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Essay on Secondary Market
Essay Contents:
- Essay on the Introduction to Secondary Market
- Essay on the Exchange Management of Secondary Market
- Essay on the Membership of Secondary Market
- Essay on the Listing of Securities in Secondary Market
- Essay on Buy Back of Shares in Secondary Market
- Essay on the Delisting of Securities in Secondary Market
- Essay on the Trading Mechanism of Secondary Market
- Essay on the Clearing and Settlement of Securities in Secondary Market
Essay # 1. Introduction to Secondary Market:
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The stock exchanges, recognized under the Securities Contract Regulation Act are the exclusive centres for trading securities. Though the area of operation/jurisdiction of an exchange was being specified at the time of its recognition, they have been allowed recently to set up trading terminals anywhere in the country.
The three newly setup exchanges (OCTEI, NSE and ICSE) were permitted since their inception to have nationwide trading, the trading platforms of a few exchanges are now accessible from many locations. Further, with extensive use of information technology, the trading platforms of a few exchanges are also accessible from anywhere through the Internet and mobile devices.
Till recently, the brokers of an exchange were allowed to trade among themselves. By a recent amendment to the Securities Contract Regulation Act they have been allowed to trade with the brokers of other stock exchanges also. With this amendment it will be possible for trades to be executed on BSE between a broker of Jaipur exchange and a broker of Chennai Exchange.
Essay # 2.
Exchange Management of Secondary Market:
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Only three exchanges (Mumbai, Ahmedabad and Madhya Pradesh) are organised in the form of “Association of Persons”, while the remaining are organized as companies, either limited by guarantee or by shares. Except National Stock Exchange (NSE), all other exchanges, whether corporates or association of persons, are not-for-profit organizations.
Most of the stock exchanges in the country are organised as “mutuals” which was considered beneficial in terms of tax benefits and matters of compliance. The trading members, who provide brokering services, also own, control and manage the exchanges.
This is not an effective model for self-regulatory organisations as the regulatory and public interest of the exchange conflicts with private interest. In contrast, in a demutualised exchange, the ownership and management and trading membership are segregated and vested with different sets of persons.
This model eliminates conflicts of interest and helps the exchange to pursue market efficiency and investor interest aggressively. On realising the limitations of mutual structure and discovering the advantages of demutual structure, the authorities and exchanges are working to demutualise all the non-demutualised exchanges.
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The exchanges (except two exchanges NSE and OCTEI which are already demutualised) have been mandated by the Securities Laws (Amendment) Act, 2004 to demutualise and corporatise themselves by an appointed date.
Essay # 3.
Membership of Secondary Market:
The trading platform of an exchange is accessible only to brokers. They execute trades on exchanges either on their own account or on behalf of their clients. Demutualised exchanges allow free entry and exit of brokers, while others have limitations on the number of brokers.
The standards for admission of members lay emphasis on factors such as corporate structure, capital adequacy, track record, education, experience etc., and reflect a conscious endeavour to ensure quality broking services.
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No stockbroker is allowed to buy, sell or deal in securities, unless he or she holds a certificate of registration granted by SEBI. A broker/sub-broker complies with the code of conduct prescribed by SEBI. Over time, number of brokers’ proprietor firms and partnership firms have converted themselves into corporate. Out of 9,339 brokers registered with SEBI at the end of March 2006, 3787 brokers, accounting for nearly 40.4% of the total, were corporate entities.
At the end of March 2006, there were 23,479 sub-brokers registered with SEBI. The small exchanges have floated subsidiaries, which have trading membership on bigger exchanges, and about 2600 brokers of small exchanges trade as sub-brokers through these subsidiaries. During 2003-04 they accounted for about 7% of the cash market turnover on exchanges.
Essay # 4.
Listing of Securities in Secondary Market:
A company seeking listing satisfies the exchange that at least 10 percent of the securities, subject to a minimum of 20 lakh securities, were offered to the public for subscription, the size of the net offer to the public (i.e., the offer price multiplied by the number of securities offered to the public, excluding reservations, firm allotment and promoters’ contribution) was not less than Rs. 100 crore and the issue is made only through book building method with allocation of 60% of the issue size to the qualified institutional buyers.
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Otherwise, it is required to offer at least 25% of the securities to the public. The company is also required to maintain the minimum level of non-promoter holding on a continuous basis.
Before making an application for listing to any stock exchange, a corporate body, Mutual Fund or Collective Investment Scheme, is required to obtain a letter of recommendation for listing from the Central Listing Authority. The basic norms for listing of securities on stock exchanges are uniform for all exchanges.
These norms are specified in the listing agreement entered between the company and the exchange concerned. The listing agreement prescribes a number of requirements to be continuously complied with by the issuers for continued listing and such compliance is monitored by the exchanges.
It also stipulates the disclosures to be made by the companies and the corporate governance practices to be followed by them. SEBI has been issuing guidelines/circulars prescribing certain norms to be included in the listing agreement and to be complied with by the companies.
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A listed security is available for trading on the exchange. 9,359 securities were listed on exchanges at the end of March 2004. A security listed on other exchanges is also permitted for trading. The stock exchanges levy listing fees i.e., initial fees and annual fees from the listed companies.
It had been a major source of income for many exchanges till recently. With the withdrawal of requirement of listing on regional exchanges, liberalisation of delisting, and virtually no trades on exchanges, no new company is seeking listing on regional exchanges and the existing companies too are getting delisted.
Essay # 5.
Buy Back of Shares in Secondary Market:
Shares bought back by a company from its shareholders is termed as buy back of shares. The main objectives of buy back of shares are to improve liquidity, enhance shareholders’ wealth, increase promoters holding, increase earnings per share, rationalise the capital structure by writing off capital not represented by available assets, support share value, to thwart takeover bid to pay surplus cash not required by business. In pursuance of the amendments in the company law regulations in 1998, Securities Exchange Board of India [SEBI], has formulated buy-back regulations for listed companies.
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Under this law, a company is permitted to buy back its shares:
(a) From the existing shareholders on a proportionate basis through the tender offer i.e., by means of offer document,
(b) From open market through stock exchanges, and book building process, and
(c) From shareholders holding odd lot shares.
Essay # 6.
Delisting of Securities in Secondary Market:
According to Delisting guidelines, a listed company can voluntarily delist its securities from stock exchange after providing an exit opportunity to holders of securities at a price determined through reverse book building. An exit opportunity is not necessary, if the security remains listed on an exchange having nationwide trading terminals.
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According to the recent amendment in the Securities Contract Regulation Act, a stock exchange may delist securities on any of the grounds as may be prescribed in the rules, after giving the company concerned an opportunity of hearing.
Essay # 7.
Trading Mechanism of Secondary Market:
The secondary market overcame the geographical barriers by moving to screen based trading. The trading terminals is now accessed through 10,000 trading terminals spread across more than 400 cities and towns in the Indian sub-continent and also through the Internet and hand held mobile devices from all over the world.
The exchanges provide a fully automated on-line 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 order from a counter party.
SBTS electronically match orders on a strict price/time priority and hence cuts down on time, cost, risk of error, as well as on fraud thereby resulting in improved operational efficiency. It allows faster incorporation of price sensitive information into prevailing prices, thus increasing the informational efficiency of markets.
It enables market participants to see the full market on real time basis, making the market transparent. It allows a large number of participants, irrespective of their geographical locations, to trade with one another simultaneously, improving the depth and liquidity of the market.
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It provides full anonymity, by accepting orders, big or small from members without revealing their identity, thus providing equal access to everybody. Trading platform is also accessible to an investor through the Internet and mobile devices such as WAP. It also provides a perfect audit trail, which helps to resolve disputes by logging in the trade execution process in entirety.
Insider Trading:
Insider trading means dealing in securities of a company by insiders which includes Directors, Officers and Employees of the Company who are connected with the Company and/or reasonably expected to have access to Unpublished Price Sensitive Information (UPSI) in respect of securities of the Company or who had access to such UPSI.
Such dealings by Insiders erode the investors’ confidence in the fairness and integrity of the management. Rampant insider trading deters investment from capital market which in turn affects growth of economy.
The Securities and Exchange Board of India (SEBI), as part of its efforts to protect the interests of investors in general, had issued the SEBI (Insider Trading) Regulations, 1992 under the powers conferred on it by the SEBI Act 1992. Applicable to all listed companies, these Regulations came into force with effect from 19th November 1992.
Under the Regulations, it is mandatory for every listed company/entity to adopt a Code of Conduct for Prevention of Insider Trading, for its Directors, Officers and Employees in terms of Schedule I to the Regulations. The Directors, officers and employees of the Company owe a fiduciary duty to all the stakeholders of the Company.
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The interests of such stakeholders have to be placed above the interests of the said Directors, officers and employees. In view of this, this Code lays down that these persons shall deal in the securities of the Company in a manner that does not create any conflict of interest.
Price Bands:
Stock market volatility is generally a cause of concern for both policy makers as well as investors. To curb excessive volatility, SEBI has prescribed a market wide circuit breaker system which brings about coordinated trading halt in all equity and equity derivatives markets nationwide, when the index moves either way by 10%, 15% and 20%.
The movement of either Standard & Poor CNX Nifty or Sensex, whichever is breached earlier, triggers the trading halt. As an additional measure of safety, exchanges have imposed individual scrip wise price bands as high as 20% in some securities. However, in respect of securities for which derivative products are available, a daily price limit of 10% is applicable.
Demat Trading:
Dematerialization has been introduced. “Demat” is a process whereby securities like shares, debentures etc., are converted into electronic data and stored in Computers by a Depository. The securities on Dematerialization appear as balances in depository account. These balances are transferable like physical shares.
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Depository functions like a securities bank, where the dematerialized physical securities are traded and held in custody. This facilitates faster, risk free and low cost settlement. Depository is much like a bank and performs many activities that are similar to a bank. At present there are two depositories in India, National Securities Depository Ltd. (NSDL) and Central Depository Services Limited (CDSL).
NSDL carries out its activities through various functionaries called business partners who include Depository Participants (DPs), Issuing corporates and their Registrars and Transfer Agents, Clearing corporations/Clearing Houses etc. NSDL is electronically linked to each of these business partners via a satellite link through Very Small Aperture Terminals (VSATs).
The entire integrated system (including the VSAT linkups and the software at NSDL and each business partner’s end) has been named as the “NEST” [National Electronic Settlement & Transfer] system. The investor interacts with the depository through a depository participant of NSDL. A DP can be a bank, financial institution, a custodian or a broker.
Transacting the depository way has several advantages over the traditional system of transacting using share certificates. Some of the benefits are – Trading in Demat segment completely eliminates the risk of bad deliveries, which in turn eliminates all cost and wastage of time associated with follow up for rectification.
This reduction in risk associated with bad delivery has led to reduction in brokerage to the extent of 0.5% by quite a few brokerage firms. In case of transfer of electronic shares, there is no stamp duty and one also avoid the cost of courier/notarization/the need for further follow-up with the broker for shares returned due to company objection.
The problems associated with certificates lost in transit or share certificates become mutilated or misplaced, are completely eliminated in the demat form. The investor can also receive his bonuses and rights into his depository account as a direct credit, thus eliminating risk of loss in transit.
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Banks charge a lower interest charge for loans taken against demat shares as compared to the interest for loan against physical shares. RBI has increased the limit of loans against dematerialized securities as collateral to Rs.2 million per borrower as against Rs. 1 million per borrower in case of loans against physical securities.
RBI has also reduced the minimum margin to 25% for loans against dematerialized securities as against 50% for loans against physical securities. The speed of transaction is very fast. The clients can now do their transactions on the Internet also.
The depositories operate under the Depositories Act, 1996 and SEBI (Depositories and Participants Regulations) 1996. The admission to a depository for dematerialisation of securities has been made a prerequisite for making a public or rights issue or an offer for sale. It has also been made compulsory for public listed companies making IPO of any security for Rs. 10 crore or more to do the same only in dematerialised form. All new IPOs are compulsorily traded in demat form.
Charges Levied:
The investors directly or indirectly pay different kinds of charges for securities transactions. These are ultimately paid to the Exchanges, Depositories, SEBI, State and Central Government. The brokers are required to pay service tax at the rate of 10 percent on their brokerage income.
Registration Fee:
A stock broker in cash segment is required to pay to SEBI a registration fee of Rs. 5,000 for every financial year, if his annual turnover does not exceed Rs.1 crore. If the turnover exceeds Rs.1 crore during the financial year he has to pay Rs. 5,000 plus 0.001 percent of the turnover in excess of 1 crore.
After the expiry of five years from the date of initial registration as a broker, he has to pay Rs. 5,000 for a block of five financial years. A sub-broker is similarly required to pay Rs. 1,000 per year for the initial five years and Rs. 500 per year for subsequent years. A broker in derivative segment is required to pay Rs. 10,000 per year plus 10 paise for Rs. 1,00,000 of turnover in excess of Rs. 500 crore. A clearing member on the derivative segment pays a fee of Rs. 25,000 per year.
Transaction Charges:
Besides, the exchanges collect transaction charges from its trading members NSE levies a transaction charge of Rs. 4 per 1 lakh turnover to cash segment. It levies a transaction charge at the rate of 5 paise per Rs lakh of turnover for trades upto Rs. 25,000 crore and at the rate of 2 paise per Rs. 1 per lakh of turnover for trades in excess of Rs. 25 000 crore on Wholesale Debt Market (WDM) segment.
It levies a transaction charge of Rs. 2 per lakh of turnover in derivative segment let a minimum of Rs. 1 lakh per year. No separate charge is levied for trading and for clearing and settlement.
However in case of transactions in government securities, which are settled through Clearing Corporation of India Limited (CCIL), CCIL charges fees a different rates for different kinds of transactions. For settlement of outright trades in government securities, each counter party pays to CCIL a sum of Rs. 150 per crore of face value, subject to a minimum of Rs. 25 and a maximum of Rs. 5.00 per trade.
Brokerage Charges:
The maximum brokerage a trading member can levy an investor in respect of securities transactions is 2.5% of contract price, exclusive of statutory levies like SEBI fee, service tax and stamp duty. The maximum brokerage is inclusive of the brokerage charged by the sub-broker, which shall not exceed 1.5% of the contract price. However, brokerage as low as 0.15% is also observed in the market.
Stamp Duty:
Stamp duties are payable as per the rates prescribed, by, the relevant state, in Maharashtra, it is charged at the rate of Re. 1 for every Rs10,000 or part thereof (i.e., 0.001%) of the value of security at the time of its purchase/sale as the case may be. However, if the securities are not delivered, it is levied at the rate of 20 paise for every Rs. 10,000 or part thereof (0.002%).
The depositories provide depository services to investors through depository participants. They do not charge the investors directly, but charge their DPs who are free to have their own fee structure for their client. By a recent SEBI directive, the account opening charges, custody charges and the charges on credit of securities have been waived.
A depository is required to pay a registration fee of Rs. 25,00,000 and an annual fee of Rs. 10,00,000 to SEBI, while a DP is required to pay a registration fee of Rs. 1,00,000 and an annual fee of Rs. 1,000.
Securities Transaction Tax:
The Finance Act 2004 brought a new tax regime for capital market transactions. Securities Transaction Tax (STT) was introduced for the first time. Income tax on long term capital gain on securities transactions attracting STT has been abolished and tax on short term capital gain on such transactions has been brought down to 10%.
Transactions by investors in specified securities (equity shares, units of equity-oriented funds and derivatives) have been subjected to a securities transaction tax at a prescribed rate on the value of transaction. The securities transaction tax has come into effect from 1st of October 2004. The responsibility for collection and payment of securities transaction tax has been entrusted to the principal officer or managing director of the exchange or the trustee/persons managing affairs of the mutual fund, as the case may be.
Essay # 8.
Clearing and Settlement of Securities in Secondary Market:
All kinds of securities, debt and equity, government and corporate are traded on exchanges side by side. Trades enjoy counter-party guarantee. The trading cycle shortened to a day and trades are settled within 2 working days, while all deferral products were banned. It is the first major market to have implemented T+2 rolling settlement.
Physical security certificates almost disappeared. The settlement complies with the Committee on Payment and Settlement Systems and International Organisation of Securities Commissions (CPSS-IOSCO) recommendations and the Group of Thirty’s (often abbreviated to G30, an international body of leading financiers and academics which aims to deepen understanding of economic and financial issues) recommendations in letter and spirit.
The trades accumulate over a trading cycle of one day and at the end of the day, these are clubbed together, and positions are netted and payment of cash and delivery of securities settle the balance after two working days. All trades executed on day ‘T’ are settled on T+2 day.
Trades are executed on screen and matched details are linked to settlement system electronically, and hence matching and confirmation of trades for direct participants are instantaneous. All communications relating to securities settlement is fully electronic and automated.
For instance, the clearing agency downloads the obligations and pay-in advices of funds/securities to members electronically through secured networks. It also sends electronic advice to clearing banks and depositories to debit the members’ accounts to the extent of their obligations.
The banks and the depositories debit accounts of members and credit the account of the clearing agency electronically. The reverse happens when the funds/securities are paid out to members. The exchange is connected electronically to the clearing and settlement agency, which in turn is connected electronically to clearing banks, depositories, custodians and members.
The depositories have electronic communication with depository participants, clearing agency, custodians, clients and exchanges. Most of these electronic communications are interactive.
Except at the stage of entering orders into trading system, no data is entered manually or electronically in the entire value chain. No fresh inputting of data takes place at any stage. Data flows seamlessly among the entities viz. from exchanges to clearing agency and from clearing agency to clearing banks, depository, members and custodians.
Once a trade is executed, it has to be settled. There is no way that it can be cancelled. The clearing corporations/houses have been allowed to borrow and settle the trades on behalf of the brokers who fail to deliver securities. Though the largest exchange uses the services of a clearing corporation to clear and settle the trades, all exchanges are being required to transfer these functions to a clearing corporation.
Risk Management:
To pre-empt market failures and protect investors, the regulator/exchanges have developed a comprehensive risk management system, which is constantly monitored and upgraded. It encompasses capital adequacy of members, adequate margin requirements, limits on exposure and turnover, indemnity insurance, on-line position monitoring and automatic disablement, etc.
They also administer an efficient market surveillance system to curb excessive volatility and to detect and prevent price manipulations. Exchanges have set up trade/settlement guarantee funds for meeting shortages arising out of nonfulfillment /partial fulfillment of funds obligations by the members in a settlement. A clearing corporation assumes the counterparty risk of each member and guarantees financial settlement in respect of trades executed on NSE.
Derivatives Market:
Only two exchanges, namely the NSE and BSE, offer a platform for trading in derivatives of securities. 99.5% market of share of derivatives trading is with NSE. The derivatives trading system at NSE provides fully automated screen-based trading for Nifty futures and options, stock futures and options and interest rate derivatives on a nationwide basis as well as an online monitoring and surveillance mechanism.
It supports an anonymous order driven market which operates on a strict price/time priority. It provides tremendous flexibility to users in terms of kinds of orders that can be placed on the system. A variety of derivatives were permitted. Corporate governance practices improved significantly.