XI

Equity
Sales
 Workbook for
NISM-Series-XI: Equity Sales
Certification Examination

National Institute of Securities Markets

www.nism.ac.in
This workbook has been developed to assist candidates in preparing for the National Institute
of Securities Markets (NISM) for NISM-Series-XI: Equity Sales Certification Examination.

Workbook Version: October 2019

Published by:
National Institute of Securities Markets
© National Institute of Securities Markets, 2019
NISM Bhavan, Plot 82, Sector 17, Vashi
Navi Mumbai – 400 703, India

All rights reserved. Reproduction of this publication in any form without prior permission of
the publishers is strictly prohibited.

ii
Foreword

NISM is a leading provider of high end professional education, certifications, training and
research in financial markets. NISM engages in capacity building among stakeholders in the
securities markets through professional education, financial literacy, enhancing governance
standards and fostering policy research. NISM works closely with all financial sector regulators
in the area of financial education.

NISM Certification programs aim to enhance the quality and standards of professionals
employed in various segments of the financial services sector. NISM’s School for Certification
of Intermediaries (SCI) develops and conducts certification examinations and Continuing
Professional Education (CPE) programs that aim to ensure that professionals meet the defined
minimum common knowledge benchmark for various critical market functions.

NISM certification examinations and educational programs cater to different segments of

intermediaries focusing on varied product lines and functional areas. NISM Certifications have
established knowledge benchmarks for various market products and functions such as
Equities, Mutual Funds, Derivatives, Compliance, Operations, Advisory and Research.

NISM certification examinations and training programs provide a structured learning plan and
career path to students and job aspirants who wish to make a professional career in the
securities markets. Till March 2019, NISM has certified nearly 8 lakh individuals through its
Certification Examinations and CPE Programs.

NISM supports candidates by providing lucid and focused workbooks that assist them in
understanding the subject and preparing for NISM Examinations. The book covers basics of
the Indian equity markets, risk, return and taxation aspects of equity, clearing, settlement and
risk management as well as the regulatory environment in which the equity markets operate
in India. It will be immensely useful to all those who want to have a better understanding of
Indian equity markets.

S. K. Mohanty
Director

iii
Disclaimer

The contents of this publication do not necessarily constitute or imply its endorsement,
recommendation, or favouring by the National Institute of Securities Markets (NISM) or the
Securities and Exchange Board of India (SEBI). This publication is meant for general reading
and educational purpose only. It is not meant to serve as guide for investment. The views and
opinions and statements of authors or publishers expressed herein do not constitute personal
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The statements/explanations/concepts are of general nature and may not have taken into
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move or action taken based on the information available in this publication.

Therefore, before acting on or following the steps suggested on any theme or before
following any recommendation given in this publication, the user/reader should
consider/seek professional advice.

The publication contains information, statements, opinions, statistics and materials that have
been obtained from sources believed to be reliable and the publishers of this title have made
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Since the work and research is still going on in all these knowledge streams, NISM and SEBI
do not warrant the totality and absolute accuracy, adequacy or completeness of this
information and material and expressly disclaim any liability for errors or omissions in this
information and material herein. NISM and SEBI do not accept any legal liability what so ever
based on any information contained herein.

While the NISM Certification examination will be largely based on material in this workbook,
NISM does not guarantee that all questions in the examination will be from material covered
herein.

iv
Acknowledgement

This workbook has been developed and reviewed by the Certification team of NISM in
coordination with its subject matter experts. NISM gratefully acknowledges the contribution
of the Examination Committee of NISM-Series-XI: Equity Sales Certification Examination
consisting of representatives from the Indian Securities Market and Industry Experts.

v
About NISM Certifications

The School for Certification of Intermediaries (SCI) at NISM is engaged in developing and
administering Certification Examinations and CPE Programs for professionals employed in
various segments of the Indian securities markets. These Certifications and CPE Programs are
being developed and administered by NISM as mandated under Securities and Exchange
Board of India (Certification of Associated Persons in the Securities Markets) Regulations,
2007.

The skills, expertise and ethics of professionals in the securities markets are crucial in
providing effective intermediation to investors and in increasing the investor confidence in
market systems and processes. The School for Certification of Intermediaries (SCI) seeks to
ensure that market intermediaries meet defined minimum common benchmark of required
functional knowledge through Certification Examinations and Continuing Professional
Education Programs on Mutual Funds, Equities, Derivatives, Securities Operations,
Compliance, Research Analysis, Investment Advice and many more.

Certification creates quality market professionals and catalyzes greater investor participation
in the markets. Certification also provides structured career paths to students and job
aspirants in the securities markets.

vi
About the Workbook

This workbook has been developed to assist candidates in preparing for the National Institute
of Securities Markets (NISM) Equity Sales Certification Examination. NISM-Series-XI: Equity
Sales Certification Examination seeks to create common minimum knowledge benchmark for
all persons involved in the sale of equity products in order to enable a better understanding
of equity markets, better quality investor service, operational process efficiency and risk
controls.

The book covers basics of the Indian equity markets, risk, return and taxation aspects of
equity, clearing, settlement and risk management as well as the regulatory environment in
which the equity markets operate in India.

vii
About the NISM-Series-XI: Equity Sales Certification Examination

The examination seeks to create a common minimum knowledge benchmark for all persons
involved in the sale of equity products in order to enable a better understanding of equity
markets, better quality investor service, operational process efficiency and risk controls.
It seeks to ensure a basic understanding of the various aspects of the equity products, the
process flow involved in trading, clearing and settlement of these products and the regulatory
environment under which the market operates.

Examination Objectives
On successful completion of the examination the candidate should:
 Know the basics of the Indian equity market.
 Understand the characteristics of equity, associated risks and returns and taxation
aspects.
 Understand the clearing, settlement and risk management as well as the operational
mechanism related to equity market.
 Know the regulatory environment in which the equity market operates in India.

Assessment Structure
The examination consists of 100 questions of 1 mark each and should be completed in 2
hours. The passing score for the examination is 50%. There shall be negative marking of 25%
of the marks assigned to a question.

How to register and take the online certification examination

To find out more and register for the examination please visit www.nism.ac.in

viii
TABLE OF CONTENTS
1 Overview of Indian Securities Market.......................................................................... 1
1.1 Introduction ............................................................................................................................ 1
1.2 Market Regulators .................................................................................................................. 3
1.3 Market Segments .................................................................................................................... 5
1.4 Market Participants................................................................................................................. 8
1.5 Types of Investors ................................................................................................................. 11
1.6 Some Key Concepts ............................................................................................................... 12
2 Regulatory Framework.............................................................................................. 17
2.1 Securities Contracts (Regulation) Act, 1956 ......................................................................... 17
2.2 Securities Contracts (Regulation) Rules, 1957 ...................................................................... 18
2.3 Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations,
2018 ...................................................................................................................................... 20
2.4 Securities and Exchange Board of India Act, 1992 ................................................................ 21
2.5 The Depositories Act, 1996 ................................................................................................... 23
2.6 The Companies Act 1956/2013 ............................................................................................. 23
2.7 Prevention of Money Laundering Act, 2002 ......................................................................... 26
2.8 SEBI (Stock-Brokers) Regulations, 1992 ................................................................................ 28
2.9 SEBI (Prohibition of Insider Trading) Regulations, 2015 ....................................................... 31
2.10 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulation, 2003 ................................................................................................................... 34
2.11 Authorised Persons ............................................................................................................... 35
3 Primary Market ........................................................................................................ 40
3.1 Introduction .......................................................................................................................... 40
3.2 Issue of Shares ...................................................................................................................... 41
3.3 Public Issue............................................................................................................................ 47
4 Secondary Market..................................................................................................... 56
4.1 Introduction .......................................................................................................................... 56
4.2 Functioning of the Secondary Market .................................................................................. 57
4.3 Market Phases....................................................................................................................... 60
5 Understanding Market Indicators.............................................................................. 63
5.1 Index and its Significance ...................................................................................................... 63
5.2 Types of Indices based on Calculation Methodology ........................................................... 65
5.3 Indices in India ...................................................................................................................... 68
5.4 Impact cost – A Measure of Market Liquidity ....................................................................... 70
5.5 Risk and Beta ......................................................................................................................... 70
5.6 Market Capitalization Ratio .................................................................................................. 71
5.7 Turnover Ratio ...................................................................................................................... 72
5.8 Fundamental Analysis ........................................................................................................... 73
5.9 Technical Analysis ................................................................................................................. 74
6 Trading and Risk Management .................................................................................. 79
6.1 Trading Systems in India ....................................................................................................... 79
6.2 Orders ................................................................................................................................... 81

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 6.3 Trade Life Cycle ..................................................................................................................... 83
6.4 Mechanism of Circuit Breakers ............................................................................................. 84
6.5 Transaction Charges .............................................................................................................. 85
6.6 Capital Adequacy Requirements of Trading Members ......................................................... 87
6.7 Risk Management System ..................................................................................................... 88
6.8 Margin Trading ......................................................................................................................... 95
7 Clearing and Settlement ............................................................................................ 99
7.1 Types of Accounts ................................................................................................................. 99
7.2 Clearing Process .................................................................................................................. 100
8 Market Surveillance ................................................................................................ 108
8.1 Introduction ........................................................................................................................ 108
8.2 Market Surveillance Mechanism......................................................................................... 109
8.3 Surveillance Actions ............................................................................................................ 116
8.4 Surveillance Measures ........................................................................................................ 117
9 Client Management ................................................................................................ 120
9.1 Introduction ........................................................................................................................ 120
9.2 Types of Risks ...................................................................................................................... 120
9.3 Risk Profiling of Investors .................................................................................................... 122
9.4 Financial Planning ............................................................................................................... 122
9.5 Product Suitability ............................................................................................................... 127
9.6 Review of Client’s Portfolio ................................................................................................. 128
9.7 Client Account ..................................................................................................................... 128
9.8 Taxation............................................................................................................................... 130
9.9 Investor Grievance Mechanism .......................................................................................... 132

x
 1 Overview of Indian Securities Market

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Overview of the Indian Financial Markets
 Financial Market Regulators
 Market segments in securities markets and products traded in those segments
 Types of market participants in securities markets
 Types of investors

1.1 Introduction
Securities market helps in transfer of resources from those with idle or surplus resources to
others who have a productive need for them. To state formally, securities market provides
channels for allocation of savings to investments and thereby decouple these two activities.
As a result, the savers and investors are not constrained by their individual abilities, but by
the economy’s abilities to invest and save respectively, which inevitably enhances savings and
investment in the economy. A financial market consists of investors (buyers of securities),
borrowers (sellers of securities), intermediaries (providing the infrastructure for fair trading)
and regulatory bodies.

1.1.1 Indian Securities Market

The Indian financial market has been illustrated in the figure below (Figure 1.1).

Figure 1.1: Indian Financial Market

Financial
Market

Securities
Money Market
Market

Organised Unorganised Secondary

Primary Market
Money Market Money Market Market

Short Term Money Lenders

Lending / / Indigenous
Borrowing Bankers

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The securities market has two interdependent and inseparable segments, viz., the new issuers
(primary) market and the stock (secondary) market.
The primary market is used by issuers for raising fresh capital from the investors by making
initial public offers or rights issues or offers for sale of equity or debt; on the other-hand the
secondary market provides liquidity to these instruments, through trading and settlement on
the stock exchanges. An active secondary market promotes the growth of the primary market
and capital formation, since there is a continuous market where investors have an option to
liquidate their investments, as per their needs. Thus, in the primary market, the issuer has
direct contact with the investor, while in the secondary market, the dealings are between two
investors and there is no role of the issuer.
The resources in the primary market can be raised either through the private placement route
or through the public issue route by way of Initial Public Offer (IPO) or Further Public Offer
(FPO). It is a public issue, if it is open to general public, whereas, if the issue is offered to select
group of people (less than 50 in number) then it is termed as private placement.
The secondary market on the other hand operates through two mediums, namely, the Over-
The-Counter (OTC) market and the Exchange Traded Market. OTC markets are the informal
markets where trades are negotiated. The other option of trading is through the stock
exchanges (exchange traded market), where settlements of standard trades are done as per
a fixed time schedule. The trades executed on the exchange are settled through the clearing
corporation, which acts as a counterparty and guarantees settlement.
Normally, OTC transactions do not happen through exchange platforms. This might lead to
chances of counter party risks in OTC transactions. In case of transaction through Exchange
platforms, the clearing corporation acts as a central counter party and hence, counter party
risk is less or almost nil. OTC is more an informal market while trades through exchange are
well regulated.
There are several major players in the primary market; market participants and
intermediaries. These include the merchant bankers (MB) or investment bankers, mutual
funds (MF), financial institutions (FI), foreign portfolio investors (FPI), individual investors; the
issuers including companies, bodies corporate; lawyers, bankers to the issue, brokers, and
depository participants. The stock exchanges are involved to the extent of listing of the
securities. In the secondary market, there are the stock exchanges, stock brokers, the mutual
funds, financial institutions, FPIs, individual investors, depository participants and banks.
The Registrars and Transfer Agents (RTA), Clearing Corporations, Custodians and Depositories
are capital market intermediaries which provide infrastructure services to both the primary
and the secondary markets.
1.1.2 Role of Securities Markets in India
The securities market allows people to do more with their savings than they would otherwise.
It also facilitates people to invest in the best ideas and talents in the economy. It mobilizes
savings and channelises them through securities into preferred enterprises.
The securities market enables all individuals, irrespective of their means, to share the
increased wealth provided by competitive enterprises. The securities market allows
individuals, who cannot carry an activity in its entirety within their resources, to invest their
money in varied proportions into business units engaged in such activities.

2
Conversely, individuals who cannot begin an enterprise they like, can attract enough
investment from others to make a start and continue to progress and prosper. In either case,
individuals who contribute to the investment share the profits.
The securities market also provides a market place for purchase and sale of securities and
thereby ensures transferability of securities, which is the basis for the joint stock enterprise
system. The liquidity available to investors does not inconvenience the enterprises that
originally issued the securities to raise funds and, in fact, facilitates the enterprises to raise
additional funds, if and when required. The existence of the securities market makes it
possible to satisfy simultaneously the needs of the enterprises for capital and of investors for
liquidity.
The liquidity the market confers and the yield promised or anticipated on security encourages
people to make additional savings out of current income. In the absence of the securities
market, the additional savings would have been consumed otherwise. Thus the provision of
securities market results in net savings. The securities market enables a person to allocate his
savings among a number of investments. This helps him to diversify risks among many
enterprises, which increases the likelihood of long term overall gains.1
1.2 Market Regulators
The regulators in the Indian securities market ensures that the market participants behave in
a desired manner so that securities market continues to be a major source of finance for
corporate and government and the interest of investors are protected. Various regulators
who regulate the activities of different sectors of the financial market are as given below:
 Ministry of Finance (MoF)
 Ministry of Corporate Affairs (MCA)
 Reserve Bank of India (RBI) is the authority to regulate and monitor the Banking sector
 Securities and Exchange Board of India (SEBI) regulates the Securities Industry
 Insurance Regulatory and Development Authority of India (IRDAI) regulates the
Insurance sector
 Pension Fund Regulatory and Development Authority (PFRDA) regulates the pension
fund sector
The process of mobilisation of resources is carried out under the supervision and overview of
the regulators. The regulators develop fair market practices and regulate the conduct of
issuers of securities and the intermediaries. They are also in charge of protecting the interests
of the investors. The regulator ensures a high service standard from the intermediaries and
supply of quality securities and non-manipulated demand for them in the market.
1.2.1 Securities and Exchange Board of India
Securities and Exchange Board of India (SEBI) is the regulatory authority for the securities
markets in India. SEBI was established in accordance with the provisions of the SEBI Act, 1992.
The Preamble of the SEBI describes the basic functions as:

1
Source: S. D. Gupte Memorial Lecture delivered by Shri G. N. Bajpai, Chairman, SEBI at Mumbai on March 13,
2003. This lecture heavily borrows from the Indian Securities Market Review, 2002, a publication of NSE and an
article “Securities Market Reforms in a Developing Country” by M. S. Sahoo, published in Chartered Secretary,
November 1997.

3
“….. to protect 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”
Thus, SEBI’s primary role is to protect the interest of the investors in securities and to promote
the development of and to regulate the securities market, by measures it thinks fit.
SEBI’s regulatory jurisdiction extends over corporates in the issuance of capital and transfer
of securities, in addition to all intermediaries and persons associated with securities market.
It can conduct enquiries, audits and inspection of all concerned and adjudicate offences under
the Act. It has powers to register and regulate all market intermediaries and also to penalise
them in case of violations of the provisions of the Act, Rules and Regulations made there
under. SEBI has full autonomy and authority to regulate and develop an orderly securities
market.
The main functions of SEBI are listed as below:
 Protecting the interests of investors in securities.
 Promoting the development of the securities market.
 Regulating the business in stock exchanges and any other securities markets.
 Registering and regulating the working of intermediaries, such as stock brokers, share
transfer agents, investment advisers etc., associated with the securities markets.
 Promoting and regulating self-regulatory organizations
 Promoting investors’ education and training of intermediaries of securities markets.
 Prohibiting fraudulent and unfair trade practices and insider trading in securities
 Calling for information from, undertaking inspection, conducting inquiries and audits
of the stock exchanges, intermediaries, self–regulatory organizations, mutual funds
and other persons associated with the securities market.
The orders of SEBI under the securities laws are appealable before Securities Appellate
Tribunal (SAT).
1.2.2 Reserve Bank of India
Reserve Bank of India (RBI) is the central bank of the country which has the responsibility of
administering the monetary policy. It focuses on adequate flow of money supply in the
economy to facilitate financial transactions and economic growth along with a stable
permissible inflation rate. This is borne out in its Preamble, in which the basic functions of the
Bank are thus defined: “…to regulate the issue of Bank Notes and keeping of reserves with a
view to securing monetary stability in India and generally to operate the currency and credit
system of the country to its advantage”. In addition to the primary responsibility of
administering India’s monetary policy, RBI has other onerous responsibilities, such as financial
supervision.
The main functions of RBI are listed as below:
1. As the monetary authority: to formulate, implement and monitor the monetary policy
in a manner as to maintain price stability while ensuring an adequate flow of credit to
productive sectors of the economy.

4
 2. As the regulator and supervisor of the financial system: To prescribe broad
parameters of banking operations within which Indian banking and financial system
functions. The objective here is to maintain public confidence in the system, protect
the interest of the people who have deposited money with the bank and facilitate
cost-effective banking services to the public.
3. As the manager of Foreign Exchange: To administer the Foreign Exchange
Management Act 1999, in a manner as to facilitate external trade and payment and
promote orderly development and maintenance of the foreign exchange market in
India.
4. As the issuer of currency: To issue currency and coins and to exchange or destroy the
same when not fit for circulation. The objective that guides RBI here is to ensure the
circulation of an adequate quantity of currency notes and coins of good quality.
5. Developmental role: To perform a wide range of promotional functions to support
national objectives.
6. Banking functions: RBI acts as a banker to the Government and manages issuances of
Central and State Government Securities. It also acts as banker to the banks by
maintaining the banking accounts of all scheduled banks.
1.2.3 Self Regulatory Organisations (SRO)
SEBI has framed the SEBI (Self Regulatory Organisations) Regulations, 2004, which require the
SROs to undertake the following:
 Abiding by rules of SEBI
 Responsibility for investor protection and investor education
 Ensuring the observation of securities law by its members
 Specifying code of conduct for members and ensuring compliance thereon
 Conducting audit and inspection of members through independent auditors
 Submitting its annual report to SEBI
 Keeping SEBI promptly informed of any violations of securities law by any of its
members
 Conducting screening and certification tests for members
The SROs ensure compliance with their own rules as well as with the rules relevant for them
under the securities laws. Thus, they are the first level market regulators. They share the
responsibility of market regulation with SEBI. They are empowered to establish their bye-laws
and enforce the same.
1.3 Market Segments
The investors in the Indian securities market have a wide choice of product base to choose
from depending upon a person’s risk appetite and needs. Broadly, the products available can
be categorized as equity, debt and derivatives.
1.3.1 Equity Segment
The equity segment of the stock exchange allows trading in shares, debentures, warrants,
mutual funds and exchange traded funds (ETFs).

5
Equity shares represent the form of fractional ownership in a business venture. Equity
shareholders collectively own the company. They bear the risk and enjoy the rewards of
ownership.
Indian companies are permitted to raise foreign currency resources in the form of issue of
ordinary equity shares through depository receipts, i.e., Global depository receipts (GDR) and
American depository receipts (ADR).
A depository receipt is a negotiable instrument in the form of a certificate denominated in
US Dollars. The certificates are issued by an overseas depository bank against certain
underlying stock/ shares. The shares are deposited by the issuer with the overseas depository
bank and the shares are held by the local custodian, appointed for this purpose. The receipt
holder has a right to receive dividend, other payments and benefits which the company
announces for the shareholders. However, it is a non-voting equity holding. As the name
suggests, ADRs are issued in the American market and GDRs in the global (mainly European)
markets.
In order to improve liquidity in the ADR/GDR market, RBI issued guidelines in 2002 to permit
two-way fungibility for ADRs/GDRs. This means that investors in any ADR/ GDR can convert
their holdings into shares and vice versa. Thus, when a security is termed fungible, it refers to
the feature that allows an instrument to be replaced by another of a similar description, as
for instance, an ADR, vis-à-vis its underlying share.
Debentures are instruments for raising long term debt. Debentures in India are typically
secured by tangible assets. There are 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. 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 a feature of conversion. The NCDs are
repayable on maturity. Partly Convertible debentures have features of convertible and non-
convertible debentures. Thus, debentures can be pure debt or quasi-equity, as the case may
be.
Warrants entitle an investor to buy equity shares after a specified time period at a given price.
Mutual Funds (MF) are investment vehicles where people with similar investment objective
come together to pool their money and then invest accordingly. In turn the investors are
issued units of the MF scheme under which they would have invested. MF schemes can be
classified as open-ended or close-ended.
An open-ended scheme offers the investor the option to buy units from the fund at any time
and sell the units back to the fund at any time. These schemes do not have any fixed maturity
period. The units can be bought and sold at Net Asset Value (NAV) related prices.
The units of a close-ended scheme are offered to the investors for subscription for a specified
time period. After the subscription period closes, the fund does not accept any new
subscriptions. The close-ended schemes have a fixed maturity period. These schemes are
mandatorily listed and traded on the stock exchange to provide liquidity to its investors.
Mutual funds can invest in many kinds of securities. The most common are cash instruments,
stocks, and bonds, but there are many sub-categories. Equity mutual funds, for instance, can

6
invest primarily in the shares of a particular industry, such as technology or utilities. These are
known as sector funds. Bond funds can vary according to risk (e.g., investment-grade
corporate bonds), type of issuers (e.g., government agencies, corporations, or municipalities),
or maturity of the bonds (short or long-term). There are also fund of funds, international funds
and arbitrage funds, among the sub-categories.
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.
1.3.2 Debt Segment
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 two parts: government securities (G-Sec)
market and the corporate bond market.
Government Securities Market: The government needs enormous amount of money to
perform various functions such as maintaining law and order, justice, national defence,
central banking, creation of physical infrastructure. For this, it borrows from banks and other
financial institutions. It also borrows funds from corporate and Foreign Portfolio Investors
(FPIs). This is the government securities market.
The government raises short term and long term funds by issuing securities. These securities
do not carry default risk as the government guarantees the payment of interest and the re-
payment of principal. They are referred to as gilt edged securities. Government securities 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, FPIs. Government securities are of two types- treasury bills and government
dated securities.
Corporate Bond Market: Corporate bonds are bonds issued by companies to meet their
needs for expansion, modernization, restructuring operations, mergers and acquisitions. The
corporate debt market is a market where debt securities of corporates are issued and traded
therein. The investors in this market are banks, financial institutions, insurance companies,
mutual funds, FPIs etc. Corporates adopt either the public offering route or the private
placement route for issuing debentures/bonds.
Other instruments available for trading in the debt segment are Treasury Bills (T-bill),
Commercial Papers (CP) and Certificate of Deposits (CD).
1.3.3 Derivatives Segment
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). The underlying asset can be equity,
forex, commodity or any other asset. The derivatives segment in India allows trading in the
equities, currency, interest rates and commodities. There are two types of derivatives
instruments viz., Futures and Options that are traded on the Indian stock exchanges.
Derivatives are like contracts, as you will observe from the examples below.

7
Index or 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 or 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 buyer 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 i.e. Currency Futures and Options are traded on Indian exchanges on
the Indian Rupee (INR) currency pairs (USD-INR, EUR-INR, GBP-INR and JPY-INR) and also on
cross currency pairs (EUR-USD, GBP-USD and USD-JPY).
Commodity Derivatives markets are markets where raw or primary products such as gold,
silver and agricultural goods are exchanged. These raw commodities are traded on regulated
commodities exchanges, in which they are bought and sold in standardized contracts for a
specified future date. Commodity markets facilitate the trading of commodities.
Interest Rate Futures contract is an agreement to buy or sell a debt instrument at a specified
future date at a price that is fixed today. The underlying security for Interest Rate Futures is
either Government of India (GOI) Bond or T-Bill. Exchange traded Interest Rate Futures are
standardized contracts based on 91-day T-Bill and on GOI bonds of 6-years, 10-Years and 13-
years maturity and are cash settled.
Internationally many more derivative products are traded including interest rate swaps,
collateralised debt obligations (CDO), bond derivatives, etc.
1.4 Market Participants
Market Participants provide intermediation services between the buyers and sellers of
securities in the Indian securities markets. Before providing facilities to the investors, it is
mandatory for intermediaries to get themselves registered with the Securities Market
Regulator, i.e. SEBI. Market participants may get registered with SEBI as Stock Exchanges,
Stock Brokers, Registrars and Transfer Agents, Merchant Bankers, Clearing Corporation,
Depositories, Depository Participants, etc. We briefly discuss the function provided by each
registered market participant in the Indian context.
1.4.1 Stock Exchanges
The stock exchanges provide a trading platform where the buyers and sellers (investors) can
transact in securities. In the olden days the securities transactions used to take place in the
trading hall or the “Ring” of the Stock Exchanges where the Stock Brokers used to meet and
transact whereas, in the modern world the trading takes place online through computer
connected through VSATs & Internet.
The Securities Contracts (Regulation) Act, 1956 (SCRA) defines ‘Stock Exchange’ as a body of
individuals, whether incorporated or not, constituted for the purpose of assisting, regulating
or controlling the business of buying, selling or dealing in securities. Stock exchange could be
a regional stock exchange whose area of operation/jurisdiction is specified at the time of its
recognition or national exchanges, which are permitted to have nationwide trading since
inception.

8
1.4.2 Depositories
Depositories are organisations that hold securities (like shares, debentures, bonds,
government securities, mutual fund units, etc.) of investors in electronic form at the request
of the investors through a registered Depository Participant. It also provides services related
to transactions in securities. Currently there are two Depositories in India, Central Depository
Services (India) Limited (CDSL) and National Securities Depository Limited (NSDL), registered
with SEBI. They have been established under the Depositories Act, 1996 for the purpose of
facilitating dematerialization of securities and assisting in trading of securities in the demat
form.
Besides providing custodial facilities and dematerialisation, depositories offer various
transactional services to its clients to effect buying, selling, transfer of shares etc.
1.4.3 Depository Participant
A Depository Participant (DP) is an agent of the depository through which it interfaces with
the investors and provides depository services.
Depository Participants are appointed by a depository with the approval of SEBI. Public
financial institutions, scheduled commercial banks, foreign banks operating in India with the
approval of the Reserve Bank of India, state financial corporations, custodians, stock-brokers,
clearing corporations /clearing houses, NBFCs and Registrar to an Issue or Share Transfer
Agents complying with the requirements prescribed by SEBI can be registered as DP. Like
banking services can be availed through a branch, similarly, depository services can be availed
through a DP.
1.4.4 Trading Members / Stock Brokers & Authorized Persons
Trading member or a Stock Broker is a member of a Stock Exchange. Authorized Person is also
a member of Stock Exchange and acts on behalf of a trading member as an agent or otherwise
for assisting the investors in buying, selling or dealing in securities through such trading
members. Trading members can be individuals (sole proprietor), Partnership Firms,
Corporates and Banks, who are permitted to become trading and clearing members of
recognized stock exchanges subject to fulfillment of minimum prudential requirements.
1.4.5 Clearing Members
Clearing Members are those who help in clearing of the trades. There are Professional
Clearing Members (PCM), Trading Cum Clearing Members (TCM) and Self Clearing Members
(SCM) in the securities market.
 Professional Clearing Members (PCM) & Trading cum Clearing Members (TCM)
PCM has the right only to clear trades. A PCM does not have any trading rights. The
TCM has both trading and clearing rights.
 Self Clearing Members (SCM)
As the name implies, self clearing members can clear their own trades. The only
difference between SCM and TCM is that SCM does not have the rights to clear the
trades of other members. SCM can only clear his own trades, whereas TCM can clear
the trades of other trading members in addition to his own trades.

9
Any member of the equity segment of the Exchange is eligible to become trading cum clearing
member of the Derivatives Segment also. However, membership is not automatic and has to
be applied for.
Custodians
A Custodian is an entity that helps register and safeguard the securities of its clients. Besides
safeguarding securities, a custodian also keeps track of corporate actions on behalf of its
clients. It also helps in:
 Maintaining a client’s securities account
 Collecting the benefits or rights accruing to the client in respect of securities
 Keeping the client informed of the actions taken or to be taken by the issuer of
securities, having a bearing on the benefits or rights accruing to the client.
Custodians are clearing members like 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. The custodian is required to confirm, after conferring with his client, whether he
is going to settle that trade or not. In case the custodian fails to confirm, then the onus of
settling the trade falls on the trading member who has executed the trade.
1.4.6 Clearing House / Clearing Corporation
A Clearing Corporation / Agency can be a part of an exchange or can be a separate entity,
which performs three main functions:
 clearing and settling all transactions executed in the stock market, i.e. completes the
process of receiving and delivering shares/funds to the buyers and sellers in the
market,
 providing financial guarantee for all transactions executed on stock exchanges
 providing risk management functions 2
Clearing houses play an important role in safeguarding interest of investors. The counter party
risk is eliminated as the clearing house acts as central counterparty for both sides of
transactions (buyers as well as sellers). Also as it provides guarantee of fulfilment of buyers’
as well as sellers’ obligations and thus, any contracts executed by the exchange participants
are safeguarded by clearing houses.
The clearing agency determines fund/security obligations and arranges for pay-in of the same.
It collects and maintains margins and processes for shortages in funds and securities. In this
process of settling the trades, the clearing corporation is helped by the clearing members,
clearing banks, custodians and depositories.
1.4.7 Clearing Banks
Clearing Bank acts as an important intermediary between clearing member and clearing
corporation. Every clearing member needs to maintain an account with clearing bank. It is the
clearing member’s function to make sure that the funds are available in its account with
clearing bank on the day of pay-in to meet the obligations. In case of a pay-out clearing
member receives the amount on pay-out day.

2
This process is called novation.

10
Multiple clearing banks facilitate introduction of new products and clearing members will
have a choice to open an account with a bank which offers more facilities.
Normally the demat accounts of investors require the details of a bank account linked to it
for facilitation of funds transfer. Ideally, all transactions of pay-in/pay-out of funds are carried
out by these clearing banks. The obligation details are passed on to the clearing banks, which
then carry out the pay-in/pay-out of funds based on the net obligations.
1.5 Types of Investors
An investor is the backbone of the securities market in any economy, as the investor is the
one lending surplus resources to companies. Investors in securities market can be broadly
classified into Retail Investors and Institutional Investors.
Retail Investors
Retail Investors are individual investors who buy and sell securities for their personal account,
and not for another company or organization. During initial public offerings (IPO), those who
invest less than rupees two lakhs are treated as retail investors. High Networth Individuals
(HNIs) are individual investors who invest more than rupees two lakhs in a single transaction.
Institutional Investors
Institutional Investors comprise domestic Financial Institutions, Banks, Insurance Companies,
Mutual Funds and Foreign Institutional Investors. A Foreign Portfolio investor, or FPI, is an
entity established or incorporated outside India that proposes to make investments in India.
Person of Indian origin & Non-Resident Indian
For the purposes of availing of the facilities of opening and maintaining bank accounts and
investments in shares/securities in India, Person of Indian origin (PIO) means a citizen of any
country other than Pakistan or Bangladesh if,
 He at any time, held an Indian passport
 He or either of his parents or any of his grandparents was a citizen of India by virtue
of the Constitution of India or Citizenship Act, 1955 (57 of 1995)
 The person is a spouse of an Indian citizen
Non-Resident Indian (NRI) means a person resident outside India who is a citizen of India or is
a person of Indian origin.
NRIs and PIOs are permitted to open bank accounts in India out of funds remitted from
abroad, foreign exchange brought in from abroad or out of funds legitimately due to them in
India, with authorised dealer. Such accounts can be opened with banks specially authorised
by the Reserve Bank of India.
Reserve Bank of India has granted general permission to NRIs and PIOs, for undertaking direct
investments in Indian companies under the Automatic Route, purchase of shares under
Portfolio Investment Scheme, investment in companies and proprietorship/partnership
concerns on non-repatriation basis and for remittances of current income. NRIs and PIOs do
not have to seek specific permission for approved activities under these schemes.
Foreign Portfolio Investors
Foreign Portfolio Investor (FPI) means a person who satisfies the eligibility criteria prescribed
in SEBI (Foreign Portfolio Investors) Regulations, 2014 and is registered with SEBI.

11
FPIs can invest only in shares, debentures and warrants of companies (listed or to be listed in
Indian stock exchanges) through primary and secondary markets, units of schemes floated by
domestic mutual funds, units of schemes floated by a collective investment scheme,
derivatives traded on a recognised stock exchange, treasury bills and dated government
securities, commercial papers issued by an Indian company, Rupee denominated credit
enhanced bonds, Indian depository receipts etc. and such other instruments specified by SEBI.
In respect of investments in the secondary market, the FPI transacts in the securities in India
only on the basis of taking and giving delivery of securities purchased or sold.
Qualified Institutional Buyers
Qualified Institutional Buyers (QIB) are institutional investors who are expected to possess
expertise and knowledge to evaluate and invest in the capital markets.
As per the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, a 'Qualified
Institutional Buyer' means:
a. A mutual fund, venture capital fund, alternative investment fund and foreign venture
capital investor registered with SEBI
b. A foreign portfolio investor (other than Category III FPI) registered with SEBI
c. A public financial institution
d. A scheduled commercial bank
e. A multilateral and bilateral development financial institution
f. A state industrial development corporation
g. An insurance company registered with IRDAI
h. A provident fund with minimum corpus of Rs. 25 crores
i. A pension fund with minimum corpus of Rs. 25 crores
j. National Investment Fund set up by resolution no. F. No. 2/3/2005-DDII dated
November 23, 2005
k. Insurance funds set up and managed by army, navy or air force of the Union of India
l. Insurance funds set up and managed by the Department of Posts, India
m. Systemically important non-banking financial companies

1.6 Some Key Concepts

This section introduces concepts that will be used in the rest of the workbook.
Dematerialisation / Rematerialisation
Dematerialisation is the process of converting securities held in physical form into holdings in
book entry/electronic form. In the demat form, one investor's shares are not distinguished
from another investor’s shares. These shares do not have any distinct numbers. These shares
are fully fungible. Fungibility means that any share of a company is exactly the same as any
other share of that company.
Rematerialisation is the process of conversion of securities in electronic form to their physical
form. These are then allotted physical form and distinct numbers.

12
ISIN
ISIN or International Securities Identification Number is a 12-character alpha-numeric code
that uniquely identifies a security, across the world. The securities include shares, bonds,
warrants, etc. Securities with which ISINs can be used include debt securities, shares, options,
derivatives and futures.
The ISIN Organization manages International Securities Identification Numbers (ISIN). ISIN
uniquely identify a security -- its structure is defined in ISO 6166. Securities for which ISINs
are issued include bonds, commercial papers, equities and warrants. Think of it as a serial
number that does not contain information characterizing financial instruments but rather
serves to uniformly identify a security for trading and settlement purposes.
ISIN constitutes of three parts. It has three components - a pre-fix, a basic number and a check
digit. The pre-fix is a two-letter country code as stated under ISO 6166 (IN for India). The
country code is followed by a 9-character alpha-numeric national security identification code
assigned to a security by the governing bodies in each country. This is followed by a single
character check digit, which will validate the ISIN code.
In India, SEBI has delegated the assigning of ISIN of various securities to NSDL. For securities
getting admitted on CDSL, the ISIN is allotted to those securities on receiving request from
the CDSL. Allotment of ISIN for G-sec is done by Reserve Bank of India.
To illustrate, ISIN INE 475C 01 012 has the following break up:
IN - India
E – Company Type
First four digits 475C - Company serial number;
01 - equity (it can be mutual fund units, debt or Government securities);
01 - issue number;
2 (Last digit) - check digit.
The third digit (E in the above example) may be E, F, A, B or 9. Each one carries the following
meaning:
E - Company
F - Mutual fund unit
A - Central Government Security
B - State Government Security
9 - Equity shares with rights which are different from equity shares bearing INE number.
In an ISIN number, it is important to pay special attention to the third digit.
In a time when trading securities across the geographical boundaries of countries has become
common, having a unique identifier for a security greatly helps traders as well as brokers in
various countries to unambiguously identify and trade a security.
Pledge / Unpledge
Pledge is an activity of taking loan against securities by the investor. The investor is called as
‘pledgor’ and the entity who is giving the loan against the securities is called as ‘pledgee’.

13
Securities held in a depository account can be pledged/ hypothecated to avail of loan/credit
facility. Pledge of securities in a depository requires that both the borrower (pledgor) and the
lender (pledgee) should have account in the depository.
Procedure for pledging securities in demat form is very convenient, both, for the pledgor and
the pledgee. Moreover, a pledgor may be able to obtain higher loan amounts, with lower rate
of interest for securities in demat form as compared to securities held in physical form.
When dematerialized securities are pledged, they remain in the pledgor Beneficial Owner’s
(BO) demat account but they are blocked so that they cannot be used for any other
transaction.
In physical form pledged shares have to be handed over to the pledgee.
Pledged securities can be unpledged, once the obligations of pledge are fulfilled. In case of
default, the pledgee can invoke the pledge.
Transfer / Transmission
A transfer is the legal change of ownership of a security in the records of the issuer. For
effecting a transfer, certain legal steps have to be taken like endorsement, execution of a
transfer instrument and payment of stamp duty, which the DP helps the investors in.
Transmission is the legal change of ownership of a security on account of death or
incapacitation of the original owner.
Freeze / Unfreeze
DP accounts may be frozen by the depositories or participants or by the account holder(s).
The Depository or Participant may freeze the account in case of any discrepancy in the
account like non-submission of PAN card, etc.
A depository account holder can freeze securities lying in the account for as long as he/she
wishes. By freezing, the account holder can stop unexpected debits or credits or both,
creeping into the account.
The various types of freezing are-
 Freezing for Debit - Here, any debit instructions cannot be passed. But, the credit in
the account will be received provided standing instructions are given for the same
 Freezing for all - Here, no transfer from and to the account is possible
 ISIN Freezing - Here, a specified ISIN can be frozen for debit
 Quantity Freezing - Here, a specified quantity of a specified ISIN can be frozen,
blocking the specified quantity for debit.
An account holder can freeze the account for any of the above-mentioned types by giving an
appropriate instruction to its DP — forms for freeze/unfreeze are available with the DPs.
Such instructions have to be given to the DP at least one full working day prior to the date of
freeze. For example, if the client wishes to freeze its account with effect from Friday, such
instruction must be given latest by Wednesday.
The freeze is reflected in the Transaction Statement and is shown under the heading `Status'
in the statement.

14
If a particular ISIN or specific number of securities is/are frozen in an account, the status of
the account will remain `Active', but the securities or the ISIN frozen will be shown as a
separate entry in the Transaction Statement indicating that these securities or ISINs have
been frozen and cannot be debited.
On unfreezing, the status of the account will be shown as `Active' and on removing the freeze
on the securities or the specific ISIN, the statement will show them as free balance in the
account.
Nomination
By filling up and signing on the nomination form that is provided by the DPs, individuals can
make nominations in Demat accounts. The nominee is entitled to all the holdings of the
account in case of death of the account holder. Presently, there can be only one nominee for
an account.
A minor can also be a nominee. In such a case, a guardian needs to be appointed on behalf of
the minor.
An account holder can change the nomination by simply filling up the nomination form once
again and submitting it to the DP.
Bid Ask Spread
The amount by which the ask price exceeds the bid is called the bid-ask spread. This is
essentially the difference in price between the highest price that a buyer is willing to pay and
the lowest price for which a seller is willing to sell. The spread, the difference between the
bid and ask, generates profit for the market making companies.

15
Quiz

1. Retail investors invest below Rs. ______ in a single IPO transaction.

2. _______ is a unique 12-character alpha-numeric code that uniquely identifies a security

internationally.

3. _______ allows investors to take loan against securities held by them.

4. Foreign Portfolio Investors (FPIs) are allowed to invest in Indian equity market. State
whether True or False.

5. Value of a derivative security depends on that of the underlying assets. State whether True
or False.

Answers

1. 2 lakhs

2. International Securities Identification Number (ISIN)

3. Pledging

4. True

5. True

16
 2 Regulatory Framework

LEARNING OBJECTIVES:

After studying this chapter, you should know about the salient features of:
 Securities Contracts (Regulation) Act, 1956
 Securities Contracts (Regulations) Rules, 1957
 Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations)
Regulations, 2018
 SEBI Act, 1992
 The Depositories Act, 1996
 Companies Act
 Other Regulations relating to brokers, insider trading and unfair practices

The Indian securities market is governed primarily by the five main Acts, which are:
(a) The Companies Act, 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.
(b) The Securities Contracts (Regulation) Act, 1956, which provides for regulation of
transactions in securities through control over stock exchanges.
(c) The SEBI Act, 1992 which provides for the establishment of SEBI to protect the
interests of the investors in securities and to promote the development of and to
regulate the securities market.
(d) The Depositories Act, 1996 which provides for electronic maintenance and transfer
of ownership of demat shares.
(e) The Prevention of Money Laundering Act, 2002 which provides for prevention of
money-laundering and confiscation of property derived from, or involved in, money-
laundering.
In this chapter, we will understand these statutes along with some of the other SEBI
regulations.

2.1 Securities Contracts (Regulation) Act, 1956

The Securities Contracts (Regulation) Act, 1956 (SC(R)A), provides for direct and indirect control of
virtually all aspects of securities trading and the running of stock exchanges. It prevents undesirable
transactions in securities by regulating the business of securities dealing and trading. In
pursuance of its objective, the act covers a variety of issues, of which some are listed below:
1. Granting recognition to stock exchanges
2. Corporatization and demutualization of stock exchanges

17
 3. The power of the Central Government to call for periodical returns from stock
exchanges
4. The power of SEBI to make or amend bye-laws of recognized stock exchanges
5. The power of the Central Government (exercisable by SEBI also) to supersede the
governing body of a recognized stock exchange
6. The power to suspend business of recognized stock exchanges
7. The power to prohibit undesirable speculation
The Securities Contracts (Regulation) Act, 1956 (SCRA) gives SEBI the jurisdiction over stock
exchanges through recognition and supervision. It also gives SEBI the jurisdiction over
contracts in securities and listing of securities on stock exchanges.
SCRA states that in order to be recognized, a stock exchange has to comply with conditions
prescribed by SEBI. It specifies that organized trading of securities can take place only on
recognized stock exchanges. The stock exchanges can lay out their own listing requirements,
which have to conform to the listing criteria set out in the rules.
This Act gives the powers to stock exchanges to make their own bye-laws, subject to prior
approval by SEBI. These bye-laws can cover the day-to-day working of the stock exchanges
and the operations thereon.

2.2 Securities Contracts (Regulation) Rules, 1957

Section 30 of the SCRA empowers the Central Government to make rules for the purpose of
implementing the objects of the said act. Pursuant to the same, the Securities Contracts
(Regulation) Rules 1957 was introduced. These rules contain specific information and
directions on a variety of issues, some of which are given as under:
 Formalities to be completed, including submission of application for recognition of a
stock exchange
 Qualification norms for membership of a recognized stock exchange
 Mode of entering into contracts between members of a recognized stock exchange
 Obligation of the governing body to take disciplinary action against a member, if so
directed by the SEBI
 Audit of accounts of members
 Maintaining and preserving books of accounts by every recognized stock exchange
and by every member
 Submission of the annual report and periodical returns by every recognized stock
exchange
 Manner of publication of bye-laws for criticism
 Requirements with respect to listing of securities on a recognized stock exchange
 Requirements with respect to the listing of units or any other instrument of a
Collective Investment Scheme on a recognized stock exchange
 Delisting of securities from a recognised stock exchange

18
Some of the important Rules under the SCRR, 1957 are given here.
Rule 8 of SCRR specifies the rules relating to admission of members of the stock exchange. No
person is eligible to be elected as a member if he (a) is less than 21 years of age, (b) is not a
citizen of India provided that the governing body may in suitable cases relax this condition
with the prior approval of the SEBI, (c) has been adjudged bankrupt or a receiving order in
bankruptcy has been made against him or has been proved to be insolvent even though he
has obtained his final discharge, (d) has compounded with his creditors unless he has paid
sixteen annas in the rupee, (e) has been convicted of an offence involving fraud or dishonesty,
(f) is engaged as principal or employee in any business other than that of securities or
commodity derivatives except as a broker or agent not involving any personal financial liability
unless he undertakes on admission to sever his connection with such business, (g) has been at
any time expelled or declared a defaulter by any other stock exchange, (h) has been previously refused
admission to membership unless a period of one year has elapsed since the date of such rejection.

Rule 9 of the SCRR requires all contracts entered into between members of a recognized stock
exchange to be confirmed in writing.
Rule 15(1) requires every member of a recognized stock exchange to maintain and preserve
the following books of account and documents for a period of 5 years:
 Register of transactions (Sauda book)
 Clients’ ledger
 General ledger
 Journals
 Cash book
 Bank pass-book
 Documents register showing full particulars of shares and securities received and
delivered
Rule 15(2) requires every member of a recognized stock exchange to maintain and preserve
the following documents for a period of 2 years:
 Member’s contract books showing details of all contracts entered into by the member
with other members of the same exchange or counterfoils or duplicates of memos of
confirmation issued to such other members.
 Counterfoils or duplicates of contract notes issued to clients.
 Written consent of clients in respect of contracts entered into as principals.
SEBI is entitled to inspect such books and also conduct audit, thus keeping a check on all
contracts entered into by the members.

19
2.3 Securities Contracts (Regulation) (Stock Exchanges and Clearing
Corporations) Regulations, 2018
The Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations)
Regulations, 2018 were issued to regulate ownership and governance in stock exchanges and
clearing corporations.
Chapter I of the regulation covers the preliminary part like short title and definitions.
Chapter II contains the provisions for recognition of stock exchanges and clearing
corporations.
Chapter III talks about the networth of stock exchanges and clearing corporations.
Chapter IV provides for ownership of stock exchanges and clearing corporations.
Chapter V talks about the governance of stock exchanges and clearing corporations.
Chapter VI talks about the general obligations.
Chapter VII is devoted to listing of securities.
Chapter VIII provides for inspection, enquiries and enforcement.
Chapter IX gives the miscellaneous provisions, not covered above.
A recognised stock exchange, having completed 3 years of continuous trading operations
(immediately preceding the date of application of listing), can apply for listing of its securities
on any bourse other than itself and associated exchanges. The listing application can be
submitted after obtaining approval from SEBI and has to be in compliance with the provisions
of the regulations. Shares of recognised stock exchanges and clearing corporations must be
in demat form.
Some of the important provisions are as below:
 Stock exchanges should have a minimum networth of Rs. 100 crores at all times.
 The public holding in a recognised stock exchange shall not be less than 51 percent of
the paid up equity share capital of that of that recognised stock exchange.
 No single stock holder, resident in India, can hold more that 5 percent stake in any
stock exchange. However, (i) a stock exchange, (ii) a depository, (iii) an insurance
company, (iv) a banking company or (v) public financial institution may hold upto 15
percent of paid-up equity share capital of a recognised stock exchange.
 No person resident outside India can hold more than 5 percent of the paid up equity
share capital in a recognised stock exchange. However, select non-resident institutions,
namely (i) a foreign stock exchange; (ii) a foreign depository; (iii) a foreign banking company;
(iv) a foreign insurance company; (v) a foreign commodity derivative exchange; and (vi) a
bilateral or multilateral financial institution approved by the Central Government are

20
 permitted to hold up to 15 percent of the paid up equity share capital of a recognised stock
exchange.

 The collective holding of entities resident outside India in the paid up equity share
capital of recognised stock exchange shall not exceed 49 percent.
 No clearing corporation shall hold any right, stake or interest in any recognised stock
exchange.
 A recognised stock exchange and a recognised clearing corporation shall maintain and
preserve all the books, registers, other documents and records relating to the issue or
transfer of its securities for a period of not less than8 years.

2.4 Securities and Exchange Board of India Act, 1992

The SEBI Act of 1992 was enacted upon “to provide for the establishment of a Board to protect
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”.

2.4.1 Powers and Functions of SEBI

SEBI in the broader sense performs the functions as stated in the above para, however,
without any prejudice to the generality, the Act also provides for the following measures:
Section 11(1) of the SEBI Act, 1992, lays down that subject to the provisions of the SEBI Act,
1992, it shall be the duty of SEBI to protect the interests of investors in securities and to
promote the development of and to regulate the securities market, by such measures as it
thinks fit.
Section 11(2) lists the specific functions as:
a) To regulate the business in stock exchanges and any other securities markets.
b) To register and regulate the working of stockbrokers, share transfer agents, bankers to
an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters,
portfolio managers, investment advisers and others associated with the securities
market. SEBI’s powers also extend to registering and regulating the working of
depositories and depository participants, custodians of securities, foreign portfolio
investors, credit rating agencies, and others as may be specified by SEBI.
c) To register and regulate the working of venture capital funds and collective investment
schemes including mutual funds.
d) To promote and regulate Self Regulatory Organisations (SRO).
e) To prohibit fraudulent and unfair trade practices relating to the securities market.
f) To promote investors’ education and training of intermediaries in the securities market.
g) To prohibit insider trading in securities.
h) To regulate substantial acquisition of shares and takeover of companies.

21
i) To require disclosure of information, to undertake inspection, to conduct inquiries and
audits of stock exchanges, mutual funds, other persons associated with the securities
market, intermediaries and SROs in the securities market. The requirement of disclosure
of information can apply to any bank or any other authority or board or corporation.
j) To perform such functions and to exercise such powers under the Securities Contracts
(Regulation) Act, 1956 as may be delegated to it by the Central Government.
k) To levy fees or other charges pursuant to implementation of this section.
l) To conduct research for the above purposes.
Further, SEBI is also empowered to enforce disclosure of information or to furnish information
to agencies as may be deemed necessary.
SEBI Act empowers SEBI to impose penalties and initiate adjudication proceedings against
intermediaries who default on the following grounds such as failure to furnish information,
return etc. or failure by any person to enter into agreement with clients etc. under the various
sub sections of Section 15 of the SEBI Act.
A list of the various sub-sections of Section 15 dealing with penalties and adjudication are
given below:
 Section 15 A: Penalty for failure to furnish information, return, etc.
 Section 15 B: Penalty for failure by any person to enter into agreement with clients
 Section 15 C: Penalty for failure to redress investors’ grievances
 Section 15 D: Penalty for certain defaults in case of mutual funds
 Section 15 E: Penalty for failure to observe rules and regulations by an asset
management company (AMC)
 Section 15 EA: Penalty for default in case of alternative investment funds,
infrastructure investment trusts and real estate investment trusts
 Section 15 EB: Penalty for default in case of investment adviser and research analyst
 Section 15 F: Penalty for default in case of stock brokers
 Section 15 G: Penalty for insider trading
 Section 15 H: Penalty for non-disclosure of acquisition of shares and takeovers
 Section 15 HA: Penalty for fraudulent and unfair trade practices
 Section 15 HB: Penalty for contravention where no separate penalty has been
provided
 Section 15 I: Power to adjudicate
 Section 15 J: Factors to be taken into account while adjudging quantum of penalty

22
  Section 15 JA: Crediting sums realised by way of penalties to Consolidated Fund of
India
 Section 15 JB: Settlement of administrative and civil proceedings

2.5 The Depositories Act, 1996

The Depositories Act, passed by Parliament, was notified in The Gazette of India on August
1996. The Act enables the setting up of multiple depositories in the country. This was to
ensure that there is competition in the service and more than one depository is in operation.
The Depositories Act facilitated the establishment of the two depositories in India viz., NSDL
and CDSL. Only a company registered under the Companies Act and sponsored by the
specified category of institutions can set up a depository in India. Before commencing
operations, depositories should obtain a certificate of registration and a certificate of
commencement of business from SEBI. A depository established under the Depositories Act
can provide any service connected with recording of allotment of securities or transfer of
ownership of securities in the record of a depository. A depository however, cannot directly
open accounts and provide services to clients. Any person willing to avail of the services of
the depository can do so by entering into an agreement with the depository through any of
its Depository Participants. The rights and obligations of depositories, depository participants,
issuers and beneficial owners are spelt out clearly in this Act.
SEBI may call upon any issuer, depository, participant or beneficial owner to furnish in writing
such information relating to the securities held in a depository as it may require or it may
authorize any person to make an enquiry or inspection in relation to the affairs of the issuer,
beneficial owner, depository participant who shall submit a report of such enquiry or
inspection to it within such period. After making or causing to be made an enquiry, SEBI can
issue appropriate directions to the depository participant.

2.6 The Companies Act 1956/2013

The Companies Act is a legislation to consolidate and amend the law relating to companies
and certain other associations. It came into force on April 1, 1956, but has undergone
amendments by several subsequent enactments, some of which were warranted by events
such as the establishment of depositories owing to dematerialization of shares. In 2013, the
Companies Act 2013 came into force and was notified in the Official Gazette. However, some
provisions of the Companies Act 1956 are still in force.
The Act introduced a uniform law pertaining to companies throughout India. The provisions
of the Act apply to:
(a) companies incorporated under this Act or under any previous company law
(b) insurance companies (except in so far as the said provisions are inconsistent with the
provisions of the Insurance Act, 1938 or the Insurance Regulatory and Development
Authority Act, 1999)

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 (c) banking companies (except in so far as the said provisions are inconsistent with the
provisions of the Banking Regulation Act, 1949)
(d) companies engaged in the generation or supply of electricity (except in so far as the
said provisions are inconsistent with the provisions of the Electricity Act, 2003)
(e) any other company governed by any special Act
(f) such body corporate incorporated by any Act as specified by the Central Government
The Companies Act 2013 consists of 29 chapters covering 470 sections. A brief description of
the Chapters are as follows:
Chapter I- Preliminary: This mentions the title, commencement, extent and also contains
definitions of terms such as “company”, “private company”, “public company” and “officer
who is in default” etc.
Chapter II- Incorporation of company and incidental matters. The sections cover matters such
as registration of companies, Memorandum of Association, Articles of Association,
membership of a company, private companies, investments of a company and the official
seal.
Part III: Prospectus and Allotment of securities: Matters covered include the public offer and
private placements, power of SEBI to regulate issue and transfer of securities, contents of a
prospectus, its registration, civil and criminal liabilities for mis-statements in the prospectus,
allotment of securities, global depository receipts etc.
Chapter IV- Share Capital and Debentures: The sections relate to, among other matters, the
nature, numbering and certificate of shares, kinds of share capital, reduction of share capital
and transfer of shares and debentures, payments of dividend.
Chapter V- Acceptance of deposits by Companies: The sections herein include prohibition of
acceptance of deposits from public, repayment of deposits accepted before commencement
of the Act etc.
Chapter VI- Registration of Charges: The sections explain the duty to register charges, the
application for registration of charge, power of Registrar, punishment for contravention etc.
Chapter VII- Management and Administration: Matters dealt with herein include the
registered office and name, the Register of Members and debenture holders, Annual Returns,
meetings and proceedings, maintenance and inspection of documents in electronic form.
Chapter VIII- Declaration and Payment of Dividend: The sections here deal with declaration
of dividend, Investor Education and Protection Fund and punishment for failure to distribute
dividends.
Chapter IX- Accounts of Companies: The sections pertain to books of accounts to be kept by
company, financial statement, constitution of National Financial Reporting Authority, internal
audit and so on.

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Chapter X- Audit and Auditors: Matters dealt with here are appointment of auditors,
eligibility, qualifications, disqualifications and remuneration of auditors etc.
Chapter XI- Appointment and Qualifications of Directors: The sections pertain to appointment
of directors, manner of selection of independent directors, duties of directors, resignation
and removal of director.
Chapter XII- Meetings of Board and its Powers: The sections relate to Board meetings, quorum
for meetings, audit committee, restrictions on powers of Board and so on.
Chapter XIII- Appointment and Remuneration of Managerial Personnel: The sections deal with
appointment of key managerial personnel, directors and whole-time members, calculation of
profits, managerial remuneration etc.
Chapter XIV- Inspection, Inquiry and Investigation: The sections pertain to conducting
inspection, inquiry, search and seizure etc.
Chapter XV- Compromises, Arrangements and Amalgamations: The sections deal with
merger, acquisitions and amalgamations and related topics.
Chapter XVI- Prevention of Oppression and Mismanagement: The sections dwell into the
powers of Tribunal and application to Tribunal for relief in cases of oppression.
Chapter XVII- Registered Valuers: It deals with the valuation by registered valuers.
Chapter XVIII- Removal of names of companies from the Register of Companies: The sections
deal with the power of Registrar to remove name of a company from register of companies
and related topics.
Chapter XIX- Revival and Rehabilitation of Sick Companies: The chapter has been omitted by
Insolvency and Bankruptcy Code, 2016.
Chapter XX- Winding Up: The sections relate to modes of winding up and the legal processes
and formalities pertaining to the same.
Chapter XXI deals with companies authorised to register under this Act and winding up of
unregistered companies.
Chapter XXII- Companies incorporated outside India: The sections pertain to the obligations
and formalities of companies incorporated outside India.
Chapter XXIII- Government Companies: The chapter deals with the annual reports on
Government companies.
Chapter XXIV relates to registration offices and fees.
Chapter XXV deals with power of Central Government to direct companies to furnish
information or statistics.
Chapter XXVI deals with Nidhis.

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Chapter XXVII- National Company Lay Tribunal (NCLT) and Appellate Tribunal: The sections
here deal with the definition and constitution of NCLT, qualifications of members of Tribunal,
their powers and so on.
Chapter XXVIII- Special Courts: The sections pertain to the establishment of special courts,
offences triable by such courts, application of fines etc.
Chapter XXIX deals with miscellaneous matters such as punishment for fraud, false statement,
false evidence etc. adjudication of penalties, dormant company and so on.

2.7 Prevention of Money Laundering Act, 2002

Money laundering refers to suppressing the origin of financial assets that are generated
through illegal activities and utilising the assets in other legitimate ventures. Through money
laundering, the launderer transforms the monetary proceeds derived from criminal activity
into funds with an apparently legal source.
The Prevention of Money-Laundering Act, 2002 (PMLA), is an act to prevent and control
money-laundering and to provide for confiscation of property derived from, or involved in,
money-laundering and for related matters. Chapter II, section 3 describes the offence of
money-laundering thus: ‘Whosoever directly or indirectly attempts to indulge, or knowingly
assists or knowingly is a party or is actually involved in any process or activity connected with
the proceeds of crime including its concealment, possession acquisition or use and projecting
or claiming it as untainted property shall be guilty of the offence of money-laundering.’
The offences are classified under Part A, Part B and Part C of the Schedule. Under Part A,
offences include counterfeiting currency notes under the Indian Penal Code, raising fund for
a terrorist organisation under the Unlawful Activities (Prevention) Act, 1967, criminal
misconduct by a public servant under the Prevention of Corruption Act, 1988, etc. Under Part
B, offences are considered as money laundering if the total value of such offences is Rs. 1
crore or more. Such offences include false declaration or false documents etc. under the
Customs Act, 1962. Part C includes all offences specified under Part A that has cross-border
implications, offences against property under Indian Penal Code and offences of wilful
attempt to evade any tax, penalty or interest referred in provisions under the Black Money
(Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.
Section 6 of the PMLA confers powers on the Central Government to appoint Adjudicating
Authority to exercise jurisdiction, powers and authority conferred by or under the Act.
According to section 9, in the event of an order of confiscation being made by an Adjudicating
Authority (AA) in respect of any property of a person, all the rights and title in such property
shall vest absolutely in the Central Government without any encumbrances.

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Section 11 of the Act makes it clear that the Adjudicating Authority shall have the same
powers as are vested in a civil court under the Code of Civil Procedure, 1908 while trying a
suit, with regard to the following matters:
a. Discovery and inspection
b. Enforcing the attendance of any person, including any officer of a banking company
or a financial institution or a company and examining him on oath
c. Compelling the production of records
d. Receiving evidence on affidavits
e. Issuing commissions for examination of witnesses and documents
f. Any other matter which may be prescribed
All the persons summoned as mentioned above shall be bound to attend the proceedings in
person or through authorized agents and shall be bound to state the truth and produce such
documents as may be required. Further, every proceeding under the section shall be deemed
to be a judicial proceeding within the meaning of sections 193 and 228 of the Indian Penal
Code (IPC).
Section 12 of PMLA stipulates that every banking company, financial institution and
intermediary shall
(a) maintain a record of all transactions in such manner as to enable it to reconstruct
individual transactions,
(b) furnish information relating to such transactions, whether attempted or executed, the
nature and value of which may be prescribed,
(c) maintain record of documents evidencing identity of its clients and beneficial owners
as well as account files and business correspondence relating to its clients
Every information maintained, furnished or verified shall be kept confidential. The records
shall be maintained for a period of 5 years from the date of cessation of the transactions
between the clients and the banking company or financial institution or intermediary, as the
case may be.
Sections 16 and 17 lay down the powers of the authorities to carry out surveys, searches and
seizures. Section 24 makes it clear that when a person is accused of having engaged in money-
laundering, the burden of proving that the proceeds of the alleged crime are untainted shall
be on the accused. Sections 25 and 26 relate to the establishment of an Appellate Tribunal
and the procedures for filing an appeal to the same. Section 42 deals with appeals against any
decision or order of the Appellate Tribunal to the High Court. Section 43 empowers the
Central Government to designate Courts of Session as Special Courts for the trial of the
offence of money-laundering.

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The offence of money laundering is punishable with rigorous imprisonment for a term which
shall not be less than 3 years but which may extend to 7 years and shall also be liable to fine.
Measures to Check Money Laundering
There are several ways to check money laundering. Discussed below are some of the
measures which may be adopted by firms for anti-money laundering:
a) Organizing training programs on anti-money laundering for the staff, especially
personnel engaged in KYC, settlement, demat and account opening processes.
b) Verifying documents of clients during the account opening process.
c) Interviewing clients who have declared wealth above Rs. 10 lakh or intend to trade
(intraday) above Rs. 2 crore in a month or who have given initial margin of Rs. 4 to 5 lakh
and above in the form of monies or securities.
d) Interviewing clients who are NRIs or corporate/trust who promote NRIs.
e) Gauging the risk appetite of the client, as it helps in finding out any suspicious trading
or transactions in the future.
f) Scrutinizing documents including income documents of the employee involved in
maintaining and updating critical information about the transactions of the client and
also of the employees who facilitate transactions of the clients like dealers, settlement
officers.

2.8 SEBI (Stock-Brokers) Regulations, 1992

The SEBI (Stock-Brokers) Regulations, 1992 is prescribed for anyone who wishes to register as
a stock broker for indulging in any transaction of business in the securities market. Stock
brokers shall ensure that they comply at all times with the various sections as given under this
regulation.
The stock brokers who are granted registration by SEBI shall ensure compliance of the
following conditions:
 the stock broker shall hold the membership of the stock exchange;
 the stock broker shall abide by the rules, regulations and bye-laws of the stock
exchange;
 the stock broker shall obtain prior approval of the SEBI whenever it proposes to
change its status or constitution;
 the stock broker shall pay fees charged by the SEBI; and
 the stock broker shall take adequate steps to redress investors’ grievances within 1
month of the date of receipt of the complaint and keep SEBI informed about the
details of such complaints.

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Schedule II of the Regulation requires the stock brokers to abide by the Code of Conduct so
specified under Regulation 9. Regulation 8 specifies about the fees (prescribed by SEBI)
payable by the stock brokers for the registration within a stipulated timeframe; however,
where a stock broker fails to pay the fees as provided in the regulations, SEBI may suspend or
cancel the registration certificate, whereupon the stock broker shall cease to buy, sell or deal
in securities as a stock broker.
SEBI’s Code of Conduct for Stock Brokers
A stock broker needs to adhere to a particular code of conduct as prescribed in the Schedule
II of the SEBI (Stock-Brokers) Regulations, 1992, which has been discussed herein.
Code of Conduct for Stock Brokers
A. General
1. Integrity: A stock-broker shall maintain high standards of integrity, promptitude and
fairness in the conduct of all its business.
2. Exercise of Due Skill and Care: A stock-broker shall act with due skill, care and diligence
in the conduct of all its business.
3. Manipulation: A stock-broker shall not indulge in manipulative, fraudulent or deceptive
transactions or schemes or spread rumours with a view to distorting market equilibrium
or making personal gains.
4. Malpractices: A stock-broker shall not create false market either singly or in concert with
others or indulge in any act detrimental to the investors’ interest or which leads to
interference with the fair and smooth functioning of the market. A stock-broker shall
not involve itself in excessive speculative business in the market beyond reasonable
levels not commensurate with its financial soundness.
5. Compliance with Statutory Requirements: A stock-broker shall abide by all the
provisions of the Act and the rules, regulations issued by the Government, SEBI and the
stock exchange from time to time as applicable.
B. Duty to the Investor
1. Execution of Orders: A stock-broker, in its dealings with the clients and the general
investing public, shall faithfully execute the orders for buying and selling of securities
at the best available market price and not refuse to deal with a small investor 3 merely
on the ground of the volume of business involved. A stock-broker also shall promptly
inform its client about the execution or non-execution of an order, and make prompt
payment in respect of securities sold and arrange for prompt delivery of securities
purchased by clients.

3
Small investor means any investor buying or selling securities on a cash transaction for a market value not
exceeding Rupees Fifty Thousand in aggregate on any day as shown in a contract note issued by the stock broker.

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2. Issue of Contract Note: A stock-broker shall issue without delay to its client a contract
note for all transactions in the form specified by the stock exchange.
3. Breach of Trust: A stock-broker shall not disclose or discuss with any other person or
make improper use of the details of personal investments and other information of a
confidential nature of the client which it comes to know in its business relationship.
4. Business and Commission:
 A stock-broker shall not encourage sales or purchases of securities with the sole
object of generating brokerage or commission.
 A stock-broker shall not furnish false or misleading quotations or give any other
false or misleading advice or information to the clients with a view of inducing him
to do business in particular securities and enabling itself to earn brokerage or
commission thereby.
5. Business of Defaulting Clients: A stock-broker shall not deal or transact business
knowingly, directly or indirectly or execute an order for a client who has failed to carry
out his commitments in relation to securities with another stock-broker.
6. Fairness to Clients: A stock-broker, when dealing with a client, shall disclose whether it
is acting as a principal or as an agent and shall ensure at the same time that no conflict
of interest arises between it and the client. In the event of a conflict of interest, it shall
inform the client accordingly and shall not seek to gain a direct or indirect personal
advantage from the situation and also not consider clients’ interest inferior to his own.
7. Investment Advice: A stock-broker shall not make a recommendation to any client who
might be expected to rely thereon to acquire, dispose of, retain any securities unless it
has reasonable grounds for believing that the recommendation is suitable for such a
client upon the basis of the facts, if disclosed by such a client as to his own security
holdings, financial situation and objectives of such investment. The stock-broker shall
seek such information from clients, wherever it feels it is appropriate to do so.
7(A) Investment Advice in publicly accessible media
 A stock broker or any of its employees shall not render, directly or indirectly, any
investment advice about any security in the publicly accessible media, whether real
time or non-real-time, unless a disclosure of his interest including the interest of
his dependent family members and the employer including their long or short
position in the said security has been made, while rendering such advice.
 In case, an employee of the stock broker is rendering such advice, he shall also
disclose the interest of his dependent family members and the employer including
their long or short position in the said security, while rendering such advice.
8. Competence of Stock Broker: A stock-broker shall have adequately trained staff and
arrangements to render fair, prompt and competent services to its clients.

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C. Dealing with other Stock Brokers
1. Conduct of Dealings: A stock-broker shall co-operate with the other contracting party in
comparing unmatched transactions. A stock-broker shall not, knowingly and wilfully
deliver documents which constitute bad delivery and shall cooperate with other
contracting party for prompt replacement of documents which are declared as bad
delivery.
2. Protection of Clients Interests: A stock-broker shall extend fullest cooperation to other
stock-brokers in protecting the interests of its clients regarding their rights to dividends,
bonus shares, right shares and any other right related to such securities.
3. Transactions with Stock-Brokers: A stock-broker shall carry out its transactions with
other stock-brokers and shall comply with its obligations in completing the settlement
of transactions with them.
4. Advertisement and Publicity: A stock-broker shall not advertise its business publicly
unless permitted by the stock exchange.
5. Inducement of Clients: A stock-broker shall not resort to unfair means of inducing clients
from other stock- brokers.
6. False or Misleading Returns: A stock-broker shall not neglect or fail or refuse to submit
the required returns and not make any false or misleading statement on any returns
required to be submitted to SEBI and the stock exchange.

2.9 SEBI (Prohibition of Insider Trading) Regulations, 2015

The regulations prohibiting insider trading have been made pursuant to section 30 of the SEBI
Act, 1992.
The regulations define “insider” as any person who is a connected person or one who is in
possession of or having access to unpublished price sensitive information. A connected
person is defined by the act as anyone who has been associated with the company in the six
months prior to the connected act and include any person who has been in frequent
communication with the officers of the company in pursuit of contractual, fiduciary or
employment relationship or as an officer, employee or director of the company or holds any
position that provides access to such unpublished price sensitive information. Further, an
explanation is provided for the expression, “person is deemed to be a connected person” in
detail. Such persons are deemed to be connected persons until the contrary is established.
Examples of such person are:
1. An immediate relative of a connected person including spouse, parent, sibling and child
and other dependent persons
2. A holding company, subsidiary or associate company under the same management or
group

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3. An intermediary as specified in section 12 of the SEBI Act, 1992, Investment Company,
Trustee Company, Asset Management Company or an employee or director thereof or an
official of a stock exchange or of clearing house or corporation
4. A merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker,
portfolio manager and others, as specified
5. A member of the Board of Directors or an employee of a public financial institution as
defined in the Companies Act
6. A relative of any of the aforementioned persons
7. A banker of the company
The regulations define unpublished price sensitive information (UPSI) as any information
relating to a company or its securities that is not generally available and which can materially
affect the price of the securities once made available to public. Such information includes the
following:
1. Periodical financial results of the company
2. Intended declaration of dividends, both interim and final
3. Issue of securities, or buyback of securities and other change in capital structure
4. Mergers, acquisitions, demergers, delisting, disposal and expansion of business
5. Any change in key managerial personnel
Regulation 3 of the SEBI (Prohibition of Insider Trading) Regulations 2015, prohibits an insider
from communicating, allowing and/or providing access to unpublished price sensitive
information to any person including other insiders except in the course of the execution of
their responsibilities (legitimate purposes) and legal obligations. Similarly, no person shall
procure such information except for the performance of their duties or execution of legal
obligations. The board of directors of a listed company shall formulate a policy for
determination of ‘legitimate purposes’ as part of “Codes of Fair Disclosure and Conduct”. Also
any person in receipt of unpublished price sensitive information pursuant to a ‘legitimate
purpose’, shall be considered as an insider and due notice shall be given to such person to
maintain confidentiality of such unpublished price sensitive information.
Regulation 4 prohibits the trading in listed securities or those proposed to be listed by any
insider in possession of UPSI. Exceptions to this rule include off-market transactions between
insiders who all have the same information. If the trades were done by non-individuals, then
the persons taking decisions on the trade were not in possession of the UPSI. Insiders can
trade in the securities if the trades were in accordance to a trading plan that has been
approved by the compliance officer. The trades shall not be done earlier then 6 months from
the public disclosure of the plan or within the period defined by the regulations of the
announcement of the financial results of the company. Connected persons have to establish
that any trades done by them are not in violations of the regulations.
Chapter III of the regulation states the provisions related to disclosure of trading by insiders.
Trading has to be disclosed in the prescribed form. Disclosures include those by the relatives

32
of the insider as well as of those for whom the insider makes trading decisions. Initial
disclosures of holding by promoters, members of the promoter group, directors and key
personnel have to be made within 30 days of the regulations coming into force or 7 days of
such appointment. Continuous disclosures have to be made every calendar quarter where the
trading value exceeds Rs. Ten lakhs. The company has to inform the stock exchange of the
disclosures within two days of it being received. The company may require any connected
persons to make required disclosures as and when deemed fit.
As per the SEBI’s Regulations, an organization needs to appoint a compliance officer who is
responsible for setting forth policies and procedures and monitoring adherence to the code
of fair disclosure and code of conduct aimed at preservation of “Price Sensitive Information”.
The principles of fair disclosure include ensuring prompt, uniform and universal dissemination
of UPSI to avoid selective disclosure, ensuring information provided to analysts and
consultants is not UPSI and developing best practices to record the proceedings in meetings
with analysts and investor relation conferences to ensure official confirmation of the
information provided. Designated persons who have access to information as part of their
functions cannot trade in the securities during the period in which they are expected to hold
UPSI. The compliance officer will decide when trading can commence based on factors such
as when the UPSI will become generally available information. Designated persons include
analysts, law firms, auditors and consultants, among others. Trading by the designated
persons is subject to pre-clearance by the compliance officer if the value exceeds the limits
set by the board of directors. Entities handling UPSI, such as auditors, analysts, consultants
and others, are also required to formulate a code of conduct to monitor the trading in the
securities by their employees.

Chinese Wall
To prevent the misuse of confidential information the organisation/firm shall adopt a
“Chinese Wall” policy which separates those areas of the organisation/firm which routinely
have access to confidential information, considered “insider areas” from those areas which
deal with sale/marketing/investment advice or other departments providing support services
considered public areas and processes which would permit any designated persons to cross
the wall”.
The employees in the insider area shall not communicate any Price Sensitive Information to
anyone in the public area. The employees in the inside area may also be physically segregated
from the employees in the public area. The demarcation of the various departments as inside
area may be implemented by the organisation/firm. However, in exceptional situations,
employees from the public areas may be brought “cross the wall” and given confidential
information on the basis of “need to know” criteria. Such cases shall necessarily be intimated
to the Compliance Officer.
These regulations also state that "Analysts, if any, employed with the organization /firm while
preparing research reports of client company(s) shall disclose their shareholdings/interest in

33
such company(s) to the Compliance Officer and the Analysts who prepare research report of
listed company shall not trade in securities of that company for thirty days from preparation
of such report."

2.10 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to

Securities Market) Regulation, 2003
The Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade
Practices relating to Securities Market) Regulations, 2003 prohibit fraudulent, unfair and
manipulative trade practices in securities. These regulations have been made in exercise of
the powers conferred by section 30 of the SEBI Act, 1992.
Regulation 2(1) (c) defines fraud as any act, expression, omission or concealment committed
to induce another person or his agent to deal in securities. There may or may not be wrongful
gain or avoidance of any loss. However, that is inconsequential in determining if fraud has
been committed. Some of the instances cited are as follows:
a) A wilful misrepresentation of the truth or concealment of material fact in order that
another person may act to his detriment
b) A suggestion as to a fact which is not true, by one who does not believe it to be true
c) An active concealment of a fact by a person having knowledge or belief of the fact
d) A promise made without any intention of performing it
e) A representation, whether true or false, made in a reckless and careless manner
Prohibitive Activities
Chapter II of the regulation prohibits certain dealings in securities and other manipulative and
unfair trade practices. Listed below are some of the prohibitive activities as specified in the
regulation:
a. Knowingly indulging in an act which creates a false or misleading appearance
of trading in the securities market.
b. Dealing in a security which is not intended to effect a transfer of beneficial
ownership but to serve only as a device to inflate or depress or cause
fluctuations in the price of such security for wrongful gain or avoidance of loss.
c. Inducing any person to subscribe to an issue of the securities for fraudulently
securing the minimum subscription to such issue of securities, by advancing or
agreeing to advance any money to any other person or through any other
means.
d. Inducing any person for dealing in any securities for artificially inflating,
depressing, maintaining or causing fluctuation in the price of securities
through any means including by paying, offering or agreeing to pay or offer any
money or money’s worth, directly or indirectly, to any person.

34
 e. Any act or omission which is tantamount to a manipulation of the price of a
security including influencing or manipulating the reference price or
benchmark price of any securities.
f. Disseminating information or advice through any media. Whether physical or
digital, which the disseminator knows to be false or misleading and which is
designed or likely to influence the decision of investors dealing in securities.
Investigation
Chapter III of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003 relates to investigation of transactions of the nature
described above. In particular, under regulation 8(1), it shall be the duty of every person who
is under investigation:
a. To produce books, accounts and documents to the Investigating Authority and also
to furnish statements and information as required.
b. To appear before the Investigating Authority personally when required to do so
and to answer questions posed by the authority.
SEBI may without prejudice to the provisions contained in sub-sections (1), (2), (2A) and (3)
of section 11 and section 11B of the SEBI Act, by an order in the interests of the investors and
the securities market issue or take any of the following actions or directions either pending
investigation or enquiry or on completion of the investigation or enquiry namely:
i. Restrain persons from accessing the securities market,
ii. Impound and retain the proceeds or securities in respect of any transaction which
is in violation or prima facie in violation of these regulations,
iii. Direct an intermediary or any person associated with the securities market in any
manner not to dispose of or alienate an asset forming part of a fraudulent and
unfair transaction.
SEBI may even take the following action against an intermediary:
a. Issue a warning or censure;
b. Suspend the registration of the intermediary;
c. Cancel the registration of the intermediary.

2.11 Authorised Persons

In order to expand the reach of the markets for exchange traded products, SEBI has allowed
SEBI registered stock brokers (including trading members) of stock exchanges to provide
access to clients through authorized persons.

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An Authorised Person is any person (individual, partnership firm, LLP or body corporate) who
is appointed by a stock broker (including trading member) and who provides access to trading
platform of a stock exchange as an agent of the stock broker. A stock broker may appoint one
or more authorised person(s) after obtaining prior approval from the stock exchange
concerned.

Eligibility Criteria

An individual is eligible to be appointed as authorised person if he:

a. is a citizen of India;
b. is not less than 18 years of age;
c. has not been convicted of any offence involving fraud or dishonesty;
d. has good reputation and character;
e. has passed at least 10th standard or equivalent examination from an institution
recognized by the Government;

A partnership firm, LLP or a body corporate is eligible to be appointed as authorized person

a. if all the partners or directors, as the case may be, comply with the requirements
stated above and
b. the object clause of the partnership deed or of the Memorandum of Association
contains a clause permitting the person to deal in securities business.

The person shall have the necessary infrastructure like adequate office space, equipment and
manpower to effectively discharge the activities on behalf of the stock broker.

Conditions of Appointment

The following are the conditions of appointment of an authorised person:

a) The stock broker and authorised person shall enter into written agreement(s) in the
form(s) specified by the stock exchange;
b) The authorised person shall not receive or pay any money or securities in its own name
or account. All receipts and payments of securities and funds shall be in the name or
account of stock broker;
c) The authorised person shall receive his remuneration (fees, charges, commission,
salary, etc.) for his services only from the stock broker and he shall not charge any
amount from the clients;
d) A person shall not be appointed as authorized person by more than one stock broker
on the same stock exchange;
e) A partner or director of an authorised person shall not be appointed as an authorised
person on the same stock exchange.

Obligations of Stock Broker

a) The stock broker shall be responsible for all acts of omission and commission of his
authorised person(s) and/or their employees, including liabilities arising there from;

36
b) If any trading terminal is provided by the stock broker to an authorised person, the
place where such trading terminal is located shall be treated as branch office of the
stock broker;
c) Stock broker shall display at each branch office additional information such as
particulars of authorised person in charge of that branch, time lines for dealing
through authorised person, etc., as may be specified by the stock exchange;
d) Stock broker shall notify changes, if any, in the authorised person to all registered
clients of that branch at least 30 days before the change;
e) The client shall be registered with stock broker only. All documents like contract note,
statement of funds and securities would be issued to client by stock broker only.
Authorised person may provide administrative assistance in procurement of
documents and settlement, but shall not issue any document to client in its own name;
f) Stock broker shall conduct periodic inspection of branches assigned to authorised
persons and records of the operations carried out by them;
g) On noticing irregularities, if any, in the operations of authorised person, stock broker
shall seek withdrawal of approval, withhold all moneys due to authorised person till
resolution of investor problems, alert investors in the location where authorised
person operates, file a complaint with the police, and take all measures required to
protect the interest of investors and market.

37
Quiz

1. Recognised stock exchanges have the power to promote and regulate Self Regulatory
Organisation (SROs). State whether True or False.

2. As per SCRR, books of account should be maintained for a period of ___ years.

3. A stock-broker should not encourage sales or purchases of securities with the sole motive
of generating _____.

4. Under PMLA, the offence of money laundering is punishable with rigorous imprisonment
for atleast 3 years but may extend to ____ years, apart from fine.

5. A company under the same management or group is an insider. State whether True or
False.

Answers

1. False

2. 5

3. Brokerage

4. 7

5. True

38
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intentionally kept blank

39
 3 Primary Market

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Functions of primary market
 Types of public issues
 IPO pricing
 Intermediaries involved in public issues
 Draft offer document and Red Herring Prospectus
 Application Supported by Blocked Amount (ASBA)

3.1 Introduction
Primary markets serve a vital role in any economy in terms of not only effectively channelizing
the capital but also matching the risk return expectations of the investors. It helps businesses
in accessing the markets to raise capital. This market enables the friction-less flow of capital
and provides long term sustainability to the economy. The surplus units in an economy are
called investors. The deficit units are called issuers. In the primary market, the surplus units
supply funds to deficit units. In lieu of the funds supplied, they receive a certificate of
investment from the issuers. This certificate could be a share, debenture or other securities.
The price at which the issue takes place in the primary market depends upon various factors
such as company fundamentals, company's future growth possibilities, and the demand-
supply relationship at the time of issue. In addition, the broad market sentiment prevailing at
that time could also influence the issue price. It should be noted that the determination of
issue price is purely driven by the market process and the regulator has nothing to do with it
except its regulatory oversight of protecting market integrity. In the pre-SEBI days, the office
of Controller of Capital Issues in the Ministry of Finance played an important role in fixing the
issue price. In this sense, Indian securities markets have moved from administered pricing to
market determined pricing and from merit based regulations to disclosure based regulations.
As information flows into the market dynamically and continuously, one would notice a
ceaseless trading activity on the stock exchanges. Due to this, prices keep changing from time
to time. In this sense, stock exchanges are said to discover prices of instruments including
shares listed on them. Regardless of the price at which the share was issued, the fair economic
value of a share at any point in time is the price quoted on the exchange.
The exchanges play an important role in converting savings into investments. On one hand it
provides the platform for businesses to access savings and on the other hand it provides
opportunities for savers to participate in economic activities and share profits. They also help
mobilization of credit, as the securities can be used as collaterals for loans. The GDP growth
and the growth of the securities market are usually positively correlated. It can be said that
the stock exchanges are important for the working of the economy.

40
The primary market is used by issuers for raising fresh capital from the investors by making
initial public offers or rights issues or offers for sale of equity or debt. The primary market
facilitates easy marketability and generation of funds for the company. It helps investors
monitor the company’s performance.
In the primary market, companies (issuers) sell shares directly to public (investors). Such
a sale could either be an Initial Public Offering (IPO) or a Follow-on Public Offering (FPO). An
IPO is the first public offer; the subsequent public offers are called FPO. A Qualified
Institutions Placement (QIP) is an issue of shares to Qualified Institutional Buyers (QIBs), not
offered to the public.
An issuer in need of funds for expanding its operations can further raise capital from public in
the primary market. The investors also get to benefit from the earnings of the issuer, by
investing in the securities and earning dividends.
Every shareholder owns a part of the company, proportionate to the number of shares held
by them. Once the shares are listed on a recognized stock exchange, the company becomes a
"Listed Company". The regulations are far more stringent for listed companies as there is a
need to safeguard the interests of the investing public.
Listing its shares offers a number of advantages to the company. Listing and trading generates
considerable investor interest in the company, creating an opportunity for the company to
repeatedly access the primary market for raising capital through follow-on public issues. The
company may be able to establish itself in the market and improve its valuation by creating
awareness about itself in the market. Active trading on the stock market enables price
discovery for the shares of the company. The performance of the company can be monitored
by tracking the movement of its share prices. As a listed company is more stringently
regulated than an unlisted entity, investors are likely to be more comfortable to make
investments in the shares of the listed company. Regulators demand higher standards for
corporate governance and business practices from listed companies. In addition to follow-on
public issues, the company could mobilize additional equity funds through private placements
and rights issues.

3.2 Issue of Shares

A securities market is similar to any other market for goods and services in that the forces of
demand and supply apply to this market also. In other words, securities are bought and sold
on the basis of demand and supply. In the primary market, companies (issuers) sell
shares directly to public (investors). Such a sale could either be an Initial Public Offering (IPO)
or a Follow-on Public Offering (FPO). An IPO is the first public offer; the subsequent public
offers are called FPO. In a FPO, public investors have the advantage of knowing more about
the company as compared to an IPO.

41
To help Indian companies increase their public shareholding, SEBI has allowed an additional
way through which the promoters/ promoter groups etc. of the listed companies can make
an Offer for Sale (OFS) through Stock Exchanges.
The offer for sale can be compared to selling shares on the exchanges through auction. There
is a separate window for this which is open during normal trading hours. 100 percent margin
must be paid upfront by the bidders.
3.2.1 Initial Public Offer (IPO)
A company needs to prepare itself for an IPO and usually sets up an IPO team in the company
for ensuring coordination of all IPO related activities. The team provides timely and accurate
information for preparing the prospectus. This team coordinates the entire process, ensures
legal compliance and carries out due diligence. The team also puts together detailed forecasts
to facilitate valuation and pricing.
Intermediaries Involved in an IPO
The issuing company appoints the following intermediaries:
 Investment Bankers
 Syndicate Members
 Underwriters
 Registrars to an Issue and Share Transfer Agents
 Bankers to an Issue
In addition to the above, depositories play a key role in an IPO. The company, the depository
and the registrar enter into a tripartite agreement. This facilitates dematerialisation of the
shares and paves the way for trading on the exchanges after listing.
The following sections carry details of the functions of these intermediaries.
Investment bankers
The key role in an IPO is played by the investment bankers (merchant bankers) in their
capacity as lead managers. They act as advisors to the issuer and take the company through
the IPO process. The key responsibilities of the investment bankers include:
 Conducting due diligence on disclosures in offer document and publicity materials
 Coordinating the offer process
 Appointing other intermediaries
 Obtaining legal clearances for the offering
 Obtaining clearances from SEBI and stock exchanges for the offering
 Managing the syndicate
 Coordinating the allotment and listing process
Typically, most IPOs involve more than one investment banker. A 'syndicate' is constituted to
manage the issue. The leader is 'Book Running Lead Manager' (BRLM). The other book runners

42
support this BRLM in marketing the IPO. Retail brokers are appointed to support the book
runners in selling the securities to individuals across the country.
Syndicate members
Syndicate members procure bids for an IPO from institutional and retail investors. Brokers
registered with SEBI work as syndicate members for an IPO.
Underwriters
Underwriters agree to subscribe to the securities that are not subscribed to by the public or
shareholders in cases of issue of securities. In exchange for this undertaking, they are paid a
commission. They can be merchant bankers or stock brokers or other registered underwriters
under the SEBI guidelines.
Registrars to an issue and Share Transfer Agents
The registrars process the application forms received in the IPO. They co-ordinate with the
bankers associated to the issue and the investment bankers to complete the reconciliation of
applications received and also to complete the post-issue activities on time. They prepare the
documents required for allotment of shares and securing approval for listing. They also
process data for transfer of funds in case of refund and for the transfer of securities in the
demat form for the allotted shares.
Share Transfer Agents (STAs) help the investors in effecting transfers of shares between the
existing holders and the new buyers. Share Transfer Agents, on behalf of the company,
maintain the records of holder of securities issued by such company and deal with all matters
connected with the transfer and redemption of securities of the company.
Bankers to an issue
Bankers collect application forms along with application moneys. They then deliver the
application forms to the registrar with detailed schedules providing provisional and final
certificates as per the schedule agreed. They also ensure refund of money in case of fully or
partly rejected applications. They also assist in post issue reconciliation.
IPO grading
The issuer company may obtain grading for its IPO from one or more credit rating agencies
registered with SEBI. The Credit Rating Agency assigns a ’grade‘ to the IPO based on the
relative assessment of the fundamentals of the issue in relation to other listed securities in
the country. IPO Grading is a voluntary exercise that helps investors, particularly the retail
investors, in taking informed investment decisions. The issuer company has to disclose all the
grading it has received for the IPO, if graded by multiple agencies.
The Credit Rating Agencies registered with SEBI are CRISIL Limited (CRISIL), ICRA Limited
(ICRA), Credit Analysis and Research Limited (CARE), Fitch Ratings India Private Ltd., Brickwork
Ratings India Pvt. Ltd., and SME Rating Agency of India Ltd. (SMERA).

43
3.2.2 Follow-on Public Offer (FPO)
When an already listed company makes either a fresh issue of securities to the public or an
offer for sale to the public, it is called a Follow-on Public Offer or Further Public Offer.
A listed issuer making a follow-on public issue (FPO) is required to satisfy the following
requirement:
(a) If the company has changed its name within the last one year, at least 50 percent of the
revenue for the preceding 1 full year should be from the activity suggested by the new name.
Any listed company not fulfilling the condition is eligible to make a further public offer if the
offer is made through book-building process and the issuer undertakes to allot atleast 75
percent of the net offer to Qualified Institutional Buyers (QIBs). Also, the issuer shall refund
full subscription money if it fails to make the above mentioned minimum allotment to QIBs.
3.2.3 Rights and Preferential Issues
When an issue of securities is made by an issuer to its shareholders, existing as on a particular
date fixed by the issuer (i.e. record date), it is called a rights issue. The rights are offered in a
particular ratio to the number of securities held as on the record date.
“Preferential issue” means an issue of specified securities by a listed issuer to any select
person or group of persons on a private placement basis and does not include an offer of
specified securities made through employee stock option scheme, employee stock purchase
scheme or an issue of sweat equity shares or depository receipts issued in a country outside
India or foreign securities.4
The issuer is required to comply with various provisions which inter‐alia include pricing,
disclosures to shareholders, lock‐in and restrictions in transferability etc, in addition to the
requirements specified in the Companies Act.
3.2.4 Qualified Institutions Placement (QIP)
As per the SEBI ICDR Regulations, “qualified institutions placement” means issue of eligible
securities by a listed issuer to qualified institutional buyers on a private placement basis and
includes an offer for sale of specified securities by the promoters and/ or promoter group on
a private placement basis.
3.2.5 Private Placements
When an issuer makes an issue of securities to a select group of persons not exceeding 50,
and which is neither a rights issue nor a public issue, it is called a private placement. It can be
in the form of preferential allotment or a QIP.

4
As defined in SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 [SEBI ICDR Regulations].

44
3.2.6 Depository Receipts
Depository receipts (DRs) are financial instruments that represent shares of a local company
that are listed and traded on a stock exchange outside the country. DRs are issued in foreign
currency, usually dollars.
To issue a DR, a specific quantity underlying equity shares of a company are lodged with a
custodian bank, which authorises the issue of Depository Receipts against the shares.
Depending on the country of issue and conditions of issue, the DRs can be converted into
equity shares.
DRs are called American Depository Receipts (ADRs) if they are listed on a stock exchange in
the USA such as the New York Stock Exchange. If the DRs are listed on a stock exchange
outside the US, they are called Global Depository Receipts (GDRs). The listing requirements
of stock exchanges can be different in terms of size of the company, state of its finances,
shareholding pattern and disclosure requirements.
When DRs are issued in India and listed on Indian stock exchanges with foreign stocks as
underlying shares, these are called Indian Depository Receipts (IDRs).
The shares of a company that form the basis of an ADR/GDR/IDR issue may be existing shares
i.e. shares that have already been issued by the company. These shareholders now offer the
shares at an agreed price for conversion into DRs. Such a DR issue is called a sponsored issue.
The company can also issue fresh shares which form the underlying shares for the DR issue.
The funds raised abroad have to be repatriated to India within a specified period, depending
on the exchange control regulations that will be applicable.
The company, whose shares are traded as DRs, gets a wider investor base from the
international markets. Investors in international markets get to invest in shares of company
that they may otherwise have been unable to do because of restrictions on foreign investor
holdings. Investors get to invest in international stocks on domestic exchanges. Holding DRs
give investors the right to dividends and capital appreciation from the underlying shares, but
does not give voting rights to the holder.
The steps in issuing DRs are as follows:
- The company has to comply with the listing requirements of the stock exchange where
they propose to get the DRs listed.
- The company appoints a depository bank which will hold the stock and issue DRs
against it.
- If it is a sponsored issue, the stocks from existing shareholders are acquired and
delivered to the local custodian of the depository bank. Else the company issues fresh
shares against which the DRs will be issued.
- Each DR will represent certain number of underlying shares of the company.

45
Once the custodian confirms that the shares have been received by them, the depository bank
in the foreign country will issue the depository receipts to the brokers to trade in the chosen
stock exchange where the DRs have been listed. DRs may feature two-way fungibility, subject
to regulatory provisions. This means that shares can be bought in the local market and
converted into DRs to be traded in the foreign market. Similarly, DRs can be bought and
converted into the underlying shares which are traded on the domestic stock exchange.
SEBI has laid down the regulations to be followed by companies for IDRs. This includes the
eligibility conditions for an issuing company, conditions for issue of IDR, minimum
subscription required, fungibility, filing of draft prospectus, due diligence certificates,
payment of fees, issue advertisement for IDR, disclosures in prospectus and abridged
prospectus, post-issue reports and finalisation of basis of allotment.

3.2.7 Foreign Currency Convertible Bonds

Foreign Currency Convertible Bonds (FCCBs) are a foreign currency (usually dollar)
denominated debt raised by companies in international markets, which have the option of
converting into equity shares of the company before they mature.
The payment of interest and repayment of principal is in foreign currency. The conversion
price is usually set at a premium to the current market price of the shares. FCCBs allow
companies to raise debt at lower rates abroad. Also the time taken to raise FCCBs may be
lower than what takes to raise pure debt abroad.
An Indian company that is not eligible to raise equity capital in the domestic market is not
eligible to make an FCCB issue either. Unlisted companies that have raised capital via FCCB in
foreign markets are required to list the shares on the domestic markets within a stipulated
time frame.
FCCBs are regulated by RBI notifications under the Foreign Exchange Management Act
(FEMA). The Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through
Depository Receipt Mechanism) 1993 lays down the guidelines for such issues.
The issue of FCCBs should be within the limits specified by RBI from time to time. Public issue
of FCCB will be managed by a lead manager in the international markets. Private placement
of FCCBs is made to banks, financial institutions, foreign collaborators, foreign equity holders
holding at least 5 percent stake.
The maturity of FCCB will be not less than five years. Proceeds from FCCB shall not be used
for stock market activities or real estate. If it is to be used for financing capital expenditure, it
can be retained abroad.
The expenses shall be limited to 4 percent of the issue size in case of public issue and 2 percent
in the case of private placement. Within 30 days of the issue a report has to be furnished to
RBI giving details of the amount of FCCBs issued, the name of the investors outside India to

46
whom the FCCBs were issued and the amount and the proceeds that have been repatriated
to India.

3.3 Public Issue

3.3.1 Book Built Issue
When the price of an issue is discovered on the basis of demand received from the
prospective investors at various price levels, it is called “Book Built issue”. In this, book
building refers to the process of price discovery used in Initial Public Offerings. As per SEBI
guidelines, book building is a process undertaken by which a demand for the securities
proposed to be issued by a corporate is elicited and built-up and the price for such securities
is assessed for the determination of the quantum of such securities to be issued. Investors
bid at different prices which may be equal to or more than the floor price and the issue price
of shares is determined at the end of the bidding period. Normally all public offerings are
through the book building route.
The issue is kept open for minimum of 3 working days and a maximum of 10 working days,
including extension due to price revision during which applications are received from
investors. Based on investor response, an order book is built. The order book indicates the
quantities bid at different levels of prices.
The IPO is finally closed after bidding is completed. After the bidding closes, the company
finalizes the issue price and completes the allotment process.
The company must now update the prospectus with information such as stock market data,
audited results, etc. as applicable. The Board of Directors of the company then meet to accept
letters of underwriting, approve, sign and authorize filing of prospectus with Registrar of
Companies, note the listing application made with the stock exchanges, authorize opening of
accounts with the bankers and file the prospectus with the Registrar of Companies, after
pricing, along with material contracts and documents.
At the end of this process the shares are allotted and transferred to the respective depository
accounts of the investors. They then become the shareholders of the company.
3.3.2 Fixed Price Issue
When the issuer at the outset decides the issue price and mentions it in the Offer Document,
it is commonly known as “Fixed price issue”. This price is fixed in consultation with the
merchant bankers and the IPO team, based on various factors like profitability, track record,
promoters’ record, brand value, prices of similar companies, etc. Nowadays, no public
offerings are offered at fixed price. However, this route is not completely closed. It is expected
to benefit SMEs, for whom book building may not be the best option. Smaller sized issues are
still expected to use this route.

47
3.3.3 Draft Offer Document
Draft offer document is an offer document filed with SEBI for specifying changes, if any, in it,
before it is filed with the Registrar of Companies (ROC). Draft offer document is made
available in public domain including SEBI website, for enabling public to provide comments, if
any, on the draft offer document. The details of the issue are covered in this draft offer
document. This is the document on the basis of which the investors place their trust in the
company and invest their monies. The various sections in this document give the details about
the company, issue, etc. This must be read carefully before investing in any issue. This is a
very important document, as it forms the basis for the issue of securities by the company. The
various sections of the draft offer document are summarised as below:
(a) Cover Page
Under this head, full contact details of the Issuer Company, lead managers and registrars, the
nature, number, price and amount of instruments offered and issue size, and the particulars
regarding listing are disclosed. Other details such as Credit Rating, IPO Grading, risks in
relation to the first issue, etc. are also disclosed if applicable.
This is the summary of the entire document. It incorporates in a nutshell, the details of the
offer. Investors need to read the section very carefully.
(b) Risk Factors
Under this head the management of the issuer company gives its view on the internal and
external risks envisaged by the company and the proposals, if any, to address such risks. The
company also makes a note on the forward looking statements. This information is disclosed
in the initial pages of the document and also in the abridged prospectus. It is generally advised
that the investors should go through all the risk factors of the company before making an
investment decision.
The section provides details about the risk an investor is exposed to by investing in the company.

(c) Introduction
This section includes the following details:
 Issue details in brief
 Summary of consolidated financial information statements
(d) General Information
This section includes details like:
 Summary of the industry in which the issuer operates
 Business of the Issuer Company
 Other relevant information of the company
 Details of merchant bankers and their responsibilities
 Details of brokers and Syndicate members

48
  Credit Rating for debt
 IPO grading for equity (if any)
 Details of underwriting agreements
The entire details of the offering, the purposes of the offering, the usage of funds involved is
also given along with basis of issue price.
Under this head a summary of the industry in which the issuer company operates, the
business of the Issuer Company, offering details in brief, summary of consolidated financial
statements and other data relating to general information about the company, the merchant
bankers and their responsibilities, the details of brokers/syndicate members to the Issue,
credit rating (in case of debt issue), debenture trustees (in case of debt issue), monitoring
agency, book building process in brief, IPO Grading in case of First Issue of Equity capital and
details of underwriting Agreements are given.
(e) Capital Structure and Particular of the Issue
Important details of capital structure, objects of the offering, funds requirement, funding
plan, schedule of implementation, funds deployed, sources of financing of funds already
deployed, sources of financing for the balance fund requirement, interim use of funds, basic
terms of issue, basis for issue price, tax benefits are covered under these sections.
These are informative sections about the company. More details required for making an
informed decision can be obtained from these sections. The investor can look at the industry
before making the investment decision.
The following sections give details about the company, for the investor to make an informed
decision.
(f) About the Issuer
Under this head a review of the details of business of the company, business strategy,
competitive strengths, insurance, industry‐regulation (if applicable), history and corporate
structure, main objects, subsidiary details, management and board of directors,
compensation, corporate governance, related party transactions, exchange rates, currency of
presentation and dividend policy are given.
(g) Financial Statements
Under this head financial statement and restatement as per the requirement of the
Guidelines and differences between any other accounting policies and the Indian Accounting
Policies (if the Company has presented its Financial Statements also as per either US
GAAP/IFRS) are presented.
(h) Legal and other information
Under this head outstanding litigations and material developments, litigations involving the
company, the promoters of the company, its subsidiaries, and group companies are disclosed.
Also material developments since the last balance sheet date, government

49
approvals/licensing arrangements, investment approvals (FIPB/RBI etc.), technical approvals,
and indebtedness, etc. are disclosed.
The following sections give details of the issue that will help the investors to make investment
decision.
(i) Other regulatory and statutory disclosures
Under this head, authority for the Issue, prohibition by SEBI, eligibility of the company to enter
the capital market, disclaimer statement by the issuer and the lead manager, disclaimer in
respect of jurisdiction, distribution of information to investors, disclaimer clause of the stock
exchanges, listing, impersonation, minimum subscription, letters of allotment or refund
orders, consents, expert opinion, changes in the auditors in the last 3 years, fees payable to
the intermediaries involved in the issue process, details of all the previous issues, all
outstanding instruments, commission and brokerage on, previous issues, capitalization of
reserves or profits, option to subscribe in the issue, purchase of property, revaluation of
assets, classes of shares, stock market data for equity shares of the company, promise vis‐à‐
vis performance in the past issues and mechanism for redressal of investor grievances are
disclosed.
(j) Offering information
Under this head Terms of the Issue, ranking of equity shares, mode of payment of dividend,
face value and issue price, rights of the equity shareholder, market lot, nomination facility to
investor, issue procedure, book building procedure in details along with the process of making
an application, signing of underwriting agreement and filing of prospectus with SEBI/ROC,
announcement of statutory advertisement, issuance of Confirmation of Allocation Note
("CAN") and allotment in the issue, designated date, general instructions, instructions for
completing the bid form, payment instructions, submission of bid form, other instructions,
disposal of application and application moneys , interest on refund of excess bid amount,
basis of allotment or allocation, method of proportionate allotment, dispatch of refund
orders, communications, undertaking by the company, utilization of issue proceeds,
restrictions on foreign ownership of Indian securities, are disclosed.
(k) Other Information
This covers description of equity shares and terms of the Articles of Association, material
contracts and documents for inspection, declaration, definitions and abbreviations, etc.
3.3.4 Offer Document
‘Offer document’ is a document which contains all the relevant information about the
company, promoters, projects, financial details, objectives of raising the money, terms of the
issue etc. and is used for inviting subscription to the issue being made by the issuer.
‘Offer Document’ is called “Prospectus” in case of a public issue or offer for sale and “Letter
of Offer” in case of a rights issue.

50
3.3.5 Draft Red Herring Prospectus
Draft red herring prospectus (DRHP) is a draft prospectus which is used in book built issues. It
contains all disclosures except the price. It is filed with SEBI for their observations/ comments.
DRHP contains all statutory disclosures.
The DRHP contains disclosure about the company and also group companies. The information
includes financials, objects of the issue, project details, details of promoters and
management, outstanding litigations against the company and directors, auditor's reports,
management discussion & analysis of financial performance, related party transactions and
risk factors. This DRHP must be filed with SEBI for their observations.
The company fixes the price band in consultation with the investment bankers and files the
red herring prospectus (RHP) with the Registrar of Companies (RoC). This RHP also includes
the bid opening and closing date.
3.3.6 Prospectus
Prospectus is an offer document in case of a public issue, which has all relevant details
including price and number of shares being offered. This document is registered with RoC
before the issue opens in case of a fixed price issue and after the closure of the issue in case
of a book built issue.
3.3.7 ASBA
ASBA stands for "Application Supported by Blocked Amount". This facility is available for all
investors. In the ASBA process, the investor is not required to pay the application fee by
cheque. Instead, he authorises his banker to block that amount in his account. The account
is debited only if the investor receives allotment. There is no concept of refund of application
money. Till the allotment is made, the investor has the opportunity to earn interest on this
money lying in his account.
All the investors applying in a public issue shall use only ASBA facility for making payment i.e.
just writing their bank account numbers and authorising the banks to make payment in case
of allotment by signing the application forms, thus obviating the need of writing the cheques.
SEBI in its continuous efforts to further streamline the public issue process, has introduced
the Unified Payment Interface (UPI) as a payment mechanism with ASBA for applications in
public issues by retail individual investors through intermediaries.5 The UPI with ASBA facility
is implemented in a phased manner.
3.3.8 Green Shoe Option
Green Shoe Option is a price stabilizing mechanism in which shares are issued in excess of the
issue size, by a maximum of 15 percent of the issue size. From an investor’s perspective, an
issue with green shoe option provides more probability of getting shares and also that post
listing price may show relatively more stability as compared to market volatility.

5
SEBI Circular No.: SEBI/HO/CFD/DIL2/CIR/P/2018/138 dated November 1, 2018.

51
3.3.9 Basis of Allotment
On highly oversubscribed issues the applicant may not get full allotment for the number of
shares that s/he had applied for. After the closure of the issue, say a book built public issue,
the bids received are aggregated under different categories i.e., firm allotment, Qualified
Institutional Buyers (QIBs), Non‐Institutional Buyers (NIBs), Retail, etc. The oversubscription
ratios are then calculated for each of the categories as against the shares reserved for each
of the categories in the offer document. Within each of these categories, the bids are then
segregated into different buckets based on the number of shares applied for. The
oversubscription ratio is then applied to the number of shares applied for and the number of
shares to be allotted for applicants in each of the buckets is determined. Then, the number
of successful allottees is determined. This process is followed in case of proportionate
allotment. The allotment to each investor is done on proportionate basis in both book built
and fixed price public issues.
At present, in a book-built issue allocation to Retail Individual Investors (RIIs), Non-
Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of
35:15:50, respectively. In certain cases, the allocation for QIBs is 75 percent mandatory, RIIs
will be allotted 10 percent and NIIs will be offered 15 percent.
3.3.10 Corporate Actions
Bonus Issue
A bonus issue of shares is given to the shareholders in order to convert reserves to capital.
The bonus shares are issued in a certain ratio. For example, a ratio of 1:1 implies that for every
share held, one share is issued as bonus. There is no payment involved for the shareholder.
The shareholders get more capital and higher returns as they now own more shares.
Rights Issue
In a rights issue, the shares are offered for sale to the shareholders. Again, this is in a certain
ratio. However, the shareholders have to pay for their shares bought by them. This is normally
at a price lower than the market price. This is carried out to get more capital by the company
without going for a public issue. This is also beneficial to the shareholders as they can buy
shares at a lower price than the market.
Stock Split
This is carried out by splitting each share into two or more shares. This is done when the share
prices are very high compared to its peer companies and the company wants to keep the price
at a certain level so that individual investors can afford to invest in the stock. If the share is
split into two parts, each shareholder will get twice the number of shares that he owns and
the price of the share will be halved, although the market capitalisation will remain
unchanged.

52
Buy Back of Shares
The company offers to buy back its shares from the shareholders in certain cases. This is
carried out when the company feels that the company is over capitalised. SEBI (Buy-Back of
Securities) Regulations, 2018 govern buy back of shares.
3.3.11 Advertising Code
SEBI ICDR Regulations specifies guidelines on the advertisements and publicity matters
relating to a public issue.
Any public communications, publicity materials, advertisements and research reports made
by the issuer or their intermediary, concerned with the issue, will contain only facts. No
projections, estimates, conjectures, are to be given.
Any practices of the company being changed during the course of the public issue, shall be
declared in the advertisement or publicity material.
The advertisement must show that the issuer is proposing to make a public/rights issue and
the fact of the offer document filed with SEBI or the Registrar of Companies or the filing of
the letter of offer with the exchange must be clearly stated.
The draft offer document must be available on the website of the issuer, lead merchant
banker or lead book runner.
Any material development taking place during the following period must be disclosed
promptly in a true and fair manner:
 In a public issue, between the date of registering final or red herring prospectus and
date of allotment;
 In a rights issue, between the date of filing letter of offer and the date of allotment.
The issuer shall not release at any time, any material which is not contained in the offer
document, whether in a conference or otherwise.
The approval of the lead merchant banker is to be obtained by the issuer for all public
communications, advertisements and publicity materials. A copy of all this is to be made
available to the lead merchant banker.
Any advertisement/publicity material/research report issued by issuer or intermediary shall
comply with following:
 It shall be fair and truthful and not manipulative or distorted or deceptive.
 It shall not contain false or misleading data, statement, promise or forecast.
 Anything copied or reproduced from offer document shall be in full with all relevant
facts and not select extracts.
 The language should be clear, concise and understandable.

53
  It should not have any slogans or brand names for the issue except the name of the
issuer or the brand names of products of the issuer.
 Any financial data should be for the last three years including sales, gross profit, net
profit, share capital, reserves, earnings per share, dividends and the book values.
 The advertisement is not to use technical or legal terminology or complex terms that
are not understandable or excess details that distract the investor.
 No statements shall contain promises or guarantee of rapid increase in profits.
 Issue advertisements shall not display models, celebrities, fictional characters,
landmarks, caricatures or the likes.
 Issues cannot be advertised as crawlers (the narrow strip at the bottom of the
television screen).
 Any advertisement on television shall advise viewers to refer to the red herring
prospectus or offer document for details and the risk factors shall not be scrolled on
the television screen.
 Any issue advertisement should not have slogans, expletives, etc. The titles should not
be non-factual or unsubstantiated.
 If there are certain highlights in the advertisements or research reports, the risk
factors also to be given with equal importance.
Any advertisement giving any impression that the issue has been fully subscribed or
oversubscribed should not be published during the period when the issue is open for
subscription.
Any announcement regarding closure of issue can be made only after the date of issue
closure. This can be made only after lead merchant banker is satisfied that 90 percent of the
issue is subscribed and the registrar has certified thus.
No advertisement can contain any incentives, whether in cash or kind or services or
otherwise.
No product advertisement can contain reference to performance of issue from the date of
board resolution for issue of securities till the date of allotment of such securities.
A research report may be prepared only on the basis of information, disclosed to the public
by the issuer, by updating the offer document or otherwise.

54
Quiz

1. All the investors applying in a public issue shall use only ________ facility for making
payment.

2. SEBI appoints a specific credit rating agency to grade an IPO. State whether True or False.

3. Draft offer document is first filed with ______ and then with ____.

4. Green Shoe Option is a ______ stabilizing mechanism.

5. In a rights issue, shares are offered for sale to ________ shareholders.

Answers

1. Application Supported by Blocked Amount (ASBA)

2. False

3. SEBI; Register of Companies (RoC)

4. Price

5. Existing

55
 4 Secondary Market

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Meaning and functions of secondary market
 History of stock exchanges in India and reforms in securities market
 Features of secondary market in India
 Market Phases—Bulls and Bears

4.1 Introduction
While the primary market is used by issuers for raising fresh capital from the investors through
issue of securities, the secondary market provides liquidity to these instruments, through
trading and settlement on the stock exchanges. An active secondary market promotes the
growth of the primary market and capital formation, since the investors in the primary market
are assured of a continuous market where they have an option to liquidate their investments.
Thus, in the primary market, the issuer has direct contact with the investor, while in the
secondary market, the dealings are between two investors and the issuer does not come into
the picture.
The secondary market operates 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. Indian markets have recognized OTC exchanges like the OTCEI
(OTC Exchange of India); however, they do not give much volume. 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 don’t know each other. The settlements of trades are
done as per a fixed time schedule. The trades executed on the exchange are settled through
the clearing corporation, who acts as a counterparty and guarantees settlement.
The securities traded on the stock exchanges are grouped into "listed securities" and
"permitted securities". The securities of companies which have signed a listing agreement
with the exchanges are known as listed securities. Almost all equity segment securities fall
under this category. An exchange may permit trade in unlisted securities provided they meet
certain norms specified by the exchange. Such securities are termed as permitted securities.
Earlier, trading of securities was on the basis of open outcry system where the brokers used
to actually meet on the exchange floor for trading. This necessitated setting up of regional
exchanges in order to give liquidity to securities all over the country. However, with the
commencement of nationwide electronic trading on NSE and BSE, the importance of the
regional stock exchanges has diminished. Units of close- ended schemes of mutual funds are
also traded in the secondary market.

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4.2 Functioning of the Secondary Market
The stock exchanges facilitate the trading of securities. After the trade is made, the securities
are transferred by depositories.
Brokers are the trading members of a stock exchange. They have to hold membership of stock
exchange and registered with SEBI. The placing of order, its conversion into a contract, and
the final settlement are carried out by the brokers. Only the brokers have access to the
terminals of the stock exchange. They place the orders on the order book of the exchange on
behalf of their clients.
The orders are entered through trading terminals situated in the brokers' offices. These
orders flow into an order book (another computer), maintained and managed by the stock
exchange. Using a specific protocol, called price-time priority, the buy and sell orders lying
on the order book are matched by the computer. This is called order execution. The orders
that have been executed on the order book are communicated to the clearing house for
clearing and subsequent settlement. In this sense, manual intervention in the trading, clearing
and settlement cycle has considerably decreased.
The introduction of internet trading has further made it possible for the client to virtually
place the order through the broker's terminal. The introduction of Straight Through
Processing (STP) has created a seamless, trading, clearing and settlement environment
without manual intervention. The electronic environment has increased the capacity of the
securities market to handle very high volumes of transactions. One must remember that
electronic environment brings its own risks into the market and suitable steps must be taken
to address the risks associated with it.
As information flows into the market dynamically and continuously, one would notice a
ceaseless trading activity on the stock exchanges. Due to this, prices keep moving up and
down from time to time. In this sense, stock exchanges are said to discover prices of shares
listed on them. Regardless of the price at which the share was issued, the fair economic value
of a share at any point in time is the price quoted on the exchange.
The exchanges play an important role in converting savings into investments. They also help
mobilization of credit, as the securities can be used as collaterals for loans. The GDP growth
and the growth of the securities market are usually positively correlated. It can be said that
the stock exchanges are important for the working of the economy.
4.2.1 Brief History of Stock Exchanges in India
Early history
Indian securities market is one of the oldest in Asia. Its history dates back nearly 200 years.
The expansion of the cotton industry led to trading of stocks and shares in banks and cotton
presses. This led to growth in commercial enterprise. Following the civil war in America, the
brokers who thrived during this war period established the “Native Share and Stock Brokers

57
Association” in Bombay (now Mumbai). The place, subsequently, came to be known as Dalal
Street meaning brokers’ street.
This subsequently led to the establishment of many stock exchanges across India. Many
closed down in the depression of post World War II. But the Indian independence saw revival
in the markets and exchanges were being slowly set up. However, 1980s saw the
establishment of many exchanges.
The reforms of the 1990s saw the establishment of OTCEI and NSE.
Reforms since the 1990s
The 1990s witnessed major policy changes leading to the liberalization of the Indian securities
markets. These were promulgated with a view to improve market efficiency, preventing unfair
trade practices, ensuring investor protection and to bring the Indian markets at par with
international standards.
SEBI Act, 1992
Although SEBI was established in 1988, this was the landmark Act which gave SEBI complete
control over the regulation of the securities markets in India. The aim was to have a single
regulator for the securities markets in India and to protect the interests of the investors and
also to promote the development of the securities markets.
SEBI (DIP) Guidelines, 1992 and ICDR Regulations
SEBI issued the Disclosure and Investor Protection Guidelines in 1992. This was issued in the
interest of the investors. The guidelines contain the requirements for the issuers and the
intermediaries, when a company raises fresh capital. The intention behind these guidelines is
to ensure that all the market participants observe high standards of integrity, and comply with
all the requirements. Adequate disclosures about the issuer, its business, promoters, project
and financials of the issuer company are made to enable the prospective investors to take an
informed investment decision in any public offering.
The DIP Guidelines concentrated on disclosure norms. Earlier, the Competition Commission
of India (CCI) would allow the issuers to come out with securities offerings based on merit and
the previous track records. But, with the DIP Guidelines, the emphasis is on disclosure.
Adequate disclosure is the criteria for permission for issue of securities. The DIP guidelines
were repealed and the SEBI (Issue of Capital and Disclosure) Regulations (ICDR) were notified
by SEBI in 2009 in order to provide these guidelines a statutory backing. The ICDR Regulations
attempt to streamline the framework for public issues by removing unnecessary stipulations,
introducing market-driven procedures and simplifying the clutter of legality. Further, SEBI
ICDR 2009 was repealed and the SEBI (Issue of Capital and Disclosure Requirements)
Regulations 2018 was introduced to align the regulations with changes to other statutes and
regulations.

58
Screen Based Trading
Electronic screen based trading commenced in India in 1992 with the trading platform of
OTCEI. NSE and BSE followed suit in 1994. This was a milestone in the Indian securities market
as it subsequently led to the opening of trading terminals all over India. It took trading to
nation-wide scale. This was a vast improvement over the open outcry system followed earlier.
Trading Cycle
Before the introduction of electronic trading, settlement was done at the end of the
settlement period which varied from 14 days to 30 days, depending on the securities traded.
The introduction of the rolling settlement in 2001, led to the settlement being carried out in
T+5 days, i.e., the 5th day after the trade. This settlement time reduced to T+3 in 2002 and
T+2 in 2003. This is in accordance with international standards and in fact better than most
markets. The shorter settlement cycle helps investors make quick decisions and they have a
better control over the trades made by them. They can also ensure that the trades carried
out are executed correctly and exercise control over their contracts.
Derivatives Trading
In order to introduce derivatives trading in India, the Securities Contract (Regulation) Act,
1956 (SCRA) was amended in 1995 to lift the ban on options in securities. However,
derivatives trading did not commence as expected on account of the absence of regulations
governing such trading. The SCRA was amended further in 1999 to include derivatives in the
definition of securities. Thus the same regulatory system governed both securities trading as
well as derivatives trading. Derivatives trading took off in 2000 on the NSE and the BSE. The
derivative products that are being traded include stock futures, index futures and options on
index, currencies, interest rates and individual stocks.
Demutualisation
Stock exchanges were owned, controlled and managed by brokers. This led to a conflict of
interest over the settlement of disputes as self interest got precedence over regulations. The
regulators advised the stock exchanges for 50 percent representation by non-brokers, but the
same was not successful. Hence, in 2001, the Government put forth a proposal to corporatise
the stock exchanges by which the ownership, management and trading membership would
be segregated from one another. The ordinance towards the same was proposed in 2004 and
has since been enacted. The process has been initiated since 2005 by the stock exchanges.
Most of the exchanges are now corporatised and demutualised.
Depositories Act, 1996
Bad delivery was one of the major problems of the securities markets. Settlement cycles were
long and transfer was carried out using physical securities. However, the settlement system
was not efficient. Electronic settlement had become necessary. The Depositories Act was
enacted in 1996 to dematerialize securities and to enable trading in the electronic form.

59
Globalisation
OTCEI in 1992, NSE in 1994 and BSE in 1996, were allowed to open trading terminals to trade
outside Mumbai. Initially terminals were allowed only in places where the regional exchanges
did not operate. However, since 1999, any place in India could have trading terminals of the
BSE and NSE. Now, trading terminals have been opened abroad and Indian securities can be
traded outside India. The Indian securities market is open to FPIs and they can invest in Indian
securities. Indian companies are allowed to issue FCCBs/ADRs/GDRs abroad leading to a
complete globalisation of the Indian securities market.

4.3 Market Phases

A Bull phase in the market is a phase marked by rising prices of stocks due to abundance of
buyers and relatively few sellers. Consequent to the push in the price of stocks upwards, the
indices also rise. This is when the market is said to be showing confidence in economy. Volume
of shares traded also is usually high and the number of companies entering the primary
market is also on the rise.
A Bear phase in the market is when the market is weak or where the stock prices are falling
indicating the dominance of sellers. As there are more sellers and lesser buyers in this phase,
the prices of stocks are pulled down. The indices also show a downward trend. Thus, in bear
phase a market shows a lack of confidence in general in the market.
A good investment strategy is to buy stocks in a bear market when the prices are low and sell
stocks in a bull market when prices are higher. However, knowing when is the best time to
buy and sell is not always that simple.
In a bullish market, there is scope for appreciation but determining exactly when the bottom
and the peak will occur is impossible. However, during this phase, an investor can actively and
confidently invest in more equity with a higher probability of making a return.
Investing in a bearish market gives a higher chance of experiencing losses as timing the entry
into the market is very difficult. Even if there are hopes of an upturn, there is likelihood of a
further dip in the market before any turnaround. Most of the profitability under bearish
market conditions is usually in short selling or investing in safer investments such as fixed-
income securities. While in bear mode, an investor may also turn to low beta stocks, these
are stocks whose performance is less affected by the changing trends in the broader market
like utilities.
However, the decision to enter or to exit the market, during any phase, should be in
accordance with the risk appetite of the investor.
Unfortunately, most investors too often go by the market sentiment and end up selling in a
bearish market or buying in bullish markets. Investors can make some money this way, but
trading on sentiment is one of the main reasons investors lose money trying to time the
market. The safest way for small investors is to invest in the market regularly through
Systematic Investment Plans (SIP) and hold their investments for a long period of time.

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Quiz

1. In the ______ market, the securities are traded and settled bilaterally.

2. Orders in the order book are sorted based on _________.

3. A ___ phase in the market is when the stock prices are falling.

4. The secondary market operates through two mediums: Over-the-counter and _______.

5. A good investment strategy is to buy stocks in a bear market when the prices are low and
sell stocks in a bull market when prices are higher. State whether True or False.

Answer

1. Over-the-Counter (OTC)

2. Price-time priority

3. Bear

4. Exchange Traded Market

5. True

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 5 Understanding Market Indicators

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Meaning of Index and its significance
 Different types of indices--Market capitalisation, Free float and Total Returns
 Concept of Impact Cost, Beta, Market Capitalisation ratio, Turnover ratio
 Fundamental Analysis and Technical Analysis

Normally, stock markets are measured by the indices that are representative of the stocks.
However, there are other indicators also which help us measure market liquidity, value of a
portfolio, risk in a particular scrip, etc. Here are some indicators related to the Indian stock
markets.

5.1 Index and its Significance

A stock market index is a measure of the relative value of a group of stocks. The index value
depends on the value of the stocks in the group. In simple terms, if an index increases by 2
percent, it means the total value of the group of stocks in that index has also risen by 2 percent
although individual stocks may behave differently compared to the index. There is a direct
correlation between the index and the value of its group of stocks.
Example:
Assume an index called Super Index is made up of five companies. The end of the day’s value
is 2,134 points. The next day, two companies’ stock prices moved up, one company’s stock
price remained the same and two companies’ stock prices reduced. However, the net change
increased the index by 1 percent. So the Super Index is now higher by 1 percent or is at 2,155
points.
5.1.1 Introduction
An index is a numerical representation of the value of the group of stocks. Any change in the
value of stocks changes the value of index. The index acts as a benchmark value to measure
the performance of investments.
The major uses of indices are:
 The index can give a comparison of returns on investments in stock markets as
opposed to other investments like gold or debt, etc.
 For the comparison of performance with an equity fund, a stock market index can be
the benchmark.
 The performance of the economy or any sector of the economy is indicated by the
index.

63
  Real time market sentiments are indicated by indices.
 Acts us an underlying in Index Funds, Index Futures and Options in the fields of
financial investments and risk management.
5.1.2 Understanding Index
A group of stocks that represent the market or its segment are picked up to create an index.
In the calculation of an index, a base period and a base index value is used. Indices can be
used in financial, commodities or any other markets to gather information about their
movements in prices. Price movements of stocks, bonds, T-Bills and other forms of
investments are measured by constructing financial indices. The overall behaviour of the
stock markets is measured by the movements in the stock market indices.
An index is just a benchmark of a segment or market as a whole. A particular stock may not
actually follow the movement of the index. It could be higher or lower. It may also move in
the reverse direction to the index. However, on a particular day or over a particular period of
time, indices are good indicators of price movements.
Investments are best measured against a relevant index. If there is a constant lagging behind
of the investment, it may be time to rethink the strategy. However, if the investment
outperforms the index, it may be good to hold.
5.1.3 Investing in Indices
Indices, being the benchmark of market performance, are very useful to investors, especially
in stock markets.
As indices are indicators of the markets, they provide market insights and can provide
guidance to investors. Investors who do not know which stocks to invest in can use indexing
to choose their stock investments. Investment in index funds or index Exchange Traded Funds
(ETF) is a good option for such investors. An investor can compare his individual stocks or
portfolio with index movements, as indices act as yardsticks to measure performance. The
market movements are predicted using indices as forecasting tools. Such forecast is based on
historical data.
5.1.4 Economic Significance of Index Movements
Analysis of historical data shows that the indices reflect the economic trend of a country.
Index is therefore considered a primary indicator of the country’s economic strength and
development. An index on the rise leads to higher investments and the converse is also true,
generally. In this book we discuss mainly about index in the Indian market. However, due to
globalization and to be able to assess impact of global events on Indian market, one should
also track major indices such as Dow Jones, FTSE, NASDAQ 100, S&P 500, Nikkei 225, etc. Later
in this chapter, we will introduce technical analysis that uses historic data to predict market
movements.

64
5.1.5 Types of Indices
The most popular indices are the S&P BSE Sensex (comprises of 30 stocks), NSE’s Nifty 50
(comprises of 50 stocks) and MSEI’s SX40 (comprises of 40 stocks).
These are popular, but there are also broad based indices which include stocks going to
hundreds in number. There are also the sector indices like tech index, bank index, consumer
goods index, etc. They represent a particular segment of the economy. Indices spanning
across countries and exchanges are global indices.
5.1.6 Attributes of an Index
The stock price movements are affected by many factors. This includes news about a
company, an industry, the country itself. A product launch, a major order, closure of a branch,
Government policies, budget announcement, floods, drought, etc. are examples of news
which affect stock prices, both favourably and unfavourably.
An index is designed such that it captures the movements of the stock market based on news
about the country. This is carried out by means of averaging. A stock price comprises stock
news and index news. Suppose we take the returns of many stocks and average them out, the
upward movement in some may be cancelled out by the downward movement in others. An
index cancels out the index movements and the only thing left will be generally common to
all stocks.
The working of an index is to be understood in order to start analysing stock movements and
their relevance in the economy. The composition of the index is to be studied for this.
As mentioned earlier, a broad based index, also called composite index, covers almost all
stocks on the exchange or at least a certain majority taken as a percentage of market
capitalisation of the exchange. The broad based index acts as a proxy for the performance of
the market as a whole, revealing market sentiments of the investors.

5.2 Types of Indices based on Calculation Methodology

In this section, we will look at various methods of calculating an index.
5.2.1 Market Capitalisation Weighted Index
The method followed earlier for calculation of indices was called the “Market Capitalisation-
Weighted” method. The stocks taken for the calculation were of companies which were large,
well-established and financially sound.
As the name suggests, the weightage given to each company in this method depends on the
market capitalisation of the company. The market capitalisation is the product of the current
market price of the company and the number of shares outstanding. A company with
10,00,00,000 shares outstanding and with a market price of Rs. 580/- per share would have a
market capitalisation of Rs. 58,00,00,00,000/-. A higher market capitalisation means a higher
weightage for the company in the index.

65
Example:
A market capitalization based index on 1st Jan 2009 has been constructed with 5 stocks and
assigned a base value of 100 to this index and now it is required to calculate the index value
on 15th July 2019.
Stock price as
Serial on January 1, Number of Shares Stock price as at
Number Stock Name 2009 (in lakhs) July 15, 2019
1 ABCD 250 18 550
2 EFGH 400 14 450
3 IJKL 550 25 500
4 MNOP 200 15 250
5 QRST 350 10 400
Market capitalization = Number of Shares * Market Price
Combined market capitalization of the 5 stocks on 1st Jan 2009 would be
= (250*18 + 400*14 + 550*25 + 200*15 + 350*10) = Rs. 30,350 lakhs.
This is equated to a base value of 100.
Sum of the market capitalization of all constituent stocks as on 15th July, 2019
= (550*18 + 450*14 + 500*25 + 250*15 + 400*10) = Rs. 36,450 lakhs.
The value of the index as per market capitalisation weight method
= (36,450*100/30,350) = 120.09
Thus, the value of the index as on July 15, 2019 is 120.09. As stated earlier, the value of the
index changes with value of the stocks included therein.
Some examples of market capitalisation weighted index include: S&P 500 NYSE Composite
Index, NASDAQ Composite Index, etc.
5.2.2 Free-Float Market Capitalisation Index
The popular method of calculation of indices now is the free-float market capitalisation
methodology. Here the market capitalisation of the company is multiplied by the free-float
factor to determine the free-float market capitalisation.
In this method, only the free-float capitalisation of the company is taken into consideration
for the purpose of assigning weight to the stock in the index. Free-float capitalisation method
takes into consideration only those shares issued by the company that are readily available
for trading in the stock markets. Normally, promoter shareholding is excluded. Government
shareholding, strategic holding and other locked-in shares are also not taken into account in

66
this method. Therefore, free-float means only those shares that are readily available for
trading in the market.
Shares that usually do not come into the open market for trading are called
“Controlling/Strategic” holdings. These are not included in the free-float.
The categories that are excluded from free- float are:
 Shares held by founders/directors/ acquirers which has control element
 Shares held by persons/ bodies with "Controlling Interest"
 Shares held by Government as promoter/acquirer
 Holdings through the FDI Route
 Strategic stakes by private corporate bodies/ individuals
 Equity held by associate/group companies (cross-holdings)
 Equity held by Employee Welfare Trusts
 Locked-in shares and shares which would not be sold in the open market in normal
course
The remaining shares fall under the Free-float category.
Example:
The free float factor for five companies is as follows:
ABCD- 55 percent or .55
EFGH- 35 percent or .35
IJKL – 40 percent or .40
MNOP – 80 percent or .80
QRST- 50 percent or .50
Assume that the free-float factor is constant for all the companies. Actually, the free-float
factor keeps changing due to factors related to the company either directly or indirectly.
Sum of the free float market capitalisation of all constituent stocks as on January 1, 2009
= (250*18*0.55 + 400*14*0.35 + 550*25*0.40 + 200*15*0.80 + 350*10*0.50)
= Rs. 14,085 lakhs.
Sum of the market capitalization of all constituent stocks as on July 15, 2019
= (550*18*0.55 + 450*14*0.35 + 500*25*0.40 + 250*15*0.80 + 400*10*0.50)
= Rs. 17,650 lakhs.
Now the value of the index = (17,650*100/14,085) = 125.31.
Thus, the present value of Index under free float market capitalisation weighted method is
125.31.

67
Some examples of free float market capitalisation weighted indices include: S&P BSE Sensex,
Nifty 50, SX40.
5.2.3 Total Returns Index
A price index like Nifty reflects the returns earned if investment is made in the index portfolio
itself. But a price index does not take in the returns arising from dividend receipts. However,
capital gains arising due to the movements in the prices of the stocks therein are considered
and indicated in a price index. By taking into account the dividends received from the stocks
that comprise the index, gives a truer picture. The index including the dividend received is
called the Total Returns Index. Thus, the total returns index takes care of the price movements
as well as the dividend receipts.
Methodology for calculating the Total Returns Index (TR) is as follows:
Information required includes:
 Price Index close
 Price Index returns
 Dividend payout in Rupees
 Index Base capitalisation on ex-dividend date
Dividend payouts as they occur are indexed on ex-date.

Indexed dividends are then reinvested in the index to give TR Index.

Base for both the Price index close and Total Return index close will be the same.
An investor in index stocks should benchmark his investments against the Total Returns Index
instead of the price index to determine the actual returns vis-à-vis the index.

5.3 Indices in India

The following are some of the indices in India6:

BSE NSE
General Indices
S&P BSE Sensex Nifty 50
S&P BSE Sensex Next 50 Nifty Next 50
S&P BSE 500 Nifty 500
S&P BSE 150 Midcap Nifty Midcap 150
S&P BSE AllCap Nifty Smallcap 250
S&P BSE 250 LargeMidCap Nifty LargeMidcap 250

6
BSE: https://www.bseindia.com/Sensex/IndexHighlight.html
NSE: https://www.nseindia.com/products/content/equities/indices/about_indices.htm

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 BSE NSE
S&P BSE 400 MidSmallCap Nifty MidSmallcap 400

Sectoral Indices
S&P BSE Energy Nifty Auto
S&P BSE Finance Nifty Bank
S&P BSE Industrials Nifty Financial Services
S&P BSE Telecom Nifty FMCG
S&P BSE FMCG Nifty IT
S&P BSE Healthcare Nifty Pharma
S&P BSE Information Technology

Thematic Indices
S&P BSE Public Sector Undertakings (PSU) Nifty 100 ESG
S&P BSE India Infrastructure Nifty SME Emerge
S&P BSE India Manufacturing Index Nifty Commodities
S&P BSE Central Public Sector Enterprises Nifty CPSE
(CPSE) Nifty Energy
S&P BSE 500 Shariah Nifty Infrastructure
Nifty Services Sector
Nifty 500 Shariah

Strategic Indices
S&P BSE Enhanced Value Nifty 100 Equal Weight
S&P BSE Momentum Nifty Multi-Factor
S&P BSE Dividend Stability Nifty 50 Arbitrage
S&P BSE Low Volatility Nifty 50 Futures
S&P BSE Sensex Futures Nifty 100 Alpha 30
S&P BSE IPO Nifty High Beta 50
S&P BSE SME IPO Nifty Growth Sectors 15
S&P BSE Arbitrage Rate

Fixed Income Indices

S&P BSE Liquid Rate Index Nifty AAA Corporate Bond
S&P BSE India Corporate Bond Nifty Banking and PSU Bond
S&P BSE India Bond Nifty G-Sec
S&P BSE India 10 yr. Sovereign Bond Nifty Fixed Income Aggregate
S&P BSE India Government Bill Nifty T-Bills
Nifty 10 yr. Benchmark G-Sec (Clean Price)
Nifty Composite G-Sec
Nifty 1D Rate Index

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5.4 Impact cost – A Measure of Market Liquidity
The ease of executing large orders without incurring high transaction costs is referred as market
liquidity. The transaction costs referred here are the costs associated with lack of market liquidity
which both the buyers and the sellers incur to execute their transactions and do not include fixed costs
such as brokerage, transaction charges, depository charges etc. The buyers and sellers, by trading
extensively, bring liquidity in the market.
The electronic limit order book (ELOB) that the stock exchanges maintain provides details of
market liquidity. It keeps track of the entire buy and the sell orders available in the market.
This helps anyone in the market to match their orders with the best available orders.
An order placed by a buyer or a seller can execute his order effortlessly against the best order
available in the order book. Thus, the liquidity is represented in the order book, where the
orders are the intentions of the buyers and seller converted into orders to be executed.
Market liquidity can be measured by computing the impact cost associated with the
transaction. Impact cost represents the cost of executing a transaction in a given stock, for a
specific predefined order size, at any given point of time.
Impact cost is a practical method of measuring market liquidity that is closer to true cost of
execution as compared to the bid-ask spread.
It should however be emphasised that:
 impact cost is separately computed for buy and sell
 impact cost may vary for different transaction sizes
 impact cost is dynamic and depends on the outstanding orders
 where a stock is not sufficiently liquid, a penal impact cost is applied
Mathematically, impact cost is the percentage mark-up observed while buying or selling the
desired quantity of a stock with reference to its ideal price. Ideal price is the simple average
of best buy and best sell values i.e. (best buy + best sell)/2.

5.5 Risk and Beta

One of the important considerations in holding a portfolio is risk. Risk is defined as any
deviations from the standard. Risk refers to both upside and downside risk; though downside
risk is the main concern in portfolio decision making. The probability of getting a lower return
compared to the expected return is the risk for that investment.
Risk can be classified as Systematic risk and Unsystematic risk.
Unsystematic risks are unique to a firm or industry. Factors like consumer preferences,
capability of management, labour, etc., add to unsystematic risk. These are normally
controllable and can be reduced by the simple method of portfolio diversification. Hence
these are also called diversifiable risk.

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Macro-level factors like economic, political, sociological and other changes are contributors
to systematic risk. They affect the entire market as a whole. As a result, they cannot be
controlled by way of diversification of portfolio. These are also referred as market risk.
Beta measures the degree to which the different stocks/ portfolios are affected by the
systematic risks, in comparison to the market as a whole. The systematic risks of the various
securities differ due to their relationship with the market. Stock market indices provide the
true picture of the market returns and are considered as the benchmark for portfolio
evaluation.
Beta is calculated as:

Where,
Y is the returns on your portfolio or stock - DEPENDENT VARIABLE
X is the market returns or index - INDEPENDENT VARIABLE
Variance is the square of standard deviation.
Covariance is a statistical measure reflecting relations between two variables, X and Y, and is
given by:

Where, N denotes the total number of observations, and and respectively represent the
arithmetic averages of x and y.
The beta of a portfolio is arrived at by multiplying the weightage of each stock in the portfolio
with its respective beta value. This gives the weighted average beta of the portfolio.
The statistical tool to measure volatility or variability of returns from the expected value is
the Standard Deviation. It is denoted by sigma(s), mathematically represented as:

Where, is the sample mean, xi’s are the observations (returns), and N is the total number
of observations or the sample size.

5.6 Market Capitalization Ratio

Market capitalisation or market cap measures the size of a business enterprise. It is the price
of the share on a given date multiplied by the number of outstanding shares of a listed
company.

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 Market cap of a listed company on a particular date = Number of shares outstanding of
that company X the share price on that date
The stock market capitalisation refers to the market cap of all the listed companies on that
stock market.
Market capitalisation to GDP ratio determines the under or over valuation of the entire stock
market.
Market capitalization to GDP is calculated as below. It can be calculated for specific countries,
or for the world as a whole. This depends on what values are used in the calculation.

The result of this calculation is the percentage of a country’s GDP that represents its stock
market value.
Example:
If the market cap of all the listed companies in a market is Rs.60,00,00,000 and the GDP of
that country is Rs. 20,00,00,000, then the market cap raio will be 300 percent
[(600000000/200000000)*100].
A ratio over 100 percent means that the market is overvalued and below 50 percent means
that the market is undervalued. This ratio is used to indicate the state of the markets and
their valuation.

5.7 Turnover Ratio

A stock exchange turnover refers to the value or volume of shares traded on a stock exchange
in a certain period. This shows the amount of trade happening in a specific period like a month
or a fortnight.
Turnover can be defined as the volume or value of shares traded on a stock exchange during
a day, month, or year.
This ratio is arrived at by dividing the total shares traded by the market capitalisation. Thus,
the total value of shares traded during that period is divided by the average market
capitalisation for the period. Average market capitalisation is calculated as the average of the
end-of-period value for the current and previous period.
The turnover ratio actually shows how often shares change hands. High turnover is seen in
some emerging markets.
Normally, a high turnover ratio is used as an indicator of low transaction costs, although it is
not considered a direct measure of theoretical definitions of liquidity.
The market capitalisation ratio is complemented by the turnover ratio. A characteristic of a
large and inactive market is a high market capitalisation ratio and a low turnover ratio.

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A turnover ratio also complements the total value traded ratio. The total value traded ratio
shows the trading in relation to the size of the economy. Turnover measures trading relative
to size of stock market. A small but liquid market is characterised by a high turnover ratio but
a low total value traded ratio.

5.8 Fundamental Analysis

5.8.1 Introduction
The basis of fundamental analysis, as the name suggests, is to determine the value of a share
through analysis of the financials which are fundamental to the company. In this analysis, the
financial data of a company like its earnings, income, dividend, etc., are taken into
consideration. The prime focus is on the company’s business and its activities.
The basis of fundamental analysis is the company’s annual report. Data is taken from the
various financials presented in the annual report and analysed to determine the value of the
stock.
Fundamental Analysis measures the financial soundness of a company. By reading the
financial statements of a company one gets the information about the company's
performance and its future prospects. Also, it takes into consideration the macro economic
factors that affect the company’s performance. Thus, fundamental analysis involves analyzing
its financial statements, its management and competitive advantages, and its competitors
and markets. The analysis helps in studying/ analysing historical and current data to project
future earnings.
Fundamental analysis is a very useful tool and is used either by itself or in combination with
other techniques. The different reasons for performing fundamental analysis are:
1. to calculate its credit risk,
2. to make projections of its performance,
3. to evaluate the company's stock and project future.
Various ratios that are calculated under fundamental analysis are discussed here.
5.8.2 Earnings Per Share
Earnings per Share (EPS) is an indicator of profitability of a company. EPS can be calculated
by dividing the net profit after tax (PAT) by the number of outstanding equity shares of the
company.
A higher EPS shows higher profitability and better earnings for the shareholders and will be
preferred over shares of companies with lower EPS. EPS is generally considered to be a
significant variable in determining a share's price.

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5.8.3 Dividend Yield and Dividend Payout
The dividend yield is expressed in terms of the market value per share. The dividend yield is
obtained by dividing the dividend per share by the market price of each share.
The dividend payout ratio is calculated by dividing the dividend by the profit after tax. This
ratio indicates the dividend paying capacity of the company.
5.8.4 Price Earnings (P/E)
The broadest and the most widely used overall measure of performance of a company is its
price earnings (P/E) ratio. This is calculated by dividing the market price per share by the
earnings per share (EPS).
In general, a high P/E suggests that investors are expecting higher earnings growth in the
future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the
whole story by itself. It's usually more useful to compare the P/E ratios of one company to
other companies in the same industry, to the market in general or against the company's own
historical P/E.
The P/E is sometimes referred to as the "multiple", because it shows how much investors are
willing to pay per rupee of earnings. If a company were currently trading at a multiple (P/E)
of 20, the interpretation is that an investor is willing to pay Rs. 20 for Re.1 of current earnings.
5.8.5 Book Value
Book value is calculated as total assets less total liabilities of the company. It is also
commonly referred to as the net worth of the company.
5.8.6 Return on Equity (ROE)
This is the comparison of profitability against equity of the company. ROE is calculated by
dividing profit after tax by the value of equity in the balance sheet.

5.9 Technical Analysis

5.9.1 Introduction
The study of trends in share prices in order to predict future share price movements is called
technical analysis. Here, the basis is that the past trend will determine the future course of
prices.
A stock chart is a price and time chart. The stock or index price movements over time are
given in the chart against time intervals. The time frame can vary from minutes to weeks and
so on. Stock charts can be made for stocks as well as indices.
Trends are measured by trendlines. The past trend is identified by the movement of the line.
The trend shows the rate of change of the price over a period of time. The two upper and

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lower limit lines are called Support and Resistance. The trendline moves between these two
lines.
In an upward movement, when the trendline touches the upper line, the resistance kicks in
and the stock price moves down. When the trendline touches the lower line, then the support
kicks in and the price increases.
5.9.2 Dow Theory
Technical analysis is primarily based on theory of Charles Dow, the first editor of the Wall
Street Journal. His theory proposed that the way the averages move shows the movement of
the market. He believed that the markets show three movements which are defined and
which fit within each other.
 Ripple: The first movement consists of daily variation on account of the particular
trades of that day and the causes thereon.
 Wave: The second movement occurs over days or weeks, normally averaging six to
eight weeks.
 Tide: The third move covers anything between six months to four years.
Primary trends are marked by a bull or a bear phase. The secondary trends are movements of
upto one-third or two thirds of the primary trend. This happens with respect to the previous
secondary movement. The daily movements are more for short-term trading but do not carry
much weightage for the broad market movements.
5.9.3 Elliot Wave Theory
This theory is named after Ralph Nelson Elliott who propounded this theory having been
inspired by Dow Theory. The basis here is that the stock market movement can be predicted
by a pattern of waves which are repetitive. In fact, Elliott stated that all activities and not only
stock market movements are influenced by these waves which form an identifiable series. In
the simplest form, the trend direction contains five waves and corrections in trends contain
three waves. Smaller patterns are easily identified inside bigger patterns. Both long and short
term charts show these patterns.
5.9.4 Bar Charts
Bar charts represent price plotting of a share. The open, high, low and close are easily
identifiable here. The time frame can be in minutes, hours, days, weeks or even months. The
total height represents the price range, - the top being the highest price, the bottom being
the lowest price. Open and Close are indicated by dashes on the left and right hand sides.
5.9.5 Candlestick Charts
These are advanced forms of bar charts with the same data used as in bar charts, i.e. open,
high, low and close prices. They are visually better to look at than bar charts. The candlestick
body represents the open and close price and ranges in between. A black candlestick body or

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that which is filled in represents that the close during the time period was lower than the
open, (normally considered bearish) and when the body is not filled in or white, that means
the close was higher than the open (normally bullish). The thin vertical line above and/or
below the real body is called the upper/lower shadow, representing the high/ low for the
period.

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Quiz

1. Index movements help in judging market sentiments. State whether True or False.

2. Beta is a measure of ____.

3. In emerging markets, turnover ratio is ______.

4. Market cap = Number of outstanding shares X ________.

5. Earnings per share (EPS) is an indicator of _______.

Answers

1. True

2. Risk

3. High

4. Current share price

5. Profitability

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 6 Trading and Risk Management

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Important concepts in trading system
 Types of orders
 Trade life cycle
 Transaction charges
 Circuit Breakers
 Capital adequacy requirements for trading members
 Risk management systems in securities markets

6.1 Trading Systems in India

As seen earlier in this book, trading involves buying and selling of securities or financial
products. Trade also means the conversion of an order into execution through exchange of
funds and securities. The end point of a trade is settlement.
The trade begins with the placing of order by an investor through a broker or through internet
trading. The broker confirms the order before entering it into the trading system of the
exchange. The order is then automatically matched based on price-time priority and
confirmed by the stock exchange. Once the exchange confirms the trade to the broker, he
passes on the information to the investor. Clearing and settlement of the trade involves
Depository Participants (DPs) and clearing banks that carry out the pay-in/pay-out of
securities and funds respectively.
Any transaction or behaviour, whether it is buying, selling or instigating in a manner to wilfully
produce an abnormal effect on prices and / or volumes, goes against the very fundamental
objective of the securities markets. Here the risk management system plays a crucial role. An
efficient risk management system is integral to an efficient settlement system.
6.1.1 Some Important Concepts in Trading System
Market Timing
Trading on the equities segment takes place on all days of the week, except Saturdays and
Sundays and holidays. Holidays are declared by the exchanges in advance. The normal market
timings of the equities segment is from 9.15 a.m. to 3.30 p.m.
Bid Ask Spread
As discussed in Chapter 1, Bid is the price at which a broker buys a stock and Ask is the price
at which the broker sells the position. The gap between the bid and the ask, referred as
spread, depends on various factors such as how much liquidity the instrument has, how
volatile the general day trading market is, the ratio of day trading buyers vs sellers and so on.

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Bid is made up of a Buy Limit Order that has been put into the market. An Ask is made up of
an open Sell Limit Order.
Order Book
Orders placed in the stock exchange are automatically entered by the system of the exchange
into its order book, where order matching happens and the orders get converted into trade.
Order Matching
Once an order is entered and confirmed by the investor / dealer at his trading terminal and
verified by the broker portal, the order is routed to the exchange for its execution. The
exchange system allots a unique order number for all orders received in the system. This is
given as order confirmation along with the time stamp to the broker.
If the order is a market order it gets executed immediately. If it is a limit order it is stored in
the order book and matched against appropriate orders. Once an order is matched a trade is
said to be executed. As soon as a trade is executed the trade confirmation message is sent to
the broker’s office which in turn informs the investor through a message on the trading
terminal (only if the investor is trading on internet platform).
All orders can be modified or cancelled during the trading hours and pre-open market stage,
provided they are not fully executed. For the orders, which are partially executed, only the
open or unexecuted part of the order can be cancelled / modified.
The order matching in an exchange is done based on price-time priority. The best price orders
are matched first. If more than one order arrives at the same price they are arranged based
on time of receipt of order. Best buy price is the highest buy price amongst all orders and
similarly best sell price is the lowest price of all sell orders. Let us take an example here to
understand this better.
A sample of the order book is given below for understanding.
Buy Quantity Buy Price (Rs.) Sell Quantity Sell Price (Rs.)
50 121.20 50 121.50
100 121.10 200 121.80
25 120.90 3000 122.10
500 120.00 1000 122.20
5000 120.00 200 122.60

These quotes given in the table above are visible to investors. Now if a buy market order
comes with an order quantity of 50 it gets executed for a price of Rs. 121.50 and the order
book entries on the sell side moves up by one notch i.e. the Rs. 121.80 order comes to top.
On the other hand, if a limit order with a sell price of Rs. 121.20 for a quantity of 500 comes
50 shares get executed and the order for remaining 450 stays at the top on the sell side.

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All orders come as active orders into the order book. If they get a match they will be executed
immediately, else they are entered into the order book according to price and time as passive
orders.
Trades done during the day can be cancelled with mutual consent of both the parties. This is
mostly due to the errors in the system. Trade cancellations, however are rare in an exchange
traded market.

6.2 Orders
The three components of an order are the price of the security, the time the order was placed
and the quantity of the security being traded. This is as far as the order being placed.
There are three types of orders itself that can be placed on the exchanges. These are market
orders, stop orders and limit orders. Although the exchange systems show more types of
orders, they are variations of these three types. The variations are present for precision and
for the security of the investor. These variations occur on account of different conditions or
preferences of the price, time and quantity. There are also occasions where more than one
order is required.
6.2.1 Types of Orders
Market Order
A market order is where a trader purchases or sells his security at the best market price
available. In the market order there is no need to specify the price at which a trader wants to
purchase or sell. There are two variations on the market order. The Market on Open Order
means that the trade must be done during the opening range of trading prices. So the highest
price for selling and lowest price for buying.
The Market on Close order is done within minutes of the market closing. This is done at the
price that is available at the time. This is generally the volume weighted average price of the
security in the last half-an-hour of the trade before the market close and trade takes place in
a separate session called “post closing session”.
Example:
Buy 50 shares of XYZ Ltd.
Sell 100 shares of ABC Ltd.
Limit Order
Limit orders involve setting the entry or exit price and then aiming to buy at or below the
market price or sell at or above it. Unlike market order, in case of limit orders, the trader
needs to specify at least one price. The price can be changed any time before execution.
Reaching these limits/targets is not certain and sometimes the orders do not go through. Limit
orders are very common for online traders.

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Another variation in Limit order called IOC (immediate or cancel). In this case the trader puts
the current market rate as the limit and the order gets executed to the extent of available
quantity at that rate. The balance unexecuted quantity, if any, not kept pending in the order
book and is cancelled instead.
Example:
Buy 100 shares of ABC Ltd. at Rs.50/- or better
Sell 200 shares of XYZ Ltd. at Rs.150/- or better
Stop Loss Orders
Stop loss orders are used for both opening and closing positions. They are the opposite of
Limit Orders. In a limit order when the price of the security rises to a certain level a sell order
is given. In the case of stop order, a buy signal is given and vice-versa for when the price drops.
In the case of a “sell stop”, it is done so buyers can cut their losses when a share price falls
too low. A "buy stop" is more common and is put into place if the share price is predicted to
break through its peak level and head to a new high.
There are down sides and risks associated with both types of stop orders though and should
be made with careful scrutiny. Traders should be certain about their technical analysis are
correct in predicting breakthroughs in share prices in the risk of buying high and selling low.
While placing these orders there are two prices which need to be entered by the trader. The
first one is at which level the trigger for the order will be activated and the second price is up
to which level the order can be executed once the trigger is activated. One must be aware
that at times the stop order might be activated but not executed due to current market price
being beyond the limit set by the trader for execution.
Example:
An investor short sells PQR Ltd. shares at Rs. 200/- in expectation that the price will fall.
However, in the event the price rises above the sell price, the investor would like to limit the
losses. The investor then may place a limit buy order specifying a Stop loss trigger price of Rs.
220/- and a limit price of Rs. 240/-. The stop loss trigger price (SLTP) has to be between the
last traded price and the buy limit price. Once the market price of PQR Ltd. breaches the SLTP
i.e. Rs. 220/-, the order gets converted to a limit buy order at Rs. 240/-.
An investor buys LMN Ltd. at Rs 400/- in expectation that the price will rise. However, in the
event the price falls, the investor would like to limit the losses. The investor may then place
a limit sell order specifying a stop loss trigger price of Rs. 380/- and a limit price of Rs. 360/-.
The stop loss trigger price has to be between the limit price and the last traded price at the
time of placing the stop loss order. Once the last traded price touches or crosses Rs. 380/-,
the order gets converted into a limit sell order at Rs. 360/-.
In a buy order the SLTP cannot be less than the last traded price. This is treated as a normal
order because the condition that the last traded price should exceed the stop loss trigger price

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for a buy order is already satisfied. Similarly, in case of a stop loss sell order the SLTP should
not be greater than the last traded price for the same reason.
The variations in the three orders require traders to be well aware of the options when
trading. Studying the stock and predicting the trend accurately is very important.

6.3 Trade Life Cycle

A pictorial representation of the securities trade life cycle from the broker’s point of view is
given in the figure below (Figure 6.1). It can be seen that the flow starts from placing of orders
by the client. Clients have the option of placing the orders over phone or through the internet
also. Once the orders are received, the front office captures the order in its system and then
enters the order into the system of the stock exchange. Exchange gives order confirmation by
assigning a unique number along with time stamp. The order entered into the system is
matched with a similar order, and once confirmed /executed, is given a unique trade code.
This unique trade code is then sent to the stock broker who had placed the order. It is the
middle office that books the order and validates the trade with the investor or custodian, as
the case may be. Once, the confirmation of the trade is received the back office takes over
for generating contract bills, clearing and settlement of the trade. The stock market systems
are such that once the trade is confirmed, intimation is automatically sent to the DP and the
clearing banks for pay-in/pay-out of funds and securities. When the investor who has sold
securities has received the funds against it and vice versa, we say that the particular trade is
cleared and settled, hence the trade is concluded. The Indian securities market follows a T+2
rolling settlement in the equity market. There is a separate settlement cycle for Government
Securities.
Figure 6.1: Securities Trade Life Cycle

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The transaction taking place to buy or sell securities is called “Trade”. A trade is the conversion
of an order placed on the exchange which results into pay-in and pay-out of funds and
securities. Trade ends with the settlement of the order placed.
 Trade in financial market means transaction to buy or sell securities.
 It originates with two orders, one from the buyer and another from the seller.
 When there is a match between the expectations of the buyer and the seller, the order
culminates into a trade.
 Subsequent to trade execution, securities and funds are exchanged between the buyer and
the seller.
The steps below show how a client’s order moves in the exchange system to be converted
into a trade:
 Placing of the Order
When a client places a buy order with the broker:
When the broker receives a buy order from a client either by phone or through
internet banking, the broker’s system first checks whether there are sufficient funds
in the client’s account. The order will only be sent to the exchange for execution, if
there are sufficient funds in the client’s account. Otherwise, the order will be rejected
by the broker’s system.
When a client places a sell order with the broker:
When the broker receives a sell order from a client, the broker’s system first checks
whether there are sufficient securities in the client’s demat account. The order will
only be sent to the exchange for execution, if there are sufficient securities in the
client’s demat account. Otherwise, the order will be rejected by the broker’s system.
(Exception to this order flow is if the client chooses to “short sell”). In such scenario,
the broker shall verify with the clients as a prudential measure.
 Order matching and its conversion into trade
On receiving the order, the exchange will send an order confirmation to the broker’s
system and order is matched with the suitable counter order. If a counter order is found,
the order is executed and the trade confirmation message is sent to the broker’s system.
If the order is not matched, then it lies in the order book (in case of limit order) or it is
cancelled (in case of immediate-or-cancel order).
6.4 Mechanism of Circuit Breakers
The index-based market-wide circuit breaker system is applicable at three stages of the index
movement either way at 10 percent, 15 percent and 20 percent. This circuit breaker brings
about a coordinated trading halt in all equity and equity derivative markets nationwide.
The market wide circuit breakers would be triggered by movement of either S&P BSE SENSEX
or the NIFTY 50, whichever is breached earlier.
The market re-opens, post the index-based market-wide circuit breach, with a pre-open call
auction session. The details are given in the following table (Table 6.1):

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Table: 6.1: Market-wide Circuit Breaker
Trigger Trigger time Market halt Pre-open call auction session
limit duration post market halt
10% Before 1:00 pm 45 minutes 15 minutes
At or after 1:00 pm upto 15 minutes 15 minutes
2.30 pm
At or after 2.30 pm No halt Not applicable
15% Before 1 pm 1 hour 45 15 minutes
minutes
At or after 1:00 pm 45 minutes 15 minutes
before 2:00 pm
On or after 2:00 pm Remainder of the Not applicable
day
20% Any time during market Remainder of the Not applicable
hours day

The index based circuit breaker limits for the aforesaid levels are computed by the stock
exchanges on a daily basis based on the previous day’s closing level of the index and is
rounded off to the nearest tick size.
SEBI’s Technical Advisory Committee (TAC) and Secondary Market Advisory Committee
(SMAC) have recommended the following to further strengthen the market wide index based
circuit breaker mechanism:
(a) The stock exchanges shall compute their market wide index after every trade in the
index constituent stocks and shall check for breach of market-wide circuit breaker
limits after every such computation of the market-wide index.
(b) In the event of breach of market-wide circuit breaker limit, stock exchange shall stop
matching of orders in order to bring about a trading halt. All unmatched orders
present in the system shall thereupon be purged by the stock exchange.
Dynamic Price Bands, implemented through SEBI regulations, prevent acceptance of orders for
execution that are placed beyond the price limits set by the stock exchanges. The previous day’s
closing price forms the threshold for dynamic price band in the pre-open session and
subsequent trading sessions.

6.5 Transaction Charges

The transaction charges for securities transactions include:
1. Brokerage charged by member broker
2. Securities Transaction Tax (STT) as applicable
3. Goods and Services Tax (GST) as stipulated
4. Stamp Duty
5. Penalties, if any, arising on specific default on behalf of client (investor)

85
The brokerage, GST, Stamp Duty and STT are indicated separately in the contract note.
The maximum brokerage chargeable by a broker cannot exceed 2.5 percent of the contract
price excluding statutory levies.
The Securities Transaction Tax (STT) was introduced by Chapter VII of The Finance (No. 2) Act,
2004. It is a tax applicable on the purchase or sale of equity shares, derivatives, equity-
oriented funds and equity-oriented mutual funds.
The Finance (No. 2) Act, 2004 lays down that every recognized stock exchange shall collect
the STT from every person whether a purchaser or seller as the case may be, who enters into
a taxable securities transaction in that stock exchange, at the rates prescribed in the Act.

The following STT rates are applicable for trades executed on the Stock Exchange platform:

Sr. No. Taxable securities transaction Rates Payable by

1. Purchase/ Sale of equity shares (delivery based) 0.100 percent Purchaser/ Seller

Sale of units of equity oriented mutual funds

2. (delivery based) 0.001 percent Seller

Sale of equity shares, units of business trust, units of

3. equity oriented mutual fund (non-delivery based) 0.025 percent Seller

4. Sale of an option in securities 0.05 percent Seller

Sale of an option in securities, where option is

5. exercised 0.125 percent Purchaser

6. Sale of a futures in securities 0.01 percent Seller

All the transactions are identified based on the Client Code placed by the members at the time of
order entry on the trading system of the exchange and the value of the taxable securities transaction
is determined with respect to the trade executed under a particular client code at the end of each
trading day. Members can modify the Client Code using a client code modification facility provided by
the Exchange within the prescribed time frame during trading hours on the respective trading day.

Goods and Services Tax (GST) is charged at 18 percent on brokerage. Both STT and GST go to
the Central government.

Stamp duty is levied on the value of shares transferred. Stamp duty is levied by state
governments, so the actual rate depends on the state in which the transaction takes place.

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6.6 Capital Adequacy Requirements of Trading Members
Credit risks are inevitable in financial markets, and managing them is a crucial part of market
functioning. Credit risk management ensures that trading member obligations are
commensurate with their networth. This was introduced in order to minimise or eliminate
the risk of non-payment or inadequate settlement of funds. In the equities and derivatives
market, brokers' capital adequacy is one of the two critical components of credit risk
management, the other being daily margins. The Capital Adequacy Requirements consists of
two components i.e. the Base Minimum Capital and the Additional or Optional Capital related
to volume of the Business.
Base Minimum Capital
Base Minimum Capital (BMC) is the deposit a stock broker has to make with the stock
exchange to get trading rights on the exchange. Even then, the broker may take positions (the
sum of his and his clients') only up to a pre-specified multiple of this deposit amount.
SEBI has stipulated the following slabs of Base Minimum Capital for various categories of
trading members. No exposure is granted against such BMC deposit:
Categories BMC Deposit
(Rs.)
Only Proprietary trading without Algorithmic trading (Algo) 10 Lacs
Trading only on behalf of Client (without proprietary trading) and 15 Lacs
without Algo
Proprietary trading and trading on behalf of Client without Algo 25 Lacs
All Trading Members/Brokers with Algo 50 Lacs
The Base Minimum Capital deposit requirement is applicable to all stock brokers / trading
members of exchanges having nation-wide trading terminals. For stock brokers / trading
members of exchanges not having nation-wide trading terminals, the deposit requirement
shall be 40 percent of the above said BMC deposit requirements. Minimum 50 percent of the
BMC shall be in the form of cash and cash equivalents.
Additional Base Capital
The Stock Exchanges prescribe suitable deposit requirements, over and above the SEBI
prescribed norms, based on their perception and evaluation of risks involved. The additional
or optional capital required of a member shall at any point be such that together with the
base minimum capital it is not less than 8 percent of the gross outstanding business in the
exchange. The gross outstanding business would mean aggregate of upto date sales and
purchases by a member broker in all securities put together at any point of time during the
current settlement.
Exchanges are free to stipulate a higher base capital. The capital adequacy requirements by
stock exchanges depend on the segment of the market and the type of membership sought
by the members. The deposits kept with the exchange as a part of the membership

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requirement may be used towards the margin requirement of the member. Additional capital
may be provided by the member for taking additional exposure.

6.7 Risk Management System

A sound risk management system is integral to an efficient clearing and settlement system.
The system must ensure that trading member obligations are commensurate with their net-
worth.
Risk containment measures include capital adequacy requirements, margin requirements,
position limits based on capital, online monitoring of client positions etc. The main concepts
of a Risk Management System are listed below:
 There should be a clear balance available in the client’s ledger account in the broker’s
books.
 The clients are required to provide margins upfront before putting in trade requests
with the brokers.
 The aggregate exposure of the client’s obligations should commensurate with the
capital and networth of the broker.
 Ideally, the client must square-up all the extra positions that have been created on an
intra-day basis before 3.00 p.m.
 The clients must settle the debits, if any, arising out of MTM settlements.
 For positions taken in the futures and options segment, the same should be squared-
off before the expiry day.
6.7.1 Internal Client Account Control
The stock broker shall segregate client funds from their own funds. Stock broker shall keep
the client’s money in a separate bank account designated as client account and their own
money in a separate bank account.
The stock broker shall also not transfer funds from one client’s account to another. The stock
broker shall not use clients’ funds for the purpose of self trading or other clients’ trading.
All payments made to/received from the client shall be through account payee cheques or
demand drafts or by way of direct credit to the account through electronic fund transfer or
any other mode permitted by the RBI. The stock brokers shall accept cheques drawn only by
the clients and issue cheques in favour of the clients only, for their transactions. Stock Brokers
shall not accept cash from their clients either directly or by way of cash deposit to the bank
account of stock broker.

Pay-out of securities to the clients against which payments have been made by the clients,
shall be made within one working day from the day of pay-out by the Exchanges. The stock
brokers shall hold the securities that have not been paid for in full by the clients in a separate
account. Such securities shall either be transferred to clients’ demat account upon fulfilment

88
of their funds obligation or shall be disposed off in the market by the stock broker within five
trading days after the pay-out.7
The stock broker is also required to maintain records in respect of dividends received on
shares held on behalf of the clients. This is to distinguish between the dividends received on
own account and clients’ account. The transfer of such dividends to clients account should be
carried out within appropriate time.
Balances lying in client’s bank account if it contains, a portion representing brokerage, stock
broker may transfer such brokerage to own bank account. Stock brokers are not supposed to
incur any expenses from client bank account directly out of such amount.
The stock brokers are required to maintain separate beneficiary accounts for clients’
securities and own securities. This is to prevent improper use of clients’ securities by stock
brokers. SEBI has specified that all bank accounts and demat accounts maintained by stock
brokers shall have appropriate nomenclature to reflect the purpose for which those accounts
are being maintained.
The stock broker, may deliver securities into such accounts only towards pay-in, margin or
security deposit or as replacement for those which have been withdrawn by mistake from the
account. Similarly, they cannot be withdrawn unless the client so authorizes for delivery on
his / her behalf or towards dues to the stock broker, or to remove securities deposited by
mistake into that account.
The clients’ securities shall not be mixed with those of trading members own securities. The
stock broker shall not use the clients’ securities for purposes other than the specified.
Receipt and delivery of securities shall be from/ to respective clients’ demat account only.
6.7.2 Value at Risk Margin
Value at Risk (VaR) is a statistical measure to estimate the maximum probable loss value of
an asset in a given period of time at a particular confidence level. This technique helps the
securities market to study the past price movement trends and predict the largest future
probable loss. In stock market scenario, VaR calculates the largest probable loss that an
investor may face on a single day at 99 percent of confidence level. Thus, to mitigate the loss
probability, members need to maintain VaR margin. The VaR Margin is a margin intended to
cover the largest loss that can be encountered on 99% of the days (99% Value at Risk).
For liquid stocks, the margin covers one-day losses while for illiquid stocks, it covers three-
day losses. For liquid stocks, the VaR margins are based only on the volatility of the stock while
for other stocks, the volatility of the market index is also used in the computation.
All securities are classified into three groups for the purpose of VaR margin computation.

7
SEBI Circular No.: CIR/HO/MIRSD/DOP/CIR/P/2019/75 dated June 20, 2019 on Handling of Clients’ Securities
by Trading Members/ Clearing Members.

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  Group I consists of scrips that are traded at least 80 percent of the trading days in the
previous six months and the mean impact cost (successive changes in share price due
to execution of buy and sell orders) of shares of the same is less than or equal to 1
percent.
 Group II consists of scrips that are traded at least 80 percent% of the trading days in
the previous six months and the mean impact cost of the same is more than 1 percent.
 Group III consists of scrips that do not fall under either of the above categories.

For the securities listed in Group I, scrip wise daily volatility calculated using the exponentially
weighted moving average methodology is applied to daily returns. The scrip wise daily VaR is
3.5 times the volatility so calculated subject to a minimum of 7.5 percent.
For the securities listed in Group II, the VaR margin is higher of scrip VaR (3.5 sigma) or three
times the index VaR, and it is scaled up by square root of 3 (√3).
For the securities listed in Group III the VaR margin is equal to five times the index VaR and
scaled up by square root of 3 (√3).
The index VaR, for the purpose, is the higher of the daily Index VaR based on NSE NIFTY or
BSE SENSEX, subject to a minimum of 5 percent.
The VaR margin rate computed as mentioned above is charged on the net outstanding
position (buy value - sell value) of the respective clients on the respective securities across all
open settlements. There is no netting off of positions across different settlements. The net
position at a client level for a member is arrived at and thereafter, it is grossed across all the
clients including proprietary position to arrive at the gross open position.
The VaR margin is collected on an upfront basis by adjusting against the total liquid assets of
the member at the time of trade.
The VaR margin so collected is released on completion of pay-in of the settlement or on
individual completion of full obligations of funds and securities by the respective
member/custodians after crystallization of the final obligations on T+1 day.

6.7.3 Extreme Loss Margin

Margins to cover the expected loss in situations that lie outside the coverage of the VaR
margins. The Extreme Loss Margin (ELM) for any stock shall be higher of 5 percent or 1.5 times
the standard deviation of daily logarithmic returns of the stock price in the last six months.
This computation shall be done at the end of each month by taking the price data on a rolling
basis for the past six months and the resulting value shall be applicable for the next month.
The ELM is collected/ adjusted against the total liquid assets of the member on a real time
basis.

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The ELM is collected on the gross open position of the member. The gross open position for
this purpose means the gross of all net positions across all the clients of a member including
his proprietary position.
For this purpose, there is no netting of positions across different settlements. The ELM so
collected is released on completion of pay-in of the settlement or on individual completion of
full obligations of funds and securities by the respective member/custodians after
crystallization of the final obligations on T+1 day.
6.7.4 Mark To Market Margin
Marking to Market (MTM) refers to the accounting act of recording the price or value of a
security, portfolio or account to reflect its current market value rather than its book value.
This is done most often in futures accounts to make sure that margin requirements are being
met. If the current market value causes the margin account to fall below its required level,
the trader will be faced with a margin call.
Mark to market is calculated by marking each transaction in security to the closing price of
the security at the end of trading. In case the security has not been traded on a particular day,
the latest available closing price is considered as the closing price. In case the net outstanding
position in any security is nil, the difference between the buy and sell values shall be
considered as notional loss for the purpose of calculating the mark to market margin payable.
The MTM margin is collected from the member before the start of the trading of the next day.
The MTM margin is collected/adjusted from/against the cash/cash equivalent component of
the liquid net worth deposited with the Exchange.
The MTM margin is collected on the gross open position of the member. The gross open
position for this purpose means the gross of all net positions across all the clients of a member
including broker’s proprietary position. For this purpose, the position of a client is netted
across its various securities and the positions of all the clients of a member are grossed.
There is no netting off of the positions and set-off against MTM profits across two rolling
settlements i.e. T day and T+1 day. However, for computation of MTM profits/losses for the
day, netting or set-off against MTM profits is permitted.
The MTM methodology assumes that all open positions and transactions are settled at the
end of each day and new positions are opened the next day.
Example:
 100 shares of XYZ are purchased at Rs.50.00 on Day 1
 Another 200 shares are purchased at Rs.52.00 on Day 2
 200 shares are sold at Rs. 53.00 on Day 3
 100 shares are sold at Rs. 53.50 on Day 4

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 Day Closing price of XYZ (Rs.)
1 50.50
2 51.50
3 54.00
4 54.00

The MTM statement calculations for each day would be:

Day 1
Transaction MTM: Rs. 50.00 ((50.50 – 50.00) * 100)
Prior Period MTM: Rs.0.00
Total MTM: Rs.50.00
Day 2
Transaction MTM: (Rs.100.00) ((51.50 – 52.00) * 200)
Prior Period MTM: Rs.100.00 ((51.50 – 50.50) * 100)
Total MTM: Rs.0.00
Day 3
Transaction MTM: (Rs.200.00) ((53.00 – 54.00) * 200)
Prior Period MTM: Rs.750.00 ((54.00 – 51.50) * 300)
Total MTM: Rs.550.00
Day 4
Transaction MTM: (Rs.50.00) ((53.50 – 54.00) * 100)
Prior Period MTM: Rs.0.00 ((54.00 – 54.00) * 100)
Total MTM: (Rs.50.00)
Total MTM for days 1 to 4: Rs.550.00
It may be noted that these are only book entries at the end of the day for reporting and closing
the margins which helps in reducing counterparty credit risks. The actual profit or loss to the
participants solely depends on their own execution prices. Except in the case where contracts
are left open till final settlement (expiry), and the profit and loss is simply the value difference
between entry prices and settlement prices.

6.7.5 Margins in Futures & Options (F&O) segment

Margins on F&O segment comprise of the following:

 Initial Margin

Initial margin requirements are based on 99% value at risk over a two-day time
horizon. Initial Margin includes SPAN Margin, premium margin, assignment margin,
intra-day crystallised losses, delivery margin and any other applicable margin.

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 The margin calculation is done using SPAN (Standard Portfolio Analysis of Risk) system,
a product developed by Chicago Mercantile Exchange (Box 6.1). The margin is levied
at trade level on real-time basis. The rates are computed at 6 intervals one at the
beginning of the day, 4 during market hours and one at the end of the day.

The objective of SPAN is to identify overall risk in a portfolio of futures and options
contracts for each client. The system treats futures and options contracts uniformly,
while at the same time recognizing the unique exposures associated with options
portfolios like extremely deep out-of-the-money short positions and inter-month risk.

Intra-day crystallised losses are computed for all trades which are executed and results
into closing out of open positions.

Box 6.1: Standard Portfolio Analysis of Risk (SPAN)

Developed by the Chicago Mercantile Exchange in 1988, the Standard Portfolio Analysis of
Risk (SPAN) performance bond requirements margining system for calculating margin
requirements, has become the futures industry standard. SPAN evaluates the risk of an entire
account’s futures/options portfolio and assesses margin requirement based on such risk. It
accomplishes this by establishing reasonable movements in futures prices over a one day
period. The resulting effect of these “risk arrays” is to capture respective gains or losses of
futures and options positions within that underlying. Each Exchange maintains the
responsibility of determining these risk arrays as well as the option calculations that are
needed to determine the effect of various futures price movements on option values.
Advantages and Rationale of SPAN
SPAN recognizes the special characteristics of options, and seeks to accurately assess the
impact on option values from not only futures price movements but also changes in market
volatility and the passage of time. The end result is that the minimum margin on the portfolio
will more accurately reflect the inherent risk involved with those positions as a whole.

In addition to these margins, in respect of options contracts the following additional margins
are collected:

a. Premium Margin

Premium Margin is charged to members in addition to Span Margin. The premium

margin is the client wise premium amount payable by the buyer of the option and is
levied till the completion of pay-in towards the premium settlement.

b. Assignment Margin

Assignment Margin is levied on a clearing member in addition to SPAN margin and

Premium margin. It is levied on assigned positions of clearing members towards

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 interim and final exercise settlement obligations for option contracts on index and
individual securities till the pay-in towards exercise settlement is complete.

c. Delivery Margin

Delivery margin is levied on potential in-the-money long option positions 4 days prior
to expiry of derivative contract which has to be settled through delivery.

 Exposure Margin

Exposure Margin is based on a single percentage on the value of the scrip determined
at the beginning of every month for the following month by the exchange. This is
charged over and above the initial margin and is popularly referred as second line of
defence.

The margin is required to be paid on the gross open position of the stock broker. The gross
open position signifies the gross of all net positions across all the clients of a member,
including the proprietary position of the member. Thus, it is important for the stock broker at
any time to know the position on both gross and net basis for all clients.

6.7.6 Risk Reduction Mode

SEBI has directed stock exchanges to move to risk reduction mode with respect to brokers.
The risk reduction criteria have been revised by SEBI recently on account of interoperability.8
The circular states:

Stock exchanges shall ensure that the stock brokers are mandatorily put in risk-reduction
mode when 85 percent of the stock broker’s collateral available for adjustment against
margins gets utilized on account of trades that fall under a margin system. Such risk reduction
mode shall include the following:

(a) All unexecuted orders shall be cancelled once stock broker breaches 85 percent
collateral utilization level.

(b) Only orders with Immediate or Cancel attribute shall be permitted in this mode.

(c) All new orders shall be checked for sufficiency of margins.

(d) Non-margined orders shall not be accepted from the stock broker in risk reduction
mode.

(e) The stock broker shall be moved back to the normal risk management mode as and
when the collateral of the stock broker is lower than 80 percent utilization level.

8
SEBI Circular No.: CIR/MRD/DRMNP/CIR/P/2018/145 dated November 27, 2018.

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Stock exchanges may prescribe more stringent norms based on their assessment, if desired.
The stock exchanges can however make the norms more stringent for their members.

6.8 Margin Trading

Margin Trading is trading with borrowed funds. 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.
Corporate brokers with net worth of at least Rs.3 crore are eligible for providing Margin
trading facility to their clients. Further, the Rights and Obligations document laying down the
rights and obligations of stock brokers and clients for the purpose of margin trading facility
issued by the Exchange shall be mandatory and binding on the Broker/Trading Member and
the clients for executing trade in the Margin Trading framework.
The facility of margin trading is available for Group I 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 exchanges9.
For providing the margin trading facility, a broker may use his own funds or borrow from
scheduled commercial banks or NBFCs regulated by the RBI or by issuing Commercial Papers
(CP) or by taking unsecured long term loans from their promoters and directors. The
borrowings shall be subject to compliance with appropriate Act/ Guidelines. A broker is not
allowed to borrow funds from any other source.10

The maximum allowable exposure of the broker towards the margin trading facility should
not exceed the borrowed funds and 50 percent 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 percent of the maximum allowable exposure of the broker.
In order to avail margin trading facility, initial margin required shall be as under:
Category of Stock Applicable margin
Group I stocks available for trading in the VaR + 3 times of applicable ELM*
F & O Segment

Group I stocks other than F & O stocks VaR + 5 times of applicable ELM*

*For aforesaid purpose the applicable Value at Risk (VaR) and Extreme Loss Margin (ELM)
shall be as in the cash segment for a particular stock.

9
Group I securities: The securities having mean impact cost of less than or equal to 1 and having traded on at
least 80% (+5%) of the days for the previous 18 months.
10
SEBI Circular No.: CIR/MRD/DP/54/2017 dated June 13, 2017 and SEBI Circular No.: CIR/MRD/DP/ 86/2017
dated August 2, 2017.

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The initial margin payable by the client to the Stock Broker shall be in the form of cash, cash
equivalent or Group I equity shares, with appropriate hair cut as specified by SEBI. Stock
brokers shall ensure maintenance of the aforesaid margin at all times during the period that
the margin trading facility is being availed by the client. In case of short fall, stock broker shall
make necessary margin calls.

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Quiz

1. Securities Transaction Tax (STT) is ______ on sale of derivatives.

2. A stock broker has to deposit _______ with the stock exchange to get trading rights on the
exchange.

3. Trading with borrowed funds is called ________.

4. The VaR margin is collected on an upfront basis. State whether True or False.

5. Post the index-based market-wide circuit breach, the market re-opens with a pre-open call
auction session. State whether True or False.

Answers

1. Applicable

2. Base minimum capital

3. Margin trading

4. True

5. True

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 7 Clearing and Settlement

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Clearing and settlement mechanism
 Important terminologies related to clearing and settlement
 Types of clearing members
 Role of Clearing corporation, Depositories, Clearing Banks in clearing and settlement
 Concept of netting of obligations

Clearing and settlement is a post trading activity that constitutes the core part of equity trade
life cycle. After any security deal is confirmed (when securities are obliged to change hands),
the broker who is involved in the transaction issues a contract note to the investor which has
all the information about the transactions in detail, at the end of the trade day. In response
to the contract note issued by broker, the investor now has to settle his obligation by either
paying money (if his transaction is a buy transaction) or delivering the securities (if it is a sell
transaction).
Clearing corporation is an entity through which settlement of securities takes place. The
details of all transactions performed by the brokers are made available to the Clearing
corporation by the Stock exchange. The Clearing corporation gives an obligation report to
Brokers and Custodians who are required to settle their money/securities obligations with
the specified deadlines, failing which they are required to pay penalties. This obligation report
serves as statement of mutual contentment.
Pay-In is a process where brokers and custodians (in case of Institutional deals) bring in money
or securities, or both, to the Clearing corporation. This is the first phase of the settlement
activity.
Pay-Out is a process where Clearing corporation pays money or delivers securities to the
brokers and custodians. This is the second phase of the settlement activity.
In India, the Pay-in of securities and funds happens on T+ 2 by 10:30 AM, and Pay-out of
securities and funds happens on T+2 by 1:30 PM.

7.1 Types of Accounts

As already discussed in Chapter 1, there are three types of clearing members who help in
clearing of trades. They are-
 Professional Clearing Member (PCM)
 Trading Cum Clearing Member (TCM)
 Self Clearing Member (SCM)

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Clearing members also need to take membership with the clearing corporations. They then
get a unique member ID number from the corporation. Once the clearing corporation gives a
list of the trading transactions made by the respective members, it has to be confirmed by
the clearing members that these are genuine transactions. Once this is done, the clearing
corporation then determines the net obligations of the clearing members through multilateral
netting.
It is mandatory for clearing members to open demat accounts with both the depositories, i.e.,
CDSL and NSDL. This account is called a clearing member account.
Unlike the usual demat account, the clearing member does not get any ownership or
beneficiary rights over the shares held in these accounts. The accounts are of three types:
 Pool accounts are used to receive shares from selling clients and to send shares to
buying clients.
 Delivery accounts are used to transfer securities from pool accounts to clearing
corporation’s account.
 Receipt accounts are used to transfer securities from clearing corporation’s account
to pool accounts.

7.2 Clearing Process

At the end of the trading day, the transactions entered into by the brokers are tallied to
determine the total amount of funds and/or securities that the stock broker needs either to
receive or to pay the other stock brokers. This process is called clearing. In the stock
exchanges this is done by a process called multilateral netting, which determines the net
settlement obligations (delivery/receipt positions) of the clearing members. Accordingly, a
clearing member would have either pay-in or pay-out obligations for funds and securities
separately. This process is performed by clearing members. The clearing process has been
represented diagrammatically below (Figure 7.1).
Clearing Corporations ensure trading members meet their fund/security obligations. One or
more recognised clearing corporations act as a legal counter party to all trades and
guarantees settlement for all members. This is known as novation. The original trade between
the two parties is cancelled and the clearing corporation acts as the counter party to both the
parties, thus manages risk and guarantees settlement to both the parties.
It determines fund/security obligations and arranges for pay-in of the same. It collects and
maintains margins, processes for shortages in funds and securities. It takes help of clearing
members, clearing banks, custodians and depositories to settle the trades.
The settlement cycle in India is T+2 days i.e. Trade + 2 days. T+2 means the transactions done
on the Trade day (T), will be settled by exchange of money and securities on the second
business day (excluding Saturdays, Sundays, Bank and Exchange Trading Holidays). Pay-in and
Pay-out for securities settlement is done on a T+2 basis.

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Figure 7.1: Diagrammatic Representation of the clearing process

The following summarises trading and settlement process in India for equities:
Investors place orders from their trading terminals.
 Broker houses validate the orders and routes them to the exchange (BSE or NSE
depending on the client’s choice).
 Order matching is done at the exchange.
 Trade confirmation is send to the investors through the brokers.
 Trade details are sent to Clearing Corporation from the Exchange.
 Clearing Corporation notifies the trade details to clearing Members/Custodians who
confirm back. Based on the confirmation, Clearing Corporation determines
obligations.
 Download of obligation and pay-in advice of funds/securities by Clearing Corporation.
 Clearing Corporation gives instructions to clearing banks to make funds available by
pay-in time.
 Clearing Corporation gives instructions to depositories to make securities available by
pay-in-time.

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  Pay-in of securities: Clearing Corporation advises depository to debit pool account of
custodians/Clearing members and credit its (Clearing Corporation’s) account and
depository does the same.
 Pay-in of funds: Clearing Corporation advises Clearing Banks to debit account of
Custodians/Clearing members and credit its account and clearing bank does the same.
 Pay-out of securities: Clearing Corporation advises depository to credit pool accounts
of custodians/Clearing members and debit its account and depository does the same.
 Pay-out of funds: Clearing Corporation advises Clearing Banks to credit account of
custodians/ Clearing members and debit its account and clearing bank does the same.
Note: Clearing members for buy order and sell order are different and Clearing
Corporation acts as a link.
 Depository informs custodians/Clearing members through Depository Participants
(DP) about pay-in and pay-out of securities.
 Clearing Banks inform custodians/Clearing members about pay-in and pay-out of
funds.
 In case of buy order by investors the clearing members instruct the DP to credit the
client’s account and debit the member’s account. The money will be debited (Total
settled amount - margins paid at the time of trade) from the client’s account.
 In case of sell order by investors clearing members instruct the DP to debit the client’s
account and credit its own account. The money will be credited to the client’s account.
The process for custodian settled trade for institutional clients is as follows:
 Trade happens on T day.
 On T+1 morning Trade confirmation to broker (exchange obligations move from
broker to custodian) is sent.
 On T+1 evening payment of margins is completed.
 On T+2 day shares /funds are credited to client account.
In case of trades by mutual fund houses the custodians act as clearing members.
It may be noted that a clearing member is the brokerage firm which acts as a trading member
and clearing member of clearing corporations whereas custodians are only clearing members.
Even if the clients don’t meet their obligations, clearing members are required to meet their
obligations to the clearing corporations.

7.2.1 Clearing Corporation

Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations,
2018 defines ‘Clearing Corporation’ as an entity that is established to undertake the activity
of clearing and settlement of trades in securities or other instruments or products that are
dealt with or traded on a recognized stock exchange and includes a clearing house.

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Every recognised clearing corporation need to comply with the applicable regulations
specified in Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations)
Regulations, 2018 on continuous basis.11 The recognised stock exchanges shall use the
services of recognised clearing corporation(s) for clearing and settlement of its trades.

Clearing Corporations ensure trading members meet their fund/security obligations. It acts
as a legal counter party to all trades and guarantees settlement for all members. This is called
novation. The recognised clearing corporations establish and maintain a Settlement
Guarantee Fund (SGF) for each segment to guarantee the settlement of trades executed in
respective segments of a recognised stock exchange. In the event of a clearing member failing
to honour his settlement obligations, the Fund is utilized to complete the settlement. The
recognised stock exchange, the recognised clearing corporation and the clearing members
contribute to the Fund in a manner specified by SEBI from time to time.

With a view to enhance safety and efficiency and saving on costs in clearing and settlement
process, SEBI has allowed interoperability among Clearing Corporations. The interoperability
allows market participants to consolidate their clearing and settlement functions at a single
clearing corporation, irrespective of the stock exchange on which the trade is executed. All
the products available for trading on the stock exchanges (except commodity derivatives) are
made available under the interoperability framework.12

The NSE Clearing Limited (NSE Clearing), Indian Clearing Corporation Limited (ICCL) &
Metropolitan Clearing Corporation of India Ltd. (MCCIL) may clear & settle trades irrespective
of the stock exchange on which the trade is executed.

Thus, the clearing corporation is the main entity managing clearing and settlement on a stock
exchange. It interacts with the stock exchanges, clearing banks, clearing members and
depositories through electronic connection.

7.2.2 Clearing Banks

Clearing Bank acts as an important intermediary between clearing member and clearing
corporation. Every clearing member needs to maintain an account with clearing bank. It’s the
clearing member’s function to make sure that the funds are available in his account with
clearing bank on the day of pay-in to meet the obligations. In case of a pay-out, clearing
member receives the amount on pay-out day.
Multiple clearing banks facilitate introduction of new products and clearing members will
have a choice to open an account with a bank which offers more facilities.
Normally the demat accounts of investors require the details of a bank account linked to it
for facilitation of funds transfer. Ideally, all transactions of pay-in/pay-out of funds are carried

11
Recognised clearing corporation means a clearing corporation which is recognised by SEBI under section 4 and
section 8A of the Securities Contracts (Regulation) Act, 1956.
12
SEBI Circular No.: CIR/MRD/DRMNP/CIR/P/2018/145 dated November 27, 2018.

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out by these clearing banks. The obligation details are passed on to the clearing banks, which
then carry out the pay-in/pay-out of funds based on the net obligations. This happens on T+2
day.
7.2.3 Depositories
A depository can be defined as an institution where the investors can keep their financial as-
sets such as equities, bonds, mutual fund units etc. in the dematerialised form and
transactions could be effected on it. In clearing and settlement process, the depositories
facilitate transfer of securities from one account to another at the instruction of the account
holder. In the depository system both transferor and transferee have to give instructions to
its depository participants (DPs) for delivering (transferring out) and receiving of securities.
However, transferee can give 'Standing Instructions' (SI) to its DP for receiving in securities. If
SI is not given, transferee has to give separate instructions each time securities are to be
received.
Transfer of securities from one account to another may be done for any of the following
purposes:
a. Transfer due to a transaction done on a person to person basis, called 'off-market'
transaction.
b. Transfer arising out of a transaction done on a stock exchange.
c. Transfer arising out of transmission and account closure.
A beneficiary account can be debited only if the beneficial owner has given 'Delivery
Instruction' (DI) in the prescribed form.
The DI for an off-market trade or for a market trade has to be clearly indicated in the form by
marking appropriately. The form should be complete in all respects. All the holder(s) of the
account have to sign the form. If the debit has to be effected on a particular date in future,
account holder may mention such date in the space provided for 'execution date' in the form.
Any trade that is cleared and settled without the participation of a clearing corporation is
called off-market trade, i.e., transfer from one beneficiary account to another due to a trade
between them. Large deals between institutions, trades among private parties, large trades
in debt instruments are normally settled through off-market route.
The transferor submits a DI with 'off-market trade' ticked off to initiate an off-market debit.
The account holder is required to specify the date on which instruction should be executed
by mentioning the execution date on the instruction. The debit is effected on the execution
date. DP enters the instruction in the system of the depository participant (which links the DP
with its depository) if the instruction form is complete in all respect and is found to be in
order. This system generates an 'instruction number' for each instruction entered. DP writes
the instruction number on the instruction slip for future reference. The instruction is triggered
on the execution date.

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If there is adequate balance in the account, such quantity is debited on the execution date. If
adequate balances do not exist in the account, then instruction will wait for adequate
balances till the end of the execution day. The account is debited immediately on receipt of
adequate balances in the account. If adequate balances are not received till the end of the
day of the execution date, the instruction will fail.
Transferee receives securities into the account automatically if SI were given to the DP at the
time of account opening. If SI is not given, transferee has to submit duly filled in 'Receipt-
Instruction' (RI) form for every expected receipt. Exchange of money for the off-market
transactions are handled outside the depository system. An off-market trade can be executed
only when trade order details from both the counter parties match.
A market trade is one that is settled through participation of a Clearing Corporation. In the
depository environment, the securities move through account transfer. Once the trade is
executed by the broker on the stock exchange, the seller gives a delivery instruction to his DP
to transfer securities to his broker's account.
The broker has to then complete the pay-in before the deadline prescribed by the stock
exchange. The broker transfers securities from his account to Clearing Corporation before the
deadline given by the stock exchange.
The Clearing Corporation pays out the securities i.e. securities are transferred to the buying
broker's account. The broker then gives delivery instructions to his DP to transfer securities
to the buyer's account. The movement of funds takes place outside the Depository system.
 Seller gives delivery instructions to his DP to move securities from his account to his
broker's account.
 Securities are transferred from broker's account to Clearing Corporation on the basis
of a delivery out instruction.
 On pay-out, securities are moved from Clearing Corporation to buying broker's ac-
count.
 Buying broker gives instructions and securities move to the buyer's account.
The members need to maintain clearing account with a DP of the two depositories viz National
Securities Depositories Ltd (NSDL) and Central Depository Services Ltd (CDSL) for the purpose
of trade settlement.

7.2.4 Netting of Obligation

Netting of clients’ accounts
The stock brokers are allowed to net the client account within the firm. At the end of the day,
the position of each client is netted against all his transactions and the final pay-in/pay-out of
securities/funds is carried out through clearing banks and depository participants.

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Netting of brokers’ obligations
Every day, the clearing corporation sends the clearing member a list of all trading trans-
actions made by him and his clients for the day. The clearing member then verifies the list
and makes the corrections and sends it back to the clearing corporation. After this, clearing is
performed by multilateral netting. Then the members are informed by the clearing
corporation of the amount/securities to be received / paid by them to the other members.
Interoperability among Clearing Corporations

With the introduction of the interoperability facility, the clearing corporations undertake
multilateral netting to create inter-clearing corporation net obligations and exchange funds
and securities on a net basis. The pay-in and pay-out are completed as per the settlement
schedule prescribed by SEBI.

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Quiz

1. Pay in of securities is done by __________.

2. A broker is a ______ of the stock exchange.

3. _______ acts as a legal counter party to all trades and guarantees settlement of trades.

4. ____ can trade and clear trades made by him and as well as other members.

5. The settlement cycle in India is ______.

Answers

1. Depository Participants

2. Member

3. Clearing Corporation

4. Trading cum Clearing Member (TCM)

5. T+2 days

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 8 Market Surveillance

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Market surveillance mechanisms at stock exchanges
 SEBI’s Integrated Market Surveillance System
 Different kinds of surveillance actions and surveillance measures

8.1 Introduction
Development and regulation of capital markets have become a critical point. With the
growing demand for property ownership, small-scale investment, and savings for retirement
in the economy, capital market performs an important role. Capital markets offer individuals
and small and medium-scale enterprises a broader menu of financial services and tailored
financial instruments like government debt, housing finance, and other securities to meet
their needs. A competitive, diversified financial sector, in turn, broadens access and increases
stability.
Effective surveillance is the most critical component for a well functioning capital market. As
an integral part in the regulatory process, effective surveillance can achieve investor
protection, market integrity and capital market development. According to IOSCO, “the goal
of surveillance is to spot adverse situations in the markets and to pursue appropriate
preventive actions to avoid disruption to the markets.”
In India, the stock exchanges hitherto have been entrusted with the primary responsibility of
undertaking market surveillance. Given the size, complexities and level of technical
sophistication of the markets, the tasks of information gathering, collation and analysis of
data/information are divided among the exchanges, depositories and SEBI. Information
relating to price and volume movements in the market, broker positions, risk management,
settlement process and compliance pertaining to listing agreement are monitored by the
exchanges on a real time basis as part of their self regulatory function. However, regulatory
oversight, exercised by SEBI, extends over the stock exchanges through reporting and
inspections. In exceptional circumstances, SEBI initiates special investigations on the basis of
reports received from the stock exchanges or specific complaints received from stakeholders
as regards market manipulation and insider trading.
Surveillance System detects on real time basis potential abnormal activity by comparing with
historical data. Abnormal activity may be pertaining to abnormality in respect of price, volume
etc. The surveillance system captures real time data and provides instantaneous updation of
data on price and quantity. To generate alerts in case of aberrations – Surveillance system
generates alerts across live data based on predefined parameters.

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8.2 Market Surveillance Mechanism
In order to ensure investor protection and to safeguard the integrity of the markets, it is
imperative to have in place an effective market surveillance mechanism. The surveillance
function is an extremely vital link in the chain of activities performed by the regulatory agency
for fulfilling its avowed mission of protection of investor interest and development and
regulation of capital markets.
The surveillance system adopted by SEBI is two pronged:
 Surveillance Cell in the stock exchange
 Integrated Surveillance Department in SEBI
8.2.1 Surveillance Cell in the Stock Exchanges
The stock exchanges as said earlier, are the primary regulators for detection of market
manipulation, price rigging and other regulatory breaches regarding capital market
functioning. This is accomplished through Surveillance Cell in the stock exchanges. SEBI keeps
constant vigil on the activities of the stock exchanges to ensure effectiveness of surveillance
systems. The stock exchanges are charged with the primary responsibility of taking timely and
effective surveillance measures in the interest of investors and market integrity. Proactive
steps are to be taken by the exchanges themselves in the interest of investors and market
integrity as they are in a position to obtain real time alerts and thus know about any
abnormalities present in the market. Unusual deviations are informed to SEBI. Based on the
feedback from the exchanges, the matter is thereafter taken up for a preliminary enquiry and
subsequently, depending on the findings gathered from the exchanges, depositories and
concerned entities, the matter is taken up for full-fledged investigation, if necessary.
The surveillance functions followed by the stock exchanges are summarised below:

 PRISM in NSE
PRISM (Parallel Risk Management System) is the real-time position monitoring and risk
management system for Derivatives segment at NSE Clearing Ltd. The risk of each trading and
clearing member is monitored on a real-time basis and alerts/disablement messages are
generated if the member crosses the set limits.
Clearing members (CM), who have violated any requirement and / or limits, may reduce the
position by closing out its existing position or, bring in additional cash deposit by way of cash
or bank guarantee or FDR or securities. Similarly, in case of margin violation by trading
members, clearing member has to set its limit for enablement.
Initial Margin Violation
The initial margin on positions of a CM is computed on a real time basis i.e., for each trade.
The initial margin amount is reduced from the effective deposits of the CM with the Clearing
Corporation. For this purpose, effective deposits are computed by reducing the total deposits

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of the CM by Rs. 50 lakhs (referred to as minimum liquid networth). The CM receives warning
messages on his terminal when 70 percent, 80 percent, and 90 percent of the effective
deposits are utilised. At 100 percent the clearing facility provided to the CM is withdrawn.
Withdrawal of clearing facility of a CM in case of a violation will lead to withdrawal of trading
facility for all TMs and/ or custodial participants clearing and settling through the CM.
Similarly, the initial margins on positions taken by a TM are computed on a real time basis and
compared with the TM limits set by his CM. The initial margin amount is reduced from the TM
limit set by the CM. Once the TM limit has been utilised to the extent of 70 percent, 80
percent, and 90 percent, a warning message is received by the TM on his terminal. At 100
percent utilization, the trading facility provided to the TM is withdrawn.
A member is provided with warnings at 70 percent, 80 percent and 90 percent level before
his trading/ clearing facility is withdrawn. A CM may thus accordingly reduce his exposure to
contain the violation or alternately bring in Additional Base Capital.
Exposure Limit Violation
This violation occurs when the exposure margin of a Clearing Member exceeds his liquid
networth, at any time, including during trading hours. The liquid net worth means the
effective deposits as reduced by initial margin, net buy premium and Rs. 50 lacs. In case of
violation, the clearing facility of the clearing member is withdrawn leading to withdrawal of
the trading facilities of all trading members and/ or clearing facility of custodial participants
clearing through the clearing member.
Trading Member-wise Position Limit Violation
This violation occurs when the open position of the trading member /custodial participant
exceeds the Trading Member-wise Position Limit at any time, including during trading hours.
In case of violation, trading member is restrained from taking any further position only in
respect of index/ security in which there is violation and trading member is required to bring
their position within specified limit.
In respect of initial margin violation, exposure margin violation and position limit violation,
penalty is levied on a monthly basis. In the event of such violations, TM / CM should
immediately ensure,
(i) that the client does not take fresh positions and
(ii) the positions of such clients are reduced to be within permissible limits.
Additionally, in the event of Position Limit violation, penalty would be charged to Clearing
Members for every day of violation.
The penalty levied on violations of limits are as follows:
 1 percent of the value of the quantity in violation (i.e., excess quantity over the
allowed quantity, valued at the closing price of the underlying stock) per client or

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 Rs.1,00,000 per client, whichever is lower, subject to a minimum penalty of Rs. 5,000
per violation / per client.
 When the client level violation is on account of open position of client exceeding 5
percent of open interest, a penalty of Rs. 5,000 per instance is charged to clearing
member.
The Clearing Member can recover the penalty so charged from the respective Trading
Member / Client violating the requirement of position limits and in cases where it is levied
and collected from Trading Member, such trading member, in turn, can recover the same
from the respective clients who violated the position limits.
Disclosure for Client Positions in Index Based Contracts
Any person or persons acting in concert who together own 15 percent or more of the open
interest on a particular underlying index is required to report this fact to the Exchange/
Clearing Corporation. Failure to do so is treated as a violation and attracts appropriate penal
and disciplinary action in accordance with the Rules, Byelaws and Regulations of the Clearing
Corporation.
For futures contracts, open interest is equivalent to the open positions in the futures contract
multiplied by last available traded price or closing price, as the case may be. For option
contracts, open interest is equivalent to the notional value which is computed by multiplying
the open position in that option contract with the last available closing price of the underlying.
Market wide Position Limits for Derivative Contracts on Underlying Stocks
At the end of each day during which the ban on fresh positions is in force for any scrip, when
any member or client has increased his existing positions or has created a new position in that
scrip the client/ TMs are charged a penalty.
The penalty is recovered from the clearing member affiliated with such trading
members/clients on a T+1 day basis along with pay-in. The amount of penalty is informed to
the clearing member at the end of the day.
Violation arising out of Mis-utilisation of Trading Member/ Constituent Collaterals and/or
Deposits
This violation takes place when a clearing member utilises the collateral of one TM and/ or
constituent towards the exposure and/ or obligations of another TM/ constituent.
Violation of Exercised Positions
When option contracts are exercised by a CM, where no open long positions for such CM/ TM
and/ or constituent exist at the end of the day, at the time the exercise processing is carried
out, it is termed as violation of exercised positions.

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  BOSS-i in BSE
The surveillance function at BSE has assumed greater importance over the last few years. It
has a dedicated Surveillance Department to keep a close, and a daily, watch on the price
movement of scrips, detect market manipulations like price rigging, etc., monitor abnormal
prices and volumes which are not consistent with normal trading pattern and monitor the
Members' exposure levels to ensure that defaults do not occur.
As per the guidelines issued by SEBI, except for scrips on which derivative products are
available and are part of indices on which derivative products are available, a daily price band
is applied on all scrips. Daily price band ensures that the price of a scrip cannot move upward
or downward beyond the limit set for the day. BSE has also imposed dynamic price bands for
scrips which are excluded from the requirement of price bands. This helps to avoid freak trade
due to punching errors by the Trading Members.
The abnormal variation in the prices as well as the volumes of the scrips are scrutinised and
appropriate actions are taken. The scrips which reach new high or new low and companies
which have high trading volumes are watched closely. A special emphasis is laid on the newly
listed scrips.
In case certain abnormalities are noticed, the circuit filters are reduced to make it difficult for
the price manipulators to increase or push down the prices of a scrip within a short period of
time. BSE imposes special margins in scrips where it suspects an attempt to ramp up the prices
by creating artificial volumes. BSE also transfers the scrips for trading and settlement to the
trade-to-trade category which leads to giving/taking delivery of shares on a gross level and no
intra-day netting off/squaring off facility is permitted. If abnormal movements continue
despite the aforesaid measures, BSE suspends the trading in the scrip. Securities on which
derivatives products are available are not considered for transfer to Trade for Trade segment.
Detailed investigations are conducted in cases where price manipulation is suspected and
disciplinary action is taken against the concerned Members.
BSE has an On-line Real Time (OLRT) Surveillance System, which has been in operation since
July 15, 1999. Under this system, alerts are generated on-line, in real time during the trading
hours, based on certain preset parameters like the price and volume variation in scrips, a
Member taking unduly large positions not commensurate with their financial position or
having concentrated positions in one or more scrips.
BSE Online Surveillance System - integrated (BOSS-i) is a Real-time system to closely monitor
the trading and settlement activities of the member-brokers. This system enables BSE to
detect market abuses at a nascent stage, improve the risk management system and
strengthen the self-regulatory mechanisms.
This system integrates several databases like company profiles, Members' profiles and
historical data of turnover and price movement in scrips, Members' turnovers, their pay-in
obligations, etc.

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  FOVEA Surveillance Management System (FSMS) in MSEI
For online market monitoring and surveillance, MSEI uses Exchange Administration Terminal
(EAT) and Fovea Surveillance Management System (FSMS). The exchange’s Surveillance & Risk
Management Department monitors the open positions taken by participants and also price &
volume variation.

EAT is primary system used for online monitoring and it provides online data / information
pertaining to position limit alerts, margin utilization alerts, mark-to-market (MTM) loss alerts.
Additionally, offline monitoring is done for generating reports/ offline alerts/ analysis. Online
information/ data/ alerts facilitate the exchange in maintaining market safety and integrity
whereas offline alerts/ reports facilitate in detecting suspected abnormal patterns/
manipulation cases.

Different position limits are applicable at member level and various client category levels, as
stipulated by SEBI. When the open position of any participant exceeds the specified position
limit at any time, during trading hours, it shall be treated as a violation. In case of any violation
with respect to the Margin limit, MTM limit, Position limit the trading member is
automatically placed in the square off mode by the system.
FSMS (Fovea Surveillance Management System) has provision for setting up online alert
parameters in respect of price and volume. The alerts generated on the basis of benchmark
values of these parameters are processed further to detect abnormal trades/ trading
patterns. The parameters for various types of alerts are reviewed on a periodical basis.

Moreover, dynamic price bands are applicable for the various scrips and contracts traded in
the various segments of the exchange. Orders placed at prices beyond the dynamic price band
applicable for the specific product will be rejected. However, for better price discovery and
uninterrupted trading, the dynamic price band may be relaxed based on certain parameters
and in co-ordination with other exchanges.

As part of offline monitoring, potentially reversal trades (pre-arranged trades between group
of entities with a motive to earn profit or book loss) in illiquid scrips/ contracts, wash
transactions and other manipulative trades are identified and analysed.

Further, economic disincentives have been put in place with regard to high daily order-to-
trade ratio (OTR) of algorithmic trading by trading members. OTR is the ratio of orders to
trades executed by members. Monitoring of high order to trade ratio is to identify and initiate
measures to impede any possible instances of order flooding by algos.
8.2.2 Integrated Surveillance Department in SEBI
SEBI on its own also initiates surveillance cases based on references received from other
regulatory agencies, other stakeholders (investors, corporate, shareholders) and media
reports. Being proactive is one of the necessary features for success in taking surveillance
measures. Keeping the same in mind, the Integrated Surveillance Department of SEBI keeps

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tab on the news appearing in print and electronic media. News and rumours appearing in the
media are discussed in the joint surveillance meetings with the stock exchanges and necessary
actions are initiated. Apart from the above, the department generates reports at the end of
each day on the details of major market players, scrips, clients and brokers during the day in
the Cash and F&O segment of the stock exchanges. This ensures timely identification of the
market players responsible for unusual developments on a daily basis. The department
monitors the market movements, analyses the trading pattern in scrips and indices and
initiates appropriate action, if necessary, in conjunction with stock exchanges and the
depositories. Thus, SEBI supplements the primary regulator i.e., the stock exchanges in
ensuring safe market for the investors.
SEBI has established standards for effective surveillance in Indian securities markets in line
with global standards thereby setting up global benchmark for effective surveillance in
securities market. SEBI also ensures a rigorous application of the standards and effective
enforcement against offences to ensure the safety and integrity of the market. SEBI also
established cooperation among overseas regulators of securities and futures markets to
strengthen surveillance on cross border transactions. As a result, the securities market in India
is considered as one of the most efficient and sound markets in the world.
The various processes and systems implemented by SEBI to help detecting Fraud and Unfair
Trade Practices (FUTP) are:
 Integrated Market Surveillance System (IMSS): In order to enhance the efficacy of the
surveillance function, SEBI has put in place a world-class comprehensive Integrated
Market Surveillance System (IMSS) across stock exchanges and across market
segments (cash and derivative markets). The IMSS solution seeks to achieve the
following objectives:
a) An online data repository with the capacity to capture market transaction
data and reference data from a variety of sources like stock exchanges, clearing
corporations/houses, depositories, etc., in different formats for the securities
and derivatives markets;
b) A research and regulatory analysis platform to check instances of potential
market abuse; and
c) Sophisticated alert engines that work with various data formats (database,
numeric and text data) to automatically detect patterns of abuse and then
issue an alert. These include insider trading engine, fraud alert engine and
market surveillance engine.
 Data Warehousing and Business Intelligence System (DWIBS): It is used for speedy
analysis of trade data to identify clients who possibly indulged in securities law
violations such as insider trading, share price manipulation etc. It comprises of data
warehouse, data mining and business intelligence tools.

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  Inter-Regulatory Alert System: In view of the growing linkages between the securities
market and the banking system, it was felt desirable to set up an inter-regulatory alert
system between SEBI and RBI. Towards this end, a SEBI-RBI Group on Integrated
System of Alerts has been set up to share information and to recommend suitable
measures for co-ordinated action. In accordance with the recommendations made by
the Group, appropriate alerts and data have been identified. A system making use of
the same has been put in place since February 2004.
Alerts
SEBI and the stock exchanges have put in place robust surveillance mechanisms that monitor
the activities across market segments/ exchanges and generate alerts on price and volume
variations.
 Online Real Time Alerts
Real time alerts are generated regarding abnormal movement in intraday prices, abnormal
trade quantity or trade value based on the intraday trade information. The purpose of these
alerts is to identify any abnormality on real time basis.
 Online End of Day Alerts
Trade related information of the entire day is analyzed against the historical information in
order to identify and generate alerts regarding price, volume and value aberrations.
Price Variation
Price variation is the variation between the last trade price (LTPt) and the previous close price
(PCP) of a security as a percentage of the previous close price (PCP).
Price Variation = { (LTPt − PCP) / PCP } × 100
High-Low Variation
High-Low variation is the difference between the high price (HP) and the low price (LP) of a
security as a percentage of the previous close price (PCP).
High-Low Variation = { (HP − LP) / PCP } × 100
Consecutive Trade Price Variation
Consecutive Trade Price Variation is the difference between the last trade price (LTPt) and the
previous trade price (LTPt-1) of a security expressed as a percentage of the previous trade price
(LTPt-1).
Consecutive Trade Price Variation = { (LTPt − LTPt-1) / LTPt-1 } × 100
Quantity Variation
Quantity Variation is the percentage variation between the total traded quantity (TTQ) and
the average traded quantity (ATQ) as a percentage of the average traded quantity (ATQ).

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Quantity Variation = {(TTQ − ATQ) / ATQ } × 100
Where ATQ is calculated as the total number of shares traded in the last N trading days / N.

8.3 Surveillance Actions

Rumour Verification
Leading financial dailies are scrutinized for any price sensitive information pertaining to the
companies listed with the Exchange. In case, such news is not intimated to the Exchange and
there was impact on the price (or the threshold percentage in price), letters are sent to the
companies seeking clarifications. The reply received from the companies is broadcast to the
members, updated on the website and a press release is issued to the effect.
Price Bands
Price bands refer to the daily price limits parameterized through appropriate program on the
trading system, within which the price of a security is allowed to go up or down. Daily price
bands are applied at 2 percent, 5 percent and 10 percent (either way) on individual scrips. No
price bands are applicable on securities on which derivative products are available or
securities included in indices on which derivative products are available. Price bands of 20
percent are applicable on all securities (including debentures, warrants, preference shares
etc.), other than specifically identified securities. Also the scrips on which no derivatives
products are available, but are a part of Index Derivatives, price bands of upto 20 percent is
applied on such individual scrips.
In order to prevent members from entering orders at erroneous prices in securities that are
excluded from the requirement of price bands, the Exchanges apply dynamic price bands at
10 percent of the previous closing price. In the event of a market trend in either direction, the
dynamic price bands are relaxed by the stock exchanges in increments of 5 percent.

The price bands for the securities in the Limited Physical Market are the same as those
applicable for the securities in the Normal Market. For the Auction Market the price band of
20 percent are applicable.

Market Wide Circuit Breakers

In addition to the above-stated price bands on individual securities, SEBI has decided to
implement index based market wide circuit breakers system, w.e.f., July 02, 2001. The index-
based market-wide circuit breaker system applies at 3 stages of the index movement, either
way viz. at 10 percent, 15 percent and 20 percent. These circuit breakers when triggered bring
about a coordinated trading halt in all equity and equity derivative markets nationwide to
provide for a cooling-off period giving buyers and sellers time to assimilate information. The
market-wide circuit breakers are triggered by movement of either the Nifty 50 or S&P BSE
Sensex, whichever is breached earlier.

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The Index circuit breaker limits are computed by the stock exchanges on a daily basis based
on the previous day’s closing level of the index and is rounded off to the nearest tick size.

Trade for Trade Action

Trade for trade deals are settled on a trade for trade basis and settlement obligations arise
out of every deal. When a security is shifted to trade for trade segment, selling/ buying of
shares in that security results into giving or taking delivery of shares and no intraday or
settlement netting off/ square off facilities are permitted. Trading in this segment is available
only for the securities:
• which have not established connectivity with both the depositories as per SEBI
directives. The list of these securities is notified by SEBI from time to time.
• on account of surveillance action.
The surveillance action whereby securities are transferred for trading and settlement
on a trade-for-trade basis is based on various factors like market capitalization, price
earnings ratio, price variation vis-à-vis the market movement etc. The said action is
reviewed at periodic intervals.

8.4 Surveillance Measures

8.4.1 Graded Surveillance Measure (GSM)

SEBI and the stock exchanges, in joint surveillance meetings, have decided that along
with other measures, Graded Surveillance Measure (GSM) on securities shall be
implemented. The securities that witness abnormal price rise, not commensurate with
their financial health and fundamentals (such as, earnings, book value, networth, P/E
multiple etc.), shall come under the purview of GSM. The main objectives of these
measures are to:
 Alert and advice investors to be extra cautious while dealing in such securities
and
 Advise market participants to carry out necessary due diligence while dealing
in these securities.

The GSM framework came into force on March 14, 2017. The list of securities identified
under GSM are informed to the market participants at specific intervals and are also
available on the website of the stock exchanges.

There are 6 stages defined under GSM framework and surveillance actions has been
defined for each stage. Once a security goes into a particular stage, it attracts the
corresponding surveillance action. The securities are placed in a particular stage by the
exchange based on monitoring of price movement and predefined objective criteria. The

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 exchanges carry out reviews at regular intervals for moving securities in/ out of GSM
framework.

8.4.2 Additional Surveillance Measure (ASM)

In addition to the aforementioned GSM framework, Additional Surveillance Measures
(ASM) has been implemented by the exchanges on securities with surveillance
concerns based on objective parameters such as, price/ volume variation, volatility
etc. as decided jointly by SEBI and the exchanges. As stated, ASM framework shall work
in addition to existing actions undertaken by the Exchange on the securities.

The monitoring of securities under ASM framework has come into force with effect from
March 26, 2018. The updated list of securities that are shortlisted under ASM are being
published from time to time.

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 Quiz

1. Initial margin on positions of clearing members are calculated on _____ basis.

2. ________ violation happens when the open position of the trading member exceeds the
Trading Member wise Position Limit.

3. All alerts generated on the surveillance system are real time. State whether True or False.

4. Market wide circuit breakers are based on _____ movement.

5. The securities that witness abnormal price rise, not commensurate with their financial
health and fundamentals shall come under the purview of _________.

Answers

1. Real-time

2. Position Limit

3. False

4. Index

5. Graded Surveillance Measure (GSM)

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 9 Client Management

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Different kinds of risks
 Risk profiling of individuals
 Financial planning
 Trading account opening procedure for clients
 Taxes applicable for buy and sale transactions of securities and mutual funds
 Investor Grievance Mechanism

9.1 Introduction
Risk and investing go hand in hand. Risk can be defined as the chance one takes that all or
part of the money put into an investment can be lost. Investing risk comes with the potential
for investing reward which makes investing a good option for earning returns.
The vital aspect of risk is that it increases as the potential return increases. Thus, the bigger
the risk is, the bigger the potential payoff.
Even seemingly “no-risk” products such as savings accounts and government bonds carry the
risk of earning less than the inflation rate. If the return is less than the rate of inflation, the
investment has actually lost ground because your earning isn’t being maximised as they might
have been with a different investment vehicle.
While you stay invested, it is crucial that you take necessary measures to manage your risk.
Once you invest in any asset class you should monitor your investments and keep yourself
updated about various market happenings to avoid any pitfalls. A prudent investor should
always check the potential risks when quoted returns are unusually high.

9.2 Types of Risks

There are a number of different types of risks that can affect investments and returns on
them. Understanding the different types of risks is the key to plan, so as to maximise returns
on the investments.
All investments are affected broadly by systematic and unsystematic risks. Systematic risk
influences a large number of assets. A significant political event, for example, could affect
several of the assets invested in. Unsystematic risk is sometimes referred to as "specific risk".
This kind of risk affects a few companies or a small number of securities invested in. An
example is news that affects a specific stock such as a sudden strike by employees or major
load shedding in the areas of heavy industries, is bound to affect production/output of certain
companies leading to a loss in income and consequently, reduction in the price of securities
of the companies.

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9.2.1 Interest Rate Risk
Interest rate risk is the risk that an investment's value will change as a result of a change in
interest rates. This risk affects the value of bonds/debt instruments more directly than stocks.
Any reduction in interest rates will increase the value of the instrument and vice versa.
9.2.2 Foreign Exchange Risk
Investing in foreign countries/companies carries the exchange rate risk. Foreign-exchange risk
applies to all financial instruments that are in a currency other than in domestic currency (say,
Indian rupees). Depreciation in the value of the foreign currency could neutralise any income
earned from that asset.
9.2.3 Country Risk
Country risk refers to the risk related to a country as a whole. There is a possibility that it will
not be able to honour its financial commitments. When a country defaults on its obligations,
this can affect the performance of all other securities in that country as well as other countries
it has relations with. Country risk applies to all types of securities issued in that country.
9.2.4 Credit or Default Risk
Credit risk is the risk that a company or individual will be unable to pay the contractual interest
or principal or both on its debt obligations. This type of risk is of particular concern to investors
who hold bonds in their portfolios. Government bonds, especially those issued by the central
government, have the least amount of default risk and the lowest returns, while corporate
bonds tend to have the highest amount of default risk but also higher interest rates. Bonds
with a lower chance of default are considered to be investment grade, while bonds with
higher chances are considered to be junk bonds. Bond rating services by credit rating agencies
allow investors to determine which bonds are investment-grade, and which bonds are junk.
9.2.5 Political Risk
Political risk represents the financial risk that arises out of sudden change in government
policies, political instability, change in government through a coup, etc. Political factors can
affect the value of securities.
9.2.6 Market Risk
This risk is also referred to as market volatility. It is the day-to-day fluctuations in a stock's
price. This may follow the movement of the index or affect the index movement. Normally a
bull market sees good performances and a bear market sees the prices of securities in a
downtrend. However, day to day volatility is also common. Although the risk is high, the
returns are also consequently high for volatile securities. This volatility represents the market
sentiments of the investors.

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9.3 Risk Profiling of Investors
Understanding risk profile of investors is key in order to suggest suitable investment avenues
and keep track of their portfolios constantly. Some investors like to invest in order to achieve
a certain level of financial independence that allows them to meet not only their basic needs,
but also a certain cushion for comforts and future needs. Some investors would prefer to
accept smaller returns from safer investments and vice versa. Hence, a single investment
model will not be suitable for all investors.
Some of the key parameters on which an investor’s risk tolerance can depend on are: age,
personal income, family income, gender, number of dependents, occupation, marital status,
education, and access to other inherited sources of wealth.
It is also important to understand the investors’ needs during the time period for which
investors plan to invest, whether it is long term or short term. Investment advice should be
given based on this investment horizon.

9.4 Financial Planning

A very commonly used definition of Financial Planning is: “Financial Planning is the process of
meeting one’s life goals through the proper management of personal finances”. It’s best to
understand the above definition by breaking it up into three parts;
Financial Planning is a Process: Worldwide professional financial advisors follow a standard
six-step process to deliver Financial Planning services consisting of:
1. Establishing and defining client relationship
2. Gathering client data, including goals
3. Analyzing and evaluating current situation and needs
4. Developing and presenting recommendations
5. Implementing the recommendations
6. Monitoring and reviewing the Financial Plan
Meeting one’s Life Goals: Individuals and families have many goals to fulfil for which they will
have to save, accumulate and grow their money. Some common life goals are:
1. Children’s future including education and marriage
2. Buying a house
3. Comfortable Retirement
Other goals may include going on regular or one time vacations, purchasing a car/vehicle,
corpus for starting own business and being debt-free (home loan, car loan), etc.
Management of Personal Finances: Financial Planning is all about managing finances of an
individual or a family. It should not be mistaken for corporate finance although many of the
concepts used in corporate finance are used in Financial Planning. While offering solutions to
clients, the following aspects of personal finance should be analysed as a whole rather than
seeing them in isolation:
1. Income

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 2. Expenses
3. Assets
4. Liabilities
5. Insurance
6. Taxation
7. Estate
9.4.1 Financial Advisory Services
Financial Advisory in general has a very wide scope and encompasses all the areas of personal
finance. Financial Planners can offer any one or all the services based on what the client needs
and also based on what the planner is capable of offering in terms of his tie-ups with product
manufacturers, education and regulatory framework. The scope can be bifurcated into pure
advisory services and transaction based services.
Advisory Services
Insurance Planning
Insurance Planning is determining the adequacy of insurance cover required by the client to
cover the risk associated with one’s life, medical emergencies and assets. While offering
Insurance Planning services, a Financial Planner may do the following:
- Assess adequate life cover
- Assess situation in case of premature death
- Assess health insurance requirement for medical emergency
- Evaluate options of accident policy and critical illness policy
- Assess need for theft insurance
- Advice on insurance products suitable for the client
Retirement Planning
Retirement Planning is determining how much of corpus is required to fund the expenses
during the retirement years and ways to build that corpus in the pre-retirement period. It also
dwells upon the utilisation of the corpus accumulated during the retirement years. And while
offering the service to a person who has already retired, a planner can offer investment
advisory services to help client generate required income from the retirement corpus and also
manage the investment portfolio. While offering Retirement Planning Services, a Financial
Planner must assess:
- Retirement corpus required to lead a similar lifestyle after retirement
- Impact of inflation on sustainability of retirement corpus
- Requirement for additional investments to build retirement corpus
- Advice on suitable retirement products for client
Investment Planning
Investment Planning determines the optimum investment and asset allocation strategies
based on the time horizon, risk profile and financial goals of the client. There is a wide range
of investment options available today. A Financial Planner offering Investment Planning

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services should understand and analyze various asset classes as well as the products available
under each asset class before recommending an investment strategy to the client for
achieving financial goals. While offering Investment Planning Services, a Financial Planner
performs the following:
- Translation of life goals to financial goals
- Assessing client’s risk profile
- Ascertaining the time horizon available for investments
- Advice on the ideal Asset Allocation
- Advice on the asset allocation strategy
- Ensure diversification of investments
- Suggest investment as per investment objective – income, growth or just capital
protection
- Suggest investment amount, product and frequency
Tax Planning
Tax Planning includes planning of income, expenses and investments in a tax efficient manner
to gain maximum benefit of prevailing tax laws. Key features include:
- Optimizing of tax benefits and post tax gains
- Assessing and monitoring effect of capital gains on investments
- Assessing tax liability for the previous year
Comprehensive Financial Planning
Comprehensive Financial Planning is the act of planning for and prudently addressing life
events. It addresses everything from buying a new car or home, to planning for a child’s
education, preparing for eventual retirement or creating a plan for your estate. But it goes
well beyond these basic life events. It addresses the planning part of all major financial
transaction which has a bearing on long-term finances, cash flows and asset creation. While
the financial goals are met at different time periods, the associated liability and risk to life and
assets are to be adequately covered with tax efficiency of financial transactions. A Financial
Planner offering comprehensive Financial Planning should offer customized advice to help
his/her clients meet their goals and objectives.
Transaction Based Services
While a Financial Advisor may charge a professional fee for the above mentioned advisory
services, he/she may also opt to provide advisory as a complimentary service while earning a
commission on the product sales that take place when the client implements the advice
through him. Below are some of the transaction-based services a Financial Planner can offer:
 Life Insurance products
 General Insurance products
 Mutual Funds
 Stock Broking
 Others:

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 - Banking products – Loans & Deposits
- Post Office Savings Schemes
- Public issues of shares, debentures or other securities (popularly known as IPOs)
- Corporate Deposits
9.4.2 Investment Need Analysis
Utilising Time Value of Money
Time value of money is a concept that explains Rs. 100 in hand today is worth more than Rs.
100 after 2 years due to its interest earning capacity during the time period Hence, investing
today is important and one should not let money remain idle for long.
Estimating Future Value of Goals
When an individual is planning for future goals, it becomes important to plan for their future
value rather than their current value. Inflation is an important factor while calculating the
future value. As inflation erodes away the value of money with time, future planning based
on current value will be insufficient to meet future goals.
Determining Investment Horizon
One needs to invest to meet a future need. A person sacrifices use of money today for a higher
gratification at a later date. Identify the need/ goal and time horizon and you can evaluate
where the investment needs to be done.
Lump-sum Investments & Regular Investments
As and when a person is in receipt of lump-sum money, he should ensure he is investing it
according to his requirements. Apart from this, there should be a regular investment to
ensure discipline in savings habits.
9.4.3 Financial Cash Flows and Budgeting
Budget
A budget is a list of planned expenses and revenues. One should ensure that there are also
budgets for some items to splurge on and those that provide for some emergency situations.
Cash Flows
A cash flow is a revenue stream usually arising from multiple entries of inflows and outflows,
i.e. income and expenses.
Keeping Cash Flows Positive
It is important to have a positive cash flow at all points of time else it indicates deficit. A
negative cash flow balance depicts that investments are used to meet regular requirements,
which should only happen during retirement; not otherwise.

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9.4.4 Understanding Various Asset Classes
As seen earlier, there are various investment options having different features. A financial
advisor’s role is to suggest the appropriate investments based on the needs of the investor.
After analysing the needs of the investor as outlined in the previous paragraphs, the advisor
then recommends an investment strategy.
For example, if the investor needs to grow the value of investments over long period of time
and to beat inflation, the advisor is likely to suggest investing a good amount in equity related
avenues. If the investor needs to withdraw money from the investments within a very short
period, liquid investment option is the ideal choice.
The investment plan recommends how much money should be invested in which options and
how such allocation should be changed over a period of time. Such a strategy is commonly
known as asset allocation.
9.4.5 Asset Allocation
Asset Allocation decision is the most important decision while designing a portfolio. In fact a
folio’s long term return characteristics and risk level are determined by the asset allocation.
The asset allocation depends on a lot of factors specific to an individual such as age and risk
profile, nature of goal – short-term or long-term, sensitivity of goal to be achieved, as well as
certain external factors like stock market and interest rate scenario in the period to achieve a
particular goal, etc. The other factors like scheme selection, etc. contribute, but to a much
lesser effect.
For example, the returns from equity and debt classes are 20.73 percent & 6.67 percent
respectively. If one invests entirely into equity, the return will be 20.73 percent whereas if it
is entirely into debt, the return will be 6.67 percent. As the difference is huge, instead of
investing entirely in equity or entirely in debt, a fair asset allocation needs to be determined
for achieving a specific goal.
Such allocation is decided based on how much return one needs to earn as well as the ability
and willingness of an investor to withstand the fluctuations in the market price of
investments. For short durations, equity is highly volatile and may even result in losing capital
invested. On the other hand, over long periods, equity has the potential to beat inflation,
whereas debt may provide less than inflation returns after taxes. That is why, a predominantly
debt portfolio is recommended for near term goals, a balanced portfolio for medium term
goals and a predominantly equity portfolio for long to very long-term goals.
Asset Allocation is also important because it is not possible to be invested in the best asset
class at all times. Whereas the occasional rewards could be huge, the cost of a mistake could
be very large.
All assets in a portfolio will not be impacted to a similar extent by the same factor. So, if the
portfolio has a mix of unrelated assets, fluctuation in the value of one asset class tends to

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cancel in another, thus reducing overall fluctuation in the portfolio’s value. Advisors also insist
on consistently sticking to the asset allocation, which requires periodic rebalancing. This
means, if the value of one part of the portfolio rises faster than the other, the advisor
recommends that the money be shifted to restore the original asset allocation.
For example, let us assume that an investor started with 50 percent allocation each between
equity and debt. After a year, equity market gave 50 percent appreciation, while debt moved
up by 5 percent. In such a scenario, the balance is tilted in favour of equity. The advisor will
now recommend that part of equity portfolio may be sold and the proceeds may be used to
buy fixed income assets. Thus, there is an automatic profit booking when the equity prices
rose very fast. In another scenario, if the equity prices rose less than debt prices or went
down, the advisor would suggest selling some part of the debt portfolio and buy equity. Thus,
more equity is bought when the equity prices are low.
Asset Allocation Strategies
Strategic Asset Allocation: This is a portfolio strategy that involves sticking to long-term asset
allocation.
Tactical Asset Allocation: An active portfolio management strategy that rebalances the
percentage of investments held in various categories of assets in order to take advantage of
market pricing anomalies or strong market sectors.
The major difference between the two is that strategic asset allocation ignores the anomalies
in the stock or bond or other markets and focuses only on the investor’s needs. The
assumption here is that asset allocation ensures the plan would perform in a more predictable
manner helping the investor reach their financial goals comfortably. Proponents of tactical
asset allocation believe that the various markets keep offering opportunities that can be
exploited to enhance the portfolio returns.
It is for an advisor to decide which one to follow based on one’s beliefs and abilities. If the
advisor believes that there are inefficiencies in the market and also believes that one has the
ability to exploit those, one may resort to tactical asset allocation. However, the believers of
efficient markets usually stick to strategic asset allocation.
We have discussed basic concepts of financial planning. We now discuss various steps in
advising a client on equity.

9.5 Product Suitability

Every asset class is associated with risk and return. Equity investments are considered to be
risky investments as they might lead to erosion of entire capital invested, whereas
government bonds are considered to be risk free as the investors are confident that the
government will not default on its principal and interest payments.

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This is where asset allocation plays a crucial role. Asset allocation is a technique for investing
the money into various asset classes that suits the income requirements and risk appetite of
the investor.
Asset allocation involves trade-offs among three important variables:
 time frame
 risk tolerance
 personal circumstances
Depending on the investor’s age, lifestyle and family commitments the financial goals will
vary. While allocating the funds to various assets, it is important to see that the investor
benefits from diversification.
Right investment is a balance of three things: Liquidity, Safety and Return. Liquidity means
the ease of converting investments to cash. Some liquid investments like savings bank
deposits are required to meet exigencies. Safety refers to the level of risk of the investment.
Some investments may promise high returns while the money may be lost, like junk bonds.
However, investments which offer good returns also ensure safe return of principal, like
mutual funds, securities of blue chip companies, Government securities, etc. Inflation is a risk,
which reduces the real income of an investment. Like long term investments in bonds,
debentures, etc., earn the same interest, however, the inflation risk exists in these
investments. Return refers to the income generated by the investment. Risky investments
offer high or negative returns and safe investments offer steady but lower incomes.
Thus, the investor’s needs have to be understood and products suitable to the individual
investor should be recommended.

9.6 Review of Client’s Portfolio

The client’s portfolio needs review from time to time. For customers with short term
investment time frames, review needs to be carried out at more frequent intervals. The
portfolio needs to be developed and maintained to suit the investor’s risk profile and
appetite.
For clients with long term investment time frames, the review can be less frequent. However,
while conducting such a review, the customers’ needs must be kept in mind. Any investment,
that does not fall within the clients’ needs, must be sold and new investments should be
made, with the consent of the customer.

9.7 Client Account

9.7.1 Client Account Opening
This refers only to the opening of accounts (Demat account and Trading Account) for new
clients. There are certain procedures to be followed before the account can be opened and
the broker can execute the orders of the client. The client has to fill up the account opening
form and submit it along with KYC documents and photographs.

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9.7.2 KYC and Other Documents
KYC is an acronym for “Know your Client”, a term commonly used for Customer Identification
Process. SEBI has prescribed certain requirements relating to KYC norms for Financial
Institutions and Financial Intermediaries including Mutual Funds and Stock Brokers to ‘know’
their clients. This entails verification of identity and address, financial status, occupation and
such other personal information as may be prescribed by guidelines, rules and regulations.
A broker must ensure that the clients fill-up the KYC form and submit it to them. There are
separate forms for individuals and non-individuals. Brokers must also ensure that the
following documents are submitted along with the KYC form by the client.
 PAN Card: The photocopy of the PAN card is mandatory. The same to be verified with
original PAN card and the original should be returned to the client immediately.
 Proof of Identity: The client needs to submit any one of the following documents:
Unique Identification Number (UID) (Aadhaar), Passport, Voters ID card, Valid Driving
license.
 Proof of Address Document: (one for each distinct address). The documents may
include one of the following: Latest Telephone/Electricity Bill, Passport, Driving
License, Latest Bank Passbook or A/c Statement, Voter Identity Card, Ration Card,
Latest Demat Account Statement, Registered Lease / Sale Agreement of residence and
the details of registration and proof of address of registered office for non-individuals.
 In-person verification (IPV) is also required to be made by the broker or by the person
authorised by him for each new client added on the books.
 The client must also have a valid bank account from which transactions can be made
for pay-in/out of funds. The details are to be given with the KYC. A cancelled cheque
leaf with a copy of the latest bank A/C statement / pass book should also be submitted
at the time of opening the trading A/C. This Bank A/C will be mapped to the Client’s
Trading A/C and thereafter, generally, payment will be accepted only from this A/C. A
client can map more than one Bank A/C also, but should provide the proof of the same.
The client must have also opened a demat account with a DP for pay-in/out of
securities. A copy of the client master given by the respective DP to the client should
be submitted to broker at the time of opening the trading A/C.
 Normally a client prefers to open both trading and demat accounts with the same
broker. If the client wishes to give Power of Attorney (POA) in favour of broker for
smooth functioning, it may be exacted as per formats and stipulations issued by SEBI.
 The retail clients normally do not wish to exchange cheques to and fro for every con-
tract. They prefer to settle the account with the broker at periodic intervals. To
facilitate this SEBI has approved brokers to collect running authority letter from the
client. In spite of this letter the broker should settle the accounts at least once a
quarter or earlier as per the client preference.

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SEBI has initiated the usage of a uniform KYC process across all registered intermediaries. In
this regard SEBI has issued the SEBI {KYC (Know Your Client) Registration Agency (KRA)},
Regulations, 2011.

KRA acts as a centralised KYC record keeping agency in the securities markets. The KYC details
of the clients are uploaded on the system of KYC Registration Agency by the intermediaries.
This information is available to all the SEBI registered intermediaries and can be accessed at
the time of dealing with the client. This has reduced the duplication of work .
9.7.3 Unique Client Codes
Once the formalities of KYC and other details thereon are complete, each client is assigned a
unique client code (UCC) by the broker. This acts as an identity for the client with respect to
the broker. SEBI has made it mandatory for all the brokers to use unique client codes for all
clients. The client code has to be linked to the PAN number of the client. This PAN number
becomes the investor’s identity across brokers and exchanges.
Earlier, this was not the case. For those individual investors who do not have a PAN number,
till the PAN number was allotted, they needed to furnish the passport number and place and
date of issue. Where clients did not have PAN number as well as Passport, they needed to
furnish driving license number and place and date of issue. However, in cases where none of
the above mentioned identifications were available, the clients would furnish the voter ID
card.
However, now, PAN is mandatory and no trade takes place without it.
A broker has to inform the exchange the details of the clients through an upload, before
entering into any trade for the client. If the broker fails to register the unique client code with
the exchange and transacts on behalf of client, then penalty is levied on the broker for each
day till the information is submitted.

9.8 Taxation
9.8.1 Securities Transaction Tax
The Securities Transaction Tax (STT) was introduced by Chapter VII of The Finance (No. 2) Act,
2004. It is a tax applicable on the purchase or sale of equity shares, derivatives, equity-
oriented funds and equity-oriented mutual funds. Examples of transactions done in a
recognized stock exchange on which STT is applicable are as follows:
 Purchase or sale of equity shares and units of business trust (delivery-based)
 Sale of units of equity-oriented fund (delivery based)
 Sale of equity shares, units of business trust and units of equity-oriented mutual funds
(non-delivery based)
 Sale of derivatives
 Sale of units of an equity-oriented fund to the Mutual Fund
 Sale of unlisted equity shares and units of business trust under an initial offer

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9.8.2 Capital Gains Tax
Financial securities (mostly shares, but also listed debentures and mutual funds) provide
regular income in the form of dividends on shares and units of mutual funds, and interest on
debt securities. Dividends received from domestic companies listed in India are tax free in the
hands of the investors upto Rs. 10 lakhs. Additional tax of 10 percent (plus applicable
surcharge and cess) is applicable in case of all resident tax payers, excluding domestic
companies and few other specified entities, for dividend income of more than Rs. 10 lakhs
received from domestic companies in a financial year. However, dividends received from
mutual funds are completely tax free in the hands of the investors. Interest income from
debentures and bonds are subject to Income Tax. An exemption from interest from specific
‘Tax Free Bonds’ is sometimes granted by the Income Tax authorities.
When securities such as shares, listed debentures and equity-oriented mutual funds are sold,
it could result in a gain or loss, depending on the cost of purchase. In case of Equity Shares, if
held for more than 12 months before sale (called a transfer), it could result in a Long Term
Capital Gain or Long Term Capital Loss. If the holding period is equal to or less than 12 months,
the resultant Gain or Loss is called as Short Term Capital Gain or Short Term Capital Loss.
In addition to Income Tax (which is directly borne by the assessee), there is also a Securities
Transaction Tax (STT), which is an Indirect Tax. This is levied by the stock-broker through the
contract note and recovered from the customer, and ultimately paid to the tax authorities.
In case of Equity Shares, Short Term Capital Gains are taxed at 15 percent (plus surcharge and
cess as applicable), on transactions done on recognized Stock Exchanges in India where STT is
paid. In the Budget of 2018, Long Term Capital Gain Tax (LTCG Tax) has been re-introduced
and an LTCG tax at the rate of 10 percent (plus surcharge and cess as applicable) is applied on
securities traded through recognized Stock Exchanges where STT is paid. However, this LTCG
tax of 10 percent would be levied only on the gains exceeding Rs. 1 lakh in a financial year.
Also, all gains up to January 31, 2018 are grandfathered i.e., as the fair market value on
January 31, 2018 will be taken as cost of acquisition, the gains accrued up to January 31, 2018
will continue to be exempt.
Long Term Capital Losses can be set off only against Long Term Capital Gains, if there is any
such income to be taxed.
Short Term Capital Losses can be set off either against Short Term Capital Gains or Long Term
Capital Gains, if any.
Losses (both Long and Short Term) if not set off in a year due to lack of offsetting income, can
be carried forward for 8 years.
The above provisions apply in respect of securities held as capital assets, not by persons
regularly engaged in the business of buying and selling securities. For persons holding
financial securities as a business asset (inventory or stock) for sale and filing Income Tax

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returns specifically under Business Profits, the losses and gains are computed under the
income head ‘Business Profits’.
9.8.3 Dividend Distribution Tax
Dividend Distribution Tax (DDT) is the tax levied by the Indian Government on companies
according to the dividend paid to a company's investors. The said dividend distribution tax is
in addition to the income tax chargeable on the total income of the Company and the same
shall be payable at 15 percent (plus surcharge and cess as applicable). This applies to dividend
payments made either out of current or accumulated profits. The Dividend Distribution Tax is
payable by a Domestic Company even if no income-tax is payable on its total income.
The DDT provisions are applicable to a domestic company for any assessment year, on an
amount declared, distributed or paid by such company by way of dividends (whether interim
or otherwise). The Company is required to pay the Dividend Distribution Tax within 14 days
from the date of declaration or distribution or payment of any dividend whichever is earlier.
In case of equity-oriented mutual funds, the dividend distributed are taxed in the hands of
the Mutual Fund schemes at the rate of 10 percent (plus surcharge and cess as applicable).

9.9 Investor Grievance Mechanism

Each exchange has a process for grievance redressal. The general features of these processes
are mentioned below:
 Investor Grievance Resolution Mechanism
All exchanges have a dedicated department to handle grievances of investors against the
Trading Members and Issuers. Generally, these departments operate from all offices of
the exchange so as to provide easy access to investors. All exchanges also have supervision
mechanisms for the functioning of this department/cell. These include the Investor
Service Committees (ISC) consisting of Exchange officials and independent experts whose
nomination is approved by Securities and Exchange Board of India (SEBI). SEBI also
monitors exchange performance related to investor grievance redressal.
 Arbitration
Arbitration is a quasi-judicial process of settlement of disputes between Trading
Members, Investors, & Clearing Members and between Investors and Issuers. If any
complainant is not satisfied with the resolution of his complaint by the stock exchange,
the party may choose the route of arbitration. Generally, the application for arbitration
has to be filed at the Regional Arbitration Centres (RAC) established by the exchanges
within 3 years from the date of dispute. Arbitration is governed by Bye-laws, Regulations
and Circulars issued by stock exchanges and SEBI.
The parties to arbitration are required to select the arbitrator from the panel of arbitrators
provided by the Exchange. The arbitrator conducts the arbitration proceeding and passes
the award normally within a period of four months from the date of initial hearing.

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The arbitration award is binding on both the parties. However, the aggrieved party, within
thirty days of the receipt of the award from the arbitrator, can file an appeal to the
arbitration tribunal for re-hearing the whole case. On receipt of the appeal, the Exchange
appoints an Appellate Bench consisting of three arbitrators who re-hear the case and then
give the decision. The judgment of the Bench is by a ‘majority’ and is binding on both the
parties. The final award of the Bench is enforceable as if it were the decree of the Court.
Any party who is dissatisfied with the Appellate Bench Award may challenge the same
only in a Court of Law.
SCORES
SEBI’s web based complaints redressal system is called SCORES (Sebi COmplaints REdress
System). SCORES is a centralized grievance management system with tracking mechanism
to know the latest updates and time taken for resolution. Each complaint will have a
unique reference number, which will help customers keep a track and follow up the
resolution. It was introduced on June 8, 2011 to facilitate redressal of investor grievances
in a speedy manner. The salient features of SCORES are:
(i) Centralised database of investor complaints
(ii) Online movement of complaints to the concerned listed company or SEBI
registered intermediary
(iii) Online upload of Action Taken Reports (ATRs) by the concerned listed company or
SEBI registered intermediary
(iv) Online viewing by investors of actions taken on the complaint and its current
status
All complaints are lodged electronically at: https://scores.gov.in
Investors may contact the Investor Associations (IAs) recognized by SEBI for any assistance
in filing complaints on SCORES. The lists of Investor Associations are available on SEBI
website (www.sebi.gov.in). Investors may also seek assistance in filing complaints on
SCORES from SEBIs toll free helpline number 1800 266 7575 or 1800 22 7575.
The companies are required to view the pending complaints and take action and provide
resolution along with necessary documents (can be uploaded online). If the company fails
to provide resolution within specific turn-around time, it will be treated as non-redressal
or non-compliance in the SCORES system and the regulator will keep a track of such
instances.
Process
 Receipt of Complaints
The investor is required to submit his complaint in the prescribed complaint form against
the trading member providing the details as specified in the instructions annexed to the
complaint registration form along with supporting documents substantiating his claim.
On receipt of the complaint, the nature of complaint and adequacy of documents
submitted along with the complaint would be scrutinized and if all the relevant documents

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 are submitted, the complaint is recorded, a complaint number is assigned and an
acknowledgement towards receipt of complaint is sent to the investor. If the documents
are inadequate, the investor is advised to set right the deficiencies in the documents.
 Redressal of Complaints
Generally, exchanges initially try to resolve the complaint by following up with the
member and the complainant. The issues raised by the complainant are analyzed and the
complaint is taken up to the concerned trading member for resolution / response within
the set timeframe. Subsequently, the response received from the trading member is
reviewed.
 If the Trading Member has agreed with the contents of the complaint, he is
advised to settle the matter immediately and confirm.
 If the Trading Member states that he has already settled the complaint, proof
of settlement is solicited and cross confirmation is obtained from the investor.
 If the Trading Member raises issues from his side, the comments are analyzed
and forwarded to the investor for his views and comments. If differences
persist the Exchange holds meeting with the parties at the Exchange premises
for expeditious resolution of the complaints. In case differences still persist the
investor is informed that he may opt for Arbitration proceedings.
 If the Trading Member has justifiable reasons for his actions which are within
the regulatory framework, the investor is informed on the correct position on
the matter.
 Nature of Complaints
Exchanges provide assistance if the complaints fall within the purview of the Exchange
and are related to trades that are executed on the Exchange Platform such as:
 Complaints against Exchange Members:
 Non-issuance of the documents by the Trading Member
 Non-receipt of funds / securities
 Non-receipt of margin / security deposit given to the Trading Member (TM)
 Non-receipt of corporate benefits (dividend, interest, bonus, etc.)
 Auction value / close out value received or paid
 Execution of trades without consent
 Excess brokerage charged by Trading Member
 Non-receipt of credit balance as per the statement of account
 Non-receipt of funds / securities kept as margin
 Complaints against Listed Companies:
 Regarding non-receipt of allotment advice, securities allotted, refund order
 Interest on delay in redemption / refund amount
 Sale proceeds of fractional entitlement
 Composite Application Form (CAF) for Rights offer
 Securities purchased through a Rights offer

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  Letter of offer for buyback
 Regarding non-receipt of dividend, interest, bonus shares, stock split shares,
etc.
 Regarding non-receipt of securities after dematerialization, after transfer /
transmission.
SEBI mandates that all listed companies are required to view the complaints pending
against them and submit ATRs along with supporting documents electronically in SCORES.
Failure on the part of the company to update the ATR in SCORES will be treated as non-
redressal of investor complaints by the company. SEBI also mandates that companies
desirous of getting their equity shares listed on the stock exchanges should also obtain
authentication on SCORES, before Listing Approval is granted by stock exchanges.
Effective from August 01, 2018, the following procedure is followed for filing and redressal
of investor grievances using SCORES:
Investors who wish to lodge a complaint on SCORES have to register themselves on
www.scores.gov.in. While filing the registration form, mandatory details like name of the
investor, address, e-mail id, PAN and Contact details/ mobile number needs to be
furnished. Upon successful registration, a unique user id and a password will be
communicated to the investor through an acknowledgement email. Using the login
credentials, the investor can lodge his/her complaint on SCORES. The complainant may
use SCORES to submit the grievance directly to companies / intermediaries and the
complaint shall be forwarded to the entity for resolution. The entity is required to redress
the grievance within 30 days, failing which the complaint will be routed to SEBI directly
and a new SCORES registration number for the complaint will be generated. When
complaints come to SEBI, it forwards the complaint to the concerned entity with an advice
to send a written reply to the investor and file an action taken report (ATR) in SCORES.
If a complaint in SCORES is disposed off and the investor is not satisfied with the closure
of the complaint, the investor needs to mandatorily provide the reasons for his/ her
dissatisfaction with the redressal within a period of 15 days from the closure of the
complaint. The said complaint then shall be escalated to the appropriate Supervising
Officer in SEBI.
The detailed process of registering into SCORES and filing complaints into the system can
be accessed from: https://www.sebi.gov.in/sebi_data/faqfiles/apr-2019/1556089488014.pdf

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Quiz

1. ___________ is the risk that an investment's value will change as a result of a change in
interest rates.

2. ___________ is the risk that a company or individual will be unable to pay the contractual
interest or principal on its debt obligations.

3. ___________ is the process of meeting one’s life goals through the proper management of
personal finances.

4. __________________ is an active portfolio management strategy that rebalances the

percentage of assets held in various categories in order to take advantage of market pricing
anomalies or strong market sectors.

5. Short Term Capital Gains are taxed at _____ on equity transactions subject to STT.

Answers

1. Interest rate risk

2. Credit risk

3. Financial Planning

4. Tactical Asset Allocation

5. 15 percent

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 About NISM
National Institute of Securities Markets (NISM) is an educational institution established by the
Securities and Exchange Board of India (SEBI), the securities market regulator, in 2006. The
Institute was established in pursuant to the Union Finance Minister’s proposal, in his 2005-06
Budget Speech, to set up an institution ‘for teaching and training intermediaries in the securi-
ties markets and promoting research’.

NISM is committed to its vision ‘to lead, catalyze and deliver educational initiatives to enhance
the quality of securities markets’. The Institute conducts a wide range of capacity building
programmes in securities markets - from basic financial literacy to full-time post-graduation
programmes. The Institute’s six Schools of Excellence, viz., School for Certification of Interme-
diaries, School for Securities Education, School for Investor Education and Financial Literacy,
School for Regulatory Studies and Supervision, School for Corporate Governance and School
for Securities Information and Research upholds NISM’s vision and works in synergy towards
professionalizing the markets.

NISM is mandated by SEBI (Certification of Associated Persons in the Securities Markets) Reg-
ulations, 2007 to conduct certification examinations and continuing professional education
programs for associated persons engaged by an intermediary. NISM also conducts certifica-
tion examinations for other regulators like IBBI and PFRDA. NISM’s certifications establish a
single market-wide knowledge benchmark for different functions in the Indian securities
market and enable the associated persons to advance their knowledge and skills.

About the Workbook

This workbook has been developed to assist candidates in preparing for the National
Institute of Securities Markets (NISM) Equity Sales Certification Examination. NISM-Se-
ries-XI: Equity Sales Certification Examination seeks to create common minimum knowl-
edge benchmark for all persons involved in the sale of equity products in order to enable
a better understanding of equity markets, better quality investor service, operational
process efficiency and risk controls.

The book covers basics of the Indian equity markets, risk, return and taxation aspects of
equity, clearing, settlement and risk management as well as the regulatory environment
in which the equity markets operate in India.

NATIONAL INSTITUTE OF SECURITIES MARKETS

NISM Bhavan NISM Campus
NISM Bhavan, Plot No. 82, Sector - 17, Plot No. IS-1 & IS-2, Patalganga Industrial Area,
Vashi, Navi Mumbai, Maharashtra - 400703 Mohopada, Taluka Khalapur, District Raigad,
Tele: 022-66735100-02 Maharashtra - 410222
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