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Indian capital markets

 Indian capital markets have been receiving global attention, especially from sound investors, due to the improving macroeconomic fundamentals. The presence of a great pool of skilled labour and the rapid integration with the world economy increased India’s global competitiveness. No wonder, the global ratings agencies Moody’s and Fitch have awarded India with investment grade ratings, indicating comparatively lower sovereign risks.
The Securities and Exchange Board of India (SEBI), the regulatory authority for Indian securities market, was established in 1992 to protect investors and improve the microstructure of capital markets. In the same year, Controller of Capital Issues (CCI) was abolished, removing its administrative controls over the pricing of new equity issues. In less than a decade later, the Indian financial markets acknowledged the use of technology (National Stock Exchange started online trading in 2000), increasing the trading volumes by many folds and leading to the emergence of new financial instruments. With this, market activity experienced a sharp surge and rapid progress was made in further strengthening and streamlining risk management, market regulation, and supervision.
The securities market is divided into two interdependent segments:
  • The primary market provides the channel for creation of funds through issuance of new securities by companies, governments, or public institutions. In the case of new stock issue, the sale is known as Initial Public Offering (IPO).
  • The secondary market is the financial market where previously issued securities and financial instruments such as stocks, bonds, options, and futures are traded.
In the recent past, the Indian securities market has seen multi-faceted growth in terms of:
  • The products traded in the market,  viz. equities and bonds issued by the government and companies, futures on benchmark indices as well as stocks, options on benchmark indices as well as stocks, and futures on interest rate products such as Notional 91-Day T-Bills, 10-Year Notional Zero Coupon Bond, and 6% Notional 10-Year Bond.
  • The amount raised from the market, number of stock exchanges and other intermediaries, the number of listed stocks, market capitalization, trading volumes and turnover on stock exchanges, and investor population.
  • The profiles of the investors, issuers, and intermediaries.
Broad Constituents in the Indian Capital Markets
Fund Raisers are companies that raise funds from domestic and foreign sources, both public and private. The following sources help companies raise funds:
Fund Providers are the entities that invest in the capital markets. These can be categorized as domestic and foreign investors, institutional and retail investors. The list includes subscribers to primary market issues, investors who buy in the secondary market, traders, speculators, FIIs/ sub accounts, mutual funds, venture capital funds, NRIs, ADR/GDR investors, etc.
Intermediaries are service providers in the market, including stock brokers, sub-brokers, financiers, merchant bankers, underwriters, depository participants, registrar and transfer agents, FIIs/ sub accounts, mutual Funds, venture capital funds, portfolio managers, custodians, etc.
Organizations include various entities such as MCX-SX, BSE, NSE, other regional stock exchanges, and the two depositories National Securities Depository Limited (NSDL) and Central Securities Depository Limited (CSDL).
Market Regulators include the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), and the Department of Company Affairs (DCA).
Market Regulator Chart
Appellate Authority: The Securities Appellate Tribunal (SAT)
Participants in the Securities Market
SAT, regulators (SEBI, RBI, DCA, DEA), depositories, stock exchanges (with equity trading, debt market segment, derivative trading), brokers, corporate brokers, sub-brokers, FIIs, portfolio managers, custodians, share transfer agents, primary dealers, merchant bankers, bankers to an issue, debenture trustees, underwriters, venture capital funds, foreign venture capital investors, mutual funds, collective investment schemes.
History of the Market
With the onset of globalization and the subsequent policy reforms, significant improvements have been made in the area of securities market in India. Dematerialization of shares was one of the revolutionary steps that the government implemented. This led to faster and cheaper transactions, and increased the volumes traded by many folds. The adoption of the market-oriented economic policies and online trading facility transformed Indian equity markets from a broker-regulated market to a mass market. This boosted the sentiment of investors in and outside India and elevated the Indian equity markets to the standards of the major global equity markets.
The 1990s witnessed the emergence of the securities market as a major source of finance for trade and industry. Equity markets provided the required platform for companies and start-up businesses to raise money through IPOs, VC, PE, and finance from HNIs. As a result, stock markets became a people’s market, flooded with primary issues. In the first 11 months of 2007, the new capital raised in the global public equity markets through IPOs accounted for $107 billion in 382 deals out of the total of $255 billion raised by the four BRIC countries. This was a sizeable growth from $90 billion raised in 302 deals in 2006. Today, the corporate sector prefers external sources for meeting its funding requirements rather than acquiring loans from financial institutions or banks.

Derivative Markets
The emergence of the market for derivative products such as futures and forwards can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of price fluctuations in various asset classes. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking in asset prices. However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. This instrument is used by all sections of businesses, such as corporates, SMEs, banks, financial institutions, retail investors, etc. According to the International Swaps and Derivatives Association, more than 90 percent of the global 500 corporations use derivatives for hedging risks in interest rates, foreign exchange, and equities. In the over-the-counter (OTC) markets, interest rates (78.5%), foreign exchange (11.4%), and credit form the major derivatives, whereas in the exchange-traded segment, interest rates, government debt, equity index, and stock futures form the major chunk of the derivatives.
What are futures contracts?
Futures contracts are standardized derivative instruments. The instrument has an underlying product (tangible or intangible) and is impacted by the developments witnessed in the underlying product. The quality and quantity of the underlying asset are standardized. Futures contracts are transferable in nature. Three broad categories of participants—hedgers, speculators, and arbitragers—trade in the derivatives market.
  • Hedgers face risk associated with the price of an asset. They belong to the business community dealing with the underlying asset to a future instrument on a regular basis. They use futures or options markets to reduce or eliminate this risk.
  • Speculators have a particular mindset with regard to an asset and bet on future movements in the asset’s price. Futures and options contracts can give them an extra leverage due to margining system.
  • Arbitragers are in business to take advantage of a discrepancy between prices in two different markets. For example, when they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.
Important Distinctions
Exchange-Traded Vs. OTC Contracts: A significant bifurcation in the instrument is whether the derivative is traded on the exchange or over the counter. Exchange-traded contracts are standardized (futures). It is easy to buy and sell contracts (to reverse positions) and no negotiation is required. The OTC market is largely a direct market between two parties who know and trust each other. Most common example for OTC is the forward contract. Forward contracts are directly negotiated, tailor-made for the needs of the parties, and are often not easily reversed.
Distinction between Forward and Futures Contracts:
Futures Contracts Forward Contracts
Meaning: A futures contract is a contractual agreement between two parties to buy or sell a standardized quantity and quality of asset on a specific future date on a futures exchange. A forward contract is a contractual agreement between two parties to buy or sell an asset at a future date for a predetermined mutually agreed price while entering into the contract. A forward contract is not traded on an exchange.
Trading place: A futures contract is traded on the centralized trading platform of an exchange. A forward contract is traded in an OTC market.
Transparency in contract price: The contract price of a futures contract is transparent as it is available on the centralized trading screen of the exchange. The contract price of a forward contract is not transparent, as it is not publicly disclosed.
Valuations of open position and margin requirement: In a futures contract, valuation of open position is calculated as per the official closing price on a daily basis and mark-to-market (MTM) margin requirement exists. In a forward contract, valuation of open position is not calculated on a daily basis and there is no requirement of MTM on daily basis since the settlement of contract is only on the maturity date of the contract.
Liquidity: Liquidity is the measure of frequency of trades that occur in a particular futures contract. A futures contract is more liquid as it is traded on the exchange. A forward contract is less liquid due to its customized nature.
Counterparty default risk: In futures contracts, the exchange clearinghouse provides trade guarantee. Therefore, counterparty risk is almost eliminated. In forward contracts, counterparty risk is high due to the customized nature of the transaction.
Regulations: A regulatory authority and the exchange regulate a futures contract. A forward contract is not regulated by any exchange.
Benefits of Derivatives
  1. Price Risk Management: The derivative instrument is the best way to hedge risk that arises from its underlying. Suppose, ‘A’ has bought 100 shares of a real estate company with a bullish view but, unfortunately, the stock starts showing bearish trends after the subprime crisis. To avoid loss, ‘A’ can sell the same quantity of futures of the script for the time period he plans to stay invested in the script. This activity is called hedging. It helps in risk minimization, profit maximization, and reaching a satisfactory risk-return trade-off, with the use of a portfolio. The major beneficiaries of the futures instrument have been mutual funds and other institutional investors.
  2. Price Discovery: The new information disseminated in the marketplace is interpreted by the market participants and immediately reflected in spot and futures prices by triggering the trading activity in one or both the markets. This process of price adjustment is often termed as price discovery and is one of the major benefits of trading in futures. Apart from this, futures help in improving efficiency of the markets.
  3. Asset Class: Derivatives, especially futures, offer an exclusive asset class for not only large investors like corporates and financial institutions but also for retail investors like high networth individuals. Equity futures offer the advantage of portfolio risk diversification for all business entities. This is due to the fact that historically it has been witnessed that there lies an inverse correlation of daily returns in equities as compared to commodities.
  4. High Financial Leverage: Futures offer a great opportunity to invest even with a small sum of money. It is an instrument that requires only the margin on a contract to be paid in order to commence trading. This is also called leverage buying/selling.
  5. Transparency: Futures instruments are highly transparent because the underlying product (equity scripts/index) are generally traded across the country or even traded globally. This reduces the chances of manipulation of prices of those scripts. Secondly, the regulatory authorities act as watchdogs regarding the day-to-day activities taking place in the securities markets, taking care of the illegal transactions.
  6. Predictable Pricing: Futures trading is useful for the genuine investor class because they get an idea of the price at which a stock or index would be available at a future point of time.
Domestic Exchanges
Indian equities are traded on three major national exchanges: MCX Stock Exchange Limited (MCX-SX), Bombay Stock Exchange Limited (BSE) and National Stock Exchange of India Limited (NSE).
MCX Stock Exchange
MCX Stock Exchange Limited (MCX-SX), India’s new stock exchange, is recognized by the Securities and Exchange Board of India (SEBI) under Section 4 of the Securities Contracts (Regulation) Act, 1956. The Exchange was granted the status of a ‘recognized stock exchange’ by the Government of India on December 19, 2012. In line with global best practices and regulatory requirements, clearing and settlement of trades is conducted through a separate clearing corporation-MCX-SX Clearing Corporation Limited (MCX-SX CCL).

MCX-SX commenced operations in Currency Futures in the Currency Derivatives segment on October 7, 2008 under the regulatory framework of SEBI and Reserve Bank of India (RBI). The Exchange commenced trading in Currency Options on August 10, 2012. The Exchange received permissions to deal in Interest Rate Derivatives, Equity, Futures and Options on Equity and Wholesale Debt segments, vide SEBI’s letter dated July 10, 2012. The Exchange further received permission to commence trading in these new segments, vide SEBI’s letter dated December 19, 2012. The Exchange commenced trading in the Equity segment on February 11, 2013.

Benchmark Index: SX40

Bombay Stock Exchange (BSE)
BSE is the oldest stock exchange in Asia. The extensiveness of the indigenous equity broking industry in India led to the formation of the Native Share Brokers Association in 1875, which later became Bombay Stock Exchange Limited (BSE).
BSE is widely recognized due to its pivotal and pre-eminent role in the development of the Indian capital market.
  • In 1995, the trading system transformed from open outcry system to an online screen-based order-driven trading system.
  • The exchange opened up for foreign ownership (foreign institutional investment).
  • Allowed Indian companies to raise capital from abroad through ADRs and GDRs.
  • Expanded the product range (equities/derivatives/debt).
  • Introduced the book building process and brought in transparency in IPO issuance.
  • T+2 settlement cycle (payments and settlements).
  • Depositories for share custody (dematerialization of shares).
  • Internet trading (e-broking).
  • Governance of the stock exchanges (demutualization and corporatization of stock exchanges) and internet trading (e-broking).
BSE has a nation-wide reach with a presence in more than 450 cities and towns of India. BSE has always been at par with the international standards. It is the first exchange in India and the second in the world to obtain an ISO 9001:2000 certification. It is also the first exchange in the country and second in the world to receive Information Security Management System Standard BS 7799-2-2002 certification for its BSE Online Trading System (BOLT).
Benchmark Indices futures: BSE 30 SENSEX, BSE 100, BSE TECK, BSE Oil and Gas, BSE Metal, BSE FMCG

National Stock Exchange (NSE)
NSE was recognised as a stock exchange in April 1993 under the Securities Contracts (Regulation) Act. It commenced its operations in Wholesale Debt Market in June 1994. The capital market segment commenced its operations in November 1994, whereas the derivative segment started in 2000. NSE introduced a fully automated trading system called NEAT (National Exchange for Automated Trading) that operated on a strict price/time priority. This system enabled efficient trade and the ease with which trade was done. NEAT had lent considerable depth in the market by enabling large number of members all over the country to trade simultaneously, narrowing the spreads significantly.
The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12, 2000. The futures contract on NSE is based on S&P CNX Nifty Index. The Futures and Options trading system of NSE, called NEAT-F&O trading system, provides a fully automated screen based trading for S&P CNX Nifty futures on a nationwide basis and an online monitoring and surveillance mechanism. It supports an order-driven market and provides complete transparency of trading operations.
Benchmark Indices futures: Nifty Midcap 50 futures, S&P CNX Nifty futures, CNX Nifty Junior, CNX IT futures, CNX 100 futures, Bank Nifty futures

International Exchanges
Due to increasing globalization, the development at macro and micro levels in international markets is compulsorily incorporated in the performance of domestic indices and individual stock performance, directly or indirectly. Therefore, it is important to keep track of international financial markets for better perspective and intelligent investment.
  1. NASDAQ (National Association of Securities Dealers Automated Quotations) NASDAQ is an American stock exchange. It is an electronic screen-based equity securities trading market in the US. It was founded in 1971 by the National Association of Securities Dealers (NASD). However, it is owned and operated by NASDAQ OMX group, the stock of which was listed on its own stock exchange in 2002. The exchange is monitored by the Securities and Exchange Commission (SEC), the regulatory authority for the securities markets in the United States.
    NASDAQ is the world leader in the arena of securities trading, with 3,900 companies (NASDAQ site) being listed. There are four major indices of NASDAQ that are followed closely by the investor class, internationally.
    1. NASDAQ Composite: It is an index of common stocks and similar stocks like ADRs, tracking stocks and limited partnership interests listed on the NASDAQ stock market. It is estimated that the total components count of the Index is over 3,000 stocks and it includes stocks of US and non-US companies, which makes it an international index. It is highly followed in the US and is an indicator of performance of technology and growth companies. When launched in 1971, the index was set at a base value of 100 points. Over the years, it saw new highs; for instance, in July 1995, it closed above 1,000-mark and in March 2000, it touched 5048.62. The decline from this peak signalled the end of the dotcom stock market bubble. The Index never reached the 2000 level afterwards. It was trading at 1316.12 on November 20, 2008.
    2. NASDAQ 100: It is an Index of 100 of the largest domestic and international non-financial companies listed on NASDAQ. The component companies’ weight in the index is based on their market capitalization, with certain rules controlling the influence of the largest components. The index doesn’t contain financial companies. However, it includes the companies that are incorporated outside the US. Both these aspects of NASDAQ 100 differentiate it from S&P 500 and Dow Jones Industrial Average (DJIA). The index includes companies from the industrial, technology, biotechnology, healthcare, transportation, media, and service sectors.
    3. Dow Jones Industrial Average (DJIA): DJIA was formed for the first time by Charles Henry Dow. He formed a financial company with Edward Jones in 1882, called Dow Jones & Co. In 1884, they formed the first index including 11 stocks (two manufacturing companies and nine railroad companies). Today, the index contains 30 blue-chip industrial companies operating in America. The Dow Jones Industrial Average is calculated through the simple average, i.e., the sum of the prices of all stocks divided by the number of stocks (30).
    4. S&P 500: The S&P 500 Index was introduced by McGraw Hill's Standard and Poor's unit in 1957 to further improve tracking of American stock market performance. In 1968, the US Department of Commerce added S&P 500 to its index of leading economic indicators. S&P 500 is intended to be consisting of the 500 largest publically-traded companies in the US by market capitalization (in contrast to the FORTUNE 500, which is the largest 500 companies in terms of sales revenue). The S&P 500 Index comprises about three-fourths of total American capitalization.

  2. LSE (London Stock Exchange) The London Stock Exchange was founded in 1801 with British as well as overseas companies listed on the exchange. The LSE has four core areas:
    1. Equity markets: The LSE enables companies from around the world to raise capital. There are four primary markets; Main Market, Alternative Investment Market (AIM), Professional Securities Market (PSM), and Specialist Fund Market (SFM).
    2. Trading services: Highly active market for trading in a range of securities, including UK and international equities, debt, covered warrants, exchange-traded funds (ETFs), exchange-traded commodities (ETCs), REITs, fixed interest, contracts for difference (CFDs), and depositary receipts.
    3. Market data information: The LSE provides real-time prices, news, and other financial information to the global financial community.
    4. Derivatives: A major contributor to derivatives business is EDX London, created in 2003 to bring the cash, equity, and derivatives markets closer together. It combines the strength and liquidity of LSE and equity derivatives technology of NASDAQ OMX group.
    The exchange offers a range of products in derivatives segment with underlying from Russian, Nordic, and Baltic markets. Internationally, it offers products with underlying from Kazakhstan, India, Egypt, and Korea.

  3. Frankfurt Stock Exchange It is situated in Frankfurt, Germany. It is owned and operated by Deutsche Börse. The Frankfurt Stock Exchange has over 90 percent of turnover in the German market and a big share in the European market. The exchange has a few well-known trading indices of the exchange, such as DAX, DAXplus, CDAX, DivDAX, LDAX, MDAX, SDAX, TecDAX, VDAX, and EuroStoxx 50. 
    DAX is a blue-chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. Prices are taken from the electronic Xetra trading system of the Frankfurt Stock Exchange.

There are four main legislations governing the securities market:
  1. The SEBI Act, 1992 establishes SEBI to protect investors and develop and regulate the securities market.
  2. The Companies Act, 1956 sets out the code of conduct for the corporate sector in relation to issue, allotment, and transfer of securities, and disclosures to be made in public issues.
  3. The Securities Contracts (Regulation) Act, 1956 provides for regulation of transactions in securities through control over stock exchanges.
  4. The Depositories Act, 1996 provides for electronic maintenance and transfer of ownership of demat securities.
In India, the responsibility of regulating the securities market is shared by DCA (the Department of Company Affairs), DEA (the Department of Economic Affairs), RBI (the Reserve bank of India), and SEBI (the Securities and Exchange Board of India).
The DCA is now called the ministry of company affairs, which is under the ministry of finance. The ministry is primarily concerned with the administration of the Companies Act, 1956, and other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the corporate sector in accordance with the law. 
The ministry exercises supervision over the three professional bodies, namely Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of India (ICSI), and the Institute of Cost and Works Accountants of India (ICWAI), which are constituted under three separate Acts of Parliament for the proper and orderly growth of professions of chartered accountants, company secretaries, and cost accountants in the country.

SEBI protects the interests of investors in securities and promotes the development of the securities market. The board helps in regulating the business of stock exchanges and any other securities market. SEBI is also responsible for registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, and such other intermediaries who may be associated with securities markets in any manner.
The board registers the venture capitalists and collective investments like mutual funds. SEBI helps in promoting and regulating self regulatory organizations.

RBI is also known as the banker’s bank. The central bank has some very important objectives and functions such as:
  • Maintain price stability and ensure adequate flow of credit to productive sectors.
  • Maintain public confidence in the system, protect depositors' interest, and provide cost-effective banking services to the public.
  • Facilitate external trade and payment and promote orderly development and maintenance of the foreign exchange market in India.
  • Give the public adequate quantity of supplies of currency notes and coins in good quality.
  • Formulate implements and monitor the monetary policy.
  • Prescribe broad parameters of banking operations within which the country's banking and financial system functions.
  • Manage the Foreign Exchange Management Act, 1999.
  • Issue new currency and coins and exchange/destroy currency and coins not fit for circulation.
  • Perform a wide range of promotional functions to support national objectives.

The DEA is the nodal agency of the Union government to formulate and monitor the country's economic policies and programmes that have a bearing on domestic and international aspects of economic management. Apart from forming the Union Budget every year, it has other important functions like:
  1. Formulation and monitoring of macro-economic policies, including issues relating to fiscal policy and public finance, inflation, public debt management, and the functioning of capital market, including stock exchanges. In this context, it looks at ways and means to raise internal resources through taxation, market borrowings, and mobilization of small savings.
  2. Monitoring and raising of external resources through multilateral and bilateral development assistance, sovereign borrowings abroad, foreign investments, and monitoring foreign exchange resources, including balance of payments.
  3. Production of bank notes and coins of various denominations, postal stationery, postal stamps, cadre management, career planning, and training of the Indian Economic Service (IES).

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