is closed out as per SEBI guidelines.

Margin Trading

• Margin Trading is trading with borrowed funds/securities. It is essentially a leveraging mechanism which enables investors to take exposure in the market over and above what is possible with their own resources. SEBI has been prescribing eligibility conditions and procedural details for allowing the Margin Trading Facility from time to time.

• The facility of margin trading is available for Group 1 securities and those securities which are offered in the initial public offers and meet the conditions for inclusion in the derivatives segment of the stock exchanges.

Margin Trading

• For providing the margin trading facility, a broker may use his own funds or borrow from scheduled commercial banks or non-banking finance companies (NBFCs) regulated by the RBI. A broker is not allowed to borrow funds from any other source. 

• The "total exposure" of the broker towards the margin trading facility should not exceed the borrowed funds and 50 per cent of his "net worth". While providing the margin trading facility, the broker has to ensure that the exposure to a single client does not exceed 10 per cent of the "total exposure" of the broker.

• Initial margin has been prescribed as 50% and the maintenance margin has been prescribed as 40%.

Short Selling and Securities Lending & Borrowing

• Short Selling means selling of a stock that the seller does not own at the time of trade. Short selling can be done by borrowing the stock through Clearing Corporation/Clearing House of a stock exchange which is registered as Approved Intermediaries (AIs). Short selling can be done by retail as well as institutional investors. Naked short sale is not permitted in India, all short sales must result in delivery, and information on short sale has to be disclosed to the exchange by end of day by retail investors, and at the time of trade for institutional investors. The Securities Lending and Borrowing mechanism allows short sellers to borrow securities for making delivery. Securities in the F&O segment are eligible for short selling.

Short Selling and Securities Lending & Borrowing

• Securities Lending and Borrowing (SLB) is a scheme that has been launched to enable settlement of securities sold short. SLB enables lending of idle securities by the investors through the clearing corporation/clearing house of stock exchanges to earn a return through the same. For securities lending and borrowing system, clearing corporations/clearing house of the stock exchange would be the nodal agency and would be registered as the “Approved Intermediaries”(AIs) under the Securities Lending Scheme, 1997.

• Under SLB, securities can be borrowed for a period of 7 days through a screen based order matching mechanism. Securities in the F&O segment are eligible for SLB.

Depositories

• The increase in the volume of activity on SEs and the advent of screen based trading system coupled with inefficiencies of the earlier trading and settlement systems led to the emergence of a new system called the Depository System.

• A depository is an organisation which holds securities of investors in electronic form at the request of the investors through a registered Depository Participant.

• SEBI has mandated compulsory trading and settlement of select securities in dematerialized form.

• A demat share is held by the depository on behalf of the investor.

• Demat settlements have eliminated bad deliveries and other related problems associated with physical securities.

Depository System

• A depository system enables immediate allotment, transfer and registration of securities.

• At present two Depositories viz. National Securities Depository Limited (NSDL) and Central Depository Services (I) Limited (CDSL) are registered with SEBI.

• NSDL, promoted by IDBI, UTI, NSE and SBI, was set up as the first depository in India. NSDL commenced operations in November 1996.

• CSDL, set up by BSE, and co-sponsored by SBI, Bank of Baroda, Bank of India and HDFC Bank, was the second depository to be set up. It commenced operations in March 1999.

• To avail the services of a depository an investor is required to open an account with a depository participant of any depository.

Depository System

• A Depository Participant (DP) is an agent of the depository through which it interfaces with the investor. A DP can offer depository services only after it gets proper registration from SEBI. Banking services can be availed through a branch whereas depository services can be availed through a DP.

• If the investor provides his bank account details to the DP, the bank account number will be mentioned on the interest or dividend warrant, so that such warrant cannot be encashed by any one else. Further, cash corporate benefits such as dividend, interest will be credited to the investors account directly through the ECS (Electronic Clearing Service) facility, wherever available, by the company.

• As per the available statistics at BSE and NSE, 99.9% settlement takes place in demat mode only.

Benefits of Availing Depository Services• A safe and convenient way to hold securities;• Immediate transfer of securities;• No stamp duty on transfer of securities;• Elimination of risks associated with physical certificates such as bad

delivery, fake securities, delays, thefts etc.;• Reduction in paperwork involved in transfer of securities;• Reduction in transaction cost;• No odd lot problem, even one share can be sold;• Nomination facility;• Change in address recorded with DP gets registered with all

companies in which investor holds securities electronically eliminating the need to correspond with each of them separately;

• Transmission of securities is done by DP eliminating correspondence with companies;

• Automatic credit into demat account of shares, arising out of bonus/split/consolidation/merger etc.

• Holding investments in equity and debt instruments in a single account.

Accounts of an Investor

• What are the various accounts an investor should have for trading in securities market?

• Beneficial owner Account (B.O. account) / Demat Account: It is an account opened with a depository participant in the name of client for the purpose of holding and transferring securities.

• Trading Account: An account which is opened by the broker in the name of the respective investor for the maintenance of transactions executed while buying and selling of securities.

• Client Account / Bank Account: A bank account which is in the name of the respective client and is used for debiting or crediting money for trading in the securities market.

Dematerialisation• Dematerialisation is the process by which physical

certificates of an investor are converted to an equivalent number of securities in electronic form and credited into the investor's account with his/her DP. Odd lot share certificates can also be dematerialised.

• Dematerialised shares do not have any distinctive numbers. These shares are fungible, which means that all the holdings of a particular security will be identical and interchangeable.

• To give the delivery one has to fill a form called Delivery Instruction Slip (DIS). DIS may be compared to cheque book of a bank account. Both NSDL and CDSL have launched the facility for delivering instructions by the investor to his/her DP over Internet, called SPEED-e and EASI respectively. The facility can be used by all registered users after paying the applicable charges.

Dematerialisation

• It is possible to get securities allotted to in Public Offerings directly in the electronic form. In the public issue application form there is a provision to indicate the manner in which an investor wants the securities allotted. He has to mention the BO ID and the name and ID of the DP on the application form. Any allotment made will be credited into the BO account.

• The DP gives a Transaction Statement periodically, which will detail current balances and various transactions made through the depository account. If so desired, DP may provide the Transaction Statement at intervals shorter than the stipulated ones, at a cost.

• DPs have to provide transaction statements to their clients once in a month, if there are transactions and once in a quarter, if there are no transactions.

Custodians

• Custodians provide custodial services which are different from those provided by depositories. A custodian is an intermediary who keeps the scrips of the clients in custody, may be a keeper of the accounts of its clients, provides ancillary services such as physical transfer of share certificates, collecting dividends and interest warrants, updating clients on their investment status, etc.

• To claim benefits on behalf of its clients, a custodian keeps track of book closures, record dates, bonus and rights shares.

Custodians

• Even though depositories have been set up, there is a need for custodians as they act as complements to depositories. For example, the volume of transactions by mutual funds and other fund managers may be so large, that custodians can play a useful role.

• Custodians are clearing members but not trading members.

• In India, the Stock Holding Corporation of India and SBI Share Holding Corporation are prominent custodians. Foreign banks also operate in this field.

Clearing Process• After a trade has been executed, securities and money

must change hands within a certain number of business days of the trade date, on what is called the settlement date.

• Basically, two tasks are carried out in the clearing process: trade comparison and settlement.

• Trade comparisons are made through the facilities of a clearing corporation that receives reports of each transaction from the brokers participating in the transaction. Unmatched entries are flagged off and followed up. Much of the process is automated.

• The second step in the clearing process – the final settlement – is also automated.

• The key change permitting the use of book entries has been the immobilisation of securities certificates. Securities are immobilised at a securities depository.

Clearing Corporation of India Ltd.

• The corporation acts as the central counterparty in the settlement of all trades in government securities, treasury bills, money market instruments, repos, inter-bank foreign exchange deals, and derivatives of various types, where the underlying instrument in a security or money market instrument.

• CCIL has been promoted by SBI and other banks, FIs and PDs.

• CCIL is the clearing and settlement agency in respect of all trades by institutional players such as banks, DFIs, primary dealers, mutual funds, corporates and NBFCs who account for more than 98 per cent of the total sales.

• CCIL manages various risks such as credit and market risks, liquidity risk and operational risk to avoid serious system failures.

Taxes

• The final rate of return to the investor it must be remembered is net of taxes

• Interest Tax• Income Tax• Tax Deduction at Source (TDS)• Capital Gains and Loss Taxes• Long Term Capital Gains Tax• Short Term Capital Gains Tax• Security Transaction Tax

Miscellaneous Capital Market Issues

Buy Back of Shares

• A company can buy back its shares in any of the following ways:

• From the existing shareholders on a proportionate basis through the tender offer,

• From open market through: – Book building process – Stock exchange,

• From odd lot holders.

Delisting of Shares

• The term "delisting" of securities means permanent removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange.

• Difference between Voluntary delisting and Compulsory delisting:

• Compulsory delisting refers to permanent removal of securities of a listed company from a stock exchange as a penalizing measure at the behest of the stock exchange for not making submissions/complying with various requirements set out in the Listing agreement within the time frames prescribed. In voluntary delisting, a listed company decides on its own to permanently remove its securities from a stock exchange.

Exit Opportunity for Investors

• SEBI (Delisting of Securities) Guidelines, 2003 provide an exit mechanism, whereby the exit price for voluntary delisting of securities is determined by the promoter of the concerned company which desires to get delisted, in accordance to book building process. The offer price has a floor price, which is average of 26 weeks average of traded price quoted on the stock exchange where the shares of the company are most frequently traded preceding 26 weeks from the date public announcement is made. There is no ceiling on the maximum price.

• In case of infrequently traded securities, the offer price is as per Regulation 20 (5) of SEBI (Substantial Acquisition and Takeover) Regulations.

Portfolio Management

• Professional portfolio management services (PMS) are available in India. In return for a fee, portfolio managers offer standardized packages to high net worth individuals. The usual minimum size of a portfolio should be around Rs.25-50 lakhs even though a few players offer such services for investment sizes of as low as Rs.5-10 lakhs. Apart from cash, investors can hand over an existing portfolio stocks, bonds or mutual funds to a PMS.

Portfolio Management

• There are two types of portfolio managers – discretionary portfolio manager and non-discretionary portfolio manager. The discretionary portfolio manager individually and independently manages the funds of each client in accordance with the needs of each client, while the non-discretionary portfolio manager manages the funds in accordance with the directions of the client.

• Portfolio managers have to be registered with SEBI. As part of the registration process, the applicant should have in its employment minimum of two persons who, between them, have at least five years experience as portfolio manager or stock broker or investment manager or in the areas relating to fund management. The portfolio manger is also required to have a minimum net worth of Rs.50 lakhs.

Rating Agencies

Credit Rating

• Credit rating is the assessment of a borrower’s credit quality.

• Credit rating is merely an indicator of the current opinion of the relative capacity of a borrowing entity to service its debt obligations within a specified time period and with particular reference to the debt instrument being rated.

• It is not a recommendation to buy, sell or hold.• Credit rating agencies now undertake financial analysis

and assessment of financial products, individual institutions and governments.

• Credit rating helps in the development of financial markets.

Credit Rating

• It saves the investors’ time and money and enables him to take quick decisions.

• It provides a means of pricing the risk premium that should be attached to various financial instruments.

• It acts as a marketing tool to issuers with a high credit rating.

• It often acts as a eligibility criteria to approach a particular financial market to raise funds.

• The world’s biggest rating agencies are Moody’s Investor Service and Standard and Poor (S&P). Next is Fitch Investors Service.

• US rating agencies offer both solicited and unsolicited ratings.

Rating Agencies in India The prominent rating agencies in India are:• CRISIL: Credit Rating Information Services of

India Limited• ICRA: Investment Information and Credit Rating

Agency of India Limited• CARE: Credit Analysis and Research Limited• Fitch Ratings India Private Limited Usually covers four broad areas:• Business Analysis • Financial Analysis • Management Evaluation• Fundamental Analysis

Business Analysis

• Industry risk covers an analysis of actual and estimated demand/ supply, number of firms and potential entrants in the industry, government policies relating to the industry, the performance of the industry, future potential, etc.

• Market position in the industry covers the market share of the firms, marketing arrangements, products and customers.

• Operational efficiency is a study of the production processes of the firm, its cost structure, locational advantages, labour relationships, input availability, etc.

• Legal position covers a study of the accuracy of the information and filing of the required forms, returns and so on with the regulatory authorities.

Financial Analysis

• Accounting quality studies the method of income recognition, inventory valuation, depreciation policies, auditor’s remarks, off-balance sheet liabilities, and so on

• Earnings protection is examined with reference to profitability ratios, earnings growth, projected earnings, etc.

• Adequacy of cash flows includes a study of future cash flows, working capital needs and capital budgets.

• Financial flexibility is examined in terms of whether alternative financial plans have been developed and the feasibility of such plans

Management Evaluation & Fundamental Analysis

Management Evaluation:• Track record of the management• Whether the management has the capacity to overcome

adverse situations• Management’s goals, philosophy and strategies• Corporate governance Fundamental Analysis:• Liquidity management• Asset quality• Profitability• Interest and tax sensitivity

Credit Rating• Once the quantitative and qualitative data is analysed, it is the

seasoned judgement of the rating committee which makes the rating of an agency unique and sometimes controversial.

• Rating involves a particular number which is assigned, and this involves a lot of subjectivity.

• The rating assigned is then notified to the issuer and in normal cases only on his acceptance, is the rating published. If the client wants to furnish additional information, he can do so.

• Once the issuer decides to use and publish the rating, the agency has to continuously monitor it over the entire life of the instrument. This process is known as surveillance. Rating may be upgraded, downgraded or continue unchanged.

• However, it should be remembered that rating agencies can also make mistakes.

Rating Symbols

• Rating agencies use symbols such as AAA, AA, BBB, B, C and D to convey the safety grades to the investor.

• These grades can be also divided into high investment grades, investment grades and speculative grades.

• Rating fees are paid by the issuer of the financial instruments, and not the users of the rating services, such as investors, financial intermediaries and other end-users.

• Covered by Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

Role of Investment Banking Firms

• Investment banking firms perform two general functions

• For corporations, government entities and foreign entities that need funds, investment banking firms assist in obtaining those funds.

• For investors who wish to invest funds, investment banking firms act as brokers or dealers in the buying and selling of securities. Thus, investment banking firms perform a critical role in the primary and the secondary market.

Investment Banking Firms

• Investment banking firms generate revenue from commissions, fee income, spread income, and principal activities. These activities can be classified as follows:

• Public offering (underwriting) of securities• Trading of securities• Private placement of securities• Securitization of assets• Mergers and acquisitions• Merchant banking• Trading and creation of derivative instruments• Money management

Investment Banking Firms

• The securitization of assets refers to the issuance of securities using a pool of assets as collateral. The securitization of home mortgage loans to create mortgage-backed securities was the first example of this process. When other types of loans and receivables are used as collateral or pool, such securities are known as asset-backed securities.

• Sometimes an investment banking firm may commit its own funds by either taking an equity interest or creditor position in companies.

Some Leading World Markets

Index Country

Nasdaq Composite US

Nikkei 225 Japan

FTSE 100 UK

SSE Composite China

S&P 500 US

Dow Jones Industrial Average US

Bombay Sensex India

Bloomberg European 500 Europe

Jakarta Composite Indonesia

Hang Seng Hong Kong

Some Leading World Markets

Index Country

Dax Index Germany

Kuala Lumpur Composite Malaysia

CAC 40 France

Straits Times Singapore

Taiwan Taiex Taiwan

FTSE JSE Africa All Share South Africa

Stock Exchange of Thailand Thailand

KOSPI Korea Composite South Korea

Brazil Bovespa Stock Index Brazil

Russian RTS Russia