chapter ii stock market in india: a historical...
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CHAPTER – II
STOCK MARKET IN INDIA: A HISTORICAL
RETROSPECT
2.1. Introduction
The capital market of a country is the barometer of that country’s economy and
provides a mechanism for capital formation. Financial market consisting of capital
market and money market constitute one of the major elements of the corporate firm’s
operating environment. These firms use capital market in raising long-term funds to
take up their capital budgeting proposals. The capital market in India is one of the
emerging and promising capital markets of the world.
The last couple of decades have witnessed several changes in the Indian corporate
scene and though the changes themselves may have drawn their inspiration from
different sources and have been independent of each other, they have in their own
way interacted on and combined with each other. They are so important qualitatively
that it would not be an exaggeration to describe their total effect as almost
revolutionary but it is a revolution that has just begun and taken the market towards
maturity and facing global challenges. The decade of 90’s has witnessed several
changes in reformation of capital market in India.
The Indian economy is growing at a fast pace due to the liberalization policies
adopted by the Government of India. This has aroused interest in the Indian capital
market from investors in India and abroad. This also has resulted in the growth of the
stock exchange system in India. The capital market works as a mechanism to
facilitate the transfer of funds from the savers (investors) to the borrowers (issuer of
securities).
By any reckoning, the Indian corporate sector has grown very significantly in
quantitative terms in the last couple of decades whether we look at it in terms of
public and private limited companies, their share capitalization, their sales turnover or
their contribution to capital formation. With this came the legislation of Securities
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and Exchange Board of India (SEBI) to act as a regulatory body to protect investors.
More recently, beginning with 1980 and particularly after 1985, we had a major
movement towards deregulation and liberalization of industrial policies over a wide
area and especially those pertaining to investment, production and pricing. The
process is not yet complete, but enough has taken place to expose Indian industry to a
much-needed competition and to act as a spur to growth and efficiency. The very
character of liberalization aims at trying to achieve scale economics, promote
diversification through broad banding and ease the process of capital expansion.
During the past decades the Indian Capital Market has witnessed vibrant growth.
Several new features have come up since the Securities and Exchange Board of India
(SEBI) was established in 1992. The emergences of the screen-based (on-line)
trading, automation, transparency, strict surveillance, depository system, credit rating
system, investor’s protection, new rules and regulations etc., are some new concepts
on the horizon which only reflect the growth of the Indian capital market.
The changes in economic scenario and the economic growth have raised the interest
of Indian as well as Foreign Institutional Investors in the Indian capital market. The
massive structural reforms on the economic and industry front in the form of de-
licensing, rupee convertibility, tapping of foreign funds, allowing foreign investors to
come to India, have resulted, on one hand, in the quantum leap in activities / volume
in the Indian capital market, and on the other hand, the Indian capital market has
undergone a metamorphosis in terms of institutions, instruments, etc. The buoyancy
in the capital market has appeared as a result of increasing industrialization, growing
awareness, globalization of the capital market, etc. Several financial institutions,
financial instruments and financial services have emerged as a result of economic
liberalization policy of the Government of India.
The capital market or the securities market is the market for equity, debt and
derivatives. The debt market may be divided into three parts, i.e., the government
securities market, the corporate debt market and the money market. The derivatives
market, in turn, may be divided into two parts, i.e., the options market and the futures
market. Except the derivatives market, each of the other markets has two
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components, the primary market and the secondary market. The market where new
securities are issued is called the primary market and the market where outstanding
securities (called scrips) are traded is called the secondary market. It is a market
place, which provides liquidity to the scrips issued in the primary market.
Thus, the growth of secondary market is dependent upon primary market. More the
number of companies entering the primary market, the greater are the volume of trade
at the secondary market. The growth of stock exchanges has a bearing on the growth
of a capital market. If a continuous secondary market exists, where prices are
competitively determined, it is easier for firms to float new securities successfully.
The continuous price mechanism of the stock exchanges also facilitates the
determination of the offering prices of a new issue.
Trading activities in the secondary market are done through recognized stock
exchanges, which are 25 in number including OTCEI, NSE and ISE. Of these 25, the
principal bourses are the BSE and the NSE, accounting for the bulk of the business
done on the Indian stock market. Though the firms do not obtain any new financing
from these markets, the secondary market provides the lifeblood to any financial
system in general and to the capital market in particular. The stock exchange is a
perfectly competitive market, as a large number of sellers and buyers participate in it
and the information regarding the securities is publicly available to all the investors.
Till 1994, trading on the stock market in India was based on the open outcry system.
With the establishment of the NSE in 1994, India entered the era of screen-based
trading. Within a short span of time, screen-based trading has supplanted the open
outcry system on all the stock exchanges in the country, thanks to the initiative of
SEBI in this respect. No country has achieved such a transformation so rapidly. The
kind of screen-based trading system adopted in India is referred to as the open
electronic limit order book (ELOB) market system. The key features of this system
are as follows:
i. Buyers and sellers place their orders on the computer. They can be limit
orders (if price limits are mentioned) or best market price orders
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ii. The computer constantly tries to match mutually compatible orders on price
and time priority
iii. The limit order book, i.e., the list of unmatched limit orders is displayed on the
screen. Put differently, it is open for inspection to all traders.
Government securities are traded outside the trading ring in the form of over-the-
counter sales or purchases. The bargains that are struck in the trading ring by the
members of the stock exchanges are at the fairest prices determined by the basic laws
of supply and demand.
Capital market structure has also undergone a sea change with number of financial
services and banking companies, merchant bankers, more stock exchanges, venture
capital funds, mutual funds, Foreign Institutional Investors (FII), Over-The-Counter
Exchange of India (OTCEI), National Stock Exchange (NSE), Inter-connected Stock
Exchange of India Limited (ISE), credit rating agencies, custodial services, portfolio
management services, non-resident investment, depositories, automation of stock
exchanges, new instruments, euro issues, new regulations for takeovers, insider
trading, unfair trade practices, book building issues, collective investment schemes,
derivatives, etc. emerging on the Indian capital market scene.
The repeal of Capital Issues (Control) Act, 1947 and the establishment of SEBI has
been a milestone in the history of capital market in India. There has been a complete
metamorphosis of market system, policies and regulations with the birth of SEBI
which has introduced a set of comprehensive guidelines for various issues involved
with primary and secondary market and made rules and regulations for various market
intermediaries, insider trading, venture capital, mutual funds, takeover regulation of
credit rating agencies and collective investment schemes, depositories, etc. Investor
protection has been the motive behind all these regulations and guidelines.
SEBI has issued several guidelines on the regulation of secondary market, conduct
and registration of brokers and portfolio managers. It has taken several measures to
control and regulate the secondary market in India. Some of these are expansion of
stock exchanges and their integration, improvement in trading system and settlement
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procedures, registration of brokers and sub-brokers, prohibition on insider trading,
bringing greater transparency in trading activities, on-line trading, trading in demat
mode, compulsory de-materialization of more than 100 scrips, restructuring of stock
indices, eligibility norms and capital adequacy norms, etc.
Mutual funds have also been brought under the strict purview of SEBI. It has made
takeovers transparent and fair. SEBI has also made registration mandatory for sub-
brokers, investment advisers, portfolio managers and spot dealers. Internet trading
has also been introduced in India in February 2000. The trading in derivatives (index
futures) has also been introduced.
SEBI uses 4 types of control to make stock exchanges safer. These are:
a. It makes stock exchanges to impose minimum capital requirements on the
members
b. It encourages stock exchanges to stop trading in a security if the price is too
volatile. The circuit-breakers are applied to help brokers calm down and consider
their positions before going for further transactions
c. It prohibits the price of a security from rising or falling too fast. The price is
allowed to change within fixed limits over a day or over a week
d. It makes the stock exchanges to impose various types of margins on their
members, like
Carry forward margins
Incremental carry forward margins
Mark to market margins
Concentrations margins
Volatility margins
Special ad-hoc margins
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2.2. History of Indian Stock Markets / Exchanges
Stock market refers to the market provided by different stock exchanges to the
securities that include shares, debentures, bonds and other government securities. A
stock exchange fulfils a vital function in the economic development of the nation. Its
main function is to liquidify capital by enabling a person who has invested money in
shares of a company to convert it into cash by disposing off his shares in the company
to someone else. It is a market place where buyers and sellers of shares and securities
admitted to dealings, can do business at competitive open prices both for equities and
debt instruments. Stock markets and equity prices are the barometer of the economy.
The origin of the stock market in India goes back to the end of the eighteenth century
when long-term negotiable securities were first issued. However, for all practical
purposes, the real beginning occurred in the middle of the nineteenth century after the
enactment of the Companies Act in 1850, which introduced the feature of limited
liability and generated investor interest in corporate securities. An important early
event in the development of the stock market in India was the formation of the Native
Share and Stock Brokers’ Association at Bombay in 1875. The stock brokers, aghast
at their plight following the severe depression in securities industry, decided to form
“an association for protection of the character, status and interest of native share and
stock brokers and of providing a hall or building for the use of members of such an
association”. Thus came the precursor of the present day BSE. This process
gradually spread to the other cities of the country.
Kolkata and Mumbai were the two business centers of the 19th
century in India where
securities were traded. Trading was concentrated in bank shares. In 1836, the
Kolkata newspaper “Englishman” quoted share prices of the Bank of Bengal
(bid/offer: Rs.5,000/7,500), the Commercial Bank and the Chartered Mercantile Bank.
Similarly, bank stocks like the Commercial Bank, Chartered Mercantile Bank,
Chartered Bank, Agra Bank, and Oriental Bank were traded in Mumbai.
India saw her first boom in stocks during 1861-65 and her first bubble bursting in
1865. A group of stockbrokers in Mumbai had already come into prominence by
then. Furthermore, 125 new companies went public during 1863-65. The boom was
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a windfall of the American Civil War (1860-65) as the war brought about an upsurge
of Indian cotton exports to Europe in place of American cotton. After this first boom,
Indian stock markets went through several ups and downs, reflecting the two World
Wars, the Great Depressions, and her own Independence movement. Interestingly,
the excitement of the Non-cooperative Movement (1920-22) correlated with a leap in
stock prices. The share price index (1914=100) shot up to 294 by 1921. The buoyant
market collapsed by the end of 1922 as Mahatma Gandhi called off the campaign and
was arrested soon thereafter.
The repeated collapses of the market left casualties led to first reform attempt, which
ended with the legislation of the Bombay Securities Contract Act of 1925. The
second one was almost squashed. The third reform attempt was made after the
collapse of the World War II boom of 1942-46. The company law, then in force,
overlooked manipulating and rigging of share prices. The reform took a long time. It
was not until nine years after independence, that the Companies Act 1956 was enacted
to plug-in the loopholes of the previous company law. As a result, a large number of
ephemeral exchanges emerged mainly in buoyant periods to recede into oblivion
during depressing times subsequently.
In order to check such aberrations and promote a more orderly development of the
stock market, the central government introduced a legislation called the Securities
Contracts (Regulation) Act, 1956, (the first all-India legislation regulating the stock
exchanges in the country).
Up to 80’s there were 8 stock exchanges recognized of which only 7 were with a
permanent recognition from the Central Government. They are the stock exchanges
of Bombay (Mumbai), Ahmedabad, Bangalore, Calcutta (Kolkata), Delhi, Hyderabad
and Madras (Chennai). As of January 2013 there are 25 stock exchanges recognized
by the central government. They are located at Ahmedabad, Bangalore, Baroda,
Bhubaneshwar, Kolkata, Chennai, Cochin, Coimbatore, Delhi, Guwahati, Hyderabad,
Indore, Jaipur, Kanpur, Ludhiana, Mangalore, Patna, Pune, Rajkot, Mumbai (BSE),
Mumbai (NSE), Mumbai (ISE), Mumbai (OTCEI), Mumbai (MCX Stock Exchange)
and Mumbai (United Stock Exchange of India).
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The Indian stock market is often interpreted as the NSE, BSE market as majority of
the transactions takes place at these bourses though there are other smaller stock
exchanges. Both bourses have been instrumental in steering the Indian stock market
towards the present position. It is the Securities and Exchange Board of India (SEBI)
that monitors the functioning of the stock exchanges besides protecting the interests of
investors in securities in the Indian stock market. With appropriate regulations from
time to time, this Govt. of India body also promotes the development of the securities
market.
The Indian stock market is counted as one of the world’s best performing markets.
The NSE today is the second fastest growing stock exchange in the world besides
being the world’s third largest Stock Exchange in terms of the number of trades in
equities. The BSE is the 11th largest stock exchange in the world besides being cited
as the world's best performing shares market. The stature of the bourses has elevated
the position of the Indian stock market in the world map.
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Table 2.1: Stock Exchanges in India
S.No. Name of the Stock
Exchange
Head
quarters About the Stock Exchange / Vision
Year of
Formation
No. of
listings
1 Bombay Stock
Exchange
Mumbai,
India
Emerges as the premier Indian stock exchange by
establishing global benchmarks. 1875 5112
2 National Stock
Exchange of India
Mumbai,
India It is mutually-owned but demutually operated 1992 1640
3 Calcutta Stock
Exchange
Kolkata,
India It is the second largest bourse in India. 1908 3500
4 Madras Stock
Exchange
Chennai,
India
The MSE is the fourth stock exchange to be established in
the country and the first in South India. 1937 1785
5
Inter-connected
Stock Exchange
Ltd.
Mumbai,
India
It is a national-level stock exchange, providing trading,
clearing, settlement, risk management and surveillance
support to its trading members.
1998 4500
6 United Stock
Exchange of India
Mumbai,
India
It is the fourth pan India exchange to be launched for trading
financial instruments in India over the last 140 years. 2010 --
7 OTC Exchange Of
India
Mumbai,
India It is the first exchange for small companies. 1990 115
8 MCX Stock
Exchange
Mumbai,
India
It is an India-wide electronic platform for trading in currency
futures under the regulatory control of SEBI and RBI. 2008 --
9 Bangalore Stock
Exchange
Bangalore,
India
The stock exchange is managed by a Council of
Management, consisting of members appointed by the
Securities and Exchange Board of India.
1963 595
Source: Compiled from Wikipedia
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Table 2.1. Contd.
S.No. Name of the Stock
Exchange
Head
quarters About the Stock Exchange / Vision
Year of
Formation
No. of
listings
10 Ahmedabad Stock
Exchange
Ahmedabad,
India
It is recognized by Securities Contract
(Regulations) Act, 1956 as permanent stock
exchange.
1894 333
11 Bhubaneshwar
Stock Exchange
Bhubaneshwar,
India
It is one among the 21 odd regional stock
exchanges in India. 1989 234
12 Vadodara Stock
Exchange Gujarat, India
It is the third largest stock exchange in the
state of Gujarat after Ahmedabad and Rajkot. 1986 459
13 Cochin Stock
Exchange Kochi, India
It is a capital stock market in Kochi, Kerala in
India. 1978 350
14 Hyderabad Stock
Exchange * Hyderabad, India The exchange was disbanded in 2007. 1941 --
15 Delhi Stock
Exchange New Delhi, India
It is India's fifth exchange. The exchange is
one of the premier Stock Exchange in India. 1947 3000
16 Madhya Pradesh
Stock Exchange
Madhya Pradesh,
India
It was granted permanent recognition under the
provisions of the Securities Contract
(Regulation) Act, 1956 (“SCRA”), by the
Government of India in 1988.
1928 343
17 Jaipur Stock
Exchange Jaipur, India
JSE is the third largest exchange in India in
terms of membership. 1989 740
* Recognition of Hyderabad Stock Exchange was withdrawn w.e.f. 29 Aug 2007
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Table 2.1. Contd.
S.No. Name of the Stock
Exchange
Head
quarters About the Stock Exchange / Vision
Year of
Formation
No. of
listings
18 UP Stock Exchange
Limited Kanpur, India
It plays an important role in the development of
the capital market of North India. 1982 540
19 Coimbatore Stock
Exchange
Tamilnadu,
India It is the youngest stock exchange in India 1996 299
20 Gauhati Stock
Exchange Guwahati, India
It takes good regard in guiding the investors by
setting up its own investors service cell. 1983 290
21 Ludhiana Stock
Exchange Ludhiana, India
It is the second exchange to come out with a
modified carry forward system after BSE 1981 295
22 Mangalore Stock
Exchange **
Mangalore,
India The exchange was disbanded in 2007. 1984 --
23 Magadh Stock
Exchange # Patna, India The exchange was disbanded in 2007. 1986 --
24 Pune Stock
Exchange Pune, India
It takes great care in all grievances of the
exchange and also caters to the interests of the
investors.
1982 185
25 Saurashtra Kutch
Stock Exchange # # Rajkot, India The exchange was disbanded in 2007. 1989 --
** SEBI de-recognized the Mangalore Stock Exchange w.e.f. 4 Oct 2006
# Renewal of registration refused for Magadh Stock Exchange w.e.f. 3 Sep 2007
# # SEBI withdrew recognition of Saurashtra Kutch Stock Exchange w.e.f. 6 Jul 2007
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These 25 exchanges (in Table 2.1) were founded at different times, in different places,
under different laws. However, all of them have now been recognized and regulated
under a single law, the Securities Contracts (Regulation) Act, 1956. No person is, in
principle, allowed to organize stock exchanges other than the recognized ones. The
stock exchanges are tightly regulated as self-regulatory organizations (SRO) under the
Act. In addition to the ordinary regulatory powers over the stock exchanges, the
Central Government and / or SEBI may nominate up to three members to the board of
each stock exchange. The government and/or the agency have the authority to make,
approve and amend the byelaws of the stock exchanges. In return, the stock
exchanges have been granted a strong disciplinary authority over their member
stockbrokers.
All the stock exchanges are connected with PTI stock scan service and are engaged in
on-line trading. The Indian stock exchanges are perhaps the most exciting in the
world and up to some extent dangerous too. Extreme volatility is one reason why
India’s Stock Market is a dangerous place to invest in.
Individuals, corporates, overseas corporate bodies (OCBs), non-resident Indians
(NRIs), domestic financial institutions (DFIs), mutual funds (MFs) and foreign
financial institutions (also referred to as foreign institutional investors or FIIs)
registered with SEBI can all invest in Indian stocks also through secondary market.
Liberalization measures introduced in the Indian economy by the Government
through devaluation, deregulation, de-licensing, globalization, capital market reforms
and free pricing have further increased the interest in the stock market. A number of
new investors as well as significant fresh funds have been inducted into the market.
With the opening up of the Indian economy, domestic exchanges are trying to bring
their operations up to par with international standards. The advantages for an investor
would ultimately come through in the form of better transparency and liquidity.
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2.3. The Stock Exchange, Mumbai (BSE)
The main function of any stock exchange is to facilitate the raising of capital at the
first instance through floating of issues and then facilitating trading of those securities
later on so as to provide liquidity. In July 1875, BSE was established as “The Native
Share and Stock-Brokers’ Association” through the presidency of Bombay with the
approval of the then Central Government. It was set up in order
(i) To safeguard the interests of the investing public
(ii) To establish and promote honorable and just practices in securities transactions
(iii) To promote, develop and maintain a well regulated market for dealing in
securities, and
(iv) To promote industrial development in the country through efficient resource
mobilization by way of investment in corporate securities.
It was recognized by the Government of India on August 31, 1957 under the
Securities Contracts (Regulations) Act, 1956. The capital requirements for
companies, which are already listed on other stock exchanges and seek listing on the
BSE, are
(i) The minimum issued equity capital of Rs.3 crores
(ii) A profitability record of at least 3 years
(iii) The minimum market capitalization of Rs.20 crores (based upon average size)
of last six months
(iv) Trading for a minimum of 50 per cent of the total trading days during the same
six months on any exchange, and
(v) The minimum average volume traded per day during the last three completed
months should be 500 shares and at least five trades per day.
For new companies seeking listing on the exchange and de-listed companies seeking
re-listing on the exchange, the minimum post-issued equity capital requirement is
Rs.10 crores.
The BSE computerized its trading system by introducing BOLT (Bombay On-Line
Trading) on March 14, 1995. Initially screen-based trading was confined to 818
major scrips while trading in the remaining scrips was done by the traditional way.
Trading in all the 5000 odd scrips has been transferred to BOLT on July 3, 1995.
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BOLT provides a quote-driven automatic trading facility with an order book
functioning as an auxiliary jobber. It serves two purposes,
(i) It allows retention and matching of orders against one another where no quotes
exist in the system for particular scrip, and
(ii) It improves the price competitive character of the market, in case investors are
willing to deal at prices better than the current best quotes.
It took the exchange only fifty days to make this transition. This automated, screen-
based trading platform called BSE On-line trading (BOLT) currently has a capacity of
8 million orders per day. The BSE has also introduced the world's first centralised
exchange-based internet trading system, BSEWEBx.co.in to enable investors
anywhere in the world to trade on the BSE platform.
The exchange has signed a memorandum of understanding with eleven stock
exchanges, viz., Kolkata, Pune, Ahmedabad, Saurashtra Kutchh, Madhya Pradesh,
Vadodara, Bhubaneshwar, Magadh (Patna), Jaipur, Coimbatore and Chennai, to
provide BOLT connections to the members of the exchanges after obtaining necessary
clearance from the SEBI.
The price indices of securities traded on the BSE are reflected through the BSE
Sensitive Index (Sensex) and the BSE National Index (Natex). The BSE Sensex was
introduced on January 1, 1986 with the base year of 1978-79. Only 30 scrips are
selected from the companies listed on the BSE and selection is based upon their
market activity, i.e., those which are highly sensitive to market fluctuations. The BSE
started the Natex (BSE 100) in 1988-89 with the base year of 1983-84. It covers 100
actively traded scrips of major stock exchanges, i.e., Mumbai, Delhi, Kolkata,
Ahmedabad and Chennai. Out of the 100 scrips chosen, 22 are quoted exclusively on
the BSE, 72 scrips are quoted on the BSE along with other stock exchanges and the
remaining 6 scrips are quoted only on other stock exchanges. Thus 94 per cent of the
sample scrips are traded on BSE.
The BSE introduced two new indices, i.e., the BSE National Index-200 and Dollex,
both with the base year 1989-90. Dollex presents the current as well as the base year
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values in dollar terms, which are very useful for foreign investment institutions,
overseas corporate bodies, foreign investors, etc. These indices reflect the market
sentiment in a systematic manner to enable investors to know in which direction share
prices are moving so that they can revise their portfolio accordingly.
On July 8, 1999 the BSE introduced one more index to the list of indices, the BSE-
500 with the base date February 1, 1999. It consists of all the scrips in the existing
indices such as BSE-30, BSE-100 and BSE-200 and represents 23 major industries
and 102 sub-sectors of the economy. The scrips have been selected taking into
account various parameters i.e., market capitalization, industry representation, trading
frequency (trading on at least 70 per cent of trading days for the last six months) and
number of trades (at least five trades on an average per day during the last six
months).
However, the BSE has also set up separate indices for different sectors of the
economy, namely, the BSE Durable Index, the BSE Capital Goods Index, the BSE
FMCG Index, the BSE Health Care Index, and the BSE InfoTech Index. These
sectoral indices are helpful to investors to track industry-wise trends in the market.
Besides these, the BSE has also introduced BSETECK, BSEPSU and BANKEX
indices.
BSE is a corporatised and demutualised entity, with a broad shareholder-base which
includes two leading global exchanges, Deutsche Bourse and Singapore Exchange as
strategic partners. BSE provides an efficient and transparent market for trading in
equity, debt instruments, derivatives, mutual funds. It also has a platform for trading
in equities of small-and-medium enterprises (SME). Around 5000 companies are
listed on BSE making it world's No. 1 exchange in terms of listed members.
The companies listed on BSE Ltd command a total market capitalisation of USD
Trillion 1.2 as of 31 October 2012. BSE Ltd is world's fifth most active exchange in
terms of number of transactions handled through its electronic trading system. It is
also one of the world’s leading exchanges (3rd largest in July 2012) for Index options
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trading (Source: World Federation of Exchanges). It operates one of the most
respected capital market educational institutes in the country (the BSE Institute Ltd.).
BSE’s popular equity index - the S&P BSE SENSEX [Formerly SENSEX] - is India's
most widely tracked stock market benchmark index. It is traded internationally on the
EUREX as well as leading exchanges of the BRCS nations (Brazil, Russia, China and
South Africa). On Tuesday, 19 February 2013 BSE has entered into Strategic
Partnership with S&P DOW JONES INDICES and the SENSEX has been renamed as
"S&P BSE SENSEX".
Table 2.2: Indices on BSE as on 1 June 2013
Category Name of the Index
Broad Indices
S & P BSE Sensex
S & P BSE Midcap Index
S & P BSE Small Cap Index
S & P BSE 100 Index
S & P BSE 200 Index
S & P BSE 500 Index
Volatility Indices
S & P BSE Real Vol-1 mth
S & P BSE Real Vol-2 mth
S & P BSE Real Vol-3 mth
Thematic Indices
S & P BSE Greenex
S & P BSE Carbonex
S & P BSE 500 Shariah
Investment Strategy Indices
S & P BSE IPO Index
S & P BSE SME IPO Index
S & P BSE Dollex 30 Index
S & P BSE Dollex 100 Index
S & P BSE Dollex 200 Index
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Table 2.2 contd.
Category Name of the Index
Sectoral Indices
S & P BSE Auto Index
S & P BSE Bankex
S & P BSE Consumer Durables Index
S & P BSE FMCG Index
S & P BSE Health Care Index
S & P BSE IT Index
S & P BSE Metal Index
S & P BSE Realty Index
S & P BSE Oil & Gas Index
S & P BSE Capital Goods Index
S & P BSE Teck Index
S & P BSE PSU Index
S & P BSE Power Index
Source: www.bseindia.com
2.4. The National Stock Exchange (NSE)
In 1991, the High Powered Study Group popularly known as the Pherwani Committee
recommended the setting up of a model Stock Exchange for the development of
National Market System in the country. As a result, the NSE was established and
recognized by the Government of India as a public limited company owned by the
Industrial Development Bank of India (IDBI) and other all-India financial institutions
such as the ICICI, the IFCI, the GIC, the LIC, and subsidiaries of the SBI, the BOB,
the Canara Bank, the PNB, the Corporation Bank, the Indian Bank, the Oriental Bank
of Commerce, the Union Bank of India, the SBI Caps, and the Stock Holding
Corporation of India Limited (SHCIL) in Mumbai in November 1992 with a paid up
equity of Rs.25 crores. It was set up with the following objectives
(i) To establish a nation-wide trading for equities and debt instruments
(ii) To provide a fair, efficient and transparent securities market, and
(iii) To meet the international standards of securities market.
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The price index of securities traded on the NSE is reflected through the NSE-50 index
popularly known as Nifty. It comprises 50 scientifically selected scrips having
market capitalization of Rs.5 billion each. Further the scrips are required to satisfy
the required execution on 85 percent of the trading days at an impact cost of less than
1.5 per cent. It was introduced on April 22, 1996 with the base date of November 3,
1995 with the following objectives
(i) To reflect market movement more accurately
(ii) To provide fund managers a tool for measuring portfolio return vis-à-vis
market returns, and
(iii) To serve as a basis for introducing index based derivatives
The NSE has introduced two new indices i.e., the Nifty Junior Index (Mid Cap Index)
and the Dollar Denominated Nifty (Defty). The Mid Cap Index was introduced with
the explicit objective of measuring the performance of stocks in the mid cap range on
January 1, 1997. It comprises 50 scrips, having a market capitalization of Rs.200
crores each. The securities included in the index have to satisfy the required
execution on 85 per cent of the trading days at an impact cost of less than 2.5 per cent.
The Defty was introduced exclusively for institutional investors, fund managers,
offshore funds, etc., having an equity exposure in India, for measuring returns on their
equity investments in India. On March 17, 1998, the NSE joined hands with the two
rating agencies i.e., Credit Rating Information Services of India Limited (CRISIL)
and the US-based Standard and Poor’s Financial Information Services (S&P), to forge
an alliance for launching equity index business in India. Now Nifty, Mid Cap Index
and Defty are known as CNX Nifty, CNX Nifty Midcap and CNX Defty respectively.
The NSE commenced trading in derivatives with the launch of index futures on 12
June 2000. The futures and options segment of NSE has made a mark for itself
globally. In the Futures and Options segment, trading in CNX Nifty Index, CNX IT
index, Bank Nifty Index, Nifty Midcap 50 index and single stocks are available.
Trading in Mini Nifty Futures & Options and Long term Options on CNX Nifty are
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also available. The average daily turnover in the F&O Segment of the Exchange
during 2009-10 was Rs. 72,392 crore (US $ 16,097 million).
On 29 August 2011, NSE launched derivative contracts on the world’s most followed
equity indices, the S&P 500 and the Dow Jones Industrial Average. This was the first
time that derivative contracts on global indices were available in India. This is also
the first time in the world that futures contracts on the S&P 500 index were
introduced and listed on an exchange outside of their home country, USA. The new
contracts include futures on both the DJIA and the S&P 500, and options on the S&P
500. The first day volume at the close of trading on 29 August 2011 at 15:30, on the 2
indices in futures and options contracts was nearly Rs 122 crores (1220 million).
On 3 May 2012, The National Stock exchange launched derivative contracts (futures
and options) on FTSE 100, the widely tracked index of the UK equity stock market.
This was the first of its kind for an index of the UK equity stock market to be
launched in India. FTSE 100 includes 100 largest UK listed blue chip companies and
has given returns of 17.8 per cent on investment over three years. The index
constitutes 85.6 per cent of UK’s equity market cap. NSE recorded a volume of 500
crores (5000 million) on the 1st day of trading.
In August 2008 currency derivatives were introduced in India with the launch of
Currency Futures in USD INR by NSE. It also added currency futures in Euros,
Pounds and Yen. Interest Rate Futures were introduced for the first time in India by
NSE on 31 August 2009, exactly one year after the launch of Currency Futures.
NSE became the first stock exchange to get approval for interest rate futures, As
recommended by SEBI-RBI committee, on 31 August 2009, a futures contract based
on 7% 10 Year Government of India (Notional) was launched with quarterly
maturities.
NSE is the 11th largest stock exchange in the world by market capitalization and
largest in India by daily turnover and number of trades, for both equities and
derivative trading. NSE has a market capitalization of around US$1 trillion and over
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1,652 listings as of July 2012. Though a number of other exchanges exist, NSE and
the BSE are the two most significant stock exchanges in India and between them are
responsible for the vast majority of share transactions. The NSE's key index is the
CNX Nifty, known as the NSE NIFTY (National Stock Exchange fifty), an index of
fifty major stocks weighted by market capitalization.
NSE is mutually owned by a set of leading financial institutions, banks, insurance
companies and other financial intermediaries in India but its ownership and
management operate as separate entities. There are at least 2 foreign investors NYSE
Euronext and Goldman Sachs who have taken a stake in the NSE. As of 2006, the
NSE VSAT terminals, 2799 in total, cover more than 1500 cities across India. In
2011, NSE was the third largest stock exchange in the world in terms of the number
of contracts (1221 million) traded in equity derivatives. It is the second fastest
growing stock exchange in the world with a recorded growth of 16.6%.
Table 2.3: Indices on NSE as on 1 June 2013
Category Name of the Index
Broad Market Indices
CNX Nifty
CNX Nifty Junior
CNX Nifty 100
CNX Nifty 200
CNX Nifty 500
CNX Nifty Midcap
CNX Nifty Midcap 50
CNX Smallcap Index
India VIX
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Table 2.3 contd.
Category Name of the Index
Sectoral Indices
CNX Auto Index
CNX Bank Index
CNX Energy Index
CNX Finance Index
CNX FMCG Index
CNX IT Index
CNX Media Index
CNX Metal Index
CNX Pharma Index
CNX PSU Bank Index
CNX Realty Index
IISL CNX Industry Indices
Thematic Indices
CNX Commodities Index
CNX Consumption Index
CNX Infrastructure Index
CNX MNC Index
CNX PSE Index
CNX Service Sector Index
CNX Nifty Shariah / CNX 500 Shariah
S&P ESG India Index
Strategy Indices
CNX 100 Equal Weight
CNX Alpha Index
CNX Defty Index
CNX Dividend Opportunity Index
CNX High Beta Index
CNX Low Volatility Index
CNX Nifty Dividend Index
Source: www.nseindia.com
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2.5. Over The Counter Exchange of India (OTCEI)
The OTCEI has been set up to provide a cost effective and convenient platform for
raising finance from the capital market. OTCEI was promoted by a consortium of
financial institutions and started its operations in 1992. It is a ring-less, electronic,
nationwide stock exchange committed to providing entrepreneurs with a smooth
economical vehicle for going public and investors with a fair, stable and efficient
market. Thus, the OTCEI brings investors and promoters closer together. The
important features of OTCEI are as follows:
i. Nationwide listing: The OTC network is spread all over India through
members, dealers and representative office counters. Hence, by listing on just
one stock exchange, the company and its products get nationwide exposure
and investors all over India can start trading in that scrip
ii. Sponsorship: The companies that seek listing on the OTC Exchange have to
approach one of the members appointed by the OTC for acting as the sponsor
to the issue. The sponsor appraises the project. By entering into the
sponsorship agreement, the sponsor is committed to making market in that
scrip by giving a buy / sell quote for a minimum period of 1½ year. Investors
are benefited by this as it enhances the liquidity of the scrips listed on the OTC
Exchange
iii. Bought-out deals: Through the concept of bought-out deals, OTC allows
companies to place its equity meant to be offered to the public with the
sponsor-member at a mutually agreed upon price. This ensures swifter
availability of funds to companies for timely completion of projects and a
listed status at a later date
iv. Listing of small and medium sized companies: In the past, many small and
medium sized companies were not able to enter the capital market, due to the
listing requirement of the SCRA that specifies a minimum issues equity
capital of Rs.3 crores. The OTC Exchange provides an ideal opportunity to
these companies to enter the capital market. In fact, any company with a paid
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up capital of more than Rs.30 lakhs and less than Rs.25 crores can raise
finance from the capital market through the OTC Exchange
v. Liquidity through market making: The sponsor-member is required to give
two-way quotes (buy and sell) for the scrip for 18 months from the date of
commencement of trading. Besides the compulsory market maker, there is an
additional market maker and voluntary market makers who give two-way
quotes for the scrip. Competition among market makers produces efficient
pricing, reduces spreads between buy and sell quotations and increases the
capacity to absorb larger volumes. The market makers continually analyses
companies and provide information about them to their investors, thus
intensifying investor interest
vi. Ring-less and screen-based trading: For the first time in India, the OTC
Exchange has introduced automated, screen-based trading in place of the
traditional trading ring found in other stock exchanges. The network of on-
line computers provides all relevant information on the computer screens of
the market participants. Allowing them the luxury of executing their deals
from the comfort of their own offices
vii. Transparency of transactions: At the OTC Exchange, the investor can see
the available quotations on the computer screen at the dealer’s office before
placing the order. The confirmation slip / trading document generated through
the computer gives him the exact price of the transaction and the brokerage
change through which the investor’s interest is totally safeguarded. This
system also ensures that transactions are done at the best prevailing quotation
in the market
viii. Faster delivery and payment: On the OTC Exchange the transaction is
settled within an incredibly short span of 7 days, which means the investor
actually gets the delivery of the scrip or the payment for the scrip sold within 7
days
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ix. Technology: The most distinguishing characteristic of the OTC market is its
state-of-the-art technology. The OTC Exchange uses computers and tele-
communications, technologies of the information age, to bring members /
dealers together electronically, enabling them to trade with one another over
the computer rather than on a trading floor in a single location. All the
information needed for trading is in the open and easily accessible on the OTC
computer screen, by going into the respective units.
2.6. The Inter-connected Stock Exchange of India Ltd (ISE)
The ISE has been promoted by 15 regional stock exchanges to provide trading linkage
/ connectivity to all the participating exchanges to widen their market. Thus, ISE is a
national level exchange providing trading, clearing, settlement, risk management and
surveillance support to the Inter-Connected Market System (ICMS). ISE aims to
address the needs of small companies and retail investors with the guiding principle of
optimizing the infrastructure and harnessing the potential of regional markets to
transform these into a liquid and vibrant market through the use of technology and
networking.
In order to leverage its infrastructure as also expand its nation-wide reach, ISE has
also appointed Dealers across various cities other than the participating Exchange
centers. These Dealers are administratively supported through strategically located
regional offices at Delhi, Calcutta, Chennai and Nagpur. ISE thus expects to emerge
as a low cost National Level Exchange in the country for retail investors and small
intermediaries.
The ISE commenced its trading operations on February 26, 1999. The 15
participating exchanges of the ISE have about 4500 members and about 3500
securities listed on them. The ISE is a stock exchange of stock exchanges, members
of the participating stock exchanges being the only traders on the ISE. The ISE has
provided a highly automated trading system open to all the registered traders of the
participating exchanges with direct access to its national-level trading platform on an
equal footing regardless of the location of the participating exchanges and of the
status of the exchange in terms of turnover, financial strength, etc. It has not only a
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professionally qualified managing director, but also a public representative as the
chairman of the exchange. Most importantly, the ISE is a centralized national-level
market for trading in securities with decentralized operations as the participating
regional stock exchanges continue to be the centers for trading, clearing and
settlement.
The ISE is also enrolling about 500 dealers in 61 centers in the country other than the
participating regional stock exchange centers. A major task ISE has set for self is, to
ensure liquidity for the regionally listed securities by providing for a national segment
of trading. Thus a truly national network for trading in securities is getting built up.
This will help greatly in the spread of equity cult throughout the country. As SEBI
has permitted regional stock exchanges to float subsidiaries, which can become
members of major stock exchanges and members of regional stock exchanges can
trade on the major stock exchanges as sub-brokers, ISE has also become a member of
NSE.
Some of the features that make ISE a New Age Stock Exchange are as follows:
i. ISE is a national level recognized stock exchange having moderate listing fees
and granting listing and trading permission to small and medium sized
companies having a Post Public issue paid-up capital of Rs.3 crores to Rs.5
crores (subject to the appointment of market makers) besides companies with
a capital of above Rs.5 crores
ii. All traders and dealers of ISE have access to NSE through ISS, which ensures
continuous attention of investors
iii. ISE has set up an ‘Investor Grievance and Service Cell’ which looks after all
types of complaints of investors located across the country and provides
decentralized support
iv. Listing of stocks with ISE would give the company an advantage of being
identified as a technology-savvy and investor-friendly company
v. ISE is proposing to introduce the ‘IPO Distribution System’ for offering
primary market issue
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2.7. Reforms of Stock Exchanges in India
The process of reforms of the economic system as a whole, including the financial
sector of which stock exchanges constitute an integral part, received a tremendous
fillip with the induction in June 1991 of a stable government at the center, which
ushered in an era of deregulation, liberalization and globalization of the Indian
economy. Launching of the NSE in 1992, which resulted in emergence of keen
competition among the various stock exchanges of the country, gave a further boost to
the reforms process in the stock exchanges.
2.7.1. Quality of the market: There has been a sea change in the quality of the
market compared to what it was during the last decade. In the primary market, the
policy of free pricing of securities, no more bridled with controls has been adopted.
Disclosure of information for subscription in the new issues market for initial public
offerings as also for other issues is almost on par with international standards. The
country has launched the book-building system for public subscription, resulting in
better discovery of prices and reducing the cost of public subscription. The time lag
between closure of issues and listing of securities has also been reduced greatly,
thereby enhancing liquidity in investment in capital market instruments.
In the secondary market, screen-based trading with on-line connectivity virtually
throughout the length and breadth of the country is the order of the day. In fact,
screen-based trading is a condition precedent for grant of recognition to a new stock
exchange by the SEBI. There has been tremendous progress in replacing the physical
stock of shares straight away by the dematerialization system, skipping the
immobilization of securities stage, which some of the countries like USA still have.
2.7.2. Free Pricing Policy: Guidelines issues by the SEBI based on the Malegam
Committee’s recommendations, effective from May 1, 1996, requiring justification of
premium on the basis of six parameters, viz., (i) earnings per share (EPS) for the last
three years, (ii) P/E ratio pre-issue and comparison with the industry P/E ratio, (iii)
average return on net worth for the last three years, (iv) minimum return on increased
net worth required to maintain pre-issue EPS, (v) latest net asset value per share, and
(vi) net asset value per share after issue and comparison with the issue price. But
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these measures have failed in avoiding price manipulation by merchant bankers.
SEBI has now introduced book building, which is permitted for all issues, including
issues below Rs. 25 crores. Book building has a major objective of acting as a good
price discovery mechanism.
2.7.3. Fly-by Night Companies: Yet another remedy can be institution of drastic
penal action against promoters and directors of fly-by night companies, which vanish
from the scene after tapping the capital market. The SEBI has initiated some drastic
action against quite a number of directors of some ‘vanishing’ companies.
2.7.4. Merchant Bankers: Investors can also be benefited by a compulsory
requirement to have merchant bankers rated by authorized rating agencies, which will
evolve their own norms, including post-listing appreciation / depreciation in prices of
securities handled by the merchant bankers.
2.7.5. Merging Companies: A sad spectacle that has emerged in the primary market
in recently years is the evasion of public offer by having recourse to merger of a large
unlisted company with a small listed company. At least 25 per cent of the capital of
the merging company should be offered to the public, without relaxing in any way
provisions of rule 19(2) of the Securities Contracts (Regulation) Rules, either by way
of a fresh issue or an offer for sale at the price on the basis of which the swap ratio for
exchange of shares of the merging company with the merged company has been
arrived at.
2.7.6. Liquidity: All-round efforts are needed to improve liquidity in the stock
markets. The recommendation made by the G.P. Gupta Committee to appoint market
makers is no doubt welcome, but that alone will not be adequate. Liquidity can also
be improved by initiating a number of other measures like enhancing the minimum
public offer for qualifying for listing from 25 per cent or 10 per cent to 40 per cent of
the issued capital of the company, etc.
2.7.7. Futures and Options: Both the NSE and the BSE have commenced trading
from June 2000 in index futures and options on index futures. The two principal
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norms for assessment of the relative merits and demerits of futures, options and badla,
are –
(i) Utility as a hedge instrument, and
(ii) Generation of liquidity by the use of these instruments and its consequent
impact on volatility.
Futures contracts no doubt increase liquidity but options seem to be divided with
regard to their impact on volatility. Several studies have been conducted in advanced
countries about the impact of options on trading in shares. There is a general
consensus that the turnover increases in the underlying shares of those companies in
respect of which options have been launched. It is, however, not clear whether the
increase in turnover has led to any decline in volatility. One generally accepted fact is
that options stimulate speculation, which cannot be said to be a healthy sign.
2.7.8. Mutual Funds and Derivatives: The SEBI has already amended Mutual Funds
Regulations permitting them to enter into derivatives transactions for the purpose of
hedging and portfolio balancing activities.
2.8. Nature of Transactions in Stock Market
The transactions entered in stock market may be classified in to the following
categories:
2.8.1. Transactions in Cash Market
The transactions entered into the cash segment are a peculiar form of forward trading,
as these are not settled immediately on the same day. These accumulate over a
trading cycle and at the end of the cycle, all the transactions are clubbed together,
positions are netted out and the balance is settled by payment of cash and delivery of
securities. Such transactions are usually called ‘hand delivery’ contracts. Since these
contracts do not require performance immediately and can be squared up by another
contract entered into before the end of the trading cycle, some parties get tempted to
engage in speculation.
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2.8.2. Carry Forward Transactions: These transactions are popularly known as
‘forward trading’ or ‘badla trades’, which were prohibited by SEBI in the year 2001.
Under this system of trading, stock exchanges categorized certain active shares under
‘A’ group and trading in these shares were carried forward from one settlement period
of 14 days to another by the concerned stock brokers by entering into fresh contracts
of purchase and sale at the beginning of every new settlement period. Such an
informal system of forward trading periodically created several problems and crisis
situations in the stock exchanges because of the lack of necessary regulation by the
stock exchanges, under their byelaws and regulations of such trading. There were
payment crises from time to time and frequent closure of the market.
2.8.3. Ready Forward Transactions: A ready forward transaction, usually known as
repo, allows a holder of securities to sell with a commitment to repurchase them at a
predetermined price and date. In a reverse repo securities are bought with a
commitment to resell them to the original holder. The ingredients of a repo are:
i. There must be a sale or purchase with the commitment to repurchase or resell
in future
ii. The contract must be between two parties
iii. It must be in respect of some kind of securities and for the same quantum of
securities
iv. It must be entered into on the same day or contemporaneously and the price of
resale or repurchase would be fixed at the stage of first leg itself
The repo facility is restricted to certain identified players and thus a large number of
potential users are denied participation. Such transactions are permitted only in
government securities. Other securities such as shares, bonds, and commercial paper,
do not have this facility. But as a negative aspect the mechanism does not permit
players to go short. There is no standard documentation / master agreement
governing a repo transaction. There is no clearing-house to take counter party risk.
The securities are not dematerialized.
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2.9. Trading
Each stock exchange has certain listed securities and permitted securities that are
traded on it. Members of the exchange alone are entitled to the trading privileges.
Investors interested in buying or selling securities should place their orders with the
members, also called brokers, of the exchange. There are two ways of organizing the
trading activity: the open outcry system and the screen-based system.
2.9.1. Open outcry system
Here the traders shout and resort to signals on the trading floor of the exchange that
consists of several ‘notional’ trading posts for different securities. A member (or his
representative) wishing to buy or sell a certain security reaches the trading post where
the security is traded. Here, he comes in contact with others interested in transacting
in that security. Buyers make their bids and sellers make their offers and bargains are
closed at mutually agreed-upon prices. In stocks where jobbing is done, the jobber
plays an important role. He stands ready to buy or sell on his account. He quotes his
‘bid’ (buying) and ‘ask’ (selling) prices. He provides some stability and continuity to
the market.
2.9.2. Screen-based system
In the screen-based system, the trading ring is replaced by the computer screen and
distant participants can trade with each other through the computer network. A large
number of participants, geographically separated, can trade simultaneously at high
speeds. The screen-based trading system (a) enhances the informational efficiency of
the market as more participants trade at a faster speed; (b) permits the market
participants to get a full view of the market, which increases their confidence in the
market; (c) establishes transparent audit trails. While computerized trading is more
efficient, it decidedly lacks the vibrancy and vitality of the traditional floor trading.
Technology seems to have its own way of pushing colorful traditions and practices
into oblivion.
Till 1994, trading on the stock market in India was based on the open outcry system.
With the establishment of the NSE in 1994, India entered the era of screen-based
trading. Within a short span of time, screen-based trading has supplanted the open
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outcry system on all the stock exchanges in the country, thanks to the initiative of
SEBI in this respect. No country has achieved such a transformation so rapidly. The
kind of screen-based trading system adopted in India is referred to as the open
electronic limit order book (ELOB) market system. The key features of this system
are as follows:
i. Buyers and sellers place their orders on the computer. They can be limit
orders (if price limits are mentioned) or best market price orders
ii. The computer constantly tries to match mutually compatible orders on price
and time priority
iii. The limit order book, i.e., the list of unmatched limit orders is displayed on the
screen. Put differently, it is open for inspection to all traders
2.9.3. Forward Trading
Forward trading is simply an arrangement between two parties to buy or sell a certain
quantity of securities at a certain future time for a certain price. The securities and
consideration do not change hands at the time the contract is entered into. The
contract is settled at maturity when the seller delivers the securities to the buyer in
return for the consideration or carried forward for settlement at a further future time.
This arrangement enables market players to carry huge positions far more than
supportable by funds available with them and trade in the same actively. While this
helps to make the market active and liquid, it has the danger of encouraging excessive
speculation, if not effectively regulated.
2.9.4. Margin Trading
Margin trading is purchasing securities by borrowing a portion of the transaction
value and using the securities in the portfolio as collateral. It increases the purchasing
power of the investors. This led to leveraging and expansion of portfolio. While the
imposition of margins can help calm the markets, it cannot be a substitute for
surveillance and monitoring by stock exchanges (Ashok Rambhia 1998).
2.9.5. Scripless Trading
Scripless trading is a method of securities trading in which the settlement of
transactions take place via book entry instead of physical exchange and delivery of
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securities certificates. The major objective of introducing scripless trading is to
ensure the safety of securities certificates and to improve the liquidity position of the
stock markets both in primary and secondary markets. The major advantages of the
scripless trading system are as follows:
i. Reduction in paper work of stock brokers and stock exchanges
ii. Ensure safety of certificates from theft, fake certificates, mutilation,
department, etc
iii. Reduction in cumbersome share transfer procedures
iv. Greater speed in exchange and delivery of securities certificates
v. Improves liquidity of both the individual scrips and stock market position.
2.9.6. Internet Trading & WAP Trading
Internet has become an important part of each person’s life. The usage is growing day
by day. Internet is a good medium, which can be used as an efficient tool for trading
in shares. Internet is a medium through which communication takes place between
two computers. A person from anywhere on the globe can access another computer
on the Internet. The brokers would set up software for trading in shares on their
website. Their clients would access the website of the broker and would place orders
for buying and selling of shares. These orders would be executed by the broker
electronically either through counter orders from another client or on the stock
exchange with another broker.
With the payment gateways built by banks, it would be very easy for transfer of funds
upon execution of transaction. It is believed that Internet would change completely
the way in which transactions on the exchange takes place. The volumes will increase
manifold in view of the ease with which the transactions could be put through
especially in case of small investors. The activity of transacting on a stock exchange
would not only be restricted to exchange floor, exchange terminals, from the offices
or from homes but even while one is mobile, say in a car or train or for that matter in
an aircraft. This would be made possible with WAP – Wireless Application Protocol.
WAP is a mode of communication between the mobile phone and another mobile
phone or a computer. With the wireless world a reality, the capital market will see a
sea change in the way in which the transactions are put through.
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2.10. Settlement
Traditionally, trades in India were settled by physical delivery. This means that the
securities had to physically move from the seller to the seller’s broker, from the
seller’s broker to the buyer’s broker (through the clearing house of the exchange or
directly), and from the buyer’s broker to the buyer. Further, the buyer had to lodge
the securities with the transfer agents of the company and the process of transfer took
one to three months. This led to high paperwork cost and created bad paper risk. To
migrate the costs and risks associated with physical delivery, security transactions in
developed countries are settled mainly through electronic delivery facilitated by
depositories. A depository is an institution that dematerializes physical certificates
and effects transfer of ownership by electronic book entries.
To enable the creation of depositories to facilitate dematerialized trading in India, the
central government passed the Depositories Act, 1996. The National Securities
Depository Limited (NSDL), India's first depository, was set up in 1996. It was
followed by the Central Securities Depositories Limited (CSDL). Both the
depositories, the NSDL in particular, have recorded a significant growth in their
operations. SEBI has made settlement of trades in dematerialized (popularly called
demat) form compulsory for all the stock exchanges in the country. This means that if
you want to buy or sell shares on any exchange you have to do it only in the
dematerialized form. Of course, two parties may engage in an off-market spot
transaction that can be settled through the delivery of shares in physical form. There
is a transfer duty of 0.50 per cent on physical transfer.
2.10.1. Shift to Rolling Settlement
Till recently share transactions in India were settled on the basis of a weekly account
period. (On the BSE the account period was Monday to Friday and on the NSE the
settlement account period was Wednesday to Tuesday.) This meant that purchases
and sales during an account period could be squared up; and at the end of the account
period, transactions could be settled on a net basis. For example, if you bought 100
shares of Infosys on BSE on a Monday at Rs.5000 a share and sold 95 shares of
Infosys at Rs.5050 on the Friday of that week, you were required to take delivery for
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only 5 shares by paying Rs.20250 (purchase consideration of Rs.500000 – Sale
consideration of Rs.479750) at the end of the account period.
The weekly settlement system along with the badla system of carrying forward
transactions from one account period to the next, according to many informed
observers of the Indian stock market, led to unbridled speculative activity and
periodic market crisis. Rolling settlement is an important measure to enhance the
efficiency and integrity of the securities market. The shift from the traditional
account period settlement marks an important change in the market design and age-
old practices.
In January 1998, as dematerialization took off, NSE provided an option to settle the
trades in demat securities on rolling basis. In January 2000, SEBI made rolling
settlement compulsory for trades in 10 scrips selected on the basis of the criteria that
they were in the compulsory demat list and had daily turnover of about Rs.1 crore or
more. SEBI reviewed the progress of rolling settlement in February 2000. Consequent
on the review, SEBI added a total of 156 scrips under rolling settlement. Scrips that
trade on any of the exchanges and had signed agreements with both the depositories
were included for compulsory rolling settlement from March 21, 2000.
The then Finance Minister announced on March 13, 2001 that the rolling settlement
would be extended to BSE-200 list and would be traded only in the compulsory
rolling settlement on all the exchanges from July 2, 2001. Further, SEBI mandated
rolling settlement for the remaining securities from December 31, 2001. SEBI
introduced T+5 rolling settlement in equity market from July 2001, subsequently
shortened the settlement cycle to T+3 from April 1, 2002. After having gained
experience of T+3 rolling settlement, it was felt appropriate to further reduce the
settlement cycle to T+2 thereby reducing the risk in the market and to protect the
interest of investors. As a result, SEBI, as a step towards easy flow of funds and
securities, introduced T+2 rolling settlement in Indian equity market from 1st April
2003. Since then 10 years rolled, but the ideal T+1 settlement cycle is yet to be
achieved.
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Thanks to the introduction of screen-based trading and electronic delivery, the stock
market has been veritably transformed. Their combined effect has been to reduce the
transaction costs in the Indian stock market dramatically. As of mid-1993, according
to Ajay Shah (1995) and Susan Thomas (1995), the total transaction cost in the Indian
market was 5.00 per cent; presently it is around 0.50 per cent.
With this the Indian securities market is complying with the standard for clearing and
settlement laid down by the joint committee of clearing and payment system of the
Bank for International Settlements and International Organization of Securities
Commissions. The advantage of the shorter settlement is early settlement of
transactions, which benefits the brokers as well as investors.
2.11. Risk Management Systems at the Exchanges
The risk management systems at the exchange has improved substantially in the
recent past because of positive steps taken by the exchange in terms of prescribing
capital adequacy norms for members, margins, on line surveillance, inspection of
broker’s books, etc. Poon & Granger (2003) emphasize on the importance of
volatility forecasting in various things such as options pricing, financial risk
management, etc.
The margin systems have become more sophisticated to consider the factors of
volatility, volumes and other factors. The margins are required to be compulsorily
collected from the clients by the brokers. A quarterly certificate has been prescribed
for compliance of the margin system. With the infrastructure of risk management
enhanced, the stock exchanges as well as the investors are better protected towards
risks of various scams that had recently shaken the market. A more analytical media
reporting which highlights better risk management coupled with investor learning will
surely lead to more stable market (Piyush Chowhan and Vasant Shukla 2003).
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2.12. Demutualization of Stock Exchanges
Historically stock exchanges were formed as ‘mutual’ organizations, which were
considered beneficial in terms of tax benefits and matters of compliance. They are
generally ‘not-for-profit’ and tax exempted entities. The trading members who
provide broking services, also own, control and manage such exchanges for their
common benefit, but do not distribute the profits among themselves. The ownership
rights and trading rights are clubbed together in a membership card that is not freely
transferable and hence this card at times carries a premium.
In contrast, in a ‘demutual’ exchange, three separate sets of people own the exchange,
manage it and use its services. The owners usually vest management in a board of
directors, which is assisted by a professional team. A completely different set of
people use trading platform of the exchange. These are generally ‘for-profit’ and
taxpaying entities. The ownership rights are freely transferable. Trading rights are
acquired / surrendered in terms of transparent rules. Membership cards do not exist.
These two models of exchanges are generally referred to as ‘club’ and ‘institution’
respectively.
Of all the 25 recognized stock exchanges in the country, three are ‘Association of
Persons’, while the balance are companies, either limited by guarantee or by shares.
Except one exchange (NSE), all exchanges, whether corporates or association of
persons, are not-for-profit making organizations. Except for two (OTCEI and NSE),
all exchanges are ‘mutual’’ organizations.
The concept of demutualized exchange most probably originated in India, where two
exchanges (OTCEI in 1990 and NSE in 1992) adopted pure demutualized structure
from their birth. Later an expert committee appointed by SEBI has recommended
demutualization of stock exchanges since stock exchanges, brokers associations and
investors associations have overwhelmingly felt that such a measure was desirable.
The committee has accordingly suggested the steps for such demutualization. The
most important development in the capital market is concerning the demutualization
of the stock exchanges, which means segregating the ownership from management.
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This move was necessitated by the fact that brokers in the management of the stock
exchange were misusing their position for personal gains. Demutualization brings in
transparency and prevents conflict of interest in the functioning of the stock
exchanges. The Stockholm Stock Exchange was the first major stock exchange in the
world to become demutualized in 1993. Since then, over 20 exchanges have
demutualized. Some of them like Australian Stock Exchange, London Stock
Exchange and Singapore Stock Exchange have gone one step further by becoming a
listed company. Many others, including commodity exchanges, are in the process of
demutualization.
2.13. Stock Market in India Today
Undoubtedly India remains as one of the few long term sustainable growth stories in
the world. The long term Indian growth story is intact with its favorable demographics
and income growth. Yet the stock market movements are not always governed by
long term factors. Equity Markets in the short term tend to be volatile and factor more
of current concerns. Some of the reasons for the market correction include
a. Domestic Factors like food inflation – fuel price hike – interest rate concerns –
fiscal deficit – current account deficit – scams, etc
b. International factors like oil price hikes[Libyan factor including], Egypt crisis,
outperformance of developed markets which means lesser appetite for emerging
markets, FII profit booking, sell off by short term oriented foreign investors like
hedge funds, ETF, etc.
A somewhat panicky situation has been prevailing in the share market of India. This
is because of the constant plunging of the NSE of India and the BSE of India. The
rapid flow of foreign funds and with Indian investors heavily investing, it was the
force of the bull that reigned supreme. But the situation lasted for a shorter time and
the bear market gained momentum on the NSE and BSE markets. No investor can do
away with the forces of the bear and the bull which is a common affair in the NSE and
BSE markets. There are several reasons that led to the plunge of the Nifty
and Sensex. Here is a list of the same:
i. 2G spectrum scam creating political instability; it did have an impact on the
dampening of the NSE and BSE markets
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ii. The housing finance bribery scam involving top officials in from top financial
institutions and PSUs; the scam is unearthed by CBI, which has dampened the
domestic trading
iii. Credit concerns in Europe
iv. Korean fears leading to sell-off in global markets
v. Monetary tightening in China, and more.
The above factors accounted for the current downtrend. One reason that led to the fast
rise of the BSE Sensex resulting in an all-time high is because foreign investors who
majorly contributed to the inflow of funds did not participate in the selling. But the
greatest downtrend was witnessed during the recession period that greatly affected
world markets including the NSE of India and BSE of India. And the markets did
recuperate and special mention needs to be made of the fast recuperation of the share
market of India.
The Indian economy is expected to witness a GDP growth of 8% p.a. considering the
tremendous growth in the infrastructure sectors like power, transport, mining &
metallurgy, textiles, housing, retail, social welfare, medical etc. With the Foreign
Institutional Investors still looking at India favorably, the investment in Indian
equities can give better returns in comparison with other global markets in the coming
years.
Stock exchanges are witnessing changes in their landscape. The Hyderabad Stock
Exchange (HSEL) exited stock trading business, and a new nation-wide entrant,
MCX-SX, started trading in equity and equity derivatives segment.
There are at present (February 2013) 25 stock exchanges across the country most of
which are regional in nature and non-operational. Only five have trading platforms,
which includes National Stock Exchange (NSE), Bombay Stock Exchange (BSE),
MCX Stock Exchange (MCX-SX), United Stock Exchange (USE) and Calcutta Stock
Exchange (CSE). Among them, USE is a currency trading platform.
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The entry of MCX-SX will help in the long run diluting the dominance of one
exchange in the market place, says Arun Kejriwal, Founder, Kejriwal Research &
Investment Services. “Over-time, domination led to an institution-promoted exchange
to behave in a similar fashion as a broker-promoted exchange behaved in earlier
years,” said Mr. Kejriwal.
The NSE captures about 83 per cent transactions of the cash segment and 79 per cent
of the derivatives segment. Over the years, its products such as Nifty and Gold ETF’s
have become popular among investors. At the same time, products such as Bank Nifty
and stock options have also seen good growth.
In the present market scenario, market participants expect better efficiency,
dissemination of information and better use of technology which would reduce cost.
Once MCX-SX was cleared by the Securities and Exchange Board of India (SEBI)
last calendar year, the NSE brought down its transaction fees. If MCX-SX wants to
be a successful stock exchange, it has to bring in measures to lower costs, better
technology and financial literacy.
As competition has intensified, what the exchanges need the most is transparency.
Last year, the regulator had allowed stock exchanges to be listed on other than its own
exchange. This would bring more transparency to the exchanges. It was stipulated that
51 per cent stake of an exchange could be with the public. However, this listing norm
is not mandatory, but only by choice. Since this announcement, MCX commodity
exchange was the only exchange which was listed so far and BSE is now planning to
list.
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2.14. Stock Market versus Derivatives Market
Financial markets, including capital and derivatives markets, are worldwide
exchanges for small and large businesses to raise capital and hedge against different
types of risks. Capital markets include stock and bond markets, and derivatives
markets include futures and options markets. Investors may invest in these markets
directly through banks and online stockbrokers and indirectly through mutual funds
and pension funds.
Stocks and bonds are two common capital-market securities. Stocks represent
ownership interest in companies, while bonds represent slices of large loans to
companies in exchange for regular interest payments. Other capital-market securities
include preferred stocks and convertible bonds, which include features of both stocks
and bonds. Futures and options are two common derivatives-market securities.
Derivatives derive their properties from underlying assets, such as commodities,
stocks, bonds and currencies.
The capital markets consist of regulated stock exchanges, such as the National Stock
Exchange and the Stock Exchange, Mumbai; over-the-counter markets for stocks that
do not qualify for listing on the major exchanges; and bond markets for trading
corporate and government bonds. Businesses use the capital markets to raise funds for
various operational and strategic reasons. Governments also use the capital markets to
issue short-term and long-term bonds to pay for services and operations. Investment
banks facilitate the listing process for stocks and bonds, which typically includes
regulatory filings and marketing efforts to generate investor demand. Most of the
research analysts use published financial reports and industry data to provide
recommendations on which stocks to buy or sell and at what price.
Derivatives trade on regulated exchanges, and on over-the-counter markets. Over-the-
counter derivatives include standardized contracts, which have features similar to the
standard contracts trading on the regulated exchanges, and customized contracts
between two parties. Businesses and financial institutions are the main users of the
derivatives markets, which provide risk protection at minimal upfront cost. People
may use derivatives to hedge their investments or to speculate on the future direction
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of asset prices. These risk factors include commodity price fluctuations and interest
rate fluctuations.
Derivatives are financial instruments whose values are derived from something else
such as assets or indexes such as interest rates or the stock market. They are used to
mitigate or hedge the risk of economic loss from the changes in the value of the
underlining asset or index. Derivatives may also be used to acquire risk rather than
insure against it to speculate, betting that the party seeking insurance will be wrong
about the future value. The derivative market is largely unregulated with no loss
reserve requirement.
By the end of 2009, world’s total derivatives were $1000 trillion or 19 times the total
world GDP of $54 trillion. Over-the-counter derivatives totaled $684 trillion of which
67 percent were interest rate swaps. Exchange-traded derivatives totaled $344 trillion.
Interest rate swaps are the largest derivative powder keg waiting to blow the world
financial markets to supernova.
2.15. Causes for Decline of Regional Stock Exchanges
Establishment of National Stock Exchange of India Ltd., (NSE) in 1994 with an all-
India spread and expansion of operations of Bombay Stock Exchange (BSE)
throughout the country, both of which have their trader work stations at over 400
centers in the country today, have led to the virtual extinction of all the 19 Regional
Stock Exchange (RSEs) spread across the length and breadth of the country. The
share of 19 RSEs, which was as much as 45.6 per cent of the total all-India turnover
of Rs. 2.39 lakh crore in 1995-96, declined progressively year after year and in 2001-
02, it was just 8.4 per cent of the total volume of Rs. 8.96 lakh crore. At present, there
is virtually no trading at any of the RSEs.
Trading in the cash segment is thus confined to NSE and BSE only, with the share of
the latter, which used to account for over 70 percent of the all-India volume of trading
till 1995, is also progressively declining. Currently, BSE accounts for about 30 per
cent of the aggregate volume of trading on NSE and BSE in the cash segment. In the
derivatives segment, while NSE clocks in about Rs. 2000 crore daily, the turnover on
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BSE has been progressively declining virtually to the zero level. The RSEs of the
country and their members had spent over Rs. 200 crore in automating their trading,
clearing and settlement systems, largely driven by regulatory compulsions, sadly to
witness them lying idle at present.
Abolition of Badla with effect from July 2, 2001, acted as the backbone of trading at
the Calcutta, Delhi, Ahmedabad and Ludhiana Stock Exchange Association and also
at a few other exchanges, which conducted Badla trading but in a clandestine manner,
dealt a serious blow to trading at the RSEs. Introduction of uniform trading cycles at
all the stock exchanges, also effective from July 2, 2001, reduced further the volume
of trading at the RSEs due to diminished opportunities for arbitrage transactions.
Introduction of compulsory rolling settlements, initially in a few securities and
subsequently in all securities effective from December 31, 2001 on a T+5 bases
accelerated the reduction in turnover at the RSEs. The switch over of the rolling
settlement to T+3 effective from April 1, 2002 and to T+2 with effect from April 1,
2003 sealed the fate of the RSEs. Yet another major reason for the absence of trading
at the RSEs is that all the major operators of all these exchanges acquired
memberships of either NSE or BSE or of both, while most others acquired the sub-
brokerships of members of NSE/BSE and all of them switched over their operations
completely to NSE and BSE. In spite of the fact that trading at the RSEs has ground to
a halt, RSEs have managed to survive so far because of the annual listing fees that are
being received from the listed companies. The circulars issued by the Ministry of
Finance on April 23, 2003 withdrawing its earlier circulars which required all
companies including existing listed companies, to be listed on the stock exchanges
located in the State where the registered office or the main works/fixed assets of the
company are situated, has led to the conclusion of RSEs as companies have started
lining up one after the other to get themselves delisted from the RSEs.
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2.16. Future of Regional Stock Exchanges
The Indian stock market has undergone a sea change with the opening up of the
economy and economic reforms. With competition swaying the entire market, stock
exchanges have been no exception. In India, the area of operation and jurisdiction of
the regional stock exchanges were specified. The emergence of a number of regional
stock exchanges was the result of India’s geographical and telecommunications
limitations.
The national reach of BSE and NSE and cutthroat competition between them,
threatened the existence of the regional stock exchanges (RSEs). The volume of
business on the RSEs plummeted. Trading at stock exchanges in Guwahati, Magadh,
Indore, Mangalore, and Rajkot came to a halt even though trading at all these stock
exchanges too had been automated. The survival of these RSEs, which once had a
secure position, had now become a cause for concern. So these RSEs formed the
Federation of Indian Stock Exchanges (FISE) in early 1996. The eroding market
share, dwindling volume, and declining profitability of members at the RSEs left the
FISE with two options: join hands with the BOLT expansion plan or maintain status
quo and wait until the capital market.
It was impossible for most of the RSEs to become members of either BSE or NSE.
Hence, to improve market efficiency and facilitate trading among the RSEs, FISE
proposed an Inter Connected Market System (ICMS). It sought technical assistance
from the USA International Development – Financial Institutions Reforms and
Expansion (USAID – FIRE) Project, administered by Price Waterhouse. With its
assistance, the Interconnected Stock Exchange of India (ISE) was set up as the twenty
third stock exchange of the country.
The ISE, promoted by 15 RSEs, opened a new national segment of trade to all
members of the exchanges while retaining the regional segments of trading at these
exchanges. The ISE was granted recognition under the Securities Contracts
(Regulation) Act, 1956 by SEBI in November 1998. ISE commenced its trading
operations on February 26, 1999. The 15 participating exchanges of ISE have about
4,500 members and about 3,500 securities listed on them. ISE is the stock exchange
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of stock exchanges, members of the participating stock exchanges being only traders
on ISE.
ISE has provided a highly automated trading system open to all the registered traders
of the participating exchanges with direct access to its national level trading platform
on an equal footing regardless of the location of the participating exchange and of the
status of the exchange in terms of turnover, financial strength, and so on. It has not
only a professionally qualified managing director and a full time director, but also a
public representative as the chairman of the exchange.
ISE has a uniform trading and settlement cycle and a settlement guarantee fund. It is a
centralized national level market for trading in securities; with decentralized
operations as the participating regional stock exchanges continue to be centers for
trading, clearing, and settlement as also for redressal of grievances of investors and
others.
ISE contributed a meager turnover of Rs 545 crore in 1999-2000, Rs 233 crore during
2000-01 and Rs 55 crore in 2001-02. This stock exchange has also failed to make its
presence felt in the Indian stock market.
One significant aspect of the Indian capital market is the existence of as many as 19
regional stock exchanges – the highest in the world. RSEs existed in developed
markets also but ultimately, they had to shut down or merge with the principal
exchanges. Over 20 stock exchanges existed in the UK until 1973. By 1965, the
regional exchanges joined together to form the Federation of Stock Exchanges and
amalgamated to become a fully unified stock exchange in 1973.
Australia has six exchanges which got together and established the Australia
Associated Stock Exchanges (AASE), a company limited by its guarantee, to
represent them at the national level. In 1987, the Australian Stock Exchange (ASX)
commenced operations, with the six capital city exchanges as its wholly owned
subsidiaries. In Italy, all securities listed on the Milan Stock Exchange and nine other
SEs were transferred to a national computerized order-driven trading system under the
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Italian Stock Exchange in 1991. Today, the Italian stock market is a computerized
system which has no specific location.
A disturbing development has been the progressive decline in the turnover at the
regional stock exchanges following the rapid expansion of the operations of the NSE
and the BSE to about 390 and 330 centers respectively in the country. As the regional
stock exchanges individually lack the necessary depth to compete effectively with the
NSE and the BSE, the only way of ensuring that the valuable services of members of
these stock exchanges are not lost to the securities industry is to forge a new national
segment of trading open to all the members of these stock exchanges while retaining
the regional segments of trading at these exchanges.
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