capital market reforms in india with evolution of sebi

7/27/2019 Capital Market Reforms in India With Evolution of Sebi

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TABLE OF CONTENTSTABLE OF CONTENTS

Acknowledgement ---------------------------------------------------------2

Declaration ------------------------------------------------------------------3

Preface -----------------------------------------------------------------------4

Research Objectives -------------------------------------------------------5

Research Methodology and Design -------------------------------------6

Introduction of Financial Sector ----------------------------------------7

How Capital Market Reformed in India ------------------------------12

Recent Rules & Regulations Of SEBI --------------------------------29

Conclusions -------------------------------------------------------------67

Bibliography ----------------------------------------------------------------68


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ACKNOWLEDGEMENTACKNOWLEDGEMENT

No gain without pains is a common saying. Gratitude is the hardest of

emotion to express and often does not find adequate words to convey.

Therefore, a Survey Project Report is not an effort of a single person but it

is a contributory effort of many hands and brains. So, I would like to

thanks all those who have helped me directly or indirectly during my

Survey Project.

With an ineffable sense of gratitude I take this opportunity to

express my deep sense of indebtness to for allowing me to carry

out this survey work.

I am also thankful to for his keen interest,

constructive criticism, persistent encouragement and untiring guidancethroughout the development of the project. It has been my great privilege

to work under his inspiring and provoking guidance.

I would like to thank all my teachers, staff members, and

Library members for their valuable advice and guidance which help me to

make this report effective, interesting and purposeful.

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DECLARATIONDECLARATION

I hereby declare that the information presented here is correct to

the best of my knowledge. Also, the report presented has not been

published anywhere.

Place:

DATE:

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PREFACEPREFACE

It is great honour to work on the project assigned to me and to prepare a

report on this.

In the presented report the introduction ofFINANCIAL SECTORis given

in detail which will make the reader to make a clear figure of it in mind.

The topic assigned to me was a very challenging one and after a hard work

in collecting the data & analysis, I have reached to the conclusion which is

very clearly shown in the report presented.

It was not an easy job to work on it and this was possible only with the

great help and guidance of my mentor , who guided me to the

right path in each and every problem, came in front. Help of other possiblesources has also been taken.

It is request to the respected readers to give their views and suggestions

regarding this project and will be honoured, which will definitely help me

on my next task.

Thanking you.

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RESEARCH OBJECTIVESRESEARCH OBJECTIVES

The Report is prepared with following the objectives:-

To know about the financial sector.

To know about the reforms in Capital Market.

To make an analysis of SEBI Rules & Regulations

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RESEARCH METHODOLOGYRESEARCH METHODOLOGY

Significance of study:- The Report was prepared to analyse the

CAPITAL MARKET REFORMS IN INDIA.

Data Collection Method: - The collected data is Secondary in nature. Data

have been collected from Internet.

Research Design:- Analytical Research

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Financial Sector

The financial sector is in a process of rapid transformation. Reforms are continuing as partof the overall structural reforms aimed at improving the productivity and efficiency of theeconomy. The role of an integrated financial infrastructure is to stimulate and sustaineconomic growth.

The US$ 28 billion Indian financial sector has grown at around 15 per cent and hasdisplayed stability for the last several years, even when other markets in the Asian regionwere facing a crisis. This stability was ensured through the resilience that has been builtinto the system over time. The financial sector has kept pace with the growing needs ofcorporate and other borrowers. Banks, capital market participants and insurers havedeveloped a wide range of products and services to suit varied customer requirements. TheReserve Bank of India (RBI) has successfully introduced a regime where interest rates aremore in line with market forces.

Financial institutions have combated the reduction in interest rates and pressure on their

margins by constantly innovating and targeting attractive consumer segments. Banks andtrade financiers have also played an important role in promoting foreign trade of thecountry.

Banks

The Indian banking system has a large geographic and functional coverage. Presently thetotal asset size of the Indian banking sector is US$ 270 billion while the total deposits

amount to US$ 220 billion with a branch network exceeding 66,000 branches across thecountry. Revenues of the banking sector have grown at 6 per cent CAGR over the past fewyears to reach a size of US$ 15 billion. While commercial banks cater to short and mediumterm financing requirements, national level and state level financial institutions meetlonger-term requirements. This distinction is getting blurred with commercial banksextending project finance. The total disbursements of the financial institutions in 2001were US$ 14 billion.

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Banking today has transformed into a technology intensive and customer friendly modelwith a focus on convenience. The sector is set to witness the emergence of financialsupermarkets in the form of universal banks providing a suite of services from retail tocorporate banking and industrial lending to investment banking. While corporate bankingis clearly the largest segment, personal financial services is the highest growth segment.

The recent favorable government policies for enhancing limits of foreign investments to 49per cent among other key initiatives have encouraged such activity. Larger banks will beable to mobilizes sufficient capital to finance asset expansion and fund investments in

technology.

Capital Market

The Indian capital markets have witnessed a transformation over the last decade. India isnow placed among the mature markets of the world. Key progressive initiatives in recentyears include:

The depository and share dematerialization systems that have enhanced theefficiency of the transaction cycle

Replacing the flexible, but often exploited, forward trading mechanism with rollingsettlement, to bring about transparency

The InfoTech-driven National Stock Exchange (NSE) with a national presence (forthe benefit of investors across locations) and other initiatives to enhance the qualityof financial disclosures.

Corporatisation of stock exchanges.

The Securities and Exchange Board of India (SEBI) has effectively beenfunctioning as an independent regulator with statutory powers.

Indian capital markets have rewarded Foreign Institutional Investors (FIIs) withattractive valuations and increasing returns.

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The Mumbai Stock Exchange continues to be the premier exchange in the countrywith an increase in market capitalisation from US$ 40 billion in 1990-1991 to US$203 billion in 1999-2000. The stock exchange has about 6,000 listed companies andan average daily volume of about a billion dollars

Many new instruments have been introduced in the markets, including indexfutures, index options, derivatives and options and futures in select stocks.

Insurance

With the opening of the market, foreign and private Indian players are keen to convertuntapped market potential into opportunities by providing tailor-made products:

The presence of a host of new players in the sector has resulted in a shift inapproach and the launch of innovative products, services and value-added benefits.Foreign majors have entered the country and announced joint ventures in both lifeand non-life areas. Major foreign players include New York Life, Aviva, TokyoMarine, Allianz, Standard Life, Lombard General, AIG, AMP and Sun Life amongothers.

With competition, the erstwhile state sector companies have become aggressive interms of product offerings, marketing and distribution.

The Insurance Regulatory and Development Authority (IRDA) has played aproactive role as a regulator and a facilitator in the sectors development.

The size of the market presents immense opportunities to new players with only 20per cent of the countrys insurable population currently insured.

The state sector Life Insurance Corporation (LIC), the largest life insurer in 2000,sold close to 20 million new policies with a turnover of US$ 5 billion.

The gross premia for the insurance sector was US$ 13 billion for 2001-02.

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There are four public sector and nine private sector insurance companies operatingin general/non-life insurance business with a premium income of over US$ 2.58

billion.

The markets potential has been estimated to have a premium income of US$ 80billion with a potential size of over 300 million people. The General InsuranceCorporation (GIC) (which covers the non-life sector) had a total premium income ofUS$ 2 billion in 2001-02. This has the potential to reach US$ 9 billion in the nextfive years.

Venture Capital

Technology and knowledge have been and continue to drive the global economy. Giventhe inherent strength by way of its human capital, technical skills, cost competitiveworkforce, research and entrepreneurship, India is positioned for rapid economic growth ina sustainable manner. To realise the potential, there is a need for risk finance and venturecapital (VC) funding to leverage innovation, promote technology and harness knowledge

based ideas.

The Indian venture capital sector has been active despite facing a challengingexternal environment in 2001 and a competitive market scenario.

There were 34 VCFs and 2 Foreign VCFs registered with SEBI in March 2002.

According to a survey conducted by Thomson Financial and Prime Database, Indiaranked as the third most active venture capital market in Asia Pacific (excluding

Japan). It recorded 115 deals in 2001 with average investment per deal amounting toUS$ 7.9 million. 57 VCFs invested US$ 908 million in 101 Indian companies during2001.

Disbursements for 2002 are expected to be US$ 2 billion and are estimated to reachUS$ 10 billion by 2007.

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There is an increased interest in India: 70 VC funds operate in India with the totalassets under management worth about US$ 6 billion.

The amount has grown nearly twenty fold in the past five years. Most VCs believethat 2002-03 will be driven by a relatively stable economy and new initiatives thatwill boost the e-commerce sector, particularly on-line trading and e-banking sectors.

Opportunities

There is no tax on distributed income of VCFs. The income distributed by the funds isonly taxed at the hands of the investors.

Increase in incomes with potentially high penetration of both banking and insuranceproducts to increase the market size, will be the powerful drivers of growth in thesector.

Continued de-regulation and increased competition is expected to result into theIndian financial services reach US$ 51 billion by 2007.

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How the Capital Market in India was reformed

The role of the State, and that of public policy, in the development of the financial sector ismuch debated. There is a considerable consensus about the role of the State in producingthe public goods of financial regulation. Beyond that, whether the State can play a role inshaping the design of markets, or to what extent the State should do so, is questionable.

There appears to be a contradiction in having the State play a role in developing acompetitive market system that enables efficient capital allocation and risk sharing. But

financial market systems in developed and emerging markets have been known to bevulnerable to capture by vested interests (Rajan and Zingales, 2003). Inefficient ways oforganising markets, such as floor trading or telephone markets, are associated with rentscaptured by the insiders who dominate those markets. Thus there does appear to be a rolefor intervention from the State to help financial market systems move towards acompetitive outcome with a lack of entry barriers and an absence of rents accruing to

participants with concentrated market power. Of course, these problems can also beinduced by malfunctioning state intervention.

India is a very interesting case study which helps us understand both the impact of State

guided financial sector development, with stories of success as well as failure.

1 Background: State-dominated finance

The Indian financial system remained a relatively free but unsophisticated market systemup to the seventies. This included a private banking sector, fragmented but active stockmarkets, and active commodity spot and futures markets. The first milestone of Indiassocialism was in the 1950s with the closing of the capital account. More changes came inthe 1960s and 1970s, with the nationalizations of financial service providers. This changed

the structure of the financial services industry from a fairly competitive sector to onedominated by large public sector monopolies.

The main target of the nationalizations drive was the banking sector. Interest rates for abroad range of transactions were set by the central bank. The central bank shifted focus toan elaborate system of price and quantity controls on finance.

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The State developed monolithic finance companies that were monopolies in providing awide range of financial services. This included development financial institutions (IDBI,

ICICI, IFCI), insurance (LIC, GIC) and fund management (EPFO for pensions, UTI formutual funds). These public sector organisations had rigid investment guidelines that weredictated by the State and effectively enabled the State to appropriate resources.

This period also saw the closure of commodity derivatives markets. This took place in thelatter part of the 1960s, when these markets saw a large number of trader defaults during a

period of three consecutive drought years.At the end of the seventies, the equity market was the only component of Indianfinancethat retained a relatively private sector character. Even here, the State is believed tohave used UTI, the only mutual fund in the country, to influence stock prices. Also, whilesecondary market price discovery was relatively free, the Controller of Capital Issues(CCI) dictated whether, and at what price, firms could sell shares to the public.

The global financial system, which could have acted as a competitive check on the flaws indomestic financial sector policy, had no role to play. Capital controls ensured that Indiashouseholds and Indias firms had no choice but to go through Indias financial system.

By the late 1980s, the following were key weaknesses in Indian finance:

Most banks were state-owned and had negligible equity capital. Basic concepts ofaccounting, asset classification, and provisioning were absent.

Banks, pension funds and insurance companies were forced to purchase governmentbonds as their primary investments.

The largest of the local stock exchanges, Bombay Stock Exchange (BSE), was a closedmarket. The exchange focussed on the interests of broker members, did not have outreachacross the country, and did not have appropriate structures for governance and regulation.

Apart from a small currency forward market and local commodity derivatives markets,there were no financial derivatives markets.

Financial transactions were controlled by the RBI (setting interest rates on variousproducts) and the Ministry of Finance (controlling the price at which securities wereissued), with a plethora of price and quantity restrictions.

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The financial industry was riddled with entry barriers in every sub-industry. It wasextremely difficult to start a bank, a mutual fund, a brokerage firm, an insurance company,a pension fund, a securities exchange or a broking firm. Apart from banking, foreign firmscould not operate in any of these areas.

A comprehensive system of capital controls was in place, which ensured that domestichouseholds and domestic firms had to go to the domestic financial system, in order toaccess financial services.

Few areas of the Indian economy were as dominated by the State as was finance. The fullrange of interventions contaminated resource allocation in fundamental ways. It wasdifficult for an entrepreneur to build a company without obtaining support from the State inorder to access equity or debt capital. This led to directly unproductive, rent-seekingactivities (Bhagwati, 1982; Krueger, 1974). The State had incentives to introduce greatercontrols since these would increase rents.

Towards the end of the 1980s, new economic forces came into play which emphasized theneed for modernisation of the financial system.

1. The higher economic growth of the 1980s had been accompanied by a boom in IPOs,and a considerable growth in the size of the stock market. This increased the interest fromthe rest of the country in stock market participation. These factors placed new stresses onthe traditional south-Bombay club market.

2. In 1990, India went through a balance of payments crisis. The government needed tofind non-debt capital inflows to fund the current account deficit. The government targetedforeign equity capital through FDI and portfolio flows as the desired form of capitalinflows. This led to new demands upon the financial market system to cater to the needs offoreign firms (Echeverri-Gent, 1999; Shah and Patnaik, Forthcoming).

3. The final and immediate trigger for reforms was the bond and stock market crisis of1991-1992. This event involved weak supervision and governance of banks, faultysettlement system run by the Reserve Bank of India for government bonds, and weaknessesin the Bombay Stock Exchange (Basu and Dalal, 2001; Barua and Varma, 1993).

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This crisis served to highlight the difficulties of the traditional functioning of the Ministryof Finance (MoF) and the Reserve Bank of India (RBI). For both the MoF and the RBI,this was a very visible embarassment, particularly because it took place at a time whenIndia was trying to attract foreign investors into the country.

At the time of the 1991 crisis, Indias financial sector had the following components:equity markets, bond markets, commodity markets, and the fund management sectors ofinsurance, mutual fund, pensions. All of these were targets for the financial sector reformsin the period after 1991. The end goal for the reforms was to enable liberal access to thefinancial sector, both for firms as well as investors. The broad principles to achieve thisend was to foster competition and enabling institutional innovation (Varma, 2002).

There were two alternative approaches in the policy discussion: The first was to considerthe reforms of the existing institutions. The second was to create completely newinstitutions.

Institution building is expensive in terms of the human resources required. In addition,institutions take time to build and establish themselves to the point at which they could beeffective. Both the lack of available capable human resources and the lack of time for

institutions to establish themselves became arguments for reforming existing institutions,rather than building new ones. Thus there was an initial bias in favour of reformingexisting institutions rather than build new ones. However, there was one set of institutionsthat did not exist and needed to be built from scratch. These were the financial sectorregulators. It was strongly felt thatmoving from a largely state-controlled environment to a free-market environment couldnot be done without having a strong regulatory capacity. The market manipulation crisis of1991-1992 reinforced the view that this capacity was missing. Another argument was thatan independent regulator in place would be more effective in driving the reforms of theexisting markets.

Thus, the first step undertaken by the MoF was to create independent regulators for someparts of finance: equity in 1988 and insurance in 1999.

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2 The reform of the equity market

As of 1990, the Indian equity market had archaic practices in trading, clearing andsettlement. A lot of the differences between Indian market and international market

practices stemmed from trade settement practices. Settlement was done on a bi-weeklyperiod. traders could carry forward positions beyond the trading day to the next, andcontinue this roll-over of positions upto two weeks forward.

There was also a practice of carrying positions forward beyond the settlement cycle, usinga mechanism called badla. The ability to trade for settlement in the future, as done with aforward or a futures contract, is a valuable component of any financial system. However,most markets in the world had a clear distinction between the spot and the forwardsmarket. India did not forward positions were taken in the form of badla and these were

part of the spot market process itself. Very few market transactions were spot transactions

badla was the default. Moreover, poor risk management at the Indian exchangesmeant that badla presented high systemic risk for equity investors.

Stock exchanges in India had a dubious reputation in their role as a transparent mechanism

for price discovery. A large number of transactions were done outside of the exchange.

Actual trade prices often diverged from those reported to customers.The exchanges were largely left to regulate and supervise themselves. They ran asselfregulating organisations, typically as an association of brokers. This was similar to theorganisational structure of the New York Stock Exchange. However, there was no formalregulatory capacity to monitor and supervise these exchanges.

The exchanges presented two sets of problems from the point of view of competitionpolicy.

The BSE was a closed club, and would not give memberships to new securities firms.Further, BSE was a monopoly. A key priority for reforms was to introduce contestabilityinto the market for exchanges and into the market for brokerage firms.

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2.1 Breaking the status quo: creating new institutions

Lessons from OTCEI

Even before the crisis of 1991, there had been a demand from domestic financialinstitutions (DFIs) to reform Indian equity markets. Liquidity on the exchanges lacked thedepth the DFIs needed to execute large transactions. They also faced problems with

brokers front- running against their orders, or the lack of resilience of liquidity once it wasknown that the DFIs had placed orders in the market.

These problems in secondary market liquidity led to a first attempt to innovate on a designfor the equity markets. This attempt was made by the DFIs and became the Over TheCounter Exchange of India, Ltd. (OTCEI). OTCEI was inspired by the NASDAQ systemof using multiple, competing market makers. This exchange started as a national marketthat was limited to trading shares that had very low liquidity on the existing exchanges.

OTCEI was unable to create a liquid market and was ultimately considered a failure infinancial institution building. However, OTCEI had a significant role to play in the reformsthat followed. The first lesson learnt was that the failure of the OTCEI stemmed from

problems of transplanting an international market design into India. Second, it reinforcedthe idea that an effort by the government to create viable financial market institutions wasnot credible. This raised the level of complacency among the incumbent exchanges andincumbent brokers about future attempts by the government to build a competingexchange. These lessons shaped the next attempts in market reforms.

Securities and Exchange Board of India (SEBI)

The next step taken was to strengthen the regulatory processes for equity markets. SEBI

was created as an independent regulator with a clear and sole focus on regulation ofsecurities markets. This was a major milestone in Indian economic policy thinking. Itmarked a sharp contrast with the prevalent style of the regulatory functions at the central

bank, where a wide range of functions merged together, contaminating the independenceand end effect of each function. In contrast, SEBI was the first element of Indias financialarchitecture that was modern in the approach to focus on one function.

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SEBI was created by adminstrative order in 1988. It became operational as an independentregulator when the SEBI Act was passed in 1992. Simultaneously, the Controller ofCapital Issues (CCI) was closed down.The creation of a new and independent regulator led to focussed reforms of the equitymarkets. SEBI imposed a greater degree of constraint on the freedom of the existingexchanges, and engaged in conflicts with incumbent market participants.

The Bombay Stock Exchange (BSE) demonstrated that they were highly effective inblocking reforms in the equity market (Ramakrishna, 2004). Early in SEBIs life, modestreforms were attempted on issues such as a requirement to unbundle the brokerage feefrom the price for a share when a broker issued a contract note to a customer. The BSEwent on strike in protest against this move. Such intransigence persuaded policy makersthatincremental reform of the incumbent exchanges was not feasible. They then pushed formore fundamental reform and shifted focus onto the creation of a new exchange that wouldcompete with the BSE.

National Stock Exchange of India Ltd. (NSE)

There were two guiding principles that drove the design of the new exchange: first, that theprice discovery process should be as transparent as possible; second, the exchange shouldsupport competition - there should be equal access for all equity market participants. Thesalient features that differentiated the design of the NSE from the existing exchanges were:

1. National platform that offered equal access to traders from all corners of a widespreadgeographical area,

2. A competitive market in securities intermediation, with a steady pace of entry and exit,

3. Orders matched electronically, on the basis of price-time priority,

4. Anonymous trading followed by guaranteed settlement,

5. Demutalised governance structure, as opposed to being an association of brokers,

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with a professional management team running the operations of the exchange.

NSE started trading bonds in June 1994, and equity in November 1994. Orders from allacross the country were pooled into the same trading floor. The electronic order matchingsystem increased the speed and the transparency of the price discovery process. Thenumber of brokers who were able to access a common order flow was unprecented. Whatwas even more interesting was the collapse of the geographical dispersion of investors:

Brokers from any corner of the country had instantaneous access to exactly the sameinformation about prices and depth.

The impact was tremendous (Shah and Thomas, 1996, 1997, 1999). By the end of 1996, alittle more than a year after NSE started equity market trading:

The liquidity on the most frequently traded shares had shifted from the BSE to the NSE.

Brokerage fees had dropped from an estimated 2.5 percent to less than 0.50 percent.

Daily traded volumes had gone up by more than 100 percent.

Most significantly, the BSE had transformed itself from a venerable, open-outcry

exchange to an electronic limit order book exchange.

The transformation of the BSE was a powerful sign of the success of the NSE. Thistransformation, which had earlier been debated and dismissed by incumbents as irrationaland impossible to implement rapidly, was achieved in less than a year after the competitive

pressure from the NSE. This highlights the importance of competition in financial sectorreforms policy.The success of the NSE gave greater confidence to policy makers as architects of marketreforms. This eased the way for the next steps of the reforms and inspired greater policyactivism in the securities markets.

The National Securities Clearing Corporation, Ltd. (NSCCL)

One of the integral differences between the electronic trading system at the NSE ascompared to the traditional open outcry (or the dealer-based architectures such as that

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found in bond markets all over the world) is the anonymity of counterparties involved in atrade.

In traditional trading systems, counterparty credit risk management involved knowing yourcounterparty. This restricted traders to a subset of counterparties whose credit risk theywere confident of taking.

In contrast, all trades at the NSE had a common counterparty: the clearing corporation.This was implemented through the legal mechanism of innovation at the NationalSecurities Clearing Corporation Ltd. (NSCCL). An innovation in financial institutions inIndia, NSCCL was set up in 1996 as a fully-owned subsidiary of the NSE.

Operationally, the separation between the clearing corporation and the exchange meant thatany systemic impact of counterparty defaults could affect the clearing function, but would

permit trading to continue unimpaired. It also permitted the NSCCL to focus on evaluatingcounterparty credit risk, and NSE to focus on operational and trading system risks.

NSCCL as the common counterparty to all trades had a dramatic impact on the trading atNSE. Risk management by NSCC brought all traders in India on an equal footing, andeliminated the reputational advantage of being a large firm or an old firm. Order flow wasno longer fragmented across counterparties with different credit risk. Trading participation

could, and did, become anonymous because with no fear of counterparty default, there wasno longer a need to reveal the identity of traders. This helped to enhance competition in theequity market, and in turn, enhance liquidity. By bringing a diverse set of market

participants from across the country, who did not know each other, NSE was able tobecome a truly national market for equity.

The National Securities Depository Ltd. (NSDL)

The last part of the securities market infrastructure dealt with the settlement process, whichinvolved the actual transfer of ownership of the asset from seller to the buyer. One of theoperational problems at the new national exchange was how to ensure settlement of tradeswhere the buyer was in the northern corner of Srinagar, and the seller could be in thesouthern tip of Kanyakumari. Such transactions were afflicted by the presence offraudulent share certificates, and incidents of theft of certificates.

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The bigger problem was the increasing incidence of fraud physical shares after 1990.Anecdotal evidence points to a steady increase of buyers receiving fake shares, reflectingimprovements in the technologies of scanning and reprography. The policy reaction to this

was to discuss, create, and pass the Depositories Act in 1996. The Act enabled the creationof a depository that would be the repository of all shares issued in the country.The first attempt at creating a depository was managed by one of the largest custodianfirms in India in 1988. The project aimed to create single central registry of ownership,where the shares would be immobilised (held in physical form). However, immobilization

proved to be a stumbling block: the project ran into cost and scheduling over-runs.

An effort to create a depository began at the NSE in 1995. The design aimed to create acentral registry of ownership of shares where the shares would be dematerialised ratherthan immobilised. Once the Depositories Act was passed in 1996, the project at NSE wasseparated out as as an independent entity called NSDL.

In a manner similar to the effect of the clearing corporation that eliminated differencesbetween counterparties and permitted for pooling of orders on an exchange, the depositoryalso became a great equaliser across geographical locations and service providers. As anequity investor, there was now no difference where the investor lived, or who their brokerwas. This helped enhance competition in the market.

Innovations in information systems: Nifty, MIBOR

Nifty: The NSE-50 index

The transparency of price discovery on the stock exchanges had led to increased volumesand efficiency of the stock markets. The increased focus on the equity markets made itimportant to create and disseminate a high quality index of market performance. Thisinformation would support and enhance daily intra-day price discovery. In addition, itwould set the foundation for the next stage of development of the fund managementindustry into index funds, index futures, index options, and benchmarking of fundmanagers using the index.

This led to the NSE-50 index (Shah and Thomas, 1998). The largest stocks by marketcapitalisation was selected, so that the index would represent as much of the countrys

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market capitalisation as possible. Simultaneously the most liquid stocks were selected sothat the index would be tradeable.The transparency of liquidity at NSE threw up opportunities to use new measures of

liquidity in selecting the most liquid stocks, which was the innovation in Nifty. Liquidity

was calculated using exact information from the computerised market, for the transactionscosts faced when doing a trade on the index portfolio on the exchange.

This was a step forward compared with the imprecise measurement of liquidity that wastraditionally used to create stock market indexes.Typically a stock market index, once entrenched, is difficult to displace from a marketsetting where they are widely used. A case in point is the Dow Jones index, whichcontinues to act as the principal stock market indicator in the US. In India, the BSE Sensexwas extremely well established, and even today plays a role much like the Dow Jonesindex. As of end-2005 however, Nifty had become the index of choice in a variety oftransaction-intensive activities. Today, it is the dominant index based on which index fundsare managed, as well as the dominant index based on which equity index-based derivatives

products are traded.

NSE MIBID-MIBOR: The Mumbai Interbank BID and the Mumbai Interbank Offer Rates.

The next innovation in information systems came with the use of the polling method tocollect price information for interest rate and commodity markets. The polled benchmarkrate was first implemented by the NSE to collect short-term interest rates from the dealersin the fixed income markets, typically from banks. This was the MIBOR.

The MIBOR, like the London Inter-Bank Offer Rate (LIBOR), is calculated as a robustaverage of rates quoted by dealers in the market. It uses the adaptive trimmed mean tooptimally compute a trimmed mean, as compared with the fixed trimmed mean used byLIBOR (Shah, 2000).The same methodology was later used to poll benchmark spot market prices forcommodities that traded futures at the commodity derivative exchanges.These innovations in better information capture and rapid release, in areas such as Nifty,MIBOR, the NCDEX polled rates, added up to a far-reaching strengthening of theinformational foundations of the decision making of private economic agents.

3 Impact of the reforms on securities market outcomes

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3.1 Impact on transparency in prices

The first and biggest impact was that there was a unique stock price across the entirecountry for firms. Prior to the reforms, equity markets were fragmented across multiple

local exchanges. The high costs of telecommunication and physical settlement meant thatarbitrage betweendifferent exchanges was costly. This, in turn, meant that the price of a stock that waswidely traded could vary widely on different exchanges. The closing prices reported onBombay and other metropolitan cities often differed by as much as one percent even onstocks like Reliance Industries. These differences were exacerbated for smaller towns andcities, and for less liquid stocks.

After the reforms, there are only two exchanges in India for all practical purposes, the BSEand the NSE. The difference in closing prices between the two are insignficant. There is anactive set of arbitrage brokers that equalises prices between these two exchanges, evenintra-day. Therefore, the price for an underlying security is unique and well-observed.

3.2 Impact on the costs of financial services

Shah and Thomas (1997) document transactions costs in the equity market before and after

the reforms. An updated version is presented in Table 1, which demonstrates thesignificant reduction in transactions costs since the start of the reforms.

One observation is that the reduction in the costs was not a one-time change. These costshave continued to reduce with time. Another observation comes from the juxtaposition ofthese costs against those in the New York Stock Exchange (NYSE). The NSE costs oftrading were lower than those reported at the NYSE as of 1997. This might be evidencethat a fully transparent trading system such as the electronic limit order book of the NSE isa more efficient transaction system than the market making system of the NYSE.

Major Reforms in Capital Markets

The major reform in the capital market was the abolition of capital issues control and theintroduction of free pricing of equity issues in 1992. Simultaneously the Securities andExchange Board of India (SEBI) was set up as the apex regulator of the Indian capital

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markets. In the last five years, SEBI has framed regulations on a number of mattersrelating to capital markets. Some of the measures taken in the primary market include:

Entry norms for capital issues were tightened

Disclosure requirements were improved Regulations were framed and code of conduct laid down for merchant bankers,

underwriters, mutual funds, bankers to the issue and other intermediaries

In relation to the secondary market too, several changes were introduced: Capital adequacy and prudential regulations were introduced for brokers, sub-

brokers and other intermediaries Dematerialization of scrips was initiated with the creation of a legislative framework

and the setting up of the first depository On-line trading was introduced at all stock exchanges. Margining system was

rigorously enforced. Settlement period was reduced to one week; carry forward trading was banned and

then reintroduced in restricted form; and tentative moves were made towards arolling settlement system.

In the area of corporate governance: Regulations were framed for insider trading Regulatory framework for take-overs was revamped

SEBI has been going through a protracted learning phase since its inception. The apparenturgency of immediate short term problems in the capital market has often seemed to

distract SEBI from the more critical task of formulating and implementing a strategicvision for the development and regulation of the capital markets.

In quantitative terms, the growth of the Indian capital markets since the advent of reformshas been very impressive. The market capitalization of the Bombay Stock Exchange(which represents about 90% of the total market capitalization of the country) hasquadrupled from Rs 1.1 trillion at the end of 1990-91 to Rs 4.3 trillion at the end of 1996-97 (see Chart 1). As a percentage of GDP, market capitalization has been more erratic, buton the whole this ratio has also been rising. Total trading volume at the Bombay StockExchange and the National Stock Exchange (which together account for well over half ofthe total stock market trading in the country) has risen more than ten-fold from Rs 0.4trillion in 1990-91 to Rs 4.1 trillion in1996-97 (see Chart 2). The stock market index has shown a significant increase during the

period despite several ups and downs, but the increase is much less impressive in dollarterms because of the substantial depreciation of the Indian rupee (see Chart 3). It may also

be seen from the chart that after reached its peak in 1994-95, the stock market index has

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been languishing at lower levels apart from a brief burst of euphoria that followed aninvestor friendly budget in 1997. For the primary equity market too, 1994-95 was the bestyear with total equity issues (public, rights and private placement) of Rs 355 billion

thereafter, the primary market collapsed rapidly. Equity issues in 1996-97 fell to one-thirdof 1994-95 levels and the decline appears to be continuing in 1997-98 as well. More

importantly, most of the equity issues in recent months have been by the public sector andby banks. Equity issues by private manufacturing companies are very few.

Extensive Capital Market Reforms were undertaken during the 1990s encompassinglegislative regulatory and institutional reforms. Statutory market regulator, which wascreated in 1992, was suitably empowered to regulate the collective investment schemesand plantation schemes through an amendment in 1999. Further, the organizationstrengthening of SEBI and suitable empowerment through compliance and enforcement

powers including search and seizure powers were given through an amendment in SEBIAct in 2002. Although dematerialisation started in 1997 after the legal foundations forelectronic book keeping were provided and depositories created the regulator mandatedgradually that trading in most of the stocks take place only in dematerialised form.Till 2001 India was the only sophisticated market having account period settlementalongside the derivatives products. From middle of 2001 uniform rolling settlement andsame settlement cycles were prescribed creating a true spot market.

After the legal framework for derivatives trading was provided by the amendment ofSCRA in 1999 derivatives trading started in a gradual manner with stock index futures inJune 2000. Later on options and single stock futures were introduced in 2000-2001 andnow India s derivatives market turnover is more than the cash market and India is one ofthe largest single stock futures markets in the world.

India s risk management systems have always been very modern and effective. The VaRbased margining system was introduced in mid 2001 and the risk management systemshave withstood huge volatility experienced in May 2003 and May 2004. This included realtime exposure monitoring, disablement of broker terminals, VaR based marginingetc.

India is one of the few countries to have started the screen based trading of governmentsecurities in January 2003.

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In June 2003 the interest rate futures contracts on the screen based trading platform wereintroduced.

India is one of the few countries to have started the Straight Through Processing (STP),which will completely automate the process of order flow and clearing and settlement onthe stock exchanges.

RBI has introduced the Real Time Gross Settlement system (RTGS) in 2004 onexperimental basis. RTGS will allow real delivery v/s. payment which is the internationalnorm recognized by BIS and IOSCO.

To improve the governance mechanism of stock exchanges by mandating demutualisationand corporatisation of stock exchanges and to protect the interest of investors in securitiesmarket the Securities Laws (Amendment) Ordinance was promulgated on 12th October2004. The Ordinance has since been replaced by a Bill.

Capital market developments

The Capital Issues (Control) Act, 1947, repealed, office of the Controller of Capital Issueswere abolished and the initial share pricing were decontrolled. SEBI, the capital marketregulator was established in 1992.

Foreign institutional investors (FIIs) were allowed to invest in Indian capital markets afterregistration with the SEBI. Indian companies were permitted to access international capitalmarkets through euro issues.

The National Stock Exchange (NSE), with nationwide stock trading and electronic display,clearing and settlement facilities was established. Several local stock exchanges changedover from floor based trading to screen based trading.

Private mutual funds permitted

The Depositories Act had given a legal framework for the establishment of depositories torecord ownership deals in book entry form. Dematerialisation of stocks encouraged

paperless trading. Companies were required to disclose all material facts and specific riskfactors associated with their projects while making public issues. To reduce the cost ofissue, underwriting by the issuer were made optional, subject to conditions. The practice of

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making preferential allotment of shares at prices unrelated to the prevailing market pricesstopped and fresh guidelines were issued by SEBI.

SEBI reconstituted governing boards of the stock exchanges, introduced capital adequacynorms for brokers, and made rules for making client or broker relationship moretransparent which included separation of client and broker accounts.

Buy back of shares allowed

The SEBI started insisting on greater corporate disclosures. Steps were taken to improvecorporate governance based on the report of a committee. SEBI issued detailed employeestock option scheme and employee stock purchase scheme for listed companies.

Standard denomination for equity shares of Rs. 10 and Rs. 100 were abolished. Companiesgiven the freedom to issue dematerialised shares in any denomination. Derivatives tradingstarts with index options and futures. A system of rolling settlements introduced. SEBIempowered to register and regulate venture capital funds.

The SEBI (Credit Rating Agencies) Regulations, 1999 issued for regulating new creditrating agencies as well as introducing a code of conduct for all credit rating agenciesoperating in India.

Monetary policy and debt markets

In the early nineties, the Indian debt market was best described as a dead market. Financialrepression and over-regulation were responsible for this situation (Barua et al., 1994).Reforms have eliminated financial repression and created the pre-conditions for thedevelopment of an active debt market:

The government reduced its pre-emption of bank funds and moved to market

determined interest rates on its borrowings. Simultaneously, substantial deregulationof interest rates took place as described earlier.

Automatic monetization of the governments deficit by the central bank was limitedand then eliminated by abolishing the system of ad hoctreasury bills. Severaloperational measures were also taken to develop the debt market, especially themarket for government securities:

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withdrawal of tax deduction at source on interest from government securities and

provision of tax benefits to individuals investing in them introduction of indexed bonds where the principal repayment would be indexed to

the inflation rate. setting up of a system of primary dealers and satellite dealers for trading in

government securities permission to banks to retail government securities

opening up of the Indian debt market including government securities to ForeignInstitutional Investors.

Meanwhile a spate of well subscribed retail debt issues in 1996 and 1997 shattered themyth that the Indian retail investor has no appetite for debt. While only Rs 6 billion wasraised through public debt issues in 1994 and Rs 11 billion in 1995, the amounts raised in1996 was Rs 56 billion. Debt accounted for more than half of the total amount raisedthrough publicissues in 1996 compared to less than 10% two years earlier. In 1997, public issues of debtfell to Rs 29 billion, but with the collapse of the primary market for equity, the share ofdebt in all public issues increased to 57%. Meanwhile, private placement of debt (which isa much bigger market than public issues) has grown very rapidly. Private placement ofdebt jumped from Rs 100 billion in 1995-96 to Rs 181 billion in 1996-97; in the first halfof 1997-98, it grew again by over 50% with Rs 136 billion mobilized in these six months

alone1.

India is perhaps closer to the development of a vibrant debt market than ever before, butseveral problems remain:

The central bank has repeatedly demonstrated its willingness to resort to micro-regulation and use market distorting instruments of monetary and exchange rate

policy rather than open market operations and interventions (Varma and Moorthy,1996). For example, as late as 1996, the central bank was relying on moral suasionand direct subscriptions to government securities (devolvements) to complete thegovernments borrowing programme. The RBIs response to the pressure on therupee in late 1997 and early 1998 also reveal an undiminished penchant for micro-regulation.

Some of the vibrancy of debt markets in 1996 and 1997 was due to the depressedconditions in the equity markets.

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Little progress has been made on the major legal reforms needed in areas like bankruptcy,foreclosure laws, and stamp duties.

Recent Rules & Regulations of SEBI for development of Security Market:

Stock Brokers

Introduction

A broker is an intermediary who arranges to buy and sell securities on behalf ofclients (the buyer and the seller).

According to Rule 2 (e) of SEBI (Stock Brokers and Sub-Brokers) Rules, 1992, a stockbroker means amember of a recognized stock exchange. No stockbroker is allowed to buy, sell or deal in securities,unless he or she holds a certificate of registration granted by SEBI.

A stockbroker applies for registration to SEBI through a stock exchange or stock exchanges of which heor she is admitted as a member. SEBI may grant a certificate to a stock-broker [as per SEBI (StockBrokers and Sub-Brokers) Rules, 1992] subject to the conditions that:

a) he holds the membership of any stock exchange;b) he shall abide by the rules, regulations and bye-laws of the stock exchange or stock exchanges of whichhe is a member;c) in case of any change in the status and constitution, he shall obtain prior permission of SEBI to continueto buy, sell or deal in securities in any stock exchange;d) he shall pay the amount of fees for registration in the prescribed manner; and

e) he shall take adequate steps for redressal of grievances of the investors within one month of the date ofthe receipt of the complaint and keep SEBI informed about the number, nature and other particulars of thecomplaints.

While considering the application of an entity for grant of registration as a stock broker, SEBI shall takeinto account the following namely, whether the stock broker applicant

a) is eligible to be admitted as a member of a stock exchange;

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b) has the necessary infrastructure like adequate office space, equipment and man power to effectivelydischarge his activities;c) has any past experience in the business of buying, selling or dealing in securities;d) is being subjected to any disciplinary proceedings under the rules, regulations and bye-laws of a stockexchange with respect to his business as a stockbroker involving either himself or any of his partners,directors or employees.

Membership in Stock Exchange (in NSE perspective)

There are no entry/exit barriers to the membership in NSE. Anybody can become member by complying

with the prescribed eligibility criteria and exit by surrendering membership without any hidden/overt cost.

The members are admitted to the different segments of the Exchange subject to the provisions of theSecurities Contracts (Regulation) Act, 1956, the Securities and Exchange Board of India Act, 1992, theRules, circulars, notifications, guidelines, etc., issued thereunder and the Bye laws, Rules and Regulationsof the Exchange.

The standards for admission of members laid down by the Exchange stress on factors such as, corporatestructure, capital adequacy, track record, education, experience, etc. and reflect a conscious effort on thepart of NSE to ensure quality broking services so as to build and sustain confidence among investors inthe Exchanges operations.

Benefits to the trading membership of NSE include:

1. access to a nation-wide trading facility for equities, derivatives, debt and hybrid instruments / products,2. ability to provide a fair, efficient and transparent securities market to the investors3. use of state-of-the-art electronic trading systems and technology,4. dealing with an organisation which follows strict standards for trading & settlement at par with thoseavailable at the top international bourses,5. a demutualised Exchange which is managed by independent and experienced professionals, and6. dealing with an organisation which is constantly striving to move towards a global marketplace in thesecurities industry.

New Membership

Membership of NSE is open to all persons desirous of becoming trading members, subject to meetingrequirements/criteria as laid down by SEBI and the Exchange.

The different segments currently available on the Exchange for trading are:

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Capital Market (Equities and Retail Debt) Wholesale Debt Market Derivatives (Futures and Options) Market

Admission to membership of the Exchange to any of the segments is currentlyopen and available.

Persons or Institutions desirous of securing admission as Trading Members (Stock Brokers) on theExchange may apply for any one of the following segment groups:

I. Wholesale Debt Market (WDM) SegmentII. Capital Market (CM) and Wholesale Debt Market (WDM) segmentsIII. Capital Market (CM) and Futures & Options (F&O) segmentsIV Capital Market (CM), Wholesale Debt Market (WDM) and Futures & Options(F&O) segmentV. Clearing Membership of National Securities Clearing Corporation

Ltd.(NSCCL) as a Professional Clearing Member (PCM)

Eligibility for acquiring membership of NSE is as follows:

1) The following persons are eligible to become trading members:

(a) Individuals(b) Partnership firms registered under the Indian Partnership Act, 1932Individual and Partnership firm are not eligible to apply for membership on

WDM segment.

(c) Institutions, including subsidiaries of banks engaged in financial services.(d) Body Corporates including companies as defined in the Companies Act,1956.

A company shall be eligible to be admitted as a member if:

i) such company is formed in compliance with the provisions of Section 12 of the said Act;ii) such company undertakes to comply with such financial requirements and norms as may be specifiedby the Securities and Exchange Board of India for the registration of such company;

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iii) the directors of such company are not disqualified for being members of a stock exchange and havenot held the offices of the Directors in any company which had been a member of the stock exchange andhad been declared defaulter or expelled by the stock exchange; and(e) such other persons or entities as may be permitted from time to time by RBI / SEBI under theSecurities Contracts (Regulations) Rules, 1957.

2) No person shall be admitted as a trading member if:

(a) he has been adjudged bankrupt or a receiver order in bankruptcy has been made against him or he hasbeen proved to be insolvent even though he has obtained his final discharge;(b) he has compounded with his creditors for less than full discharge of debts;(c) he has been convicted of an offence involving a fraud or dishonesty;(d) he is engaged as a principal or employee in any business other than that of Securities, except as abroker or agent not involving any personal financial liability or for providing merchant banking,underwriting or corporate or investment advisory services, unless he undertakes to severe its connections

with such business on admission, if admitted;(e) he has been at any time expelled or declared a defaulter by any other Stock Exchange or he has beendebarred from trading in securities by any Regulatory Authorities like SEBI, RBI etc;(f) he has been previously refused admission to trading membership by NSE unless a period of one yearhas elapsed since the date of such rejection;(g) he incurs such disqualification under the provisions of the Securities Contract (Regulations) Act, 1956or Rules made thereunder so as to disentitle him from seeking membership of a stock exchange;(h) incurs such disqualification consequent to which NSE determines it to be not in public interest toadmit him as a member on the Exchange Provided that in case of registered firms, body corporates andcompanies, the condition from (a) to (h) above will apply to all partners in case of partnership firms, andall directors in case of companies;

(i) it is a body corporate which has committed any act which renders it liable to be wound up under theprovisions of the law;(j) it is a body corporate or a company in respect of which a provisional liquidator or receiver or officialliquidator has been appointed by a competent court;

Education and Experience

Where an applicant is a corporate, not less than two directors of the company (in case of a soleproprietorship, individual and in case of a partnership firm, two partners) should satisfy the following

criteria:

They should be at least graduates and each of them should possess at least two years' experience in anactivity related to broker, sub-broker, authorised agent or authorised clerk or authorised representative orremisier or apprentice to a member of a recognised stock exchange. Such experience will include workingas a dealer, jobber, market maker, or in any other manner in the dealing in securities or clearingand settlement thereof, as portfolio manager or merchant bankers or as a researcher with any individual ororganisation operating in the securities market.

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Shareholding Pattern : Securities markets have the inherent tendency to be volatile and risky. Therefore,there should be adequate risk containment mechanisms in place for the Stock Exchanges. One such riskcontainment tool is the concept of Dominant Promoter/Shareholder Group which is very unique forapplicants acquiring membership on the NSE. Though membership on NSE is granted to the entityapplying for it, but for all practical purposes the entity is managed by a few shareholders who havecontrolling interest in the company. The shareholders holding the majority of shares have a dominant rolein the affairs of the company.

In case of any default by the broking entity, the Exchange should be able to identify and take actionagainst the persons who are behind the company. The Exchange, therefore, needs to know thebackground, financial soundness and integrity of these shareholders holding such controlling interest.Hence, during the admission process the dominant shareholders are called for an interview with theMembership Approval Committee.

Salient features on the concept of Dominant Promoter/Shareholder Group:

a) Dominant Promoter / Shareholder Group (DPG) is a group of shareholders of the Trading membercorporate who normally would be individuals, not exceeding 4 in number, and who would jointly and/orseverally hold not less than 51% of shares (40% in case of listed companies) in the trading membercorporate at the time of admission as well as subsequently at all relevant points of time.

b) The shareholding/interest of close relatives of the DPG viz. Parents, spouse, children, brothers andsisters would also be counted for arriving at total dominant holding / interest of a particular dominantshareholder, if such relative(s) give an unqualified and irrevocable support in writing to the concerned

dominant shareholder in respect of such holding / interest.

c) Corporate shareholders of the trading member company can also extend their support to the DPG,provided the shareholding of the Dominant Promoter Group along with the support of their specifiedrelatives in the corporate shareholder is not less than 51% or 40%, as the case may be. The indirectshareholding shall be calculated proportionately by reckoning the direct shareholding of the DPG alongwith the support of their specified relatives in the corporate shareholder of the trading member company.

d) If none of the dominant promoters/shareholders is a Director on the Board of Directors of the tradingmember company, then at least two other directors having the requisite experience and qualification shallhold a minimum of 5% shares (each) in the paid up equity capital of the trading member company.

Once a trading entity nominates/determines a group of shareholders (1 to 4) as the DPG, no othershareholder (existing or new) would be allowed to join the DPG. However, one or more shareholderswithin the DPG may be allowed to divest their shares and quit the group. In such an eventuality, it is to beensured that the remaining dominant shareholders always maintain among themselves, aminimum of 51% of the shares of the company (40% in case of listed trading member corporate) at allpoints of time.

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Failure to maintain this required level of shareholding will be treated as a breach of the continuingmembership norms, which would tantamount to a reconstitution of the trading member corporate as theexisting DPG would no longer hold controlling interest in the trading member corporate or alternativelya new group would have emerged with controlling stake. NSE would immediately withdraw the tradingfacility of such trading members. They could be re-instated upon rectifying the defect or seeking theapproval of the Exchange for identifying the new group of shareholders as the dominant shareholders, forwhich the process of going through the Membership Approval Committee and the Board will need to befollowed.

e) The DPG may also be permitted to consist of corporate shareholders, provided: the trading member is a wholly owned subsidiary of another company the said holding company is not a subsidiary of any other company the identifiable individual dominant promoter(s) (not more than 4) hold atleast 51% of the share capitalof the holding company,

Or

there are two or more listed corporate shareholders jointly holding atleast 51% of the share capital of theholding company

or

one or more listed corporate shareholders alongwith individual shareholders together, not exceeding fourin number, jointly hold atleast 51% of the shares of the holding company, Provided that in none of theabove instances the holding company of the trading member corporate becomes the subsidiary of anothercorporate.

the said dominant promoters undertake in writing, not to dilute their shareholding in the holdingcompany without prior consent of the Exchange.

Such corporate dominant shareholders are widely held listed Finance companies having networth of Rs.20 crores and above and their debt instruments, if any, have been accorded at least investment grade creditrating by reputed rating agencies.

If such corporate dominant shareholders are non-finance companies listed on NSE and have a networthof Rs. 20 crores and their debt instruments, if any, have been accorded at least investment grade creditrating by reputed rating agencies, then such a company shall be permitted to be included in

the DPG.

Private Banks, central or state government owned Finance and/or Development Institutions etc are alsoallowed to be identified as dominant shareholder(s) even if they are not listed provided they have anetworth of at least Rs. 20 crores and the debt instruments, if any, have investment grade credit ratingmade by one of the reputed credit rating agencies.

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The aforesaid norms are also applicable to trading members who are partnership firms. The term dominantshareholder/promoter may be substituted as dominant partner.

Eligibility Criteria for trading Membership.

The eligibility criteria and deposits/fees payable for trading membership aresummarised in Table 3.1.

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* No additional networth is required for self clearing members in the F&O segment. However, a networthof Rs. 300 lakh is required for members clearing for self as well as for other TMs.

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_ Additional Rs. 25 lakh is required for clearing membership on the F&O segment. In addition, a memberclearing for others is required to bring in IFSD of Rs. 2 lakh and CSD of Rs. 8 lakh per trading member,he undertakes to clear in the F&O segment.

An applicant needs to pay the membership and other fees, deposits etc, as applicable at the time ofadmission. The security deposit is included while determining the networth of the trading member.However, the annual subscription fee / other periodical charges are excluded for this purpose.

An applicant for membership must possess the minimum stipulated networth. The networth for thepurpose should be calculated as stipulated by the Exchange/SEBI. In case the company is a member ofany other Stock Exchange(s), it should satisfy the combined minimum networth requirements of allthese Stock Exchanges including NSEIL. The minimum paid up capital of a corporate applicant fortrading membership should be Rs. 30 lakh.

Eligibility Criteria for Professional Clearing Member of NSCCL.

Applicants seeking admission as Professional Clearing Members on the Futures & Options and /orCapital Market Segments of NSCCL would be required to meet the capital adequacy norms includingadditional deposits and fees as given below:

* Collateral Security Deposit with NSCCL can be - by way of cash or bank guarantees or fixeddeposits or select demat securities with appropriate hair cuts.

SEBI Registered Custodians and Banks recognised by NSEIL/NSCCL for issuance of bank guarantees areeligible to become PCMs of NSCCL for Futures & Options and/or Capital Market Segment provided theyfulfil the prescribed criteria.

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For the Futures & Options Segment, the clearing members (PCMs) are required to bring in additionalsecurity deposits as specified below only in respect of trading members whose trades they undertake toclear and settle in this segment :

Interest Free Security Deposit with NSCCL (Cash): Rs.2 lakhs per tradingmember. Collateral Security Deposit with NSCCL (By way of cash or bank guarantees orfixed deposits or select demat securities with appropriate hair cuts) : Rs.8 lakhs pertrading member.

For Capital Market Segment, the clearing members (PCMs) are required to bring in additional securitydeposits as specified below only in respect of trading members whose trades they undertake to clear andsettle in this segment:

In cases, where the cash and collateral deposit are already available with NSCCL for a trading member,the Professional Clearing Members shall not be required (to the extent available) to bring in cash andcollateral as aforementioned for settling the trades of that trading member. In case the trading member isrequired to have deposits with NSCCL greater than the amounts as stated above, the same would have tobe brought in by the Professional Clearing Member.

All applicants must be in a position to pay the membership and other fees, deposits etc, as applicable atthe time of admission, within the time schedule as specified by NSCCL. The security deposit will beincluded in determining the networth of the clearing member, however, the annual subscription fee / other

periodical charges would be excluded for this purpose. Clearing in Futures & Options Segment will bepermitted after obtaining the required regulatory approvals.

Admission Procedure .

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Applicants are required to submit application form, in the prescribed format, along with other relevantdocuments. Admission is a two-stage process with applicants requiring to go through an examination (amodule of NCFM) followed by an interview with the Membership Approval Committee (MAC). Theexamination is conducted so as to test the knowledge of the people associated with the Exchange ondifferent aspects of the capital/financial markets in India, as it would ensure the conduct of fair,professional and sound dealing practices. MAC consists of seven persons from various disciplines,including the Managing Director of the Exchange. The MAC conducts interviews with the applicants fortrading membership. The purpose of the interview is to gain knowledge about the prospects as to theircapability and commitment to carry on stock broking activities, financial standing, integrity, etc.Based on the performance of the applicant in the written test, the interview and fulfillment of othereligibility criteria, the MAC recommends the names for admission as trading members, to the Board ofDirectors of the Exchange (Board).

The Board after taking into consideration the recommendations of the MAC either approves or rejects theapplications. After getting approval from the Board, a letter granting admission on a provisional basis is

issued to the applicant subject to certain conditions like Registration with SEBI, submission of relevantfees/deposits and documents. On obtaining SEBI Registration, the TM is enabled to trade on the systemand issued user ids after payment of fees/deposits, submission of relevant documents and satisfying all theformalities and requirements with regard to the Exchange and NSCCL. The dealers are required toclear the Capital Market (Dealers) Module of NCFM while dealers on Futures & Options Segment arerequired to clear the Derivatives Core Module of NCFM. This is a pre-requisite without which user-ids arenot issued.

Sub-Brokers

A Sub-broker is a person who intermediates between investors and stock brokers. He acts on behalf of a

stock-broker as an agent or otherwise for assisting the investors for buying, selling or dealing in securitiesthrough such stock-broker. No sub-broker is allowed to buy, sell or deal in securities, unless he or sheholds a certificate of registration granted by SEBI. A sub-broker may take the form of a

sole proprietorship, a partnership firm or a company. Stockbrokers of the recognised stock exchanges arepermitted to transact with sub-brokers. Sub-brokers are required to obtain certificate of registration fromSEBI in accordance with SEBI (Stock Brokers & Sub-brokers) Rules and Regulations, 1992, withoutwhich they are not permitted to buy, sell or deal in securities.

SEBI may grant a certificate to a sub-broker, subject to the conditions that:

(a) he shall pay the fees in the prescribed manner;(b) he shall take adequate steps for redressal of grievances of the investors within one month of the date ofthe receipt of the complaint and keep SEBI informed about the number, nature and other particulars of thecomplaints received;(c) in case of any change in the status and constitution, the sub- broker shall obtain prior permission ofSEBI to continue to buy, sell or deal in securities in any stock exchange; and(d) he is authorised in writing by a stock-broker being a member of a stock exchange for affiliatinghimself in buying, selling or dealing in securities.

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In case of company, partnership firm and sole proprietorship firm, the directors, the partners and theindividual, shall comply with the following requirements:

(a) the applicant is not less than 21 years of age;(b) the applicant has not been convicted of any offence involving fraud or dishonesty;(c) the applicant has atleast passed 12th standard equivalent examination from an institution recognised bythe Government.(d) They should not have been debarred by SEBI.(e) The corporate entities applying for sub-brokership shall have a minimum paid up capital of Rs. 5 lakhand it shall identify a dominant shareholder who holds a minimum of 51% shares either singly or with theunconditional support of his/her spouse.

The salient features of the circular Ref. No. SMD/POLICY/CIRCULAR/11-97 dated May 21, 1999 issuedby SEBI is as under:

1. The registered sub-broker can transact only through the member broker who had recommended hisapplication for registration. If the Sub-broker is desirous of doing business with more than one broker, hewill have to obtain separate registration in each case.

2. The sub-broker shall disclose the names of all other sub-brokers/brokers where he is having direct orindirect interest.

3. It shall be the responsibility of the broker to report the default if any of his subbroker to all otherbrokers with whom sub-broker is affiliated.

4. The agreement can be terminated by giving the notice in writing of not less than 6 months by eitherparty.

5. Sub-brokers are obligated to enter into agreements and maintain the database of their clients/investorsin the specified format.

The applicant sub-broker shall submit the required documents to the stock exchange with therecommendation of a TM. After verifying the documents, the stock exchange may forward the documentsof the applicant sub-broker to SEBI for registration. A sub-broker can trade in that capacity after gettinghimself registered with SEBI. The Exchange may not forward the said application of the sub-broker toSEBI for registration if the applicant is found to have introduced or otherwise dealt with fake, forged,

stolen, counterfeit etc. shares and securities in the market.

The sub-broker of a TM of the Exchange has to comply with all the requirements under SEBI (stockbrokers and sub-brokers) Regulation, 1992 and the requirements of the Exchange as may be laid downfrom time to time. The subbroker is bound by and amenable to the Rules, Byelaws and Regulations of the

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Exchange. The sub-broker shall also comply with all terms and conditions of the agreement entered intoby him with the TM.

After registration with SEBI, the sub-broker can buy, sell or deal in securities on behalf of the investorsthrough the broker with whom he is affiliated. The TM has to issue contract notes for all trades in respectof its sub-broker in the name of the sub-broker and the sub-broker shall, in turn issue purchase/sale notesto his clients as per the format prescribed by the Exchange.

The TM with whom the sub-broker is affiliated is responsible for -1) ensuring the compliance by a sub-broker of the Rules, Bye-laws and Regulations of the Exchange2) inspecting that the sub-brokers are registered and recognised3) ensuring that the sub-brokers function in accordance with the Scheme, Rules, Byelaws, Regulations etc.of the Exchange/NSCCL and the SEBI Regulations etc.4) informing the sub-broker and keeping him apprised about trading/settlement cycles, delivery/paymentschedules and any changes therein from time to time.

5) reporting any default or delay in carrying out obligations by any of the subbrokers affiliated to him, toall other stock brokers with whom the said subbroker is affiliated.

Legal Framework

This section deals with legislative and regulatory provisions relevant from the viewpoint of a tradingmember. The four main legislations governing the securities market are:(a) the Securities Contracts(Regulation) Act, 1956, which provides for regulation of transactions in securities through control overstock exchanges; (b) the Companies Act, 1956, which sets out the code of conduct for the corporate sectorin relation to issue, allotment and transfer of securities, and disclosures to be made in public issues; (c)the SEBI Act, 1992 which establishes SEBI to protect investors and develop and regulate securities

market; and (d) the Depositories Act, 1996 which provides for electronic maintenance and transfer ofownership of dematerialised securities.

Legislations

Capital Issues (Control) Act, 1947

The Act had its origin during the war in 1943 when the objective was to channel resources to support thewar effort. It was retained with some modifications as a means of controlling the raising of capital bycompanies and to ensure that national resources were channelled into proper lines, i.e., for desirablepurposes to serve goals and priorities of the government, and to protect the interests of investors.

Under the Act, any firm wishing to issue securities had to obtain approval from the Central Government,which also determined the amount, type and price of the issue. As a part of the liberalisation process, theAct was repealed in 1992 paving way for market determined allocation of resources.

Securities Contracts (Regulation) Act, 1956

It provides for direct and indirect control of virtually all aspects of securities trading and the running ofstock exchanges and aims to prevent undesirable transactions in securities. It gives Central Government

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regulatory jurisdiction over (a) stock exchanges through a process of recognition and continuedsupervision, (b) contracts in securities, and (c) listing of securities on stock exchanges. As a condition ofrecognition, a stock exchange complies with conditions prescribed by Central Government. Organisedtrading activity in securities takes place on a specified recognised stock exchange. The stock exchangesdetermine their own listing regulations which have to conform to the minimum listing criteria set out inthe Rules.

SEBI Act, 1992

The SEBI Act, 1992 was enacted to empower SEBI with statutory powers for (a) protecting the interestsof investors in securities, (b) promoting the development of the securities market, and (c) regulating thesecurities market. Its regulatory jurisdiction extends over corporates in the issuance of capital and transferof securities, in addition toall intermediaries and persons associated with securities market. It can conductenquiries, audits and inspection of all concerned and adjudicate offences under the Act. It has powers toregister and regulate all market intermediaries and also to penalise them in case of violations of the

provisions of the Act, Rules and Regulations made thereunder. SEBI has full autonomy and authority toregulate and develop an orderly securities market.

Depositories Act, 1996

The Depositories Act, 1996 provides for the establishment of depositories in securities with the objectiveof ensuring free transferability of securities with speed, accuracy and security by (a) making securities ofpublic limited companies freely transferable subject to certain exceptions; (b) dematerialising thesecurities in the depository mode; and (c) providing for maintenance of ownership records in a book entryform. In order to streamline the settlement process, the Act envisages transfer of ownership of securitieselectronically by book entry without making the securities move from person to person. The Act has madethe securities of all public limited companies freely transferable, restricting the companys right to use

discretion in effecting the transfer of securities, and the transfer deed and other procedural requirementsunder the Companies Act have been dispensed with.

Companies Act, 1956

It deals with issue, allotment and transfer of securities and various aspects relating to companymanagement. It provides for standard of disclosure in public issues of capital, particularly in the fields ofcompany management and projects, information about other listed companies under the samemanagement, and management perception of risk factors. It also regulates underwriting, the use ofpremium and discounts on issues, rights and bonus issues, payment of interest and dividends, supply ofannual report and other information.

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Rules and Regulations

The Government has framed rules under the SC(R)A, SEBI Act and the Depositories Act. SEBI hasframed regulations under the SEBI Act and the Depositories Act for registration and regulation of allmarket intermediaries, for prevention of unfair trade practices, insider trading, etc. Under these Acts,Government and SEBI issue notifications, guidelines, and circulars, which need to be complied with bymarket participants. The self-regulatory organisaitons (SROs) like stock exchanges have also laid downtheir rules of game.

Regulators

The regulators ensure that the market participants behave in a desired manner so that the securities marketcontinue to be a major source of finance for corporates and government and the interest of investors areprotected. The responsibility for regulating the securities market is shared by Department of Economic

Affairs (DEA), Department of Company Affairs (DCA), Reserve Bank of India (RBI), Securities andExchange Board of India (SEBI) and Securities Appellate Tribunal (SAT), as may be seen from the Table4.1.

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Most of the powers under the SC(R)A are excercisable by Department of Economic Affairs (DEA), whilea few others by SEBI. The powers of the DEA under the SC(R)A are also con-currently exercised bySEBI. The powers in respect of the contracts for sale and purchase of securities, gold-related securities,

money market securities and securities derived from these securities and ready forward contracts in debtsecurities are exercised concurrently by RBI. The SEBI Act and the Depositories Act are mostlyadministered by SEBI. All these are administered by SEBI. The powers under the Companies Act relatingto issue and transfer of securities and non-payment of dividend are administered by SEBI in case of listedpublic companies and public companies proposing to get their securities listed. The SROs ensurecompliance with their own rules relevant for them under the securities laws.

Securities and Exchange Board of India Act, 1992

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Major part of the liberalisation process was the repeal of the Capital Issues (Control) Act, 1947, in May1992. With this, Governments control over issues of capital, pricing of the issues, fixing of premia andrates of interest on debentures etc. ceased, and the office which administered the Act was abolished: themarket was allowed to allocate resources to competing uses. However, to ensure effective regulation ofthe market, SEBI Act, 1992 was enacted to establish SEBI with statutory powers for:

(a) protecting the interests of investors in securities,(b) promoting the development of the securities market, and(c) regulating the securities market.

Its regulatory jurisdiction extends over companies listed on Stock Exchanges and companies intending toget their securities listed on any recognized stock exchange in the issuance of securities and transfer ofsecurities, in addition to all intermediaries and persons associated with securities market. SEBI can specifythe matters to be disclosed and the standards of disclosure required for the protection of investors in

respect of issues; can issue directions to all intermediaries and other persons associated with the securitiesmarket in the interest of investors or of orderly development of the securities market; and can conductenquiries, audits and inspection of all concerned and adjudicate offences under the Act. In short, it hasbeen given necessary autonomy and authority to regulate and develop an orderly securities market. All theintermediaries and persons associated with securities market, viz., brokers and sub-brokers, underwriters,merchant bankers, bankers to the issue, share transfer agents and registrars to the issue, depositories,depository participants, portfolio managers, debentures trustees, foreign institutional investors, custodians,venture capital funds, mutual funds, collective investments schemes, credit rating agencies, etc., shall beregistered with SEBI and shall be governed by the SEBI Regulations pertaining to respective marketintermediary.

Constitution of SEBI

The Central Government has constituted a Board by the name of SEBI under Section 3 of SEBI Act. Thehead office of SEBI is in Mumbai. SEBI may establish offices at other places in India.

SEBI consists of the following members, namely:-

(a) a Chairman;(b) two members from amongst the officials of the Ministries of the Central Government dealing withFinance and administration of Companies Act, 1956;(c) one member from amongst the officials of the Reserve Bank of India;

(d) five other members of whom a

capital market reforms in india with evolution of sebi

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