Indian Capital Market. | All you need to know.

Introduction to the Indian Capital Market

Capital Markets play a very important role in the development of the economy. It helps in allocating the unutilized resources i.e. transfer of funds from savers to its efficient users. It provides channels for allocation of savings to investments. They consist of investors, who are the backbone of the economy, issuers, regulatory bodies and intermediaries. The movement of capital in the economy from the savings pool to the investment pool is performed by two main platforms of institutional intervention – (a) Financial institution and banking framework and (b) the capital market framework. The capital market plays the primary role of a facilitator and an intermediary in raising capital and deployment of the same in the economy.  

Capital Market - An Overview

Capital Market provides a platform for the issuers and the investors to come together. It helps the issuers to raise capital for productive deployment in creating economic wealth. At the same time, the capital market offersinvestment avenuesto investors with appetite for higher risks and returns as compared to the safe investment option with banks. Capital Market is further divided into the Primary Market and Secondary Market whereas Money Market is classified into Organized Money Market and Unorganized Money Market. 

Primary Market is the new issue market, which provides opportunity to issuers of securities, Government as well as corporates, to raise resources to meet their requirements of investments and/or discharge some obligation. If securities are allotted to the public for the first time for the purpose of listing, it is called Initial Public Offer (IPO). Once the securities are listed on the Stock Exchanges, the same shares traded will be on the secondary market, between investors themselves. If securities are already listed and the issuer company wants to issue further class of securities to the investors again, it is called Further Public Offer (FPO).

Secondary Market helps in providing liquidity to the securities which has already been issued in the primary market. In this market, an investor liquidates his own investments. Since the securities are traded on the stock exchange and the transactions are between two investors, the issuer does not come into picture. Secondary Markets operate through two mediums, namely, the Over‐The‐Counter (OTC) market and the Exchange Traded Market. OTC markets are the informal type of markets where trades are negotiated. In this type of market, the securities are traded and settled bilaterally over the counter. The other option of trading is through the stock exchange route, where trading and settlement is done through the stock exchanges and the buyers and sellers may not be in touch with each other.  The transaction is carried out through SEBI registered stock brokers or sub‐brokers. 

Money market is a market for financial assets that are close substitutes for money. It is a market forshort term, medium term and long term funds. The money market deals primarily in securities and investments, such as banker’s acceptances, negotiable certificates of deposit (CDs), repos and Treasury Bills (T‐bills), call/notice money market, commercial papers. Government securities such as infrastructure bonds and oil bonds are also a part of the money market.

Products in Indian Securities Market

Indian Securities Markets cover a wide range of products depending upon the risk appetite of the investors. For example, if an investor wants to invest in risky products he has the option to invest in products of the equity market, whereas a risk‐averse investor can invest in bond markets which are comparatively less risky. Product portfolio of Indian securities markets can be broadly classified into 3 categories:

a) Equity Market Products

b) Derivative Market Products

c) Debt Market Products

a) Equity Market Products: The equity segment of the stock exchange allows trading in shares, debentures, warrants, mutual funds and exchange traded funds (ETFs). 

Equity Shares represent a form of fractional ownership in a business venture. Equity shareholders collectively own the company and also bear the risk and enjoy the rewards of ownership. 

  

Debentures are instruments for raising long term debt. Debentures in India are typically secured by tangible assets. There are fully convertible, optionally fully convertible, non‐ convertible and partly convertible debentures. Fully convertible debentures will be converted into ordinary shares of the same company under specified terms and conditions. Optionally fully convertible debentures will be converted into equity shares of the same company at the option of the investor.  Partly convertible debentures (PCDs) will be partly converted into ordinary shares of the same company under specified terms and conditions. Thus it has features of both debenture as well as equity. Non‐Convertible Debentures (NCDs) are pure debt instruments without the feature of conversion. The NCDs are repayable on maturity. 

Warrants entitle an investor to buy equity shares after a specified time period at a given

price.

Mutual Funds pools money from numerous investors who wish to save or make investments having similar investment objective.  The Mutual Fund invests in different types of funds in consonance with the investment objectives. A mutual fund company pools money from many investors and invests the money in stocks, bonds, short‐term money‐market instruments, other securities or assets, or some combination of these investments, depending on the objectives of the fund. There are funds which invest in equities, better known as equity MF schemes which are considered riskier than debt mutual funds.

Exchange Traded Fund is a fund that can invest in either all of the securities or a representative sample of securities included in the index. Importantly, the ETFs offer a one‐stop exposure to a diversified basket of securities that can be traded in real time like individual stock example gold exchange traded fund.

b) Derivative Market Products: Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. The derivatives segment in India allows trading in the equities, currency and commodities. There are two types of derivatives instruments viz., Futures and Options that are traded on the Indian stock exchanges. 

Index/Stock Future is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange‐traded contracts. Futures contracts are available on certain specified stocks and indices. 

  

Index / Stock Options are of two types ‐ calls and puts. Calls give the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the seller the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date. 

  

Currency Derivatives trading was introduced in the Indian financial markets with the launch of currency futures trading in the USD‐INR pair on the National Stock Exchange of India Limited (NSEIL) on August 29, 2008. Few more currency pairs have also been introduced thereafter. As at end January 2013, currency futures are traded on the USD‐ INR, GBP‐INR, EUR‐INR and JPY‐INR on NSE, MCX‐SX and USE. 

Commodity Derivatives markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold on the basis of standardized contracts for a specified future date. Commodity markets facilitate the trading of commodities such as gold, silver and various agricultural goods.

Interest Rate Futures trading is based on notional 10 year coupon bearing Government of India (GOI) security. These contracts are settled by physical delivery of deliverable grade securities using electronic book entry system of the existing depository’s viz., NSDL and CDSL and the Public Debt Office of the Reserve Bank unlike the cash settlement of the other derivative products. 

c) Debt Market Products: Debt market consists of Bond markets, which provide financing through the issuance of Bonds, and enable the subsequent trading thereof. Instruments like bonds/debentures are traded in this market. These instruments can be traded in OTC or Exchange traded markets. In India, the debt market is broadly divided into government securities (G‐Sec) market and the corporate bond market. 

Government Securities Market: The Government needs enormous amount of money and one of the important sources of borrowing funds is the government securities market. The government raises short term and long term funds by issuing securities. These securities do not carry default risk asthe government guarantees the payment of interest and the repayment of principal. They are therefore referred to as gilt edged securities. Governmentsecurities are issued by the central government,state government and semi‐government authorities. The major investors in this market are banks, insurance companies, provident funds, state governments, FIIs. Government securities are of two types‐ treasury bills and government dated securities.

  

Corporate Bond Market: Corporate bonds are bonds issued by firms, corporate and are issued to meet needs for expansion, modernization, restructuring operations, mergers and acquisitions. The corporate bond/debt market is a market wherein debt securities of corporates are issued and traded therein. The investorsin this market are banks, financial institutions, insurance companies, mutual funds, FIIs etc. Corporates adopt either the public offering route or the private placement route for issuing debentures/bonds. 

  

Some of the other instruments available for trading in the debtsegment are Treasury Bills, Commercial Papers and Certificate of Deposits.

Participants in Indian Securities Market

There are different participants who play an important role in the securities market. Entities develop, issue, register and sellsecuritiesfor the purpose of financing their operations. There are people who invest in these securities and there are some entities that provide the service of intermediation. Some of them are discussed here:

(i) Issuer means any company/corporate making an offer ofsecurities.  They are the persons who actually approach the market stating their specific objectives and collect funds from the general public by offering securities.

(ii) Investors are the persons who actually invest their funds in the securities offered by the issuer. They are broadly categorised as Retail Investors, Institutional Investors and Non‐ Institutional Investors. Investors investing upto Rs. Two lakh in a single public issue transaction is termed as Retail investors, whereas institutional investors comprise of domestic financial institution, mutual funds, FIIs etc commonly known as Qualified Institutional Buyers (QIBs).

(iii) Intermediaries:  There are many intermediaries in the Indian securities market.  As per the SEBI Act, 1992, intermediaries include stock brokers, sub‐brokers, share transfer agents, bankers to an issue,  self‐certified syndicate bank (SCSBs), trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, mutual funds and such other intermediaries who may be associated with securities markets in any manner, depositories, participants, custodians of securities, credit rating agencies and such other intermediaries as SEBI may, by notification, specify in this behalf.  Some of them are discussed below:

• Stock Brokers & Sub‐Brokers: Stock brokers have been defined as a member of a stock exchange while a sub‐broker means any person not being a member of stock exchange who acts on behalf of a stock broker as an agent or otherwise for assisting the investors in buying,selling or dealing in securitiesthrough such stock brokers; Stock Brokers are the members of the Stock Exchange and can either be individuals or corporate. They give their advice and recommendations relating to investment opportunities to their clients. Their clients may be retail investors or institutional clients and they execute the trade on their client’s behalf on the exchange.
• Custodians: mean any person who carries on or proposes to carry on the business of providing custodial services.  Custodial services include safekeeping of the securities. A Custodian is an entity that helps safeguard the securities of its clients. Custodians may also be clearing members like Professional Clearing Members (PCMs) but not trading members. They settle trades on behalf of the clients of the trading members, when a particular trade is assigned to them for settlement.
• Depositories:  means a depository as defined in clause (e) of sub‐section (1) of section 2 of the Depositories Act, 1996. Depositories offer various services to their clients, however, the principal function is to provide a facility for investors to hold and transfer securities in dematerialised form. Through a system of paperless securities, depositories have made the going easier to other institutions as well such as Stock Exchanges and its clearing houses, stock broking firms, issuing companies, share transfer agents etc. As on date, there are two Depositoriesin India, Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL).
• Depository Participants (DPs): means a person registered as a participant with the SEBI. The Depository providesitsservicesto clientsthrough its agents called depository participants. These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and body corporate engaged in providing financial services provided certain conditions are fulfilled can become DPs.
• Merchant Bankers: means any entity who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management. They need to be registered with SEBI to act & perform as Merchant Banker. They perform a variety of activities including managing capital issues, managing individual funds and advising clients on proper valuation of their security and often the underwriting of issues. Most of these activities are also performed by money‐market dealers, commercial banks and financial institutions, share brokers and investment funds and unit trust managers under registration as Merchant Bankers.
• Registrars and Transfer Agents: Registrars to an issue are entities, who on behalf of anybody corporate collect applications from investors in respect of an issue, keep proper record of applications and monies received from investors and assists body corporate to determine basis of allotment, process and despatch allotment letters, refund orders or certificates in respect of an issue.  Share transfer agents maintain the record of holders of securities issued by such body corporate and deal with all matters connected with the transfer and redemption of its securities. Share transfer agent can also be a department or division (by whatever name called) of a body corporate performing the above activities if, at any time the total number of the holders of securities issued exceed one lakh.
• Self ‐ Certified Syndicated Bank (SCSBs): SCSBs are Banker to an Issue registered with the SEBI, which offers the facility of Application Supported by Blocked Amount.

In addition to the Self Certified Syndicate Banks (SCSBs), Syndicate Members and Registered Brokers of Stock exchanges, the Registrars to an Issue and share transfer Agents (RTAs) and Depository Participants (DPs) registered with SEBI are also permitted to accept application forms (both physical as well as online) in public issues.  

Regulators in Indian Securities Market

In order to have effective functioning and proper development of the market, there is a need for a regulator. Amongst other tasks, the first and foremost task of the regulator would be to protect the interest of investors and to ensure that there is no violation of rules and regulations. In India, securities markets are regulated by different regulators and hence there may be instances where there is a regulatory overlap.  

The Securities and Exchange Board of India (SEBI) is the securities market regulator. As per SEBI Act 1992, it is “responsible for protecting the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto”. It also regulates the issue of new securities, has the power to make rules for regulating the stock exchange, provides license to dealers and brokers and deals with frauds and inconsistencies in the capital market.

The money market which deals with bonds and depositsisregulated by the Reserve Bank of India (RBI). It looks at the macroeconomic conditions and decides the rate of interest to be paid on government securities as well as important factors like the Statutory Lending Ratio (SLR) and the Cash Reserve Ratio (CRR). It works with the Government to balance the growth of the country with factors such as inflation, current account deficits and the exchange rates of the rupee vis‐à‐vis the global currencies.

Ministry of Company Affairs (MCA) through the Registrar of Companies regulates the Corporate Sector. The Ministry is primarily concerned with administration of the Companies Act, 2013, other allied Acts and rules&regulationsframed there‐under mainly forregulating the functioning of the corporate sector in accordance with law. The Ministry is also responsible for administering the Competition Act, 2002.

Insurance Regulatory and Development Authority of India (IRDAI) is the watchdog for the insurance sector. Its mission is “to protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto”. It regulates the insurance and re‐insurance business and has the mandate to register new insurance issuers, deal with issues of policyholders and to specify the code of conduct of the insurance business.  

Pension Fund Regulatory and Development Authority (PFRDA) is mandated to regulate the pension sectorin India. It wasformed through the PFRDA Act of 2003. It isresponsible for carrying out the Government of India’s effort to find a sustainable solution to providing adequate retirement income to the citizens. Since 2008, the pension contributions of the central government employees are being invested by professional pension fund managersin accordance with Government of India guidelines, under the regulation of the PFRDA.

Ministry of Finance (MOF) works through the Reserve Bank of India to regulate the securities market to the extent of investments into India by foreign or Non‐Resident Indian investors.   Foreign Exchange Management Act, 1999 came into force in 2000. The Act along with the Regulations and Rules thereunder specify the conditions to be fulfilled and the compliances to be made for investment into India.

All the authorities have an interrelation with each other.  Example: If a company is issuing equity shares in the securities market for the first time, MCA is the primary regulator along with SEBI. Apart from this, if the issue is subscribed to, by the foreign investors or Non‐resident Indians, the company will be subject to the RBI regulations as well.  Further, if a company is a bank or an insurance company, it is primarily regulated by RBI or IRDAI respectively, once the company decides to come with an IPO and lists its shares, it also comes within the jurisdiction of SEBI, the securities market regulator. Given above is a perfect example of regulatory overlap.

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