A

REPORT

ON

“RISK MANAGEMENT MECHANISM IN STOCK EXCHANGE - HOW EFFICIENT IT

IS?

AN ANALYSIS

UNDER

BHUBANESWAR STOCK EXCHANGE

By

SMRITIREKHA CHOWDHURY, Regd No-1406278056

GLOBAL INSTITUTE OF MANAGEMENT

BHUBANESWAR

1

A STUDY ABOUT “Risk management mechanism in

stock exchange – how efficient is it? ”

A Report Submitted to

Global Institute Of Management

In partial fulfillment of the requirements for award of the Degree in Management

BY

SMRITIREKHA CHOWDHURY

REGD NO- 1406278056

MBA

Under the guidance of

Name of Corporate Guide

with Company’s name

Mr.BIPIN DUTTA

Bhubaneswar Stock Exchange

Name of Faculty Guide with college’s name

Prof. B.R.MOHANTY

GLOBAL INSTITUTE OF MANAGEMENT

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CERTIFICATE

Certified that the project work with the title “Risk management mechanism in stock exchange – how efficient is it?” undertaken by SMRITIREKHA CHOWDHURY, was conducted under my guidance and supervision. She has designed the research, collected the data, analysed the results, interpreted the findings and observations and prepared the report.

Faculty Guide Prof. B R Mohanty

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DECLARATION

I hereby declare that the project report with the title “Risk

management mechanism in stock exchange – how efficient is it?”,

being submitted to Global Institute of Management in partial

fulfilment of the requirements for award of the degree of Post

Graduate in Management, is an original piece of research work

carried out by me. It has not been published/awarded elsewhere, nor

has it been submitted in full or part for any other degree or diploma.

Smritirekha chowdhury Date-

4

ACKNOWLEDGEMENTS

The 40 Days of summer internship gave me a very good opportunity for learning new things, with timely and successful completion of project. These all have been made possible by the efforts of many individuals and therefore it is necessary for me to express my sincere thanks to each one of them.First, I would like to thank Mr. Debraj Biswal, MD and CEO of Bhubaneswar Stock Exchange for allowing us to conduct our summer internship project in the organization.I take this opportunity to express my deep sense of gratitude to my company guide, Mr. Bipin Dutta, Assistant Manager, Bhubaneswar Stock Exchange, for his wonderful guidance on the topic of the project undertaken by me and also for his immense support by giving enough clarifications to my doubt whenever it was required, throughout the journey of my internship. Without his direction, it would have been impossible for me to proceed and give my best. He has significantly contributed in making concepts related to my work simple to understand. Every time he kept motivating me to come up with something new in my study. I am also thankful to the Managing Director of Bhubaneswar stock exchange for accepting and giving me the chance of doing SIP.I am also very much thankful to my faculty guide, Prof. Biswa Ranjan Mohanty, for suggesting me to undertake internship in Bhubaneswar Stock Exchange. He has constantly motivated me to deliver my best and also gave right information in the quickest possible time. I am thankful to him for inspiring me to do case study or research work which made me enthusiastic for my work.At last, I would like to thank my seniors and family members, who gave me nice support in making this project successful.

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TO WHOM IT MAY CONCERN

This is to certify that the project entitled “RISK MANAGEMENT MECHANISM IN STOCK EXCHANGE – HOW EFFICIENT IS IT?” is a genuine interim report carried out by “Smritirekha Chowdhury” of Global Institute Of Management, Bhubaneswar at Bhubaneswar stock exchange, Bhubaneswar during the project tenure 1st June to 10th July.

She has given good performance throughout the training period. I wish her all the best for her bright career.

(Corporate Guide)

Place: Bhubaneswar MR. BIPIN DUTTA

Date: Asst. Manager

. Bhubaneswar Stock Exchange

Bhubaneswar

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CONTENTS CHAPTERS

Page no1. Abstract 92. Company Analysis

2.1 Company Profile 2.2 Business Model of BhSE 2.3 SWOT Analysis of BhSE

10101015

3. Introduction 3.1 Objective of study 3.2 Data sources 3.3 Research Methodology

16181919

4. Investment in securities and role of stock exchange 4.1 Confidence of investors. How securities market define it 4.2 Investment in securities rest on 3 objectives

2027

28

5. Risk management5.1 Common types 5.2 Risk management for trade5.3 Portfolio risk management

30303131

6. Risk Management engines of stock exchange for equity market 6.1 At trading level 6.2 At trader’s level 6.3 At investors’ level

33

333334

7. Investors to take care of risk 7.1 Contract Note7.2 Other responsibilities

353537

8. Usage of risk management weapons8.1 On rolling basis8.2 As and when required8.3 In case of default

39394041

7

9. Case studyCaselet 1:Harshad Mehta Scam Caselet 2:Ketan Parekh Scam Caselet 3: A ‘parallel’ crisis in Calcutta Stock Exchange-SGF to rescue Caselet 4: North Star Gems (India) Limited- Market manipulation and price rigging Caselet 5: Maruti Organics Ltd- Not compliance with KYC norms & Margin Requirements Caselet 6: Market Surveillance

43445056

60

6162

10. Findings 6511. Conclusion 7212. Bibliography 74

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1. ABSTRACT

Securities market is an essential platform for the growth and development of any economy. Securities market offers individuals, large, small and medium-scale enterprises with a broader menu of financial services and financial instruments like equities, debentures, government debt, derivatives and other securities. Further, since retail investors place an increasing proportion of their money in mutual funds, other collective investment vehicles, stocks etc., securities market therefore plays an important role for the growth of individual wealth. However, securities market requires a sound and effective risk management system that is necessary in building up the investors’ confidence in the market by ensuring fair and efficient transactions and also reducing systemic risk, so that investors do not hesitate to invest because of risks involved in stock market operations.

The paper aims to study risk management framework of stock exchanges and how it works and also, at which level, what kind mechanism is implemented.

Finally, the paper presents a detailed case analysis on “Different securities scams happened in Indian Stock Market” and analysis of each scam to understand impact on stock market and investors.

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2. Company Analysis2.1 Company profileBhubaneswar Stock Exchange Ltd. (BhSE) has been functioning as a recognized Stock Exchange in the state of Orissa for about 20 years. It was initially incorporated on 17 April,1989 as a Public Company, limited by guarantee with an objective to facilitate, assist, regulate or control the business of buying, selling or dealing in stocks, shares and like securities. Govt. of India granted recognition to the BhSE on 5 June,1989 under the provisions of the Securities Contracts (Regulation) Act,1956 for an initial period of five years. Thereafter, the recognition of BhSE is being renewed from time to time by Securities and Exchange Board of India (SEBI).Subsequent to the amendment to the Securities Contracts (Regulation) Act,1956 during the year 2004 by the Govt. of India in order to provide for corporatization and demutualization of the stock exchanges in the country, BhSE, first in order to become a corporatised entity, was converted from a company limited by guarantee to a company limited by shares on 9 December, 2005 by way of fresh incorporation under the Companies Act,1956. Further, during the year 2007 BhSE successfully diluted its share capital to public in compliance with the requirement of demutualization in order to ensure at least 51% of paid up share capital are held by the persons other than the stock-broker shareholders.

2.2 Business Model of BhSEInter-connectivityBhSE has played an instrumental role, among others, in mooting the idea of establishing of an Inter-connected Market System (ICMS). This effort resulted in establishing “Inter-connected Stock Exchange of India of Ltd. (ISE)” at Navi Mumbai. The object of establishing ISE was to provide a

10

nationwide equity market through the trading members of participating Stock Exchanges. Trading operation was carried out on the ISE segment for quite sometimes. However, in the presence of nationwide terminals provided by National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), ISE trading activities did not go a long way in absence of liquidity in its segment. ISE, as an alternative measure to provide active trading segments in the securities market to the trading members of its participating Stock Exchanges as well as its dealers, floated a wholly owned subsidiary company, namely, ISE Securities & Services Ltd. (ISS) which in turn obtained the trading membership of NSE and BSE. At present the trading members of BhSE are conducting trading on NSE and BSE segments as the registered sub-brokers of ISS.

Management:

The affairs of the BhSE are controlled and supervised by the Board of Directors. The day to day affairs are managed by the Managing Director of the Stock Exchange. The Board of Directors of the Stock Exchange comprises of 8 Directors which includes, 4 Public Interest Directors nominated by SEBI and 4 Shareholder Directors appointed by the shareholder of the BhSE and Managing Director who is the ex-officio Director of the Board.

Trading Operation:

The trading and settlement operation of the BhSE was computerized since inception. The Exchange switched over from “out-cry system” of trading to “Screen Based Trading” with effect from 20 May,1997. However, the trading on the BhSE segment is presently dispensed with the instruction of SEBI in the want of adequate market infrastructure and regulatory mechanism.

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Settlement System:

The settlement at the Exchange is carried out on “Daily Rolling Basis” (T+2) as per the SEBI Guidelines. Pay-in/pay-out, in terms of Settlement, is carried out well in time through the centralized banking system of the Stock Exchange. BhSE has established Branch of Canara Bank, within its campus to facilitate the pay-in/pay-out activities as well as the banking transactions of the Stock Exchange and its trading members.

Clearing House:

BhSE has its own Clearing House. The transactions conducted by the trading members are settled by the Clearing House of the Stock Exchange in accordance with the prescribed settlement program under a “Centralized Delivery and Payment System”.

Depository Participant Services

BhSE is a registered Depository Participant (DP) of Central Depository Services (India)Ltd. (CDSL) and has been providing DP services to the investors in securities.

Listing of Securities

The total companies listed with BhSE are 46. Pursuant to enforcement of liberal regulatory norm i.e delisting guidelines, 2003 issued by SEBI and subsequent withdrawal of mandatory provision requiring for listing of securities of companies on their respective regional stock exchange , by the Government of India, many companies have sought delisting of their securities

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from the exchange causing an adverse impact on the revenue of the exchange.

Primary Market

BhSE has been playing an active role for the growth of primary market activities with the support of its trading members. The Stock Exchange ensures promotional steps for participation of investing public at a large scale in the Initial Public Offers (IPOs)/Public Issues of several companies.

Customers’ Protection Fund

BhSE has established a Statutory Fund namely, “Bhubaneswar Stock Exchange Customers’ Protection Fund” with an objective to protect the customers from the risk of defaulter trading members. As per the Rules, presently a customer is entitled to be indemnified to the extent of Rs.50,000/- towards his legitimate claim against a defaulter trading member of the Stock Exchange. The size of the corpus as on 31 March ,2014 was Rs. 53, 90,399

Investors’ Service Cell

BhSE has an “Investors’ Service Cell” to redress the investors’ grievances ,ensuring protection of the investors. It promptly attends the complaints lodged by the investors against companies as well as the trading members of the Stock Exchange. The Investors’ Service Cell undertakes due care to build up confidence of the common investors in the securities market.

Settlement Guarantee Fund

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The stock exchange in terms of its Bye- laws, has established Settlement Guarantee Fund(SGF) with the approval of SEBI. The corpus of SGF as at 31 March, 2014 was Rs. 1,67,57,457

Current Activities other than trading operation

Apart from trading operation, BhSE is engaged in promotion and development of securities market in the interest of the investing public in a big way such as –

Investors’ Awareness Programme

BhSE is conducting investors’ awareness programmes by way of seminars/workshop from time to time for education and awareness of investing public in securities. The aim of the BhSE is to have at least 5-6 awareness programmes in a year at different location of the State of Odisha.

Securities Market Training Programme

BhSE is providing a Certificate Course, namely, “Basics of Capital Market”. With the expansion of capital market, BhSE aims at undertaking practical oriented training programmes for the students of Commerce and B-Schools in a big way for the youths who want to make their career in securities market. At present, BhSE is engaged in imparting training to the students of various management institutes.

Students Assistance Programme

The students of a number of Institutes and B-Schools visit BhSE either directly or sponsored by their institutes every year for assistance in preparation of their project papers. BhSE assists

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and supports those students in their project work by providing necessary guidance and securities market information.

2.3 SWOT Analysis of BhSE

STRENGTHS

WEAKNESSES

Provides smooth clearing and settlement process.

Has adequate internal checks and internal control systems which are commensurate with its size and nature of its business.

The exchange has corpus of SGF of Rs. 1,67,57,457 & IPF of Rs. 53,90,399.

Provides other services like Investors’ Awareness Programme, Securities Market Training Programme, Students Assistance Programme.

Only 46 companies are listed in the exchange generating less revenue for exchange.

Very few employees.

OPPORTUNITIES

THREATS

Business tie-up with other national level stock exchange.

Merger /consolidation of

Continuous decrease in profit, making difficult for exchange to survive,

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the exchange with other exchanges viz. MCX-SX, Calcutta Stock Exchange and Inter-Connected Stock Exchange of India.

Alternate business plans for survival of the entity.

which subsequently may cause to shift in other business.

3. INTRODUCTION

Financial Markets are broadly classified into money market and capital market. Money market is associated with trading of instruments for raising of short term funds, having maturity period of less than 1 year, whereas capital market is associated with trading of instruments for raising long term funds having maturity of more than 1 year. Capital market/Securities market is in turn divided into primary and secondary market, also called as stock market.

In primary market, creation and sale of new issues takes place, whereas in secondary market, securities already issued in the primary market are traded. There are 3 kinds of participants in securities market: the issuer of securities, the investor in securities, and the intermediaries. The issuers issue securities to raise funds; the investors invest their savings in the securities for getting returns in the form of some income either as a fixed regular income of dividends /interest or capital gains in future. The role of intermediaries is to act as agents or middlemen to bring together users and suppliers of funds, in return for a commission. There are large variety and number of

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intermediaries providing various services in the Indian securities market. Indian securities market has two major Market Infrastructure Institutions i.e. BSE (Bombay Stock Exchange, Ltd) and NSE (National Stock Exchange, Ltd.). They provide platform for trading of securities.

However the process of mobilizing the resources needs to be carried out under the supervision of the regulators. The regulators develop fair market practices and take responsibility of protecting the interests of the investors. The Market Regulator, Securities and Exchange Board of India (SEBI) have taken several measures to improve the integrity, fairness and transparency at both new issue and trading levels. At trading level in particular, SEBI has, from time to time, put in place various risk containment measures to address the risks involved in the cash and derivatives market. These measures have successfully addressed the market risks. However, to keep up with the dynamic state of the market, risk management systems cannot remain static and has to constantly address the changing risk profile of the market. Now the question is, why one should be interested in knowing what are the risks and how stock exchanges take care of such risk. Since a common man invests his money in stock market, his interest has to be protected and any kind of obligations should be fulfilled. We can say that Risk Management is necessary at 3 particular levels for obvious reasons -

At Trading Level

* Business continuity

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* Smooth and faster settlement of transactions * Countering high degree volatility* Countering insider trading* Combating information asymmetry and market

vagaries * Safer market for investmentAt Trader Level

* Fulfillment of business obligation* Avoidance of risk of defaultAt Investor Level

* Timely receipt of claim* Protection of interest* Receipt of legitimate claim against a defaulter * Redressal of grievance* Reliance on the market

At each level, to address different issues, stock exchange is equipped with different risk management engines.

3.1 Objective of study

Following are the objectives of study:

To understand the stock market operations, covering equity market

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Risk management techniques operating in equity market.

Study of scams and their origination.

To analyze how present risk management framework can avoid such scams.

To analyze how efficient present risk management framework is.

3.2 Data sources

Data has been collected from secondary sources, i.e from stock exchanges website mainly from National Stock Exchange of India Ltd. and Bombay Stock Exchange Ltd. and Securities & Exchange Board of India (SEBI).

3.3 Methodology

The methodology used in this study is case based and some real time incidents data, it also includes secondary data.

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4. Investment in securities and role of stock exchange

Though the primary role of any stock exchange is to provide platform for trading of securities and raising funds through the way of debt and equity but its importance is not limited only up to this point.

The role of stock exchange is varied and it plays a major role in the development of economy of a country.

Role of stock exchange in economic development and Indian economy:-

Raising capital for businessesThe stock market is a place where entrepreneurs can raise funds for setting up new business or for expansion of existing business by issuing of shares and securities. Exchanges help companies to capitalize by selling shares to the investing public.

Mobilizing saving for investment

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The people can deploy their savings by investment in shares. Shares are lucrative investments giving higher returns to investors. At the same time investors’ money can be used by company for further investments resulting in overall growth of company. These funds can be directed for benefits of several economic sectors such as agriculture, commerce and industry thereby leading to a stronger economic growth and higher productivity levels and firms.

Facilitating company growthCompanies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.

Creating investment opportunities for small investors

Investing in shares is open to both the large and small equity investors because a person buys the number of shares that he can afford. A Stock Exchange provides opportunity for small investors to own shares of the same companies as large investors.

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Government capital-raising for development projectsGovernment also sometimes to finance the infrastructure projects like construction of roads, bridges, and etc. approach debt market of stock exchange to raise funds and start selling bonds thus taking loan from public.

Barometer of the economyThe stock market indices may go up or down. When index rises, we say share prices of most of the companies have gone up which means most of the companies or sectors are doing well. This implies that our economy also doing well and growing. Whereas in case of economic recession, depression, or financial crisis, stock market crash and share prices fall. Therefore, the movement of the stock index can be an indicator of the general trend in the economy.

Role of stock exchanges in capital market of India :-

Stock Exchanges play a crucial role in the consolidation of a national economy in general and in the development of industrial sector in particular. It is the most dynamic and organised component of capital market. Especially, in developing countries like India, the stock exchanges play a cardinal role in promoting the level of capital formation through effective mobilisation of savings and ensuring investment safety.

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Effective Mobilization of savings

Stock exchanges provide organised market for an individual as well as institutional investors. They regulate the trading transactions with proper rules and regulations in order to ensure investor's protection. This helps to consolidate the confidence of investors and small savers. Thus, stock exchanges attract small savings especially of large number of investors in the capital market.

Promoting Capital formation

The funds mobilised through capital market are provided to the industries engaged in the production of various goods and services useful for the society. This leads to capital formation and development of national assets. The savings mobilised are channelised into appropriate avenues of investment.

Wider Avenues of investment

Stock exchanges provide a wider avenue for the investment to the people and organisations with investible surplus. Companies from diverse industries like Information Technology, Steel, Chemicals, Fuels and Petroleum, Cement, Fertilizers, etc. offer various kinds of equity and debt securities to the investors. Online trading facility has brought the stock exchange at the doorsteps of investors through computer network. Diverse type of securities is made available in the stock exchanges to suit the varying objectives and notions of different classes of investor. Necessary information from stock

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exchanges available from different sources guides the investors in the effective management of their investment portfolios.

Liquidity of investment

Stock exchanges provide liquidity of investment to the investors. Investors can sell out any of their investments in securities at any time during trading days and trading hours on stock exchanges. Thus, stock exchanges provide liquidity of investment. The on-line trading and online settlement of demat securities facilitates the investors to sell out their investments and realise the proceeds within a day or two. Even investors can switch over their investment from one security to another according to the changing scenario of capital market.

Investment priorities

Stock exchanges facilitate the investors to decide his investment priorities by providing him the basket of different kinds of securities of different industries and companies. He can sell stock of one company and buy a stock of another company through stock exchange whenever he wants. He can manage his investment portfolio to maximise his wealth.

Investment safety

Stock exchanges through their by-laws, Securities and Exchange Board of India (SEBI) guidelines, transparent procedures try to provide safety to the investment in industrial securities. Government has established the National Stock Exchange (NSE) and Over The Counter Exchange of India

24

(OTCEI) for investors' safety. Exchange authorities try to curb speculative practices and minimise the risk for common investor to preserve his confidence.

Wide Marketability to Securities

Online price quoting system and online buying and selling facility have changed the nature and working of stock exchanges. Formerly, the dealings on stock exchanges were restricted to its head quarters. The investors across the country were absolutely in dark about the price fluctuations on stock exchanges due to the lack of information. But today due to Internet, on line quoting facility is available at the computers of investors. As a result, they can keep track of price fluctuations taking place on stock exchange every second during the working hours. Certain T.V. Channels like CNBC are fully devoted to stock market information and corporate news. Even other channels display the on line quoting of stocks. Thus, modern stock exchanges backed up by internet and information technology provide wide marketability to securities of the industries. Demat facility has revolutionised the procedure of transfer of securities and facilitated marketing.

Financial resources for public and private sectors

Stock Exchanges make available the financial resources available to the industries in public and private sector through

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various kinds of securities. Due to the assurance of liquidity, marketing support, investment safety assured through stock exchanges, the public issues of securities by these industries receive strong public response (resulting in oversubscription of issue).

Funds for Development Purpose

Stock exchanges enable the government to mobilise the funds for public utilities and public undertakings which take up the developmental activities like power projects, shipping, railways, telecommunication, dams & roads constructions, etc. Stock exchanges provide liquidity, marketability, price continuity and constant evaluation of government securities.

Indicator of Industrial Development

Stock exchanges are the symbolic indicators of industrial development of a nation. Productivity, efficiency, economic-status, prospects of each industry and every unit in an industry is reflected through the price fluctuation of industrial securities on stock exchanges. Stock exchange sensex and price fluctuations of securities of various companies tell the entire story of changes in industrial sector.

Barometer of National Economy

Stock exchange is taken as a Barometer of the economy of a country. Each economy is economically symbolized (indicators) by its most significant stock exchange. New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange and

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Bombay Stock Exchange are considered as barometers of U.S.A, United Kingdom, Japan and India respectively. At both national and international level these stock exchanges represent the progress and conditions of their economies.

Thus, stock exchange serves the nation in several ways through its diversified economic services which include imparting liquidity to investments, providing marketability, enabling evaluation and ensuring price continuity of securities.

4.1 Confidence of investors. How does securities market define it?Investors may be an individual or institutions who subscribe to the securities issued in stock market. The interest of investors needs to be protected so as to generate confidence among them. If investors do not have confidence in the stock market or on its regulatory mechanism, then they may hesitate to invest their money in any kind of securities. People would rather prefer to keep their money in the banks in the form of safe fixed deposit and may not even turn to stock market Companies will also find it difficult to raise funds. As a result, not enough investments will not take place in economy. Finally, both private and public corporate sectors will not grow in the absence of investment and this will lead an economy to suffer a lot. Therefore, a prudent regulatory framework has been designed to enjoy such confidence of investors. To ensure fair,

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efficient, transparent market, securities markets are governed by 5 main Acts.

The SEBI Act, 1992; which provides power to SEBI for protecting the interests of investors in securities, promoting the development of the securities market, and regulating the securities market. Its regulatory power extends over corporate in the issuance of capital and transfer of securities, and also to all intermediaries and persons associated with the securities market. It can conduct enquiries, audits, and inspection for all concerned reasons. It has the powers to register and regulate all market intermediaries, as well as to penalize them in case of violations of the provisions of the Act, Rules, and Regulations. The Companies Act, 1956, which sets the code of conduct for the corporate sector in relation to issuance, allotment, and transfer of securities, and disclosures to be made in public issues. The Securities Contracts (Regulation) Act, 1956, which provides for the regulation of transactions in securities through control over stock exchanges. The Depositories Act, 1996 which provides for electronic maintenance and transfer of ownership of demit (dematerialized) shares. The Act ensures free transferability of securities with speed, accuracy, and security. The Prevention of Money Laundering Act, 2002, which provides measures to prevent money laundering and prescribes the punishment for such offence.

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4.2 Investment in securities rest on three objectives Investors’ ProtectionInvestors should be protected from misleading, manipulative or fraudulent practices, including insider trading, front running and the misuse of client assets. Full disclosure of information which might be important for an investor to make investment decisions is the most important means for ensuring investors’ interest protection. Ensuring fair, transparent and efficient market

Efficient market is one where investors have fair access to market or have correct information about the prices of securities. Also not a single investor is able to influence the market or share price. In a fair, transparent and efficient market, dissemination of any relevant information is widespread and gets reflected in the share price or price formation process. Market structure does not unduly favor some market users over others. In violation of these, Regulation should detect, prevent and penalize market manipulations and any other unfair trading practices.

Reduction of Systemic Risk

Regulation should seek to reduce the impact of failure of any market intermediary in fulfilling its obligations. Market intermediaries should, therefore, be subject to adequate and ongoing capital and other important requirements. If necessary,

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an intermediary should be able to wind up its business without making loss or any damage to its customers and counterparties. Prudent supervision and effective utilization of risk management tools are essential to ensure efficient clearing and settlement process in the interest of the market as well as of investors.

5. What is Risk Management? 

Risk management is the process of measuring, or assessing risk and then developing strategies to manage the risk while attempting to maximize returns. Typically involves utilizing a variety of trading techniques, models and financial analyses. The potential return from any investment is generally depending to the amount of risk the investor is willing to assume. Investors will not take on greater risks without the possibility of higher earnings. This is called the risk premium.

 

5.1 Common types of Risk 

There are two common risks that investors should notice them well: Market Risk: The possibility that the value of financial markets rise or fall. Inflation Risk: The risk that rising prices of goods and services over time, Inflation risk is also known as 'purchasing-power risk' and it is one of the most important factors for long-term

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investing. You can't control the inflation risk, but with a good strategy you can manage and control the affect of market risk on your stocks. A professional trader always tries to understand and control portfolio risk. Before entering into any trade, good traders first think about how much risk to take and how much risk exposure comes with a particular trade selection. Only then do they allow themselves to think about how much profit they stand to make. Prudent investors always close their position and exposure if they determine that a portfolio carries too much risk. 

5.2 Risk Management for a Trade 1- Before you decide to trade consider to these fundamental principles: 2- Before you trade a stock, know how much you are willing to lose. 3- Check the stock to be sufficiently liquid, can you buy or sell promptly? 4- Determine the cut-loss level before trading. 5- Determine your profit target (take-profit-level). 6- Buy the stock only at an acceptable price level. Use a limit order when you buy a stock. 7- Immediately after the trade has been confirmed, enter the stop-loss-at- market order at your predetermined stop-loss level. 8- Take profit when the trade reaches your profit target. 

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For example: so many traders determine their cut-loss level 2% of their capital and they call it 2% rule. If you own 1000 shares of X at $100 with a $2 stop loss order in place, your risk is: $2 * 1000 = $2,000. So long as you have capital amounting to at least $100,000 on hand, you would not be considered to be in breach of this "rule". 

5.3 Portfolio Risk ManagementWhile managing the risk of each trade your portfolio risk will be well under control and you manage your portfolio risk actively, but to control your portfolio risk management better notice to this pointes: 1- Determine your overall cut-loss level. Usually your portfolio should not lose more than 10% of your capital. 2- Diversify your investment in at least six or more different stocks. 3- Know your overall risk tolerance before building up the portfolio. 4- Act quickly when you see your risk limits exceeded. 5- Close out the entire portfolio if it loses to your overall stop-loss level.

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6. Risk Management Engines of Stock Exchange for Equity Market

An effective risk management technique is very essential for efficient and smooth functioning of stock market. Risk containment measures are therefore implemented from all possible sides or levels, i.e at trading level, traders’ level and investors’ level.

6.1 At Trading level Segregation of trading and settlement from each other Market surveillance Circuit Filters/Breakers Price Band Settlement through dematerialized securities Settlement/Trade Guarantee Fund (SGF/TGF) to guarantee

settlement of transactions

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Defaults Committee Plan for business continuity and site for disaster

management

6.2 Trader’s level Base Minimum Capital (BMC) and Additional Capital

Deposit with Stock Exchange or Clearing Corporation. Time to time deposits of various margins with Stock

Exchange

6.3 At Investor’s level Compliance of KYC Norms by the investors Investor Protection Fund to compensate legitimate claims

of investors against a defaulter stock-broker Investor Service Centre Investor Grievance Committee

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7. Investors to Take Care of Risk in Trade.

A.Contract note:A contract note is something which imposes a legal relationship between the client and trading member with respect to purchase/sale of securities and settlement of trades. It is an important document for investors which keeps the legal record of client’s transaction carried on a stock exchange through a broker. After verifying the details contained in contract note, the client keeps one copy and returns the second copy to the trading member duly acknowledged by him. Only broker can issue contract notes. A broker is supposed to send the contract note to its client within 24 hours.

A contract note contains following important details:

Name, address and SEBI Registration number of the Member broker.

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Name of partner /proprietor /Authorized Signatory. Dealing Office Address/Tel No/Fax no, Code number of the

member given by the Exchange. Unique Identification Number Contract number, date of issue of contract note,

settlement number and time period for settlement. Constituent (Client) name/Code Number. Order number and order time corresponding to the trades. Trade number and Trade time. Quantity and Kind of Security brought/sold by the client. Brokerage and Purchase /Sale rate are given separately. Service tax rates and any other charges levied by the

broker. Securities Transaction Tax (STT) as applicable. Appropriate stamps have to be affixed on the original

contract note or it is mentioned that the consolidated stamp duty is paid.

Signature of the Stock broker/Authorized Signatory.

Why receipt of contract note from the broker in respect of buying or selling of shares, is very essential.

It will help an investor to lodge complaint against his broker in case his claim is not received.

It will also help an investor in getting his legitimate claims against a defaulter stock broker.

Contract Note is a confirmation of trades done on a particular day by a trading member on behalf of its client.

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A contract note not only records transactions but it also provides the details of the transaction in writing.

The contract note contains details that enable the investor to spot a particular transaction among the thousands of transactions taking place on the stock exchange and further cross-check the trade information with that provided by the stock exchange.

Investor should always check the contents of the contract note and seek clarifications from brokers for discrepancies.

Contract notes tell investors /clients what they have transacted into. There are instances where companies with similar names trade on bourses or multiple instruments issued by one company trade on exchange.

Bad communication between investor / client and the broker at the time of trading may result in wrong securities bought or sold.

Contract note helps arbitrators for settlement of disputes if any arising out of transactions.

By going through the contract note investors get to know what they have bought or sold. The contract note can be used to check the demat holdings and ascertain the exact brokerage paid.

Contract notes are also useful to ascertain the capital gains tax payable.

B.Other Responsibilities:

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May or may not execute Power of Attorney (PoA) in favour of stock broker as this is not mandatory for opening a trading account or for dealing in shares and securities.

Ensure PoA is not mis-utilized if it is given in favour of the stock broker

Make payment, if any, to the broker only through cheque

Ensure receiving SMS/ e-mail alerts from the stock exchange in respect of buying or selling of shares, if any.

Ensure receiving SMS/ e-mail alerts from the Depositories in respect of credit or debit to the Demat A/c. consequent to buying or selling of shares, if any

Check the holding status in Demat A/c. regularly. Ensure settlement of your claim by the stock broker in

time in respect of buying or selling of shares, if any. Don’t engage in excess day trading and try to become a

long term investor in right stocks. Don’t be panic while buying or selling shares and try to

select good stocks for investment. Be careful in investing in high volatile market.

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8. Usage of Risk management Weapons

A. On rolling basis-It is imperative that a proper risk management service is in place to prevent untoward losses for both the Clients as well as the Broking entity

Role of surveillance department-

Scrip-wise Surveillance is done through online surveillance, offline surveillance and Client-wise Surveillance. In Online Surveillance the surveillance team watches the online trades as they are executed, and extra ordinary volume in the particular scrip or client is immediately investigated by calling up the sub broker / branch and asking for details of clients and as per the details made available, the clients previous purchase or sales transactions are looked into, by viewing the ledgers.

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Monitoring exposure limit and outstanding position of brokers-The stock market in India have undergone into tremendous changes and one of the important change which has instilled greater confidence among investor in India and abroad is reduction of settlement period to one day and introduction of Depository System to eliminate the risk of bad paper. These changes have reduced the risk of default on broker. The Front End trading software has a sophisticated system of setting limits based on exposure, number of trades, value of trades, scrips allowed to trade in, quantity per order, etc. Scrips can be excluded from trading if they are on ban list or upon the discretion of the Management based on risk perception.

Applicability of various margins

Online surveillance is carried out to see whether mark to market loss of client is crossing a set limit or if it is exceeding the credit balance in our account. In such cases, additional margins are called for from the clients or clients are advised to reduce the exposure. While allowing trades in Odd lot and Z category shares, necessary permissions are obtained by Risk Management Department/Compliance Officer to avert the possibility of synchronized / circular trading. The client’s trading track record regard to his financial capability and dealing in such scrip is looked into. B. As and when required

Checking of high degree volatility /price fluctuations

Volatility as a phenomenon as well as a concept remains central to modern financial markets and academic research. The link between volatility and risk has been to some extent exclusive, but stock market volatility is not necessarily a bad thing. In fact, fundamentally justified volatility can form the

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basis for efficient price discovery and it act as a risk management weapons.

Applicability of circuit filter/breakersThere may be market wide circuit breakers, as may be decided by the Relevant Authority from time to time. There may be circuit filters specific to securities, as may be decided by Relevant Authority from time to time. Market wide circuit breakers or security specific circuit breakers shall cause temporary or permanent trading halts for market as a whole or specific to a security, as the case may be, and as may be decided by the Relevant Authority from time to time to act as a weapon for risk management when required.

Applicability of price brand

There may be daily/intra-day/weekly price bands, as the case may be, for all the securities, as may be provided in the relevant Regulations from time to time, except in respect of securities in which trading in its derivative instruments is permitted and the securities included in the indices on which derivative products are available for trading, unless specifically decided otherwise by the Relevant Authority. These price bands may be made uniformly applicable and implemented at all the stock exchanges.

Prevention of insider tradingUnder prevention of insider trading of securities the company is committed to the preventing the confidentiality and preventing the misuse of any unpublished price sensitive information. Insider trading means when insider uses unpublished price sensitive information to arrive at securities trading. Insider means any person who is a connected person and who is reasonable, expected to have access to unpublished price sensitive information in respect of securities of the company.

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C. In case of default

Guarantee to settlement

SEBI has from time to time put in place various risk containment measures to address the risks involved in the securities market. One such measure prescribed was norms for Settlement Guarantee Fund (SGF) at stock exchanges including corpus, contribution, management, usage and recoupment of the fund corpus. The new norms would further strengthen the system to deal with settlement defaults, although there have been very few such cases in recent times, as settlement commitments have mostly been meet even in times of freak trades and temporary outages on stock exchange platforms. To safeguard markets from systemic risks, regulator SEBI today put in place a new layer of safety net in form of 'core settlement guarantee fund' to mitigate risks from possible default in institutional trades. The new system would enhance the robustness of the present risk management system of the clearing corporations to enable them to deal with defaults of the clearing members much more effectively. This new core fund would be created within the existing Settlement Guarantee Fund (SGF), against which no exposure is given and which is readily and unconditionally available to meet settlement obligations of clearing corporation in case of clearing members failing to honor settlement obligation.

Subsequent action of stock exchangeIn a subsequent action, the new shares are usually issued from the company’s treasury and the net offering proceeds go to the company. Since the subsequent offering increases the company’s shares outstanding, it has a dilutive effect i.e. it dilutes the stakes of existing share holders.

Committee to deal with defaultThe defaulter committee is statutory committees of the stock exchange setup to administrator the assets in respect of the defaulter members vesting in the stock exchange. The defaulter’s committee distributes the amount available in the defaulter’s account to the admitted claims on pro-rata basis as per the priority laid out under its rules.

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Compensation for legitimate claims of clients of defaulter

Legitimate claims and rights of the purchaser in case of default delivery remain unaffected. The purchaser is able to sell all the conditional stock and assets of normal business activities.

9. CASE STUDYDuring the late nineteen eighties, the share mania spread so rapidly that many new Stock Exchanges came into existence. There was a hectic boom in the primary market activities with a number of existing and new companies floating issues. The number of companies getting listed on the exchange increased steadily. Investments and trading picked up such a speed that it gave birth to some of major scams in the secondary market during 1990s. Analysis of such scams sometimes becomes necessary to understand what were the loopholes present in the system earlier, how did market respond, what market regulators did to overcome those loopholes and last but not the least to check how present risk containment measures adopted by our stock exchanges can possibly avoid any further scams and any

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exceptional market scenarios to ensure safety & integrity of entire financial system.

CASELET 1: Harshad Mehtas ScamIn the year 1992, the rise in BSE Sensex raised many questions. The man behind all this was Harshad Mehta.

Who was Harshad Mehta ?Harshad Shantilal Mehta was a high-profile Indian stock broker who grabbed the headlines for making Bombay Stock Exchange, one of the victims of biggest security scam till ever. He was accused of massive stock manipulation by the help of worthless bank receipts. In reality he actually exposed the loopholes in the Bombay Stock Exchange (BSE) transaction system, Indian Banking System and SEBI, which further introduced new rules to overcome those loopholes. Mehta was convicted by the Bombay High Court and Supreme Court of India for financial scandal valued Rs 4,999 crore , which took

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place on the Bombay Stock Exchange (BSE). He was tried for 9 years, until he died in the late 2001.

Early life and Career: Mehta was born on 29 July, 1954 in a lower middle-class Gujarati Jain family & had spent his early childhood in Mumbai where his father was a small businessman. After doctors advice to Mehta’s father to shift to a drier place on account of his health, the family relocated to Raipur in Chhattisgarh. Mehta studied from Holy Cross Higher Secondary School, Byron Bazar, and Raipur. By profession, Mehta was Graduate in commerce. His journey from a stock broker to big market bullDuring 1980s, for a period of 10 years, Mehta worked at the position of increasing responsibilities in several brokerage firms. He left his job at The New India Assurance Company in 1980 and got new one with BSE-affiliated stockbroker P. Ambalal. In 1981, Mehta became a sub-broker for stockbrokers J.L. Shah and Nandalal Sheth. After gaining considerable experience as a sub-broker, he started a new venture called Grow More Research and Asset Management Company Limited with his brother Sudhir. When the BSE auctioned a broker’s card, the Mehta’s company bid for it with the financial support of J.L. Shah and Nandalal Sheth. By year 1990, Mehta had become a prominent name in the Indian stock market. He started buying shares heavily, especially the shares of India's foremost cement manufacturer, Associated Cement Company

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(ACC). Due to heavy trading in ACC, price of the cement company rose from 200 to 9000 (approx.) implying a 4400% increase in its price. It was later revealed that Mehta used the replacement cost theory to justify the reasons for price rise. Replacement cost theory, basically states that the older companies should be valued on the basis of the amount of money that would be needed to create another similar company and by help of this theory he stated that stock had been undervalued and the market had simply corrected it when it revalued the company again by taking this theory into account. By the latter half of 1991, Mehta earned a nick name of ‘Big Bull’ as people credited him for having initiated the Bull Run in stock market.

The making of 1992 security scam:

Indian banking system was not very strong at that time, that’s why he was able to misuse the system. Mehta and his associates took the advantages of loopholes and diverted the funds involved in interbank transactions into the stock market between April 1991 to May 1992. They were buying shares heavily across many industries at premium. Indian Stock Exchange Index (Sensex), which was hovering around the 800 mark in early 1990, flared up past 3500 by April 1992.

The exposure of 1992 security scam and its outcome:

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Harshad Mehta scam’s was exposed on April 23, 1992, when veteran columnist Sucheta Dalal wrote an article in The Times of India. Dalal’s column read: “The crucial mechanism through which the scam was affected was the ready forward (RF) deal. The RF is a secured short-term (typically 15-day) loan from one bank to another. Crudely put, the bank lends against government securities just as a pawnbroker lends against jewellers. The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price. It was this ready forward deal that Mehta and his associates used with great success to channel money from the banking system.”In a ready-forward deal, a broker usually brings two banks together and earns a commission for this. Although the broker does not handle the cash or the securities, this was not the case in the prelude to the Mehta scam. Mehta and his associates used this RF deal with great success for channelizing money through banks. The securities and payments were delivered through the broker in the settlement process. The role of the broker was to function as intermediary. A broker received the securities from the seller and money in form of cheque from the buyer. He handed over those securities to the buyer and subsequently made the payment to the seller. However such a settlement process meant that, both the buyer and the seller may not even know each other from whom they have traded with and only the broker would know both the parties. The brokers could manage this method expertly as they had already become

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market makers by then and had started trading on their account. Another instrument used by Mehta and his associates in this scam was the Bank Receipt (BR). A BR is a receipt for the money received by the selling bank and pledges to deliver the securities to the buyer. A BR thus confirmed the sale of securities. In this scam, no securities were being traded in reality but the seller gave the buyer a BR.Ready with such dangerous game plan, Mehta started searching for banks which would readily issue fake BRs. His search ended when he found that the, two small and little known lenders, Bank of Karad (BOK), Mumbai and the Metropolitan Co-operative Bank (MCB), were willing to do such things in return for a fee. These two banks agreed to issue BRs as and when required. Once they issued the fake BRs, Mehta passed them on to other banks who in turn lent him money under false assumption that they were lending money against government securities. Now this money was used by Mehta and his associates for buying shares in stock market and driving up the prices of stock by buying them at low prices. When the time for returning money to the bank came, the shares were sold for significant profits and the BRs were retired and banks also got their money back.

Outcome: There were serious consequences of this scam. When the scam was exposed, it caused many problems in the capital market and money market. Upon the exposure of the scam several banks found that they were holding BR of no value at all, as they all were fake. Banks started demanding

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their money back, which caused Sensex to fall almost dramatically the way it had raised. However by this time the whole banking system had already suffered a loss of Rs 4,000 crore. The scam was taken in the Indian Parliament, leading to Mehta's imprisonment. The scam’s exposure led to the death of the Chairman of the Vijaya Bank who reportedly committed suicide by jumping from his office roof. He was guilty of having issued checks to Mehta and knew accusations and shame he would have to face from the public.

Mehta was charged with 72 criminal offences, out of which he was convicted for only one. On 9 November 1992, CBI arrested Mehta and his associates, for allegedly misappropriating more than 2.8 million shares (2.8 million) of about 90 companies, including ACC and Hindalco and later banned from the stock market with investigators holding them responsible for causing a loss to various entities. However, in September 1999, Bombay High Court convicted and sentenced him to five years rigorous imprisonment and a fine of Rs. 25000. On 14 January 2003, Supreme Court of India confirmed High Court's judgment. He died of heart ailment, at the age of 47, on 31st December 2001. Nine years after the death of Harshad Mehta, the IT department and public sector banks (PSBs) have successfully recovered a significant portion of their claims. The Supreme Court directed the Custodian to liquidate the assets of the Harshad Mehta Group (HMG) in March 2011 to make payments of Rs1,995.66 crore to the IT department and Rs 199.25 crore to the State Bank of India (SBI), making the two institutions two of the earliest claimants to recover their dues.

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While the SBI’s total principal amount claim of Rs 1,000 crore have been largely settled, financial institutions have also received some money. However, Standard Chartered Bank, which had claim of Rs 500 crore, has yet to recover its dues. Although the total claim over the HMG is of more than Rs 20,000 crore, the Supreme Court has said that for the present, it would only consider claims towards the principal amount. Measures taken post scam:

Post Mehta scam, Government of India, passed “SEBI Act 1992” and conferred statutory powers to it.

Suspended brokers who were directors and other officials of BSE for alleged insider trading.

Imposed additional volatile 10% margin on Group ‘A’ shares.

Imposed margin on net outstanding selling position of FIIs, financial institution, bankers and mutual funds.

Rolling settlement system was made compulsory. Launched trade guarantee fund to guarantee settlement

of all transactions. Reduced gross exposure limit for brokers on base

minimum capital to 10 times in NSE and 15 times for other stock exchange.

QUESTION FOR DISCUSSION1) Analyze this case first and its impact.

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CASELET 2:- Ketan Parekh’s Scam- A BIG HIT TO SMALL INVESTORS“I have left with zero saving. I don’t know how to feed my family.”This was the sentence used by small innocent investors during this scam. Many people were left with zero saving, as their money had no value. Some suicide cases were also reported during this time. But what happened in this scam? …………..

A Crash that became “Talk of Nation”:

On March 1, 2001 the Bombay Stock Exchange Sensitive Index (Sensex) fell by 176 points which shocked the government, stock market and the Indian investors because just one day before the Finance Minister, Mr. Jaswant Sinha had issued budget in the parliament which had prompted a 177 point rise in the Sensex. This sudden crash in the stock market prompted the Securities & Exchange Board of India (SEBI) to start immediate investigations for checking sudden high volatility of stock market. Reserve Bank of India (RBI) also ordered some banks to furnish data related to their capital market exposure. Media reports revealed that private sector banks have exceeded their prudential norms of capital exposure, thereby contributing to the stock market volatility.The man behind this scam was Ketan Parekh [KP]. The Sensex crashed further by 147.18 points after the arrest of Ketan Parekh by the Central Bureau of Investigation (CBI) on 30 March, 2001.

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Ketan Parekh was a chartered accountant by profession and used to manage his small family business NH securities started by his father. He was a trainee of Harshad Mehta and also known as “Bombay Bull” having connections with movie stars, politicians and leading international entrepreneurs. Over the years, KP had built a network of companies, involved in stock market operations, mainly in Mumbai.

The birth of scamThe stocks of Information, Communications, and Entertainment sector were rising all over the world in early 1999 which led to a rise of the Indian stock markets as well.KP invested in the stocks of Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics. According to media reports, KP took advantage of low liquidity in these stocks, which eventually came to be known as the 'K-10' stocks. These shares were held through KP's company. From January to July 1999, the K-10 stocks went on rising. HFCL and Global were major gainers. He started trading of these shares within the network of his own companies with the intention of creating buying pressure for shares of K-10. Continuous trading by Ketan Parekh made other brokers in the market to suspect that something is happening inside K-10. Thus brokers started buying shares of K-10 for themselves and also urged their clients to buy these shares.

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Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. HFCL's traded volumes went up from 80,000 to 1,047,000 shares. Global's total traded value in the Sensex was Rs 51.8 billion.KP had formed a network of brokers from smaller exchanges such as the Allahabad Stock Exchange and the Calcutta Stock Exchange. He used to buy shares in the fictitious names of poor people living in Mumbai, though KP was a successful broker, he did not have the money to large purchase. According to a report, 12 lakh shares of Global would have cost KP around Rs 200 million and Aftek Infosys would have cost him Rs 50 million, while the Zee and HFCL stakes would have cost Rs 250 million each. Analysts claimed that KP borrowed funds from various companies and banks. He bought shares when their prices were low and continuously saw the prices going up in the bull market because of continuous trading. When the prices were high enough, he pledged the shares with banks as collateral for funds and carry on this process. A small Ahmedabad-based bank, Madhavapura Mercantile Cooperative Bank (MMCB) was trapped in KP’s game. MMCB issued funds to KP without proper collateral security and even crossed its capital market exposure limits. Parekh and his associates secured Rs 1,000 crore as loan from the Madhavpura Mercantile Co-operative Bank despite RBI regulations that the maximum amount a broker could get as a loan was Rs15 crore. Hence, it was clear that KP’s motive was

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to inflate shares of selected companies in collusion with their promoters. Lady luck disfavours Parekh: Just a day after the presentation of the Union Budget in February 2001, Parekh appeared to have run out of luck. It’s interesting to know how this happened. KP's strategy of raising loans by offering shares as collateral security to the banks worked well in accordance with the continuous rise in share price, but it changed just the other way round, when the markets started declining in March 2000. Due to fall in the NASDAQ, K-10 stocks also started declining. KP was asked to either keep more shares as collateral or return some of the borrowed money to banks. In either case, it put financial pressure on him. In the next two months, when the Sensex fell by 23% and the NASDAQ by 36%, K-10 stocks saw fell hugely by 67%. However, with improvements in the global technology the K-10 stocks began moving up once again in May 2000. In December 2000, the NASDAQ crashed again and this time technology stocks were top losers. Such uncertainty created doubts regarding the future of technology stocks causing prices to fall across the globe. This created panic among many investors / traders / mutual funds / brokers. A team of traders, Shankar Sharma, Anand Rathi and Nirmal Bang, known as the “bear cartel” subsequently placed sell orders on K-10 stocks, and crushed their inflated prices. KP began to have liquidity problems and payment crisis.

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The payment crisis at Calcutta Stock Exchange (CSE) came as one of the biggest setbacks for KP. KP had network of brokers at CSE who used to buy shares at KP's behest. By February 2001, the scrips held by KP's brokers at CSE were reduced to half from their initial worth of Rs 12 billion. The situation worsened as KP's payments of Rs 5-6 billion were not honored on time for the settlement and about 70 CSE brokers, including the top three brokers of the CSE (Dinesh Singhania, Sanjay Khemani and Ashok Podar) became defaulter on their payments. By mid-March, the value of stocks held by CSE brokers further became half. The CSE brokers started pressurizing KP for payments. KP again turned to MMCB to get loans. But the outflow of funds from MMCB had already crossed the limits from January 2001. Now the all the borrowings of KP put together also could not rescue him.

The Exposure of scam and outcome:Ketan Parekh's fraudulent practices were first exposed by veteran columnist Sucheta Dalal. Sucheta's column read, “It was yet another black Friday for the capital market. The BSE sensitive index crashed another 147 points and the Central Bureau of Investigation (CBI) finally ended Ketan Parekh’s two-year dominance of the market by arresting him in connection with the Bank of India (BoI) complaint. Many people in the market are not surprised with Parekh’s downfall because his speculative operations were too large, he was keeping dubious company, and he was dealing in too many shady scrips.”

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Who were major victims? Public, Buyers of shares of companies, UTI, MMCB, Bank of India, State Bank of India, Global Trust Bank, Calcutta Stock Exchange were major victims of this scam. When the prices of selected shares started constantly rising, innocent investors were buying such shares believing that the market was genuine. Soon after the scam was exposed, the prices of these stocks came down to the fraction of the values at which they had been bought. When the scam was fully burst, the rigged shares lost their values so heavily that few people lost their life time savings.

Consequences: The Global Trust Bank and the Madhavpura Cooperative Bank became bankrupt. MMCB was liquidated. Some banks including Bank of India lost significant amounts of money. The small investors felt that all parties in the functioning of the market were responsible for the scams. They opined that the broker-banker-promoter nexus was the main reason for the scams in the Indian stock markets. Parekh was held on charges of draining out Rs 1,370 million from Bank of India (BOI) through pay orders issued by Madhavpura Mercantile Co-operative Bank in Ahmedabad, Gujarat The CBI registered a case against Parekh after BOI filed a complaint Parekh had defrauded it. Preakh was convicted in 2008 and he is banned from trading till 2017. KP still owes Rs 400 crore to its stockholder. SEBI actions to control damages: Some of the steps taken by SEBI post scam were :-

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The trading cycle was cut short from a week to a day. A historical decision to ban carry-forward system in stock trading called ‘BADLA’ was taken, effectively from July 2001.SEBI introduced forward trading in the form of exchange-traded derivatives to ensure a well-regulated futures market. Withdrew broker control over stock exchanges.SEBI also banned trading by all stock exchange presidents, vice-presidents and treasurers.

QUESTIONS FOR DISCUSSION 1. Identify the loopholes in the entire financial system which

set platform for KP to plan such scam.2. Do you think steps initiated by SEBI were right? What else

SEBI could have done.3. Considering present risk management measures that are

available now, comment on how this scam could have been prevented by taking each measure into account.

CASELET 3: A ‘parallel’ crisis in Calcutta Stock Exchange-Settlement Guarantee Fund to rescue.In March 2001, Calcutta Stock Exchange (CSE) was trapped in Country’s worst ever payment crisis, making for CSE difficult to survive, when its 10 brokers were defaulted in their payment for the amount of Rs 120 crore in three consecutive weekly settlements. Crisis was a consequence of scam by Ketan Parekh.

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The CSE officials had to use Settlement Guarantee Fund (SGF) which decreased the SGF at CSE by Rs 48 crores and depleted the general reserves to the extent of Rs.20 crore. Three elected broker members - Dinesh Kumar Singhania, a director on the CSE board, Harish Biyani and Ashok Kumar Poddar were made to resign. Till February-end CSE had average daily turnover of Rs.1,500 crores, but the volume shrink to less than Rs.100 crores in the second half of March. The total loss was for Rs. 800 for all the parties and more than 70 % of brokers especially small and medium brokers lost their life time savings. Abhisekh Banka, a 22 years old sub-broker was reported to commit suicide by drowning. His wife killed herself by jumping off a multi-storied building.

The crisis at CSE originated due to Ketan Parekh’s scam in the same year. The Mumbai-based bull trader Ketan Parekh had connections with chain of brokers at several small stock exchanges including Calcutta Stock Exchange mainly, which used to buy shares on Parekh’s behest for his official and unofficial deals in the ICE (information, communication and entertainment) shares. The fall in the technology stocks, made it difficult for Ketan Parekh to fulfill his payment obligations, as a result, the whole gang of brokers also got engulfed in payment crisis in parallel and became big defaulters to the exchange.

According to Tapas Dutta, executive director of CSE, there was a shortfall of Rs 32crore in settlement no.148, which was for the first time, a very huge default at any major exchange of the country. Defaults were mainly in the HCFL scrip and the DSQ

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software scrip. According to CSE officials, the pay-in shortfall was a rare phenomenon and even if there was a shortfall, it was never more than few lakhs and such shortfalls were recovered from margin deposits –a kind of advance payment or collateral against outstanding position, of defaulted brokers.

CSE attempted to bridge the gap by encashing the bank guarantee and fixed deposits of default brokers kept with the exchange as margin, which were around Rs.70 crore. It even sold the shares bought by the brokers, but could not fulfill the gap. After utilizing these funds and Settlement Guarantee Fund on March 15, there was still a shortfall of Rs 13.08 crore for the settlement no.149. On March 22, 40 more brokers became unable to fulfill their commitment towards the settlement no.150 as they all were hit by chain reaction of earlier defaults of Singhania, Biyani and Poddar. CSE officials used the same method as in earlier two settlements and bridged the gap of shortfall.

On March 26, the CSE formally declared 10 brokerages owned by Singhania, Biyani and Poddar as defaulters.

The CSE authorities were blamed for not being able to prevent the crisis and "allowing it to blow out of proportion". One broker blamed the lack of regulations and surveillance on the bourse allowed a highly illegal and volatile BADLA business. Ajit Dey, former president of the CSE said: "It is obvious that the CSE authorities did not anticipate that things will take such a turn." The majority of the brokers demanded the resignation of the elected directors of the CSE. On March 30, the eight elected

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members - president Kamal Parekh, vice-president K.K. Daga and six directors resigned., A new management sub-committee comprising of six public representatives, three SEBI nominees and the executive director was formed by the governing committee on April 2, who decided first to replenish the depleted SGF. If not replenished according to SEBI guidelines, it would be end of CSE. The main concern of the management now was to restore the CSE's financial position to establish CSE as demutualised entity by separating the ownership and management. However, Ajit Day was afraid believing dark future of the CSE as the payment crisis had created confusion in the market and a drop in business.

QUESTIONS FOR DISCUSSION1) Analyze the importance of Settlement Guarantee Fund.2) Should the pay-in/pay-out to client be done through the

broker /TM or directly through Professional Clearing member (PCM) or should it be made mandatory for all TMs to tie-up with designated PCM for providing this service to their clients?

CASELET 4: North Star Gems (India) Limited- Market manipulation and price rigging

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The abnormal rise in price and volume in the scrip of North Star Gems (India) Limited, just after its public issue prompted SEBI to conduct an investigation which revealed that a group of persons with the help of its associate entities operated in the scrip with a view to manipulate the prices. This group of persons in collusion with the promoters of the company cornered the shares offered in the public issue and through secondary market purchases. The buying pressure created a false market in the scrip and some of the investors were induced to sell short at the higher level of prices. This resulted in auction and closeout at abnormally high prices. On completion of investigations, the SEBI ensured that the manipulators in any case, would not receive ill-gotten gains arising out of such market manipulations and hence directed amount of Rs. 1.75 to be transferred to the Investor Protection Fund of the concerned stock exchange. Enquiry proceedings were initiated against the stock brokers involved in the case and against the registrar to the Issue. Show cause notices were issued to the non-intermediaries including the promoters of the company.

CASELET 5: Maruti Organics Ltd- Not compliance with KYC norms & Margin RequirementsIn June, 1996, NSE alleged that there was an attempt to defraud the clearing corporation of NSE by some brokerage

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firms who were trading in the scrip of Maruti Organics Ltd (MOL). Investigations revealed that the brokers at whose terminal buying position were created were not acting diligently and enrolled clients without making any meaningful enquiries and failed to verify details like, bank a/c or address etc. of the their clients. The buying position was built up across the country i.e. at Ahmedabad, Bangalore, Mumbai, Hyderabad, Chennai, etc. Clients dealt with the broker and when the time for pay in had come, they escaped without paying brokers for the purchase made by them. As Settlement Guarantee Fund of NCCL guarantees settlement/payment for each trade entered at the Exchange, in the event of failure of the buyer to pay, NCCL would have to pay the sellers. NSE, from its investigations, held that these transactions in MOL were collusive trades and ordered dismissal of the same. Brokers were accused of not taking enough precaution by allowing unknown clients, to build up huge buying position in scrip which was volatile and illiquid without collecting sufficient margins from them and which was beyond their financial capacity and also for their carelessness which put the settlement system of the Exchange at risk. On these facts, violation of SEBI (Stock Broker & Sub-Broker) Regulations, 1992, enquiry proceedings were initiated against the broker.

CASELET 6: Market Surveillance-Handling exceptional market conditionsDuring 1996-97, stock market witnessed several periods of volatility and turbulence. For example, the BSE Sensex

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decreased sharply by 5.45 per cent and 6.52 per cent on January 16, 1997 and March 31, 1997 respectively. On January 16, 1997, intra-day volatility of 357 points was witnessed at the Stock Exchange, Mumbai. However the market remained safe during these periods of volatility because of the risk containment measures that were in place.

During 1997-98 also, the market witnessed certain periods of volatility. Due to large currency depreciation in Asian economy, since July 1997, countries like Thailand, Malaysia, Philippines, Indonesia as well as South Korea were severely affected. The fall out on Indian securities markets exhibited unusual price volatility on some occasions during this period when the BSE Sensex fell by more than 3 per cent to 7 per cent against an annual average intra-day price volatility of around 1.9 per cent. On August 20, 1997 the intra-day price volatility of the Sensex was exceptionally high at 3.4 per cent. On October 28, 1997, The Stock Exchange, Mumbai was closed due to festive holidays. However, the National Stock Exchange of India Ltd, (NSEIL) remained open and the Nifty fell by 7.9 per cent on a single day. The relatively steep decline on this day was affected by events in other developed markets specially the decline in equity prices in Hong Kong. Equity prices in the United States, Japan and Europe fell on October 27, 1997, causing Dow Jones Industrial Average of U.S stocks to decline by 7.1 per cent on the same day. This fall in the Dow affected sentiments in the Asian markets when they opened on October 28, 1997. Indian market took cue. On this day, the scrip specific price bands were imposed on 294 securities out of 1350 securities which

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were traded on the NSEIL. Apart from the strict monitoring of market movements and positions of brokers which is now being done automatically in the stock exchanges, the SEBI took pro-active action after discussing with the stock exchanges to arrest the fall. The NSEIL reduced the daily price band from the standard 10 per cent level to 7 per cent level. This measure along with exposure limits helped in stabilizing the market. On January 15, 1998, the Indian securities markets again witnessed high level of activity and the intra-day price volatility of the BSE Sensex was close to 3 per cent. On the following day, the market improved reversing the previous day’s trend. Also there was not a single default or failure in the market and market remained stable.

Other regulatory measures taken by the SEBI and the stock exchanges to stabilize the markets during the period of exceptional market volatility have been stringent administration of mark to market margining system and adherence to prudential exposure norms. In Indian securities markets, securities specific circuit breakers and price bands are followed. Experience has shown that scrip related circuit breakers and price bands were more appropriate when compared to index related circuit breakers. It ensured that the market remained open and only those counters where volatile scrip which touched the lower of the daily band of 10 per cent or weekly band of 25 per cent, were closed. On account of such measures the panic that had set in all over the world could not aggravate the market conditions in India. In fact the situation was well under control.

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QUESTIONS FOR DISCUSSION

1) Discuss various risk containment measures that have been used in above cases.

2) Discuss the role of market surveillance in case of volatility.

3) Why security specific circuit breaker or price band is more appropriate.

10. FINDINGS

A. Analysis of Harshad Mehta’s Scam Market capitalization of listed companies in BSE

BSE (Market Turnover) AllIndia Market

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Year Amount in Rs crore Capitalisation (Rs crore)1990-91 36012 1102731991-92 71777 3541061992-93 45696 2287801993-94 84526 400077

As per the data ,we can see that the BSE Market turnover had declined from Rs.71777 crores in the year 1991-92 to Rs.45696 crore in the year 1992-93. Simultaneously there was an impact on the Market capitalisation of the economy during the same year.

Difference before and after scam

EFFECTS Before & During Scam After Scam

Effect on Market (Sensex)

Around 4500 points Fell to 2500 points.

Market Capitalization

Fell by Rs 100,000 crore

Investors wealth

Continuous Rise in share price leading to rise in investors wealth also

Shares became “Tainted’

Share price Prices of share were soaring.

Drop in share price by 40%

Liquidity in stock market

Greater Liquidity was imparted to stock market during the scam

Liquidity decreased as investors were afraid of investments after such scams.

Brokers role/ outstanding position

Brokers got involved in inter-banking transactions just like stock market

Control over brokers was implemented.

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operations. They took positions in market.

Clearing and Settlement system

Brokers started playing role in settlement process & managed to get cheques in their account.

Clearing corporation was set across exchanges and Clearing House of stock exchanges took the responsibility of settlement guarantee.

Settlement Period

Settlement Cycle was a period of 15 days.

Settlement period was shortened to 1 week

Money Laundering

The scam is one of the cases of money laundering.

“The Prevention of Money Laundering Act” was passed in 2002

Loss Rs.4000 Crore to banking sector and overall loss of Rs. 5000 crore .

Before the scam, the Sensex was hovering around 4500 which fell to 2500 points in April 1992 on exposure of scam. The market capitalization fell by Rs 100,000 crores. Let’s go through the performance of stock market just before this scam.

1000 points, 25 July 1990- On 25 July 1990, the SENSEX closed at 1,001 which was a four-digit number on the account of a good monsoon and excellent corporate results.

2000 points, 15 January 1992- On 15 January 1992, the SENSEX crossed the 2,000 mark and closed at 2,020 after the liberal economic policy initiatives undertaken by the then finance minister and Prime Minister of India Dr Manmohan Singh.

3000 points, 29 February 1992 - On 29 February 1992, the SENSEX crossed 3,000 marks on the account of market-friendly budget announced by Manmohan Singh.

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4000 points, 30 March 1992- On 30 March 1992, the SENSEX crossed the 4,000 mark and closed at 4,091 on the expectations of a liberal export-import policy.

Investors who had bought shares through brokers who accused in this scam, suffered huge loss as their shares were declared “tainted “ shares. “Tainted” shares means, shares which do not have value, they are just piece of share and cannot be delivered in market. Share price of most of the stocks fell by 40%. Clearing and settlement process was done through brokers. A lot of brokers were involved. Generally government securities were traded directly between the two transacting banks, and brokers role was to bring the two banks together. Brokers should not have handled cash or securities. But here brokers took active position just like operations in stock market. Brokers managed to get cheques in their account. This opened the way of money laundering, which facilitated the diversion of the funds into stock market. Brokers imparted greater liquidity in the market. Even if we consider clearing and settlement process, it was 15 days which

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gave enough time to these brokers to keep money with them.

Some fluctuations had caused sensex to fall to 2,037 points by April 1993. However after the entry of foreign institutional investors (FIIs), the index started rising again from mid-1993, and by February 1994 it recovered much of the losses and reached 4,286. By December 1994, the index reached the 4,631 points which was post-scam high.

Analysis of Ketan Parekh’s case & Payment Crisis at Calcutta Stock Exchange

Effect on market (Sensex) Fell by 176 pointsWas this an Insider trading case?

Yes

What was Brokers role? Creating large buying position in selected stocks across various locations.

What happened to share price?

Only k-10 stocks prices rising up

What was unusual price movement and Volatility status?

Remained unchecked.

How was Market Surveillance System?

Poor

What about the Liquidity in stock market?

Greater liquidity was imparted to stock market.

What happened to Capital exposure limit of Banks?

Exceeded

How was Banking System? Poor and weak.What was Funding Mechanism ?

Simple Borrowing & BADLA system

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How long was Settlement period ?

1 week

What about Record and Margins ?

Lack of records and margins at Calcutta Stock Exchange.

How Pay-in/pay-out was done?

Brokers and Trading members. No PCM were involved.

There was a fall in sensex by 176 points immediately after the exposure of scam and further by 147 points post arrest of accused Ketan Parekh. I would relate this case not only with money laundering but also with the “insider trading” to some extent because in this scam company promoters were together involved with the brokers. Brokers had created large buying positions at various locations. Brokers had formed a chain of networks across exchanges, and persuaded innocent investors to buy selected stocks and built up large buying positions. SEBI ignored such things. When huge trading order for these stocks were getting placed and prices of selected k-10 stocks were rising, SEBI watched it as normal activity over the period of 18 months. It could have raised a question or doubt that why only the prices of K-10 stocks were rising. When whole Information, Communication, Entertainment sector was booming, why didn’t the prices of stocks of companies belonging to same sector also increased. Moreover the annual report to look into growth and earning prospectus of K-10 companies were not asked by SEBI or Bombay Stock Exchange. This clearly shows that investment in such stocks were done deliberately, to inflate their prices and hence

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Market Surveillance System of stock exchange was also poor which did not act diligently. Greater liquidity was imparted to stock market, as some banks had exceeded their capital market exposure limit. Banking system was also poor and weak as, it allowed to give loans without proper collateral. Settlement period was still 1 week thus giving enough time in movement of securities and funds. There was lack of record and margins at Calcutta stock Exchange, due to which CSE was engulfed in payment crisis. CSE officials used Settlement Guarantee Fund to settle the transactions and come out from the payment crisis of its defaulter brokers. If SGF would not have been there, CSE would have died.

Analysis of Exceptional Market Conditions/Price Rigging Cases/Margin DepositsFollowing risk scenarios have been identified from the cases and measures that could help best have been suggested.

Scenarios Effective MeasuresChecking of Intra-day price movement of particular security.

Applying security specific circuit breaker rather than index-based circuit breaker. A security specific circuit breaker will halt the trading in that security only but index-based trading will halt the trading in entire market, i.e market will be closed.

To avoid risk to settlement Collection of sufficient margins 71

and to ensure smooth clearing and settlement process.

from the client on upfront basis, according to volatility of stock and its trading frequency.

To keep track record of client until transaction is settled.

Obtaining basic details and verification of details by brokers / trading members.

To check any unusual price movement or unusual trading pattern in any scrip.

A Pro-active Market Surveillance System Ensuring continuous online monitoring with immediate generation of alert to trading members.

11. CONCLUSION As the objective of this project was to analyze the whole risk management

framework of Indian stock market and how much efficient it is, so in regard to

this, some of the strengths and weakness in this framework have been identified

after going through all the incidents and cases taken in the study. They have

been mentioned below:

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Strength or Efficiency of present risk management framework

lies in following: The way Index-based Circuit breaker / Securities specific price

band has been implemented by our stock exchanges, which have

been proven efficient in checking volatility and protect market in

some of the exceptional scenarios faced by stock market in past.

Time to time margin Deposits as a collateral from the client on

their open position and at broker level, it is gross of all the net

positions across all the clients, thereby ignoring any netting-off that

may occur between client-client and client proprietary positions.

Segregation of trading and clearing and settlement process by the

way of clearing corporation has guaranteed the smooth settlement

of all the transactions taking place at exchange.

The need for sufficient Settlement Guarantee Fund across all the

stock exchanges, has proven to be good way to reduce any

systemic risk. With the help of STF ,CSE had managed to

overcome the payment crisis.

Margining framework that has evolved for mitigation of risk to CC has given

rise to another risk, the risk of clients losing their collateral in the event of

default/bankruptcy of the broker or TM, CM, and accordingly there is a need to

take steps to mitigate this. However, even in presence of such measures

implemented the various scams that have occurred in the past shows that our

risk management framework is still not very much efficient and there can be

further improvement. Areas where improvement needed is

Brokers’ role

Settlement period.

Checking /prevention of insider trading.

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