Secondary Markets in India

Types of Financial Markets

• The financial markets can broadly be divided into money
and capital market.
• Money Market: Money market is a market for debt
securities that pay off in the short term usually less than
one year; for example the market for 90-days treasury
bills. This market encompasses the trading and issuance
of short term non equity debt instruments including
treasury bills, commercial papers, bankers acceptance,
certificates of deposits, etc.
• Capital Market: Capital market is a market for long-term
debt and equity shares. In this market, the capital funds
comprising of both equity and debt are issued and
traded. This also includes private placement sources of
debt and equity as well as organized markets like stock
exchanges. Capital market can be further divided into
primary and secondary markets.
 Secondary Market
• Secondary Market refers to a market where securities
are traded after being initially offered to the public in the
primary market and/or listed on the Stock Exchange.
Majority of the trading is done in the secondary market.
Secondary market comprises of equity markets and the
debt markets.
• For the general investor, the secondary market provides
an efficient platform for trading of his securities. For the
management of the company, secondary equity markets
serve as a monitoring and control conduit—by facilitating
value-enhancing control activities, enabling
implementation of incentive-based management
contracts, and aggregating information (via price
discovery) that guides management decisions.
 Difference between Primary &
Secondary Markets
• In the primary market, securities are offered to
public for subscription for the purpose of raising
capital or fund. Secondary market is an equity
trading avenue in which already existing/pre-
issued securities are traded amongst investors.
Secondary market could be either auction or
dealer market. While stock exchange is the part
of an auction market, Over-the-Counter (OTC) is
a part of the dealer market.
 Role of SEBI

• The SEBI is the regulatory authority established

under Section 3 of SEBI Act 1992 to protect the
interests of the investors in securities and to
promote the development of, and to regulate, the
securities market and for matters connected
therewith and incidental thereto.
 Stock Exchanges in India

• There are 19 recognised stock exchanges in

India. However, the main business is with NSE
and BSE.
• It is important that while structuring stock
exchanges, all the three main functions, viz.
ownership, management and trading are clearly
segregated. In India this has been ensured by
SEBI.
 Trading in Corporate Bonds
• The term Corporate Bonds includes all debt securities issued by
institutions such as Banks, Public Sector Undertakings, Municipal
Corporations, bodies corporate and companies having a tenure of
more than 365 days. Such an issue of bonds, if offered to the public,
shall be required to comply with the SEBI (Disclosure and Investor
Protection Guidelines), 2000. Also, a private placement of corporate
bonds made by a listed company shall be required to comply with
provisions contained in SEBI Circulars in this regard.
• The SEBI Circulars dated September 30, 2003 and December 22,
2003 have laid out norms pertaining to the disclosure norms on
issuance of such securities, which include compliance with Chapter
VI of the SEBI (Disclosure and Investor Protection) Guidelines,
2000, Companies Act, 1956, listing agreement for debentures with
the stock exchanges, rating to be obtained from a Credit Rating
Agency registered with SEBI, requirement for appointing a
debenture trustee registered with SEBI, mandatory trading in
dematerialized form, etc.
 Trading in Corporate Bonds

• BSE and NSE have launched an order driven

trade matching platform which retains essential
features of OTC market where trades are
executed through brokers. OTC trades however
continue to be reported on the exchange
reporting platforms. In order to encourage wider
participation, the lot size for trading in bonds has
been reduced to Rs.1 lakh.
 Primary Dealer System
• A system of primary dealers (PDs) was
introduced in 1996 to strengthen the government
securities market infrastructure and to make it
more liquid and broad based.
• In order to enable PDs to perform their role
effectively, the RBI has cast certain obligations
upon them, which include an annual minimum
bidding for dated securities and treasury bills
with a minimum success ratio and commitment
to underwrite the shortfall (gap) between the
subscribed/ accepted amount and the notified
amount.
 Role of Brokers/ Sub-brokers
• A broker is a member of a recognized stock exchange,
who is permitted to do trade on the screen-based trading
system of different stock exchanges. He is enrolled as a
member with the concerned exchange and is registered
with SEBI.
• A sub broker is a person who is registered with SEBI as
such and is affiliated to a member of a recognized stock
exchange.
• For the purpose of engaging a broker to execute trades
on the investor’s behalf from time to time, details of the
investor have to be furnished for enabling the broker to
maintain client registration form. The investor has to sign
the “Member - Client agreement” if dealing directly with a
broker. In case the investor is dealing through a sub-
broker then she will have to sign a ”Broker - Sub broker -
Client Tripartite Agreement”.
 Selecting a Broker
• Brokers differ enormously by size and type of
clientele.
• Some brokers concentrate on institutions while
others specialise in dealing with individuals.
• Some brokers do their own analysis, while
others depend upon second-hand analysis.
• Fees usually vary depending upon type and size
of business, negotiating capacity of client, etc.
• Commission levels have declined in recent years
on account of competition
 Charges Incurred by Investors
• The maximum brokerage that can be charged by a
broker has been specified in the Stock Exchange
Regulations and hence, it may differ across various
exchanges. As per the BSE & NSE Bye Laws, a broker
cannot charge more than 2.5% brokerage from his
clients.
• Securities Transaction Tax (STT) is a tax being levied
on all transactions done on the stock exchanges at rates
prescribed by the Central Government from time to time.
Pursuant to the enactment of the Finance (No.2) Act,
2004, the Government of India notified the Securities
Transaction Tax Rules, 2004 and STT came into effect
from October 1, 2004.
 Process of Online Trading
• The normal course of online trading in the Indian market context is
placed below:
• Step 1: Investor / trader decides to trade
• Step 2: Places order with a broker to buy / sell the required quantity
of respective securities
• Step 3: Best priced order matches based on price-time priority
• Step 4: Order execution is electronically communicated to the
broker’s terminal
• Step 5: Trade confirmation slip issued to the investor / trader by the
broker
• Step 6: Within 24 hours of trade execution, contract note is issued
to the investor / trader by the broker
• Step 7: Pay-in of funds and securities before T+2 day
• Step 8: Pay-out of funds and securities on T+2 day
• In case of short or bad delivery of funds / securities, the exchange
orders for an auction to settle the delivery. If the shares could not be
bought in the auction, the transaction is closed out as per SEBI
guidelines.
 Margin Trading
• Margin Trading is trading with borrowed funds/securities.
It is essentially a leveraging mechanism which enables
investors to take exposure in the market over and above
what is possible with their own resources. SEBI has
been prescribing eligibility conditions and procedural
details for allowing the Margin Trading Facility from time
to time.
• The facility of margin trading is available for Group 1
securities and those securities which are offered in the
initial public offers and meet the conditions for inclusion
in the derivatives segment of the stock exchanges.
 Margin Trading
• For providing the margin trading facility, a broker may
use his own funds or borrow from scheduled commercial
banks or non-banking finance companies (NBFCs)
regulated by the RBI. A broker is not allowed to borrow
funds from any other source. 
• The "total exposure" of the broker towards the margin
trading facility should not exceed the borrowed funds and
50 per cent of his "net worth". While providing the margin
trading facility, the broker has to ensure that the
exposure to a single client does not exceed 10 per cent
of the "total exposure" of the broker.
• Initial margin has been prescribed as 50% and the
maintenance margin has been prescribed as 40%.
Short Selling and Securities Lending &
Borrowing
• Short Selling means selling of a stock that the seller
does not own at the time of trade. Short selling can be
done by borrowing the stock through Clearing
Corporation/Clearing House of a stock exchange which
is registered as Approved Intermediaries (AIs). Short
selling can be done by retail as well as institutional
investors. Naked short sale is not permitted in India, all
short sales must result in delivery, and information on
short sale has to be disclosed to the exchange by end of
day by retail investors, and at the time of trade for
institutional investors. The Securities Lending and
Borrowing mechanism allows short sellers to borrow
securities for making delivery. Securities in the F&O
segment are eligible for short selling.
Short Selling and Securities Lending &
Borrowing
• Securities Lending and Borrowing (SLB) is a scheme
that has been launched to enable settlement of
securities sold short. SLB enables lending of idle
securities by the investors through the clearing
corporation/clearing house of stock exchanges to earn a
return through the same. For securities lending and
borrowing system, clearing corporations/clearing house
of the stock exchange would be the nodal agency and
would be registered as the “Approved
Intermediaries”(AIs) under the Securities Lending
Scheme, 1997.
• Under SLB, securities can be borrowed for a period of 7
days through a screen based order matching
mechanism. Securities in the F&O segment are eligible
for SLB.
 Depositories
• The increase in the volume of activity on SEs and the
advent of screen based trading system coupled with
inefficiencies of the earlier trading and settlement
systems led to the emergence of a new system called
the Depository System.
• A depository is an organisation which holds securities of
investors in electronic form at the request of the
investors through a registered Depository Participant.
• SEBI has mandated compulsory trading and settlement
of select securities in dematerialized form.
• A demat share is held by the depository on behalf of the
investor.
• Demat settlements have eliminated bad deliveries and
other related problems associated with physical
securities.
 Depository System
• A depository system enables immediate allotment,
transfer and registration of securities.
• At present two Depositories viz. National Securities
Depository Limited (NSDL) and Central Depository
Services (I) Limited (CDSL) are registered with SEBI.
• NSDL, promoted by IDBI, UTI, NSE and SBI, was set up
as the first depository in India. NSDL commenced
operations in November 1996.
• CSDL, set up by BSE, and co-sponsored by SBI, Bank
of Baroda, Bank of India and HDFC Bank, was the
second depository to be set up. It commenced
operations in March 1999.
• To avail the services of a depository an investor is
required to open an account with a depository participant
of any depository.
 Depository System
• A Depository Participant (DP) is an agent of the
depository through which it interfaces with the investor. A
DP can offer depository services only after it gets proper
registration from SEBI. Banking services can be availed
through a branch whereas depository services can be
availed through a DP.
• If the investor provides his bank account details to the
DP, the bank account number will be mentioned on the
interest or dividend warrant, so that such warrant cannot
be encashed by any one else. Further, cash corporate
benefits such as dividend, interest will be credited to the
investors account directly through the ECS (Electronic
Clearing Service) facility, wherever available, by the
company.
• As per the available statistics at BSE and NSE, 99.9%
settlement takes place in demat mode only.
 Benefits of Availing Depository Services
• A safe and convenient way to hold securities;
• Immediate transfer of securities;
• No stamp duty on transfer of securities;
• Elimination of risks associated with physical certificates such as bad
delivery, fake securities, delays, thefts etc.;
• Reduction in paperwork involved in transfer of securities;
• Reduction in transaction cost;
• No odd lot problem, even one share can be sold;
• Nomination facility;
• Change in address recorded with DP gets registered with all
companies in which investor holds securities electronically
eliminating the need to correspond with each of them separately;
• Transmission of securities is done by DP eliminating
correspondence with companies;
• Automatic credit into demat account of shares, arising out of
bonus/split/consolidation/merger etc.
• Holding investments in equity and debt instruments in a single
account.
 Accounts of an Investor
• What are the various accounts an investor should have
for trading in securities market?
• Beneficial owner Account (B.O. account) / Demat
Account: It is an account opened with a depository
participant in the name of client for the purpose of holding
and transferring securities.
• Trading Account: An account which is opened by the
broker in the name of the respective investor for the
maintenance of transactions executed while buying and
selling of securities.
• Client Account / Bank Account: A bank account which is
in the name of the respective client and is used for debiting
or crediting money for trading in the securities market.
 Dematerialisation
• Dematerialisation is the process by which physical
certificates of an investor are converted to an equivalent
number of securities in electronic form and credited into
the investor's account with his/her DP. Odd lot share
certificates can also be dematerialised.
• Dematerialised shares do not have any distinctive
numbers. These shares are fungible, which means that
all the holdings of a particular security will be identical
and interchangeable.
• To give the delivery one has to fill a form called Delivery
Instruction Slip (DIS). DIS may be compared to cheque
book of a bank account. Both NSDL and CDSL have
launched the facility for delivering instructions by the
investor to his/her DP over Internet, called SPEED-e and
EASI respectively. The facility can be used by all
registered users after paying the applicable charges.
 Dematerialisation
• It is possible to get securities allotted to in Public
Offerings directly in the electronic form. In the public
issue application form there is a provision to indicate the
manner in which an investor wants the securities allotted.
He has to mention the BO ID and the name and ID of the
DP on the application form. Any allotment made will be
credited into the BO account.
• The DP gives a Transaction Statement periodically,
which will detail current balances and various
transactions made through the depository account. If so
desired, DP may provide the Transaction Statement at
intervals shorter than the stipulated ones, at a cost.
• DPs have to provide transaction statements to their
clients once in a month, if there are transactions and
once in a quarter, if there are no transactions.
 Custodians
• Custodians provide custodial services which are
different from those provided by depositories. A
custodian is an intermediary who keeps the
scrips of the clients in custody, may be a keeper
of the accounts of its clients, provides ancillary
services such as physical transfer of share
certificates, collecting dividends and interest
warrants, updating clients on their investment
status, etc.
• To claim benefits on behalf of its clients, a
custodian keeps track of book closures, record
dates, bonus and rights shares.
 Custodians
• Even though depositories have been set up,
there is a need for custodians as they act as
complements to depositories. For example, the
volume of transactions by mutual funds and
other fund managers may be so large, that
custodians can play a useful role.
• Custodians are clearing members but not trading
members.
• In India, the Stock Holding Corporation of India
and SBI Share Holding Corporation are
prominent custodians. Foreign banks also
operate in this field.
 Clearing Process
• After a trade has been executed, securities and money must
change hands within a certain number of business days of
the trade date, on what is called the settlement date.
• Basically, two tasks are carried out in the clearing process:
trade comparison and settlement.
• Trade comparisons are made through the facilities of a
clearing corporation that receives reports of each transaction
from the brokers participating in the transaction. Unmatched
entries are flagged off and followed up. Much of the process
is automated.
• The second step in the clearing process – the final
settlement – is also automated.
• The key change permitting the use of book entries has been
the immobilisation of securities certificates. Securities are
immobilised at a securities depository.
 Clearing Corporation of India Ltd.
• The corporation acts as the central counterparty in the
settlement of all trades in government securities, treasury
bills, money market instruments, repos, inter-bank foreign
exchange deals, and derivatives of various types, where
the underlying instrument in a security or money market
instrument.
• CCIL has been promoted by SBI and other banks, FIs and
PDs.
• CCIL is the clearing and settlement agency in respect of all
trades by institutional players such as banks, DFIs, primary
dealers, mutual funds, corporates and NBFCs who account
for more than 98 per cent of the total sales.
• CCIL manages various risks such as credit and market
risks, liquidity risk and operational risk to avoid serious
system failures.
 Taxes
• The final rate of return to the investor it must be
remembered is net of taxes
• Interest Tax
• Income Tax
• Tax Deduction at Source (TDS)
• Capital Gains and Loss Taxes
• Long Term Capital Gains Tax
• Short Term Capital Gains Tax
• Security Transaction Tax
Miscellaneous Capital Market
Issues
 Buy Back of Shares

• A company can buy back its shares in

any of the following ways:
• From the existing shareholders on a
proportionate basis through the tender
offer,
• From open market through:
– Book building process
– Stock exchange,
• From odd lot holders.
 Delisting of Shares
• The term "delisting" of securities means permanent
removal of securities of a listed company from a stock
exchange. As a consequence of delisting, the securities
of that company would no longer be traded at that stock
exchange.
• Difference between Voluntary delisting and
Compulsory delisting:
• Compulsory delisting refers to permanent removal of
securities of a listed company from a stock exchange as
a penalizing measure at the behest of the stock
exchange for not making submissions/complying with
various requirements set out in the Listing agreement
within the time frames prescribed. In voluntary delisting,
a listed company decides on its own to permanently
remove its securities from a stock exchange.
 Exit Opportunity for Investors
• SEBI (Delisting of Securities) Guidelines, 2003 provide
an exit mechanism, whereby the exit price for voluntary
delisting of securities is determined by the promoter of
the concerned company which desires to get delisted, in
accordance to book building process. The offer price has
a floor price, which is average of 26 weeks average of
traded price quoted on the stock exchange where the
shares of the company are most frequently traded
preceding 26 weeks from the date public announcement
is made. There is no ceiling on the maximum price.
• In case of infrequently traded securities, the offer price is
as per Regulation 20 (5) of SEBI (Substantial Acquisition
and Takeover) Regulations.
 Portfolio Management

• Professional portfolio management services

(PMS) are available in India. In return for a fee,
portfolio managers offer standardized packages
to high net worth individuals. The usual minimum
size of a portfolio should be around Rs.25-50
lakhs even though a few players offer such
services for investment sizes of as low as Rs.5-
10 lakhs. Apart from cash, investors can hand
over an existing portfolio stocks, bonds or
mutual funds to a PMS.
 Portfolio Management
• There are two types of portfolio managers –
discretionary portfolio manager and non-discretionary
portfolio manager. The discretionary portfolio manager
individually and independently manages the funds of
each client in accordance with the needs of each client,
while the non-discretionary portfolio manager manages
the funds in accordance with the directions of the client.
• Portfolio managers have to be registered with SEBI. As
part of the registration process, the applicant should
have in its employment minimum of two persons who,
between them, have at least five years experience as
portfolio manager or stock broker or investment manager
or in the areas relating to fund management. The
portfolio manger is also required to have a minimum net
worth of Rs.50 lakhs.
Rating Agencies
 Credit Rating
• Credit rating is the assessment of a borrower’s credit
quality.
• Credit rating is merely an indicator of the current opinion
of the relative capacity of a borrowing entity to service its
debt obligations within a specified time period and with
particular reference to the debt instrument being rated.
• It is not a recommendation to buy, sell or hold.
• Credit rating agencies now undertake financial analysis
and assessment of financial products, individual
institutions and governments.
• Credit rating helps in the development of financial
markets.
 Credit Rating
• It saves the investors’ time and money and enables him
to take quick decisions.
• It provides a means of pricing the risk premium that
should be attached to various financial instruments.
• It acts as a marketing tool to issuers with a high credit
rating.
• It often acts as a eligibility criteria to approach a
particular financial market to raise funds.
• The world’s biggest rating agencies are Moody’s Investor
Service and Standard and Poor (S&P). Next is Fitch
Investors Service.
• US rating agencies offer both solicited and unsolicited
ratings.
 Rating Agencies in India
The prominent rating agencies in India are:
• CRISIL: Credit Rating Information Services of
India Limited
• ICRA: Investment Information and Credit Rating
Agency of India Limited
• CARE: Credit Analysis and Research Limited
• Fitch Ratings India Private Limited
Usually covers four broad areas:
• Business Analysis
• Financial Analysis
• Management Evaluation
• Fundamental Analysis
 Business Analysis
• Industry risk covers an analysis of actual and estimated
demand/ supply, number of firms and potential entrants
in the industry, government policies relating to the
industry, the performance of the industry, future
potential, etc.
• Market position in the industry covers the market share
of the firms, marketing arrangements, products and
customers.
• Operational efficiency is a study of the production
processes of the firm, its cost structure, locational
advantages, labour relationships, input availability, etc.
• Legal position covers a study of the accuracy of the
information and filing of the required forms, returns and
so on with the regulatory authorities.
 Financial Analysis
• Accounting quality studies the method of income
recognition, inventory valuation, depreciation policies,
auditor’s remarks, off-balance sheet liabilities, and so on
• Earnings protection is examined with reference to
profitability ratios, earnings growth, projected earnings,
etc.
• Adequacy of cash flows includes a study of future cash
flows, working capital needs and capital budgets.
• Financial flexibility is examined in terms of whether
alternative financial plans have been developed and the
feasibility of such plans
 Management Evaluation &
Fundamental Analysis
Management Evaluation:
• Track record of the management
• Whether the management has the capacity to overcome
adverse situations
• Management’s goals, philosophy and strategies
• Corporate governance
Fundamental Analysis:
• Liquidity management
• Asset quality
• Profitability
• Interest and tax sensitivity
 Credit Rating
• Once the quantitative and qualitative data is analysed, it is
the seasoned judgement of the rating committee which
makes the rating of an agency unique and sometimes
controversial.
• Rating involves a particular number which is assigned, and
this involves a lot of subjectivity.
• The rating assigned is then notified to the issuer and in
normal cases only on his acceptance, is the rating published.
If the client wants to furnish additional information, he can do
so.
• Once the issuer decides to use and publish the rating, the
agency has to continuously monitor it over the entire life of
the instrument. This process is known as surveillance. Rating
may be upgraded, downgraded or continue unchanged.
• However, it should be remembered that rating agencies can
also make mistakes.
 Rating Symbols
• Rating agencies use symbols such as AAA, AA, BBB, B,
C and D to convey the safety grades to the investor.
• These grades can be also divided into high investment
grades, investment grades and speculative grades.
• Rating fees are paid by the issuer of the financial
instruments, and not the users of the rating services,
such as investors, financial intermediaries and other end-
users.
• Covered by Securities and Exchange Board of India
(Credit Rating Agencies) Regulations, 1999.
 Role of Investment Banking Firms
• Investment banking firms perform two general
functions
• For corporations, government entities and
foreign entities that need funds, investment
banking firms assist in obtaining those funds.
• For investors who wish to invest funds,
investment banking firms act as brokers or
dealers in the buying and selling of securities.
Thus, investment banking firms perform a critical
role in the primary and the secondary market.
 Investment Banking Firms
• Investment banking firms generate revenue from
commissions, fee income, spread income, and principal
activities. These activities can be classified as follows:
• Public offering (underwriting) of securities
• Trading of securities
• Private placement of securities
• Securitization of assets
• Mergers and acquisitions
• Merchant banking
• Trading and creation of derivative instruments
• Money management
 Investment Banking Firms
• The securitization of assets refers to the
issuance of securities using a pool of assets as
collateral. The securitization of home mortgage
loans to create mortgage-backed securities was
the first example of this process. When other
types of loans and receivables are used as
collateral or pool, such securities are known as
asset-backed securities.
• Sometimes an investment banking firm may
commit its own funds by either taking an equity
interest or creditor position in companies.
 Some Leading World Markets
Index Country
Nasdaq Composite US
Nikkei 225 Japan
FTSE 100 UK
SSE Composite China
S&P 500 US
Dow Jones Industrial Average US
Bombay Sensex India
Bloomberg European 500 Europe
Jakarta Composite Indonesia
Hang Seng Hong Kong
 Some Leading World Markets
Index Country
Dax Index Germany
Kuala Lumpur Composite Malaysia
CAC 40 France
Straits Times Singapore
Taiwan Taiex Taiwan
FTSE JSE Africa All Share South Africa
Stock Exchange of Thailand Thailand
KOSPI Korea Composite South Korea
Brazil Bovespa Stock Index Brazil
Russian RTS Russia