Stock Exchanges Role in Markets Finance Essay

The Stock Exchange is an organized market for purchase and sale of listed industrial and financial securities. The securities traded on stock exchanges include shares and debentures of Public Limited Co.’s, Govt. Securities, etc. According to the Securities Contracts (Regulation) Act, 1956, “Stock exchange is an association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing securities.” [1] Stock market refers to the market provided by different stock exchanges to the securities which include share, debenture, bond and other Government securities. It is a market place where buyers and sellers of shares and securities admitted to dealings, can do business at competitive open prices, both for equities and debt instruments. [2] Participants The securities market, thus, has essentially three categories of participants, namely the issuers of securities, investors in securities and the intermediaries and two categories of products, namely the services of the intermediaries and the securities, including derivatives. The issuers and investors are the consumers of services rendered by the intermediaries while the investors are consumers of securities issued by issuers. Those who receive funds in exchange for securities and those who receive securities in exchange for funds often need the reassurance that it is safe to do so. This reassurance is provided by the law and custom, often enforced by the regulator. The regulator develops fair market practices and regulates the conduct of issuers of securities and the intermediaries so as to protect the interests of investors in securities. The regulator ensures a high standard of service from intermediaries and supply of quality securities and non manipulated demand for them in the market. [3] While the corporate sector and governments together raised a sum of Rs. 226,911 crore during 2001-02, the household sector invested 4.3% of their financial savings through the securities market during 2000-01. [4] Corporate Sector: The 1990s witnessed emergence of the securities market as a major source of finance for trade and industry. The share of capital market based instruments in resources raised externally increased to 53% in 1993-94, but declined thereafter to 31% by 2000-01. [5] Governments: Along with increase in fiscal deficits of the governments, the dependence on market borrowings to finance fiscal deficits has increased over the years. The state governments and the central government financed about 14% and 18% respectively of their fiscal deficit by market borrowings during 1990-91. In percentage terms, dependence of the state governments on market borrowing did not increase much during the decade 1991-2002. In case of central government, it increased to 69.4% by 2001-02. [6] Households: Household sector accounted for 89% of gross domestic savings during 2000-01; 53% of their savings were in financial assets. The share of financial savings of the household sector in securities (shares, debentures, public sector bonds and units of UTI and other mutual funds and government securities) is estimated to have gone down from 22.9% in 1991-92 to 4.3% in 2000-01. [7] A Brief History The AMSTER DAMBERUS is the world’s oldest Stock Exchange, where corporate stocks were dealt in 1585 A.D. Thereafter, dealings in stocks started in London (1675), Brussels (1801), Paris Bourse Stock Exchange (1808), and New York Stock Exchange (1810) and so on. [8] Though the historical records relating to securities market in India is meagre and obscure, there is evidence to indicate that the loan securities of the East Indian Company used to be traded towards close of the 18th century. By 1830’s, the trading in shares of banks started. The trader by the name of broker emerged in 1830 when 6 persons called themselves as share brokers. This number grew gradually. Till 1850, they traded in shares of banks and securities of the East India Company in Mumbai under a sprawling Banyan Tree in front of the Town Hall, which is now in the Horniman Circle Park. It is no surprise that the majestic Phiroze Jeejeebhoy Towers is located at the Horniman Circle. In 1850, the Companies Act introducing limited liability was enacted heralding the era of modern joint stock company which propelled trading volumes. [9] After a boom due to the increase demand of cotton and thus the incorporation of various companies in India during the American Civil War the number of brokers, which had increased during the civil war to about 250, declined. During the civil war, they had become so influential and powerful that even the police had only salams for them. But after the end of the civil war, they were driven from pillar to post by the police. They moved from place to place till 1874 when they found a convenient place, which is now appropriately called Dalal Street after their name. They organized an informal association on or about 9th July 1875 for protecting their interests. On 3rd December 1887, they established a stock exchange called ‘Native Share and Stock Brokers’ Association’. This laid the foundation of the oldest stock exchange in India. The word ‘native’ indicated that only natives of India could be brokers of the Exchange. In 1880s a number textile mills came up in Ahmedabad. This created a need for trading of shares of these mills. In 1894, the brokers of Ahmedabad formed “The Ahmedabad Share and Stock Brokers’ Association”. The 1870s saw a boom in jute prices, 1880s and 1890s saw boom in tea prices, then followed coal boom. When the booms ended, there were endless differences and disputes among brokers in eastern India which was home to production of jute, tea and coal. This provoked the establishment of “The Calcutta Stock Exchange Association” on June 15, 1908. Then followed the proliferation of exchanges, many of them even do not exist today. The rest is history. Control of capital issues was introduced through the Defence of India Rules in 1943 under the Defence of India Act, 1939 to channel resources to support the war effort. The control was retained after the war with some modifications as a means of controlling the raising of capital by companies and to ensure that national resources were channeled to serve the goals and priorities of the government, and to protect the interests of investors. The relevant provisions in the Defence of India Rules were replaced by the Capital Issues (Continuance of Control) Act in April 1947. [10] Though the stock exchanges were in operation, there was no legislation for their regulation till the Bombay Securities Contracts Control Act was enacted in 1925. This was, however, deficient in many respects. Under the constitution which came into force on January 26, 1950, stock exchanges and forward markets came under the exclusive authority of the central government. Following the recommendations of the A. D. Gorwala Committee in 1951, the Securities Contracts (Regulation) Act, 1956 was enacted to provide for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and to prevent undesirable transactions in securities. [11] In 1980s and 1990s, it was increasingly realized that an efficient and well developed securities market is essential for sustained economic growth. Without venturing into a detailed discussion at this stage, it would suffice if the researcher just says that the securities market fosters economic growth to the extent it augments the quantities of real savings and capital formation from a given level of national income and it raises productivity of investment by improving allocation of investible funds. The extent depends on the quality of the securities market. In order to improve the quality of the market, that is, to improve market efficiency, enhance transparency, prevent unfair trade practices and bring the Indian market up to international standards, a package of reforms consisting of measures to liberalise, regulate and develop the securities market is being implemented since early 1990s. This has had various beneficial implications. [12] Regulatory Framework The four main legislations governing the securities market are: the SEBI Act, 1992 which establishes SEBI to protect investors and develop and regulate securities market; the Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities, and disclosures to be made in public issues; the Securities Contracts (Regulation) Act, 1956, which provides for regulation of transactions in securities through control over stock exchanges; the Depositories Act, 1996 which provides for electronic maintenance and transfer of ownership of demat securities. The two exclusive legislations that governed the securities market till early 1992were the Capital Issues (Control) Act, 1947 (CICA) and the Securities Contracts (Regulation) Act, 1956 (SCRA). The CICA had its origin during the war in 1943 when the objective was to channel resources to support the war effort. Control of capital issues was introduced through the Defence of India Rules in May 1943 under the Defence of India Act, 1939. The control was retained after the war with some modifications as means of controlling the raising of capital by companies and to ensure that national resources were channeled into proper lines, i.e., for desirable purposes to serve goals and priorities of the government, and to protect the interests of investors. The relevant provisions in the Defence of India Rules were replaced by the Capital Issues (Continuance of Control) Act in April 1947. This Act was made permanent in 1956 and enacted as the Capital Issues (Control) Act, 1947. Under the Act, the Controller of Capital Issues was set up which granted approval for issue of securities and also determined the amount, type and price of the issue. This Act was, however, repealed in 1992 as a part of liberalization process to allow the companies to approach the market directly provided they issue securities in compliance with prescribed guidelines relating to disclosure and investor protection. [13] Though the stock exchanges were in operation, there was no legislation for their regulation till the Bombay Securities Contracts Control Act was enacted in 1925. This was, however, deficient in many respects. Under the constitution which came into force on January 26, 1950, stock exchanges and forward markets came under the exclusive authority of the Central Government. The Government appointed the A. D. Gorwala Committee in 1951 to formulate legislation for the regulation of the stock exchanges and of contracts in securities. Following the recommendations of the Committee, the SCRA was enacted in 1956 to provide for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and to prevent undesirable transactions in securities. The authorities have been quite sensitive to requirements of the development of securities market, so much so that the last decade (1992-2003) witnessed nine special legislative interventions, including two new enactments, namely the Securities and Exchange Board of India (SEBI) Act, 1992 and the Depositories Act, 1996. The SCRA, the SEBI Act and the Depositories Act were amended six, five and three times respectively during the same period. The developmental need was so urgent at times, that the last decade witnessed five ordinances relating to securities laws. Besides, a number of other legislations (the Income Tax Act, the Companies Act, the Indian Stamps Act, the Bankers’ Book Evidence Act, the Benami Transactions (Prohibition) Act etc.) having bearing on securities markets have been amended in the recent past to complement amendments in securities laws. The legal reforms began with the enactment of the SEBI Act, 1992, This was followed by repeal of the Capital Issues (Control) Act, 1947 in 1992 which paved way for market determined allocation of resources. Then came the Securities Laws (Amendment) Act in 1995 followed by the Depositories Act in 1996 to provide for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security. The Depositories Related Laws (Amendment) Act, 1997 amended various legislations to facilitate dematerialization of securities. The Securities Laws (Amendment) Act, 1999 was enacted to provide a legal framework for trading of derivatives of securities and units of CIS. The Securities Laws (Second Amendment) Act, 1999 was enacted to empower SAT to deal with appeals against orders of SEBI under the Depositories Act and the SEBI Act, and against refusal of stock exchanges to list securities under the SCRA. The next intervention is the SEBI (Amendment) Act, 2002 which enhanced powers of SEBI substantially in respect of inspection, investigation and enforcement. The latest and the ninth legislative intervention namely the Securities Laws (Amendment) Bill, 2003 was introduced in the Parliament to amend the SCRA to provide for demutualization of stock exchange. Repeal of Capital Issues (Control) Act, 1947 It is believed that a liberalized securities market helps promote economic growth. The more liberalized a securities market is, the better is its impact on economic growth. [14] Interventions in the securities market were originally designed to help governments expropriate much of the seigniorage and control and direct the flow of funds for favoured uses. These helped governments to tap savings on a low or even no-cost basis. Besides government used to allocate funds from the securities market to competing enterprises and decide the terms of allocation. The result was channelisation of resources to favoured uses rather than sound projects. In such circumstances accumulation of capital per se meant little, where rate of return on some investments were negative while extremely remunerative investment opportunities were foregone. This kept the average rate of return from investment lower than it would otherwise have been and, given the cost of savings, the resulting investment was less than optimum. As a part of the liberalization process, the CICA was repealed by an Ordinance on May 29, 1992 paving way for market determined allocation of resources. With this the office of Controller of Capital Issues was abolished and the cost of rationing the resources was saved. The Act earlier required a firm wishing to issue securities to obtain prior approval from the government, which also determined the amount, type and price of the issue. Now the eligible firms comply with the specified requirements and access the market to raise as much resources and at such terms as the market can bear. In the issues made through book building, the investors have freedom to subscribe for the securities at the prices they consider appropriate. SEBI Act, 1992: The SEBI Act, 1992 establishes SEBI with statutory powers for (a) protecting the interests of investors in securities, (b) promoting the development of the securities market, and (c) regulating the securities market. Its 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. [15] 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 [16] and also to penalize them in case of violations of the provisions of the Act, Rules and Regulations made there under. [17] SEBI has full autonomy and authority to regulate and develop an orderly securities market. As observed by the Supreme Court in the words of J. Sinha on behalf of a three judge bench in the case of Swedish Match AB v. SEBI [18] the purpose and objective behind the introduction of SEBI was, Establishment of independent regulatory agencies and need for expert regulations were long felt primarily as a response to the growing complexity in human affairs and trade and business in particular. It was felt that a regulator who was aware of the realities of that field should be ready to regulate that field. Demand for regulators who were not mere Government officials but people who are experts in the field came up. Regulations framed by an expert body like SEBI was felt to be an effective substitute for government regulation. The evolution in respect whereof can be traced back to the Great Depression of 1930s. As a part of the new deal, several expert bodies were established like the Federal Communications Commission and Securities Exchange Commission. In the Indian context, this rationale was invoked for the establishment of an expert body to regulate the securities market after the Securities Scam in 1992. Securities Contracts (Regulation) Act, 1956: It provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and aims to prevent undesirable transactions in securities. It gives central government/SEBI regulatory jurisdiction over (a) stock exchanges through a process of recognition and continued supervision, (b) contracts in securities, and (c) listing of securities on stock exchanges. As a condition of recognition, a stock exchange complies with prescribed conditions of Central Government. Organised trading activity in securities takes place on a specified recognised stock exchange. The stock exchanges determine their own listing regulations which have to conform to the minimum listing criteria set out in the Rules. Depositories Act, 1996: The Depositories Act, 1996 provides for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security by (a) making securities of public limited companies freely transferable subject to certain exceptions; (b) dematerialising the securities in the depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order to streamline the settlement process, the Act envisages transfer of ownership of securities electronically by book entry without making the securities move from person to person. The Act has made the securities of all public limited companies freely transferable, restricting the company’s right to use discretion in effecting the transfer of securities, and the transfer deed and other procedural requirements under the Companies Act have been dispensed with. Companies Act, 1956: It deals with issue, allotment and transfer of securities and various aspects relating to company management. It provides for standard of disclosure in public issues of capital, particularly in the fields of company management and projects, information about other listed companies under the same management, and management perception of risk factors. It also regulates underwriting, the use of premium and discounts on issues, rights and bonus issues, payment of interest and dividends, supply of annual report and other information. [19] A Functional Approach to the Markets Need for a Stock Exchange The Stock Exchange is a key financial institution which plays an important role in the course of the issue and sale of various types of securities. This is an institution and a pivot around which every activity of the national capital markets revolve. It is continuously engaged in the capital mobilization process. The Stock exchange provides opportunity to the fund users for the continuous trading in securities. Through the medium of Stock Exchange, the investors get an impetus and motivation to invest in securities without which they would have had no chance to liquidate their investments or adjust their portfolios. Had there been no institution of stock exchanges many of the savers would have had simply held on to their savings either in cash or in banks. Another consequence of the non-existence of Stock Exchanges would have been lower aggregate savings of the community. The Stock exchange provides safety and liquidity to the investing public and generates a sense to save and put their money in securities instead of investing in small firms whose integrity and competence they would never judge themselves accurately. A stock market is a place where enormous capital is raised, which is generally required to operate the industrial and commercial enterprise of a country. The types of Companies, the concept of listing and the role of Stock Exchange. The word ‘Company’ is an amalgamation of the Latin word ‘Com’ meaning “with or together” and ‘Pains’ meaning “bread”. Originally, it referred to a group of persons who took their meals together. A company is nothing but a group of persons who have come together or who have contributed money for some common person and who have incorporated themselves into a distinct legal entity in the form of a company for that purpose. Under Halsbury’s Laws of England, the term “company” has been defined as a collection of many individuals united into one body under special domination, having perpetual succession under an artificial form and vested by the policies of law with the capacity of acting in several respect as an individual, particularly for taking and granting of property, for contracting obligation and for suing and being sued, for enjoying privileges and immunities in common and exercising a variety of political rights, more or less extensive, according to the design of its institution or the powers upon it, either at the time of its creation or at any subsequent period of its existence [20] . Capital refers to the amount invested in the company so that it can carry on its activities. In a company capital refers to “share capital”. A particular company raises capital by issuing shares to people who on acquiring such shares become members. ‘Shareholder’ has neither been defined in the Act nor in the Regulations; whereas ‘shares’ has been defined to mean shares in the share capital of a company carrying voting rights and includes any security which would entitle the holder to receive shares with voting rights but shall not include preference shares. [21] The capital clause in Memorandum of Association (MA) must state the amount of capital with which company is registered giving details of number of shares and the type of shares of the company. [22] A company cannot issue share capital in excess of the limit specified in the Capital clause without altering the capital clause of the MA. [23] Shares in a company are freely transferable, subject to certain conditions, such that no share-holder is permanently or necessarily wedded to a company. When a member transfers his shares to another person, the transferee steps into the shoes of the transferor and acquires all the rights of the transferor in respect of those shares. Public limited companies can be broadly classified into a listed company and non-listed company. ‘Listed Company’ means a public limited company which is listed on any one or more recognised stock exchange(s) in India and securities (the i.e. shares, debentures etc.) of such company are traded on such stock exchanges. ‘Unlisted Company’, therefore, means a company whose securities are not listed on any of the recognised stock exchanges in India. Some of the advantages of a listed companies are :- securities freely transferable easy liquidity of securities easy availability of prices of securities reputation public awareness more transparency helps in obtaining loans from banks/institutions helps in marketing its products In order to come out with a Public Issue (the i.e. to offer further securities to public) or make an offer for sale of existing securities to the public, the securities of a public limited company must be listed so as to allow its shares to be traded on any recognised stock exchanges. [24] This can be done by issue of Prospectus and complying with all the provisions of Companies Act, 1956, rules & regulations issued by Securities & Exchange Board of India (SEBI) and other concerned authorities from time to time. The functions performed by the Stock exchange on this account. Each Stock Exchange has its own criteria for listing the securities which should also be met. [25] For example, if the company intends to list its securities on The Stock Exchange, Mumbai the post issue capital (the researcher.e. paid up capital after the proposed public issue) of such company should be at least Rs. 10 crores. [26] After the successful completion of the issue, the company finalizes the basis of allotment with the regional stock exchange. If the company has proposed to list its securities with more than one stock exchange, then the basis of allotment should be finalized with the stock exchange which is situated in the state in which registered office of the company is situated (regional stock exchange). The Company enters into a listing agreement with the concerned stock exchanges and on receipt of permission from the concerned stock exchange(s), the company is listed and securities are thereafter traded on such stock exchange(s). Such companies have certain obligations with respect to the stock exchanges where their securities are listed. These obligations have been arrived from the listing agreement which the company enters with each of the stock exchanges. SEBI, through its SEBI (Central Listing Authority) Regulations, 2003 has provided for establishment of a self-regulatory authority – Central Listing Authority (CLA). The functions of CLA will include processing the application made by any body corporate, mutual fund or collective investment scheme for the letter of recommendation for listing; and making recommendations as to listing conditions. The CLA may also perform any other function as may be specified by SEBI from time to time. Transfer of shares Members can sell their shares to any person, either directly or indirectly. This can be done through a duly executed share transfer deed. [27] The shares of the listed companies are traded on stock exchanges on which they are listed. The transactions are done through brokers/sub-brokers who buy/sell the securities on behalf of their clients. On receipt of the share certificates (alongwith the share transfer form), the purchaser has an option either to resell the securities through a broker in the stock market or to send the same to the company for registration of transfer. If he opts to send the share certificates to the company for registration of transfer, he has to sign the share transfer form and fill in such other particulars as prescribed under the form. However the trend has changed and the transfer of shares is no more such a cumbersome task, due to the introduction of Dematerialization of Shares. These procedures are now electronically processed and undertaken by various authorized depositories. [28] Role of Stock exchanges in Capital Markets Stock Market – An indispensable institution View of the Apex Court As observed by a five judge bench , the history of stock exchanges in foreign countries as well as in India shows that the development of joint stock enterprises would have never reached its present stage save for the facilities which the stock exchanges have provided for dealing in securities. They have a very important function to fulfill in the country’s economy. [29] The Supreme Court has also highlighted upon how this function is performed in the following words of J. Shah: “A Stock Exchange fulfils a vital function in the economic development of a nation: its main function is to “liquefy capital by enabling a person who has invested money in say a factory or a railway to convert it into cash by disposing of his share in the enterprise to some one else”. Investment in joint stock companies is attractive to the public, because the value, of the shares is announced day after day in the Stock Exchanges, and the shares quoted on the Exchanges are capable of almost immediate conversion into money. In modern days a company stands little chance of inducing the public to subscribe to its capital, unless its shares are quoted in an approved Stock Exchange. All public companies are anxious to obtain permission from reputed exchanges for securing quotations of their shares and the management of a company is anxious to inform the investing public that the shares of the company will be quoted on the Stock exchange.” [30] Briefly the role that Stock Exchanges perform in the development and functioning of capital markets would be: It provides ready market for securities. It provides liquidity. It ensures easy negotiability. It helps in the distribution of new securities. It helps in Capital formation process. It performs the role of an intermediary performing an informative an educative role for the investors. Economic Growth A well functioning securities market is conducive to sustained economic growth. [31] There have been a number of studies, starting from World Bank and IMF to various scholars [32] , which have established robust relationship not only one way, but also the both ways, between the development in the securities market and the economic growth. As analyzed and put forth by Mercereau [33] the securities market fosters economic growth to the extent that it-(a) augments the quantities of real savings and capital formation from any given level of national income, (b) increases net capital inflow from abroad, (c) raises the productivity of investment by improving allocation of investible funds, and (d) reduces the cost of capital. [34] It is reasonable to expect savings and capital accumulation and formation to respond favorably to developments in securities market. The provision of even simple securities decouples individual acts of saving from those of investment over both time and space and thus allows savings to occur without the need for a concomitant act of investment. If economic units rely entirely on self-finance, investment is constrained in two ways: by the ability and willingness of any unit to save, and by its ability and willingness to invest. The unequal distribution of entrepreneurial talents and risk taking proclivities in any economy means that at one extreme there are some whose investment plans may be frustrated for want of enough savings, while at the other end, there are those who do not need to consume all their incomes but who are too inert to save or too cautious to invest the surplus productively. For the economy as a whole, Bhagwati [35] argues, productive investment may thus fall short of its potential level. In these circumstances, the securities market provides a bridge between ultimate savers and ultimate investors and creates the opportunity to put the savings of the cautious at the disposal of the enterprising, thus promising to raise the total level of investment and hence of growth. The indivisibility or lumpiness of many potentially profitable but large investments reinforces this argument. These are commonly beyond the financing capacity of any single economic unit but may be supported if the investor can gather and combine the savings of many. Moreover, the availability of yield bearing securities makes present consumption more expensive relative to future consumption and, therefore, people might be induced to consume less today. [36] The composition of savings may also change with fewer saving being held in the form of idle money or unproductive durable assets, simply because more divisible and liquid assets are available. International Linkage The securities market facilitates the internationalization of an economy by linking it with the rest of the world. This linkage assists through the inflow of capital in the form of portfolio investment. Moreover, a strong domestic stock market performance forms the basis for well performing domestic corporate to raise capital in the international market. [37] Eatwell, thus argues, that the domestic economy is opened up to international competitive pressures, which help to raise efficiency. It is also very likely that existence of a domestic securities market will deter capital outflow by providing attractive investment opportunities within domestic economy. [38] Any financial development produces allocational improvement over a system of segregated investment opportunities. The benefits of improved investment allocation are such that Eatwell defines economic development as reduction of the great dispersion in social rate of return to existing and new investments under domestic entrepreneurial control. [39] Instead of emphasising scarcity of capital, he focuses on the extra-ordinary distortions commonly found in the domestic securities markets of the developing countries. The distortions in the real sectors such as monopoly power, tariff protection, import quotas, credit rationing add salt to injury. In the face of great discrepancies in rate of return, the accumulation of capital does not contribute much to development. A developed securities market successfully monitors the efficiency with which the existing capital stock is deployed. Contributions to the Financial Sector In as much as the securities market enlarges the financial sector, promoting additional and more sophisticated financing, it increases opportunities for specialisation, division of labour and reductions in costs in financial activities. [40] The securities market and its institutions help the user in many ways to reduce the cost of capital. They provide a convenient market place to which investors and issuers of securities go and thereby avoid the need to search a suitable counterpart. The market provides standardized products and thereby cuts the information costs associated with individual instruments. The market institutions specialize and operate on large scale which cuts costs through the use of tested procedures and routines. [41] There are also other developmental benefits associated with the existence of a securities market. The securities market provides a fast-rate breeding ground for the skills and judgment needed for entrepreneurship, risk bearing, portfolio selection and management. [42] An active securities market serves as an ‘engine’ of general financial development and may, in particular, accelerate the integration of informal financial systems with the institutional financial sector. [43] Securities directly displace traditional assets such as gold and stocks of produce or, indirectly, may provide portfolio assets for unit trusts, pension funds and similar FIs that raise savings from the traditional sector. [44] The existence of securities market enhances the scope, and provides institutional mechanisms, for the operation of monetary and financial policy. [45] Regulation and Liberalization- The Path to Reform Reforms since 1990’s The researcher makes a dhobi list of reforms undertaken since early 1990s. Instead let me discuss only a few major reforms. a. Control over Issue of Capital: As discussed earlier [46] , one of the major initiatives of liberalisation was the repeal of the Capital Issues (Control) Act, 1947 in May 1992. b. Establishment of Regulator: A major initiative of regulation was establishment of a statutory autonomous agency, called SEBI, to provide reassurance that it is safe to undertake transactions in securities. As the researcher discussed at an earlier occcasion [47] the SEBI Act, 1992 introduced a regulator in the lattice of the Capital Markets. c. Screen Based Trading: A major developmental initiative was a nation-wide on-line fully-automated screen based trading system (SBTS) where a member can punch into the computer quantities of securities and the prices at which he likes to transact and the transaction is executed as soon as it finds a matching sale or buy order from a counter party. SBTS electronically matches orders on a strict price/time priority and hence cut down on time, cost and risk of error, as well as on fraud resulting in improved operational efficiency. It allowed faster incorporation of price sensitive information into prevailing prices, thus increasing the informational efficiency of markets. It enabled market participants to see the full market on real-time, making the market transparent. It allowed a large number of participants, irrespective of their geographical locations, to trade with one another simultaneously, improving the depth and liquidity of the market – over 10,000 terminals creating waves by clicks from over 400 towns / cities in India. It provided full anonymity by accepting orders, big or small, from members without revealing their identity, thus providing equal access to everybody. It also provided a perfect audit trail, which helps to resolve disputes by logging in the trade execution process in entirety. The SBTS shifted the trading platform from the trading hall of an exchange to brokers’ premises. It was then shifted to the PCs in the residences of investors through the Internet and to hand-held devices through WAP for convenience of mobile investors. This made a huge difference in terms of equal access to investors in a geographically vast country like India. d. Risk management: A number of measures were taken to manage the risks in the market so that the participants are safe and market integrity is protected. These include: i. Trading Cycle: The trading cycle varied from 14 days for specified securities to 30 days for others and settlement took another fortnight. Often this cycle was not adhered to. This was euphemistically often described as T+ any thing. Many things could happen between entering into a trade and its performance providing incentives for either of the parties to go back on its promise. This had on several occasions led to defaults and risks in settlement. In order to reduce large open positions, the trading cycle was reduced over a period of time to a week initially. Rolling settlement on T+5 basis was introduced in phases. All scrips moved to rolling settlement from December 2001. T+5 gave way to T+3 from April 2002 and T+2 from April 2003. ii. Dematerialization: Settlement system on Indian stock exchanges gave rise to settlement risk due to the time that elapsed before trades are settled. Trades were settled by physical movement of paper. This had two aspects. First, the settlement of trade in stock exchanges by delivery of shares by the seller and payment by the purchaser. The process of physically moving the securities from the seller to the ultimate buyer through the seller’s broker and buyer’s broker took time with the risk of delay somewhere along the chain. The second aspect related to transfer of shares in favour of the purchaser by the company. The system of transfer of ownership was grossly inefficient as every transfer involved physical movement of paper securities to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. In many cases the process of transfer took much longer, and a significant proportion of transactions ended up as bad delivery due to faulty compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities were rampant, and in addition the issuer had the right to refuse the transfer of a security. All this added to costs, and delays in settlement, restricted liquidity and made investor grievance redressal time consuming and at times intractable. To obviate these problems, the Depositories Act, 1996 was passed and as discussed earlier. [48] Currently 99% of market capitalization is dematerialized and 99.9% of trades are settled by delivery. iii. Derivatives: To assist market participants to manage risks better through hedging, speculation and arbitrage, SC(R)A was amended in 1995 to lift the ban on options in securities. The SC(R)A was amended further in December 1999 to expand the definition of securities to include derivatives so that the whole regulatory framework governing trading of securities could apply to trading of derivatives also. A three-decade old ban on forward trading, better known as BADLA, which had lost its relevance and was hindering introduction of derivatives trading, was withdrawn. Derivative trading took off in June 2000 on two exchanges [49] . iv. Settlement Guarantee: A variety of measures were taken to address the risk in the market. Clearing corporations emerged to assume counter party risk. Trade and settlement guarantee funds were set up to guarantee settlement of trades irrespective of default by brokers. These funds provide full novation and work as central counter party. The Exchanges /clearing corporations monitor the positions of the brokers on real time basis. Various measures taken over last decade or so have yielded considerable benefits to the market, as evidenced by the growth in number of market participants, growth in volumes in securities transactions, increasing globalization of the Indian market, reduction in transaction costs, and compliance with international standards. In terms of number of trades, NSE is the third largest exchange in the world. The researcher is not going in to these details, as my objective is not to boost our performance here except to quote from the Economic Intelligence Unit 2003 study: “Top of the Country class, as might be expected is Singapore followed by Hongkong and, somewhat surprisingly, India where overall disclosure standards have improved dramatically, accounting differences between local and US standards have been minimized and the number of companies with a majority of independent directors has risen significantly.” Corporatisation and Demutualisation of a stock exchange The Finance Minister, during his Budget Speech for the year 2002-03, had mentioned that corporatisation of stock exchanges would be completed during the year to implement the Government’s proposal to segregate ownership, management and operation of stock exchanges. [50] Corporatisation and Demutualisation of a stock exchange is essentially a conversion from a not for profit entity to a for-profit company. The company so constituted may be a listed or an unlisted closely held public company. [51] Demutualisation involves the segregation of members’ rights into distinct segments of ownership rights and trading rights. The relationship between members and the stock exchange is altered with members retaining their trading rights and acquiring ownership rights in the stock exchange. These ownership rights have a market value and the benefits of limited liability. Professional management, availability of capital through public/ private issues and management accountability are some of the benefits of demutualisation. [52] SEBI constituted the Group on Corporatisation and Demutualisation of Stock Exchanges (‘the Group’) in order to review and examine the present structure of stock exchanges. Examine the various legal, accounting and tax issues associated with the corporatisation of stock exchanges. Recommend specific steps that need to be taken for implementation of the above. Advise on the consolidation and merger of stock exchanges. The Group submitted its report on 28 August 2002 and made the following salient observations and recommendations: Stock Exchanges are converted to companies limited by shares from associations of persons/ companies limited by guarantee. Amendments are made to the Income-tax Act, 1961, so that past accumulated profits of the stock exchanges are not subject to tax. Amendments would also be required in the Indian Stamp Act, 1899, and Sales Tax Laws to allow a tax-free transfer of assets from the old entity to the demutualised new entity. The current system of permission to trade on the basis of ownership of a trading card is replaced by a system where money is deposited to obtain trading rights. Shareholders, brokers and the investing public are equally represented on the governing board of the demutualised exchange. A uniform model for corporatisation and demutualisation would have to be adopted by all stock exchanges. The merger of stock exchanges is a commercial decision that would be left to the stock exchanges. The Group is of the view that the corporatisation and demutualization of stock exchanges would help the consolidation of stock exchanges. If the recommendations of the Group are adopted and suitable legislative changes are carried out to implement the recommendations, the stock exchanges will be required to submit a scheme of demutualisation to SEBI by an appointed date. Non-compliance in this regard would result in temporary or permanent lapse of recognition granted to an existing stock exchange. To put these recommendations into effect the Securities Laws (Amendment) Bill, 2003 was introduced in the Parliament to amend the SCRA to provide for Corporatisation and Demutualization of stock exchange.

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