CAPITAL, COMMODITY AND MONEY MARKET
Content
STUDY MATERIAL
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY
AND
MONEY MARKET
MODULE 3
ELECTIVE PAPER 9.2
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i
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ii
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
Efficient financial systems are indispensable for speedy economic development. The financial system of a
country is a conglomeration of sub market, viz. capital, commodity and money market. The flow of funds in these
markets is multi directional depending upon liquidity, risk profile, yield pattern, interest rate differential or arbitrage
opportunities, regulatory restrictions etc. As the Indian economy gets integrated with the global economy
empowered by increasingly sophisticated information and technology systems, there is an acute need for trained
professionals to entrust important roles in all the spheres of the financial market activity. This study material has
been designed to provide expert knowledge and understanding of various capital market instruments, commodity
market products, money market instruments, key features and participants in these markets, raising capital in
international market by companies etc.
This study material has been published to aid the students in preparing for the Capital, Commodity and Money
Market paper of the CS Professional Programme. It is part of the educational kit and takes the students step by
step through each phase of preparation stressing key concepts, pointers and procedures.
Company Secretaryship being a professional course, the examination standards are set very high, with emphasis
on knowledge of concepts, applications, procedures, for which sole reliance on the contents of this study material
may not be enough. Besides, as per the Company Secretaries Regulations, 1982, students are expected to be
conversant with the amendments to the laws made upto six months preceding the date of examination. The
material may, therefore, be regarded as the basic material and must be read alongwith the original Bare Acts,
Rules, Regulations, Academic Guidance etc. This study has been updated upto June 30, 2013.
The subject of Capital, Commodity and Money Market is inherently complicated and is subject to constant
refinement through, rules and regulations made thereunder. It is, therefore becomes necessary for every student
to constantly update himself with the various legislative changes made from time to time by referring to the
Institute’s journal ‘Chartered Secretary’ as well as other professional journals. In the event of any doubt, students
may write to the Directorate of Academics and Perspective Planning of the Institute for clarification at
[email protected] and [email protected].
Although care has been taken in publishing this study material yet the possibility of errors, omissions and/or
discrepancies cannot be ruled out. This publication is released with an understanding that the Institute shall not
be responsible for any errors, omissions and/or discrepancies or any action taken in that behalf.
Should there be any discrepancy, error or omission noted in the study material, the Institute shall be obliged if
the same is brought to its notice.
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SYLLABUS
ELECTIVE PAPER 2: CAPITAL, COMMODITY & MONEY MARKET (100 Marks)
Level of Knowledge: Expert Knowledge
Objective: To acquire specialized knowledge of Capital, Commodity and Money Market
Detailed Contents:
1. Economic Framework
– Basic structure of Flow of funds in the economy;
– Capital Markets its Role in Capital formation, Functions of Liquidity, , Resource Allocation and Transaction
Cost-reduction
2. Legal Framework
– Ministry of Finance (Capital Markets Division,Department of Economic Affairs)
– Ministry of Corporate Affairs
– Companies Act, 1956
– SEBI Act, 1992
– Securities Contracts (Regulation) Act, 1956 (SCRA)
– Depositories Act, 1996
– SEBI Regulations and Guidelines– An Overview, SEBI (Prohibition of Insider Trdaing) Regulations,
1992, SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 (SAST)
– Prevention of Money Laundering Act, 2002
– Grievance Redressal Mechanism: Stock Exchange (Investor Protection Fund), SEBI, Securities
Appellate Tribunal (SAT), Supreme Court
– Enforcement: Economic Offences Wing, Financial Intelligence Unit, Central Bureau of Investigation,
Financial Action Task Force (FATF)
3. Financial Intermediaries Framework
– Framework of Market Infrastructure Institutions (MII), Stock Exchanges Clearing Corporations,
Custodians,
– Depositories, Depository Participants, Registrars and Transfer Agents (RTA), Bankers to issue
– Merchant Bankers, Underwriters, , Investment Advisors, Portfolio Managers, Self Certified Syndicate
Banks,
– Brokers, Sub-brokers, Market-makers
– Credit Rating Agencies
4. Primary Markets
– IPO, FPO, Offer for Sale, Private Placement, Preferential Allotment, Institutional Placement Procedures
(IPP), Qualified Institutional Placement (QIP), Rights Issue, Bonus Issue
iv
– Prospectus, DRHP, Shelf Prospectus, Red Herring prospectus
– Private Investment in Public Equity (PIPE)
– SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009
– Lead Manager (Pre & Post Issue Activities)
– Due Diligence Review
– Underwriting obligations
– Basis of Allotment
– Book-building
– Pre-issue and Post-issue activities,
– Green-shoe Option
– Pre-listing and Post-listing activities, Listing Agreement
5. Secondary Markets
– Opening day (listing)
– Continuing compliance obligations and disclosures: Post-listing activities, Corporate Actions
– Requirements for Continuing Listing
– Corporate Governance Norms
– Disclosures as per Listing Agreement: Price Sensitive Information, Material Changes, Quarterly results
– Functioning of an Exchange: Margining, Trading, Clearing and Settlement, Trade Guarantee Fund,
Trading Software, Arbitration Mechanism
– Stock Market Indices
6. Capital Market Investment Institutions
– Domestic Financial Institutions (DFI) , Qualified Institutional Buyers (QIB), Foreign Institutional Investors
(FII) , Private Equity (PE), Angel Funds, HNIs, Venture Capital (VC), Qualified Foreign Investors (QFI),
Mutual Funds, Alternative Investment Funds (AIF), Hedge Funds, Pension Funds
7. Capital Market Instruments
– Equities
– Preference Shares, Shares with Differential Voting Rights (DVR)
– Corporate Debt :Non Convertible Debentures (NCD), Partly-and Fully-Convertible Debentures (PCD,
FCD)
– NCDs with or without Call and Put Features
– Bonds, Foreign Currency Convertible Bonds (FCCB)
– Indian Depository Receipts (IDR)
– Derivatives: Single Stock Futures, Single Stock Options, Index futures (SENSEX, NIFTY), Index Options,
Interest Rate Futures, Currency futures
– Exchange Traded Funds (ETF)
– Warrants
v
8. Resource Mobilization through International Markets
– Global Depository Receipt (GDR)
– American Depository Receipt (ADR)
– Listing on the London Alternative Investment Market (AIM), NASDAQ, NYSE
9. Landmark Studies and Report of Committees on Capital Markets
10. Economics of Commodities Marketing
(a) Economic Rationale for Commodities Trading Place and store value
(b) Perishables and non-perishables
(c) Tangibles and Intangibles (Weather , Freight)
(d) How resources can be optimized through price hedges
11. Commodities Market Operations
– Origin of Commodity Market in India
– Products, Participants and Functions
– Evolution of Commodity Exchanges; Regulatory Framework
– Structure Of Commodity exchanges, membership, Risk Management, Clearing and Settlement System,
Commodities Traded on Stock Exchanges Platform-NCDEX, MCX SX
– Instruments available for Trading
– Using commodity exchanges for Hedging, Speculation and Arbitrage
12. Introduction to Money Market
– Nature & Deployment of Surplus Funds and Raising of Short-term funds, Characteristics of Money
Market
– Regulatory framework of RBI, FIMMDA (Fixed Income, Money Market and Derivatives Association)
and Foreign Exchange Dealers Association of India (FEDAI) Call Money Market-Players, Utility, Money
market Instruments: Commercial Paper, Certificates of Deposits, Bills of Exchange, Treasury Bills (TBills), Bill Discounting, Factoring, Letter of Credit, Money Market Mutual Funds, Fixed Maturity Plans
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LIST OF RECOMMENDED BOOKS
MODULE 3
PAPER 9.2 : CAPITAL, COMMODITY AND MONEY MARKET
The students may refer to the given books and websites for further knowledge and study of the subject :
READINGS
1. M.Y. Khan
: Indian Financial Systems; Tata McGraw Hill, 4/12, Asaf Ali Road, New Delhi
110 002.
2. Taxmann
: SEBI Manual
3. Shashi K Gupta
Neeti Gupta
Nishja Aggarwal
: Financial Institutions and Markets ; Kalyani Publishers, 4863/2B, Bharat Ram
Road, 24, Daryaganj, New Delhi -110002
4. Indian Institute of
Banking & Finance
: Securities Markets and Products; Taxmann Publications (P) Ltd., 21/35, West
Punjabi Bagh, New delhi-110026
5. Dr. S Gurusamy
: Capital Markets, Tata McGraw Hill Education Private Limited, 7 West Patel
Nagar, New Delhi-110008
6. Niti Nandini
Chatnani
: Commodity Markets, Tata McGraw Hill Education Private Limited, 7 West
Patel Nagar, New Delhi-110008
7. Bharat Kulkarni
: Commodity Markets and Derivatives, Excel Books, A-45, Naraina, Phase I,
New Delhi-1100028
REFERENCES
Website :
www.sebi.gov.in
www.nse-india.com
www.bseindia.com
www.rbi.org.in
www.mca.gov.in
www.iica.in
www.corporateprofessionals.com
JOURNALS
1. SEBI and
Corporate Laws
: Taxmann, 59/32, New Rohtak Road, New Delhi-110 005.
2. Corporate Law
Adviser
: Corporate Law Adviser, Post Bag No. 3, Vasant Vihar, New
Delhi-110052.
vii
3. SEBI Monthly Bulletin
SEBI Annual Report
4. NSE News
: SEBI, Mumbai.
: National Stock Exchange of India Ltd., Mahindra Towers, Worli, Mumbai400018.
Note : Students are advised to read relevant Bare Acts and Rules and Regulations relating thereto. ‘Student
Company Secretary’ and ‘Chartered Secretary’ should also be read regularly for updating the knowledge.
viii
ARRANGEMENT OF STUDY LESSONS
Study Lesson No.
Topic
1.
Economic Framework of Capital Market
2.
Legal Framework
3.
Framework of Market Infrastructure Institutions
4.
Financial Intermediaries Framework
5.
Primary Market
6.
Secondary Market
7.
Capital Market Investment Institutions
8.
Capital Market Instruments
9.
Resource Mobilization through International Markets
10.
Economics of Commodities Marketing
11.
Commodities Market Operations
12.
Money Market
13.
Insider Trading
14.
Substantial Acquisition of Shares and Takeovers
REPORT OF THE COMMITTEES ON CAPITAL MARKET
TEST PAPERS
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CONTENTS
CAPITAL, COMMODITY AND MONEY MARKET
LESSON 1
ECONOMIC FRAMEWORK OF CAPITAL MARKET
Introduction
2
Constitutents Of The Financial System
2
Financial Assets
2
Financial Intermediaries
3
Financial Markets
3
Capital Market
5
Primary Market
6
Secondary Market
6
Functions of Capital Market
8
Role of Capital Market in Resource Allocation
9
Capital Formation
10
Stages of Capital Formation
10
Role of Capital Market in capital Formation
11
LESSON SUMMARY
12
SELF TEST QUESTIONS
13
LESSON 2
LEGAL FRAMEWORK
Introduction
16
Department of Economic Affairs (DEA)
16
Capital Market Division
17
Ministry of Corporate Affairs
18
Company Law Board
18
Reserve Bank of India
19
Securities and Exchange Board of India (SEBI)
19
Legislations
20
Grievance Redressal Mechanism
20
Grievance Rederessal Mechanism at Stock Exchange
20
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Investor Protection Fund
21
Grievance Rederessal Mechanism at SEBI
21
Investor Protection and Education Fund
21
Securities Appellate Tribunal
22
Prevention of Money Laundering Act, 2002
23
Investigating Agencies in case of PMLA, 2002
27
LESSON ROUND UP
31
SELF TEST QUESTIONS
32
LESSON 3
FRAMEWORK OF MARKET INFRASTRUCTURE INSTITUTIONS
Introduction
36
Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012
36
The Depositories Act, 1996
41
Enquiry and Inspection
43
Penalty
44
Offences
47
Special Court
48
Appeals
49
Securities Contracts (Regulation) Act, 1956
51
LESSON ROUND UP
56
SELF TEST QUESTION
57
LESSON 4
FINANCIAL INTERMEDIARIES FRAMEWORK
Introduction
60
Primary market intermediaries
60
Merchant Banker
60
SEBI (Merchant Bankers) Regulations, 1992
60
Registrars to an Issue and Share Transfer Agents
66
SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993
66
Code of Conduct
67
Underwriters
70
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Page
SEBI (Underwriters) Regulations, 1993
70
Banker to an Issue
72
SEBI (Banker to an Issue) Regulation, 1994
72
Code of Conduct
74
Debenture Trustees
74
SEBI (Debenture Trustees) Regulations, 1993
75
Secondary market intermediaries
78
Stock Brokers and Sub-broker
79
SEBI (Stock Brokers & Sub-Brokers) Regulations, 1992
79
A Case Study on Fraudulent dealings
87
Portfolio manager
89
SEBI (Portfolio Managers) Regulations, 1993
89
Internal Audit of Portfolio Manager
98
Custodian of securities
98
SEBI (Custodian of Securities) Regulations, 1996
98
Foreign Institutional Investor
104
SEBI (Foreign Institutional Investors) Regulations, 1995
104
Qualified Foreign Investors (QFIs)
111
SEBI (Investment Advisers) Regulations, 2013
112
SEBI (Credit Rating Agencies) Regulations, 1999
116
Market Maker
123
Guidelines for Market Maker
123
SEBI (Depositories and Participants) Regulations, 1996
125
Governance of Depository
126
Audit under SEBI (Depositories and Participants) Regulations, 1996
127
Internal Audit of Operations of Depository Participants
127
Concurrent Audit
128
Qualified Depository Paticipants
128
LESSON ROUND UP
130
SELF TEST QUESTIONS
131
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Page
LESSON 5
PRIMARY MARKET
Introduction
134
Types of Issue
134
Offer for Sale
135
OFS Process
135
Difference between Offer for Sale (OFS) process and IPOs/FPOs
136
SEBI Guidelines on Offer for Sale (OFS) of shares by promoters through the Stock Exchange Mechanism
136
Understanding the Guideline Step wise
140
Different form of Prospectus
141
Filing of Offer Document
142
Lead Manager
142
Underwriting
144
Due Diligence
145
Due Diligence in IPO/FPO
145
Basis of Allotment
150
Book Building
151
Additional Disclosures in Case of Book Building
157
Green Shoe Option Facility
159
Illustration
161
Pre-Issue Activities
162
Rights Issue
164
Bonus Issue
167
Preferential Issue
170
Qualified Institutions Placement
174
Institutional Placement Programme
177
Listing Agreement
179
Event based and time based Compliances under Listing Agreement
180
LESSON ROUND UP
185
SELF TEST QUESTIONS
186
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Page
LESSON 6
SECONDARY MARKET
Introduction
190
Corporate Actions
190
Requirement under Listing Agreement for corporate action
190
Continuous Listing
190
Material Events under Listing Agreement
193
Submission of Interim and Annual Financial Results under Listing Agreement
195
Disclosures under Listing Agreement
196
Corporate Governance
198
Regulatory Framework of Corporate Governance in India
198
Companies Act, 1956
198
Corporate Governance -Voluntary Guidelines 2009
199
Guidelines on Corporate Governance for Central Public Sector Enterprises
199
National Voluntary Guidelines on Social, Environmental & Economic Responsibilities of Business, 2011
200
Companies Bill, 2012
200
Evolution of Clause 49 of Listing Agreement
200
Clause 49
202
Stock Exchange Mechanism
209
Arbitration Mechanism
209
Margining
214
Types of Margins in Cash and Derivative Segment
215
Trading of Securities
217
Settlement System
218
Clearing and Settlement
219
Clearing & Settlement Process
219
Trade Guarantee Fund
220
Trading Software
221
Stock Market Indices
221
Types of Indices
221
BSE Indices
222
CNX Nifty
228
Investible Weight Factors (IWFs)
229
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Page
LESSON ROUND UP
230
SELF TEST QUESTION
231
LESSON 7
CAPITAL MARKET INVESTMENT INSTITUTIONS
Introduction
234
National Level Institutions
234
State Level Institutions
236
Qualified Institutional Buyers
236
Private Equity
237
Venture Capital
238
Stages of Investment Financing
238
A. Early Stage Financing
238
B. Later Stage Financing
239
Angel Fund
240
Types of Angel Investors
240
Pension Fund
241
Qualified Foreign Investor
243
Mutual Fund
244
Alternative Investment Funds
246
Hedge Funds
249
LESSON ROUND UP
250
SELF TEST QUESTIONS
251
LESSON 8
CAPITAL MARKET INSTRUMENTS
Introduction
254
Equity Shares
254
Characteristics of Equity Shares
254
Shares with differential Voting Rights
255
Preference Shares
258
Cumulative Preference Shares
258
Non-Cumulative Preference Shares
258
Convertible Preference Shares
258
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Page
Redeemable Preference Shares
258
Participating Preference Shares
259
Non Participating Preference Shares
259
Fully Convertible Cumulative Preference Share (EQUIPREF)
259
Debentures
259
Fully Convertible Debentures With Interest (Optional)
262
Non Convertible Debentures (NCDs) with Put and Call Options
262
Bonds
262
Sweat Equity Shares
263
Warrant
264
Share Warrant
264
Secured Premium Notes (SPN)
265
Equity Shares with Detachable Warrants
265
Foreign Currency Convertible Bonds (FCCBs)
265
Foreign Currency Exchangeable Bonds (FCEBs)
266
American Depository Receipts(ADR) / Global Depository Receipts (GDR)
266
Indian Depository Receipts (IDRs)
267
Derivative
268
Futures
268
Options
268
Index Futures & Options
269
Currency Futures
270
Interest Rate Futures (IRFs)
270
Stock Futures and Stock Options
270
Exchange Traded Funds (ETFs)
271
LESSON ROUND UP
271
SELF TEST QUESTIONS
272
LESSON 9
RESOURCE MOBILIZATION THROUGH INTERNATIONAL MARKETS
Introduction
274
American Depository Receipt
274
Global Depository Receipts
275
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Page
Advantage of ADRs and GDRs
276
Sponsored ADR/GDR Issue
277
Two-Way Fungibility Scheme
278
Issuance of Shares under ADR/GDR
278
Statutory Approvals Required for issue of GDR/ADR
279
Agencies involved in ADR/GDR issue
280
Agreements and related Documents
281
Procedural requirements
283
Roadshows
284
Stepwise Procedure for Issue of ADR/GDR
285
Reporting of ADR/GDR Issues
286
FCCB and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993
287
Listing of GDR
289
London Stock Exchange
289
Listing on the Main Market
289
Listing on Professional Security Market
292
Listing on AIM
293
Luxembourg Stock Exchange
294
Listing requirements
294
Continuing obligations
294
Listing of ADR
294
NASDAQ
295
The NASDAQ Global Select Market (NGSM)
295
The NASDAQ Capital Market (NCM)
297
The NASDAQ Global Market (NGM)
299
NewYork Stock Exchange (NYSE)
301
NYSE Quantitative Listing and Maintenance Standards
301
LESSON ROUND UP
305
SELF TEST QUESTIONS
306
LESSON 10
ECONOMICS OF COMMODITIES MARKETING
Introduction
308
Types of Commodities
308
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Page
Commodity Markets
308
Marketing of Agricultural Commodities
309
Direct Marketing
310
Indirect Marketing
310
Contract Farming
310
Storage
311
Types of Storage
311
Warehousing
312
Types of warehouse
313
Warehousing in India
313
Variance in Commodity Market
314
Weather Derivatives
315
Freight Derivatives
315
Electricity Derivates
316
Catastrophe Derivatives
317
Carbon Derivatives
317
Hedging
318
Hedging Risks
318
Understanding Basis Risk
319
LESSON ROUND UP
319
SELF TEST QUESTIONS
320
LESSON 11
COMMODITIES MARKET OPERATIONS
Introduction
324
Role of Commodity Exchanges
324
Evolution of Commodity Exchanges
324
Origin of Commodity market in India
324
Regulatory Framework
325
Three-tier Regulatory System
326
Forward Market Commission of India
326
Commodity Exchanges in India
327
Participants/Players
328
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Page
Hedgers
328
Speculator
329
Arbitrageurs
330
Commodity Producers/Consumers
330
Trading in Commodity Market
331
Order Types
332
Electronic Spot Exchanges
333
Exchange Membership
334
Clearing and Settlement
334
Clearing
334
Settlement
335
Settlement Mechanism
336
Settlement Methods
337
Entities involved in Physical Settlement
339
Instruments Available For Trading
340
Forward Contract
340
Futures
341
Options
342
Using Commodity Exchanges for Hedging, Speculation and Arbitrage
344
Hedging
344
Speculation
346
Arbitrage
347
LESSON ROUND UP
348
SELF TEST QUESTIONS
348
LESSON 12
MONEY MARKET
Introduction
352
Features of Money Market
352
Money Market Vs. Capital Market
353
Growth of Money Market
353
Structure and Institutional Development
354
Money Market Instruments
355
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Page
Government Securities
355
Gilt-Edged (Government) Securities
356
Call Money and Notice Money
356
Term Money
357
Bill Discounting
357
Bill Rediscounting Scheme (BRD)
359
Repurchase Agreements
359
Banker’s Acceptance
360
Treasury Bills
360
Certificates Of Deposits
364
Inter-corporate Deposits
366
Commercial Bills
366
Commercial Paper
366
Money Market Mutual Funds (MMFS)
369
Factoring
369
Factoring Process
370
Types of Factoring
372
Letter of Credit
372
Basic forms of LCs
373
Working Mechanism
373
Bill of Exchange
375
FIMMDA
376
Objectives of FIMMDA
376
Foreign Exchange Dealer’s Association of India
376
LESSON ROUND UP
377
SELF TEST QUESTIONS
378
LESSON 13
INSIDER TRADING
Introduction
380
SEBI (Prohibition of Insider Trading) Regulations, 1992
380
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Page
Important Definitions
380
Prohibition on Dealing Communication or Counselling on Matters Relating to Insider Trading
382
Code of Internal Procedures and Conduct for Listed Companies and Other Entities
383
Disclosure of Interest or Holding in a Listed Companies by Certain Persons
383
Model Code of Conduct for Prevention of Insider Trading for Listed Companies
384
Model Code of Conduct for Prevention of Insider Trading for other Entities
387
Code of Corporate Disclosure Practices for Prevention of Insider Trading
388
Corporate Disclosure Policy
388
Investigation by SEBI
389
Penalty Provisions for Violations of the Regulations
391
Role of Company Secretary in Compliance Requirements
392
SEBI’s view on the Role of the Compliance Officer in Case of Insider Trading
394
LESSON ROUND UP
395
SELF TEST QUESTIONS
396
LESSON 14
SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS
Introduction
398
Important Definitions
398
Trigger Point for Making an Open Offer by an Acquirer
401
Open Offer
401
Open Offer Process
404
Public Announcement
406
Offer price
408
Provision of Escrow
409
Mode of Payment
409
Disclosures
410
Exemptions
411
Regulation 10 – Automatic Exemptions
411
Regulation 11 – Exemption by SEBI
415
LESSON ROUND UP
416
SELF TEST QUESTIONS
417
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Page
REPORT OF THE COMMITTEES ON CAPITAL MARKET
Introduction
419
Report of Financial Sector Legislative Reforms Commission
419
The Draft Indian Financial Code
419
Report of the Takeover Regulations Advisory Committee under the Chairmanship of Mr. C. Achuthan
421
Summary of Key Recommendations of the Committee
421
Summary of Recommendations of the Achuthan Committee and the Provisions in the Takeover
Regulations, 1997
422
Report of Justice Dhanuka Committee on Securities Laws
435
Executive Summary of Principal Recommendations
436
TEST PAPERS
Test Paper 1/2013
443
Test Paper 2/2013
444
Test Paper 3/2013
445
xxii
Lesson 1
Economic Framework of Capital Market
Lesson 1
Economic Framework of Capital Market
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
The financial system plays a key role in the
economy by stimulating economic growth,
influencing economic performance of the
factors, affecting economic welfare. This is
achieved by financial infrastructure, in which
entities with funds allocate funds to those who
have potentially more productive ways to invest.
A financial system facilitates more efficient
transfer of funds. As one party of the transaction
may possess superior information than the other
party, it can lead to the information asymmetry
problem and inefficient allocation of financial
resources. By overcoming asymmetry problem
the financial system facilitates balance between
those with funds to invest and those needing
funds.
– Constituents of Financial System
– Financial Assets
– Financial Intermediaries
– Financial Markets
– Classification of Financial Markets
– Capital Market
– Functions of Capital Market
– Role of Capital Market in Resource
Allocation
– Capital Formation
– Stages of Capital Formation
– Role of Capital Market in Capital Formation
The aim of this lesson is to enable students to
know the economic framework of financial
system in India, how Capital Market plays an
important role in resource allocation and capital
formation, reduction in transaction cost and such
other related matters.
– LESSON ROUND UP
– SELF TEST QUESTIONS
1
1
2 PP-CC&MM
INTRODUCTION
The economic development of any country depends upon the existence of a well organized financial system. It
is the financial system which supplies the necessary financial inputs for the production of goods and services
which in turn promotes the well being and standard of living of the people of a country. Thus, the ‘financial
system’ is a broader term which brings under its fold the financial markets and the financial institutions which
support the system. The major assets traded in the financial system are money and monetary assets. The
responsibility of the financial system is to mobilize the savings in the form of money and monetary assets and
invest them to productive ventures. An efficient functioning of the financial system facilitates the free flow of
funds to more productive activities and thus promotes investment. Thus, the financial system provides the
intermediation between savers and investors which in turn promotes faster economic development.
CONSTITUTENTS OF THE FINANCIAL SYSTEM
The three main constituents of the financial system are:
1. Financial Assets
2. Financial Intermediaries
3. Financial markets
FINANCIAL ASSETS
An asset is something that provides its owner with expected future benefits. Financial assets are assets, such as
stocks or bonds, whose benefit to the owner depends on the issuer of the asset meeting certain obligations.
These obligations are called financial liabilities. Every financial asset has a corresponding financial liability; it’s
that financial liability that gives financial asset its value.
Classification of Financial Assets
Financial assets can be classified differently under different circumstances, viz. :
A. (i) Marketable assets and (ii) Non-marketable assets
B. (i) Money/cash asset (ii) Debt asset and (iii) Stock assets
A. (i) Marketable Assets : Marketable assets are those which can be easily transferred from one person to
another without much hindrance. E.g.Equity shares of listed companies, Bonds of PSUs, Government Securities.
(ii) Non-marketable Assets : Non-marketable assets are those assets which cannot be transferred easily. E.g.
FDRs, PF, Pension Funds, NSC, Insurance policy etc.
B. (i) Cash Assets : Cash assets are those assets that may readily be converted to cash. These assets often
retain high levels of liquidity and may be used to ensure the financial ability of a company or individual to conduct
daily operations. E.g. cash, money market funds, commercial papers.
(ii) Debt Asset : Debt asset is issued by a variety of organizations for the purpose of raising their debt capital.
There are different ways of raising debt capital. E.g.- issue of debentures, raising of term loans, working capital
advances etc.
(iii) Stock Asset : Stock asset is issued by business organizations for the purpose of raising their fixed capital.
There are two types of stock namely equity and preference.
Lesson 1
Economic Framework of Capital Market
3
FINANCIAL INTERMEDIARIES
The term financial intermediaries include all kinds of organizations which intermediate and facilitate financial
transactions of both individuals and corporate customers. Thus, it refers to all kinds of FIs and investing institutions
which facilitate financial transactions in financial markets. They may be in the organized sector or in the
unorganized sector and may be further classified into two types :
(i) Capital Market Intermediaries: These intermediaries mainly provide long term funds to individuals
and corporate customers. They consist of term lending institutions like financial corporations and
investment institutions like Life Insurance Corporation of India (LIC).
(ii) Money Market Intermediaries: Money market intermediaries supply only short term funds to individuals
and corporate customers. They consist of commercial banks, cooperative bank.
FINANCIAL MARKETS
A financial market is a market where financial assets and financial liabilities are bought and sold. Financial
Markets perform the essential economic function of channeling funds from savers who have an excess of funds
to spenders who have a shortage of funds. This function is shown schematically in figure below:
Flow of funds through the financial system:-
INDIRECT FINANCE
Financial
Intermediaries
F
U
N
D
S
Lender-Saver
1. Households
2. Business Firms
3. Government
4. Foreigners
FUNDS
Financial
Markets
DIRECT FINANCE
FUNDS
Borrowers-Spenders
1. Business Firms
2. Government
3. Households
4. Foreigners
Financial markets can perform this basic function either through direct finance in which borrowers borrow funds
directly from lenders by selling them securities or through indirect finance, which involves a financial intermediary
who stands between the lender-savers and borrower-spenders and helps transfer funds from one to the other.
This channelising of funds improves the economic welfare of everyone in the society because it allows funds to
move from people who have no productive investment opportunities to those who have such opportunities,
thereby contributing to increased efficiency in the economy.
CLASSIFICATION OF FINANCIAL MARKETS
The financial markets in India can be classified as follows :
(a) Unorganized Markets : In unorganized markets, there are a number of money lenders, indigenous
bankers, traders, etc. who lend money to the public. Indigenous bankers also collect deposits from the
4 PP-CC&MM
public. There are also private finance companies, chit funds etc whose activities are not controlled by
the RBI. The RBI has already taken some steps to bring unorganized sector under the organized fold.
(b) Organized Markets : In the organized markets, there are standardized rules and regulations governing
their financial dealings. There is also a high degree of institutionalization and instrumentalization. These
markets are subject to strict supervision and control by the RBI or other regulatory bodies. These organized
markets can be further classified into two types. They are:
(i) Capital Market and
(ii) Money Market.
(i) Capital Market
The capital market is a market for financial assets which have a long or indefinite maturity. Generally, it deals
with long term securities which have a maturity period of more than one year. Capital market may be further
divided into three types namely :
1. Industrial Securities Market
2. Government Securities Market and
3. Long-term Loans Market.
1. Industrial Securities Market
As the very name implies, it is a market for industrial securities, namely : (i) equity shares (ii) Preference shares
and (iii) Debentures or bonds. It is a market where industrial concerns raise their capital or debt by issuing
appropriate instruments. It can be further subdivided into two types. They are
(a) Primary market or New Issue Market,
(b) Secondary market or Stock Exchange.
2. Government Securities Market
It is otherwise called Gilt-Edged Securities Market. It is a market where government securities are traded. In
India there are many kinds of Government securities – short term and long term. Long-term securities are
traded in this market while short term securities are traded in money market. The secondary market for these
securities is very narrow since most of the institutional investors tend to retain these securities until maturity.
3. Long-term Loans Market
Development banks and commercial banks play a significant role in this market by supplying long term loans to
corporate customers. Long term loans market may further be classified into – (i) Term loans, (ii) Mortgages and
(iii) Financial Guarantees markets.
(ii) Money Market
Money market is a very important segment of a financial system. It is the market for dealing in monetary assets
of short-term nature. Short-term funds up to one year and financial assets that are close substitutes for money
are dealt in the money market. Money market instruments have the characteristics of liquidity (quick conversion
into money), minimum transaction cost and no loss in value. Excess funds are deployed in the money market,
which in turn is availed of to meet temporary shortages of cash and other obligations. Money market provides
access to providers and users of short-term funds to fulfill their investments and borrowings requirements
respectively at an efficient market clearing price. It performs the crucial role of providing an equilibrating mechanism
to even out short-term liquidity, surpluses and deficits and in the process, facilitates the conduct of monetary
policy. The money market is one of the primary mechanism through which the Central Bank influences liquidity
and the general level of interest rates in an economy. The Bank’s interventions to influence liquidity serve as a
Lesson 1
Economic Framework of Capital Market
5
signaling-device for other segments of the financial system.
The money market functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
Funds are available in this market for periods ranging from a single day upto a year. Mostly government, banks
and financial institutions dominate this market. It is a formal financial market that deals with short-term fund
management.
Features of Money Market
The money market is a wholesale market where the volumes of transactions is very large and is settled on a
daily basis. Trading in the money market is conducted over the telephone, followed by written confirmation
through e-mails, texts from the borrowers and lenders.
There are a large number of participants in the money market: commercial banks, mutual funds, investment
institutions, financial institutions and finally the Reserve Bank of India. The bank’s operations ensure that the
liquidity and short-term interest rates are maintained at levels consistent with the objective of maintaining price
and exchange rate stability. The Central bank occupies a strategic position in the money market. The money
market can obtain funds from the central bank either by borrowing or through sale of securities. The bank
influences liquidity and interest rates by open market operations, REPO transactions changes in Bank Rate,
Cash Reserve Requirements and by regulating access to its accommodation. A well-developed money market
contributes to an effective implementation of the monetary policy. It provides:
1. A balancing mechanism for short-term surpluses and deficiencies.
2. A focal point of central bank intervention for influencing liquidity in the economy, and
3. A reasonable access to the users of short-term funds to meet their requirements at realistic/reasonable
price or cost.
CAPITAL MARKET
Capital Market may be defined as a market for borrowing and lending long-term capital funds required by
business enterprises. Capital Market is the market for financial assets that have long or indefinite maturity.
Capital Market offers an ideal source of external finance. It refers to all the facilities and the institutional
arrangements for borrowing and lending medium-term and long-term funds. Like any market, the Capital Market
is also composed of whose who demand funds (borrowers) and those who supply funds (lenders).
Transfer of resources from those with idle resources to others who have a productive need for them is perhaps
most efficiently achieved through the Capital Markets. Stated formally, Capital Markets provide channels for
reallocation of savings to investments and entrepreneurship 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. Savings are
linked to investments by a variety of intermediaries through a range of complex financial products called “securities”.
There are a set of economic units who demand securities in lieu of funds and others who supply securities for
funds. These demand for and supply of securities and funds determine, under competitive market conditions in
both goods and Securities Market, the prices of securities which reflect the present value of future prospects of
the issuer, adjusted for risks and also prices of funds.
It is not that the users and suppliers of funds meet each other and exchange funds for securities. It is difficult to
accomplish such double coincidence of wants. The amount of funds supplied by the supplier may not be the
amount needed by the user. Similarly, the risk, liquidity and maturity characteristics of the securities issued by
the issuer may not match preference of the supplier. In such cases, they incur substantial search costs to find
each other. Search costs are minimised by the intermediaries who match and bring the suppliers and users of
funds together. These intermediaries may act as agents to match the needs of users and suppliers of funds for
6 PP-CC&MM
a commission, help suppliers and users in creation and sale of securities for a fee or buy the securities issued by
users and in turn, sell their own securities to suppliers to book profit.
The Capital Market, thus, has essentially three categories of participants, namely
(i) the issuers of securities,
(ii) investors in securities and
(iii) the intermediaries.
The issuers and investors are the consumers of services rendered by the intermediaries while the investors are
consumers (they subscribe for and trade in securities) of securities issued by issuers. In pursuit of providing a
product to meet the needs of each investor and issuer, the intermediaries churn out more and more complicated
products. They educate and guide them in their dealings and bring them together. 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 by 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 suppliers of funds. The regulator ensures a high standard of service from
intermediaries and supply of quality securities and non-manipulated demand for them in the market.
The market does not work in a vacuum; it requires services of a large variety of intermediaries. The
disintermediation in the Capital Market is in fact an intermediation with a difference; it is a risk-less intermediation,
where the ultimate risks are borne by the savers and not the intermediaries.
The Capital Market has two interdependent and inseparable segments, the new issues (primary market) and
the stock (secondary) market.
PRIMARY MARKET
The Primary Market provides the channel for sale of new securities. Primary Market provides opportunity to
issuers of securities; government as well as corporates, to raise resources to meet their requirements of investment
and/or discharge some obligation.
They may issue the securities at face value, or at a discount/premium and these securities may take a variety of
forms such as equity, debt etc. They may issue the securities in domestic market and/ /or international market.
The Primary Market issuance is done either through public issues or private placement. A public issue does not
limit any entity in investing while in private placement, the issuance is done to select people.
There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity
instruments (shares, debentures, etc.), while the governments (central and state governments) issue debt
securities (dated securities, treasury bills). The price signals, which subsume all information about the issuer
and his business including associated risk, generated in the secondary market, help the Primary Market in
allocation of funds.
SECONDARY MARKET
Secondary Market refers to a market where securities are traded after being initially offered to the public in the
Primary Market and/or listed on the Stock Exchange. Majority of the trading is done in the Secondary Market.
Secondary Market comprises of equity markets and the debt markets.
The Secondary Market enables participants who hold securities to adjust their holdings in response to changes
in their assessment of risk and return. They also sell securities for cash to meet their liquidity needs. The
Secondary Market has further two components, namely the over-the-counter (OTC) market and the exchangetraded market. OTC is different from the market place provided by the Over The Counter Exchange of India
Lesson 1
Economic Framework of Capital Market
7
Limited. OTC markets are essentially informal markets where trades are negotiated. Most of the trades in
government securities are in the OTC market. All the spot trades where securities are traded for immediate
delivery and payment take place in the OTC market. The exchanges do not provide facility for spot trades in a
strict sense. Closest to spot market is the cash market where settlement takes place after some time. Nearly
100% of the trades settled by delivery are settled in demat form. A variant of Secondary Market is the forward
market, where securities are traded for future delivery and payment. Pure forward is outside the formal market.
The versions of forward in formal market are futures and options. In futures market, standardised securities are
traded for future delivery and settlement. These futures can be on a basket of securities like an index or an
individual security. In case of options, securities are traded for conditional future delivery. There are two types of
options–a put option permits the owner to sell a security to the writer of options at a predetermined price while a
call option permits the owner to purchase a security from the writer of the option at a predetermined price. These
options can also be on individual stocks or basket of stocks like index.
The past few years in many ways have been remarkable for Capital Market in India. It has grown exponentially
as measured in terms of amount raised from the market, number of stock exchanges and other intermediaries,
the number of listed stocks, market capitalisation, trading volumes and turnover on stock exchanges, and investor
population. Along with this growth, the profiles of the investors, issuers and intermediaries have changed
significantly. The market has witnessed fundamental institutional changes resulting in drastic reduction in
transaction costs and significant improvements in efficiency, transparency and safety.
What is Transaction Cost?
Transaction cost for a market is important for several reasons. It is a key parameter to measure the impact of
modernization of market infrastructure, institutionalisation of the market and market regulation. Besides,
transaction cost directly impacts the profits of investors and affects the return on their investments. Investors
therefore, seek continuous reduction in transaction cost. Reduction in transaction cost induces investors to
trade more frequently resulting in higher volumes.
Transaction cost can be classified into two categories :
(A) Explicit costs
(B) Implicit costs
(A) Explicit costs are observable and measurable. They can be easily measured and are directly borne by
the investors. These costs include :
(i) Brokerage commission
(ii) Stamp duty
(iii) Service tax
(iv) Custody charges; and
(v) Regulatory chargesSome of these charges, such as stamp duty and service tax are also levied in
few other markets.
(B) The implicit costs include :
(i) Bid-ask spreads
(ii) Realised spreads
(iii) Opportunity cost of delayed execution (timing costs) or non-execution.
There are certain additional components of implicit costs peculiar to the Indian markets, which arise on
account of existence of physical securities and the process of registration of securities. The risks associated
8 PP-CC&MM
with physical securities such as bad deliveries and delays in transfer, result in loss of liquidity and add to the
opportunity costs for the investors.Transaction costs can also be categorised into:
(1) cost of search and information,
(2) cost of contracting and monitoring,
(3) cost of incentive problems between buyers and sellers of financial assets.
(i) Costs of search and information are defined in the following way:
Search cost fall into categories of explicit cost and implicit cost. Information cost is associated with
assessing a financial instrument’s investment attributes. In a price efficient market, prices reflect
the aggregate information collected by all market participants.
(ii) Cost of contracting and monitoring is related to the cost necessary to resolve information asymmetry
problems, when the two parties entering into the transaction possess limited information on each
other and seek to ensure that the transaction obligations are fulfilled.
(iii) Cost of incentive problems between buyers and sellers arise, when there are conflicts of interest
between the two parties, having different incentives for the transactions involving financial asset.
Transaction cost is one of the most important factor which affects the investors and determines the decision
making process. Reduction in transaction costs is one of the phenomena which characterizes an efficient
financial market and affects the level of market development. This means that, other things being equal, the
investors’ preference is to invest in markets which have the least transaction costs as the investor aims to
maximize profit by incurring the least possible cost.
FUNCTIONS OF CAPITAL MARKET
The main functions of Capital Market are:
1. Allocation Function
2. Liquidity Function
3. Other Function
1. Allocation Function
Capital Market allows for the channelization of the saving of innumerable investors into various productive
avenues of investments. Accordingly, the current savings for a period are allocated amongst the various users
and uses. The market attracts new investors who are willing to make new funds available to business. It also
allocates and rations funds by a system of incentives and penalties.
2. Liquidity Function
Capital Market provides a means whereby buyers and sellers can exchange securities at mutually agreed
prices. This allows better liquidity for the securities that are traded.
3. Other Functions
In addition to the functions of funds allocation and liquidity, Capital Market also renders the following functions:
1. Indicative Function– A Capital Market acts as a barometer showing not only the progress of a company,
but also of the economy as a whole through share price movements.
2. Savings & Investment Function– Capital Market provides a means of quickly converting long-term
investment into liquid funds, thereby generating confidence among investors and speeding up the process
of saving and investment.
Lesson 1
Economic Framework of Capital Market
9
3. Transfer Function– Capital Market facilitates the transfer of existing assets – tangible and intangible
among individual economic units or groups.
4. Merger Function– Capital Market encourages voluntary or coercive take-over mechanism to put the
management of inefficient companies into more competent hands.
ROLE OF CAPITAL MARKET IN RESOURCE ALLOCATION
Capital Market plays an important role in mobilising resources, and diverting them towards productive channels.
In this way, it facilitates and promotes the process of economic growth in the country as discussed below:
1. Link between Savers and Investors:
The Capital Market functions as a link between savers and investors. It plays an important role in mobilising the
savings and diverting them in productive investment. In this way, Capital Market plays a vital role in transferring
the financial resources from surplus and wasteful areas to deficit and productive areas, thus increasing the
productivity and prosperity of the country.
2. Encouragement to Saving:
With the development of Capital Market, the banking and non-banking institutions provide facilities, which
encourage people to save more. In the less- developed countries, in the absence of a Capital Market, there are
very little savings and those who save often invest their savings in unproductive and wasteful directions, i.e., in
real estate (like land, gold, and jewellery) and conspicuous consumption.
3. Encouragement to Investment:
The Capital Market facilitates lending to the businessmen and the Government and thus encourages investment.
It provides facilities through banks and nonbank financial institutions. Various financial assets, e.g., shares,
securities, bonds, etc., induce savers to lend to the Government or invest in industry. With the development of
financial institutions, capital becomes more mobile, interest rate falls and investment increases.
4. Promotes Economic Growth:
The Capital Market not only reflects the general condition of the economy, but also smoothens and accelerates
the process of economic growth. Various institutions of the Capital Market, like non-bank financial intermediaries,
allocate the resources rationally in accordance with the development needs of the country. The proper allocation
of resources results in the expansion of trade and industry in both public and private sectors, thus promoting
balanced economic growth in the country.
5. Stability in Security Prices:
The Capital Market tends to stabilise the values of stocks and securities and reduce the fluctuations in the prices
to the minimum. The process of stabilisation is facilitated by providing capital to the borrowers at a lower interest
rate and reducing the speculative and unproductive activities.
6. Benefits to Investors:
The Capital Market helps the investors, i.e., those who have funds to invest in long-term financial assets, in
many ways:
(a) It brings together the buyers and sellers of securities and thus ensure the marketability of investments,
(b) By advertising security prices, the Stock Exchange enables the investors to keep track of their investments
and channelize them into most profitable lines,
(c) It safeguards the interests of the investors by compensating them from the Stock Exchange’s Investor
Protection Fund in the event of fraud and default.
10 PP-CC&MM
CAPITAL FORMATION
Capital formation is regarded as a key to economic development. It is because capital formation leads to an
increase in the supply of machinery, equipments, plants, and also an increase in human capital. This increases
production and productivity in an economy. This in turn increases employment opportunities and standard of
living of people. Thus, capital formation is considered very important.
The chart below indicates the capital formation process.
Increase in Saving
Mobilisation of Saving
Investment of Saving
Capital Formation
STAGES OF CAPITAL FORMATION
Capital formation process has three stages which are described below:1. Increase in Savings
Capital formation depends on saving. According to J.M. Keynes “Saving is the excess of income over consumption
expenditure”. To be more precise, saving is a part of income that is not spent on current consumption. If consumers
spend their entire incomes on consumers’ goods, there could be no accumulation of capital goods. If, on the
other hand, consumers decide to save part of their incomes, country’s resources can be devoted to making
capital goods. Thus, the production of capital goods depends on saving as shown in the following chart:Total Income
Amount Spent
Amount Saved
Production of
Consumer’s Goods
Production of
Producer’s Goods
(Investment)
In economics, the term investment is used to mean the actual production of capital goods. So it can be said that
investment depends on saving. Capital accumulation depends on volume of saving. The volume of saving in
turn depends broadly on three factors–power to save, will to save and facilities to save.
2. Mobilization of savings
The second stage of capital formation is the mobilization of available savings. The act of mobilizing savings is
done by the financial institutions such as commercial banks, finance companies, insurance companies, cooperative
societies and so on. These institutions collect deposits from general public, provide security to savings, provide
liquidity to savers, and also provide income in the form of interest. Due to this, people like to save through
financial institutions. These institutions mobilize the savings collected toward productive investments. Saving
and investment are done by different classes of people. Financial institutions act as intermediaries between
savers and investors. This leads to the increase in capital formation.
Lesson 1
Economic Framework of Capital Market
11
3. Investment of Savings
The third stage of capital formation is the investment of savings. Investment creates capital goods. The act of
investment is done by entrepreneurs. Therefore, a large number of bold and skilled entrepreneurs are
indispensable for increasing capital formation in the country. Entrepreneurs acquire surplus funds from financial
institutions and the Capital Market and make productive investment in various types of industries. Investments
create and increase machinery and equipments. This leads to the increase in the national income of the country.
ROLE OF CAPITAL MARKET IN CAPITAL FORMATION
Capital Market has a crucial significance to capital formation. For a speedy economic development adequate
capital formation is necessary. The significance of Capital Market in economic development is explained below:
1. Mobilisation of Savings and Acceleration of Capital Formation :In Capital Market, various types of securities helps to mobilise savings from various sectors of population. The
twin features of reasonable return and liquidity in stock exchange are definite incentives to the people to invest
in securities. This accelerates the capital formation in the country.
2. Raising Long-Term Capital :The existence of a stock exchange enables companies to raise permanent capital. The investors cannot commit
their funds for a permanent period but companies require funds permanently. The stock exchange resolves this
clash of interests by offering an opportunity to investors to buy or sell their securities, while permanent capital
with the company remains unaffected.
3. Promotion of Industrial Growth :The stock exchange is a central market through which resources are transferred to the industrial sector of the
economy. The existence of such an institution encourages people to invest in productive channels. Thus it
stimulates industrial growth and economic development of the country by mobilising funds for investment in the
corporate securities.
4. Ready and Continuous Market :The stock exchange provides a central convenient place where buyers and sellers can easily purchase and sell
securities. Easy marketability makes investment in securities more liquid as compared to other assets.
5. Technical Assistance :An important shortage faced by entrepreneurs in developing countries is technical assistance. By offering advisory
services relating to preparation of feasibility reports, identifying growth potential and training entrepreneurs in
project management, the financial intermediaries in Capital Market play an important role.
6. Reliable guide to Performance :The Capital Market serves as a reliable guide to the performance and financial position of corporates, and
thereby promotes efficiency.
7. Proper channelisation of funds :The prevailing market price of a security and relative yield are the guiding factors for the people to channelise
their funds in a particular company. This ensures effective utilisation of funds in the public interest.
8. Provision of variety of services :The financial institutions functioning in the Capital Market provide a variety of services such as grant of long term
and medium term loans to entrepreneurs, provision of underwriting facilities, assistance in promotion of companies,
participation in equity capital, giving expert advice etc.
12 PP-CC&MM
9. Development of backward areas :Capital Markets provide funds for projects in backward areas. This facilitates economic development of backward
areas. Long term funds are also provided for development projects in backward and rural areas.
10. Foreign Capital :Capital Markets makes possible to generate foreign capital. Indian firms are able to generate capital funds from
overseas markets by way of bonds and other securities. Government has liberalised Foreign Direct Investment
(FDI) in the country. This not only brings in foreign capital but also foreign technology which is important for
economic development of the country.
11. Easy liquidity :With the help of secondary market investors can sell off their holdings and convert them into liquid cash.
Commercial banks also allow investors to withdraw their deposits, as and when they are in need of funds.
12. Revival of Sick Units :The Commercial and Financial Institutions provide timely financial assistance to viable sick units to overcome
their industrial sickness. To help the weak units to overcome their financial industrial sickness banks and FIs
may write off a part of their loan.
LESSON SUMMARY
– An efficient functioning of the financial system facilitates the free flow of funds to more productive
activities and thus promotes investment. Thus, the financial system provides the intermediation between
savers and investors and promotes faster economic development.
– Financial assets are assets, such as stocks or bonds, whose benefit to the owner depends on the
issuer of the asset meeting certain obligations.
– Financial assets can be classified differently under different circumstances. E.g. : A. (i) Marketable
assets and (ii) Non-marketable assets, B. (i) Money/cash asset (ii) Debt asset and (iii) Stock assets.
– The term financial intermediaries include all kinds of organizations which intermediate and facilitate
financial transactions of both individuals and corporate customers.
– Financial Markets perform the essential economic function of channeling funds from savers who have
an excess of funds to spenders who have a shortage of funds.
– Capital Market may be defined as a market for borrowing and lending long-term capital funds required by
business enterprises. Capital Market is the market for financial assets that have long or indefinite maturity.
– Capital Market plays an important role in mobilising resources, and diverting them in productive channels.
In this way, it facilitates and promotes the process of economic growth in the country.
– Capital formation is regarded as a key to economic development. It is because capital formation leads
to an increase in the supply of machinery, equipments, plants, and also an increase in human capital.
This increases production and productivity in an economy. This in turn increases employment
opportunities and standard of living of people. Thus, capital formation is considered very important.
– Capital formation process has three stages-(i) Increase in savings (ii) Mobilization of savings (iii)
Investment of savings.
– Capital Market has a crucial significance to capital formation. For a speedy economic development
adequate capital formation is necessary.
Lesson 1
Economic Framework of Capital Market
13
– Transaction cost is a key parameter to measure the impact of modernization of market infrastructure,
institutionalisation of the market and market regulation. Besides, transaction cost directly reduces the
profits of investors and affects the return on their investments.
– Transaction cost can be classified into two categories: (A) Explicit costs (B) Implicit costs.
– Transaction cost is one of the most important factors which affect the investors and determines the
decision making process; because the investors need to be compensated for the risk and transaction
cost involved in the buying and selling process.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is financial market? Briefly discuss about various types of Financial Market.
2. Explain the various functions of Capital Market.
3. What do you understand by capital formation? Discuss various stages of capital formation.
4. What is a transaction cost? How does it impact an investor?
14 PP-CC&MM
Lesson 2
Legal Framework of Capital Market
Lesson 2
Legal Framework
LESSON OUTLINE
15
LEARNING OBJECTIVES
– Introduction
Securities Market is an important mobilizer of
resources for the corporate sector. Investors’
confidence is key to the healthy developments
of Securities Market, it is necessary that
comprehensive and adequate laws exists to
regulate security industry to protect investors
interests and rights.
– Department of Economic Affairs (DEA)
– Capital Market Division
– Ministry of Corporate Affairs
– Company Law Board
– Reserve Bank of India
– Securities and Exchange Board of
India(SEBI)
Further, the investor need protection from the
various malpractices and unfair practices made
by the corporate and intermediaries. For this
purpose, the Government of India has developed
a strong legal and regulatory framework that
governs and regulates the business, corporate
transaction and the intermediaries.
– Legislations
– Grievance Redressal Mechanism
– Grievance Rederessal Mechanism at
Stock Exchanges
– Grievance Rederessal Mechanism at
SEBI
Keeping this in view, this lesson will enable the
students to give an overview of the legal
framework of the Securities Market in India, the
agencies involved in regulating the Securities
Market, and the investigations agencies
involved in initiating proceedings against money
laundering.
– Securities Appellate Tribunal
– Prevention of Money Laundering Act,
2002
– Investigating Agencies in case of PMLA,
2002
– Diretorate of Enforcement
– Central Bureau of Investigation
– Financial Intelligence Unit – India
(FIU-IND)
– The Financial Action Task Force (FATF)
– FATF Recommendations 2012
– LESSON ROUND UP
– SELF TEST QUESTIONS
15
16 PP-CC&MM
INTRODUCTION
The Securities Market operations promote the economic growth of the country. More efficient is the Securities
Market, the greater is the promotion effect on economic growth. It is, therefore, necessary to ensure that Securities
Market operations are more efficient, transparent and safe. In this context, the investors need protection from
the various malpractices and unfair practices made by the corporate and intermediaries. As the individual investors’
community and the investment avenues are on the rise, it is necessary to protect the investors through various
legislations. Securities Market in general are to be regulated to improve the market operations in fair dealings
and easy to access the market by corporates and investors.
Successive Corporate scams also have prompted Government around the world including in India to develope
a strong legal and regulatory framework that governs and regulates business and corporate transactions. Some
of the central issue while regulating the working of corporations, include rules and regulations, roles and
responsibilities and jurisdiction of regulatory institutions and co-ordination among regulatory bodies.
The following agencies have a significant regulatory influence, directly or indirectly, over the Securities Markets
in India currently. These are:
– Department of Economic Affairs (DEA) which is responsible for the economic management of the country
and is the arm of the government that is concerned with the orderly functioning of the financial markets
as a whole.
– Ministry of Corporate Affairs (MCA) which is at the apex of a three tier structure that has responsibility
for the registration and oversight of incorporated entities which fall under the regulatory purview of the
Companies Act.
– The Company Law Board (CLB) which is a quasi judicial body that exercises some of the quasi
judicial and judicial powers under the Act previously exercised by the High Court and the Central
Government.
– The Reserve Bank of India (RBI) which is primarily responsible, inter alia, for the supervision of banks
and Money Markets.
– Securities and Exchange Board of India (SEBI) which is responsible for the regulation of Capital Markets
and the various participants and activities therein; and
Of the above, the agency that is directly charged with the supervision of the Capital Market in India is SEBI. The
role and function of each agency has been discussed below:
DEPARTMENT OF ECONOMIC AFFAIRS (DEA)
The DEA is the nodal agency of the Union government to formulate and monitor the country's economic policies
and programmes that have a bearing on domestic and international aspects of economic management. Apart
from forming the Union Budget every year, it has other important functions like:
(i) Formulation and monitoring of macro-economic policies, including issues relating to fiscal policy and
public finance, inflation, public debt management, and the functioning of Capital Market, including stock
exchanges. In this context, it looks at ways and means to raise internal resources through taxation,
market borrowings, and mobilization of small savings.
(ii) Monitoring and raising of external resources through multilateral and bilateral development assistance,
sovereign borrowings abroad, foreign investments, and monitoring foreign exchange resources, including
balance of payments.
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17
(iii) Production of bank notes and coins of various denominations, postal stationery, postal stamps, cadre
management, career planning, and training of the Indian Economic Service (IES).
Capital Market Division
In India, the Capital Markets is regulated by the Capital Markets division of the DEA, Ministry of Finance. The
Capital Markets Division of DEA comprises various sections. The sections along with the work handled by them
are:
(i) Primary Market (PM)
– Primary Market Related Intermediaries & Participants
– SEBI Board Meeting (primary responsibility)
– SEBI Act
– Related Rules and Regulations
– Corporate Debt Market Development
– Collective Investment Schemes (CIS) including Mutual Funds
– Sectoral Charge of Ministry of Corporate Affairs
– Budget related matters
– National Institute of Securities Market (NISM)
(ii) Secondary Market (SM)
– Securities Contracts (Regulations) Act, 1956
– Depositories Act, 1996
– Related Rules and Regulations
– Taxes and Stamp Duties in Securities Markets
– Database relating to Securities Markets
– Monitoring of Stock Market Movements / Financial Markets
– Related Intermediaries & Participants like Depositories, Stock Exchanges, Clearing Corporations,
Governance of such institutions
– Self Regulatory Organisations
– SME Exchange
– SEBI Board Meeting (secondary responsibility)
(iii) External Markets (EM)
– International Financial Market
– Mumbai International Financial Center
– FEMA and Rules & Regulations
– FATF Cell (Financial Action Task Force)
18 PP-CC&MM
– Liaison / Branch Offices
– High Level Coordination Committee (HLCC) on Financial Markets
– Sectoral (Legal Affairs, Legislative Department and Parliamentary Affairs) Charge
– Foreign Travels of State Govt/UT functionaries
(iv) External Commercial Borrowings (ECB)
– ECB/FCCB (Foreign Convertible Currency Bond)
– American Depository Receipts (ADR)/ Global Depository Receipts (GDR )
– Foreign Institutional investment (FII)
The principal subjects dealt with in the Capital Market Division are the following:
– Policy matters relating to the Securities Markets, related intermediaries and participants;
– Policy matters relating to the regulation and development of the Securities Markets and investor protection ;
– The main Acts/Rules being administered by Capital Markets Division are:– Depositories Act, 1996 and Rules made thereunder
– Securities Contracts (Regulation) Act, 1956 and rules made thereunder
– Securities and Exchange Board of India Act, 1992 and rules made thereunder
– Rules made under the above Acts
– Securities and Exchange Board of India (Terms and Conditions of Services of Chairman and
Members) Rules, 1992
– Securities Appellate Tribunal (Services, Allowance and other Terms and Conditions of Presiding
Officers and other Members) Rules, 2003
– Foreign Exchange Management Act (FEMA), 1999
– Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002.
Ministry of Corporate Affairs
The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act, 1956,
other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the
corporate sector in accordance with law. It exercises supervision over the three professional bodies, namely,
Institute of Chartered Accountants of India(ICAI), Institute of Company Secretaries of India(ICSI) and the
Institute of Cost Accountants of India (ICAI) which are constituted under three separate Acts of the Parliament
for proper and orderly growth of the professions concerned. The Ministry of Corporate Affairs also has the
responsibility of carrying out the functions of the Central Government relating to administration of Partnership
Act, 1932, the Companies (Donations to National Funds) Act, 1951 and Societies Registration Act,
1980.
Company Law Board
The Company Law Board addresses the investor grievances & it can proceed against a company on its own.
The CLB is a quasi-judicial body, set up by the Central Government u/s 10E of the Companies Act, 1956
exercising equitable jurisdiction, which was earlier being exercised by the High Court or the Central Government.
The Board has powers to regulate its own procedures. The Company Law Board has framed “Company Law
Lesson 2
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19
Board Regulations 1991” prescribing the procedure for filing the applications/petitions before it. The Central
Government has also prescribed the fees for making applications/petitions before the Company Law Board,
under the “Company Law Board, (Fees on applications and Petitions) Rules 1991”.
Reserve Bank of India
The Reserve Bank of India (RBI) was established on 1.4.1935, in accordance with the provisions of the RBI Act,
1934. The main functions of RBI are :
(i) operating monetary policy with the aim of maintaining economic and financial stability and ensuring
adequate financial resources for development purposes;
(ii) meeting the currency requirement of the public;
(iii) promotion of an efficient financial system;
(iv) foreign exchange reserve management;
(v) the conduct of banking and financial operations of the government.
The Reserve Bank has systematically focussed on developing and regulating the financial markets in view of
the cross-linkages with other sectors of the economy. Further, a healthy, robust and vibrant financial market is
crucial for stronger monetary policy transmission. To enable the smooth functioning of the market and to
contain systemic risks that can adversely impact the real economy, the Reserve Bank continues to play a
strategic role.
RBI controls the monetary policy of India by controlling cash liquidity in the country. Frequent alteration of the
values of financial tools like Cash Reserve Ratio (CRR), Repo Rate, Reverse Repo Rate, and Statutory Liquidity
Ratio (SLR), restricts the cash flow within the country. As an anti-inflationary measure, RBI limits huge foreign
capital inflows to stabilize the Rupee value. RBI regulates the foreign exchange inflow and outflow, by the
Foreign Exchange Management Act, 1999 of RBI. All money transfer out of India is subject to limits defined by
the RBI. To maintain the exchange rate of Indian Rupee versus foreign currencies like the US Dollar, Euro,
Pound sterling, and Japanese yen, RBI buys and sells foreign currencies. The Reserve Bank of India has the
power to influence the volume of credit created by banks in India, which means that it is the controller of credit.
Carrying out open market operations or changing the Bank rate helps RBI to achieve this. Through quantitative
and qualitative measures, it controls the credit operations of other banks. The gold trade is also regulated by the
Reserve Bank of India.
Securities and Exchange Board of India (SEBI)
SEBI was brought into existence by the Securities and Exchange Board of India Act, 1992 which came into
effect on January 30, 1992. The preamble to the act describes the purpose of the Act in broad terms as “an act
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”.
The Securities and Exchange Board of India (SEBI) is the regulator charged with the orderly functioning of the
Securities Market in India, protect the interests of investors and ensure development of the Securities Market.
Since the establishment of SEBI in 1992, the Indian Securities Market has grown enormously in terms of volumes,
new products and financial services.
SEBI has full autonomy and authority to regulate and develop the Capital Market. The government has framed rules
under the Securities Contracts (Regulation) Act (SCRA), the SEBI Act and the Depositories Act. The SEBI has framed
regulations under the SEBI Act and the Depositories Act for registration and regulation of all market intermediaries, for
prevention of unfair trade practices, and insider trading. SEBI issue notifications, guidelines and circulars which need
to be complied with by market participants. All the rules and regulations are administered by the SEBI.
20 PP-CC&MM
LEGISLATIONS
The four main legislations governing the Securities Market are: (a) the SEBI Act, 1992 which establishes SEBI
to protect investors and develop and regulate Securities Market; (b) 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; (c) the Securities Contracts (Regulation) Act, 1956, which provides for regulation of
transactions in securities through control over stock exchanges; and (d) the Depositories Act, 1996 which provides
for electronic maintenance and transfer of ownership of demat securities.
(a) SEBI Act, 1992: The provisions of the SEBI Act define its role in more specific terms. These broadly relate to
(i) Regulating the business in stock exchanges and any other Securities Markets (ii) Registration and regulation
of a range of financial intermediaries and trade participants (iii) Prohibiting practices that are considered to be
unhealthy for development of the Securities Market such as insider trading and fraudulent and unfair trade
practices for promoting and regulating self regulatory organizations (iv) Promoting investors education and
training of intermediaries of Securities Markets (v) Inspection and calling for information from various regulated
entities referred to in (ii) above (vi) Conducting research (viii) Collecting fees or other charges for carrying out
the purposes of this section and (ix) Performing such other functions as may be prescribed.
(b) 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.
(c) 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.
(d) 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.
GRIEVANCE REDRESSAL MECHANISM
The Capital Market can grow only when investors find it safe for them to invest and they are assured that the
rules governing the market are fair and just for all the players. For gaining the confidence of investors in the
Capital Market there should be a series of systematic measures which would build their confidence in the
systems and processes and protect the interest of investors. An effective mechanism for resolutions of disputes
and grievances is required to be in place.
Grievance Rederessal Mechanism at Stock Exchange
Investors who are not satisfied with the response to their grievances received from the brokers/Depository
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Participants/listed companies, can lodge their grievances with the Stock Exchanges or Depositories. In case of
unsatisfactory redressal, the Stock exchange has designated Investor Grievance Redressal Committees (IGRCs),
or Regional Investor Complaints Resolution Committees (RICRC). This forum acts as a mediator to resolve the
claims, disputes and differences between entities and complainants. Stock Exchanges provide a standard format
to the complainant for referring the matter to IGRC/RICRC. The committee calls for the parties and acts as a
nodal point to resolve the grievances. If the grievance is still not resolved, an investor can file arbitration under
the Rules, Bye laws and Regulations of the respective Stock Exchange/Depository. If the investor has an account
with the broker or a depository participant (DP), he/she can choose arbitration to settle disputes. The investor
generally cannot pursue an issue through arbitration if it is barred by limitation prescribed. When deciding
whether to arbitrate, the investor has to bear in mind that if the broker or DP goes out of business or declares
bankruptcy, he/she might not be able to recover money even if the arbitrator or court rules in his/her favor.
However, with certain restriction to the nature of transactions, Stock Exchanges may settle on case to case
basis the claim of an investor up to a limit prescribed in the “Investor protection fund” guidelines of the respective
Stock Exchange.
Investor Protection Fund
Investor Protection Fund (IPF) or Customer Protection Fund (CPF) is the fund set up by the Stock Exchanges to
meet the legitimate investment claims of the clients of the defaulting members that are not of speculative nature.
SEBI has prescribed guidelines for utilisation of IPF at the Stock Exchanges. The Stock Exchanges have been
permitted to fix suitable compensation limits, in consultation with the IPF/CPF Trust. It has been provided that
the amount of compensation available against a single claim of an investor arising out of default by a member
broker of a Stock Exchange shall not be less than ` 1 lakh in case of major Stock Exchanges and ` 50,000/- in
case of other Stock Exchanges.
Grievance Rederessal Mechanism at SEBI
SEBI has a dedicated department viz., Office of Investor Assistance and Education (OIAE) to receive investor
grievances and to provide assistance to investors by way of education. Investors who are not satisfied with the
response to their grievances received from the Stock Exchanges/Depositories can lodge their grievances with
SEBI. Grievances pertaining to stock brokers and depository participants are taken up with respective stock
exchange and depository for redressal and monitored by SEBI through periodic reports obtained from them.
Grievances pertaining to other intermediaries are taken up with them directly for redressal and are continuously
monitored by SEBI. Grievances against listed company are taken up with the respective listed company and are
continuously monitored. The company is required to respond in prescribed format in the form of Action Taken
Report (ATR). Upon the receipt of ATR, the status of grievances is updated. Where the response of the company
is insufficient / inadequate, follow up action is initiated. If the progress of redressal of investor grievances by an
entity, is not satisfactory, appropriate enforcement actions (adjudication, direction, prosecution etc.) are initiated
against such entity.
SEBI has a web based centralized grievance redress system called SCORES which enables investors to lodge
and follow up their complaints and track the status of redressal of such complaints online from the website
SCORES (http://scores.gov.in) from anywhere. This enables the market intermediaries and listed companies to
receive the complaints online from investors, redress such complaints and report redressal online. All the activities
starting from lodging of a complaint till its closure by SEBI would be online in an automated environment and the
complainant can view the status of his complaint online. An investor, who is not familiar with SCORES or does
not have access to SCORES, can lodge complaints in physical form at any of the offices of SEBI. Such complaints
would be scanned and also uploaded in SCORES for processing.
Investor Protection and Education Fund
To protect the interest of investor and shareholder SEBI has set up an Investor Protection and Education Fund.
22 PP-CC&MM
SEBI has notified regulations for administration of the fund which is used solely for the purpose to educate the
investor, to conduct the awareness programme and other incidental matters. These regulations are called the
SEBI (Investor Protection and Education Fund) Regulations, 2009. The following amounts shall be credited to
the Fund:
(a) contribution as may be made by SEBI to the Fund;
(b) grants and donations given to the Fund by the Central Government, State
(c) Government or any other entity approved by SEBI for this purpose;
(d) proceeds in accordance with the sub-clause (ii) of clause(e) of sub-regulation (12) and the sub- regulation
(13)of regulation 28 of the Securities and Exchange Board of India (Substantial Acquisition of Shares
and Takeovers) Regulations, 1997;
(e) security deposits, if any, held by stock exchanges in respect of public issues and rights issues, in the
event of de-recognition of such stock exchanges;
(f) amounts in the Investor Protection Fund and Investor Services Fund of a stock exchange, in the event
of de-recognition of such stock exchange;
(g) interest or other income received out of any investments made from the Fund;
(h) such other amount as SEBI may specify in the interest of investors.
SECURITIES APPELLATE TRIBUNAL
Securities Appellate Tribunal (SAT) is a statutory body established under the provisions of Section 15K of the
SEBI Act, 1992 to hear and dispose of appeals against orders passed by SEBI or by an adjudicating officer
under the Act and to exercise jurisdiction, powers and authority conferred on the Tribunal by or under SEBI Act
or any other law for the time being in force.
Any Securities Market intermediary/person aggrieved by an order of an adjudicating officer/SEBI has a right to
appeal to Securities Appellate Tribunal (SAT). The appeal must be filed within a period of 45 days from the date
of receipt of the order by the adjudicating officer/SEBI. The SAT can entertain an appeal after the expiry of 45
days for sufficient cause. It can confirm/modify/set aside the order appealed against within six months from the
date of receipt of appeal.
In order to enable the SAT to dispose off appeals expeditiously, it is not bound by the procedure laid down by the
criminal procedure code; instead it is guided by the principle of natural justice. It has the powers to regulate its
own procedure including the place of sitting. For the purpose of discharging its functions, the SAT has the same
powers as are vested in a civil court under the civil procedure code while trying a suit in respect of : (a) summoning
and enforcing the attendance of any person and examining him on oath; (b) requiring the delivery and production
of documents; (c) receiving evidence on affidavits; (d) issuing commission for the examination of witness/
documents; (e) reviewing the decisions; (f) dismissing an application for default or deciding it ex-parte; (g)
setting aside any order of dismissal of any application for default or any order passed by it ex-parte and (h) any
other mater which may be prescribed.
Any proceeding before the SAT is deemed to be a judicial proceeding under the Indian Penal Code and the SAT
is deemed to be a civil court under the Code of Criminal Procedure.
No civil court has jurisdiction over the adjudicating officers and the SAT. The only remedy available to any aggrieved
party against the decision/order of the SAT is an appeal within 60 days from the date of communication to the decision
or order of the Securities Appellate Tribunal on any question of fact or law arising out of such order to a Supreme
Court. It has been provided that the Supreme Court may, if it is satisfied that the applicant was prevented by sufficient
cause from filing the appeal within the said period, allow it to be filed within a further period not exceeding 60 days.
Lesson 2
Legal Framework of Capital Market
23
PREVENTION OF MONEY LAUNDERING ACT, 2002
The Prevention of Money Laundering Act (PMLA), 2002 was enacted in January, 2003. The Act along with the
Rules framed thereunder have come into force with effect from 1st July, 2005.
Section 3 of PMLA defines offence of money laundering as 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 and projecting it as untainted property shall be guilty of offence of money-laundering. It
prescribes obligation of banking companies, financial institutions and intermediaries for verification and
maintenance of records of the identity of all its clients and also of all transactions and for furnishing information
of such transactions in prescribed form to the Financial Intelligence Unit-India (FIU-IND). It empowers the Director
of FIU-IND to impose fine on banking company, financial institution or intermediary if they or any of its officers
fails to comply with the provisions of the Act as indicated above.
PMLA empowers certain officers of the Directorate of Enforcement to carry out investigations in cases involving
offence of money laundering and also to attach the property involved in money laundering. PMLA envisages
setting up of an Adjudicating Authority to exercise jurisdiction, power and authority conferred by it essentially to
confirm attachment or order confiscation of attached properties. It also envisages setting up of an Appellate
Tribunal to hear appeals against the order of the Adjudicating Authority and the authorities like Director FIU-IND.
PMLA envisages designation of one or more courts of sessions as Special Court or Special Courts to try the
offences punishable under PMLA and offences with which the accused may, under the Code of Criminal Procedure
1973, be charged at the same trial. PMLA allows Central Government to enter into an agreement with Government
of any country outside India for enforcing the provisions of the PMLA, exchange of information for the prevention
of any offence under PMLA or under the corresponding law in force in that country or investigation of cases
relating to any offence under PMLA.
Objective
The PML Act seeks to combat money laundering in India and has three main objectives:
– To prevent and control money laundering
– To confiscate and seize the property obtained from the laundered money; and
– To deal with any other issue connected with money laundering in India.
Offence of Money-Laundering
Section 3 of the Prevention of Money Laundering Act, 2002 defines offence of money laundering as under:
“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 and projecting it as untainted property
shall be guilty of offence of money laundering."
Punishment for Money-Laundering
Section 4 of the Prevention of Money Laundering Act, 2002 specifies punishment for money laundering as
under:
Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term
which shall not be less than three years but which may extend to seven years and shall also be liable to fine
which may extend to five lakh rupees.
Provided that where the proceeds of crime involved in money-laundering relates to any offence specified under
paragraph 2 of Part A of the Schedule, the provisions of this section shall have effect as if for the words "which
may extend to seven years", the words "which may extend to ten years" had been substituted."
24 PP-CC&MM
Obligations of Banking Companies, Financial Institutions and Intermediaries of Securities
Market
Section 12 of the Prevention of Money Laundering Act, 2002 lays down following obligations on banking
companies, financial institutions and intermediaries.
Every banking company, financial institution and intermediary shall –
(a) maintain a record of all transactions, the nature and value of which may be prescribed, whether such
transactions comprise of a single transaction or a series of transactions integrally connected to each
other, and where such series of transactions take place within a month;
(b) furnish information of transactions referred to in clause (a) to the Director within such time as may be
prescribed;
(c) verify and maintain the records of the identity of all its clients, in such a manner as may be prescribed.
Provided that where the principal officer of a banking company or financial institution or intermediary, as the
case may be, has reason to believe that a single transaction or series of transactions integrally connected to
each other have been valued below the prescribed value so as to defeat the provisions of this section, such
officer shall furnish information in respect of such transactions to the Director within the prescribed time.
The records referred above is required to be maintained for a period of ten years from the date of transactions
between the clients and the banking company or financial institution or intermediary, as the case may be.
The records referred to in clause (c) shall be maintained for a period of ten years from the date of cessation of
transactions between the clients and the banking company or financial institution or intermediary, as the case
may be.
Intermediary under PMLA includes following persons registered under Section 12 of SEBI Act:(i) Stock brokers
(ii) Sub-brokers
(iii) Share transfer agents
(iv) Bankers to an issue
(v) Trustees to trust deed
(vi) Registrars to issue
(vii) Merchant bankers
(viii) Underwriters
(ix) Portfolio Managers
(x) Investment advisers
(xi) Depositories and Depository Participants
(xii) Custodian of securities
(xiii) Foreign institutional investors
(xiv) Credit rating agencies
(xv) Venture capital funds
(xvi) Collective investment schemes including mutual funds
Lesson 2
Legal Framework of Capital Market
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Cash Transaction Reports
The Prevention of Money-laundering Act, 2002, and rule thereunder require every banking company, financial
institution and intermediary, to furnish to FIU-IND information relating to A. All cash transactions of the value of more than rupees ten lakhs or its equivalent in foreign currency;
B. All series of cash transactions integrally connected to each other which have been valued below rupees
ten lakhs or its equivalent in foreign currency where such series of transactions have taken place within
a month;
Suspicious Transaction Reports
Every banking company, financial institution and intermediary shall furnish to FIU-IND information of all suspicious
transactions whether or not made in cash.
Suspicions Transaction means a transaction including an attempted transaction, whether or not made in
cash which, to a person acting in good faith –
(a) gives rise to a reasonable ground of suspicion that it may involve proceeds of an offence specified in
the Schedule to the Act, regardless of the value involved; or
(b) appears to be made in circumstances of unusual or unjustified complexity; or
(c) appears to have no economic rationale or bonafide purpose; or
(d) gives rise to a reasonable ground of suspicion that it may involve financing of the activities relating to
terrorism.
Broad categories of reason for suspicion and examples of suspicious transactions for a banking company
are indicated as under:
Identity of client
– False identification documents
– Identification documents which could not be verified within reasonable time
– Accounts opened with names very close to other established business entities
Background of client
– Suspicious background or links with known criminals
Multiple accounts
– Large number of accounts having a common account holder, introducer or authorized
Signatory with no rationale
– Unexplained transfers between multiple accounts with no rationale
Activity in accounts
– Unusual activity compared with past transactions
– Sudden activity in dormant accounts
– Activity inconsistent with what would be expected from declared business
Nature of transactions
– Unusual or unjustified complexity
26 PP-CC&MM
– No economic rationale or bonafide purpose
– Frequent purchases of drafts or other negotiable instruments with cash
– Nature of transactions inconsistent with what would be expected from declared business
Value of transactions
– Value just under the reporting threshold amount in an apparent attempt to avoid reporting
– Value inconsistent with the client’s apparent financial standing
Broad categories of reason for suspicion and examples of suspicious transactions for an intermediary
are indicated as under:
Identity of Client
– False identification documents
– Identification documents which could not be verified within reasonable time
– Non-face to face client
– Doubt over the real beneficiary of the account
– Accounts opened with names very close to other established business entities
Suspicious Background
– Suspicious background or links with known criminals
Multiple Accounts
– Large number of accounts having a common account holder, introducer or authorized
Signatory with no rationale
– Unexplained transfers between multiple accounts with no rationale
Activity in Accounts
– Unusual activity compared to past transactions
– Use of different accounts by client alternatively
– Sudden activity in dormant accounts
– Activity inconsistent with what would be expected from declared business
– Account used for circular trading
Nature of Transactions
– Unusual or unjustified complexity
– No economic rationale or bonafide purpose
– Source of funds are doubtful
– Appears to be case of insider trading
– Investment proceeds transferred to a third party
– Transactions reflect likely market manipulations
– Suspicious off market transactions
Lesson 2
Legal Framework of Capital Market
27
Value of Transactions
– Value just under the reporting threshold amount in an apparent attempt to avoid reporting
– Large sums being transferred from overseas for making payments
– Inconsistent with the clients apparent financial standing
– Inconsistency in the payment pattern by client
– Block deal which is not at market price or prices appear to be artificially inflated/deflated.
Agreements with foreign countries
Section 56 of the Prevention of Money Laundering Act, 2002 provides for agreements with foreign countries to
facilitate exchange of information with them.
– The Central Government may enter into an agreement with the Government of any country outside
India for(i) enforcing the provisions of this Act;
(ii) exchange of information for the prevention of any offence under this Act or under the corresponding
law in force in that country or investigation of cases relating to any offence under this Act.
and may, by notification in the Official Gazette, make such provisions as may be necessary for
implementing the agreement.
– The Central Government may, by notification in the Official Gazette, direct that the application of this Act
in relation to a contracting State with which reciprocal arrangements have been made, shall be subject
to such conditions, exceptions or qualifications as are specified in the said notification.
As per the PMLA, the officers of the Directorate of Enforcement have been given powers to investigate cases of
Money Laundering. The enforcement agency has extensive powers to discharge its duties under the Act. The
officers have also been authorised to initiate proceedings for attachment of property and to launch prosecution
in the designated Special Court. Financial Intelligence Unit-India (FIU-IND) is the authority to implement the
provisions of the Act. The application of AML measures by market intermediaries has been emphasized by
International Regulatory agencies as a key element in combating money laundering. Financial Action Task
Force (FATF) is the agency who evaluates the member countries and certify whether they are compliant or not.
India has been confirmed as one of the country that is compliant with AML regulations during December 2010.
Apart from the FIU and FATF, Central Bureau of Investigation(CBI) is also empowered to investigate cases
relating to Money Laundering.
INVESTIGATING AGENCIES IN CASE OF PMLA, 2002
The following investigating agencies are involved in case of PMLA, 2002
Directorate of Enforcement
The Directorate of Enforcement, with its Headquarters at New Delhi is headed by the Director of Enforcement.
In case of money laundering investigation can be initiated only by authorities designated by Central Government
such as Directorate of Enforcement. These authorities can carry out interim measures such as the survey,
search, seizure and arrest of the accused. Section 13 of the Prevention of Money Laundering Act, 2002, confers
power on the Director (appointed by the Central Government and entrusted with powers of a civil court) to
ensure compliance and to call for records and make appropriate inquiries when necessary.
Functions
The main functions of the Directorate are as under :
28 PP-CC&MM
1. Investigate contraventions of the provisions of Foreign Exchange Management Act, 1999 (FEMA).
Contraventions of FEMA are dealt with by way of adjudication by designated authorities of Enforcement
Directorate (ED) and penalties upto three times the sum involved can be imposed.
2. Investigate offence of money laundering under the provisions of Prevention of Money Laundering Act,
2002 (PMLA) and to take actions of attachment and confiscation of property if the same is determined
to be proceeds of crime derived from a Scheduled Offence under PMLA, and to prosecute the persons
involved in the offence of money laundering. There are 156 offences under 28 statutes which are
Scheduled Offences under PMLA.
3. Adjudicate Show Cause Notices issued under the repealed Foreign Exchange Regulation Act, 1973
(FERA) upto 31.5.2002 for the alleged contraventions of the Act which may result in imposition of penalties.
Pursue prosecutions launched under FERA in the concerned courts.
4. Sponsor cases of preventive detention under Conservation of Foreign Exchange and Prevention of
Smuggling Activities Act, 1974 (COFEPOSA) in regard to contraventions of FEMA.
5. Render cooperation to foreign countries in matters relating to money laundering and restitution of assets
under the provisions of PMLA and to seek cooperation in such matters.
Central Bureau of Investigation
Investigating in CBI was conducted by its Economic Offences Wing, a separate division in the CBI for investigating
of economic offences.
CBI derives its powers of investigation from Delhi Special Police Establishment Act (DSPE) and investigates
cases notified U/S 3 of the DSPE Act, 1946. However, as the law and order is a State subject and basic
jurisdiction to investigate crimes lies with the State Police, the CBI suo moto investigates cases against
employees of Central Government/Public Sector Undertakings of the Government of India in the Union
Territories. Investigation in respect of them is conducted in the States with the consent of concerned State U/
S 6 of the DSPE Act.
As regards economic offences, CBI is empowered to investigate offences which are also notified U/S 3 of the
DSPE Act in the Union Territories and such offences can be investigated in the State with the consent of the
State Government as required U/S 6 of the DSPE Act.
Therefore, in terms of Economic Offences, CBI can investigate : –
(i) Cases of fraud, cheating, embezzlement and the like relating to companies in which large funds are
involved and some other cases when committed by organized gangs or professionals having ramifications
in several States.
(ii) Cases having inter-state and international ramifications and involving several official agencies where it
is considered necessary that a single investigating agency like CBI should be in charge of investigation.
Financial Intelligence Unit – India (FIU-IND)
FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the
Finance Minister of India. Financial Intelligence Unit – India (FIU-IND) was set by the Government of India vide
O.M. dated 18th November 2004 as the central national agency responsible for receiving, processing, analyzing
and disseminating information relating to suspect financial transactions. FIU-IND is also responsible for
coordinating and strengthening efforts of national and international intelligence, investigation and enforcement
agencies in pursuing the global efforts against money laundering and related crimes.
Lesson 2
Legal Framework of Capital Market
29
Functions of FIU-IND
The main function of FIU-IND is to receive cash/suspicious transaction reports, analyse them and, as appropriate,
disseminate valuable financial information to intelligence/enforcement agencies and regulatory authorities . The
functions of FIU-IND are:
1. Collection of Information: Act as the central reception point for receiving Cash Transaction reports (CTRs)
and Suspicious Transaction Reports (STRs) from various reporting entities.
2. Analysis of Information: Analyze received information in order to uncover patterns of transactions suggesting
suspicion of money laundering and related crimes.
3. Sharing of Information: Share information with national intelligence/law enforcement agencies, national
regulatory authorities and foreign Financial Intelligence Units.
4. Act as Central Repository: Establish and maintain national data base on cash transactions and suspicious
transactions on the basis of reports received from reporting entities.
5. Coordination: Coordinate and strengthen collection and sharing of financial intelligence through an effective
national, regional and global network to combat money laundering and related crimes.
6. Research and Analysis: Monitor and identify strategic key areas on money laundering trends, typologies
and developments.
The Financial Action Task Force (FATF)
Financial Action Task Force (FATF) was established in July 1989 by a Group of Seven (G-7) Summit in Paris,
initially to examine and develop measures to combat money laundering. The objectives of the FATF are to set
standards and promote effective implementation of legal, regulatory and operational measures for combating
money laundering, terrorist financing and other related threats to the integrity of the international financial system.
The FATF is therefore a “policy-making body” which works to generate the necessary political will to bring about
national legislative and regulatory reforms in these areas.
The FATF has developed a series of Recommendations that are recognised as the international standard for
combating of money laundering and the financing of terrorism and proliferation of weapons of mass destruction.
They form the basis for a co-ordinated response to these threats to the integrity of the financial system and help
ensure a level playing field. First issued in 1990, the FATF Recommendations were revised in 1996, 2001, 2003
and most recently in 2012 to ensure that they remain up to date and relevant, and they are intended to be of
universal application.
The FATF monitors the progress of its members in implementing necessary measures, reviews money
laundering and terrorist financing techniques and counter-measures, and promotes the adoption and
implementation of appropriate measures globally. In collaboration with other international stakeholders, the
FATF works to identify national-level vulnerabilities with the aim of protecting the international financial system
from misuse.
FATF Recommendations 2012
The FATF Recommendations are the basis on which all countries should meet the shared objective of tackling
money laundering, terrorist financing and the financing of proliferation. The FATF calls upon all countries to
effectively implement these measures in their national systems.
A – AML/CFT POLICIES AND COORDINATION
1 - Assessing risks & applying a risk-based approach
2 - National cooperation and coordination
30 PP-CC&MM
B – MONEY LAUNDERING AND CONFISCATION
3 - Money laundering offence
4 - Confiscation and provisional measures
C – TERRORIST FINANCING AND FINANCING OF PROLIFERATION
5 - SRII Terrorist financing offence
6 - SRIII Targeted financial sanctions related to terrorism & terrorist financing
7 - Targeted financial sanctions related to proliferation
8 - Non-profit organisations
D – PREVENTIVE MEASURES
9 - Financial institution secrecy laws
Customer due diligence and record keeping
10 - Customer due diligence
11 - Record keeping
Additional measures for specific customers and activities
12 - Politically exposed persons
13 - Correspondent banking
14 - Money or value transfer services
15 - New technologies
16 - Wire transfers
Reliance, Controls and Financial Groups
17 - Reliance on third parties
18 - Internal controls and foreign branches and subsidiaries
19 - Higher-risk countries
Reporting of suspicious transactions
20 - Reporting of suspicious transactions
21 - Tipping-off and confidentiality
Designated non-financial Businesses and Professions (DNFBPs)
22 - DNFBPs: Customer due diligence
23 - DNFBPs: Other measures
E – TRANSPARENCY AND BENEFICIAL OWNERSHIP OF LEGAL PERSONS AND ARRANGEMENTS
24 - Transparency and beneficial ownership of legal persons
25 - Transparency and beneficial ownership of legal arrangements
F – POWERS AND RESPONSIBILITIES OF COMPETENT AUTHORITIES AND OTHER INSTITUTIONAL
MEASURES
Regulation and Supervision
Lesson 2
Legal Framework of Capital Market
31
26 - Regulation and supervision of financial institutions
27 - Powers of supervisors
28 - Regulation and supervision of DNFBPs
Operational and Law Enforcement
29 - Financial intelligence units
30 - Responsibilities of law enforcement and investigative authorities
31 - Powers of law enforcement and investigative authorities
32 - Cash couriers
General Requirements
33 - Statistics
34 - Guidance and feedback
Sanctions
35 - Sanctions
G – INTERNATIONAL COOPERATION
36 - International instruments
37 - Mutual legal assistance
38 - Mutual legal assistance: freezing and confiscation
39 - Extradition
40 - Other forms of international cooperation
LESSON ROUND UP
– The Securities Market operations promote the economic growth of the Country. More efficient is the
Securities Market, the greater is the promotion effect on economic growth.
– The Department of Economic Affairs is the nodal agency of the Union Government to formulate and
monitor the country's economic policies and programmes that have a bearing on domestic and
international aspects of economic management.
– The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act, 1956,
other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the
corporate sector in accordance with law.
– The CLB is a quasi-judicial body, exercising equitable jurisdiction, which was earlier being exercised by
the High Court or the Central Government.
– RBI regulates the foreign exchange inflow and outflow, by the Foreign Exchange Management Act,
1999 of RBI. All money transfer out of India is subject to limits defined by the RBI.
– The Securities and Exchange Board of India (SEBI) is the regulator charged with the orderly functioning
of the Securities Market in India, protect the interests of investors and ensure development of the
Securities Market.
32 PP-CC&MM
– The four main legislations governing the Securities Market are: (a) the SEBI Act, 1992 (b) the Companies
Act, 1956 (c) the Securities Contracts (Regulation) Act, 1956 (d) the Depositories Act, 1996.
– The Stock Exchange has designated Investor Grievance Redressal Committees (IGRCs), or Regional
Investor Complaints Resolution Committees (RICRC). This forum acts as a mediator to resolve the
claims, disputes and differences between entities and complainants.
– Investor Protection Fund (IPF) or Customer Protection Fund (CPF) is the fund set up by the Stock
Exchanges to meet the legitimate investment claims of the clients of the defaulting members that are
not of speculative nature.
– SEBI has a dedicated department viz., Office of Investor Assistance and Education (OIAE) to receive
investor grievances and to provide assistance to investors by way of education. Investors who are not
satisfied with the response to their grievances received from the Stock Exchanges/Depositories can
lodge their grievances with SEBI.
– To protect the interest of investor and shareholder SEBI has set up an Investor Protection and Education
Fund.
– Any Securities Market intermediary/person aggrieved by an order of an adjudicating officer/SEBI has a
right to appeal to Securities Appellate Tribunal (SAT).
– The Prevention of Money Laundering Act (PMLA), 2002 was enacted in January, 2003.
– Section 3 of PMLA defines offence of money laundering as 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 and projecting it as untainted property shall be guilty of offence of
money-laundering.
– PMLA empowers certain officers of the Directorate of Enforcement to carry out investigations in cases
involving offence of money laundering and also to attach the property involved in money laundering.
– CBI derives its powers of investigation from Delhi Special Police Establishment Act (DSPE) and
investigates cases notified U/S 3 of the DSPE Act, 1946.
– Financial Intelligence Unit – India (FIU-IND) was set by the Government of India as the central national
agency responsible for receiving, processing, analyzing and disseminating information relating to suspect
financial transactions.
– Financial Action Task Force (FATF) was established in July 1989 by a Group of Seven (G-7) Summit in
Paris, initially to examine and develop measures to combat money laundering.
– The FATF Recommendations are the basis on which all countries should meet the shared objective of
tackling money laundering, terrorist financing and the financing of proliferation.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly explain about the legislations governing Securities Market in India.
2. Discuss about the Grievance Redressal Mechanism at Stock Exchanges.
3. Explain the procedure relating to filing an appeal with SAT against an order passed by an adjudicating
officer or SEBI ?
4. What are the Obligations of Banking Companies, Financial Institutions and Intermediaries of Securities
Market under the Prevention of Money Laundering Act, 2002?
5. Describe the various functions of Financial Intelligence Unit – India (FIU-IND).
Lesson 2
Legal Framework of Capital Market
33
34 PP-CC&MM
Lesson 3
Framework of Market Infrastructure Institutions
Lesson 3
Framework of Market Infrastructure
Institutions
LESSON OUTLINE
35
LEARNING OBJECTIVES
– Introduction
Stock Exchanges and other institutions like
– Securities Contract(Regulation)( Stock
Exchanges and Clearing Corporations)
Regulations, 2012
Depositories and Clearing Corporations which
– Recognition of Stock Exchanges and
Clearing Corporations
country’s financial development and serve as
are as much a vital part of the market
infrastructure, are systemically important for the
the infrastructure necessary for the Securities
Market. SEBI has prescribed various Act and
– Networth Requirements
Regulations which have been modified from
– Ownership of Stock Exchanges
time to time as to respond to the needs of the
– Ownership of Clearing Corporations
technological advancement world over.
market and in keeping with financial and
The main objective of this lesson is to enable
– Governance of Stock Exchanges and
Clearing Corporations
the students to understand the Regulatory
Fram ework
– Listing of Securities
governing
the
the
Stock
Exchanges, Clearing Corporations and
Depositories in India.
– Procedural Norms
– Depositories Act, 1996
– Securities Contracts (Regulation) Act, 1956
– LESSON ROUND UP
– SELF TEST QUESTIONS
35
36 PP-CC&MM
FRAMEWORK OF MARKET INFRASTRUCTURE INSTITUIONS
Introduction
Stock Exchanges in India have a long history of more than 175 years. Stock Exchanges have witnessed drastic
change in their ownership and governance structure over time, from a purely closed club of trading members to
full demutualization, and from an organization resembling more a self regulatory organization to a SEBI regulated
entity. Changes have been made from time to time in the management and functioning of the stock exchanges
to serve the overarching objective of market development, financial inclusion, transparency, developing and
operating and risk free trading system. Along with stock exchanges other institutions (depositories and clearing
corporations) which are as much a vital part of the market infrastructure, for achieving the above objectives also
developed. These institutions (i.e., stock exchanges, depositories and clearing corporations) are systemically
important for the country’s financial development and serve as the infrastructure necessary for the securities
market. These institutions are collectively referred to as Market Infrastructure Institutions (MIIs). SEBI has
prescribed various Act and Regulations from time to time for the smooth functioning of these MIIs. These Acts
and Regulations have been modified from time to time as to respond to the needs of the market and in keeping
with financial and technological advancement world over.
SECURITIES CONTRACT (REGULATION) (STOCK EXCHANGES AND CLEARING
CORPORATIONS) REGULATIONS, 2012
SEBI notified the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations,
2012 (“SECC Regulations“) on June 20, 2012 to regulate recognition, ownership and governance in Stock
Exchanges and Clearing Corporations and matters connected therewith or incidental thereto.
These Regulations provides for recognition, ownership, governance and listing provisions with respect to Stock
Exchanges as well as Clearing Corporations. The important provisions of the new Regulations are discussed
here under:
Recognition of Stock Exchanges and Clearing Corporations
As per the provisions of these Regulations, all Stock Exchanges and Clearing Corporations are required to
apply for recognition by the SEBI. The Stock Exchanges which have been recognized under the Act as on the
date of commencement of these Regulations shall be deemed to have been recognized under these Regulations
and all the provisions shall be applicable on them. The existing Clearing Corporations will continue for a period
of 3 months from the date of applicability of these Regulations until an application made for the recognitions is
disposed of. The Regulations provides for manner of making application, fees, documents required and
consideration for grant of recognition by SEBI. The Regulations also provides for the period of recognition,
regulatory fees as well as provisions with respect to renewal and withdrawal of recognition.
Networth Requirements
Stock Exchanges and Clearing Corporations are required to maintain minimum networth requirements of ` 100
crores at all times. The existing recognized Stock Exchanges and Clearing Corporations are required to fulfill the
networth requirement within a maximum period of 3 years from the date of commencement of these Regulations.
The limit is not to apply to an applicant performing clearing functions of a recognized stock exchange on the date
of commencement of these regulations. It is further provided that the recognized Stock Exchange or the recognized
Clearing Corporation shall not distribute profit in manner to its shareholders until specified networth limit is met.
The manner of calculation of networth is also prescribed which vary in case of Stock Exchange and Clearing
Corporations.
Lesson 3
Framework of Market Infrastructure Institutions
37
Ownership of Stock Exchanges
As per the provisions of the Regulations, the shareholding or ownership of a stock exchange shall be as following:
Shareholder
Equity share holding limit
Equity Share Capital to be held by Public
Atleast 51% total
Individual resident in India (either directly or indirectly and either
individually or with Person Acting in Concert (PAC))
Not more than 5% individually
Further
Not more than 15% individually
– Stock exchange
– Depository
– Banking company
– Insurance company
– Public financial Institution
(either directly or indirectly and either individually or with PAC)
All the residents outside India taken together
Not more than 49% total
An Individual resident outside India (either directly or indirectly and
either individually or with PAC)
Not more than 5% individually
Total holding of residents outside India through FDI route
Not to exceed 26% in total
Total holding of Foreign Institutional Investors (no shares to be
acquired other than through secondary market)
Not to exceed 23% in total
No Clearing Corporation shall hold any right, stake or interest in any recognized Stock Exchange.
Any person who directly or indirectly and either individually or with PAC acquires 2% or more in equity capital
would require to apply for approval of SEBI within 15 days of such acquisition. If the approval is not granted
the shares so acquired shall be forthwith divested. Shareholders of existing recognized Exchange holding
more than 2% equity may apply for approval within 90 days of commencement of these Regulations.
Stock exchange, Depository, Banking company, Insurance company, Public financial Institution allowed to
hold upto 15% equity capital, cannot acquire either directly or indirectly and either individually or with PAC
any holding over and above 5% without the prior approval from SEBI.
Every shareholder of the recognized Stock Exchange is required to be a Fit & Proper person.
Ownership of Clearing Corporations
The provisions with respect to ownership and shareholding of recognized Clearing Corporations as similar to
the aforesaid provisions as applicable to recognized Stock Exchanges except for as following:
– 51% or more equity share capital to be held by one or more recognized Stock Exchanges.
– A single Stock Exchange cannot hold more than 15% of equity share capital in one Clearing Corporation.
Governance of Stock Exchanges and Clearing Corporations
The provisions with respect to management and governance of recognized Stock Exchanges as well as Clearing
Corporations are also provided in the Regulation broadly covering the following:
38 PP-CC&MM
– Composition of Governance Board
– Guidelines for election of chairperson as well as number of public interest directors, appointment of
Shareholder director, etc on the Governing Board.
– Conditions for appointment of Directors and the Managing Director.
– Code of conduct for Directors and Key Managerial Personnel.
– Compensation and Tenure for Key Managerial Personnel.
– Segregation of regulatory department from other departments.
– Constitution of Oversight committee
To address conflicts of interest in respect of member regulation, listing functions and trading and surveillance
function.
– Constitution of Advisory Committee
To advice governing board on non regulatory and operational matters including product design,
technology, charges and levies.
– Constitution of Risk Management committee (in case of clearing corporations)
– To formulate and implement a comprehensive detail risk management policy.
– Appointment of compliance officer
– Transfer of Profits
– Transfer of penalties
– Disclosure and Corporate Governance norms.
Listing of Securities
As per the provisions of the Regulations, a recognized stock exchange can apply for the listing of its securities
on any recognized stock exchange other than itself if:
– It complies with the provisions of these regulations.
– It has completed 3 years of continuous trading operations immediately preceding the date of application
of listing.
– It has the approval of the board.
Though as per the provisions of these Regulations, the securities of a recognized Clearing Corporation shall not
be listed on a stock exchange.
The Regulations also requires securities of both the recognized Stock Exchanges as well as Clearing Corporations
to be held in dematerialized form.
PROCEDURAL NORMS
To facilitate the implementation of the SECC Regulations and provide guidelines to Stock Exchanges and Clearing
Corporations for their operations in accordance with the terms of SECC Regulations, SEBI has issued procedural
norms on recognition, ownership and governance for Stock Exchanges and Clearing Corporations dated
December 13, 2012.
The Procedural Norms are divided into four (4) parts as Parts A to D which are discussed in brief as follows:
Lesson 3
Framework of Market Infrastructure Institutions
39
Part A: Recognition
For the purpose of granting in principle approval in terms of regulation 7(5) of the SECC Regulations, SEBI is
entitled to consider inter alia the following information in relation to an application made under regulation 4 of
the SECC Regulations:
– Business feasibility plan for the next five years;
– Net worth certificate/ financial books and bank account details;
– Detailed write-up on each of its functions;
– Details of authorized officials along with specimen signatures of the authorized signatories;
– Proposed organizational structure;
– Necessary undertakings;
– Manpower planning;
– Background and necessary information (as specified herein) to establish that its shareholders/promoters
are fit and proper persons, Information regarding its Office set-up, Appointment of Managing Director
after following due process;
Paragraph 2 of the Procedural Norms provides that a Clearing Corporation shall make bye-laws providing inter
alia for the following:
– The timings for pay-in and pay-out of funds and securities;
– Rules for clearing and settlement;
– Risk management mechanism;
– Process of netting, novation and guarantee for settlement of trades;
– Norms for contribution into and utilization of the Fund in terms of regulation 39 of SECC Regulations;
– Rights and obligations of the clearing members vis a vis the clearing Corporation, other clearing members,
the trading members and clients of such trading members;
– Criteria for admission and regulation of clearing members;
– Default handling mechanism;
– Committees as mentioned in paragraph 7 of the Procedural Norms;
– Any other matter as may be specified by SEBI.
Part B : Action Plan for achieving Networth
– In terms of regulation 14 of SECC Regulations a recognized stock exchange is required to have a net
worth of ` 100 crore. However, in case of a stock exchange having a net worth less than ` 100 crore
such stock exchange is required to submit a plan duly approved by its shareholders to achieve such net
worth in accordance with the terms of regulation 14 of the SECC Regulations. This plan has to be
submitted within a period of ninety days from the date of issue of the Procedural Norms.
– A clearing corporation which has made application for recognition in terms of Regulation 3 of SECC Regulations
and has a networth of less than ` 300 crore shall submit its plan duly approved by its shareholders to SEBI
for achieving its networth withhin 90 days from the date of issue of the Procedural Norms.
Ownership
– In terms of Regulation 17(2) of the SECC Regulations except no person resident in India is allowed to
hold or acquire more than 5% of the paid up equity capital in a stock exchange.
40 PP-CC&MM
– However, a stock exchange, depository, banking company, insurance company and a public financial
institution may acquire or hold up to 15% of the paid up equity capital in a stock exchange.
– Despite the SECC Regulations providing a threshold of 5% for the shareholding, the Procedural Norms
state that a shareholder holding more than 2% of the paid up equity capital in a stock exchange is
required to obtained SEBI’s prior approval.
– Under paragraph 5 of the Procedural Norms, the stock exchange/clearing corporation is required to put
in place a monitoring mechanism to ensure compliance with the shareholding requirements at all times.
The stock exchange/clearing corporation is also required to:
– Disseminate on its website the number of shares available in non-public, FII and FDI category. The
same shall also be disseminated by the stock exchange where shares of such stock exchange/clearing
corporation are listed;
– Check the shareholding pattern of the stock exchange/clearing corporation from time to time to ensure
compliance with the SECC Regulations;
– Upon breach of shareholding limits, same shall be intimated to SEBI within seven days.
Part C: Governance
– Paragraph 6.2.1 of the Procedural Norms states that for the purpose of appointment of CEO/Managing
Director/Executive Director the Stock Exchange/Clearing Corporation shall constitute a committee which
shall oversee the appointment. In this regard the managing director shall be selected through open
advertisement in all editions of at least one national daily from amongst persons qualified in the fields of
capital markets/ finance/ management and possessing sufficient experience.
– Under paragraph 6.3.1 of the Procedural Norms the Board of the Stock Exchange/Clearing Corporation
may forward a minimum of two names for each vacancy of public interest directors. In terms of paragraph
6.3.3 chairperson of the Stock Exchange/Clearing Corporation shall be appointed with the prior approval
of SEBI. In terms of paragraph 6.3.4 public interest directors are not permitted to simultaneously hold
positions on the board of other Stock Exchanges/Clearing Corporations or their subsidiaries.
– Paragraph 6.4 deals with shareholder directors. Names of persons nominated for appointment as
shareholder directors shall be sent to SEBI after approval of such names from the Board of the Stock
Exchange/Clearing Corporations and Shareholders’ approval of the Stock Exchange/Clearing
Corporation.
– The Board shall appoint trading members/ clearing members to the advisory committee after being
satisfied that they are fit and proper persons in terms of regulation 20 of the SECC Regulations. The
Board shall also appoint a compliance officer in terms of regulation 32 of the SECC Regulation. The
Board shall ensure that all key management persons are fit and proper as per regulation 20 of SECC
Regulations.
– Paragraph 7 requires the formation of various statutory committees. Stock exchanges are required to
have committees such as Investor Grievance Redressal Committee, Defaulters’ Committee, Investor
Services Committee, Advisory Committee, Ethics Committee, Arbitration Committee, and Independent
Oversight Committee of the Governing Board for Trading and Surveillance Function, etc. and Clearing
Corporation to have Advisory Committee, Risk Management Committee, and Ethics Committee.
– Paragraph 8 provides for Norms for Compensation Policy. Regulation 27 of SECC Regulations mandates
that the Compensation Policy for Key Management Personnel of Stock Exchange/Clearing Corporation
shall be in accordance with the norms specified by SEBI.
– Paragraph 9 of the Procedural Norms mandates the segregation of regulatory departments from other
Lesson 3
Framework of Market Infrastructure Institutions
41
departments in Stock Exchanges. Some of the key regulatory departments are surveillance, listing,
member registration, compliance, inspection, enforcement, investor protection, etc. Similarly such a
separation is mandated for clearing corporations. Some of the key regulatory departments in clearing
corporations are risk management, member registration, compliance, inspection, enforcement, default,
investor protection, etc.
Part D of the Procedural Norms deals with Miscellany including procedural aspects such as amendments to the
bye laws of Stock Exchanges/Clearing Corporations, internal manual for conflict resolution, disclosure of securities
transactions by directors and parties related thereto, other clarifications, etc.
THE DEPOSITORIES ACT, 1996
The Depositories Act, 1996 provides for the establishment of single or multiple depositories. Any body to be
eligible for providing depository services must be formed and registered as a company under the Companies
Act, 1956 and seek registration with SEBI and obtain a Certificate of Commencement of Business from SEBI on
fulfilment of the prescribed conditions.
Objectives
The depositories legislation as per the Statement of objects and reasons appended to the Depositories Act,
1996 aims at providing for:
– A legal basis for establishment of depositories to conduct the task of maintenance of ownership records
of securities and effect changes in ownership records through book entry;
– Demateralisation of securities in the depositories mode as well as giving option to an investor to choose
between holding securities in physical mode and holding securities in a dematerialized form in a
depository;
– Making the securities fungible;
– Making the shares, debentures and any interest thereon of a public limited company freely transferable;
and
– Exempting all transfers of shares within a depository from stamp duty.
Eligibility condition for Depository Services
Any company or other institution to be eligible to provide depository services must:
– be formed and registered as a company under the Companies Act, 1956.
– be registered with SEBI as a depository under SEBI Act, 1992.
– has framed bye-laws with the previous approval of SEBI – has one or more participants to render
depository services on its behalf.
– has adequate systems and safeguards to prevent manipulation of records and transactions to the
satisfaction of SEBI.
– complies with Depositories Act, 1996 and SEBI (Depositories and Participants) Regulations, 1996.
– meets eligibility criteria in terms of constitution, network, etc.
Eligible Securities required to be in the Depository Mode
Section 8 of the Depositories Act gives the option to the investors to receive securities in physical form or in
depository mode.
42 PP-CC&MM
It is not necessary that all eligible securities must be in the depository mode. The investor has the choice of
holding physical securities or opt for a depository based ownership record.
However in case of fresh issue of securities all securities issued have to be in dematerialized form. However
after that investor will also have the freedom to switch from depository mode to non-depository mode and vice
versa. The decision as to whether or not to hold securities within the depository mode and if in depository mode,
which depository or participant, would be entirely with the investor.
Fungibility
Section 9 states that securities in depositories shall be in fungible form.
The Act envisages that all securities held in depository shall be fungible i.e. all certificates of the same security
shall become interchangeable in the sense that investor loses the right to obtain the exact certificate he surrenders
at the time of entry into depository. It is like withdrawing money from the bank without bothering about the
distinctive numbers of the currencies.
Immobilisation of securities in a depository mode refers to a situation where the depository holds securities in
the form of physical paper side by side with electronic evidence of ownership. In such a case the transfers are
not accompanied by physical movement of securities but securities are in existence in the custody of the depository.
However, the Depositories Act, envisages dematerialisation in the depository mode. In such a case the securities
held in a depository shall be dematerialized and the ownership of the securities shall be reflected through book
entry only. The securities outside the depository shall be represented by physical scrips. Hence, the depository
legislation envisages partial dematerialisation, i.e. a portion of the securities in dematerialized form and the
other portion in physical form. Sections 153, 153A, 153B, 187B, 187C and 372 (now 372A) of Companies Act,
1956 shall not apply to a depository in respect of shares held on behalf of beneficial owners in depositories.
Rights of Depositories and Beneficial Owner
A depository should be deemed to be the registered owner for the purposes of effecting transfer of ownership of
security on behalf of a beneficial owner. The depository as a registered owner should not have any voting rights
or any other rights in respect of securities held by it. The beneficial owner is entitled to all the rights and benefits
and be subjected to all the liabilities in respect of his securities held by a depository.
Register of beneficial owner
Every depository is required to maintain a register and an index of beneficial owners in the manner provided in
the Companies Act.
Pledge or hypothecation of securities held in a depository
A beneficial owner may with the previous approval of the depository create a pledge or hypothecation in respect
of a security owned by him through a depository. Every beneficial owner should give intimation of such pledge or
hypothecation to the depository and such depository is required to make entries in its records accordingly. Any
entry in the records of a depository should be evidence of a pledge or hypothecation.
Pledge and Hypothecation
If the lender (pledgee) has unilateral right (without reference to borrower) to appropriate the securities to his
account if the borrower (pledgor) defaults or otherwise, the transaction is called a pledge. If the lender needs
concurrence of the borrower (pledgor) for appropriating securities to his account, the transaction is called
hypothecation. The Depositories Act, 1996 permits the creation of pledge and hypothecation against securities.
Securities held in a depository account can be pledged or hypothecated against a loan, credit, or such other
facility availed by the beneficial owner of such securities. For this purpose, both the parties to the agreement,
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i.e., the pledgor and the pledgee must have a beneficiary account with Depository. However, both parties
need not have their depository account with the same DP. The nature of control on the securities offered as
collateral determines whether the transaction is a pledge or hypothecation.
Procedure for Pledge/Hypothecation
The pledgor initiates the creation of pledge/hypothecation through its DP and the pledge instructs its DP to
confirm the creation of the pledge. The pledge/hypothecation so created can either be closed on repayment
of loan or invoked if there is a default. After the pledgor has repaid the loan to the pledgee, the pledgor
initiates the closure of pledge/hypothecation through its DP and the pledgee instructs its DP to confirm the
closure of the pledge/hypothecation. If the pledgor defaults in discharging his obligation under the agreement,
the pledgee may invoke the pledge/ hypothecation. This has to be done after taking the necessary steps
under the terms of the agreement with the pledgor and the Bye-Laws of Depository and rules and regulations
framed by SEBI.
Furnishing of information and records by depository and issuer
Every depository is required to furnish to the issuer information about the transfer of securities in the name of
beneficial owners at such intervals and in such manner as may be specified by the bye-laws of depository. Every
issuer should make available to the depository copies of the relevant records in respect of securities held by
such depository.
Option to opt out in respect of any security
Section 14 of the Depository Act provides that if a beneficial owner seeks to opt out of a depository in respect of
any security he should inform the depository accordingly. After the receipt of intimation the depository should
make appropriate entries in its records and also inform the issuer. Every issuer may, within thirty days of the
receipt of intimation from the depository and on fulfilment of such conditions and on payment of such fees as
may be specified by the regulations, issue the certificate of securities to the beneficial owner or the transferee,
as the case may be.
Depositories to indemnify loss in certain cases
Any loss caused to the beneficial owner due to the negligence of the depository or the participant, would be
indemnified by the depository to such beneficial owner. Where the loss due to the negligence of the participant
is indemnified by the depository, the depository has the right to recover the same from such participant.
ENQUIRY AND INSPECTION
Power of SEBI
Section 18 of the Depositories Act provides that SEBI in the public interest or in the interest of investors
may by order in writing to 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 authorise any
person to make an enquiry or inspection in relation to the affairs of the issuer, beneficial owner, depository
or participant, who shall submit a report of such enquiry or inspection to it within such period as may be
specified in the order.
Sub-section (2) to Section 18 provides that every director, manager, partner, secretary, officer or employee of
the depository or issuer or the participant or beneficial owner shall on demand produce before the person
making the enquiry or inspection all information or such records and other documents in his custody having a
bearing on the subject matter of such enquiry or inspection.
If after making or causing to be made an enquiry or inspection, SEBI is satisfied that it is necessary in the
44 PP-CC&MM
interest of investors, or orderly development of securities market; or to prevent the affairs of any depository or
participant being conducted in the manner detrimental to the interests of investors or securities market, SEBI
may issue such directions to any depository or participant or any person associated with the securities market;
or to any issuer as may be appropriate in the interest of investors or the securities market.
Power of SEBI to give directions
Section 19 provides that after making an enquiry or inspection, SEBI if satisfied, can issue directions:
(a) to any depository or participant or any person associated with the securities market; or
(b) to any issuer
as may be appropriate in the interest of investors or the securities market.
The power to issue directions under Section 19 shall include and always be deemed to have been
included the power to direct any person, who made profit or averted loss by indulging in any transaction
or activity in contravention of the provisions of this Act or regulations made thereunder to disgorge
an amount equivalent to the wrongful gain made or loss averted by such contravention.
PENALTY
Penalty for failure to furnish information/return etc.
Section 19A provides that any person, who is required under Depositories Act or any rules or regulations or
bye¬laws made there under –
(a) to furnish any information, document, books, returns or report to SEBI, fails to furnish the same within
the time specified therefore fails to furnish the same within specified time;
(b) to file any return or furnish any information, books or other documents within the time specified therefore
in the regulations or bye-laws, fails to file return or furnish the same within the time specified therefore;
(c) to maintain books of account or records, fails to maintain the same;
he shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to enter into agreement
Section 19B provides that if a depository or participant or any issuer or its agent or any person, who is a
registered intermediary with SEBI and is required under this Act or any rules or regulations made there under, to
enter into an agreement, fails to enter into such agreement, such intermediary shall be liable to a penalty of one
lakh rupees for each day during which such failure continues or one crore rupees, whichever is less for every
such failure.
Penalty for failure to redress investors' grievances
Section 19C lays down that if any depository or participant or any issuer or its agent or any person, who is
registered intermediary with SEBI, after having been called upon by the SEBI in writing, to redress the grievances
of the investors, fails to redress such grievances within the time specified, such depository or participant or
issuer or its agents or intermediary shall be liable to a penalty of one lakh rupees for each day during which such
failure continues or one crore rupees, whichever is less.
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Penalty for delay in dematerialisation or issue of certificate of securities
Section 19D stipulates that if any issuer or its agent or any person, who is a registered intermediary, fails to
dematerialise or issue the certificate of securities on opting out of a depository by the investors, within the time
specified under this Act or regulations or bye-laws made there under or abets in delaying the process of
dematerialisation or issue the certificate of securities on opting out of a depository of securities, such intermediary
shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to reconcile records
Section 19E provides that if a depository or participant or any issuer or its agent or any person, who is a
registered intermediary, fails to reconcile the records of dematerialised securities with all the securities issued
by the issuer as specified in the regulations, such depository or participant or issuer or its agent or intermediary
shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to comply with directions issued by SEBI
Section 19F requires that if any person fails to comply with the directions issued by SEBI under section 19,
within the time specified by it, he shall be liable to a penalty of one lakh rupees for each day during which such
failure continues or one crore rupees, whichever is less.
Penalty for contravention where no separate penalty has been provided
Section 19G provides that whoever fails to comply with any provision of this Act, the rules or the regulations or
bye-laws made or directions issued by SEBI thereunder for which no separate penalty has been provided, shall
be liable to a penalty which may extend to one crore rupees.
Thing You May Know
Every intermediary in the Capital Market is required to be registered with SEBI under Seciton 12 of the SEBI
Act, 1992.
Power to adjudicate
Section 19H provides that for the purpose of adjudging, SEBI shall appoint any officer not below the rank of a
Division Chief of SEBI to be an adjudicating officer for holding an inquiry in the prescribed manner after giving
any person concerned a reasonable opportunity of being heard for the purpose of imposing any penalty. While
holding an inquiry, the adjudicating officer shall have power to summon and enforce the attendance of any
person acquainted with the facts and circumstances of the case to give evidence or to produce any document,
which in the opinion of the adjudicating officer, may be useful for or relevant to the subject matter of the inquiry
and if, on such inquiry, he is satisfied that the person has failed to comply with the provisions of any of the
sections specified in this Act, he may impose such penalty as he thinks fit in accordance with the provisions of
any of those sections.
Factors to be taken into account by Adjudicating Officer
Accroding to Section 19 I, while adjudging the quantum of penalty, the adjudicating officer shall have due regard
to the following factors, namely–(a) the amount of disproportionate gain or unfair advantage, wherever quantifiable,
made as a result of the default; (b) the amount of loss caused to an investor or group of investors as a result of
the default; (c) the repetitive nature of the default.
46 PP-CC&MM
Settlement of Administrative Civil Proceedings
Section 19-IA stipulates that any person, against whom any proceedings have been initiated or may be initiated
under section 19, section 19H, as the case may be, can file an application in writing to SEBI proposing for
settlement of the proceedings initiated or to be initiated for the alleged defaults.
SEBI may, after taking into consideration the nature, gravity and impact of defaults, agree to the proposal
for settlement, on payment of such sum by the defaulter or on such other terms as may be determined by SEBI
in accordance with the regulations made under the SEBI Act, 1992.
The settlement procedure will be as provided in SEBI Act, 1992.
No appeal shall lie under section 23A against any order passed by SEBI or the adjudicating officer, as the case
may be, under this section.
Recovery of amounts
1. 19-IB provides that if a person fails to pay the penalty imposed by the adjudicating officer or fails to comply
with a direction of disgorgement order issued under Section 19 or fails to pay any fees due to SEBI, the Recovery
Officer may draw up under his signature a statement in the specified form specifying the amount due from the
person (such statement being hereafter in this Chapter referred to as certificate) and shall proceed to recover
from such person the amount specified in the certificate by one or more of the following modes, namely:(a) attachment and sale of the person’s movable property;
(b) attachment of the person’s bank accounts;
(c) attachment and sale of the person’s immovable property;
(d) arrest of the person and his detention in prison;
(e) appointing a receiver for the management of the person’s movable and immovable properties.
For this purpose, the provisions of section 221 to 227, 228A, 229, 231, 232, the Second and Third Schedules to
the Income-tax Act, 1961 and the Income-tax (Certificate Proceedings) Rules, 1962, as in force from time to
time, in so far as may be, apply with necessary modifications as if the said provisions and the rules thereunder
were the provisions of this Act and referred to the amount due under this Act instead of to income-tax under the
Income-tax Act, 1961.
“Recovery Officer” means any officer of SEBI who may be authorised, by general or special order in
writing, to exercise the powers of a Recovery Officer.
2. The Recovery Officer shall be empowered to seek the assistance of the local district administration while
exercising the powers.
3. The recovery of amounts by a Recovery Officer under this Section pursuant to noncompliance with any
direction issued by SEBI under section 19, shall have precedence over any other claim against such person.
Explanation 1
For the purpose of this sub-section, the person's movable or immovable
property or monies held in bank accounts shall include any property or monies held
in bank accounts which has been transferred directly or indirectly on or after the
date when the amount specified in certificate had become due, by the person to
his spouse or minor child or son’s wife or son's minor child, otheiveise than for
adequate consideration, and which is held by, or stands in the name of, any of the
persons aforesaid; and so far as the movable or immovable property or monies
held in bank accounts so transferred to his minor Mild or his son's minor child is
concerned, it shall, even after the date of attainment of majority by such minor child
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or son's minor child, as the case may be, continue to be included in the person's
movable or immovable property or monies held in bank accounts for recovering
any amount due from the person under this Act
Explanation 2
Explanation 3
Explanation 3
Any reference under the provisions of the Second and Third Schedules to the Incometax Act, 1961 and the Income-tax (Certificate Proceedings) Rules, 1962 to the
assessee shall be construed as a reference to the person specified in the certificate.
Any reference to appeal in Chapter XVIID and the Second Schedule to the Incometax Act, 1961, shall be construed as a reference to appeal before the Securities
Appellate Tribunal under Section 23A of this Act.
Crediting of penalties to consolidated fund of India
All sums realised by way of penalties under this Act shall be credited to the Consolidated Fund of India.
OFFENCES
Section 20 provides that without prejudice to any award of penalty by the adjudicating officer under this Act, if
any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of
any rules or regulations or bye-laws made there under, he shall be punishable with imprisonment for a term
which may extend to ten years, or with fine, which may extend to twenty-five crore rupees, or with both. If any
person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his directions or
orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which
may extend to ten years, or with fine, which may extend to twenty-five crore rupees, or with both.
Offences by companies
Section 21 requires, that where an offence under this Act has been committed by a company, every person who
at the time the offence was committed was in charge of, and was responsible to, the company for the conduct of
the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be
liable to be proceeded against and punished accordingly. The proviso to the section also provides that nothing
contained in this sub-section shall render any such person liable to any punishment provided in this Act, if he
proves that the offence was committed without his knowledge or that he had exercised all due diligence to
prevent the commission of such offence. Where an offence under this Act has been committed by a company
and it is proved that the offence has been committed with the consent or connivance of, or is attributable to any
neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager,
secretary or other officer shall also be deemed to be guilty of the offence and shall be liable to be proceeded
against and punished accordingly.
48 PP-CC&MM
Cognizance of offences by Courts
According to Section 22 a court should not take cognizance of any offence punishable under this Act or any
rules or regulations or bye-laws made there under except on a complaint made by the Central Government or
State Government or SEBI.
Composition of certain offences
Section 22A provides that any offence punishable under this Act, not being an offence punishable with imprisonment
only, or with imprisonment and also with fine, may either before or after the institution of any proceeding, be
compounded by a Securities Appellate Tribunal or a court before which such proceedings are pending.
Power to grant immunity
Section 22B empowers the Central Government to grant immunity, on recommendation by SEBI, if the Central
Government is satisfied, that any person, who is alleged to have violated any of the provisions of this Act or the rules
or the regulations made there under, has made a full and true disclosure in respect of alleged violation, grant to such
person, subject to such conditions as it may think fit to impose, immunity from prosecution for any offence under this
Act, or the rules or the regulations made there under or also from the imposition of any penalty under this Act with
respect to the alleged violation. No such immunity shall be granted by the Central Government in cases where the
proceedings for the prosecution for any such offence have been instituted before the date of receipt of application for
grant of such immunity and the recommendation of SEBI is not binding upon the Central Government in this case.
The immunity granted to a person may, at any time, be withdrawn by the Central Government, if it is satisfied
that such person had, in the course of the proceedings, not complied with the condition on which the immunity
was granted or had given false evidence, and thereupon such person may be tried for the offence with respect
to which the immunity was granted or for any other offence of which he appears to have been guilty in connection
with the contravention and shall also become liable to the imposition of any penalty under this Act to which such
person would have been liable, had not such immunity been granted.
SPECIAL COURT
Establishment of Special Courts
Section 22 C provides that the Central Government may, for the purpose of providing speedy trial of offences
under this Act, by notification, establish or designate as many Special Courts as may be necessary.
A Special Court shall consist of a single judge who shall be appointed by the Central Government with the
concurrence of the Chief Justice of the High Court within whose jurisdiction the judge to be appointed is working.
A person shall not be qualified for appointment as a judge of a Special Court unless he is, immediately before
such appointment, holding the office of a Sessions Judge or an Additional Sessions Judge, as the case may be.
Offences triable by Special Courts
Section 22D says that all offences under this Act committed prior to the date of commencement of the Securities
Laws (Amendment) Ordinance, 2013 or on or after the date of such commencement, shall be taken cognizance
of and triable by the Special Court established for the area in which the offence is committed or where there are
more Special Courts than one for such area, by such one of them as may be specified in this behalf by the High
Court concerned.
Appeal and Revision
Section 22E stipulates that the High Court may exercise, so far as may be applicable, all the powers conferred
by Chapters XXIX and XXX of the Code of Criminal Procedure, 1973 on a High Court, as if a Special Court within
the local limits of the jurisdiction of the High Court were a Court of Session trying cases within the local limits of
the jurisdiction of the High Court.
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Application of Code to proceedings before Special Court
Section 22F stipulates that the provisions of the Code of Criminal Procedure, 1973 shall apply to the proceedings
before a Special Court and for the purposes of the said provisions, the Special Court shall be deemed to be a
Court of Session and the person conducting prosecution before a Special Court shall be deemed to be a Public
Prosecutor within the meaning of clause (u) of section 2 of the Code of Criminal Procedure, 1973.
The person conducting prosecution should have been in practice as an Advocate for not less than seven years
or should have held a post, for a period of not less than seven years, under the Union or a State requiring special
knowledge of law.
Transitional provisions
Under Section 22, any offence committed under this Act, which is triable by a Special Court shall, until a Special
Court is established, be tried by a Court of Session exercising jurisdiction over the area, notwithstanding anything
contained in the Code of Criminal Procedure, 1973.However, nothing contained in this section shall affect the
powers of the High Court, under section 407 of the Code to transfer any case or class of cases taken cognizance
by a Court of Session under this Section.
APPEALS
Section 23 provides that any person aggrieved by an order of SEBI made under this Act, or the regulations
made thereunder may prefer an appeal to the Central Government within such time as may be prescribed.
No appeal shall be admitted if it is preferred after the expiry of the period prescribed therefor. However, an
appeal may be admitted after the expiry of the period prescribed therefor if the appellant satisfies the Central
Government that he had sufficient cause for not preferring the appeal within the prescribed period.
Every appeal made under this section shall be made in such form and shall be accompanied by a copy of the
order appealed against and by such fees as may be prescribed. The procedure for disposing of an appeal shall
be such as may be prescribed. However, before disposing of an appeal, the appellant shall be given a reasonable
opportunity of being heard.
Appeal to Securities Appellate Tribunal
Section 23A provides that, any person aggrieved by an order of SEBI or by an adjudicating officer under this Act
may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter. Every appeal shall be
filed within a period of forty-five days from the date on which a copy of the order made by SEBI is received by the
person and it shall be in such form and be accompanied by such fee as may be prescribed:
The Securities Appellate Tribunal may entertain an appeal after the expiry of the said period of forty-five days if
it is satisfied that there was sufficient cause for not filing it within that period.
On receipt of an appeal, the Securities Appellate Tribunal may, after giving the parties to the appeal an opportunity
of being heard, pass such orders thereon as it thinks fit, confirming, modifying or setting aside the order appealed
against.
The Securities Appellate Tribunal shall send a copy of every order made by it to SEBI and parties to the appeal.
The appeal filed before the Securities Appellate Tribunal shall be dealt with by it as expeditiously as possible
and endeavour shall be made by it to dispose of the appeal finally within six months from the date of receipt of
the appeal.
The provisions of Limitations Act, 1963, will apply to an appeal made to a Securities Appellate Tribunal.
50 PP-CC&MM
Procedure and powers of Securities Appellate Tribunal
Section 23B provides that the Securities Appellate Tribunal shall not be bound by the procedure laid down by the
Code of Civil Procedure, 1908, but shall be guided by the principles of natural justice and, subject to the other
provisions of this Act and of any rules, the Securities Appellate Tribunal shall have powers to regulate their own
procedure including the places at which they shall have their sittings. The Securities Appellate Tribunal shall
have, for the purpose of discharging their functions under this Act, the same powers as are vested in a civil court
under the Code of Civil Procedure, 1908, while trying a suit, in respect of the following matters, namely –
(a) summoning and enforcing the attendance of any person and examining him on oath;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits;
(d) issuing commissions for the examination of witnesses or documents;
(e) reviewing its decisions;
(f) dismissing an application for default or deciding it ex parte;
(g) setting aside any order of dismissal of any application for default or any order passed by it ex parte; and
(h) any other matter which may be prescribed.
Every proceeding before the Securities Appellate Tribunal shall be deemed to be a judicial proceeding
within the meaning of sections 193 and 228, and for the purposes of section 196 of the Indian Penal
Code and the Securities Appellate Tribunal shall be deemed to be a civil court for all the purposes of
section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973.
Appeal to Supreme Court
Section 23F provides that any person aggrieved by any decision or order of the Securities Appellate Tribunal
may file an appeal to the Supreme Court within sixty days from the date of communication of the decision or
order of the Securities Appellate Tribunal to him on any question of law arising out of such order. However, the
Supreme Court may, if it is satisfied that the appellant was prevented by sufficient cause from filing the appeal
within the said period, allow it to be filed within a further period not exceeding sixty days.
Right to legal representation
Section 23C stipulates that the appellant may either appear in person or authorise one or more Chartered
Accountants or Company Secretaries or Cost Accountants, in practice or Legal Practitioners or any of its officers
to present his/its case before the Securities Appellate Tribunal.
Civil Court not to have Jurisdiction
According to Section 23E, a Civil Court shall not have jurisdiction to entertain any suit or proceeding in respect
of any matter which a Securities Appellate Tribunal is empowered by or under this Act to determine and no
injunction can be granted by any court or other authority in respect of any action taken or to be taken. In
pursuance of any power conferred by or under this Act.
Areas on which rules may be framed by the Central Government
The Central Government under Section 24, may frame Rules to provide, inter alia, for:
– the manner of inquiry under Section 19H(1).
– the time within which an appeal may be preferred from the orders of SEBI under Section 23(1).
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– the form in which an appeal may be preferred and the fees payable in respect of such appeal.
– the procedure for disposing of an appeal.
– the form in which an appeal may be filed before the Securities Appellate Tribunal under Section 23A and
the fees payable in respect of such appeal.
SECURITIES CONTRACTS (REGULATION) ACT, 1956
The SCRA, 1956 provides for direct and indirect control of virtually all aspects of the securities trading including
the running of stock exchanges which aims to prevent undesirable transaction in securities. It gives the Central
Government 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 the requirements prescribed by the Central Government. The stock exchange
frame their own listing regulations in consonance with the minimum listing criteria set out in Securities contracts
Regulation Rules 1956. Power to recognize Stock Exchange vests with Central Government. However, central
Government has delegated the powers to SEBI vide its notification No. F. No.1/57/SE/93 dated 13.9.1994.
Application for recognition of stock exchanges
Section 3 of the Act requires that, any stock exchange, which is desirous of being recognised for the purposes
of this Act, may make an application in the prescribed manner to the Central Government.
Every application must contain such particulars as may be prescribed, and shall be accompanied by a copy of
the bye-laws of the stock exchange for the regulation and control of contracts and also a copy of the rules
relating in general to the constitution of the stock exchange and in particular, to—
(a) the governing body of such stock exchange, its constitution and powers of management and the manner
in which its business is to be transacted;
(b) the powers and duties of the office bearers of the stock exchange;
(c) the admission into the stock exchange of various classes of members, the qualifications for membership,
and the exclusion, suspension, expulsion and re-admission of members therefrom or thereinto;
(d) the procedure for the registration of partnerships as members of the stock exchange in cases where the
rules provide for such membership; and the nomination and appointment of authorised representatives
and clerks.
Grant of recognition to stock exchanges
Section 4 lays down that if the Central Government is satisfied, after making such inquiry as may be necessary
in this behalf and after obtaining such further information, if any, as it may require,—
(a) that the rules and bye-laws of a stock exchange applying for registration are in conformity with such
conditions as may be prescribed with a view to ensure fair dealing and to protect investors;
(b) that the stock exchange is willing to comply with any other conditions (including conditions as to the
number of members) which the Central Government, after consultation with the governing body of the
stock exchange and having regard to the area served by the stock exchange and its standing and the
nature of the securities dealt with by it, may impose for the purpose of carrying out the objects of this Act;
and
(c) that it would be in the interest of the trade and also in the public interest to grant recognition to the stock
exchange; it may grant recognition to the stock exchange subject to the conditions imposed upon it as
aforesaid and in such form as may be prescribed.
52 PP-CC&MM
The conditions which the Central Government may prescribe for the grant of recognition to the stock exchanges
may include, among other matters, conditions relating to,—
(i) the qualifications for membership of stock exchanges;
(ii) the manner in which contracts shall be entered into and enforced as between members;
(iii) the representation of the Central Government on each of the stock exchange by such number of persons
not exceeding three as the Central Government may nominate in this behalf; and
(iv) the maintenance of accounts of members and their audit by chartered accountants whenever such
audit is required by the Central Government.
Every grant of recognition to a stock exchange under section 4 shall be published in the Gazette of India and
also in the Official Gazette of the State in which the principal office as of the stock exchange is situate, and such
recognition shall have effect as from the date of its publication in the Gazette of India.
An application for the grant of recognition shall not be refused except after giving an opportunity to the stock
exchange concerned to be heard in the matter; and the reasons for such refusal shall be communicated to the
stock exchange in writing. No rules of a recognised stock exchange shall be amended except with the approval
of the Central Government.
Withdrawal of recognition
Section 5 stipulates that if the Central Government is of opinion that the recognition granted to a stock exchange
under the provisions of SCR Act should, in the interest of the trade or in the public interest, be withdrawn, the
Central Government may serve on the governing body of the stock exchange a written notice that the Central
Government is considering the withdrawal of the recognition for the reasons stated in the notice and after giving
an opportunity to the governing body to be heard in the matter, the Central Government may withdraw, by
notification in the Official Gazette, the recognition granted to the stock exchange.
However, no such withdrawal shall affect the validity of any contract entered into or made before the date of the
notification, and the Central Government may, after consultation with the stock exchange, make such provision
as it deems fit in the notification of withdrawal or in any subsequent notification similarly published for the due
performance of any contracts outstanding on that date.
Where the recognised stock exchange has not been corporatised or demutualised or it fails to submit the
scheme within the specified time therefor or the scheme has been rejected by SEBI the recognition granted to
such stock exchange under section 4, shall, notwithstanding anything to the contrary contained in this Act, stand
withdrawn and the Central Government shall publish, by notification in the Official Gazette, such withdrawal of
recognition.
Further, no such withdrawal shall affect the validity of any contract entered into or made before the date of the
notification, and SEBI may, after consultation with the stock exchange, make such provisions as it deems fit in
the order rejecting the scheme published in the Official Gazette.
Power of Central Government to call for periodical returns or direct inquiries to be made
Section 6 provides that every recognised stock exchange shall furnish to SEBI such periodical returns relating
to its affairs as may be prescribed.
Every recognised stock exchange and every member thereof shall maintain and preserve for such periods not
exceeding five years such books of account, and other documents as the Central Government, after consultation
with the stock exchange concerned, may prescribe in the interest of the trade or in the public interest, and such
books of account, and other documents shall be subject to inspection at all reasonable times by SEBI.
If SEBI is satisfied that it is in the interest of the trade or in the public interest so to do, may, by order in writing,—
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(a) call upon a recognised stock exchange or any member thereof to furnish in writing such information or
explanation relating to the affairs of the stock exchange or of the member in relation to the stock exchange
as SEBI may require; or
(b) appoint one or more persons to make an inquiry in the prescribed manner in relation to the affairs of the
governing body of a stock exchange or the affairs of any of the members of the stock exchange in
relation to the stock exchange and submit a report of the result of such inquiry to SEBI within such time
as may be specified in the order or, in the case of an inquiry in relation to the affairs of any of the
members of a stock exchange, direct the governing body to make the inquiry and submit its shall be
bound to produce before the authority making the inquiry all such books of account, and other documents
in his custody or power relating to or having a bearing on the subject-matter of such inquiry and also to
furnish the authorities within such time as may be specified with any such statement or information
relating thereto as may be required of him.
Annual reports to be furnished to Central Government by stock exchanges
Section 7provides that every recognised stock exchange shall furnish the Central Government with a copy of
the annual report, and such annual report shall contain such particulars as may be prescribed.
Power of recognised stock exchange to make rules restricting voting rights, etc
According to Section 7A a recognised stock exchange may make rules or amend any rules made by it to provide
for all or any of the following matters, namely :—
(a) the restriction of voting rights to members only in respect of any matter placed before the stock exchange
at any meeting;
(b) the regulation of voting rights in respect of any matter placed before the stock exchange at any meeting
so that each member may be entitled to have one vote only, irrespective of his share of the paid-up
equity capital of the stock exchange;
(c) the restriction on the right of a member to appoint another person as his proxy to attend and vote at a
meeting of the stock exchange;
(d) such incidental, consequential and supplementary matters as may be necessary to give effect to any of
the matters specified in clauses (a), (b) and (c).
No rules of a recognised stock exchange made or amended in relation to any matter referred to in clauses (a) to
(d) of sub-section (1) shall have effect until they have been approved by the Central Government and published
by that Government in the Official Gazette and, in approving the rules so made or amended, the Central
Government may make such modifications therein as it thinks fit, and on such publication, the rules as approved
by the Central Government shall be deemed to have been validly made, notwithstanding anything to the contrary
contained in the Companies Act, 1956.
Power of Central Government to direct rules to be made or to make rules
Section 8 lays down that Where, after consultation with the governing bodies of stock exchanges generally or
with the governing body of any stock exchange in particular, the Central Government is of opinion that it is
necessary or expedient so to do, it may, by order in writing together with a statement of the reasons therefore
direct recognised stock exchanges generally or any recognised stock exchange in particular, as the case may
be, to make any rules or to amend any rules already made in respect of all or any of the matters specified in
section 3 within a period of two months from the date of the order.
If any recognised stock exchange fails or neglects to comply with any order made under this Act within the
period specified therein, the Central Government may make the rules for, or amend the rules made by, the
54 PP-CC&MM
recognised stock exchange, either in the form proposed in the order or with such modifications thereof as may
be agreed to between the stock exchange and the Central Government.
Where in pursuance of this section any rules have been made or amended, the rules so made or amended shall
be published in the Gazette of India and also in the Official Gazette or Gazettes of the State or States in which
the principal office or offices of the recognised stock exchange or exchanges is or are situate, and, on the
publication thereof in the Gazette of India, the rules so made or amended shall, notwithstanding anything to the
contrary contained in the Companies Act, 1956, or in any other law for the time being in force, have effect as if
they had been made or amended by the recognised stock exchange or stock exchanges, as the case may be.
Clearing Corporation
Section 8A stipulates that a recognised stock exchange may, with the prior approval of SEBI, transfer the duties
and functions of a clearing house to a clearing corporation, being a company incorporated under the Companies
Act, 1956 , for the purpose of—
(a) the periodical settlement of contracts and differences thereunder;
(b) the delivery of, and payment for, securities;
(c) any other matter incidental to, or connected with, such transfer.
Every clearing corporation shall, for the purpose of transfer of the duties and functions of a clearing house to a
clearing corporation, make bye-laws and submit the same to SEBI for its approval.
SEBI may, on being satisfied that it is in the interest of the trade and also in the public interest to transfer the
duties and functions of a clearing house to a clearing corporation, grant approval to the byelaws submitted to it
and approve the transfer of the duties and functions of a clearing house to a clearing corporation.
Power of SEBI to make or amend bye-laws of recognised stock exchanges
Section 10 requires that SEBI may, either on a request in writing received by it in this behalf from the governing
body of a recognised stock exchange or on its own motion, if it is satisfied after consultation with the governing
body of the stock exchange that it is necessary or expedient so to do and after recording its reasons for so doing,
make bye-laws for all or any of the matters specified in section 9 or amend any bye-laws made by such stock
exchange under that section.
Where in pursuance of this section any bye-laws have been made or amended the bye-laws so made or amended
shall be published in the Gazette of India and also in the Official Gazette of the State in which the principal office
of the recognised stock exchange is situate, and on the publication thereof in the Gazette of India, the bye-laws
so made or amended shall have effect as if they had been made or amended by the recognised stock exchange
concerned.
Notwithstanding anything contained in this section, where the governing body of a recognised stock exchange
objects to any bye-laws made or amended under this section by SEBI on its own motion, it may, within two
months of the publication thereof in the Gazette of India apply to SEBI for revision thereof, and SEBI may, after
giving an opportunity to the governing body of the stock exchange to be heard in the matter, revise the bye-laws
so made or amended, anywhere any bye-laws so made or amended are revised as a result of any action taken
under this section, the byelaws so revised shall be published and shall become effective as provided in this
section.
The making or the amendment or revision of any bye-laws shall in all cases be subject to the condition of
previous publication. However, if the SEBI is satisfied in any case that in the interest of the trade or in the public
interest any bye-laws should be made, amended or revised immediately, it may, by order in writing specifying
the reasons therefor, dispense with the condition of previous publication.
Lesson 3
Framework of Market Infrastructure Institutions
55
Power of Central Government to supersede governing body of a recognised stock exchange
Section 11 provides that without prejudice to any other powers vested in the Central Government under this Act,
where the Central Government is of opinion that the governing body of any recognised stock exchange should
be superseded, then, notwithstanding anything contained in any other law for the time being in force, in the
Central Government may serve on the governing body a written notice that the Central Government is considering
the supersession of the governing body for the reasons specified in the notice and after giving an opportunity to
the governing body to be heard in the matter, it may, by notification in the Official Gazette, declare the governing
body of such stock exchange to be superseded, and may appoint any person or persons to exercise and
perform all the powers and duties of the governing body, and, where more persons than one are appointed, may
appoint one of such persons to be the chairman and another to be the vice-chairman thereof.
On the publication of a notification in the Official Gazette under this section, the following consequences shall
ensue, namely:—
(a) the members of the governing body which has been superseded shall, as from the date of the notification
of supersession, cease to hold office as such members;
(b) the person or persons appointed may exercise and perform all the powers and duties of the governing
body which has been superseded;
(c) all such property of the recognised stock exchange as the person or persons appointed may, by order
in writing, specify in this behalf as being necessary for the purpose of enabling him or them to carry on
the business of the stock exchange, shall vest in such person or persons.
Notwithstanding anything to the contrary contained in any law or the rules or bye-laws of the recognised stock
exchange the governing body of which is superseded, the person or persons appointed shall hold office for such
period as may be specified in the notification published and the Central Government may from time to time, by
like notification, vary such period.
The Central Government may at any time before the determination of the period of office of any person or
persons appointed under this section call upon the recognised stock exchange to re-constitute the governing
body in accordance with its rules and on such re-constitution all the property of the recognised stock exchange
which has vested in, or was in the possession of, the person or persons appointed shall re-vest or vest, as the
case may be, in the governing body so re-constituted.
However, until a governing body is so re-constituted, the person or persons appointed shall continue to exercise
and perform their powers and duties.
Power to suspend business of recognised stock exchanges
According to Section 12, if in the opinion of the Central Government an emergency has arisen and for the
purpose of meeting the emergency the Central Government considers it expedient so to do, it may, by notification
in the Official Gazette, for reasons to be set out therein, direct a recognised stock exchange to suspend such of
its business for such period not exceeding seven days and subject to such conditions as may be specified in the
notification, and, if, in the opinion of the Central Government, the interest of the trade or the public interest
requires that the period should be extended, may, by like notification extend the said period from time to time.
However, where the period of suspension is to be extended beyond the first period, no notification extending the
period of suspension shall be issued unless the governing body of the recognised stock exchange has been
given an opportunity of being heard in the matter.
Penalty
Section 23G deals with penalty for failure to furnish periodical returns, etc by a recognised stock exchange. If a
56 PP-CC&MM
recognised stock exchange fails or neglects to furnish periodical returns to SEBI or fails or neglects to make or
amend its rules or bye-laws as directed by SEBI or fails to comply with directions issued by SEBI, such recognised
stock exchange shall be liable to a penalty which may extend to twenty-five crore rupees.
Section 23H deals with penalty for contravention where no separate penalty has been provided. Whoever fails
to comply with any provision of this Act, the rules or articles or bye- laws or the regulations of the recognised
stock exchange or directions issued by SEBI for which no separate penalty has been provided, shall be liable to
a penalty which may extend to one crore rupees.
LESSON ROUND UP
– Stock Exchanges, Clearing Corporations and Depositories are systemically important for the country’s
financial development and serve as the infrastructure necessary for the securities market. These
institutions are collectively referred to as Market Infrastructure Institutions (MIIs).
– SEBI has prescribed various Act and Regulations from time to time for the smooth functioning of these
MIIs.
– SEBI notified the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations)
Regulations, 2012 (“SECC Regulations”) on June 20, 2012 to regulate recognition, ownership and
governance in stock exchanges and clearing corporations and matters connected therewith or incidental
thereto.
– These Regulations provides for recognition, ownership, governance and listing provisions with respect
to Stock Exchanges as well as Clearing Corporations.
– To facilitate the implementation of the SECC Regulations and provide guidelines to stock exchanges
and clearing corporations for their operations in accordance with the terms of SECC Regulations,
SEBI has issued procedural norms on recognition, ownership and governance for stock exchanges
and clearing corporations dated December 13, 2012.
– The Depositories Act, 1996 provides for the establishment of single or multiple depositories. Any body
to be eligible for providing depository services must be formed and registered as a company under the
Companies Act, 1956 and seek registration with SEBI and obtain a Certificate of Commencement of
Business from SEBI on fulfillment of the prescribed conditions.
– Section 23 provides that any person aggrieved by an order of SEBI made under Depositories Act, or
the regulations made thereunder may prefer an appeal to the Central Government within such time as
may be prescribed.
– The SCRA, 1956 provides for direct and indirect control of virtually all aspects of the securities trading
including the running of stock exchanges which aims to prevent undesirable transaction in securities.
– Section 3 of the SCRA, 1956 requires that, any stock exchange, which is desirous of being recognised
for the purposes of this Act, may make an application in the prescribed manner to the Central
Government.
– Section 23G deals with penalty for failure to furnish periodical returns, etc by a recognised stock
exchange. If a recognised stock exchange fails or neglects to furnish periodical returns to SEBI or fails
or neglects to make or amend its rules or bye-laws as directed by SEBI or fails to comply with directions
issued by SEBI, such recognised stock exchange shall be liable to a penalty which may extend to
twenty-five crore rupees.
Lesson 3
Framework of Market Infrastructure Institutions
57
SELF TEST QUESTIONS
1. Describe the provisions relating to maintenance of networth by a Stock Exchange and Clearing
Corporations under SECC Regulations.
2. What do you understand by Pledge and Hypothecation of Securities? Explain the procedure for pledge
or Hypotecation of Securities which is in demat account.
3. Briefly explain the provision relating to Appeal to be made under the Depositories Act, 1996.
58 PP-CC&MM
Lesson 4
Financial Intermediaries Framework
Lesson 4
Financial Intermediaries Framework
LESSON OUTLINE
59
LEARNING OBJECTIVES
– Introduction
Intermediaries are service providers and are an
integral part of any financial system. SEBI
regulates various intermediaries in the primary
and secondary markets through its Regulations
for these respective intermediaries. SEBI has
defined the role of each of the intermediary, the
eligibility criteria for granting registration, their
functions and responsibilities and the code of
conduct to which they are bound. These
Regulations also empower SEBI to inspect the
functioning of these intermediaries and to collect
fees from them and to impose penalties on
erring entities.
– SEBI (Merchant Bankers) Regulations,
1992
– SEBI (Registrars to an Issue and Share
Transfer Agents) Regulations, 1993
– SEBI (Underwriters) Regulations, 1993
– SEBI (Bankers to an Issue) Regulations,
1994
– SEBI (Debenture Trustees) Regulations,
1993
– SEBI (Stock Brokers and Sub Brokers)
Regulations, 1992
The main objective of this lesson is to give the
detailed framework of the Market Intermediaries
as prescribed by SEBI.
– SEBI (Portfolio Managers) Regulations,
1993
– SEBI (Custodian of Securities) Regulations,
1996
– SEBI (Foreign Institutional Investors)
Regulations, 1995
– SEBI (Investment Advisers) Regulations,
2013
– SEBI (Credit Rating Agencies) Regulations,
1999
– Guideline for Market Maker
– SEBI ( Depositories and Participant)
Regulations, 1996
– Qualified Depository Participants
– LESSON ROUND UP
– SELF TEST QUESTIONS
59
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INTRODUCTION
The Market Regulator, SEBI regulates various intermediaries in the primary and secondary markets through its
Regulations for these intermediaries. SEBI has defined the role of each of the intermediary, the eligibility criteria
for granting registration, their functions and responsibilities and the code of conduct to which they are bound.
These Regulations also empower SEBI to inspect the functioning of these intermediaries and to collect fees
from them and to impose penalties on erring entities. As per Section 11 of SEBI Act, it is the duty of SEBI to
register and regulate the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue,
trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment
advisors and such other intermediaries who may be associated with securities market in any manner.
SEBI has issued regulations in respect of each intermediary to ensure proper services to be rendered by them
to the investors and the capital market.
PRIMARY MARKET INTERMEDIARIES
The following market intermediaries are involved in the Primary Market:
– Merchant Bankers/Lead Managers
– Registrars and Share Transfer Agents
– Underwriters
– Bankers to issue
– Debenture Trustees
MERCHANT BANKER
‘Merchant Banker’ means any person engaged in the business of issue management by making arrangements
regarding selling, buying or subscribing to securities or acting as manager/consultant/advisor or rendering
corporate advisory services in relation to such issue management.
SEBI (MERCHANT BANKERS) REGULATIONS, 1992
The activities of the merchant bankers in the Indian capital market are regulated by SEBI (Merchant Bankers)
Regulations, 1992. Regulation 3 of SEBI (Merchant Bankers) Regulations, 1992 lays down that an application by a
person desiring to become merchant banker shall be made to SEBI in the prescribed form seeking grant of a certificate
of initial registration alongwith a non-refundable application fee as specified in Schedule II of the Regulations.
Regulation 4 and 5 deal with the methodology for application and furnishing of information, clarification and
personal representation by the applicant. Incomplete or non-conforming applications shall be rejected after
giving an opportunity to remove the deficiencies within a time specified by SEBI.
Regulation 6 lists out the following considerations for being taken into account by SEBI to grant the certificate of
registration.
(a) the applicant shall be a body corporate other than a non-banking financial company as defined under
clause(f) of section 45-I of the RBI Act, 1934;
(b) the applicant has the necessary infrastructure like adequate office space, equipments and manpower to
effectively discharge his activities;
(c) the applicant has in his employment a minimum of two persons who have the experience to conduct the
business of the merchant banker;
Lesson 4
Financial Intermediaries Framework
61
(d) a person directly or indirectly connected with the applicant has not been granted registration by SEBI;
(e) the applicant fulfills the capital adequacy requirement;
(f) the applicant, his partner, director or principal officer is not involved in any litigation connected with the
securities market which has an adverse bearing on the business of the applicant;
(g) the applicant, his director, partner or principal officer has not at any time been convicted for any offence
involving moral turpitude or has been found guilty of any economic offence;
(h) the applicant has the professional qualification from an institution recognised by the Government in
finance, law or business management;
(i) the applicant is a fit and proper person;
(j) grant of certificate to the applicant is in the interest of investors.
Capital Adequacy
Regulation 7 prescribes that the capital adequacy requirement shall be a networth of not less than five crore
rupees.
‘Networth’ means the sum of paid-up capital and free reserves of the applicant at the time of making
application.
Regulation 8, 9A and 10 deal with procedure for registration, renewal of certificate conditions of registration and
procedure where registration is not granted.
Regulation 11 stipulate that on refusal of registration by SEBI, the applicant shall cease to carry on any activity
as a merchant banker from the date of receipt of SEBI’s refusal letter.
Regulation 12 provides for payment of fees and consequences of failure to pay annual fees. It provides that
SEBI may suspend the registration certificate if merchant banker fails to pay fees.
General Obligations and Responsibilities of Merchant Banker
Chapter III of the Regulations containing Regulations 13 to 28 deal with general obligations and responsibilities
of Merchant Bankers.
Regulation 13 stipulates that every merchant banker shall abide by the code of conduct which has been specified
in Schedule III. The code of conduct as provided in the schedule is as under:
CODE OF CONDUCT FOR MERCHANT BANKERS
1. A merchant banker shall make all efforts to protect the interest of investors.
2. A merchant banker shall maintain high standards of integrity, dignity and fairness in the conduct of its business.
3. A merchant banker shall fulfil its obligations in a prompt, ethical, and professional manner.
4. A merchant banker shall at all times exercise due diligence, ensure proper care and exercise independent
professional judgement.
5. A merchant banker shall endeavour to ensure that –
(a) inquiries from investors are adequately dealt with;
(b) grievances of investors are redressed in a timely and appropriate manner;
(c) where a complaint is not remedied promptly, the investor is advised of any further steps which may be
available to the investor under the regulatory system.
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6. A merchant banker shall ensure that adequate disclosures are made to the investors in a timely manner in
accordance with the applicable regulations and guidelines so as to enable them to make a balanced and informed
decision.
7. A merchant banker shall endeavour to ensure that the investors are provided with true and adequate information
without making any misleading or exaggerated claims or any misrepresentation and are made aware of the
attendant risks before taking any investment decision.
8. A merchant banker shall endeavour to ensure that copies of the prospectus, offer document, letter of offer or
any other related literature is made available to the investors at the time of issue or the offer.
9. A merchant banker shall not discriminate amongst its clients, save and except on ethical and commercial
considerations.
10. A merchant banker shall not make any statement, either oral or written, which would misrepresent the
services that the merchant banker is capable of performing for any client or has rendered to any client.
11. A merchant banker shall avoid conflict of interest and make adequate disclosure of its interest.
12. A merchant banker shall put in place a mechanism to resolve any conflict of interest situation that may arise
in the conduct of its business or where any conflict of interest arises, shall take reasonable steps to resolve the
same in an equitable manner.
13. A merchant banker shall make appropriate disclosure to the client of its possible source or potential areas of
conflict of duties and interest while acting as merchant banker which would impair its ability to render fair,
objective and unbiased services.
14. A merchant banker shall always endeavour to render the best possible advice to the clients having regard to
their needs.
15. A merchant banker shall not divulge to anybody either orally or in writing, directly or indirectly, any
confidential information about its clients which has come to its knowledge, without taking prior permission
of its clients, except where such disclosures are required to be made in compliance with any law for the
time being in force.
16. A merchant banker shall ensure that any change in registration status/any penal action taken by the SEBI or
any material change in the merchant banker’s financial status, which may adversely affect the interest of clients/
investors, is promptly informed to the clients and any business remaining outstanding is transferred to another
registered intermediary in accordance with any instructions of the affected clients.
17. A merchant banker shall not indulge in any unfair competition, such as weaning away the clients on assurance
of higher premium or advantageous offer price or which is likely to harm the interest of other merchant bankers
or investors or is likely to place such other merchant bankers in a disadvantageous position while competing for
or executing any assignment.
18. A merchant banker shall maintain arms length relationship between its merchant banking activity and any
other activity.
19. A merchant banker shall have internal control procedures and financial and operational capabilities which
can be reasonably expected to protect its operations, its clients, investors and other registered entities from
financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or omissions.
20. A merchant banker shall not make untrue statement or suppress any material fact in any documents, reports
or information furnished to the SEBI.
21. A merchant banker shall maintain an appropriate level of knowledge and competence and abide by the
provisions of the Act, regulations made thereunder, circulars and guidelines, which may be applicable and
Lesson 4
Financial Intermediaries Framework
63
relevant to the activities carried on by it. The merchant banker shall also comply with the award of the Ombudsman
passed under the Securities and Exchange Board of India (Ombudsman) Regulations, 2003.
22. A merchant banker shall ensure that the Board is promptly informed about any action, legal proceedings,
etc., initiated against it in respect of material breach or non-compliance by it, of any law, rules, regulations,
directions of the Board or of any other regulatory body.
23. (a) A merchant banker or any of its employees shall not render, directly or indirectly, any investment
advice about any security in any publicly accessible media, whether real-time or non-real-time, unless a
disclosure of his interest including a long or short position, in the said security has been made, while rendering
such advice.
(b) In the event of an employee of the merchant banker rendering such advice, the merchant banker shall
ensure that such employee shall also disclose the interest, if any, of himself, his dependent family members and
the employer merchant banker, including their long or short position in the said security, while rendering such
advice.
24. A merchant banker shall demarcate the responsibilities of the various intermediaries appointed by it clearly
so as to avoid any conflict or confusion in their job description.
25. A merchant banker shall provide adequate freedom and powers to its compliance officer for the effective
discharge of the compliance officer’s duties.
26. A merchant banker shall develop its own internal code of conduct for governing its internal operations and
laying down its standards of appropriate conduct for its employees and officers in carrying out their duties. Such
a code may extend to the maintenance of professional excellence and standards, integrity, confidentiality,
objectivity, avoidance or resolution of conflict of interests, disclosure of shareholdings and interests, etc.
27. A merchant banker shall ensure that good corporate policies and corporate governance are in place.
28. A merchant banker shall ensure that any person it employs or appoints to conduct business is fit and proper
and otherwise qualified to act in the capacity so employed or appointed (including having relevant professional
training or experience).
29. A merchant banker shall ensure that it has adequate resources to supervise diligently and does supervise
diligently persons employed or appointed by it in the conduct of its business, in respect of dealings in securities
market.
30. A merchant banker shall be responsible for the Acts or omissions of its employees and agents in respect of
the conduct of its business.
31. A merchant banker shall ensure that the senior management, particularly decsions makers have access to
all relevant information about the business on a timely basis.
32. A merchant banker shall not be a party to or instrument for –
(a) creation of false market; or
(b) price rigging or manipulation; or
(c) passing of unpublished price sensitive information in respect of securities which are listed and proposed
to be listed in any stock exchange to any person or intermediary in the securities market.
Regulation 13A provides that no merchant banker other than a bank or a public financial institution who has
been granted a certificate of registration shall carry on any business other than that of the securities market.
However, a merchant banker who has been granted certificate of registration under these regulations may
ensure market making in accordance with Chapter XB of SEBI (ICDR) Regulations, 2009.
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Regulations 14 to 17 deal with maintenance of books of accounts, records, submission of half-yearly results,
rectifying deficiencies pointed out in the auditor’s report etc.
Responsibilities of Lead Manager
Regulation 20 provides that no lead manager shall agree to manage or be associated with any issue unless his
responsibilities relating to the issue mainly those of disclosures, allotment and refund are clearly defined, allocated
and determined and a statement specifying such responsibilities is furnished to SEBI at least 1 month before the
opening of the issue for subscription but where there are more than 1 lead merchant banker to the issue the
responsibility of each such lead merchant banker shall clearly be demarcated and the statement specifying
such responsibilities shall be furnished to SEBI at least 1 month before the opening of the issue for subscription.
Regulation 21 stipulates that a lead merchant banker shall not associate himself with any issue if a merchant
banker not holding a certificate from SEBI is associated with the issue.
Merchant Banker not to Act as such for an Associate
Regulation 21A provides that a merchant banker shall not lead manage any issue or be associated with any
activity undertaken under any regulations made by SEBI, if he is a promoter or a director or an associate of the
issuer of securities or of any person making an offer to sell or purchase securities. However, a merchant banker
who is an associate of such issuer or person may be appointed, if he is involved only in the marketing of the
issue or offer.
Here, a merchant banker shall be deemed to be an “associate of the issuer or person” if:
(i) either of them controls, directly or indirectly through its subsidiary or holding company, not less than
15% of the voting rights in the other; or
(ii) either of them, directly or indirectly, by itself or in combination with other persons, exercises control over
the other; or
(iii) there is a common director, excluding nominee director, amongst the issuer, its subsidiary or holding
company and the merchant banker.
Minimum Underwriting Obligation
Regulation 22 lays down that in respect of every issue to be managed, the lead merchant banker holding a
certificate under Category I shall accept a minimum underwriting obligation of 5% of the total underwriting
commitment or ` 25 lakhs whichever is less but if the lead merchant banker is unable to accept the minimum
underwriting obligation, that lead merchant banker shall make arrangement for having the issue underwritten to
that extent by a merchant banker associated with the issue and shall keep SEBI informed of such arrangement.
In case of issue made in accordance with Chapter XB of SEBI (ICDR) Regulations, 2009, the merchant banker
shall itself or jointly with other merchant bankers associated with the issues, underwrite atleast 15% of the issue
size.
Prohibition to Acquire Shares
Regulation 26 lays down that no merchant banker or any of its directors, partners or manager or principal officer
shall either on their own account or through their associates or relatives, enter into any transaction in securities
of bodies corporate on the basis of unpublished price sensitive information obtained by them during the course
of any professional assignment either from the clients or otherwise.
Regulation 27 requires every merchant banker to submit to SEBI complete particulars of any transaction for
acquisition of securities of any body corporate whose issue is being managed by that merchant banker, within
15 days from the date of entering into such transaction. In case of any transaction for acquisition of securities
made in pursuance of underwriting or market making obligation in accordance with Chapter XB of SEBI
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Financial Intermediaries Framework
65
(ICDR) Regulations, 2009, the complete particulars of the transaction shall be submitted to SEBI on quarterly
basis.
Regulation 28 provides that a merchant banker is required to disclose to SEBI, as and when required, the
following information, namely:
(i) his responsibilities with regard to the management of the issue;
(ii) any change in the information or particulars previously furnished, which have a bearing on the certificate
granted to it;
(iii) the names of the body corporate whose issues he has managed or has been associated with;
(iv) the particulars relating to the breach of the capital adequacy requirement;
(v) relating to his activities as a manager, underwriter, consultant or adviser to an issue, as the case may
be.
The merchant banker shall submit a periodic report in such manner as may be specified by SEBI from time to
time.
Appointment of Compliance Officer
Regulation 28A requires every merchant banker to appoint a compliance officer who shall be responsible for
monitoring the compliance of the Act, rules and regulations, notifications guidelines, instructions etc. issued by
SEBI or Central Government and for redressal of investor grievances. Compliance officer is required to immediately
and independently report to SEBI, any non-compliance observed by him and ensure that observations made or
deficiencies pointed out by SEBI on/in the draft prospectus or letter of offer as the case may be, do not occur.
Procedure for Inspection
Chapter IV containing Regulations 29 to 34 lays down the procedure for inspection of the merchant bankers
offices and records by SEBI.
Regulation 29 empowers SEBI to appoint one or more persons as inspecting authority to undertake inspection
of books of accounts, records and documents etc. of the merchant banker:
(a) to ensure that such books and records are maintained in the prescribed manner;
(b) the provisions of SEBI Act and the rules and regulations thereunder are complied with;
(c) to investigate into complaints from investors, other merchant bankers or other persons on any matter
having a bearing on the activities of the merchant banker; and
(d) to investigate suo-moto in the interest of the securities business or investors interest into the working of
the merchant banker.
Regulation 30 and 31 authorise SEBI to undertake such inspection with or without notice and the obligations of
the merchant bankers in relation to such inspection.
Regulation 32 provides for the submission of an inspection report to SEBI by the inspecting authority on completion
of inspection. Regulation 33 requires that SEBI or chairman shall after consideration of inspection or investigation
report take such action as SEBI or chairman may deem fit and appropriate including action under Chapter V of
the SEBI (Intermediaries) Regulations, 2008.
Regulation 34 permits SEBI to appoint a qualified auditor to investigate into the books of accounts or the affairs
of the merchant banker and such auditor shall have the same powers of the inspecting authority referred to
above.
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Procedure for Action against Merchant Banker in case of Default
Chapter V containing Regulation 35 deals with the procedure for taking action against the merchant banker in
case of default. Regulation 35 provides that a merchant banker who contravenes any of the provisions of the
Act, rules or regulations, framed thereunder shall be liable for one or more actions specified therein including the
action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS
The Registrars to an Issue and Share Transfer Agents constitute an important category of intermediaries in the
primary market. They render very useful services in mobilising new capital and facilitating proper records of the
details of the investors, so that the basis for allotment could be decided and allotment ensured as per SEBI
Regulations.
SEBI (REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS) REGULATIONS, 1993
SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 were notified by SEBI on 31st May,
1993 in exercise of the powers conferred by Section 30 of SEBI Act,1992, with the approval of Central Government.
Chapter I of the Regulations contains preliminary items and Chapter II consisting of Regulations 3 to 12 dealing
with procedure for applying for registration as Registrar to an Issue (RTI) and Share Transfer Agents (STA),
either as Category-I to carry on both the activities of RTA and STA or Category-II to carry on the activity either as
Registrar to an Issue or as a Share Transfer Agent. The application should be complete and conform to the
requirements otherwise it will be rejected. But an opportunity will be given to remove the objections as may be
indicated by SEBI. In case of failure the application may be rejected.
Criteria for Registration
Regulation 6 lays down that SEBI shall take into account the following matters while considering the applications
for registration. It shall assess whether the applicant:
(a) has the necessary infrastructure like adequate office space, equipments and manpower to effectively
discharge his activities;
(b) has any past experience in the activities;
(c) any person directly or indirectly connected with him has been granted registration by SEBI under the
Act;
(d) Fulfils the capital adequacy requirement;
(e) has been subjected to any disciplinary proceedings under the Act;
(f) any of its director, partner or principal officer is or has at any time been convicted for any offence
involving moral turpitude or has been found guilty of any economic offence;
(g) is a fit and proper person.
Regulation 7 stipulates the capital adequacy requirement (networth) for category I ` 50,00,000 lacs and category
II ` 25,00,000 lacs.
Regulations 8 to 10 lay down the procedure for registration, renewal of certificate, conditions of registration,
period of validity of certificate and the procedure where registration is not granted. It is made clear that the
applicant will be given due opportunity of being heard before rejection of his application.
Regulation 11 says that in case of refusal to grant or renew a certificate of registration, the concerned person
shall cease to carry on any activity as registrar or share transfer agent. Regulation 12 prescribes payment of
fees and indicates the consequences of failure to pay fees. In the latter case SEBI may suspend the certificate
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with the consequence that the RTA shall cease to carry on his activity from the date of suspension of the
certificate.
General Obligations and Responsibilities
Chapter III consisting of Regulations 13 to 15 lays down the general obligations and responsibilities of RTAs.
Regulation 13 lays down that the RTA holding a certificate shall at all time abide by the Code of Conduct
specified below:
CODE OF CONDUCT
1. A Registrar to an Issue and share transfer agent shall maintain high standards of integrity in the conduct of its
business.
2. A Registrar to an Issue and share transfer agent shall fulfil its obligations in a prompt ethical and professional
manner.
3. A Registrar to an Issue and share transfer agent shall at all times exercise due diligence, ensure proper care
and exercise independent professional judgement.
4. A Registrar to an Issue and share transfer agent shall exercise adequate care, caution and due diligence
before dematerialisation of securities by confirming and verifying that the securities to be dematerialised have
been granted listing permission by the stock exchange/s.
5. A Registrar to an Issue and share transfer agent shall always endeavour to ensure that—
(a) inquiries from investors are adequately dealt with;
(b) grievances of investors are redressed without any delay;
(c) transfer of securities held in physical form and confirmation of dematerialisation/rematerialisation requests
and distribution of corporate benefits and allotment of securities is done within the time specified under
any law.
6. A Registrar to an Issue and share transfer agent shall make reasonable efforts to avoid misrepresentation and
ensure that the information provided to the investors is not misleading.
7. A Registrar to an Issue and share transfer agent shall not reject the dematerialisation/rematerialisation requests on
flimsy grounds. Such request could be rejected only on valid and proper grounds and supported by relevant documents.
8. A Registrar to an Issue and share transfer agent shall avoid conflict of interest and make adequate disclosure
of its interest.
9. A Registrar to an Issue and share transfer agent shall put in place a mechanism to resolve any conflict of
interest situation that may arise in the conduct of its business or where any conflict of interest arises, shall take
reasonable steps to resolve the same in an equitable manner.
10. A Registrar to an Issue and share transfer agent shall make appropriate disclosure to the client of its possible
source or potential areas of conflict of duties and interest which would impair its ability to render fair, objective
and unbiased services.
11. A Registrar to an Issue and share transfer agent shall not indulge in any unfair competition, which is likely to
harm the interest of other Registrar to the Issue and share transfer agent or investors or is likely to place such
other registrar in a disadvantageous position in relation to the Registrar to Issue and share transfer agent while
competing for or executing any assignment.
12. A Registrar to an Issue and share transfer agent shall always endeavour to render the best possible advice
to the clients having regard to their needs.
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13. A Registrar to an Issue and share transfer agent shall not divulge to other clients, press or any other person any
confidential information about its clients which has come to its knowledge except with the approval/ authorisation
of the clients or when it is required to disclose the information under any law for the time being in force.
14. A Registrar to an Issue or share transfer agent shall not discriminate amongst its clients, save and except on
ethical and commercial considerations.
15. A Registrar to an Issue and share transfer agent shall ensure that any change in registration status/any
penal action taken by the Board or any material change in financials which may adversely affect the interests of
clients/investors is promptly informed to the clients.
16. A Registrar to an Issue and share transfer agent shall maintain the required level of knowledge and competency
and abide by the provisions of the Act, rules, regulations, circulars and directions issued by the Board. The
Registrar to an Issue and share transfer agent shall also comply with the award of the Ombudsman passed
under Securities and Exchange Board of India (Ombudsman) Regulations, 2003.
17. A Registrar to an Issue and share transfer agent shall co-operate with the Board as and when required.
18. A Registrar to an Issue and share transfer agent shall not neglect or fail or refuse to submit to the Board or
other agencies with which he is registered, such books, documents, correspondence, and papers or any part
thereof as may be demanded/requested from time to time.
19. A Registrar to an Issue and share transfer agent shall ensure that the Board is promptly informed about any
action, legal proceeding, etc. initiated against it in respect of any material breach or non-compliance by it, of any
law, rules, regulations, directions of the Board or of any other regulatory body.
20. A Registrar to an Issue and share transfer agent shall take adequate and necessary steps to ensure that
continuity in data and record keeping is maintained and that the data or records are not lost or destroyed.
Further, it shall ensure that for electronic records and data, up-to-date back up is always available with it.
21. A Registrar to an Issue and share transfer agent shall endeavour to resolve all the complaints against it or in
respect of the activities carried out by it as quickly as possible.
22. (a) A Registrar to an Issue and share transfer agent 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 nonreal-time, unless a disclosure of its long or short position in the said security has been made, while rendering
such advice.
(b) In case an employee of a Registrar to an Issue and share transfer agent is rendering such advice, the
Registrar to an issue and share transfer agent shall ensure that it also discloses its own interest, the interests of
his dependent family members and that of the employer including their long or short position in the said security,
while rendering such advice.
23. A Registrar to an Issue and share transfer agent shall handover all the records/data and all related documents
which are in its possession in its capacity as a Registrar to an Issue and/or share transfer agent to the respective
clients, within one month from the date of termination of agreement with the respective clients or within one
month from the date of expiry/cancellation of certificate of registration as Registrar to an Issue and/or share
transfer agent, whichever is earlier.
24. A Registrar to an Issue and share transfer agent shall not make any exaggerated statement, whether oral or
written, to the clients either about its qualifications or capability to render certain services or about its achievements
in regard to services rendered to other clients.
25. A Registrar to an Issue and share transfer agent shall ensure that it has satisfactory internal control procedures
in place as well as adequate financial and operational capabilities which can be reasonably expected to take
care of any losses arising due to theft, fraud and other dishonest acts, professional misconduct or omissions.
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26. A Registrar to an Issue and share transfer agent shall provide adequate freedom and powers to its compliance
officer for the effective discharge of its duties.
27. A Registrar to an Issue and share transfer agent shall develop its own internal code of conduct for governing
its internal operations and laying down its standards of appropriate conduct for its employees and officers in
carrying out its duties as a Registrar to an Issue and share transfer agent and as a part of the industry. Such a
code may extend to the maintenance of professional excellence and standards, integrity, confidentiality, objectivity,
avoidance of conflict of interests, disclosure of shareholdings and interests, etc.
28. A Registrar to an Issue and share transfer agent shall ensure that good corporate policies and corporate
governance are in place.
29. A Registrar to an Issue and share transfer agent shall ensure that any person it employs or appoints to
conduct business is fit and proper and otherwise qualified to act in the capacity so employed or appointed
(including having relevant professional training or experience).
30. A Registrar to an Issue and share transfer agent shall be responsible for the acts or omissions of its employees
and agents in respect of the conduct of its business.
31. A Registrar to an Issue and share transfer agent shall not, in respect of any dealings in securities, be party
to or instrumental for –
(a) creation of false market;
(b) price rigging or manipulation;
(c) passing of unpublished price sensitive information in respect of securities which are listed and proposed
to be listed in any stock exchange to any person or intermediary.
Regulation 13A prohibits an RTA from acting as such Registrar in case he or it is an associate of the body
corporate issuing the securities. For the purposes of this regulation, Registrar to an Issue or the body corporate,
as the case may be, shall be deemed to be an associate of other where –
(i) he or it controls directly or indirectly not less than10% of the voting power of the body corporate or of Registrar
to an issue, as the case may be or he or any of his relative is a director or promoter of the body corporate or of
the Registrar to an issue, as the case may be. The term ‘relative’ shall have the same meaning as assigned to
it under Section 6 of the Companies Act, 1956.
The RTA has to maintain of three preceeding financial years proper books and records as prescribed in Regulation
14 and preserve the account books and other records for a minimum period of 3 years. Regulation 15A provides
that every Registrar to an Issue and share transfer agent shall appoint a compliance officer who shall be
responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions
etc. issued by SEBI or Central Government and for redressal of investor grievances. Compliance officer shall
immediately and independently report to SEBI any non-compliance observed by him.
Procedure for Inspection
Chapter IV containing Regulation 16 to 21 deals with procedure for inspection by SEBI appointed inspecting
authority to ensure that the books of accounts and documents are maintained as prescribed and that the
provisions of SEBI Act and the rules and regulations thereunder are complied with. Investigation may be
undertaken on the basis of complaints received from the investors, other registrars or any other intermediaries
in respect of RTA.
Regulation 17 lays down the procedure and Regulation 18 indicates the obligations of the RTA in relation to
such inspection/investigation.
Regulations 19 and 20 stipulate that the inspecting authority shall on the conclusion of his inspection submit a
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report to SEBI. SEBI after considering the inspection or investigation report take such action as SEBI or chairman
may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
Regulation 21 authorises SEBI to appoint an Auditor to investigate into the books of account or the affairs of the
RTA and STA. The Auditor shall have the same powers as SEBI appointed inspecting authority.
Liability for Action in case of default
A registrar to an Issue who –
(i) fails to comply with any conditions subject to which registration has been granted.
(ii) Contravenes any of the provisions of the Act, rules or regulations.
(iii) Contravenes the provisions of the SCRA and the rules made thereunder, provisions of the Depositories
Act or rules made thereunder, the rules, regulations or bye laws of the stock exchange, shall be dealt
with in the manner provided in Chapter V of the Securities and Exchange Board of India (Intermediaries)
Regulations, 2008.
UNDERWRITERS
Underwriters represent one of the key elements among the capital market intermediaries. They facilitate raising
of capital by assuring to take up the unsubscribed portion upto a specified limit. Underwriting is an arrangement
whereby certain parties assure the issuing company to take up shares, debentures or other securities to a
specified extent in case the public subscription does not amount to the expected levels. For this purpose, an
arrangement (agreement) will be entered into between the issuing company and the assuring party such as a
financial institution, banks, merchant banker, broker or other person.
SEBI (UNDERWRITERS) REGULATIONS, 1993
These regulations were notified by SEBI in exercise of the powers conferred by Section 30 of SEBI Act, 1992
with the approval of Central Government. They came into force from 8th October, 1993.
Chapter I contains preliminary matters including definitions.
Chapter II deals with the procedure for registration of underwriters and it contains Regulations 3 to 12.
Regulation 3 lays down that the applicant seeking the certificate shall apply to SEBI in form A. Every Stock
Broker or Merchant Banker holding a valid certificate of registration under section 12 of SEBI Act shall be
entitled to act as an underwriter without obtaining a separate certificate under these regulation. Regulation 4
and 5 requires the applicant to furnish further information and clarification to SEBI regarding matters relevant to
underwriting. If SEBI on receipt of further information is of the opinion that the information so furnished is not
sufficient to decide on the application and seeking further information through correspondence may delay the
matter, it may require the applicant or its principal officer to appear before SEBI in order to give an opportunity to
the applicant to give further clarifications on the application.
Regulation 5 provides that an application not complete in all respects and not conforming to instructions specified
in the form would be rejected. The applicant would be given an opportunity to remove within one month, the
objections as may be indicated by SEBI. SEBI may however extend the time by another one month in order to
enable the applicant to comply with the requirements of SEBI.
Regulation 6 prescribes the following conditions for consideration of the application:
1. the applicant shall have necessary infrastructure like adequate office space, equipments and manpower and
past experience in underwriting, employing at least two persons with such experience. No person directly or
indirectly connected with the applicant should have been granted registration by SEBI.
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SEBI shall take into account whether a previous application for a certificate of any person directly or indirectly
connected with the applicant has been rejected by SEBI or any disciplinary action has been taken against such
person under the Act or any rules/regulations.
2. the applicant should be a fit and proper person, fulfilling the capital adequacy requirements and no director,
partner or principal officer should have been at any time convicted for an offence involving moral turpitude or
found guilty of any economic offence.
Regulation 7 prescribes for the following capital adequacy requirement:
1. The networth should not be less than ` 20 lakhs.
2. The stock broker–underwriter should have capital adequacy as prescribed by the stock exchange.
3. The merchant banker-underwriter shall fulfill capital adequacy as laid down in Merchant Banker’s
Regulations.
Regulations 8 and 9, 9A, 9B deal with procedure for registration and renewal of certificate, conditions of registration,
period of validity of certificate.
Regulations 10 and 11 deal with the procedure where registration is not granted and the effect of refusal to grant
or renew the certificate. Regulation 12 prescribes fees payable and consequences of failure to pay fees.
Obligations and Responsibilities of Underwriters
Chapter III consisting of Regulation 13 to 18 deals with these matters. Every underwriter shall abide by the code
of conduct at all times.
Regulations 14 and 15 contain provisions regarding the matters on which every underwriter shall enter into an
agreement with the body corporate and his general responsibilities.
The contents of the agreement shall include the period of agreement, the amount of underwriting obligations,
the period by which the underwriter should subscribe, the amount of commission/brokerage payable, and other
details for fulfilling the underwriting obligations. The general responsibilities of the underwriter are as follows:
1. The underwriter shall not derive any direct or indirect benefit from underwriting the issue other than the
commission or brokerage payable under an agreement for underwriting.
2. The total underwriting obligations under all the agreements shall not exceed 20 times the networth.
3. Every underwriter, in the event of being called upon to subscribe for securities of a body corporate
pursuant to an agreement shall subscribe to such securities within 45 days of the receipt of such
intimation from such body corporate.
Regulation 16 to 18 relate to maintenance of proper accounts, books and records and their preservation for 5
years and SEBI’s power call for and obtain information from the underwriter.
Appointment of Compliance Officer
Regulation 17A requires every underwriter to appoint a compliance officer responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the
Central Government and for redressal of investors’ grievances. The compliance officer is required to report to
SEBI immediately and independently any non-compliance observed by him.
Inspection and Disciplinary Proceedings
Chapter IV containing Regulations 19 to 24 makes provisions on this subject. SEBI is empowered to appoint
inspectors to ensure that books of accounts, records etc. are maintained properly and the Act along with the
rules and regulations are duly complied with. SEBI is also empowered to investigate into complaints from investors,
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other underwriters etc. as well as under their own power to investigate suo moto in the interest of securities
business and the investors. Regulations 20 and 21 lay down the procedure for inspection and obligations of
underwriter during such inspections.
Regulations 22 relate to submission of inspection report to SEBI.
Regulation 23 provides that SEBI Board or chairman after the consideration of inspection or investigation report
may take action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
Regulation 24 authorise SEBI to appoint a qualified auditor to investigate into the affairs and the accounts of the
underwriter with the same powers as applicable in the case of SEBI appointed inspector.
Procedure for Action in Case of Default
Chapter V containing Regulation 25 to 32 lays down the procedure for action in case of default. An underwriter
or a stock broker or a merchant banker entitled to carry on business of underwriting who fails to comply with any
conditions subject to which certificate has been granted and who contravenes any of the provisions of the Act,
rules or regulations, shall be dealt with in the manner provided under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
BANKER TO AN ISSUE
Banker to an Issue means a scheduled bank carrying on all or any of the following activities :
– Acceptance of application and application monies;
– Acceptance of allotment or call monies;
– Refund of application monies;
– Payment of dividend or interest warrants.
SEBI (BANKER TO AN ISSUE) REGULATION, 1994
SEBI notified these regulations effectiveness from 14th July, 1994 in exercise of the powers conferred by Section
30 of SEBI Act, 1994 after approval by the Central Government.
Chapter I deal with preliminary matters and definitions.
Chapter II containing Regulations 3 to 11 deals with registration of Bankers to an Issue with SEBI.
Regulations 3 to 5 prescribe that the application by a scheduled bank for grant of certificate as a banker to an
issue should be made to SEBI in Form A conforming to the instructions therein failing which, it shall be rejected
after giving due opportunity to remove such defects within specified time. SEBI may call for and obtain further
information or clarification from the applicant.
Consideration of Application
Regulation 6 prescribes the matters that are considered by SEBI in relation to the application:
(a) the applicant has the necessary infrastructure, communication and data processing facilities and
manpower to effectively discharge his activities;
(b) the applicant or any of its directors is not involved in any litigation connected with the securities market
and which has an adverse bearing on the business of the applicant or has not been convicted of any
economic offence;
(c) the applicant is a scheduled bank and a fit and a proper person;
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(d) the applicant is a fit and proper person;
(e) grant of certificate to the applicant is in the interest of investors.
Procedure for Registration
Regulations 7, 8, 8A and 8B deal with the procedure for registration and renewal of the certificate, conditions of
registration and period of validity of certificate. Regulation 9 relates to the procedure where the registration is not
granted, leading to the rejection of the application after giving an opportunity to the applicant to be heard. The
applicant has right to appeal for reconsideration and SEBI shall reconsider the application and communicate its
decision to the applicant in writing.
Regulation 10 lays down that the applicant whose application is refused by SEBI shall cease to carry on any
activity as a banker to an issue from the date on which he receives the communication of refusal.
Regulation 11 imposes the duty on the applicant to pay the fees as prescribed. Non-payment of fees may result
in suspension of the registration and the applicant shall cease to carry on the activity as a banker to the issue
during the period of suspension.
General Obligations and Responsibilities
Regulation 12 requires every banker to an issue to maintain the following records:
(a) the number of applications received, the names of the investors, the dates on which the applications
were received and the amounts so received from the investors;
(b) the time within which the applications received from the investors were forwarded to the body corporate
or registrar to an issue as the case may be;
(c) the dates and amount of the refund monies paid to the investors;
(d) dates, names and amount of dividend/interest warrant paid to the investors.
The Banker to an issue shall intimate SEBI about the place where these documents are kept and shall preserve
them for a minimum period of 3 years.
Regulation 13 requires the banker to inform SEBI as to the number of issues for which he was engaged as
banker and certain other additional information regarding the monies received, the refunds made and the dividend/
interest warrant paid.
Regulation 14 requires the banker to issue to enter into an agreement with the body corporate for whom he is
acting as an banker to issue with regard to the following matters:
(a) the number of centres at which the application and the application monies of an issue of a body corporate
will be collected from the investors;
(b) the time within which the statements regarding the applications and the application monies received
from the investors investing in an issue of a body corporate will be forwarded to the registrar to an issue
of the body corporate, as the case may be;
(c) the daily statement will be sent by the designated controlling branch of the bankers to the issue to the
registrar to an issue indicating the number of body corporate and the amount of application money
received.
Regulation 15 requires the banker to inform SEBI about disciplinary action taken, if any by the RBI against him
in relation to issue payment work. If as a result of such action the banker is prohibited from carrying on the
activities, the certificate shall be deemed to have been cancelled or suspended as the case may be.
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CODE OF CONDUCT
Regulation 16 prescribes that every banker to an issue shall abide by the Code of Conduct as specified in
Schedule III of the Regulations.
Compliance Officer
Regulation 16A provides that every banker to an issue is required to appoint a compliance officer responsible for
monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by
SEBI or Central Government. He shall also be entrusted with the responsibility of redressal of investors’ grievances.
He is required to immediately and independently report to SEBI regarding any non-compliance observed by
him.
Procedure for Inspection
Chapter IV containing Regulation 17 to 22 deals with inspection of Banker to an Issue.
Regulation 17 and 18 authorise SEBI to request RBI to undertake inspection of the books of accounts, records
and documents of the banker, to ensure their proper maintenance, and compliance with SEBI Act, Rules and
Regulations, to investigate into the complaints received from investors, body corporates or any other person in
relation to the work of the banker as a banker to an issue and to investigate into any other matter referred by
SEBI.
Regulation 19 lays down that RBI shall on receipt of the request from SEBI take appropriate steps to undertake
inspection of Bankers to an Issue for such purposes as may be required by SEBI.
Regulation 20 requires that the banker shall offer all assistance and cooperation to RBIs inspecting officers to
facilitate the inspection.
Regulation 21 stipulates that the RBI shall furnish to SEBI, copy of the inspection report along with copies of
other relevant documents in support of the observations made by the inspecting authority.
Action on Inspection or Investigation Report
SEBI Board or the Chairman after consideration of inspection or investigation report may take such action as the
Board or SEBI may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
Procedure for Action in Case of Default
Regulation 23 provides that banker to an Issue who contravenes any of the provisions of the Act, rules or
regulations framed thereunder, shall be dealt with in the manner provided under Chapter V of the SEBI
(Intermediaries) Regulations, 2008.
DEBENTURE TRUSTEES
Debenture trustee means a trustee of a trust deed for seeing any issue of debentures of a body corporate.
Debentures, Bonds and other hybrid instruments in most cases unless otherwise specified, carry securities for
the investors unlike in the case of equity and preference shares. It is necessary that the company makes proper
arrangements to extend assurances and comply with legal requirements in favour of the investors who are
entitled to this type of security. Intermediaries such as Trustees who are generally Banks and Financial Institutions
render this service to the investors for a fee payable by the company. The issuing company has to complete the
process of finalising and executing the trust deed or document and get it registered within the prescribed period
and file the charge with the Registrar of Companies (ROC) in respect of the security offered.
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SEBI (DEBENTURE TRUSTEES) REGULATIONS, 1993
These regulations were notified by SEBI effective from 29th December, 1993 in exercise of the powers conferred
by Section 30 of SEBI Act, 1992 after previous approval of the Central Government.
Chapter I contains preliminary matters and definitions.
Chapter II consisting Regulations 3 to 12 deals with the procedure for initial or permanent registration of debenture
trustees.
Regulation 3 stipulates that the application shall be made in Form A these Regulation. An application for registration
made shall be accompanied by a non-refundable application fee as prescribed in these Regulation. Regulation
4 authorises SEBI to call for and obtain further information from the applicant before granting the registration.
The applicant or its principal officer may, if so required, appear before SEBI for personal representation. Regulation
5 stipulates that an application which is incomplete and does not conform to instructions shall be rejected after
giving an opportunity to the applicant to remove such objections within time specified.
Regulation 6 lays down that SEBI shall take into account the following matters in considering the application,
namely that the applicant:
(1) has the necessary infrastructure like adequate office space, equipments, and manpower to effectively discharge
his activities;
(2) has any past experience as a debenture trustee or has in his employment minimum two persons who had the
experience in matters which are relevant to a debenture trustee; or
(3) any person, directly or indirectly connected with the applicant has not been granted registration by SEBI
under the Act;
(4) has in his employment at least one person who possesses the professional qualification in law from an
institution recognised by the Government; or
(5) any of its director or principal officer is or has at any time been convicted for any offence involving moral
turpitude or has been found quality of any economic offence.
(6) is a fit and proper person;
(7) fulfils the capital adequacy requirements specified in Regulation 7A of SEBI Regulations.
Regulation 7 lays down that to be a debenture trustee the applicant shall be a scheduled bank carrying on
commercial activity, a public financial institution, an insurance company or a body corporate.
Regulation 7A of the Regulations provide that the capital adequacy requirement of debenture trustee shall not
be less than the networth of ` 1 crore.
Regulations 8 and 9A deal with the procedure for registration and the renewal thereof, conditions of registration,
time period for disposal of application and period of validity of certificate.
Regulation 10 lays down that if an applicant does not fulfil the requirements of Regulation 6 above, it may be
rejected after giving reasonable opportunity to the applicant for being heard. The rejection shall be conveyed in
writing by SEBI and the applicant may again apply for reconsideration of SEBI. After due reconsideration SEBI
shall communicate its bindings in writing to the applicant.
Regulations 11 and 12 deal with effect of refusal to grant certificate of permanent registration by SEBI and nonpayment of fees by the applicant. In the absence of a valid certificate the trustee shall cease to act as a debenture
trustee.
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Responsibilities and Obligations of Debenture Trustees
Chapter III containing Regulations 13 to 18 deals with this topic. Regulation 13 lays down that no debenture
trustee who has been granted a certificate by SEBI shall act as debenture trustee unless he enters into a written
agreement with the body corporate before the opening of the subscription list for issue of debentures and the
agreement inter alia contains that debenture trustee has agreed to act as such under the trust deed for securing
an issue of debentures for the body corporate and the time limit within which the security for the debentures
shall be created.
Regulation 13A stipulates that no debenture trustee shall act as such for any issue of debentures in case:
(a) it is an associate of the body corporate; or
(b) it has lent and the loan is not yet fully repaid or is proposing to lend money to the body corporate.
Regulation 14 provides that every debenture trustee shall amongst other matters accept the trust deed which
contains the matters specified in Schedule IV to the Regulations.
Duties of Debenture Trustees
Regulation 15 casts the following duties on the debenture trustees:
(1) call for periodical reports from the body corporate;
(2) take possession of trust property in accordance with the provisions of the trust deed;
(3) enforce security in the interest of the debenture holders;
(4) do such acts as necessary in the event the security becomes enforceable;
(5) carry out such acts as are necessary for the protection of the debenture holders and to do all things
necessary in order to resolve the grievances of the debenture holders;
(6) ascertain and specify that:
(a) in case where the allotment letter has been issued and debenture certificate is to be issued after
registration of charge, the debenture certificates have been despatched by the body corporate to
the debenture holders within 30 days of the registration of the charge with ROC;
(b) debenture certificates have been despatched to the debenture holders in accordance with the
provisions of the Companies Act;
(c) interest warrants for interest due on the debentures have been despatched to the debenture holders
on or before the due dates;
(d) debentureholders have been paid the monies due to them on the date of redemption of the
debentures;
(7) ensure on a continuous basis that the property charged to the debenture is available and adequate at
all time to discharge the interest and principal amounts payable in respect of the debentures and that
such property is free from any other encumbrances save and except those which are specifically agreed
to by the debenture trustee.
(8) exercise due diligence to ensure compliance by the body corporate, with the provisions of the Companies
Act, the listing agreement of the stock exchange or the trust deed;
(9) to take appropriate measures for protecting the interest of the debenture holders as soon as any breach
of the trust deed or law comes to his notice;
(10) to ascertain that the debentures have been converted or redeemed in accordance with the provisions
and conditions under which they are offered to the debenture holders;
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(11) inform SEBI immediately of any breach of trust deed or provision of any law;
(12) appoint a nominee director on the Board of the body corporate in the event of :
(i) two consecutive defaults in payment of interest to the debentures; or
(ii) default in creation of security for debentures; or
(iii) default in redemption of debentures.
(13) communicate to the debenture holders on half yearly basis the compliance of the terms of the issue by
the body corporate, defaults, if any, in payment of interest or redemption of debentures and action taken
therefore;
(14) The debenture trustee shall –
(a) obtain reports from the leading bank regarding the progress of project.
(b) monitor utilization of funds raised in the issue.
(c) obtain a certificate from the issuer’s auditors.
(i) in respect of utilization of funds during the implementation period of the project; and
(ii) in the case of debentures issued for financing working capital at the end of accounting year.
(15) A debenture trustee may call or cause to be called by the body corporate a meeting of all the debenture
holders on –
(a) a requisition in writing signed by at least one-tenth of the debentureholders in value for the time
being outstanding.
(b) the happening of any event, which constitutes a default or which in the opinion of the debenture
trustees affects the interest of the debentureholders.
(16) No debenture trustee should relinquish its assignment in respect of the debenture issue of any body
corporate, unless and until another debenture trustee is appointed in its place by the body corporate.
(17) A debenture trustee is required to maintain the networth requirements on a continuous basis. He is
under an obligation to inform SEBI immediately in respect of any shortfall in the networth. He is also
not entitled to undertake new assignments until it restores the networth to the level of specified requirement
within the time specified by the Board.
(18) Debenture trustee may inspect books of accounts, records, registers of the body corporate and the trust
property to the extent necessary for discharging its obligations.
Code of Conduct
Regulation 16 requires that every debenture trustee shall abide by the code of conduct as specified in Schedule
III to the Regulations.
Maintenance of Records
Regulations 17 and 18 deal with maintenance of books of accounts, records and documents relating to trusteeship
functions for a period of not less than five financial years preceding the current financial year. Every debenture
trustee would inform SEBI about the place where the books of accounts records and documents are maintained
and furnishing of various information to SEBI by the debenture trustee.
Appointment of Compliance Officer
Every debenture trustee is required to appoint a compliance officer responsible for monitoring the compliance of
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the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or Central Government.
He is also responsible for redressal of investor grievances. Compliance officer is under an obligation to immediately
and independently report to SEBI any non-compliance observed by him. He would also report any non-compliance
of the requirements specified in the listing agreement with respect to debenture issues and debentureholders,
by the body corporate to SEBI.
Information to SEBI
Debenture trustee is required to submit the following information and documents to SEBI, as and when SEBI
may require –
(a) The number and nature of the grievances of the debentureholders received and resolved.
(b) Copies of the trust deed.
(c) Non-Payment or delayed payment of interest to debentureholders, if any, in respect of each issue of
debentures of a body corporate.
(d) Details of despatch and transfer of debenture certificates giving therein the dates, modes etc.
(e) Any other particular or document which is relevant to debenture trustee.
Inspection and disciplinary Proceedings
Chapter IV consisting of Regulation 19 to 24 deals with inspection and disciplinary proceedings.
Regulation 19 authorises SEBI to appoint one or more persons as inspecting authority to undertake the inspection
of books of accounts, records and documents of the debenture trustee to ensure their proper maintenance and
compliance with SEBI Act, Rules and Regulation, disposal of investors complaints promptly and to investigate
suo moto in the interest of the securities business or investors interest into the affairs of the debenture trustee.
Regulations 20 to 22 deal with procedure for inspection, obligations of the trustee to fully assist and co-operate
in the inspection, submission of report by the inspecting authority.
Action on Inspection or Investigation Report
SEBI Board or chairman may after consideration of inspection or investigation report take such action as the
Board or chairman may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
Regulation 24 permits SEBI to appoint a qualified auditor to investigate the records and affairs of the debenture
trustee with the same powers given to the inspecting authority.
Procedure for Action in Case of Default
Regulation 25 of Chapter V lays down that a debenture trustee would be dealt with in the manner provided
under Chapter V of SEBI (Intermediaries) Regulations, 2008, if he fails to comply with the conditions of registration,
contravenes the provisions of SEBI Act/Companies Act, Rules and Regulations.
SECONDARY MARKET INTERMEDIARIES
The following market intermediaries are involved in the secondary market:
– Stock brokers
– Sub-brokers
– Portfolio managers
– Custodians
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– Foreign Institutional Investors
– Investment Advisers
STOCK BROKERS AND SUB-BROKER
A stock-broker plays a very important role in the secondary market helping both the seller and the buyer of the
securities to enter into a transaction.
A sub-broker is one who works along with the main broker and is not directly registered with the stock exchange
as a member. He acts on behalf of the stock broker as an agent or otherwise for assisting the investors in
buying, selling or dealing in securities through such stock brokers.
No stock broker or sub-broker shall buy, sell or deal in securities unless he holds a certificate of registration
granted by SEBI under the Regulations made by SEBI in relation to them.
SEBI (STOCK BROKERS & SUB-BROKERS) REGULATIONS, 1992
SEBI (Stock Brokers & Sub-Brokers) Regulations, 1992 were notified by SEBI in exercise of the powers conferred
by section 30 of SEBI Act, 1992 and came into effect on 23rd October, 1992.
Chapter II of the Regulations containing Regulations 3 to 10 deal with registration of Stock Brokers. An application
by a stock broker for grant of a certificate of registration shall be made in Form A through the Stock exchange or
stock exchanges, as the case may be, of which he is admitted as a member. The stock exchange shall forward
the application form to SEBI as early as possible but not later than 30 days from the date of its receipt. SEBI may
require the applicant to furnish such further information or clarifications regarding the dealings in securities and
related matters to consider the application for granting a certificate of registration. The applicant or its principal
officer shall, if so required, appear before SEBI for personal representation.
SEBI shall take into account the following aspects before granting a certificate:
(a) whether the stock broker is eligible to be admitted as a member of a stock exchange;
(b) whether he has the necessary infrastructure like adequate office space, equipment and manpower to
effectively discharge his activities;
(c) whether he has any past experience in the business of buying, selling or dealing in securities;
(d) whether he was subjected to disciplinary proceedings under the rules, regulations and bye-laws of a
stock exchange with respect to his business as a stock broker involving either himself or any of his
partners, directors or employees; and
(e) whether he is a fit and proper person.
SEBI, on being satisfied that the stock broker is eligible, shall grant a certificate of registration to him and send
an intimation to that affect to the stock exchange or stock exchanges as the case may be. However, subject to
the conditions as stipulated by SEBI for registration, a stock broker holding a certificate of registration with
respect to membership of a recognised stock exchange having nationwide trading terminals shall be eligible for
trading on SME platform established by such stock exchange without obtaining a separate certificate of registration
for trading on the SME platform. Regulation 6A lays down the conditions of registration. The stock broker holding
a certificate shall at all times abide by the Code of Conduct as specified in Schedule II of the Regulations.
Rejection of Application of Brokers
Where an application for grant of a certificate does not fulfil the requirements, as prescribed in the Regulations,
SEBI may reject the application after giving a reasonable opportunity of being heard. The refusal to grant the
registration certificate shall be communicated by SEBI within 30 days of such refusal to the concerned stock
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exchange and to the applicant stating therein the grounds on which the application has been rejected. An
applicant may, being aggrieved by the decision of SEBI, may apply within a period of 30 days from the date of
receipt of such intimation, to SEBI for reconsideration of its decision. SEBI shall reconsider an application made
and communicate its decision as soon as possible in writing to the applicant and to the concerned stock exchange.
The stock broker whose application for grant of a certificate has been refused by SEBI shall not, on and from the
date of the receipt of SEBI’s communication, buy, sell or deal in securities as a stock broker.
Every applicant eligible for grant of a certificate of registration shall pay such fees and in such manner as
specified in Schedule III to the regulations. However SEBI may on sufficient cause being shown, permit the
stock broker to pay such fees at any time before the expiry of 6 months from the date on which such fees
become due. Where a stock broker fails to pay the fees as provided, SEBI may suspend the registration certificate,
where upon the stock broker shall cease to buy, sell or deal in securities as a stock broker.
Registration of Sub-brokers
Chapter III of the Regulations containing Regulations 11 to 16 deal with registration of sub-brokers. A sub-broker
cannot act such unless he holds a certificate granted by SEBI. Where a sub-broker merely charges his affiliation
from one stock broker to another stock broker being a member of the same stock exchange. There is no
requirement of obtaining fresh certificate. Again there is no need of obtaining fresh certificate where a registered
stock broker is affiliated to stock broker who is eligible to trade on SME platform.
Regulation 11A lays down that an application by a sub-broker for the grant of certificate shall be made in
Form- B. Such application from the sub-broker applicant shall be accompanied by a recommendation letter in
Form-C from a stock broker of a recognised stock exchange with whom the former is to be affiliated along with
two references including one from his banker. The application form shall be submitted to the stock exchange of
which the stock broker with whom he is to be affiliated is a member.
The stock exchange on receipt of an application shall verify the information contained therein and shall also
certify that the applicant is eligible for registration as per criteria specified below:
(1) In the case of an individual:
(a) the applicant is not less than 21 years of age;
(b) the applicant has not been convicted of any offence involving fraud or dishonesty;
(c) the applicant has at least passed 12th standard equivalent examination from an Institution recognised
by the Government. However, SEBI may relax this criterion on merits having regard to the applicant’s
experience;
(d) the applicant is a fit and proper person.
(2) In the case of partnership firm or a body corporate, the partners or directors as the case may be shall
comply with the requirements stated above. It is also to be assessed whether the applicant has necessary
infrastructure like adequate office space, equipment and manpower to effectively discharge his activities.
The applicant should be person recognised by the stock exchange as a sub-broker affiliated to a member
broker of the stock exchange. The stock exchange shall forward the application form of such applicants,
alongwith recommendation letter issued by the stock broker with whom he affiliated alongwith a recognition
letter issued by the stock exchange to SEBI within 30 days from the date of its receipt.
SEBI on being satisfied that the sub-broker is eligible, shall grant a certificate in Form-E to the sub-broker and send
an intimation to that affect to the stock exchange or exchanges as the case may be. SEBI may grant a certificate
of registration to the applicant subject to the terms and conditions as laid down by SEBI in Regulation 12A.
Regulation 12A lays down the conditions of registration. Any registration granted by SEBI shall be subject to the
following conditions: –
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(a) he shall abide by the rules, regulations and bye-laws of the stock exchange which are applicable to him;
(b) he shall pay fees charged by SEBI;
(c) he shall take adequate steps for redressal of grievances, of the investors within one month of the date
of receipt of the complaint and keep SEBI informed about the number, nature and other particulars of
the complaints received from such investors; and
(d) he is authorized in writing by a stock-broker being a member of a stock exchange for affiliating himself
in buying, selling or dealing in securities.
Where an application for grant of a certificate does not fulfil the requirements mentioned in Regulation 11A,
SEBI may reject the application after giving a reasonable opportunity of being heard. The refusal to grant the
certificate shall be communicated by SEBI within 30 days of such refusal to the concerned stock exchange and
to the applicant in writing stating therein the grounds on which the application has been rejected. An applicant
being aggrieved by the decision of SEBI may, within a period of 30 days from the date of receipt of such
intimation apply to SEBI for reconsideration of the decision.
SEBI shall reconsider an application made and communicate its decision to the applicant in writing and to the
concerned stock exchange as soon as possible.
A person whose application for grant of a certificate has been refused by SEBI shall, on and from the date of
communication of refusal cease to carry on any activity as a sub-broker. The sub-broker has the following
general obligations:
(a) pay the fees as per Schedule III;
(b) abide by the Code of Conduct specified in Schedule II;
(c) enter into an agreement with the stock broker for specifying the scope of his authority and responsibilities;
(d) comply with the rules, regulations and bye laws of the stock exchange;
(e) not be affiliated to more than one stock broker of one stock exchange.
The sub-broker shall keep and maintain the books and documents specified in the Regulations.
No director of a stock broker can act as a sub-broker to the same stock broker.
The general obligations and responsibilities, procedure for inspection and for taking action in case of default
shall be the same for both stock brokers and sub-brokers.
Registration of Trading and Clearing Members
Chapter IIIA consisting of Regulation 16A to 16I deals with registration of trading and clearing members. Regulation
16A on the procedure for application for registration requires that an application for grant of certificate of registration
by a trading member of a derivatives exchange or derivatives segment of a stock exchange shall be made in
Form-AA of Schedule-I, through the concerned derivatives exchange or derivatives segment of a stock exchange
of which he is a member. Similarly an application for grant of certificate of registration by a clearing member or
self clearing member of the clearing corporation or clearing house of a derivatives exchange or derivatives
segment of a stock exchange shall be made in Form-AA of Schedule-I, through the concerned clearing corporation
or clearing house of which is he a member. However, a trading member who also seeks to act as a clearing
member or self clearing member shall make separate applications for each activity. The concerned exchange
shall forward the application to SEBI as early as possible but not later than 30 days from the date of its receipt.
SEBI may require the applicant or the concerned stock exchange or segment or clearing house or corporation
to furnish such other information or clarification regarding the trading and settlement in derivatives and matters
connected thereto, to consider the application for grant of a certificate. The applicant or its principal officer, if so
required shall appear before SEBI for personal representation.
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SEBI shall take into account the following aspects while considering the application, namely –
1 whether the applicant is eligible to be admitted as a trading member or a clearing member as the case
may be;
2 whether the applicant has the necessary infrastructure like adequate office space, equipment and man
power to effectively undertake his activities; and
3 whether he is/was subjected to disciplinary procedures under the rules, regulations and bye-laws of any
stock exchange with respect to his business, involving either himself or any of his partners, directors or
employees;
4 whether the applicant has any financial liability which is due and payable to the SEBI.
The applicant shall also have a net worth as may be specified from time to time and the approved user and sales
personnel of the trading member shall have passed a certification programme approved by SEBI. An applicant
who desires to act as a clearing member shall also have a minimum net worth of ` 300 lakhs and shall deposit
at least a sum of ` 50 lakhs or higher amount with a clearing corporation or a clearing house of the derivatives
exchange or derivatives segment in the form specified from time to time. An applicant who derives to act as a
self clearing member, in addition shall complying with the requirement of minimum networth of ` 100 lakhs and
shall deposit atleast a sum of ` 50 lacs or higher amount with the clearing corporation or clearing house of the
derivatives exchange or derivatives segment in the form specified from time to time.
Net worth in this context shall mean paid up capital plus free reserves and other securities approved by SEBI
from time to time (but does not include fixed assets, pledged securities, value of members card, non allowable
securities which are unlisted, bad deliveries, doubtful dates and advances of more than three months and debt/
advances given to the associate persons of the members), pre-paid expenses, losses, intangible assets and
30% value of marketable securities.
Registration Procedure for Trading and Clearing Member
On being satisfied that the applicant is eligible, SEBI shall grant a certificate in Form-DA of Schedule-I to the
applicant and send an intimation to that effect to the derivative segment of the stock exchange or derivatives
exchange or clearing corporation or clearing house as the case may be. Where an application does not fulfil the
requirements, SEBI may reject the application after giving a reasonable opportunity to the applicant of being
heard. The refusal to grant such certificate shall be communicated by SEBI within 30 days of such refusal to the
concerned segment of stock exchange or clearing corporation or clearing house and to the applicant stating
therein the grounds on which the application has been rejected. If aggrieved by the decision of SEBI as referred
to above, the applicant may apply within a period of 30 days from the date of receipt of such information to SEBI
for reconsideration of its decision. SEBI shall reconsider the application and communicate its decision as soon
as possible in writing to the applicant and to the concerned segment of stock exchange or clearing house or
corporation. If certificate of registration is refused to an applicant he shall not from the date of receipt of SEBI’s
letter of rejection deal in or settle the derivatives contracts as a member of the derivatives exchange as a
member of derivatives exchange, segment, clearing corporation or clearing house. Every applicant eligible for
grant of certificate as a trading or clearing member or self clearing member, shall pay such fee as may be
specified. If the fee is not paid, SEBI may suspend or cancel the registration after giving an opportunity of being
heard where upon the trading or clearing member shall cease to deal in and settle the derivatives contract.
Registration of Trading and Clearing Members of Currency Derivatives Segment
Chapter IIIB containing Regulation 16J to 16R deals with registration of trading and clearing member of currency
derivative segment. Regulation 16J provide that the application for grant of certificate of registration by a trading
member of currency derivatives segment of a stock exchange shall be made in Form AB of Schedule I, through
the concerned currency derivatives segment of a stock exchange of which he is a member. An application for
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grant of certificate of registration by a clearing member of the clearing corporation or clearing house of currency
derivatives segment of a stock exchange, shall be made in Form AB of Schedule I, through the concerned
clearing corporation or clearing house of which he is a member: However, a trading member who also seeks to
act as a clearing member shall make separate applications for each activity in Form AB of Schedule I.The
currency derivatives segment or clearing house or corporation, as the case may be, shall forward the application
to the Board as early as possible but not later than thirty days from the date of its receipt.
SEBI may require the applicant or the concerned stock exchange or segment or clearing house or corporation
to furnish such other information or clarifications, regarding the trading and settlement in currency derivatives
and matters connected thereto, to consider the application for grant of a certificate. The applicant or its principal
officer shall, if so required, appear before SEBI for personal representation.
SEBI shall take into account for considering the grant of a certificate all matters relating to dealing and settlement
in currency derivatives and in particular the following, namely –
(a) Whether the applicant is eligible to be admitted as a trading member or a clearing member
(b) Whether the applicant has the necessary infrastructure like adequate office place, equipment and
manpower to effectively undertake his activities;
(c) Whether he is subjected to disciplinary proceedings under the rules, regulations and bye-laws of any
stock exchange with respect to his business involving either himself or any of his partners, directors or
employees;
(d) Whether the applicant has any financial liability which is due and payable to the Board under these
regulations.
An applicant shall also have a net worth of ` 1 Crore and shall ensure that its approved user and sales personnel
have passed a certification programme approved by SEBI. An applicant who desires to act as a clearing member,
shall have a minimum net worth of ` 10 crore and shall deposit at least a sum of ` 50 lacs or higher amount with
the clearing corporation or clearing house of the currency derivatives segment in the form specified from time to
time.
Registration Procedure
On being satisfied that the applicant is eligible, SEBI shall grant a certificate in Form DB of Schedule I, to the
applicant and send an intimation to that effect to the currency derivatives segment of the stock exchange or
clearing corporation or clearing house, as the case may be. Where an application for the grant of a certificate
does not fulfil the requirements SEBI may reject the application of the applicant after giving a reasonable
opportunity of being heard. The refusal to grant the certificate of registration shall be communicated by SEBI
within 30 days of such refusal to the currency derivatives segment of the stock exchange, or clearing house or
corporation and to the applicant stating therein the grounds on which the application has been rejected. An
applicant may, if aggrieved by the decision of SEBI as referred to above, the applicant may apply within a period
of thirty days from the date of receipt of such information to SEBI for reconsideration of its decision. SEBI shall
reconsider an application made and communicate its decision as soon as possible in writing to the applicant and
to the currency derivatives segment of the stock exchange or clearing house or corporation.
An applicant, whose application for the grant of a certificate of registration has been refused by SEBI shall not on
and from the date of receipt of the communication deal in or settle the currency derivatives contracts as a
member of the currency derivatives segment of the stock exchange or clearing corporation or clearing house.
Code of Conduct
The code of conduct specified for the stock broker as stipulated in Schedule-II shall be applicable mutatis
mutandis to the trading member, clearing member and self-clearing member and such members shall at all
times abide by the same. The trading member shall obtain details of the prospective clients in “know your client”
84 PP-CC&MM
format as specified by SEBI before executing an order on behalf of such client. The trading member shall
mandatorily furnish “risk disclosure document” disclosing the risk inherent in trading in derivatives to the prospective
clients in the form specified. The trading or clearing member shall deposit a margin money or any other deposit
and shall maintain position or exposure limit as specified by SEBI or the concerned exchange or segment or
clearing corporation or clearing house from time to time.
General Obligations and Responsibilities
Regulation 17 and 18 deal with the general obligations and responsibilities of stock brokers. It lays down that
every stock broker shall keep and maintain books of accounts, records and documents namely – Register of
Transactions (Sauda book); clients ledger; general ledger; journals; cash book; bank pass book; documents
register including particulars of securities received and delivered in physical form and the statement of account
and other records relating to receipt and delivery of securities provided by the depository participants in respect
of dematerialised securities, members contract books showing details of all contracts entered into by him 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 consents of clients in
respect of contracts entered into as principals; margin deposit book; registers of accounts of sub-brokers; an
agreement with sub-broker specifying scope of authority, and responsibilities of the stock brokers as well as
sub-brokers and an agreement with the sub-broker and with the client of sub-broker to establish privity of
contract between the stock broker and the client of the sub-broker.
Every stock broker shall intimate to SEBI the place where the books of accounts, records and documents are
maintained. He shall, after the close of each accounting period, furnish to SEBI if so required, as soon as
possible but not later than 6 months from the close of the said period, a copy of the audited balance sheet and
profit and loss account for the said accounting period.
If this is not possible, the stock broker shall keep SEBI informed of the same together with the reasons for the
delay and the period of time by which such documents would be furnished to SEBI. Every stock broker shall
preserve the books of accounts and other records for a minimum period of 5 years. Stock broker shall not deal
with any person as sub-broker unless such person has been granted certificate of registration by SEBI.
Compliance Officer
Every stock broker is required to appoint a compliance officer who shall be responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or Central
Government and for redressal of investors’ grievances. Compliance officer shall immediately and independently
report to SEBI any non-compliance observed by him.
Procedure for Inspection of Stock Brokers’ Offices
Regulations 19 to 24 provides for procedure for inspection. It is provided that where it appears necessary to
SEBI, it may appoint one or more persons as inspecting authority to undertake inspection of the books of
accounts other records and documents of the stock brokers:(a) to ensure that the books of account and other books are being maintained in the manner required,
(b) that the provisions of the Act, rules and regulations as well as the provisions of the Securities Contracts
(Regulation) Act, 1956 and the rules made thereunder are being complied with,
(c) to investigate into the complaints received from investors, other stock brokers, sub-brokers or any other
person on any other matter having a bearing on the activities of the stock brokers, and
(d) to investigate suo moto in the interest of securities business or investors interest into the affairs of the
stock broker.
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Before undertaking inspection, SEBI shall give a reasonable notice to the stock broker. However, if SEBI is
satisfied that in the interest of the investors or in public interest, no such notice should be given, it may by an
order in writing, direct that the inspection be taken up without such notice to the stock broker. On being empowered
by SEBI, the inspecting authority shall undertake the inspection and the stock broker concerned shall be bound
to discharge his obligations to facilitate and co-operate for the conduct of inspection by the said authority.
Obligations of Stock Broker on Inspection by SEBI
It shall be the duty of every director, proprietor, partner, officer and employee of the stock broker who is being
inspected, to produce to the inspecting authority such books, accounts and other documents in his custody or
control and furnish him with the statements and information relating to the transactions in securities market
within such time as the inspecting authority may require.
The stock broker shall allow the inspecting authority to have reasonable access to the premises occupied by
such stock broker or by any other person on his behalf and also extend reasonable facility for examining any
books, records, documents and computer data in the possession of the stock broker or any other person and
also provide copies of documents or other materials which in the opinion of the inspecting authority are relevant.
The said authority in the course of inspection shall be entitled to examine or record statements of any member,
director, partner, proprietor and employee of the stock broker. It shall be duty of every director, proprietor,
partner, officer and employee of stock broker to give the said authority all assistance in connection with the
inspection, which the stock broker may be reasonably expected to give.
The inspecting authority shall as soon as possible submit an inspection report to SEBI who shall after consideration
of inspection or investigation report take such action as it may deem fits and appropriate including action under
Chapter V of SEBI (Intermediaries) Regulations, 2008.
SEBI is also empowered to appoint a qualified auditor to investigate into the books of accounts or the affairs of
the stock broker. The auditor so appointed shall have the same powers of the inspecting authority as enumerated
above and the obligations of the stock broker as detailed above shall be applicable to the investigation.
Procedure for Action in Case of Default
A stock broker or a sub-broker who contravenes any of the provisions of the Act, rules or regulations framed
thereunder shall be liable for any one or more of the following actions –
(i) Monetary penalty under Chapter VIA of the Act.
(ii) Penalties as specified under Chapter V of SEBI (Intermediaries) Regulations, 2008 including suspension
or cancellation of certificate of registration as a stock broker or a sub-broker.
(iii) Prosecution under Section 24 of the Act.
Liability for Monetary Penalty
A stock broker or a sub-broker shall be liable for monetary penalty in respect of the following violations, namely –
(i) Failure to file any return or report with SEBI.
(ii) Failure to furnish any information, books or other documents within 15 days of issue of notice by SEBI.
(iii) Failure to maintain books of account or record as per the Act, rules or regulations framed thereunder.
(iv) Failure to redress the grievances of investors within 30 days of receipts of notice from SEBI.
(v) Failure to issue contract notes in the form and manner specified by the Stock Exchange of which such
broker is a member.
(vi) Failure to deliver any security or make payment of the amount due to the investor within 48 hours of the
settlement of trade unless the client has agreed in writing otherwise.
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(vii) Charging of brokerage which is in excess of brokerage specified in the regulations or the bye-laws of
the stock exchange.
(viii) Dealing in securities of a body corporate listed on any stock exchange on his own behalf or on behalf of
any other person on the basis of any unpublished price sensitive information.
(ix) Procuring or communicating any unpublished price sensitive information except as required in the ordinary
course of business or under any law.
(x) Counselling any person to deal in securities of any body corporate on the basis of unpublished price
sensitive information.
(xi) Indulging in fraudulent and unfair trade practices relating to securities.
(xii) Execution of trade without entering into agreement with the client under the Act, rules or regulations
framed thereunder or failure to maintain client registration form or commission of any irregularities in
maintaining the client agreement.
(xiii) Failure to segregate his own funds or securities from the client’s funds or securities or using the securities
or funds of the client for his own purpose or for purpose of any other client.
(xiv) Acting as an unregistered sub-broker or dealing with unregistered sub-brokers.
(xv) Failure to comply with directions issued by SEBI under the Act or the regulations framed thereunder.
(xvi) Failure to exercise due skill, care and diligence.
(xvii) Failure to seek prior permission of SEBI in case of any change in its status and constitution.
(xviii) Failure to satisfy the net worth or capital adequacy norms, if any, specified by SEBI.
(xix) Extending use of trading terminal or any unauthorized person or place.
(xx) Violations for which no separate penalty has been provided under these regulations.
Liability for Action under the Enquiry Proceeding
A stock broker or a sub-broker shall be liable for any action as specified in SEBI (Intermediaries) Regulations,
2008 including suspension or cancellation of his certificate of registration as a stock broker or a sub-broker, as
the case may be, if he –
(i) ceases to be a member of a stock exchange; or
(ii) has been declared defaulter by a stock exchange and not readmitted as a member within a period of six
months; or
(iii) surrender his certificate of registration to SEBI; or
(iv) has been found to be not a fit and proper person by SEBI under these or any other regulations; or
(v) has been declared insolvent or order for winding up has been passed in the case of a broker or subbroker being a company registered under the Companies Act, 1956; or
(vi) or any of the partners or any whole-time director in case a broker or sub-broker is a company registered
under the Companies Act, 1956 has been convicted by a court of competent jurisdiction for an offence
involving moral turpitude; or
(vii) fails to pay fee as per Schedule III of these regulations; or
(viii) fails to comply with the rules, regulations and bye-laws of the stock exchange of which he is a member;
or
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(ix) fails to co-operate with the inspecting or investigating authority; or
(x) fails to abide by any award of the Ombudsman or decision of the Board under the Securities and
Exchange Board of India (Ombudsman) Regulations, 2003; or
(xi) fails to pay the penalty imposed by the Adjudicating Officer; or
(xii) indulges in market manipulation of securities or index; or
(xiii) indulges in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations, 1992; or
(xiv) violates SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003; or
(xv) commits violation of any of the provisions for which monetary penalty or other penalties could be imposed;
or
(xvi) fails to comply with the circulars issued by SEBI; or
(xvii) commits violations specified in Regulation 26 which in the opinion of SEBI are of a grievous nature.
Liability for Prosecution
A stock broker or a sub-broker shall be liable for prosecution under Section 24 of the Act for any of the following
violations, namely –
(i) Dealing in securities without obtaining certificate of registration from the Board as a stock broker or a
sub-broker.
(ii) Dealing in securities or providing trading floor or assisting in trading outside the recognized stock exchange
in violation of provisions of the Securities Contract (Regulation) Act, 1956 or rules made or notifications
issued thereunder.
(iii) Market manipulation of securities or index.
(iv) Indulging in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations, 1992.
(v) Violating SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003.
(vi) Failure without reasonable cause –
(a) to produce to the investigating authority or any person authorized by him in this behalf, any books,
registers, records or other documents which are in his custody or power; or
(b) to appear before the investigating authority personally or to answer any question which is put to him
by the investigating authority; or
(c) to sign the notes of any examination taken down by the investigating authority.
(vii) Failure to pay penalty imposed by the adjudicating officer or failure to comply with any of his directions
or orders.
A CASE STUDY ON FRAUDULENT DEALINGS
Bishwanath Murlidhar Jhunjhunwala v. SEBI
SEBI noticed a spurt in the volume in the trading of the scrip of Snowcem India Ltd. (SIL), both at NSE and BSE.
Though the scrip was not very liquid, it was observed that during June 1999 to August 1999, price of the scrip
ranged between `55 to `127. The Appellant, a stock broker of BSE himself was found to have registered himself
as a client with a broker of NSE and placed orders in large quantities in the scrip of SIL to the tune of 2,87,400
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shares which amounted to 5.59 percent of the total volume traded at NSE between June 1999 and August 1999.
Orders placed by the Appellant were matched with those orders placed by Kosha Investment Ltd. (KIL). Further,
the Appellant had not traded in his own account at BSE. The conduct of the Appellant was in violation of Regulation
4(a), (b) and (d) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations, 2003 in view of which he was prohibited from accessing capital market for a period of 2 years.
Upholding the impugned order in its totality, the Hon’ble SAT noted that, “It is a fact that the persons who operate
in the market are required to maintain high standards of integrity, promptitude and fairness in the conduct of
business dealings.
Submission of Annual Returns
As part of the continued compliance, National Stock Exchange of India requires its Members to submit Annual
Returns i.e. details in respect of shareholding, directors, etc. in the prescribed format to the Exchange. Members
having financial year ending other than March 31, are required to submit the said documents within a period of
6 months from the end of their respective financial year. Accordingly, such members are required to inform the
Exchange about the financial year followed by them on or before October 31 every year. In case any member
has changed its financial year from the one followed earlier, it shall convey such details to the Exchange on or
before October 31. Trading Members are required to file the prescribed information/documents in electronic
form over and above the submission in hard form.
Bombay Stock Exchange of India also requires its all active members including Representative members of
Cash segment, Limited Trading members & Trading and/or Clearing members of the Derivatives segment of the
Bombay Stock Exchange to submit Networth Certificate to the Exchange.
CERTIFICATION BY PRACTICING COMPANY SECRETARY
1. Internal Audit for Stock Brokers/Trading Members/ Clearing Members
SEBI has authorized the Practicing Company Secretary to carry out complete internal audit of stock brokers/
trading members/clearing members on a half yearly basis. The circular states that stock brokers/trading members/
clearing members shall carry out complete internal audit on a half yearly basis by chartered accountants, company
secretaries or cost and management accountants who are in practice and who do not have any conflict of
interest. The scope of such audit covers, inter alia, the existence, scope and efficiency of the internal control
system, compliance with the provisions of the SEBI Act, 1992, Securities Contracts (Regulation) Act 1956, SEBI
(Stock Brokers and Sub-Brokers) Regulations, 1992, circulars issued by SEBI, agreements, KYC requirements,
Bye Laws of the Exchanges, data security and insurance in respect of the operations of stock brokers/clearing
members. The objective of internal audit is –
(i) to ensure that the books of account, records (including telephone records and electronic records) and
documents are being maintained in the manner required under SEBI Act, 1992, SCR Act, 1956 and
SEBI (Stock brokers and Sub-brokers) Regulations, 1992.
(ii) to ascertain as to whether adequate internal control systems, procedures and safeguards have been
established and are being followed by the intermediary to fulfill its obligations within the scope of the audit.
(iii) to ascertain as to whether any circumstances exist which would render the intermediary unfit or ineligible.
(iv) to ascertain whether the provisions of the securities laws and the directions or circulars issued thereunder
are being complied with.
(v) to ascertain whether the provision of stock exchange bye-laws, notices, circulars, instructions or orders
issued by stock exchanges are being complied with.
(vi) to inquire into the complaints received from investors, clients, other market participants or any other
person on any matter having a bearing on the activities of the stock broker.
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PORTFOLIO MANAGER
Portfolio manager means any person who pursuant to contract or arrangement with the client, advises or directs
or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management
or administration of a portfolio of securities or the funds of the clients as the case may be. “Discretionary portfolio
manager” is defined as one who exercises or may exercise, under a contract relating to portfolio management,
any degree of discretion as to the investment or the management of the portfolio of the securities or the funds of
the client. “Portfolio” means the total holdings of securities belonging to any person.
A portfolio manager thus, with professional experience and expertise in the field, studies the market and adjusts
the investment mix for his client on a continuing basis to ensure safety of investment and reasonable returns
therefrom.
SEBI (PORTFOLIO MANAGERS) REGULATIONS, 1993
SEBI issued SEBI (Portfolio Managers) Regulations, 1993 in exercise of the powers conferred by Section 30 of
SEBI Act, 1992. These regulations took effect from 7th January, 1993.
Regulation 3A lays down that an application by a portfolio manager for grant of the certificate shall be made to
SEBI in the prescribed form-A and shall be accompanied by a non-refundable application fee, as specified in
Clause (1) of Schedule II, to be paid in the manner specified in Part B thereof. Incomplete applications shall be
rejected after the applicant is given an opportunity to remove within the time specified such objections on the
application as may be indicated by SEBI. Before disposing the application, SEBI may require the applicant to
furnish further information or clarification and the applicant or its principal officer who is mainly responsible for
the activities as a portfolio manager, shall appear before SEBI to make a personal representation, if required.
Norms for Registration as Portfolio Managers
The requirements to be satisfied by the applicant for getting the certificate of registration as mentioned in Regulation
6 are as follows:
(a) the applicant is a body corporate;
(b) the applicant has the necessary infrastructure like adequate office space, equipments and the manpower
to effectively discharge the activities of a portfolio manager;
(c) the principal officer of the applicant has the professional qualifications in finance, law, accountancy or
business management from an institution recognised by the Government or a foreign university or an
experience of at least 10 years in related activities in the securities market including in a portfolio manager,
stock broker or as a fund manager;
(d) the applicant has in its employment minimum of two persons who, between them, have at least five
years experience as portfolio manager or stock broker or investment manager or in the areas related to
fund management;
(e) any previous application for grant of certificate made by any person directly or indirectly connected with
the applicant has been rejected by SEBI;
(f) any disciplinary action has been taken by the Board against a person directly or indirectly connected
with the applicant under the Act or the Rules or the Regulations made thereunder.
The expression ‘person directly or indirectly connected’ means any person being an associate, subsidiary,
inter-connected company or a company under the same management within the meaning of Section
370(1B) of the Companies Act, 1956 or in the same group;
(g) the applicant fulfils the capital adequacy requirements;
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(h) the applicant, its director, principal officer or the employee as specified in Clause (d) is involved in any
litigation connected with the securities market which has an adverse bearing on the business of the
applicant;
(i) the applicant, its director, principal officer or the employee as specified in Clause (d) has at any time
been convicted for any offence involving moral turpitude or has been found guilty of any economic
offence;
(j) the applicant is a fit and proper person;
(k) grant of certificate to the applicant is in the interests of investors.
Capital Adequacy Requirement
Portfolio manager must have capital adequacy requirement of not less than networth of two crore rupees.
However the portfolio manager shall fulfill capital adequacy requirement under these regulations, separately
and independently of capital adequacy requirements if any for each activity undertaken by it under the relevant
regulations. Networth for the purpose means the aggregate value of paid-up equity capital plus free reserves
(excluding reserves created out of revaluation) reduced by the aggregate value of accumulated looses and
deferred expenditure not written off, including miscellaneous expenses not written off.
SEBI on being satisfied that the applicant fulfils the requirement specified above shall send an intimation to the
applicant. On payment of the requisite fees by the applicant in accordance with Clause 1A of Schedule II of the
Regulations, he will be granted a certificate of Registration in Form-B.
Renewal of Certificate
A portfolio manager may make an application for renewal of his registration at least three months before the
expiry of the validity of his certificate.
SEBI, in addition to the information furnished in form A along with fees specified in Clause 1 of Schedule II has
prescribed for certain additional information to be submitted by the applicant while seeking registration/ renewal
as portfolio managers. The applicant has been required to furnish the additional detailed information in the
following areas:
1. Memorandum and Articles of Association of the applicant
2. Details of Directors & shareholding pattern
3. Details of Promoters & shareholding pattern
4. Details of applicant registered with SEBI as any other intermediary
5. Details of the Principal Officer
6. Details of Key personnel
7. Details of infrastructure facilities
8. Details of the proposed Schemes
9. Details of facility for safe custody
10. Details of facility for equity research
11. Financial Accounts of the applicant
12. Report from principal bankers
13. List of brokers
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14. Details regarding applicant registered with RBI (if any)
15. Details of associated registered intermediaries
16. Declaration by at least two directors
17. Declaration for fit and proper person
18. Director’s Declaration under regulation 6.
The applicant has been advised to note that furnishing of incomplete information would delay the processing of
the application. The applicant has also been advised to keep the Board informed of all the consequent changes
in the information provided to the board.
Conditions of Registration
Any registration granted or any renewal granted under these regulation shall be subject to the following conditions
namely:
(a) where the portfolio manager proposes to change its status or constitution, it shall obtain prior approval
of the Board for continuing to act as such after the change;
(b) it shall pay the fees for registration or renewal, as the case may be, in the manner provided in these
regulations;
(c) it shall take adequate steps for redressal of grievances of the investors within one month of the date of
the receipt of the complaint and keep the Board informed about the number, nature and other particulars
of the complaints received;
(d) it shall maintain capital adequacy requirements specified in these regulation at all times during the
period of the certificate or renewal thereof;
(e) it shall abide by the regulations made under the Act in respect of the activities carried on by it as portfolio
manager.
Period of Validity of Certificate
The certificate of registration granted and its renewal granted under these regulation shall be valid for a period
of three years from the date of its issue to the applicant.
Procedure Where Registration is not Granted
Where the applicant does not satisfy the requirement of registration, SEBI may reject the application after giving
an opportunity of being heard. The refusal shall be communicated by SEBI within 30 days of such refusal
indicating the grounds for rejection. An applicant if aggrieved by SEBI’s rejection may apply within a period of 30
days from the date of receipt of rejection letter to SEBI for reconsideration. SEBI shall reconsider the matter and
communicate its final decision as soon as possible in writing to the applicant. The applicant shall cease to carry
on activity as portfolio manager on receipt of rejection of his application. If the portfolio manager fails to pay the
fees as provided in Schedule II, SEBI may suspend the certificate and during the period of suspension the
portfolio manager shall not carry on activity as such portfolio manager.
Code of Conduct
Regulation 13 lays down that every portfolio manager shall abide by the code of conduct as specified in Schedule
III to the Regulations which is as follows:
1. A portfolio manager shall, in the conduct of his business, observe high standards of integrity and fairness in all
his dealings with his clients and other portfolio managers.
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2. The money received by a portfolio manager from a client for an investment purpose should be deployed by
the portfolio manager as soon as possible for that purpose and money due and payable to a client should be
paid forthwith.
3. A portfolio manager shall render at all times high standards of service, exercise due diligence, ensure proper
care and exercise independent professional judgement. The portfolio manager shall either avoid any conflict of
interest in his investment or disinvestment decision, or where any conflict of interest arises, ensure fair treatment
to all his customers. He shall disclose to the clients, possible sources of conflict of duties and interests, while
providing unbiased services. A portfolio manager shall not place his interest above those of his clients.
4. A portfolio manager shall not make any statement or become privy to any act, practice or unfair competition,
which is likely to be harmful to the interests of other portfolio managers or is likely to place such other portfolio
managers in a disadvantageous position in relation to the portfolio manager himself, while competing for or
executing any assignment.
5. A portfolio manager shall not make any exaggerated statement, whether oral or written, to the client either
about the qualification or the capability to render certain services or his achievements in regard to services
rendered to other clients.
6. At the time of entering into a contract, the portfolio manager shall obtain in writing from the client, his interest
in various corporate bodies which enables him to obtain unpublished price-sensitive information of the body
corporate.
7. A portfolio manager shall not disclose to any clients or press any confidential information about his client,
which has come to his knowledge.
8. The portfolio manager shall where necessary and in the interest of the client take adequate steps for registration
of the transfer of the clients’ securities and for claiming and receiving dividends, interest payments and other
rights accruing to the client. He shall also take necessary action for conversion of securities and subscription/
renunciation of/or rights in accordance with the clients’ instruction.
9. A portfolio manager shall endeavour to –
(a) ensure that the investors are provided with true and adequate information without making any misguiding
or exaggerated claims and are made aware of attendant risks before any investment decision is taken
by them;
(b) render the best possible advice to the client having regard to the client’s needs and the environment,
and his own professional skills;
(c) ensure that all professional dealings are effected in a prompt, efficient and cost effective manner.
10. (1) A portfolio manager shall not be a party to –
(a) creation of false market in securities;
(b) price rigging or manipulation of securities;
(c) passing of price sensitive information to brokers, members of the stock exchanges and any other
intermediaries in the capital market or take any other action which is prejudicial to the interest of the
investors.
(2) No portfolio manager or any of its directors, partners or manager shall either on their respective accounts or
through their associates or family members and relatives enter into any transaction in securities of companies
on the basis of unpublished price sensitive information obtained by them during the course of any professional
assignment.
11. (a) A portfolio manager or any of his employees shall not render, directly or indirectly any investment advice
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about any security in the publicly accessible media, whether real-time or non-real-time, unless a disclosure of
his long or short position in the said security has been made, while rendering such advice.
(b) In case an employee of the portfolio manager is rendering such advice, he shal 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.
12. (a) The portfolio manager shall abide by the Act, and the Rules, Regulations made thereunder and the
Guidelines/Schemes issued by the Board.
(b) The portfolio manager shall comply with the model code of conduct specified in SEBI (Prohibition of Insider
Trading) Regulations, 1992.
(c) The portfolio manager shall not use his status as any other registered intermediary to unduly influence the
investment decision of the clients while rendering portfolio management services.
Contract with Clients and Disclosures
The portfolio manager, before taking up an assignment of management of funds or portfolio of securities on
behalf of a client, enter into an agreement in writing with such client clearly defining the inter se relationship and
setting out their mutual rights, liabilities and obligations relating to the management of funds or portfolio of
securities containing the details as specified in Schedule IV to the Regulations:
The agreement between the portfolio manager and the client shall, inter alia, contain:
(i) the investment objectives and the services to be provided;
(ii) areas of investment and restrictions, if any, imposed by the client with regard to the investment in a
particular company or industry;
(iii) type of instruments and proportion of exposure;
(iv) tenure of portfolio investments;
(v) terms for early withdrawal of funds or securities by the clients;
(vi) attendant risks involved in the management of the portfolio;
(vii) period of the contract and provision of early termination, if any;
(viii) amount to be invested subject to the restrictions provided under these regulations;
(ix) procedure of settling client’s account including form of repayment on maturity or early termination of
contract;
(x) fees payable to the portfolio manager;
(xi) the quantum and manner of fees payable by the client for each activity for which service is rendered by
the portfolio manager directly or indirectly (where such service is outsourced);
(xii) custody of securities;
(xiii) in case of a discretionary portfolio manager a condition that the liability of a client shall not exceed his
investment with the portfolio manager;
(xiv) the terms of accounts and audit and furnishing of the reports to the clients as per the provisions of these
regulations; and
(xv) other terms of portfolio investment subject to these regulations.
The portfolio manager shall provide to the client, the Disclosure Document as specified in Schedule V, along
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with a certificate in Form C as specified in Schedule I, at least two days prior to entering into an agreement with
the client as referred to in Sub-regulation
(1). The Disclosure Document, shall inter alia contain the following –
(i) the quantum and manner of payment of fees payable by the client for each activity for which service is
rendered by the portfolio manager directly or indirectly (where such service is outsourced);
(ii) portfolio risks;
(iii) complete disclosures in respect of transactions with related parties as per the accounting standards
specified by the Institute of Chartered Accountants of India in this regard;
(iv) the performance of the portfolio manager :
Provided that the performance of a discretionary portfolio manager shall be calculated using weighted
average method taking each individual category of investments for the immediately preceding three
years and in such cases performance indicators shall also be disclosed;
(v) the audited financial statements of the portfolio manager for the immediately preceding three years.
The contents of the Disclosure Document would be certified by an independent chartered accountant.
The portfolio manager is required to file with SEBI, a copy of the Disclosure Document before it is circulated or
issued to any person and every six months thereafter or whenever any material change is effected therein
whichever is earlier, along with the certificate in Form C as specified in Schedule I. The portfolio manager shall
ensure that the disclosure document is given to clients along with the account opening form atleast 2 days in
advance of signing of the agreement. The portfolio manager shall charge an agreed fee from the clients for
rendering portfolio management services without guaranteeing or assuring, either directly or indirectly, any
return and the fee so charged may be a fixed fee or a return based fee or a combination of both.
The portfolio manager may, subject to the disclosure in terms of the Disclosure Document and specific permission
from the client, charge such fees from the client for each activity for which service is rendered by the portfolio
manager directly or indirectly (where such service is outsourced).
Responsibilities of a Portfolio Manager
Regulation 15 lays down that the discretionary portfolio manager shall individually and independently manage
the funds of each client in accordance with the needs of a client in a manner which does not partake the
character of a mutual fund, whereas the non discretionary portfolio manager shall manage the funds in accordance
with the directions of the client.
(a) The portfolio manager shall not accept from the client, funds or securities worth less than five lacs
rupees.
(b) The portfolio manager shall act in a fiduciary capacity with regard to the clients funds.
(c) He shall transact in securities within the limitation placed by the client for dealing in securities under the
provisions of RBI Act, 1934.
(d) He shall not derive any direct or indirect benefit out of the clients funds or securities.
(e) The portfolio manager shall not accept from the client, funds or securities worth less than five lacs
rupees. However, the minimum investment amount per client shall be applicable for new clients and
fresh investment by existing clients.
The portfolio manager shall keep the funds of all clients in a separate account to be maintained by it in a
Scheduled Commercial Bank. He shall ensure proper and timely handling of complaints from his clients and
take appropriate action promptly.
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Investment of Clients Money
(1) The money or securities accepted by the portfolio manager shall not be invested or managed by the portfolio
manager except in terms of the agreement between the portfolio manager and the client.
(2) Any renewal of portfolio fund on maturity of the initial period shall be deemed as a fresh placement.
(3) The funds or securities can be withdrawn or taken back by the client before the maturity of the contract under
the following circumstances, namely –
(a) voluntary or compulsory termination of portfolio management services by the portfolio manager or the
client.
(b) suspension or cancellation of the certificate of registration of the portfolio manager by the Board.
(c) bankruptcy or liquidation of the portfolio manager.
(4) The portfolio manager shall invest funds of his clients in money market instruments or derivatives or as
specified in the contract:
However, leveraging of portfolio shall not be permitted in respect of investment in derivatives further the portfolio
manager shall not deploy the clients’ funds in bill discounting, badla financing or for the purpose of lending or
placement with corporate or non-corporate bodies. “Money market instruments” includes commercial paper,
trade bill, treasury bills, certificate of deposit and usance bills.
(5) The portfolio manager shall not while dealing with clients’ funds indulge in speculative transactions that is, he
shall not enter into any transaction for purchase or sale of any security which is periodically or ultimately settled
otherwise than by actual delivery or transfer of security except the transactions in derivatives.
(6) The portfolio manager shall, ordinarily purchase or sell securities separately for each client. However, in the
event of aggregation of purchases or sales for economy of scale, inter se allocation shall be done on a pro rata
basis and at weighted average price of the day’s transactions. The portfolio manager shall not keep any open
position in respect of allocation of sales or purchases effected in a day. Any transaction of purchase or sale
including that between the portfolio manager’s own accounts and client’s accounts or between two clients’
accounts shall be at the prevailing market price.
(7) The portfolio manager shall segregate each clients’ funds and portfolio of securities and keep them separately
from his own funds and securities and be responsible for safekeeping of clients’ funds and securities.
(8) The portfolio manager shall not hold the listed securities, belonging to the portfolio account, in its own name
on behalf of its clients either by virtue of contract with clients or otherwise. The portfolio managers, may, subject
to authorization by the client in writing, participate in securities lending.
Foreign institutional investors and sub accounts registered with SEBI may avail of the services of a portfolio
manager.
(9) Every portfolio manager shall appoint a custodian in respect of securities managed or administered by it.
However, this regulation shall not apply to a portfolio Manager who has total assets under management of value
less than five hundred crore rupees; or who performs purely advisory functions.
Accounting by Portfolio Managers
Regulations 17 to 20 deal with books of accounts, records, accounts and audit.
Regulation 17 lays down that every portfolio manager shall keep and maintain the following books of accounts,
records and documents, namely -a) a copy each of balance sheet, profit and loss account and the auditor’s
account in respect of each accounting period b) a statement of financial position and c) records in support
of every investment transaction or recommendation which will indicate the data, facts and opinions leading
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to that investment decision. Every portfolio manager shall intimate to SEBI where the books of accounts,
records or documents are maintained. Every portfolio manager shall after the end of each accounting
period furnish to SEBI copies of the balance sheet, profit and loss account and such other documents as
are required by the regulations. Regulation 18 provides that portfolio manager should furnish to SEBI halfyearly unaudited financial results when required by SEBI with a view to assist in monitoring the capital
adequacy of the portfolio manager.
The portfolio manager shall preserve the books of account and other records and documents mentioned in any
of the regulations mentioned under this chapter for a minimum period of five years.
Regulation 20 lays down that the portfolio manager shall maintain separate client-wise accounts. The funds
received from the clients, investments or disinvestments and all the credits to the account of the client like
interest, dividend, bonus or any other beneficial interest received on the investment and debits for expenses if
any shall be properly accounted for and details thereof shall be reflected correctly in the clients accounts. The
tax deducted at source as required under the Income Tax Act, 1961 shall be recorded in the portfolio account.
The books of account will be audited by a qualified auditor to ensure that portfolio manager has followed proper
accounting methods and procedures and that he has performed the duties in accordance with the law. A certificate
to this effect shall, if so specified be submitted to SEBI within 6 months of the close of the portfolio managers
accounting period.
The portfolio accounts of the portfolio manager shall be audited annually by an independent chartered accountant
and a copy of the certificate issued by the chartered accountant shall be given to the client.
The client may appoint a chartered accountant to audit the books and accounts of the portfolio manager relating
to his transactions and the portfolio manager shall co-operate with such chartered accountant in course of the
audit.
Reports by Portfolio Manager to the Client
Regulation 21 lays down that the portfolio manager shall furnish periodically a report to the client as agreed to in
the contract but not exceeding a period of 6 months and such report shall contain the following details, namely–
(a) the composition and the value of the portfolio, description of security, number of securities, value of
each security held in a portfolio, cash balance and aggregate value of the portfolio as on the date of
report.
(b) transactions undertaken during the period of report including dates of transaction and details of purchases
and sales.
(c) beneficial interest received during that period in respect of interest, dividend, bonus shares, rights shares
and debentures.
(d) expenses incurred in managing the portfolio of the client.
(e) details of risk foreseen by the portfolio manager and the risk relating to the securities recommended by
the portfolio manager for investment or disinvestment.
Regulation 21(1A) provides that the report may be made available on the website of the portfolio manager with
restricted access to each client.
The portfolio manager shall also furnish to the client documents and information relating only to the management
of a portfolio. On termination of the contract, the portfolio manager shall give a detailed statement of accounts to
the client and settle the account with the client as agreed in the contract. The client has the right to obtain details
of his portfolio from the portfolio manager.
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Action on Auditor’s Report and Disclosure to SEBI
Every portfolio manager shall within two months from the date of the auditor’s report take steps to rectify the
deficiencies made out in such report. A portfolio manager shall disclose to SEBI as and when required the
information, namely -Particulars regarding the management of a portfolio; any change in the information or
particulars previously furnished; which have a bearing on the certificate granted to him; the names of the clients
whose portfolio he has managed; and particulars relating to the capital adequacy requirement.
Compliance Officer
Every portfolio manager is required to appoint a compliance officer responsible for monitoring the compliance of
the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the Central Government
and for redressal of investors’ grievances. The compliance officer should independently and immediately report
to SEBI for any non-compliance observed by him.
Inspection and Disciplinary Proceedings
Regulations 24 to 29 contain provisions on this subject.
Regulation 24 empowers SEBI to appoint one or more persons as inspecting authority to undertake the inspection
of the books of accounts, records and documents of the portfolio manager to ensure that they are being maintained
in the manner required, that the provisions of the Act, Rules and Regulations are being complied with. The
inspecting authority shall investigate into the complaints received from the investors, other portfolio managers or
any other person on any matter having a bearing on the activities of the portfolio manager and investigate suo
moto in the interest of securities business or investors interest into the affairs of the portfolio manager.
Notice before Inspection
SEBI shall give a reasonable notice to the portfolio manager before undertaking an inspection. However, where
SEBI is satisfied that in the interest of the investors, no such notice should be given it may by an order in writing
direct that the inspection of the affairs of the portfolio manager be taken up without such notice. During the
course of the inspection the portfolio manager against whom an inspection is being carried out shall be bound to
discharge his obligations as stated below:
Obligations of Portfolio Manager
(1) It shall be the duty of every director, proprietor, partner, officer and employee of the portfolio manager who is
being inspected, to produce to the inspecting authority such books of accounts and documents in his custody or
control and furnish him with the statements and information relating to these activities within such time as the
inspecting authority may require.
(2) The portfolio manager shall allow the inspecting authority to have reasonable access to the premises occupied
by the former or by any other person on his behalf and also extend reasonable facility for examining any books,
records, documents and computer data in his possession or in the possession of any other person and also
provide copies of documents or other material which in the opinion of the inspecting authority are relevant for the
purposes of the inspection.
(3) In the course of inspection, the inspecting authority shall be entitled to examine or record statements of any
principal officer, director, partner, proprietor and employee of the portfolio manager.
(4) It shall be the duty of each such person to give to the inspecting authority all assistance in connection with
the inspection which the portfolio manager may reasonably be expected to give.
The inspecting authority shall submit an inspection report to SEBI as soon as it is possible. SEBI or chairman
shall after consideration of the inspection or investigation report take such action as SEBI or its chairman may
deem fit and appropriate including action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
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Appointment of Auditor
SEBI may appoint a qualified auditor to investigate into the books of accounts or the affairs of the portfolio
manager. The auditor so appointed shall have the same powers of the inspecting authority outlined above and
the obligation of the portfolio manager and his employees in connection therewith shall be applicable also to the
investigation under this Regulation.
Liability for Action in Case of Default
A portfolio manager who contravenes any of the provisions of the Act, Rules or Regulations framed there under
shall be liable for one or more action specified therein including the action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
INTERNAL AUDIT OF PORTFOLIO MANAGER
Every Portfolio manager is required to appoint a Practising Company Secretary or a Practising Chartered
Accountant for conducting the internal audit. The Portfolio manager is required to report the compliance of the
aforesaid requirement to SEBI while submitting the half yearly report.
The report is to be submitted twice a year, as on 31st of March and 30th of September. The report should reach
SEBI within thirty days of the period to which it relates.
No precise period has been prescribed for the PCS to submit his report to the Board of the company. However,
it would be advisable for the PCS to give the audit report to the Portfolio Manager sufficiently well in advance to
enable the Company to report the compliance of the same to SEBI.
The scope of the internal audit would comprise the checking of compliance of SEBI (Portfolio Managers)
Regulations 1993 and circulars notifications or guidelines issued by SEBI and internal procedures followed by
the Portfolio Manager.
CUSTODIAN OF SECURITIES
Custodian of securities means any person who carries on or proposes to carry on the business of providing
custodial services. The term “custodial services” in relation to securities of a client or gold or gold related
instruments held by a mutual fund in accordance with the SEBI (Mutual Funds) Regulations, 1996 means
safekeeping of securities or gold or gold related instruments and providing services incidental thereto, and
includes –
(i) maintaining accounts of securities or gold or gold related instruments or title deeds of real estate assets;
(ii) undertaking activities as a Domestic Depository in terms of the Companies (Issue of Indian Depository
Receipts) Rules, 2004.
(iii) collecting the benefits or rights accruing to the client in respect of securities or gold or gold related
instruments;
(iv) 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; and
(v) maintaining and reconciling records of the services referred to in points (i) to (iii).
SEBI (CUSTODIAN OF SECURITIES) REGULATIONS, 1996
In exercise of the powers conferred by section 30 of SEBI Act, 1992 (15 of 1992) SEBI issued SEBI (Custodian
of Securities) Regulations, 1996 on May 16, 1996.
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99
Application for Grant of Certificate
Regulation 3(1) provides that any person proposing to carry on business as custodian of securities on or after
the commencement of these regulations shall make an application to SEBI for grant of a certificate. SEBI may,
however in special cases, where it is of the opinion that it is necessary to do so for reasons to be recorded in
writing, may extend the period upto a maximum of six months from the date of such commencement.
Any person who fails to make an application for grant of certificate within the period or the extended period
specified therein, shall cease to carry on any activity as custodian of securities and shall be subject to the
directions of the Board with regard to the transfer of records, documents or securities relating to his activities as
custodian of securities.
Application to Conform to Requirements
An application which is not complete in all respects or which does not conform to the instructions specified
therein will be rejected. However before rejecting any such application, SEBI would give the applicant an
opportunity to remove the objection, within such time as may be specified.
Furnishing of Information
SEBI may require the applicant to furnish such further information or clarification regarding matters relevant to
the activities of a custodian of securities for the purpose of consideration of the application. The applicant or his
authorised representative may, if so required, appear before SEBI for personal representation, in connection
with the grant of certificate.
Consideration of Application for Grant of Certificate
SEBI, while granting the Certificate shall take into account following matters which are relevant to the activities
of a custodian of securities:
(a) the applicant fulfils the capital requirement;
(b) the applicant has the necessary infrastructure, including adequate office space, vaults for safe custody
of securities and computer systems capability, required to effectively discharge his activities as custodian
of securities;
(c) the applicant has the requisite approvals under any law for the time being in force, in connection with
providing custodial services in respect of gold or gold related instruments of a mutual fund, or title deeds
of real estate assets held by a real state mutual funds scheme where applicable;
(d) the applicant has in his employment adequate and competent persons who have the experience, capacity
and ability of managing the business of the custodian of securities;
(e) the applicant has prepared a complete manual, setting out the systems and procedures to be followed
by him for the effective and efficient discharge of his functions and the arms length relationships to be
maintained with the other businesses, if any, of the applicant;
(f) the applicant is a person who has been refused a certificate by SEBI or whose certificate has been
cancelled by SEBI;
(g) the applicant, his director, his principal officer or any of his employees is involved in any litigation connected
with the securities market;
(h) the applicant, his director, his principal officer or any of his employees has at any time been convicted of
any offence involving moral turpitude or of any economic offence;
(i) the applicant is a fit and proper person; and
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(j) the grant of certificate is in the interest of investors.
Also SEBI shall not consider an application unless the applicant is a body corporate.
Capital Requirement
Regulation 7(1) provides for the capital adequacy requirement. It provides that the applicant must have a net
worth of a minimum of rupees fifty crores. The term “net worth” means the paid up capital and the free reserves
as on the date of the application. However any custodian of securities which has been approved by SEBI under
the provisions of SEBI (Mutual Fund) Regulations, 1993 or SEBI (Foreign Institutional Investors) Regulations,
1995, or the Government of India Guidelines for Foreign Institutional Investors dated September 14, 1992, even
if it does not have the networth specified in above may continue to function as a custodian of securities and shall
within a period of one year from the date of commencement of these regulations raise its networth as specified.
The period specified above may be extended by SEBI upto a maximum of 5 years.
Any applicant is permitted to fulfil his capital adequacy requirements within one month of the receipt of certificate.
Procedure and Grant of Certificate
Regulation 8(1) of the Regulation provides that after considering the application, if SEBI is satisfied that all
particulars sought have been furnished and the applicant is eligible for the grant of a certificate, it will send an
intimation of the same to the applicant.
On receipt of an intimation the applicant shall pay to SEBI specified registration fee. SEBI shall thereafter grant
a certificate to the applicant on receipt of the registration fee. It has been provided that SEBI may restrict the
certificate of registration to providing custodial services either in respect of securities or in respect of gold or gold
related instruments of a client or title deeds of real estate assets held by a real estate mutual fund scheme.
A custodial of securities holding a certificate of registration may provide custodial services in respect of gold or
gold related instruments of a mutual fund and in respect of title deeds of real estate assets held by a real estate
mutual fund scheme, only after taking prior approval of the SEBI.
Conditions of Certificate
The certificate granted to the custodian of securities may be subject to the following conditions, namely:
(a) it shall not commence any activities as custodian of securities unless it fulfils the capital requirement;
(b) it shall abide by the provisions of the Act and these regulations in the discharge of its functions as
custodian of securities;
(c) it shall enter into a valid agreement with its client for the purpose of providing custodial services;
(d) it shall pay annual fees as specified in the manner specified;
(e) if any information previously submitted by it to SEBI is found by it to be false or misleading in any
material particular, or if there is any change in such information, it shall forthwith inform SEBI in writing;
and
(f) besides providing custodial services, it shall not carry on any activity other than activities relating to
rendering of financial services.
Period of Validity
Regulation 9A of the Regulations provide that every certificate granted under these regulation shall be valid for
a period of three years from the date of grant.
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Renewal of Certificate
Regulation 9B of the Regulations provide that a custodian of securities, desirous of having its certificate renewed
shall make an application to SEBI for renewal of the certificate in Form A, not less than three months before the
expiry of its period of validity under Regulation 9A. The application for renewal of certificate shall be dealt with,
as far as may be, as if it were an application for the grant of a fresh certificate and shall be accompanied with the
application fee as specified in Schedule II. However, no registration fee is payable by a custodian in case of a
renewal of certificate.
Procedure where Certificate is not Granted
Regulation 10(1) of the Regulations provide that after considering an application for grant of certificate, if SEBI
is satisfied that a certificate should not be granted, SEBI may reject the application after giving the applicant a
reasonable opportunity of being heard.
The decision of SEBI rejecting the application shall be communicated within thirty days of such decision to the
applicant in writing, stating therein the grounds on which the application has been rejected. An applicant, aggrieved
by the decision of SEBI may within a period of thirty days from the date of receipt of communication apply to
SEBI for re-consideration of its decision.
SEBI shall, as soon as possible, in the light of the submissions made in the application for re-consideration and
after giving the applicant a reasonable opportunity of being heard, convey its decision in writing to the applicant.
Effect of Refusal to Grant Certificate
Any custodian of securities whose application for grant of certificate has been rejected by SEBI shall, on and
from the date of the receipt of the communication ceases to carry on any activity as custodian of securities and
shall be subject to the directions of SEBI with regard to the transfer of records, documents or securities that may
be in its custody or control relating to its activity as custodian of securities.
Code of conduct
Every custodian of securities shall abide by the Code of Conduct as specified in the Third Schedule to the Regulations.
Segregation of Activities
Regulation 13 provides that where a custodian of securities is carrying on any activity besides that of acting as
custodian of securities, then the activities relating to his business as custodian of securities shall be separate
and segregated from all other activities and its officers and employees engaged in providing custodial services
shall not be engaged in any other activity carried on by him.
Mechanism for Monitoring Review
Regulation 14(1) provides that every custodian of securities shall have adequate mechanisms for the purposes
of reviewing, monitoring and evaluating the custodian’s controls, systems, procedures and safeguards. The
custodian of securities shall cause to be inspected annually the mechanism by an expert and forward the
inspection report to SEBI within three months from the date of inspection.
Prohibition of Assignment
No custodian of securities shall assign or delegate its functions as a custodian of securities to any other person
unless such person is a custodian of securities.
However, a custodian of securities may engage the services of a person not being a custodian, for the purpose
of physical safekeeping of gold belonging to its client being a mutual fund having a gold exchange traded fund
scheme, subject to the following conditions:
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(a) the custodian shall remain responsible in all respects to its client for safekeeping of the gold kept with
such other person, including any associated risks;
(b) all books, documents and other records relating to the gold so kept with the other person shall be
maintained in the premises of the custodian or if they are not so maintained, they shall be made available
therein, if so required by SEBI;
(c) the custodian of securities shall continue to fulfil all duties to the clients relating to the gold so kept with
the other person, except for its physical safekeeping.
Separate Custody Account
Every custodian of securities is required to open a separate custody account for each client, in the name of the
client whose securities are in its custody and ensure that the assets of one client would not be mixed with those
of another client.
Agreement with the Client
Every custodian of securities is required to enter into an agreement with each client on whose behalf it is acting
as custodian of securities and every such agreement shall provide for the following matters, namely:
(a) the circumstances under which the custodian of securities will accept or release securities, assets or
documents from the custody account;
(b) the circumstances under which the custodian of securities will accept or release monies from the custody
account.
(c) the circumstances under which the custodian of securities will receive rights or entitlements on the
securities of the client;
(d) the circumstances and the manner of registration of securities in respect of each client;
(e) details of the insurance, if any, to be provided for by the custodian of securities.
Internal Controls
Every custodian of securities is required to have adequate internal controls to prevent any manipulation of
records and documents, including audits for securities and rights or entitlements arising from the securities held
by it on behalf of its client. Every custodian of securities would take appropriate safekeeping measures to
ensure that such securities, assets or documents are protected from theft and natural hazard.
Maintenance of Records and Documents
Regulation 19(1) provides that every custodian of securities is required to maintain the following records and
documents, containing details of:
(a) securities, assets or documents received and released on behalf of each client;
(b) monies received and released on behalf of each client;
(c) rights or entitlements of each client arising from the securities held on behalf of the client;
(d) registration of securities in respect of each client;
(e) ledger for each client;
(f) instructions received from and sent to clients; and records of all reports submitted to SEBI.
The Custodian of securities would intimate to SEBI the place where the records and documents are maintained and
custodian of securities shall preserve the records and documents maintained for a minimum period of five years.
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Appointment of Compliance Officer
Regulation 19A(1) provides that every custodian of securities would appoint a compliance officer responsible for
monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by
SEBI or the Central Government. He is under an obligation for redressal of investors’ grievances.
The compliance officer is required to immediately and independently report to SEBI any non-compliance observed
by him.
Information to SEBI
SEBI may, at any time, call for any information from a custodian of securities with respect to any matter relating
to its activity as custodian of securities. Where any information is called for by SEBI, it shall be the duty of the
custodian of securities to furnish such information, within such reasonable period as SEBI may specify.
Inspection and Audit
SEBI may appoint one or more persons as inspecting officer to undertake inspection of the books of accounts,
records and documents of the custodian of securities for any of the following purposes, namely:
(a) to ensure that the books of account, records and documents are being maintained by the custodian of
securities in the manner specified in these regulations;
(b) to investigate into complaints received from investors, clients or any other person, on any matter having
a bearing on the activities of the custodian of securities;
(c) to ascertain whether the provisions of the Act and these regulations are being complied with by the
custodian of securities; and
(d) to investigate suo moto into the affairs of the custodian of securities, in the interest of the securities
market or in the interest of investors.
Notice Before Inspection
SEBI, before ordering inspection shall give not less than ten days notice to the custodian of securities. Where the
Board is satisfied that in the interest of the investors no such notice should be given, it may by an order in writing
direct that the inspection of the affairs of the custodian of securities be taken up without such notice. The custodian
of securities against whom the inspection is being carried out is under an obligation to discharge his obligations.
Obligations of Custodian
It is the duty of the custodian of securities whose affairs are being inspected, and of every director, officer and
employee thereof, to produce to the inspecting officer such books, securities, accounts, records and other
documents in its custody or control and furnish him with such statements and information relating to his activities
of the custodian of securities, as the inspecting officer may require, within such reasonable period as the inspecting
officer may specify.
The custodian of securities is required to allow the inspecting officer to have reasonable access to the premises
occupied by such custodian or by any other person on his behalf and also extend reasonable facility for examining
any books, records, documents and computer data in the possession of the custodian of securities or such other
person and also provide copies of documents or other materials which, in the opinion of the inspecting officer
are relevant for the purposes of the inspection.
The inspecting officer, in the course of inspection, is entitled to examine or to record the statements of any
director, officer or employee of the custodian of securities. It is the duty of every director, officer or employee of
the custodian of securities to give to the inspecting officer all assistance in connection with the inspection, which
the inspecting officer may reasonably require.
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Submission of Report to SEBI
The inspecting officer shall, as soon as possible, on completion of the inspection submit an inspection report to
SEBI and that if directed by SEBI, he may submit an interim report.
SEBI or the Chairman shall after consideration of inspection or investigation report take such action as the
Board or Chairman may deem fit and appropriate including action under Chapter V of the Securities and Exchange
Board of India (Intermediaries) Regulations, 2008.
Liability for Action in Case of Default
A custodian of securities who contravenes any of the provisions of the Act, the rules framed there under or these
regulations or fails to furnish any information relating to his activity as custodian of securities as required by
SEBI or furnishes to SEBI information which is false and misleading in any material particular or does not submit
periodic returns or reports as required by SEBI or does not co-operate in any enquiry or inspection conducted by
SEBI or fails to update its systems and procedures as recommended by SEBI or fails to resolve the complaints
of clients or fails to give a satisfactory reply to SEBI in this behalf or is guilty of misconduct or makes a breach of
the Code of Conduct specified in the Third Schedule or fails to pay annual fees, shall be dealt with in the manner
provided under Chapter V of SEBI (Intermediaries) Regulations, 2008.
FOREIGN INSTITUTIONAL INVESTOR
“Foreign Institutional Investor” means an institution established or incorporated outside India which proposes to
make investment in India in securities. No person can buy, sell or otherwise deal in securities as a Foreign
Institutional Investor unless he holds a certificate granted by SEBI under these regulations. An application for
the grant of certificate should be made to SEBI in the prescribed form.
SEBI (FOREIGN INSTITUTIONAL INVESTORS) REGULATIONS, 1995
In exercise of the powers conferred by Section 30 of SEBI Act, 1992 SEBI made these regulations.
SEBI may require the applicant to furnish such further information or clarification as SEBI considers necessary
regarding matters relevant to the activities of the applicant for grant of certificate. The applicant or his authorised
representative, if so required by SEBI, appear before SEBI for personal representation in connection with the
grant of a certificate. An application, which is not complete in all respects and does not conform to the instructions
specified in the form or is false or misleading in any material particular, should be rejected by SEBI. However
before rejecting any such application, the applicant should be given a reasonable opportunity to remove, within
the time specified by SEBI, such objections as may be indicated by SEBI.
Consideration of Application
While granting certificate of Registration, SEBI should take into account the following matters:
(i) the applicant’s track record, professional competence, financial soundness, experience, general
reputation of fairness and integrity;
However, in case of a newly established fund, the track record of the investment manager of the fund
who has promoted it may be taken into consideration. However, investment manager shall furnish the
details in respect of disciplinary action, if any, taken against it.
(ii) whether the applicant is regulated by an appropriate foreign regulatory authority;
However, university funds, endowments, foundations, charitable trusts and charitable societies may be
considered for registration even though they are not regulated by a foreign regulatory authority.
(iii) whether the applicant has been granted permission under the provisions of the Foreign Exchange
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Financial Intermediaries Framework 105
Regulation by the Reserve Bank of India for making investments in India as a Foreign Institutional
Investor;
(iv) whether the applicant is –
(a) an institution established or incorporated outside India as Pension Fund, Mutual Fund or Investment
Trust, Insurance Company or reinsurance company;
(aa) a international or multilateral organisation or an agency thereof or a Foreign Governmental Agency,
Sovereign Wealth Fund, or a Foreign Central Bank;
(b) an Asset Management Company, Investment Manager or Advisor, Bank or Institutional Portfolio
Manager, established or incorporated outside India and proposing to make investments in India on
behalf of broad based funds and its proprietary funds, if any; or
(c) a trustee of a trust established outside India and proposing to make investments in India on behalf
of broad based funds and its proprietary funds, if any;
(d) university fund, endowments, foundations or charitable trusts or charitable societies. However while
considering the application from SEBI may take into account the following namely:
– whether the applicant has been in existence for a period of atleast 5 years.
– whether it is legally permissible for the applicant to invest in securities outside the country of its
incorporation or establishment;
– whether the applicant has been registered with any statutory authority in the country of their
incorporation or establishment;
– whether any legal proceeding has been initiated by any statutory authority against the applicant.
– whether the applicant has been serving public interest.
“Broad based fund” means a fund, established or incorporated outside India, which has at least
twenty investors, with no single individual investor holding more than forty-nine per cent of the
shares or units of the fund. However if the broad based fund has institutional investor(s), it shall
not be necessary for the fund to have twenty investors: However that if the broad based fund
has an institutional investor who holds more than forty nine percent of the shares or units in the
fund, then the institutional investor must itself be a broad based fund.
1 whether the grant of certificate to the applicant is in the interest of the development of the securities
market.
2 whether the applicant is a fit and proper person.
Procedure for Grant of Certificate
SEBI, if satisfied that the application is complete in all respects, all particulars sought have been furnished and
the applicant is found to be eligible for the grant of certificate, grant a certificate subject to payment of fees with
in three months from the documents furnished. However SEBI may exempt from the payment of fees, an applicant
such as the World Bank and other institutions established outside India for providing aid, and which have been
granted privileges and immunities from the payment of tax and duties by the Central Government. It has been
provided further that SEBI should refund the fees already collected from the institutions which are exempted
from the payment of fees.
Validity of Certificate
Subject to the compliance of the provisions of the Act, these regulations, the circulars issued there under and
the obligation to pay fees as specified in these regulation, any registration granted by SEBI shall be permanent
106 PP-CC&MM
unless suspended or cancelled by SEBI. Foreign institutional investor or a sub-account, having a certificate
specified in this regulation shall file information in the prescribed form as the case may be, at least three months
prior to the expiry of period of certificate. A foreign institutional investor or a sub account may surrender the
certificate of registration granted to it by SEBI. While accepting a surrender of registration, SEBI may impose
such conditions upon the foreign institutional investor or the sub account as it deems fit.
Grant of Certificate
The grant of certificate to the Foreign Institutional Investor may be subject to the following conditions:
(i) he shall abide by the provisions of these regulations;
(ii) if any information or particulars previously submitted to the Board are found to be false or misleading, in
any material respect, he shall forthwith inform SEBI in writing;
(iii) if there is any material change in the information previously furnished by him to SEBI, which has a
bearing on the certificate granted by SEBI, he shall forthwith inform to SEBI;
(iv) he shall appoint a domestic custodian and before making any investments in India, enter into an
agreement with the domestic custodian providing for custodial services in respect of securities;
(v) he shall, before making any investments in India, enter into an arrangement with a designated bank for
the purpose of operating a special non-resident rupee or foreign currency account;
(vi) before making any investments in India on behalf of a sub-account, if any, he shall obtain registration of
such sub-account, under these regulations.
Procedure where Certificate is not Granted
SEBI may reject the application where an application for grant of a certificate does not satisfy the requirements
after giving the applicant a reasonable opportunity of being heard. The decision to reject the application should
be communicated by SEBI to the applicant in writing stating therein the grounds on which the application has
been rejected. The applicant, who is aggrieved by the decision of SEBI may, within a period of thirty days from
the date of receipt of communication apply to SEBI for reconsideration of its decision. SEBI may, in the light of
the submissions made in the application for reconsideration and after giving a reasonable opportunity of being
heard, convey its decision in writing to the applicant.
Application for Registration of Sub-accounts
A Foreign Institutional Investor should seek from SEBI registration of each sub-account on whose behalf he
proposes to make investments in India. However, before making an application for registration on behalf of a
proposed sub-account being a foreign corporate, the foreign institutional investor shall verify the necessary
details and documents and satisfy itself about the identity of the proposed sub-account after applying its know
your client procedure. Any sub-account that has been granted approval prior to the commencement of these
regulations by SEBI should be deemed to have been granted registration as a sub-account by SEBI under these
regulation. An application for registration as sub-account shall be made in Form AA.
Procedure and Grant of Registration of Sub-accounts
SEBI may take into account the following matters which are relevant to the grant of such registration to the subaccount:
(a) the applicant falls into any of the following categories, namely:
(i) broad based fund or portfolio which is broad based, incorporated or established outside India; or
(ii) proprietary fund of a registered foreign institutional investor; or
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Financial Intermediaries Framework 107
(iii) foreign corporate; or
(iv) foreign individual; or
(v) university fund, endowment, foundation, charitable trust or charitable society who are eligible to be
registered as a foreign institutional investor under these regulations.
(b) the applicant is a fit and proper person;
(c) the Foreign Institutional Investor through whom the application for registration is made to SEBI holds a
certificate of registration as Foreign Institutional Investor;
(d) the Foreign Institutional Investor through whom an application for registration of sub-account is made,
is authorised to invest on behalf of the sub-account;
(e) the applicant and the foreign institutional investor through whom the application for registration is made,
have submitted joint undertakings as required by Form AA of First Schedule of the Regulations;
(f) the sub-account has paid registration fees as specified.
SEBI on receipt of the undertakings and the registration fees as may grant registration to the sub-account. A
sub-account granted registration in accordance with the regulation should be deemed to be registered as a
Foreign Institutional Investor with SEBI for the limited purpose of availing of the benefits available to FIIs under
Section 115AD of Income Tax Act, 1961.
Responsibility of FIIs
A foreign institutional investor shall be responsible and liable for all acts of commission and omission of all its
sub-accounts and other deeds and things done by such sub-accounts in their capacity as sub-accounts under
these regulations. However, it shall not be deemed to detract from any responsibility or liability of the subaccount under these regulations or under any other law for the time being in force. It shall have effect irrespective
of whether the foreign institutional investor exercises discretion in respect of funds of the sub account or not.
Investment Conditions and Restrictions
Regulation 14 provides that a Foreign Institutional Investor cannot make any investments in securities in India
without complying with the provisions. A Foreign Institutional Investor can invest only in the following:
(a) securities in the primary and secondary markets including shares, debentures and warrants of companies
unlisted, listed or to be listed on a recognised stock exchange in India; and
(b) units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a
recognised stock exchange or not, units of scheme floated by a collective investment scheme.
(c) dated Government Securities.
(d) derivatives traded on a recognised stock exchange.
(e) commercial paper.
(f) security receipts.
(g) Indian Depository Receipts
Where a foreign institutional investor or sub-account holds equity shares in a company whose shares are not
listed on any recognised stock exchange, and continues to hold such shares after initial public offering and
listing thereof, such shares shall be subject to lock-in for the same period, if any, as is applicable to shares held
by a foreign direct investor placed in similar position, under the policy of the Central Government relating to
foreign direct investment for the time being in force.
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Sub-regulation (2) of Regulation 15 the total investments in equity and equity related instruments (including fully
convertible debentures, convertible portion of partially convertible debentures and tradable warrants) made by
a Foreign Institutional Investor in India, whether on his own account or on account of his sub-accounts, should
not be less than seventy per cent of the aggregate of all the investments of the Foreign Institutional Investor in
India, made on his own account and on account of his sub-accounts. However it may apply to any investment of
the foreign institutional investor either on its own account or on behalf of its sub-accounts in debt securities
which are unlisted or listed or to be listed on any stock exchange if the prior approval of SEBI has been obtained
for such investments. These Regulations further provide that SEBI may while granting approval for the investments
impose conditions as are necessary with respect to the maximum amount which can be invested in debt securities
by the foreign institutional investor on its own account or through its sub accounts. The conditions mentioned in
sub-regulation (2) shall not apply to investments made by foreign institutional investors in security receipts
issued by securitisation companies or asset reconstruction companies under the Securitisation and Reconstruction
of Financial Assets and Enforcement of Security Interest Act, 2002 and the rules made thereunder.
Further, no FII shall invest in Security Receipts on behalf of its sub-account. A foreign corporate or individual is
not be eligible to invest through the hundred percent debt route. In respect of investments in the secondary
market, additional conditions also provided by these regulations shall apply.
The Regulations clarify that unless otherwise approved by SEBI, securities shall be registered in the name of
the Foreign Institutional Investor, provided the Foreign Institutional Investor is making investments on his own
behalf; or in his name on account of his sub-account, or in the name of the sub-account, in case he is investing
on behalf of the sub-account. However the names of the sub-accounts on whose behalf the Foreign Institutional
Investor is investing are required to be disclosed to SEBI by the Foreign Institutional Investor.
The purchase of equity shares of each company by a Foreign Institutional Investor investing on his own account
should not exceed ten percent of the total issued capital of that company. In respect of a Foreign Institutional
Investor investing in equity shares of a company on behalf of his sub-accounts, the investment on behalf of each
such sub-account shall not exceed ten percent of the total issued capital of that company. However in case of
foreign corporates or individuals, each of such sub-account shall not invest more than 5% of the total issued
capital of the company in which such investment is made. The investment by the Foreign Institutional Investor is
also subject to Government of India Guidelines. A Foreign Institutional Investor or sub-account may lend securities
through an approved intermediary in accordance with stock lending scheme of SEBI.
Conditions for Issuance of Offshore Derivative Instruments
A foreign institutional investor cannot issue, or otherwise deal in offshore derivative instruments, directly or
indirectly, unless the following conditions are satisfied:
(a) such offshore derivative instruments are issued only to persons who are regulated by an appropriate
foreign regulatory authority;
(b) such offshore derivative instruments are issued after compliance with ‘know your client’ norms.
A foreign institutional investor shall ensure that no further issue or transfer is made of any offshore derivative
instruments issued by or on behalf of it to any person other than a person regulated by an appropriate foreign
regulatory authority. A sub-account cannot, directly or indirectly, issue offshore derivative instruments:
‘Offshore derivative instrument’ means any instrument, by whatever name called, which is issued overseas by a
foreign institutional investor against securities held by it that are listed or proposed to be listed on any recognised
stock exchange.
“Person regulated by an appropriate foreign regulatory authority” means and includes the following, namely:
(i) any person that is regulated/supervised and licensed/registered by a foreign central bank;
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(ii) any person that is registered and regulated by a securities or futures regulator in any foreign country or
state;
(iii) any broad based fund or portfolio incorporated or established outside India or proprietary fund of a
registered foreign institutional investor or university fund, endowment, foundation, charitable trust or
charitable society whose investments are managed by a person covered above.
General Obligations and Responsibilities
A Foreign Institutional Investor or a global custodian acting on behalf of the Foreign Institutional Investor, should
enter into an agreement with a domestic custodian to act as custodian of securities for the Foreign Institutional
Investor. The Foreign Institutional Investor should ensure that the domestic custodian takes steps for:
(a) monitoring of investments of the Foreign Institutional Investor in India;
(b) reporting to SEBI on a daily basis the transactions entered into by the Foreign Institutional Investor;
(c) preservation for five years of records relating to his activities as a Foreign Institutional Investor; and
(d) furnishing such information to SEBI as may be called for by SEBI with regard to the activities of the
Foreign Institutional Investor and as may be relevant for the purpose of this regulation.
A Foreign Institutional Investor may appoint more than one domestic custodian with prior approval of SEBI, but
only one custodian may be appointed for a single sub-account of a Foreign Institutional Investor. A Foreign
Institutional Investor should appoint a branch of a bank approved by the Reserve Bank of India for opening of
foreign currency denominated accounts and special non-resident rupee accounts. A Foreign Institutional Investor
or any of his employees should 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 long
or short position in the said security has been made, while rendering such advice. In case, an employee of the
Foreign Institutional Investor is rendering such advice, he should 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.
Maintenance of Proper Books of Accounts, Records, Etc.
Every Foreign Institutional Investor should keep or maintain the following books of accounts, records and
documents:
(a) true and fair accounts relating to remittance of initial corpus for buying, selling and realising capital gains
of investment made from the corpus;
(b) accounts of remittances to India for investments in India and realising capital gains on investments
made from such remittances;
(c) bank statement of accounts;
(d) contract notes relating to purchase and sale of securities; and
(e) communication from and to the domestic custodian regarding investments in securities.
The Foreign Institutional Investor should intimate to SEBI in writing the place where such books, records and
documents will be kept or maintained. Every Foreign Institutional Investor should preserve the books of accounts,
records and documents as specified for a minimum period of five years.
Appointment of Compliance Officer
Every Foreign Institutional Investor should appoint a compliance officer who is responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the
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Central Government. The compliance officer should immediately and independently report to SEBI any noncompliance observed by him.
Information to SEBI
Every Foreign Institutional Investor as and when required by SEBI or the Reserve Bank of India, would submit
any information, record or documents in relation to his activities.
Foreign Institutional Investors are required to fully disclose information concerning the terms of and parties to
off¬shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other such instruments,
by whatever names they are called, entered into by it or its sub-accounts or affiliates relating to any securities
listed or proposed to be listed in any stock exchange in India, as and when and in such form as SEBI may
require.
Procedure for Action in Case of Default
A Foreign Institutional Investor who contravenes any of the provisions of the Act, rules or regulations framed
thereunder shall be liable for one or more actions specified therein including the action under Chapter V of the
SEBI (Intermediaries) Regulations, 2008.
Code of Conduct
(1) A Foreign Institutional Investor and its key personnel should observe high standards of integrity, fairness and
professionalism in all dealings in the Indian securities market with intermediaries, regulatory and other government
authorities.
(2) A Foreign Institutional Investor is required at all times to render high standards of service, exercise due
diligence and independent professional judgement.
(3) A Foreign Institutional Investor should ensure and maintain confidentiality in respect of trades done on its
own behalf and/or on behalf of its sub-accounts/clients.
(4) A Foreign Institutional Investor is required to ensure clear segregation of its own money/ securities and subaccounts’ money/securities and arms length relationship between its business of fund management/ investment
and its other business.
(5) A Foreign Institutional Investor has to maintain an appropriate level of knowledge and competency and abide
by the provisions of the Act, regulations made there under and the circulars and guidelines, which may be
applicable and relevant to the activities carried on by it.
(6) Every Foreign Institutional Investor has to comply with award of the Ombudsman and decision of the Board
under SEBI (Ombudsman) Regulations.
(7) A Foreign Institutional Investor should not make any untrue statement or suppress any material fact in any
documents, reports or information furnished to the Board.
(8) A Foreign Institutional Investor is required to ensures good corporate policies and corporate governance.
(9) A Foreign Institutional Investor should ensure that it does not engage in fraudulent and manipulative
transactions in the securities listed in any stock exchange in India.
(10) A Foreign Institutional Investor should not, either through its/his own account or through any associate or
family members, relatives or friends indulge in any insider trading.
(11) A Foreign Institutional Investor shall not be a party to or instrumental for creation of false market in securities
listed or proposed to be listed in any stock exchange in India, price rigging or manipulation of prices of securities
listed or proposed to be listed in any stock exchange in India and for passing of price sensitive information to any
person or intermediary in the securities market.
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Financial Intermediaries Framework 111
QUALIFIED FOREIGN INVESTORS (QFIS)
Foreign Capital inflows to India have significantly grown in importance over the years. These flows have been
influenced by strong domestic fundamentals and buoyant yields reflecting robust corporate sector performance.
In the present arrangement relating to foreign portfolio investments, only FIIs/sub-accounts and NRIs are allowed
to directly invest in Indian equity market. In this arrangement, a large number of Qualified Foreign Investors
(QFIs), in particular, a large set of diversified individual foreign nationals who are desirous of investing in Indian
equity market do not have direct access to Indian equity market. In the absence of availability of direct route,
many QFIs find difficulties in investing in Indian equity market.
The Central Government, vide press release dated January 1, 2012 has announced its decision to allow QFIs to
directly invest in Indian equity market in order to widen the class of investors, attract more foreign funds, reduce
market volatility and to deepen the Indian capital market. SEBI decided that the Foreign investors (termed as
Qualified Foreign Investors/ QFI) who meet prescribed Know Your Customer (KYC) requirements may invest in
equity shares listed on the recognized stock exchanges and in equity shares offered to public in India. In order
to enable this they will hold equity shares in a demat account opened with a SEBI registered qualified Depository
Participant.
Qualified Foreign Investors
"QFI shall mean a person who fulfils the following criteria:
(i) Resident in a country that is a member of Financial Action Task Force (FATF) or a member of a group
which is a member of FATF; and
(ii) Resident in a country that is a signatory to IOSCO’s MMOU or a signatory of a bilateral MOU with SEBI.
Provided that the person is not resident in a country listed in the public statements issued by FATF from time to
time on-(i) jurisdictions having a strategic Anti-Money Laundering/Combating the Financing of Terrorism (AML/
CFT) deficiencies to which counter measures apply, (ii) jurisdictions that have not made sufficient progress in
addressing the deficiencies or have not committed to an action plan developed with the FATF to address the
deficiencies.
Provided further such person is not resident in India. Provided further that such person is not registered with
SEBI as Foreign Institutional Investor or Sub-account or Foreign Venture Capital Investor.
Permissible transactions allowed for QFI’s investing into Indian securities
QFIs can transact only in the following:
(a) Purchase/subscription of mutual fund units through Demat Account mode (Direct Route) and Unit
Confirmation Receipt (UCR) [Indirect Route].
(b) Purchase of equity shares in public issues, to be listed on recognised stock exchange(s).
(c) Purchase of listed equity shares through SEBI registered stock brokers, on recognized stock exchanges
in India.
(d) Redemption of mutual fund units purchased/subscribed through direct and indirect route.
(e) Sale of equity shares which are held in their demat account through SEBI registered stock brokers.
(f) Subscription of equity shares against rights issues.
(g) Receipt of bonus shares or receipt of shares on stock split/ consolidation.
(h) Receipt of equity shares due to amalgamation, demerger or such other corporate actions, subject to the
investment limits.
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(i) Receipt of dividends and interest payments.
(j) Tender equity shares in open offer in accordance with SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011.
(k) Tender equity shares in open offer in accordance with SEBI (Delisting of Equity Shares) Regulations,
2009.
(l) Tender equity shares in case of buy-back by listed companies in accordance with SEBI (Buyback of
Securities) Regulations, 1998
(m) Purchase and sale of corporate debt securities listed on recognized stock exchange(s);
(n) Purchase of corporate debt securities through public issues, if the listing on recognized stock exchange(s)
is committed to be done as per the extant provisions of the Companies Act, 1956;
(o) Sale of corporate debt securities by way of buyback or redemption by the issuer;
(p) Purchase and sale of units of debt schemes of Indian mutual funds.
INVESTMENT ADVISER
“Investment Adviser” means any person, who for consideration, is engaged in the business of providing investment
advice to clients or other persons or group of persons and includes any person who holds out himself as an
investment adviser, by whatever name called.
“Investment advice” means advice relating to investing in, purchasing, selling or otherwise dealing in securities
or investment products, and advice on investment portfolio containing securities or investment products, whether
written, oral or through any other means of communication for the benefit of the client and shall include financial
planning:
However, investment advice given through newspaper, magazines, any electronic or broadcasting or
telecommunications medium, which is widely available to the public shall not be considered as investment
advice for the purpose of these regulations;
SEBI (INVESTMENT ADVISERS) REGULATIONS, 2013
In exercise of the powers conferred by sub-section (1) of Section 30 read with clause (b) of sub-section (2) of
Section 11 of SEBI Act, 1992, SEBI made these regulations.
Registration of Investment Advisers
Regulation 3 deals with the application for grant of certificate by SEBI. A person shall not act as an investment
adviser or hold itself out as an investment adviser unless he has obtained a certificate of registration from
SEBI.
However, a person acting as an investment adviser immediately before the commencement of these regulations
may continue to do so for a period of six months from such commencement or, if it has made an application for
a certificate within the said period of six months, till the disposal of such application. An application for grant of
certificate of registration shall be made in Prescribed Form and shall be accompanied by a non refundable
application fee to be paid in the manner specified in these regulations.
Exemption from registration
Regulation 4 provides that certain persons are exempted from the requirement of registration under Regulation
3 subject to the fulfilment of the conditions stipulated therefore, —
(a) Any person who gives general comments in good faith in regard to trends in the financial or securities
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Financial Intermediaries Framework 113
market or the economic situation where such comments do not specify any particular securities or
investment product;
(b) Any insurance agent or insurance broker who offers investment advice solely in insurance products and
is registered with Insurance Regulatory and Development Authority for such activity;
(c) Any pension advisor who offers investment advice solely on pension products and is registered with
Pension Fund Regulatory and Development Authority for such activity;
(d) Any distributor of mutual funds, who is a member of a self regulatory organisation recognised by SEBI
or is registered with an association of asset management companies of mutual funds, providing any
investment advice to its clients incidental to its primary activity;
(e) Any advocate, solicitor or law firm, who provides investment advice to their clients, incidental to their
legal practise;
(f) Any member of Institute of Chartered Accountants of India, Institute of Company Secretaries of India,
Institute of Cost and Works Accountants of India, Actuarial Society of India or any other professional
body as may be specified by SEBI, who provides investment advice to their clients, incidental to his
professional service;
(g) Any stock broker or sub-broker registered under SEBI (Stock Broker and Sub Broker) Regulations,
1992, portfolio manager registered under SEBI (Portfolio Managers) Regulations, 1993 or merchant
banker registered under SEBI (Merchant Bankers) Regulations, 1992, who provides any investment
advice to its clients incidental to their primary activity: However, such intermediaries shall comply with
the general obligation(s) and responsibilities as specified in Chapter III of these regulations. Further the
existing portfolio manager offering only investment advisory services may apply for registration under
these regulations after expiry of his current certificate of registration as a portfolio manager;
(h) Any fund manager, by whatever name called of a mutual fund, alternative investment fund or any other
intermediary or entity registered with SEBI;
(i) Any person who provides investment advice exclusively to clients based out of India: However, persons
providing investment advice to Non-Resident Indian or Person of Indian Origin shall fall within the purview
of these regulations;
(j) Any representative and partner of an investment adviser which is registered under these regulations.
However, such representative and partner shall comply with these regulations;
(k) Any other person as may be specified by SEBI.
Qualification & Certification
– Investment Advisers will be required to hold a professional qualification or post-graduate degree or post
graduate diploma in finance, accountancy, business management, commerce, economics, capital market,
banking, insurance or actuarial science. Alternatively, advisors having a graduate in any discipline with
experience of at least five years in financial advisory or securities or fund or asset or portfolio management
are also qualified.
– Investment Advisers, their partners and their representatives should have a certification on financial planning
or fund or asset or portfolio management or investment advisory services from NISM or from any other
organization or institution including Financial Planning Standards Board India (FPSB) or stock exchange
provided that such certification is accredited by NISM.
– Existing investment advisers and their representatives seeking registration under these regulations will
have to obtain certification within two years from the date of commencement of advisor regulations. Investment
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advisers whose existing certificates which are due for expiry need to also obtain the above mentioned
certification to continue their practice.
Capital adequacy
SEBI has also laid down capital adequacy requirements for corporate and individual distributors. Corporate
distributors will require a minimum net worth of ` 25 lakh while individuals and partnership firms will require to
posses tangible assets worth at least ` 1 lakh.
Registration
After complying with the investment advisers regulations, Investment advisers would need to register with SEBI
by paying a non-refundable application fee of ` 5,000. Individual advisors will have to shell out a registration fee
of ` 10,000 while corporate will have to cough up ` 1 lakh in addition to the application fee. This certificate will be
valid for a period of five years.
General Obligations and Responsibilities
Regulation 15 deals with the general obligation of Investment Advisers.
– An investment adviser shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of
interests as and when they arise.
– An investment adviser shall not receive any consideration by way of remuneration or compensation or in
any other form from any person other than the client being advised, in respect of the underlying products or
securities for which advice is provided.
– An investment adviser shall maintain an arms-length relationship between its activities as an investment
adviser and other activities.
– An investment adviser which is also engaged in activities other than investment advisory services shall
ensure that its investment advisory services are clearly segregated from all its other activities.
– An investment adviser shall ensure that in case of any conflict of interest of the investment advisory activities
with other activities, such conflict of interest shall be disclosed to the client.
– An investment adviser shall not divulge any confidential information about its client, which has come to its
knowledge, without taking prior permission of its clients, except where such disclosures are required to be
made in compliance with any law for the time being in force.
– An investment advisor shall not enter into transactions on its own account which is contrary to its advice
given to clients for a period of fifteen days from the day of such advice.
However, during the period of such fifteen days, if the investment adviser is of the opinion that the situation has
changed, then it may enter into such a transaction on its own account after giving such revised assessment to
the client at least 24 hours in advance of entering into such transaction.
– An investment advisor shall follow Know Your Client procedure as specified by SEBI from time to time.
– An investment adviser shall abide by Code of Conduct as specified in Third Schedule.
– An investment adviser shall not act on its own account, knowingly to sell securities or investment products
to or purchase securities or investment product from a client.
– In case of change in control of the investment adviser, prior approval from SEBI shall be taken.
– Investment advisers shall furnish to SEBI information and reports as may be specified by SEBI from time to
time.
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Financial Intermediaries Framework 115
– It shall be the responsibility of the Investment Adviser to ensure that its representatives and partners, as
applicable, comply with the certification and qualification requirements under these Regulation at all times.
Code of Conduct for Investment Adviser
1. Honesty and fairness: An investment adviser shall act honestly, fairly and in the best interests of its clients
and in the integrity of the market.
2. Diligence: An investment adviser shall act with due skill, care and diligence in the best interests of its clients
and shall ensure that its advice is offered after thorough analysis and taking into account available alternatives.
3. Capabilities: An investment adviser shall have and employ effectively appropriate resources and procedures
which are needed for the efficient performance of its business activities.
4. Information about clients: An investment adviser shall seek from its clients, information about their financial
situation, investment experience and investment objectives relevant to the services to be provided and maintain
confidentiality of such information.
5. Information to its clients: An investment adviser shall make adequate disclosures of relevant material
information while dealing with its clients.
6. Fair and reasonable charges: An investment adviser advising a client may charge fees, subject to any
ceiling as may be specified by SEBI, if any. The investment adviser shall ensure that fees charged to the clients
is fair and reasonable.
7. Conflicts of interest: An investment adviser shall try to avoid conflicts of interest as far as possible and when
they cannot be avoided, it shall ensure that appropriate disclosures are made to the clients and that the clients
are fairly treated.
8. Compliance: An investment adviser including its representative(s) shall comply with all regulatory requirements
applicable to the conduct of its business activities so as to promote the best interests of clients and the integrity
of the market.
9. Responsibility of senior management: The senior management of a body corporate which is registered as
investment adviser shall bear primary responsibility for ensuring the maintenance of appropriate standards of
conduct and adherence to proper procedures by the body corporate.
Maintenance of records
An investment adviser shall maintain the following records,
(a) Know Your Client records of the client;
(b) Risk profiling and risk assessment of the client;
(c) Suitability assessment of the advice being provided;
(d) Copies of agreements with clients, if any;
(e) Investment advice provided, whether written or oral;
(f) Rationale for arriving at investment advice, duly signed and dated;
(g) A register or record containing list of the clients, the date of advice, nature of the advice, the products/
securities in which advice was rendered and fee, if any charged for such advice.
All records shall be maintained either in physical or electronic form and preserved for a minimum period of five
years. However, where records are required to be duly signed and are maintained in electronic form, such
records shall be digitally signed.
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Liability for action in case of default
An investment adviser who –
(a) contravenes any of the provisions of the Act or any regulations or circulars issued thereunder;
(b) fails to furnish any information relating to its activity as an investment adviser as required by SEBI;
(c) furnishes to SEBI information which is false or misleading in any material particular;
(d) does not submit periodic returns or reports as required by SEBI;
(e) does not co-operate in any enquiry, inspection or investigation conducted by the SEBI;
(f) fails to resolve the complaints of investors or fails to give a satisfactory reply to SEBI in this behalf,
shall be dealt with in the manner provided under the Securities and Exchange Board of India (Intermediaries)
Regulations, 2008
Audit of Investment Adviser
According to Regulation 19(3) an investment adviser shall conduct yearly audit in respect of compliance with
these regulations from a member India or Institute of Company Secretaries of India.
SEBI (CREDIT RATING AGENCIES) REGULATIONS, 1999
SEBI regulations for Credit Rating Agencies (CRAs) cover rating of securities only and not rating of fixed deposits,
foreign exchange, country ratings, real estates etc. CRAs can be promoted by public financial institutions,
scheduled commercial banks, foreign banks operating in India, foreign credit rating agencies recognised in the
country of their incorporation, having at least five years experience in rating, or any company or a body corporate
having continuous net worth of minimum `100 crore for the previous five years. CRAs would be required to have
a minimum net worth of ` 5 crore. A CRA cannot rate a security issued by its promoter. No Chairman, Director or
Employee of the promoters shall be Chairman, Director or Employee of CRA or its rating committee. A CRA
cannot rate securities issued by any borrower, subsidiary, an associate promoter of CRA, if there are common
Chairman, Directors and Employees between the CRA or its rating committee and these entities. A CRA cannot
rate a security issued by its associate or subsidiary if the CRA or its rating committee has a Chairman, Director
or Employee who is also a Chairman, Director or Employee of any such entity. CRAs would have to carry out
periodic reviews of the ratings given during the lifetime of the rated instrument. For ensuring that corporates
provide correct/ adequate information to CRAs, a clause would be incorporated in the listing agreement of the
stock exchanges requiring the companies to co-operate with the rating agencies in giving correct and adequate
information. Issuers coming out with a public/rights issue of debt securities would be required to incorporate an
undertaking in the offer documents promising necessary co-operation with the rating agency in providing true
and adequate information.
Registration of Credit Rating Agencies
(1) Any person proposing to commence any activity as a credit rating agency should make an application to
SEBI for the grant of a certificate of registration for the purpose.
(2) Any person, who before the said date carrying on any activity as a credit rating agency, should make an
application to SEBI for the grant of a certificate within a period of three months from such date. However SEBI
may, where it is of the opinion that it is necessary to do so, for reasons to be recorded in writing, extend the said
period upto a maximum of six months from such date.
(3) An application for the grant of a certificate should be made to SEBI accompanied by a non-refundable
specified application fee.
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Financial Intermediaries Framework 117
(4) Any person who fails to make an application for the grant of a certificate within the period specified in that
sub-regulation, ceases to carry on rating activity.
Promoter of Credit Rating Agency
SEBI should not consider an application unless the applicant is promoted by a person belonging to any of the
following categories, namely:
(i) a public financial institution;
(ii) a scheduled commercial bank;
(iii) a foreign bank operating in India with the approval of the Reserve Bank of India;
(iv) a foreign credit rating agency recognized under Indian Law and having at least five years experience in
rating securities;
(v) any company or a body corporate, having continuous net worth of minimum rupees one hundred crores
as per its audited annual accounts for the previous five years in relation to the date on which application
to SEBI is made seeking registration.
Eligibility Criteria
SEBI shall not consider an application for the grant of a certificate unless the applicant satisfies the following
conditions, namely:
(a) the applicant is set up and registered as a company under the Companies Act, 1956;
(b) the applicant has, in its Memorandum of Association, specified rating activity as one of its main objects;
(c) the applicant has a minimum net worth of ` 5 crores. However a credit rating agency existing at the
commencement of these regulations, with a net worth of less than ` 5 crores, shall be deemed to have
satisfied this condition, if it increases its net worth to the said minimum within a period of three years of
such commencement.
(d) the applicant has adequate infrastructure, to enable it to provide rating services in accordance with the
provisions of the Act and these regulations;
(e) the applicant and the promoters of the applicant, have professional competence, financial soundness
and general reputation of fairness and integrity in business transactions, to the satisfaction of SEBI;
(f) neither the applicant, nor its promoter, nor any director of the applicant or its promoter, is involved in any
legal proceeding connected with the securities market, which may have an adverse impact on the
interests of the investors;
(g) neither the applicant, nor its promoters, nor any director, of its promoter has at any time in the past been
convicted of any offence involving moral turpitude or any economic offence;
(h) the applicant has, in its employment, persons having adequate professional and other relevant experience
to the satisfaction of the SEBI;
(i) neither the applicant, nor any person directly or indirectly connected with the applicant has in the past
been –
(i) refused by SEBI a certificate under these regulations or
(ii) subjected to any proceedings for a contravention of the Act or of any rules or regulations made
under the Act.
(j) the applicant, in all other respects, is a fit and proper person for the grant of a certificate;
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(k) grant of certificate to the applicant is in the interest of investors and the securities market.
Application to Conform to the Requirements
Any application for a certificate, which is not complete in all respects or does not conform to the requirement or
instructions as specified should be rejected by SEBI. However before rejecting any application, the applicant
should be given an opportunity to remove, within thirty days of the date of receipt of relevant communication,
from SEBI such objections as may be indicated by SEBI. It has been further provided that SEBI may on sufficient
reason being shown, extend the time for removal of objections by such further time, not exceeding thirty days to
enable the applicant to remove such objections.
Furnishing of Information, Clarification and Personal Representation
SEBI may require the applicant to furnish such further information or clarification as it consider necessary, for
the purpose of processing of the application. SEBI if so desires, may ask the applicant or its authorised
representative to appear before SEBI for personal representation in connection with the grant of a certificate.
Grant of Certificate
SEBI grants a certificate after getting satisfied that the applicant is eligible for the grant of a certificate of registration.
The grant of certificate of registration should be subject to the payment of the specified registration fee in the
manner prescribed.
Conditions of Certificate
The certificate granted is subject to the condition that the credit rating agency should comply with the provisions
of the Act, the regulations made thereunder and the guidelines, directives, circulars and instructions issued by
SEBI from time to time on the subject of credit rating. The credit rating agency should forthwith inform SEBI in
writing where any information or particulars furnished to SEBI by a credit rating agency is found to be false or
misleading in any material particular; or has undergone change subsequently to its furnishing at the time of the
application for a certificate.
Procedure where Certificate is not granted
SEBI may reject the application if after considering an application is of the opinion that a certificate should not be
granted or renewed, after giving the applicant a reasonable opportunity of being heard. The decision of SEBI not
to grant or not to renew the certificate should be communicated by SEBI to the applicant within a period of thirty
days of such decision, stating the grounds of the decision. Any applicant aggrieved by the decision of SEBI
rejecting his application may, within a period of thirty days from the date of receipt by him of the communication
apply to SEBI in writing for re-consideration of such decision. Where an application for re-consideration is made,
SEBI should consider the application and communicate to the applicant its decision in writing, as soon as may
be.
Effect of Refusal to Grant Certificate
An applicant whose application for the grant of a certificate has been rejected should not undertake any
rating activity. An applicant, whose application for the grant of a certificate has been rejected by SEBI,
should on and from the date of the receipt of the communication ceases to carry on any rating activity. If
SEBI is satisfied that it is in the interest of the investors, it may permit the credit rating agency to complete
the rating assignments already entered into by it, during the pendency of the application or period of validity
of the certificate. SEBI in order to protect the interest of investors may issue directions with regard to the
transfer of records, documents or reports relating to the activities of a credit rating agency, whose application
for the grant or renewal of a certificate has been rejected and for this purpose also determines the terms
and conditions of such appointment.
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Code of Conduct
Every credit rating agency is required to abide by the Code of Conduct as per SEBI Regulations:
(1) A credit rating agency in the conduct of its business should observe high standards of integrity, dignity and
fairness in all its dealings with its clients.
(2) A credit rating agency should fulfil its obligations in an ethical manner.
(3) A credit rating agency should render at all times high standards of service, exercise due diligence, ensure
proper care and exercise independent professional judgement. It shall wherever necessary, disclose to the
clients, possible sources of conflict of duties and interests, while providing unbiased services.
(4) The credit rating agency should avoid any conflict of interest of any member of its rating committee participating
in the rating analysis. Any potential conflict of interest shall be disclosed to the client.
(5) A credit rating agency should not indulge in unfair competition nor they wean away client of any other rating
agency on assurance of higher rating.
(6) A credit rating agency should not make any exaggerated statement, whether oral or written, to the client
either about its qualification or its capability to render certain services or its achievements in regard to services
rendered to other clients.
(7) A credit rating agency should always endeavour to ensure that all professional dealings are effected in a
prompt and efficient manner.
(8) A credit rating agency should not divulge to other clients, press or any other party any confidential information
about its client, which has come to its knowledge, without making disclosure to the concerned person of the
rated company/client.
(9) A credit rating agency should not make untrue statement or suppress any material fact in any documents,
reports, papers or information furnished to SEBI or to public or to stock exchange.
(10) A credit rating agency should not generally and particularly in respect of issue of securities rated by, it be a
party –
(a) to creation of false market
(b) passing of price sensitive information to brokers, members of the stock exchanges, other players in the
capital market or to any other person or take any other action which is unethical or unfair to the investors.
(11) A credit rating agency should maintain an arm’s length relationship between its credit rating activity and any
other activity. A credit rating agency or any of his employees should 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 long or short position in the said security has been made, while rendering such advice.
In case an employee of the credit rating agency is rendering such advice, he should also disclose the interest of
his dependent family members and the employer including their long or short in the said security, while rendering
such advice.
(12) A credit rating agency is required to abide by the provisions of the Act, regulations and circulars which may
be applicable and relevant to the activities carried on by the credit rating agency.
Agreement with the Client
Every credit rating agency is required to enter into a written agreement with each client whose securities it
proposes to rate, and every such agreement should include the following provisions, namely:
(a) the rights and liabilities of each party in respect of the rating of securities shall be defined;
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(b) the fee to be charged by the credit rating agency shall be specified;
(c) the client shall agree to a periodic review of the rating by the credit rating agency during the tenure of the
rated instrument and to co-operate with the credit rating agency in order to enable the latter to arrive at,
and maintain, a true and accurate rating of the clients’ securities and shall in particular provide to the
latter, true, adequate and timely information for the purpose;
(d) the credit rating agency shall disclose to the client the rating assigned to the securities of the latter
through regular methods of dissemination, irrespective of whether the rating is or is not accepted by the
client;
(e) the client shall agree to disclose the rating assigned to the client’s listed securities by any credit rating
agency during the last three years and any rating given in respect of the client’s securities by any other
credit rating agency, which has not been accepted by the client in the offer document;
(f) the client shall agree to obtain a rating for any issue of debt securities in accordance with the relevant
regulations
Monitoring of Ratings
Credit rating agency should during the lifetime of securities rated by it continuously monitor the rating of such
securities. It should also disseminate information regarding newly assigned ratings, and changes in earlier
rating promptly through press releases and websites, and, in the case of securities issued by listed companies,
such information should also be provided simultaneously to the concerned to all the stock exchanges where the
said securities are listed.
Procedure for Review of Rating
Every credit rating agency should carry out periodic review of all published ratings during the lifetime of the
securities. If the client does not co-operate with the credit rating agency so as to enable the credit rating agency
to comply with its obligations, the credit rating agency should carry out the review on the basis of the best
available information.
However, it has been provided that if owing to such lack of co-operation, a rating has been based on the best
available information, the credit rating agency should disclose to the investors the fact that the rating is so
based. A credit rating agency should not withdraw a rating so long as the obligations under the security rated by
it are outstanding, except where the company whose security is rated is wound up or merged or amalgamated
with another company.
Internal Procedures to be Framed
Credit rating agency should frame appropriate procedures and systems for monitoring the trading of securities
by its employees in the securities of its clients, in order to prevent contravention of SEBI (Insider Trading)
Regulations, 1992; SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market)
Regulations, 2003; and other laws relevant to trading of securities.
Disclosure of Rating Definitions
Credit rating agency should make public the definitions of the concerned rating, along with the symbol and state
that the ratings do not constitute recommendations to buy, hold or sell any securities. It should also make
available to the general public information relating to the rationale of the ratings, which shall cover an analysis of
the various factors justifying a favourable assessment, as well as factors constituting a risk.
Submission of Information
In case any information is called by SEBI from a credit rating agency including any report relating to its activities,
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Financial Intermediaries Framework 121
the credit rating agency is required to furnish such information to SEBI within a period specified or if no such
period is specified, then within a reasonable time. It should also furnish to SEBI, copies of its balance sheet and
profit and loss account at the close of each accounting period,
Every credit rating agency is required to comply with such guidelines, directives, circulars and instructions as
issued by SEBI from time to time.
Appointment of Compliance Officer
It is under an obligation to appoint a compliance officer who will be responsible for monitoring the compliance of
the Act, Rules and Regulations, notifications, guidelines, instructions etc issued by SEBI or the Central
Government. The compliance officer should immediately and independently report to SEBI any non-compliance
observed by him.
Maintenance of Books of Accounts Records, etc.
Credit rating agency should keep and maintain, for a minimum period of five years, the following books of
accounts, records and documents, namely:
(i) copy of its balance sheet, as on the end of each accounting period;
(ii) a copy of its profit and loss account for each accounting period;
(iii) a copy of the auditor’s report on its accounts for each accounting period.
(iv) a copy of the agreement entered into, with each client;
(v) information supplied by each of the clients;
(vi) correspondence with each client;
(vii) ratings assigned to various securities including upgradation and down gradation (if any) of the ratings
so assigned;
(viii) rating notes considered by the rating committee;
(ix) record of decisions of the rating committee;
(x) letter assigning rating;
(xi) particulars of fees charged for rating and such other records as SEBI may specify from time to time.
Credit rating agency is required to intimate to SEBI, the place where the books of account, records and documents
required to be maintained under these regulations are being maintained.
Steps on Auditor’s Report
Credit rating agency should within two month’s from the date of the auditor’s report, take steps to rectify the
deficiencies if any, made out in the auditor’s report, in so far as they relate to the activity of rating of securities.
Confidentiality
Every credit rating agency shall treat, as confidential, information supplied to it by the client and no credit rating
agency shall disclose the same to any other person, except where such disclosure is required under any law.
Rating Process
Credit rating agency should specify the rating process and file a copy of the same with SEBI for record and also
file with SEBI any modifications or additions made therein from time to time. It should in all cases follow a proper
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rating process. Credit rating agency is required to have professional rating committees, comprising members
who are adequately qualified and knowledgeable to assign a rating. All rating decisions, including the decisions
regarding changes in rating, should be taken by the rating committee. Credit rating agency should be staffed by
analysts qualified to carry out a rating assignment. Credit rating agency should inform SEBI about new rating
instruments or symbols introduced by it. Credit rating agency, while rating a security should exercise due diligence
in order to ensure that the rating given by the credit rating agency is fair and appropriate. A credit rating agency
should not rate securities issued by it. Rating definition, as well as the structure for a particular rating product,
should not be changed by a credit rating agency, without prior information to SEBI. A credit rating agency should
disclose to the concerned stock exchange through press release and websites for general investors, the rating
assigned to the securities of a client, after periodic review, including changes in rating, if any.
Restrictions on Rating of Securities Issued by Promoter and Certain Entities, Connected with
A Promoter, or Rating Agency
Credit rating agency shall not rate a security issued by its promoter:
(1) No credit rating agency should rate a security issued by an entity,
(a) which is a borrower of its promoter or
(b) a subsidiary of its promoter or
(i) an associate of its promoter, if there are common Chairman, Directors between credit rating
agency and these entities,
(ii) there are common employees,
(iii) there are common Chairman, Directors, Employees on the rating committee.
(2) No credit rating agency should rate a security issued by its associate or subsidiary, if the credit
rating agency or its rating committee has a Chairman, director or employee who is also a Chairman,
director or employee of any such entity.
However, these conditions do not apply to securities whose rating has been already done by a credit rating
agency before the commencement of these regulations, and such securities may, subject to the provisions of
the other Chapters of these regulations, continue to be rated, without the need to comply with the restrictions
imposed by the regulations.
Procedure for Inspection and Investigation
SEBI can appoint one or more persons as inspecting officers, to undertake inspection or investigation of the
books of account, records and documents of the credit rating agencies, for any of the purposes specified in the
regulations. The purposes referred to in regulation should be to ascertain whether the books of account, records
and documents are being maintained properly, to ascertain whether the provisions of the Act and these regulations
are being complied with, to investigate into complaints received from investors, clients or any other person on
any matter having a bearing on activities of the credit rating agency and in the interest of the securities market
or in the interest of investors. The inspections ordered by SEBI should not ordinarily go into an examination of
the appropriateness of the assigned ratings on the merits. Inspections to judge the appropriateness of the
ratings may be ordered by SEBI, only in case of complaints which are serious in nature to be carried out either
by the officers of SEBI or independent experts with relevant experience or combination of both.
Notice of Inspection or Investigation
SEBI shall give ten days written notice to the credit rating agency before ordering an inspection or investigation.
SEBI in the interest of the investors may order in writing, direct that the inspection or investigation of the affairs
of the credit rating agency to be taken up without such notice. During the course of an inspection or investigation,
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Financial Intermediaries Framework 123
the credit rating agency against whom the inspection or investigation is being carried out should be bound to
discharge all its obligations as provided in this regulation.
Obligations of Credit Rating Agency
It should be the duty of credit rating agency whose affairs are being inspected or investigated, and of every
director, officer or employee thereof, to produce to the inspecting or investigating officer such books, accounts
and other documents in its or his custody or control and furnish him with such statements and information
relating to its rating activities, as the inspecting officer may require within such reasonable period as may be
specified by the officer. The credit rating agency should allow the inspecting officer to have reasonable access
to the premises occupied by such credit rating agency or by any other person on its behalf and extend to the
inspecting officer reasonable facility for examining any books, records, documents and computer data in the
possession of the credit rating agency and to provide copies of documents or other materials which, in the
opinion of the inspecting officer, are relevant for the purposes of the inspection or investigation, as the case may
be. The inspecting officer, in the course of inspection or investigation, should be entitled to examine, or record
the statements, of any officer, director or employee of the credit rating agency for the purposes connected with
the inspection or investigation. Every director, officer or employee of the credit rating agency is bound to render
to the inspecting officer all assistance in connection with the inspection or investigation which the inspecting
officer may reasonably require.
The inspecting officer should as soon as possible, on completion of the inspection or investigation, submit a
report to SEBI. However if directed to do so by SEBI, he may submit an interim report. SEBI after considering
the inspection report or the interim report referred to in regulation communicate the findings of the inspecting
officer to the credit rating agency and give it a reasonable opportunity of being heard in the matter. SEBI may
call upon the credit rating agency on receipt of the explanation, if any to take such measures as it may deem
fit in the interest of the securities market and for due compliance with the provisions of the Act and the
regulations.
Action in case of Default
A credit rating agency which –
(a) fails to comply with any condition subject to which a certificate has been granted;
(b) contravenes any of the provisions of the Act or these regulations or any other regulations made under
the Act; shall be dealt with in the manner provided under Chapter V of the Securities and Exchange
Board of India (Intermediaries) Regulations, 2008.
MARKET MAKER
“Market-Maker” means a trading member of the Stock Exchange registered as such as per the Rules and Byelaws of the Stock Exchange. A market-maker is responsible for enhancing the demand supply situation in securities
such as stocks and futures & options.
Market-making means infusing liquidity in securities that are not frequently traded on stock exchanges.
GUIDELINES FOR MARKET MAKER
SEBI issued ‘Guidelines for Market Makers on Small and Medium Enterprise (SME) Exchange/separate platform
of existing Exchange having nationwide terminal’. As per the circular, market making has been made mandatory
in respect of all scrips listed and traded on SME Exchange.
Registration of the Market Maker
Any member of the Exchange would be eligible to act as Market Maker provided the criteria laid down by the
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exchange are met. The member brokers desirous of acting as Market Maker in this exchange shall apply to the
concerned stock exchange for registration as Market Makers unless already registered as a Market Maker.
The Obligations and Responsibilities of Market Makers
The Market Maker shall fulfil the following conditions to provide depth and continuity on this exchange:
(a) The Market Maker shall be required to provide a 2-way quote for 75% of the time in a day. The same
shall be monitored by the stock exchange. Further, the Market Maker shall inform the exchange in
advance for each and every black out period when the quotes are not being offered by the Market
Maker.
(b) The minimum depth of the quote shall be `1,00,000. However, the investors with holdings of value less
than ` 1,00,000 shall be allowed to offer their holding to the Market Maker in that scrip provided that he
sells his entire holding in that scrip in one lot along with a declaration to the effect to the selling broker.
(c) Execution of the order at the quoted price and quantity must be guaranteed by the Market Maker, for the
quotes given by him.
(d) There would not be more than five Market Makers for a scrip. These would be selected on the basis of
objective criteria to be evolved by the Exchange which would include capital adequacy, networth,
infrastructure, minimum volume of business etc.
(e) The Market Maker may compete with other Market Makers for better quotes to the investors;
(f) Once registered as a Market Maker, he has to start providing quotes from the day of the listing / the day
when designated as the Market Maker for the respective scrip and shall be subject to the guidelines laid
down for market making by the exchange.
(g) Once registered as a Market Maker, he has to act in that capacity for a period as mutually decided
between the Merchant Banker and the market maker.
(h) Further, the Market Maker shall be allowed to deregister by giving one month notice to the exchange,
subject to (g) above.
Dissemination of Information
The exchange should disseminate the list of Market Makers for the respective scrip to the public.
Number of Shares per Market Maker
The number of companies in whose shares a Market Maker would make market should be linked to his capital
adequacy as decided by the exchange.
Risk Containment Measures and Monitoring for Market Makers
All applicable margins should be levied and collected without any waiver/exemption.
Capital Adequacy
The exchanges would prescribe the capital adequacy requirement for its members to commensurate with the
number of companies which Market Maker proposes to make market. Further, the stock exchange may lay
down additional criteria also for Market Makers as risk containment measures. The same shall be monitored by
the stock exchange
Monitoring
All the requirements with regard to market making shall be monitored by the stock exchange and any violation
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Financial Intermediaries Framework 125
of these requirements would be liable for punitive action to be taken by the Disciplinary Action Committee (DAC)
of the Exchange, which may also include monitory penalty apart from the trade restriction as decided by the
DAC under intimation to the Merchant Banker.
Price Band and Spreads
The exchanges shall prescribe the maximum spread between bid and ask price. The exchange, may at its
discretion also prescribe the price bands for the same. Further, in case of new issue the spread shall also be
specified in the offer document with the prior approval of the exchange.
SEBI (DEPOSITORIES AND PARTICIPANTS) REGULATIONS, 1996
SEBI had issued SEBI (Depositories and Participants) Regulations, 1996 on 16th May, 1996 which apply to
depositories and its participants.
These regulations also contain provisions for operations and functioning of depositories, form for application
and certificates used and schedule of fees for participants, etc. It also contains provisions for registration of
depository and depository participants, rights and obligations of various users and constituents, inspection and
procedure for action in case of default.
Entities desiring to become depository participants must apply to the depository and are required to be
recommended to SEBI by the depository. If approved and registered by SEBI, the depository participant can be
admitted on the depository. The depository has to formulate its own set of criteria for selection of participants.
Every participant holding a certificate is required at all times to abide by the specified Code of Conduct.
The regulations require the depository to list out, through its Bye-laws, the securities which are eligible to be
admitted to the depository for dematerialization. Equity shares, debentures, warrants, bonds, units of mutual
funds, etc. are part of the list of eligible securities. The depository is empowered to set its own criteria for
selection of securities and make securities eligible to be maintained in the form of electronic holdings on the
depository. Further, the regulations stipulate that agreements should be entered into by the following entities:
– depository and every participant
– participant and every client
– depository, issuer company and the Registrar
The draft of these agreements are to be included in the Bye-laws and to be approved by SEBI. The depository
is required to ensure that sufficient safeguards are in place to protect the data available with it and with the
participants. To reduce risk in operations, the regulations stipulate that adequate insurance cover be provided
by the depository and by the depository participants as well.
The regulations also require for reconciliation to be carried out on a daily basis. Further, the depository and the
registrar will also reconcile balances on a daily and a periodic basis.
Rights and Obligations of Depositories and its Constituents
This Regulations deal with rights and obligations of depositories and every depository has to state in its bye¬laws
the eligible securities for dematerialisation which include shares, scrips, stock, bonds, debentures stock, etc.,
and include units of mutual funds, rights under collective investment schemes and venture capital funds,
commercial paper, certificate of deposit, securitised debt, money market instruments and even unlisted securities.
Every depository is required to enter into an agreement with the issuer in respect of securities disclosed as
eligible to be held in demat form. No agreement is required to be entered into where the depository itself is an
issuer of securities.
The depository is also required to enter into a tripartite agreement with the issuer, its transfer agent and itself
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where company has appointed a transfer agent. Every depository is required to maintain continuous connectivity
with issuers, registrars and transfer agents, participants and clearing house or clearing corporations. Depositories
should take adequate measures including insurance to protect the interest of the beneficial owners.
Every depository is required to maintain the following records and documents namely:
– records of securities dematerialised and rematerialised;
– the names of the transferor, transferee, and the dates of transfer of securities;
– a register and an index of beneficial owners;
– details of holding of the securities of the beneficial owners as at the end of the each day;
– records of instruction(s) received from and sent to participants, issuers’ agents and beneficial owners;
– records of approval, notice, entry and cancellation of pledge or hypothecation, as the case may be;
– details of participants;
– details of securities declared to be eligible for dematerialisation in the depository; and
– such other records as may be specified by SEBI for carrying on the activities as a depository.
Every depository has to intimate SEBI the place where the records and documents are maintained. Subject to
the provisions of any other law, the depository shall preserve records and documents for a minimum period of
five years. Participants are required to enter into an agreement with beneficial owners. It is required that separate
accounts are to be opened by every participant in the name of each of the beneficial owner and the securities of
each beneficial owners are to be segregated and shall not be mixed up with the securities of other beneficial
owners or with the participant’s own securities. The participants are obliged to reconcile the records with every
depository on a daily basis.
Participants are required to maintain the following records for a period of five years:
– records of all the transactions entered into with a depository and with a beneficial owner;
– details of security dematerialised, rematerialised on behalf of beneficial owners with whom it has entered
into an agreement;
– records of instructions received from beneficial owners and statements of account provided to beneficial
owners; and
– records of approval, notice, entry and cancellation of pledge or hypothecation as the case may be.
GOVERNANCE OF DEPOSITORY
Governing Board, Disclosures and Corporate Governance
– Regulations deal with the composition of Governing Board of a Depository –
– The governing board of every depository is required to include:
(a) shareholder directors;
(b) public interest directors; and
(c) managing director.
– Any employee of a depository may be appointed on the governing board in addition to the managing director,
and such director shall be deemed to be a shareholder director.
– The chairperson shall be elected by the governing board from amongst the public interest directors Subject
to prior approval of SEBI.
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Financial Intermediaries Framework 127
– The number of public interest directors shall not be less than the number of shareholder directors in a
depository.
– The managing director shall be an ex-officio director on the governing board and shall not be included in
either the category of public interest directors or shareholder directors.
The disclosure requirements and corporate governance norms as specified for listed companies shall mutatis
mutandis apply to a depository.
Investor Protection Fund
Every depository is required to establish and maintain an Investor Protection Fund for the protection of interest
of beneficial owners. Every depository should credit twenty five per cent of its profits every year to the Investor
Protection Fund.
AUDIT UNDER SEBI (DEPOSITORIES AND PARTICIPANTS) REGULATIONS, 1996
Regulation 55A of SEBI (Depositories and Participants) Regulations, 1996 provides that every issuer shall
submit audit report on a quarterly basis to the concerned stock exchanges audited by a Practicing Company
Secretary or a qualified Chartered Accountant, for the purposes of reconciliation of the total issued capital,
listed capital and capital held by depositories in dematerialized form, the details of changes in share capital
during the quarter and the in-principle approval obtained by the issuer from all the stock exchanges where it is
listed in respect of such further issued capital.
The audit report is required to give the updated status of the register of members of the issuer and confirm that
securities have been dematerialized as per requests within 21 days from the date of receipt of requests by the
issuer and where the dematerialization has not been effected within the said stipulated period, the report would
disclose the reasons for such delay.
The issuer is under an obligation to immediately bring to the notice of the depositories and the stock exchanges,
any difference observed in its issued, listed, and the capital held by depositories in dematerialized form.
INTERNAL AUDIT OF OPERATIONS OF DEPOSITORY PARTICIPANTS
The two Depository service providers in India, viz., National Securities Depository Ltd. (NSDL) and Central
Depository Services (India) Limited (CDS) have allowed Company Secretaries in Whole-time Practice to undertake
internal audit of the operations of Depository Participants (DPs).
NSDL has vide its circular No. NSDL/SG/II/010/99 dated 26th March 1999 notified amendment of its Bye Law
10.3.1 of Chapter 10 as follows:
10.3.1 “Every Participant shall ensure that an internal audit in respect of the operations of the Depository is
conducted at intervals of not more than three months by a qualified Chartered Accountant or a Company
Secretary holding a certificate of Practice and a copy of the internal audit report shall be furnished to the
Depository.”
CDSL has vide its letter dated September 28, 1999 notified amendment of its Bye Laws 16.3.1 as follows:
16.3.1 “Every Participant shall ensure that an internal audit shall be conducted in respect of the participant’s
operations relating to CDS by a qualified Chartered Accountant in accordance with the provisions of the
Chartered Accountants Act, 1949 or by a Company Secretary in practice in accordance with the provisions of
the Company Secretaries Act, 1980, at such intervals as may be specified by CDS from time to time. A copy
of Internal Audit report shall be furnished to CDS.”
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CONCURRENT AUDIT
National Securities Depository Limited vide its Circular No. NSDL/POLICY/ 2006/0021 dated June 24, 2006
provides for concurrent audit of the Depository Participants. The Circular provides that w.e.f. August 1, 2006, the
process of demat account opening, control and verification of Delivery Instruction Slips (DIS) is subject to.
Depository Participants have been firm of qualified Chartered Accountant(s) or Company Secretary(ies) holding
a certificate of practice for conducting the concurrent audit. However, the participants in case they so desire,
may entrust the concurrent audit to their Internal Auditors.
In respect of account opening, the auditor should verify all the documents including KYC documents furnished
by the Clients and verified by the officials of the Participants. The scope of concurrent audit with respect to
control and verification of DIS cover the areas given below:
(I) Issuance of DIS
The procedure followed by the Participants with respect to:
(a) Issuance of DIS booklets including loose slips.
(b) Existence of controls on DIS issued to Clients including pre-stamping of Client ID and unique preprinted
serial numbers.
(c) Record maintenance for issuance of DIS booklets (including loose slips) in the back office.
(II) Verification of DIS
The procedure followed by the Participants with respect to:
(a) Date and time stamping (including late stamping) on instruction slips.
(b) Blocking of used/reported lost/stolen instruction slips in back office system/ manual record.
(c) Blocking of slips in the back office system/manual record which are executed in DPM directly.
(d) Two step verification for a transaction for more than ` 5 lakh, especially in case of off-market transactions.
(e) Instructions received from dormant accounts.
The Concurrent Auditor should conduct the audit in respect of all accounts opened, DIS issued and controls on
DIS as mentioned above, during the day, by the next working day. In case the audit could not be completed
within the next working day due to large volume, the auditor should ensure that the audit is completed within a
week’s time.
Any deviation and/or non-compliance observed in the aforesaid areas should be mentioned in the audit report of
the Concurrent Auditor. The Management of the Participant should comment on the observations made by the
Concurrent Auditor.
The Concurrent Audit Report should be submitted to NSDL, on a quarterly basis, in a hard copy form. If the
Auditor for Internal and Concurrent Audit is the same, consolidated report may be submitted.
QUALIFIED DEPOSITORY PATICIPANTS
A Depository Participant that has taken approval from / registered with SEBI to offer services to Qualified Foreign
Investor (QFI) is called Qualified Depository Participants (QDP).
Eligibility criteria
To become a qualified Depository Participant, a SEBI registered DP shall fulfil the following:
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Financial Intermediaries Framework 129
(i) DP shall have net worth of ` 50 crore or more.
(ii) DP shall be either a clearing bank or clearing member of any of the clearing corporations;
(iii) DP shall demonstrate that it has systems and procedures to comply with the FATF Standards, Prevention
of Money Laundering (PML) Act, Rules and SEBI circulars issued from time to time; and
(iv) DP shall obtain prior approval of SEBI before commencing the activities relating to QFI.
Role and responsibilities of QDP
– The qualified DPs are required to comply with the extant laws, rules and regulations of jurisdictions where
they carry out their operations in the capacity of qualified DP, such as solicitation of investments.
– In case of any violations by QFI a qualified DP is obliged to bring such instances to the notice of concerned
depository and SEBI.
– The qualified DP shall not perform any acts or deeds with regard to QFI that puts any of his other client(s) at
an disadvantageous position. The qualified DP shall deal with its QFI clients in a fair and impartial manner.
– The qualified DP shall obtain appropriate declarations/undertakings as prescribed by depositories from time
to time.
– The qualified DP shall report QFI holdings in the format prescribed by the depositories from time to time.
– The qualified DP will route the order of QFI to the broker only after checking applicable limits.
Responsibilities on the QDP with respect to the regulator
(i) Each day QDP should provide QFI wise, ISIN wise and company wise buy / sell information and any other
transaction or any related information to their respective depositories as per time lines stipulated by depositories.
(ii) Notify information of any penalty, pending litigations or proceedings, findings of inspections or investigations
for which action may have been taken or is in the process of being taken by an overseas regulator against the
QDP / QFI forthwith, to the attention of SEBI, depositories and stock exchanges.
Concern need to be taken by QDP while registering a QFI
(i) QDP shall ensure that only those entities are allowed to open demat account as QFI whose ultimate/ end
beneficial ownership is not resident in India.
(ii) The entities having opaque structure(s) such that the details of ultimate/ end beneficiary are not accessible or
where the beneficial owners are ring fenced from each other or where the beneficial owners are ring fenced with
regard to enforcement shall not be allowed to open demat account as QFI.
(iii) In case of any direct/ indirect change in structure or beneficial ownership of the QFI, the QFI shall bring the
same to the notice of its QDP, forthwith. The QDP shall assess the eligibility of that QFI afresh, before allowing
it to undertake any further transactions.
(iv) The QDP shall open a demat account for the QFI only after ensuring compliance with all the requirements as
per PML Act, rules and regulations, FATF standards and SEBI circulars issued in this regard, from time to time
and shall also ensure that QFI comply with all these requirements on an ongoing basis.
(v) The QDP shall, at all times, ensure compliance with laws, rules and regulations of the jurisdictions where the
QFI are based.
Undertakings that the QDP's need to obtain from the QFI's
(i) QFI does not hold any other demat account in any capacity whatsoever in India.
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(ii) The ultimate / end beneficial ownership is not a person resident in India.
(iii) Entities with an opaque structure are prohibited from opening a demat account in India. In effect, the ultimate
beneficiary details need to be fully disclosed.
(iv) The QFI shall keep the QDP informed of any changes in the structure or beneficial ownership of the entity,
directly or indirectly. Each time there are changes in the beneficial ownership, the QDP shall assess afresh
before allowing the QFI to undertake any further transactions.
(v) Authorize the QDP to furnish such QFI information as may be required by any of the Indian Regulators from
time to time.
(vi) At all times, the QFI shall, in relation to their activities as QFI in India, be subject the Indian laws, rules,
regulations, circulars etc. as applicable from time to time.
(vii) QFI to furnish, on an ongoing basis, details of any penalties, litigations or proceedings, findings of inspections
or investigations by any overseas regulator.
(viii) The QFI is prohibited from issuing any offshore derivatives instruments / participatory notes against the
shares held by the QFI in Demat account in India.
(ix) QFI to authorize the QDP to disinvest holdings in excess of prescribed limits should a situation so arise.
(x) QFI to transact only through one bank account.
Apart from this, all the securities market Intermediaries are also required to comply with the SEBI
(Self Regulatory Organisations) Regulations, 2004 , SEBI (Intermediaries ) Regulations, 2008 and
SEBI {KYC(Know Your Client) Registration agency(KRA)}, Regulations, 2011 which have already
been elaborated at the executive level.
LESSON ROUND UP
– SEBI has issued regulations in respect of each intermediary to ensure proper services to be rendered
by them to the investors and the capital market.
– Regulation 3 of SEBI (Merchant Bankers) Regulations, 1992 lays down that an application by a person
desiring to become merchant banker shall be made to SEBI in the prescribed form seeking grant of a
certificate of initial registration alongwith a non-refundable application fee as specified in Schedule II of
the Regulations.
– The Registrars to an Issue and Share Transfer Agents constitute an important category of intermediaries
in the primary market.
– Underwriting is an arrangement whereby certain parties assure the issuing company to take up shares,
debentures or other securities to a specified extent in case the public subscription does not amount to
the expected levels.
– Banker to an Issue means a scheduled bank carrying on all or any of the following activities:
– Acceptance of application and application monies;
– Acceptance of allotment or call monies;
– Refund of application monies;
– Payment of dividend or interest warrants.
– Regulation 25 of Chapter V of SEBI (Debenture Trustees) Regulations, 1993 lays down that a debenture
Lesson 4
Financial Intermediaries Framework 131
trustee would be dealt with in the manner provided under Chapter V of SEBI (Intermediaries) Regulations,
2008, if he fails to comply with the conditions of registration, contravenes the provisions of SEBI Act/
Companies Act, Rules and Regulations.
– SEBI has authorized the Practicing Company Secretary to carry out complete internal audit of stock
brokers/ trading members/clearing members on a half yearly basis.
– Every Portfolio Manager is required to appoint a Practising Company Secretary or a Practising Chartered
Accountant for conducting the internal audit.
– Any person proposing to carry on business as custodian of securities on or after the commencement
of these regulations shall make an application to SEBI for grant of a certificate.
– “Foreign Institutional Investor” means an institution established or incorporated outside India which
proposes to make investment in India in securities.
– “Investment Adviser” means any person, who for consideration, is engaged in the business of providing
investment advice to clients or other persons or group of persons and includes any person who holds
out himself as an investment adviser, by whatever name called.
– SEBI regulations for Credit Rating Agencies (CRAs) cover rating of securities only and not rating of
fixed deposits, foreign exchange, country ratings, real estates etc.
– “Market-Maker” means a trading member of the Stock Exchange registered as such as per the Rules
and Bye-laws of the Stock Exchange.
– SEBI (Depositories and Participants) Regulations, 1996, contain provisions for operations and
functioning of depositories, form for application and certificates used and schedule of fees for participants,
etc.
– A Depository Participant that has taken approval from/registered with SEBI to offer services to Qualified
Foreign Investor (QFI) is called Qualified Depository Participant (QDP)
SELF TEST QUESTIONS
1. Briefly discuss the general obligations and responsibilities of the merchant banker and due diligence
certificate issued by the merchant banker.
2. Explain the code of conduct prescribed by SEBI for Investment Advisers.
3. Explain general obligations of Credit Rating Agencies under Chapter III of SEBI (Credit Rating Agencies)
Regulations, 1999.
4. What do you understand by a Qualified Depository Participant (QDP)? Describe the Eligibility Criteria
required to be fulfiled to become a QDP.
5. Enumerate the provisions relating to Reconciliation of Share Capital Audit under SEBI (Depositories
and Participants) Regulations, 1996.
132 PP-CC&MM
Lesson 5
Primary Market
LESSON OUTLINE
Lesson 5
Primary Market 133
LEARNING OBJECTIVES
– Introduction
One of the important segment in the financial
system is the primary market which is seen as
an excellent avenue for companies to raise huge
amount of money as the investment directly
made to the issuer by tapping a cross section
of investors and using different fund raising
methods. Public issue of securities whether it
is being in the form of rights issue, bonus issue
or through Qualified Institutional Placement
(QIP)or Institutional Placement Programme
(IPP), it has to comply with the SEBI (ICDR)
Regulations, 2009.
– Types of Issue
– Offer for Sale
– Difference between Offer for Sale (OFS)
process and IPOs/FPOs
– SEBI Guidelines on Offer for Sale of
shares by promoters through the Stock
Exchange Mechanism
– Different form of prospectus
– Filing of offer Document
– Lead manager
– Pre-issue management
The main objective of this lesson is to give a
detailed view of provisions relating to SEBI
(ICDR) Regulations, 2009 pertaining to different
types of public issue of securities. Apart from
this, this lesson will also provides how basis of
allotment is finalised, book building process,
Green Shoe Option, Due diligence carried out
in IPO/FPO and the time based and event based
compliances required under Listing Agreement
etc.
– Post-issue management
– Underwriting
– Due Diligence
– Due Diligence in IPO/FPO
– Basis of Allotment
– Book Building
– Alternate Method of book Building
– Green Shoe Option Facility
– Pre-issue activities
– Rights Issue
– Bonus Issue
– Preferential Issue
– Qualified Institutional Placement
– Institutional Placement Programme
– Listing Agreement
– LESSON ROUND UP
– SELF TEST QUESTIONS
133
134 PP-CC&MM
INTRODUCTION
Primary Market is a Market for new issues or financial claims. Hence it is also called new issue market. Primary
Market deals with those securities which are issue to the public for the first time. Primary Market provides
opportunity to issuers of securities, Government as well as corporates, to raise resources to meet their
requirements of investment and/or discharge some obligation. The issuers create and issue fresh securities in
exchange of funds through public issues and/or as private placement. When equity shares are exclusively
offered to the existing shareholders it is called ‘Rights Issue’ and when it is issued to selected mature and
sophisticated institutional investors as opposed to general public it is called ‘Private Placement Issues’. Issuers
may issue the securities at face value, or at a discount/premium and these securities may take a variety of forms
such as equity, debt or some hybrid instruments.
Types of Issue
Public Issue of shares means the selling or marketing of shares for subscription by the public by issue of
prospectus. For raising capital from the public by the issue of shares, a public company has to comply with the
provisions of the Companies Act, the Securities Contracts (Regulation) Act, 1956 including the Rules made
thereunder and the guidelines and instructions issued by the concerned Government authorities, the Stock
Exchanges and SEBI etc.
A company can raise funds from the primary market through different method.
(a) Public issue: When an issue/offer of securities is made to new investors for becoming part of
shareholders’ family of the issuer it is called a public issue. Public issue can be further classified into
Initial public offer (IPO) and Further public offer (FPO). The significant features of each type of public
issue are illustrated below:
(i) Initial public offer (IPO): When an unlisted company makes either a fresh issue of securities or
offers its existing securities for sale or both for the first time to the public, it is called an IPO. This
paves way for listing and trading of the issuer’s securities in the Stock Exchanges.
(ii) Further 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 FPO.
(b) Right issue (RI): 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.
(c) Bonus issue: When an issuer makes an issue of securities to its existing shareholders as on a record date,
without any consideration from them, it is called a bonus issue. The shares are issued out of the Company’s
free reserve or share premium account in a particular ratio to the number of securities held on a record date.
(d) Private placement: When an issuer makes an issue of securities to a select group of persons not
exceeding 49, and which is neither a rights issue nor a public issue, it is called a private placement.
Private placement of shares or convertible securities by listed issuer can be of two types:
(i) Preferential allotment: When a listed issuer issues shares or convertible securities, to a select group
of persons in terms of provisions of Chapter VII of SEBI (ICDR) Regulations, it is called a preferential
allotment. The issuer is required to comply with various provisions which inter alia include pricing,
disclosures in the notice, lock in etc., in addition to the requirements specified in the Companies Act.
(ii) Qualified institutions placement (QIP): When a listed issuer issues equity shares or securities
convertible in to equity shares to Qualified Institutions Buyers only in terms of provisions of Chapter
VIII of SEBI (ICDR) Regulations, it is called a QIP.
Lesson 5
Primary Market 135
Issues
Public Issue
Rights Issue
IPO
FPO
Fresh Issue
Fresh Issue
Offer for sale
Offer for sale
Bonus Issue
Private Placement
Preferential Issue
Qualified Institutional
Placement
OFFER FOR SALE
Offer for Sale (OFS) is another form of share sale, very much similar to Further Public Offer (FPO). OFS mechanism
facilitates the promoters of an already listed company to sell or dilute their existing shareholdings through an
exchange based bidding platform.
Except the promoters of the company, all market participants like individuals, mutual funds, foreign institutional
investors (FIIs), insurance companies, corporates, other Qualified Institutional Bidders (QIBs), HUFs etc. can
bid/participate in the OFS process or buy the shares. The promoters of the company can only participate as the
sellers in the process.
OFS PROCESS
The following is the process for offer for sale:
(i) The sellers are required to deposit the offered shares with the exchange before 11.00 a.m. on T–1 day,
where ‘T’ is the day of OFS.
(ii) Once the OFS starts, one can participate in the process himself using online trading accounts by
placing bids under the ‘OFS’ section of their respective broking websites.
(iii) Investors, who do not have online trading accounts, can place their bids by directing the dealer of their
broking company to do it on their behalf. The investor can modify or cancel their bids during the offer
timings except in the last 60 minutes i.e. till 2:30 p.m.
(iv) The exchange will announce the “Indicative Price” only during the last 60 minutes of the OFS. Indicative
Price is the volume weighted average price of all the valid/confirmed bids. e.g. There are total 1000
shares in an offer for sale with ` 200 as the floor price. If the investors bid for 200 shares at ` 210 and
800 shares at ` 200, the indicative price for the offer would be [(200*210)+(800*200)]/1000 = ` 202.
(v) No leverage is provided to the investors against the stock margin available in the trading accounts and
thus, they are required to deposit 100% of the order value in cash to bid for it. Also, the funds allocated for
OFS cannot be utilised for other investment purposes or against any other obligation of the trading member.
(vi) Once the bidding gets over, allotment price is fixed and allocation is done. The successful bidders will
136 PP-CC&MM
be allotted shares directly into their demat account on T+1 basis the very next day. In case of partial
allotment or no allotment, the refunds will be made on the same day itself. This makes the OFS process
really fast, just like buying shares of the company from the open market.
(vii) During the offer timings or once the offer gets completed, the investor can monitor the quantity and price
of bids received etc. from the website of the Stock Exchange.
Difference between Offer for Sale (OFS) process and IPOs/FPOs
(i) Physical Application: Unlike IPOs/FPOs, no physical application forms are issued to apply for shares in the
OFS process. OFS process is completely platform based.
(ii) Time Period: While IPOs/FPOs remain open for 3-4 days, OFS gets over in a single trading day as the
markets gets closed for trading at 3:30 p.m.
(iii) Price Band: Under IPOs/FPOs, there is a price band in which the investors need to bid for the shares or
simply give their consent to buy the shares at the “Cut-Off” price. With OFS, there is a “Floor Price”. As the name
suggests, it is the minimum price at which the investor can bid for the shares under OFS. An investor will not be
able to place an order below the floor price as it will not be accepted by the system.
Though it is not mandatory to disclose the floor price before the issue opens, the promoters usually disclose it
prior to the share sale in almost all of the issues. Alternatively, the promoters can submit the floor price in a
sealed envelope to the exchange which will be disclosed post closure of the offer. In case the floor price is not
disclosed to the public, the investors can place their bids at any price they want.
(iv) Charges: Investors are not required to pay any kind of charges over and above the ‘Fixed Price’ in an IPO or
FPO. But, the OFS process involve certain transaction charges including the brokerage, Securities Transaction Tax
(STT) and other charges, which the investors normally pay when they buy shares of a company in the cash market.
On the OFS day, normal trading in the shares of the company will continue even when the bidding process is
‘ON’. The investors have the option to either buy the shares of the company in the normal market or place their
bids for the shares on sale in the OFS. The investors can place only ‘Limit’ orders under the OFS facility as
‘Market’ orders are not allowed.
SEBI GUIDELINES ON OFFER FOR SALE (OFS) OF SHARES BY PROMOTERS THROUGH THE
STOCK EXCHANGE MECHANISM
SEBI has detailed guidelines on how the offer-for-sale should be followed which is discussed below:
1. Eligibility
(a) Exchanges
The facility of offer for sale of shares shall be available on Bombay Stock Exchange (BSE) and National Stock
Exchange (NSE).
(b) Sellers
(i) All promoter(s)/ promoter group entities of such companies that are eligible for trading and are required to
increase public shareholding to meet the minimum public shareholding requirements in terms of Rule 19(2)(b) and
19A of Securities Contracts (Regulation) Rules, 1957 (SCRR), read with clause 40A (ii) (c) of Listing Agreement.
(ii) All promoters/promoter group entities of top 100 companies by market capitalisation in any of the last four
completed quarters, market capitalisation being calculated as average market capitalisation in a quarter.
For (i) and (ii) above, the promoter/promoter group entities should not have purchased and/or sold the shares of
the company in the 12 weeks period prior to the offer and they should undertake not to purchase and/or sell
shares of the company in the 12 weeks period after the offer. However, within the cooling off period of +12
Lesson 5
Primary Market 137
weeks, the promoter(s)/promoter group entities can offer their shares only through OFS/ Institutional Placement
Programme (IPP) with a gap of 2 weeks between successive offers. The above shall also be applicable on
promoter(s) /promoter group entities who have already offered their shares through OFS/IPP.
(c) Buyers
All investors registered with the brokers of the aforementioned stock exchanges other than the promoter(s)/
promoter group entities.
2. Definitions
"Single Clearing Price” is the price at which the shares are allocated to the successful bidders in a
proportionate basis methodology.
“Multiple Clearing Prices” are the prices at which the shares are allocated to the successful bidders in a
price priority methodology.
“Indicative Price” is the volume weighted average price of all the valid bids.
“Floor Price” is the minimum price at which the seller intends to sell the shares.
3. Size of Offer for sale of shares
The size of the offer shall be a minimum of ` 25 crores. However, size of offer can be less than `25 crores so as
to achieve minimum public shareholding in a single tranche.
4. Advertisement and offer expenses
(a) Advertisements about the offer for sale of shares through stock exchange(s) , if any, shall be made after the
announcement/ notice of the offer for sale of shares to the stock exchanges in accordance with para 5 (b)
below and its contents shall be restricted to the contents of the notice as given to the stock exchange under
Para 5 (b).
(b) All expenses relating to offer for sale of shares through stock exchange(s) shall be borne by the seller(s).
5. Operational Requirements
(a) Appointment of Broker
The Seller(s) will appoint broker(s) for this purpose. The Seller’s broker(s) may also undertake transactions on
behalf of eligible buyers.
(b) Contents of the announcement/ Notice of the Offer for sale of shares
Seller(s) shall announce the intention of sale of shares at least on the day prior to the offer for sale, along with
the following information:
(i) Name of the seller(s) (promoter/ promoter group) and the name of the company whose shares are
proposed to be sold.
(ii) Name of the Exchange(s) where the orders shall be placed. In case orders are to be placed on both
BSE and NSE, one of them shall be declared as the Designated Stock Exchange (DSE).
(iii) Date and time of the opening and closing of the offer.
(iv) Allocation methodology i.e. either on a price priority (multiple clearing prices) basis or on a proportionate
basis at a single clearing price.
(v) Number of shares being offered for sale.
138 PP-CC&MM
(vi) The maximum number of shares that the seller may choose to sell over and above the offer made at
point (v) above. The name of the broker(s) on behalf of the seller(s).
(vii) The date and time of the declaration of floor price, if the seller(s) chooses to announce it to the market.
Alternatively, a declaration to the effect that the floor price will be submitted to the DSE in a sealed
envelope that shall be disclosed post closure of the offer.
(viii) Conditions, if any, for withdrawal or cancellation of the offer.
(c) Floor price
(i) In case the seller chooses to disclose the floor price, the seller(s) shall declare it after the close of
trading hours and before the close of business hours of the exchanges on T-1 day else the seller(s)
shall give the floor price in a sealed envelope to DSE before the opening of the offer. (T day being the
day of the offer for sale)
(ii) The floor price if not declared to the market, shall not be disclosed to anybody, including the selling
broker(s).
(iii) Sealed envelope shall be opened by the DSE after the closure of the offer for sale and the floor price
suitably disseminated to the market.
(d) Timelines
(i) The duration of the offer for sale shall be as per the trading hours of the secondary market and shall not
exceed one trading day.
(ii) Orders shall be placed during trading hours.
(e) Order Placement
(i) A separate window for the purpose of sale of shares through OFS shall be created. The following orders
shall be valid in the OFS window:
A. Orders with 100% of margin paid upfront by institutional investors and non-institutional investors.
Such orders can be modified or canceled at any time during the trading hours.
B. Orders without paying upfront margin by institutional investors only. Such orders cannot be modified
or cancelled by the investors or stock brokers, except for making upward revision in the price or
quantity.
(ii) Cumulative bid quantity shall be made available online to the market throughout the trading session at
specific intervals in respect of orders with 100% upfront margin and separately in respect of orders
placed without any upfront margin. Indicative price shall be disclosed to market throughout the trading
session. The indicative price shall be calculated based on all valid bids/orders.
(iii) If the security has a price band in the normal segment, the same shall not apply for the orders placed in
the offer for sale. Stock specific tick size as per the extant practice in normal trading session shall be
made applicable for this window.
(iv) In case of shares under offer for sale, the trading in the normal market shall also continue. However, in
case of market closure due to the incidence of breach of ‘Market wide index based circuit filter’, the offer
for sale shall also be halted.
(v) Only limit orders/ bids shall be permitted.
(vi) Multiple orders from a single buyer shall be permitted.
(vii) In case floor price is disclosed, orders/ bids below floor price shall not be accepted.
Lesson 5
Primary Market 139
6. Risk Management
(a) Clearing Corporation shall collect 100% margin in cash from non-institutional investors. In case of
institutional investors who place orders/bids with 100% of margin upfront, custodian confirmation shall
be within trading hours. In case of institutional investors who place orders without upfront margin, custodian
confirmation shall be as per the existing rules for secondary market transactions. The funds collected
shall neither be utilized against any other obligation of the trading member nor co-mingled with other
segments.
(b) In case of order/bid modification or cancellation, such funds shall be released/ collected on a real time
basis by clearing corporation.
(c) The seller(s) shall deposit the entire quantity of shares offered for sale including the additional shares
disclosed at Para 5(b)(vi) as pay-in with the clearing corporation/clearing house of DSE prior to the
commencement of the offer. No other margin shall be charged on the seller(s).
7. Allocation
(a) Minimum of 25% of the shares offered shall be reserved for mutual funds and insurance companies,
subject to allocation methodology. Any unsubscribed portion thereof shall be available to the other
bidders.
(b) The orders shall be cumulated by the DSE immediately on close of the offer. Based on the methodology
for allocation to be followed as disclosed in the notice, the DSE shall draw up the allocation. i.e. either
on a price priority (multiple prices) basis or on a proportionate basis at a single clearing price.
(c) No allocation will be made in case of order/ bid is below floor price.
(d) No single bidder other than mutual funds and insurance companies shall be allocated more than 25%
of the size of offer for sale.
(e)
The allocation details shall be shared by the DSE with the other exchange after the allocation is
crystallized.
8. (i) Settlement
(a) The allocation and the obligations resulting thereof shall be intimated to the brokers on T day.
(b) Settlement shall take place on trade for trade basis. For non-institutional orders/bids and for institutional
orders with 100% margin, settlement shall take place on T+1 day. In case of orders/bids of institutional
investors with no margin, settlement shall be as per the existing rules for secondary market.
(c)
Funds collected from the bidders who have not been allocated shares shall be released after the
download of the obligation.
(d) On T+1 day, to the extent of obligation determined, the clearing Corporation/ Clearing house of DSE
shall transfer such number of shares to the clearing corporation/clearing house of the other stock
exchange, without consideration of money. Excess shares, if any, shall be returned to seller broker(s).The
direct credit of shares shall be given to the demat account of the successful bidder provided such
manner of credit is indicated by the broker/bidder.
(ii) Handling of default in pay-in
(a) In case of default in pay-in by any investor, 10% of the order value shall be charged as penalty from the
investor and collected from the broker. This amount shall be credited to the Investor Protection Fund of
the stock exchange.
(b) The price at which allotments have been made based on the allocation on T day shall not be revised as
a result of any default in pay-in.
140 PP-CC&MM
(c) Issuer shall have the option to cancel in full or conclude the offer.
(d) Allotment details after settlement shall also be disseminated by the exchange.
(e) Allocation details after settlement shall be consolidated by the DSE and excess shares, if any, shall be
returned by the respective Clearing Corporation/ Clearing house to the seller(s) broker(s).
(f) Settlement Guarantee Fund shall not be available for OFS through stock exchange mechanism.
9. Issuance of Contract Notes
The brokers shall be required to issue contracts note to its clients based on the allotment price and quantity in
terms of conditions specified by the exchange.
10. Withdrawal of offer
The offer for sale may be withdrawn prior to its proposed opening. In such a case there will be a cooling off
period of 10 trading days from the date of withdrawal before an offer is made once again. The stock exchange(s)
shall suitably disseminate details of such withdrawal.
11. Cancellation of offer
Cancellation of offer shall not be permitted during the bidding period. If the seller(s) fails to get sufficient demand
at or above the floor price, he may choose to either conclude the offer or cancel it in full. The seller may also
choose to conclude the offer or cancel it in full, in case of defaults in settlement obligation.
UNDERSTANDING THE GUIDELINE STEP WISE
Step 1 – The seller (promoter) appoints a broker for the offer-for-sale.
Step 2 – The seller announces his intention to sell shares at least one trading day before the offer-for-sale
opens.
It will have the details of seller, designated stock exchange, date and time of offer open and close. It also has
details of number of shares offered, allocation methodology, maximum offer size over and above offer-for-sale
size, name of seller’s broker(s). Finally, it should have details on the date and time of declaration of floor price.
Step 3 – The seller shall declare the floor price after trading hours and before close of business hours to the
designated stock exchange a day before the offer-for-sale date (Trade date minus one day). This is applicable
if the seller chooses to declare the floor price.
Otherwise, the floor price is given in a sealed envelope to the stock exchange and not disclosed to anybody,
including the selling broker.
The stock exchange disseminates it to the market after the offer-for-sale closes.
The offer duration will coincide with trading hours in the secondary market (9 a.m. to 3.30 p.m.). Order processing
and funds pay-in shall occur only during trading hours on the exchange platform.
For institutional trades, custodians are expected to conclude bid confirmation with available funds latest by half
an hour post the session.
Orders can be placed in a separate window created by the exchange. Order modification is allowed only for bids
with 100 per cent upfront margins. Orders cannot be modified in the last 60 minutes of the offer-for-sale.
Information on bid quantity shall be made available by the exchanges at specified time intervals. Exchanges
shall disclose the indicative price only during the last 60 minutes of the offer-for-sale.
Price band for the scrip in the normal segment would not be applicable to the offer-for-sale. However, standard
Lesson 5
Primary Market 141
tick sizes would apply. Tick size is the minimum price by which share prices can move up or down.
Though normal market trading for scrips under the offer-for-sale would continue, it would be halted if the scrip
hits the circuit in the normal market.
Only limit orders are permitted and buyers are allowed to place multiple orders. Orders below floor price (if
disclosed) would not be accepted.
Step 4 – All non-institutional investors have to bring in 100 per cent upfront margin. Institutions are allowed to
pay either 25 per cent or 100 per cent as upfront margin. The seller has to deposit the entire quantity of shares
under the offer to the clearing corporation as pay–in before the offer-for-sale starts.
Step 5 – One fourth of shares of OFS is reserved for mutual funds and insurance companies. The stock exchange
allocates shares either on price priority (in case of multiple clearing prices) or proportionate basis (in case of
single clearing price).
Orders below floor price are not taken up for allocation. No single bidder other than mutual funds and insurance
companies would be allocated over 25 per cent.
Step 6 – The allocation and obligations are intimated to brokers on the trade date (T). Trades are settled on the
T+1 date. The clearing corporation will transfer shares into the demat accounts of successful bidders.
Step 7 – Bidders will forfeit 10 per cent of their bid value to the investor protection fund if they default on the payin amount. Allotment price on the T day would not change due to any default pay-in.
Issuer has the option to conclude the offer or cancel it in full. The settlement guarantee fund is not available for
this facility through stock exchange mechanism.
Step 8 - Brokers would issue contract notes to their clients based on the allotment price and quantity.
DIFFERENT FORM OF PROSPECTUS
A company is required to issue a prospectus each time it accesses the capital market. The different forms of
prospectus are discussed below:
Offer Document
“Offer document” means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a right
issue, which is filed with Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all
the relevant information to help an investor to make his/ her investment decision.
Draft Offer Documents
“Draft Offer document” means the offer document in draft stage. The draft offer documents are filed with SEBI,
atleast 30 days prior to the filing of the Offer Document with ROC/SEs. SEBI may specifies changes, if any, in
the Draft Offer Document and the Issuer or the Lead Merchant banker shall carry out such changes in the draft
offer document before filing the Offer Document with ROC/SEs. The Draft Offer document is available on the
SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI.
RHP (Red Herring Prospectus)
“ Red Herring Prospectus” is a prospectus, which does not have details of either price or number of shares being
offered, or the amount of issue. This means that in case price is not disclosed, the number of shares and the
upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the
number of shares are determined later. An RHP for an FPO can be filed with the ROC without the price band and
the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to
the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot
be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring
142 PP-CC&MM
prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding
process, the details of the final price are included in the offer document. The offer document filed thereafter with
ROC is called a prospectus.
Shelf Prospectus
Shelf prospectus means a prospectus issued by any financial institution or bank for one or more issues of the
securities or class of securities specified in that prospectus. Section 60A of the Companies Act, 1956 enable
public financial institutions, public sector banks, and scheduled banks, whose main object is to make loans to, or
subscribe for securities of private industrial enterprises engaged in infrastructure financing to issue shelf
prospectus. Section 60 A lays down that– Any public financial institution, public sector bank or scheduled bank whose main object is financing
shall file a shelf prospectus.
– A company filing a shelf prospectus with the Registrar shall not be required to file prospectus afresh at
every stage of offer of securities by it within a period of validity of such shelf prospectus.
– A company filing a shelf prospectus shall be required to file an information memorandum on all material
facts relating to new charges created, changes in the financial position as have occurred between the
first offer of securities, previous offer of securities and the succeeding offer of securities within such
time as may be prescribed by the Central Government, prior to making of a second or subsequent offer
of securities under the shelf prospectus.
– An information memorandum shall be issued to the public along with shelf prospectus filed at the stage
of the first offer of securities and such prospectus shall be valid for a period of one year from the date of
opening of the first issue of securities under that prospectus:
Provided that where an update of information memorandum is filed every time an offer of securities is made,
such memorandum together with the shelf prospectus shall constitute the prospectus.
Filing of Offer Document
An issuer company cannot make any public issue of securities, unless a draft offer document has been filed with
SEBI through a Merchant Banker, at least 30 days prior to registering the prospectus with the Registrar of
Companies (ROC) or filing the letter of offer with the designated stock exchange.
However, if SEBI specifies changes or issues observations on the draft Prospectus within 30 days from the date
of receipt of the draft Prospectus by SEBI the issuer company or the Lead Manager to the Issue shall carry out
such changes in the draft Prospectus or comply with the observations issued by SEBI before filing the Prospectus
with ROC.
SEBI may specify changes or issue observations, if any, on the draft prospectus within 30 days from the later of
the date of receipt of the draft offer document or the date of receipt of satisfactory reply from the lead merchant
bankers. Where SEBI has sought any clarification or additional information from them or the date of receipt of
clarification or information from any regulator or agency, where SEBI has sought any clarification or information
from such regulator or agency or the date of receipt of a copy of in-principal approval letter issued by the
recognized stock exchanges.
The lead merchant banker should while filing the offer document with SEBI, file a copy of such document with
the recognized stock exchanges where the specified securities are proposed to be listed and a soft copy of the
offer document should also be furnished to SEBI.
LEAD MANAGER
The public issue of corporate securities involves marketing of capital issues of new and existing companies,
Lesson 5
Primary Market 143
additional issues of existing companies including rights issue and dilution of shares by letter of offer,. The public
issues are managed by the involvement of various agencies i.e. underwriters, brokers, bankers, advertising
agency, printers, auditors, legal advisers, registrar to the issue and merchant bankers providing specialized
services to make the issue of the success. However merchant banker is the agency at the apex level than that
plan, co-ordinate and control the entire issue activity and direct different agencies to contribute to the successful
marketing of securities.
Merchant bankers are independent financial institution appointed by the company going public. Companies
appoint more then one lead manager to manage IPO's. They are known as Book Running Lead Manager and
Co Book Running Lead Managers. Their main responsibilities are to initiate the IPO processing, help company
in road shows, creating draft offer document and get it approve by SEBI and stock exchanges and helping
company to list shares at stock market. The procedure of the managing a public issue by a merchant banker is
divided into two phases, viz;
– Pre-issue management
– Post-issue management
Pre-Issue Management
Steps required to be taken to manage pre-issue activity is as follows:(1) Obtaining stock exchange approvals to memorandum and articles of associations.
(2) Taking action as per SEBI Regulations
(3) Finalizing the appointments of the following agencies:
– Co-manager/Advisers to the issue
– Underwriters to the issue
– Brokers to the issue
– Bankers to the issue and refund Banker
– Advertising agency
– Printers and Registrar to the issue
(4) Advise the company to appoint auditors, legal advisers
(5) Drafting of prospectus
(6) Obtaining approvals of draft prospectus from the company’s legal advisers, underwriting financial institutions/
Banks
(7) Obtaining consent from parties and agencies acting for the issue to be enclosed with the prospectus.
(8) Approval of prospectus from SEBI.
(9) Filing of the prospectus with Registrar of Companies.
(10) Making an application for enlistment with Stock Exchange along, with copy of the prospectus.
(11) Publicity of the issue with advertisement and conferences.
(12) Open subscription list.
Post-issue Management
Steps involved in post-issue management are:-
144 PP-CC&MM
(1) To verify and confirm that the issue is subscribed to the extent of 90% including devolvement from
underwriters in case of under subscription.
(2) To supervise and co-ordinate the allotment procedure of registrar to the issue as per prescribed Stock
Exchange guidelines.
(3) To ensure issue of refund order, allotment letters / certificates within the prescribed time limit after the
closure of subscription list.
(4) To report periodically to SEBI about the progress in the matters related to allotment and refunds.
(5) To ensure the listing of securities at Stock Exchanges.
(6) To attend the investors grievances regarding the public issue.
Co-ordination with Intermediaries
– The Post-issue lead merchant banker shall maintain close co-ordination with the Registrars to the Issue
and arrange to depute its officers to the offices of various intermediaries at regular intervals after the
closure of the issue to monitor the flow of applications from collecting bank branches, and/or self certified
syndicate banks processing of the applications including application form for applications supported by
blocked amount and other matters till the basis of allotment is finalised, despatch of security certificates
and refund orders are completed and securities are listed.
– Any act of omission or commission on the part of any of the intermediaries noticed during such visits
shall be duly reported to SEBI.
– In case there is a development on underwriters, the merchant banker is required to ensure that the
notice for development containing the obligation of the issuer is issued within a period of 10 days from
the date of closure of the issue.
– In case of undersubscribed issues, the merchant bank is required to furnish information in respect of
underwriters who have failed to meet their underwriting development to SEBI in the format specified in
these regulations.
– The post-issue merchant banker is required to confirm to the bankers to the issue by way of copies of
listing and trading approval that all formalities in connection with the issue have been completed and
that the banker is free to release the money to the issuer or refund it in case of failure of the issue.
UNDERWRITING
Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate
when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to
them.
(1) Where the issuer making a public issue (other than through the book building process) or rights issue,
desires to have the issue underwritten, it shall appoint the underwriters in accordance with SEBI (Underwriters)
Regulations, 1993.
(2) Where the issuer makes a public issue through the book building process, such issue shall be underwritten
by book runners or syndicate members.
However, 75 % of the net offer to public proposed to be compulsorily allotted to qualified institutional buyers
cannot be underwritten.
(3) The issuer shall enter into underwriting agreement with the book runner, who in turn shall enter into underwriting
agreement with syndicate members, indicating therein the number of specified securities which they shall subscribe
to at the predetermined price in the event of under subscription in the issue.
Lesson 5
Primary Market 145
(4) If syndicate members fail to fulfill their underwriting obligations, the lead book runner shall fulfill the underwriting
obligations.
(5) The book runners and syndicate members shall not subscribe to the issue in any manner except for fulfilling
their underwriting obligations.
(6) In case of every underwritten issue, the lead merchant banker or the lead book runner shall undertake
minimum underwriting obligations as specified in the SEBI (Merchant Bankers) Regulations, 1992.
(7) Where 100% of the offer through offer document is underwritten, the underwriting obligations shall be for the
entire 100% of the offer through offer document and shall not be restricted upto the minimum subscription level.
In respect of an underwritten issue, the lead merchant banker shall ensure that the relevant details of underwriters
are included in the offer document as follows:
Underwriting of the issue:
(a) Names and addresses of the underwriters and the amount underwritten by them
(b) Declaration by board of directors of the issuer company that the underwriters have sufficient resources
to discharge their respective obligations.
In case of under subscription at an issue, the Lead Merchant Banker responsible for underwriting arrangements
shall invoke underwriting obligations and ensure that the underwriters pay the amount of development and the
same shall be incorporated in the inter-se allocation of responsibilities accompanying the due diligence certificate
submitted by the Lead Merchant Banker to the SEBI.
Due Diligence
Due diligence is a detailed investigation of the affairs of a business. As such, it spans investigation into all
relevant aspects of the past, present and predictable future of the business of a target company. Due diligence
is a process of a thorough and objective examination that is undertaken before corporate entities enter into
major transactions such as mergers and acquisitions, issuing new stock or other securities, project finance,
securitization, etc.
One of the key objectives of due diligence is to minimize and to the maximum extent practicable, the possibility
of there being unknown liabilities or risks. The exercise is multi-dimensional and involves investigation into the
business, tax, financial, accounting and legal aspects of an issuer. The aim of due diligence is to identify problems
within the business, particularly any issues which may give rise to unexpected liabilities in the future.
Due Diligence in IPO/FPO
When the due diligence is carried out as part of the steps leading to an IPO, the exercise takes on added
meaning and encompasses a wider scope, as it identifies the areas or the issues where the company exhibits
weaknesses and the due diligence process becomes a tool, which shows the company the way to optimize its
potential and thereby increasing its value to potential investors. Pre-IPO due diligence process will result in a
gap analysis between the present status of the company and the company that should be floated i.e., a gap is
an expectations gap created as a result of how the market expects a listed company to conduct its affairs. In
this scenario, once these gaps have been highlighted the due diligence exercise should not stop there but
should include advice given by the advisors to the company on the processes and activities which are required
to fill the gaps identified. In an IPO the due diligence exercise is a broader, fuller exercise which apart from
identifying the weaknesses also looks at resolving them with the purpose of increasing the value of the
company.
146 PP-CC&MM
The due diligence process aspires to achieve the following:
– to assess the reasonableness of historical and projected earnings and cash flows;
– to identify key vulnerabilities, risk and opportunities;
– to gain an intimate understanding of the company and the market in which the company operates such
that the company’s management can anticipate and manage change;
– to set in motion the planning for the post-IPO operations.
It will result in a critical analysis of the control, accounting and reporting systems of the company and a critical
appraisal of key personnel. It will identify the value drivers of the company thus enabling the directors to understand
where the value is and to focus their efforts on increasing that value.
Due diligence spans the entire public issue process. The steps involved in due diligence are given broadly
below:
1. Decision on public issue
2. Business due diligence
3. Legal and Financial Due Diligence
4. Disclosures in Prospectus
5. Marketing to Investors
6. Post issue compliance
Key areas to be focused:
(a) the financial statements – to ensure their accuracy;
(b) the assets – confirm their value, condition existence and legal title;
(c) the employees – identification and evaluation of the key movers and shakers;
(d) the sales strategy – analyzing the policies and procedures in place and assessing what works and what
does not;
(e) the marketing – what is driving the business and is it effective?
(f) the industry in which the company operates – understand trends and new technologies;
(g) the competition – identify the threats;
(h) the systems – how efficient are they? Are upgrades required?
(i) legal and corporate and tax issues – is the shareholding structure robust? Are there any tax issues
which need to be resolved?
(j) company contracts and leases – identify what the risks and obligations are;
(k) suppliers – are they expected to remain around?
Illustrative list of documents/information to be examined during due-diligence process:
(i) Basic documents
Review of basic corporate documents like:
– Memorandum and Articles of Association of the Company
– Copies of Incorporation Certificate/Commencement of Business Certificate/ Change of Name
certificate (if applicable)
Lesson 5
Primary Market 147
– Registered office address of the company
– History/businesses of the company
– Special rights available to any persons through shareholder or other Agreements.
(ii) Promoters/Personnel
1. Promoters’ bio-data with special reference to qualification and experience. Track record of the promoters
in the capital market – public issue by other group companies, violation of securities laws.
2. Directors’ & Key Personnel – details bio-data including father’s name, address, occupation, year-wise
experience. Background of the Directors – including examining the list of willful defaulters periodically
prepared by RBI.
3. Constitution of Audit Committee, remuneration Committee etc., Terms of reference of these committees.
4. Organization Chart.
5. Key Personnel/Employees/Directors left in the last two years with reasons.
6. Break-up of Employees – whether any agreement are entered into with employee – If so, copy of
agreement.
7. Details of Pay scales/Bonus (including performance)/PF/Gratuity etc.
8. Employment of contract labour – no. of workers, copy of contract.
(iii) Financials
1. Projections of combined operations (existing + proposed) for 5 years including the following:
– Income details including prices
– Cash flow and Balance Sheet
– Capacity utilization details
– Interest calculation – Assn. of rate/Repayment schedule
– Depreciation – Book & I.T.
– Tax
– Tax etc.
– Assumptions w.r.t. cost items
– Commencement of commercial production (Year to be mentioned)
– IT depreciation table for past OR (in case projections have to be prepared)
– Latest provisional accounts with all schedules
– Latest income Tax Depreciation calculation
– Input-Output ration (consumption norms) for each segment alongwith prices and input prices
– Services-wise capacity & Capacity utilization projects for the next 5 years
– Working Capital norms
– Basis for working out various expenses
– Month from which the commercial production will commence for the new project
– IT depreciation table for past.
148 PP-CC&MM
2. Bankers to the Company – name & addresses.
3. Details of Banks Loan, Term Loan, Promissory notes, Hundis, Credit Agreements, Lease, Hire Purchase,
Guarantees or any other evidences of indebtedness, Copies of Sanction letters, Original amount, Interest
rate, Amount outstanding, Repayment schedule.
4. Details of default/reschedulements, if any – copy of correspondence with lenders.
5. Accounts for last 3 years and latest unaudited accounts.
6. Associate/Group Companies’ concerns accounts for last 3 years. Also give: Profile of the concerns.
7. Audited Balance Sheet, P&L Account for last 3 years of the promoter company (i.e. if promoter is a Co.)
8. In case any liabilities are not disclosed in the Balance Sheet, details thereof, or any secret reserves.
9. Age-wise analysis of stocks, debtors, creditors and loans & advances given
10. Terms of various loans & advances given
11. If names of any associates/related units are present in the debtors or parties to whom loans & advances
have been given
12. Details of contingents liabilities including guarantees given by Co./directors
13. Trends in profit ratios.
(iv) Project Information
1. Project Feasibility report
2. Reports/documents prepared by independent research agencies in respect of the state of the industry
and demand and supply for the company’s products
3. Break-up of Cost of Project:
– Land – Locational site & map, area, copy of documents i.e. Sale/lese Deed for land, Soil Test
Report, Order for converting land into Industrial land etc.
– Building – Details break-up from Architect, Approval details from Municipality etc. and Valuation
Report from a chartered engg. (for existing building and suitability of site)
– Equipments – Invoices/Quotations of main items. (Indicate Imported mach. Separately)
– Margin Money for Working Capital – Margin Money for Working Capital (calculation)
– Preliminary & Pre-operative expenses – break-up
– Provision for contingencies – break-up
4. Schedule of Implementation.
5. Status of Project as on a recent date – Amount spent & sources
6. Promoter’s contribution till date (supported by Auditor’s certificate if possible)
7. Current & proposed Shareholding pattern
8. Sanctions received by the issuer from bankers/institutions for debt financing in the project
9. Notes on the following: Technical process, utilities (power, water, transport, effluent treatment), location,
land building, Plant & Machinery).
(a) Manpower
Lesson 5
Primary Market 149
(i) Break-up of employees – whether any agreements are entered into with employee – If so, copy
of agreement
(ii) Details of Pay scales/bonus (including performance bonus)/PF/ Gratuity etc.
(iii) Employment of contract labour – no. of workers, copy of contract.
(b) Quality Control facilities, Research & Development.
10. Market (Demand/supply with sources alongwith copies),
11. Marketing & Distribution (network etc.) & relevant documents wherever applicable.
12. Arrangements and strategy of the company for marketing its products
13. Discussions with important customers, suppliers, Joint Venture partners, collaborators of the company.
(v) General Information
1. Details on Litigation, Disputes, overdue, statuary dues, other Material development and tax status of
Company & promoters.
2. Copies of IT returns of the Company along with copies of Assessment orders for last three years.
3. Copies of IT/Wealth tax returns of the promoters along with copies of Assessment orders for last three
years.
4. Copy of documents for Collaborations/Marketing Tie-ups/Other Tie-ups if any.
5. NOC/Approval/Sanctions from SEB/SPCB or copy of application.
6. Copy of SIA Registration/SSI Regn./EOU License/LOI or License.
7. Incentives if any – such as subsidy, Sales tax loans/exemption/concession/ power subsidy (Copy of
Booklet or notification).
8. List of existing plant & machinery with cost & age & type of ownership (lease etc.)
9. R&D (if any) cost for the project for the last three years. (Sources of any outside R&D funds including
any joint venture agreements)
10. Summary of Bad Debts experience for the last five years.
11. Approvals from company’s Board of Directors/Shareholders to issue securities to the public.
12. Copies of documents filed with Registrar of Companies.
13. Names of stock exchanges where shares of the Co. are listed.
14. Stock Market quotation of share, wherever applicable, as on recent date.
15. Special legislation applicable, if any, and compliance thereof (e.g. NBFCs etc.)
(vi) Third Parties
1. Brochure on collaborators, copy of Government approval for collaboration.
2. Copy of Agreement with Consultants, Copy of Government approval in case of foreign consultants.
3. Copies of important Agreements/Contracts of any sort with all the parties concerned with the company.
4. Copy of FIPB/RBI approvals (NRI/Foreign participant etc.), wherever applicable.
5. Details of Patents, Trademarks, Copyrights, Licenses etc., if any.
6. List of major customers/clients (attach copies of main pending orders).
150 PP-CC&MM
7. Competitors & Market shares for Company’s products (with sources, wherever possible).
8. Sales arrangements, terms & conditions.
9. Main suppliers – terms & conditions.
Pre-issue-Due Diligence Certificates
According to SEBI (ICDR) Regulations, 2009, the lead merchant baker is required to submit due diligence
certificate with SEBI at the time of:– Filing of draft offer document with SEBI.
– At the time of registering prospectus with ROC.
– Immediately before opening of the issue.
– After the opening of the issue and before its closure before it closes for subscription.
Post issue diligence
– The lead merchant banker shall exercise due diligence and satisfy himself about all the aspects of the
issue including the veracity and adequacy of disclosure in the offer documents.
– The lead merchant banker shall call upon the issuer, its promoters or directors or in case of an offer for
sale , the selling shareholders, to fulfil their obligations as disclosed by them in the offer document and
as required in terms of these regulations.
– The post –issue merchant banker shall continue to be responsible for post issue activities till the
subscribers have received the securities certificates, credit to their demat account or refund of application
moneys and the listing agreement is entered into by the issuer with the stock exchanges and listing/
trading permission is obtained.
BASIS OF ALLOTMENT
After the closure of the issue, for e.g a book built public issue, the bids received are aggregated under different
categories i.e 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. Thus allotment to each investor
is done based on proportionate basis in both book built and fixed price public issue.
Example-Allocation to retail Investor
CARE IPO had total 71,99,700 equity shares on offer in the IPO, at an issue price of ` 750 per share. 35% of the
offer was available for allocation to the retail individual bidders in accordance with the SEBI Regulations, which
makes it 25,19,895 equity shares.
When the investors apply for a company’s shares in an IPO, there is a bid ‘lot’ system. With CARE IPO, the bid
lot size was in multiples of 20 shares and the retail investors had the option to apply for a maximum of 13 lots
(260 shares) and a minimum of 1 lot (20 shares). So, the minimum investment in the CARE IPO was ` 15,000
and ` 1,95,000 as the maximum.
Retail investors have been allotted only 20 shares irrespective of their application size i.e. whether they applied
for 20 shares or 260 shares or any number of shares in between, they got only 20 shares allotted in the ratio of
101:256 i.e. only 101 applicants got these 20 shares out of 256 applicants.
Lesson 5
Primary Market 151
Actually, a total of 3,19,350 retail individual applicants applied for it, in varying number of bid lots i.e. between 1
to 13 bid lots and only 1,25,994 applicants got the shares allotted in the ratio of 101:256.
Allocation to Retail Individual Bidders (after technical rejection)
No. of
Shares
Applied
No.of
% of Total
Applications
Received
Total No. of
Equity Shares
Applied
% of
Total
No. of
Equity
Shares
Allocated
Ratio of
Allottees to
Applicants
Total No. of
Equity
Shares
Allocated
20
245680
76.93
4913600
32.58
20
101:256
1938580
40
15853
4.96
634120
4.20
20
101:256
125100
60
9199
2.88
551940
3.66
20
101:256
72580
80
4505
1.41
360400
2.39
20
101:256
35540
100
5832
1.83
583200
3.87
20
101:256
46020
120
7892
2.47
947040
6.28
20
101:256
62280
140
3831
1.20
536340
3.56
20
101:256
30220
160
1223
0.38
195680
1.30
20
101:256
9660
180
657
0.21
118260
0.78
20
101:256
5180
200
2324
0.73
464800
3.08
20
101:256
18340
220
480
0.15
105600
0.70
20
101:256
3780
240
843
0.26
202320
1.34
20
101:256
6660
260
21031
6.59
5468060
36.26
20
101:256
165940
Total
319350
100
15081360
100
N.A.
N.A.
2519880
In the table above, there were 2,45,680 applicants who applied for 20 shares with each of their applications. Out
of these 2,45,680 applicants, 96,929 applicants have been allotted 20 shares each or total of 19,38,580 shares.
2,45,680 * 101/256 = 96,929 * 20 shares = 19,38,580
Similarly, 15,853 * 101/256 = 6,255 * 20 shares = 1,25,100
9,199 * 101/256 = 3,629 * 20 shares = 72,580 and so on.
BOOK BUILDING
Book Building means a process undertaken to elicit demand and to assess the price for determination of the
quantum or value of specified securities or Indian Depository Receipts, as the case may be.
The book building process in India is very transparent. All investors including small investors can see on an
hourly basis where the book is being built before applying. According to this method, share prices are determines
on the basis of real demand for the shares at various price levels in the market.
1. An issuer company may, subject to the requirements specified make an issue of securities to the public
through a prospectus through 100% of the net offer to the public through book building process.
2. Reservation to the extent of percentage specified in these Regulations can be made only to the following
categories:
152 PP-CC&MM
(a) employees and in case of a new issuer, persons who are in permanent and full time employment
of the promoting companies excluding the promoter and the relative of promoter of such
companies
(b) ‘shareholders of the listed promoting companies in the case of a new company and shareholders of
listed group companies in the case of an existing company’ on a ‘competitive basis’ or on a ‘firm
allotment basis’ excluding promoters. However, if the promoting companies are designated financial
institutions or state or central financial institutions, the shareholder of such promoting companies
shall be excluded for this purpose.
(c) persons who, on the date of filing of the draft offer document with SEBI, have business association,
as depositors, bondholders and subscribers to services, with the issuer making an initial public
offering.
However, no reservation can be made for the issue management team, syndicate members, their
promoters, directors and employees and for the group/associate companies of issue management
team and syndicate members and their promoters, directors and employees.
3. The issuer company is required to enter into an agreement with one or more of the Stock Exchange(s)
which have the requisite system of on-line offer of securities. The agreement would cover inter-alia, the
rights, duties, responsibilities and obligations of the company and stock exchange (s) inter se. The
agreement may also provide for a dispute resolution mechanism between the company and the stock
exchange.
The company may also apply for listing of its securities on an exchange other than the exchange through
which it offers its securities to public through the on-line system.
4. The Lead Merchant Banker shall act as the Lead Book Runner.In case the issuer company appoints
more than one merchant banker,the names of all such merchant bankers who have submitted the due
diligence certificate to SEBI, may be mentioned on the front cover page of the prospectus. A disclosure
to the effect that “ the investors may contact any of such merchant bankers, for any complaint pertaining
to the issue” is required to be made in the prospectus, after the “risk factors.
5. The lead book runner/issuer may designate, in any manner, the other Merchant Bankers if the inter-se
allocation of responsibilities amongst the merchant bankers is disclosed in the prospectus on the page
giving the details of the issue management team and a co-ordinator has been appointed amongst the
lead book runners, for the purpose of co-ordination with SEBI. However the names of only those merchant
bankers who have signed the inter-se allocation of responsibilities would be mentioned in the offer
document on the page where the details of the issue management team is given.
6. The primary responsibility of building the book is of the Lead Book Runner. The Book Runner(s) may
appoint those intermediaries who are registered with SEBI and who are permitted to carry on activity as
an ‘Underwriter’ as syndicate members. The Book Runner(s)/syndicate members shall appoint brokers
of the exchange, who are registered with SEBI, for the purpose of accepting bids, applications and
placing orders with the company and ensure that the brokers so appointed are financially capable of
honouring their commitments arising out of defaults of their clients/investors, if any. However, in case of
Application Supported by Blocked Amount, Self Certified Syndicate Banks shall accept and upload the
details of such application in electronic bidding system of the stock exchange.
7. The brokers, and self certified syndicate banks accepting applications and application monies, are
considered as ‘bidding/collection centres’. The broker/s so appointed, shall collect the money from his/
their client for every order placed by him/them and in case the client/investors fails to pay for shares
allocated as per the Regulations, the broker shall pay such amount.
Lesson 5
Primary Market 153
8. In case of Applications Supported by Blocked Amount, the Self Certified Syndicate Banks shall
follow the procedure specified by SEBI in this regard. The company shall pay to the broker/s/
Self Certified Syndicate Banks a commission/fee for the services rendered by him/them. The
exchange shall ensure that the broker does not levy a service fee on his clients/investors in lieu of
his services.
The draft prospectus containing all the disclosures except that of price and the number of securities to
be offered to the public shall be filed by the Lead Merchant Banker with SEBI. The total size of the issue
shall be mentioned in the draft prospectus
9. The red herring prospectus shall disclose, either the floor price of the securities offered through it or a
price band along with the range within which the price can move, if any.
However, the issuer may not disclose the floor price or price band in the red herring prospectus if the
same is disclosed in case of an initial public offer, at least two working days before the opening of the bid
and in case of a further public offer, at least one working day before the opening of the bid, by way of an
announcement in all the newspapers in which the pre-issue advertisement was released by the issuer
or the merchant banker;
Further, the announcement shall contain the relevant financial ratios, computed for both upper and
lower end of the price band and also a statement drawing attention of the investors to the section titled
“basis of issue price” in the offer document.
Where the issuer opts not to make the disclosure of the price band or floor price in the red-herring
prospectus in terms of the foregoing proviso, the following shall be additionally disclosed in the redherring prospectus:
(a) a statement that the floor price or price band, as the case may be, shall be disclosed atleast two
working days (in case of an initial public offer) and atleast one working day (in case of a further
public offer) before the opening of the bid;
(b) a statement that the investors may be guided in the meantime by the secondary market prices in
case of public offer;
(c) names and editions of the newspapers where the announcement of the floor price or price band
would be made;
(d) names of websites (with address), journals or other media in which the said announcement will be
made.
Where the issuer decides to opts for price band instead of floor price, the lead book runner shall ensure
compliance with the following conditions:
(a) The cap of the price band should not be more than 20% of the floor of the band; i.e., cap of the price
band shall be less than or equal to 120% of the floor of the price band.
(b) The price band can be revised during the bidding period in which case the maximum revision on
either side shall not exceed 20% i.e floor of price band can move up or down to the extent of 20% of
floor of the price band disclosed in the red herring prospectus and the cap of the revised price band
will be fixed in accordance with Clause (a) above;
(c) Any revision in the price band shall be widely disseminated by informing the stock exchanges, by
issuing press release and also indicating the change on the relevant website and the terminals of
the syndicate members.
154 PP-CC&MM
(d) In case the price band is revised, the bidding period shall be extended for a further period of three
days, subject to the total bidding period not exceeding ten working days.
(e) The manner in which the shortfall, if any, in the project financing, arising on account of lowering of
price band to the extent of 20% will be met shall be disclosed in the red herring prospectus. It shall
also be disclosed that the allotment shall not be made unless the financing is tied up.
10. In case of appointment of more than one Lead Merchant Banker or Book Runner for book building, the
rights, obligations and responsibilities of each should be delineated. In case of an under subscription in
an issue, the shortfall shall have to be made good by the Book Runner(s) to the issue and the same
shall be incorporated in the inter se allocation of responsibility as provided in the Regulations.
11. The issuer company shall circulate the application forms to the Brokers.
12. The pre-issue obligations and disclosure requirements shall be applicable to issue of securities through
book building unless stated otherwise in these regulations.
13. The Book Runner(s) and the issuer company shall determine the issue price based on the bids received
through the ‘Syndicate Members’ and ‘Self Certified Syndicate Banks’.
14. Retail individual investors may bid at “cut off” price instead of their writing the specific bid prices in the
bid forms.
15. On determination of the price, the number of securities to be offered shall be determined i.e. issue size
divided by the price which has been determined.
16. Once the final price (cut-off price) is determined all those bidders whose bids have been found to be
successful shall become entitle for allotment of securities.
17. No incentive, whether in cash or kind, shall be paid to the investors who have become entitled for
allotment of securities.
18. The broker may collect an amount to the extent of 100% of the application money as margin money
from the clients/investors before he places an order on their behalf. The margin collected shall be
uniform across all categories of investors.
19. Bids for securities beyond the investment limit prescribed under relevant laws shall not be accepted by
the syndicate members/brokers from any category of clients/investors.
20. The lead book runner may reject a bid placed by a Qualified Institutional Buyer for reasons to be recorded
in writing provided that such rejection shall be made at the time of acceptance of the bid and the
reasons therefor shall be disclosed to the bidders. Necessary disclosures in this regard shall also be
made in the offer document.
21. On determination of the entitlement, the information regarding the same i.e. the number of securities
which the investor becomes entitled shall be intimated immediately to the investors.
22. The final prospectus containing all disclosures as per SEBI ICDR Regulations including the price and
the number of securities proposed to be issued shall be filed with the Registrar of Companies.
23. Arrangement shall be made by the issuer for collection of the applications by appointing mandatory
collection centres as per these Regulations.
24. The bidding terminals shall contain a online graphical display of demand and bid prices updated at
periodic intervals not exceeding 30 minutes. The book running lead manager shall ensure the availability
of adequate infrastructure with syndicate members for data entry of the bids in a timely manner.
Lesson 5
Primary Market 155
25. The investors who had not participated in the bidding process or have not received intimation of entitlement
of securities may also make an application.
Example
Let's take an example.
Number of shares issued by the company = 100.
Price band = ` 30 - ` 40.
Now let's check what individuals have bid for.
Bid
Number of shares
Price per share
1
20
` 40
2
10
` 38
3
20
` 37
4
30
` 36
5
20
` 35
6
20
` 33
7
20
` 30
The shares will be sold at the Bid 5 price of 20 shares for ` 35.
Because Bidders 1 to 5 are willing to pay at least ` 35 per share. The total bids from Bidders 1 to 5 ensure all
100 shares will be sold (20 + 10 + 20 + 30 + 20). The cut-off price is therefore Bid 5's price = ` 35.
Bidders 1 to 5 get allotments at that price. Bidders 6 and 7 don't get an allotment because their bids are below
the cut-off price. On allotment, the extra amount paid will be refunded to the investor. Since the cut-off price is `
35, the 10 shares will cost ` 350 (10 x ` 35). The balance ` 50 will be refunded to the investor.
BOOK BUILDING PROCESS THROUGH A FLOWCHART
Issuer Company
Agreement with Stock Exchange
for online offer of securities
Application for In-principle
Approval
Appoints Lead Book Runners/Co
Book Runners
Lead Merchant Banker (LMB) to
act as Lead Book Runner. If more
than one LBM/LBR, inter-se,
allocation of Responsibilities to
be decided
156 PP-CC&MM
LBR Appoints Syndicate Numbers
(SN)
LBR/SN to underwrite/sub
underwrite
LBR/SN to finalise Bidding/
Collection Centres who are either
SEBI Regd. Stock Broker
Self certified Syndicate Bank
(for ASBA facility)
Filing of Draft offer document with
SEBI
Red Herring Prospectus with ROC
Pre issue Advertisement
Issue opens
Investor submits forms at bidding
centres
Electronic Bidding Process
Determination of price
Registration of final prospectus
with RoC
Allocation/Manner of Allotment
Application for Listing
Bidding and allocation for Anchor
Investors one day before opening
of issue
Lesson 5
Primary Market 157
ADDITIONAL DISCLOSURES IN CASE OF BOOK BUILDING
Apart from meeting the disclosure requirements as specified in SEBI ICDR Regulations, the following disclosures
shall be suitably made:
(i) The particulars of syndicate members, brokers, self certified syndicate banks, registrars, bankers to the
issue, etc.
(ii) The following statement shall be given under the ‘basis for issue price’:
“The issue price has been determined by the Issuer in consultation with the Book Runner(s), on the
basis of assessment of market demand for the offered securities by way of Book-building.”
(iii) The following accounting ratios shall be given under the basis for issue price for each of the accounting
periods for which the financial information is given:
1. EPS, pre-issue, for the last three years (as adjusted for changes in capital).
2. P/E pre-issue
3. Average return on net-worth in the last three years.
4. Net-Asset value per share based on last balance sheet.
5. Comparison of all the accounting ratios of the issuer company as mentioned above with the industry
average and with the accounting ratios of the peer group (i.e companies of comparable size in the
same industry. (Indicate the source from which industry average and accounting ratios of the peer
group has been taken)
6. The accounting ratios disclosed in the offer document shall be calculated after giving effect to the
consequent increase of capital on account of compulsory conversions outstanding, as well as on
the assumption that the options outstanding, if any, to subscribe for additional capital shall be
exercised)
(iv) The proposed manner of allocation among respective categories of investors, in the event of under
subscription.
Procedure for Bidding
The process of bidding should be in compliance of the following requirements:
(a) Bidding process shall be only through an electronically linked transparent bidding facility provided by
recognised stock exchange(s).
(b) The lead book runner shall ensure the availability of adequate infrastructure with syndicate members
for data entry of the bids in a timely manner.
(c) The syndicate members shall be present at the bidding centres so that at least one electronically linked
computer terminal at all the bidding centres is available for the purpose of bidding.
(d) During the period the issue is open to the public for bidding, the applicants may approach the stock
brokers of the stock exchange/s through which the securities are offered under on-line system or Self
Certified Syndicate Banks, as the case may be, to place an order for bidding for the specified securities.
(e) Every stock broker shall accept orders from all clients/investors who place orders through him and
every Self Certified Syndicate Bank shall accept Applications Supported by Blocked Amount from ASBA
investors.
(f) Applicants who are qualified institutional buyers shall place their bids only through the stock brokers
who shall have the right to vet the bids;
158 PP-CC&MM
(g) The bidding terminals shall contain an online graphical display of demand and bid prices updated at
periodic intervals, not exceeding thirty minutes.
(h) At the end of each day of the bidding period, the demand including allocation made to anchor investors,
shall be shown graphically on the bidding terminals of syndicate members and websites of recognised
stock exchanges offering electronically linked transparent bidding facility, for information of public.
(i) The retail individual investors may either withdraw or revise their bids until finalization of allotment.
(j) The issuer may decide to close the bidding by qualified institutional buyers one day prior to the closure
of the issue subject to the following conditions:
(i) bidding shall be kept open for a minimum of three days for all categories of applicants;
(ii) disclosures are made in the red herring prospectus regarding the issuer’s decision to close the
bidding by Qualified Institutional Buyers one day prior to closure of issue.
(k) The Qualified Institutional Buyers and the non-institutional investors shall neither withdraw nor lower
the size of their bids at any stage .
(l) The identity of Qualified Institutional Buyers making the bidding shall not be made public.
(m) The stock exchanges shall continue to display on their website, the data pertaining to book built issues
in an uniform format, inter alia giving category-wise details of bids received, for a period of at least three
days after closure of bids.
Alternate Method of Book Building
In case of further public offers, the issuer may opt for an alternate method of book building, subject to the
following:
(a) Issuer shall follow the procedure laid down in Part A of Schedule XI of SEBI (ICDR) Regulations, 2009.
(b) The issuer may mention the floor price in the red herring prospectus or if the floor price is not mentioned
in the red herring prospectus, the issuer shall announce the floor price at least one working day before
opening of the bid in all the newspapers in which the pre-issue advertisement was released.
(c) Qualified Institutional Buyers shall bid at any price above the floor price.
(d) The bidder who bids at the highest price shall be allotted the number of securities that he has bided for
and then the bidder who has bided at the second highest price and so on, until all the specified securities
on offer are exhausted.
(e) Allotment shall be on price priority basis for qualified institutional buyers.
(f) Allotment to retail individual investors, non-institutional investors and employees of the issuer shall be
made proportionately .
(g) Where, however the number of specified securities bided for at a price is more than available quantity,
then allotment shall be done on proportionate basis.
(h) Retail individual investors, non-institutional investors and employees shall be allotted specified securities
at the floor price.
(i) The issuer may:(A) place a cap either in terms of number of specified securities or percentage of issued capital of the
issuer that may be allotted to a single bidder;
(B) decide whether a bidder be allowed to revise the bid upwards or downwards in terms of price and/
or quantity;
Lesson 5
Primary Market 159
(C) decide whether a bidder be allowed single or multiple bids.
GREEN SHOE OPTION FACILITY
“Green Shoe Option” means an option of allocating shares in excess of the shares included in the public issue
and operating a post-listing price stabilizing mechanism in accordance with the provisions of Regulation 45 of
SEBI (ICDR) Regulations, 2009.
GSO in the system of IPO using book-building method was recognised by SEBI in India through its new guidelines
on 14th August 2003 (vide SEBI/ CFD/DIL/DIP/ Circular No. 11). ICICI bank was the first to use Green Shoe
Option in its public issue through book building mechanism in India.
A company desirous of availing this option, should in the resolution of the general meeting authorising the public
issue, seek authorisation also for the possibility of allotment of further shares to the ‘Stabilising Agent’ (SA) at the
end of the stabilisation period. The company should appoint one of the merchant bankers or book runners,
amongst the issue management team, as the “stabilising agent” (SA), who will be responsible for the price
stabilisation process, if required. The SA shall enter into an agreement with the issuer company, prior to filing of
offer document with SEBI, clearly stating all the terms and conditions relating to this option including fees
charged/expenses to be incurred by SA for this purpose.
The SA should also enter into an agreement with the promoter(s) or pre-issue shareholders who will lend their
shares under the provisions of this scheme, specifying the maximum number of shares that may be borrowed
from the promoters or the shareholders, which shall not be in excess of 15% of the total issue size.
The details of the agreements mentioned above should be disclosed in the draft prospectus, the draft Red
Herring prospectus, Red Herring prospectus and the final prospectus. The agreements should also be included
as material documents for public inspection. The lead merchant banker or the Lead Book Runner, in consultation
with the SA, shall determine the amount of shares to be over-allotted with the public issue, subject to the
maximum number specified above.
The draft prospectus, draft Red Herring prospectus, the Red Herring prospectus and the final prospectus should
contain the following additional disclosures:
(a) Name of the SA.
(b) The maximum number of shares (as also the percentage vis-a-vis the proposed issue size) proposed to
be over-allotted by the company.
(c) The period, for which the company proposes to avail of the stabilisation mechanism.
(d) The maximum increase in the capital of the company and the shareholding pattern post issue, in case
the company is required to allot further shares to the extent of over-allotment in the issue.
(e) The maximum amount of funds to be received by the company in case of further allotment and the use
of these additional funds, in final document to be filed with ROC.
(f) Details of the agreement/arrangement entered into by SA with the promoters to borrow shares from the
latter which inter alia shall include name of the promoters, their existing shareholding, number and
percentage of shares to be lent by them and other important terms and conditions including the rights
and obligations of each party.
(g) The final prospectus shall additionally disclose the exact number of shares to be allotted pursuant to the
public issue, stating separately therein the number of shares to be borrowed from the promoters and
over-allotted by the SA, and the percentage of such shares in relation to the total issue size.
In case of an initial public offer by a unlisted company, the promoters and pre-issue shareholders and in case of
public issue by a listed company, the promoters and pre-issue shareholders holding more than 5% shares, may
160 PP-CC&MM
lend the shares subject to the provisions of this scheme. The SA should borrow shares from the promoters or
the pre-issue shareholders of the issuer company or both, to the extent of the proposed over-allotment. However,
the shares so referred shall be in dematerialized form only.
The allocation of these shares should be on pro rata basis to all the applicants.
The stabilisation mechanism should be available for the period disclosed by the company in the prospectus,
which shall not exceed 30 days from the date when trading permission was given by the exchange(s).
The SA should open a special account with a bank to be called the “Special Account for GSO proceeds of………
company” (hereinafter referred to as the GSO Bank Account) and a special account for securities with a depository
participant to be called the “Special Account of GSO shares of……….. company” (hereinafter referred to as the
GSO Demat Account).
The money received from the applicants against the over-allotment in the green shoe option should be kept in
the GSO Bank Account, distinct from the issue account and shall be used for the purpose of buying shares from
the market, during the stabilisation period.
The shares bought from the market by the SA, if any during the stabilisation period, should be credited to the
GSO Demat Account.
The shares bought from the market and lying in the GSO Demat Account should be returned to the promoters
immediately, in any case not later than 2 working days after the close of the stabilisation period.
The prime responsibility of the SA should be to stabilise post listing price of the shares. To this end, the SA
should determine the timing of buying the shares, the quantity to be bought, the price at which the shares are to
be bought etc.
On expiry of the stabilisation period, in case the SA does not buy shares to the extent of shares over-allotted by
the company from the market, the issuer company shall allot shares to the extent of the shortfall in dematerialized
form to the GSO Demat Account, within five days of the closure of the stabilisation period. These shares shall be
returned to the promoters by the SA in lieu of the shares borrowed from them and the GSO Demat Account shall
be closed thereafter. The company shall make a final listing application in respect of these shares to all the
exchanges where the shares allotted in the public issue are listed. The provisions relating to preferential issues
shall not be applicable to such allotment.
The shares returned to the promoters as above, as the case may be, shall be subject to the remaining lock-inperiod as provided in lock-in or pre-issue share capital of an unlisted company.
The SA shall remit an amount equal to (further shares allotted by the issuer company to the GSO Demat
Account) (issue price) to the issuer company from the GSO Bank Account. The amount left in this account, if
any, after this remittance and deduction of expenses incurred by the SA for the stabilisation mechanism, shall be
transferred to the investor protection fund(s) established by SEBI. The GSO Bank Account shall be closed soon
thereafter.
The SA should submit a report to the stock exchange(s) on a daily basis during the stabilisation period. The SA
should also submit a final report to SEBI in the format specified in Schedule XII. This report shall be signed by
the SA and the company. This report shall be accompanied with a depository statement for the “GSO Demat
Account” for the stabilisation period, indicating the flow of the shares into and from the account. The report shall
also be accompanied by an undertaking given by the SA and countersigned by the depository(ies) regarding
confirmation of lock-in on the shares returned to the promoters in lieu of the shares borrowed from them for the
purpose of the stabilisation.
The SA shall maintain a register in respect of each issue having the green shoe option in which he acts as a SA.
The register shall contain the following details of:
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Primary Market 161
– in respect of each transaction effected in the course of the stabilising action, the price, date and time.
– the details of the promoters from whom the shares are borrowed and the number of shares borrowed
from each; and
– details of allotments made.
The register must be retained for a period of at least three years from the date of the end of the stabilising period.
For the aforesaid, over allotment shall mean an allotment or allocation of shares in excess of the size of a public
issue, made by the SA out of shares borrowed from the promoters or the pre-issue shareholders or both, in
pursuance of green shoe option exercised by the company in accordance with the provisions of the scheme.
ILLUSTRATION
Consider a company planning an IPO of say, 100,000 shares, at a book-built price of ` 100/-, resulting in an IPO
size of ` 100,00,000. As per the ICDR Regulations, the over-allotment component under the Green Shoe
mechanism could be up to 15% of the IPO, i.e. up to 15,000 shares, i.e. Green Shoe shares. Prior to the IPO, the
stabilising agent would borrow such number of shares to the extent of the proposed Green Shoe shares from
the pre-issue shareholders. These shares are then allotted to investors along with the IPO shares. The total
shares issued in the IPO therefore stands at 115,000 shares. IPO proceeds received from the investors for the
IPO shares, i.e. `100,00,000–100,000 shares at the rate of R100 each, are remitted to the Issuer Company,
while the proceeds from the Green Shoe Shares (` 15,00,000/-, being 15,000 shares x ` 100/-) are parked in a
special escrow bank account, i.e. Green Shoe Escrow Account. During the price stabilisation period, if the
share price drops below ` 100, the stabilising agent would utilise the funds lying in the Green Shoe Escrow
Account to buy these back shares from the open market. This gives rise to the following three situations:
– Situation #1 - where the stabilising agent manages to buyback all of the Green Shoe Shares, i.e.,15,000 shares;
– Situation #2 - where the stabilising agent manages to buyback none of the Green Shoe Shares;
– ituation #3 - where the stabilising agent manages to buy-back some of the Green Shoe Shares, say 10,000
shares.
Let us examine each of these situations separately:
Situation #1 – where all Green Shoe Shares are bought back: In this situation, funds in the Green Shoe Escrow
Account (` 15,00,000, in this case) would be deployed by the stabilising agent towards buying up shares from
the open market. Given that the prices prevalent in the market would be less than the issue price of ` 100, the
stabilising agent would have sufficient funds lying at his disposal to complete this operation. Having bought back
all of the 15,000 shares, these shares would be temporarily held in a special depository account with the
depository participant (Green Shoe Demat Account), and would then be returned back to the lender shareholders,
within a maximum period of two days after the stabilisation period.
Situation #2 – where none of the Green Shoe Shares are bought back: This situation would arise in the (very
unlikely) event that the share prices have fallen below the Issue Price, but the stabilising agent is unable to find
any sellers in the open market, or in an event where the share prices continue to trade above the listing price,
and therefore there is no need for the stabilising agent to indulge in price stabilisation activities. In either of the
above-said situations, the stabilising agent is under a contractual obligation to return the 15,000 shares that had
initially been borrowed from the lending shareholder(s). Towards meeting this obligation, the issuer company
would allot 15,000 shares to the stabilising agent into the Green Shoe Demat Account (the consideration being
the funds lying the Green Shoe Escrow Account), and these shares would then be returned by the stabilising
agent to the lending shareholder(s), thereby squaring off his responsibilities.
Situation #3 – where some of the Green Shoe Shares are bought back, say 10,000 shares: This situation could
arise in an event where the share prices witness a drop in the initial stages of the price stabilisation period, but
162 PP-CC&MM
recover towards the latter stages. In this situation, the stabilising agent has a responsibility to return 15,000
shares to the lending shareholder(s), whereas the stabilising activities have yielded only 10,000 shares.
Similar to the instance mentioned in Situation #2 above, the issuer company would allot the differential 5,000
shares into the Green Shoe Demat Account to cover up the shortfall, and the Stabilising Agent would discharge
his obligation to the lending shareholder(s) by returning the 15,000 shares that had been borrowed from them.
Both in Situation #2 and #3, the issuer company would need to apply to the exchanges for obtaining listing/
trading permissions for the incremental shares allotted by them, pursuant to the Green Shoe mechanism.
Any surplus lying in the Green Shoe Escrow Account would then be transferred to the Investor Protection and
Education Fund established by SEBI, as required under Regulation 45(9) of the ICDR Regulations and the
account shall be closed thereafter.
GREEN SHOE OPTION PROCESS
Company obtains shareholder approval for exercising Green Shoe Option
Appointment of stabilizing Agent
Agreement with stabilizing Agent
Agreement with promoter for borrowing shares
Opening special Account with Bank and Depository
Company over allots
Commencement of Trading
Yes
Drop in Prices
No
Stabilizing agent process shares
from open market
Issuer allots shares to
stabilizing agent
Shares borrowed are returned
SA return shares
Excess in any transferred
to SEBI IEPF fund
Separate listing application
for shares issued
PRE-ISSUE ACTIVITIES
1. Signing of MoU: Signing of MoU between the client company and the merchant banker-issue management
activities marks the award of the contract.
Lesson 5
Primary Market 163
2. Obtaining appraisal note: An appraisal note containing he details of the proposed capital outlay of the
project and the sources of funding is either prepared in-house or is obtained from external appraising agencies
viz., financial institutions/banks etc. A project may be funded either by borrowing money from outside agencies
or by injecting capital.
3. Optimum capital structure: The level of capital that would maximize the shareholders value and minimize
the overall cost of capital has to be determined. This has to be done considering the nature and size of the
project. Equity funding is preferable especially when the project is capital intensive.
4. Convening meeting: A meeting of the board of directors of the issuing company is convened. This is followed
by an EGM of its members. The purpose of these meetings is to decide the various aspects related to the issue
of securities. An application to RBI, seeking its permission is made, where capital issue of shares is to be offered
to NRIs/OCBs or FIIs.
5. Appointment financial Intermediary: Financial intermediaries such as Underwriters, Registrars, etc. have
to be appointed. Necessary contracts need to be made with the underwriter to ensure due subscription to offer.
Similar contracts when entered into with the Registrars to an issue, will help in share allotment related work,
appointment of bankers to an issue for handling the collection of applications at various centers, printers for bulk
printing of Issue related stationery, legal advisors and advertising agency. Simultaneously consents from various
experts such as auditors, solicitors, legal advisors etc has to be obtained under Section 58 of the Companies
Act, 1956.
6. Preparing documents: As part of the issue management procedure the documents to be prepared are initial
applications of submission to those stock exchanges where the issuing company intends to get its securities
listed. MoU with the registrar, with bankers to the issue, with advisors to the issue and co-managers to the issue,
agreement for purchase of properties etc. This has to be sent for inclusion in the prospectus.
7. Due diligence certificate: The lead manager issue a due diligence certificate which certifies that the company
has scrupulously followed all legal requirements has exercised utmost care while preparing the offer document
and has made a true fair and adequate disclosures in the draft offer document
8. Submission of offer document: The draft offer document along with the due diligence certificate is filed with
SEBI. The SEBI in turn makes necessary corrections in the offer document and returns the same with relevant
observations, if any within 21 days from the receipt of the offer document.
9. Finalization of collection centers: In order to collect the issue application forms from the prospective investors
to lead manager finalizes the collection centers.
10. Filing with RoC: The offer document completed in all respects after incorporating SEBI observation is filed
with Registrar of Companies (RoC) to obtain acknowledgement.
11. Launching the issue: The process of marketing the issue starts once legal formalities are completed and
statutory permission for issue of capital is obtained. The lead manager has to arrange for the distribution of
public issue stationary to various collecting banks, brokers, investors etc. The issue is opened for public
immediately after obtaining the observation letter from SEBI. Conducting press conferences, brokers’ meets,
issuing advertisements in various newspapers and mobilizing brokers and sub-brokers marks the launching of
a public issue. The announcement regarding opening of issue is also required to be made through advertising in
newspapers, 10 days before the opening of the public issue.
12. Promoters’ contribution: A certificate to the effect that the required contribution of the promoters has been
raised before opening the issue, has to be obtained from a Chartered Accountant, and duly filed with SEBI.
13. Issue closure: An announcement regarding the closure of the issue should be made in the newspaper.
164 PP-CC&MM
RIGHTS ISSUE
Rights issue as identified in the SEBI ICDR Regulations is an issue of capital under Section 81(1) of the Companies
Act, 1956 to be offered to the existing shareholders of the company through a letter of offer. This regulation is not
applicable to the rights issue where the aggregate value of securities offered does not exceed ` 50 lakhs.
– A listed issuer company can not make any rights issue of securities, where the aggregate value of such
securities, including premium, if any, exceeds ` 50 lakhs unless a draft letter of offer has been filed with
SEBI, through a Merchant Banker, at least 30 days prior to the filing of the letter of offer with the Designated
Stock Exchange (DSE).
However, in case of the rights issue where the aggregate value of the securities offered is less than `50
Lakhs, the company shall prepare the letter of offer in accordance with the disclosure requirements
specified in SEBI ICDR and file the same with SEBI for its information and for being put on the SEBI
website.
– An issuer company can not make any public issue of securities, unless a letter of offer has been filed
with SEBI through a Merchant Banker, at least 30 days prior to the filing of the Prospectus with the
Registrar of Companies (ROC).
However, if SEBI specifies changes or issues observations on letter of offer within 30 days from the date
of receipt of the draft Prospectus by SEBI the issuer company or the Lead Manager to the Issue shall
carry out such changes or comply with the observations issued by SEBI before filing the letter of offer
with ROC.
– SEBI may specify changes or issue observations, if any, on the letter of offer only after receipt of copy of
in-principle approval from all the stock exchanges on which the issuer company intends to list the
securities proposed to be offered through the letter of offer.
– A Company can not make a rights issue of equity share or any security convertible at later date into
equity share, unless all the existing partly paid-up shares have been fully paid or forfeited.
– A company can not make a rights issue of securities unless firm arrangements of finance through
verifiable means towards 75% of the stated means of finance, excluding the amount to be raised through
proposed Public/Rights issue, or through identifiable internal accruals have been made.
– A listed company whose equity shares are listed on a stock exchange, may freely price its equity shares
and any security convertible into equity at a later date, offered through a rights issue.
– In case of a rights issue, issue price or price band may not be disclosed in the draft letter of offer filed
with SEBI. The issue price may be determined anytime before fixation of the record date, in consultation
with the Designated Stock Exchange
– An eligible company shall be free to make public or rights issue of equity shares in any denomination
determined by it in accordance with Sub-section (4) of Section 13 of the Companies Act, 1956 and in
compliance with the following and other norms as may be specified by SEBI from time to time:
– In case of rights issue the promoters shall disclose their existing shareholding and the extent to which
they are participating in the proposed issue, in the offer document.
– A company cannot make an issue of security through a public or rights issue unless a Memorandum of
Understanding has been entered into between a lead merchant banker and the issuer company specifying
their mutual rights, liabilities and obligations relating to the issue.
Lesson 5
Primary Market 165
– In case a rights issue is managed by more than one Merchant Banker the rights, obligations and
responsibilities of each merchant banker shall be demarcated as specified in Chapter VI.
– In the case of rights issues, lead merchant banker shall ensure that the abridged letters of offer are
dispatched to all shareholders at least three days before the date of opening of the issue.
However, if a specific request for letter of offer is received from any shareholder, the Lead Merchant
Banker shall ensure that the letter of offer is made available to such shareholder.
– A disclosure to the effect that the securities offered through this rights issue shall be made fully paid up
or may be forfeited within 12 months from the date of allotment of securities in the manner specified in
SEBI ICDR Regulations.
– A Company can not make any further issue of capital during the period commencing from the submission
of offer document to SEBI on behalf of the company for rights issues, till the securities referred to in the
said offer document have been listed or application moneys refunded on account of non-listing or under
subscription etc. unless full disclosures regarding the total capital to be raised from such further issues
are made in the draft offer document.
– A Company can not issue any shares by way of rights unless it has made reservation of equity shares
of the same class in favour of the holders of outstanding compulsorily convertible debt instruments ,if
any, in proportion to the convertible part.
– The share so reserved for the holders of fully or partially compulsorily convertible debt instruments shall
be issued at the time of conversion of such convertible debt instruments on the same terms at which the
equity shares offered in the rights issue were issued may be issued at the time of conversion(s) of such
debentures on the same terms on which the rights issue was made.
– The Lead Merchant Banker shall ensure that in case of a rights issue, an advertisement giving the date
of completion of despatch of letters of offer, shall be released in at least in an English National Daily with
wide circulation, one Hindi National Paper and a Regional language daily circulated at the place where
registered office of the issuer company is situated at least 3 days before the date of opening of the issue
– An issuer company shall not withdraw rights issue after announcement of record date in relation to such
issue.
– In cases where the issuer has withdrawn the rights issue after announcing the record date, the issuer
company shall not make an application for listing of any securities of the company for a minimum period
of 12 months from the record date.
However, shares resulting from the conversion of PCDs/ FCDs/ Warrants issued prior to the announcing
of the record date in relation to rights issue may be granted listing by the concerned Stock exchange
– Rights issues shall be kept open for at least 15 days and not more than 30 days.
– The quantum of issue whether through a rights or a public issue, shall not exceed the amount specified
in the prospectus/ letter of offer.
However, an oversubscription to the extent of 10% of the net offer to public is permissible for the purpose
of rounding off to the nearer multiple of 100 while finalising the allotment.
– If the issuer company does not receive the minimum subscription of ninety per cent. of the issue (including
devolvement of underwriters where applicable), the entire subscription shall be refunded to the applicants
within fifteen days from the date of closure of the issue.
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– If there is delay in the refund of subscription by more than 8 days after the company becomes liable to
pay the subscription amount (i.e. fifteen days after closure of the issue), the issuer company will pay
interest for the delayed period, at rates prescribed under sub-sections (2) and (2A) of Section 73 of the
Companies Act, 1956.
– The time period for finalization of basis of allotment in the rights issues is 15 days from the date of
closure of the issue.
– The issuer company may utilise the funds collected in the rights issue only after the basis of allotment is
finalized.
STEPS INVOLVED IN ISSUE OF RIGHTS SHARES
The various steps involved for issue of rights share are enumerated below:
1. Check whether the rights issue is within the authorised share capital of the company. If not, steps should be
taken to increase the authorised share capital.
2. In case of a listed company, notify the stock exchange concerned the date of Board Meeting at which the
rights issue is proposed to be considered at least 2 days in advance of the meeting.
3. Rights issue shall be kept open for at least 15 days and not more than 30 days.
4. Convene the Board meeting and place before it the proposal for rights issue.
5. The Board should decide on the following matters:
(i) Quantum of issue and the proportion of rights shares.
(ii) Alteration of share capital, if necessary, and offering shares to persons other than existing holders of
shares in terms of Section 81(1A).
(iii) Fixation of record date.
(iv) Appointment of merchant bankers and underwriters (if necessary).
(v) Approval of draft letter of offer or authorisation of managing director/ company secretary to finalise the
letter of offer in consultation with the managers to the issue, the stock exchange and SEBI. The letter of
offer should conform to the disclosures prescribed in Form 2A under Section 56(3) of the Companies
Act (memorandum containing the salient features of prospectus) also contents as specified in SEBI
regulations. Full justification and parameters used for issue price should clearly be mentioned in the
letter of offer.
6. Immediately after the Board Meeting notify the concerned Stock Exchanges about particulars of Board’s
decision.
7. If it is proposed to offer shares to persons other than the shareholders of the company, a General Meeting
has to be convened and a resolution is to be passed for the purpose in terms of Section 81(1A) of the Companies
Act.
8. Forward 6 sets of letter of offer to concerned Stock Exchange(s).
9. Despatch letters of offer to shareholders by registered post.
10. Check that an advertisement giving date of completion of despatch of letter of offer has been released in at
least an English National Daily, one Hindi National Paper and a Regional Language Daily where registered
office of the issuer company is situated.
11. Check that the advertisement contains the list of centres where shareholders or persons entitled to rights
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may obtain duplicate copies of composite application forms in case they do not receive original application form
alongwith the prescribed format on which application may be made.
12. The applications of shareholders who apply both on plain paper and also in a composite application form are
liable to be rejected.
13. Make arrangement with bankers for acceptance of share application forms.
14. Prepare a scheme of allotment in consultation with Stock Exchange.
15. Convene Board Meeting and make allotment of shares.
16. Make an application to the Stock Exchange(s) where the company’s shares are listed for permission of
listing of new shares.
BONUS ISSUE
A company may, if its Articles provide, capitalize its profits by issuing fully-paid bonus shares. The issue of bonus
shares by a company is a common feature. When a company is prosperous and accumulates large distributable
profits, it converts these accumulated profits into capital and divides the capital among the existing members in
proportion to their entitlements. Members do not have to pay any amount for such shares. They are given free.
The bonus shares allotted to the members do not represent taxable income in their hands. [Commissioner of
Income Tax, Madras v. A.A.V. Ramchandra Chettiar (1964) 1 Mad CJ 281]. Issue of bonus shares is a bare
machinery for capitalizing undistributed profits. The vesting of the rights in the bonus shares takes place when
the shares are actually allotted and not from any earlier date.
Advantages of Issuing Bonus Shares
1. Fund flow is not affected adversely.
2. Market value of the Company’s shares comes down to their nominal value by issue of bonus shares.
3. Market value of the members’ shareholdings increases with the increase in number of shares in the company.
4. Bonus shares is not an income. Hence it is not a taxable income.
5. Paid-up share capital increases with the issue of bonus shares.
Pursuant to the provisions of Section 78 of the Companies Act, 1956, securities premium account can be used
in paying up unissued shares of the company to be issued to its members as fully-paid bonus shares. Other free
reserves created from out of the profits actually earned during earlier years like general reserve, capital redemption
reserve account [Section 80(5)], devolvement rebate reserve etc. can be utilised by company for issue of fully
paid bonus shares to its members.
There are no guidelines on issuing bonus shares by private or unlisted companies. However, SEBI has notified
Regulations for Bonus Issue which are contained in Chapter IX of SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 with regard to bonus issues by listed companies.
When a company has accumulated free reserves and is desirous of bridging the gap between the capital and
fixed assets, it issues bonus shares to its equity shareholders. Such an issue would not place any fresh funds in
the hands of the company. On the contrary, after a bonus issue it would become necessary for the company to
earn more to effectively service the increased capital. The shareholder will, however, be benefitted by way of
increased return on investment and increased number of shares in their hands.
The following conditions must be satisfied before issuing bonus shares:
(a) Bonus Issue must be authorised by the articles of the company. Such a provision is generally there in articles
of almost all the companies as they adopt Table A of Schedule 1 of the Companies Act (Regulation 96).
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(b) Bonus Issue must be sanctioned by shareholders in general meeting on recommendation of the Board
of directors of the company.
(c) Regulations issued by SEBI must be complied with.
(d) Authorised Capital must be increased where necessary.
SEBI Regulations Pertaining to Bonus Issue
1. Rights of FCD/PCD holders
The proposed bonus issue should not dilute the value or rights of the fully or partly convertible debentures.
A company shall not make a bonus issue of equity shares unless it has made reservation of equity shares of the
same class in favour of the holders of outstanding compulsorily convertible debt instruments ,if any, in proportion
to the convertible part thereof.
The equity shares so reserved for the holders of fully or partly compulsorily convertible debt instruments shall be
issued at the time of conversion of such convertible debt instruments on the same terms or same proportion at
which the bonus shares were issued.
2. Out of Free Reserves
The bonus issue is to be made out of free reserves built out of the genuine profits or securities premium collected
in cash only.
3.Revaluation Reserves
The reserves created by revaluation of fixed assets should not be capitalised. These reserves are in fact capital
reserves. However, if the assets are subsequently sold and the profits are realised, such profits could be utilised
for capitalisation purposes. In fact the Government has in the past approved issue of bonus shares out of capital
reserves representing realised capital profits.
4. Bonus Issue not to be in lieu of Dividend
Bonus issue should not be made in lieu of dividend.
5. Fully Paid Shares
If there are any partly paid-up shares outstanding on the date of allotment, these shares should be made fully
paid-up before the bonus issue is made.
6. No Default in respect of Fixed Deposits/Debentures
The company should not have defaulted in the payment of any interest or principal in respect of its fixed deposits,
debt securities issued by it.
7. Statutory Dues of the Employees
The company should not have defaulted in the payment of its statutory dues to the employees such as contribution
to provident fund, gratuity, bonus.
8. Implementation of Proposal within fifteen days
A company which announces bonus should implement bonus issue within fifteen days issue after the approval
of board of directors and does not require shareholders’ approval for capitalisation of profits or reserves for
making bonus issue as per the Articles of Association and shall not have the option of changing the decision.
However, where the company is required to seek shareholders’ approval for capitalisation of profits or reserves
for making bonus issue as per the Articles of Association, the bonus issue should be implemented within two
months from the date of the meeting of the board of directors wherein the decision to announce bonus was
taken subject to shareholders’ approval.
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9. Provision in Articles of Association
The Articles of Association of the Company should provide for capitalisation of reserves and if not a General
Body Meeting of the company is to be held and a special resolution making provisions in the Articles of Association
for capitalisation should be passed.
10. Authorised Capital
If consequent upon the issue of bonus shares, the subscribed and paid-up capital of the company exceed the
authorised share capital, a General Meeting of the company should be held to pass necessary resolution for
increasing the authorised capital.
Steps involved in Issue of Bonus Shares
A company issuing bonus shares should ensure that the issue is in conformity with the Regulations for bonus
issue laid down by SEBI (ICDR) Regulations, 2009.
The procedure for issue of bonus shares by a listed company is enumerated below:
1. Ensure that if conversion of FCDs/PCDs is pending, similar benefit has been extended to the holders of
such FCDs/PCDs, through reservation of shares in proportion of such convertible part of FCDs/PCDs.
The shares so reserved may be issued at the time of conversion(s) of such debentures on the same
terms on which the bonus issue was made.
2. Ensure that bonus issue has been made out of free reserves built out of the genuine profits or securities
premium collected in cash only.
3. Ensure that reserves created by revaluation of fixed assets are not capitalised.
4. Ensure that the company has not defaulted in payment of interest or principal in respect of fixed deposits
or debt securities issued by it or in respect of the payment of statutory dues of the employees such as
contribution to provident fund, gratuity, bonus etc.
5. Ensure that the bonus issue is not made in lieu of dividend.
6. There should be a provision in the articles of association of the company permitting issue of bonus
shares; if not, steps should be taken to alter the articles suitably.
7. The share capital as increased by the proposed bonus issue should be well within the authorised capital
of the company; if not, necessary steps have to be taken to increase the authorised capital.
8. Finalise the proposal and fix the date for the Board Meeting for considering the proposal and for authorising
the taking up of incidental and attendant matters.
9. If there are any partly paid-up shares, ensure that these are made fully paid-up before the bonus issue
is recommended by the Board of directors.
10. The date of the Board Meeting at which the proposal for bonus issue is proposed to be considered
should be notified to the Stock Exchange(s) where the company’s shares are listed.
11. Hold the Board Meeting and get the proposal approved by the Board.
12. The resolution to be passed at the General Meeting should also be approved by the Board in its meeting.
The intention of the Board regarding the rate of dividend to be declared in the year after the bonus issue
should be indicated in the resolution for bonus issue to be passed by members in general meeting.
13. Immediately after the Board meeting intimate the Stock Exchange(s) regarding the outcome of the
Meeting.
14. Ensure that the company has announced bonus issue after the approval of Board of Directors and did not
170 PP-CC&MM
require shareholders’ approval for capitalization of profits or reserves for making bonus issue as per the
Article of Association, had implemented bonus issue within fifteen days from the date of approval of the
issue by the board of directors of the company and must not have the option of changing the decision.
However, where the company was required to seek shareholders’ approval for capitalization of profits or
reserves for making bonus issue as per the Article of Association, the bonus issue has implemented
within two months from the date of the meeting of the Board of Directors where in the decision to
announce bonus was taken subject to shareholders’ approval.
15. Arrangements for convening the general meeting should then be made keeping in view the requirements
of the Companies Act, with regard to length of notice, explanatory statement etc. Also three copies of
the notice should be sent to the Stock Exchange(s) concerned.
16. Hold the general meeting and get the resolution for issue of bonus shares passed by the members. A
copy of the proceedings of the meeting is to be forwarded to the concerned Stock Exchange(s).
17. In consultation with the Regional Stock Exchange fix the date for closure of register of members or
record date and get the same approved by the Board of directors. Issue a general notice under Section
154 of Companies Act in respect of the fixation of the record date in two newspapers one in English
language and other in the language of the region in which the Registered Office of the company is
situated.
18. Give 7 days notice to the Stock Exchange(s) concerned before the date of book closure/record date.
19. After the record date process the transfers received and prepare a list of members entitled to bonus
shares on the basis of the register of members as updated. This list of allottees is to be approved by the
Board or any Committee thereof. The list usually serves as allotment list and on this basis the allotment
is to be made to the eligible members.
20. File return of allotment with the Registrar of Companies within 30 days of allotment (Section 75 of the
Companies Act). Also intimate Stock Exchange(s) concerned regarding the allotments made.
21. Ensure that the allotment is made within fifteen days of the date on which the Board of directors approved
the bonus issue.
22. Submit an application to the Stock Exchange(s) concerned for listing the bonus shares allotted.
PREFERENTIAL ISSUE
Preferential issue means issuance of equity shares to promoter group or selected investors. It covers allotment
of fully convertible debentures, partly convertible debentures or any other financial instruments that could be
converted into equity shares at a later date. The investors could be institutional investors, private equity investors,
high net-worth individuals, or companies.
Preferential issue is one of the key sources of funding for companies. It has its own advantages and disadvantages.
One of the biggest advantages of a preferential issue is that the company can raise money quickly and cheaply
compared with other means of raising money, say IPO or issue of shares on a rights basis.
On the other hand, preferential issues and private placement is only for selected class of investors and not for
the retail investors. It is like a wholesale market, where institutions with financial clout are allowed to participate.
This deprives investment opportunity to the retail investors.
SEBI ICDR Regulations, 2009 Pertaining to Preferential Issue
1. Applicability
The preferential issue of equity shares/Fully Convertible Debentures (FCDs)/ Partly Convertible Debentures
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(PCDs) or any other financial instruments which would be converted into or exchanged with equity shares at a
later date, by listed companies whose equity share capital is listed on any stock exchange, to any select group
of persons under Section 81(1A) of the Companies Act 1956 on private placement basis is governed by these
Regulations.
2. Pricing of the issue
(i) Where the equity shares of the company have been listed on a stock exchange for a period of twenty six
weeks or more as on the relevant date, the issue of equity shares on preferential basis is being made at
a price not less than higher of the following:
(a) The average of the weekly high and low of the closing prices of the related equity shares quoted on
the stock exchange during the twenty six weeks preceding the relevant date;
OR
(b) The average of the weekly high and low of the closing prices of the related equity shares quoted on
a stock exchange during the two weeks preceding the relevant date.
(ii) Where the equity shares of a company have been listed on a stock exchange for a period of less than
twenty six weeks as on the relevant date, the issue of shares on preferential basis has been made at a
price not less than the higher of the following:
(a) The price at which shares were issued by the company in its IPO or the value per share arrived at
in a scheme of arrangement under Section 391 to 394 of the Companies Act, 1956, pursuant to
which shares of the company were listed , as the case may be;
OR
(b) The average of the weekly high and low of the closing prices of the related shares quoted on the
stock exchange during the period shares have been listed preceding the relevant date;
OR
(c) The average of the weekly high and low of the closing prices of the related shares quoted on a stock
exchange during the two weeks preceding the relevant date.”
W here the price of the equity shares is determined in terms of provision (ii), such price shall be recomputed
by the issuer on completion of twenty six weeks from the date of listing on a recognized stock exchange
with reference to the average of weekly high and low of the closing prices of the related equity shares
quoted on the recognized stock exchange during these twenty six weeks and if such recomputed price
is higher than the price paid on allotment, the difference shall be paid by the allottees to the issuer.
An issue of shares on preferential basis to Qualified Institutional Buyers not exceeding five in numbers
all be made at a price not less than the average of the weekly high and low of the closing prices of the
related shares quoted on a stock exchange during the two weeks preceding the relevant date.
Relevant date means the date thirty days prior to the date on which the meeting of general
body of shareholders is held, in terms of Section 81(1A) of the Companies Act, 1956.
3. Upfront Payment on warrants
(i) A an amount equivalent to at least twenty five per cent of price of shares fixed should be paid on the date
of their allotment.
(ii) This amount would be adjusted against the price payable subsequently on acquisition of shares by
exercising an option for the purpose.
(iii) If the option to acquire shares is not exercised, the amount so paid would stand forfeited.
172 PP-CC&MM
4. Disclosures
The explanatory statement to the notice for the general meeting contains the details about the objects of the
issue through preferential offer, intention of promoters/directors/key management persons to subscribe to the
offer, shareholding pattern before and after the offer, proposed time within which the allotment shall be complete,
identity of the proposed allottees and the percentage of post-preferential issue capital that may be held by them.
5. Tenure of Convertible Securities
The tenure of the convertible securities of the issuer does not exceed beyond 18 months from the date of their
allotment.
6. Lock-in-period
(i) The specified securities allotted on a preferential basis to the promoter or promoter group and the equity
shares allotted to such promoter or promoter group pursuant to exercise of options attached to warrants
issued on preferential basis are subjected to lock in period of three years from the date of their allotment.
However, not more than 20% of the total capital of the company, should be locked in for a period of three
years from the date of allotment.
Further the equity shares allotted in excess of twenty percent pursuant to exercise of options attached
to warrants issued on preferential basis to promoter/promoter group of the issuer, should be locked-in
for a period of one year from the date of their allotment
(ii) The specified securities allotted on preferential basis and the equity shares allotted pursuant to exercise
of options attached to warrants issued on preferential basis to any person other than the promoter/
promoter group of the issuer should be locked in for a period of one year from the date of their allotment.
(iii) Shares acquired by conversion of the convertible instruments other than warrants should be locked in for a
period as reduced by the extent the convertible instrument other than warrants have already been locked in.
(iv) The lock-in period in respect of shares issued on preferential basis pursuant to a scheme approved
under Corporate Debt Restructuring framework of Reserve Bank of India, shall commence from the
date of allotment and has been continued for a period of one year and in case of allotment of partly paid
up shares the lock-in period shall commence from the date of allotment and continue for a period of one
year from the date when shares become fully paid up.
(v) No listed company shall make preferential issue of equity shares/ warrants/ convertible instruments to
any person unless the entire shareholding of such persons in the company, if any, is held by him in
dematerialized form.
(vi) The entire pre preferential allotment shareholding of such allottees shall be under lock-in from the
relevant date upto a period of six months from the date of preferential allotment.
(vii) The shares/ warrants/ convertible instruments shall be issued on preferential basis, the shareholders
who have sold their shares during the six months period prior to the relevant date shall not be eligible for
allotment of shares on preferential basis.
7. Allotment Pursuant to Shareholders Resolutions
(i) Allotment pursuant to any resolution passed at a meeting of shareholders of a company granting consent
for preferential issues of any financial instrument shall be completed within a period of fifteen days from
the date of passing of the resolution.
However, where any application for exemption for the allotment on preferential basis is pending on
account of pendency of any approval of such allotment by any regulatory authority or the Central
Government; the allotment shall be completed within 15 days from the date of such approval.
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However, SEBI has granted relaxation to the issuer in terms of the SEBI (Substantial Acquisition of
Shares and Takeovers) Regulations, 2011, the preferential allotment of shares, fully convertible
debentures and partly convertible debentures, shall be made by it within such time as may be specified
by SEBI in its order granting relaxation.
(ii) The equity shares and securities convertible into equity shares at a later date, allotted in terms of the
above said resolution shall be made fully paid up at the time of their allotment
However payment in case of warrants shall be made in terms of these Regulations.
(iii) Nothing contained in the above mentioned shall apply in case of allotment of shares and securities
convertible into equity shares at a later date on preferential basis pursuant to a scheme of Corporate
Debt Restructuring framework specified by the Reserve Bank of India.
(iv) If allotment of instruments and dispatch of certificates is not completed within fifteen days from the date
of such resolution, a fresh consent of the shareholders shall be obtained.
8. Compliance Certificate
(i) A certificate is obtained from the statutory auditors of Issuer Company certifying that the preferential
issue of instruments is being made in accordance with the requirements of SEBI Regulations.
(ii) The auditor certificate shall be placed before the meeting of shareholders convened to consider the
proposed issue.
9. Submission of Valuation Report
In case of preferential allotment of shares to promoters, their relatives, associates and related entities, for
consideration other than cash, valuation of assets in consideration for which the shares are proposed to be
issued, shall be done by an independent qualified valuer. The valuation report has been submitted to the
exchanges on which shares of issuer company are listed.
10. Use of Issue Proceeds
The details of all monies utilised out of the preferential issue proceeds should be disclosed under an appropriate
head in the balance sheet of the company indicating the purpose for which such monies have been utilised. The
details of unutilised monies should also be disclosed under a separate head in the balance sheet of the company
indicating the form in which such utilised monies have been invested.
11. Other Requirements
– A special resolution is required to be passed by its shareholders.
– All the equity shares if any, held by the proposed allottees in the issuer are in dematerialise form.
– An issuer cannot make preferential issue of securities to any person who has sold any equity shares of
the issuer during the six months proceeding the relevant date.
– A listed company shall not make any preferential issue of specified securities unless it is in compliance
with the conditions for continuous listing.
– A listed company shall not make any preferential allotment of specified securities unless it has obtained
the Permanent Account Number of the proposed allottees.
Non-Applicability
(1) These regulations are not applicable in case of the following:
(a) pursuant to conversion of loan or option attached to convertible debt instruments in terms of Subsections (3) and (4) of Sections 81 of the Companies Act, 1956.
174 PP-CC&MM
(b) pursuant to a scheme approved by a High Court under Section 391 to 394 of the Companies Act, 1956.
(c) in terms of the rehabilitation scheme approved by the Board of Industrial and Financial Reconstruction
under the Sick Industrial Companies (Special Provisions) Act, 1985.
(2) Pricing and lock-in provisions of ICDR Regulations shall not apply to equity shares allotted to any financial
institution within the meaning of sub-clauses (ia) and (ii) of Clause (h) of Section 2 of the Recovery of Debts due
to Banks and Financial Institutions Act, 1993.
(3) Disclosure and pricing relating to a preferential issue of equity shares and compulsorily convertible debt
instruments, whether fully or partly, where the Board has granted relaxation to the issuer in terms of the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011, if adequate disclosures about the plan
and process proposed to be followed for identifying the allottees are given in the explanatory statement to notice
for the general meeting of shareholders.
(4) Criteria relating to Lock –in and selling of equity shares during six months preceding the preferential issue
shall not apply to preferential issue of specified securities where the proposed allottee is a Mutual Fund registered
with the Board or Insurance Company registered with Insurance Regulatory and Development Authority.
QUALIFIED INSTITUTIONS PLACEMENT
A Qualified Institutions Placement means allotment of eligible securities by a listed issuer to qualified institutional
buyers on private placement basis in terms of SEBI (ICDR) Regulations. This QIP is different from offer of
securities to qualified institutional buyers in an IPO.
Qualified Institutional Buyer
(i) A mutual fund, venture capital fund and foreign venture capital investor registered with SEBI;
(ii) A foreign institutional investor and sub-account (other than a sub-account which is a foreign corporate
or foreign individual), registered with SEBI;
(iii) A public financial institution as defined in section 4A of the Companies Act, 1956;
(iv) A scheduled commercial bank;
(v) A multilateral and bilateral development financial institution;
(vi) A state industrial development corporation;
(vii) An insurance company registered with the Insurance Regulatory and Development Authority;
(viii) A provident fund with minimum corpus of twenty five crore rupees;
(ix) A pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by the Government of India published in the Gazette of India;
(xi) Insurance funds set up and managed by army, navy or air force of the Union of India;
(xii) Insurance funds set up and managed by Department of Posts, India.
Eligible securities for the purpose of QIP
Eligible Securities include equity shares, non-convertible debt instruments along with warrants and convertible
securities other than warrants.
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Relevant date
In case of allotment of equity shares, the date of the meeting in which the board of directors or the committee
of directors duly authorised by the board of directors of the issuer decides to open the proposed issue .In
case of allotment of eligible convertible securities, either the date as mentioned above or the date on which
the holders of such convertible securities become entitled to apply for the equity shares.
Conditions for making QIP
A listed issuer can make qualified institutions placement subject to the following conditions:
– A special resolution approving the issue is required to be passed by its shareholders.
– Prior to the date of issuance of notice to its shareholders for convening the meeting to pass the special
resolution, the equity shares of the same class, which are proposed to be allotted through QIP, are listed
on a recognised stock exchange having nation wide trading terminal for a period of at least one year.
– If an issuer, being a transferee company in a scheme of merger, de-merger, amalgamation or arrangement
sanctioned by a High Court under sections 391 to 394 of the Companies Act, 1956, makes QIP, the
period for which the equity shares of the same class of the transferor company were listed on a stock
exchange having nation wide trading terminals are also eligible to be considered for the purpose of
computation of the period of one year.
– It is in compliance with the requirement of minimum public shareholding specified in the listing agreement
with the stock exchange.
– In the special resolution, it shall be, among other relevant matters, the resolution must specify the
relevant date and the also specify that the allotment is proposed to be made through QIP.
Intermediaries involved in QIP and their roles
A Qualified Institutions Placement is required to be managed by merchant banker(s) who will exercise due diligence.
While seeking in-principle approval for listing of the eligible securities issued under qualified institutions placement,
the merchant banker furnishes to each stock exchange on which the same class of equity shares of the issuer
are listed, a due diligence certificate regarding compliance of ICDR regulations and stating that the eligible
securities are being issued under qualified institutions placement.
Placement document
‘Placement Document’ means document prepared by Merchant Banker for the purpose of Qualified Institutions
Placement and contains all the relevant and material disclosures to enable QIBs to make an informed decision.
Disclosures required to be made in Placement Document
– The qualified institutions placement is required to be made on the basis of a placement document which
contains all material information, including those specified in ICDR Regulations.
– The placement document needs to be serially numbered and copies are required to be circulated only
to select Investors.
– The issuer, while seeking in-principle approval from the recognised stock exchange is require to furnish
a copy of the placement document, a certificate confirming compliance with the provisions ICDR
Regulations along with any other documents required by the stock exchange.
– The placement document is required to a be placed on the website of the issuer and concerned stock
exchange with a disclaimer to the effect that it is in connection with a Qualified Institutions Placement
and that no offer is being made to the public or to any other category of investors.
176 PP-CC&MM
Time period for filing the copy of placement document with SEBI
A copy of the placement document is required to be filed with SEBI for its record within thirty days of the
allotment of eligible securities.
Pricing
The Qualified Institutions Placement is required to be made at a price not less than the average of the weekly
high and low of the closing prices of the equity shares of the same class listed on the stock exchange during the
two weeks preceding the relevant date.
If the eligible securities are convertible into or exchangeable with equity shares the issuer is require to determine
the price of such equity shares allotted pursuant to such conversion or exchange taking the relevant date as
decided and disclosed by it while passing the special resolution.
Issue of partly paid-up securities
An issuer can not allot partly paid up eligible securities. In case of allotment of equity shares on exercise of
options attached to warrants, such equity shares shall be fully paid up. However, on allotment of non convertible
debt instruments along with warrants, the allottees can pay the full consideration or part thereof payable with
respect to warrants, at the time of allotment of such warrants.
The prices determined for Qualified Institutions Placement are subject to appropriate adjustments in certain
cases. If the issuer :
– makes an issue of equity shares by way of capitalization of profits or reserves, other than by way of a
dividend on shares.
– makes a rights issue of equity shares.
– consolidates its outstanding equity shares into a smaller number of shares.
– divides its outstanding equity shares including by way of stock split.
– re-classifies any of its equity shares into other securities of the issuer.
– is involved in such other similar events or circumstances, which in the opinion of the concerned stock
exchange, requires adjustments.
Here stock exchange means any of the recognised stock exchanges in which the equity shares of the
same class of the issuer are listed and in which the highest trading volume in such equity shares has
been recorded during the two weeks immediately preceding the relevant date.
Restrictions on allotment
– Minimum 10% of eligible securities is required to be allotted to mutual funds. In case the mutual funds
do not subscribe to said minimum percentage or any part thereof, such minimum portion or part thereof
can be allotted to other qualified institutional buyers.
– An allotment can not be made, either directly or indirectly, to any qualified institutional buyer who is a
promoter or any person related to promoters of the issuer.
– A qualified institutional buyer who does not hold any shares ‘in the issuer and who has acquired the said
rights in the capacity of a lender can not be deemed to be a person related to promoters.
– In a qualified institutions placement of non-convertible debt instrument along with warrants, an investor
can subscribe to the combined offering of-non- convertible debt instruments with warrants or to the
individual securities, that is, either non- convertible debt instruments or warrants.
Lesson 5
Primary Market 177
Here a Qualified Institutional Buyer who has any of the following rights is deemed to be a person related to the
promoters of the issuer:
(a) rights under a shareholders’ agreement or voting agreement entered into with promoters or persons
related to the promoters.
(b) veto rights or
(c) right to appoint any nominee director on the board of the issuer.
Do you know?
The applicants in Qualified Institutions Placement can not withdraw their bids after the closure of the issue.
Minimum numbers of allottees
– If the size of the issue is less than of equal to 250 crore rupees minimum two allottees for each placement
and where the issue size is greater than 250 rupees minimum of five allottees required.
– A single allottee can not be allotted more than 50% of the issue size.
– The qualified institutional buyers belonging to the same group or who are under same control are
deemed to be a single allottee.
Here Qualified Institutional Buyers belonging to the same group are assigned the same meaning as derived
from sub-section (11) of section 372 of the Companies Act, 1956.
Validity of the special resolution
An allotment pursuant to the special resolution approving the proposed QIP is required to be completed within a
period of twelve months from the date of passing of the resolution.
The issuer can not make subsequent Qualified Institutions Placement until expiry of six months from the date of
the prior qualified institutions placement made pursuant to one or more special resolutions.
Do you know ?
Allotment to QIBs is to be made with in 12 months of passing Special Resolution approving such allotment.
Restriction on amount raised
The aggregate of the proposed QIP and all previous QIPs made by the issuer in the same financial year should
not exceed five times the net worth of the issuer as per the audited balance sheet of the previous financial year.
Tenure
The tenure of the convertible or exchangeable eligible securities issued through qualified institutions placement
should not be more than sixty months from the date of allotment.
Transferability of Securities
The eligible securities allotted can not be sold by the allottee for a period of one year from the date of allotment,
except on a recognised stock exchange.
INSTITUTIONAL PLACEMENT PROGRAMME
“Institutional Placement Programme” means a further public offer of eligible securities by an eligible seller, in
178 PP-CC&MM
which the offer, allocation and allotment of such securities is made only to Qualified Institutional Buyers in terms
of Chapter VIII A of SEBI ICDR Regulations, 2009.
SEBI vide its notification dated January 30, 2012 has amended the Issue of Capital and Disclosure Requirements
Regulations, 2009 whereby Chapter VIII-A - Institutional Placement Programme (IPP) has been inserted.
The provisions of this Chapter shall apply to issuance of fresh shares and or offer for sale of shares in a listed
issuer for the purpose of achieving minimum public shareholding in terms of Rule 19(2)(b) and 19A of the
Securities Contracts (Regulation) Rules, 1957.
Conditions for Institutional Placement Programme
– An institutional placement programme may be made only after a special resolution approving the
institutional placement programme has been passed by the shareholders of the issuer in terms of
section 81(1A) of the Companies Act, 1956.
– No partly paid-up securities shall be offered.
– The issuer shall obtain an in-principle approval from the stock exchange(s).
Appointment of Merchant Banker
An institutional placement programme shall be managed by merchant banker(s) registered with the Board who
shall exercise due diligence.
Offer Document
– The institutional placement programme shall be made on the basis of the offer document which shall
contain all material information.
– The issuer shall, simultaneously while registering the offer document with the Registrar of Companies,
file a copy thereof with the Board and with the stock exchange(s) through the lead merchant banker.
– The issuer shall file the soft copy of the offer document with SEBI, along with the fee.
– The offer document shall also be placed on the website of the concerned stock exchange and of the
issuer clearly stating that it is in connection with institutional placement programme and that the offer is
being made only to the Qualified Institutional Buyers.
– The merchant banker shall submit to SEBI a due diligence certificate, stating that the eligible securities
are being issued under institutional placement programme and that the issuer complies with requirements
of this Chapter.
Pricing and Allocation/allotment
– The eligible seller shall announce a floor price or price band at least one day prior to the opening of
institutional placement programme.
– The eligible seller shall have the option to make allocation/allotment as per any of the following methods – proportionate basis;
– price priority basis; or
– criteria as mentioned in the offer document.
– The method chosen shall be disclosed in the offer document.
– Allocation/allotment shall be overseen by stock exchange before final allotment.
Lesson 5
Primary Market 179
Restrictions
– The promoter or promoter group who are offering their eligible securities should not have purchased
and/ or sold the eligible securities of the company in the twelve weeks period prior to the offer and they
should undertake not to purchase and / or sell eligible securities of the company in the twelve weeks
period after the offer. However, such promoter or promoter group may , within the twelve weeks period
offer eligible securities held by them through institutional placement programme or offer for sale through
stock exchange mechanism subject to the condition that there shall be a gap of minimum two weeks
between the two successive offer(s) and /or programme(s)
– Allocation/allotment under the institutional placement programme shall be made subject to the following
conditions:
– Minimum of twenty five per cent of eligible securities shall be allotted to mutual funds and insurance
companies. However, if the mutual funds and insurance companies do not subscribe to said minimum
percentage or any part thereof, such minimum portion or part thereof may be allotted to other
qualified institutional buyers;
– No allocation/allotment shall be made, either directly or indirectly, to any qualified institutional buyer
who is a promoter or any person related to promoters of the issuer. However, a qualified institutional
buyer who does not hold any shares in the issuer and who has acquired the rights in the capacity of
a lender shall not be deemed to be a person related to promoters.
– The issuer shall accept bids using ASBA facility only.
– The bids made by the applicants in institutional placement programme shall not be revised downwards
or withdrawn.
Restrictions on size of the offer
– The aggregate of all the tranches of institutional placement programme made by the eligible seller shall
not result in increase in public shareholding by more than ten per cent or such lesser per cent as is
required to reach minimum public shareholding.
– Where the issue has been oversubscribed, an allotment of not more than ten percent of the offer size
shall be made by the eligible seller.
Period of Subscription and display of demand
– The issue shall be kept open for a minimum of one day or maximum of two days.
– The aggregate demand schedule shall be displayed by stock exchange(s) without disclosing the price.
Withdrawal of offer
The eligible seller shall have the right to withdraw the offer in case it is not fully subscribed.
Transferability of eligible securities
The eligible securities allotted under institutional placement programme shall not be sold by the allottee for a
period of one year from the date of allocation/allotment, except on a recognised stock exchange.
LISTING AGREEMENT
Listing means admission of securities to dealings on a recognised stock exchange. The securities may be of
any public limited company, Central or State Government, quasi governmental and other financial institutions/
corporations, municipalities, etc.
180 PP-CC&MM
Benefits of listing
The following benefits accrue to a company whose securities are listed on the stock exchange–
(1) Public image of the company is enhanced.
(2) The liquidity of the security is ensured making it easy to buy and sell the securities in the stock exchange.
(3) Tax concessions are available both to the investors and the companies.
(4) Listing procedure compels company management to disclose important information to the investors
enabling them to make crucial decisions with regard to keeping or disposing of such securities.
(5) Listed companies command better support such as loans and investments from Banks and FIs.
Listing Agreement
Listing Agreement means a document which a company signs when being listed on the Stock Exchange, in
which the company promises to abide by stock exchange regulations, bye laws.
Laws governing Listing
– Securities Contracts (Regulation) Act, 1956
– Securities Contracts (Regulation) Rules, 1957
– Companies Act, 1956
– Guidelines issued by SEBI and
– Rules, Bye-laws and Regulations of respective Stock Exchange.
– Listing Agreement
Event based and time based Compliance under Listing Agreement
EVENT BASED COMPLIANCES
Sl.
No.
Clause
No. of
Listing
Agreement
Particulars of Compliance
Advance Notice/Intimation
1.
13
Intimation of particulars of the securities affected
due to the prohibitory orders restraining the
company from transfer.
Promptly notify the
Exchange
2.
16
Date of closure of transfer books/ record date.
7 working days advance
notice required,.
Notice of Corporate action like mergers, demergers,
split and bonus sahres
Atleast 7 working days
notice is required.
3.
19 (a)
Prior Intimation of Board Meeting having agenda of
Buy back, dividend, Rights Issue, Bonus Shares,
issue of Convertible debentures.
2 working days advance
notice required.
4.
19 (e)
Intimation of Board meeting regarding the FPO to
be made through fix price route.
Atleast 48 hours in advance
of the board meeting.
5.
20
Intimation by phone, fax, telegram, e-mail, details
Within 15 minutes of
Lesson 5
Primary Market 181
of dividend/cash bonuses, buy back of securities,
the total turnover, gross profit/ loss, provision for
depreciation, tax provisions and net profits for the
year (with comparison with the previous year) and
the amounts appropriated from reserves, capital
profits, accumulated profits of past years or other
special source to provide wholly or partly for the
dividend even if this calls for qualification that
such information is provisional or subject to audit.
conclusion of Board
Meeting.
Intimate by phone, fax, telegram, e-mail, short
particulars of increase in share capital, alteration in
capital, re-issue of forfeited shares etc.
Within 15 minutes of
conclusion of Board
Meeting.
6.
22
7.
24 (d)
SEBI acknowledgement card/ observations received
on draft prospectus, certificate from lead merchant
banker ensuring positive compliance with SEBI
ICDR regulations 2009.
Immediately on the receipt
of acknowledgement card
from SEBI.
8.
24 (f)/24 (i)
File copy of Scheme/Petition proposed to be filed
before any Court under section 391/394 & 101 of
Companies Act, 1956 along with auditor’s certificate
ensuring compliance with all Accounting Standards
Specified by the Central Government in Section
211(3c) of Companies Act, 1956.
1 month before it is
presented to the court.
9.
25
Intimation regarding details of granting option by the
company, if any.
Promptly notify the
Exchange.
10.
26
Intimation with respect to the redemption of securities
otherwise than pro rata or lot basis, if any.
Promptly notify the
Exchange.
11.
27
Actions resulting redemption cancellation, retirement,
drawing of securities and date of drawing and period
of the closing of transfer books for such drawing.
Promptly notify the
Exchange.
12.
28
Prior intimation of change in the form of nature of any
of the securities of the company.
Promptly notify the
Exchange.
13.
29
Intimation about any proposed change in the general
character or nature of its business.
Notify promptly the
Exchange.
14.
30
Notification of change in Board of Directors, MD,
Notify promptly the
Managing agents, secretaries, treasurers, and auditors Exchange.
etc.
15.
31
Six copies of the Statutory and Directors’ Annual
Reports, Balance Sheets and Profits & Loss Accounts
and of all periodical and special reports, all notices,
circulars relating to new issue.
Three copies of all the notices, call letters or any other
circulars including notices of meetings convened u/s
391 or Section 394 read with Section 391 of the
Companies Act, 1956 together with Annexures.
Forward promptly to the
Exchange.
182 PP-CC&MM
Copy of proceedings of all AGM/EGM.
16.
33
File 6 copies of amended AOA & MOA (one of which
will be certified) and copies of all notices sent to the
shareholders with respect to such amendments.
As soon as the
amendments to the MOA
and AOA are approved in
the general meeting.
17.
35
Filing of shareholding pattern separately for each class
of equity shares/security.
Corporate restructuring of the company resulting in a
change exceeding +/- 2% of the total paid-up capital.
One day prior to listing of its
securities on the stock
exchanges.
On a quarterly basis, within
21 days from the end of
each quarter.
Within 10 days of any
corporate restructuring.
18.
35A
Submit details of the voting results of the AGM/EGM.
Within 48 hours of the
conclusion of the AGM/
EGM.
19.
36
Intimation of events/happenings having important
Notify the Exchange on
bearings and which are likely to materially affect the
Occurrence and after the
financial performance of the Company and its stock
Event.
prices like strikes, lock-outs, closure of units for any
reason, disruption of operations due to natural calamity,
litigation/dispute having material impact. Any price
sensitive information like acquisition, merger,
amalgamation, delisting, share forfeiture etc;
20.
43
Furnishing the details indicating the variations between On a quarterly basis.
projected utilisation of funds and/ or projected
profitability statement made by it in its prospectus or
letter of offer and the actual utilisation of funds and/or
actual profitability.
21.
43A
Furnish a statement indicating material deviations, if
any, in the use of proceeds of a public or rights issue
from the objects stated in the offer document.
On a quarterly basis.
Intimation about any deviation in the use of the
proceeds or any other reservations about the end use
of fund given by the monitoring agency.
Immediately without any
delay after receiving the
reservations from the
monitoring agency.
22.
47 (a)
The Company is required to appoint a Compliance
Officer.
Inform on appointment and
as and when there is
change in the Compliance
Officer.
23.
47 (e)
Submit copy of MOU executed with RTA
Within 48 hours of
execution of MOU
24.
52
Electronic filing of information through Corporate Filing
Information as may be
Lesson 5
25.
53
Primary Market 183
and Dissemination System(CFDS)
specified by the
participating exchanges.
Intimation to the exchange when entered into agreement
with media companies about :
– The shareholding (if any) of such media companies/
associates in the issuer company.
Immediately upon entering
into agreement with media
companies or their
associates.
– Details of nominee of the media companies on the
Board of the issuer company, any management control
or potential conflict of interest arising out of such
agreements, etc.
– Any other back to back treaties/contracts/agreements/
MoUs or similar instruments entered into by the issuer
company with media companies and/or their associates
for the purpose of advertising, publicity, etc.
26.
55
Listed entities shall submit, as part of their Annual
Reports, Business Responsibility Reports, describing
the initiatives taken by them from an environmental,
social and governance perspective, in the format
prescribed by SEBI.
Promptly to the stock
exchange as soon as the
annual report is issued
TIME BASED COMPLIANCES
Sl.
No.
Particulars of Compliance
Clause
of Listing
Agreement
Due Date
For 1st Quarter ended 30th June
1.
Submit quarterly Corporate Governance Compliance reports.
49 (VI)(ii)
15th July
2.
Submit Shareholding Pattern as at the end of quarter.
35
21st July
3.
Notice to Stock Exchange for holding Board Meeting to approve
Unaudited Financial Results along with limited review report for the
1st Quarter
41
6th August
4.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
6th August
5.
To hold Board Meeting for approval of Unaudited Financial Results
41
14th August
6.
Approved Unaudited Financial Results submitted to Stock Exchange 41
within 15 minutes of conclusion of the Board Meeting
14th August
7.
Publish approved Unaudited Financial Results within 48 hours of
Board Meeting
41
16th August
For 2nd Quarter ended 30th Sept & AGM
8.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th October
9.
Submit Shareholding Pattern as at the end of quarter.
35
21st October
184 PP-CC&MM
10.
Notice to Stock Exchange for holding Board Meeting to approve
Un-audited Financial Results along with limited review report for
the 2nd Quarter
41
7th November
11.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of
the Company is situated).
41
7th November
12.
To hold Board Meeting for approval of Un-audited Financial Results
41
15th November
13.
Approved Un-audited Financial Results submitted to Stock Exchange
within 15 minutes of conclusion of the Board Meeting
41
15th November
14.
Publish approved Unaudited Financial Results within 48 hours of
Board Meeting
41
17th November
15.
Submit Certificate obtained from Practising Company Secretary
certifying that all certificates have been issued within one month
of lodgement for transfer, sub-division etc. for the half year ended
30th September.
47(c)
30th Oct.
For 3rd Quarter ended on 30th December
16.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th Jan.
17.
Submit Shareholding Pattern as at the end of quarter.
35
21st Jan
18.
Notice to Stock Exchange for holding Board Meeting to approve
Un-audited Financial Results for the 3rd Quarter
41
6th February
19.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of
the Company is situated).
41
22nd Jan
20.
To hold Board Meeting for approval of Un-audited Financial Results
41
14th February
21.
Approved Un-audited Financial Results submitted to Stock
Exchange along with limited review report for the 3rd Quarter
within 15 minutes of conclusion of the Board Meeting
41
14th February
22.
Publish approved Un-audited Financial Results within 48 hours of
Board Meeting held.
41
16th February
For 4th Quarter ended on March 31st
23.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th April
24.
Submit Shareholding Pattern as at the end of quarter.
35
21st April
25.
Pay Annual Listing fee.
38
30th April
26.
Submit half yearly Certificate obtained from Practising Company
Secretary.
47(c)
30th April
27.
Notice to Stock Exchange (SE) for holding Board Meeting (BM)
to approve Un-audited Financial Results(UAFR), subject to Limited
Review Report (LRR) by Statutory Auditors, for the quarter ended
on 31st March
41
7th May
Lesson 5
Primary Market 185
28.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
7th May
29.
To hold Board Meeting for approval of un-audited financial results.
41
15th May
30.
Submit un-audited financial results to the SE within 15 minutes of
conclusion of the BM.
41
15th May
31.
Publication of un-audited financial results in atleast one English
daily newspaper and one daily regional newspaper within 48 hours
of conclusion of Board Meeting.
41
17th May
32.
Notice to Stock Exchange (SE) for holding Board Meeting (BM) to
approve Audited Financial Results
41
22nd May
33.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
22nd May
34.
To hold Board Meeting for approval of financial results.
41
30th May
35.
Submit audited Financial Results to the Stock Exchange within 15
minutes of conclusion of the Board Meeting
41
30th May
36.
Publication of financial results in atleast one English daily newspaper
and one daily regional newspaper within 48 hours of conclusion of
Board Meeting.
41
June 1st
37.
Submit shareholding pattern, annual Corporate Governance Report, 52
Quarterly Results, Half yearly financial statements, Statement of
action taken against the company by any regulatory agency and full
version of annual report on SEBI www.corpfiling.co.in
Within such time
as specified by
SEBI.
LESSON ROUND UP
– Public Issue of shares means the selling or marketing of shares for subscription by the public by issue
of prospectus.
– Public Issue of shares are regulated by SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009.
– Offer for Sale (OFS) is another form of share sale, very much similar to Follow–On Public Offer (FPO).
OFS mechanism facilitates the promoters of an already listed company to sell or dilute their existing
shareholdings through an exchange based bidding platform.
– SEBI has detailed guidelines on Offer for sale (OFS) of Shares by Promoters Through stock Exchange
Mechanism.
– A company is required to issue a prospectus each time it accesses the capital market. The different form
of prospectus are Offer document, Draft Offer document, Red Herring Prospectus, Shelf prospectus etc.
– Their main responsibilities of Lead Manager is to initiate the IPO processing, help company in road
shows, creating draft offer document and get it approve by SEBI and stock exchanges and helping
company to list shares at stock market.
186 PP-CC&MM
– Underwriting means an agreement with or without conditions to subscribe to the securities of a body
corporate when the existing shareholders of such body corporate or the public do not subscribe to the
securities offered to them.
– Due diligence is a process of a thorough and objective examination that is undertaken before corporate
entities enter into major transactions such as mergers and acquisitions, issuing new stock or other
securities, project finance, securitization, etc.
– Book Building means a process undertaken to elicit demand and to assess the price for determination
of the quantum or value of specified securities or Indian Depository Receipts, as the case may be.
– “Green Shoe Option” means an option of allocating shares in excess of the shares included in the
public issue and operating a post–listing price stabilizing mechanism in accordance with the provisions
of Regulation 45 of SEBI (ICDR) Regulations, 2009.
– A company may, if its Articles provide, capitalize its profits by issuing fully–paid bonus shares.
– Preferential issue means issuance of equity shares to promoter group or selected investors. It covers
allotment of fully convertible debentures, partly convertible debentures or any other financial instruments
that could be converted into equity shares at a later date.
– A Qualified Institutions Placement means allotment of eligible securities by a listed issuer to qualified
institutional buyers on private placement basis in terms of SEBI (ICDR) Regulations.
– Institutional Placement Programme means a further public offer of eligible securities by an eligible
seller, in which the offer, allocation and allotment of such securities is made only to qualified institutional
buyers in terms of Chapter VIII A of SEBI ICDR Regulations, 2009.
– Listing Agreement is a document which a company signs when being listed on the Stock Exchange, in
which the company promises to abide by stock exchange regulations, bye laws.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly discuss the different methods of raising funds from Primary Market.
2. Distinguish between Offer For Sale Process and IPO/FPO.
3. Define Shelf Prospectus. Enumerate the provisions relating to Shelf Prospectus.
4. What do you understand by Due Diligence? Describe the pre–issue and post–issue due diligence in
public issue.
5. Explain how basis of allotment is determined.
6. Explain Green Shoe Option with the help of an example.
Lesson 5
Primary Market 187
188 PP-CC&MM
Lesson 6
Lesson 6
Secondary Market
LESSON OUTLINE
Secondary Market 189
LEARNING OBJECTIVES
– Introduction
Secondary Market refers to a market where
– Corporate Actions
securities are traded after being initially offered
– Continuous Listing
to the public in the primary market and/or listed
– Material Events under Listing Agreement
on the Stock Exchange. Majority of the trading
– Price sensitive Information
is done in the Secondary Market. When a
com pany listed its securities on Stock
– Submission of Interim and Annual
Financial Results under Listing
Agreement
Exchange it has to com ply with certain
conditions of the Stock Exchange under the
listing agreement. Further Stock Exchange is
– Disclosures under Listing Agreement
an essential part of Secondary Market. The
– Corporate Governance
stock exchanges along with a host of other
– Regulatory Framework of Corporate
Governance in India
intermediaries provide the necessary platform
– Clause 49
clearing and settlement.
– Arbitration Mechanism
The objective of this lesson is to give a detailed
– Arbitration
Exchanges
Mechanism
at
for trading in Secondary Market and also for
view of the compliance requirement need to be
Stock
fulfilled by a company with respect to the
Corporate Action, Disclosure, Price sensitive
– Margining
information, Corporate Governance Norms.
– Trading of Securities
Further, after going through this lesson a student
– Settlement System
will be able to understand the arbitration
– Clearing and settlement
mechanism at the stock exchanges, Trading
Clearing and Settlement process at Stock
– Trade Guarantee Fund
Exchanges. Basics of Stock indices, Calculation
– Trading Software
Methodology of index etc.
– Stock Market Indices
– Sensex
– CNX Nifty
– Investible Weight Factors (IWFs)
– LESSON ROUND UP
– SELF TEST QUESTIONS
189
190 PP-CC&MM
INTRODUCTION
Secondary market refers to a market where securities are traded after being initially offered to the public in the
primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market.
For the general investor, the Secondary Market provides an efficient platform for trading of his securities. For the
management of the company, Secondary Markets serve as a monitoring and control conduit—by facilitating
value-enhancing control activities, enabling implementation of incentive-based management contracts, and
aggregating information (via price discovery) that guides management decisions. When a company list its
securities on the Stock Exchange, it has to comply with various conditions of the Listing Agreement of the Stock
Exchange such as notice to be given under Corporate Action, continuous listing requirements, Disclosure of
Price Sensitive Information, Material events, Submission of Financial results to the Stock Exchange etc. These
compliance requirements are discussed below.
CORPORATE ACTIONS
Corporate action is a process by which a company gives benefits to the investors who are holding securities of
the company. Corporate actions are classified in to two main categories Cash and Non-cash corporate actions.
– Cash corporate action results in investors getting benefits in form of cash. Examples of cash corporate
actions are payment of interest / dividend.
– Non cash corporate actions result in the investors getting benefits in form of securities. Examples of non
cash corporate action are bonus, rights, merger, split etc.
Corporate actions tend to have a bearing on the price of a security. When a company announces a corporate
action, it is initiating a process that will bring actual change to its securities either in terms of number of shares
increasing in the hands on the shareholders or a change to the face value of the security or receiving shares of
a new company by the shareholders as in the case of merger or acquisition etc. By understanding these different
types of processes and their effects, an investor can have a clearer picture of what a corporate action indicates
about a company’s financial affairs and how that action will influence the company’s share price and performance.
Corporate actions are typically agreed upon by a company’s Board of Directors and authorized by the
shareholders.
REQUIREMENT UNDER LISTING AGREEMENT FOR CORPORATE ACTION
A listed company is required to give notice for corporate action under clause 16 of the Listing agreement.
– The Company is required to close its transfer books at least once a year at the time of the Annual
General Meeting if they have not been otherwise closed at any time during the year.
– The Company must ensure that there is a gap of at least 30 days between 2 book closure and/or record
date.
– The Company shall give an advance notice of at least 7 working days (Excluding the date of the intimation
and record date/book closure start date) to the Stock Exchange for corporate actions (Book closure/
Record date) fixed for the purpose of corporate benefits like mergers, de-mergers, split , bonus, dividend,
rights etc.
CONTINUOUS LISTING
The Securities Contract Regulation Rules, 1957(SCRR) prescribes the requirements which have to be satisfied
by companies for the purpose of getting their securities listed on any stock exchange in India. Rule 19(2) (b)
Prescribes for requirements with respect to the listing of Securities on a recognised stock exchanges and 19A
prescribes the requirement for continuous listing.
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Rule 19(2)(b)
Rule 19(2)(b) lays down that –
(i) At least twenty five per cent. of each class or kind of equity shares or debentures convertible into equity
shares issued by the company was offered and allotted to public in terms of an offer document; or
(ii) At least ten per cent of each class or kind of equity shares or debentures convertible into equity shares
issued by the company was offered and allotted to public in terms of an offer document if the post issue
capital of the company calculated at offer price is more than four thousand crore rupees.
Provided that the requirement of post issue capital being more than four thousand crore rupees shall not apply
to a company whose draft offer document is pending with the Securities and Exchange Board of India on or
before the commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, if it satisfies the
conditions prescribed in clause (b) of sub-rule 2 of rule 19 of the Securities Contracts (Regulation) Rules, 1956
as existed prior to the date of such commencement:
Provided further that the company, referred to in sub clause (ii), shall increase its public shareholding to at least
twenty five per cent, within a period of three years from the date of listing of the securities, in the manner
specified by the Securities and Exchange Board of India
Rule 19A
Rule 19A provides for Continuous Listing Requirement which stipulates that –
(1) Every listed company other than public sector company shall maintain public shareholding of at least
twenty five per cent.
Provided that any listed company which has public shareholding below twenty five per cent, on the
commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, shall increase its
public shareholding to at least twenty five per cent, within a period of three years from the date of such
commencement, in the manner specified by the Securities and Exchange Board of India.
Explanation: For the purposes of this sub-rule, a company whose securities has been listed pursuant to
an offer and allotment made to public in terms of sub-clause (ii) of clause (b) of sub-rule (2) of rule 19,
shall maintain minimum twenty five per cent, public shareholding from the date on which the public
shareholding in the company reaches the level of twenty five percent in terms of said sub-clause.
(2) Where the public shareholding in a listed company falls below twenty five percent at any time, such
company shall bring the public shareholding to twenty five percent within a maximum period of twelve
months from the date of such fall in the manner specified by the Securities and Exchange Board of
India.
(3) Notwithstanding anything contained in this rule, every listed public sector company shall maintain public
shareholding of at least ten per cent :
Provided that a listed public sector company –
(a) which has public shareholding below ten per cent, on the date of commencement of the Securities
Contracts (Regulation) (Second Amendment) Rules, 2010 shall increase its public shareholding to
at least ten per cent, in the manner specified by the Securities and Exchange Board of India, within
a period of three years from the date of such commencement;
(b) whose public shareholding reduces below ten per cent, after the date of commencement of the
Securities Contracts (Regulation) (Second Amendment) Rules, 2010 shall increase its public
shareholding to at least ten per cent, in the manner specified by the Securities and Exchange
Board of India, within a period of twelve months from the date of such reduction.
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The provision quoted above require all listed companies in the private sector to achieve and maintain public
shareholding of 25% of each class or kind of equity shares or debentures convertible into equity shares issued
by such companies. Those companies with public shareholding of less than 25 % are required to achieve the
same, within a period of 3 years from the date of commencement of the first amendment in the manner specified
by SEBI.
In order to align the requirement in the listing agreement with the requirement specified in Rule 19 (2) (b) and 19
A of SCRR and to specify the manner in which public shareholding may be raised to prescribe minimum level,
SEBI issued a circular on December 16, 2010 to amend Clause 40A of Listing Agreement for complying with the
minimum public shareholding which is as under:
“Where the company is required to achieve the level of public shareholding as specified in Rule 19(2) and/
or 19A of the Rules, it shall adopt any of the following methods to raise the public shareholding to the
required level:
(a) issuance of shares to public through prospectus; or
(b) offer for sale of shares held by promoters to public through prospectus; or
(c) sale of shares held by promoters through the secondary market.
For adopting methods as specified at point (c) the company agrees to take prior approval of the Specified
Stock Exchange, which may impose such conditions as it may deem fit.”
SEBI issue another circular dated February 8, 2012 which provided that listed company may achieve the minimum
public shareholding requirement through Institutional Placement Programme (IPP). Further to facilitate listed
entities to comply with the minimum public shareholding requirements within the time specified in Securities
Contracts (Regulation) Rules, 1957 SEBI issued a circular on August 29, 2012 specified the following additional
methods:(a) Rights Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue.
(b) Bonus Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue.
(c) any other method as may be approved by SEBI, on a case to case basis.
Clause 40A of Listing Agreement
Minimum level of public shareholding
(i) The issuer company agrees to comply with the requirements specified in Rule 19(2) and Rule 19A of the
Securities Contracts (Regulation) Rules, 1957.
(ii) Where the issuer company is required to achieve the minimum level of public shareholding specified in
Rule 19(2)(b) and/or Rule 19A of the Securities Contracts (Regulation) Rules, 1957, it shall adopt any of
the following methods to raise the public shareholding to the required level:(a) issuance of shares to public through prospectus; or
(b) offer for sale of shares held by promoters to public through prospectus; or
(c) sale of shares held by promoters through the secondary market in terms of SEBI circular CIR/MRD/
DP/05/2012 dated February 1, 2012; or
(d) Institutional Placement Programme (IPP) in terms of Chapter VIIIA of SEBI (Issue of Capital and
Disclosure Requirements) Regulations, 2009, as amended; or
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(e) Rights Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue; or
(f) Bonus Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue; or
(g) any other method as may be approved by SEBI, on a case to case basis.
40 B – Take Over Offer
Under this clause, it is a condition for continued listing that whenever the take-over offer is made or there is any
change in the control of the management of the company, the person who secures the control of the management
of the company and the company whose shares have been acquired shall comply with the relevant provisions of
the SEBI (Substantial Acquisition of Shares and Take-overs) Regulations, 2011.
Points to Remember
A listed company as a continuous listing requirement has to comply with Rule 19 (2)(b) and 19 A of the SCRR,
1957 along with Clause 40A and 40 B of the Equity Listing Agreement.
MATERIAL EVENTS UNDER LISTING AGREEMENT
Clause 36 of the listing agreement deals with the material events which are required to be intimated to the stock
exchange by a company. It provides that a company is required to intimate the stock exchange about the major
events such as strikes, lock outs, closure on account of power cuts, etc. and all events which will have a bearing
on the performance / operations of the company as well as price sensitive information both at the time of
occurrence of the event and subsequently after the cessation of the event in order to enable the security holders
and the public to appraise the position of the Issuer and to avoid the establishment of a false market in its
securities. In addition, on request of the stock exchange the company may provide such information as required
by the stock exchanges. The material events may be events such as:
– Change in the general character or nature of business
The company will promptly notify the Exchange of any material change in the general character or nature of
its business where such change is brought about by the Issuer entering into or proposing to enter into any
arrangement for technical, manufacturing, marketing or financial tie-up or by reason of the Issuer, selling or
disposing of or agreeing to sell or dispose of any unit or division or by the Issuer, enlarging, restricting or
closing the operations of any unit or division or proposing to enlarge, restrict or close the operations of any
unit or division or otherwise.
– Disruption of operations due to natural calamity
The company will soon after the occurrence of any natural calamity like earthquake, flood or fire disruptive
of the operation of any one or more units of the Issuer keep the Exchange informed of the details of the
damage caused to the unit thereby and whether the loss/damage has been covered by insurance and
without delay furnish to the Exchange an estimate of the loss in revenue or production arising therefrom,
and the steps taken to restore normalcy, in order to enable the security holders and the public to appraise
the position of the issue and to avoid the establishment of a false market in its securities.
– Commencement of Commercial Production/Commercial Operations
The company will promptly notify the Exchange the commencement of commercial/production or the
commencement of commercial operations of any unit/division where revenue from the unit/division for a full
year of production or operations is estimated to be not less than ten per cent of the revenues of the Issuer
for the year.
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– Developments with respect to pricing/realisation arising out of change in the regulatory framework
The company will promptly inform the Exchange of the developments with respect to pricing of or in realisation
on its goods or services (which are subject to price or distribution, control/restriction by the Government or
other statutory authorities, whether by way of quota, fixed rate of return, or otherwise) arising out of modification
or change in Government's or other authorities’ policies provided the change can reasonably be expected to
have a material impact on its present or future operations or its profitability.
– Litigation /dispute with a material impact
The comapany will promptly after the event inform the Exchange of the developments with respect to any
dispute in conciliation proceedings, litigation, assessment, adjudication or arbitration to which it is a party or
the outcome of which can reasonably be expected to have a material impact on its present or future operations
or its profitability or financials.
– Revision in Ratings
The company will promptly notify the Exchange, the details of any rating or revision in rating assigned to any
debt or equity instrument of the Issuer or to any fixed deposit programme or to any scheme or proposal of
the Issuer involving mobilisation of funds whether in India or abroad provided the rating so assigned has
been quoted, referred to, reported, relied upon or otherwise used by or on behalf of the Issuer.
– Any other information having bearing on the operation/performance of the company as well as price
sensitive information.
Price Sensitive Information (PSI)
Clause 36 of the listing agreement also defines price sensitive information. Price sensitive information which
includes but not restricted to:
1. Issue of any class of securities.
2. Acquisition, merger, de-merger, amalgamation, restructuring, scheme of arrangement, spin off of setting
divisions of the company, etc.
3. Change in market lot of the company's shares, sub-division of equity shares of the company.
4. Voluntary delisting by the company from the stock exchange(s).
5. Forfeiture of shares.
6. Any action which will result in alteration in the terms regarding redemption/cancellation/retirement in
whole or in part of any securities issued by the company.
7. Information regarding opening, closing of status of ADR, GDR or any other class of securities to be
issued abroad.
8. Cancellation of dividend/rights/bonus, etc.
SEBI (Prohibition of Insider trading) Regulations, 1992 also defines price sensitive information. Under the
regulation Price Sensitive Information means any information which relates directly or indirectly to a company
and which if published is likely to materially affect the price of securities of a company. The following shall be
deemed to be price sensitive information:– periodical financial results of the company;
– intended declaration of dividends (both interim and final);
– issue of securities or buy-back of securities;
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– any major expansion plans or execution of new projects;
– amalgamation, mergers or takeovers;
– disposal of the whole or substantial part of the undertaking;
– any significant changes in policies, plans or operations of the company.
SUBMISSION OF INTERIM AND ANNUAL FINANCIAL RESULTS UNDER LISTING AGREEMENT
Every Listed Company under Clause 41 of the Listing Agreement is required to furnish unaudited quarterly
results on a quarterly basis in the prescribed format to the concerned Stock Exchanges within forty five days of
the end of the quarter. Under Clause 41, listed companies have been given the option to furnish either audited
or unaudited results within forty-five days from the end of the respective quarter (other than the last quarter).
Thus, Companies which are ready with audited financial results within forty five days after the end of the respective
quarter will be able to disclose such results without bothering to first disclose unaudited results. However, the
audited results shall be accompanied by the audit report. The following relevant provisions should be noted:—
– The company shall intimate to the Stock Exchange (normally through Fax, e-mail etc.) within 15 minutes
of the closure of the Board meeting in which the unaudited/audited financial results are placed.
– Further the company shall publish within 48 hours of the said meeting the unaudited/audited results in
the prescribed format in at least one national English newspaper and one Regional language daily
newspaper.
– The Board of Directors or its sub-committee should take on record the un-audited/audited quarterly
results, which shall be signed by chairman or managing director or a whole time director. The Audit
Committee which comprises mostly of independent directors need to review the results before the
same is taken up by the board.
– The company shall inform the Stock Exchange where its securities are listed about the date of the Board
Meeting at least 7 days in advance and shall also issue immediately a press release in at least one
national English newspaper and one regional language newspaper about the date of the aforesaid
Board or its sub-committee meeting.
– The company will furnish segment wise revenue, results and capital employed along with the quarterly
unaudited financial results after the ending of quarters as per the prescribed format.
– In case of change of name of the company, the new activity of business, turnover and the income from
the said new activity shall be separately disclosed for a period of three years from the date of such
change.
– The quarterly report should be prepared on the basis of accrual accounting policy and in accordance
with the uniform accounting practices adopted for all quarters.
– The listed companies are required to provide explanation for variation between items of unaudited and
audited quarterly/year to date/annual results only in respect of net profit or loss after Tax and for
exceptional/extraordinary items. Further, the such variation should not be more than 10% or ` 10 lakh
whichever is higher.
– The company will have the option to publish consolidated quarterly results in addition to the unaudited
quarterly results of the parent company.
– The quarterly unaudited results are subject to limited review by the Statutory Auditors of the company, to
be submitted within 45 days from end of the quarter.
– In respect of the half yearly results, if the company intimates in advance to the Stock Exchange/s that
it will publish audited half yearly financial results within two months of the close of the half year then
196 PP-CC&MM
in such a case unaudited results and limited review need not be published/given to the stock exchange/
s.
– As a part of its audited or unaudited financial results for the half-year, the company shall also submit by
way of a note, a statement of assets and liabilities as at the end of the half-year.
– In respect of results for the last quarter of the financial year, if the company intimates in advance to the
stock exchange/s that it will publish audited results within a period of 60 days from the end of the last
quarter of the financial year, in such a case unaudited results for the last quarter need not be published/
given to the Stock Exchange/s. The intimation of the decision to submit audited results should be send
within 45 days from the end of the quarter.
However, when a company opts to submit un-audited financial results for the last quarter of the financial
year, it shall, submit a statement of assets and liabilities as at the of financial year only along with the
audited financial results for the entire financial year, as soon as they are approved by the Board.
– The manufacturing and trading/services companies which have followed functional (secondary)
classification of expenditure in the Annual Profit & Loss Account in their most recent Annual report may
furnish results on a quarterly basis in this alternative format.
– In case the company has subsidiaries and it opts to submit consolidated financial result as mentioned at
(e) above, it may submit the consolidated financials as per the International Financial Reporting Standards
(IFRS) notified by the International Accounting Standards Board.
– The company shall ensure that the limited review/audit reports submitted to the stock exchanges on a
quarterly/annual basis shall be given only by an auditor who has subjected himself to the peer review
process of Institute of Chartered Accountants of India (ICAI) and holds a valid certificate issued by the
Peer Review Board of the ICAI.
DISCLOSURES UNDER LISTING AGREEMENT
Disclosure relating to shareholding pattern (Clause 35)
A company is required to file the details of their shareholding pattern with stock exchange separately for each
class of equity shares/security in the formats Prescribed, in compliance with the following timelines, namely :
(a) One day prior to listing of its securities on the stock exchanges.
(b) On a quarterly basis, within 21 days from the end of each quarter.
(c) Within 10 days of any capital restructuring of the company resulting in a change exceeding +/-2% of the
total paid-up share capital”
The following details are required to be disclosed to the stock exchange:
– Statement showing shareholding Pattern of the company
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
belonging to the category “Promoter and Promoter Group”
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
belonging to the category “Public” and holding more than 1% of the total number of shares
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
(together with Persons Acting in Concert (PAC)) belonging to the category “Public” and holding more
than 5% of the total number of shares of the company
– Statement showing details of locked-in shares
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– Statement showing details of Depository Receipts (DRs)
– Statement showing holding of Depository Receipts (DRs), where underlying shares held by ‘promoter/
promoter group’ are in excess of 1% of the total number of shares
– Statement showing the voting pattern of shareholders, if more than one class of shares/securities is
issued by the issuer.
Disclosure under Clause 41
– The company shall disclose the auditor’s qualification or other reservation and impact of the same on
the profit or loss,
– If the company has changed its name, it shall disclose the net sales or income, expenditure and net
profit or loss after tax figures pertaining to the said new line of business separately in the financial
results.
– If the company had not commenced commercial production or commercial operations during the
reportable period, the company shall disclose the details of amount raised, the portions thereof which is
utilized and that remaining unutilized, the details of investment made pending utilisation, brief description
of the project which is pending completion, status of the project and expected date of commencement of
commercial production or commercial operations.
– All items of income and expenditure arising out of transactions of exceptional nature shall be disclosed.
– Extraordinary items or changes in accounting standard, if any, shall be disclosed in accordance with
Accounting Standard 5 issued by ICAI/Company (Accounting Standards) Rules, 2006, whichever is
applicable.
– Companies, whose revenues are subject to material seasonal variations, shall disclose the seasonal
nature of their activities. In addition, they may supplement their financial results with information for the
12 months period ending on the last day of the quarter for the current and preceding years on a rolling
basis.
– The company shall disclose any event or transaction which occurred during or before the quarter that is
material to an understanding of the results for the quarter including but not limited to completion of
expansion and diversification programmes, strikes and lock-outs, change in management and change
in capital structure. The company shall also disclose similar material events or transactions that take
place subsequent to the end of the quarter.
– The company shall disclose the following in respect of dividends paid or recommended for the year,
including interim dividends:
– amount of dividend distributed or proposed for distribution per share; the amounts in respect of
different classes of shares shall be distinguished and the nominal values of shares shall also be
indicated;
– where dividend is paid or proposed to be paid pro-rata for shares allotted during the year, the date
of allotment and number of shares allotted, pro-rata amount of dividend per share and the aggregate
amount of dividend paid or proposed to be paid on pro-rata basis.
– The company shall disclose the effect on the financial results of material changes in the composition of
the company, if any, including but not limited to business combinations, acquisitions or disposal of
subsidiaries and long term investments, any other form of restructuring and discontinuance of operations.
– The company shall also disclose the number of investor complaints pending at the beginning of the quarter,
those received and disposed of during the quarter and those remaining unresolved at the end of the quarter.
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Disclosure regarding agreements with media companies (Clause 53)
This clause requires disclosure of agreements entered into between the listed entities and the media companies.
As per clause 53, the listed entities are required to disclose details of such agreements on their websites and
also notify the concerned stock exchange.
CORPORATE GOVERNANCE
Corporate Governance may be defined as a set of systems, processes and principles which ensure that a
company is governed in the best interest of all stakeholders. It is the system by which companies are directed
and controlled. It is about promoting corporate fairness, transparency and accountability. In other words, 'good
corporate governance' is simply 'good business'. It ensures:
– Adequate disclosures and effective decision making to achieve corporate objectives;
– Transparency in business transactions;
– Statutory and legal compliances;
– Protection of shareholder interests;
– Commitment to values and ethical conduct of business.
The fundamental objective of corporate governance is to enhance shareholders' value and protect the interests
of other stakeholders by improving the corporate performance and accountability. Hence it harmonizes the need
for a company to strike a balance at all times between the need to enhance shareholders' wealth whilst not in
any way being detrimental to the interests of the other stakeholders in the company. Further, its objective is to
generate an environment of trust and confidence amongst those having competing and conflicting interests.
REGULATORY FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA
Good corporate governance practices are a sine qua non for sustainable business that aims at generating long
term value to all its shareholders and other stakeholders. Some aspects of corporate governance have been
enshrined in the law that is administered by the Ministry of Corporate Affairs, SEBI and other sectoral regulators.
The important legislations for regulating the various aspects of governance in companies are Companies Act,
1956 and Companies Bill, 2012. These laws have been introduced and amended, from time to time, to bring
more transparency and accountability in the provisions of corporate governance. The SEBI Act, 1992 empowers
SEBI to frame regulations, pursuant to which the regulator has introduced a comprehensive set of guidelines
on insider trading, mergers and takeovers, fraudulent practices, etc all of which have a significant impact on
corporate governance in the country. SEBI, as a market regulator, also decides the terms and conditions of
listing agreement which govern the arrangement between stock exchanges and companies listed on the
stock exchange. The corporate governance standards are elaborated in Clause 49 of the listing agreement.
Regulators such as the Reserve Bank of India (“RBI”) and the Insurance Regulatory Development Authority
(“IRDA”) also prescribe corporate governance guidelines applicable for banking and insurance companies,
respectively.
The various legislations governing the corporate governance in companies are discussed below:
Companies Act, 1956
The main provisions dealing with Corporate Governance in the Indian Companies Act are given in the table
below:Section 217(2AA) Directors Responsibility Statement to be included in the Director’s Report.
Section 299
Requires every director of a company to make disclosure, at the board meeting, of the
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nature of his concern or interest in a contract or arrangement (present or proposed)
entered by or on behalf of the company.
Section 292A
Requires every public company having paid up capital of ` 5 Crore or more to constitute
a committee of the board called the Audit Committee.
Section 309(1)
Requires the remuneration payable both to the executive as well as non-executive
directors is required to be determined by the Board in accordance with and subject to the
provisions of sec 198 either by the articles of the company or by resolution or if the article
so require by a special resolution, passed by the company in general meeting.
Schedule VI
Requires disclosure of Director’s remuneration and computation of net profit for that
purpose.
CORPORATE GOVERNANCE -VOLUNTARY GUIDELINES 2009
The ‘Corporate Governance -Voluntary Guidelines 2009’, being proposed for voluntary adoption by the Corporate
Sector have taken into account the recommendations of the Task Force set up by Confederation of Indian
Industry (CII) under chairmanship of Shri Naresh Chandra in February, 2009 to recommend ways to further
improve corporate governance standards and practices. Base on the report of the Task Force of CII on corporate
governance headed by Shri Naresh Chandra and the recommendations of the Institute of Company Secretaries
of India for strengthening corporate governance framework the Ministry of Corporate Affairs issued “Corporate
Governance -Voluntary Guidelines 2009” which provides for a set of good practices which may be voluntarily
adopted by the Public companies.The guidelines are recommendatory in nature.
GUIDELINES ON CORPORATE GOVERNANCE FOR CENTRAL PUBLIC SECTOR ENTERPRISES
Department of Public Enterprises has issued Guidelines on Corporate Governance for Central Public Sector
Enterprises (CPSEs) which were revised by a notification no. 18(8)/2005-GM dt. 14th May 2010. The guidelines
on Corporate Governance for listed and unlisted CPSEs are being dealt in separate chapters under the following
headings.
– Board of Directors
– Audit Committee
– Remuneration Committee
– Subsidiary Companies
– Disclosures
– Report, Compliance and Schedule of Implementation
Applicability
For the purpose of the guidelines the public sector enterprises have been categorized in two groups; (a) listed
entities and (b) Non-listed entities.
CPSEs listed on Stock Exchanges:
All listed CPSEs are required to follow the SEBI Guidelines on Corporate Governance. In addition, they shall
follow those provisions of these Guidelines which do not exist in the SEBI Guidelines and also do not contradict
any of the provisions of the SEBI Guidelines.
Non-listed CPSEs
Each CPSE should strive to institutionalize good Corporate Governance practices broadly in conformity with the
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SEBI Guidelines. The guidelines provide that the provisions shall also be applicable to all the unlisted CPSE’s
on mandatory basis.
NATIONAL VOLUNTARY GUIDELINES ON SOCIAL, ENVIRONMENTAL & ECONOMIC
RESPONSIBILITIES OF BUSINESS, 2011
On 8 July 2011, the Ministry of Corporate Affairs launched the National Voluntary Guidelines on Social,
Environmental & Economic Responsibilities of Business. The Guidelines, directed at all business types and
sizes, provide a basic framework that may be adopted voluntarily in order to address the interests of various
stakeholders, including employees, customers and investors. The original 2009 Voluntary Guidelines were revised
following consultations with business and civil society representatives which demonstrates the government’s
continued commitment to sustainable business. While the 2011 Guidelines identify the areas where responsible
practices need to be adopted, the accompanying Reporting Framework provides a standard disclosure template
which can be used to report on performance in these areas.
These guidelines contain comprehensive principles to be adopted by companies as part of their business practices
and a structured business responsibility reporting format requiring certain specified disclosures, demonstrating
the steps taken by companies to implement the said principles.
COMPANIES BILL, 2012
In the Companies Bill 2012, various new provisions have been included (which are not provided for in Companies
Act, 1956) for better governance of the companies. Some of those new provisions are:
– Requirement to constitute Remuneration and nomination committee and Stakeholders Grievances
Committee
– Granting of More powers to Audit Committee
– Specific clause pertaining to duties of directors
– Mode of appointment of Independent Directors and their tenure
– Code of Conduct for Independent Directors
– Rotation of Auditors and restriction on Auditor's for providing non-audit services
– Enhancement of liability of Auditors
– Disclosure and approval of RPTs
– Mandatory Auditing Standards
– Enabling Shareholders Associations/Group of Shareholders for taking class action suits and
reimbursement of the expenses out of Investor Education and Protection Fund
– Constitution of National Financial Reporting Authority, an independent body to take action against the
Auditors in case of professional mis-conduct
– Requirement to spend on CSR activities
EVOLUTION OF CLAUSE 49 OF LISTING AGREEMENT
Corporate governance denotes the process, structure and relationship through which the Board of Directors
oversees what the management does. It is also about being answerable to different stakeholders.
CII constituted a Committee to recommend a Code of Corporate Governance to be observed by corporates in
their functioning. The Committee further recommended a Code popularly known as “Desirable Corporate
Governance Code” which defined Corporate Governance as follows:
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“Corporate governance deals with laws, procedures, practices and implicit rules that determine a
company’s ability to take informed managerial decisions vis-a-vis its claimants – in particular, its
shareholders, creditors, customers, the State and employees. There is a global consensus about the
objective of ‘good’ corporate governance: maximising long-term shareholder value.”
The Kumar Mangalam Birla Committee Constituted by SEBI has observed that:
“Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important
instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and
high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting
structure.”
N.R. Narayana Murthy Committee on Corporate Governance constituted by SEBI has observed that:
“Corporate Governance is the acceptance by management of the inalienable rights of shareholders as the
true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about
commitment to values, about ethical business conduct and about making a distinction between personal and
corporate funds in the management of a company.”
The Institute of Company Secretaries of India has also defined the term Corporate Governance as under:
“Corporate Governance is the application of best management practices, compliance of law in true letter and
spirit and adherence to ethical standards for effective management and distribution of wealth and discharge
of social responsibility for sustainable development of all stakeholders.”
Good Governance in capital market has always been high on the agenda of SEBI. Corporate Governance is
looked upon as a distinctive brand and benchmark in the profile of Corporate Excellence. This is evident from
the continuous updation of guidelines, rules and regulations by SEBI for ensuring transparency and accountability.
In the process, SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri
Kumar Mangalam Birla. The Committee in its report observed that “the strong Corporate Governance is
indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is
the blood that fills the veins of transparent corporate disclosure and high quality accounting practices. It is the
muscle that moves a viable and accessible financial reporting structure.”
Based on the recommendations of the Committee, the SEBI had specified principles of Corporate Governance
and introduced a new clause 49 in the Listing agreement of the Stock Exchanges in the year 2000. These
principles of Corporate Governance were made applicable in a phased manner and all the listed companies
with the paid up capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history
of the company, were covered as of March 31, 2003.
SEBI, as part of its endeavour to improve the standards of corporate governance in line with the needs of a
dynamic market, constituted another Committee on Corporate Governance under the Chairmanship of Shri N.
R. Narayana Murthy to review the performance of Corporate Governance and to determine the role of companies
in responding to rumour and other price sensitive information circulating in the market in order to enhance the
transparency and integrity of the market. The Committee in its Report observed that “the effectiveness of a
system of Corporate Governance cannot be legislated by law, nor can any system of Corporate Governance be
static. In a dynamic environment, system of Corporate Governance need to be continually evolved.”
With a view to promote and raise the standards of Corporate Governance, SEBI on the basis of recommendations
of the Committee and public comments received on the report and in exercise of powers conferred by Section
11(1) of the SEBI Act, 1992 read with section 10 of the Securities Contracts (Regulation) Act 1956, revised the
existing clause 49 of the Listing agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated August 26,
2003.
SEBI vide circular number SEBI/CFD/ DIL/CG/1/2004/12/10 dated October 29, 2004 again revised the existing
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Clause 49 of the Listing Agreement directing all the Stock Exchanges to amend the Listing Agreement by
replacing the existing Clause 49 of the Listing Agreement. As per the Circular, the provisions of the Clause 49
were to be implemented as per the schedule of implementation given below:
(a) For entities seeking listing for the first time, at the time of seeking in-principle approval for such listing.
(b) For existing listed entities which were required to comply with Clause 49 which is being revised i.e.
those having a paid up share capital of ` 3 crores and above or net worth of ` 25 crores or more at any
time in the history of the company, by April 1, 2005.
However noticing that large number of companies were not in the state of preparedness to be fully compliant
with the requirements of revised Clause 49 of the listing agreement, SEBI allowed more time to corporates to
conform to Clause 49 of the listing agreement and extended the date for ensuring compliance with the Clause
49 of the listing agreement to December 31, 2005. Now as on date, Clause 49 is applicable.
CLAUSE 49
Clause 49 of the Equity Listing Agreement consists of mandatory as well as non-mandatory provisions. Those
which are absolutely essential for corporate governance can be defined with precision and which can be enforced
without any legislative amendments are classified as mandatory. Others, which are either desirable or which
may require change of laws are classified as non-mandatory. The non-mandatory requirements may be
implemented at the discretion of the company. However, the disclosures of the compliance with mandatory
requirements and adoption (and compliance) / non-adoption of the non-mandatory requirements shall be made
in the section on corporate governance of the Annual Report.
Gist of Cause 49 is as follows:
Mandatory provisions comprises of the following:
– Composition of Board and its procedure - frequency of meeting, number of independent directors, code
of conduct for Board of directors and senior management;
– Audit Committee, its composition, and role
– Provision relating to Subsidiary Companies
– Disclosure to Audit committee, Board and the Shareholders
– CEO/CFO certification
– Quarterly report on corporate governance
– Annual compliance certificate
Non-mandatory provisions consist of the following:
– Constitution of Remuneration Committee
– Despatch of Half-yearly results
– Training of Board members
– Peer evaluation of Board members
– Whistle Blower policy
Composition of Board of Directors
As per the Listing Agreement, the Board of Directors of the company shall have an optimum combination of
executive and non executive directors. Further-
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Secondary Market 203
– not less than 50 per cent of the board of directors shall comprise of non-executive directors;
– the number of independent directors would depend on whether the chairman is executive or nonexecutive;
– if the Board has a Non-Executive Chairman, at least one third of the Board should comprise of independent
directors;
– if the Board has an Executive Chairman, at least half of the Board should comprise of independent
directors.
If the non-executive Chairman is a promoter or is related to promoters or persons occupying management
positions at the board level or at one level below the board, at least one-half of the board of the company should
consist of independent directors. The expression “related to any promoter” means:
(a) If the promoter is a listed entity, its directors other than the independent directors, its employees or its
nominees shall be deemed to be related to it;
(b) If the promoter is an unlisted entity, its directors, its employees or its nominees shall be deemed to be
related to it.
Definition of Independent Director
‘Independent director’ shall mean non-executive director of the company who –
(a) apart from receiving director’s remuneration, does not have any material pecuniary relationships or
transactions with the company, its promoters, its directors, its senior management or its holding company,
its subsidiaries and associates which may affect the independence of the director;
(b) is not related to promoters or persons occupying management positions at the board level or at one
level below the board;
(c) has not been an executive of the company in the immediately preceding three financial years;
(d) is not a partner or an executive or was not partner or an executive during the preceding three years, of
any of the following:
(i) the statutory audit firm or the internal audit firm that is associated with the company;
(ii) the legal firm(s) and consulting firm(s) that have a material association with the company.
(e) is not a material supplier, service provider or customer or a lessor or lessee of the company which may
effect the independence of the director;
(f) is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting
shares; and
(g) is not less than 21 year age.
An independent director who resigns or is removed from the Board of the Company shall be replaced by a
new independent director within a period of not more than 180 days from the day of such resignation or
removal, as the case may be. However, if the company fulfils the requirement of independent directors in its
Board even without filling the vacancy created by such resignation or removal, as the case may be, the
requirement of replacement by a new independent director within the period of 180 days would not apply.
Nominee Directors to be treated as Independent Director
The clause provides that Nominee directors appointed by an institution which has invested in or lent to the
company shall be deemed to be independent directors.
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Non Executive Directors’ Compensation and Disclosures
The clause provides that all fees/compensation, if any paid to non-executive directors, including independent
directors, shall be fixed by the Board of Directors and require previous approval of shareholders in general
meeting. The requirement of obtaining prior approval of shareholder in general meeting is not applicable to
payment of sitting fees to non-executive directors, if made within the limits prescribed under the Companies Act,
1956 for payment of sitting fees, without approval of the Central Government.
Disclosures on Remuneration of Directors
The specific disclosures on the remuneration of directors regarding all elements of remuneration package of
individual directors summarized under major groups such as salary, benefits, bonuses, pensions, stock options
etc., details of fixed component and performance linked incentives, along with performance criteria, service
contracts, notice period, severance fees, stock option details, if any, and whether issued at a discount as well as
the period over which accrued and over which exercisable, should be made in the section on Corporate
Governance of the Annual Report.
Limits on Membership of Committees
A director shall not be a member in more than 10 committees or act as chairman of more than five committee
across all companies in which he is a director.
For the purpose of considering the limit of the committees on which a director can serve, Chairmanship/
membership of the Audit Committee and the Share-holders' Grievance Committee alone are to be considered.
Code of Conduct
The clause states that all Board members and senior management personnel shall affirm compliance with the
code of conduct laid down by the Board on an annual basis and the Annual Report of the company shall contain
a declaration to this effect signed by the CEO.
Board of Meetings
The Board shall meet at least four times a year with a maximum time gap of four months between any two
meetings.
Audit Committee
(i) The requirement of giving terms of reference of the Audit Committee is a must.
(ii) There should be minimum three members as directors.
(iii) It further provides that 2/3rd of the members of audit committee shall be independent directors.
(iv) The clause provides that all members of audit committee shall be financially literate and at least one
member shall have accounting or related financial management expertise.
(v) The clause provides that the term “financially literate” means the ability to read and understand basic
financial statements i.e. balance sheet, profit and loss account, and statement of cash flows.
(vi) It further provides that a member will be considered to have accounting or related financial management
expertise if he or she possesses experience in finance or accounting, or requisite professional certification
in accounting, or any other comparable experience or background which results in the individual’s
financial sophistication, including being or having been a chief executive officer, chief financial officer, or
other senior officer with financial oversight responsibilities.
(vii) Calling of executives is optional. The finance director, head of internal audit and representative of statutory
auditor may be present as invitees for the meetings of the audit committee.
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(viii) The Chairman of the audit committee should be an independent director and should also be present at
the Annual General Meeting to answer shareholder queries.
(ix) The company secretary should act as the secretary to the committee.
Quorum of Audit Committee
The quorum for the Audit Committee meeting shall be either two members or one-third of the members of the
Audit Committee; whichever is greater but there should be a minimum of two independent directors present.
Powers of the Audit Committee
The powers of the Audit Committee shall include the following:
(i) To investigate any activity within its terms of reference.
(ii) To seek information from any employee.
(iii) To obtain outside legal or other professional advice.
(iv) To secure attendance of outsiders with relevant expertise, if it considers necessary.
The powers of the Audit Committee specified above are illustrative and apart from the above, the Board may
delegate such other powers, as it may deem fit and proper.
Meetings and Role of Audit Committee
There is requirement of holding atleast four meetings in a year. The clause also provides that not more than four
months shall elapse between the two meetings of audit committee. The role of the audit committee include the
following:
1. Oversight of the company’s financial reporting process and the disclosure of its financial information to
ensure that the financial statement is correct, sufficient and credible.
2. Recommending to the Board, the appointment, re-appointment and, if required, the replacement or removal
of the statutory auditor and the fixation of audit fees.
3. Approval of payment to statutory auditors for any other services rendered by the statutory auditors.
4. Reviewing, with the management, the annual financial statements before submission to the board for approval,
with particular reference to:
(a) Matters required to be included in the Director’s Responsibility Statement to be included in the Board’s
report in terms of clause (2AA) of section 217 of the Companies Act, 1956.
(b) Changes, if any, in accounting policies and practices and reasons for the same.
(c) Major accounting entries involving estimates based on the exercise of judgment by
management.
(d) Significant adjustments made in the financial statements arising out of audit findings.
(e) Compliance with listing and other legal requirements relating to financial statements.
(f) Disclosure of any related party transactions.
(g) Qualifications in the draft audit report.
5. Reviewing, with the management, the quarterly financial statements before submission to the board for approval.
5A. Reviewing, with the management, the statement of uses/application of fund raised through an issue (public
issue, right issue, preferential issue, etc.), the statement of funds utilized for purposes other than those stated in
206 PP-CC&MM
the offer document/prospectus/notice and the report submitted by the monitoring agency monitoring the utilization
of proceeds of a public or rights issue, and making appropriate recommendations to the Board to take steps in
this matter.
6. Reviewing, with the management, performance of statutory and internal auditors, adequacy of the internal
control systems.
7. Reviewing the adequacy of internal audit function, if any, including the structure of the internal audit department,
staffing and seniority of the official heading the department, reporting structure coverage and frequency of
internal audit.
8. Discussion with internal auditors any significant findings and follow up there on.
9. Reviewing the findings of any internal investigations by the internal auditors into matters where there is
suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the
matter to the board.
10. Discussion with statutory auditors before the audit commences, about the nature and scope of audit as well
as post-audit discussion to ascertain any area of concern.
11. To look into the reasons for substantial defaults in the payment to the depositors, debenture holders,
shareholders (in case of non payment of declared dividends) and creditors.
12. To review the functioning of the Whistle Blower mechanism, in case the same is existing.
12A. Approval of appointment of CFO (i.e. the whole-time finance Director or any other person heading the
finance function or discharging that function) after assessing the qualification, experience and back of mind, etc.
of the candidate.
13. Carrying out any other function as is mentioned in the terms of reference of the Audit Committee
Review of Information by Audit Committee
The Audit Committee is required to mandatorily review the following information:
(a) Management discussion and analysis of financial condition and results of operations;
(b) Statement of significant related party transactions (as defined by the audit committee), submitted by the
management;
(c) Management letters/letters of internal control weaknesses issued by statutory auditors;
(d) Internal audit reports relating to internal control weaknesses; and
(e) The appointment, removal and terms of remuneration of the Chief internal auditor shall be subject to
review by the Audit Committee.
SUBSIDIARY COMPANY
(i) At least one independent director on the Board of Directors of the holding company shall be a director on the
Board of Directors of material non-listed Indian subsidiary company.
(ii) The Audit Committee of the listed holding company shall also review the financial statements, in particular the
investments made by the unlisted subsidiary company.
(iii) The minutes of the Board meetings of the unlisted subsidiary company is required to be placed at the Board
meeting of the listed holding company.
(iv) The management should periodically bring to the attention of the Board of Directors of the listed holding company,
a statement of all significant transactions and arrangements entered into by the unlisted subsidiary company.
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(v) The term “material non-listed Indian subsidiary” means an unlisted subsidiary, incorporated in India, whose
turnover or net worth (i.e. paid up capital and free reserves) exceeds 20% of the consolidated turnover or net
worth respectively, of the listed holding company and its subsidiaries in the immediately preceding accounting
year.
(vi) The term “significant transaction or arrangement” means any individual transaction or arrangement that
exceeds or is likely to exceed 10% of the total revenues or total expenses or total assets or total liabilities, as the
case may be, of the material unlisted subsidiary for the immediately preceding accounting year.
(vii) Where a listed holding company has a listed subsidiary which is itself a holding company, the above provisions
also apply to the listed subsidiary insofar as its subsidiaries are concerned.
SHAREHOLDERS/INVESTORS GRIEVANCE COMMITTEE
A Board Committee under the Chairmanship of a non-executive director shall be formed to specifically look into
redressal of shareholder and investors complaints like transfer of shares non-receipt of balance sheet, nonreceipt of declared dividends etc. Committee shall be designated as ‘Shareholders/Investors Grievance
Committee’. The number of meetings of the Shareholders/Investors Grievance Committee should be in
accordance with the exigencies of business requirements.
DISCLOSURES
The following disclosures are required to be made under this clause:
– Basis of related Party Transactions
– Disclosure of Accounting Treatment
– Risk Management
– Proceeds from public issues, Rights issues, preferential issues etc.
– Remuneration of Directors
– Management
– Shareholders
CEO/CFO CERTIFICATION
The CEO, i.e. the Managing Director or Manager appointed in terms of the Companies Act, 1956 and the CFO
i.e. the whole-time Finance Director or any other person heading the finance function discharging that function
shall certify to the Board that:
(a) They have reviewed financial statements and the cash flow statement for the year and that to the best
of their knowledge and belief :
(i) these statements do not contain any materially untrue statement or omit any material fact or contain
statements that might be misleading;
(ii) these statements together present a true and fair view of the company’s affairs and are in compliance
with existing accounting standards, applicable laws and regulations.
(b) There are, to the best of their knowledge and belief, no transactions entered into by the company during
the year which are fraudulent, illegal or violative of the company’s code of conduct.
(c) They accept responsibility for establishing and maintaining internal controls for financial reporting and
that they have evaluated the effectiveness of the internal control systems of the company pertaining to
financial reporting and they have disclosed to the auditors and the Audit Committee, deficiencies in the
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design or operation of such internal controls, if any, of which they are aware and the steps they have
taken or propose to take to rectify these deficiencies.
(d) They have indicated to the auditors and the Audit committee –
(i) significant changes in internal control over financial reporting during the year;
(ii) significant changes in accounting policies during the year and that the same have been disclosed in
the notes to the financial statements; and
(iii) instances of significant fraud of which they have become aware and the involvement therein, if any,
of the management or an employee having a significant role in the company’s internal control system
over financial reporting.
REPORT ON CORPORATE GOVERNANCE
The companies shall submit a quarterly compliance report to the stock exchanges within 15 days from the close
of quarter as per the format prescribed in the clause. The report is required to be signed either by the Compliance
Officer or the Chief Executive Officer of the company.
Compliance Certificate
The practising Company Secretaries have also been recognised to issue Certificate of Compliance of Conditions
of Corporate Governance. The clause provides that the company shall obtain a certificate from either the auditors
or practicing company secretaries regarding compliance of conditions of corporate governance as stipulated
in this clause and annex the certificate with the directors’ report, which is sent annually to all the shareholders of
the company. The same certificate shall also be sent to the Stock Exchanges along with the annual report filed
by the company.
Non-mandatory Requirements
The following non-mandatory requirements have additionally been provided:
(1) The Board
A non-executive Chairman may be entitled to maintain a Chairman’s office at the company’s expense and also
allowed reimbursement of expenses incurred in performance of his duties.
Independent Directors may have a tenure not exceeding, in the aggregate, a period of nine years, on the Board
of a company. The company shall ensure that the person who is being appointed as an independent director has
the requisite qualifications and experience which would be of use to the company and which in the opinion of the
company would enable aim to contribute effectively the company in his capacity as an independent director.
(2) Remuneration Committee
(i) The board may set up a remuneration committee to determine on their behalf and on behalf of the shareholders
with agreed terms of reference, the company’s policy on specific remuneration packages for executive directors
including pension rights and any compensation payment.
(ii) To avoid conflicts of interest, the remuneration committee, which would determine the remuneration packages
of the executive directors may comprise of at least three directors, all of whom should be non-executive directors,
the Chairman of committee being an independent director.
(iii) All the members of the remuneration committee could be present at the meeting.
(iv)The Chairman of the remuneration committee could be present at the Annual General Meeting, to answer
the shareholder queries. However, it would be up to the Chairman to decide who should answer the queries.
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Secondary Market 209
(3) Shareholder Rights
A half-yearly declaration of financial performance including summary of the significant events in last six-months,
may be sent to each household of share-holders.
Audit qualifications
Company may move towards a regime of unqualified financial statements.
Training of Board Members
A company may train its Board members in the business model of the company as well as the risk profile of the
business parameters of the company, their responsibilities as directors, and the best ways to discharge them.
Mechanism for evaluating non-executive Board Members
The performance evaluation of non-executive directors could be done by a peer group comprising the entire
Board of Directors, excluding the director being evaluated and Peer Group evaluation could be the mechanism
to determine whether to extend/continue the terms of appointment of non-executive directors.
Whistle Blower Policy
The company may establish a mechanism for employees to report to the management concerns about unethical
behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy. This mechanism
could also provide for adequate safeguards against victimization of employees who avail of the mechanism and
also provide for direct access to the Chairman of the Audit committee in exceptional cases. Once established,
the existence of the mechanism may be appropriately communicated within the organization.
STOCK EXCHANGE MECHANISM
Stock Exchange is an integral part of Secondary Market. The Stock Exchange is a key institution facilitating the
issue and sales of various types of securities and for this the Stock Exchange has mechanism like trading of
securities, clearing and settlement of securities through which buying and selling takes place. Further, Stock
Indices are an important part of stock market representing the performance of stock market and reflecting
investor sentiment on the state of economy. When the stock exchange opens at 9.00 a.m., there is flurry of
orders that are keyed - in from all over the world and from all strata of economic background. In this hurly burly,
turbulent and apprehensive market scenario, there are bound to be mistakes, differences and disputes. These
disputes can be between a broker, sub broker, constituents, clearing member, depositories, authorized persons,
etc. To deal with such disputes, stock exchanges have devised a dispute resolution mechanism in accordance
with the guidelines issued by SEBI from time to time.
ARBITRATION MECHANISM
Arbitration is a quasi judicial process of settlement of disputes between trading member, investor, clearing
member, sub brokers, authorized persons etc. Arbitration aims at quicker resolution of the disputes. When either
of the parties is not satisfied with the complaint resolution process or the complaint is not resolved amicably
between parties, the parties may choose the route of arbitration.
Kinds of disputes covered under Exchange Arbitration Mechanism
All disputes arising out of transactions done on the Exchange by the parties are eligible for arbitration mechanism
provided by the exchange.
Legal framework for Arbitration Mechanism provided by Exchange
Arbitration framework at Exchange is governed by the rules, Byelaws, Regulations & Circular issued by the
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exchange and SEBI, from time to time. SEBI issued circulars dated August 11, 2010 and August 31, 2010,
bringing about sweeping amendments to the manner in which arbitrations were being conducted by the stock
exchanges.
Arbitration Mechanism at Stock exchanges
A stock exchange shall provide an arbitration mechanism for settlement of disputes between a client and a
member through arbitration proceedings in accordance with the provisions of this Circular read with Section 2(4)
of the Arbitration and Conciliation, Act, 1996.
Maintenance of a Panel of Arbitrators
– A stock exchange shall maintain a panel of arbitrators. The number of arbitrators in the panel shall be
commensurate to the number of disputes so that an arbitrator handles a reasonable number of references
simultaneously and all arbitration references are disposed of within the prescribed time.
– The stock exchange shall have a set of fair and transparent criteria for inclusion of names in the panel
of arbitrators.
– While deciding to include a particular person in the panel of arbitrators, the stock exchange shall take
into account the following factors:
(i) age,
(ii) qualification in the area of law, finance, accounts, economics, management, or administration, and
(iii) experience in financial services, including securities market.
– The name of a person shall be included in the panel after obtaining:
(i) a declaration that he has not been involved in any act of fraud, dishonesty or moral turpitude, or
found guilty of any economic offence,
(ii) disclosure of the nature of his association with securities market,
(iii) disclosure of the names of his dependents associated with the securities market as member, subbroker or authorized person, and
(iv) an undertaking that he shall abide by the code of conduct as prescribed by SEBI.
– The stock exchange shall provide at least seven days of continuing education to every arbitrator each
year.
– The stock exchange shall have a mechanism to appraise the performance of arbitrators and reconstitute
the panel based on such appraisal atleast once a year.
– List of Arbitrators on the panel of all stock exchanges having nation-wide trading terminals shall be
pooled and will be called a 'Common Pool'. This list shall be made publicly available including by way of
display on websites of the stock exchanges.
– 'Common pool' of Arbitrators will consist of Arbitrators listed on the panels of all stock exchanges having
nation-wide trading terminals. The pooling of arbitrators will be done centre-wise. To illustrate, the list of
arbitrators on the panel of all stock exchanges for the region covered by the Delhi centre will be pooled.
This would enable an applicant from the region to choose any arbitrator from the 'Common Pool' for
Delhi.
– If the client and member (stock broker, trading member or clearing member) fail to choose the Arbitrator(s)
from the Common Pool, the Arbitrator(s) will be chosen by an 'Automatic Process' wherein neither the
parties to arbitration (i.e. client or member) nor the concerned Stock Exchanges will be directly involved.
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Secondary Market 211
– The 'Automatic Process' will entail a randomized, computer generated selection of Arbitrator, from the
list of Arbitrators in the 'Common Pool'. The selection process shall be in chronological order of the
receipt of arbitration reference i.e. only after selecting an arbitrator for the former arbitration reference
received, selection for the latter shall be taken up.
– The 'Automatic Process' will send a system generated, real time alert (sms, email etc.) to all entities
involved in the particular case. Further, the communication for the appointment of the Arbitrator will be
sent immediately and in any case not later than the next working day from the day of picking of the
Arbitrator. This communication will be sent by the stock exchange on which the dispute had taken place,
to all concerned entities including clients, arbitrators, members, stock exchanges etc.
Code of Conduct for Arbitrators
An arbitrator shall –
(i) act in a fair, unbiased, independent and objective manner;
(ii) maintain the highest standards of personal integrity, truthfulness, honesty and fortitude in discharge of
his duties;
(iii) disclose his interest or conflict in a particular case, i.e., whether any party to the proceeding had any
dealings with or is related to the arbitrator;
(iv) not engage in acts discreditable to his responsibilities;
(v) avoid any interest or activity which is in conflict with the conduct of his duties as an arbitrator;
(vi) avoid any activity that may impair, or may appear to impair, his independence or objectivity;
(vii) conduct arbitration proceedings in compliance with the principles of natural justice and the relevant
provisions of the Arbitration and Conciliation Act, 1996, the SEBI Act, 1992, the Securities Contracts
(Regulation) Act, 1956 and the Rules, Regulations and Bye-laws framed thereunder and the circulars,
directions issued by the Government / SEBI;
(viii) endeavour to pass arbitral award expeditiously and in any case not later than the time prescribed in this
circular; and
(ix) pass reasoned and speaking arbitral awards.
Arbitration
– The limitation period for filing an arbitration reference shall be governed by the law of limitation, i.e., The
Limitation Act, 1963.
– An arbitration reference for a claim / counter claim up to `25 lakh shall be dealt with by a sole arbitrator
while that above `25 lakh shall be dealt with by a panel of three arbitrators.
– The stock exchange shall ensure that the process of appointment of arbitrator(s) is completed within 30
days from the date of receipt of application from the applicant.
– The arbitration reference shall be concluded by way of issue of an arbitral award within four months
from the date of appointment of arbitrator(s).
– The Managing Director/ Executive Director of the stock exchange may for sufficient cause extend the
time for issue of arbitral award by not more than two months on a case to case basis after recording the
reasons for the same.
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Appellate Arbitration
– A party aggrieved by an arbitral award may appeal to the appellate panel of arbitrators of the stock
exchange against such award.
– An appeal before the appellate panel of arbitrators may be filed within one month from the date of
receipt of arbitral award.
– The appellate panel shall consist of three arbitrators who shall be different from the ones who passed
the arbitral award appealed against.
– The stock exchange shall ensure that the process of appointment of appellate panel of arbitrators is
completed within 30 days from the date of receipt of application for appellate arbitration.
– The appeal shall be disposed of within three months from the date of appointment of appellate panel of
such appeal by way of issue of an appellate arbitral award.
– The Managing Director/ Executive Director of the stock exchange may for sufficient cause extend the
time for issue of appellate arbitral award by not more than two months on a case to case basis after
recording the reasons for the same.
– A party aggrieved by the appellate arbitral award may file an application to the Court of competent
jurisdiction in accordance with Section 34 of the Arbitration and Conciliation Act, 1996.
Arbitration Fees
– Each of the parties to arbitration shall deposit an amount, as may be prescribed by the stock exchange,
at the time of making arbitration reference. The deposits (exclusive of statutory dues – stamp duty,
service tax, etc.) shall not exceed the amount as indicated under:
Amount of Claim/
of Counter Claim,
whichever is higher
(`)
If claim is filed within
six months
If claim is filed after six
months
<10,00,000
1.3% subject to a minimum of
`10,000
3.9% subject to a minimum of `30,000
>10,00,000 - <
25,00,000
` 13,000 plus 03%
amount above `10 lakh
` 39,000 plus 0.9% amount above `
10 lakh
>25,00,000
` 17,500 plus 0.2% amount
above ` 25 5 lakh subject to
maximum of `30,000
` 52,500 plus 0.6% amount above `
25 lakh subject to maximum of `
90,000
Note: six months shall be computed from the end of the quarter during which the disputed transaction(s)
were executed/ settled, whichever is relevant for the dispute.
– A client, who is a party to the arbitration for a claim/counter claim upto ` 10 lakh, shall be exempt from
the deposit provided the arbitration reference for the same is filed within six months from the end of the
quarter during which the disputed transaction(s) were executed/ settled.
– On issue of the arbitral award, the stock exchange shall refund the deposit, if any, to the party in whose
favour the award has been passed and appropriate the deposit, if any, made by the party, against whom
the award has been passed, towards arbitration fees.
– A party filing an appeal before the appellate panel shall pay a fee not exceeding ` 30,000,as may be
prescribed by the stock exchange, in addition to statutory dues (stamp duty, service tax, etc) along with
the appeal.
Lesson 6
Secondary Market 213
Place of Arbitration
– The Stock Exchanges having nationwide terminals, such as National Stock Exchange of India Ltd.,
Bombay Stock Exchange Ltd., MCX Stock Exchange Ltd., and United Stock Exchange of India Ltd.,
shall provide arbitration facility (arbitration as well as appellate arbitration) at all four regional centres
(Delhi, Mumbai, Kolkata and Chennai). The arbitration and appellate arbitration shall be conducted at
the regional centre nearest to the client.
– The application under Section 34 of the Arbitration and Conciliation Act, 1996, if any, against the decision
of the appellate panel shall be filed in the competent Court nearest to such regional centre.
– Other stock exchanges shall provide the arbitration facility, including appellate arbitration, at the place
where it is located.
Implementation of Arbitral Award in favour of Clients
– In case the arbitral / appellate arbitral award is in favour of the client, the stock exchange shall, on
receipt of the same, debit the amount of the award from the security deposit or any other monies of the
member (against whom an award has been passed) and keep it in a separate escrow account.
– The stock exchange shall implement the arbitral award, by making payment to the client, along with
interest earned on the amount that has been set aside, as soon as the time for preferring an appeal
before the appellate panel of arbitrators has expired and no appeal has been preferred.
– The stock exchange shall implement the appellate arbitral award, by making payment to the client,
along with interest earned on the amount that has been set aside, as soon as:
(a) the time for making an application to a Court to set aside such appellate arbitral award under
Section 34 of the Arbitration and Conciliation Act, 1996 has expired, and no application has been
made, or
(b) when an application to a Court to set aside such appellate arbitral award under Section 34 of the
Arbitration and Conciliation Act, 1996, having been made, it has been refused by such Court, or
(c) an application to a Court to set aside such appellate arbitral award under Section 34 of the Arbitration
and Conciliation Act, 1996, having been made, but where no stay has been granted by such Court
within a period of three months from the date on which the party making that application had received
the appellate arbitral award.
Record and Disclosures
– The stock exchange shall preserve the following documents related to arbitration:
(i) the arbitral and appellate arbitral award with acknowledgements, confirming receipt of award by the
disputing parties, permanently;
(ii) other records pertaining to arbitration for five years from the date of arbitral award, appellate arbitral
award or Order of the Court, as the case may be; and
(iii) register of destruction of records relating to (ii) above, permanently.
– The stock exchange shall disclose on its website, details of disposal of arbitration proceedings as per
the format prescribed by SEBI and details of arbitrator-wise disposal of arbitration proceedings as per
format prescribed by SEBI.
– The stock exchange shall continue to disclose on their website the arbitration awards (issued since April
1, 2007)
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Things You May Know
What happens if the appellate tribunal award is in favour of the Investor?
When the appellate tribunal is passed in favour of investor:
– Trading member may settle the award and confirm the same to the Exchange.
– Trading member can further file petition in High court under section 34 of the Arbitration and Conciliation
Act 1996. In case court dismisses the application or does not grant stay within three months from date
of filing petition , then the award amount will be released to the investor.
In which court the petition under Section 34 of the Arbitration and Conciliation Act 1996 filed?
The petition under section 34 of the Arbitration and Conciliation Act 1996 shall be filed in the competent court
nearest to regional arbitration centre situated near to the place of constituent.
MARGINING
Just as we are faced with day to day uncertainties pertaining to weather, health, traffic etc and take steps to
minimize the uncertainties, so also in the stock markets, there is uncertainty in the movement of share prices.
This uncertainty leading to risk is sought to be addressed by margining systems of stock markets.
Suppose an investor, purchases 1000 shares of ‘xyz’ company at `100/- on January 1, 2013. Investor has to
give the purchase amount of `1,00,000/- (1000 x 100) to his broker on or before January 2, 2013. Broker, in turn,
has to give this money to stock exchange on January 3, 2013.
There is always a small chance that the investor may not be able to bring the required money by required date.
As an advance for buying the shares, investor is required to pay a portion of the total amount of `1,00,000/- to
the broker at the time of placing the buy order. Stock exchange in turn collects similar amount from the broker
upon execution of the order. This initial token payment is called margin.
For every buyer there is a seller and if the buyer does not bring the money, seller may not get his / her money
and vice versa. Therefore, margin is levied on the seller also to ensure that he / she gives the 100 shares sold
to the broker who in turn gives it to the stock exchange. Margin payments ensure that each investor is serious
about buying or selling shares.
In the above example, assume that margin was 15%. That is investor has to give `15,000/-(15% of `1,00,000) to
the broker before buying. Now suppose that investor bought the shares at 11 am on January 1, 2013. Assume that
by the end of the day price of the share falls by `25/-. That is total value of the shares has come down to `75,000/
-. That is buyer has suffered a notional loss of `25,000/-. In this example buyer has paid `15,000/- as margin but
the notional loss, because of fall in price, is `25,000/-. That is notional loss is more than the margin given.
In such a situation, the buyer may not want to pay `1,00,000/- for the shares whose value has come down to
`75,000/-. Similarly, if the price has gone up by `25/-, the seller may not want to give the shares at `1,00,000/.
To ensure that both buyers and sellers fulfill their obligations irrespective of price movements, notional losses
are also need to be collected.
Prices of shares keep on moving every day. Margins ensure that buyers bring money and sellers bring shares to
complete their obligations even though the prices have moved down or up.
To execute a margin transaction, it is necessary to establish a margin account. It is opened either in the form of
cash or securities. Margin credit can be obtained from a broker or a banker, although nearly all margin trading is
done through brokers.
The broker will retain any securities purchased on margin as collateral for the loan. There are basically two
types of margin requirements: initial margin and maintenance margin.
Lesson 6
Secondary Market 215
Initial Margin
Initial margin stipulates the minimum amount of equity that must be provided by the investor at the time of
purchase. It is used to prevent overtrading and excessive speculation. Generally, it is this margin requirement
that investors refer to when discussing margin trading. Any security that can be margined has a specific initial
requirement, although these can be changed by the authorities from time to time.’
As long as the margin in an account remains at a level equal to or greater than prevailing initial requirements, the
investor is free to use the account in any way he or she sees fit. If the value of the investor’s holdings declines,
the margin in his or her account will also drop.
This situation can lead to what is known as a restricted account, one whose equity is less than the initial margin
requirement. It does not mean that the investor must put up additional cash or equity, but it does require the
investor to bring the margin back to the initial level when securities are sold while the account is restricted.
Maintenance Margin
Maintenance margin is the absolute minimum amount of margin (equity) that an investor must maintain in the
margin account at all times. If the margin falls below the maintenance margin, the broker is authorized to sell
enough of the securities to bring the account back up to standard.
When an insufficient amount of maintenance margin exists, an investor will receive a margin call to remedy the
situation. This call gives the investor a short period of time to find some means to bringing the equity up to the
required level. If this is not done, the broker has no alternative but to sell enough of the investor’s margined
holdings to bring the equity in the account up to this level.
The maintenance margin protects both the brokerage house and investors: Brokers avoid having to absorb
excessive investor losses, and investors avoid being wiped out. The maintenance margin on equity securities
rarely changes, although it is often set slightly higher by brokerage houses for the added protection of both
brokers and their customers. For straight debt securities, generally there is no official maintenance margin
except that set by the brokerage houses themselves.
TYPES OF MARGINS IN CASH AND DERIVATIVE SEGMENT
Margins in the cash market segment comprise of the following three types:
– Value at Risk (VaR) margin
– Extreme loss margin
– Mark to market Margin
Value at Risk (VaR) margin
VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example
a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities.
A VaR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage).
Example
Let us assume that an investor bought shares of a company. Its market value today is `50 lakhs. Obviously, we
do not know what would be the market value of these shares next day. An investor holding these shares may,
based on VaR methodology, say that 1-day VaR is `4 lakhs at the 99% confidence level. This implies that under
normal trading conditions the investor can, with 99% confidence, say that the value of the shares would not go
down by more than `4 lakhs within next 1-day.
In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss (in %) that may be
216 PP-CC&MM
faced by an investor for his / her shares (both purchases and sales) on a single day with a 99% confidence level.
The VaR margin is collected on an upfront basis (at the time of trade).
Extreme Loss Margin
The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins. The
Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LN (Natural Log) returns
of the stock price in the last six months or 5% of the value of the position.
This margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis for the past
six months.
Things You May Know
LN Return
LN is a natural log function in excel, it is used in calculating daily returns of a stock price.
Example
The VaR margin rate for shares of ABC Ltd. is 13%. Suppose that standard deviation of daily LN returns of the
security is 3.1%. 1.5 times standard deviation would be 1.5 x 3.1 = 4.65. Then 5% (which is higher than 4.65%)
will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13%
VaR Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR margin + extreme loss margin) on
a trade of `10 lakhs would be 1,80,000/-.
Mark-to-Market (MTM) margin
MTM is calculated at the end of the day on all open positions by comparing transaction price with the closing
price of the share for the day.
Example
A buyer purchased 1000 shares @ `100/- at 11 am on January 1, 2013. If close price of the shares on that day
happens to be `75/-, then the buyer faces a notional loss of `25,000/- on his buy position. In technical terms this
loss is called as MTM loss and is payable by January 2, 2013 (that is next day of the trade) before the trading
begins.
In case price of the share falls further by the end of January 2, 2013 to ` 70/-, then buy position would show a
further loss of `5,000/-. This MTM loss is payable by next day.
In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position is zero, but there
could still be a notional loss / gain (due to difference between the buy and sell values), such notional loss also is
considered for calculating the MTM payable.
MTM Profit/Loss = [(Total Buy Qty X Close price) – Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close
price)]
DERIVATIVES SEGMENT
There are 3 types of margin levied by the exchanges in case of derivative contracts.
– Initial Margin
– Exposure Margin
– Premium Margin
Lesson 6
Secondary Market 217
Initial Margin
This margin is calculated on a portfolio basis and not on individual scrip basis. The margin calculation is done
using SPAN (Standard Portfolio Analysis of Risk) a product developed by Chicago Mercantile Exchange. The
margin is levied at trade level on real-time basis. The rates are computed at 5 intervals one at the beginning of
the day 3 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, inter-month risk and
inter-commodity risk.
Initial margin requirements are based on 99% value at risk over a one-day time horizon. However, in the case of
futures contracts (on index or individual securities), where it may not be possible to collect mark to market
settlement value, before the commencement of trading on the next day, the initial margin may be computed over
a two-day time horizon, applying the appropriate statistical formula.
Exposure Margin
This 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.
Premium Margin
In case of option purchase the margin levied will be equivalent to the premium amount. This margin will be levied
till the time premium settlement is complete.
TRADING OF SECURITIES
The act of buying and selling of securities on a stock exchange is known as stock market trading. Following are
the steps involved in the trading of securities at a stock exchange :
Order Placing
The first and foremost step in the trading of securities is placement of an order by an investor with the broker
concerned either to buy or sell certain number of scrips at a certain specified price.
There are various kinds of orders. For instance, where in an order, the client places a limit on the price of the
security; it is a case of ‘limit order’. Where the order is to be executed by the broker at the best price, such an
order takes the name of ‘Best Rate Order’. An ‘Immediate or Cancel Order’ is one that has to be executed
immediately and may have to be cancelled if the order is not executed immediately. A Limited Discretionary
Order allows the broker to buy and sell within the specified price range and/or within the given time period as per
the best judgement of the broker. Where the client orders the broker to sell as the price reaches a particular
level, it is a case of ‘Stop Loss Order’. Under the ‘Open Order’, the client does not fix any price limit or time limit
on the execution of the order and relies on the judgement of the broker.
Order Execution
Brokers execute the orders placed by the clients for the purchase or sale of scrips. The execution takes place
during the trading hours and during the working days of the exchange. However, the trading after the normal
working hours may also take place and this is termed ‘as kerb trading’.
Entry to the trading floor of the exchange is restricted only to the identified and regular members of the exchange.
Such a member is called a ‘single jobber’ or ’tarawaniwala’ for a particular script. In respect of actively traded
scripts that involve a huge volume of business, there could be more than one jobber. Jobbers offer two-day
218 PP-CC&MM
quotes for scripts they deal in. This way, jobbers act as market-makers and provide liquidity to the market. The
order is executed either by auction or negotiation. Settlement of a transaction takes place by a mutual agreement
of the price between the parties concerned. Such prices are published in the newspaper every day.
Contract Note Preparation
When once an agreement is reached between the parties concerned as regards price, a contract note is made
out between the broker and the client. Such a note forms the basis of the transactions recorded in the ‘Pucca
Sauda Book’ after the execution of the order. Particulars such as the price, number of scrips, date of transaction,
names of parties, brokerage, etc. are found in the note
Delivery and Clearing
After the preparation of the contract note, delivery of share takes place through the instrument known as ‘transfer
deed’. The transfer deed is signed by the transferor (seller) and is authenticated by a witness. It contains the
details of the transferee, besides bearing the stamp of the selling broker. There different kinds of delivery. For
instance, in the case of ‘spot delivery,’ the transaction is settled by delivery and payment takes place on the date
of the contract or the next day. In the case of ‘hand delivery’, delivery and payment are completed within 14 days
from the date of contract. Delivery and payment may be completed after 14 days as specified at the time of the
bargain in the case of ‘specified or special delivery’. Delivery and clearing of security takes place through a
clearance house.
Share Transfer
For the purpose of effecting the transfer in the name of the transferee, the share certificate and the transfer deed
are lodged with the Company. The parties also pay necessary stamp duty. The company issues the share
certificate bearing a new ledger folio number, transfer number, date and buyer’s name at the reverse of the
certificate. The appropriate authority of the company endorses these particulars.
SETTLEMENT SYSTEM
Settlement is the process of netting of transactions and actual delivery or receipt of securities against receipts of
payment of agreed amounts. It is necessary to make a settlement to know the net effect of a series of transactions
during a given period.
There are two types of settlement systems that can be adopted in stock exchanges – Accounting period system
and rolling settlement system. Now-a-days, stock exchange in India adopts rolling settlement only.
(a) Accounting period settlement systems – There is a predetermined period of usually 7 – 12 days, over which total trades are aggregated.
– Cumulative net obligations of each member are calculated on last day of cycle.
– It is more speculative than the rolling settlements. It may lead to payment crisis in case of wide fluctuations
in the market.
(b) Rolling Settlement
In this system, each day constitutes the settlement period (T+2 System). Under rolling settlements, unlike the
account period settlements the trades done on a particular day are settled after a given number of business
days instead of settling all trades done during an account period of a week or fortnight. In case of Rolling
Settlements, pay-in and pay-out of both funds and securities is completed on the same day. Each trading day is
considered as a trading period and trades executed during the day are settled to obtain the net obligations for
the day in a rolling settlement.
Lesson 6
Secondary Market 219
CLEARING AND SETTLEMENT
The transactions in secondary market pass through three distinct phases, viz., trading, clearing and settlement.
While the stock exchanges provide the platform for trading, the clearing corporation determines the funds and
securities obligations of the trading members and ensures that the trade is settled through exchange of obligations.
The clearing banks and the depositories provide the necessary interface between the custodians/clearing
members for settlement of funds and securities obligations of trading members. Several entities, like the clearing
corporation, clearing members, custodians, clearing banks, depositories are involved in the process of clearing.
The role of each of these entities is explained below:
– Clearing Corporation: The clearing corporation is responsible for post-trade activities such as risk
management and clearing and settlement of trades executed on a stock exchange.
– Clearing Members(CM): Clearing Members are responsible for settling their obligations as determined
by the clearing corporation. They do so by making available funds and/or securities in the designated
accounts with clearing bank/ depositories on the date of settlement.
– Custodians: Custodians are clearing members but not trading members. They settle trades on behalf
of trading members, when a particular trade is assigned to them for settlement. The custodian is required
to confirm whether he is going to settle that trade or not. If the custodian confirm to settle that trade, then
clearing corporation assigns that particular obligation to him.
– Clearing Banks: Clearing banks are a key link between the clearing members and Clearing Corporation
to effect settlement of funds. Every clearing member is required to open a dedicated clearing account
with one of the designated clearing banks. Based on the clearing member’s obligation as determined
through clearing, the clearing member makes funds available in the clearing account for the pay-in and
receives funds in case of a pay-out.
– Depositories: Depository holds securities in dematerialized form for the investors in their beneficiary
accounts. Each clearing member is required to maintain a clearing pool account with the depositories.
He is required to make available the required securities in the designated account on settlement day.
The depository runs an electronic file to transfer the securities from accounts of the custodians/clearing
member to that of Clearing corporation and vice-versa as per the schedule of allocation of securities.
CLEARING & SETTLEMENT PROCESS
The clearing process involves determination of what counter-parties owe, and which counter-parties are due to
receive on the settlement date, thereafter the obligations are discharged by settlement. The clearing and settlement
process comprises of three main activities- clearing, settlement and risk management.
The clearing and settlement process for transaction in securities is given below:
1. Trade details from Exchange to Clearing Corporation (real-time and end of day trade file).
2. Clearing Corporation notifies the consummated trade details to clearing members/custodians who affirm
back. Based on the affirmation, Clearing Corporation applies multilateral netting and determines
obligations.
3. Download of obligation and pay-in advice of funds/securities.
4. Instructions to clearing banks to make funds available by pay-in time.
5. Instructions to depositories to make securities available by pay-in-time.
6. Pay-in of securities (Clearing Corporation advises depository to debit pool account of custodians/CMs
and credit its account and depository does it)
220 PP-CC&MM
7. Pay-in of funds (Clearing Corporation advises Clearing Banks to debit account of custodians/CMs and
credit its account and clearing bank does it)
8. Pay-out of securities (Clearing Corporation advises depository to credit pool account of custodians/
CMs and debit its account and depository does it)
9. Pay-out of funds (Clearing Corporation advises Clearing Banks to credit account of custodians/CMs
and debit its account and clearing bank does it)
10. Depository informs custodians/CMs through DPs.
11. Clearing Banks inform custodians/CMs.
The core processes involved in clearing and settlement include:
(a) Trade Recording: The key details about the trades are recorded to provide basis for settlement. These
details are automatically recorded in the electronic trading system of the exchanges.
(b) Trade Confrmation: The parties to a trade agree upon the terms of trade like security, quantity, price,
and settlement date, but not the counterparty which is the Clearing Corporation. The electronic system
automatically generates confirmation by direct participants.
(c) Determination of Obligation: The next step is determination of what counter-parties owe, and what
counterparties are due to receive on the settlement date. The Clearing Corporation interposes itself as
a central counterparty between the counterparties to trades and nets the positions so that a member
has security wise net obligation to receive or deliver a security and has to either pay or receive funds.
The settlement process begins as soon as members’ obligations are determined through the clearing
process. The settlement process is carried out by the Clearing Corporation with the help of clearing
banks and depositories. The Clearing Corporation provides a major link between the clearing banks
and the depositories. This link ensures actual movement of funds as well as securities on the prescribed
pay-in and pay-out day.
(d) Pay-in of Funds and Securities: This requires members to bring in their funds/securities to the clearing
corporation. The CMs make the securities available in designated accounts with the two depositories
(CM pool account in the case of NSDL and designated settlement accounts in the case of CDSL). The
depositories move the securities available in the pool accounts to the pool account of the clearing
corporation. Likewise CMs with funds obligations make funds available in the designated accounts with
clearing banks. The clearing corporation sends electronic instructions to the clearing banks to debit
designated CMs’ accounts to the extent of payment obligations. The banks process these instructions,
debit accounts of CMs and credit accounts of the clearing corporation. This constitutes pay-in of funds
and of securities.
(e) Pay-out of Funds and Securities: After processing for shortages of funds/securities and arranging for
movement of funds from surplus banks to deficit banks through RBI clearing, the clearing corporation
sends electronic instructions to the depositories/clearing banks to release pay-out of securities/funds.
The depositories and clearing banks debit accounts of the Clearing Corporation and credit accounts of
CMs. This constitutes pay-out of funds and securities. Settlement is deemed to be complete upon
declaration and release of pay-out of funds and securities.
TRADE GUARANTEE FUND
Trade or Settlement Guarantee Fund means a fund whose objective is to provide the necessary funds and
ensure timely completion of settlements in cases of failure of member brokers to fulfill their settlement obligations.
Thus establishment of such funds would give greater confidence to investors in the settlement and clearing
procedures of the stock exchanges. Keeping this objective in view, SEBI had advised all stock exchanges to set
Lesson 6
Secondary Market 221
up a Trade or Settlement Guarantee Fund to ensure that the market equilibrium is not disturbed in case of
payment default by the members. Accordingly Stock Exchange have instituted a system to guarantee settlement
of bonafide transactions of Members which form part of the settlement system.
TRADING SOFTWARE
Trading software means computer programs that facilitate trading of financial products such as stocks and
currencies. Software is usually provided by brokerage firms that enable their clients to trade financial products
and manage their accounts. Different brokerages will have different software which determines the interface in
which trades are made and information is searched. Other software can be purchased from third parties to
enhance or add to what a brokerage provides. Trading software is aimed to help investors improve their stock
picking decisions through its fundamental analysis and advanced technical analysis. Stock market trading software
is relied on by traders to pick out shares quickly and is highly recommend to all types of traders.
STOCK MARKET INDICES
Stock Indices represents the performance of stock market and by proxy, reflects investor sentiment on the state
of the economy. An Index is used to give information about the price movements of products in the financial,
commodities or any other markets. A stock market index is created by selecting a group of stocks that are
representative of the whole market or a specified sector or segment of the market.
Stock indices are barometers to measure general economic performance of an particular country / sector. It’s
updated every second throughout on every trading so as to reflect the exact picture of the economy. It’s also a
permanent record of the history of markets – it’s highs and lows, booms and crashes. A stock index is created by
selecting a group of high performing stocks. Irrespective of the type of index, the purpose of any index is the
same. It provides to the public, a quick view of how the economy (based on which the index is constructed) is
functioning. An index is calculated with reference to a base period and a base index value.
TYPES OF INDICES
There are different types of indices. Stock indices can be constructed –
– For the entire world (global indices) – For an entire continent (regional indices – for example S&P Latin
America 40)
– For an entire country (national indices – for example Sensex & Nifty for India)
– For a particular sector in a country – (sectoral indices – for example BSE BANKEX which tracks top
banking companies in India)
– For any other theme / group of economy / companies (example Dow Jones Islamic world market index)
BSE Indices
– Broad Indices- S&P BSE SENSEX, S&P BSE MID CAP, S&P BSE SMALL CAP, S&P BSE 100, S&P
BSE 200, S&P BSE 500
– Investment Strategy Indices- S&P BSE IPO, S&P BSE SME IPO, S&P BSE DOLLEX 30, S&P BSE
DOLLEX 100, S&P BSE DOLLEX 200
– Volatility Indices- S&P BSE REALVOL-1MTH, S&P BSE REALVOL-2MTH, S&P BSE REALVOL-3MTH
– Thematic Indices- S&P BSE GREENEX, S&P BSE CARBONEX
– Sectoral Indices- S&P BSE AUTO, S&P BSE BANKEX, S&P BSE CAPITAL GOODS, S&P BSE
CONSUMER DURABLES, S&P BSE FMCG, S&P BSE HEALTHCARE, S&P BSE IT, S&P BSE METAL,
S&P BSE OIL & GAS, S&P BSE POWER, S&P BSE PSU, S&P BSE REALTY, S&P BSE TECK
222 PP-CC&MM
NSE Indices
– Broad Market Indices- CNX Nifty, CNX Nifty Junior, LIX 15, CNX 100, CNX 200, CNX 500, Nifty Midcap
50, CNX Midcap, CNX Smallcap
– Sectoral Indices- CNX Auto, CNX Bank, CNX Energy, CNX Finance, CNX FMCG, CNX IT, CNX Media,
CNX Metal, CNX Pharma, CNX PSU Bank, CNX Realty
– Thematic Indices- CNX Commodities, CNX Consumption, CNX Infrastructure, CNX MNC, CNX PSE,CNX
Service Sector, S&P ESG india Index
– Strategy Indices- CNX 100 Equal Weight, CNX Alpha Index, CNX Dividend Opportunities, CNX High
Beta Index, CNX Low Volatility Index, CNX Nifty Dividend
BSE INDICES
Sensex stands for "sensitive index", it represents BSE (Bombay Stock Exchange). Sensex indicates all major
companies of BSE. Sensex is calculated using share prices of 30 major companies which are listed in BSE. If
the Sensex goes up it means that share values of most of the major companies have gone up and vice versa.
The launch of SENSEX in 1986 was followed up in January 1989 by introduction of BSE National Index (Base:
1983-84 = 100). It comprised 100 stocks listed at five major stock exchanges in India - Mumbai, Calcutta, Delhi,
Ahmedabad and Madras. The BSE National Index was renamed BSE-100 Index from October 14, 1996 and
since then, it is being calculated taking into consideration only the prices of stocks listed at BSE. BSE launched
the dollar-linked version of BSE-100 index on May 22, 2006.
With a view to provide a better representation of the increasing number of listed companies, larger market
capitalization and the new industry sectors, BSE launched on 27th May, 1994 two new index series viz., the
‘BSE-200’ and the ‘DOLLEX-200’. Since then, BSE has come a long way in attuning itself to the varied needs of
investors and market participants. In order to fulfill the need for still broader, segment-specific and sectorspecific indices, BSE has continuously been increasing the range of its indices. BSE-500 Index and 5 sectoral
indices were launched in 1999. In 2001, BSE launched BSE-PSU Index, DOLLEX-30 and the country’s first
free-float based index - the BSE TECk Index. Over the years, BSE shifted all its indices to the free-float methodology
(except BSE-PSU index).
Sensex
Things You May Know
Market Capitalisation
Market capitalization is the total worth of all outstanding (issued) shares of a company. It represents the total
worth of a company.
Market Capitalization= No. of shares outstanding x Market price of share
S&P BSE SENSEX, first compiled in 1986, was calculated on a “Market Capitalization-Weighted” methodology
of 30 component stocks representing large, well-established and financially sound companies across key sectors.
The base year of S&P BSE SENSEX was taken as 1978-79. S&P BSE SENSEX today is widely reported in both
domestic and international markets through print as well as electronic media. It is scientifically designed and is
based on globally accepted construction and review methodology. Since September 1, 2003, S&P BSE SENSEX
is being calculated on a free-float market capitalization methodology. The “free-float market capitalization-weighted”
methodology is a widely followed index construction methodology on which majority of global equity indices are
based; all major index providers like MSCI, FTSE, STOXX, and Dow Jones use the free-float methodology.
Lesson 6
Secondary Market 223
Index Specification
Base Year
1978-79
Base Index Value
100
Date of Launch
01-01-1986
Method of calculation
Launched on full market capitalization method and effective September 01,
2003, calculation method shifted to free-float market capitalization.
Number of scrips
30
SENSEX - Scrip Selection Criteria
The general guidelines for selection of constituents in SENSEX are as follows:
1. Listed History:The scrip should have a listing history of at least 3 months at BSE. Exception may be
considered if full market capitalization of a newly listed company ranks among top 10 in the list of BSE
universe. In case, a company is listed on account of merger/ demerger/ amalgamation, minimum listing
history would not be required.
2. Trading Frequency:The scrip should have been traded on each and every trading day in the last three
months at BSE. Exceptions can be made for extreme reasons like scrip suspension etc.
3. Final Rank:The scrip should figure in the top 100 companies listed by final rank. The final rank is
arrived at by assigning 75% weightage to the rank on the basis of three-month average full market
capitalization and 25% weightage to the liquidity rank based on three-month average daily turnover &
three-month average impact cost.
4. Market Capitalization Weightage:The weightage of each scrip in SENSEX based on three-month
average free-float market capitalization should be at least 0.5% of the Index.
5. Industry/Sector Representation:Scrip selection would generally take into account a balanced
representation of the listed companies in the universe of BSE.
6. Track Record:In the opinion of the BSE Index Committee, the company should have an acceptable
track record.
S & P BSE SENSEX Calculation Methodology
S&P BSE SENSEX is calculated using the “Free-float Market Capitalization” methodology, wherein, the level of
index at any point of time reflects the free-float market value of 30 component stocks relative to a base period.
The market capitalization of a company is determined by multiplying the price of its stock by the number of
shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine
the free-float market capitalization.
The base period of S&P BSE SENSEX is 1978-79 and the base value is 100 index points. This is often indicated
by the notation 1978-79=100. The calculation of S&P BSE SENSEX involves dividing the free-float market
capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to
the original base period value of the S&P BSE SENSEX. It keeps the Index comparable over time and is the
adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During
market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to
calculate S&P BSE SENSEX on a continuous basis.
Definition of Free-float
Shareholdings of investors that would not, in the normal course, come into the open market for trading are
224 PP-CC&MM
treated as ‘Controlling/ Strategic Holdings’ and hence not included in free-float. Specifically, the following categories
of holding are generally excluded from the definition of Free-float:
– 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 shareholders fall under the Free-float category.
Example
Company “XYZ Ltd’ issues 10000 shares, out of which 2000 shares held by government, 5000 shares by
directors of the company and remaining 3000 shares are available in the open market for trading. Market price
of share is ` 100
Here;
Total Shares = 10000
Shares Held by Government = 2000
Shares Held by Directors = 5000
Shares available in the Open Market = 3000 Market price of share = ` 100
Here total market capitalization of the company is 10,000 X ` 100 = ` 10,00,000 and Free float market capitalization
of the company is 3000 X ` 100 = ` 300,000
According to the rules of BSE any shares which do not fall under the following categories are considered as free
float (open market) shares.
– Government holding shares as promoters Holdings by Directors/ Founders Holdings through the FDI
route
– Stakes held by private corporate bodies or individuals.
– Any cross holdings i.e. equity held by associate or group companies. Equity held by employee welfare
trust.
Understanding Free-float Methodology Concept
Free-float Methodology refers to an index construction methodology that takes into consideration only the
free-float market capitalization of a company for the purpose of index calculation and assigning weight to
stocks in the Index. Free-float market capitalization takes into consideration only those shares issued by the
company that are readily available for trading in the market. It generally excludes promoters’ holding,
government holding, strategic holding and other locked-in shares that will not come to the market for trading
in the normal course. In other words, the market capitalization of each company in a Free-float index is
reduced to the extent of its readily available shares in the market. Subsequently all BSE indices with the
exception of BSE PSU index have adopted the free-float methodology.
Lesson 6
Secondary Market 225
Major Advantages of Free-float Methodology
– A Free-float index reflects the market trends more rationally as it takes into consideration only those
shares that are available for trading in the market.
– Free-float Methodology makes the index more broad-based by reducing the concentration of top few
companies in Index.
– A Free-float index aids both active and passive investing styles. It aids active managers by enabling
them to benchmark their fund returns vis-à-vis an investible index. This enables an apple-to-apple
comparison thereby facilitating better evaluation of performance of active managers. Being a perfectly
replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive managers as it
enables them to track the index with the least tracking error.
– Free-float Methodology improves index flexibility in terms of including any stock from the universe of
listed stocks. This improves market coverage and sector coverage of the index. For example, under a
full-market capitalization methodology, companies with large market capitalization and low free-float
cannot generally be included in the Index because they tend to distort the index by having an undue
influence on the index movement. However, under the free-float Methodology, since only the free-float
market capitalization of each company is considered for index calculation, it becomes possible to include
such closely held companies in the index while at the same time preventing their undue influence on the
index movement.
– Globally, the free-float Methodology of index construction is considered to be an industry best practice
and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same. MSCI, a
leading global index provider, shifted all its indices to the Free-float Methodology in 2002. The MSCI
India Standard Index, which is followed by Foreign Institutional Investors (FIIs) to track Indian equities,
is also based on the Free-float Methodology. NASDAQ-100, the underlying index to the famous Exchange
Traded Fund (ETF) - QQQ is based on the Free-float Methodology.
Determining Free-float Factors of Companies
BSE has designed a Free-float format, which is filled and submitted by all index companies on a quarterly basis.
BSE determines the Free-float factor for each company based on the detailed information submitted by the
companies in the prescribed format. Free-float factor is a multiple with which the total market capitalization of a
company is adjusted to arrive at the Free-float market capitalization. Once the Free-float of a company is
determined, it is rounded-off to the higher multiple of 5 and each company is categorized into one of the 20
bands given below. A Free-float factor of say 0.55 means that only 55% of the market capitalization of the
company will be considered for index calculation.
Free-float Bands
% Free-Float
Free-Float Factor%
Free-Float
Free-Float Factor
>0 – 5%
0.05
>50 – 55%
0.55>
5 – 10%
0.10
>55 – 60%
0.60
>10 – 15%
0.15
>60 – 65%
0.65
>15 – 20%
0.20
>65 – 70%
0.70
>20 – 25%
0.25
>70 – 75%
0.75
>25 – 30%
0.30
>75 – 80%
0.80
>30 – 35%
0.35
>80 – 85%
0.85
226 PP-CC&MM
>35 – 40%
0.40
>85 – 90%
0.90
>40 – 45%
0.45
>90 – 95%
0.95
>45 – 50%
0.50
>95 – 100%
1.00
Formula for Calculation of Index
All BSE indices (except BSE-PSU index) are calculated using following formula:
Free-float market capitalization of index constituents/ Base Market capitalization * Base Index Value
Example
Suppose BSE index (SENSEX) consist of only two stocks such as ‘X’ and ‘Y’
Company ‘X’ has 10000 outstanding shares out of which only 5000 are available for trading in open market.
Market price of share is `100.
Company ‘Y’ has 5000 outstanding shares out of which 2000 shares are held by promoters and remaining 3000
are free float shares (open market shares). Market price of share is `10.
Calculation of Market Capitalization
Stock
Issued Stocks
Market price
Market Cap.
X
10000
100
1000000
Y
5000
50
250000
Calculation of Free Float market capitalization
Stock
Open Market Stocks
Market price
Market Cap.
X
5000
100
500000
Y
2000
50
100000
Here;
Sum of free float market cap of company X and company Y is 500000+100000 = 600000. Assume market cap
during 1978-79 is 500000.
Now Applying formula;
600000*100/500000 = 120
For calculation of BSE-PSU index, full market capitalization of index constituents is considered instead of freefloat market capitalization. Dollex-30, Dollex-100 and Dollex-200 are dollar-linked versions of SENSEX, BSE100 and BSE-200 index.
BSE IPO index & BSE TASIS Shariah 50 Index is calculated using following formula:
Capped market capitalization of index constituents/ Base Market capitalization * Base Index Value
Where capped market capitalisation for scrips in BSE IPO Index and BSE TASIS Shariah 50 Index is arrived by
multiplying free-float adjusted market capitalisation of individual scrip with its respective capping factor. Such
capping factor is assigned to the index constituent to ensure that no single scrip based on its free-float market
capitalisation exceeds weightage of 20% in case BSE IPO Index and 8% in case of BSE TASIS Shariah 50
Index at the time of rebalancing. In case, weightage of all the constituents in the index is below 20% & 8%
respectively, each company would be assigned capping factor of 1.
Lesson 6
Secondary Market 227
Index Closure Algorithm
The closing index value on any trading day is computed taking the weighted average of all the trades of index
constituents in the last 30 minutes of trading session. If an index constituent has not traded in the last 30
minutes, the last traded price is taken for computation of the index closure. If an index constituent has not traded
at all in a day, then its last day’s closing price is taken for computation of index closure. The use of index closure
algorithm prevents any intentional manipulation of the closing index value.
Maintenance of BSE Indices
One of the important aspects of maintaining continuity with the past is to update the base year average. The
base year value adjustment ensures that replacement of stocks in Index, additional issue of capital and other
corporate announcements like ‘rights issue’ etc. do not destroy the historical value of the index. The beauty of
maintenance lies in the fact that adjustments for corporate actions in the Index should not per se affect the index
values.
The Department of BSE Indices does the day-to-day maintenance of the index within the broad index policy
framework set by the BSE Index Committee. Department of BSE Indices ensures that all BSE Indices maintain
their benchmark properties by striking a delicate balance between frequent replacements in index and maintaining
its historical continuity. The BSE Index Committee comprises capital market expert, fund managers, market
participants, members of BSE Governing Board.
On - Line Computation of the Index
During trading hours, value of the indices is calculated and disseminated on real time basis. This is done
automatically on the basis of prices at which trades in index constituents are executed.
Adjustment for Bonus, Rights and Newly Issued Capital
Index calculation needs to be adjusted for issue of bonus and rights issue. If no adjustments were made, a
discontinuity would arise between the current value of the index and its previous value despite the non-occurrence
of any economic activity of substance. At the BSE Index Cell, the base value is adjusted, which is used to alter
market capitalization of the component stocks to arrive at the index value.
The BSE Indices Department keeps a close watch on the events that might affect the index on a regular basis
and carries out daily maintenance of all BSE Indices.
– Adjustments for Rights Issues
When a company, included in the compilation of the index, issues right shares, the free-float market
capitalization of that company is increased by the number of additional shares issued based on the
theoretical (ex-right) price. An offsetting or proportionate adjustment is then made to the Base Market
capitalization.
– Adjustments for Bonus Issue
When a company, included in the compilation of the index, issues bonus shares, the market capitalization
of that company does not undergo any change. Therefore, there is no change in the Base Market
capitalization; only the ‘number of shares’ in the formula is updated.
– Other Issues
Base Market capitalization Adjustment is required when new shares are issued by way of conversion of
debentures, mergers, spin-offs etc. or when equity is reduced by way of buy-back of shares, corporate
restructuring etc.
228 PP-CC&MM
Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows:
New Base Market capitalization = Old Base Market
capitalization
New Market capitalization
x
—————————————
Old Market capitalization
To illustrate, suppose a company issues additional shares, which increases the market capitalization of the
shares of that company by say, `100 crore. The existing Base Market capitalization (Old Base Market
capitalization), say, is `2450 crore and the aggregate market capitalization of all the shares included in the index
before this issue is made is, say `4781 crore. The “New Base Market capitalization” will then be:
2450 x (4781+100)
—————————
4781
=
` 2501.24 crores
This figure of ` 2501.24 crore will be used as the Base Market capitalization for calculating the index number
from then onwards till the next base change becomes necessary.
CNX NIFTY
The CNX Nifty is the flagship index on the National Stock Exchange of India Ltd. (NSE). The Index tracks the
behavior of a portfolio of blue chip companies, the largest and most liquid Indian securities. It includes 50 of the
approximately 1600 companies listed on the NSE, captures approximately 65% of its float-adjusted market
capitalization and is a true reflection of the Indian stock market. The CNX Nifty covers 21 sectors of the Indian
economy and offers investment managers exposure to the Indian market in one efficient portfolio. The Index has
been trading since April 1996 and is well suited for benchmarking, index funds and index-based derivatives. It is
calculated using base year 1995 and base index value 1000.
Selection Criteria for CNX Nifty
Selection of the index set is based on the following criteria:
– Liquidity: For inclusion in the index, the security should have traded at an average impact cost of 0.50
% or less during the last six months, for 90% of the observations.
Impact cost is the cost of executing a transaction in a security in proportion to its index weight, measured
by market capitalization at any point in time. This is the percentage mark up suffered while buying/
selling the desired quantity of a security compared to its ideal price — (best buy + best sell)/2.
– Float -Adjusted Market Capitalization: Companies eligible for inclusion in the CNX Nifty must have at
least twice the float-adjusted market capitalization of the current smallest index constituent.
– Float: Companies eligible for inclusion in the CNX Nifty should have at least 10% of its stock available
to investors (float). For this purpose, float is stocks which are not held by the promoters and associated
entities (where identifiable) of such companies.
– Domicile: The company must be domiciled in India and trade on the NSE.
– Eligible Securities: All common shares listed on the NSE (which are of equity and not of a fixed income
nature) are eligible for inclusion in the CNX Nifty index. Convertible stock, bonds, warrants, rights, and
preferred stock that provide a guaranteed fixed return are not eligible.
– Other Variables .A company which comes out with an IPO is eligible for inclusion in the index if it fulfills
the normal eligibility criteria for the index — impact cost, float-adjusted market capitalization and float —
Lesson 6
Secondary Market 229
for a three-month period instead of a six-month period.
Price Index Calculations Formula
The CNX Nifty is computed using market capitalisation weighted method wherein the level of the Index reflects
the total market value of all the stocks in the Index relative to the base period November 3,1995.
Free Float Market Capitalization = Equity Capital * Price * IWF (Investible Weight Factors)
Index Value = Current Market Value / Base Market Capital * Base Index Value (1000)
Base market capital of the Index is the aggregate market capitalisation of each scrip in the Index during the base
period. The market cap during the base period is equated to an Index value of 1000 known as the base Index
value.
INVESTIBLE WEIGHT FACTORS (IWFS)
IWF as the term suggests is a unit of floating stock expressed in terms of a number available for trading and
which is not held by the entities having strategic interest in a company. Higher IWF suggest greater number of
shares held by the investors as reported under public category within a shareholding pattern reported by each
company.
The IWFs for each company in the index are determined based on the public shareholding of the companies as
disclosed in the shareholding pattern submitted to the stock exchanges on quarterly basis. The following categories
are excluded from the free float factor where identifiable separately:
– Shareholding of promoter and promoter group
– Government holding in the capacity of strategic investor
– Shares held by promoters through ADR/GD`
– Strategic stakes by corporate bodies
– Investments under FDI category
– Equity held by associate/group companies (cross-holdings)
– Employee Welfare Trusts
– Shares under lock-in category
Example
For XYZ Ltd.
Total Shares
Shares
%
1,00,00,000
100.00
Shareholding of promoter and promoter group
Government holding in the capacity of strategic investor
Shares held by promoters through ADR/GDRs.
Equity held by associate/group companies (cross-holdings)
Employee Welfare Trusts
Shares under lock-in category
Shares
%
19,75,000
19.75
50,000
0.50
2,50,000
2.50
12,575
0.13
1,45,987
1.46
14,78,500
14.79
230 PP-CC&MM
IWF = [1,00,00,000 – (19,75,000 + 50,000 +2,50,000 +12,575 +1,45,987 +14,78,500)] / 1,00,00,000. =0.60870
LESSON ROUND UP
– Secondary market refers to a market where securities are traded after being initially offered to the
public in the primary market and/or listed on the Stock Exchange.
– Corporate action is a process by which a company gives benefits to the investors who are holding
securities of the company.
– A company is required to give notice for corporate action under clause 16 of the Listing agreement.
– A listed company as a continuous listing requirement has to comply with Rule 19 (2)(b) and 19 A of the
SCRR, 1957 along with Clause 40A and 40 B of the Equity Listing Agreement.
– Clause 36 of the listing agreement deals with the material events which are required to be intimated to
the stock exchange by a company.
– Every Listed Company under Clause 41 of the Listing Agreement is required to furnish unaudited
quarterly results on a quarterly basis in the prescribed format to the concerned Stock Exchanges
within forty five days of the end of the quarter.
– Corporate Governance may be defined as a set of systems, processes and principles which ensure
that a company is governed in the best interest of all stakeholders. It is the system by which companies
are directed and controlled.
– Arbitration is a quasi judicial process of settlement of disputes between trading member, investor,
clearing member, sub brokers, authorized persons etc.
– Arbitration framework at Exchange is governed by the rules, Byelaws, Regulations &Circular issued
by the exchange and SEBI, from time to time.
– VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for
example a share or a portfolio of a few shares), based on the statistical analysis of historical price
trends and volatilities.
– The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR
margins.
– Mark-to-Market (MTM) margin is calculated at the end of the day on all open positions by comparing
transaction price with the closing price of the share for the day.
– The act of buying and selling of securities on a stock exchange is known as stock market trading.
– Settlement is the process of netting of transactions and actual delivery or receipt of securities against
receipts of payment of agreed amounts.
– The transactions in secondary market pass through three distinct phases, viz., trading, clearing and
settlement.
– Trade or Settlement Guarantee Fund means a fund which objective is to provide the necessary funds
and ensure timely completion of settlements in cases of failure of member brokers to fulfill their settlement
obligations.
– Stock Indices represents the performance of stock market and by proxy, reflects investor sentiment on
the state of the economy.
– Sensex is calculated using share prices of 30 major companies which are listed in BSE.
Lesson 6
Secondary Market 231
– The CNX Nifty is the flagship index on the National Stock Exchange of India Ltd.
– Investible Weight Factors (IWFs) as the term suggests is unit of floating stock expressed in terms of
number available for trading and which is not held by the entities having strategic interest in a company.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What do you understand by Corporate Action? Discuss the compliances required for Corporate Action
under the Listing Agreement.
2. Briefly explain the provisions relating to price sensitive Information.
3. What is Corporate Governance? Give a brief on the mandatory and non-mandatory provisions of
Clause 49 under listing agreement.
4. What is settlement system? Discuss the various types of settlement system.
5. What do you understand by Investible Weight Factors (IWFs)? Explain with the help an example.
232 PP-CC&MM
Lesson 7
Capital Market Investment Institutions 233
Lesson 7
Capital Market Investment Institutions
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Financial Sector plays an indispensable role
– National Level Institutions
in the overall development of a country. The
– All India Development banks
most important constituent of this sector is the
– Specialised financial Institutions
financial institutions, which act as a conduit for
– Investment Institutions
the transfer of resources from net savers to
net borrowers, that is, from those who spend
– State Level Institutions
less than their earnings to those who spend
– Qualified Institutional Buyers
more than their earnings. These institutions
provide a variety of financial products and
– Private Equity
services to fulfil the varied needs of the
– Types of Private Equity
commercial sector. Besides, they provide
– Venture Capital
assistance to new enterprises, small and
– Stages of Investment Financing
medium firms as well as to the industries
established in backward areas. Financial
– Angel Funds
institutions can be of different types e.g.
– Pension Funds
Insurance Companies, Pension Fund, Mutual
– Foreign Institutional Investor
Fund, Capital Market Intermediaries etc.
– Qualified Foreign Investor
Keeping in view the role played by the institutions
– Mutual Fund
in the developement of Capital Market, this lesson
will give an overview of different categories of
– Types of Mutual Fund schemes
Investment Institutions like Venture Capital,
– Alternative Investment Fund
Private Equity, Hedge Funds, Qualified Institutional
– Hedge Funds
Buyer, Pension Funds, Foreign Institutional
– LESSON ROUND UP
Investor etc. which are active participant in the
Financial Market.
– SELF TEST QUESTIONS
233
234 PP-CC&MM
INTRODUCTION
Financial sector plays an indispensable role in the overall development of a country. The most important constituent
of this sector is the financial institutions, which act as a conduit for the transfer of resources from net savers to
net borrowers, that is, from those who spend less than their earnings to those who spend more than their
earnings. In any economy, financial Institutions play an important role because all the financial dealings and
matters are handled and monitored by such Institutions. The major components of financial Institutions are
banks, insurance companies, investment companies, consumer finance companies, and other specialized financial
institutes. These institutions provide a variety of financial products and services to fulfil the varied needs of the
commercial sector. Besides, they provide assistance to new enterprises, small and medium firms as well as to
the industries established in backward areas. Thus, they have helped in reducing regional disparities by inducing
widespread industrial development.
The Government of India, in order to provide adequate supply of credit to various sectors of the economy, has
evolved a well developed structure of financial institutions in the country. These financial institutions can be
broadly categorised into All India institutions and State level institutions, depending upon the geographical coverage
of their operations. At the national level, they provide long and medium term loans at reasonable rates of interest.
They subscribe to the debenture issues of companies, underwrite public issue of shares, guarantee loans and
deferred payments, etc. Though, the State level institutions are mainly concerned with the development of
medium and small scale enterprises, but they provide the same type of financial assistance as the national level
institutions.
National Level Institutions
A wide variety of financial institutions have been set up at the national level. These institutions cater to the
diverse financial requirements of the entrepreneurs. They include all India development banks like IDBI, SIDBI,
IFCI Ltd, IIBI; specialised financial institutions like IVCF, ICICI Venture Funds Ltd, TFCI ; investment institutions
like LIC, GIC, UTI; etc.
1. All-India Development Banks (AIDBs):- Includes those development banks which provide institutional
credit to not only large and medium enterprises but also help in promotion and development of small
scale industrial units.
– Industrial Development Bank of India (IDBI):- It was established in July 1964 as an apex financial
institution for industrial development in the country. It caters to the diversified needs of medium and
large scale industries in the form of financial assistance, both direct and indirect. Direct assistance
is provided by way of project loans, underwriting of and direct subscription to industrial securities,
soft loans, technical refund loans, etc. While, indirect assistance is in the form of refinance facilities
to industrial concerns.
– Industrial Finance Corporation of India Ltd (IFCI Ltd):- It was the first development finance
institution set up in 1948 under the IFCI Act in order to pioneer long-term institutional credit to
medium and large industries. It aims to provide financial assistance to industry by way of rupee and
foreign currency loans, underwrites/subscribes the issue of stocks, shares, bonds and debentures
of industrial concerns, etc. It has also diversified its activities in the field of merchant banking,
syndication of loans, formulation of rehabilitation programmes, assignments relating to amalgamations
and mergers, etc.
– Small Industries Development Bank of India (SIDBI):- It was set up by the Government of India
in April 1990, as a wholly owned subsidiary of IDBI. It is the principal financial institution for promotion,
financing and development of small scale industries in the economy. It aims to empower the Micro,
Lesson 7
Capital Market Investment Institutions 235
Small and Medium Enterprises (MSME) sector with a view to contributing to the process of economic
growth, employment generation and balanced regional development.
– Industrial Investment Bank of India Ltd (IIBI):- It was set up in 1985 under the Industrial
reconstruction Bank of India Act, 1984, as the principal credit and reconstruction agency for sick
industrial units. It was converted into IIBI on March 17, 1997, as a full-fledged development financial
institution. It assists industry mainly in medium and large sector through wide ranging products and
services. Besides project finance, IIBI also provides short duration non-project asset-backed financing
in the form of underwriting/direct subscription, deferred payment guarantees and working capital/
other short-term loans to companies to meet their fund requirements.
2. Specialised Financial Institutions (SFIs):- These are the institutions which have been set up to serve
the increasing financial needs of commerce and trade in the area of venture capital, credit rating and
leasing, etc.
– IFCI Venture Capital Funds Ltd (IVCF):- IVCF formerly known as Risk Capital & Technology Finance
Corporation Ltd (RCTC), is a subsidiary of IFCI Ltd. It was promoted with the objective of broadening
entrepreneurial base in the country by facilitating funding to ventures involving innovative product/
process/technology. Initially, it started providing financial assistance by way of soft loans to promoters
under its 'Risk Capital Scheme' . Since 1988, it also started providing finance under 'Technology
Finance and Development Scheme' to projects for commercialisation of indigenous technology for
new processes, products, market or services. Over the years, it has acquired great deal of experience
in investing in technology-oriented projects.
– ICICI Venture Funds Ltd:- Formerly known as Technology Development & Information Company
of India Limited (TDICI), it was founded in 1988 as a joint venture with the Unit Trust of India.
Subsequently, it became a fully owned subsidiary of ICICI. It is a technology venture finance company,
set up to sanction project finance for new technology ventures. The industrial units assisted by it are
in the fields of computer, chemicals/polymers, drugs, diagnostics and vaccines, biotechnology,
environmental engineering, etc.
– Tourism Finance Corporation of India Ltd. (TFCI):- It is a specialised financial institution set up
by the Government of India for promotion and growth of tourist industry in the country. Apart from
conventional tourism projects, it provides financial assistance for non-conventional tourism projects
like amusement parks, ropeways, car rental services, ferries for inland water transport, etc.
3. Investment Institutions:- These are the most popular form of financial intermediaries, which particularly
catering to the needs of small savers and investors. They deploy their assets largely in marketable
securities.
– Life Insurance Corporation of India (LIC):- It was established in 1956 as a wholly-owned corporation
of the Government of India. It was formed by the Life Insurance Corporation Act, 1956, with the
objective of spreading life insurance much more widely and in particular to the rural area. It also
extends assistance for development of infrastructure facilities like housing, rural electrification, water
supply, sewerage, etc. In addition, it extends resource support to other financial institutions through
subscription to their shares and bonds, etc.
– Unit Trust of India (UTI):- It was set up as a body corporate under the UTI Act, 1963, with a view to
encourage savings and investment. It mobilises savings of small investors through sale of units and
channelises them into corporate investments mainly by way of secondary capital market operations.
Thus, its primary objective is to stimulate and pool the savings of the middle and low income groups
and enable them to share the benefits of the rapidly growing industrialisation in the country. In
December 2002, the UTI Act, 1963 was repealed with the passage of Unit Trust of India (Transfer of
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Undertaking and Repeal) Act, 2002, paving the way for the bifurcation of UTI into 2 entities, UTI-I
and UTI-II with effect from 1st February 2003.
– General Insurance Corporation of India (GIC) :- It was formed in pursuance of the General
Insurance Business (Nationalisation) Act, 1972(GIBNA ), for the purpose of superintending, controlling
and carrying on the business of general insurance or non-life insurance. Initially, GIC had four
subsidiary branches, namely, National Insurance Company Ltd ,The New India Assurance Company
Ltd , The Oriental Insurance Company Ltd and United India Insurance Company Ltd . But these
branches were delinked from GIC in 2000 to form an association known as 'GIPSA' (General
Insurance Public Sector Association).
State Level Institutions
Several financial institutions have been set up at the State level which supplement the financial assistance
provided by the all India institutions. They act as a catalyst for promotion of investment and industrial development
in the respective States. They broadly consist of 'State financial corporations' and 'State industrial development
corporations'.
– State Financial Corporations (SFCs) :- These are the State-level financial institutions which play a
crucial role in the development of small and medium enterprises in the concerned States. They provide
financial assistance in the form of term loans, direct subscription to equity/debentures, guarantees,
discounting of bills of exchange and seed/ special capital, etc. SFCs have been set up with the objective
of catalysing higher investment, generating greater employment and widening the ownership base of
industries. They have also started providing assistance to newer types of business activities like
floriculture, tissue culture, poultry farming, commercial complexes and services related to engineering,
marketing, etc. There are 18 State Financial Corporations (SFCs) in the country.
– State Industrial Development Corporations (SIDCs) :- These have been established under the
Companies Act, 1956, as wholly-owned undertakings of State Governments. They have been set up
with the aim of promoting industrial development in the respective States and providing financial assistance
to small entrepreneurs. They are also involved in setting up of medium and large industrial projects in
the joint sector/assisted sector in collaboration with private entrepreneurs or wholly-owned subsidiaries.
They are undertaking a variety of promotional activities such as preparation of feasibility reports;
conducting industrial potential surveys; entrepreneurship training and development programmes; as
well as developing industrial areas/estates.
QUALIFIED INSTITUTIONAL BUYERS
Generally QIBs are investment institutions who buy the shares of a company on a large scale. Qualified Institutional
Buyers are those Institutional investors who are generally perceived to possess expertise and the financial
muscle to evaluate and invest in the Capital Markets. According to SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009, “Qualified Institutional Buyer” means:
(i) a mutual fund, venture capital fund, Alternative Investment Fund and foreign venture capital investor
registered with SEBI;
(ii) a foreign institutional investor and sub-account (other than a sub-account which is a foreign corporate
or foreign individual), registered with SEBI;
(iii) a public financial institution as defined in section 4A of the Companies Act, 1956;
(iv) a scheduled commercial bank;
(v) a multilateral and bilateral development financial institution;
(vi) a state industrial development corporation;
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Capital Market Investment Institutions 237
(vii) an insurance company registered with the Insurance Regulatory and Development Authority;
(viii) a provident fund with minimum corpus of twenty five crore rupees;
(ix) a pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by resolution no. F. No. 2/3/2005-DDII dated November 23, 2005 of
the Government of India published in the Gazette of India;
(xi) insurance funds set up and managed by army, navy or air force of the Union of India;
(xii) insurance funds set up and managed by the Department of Posts, India;
SEBI has laid down certain criteria in SEBI (ICDR) Regulations, 2009, under which a QIB is entitled to get the
shares in a public issue to the extent it is specified by SEBI.
Anchor Investor
Anchor investor means a Qualified Institutional Buyer (QIB) who makes an application for a value of ten crore
rupees or more in a public issue made through the book building process. An Anchor Investor is also an Investment
Institution as it means a QIB which is again a Financial Institutions.
PRIVATE EQUITY
Private equity is essentially a way to invest in some assets that isn't publicly traded, or to invest in a publicly
traded asset with the intention of taking it private. Unlike stocks, mutual funds, and bonds, private equity funds
usually invest in more illiquid assets, i.e. companies. By purchasing companies, the firms gain access to those
assets and revenue sources of the company, which can lead to very high returns on investments. Another
feature of private equity transactions is their extensive use of debt in the form of high-yield bonds. By using debt
to finance acquisitions, private equity firms can substantially increase their financial returns.
Private equity consists of investors and funds that make investments directly into private companies or conduct
buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from
retail and institutional investors, and can be used to fund new technologies, expand working capital within an
owned company, make acquisitions, or to strengthen a balance sheet. The major of private equity consists of
institutional investors and accredited investors who can commit large sums of money for long periods of time.
Private equity investments often demand long holding periods to allow for a turn around of a distressed company
or a liquidity event such as IPO or sale to a public company. Generally, the private equity fund raise money from
investors like Angel investors, Institutions with diversified investment portfolio like –pension funds, insurance
companies, banks, funds of funds etc.
Types of Private Equity
Private equity investments can be divided into the following categories:
Leveraged Buyout (LBO): This refers to a strategy of making equity investments as part of a transaction in
which a company, business unit or business assets is acquired from the current shareholders typically with the
use of financial leverage. The companies involved in these transactions are typically more mature and generate
operating cash flows.
Venture Capital: It is a broad sub-category of private equity that refers to equity investments made, typically in
less mature companies, for the launch, early development, or expansion of a business.
Growth Capital: This refers to equity investments, most often minority investments, in companies that are
looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without
a change of control of the business.
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VENTURE CAPITAL
Venture Capital is one of the innovative financing resource for a company in which the investor has to give up
some level of ownership and control of business in exchange for capital for a limited period, say, 3-5 years.
Venture Capital is generally equity investments made by Venture Capital funds, at an early stage in privately
held companies, having potential to provide a high rate of return on their investments. It is a resource for
supporting innovation, knowledge based ideas and technology and human capital intensive enterprises.
Essentially, a venture capital company is a group of investors who pool investments focused within certain
parameters. The participants in venture capital firms can be institutional investors like pension funds, insurance
companies, foundations, corporations or individuals. Unlike banks, which seek their return through interest
payments, venture firms seek for capital appreciation. Generally Venture Capital firms look for a return of five to
ten times the original investment.
Areas of Investment
Different venture groups prefer different types of investments. Some specialize in seed capital and early expansion
while others focus on exit financing. Biotechnology, medical services, communications, electronic components
and software companies seem to be attracting the most attention from venture firms and receiving the most
financing. Venture capital firms finance both early and later stage investments to maintain a balance between
risk and profitability.
In India, software sector has been attracting a lot of venture finance. Besides media, health and pharmaceuticals,
agribusiness and retailing are the other areas that are favored by a lot of venture companies.
STAGES OF INVESTMENT FINANCING
Venture capital firms finance both early and later stage investments to maintain a balance between risk and
profitability. Venture capital firms usually recognise the following two main stages when the investment could be
made in a venture namely:
A. Early Stage Financing
i. Seed Capital & Research and Development Projects.
ii. Start Ups
ii. Second Round Finance
B. Later Stage Financing
i. Development Capital
ii. Expansion Finance
iii. Replacement Capital
iv. Turn Arounds
v. Buy Outs
A. EARLY STAGE FINANCING
I. Seed Capital and R & D Projects: Venture capitalists are more often interested in providing seed finance i. e.
making provision of very small amounts for finance needed to turn into a business. Research and Development
activities are required to be undertaken before a product is to be launched. External finance is often required by
the entrepreneur during the development of the product. The financial risk increases progressively as the research
phase moves into the development phase, where a sample of the product is tested before it is finally
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commercialised venture capitalists/ firms/ funds are always ready to undertake risks and make investments in
such R & D projects promising higher returns in future.
II. Start Ups: The most risky aspect of venture capital is the launch of a new business after the Research and
Development activities are over. At this stage, the entrepreneur and his products or services are as yet untried.
The finance required usually falls short of his own resources. Start-ups may include new industries / businesses
set up by the experienced persons in the area in which they have knowledge. Others may result from the
research bodies or large corporations, where a venture capitalist joins with an industrially experienced or corporate
partner. Still other start-ups occur when a new company with inadequate financial resources to commercialise
new technology is promoted by an existing company.
III. Second Round Financing: It refers to the stage when product has already been launched in the market but
has not earned enough profits to attract new investors. Additional funds are needed at this stage to meet the
growing needs of business. Venture Capital Institutions (VCIs) provide larger funds at this stage than at other
early stage financing in the form of debt. The time scale of investment is usually three to seven years.
B. LATER STAGE FINANCING
Those established businesses which require additional financial support but cannot raise capital through public
issue approach venture capital funds for financing expansion, buyouts and turnarounds or for development
capital.
I. Development Capital: It refers to the financing of an enterprise which has overcome the highly risky stage
and have recorded profits but cannot go public, thus needs financial support. Funds are needed for the purchase
of new equipment/ plant, expansion of marketing and distributing facilities, launching of product into new regions
and so on. The time scale of investment is usually one to three years and falls in medium risk category.
II. Expansion Finance: Venture capitalists perceive low risk in ventures requiring finance for expansion purposes
either by growth implying bigger factory, large warehouse, new factories, new products or new markets or
through purchase of exiting businesses. The time frame of investment is usually from one to three years. It
represents the last round of financing before a planned exit.
III. Buy Outs: It refers to the transfer of management control by creating a separate business by separating it
from their existing owners. It may be of two types.
i. Management Buyouts (MBOs): In Management Buyouts (MBOs) venture capital institutions provide funds to
enable the current operating management/ investors to acquire an existing product line/business. They represent
an important part of the activity of VCIs.
ii. Management Buy-ins (MBIs): Management Buy-ins are funds provided to enable an outside group of
manager(s) to buy an existing company. It involves three parties: a management team, a target company and an
investor (i.e. Venture capital institution). MBIs are more risky than MBOs and hence are less popular because it
is difficult for new management to assess the actual potential of the target company. Usually, MBIs are able to
target the weaker or under-performing companies.
IV. Replacement Capital: VCIs another aspect of financing is to provide funds for the purchase of existing
shares of owners. This may be due to a variety of reasons including personal need of finance, conflict in the
family, or need for association of a well known name. The time scale of investment is one to three years and
involve low risk.
V. Turnarounds: Such form of venture capital financing involves medium to high risk and a time scale of three
to five years. It involves buying the control of a sick company which requires very specialised skills. It may
require rescheduling of all the company’s borrowings, change in management or even a change in ownership.
A very active “hands on” approach is required in the initial crisis period where the venture capitalists may appoint
its own chairman or nominate its directors on the board.
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ANGEL FUND
Angel investments are typically the earliest equity investments made in start up companies. Angel Investors are
almost always healthy individuals and commonly band together in investor networks. Often these networks are
based on regional, industry in investor or academic affiliation. Angel Investors are often former entrepreneurs
themselves, and typically enjoy working with companies at the earliest stages of business formation.
The most effective Angels help entrepreneurs shape business models, create business plans and connect to
resources - but without stepping into a controlling or operating role. Often Angels are entrepreneurs who have
successfully built companies, or have spent a part of their career coaching young companies.
Less is known about angel investing than venture capital because of the individuality and privacy of the
investments. However, every success story can track its initial entry into the market to an Angel or group of
Angels that provided the needed knowledge and capital to launch and gone that company.
TYPES OF ANGEL INVESTORS
There are several types of angel investors, and fall into the following main categories:
Core Angels
These angel investors are individuals with extensive business experience who have operated and owned successful
businesses of their own. Such Angel Investors possess a diversified portfolio that encompasses all industries, including
public and private equity and real estate. They serve as valuable mentors and advisors to their invested firms.
High-tech Angels
These angel investors may have less experience than core angels, but invest significantly in the latest trends
of modern technology. Their investments primarily depend on the value of their other high-tech holdings,
which can vary considerably.
Return On investment (ROI) Angels
ROI angel investors are primarily concerned with the financial reward of high-risk investments. Their motivation
behind investing is their perception of what other angel investor gross income may be. Return on investment
angels tend to stay away from investing when market performance is poor and emerge once the market shows
stability and improvement. They view each of their investments as another company added to their diversified
portfolio and rarely become actively involved in the invested firms.
Enthusiast Angels
These angel investors are older (age 65 and above) businessmen who are independently wealthy before their
investments. They often invest small amounts of capital in many different enterprises and view investing as a
mere hobby. They do not take an active role in management.
Micromanagement Angels
These individuals are considered to be serious angel investors. They often demand a board position and are
known to impose the same strategies they have used with their own companies towards their invested companies.
Professional Angels
These angel investors are professionally employed as doctors, lawyers, accountants, etc. who invest in companies
in their related field. Professional angels invest in many companies at the same time. They may also provide
services to their invested firm (legal, accounting or financial) at a discounted rate. Professional angel investors
are of tremendous value for initial needed capital and rarely make follow-on investments.
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PENSION FUND
Pension Fund means a fund established by an employer to facilitate and organize the investment of employees'
retirement funds contributed by the employer and employees. The pension fund is a common asset pool meant
to generate stable growth over the long term, and provide pensions for employees when they reach the end of
their working years and commence retirement. Pension funds are commonly run by some sort of financial
intermediary for the company and its employees, although some larger corporations operate their pension funds
in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors
in many nations. Pension funds nowadays in India play a huge role in development of the economy and it play
active role in the Indian equity markets. A change both in their investment attitudes and in the regulatory climate,
encouraging them to increase their investment levels in equities and would have a massive impact on capital
market and on the economy as a whole.
Pensions broadly divided into two sector:
A-Formal sector Pensions
B-Informal sector Pensions
A. Formal sector Pensions
Formal sector pensions in India can be divided into three categories; viz those schemes that come under an Act
or Statute, Government pensions and voluntary pensions.
Pensions under an Act
There are three defining Acts for pensions in India.
1. Pensions under the EPF&MP Act 1952: These include the Employees Provident Fund, Employees
Pension Scheme, and Employees Deposit Linked Insurance Scheme,
2. Pensions under the Coal mines PF&MP Act 1948: These include Coal mines provident fund, Coal
mines pension scheme & Coal mines linked insurance scheme.
3. Gratuity under the Payment of Gratuity Act, 1972.
There are other provident funds in India like Assam Tea Plantations PF, J&K PF, and Seamens PF etc.
Government Pension
Government pensions in India are defined under the Directive Principles of State policy and are therefore not
under a Statute. The Government amended the regulations to put in place the new pension system. The old
scheme continues for the existing employees (i.e. those who joined service prior to January 1, 2004). Pensions
for government employees would include employees of the central as well as the state governments.
(A) Central Government Pensions like Civil servants pensions, Defences, Railways, Posts.
(B) State Government Pensions, Bank pensions like Reserve Bank of India (RBI), Public Sector Banks,
National Bank for Agriculture and Rural Development (NABARD) and other banks pensions.
Superannuation schemes are also sold in the market. These are typically plans sold by Mutual funds and
Insurance companies (Life Insurance & Postal Life Insurance).
Pension Fund Management
Pension Fund is regulated by Pension Fund Regulatory and Development Authority (PFRDA). Pension Funds
are managed by Pension Fund Administrators and they are responsible for taking investment decisions but in
some jurisdictions, pension fund management can be managed by asset management and insurance companies
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and some management decisions may be the responsibility of Boards of Trustees in some corporate organisations.
Pension Fund Custodians are those who keep custody of pension funds. Regulations of pension funds require
the appointment of a custodian, depository institution or trustee, standards of conduct and minimum suitability of
the operators of pension funds, the rights of investors to withdraw funds and the right of investors to full, timely
and accurate information disclosure. Regulations required promoting both the performance and the financial
security of pension assets. Main goals of pension investment are to ensure adequate, affordable and sustainable
benefits to contributors, secure safety & security of funds and ensure adequate liquidity to pay all pension
benefits of contributors as and when due risk management for pension assets established on quantitative limits
which is maximum limits for individual, class or class of mix assets.
FOREIGN INSTITUTIONAL INVESTOR
Foreign Institutional Investor (FII) means an entity established or incorporated outside India which proposes to
make investment in India in securities and which is registered as a FII in accordance with the SEBI (Foreign
Institutional Investor) Regulations 1995.
Foreign Institutional Investor (FII) is used to denote an investor - mostly of the form of an institution or entity,
which invests money in the financial markets of a country different from the one where in the institution or entity
was originally incorporated.
Entities covered by the term ‘FII’ include “Overseas pension funds, mutual funds, investment trust, asset
management company, nominee company, bank, institutional portfolio manager, university funds, endowments,
foundations, charitable trusts, charitable societies etc.(fund having more than 20 investors with no single investor
holding more than 10 per cent of the shares or units of the fund).
FIIs can invest their own funds as well as invest on behalf of their overseas clients registered as such with SEBI.
These client accounts that the FII manages are known as ‘sub-accounts’.
Why FIIs Required?
FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI (Foreign
direct investment) are insufficient. Following are the some advantages of FIIs.
– It lowers cost of capital, access to cheap global credit.
– It supplements domestic savings and investments.
– It leads to higher asset prices in the Indian market.
– And has also led to considerable amount of reforms in capital market and financial sector.
Investment by FIIs
There are generally two ways FIIs can invest.
(i) Equity Investment : 100% investments could be in equity related instruments or up to 30% could be
invested in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments)
(ii) 100% Debt: 100% investment has to be made in debt securities only.
Equity Investment Route
In case of Equity route the FIIs can invest in the following instruments:
A. Securities in the primary and secondary market including shares which are unlisted, listed or to be listed
on a recognized stock exchange in India.
B. Units of schemes floated by the Unit Trust of India and other domestic mutual funds, whether listed or
not.
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C. Warrants
100% Debt Route:
In case of Debt Route the FIIs can invest in the following instruments:
A. Debentures (Non Convertible Debentures, Partly Convertible Debentures etc.)
B. Bonds
C. Dated government securities
D. Treasury Bills
E. Other Debt Market Instruments
It should be noted that foreign companies and individuals are not be eligible to invest through the 100% debt
route.
Investment by FIIs under Portfolio Investment Scheme
The RBI has given general permission to SEBI-registered FIIs/sub-accounts to invest under the Portfolio
Investment Scheme (PIS).
– The total holding of each FII/sub-account under this scheme should not exceed 10 percent of the total
paid up capital or 10 percent of the paid-up value of each series of convertible debentures issued by the
Indian company.
– The total holding of all the FIIs/sub-accounts put together should not exceed 24 percent of the paidup capital or the paid-up value of each series of convertible debentures. This limit of 24 percent can
be increased to the sectoral cap/statutory limit as applicable to the Indian company concerned, by
passing a resolution of its Board of Directors, followed by a special resolution to that effect by its
General Body.
– A domestic asset management company or portfolio manager who is registered with the SEBI as an FII
for managing the funds of a sub-account can make investments under the scheme on behalf of:
– A person resident outside India who is a citizen of a foreign state; or
– A corporate body registered outside India.
However, such investment should be made out of the funds raised, collected, or brought from outside through a
normal banking channel. The investments by such entities should not exceed 5 percent of the total paid-up
equity capital or 5 percent of the paid-up value of each series of convertible debentures issued by an Indian
company, and should also not exceed the overall ceiling specified for FIIs.
QUALIFIED FOREIGN INVESTOR
A Qualified Foreign Investor (QFI) means a non-resident investor (other than SEBI registered FII and SEBI
registered Foreign Venture Capital Investor) who meets the KYC requirements of SEBI for the purpose of making
investments in accordance with the regulations/orders/circulars of RBI/SEBI.
QFls are permitted to invest through SEBI registered Depository Participants (DPs) only in equity shares of
listed Indian companies through recognized brokers on recognized stock exchanges in India as well as in
equity shares of Indian companies which are offered to public in India in terms of the relevant and applicable
SEBI guidelines/regulations. QFls are also permitted to acquire equity shares by way of right shares, bonus
shares or equity shares on account of stock split / consolidation or equity shares on account of amalgamation,
demerger or such corporate actions subject to the prescribed investment limits. QFIs are allowed to sell the
equity shares so acquired subject to the relevant SEBI guidelines.
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The individual and aggregate investment limits for the QFls shall be 5% and 10% respectively of the paid up
capital of an Indian company. These limits shall be over and above the FII and NRI investment ceilings prescribed
under the Portfolio Investment Scheme for foreign investment in India. Further, wherever there are composite
sectoral caps under the extant FDI policy, these limits for QFI investment in equity shares shall also be within
such overall FDI sectoral caps.
Dividend payments on equity shares held by QFls can either be directly remitted to the designated overseas
bank accounts of the QFIs or credited to the single non-interest bearing Rupee account. In case dividend
payments are credited to the single non-interest bearing Rupee account they shall be remitted to the
designated overseas bank accounts of the QFIs within five working days (including the day of credit of such
funds to the single non-interest bearing Rupee account). Within these five working days, the dividend
payments can be also utilized for fresh purchases of equity shares under this scheme, if so instructed by
the QFI.
MUTUAL FUND
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial
goal. Anybody with an investible surplus of as little as a few hundred rupees can invest in Mutual Funds.
These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and
strategy.
The money thus collected is then invested by the fund manager in different types of securities. These could
range from shares to debentures to money market instruments, depending upon the scheme’s stated objectives.
The income earned through these investments and the capital appreciation realised by the scheme are shared
by its unit in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment
for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost. In India, Mutual Fund is regulated by SEBI (Mutual Funds) Regulations, 1996.
According to these regulations “Mutual Fund means a fund established in the form of trust to raise monies
through the sale of units to the public or a section of public under one or more schemes for investing in
securities including the money market instruments or gold or gold related instruments.”
Types of Mutual Fund Schemes
(A) By Structure
(i) Open-Ended Schemes: These type of scheme do not have a fixed maturity. The key feature is liquidity. The
investor can conveniently buy and sell units at Net Asset Value(NAV) related prices, at any point of time.
(ii) Close Ended Scheme: Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are
called close ended schemes. The investor can invest in the scheme at the time of the initial issue and thereafter
he/she can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price
at the stock exchange could vary from the scheme’s NAV on account of demand and supply situation, unitholders’
expectations and other market factors. One of the characteristics of the close-ended schemes is that they are
generally traded at a discount to NAV; but closer to maturity, the discount narrows.
Some close-ended schemes give the investor an additional option of selling the units to the Mutual Fund through
periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are
provided to the investor under the close ended schemes.
(iii) Interval Schemes: These combine the features of open-ended and close-ended schemes. They may be
traded on the stock exchange or may be open for sale or redemption during predetermined intervals at NAV related
prices.
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(B) By Investment Objective
(i) Growth Schemes: Aim to provide capital appreciation over the medium to long term. These schemes normally
invest a majority of their funds in equities and are willing to bear short term decline in value for possible future
appreciation. These schemes are not for investors seeking regular income or needing their money back in the
short term.
(ii) Income Schemes: Aim to provide regular and steady income to investors. These schemes generally invest
in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may
be limited.
(iii) Balanced Schemes: Aim to provide both growth and income by periodically distributing a part of the income
and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in
their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace or fall
equally when the market falls.
(iv) Money Market / Liquid Schemes: Aim to provide easy liquidity, preservation of capital and moderate
income. These schemes generally invest in safer, short term instruments such as treasury bills, certificates of
deposit, commercial paper and interbank call money. Returns on these schemes may fluctuate, depending
upon the interest rates prevailing in the market.
(v) Other Schemes: Tax Saving Schemes (Equity Linked Saving Scheme - ELSS): These schemes offer tax
incentives to the investors under tax laws as prescribed from time to time and promote long term investments in
equities through Mutual Funds.
(vi) Special Schemes: This category includes index schemes that attempt to replicate the performance of a
particular index such as the BSE Sensex, the NSE 50 (NIFTY) or sector specific schemes which invest in
specific sectors such as Technology, Infrastructure, Banking, Pharma etc.
Besides, there are also schemes which invest exclusively in certain segments of the capital market, such as
Large Caps, Mid Caps, Small Caps, Micro Caps, 'A' group shares, shares issued through Initial Public Offerings
(IPOs), etc.
Fixed Maturity Plans
Fixed Maturity Plans (FMPs) are investment schemes floated by mutual funds and are close ended with a fixed
tenure, the maturity period ranging from one month to three/five years. These plans are predominantly debtoriented, while some of them may have a small equity component. The objective of such a scheme is to generate
steady returns over a fixed-maturity period and protect the investor against market fluctuations. FMPs are
typically passively managed fixed income schemes with the fund manager locking into investments with maturities
corresponding with the maturity of the plan. FMPs are not guaranteed products.
Exchange Traded Funds (ETFs)
Exchange Traded Funds are essentially index funds that are listed and traded on exchanges like Index fund
schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Globally,
ETFs have opened a whole new panorama of investment opportunities to retail as well as institutional investors.
ETFs enable investors to gain broad exposure to entire stock markets as well as in specific sectors with relative
ease, on a real-time basis and at a lower cost than many other forms of investing.
An ETF is a basket of stocks that reflects the composition of an index, like S&P CNX Nifty, BSE Sensex, CNX
Bank Index, CNX PSU Bank Index, etc. The ETF's trading value is based on the net asset value of the underlying
stocks that it represents. It can be compared to a stock that can be bought or sold on real time basis during the
market hours. Benchmark Nifty Bees was the first ETF in India.
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Capital Protection Oriented Schemes
Capital Protection Oriented Schemes are schemes that endeavour to protect the capital as the primary objective
by investing in high quality fixed income securities and generate capital appreciation by investing in equity /
equity related instruments as a secondary objective. Franklin Templeton Capital Protection Oriented Fund was
the first Capital Protection Oriented Fund in India.
Gold Exchange Traded Funds (GETFs)
Gold Exchange Traded Funds offer investors an innovative, cost-efficient and secure way to access the gold
market. Gold ETFs are intended to offer investors a means of participating in the gold bullion market by buying
and selling units on the Stock Exchanges, without taking physical delivery of gold. Benchmark GETF was the
first Gold ETF in India and listed on the NSE.
Quantitative Funds
A quantitative fund is an investment fund that selects securities based on quantitative analysis. The managers of
such funds build computer based models to determine whether or not an investment is attractive. In a pure
"quant shop" the final decision to buy or sell is made by the model. However, there is a middle ground where the
fund manager will use human judgment in addition to a quantitative model. Lotus Agile Fund was the first Quant
based Mutual Fund Scheme in India.
Funds Investing Abroad
With the opening up of the Indian economy, Mutual Funds have been permitted to invest in foreign securities/
American Depository Receipts (ADRs) / Global Depository Receipts (GDRs). Some of such schemes are
dedicated funds for investment abroad while others invest partly in foreign securities and partly in domestic
securities. While most such schemes invest in securities across the world there are also schemes which are
country specific in their investment approach.
Fund of Funds (FOFs)
Fund of Funds are schemes that invest in other mutual fund schemes. The portfolio of these schemes comprise
only of units of other mutual fund schemes and cash / money market securities/ short term deposits pending
deployment. The first FOF was launched by Franklin Templeton Mutual Fund on October 17, 2003. Fund of
Funds can be Sector specific e.g. Real Estate FOFs, Theme specific e.g. Equity FOFs, Objective specific e.g.
Life Stages FOFs or Style specific e.g. Aggressive/ Cautious FOFs etc.
ALTERNATIVE INVESTMENT FUNDS
Alternative investment funds (AIFs) are defined in Regulation 2(1)(b) of SEBI (Alternative Investment Funds)
Regulations, 2012. It refers to any privately pooled investment fund, (whether from Indian or foreign sources), in
the form of a trust or a company or a body corporate or a Limited Liability Partnership(LLP) which are not
presently covered by any Regulation of SEBI governing fund management (like, Regulations governing Mutual
Fund or Collective Investment Scheme)nor coming under the direct regulation of any other sectoral regulators in
India-IRDA, PFRDA, RBI. Hence, in India, AIFs are private funds which are otherwise not coming under the
jurisdiction of any regulatory agency in India.
The text of the Regulation 2(1) (b) is as under:
“Alternative Investment Fund” means any fund established or incorporated in India in the form of a trust or a
company or a limited liability partnership or a body corporate which,(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign,
for investing it in accordance with a defined investment policy for the benefit of its investors; and
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Capital Market Investment Institutions 247
(ii) is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes)
Regulations, 1999 or any other regulations of SEBI to regulate fund management activities:
Provided that the following shall not be considered as Alternative Investment Fund for the purpose of
these regulations, –
(i) family trusts set up for the benefit of ‘relatives’ as defined under Companies Act, 1956;
(ii) ESOP Trusts set up under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase
Scheme), Guidelines, 1999 or as permitted under Companies Act, 1956;
(iii) employee welfare trusts or gratuity trusts set up for the benefit of employees;
(iv) ‘holding companies’ within the meaning of Section 4 of the Companies Act, 1956;
(v) other special purpose vehicles not established by fund managers, including securitization trusts,
regulated under a specific regulatory framework;
(vi) funds managed by securitisation company or reconstruction company which is registered with the
Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002; and
(vii) any such pool of funds which is directly regulated by any other regulator in India;
Thus, the definition of AIFs includes venture Capital Fund, hedge funds, private equity funds, commodity funds,
Debt Funds, infrastructure funds, etc., while, it excludes Mutual funds or collective investment Schemes, family
trusts, Employee Stock Option / purchase Schemes, employee welfare trusts or gratuity trusts, ‘holding companies’
within the meaning of Section 4 of the Companies Act, 1956, securitization trusts regulated under a specific
regulatory framework,and funds managed by securitization company or reconstruction company which is
registered with the RBI under Section 3 of the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002. One AIF can float several schemes. Investors in these funds are
large institutions, high net worth individuals and corporates.
In India AIF is regulated by SEBI (Alternative Investment Funds) Regulations, 2012 .
Types of AIFs
AIFs are categorized into the following three categories, based on their impact on the economy and the regulatory
regime intended for them:
– Category I AIF are those AIFs with positive spillover effects on the economy, for which certain
incentives or concessions might be considered by SEBI or Government of India; Such funds generally
invests in start-ups or early stage ventures or social ventures or SMEs or infrastructure or other
sectors or areas which the government or regulators consider as socially or economically desirable.
They cannot engage in any leverage except for meeting temporary funding requirements for not
more than thirty days, on not more than four occasions in a year and not more than ten percent
of the corpus.eg. Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure
Funds.
– Category II AIF are those AIFs for which no specific incentives or concessions are given. They do not
undertake leverage or borrowing other than to meet the permitted day to day operational requirements,
as is specified for Category I AIFs. eg. Private Equity or debt fund.
– Category III AIF are funds that are considered to have some potential negative externalities in certain
situations and which undertake leverage to a great extent; These funds trade with a view to make short
term returns. These funds are allowed to invest in Category I and II AIFs also. They receive no specific
incentives or concessions from the government or any other Regulator.eg. Hedge Funds (which employs
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diverse or complex trading strategies and invests and trades in securities having diverse risks or complex
products including listed and unlisted derivatives).
Where an AIF can Invest
An AIF is allowed to invest in following:
– In securities of companies incorporated outside India subject to such conditions as may be prescribed
by SEBI and RBI;
– Co-investment in an investee company by a Manager or Sponsor shall not be on terms more favourable
than those offered to the AIF;
– Category I and II AIFs are not allowed to invest not more than twenty five percent of the corpus in one
Investee Company;
– Investee company includes an LLP, meaning an AIF can also invest in LLPs.
– Category III AIF are allowed to invest up to ten percent of the corpus in one Investee Company;
– AIFs are allowed to invest in associates subject to approval of seventy five percent of investors;
– Un-invested portion of the corpus may be invested in liquid mutual funds or bank deposits or other
liquid assets of higher quality such as Treasury bills, Collateralised Borrowing and Lending Obiligations
(CBLOs), Commercial Papers, Certificates of Deposits, etc. till deployment of funds as per the investment
objective;
Category wise Investment Condition
Investment conditions for Category 1: Category 1 AIFs are allowed to invest in SPVs, LLPs, investee companies,
venture capital undertakings and even in units of other AIFs of category 1. The AIFs in this category are not allowed
to borrow funds directly or indirectly or engage in any leverage except for meeting temporary funding requirements
for not more than thirty days, on not more than four occasions in a year and not more than ten percent of the
corpus. Additional conditions have been prescribed for Venture Capital Funds (VCFs) under this category:
– The same were previously there in the VCF Regulations.
– Investments in SME segment (in listed or proposed to be listed SME companies) have been permitted
by the new Regulations which were not allowed earlier.
– Limited investment through Qualified Institutional Placement in preferential allotment is allowed in equity
linked instruments of listed entities.
Additional conditions provided for SME Funds:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or partnership interest
of venture capital undertakings or investee companies which are SMEs or in companies listed or proposed
to be listed on SME exchange or SME segment of an exchange.
Additional condition for Social Welfare Funds include:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or partnership interest
of social ventures.
– Such funds may accept grants, provided that such utilization of such grants shall be restricted to clause
mentioned above.
Additional conditions for Infrastructure Funds:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or units or partnership
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Capital Market Investment Institutions 249
interest of venture capital undertaking or investee companies or special purpose vehicles, which are
engaged in or formed for infrastructure projects
– These funds may also invest in listed securitized debt instruments or listed debt securities of investee
companies or special purpose vehicles, engaged in infrastructure projects.
Conditions for Category II AIFs
These shall primarily invest in unlisted investee companies or in units of other AIFs of Category I and II. May not
borrow funds directly or indirectly and shall not engage in leverage except for meeting temporary funding
requirements for not more than thirty days, not more than four occasions in a year and not more than ten percent
of the corpus. Category II AIFs may engage in hedging, subject to guidelines as specified by SEBI.
Conditions for Category III AIFs
These AIFs may invest in securities of listed or unlisted investee companies or derivatives or complex or structured
products and in units of other AIFs of Category I and II. Such AIFs may engage in leverage or borrow subject to
consent from the investors in the fund and subject to a maximum limit, as may be specified by SEBI.
HEDGE FUNDS
Hedge funds, are unregistered private investment partnerships funds or pools that may invest and trade in many
different markets, strategies and instruments (including securities, non-securities and derivatives) and are not
subject to the same regulatory requirements as mutual funds.
The term can also be defined by considering the characteristics most commonly associated with hedge funds.
Usually, hedge funds:
– are organized as private investment partnerships or offshore investment corporations;
– use a wide variety of trading strategies involving position-taking in a range of markets;
– employ as assortment of trading techniques and instruments, often including short-selling, derivatives
and leverage;
– pay performance fees to their managers; and
– have an investor base comprising wealthy individuals and institutions and relatively high minimum
investment limit (set at US $1,00,000 or higher for most funds).
Domestic Hedge Fund
Domestic hedge funds are usually organized (in USA) as limited partnerships to accommodate investors that
are subject to U.S. income taxation. The fund’s sponsor typically is the general partner and investment adviser.
Hedge funds may also take the form of limited liability companies (LLC) or business trusts. LLPs, LLCs and
business trusts are generally not separately taxed and, as a result, income is taxed only at the level of the
individual investors. Each of three firms also limits investors liability; LLCs offer the additional benefit of limited
liability for fund advisors (general partners).
Offshore Hedge Fund
Offshore hedge funds are typically organized as corporations in countries such as the Cayman Islands, British
Virgin Islands, the Bahamas, Panama, The Netherlands Antilles or Bermuda. Offshore funds generally attract
investments of US. tax exempt entities, such as pension funds, charitable trusts, foundations and endowments,
as well as non-U.S. residents. U.S. tax-exempt investors favour investments in offshore hedge funds because
they may be subject to taxation, if they invest in domestic limited partnership hedge funds.
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A Taxonomy of Hedge Fund Strategies
Strategy
Description
Directional Trading
Based upon speculation of market direction in multiple asset classes. Both modelbased systems and subjective judgment are used to make trading decisions.
Relative Value
Focus on spread relationships between pricing components of financial assets. Market
risk is kept to minimum and many managers use leverage to enhance returns.
Specialist Credit
Based around lending to credit sensitive issuers. Funds in this strategy conduct a
high level of due diligence in order to identify relatively inexpensive securities.
Stock Selection
Combine long and short positions, primarily in equities, in order to exploit under and
overvalued securities. Market exposure can vary substantially.
Market Benefits of Hedge Funds
Hedge funds can provide benefits to financial markets by contributing to market efficiency and enhance liquidity.
Many hedge fund advisors take speculative trading positions on behalf of their managed hedge funds based
extensive research about the true value or future value of a security. They may also use short term trading
strategies to exploit perceived mis-pricings of securities. Because securities markets are dynamic, the result of
such trading is that market prices of securities will move toward their true value. Trading on behalf of hedge
funds can thus bring price information to the securities markets, which can translate into market price efficiency.
Hedge funds also provide liquidity to the capital markets by participating in the market.
Hedge funds play an important role in a financial system where various risks are distributed across a variety of
innovative financial instruments. They often assume risks by serving as ready counter parties to entities that
wish to hedge risks. For example, hedge funds are buyers and sellers of certain derivatives, such as securitised
financial instruments, that provide a mechanism for banks and other creditors to un-bundle the risks involved in
real economic activity. By actively participating in the secondary market for these instruments, hedge funds can
help such entities to reduce or manage their own risks because a portion of the financial risks are shifted to
investors in the form of these tradable financial instruments. By reallocating financial risks, this market activity
provides the added benefit of lowering the financing costs shouldered by other sectors of the economy. The
absence of hedge funds from these markets could lead to fewer risk management choices and a higher cost of
capital. Hedge fund can also serve as an important risk management tool for investors by providing valuable
portfolio diversification. Hedge fund strategies are typically designed to protect investment principal. Hedge
funds frequently use investment instruments (e.g. derivatives) and techniques (e.g. short selling) to hedge
against market risk and construct a conservative investment portfolio – one designed to preserve wealth.
In addition, hedge funds investment performance can exhibit low correlation to that of traditional investments in
the equity and fixed income markets. Institutional investors have used hedge funds to diversify their investments
based on this historic low correlation with overall market activity.
LESSON ROUND UP
– The most important constituent of financial sector is the financial institutions, which act as a conduit for
the transfer of resources from net savers to net borrowers, that is, from those who spend less than
their earnings to those who spend more than their earnings.
– All-India Development Banks (AIDBs) Includes those development banks which provide institutional
credit to not only large and medium enterprises but also help in promotion and development of small
scale industrial units.
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Capital Market Investment Institutions 251
– Specialised Financial Institutions (SFIs) are the institutions which have been set up to serve the increasing
financial needs of commerce and trade in the area of venture capital, credit rating and leasing, etc.
– Investment Institutions are the most popular form of financial intermediaries, which particularly catering
to the needs of small savers and investors. They deploy their assets largely in marketable securities.
– Several financial institutions have been set up at the State Level which supplements the financial
assistance provided by the all India institutions.
– Qualified Institutional Buyers (QIB) means those buyers who are recommended by SEBI and generally
perceived to possess expertise and the financial muscle to evaluate and invest in the Capital Market.
– Private equity is essentially a way to invest in some assets that isn't publicly traded, or to invest in a
publicly traded asset with the intention of taking it private.
– Venture Capital is one of the innovative financing resource for a company in which the investor has to
give up some level of ownership and control of business in exchange for capital for a limited period,
say, 3-5 years.
– Angel Investors are often former entrepreneur themselves and typically enjoy working with companies
at the earliest stages of business formation.
– Pension Fund means a fund established by an employer to facilitate and organize the investment of
employees' retirement funds contributed by the employer and employees.
– Foreign Institutional Investor (FII) means an entity established or incorporated outside India which
proposes to make investment in India in securities and which is registered as a FII in accordance with
the SEBI (Foreign Institutional Investor) Regulations 1995.
– A Qualified Foreign Investor (QFI) means a non-resident investor (other than SEBI registered FII and
SEBI registered Foreign Venture Capital Investor) who meets the KYC requirements of SEBI for the
purpose of making investments in accordance with the regulations/orders/circulars of RBI/SEBI.
– Mutual Fund means a fund established in the form of trust to raise monies through the sale of units to
the public or a section of public under one or more schemes for investing in securities including the
money market instruments or gold or gold related instruments.
– In India AIF is regulated by SEBI (Alternative Investment Funds) Regulations, 2012.
– Hedge funds play an important role in a financial system where various risks are distributed across a
variety of innovative financial instruments. They often assume risks by serving as ready counter parties
to entities that wish to hedge risks.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly explain about different types of national level financial institutions.
2. What do you understand by private equity? Discuss about different categories of private equity.
3. Discuss about different stages of venture capital financing.
4. Discuss the provisions relating to Investment made by FIIs under portfolio management scheme.
5. Define Alternative Investment Fund under SEBI (Alternative Investment Funds) Regulations, 2012.
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Lesson 8
Capital Market Instruments 253
Lesson 8
Capital Market Instruments
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Financial instruments that are used for raising
– Equity Shares
capital resources in the capital market are
– Shares with Differential Voting Rights
(DVRs)
known as Capital Market Instruments. Capital
– Preference Shares
Market instruments are responsible for
– Fully Convertible Cumulative Preference
Share (Equipref)
and governments. These are used by the
generating funds for companies, corporations
– Debentures
investors to make a profit out of their respective
– Non Convertible Debentures with Put and
Call Option
number of capital market instruments playing
markets based on their needs. There are a large
in the market namely Equity shares, Preference
– Bonds
shares, Bonds, Debentures, variants of equity
– Sweat Equity Shares
shares etc. Again, the capital markets have
– Warrant
continued to produce a multitude of new
– Share Warrant
products, including various new forms of
– Secured Premium Notes
derivatives.
– Equity Shares with detachable warrants
Keeping this in view, it is imperative for a student
– Foreign Currency Convertible Bonds
(FCCBs)
to know the various types of Capital Market
– Foreign Currency Exchangeable Bonds
(FCEBs)
Instruments as well as financial innovation
– American Depository Receipts(ADRs)/
Global Depository Receipts(GDRs)
complete overview of various financial
– Indian Depository Receipts(IDRs)
debentures and new form of Derivatives like
– Derivatives
Interest Rate Futures, Currency Futures,
– Futures
Exchange Traded Funds etc. and companies
prevailing in the market .This lesson will give a
instruments like equity, preference shares,
issuing such instruments.
– Options
– Index Futures & options
– Currency Futures
– Interest Rate Futures
– Exchange Traded Funds (ETFs)
– LESSON ROUND UP
– SELF TEST QUESTIONS
253
254 PP-CC&MM
INTRODUCTION
Financial instruments that are used for raising capital resources in the capital market are known as Capital
Market Instruments. Capital Market Instruments are responsible for generating funds for companies, corporations
and sometimes governments. These are used by the investors to make a profit out of their respective markets.
The changes in the regulatory framework of the capital market and fiscal policies have resulted in newer kinds
of financial instruments (securities) being introduced in the market. Also, a lot of financial innovation by companies
who are now permitted to undertake treasury operations, has resulted in newer kinds of instruments - all of
which can be traded being introduced. The variations in all these instruments depend on the tenure, the nature
of security, the interest rate, the collateral security offered and the trading features, etc. While all Capital Market
Instruments are designed to provide a return on investment, the risk factors are different for each and the
selection of the instrument depends on the choice of the investor.
There are a large number of Capital Market Instruments playing in the market namely Equity Shares, Preference
Shares, Bonds, Debentures, Derivative Products like Futures, Options, , Interest rate derivatives etc. The different
types of Capital Market Instruments are explained below:
EQUITY SHARES
Equity shares, commonly referred to as ordinary share also represents the form of fractional ownership in which
a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business
venture. The holder of such shares is the member of the company and has voting rights.
Equity capital and further issues of equity capital by a company are generally based on the condition that they
will rank pari passu along with the earlier issued share capital in all respects. However, as regards dividend
declared by the company such additional capital shall be entitled to dividend ratably for the period commencing
from the date of issue to the last day of the accounting year, unless otherwise specified in the articles or in the
terms of the issue.
CHARACTERISTICS OF EQUITY SHARES
Equity shares, other than non-voting shares, have voting rights at all general meetings of the company. These
votes have the affect of the controlling the management of the company. Equity shareholdes have the right to
share the profits of the company in the form of dividend (cash) and bonus shares. However even equity
shareholders cannot demand declaration of dividend by the company which is left to the discretion of the Board
of Directors. When the company is wound up, payment towards the equity share capital will be made to the
respective shareholders only after payment of the claims of all the creditors and the preference share capital.
The important provisions relating to the rights of an equity shareholder are laid down in Companies Act, 1956.
Equity share holders enjoy different rights as members such as:
(a) right of pre-emption in the matter of fresh issue of capital. (Section 81)
(b) right to apply to the court to set aside variations of their rights to their detriment. (Section 107)
(c) right to receive a copy of the statutory report before the holding of the statutory meeting by public
companies. (Section 165)
(d) right to apply to Central Government to call for the Annual General Meeting, if the company fails to call
such a meeting. (Section 167)
(e) right to apply to Company Law Board for calling for an extra-ordinary general meeting of the company.
(Section 186)
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Capital Market Instruments 255
(f) right to receive annual accounts along with the auditors report, directors report and other information
(Section 210, 217 & 219).
[The rights mentioned at (b), (c), (d), (e) and (f) are also available to the preference shareholders. The right of
pre-emption in the matter of fresh issue of capital is available only to the equity shareholders vide Section
81(1)(a)].
Equity shareholders, other than non-voting shares are entitled to voting rights in all matters, whereas preference
shareholders are entitled to voting rights if the assured dividend to which they are entitled has been in arrears for
a specified period. In the normal course where there is no dividend in arrears to be paid to them they have no
voting rights except in a class meeting convened for preference share holders for specific purpose.
SHARES WITH DIFFERENTIAL VOTING RIGHTS
Where the voting rights on new shares are different from the voting rights on the equity shares already issued,
the new shares are known as Differential Voting Rights Shares (DVRS).
As per section 2(46A) of Companies Act, 1956 a share with differential rights means a share that is issued with
differential rights in accordance with the provisions of section 86 of the Act. The equity shares with differential
rights include equity shares with differential rights as to – (a) voting; (b) dividend; and (c) otherwise. Neither the
Act nor the Rules define the term – "otherwise", which may include any other right attached to equity shares.
Owners of this kind of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid
regularly before dividend can be paid in respect of equity shares. They also enjoy privity over the equity
shareholders in payment of surplus. But in the event of liquidation their claims rank below the claims of company’s
creditors, bondholders/debenture holders.
A company can issue new equity shares with higher or lower voting rights as compared to the rule of one share
one vote applicable for the existing equity shares. Section 86 of the Companies Act permits the issue of equity
shares with DVRs, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential
Voting Rights) Rules, 2001.
Pre-conditions for issue of DVRS
Rules 3 of the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001 enables companies
limited by shares to issue shares with differential rights as to dividend, voting or otherwise, subject to fulfilment
of certain conditions. The conditions are :
(1) It has distributable profits in terms of section 205 of the Companies Act, 1956 for three financial years
preceding the year in which it was decided to issue such shares.
(2) It has not defaulted in filing annual accounts and annual returns for three financial years immediately
preceding the financial year in which it was decided to issue such shares.
(3) The company has not failed to repay its deposits or interest thereon on due date or redeem its debentures
on due date or pay dividend.
(4) The Articles of Association of the company must authorize the issue of shares with differential
voting rights. If the Articles do not authorize, they have to be altered before the issuance of such
shares.
(5) The company has not been convicted of any offence arising under SEBI Act, 1992, Securities Contracts
(Regulation) Act, 1956, Foreign Exchange Management Act, 1999.
(6) The company has not defaulted in meeting investors’ grievances.
(7) The company has obtained the approval of the shareholders in general meeting by passing resolution
256 PP-CC&MM
as required under the provision of sub-clause (a) of sub-section (1) of Section 94 read with sub-section
(2) of Section 94 of the Companies Act.
(8) The listed company has obtained the approval of the shareholders in a postal ballot. The Companies
(Passing of Resolution by Postal ballot) Rules, 2001 will govern the aforesaid condition.
(9) The notice of the meeting at which resolution is proposed to be passed is accompanied by an explanatory
statement stating(a) the rate of voting rights which the equity share capital with differential voting right shall carry;
(b) the scale or in proportion to which voting rights of such class or type of such shares will vary;
(c) the company shall not convert its equity capital with voting rights into equity share capital with differential
voting rights and the shares with differential voting rights into equity share capital with voting rights;
(d) the shares with differential voting rights shall not exceed 25% of the total share capital issued;
(e) that a member of the company holding any equity shares with differential voting rights shall be entitled
to bonus shares, rights shares of the same class;
(f) the holders of equity shares with differential voting rights shall enjoy all other rights to which the holder
is entitled to excepting the right to vote as indicated in (a) above.
Examples
Pantaloons Retail India Ltd. (PRIL)
In July 2008, PRIL, India’s leading retailer, was the first to issue bonus shares with a DVR option. The company
made a bonus issue of 1: 10 shares with differential voting rights and 5% additional dividends as well. Although
there is no fund-raising involved in a bonus issue of shares, the idea was to get the markets familiar with such
instruments and create another alternative to raise funds in the future.
Tata Motors
In October 2008, Tata Motors became the first Indian company to make a rights issue of shares carrying differential
voting rights (DVR) (issue size: `1960.42 crores). DVR shares had 1/10th of voting rights of ordinary shares and
offer a 5% higher rate of dividend over the normal shares. It issued these shares at `305 i.e., about 10% lower
than the issue of normal rights at `340.
PROHIBITION ON SUPERIOR RIGHTS – CLAUSE 28 A
Clause 28A of the Listing Agreement, provides that a listed company cannot issue shares in any manner which
may confer on any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares which are
already listed.
Anand Jaiswal v. Jagatjit Industries Limited- Case Law
Karamjit Jaiswal and his unlisted firm, LP Jaiswal and Sons Pvt. Ltd, together owned 23.59% (8.59% by Karamjit
Jaiswal and 15% by his firm) in liquor firm Jagatjit Industries. In pursuance to an approval by the Board and
shareholders of Jagatjit Industries, LP Jaiswal and Sons Pvt. Ltd. subscribed to 2.5 million shares in Jagatjit
Industries, increasing its stake to 19.1% from 15%. However, each of these 2.5 million shares carried 20 voting
rights. Karamjit Jaiswal later acquired around 2.19 million ordinary shares, increasing his stake to 13% from
8.59%. With this, he and LP Jaiswal together owned a combined 32.1% in Jagatjit Industries Ltd. However,
because of the differential voting rights of the shares acquired by LP Jaiswal and Sons, this minority holding had
corresponding voting rights of 62%, giving Karamjit Jaiswal complete control over the company. In 2006, LP
Jaiswal and Sons Pvt. Ltd. along with associated persons, after their holding crossed 15% made a public
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Capital Market Instruments 257
announcement of open offer to the extent of 20% of the voting capital of Jagatjit Industries as required under
SEBI Takeover Regulations. Meanwhile Anand Jaiswal and Jagatjit Jaiswal, who together own 12% in Jagatjit
Industries filed a petition before SEBI challenging that the pricing of differential voting shares has been done in
an inappropriate manner. Moreover, they also contended that the in-principle approval from stock exchanges
has not been received and the provisions of Companies Act have been violated. SEBI held in its order that it is
not competent to decide the present issue. The powers of SEBI have been enumerated under Section 55A of
the Companies Act, 1956. At present, section 55A of the Companies Act, 1956 confers upon SEBI the right to
administer certain provisions relating to the issue and transfer of securities and non-payment of dividend in the
case of listed public companies and those companies that intend to get their securities listed. Since Section 86
of the Act doesn’t come under the purview of the Section 55A, SEBI left it to the Company Law Board to decide
upon.
Ruling by Company Law Board
Mr. Anand Jaiswal and Jagatjit Jaiswal had petitioned before the Company Law Board to declare a resolution
passed at the company’s Extraordinary General Meeting on June 16, 2004 as null and void through which 2.5
million preferential shares were allotted to LP Jaiswal & Sons, each share containing 20 voting rights. The
Company Law Board upheld the validity of the resolution passed at the meeting thus stating that issue of
differential voting shares is permissible under Section 86 of the Companies Act read with the Rules prescribed
by Central Government. The Company Law Board directed Karamjit Singh and associated persons to buy out,
on behalf of the Company, Mr. Anand and Jagatjit Jaiswal’s stake in the company for around ` 73 crores. The
company would acquire the stake as buyback of shares in cash, and consequently the equity share capital,
would stand reduced to that extent. The transaction is to be completed within three months from the date of the
order of Company Law Board.
Reform by SEBI
Subsequent to the ruling by Company Law Board in the case of Jagatjit Industries Limited, SEBI came up with
some changes vis-a-vis shares with superior voting rights in a SEBI Board Meeting on Primary Market Reforms
on June 18, 2009. It proposed that no listed company can issue shares with superior voting rights. This was
brought in to prevent the possible misuse by the persons in control to the detriment of public shareholders.
Moreover, SEBI apprehended that the precedence set by JIL may be followed by the promoters of other listed
companies also to increase their voting power through preferential allotment of DVRS. Further, the pricing
formula for preferential allotment of shares, i.e., average of the closing price of the shares at the stock exchange
during the last 26 weeks or last two weeks preceding the relevant date, whichever is higher, cannot be applied
as it is for the issue of DVRS because the issue of superior voting rights shares on preferential basis considerably
dilutes the voting power of the other shareholders vis-a-vis the promoter group.
SEBI issued a Circular on July 21, 2009 instructing the stock exchanges to amend the equity listing agreement
by inserting a new clause 28A thereby prohibiting issue of shares which may confer on any person, superior
rights as to voting or dividend vis-a-vis the rights on equity shares that are already listed.
In other words, the listed companies have been forbidden from issuing not only superior voting rights shares but
also inferior voting rights shares if such inferior voting rights shares confer on the holders thereof superior
dividend rights. Inferior voting rights shares would always carry higher dividend rate in order to make them
attractive for the investors, otherwise why would investors subscribe to such shares? It may be noted that
whenever higher dividend rate would be offered on new shares with inferior voting rights, it would tantamount to
contravention of clause 28A of the listing agreement because clause 28A prohibits issue of shares which would
confer on the holder superior rights as to dividend vis-a-vis the dividend on the already listed equity shares.
Thus, the aforesaid amendment has not only altogether banned the issue of superior voting rights shares but
also marred to a great extent the possibility of issue of inferior voting rights shares. Although the DVRS issued
258 PP-CC&MM
by Tata Motors and Pantaloon Retail entitle the holders thereof to an additional 5 per cent dividend over and
above the dividend paid on the normal equity shares, nonetheless they are valid since they were issued before
the amendment in the listing agreement. However, henceforth no listed company can issue DVRS on the same
terms and conditions, as issued by Tata Motors and Pantaloon, because although these DVRS would carry
fewer voting rights (1:10) but they would entitle their holder to 5 per cent additional dividend every year over and
above the dividend paid on the normal equity shares.
PREFERENCE SHARES
Sec. 85(1) of the Companies Act, 1956, defines preference shares as those shares which carry preferential
rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the
company.
CUMULATIVE PREFERENCE SHARES
In this type of preference shares the dividend payable every year becomes a first claim while declaring dividend
by the company. In case the company does not have adequate profit or for some reason the company does not
want to pay preference dividend, it gets accumulated for being paid subsequently. Such arrears of preference
dividend will be carried forward and paid out of the profits of the subsequent years, before payment of equity
dividend. However, if a company goes into the liquidation no arrears of preference dividend will be payable
unless the Articles of Association of the issuing company contains a specific provision to make such payment
even in winding up.
NON-CUMULATIVE PREFERENCE SHARES
In the case of these preference shares, dividend does not accumulate. If there are no profits or the profits are
inadequate in any year, the shares are not entitled to any dividend for that year. Unless there is a specific
provision in the Articles of Association of the company, the preference shareholders have no right to participate
in the surplus profits or in the surplus assets in a winding up. They are entitled to payment of the declared
preference dividend in any particular year and to the repayment of their preference capital in the event of
winding up before payment to the equity shareholders.
CONVERTIBLE PREFERENCE SHARES
If the terms of issue of preference shares includes a right for converting them into equity shares at the end of a
specified period they are called convertible preference shares. In the absence of such condition or right, the
preference shares are not converted into equity shares to become eligible for various rights such as voting,
higher dividend, bonus issue etc. as in the case of equity shares. These shares are sometimes referred to as
quasi equity shares in common parlance. Companies may even charge a premium as part of the terms of
conversion of preference shares, as they do sometimes while converting debentures into equity shares.
REDEEMABLE PREFERENCE SHARES
If the articles of a company so authorize, redeemable preference shares can be issued. This is in contrast to the
principle that the company normally can not redeem or buy back its own shares vide Section 77 of the Companies
Act, except by following the procedure for reduction of capital and getting the sanction of the High Court in
pursuance of Sections 100 to 104 or of Section 402. With effect from 31st October, 1998 a new Section 77A was
inserted in the Act empowering companies to purchase its own securities under certain circumstances and
subject to certain conditions.
Section 80 regulates the redemption of redeemable preference shares as follows:
1. The partly paid shares, if any, must be made fully paid up.
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Capital Market Instruments 259
2. The shares are to be redeemed only out of the profits of the company, which would otherwise be
available for distribution of dividend or out of the proceeds of a fresh issue of shares made for the
purpose.
3. The premium, if any payable, on redemption should be provided for out of the profits of the company or
its security premium account.
4. Where redemption is made out of profits, a sum equal to the nominal value of the shares redeemed,
must be transferred to a capital redemption reserve account which can be utilised only to pay up unissued
shares of the company to be issued as fully paid bonus shares.
According to section 80(5A) of Companies Act, 1956, a company limited by shares shall not issue any preference
shares which is irredeemable or is redeemable after the expiry of a period of 20 years from the date of its issue.
PARTICIPATING PREFERENCE SHARES
Preference shareholders are not entitled to dividend more than what has been indicated as part of the terms of
issue, even in a year in which the company has made huge profits. Subject to provision in the terms of issue
these shares can be entitled to participate in the surplus profits left, after payment of dividend to the preference
and the equity shareholders to the extent provided therein. Subject to provisions in the terms of issue such
preference shares can be entitled even to bonus shares.
NON PARTICIPATING PREFERENCE SHARES
Unless the terms of issue indicate specifically otherwise, all preference shares are to be regarded as non
participating preference shares.
FULLY CONVERTIBLE CUMULATIVE PREFERENCE SHARE (EQUIPREF)
This instrument is in two parts A & B. Part A is convertible into equity shares automatically and compulsorily on
the date of allotment without any application by the allottee, and Part B is redeemed at par/ converted into equity
after a lock in period at the option of the investor, at a price 30% lower than the average market price. The
dividend is given only for part B shares. The dividend on fully convertible cumulative preference shares is fixed
and shall be given only for the portion that represents second part shares.
DEBENTURES
Section 2(12) of the Companies Act, 1956 defines debentures as follows:
“Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a
charge on the assets of the company or not.”
Debenture is a document evidencing a debt or acknowledging it and any document which fulfills either of these
conditions is a debenture.
Features of Debentures
The important features of a debenture are:
1. It is issued by a company as a certificate of indebtedness.
2. It usually indicates the date of redemption and also provides for the repayment of principal and payment
of interest at specified date or dates.
3. It usually creates a charge on the undertaking or the assets of the company. In such a case the lenders
of money to the company enjoy better protection as secured creditors, i.e. if the company does not pay
interest or repay principal amount, the lenders may either directly or through the debenture trustees
260 PP-CC&MM
bring action against the company to realise their dues by sale of the assets/undertaking earmarked as
security for the debt.
Types of Debentures
(a) Naked or unsecured debentures
Debentures of this kind do not carry any charge on the assets of the company. The holders of such
debentures do not therefore have the right to attach particular property by way of security as to repayment
of principal or interest.
(b) Secured debentures
Debentures that are secured by a mortgage of the whole or part of the assets of the company are called
mortgage debentures or secured debentures. The mortgage may be one duly registered in the formal
way or one which is secured by the deposit of title deeds in case of urgency.
(c) Redeemable debentures
Debentures that are redeemable on expiry of certain period are called redeemable debentures. Such
debentures after redemption can be reissued in accordance with the provisions of Section 121 of the
Companies Act, 1956.
(d) Perpetual debentures
If the debentures are issued subject to redemption on the happening of specified events which may not
happen for an indefinite period, e.g. winding up, they are called perpetual debentures.
(e) Bearer debentures
Such debentures are payable to bearer and are transferable by mere delivery. The name of the debenture
holder is not registered in the books of the company, but the holder is entitled to claim interest and principal
as and when due. A bonafide transferee for value is not affected by the defect in the title of the transferor.
(f) Registered debentures
Such debentures are payable to the registered holders whose name appears on the debenture certificate/
letter of allotment and is registered on the companies register of debenture holders maintained as per
Section 152 of the Companies Act, 1956.
Classification of Debentures based Upon Convertibility
Based on convertibility, debentures can be classified under three categories:
1. Fully Convertible Debentures (FCDs)
2. Non Convertible Debentures (NCDs)
3. Partly Convertible Debentures (PCDs)
Basic Features of Convertible Debentures
– Debentures are issued for cash at par.
– They are converted into specified or unspecified number of equity shares at the end of the specified period.
The ratio at which the convertible debentures are exchanged for equity shares is known as conversion price
or conversion ratio which is worked out by dividing the face value of a convertible debenture by its conversion
price. For instance if the face value of a convertible debenture is `100 and it is convertible into two equity
shares, the conversion price is `50 and the conversion ratio is 2. The difference between the conversion
price and the face value of the equity share is called conversion premium.
Lesson 8
Capital Market Instruments 261
– Convertible debentures may be fully or partly convertible. In case it is fully convertible the entire face value
is converted into equity shares on expiry of the stipulated period. If partly convertible, the convertible portion
is converted into equity shares on expiry of the specified period and the non convertible portion is redeemed
at the expiry of certain period.
– Conversion into equity shares may take place in one or more stages at the end of specified period or periods
in the case of fully or partly convertible debentures.
– If one or more parts of the debentures are convertible after 18 months, a company should get a credit rating
done by a credit rating agency approved by SEBI. Fresh rating is required if debentures are rolled over.
– Convertible debentures of public companies can be listed on the stock exchanges to assure liquidity to the
holders.
Advantages of Convertible Debentures
Advantages to the company
The advantages of convertible debentures to the company are –
1. Capitalisation of interest cost till the date of commissioning of the project is allowed in accordance with
accounting principle. If the conversion of the debentures is duly linked with the commissioning of the
project the entire interest cost can be capitalised, without charging the interest to profit & loss account
and pulling down the profits of the company.
2. Convertible debentures carry lower interest as compared to the rate charged by the Banks and Financial
Institutions.
3. From the point of view of the debt equity ratio the convertible part of the debentures is treated as equity
by financial institutions. The company is thus enabled to have a high degree of flexibility in financing its
future projects.
4. Equity capital gets increased after each conversion, facilitating easier servicing of equity by payment of
dividend.
5. Tax benefits are higher as interest on debentures is allowed as a deduction in computation of taxable
income of the company. Additionally a company having a proven track record and future earning potential
will be able to reasonable premium at the time of conversion. This will result in reducing the servicing
cost of equity.
6. This is a popular form of financing in companies as the interest rates are cheaper than those charged by
Financial Institutions on term loans.
7. In the case of term loans from Financial Institutions (FIs) and Banks they usually impose many conditions
on management including placing their representative on the Board. In the case of convertible debentures
there is thus a greater degree of autonomy for the companies.
Advantages to the Investor
The advantages of the convertible debentures to the investors are –
1. The investor is assured of a fixed return by way of interest on the debentures till conversion. On conversion
equity shares the investor becomes entitled to receive dividend declared on equity shares. The advantage
to the investor is that he receives a fixed return on his investment by way of interest even during the
gestation period and project implementation period.
2. As price of equity shares tends to rise on completion of the project of the company, the investor gets
value appreciation on his investment, if converted into equity share.
262 PP-CC&MM
3. In most cases, debentures carry security with a charge on all or a part of movable/immovable properties
of the company. This assures prompt payment of principal and interest by invoking the assistance of a
debenture trustee. However in terms of SEBI Regulations where the debentures have a maturity period
of 18 months or less it is mandatory for the company to create security on the debentures.
4. A fair amount of liquidity is enjoyed by convertible debentures listed on the stock exchanges depending
on the track record of the companies. Even if debentures are not traded as actively as equity shares,
convertible debentures of good companies command reasonable liquidity. Where a debenture has several
parts, each part of the convertible debentures can be traded separately or in full on the stock exchanges.
5. The following options are available to the investor who has bought convertible debentures issued in
several parts:
(a) To sell all the parts immediately on allotment;
(b) To sell one or more parts and retain other or others till conversion and to obtain equity shares for
retention or sale.
Fully Convertible Debentures With Interest (Optional)
In this case there is no interest payment involved say for the first 6 months. Then the holder can exercise option
and apply for securities at a premium without paying additional amount. However interest will be payable at a
determined rate from the date of first conversion to second/final conversion and in lieu thereof equity shares are
issued. Upon conversion of each part, the face value stands reduced proportionately on the date of conversion.
NON CONVERTIBLE DEBENTURES (NCDs) WITH PUT AND CALL OPTIONS
Put Options in NCD
A “put” option means that the investor has an option to surrender the debenture if he wants to, and get back the
principal. A put option gives a lot of flexibility to the investor – if interest rates go up, he can get better rates from
the market. He can exercise the put option and get back the money and invest it elsewhere.
Call Option in NCD
A “call” option means that the company has an option to ask the investor to surrender the debenture, and pay
back the principal to the investor. A call option gives flexibility to the company – if interest rates go down, and the
company can get funds at lower rates from the market, it can exercise the call option and give the money back
and can raise money from the market at lower rates.
Example
TATA Capital has issued Non Convertible Debentures in the year 2009 and the rate of interest offered by the
issue was 12% compounded per annum. The company has offered that the NCD holder can exercise put or
call option after completion of 36 months of the issue. As interest rates offered in 2009 was higher than in
March 2012( Option exercising period) the company decided to offer revised interest rates, if not agreed then
investors can exercise put option and exit from the NCDs with principal and accumulated interest (if any) as
on the date.
BONDS
Bonds are the debt security where an issuer is bound to pay a specific rate of interest agreed as per the terms
of payment and repay principal amount at a later time. The bond holders are generally like a creditor where a
company is obliged to pay the amount. The amount is paid on the maturity of the bond period. Generally these
bonds duration would be for 5 to 10 years.
Lesson 8
Capital Market Instruments 263
Characteristics of a Bond
A bond, whether issued by a government or a corporation, has a specific maturity date, which can range from a
few days to 20-30 years or even more. Based on the maturity period, bonds are referred to as bills or short-term
bonds and long-term bonds. Bonds have a fixed face value, which is the amount to be returned to the investor
upon maturity of the bond. During this period, the investors receive a regular payment of interest, semi-annually
or annually, which is calculated as a certain percentage of the face value and know as a 'coupon payment.'
Types of Bond
There are various types of bonds in India:
(1) Government Bonds: These are the bonds issued either directly by Government of India or by the
Public Sector Units (PSU’s) in India. These bonds are secured as they are backed up with security from
Government. These are generally offered with low rate of interest compared to other types of bonds.
(2) Corporate Bonds: These are the bonds issued by the private corporate companies. Indian corporates
issue secured or non secured bonds. E.g. IIFL bonds issue which came up during Sep-2012 was
unsecured bond and Shriram city union bond issue in Sep-2012 was a secured bond issue.
(3) Banks and other financial institutions bonds: These bonds are issued by banks or any financial
institution. The financial market is well regulated and the majority of the bond markets are from this
segment. However care to be taken to consider the credit rating given by Credit Rating Agencies before
investing in these bonds. In case of poor credit rating, better to stay away from such bonds.
(4) Tax saving bonds: In India, the tax saving bonds are issued by the Government of India for providing
benefit to investors in the form of tax savings. Along with getting normal interest, the bond holder would
also get tax benefit.
In India, all these bonds are listed in National Stock Exchange and Bombay Stock Exchange in India, hence they
can be easily liquidated and sold in the open market.
SWEAT EQUITY SHARES
Sweat Equity Shares means equity shares issued by the company to employees or directors at a discount or for
consideration other than cash for providing know how or making available rights in the nature of intellectual
property rights or value additions, by whatever name called. Since these shares are issued at a discount or for
consideration other than cash, the company will generally select those employees and directors as per norms
approved by the Board of Directors, based on the know how provided or intellectual property rights created and
given for value additions made by such directors and employees to the company.
According to section 79A of Companies Act, 1956, a public company may issue sweat equity shares of a class
of shares already issued if the following conditions are fulfilled:
(a) The issue of sweat equity share is authorized by a special resolution passed by the company in the
general meeting.
(b) The resolution specifies the number of shares, current market price, consideration if any and the class
or classes of directors or employees to whom such equity shares are to be issued.
(c) Not less than one year has been elapsed at the date of the issue, since the date on which the company
was entitled to commence business.
(d) The sweat equity shares of a company whose equity shares are listed on a recognised stock exchange
are issued in accordance with the regulations made by SEBI in this regard.
However, in the case of a company whose equity shares are not listed on any recognised stock exchange, the
sweat equity shares are to be issued in accordance with the guidelines as may be prescribed.
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All the limitations, restrictions and provisions relating to equity shares are also applicable to such sweat equity
shares issued under Section 79A. Apart from this SEBI has issued the SEBI (Issue of Sweat Equity) Regulations,
2002 that is applicable to issue of sweat equity shares by listed companies and MCA has notified Unlisted
Companies( Issue of Sweat Equity) Rules, 2003 for unlisted companies.
WARRANT
Warrant means an option issued by a company whereby the buyer is granted the right to purchase a number of
shares (usually one) of its equity share capital at a given exercise price during a given period.
The holder of a warrant has the right but not the obligation to convert into equity shares. Thus in the true sense,
a warrant signifies optional conversion. In case the investor benefits by capital gains, he will convert the warrants,
else he may simply let the warrant lapse. Thus in such cases, there is no possibility of the investor suffering any
capital losses.
For example if the conversion price of the warrant is ` 70/- and the current market price is `110/-, then the
investor will convert the warrant and enjoy the capital gain of `40/-. In case the conversion is at ` 70/- and the
current market price is `40/-, then the investor will simply let the warrant lapse without conversion.
SHARE WARRANT
A share warrant is a bearer document of title to the specified shares. As per Section 114 and 115 of the Companies
Act, 1956, share warrants can be issued only by public limited companies and that to against fully paid up
shares only. A share warrant cannot be issued by a private company, because the share warrant states that its
bearer is entitled to a number of shares mentioned there in. It is a negotiable document and is easily transferable
by mere delivery to another person. The holder of the share warrant is entitled to receive dividend as decided by
the company.
Position of the Holder of a share warrant
When a share warrant is issued in respect of any shares, the company must strike out from the register of
members the names of the members who held the shares, now comprised in the share warrant and should
enter into the register:
– The fact of the issue of share warrant;
– A statement of the shares included in the warrant , distinguishing each share by its number; and
– The date of issue of the warrant.
Since the name of the shareholder has been removed from the register of members, the company is no more in
a position to know who the shareholder is and who is entitled to dividends. For this reason, a share warrant is
accompanied by attached coupons showing the date for the payment of future dividends.
Conditions for the issue of a share warrant
– Share warrant can be issued by the public limited companies. It cannot be issued by private companies.
– A share warrant is only issued against share certificate of fully paid up shares.
– There must be a provision in the Articles of Association regarding the issue of share warrant. If there is a
provision, the company can issue a share warrant. If there is no provision in the Articles, the company
cannot issue a share warrant.
– Prior permission from the Central Government is necessary for the issue of share warrant.
– Share warrant is not issued originally at the time of initial issue.
Lesson 8
Capital Market Instruments 265
A share warrant is issued at the request of the Shareholders/member and not by the company at its own
initiative.
SECURED PREMIUM NOTES (SPN)
These instruments are issued with detachable warrants and are redeemable after a notified period say 4 to 7
years. The warrants enable the holder to get equity shares allotted provided the secured premium notes are fully
paid. During the lock in period no interest is paid. The holder has an option to sell back the SPN to the company
at par value after the lock in period. If the holder exercises this option, no interest/premium is paid on redemption.
In case the holder keeps it further, he is repaid the principal amount along with the additional interest/premium
on redemption in installments as per the terms of issue. The conversion of detachable warrants into equity has
to be done within the specified time.
Example
TISCO in the year 1992 wanted to raise money for its modernization program without expanding its equity
excessively in the next few years. The company made the issue to the existing shareholders on a rights basis
along with the rights issue. The salient features of the TISCO issue were as follows :
(a) Face value of each SPN was `300.
(b) No interest was payable during the first three years after allotment.
(c) The redemption started at the end of the fourth year of issue.
(d) Each of the SPN of `300 was repaid in four equal amount instalments of `75 which comprised of the
principal, the interest and the relevant premium. (Low interest and high premium or high interest and
low premium, at the option to be exercised by the SPN holder at the end of the third year.
(e) Warrant attached to each SPN entitled the holder the right to apply for or seek allotment of one equity
share for cash payment of `80 per share. Such a right was exercisable between first year and one-anda-half year after allotment by which time the SPN would be fully paid-up.
The instrument tremendously benefited TISCO, as there was no interest outgo. This helped TISCO to meet the
difficulties associated with the cash generation. In addition, the company was able to borrow at a cheap rate of
13.65 per cent as against 17 to 18 per cent offered by most companies. This enabled the company to start
redemption earlier through the generation of cash flow by the company’s projects. The investors had the flexibility
of tax planning while investing in SPNs. The company was also equally benefited as it gave more flexibility.
EQUITY SHARES WITH DETACHABLE WARRANTS
The holder of the warrant is eligible to apply for the specified number of shares on the appointed date at the
predetermined price. These warrants are separately registered with the stock exchanges and traded separately.
The practice of issuing non convertible debentures with detachable warrants also exists in the Indian market.
FOREIGN CURRENCY CONVERTIBLE BONDS (FCCBs)
The FCCBs are unsecured, carry a fixed rate of interest and an option for conversion into a fixed number of
equity shares of the issuer company. Interest and redemption price (if conversion option is not exercised) is
payable in dollars. FCCBs shall be denominated in any freely convertible Foreign Currency. However, it must be
kept in mind that FCCB, issue proceeds need to conform to ECB end use requirements.
Foreign investors also prefer FCCBs because of the Dollar denominated servicing, the conversion option and,
the arbitrage opportunities presented by conversion of the FCCBs into equity shares at a discount on prevailing
Indian market price.
266 PP-CC&MM
In addition, 25% of the FCCB proceeds can be used for general corporate restructuring.
Example
Suppose a company ‘A’ issues bonds with following terms –
Issue Price of the Bond
Coupon rate
Maturity
` 1000
2%
2 years
Convertible into equity shares @ ` 800 per share
Now suppose an investor subscribes to 4 of these bonds. Thus the total investment is ` 4000. On this investment,
he is entitled to get an interest @2% for 2 years. On the maturity date, i.e. after 2 years, the investor will have an
option – to either claim full redemption of the amount from the company or get the bonds converted into fully paid
equity shares @ ` 800 per share. Thus if he goes for the conversion he will be entitled to 5 (4000/800) equity
shares. The choice he makes will depend on the market price of the share on the date of conversion.
If the shares of the company ‘A’ is trading at lower than ` 800, let’s say ` 500, the investor will be better off by
claiming full redemption of his bonds and buying the shares from the market. In this case, he will get 8 (4000/
500) equity shares as against 5 which he was getting on conversion. Similarly if the market price of the share is
higher than ` 800, the investor will benefit by getting its shares converted. Thus, on the day of maturity, an
investor will seek full redemption if the conversion price is higher than the current market price, and will go for
conversion if the conversion price is less than the current market price.
FOREIGN CURRENCY EXCHANGEABLE BONDS (FCEBs)
The FCEB is used to raise funds from the international markets against the security and exchangeability of
shares of another company. Foreign Currency Exchangeable Bond (FCEB) means –
(i) a bond expressed in foreign currency,
(ii) the principal and the interest in respect of which is payable in foreign currency
(iii) issued by an issuing company, being an Indian company
(iv) subscribed by a person resident outside India
(v) Exchangeable into equity shares of another company, being offered company which is an Indian company.
(vi) Either wholly or partly or on the basis of any equity related warrants attached to debt instruments.
It may be noted that issuing company to be the part of promoter group of offered company and the offered
company is to be listed and is to be eligible to receive foreign investment. Under this option, an issuer company
may issue FCEBs in foreign currency, and these FCEBs are convertible into shares of another company (offered
company) that forms part of the same promoter group as the issuer company. E.g., company ABC Ltd. issues
FCEBs, then the FCEBs will be convertible into shares of company XYZ Ltd. that are held by company ABC Ltd.
and where companies ABC Ltd. and XYZ Ltd. form part of the same promoter group. Unlike FCCBs that convert
into shares of issuer itself, FCEBs are exchangeable into shares of Offered Company (OC). Also, relatively,
FCEB has an inherent advantage that it does not result in dilution of shareholding at the OC level.
AMERICAN DEPOSITORY RECEIPTS(ADR) / GLOBAL DEPOSITORY RECEIPTS (GDR)
ADR
An American Depository Receipt (ADR) is a dollar denominated form of equity ownership in the form of
depository receipts in a non-US company. It represents the foreign shares of the company held on deposit by
Lesson 8
Capital Market Instruments 267
a custodian bank in the company’s home country and carries the corporate and economic rights of the foreign
shares.
Advantages of ADRs
– Cost-effective - ADRs are an easy and cost-effective way to buy shares in a foreign company. They
save money by reducing administration costs and avoiding foreign taxes on each transaction.
– Diversification - Investor gains the potential to capitalize on emerging economies by investing in different
countries.
– More US exposure – Foreign entities favour ADRs because they get more US exposure, allowing them
to tap into the wealthy North American equity markets
GDR
GDRs have access usually to Euro market and US market. The US portion of GDRs to be listed on US exchanges
to comply with SEC requirements and the European portion are to be complied with EU directive.
Listing of GDR may take place in international stock exchanges such as London Stock Exchange, New York
Stock Exchange, American Stock Exchange, NASDAQ, Luxemburg Stock Exchange etc.
Advantages to issuing company
– Accessibility to foreign capital markets
– Increase in visibility of the issuing company
– Rise in the capital because of foreign investors
Advantages to investor
– Helps in diversification, hence reducing risk
– More transparency since competitor’s securities can be compared
– Prompt dividend and capital gain payments.
Difference between American Depository Receipts (ADR) and Global Depository Receipts (GDR)
– ADR are US $ denominated and traded in US.
– GDRs are traded in various places such as New York Stock Exchange, London Stock Exchange, etc.
INDIAN DEPOSITORY RECEIPTS (IDRs)
IDRs is an instrument denominated in Indian Rupees in the form of a depository receipt created by a domestic
depository (Custodian of securities registered with SEBI) against the underlying equity of issuing company to
enable foreign companies to raise funds from the Indian securities markets.
In an IDR, foreign companies would issue shares, to a domestic (Indian) depository, which would in turn issue
depository receipts to investors in India. The actual shares underlying the IDRs would be held by an Overseas
Custodian, which shall authorize the Indian depository to issue the IDRs. To that extent, IDRs are derivative
instruments because they derive their value form the underlying shares.
Benefits of IDRs
Issuing Company: Any foreign company listed in its home country and satisfying the eligibility criteria can issue
IDRs. A company which has significant business in India can increase its value through IDRs by breaking down
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market segmentations, reaching trapped pools of liquidity, achieving global benchmark valuation, accessing
international shareholder base and improving its brands presence through global visibility.
Investors: IDRs can lead to better portfolio management and diversification for investors by giving them a
chance to buy into the stocks of reputed companies abroad.
DERIVATIVE
A derivative is a financial instrument that derives its value from an underlying asset. This underlying asset can
be stocks, bonds, currency, commodities, metals and even intangible, assets like stock indices. Derivatives can
be of different types like futures, options, swaps, caps, floor, collars etc. The most popular derivative instruments
are futures and options.
FUTURES
A futures contract is an exchange traded forward contract to buy or sell a predetermined quantity of an asset on
a predetermined future date at a predetermined price. Contracts are standardized and there’s centralized trading
ensuring liquidity.
There are two positions that one can take in a future contract:
– Long Position- This is when a futures contact is purchased and the buyer agrees to receive delivery of
the underlying asset. (Stock/Indices/Commodities).
– Short Position- This is when a futures contract is sold and the seller agrees to make delivery of the
underlying asset. (stock/Indices/Commodities)
OPTIONS
Options Contract give its holder the right, but not the obligation, take or make delivery on or before a specified
date at a stated price. But this option is given to only one party in the transaction while the other party has an
obligation to take or make delivery. Since the other party has an obligation and a risk associated with making the
good the obligation, he receives a payment for that. This payment is called as option premium.
Option contracts are classified into two types on the basis of which party has the option:
– Call option- A call option is with the buyer and gives the holder a right to take delivery.
– Put option- The put option is with the seller and the option gives the right to take delivery.
Option Contracts are classified into two types on the basis of time at which the option can be exercised:– European Option- European style options are those contacts where the option can be exercised only on
the expiration date.
– American Option- American style options are those contacts where the option can be exercised on or
before the expiration date.
Example
Case 1
Rajesh purchases 1 lot of Infosys Technologies MAY 3000 Put and pays a premium of ` 250. This contract
allows Rajesh to sell 100 shares of Infosys at ` 3000 per share at any time between the current date and the end
of May. In order to avail this privilege, all Rajesh has to do is pay a premium of ` 25,000 (` 250 a share for 100
shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.
Lesson 8
Capital Market Instruments 269
Case 2
If an investor is of the opinion that a particular stock say "Ray Technologies" is currently overpriced in the month
of February and hence expect that there will be price corrections in the future. However he doesn't want to take
a chance, just in case the prices rise. So the best option for the investor would be to take a Put option on the
stock.
Lets assume the quotes for the stock are as under:
Spot
` 1040
May Put at 1050
` 10
May Put at 1070
` 30
So the inevstor purchases 1000 "Ray Technologies" Put at strike price of `1070 and Put price of ` 30/-. The
investor pay ` 30,000 as Put premium.
The position of investor in two different scenarios have been discussed below:
1. May Spot price of Ray Technologies = `1020
2. May Spot price of Ray Technologies = `1080
In the first situation you have the right to sell 1000 "Ray Technologies" shares at ` 1,070/- the price of which is
` 1020/-. By exercising the option the investor earn ` (1070-1020) = ` 50 per Put, which amounts to ` 50,000/.
The net income in this case is ` (50000-30000) = ` 20,000.
In the second price situation, the price is more in the spot market, so the investor will not sell at a lower price by
exercising the Put. He will have to allow the Put option to expire unexercised. In the process the investor only
lose the premium paid which is ` 30,000.
INDEX FUTURES & OPTIONS
An Index Future is a future contract with the index as the underlying asset. There is no underlying security or a
stock, which is to be delivered to fulfill the obligations as index futures are cash settled. They can be used for
hedging against an existing equity position, or speculating on future movements of the index. E.g., futures
contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying
index.
Index Option is an option contract where the option holder has the call or put option on the index. However,
unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the
underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised
/ assigned only on the expiry date.
An index, in turn derives its value from the prices of securities that constitute the index and is created to represent
the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the
whole market are broad based indices and those that represent a particular sector are sectoral indices. In the
beginning futures and options were permitted only on S&P Nifty and BSE Sensex. Subsequently, sectoral indices
were also permitted for derivatives trading subject to fulfilling the eligibility criteria. Derivative contracts may be
permitted on an index if 80% of the index constituents are individually eligible for derivatives trading. However,
no single ineligible stock in the index shall have a weightage of more than 5% in the index. The index is required
to fulfill the eligibility criteria even after derivatives trading on the index have begun. If the index does not fulfill
the criteria for 3 consecutive months, then derivative contracts on such index would be discontinued. By its very
nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these
contracts are essentially cash settled on Expiry.
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CURRENCY FUTURES
A currency futures contract is a standardized forward contract that is traded on an exchange. It is an agreement
to buy or sell a particular currency in the future at a specified rate and at a specified date. E.g., buying one lot of
December, 200X, USD/INR at 49.50 on 17th November, 200X, means the buyer has agreed to buy USD 1,000
at the rate of INR 49.50 per USD on 29th December, 200X, assuming 29th December, 200X, is the maturity date
for December 200X USD/INR Futures.
A country's currency exchange rate is typically affected by the supply and demand for the country's currency in
the international foreign exchange market. The demand and supply dynamics is principally influenced by factors
like interest rates, inflation, trade balance, and the state of economic and political affairs in the country. The level
of confidence in the economy of a particular country also influences the currency of that country. Currency
futures are standardized depending on what is being traded, the quantity, delivery time and delivery location for
each specific commodity. They consist of secondary markets and can also be dealt numerous times much like
a bond and opposed to a bank loan.
INTEREST RATE FUTURES (IRFs)
On August, 2009, RBI issued directions for trading of Interest Rate futures on Currency Derivative segment of a
Recognized Stock Exchange. The term “Interest Rate Futures” has been defined in the Regulation as:Interest Rate Futures means a standardized interest rate derivative contract traded on a recognized stock
exchange to buy or sell a notional security or any other interest bearing instrument or an index of such instruments
or interest rate at a specified future date, at a price determined at the time of the contract.
Products that can be traded in the market are futures on long bond (10 year notional G-Secs) and T- bills (91
days notional) and any other product which is approved by RBI.
Interest rate futures on 91-day treasury bill are interest rate-driven derivative products that help banks, mutual
funds and primary dealers to hedge their interest rate exposure on treasury bills. Financial institutions can lock
in the interest rate or the yield on the 91-day treasury at a given date when counter parties enter into the interest
rate futures contract.
The 91-day T-bill interest rate futures are cash settled. In case of the 91-day treasury bill, the final settlement
price of the futures contract is based on the weighted average price/ yield obtained in the weekly auction of the
91-day treasury bills on the date of expiry of the contract. But in case of interest rate futures on the 10-year
benchmark government security, the contract is physically settled.
STOCK FUTURES AND STOCK OPTIONS
Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is
an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed
upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day,
unit of price quotation, tick size and method of settlement.
In stock options, the option buyer has the right and not the obligation, to buy or sell the underlying share. In
case of stock futures, both the buyer and seller are obliged to buy/sell the underlying share. Risk-return
profile is symmetric in case of single stock futures whereas in case of stock options payoff is asymmetric.
Also, the price of stock futures is affected mainly by the prices of the underlying stock whereas in case
of stock options, volatility of the underlying stock affects the price along with the prices of the underlying
stock.
Pricing of Stock Futures
The theoretical price of a future contract is sum of the current spot price and cost of carry. However, the actual
Lesson 8
Capital Market Instruments 271
price of futures contract very much depends upon the demand and supply of the underlying stock. Generally, the
futures prices are higher than the spot prices of the underlying stocks.
Futures Price = Spot Price + Cost of Carry
Cost of carry is the interest cost of a similar position in cash market and carried to maturity of the futures contract
less any dividend expected till the expiry of the contract.
Example
Spot Price of Infosys = 1600, Interest Rate = 7% p.a. Futures Price of 1 month contract=1600 + 1600*0.07*30/
365 = 1600 + 11.51 = 1611.51
EXCHANGE TRADED FUNDS (ETFs)
Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a
sectoral fund but trades like a stock on an exchange. It is similar to a close-ended mutual fund listed on stock
exchanges. ETF's experience price changes throughout the day as they are bought and sold.
There are different types of ETFs:
(i) Equity ETFs – Equity ETF is a basket of stocks that reflects the composition of an Index, like S and P
CNX Nifty or S&P BSE SENSEX. The ETFs trading value is based on the net asset value of the underlying
stocks that it represents. Think of it as a Mutual Fund that one can buy and sell in real-time at a price that
change throughout the day.
(ii) Gold ETFs – Gold ETFs are units representing physical gold which may be in paper or dematerialized
form. These units are traded on the exchange like a single stock of any company.
(iii) Liquid ETFs – Liquid ETFS are funds whose unit price is derived from money market securities comprising
of government bonds, treasury bonds, call money market etc. The funds seek to deliver reasonable
market related returns with lower risk and higher liquidity through portfolio of debt and money market
instruments.
LESSON ROUND UP
– Financial instruments that are used for raising capital resources in the capital market are known as
Capital Market Instruments.
– Equity shares have the right to share the profits of the company in the form of dividend (cash) and bonus
shares.
– Where the voting rights on new shares are different from the voting rights on the equity shares already
issued, the new shares are known as Differential Voting Rights Shares (DVRS).
– Sec. 85(1) of the Companies Act, 1956, defines preference shares as those shares which carry preferential
rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of
the company.
– Debenture includes debenture stock, bonds and any other securities of a company, whether constituting
a charge on the assets of the company or not.
– A share warrant is a bearer document of title to the specified shares. It is a negotiable document and is
easily transferable by mere delivery to another person. The holder of the share warrant is entitled to
receive dividend as decided by the company.
272 PP-CC&MM
– Sweat Equity Share is an instrument permitted to be issued by specified Indian companies, under
Section 79A of Companies Act, 1956.
– Derivatives are contracts which derive their values from the value of one or more of other assets (known
as underlying assets).
– An Index Future is a future contract with the index as the underlying asset. There is no underlying
security or a stock, which is to be delivered to fulfill the obligations as index futures are cash settled.
– Index Option is an option contract where the option holder has the call or put option on the index.
– Interest Rate Futures means a standardized interest rate derivative contract traded on a recognized
stock exchange to buy or sell a notional security or any other interest bearing instrument or an index of
such instruments or interest rate at a specified future date, at a price determined at the time of the
contract.
– Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or
a sectoral fund but trades like a stock on an exchange.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a warrant? Briefly discuss.
2. Briefly explain about equity shares with detachable warrants.
3. Explain Non convertible Debentures with call and put option.
4. What is an Option contract? Explain it with the help of an example.
5. What do you understand by Exchange Traded Funds? Briefly discuss the various types of ETFs traded
on the Stock Exchanges.
Lesson 9
Resource Mobilization Through International Markets 273
Lesson 9
Resource Mobilization Through
International Markets
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Increased globalization and investor appetite for
– American Depository Receipts (ADRs)
diversification, offer a unique opportunity to
– Types of ADRs
companies looking to tap a new investor base to
– Global Depository Receipts (GDRs)
raise capital. Indian companies are allowed to
– Advantage of ADRs and GDRs
raise equity capital in the international market
– Process involved in Issue of ADR/GDR
through the issue of GDR/ADR in accordance
– Sponsored ADR/GDR Issue
with the Scheme for issue of Foreign Currency
– Two-way Fungibility Scheme
– Issuance of Shares under ADR/GDR
Convertible Bonds (FCCBs) and Ordinary Shares
– Statutory Approvals Required for issue of
GDR/ADR
(Through Depository Receipt Mechanism)
Scheme, 1993 and guidelines issued by the
– Agencies involved in ADR/GDR issue
Central Government there under from time to
– Agreements and related Documents
time.
– Procedural Requirements
The objective of this lesson is to give a complete
– Procedure for issue of ADR/GDR
overview of the advantages, structure, issuance
– Reporting of ADR/GDR issue
and fungibility of ADR/GDR, choice of stock
– Foreign Currency Convertible Bonds and
Ordinary Shares (Through Depository
Receipt Mechanism) Scheme, 1993
exchanges for cross-listing of companies,
criteria for Listing on NASDAQ, London stock
Exchange, New York Stock Exchange.
– Listing of GDR
– London Stock Exchange
– Listing on Main Market
– Listing on Professional Security Market
– Listing on AIM
– Luxembourg Stock Exchange
– Listing of ADR
– NASDAQ
– The NASDAQ Global Select Market
– The NASDAQ Capital Market
– The NASDAQ Global Market
– NewYork Stock Exchange (NYSE)
– LESSON ROUND UP
– SELF TEST QUESTIONS
273
274 PP-CC&MM
INTRODUCTION
Companies either raise funds from the domestic market or through international market. For international funding,
the most popular source amongst the Indian companies in the recent times has been American Depository
Receipts (ADR) and Global Depository Receipts (GDR).
AMERICAN DEPOSITORY RECEIPT
An American Depository Receipt (ADR) is a negotiable security representing ownership in some underlying
shares of a non-US company, which can be traded on US stock exchanges. ADRs are denominated in US
dollars and function on the lines of the shares of a US company in terms of trading and dividend payment.
Example I
The following example would clear the mechanism of the working of an ADR and the parties involved.
1. Suppose there is a broker, say Mr. X. He buys the shares of a company, say Reliance Industries Ltd. (RIL)
from the Bombay Stock Exchange.
2. He then goes to his custodian bank, say ICICI, to hold the shares for the issuance of ADRs.
3. He then goes to another bank, called the Depository bank, say JP Morgan and asks them to issue ADRs on
the basis of shares in the custody of ICICI.
Note: In case of sponsored ADRs, the company (RIL in this case) can itself have a designated depository
for issuance of ADRs, bypassing the custodian.
4. JP Morgan then confirms the shares held by ICICI and issues ADRs to Mr. X.
5. An ADR issued can represent a fraction of a share (say 1 ADR=1/2 a share of RIL), 1 single share or multiple
shares (say 10 shares of RIL make 1 ADR).
6. These ADRs then can be traded on the US stock exchanges in a way similar to the trading of stocks of US
companies.
The diagram below will make the working of an ADR clear :
ICICI Bank
(Custodian)
Confirmation
Requested
Confirmation
Given
US Stock
(Markets)
J P Morgan
(Depository Bank)
Get the
ADRs
Requests for
ADRs on the
basis of shares
deposited
with ICICI
Deposits RIL Shares brought
from BSE
Mr. X
(Broker)
ADRs traded on
US stock markets
Buys RIL Shares
Bombay Stock
Exchange
Lesson 9
Resource Mobilization Through International Markets 275
Example II
Let us take Infosys example – trades on the Indian stock market at around ` 2000/– This is equivalent to US$ 40 – assume for simplicity
– Now a US bank purchases 10000 shares of Infosys and issues them in US in the ratio of 10:1
– This means each ADR purchased is worth 10 Infosys shares.
– Quick calculation means 1 ADR = US $400
– Once ADR are priced and sold, its subsequent price is determined by supply and demand factors, like
any ordinary shares.
ADR RATIO
– Single: 1 ADR = 1 SHARE
ADR Ratio = 1:1
– Multiple : 1 ADR = 5 SHARES
ADR Ratio = 1:5
– Fraction : 1 ADR = ½ SHARE
ADR Ratio = 2:1
Types of ADRs
ADRs can be classified into two broad categories:
Unsponsored ADRs: In such ADRs, the company has got no agreement with the custodian or depository bank
for the issuance of ADRs. These are traded on the over-the-counter (OTC) market and are issued according to
the market demand forces. Unsponsored ADRs can be issued by a number of depository banks. Each depository
services only the ADRs issued by it.
Sponsored ADRs: These are the ADRs which are sponsored by the company itself. In this case, the foreign
company itself wants to issue ADRs and it does so by designating a depository bank that will issue ADRs in the
foreign market on its behalf. It is of the following types:
(a) Level 1 Sponsored ADRs: These are the lowest level of sponsored ADRs. These are traded only on the
OTC market. The company is supposed to adhere to minimal US Securities and Exchange Commission
(SEC) requirements and is not required to publish reports in accordance to US GAAP standards.
(b) Level 2 Sponsored ADRs: In level 2 ADRs, the ADRs are listed on a recognized US stock exchange
and can be traded thereafter. The stock exchanges in which these ADRS can be traded are New York
Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). In such ADRs, the
company is supposed to adhere to higher level of SEC regulations and is also required to publish
annual reports in accordance with US GAAP or IFRS (International Financial reporting Standards).
(c) Level 3 Sponsored ADRs: These are the highest level of sponsored ADRs. As such, it requires adherence
to stringent rules and regulations similar to the US companies. In this type of ADRs, the company rather
than letting its shares from the home market to be deposited in for the ADR program, actually issues
fresh shares in the form ADRs to raise capital from the US market.
GLOBAL DEPOSITORY RECEIPTS
Global Depository Receipts (GDRs) came into existence long after the American Depository Receipts and function
276 PP-CC&MM
on the same lines. GDRs were first issued by Citibank in 1990. Samsung Corporation, a Korean trading company,
wanted to raise equity capital in the United States through a private placement, but also had a strong European
investor base that it wanted to include in the offering. The GDR issue allowed Samsung to raise capital in the
US and Europe through one security issued simultaneously into both markets.
The mechanism of the operations of Global Depository Receipts is similar to that of the ADRs, the modulation
being they can be traded anywhere in the world (or most of the stock exchanges in the world for that matter).
GDRs are usually listed in the Luxembourg Stock Exchange and in the London Stock Exchange. They are
usually traded on the International Order Book (IOB) which is normally 1 GDR = 10 Shares.
Since one type of security can be issued anywhere in the world, GDRs are inherently very flexible. Like ADRs,
GDRs can be unsponsored and sponsored. Sponsored GDRs, again like ADRs, are of the three types mentioned
previously with similar features.
Difference between American Depository Receipts (ADR) and Global Depository Receipts (GDR)
ADR are US $ denominated and traded in US.
GDRs are traded in various places such as Luxembourg Stock Exchange, London Stock Exchange, etc.
ADVANTAGE OF ADRS AND GDRS
To the Investors
– Easy to purchase and hold.
– Investor doesn’t need to go through the hassles of govt. regulations and currency conversion to buy
stocks of foreign companies.
– Trades and settles in the same manner as any other security available in the investor’s home country’s
stock markets.
– Facilitates portfolio diversification by inclusion of foreign stocks.
– Better comparison between stocks of various companies.
– Since GDRs are denominated in the investors home currency (like ADR in US Dollars), they tend to
reduce foreign exchange risks.
To the Issuers
– Broadens investor base.
– Increases global presence.
– More avenues to raise funds.
– Price parity with global competitors.
– Facilitates mergers and acquisitions.
Point to Remember
An Indian corporate can raise foreign currency resources abroad through the issue of GDR/ADR. Regulation
4 of Schedule I of FEMA Notification no. 20 issued by RBI, allows an Indian company to issue its Rupee
denominated shares to a person resident outside India being a depository for the purpose of issuing ADRs/
GDRs.
Lesson 9
Resource Mobilization Through International Markets 277
Process involved in Issue of ADR/GDR
ADR/GDR
It is basically a receipt against
the security
Issued by
Indian Company also deliver the
share certificate to the domestic
custodian bank
Indian Company
To
Instructed
Non-resident Investor
Bank/depository outside India to
issue receipt to
Non-resident Investor
The shares are traded on various
Foreign Stock Exchange(s)
ADR
GDR
If the depository
receipt are traded in
USA, it is called an
ADR
If the depository receipt
is traded in a country
other than USA, it is
called an GDR
SPONSORED ADR/GDR ISSUE
An Indian company can also sponsor an issue of ADR / GDR. Under this mechanism, the company offers its
resident shareholders a choice to submit their shares back to the company so that on the basis of such shares,
ADRs / GDRs can be issued abroad. The proceeds of the ADR / GDR issue are remitted back to India and
distributed among the resident investors who had offered their Rupee denominated shares for conversion.
These proceeds can be kept in Resident Foreign Currency (Domestic) accounts in India by the resident
shareholders who have tendered such shares for conversion into ADRs / GDRs.
278 PP-CC&MM
TWO-WAY FUNGIBILITY SCHEME
A limited two-way Fungibility scheme has been put in place by the Government of India for ADRs / GDRs. Under
this Scheme, a stock broker in India, registered with SEBI, can purchase shares of an Indian company from the
market for conversion into ADRs/GDRs based on instructions received from overseas investors. Re-issuance of
ADRs / GDRs would be permitted to the extent of ADRs / GDRs which have been redeemed into underlying
shares and sold in the Indian market.
TERM ONE SHOULD KNOW
One way fungibility – Here investors could cancel their depository receipt and recover the proceeds by
selling the underlying shares in the Indian market; DRs once redeemed could not be converted into shares.
Two way fungibility – It means that the shares so released can be reconverted by the company into DRs
for purchase by the overseas investors. It implies that the re-issuance of DRs would be permitted to the
extent of DRs that have been redeemed and underlying shares are sold in domestic market.
Sponsor – It is a process of disinvestment by the Indian shareholders of their holding in overseas market.
ISSUANCE OF SHARES UNDER ADR/GDR
(i) Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in
accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of
India thereunder from time to time.
(ii) A company can issue ADRs / GDRs, if it is eligible to issue shares to person resident outside India under
the FDI Scheme. However, an Indian listed company, which is not eligible to raise funds from the Indian
Capital Market including a company which has been restrained from accessing the securities market by
SEBI will not be eligible to issue ADRs/GDRs.
(iii) Unlisted companies, which have not yet accessed the ADR/GDR route for raising capital in the
international market, would require prior or simultaneous listing in the domestic market, while seeking to
issue such overseas instruments. Unlisted companies, which have already issued ADRs/GDRs in the
international market, have to list in the domestic market on making profit or within three years of such
issue of ADRs/GDRs, whichever is earlier.
(iv) After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated in the RBI
Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from time to time. The company is
also required to file a quarterly return in Form DR- Quarterly as indicated in the RBI Notification ibid.
(v) There are no end-use restrictions except for a ban on deployment / investment of such funds in real
estate or the stock market.
(vi) Erstwhile Overseas Corporate Bodies (OCBs) which are not eligible to invest in India and entities
prohibited to buy / sell or deal in securities by SEBI will not be eligible to subscribe to ADRs / GDRs
issued by Indian companies.
(vii) The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at a price determined
under the provisions of the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary
Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the
Government of India and directions issued by the Reserve Bank, from time to time.
(NOTE: There is no monetary limit up to which an Indian company can raise ADRs / GDRs.)
Resource Mobilization Through International Markets 279
Lesson 9
This can be understood with the help of the following diagram:
ADR/GDR
Listed Company
Unlisted Company
Indian companies can
raise foreign currency
through ADR/GDR in
accordance with the
guidelines issued by the
Government and through
deposited receipt
mechanism scheme
However
Those companies which
have not issued ADR/
GDR yet
An Indian Company which is not
eligible to raise funds from the Indian
Capital Market will not be eligible to
raise ADR/GDR
Those companies which
have already issued ADR/
GDR
Would require prior or
simultaneous listing in the
domestic market
Have to list in the domestic
market on making profit or
within 3 year of such issue of
ADR/GDR whichever is earlier
ADR/GDR are issued on the basis of ratio worked out by the
Indian Company through lead manager to the issue
The pricing of ADR/GDR would be determined
As per scheme of issue of FCCB
and ordinary shares scheme
(Through Depository Receipt
Mechanism) Scheme, 1993
Guideline issed by Government
of India & RBI
Statutory Approvals Required for issue of GDR/ADR
(i) Approval of the Foreign Investment Promotion Board (FIPB)
Under the Foreign Exchange Management (Transfer or issue of security by a person resident outside India)
Regulations, 2000, a person resident outside India may purchase shares of an Indian company under the
foreign direct investment scheme, subject to the terms and conditions specified in Schedule I of the Regulations.
Schedule I provides that an issuer company which is engaged or proposes to engage in any activity specified in
this regard or beyond the specified sectoral cap, shall only issue shares to a person resident outside India,
provided it has secured prior approval of Secretariat for Industrial Assistance (“SIA”) or, as the case may be of
FIPB of the Government of India and the terms and conditions of such an approval are complied with.
280 PP-CC&MM
(ii) Approval of Reserve Bank of India
The issuer company has to obtain approvals from Reserve Bank of India under circumstances specified under
the guidelines issued by the concerned authorities from time to time. The issuing company is required to furnish
a statement to the Exchange Control Department of RBI, Central Office, Mumbai, within thirty (30) days from the
date of closing, stating details of the issue such as number of GDRs issued, number of underlying fresh shares
issued, capital structure before and after the issue, etc.
(iii) In-principle consent of Stock Exchanges for listing of underlying shares
In principal approval from the Stock Exchanges in India where the shares of the Company are listed, is required
prior to listing on the Overseas Exchange. The issuing company has to make a request to the domestic stock
exchange for in-principle consent for listing of underlying shares which shall be lying in the custody of domestic
custodian. These shares, when released by the custodian after cancellation of GDR, are traded on Indian stock
exchanges like any other equity shares.
(iv) Filings with SEBI
Issue of shares requires the filing of an Offering Circular with SEBI for its information and records.
(v) In-principle consent of Financial Institutions
Prior to the launch of its issue the company must obtain in-principle consent on the broad terms of the proposed
issue. Where term loans have been obtained by the company from the financial institutions, the agreement
relating to the loan contains a stipulation that the consent of the financial institution has to be obtained.
Agencies involved in ADR/GDR issue
The following agencies are normally involved in the issue of ADR/GDR:
(i) Lead Manager (ii) Co-Lead/Co-Manager (iii) Overseas Depository Bank (iv) Domestic Custodian Banks (v)
Listing Agent (vi) Legal Advisors (vii) Printers (viii) Auditors (ix) Underwriter(x) Escrow Agent
(i) Lead Manager
The company has to choose a competent lead manager to structure the issue and arrange for the marketing. Lead
managers usually charge a fee as a percent of the issue. The issues related to public or private placement, nature
of investment, coupon rate on bonds and conversion price are to be decided in consultation with the lead manager.
(ii) Co-Lead/Co-Manager
In consultation with the lead manager, the company has to appoint co-lead/co-manager to coordinate with the
issuing company/lead manager to make the smooth launching of the issue.
(iii) Overseas Depository Bank
It is the bank which is authorised by the issuing company to issue Depository Receipts against issue of ordinary
shares of issuing company.
(iv) Domestic Custodian Bank
This is a banking company which acts as custodian for the ordinary shares of an Indian company, which are
issued by it. The domestic custodian bank functions in co-ordination with the depository bank. When the shares
are issued by a company the same are registered in the name of depository and physical possession is handed
over to the custodian. The beneficial interest in respect of such shares, however, rests with the investors.
(v) Listing Agent
The appointment of listing agent is necessary to co-ordinate with issuing company for listing the securities on
Overseas Stock Exchanges.
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(vi) Legal Advisors
The issuing company should appoint legal advisors who will guide the company and the lead manager to
prepare offer document, depository agreement, indemnity agreement and subscription agreement.
(a) Indian Legal advisors – It is a firm that undertakes the Legal and Financial Due Diligence of the Issuing
Companies on behalf of the Lead Manager. It also assists the Company in preparation of the Information
Memorandum/ offer document for submitting it with the Overseas Stock Exchange.
(b) Overseas Legal Advisor – An overseas legal person who on the basis of the Due Diligence Report of the
Indian Counsel submits its report to the Overseas Stock Exchange. They also assist the Lead Manager
in preparation of the various documents such as the Deposit Agreement, Subscription Agreement and
vet the Information Memorandum (IM).
(vii) Printers
The issuing company should appoint printers of international repute for printing Offer Circular.
(viii) Auditors
The role of issuer company’s auditors is to prepare the auditors report for inclusion in the offer document,
provide requisite comfort letters and reconciliation of the issuer company’s accounts between Indian GAAP/UK
GAAP/US-GAAP and significant differences between Indian GAAP/UK GAAP/US GAAP.
(ix) Underwriters
It is desirable to get the issue underwritten by banks and syndicates. Usually, the underwriters subscribe for a
portion of the issue with arrangements for tie-up for the balance with their clients. In addition, they will interact
with the influential investors and assist the lead manager to complete the issue successfully.
(x) Escrow Agent
An Overseas Bank where an Escrow Account has to be opened for deposit of the monies received from Investors
against the ADR/ Issue till the Final Listing Approval is obtained from the Overseas Stock Exchange.
Agreements and related Documents
The following principal documents are involved: (i) Subscription Agreement (ii) Depository Agreement (iii)
Custodian Agreement (iv) Escrow Agreement (v) Offering Circular.
(i) Subscription Agreement
Subscription Agreement provides that Lead Managers and other managers agree, severally and not jointly, with
the company, subject to the satisfaction of certain conditions, to subscribe for GDRs at the offering price set
forth. It may provide that obligations of managers are subject to certain conditions precedent.
Subscription agreement may also provide that for certain period from the date of the issuance of GDR the
issuing company will not (a) authorise the issuance of, or otherwise issue or publicly announce any intention to
issue; (b) issue offer, accept subscription for, sell, contract to sell or otherwise dispose off, whether within or
outside India; or (c) deposit into any depository receipt facility, any securities of the company of the same class
as the GDRs or the shares or any securities in the company convertible or exchangeable for securities in the
company of the same class as the GDRs or the shares or other instruments representing interests in securities
in the company of the same class as the GDRs or the shares.
Subscription agreement also provides, an option to be exercisable within certain period after the date of offer
circular, to the lead manager and other managers to purchase upto a certain prescribed number of additional
GDRs solely to cover over-allotments, if any.
282 PP-CC&MM
(ii) Depository Agreement
Depository agreement lays down the detailed arrangements entered into by the company with the Depository,
the forms and terms of the depository receipts which are represented by the deposited shares. It also sets forth
the rights and duties of the depository in respect of the deposited shares and all other securities, cash and other
property received subsequently in respect of such deposited shares. Holders of GDRs are not parties to deposit
agreement and thus have no contractual rights against or obligations to the company. The depository is under
no duty to enforce any of the provisions of the deposit agreement on behalf of any holder or any other person.
Holder means the person or persons registered in the books of the depository maintained for such purpose as
holders. They are deemed to have notice of, be bound by and hold their rights subject to all of the provisions of
the deposit agreement applicable to them. They may be required to file from time to time with depository or its
nominee proof of citizenship, residence, exchange control approval, payment of all applicable taxes or other
governmental charges, compliance with all applicable laws and regulations and terms of deposit agreement, or
legal or beneficial ownership and nature of such interest and such other information as the depository may
deem necessary or proper to enable it to perform its obligations under Deposit Agreement.
The company may agree in the deposit agreement to indemnify the depository, the custodian and certain of their
respective affiliates against any loss, liability, tax or expense of any kind which may arise out of or in connection
with any offer, issuance, sale, resale, transfer, deposit or withdrawal of GDRs, or any offering document.
Copies of deposit agreement are to be kept at the principal office of Depository and the Depository is required to
make available for inspection during its normal business hours, the copies of deposit agreement and any notices,
reports or communications received from the company.
(iii) Custodian Agreement
Custodian works in co-ordination with the depository and has to observe all obligations imposed on it including
those mentioned in the depository agreement. The custodian is responsible solely to the depository. In the case
of the depository and the custodian being same legal entity, references to them separately in the depository
agreement or otherwise may be made for convenience and the legal entity will be responsible for discharging
both functions directly to the holders and the company.
Whenever the depository in its discretion determines that it is in the best interests of the holders to do so, it may,
after prior consultation with the company terminate, the appointment of the custodian and in such an event the
depository shall promptly appoint a successor custodian, which shall, upon acceptance of such appointment,
become the custodian under the depository agreement. The depository shall notify holders of such change
promptly. Any successor custodian so appointed shall agree to observe all the obligations imposed on him.
(iv) Escrow Agreement
An escrow agreement includes information such as specifying the appointed escrow agent, and specific sections
for each of the following: descriptions of any definitions pertinent to the agreement, the escrow fund and release
of funds, and the acceptable use of funds by the escrow agent, the duties and liabilities of the escrow agent, the
escrow agent's fees and expenses, and the jurisdiction and venue in the event of a legal action etc .
(v) Offering Circular
Offering Circular is a mirror through which the prospective investors can access vital information regarding the
company in order to form their investment strategies.
It is to be prepared very carefully giving true and complete information regarding the financial strength of the
company, its past performance, past and envisaged research and business promotion activities, track record of
promoters and the company, ability to trade the securities on Euro capital market.
The Offering Circular should be very comprehensive to take care of overall interests of the prospective investor.
The Offering Circular for Euro-issue offering should typically cover the following contents:
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(i) Background of the company and its promoters including date of incorporation and objects, past
performance, production, sales and distribution network, future plans, etc.
(ii) Capital structure of the company-existing, proposed and consolidated.
(iii) Deployment of issue proceeds.
(iv) Financial data indicating track record of consistent profitability of the company.
(v) Group investments and their performance including subsidiaries, joint venture in India and abroad.
(vi) Investment considerations.
(vii) Description of shares.
(viii) Terms and conditions of Global Depository Receipt and any other instrument issued along with it.
(ix) Economic and Regulatory policies of the Government of India.
(x) Details of Indian Securities Market indicating stock exchange, listing requirements, foreign investments
in Indian securities.
(xi) Market price of securities.
(xii) Dividend and capitalisation.
(xiii) Securities regulations and exchange control
(xiv) Tax aspects indicating analysis of tax consequences under Indian law of acquisition, membership and
sale of shares, treatment of capital gains tax, etc.
(xv) Status of approvals required to be obtained from Government of India.
(xvi) Summary of significant differences in Indian GAAP, UK GAAP and US GAAP and expert’s opinion.
(xvii) Report of statutory auditor.
(xviii) Subscription and sale.
(xix) Transfer restrictions in respect of instruments.
(xx) Legal matters etc.
(xxi) Other general information not forming part of any of the above.
A copy of the Offering Circular is required to be sent to the Registrar of Companies, the SEBI and the Indian
Stock Exchanges for record purposes.
PROCEDURAL REQUIREMENTS
The procedural requirements for issue of GDRs/ADRs are briefly set out here below:
(i) Preliminary Meetings
The Issuer generally holds preliminary discussions and meets with different global merchant/ investment bankers
(who would act as the Lead Manager, Co- Managers, Underwriters), Legal Advisors (Indian and Foreign), Auditors,
and other intermediaries before deciding to float a GDR/ADR Issue.
(ii) Authorization by the Board of Directors
– The Issuer is required to pass a Board Resolution approving the proposed GDR/ADR issue.
– The Issuer's Board should also approve the notice calling for a General Meeting of the shareholders for
the purpose.
284 PP-CC&MM
– It is advisable to constitute a Committee of Directors and confer on it necessary powers for approving
various matters/ documents connected with the Euro issue, once the Board of Directors (the “Board”) of
the Issuer has decided to float GDRs/ADRs in the global market. The following matters /documents
could then be approved by the Committee of Directors, namely:
(a) Offering Circular
(b) Escrow Agreement to be executed by the Escrow Agent
(c) Agreement to be executed by the Lead Manager and the Issuer
(d) Deposit Agreement to be executed by the Depository
(e) Allotment of shares in favour of the Depository
(f) Opening of bank account outside India and operation of the said account
(g) Making/filing the necessary applications of the Securities and Exchange Commission, U.S., and /or
making applications to Luxembourg Stock Exchange or other exchanges
(h) Signing and executing any deed, document, writing, confirmation, undertaking, indemnity in favour
of any party including, Lead Manager, Co- Managers, Underwriters, Legal Advisors, Accountants
and others who may be related to the issue.
– As per the listing agreement of the stock exchanges, the Issuer should notify the stock exchange, the
date of the Board Meeting at which the proposal will be considered and also inform it of the decision of
the Board of Directors.
(iii) Organizational Meetings
The Issuer formally appoints the Lead Manager, Co- Managers, Underwriters to market the issue and organize
the road shows, printers, Legal Advisors (Indian and Foreign), Depository (to issue GDRs/ADRs to the Underwriters
to arrange to place them with the ultimate investors), the Custodian (who physically holds the shares of the
Issuer on behalf of the Depository) and the overseas bankers.
The Issuer gives the necessary details about the Issue to the Lead Manager, Co- Managers and other
intermediaries. It also provides the relevant clarifications to the Indian and foreign Legal Advisors relating to
legal matters of the company and the issue. The Issuer will, along with the Lead Manager to the issue decide the
following issues, namely:
1. Public private placement
2. The number of GDRs/ADRs to be issued
3. The issue price
(iv) Authorization by shareholders
– The shareholders must approve the proposed foreign issues of GDR/ADRs by a special resolution passed
at the general meeting according to the provisions of section 81 (1A) of the Companies Act.
– Approvals should be also taken from the Issuer's shareholders with regard to Section 94 (increase in
authorized share capital), Section 16 (alteration of Capital Clause of the Memorandum of Association for
change in authorised share capital) and Section 31 (alteration of Share capital Clause in Articles of Association)
of the Companies Act, 1956, if required.
ROADSHOWS
Roadshows represent meetings of issuers, analysts and potential investors. Details about the company are
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presented in the roadshows and such details usually include the following information about the company making
the issue:
– History
– Organisational structure
– Principal objects
– Business lines
– Position of the company in Indian and international market
– Past performance of the company
– Future plans of the company
– Competition - domestic as well as foreign
– Financial results and operating performance
– Valuation of shares
– Review of Indian stock market and economic situations.
Thus at road shows, series of information presentations are organised in selected cities around the world with
analysts and potential institutional investors. It is, in fact, a conference by the issuer with the prospective investors.
Road show is arranged by the lead manager by sending invitation to all prospective investors.
STEPWISE PROCEDURE FOR ISSUE OF ADR/GDR
1. Convene a Board Meeting to approve the proposed Issue for not exceeding certain value in foreign currency.
2. Convene the Extra ordinary General Meeting for the approval of the shareholders for the proposed GDR
Issue under Sec 81(1A) of the Companies Act, 1956.
3. Identify the Agencies.
4. Convene a Board Meeting to approve the Agencies.
5. Appoint the Agencies and sign the Engagement Letters.
6. The Indian Legal Counsel to undertake the Due Diligence.
7. Prepare the first draft of the Information Memorandum (IM) in consultation with the Indian Legal Counsel
and submit the same to various Agencies for their comments thereon.
8. Prepare the 2nd/3rd draft of IM incorporating the comments.
9. The Listing Agent to submit the IM with the overseas Stock Exchange for their comments and In principle
Listing Approval.
10. Simultaneously submit draft IM to the Indian Stock Exchanges where the Issuing Company’s shares are
listed for In principle approval for listing of the underlying share.
11. Hold Board Meeting to approve the Deposit Agreement, Subscription Agreement and the Escrow Agreement.
12. On receipt of the comments on the IM from the Overseas and Indian Stock Exchanges incorporate the same
and file the final IM with Overseas Stock Exchange and obtain Final Listing.
13. The Issuing Company can open the Issue for the ADR/GDR on receipt of the In principle Listing Approval
from the Overseas and the Indian Stock Exchanges.
286 PP-CC&MM
14. Open the Escrow Account with the Escrow Agent and execute the Escrow Agreement.
15. In consultation with the Lead Manager to finalize
(a) whether the issue will be through public or a private placement,
(b) the number of ADR/ GDRs to be issued.
(c) the issue price.
(d) number of underlying shares to be issued against each ADR/ GDR.
16. On the day of the opening of the Issue execute the Deposit and Subscription Agreements.
17. The Issue should be kept open for a minimum period of 3 working days.
18. Immediately on closing of the Issue convene a Board/ Committee Meeting for allotment of the underlying
shares against the Issue of the GDRs.
19. Then Deliver the share certificate to the Domestic Custodian Bank who will in terms of the Agreement
instruct the Overseas Depository Bank to Issue the ADR/ GDR to Non Resident Investor against the shares
held by the Domestic Custodian Bank.
20. On receipt of Listing Approval from Overseas Stock Exchange submit the required documents for Final In
principle Listing Approval from Indian Stock Exchange.
21. After GDRs are listed the Lead Manager to instruct the Escrow Agent to transfer the Funds to the Company’s
Account.
22. The Company can either remit the entire funds or in part as per its discretion.
23. On obtaining the Final Approval from Indian Stock Exchanges admit the underlying shares to the depository
i.e., NSDL and CDSL.
24. Obtain Trading approval.
25. Intimate the Custodian for converting the physical shares into Demat.
26. Within 30 days of the closing of the issue, details of the ADR/ GDR Issue along with the IM should be
submitted to
(a) the Ministry of Finance.
(b) the Registrar of Companies
(c) SEBI
27.Return of Allotment in Form 2 is to be filed with ROC within 30 days of Allotment.
28.Annexure 9 is to be filed with RBI, Central office within 30 days of closure of the ADR/ Issue.
REPORTING OF ADR/GDR ISSUES
The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full details of such issue in the
Form as Annex 9 specified in Schedule I of Foreign Exchange Management (Transfer or issue of security by a
person resident outside India) Regulations, within 30 days from the date of closing of the issue. The company
should also furnish a quarterly return in the Form Annex 10 as specified in Schedule I of the said regulation, to
the Reserve Bank within 15 days of the close of the calendar quarter. The quarterly return has to be submitted
till the entire amount raised through ADR/GDR mechanism is either repatriated to India or utilized abroad as per
the extant Reserve Bank guidelines.
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Resource Mobilization Through International Markets 287
After completing the transaction, the Issuer would be required to furnish the following information to RBI:
– Details of the purpose for which the GDRs/ADRs have been raised. If funds are deployed for overseas
investment, details thereof;
– Details about the Depository, Lead Manager, Sub-Mangers to the Issue, Indian Custodian;
– Details of the FIPB Approval or the relevant NIC Code in case of automatic route;
– Details of Authorized and Issued paid up capital before the issue and after the issue;
– In case of private placement, details of investors and ADRs/GDRs issued to each of them:
– Number of GDRs/ADRs issued
– Ratio of GDRs/ADRs to the underlying shares
– Details of Issue related expenses
– Details of listing arrangements
– Amount raised and the amount repatriated
Points to Remember
The GDR holders shall not have any voting rights.
FCCB AND ORDINARY SHARES (THROUGH DEPOSITORY RECEIPT MECHANISM) SCHEME,
1993
Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in accordance with
the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt
Mechanism) Scheme, 1993 and guidelines issued by the Government of India thereunder from time to time.
Eligibility
An issuing company desirous of raising funds by issuing Global Depository Receipts is required to obtain prior
permission of the Department of Economic Affairs, Ministry of Finance, Government of India.
An Indian company, which is not eligible to raise funds from the Indian capital market including a company which
has been restrained from accessing the securities market by the SEBI is not eligible to issue shares under this
scheme.
Transfer and redemption
A non-resident holder of Global Depository Receipts may transfer those receipts, or may ask the Overseas
Depository Bank to redeem those receipts. In the case of redemption, Overseas Depository Bank shall request
the Domestic Custodian Bank to get the corresponding underlying shares released in favour of the non-resident
investor, for being sold directly on behalf of the non-resident, or being transferred in the books of account of the
issuing company in the name of the non-resident.
In case of redemption of the Global Depository Receipts into underlying shares, a request for the same is to be
transmitted by the Overseas Depository Bank to the Domestic Custodian Bank of India, with a copy of the same
being sent to the issuing company for information and record. On redemption, the cost of acquisition of the
shares underlying the Global Depository Receipts shall be reckoned as the cost on the date on which the
Overseas Depository Bank advises the Domestic Custodian Bank for redemption. The price of the ordinary
shares of the issuing company prevailing in the Bombay Stock Exchange or the National Stock Exchange on the
date of the advice of redemption shall be taken as the cost of acquisition of the underlying ordinary shares.
288 PP-CC&MM
Taxation on shares issued under Global Depository Receipt Mechanism
(1) Under the provisions of the Income-tax Act, income by way of dividend on shares is taxed at the rate of 10 per
cent. The issuing company is required to transfer the dividend payments net after deducting tax at source to the
Overseas Depository Bank.
(2) On receipt of these payments of dividend after taxation, the Overseas Depository Bank is required to distribute
them to the non-resident investors proportionate to their holdings of Global Depository Receipts evidencing the
relevant shares. The holders of the Depository Receipts may take credit of the tax deducted at source on the
basis of the certification by the Overseas Depository Bank, if permitted by the country of their residence.
(3) All transactions of trading of the Global Depository Receipts outside India, among non-resident investors, are
free from any liability to income tax on India on Capital Gains therefrom.
(4) If any capital gains arise on the transfer of the aforesaid shares in India to the non-resident investor, he will
be liable to income-tax under the provisions of the Income-tax Act. If the aforesaid shares are held by the nonresident investor for a period of more than twelve months from the date of advice of their redemption by the
Overseas Depository Bank, the capital gains arising on the sale thereof will be treated as long-term capital gains
and will be subject to income-tax at the rate 10 per cent under the provisions of Section 115AC of the Income-tax
Act. If such shares are held for a period of less than twelve months from the date of redemption advice, the
capital gains arising on the sale thereof will be treated as short-term capital gains and will be subject to tax at the
normal rates of income-tax applicable to non-residents under the provisions of the Income-tax Act.
(5) After redemption of the Depository Receipts into underlying shares, during the period, if any, during which
these shares are held by the redeeming non-resident foreign investor who has paid for these shares in foreign
exchange at the time of purchase of the Global Depository Receipt, the rate of taxation of income by way of
dividends on these shares would continue to be at the rate of 10 per cent, in accordance with Section 115AC(1)
of the Income-tax Act. The long term capital gains on the sale of these redeemed underlying shares held by nonresident investors in the domestic market shall also be charged to tax at the rate of 10 per cent, in accordance
with the provisions of Section 115 AC(1).
(6) When the redeemed shares are sold on the Indian Stock Exchanges against payment in rupees, these
shares shall go out of the purview of the Section 115 AC of the Income-tax Act and income therefrom shall not be
eligible for the concessional tax treatment provided thereunder
After the transfer of shares where consideration is in terms of rupees payment, the normal tax rates would apply
to the income arising or accruing on these shares.
(7) Deduction of tax at source on the amount of capital gains accruing on transfer of the shares would be made
in accordance with sections 195 and 196C of the Income-tax Act.
Application of Avoidance of Double Taxation Agreement in case of Global Depository Receipts
During the period of fiduciary ownership of shares in the hands of the Overseas Depository Bank, the provisions
of Avoidance of Double Taxation Agreement entered into by the Government of India with the country of residence
of the Overseas Depository Bank are applicable in the matter of taxation of income from dividends from underlying
shares and interest on Foreign Currency Convertible Bonds. During the period, if any, when the redeemed
underlying shares are held by the non-resident investor on transfer from fiduciary ownership of the Overseas
Depository Bank, before they are sold to resident purchasers, the Avoidance of Double Taxation Agreement
entered into by the Government of India with the country of residence of the non-resident investor will be applicable
in the matter of taxation of income from the dividends from the said underlying shares, or interest on Foreign
Currency Convertible Bonds, or any capital gain arising out of transfer of underlying shares.
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LISTING OF GDR
In order to list equity securities on a stock exchange, or to maintain a listing once admitted to trading, an issuer
must meet certain criteria. These requirements vary from exchange to exchange.
LONDON STOCK EXCHANGE
The London Stock Exchange (LSE) is one of the world's most international equity markets with international
companies representing more than 55 countries currently listed and traded.
The LSE has several different trading markets for negotiable equity instruments. GDRs can trade on three
markets: the Main Market, the Professional Securities Market (known as the PSM) and, in certain circumstances,
the Alternative Investment Market (known as AIM). Most GDRs have chosen to list on the Main Market, which is
the most highly regulated of the three.
The UK financial markets are regulated by the Financial Services Authority (FSA), an independent nongovernmental body. The FSA, often known amongst issuers as UKLA (UK Listing Authority), reviews and approves
prospectuses and other documents required for the listing. The UKLA grants securities listed status on regulated
markets. However, the LSE is responsible for admitting a security to the exchange to trade. When applying to
the LSE for admission, the Company specifies the market on which it would like its GDRs to trade.
Different ways in which a company can list in London
When considering a capital raising and listing in London, companies have two choices:
(i) Public offer: GDRs are offered to institutional investors and are usually underwritten. A public offering is
generally used by companies seeking to raise substantial amounts of capital or looking to raise their
profile in the London market. This is the most expensive option.
(ii) Placing: A placing is usually a more selective process whereby GDRs are offered to a small number of
institutions. While this route gives the Company more control over the distribution, it can restrict the
shareholder base and inherently limit liquidity.
LISTING ON THE MAIN MARKET
Prior to starting the formal listing process, the Company will first spend time organizing itself thoroughly. Once
the formal listing process begins, it usually takes no more than approximately 24 weeks. However, these
timeframes are largely governed by the ability of the issuer and its advisors to prepare the required documents
and complete the due diligence process.
Sponsor
The sponsor plays a pivotal role as an advisor, liaising with the Exchange and UK Listing Authority (UKLA) and
coordinator and working with other advisers. The sponsor is normally an investment bank, corporate finance
house, stockbroker or accountancy firm. The UKLA has a list of approved sponsors. It is important to note that
this is a different role from that of the Depository Bank, which manages the DR program.
FSA’s requirements for a company to receive listed status
Before starting work on the forms and documents, such as the prospectus, a company must be in compliance
with, or willing to comply with, the following requirements:
1. Company’s incorporation status
The Company must be validly incorporated and operating in conformity with its constitution as well as complying
with the following:
290 PP-CC&MM
(i) Authorization and Validity of Shares
The shares which will underly the GDRs must:
(a) Confirm with the law of the Company’s place of incorporation,
(b) Be duly authorized in accordance with the Company’s statutes, and
(c) Have any other necessary legal or corporate consents.
(ii) Transferability of the Underlying Shares
The shares underlying the GDRs must be freely transferable, fully paid and free from any restrictions on transfer.
2. GDR requirements
In order to be able to validly list the GDRs, the FSA requires that the Company must be willing to ensure that the
GDRs comply with the need for any legal or statutory consents as well as:
(i) Free float requirement : 25% of the GDRs (not total share capital) must be in public hands. The
Company will need to notify the FSA that this requirement has been met. Therefore, if at any time the
Company becomes aware it will not be able to comply with this rule, an additional conversation with the
FSA should take place. This 25% should not include any investor taking more than 5%.
(ii) Authorization of GDRs : GDRs must:
(a) Confirm with the law of the Depository’s place of incorporation and
(b) Be duly authorized according to the requirements of the Depository’s constitution.
(iii) Admission to trading : The GDRs must be admitted to trading on a Recognized Investment Exchange,
such as the LSE for listed securities.
(iv) Transferability : To be listed, GDRs must be fully paid, freely transferable and free from any liens and
restriction.
(v) Market capitalization : The expected aggregate market value of all GDRs to be listed must be at least
£700,000 unless there are shares of the same class already listed on the LSE. Please note, the FSA
may modify this rule to admit shares of a lower value if it is satisfied there will be an adequate market for
the securities concerned.
(vi) Whole class to be listed : An application for listing of securities of any class must relate to all securities
of that class, issued or proposed to be issued. If already listed, the application must relate to further
securities of that class to be issued.
(vii) No additional obligations to be imposed on the Depository by the GDRs: The GDRs must not
impose obligations on the Depository except to the extent necessary to protect the GDR holders’ rights
to and the transmission of entitlements of the Shares.
3. Continuing Obligations
The issuer must be willing to comply with ongoing continuing obligations and market reporting requirements.
3.1 Prospectus
A published prospectus is a condition for admittance to the LSE. This prospectus must be approved by the
relevant competent authority. The prospectus is the company’s information and sales document, analyzed by
market participants as they create opinions and decide whether to participate in the offering.
(i) Information
A GDR prospectus must include the necessary information that enables investors to make an informed
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assessment of (i) the assets and liabilities, financial position, profits and losses and prospects of the Company
and, (ii) the rights attached to the GDRs. This information must take into account the particular nature of GDRs
and the Company. The prospectus must be presented in a form which is comprehensible and easy to analyze.
(ii) Accounting standard
Companies should prepare their accounts in accordance with IFRS (International Financial Reporting
Standards) or an equivalent standard.
(iii) Financial information
An operating and financial review, audited financial information for the last three financial years or such
shorter period as the Company has been in operation. In the event the prospectus is more than nine months
after the end of the last financial year, unaudited half year accounts will be included as well. The prospectus
also requires details of any material contracts.
(iv) Risk summary
Management will write a summary describing the Company that includes any risks associated with investing
in the Company. The UKLA requires that the Company draft this in non-technical language that can be
easily understood by investors. When preparing the summary, the Company should be aware that this
summary must use the same data as the rest of the prospectus, and it cannot be misleading or contradict
what has been written in the rest of the document.
3.2 Block listing
The number of shares “listed” when the GDRs are admitted to the LSE is the maximum number that can be
issued without approval and publication of another prospectus. Therefore, most issuers choose to list the maximum
number of GDRs that can be created and traded on the LSE, which is likely to be greater than the number of
GDRs issued at the time of the original listing. In some cases this may be 100% of the share capital, while in
others it might be 20% due to local restrictions on foreign ownership.
3.3 Documents required to be provided to the FSA
The FSA requires that it receives the following documents, in final form, by midday two business days before the
FSA is to consider the application:
(i) A completed Application for Admission of Securities to the Official List ;
(ii) One of the following:
(a) The prospectus or listing particulars that have been approved by the FSA; or,
(b) A copy of the prospectus, a certificate approval and (if applicable) a translation of the summary of
the prospectus, if another EEA State is the home Member State for the securities; and
(c) Any approved supplementary prospectus or approved supplementary listing particulars, if applicable.
3.4 Documents to be provided on the day of the listing
A company must submit, in final form, the following documents to the FSA before 9 am on the day the FSA is to
consider the application:
(i) A copy of the resolution of the board authorizing the issue of the securities or
(ii) Written confirmation from the applicant that the board has authorized the issue of the securities.
3.5 Documents to be provided after the listing
The following documents must be submitted in final form to the FSA as soon as practicable after the FSA has
considered the application:
292 PP-CC&MM
(i) A statement of the number of securities that were issued and
(ii) A completed Issuer’s Declaration.
4. Continuing obligations on the Main Market
By listing on the Main Market, the Company is agreeing to abide by the ongoing obligations to the market and to
the exchange. These include:
(i) Publishing an annual financial report within six months of its year end. The annual financial report must
include audited financial statements, a management report and responsibility statements and must
remain publicly available for at least five years.
(ii) Publishing an unaudited semi-annual financial report within four months of the end of the financial
period.
(iii) Publication of price sensitive information. By keeping the market informed in a timely manner through
press releases and other announcements, the Company allows all investors on all its markets to trade
in a knowledgeable manner. Further, if the Company believes information has been leaked regarding a
confidential or price sensitive corporate matter, it will be important to communicate with the market to
remove uncertainty regarding the stock.
LISTING ON PROFESSIONAL SECURITY MARKET
The Professional Security Market (PSM) is part of the London Stock Exchange and is operated within the scope
of its status as a Recognized Investment Exchange. This means that the same regulatory standards currently
applied to its markets, in respect of on-going monitoring and enforcement, also apply to the PSM.
The Professional Security Market (PSM) was created in 2005 to enable those companies only interested in
accessing the “wholesale” market to be able to do so without the regulatory requirements of the Main Market.
The PSM is a more restricted access market, and as such, the FSA is able to exercise flexibility in the
implementation of the Directives.
1. Requirement of prospectus
The prospectus required by the PSM does not require historical financial information in IFRS (International
Financial Reporting Standards) or an EU approved equivalent standard, either in listing documents or as a
continuing obligation requirement. This may be a cost saving for many companies as re-stating or providing
additional disclosure as required by the Prospectus could be very expensive. However, issuers may need to
provide a description of the key differences between their local accounting standards and IFRS.
Issuers choosing the PSM will have their listing particulars approved by the UK Listing Authority and be admitted
to listing, so a key requirement for investment by funds and institutional investors will have been met. Further,
although IFRS does not apply, disclosure obligations for listed companies do apply to companies represented
on the PSM. Therefore, important regulatory information, such as annual reports and on-going disclosure, needs
to be readily available to investors.
2. Key eligibility criteria
Issuers wishing to list on the PSM must meet the following criteria:
(i) Minimum of 25% of shares in public hands
(ii) Latest three years of audited accounts (or such shorter period as the issuer has been operating)
(iii) Minimum GDR market capitalization of £700,000
(iv) National GAAP may be used in the preparation of the prospectus
Lesson 9
Resource Mobilization Through International Markets 293
3. Admission process
Admitting securities to the PSM is a two part process. The first part is to submit listing particulars to the UK
Listing Authority (UKLA) for approval and admission to the Official List. Next, the Company applies to the LSE for
admission of the DRs to trade on the PSM.
4. Trading
DRs admitted to the PSM are traded on the International Order Book.
5. Key continuing obligations
Issuers admitted to trading on the PSM must meet certain continuing obligations, including:
(i) Disclosing inside information to the market as soon as possible
(ii) Publishing an annual report and accounts within six months of the year end
(iii) Preparing and maintaining a list of people considered insiders.
LISTING ON AIM
AIM is the London Stock Exchange's international market for smaller growing companies. AIM was designed to
be a highly flexible public market. As such, it offers many unique attributes to both companies and investors.
With respect to listing GDRs on AIM, the LSE has stated that a listing of GDRs would only be appropriate if the
relevant company is incorporated in a jurisdiction which prohibits or unduly restricts the offering or trading of its
underlying securities outside that country.
1. Admissions criteria
(i) The main requirement is that a company coming to AIM must have a Nominated Adviser (Nomad) at all
times
(ii) No minimum size of company
(iii) No minimum proportion of shares to be in public hands
(iv) No trading record requirement
(v) No prior shareholder approval for the majority of transactions
(vi) No requirement to be incorporated in the UK.
2. Nominated Advisers (Nomads)
All Nomads are approved by the London Stock Exchange. To be authorized to act as Nomads, these investment
banks, corporate finance firms or brokers must demonstrate that they have the experience and ability to assess
whether a company is suitable and ready for admission to AIM and to act as that company’s formal 'mentor' once
it has been admitted to the market.
The Nomad will:
(i) Undertake extensive due diligence to ensure the Company is suitable for AIM
(ii) Guide the Company through the flotation process
(iii) Administer the admission documents and financial statements
(iv) Act as the Company’s 'referee' throughout its time on AIM
Along with company directors, a Nomad is responsible for ensuring that the business adheres correctly to AIM's
294 PP-CC&MM
rules and regulations. Its role also includes keeping the Company abreast of AIM Notices and rule revisions and
making sure the Company honors the continuing obligations of being a public company once the Company is
trading.
3. Admission process
The Company must announce its intention to float on the market via the Exchange at least 10 business days
before the start of trading of the shares (or 20 business days where they are joining from a designated market).
The application form signed by the applicant company and the admission document signed by the Nomad must
then be submitted at least three business days before the Company’s admission to trading. Unlike the other
exchanges, there is no pre-vetting of documents by the exchange.
4. Key continuing obligations
Issuers admitted to trading on the AIM must meet certain continuing obligations (with all documents produced in
English or with English translations), including:
(i) Disclosing inside information to the market as soon as possible
(ii) Annual report and accounts must be published within six months of the year end and prepared in
accordance with US or UK GAAP or with International Accounting Standards (IAS)
(iii) Issuers are required to prepare and maintain a list of people considered insiders.
LUXEMBOURG STOCK EXCHANGE
Like London Stock Exchange, Luxembourg Stock Exchange offers issuers a choice of venue: either the
Luxembourg Stock Exchange Main Market or the Euro Multilateral Trading Facility Market known as Euro MTF.
The listing requirements for the Main Market are very similar to the London Stock Exchange while the Euro MTF
is more akin to the PSM.
1. Listing requirements
Most of the listing and prospectus requirements are similar to the other main exchanges with access to the
general public:
(i) Minimum public free float of 25%
(ii) Minimum market value of at least €1,000,000
(iii) Three years operating history
2. Continuing obligations
The full list of continuing obligations are contained in the Rules and Regulations of the Luxembourg Stock
Exchange and include:
(i) Inside information, corporate actions and significant transactions disclosed as soon as possible.
(ii) Annual report and accounts published as soon as possible. The EU Transparency Directive requires
four months.
(iii) Half yearly reports must be published as soon as possible. The Transparency Directive requires two
months.
LISTING OF ADR
Many public offerings by non-U.S. companies are in the form of depositary receipts, usually as American Depositary
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Resource Mobilization Through International Markets 295
Receipts (ADRs). Non-US companies seeking to raise capital in the US do not necessarily have to become registered
with the SEC. An exemption called Rule 144A entitles a company to offer securities for sale or resale to certain
institutional investors without requiring registration of the offer or sale with the SEC. As a result, companies can
raise capital in the US without having to meet the ongoing reporting requirements associated with a SEC registration.
Financing objectives, costs and timing are among the many factors that need to be considered in deciding whether
to initiate a public or private offering. A public issue allows a company to establish a wider trading market for its
securities, as well as broader exposure to the business and investing public than is possible in a private offering.
The advantages of a private issue include potentially lower costs of preparing the offering document and faster
processing. Companies commonly use private offerings as an interim step to going public. Such private offerings
may come with registration rights to enhance post closing liquidity of the securities sold in the offering. Registration
rights are rights given to investors to sell or register with SEC unregistered shares.
There are a number of stock exchanges in the US, but the majority of foreign and domestic companies want to
be traded on the New York Stock Exchange (“NYSE”) or the National Association of Securities Dealers Automated
Quotations (“NASDAQ”). Each exchange has minimum entry listing requirements, including profit history,
shareholders’ equity, size of market capitalization, number of expected shareholders and corporate governance
as discussed below.
NASDAQ
There are three distinct markets within NASDAQ: the NASDAQ Global Market (NGM), the newly created NASDAQ
Global Select Market (NGSM) and the NASDAQ Capital Market (NCM). The NGSM mandates the highest initial
listing requirements of any market in the world, while its maintenance requirements are identical to those of the
NGM. The NGM, in turn, has more stringent quantitative listing and maintenance requirements than does the
NCM. The quantitative listing and maintenance criteria applicable to non-Canadian foreign private issuers for
the NGM, NGSM and NCM are identical to those of US domestic and Canadian issuers. Foreign Private Issuers
(FPI) (including Canadian issuers) may, however, elect to follow home country practice in lieu of compliance
with the NASDAQ corporate governance requirements.
THE NASDAQ GLOBAL SELECT MARKET (NGSM)
NGSM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
An issuer that satisfies all of the requirements for listing on the NGM will be eligible for listing on the NGSM if it
meets the additional liquidity and financial requirements described below. Each October, NASDAQ will review
the qualifications of all securities listed on the NGM to determine if any security meets the initial listing requirements
of the NGSM. Securities meeting the requirements of the NGSM at such time will be transferred to the NGSM in
January of the following year. In addition, an issuer of a security listed on either the NGM or NCM may, at any
time, apply to transfer the respective security to the NGSM.
(a) Liquidity Requirements
The security must demonstrate either:
– a minimum of 550 beneficial shareholders and an average monthly trading volume during the prior
12 months of at least 1.1 million shares per month; or a minimum of 2,200 beneficial shareholders;
or
– a minimum of 450 beneficial shareholders where the issuer lists in connection with a court-approved
reorganization under the federal bankruptcy laws or comparable foreign laws, or where the issuer is
an affiliate of another company listed on the NGSM.
296 PP-CC&MM
– In computing each of the above, the number of beneficial shareholders excludes shares held by an
officer, director or 10 percent shareholder of the issuer.
– The security must have 1.25 million publicly held shares; and
– The publicly held shares must have either:
(a) a market value of at least $110 million; or
(b) a market value of at least $100 million so long as the issuer has stockholders’ equity of at least $110
million; or
(c) a market value of at least $70 million where the issuer is listing in connection with an initial public
offering or where the issuer is an affiliate of, or a spin-off from, another company listed on the
NGSM.
(b) Financial Requirements
The issuer must meet one of the following financial standards:
Standard 1:
– aggregate income from continuing operations before income taxes of at least $11 million over the prior
three fiscal years; and
– positive income from continuing operations before income taxes in each of the prior three fiscal years;
and
– at least $2.2 million in income from continuing operations before income taxes in each of the two most
recent fiscal years.
Standard 2
– aggregate cash flows of at least $27.5 million over the prior three fiscal years; and
– positive cash flows in each of the prior three fiscal years; and
– both average market capitalization of at least $550 million over the prior 12 months and total revenue of
at least $110 million in the previous fiscal year.
Standard 3
– average market capitalization of at least $850 million over the prior 12 months; and
– total revenue of at least $90 million in the previous fiscal year.
– In addition, other than an issuer listed on the NGM that transfers its listing to the NGSM, the issuer shall
have a minimum bid price for the security of $5 per share.
2. Quantitative Maintenance Requirements
Once an issuer has been listed on the NGSM, it is subject to the same maintenance standards as issuers listed
on the NGM, as described below.
An issuer, whether a domestic issuer or Foreign Private Issuer (FPI), must generally meet all the criteria under
atleast one of the four financial standards and the liquidity requirements stated below:
Lesson 9
Financial and Qualitative
Requirements
Standard 1
Resource Mobilization Through International Markets 297
Standard 2
Standard 3
Minimum total revenue in the previous fiscal year
US$ 110 million
US$ 90 million
Minimum average market capitalization at the time
of listing
US$ 550 million
US$ 850 million
Standard 4
US$ 160 million
Bid price
US$ 4
US$ 4
US$ 4
US$ 4
Market makers
3 or 4
3 or 4
3 or 4
3 or 4
Corporate governance
Yes
Yes
Yes
Yes
Other
Minimum income
from continuing
operations before
income taxes of:
• US$ 11 million over
the prior three fiscal
years in aggregate and
Minimum cash flows of:
• US$ 27.5 million over
the prior three fiscal
years in aggregate
• Positive cash flows in
each of the prior
three fiscal years
US$ 80 million of total
assets and US$ 55
million of stockholders
equity in the most
recent publicly reported
financial statements
• US$ 2.2 million in
each of the two most
recent fiscal years
Positive income from
continuing operations
before income tax in
each of the prior three
fiscal years
Liquidity Requirement for New Company Listings (IPOs)
Round lot shareholders
or total shareholders
450 or 2,200
450 or 2,200
450 or 2,200
450 or 2,200
Publicly held shares
1.25 million
1.25 million
1.25 million
1.25 million
Market value of publicly
held shares
US$ 45 million
US$ 45 million
US$ 45 million
US$ 45 million
THE NASDAQ CAPITAL MARKET (NCM)
NCM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
For initial listing on NCM, an issuer must have:
– either: stockholders’ equity of at least $5 million, a market value of publicly held shares of at least $15
million and an operating history of at least two-years; or
– stockholders’ equity of at least $4 million, a market value of listed securities (i.e., securities listed on
NASDAQ or another national securities exchange) of at least $50 million and a market value of publicly
held shares of at least $15 million; or
– income from continuing operations of at least $750,000 in the most recently completed fiscal year or in
two of the last three most recently completed fiscal years and a market value of publicly held shares of
at least $5 million;
298 PP-CC&MM
– at least 300 round lot shareholders;
– at least 1 million publicly held shares;
– a minimum bid price of $4 per share;
– at least three registered and active market makers;
– in the case of ADRs, at least 400,000 issued.
2. Maintenance Requirements
For continued listing on NCM, an issuer must maintain:
– either (i) stockholders’ equity of at least $2.5 million, (ii) a market value of listed securities of at least $35
million or (iii) net income from continuing operations of at least $500,000 in the most recently completed
fiscal year or in two of the last three most recently completed fiscal years;
– at least 300 round lot shareholders;
– at least 500,000 publicly held shares;
– a market value of publicly held shares of at least $1 million;
– a minimum bid price of $1 per share; and
– at least three registered and active market makers.
As is the case for securities listed on the NGM, a failure to meet the continued listing requirements will be determined
to exist only if the deficiency continues for a period of either 10 or 30 consecutive business days (depending on the
requirement with respect to which there is a deficiency)125 and in each case an issuer will have a period after
notification by NASDAQ of the failure in which to achieve compliance with the applicable requirement.
An issuer, whether a domestic issuer or FPI, must meet all the criteria under at least one of the following
financial standards
Requirements
Net Income
Standard
Equity
Standard
Market Value of Listed
Securities Standard
Stockholders’ equity
US$ 4 million
US$ 5 million
US$ 4 million
Bid price
US$ 4
US$ 4
US$ 4
Market makers
3
3
3
Corporate governance
Yes
Yes
Yes
Total shareholders (round
lot shareholders)
300
300
300
Publicly held shares
1 million
1 million
1 million
Market value of publicly held shares
US$ 5 million
US$ 15 million
US$ 15 million
Other
US$ 0.75 millon of net
income from continuing
2 years of
operating history
US$ 50 million of market
value of listed securities
operations in latest
fiscal year or in two of
last three fiscal years
at least
Lesson 9
Resource Mobilization Through International Markets 299
THE NASDAQ GLOBAL MARKET (NGM)
NGM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
An issuer, whether a US domestic issuer or a foreign private issuer, generally must meet the following standards
to be listed on the NGM.
(a) Entry Standard 1
An issuer must have:
– annual pre-tax income from continuing operations of at least $1 million in the most recently completed
fiscal year or in two of the last three most recently completed fiscal years;
– at least 1.1 million publicly held shares;
– market value of publicly held shares (i.e., excluding shares held by directors, officers and 10 percent
shareholders) of at least $8 million;
– bid price per share of $5 or more;
– stockholders’ equity of at least $15 million;
– at least 400 round lot shareholders (i.e., a holder of a normal unit of trading); and
– at least three registered and active market makers with respect to the security.
(b) Entry Standard 2
An issuer must have:
– stockholders’ equity of at least $30 million;
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $18 million;
– bid price per share of $5 or more;
– at least three registered and active market makers with respect to the security;
– a two-year operating history; and
– at least 400 round lot shareholders.
(c) Entry Standard 3
An issuer must have:
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $20 million;
– a bid price per share of $5 or more;
– at least four registered and active market makers with respect to the security;
– at least 400 round lot shareholders; and
300 PP-CC&MM
– either a market capitalization of $75 million or total assets and total revenue of $75 million each for the
most recently completed fiscal year or two of the last three most recently completed fiscal years.
2. Quantitative Maintenance Requirements
Once an issuer has been listed on the NGM, it must continue to satisfy one of the following maintenance
standards.
(a) Maintenance Standard 1
An issuer must maintain:
– at least 750,000 publicly held shares;
– market value of publicly held shares of at least $5 million;
– stockholders’ equity of at least $10 million;
– at least 400 round lot shareholders;
– a bid price per share of $1 or more; and
– at least two registered and active market makers with respect to the security.
(b) Maintenance Standard 2
An issuer must maintain:
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $15 million;
– a bid price per share of $1 or more;
– at least 400 round lot shareholders;
– at least four registered and active market makers with respect to the security;and
– either a market value of listed securities of $50 million or total assets and total revenue of $50 million
each for the most recently completed fiscal year or two of the last three most recently completed fiscal
years.
(c) Failure to Meet Maintenance Requirements
A failure to meet the maintenance requirements will be determined to exist only if the deficiency continues for a
period of either 10 or 30 consecutive business days (depending on the requirement with respect to which there
is a deficiency), and an issuer will have a period after notification by NASDAQ of the failure in which to achieve
compliance with the applicable requirement.
An issuer, whether a domestic issuer or FPI, must meet all the criteria under at least one of the following
financial standards:
Lesson 9
Resource Mobilization Through International Markets 301
Requirements
Income
Standard
Equity
Standard
Market Value
Standard
Total Assets/Total
Revenue
Stockholders’ equity
US$ 15 million
US$ 30 million
–
–
Bid price
US$ 4
US$ 4
US$ 4
US$ 4
Market makers
3
3
4
4
Corporate governance
Yes
Yes
Yes
Yes
Total shareholders (round
lot shareholders)
400
400
400
400
Publicly held shares
1.1 million
1.1 million
1.1 million
1.1 million
Market value of publicly
US$ 8 million
US$ 18 million
US$ 18 million
US$ 18 million
US$ 1 millon of income
2 years of
US$ 75 million
US$ 75 million of total
continuing operations
before income taxes in
operating history
of market value
assets and US$ 75
of listed securities million of total revenue
held shares
Other
lates fiscal year or in two
of last three fiscal years
in latest fiscal year or
in two of last three
fiscal years
NEWYORK STOCK EXCHANGE (NYSE)
The NYSE’s requirements for initial listing and listing maintenance are set forth below. The foreign private
issuers may satisfy either the general NYSE listing standards applicable to US domestic issuers or the NYSE’s
Alternate Listing Standards for foreign private issuers, which are specifically designed for Foreign Private Issuers
(FPI) with a broad, liquid market for their securities in their country of origin.
A. NYSE Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
Under the NYSE’s initial listing standards, an issuer typically must meet the following minimum distribution and
market value criteria and must meet one of the two financial standards described below.
(a) Minimum Distribution and Market Value Criteria (must satisfy each of the following requirements)
Minimum Distribution Requirements:
(i) IPOs: An IPO issuer must have 400 holders of 100 shares or more and 1.1 million publicly held shares.
(ii) Transfer or Quotation: An issuer seeking to transfer to the NYSE or list its existing securities must have
either:
(a) 400 holders of 100 shares or more and 1.1 million publicly held shares; or
(b) 2,200 total stockholders, an average monthly trading volume of 100,000 shares for the most recent
six months and 1.1 million publicly held shares; or
(c) 500 total stockholders, an average monthly trading volume of 1 million shares for the most recent
12 months and 1.1 million publicly held shares.
Market Value of Publicly Held Shares:
– The aggregate market value of publicly held shares must be at least $60 million for IPO issuers or $100
million for issuers seeking to transfer to the NYSE or list their existing securities.
302 PP-CC&MM
(b) Financial Standards (must satisfy one of the following requirements)
Earnings Test:
(i) An issuer’s pre-tax earnings (from continuing operations and after minority interest, amortization and
equity in the earnings or losses of investees, subject to certain adjustments) must total:
(ii) at least $10 million in the aggregate for the last three fiscal years including a minimum of $2 million in
each of the two most recent fiscal years and positive amounts in all three years; or
(iii) at least $12 million in the aggregate for the last three fiscal years including a minimum of $5 million in the
most recent fiscal year and $2 million in the next most recent fiscal year; or
Valuation/Revenue Test:
An issuer must have:
(i) Valuation/Revenue with Cash Flow Test: At least $500 million in global market capitalization, at least
$100 million in revenues during the most recent 12-month period, and at least $25 million aggregate
cash flows for the last three fiscal years and with positive cash flows in all three fiscal years (subject to
certain adjustments); or
(ii) Pure Valuation/Revenue Test: At least $750 million in global market capitalization, and at least $75
million in revenues during the most recent fiscal year.
2. Initial Alternate Listing Standards for Foreign Private Issuers
Under the NYSE’s initial Alternate Listing Standards, a foreign private issuer typically must meet the following
minimum distribution and market value criteria and must meet one of the two financial standards described below.
(a) Minimum Distribution and Market Value Criteria (must satisfy each of the following requirements)
– Minimum Distribution Requirements
A foreign private issuer must have 5,000 worldwide holders of 100 shares or more; and 2.5 million
shares held publicly worldwide.
– Market Value of Publicly Held Shares
The aggregate worldwide market value of publicly held shares of the foreign private issuer must be at
least $100 million.
(b) Financial Standards (must satisfy one of the following requirements)
– Earnings Test:
The pre-tax earnings (from continuing operations and after minority interest, amortization and equity in
the earnings or losses of investees, subject to certain adjustments) of the foreign private issuer must be
at least $100 million in the aggregate for the last three fiscal years, including a minimum of $25 million
in each of the most recent two fiscal years; or
– Valuation/Revenue Test
A foreign private issuer must have
(i) Valuation/Revenue with Cash Flow Test
At least $500 million in global market capitalization, at least $100 million in revenues during the most
recent 12-month period, and $100 million in the aggregate cash flows for the last three fiscal years
including $25 million in each of the two most recent fiscal years (subject to certain adjustments); or
(ii) Pure Valuation/Revenue Test
At least $750 million in global market capitalization and $75 million in revenues during the most recent
fiscal year.
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Resource Mobilization Through International Markets 303
3. Quantitative Maintenance Requirements
In order to maintain its listing on the NYSE, a US domestic issuer or a foreign private issuer must meet certain
quantitative maintenance standards which are summarized below:
(a) Minimum Distribution and Financial Standards
Minimum Distribution Requirements:
The NYSE may promptly initiate suspension and delisting procedures against an issuer if:
(i) the total number of stockholders is less than 400;
(ii) the total number of stockholders is less than 1,200 and the average monthly trading volume for the most
recent 12 months is less than 100,000 shares; or
(iii) the number of publicly held shares is less than 600,000.
Minimum Financial Standards:
The NYSE will consider an issuer to be below compliance (and thus eligible for suspension and delisting) if:
(i) an issuer qualified to list under the Earnings Test, and its average global market capitalization over a
consecutive 30 trading-day period is less than $75 million and, at the same time, total stockholders'
equity is less than $75 million;
(ii) an issuer qualified to list under the Valuation/Revenue with Cash Flow Test and:
– average global market capitalization over a consecutive 30 trading-day period is less than $250
million and, at the same time, total revenues are less than $20 million over the last 12 months
(unless the issuer qualifies as an original listing under one of the other original listing standards); or
– average global market capitalization over a consecutive 30 trading–day period is less than $75
million; and
– an issuer qualified to list under the Pure Valuation/Revenue Test and:
– its average global market capitalization over a consecutive 30 trading-day period is less than $375
million and, at the same time, its total revenues are less than $15 million over the last 12 months
(unless the issuer qualifies as an original listing under one of the other original listing standards); or
– its average global market capitalization over a consecutive 30 trading–day period is less than $100 million.
(b) Other Maintenance Requirements
The NYSE may in its sole discretion subject an issuer to suspension and delisting on a number of additional
grounds, including:
– a substantial reduction in operating assets and/or scope of operations;
– the failure of an issuer to make timely, adequate and accurate disclosures of information to its shareholders
and the investing public; and
– the failure to observe good accounting practices in reporting of earnings and financial position.
An issuer, whether a domestic issuer or FPI, must meet minimum distribution and market value criteria and one
of the following financial standards:
304 PP-CC&MM
NYSE quantitative listing standards
applicable to Domestic Issuers and
Foreign Private Issuers’
NYSE Alternate Listing Standards for
Foreign Private Issuers
Minimum distribution and market
value criteria:
Number of holders of 100 shares
400
or more or of a unit of trading if less
than 100 shares
5,000 worldwide
Number of publicly held shares
1.1 million
2.5 million worldwide
Aggregate market value of publicly
held shares
US$ 40 million
US$ 100 million worldwide
Price at the time of listing
US$ 4
US$ 4
US $10 million in the aggregate for the
last three fiscal years, together with
a minimum of US $2 million in each
of the two most recent fiscal years,
and positive amounts in all three
years
OR
US $100 million in the aggregate for the
last three fiscal years, together with a
minimum of US $25 million in each of the
two most recent fiscal years
Financial standards (must satisfy
one of the following requirements):
Earnings Test:
Income before tax from continuing
operations and after minority
interest, amortization and equity
in the earnings or losses of
investees (subject to certain
adjustments) must total at least
US$ 12 million in the aggregate for the
three fiscal years, together with a
minimum last of US$ 5 million in the
most recent fiscal year and US$ 2
million in the next most recent fiscal
year
OR
Valuation/Revenue Test:
Valuation/Revenue with Cash
Flow Test Issuer must have at least
1) US$ 500 million in global market
capitalization,
1) US$ 500 million in global market
capitalization,
2) US$ 100 million in revenues
2) US$ 100 million in revenues during the
during the most recent 12 month period, most recent 12 month period, and
and
3) US$ 25 million in aggregate cash
flows for the last three fiscal years with
positive amounts in all three years
(subject to certain adjustments)
Pure Valuation./Revenue Test
Issuer must have at least
3) US$ 100 million in aggregate cash
flows for the last three fiscal years,
where each of the two most recent years
is reported at a minimum of US$ 25 million
(subject to certain adjustments)
1) US$ 750 million in global market capitalization, and
2) US$ 75 million in revenues during the most recent fiscal year
OR
Assets and Equity Test
Issuer must have at least
Corporate governance
1) US$ 150 million in global market
capitalization,
2) US$ 75 million in total assets together
with at least US$ 50 million in
stockholders‘ equity (in each case
subject to certain adjustments)
Yes
Yes
Lesson 9
Resource Mobilization Through International Markets 305
LESSON ROUND UP
– Companies either raise funds from the domestic market or through international market. For international
funding, the most popular source amongst the Indian companies in the recent times has been American
Depository Receipts (ADR) and Global Depository Receipts (GDR).
– An American Depository Receipt (ADR) is a negotiable security representing ownership in some
underlying shares of a non-US company, which can be traded on US stock exchanges.
– GDRs are usually listed in the Luxembourg Stock Exchange and in the London Stock Exchange.
– An Indian corporate can raise foreign currency resources abroad through the issue of GDR/ADR.
Regulation 4 of Schedule I of FEMA Notification no. 20 issued by RBI allows an Indian company to
issue its Rupee denominated shares to a person resident outside India being a depository for the
purpose of issuing ADRs/ GDRs.
– Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in
accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of
India thereunder from time to time.
– The following agencies are normally involved in the issue of ADR/GDR: (i) Lead Manager (ii) Co-Lead/
Co-Manager (iii) Overseas Depository Bank (iv) Domestic Custodian Banks (v) Listing Agent (vi) Legal
Advisors (vii) Printers (viii) Auditors (ix) Underwriter(x) Escrow Agent.
– The following principal documents are involved: (i) Subscription Agreement (ii) Depository Agreement
(iii) Custodian Agreement (iv) Escrow Agreement (v) Offering Circular.
– The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full details of such
issue in the Form enclosed as Annex 9 in Schedule I of Foreign Exchange Management (Transfer or
issue of security by a person resident outside India) Regulations, within 30 days from the date of
closing of the issue.
– In order to list equity securities on a stock exchange, or to maintain a listing once admitted to trading,
an issuer must meet certain criteria. These requirements vary from exchange to exchange.
– The London stock Exchange has several different trading markets for negotiable equity instruments.
GDRs can trade on three markets: the Main Market, the Professional Securities Market (known as the
PSM) and, in certain circumstances, the Alternative Investment Market (known as AIM).
– Many public offerings by non-U.S. companies are in the form of depository receipts, usually as American
Depository Receipts (ADRs).
– There are three distinct markets within NASDAQ: the NASDAQ Global Market (NGM), the newly created
NASDAQ Global Select Market (NGSM) and the NASDAQ Capital Market (NCM).
– The NGSM mandates the highest initial listing requirements of any market in the world, while its
maintenance requirements are identical to those of the NGM.
– The NGM, has more stringent quantitative listing and maintenance requirements than does the NCM.
– The quantitative listing and maintenance criteria applicable to non-Canadian foreign private issuers
for the NGM, NGSM and NCM are identical to those of US domestic and Canadian issuers.
– The foreign private issuers may satisfy either the general NYSE listing standards applicable to US
domestic issuers or the NYSE’s Alternate Listing Standards for foreign private issuers, which are
specifically designed for foreign private issuers with a broad, liquid market for their securities in their
country of origin.
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SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation)
1. What do you mean by American Depository Receipts(ADRs) ? Discuss various types of ADRs.
2. What are the advantages of Issuing ADR/GDR?
3. Briefly enumerate the provisions relating to issuance of shares under ADR/GDR.
4. Explain the information required to be furnished to RBI with respect to issue of ADR/ GDR .
5. Discuss briefly the criteria required to be fulfilled by a company to be listed on London Alternative
Investment Market (AIM).
Lesson 10
Economics of Commodities Marketing 307
Lesson 10
Economics of Commodities Marketing
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
A commodity may be defined as an article, a
product or material that is bought and sold in
an establish market between willing buyers and
sellers. Commodity Market is an important
constituent of the financial markets of any
country. This helps investors to hedge their
commodity risks, take speculative positions in
commodities and exploit arbitrage opportunities
in the market.
– Types of Commodities
– Commodities Market
– Marketing of Agricultural Commodities
– Direct Marketing
– Indirect Marketing
– Contract Farming
In this lesson the student will be able to
understand what commodity means; Different
types of commodities available; Marketing of
agricultural commodities; Variance of
commodities; Using hedge mechanism for price
risk management etc.
– Storage
– Warehousing
– Variance in Commodity Market
– Weather Derivatives
– Freight Derivatives
– Electricity Derivatives
– Catastrophe Derivatives
– Carbon Derivatives
– Hedging
– Hedging Risks
– Understanding Basis Risk
– LESSON ROUND UP
– SELF TEST QUESTIONS
307
308 PP-CC&MM
INTRODUCTION
A Commodity is an economic good, tradable good, product or article of commerce; something for which there is an
established market where the commodity can be bought and sold in commercial transactions between willing
buyers and sellers. One of the important characteristics of a commodity is that its price is determined as a function
of its market as a whole. So a commodity is understood to mean a good that has the following properties :
– Is usually produced and/or sold by many different producers
– Is uniform in quality between producers that produce and sell it.
– Is traded at a price resulting from its demand and supply.
TYPES OF COMMODITIES
Commodities can be perishable or non –perishable. Non-perishable commodities such as metals are called
hard commodities. Perishable commodities such as agricultural commodities are called soft commodities. Hard
commodities are typically natural resources that must be mined or extracted (gold, rubber, oil, etc.), whereas
soft commodities are agricultural products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.)
Agricultural Products
Industrial Metals
Precious Metals
Energy
Oil & Oil Seeds
Copper
Gold
Crude Oil
Spices
Nickel
Silver
Natural Gas
Pulses
Zinc
Platinum
Furnace Oil
Cereals
Aluminum
Aviation Turbine Fuel (ATF)
Plantations
Palladium
Power
Fibers
Lead
Potato
Tin
Sugar
Steel
Livestock
Sponge Iron
COMMODITY MARKETS
Every commodity that is produced (or grown) must eventually come to a market place where it can be bought
and sold. It is in this marketplace that all the elements of commerce will come together to settle a price at which
the commodity will get traded. For a commodity market to be established there must be very broad consensus
on the variations in the product that make it acceptable for one purpose or another. Such goods are raw or partly
refined materials whose value mainly reflects the costs of finding, gathering, or harvesting them; they are traded
for processing or incorporation into final goods. E.g. include crude oil, cotton, rubber, grains, and metals and
other minerals.
The two core participants in a commodity market are the sellers and the buyers. They meet each other in the
market, with sellers representing the supply side and buyers representing the demand side of this market. The
market functions as a price discovery mechanism, prices being determined by the supply of and demand for the
commodity. The prices are discovered through an auction mechanism such that sellers asking for a certain
price, and buyers offering them a price, come around to setting upon one mutually agreeable price. Most often,
sellers and buyers may participate in the market through intermediaries or agents, called brokers. Commodity
Markets have existed for centuries around the world because producers and buyers of good products and other
Lesson 10
Economics of Commodities Marketing 309
items have always needed a common place to trade. Though the place of trade and many of the detailed
mechanisms have changed, the basics of commodity trading remain the same.
The trading of commodities in commodity markets consists of direct physical trading (spot trading) and derivatives
trading. A market in which goods are sold for cash and delivered immediately is called the physical market.
Deals in these markets are immediately effective. The physical market is also known as the cash market or spot
market, because prices are settled in cash on the spot at current market prices, as opposed to forward prices. In
the physical markets, participation is restricted to people who are involved with that commodity, say, the farmer,
processor, wholesaler, etc. Since transactions take place directly between principals, there is a high degree of
flexibility in these transactions.
The most popular physical commodities contracts can be broken down into metals, energy, grains, livestock,
food and fiber and exotic commodities. Trading is delivery based, and is typically done through brokers and
other intermediaries. For most commodities that are physically traded, there is no market in a central meeting
place, and where it exists, it typically handles only a small part of the total trade.
The spot price or spot rate of a commodity is the price that is quoted in the physical market for immediate or spot
settlement (payment and delivery). Spot settlement is normally one or two business days from trade date. This
is in contrast with the forward price established in a forward contract or futures contract, where contract terms
(price) are set now, but delivery and payment will occur at a future date. Depending on the item being traded,
spot prices can indicate market expectations of future price movements in different ways. For a non-perishable
commodity like good, spot price reflects market expectations of future price movements. In theory, the difference
in spot and forward prices should be equal to the finance charges, plus any earnings due to the holder of the
commodity, according to the cost of carry mode. In contrast, a perishable commodity does not allow this arbitragethe cost of storage is effectively higher than the expected future price of the commodity. As a result, spot prices
will reflect current supply and demand, not future price movements. Spot prices can therefore be quite volatile
and move independently from forward prices.
MARKETING OF AGRICULTURAL COMMODITIES
Agricultural marketing includes the movement of agricultural produce from the farm where it is produced to the
end-consumers or manufacturers. This covers physical handling and transport, initial processing and packing to
simplify handling and reduce wastage, grading and quality control to simplify sales transactions and meet different
consumers’ requirements, and holding over time to match concentrated harvest seasons with the continuing
demands of consumers throughout the year.
For the farmer, the vital function of the marketing system is to offer him a suitable outlet for his produce at a
remunerative price. To the consumers and the manufacturers of products based on agricultural raw materials,
assured and steady supply at a reasonable price is the critical service. The agricultural marketing system in
India operates primarily according to the forces of supply and demand in the private sector. Prices are determined
through a free market process by negotiations at rural purchasing, wholesale and retail stages, and represent a
balance between the consumers’ ability to pay and the farmers’ need for an incentive to produce. An efficient
marketing system is also vital to (a) provide an incentive to the farmer to produce more; (b) convey the changing
production needs of the economy to the producers to enable production planning; (c) foster true competition
among the traders and (d) eliminate the exploitation of farmers, particularly the small and marginal ones.
India is one of the largest agrarian economies of the world. Its agriculture sector is at the core of the economy’s
purchasing power. The agriculture produce sector is the most important component of the Indian commodity
sector. India’s commodity sector comprises activities, regulations, institutions and producers, consumers,
intermediaries, service providers and marketplaces that collectively cause and explain some part of the economy’s
total output.
Government intervention is aimed at protecting the interests of producers and consumers and promoting organized
310 PP-CC&MM
marketing of agricultural commodities. The Indian government has adopted various measures to improve
agricultural marketing. These steps include establishing regulated markets, constructing warehouses, grading
and standardizing produce, standardizing weights and measures and providing information on agricultural prices
over the national radio network. The government also provides assistance in the establishment of infrastructure
for regulated markets, and in the setting up of rural warehouses.
(i) Various Central Government organizations are involved in agricultural marketing, including the
Commission for Agricultural Costs and Prices, the Food Corporation of India, the Cotton Corporation of
India, and the Jute Corporation of India. There also are specialized marketing boards for rubber, coffee,
tea, tobacco, spices, coconut, oilseeds, vegetable oil and horticulture.
(ii) The National Agricultural Cooperative Marketing Federation of India, the apex body of the state marketing
federations, handles much of the domestic and most of the export marketing for its member organizations.
(iii) A network of cooperatives at the local, state, and national levels assist in agricultural marketing in India.
The major commodities handled are food grains, jute, cotton, sugar, milk, and areca nuts.
(iv) The Directorate of Marketing and Inspection of the Ministry of Agriculture administers all laws related
with the marketing of agricultural produce, besides carrying out market research. The directorate also
works closely with states to provide agricultural marketing services that constitutionally are a matter of
state purview.
(v) The Central Warehousing Corporation, an entity of the Central Government, operates warehouses at
major points within its jurisdictions, and cooperatives operate warehouses in towns and villages.
Due to the characteristics of agricultural produce, such as small production from scattered farms, seasonality
and perishability of products, transportation and communication bottlenecks, etc., a large number of intermediaries
are required between the producer and the end-consumer. These intermediaries participate in the assembling
and distribution of agricultural products. Broadly, the methods adopted for marketing of agricultural produce can
be classified as :
Direct Marketing
The process of direct marketing enables farmers to meet the specific demands of wholesalers or traders from
the farmer’s inventory of graded and certified produce on one hand and of consumers based on consumers
preference on the other hand. This helps the farmers to reduce marketing costs and, thus, improve their net
margins. Besides helping farmers to improve price realization, some farmers have discovered that adding
value or marketing some minimally processed farm products directly to the consumer is another way of
enhancing financial viability. A farmer selling his produce directly to a supermarket is one example of this form
of marketing.
Indirect Marketing
In this form of marketing, rather than the agricultural commodities directly passing from producers to endconsumers, they move from producers to end-consumers through a chain of intermediaries or middlemen. The
number of intermediaries may vary from one to many, and may include several levels of wholesale dealers
(local/provincial/national) and then the retailers. Indirect marketing makes it necessary for the farmer to haul
produce to regulated markets for sale. There are three marketing functions involved in this chain of indirect
marketing, i.e., assembling, packing and distribution. Farmers going to the mandis and selling their produce
through traders is an example of indirect marketing.
Contract Farming
The process of contract farming is a newer concept that involves cultivating and harvesting for and on behalf of
big business establishments or Government agencies and forwarding the produce at a pre-determined price. In
Lesson 10
Economics of Commodities Marketing 311
return, the contracted farmers are offered high price against their farm produce. This stipulates a commitment
on the part of the farmers to provide a specific commodity in terms of quality and quantity as determined by the
purchaser and commitment on the part of company to support the farmer for production through inputs and
other technical support. The role of contract farming in Indian economy is becoming important, since organized
farming practice has become the need of the hour in the world of rapid industrialization. Some of the success
stories include National Dairy Development Board and PEPSICO.
Recently, India’s commodity exchanges have also set-up national-level electronic spot markets, the Spot
Exchanges, in recognition of the need to help farmers increase their income from farm and non-farm activities.
These spot exchanges provide a platform where farmers can sell their produce at the best possible rate and the
end-users can buy at the most competitive price, and in addition, provide services like quality certification,
storage of goods and other customized value-added services. As a result, the Indian farmers have multiple
options to sell their produce and are no longer dependent on Agricultural Produce Market Committees. The spot
exchanges also create a market where the processors end users, exporters, corporates (both private and
government) and other traders can procure agricultural produce at the most competitive price, without any
counter-party and quality risk.
STORAGE
Storage is an important marketing function, which involves holding and preserving goods from the time they are
produced until they are needed for consumption. The storage of goods, therefore, from the time of production to
the time of consumption, ensures a continuous flow of goods in the market. Storage protects the quality of
perishable and semi-perishable products from deterioration;
Some of the goods e.g., woolen garments, have a seasonal demand. To cope with this demand, production on
a continuous basis and storage become necessary; It helps in the stabilization of prices by adjusting demand
and supply. Storage is necessary for some period for performance of other marketing functions.
TYPES OF STORAGE
Underground Storage Structures
Underground storage structures are dugout structures similar to a well with sides plastered with cowdung. They
may also be lined with stones or sand and cement. They may be circular or rectangular in shape. The capacity
varies with the size of the structure.
Advantages
– Underground storage structures are safer from threats from various external sources of damage, such
as theft, rain or wind.
– The underground storage space can temporarily be utilized for some other purposes with minor
adjustments; and
– The underground storage structures are easier to fill up owing to the factor of gravity.
Surface storage structures
Foodgrains in a ground surface structure can be stored in two ways - bag storage or bulk storage.
I. Bag storage
– Each bag contains a definite quantity, which can be bought, sold or dispatched without difficulty;
– Bags are easier to load or unload.
– It is easier to keep separate lots with identification marks on the bags.
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– The bags which are identified as infested on inspection can be removed and treated easily; and
– The problem of the sweating of grains does not arise because the surface of the bag is exposed to the
atmospheres.
II. Bulk or loose storage
– The exposed peripheral surface area per unit weight of grain is less. Consequently, the danger of
damage from external sources is reduced; and
– Pest infestation is less because of almost airtight conditions in the deeper layers.
– The Government of India has made efforts to promote improved storage facilities at the farm level.
– Improved grain storage structures
WAREHOUSING
Warehouses are scientific storage structures especially constructed for the protection of the quantity and quality
of stored products.
Importance of warehousing
(i) Scientific storage: The product is protected against quantitative and qualitative losses by the use of such
methods of preservation as are necessary.
(ii) Financing: Warehouses meet the financial needs of the person who stores the product. Nationalized Banks
advance credit on the security of the warehouse receipt issued for the stored products to the extent of 75 to 80%
of their value.
(iii) Price Stabilization: Warehouses help in price stabilization of agricultural commodities by checking the
tendency to make post-harvest sales among the farmers.
(iv) Market Intelligence: Warehouses also offer the facility of market information to persons who hold their
produce in them.
Working of Warehouses
(i) Acts: The warehouses (CWC and SWCs) work under the respective Warehousing Acts passed by the Central
or State Govt.
(ii) Eligibility: Any person may store notified commodities in a warehouse on agreeing to pay the specified
charges.
(iii) Warehouse Receipt (Warrant): This is receipt/warrant issued by the warehouse manager/owner to the
person storing his produce with them. This receipt mentions the name and location of the warehouse, the date
of issue, a description of the commodities, including the grade, weight and approximate value of the produce
based on the present prices.
(iv) Use of Chemicals: The produce accepted at the warehouse is preserved scientifically and protected against
rodents, insects and pests and other infestations. Periodical dusting and fumigation are done at the cost of the
warehouse in order to preserve the goods.
(v) Financing: The warehouse receipt serves as a collateral security for the purpose of getting credit.
(vi) Delivery of produce: The warehouse receipt has to be surrendered to the warehouse owner before the
withdrawal of the goods. The holder may take delivery of a part of the total produce stored after paying the
storage charges.
Lesson 10
Economics of Commodities Marketing 313
TYPES OF WAREHOUSE
1. On the basis of Ownership
(i) Private warehouses: These are owned by individuals, large business houses or wholesalers for the storage
of their own stocks. They also store the products of others.
(ii) Public warehouses: These are the warehouses, which are owned by the Govt. and are meant for the
storage of goods.
(iii) Bonded warehouses: These warehouses are specially constructed at a seaport or an airport and accept
imported goods for storage till the payment of customs by the importer of goods. These warehouses are licensed
by the Govt. for this purpose. The goods stored in this warehouse are bonded goods. Following services are
rendered by bonded warehouses:
– The importer of goods is saved from the botheration of paying customs duty all at one time because he
can take delivery of the goods in parts.
– The operation necessary for the maintenance of the quality of goods - spraying and dusting, are done
regularly.
– Entrepot trade (re-export of imported goods) becomes possible.
2. On the basis of Type of Commodities Stored
General Warehouses: These are ordinary warehouses used for storage of most of foodgrains, fertilizers, etc.
Special Commodity Warehouses: These are warehouses, which are specially constructed for the storage of
specific commodities like cotton, tobacco, wool and petroleum products.
Refrigerated Warehouses: These are warehouses in which temperature is maintained as per requirements and
are meant for such perishable commodities as vegetables, fruits, fish, eggs and meat.
WAREHOUSING IN INDIA
Central Warehousing Corporation (CWC)
This corporation was established as a statutory body in New Delhi on 2nd March 1957. The Central Warehousing
Corporation provides safe and reliable storage facilities for about 120 agricultural and industrial commodities.
Functions
– To acquire and build godowns and warehouses at suitable places in India.
– To run warehouses for the storage of agricultural produce, seeds, fertilizers and notified commodities.
for individuals, co-operatives and other institutions.
– To act as an agent of the Govt. for the purchase, sale, storage and distribution of the above commodities.
– To arrange facilities for the transport of above commodities.
– To subscribe to the share capital of State Warehousing Corporations and
– To carry out such other functions as may be prescribed under the Act.
The Central Warehousing Corporation is running air-conditioned godowns at Calcutta, Bombay and Delhi, and
provides cold storage facilities at Hyderabad. Special storage facilities have been provided by the Central
Warehousing Corporation for the preservation of hygroscopic and fragile commodities. The corporation has
also evolved techniques for the storage of spices, coffee, seeds and other commodities.
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State Warehousing Corporations (SWCs)
State Warehousing Corporations are also set up in different States of the Indian Union. The areas of operation
of the State Warehousing Corporations are centres of district importance. The total share capital of the State
Warehousing Corporations is contributed equally by the concerned State Govt. and the Central Warehousing
Corporation.
Food Corporation of India (FCI)
Apart from CWC and SWCs, the Food Corporation of India has also created storage facilities. The Food
Corporation of India is the single largest agency which has a capacity of 26.62 million tonnes.
VARIANCE IN COMMODITY MARKET
Contracts traded on the commodity exchanges are no longer limited to traditional commodities and standardized
contracts have come to be traded on the ever-increasing range of products and indices-like electricity, freight
rates, carbon dioxide and even weather, besides the conventional base metals, soft commodities oil, gas etc.
During the past several decades, the global derivatives industry has grown manifold and derivatives contracts
on a progressively diverse array of underlying products have been launched by exchanges. The past several
decades have witnessed the emergence and rapid developments and innovations in the filed of financial
engineering and derivatives. In fact, the concept of ‘commodity’ has been stretched beyond the traditional tangible
physical products to contracts that are based on an increasing range of physical commodities, market instruments
and indices (whether settled by physical delivery or in cash). The diverse range of potential underlying assts and
payoff alternatives leads to a huge range of derivatives contracts available for trading in the market. Today,
derivatives contracts are traded on Commodity Exchange Markets around the globe, based on the following
commodities (among others) :
– Agricultural crops and livestock
– Metals, both precious and industrial
– Energy, including electricity
– Interest rates
– Freight rates
– Equities and indices
– Foreign Exchange
– Insurance
– Carbon emissions
– Weather.
Variety is the very essence of commodity trading, and depends on the ability to build liquid and transparent
derivatives in emerging asset classes. Agriculture is a risk-prone sector. Combating risk in agriculture has been,
and continues to be, one of the major challenges to scientists and policy makers. Notable among the risk
sources plaguing agriculture include a host of weather-related risks. These include extreme rainfall, temperature
events, as well as natural disasters. Economic losses from weather risks have tended to increase in the past few
decades. The energy and shipping markets also operate in an environment exposed to a variety of risks
responsible for high volatility in the prices of oil, natural gas, electricity and freight rates. The need to control this
price volatility has promoted the development of risk management methods for weather, energy assets and their
derivatives, analogous to those widely used in fixed income, equity and foreign exchange markets. A totally
different class of markets and derivatives with exotics underlying has emerged.
Lesson 10
Economics of Commodities Marketing 315
WEATHER DERIVATIVES
Weather Derivatives are financial instruments that seem like an insurance policy but are more like options. They
are unique in that there is no physical underlying asset. The underlying asset is any measureable weather
factor, that is, temperature measured in degrees Celsius or Fahrenheit, rainfall measured in centimeters, or
snowfall measured in inches. On the Chicago Mercantile Exchange, the values of these contracts are calculated
based on a weather index. Most temperature contracts in current practice are based on a Heating Degree Day
(HDD) for winter protection, or a Cooling Degree day (CDD) for summer protection. Pay-off is based on a
measurable index like HDD or CDD, and it performs relative to the strike value (not the actual loss). Coverage
has a defined maximum limit.
Heating degree days are one of the most common types of weather derivatives. HDD is the difference between
the baseline temperature and the average temperature for a day in winters. The baseline temperature is fixed;
it is 65 degrees Fahrenheit in the U.S. and 18 degrees Celsius in Europe.
HDD = Max (0.65F-average temperature in a day)
The value of the contract would be a multiple of the HDD. The contract can be valued on a daily basis, or can be
valued on a weekly, fortnightly or monthly basis, or for a season, depending on the contract specifications.
Typical terms for a HDD contract could be: for the November to March period, for each day when the temperature
falls below 65 degrees Fahrenheit, or 18 degrees Celsius, keep a cumulative count of its difference from the
average daily temperature. Depending upon whether the option is a put option or a call option, it pays out a set
amount per heating degree day that the actual count differs from the strike.
Weather Derivatives contracts are being used successfully by farmers, theme parts, ski resorts, ice-cream
manufacturers, energy and utilities companies, etc., for over a decade now. Gas and power companies may use
HDD or CDD contracts to smooth earnings.
For example, a ski resort located in Auli may buy a put option by paying a premium of `1,00,000 to buy a right to
receive `20,000 for every inch of snow below the strike amount of say, 50 inches, offsetting somewhat the loss
in revenues due to insufficient snowfall. The ski resort could also sell a call option by receiving a premium of
`1.20,000 and paying `30,000 for every inch of snow over the strike of 50 inches, again assuming higher
revenue for the resort with heavy snowfall,.
The index could also be based on rainfall. In 2005, NCDEX launched a rain day index for Mumbai city for
informational purposes only, though it can very well be used as an alternative form of crop insurance that makes
payments, based not on measures of farm yields, but rather on some objective weather event, such as rainfall.
Similarly, MCX also has rainfall indices-RAINDEXMUM, RAINDEXIDR and RAINDEXJAI-that record rainfall at
Mumbai (Colaba), Indore and Jaipur, respectively, and are designed to also consider normal rainfall in Mumbai,
Indore and Jaipur.
FREIGHT DERIVATIVES
Just as weather is a source of risk for farmers, organizations and individuals, freight rates can also cause harm
to the revenues of organizations by impacting their shipping costs adversely. This is freight market risk. Given
the current volatility of the freight markets, managing freight market risk is a significant issue for the shipping
industry. Volatility in freight rates drives the need for financial tools for risk management, and attracts speculation
on the future price movements of freight. The ability to hedge the cost of freight permits traders to price their
businesses with greater degree of certainty and long-term stability.
Freight Derivatives are financial instruments used by organizations and individuals as part of their risk management
strategy to counter the negative economic effects of freight rate alterations that harm the financial prospect of a
company. Freight derivatives are financial contracts between two parties to settle upon an agreed future price
for carrying commodities at sea. The freight derivatives market began with the trading of voyage rates for certain
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‘dry’ cargo routes in the early 1990s, and was later expanded to include ‘wet’ tanker routes. Dry cargo is of solid,
dry material, rather than liquid or gas, and generally does not require special temperature controls. Wet cargo
consists of liquids or gases that may also require special temperature conditions. Recently, with commodities
now standing at the forefront of international economics, large financial trading houses, including banks and
hedge funds, have entered this market. Freight derivatives are primarily used by ship-owners and operators, oil
companies, trading companies and grain houses, as tools for managing freight rate risk.
Take the case of a trader who has agreed in August 2012 to ship 3000 tonnes of sugar from Brazil to Japan in
April, 2013. Assume that in August 2012, for this route, the freight rate per tonne of sugar is $90 per tonne. The
trader expects the rates to go up. He can book a ship now, for April loading, but the ship owner may not want to
commit for so far into the future. The trader can, alternatively, purchase a contract for settlement in April 2013, at
$92 per tonne, and lock in this rate. The settlement is against an index, like the Baltic Dry Index (BDI) which is a
daily average of prices paid by an end customer to have a shipping company transport dry raw materials across
26 different routes throughout the world averaged into one index. BDI is based on January 1985 as 1,000, and
is made up of an average of the Baltie Supramax, Panamax, and Capesize indices. If in April 2013, the freight
index is $95 per tonne, the trader makes a profit of $3 per tonne, which is offset by the increased cost of
shipping. If the freight index has fallen to $88 per tonne, then the trader makes a loss of $4 per tonne, which is
offset by the now lower cost of shipping.
ELECTRICITY DERIVATES
Energy derivatives are derivative instruments with the underlying asset being any energy product, including oil,
natural gas and electricity, which trade either on an exchange or over-the counter. Like other derivative products,
energy derivatives can be used as a form of insurance to protect against the often volatile changes of energy
prices. Electricity futures are one type of energy derivatives. They can be options, futures or swap agreements,
among others. The value of a derivative will vary based on the changes in the price of the underlying energy
product. Electricity is a commodity characterized by :
– Seasonality of demand
– High volatility of prices
– Non-elasticity of demand
– Limited transportability
– Non-storability
In fact, electricity derivatives were visualized as hedging instruments for suppliers and users of electricity in the
United States, where electricity suppliers charge the consumers a variable tariff; the per unit rate depending on
weather, which determines the levels of electricity consumption. A need was felt for derivatives because consumers
preferred paying a fixed rate. To meet the requirement of both the parties, an intermediary structured an
arrangement with the electricity supplier to collect a fixed amount from each consumer based on an average
energy consumption pattern in the past. This is how the arrangement would work.
Electricity sector reforms initiated in the early nineties in India led to the commencement of power trading. The
Electricity Act, 2003, recoginsed power trading as a distinct licensed activity. Open access regulations and inter State
trading regulations made power trading in India a reality. The Power Trading Corporation (PTC) played the role of a
trader by purchasing power from surplus units and selling it to deficit state electricity boards (SEBs) at mutually
agreed rates. The growth in volumes necessiated a natural market based platform that would encourage Liquidity.
The Central Electricity Regulatory Commission (CERC), in 2007, granted in principle approval to commence
exchange trading, and also issued guidelines for setting up and operation of the power exchange. Indian energy
Exchange (IEX), promoted by MCX became India’s first nation-wide automated online electricity platform to
trade spot electricity, to indentify the supply side, and to act as an effective price discovery mechanism. This was
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Economics of Commodities Marketing 317
followed by Power Exchange of India Ltd. (PXIL), promoted by NCDEX and NSE. Power Exchange for Electricity
trading held streamline power trading along with standardizing electricity as tradable product, by acting as a
platform for buying, selling and trading of electricity.
MCX, with an existing basket of energy products-including crude oil, furnace oil, natural gas and aviation turbine
fuel-in January 2009 received the approval from Forward Market Commisson (FMC) for the launch of weekly
and monthly electricity contracts. The exchange launched eight weekly contracts and four monthly contracts for
trading. The contract trading unit is 1MWx24 hours with tick size as `1 per MWh. The delivery is optional for both
buyers and sellers, and due date rate is the average of daily system prices of day-ahead market of Indian
Energy Exchange (IEX) for delivery during the contract week/month.
With the launch of electricity futures, the industry has a platform to manage price risk on energy-related raw
material or output better. The launch of electricity futures will even-out the price curve in the medium-to-long run
that will help the market participants to facilitate price discovery and take an informed decision after looking at
the future prices.
CATASTROPHE DERIVATIVES
Insurers are exposed to the risk of natural and man-made Catastrophes, and need to effectively insure themselves
by fixing their projected catastrophic loss ratios irrespective of the magnitude and frequency of Catastrophes.
They have been able to protect themselves against such losses by opting for reinsurance. Whenever a primary
insurer has exposure to excessive underwriting risk, it can pass on some of this risk to reinsurers. Reinsurance
agreements can be on a pro-rata agreement wherein the primary insurer gives a portion of its premium income
to a reinsurer, and the reinsurer agrees to pay roughly the same portion of the former’s losses. There can also
be an excess-of-loss basis wherein the reinsurer agrees to pay all losses incurred by the primary insurer in
excess of a certain amount, in exchange for a flat premium from the latter.
Catastrophes represent a major source of risk for property/casualty underwriters. This is a Catastrophe risk. The
Catastrophe Derivatives market was developed in response to the need of insurance, reinsurance and other
financial companies to manage their bottom line exposure to major seasonal weather events, such as hurricanes,
that cause significant material damage.
Insurers, acting as hedgers, will buy CAT futures or CAT call options. Sellers of CAT derivatives are normally
construction companies, reinsurance companies and speculators willing to take risk for profits. Speculators are
attracted to CAT derivatives because they are perfect diversification instrument, like zero-beta assets that have
low correlation to financial markets.
CARBON DERIVATIVES
Carbon Derivatives are financial contracts with carbon dioxide emissions as the underlying. Since carbon credits
are earned by reduction in CO2 emissions, the Carbon Derivatives derive their value from these reductions.
Member firms that do not have enough allowances to cover their emissions must either make reductions or buy
another firm’s spare credits. Members with extra allowances can choose to either sell them or stock them for
future use. This is what forms the basis for the functioning of carbon derivatives markets. Market forces drive the
prices of credits.
A carbon exchange operates like a stock exchange for pollution. The Chicago Climate Exchange (CCX) was the
world’s first carbon exchange when it started in 2003. It now has over 300 members, including Intel and Kodak.
Currently, emissions-related trading is dominated by the European Climate Exchange, the world’s largest platform
for carbon emissions trading and the Chicago Climate Exchange. The establishment of the European Union’s
Emission Trading Scheme (EUETS), which commits most big businesses and airlines to emission caps, has led
to London becoming the global carbon centre, with all major investment banks running carbon trading desks
alongside traditional commodity desks.
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After China, India is the leading net seller of Certified Emission Reductions in the world, and will benefit from the
carbon credit trade. In India, MCX launched carbon trading for the first time in January 2008 through a strategic
alliance with Chicago Climate Exchange (CCX). There are five contracts of carbon credits with expiry on 15th of
respective expiry months, starting from December 2008 through December 2012. The trading unit for a contract
is of 200 tonnes, where each tonne carbon credit (carbon dioxide emission allowance) being an entitlement to
emit one tonne of carbon dioxide equivalent gases. NCDEX started carbon trading in April 2008, with each
contract of 500 tonnes.
HEDGING
Hedging is the most common method of price risk management. Hedging means reducing or controlling risk. It
entails using the futures market to take a position that balances the position in the physical market with the
objective of reducing or limiting risks associated with price changes. Hedging is a two-step process. A gain or
loss in cash position due to the changes in price levels will be countered by changes in value of future position
due to changes in future position. For instance, a wheat-grower can sell wheat futures to protect the value of his
crop prior to harvest. If there is a fall in price, the loss in cash market position will be countered by a gain in
futures position.
HEDGING RISKS
Hedging implies taking a position to reduce your risk. There are several risks inherent in business transactions.
These risks can be managed more efficiently by unbundling the risks and allowing hedging by the use of
derivatives. These risks can be separated for different businesses.
For instance, if we buy and keep copper with us as inventory, we take following risks :
Price risk : Copper prices may go up or down due to any specific reasons, If it goes down, value of our inventory
goes down.
Liquidity risk : If our position is very large, we may not be able to cover our position at the prevailing price
(called impact cost). Liquidating the position may cause loss in value as price goes down.
Counterparty (credit risk) : It may happen that after negotiating the deal and receiving the prices, the supplier
goes bankrupt or even that after the delivery, we realize that the quality is significantly different.
Once you have the physical copper with you, you can hedge by going short on the copper futures. The credit risk
will be absorbed by the exchange in this case.
In the case of a hedger seeking to offset the price risk on his holding of inventory of commodities by selling
futures in the same, his position will be as follows :
Hedging in the futures market is a two-step process. Depending upon the hedger’s cash market situation, he
either will buy or sell futures first. For instance, if he is going to buy a commodity in the cash market at a later
time, his first step is to buy futures contracts. Or if he is going to sell cash commodity at a later time, his first step
is to sell futures contracts. The second step occurs when the cash market transaction takes place. At this time,
the futures position is no longer needed for price protection and should be offset (closed out). If the hedger was
initially long (long hedge), he would offset his position by selling the contract. If he was initially short (short
hedge), he would buy back the futures contract. Both the opening and closing positions must be for the same
commodity, number of contracts, and delivery month.
However, here we have assumed that the farmer expects and finally produces the output in the same quantity.
But what in real markets do not happen is the quantity matching. There is always a gap between expected and
actual output. This is defined as a quantity risk.
If the output on the maturity is lesser, the quality mismatch may affect the hedge. Besides, it will also affect the
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Economics of Commodities Marketing 319
final revenue that the producer generates. Even with the hedging plan using futures contract, the producer is not
able to cover the losses. But unfortunately, such risk cannot be hedged using the commodity derivative.
UNDERSTANDING BASIS RISK
The primary definition of basis is the difference between cash price and futures price.
Basis = Cash Price – Futures Price
Basis is used to determine :
(i) The best time to buy or sell
(ii) When to use the futures market to hedge a purchase or sale
(iii) The futures month in which to place a hedge.
(iv) When to accept a supplier’s offer or a buyer’s bid.
(v) Resale bids.
Basis is the difference between the local cash price of a commodity and the price of a specific futures contract
of the same commodity at any given point in time.
Local cash price
`2400
Jan futures price
`2600
Basis
`200 Jan
In such case, the cash price is `200 lower than the January futures price. In market terms, it will said that the
basis is “200 under January”, On the other hand, if the cash price is `200 higher than the January futures price,
you had say the basis is “200 over January”.
Local cash price
`2800
Jan futures price
`2600
Basis
`200 Jan
In a normal (contango) market, basis is always under but in an inverted market (backwardation) it is over.
If a futures contract does not exist for a specific commodity, the price of a related futures contract may be used;
e.g., a Crude oil future is used to calculate the basis for jet fuel. We can call basis as “localizing” a futures price.
The futures market price represents the single nation/International price for commodity and is used as a benchmark
in determining the value of grain at the local level. Because basis reflects local market conditions, it is directly
included by several factors including transportation costs, local supply and demand conditions, such as quality,
availability, need local weather, storage costs, handling costs and profit margins.
LESSON ROUND UP
– A Commodity is an economic good, tradable good, product or article of commerce; something for
which there is an established market where the commodity can be bought and sold in commercial
transactions between willing buyers and sellers.
– Commodities can be perishable or non-perishable. Non-perishable commodities such as metals are
called hard commodities. Perishable commodities such as agricultural commodities are called soft
commodities.
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– Every commodity that is produced (or grown) must eventually come to a market place where it can be
bought and sold. It is in this marketplace that all the elements of commerce will come together to settle
a price at which the commodity will get traded.
– The trading of commodities in commodity markets consists of direct physical trading (spot trading) and
derivatives trading.
– Agricultural Marketing includes the movement of agricultural produce from the farm where it is produced
to the end-consumers or manufacturers.
– The process of Direct Marketing enables farmers to meet the specific demands of wholesalers or
traders from the farmer’s inventory of graded and certified produce on one hand and of consumers
based on consumers preference on the other hand.
– In Indirect Marketing, rather than the agricultural commodities directly passing from producers to endconsumers, they move from producers to end-consumers through a chain of intermediaries or
middlemen.
– Variety is the very essence of commodity trading, and depends on the ability to build liquid and
transparent derivatives in emerging asset classes.
– Weather Derivatives are financial instruments that seem like an insurance policy but are more like
options. The underlying asset is any measureable weather factor, that is, temperature measured in
degrees Celsius or Fahrenheit, rainfall measured in centimeters, or snowfall measured in inches.
– Freight Derivatives are financial instruments used by organizations and individuals as part of their risk
management strategy to counter the negative economic effects of freight rate alterations that harm the
financial prospect of a company.
– Energy derivatives are derivative instruments with the underlying asset being any energy product,
including oil, natural gas and electricity, which trade either on an exchange or over-the counter.
– The Catastrophe Derivatives Market was developed in response to the need of insurance, reinsurance
and other financial companies to manage their bottom line exposure to major seasonal weather events,
such as hurricanes, that cause significant material damage.
– Carbon Derivatives are financial contracts with carbon dioxide emissions as the underlying. Since
carbon credits are earned by reduction in CO2 emissions, the Carbon Derivatives derive their value
from these reductions.
– Hedging is the most common method of price risk management. Hedging means reducing or controlling
risk. It entails using the futures market to take a position that balances the position in the physical
market with the objective of reducing or limiting risks associated with price changes.
SELF TEST QUESTION
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a commodity? What are its properties?
2. Explain various types of commodities.
3. What is contract farming? Briefly discuss.
4. What do you understand by Weather Derivative? Briefly explain how it works?
5. What is Hedging? How risk can be reduced by using hedge mechanism?
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Lesson 11
Commodities Market Operations 323
Lesson 11
Commodities Market Operations
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Commodity Markets are an important aspect of
– Role of Commodity Exchanges
economic growth in most of the emerging
markets. Commodity Markets in India have also
– Evolution of Commodity Exchanges
witnessed rapid growth in the recent period. The
Forward Markets Commission (FMC), the
– Origin of Commodity Market in India
regulatory authority entrusted with the regulation
– Regulatory Framework
and development of commodity markets in India
– Forward Market Commission
has created
an extensive framework of
– Commodity Exchanges in India
development of institutions and intermediaries
regulation and market conduct along with
that led to impressive growth of commodity
– Participants/ Players
markets, including spot and futures exchanges,
– Trading in Commodity Market
warehouses and delivery points, quality
standards and specifications, specialized
– Order Types
investors, risk management products and
processes, and hedging tools and techniques.
– Electronic Spot Exchanges
In this background, it becomes important that
– Exchange Membership
awareness, information, and education on the
– Clearing and Settlement
functioning of commodity markets be required
to be provided to the students.
– Entities involved in phsical settlement
This lesson will enable the students to
– Instruments available for Trading
understand the knowhow of the Commodity
Market i.e. participants in the Commodity
– Using Commodity Exchanges for
Hedging, Speculation and Arbitrage
Market, Trading, Clearing and Settlement
Systems and Mechanisms at Commodity
– LESSON ROUND UP
Exchanges, instruments available for trading,
regulatory framework of Commodity Market in
– SELF TEST QUESTIONS
India etc.
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INTRODUCTION
Commodity Exchanges are defined as centers where futures trade is organized in a wider sense; it is taken to
include any organized market place where trade is routed through one mechanism, allowing effective competition
among buyers and among sellers. This would include auction-type exchanges, but not wholesale markets,
where trade is localized, but effectively takes place through many non-related individual transactions between
different permutations of buyers and sellers.
ROLE OF COMMODITY EXCHANGES
Commodity Exchanges provide platforms to suit the varied requirements of customers. Firstly, they help in price
discovery as players get to set future prices which are also made available to all participants. Hence, a farmer in
the southern part of India would be able to know the best price prevailing in the country which would enable him
to take informed decisions.
Secondly, these exchanges enable actual users (farmers, agro processors, industry where the predominant
cost is commodity input/output cost) to hedge their price risk given the uncertainty of the future - especially in
agriculture where there is uncertainty regarding the monsoon and hence prices. This holds good also for nonagro products like metals or energy products as well where global forces could exert considerable influence.
Purchasers are also assured of a fixed price which is determined in advance, thereby avoiding surprises to
them. It must be borne in mind that commodity prices in India have always been woven firmly into the international
fabric. Today, price fluctuations in all major commodities in the country mirror both national and international
factors and not merely national factors.
Thirdly, Commodity Exchanges provide liquidity and buoyancy to the system by involving the group of Investors
and Speculators.
Lastly, the arbitrageurs play an important role in balancing the market as arbitrage conditions, where they exist,
are ironed out as arbitrageurs trade with opposite positions on different platforms and hence generate opposing
demand and supply forces which ultimately narrows down the gaps in prices.
It must be pointed out that while the monsoon conditions affect the prices of agro-based commodities, the phenomenon
of globalization has made prices of other products such as metals, energy products, etc., vulnerable to changes in
global politics, policies, growth paradigms, etc. This would be strengthened as the world moves closer to the resolution
of the WTO impasse, which would become a reality shortly. Commodity exchanges would provide a valuable hedge
through the price discovery process while catering to the different kind of players in the market.
EVOLUTION OF COMMODITY EXCHANGES
Most of the Commodity Exchanges, which exist today, have their origin in the late 19th and earlier 20th century.
The first central exchange was established in 1848 in Chicago under the name Chicago Board of Trade. The
emergence of the derivatives markets as the effective risk management tools in 1970s and 1980s has resulted
in the rapid creation of new Commodity Exchanges and expansion of the existing ones. At present, there are
major Commodity Exchanges all over the world dealing in different types of commodities.
ORIGIN OF COMMODITY MARKET IN INDIA
Cotton was the first commodity to attract futures trading in the country leading to the setting up of the Bombay
Cotton Trade Association Ltd in 1875. It was the first organized futures market. Bombay Cotton Exchange Ltd.
was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants
over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the
establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and
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Commodities Market Operations 325
cotton. Futures trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most
notable futures exchange for wheat was Chamber of Commerce at Hapur set up in 1913. Futures trading in
bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in
raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of
East Indian Jute Association Ltd. These two associations amalgamated in 1945 to form the East India Jute &
Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act
was enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry
of Consumer Affairs and Public Distribution.
India was in an era of physical controls since independence. Agricultural commodities were associated with the
poor and were governed by policies such as Minimum Price Support and Government Procurement. Further, as
production levels were low and had not stabilized, there was the constant fear of misuse of these platforms
which could be manipulated to fix prices by creating artificial scarcities. This was also a period which was
associated with wars, natural calamities and disasters which invariably led to shortages and price distortions.
Hence, in an era of uncertainty with potential volatility, the government banned futures trading in commodities in
the 1960s. The Khusro Committee which was constituted in June 1980 had recommended reintroduction of
futures trading in most of the major commodities, including cotton, kapas, raw jute and jute goods and suggested
that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate
time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few
markets in Punjab and Uttar Pradesh.
With the gradual trade and industry liberalization of the Indian Economy pursuant to the adoption of the economic
reform package in 1991, Government of India constituted another committee on Forward Markets under the
chairmanship of Prof. K.N. Kabra. The committee recommended that some of the existing commodity exchanges
particularly the ones in pepper and castor seed, may be upgraded to the level of international futures markets.
The Expert Committee on Strengthening and Developing Agricultural Marketing (Guru Committee: 2001)
emphasized the need for and role of futures trading in price risk management and in marketing of agricultural
produce. This Committee's Group on Forward and Futures Markets recommended that it should be left to
interested exchanges to decide the appropriateness/usefulness of commencing futures trading in products (not
necessarily of just commodities) based on concrete studies of feasibility on a case-to-case basis. It, however,
noted that all the commodities are not suited for futures trading. For a commodity to be suitable for futures
trading it must possess some specific characteristics.
The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement
and distribution channel necessitated setting in place a market mechanism to perform the economic functions of
price discovery and risk management. The National Agriculture Policy announced in July 2000 and the
announcements of Hon'ble Finance Minister in the Budget Speech for 2002-2003 were indicative of the
Governments resolve to put in place a mechanism of futures trade/market. As a follow up, the Government
issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of these notifications
futures trading is not prohibited in any commodity. Options trading in commodity is, however presently
prohibited.
The year 2003 is a landmark in the history of commodity futures market witnessing the establishment and
recognition of three new national exchanges National Commodity and Derivatives Exchange of India Ltd. (NCDEX),
Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity Exchange of India Ltd. (NMCE)
with on-line trading and professional management. Not only was prohibition on forward trading completely
withdrawn, the new exchanges brought capital, technology and innovation to the market.
REGULATORY FRAMEWORK
After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated forward
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contracts in commodities all over India. The Act applies to goods, which are defined as any movable property
other than security, currency and actionable claims. The Act prohibited options trading in goods along with cash
settlements of forward trades. Under the Act, only those associations/exchanges, which are granted recognition
by the Government, are allowed to organize forward trading in regulated commodities. The Act envisages threetier regulation: (i) The Exchange which organizes forward trading in commodities can regulate trading on a dayto-day basis; (ii) the Forward Markets Commission provides regulatory oversight under the powers delegated to
it by the central Government, and (iii) the Central Government - Department of Consumer Affairs, Ministry of
Consumer Affairs, Food and Public Distribution - is the ultimate regulatory authority.
THREE-TIER REGULATORY SYSTEM
First tier: Central Government
Central Government has been given with highest authority to control FMC as well as Exchanges.
(a) It has powers to grant / withdraw recognition of Exchanges.
(b) It notifies the commodities under section 15,17 and 18(3).
(c) It supersedes the governing body of recognized association or exchange.
Second tier: Forward Market Commission
Forward Market Commission comes under the second tier of the authority hierarchy. It has control over Exchanges
and it works under the control of Central Government. In brief, it
(a) Approves Rules and Bye-laws of Exchanges.
(b) Grants trading permissions subject to appropriate regulatory.
(c) Monitors and surveys the markets.
(d) Conducts inspection of Exchanges and their Members.
(e) Appoints independent directors on the boards of Exchanges.
(f) May suspend a Member of the Exchange.
(g) Informs and assists Police Authorities in investigation and prosecution for illegal irregular trading.
Third tier: Exchanges
Functions of the exchanges are, –
(a) Conduct trading on the basis of the articles, Bye laws approved by the commission
(b) May take action against any intermediary.
FORWARD MARKET COMMISSION OF INDIA
The Forward Markets Commission is a regulatory body for Commodity Markets in India. The forward contracts
in commodities are regulated as per F.C.(R) Act, 1952 by this body. Inherent objective is to achieve price stability
by means of price discovery and risk management. The Commission also collects information regarding the
trading conditions in respect of goods to which any of provisions of Act is made applicable. It also advises
Central Government regarding recognition of associations.
Functions of Forward Market Commission of India
(a) To advice the Central Government in respect of the recognition or withdrawal of recognition from any
association. It also advices Government about any other matter arising out of the administration of this act.
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Commodities Market Operations 327
(b) Second function of the act includes the task of keeping forward markets under observation and take
necessary actions. The actions taken should be according to powers given to the commission by the
“Forward Contract Regulation Act”.
(c) To collect information regarding the trading conditions in respect of goods (to which any of the provisions
of this Act is made applicable) including information regarding supply, demand and prices. And publish
information whenever the Commission thinks it necessary,
It also performs the task of submitting to the Central Government periodical reports on the operation of
this Act and on the working of forward markets relating to such goods.
(d) To make recommendations generally with a view to improving the organization and working of forward
markets
(e) To undertake the inspection of the accounts and other documents of any recognized association or
registered association or any member of such association whenever it considers it necessary.
(f) To perform such specified duties and exercise assigned powers by the “Forward Contract Regulation
Act”.
Powers of Forward Market Commission
1. The Commission shall, in the performance of its functions, have all the powers of a civil court under the Code
of Civil Procedure, 1908, while trying a suit in respect of the following matters, namely:
(a) Summoning and enforcing the attendance of any person and examining him on oath
(b) Requiring the discovery and production of any document.
(c) Receiving evidence on affidavits.
(d) Requisitioning any public record or copy thereof from any office.
(e) Any other matters which may be prescribed.
2. The Commission shall have the power to require any person, subject to any privilege which may be claimed
by that person under any law for the time being in force, to furnish information on such points or matters as in
the opinion of the Commission may be useful for, or relevant to any matter under the consideration of the
Commission and any person so required shall be deemed to be legally bound to furnish such information within
the meaning of Sec. 176 of the Indian Penal code, 1860.
3. The Commission shall be deemed to be a civil court and when any offence described in Sections. 175, 178,
179, 180 or Sec. 228 of the Indian Penal Code, 1860 , is committed in the view or presence of the Commission,
the Commission may, after recording the facts constituting the offence and the statement of the accused as
provided for in the Code of Criminal Procedure, 1898 forward the case to a Magistrate having jurisdiction to try
the same and the Magistrate to whom any such case is forwarded shall proceed to hear the complaint against
the accused as if the case had been forwarded to him under Section 482 of the said Code.
4. Any proceeding before the Commission shall be deemed to be a judicial proceeding within the meaning of
Sections. 193 and 228 of the Indian Penal Code, 1860.
COMMODITY EXCHANGES IN INDIA
There are more than 20 recognised commodity futures exchanges in India under the purview of the Forward
Markets Commission (FMC). The country's commodity futures exchanges are divided majorly into two categories:
– National exchanges
– Regional exchanges
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The six exchanges operating at the national level are:
(i) National Commodity and Derivatives Exchange of India Ltd. (NCDEX)
(ii) National Multi Commodity Exchange of India Ltd. (NMCE)
(iii) Multi Commodity Exchange of India Ltd. (MCX)
(iv) Indian Commodity Exchange Ltd. (ICEX)
(v) Ace Derivatives and Commodity Exchange Limited
(vi) Universal Commodity Exchange Ltd.
The leading regional exchange is the National Board of Trade (NBOT) located at Indore. There are 16 regional
Commodity Exchanges in India.
Features
Some of the features of national and regional exchanges are listed below:
National Exchanges
– Compulsory online trading
– Transparent trading
– Exchanges to be de-mutualised
– Exchange recognised on permanent basis
– Multi commodity exchange
– Large expanding volumes
Regional Exchanges
– Online trading not compulsory
– De-mutualisation not mandatory
– Recognition given for fixed period after which it could be given for re regulation
– Generally, these are single commodity exchanges. Exchanges have to apply for trading each commodity.
– Low volumes in niche markets.
PARTICIPANTS/PLAYERS
Broadly, the participants in commodity market can be classified as Hedgers, Arbitraguers and Speculators. In
other words, manufacturers, traders, farmers, exporters and investors are all participating in this market.
HEDGERS
Hedger is the person who basically wants to avoid risk and enters into a contract with speculator. Hedger is a user of
the market, who enters into futures contract to manage the risk of adverse price fluctuation in respect of his existing
or future asset. Hedgers are those who have an underlying interest in the commodity and are using futures market to
insure themselves against adverse price fluctuations. Examples could be stockists, exporters, producers, etc
Hedging means taking a position in the futures or option market that is opposite to a position in the physical
market. It reduces or limits risks associated with unpredictable changes in price. The objective behind this
mechanism is to offset a loss in one market with a gain in another.
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Commodities Market Operations 329
Hedging is a mechanism by which the participants in the physical/ cash markets can cover their price risk.
Theoretically, the relationship between the futures and cash prices is determined by cost of carry. This enables
the participants in the physical/ cash markets to cover their price risk by taking opposite position in the futures
market.
Hedging is a mechanism of avoiding exposure to risk of fluctuating prices in futures markets will be effective only
when the following requirements are met.
– Driven by the demand and supply over a period the prices of cash and futures markets tend to move
together
– As the maturity date approaches, cash and futures prices tend to converge or reach a predictable
difference called the basis.
Hedging in the futures market in general is a two-step process, depending upon the hedger's cash market
situation
First step: If the hedger is going to buy a commodity in the cash market at a later time, his first step is to buy
futures contracts. Or if he is going to sell cash commodity at a later time, his first step in the hedging process is
to sell futures contracts.
Second step: when the cash market transaction takes place, the futures position is no longer needed for price
protection and should therefore be offset (closed out). Depending on the initial position taken long (long hedge)
or short (short hedge), hedger would offset his position by selling or buying back the futures contract. Both the
opening and closing positions must be for the same commodity, number of contracts, and delivery month.
For example, in June if a farmer expects an output of 100 tonnes of soyabean in October. Soyabean prices in
October are expected to rule relatively lower as it is harvesting season for soya bean. In order to hedge against
the price fall, the farmer/producer sells 100 contracts of one tonne each at ` 1347 on June 22. On a fall of price
to ` 1216 per tonne in October he makes a profit of ` 131 per tonne.
SPECULATOR
A trader, who trades or takes position without having exposure in the physical market, with the sole intention of
earning profit is a speculator. Speculators are those who may not have an interest in the ready contracts, etc. but
see an opportunity of price movement favourable to them. They are prepared to assume the risks, which the
hedgers are trying to cover in the futures market. They provide depth and liquidity to the market. They provide a
useful economic function and are an integral part of the futures the market. It would not be wrong to say that in
absence of speculators the market will not be liquid and may at times collapse.
A speculator is one who enters the market to profit from the future price movements. He does not have any
physical exposure. Speculators accept the risk that hedgers seek to avoid, giving the required liquidity to the
market.
Contrary to the hedging, speculation involves risk but no offsetting of cash market position. Speculators on the
other hand, wish to take risk that hedgers want to avoid with a motive to make profits and provide the necessary
liquidity through bids and offer that result into a continuous flow of transactions. Commodities are becoming
increasingly attractive to investor and hedge fund managers as an alternative asset class that may allow reduction
in overall risk of financial portfolio and enhance returns.
For example if an investor wants to diversify his investment portfolios, he can chose commodities as a bright
option. Unlike in spot markets, he has to invest only a margin amount instead of the total amount and can gain
profits to the total extent.
330 PP-CC&MM
Need of speculators in futures market
Participants in physical markets use futures market for price discovery and price risk management. In fact, in the
absence of futures market, they might speculate on prices in unorganized markets. Futures market helps them
to avoid speculation by entering into hedge contracts. It is however extremely unlikely for every hedger to find a
hedger counterpart with matching requirements. The hedgers intend to shift price risk, which they can only if
there are participants willing to accept the risk. Speculators are such participants who are willing to take risk of
hedgers in the expectation of making profit. Speculators provide liquidity to the market, therefore, it is difficult to
imagine a futures market functioning without speculators.
Difference between a speculator and gambler
Speculators are not gamblers, since they do not create risk, but merely accept the risk, which already exists in
the market. The speculators are the persons who try to assimilate all the possible price-sensitive information, on
the basis of which they can expect to make profit. The speculators therefore contribute in improving the efficiency
of price discovery function of the futures market.
ARBITRAGEURS
Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the
buying price by more than the transaction cost, resulting in risk-less profit to the arbitrageur. Arbitrage is making
purchases and sales simultaneously in two different markets to profit from the price differences prevailing in
those markets. The factors driving arbitrage are the real or perceived differences in the equilibrium price as
determined by supply and demand at various locations.
A third category of market participants is the arbitrageurs. Arbitrage is a risk-less profit realized by simultaneous
trading in two or more markets. However, arbitrage opportunities are very desirable but not easy to uncover, as
they do not last longer since the prices get adjusted soon with buying and selling
Arbitrage is possible when one of the three conditions is met:
– The same asset must trade at the different prices on all markets.
– Two assets with identical cash flows must trade at different prices.
– An asset with a known price in the future, must trade today at a different price than its future price
discounted at the risk-free interest rate.
COMMODITY PRODUCERS/CONSUMERS
These participants have natural underlying outright long (producers) and short (consumers) positions in the
relevant commodity. The inherent risk-exposure drives the use of commodity derivatives by producers and
users.
The application of commodity derivatives in frequently driven by the pattern of cash flows. Producers must
generally make significant capital investments (sometime significant in scale) to undertake the production of the
commodity. This investment must generally be made in advance of production and sale of the commodity. This
means that the producer is exposed to the price fluctuations in the commodity.
If prices decline sharply, then revenues may be insufficient to cover the cost of servicing the capital investment
(including debt service). This means that there is a natural tendency for producers to hedge at levels that ensure
adequate returns without seeking to optimize the potential returns from higher returns. This may also be
necessitated by the need to secure financing for the project.
Lesson 11
Commodities Market Operations 331
Commodity Processors
These participants have limited outright price exposure. This reflects the fact that the processors have a spread
exposure to the price differential between the cost of the input and the cost of the output. For example, oil
refiners are exposed to the differential between the price of the crude oil and the price of the refined oil products
(diesel, gasoline, heating oil, aviation fuel, etc.). The nature of the exposure drives the types of hedging activity
and the instruments used.
Commodity Traders
Commodity Markets have complex trading arrangements. This may include the involvement of trading companies.
Where involved, the traders act as an agent or principal to secure the sale/purchase of the commodity. Traders
increasingly seek to add value to pure trading relationship by providing derivative/risk management expertise.
Traders also occasionally provide financing and other services. Commodity traders have complex hedging
requirements, depending on the nature of their activities.
A trader as a pure agent will generally have no price exposure. Where a trader acts as a principal, it will generally
have outright commodity price risk that requires hedging. Where traders provide ancillary services such as
commodity derivatives as the principal, the market risk assumed will need to be hedged or managed.
Financial Institution/Dealers
Dealer participation in Commodity Markets is primarily as a provider of finance or provider of risk management
products. The dealers’ role is similar to that in the derivative market in other asset classes. The dealers provide
credit enhancement, speed, immediacy of execution and structural flexibility. Dealers frequently bundle risk
management products with other financial services such as provision of finance.
Investors
This covers financial investors seeking to invest in commodities as a distinct and a separate asset class of
financial investment. The gradual recognition of commodities as a specific class of investment assets is an
important factor that has influenced the structure of commodity derivatives markets.
TRADING IN COMMODITY MARKET
These are few important terms and its explanations which are essential for any person entering to trade in
commodities market.
Margin money
Margin money is the security deposit given by the trading members to the exchange in order to deal in different
contracts listed over there. The clients deposit this money with the members who in turn transfer it to the
respective exchanges.
The aim of margin money is to minimize the risk of default by either counter party. The amount of initial margin
is so fixed as to ensure that the probability of loss on account of worst possible price fluctuation (which cannot
be met by the amount of ordinary/initial margin) is very low. The Exchanges fix rates of ordinary/initial margin
keeping in view need to balance high security of contract and low cost of entering into contract.
In futures trading, the entire value of a contract need not be paid, rather a margin that is typically between 2 per
cent and 10 per cent of the total value of the contract need to be paid while entering into the contract.
It is part of the risk management system as prescribed by the market regulator, Forward Markets Commission
(FMC).
332 PP-CC&MM
Different types of margins payable on futures
Different margins payable on futures contracts are:
(i) ordinary/initial margin,
(ii) mark-to-market margin,
(iii) special margin,
(iv) volatility margin
(v) delivery margin
(i) Initial/ordinary margin: It is the amount required to be deposited by the market participants in his margin
account with clearing house before they can place order to buy or sell futures contracts. This must be maintained
throughout the time their position is open and is returnable at delivery, expiry or closing out.
When a futures trader enters into a futures position, he or she is required to post initial margin of an amount
specified by the exchange or clearing organization. Thereafter, the margin becomes "marked-to-market" and
the margin account will be adjusted automatically according to the changes in futures price
(ii) Mark-to-Market (MTM or M2M): At the end of every trading day, the margin account of the trader / client is
adjusted to reflect the participant’s gain or loss. The price changes on the close of every trading day may result
in some gain or loss as compared to the previous day’s closing price. These price variations are netted into the
daily margin account. This process is known as marking to the market.
Mark-to-market margins (MTM or M2M) are payable based on closing prices at the end of each trading day.
These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is
worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that
day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline
and pays to the sellers and vice versa.
Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when
futures price moves only in one direction. Hence the risk of default is reduced. Also, the participants are required to
pay less upfront margin - which is normally collected to cover the maximum, say, 99.9%, of the potential risk during
the period of mark-to-market, for a given limit on open position. Alternatively, for the given upfront margin the limit
on open position would have to be reduced, which has the effect of restraining the trade and liquidity.
(iii) Special Margin/Additional Margin: It is the additional margin imposed by the exchange to curb excess
volatility in the market. Again, this varies from commodity to commodity.
(iv) Maintenance margin: The minimum level at which the equity in a futures account must be maintained. If the
equity in an account falls below this level, a margin call will be issued, and funds must be added to bring the
account back to the initial margin level. The maintenance margin level generally is normally 75 per cent of the
initial margin requirement. If the amount of money in the margin account falls below the specified maintenance
margin, the futures trader will be required to post additional variation margin to bring the account up the initial
margin level and if the futures position is profitable, the profits will be added to the margin account.
(v) Delivery period margin: It is the extra margin imposed by the exchange on the contracts when it enters the
concluding phase (starts with tender period and goes up to delivery / settlement). This amount is applicable on
both the outstanding buy and sell positions.
ORDER TYPES
An electronic trading system allows the trading members to enter orders with various conditions attached to
them as per their requirements. These conditions are broadly divided in to the following categories.
Lesson 11
Commodities Market Operations 333
(i) Time conditions
(ii) Price conditions
(iii) Other conditions
(i) Time condition
Good till day order (GTO): A day order as the name suggests is an order which is valid for the day one which it
is entered . If the order is not executed during the day , the system cancels the order automatically at the end of
the day.
Good till cancelled (GTC) :GTC order remains in the system until the user cancels it. Consequently, it spans
trading days, if not traded on the day the order is entered.
Good till date (GTD): A GTD order allows the user to specify the date till which the order should remain in the
system if not executed.
Immediate or cancel ( IOC)/Fill or kill order: An IOC order allows the user to buy or sell a contract as soon as the
order is released in to the system,failing which the order is cancelled from the system . Partial match is possible
for the order, and the unmatched portion of the order is cancelled immediately.
(ii) Price condition
Limit order : An order to buy or sell a stated amount of commodity at a specified price , or at a better price , if
obtainable at the time of execution.
Stop loss order : A stop loss order is an order , placed with the broker , to buy or sell a particular futures contract
at the market price if and when the price reaches a specified level.Futures traders often use stop orders in an
effort to limit the amount they might lose if the futures price moves against their position.
(iii) Other Conditions
Market price : Market orders are orders for which no price is specified at the time the order is entered (Price is
market price).
Trigger price : Price at which an order gets triggered from stop loss book.
Spread order : A simple spread order involves two positions , one long and one short. They are taken in a same
commodity with different months( calendar spread) or in closely related commodities.
ELECTRONIC SPOT EXCHANGES
Electronic Spot Exchanges is an emerging phenomenon in the country .These spot exchanges provide real
time, online, transparent and vibrant spot platform for commodities. The contracts allow participants from all
over the country to buy and sell, thereby enabling producers and users to discover best price.
The Government has allowed the National Commodity Exchanges to set up three spot exchanges in the country,
namely the National Spot Exchange Ltd. (NSEL), NCDEX Spot Exchange Ltd. (NSPOT) and National Agriculture
Produce Marketing Company of India Ltd. (NAPMC). During 2009, there was significant expansion of spot
exchanges trading facilities in India. These spot exchanges have created an avenue for direct market linkage
among farmers, processors, exporters and end users with a view to reducing the cost of intermediation and
enhancing price realization by farmers. They will also provide the most efficient spot price inputs to the futures
exchanges. The spot exchanges will encompass the entire spectrum of commodities across the country and will
bring home the advantages of an electronic spot trading platform to all market participants in the agricultural and
non-agricultural segments. On the agricultural side, the exchanges would enable farmers to trade seamlessly
on the platform by providing real-time access to price information and a simplified delivery process, thereby
ensuring the best possible price. On the buy side, all users of the commodities in the commodity value chain
334 PP-CC&MM
would have simultaneous access to the exchanges and be able to procure at the best possible price. Therefore,
the efficiency levels attained as a result of such seamless spot transactions would result in major benefits for
both producers and consumers. In order to overcome current inefficiencies in the commodities spot market and
to bring transparency in trading in commodity spot markets, National Commodity and Derivatives Exchange
Limited (NCDEX) has set up an electronic spot exchange called NCDEX Spot Exchange Limited.
EXCHANGE MEMBERSHIP
The Commodity Exchange membership is open to any person, association of persons, partnerships, co-operative
societies, companies etc. that fulfills the eligibility criteria set by the Exchange. FIs, NRIs, Banks, MFs etc are
not allowed to participate in Commodity Exchanges at the moment. All the members of the Exchange have to
register themselves with the competent authority before commencing their operations. The members of commodity
exchange fall into following categories:
1. Trading cum Clearing Member (TCM) : Members can carry out the transactions (Trading, clearing and
settlement) on their own account and also on their clients' accounts. Applicants accepted for admission as TCM
are required to pay the requisite fees/ deposits and also maintain net worth as specified by the commodity
exchange.
2. Professional Clearing Members (PCM): Members can carry out the settlement and clearing for their clients
who have traded through TCMs or traded as TMs. Applicants accepted for admission as PCMs are required to
pay the requisite fee/ deposits and also maintain net worth.
3. Trading Member (TM ): Member who can only trade through their account or on account of their clients and
will however clear their trade through PCMs/STCMs.
4. Strategic Trading cum Clearing Member (STCM): This is up gradation from the TCM to STCM. Such
member can trade on their own account, also on account of their clients. They can clear and settle these trades
and also clear and settle trades of other trading members who are only allowed to trade and are not allowed to
settle and clear.
CLEARING AND SETTLEMENT
Most futures contracts do not lead to the actual physical delivery of the underlying asset. The settlement is done
by closing out open positions, physical delivery or cash settlement. All these settlement functions are taken care
of by an entity called clearing house or clearing corporation.
CLEARING
Clearing of trades that take place on an Exchange happens through the Exchange Clearing House. A clearing
house is a system by which Exchanges guarantee the faithful compliance of all trade commitments undertaken
on the trading floor or electronically over the electronic trading systems. The main task of the clearing house is
to keep track of all the transactions that take place during a day so that the net position of each of its members
can be calculated. It guarantees the performance of the parties to each transaction. Typically it is responsible for
the following:
1. Effecting timely settlement.
2. Trade registration and follow up.
3. Control of the open interest.
4. Financial clearing of the payment flow.
5. Physical settlement (by delivery) or financial settlement (by price difference) of contracts.
Lesson 11
Commodities Market Operations 335
6. Administration of financial guarantees demanded by the participants.
The clearing house has a number of members, who are responsible for the clearing and settlement of commodities
traded on the Exchange. The margin accounts for the clearing house members are adjusted for gains and
losses at the end of each day (in the same way as the individual traders keep margin accounts with the broker).
Everyday the account balance for each contract must be maintained at an amount equal to the original margin
times the number of contracts outstanding. Thus depending on a day's transactions and price movement, the
members either need to add funds or can withdraw funds from their margin accounts at the end of the day. The
brokers who are not the clearing members need to maintain a margin account with the clearing house member
through whom they trade.
Clearing Mechanism
Only clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts
through the clearing house. The clearing mechanism essentially involves working out open positions and
obligations of clearing members. This position is considered for exposure and daily margin purposes. The open
positions of PCMs are arrived at by aggregating the open positions of all the Trading Members clearing through
him, in contracts in which they have traded. A Trading-cum-Clearing Member's (TCM) open position is arrived at
by the summation of his clients' open positions, in the contracts in which they have traded. Client positions are
netted at the level of individual client and grossed across all clients, at the member level without any set-offs
between clients. Proprietary positions are netted at member level without any set-offs between client and
proprietary positions. After the trading hours on the expiry date, based on the available information, the matching
for deliveries takes place firstly, on the basis of locations and then randomly, keeping in view the factors such as
available capacity of the vault/ warehouse, commodities already deposited and dematerialized and offered for
delivery etc. Matching done by this process is binding on the clearing members. After completion of the matching
process, clearing members are informed of the deliverable/ receivable positions and the unmatched positions.
Unmatched positions have to be settled in cash. The cash settlement is only for the incremental gain/ loss as
determined on the basis of final settlement price.
Clearing Banks
Commodity exchange has designated clearing banks through whom funds to be paid and/ or to be received must
be settled. Every clearing member is required to maintain and operate a clearing account with any one of the
designated clearing bank branches. The clearing account is to be used exclusively for clearing operations i.e., for
settling funds and other obligations to commodity exchange including payments of margins and penal charges. A
clearing member having funds obligation to pay is required to have clear balance in his clearing account on or
before the stipulated pay-in day and the stipulated time. Clearing members must authorise their Clearing Bank to
access their clearing account for debiting and crediting their accounts as per the instructions of commodity exchange,
reporting of balances and other operations as may be required by commodity exchange from time to time.
The clearing bank will debit/ credit the clearing account of clearing members as per instructions received from
Commodity Exchange.
Depository participants
Every clearing member is required to maintain and operate two CM pool account each at NSDL and CDSL
through any one of the empanelled depository participants. The CM pool account is to be used exclusively for
clearing operations i.e., for effecting and receiving deliveries from Commodity Exchange.
SETTLEMENT
Settlement involves payments (Pay-Ins) and receipts (Pay-Outs) for all the transactions done by the members.
Trades are settled through the Exchange's settlement system.
336 PP-CC&MM
Future contracts have two types of settlements, the Mark-to-Market (MTM) settlement which happens on a
continuous basis at the end of each day, and the final settlement which happens on the last trading day of the
futures contract. For Instance, on the NCDEX, daily MTM settlement and final MTM settlement in respect of
admitted deals in futures contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the
respective clearing bank. All positions of a CM, either brought forward, created during the day or closed out
during the day, are marked to market at the daily settlement price or the final settlement price at the close of
trading hours on a day.
(i) Daily settlement price: Daily settlement price is the consensus closing price as arrived after closing session
of the relevant futures contract for the trading day. However, in the absence of trading for a contract during
closing session, daily settlement price is computed as per the methods prescribed by the Exchange from time to
time.
(ii) Final settlement price: Final settlement price is the polled spot price of the underlying commodity in the
spot market on the last trading day of the futures contract. All open positions in a futures contract cease to exist
after its expiration day.
Settlement Mechanism
Settlement of commodity future contracts is a little different from settlement of financial futures which are mostly
cash settled. The possibility of physical settlement makes the process a little more complicated.
(i) Daily mark to market settlement
Daily mark to market settlement is done till the date of the contract expiry. This is done to take care of daily price
fluctuations for all trades. All the open positions of the members are marked to market at the end of the day and
the profit/ loss is determined as below:
– On the day of entering into the contract, it is the difference between the entry value and daily settlement
price for that day.
– On any intervening days, when the member holds an open position, it is the difference between the daily
settlement price for that day and the previous day's settlement price.
– On the expiry date if the member has an open position, it is the difference between the final settlement
price and the previous day's settlement price.
The following explains the MTM for a member who buys one unit of December expiration Chilli contract at `6435
per quintal on December 15.
MTM on a long position in Chilli Futures
Date
Settlement Price
MTM
December 15
6320
-115
December 16
6250
-70
December 17
6312
+62
December 18
6310
-2
December 19
6315
+5
The unit of trading is 5 MT and each contract is for delivery of 5 MT. The member closes the position on December
19. The MTM profit/ loss per unit of trading show that the member makes a total loss of 1
` 20 per quintal of trading.
So upon closing his position, he makes a total loss of 6
` 000, i.e (5 x 120 x 10) on the long position taken by him.
The MTM profit and loss is settled through pay in/ pay out on T+1 basis, T being the trade day.
Lesson 11
Commodities Market Operations 337
(ii) Final settlement
On the date of expiry, the final settlement price is the closing price of the underlying commodity in the spot
market on the date of expiry (last trading day) of the futures contract. The spot prices are collected from polling
participants from base centre as well as other locations. The poll prices are bootstrapped and the mid-point of
the two boot strapped prices is the final settlement price. The responsibility of settlement is on a trading cum
clearing member for all trades done on his own account and his client's trades. A Professional Clearing Member
is responsible for settling all the participants' trades which he has confirmed to the Exchange. Members are
required to submit delivery information through delivery request window on the trader workstations provided by
commodity exchange for all open positions for a commodity for all constituents individually. This information can
be provided within the time notified by Exchange separately for each contracts. The commodity exchange on
receipt of such information matches the information and arrives at a delivery position for a member for a commodity.
A detailed report containing all matched and unmatched requests is provided to members through the extranet.
Pursuant to regulations relating to submission of delivery information, failure to submit delivery information for
open positions attracts penal charges as stipulated by the Commodity Exchange from time to time.
SETTLEMENT METHODS
Settlement of futures contracts on the commodity exchange can be done in two ways - by physical delivery of
the underlying asset and by closing out open positions. All contracts materialising into deliveries are settled in
a period as notified by the Exchange separately for each contract. The exact settlement day for each commodity
is specified by the Exchange through circulars known as 'Settlement Calendar'.
(a) Physical delivery of the underlying asset
If the buyer/seller is interested in physical delivery of the underlying asset, he must complete the delivery marking
for all the contracts within the time notified by the Exchange.
The following types of contracts are presently available for trading on the exchange Platform.
1. Compulsory Delivery
– Staggered Delivery
– Early Delivery
2. Seller's Right
3. Intention Matching
1. Compulsory Delivery Contract
Compulsory Delivery Contracts of Commodities are the contracts in which all the open positions on the expiry
date need to be compulsory settled through physical delivery.
On expiry of a compulsory delivery contract, all the sellers with open position shall give physical delivery of the
commodity. That is, the sellers need to deliver the commodity and buyers need to accept the delivery. To allocate
deliveries in the optimum location for clients, the members need to give delivery information for preferred location.
The information for delivery can be submitted during the trading hours of 3 trading days in advance of the expiry
date and up to 6 p.m. on the last day of marking delivery intention. For example, for contracts expiring on the
20th of the month, delivery intentions window will be open from the 18th and will close on the 20th.Clients can
submit delivery intentions up to the maximum of their open positions. In case the delivery intention is not marked
the seller would tender delivery from the base location.
Members will be allowed to submit one-time warehouse preference (default location). They can give even
multiple warehouse preferences. The same will be sent by the members to the Exchange. This preference will
338 PP-CC&MM
be applicable for all outstanding long and short client positions in that commodity. If the member does not mark
any specific location, the default preference will be applied for all open positions. Members can change the
default location preference on any day except the last 5 days before the expiry of the contract. For those
members, who have not submitted the preference of the default location, delivery will be marked on the base
location specified for the commodity.
After the trading hours on the expiry date, based on the available information, the delivery matching is done. All
corresponding buyers with open position as matched by the process put in place by the Exchange shall be
bound to settle his obligation by taking physical delivery. The deliveries are matched on the basis of open
positions and delivery information received by the Exchange. In the event of default by the seller, penalty as may
be prescribed by the Exchange from time to time would be levied. The sub-types of Compulsory Delivery Contracts
are (i) Staggered Delivery (ii) Early Delivery.
2. Sellers Right Contract
In Seller's Right contracts, delivery obligation is created for all valid sell requests received by the Exchange.
Simultaneously, the deliveries are allocated to the buyers with open positions on a random basis, irrespective of
whether a buy request has been submitted or not. While allocating the deliveries, preference is given to those
buyers who have submitted buy requests.
The information for delivery can be submitted during the trading hours of 3 trading days prior to 5 working days
of expiry of contracts. For example, for contracts expiring on the 20th of the month, delivery intentions window
will be open from the 13th and will close on the 15th. Clients can submit delivery intentions up to the maximum
of their open positions. All open positions of those sellers who fail to provide delivery intention information for
physical delivery shall be settled in cash.
In settling contracts that are physically deliverable, the clearing house:
– Assigns longs to shorts (no relationship to original counterparties)
– Provides a delivery venue
Successful matching of requests with respect to commodity and warehouse location results in delivery on
settlement day. After completion of the matching process, clearing members are informed of the deliverable/
receivable positions.
3. Intention Matching Contract
The delivery position for intention matching contract would be arrived at by the Exchange based on the
information to give/take delivery furnished by the seller and buyer as per the process put in place by the
Exchange for effecting physical delivery. If the intentions of the buyers and sellers match, the respective
positions would be settled by physical deliveries. The information for delivery can be submitted during the
trading hours of 3 trading days prior to 5 working days of expiry of contracts. For example, for contracts
expiring on the 20th of the month, delivery intentions window will be open from the 13th and will close on the
15th. Clients can submit delivery intentions up to the maximum of their open positions. On the expiry of the
contract, all outstanding positions not resulting in physical delivery shall be closed out at the Final Settlement
Price as announced by the Exchange.
(b) Closing out by offsetting positions
Most of the contracts are settled by closing out open positions. In closing out, the opposite transaction is effected
to close out the original futures position. A buy contract is closed out by a sale and a sale contract is closed out
by a buy. For example, an investor who took a long position in two gold futures contracts on January 30 at
`16090 per 10 grams, can close his position by selling two gold futures contracts on February 13, at `15928. In
this case, over the period of holding the position, he has suffered a loss of `162 per 10 grams. This loss would
Lesson 11
Commodities Market Operations 339
have been debited from his account over the holding period by way of MTM at the end of each day, and finally
at the price that he closes his position, that is `15928, in this case.
(c) Cash settlement
In the case of intention matching contracts, if the trader does not want to take/ give physical delivery, all open
positions held till the last day of trading are settled in cash at the final settlement price and with penalty in case
of Sellers Right contract. Similarly any unmatched, rejected or excess intention is also settled in cash. When a
contract is settled in cash, it is marked to the market at the end of the last trading day and all positions are
declared closed. For example, Paul took a short position in five Silver 5kg futures contracts of July expiry on
June 15 at `21500 per kg. At the end of 20th July, the last trading day of the contract, he continued to hold the
open position, without announcing delivery intention. The closing spot price of silver on that day was `20500 per
kg. This was the settlement price for his contract. Though Paul was holding a short position on silver, he did not
have to actually deliver the underlying silver. The transaction was settled in cash and he earned profit of ` 5000
per trading lot of silver.
ENTITIES INVOLVED IN PHYSICAL SETTLEMENT
Physical settlement of commodities involves the following three entities - an accredited warehouse, registrar &
transfer agent and an assayer.
Accredited Warehouse
The commodity exchange specifies accredited warehouses through which delivery of a specific commodity can
be effected and which will facilitate for storage of commodities. For the services provided by them, warehouses
charge a fee that constitutes storage and other charges such as insurance, assaying and handling charges or
any other incidental charges. Following are the functions of an accredited warehouse:
1. Earmark separate storage area as specified by the Exchange for the purpose of storing commodities to be
delivered against deals made on the Exchange. The warehouses are required to meet the specifications prescribed
by the Exchange for storage of commodities.
2. Ensure and co-ordinate the grading of the commodities received at the warehouse before they are stored.
3. Store commodities in line with their grade specifications and validity period and facilitate maintenance of
identity. On expiry of such validity period of the grade for such commodities, the warehouse has to segregate
such commodities and store them in a separate area so that the same are not mixed with commodities which
are within the validity period as per the grade certificate issued by the approved assayers.
Approved Registrar and Transfer agents (R&T agents)
The Exchange specifies approved R&T agents through whom commodities can be dematerialized and who
facilitate for dematerialization/rematerialization of commodities in the manner prescribed by the Exchange from
time to time. The R&T agent performs the following functions:
1. Establishes connectivity with approved warehouses and supports them with physical infrastructure.
2. Verifies the information regarding the commodities accepted by the accredited warehouse and assigns the
identification number (ISIN) allotted by the depository in line with the grade, validity period, warehouse location
and expiry.
3. Further processes the information, and ensures the credit of commodity holding to the demat account of the
constituent.
4. Ensures that the credit of commodities goes only to the demat account of the constituents held with the
Exchange empanelled DPs.
340 PP-CC&MM
5. On receiving a request for re-materialization (physical delivery) through the depository, arranges for issuance
of authorisation to the relevant warehouse for the delivery of commodities.
R&T agents also maintain proper records of beneficiary position of constituents holding dematerialized
commodities in warehouses and in the depository for a period and also as on a particular date. They are
required to furnish the same to the Exchange as and when demanded by the Exchange. R&T agents also do the
job of co-ordinating with DPs and warehouses for billing of charges for services rendered on periodic intervals.
They also reconcile dematerialized commodities in the depository and physical commodities at the warehouses
on periodic basis and co-ordinate with all parties concerned for the same.
Approved assayer
The Exchange specifies approved assayers through whom grading of commodities (received at approved
warehouses for delivery against deals made on the Exchange) can be availed by the constituents of clearing
members. Assayers perform the following functions:
1. Make available grading facilities to the constituents in respect of the specific commodities traded on the
Exchange at specified warehouse. The assayer ensures that the grading to be done (in a certificate format
prescribed by the Exchange) in respect of specific commodity is as per the norms specified by the Exchange in
the respective contract specifications.
2. Grading certificate so issued by the assayer specifies the grade as well as the validity period up to which the
commodities would retain the original grade, and the time up to which the commodities are fit for trading subject
to environment changes at the warehouses.
INSTRUMENTS AVAILABLE FOR TRADING
Forward Contract
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the
parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified
future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on
the same date for the same price. Other contract details like delivery date, price and quantity are negotiated
bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. The
salient features of forward contracts are:
1. They are bilateral contracts and hence exposed to counterparty risk.
2. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the
asset type and quality.
3. The contract price is generally not available in public domain.
4. On the expiration date, the contract has to be settled by delivery of the asset.
5. If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty, which
often results in high prices being charged.
However, forward contracts in certain markets have become very standardized, as in the case of foreign exchange,
thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches
its limit in the organized futures market.
Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of
an exporter who expects to receive payment in dollars three months later. He is exposed to the risk of exchange
rate fluctuations. By using the currency forward market to sell dollars forward, he can lock on to a rate today and
reduce his uncertainty. Similarly an importer who is required to make a payment in dollars two months hence
can reduce his exposure to exchange rate fluctuations by buying dollars forward.
Commodities Market Operations 341
Lesson 11
If a speculator has information or analysis, which forecasts an upturn in a price, then he can go long on the
forward market instead of the cash market. The speculator would go long on the forward, wait for the price to
rise, and then take a reversing transaction to book profits.
Limitations of Forward Markets
Forward markets world-wide are afflicted by several problems:
– Lack of centralization of trading,
– Illiquidity and
– Counterparty risk
In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a
real estate market in that any two consenting adults can form contracts against each other. This often makes them
design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable.
Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two
sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade standardized
contracts, and hence avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.
FUTURES
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an
agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike
forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the
futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract
with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be
delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement.
A futures contract may be offset prior to maturity by entering into an equal and opposite transaction.
The main standardized items in a futures contract are:
– Quantity of the underlying
– Quality of the underlying
– The date and the month of delivery
– The units of price quotation and minimum price change
– Delivery center
Distinction between Futures and Forward Contracts
Forward contracts are often confused with futures contracts. The confusion is primarily because both serve
essentially the same economic functions of allocating risk in the presence of future price uncertainty. However,
futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer
more liquidity. This can be clearly understood with the following:
Futures
Forward
1. Trade on an Organised Exchange
1.
OTC in nature
2. Standardized Contract terms
2.
Customised Contract terms
3. Hence mere liquid
3.
Hence less liquid
4. Required Margin Payments
4.
No Margin Payments
5. Follows daily settlement
5.
Settlement happens at end of period
342 PP-CC&MM
Futures Terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures market.
Contract cycle: The period over which a contract trades. The commodity futures contracts on the commodity
exchange have one month, two months, three months etc (not more than a year) expiry cycles. For example:
Most of the agri commodities futures contracts of NCDEX expire on the 20th day of the delivery month. Thus,
a January expiration contract expires on the 20th of January and a February expiration contract ceases to
exist for trading after the 20th of February. If 20th happens to be a holiday, the expiry date shall be the
immediately preceding trading day of the Exchange, other than a Saturday. New contracts for agri commodities
are introduced on the 10th of the month.
Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be
traded, at the end of which it will cease to exist.
Delivery unit: The amount of asset that has to be delivered under one contract. For instance, the delivery
unit for futures on Soybean on the NCDEX is 10 MT. The delivery unit for the Gold futures contract is 1 kg.
Basis: Basis is the difference between the futures price and the spot price. There will be a different basis for
each delivery month for each contract. In a normal market, futures prices exceed spot prices. Generally, for
commodities basis is defined as spot price -futures price. However, for financial assets the formula, future
price -spot price, is commonly used.
Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what
is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the
asset.
Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first
entered into is known as initial margin.
Marking-to-market (MTM): In the futures market, at the end of each trading day, the margin account is
adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking
to market.
Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance
in the margin account never becomes negative. If the balance in the margin account falls below the
maintenance margin, the investor receives a margin call and is expected to top up the margin account to the
initial margin level before trading commences on the next day.
OPTIONS
Options are fundamentally different from forward and futures contracts. An option gives the holder of the option
the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures
contract, the two parties have committed themselves in doing something. Whereas it costs nothing except
margin requirements to enter into a futures contract, the purchase of an option requires an up-front payment.
There are two basic types of options: call options and put options:
(i) Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for
a certain price.
(ii) Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for
a certain price.
Lesson 11
Commodities Market Operations 343
Option Terminology
Commodity options: Commodity options are options with a commodity as the underlying. For instance, a
gold options contract would give the holder the right to buy or sell a specified quantity of gold at the price
specified in the contract.
Stock options: Stock options are options on individual stocks. Options currently trade on over 500 stocks in
the United States. A contract gives the holder the right to buy or sell shares at the specified price.
Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but
not the obligation to exercise his option on the seller/ writer.
Writer of an option: The writer of a call/ put option is the one who receives the option premium and is
thereby obliged to sell/ buy the asset if the buyer exercises on him.
Option price: Option price is the price which the option buyer pays to the option seller. It is also referred to
as the option premium.
Expiration date: The date specified in the options contract is known as the expiration date, the exercise
date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the strike price or the exercise price.
American options: American options are options that can be exercised at any time upto the expiration date.
Most exchange-traded options are American.
European options: European options are options that can be exercised only on the expiration date itself.
In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to
the holder if it were exercised immediately. A call option on the index is said to be in-the- money when the
current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much
higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is
below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow, if it were
exercised immediately. An option on the index is at-the money when the current index equals the strike price
(i.e. spot price = strike price)
Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative
cash flow, if it were exercised immediately. A call option on the index is out-of-the-money when the current
index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much
lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is
above the strike price.
Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value
and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its
intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0; (St - K)] which means the
intrinsic value of a call is the greater of 0 or (St - K). Similarly, the intrinsic value of a put is Max[0;K - St],i.e.
the greater of 0 or (K - St). K is the strike price and St is the spot price.
Time value of an option: The time value of an option is the difference between its premium and its intrinsic
value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the
maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an
option's time value, all else equal. At expiration, an option should have no time value.
344 PP-CC&MM
USING COMMODITY EXCHANGES FOR HEDGING, SPECULATION AND ARBITRAGE
For a market to succeed, it must have all three kinds of participants - hedgers, speculators and arbitrageurs. The
confluence of these participants ensures liquidity and efficient price discovery in the market. Commodity markets
give opportunity for all three kinds of participants.
HEDGING
Many participants in the commodity futures market are hedgers. They use the futures market to reduce a particular
risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals
in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price
of wheat around the time that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by
locking in to a predetermined price. Hedging does not necessarily improve the financial outcome; What it does
however is, that it makes the outcome more certain. Hedgers could be government institutions, private corporations
like financial institutions, trading companies and even other participants in the value chain, for instance farmers,
extractors, millers, processors etc., who are influenced by the commodity prices.
Basic Principles of Hedging
When an individual or a company decides to use the futures markets to hedge a risk, the objective is to take a
position that neutralizes the risk as much as possible. Take the case of a company that knows that it will gain
`1,00,000 for each 1 rupee increase in the price of a commodity over the next three months and will lose
`1,00,000 for each 1 rupee decrease in the price of a commodity over the same period. To hedge, the company
should take a short futures position that is designed to offset this risk. The futures position should lead to a loss
of `1,00,000 for each 1 rupee increase in the price of the commodity over the next three months and a gain of
`1,00,000 for each 1 rupee decrease in the price during this period. If the price of the commodity goes down, the
gain on the futures position offsets the loss on the commodity. If the price of the commodity goes up, the loss on
the futures position is offset by the gain on the commodity.
There are basically two kinds of hedges that can be taken. A company that wants to sell an asset at a particular
time in the future can hedge by taking short futures position. This is called a short hedge. Similarly, a company
that knows that it is due to buy an asset in the future can hedge by taking long futures position. This is known as
long hedge.
Short Hedge
A short hedge is a hedge that requires a short position in futures contracts. A short hedge is appropriate when
the hedger already owns the asset, or is likely to own the asset and expects to sell it at some time in the future.
For example, a short hedge could be used by a cotton farmer who expects the cotton crop to be ready for sale
in the next two months. A short hedge can also be used when the asset is not owned at the moment but is likely
to be owned in the future. For example, an exporter who knows that he or she will receive a dollar payment three
months later. He makes a gain if the dollar increases in value relative to the rupee and makes a loss if the dollar
decreases in value relative to the rupee. A short futures position will give him the hedge he desires.
Example: Assume that today is the 15th of January and that a refined soy oil producer has just negotiated a
contract to sell 10,000 Kgs of soy oil. It has been agreed that the price that will apply in the contract is the market
price on the 15th April. The oil producer is therefore in a position where he will gain `10000 for each 1 rupee
increase in the price of oil over the next three months and lose `10000 for each one rupee decrease in the price
of oil during this period. Suppose the spot price for soy oil on January 15 is `450 per 10 Kgs and the April soy oil
futures price on the commodity exchange e.g. NCDEX is `465 per 10 Kgs. The producer can hedge his exposure
by selling 10,000 Kgs worth of April futures contracts (1 unit). If the oil producers closes his position on April 15,
the effect of the strategy would be to lock in a price close to `465 per 10 Kgs. On April 15, the spot price can
either be above `465 or below `465.
Lesson 11
Commodities Market Operations 345
Case 1: The spot price is ` 455 per 10 Kgs. The company realises `4,55,000 under its sales contract. Because
April is the delivery month for the futures contract, the futures price on April 15 should be very close to the spot
price of ` 455 on that date. The company closes its short futures position at ` 455, making a gain of `465 - `455
= `10 per 10 Kgs, or ` 10,000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about ` 465 per 10 Kgs, `4,65,000 in total.
Case 2: The spot price is `475 per 10 Kgs. The company realises `4,75,000 under its sales contract. Because
April is the delivery month for the futures contract, the futures price on April 15 should be very close to the spot
price of `475 on that date. The company closes its short futures position at ` 475, making a loss of `475 - `465
= `10 per 10 Kgs, or ` 10,000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about ` 465 per 10 Kgs, ` 4,65,000 in total.
Long Hedge
Hedges that involve taking a long position in a futures contract are known as long hedges. A long hedge is
appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a
price now.
Suppose that it is now January 15. A firm involved in industrial fabrication knows that it will require 300 kgs of
silver on April 15 to meet a certain contract. The spot price of silver is `26800 per kg and the April silver futures
price is ` 27300 per kg. A unit of trading is 30 kgs. The fabricator can hedge his position by taking a long position
in ten units of futures on the NCDEX. If the fabricator closes his position on April 15, the effect of the strategy
would be to lock in a price close to ` 27300 per kg. On April 15, the spot price can either be above ` 27300 or
below ` 27300 per kg.
Case 1: The spot price is ` 27800 per kg. The fabricator pays ` 83,40,000 to buy the silver from the spot market.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very close to
the spot price of ` 27800 on that date. The company closes its long futures position at ` 27800, making a gain of
`27800 - `27300 = `500 per kg, or ` 1,50,000 on its long futures position. The effective cost of silver purchased
works out to be about ` 27300 per Kg, or `81,90,000 in total.
Case 2: The spot price is ` 26900 per Kg. The fabricator pays `80,70,000 to buy the silver from the spot market.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very close to
the spot price of ` 26900 on that date. The company closes its long futures position at ` 26900, making a loss of
`27300 - `26900 = `400 per kg, or `1,20,000 on its long futures position. The effective cost of silver purchased
works out to be about ` 27300 per Kg, or `81,90,000 in total.
Advantages of Hedging
Besides the basic advantage of risk management, hedging also has other advantages:
1. Hedging stretches the marketing period. For example, a livestock feeder does not have to wait until his
cattle are ready to market before he can sell them. The futures market permits him to sell futures
contracts to establish the approximate sale price at any time between the time he buys his calves for
feeding and the time the fed cattle are ready to market, some four to six months later. He can take
advantage of good prices even though the cattle are not ready for market.
2. Hedging protects inventory values. For example, a merchandiser with a large, unsold inventory can sell
futures contracts that will protect the value of the inventory, even if the price of the commodity drops.
3. Hedging permits forward pricing of products. For example, a jewellery manufacturer can determine the
cost for gold, silver or platinum by buying a futures contract, translate that to a price for the finished
products, and make forward sales to stores at firm prices. Having made the forward sales, the
manufacturer can use his capital to acquire only as much gold, silver, or platinum as may be needed to
make the products that will fill its orders.
346 PP-CC&MM
SPECULATION
An entity having an opinion on the price movements of a given commodity can speculate using the commodity
market. While the basics of speculation apply to any market, speculating in commodities is not as simple as
speculating on stocks in the financial market. For a speculator who thinks the shares of a given company will
rise, it is easy to buy the shares and hold them for whatever duration he wants to. However, commodities are
bulky products and come with all the costs and procedures of handling these products. The commodities futures
markets provide speculators with an easy mechanism to speculate on the price of underlying commodities.
To trade commodity futures on the commodity exchange , a customer must open a futures trading account with
a commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables futures
traders to take a position in the underlying commodity without having to actually hold that commodity. With the
purchase of futures contract on a commodity, the holder essentially makes a legally binding promise or obligation
to buy the underlying security at some point in the future (the expiration date of the contract). We look here at
how the commodity futures markets can be used for speculation.
Speculation: Bullish Commodity, Buy Futures
Take the case of a speculator who has a view on the direction of the price movements of gold.If He knows that
towards the end of the year due to festivals and the upcoming wedding season, the prices of gold are likely to
rise, he would like to trade based on this view. Gold trades for ` 16000 per 10 gms in the spot market and he
expects its price to go up in the next two-three months. How can he trade based on this belief? In the absence
of a deferral product, he would have to buy gold and hold on to it. Suppose he buys a 1 kg of gold which costs
him ` 16,00,000. Suppose further that his hunch proves correct and three months later gold trades at ` 17000
per 10 grams. He makes a profit of ` 1,00,000 on an investment of ` 16,00,000 for a period of three months. This
works out to an annual return of about 25 percent.
Today a speculator can take exactly the same position on gold by using gold futures contracts. Let us see how
this works. Gold trades at ` 16,000 per 10 gms and three-month gold futures trades at ` 16,650 per 10 gms. The
unit of trading is 1 kg and the delivery unit for the gold futures contract on the commodity exchange is 1 kg. He
buys one kg of gold futures which have a value of ` 16,65,000. Buying an asset in the futures market only
require making margin payments. To take this position, suppose he pays a margin of ` 1,66,500. Three months
later gold trades at ` 17,000 per 10 gms. On the day of expiration, the futures price converges to the spot price
(else there would be a risk-free arbitrage opportunity). He closes his long futures position at ` 17,000 in the
process making a profit of ` 35,000 on an initial margin investment of ` 1,66,500. This works out to an annual
return of 85 percent. Because of the leverage they provide, commodity futures form an attractive tool for
speculators.
Speculation: Bearish Commodity, Sell Futures
Commodity futures can also be used by a speculator who believes that there is likely to be excess supply of a
particular commodity in the near future and hence the prices are likely to see a fall. How can he trade based on
this opinion? In the absence of a deferral product, there wasn't much he could do to profit from his opinion.
Today all he needs to do is sell commodity futures.
Let us understand how this works:
Simple arbitrage ensures that the price of a futures contract on a commodity moves correspondingly with the
price of the underlying commodity. If the commodity price rises, so will the futures price. If the commodity
price falls, so will the futures price. Now take the case of the trader who expects to see a fall in the price of
pepper. Suppose price of pepper is `14000 per quintal and he sells two pepper futures contract which is for
delivery of 2 MT of pepper (1MT each). The value of the contract is ` 2,80,000. He pays a small margin on the
same. Three months later, if his hunch was correct the price of pepper falls. So does the price of pepper
Lesson 11
Commodities Market Operations 347
futures. He close out his short futures position at ` 13000 per quintal i.e. ` 2,60,000 making a profit of `
20,000.
ARBITRAGE
A central idea in modern economics is the law of one price. This states that in a competitive market, if two assets
are equivalent from the point of view of risk and return, they should sell at the same price. If the price of the same
asset is different in two markets, there will be operators who will buy in the market where the asset sells cheap
and sell in the market where it is costly. This activity termed as arbitrage, involves the simultaneous purchase
and sale of the same or essentially similar security in two different markets for advantageously different prices.
The buying cheap and selling expensive continues till prices in the two markets reach an equilibrium.
Overpriced Commodity Futures: Buy Spot, Sell Futures
An arbitrager notices that gold futures seem overpriced. How can he cash in on this opportunity to earn risk less
profits? Say for instance, gold trades for ` 1600 per gram in the spot market. Three month gold futures on the
commodity exchange trade at `1685 per gram and seem overpriced. He could make risk less profit by entering
into the following set of transactions.
On day one, borrow ` 1,60,05,100 at 6% per annum to cover the cost of buying and holding gold. Buy 10 kgs of
gold on the cash/ spot market at ` 1,60,00,000. Pay `5100 (approx) as warehouse costs.
Simultaneously, sell 10 gold futures contract at ` 1,68,50,000.
Take delivery of the gold purchased and hold it for three months.
On the futures expiration date, the spot and the futures price converge. Now unwind the position.
Say gold closes at ` 1635 per gram in the spot market. Sell the gold for ` 1,63,50,000.
Futures position expires with profit of ` 5,00,000.
From the ` 1,68,50,000 held in hand, return the borrowed amount plus interest of ` 1,62,46,986.
The result is a risk less profit of ` 6,04,014.
If the cost of borrowing funds to buy the commodity is less than the arbitrage profit possible, it makes sense to
arbitrage. This is termed as cash-and-carry arbitrage. Exploiting an arbitrage opportunity involves trading on the
spot and futures market. In the real world, one has to build in the transactions costs into the arbitrage strategy.
Underpriced Commodity Futures: Buy Futures, Sell Spot
An arbitrageur notices that gold futures seem underpriced. How can he cash in on this opportunity to earn risk
less profits? Say for instance, gold trades for `1600 per gram in the spot market. Three month gold futures on
the commodity exchange trade at ` 1620 per gram and seem underpriced. If he happens to hold gold, he could
make risk less profit by entering into the following set of transactions.
On day one, sell 10 kgs of gold in the spot market at ` 1,60,00,000.
Invest the ` 1,60,00,000 plus the `5100 saved by way of warehouse costs for three months 6%.
Simultaneously, buy three-month gold futures on NCDEX at `1,62,00,000.
Suppose the price of gold is `1635 per gram. On the futures expiration date, the spot and the futures price of
gold converge. Now unwind the position.
The gold sales proceeds grow to ` 1,62,46,986.
The futures position expires with a profit of ` 1,50,000.
Buy back gold at `1,63,50,000 on the spot market.
348 PP-CC&MM
The result is a risk less profit of ` 46,986.
When the futures price of a commodity appears underpriced in relation to its spot price, an opportunity for
reverse cash and carry arbitrage arises. It is this arbitrage activity that ensures that the spot and futures prices
stay in line with the cost-of-carry.
LESSON ROUND UP
– Commodity exchanges are defined as centers where futures trade is organized in a wider sense; it is
taken to include any organized market place where trade is routed through one mechanism, allowing
effective competition among buyers and among sellers.
– The year 2003 is a landmark in the history of commodity futures market witnessing the establishment
and recognition of three new national exchanges National Commodity and Derivatives Exchange of
India Ltd. (NCDEX), Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity
Exchange of India Ltd. (NMCE)] with on-line trading and professional management.
– The Forward Markets Commission is a regulatory body for Commodity Markets in India.
– There are more than 20 recognised commodity futures exchanges in India under the purview of the
Forward Markets Commission (FMC).
– Broadly, the participants in commodity market can be classified as Hedgers, Arbitraguers and
Speculators.
– An electronic trading system allows the trading members to enter orders with various conditions attached
to them as per their requirements.
– Electronic spot exchanges is an emerging phenomenon in the country .These spot exchanges provide
real time, online, transparent and vibrant spot platform for commodities.
– The Commodity Exchange membership is open to any person, association of persons, partnerships,
co-operative societies, companies etc. that fulfills the eligibility criteria set by the Exchange.
– The settlement is done by closing out open positions, physical delivery or cash settlement. All these
settlement functions are taken care of by an entity called clearing house or clearing corporation.
– Settlement of commodity futures contracts is a little different from settlement of financial futures which
are mostly cash settled.
– Futures contracts have two types of settlements, the Mark-to-Market (MTM) settlement which happens
on a continuous basis at the end of each day, and the final settlement which happens on the last
trading day of the futures contract.
– Physical settlement of commodities involves the following three entities - an accredited warehouse,
registrar & transfer agent and an assayer.
– There are various instruments available for trading on Commodity exchange like forward, future, options
etc.
SELF TEST QUESTION
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a Commodity Exchange? Briefly discuss the role of a Commodity Exchange.
2. Discuss about the various participants involved in Commodity Market.
Lesson 11
Commodities Market Operations 349
3. What is an Electronic Spot Exchange? Explain the important functions performed by them.
4. Briefly explain about the various entities involved in physical settlement of commodities.
5. What is long hedge? Explain with the help of an example.
350 PP-CC&MM
Lesson 12
Money Market
LESSON OUTLINE
Lesson 12
Money Market 351
LEARNING OBJECTIVES
– Introduction
The Money Market is a market for short term
funds with maturity ranging from overnight to
one year and includes instruments that are
deemed to be close substitutes of money. The
Money Market is a key component of the
financial system as it is the fulcrum of the
monetary operations conducted by the RBI in
its pursuit of monetary policy objectives. As the
Central Bank, RBI regulates the Money Market
in India and injects liquidity in the banking
system. Important institutions operating in the
money market are central banks, commercial
banks, acceptance house, non-banking
financial institutions, bill brokers etc.
– Features of Money Market
– Money Market vs. Capital Market
– Growth of Money Market
– Structure and Institutional Development
– Money Market Instruments
– Government Securities
– Gift edged (Govt.) Securities
– Call Money and Notice Money
– Term Money
– Bill Discounting
– Bill Rediscounting Scheme(BRD)
The objective of this lesson is to provide the
students with basic understanding of Money
Market, its distinct features, various instruments
available in the Money Market, .difference
between Money Market and Capital Market,
instruments used in financing import and export
etc.
– Repurchase Agreements
– Banker’s Acceptance
– Treasury Bills
– Certificate of Deposit
– Inter-Corporate Deposit
– Commercial Bills
– Commercial Paper
– Money Market Mutual Funds(MMMFs)
– Factoring
– Letter of Credit
– Bills of Exchange
– LESSON ROUND UP
– SELF TEST QUESTIONS
351
352 PP-CC&MM
INTRODUCTION
Money Market is a very important segment of a financial system. It is the market for dealing in monetary assets
of short-term nature. Short-term funds up to one year and financial assets that are close substitutes for money
are dealt in the Money Market. Money Market instruments have the characteristics of liquidity (quick conversion
into money), minimum transaction cost and no loss in value. Excess funds are deployed in the Money Market,
which in turn is availed of to meet temporary shortages of cash and other obligations. Money Market provides
access to providers and users of short-term funds to fulfill their investments and borrowings requirements
respectively at an efficient market clearing price. It performs the crucial role of providing an equilibrating mechanism
to even out short-term liquidity, surpluses and deficits and in the process, facilitates the conduct of monetary
policy. The Money Market is one of the primary mechanism through which the Central Bank (RBI) influences
liquidity and the general level of interest rates in an economy. The Bank’s interventions to influence liquidity
serve as a signaling-device for other segments of the financial system.
The Money Market functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
Funds are available in this market for periods ranging from a single day upto a year. Mostly Government, banks
and financial institutions dominate this market. It is a formal financial market that deals with short-term fund
management.
Though there are a few types of players in Money Market, the role and the level of participation by each type of
player differs largely.
Government is an active player in the Money Market and in most of the economies; it constitutes the biggest
borrower in this market. Both, Government securities (G-secs) and Treasurybill (T-bill) is a security issued by
RBI on behalf of the Government of India to meet the latter’s borrowing for financing fiscal deficit. Apart from
functioning as a banker to the government, the central bank (RBI) also regulates the Money Market and issues
guidelines to govern the Money Market operations.
Another dominant player in the Money Market is the banking industry. Banks mobilize deposits of savers in
lending to investors of the economy. This process is known as credit creation. However, banks are not allowed
to lent out the entire amount for extending credit for investment. In order to promote certain prudential norms for
healthy banking practices, most of the developed economies require all commercial banks to maintain minimum
liquid and cash reserves in form of Statutory Liquid Ratio (SLR) and Cash Reserve Ratio (CRR) framed under
the policies of central banks. The banks are required to ensure that these reserve requirements are met before
directing deposits on their credit plans. If banks fall short of these statutory reserve requirements, the deficit
amount can be raised using the Money Market.
Other institutional players like financial institutions, corporates, mutual funds (MFs), Foreign Institutional Investors
(FIIs) etc. also transact in Money Market to fulfill their respective short term finance deficits and short falls.
However, the degree of participation of these players depends largely on the regulations formulated by the
regulating authorities in an economy. For instance, the level of participation of the FIIs in the Indian Money
Market is restricted to investment in Government securities only.
FEATURES OF MONEY MARKET
The Money Market is a wholesale market where the volumes of transactions is very large and is settled on a
daily basis. Trading in the Money Market is conducted over the telephone, followed by written confirmation
through e-mails, texts from the borrowers and lenders.
There are a large number of participants in the Money Market: commercial banks, mutual funds, investment
institutions, financial institutions and finally the Reserve Bank of India. The bank's operations ensure that the
liquidity and short-term interest rates are maintained at levels consistent with the objective of maintaining price
Lesson 12
Money Market 353
and exchange rate stability. The Central Bank occupies a strategic position in the Money Market. The Money
Market can obtain funds from the central bank either by borrowing or through sale of securities. The bank
influences liquidity and interest rates by open market operations, REPO transactions changes in Bank Rate,
Cash Reserve Requirements and by regulating access to its accommodation. A well-developed Money Market
contributes to an effective implementation of the monetary policy. It provides:
1. A balancing mechanism for short-term surpluses and deficiencies.
2. A focal point of central bank intervention for influencing liquidity in the economy, and
3. A reasonable access to the users of short-term funds to meet their requirements at realistic/reasonable price
or cost.
Things You May Know
CRR : Cash Reserve Ratio is the cash parked by the banks in their specified account maintained with RBI.
SLR : Statutory Liquid Ratio is in the form of cash (book value), gold (current market value) and balances in
unencumbered approved securities.
MONEY MARKET Vs. CAPITAL MARKET
The Money Market possesses different operational features as compared to Capital Market. Money Market is
distinguished from Capital Market on the basis of the maturity period, credit instruments and the institutions:
(i) Maturity Period: The Money Market deals in the lending and borrowing of short-term finance varying for one
year or less, while the Capital Market deals in the lending and borrowing of long-term finance for more than one
year.
(ii) Credit Instruments: The main credit instruments of the Money Market are Call Money, Treasury Bills,
Commercial Bills, Commercial Papers, and Bills of Exchange. On the other hand, the main instruments used in
the Capital Market are Stocks, Shares, Debentures, Bonds, Corporate Deposits etc.
(iii) Institutions: Important institutions operating in the Money Market are central banks, commercial banks,
acceptance houses, non banking financial institutions, bill brokers, etc. Important institutions of the Capital
Market are stock exchanges, commercial banks and non banking institutions, such as insurance companies,
mortgage banks, etc.
(iv) Purpose of Loan: The Money Market meets the short-term credit needs of business; it provides working
capital to the industrialists. The Capital Market, on the other hand, caters the long-term credit needs of the
industrialists and provides fixed capital to buy land, machinery, etc.
(v) Risk and Liquidity: The degree of risk is small and that of liquidity is higher in the Money Market as compared
to the higher risk and lower liquidity in the Capital Market.
(vi) Role of Central Bank: The central bank closely and directly has impact on the Money Market and its participants
by framing its regulations and deciding various rates of interests that has impact on the parameters of an economy,
while in case of Capital Market, Central Bank has an indirect link through other regulators like SEBI.
(vii) Market Regulation: In the Money Market, commercial banks are closely regulated. In the Capital Market,
the institutions are not much regulated.
GROWTH OF MONEY MARKET
Post reforms period in India has witnessed tremendous growth of the Indian Money Markets. Banks and other
financial institutions have been able to meet the high expectations of short term funding of important sectors like
the industry, services and agriculture. Functioning under the regulation and control of the Reserve Bank of India
(RBI), the Indian Money Market have also exhibited the required maturity and resilience over the years.
354 PP-CC&MM
The organization and structure of the Money Market has undergone a sea change in the last decade in India.
This was accompanied by a growth in quantitative terms also.
Up to 1987, the Money Market consisted of 6 facets :
1. Call Money Market;
2. Inter Bank Term Deposit/Loan Market;
3. Participation Certificate Market;
4. Commercial Bills Market;
5. Treasury Bills Market; and
6. Inter-corporate Market.
The market had 3 main deficiencies:
1. It had a very narrow base with RBI, Banks, LIC and UTI as the only participants lending funds while the
borrowers were large in number;
2. There were only few Money Market instruments.
3. The interest rates were not market determined but were controlled either by RBI or by a voluntary
agreement between the participants through the Indian Banks Association (IBA).
To set right these deficiencies, the recommendations of Chakravarthy Committee (1985) and the Vaghul Committee
(1987) laid foundation for systematic development of the Indian Money Market. The implementation of the
suggestions of the respective committees has widened and deepened the market considerably by increasing
the number of participants and instruments and introducing market determined rates as against the then existing
administered or volunteered interest rates.
Further, an active secondary market for dealings of Money Market instrument was created which positively
impacted the liquidity of these instruments. For this purpose, the Discount and Finance House of India Limited
(DFHI) was formed as an autonomous financial intermediary in April, 1988 to embellish the short-term liquidity
imbalances and to develop an active secondary market for the trading of instruments of the Money Market. The
DFHI plays the role of a market maker in Money Market instruments. With the relaxation of the regulatory
framework and the arrival of new instruments and participants, DFHI occupies a key role in ushering a more
active and de-regulated Money Market.
STRUCTURE AND INSTITUTIONAL DEVELOPMENT
The following diagram depicts the important segments and inter-relation in the Money Market:
Bankers’
Acceptances
Market
Commercial
Paper
Market
Treasury
Bill
Market
Call
Money
Market
|
|
|
|
|
|
|
|
|
|
|
|
MO N EYMAR KET
The Indian Money Market consists of two types of segments: an organized segment and an unorganized segment.
In the unorganized segment interest rates are much higher than that in the organized segment.
Lesson 12
Money Market 355
The organized segment consists of the Reserve Bank of India, State Bank of India with its associate Banks,
Public Sector Banks, Private Sector Commercial Banks including Foreign Banks, Regional Rural Banks, NonScheduled Commercial Banks, apart from Non-banking Financial Intermediaries such as LIC, GIC etc.
The unorganized segment essentially consists of indigenous bankers, money lenders and other non-bank financial
intermediaries such as Chit Funds. The share of the unorganized sector in providing trade finance has greatly
diminished after the Nationalization of Bank and expansion thereof into the length and breadth of the country.
Money Market
Organised Segment
RBI, SBI, Associate banks, Public Sector Banks,
Private Sector Commercial Banks,
Foreign banks, Regional Rural Banks,
Non Schedule Commercial Banks,
LIC, GIC, UTI etc.
Unorganised Segment
Indigenous Bankers, Money Lenders,
Non-bank financial intermediaries
such as chit funds.
MONEY MARKET INSTRUMENTS
Money Market instruments mainly include Government securities, securities issued by private sector and banking
institutions –
– Government Securities
– Gilt-edged (Government ) Securities
– Repo Market
– Money at Call and Short Notice
– Bills Rediscounting
– Money Market Mutual Funds
– Call Money Market and Short-term Deposit Market
– Treasury Bills
– Certificates of Deposits
– Inter-Corporate Deposits
– Commercial Bills
– Commercial Paper
GOVERNMENT SECURITIES
The Reserve Bank of India issues securities on behalf of the Government. The term Government Securities
includes Central Government Securities, State Government Securities and Treasury Bills. The different types of
Government Securities are –
356 PP-CC&MM
Dated
Zero
Partly Paid
Floating Rate
Capital Indexed
Securities
Coupon Bonds
Stock
Bonds
Bonds
Issued at
Issued at
Issued at face
Issued at
Issued at
face value
discount to the
face value
value, but paid
in installments
face value
face value
over a period
Interest or
Do not carry
Interest or coupon
Interest rate is
Interest rate is fixed
coupon rate is
fixed at the
any interest rate
rate is fixed at the
time of issuance,
fixed as a
percentage over a
as a percentage
over the
time of issuance,
and remains
and remains
constant till
predefined
benchmark rate
wholesale
price index at
constant till
redemption of
redemption of
the security
which may be
Treasury bill, bank
the time of
issuance.
the security
rate etc at the
time of issuance
The tenor
of security
The tenor
of security
The tenor
of security
The tenor
of security
The tenor
of security
is fixed
is fixed
is fixed
is fixed
is fixed
The security
The security
The security
The security
The principal
is redeemed at
par (face value)
is redeemed at
par (face value)
is redeemed at
par (face value)
is redeemed at
par (face value)
redemption is
linked to the
on its
maturity date
on its
maturity date
on its
maturity date
on its
maturity date
Wholesale
Price Index.
GILT-EDGED (GOVERNMENT) SECURITIES
Gilt-edged (Government) Securities have great demand by the banks to maintain the Net Demand and Time
Liquidities (NDTL) position of the bank through its buying and selling. These securities are issued by Governments
such as Central and State Governments, Semi-Government Authorities, Municipalities etc. They are long dated
securities and held by the RBI. These issues are notified a few days before opening for subscription and offer is
kept open for two to three days. The rate of interest is lower but it is payable half yearly.
CALL MONEY AND NOTICE MONEY
Call Money is a Money Market instrument wherein funds are borrowed / lent for a tenor of one day overnight
(excluding Sundays/holidays). Notice Money is a Money Market instrument, where the tenor is more than 1 day
but less than 15 days. The borrower/lender must convey his intention to repay/recall the amount borrowed/lent
with at least 24 hours notice.
Features
– Interest is calculated on Actual / 365 day basis.
– Interest payable to be rounded off to the nearest rupee.
– Interest on the amount borrowed/lent =
Amount borrowed/lent *No. of days * Rate of Interest
365 * 100
Lesson 12
Money Market 357
Settlement
The borrower of funds will collect the cheque and hand over the deposit receipt to the lender on the value date
of the deal. On the due date, the lender will give back the deposit receipt to and collect the cheque from the
borrower.
TERM MONEY
Money lent for a fixed tenor of 15 days or more is called Term Money.
Features
– Interest to be calculated on Actual / 365 day basis.
– Interest payable to be rounded off to the nearest rupee.
– Periodicity for payment of interest can be Quarterly/Half Yearly/on redemption, as agreed to at the time
of the deal.
– Interest on the amount borrowed/lent =
Amount borrowed/lent *No. of days * Rate of Interest
365 * 100
– Premature cancellation after 14 days can be done by mutual consent on mutually agreed terms.
– No loan/overdraft can be granted against Term Money.
Settlement
The borrower of funds will collect the cheque and hand over the deposit receipt to the lender on the value date
of the deal. On the due date, the lender will give back the deposit receipt to and collect the cheque from the
borrower. In case the maturity of term money falls on a holiday, the repayment will be made on the next working
day. Additional interest will be paid for such period on the amount borrowed (principal only) at the contracted
rate.
BILL DISCOUNTING
Bill Discounting is a short tenure financing instrument for companies willing to discount their purchase / sales
bills to get funds for the short run and as for the investors, it is a good instrument to park their spare funds for a
very short duration.
Bills discounting is of two types:
1. Purchase bills discounting and
2. Sales bill discounting.
A purchase bill discounting means that the investor discounts the purchase bill of the company and pays the
company, who in turn pay their supplier. The investor gets his money back from the company at the end of the
discounting period.
A sales bills discounting means the investor discounts the sales bill of the company and pays directly to the
company. The investor gets his return from the company at the end of the discounting period.
The funds generally required for this type of transaction start from ` 300,000 to upto ` 2 million. The tenure,
generally, ranges from 60 days to upto 180 days.
358 PP-CC&MM
Procedure of Bill Discounting
The procedure is that a broker will contact the investor with proposals to discount bills of different companies at
different rates of discounting. The better companies command discounting rates of 13% to 15%, while the lesser
known, by size and by safety, have to pay discounting rates of 17% to as high as 28%.
When an investor and the company agree to a particular bill discounting transaction, the following is what the
company gives to the investor:
– The original copies of bills to be discounted;
– A hundi / promissory note;
– Post Dated Cheque (PDC).
The investor simply has to issue a cheque. The amount of cheque is arrived at after deducting the discount rate.
The post-dated cheque that the company gives is of the full amount of the transaction. This can be better
explained with an example as follows.
Company A wants to discount its purchase bill of ` 2,00,000 for a period of three months. Investor P agrees to do
so at a discount rate of 21%. The deal is mutually agreed. Now, the investor will issue a cheque of ` 1,89,500.
This figure is arrived at as follows:
= 200,000 x 21% x 3/12
Thus the investor gets his/her interest before the end of the period on discounting. The company on its part will
issue a post-dated cheque of `2,00,000 for three months period.
Here the investor benefits in two ways:
He gets the interest element at the first day of issuing the cheque. i.e. he does not include that part in his cheque
amount. Thus he can earn interest on this interest for a three-month period. Even a simple bank fixed deposit on
it will earn @5% p.a. By investing `1,89,500 for three months, the investor earns `10,500 on it. A return of
22.16%.
Discount Rates
The rates depend on the following factors:
(i) The Broker: The broker has a good influence on the rates offered by companies. His relations with the
company and the investor, do make a difference of a couple of percentage point in discounting rates.
(ii) Market Liquidity: Liquidity crunch in the market tends to hike up the rates even in the best of the
companies. Since this instrument is a short tenure one, short-term changes in the market liquidity greatly
affect the discount rates.
(iii) Volume/Value of Discounting: When the volume/value of discounting done by the investor is high, he
is looking at security more than returns. The company on its part is looking at savings by way of reduced
legal paper work and a higher amount of dedicated funds for a said period and hence on the whole
reduced costs to the company.
(iv) Frequency: An investor who is regular bills discounter for the company may get upto 1% to 1.5% points
higher interest rates than a new investor. As for the investor he is trying it out with a new company and
will agree to a lesser rate to ensure safety.
(v) Company’s finance resources: This is one of the biggest factors that decide the discount rates. A
Public limited company generally tends to have a cheaper source of finance as against any other form
of company. Working capital financing of companies to a large extent manipulates the rates the companies
are willing to discount their bills at.
Lesson 12
Money Market 359
BILL REDISCOUNTING SCHEME (BRD)
Bill Rediscounting Scheme is the rediscounting of trade bills, which have already been purchased by /discounted
with the bank by the customers. These trade bills arise out of supply of goods/services.
Features
– The banks normally rediscount the bills that have already been discounted with them or raise usance
promissory notes in convenient lots and maturities and rediscount them.
– Rediscount of bills should be for a minimum period of 15 days and for a maximum period of 90 days.
– RBI has clarified to FIMMDA that in case a holiday is declared under the Negotiable Instruments Act,
1881, subsequent to the rediscounting of the bill, and the payment is to be made on the preceding
working day (as per the Negotiable Instruments Act), such payment on the preceding working day
would not be regarded as a violation of RBI’s guidelines.
– Discount is calculated on Actual/365 day basis.
– The amount payable to the borrower is the principal amount less the discount/interest.
– While discounting a bill, the amount of discount is to be deducted at the time the bill is issued.
– The discount is rounded off to the nearest rupee.
– On maturity the borrower would repay the principal amount.
Example:
Transaction Amount : ` 10,00,00,000/- (Rupees Ten Crore)
(Principal amount)
No. of Days :
45 days
Rate of Discount :
10.25% p.a.
Discount :
Transaction Amount * No . of days * Rate of interest/discount
365 * 100
=
=
Amount payable:
10,00,00,000 *45 * 10.25
365 * 100
` 12,63,699 (rounded off)
Transaction Amount – Discount/Interest
i.e. 10,00,00,000 - 12,63,699
i.e. ` 9,87,36,301/-
Amount to be repaid on maturity : ` 10,00,00,000/-
REPURCHASE AGREEMENTS
Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which two
parties agree to sell and repurchase the same security. They are usually used for overnight borrowing. Repo/
Reverse Repo transactions can be done only between the parties approved by RBI and in RBI approved securities
viz. Government of India (GoI) and State Govt Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc.
Under repurchase agreement the seller sells specified securities with an agreement to repurchase the same at
360 PP-CC&MM
a mutually decided future date and price. Similarly, the buyer purchases the securities with an agreement to
resell the same to the seller on an agreed date at a predetermined price. Such a transaction is called a Repo
when viewed from the perspective of the seller of the securities and Reverse Repo when viewed from the
perspective of the buyer of the securities. Thus, whether a given agreement is termed as a Repo or Reverse
Repo depends on which party initiated the transaction. The lender or buyer in a Repo is entitled to receive
compensation for use of funds provided to the counterparty. Effectively the seller of the security borrows money
for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security
who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate. The Repo rate is
negotiated by the counterparties independently of the coupon rate or rates of the underlying securities and is
influenced by overall Money Market conditions.
BANKER’S ACCEPTANCE
It is a short term credit investment created by a non financial firm and guaranteed by a bank to make payment.
It is simply a bill of exchange drawn by a person and accepted by a bank. It is a buyer’s promise to pay to the
seller a certain specified amount at certain date. The same is guaranteed by the banker of the buyer in exchange
for a claim on the goods as collateral. The person drawing the bill must have a good credit rating otherwise the
Banker’s Acceptance will not be tradable. The most common term for these instruments is 90 days. However,
they can very from 30 days to180 days. For corporations, it acts as a negotiable time draft for financing imports,
exports and other transactions in goods and is highly useful when the credit worthiness of the foreign trade party
is unknown. The seller need not hold it until maturity and can sell off the same in secondary market at discount
from the face value to liquidate its receivables.
TREASURY BILLS
Treasury Bills are Money Market instruments issued by RBI to finance the short term requirements of the
Government of India. These are discounted securities and thus are issued at a discount to face value. The
return to the investor is the difference between the maturity value and issue price.
In the short term category of investment instruments, the treasury bill carry the lowest risk. RBI issues these at
a prefixed date and of a fixed amount.
Treasury Bills are very useful instruments to deploy short term surpluses depending upon the availability and
requirement. Even funds which are kept in current accounts can be deployed in treasury bills to maximise
returns. Banks do not pay any interest on fixed deposits of less than 15 days, or balances maintained in current
accounts, whereas treasury bills can be purchased for any number of days depending on the requirements. This
helps in deployment of idle funds for very short periods as well. Further, since every week there is a 91 days
treasury bills maturing and every fortnight a 364 days treasury bills maturing, one can purchase treasury bills of
different maturities as per requirements so as to match with the respective outflow of funds. At times when the
liquidity in the economy is tight, the returns on treasury bills are much higher as compared to bank deposits even
for longer term. Besides, better yields and availability for very short tenors, another important advantage of
treasury bills over bank deposits is that the surplus cash can be invested depending upon the staggered
requirements.
Example
Suppose party A has a surplus cash of ` 200 crore to be deployed in a project. However, it does not require the
funds at one go but requires them at different points of time as detailed below:
Funds Available as on 1.1.2013
` 200 crore
Deployment in a project
`200 crore
Lesson 12
Money Market 361
As per the requirements
06.1.2013
` 50 crore
13.1.2013
` 20 crore
02.2.2013
` 30 crore
08.2.2013
` 100 crore
Out of the above funds and the requirement schedule, the party has following two options for effective cash
management of funds:
Option I
Invest the cash not required within 15 days in bank deposits. The party can invest a total of ` 130 crore only,
since the balance ` 70 crores is required within the first 15 days.
Assuming a rate of return of 6% paid on bank deposits for a period of 31 to 45 days, the interest earned by the
company works out to ` 76 lacs approximately.
Option II
Invest in Treasury Bills of various maturities depending on the funds requirements. The party can invest the
entire ` 200 crore in treasury bills as treasury bills of even less than 15 days maturity are also available. The
return to the party by this deal works out to around ` 125 lacs, assuming returns on Treasury Bills in the range
of 8% to 9% for the above periods.
There are four types of treasury bills :
(a) 14-day T bill
The Maturity is in 14 days. Its auction is on every Friday of every week. The notified amount for this auction is
` 100 crores.
(b) 91-day T bill
The Maturity is in 91 days. Its auction is on every Friday of every week. The notified amount for this auction is
` 100 crores.
(c) 182-day T bill
The Maturity is in 182 days. Its auction is on every alternate Wednesday (which is not a reporting week). The
notified amount for this auction is ` 100 crores.
(d) 364-day T bill
The Maturity is in 364 days. Its auction is on every alternate Wednesday (which is a reporting week). The
notified amount for this auction is ` 500 crores.
A considerable part of the government's borrowings is financed through T-bills of various maturities. Based on
the bids received at the auctions, RBI decides the cut off yield and accepts all bids below this yield. The usual
investors in these instruments are banks who invest not only to invest their short-term surpluses but also to get
benefitted for maintaining the Statutory Liquid Ratio (SLR) requirements in T-bills is reckoned for the purpose of
statutory reserves. FIIs so far have not been allowed to invest in this instrument.
These T-bills which are issued at a discount can be traded in the market. Most of the time, unless the investor
requests specifically, these are issued not as securities but as entries in the Subsidiary General Ledger (SGL)
which is maintained by RBI. The transactions cost on T-bill are non-existent and trading is considerably high in
each bill, immediately after its issue and immediately before its redemption.
362 PP-CC&MM
The yield on T-bills is dependent on the rates prevalent on other investment avenues open for investors. For
instance, low yield on T-bills as a result of high liquidity in banking system due to by low call rates, would divert
the funds from T-bills market to other markets. This would particularly be so, if banks already hold the minimum
stipulated amount of (SLR) in government instrument.
Benefits of Investing in Treasury Bills
(a) No tax deducted at source
(b) Zero default risk being sovereign paper
(c) Highly liquid Money Market instrument
(d) Better returns especially in the short term
(e) Transparency
(f) Simplified settlement
(g) High degree of tradability and active secondary market facilitates meeting unplanned fund requirements.
Features of Treasury Bills
(a) Form
The treasury bills are issued in the form of promissory note in physical form or by credit to Subsidiary General
Ledger (SGL) account or Gilt account in dematerialized form.
(b) Minimum Amount of Bids
Bids for treasury bills are to be made for a minimum amount of ` 25000/- only and in multiples thereof.
(c) Eligibility
All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate
bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident
Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to bid and purchase
Treasury bills.
(d) Repayment
The treasury bills are repaid at par on the expiry of their tenure at the office of the Reserve Bank of India.
(e) Availability
All the treasury Bills are highly liquid instruments available both in the primary and secondary market.
(f) Day Count
For treasury bills the day count is taken as 365 days for a year.
(g) Yield Calculation
The yield of a Treasury Bill is calculated as per the following formula:
Y=
(100 – P) X 365 X 100
PXD
Wherein
Y = Discounted yield
P = Price
D = Days to maturity
Lesson 12
Money Market 363
Example
A co-operative bank wishes to buy 91 Days Treasury Bill on Oct. 12, 2012 which is maturing on Dec. 6, 2012.
The rate quoted by seller is ` 99.1489 per ` 100 face values. The YTM can be calculated as following:
The days to maturity of Treasury bill are 55 (October – 20 days, November – 30 days and December – 5 days)
Yield to Maturity (YTM) = (100-99.1489) x 365 x 100/(99.1489*55) = 5.70%
Similarly if the YTM is quoted by the seller, price can be calculated by inputting the price in above formula.
Primary Market
In the primary market, treasury bills are issued by auction technique.
Salient Features of the Auction Technique:
(a) The auction of treasury bills is done only at Reserve Bank of India, Mumbai.
(b) Bids are to be submitted on Negotiated Dealing System (NDS) by 2:30 PM on Wednesday. If Wednesday
happens to be a holiday then bids are to be submitted on previous day (Tuesday).
(c) Bids are submitted in terms of price per `100. For example, a bid for 91-day Treasury bill auction could
be for ` 97.50 for per unit of T-bill of face valuer of `100.
(d) Auction committee of Reserve Bank of India decides the cut-off price and results are announced on the
same day.
(e) Bids above the cut-off price receive full allotment; bids at cut-off price may receive full or partial allotment
and bids below the cut-off price are rejected.
Things You May Know
Negotiated Dealing System
An electronic trading platform, operated by the RBI, used to facilitate the exchange of Government Securities
and other Money Market instruments. The Negotiated Dealing System is also responsible for hosting new
issues of Government Securities.
Secondary Market
The participants can also trade T-bills held from primary market in the secondary market established for the
purpose. The major advantages of dealing in treasury bill secondary market are: Market related yields, ideal
matching for funds management particularly for short-term tenors of less than 15 days, Transparency in operations
as the transactions would be put through Reserve Bank of India’s SGL or Client’s Gilt account only, two way
quotes offered by primary dealers for purchase and sale of treasury bills and certainty in terms of availability,
entry and exit.
Types of Auction
There are two types of auction for treasury bills:
(i) Multiple Price Based or French Auction: Under this method, all bids equal to or above the
cut-off price are accepted. However, the bidder has to obtain the treasury bills at the price quoted by
him. This method is followed in the case of 364 days treasury bills and is valid only for competitive
bidders.
(ii) Uniform Price Based or Dutch Auction: Under this system, all the bids equal to or above the cut-off
price are accepted at the cut- off level. However, unlike the Multiple Price based method, the bidder
obtains the treasury bills at the cut-off price and not the price quoted by him. This method is applicable
364 PP-CC&MM
in the case of 91 days treasury bills only. The system of Dutch auction has been done away with by the
RBI w.e.f 08.12.2002 for 91 day T Bill.
What is Dutch auction?
When all the bids accepted are equal to or above the cut off price it is known as Dutch Auction.
What is French Auction?
When all the bids accepted at the cut off level it is known as French Auction.
CERTIFICATES OF DEPOSITS
Certificate of Deposits (CDs) is a negotiable Money Market instrument and issued in dematerialised form or as
Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time
period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of
India, as amended from time to time.
Eligibility
CDs can be issued by:
(i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs);
(ii) selected all-India Financial Institutions that have been permitted by RBI to raise short-term resources
within the umbrella limit fixed by RBI.
Aggregate Amount
The amount of CDs allowed to be issued by:
(i) Banks: varying according to the requirements keeping in limits the CRR and SLR requirements as
stipulated by RBI.
(ii) Financial Institutions: may issue CDs within the overall umbrella limit fixed by RBI. As per the prevailing
guidelines issued by RBI, an FI can issue CDs together with other instruments viz., term money, term
deposits, commercial papers and inter corporate deposits, not exceeding 100 per cent of its net owned
funds, as per the latest audited balance sheet.
Minimum Size of Issue and Denominations
Minimum amount of a CD should be `1 lakh i.e., the minimum deposit that could be accepted from a single
subscriber should not be less than `1 lakh and in the multiples of ` 1 lakh thereafter. CDs can be issued to
individuals, corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also
subscribe to CDs, but only on non-repatriable basis which should be clearly stated in the Certificate. Such CDs
cannot be endorsed to another NRI in the secondary market.
Maturity
The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. The FIs
can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.
Discount/Coupon Rate
CDs may be issued at a discount on face value. Banks/FIs are allowed to issue CDs on the basis of floating rate
basis provided the methodology of computing the floating rate is predefined objective in nature, transparent and
market based. The issuing bank/FI is free to determine the discount/coupon rate. The interest rate on floating
rate CDs would have to be reset periodically in accordance with a pre-determined formula that indicates the
spread over a transparent benchmark.
Lesson 12
Money Market 365
Reserve Requirements
Banks have to maintain the appropriate reserve requirements, i.e., Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR), on the issue price of the CDs.
Transferability
– Physical CDs are freely transferable by endorsement and delivery.
– Demat CDs can be transferred as per the procedure applicable to other demat securities.
– There is no lock-in period for the CDs.
– Banks/FIs cannot grant loans against CDs.
– Furthermore, they cannot buy-back their own CDs before maturity.
Trades In CDs
All OTC trades in CDs shall be reported within 15 minutes of the trade on the FIMMDA reporting platform.
Format Of CDs
Banks/FIs should issue CDs only in the dematerialised form. However, according to the Depositories Act, 1996,
investors have the option to seek certificate in physical form. Accordingly, if the investor insists on physical
certificate, the bank/FI may inform to Monetary Policy Department, Reserve Bank of India about such instances
separately. Further, issuance of CD will attract stamp duty. There will be no grace period for repayment of
CDs. If the maturity date happens to be holiday, the issuing bank should make payment on the immediate
preceding working day. Banks/FIs may, therefore, so fix the period of deposit that the maturity date does not
coincide with a holiday to avoid loss of discount / interest rate.
Security Aspect
Since physical CDs are freely transferable by endorsement and delivery, it will be necessary for banks to see
that the certificates are printed on good quality security paper and necessary precautions are taken to guard
against tempering with the document. They should be signed by two or more authorized signatories.
Payment of Certificate
Since CDs are transferable, the physical certificate may be presented for payment by the last holder. The
question of liability on account of any defect in the chain of endorsements may arise. It is, therefore, desirable
that banks take necessary precautions and make payment only by a crossed cheque. Those who deal in these
CDs may also be suitably cautioned. The holders of dematted CDs will approach their respective depository
participants (DPs) and have to give transfer/delivery instructions to transfer the demat security represented by
the specific ISIN to the ‘CD Redemption Account’ maintained by the issuer. The holder should also communicate
to the issuer by a letter/fax enclosing the copy of the delivery instruction it had given to its DP and intimate the
place at which the payment is requested to facilitate prompt payment. Upon receipt of the demat credit of CDs in
the “CD Redemption Account”, the issuer, on maturity date, would arrange to repay to holder/transferor by way
of Banker’s cheque/high value cheque, etc.
Issue of Duplicate Certificates
In case of the loss of physical CD certificates, duplicate certificates can be issued after compliance of the
following conditions:
(a) A notice is required to be given in at least one local newspaper;
(b) Lapse of a reasonable period (say 15 days) from the date of the notice in the newspaper; and
366 PP-CC&MM
(c) Execution of an indemnity bond by the investor to the satisfaction of the issuer of CD.
The duplicate certificate should only be issued in physical form. No fresh stamping is, required as a duplicate
certificate is issued against the original lost CD. The duplicate CD should clearly state that the CD is a Duplicate
one stating the original value date, due date, and the date of issue (as “Duplicate issued on______”).
Accounting
Banks/FIs may account the issue price under the Head “CDs issued” and show it under deposits. Accounting
entries towards discount will be made as in the case of “cash certificates”. Banks/FIs should maintain a register
of CDs issued with complete particulars.
INTER-CORPORATE DEPOSITS
Apart from CDs, corporates also have access to another market called the Inter Corporate Deposits (ICD)
market. An ICD is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for low
rated corporates, this market allows corporates with surplus funds to lend to other corporates facing shortage of
funds. Another aspect of this market is that the better-rated corporates can borrow from the banking system and
lend in this market to make speculative profits. As the cost of funds for a corporate in much higher than that of a
bank, thus, the rates in this market are higher than those in the other markets. ICDs are unsecured, and hence
the risk inherent is high. The ICD market is an unorganised market with very less information available publicly
about transaction details.
COMMERCIAL BILLS
Commercial bills are basically negotiable instruments accepted by buyers for goods or services obtained by
them on credit. Such bills being bills of exchange can be kept upto the due maturity date and encashed by the
seller or may be endorsed to a third party in payment of dues owing to the latter. The most common practice is
that the seller who gets the accepted bills of exchange discounts it with the Bank or financial institution or a bill
discounting house and collects the money (less the interest charged for the discounting).
The volume of bills both inland and foreign, which are discounted accounted, forms a substantial part of the total
scheduled commercial bank credit. Over the years this is coming down. The Reserve Bank has been attempting
to develop a market for commercial bills. The bill market scheme was introduced in 1942 and a new scheme
called Bill Rediscount Scheme with several new features was introduced in November, 1970. Under the latter
scheme the RBI rediscount bills at the bank rates or at rates specified by it at its discretion. Since the rediscounting
facility has been made restrictive, it is generally available on a discretionary basis.
The difficulties which stand in the way of bill market development are, the incidence of stamp duty, shortage of
stamp paper, reluctance of buyers to accept bills, predominance of cash credit system of lending and the
administrative work involved in handling documents of title to goods. To be freely negotiable and marketable, the
bills should be first class bills i.e. those accepted by companies having good reputation. Alternatively, the bills
accepted by companies should be co-accepted by banks as a kind of guarantee. In the absence of these
criteria, bill market has not developed in India as the volume of first class bills is very small.
COMMERCIAL PAPER
Commercial Paper (CP) is an unsecured Money Market instrument issued in the form of a promissory note. CP, as
a privately placed instrument, was introduced in India in 1990 with a view to enable highly rated corporate borrowers
to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently,
primary dealers (PDs), satellite dealers and all-India financial institutions were also permitted to issue CP to enable
them to meet their short-term funding requirements for their operations. Guidelines for issue of CP are presently
governed by various directives issued by the Reserve Bank of India, as amended from time to time.
Lesson 12
Money Market 367
The guidelines for issue of CP are given below:
Eligible issuers of CP
Corporates, PDs and all-India financial institutions (FIs) that have been permitted to raise short-term resources
under the umbrella limit fixed by the Reserve Bank of India (RBI) are eligible to issue CP.
A corporate would be eligible to issue CP provided:
(a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than ` 4 crore.
(b) the company has been sanctioned working capital limit by bank/s or FIs.
(c) the borrowal account of the company is classified as a Standard Asset by the financing bank/institution.
(i) Rating Requirements
All eligible participants shall obtain credit rating for issuance of CP from any one of the following credit rating
agencies (CRAs), viz. the Credit Rating Information Services of India Ltd. (CRISIL), the Investment Information
and Credit Rating Agency of India Ltd. (ICRA), the Credit Analysis and Research Ltd. (CARE), the FITCH
Ratings India Pvt. Ltd. and such other CRAs as may be specified by the RBI from time to time, for the purpose.
The minimum credit rating shall be ‘A2’ [as per rating symbol and definition prescribed by SEBI]. The issuers
shall ensure at the time of issuance of the CP that the rating so obtained is current and has not fallen due for
review.
(ii) Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date
of issue. The maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is
valid.
(iii) Denominations
CP can be issued in denominations of `5 lakh or multiples thereof. Amount invested by a single investor should
not be less than `5 lakh (face value).
(iv) Limits and the Amount of Issue of CP
The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the
quantum indicated by the CRA for the specified rating, whichever is lower. Banks and FIs will, however, have the
flexibility to fix working capital limits, duly taking into account the resource pattern of company’s financing,
including CPs.
The total amount of CP proposed to be issued should be raised within a period of two weeks from the date on
which the issuer opens the issue for subscription. CP may be issued on a single date or in parts on different
dates provided that in the latter case, each CP shall have the same maturity date. Every issue of CP, including
renewal, should be treated as a fresh issue.
(v) Issuing and Paying Agent (IPA)
Only a scheduled bank can act as an IPA for issuance of CP.
(vi) Investment in CP
CP may be issued to individuals, banking companies, other corporate bodies (registered or incorporated in
India) and unincorporated bodies, Non-Resident Indians and Foreign Institutional Investors (FIIs). However,
investment by FIIs would be within the limits set for them by SEBI.
368 PP-CC&MM
(vii) Trading in CP
All OTC trades in CP shall be reported within 15 minutes of the trade to the Fixed Income Money Market and
Derivatives Association of India (FIMMDA) reporting platform.
(viii) Mode of Issuance
CP can be issued either in the form of a promissory note or in a dematerialised form through any of the depositories
approved by and registered with SEBI. CP will be issued at a discount to face value as may be determined by
the issuer. No issuer shall have the issue of CP underwritten or co-accepted.
(ix) Preference for Dematerialisation
While option is available to both issuers and subscribers to issue/hold CP in dematerialised or physical form,
issuers and subscribers are encouraged to opt for dematerialised form of issue/holding. However, banks, FIs
and PDs are required to make fresh investments and hold CP only in dematerialised form.
(x) Payment of CP
The initial investor in CP shall pay the discounted value of the CP by means of a crossed account payee cheque
to the account of the issuer through IPA. On maturity of CP, when CP is held in physical form, the holder of CP
shall present the instrument for payment to the issuer through the IPA. However, when CP is held in demat form,
the holder of CP will have to get it redeemed through the depository and receive payment from the IPA.
PROCEDURE FOR ISSUANCE
Every issuer must appoint an IPA for issuance of CP. The issuer should disclose to the potential investors, its
financial position as per the standard market practice. After the exchange of deal confirmation between the
investor and the issuer, issuing company shall issue physical certificates to the investor or arrange for crediting
the CP to the investor’s account with a depository. Investors shall be given a copy of IPA certificate to the effect
that the issuer has a valid agreement with the IPA and documents are in order.
Role and Responsibilities
The role and responsibilities of issuer, IPA and CRA are set out below:
(a) Issuer
With the simplification in the procedures for issuance of CP, issuers would now have greater flexibility. However,
they have to ensure that the guidelines and procedures laid down for CP issuance are strictly adhered to.
(b) Issuing and Paying Agent (IPA)
(i) IPA would ensure that the issuer has the minimum credit rating as stipulated by RBI and the amount mobilised
through issuance of CP is within the quantum indicated by CRA for the specified rating or as approved by its
Board of Directors, whichever is lower.
(ii) IPA has to verify all the documents submitted by the issuer, viz., copy of board resolution, signatures of
authorised executants (when CP in physical form) and issue a certificate that documents are in order. It should
also certify that it has a valid agreement with the issuer.
(iii) Certified copies of original documents, verified by the IPA, should be held in the custody of IPA.
(iv) All scheduled banks, acting as IPAs should submit the data pertaining to CP issuances on the Online Returns
Filing System (ORFS) module within two days from the date of issuance of CP.
(c) CRA
(i) Code of Conduct prescribed by the SEBI for CRAs for undertaking rating of Capital Market instruments shall
be applicable to CRAs for rating CPs.
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Money Market 369
(ii) The CRAs would henceforth have the discretion to determine the validity period of the rating depending upon
its perception about the strength of the issuer. Accordingly, they shall, at the time of rating, clearly indicate the
date when the rating is due for review.
(iii) While the CRAs can decide the validity period of credit rating, they would have to closely monitor the rating
assigned to issuers vis-à-vis their track record at regular intervals and would be required to make their revision
in the ratings public through their publications and website.
The amount of CDs allowed to be issued by:
(i) Banks: varying according to the requirements keeping in limits the CRR and SLR requirements as
stipulated by RBI.
(ii) Financial Institutions: may issue CDs within the overall umbrella limit fixed by RBI. As per the prevailing
guidelines issued by RBI, an FI can issue CDs together with other instruments viz., term money, term
deposits, commercial papers and inter corporate deposits, not exceeding 100 per cent of its net owned
funds, as per the latest audited balance sheet.
MONEY MARKET MUTUAL FUNDS (MMFS)
One of the recent development in the sphere of Money Market is the establishment of Money Market Mutual
Funds, the guidelines of which have been prescribed by the Reserve Bank of India. Money Market Mutual
Funds (MMFs) can be set up by the banks and public financial institutions. There can also be Money Market
Deposit Account (MMDAs).
(a) Limit : The limit for raising resources under the MMMF scheme should not exceed 2% of the sponsoring
bank’s fortnightly average aggregate deposits. If the limit is less than `50 crores for any bank, it may join
with some other bank and jointly set up MMMF. In the case of public financial institutions, the limit
should not exceed 2% of the long-term domestic borrowings as indicated in the latest available audited
balance sheets.
(b) Eligibility : MMMFs are primarily intended for individuals investors including NRIs who may invest on a
non-repatirable basis. MMMFs would be free to determine the minimum size of the investment by a
single investor.
(c) Minimum rate of return : There is no guaranteed minimum rate of return.
(d) Lock-in-period : The minimum lock in period would be 46 days.
(e) Deployment of capital : The resources mobilized by MMMFs should be invested exclusively in various
Money Market instruments.
(f) Money Market Mutual Fund investment limits :
(i) Treasury bills and dated government securities having an unexpired maturity upto one year – Minimum
25%.
(ii) Call/notice money – Minimum 30%.
(iii) Commercial Paper – Maximum 15%. The exposure to CP issued by an individual company should
not be more than 3%.
(iv) Commercial bills accepted/co-accepted by Banks – Maximum 20%.
(v) Certificate of deposits – No limit.
FACTORING
Factoring is a financial transaction where an entity sells its receivables to a third party called a ‘factor’, at
370 PP-CC&MM
discounted prices. Factoring is a financial option for the management of receivables. In simple definition it is the
conversion of credit sales into cash. In factoring, a financial institution (factor) buys the accounts receivable of a
company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on formation of agreement.
Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when
the customer pays the debt. Collection of debt from the customer is done either by the factor or the client
depending upon the type of factoring. The account receivable in factoring can either be for a product or service.
Examples : factoring against goods purchased, factoring for construction services (usually for government
contracts where the government body is capable of paying back the debt in the stipulated period of factoring.
Contractors submit invoices to get cash instantly), factoring against medical insurance etc.
Parties in Factoring
The factoring transaction involves three parties:
(i) The Seller, who has produced the goods/services and raised the invoice.
(ii) The Buyer, the consumer of goods/services and the party to pay.
(iii) The Factor, the financial institution that advances the portion of funds to the seller.
FACTORING PROCESS
The steps involved in factoring are listed below:
(i) The seller interacts with the funding specialist/broker and explains the funding needs.
(ii) The broker prepares a preliminary client profile form and submits to the appropriate funder for consideration.
(iii) Once both parties agree that factoring is possible, the broker puts the seller in direct contact with the
funder to ask/answer any additional questions and to negotiate a customized factoring agreement,
which will meet the needs of all concerned.
(iv) At this point, the seller may be asked to remit a fee with formal application to cover the legal research
costs, which will be incurred during "due diligence". This is the process by which the buyer’s credit
worthiness is evaluated through background checks, using national database services.
(v) During the next several days, the funder completes the "due diligence" process on the seller, further
verifies invoices and acknowledges any liens, UCC filings, judgments or other recorded encumbrances
on the seller’s accounts receivables.
(vi) The seller is advised of the facility and is asked to advise the buyers of the Factor by letter and submit
an acknowledged copy of the same to the Factor for records.
(vii) A detailed sanction letter is given to the seller and their acceptance on the same taken, with the required
signatories. (Authorized signatories would be mentioned in the “Signing Authorities” section of the Proposal
presented by seller).
(viii) Sanction terms must contain the following.
(a) All Facilities covered under the sanction.
(b) The period for which the sanction is valid
(c) When the Facility comes into effect e.g. (if Facility is dated 1/07/2013, it can state that invoices
raised from or after 15/07/2013 only would be Factored).
(d) Who the authorized signatories are for signing invoices for factoring.
(e) The limits.
(f) The seller has to advise the buyer of the Factoring agreement.
(g) Copy of such advice acknowledged by the buyer should be submitted to them Factor. Buyer’s
consent is not required to decide on the Factor.
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Money Market 371
(viii) The discounting rates, charges fixed.
(ix) In case of discounts given by the seller to the buyer, which value would be financed by the factor (since
the factored amount should never exceed the amount actually payable by buyer).
(x) Usually within 7 to 10 days of the initial contact with the factor, agreements are signed, customers are
notified, UCC forms filed and the first advance is forwarded to the company. This advance can vary
between 70 - 80% of the face value of the invoices being factored. In the construction industry, the advances
may be in the range of 60 - 70%. The remaining amount is called the "reserve" which is held by the factor
until the invoices are paid. The factor then deducts his fee and returns the remaining funds to the seller.
(xi) The seller performs services or delivers products, thus creating an invoice.
(xii) The seller sends or faxes a copy of the invoice directly to the factor.
(xiii) The funder verifies the invoice and the advance is sent to the seller as per the agreement with the factor.
In certain cases, the funder wires the funds to the seller’s account for an additional fee.
(xiv) The buyer pays the factor. The factor then returns any remaining reserve, minus the fee, which has
been predetermined in the negotiated agreement.
Advantages for the Seller
– Seller gets funds immediately after the sale is effected and on presentation of accepted sales invoices and
Promissory notes.
– Major part of paper work and correspondence is taken care of by the factor.
– Follow-up, for recovery of funds, is done mainly by the factor.
– Interest rates are not as high as normal discounting.
– Increased cash flow to meet payroll.
– Immediate funding arrangements.
– No additional debt is incurred on balance sheet.
– Other assets are not encumbered.
– Approval is not based on seller’s credit rating.
Customer
Credit sale of
goods
Client
Invoice
Pays the balance
amount
Pays the amount (In recourse
type customer pays through
client)
Submit invoice
copy
Payment up to
80% initially
Factor
372 PP-CC&MM
TYPES OF FACTORING
Factoring
Full
Factoring
Recourse
Factoring
Maturity
Factoring
Advance
Factoring
Undisclosed
Factoring
Invoice
Discounting
Non-Recourse or Full factoring
Under this type of factoring the bank takes all the risk and bear all the loss in case of debts becoming bad debts.
Recourse Factoring
Under this type of factoring the bank purchases the receivables on the condition that any loss arising out or bad
debts will be borne by the company which has taken factoring.
Maturity Factoring
Under this type of factoring bank does not give any advance to the company rather bank collects it from customers
and pays to the company either on the date of collection from the customers or on a guaranteed payment date.
Advance Factoring
Under advance factoring arrangement the factor provides an advance against the uncollected and non-due
receivables to the firm.
Undisclosed Factoring
Under this type of factoring, the customer is not informed of the factoring arrangement. The firm may collect
dues from the customer on its own or instruct to make remit once at some other address.
Invoice Discounting
Under this type of factoring the bank provide an advance to the company against the account receivables and in
turn charges interest rate from the company for the payment which bank has given to the company.
LETTER OF CREDIT
A letter of credit is a written understanding given by the buyer’s bank (the issuing bank) on behalf of and at the
request of its customer (the applicant) routed through the agency of a bank in the seller’s country (advising
bank) to the seller beneficiary that it (issuing bank) guarantees to pay the seller for the goods within a specified
time provided that the conditions laid down in documentary credit are fully satisfied.
Reasons for using LC
In international trade, buyer and seller being located in different countries may not know each other well. The
two countries will have different legal systems, currencies, trade and exchange regulations. Due to this fact both
the Buyer and Seller, need some conditions to be fulfilled, to suit their requirements, before releasing the payments
and goods respectively. The buyer and seller want the following:(a) Seller would want:
(i) To be paid as soon as he ships the goods.
(ii) An assurance that he will be paid by the buyer or his bank as per contractual obligations.
(iii) Convenience of receiving payments in his own country.
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Money Market 373
(b) Buyer would want:
(i) To pay for the goods only after they are shipped by the seller.
(ii) An assurance that seller will ship the goods ordered for and deliver them in time.
BASIC FORMS OF LCS
Basic forms of LCs are enumerated below:(a) Revocable letter of credit.
(b) Irrevocable letter of credit.
(c) Confirmed letter of credit.
(d) Revolving letter of credit
(a) Revocable Letter of Credit.
A revocable letter of credit is one which may be amended or cancelled by the issuing bank at any moment
without prior notice to the beneficiary. Therefore such a type of letter of credit does not give complete sense of
security to the beneficiary. However when the revocable letter of credit is made available at a branch of a bank
concerned, the notice of amendment or cancellation is effective only upon receipt of such notice. If such a bank
has undertaken liability (i.e. Paid, negotiated or accepted) against documents, which appear on the face of it to
be in conformity with the terms and conditions of the credit before notice of amendment/cancellation, then the
issuing Bank is bound to reimburse such a bank. If the letter of credit is silent as to whether it is revocable or
irrevocable, the credit is deemed as IRREVOCABLE.
(b) Irrevocable Letter of Credit
When the issuing Bank gives a definite, absolute and irrevocable undertaking to honour its obligations provided
the beneficiary complies with all the terms and conditions such a credit is known as an irrevocable letter of
credit. That means that the letter of credit cannot be amended, cancelled or revoked without the consent of the
parties to the letter of credit. This gives the beneficiary definite protection.
(c) Confirmed Letter of Credit
A confirmed letter of credit is one when another Bank in the beneficiary’s country adds its confirmation at the
request of the issuing Bank. This undertaking of the confirming Bank to pay/negotiate/accept is in addition to the
undertaking of the issuing bank. This is an added protection to the beneficiary. This is not to be agreed as it
undermines the credibility of our Nationalized Banks.
(d) Revolving Letter of Credit
In such credits, the amount is restored, after it has been utilized, to the original amount. Such credits are used
when the buyer is to receive partial shipment of goods at specific intervals for a long duration. It can be cumulative
or noncumulative in nature. It avoids opening letter of credit for each and every consignment.
WORKING MECHANISM
The following is a step-by-step description of a typical Letter of Credit transaction:
1. An Importer (Buyer) and Exporter (Seller) agree on a purchase and sale of goods where payment is
made by Letter of Credit.
2. The Importer completes an application requesting its bank (Issuing Bank) to issue a Letter of Credit in
favour of the Exporter. It is important to note that the Importer must have a line of credit with the Issuing
Bank in order to request that a Letter of Credit be issued.
3. The Issuing Bank issues the Letter of Credit and sends it to the Advising Bank by telecommunication or
registered mail in accordance with the Importer’s instructions. A request may be included for the Advising
Bank to add its confirmation. The Advising Bank is typically located in the country where the Exporter
carries on business and may be the Exporter’s bank but it does not have be.
374 PP-CC&MM
4. The Advising Bank will verify the Letter of Credit for authenticity and send a copy to the Exporter.
Issuance of Letter of Credit
Buyer/Importer
Beneficiary/Exporter
1
Purchase & Sales
Agreement
2
Request for a
Letter of Credit
4
Advice of
Letter of Credit
Request to Advise and
possibly confirm the Letter
of Credit
Issuing Bank
3
Advising/Confirming
Bank
5. The Exporter examines the Letter of Credit to ensure:
(a) it corresponds to the terms and conditions in the purchase and sale agreement;
(b) documents stipulated in the Letter of Credit can be produced; and
(c) the terms and conditions of the Letter of Credit may be fulfilled.
6. If the Exporter is unable to comply with any term or condition of the Letter of Credit or if the Letter of Credit
differs from the purchase and sale agreement, the Exporter should immediately notify the Importer and request
an amendment to the Letter of Credit.
7. When all parties agree to the amendments, they are incorporated into the terms of the Letter of Credit and
advised to the Exporter through the Advising Bank.
8. The Exporter arranges for shipment of the goods, prepares and/or obtains the documents specified in the
Letter of Credit and makes demand under the Letter of Credit by presenting the documents within the stated
period and before the expiry date to the “available with” Bank. This may be the Advising/Confirming Bank. That
bank checks the documents against the Letter of Credit and forwards them to the Issuing Bank. The drawing is
negotiated, paid or accepted as the case may be.
9. The Issuing Bank examines the documents to ensure they comply with the Letter of Credit terms and conditions.
The Issuing Bank obtains payment from the Importer for payment already made to the “available with” or the
Confirming Bank.
Payment under a Letter of Credit
Applicant/Importer
Beneficiary/Exporter
1
Shipment of Goods
2
3
2
Document
Payment
Document
Issuing Bank
Payment
3
2
Document
3
Payment
Advising/Confirming
Bank
Lesson 12
Money Market 375
BILL OF EXCHANGE
The Negotiable Instruments Act, 1881, defines the Bill of Exchange as “an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to
the order of, a certain person or to the bearer of the instrument.”
There are five important parties to a Bill of Exchange:
(i) The Drawer : The drawer is the person who has issued the bill. The drawer is the creditor to whom the
money is owned.
(ii) The Drawee : The drawee is the person to whom the bill is addressed or against whom the bill is drawn.
In other words, the drawee is the debtor who owes money to the drawer, the creditors.
(iii) The Payee : The payee is the person to whom the bill is payable. The bill can be drawn payable to the
drawee or his Bank.
(iv) The Endorser : The endorser of a bill is the person who has placed his name and signature at the back
of the bill signifying that he has obtained title to the bill and payment is due to him on his own account or
on account of the original payee.
(v) The Endorsee : The endorsee is the person to whom the bill is endorsed. The endorsee can obtained
payment from the drawee.
There are the following important types of Bill of Exchange :
(i) Sight Bill of Exchange : A sight or demand Bill of Exchange is one which is required to be paid by the
draweee immediately on presentation of the Bill.
(ii) Usance Bill of Exchange : In case of the usance or time Bill of Exchange, there is maturity period
called the tenor, and the payment is to be made only on the maturity of the bill.
Generally speaking, the due date of payment of the usance bill is calculated from the date of presentation
or sighting of the bill by the drawee. Such a bill is called after sight usance bill. But sometimes the date
of maturity is calculated from the date of drawing of the bill. Such a bill is known as after date usance bill.
(iii) Clean Bill of Exchange : A Bill of Exchange not accompanied by the relative shipping documents is
known as a clean Bill of Exchange. In respect of the clean Bill of Exchange, the documents are sent to
the consignee directly, and he can take delivery of the goods on their arrival at the port of destination.
(iv) Documentary Bill of Exchange : A documentary Bill of Exchange is a Bill of Exchange accompanied
by the relative shipping documents such as the bill of lading, marine insurance policy, commercial
invoice, certificate of origin, etc. The documents accompanying the bill are delivered to the importer by
the bank only upon either acceptance or payment of the bill. The former is called documents against
acceptance and the latter is called documents against payment. It is the documentary Bill of Exchange
that is commonly used in foreign trade transactions.
Upon shipment of the goods, the exporter may draw a bill of exchange on the importer or, more frequently, on
bank acting for the importer. The exporter usually draws the bill payable to his own order, or to that of his bank.
He then endorses the bill and sells it to, or discounts it at, his bank. In this way the exporter receives his money
immediately upon the shipment of the goods. The bank sends the bill and the documents to its foreign branch or
correspondent bank which, upon arrival, promptly notifies the importer and presents the bill to him for payment
or acceptance. Until the importer has accented the bill or made arrangements for payments he cannot receive
the bill of lading, which is his title to the goods.
376 PP-CC&MM
FIMMDA
FIMMDA stands for The Fixed Income Money Market and Derivatives Association of India (FIMMDA). It is an
Association of Commercial Banks, Financial Institutions and Primary Dealers. FIMMDA is a voluntary market
body for the bond, Money And Derivatives Markets.
Objectives of FIMMDA
– To function as the principal interface with the regulators on various issues that impact the functioning of
these markets.
– To undertake developmental activities, such as, introduction of benchmark rates and new derivatives
instruments, etc.
– To provide training and development support to dealers and support personnel at member institutions.
– To adopt/develop international standard practices and a code of conduct in the above fields of activity.
– To devise standardized best market practices.
– To function as an arbitrator for disputes, if any, between member institutions.
– To develop standardized sets of documentation.
– To assume any other relevant role facilitating smooth and orderly functioning of the said markets.
FOREIGN EXCHANGE DEALER'S ASSOCIATION OF INDIA
Foreign Exchange Dealer's Association of India (FEDAI) was set up in 1958 as an Association of banks dealing
in foreign exchange in India (typically called Authorised Dealers - ADs) as a self regulatory body and is incorporated
under Section 25 of The Companies Act, 1956. It's major activities include framing of rules governing the conduct
of inter-bank foreign exchange business among banks vis-à-vis public and liaison with RBI for reforms and
development of forex market.
Presently some of the functions of FEDAI are as follows:
– Guidelines and Rules for Forex Business.
– Training of Bank Personnel in the areas of Foreign Exchange Business.
– Accreditation of Forex Brokers
– Advising/Assisting member banks in settling issues/matters in their dealings.
– Represent member banks on Government/Reserve Bank of India/Other Bodies.
– Announcement of daily and periodical rates to member banks.
Due to continuing integration of the global financial markets and increased pace of de-regulation, the role of selfregulatory organizations like FEDAI has also transformed. In such an environment, FEDAI plays a catalytic role
for smooth functioning of the markets through closer co-ordination with the RBI, other organizations like FIMMDA,
the Forex Association of India and various market participants. FEDAI also maximizes the benefits derived from
synergies of member banks through innovation in areas like new customized products, bench marking against
international standards on accounting, market practices, risk management systems, etc.
Lesson 12
Money Market 377
LESSON ROUND UP
– The Money Market is a Market for dealing in monetory assets of short term nature. The Money Market
functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
– Government is an active player in the Money Market and in most of the economies; it constitutes the
biggest borrower in this market.
– The Money Market possesses different operational features as compared to Capital Market. Money
Market is distinguished from Capital Market on the basis of the maturity period, credit instruments and
the institutions.
– The Indian Money Market consists of two types of segments: an organized segment and an unorganized
segment.
– The Reserve Bank of India issues securities on behalf of the Government. The term Government
Securities includes Central Government Securities, State Government Securities and Treasury Bills.
– Call Money is a Money Market instrument wherein funds are borrowed / lent for a tenor of one ay/
overnight (excluding Sundays/holidays).
– Money lent for a fixed tenor of 15 days or more is called Term Money.
– Bill discounting is a short tenure financing instrument for companies willing to discount their purchase
/ sales bills to get funds for the short run and as for the investors in them, it is a good instrument to park
their spare funds for a very short duration.
– Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which
two parties agree to sell and repurchase the same security.
– Treasury Bills are Money Market instruments issued by RBI to finance the short term requirements of
the Government of India.
– Certificate of Deposits (CDs) is a negotiable Money Market instrument and issued in dematerialised
form or as Usance Promissory Note, for funds deposited at a bank or other eligible financial institution
for a specified time period.
– An Inter Corporate Deposits (ICD) is an unsecured loan extended by one corporate to another. Existing
mainly as a refuge for low rated corporates, this market allows corporates with surplus funds to lend to
other corporates facing shortage of funds.
– Commercial bills are basically negotiable instruments accepted by buyers for goods or services obtained
by them on credit.
– Commercial Paper (CP) is an unsecured Money Market instrument issued in the form of a promissory
note.
– One of the recent development in the sphere of Money Market is the establishment of Money Market
Mutual Funds, the guidelines of which have been prescribed by the Reserve Bank of India. Money
Market Mutual Funds (MMFs) can be set up by the banks and public financial institutions.
– Factoring is a financial transaction where an entity sells its receivables to a third party called a ‘factor’,
at discounted prices. Factoring is a financial option for the management of receivables.
– A Letter of Credit is a written understanding given by the buyer’s bank (the issuing bank) on behalf of and
at the request of its customer (the applicant) routed through the agency of a bank in the seller’s country
(advising bank) to the seller beneficiary that it (issuing bank) guarantees to pay the seller for the goods
within a specified time provided that the conditions laid down in documentary credit are fully satisfied.
378 PP-CC&MM
– The Negotiable Instruments Act, 1881, defines the Bill of Exchange as “an instrument in writing containing
an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money
only to, or to the order of, a certain person or to the bearer of the instrument.”
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. Briefly discuss about Call money and Notice Money Market.
2. Explain Treasury Bills as an effective Cash Management product and state how yield of Treasury Bill
is calculated.
3. What is Banker’s Acceptance? Discuss.
4. Explain briefly about Money Market Mutual funds.
5. How credit transaction takes place in a Letter of Credit? Explain with step wise description.
6. Discuss the various objective of FIMMDA.
Lesson 13
Insider Trading
LESSON OUTLINE
Insider Trading 379
LEARNING OBJECTIVES
– Introduction
In simple terms ‘insider trading’ is buying or
selling a security, in breach of a fiduciary duty
or other relationship of trust, and confidence,
while in possession of material, non public
information about the security. Therefore,
preventing such transactions is an important
obligation for any capital market regulatory
system, because insider trading undermines
investor confidence in the fairness and integrity
of the securities markets.
– SEBI (Prohibition of Insider Trading)
Regulation, 1992
– Important Definitions
– Prohibition on Dealing Communication or
Counselling on Matters Relating to Insider
Trading
– Code of Internal Procedures and Conduct
for Listed Companies and other Entities
– Disclosure of interest or holding by certain
persons
A Company Secretary being a Compliance
Officer of the company plays an important role
to prevent Insider Trading by establishment of
policies and procedures and over all supervision
in this regard.
– Model Code of Conduct for Prevention of
Insider Trading for Listed Companies
– Model Code of Conduct for Prevention of
Insider Trading for Other Entities
This lesson will enable the students to have the
basic understanding of the Insider Trading
Regulations prevailing in India, the disclosures
required to be made by the company, employee,
directors, promoters, etc., the duty of
compliance officer, Model Code of Conduct,
Code of Corporate Disclosure Practices, the
Penal provisions for Insider Trading etc.
– Code of Corporate Disclosure Practices
for Prevention of Insider Trading
– Investigation by SEBI
– Penalty Provisions for violations of the
Regulations
– Appeal to Securities Appellate Tribunal
– Role of Company Secretary
Compliance Requirements
Lesson 13
in
– SEBI’s view on the Role of the
Compliance Officer in case of Insider
Trading
– LESSON ROUND UP
– SELF TEST QUESTIONS
379
380 PP-CC&MM
INTRODUCTION
The practice of Insider Trading came into existence ever since the very concept of trading of securities of a
company became prevalent among the investors worldwide and has now become a formidable challenge for
investors all over the world.
The history of Insider Trading in India relates back to the 1940’s with the formulation of government committees
such as the Thomas Committee of 1948, which evaluated inter alia, the regulations in the US on short swing
profits under Section 16 of the Securities Exchange Act, 1934. Thereafter in India provisions relating to Insider
Trading were incorporated in the Companies Act, 1956 under Sections 307 and 308, which required shareholding
disclosures by the directors and managers of a company.
Due to inadequate provisions of enforcement in the companies Act, 1956, the Sachar Committee in 1979, the
Patel Committee in 1986 and the Abid Hussain Committee in 1989 proposed recommendations for a separate
statute regulating Insider Trading. The Patel committee in 1986 in India defined Insider Trading as,
“Insider trading generally means trading in the shares of a company by the persons who are in the management
of the company or are close to them on the basis of undisclosed price sensitive information regarding the
working of the company, which they possess but which is not available to others.”
The concept of Insider Trading in India started fermenting in the 80’s and 90’s and came to be known and
observed extensively in the Indian Securities market. The rapidly advancing Indian Securities market needed a
more comprehensive legislation to regulate the practice of Insider Trading, thus resulting in the formulation of
the SEBI (Insider Trading) Regulations in the year 1992, which were amended in the year 2002 after the
discrepancies observed in the 1992 regulations in the cases like Hindustan Levers Ltd. vs. SEBI, Rakesh Agarwal
vs. SEBI, etc. to remove the lacunae existing in the Regulations of 1992. The amendment in 2002 came to be
known as the SEBI ([Prohibition of] Insider Trading) Regulations, 1992.
The regulations of 1992 seemed to be more punitive in nature. The 2002 amendment regulations on the other
hand are preventive in nature. The amendment requires all the listed companies, market intermediaries and
advisers to follow the new regulations and also take steps in advance to prevent the practice of insider trading.
SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 1992
The SEBI (Prohibition of Insider Trading) Regulation 1992, comprise of four chapters and three schedules
encompassing the various regulations related to insider trading. Chapter I deal mainly with the definitions used
in regulation. Chapter II provides for prohibitions on dealing, communicating or counselling by insider. It also
contains the defences available to a company in proceeding against it on allegation of Insider Trading. Chapter
III narrates the investigating powers of SEBI under the regulation and also enumerates the prohibitory orders or
directions that it can issue against the guilty in the interest of the capital market regulation. Chapter IV deals with
the code of internal procedure and conduct to be followed by listed companies and other entities, disclosure
requirements be followed by company. It also contains appeal provisions which an aggrieved person may like to
follow against the orders of SEBI.
IMPORTANT DEFINITIONS
Dealing in securities
It means an act of subscribing buying, selling or agreeing to subscribe to buy, sell or deal in any securities by any
person either as principal or agent.
Insider
“Insider” means any person who, is or was connected with the company or is deemed to have been connected
Lesson 13
Insider Trading 381
with the company, and who is reasonably expected to have access, to unpublished price sensitive information in
respect of securities of company, or who has received or has had access to such unpublished price sensitive
information.
Connected Person
“Connected Person” means any person who –
(i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956 of a company, or is
deemed to be a director of that company by virtue of sub-clause (10) of section 307 of that Act or
(ii) occupies the position as an officer or an employee of the company or holds a position involving a
professional or business relationship between himself whether temporary or permanent and the company
and who may reasonably be expected to have an access to unpublished price sensitive information in
relation to that company;
It may be noted that “connected person” means any person who is a connected person six months prior to an
act of insider trading.
Person deemed to be connected person
“Person is deemed to be a connected person”, if such person –
(i) is a company under the same management or group, or any subsidiary company thereof within the
meaning of sub-section (1B) of section 370, or sub-section (11) of section 372, of the Companies Act,
1956 or sub-clause (g) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969 as the
case may be; or
(ii) is an intermediary as specified in section 12 of the Act, 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;
(iii) is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker, portfolio
manager, Investment Advisor, sub-broker, Investment Company or an employee thereof, or is member
of the Board of Trustees of a mutual fund or a member of the Board of Directors of the Asset Management
Company of a mutual fund or is an employee thereof who have a fiduciary relationship with the company;
(iv) is a Member of the Board of Directors or an employee of a public financial institution as defined in
section 4A of the Companies Act, 1956; or
(v) is an official or an employee of a Self-Regulatory Organisation recognised or authorised by the Board of
a regulatory body; or
(vi) is a relative of any of the aforementioned persons;
(vii) is a banker of the company.
(viii) relatives of the connected person; or
(ix) is a concern, firm, trust, Hindu undivided family, company or association of persons wherein any of the
connected persons mentioned in sub-clause (i) of clause (c), of this regulation or any of the persons
mentioned in sub-clause (vi), (vii) or (viii) of this clause have more than 10 per cent of the holding or
interest;
Price Sensitive Information
“Price sensitive information” means any information which relates directly or indirectly to a company and which
if published is likely to materially affect the price of securities of company;
382 PP-CC&MM
The following shall be deemed to be price sensitive information:– periodical financial results of the company;
– intended declaration of dividends (both interim and final);
– issue of securities or buy-back of securities;
– any major expansion plans or execution of new projects;
– amalgamation, mergers or takeovers;
– disposal of the whole or substantial part of the undertaking;
– any significant changes in policies, plans or operations of the company.
Unpublished
“unpublished” means information which is not published by the company or its agents and is not specific in
nature.
Explanation : - Speculative Reports in print or electronic media shall not be considered as published
information.
PROHIBITION ON DEALING COMMUNICATION OR COUNSELLING ON MATTERS RELATING
TO INSIDER TRADING
Regulation 3 provides that insider shall not either on his own behalf or on behalf of any other person, deal in
securities of a company listed on any stock exchange when in possession of any unpublished price sensitive
information; or communicate, counsel or procure, directly or indirectly, any unpublished price sensitive information
to any person who while in possession of such unpublished price sensitive information shall not deal in securities.
However, above provisions shall not applicable to any communication required in the ordinary course of business
or profession or employment or under any law.
Under Regulation 3A no company shall deal in the securities of another company or associate of that other
company while in possession of any unpublished price sensitive information. Any insider, who deals in securities
in contravention of the provisions of regulation 3 or 3A shall be guilty of Insider trading.
Regulation 3A not to apply in certain cases
Regulation 3B lays down that in a proceeding against a company in respect of regulation 3A, it shall be a
defence to prove that it entered into a transaction in the securities of a listed company when the unpublished
price sensitive information was in the possession of an officer or employee of the company, if :
(a) the decision to enter into the transaction or agreement was taken on its behalf by a person or persons
other than that officer or employee; and
(b) such company has put in place such systems and procedures which demarcate the activities of the
company in such a way that the person who enters into transaction in securities on behalf of the company
cannot have access to information which is in possession of other officer or employee of the company;
and
(c) it had in operation at that time, arrangements that could reasonably be expected to ensure that the
information was not communicated to the person or persons who made the decision and that no advice
with respect to the transactions or agreement was given to that person or any of those persons by that
officer or employee; and
(d) the information was not so communicated and no such advice was so given.
Lesson 13
Insider Trading 383
In a proceeding against a company in respect of regulation 3A which is in possession of unpublished price
sensitive information, it shall be defence to prove that acquisition of shares of a listed company was as per SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
Violation of provisions relating to insider trading
Regulation 4 provides that any insider who deals in securities in contravention of the provisions of regulation 3
or 3A shall be guilty of insider trading.
CODE OF INTERNAL PROCEDURES AND CONDUCT FOR LISTED COMPANIES AND OTHER
ENTITIES
Regulation 12 provides that all listed companies and organisations associated with securities markets including
the intermediaries as mentioned in section 12 of the Act, asset management company and trustees of mutual
funds; the self regulatory organisations recognised or authorised by the SEBI; the recognised stock exchanges
and clearing house or corporations; the public financial institutions as defined in Section 4A of the Companies
Act, 1956; and the professional firms such as auditors, accountancy firms, law firms, analysts, consultants, etc.,
assisting or advising listed companies, shall frame a code of internal procedures and conduct as near there to
the Model Code specified in these Regulations.
DISCLOSURE OF INTEREST OR HOLDING IN A LISTED COMPANIES BY CERTAIN PERSONS
Initial Disclosure
Regulation 13(1) provides that any person who holds more than 5% shares or voting rights in any listed company
shall disclose to the company, in the prescribed form, the number of shares or voting rights held by such person,
on becoming such holder, within 2 working days of the receipt of intimation of allotment of shares or the acquisition
of shares or voting rights, as the case may be.
Regulation 13(2) lays down that any person who is a director or officer of a listed company, shall disclose to the
company, in the prescribed form, the number of shares or voting rights held and positions taken in derivatives by
such person and his dependents (as defined by the company), within 2 working days of becoming a director or
officer of the company.
Sub-regulation 2A requires that any person who is a promoter or part of promoter group of a listed company
shall disclose to the company in prescribed Form, the number of shares or voting rights held by such person,
within two working days of becoming such promoter or person belonging to promoter group.
Continual Disclosure
Sub-regulation 3 of Regulation 13 provides that any person who holds more than 5% shares or voting rights in
any listed company shall disclose to the company in prescribed form the number of shares or voting rights held
and change in shareholding or voting rights, even if such change results in shareholding falling below 5%, if
there has been change in such holdings from the last disclosure made under sub-regulation (1) or under this
sub-regulation; and such change exceeds 2% of total shareholding or voting rights in the company.
Any person who is a director or officer of a listed company, shall disclose to the company and the stock exchange
where the securities are listed, in prescribed form the total number of shares or voting rights held and change in
shareholding or voting rights, if there has been a change in such holdings of such person and his dependents
(as defined by the company) from the last disclosure made and the change exceeds ` 5 lac in value or 25,000
shares or 1% of total shareholding or voting rights, whichever is lower. [Regulation 13(4)]
Any person who is a promoter or part of promoter group of a listed company, is required to disclose to the
company and the stock exchange where the securities are listed in prescribed Form, the total number of shares
or voting rights held and change in shareholding or voting rights, if there has been a change in such holdings of
384 PP-CC&MM
such person from the last disclosure made under Listing Agreement or under these regulations, and the change
exceeds ` 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.
[Regulation 13(4A)]
The disclosure shall be made within 2 working days of the receipt of intimation of allotment of shares, or the
acquisition or sale of shares or voting rights, as the case may be.
Disclosure by Company ot Stock Exchange
Every listed company, within 2 working days of receipt of the information mentioned above is required to disclose
to all stock exchanges on which the company is listed.
Disclosure Through E-Filing
The disclosures required under this regulation may also be made through electronic filing in accordance with the
system devised by the stock exchange.
MODEL CODE OF CONDUCT FOR PREVENTION OF INSIDER TRADING FOR LISTED
COMPANIES
Part A of schedule I of these Regulations deals with Model Code of Conduct for Prevention of Insider Trading for
Listed Companies as discussed below :
Compliance Officer
The listed company has appointed a compliance officer (senior level employee) who shall report to the Managing
Director/Chief Executive Officer.
The compliance officer shall be responsible for setting forth policies, procedures, monitoring adherence to the
rules for the preservation of “Price Sensitive Information”, pre-clearing of designated employees’ and their
dependents’ trades (directly or through respective department heads as decided by the company), monitoring of
trades and the implementation of the code of conduct under the overall supervision of the Board of the listed
company.
The compliance officer shall maintain a record of the designated employees and any changes made in the list of
designated employees.
The compliance officer shall assist all the employees in addressing any clarifications regarding the Securities
and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 and the company’s code of
conduct.
Preservation of “Price Sensitive Information”
Employees/ directors shall maintain the confidentiality of all Price Sensitive Information. Employees/ directors
shall not pass on such information to any person directly or indirectly by way of making a recommendation for
the purchase or sale of securities.
Need to Know
Price Sensitive Information is to be handled on a “need to know” basis, i.e., Price Sensitive Information should
be disclosed only to those within the company who need the information to discharge their duty.
Limited access to confidential information
Files containing confidential information shall be kept secure. Computer files must have adequate security of
login and password etc.
Lesson 13
Insider Trading 385
Prevention of misuse of “Price Sensitive Information”
All directors/ officers and designated employees of the company shall be subject to trading restrictions as
enumerated below :
Trading window
– The company shall specify a trading period, to be called “Trading Window”, for trading in the company´s
securities. The time for commencement of closing of trading window shall be decided by the company.
– The trading window shall be opened 24 hours after the following information is made public.
– The trading window shall be closed at the time of:(a) Declaration of Financial results (quarterly, half-yearly and annual)
(b) Declaration of dividends (interim and final)
(c) Issue of securities by way of public/ rights/bonus etc.
(d) Any major expansion plans or execution of new projects
(e) Amalgamation, mergers, takeovers and buy-back
(f) Disposal of whole or substantially whole of the undertaking
(g) Any changes in policies, plans or operations of the company.
– When the trading window is closed, the employees / directors shall not trade in the company’s securities
in such period.
– All directors/ officers/designated employees of the company shall conduct all their dealings in the securities
of the Company only in a valid trading window and shall not deal in any transaction involving the purchase
or sale of the company´s securities during the periods when trading window is closed or during any
other period as may be specified by the Company from time to time.
– In case of ESOPs, exercise of option may be allowed in the period when the trading window is closed.
However, sale of shares allotted on exercise of ESOPs shall not be allowed when trading window is
closed.
Pre-clearance of trades
– All directors/officers/designated employees of the company and their dependents as defined by the
company who intend to deal in the securities of the company (above a minimum threshold limit to be
decided by the company) should pre-clear the transaction as per the pre-dealing procedure as described
hereunder.
– An application can be made in such form as the company may notify in this regard, to the Compliance
Officer indicating the estimated number of securities that the designated employee/officer/director intends
to deal in, the details as to the depository with which he has a security account, the details as to the
securities in such depository mode and such other details as may be required by any rule made by the
company in this behalf.
– An undertaking shall be executed in favour of the company by such designated employee/director/
officer incorporating, inter alia, the following clauses, as may be applicable :
(a) That the employee/director/officer does not have any access or has not received “Price Sensitive
Information” upto the time of signing the undertaking.
(b) That in case the employee/director/officer has access to or receives “Price Sensitive Information”
386 PP-CC&MM
after the signing of the undertaking but before the execution of the transaction he/she shall inform
the Compliance Officer of the change in his position and that he/she would completely refrain from
dealing in the securities of the company till the time such information becomes public.
(c) That he/she has not contravened the code of conduct for prevention of insider trading as notified by
the company from time to time.
(d) That he/she has made a full and true disclosure in the matter.
Other restrictions
– All directors/officers/designated employees and their dependents (as defined by the company) shall
execute their order in respect of securities of the company within one week after the approval of
preclearance is given. If the order is not executed within one week after the approval is given, the
employee/ director must pre-clear the transaction again.
– All directors/ officers/ designated employees who buy or sell any number of shares of the company shall
not enter into an opposite transaction i.e. sell or buy any number of shares during the next six months
following the prior transaction. All directors/ officers/ designated employees shall also not take positions
in derivative transactions in the shares of the company at any time.
– In the case of subscription in the primary market (initial public offers), the above mentioned entities shall
hold their investments for a minimum period of 30 days. The holding period would commence when the
securities are actually allotted.
– In case the sale of securities is necessitated by personal emergency, the holding period may be waived
by the compliance officer after recording in writing his/her reasons in this regard.
Reporting Requirements for transactions in securities
All directors/officers/designated employees of the listed company shall be required to forward following details
of their securities transactions including the statement of dependent family members (as defined by the company)
to the Compliance Officer:
(a) all holdings in securities of that company by directors/officers/designated employees at the time of
joining the company;
(b) periodic statement of any transactions in securities (the periodicity of reporting may be defined by the
company. The company may also be free to decide whether reporting is required for trades where
preclearance is also required); and
(c) annual statement of all holdings in securities.
The Compliance Officer shall maintain records of all the declarations in the appropriate form given by the directors/
officers/designated employees for a minimum period of three years. The Compliance Officer shall place before
the Managing Director/Chief Executive Officer or a committee specified by the company, on a monthly basis all
the details of the dealing in the securities by employees/director/officer of the company and the accompanying
documents that such persons had executed under the pre-dealing procedure as envisaged in this code.
Penalty for contravention of code of conduct
– Any employee/officer/director who trades in securities or communicates any information for trading in
securities in contravention of the code of conduct may be penalised and appropriate action may be
taken by the company.
– Employees/officers/directors of the company who violate the code of conduct shall also be subject to
disciplinary action by the company, which may include wage freeze, suspension, ineligible for future
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Insider Trading 387
participation in employee stock option plans, etc.
– The action by the company shall not preclude SEBI from taking any action in case of violation of SEBI
(Prohibition of Insider Trading) Regulations, 1992.
Information to SEBI in case of violation of SEBI (Prohibition of Insider Trading) Regulations,
1992
In case it is observed by the company/Compliance Officer that there has been a violation of SEBI (Prohibition of
Insider Trading) Regulations, 1992. SEBI shall be informed by the company.
MODEL CODE OF CONDUCT FOR PREVENTION OF INSIDER TRADING FOR OTHER ENTITIES
Part B of Schedule I deals with Model Code of Conduct for Prevention of Insider Trading for other Entities. All the
compliance requirements as explained in Model Code of Conduct for Listed companies are also applicable for
other entities. There are certain addition compliance requirement for Other entities which is discussed below:
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 “inside areas” from those areas which deal with sale/marketing/investment
advise or other departments providing support services, considered “public areas”.
– The employees in the inside area shall not communicate any Price Sensitive Information to
– any one in public area.
– The employees in inside area may be physically segregated from employees in public area.
– Demarcation of the various departments as inside area may be implemented by the organisation/firm.
– In exceptional circumstances employees from the public areas may be brought “over the wall” and
given confidential information on the basis of “need to know” criteria, under intimation to the compliance
officer.
Restricted/Grey list
– In order to monitor chinese wall procedures and trading in client securities based on inside information,
the organisation/firm shall restrict trading in certain securities and designate such list as restricted/grey
list.
– Security of a listed company shall be put on the restricted/grey list if the organisation/firm is handling
any assignment for the listed company or is preparing appraisal report or is handling credit rating
assignment and is privy to Price Sensitive Information.
– Any security which is being purchased or sold or is being considered for purchase or sale by the
organisation/firm on behalf of its clients/schemes of mutual funds, etc. shall be put on the restricted/grey
list.
– As the restricted list itself is a highly confidential information it shall not be communicated directly, or
indirectly to anyone outside the organisation/firm. The Restricted List shall be maintained by Compliance
Officer.
– When any securities are on the Restricted List-trading in these securities by designated employees/
directors/partners may be blocked or may be disallowed at the time of pre-clearance.
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Other restrictions
– All directors/designated employees/partners shall execute their order within one week after the approval
of pre-clearance is given. If the order is not executed within one week after approval is given the employee/
director/partners must pre clear the transaction again.
– All directors/officers/designated employees/partners shall hold their investments for a minimum period
of 30 days in order to be considered as being held for investment purposes.
– The holding period shall also apply to purchases in the primary market (IPOs). In the case of IPOs, the
holding period would commence when the securities are actually allotted.
– In case the sale of securities is necessitated by personal emergency, the holding period may be waived
by the Compliance Officer after recording in writing his/her reasons in this regard.
– Analysts, if any, employed with the organisation/firm while preparing research reports of a client
company(s) shall disclose their shareholdings/interest in such company(s) to the Compliance Officer.
– Analysts who prepare research report of a listed company shall not trade in securities of that company
for thirty days from preparation of such report.
Things You May Know
The intermediaries such as Credit Rating Agencies, Asset Management Companies, or broking
companies etc. whose securities are listed in recognised stock exchange shall comply with both
Part A and Part B of Schedule I in respect of its own securities and client’s securities.
CODE OF CORPORATE DISCLOSURE PRACTICES FOR PREVENTION OF INSIDER TRADING
CORPORATE DISCLOSURE POLICY
To ensure timely and adequate disclosure of price sensitive information, the following norms shall be followed
by listed companies: –
– Prompt disclosure of price sensitive information
Price sensitive information shall be given by listed companies to stock exchanges and disseminated on
a continuous and immediate basis. Listed companies may also consider ways of supplementing
information released to stock exchanges by improving Investor access to their public announcements.
– Overseeing and co-ordinating disclosure
Listed companies shall designate a senior official (such as compliance officer) to oversee corporate
disclosure. This official shall be responsible for ensuring that the company complies with continuous
disclosure requirements. Overseeing and co-ordinating disclosure of price sensitive information to stock
exchanges, analysts, shareholders and media and educating staff on disclosure policies and procedure.
Information disclosure/dissemination may normally be approved in advance by the official designated
for the purpose. If information is accidentally disclosed without prior approval, the person responsible
may inform the designated officer immediately, even if the information is not considered price sensitive.
– Responding to market rumours
Listed companies shall have clearly laid down procedures for responding to any queries or requests for
verification of market rumours by exchanges. The official designated for corporate disclosure shall be
responsible for deciding whether a public announcement is necessary for verifying or denying rumours
and then making the disclosure.
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Insider Trading 389
– Timely Reporting of shareholdings/ownership and changes in ownership
Disclosure of shareholdings/ownership by major shareholders and disclosure of changes in ownership
as provided under any Regulations made under the Act and the listing agreement shall be made in a
timely and adequate manner.
– Disclosure/dissemination of Price Sensitive Information with special reference to Analysts,
Institutional Investors
Listed companies should follow the guidelines given hereunder while dealing with analysts and institutional
investors : –
(i) Only Public information to be provided - Listed companies shall provide only public information to
the analyst/research persons/large investors like institutions. Alternatively, the information given to
the analyst should be simultaneously made public at the earliest.
(ii) Recording of discussion - In order to avoid misquoting or misrepresentation, it is desirable that at
least two company representative be present at meetings with Analysts, Brokers or Institutional
Investors and discussion should preferably be recorded.
(iii) Handling of unanticipated questions - A listed company should be careful when dealing with analysts’
questions that raise issues outside the intended scope of discussion. Unanticipated questions may
be taken on notice and a considered response given later. If the answer includes price sensitive
information, a public announcement should be made before responding.
(iv) Simultaneous release of Information - When a company organises meetings with analysts, the
company shall make a press release or post relevant information on its website after every such
meet. The company may also consider live webcasting of analyst meets.
– Medium of disclosure/dissemination
(i) Disclosure/dissemination of information may be done through various media so as to achieve
maximum reach and quick dissemination.
(ii) Corporates shall ensure that disclosure to stock exchanges is made promptly.
(iii) Corporates may also facilitate disclosure through the use of their dedicated Internet website.
(iv) Company websites may provide a means of giving investors a direct access to analyst briefing
material, significant background information and questions and answers.
(v) The information filed by corporates with exchanges under continuous disclosure requirement may
be made available on the company website.
– Dissemination by stock exchanges
(i) The disclosures made to stock exchanges may be disseminated by the exchanges to investors in a
quick and efficient manner through the stock exchange network as well as through stock exchange
websites.
(ii) Information furnished by the companies under continuous disclosure requirements, should be
published on the website of the exchange instantly.
(iii) Stock exchanges should make immediate arrangement for display of the information furnished by
the companies instantly on the stock exchange website.
INVESTIGATION BY SEBI
Chapter III of these Regulations deals with the investigations made by SEBI.
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Power to make inquiries and inspection
Regulation 4A provides that if SEBI suspects that any person has violated any provision of these regulations, it
may make inquiries with such persons or any other person as deemed fit, to form a prima facie opinion as to
whether there is any violation of these regulations.
SEBI’s right to investigate
Regulation 5 empowers SEBI to investigate into the complaints received from investors, intermediaries or any
other person on any matter having a bearing on the allegations of insider trading; and to investigate suo-moto
upon its own knowledge or information in its possession to protect the interest of investors in securities against
breach of these regulations.
Before undertaking an investigation under regulation 5 SEBI shall give a reasonable notice to insider for that purpose.
However, where SEBI is satisfied that in the interest of investors or in public interest no such notice should be given,
it may by an order in writing direct that the investigation be taken up without such notice (Regulation 6).
Obligations of Insider on Investigation by SEBI
Regulation 7 deals with the obligations of an insider on investigation made by SEBI.
– It shall be the duty of every insider who is being investigated or any other person mentioned in clause (i)
of sub-section (1) of section 11 of the Act, to produce to the investigating authority such books, accounts
and other documents in his custody or control and furnish the authority with the statements and information
relating to the transactions in securities market within such time as the said authority may require.
– The insider or any other person in clause (i) of sub-section (2) of section 11 of the Act] shall allow the
investigating authority to have reasonable access to the premises occupied by such insider and also
extend reasonable facility for examining any books, records, documents and computer data in the
possession of the stock-broker or any other person and also provide copies of documents or other
materials which in the opinion of the investigating authority are relevant.
– The investigating authority, in the course of investigation, shall be entitled to examine or record statements
of any member, director, partner, proprietor and employee of the insider or any other person mentioned
in clause (i) of sub-section (2) of section 11 of the SEBI Act.
– It shall be the duty of every director, proprietor, partner, officer and employee of the insider to give to the
investigating authority all assistance in connection with the investigation, which the insider or any other
person mentioned in clause (i) of sub-section (2) of section 11 of the Act may be reasonably expected to
give.
Directions by SEBI
Regulation 11 stipulates that SEBI may without prejudice to its right to initiate criminal prosecution under the Act,
to protect the interests of investors and in the interests of the securities market and for due compliance with the
provisions of the Act, Regulations made thereunder issue any or all of the following order, namely:– directing the insider or such person not to deal in securities in any particular manner;
– prohibiting the insider or such person from disposing of any of the securities acquired in violation of
these Regulations;
– restraining the insider to communicate or counsel any person to deal in securities;
– declaring the transaction(s) in securities as null and void;
– directing the person who acquired the securities in violation of these regulations to deliver the securities
back to the seller;
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Insider Trading 391
However, in case the buyer is not in a position to deliver such securities, the market price prevailing at
the time of issuing of such directions or at the time of transactions whichever is higher, shall be paid to
the seller;
– directing the person who has dealt in securities in violation of these regulations to transfer an amount or
proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor
protection fund of a Recognised Stock Exchange.
PENALTY PROVISIONS FOR VIOLATIONS OF THE REGULATIONS
Without prejudice to the directions under regulation 11, if any person violates the provisions of these Regulations,
he shall be liable for appropriate action under Sections 11, 11 B, 11D, Chapter VIA and Section 24 of the SEBI Act.
Regulation 11 & 14 of the SEBI (Prohibition and Insider Trading) Regulations, empowers the SEBI to issue
following directions to the violators without prejudice to its right to initiate criminal prosecution under section 24
or any action under Chapter VIA of the SEBI Act, to protect the interests of investor and in the interests of the
securities market and for due compliance with the provisions of the Act, regulation made there under issue any
or all of the following order, namely:
(a) directing the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the Act
not to deal in securities in any particular manner;
(b) prohibiting the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the
Act from disposing of any of the securities acquired in violation of these regulations;
(c) restraining the insider to communicate or counsel any person to deal in securities;
(d) declaring the transaction(s) in securities as null and void;
(e) directing the person who acquired the securities in violation of these regulations to deliver the securities
back to the seller:
However, in case the buyer is not in a position to deliver such securities, the market price prevailing at
the time of issuing of such directions or at the time of transactions whichever is higher, shall be paid to
the seller;
(f) directing the person who has dealt in securities in violation of these regulations to transfer an amount or
proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor
protection fund of a recognised stock exchange.
Penalty for insider trading under SEBI Act, 1992:
Section 15G of the SEBI Act, 1992, lays down that –
If any insider who, –
(i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed
on any stock exchange on the basis of any unpublished price-sensitive information; or
(ii) communicates any unpublished price-sensitive information to any person, with or without his request
for such information except as required in the ordinary course of business or under any law; or
(iii) counsels, or procures for any other person to deal in any securities of any body corporate on the basis
of unpublished price-sensitive information shall be liable to a penalty of twenty-five crore rupees or
three times the amount of profits made out of insider trading, whichever is higher.
Section 24 of the SEBI Act, 1992 provides as under:
(1) Without prejudice to any award of penalty by the adjudicating officer under this Act, if any person
392 PP-CC&MM
contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any
rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may
extend to ten years, or with fine which may extend to twenty-five crore rupees or with both.
(2) If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his
directions or orders, he shall be punishable with imprisonment for a term which shall not be less than
one month but which may extend to ten years, or with fine, which may extend to twenty-five crore
rupees or with both.
Thus violation of the provisions of the regulations attract huge monetary penalty and may lead to criminal
prosecution. However those aggrieved by an order of SEBI, may prefer an appeal to the Securities Appellate
Tribunal within a period of forty-five days of the order. The persons aggrieved can also apply to SEBI for consent
order under the scheme announced by it in which case the case is considered by a High Power Committee
constituted under the SEBI Act, 1992.
ROLE OF COMPANY SECRETARY IN COMPLIANCE REQUIREMENTS
The obligations cast upon the Company Secretary in relation to the insider trading regulations can be summarized
as under:
1. To frame a code of internal procedures and conduct in line with the Model Code specified in the Schedule
I of the regulations and get the same approved from the Board of Directors of the Company.
2. To place before the Board the “Code of Corporate Disclosure Practices for Prevention of Insider Trading”
as enumerated in the Schedule II of the regulations.
3. The Company Secretary has to place before the Board for their consideration and approval the following:
(i) closing period for trading window.
(ii) minimum threshold limit beyond which it would be mandatory for the directors/officers/designated
employees to obtain pre-clearance from the compliance officer before they trade in the company’s
securities.
(iii) format of application form for pre-clearance.
(iv) format of undertaking to be attached with pre-clearance application.
(v) internal guidelines as to the circumstances when the holding period may be waived by the compliance
officer.
(vi) periodicity at which the directors/officers/designated employees are required to submit periodic
statement of transaction in securities of the company to comply with the Code of Corporate Disclosure
Practices.
(vii) To identify and declare the designated employees for the purpose of the regulations.
4. In case of unlisted company the company secretary is required
(i) To prepare the Chinese wall policy for adoption in the company.
(ii) To prepare Restricted/ Grey List of securities from time to time.
5. To frame and then to monitor adherences to the rules for the preservation of “Price Sensitive information”.
6. To monitor and confirm whether transactions for which pre- clearance has been granted were executed
within one week.
7. To suggest any improvements required in the policies, procedures, etc to ensure effective implementation
of the code.
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Insider Trading 393
8. To maintain a record of all directors, officers and persons covered within the ambit of the term ‘designated
employee’ and any changes in the same.
9. To assist in addressing any clarifications regarding SEBI (Prohibition of Insider Trading) Regulations,
1992 and the company’s code of conduct.
10. To maintain a list of all information termed as ‘price sensitive information’.
11. To maintain a record of names of files containing confidential information deemed to be price sensitive
information and persons in charge of the same.
12. To ensure that computer data is adequately secured.
13. To keep records of periods specified as ‘close period’ and the ‘Trading Widow’.
14. To ensure that the ‘Trading Window’ is closed at the time of:
(i) Declaration of Financial results (quarterly, half-yearly and annual).
(ii) Declaration of dividends (interim and final)
(iii) Issue of securities by way of public /right/ bonus etc.
(iv) Any major expansion plans or execution of new projects.
(v) Amalgamation, mergers, takeovers and buy-back.
(vi) Disposal of whole or substantially whole ‘of the undertaking.
(vii) Any change in policies, plans or operations of the company.
(viii) Considering ay other matter which could be construed as price-sensitive information.
(ix) All other events as specified under clause 36 of the Listing Agreement.
15. To ensure that the trading widow is opened 24 hours after the information mentioned in para 4 is made
public.
16. To ensure that the trading restrictions are strictly observed and that all directors/officers/designated
employees conduct all their dealings in the securities of the company only in a valid trading window and
do not deal in the company’s securities during the period when the trading window is closed.
17. To ensure that no sale of shares allotted on exercise of ESOPs is made during a close period.
18. To receive initial disclosure from any person holding more than 5% shares or voting rights in the company
in the prescribed form within two working days of:
(i) the receipt of information of allotment of shares; or
(ii) the acquisition of shares or voting rights, as the case may be
19. To procure initial disclosure of the number of shares or voting rights held by any person who is a director
or officer is a promoter or part of promoter group of the listed company in the prescribed form within two
working days of becoming a director or officer of the company.
20. To receive from any person continual disclosures of the number of shares or voting rights held in the
company and changes (purchase or sales or otherwise) therein, even if the shareholding falls below 5%
since the last disclosure made under para 18 or this para, and such change exceeds 2% of the total
shareholding or voting rights in the prescribed form within 2 working days of:
– the receipt of intimation of allotment of shares; or
– the acquisition or sale of shares or voting rights, as the case may be.
394 PP-CC&MM
21. To procure from any person who is a director or officer or is a promoter or part of promoter group of the
listed company, continual disclosures of the total number of shares or voting rights held and change in
shareholding or voting rights, if there has been a change in such holdings from the last disclosure made
under para 19 above or this para, and the change exceeds ` 5 lac in value or 25000 shares or 1% of
total shareholding or voting rights, whichever is lower, in the prescribed form within 4 working days of:
– the receipt of intimation of allotment of shares; or
– the acquisition or sale of shares or voting rights, as the case may be.
22. To inform all stock exchanges on which the company’s securities are listed, the information received
under para 18, 19, 20and 21 within five days of receipt.
23. To process the applications received for pre-clearance of transactions from the directors/officers/
designated employees.
24. To confirm whether the directors/ officers/ designated employees executed their order in respect of
securities of the company within one week after the approval of pre- clearance is given.
25. To ensure that a minimum holding period as specified by the company, which is not less than 30 days is
observed by all directors/officers/ designated employees.
26. To waive the requirement of holding period under certain circumstances.
27. To receive and maintain records of periodic and annual statement of holdings from directors/officers/
designated employees and their dependant family members.
28. To maintain records of all disclosures made by directors/officers/designated employees for a minimum
period of three years.
29. To place before the Managing Director or Chief Executive Officer or Committee of directors, as may be
specified for the purpose, on a monthly basis all the details of the dealings in the securities by directors/
officers of the company and the accompanying documents that such persons had executed under the
pre-clearance procedure.
30. To implement the punitive measures or disciplinary action prescribed for any violation or contravention
of the code of conduct.
External Reporting by the Company Secretary as Compliance Officer
1. To disclose within two working days of receipt, to all stock exchanges on which the company is listed, the
information received under regulation 13.
2. To inform the SEBI the violation of the SEBI (Prohibition of Insider Trading) Regulations, 1992 if any committed
by any person. But before bringing it to the notice of SEBI, the compliance officer has to inform the Managing
Director/ Chief Operating Officer and the Board of the Company.
3. In addition to the above he is also required to liaison with other authorities and the shareholders of the
Company.
SEBI’s VIEW ON THE ROLE OF THE COMPLIANCE OFFICER IN CASE OF INSIDER TRADING
SEBI Adjudication Order dated 27th July 2012 in respect of Mr. G Jayaraman in the matter of
Satyam Computer Services Ltd.
– Vide the aforesaid Order, SEBI has held the erstwhile compliance officer of Satyam Computer Services Ltd,
Mr. G Jayaraman, liable for not enforcing the safeguards under the Model Code during the period of December
2008 – January 2009. It may be noted that Mr. G Jayaraman was the Company Secretary of Satyam.
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Insider Trading 395
– The particular safeguard which the said Compliance Officer had failed to enforce was to close the
trading window after becoming aware of certain “price sensitive information” relating to Satyam, i.e. The
potential merger of Maytas with Satyam, which was not yet confirmed by the Board of Satyam.
– In the context of the facts of the case, under paragraph 20 of the said Order, SEBI has stated that
despite the Compliance Officer being under the overall supervision of the Board of Directors of the
company, he should have closed the trading window even without obtaining prior approval of the board.
SEBI has further stated that if the Compliance Officer were to always wait for instructions from the Board
to close the trading window as contended by him then the provisions contained in the Model Code of
Conduct get defeated as the provisions clearly emphasizes upon the role of the Compliance Officer who
shall, inter alia, be responsible for implementing the Code under the overall supervision of the Board. As
Compliance Officer, he cannot raise the defence that internal approvals were not available. As stated
earlier, such contention if accepted would render the stipulation of appointment of Compliance Officer
meaningless and goes against the spirit of the Prohibition of Insider Trading Regulations.
– At paragraph 29 of the said Order, SEBI summarised the role that a Compliance Officer is expected to
play in the securities market. An extract is given below:“For orderly and fair functioning of the securities market, it is essential for every market player
to fulfil the requirements mandated in the law. The duty weighs even more on a person like
Compliance Officer, who is conferred upon with key responsibilities in a company. Hence, the
violation by the Noticee needs to be viewed seriously.”
SEBI imposed a penalty of ` 5,00,000/- (Rupees Five Lakhs only) on Mr. G Jayaraman.
LESSON ROUND UP
– To curb insider trading SEBI formulated SEBI (Prohibition of Insider Trading) Regulations, 1992 and
which prescribes code of conduct and corporate disclosure practices to be followed by listed companies
and entities connected with them.
– The Insider Trading Regulations Comprises of four chapter and three schedules encompassing the
various regulations relating to Insider Trading.
– Insider means and includes deemed to be a connected person. The definition of deemed to be a
connected person is very elaborate.
– The regulations not only seeks to curb dealing in securities, they also seek to curb communicating or
counselling about securities by the insiders.
– Regulation 3 provides that insider shall not either on his own behalf or on behalf of any other person,
deal in securities of a company listed on any stock exchange when in possession of any unpublished
price sensitive information; or communicate, counsel or procure, directly or indirectly, any unpublished
price sensitive information to any person who while in possession of such unpublished price sensitive
information shall not deal in securities.
– Regulation 4A provides that if SEBI suspects that any person has violated any provision of these
regulations, it may make inquiries with such persons or any other person as deemed fit, to form a
prima facie opinion as to whether there is any violation of these regulations.
– The regulations provide for initial as well as continual disclosures by members of the company after a
threshold limit of holding and by the directors/ employees/ designated employees/promoter/promoter
group at regular interval.
– Any person who holds more than 5% shares or voting rights in any listed company shall disclose to the
company, in the prescribed form the number of shares or voting rights held by such person, on becoming
396 PP-CC&MM
such holder, within 2 working days of the receipt of intimation of allotment of shares or the acquisition
of shares or voting rights, as the case may be.
– The disclosure shall be made within 2 working days of the receipt of intimation of allotment of shares,
or the acquisition or sale of shares or voting rights, as the case may be.
– The compliance officer shall be responsible for setting forth policies, procedures, monitoring adherence
to the rules for the preservation of “Price Sensitive Information”, pre-clearing of designated employees’
and their dependents’ trades (directly or through respective department heads as decided by the
company), monitoring of trades and the implementation of the code of conduct under the overall
supervision of the Board of the listed company.
– The company shall specify a trading period, to be called “Trading Window”, for trading in the company´s
securities. The time for commencement of closing of trading window shall be decided by the company.
– Without prejudice to the directions under regulation 11, if any person violates provisions of these
regulations, he shall be liable for appropriate action under Sections 11, 11 B, 11D, Chapter VIA and
Section 24 of the SEBI Act.
– Any person aggrieved by an order of SEBI under these regulations can prefer an appeal to the Securities
Appellate Tribunal.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. What are the compliances required to be made by a company under SEBI (Prohibition of Insider
Trading) Regulations, 1992?
2. Describe the obligations cast upon the company under SEBI (Prohibition of Insider Trading) Regulations,
1992.
3. What are the Initial Disclosure Required to be made by a person under SEBI (Prohibition of Insider
Trading ) Regulations, 1992?
4. What are the Penalties for Insider Trading under SEBI Act?
5. Briefly explain the duty of Compliance Officer under these Regulations.
Lesson 14
Substantial Acquisition of Shares and Takeovers 397
Lesson 14
Substantial Acquisition of Shares and Takeovers
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
The globalization and initiation of various
economic reforms in India during early nineties
opened up the opportunities for International
Mergers and Acquisitions and began the
process of transformation of entire business
scenario. This new weapon of M&A, though
proved to be beneficial for growth, also created
a need for some regulations to protect the
interest of investors, especially in case of widely
held companies. Accordingly, SEBI came out
with SEBI Takeover Regulations, 1994 which
was later substituted by SEBI Takeover
Regulations, 1997 and now replaced by SEBI
Takeover Regulations, 2011.
– Important Definitions
– Trigger Point for making an open offer by
an acquirer
– Open Offer
– Open Offer Process
– Public Announcement
– Offer Price
– Provision of Escrow
– Mode of Payment
– Disclosures
SEBI Takeover Regulations plays a major role
in driving the acquisition and restructuring
exercises of listed companies of India. The
regulations have been developed to enshrine
the interest of various concerned entities viz.
by facilitating a guide to corporate sector in
exploiting the business opportunities by way of
acquisitions without prejudicing the interest of
investors and by providing an instrument to
investors to ensure that their funds vests in the
same hands in which they have been bestowed.
– Exemptions
– LESSON ROUND UP
– SELF TEST QUESTIONS
The objective of this lesson is to give an insight
into SEBI Takeover Regulations, 2011. This
lesson will help the students to understand the
key concepts of New Takeover Regulations.
397
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INTRODUCTION
The globalization and initiation of various economic reforms in India during early nineties opened up the
opportunities for International Mergers and Acquisitions and began the process of transformation of entire
business scenario. To compete at the world platform, the scale of businesses in India was needed to be increased.
This new weapon of M&A in the armory of corporate, though proved to be beneficial for growth, also created a
need for some regulations to protect the interest of investors, especially in case of widely held companies, so
that the process of M&A is used to develop the securities market and not to sabotage it.
Accordingly, in the year 1994, SEBI came out with SEBI Takeover Regulations, 1994 which was later substituted
by SEBI Takeover Regulations, 1997.
SEBI Takeover Regulations plays a major role in driving the acquisition and restructuring exercises of listed
companies of India. The regulations have been developed to enshrine the interest of various concerned entities
viz. by facilitating a guide to corporate sector in exploiting the business opportunities by way of acquisitions
without prejudicing the interest of investors and by providing an instrument to investors to ensure that their funds
vests in the same hands in which they have been bestowed.
SEBI Takeover Regulations, 1997 have been amended a number of times to address the changing business
scenario. To review the SEBI Takeover Regulations, 1997, SEBI constituted an expert committee, Takeover
Regulations Advisory Committee (or TRAC) under the chairmanship of Late Sh. C. Achuthan that released its
report on July 19, 2010. Finally, on September 23, 2011, SEBI has notified the much awaited New Takeover
Regulations i.e. SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 that came into
force on the 30th day from the date of their publication in the Official Gazette i.e. w.e.f. October 22, 2011.
SEBI Takeover Regulations, 2011 aims at protecting interest of the investors in securities of a listed company
providing amongst others, an opportunity for the public shareholders to exit where there is a substantial acquisition
of shares or voting rights or control over a listed company, consolidation of holdings by existing shareholders
and related disclosures and penalties for non- compliance etc. These Regulations requires an acquirer to make
an offer to shareholders of the target company on acquiring shares exceeding stipulated thresholds. It also
contains provisions relating to open offer size and price, time bound process for making an open offer, exemption
from making an open offer etc.
What is Takeover and Substantial Acquisition of Shares ?
When an “Acquirer” takes over the control of the “Target Company”, it is termed as Takeover. When an
acquirer acquires “substantial quantity of shares or voting rights” of the Target Company, it results into substantial
acquisition of shares.
Important Definitions
To understand the concept of the takeover code, it would be pertinent to first go through some of the Definitions:
Acquirer
“Acquirer” means any person who, directly or indirectly, acquires or agrees to acquire whether by himself, or
through, or with persons acting in concert with him, shares or voting rights in, or control over a target company.
Acquisition
“Acquisition” means, directly or indirectly, acquiring or agreeing to acquire shares or voting rights in, or control
over, a target company.
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Substantial Acquisition of Shares and Takeovers 399
Control
“control” includes the right to appoint majority of the directors or to control the management or policy decisions
exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of
their shareholding or management rights or shareholders agreements or voting agreements or in any other
manner.
Provided that a director or officer of a target company shall not be considered to be in control over such target
company, merely by virtue of holding such position.
Enterprise Value
Enterprise value means the value calculated as market capitalization of a company plus debt, minority interest
and preferred shares, minus total cash and cash equivalents.
Enterprise Value= Market capitalization+ Debt+ Minority Interest and Preferred Shares- Total Cash
and Cash Equivalents
Frequently Traded Shares
Frequently traded shares means shares of a target company, in which the traded turnover on any stock exchange
during the twelve calendar months preceding the calendar month in which the public announcement is made, is
at least ten per cent of the total number of shares of such class of the target company.
Provided that where the share capital of a particular class of shares of the target company is not identical
throughout such period, the weighted average number of total shares of such class of the target company shall
represent the total number of shares.
Identified Date
“Identified date” means the date falling on the tenth working day prior to the commencement of the tendering
period, for the purposes of determining the shareholders to whom the letter of offer shall be sent.
Offer Period
“Offer period” means the period between the date of entering into an agreement, formal or informal, to acquire
shares, voting rights in, or control over a target company requiring a public announcement, or the date of the
public announcement, as the case may be, and the date on which the payment of consideration to shareholders
who have accepted the open offer is made, or the date on which open offer is withdrawn, as the case may be.
Persons Acting in Concert
“Persons acting in concert" means, –
(1) persons who, with a common objective or purpose of acquisition of shares or voting rights in, or exercising
control over a target company, pursuant to an agreement or understanding, formal or informal, directly
or indirectly co-operate for acquisition of shares or voting rights in, or exercise of control over the target
company.
(2) Without prejudice to the generality of the foregoing, the persons falling within the following categories
shall be deemed to be persons acting in concert with other persons within the same category, unless
the contrary is established, –
(i) a company, its holding company, subsidiary company and any company under the same management
or control;
(ii) a company, its directors, and any person entrusted with the management of the company;
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(iii) directors of companies referred to in item (i) and (ii) of this sub-clause and associates of such
directors;
(iv) promoters and members of the promoter group;
(v) immediate relatives;
(vi) a mutual fund, its sponsor, trustees, trustee company, and asset management company;
(vii) a collective investment scheme and its collective investment management company, trustees and
trustee company;
(viii) a venture capital fund and its sponsor, trustees, trustee company and asset management company;
(ix) a foreign institutional investor and its sub-accounts;
(x) a merchant banker and its client, who is an acquirer;
(xi) a portfolio manager and its client, who is an acquirer;
(xii) banks, financial advisors and stock brokers of the acquirer, or of any company which is a holding
company or subsidiary of the acquirer, and where the acquirer is an individual, of the immediate
relative of such individual:
Provided that this sub-clause shall not apply to a bank whose sole role is that of providing normal
commercial banking services or activities in relation to an open offer under these regulations;
(xiii) an investment company or fund and any person who has an interest in such investment company or
fund as a shareholder or unitholder having not less than 10 per cent of the paid-up capital of the
investment company or unit capital of the fund, and any other investment company or fund in which
such person or his associate holds not less than 10 per cent of the paid-up capital of that investment
company or unit capital of that fund:
Provided that nothing contained in this sub-clause shall apply to holding of units of mutual funds registered with
SEBI.
Target Company
Target Company means a company and includes a body corporate or corporation established under a Central
legislation, State legislation or Provincial legislation for the time being in force, whose shares are listed on a
stock exchange.
Tendering Period
Tendering period means the period within which shareholders may tender their shares in acceptance of an open
offer to acquire shares made under these regulations.
"Volume weighted average market price"
volume weighted average market price means the product of the number of equity shares traded on a stock
exchange and the price of each equity share divided by the total number of equity shares traded on the stock
exchange.
Number of shares traded on the Stock Exchange on a particular day: X, Market Price: Y
Volume weighted Average Market Price =
X1*Y1+X2*Y2+X3*Y3………
____________________________
X1+X2+X3……………..
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Substantial Acquisition of Shares and Takeovers 401
"Volume weighted average price"
volume weighted average price means the product of the number of equity shares bought and price of each
such equity share divided by the total number of equity shares bought.
Number of shares bought on a particular day: A, Market Price: B
Volume weighted Average Price =
A1*B1+A2*B2+A3*B3………
____________________________
A1+A2+A3……………..
TRIGGER POINT FOR MAKING AN OPEN OFFER BY AN ACQUIRER
25% Shares or Voting Rights
An acquirer, along with Persons Acting in Concert( PAC) , if any, who intends to acquire shares which along with
his existing shareholding would entitle him to exercise 25% or more voting rights, can acquire such additional
shares only after making a Public Announcement (PA) to acquire minimum twenty six percent shares of the
Target Company from the shareholders through an Open Offer.
Creeping Acquisition Limit
An acquirer who holds 25% or more but less than maximum permissible non-public shareholding of the Target
Company, can acquire such additional shares as would entitle him to exercise more than 5% of the voting rights
in any financial year ending March 31 only after making a Public Announcement to acquire minimum twenty six
percent shares of Target Company from the shareholders through an Open Offer.
For Example
Name
Pre Holding
Creeping
Acuisition
Post
Holding
Applicability of SEBI Takeover
Regulations, 2011
A
23%
3%
26%
Open Offer Obligations
B
7%
%
9%
–
On analysis of the above Table, it can be seen that although the acquisition made by promoters as a group is
within the creeping acquisition limit, however, pursuant to the above acquisition of shares, the shareholding of A
is increased beyond 25% of the total voting rights of the Target Company. Accordingly, in terms of SEBI Takeover
Regulations, 2011, the above acquisition of shares by A would result into triggering the open offer obligations.
OPEN OFFER
SEBI Takeover Regulations, 2011 provides certain trigger events wherein the Acquirer is required to give Open
Offer to the shareholders of the Target Company to provide them exit opportunity.
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Open Offer
Mandatory Offer
Acquisition of Shares
(Reg. 3)
Acquisition of Control
(Reg. 4)
Voluntary Offer
(Reg. 6)
Indirect acquisition of
shares Control (Reg. 5)
I. Mandatory Open Offer
SEBI Takeover Regulations, 2011 provides a threshold for mandatory Open Offer. The regulations provides that
whenever an acquirer acquires the shares in excess of the threshold as prescribed under regulation 3 and 4 of
SEBI Takeover Regulations, 2011, then the acquirer is required to make a public announcement of offer to the
shareholders of the Target Company.
Regulation 3 of the SEBI Takeover Regulations, 2011 provides that the Acquirer to give an open offer to the
shareholders of Target Company on the acquisition of shares or voting rights entitling the Acquirer along with the
Persons Acting in Concert with him to exercise 25% or more voting rights in the Target Company.
Further any Acquirer who holds shares between 25%-75%, together with PACs can acquire further 5% shares
as creeping acquisition without giving an Open Offer to the shareholders of the Target Company upto a maximum
of 75%. The quantum of acquisition of additional voting rights shall be calculated after considering the following:
(a) No Netting off allowed:
For the purpose of determining the quantum of acquisition of additional voting rights, the gross acquisitions
without considering the disposal of shares or dilution of voting rights owing to fresh issue of shares by the target
company shall be taken into account.
(b) Incremental voting rights in case of fresh issue
In the case of acquisition of shares by way of issue of new shares by the target company, the difference between
the pre-allotment and the post-allotment percentage voting rights shall be regarded as the quantum of additional
acquisition. [Regulation 3(2)]
The most important point to be noted here is that the individual Acquirer shareholding shall also be considered
for determining the Open Offer Trigger points apart from consolidated shareholding of Acquirer and Persons
Acting in Concert. [Regulation 3(3)]
Regulation 4 of the SEBI Takeover Regulations, 2011 specifies that if any acquirer including person acting in
concert acquires control over the Target Company irrespective of the fact whether there has been any acquisition
of shares or not, then he has to give public announcement to acquire shares from shareholders of the Target
Company. [Regulation 4]
II. Voluntary Open Offer
Voluntary Open Offer means the Open Offer given by the Acquirer voluntarily without triggering the mandatory
Open Offer obligations as envisaged under the regulations. Voluntary Offers are an important means for substantial
shareholders to consolidate their stake and therefore recognized the need to introduce a specific framework for
such Open Offers.
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Substantial Acquisition of Shares and Takeovers 403
Regulation 6 of the Takeover Regulations provides the threshold and conditions for making the Voluntary Open
Offer which are detailed below:
– Eligibility
(i) Prior holding of atleast 25% shares
To be eligible for making a Voluntary Open Offer, the regulations mandates the prior holding of atleast
25% stake in the Target Company by the Acquirer along with the PACs.
(ii) Shareholding of the Acquirer and PACs post completion of Open Offer
Post completion of the Open Offer, the shareholding of the Acquirer along with PACs shall not exceed
the “maximum permissible non-public shareholding”.
– Acquisition of shares prior to the Voluntary Open Offer
The Acquirer shall become ineligible to make a Voluntary Open Offer if during the preceding 52 weeks,
the Acquirer or PACs with him has acquired shares of the Target Company without attracting the obligation
to make a Public Announcement of an Open Offer. This condition is given because the Voluntary Open
Offer is permitted as an exception to the general rule on the offer size, thus the ability to voluntarily make
an Open Offer should not be available if in the proximate past, any of such persons have made acquisitions
within the creeping acquisition limits permitted under the Regulations.
– Prohibition on the acquisition of shares during the Offer Period
SEBI Takeover Regulations, 2011 prohibits the acquirer who has made a Voluntary Open Offer from
further acquiring the shares during the Offer Period otherwise than under the Open Offer.
– Restriction of the acquisition of shares post completion of Voluntary Open Offer
An acquirer and PACs who have made a Voluntary Open Offer shall not be entitled to further acquire
shares for a period of 6 months after completion of the Open Offer except pursuant:
(a) To another Voluntary Open Offer.
(b) To Competing Open Offer to the Open Offer made by any other person for acquiring shares of the
Target Company.
– Offer size
The Voluntary Open Offer shall be made for the acquisition of at least ten per cent (10%) of the voting
rights in the Target Company and shall not exceed such number of shares as would result in the postacquisition holding of the acquirer and PACs with him exceeding the maximum permissible non-public
shareholding applicable to such Target Company.
Conditional Offer
An offer in which the acquirer has stipulated a minimum level of acceptance is known as a conditional offer.
Minimum level of acceptance implies minimum number of shares which the acquirer desires under the said
conditional offer. If the number of shares validly tendered in the conditional offer, are less than the minimum level
of acceptance stipulated by the acquirer, then the acquirer is not bound to accept any shares under the offer. In
a conditional offer, if the minimum level of acceptance is not reached, the acquirer shall not acquire any shares
in the target company under the open offer or the Share Purchase Agreement which has triggered the open
offer.
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OPEN OFFER PROCESS
These Regulations provides certain triggering events wherein the Acquirer is required to give Open Offer to the
shareholders of the Target Company to provide them exit opportunity. The objective behind giving opportunity to
the shareholders of the Target Company is to safeguard their interest in the event of change in management
and control of the Target Company or where the promoters desires to consolidate their shareholding to the
maximum permissible level. The whole process of Open Offer is divided into three parts:
1. Pre Open Offer
2. During the Open Offer
3. Post Open Offer
Pre Open Offer
1. Triggering Event: The process of open offer starts from the date of happening of triggering event itself.
The triggering event may be signing of Share Purchase Agreement or actual acquisition of shares from
the market or the Board Meeting held for considering the preferential issue of Equity Shares or acquisition
of control over Company. Thus as soon as the intention of acquirer to acquire the shares of Target
Company beyond the prescribed threshold limits is expressed clearly, the process of Takeover Offer is
initiated provided the acquisition is not exempted under regulation 10 of these regulations.
2. Appointment of Merchant Banker: As soon as the triggering event happens as mentioned above, the
acquirer is required to appoint a Merchant Banker registered with SEBI, who is responsible for executing
the entire open offer process. [Regulation 12]
3. Public Announcement: A Public Announcement shall be made to concerned stock Exchange, SEBI
and Target Company.
4. Escrow Account: The Acquirer shall open an escrow account atleast two working days prior to the date
of detailed public statement and deposit an amount aggregating to 25% of the consideration on first ‘
500 crore and additional amount of 10% on the balance consideration. [Regulation 17(1)].
5. Publication of Detailed Public Statement: A Detailed Public Statement shall be made by the Acquirer
within 5 working days from the date of Public Announcement. Such detailed public statement is required
to be published in all editions of any one English national daily with wide circulation, any one Hindi
national daily with wide circulation, and any one regional language daily with wide circulation at the
place where the registered office of the Target Company is situated and one regional language daily at
the place of the stock exchange where the maximum volume of trading in the shares of the Target
Company are recorded during the sixty trading days preceding the date of the public announcement.
[Regulation 13(4) read with Regulation 14(3)]
6. Submission of Draft Letter of Offer: The Acquirer shall submit a draft letter of offer to SEBI within 5
working days from the date of detailed public statement along with a non-refundable fee. [Regulation
16(1)]
Simultaneously, a copy of the draft letter of offer shall be send to the Target Company at its registered
office and to all the Stock Exchanges where the shares of the Company are listed. [Regulation 18(1)]
7. Identified Date: The Acquirer shall fix a date for determining the names of the shareholders to whom
the letter of offer would be send which shall be a date falling on the tenth working day prior to the
commencement of the tendering period. [Regulation 2(1) (l)]
8. Dispatch of letter of offer: The Acquirer shall ensure that the letter of offer is dispatched to the
shareholders whose names appear on the register of members of the Target Company as on the
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Substantial Acquisition of Shares and Takeovers 405
identified date, and to the custodian of shares underlying depository receipts of the Target Company
within maximum 7 working days from the date of receipt of communication of comments from SEBI or
where no comments are offered by SEBI, within 7 working days from the expiry 15 working days from
the date of receipt of draft letter of offer by SEBI. [Regulation 18(2)]
9. Upward Revision: The Acquirer is allowed to make upward revision to the Offer Price and the number
of shares sought to be acquired under the Open Offer, at any time prior to the commencement of last
three working days before the initiation of the tendering period. [Regulation 18(4)]
10. Recommendation by the Independent Directors: On the receipt of detailed public statement, the
Board of Directors of the Target Company shall constitute a committee of Independent Directors to
provide reasoned recommendations on the Open Offer to the shareholders of the Target Company and
such recommendations shall be published at least two working days before the commencement of the
tendering period, in the same newspapers where the public announcement of the Open Offer was
published and a copy of the same shall also be sent to SEBI, all Stock Exchanges where the shares of
the Target Company are listed and to Manager to the Offer. [Regulation 26 (6) and (7)]
11. Tendering Period: The tendering period shall start not later than 12 working days from the date of
receipt of comments from SEBI and shall remain open for 10 working days. [Regulation 18(8)]
During the Offer
1. Disclosure during Offer Period: The acquirer shall disclose during the offer period every acquisition
made by the acquirer or persons acting in concert with him of any shares of the Target Company to each
of the stock exchanges on which the shares of the Target Company are listed and to the Target Company
at its registered office within twenty-four hours of such acquisition. . [Regulation 18(6)]
2. Restriction on Acquisition of Shares: The acquirer and persons acting in concert with him shall not
acquire or sell any shares of the Target Company during the period between three working days prior to
the commencement of the tendering period and until the expiry of the tendering period. [Proviso of
Regulation 18(6)]
Post Open Offer
1. Completion of requirements: Within 10 working days from the last date of the tendering period, the
acquirer shall complete all requirements as prescribed under these regulations and other applicable
law relating to the Open Offer including payment of consideration to the shareholders who have accepted
the open offer. [Regulation 18(10)]
2. Post offer Advertisement: The acquirer shall issue a post offer advertisement in such form as may be
specified within five working days after the offer period, giving details including aggregate number of
shares tendered, accepted, date of payment of consideration. [Regulation 18 (12)]
3. Report to SEBI by Manager to the Offer: The manager to the Open Offer shall file a report with SEBI
within fifteen working days from the expiry of the tendering period, in such form as may be specified,
confirming status of completion of various Open Offer requirements. [Regulation 27 (7)]
4. Restriction on acquisition: The acquirer shall not acquire any shares of the Target Company for a
period of 26 weeks after the tendering period at a price higher than the offer price paid except by way
of another Open Offer, or SEBI Delisting Regulations, or open market purchases made in the ordinary
course on the stock exchanges, not being negotiated acquisition of shares of the Target Company
whether by way of bulk deals, block deals or in any other form. [Regulation 8(10)]
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ACTIVITY CHART FOR OPEN OFFER
S.
No.
Particulars
Timeline
(Legal)
1.
Public announcement through notice to Stock Exchange
X
2.
Opening of Bank Escrow & Securities Escrow
3.
Deposit of Escrow Amount in Escrow A/c
4.
Detailed Public Statement in Newspaper
X+5 Working Days
5.
Draft letter of offer to be submitted to SEBI and sent to Target Company
X+10 Working Days
6.
Receipt of comments from SEBI on draft letter of offer
X+25 Working Days
7.
Identified date for determining name of shareholders to whom the
letter of offer should be sent
X+27 Working Days
8.
Dispatch of the Letter of Offer to shareholder
X+32 Working Days
9.
Upward revision in offer
X+33 Working Days
10.
Comments on the offer by independent directors of Target Company
X+34 Working Days
11.
Issue of advertisement announcing the schedule of activities for open offer
X+36 Working Days
12.
Date of opening of offer
X+37 Working Days
13.
Date of closing of offer
X+46 Working Days
14.
Payment of Consideration
X+56 Working Days
15.
Filing of report to SEBI by Merchant Banker
X+61 Working Days
X+2 Working Days
(This is the minimum timeline as prescribed under SEBI Takeover Regulations, 2011)
PUBLIC ANNOUNCEMENT
SEBI (SAST) Regulation, 2011 (SAST Regulations) provides that whenever an Acquirer acquires the shares or
voting rights of the Target Company in excess of the limits prescribed under Regulation 3 and 4, then the
Acquirer is required to make an Open Offer to the shareholder of the Target Company. During the process of an
Open Offer, the Acquirer is required to give Public Announcement and publish Detailed Public Statement.
Regulation 14 of SAST Regulations prescribed the manner in which Public Announcement and Detailed Public
Statement is to be made.
Submission of Public Announcement (PA)
Within the time specified under Regulation 13 of SAST Regulations, the Public Announcement shall be sent to
all the stock exchanges on which the shares of the Target Company are listed. Further, a copy of the same shall
also be sent to SEBI and to the Target Company at its registered office within one working day of the date of the
public announcement.
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Substantial Acquisition of Shares and Takeovers 407
Submission of PA
Stock Exchanges
SEBI (Board)
Target Company
Publication and Submission of Detailed Public Statement
A detailed public statement shall be published by the acquirer through the manager to the open offer not later
than five working days of the public announcement in the following newspaper:
PUBLICATION OF DETAILED PUBLIC STATEMENT
One English national
daily with wide circulation
One Hindi national
daily with wide circulation
One Regional language daily
with wide circulation at the place
where the registered office of the
target company is situated
One Regional language daily of the stock exchange
where the maximum volume of trading in the shares
of the target company are recorded during the sixty
trading days preceding the date of the public announcement
Simultaneously with the publication in the newspaper, a copy of the same shall be sent to:
1. SEBI
2. All the Stock Exchanges on which the shares of the Target Company are listed; and
3. The Target Company at its registered office.
Contents of Public Announcement and Detailed Public Statement
The public announcement shall contain such information as may be specified, including the following(a) name and identity of the acquirer and persons acting in concert with him;
(b) name and identity of the sellers, if any;
(c) nature of the proposed acquisition such as purchase of shares or allotment of shares, or any other
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means of acquisition of shares or voting rights in, or control over the target company;
(d) the consideration for the proposed acquisition that attracted the obligation to make an open offer for
acquiring shares, and the price per share, if any;
(e) the offer price, and mode of payment of consideration; and
(f) offer size, and conditions as to minimum level of acceptances, if any.
The detailed public statement pursuant to the public announcement shall contain such information as may be
specified in order to enable shareholders to make an informed decision with reference to the open offer.
NOTE: The public announcement of the open offer, the detailed public statement, and any other statement,
advertisement, circular, brochure, publicity material or letter of offer issued in relation to the acquisition
of shares under these regulations shall not omit any relevant information, or contain any misleading
information.
Procedure of Filing PA and DPS
Submission of Public Announcement in accordance with the manner prescribed with the
Stock Exchange(s), SEBI and at the registered office of the Target Company within the time specified
Stock Exchange shall disseminate such PA on its website forthwith
Publication of Detailed Public Statement in the Newspapers prescribed within the specified time
Submission of the copy of the Detailed Public Statement with the SEBI,
Stock Exchange(s) and at the registered office of the Target Company
OFFER PRICE
Offer price is the price at which the acquirer announces to acquire shares from the public shareholders under
the open offer. The offer price shall not be less than the price as calculated under Regulation 8 of the SAST
Regulations, 2011 for frequently or infrequently traded shares.
If the target company’s shares are frequently traded then the open offer price for acquisition of shares under the
minimum open offer shall be highest of the following :
– Highest negotiated price per share under the share purchase agreement (“SPA”) triggering the offer;
– Volume weighted average price of shares acquired by the acquirer during 52 weeks preceding the
public announcement (“PA”),
– Highest price paid for any acquisition by the acquirer during 26 weeks immediately preceding the PA;
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Substantial Acquisition of Shares and Takeovers 409
– Volume weighted average market price for sixty trading days preceding the PA.
If the target company’s shares are infrequently traded then the open offer price for acquisition of shares under
the minimum open offer shall be highest of the following:
– Highest negotiated price per share under the share purchase agreement (“SPA”) triggering the offer;
– Volume weighted average price of shares acquired by the acquirer during 52 weeks preceding the PA;
– Highest price paid for any acquisition by the acquirer during 26 weeks immediately preceding the PA;
The price determined by the acquirer and the manager to the open offer after taking into account valuation
parameters including book value, comparable trading multiples, and such other parameters that are customary
for valuation of shares of such companies.
It may be noted that SEBI may at the expense of the acquirer, require valuation of shares by an independent
merchant banker other than the manager to the offer or any independent chartered accountant in practice
having a minimum experience of 10 years.
The shares of the target company will be deemed to be frequently traded if the traded turnover on any stock
exchange during the 12 calendar months preceding the calendar month, in which the PA is made, is at least
10% of the total number of shares of the target company. If the said turnover is less than 10%, it will be
deemed to be infrequently traded.
PROVISION OF ESCROW
Not later than two working days prior to the date of the detailed public statement of the open offer for acquiring
shares, the acquirer shall create an escrow account towards security for performance of his obligations under
these regulations and deposit in escrow account such aggregate amount as per the following scale:
Sl.
Consideration payable
Escrow Amount
No. under the Open Offer
(a)
On the first five hundred crore rupees
an amount equal to twenty-five per cent of the consideration
(b)
On the balance consideration
an additional amount equal to ten per cent of the balance
consideration
However, where an open offer is made conditional upon minimum level of acceptance, hundred percent of the
consideration payable in respect of minimum level of acceptance or fifty per cent of the consideration payable
under the open offer, whichever is higher, shall be deposited in cash in the escrow account.
The escrow account may be in the form of,(a) cash deposited with any scheduled commercial bank;
(b) bank guarantee issued in favour of the manager to the open offer by any scheduled commercial bank; or
(c) deposit of frequently traded and freely transferable equity shares or other freely transferable securities
with appropriate margin.
MODE OF PAYMENT
The offer price may be paid, –
(a) in cash;
(b) by issue, exchange or transfer of listed shares in the equity share capital of the acquirer or of any person
acting in concert;
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(c) by issue, exchange or transfer of listed secured debt instruments issued by the acquirer or any person
acting in concert with a rating not inferior to investment grade as rated by a credit rating agency registered
with SEBI;
(d) by issue, exchange or transfer of convertible debt securities entitling the holder thereof to acquire listed
shares in the equity share capital of the acquirer or of any person acting in concert; or
(e) a combination of the mode of payment of consideration stated in clause (a), clause (b), clause (c) and
clause (d):
Where any shares have been acquired or agreed to be acquired by the acquirer and persons acting in concert
with him during the fifty-two weeks immediately preceding the date of public announcement constitute more
than ten per cent of the voting rights in the target company and has been paid for in cash, the open offer shall
entail an option to the shareholders to require payment of the offer price in cash, and a shareholder who has not
exercised an option in his acceptance shall be deemed to have opted for receiving the offer price in cash. In
case of revision in offer price the mode of payment of consideration may be altered subject to the condition that
the component of the offer price to be paid in cash prior to such revision is not reduced
DISCLOSURES
In SEBI Takeover Regulations, 2011, the obligation to give the disclosures on the acquisition of certain limits is
only on the acquirer and not on the Target Company. Further as against the Open Offer obligations where the
individual shareholding is also to be considered, the disclosure shall be of the aggregated shareholding and
voting rights of the acquirer or promoter of the target company or every person acting in concert with him.
Regulation
No.
Triggering Point
To and by whom
Time Period
EVENT BASED DISCLOSURES
29(1)
Acquisition of 5% or more
shares or voting rights
To the Target Company and
Stock Exchange by the
Acquirer
Within 2 working days of:
(a) Receipt of intimation of
allotment of shares; or
(b) The acquisition of shares
or voting rights.
29(2)
Acquirer already holding
5% or more shares or
voting rights, On
acquisition/ disposal of
2% or more shares or
voting rights.
To the Target Company and
Stock Exchange by the
Acquirer/Seller
Within 2 working days of such
acquisition/disposal.
CONTINUAL DISCLOSURES
30(1)
Any person holding 25% or
more shares or voting rights
Target Company & Stock
Exchange by such person
Within 7 working days from
the end of each financial
year
30(2)
Promoter /Person having
control over the Target
Company
Target Company & Stock
Exchange by Promoter
Within 7 working days from
the end of each financial
year
Lesson 14
Substantial Acquisition of Shares and Takeovers 411
DISCLOSURE OF PLEDGED/ENCUMBERED SHARES
31(1)
On the encumbrance of
shares by the promoter
or person acting in
Concert with him
Target Company & Stock
Exchange by the promote
Within 7 working days from
the date of creation of
encumbrance
31(2)
On the invocation of or
release of such
encumbrance by the
promoter
Target Company & Stock
Exchange by the promoter
Within 7 working days from
the date of invocation of
encumbrance
Points to Remember
The important point to be noted here is that the acquisition and holding of any convertible security shall also
be regarded as shares and disclosures of such acquisition and holdings is also to be made accordingly.
EXEMPTIONS
Regulation 10 of the SEBI Takeover Regulations, 2011 provides the Acquirer automatic exemptions from the
applicability of making Open Offer to the shareholders of the Target Company in respect of certain acquisitions
subject to the compliance of certain conditions specified therein.
Further Regulation 11 of SEBI Takeover Regulations, 2011 provides the provisions whereby the acquirer can
apply to SEBI for availing the exemption from the Open Offer obligations and the Target Company can apply for
relaxation from strict compliance with any procedural requirement relating to Open Offer as provided under
Chapter III and IV of these regulations.
Exemptions
Automatic Exemptions
(Regulation 10)
Exemptions by SEBI
(Regulation 11)
Regulation 11(1)
Exemption from the open
offer obligation
Regulation 11(2)
Relaxation from Procedural
Requirements relating to
open offer
REGULATION 10 - AUTOMATIC EXEMPTIONS
Some of the important exemptions provided therein along with their conditions for exemption are detailed below:
The following acquisitions shall be exempt from the obligation to make an open offer under Regulation 3 and
Regulation 4:
(1) (a) acquisition pursuant to inter se transfer of shares amongst qualifying persons, being, –
(i) immediate relatives;
(ii) persons named as promoters in the shareholding pattern filed by the target company in terms of the
listing agreement or these regulations for not less than three years prior to the proposed acquisition;
412 PP-CC&MM
(iii) a company, its subsidiaries, its holding company, other subsidiaries of such holding company, persons
holding not less than fifty per cent of the equity shares of such company, other companies in which such
persons hold not less than fifty per cent of the equity shares, and their subsidiaries subject to control
over such qualifying persons being exclusively held by the same persons;
(iv) persons acting in concert for not less than three years prior to the proposed acquisition, and disclosed
as such pursuant to filings under the listing agreement;
(v) shareholders of a target company who have been persons acting in concert for a period of not less than
three years prior to the proposed acquisition and are disclosed as such pursuant to filings under the
listing agreement, and any company in which the entire equity share capital is owned by such shareholders
in the same proportion as their holdings in the target company without any differential entitlement to
exercise voting rights in such company:
However, for purposes of availing of the exemption under this clause, –
(i) If the shares of the target company are frequently traded, the acquisition price per share shall not be
higher by more than twenty-five per cent of the volume-weighted average market price for a period of
sixty trading days preceding the date of issuance of notice for the proposed inter se transfer, as
traded on the stock exchange where the maximum volume of trading in the shares of the target
company are recorded during such period, and if the shares of the target company are infrequently
traded, the acquisition price shall not be higher by more than twenty-five percent of the price determined;
and
(ii) the transferor and the transferee shall have complied with applicable disclosure requirements set out in
these regulations.
(b) acquisition in the ordinary course of business by, –
(i) an underwriter registered with SEBI by way of allotment pursuant to an underwriting agreement in terms
of the SEBI ICDR Regulations, 2009;
(ii) a stock broker registered with SEBI on behalf of his client in exercise of lien over the shares purchased
on behalf of the client under the bye-laws of the stock exchange where such stock broker is a member;
(iii) a merchant banker registered with SEBI or a nominated investor in the process of market making or
subscription to the unsubscribed portion of issue in terms of Chapter XB of SEBI ICDR Regulations,
2009;
(iv) any person acquiring shares pursuant to a scheme of safety net in terms of SEBI ICDR Regulations,
2009;
(v) a merchant banker registered with SEBI acting as a stabilising agent or by the promoter or pre-issue
shareholder in terms of SEBI ICDR Regulations, 2009;
(vi) by a registered market-maker of a stock exchange in respect of shares for which he is the market maker
during the course of market making;
(vii) a Scheduled Commercial Bank, acting as an escrow agent; and
(viii) invocation of pledge by Scheduled Commercial Banks or Public Financial Institutions as a pledgee.
(c) acquisitions at subsequent stages, by an acquirer who has made a public announcement of an open offer for
acquiring shares pursuant to an agreement of disinvestment, as contemplated in such agreement:
However, (i) both the acquirer and the seller are the same at all the stages of acquisition; and (ii) full disclosures
of all the subsequent stages of acquisition, if any, have been made in the public announcement of the open offer
and in the letter of offer.
Lesson 14
Substantial Acquisition of Shares and Takeovers 413
(d) acquisition pursuant to a scheme, –
(i) made under section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985 or any statutory
modification or re-enactment thereto;
(ii) of arrangement involving the target company as a transferor company or as a transferee company, or
reconstruction of the target company, including amalgamation, merger or demerger, pursuant to an
order of a court or a competent authority under any law or regulation, Indian or foreign; or
(iii) of arrangement not directly involving the target company as a transferor company or as a transferee
company, or reconstruction not involving the target company’s undertaking, including amalgamation,
merger or demerger, pursuant to an order of a court or a competent authority under any law or regulation,
Indian or foreign, subject to, –
(A) the component of cash and cash equivalents in the consideration paid being less than twenty five
per cent of the consideration paid under the scheme; and
(B) where after implementation of the scheme of arrangement, persons directly or indirectly holding at
least thirty-three per cent of the voting rights in the combined entity are the same as the persons
who held the entire voting rights before the implementation of the scheme.
(e) acquisition pursuant to the provisions of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002;
(f) acquisition pursuant to the provisions of SEBI (Delisting of Equity Shares) Regulations, 2009;
(g) acquisition by way of transmission, succession or inheritance;
(h) acquisition of voting rights or preference shares carrying voting rights arising out of the operation of subsection
(2) of section 87 of the Companies Act, 1956.
(2) The acquisition of shares of a target company, not involving a change of control over such target company,
pursuant to a scheme of corporate debt restructuring in terms of the Corporate Debt Restructuring Scheme
notified by the Reserve Bank of India vide Circular No. B.P.BC 15/21.04, 114/2001 dated August 23, 2001, or
any modification or re-notification thereto provided such scheme has been authorised by shareholders by way
of a special resolution passed by postal ballot, shall be exempted from the obligation to make an open offer
under regulation 3.
(3) An increase in voting rights in a target company of any shareholder beyond the limit attracting an obligation
to make an open offer under sub-regulation (1) of regulation 3, pursuant to buy-back of shares shall be exempt
from the obligation to make an open offer provided such shareholder reduces his shareholding such that his
voting rights fall to below the threshold referred to in sub-regulation (1) of regulation 3 within ninety days from the
date on which the voting rights so increase.
(4) The following acquisitions shall be exempt from the obligation to make an open offer under sub-regulation (2)
of regulation 3, –
(a) acquisition of shares by any shareholder of a target company, upto his entitlement, pursuant to a rights
issue;
(b) acquisition of shares by any shareholder of a target company, beyond his entitlement, pursuant to a
rights issue, subject to fulfillment of the following conditions, –
(i) the acquirer has not renounced any of his entitlements in such rights issue; and
(ii) the price at which the rights issue is made is not higher than the ex-rights price of the shares of the
target company, being the sum of, –
414 PP-CC&MM
(A) the volume weighted average market price of the shares of the target company during a period
of sixty trading days ending on the day prior to the date of determination of the rights issue
price, multiplied by the number of shares outstanding prior to the rights issue, divided by the
total number of shares outstanding after allotment under the rights issue.
However, such volume weighted average market price shall be determined on the basis of
trading on the stock exchange where the maximum volume of trading in the shares of such
target company is recorded during such period; and
(B) the price at which the shares are offered in the rights issue, multiplied by the number of shares
so offered in the rights issue divided by the total number of shares outstanding after allotment
under the rights issue:
(c) increase in voting rights in a target company of any shareholder pursuant to buy-back of shares.
However, (i) such shareholder has not voted in favour of the resolution authorising the buyback of securities under section 77A of the Companies Act, 1956; (ii) in the case of a shareholder
resolution, voting is by way of postal ballot; (iii) where a resolution of shareholders is not required
for the buyback, such shareholder, in his capacity as a director, or any other interested director
has not voted in favour of the resolution of the board of directors of the target company authorising
the buy-back of securities under section 77A of the Companies Act, 1956; and
(iii) the increase in voting rights does not result in an acquisition of control by such shareholder over the
target company. However, where the aforesaid conditions are not met, in the event such shareholder
reduces his shareholding such that his voting rights fall below the level at which the obligation to
make an open offer would be attracted under sub-regulation (2) of regulation 3, within ninety days
from the date on which the voting rights so increase, the shareholder shall be exempt from the
obligation to make an open offer;
(d) acquisition of shares in a target company by any person in exchange for shares of another target
company tendered pursuant to an open offer for acquiring shares under these regulations;
(e) acquisition of shares in a target company from state-level financial institutions or their subsidiaries or
companies promoted by them, by promoters of the target company pursuant to an agreement between
such transferors and such promoter;
(f) acquisition of shares in a target company from a venture capital fund or foreign venture capital investor
registered with the Board, by promoters of the target company pursuant to an agreement between such
venture capital fund or foreign venture capital investor and such promoters.
(5) In respect of acquisitions under clause (a) of sub-regulation (1), and clauses (e) and (f) of sub-regulation (4),
the acquirer shall intimate the stock exchanges where the shares of the target company are listed, the details of
the proposed acquisition in such form as may be specified, at least four working days prior to the proposed
acquisition, and the stock exchange shall forthwith disseminate such information to the public.
(6) In respect of any acquisition made pursuant to exemption provided for in this regulation, the acquirer shall file
a report with the stock exchanges where the shares of the target company are listed, in such form as may be
specified not later than four working days from the acquisition, and the stock exchange shall forthwith disseminate
such information to the public.
(7) In respect of any acquisition of or increase in voting rights pursuant to exemption provided for in clause (a) of
sub-regulation (1), sub-clause (iii) of clause (d) of sub-regulation (1), clause (h) of sub-regulation (1), subregulation (2), sub-regulation (3) and clause (c) of sub-regulation (4), clauses (a), (b) and (f) of sub-regulation
(4), the acquirer shall, within twenty-one working days of the date of acquisition, submit a report in such form as
may be specified along with supporting documents to SEBI giving all details in respect of acquisitions, along with
a non-refundable fee of rupees twenty five thousand by way of a , banker’s cheque or demand draft payable in
Mumbai in favour of SEBI.
Lesson 14
Substantial Acquisition of Shares and Takeovers 415
REGULATION 11 - EXEMPTION BY SEBI
Regulation 11(1) provides that on an application being made by the acquirer in writing giving the details of the
proposed acquisition and grounds on which the exemption is sought along with duly sworn affidavit, SEBI may
grant exemption to the acquirer from the Open Offer obligations subject to the compliance with such conditions
as it deems fits. For instance, in case where the exemptions is sought from the Open Offer obligations which has
been triggered pursuant to the issue of shares by way preferential allotment, SEBI may require that the approval
of shareholders should be obtained by way of postal ballot. Further, along with the application, the acquirer is
also required to pay a non refundable fee of ` 50,000 by way of banker‘s cheque or demand draft in payable in
favour of Mumbai.
However, it is to be noted that the Acquirer is not exempted from making other compliances related to the
disclosure requirements as provided under regulation 29, 30 and 31 of the SEBI Takeover Regulations, 2011.
Regulation 11(2) provides that the acquirer may also be granted the relaxation from the procedural requirements
relating to Open Offer by SEBI on an application being made in writing by the Target Company giving the details
of the proposed acquisition and grounds on which the relaxation is sought alongwith duly sworn affidavit. The
purpose and intent of regulations is to safeguard the interest of investor and not to act as an impediment in the
furtherance of their interest.
The SEBI has been given the power to relax the procedural requirements under Chapter III and IV, subject to
such conditions as it deems fit on being satisfied that:
I. The Central Government or State Government or any other regulatory authority has removed the Board
of Directors of the Target Company and has appointed new directors to hold office as directors under
any law for the time being in force if:
(a) such Board of Directors has devised a plan which provides transparent, open, and competitive
process for acquisition of shares or voting rights or control over the Target Company to secure the
smooth and continued operation of the target company in the interests of all stakeholders of the
target company and such plan does not further the interests of any particular acquirer;
(b) The conditions and requirements of the competitive process are reasonable and fair;
(c) The process adopted by the Board provides for details including the time when the public offer
would be made, completed and the manner in which the change in control would be effected;
II. The provisions of Chapter III and Chapter IV are likely to act as impediment to implementation of the
plan of the Target Company and exemption from strict compliance with one or more of such provisions
are in interest of public, investors and the securities market.
416 PP-CC&MM
Procedure for filing the application under Regulation 11
File an application with SEBI supported by duly sworn affidavit giving the details of the proposed
acquisition and the grounds on which the exemption has been sought along with non-refundable fee of
` 50,000 by way of a banker’s cheque or demand draft payable in Mumbai in favour of SEBI
SEBI may constitute a panel of experts to make recommendations on the application
made under Regulation 11(1)
SEBI will give reasonable opportunity of being heard to the concerned parties
After considering the recommendation of the panel and giving the reasonable opportunity of being heard
to the concerned parties, SEBI shall pass an order giving the reasons for accepting or rejecting the
applications as expeditiously as possible
SEBI shall publish the order passed by it on its official website
LESSON ROUND UP
– SEBI Takeover Regulations, 2011, aims at protecting interest of the investors in securities of a listed
company providing amongst others, an opportunity for the public shareholders to exit where there is a
substantial acquisition of shares or voting rights or control over a listed company, consolidation of
holdings by existing shareholders and related disclosures and penalties for non- compliance etc.
– The Takeover Regulations, 1997 stand repealed from October 22, 2011, i.e. the date on which SEBI
(SAST)Regulations, 2011 come into force.
– SEBI Takeover Regulations, 2011 provides certain trigger events wherein the Acquirer is required to
give Open Offer to the shareholders of the Target Company to provide them exit opportunity.
– Regulation 6 of the Takeover Regulations provides the threshold and conditions for making the Voluntary
Open Offer.
– An offer in which the acquirer has stipulated a minimum level of acceptance is known as a conditional
offer.
– Regulation 10 & 11 provides for automatic exemptions and exemptions by SEBI.
– The public announcement shall be sent to all the stock exchanges on which the shares of the target
company are listed, and the stock exchanges shall forthwith disseminate such information to the public.
Lesson 14
Substantial Acquisition of Shares and Takeovers 417
– In SEBI Takeover Regulations, 2011, the obligation to give the disclosures on the acquisition of certain
limits is only on the acquirer and not on the Target Company.
SELF TEST QUESTIONS
(These are meant for re-capitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is the meaning of Person Acting in Concert under SEBI Takeover Regulations, 2011?
2. What are the conditions for making Voluntary open offer?
3. What are the provisions relating to Public Announcement under the Takeover Regulations?
4. Discuss about the continuous Disclosure required to be made under these Regulations.
5. Briefly explain the conditions on which SEBI can grant exemption to an acquirer.
418 PP-CC&MM
Report of the Committees on Capital Market 419
REPORT OF THE COMMITTEES ON CAPITAL MARKET
INTRODUCTION
The Capital Market is a dynamic market and ever evolving. To keep pace with the developments of Capital
Market in the country, the Government regularly comes up with a consultative process to collate the views of
market experts and various stakeholders through the respective regulators towards formulation of industry
friendly regulatory prescriptions. In this line various Committees had been formed from time to time by the
Government to deal with particular areas or issues or concern which is outdated and crying for reform. The
Committee carries out research, investigation, empirical study and analyse the objective for which it is established.
After completion of its rigorous task assigned to it by the Government through the respective regulator, the
Committee formed an opinion and prepare a fair and unbiased report in line with the domestic as well as
international development/practice which suit the Indian situation, meet the stakeholder expectations and can
be effectively applied to various development schemes which would bolster the Indian Economy and the general
public will get benefits. The gist of Recommendation of some of the eminent Committees of recent origin has
been discussed below for the easy understanding of the students.
REPORT OF FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION
Financial Sector Legislative Reforms Commission (FSLRC) was set up by the Indian Government in pursuance
of the announcement made in Union Budget 2010-11, to help rewriting and harmonizing the financial sector
legislation, rules and regulations so as to address the contemporaneous requirements of the sector. The resolution
notifying the FSLRC was issued on March 24, 2011. FSLRC had a two year term. The Commission was chaired
by Supreme Court Justice (Retired) B. N. Srikrishna, and had ten members with expertise in the fields of finance,
economics, law and other relevant fields. The secretariat was placed at National Institute of Public Finance and
Policy (NIPFP). Secretariat consisted of a Secretary at the level of Joint Secretary to the Government of India
and other officials and support staff.
The establishment of the FSLRC is the result of a realisation that the institutional foundation (laws and
organizations) of the financial sector in India needs to be looked afresh to assess its soundness for addressing
the emerging requirements in a rapidly changing world. Today, India has over 60 Acts and multiple Rules/
Regulations that govern the financial sector. Many of them have been written several decades back. For example,
the RBI Act and the Insurance Act are of 1934 and 1938 vintage respectively and the Securities Contract
Regulation Act, which governs securities transactions, was legislated in 1956 when derivatives and statutory
regulators were unknown in the financial system. A Large number of amendments were, therefore, made in
these Acts and regulations at different points of time to address various needs. But these have also resulted in
their fragmentation, often adding to the ambiguity and complexity of regulations in the financial sector.
The Financial Sector Legislative Reforms Commission (FSLRC), constituted by the Ministry of Finance was
asked to comprehensively review and redraw the legislations governing India’s financial system. According to
the FSLRC, the current regulatory architecture is fragmented and is fraught with regulatory gaps, overlaps,
inconsistencies and arbitrage. To address this, the FSLRC submitted its report to the Ministry of Finance on
March 22, 2013, containing an analysis of the current regulatory architecture and a draft Indian Financial Code
to replace the bulk of the existing financial laws which is summarised as below.
The Draft Indian Financial Code
The draft Code is a non-sectoral, principles-based law bringing together laws governing different sectors of the
financial system. It addresses nine components, which the FSLRC believes any financial legal framework should
address:
Consumer protection: Regulators should ensure that financial firms are doing enough for consumer protection.
420 PP-CC&MM
The draft Code establishes certain basic rights for all financial consumers and creates a single unified Financial
Redressal Agency (FRA) to serve any aggrieved consumer across sectors. In addition, the FSLRC considers
competition an important aspect of consumer protection and envisages a detailed mechanism for co-operation
between regulators and the Competition Commission.
Micro-prudential regulation: Regulators should monitor and reduce the failure probability of a financial firm.
The draft Code specifies five powers for micro-prudential regulation: regulation of entry, regulation of risk-taking,
regulation of loss absorption, regulation of governance and management, and monitoring/supervision.
Resolution: In cases of financial failure, firms should be swiftly and sufficiently wound up with the interests of
small customers. A unified resolution corporation, dealing with various financial firms, should be created to
intervene when a firm is close to failure. The resolution corporation would charge a fee to all firms based on the
probability of failure.
Capital controls: While the FSLRC does not hold a view on the sequencing and timing of capital account
liberalisation, any capital controls should be implemented on sound footing with regards to public administration
and law. The FSLRC sees the Ministry of Finance creating the ‘rules’ for inbound capital flows and the RBI
creating the ‘regulations’ for outbound capital flows. All capital controls would be implemented by the RBI.
Systemic risk: Regulators should undertake interventions to reduce the systemic risk for the entire financial
system. The FSLRC envisages establishing the Financial Stability and Development Council (FSDC) as a statutory
agency taking a leadership role in minimizing systemic risk.
Development and redistribution: Developing market infrastructure and process would be the responsibility of
the regulator while redistribution policies would be under the purview of the Ministry of Finance.
Monetary policy: The law should establish accountability mechanisms for monetary policy. The Ministry of
Finance would define a quantitative target that can be monitored while the RBI will be empowered with various
tools to pursue this target. An executive Monetary Policy Committee (MPC) would be established to decide on
how to exercise the RBI’s powers.
Public debt management: The draft Code establishes a specialised framework for public debt management with
a strategy for long run low-cost financing. The FSLRC proposes a single agency to manage government debt.
Contracts, trading and market abuse: The draft Code establishes the legal foundations for contracts, property
and securities markets.
Regulators
With respect to regulators, the FSLRC stresses the need for both independence and accountability. The draft
Code adopts ownership neutrality whereby the regulatory and supervisory treatment of a financial firm is the
same whether it is a private or public company.
The draft Code seeks to move away from the current sector-wise regulation to a system where the RBI regulates
the banking and payments system and a Unified Financial Agency subsumes existing regulators like SEBI,
IRDA, PFRDA and FMC, to regulate the rest of the financial markets.
Regulators will have an empowered board with a precise selection-cum-search process for appointment of
members. The members of a regulatory board can be divided into four categories: the chairperson, executive
members, non-executive members and Government nominees. In addition, there is a general framework for
establishing advisory councils to support the board. All regulatory agencies will be funded completely by fees
charged to the financial system. Finally, the FSLRC envisages a unified Financial Sector Appellate Tribunal
(FSAT), subsuming the existing Securities Appellate Tribunal (SAT), to hear all appeals in finance.
The following chart provides an outline of the FSLRC’s proposed regulatory architecture.
Report of the Committees on Capital Market 421
Present
Proposed
RBI
RBI
SEBI
FMC
IRDA
PFRDA
United financial
agency (UFA)
Securities Appellate
Tribunal (SAT)
Functions
Monetary policy regulation and
supervision of banks;
regulation and supervision of
payments system.
Regulation and supervision of
all non-bank and payments related
markets
FSAT
Hear appeals against RBI, the
UFA and FRA.
Deposit Insurance and
Credit Guarantee
Corporation (DICGC)
Resolution
Corporation
Resolution work across the entire
financial system
Financial Stability
Development Council (FSDC)
FSDC
Statutory agency for systemic risk
and development.
Debt Management
Agency
An independent debt
management agency.
Financial Redressal Agency
Consumer complaints.
New entities
Report of the Takeover Regulations Advisory Committee under the Chairmanship of Mr. C.
Achuthan
The SEBI Act, 1992 expressly mandated SEBI to regulate substantial acquisition of shares and takeovers by
suitable measures. Accordingly, SEBI provided a legal framework by making the Takeover Regulations of 1994,
which came into force on November 4, 1994.
In November 1995, SEBI appointed a committee to review the Takeover Regulations of 1994 under the chairmanship
of Justice P.N. Bhagwati (the Bhagwati Committee). The said committee submitted its report in January 1997.
Taking into consideration its recommendations, the Takeover Regulations of 1997 were notified by SEBI on February
20, 1997, repealing the Takeover Regulations of 1994. These regulations were periodically amended in response
to events and developments in the marketplace, regulatory and judicial rulings as well as evolving global practices
as considered appropriate. In 2001, a review of the Takeover Regulations of 1997 was carried out by a reconstituted
committee chaired by Justice P.N. Bhagwati. The reconstituted Bhagwati committee submitted its report in May
2002. Based on the same, further amendments were made to the Takeover Regulations of 1997.
There has been a steady increase in corporate restructuring by Indian companies to adapt to the evolving competitive
landscape. Taking into consideration the growing level of M&A activity in India, the increasing sophistication of takeover
market, the decade-long regulatory experience and various judicial pronouncements, it was felt necessary to review
the Takeover Regulations of 1997. Accordingly, SEBI on September 4, 2009, constituted a multi-disciplinary expert
committee, Takeover Regulations Advisory Committee (TRAC) under the chairmanship of Mr. C. Achuthan, to examine
the existing Takeover Code which related to substantial acquisitions and takeovers of Indian listed companies. The
Committee framed the Takeover Regulations keeping in view the interest of public shareholders on one side and that
of the Strategic Investors, Private Equity Players, Target Company and Promoters on the other side.
On 28th July 2011, SEBI took certain key decisions on takeover regulations based on the recommendations of
TRAC. Some of the notable decisions involve increasing the initial open offer trigger threshold, increasing the
mandatory open offer size and determination of the open offer price.
Summary of Key Recommendations of the Committee
Considering the substantive changes recommended upon review of the existing law governing substantial
acquisition of the shares and takeovers, the Committee has recommended comprehensive reform of the
regulations. Some of the main recommendations of the Committee alongwith the Provisions of Takeover
Regulations, 1997 provisions are summarized below:
422 PP-CC&MM
Summary of Recommendations of the Achuthan Committee and the Provisions in the Takeover
Regulations, 1997
S.No.
Issue
1.
Offer Size and Minimum Public
Shareholding Requirement
Provisions of the Takeover
Regulations, 1997
Committee Recommendations
– Offer Size
On acquisition resulting in
triggering regulations 10, 11&
12, the acquirer is mandatorily
required to make an open offer
for a minimum of 20% of the
voting capital (reckoned as on
the 15th day after closure of the
offer).
– Every open offer pursuant to a
substantial acquisition of shares
in, or change of control over a
target company under the
Takeover Regulations ought to
be for every share held by all the
shareholders of the target
company, as on the expected
date of the close of the tendering
period.
–
Minimum
Public
Shareholding Requirement
If the acquisition made pursuant
to an open offer results in the
public shareholding in the target
company falling below the
minimum level required as
per the listing agreement, the
acquirer shall take necessary
steps to facilitate compliance
with the relevant provisions
thereof, within the time period
specified therein.
– Holders of equity linked
instruments eligible to be
converted into equity shares
prior to the aforementioned date
may do so and tender their
equity shares in the open offer.
– The target Company should stand
delisted, should the acquirer have
stated its intention to delist the
target company and the response
to the open offer is such that the
acquirer’s shareholding crosses
the delisting threshold.
– In the event the shares of the
target company stand delisted
pursuant to the open offer, every
shareholder who has not
tendered an acceptance of the
open offer shall be entitled to
require the acquirer to acquire his
shares at the offer price at any
time within a period of twelve
months from the fifteenth day on
which the shares are delisted from
the stock exchanges. This exit
window would also be available
to the holders of all equity- linked
instruments in the company. The
company and the acquirer shall
Report of the Committees on Capital Market 423
take necessary steps to facilitate
the provisions of an option to such
holders to accelerate the
conversion/vesting of such
instruments during the period of
this exit window.
– Should
the
acquirer ’s
shareholding and the delisting
threshold, such acquirer be
given
an
option
to
proportionately reduced would
be those under the open offer,
the agreement (if any) and
immediate past purchases
(except acquisitions due to
allotments by the target
company). Such reductions
would enable the acquirer not to
breach
the
maximum
permissible
non-public
shareholding.
2
Thresholds for Open Offers
– Initial Threshold
If an acquirer acquirers or
agrees to acquire shares or
voting rights such that his voting
rights exceed 15% of the voting
capital of the target company,
he is required to make an open
offer.
– Initial acquisition threshold for a
mandatory open offer be raised
to 25% of the voting capital of
the target company.
– Creeping Acquisitions
If an acquirer already holds
more than 15% but less than
55%, he may acquire additional
shares carrying not more than
5% of the voting rights within a
financial year without having to
make an open offer.
– An acquirer holding 25 % or
more voting rights in a target
company is allowed to acquire
additional voting rights in the
target company up to 5 % within
a financial year, without making
an open offer.
If holding is above 55% but less
than 75%, a one time allowance
to increase their shareholding by
5% through market purchases
or pursuant to a Buy back by the
target Company, without having
to make a open offer, has been
permitted, provided that post
acquisition holding of acquirer
does not go beyond 75%.
424 PP-CC&MM
– Voluntary Offers
3.
4.
Control
Offer Price
Consolidation of shareholding
by an acquirer who is desirous
of maximizing his shareholding
without breaching the minimum
public
shareholding
requirements. The offer size for
an open offer under this
provision is the lower of 20%
or the maximum permissible
acquisition without breaching
the
minimum
public
shareholding requirement.
– Acquirers collectively holding
shares entitling them to exercise
25% or more voting rights in the
target company may voluntarily
make an open offer to
consolidate their shareholdings.
Control shall include the right
to appoint majority of directors
or to control the management
or policy decisions exercisable
by a person or persons acting
individually or in concert,
directly or indirectly, including
by virtue of their shareholding
or management rights or
shareholder agreements or
voting agreements or in any
other manner.
– Definition of “Control” be
modified to include “ability” in
addition to “right” to appoint
majority of the directors or to
control the management or
policy decisions would constitute
control.
Provides the parameters to be
considered for determining the
minimum offer price depending
on whether or not the shares
of the target company are
“frequently traded” (shares
which have annualized trading
volume of 5% or more of the
listed share capital during a
period of 6 calendar months
preceding the month in which
the public announcement is
made). For “infrequently
traded” shares, the Takeover
Regulations require the
computation of the offer price
on the basis of financial
parameters such as return on
net worth, industry priceearnings multiples and the like,
– The minimum offer price for
direct acquisitions should be the
highest of:
– The Committee proposed a
minimum open offer size of 10%
consistent with the rationale of
consolidation option outside the
creeping route. Voluntary offers
should not, however, be of a size
that could lead to breach of the
maximum permissible on-public
shareholding.
– A director or officer of the target
company would not be regarded
as being in control merely by
virtue of holding such position.
(a) The highest negotiated price
per share of the target company
for any acquisition under the
agreement attracting the
obligation to make a public
announcement of an open offer.
(b) The volume- weighted
average price paid or payable for
any acquisition, whether by the
acquirer or by any person acting
in concert with him during the
fifty-two weeks immediately
preceding the date of the public
announcement ; and
(c) the highest price paid or
payable for any acquisition,
Report of the Committees on Capital Market 425
apart from any price actually
paid by the acquirer or persons
acting in concert during the look
back period, or in the
transactions that triggers the
open offer obligation.
The Takeover Regulations also
require addition to the open offer
price, of any amount paid
towards non-compete fee in
excess of 25% of the open offer
price.
whether by the acquirer or by
any person acting in concert with
him during the twenty-six weeks
immediately preceding the date
of the public announcement; and
(d) The volume- weighted
average market price, for
frequently traded shares, during
60 trading days immediately
preceding the date of the public
announcement, computed
based on market prices on the
stock exchange where the
shares of the company are most
frequently traded during the
period.
– Frequently traded shares having
a trading volume of 10% or more
of the total number of the shares
during a period of 12 calendar
months preceeding the month in
which the public announcement
is made.
– Clause relating to non-compete
fee be deleted from the Takeover
Regulations,
and
any
considerations paid in any form
inclusive of all ancillary and
collateral agreements shall form
part of the negotiated price.
5.
Indirect Acquisitions
– Trigger for indirect
acquisitions
The acquirer has to make an
open offer for shares of the
target company when there is
direct or indirect change of
control of the target company
irrespective of any direct
acquisition of shares of the
target company. The regulations
also provide for deferment of
open offer obligations till
consummation of the original
transaction.
– Irrespective of whether the target
company is material to the
parent transaction, open offer
obligations have to be triggered.
Where a change in control over
the target company occurs,
shareholders of the target
company ought to rightfully get
an adequate exit opportunity.
– Timing and offer Price
In case of indirect acquisition of
shares or change of control, a
public announcement may be
– Where the proportionate net
asset value, or the sales
turnover, or the market
426 PP-CC&MM
made by the acquirer at any
time from the date of the initial
announcement of the intention
to acquire or entering in to the
acquisition agreement, until
completion of three months
after the consummation of
such acquisition or change in
control or restructuring of the
parent or the company holding
shares of or control over the
target company.
Takeover Regulations currently
do not differentiate between
open offers arising due to
direct acquisitions vis-a-vis
indirect acquisitions for
computation of offer price and
the same offer price formula
prescribed
for
direct
acquisitions is used for indirect
acquisitions as well, and the
practice is to compute the offer
price as of the date of the
announcement of primary
acquisition and as of the date
of the public announcement for
the target company, whichever
is higher.
capitalization of the indirectlyacquired listed company
represents more than 80 % of the
net asset value, sales turnover
or the deal value for the parent
business or company, the
acquirer must specify the value
of the stake in the Indian
company and the basis of such
valuation that would have been
factored in, and the Takeover
Regulations would treat such
acquisitions as if they were direct
acquisitions in all respects.
– For indirectly acquired target
companies, the minimum offer
price ought to be the highest of:
(a) The highest negotiated price
per share, if any, of the target
company for any acquisition
under the agreement attracting
the obligation to make a public
announcement of an open offer;
i. Where the proportionate net
asset value, or the sales turnover,
or the market capitalization of the
indirectly acquired listed company
represents more than 15 % of the
net asset value, or the sales
turnover, or the deal value for the
parent business or company, the
acquirer shall be required to
compute and disclose the per
share value of the target company
taken into account for the
acquisition of the parent business
or company and the basis of such
valuation.
ii. Where the proportionate net
asset value, or the sales turnover,
or the market capitalization of the
indirectly acquired listed company
represents less than 15 % of the
net asset value, or the sales
turnover, or the deal value for the
parent business or company, the
acquirer shall not be necessarily
Report of the Committees on Capital Market 427
required to make the computation
as above, but to factor in the
same if the same has been
carried out.
(b) The volume-weighted average
price paid or payable for any
acquisition, whether by the
acquirer or by any person acting
in concert with him during the fiftytwo weeks immediately preceding
the date on which the intention or
the decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into;
(c) The highest price paid or
payable for any acquisition,
whether by the acquirer or by any
person acting in concert with him
during the twenty-six weeks
immediately preceding the date
on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into ; and
The highest price paid or payable
for any acquisition, whether by the
acquirer or by any person acting
in concert with him between the
date on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into and the date of
the public announcement;
– For frequently traded shares, the
volume-weighted
average
market price on the stock
exchange for a period of 60
trading days preceding the date
on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into, as traded on
the stock exchange where the
maximum volume of trading in
the shares of the target company
428 PP-CC&MM
are recorded during such period.
– The price offered as of the date
of public announcement (to be
calculated as detailed above)
shall have to be increased by 10
% per annum for the period
between the announcement of
primary acquisition and date on
which the detailed public
statement is actually made.
– For transactions where the
proportionate net asset value, or
the sales turnover, or the market
capitalization of the indirectlyacquired listed company
represents more than 80 % of the
net asset value, sales turnover
or the deal value for the parent
business or company, the public
announcement be made on the
earlier of the date on which the
intention or the decision to make
the primary acquisition was
announced in the public domain
or any agreement was entered
into. In all other cases, the public
announcement can be made
within four business days of such
date, and in such cases the
detailed public statement should
be issued within five business
days of the consummation of the
primary acquisition.
6.
Withdrawl of Open Offer
No open offer, once made,
shall be withdrawn except
under
the
following
circumstances:
(a) the statutory approval(s)
required have been
refused;
(b) the sole acquirer, being
a natural person, has
died;
(c) Such circumstances as
in the opinion of SEBI
merit withdrawal.
In addition to the grounds currently
existing, an open offer may be
withdrawn where any condition
stipulated in the agreement for
acquisition attracting the obligation to
make the open offer is not met for
reasons outside the reasonable
control of the acquirer, and such
agreement is rescinded, subject to
such conditions having been
disclosed in the detailed public
statement and the letter of offer.
Report of the Committees on Capital Market 429
7.
Competing Offer
Provide the opportunity to any
person other than the acquirer
to make a competing offer
within 21 days of the public
announcement of the first
offer. Also provide that any
competitive offer by an
acquirer shall be for such
number of shares which, when
taken together with shares
held by him shall be at least
equal to the holding of the first
bidder including the number of
shares for which the present
offer by the first bidder has
been made.
– A competing offer may be made
within 15 business days from the
date of the original detailed public
statement instead of 21 calendar
days from the date of the original
public announcement. No further
offer should be allowed to be
made after the expiry of the said
period of 15 business days until
the completion of all the
competing offers.
– An open offer made by a competing
acquirer shall not be regarded as a
voluntary open offer and therefore
all provisions of Takeover
Regulations, including relating to
offer size, shall apply accordingly.
– An acquirer who has made a
competing offer, shall be entitled
to acquire the shares acquired by
the other competing acquirers in
their respective competing open
offers within 21 business days of
the expiry of the offer period
without attracting an obligation to
make another open offer.
– An acquisition mentioned above
shall not be made at a price
exceeding the offer price in the
competing offer made by the
acquirer who buys shares in such
transaction. Moreover, such an
acquisition ought not to take the
shareholding of the acquirer
beyond the maximum permissible
non-public shareholding limit.
– Other Recommendations:
a. During the pendency of
competing offers, no appointment
of additional directors ought to be
made on the board of directors of
the target company.
b. The ability of an acquirer to
proportionately reduce his
acquisitions such that the holding
does not exceed the maximum
430 PP-CC&MM
permissible
non-public
shareholding ought not to be
available where competing offers
are underway. This is critical to
ensure that competing acquirers
compete on an identical endobjective and shareholders are
truly able to compare them on the
offer price.
c. Unless the open offer first
made is an open offer conditional
as to the minimum level of
acceptances, no open offer
made by a competing acquirer
may be conditional as to the
minimum level of acceptances.
d. The schedule of activities and
the tendering period for all
competing offers shall be carried
out with identical timelines and
the dates for tendering shares
shall be revised to the dates for
tendering shares in acceptance
of the competing offer last made.
8.
9.
Obligation of the Traget
Company
– Material Actions
The target company shall not,
during the offer period sell,
transfer,
encumber
or
otherwise dispose of assets of
the company or its subsidiaries
or enter into any material
contracts.
– The Committee recommends
retaining restrictions on the target
company during the offer period
from carrying out material
transactions outside the ordinary
course of business except with
the consent of the shareholders
through a special resolution. The
Committee recommends that
such restrictions would also
cover the subsidiaries of the
target company, and such
actions in respect of subsidiaries
would also require approval of
the shareholders of the target
company.
Composition of the Board
Till the offer formalities are
completed, the target company
shall be precluded from
inducting any person or person
nominated by the acquirer or
– The acquirer or persons acting
in concert with him may be
represented on the board only
after the expiry of a period of 15
business days from the date of
Report of the Committees on Capital Market 431
belonging to his group into the
board of the target company
other than in cases, where
acquirer
deposits
full
consideration in an escrow
account.
the detailed public statement and
provided the entire consideration
payable under the open offer is
cases, where acquirer deposits
full consideration in an escrow
account. Deposited in cash in
the escrow account required
under the Takeover Regulations
and the offer is not subject to any
conditions other than regulatory
approvals.
– If a competing offer is made,
there ought to be no
appointments of directors during
the offer period, and only casual
vacancies arising out of death or
incapacitation may be filled with
prior approval of shareholders.
10.
Timelines for the Open Offer
process
The Committee discussed the
current timelines for an open
offer under the existing
Takeover Regulations and
reviewed the same with a view
to shorten the timelines.
– A short public announcement
should be made on the same date
as the date of transaction which
triggered the open offer through a
notice to the Stock Exchange,
followed by a detailed public
statement within 5 business days
of the public announcement.
– Post submission of draft letter of
offer, all timelines are dependent
on issue of comments by SEBI,
thus the Committee recommends
to link timelines (post submission
of draft letter of offer) to the date
of receipt of SEBI comments on
the draft letter of offer.
– The letter of offer should be sent
to the most recent set of
shareholders. Therefore, the
Committee recommends that
date for reckoning the
shareholders to whom the letter
of offer shall be sent should be
ten business days prior to
commencement of the tendering
period.
– Most shareholders tender their
shares on the last few days of
432 PP-CC&MM
the offer period, after the date of
final revision in price has been
carried out, and hence the initial
part of the offer period is virtually
redundant. Hence, the overall
time frame of the tendering period
has been reduced to ten business
days, and the last date for upward
revision of offer price has been
moved up to three business days
prior to commencement of the
tendering period.
– Since the last date of upward
revision is prior to the opening of
the open offer, shareholders are
expected to be in receipt of all
information to enable them to
decide on the open offer.
Therefore, there
is
no
requirement to permit withdrawal
of shares tendered in response
to the open offer. This would also
make the process more efficient.
– The acquirer shall issue an
advertisement, 1 business day
prior to the opening of the
tendering period announcing the
schedule and procedure for
tendering acceptances.
– The entire open offer process
from the public announcement to
the payment of consideration can
now be done within fifty seven
business days.
– The
committee
also
recommended revised timelines
and activity chart for an open offer
pursuant to a direct acquisition.
11.
Mode of payment
Offer consideration shall be
payable either :
(a) by way of cash;
(b) by issue, exchange and, or
transfer of shares (other
than preference shares) of
acquirer company, if the
person seeking to acquire
– The offer price may be paid in the
form of cash or securities like
shares, convertibles, secured
debt instruments of the acquirer
or of persons acting in concert
with him or a combination of
these modes.
– To ensure that the equity shares
Report of the Committees on Capital Market 433
the shares is a listed body
corporate; or
(c) by issue, exchange and, or
transfer
of
secured
instruments of acquirer
company with a minimum A‘
grade rating from a Credit
Rating Agency registered
with the Board; or
(d) a combination of clause (a),
(b) or (c).
given in consideration for the
open offer are liquid, eligibility
conditions have been stipulated.
– If shares of the target company
carrying more than 10% voting
rights have been acquired for
cash in the preceding 52 weeks,
shareholders to whom the open
offer is made may opt to receive
the offer price only in cash.
12.
Exemption from open offer
obilgations
The Takeover Regulations
currently provide for fourteen
categories of transactions which
are exempted from the
requirement to make an open
offer subject to satisfying the
conditions specified therein, if
any, without the need to seek
SEBI‘s approval for the same.
Further, for the transactions that
are not covered in the aforesaid
fourteen categories, an
application can be made for
seeking exemption from SEBI.
Such applications are referred to
a takeover panel for its
recommendations.
SEBI
considers the recommendations
received and passes an
appropriate order.
– The Committee has classified the
exemptions on the basis of the
specific charging provisions
which deal with the obligation to
make an open offer, and has
sought to distinguish between
acquisitions involving change in
control and those involving only
consolidation of shareholding.
The deliberations in brief and the
recommendations of the
Committee on the same are
discussed below under separate
heads.
13.
Recommendation by the
independent directors of the
Target Company
The Board of Directors of the
Target Company may, if they so
desire, send their unbiased
comments
and
recommendations on the
offer(s) to the shareholders,
keeping in mind the fiduciary
responsibility of the directors to
the shareholders.
– Independent directors on the
Board of Directors of the target
company ought to make a
reasoned recommendation on
the open offer.
– For the making of such
recommendation, the board of
the target company ought to
appoint a committee of
independent directors with
freedom to consult and engage
external advisors such as
merchant bankers, chartered
accountants and lawyers at the
expense of the target company.
434 PP-CC&MM
– Such committee of independent
directors ought to make a
reasoned recommendation and
such recommendation ought to
be sent to all the stock exchanges
where the shares of the target
company are listed and be
published in the same
newspapers where the relevant
detailed public statement of the
open offer was published.
14.
15.
Obligations of the Acquirer
– Disposal of assets of the
Target Company
Where the acquirer has not
stated his intention to dispose
of or otherwise encumber any
assets of the target company
except in the ordinary course
of business of the target
company, the acquirer shall be
debarred from disposing of or
otherwise encumbering the
assets of the target company
for a period of 2 years from the
date of closure of the public
offer.
– Unless acquirer has declared an
intention in the detailed public
statement and the letter of offer,
the acquirer shall be debarred
from alienating any material
assets of the target company
(including its subsidiaries) for a
period of two years after the offer
period. However, where such
alienation is necessary despite
no such intention having been
expressed by the acquirer, the
target company shall require a
special resolution passed by the
shareholders by way of a postal
ballot.
Obligations of the Merchant
Banker
The merchant banker shall
ensure compliance of the
Takeover Regulations and any
other laws or rules as may be
applicable in this regard and
provide
other
specific
obligations under Regulations
24 of the Takeover Regulations,
1997.
– The merchant banker would be
expected to demonstrate the
application of due skill, care and
diligence in the discharge of
professional duties cast on him
and the obligations of the
merchant banker ought to be
construed accordingly.
– It is perhaps likely that despite
following best practices and full
application of diligence, skill and
care, an acquirer could end up
defaulting under the Takeover
Regulations.
In
such
circumstances, the Committee
believes that, in the least, the
expectation from a merchant
banker would be a demonstration
of the bona fide efforts undertaken
Report of the Committees on Capital Market 435
16.
Disclosure Obligations
The
current
Takeover
Regulations obligate any
acquirer who crosses the
specified thresholds to disclose
at every stage his aggregate
shareholding or voting right to
the company concerned and to
the stock exchanges where
shares of the company are
listed. It also obligates a
promoter / majority shareholder
to annually disclose to the
company and the concerned
stock exchange regarding the
number and percentage of
shares or voting rights held by
him along with PACs.
by him in professionally and
diligently discharging the role
envisaged for the merchant
banker under the regulations.
– The acquirer promoter /
shareholders shall be asked to
disclose their acquisition on
periodic as well as transaction
specific basis upon crossing the
limits specified therein to the
Stock Exchange.
– Such disclosures shall be of the
aggregated shareholding and
voting rights of the acquirer and
every person acting in concert
with him.
– The acquisition and holding of
any security or instrument that
would entitle the acquirer to
receive shares in the target
company, including warrants and
convertible debentures, shall also
be required to be disclosed.
17.
Present Tax Regime
An open offer transaction is
considered akin to an offmarket deal.
– There is a need to bring parity in
the tax treatment given to the
shareholders who tender their
shares in an open offer and those
who are selling the same in the
open market. SEBI may like to
suitably take up this issue with the
concerned authorities in the
Government.
On September 23, 2011, SEBI notified the New Takeover Regulations i.e. SEBI (Substantial Acquisitions of
Shares and Takeovers) Regulations, 2011 that came into force w.e.f. October 22, 2011.
REPORT OF JUSTICE DHANUKA COMMITTEE ON SECURITIES LAWS
On 28th February, 1997, SEBI had appointed a Committee under the Chairmanship of Justice D.R. Dhanuka,
former judge of the High Court of Bombay to examine areas of deficiency in the SEBI Act,1992, SC(R) Act,1956
and the Depositories Act,1996 to suggest the amendments to the provisions of the SEBI Act,1992; SC(R) Act,1956,
Depositories Act,1996 with a view to enable SEBI to regulate and develop the Securities Market and protect the
interests of investors and to examine the provisions of the Companies Act,1956 and to make recommendations
for amendments in the Companies Act in order to enable SEBI to better regulate issue of capital, listing of
securities, transfer of securities and to protect the interests of investors.
436 PP-CC&MM
Executive Summary of Principal Recommendations
Part - I A: Pertaining to Draft Securities Bill and Draft Depositories (Amendment) Act 1998.
1. Consolidation of Securities Contracts (Regulation) Act, 1956 and SEBI Act 1992 into a composite securities
legislation and consequent repeal of SCR Act and SEBI Act. SEBI should be the sole regulatory agency for
securities market, including in relation to certain provisions in the Companies Act.
2. Several additional provisions introduced in the consolidated Securities Act so as to provide for the statutory
basis for regulation of a number of aspects relating to the Securities Market. Some of these features are referred
below:
2.1 - Long arm jurisdiction provided so as to make the Act applicable to an entity outside India dealing directly or
indirectly in securities in India.
2.2 - Several new definitions including that of “derivatives” “fraudulent and unfair trade practices”, “insider trading”,
“intermediaries”, “issuer”, “mutual fund”, “offer documents”, “private placement”, “qualified institutional investors”,
“self regulatory organsiations” and “venture capital funds” have been statutorily introduced.
The insertion of definition of “qualified institutional investor” enables identification of a class of “qualified institutional
investors” who may be subject to a more liberal, enabling regulation regime. This would be particularly relevant
in the context of private placements.
Provision has been made for comprehensive definition of “securities”. This now includes derivatives, plantation
companies, time shares, securitised instruments, etc.
Some existing definitions, have also been modified to make the same more comprehensive. Insertion /
modifications of these definitions will provide the basis for promoting of trading in “derivatives”, statutory regulation
and punishment of insider trading and fraudulent and unfair trade practices as also, regulations of private
placements.
The same also includes regulation of issuer and improving disclosure standards to be followed by the issuer.
3. Powers and functions of SEBI rationalised. Provision is made for power to issue general and special directions
including those for enforcement of such directions and recovery of money as arrears of land revenue.
3.1 Scope of SEBI’s powers to issue directions, is expressly extended also to investors or any other person,
rather than merely intermediaries.
4. Statutory provision is made for restriction of professionals practicing in the securities market including advocates,
chartered accountants also who act as experts if they are found to be guilty of malpractices. This is without
prejudice to the Advocates Act as the autonomy of the bar and the Chartered Accountant Act is maintained and
is in furtherance of the strong desire of the Committee to encourage raising of professional standards and
creation of a larger force of securities market professionals.
5. A new Chapter for recognition and regulations of self regulatory organisations is inserted. The encouragement
of self regulatory organisations and the statutory regulation thereof are the key recommendations of this Committee.
5.1 The right to carry on business as intermediary has been linked to membership of an SRO.
6. The scope of recognition and regulation of stock exchange, also a form of SRO has now been rationalised.
6.1 The definition of stock exchange has been extended to include “exchanges promoted by other exchanges.”
6.2 Concept of “territoriality” with reference to recognition of exchanges has been abandoned. SEBI’s approval
for additional trading floors will still be required.
6.3 In case of supersession of the governing board, some members may continue till reconstitution of new
governing body.
Report of the Committees on Capital Market 437
7. Strict provisions made for the regulation of the issuer, particularly, in relation to issue of securities and disclosure
standards.
8. Consequential provisions are prescribed for mis-statement in terms of civil and criminal consequences.
9. Non company issuers are also to be included in the regulatory net.
10. Parallel action under the SEBI Act can be also taken in case of mis-statements in offer documents and action
is not confined to mis-statement in prospectus, under Companies Act.
11. Provision has been made for establishment of a clearing corporation and the regulation thereof.
12. Provision has been made for recovery of the listing fees. Directors or persons in management are personally
liable for payment of listing fees which can be recovered as land revenue from the issuer, management in case
of default.
13. Parameters are prescribed for delisting of securities. Voluntary de-listing to be permitted by stock exchanges
and SEBI only with the consent of the prescribed majority of the shareholders and also upon specific conditions.
14. Provisions regarding contracts and options in securities are streamlined.
14.1 Hence, dealing in securities may take place in any of three ways.
(1) through members of the stock exchange
(2) spot delivery contracts
(3) special exceptions such as repos in Government securities, securities of private companies, private
shareholder agreement, deliveries as per takeover code, etc. These may take place other than through
members of stock exchanges and not necessarily as spot delivery contracts.
15. The business of spot deliveries to be strictly regulated. Hence, share shoppes to be prohibited unless
licensed.
16. Compulsory dematerialisation for new issue of securities exceeding rupees 10 crores in value.
17. UTI to be regulated as a Mutual Fund notwithstanding the provisions of UTI Act, 1963.
18. New Chapter inserted for empowering SEBI and its officials for Investigation and Enforcement on lines of
other economic legislations including powers, examination of persons, search and seizure, etc.
19. Provision inserted to take approver, evidence and to offer consequential immunity for prosecution.
20. To prevent abuse of power necessary safeguards for prevention of vexatious searches, draconian exercise
of powers provided for. SEBI to follow settled principles of administrative law subject to judicial review.
21. Provisions as to penalty and adjudication are rationalised.
22. New categories of penalties for mis-statement in offer documents and other documents. In relation to offences
of insider trading and unfair trade practices, persons who knowingly benefit are also liable for penalty.
23. Provisions related to a single Appellate Authority i.e. Securities Appellate Tribunal has been rationalised.
24. Power to make rules and regulations, rationalised in the new context.
25. Intermediaries to hold securities or funds of investor as trustee pending executions of contract.
Part I B: Dematerialisation / Depositories Act, 1996 - Amendments
26. Issuer not to resile or withdraw from agreement with depository after dematerlisation of its securities.
27.Option to issuer to enter into agreement with anyone of the depository in case of several depositories.
438 PP-CC&MM
28.Nomination facility to the beneficial owner in respect of dematerialised security.
29.In case of pledge of dematerialised securities, the provisions of Contract Act not to be applicable.
30.Bankers Book Evidence Act, 1879 applicable also to the statement issued by “participant”.
31.Depository to indemnify the beneficial owner only for its own negligence and fraud and not generally.
32.Contravention of direction of the Board is made punishable.
33.Appeal to lie to Securities Appellate Tribunal from the order of the Board.
34.Jurisdiction of Consumer Forum barred in relation to dispute relating to dematerialised securities.
35.Depository Act to override memorandum and articles of association of companies.
36.Exemption from stamp duty in respect of issue and transfer of dematerialised security.
37.Participants to hold securities of beneficial owner as trustee pending dematerialisation .
*Special problems - Plantation companies
PART II - PERTAINING TO WORKING DRAFT OF COMPANIES BILL, 1997
– Definition of the expression “security” be restructured. The expressions “derivative” and “option in
securities” can be more appropriately defined in SC(R) Act.
– As per the Working Draft Report, only Part III is proposed to be administered by SEBI. It is recommended
that all the provisions relating to listed companies in so far as they relate to subject matter of capital
market and issuance or dealing in securities wherever found in Companies Act be administered by
SEBI. SEBI should be the sole authority for framing regulations in relation to the subjects entrusted to it
under the new legislation.
– Provisions relating to prospectus, shelf-prospectus and red herring prospectus require several
modifications.
– Private Placement should be regulated. Broad parameters should be laid down in the Act. Details to be
determined by SEBI.
– Provisions made in the Working Draft for buy back of securities require several modifications.
(i) The provision for buy-back should be restricted to “shares” only.
(ii) The company should not be allowed to utilise proceeds of “prior issue” for purpose of “buy-back”.
(iii) The company should be allowed to re-issue the shares which are bought back, subject to safeguards
and stipulations which may be laid down.
(iv) Implications relating to insider trading to be considered.
– Penal provisions of the Act be made deterrent.
– Listing period be reduced from 10 weeks to 30 days. It should not be mandatory to have the securities
listed on the regional stock exchange.
– Clauses 94-98 of the Working Draft require several amendments. SEBI may be authorised by the Act to
frame regulations relating to transfer of securities of listed companies, etc.
– Obtaining of duplicate share certificate and issue thereof as a result of fraud or collusion be made a
serious criminal offence.
– If a person is found guilty of contravening the provisions of SEBI Act, SC(R) Act or depository Act, or is
Report of the Committees on Capital Market 439
penalised by the adjudicating officer under the SEBI Act, he should be disqualified from becoming the
director of the company. The Committee has formulated amendments.
– Securities audit be made compulsory.
– Monetary penalty concept be introduced so that investors can seek remedy of claiming compensation,
damages, etc.
– In order to enhance corporate democracy, the concept of Postal Ballot to be introduced to enable
shareholders to vote through postal ballot.
– The blank transfer deeds should not be permitted.
– SEBI should have power of inspection of books of accounts, records of the listed companies.
– Rights issue with right of renounciation be treated as public issue.
– Printing of share certificates be regulated and technical standards to be prescribed.
– Verification of transfer deeds by companies on payment of nominal fees before lodgment of certificate
of transfer.
– Company’s right to refuse transfer limited to be limited to violation of SEBI Act and regulations, or any
other law and not on “sufficient cause” as presently prescribed under section 111A.
– The concept of deemed public company be reintroduced. Section 43A of existing Act is a useful provision
in the Act and it should not be deleted.
– The Reserve Bank of India should have power to freeze voting rights in respect of “shares under transfer”
concerning Banking Companies pending consideration of Application for Acknowledgment. If the shares
of a Banking Company are transferred in violation of Banking Regulation Act, 1949 or the circulars /
guidelines issued by Reserve Bank having the force of law, the Reserve Bank should have locus standii
to apply to Company Law Board for rectification of Register on par with SEBI and other authorities.
– Companies making initial public offer of securities for a sum of `10 crores or more to be issued only in
dematerialised form through a depository.
Recommendation for Issue of an Ordinance for Moving of an Urgent Bill To Curb The Growing
Evil Emanating From Collective Investment Schemes
The Government of India issued press release dated 18/11/1997 that the Collective Investment Schemes based
on issuing instruments like Agro Bonds, Plantation Bonds, etc. are within the purview of SEBI Act,1992 and
particularly the provisions of law contained in Section 11(2)(c) of the SEBI Act. The said sub-clause was
incorporated in the Act by the Securities Laws (Amendment) Act, 1995 with effect from 25/1/1995 for “Collective
Investment Schemes”.
Section 11(1) of the Act provides that it shall be the duty of the Board 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
deems fit. Section 11(2)(c) of the said Act provides that the generality from the provisions, the measure referred
to therein may provide for restructuring and regulating the working of venture capital funds and collective
investment schemes, including mutual funds.
SEBI was facing writ petitions in the Hon’ble Courts where content of one writ petition is that the plantation
companies, etc. are not within the jurisdiction of SEBI in as much as such companies do not operate in the
securities market and the bonds issued by such companies do not constitute securities.
The Committee was of the view that as a measure of the abundant caution, clarificatory provision should be
made in the new legislation restructuring the definition of securities so as to specifically provide that Agro Bonds,
440 PP-CC&MM
Plantation Bonds, etc. be expressly included in definition of the expression securities. The existing definition of
the expression “securities” contained in Section 2(h) of Securities Contracts (Regulation ) Act,1956 is an inclusive
definition and the same definition has been adopted in SEBI Act,1992 by Section 2(i) thereof.
The clarificatory definition of the expression security should not indicate any change in law as such but should
in terms clarify and provide that the collective investment schemes were within the range of the definition of the
expression securities and whatever be the nature of document issued by these companies, these documents
would constitute securities. The Committee had prepared draft of an extensive definition of the expression
“security” for being included in the proposed Securities Act, 1998. Above draft of a consolidated legislation was
prepared by the Committee after holding about 22 meetings. In the draft-Bill of the securities, the definition of
securities was widened. The committee was of the view that the said definition be taken into consideration by
the authorities concerned while drafting new legislation in the form of an Ordinance or the Bill as may be deemed
fit.
The Committee made a few suggestions / recommendations indicating the nature of powers, duties and obligations
to be conferred on the regulatory body for giving better protection to investors whose interests are in jeopardy.
A list of such provisions is particularly indicated hereinafter.
1. Power of making enquiry and investigation. Thus, the power to issue summons and record statements of
individuals, suspected of fraud and malpractices - power to search the premises, to seize the records - power to
appoint a Chartered Accountant or any other officer to take inspection of the records of the company concerned.
2. Power to take-over the management of the entity concerned for a limited duration.
3. Power to appoint Chairman or additional directors as Government nominees or as SEBI nominees with
special obligations to protect the interest of the investors and make report to the authorities including authority
to perform Bank Accounts.
4. Power to make inventory inspection of the assets of the company. Appointment of receiver or freeze assets of
the company including Bank Accounts where the regulatory authority has reason that the company is indulging
in activities prejudicial in the interest of the investors or is dealing with the assets in a manner prejudicial or
manipulating in activities in accordance with law.
5. Power to prosecute the manipulators and persons who are prima - facie suspected fraud after investigation.
6. Power to issue directions including directives in respect of freezing the assets of the company and such other
directions as are deemed necessary in the interest of the investors.
7. In case the company or the unit is found insolvent or the interests of the investors are in jeopardy or it is primafacie deemed just and equitable to seek winding up of such companies to make necessary applications for
winding up of the company.
Test Papers 441
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
PP-CC&MM/2013
TEST PAPERS
This Test Paper set contains three test papers Test Paper 1/2013, 2/2013 and 3/2013. The maximum time
allowed to attempt each test paper is 3 hours. Students are advised to attempt atleast one Test Paper
from Test Papers 1/2013 or 2/2013 or 3/2013 and send the response sheet for evaluation to make him/
her eligible for Coaching Completion Certificate. However, students may, if they so desire, may send more
response sheets for evaluation. While writing answers, students should take care not to copy from the
study material, text books or other publications. Instances of deliberate copying from any source will be
viewed very seriously.
442 PP-CC&MM
WHILE WRITING THE RESPONSE SHEETS TO THE TEST PAPERS GIVEN AT END OF THIS STUDY
MATERIAL, THE STUDENTS SHOULD KEEP IN VIEW THE FOLLOWING WARNING AND DESIST FROM
COPYING.
WARNI NG
Time and again, it is brought to our notice by the examiners evaluating response sheets that some students
use unfair means in completing postal coaching by way of copying the answers of students who have
successfully completed the postal coaching or from the suggested answers/study material supplied by the
Institute. A few cases of impersonation by handwriting while answering the response sheets have also
been brought to the Institute’s notice. The Training and Educational Facilities Committee has viewed seriously
such instances of using unfair means to complete postal coaching. The students are, therefore, strongly
advised to write response sheets personally in their own hand-writing without copying from any original
source. It is also brought to the notice of all students that use of any malpractice in undergoing postal or
oral coaching is a misconduct as provided in the explanation to Regulation 27 and accordingly the studentship
registration of such students is liable to be cancelled or terminated. The text of regulation 27 is reproduced
below for information :
“27. Suspension and cancellation of examination results or registration
In the event of any misconduct by a registered student or a candidate enrolled for any examination conducted
by the Institute, the Council or the Committee concerned may suo motu or on receipt of a complaint, if it is
satisfied that, the misconduct is proved after such investigation as it may deem necessary and after giving
such student or candidate an opportunity to state his case, suspend or debar the person from appearing in
any one or more examinations, cancel his examination result, or studentship registration, or debar him
from future registration as a student, as the case may be.
Explanation - Misconduct for the purpose of this regulation shall mean and include behaviour in a disorderly
manner in relation to the Institute or in or near an Examination premises/centre, breach of any regulation,
condition, guideline or direction laid down by the Institute, malpractices with regard to postal or oral tuition
or resorting to or attempting to resort to unfair means in connection with the writing of any examination
conducted by the Institute”.
Test Paper 1/2013 443
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
TEST PAPER 1/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt All Questions
1. Write short note on any four of the following:
(a) Private Equity
(b) Warrant
(c) Shelf prospectus
(d) Suspicious Transaction Report
(e) Price Sensitive Information (PSI)
(5 marks each)
2. What do you meant by Voluntary Open Offer? Briefly discuss the conditions required to be fulfilled by an
acquirer for making Voluntary Open Offer under the SEBI Takeover Regulations, 2011.
(10 marks)
3. (a) Discuss the various types of American Depository Receipts (ADRs)?
(b) What is Bill Discounting? Explain.
(6 marks)
(4 marks)
4. The Executive Committee of a recognized Stock Exchange desires to transfer certain duties and functions
of a clearing house to a recently set up Clearing Corporation, incorporated as a company under the
Companies Act, 1956. Examining the provisions of the Securities Contracts (Regulation) Act, 1956:
(i) State the purpose for which such transfer of duties and functions can be made to Clearing
Corporation?
(ii) What is the procedure to be adopted for such transfer of duties and functions?
(10 marks)
5. Distinguish between the following:
(a) Offer for Sale and Initial Public Offer
(b) Accounting Period Settlement and Rolling Settlement
(5 marks each)
6. What is Investible Weight Factors (IWFs)? How IWFs can be calculated, explain with the help of an
example.
(10 marks)
7. Enumerate the provisions relating to alternate method of Book Building under SEBI (ICDR) Regulations,
2009.
(10 marks)
8. What are the obligations on banking companies, financial institutions and intermediaries under the
Prevention of Money Laundering Act, 2002?
(10 marks)
9. Explain different categories of Angel Investors?
(10 marks)
444 PP-CC&MM
TEST PAPER 2/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt all Questions
1. Write short note on any four of the following:
(a) Qualified Foreign Investors
(b) Transaction cost
(c) NCD with Call and Put Option
(d) London Stock Exchange (LSE)
(e) Conditional Offer
(5 marks each)
2. What do you understand by an Investment Adviser? Explain the Code of Conduct prescribed by SEBI
for an Investment Adviser.
(10 marks)
3. What is Letter of Credit (LC)? Enumerate the various forms of Letter of Credit.
(10 marks)
4. Distinguish between the following:
(a) Forward and Futures
(b) Currency futures and Interest rate futures
(5 marks each)
5. What is trading window? Briefly explain the provisions relating to trading window under SEBI (Prohibition
of Insider Trading) Regulations, 1992?
(10 marks)
6. Discuss the concept of storage with respect to commodities .Explain various types of storage systems
used for preserving commodities.
(10 marks)
7. What do you mean by Institutional Placement Programme (IPP)? Discuss the restrictions laid down
under SEBI ICDR Regulations, 2009 on a company for making an IPP.
(10 marks)
8. (a) Examine with reference to the provisions of the Securities Contracts (Regulation) Act, 1956 whether
it is possible for City Stock Exchange Limited, a company incorporated under the Companies Act, 1956
and a recognized Stock Exchange, to insist that its members should appoint only other members as
their proxies to attend and vote at the meeting of the Stock Exchange.
(6 marks)
(b) Complaints of unethical practices have been received against members of a recognized Stock
Exchange by the Government. Examine whether the government has any power to suspend the business
of such a recognized Stock Exchange.
(4 marks)
9. Briefly enumerate the provisions under Rule 19A of SCRR, 1957, relating to minimum public shareholding
required to be maintained by a company for the purpose of continuous listing requirements.(10 marks)
Test Paper 3/2013 445
TEST PAPER 3/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt all Questions
1. Write short note on any four of the following:
(a) State Financial Corporations
(b) Speculator
(c) Mobilization of Savings
(d) Trade Guarantee Fund
(e) Term Money
(5 marks each)
2. Briefly describe the Offer for Sale mechanism in a stepwise manner in accordance with SEBI Guidelines.
(10 marks)
3. Explain the procedure for issue of ADR/ GDR in a stepwise description.
(10 marks)
4. What are the different types of entities involved in physical settlement of commodities? Discuss.
(10 marks)
5. What are the agencies involved in investigating cases of Money Laundering? Give a brief of each
investigating agency.
(10 marks)
6. Define “Bill of Exchange”? Enumerate various types of Bill of Exchange.
(10 marks)
7. Discuss briefly the ground on which SEBI can grant exemption from the open offer obligation to an
acquirer under SEBI Takeover Regulations 2011.
(10 marks)
8. Explain the various obligations and responsibilities cast on a market maker under the SEBI Guidelines.
(10 marks)
9. State in the light of requirement of clause 49 of the listing agreement as to whether the following persons
can be appointed as independent directors on the Board :
(i) Krishan, who is an executive of the company since its inception.
(ii) Soumitro, who holds 1.5% of the equity shares of the company having voting rights.
(iii) Pradeep, who is already a director of 14 companies.
(iv) Shalini, who is appointed by a financial institution which has lent funds to the company.
(10 marks)
NOTES
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY
AND
MONEY MARKET
MODULE 3
ELECTIVE PAPER 9.2
ICSI House, 22, Institutional Area, Lodi Road, New Delhi 110 003
tel 011-4534 1000, 4150 4444 fax +91-11-2462 6727
email [email protected] website www.icsi.edu
i
© THE INSTITUTE OF COMPANY SECRETARIES OF INDIA
TIMING OF HEADQUARTERS
Monday to Friday
Office Timings – 9.00 A.M. to 5.30 P.M.
Public Dealing Timings
Without financial transactions – 9.30 A.M. to 5.00 P.M.
With financial transactions – 9.30 A.M. to 4.00 P.M.
Phones
41504444, 45341000
Fax
011-24626727
Website
www.icsi.edu
[email protected]
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Printed at Tan Prints
ii
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
Efficient financial systems are indispensable for speedy economic development. The financial system of a
country is a conglomeration of sub market, viz. capital, commodity and money market. The flow of funds in these
markets is multi directional depending upon liquidity, risk profile, yield pattern, interest rate differential or arbitrage
opportunities, regulatory restrictions etc. As the Indian economy gets integrated with the global economy
empowered by increasingly sophisticated information and technology systems, there is an acute need for trained
professionals to entrust important roles in all the spheres of the financial market activity. This study material has
been designed to provide expert knowledge and understanding of various capital market instruments, commodity
market products, money market instruments, key features and participants in these markets, raising capital in
international market by companies etc.
This study material has been published to aid the students in preparing for the Capital, Commodity and Money
Market paper of the CS Professional Programme. It is part of the educational kit and takes the students step by
step through each phase of preparation stressing key concepts, pointers and procedures.
Company Secretaryship being a professional course, the examination standards are set very high, with emphasis
on knowledge of concepts, applications, procedures, for which sole reliance on the contents of this study material
may not be enough. Besides, as per the Company Secretaries Regulations, 1982, students are expected to be
conversant with the amendments to the laws made upto six months preceding the date of examination. The
material may, therefore, be regarded as the basic material and must be read alongwith the original Bare Acts,
Rules, Regulations, Academic Guidance etc. This study has been updated upto June 30, 2013.
The subject of Capital, Commodity and Money Market is inherently complicated and is subject to constant
refinement through, rules and regulations made thereunder. It is, therefore becomes necessary for every student
to constantly update himself with the various legislative changes made from time to time by referring to the
Institute’s journal ‘Chartered Secretary’ as well as other professional journals. In the event of any doubt, students
may write to the Directorate of Academics and Perspective Planning of the Institute for clarification at
[email protected] and [email protected].
Although care has been taken in publishing this study material yet the possibility of errors, omissions and/or
discrepancies cannot be ruled out. This publication is released with an understanding that the Institute shall not
be responsible for any errors, omissions and/or discrepancies or any action taken in that behalf.
Should there be any discrepancy, error or omission noted in the study material, the Institute shall be obliged if
the same is brought to its notice.
iii
SYLLABUS
ELECTIVE PAPER 2: CAPITAL, COMMODITY & MONEY MARKET (100 Marks)
Level of Knowledge: Expert Knowledge
Objective: To acquire specialized knowledge of Capital, Commodity and Money Market
Detailed Contents:
1. Economic Framework
– Basic structure of Flow of funds in the economy;
– Capital Markets its Role in Capital formation, Functions of Liquidity, , Resource Allocation and Transaction
Cost-reduction
2. Legal Framework
– Ministry of Finance (Capital Markets Division,Department of Economic Affairs)
– Ministry of Corporate Affairs
– Companies Act, 1956
– SEBI Act, 1992
– Securities Contracts (Regulation) Act, 1956 (SCRA)
– Depositories Act, 1996
– SEBI Regulations and Guidelines– An Overview, SEBI (Prohibition of Insider Trdaing) Regulations,
1992, SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 (SAST)
– Prevention of Money Laundering Act, 2002
– Grievance Redressal Mechanism: Stock Exchange (Investor Protection Fund), SEBI, Securities
Appellate Tribunal (SAT), Supreme Court
– Enforcement: Economic Offences Wing, Financial Intelligence Unit, Central Bureau of Investigation,
Financial Action Task Force (FATF)
3. Financial Intermediaries Framework
– Framework of Market Infrastructure Institutions (MII), Stock Exchanges Clearing Corporations,
Custodians,
– Depositories, Depository Participants, Registrars and Transfer Agents (RTA), Bankers to issue
– Merchant Bankers, Underwriters, , Investment Advisors, Portfolio Managers, Self Certified Syndicate
Banks,
– Brokers, Sub-brokers, Market-makers
– Credit Rating Agencies
4. Primary Markets
– IPO, FPO, Offer for Sale, Private Placement, Preferential Allotment, Institutional Placement Procedures
(IPP), Qualified Institutional Placement (QIP), Rights Issue, Bonus Issue
iv
– Prospectus, DRHP, Shelf Prospectus, Red Herring prospectus
– Private Investment in Public Equity (PIPE)
– SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009
– Lead Manager (Pre & Post Issue Activities)
– Due Diligence Review
– Underwriting obligations
– Basis of Allotment
– Book-building
– Pre-issue and Post-issue activities,
– Green-shoe Option
– Pre-listing and Post-listing activities, Listing Agreement
5. Secondary Markets
– Opening day (listing)
– Continuing compliance obligations and disclosures: Post-listing activities, Corporate Actions
– Requirements for Continuing Listing
– Corporate Governance Norms
– Disclosures as per Listing Agreement: Price Sensitive Information, Material Changes, Quarterly results
– Functioning of an Exchange: Margining, Trading, Clearing and Settlement, Trade Guarantee Fund,
Trading Software, Arbitration Mechanism
– Stock Market Indices
6. Capital Market Investment Institutions
– Domestic Financial Institutions (DFI) , Qualified Institutional Buyers (QIB), Foreign Institutional Investors
(FII) , Private Equity (PE), Angel Funds, HNIs, Venture Capital (VC), Qualified Foreign Investors (QFI),
Mutual Funds, Alternative Investment Funds (AIF), Hedge Funds, Pension Funds
7. Capital Market Instruments
– Equities
– Preference Shares, Shares with Differential Voting Rights (DVR)
– Corporate Debt :Non Convertible Debentures (NCD), Partly-and Fully-Convertible Debentures (PCD,
FCD)
– NCDs with or without Call and Put Features
– Bonds, Foreign Currency Convertible Bonds (FCCB)
– Indian Depository Receipts (IDR)
– Derivatives: Single Stock Futures, Single Stock Options, Index futures (SENSEX, NIFTY), Index Options,
Interest Rate Futures, Currency futures
– Exchange Traded Funds (ETF)
– Warrants
v
8. Resource Mobilization through International Markets
– Global Depository Receipt (GDR)
– American Depository Receipt (ADR)
– Listing on the London Alternative Investment Market (AIM), NASDAQ, NYSE
9. Landmark Studies and Report of Committees on Capital Markets
10. Economics of Commodities Marketing
(a) Economic Rationale for Commodities Trading Place and store value
(b) Perishables and non-perishables
(c) Tangibles and Intangibles (Weather , Freight)
(d) How resources can be optimized through price hedges
11. Commodities Market Operations
– Origin of Commodity Market in India
– Products, Participants and Functions
– Evolution of Commodity Exchanges; Regulatory Framework
– Structure Of Commodity exchanges, membership, Risk Management, Clearing and Settlement System,
Commodities Traded on Stock Exchanges Platform-NCDEX, MCX SX
– Instruments available for Trading
– Using commodity exchanges for Hedging, Speculation and Arbitrage
12. Introduction to Money Market
– Nature & Deployment of Surplus Funds and Raising of Short-term funds, Characteristics of Money
Market
– Regulatory framework of RBI, FIMMDA (Fixed Income, Money Market and Derivatives Association)
and Foreign Exchange Dealers Association of India (FEDAI) Call Money Market-Players, Utility, Money
market Instruments: Commercial Paper, Certificates of Deposits, Bills of Exchange, Treasury Bills (TBills), Bill Discounting, Factoring, Letter of Credit, Money Market Mutual Funds, Fixed Maturity Plans
vi
LIST OF RECOMMENDED BOOKS
MODULE 3
PAPER 9.2 : CAPITAL, COMMODITY AND MONEY MARKET
The students may refer to the given books and websites for further knowledge and study of the subject :
READINGS
1. M.Y. Khan
: Indian Financial Systems; Tata McGraw Hill, 4/12, Asaf Ali Road, New Delhi
110 002.
2. Taxmann
: SEBI Manual
3. Shashi K Gupta
Neeti Gupta
Nishja Aggarwal
: Financial Institutions and Markets ; Kalyani Publishers, 4863/2B, Bharat Ram
Road, 24, Daryaganj, New Delhi -110002
4. Indian Institute of
Banking & Finance
: Securities Markets and Products; Taxmann Publications (P) Ltd., 21/35, West
Punjabi Bagh, New delhi-110026
5. Dr. S Gurusamy
: Capital Markets, Tata McGraw Hill Education Private Limited, 7 West Patel
Nagar, New Delhi-110008
6. Niti Nandini
Chatnani
: Commodity Markets, Tata McGraw Hill Education Private Limited, 7 West
Patel Nagar, New Delhi-110008
7. Bharat Kulkarni
: Commodity Markets and Derivatives, Excel Books, A-45, Naraina, Phase I,
New Delhi-1100028
REFERENCES
Website :
www.sebi.gov.in
www.nse-india.com
www.bseindia.com
www.rbi.org.in
www.mca.gov.in
www.iica.in
www.corporateprofessionals.com
JOURNALS
1. SEBI and
Corporate Laws
: Taxmann, 59/32, New Rohtak Road, New Delhi-110 005.
2. Corporate Law
Adviser
: Corporate Law Adviser, Post Bag No. 3, Vasant Vihar, New
Delhi-110052.
vii
3. SEBI Monthly Bulletin
SEBI Annual Report
4. NSE News
: SEBI, Mumbai.
: National Stock Exchange of India Ltd., Mahindra Towers, Worli, Mumbai400018.
Note : Students are advised to read relevant Bare Acts and Rules and Regulations relating thereto. ‘Student
Company Secretary’ and ‘Chartered Secretary’ should also be read regularly for updating the knowledge.
viii
ARRANGEMENT OF STUDY LESSONS
Study Lesson No.
Topic
1.
Economic Framework of Capital Market
2.
Legal Framework
3.
Framework of Market Infrastructure Institutions
4.
Financial Intermediaries Framework
5.
Primary Market
6.
Secondary Market
7.
Capital Market Investment Institutions
8.
Capital Market Instruments
9.
Resource Mobilization through International Markets
10.
Economics of Commodities Marketing
11.
Commodities Market Operations
12.
Money Market
13.
Insider Trading
14.
Substantial Acquisition of Shares and Takeovers
REPORT OF THE COMMITTEES ON CAPITAL MARKET
TEST PAPERS
ix
CONTENTS
CAPITAL, COMMODITY AND MONEY MARKET
LESSON 1
ECONOMIC FRAMEWORK OF CAPITAL MARKET
Introduction
2
Constitutents Of The Financial System
2
Financial Assets
2
Financial Intermediaries
3
Financial Markets
3
Capital Market
5
Primary Market
6
Secondary Market
6
Functions of Capital Market
8
Role of Capital Market in Resource Allocation
9
Capital Formation
10
Stages of Capital Formation
10
Role of Capital Market in capital Formation
11
LESSON SUMMARY
12
SELF TEST QUESTIONS
13
LESSON 2
LEGAL FRAMEWORK
Introduction
16
Department of Economic Affairs (DEA)
16
Capital Market Division
17
Ministry of Corporate Affairs
18
Company Law Board
18
Reserve Bank of India
19
Securities and Exchange Board of India (SEBI)
19
Legislations
20
Grievance Redressal Mechanism
20
Grievance Rederessal Mechanism at Stock Exchange
20
x
Page
Investor Protection Fund
21
Grievance Rederessal Mechanism at SEBI
21
Investor Protection and Education Fund
21
Securities Appellate Tribunal
22
Prevention of Money Laundering Act, 2002
23
Investigating Agencies in case of PMLA, 2002
27
LESSON ROUND UP
31
SELF TEST QUESTIONS
32
LESSON 3
FRAMEWORK OF MARKET INFRASTRUCTURE INSTITUTIONS
Introduction
36
Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012
36
The Depositories Act, 1996
41
Enquiry and Inspection
43
Penalty
44
Offences
47
Special Court
48
Appeals
49
Securities Contracts (Regulation) Act, 1956
51
LESSON ROUND UP
56
SELF TEST QUESTION
57
LESSON 4
FINANCIAL INTERMEDIARIES FRAMEWORK
Introduction
60
Primary market intermediaries
60
Merchant Banker
60
SEBI (Merchant Bankers) Regulations, 1992
60
Registrars to an Issue and Share Transfer Agents
66
SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993
66
Code of Conduct
67
Underwriters
70
xi
Page
SEBI (Underwriters) Regulations, 1993
70
Banker to an Issue
72
SEBI (Banker to an Issue) Regulation, 1994
72
Code of Conduct
74
Debenture Trustees
74
SEBI (Debenture Trustees) Regulations, 1993
75
Secondary market intermediaries
78
Stock Brokers and Sub-broker
79
SEBI (Stock Brokers & Sub-Brokers) Regulations, 1992
79
A Case Study on Fraudulent dealings
87
Portfolio manager
89
SEBI (Portfolio Managers) Regulations, 1993
89
Internal Audit of Portfolio Manager
98
Custodian of securities
98
SEBI (Custodian of Securities) Regulations, 1996
98
Foreign Institutional Investor
104
SEBI (Foreign Institutional Investors) Regulations, 1995
104
Qualified Foreign Investors (QFIs)
111
SEBI (Investment Advisers) Regulations, 2013
112
SEBI (Credit Rating Agencies) Regulations, 1999
116
Market Maker
123
Guidelines for Market Maker
123
SEBI (Depositories and Participants) Regulations, 1996
125
Governance of Depository
126
Audit under SEBI (Depositories and Participants) Regulations, 1996
127
Internal Audit of Operations of Depository Participants
127
Concurrent Audit
128
Qualified Depository Paticipants
128
LESSON ROUND UP
130
SELF TEST QUESTIONS
131
xii
Page
LESSON 5
PRIMARY MARKET
Introduction
134
Types of Issue
134
Offer for Sale
135
OFS Process
135
Difference between Offer for Sale (OFS) process and IPOs/FPOs
136
SEBI Guidelines on Offer for Sale (OFS) of shares by promoters through the Stock Exchange Mechanism
136
Understanding the Guideline Step wise
140
Different form of Prospectus
141
Filing of Offer Document
142
Lead Manager
142
Underwriting
144
Due Diligence
145
Due Diligence in IPO/FPO
145
Basis of Allotment
150
Book Building
151
Additional Disclosures in Case of Book Building
157
Green Shoe Option Facility
159
Illustration
161
Pre-Issue Activities
162
Rights Issue
164
Bonus Issue
167
Preferential Issue
170
Qualified Institutions Placement
174
Institutional Placement Programme
177
Listing Agreement
179
Event based and time based Compliances under Listing Agreement
180
LESSON ROUND UP
185
SELF TEST QUESTIONS
186
xiii
Page
LESSON 6
SECONDARY MARKET
Introduction
190
Corporate Actions
190
Requirement under Listing Agreement for corporate action
190
Continuous Listing
190
Material Events under Listing Agreement
193
Submission of Interim and Annual Financial Results under Listing Agreement
195
Disclosures under Listing Agreement
196
Corporate Governance
198
Regulatory Framework of Corporate Governance in India
198
Companies Act, 1956
198
Corporate Governance -Voluntary Guidelines 2009
199
Guidelines on Corporate Governance for Central Public Sector Enterprises
199
National Voluntary Guidelines on Social, Environmental & Economic Responsibilities of Business, 2011
200
Companies Bill, 2012
200
Evolution of Clause 49 of Listing Agreement
200
Clause 49
202
Stock Exchange Mechanism
209
Arbitration Mechanism
209
Margining
214
Types of Margins in Cash and Derivative Segment
215
Trading of Securities
217
Settlement System
218
Clearing and Settlement
219
Clearing & Settlement Process
219
Trade Guarantee Fund
220
Trading Software
221
Stock Market Indices
221
Types of Indices
221
BSE Indices
222
CNX Nifty
228
Investible Weight Factors (IWFs)
229
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Page
LESSON ROUND UP
230
SELF TEST QUESTION
231
LESSON 7
CAPITAL MARKET INVESTMENT INSTITUTIONS
Introduction
234
National Level Institutions
234
State Level Institutions
236
Qualified Institutional Buyers
236
Private Equity
237
Venture Capital
238
Stages of Investment Financing
238
A. Early Stage Financing
238
B. Later Stage Financing
239
Angel Fund
240
Types of Angel Investors
240
Pension Fund
241
Qualified Foreign Investor
243
Mutual Fund
244
Alternative Investment Funds
246
Hedge Funds
249
LESSON ROUND UP
250
SELF TEST QUESTIONS
251
LESSON 8
CAPITAL MARKET INSTRUMENTS
Introduction
254
Equity Shares
254
Characteristics of Equity Shares
254
Shares with differential Voting Rights
255
Preference Shares
258
Cumulative Preference Shares
258
Non-Cumulative Preference Shares
258
Convertible Preference Shares
258
xv
Page
Redeemable Preference Shares
258
Participating Preference Shares
259
Non Participating Preference Shares
259
Fully Convertible Cumulative Preference Share (EQUIPREF)
259
Debentures
259
Fully Convertible Debentures With Interest (Optional)
262
Non Convertible Debentures (NCDs) with Put and Call Options
262
Bonds
262
Sweat Equity Shares
263
Warrant
264
Share Warrant
264
Secured Premium Notes (SPN)
265
Equity Shares with Detachable Warrants
265
Foreign Currency Convertible Bonds (FCCBs)
265
Foreign Currency Exchangeable Bonds (FCEBs)
266
American Depository Receipts(ADR) / Global Depository Receipts (GDR)
266
Indian Depository Receipts (IDRs)
267
Derivative
268
Futures
268
Options
268
Index Futures & Options
269
Currency Futures
270
Interest Rate Futures (IRFs)
270
Stock Futures and Stock Options
270
Exchange Traded Funds (ETFs)
271
LESSON ROUND UP
271
SELF TEST QUESTIONS
272
LESSON 9
RESOURCE MOBILIZATION THROUGH INTERNATIONAL MARKETS
Introduction
274
American Depository Receipt
274
Global Depository Receipts
275
xvi
Page
Advantage of ADRs and GDRs
276
Sponsored ADR/GDR Issue
277
Two-Way Fungibility Scheme
278
Issuance of Shares under ADR/GDR
278
Statutory Approvals Required for issue of GDR/ADR
279
Agencies involved in ADR/GDR issue
280
Agreements and related Documents
281
Procedural requirements
283
Roadshows
284
Stepwise Procedure for Issue of ADR/GDR
285
Reporting of ADR/GDR Issues
286
FCCB and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993
287
Listing of GDR
289
London Stock Exchange
289
Listing on the Main Market
289
Listing on Professional Security Market
292
Listing on AIM
293
Luxembourg Stock Exchange
294
Listing requirements
294
Continuing obligations
294
Listing of ADR
294
NASDAQ
295
The NASDAQ Global Select Market (NGSM)
295
The NASDAQ Capital Market (NCM)
297
The NASDAQ Global Market (NGM)
299
NewYork Stock Exchange (NYSE)
301
NYSE Quantitative Listing and Maintenance Standards
301
LESSON ROUND UP
305
SELF TEST QUESTIONS
306
LESSON 10
ECONOMICS OF COMMODITIES MARKETING
Introduction
308
Types of Commodities
308
xvii
Page
Commodity Markets
308
Marketing of Agricultural Commodities
309
Direct Marketing
310
Indirect Marketing
310
Contract Farming
310
Storage
311
Types of Storage
311
Warehousing
312
Types of warehouse
313
Warehousing in India
313
Variance in Commodity Market
314
Weather Derivatives
315
Freight Derivatives
315
Electricity Derivates
316
Catastrophe Derivatives
317
Carbon Derivatives
317
Hedging
318
Hedging Risks
318
Understanding Basis Risk
319
LESSON ROUND UP
319
SELF TEST QUESTIONS
320
LESSON 11
COMMODITIES MARKET OPERATIONS
Introduction
324
Role of Commodity Exchanges
324
Evolution of Commodity Exchanges
324
Origin of Commodity market in India
324
Regulatory Framework
325
Three-tier Regulatory System
326
Forward Market Commission of India
326
Commodity Exchanges in India
327
Participants/Players
328
xviii
Page
Hedgers
328
Speculator
329
Arbitrageurs
330
Commodity Producers/Consumers
330
Trading in Commodity Market
331
Order Types
332
Electronic Spot Exchanges
333
Exchange Membership
334
Clearing and Settlement
334
Clearing
334
Settlement
335
Settlement Mechanism
336
Settlement Methods
337
Entities involved in Physical Settlement
339
Instruments Available For Trading
340
Forward Contract
340
Futures
341
Options
342
Using Commodity Exchanges for Hedging, Speculation and Arbitrage
344
Hedging
344
Speculation
346
Arbitrage
347
LESSON ROUND UP
348
SELF TEST QUESTIONS
348
LESSON 12
MONEY MARKET
Introduction
352
Features of Money Market
352
Money Market Vs. Capital Market
353
Growth of Money Market
353
Structure and Institutional Development
354
Money Market Instruments
355
xix
Page
Government Securities
355
Gilt-Edged (Government) Securities
356
Call Money and Notice Money
356
Term Money
357
Bill Discounting
357
Bill Rediscounting Scheme (BRD)
359
Repurchase Agreements
359
Banker’s Acceptance
360
Treasury Bills
360
Certificates Of Deposits
364
Inter-corporate Deposits
366
Commercial Bills
366
Commercial Paper
366
Money Market Mutual Funds (MMFS)
369
Factoring
369
Factoring Process
370
Types of Factoring
372
Letter of Credit
372
Basic forms of LCs
373
Working Mechanism
373
Bill of Exchange
375
FIMMDA
376
Objectives of FIMMDA
376
Foreign Exchange Dealer’s Association of India
376
LESSON ROUND UP
377
SELF TEST QUESTIONS
378
LESSON 13
INSIDER TRADING
Introduction
380
SEBI (Prohibition of Insider Trading) Regulations, 1992
380
xx
Page
Important Definitions
380
Prohibition on Dealing Communication or Counselling on Matters Relating to Insider Trading
382
Code of Internal Procedures and Conduct for Listed Companies and Other Entities
383
Disclosure of Interest or Holding in a Listed Companies by Certain Persons
383
Model Code of Conduct for Prevention of Insider Trading for Listed Companies
384
Model Code of Conduct for Prevention of Insider Trading for other Entities
387
Code of Corporate Disclosure Practices for Prevention of Insider Trading
388
Corporate Disclosure Policy
388
Investigation by SEBI
389
Penalty Provisions for Violations of the Regulations
391
Role of Company Secretary in Compliance Requirements
392
SEBI’s view on the Role of the Compliance Officer in Case of Insider Trading
394
LESSON ROUND UP
395
SELF TEST QUESTIONS
396
LESSON 14
SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS
Introduction
398
Important Definitions
398
Trigger Point for Making an Open Offer by an Acquirer
401
Open Offer
401
Open Offer Process
404
Public Announcement
406
Offer price
408
Provision of Escrow
409
Mode of Payment
409
Disclosures
410
Exemptions
411
Regulation 10 – Automatic Exemptions
411
Regulation 11 – Exemption by SEBI
415
LESSON ROUND UP
416
SELF TEST QUESTIONS
417
xxi
Page
REPORT OF THE COMMITTEES ON CAPITAL MARKET
Introduction
419
Report of Financial Sector Legislative Reforms Commission
419
The Draft Indian Financial Code
419
Report of the Takeover Regulations Advisory Committee under the Chairmanship of Mr. C. Achuthan
421
Summary of Key Recommendations of the Committee
421
Summary of Recommendations of the Achuthan Committee and the Provisions in the Takeover
Regulations, 1997
422
Report of Justice Dhanuka Committee on Securities Laws
435
Executive Summary of Principal Recommendations
436
TEST PAPERS
Test Paper 1/2013
443
Test Paper 2/2013
444
Test Paper 3/2013
445
xxii
Lesson 1
Economic Framework of Capital Market
Lesson 1
Economic Framework of Capital Market
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
The financial system plays a key role in the
economy by stimulating economic growth,
influencing economic performance of the
factors, affecting economic welfare. This is
achieved by financial infrastructure, in which
entities with funds allocate funds to those who
have potentially more productive ways to invest.
A financial system facilitates more efficient
transfer of funds. As one party of the transaction
may possess superior information than the other
party, it can lead to the information asymmetry
problem and inefficient allocation of financial
resources. By overcoming asymmetry problem
the financial system facilitates balance between
those with funds to invest and those needing
funds.
– Constituents of Financial System
– Financial Assets
– Financial Intermediaries
– Financial Markets
– Classification of Financial Markets
– Capital Market
– Functions of Capital Market
– Role of Capital Market in Resource
Allocation
– Capital Formation
– Stages of Capital Formation
– Role of Capital Market in Capital Formation
The aim of this lesson is to enable students to
know the economic framework of financial
system in India, how Capital Market plays an
important role in resource allocation and capital
formation, reduction in transaction cost and such
other related matters.
– LESSON ROUND UP
– SELF TEST QUESTIONS
1
1
2 PP-CC&MM
INTRODUCTION
The economic development of any country depends upon the existence of a well organized financial system. It
is the financial system which supplies the necessary financial inputs for the production of goods and services
which in turn promotes the well being and standard of living of the people of a country. Thus, the ‘financial
system’ is a broader term which brings under its fold the financial markets and the financial institutions which
support the system. The major assets traded in the financial system are money and monetary assets. The
responsibility of the financial system is to mobilize the savings in the form of money and monetary assets and
invest them to productive ventures. An efficient functioning of the financial system facilitates the free flow of
funds to more productive activities and thus promotes investment. Thus, the financial system provides the
intermediation between savers and investors which in turn promotes faster economic development.
CONSTITUTENTS OF THE FINANCIAL SYSTEM
The three main constituents of the financial system are:
1. Financial Assets
2. Financial Intermediaries
3. Financial markets
FINANCIAL ASSETS
An asset is something that provides its owner with expected future benefits. Financial assets are assets, such as
stocks or bonds, whose benefit to the owner depends on the issuer of the asset meeting certain obligations.
These obligations are called financial liabilities. Every financial asset has a corresponding financial liability; it’s
that financial liability that gives financial asset its value.
Classification of Financial Assets
Financial assets can be classified differently under different circumstances, viz. :
A. (i) Marketable assets and (ii) Non-marketable assets
B. (i) Money/cash asset (ii) Debt asset and (iii) Stock assets
A. (i) Marketable Assets : Marketable assets are those which can be easily transferred from one person to
another without much hindrance. E.g.Equity shares of listed companies, Bonds of PSUs, Government Securities.
(ii) Non-marketable Assets : Non-marketable assets are those assets which cannot be transferred easily. E.g.
FDRs, PF, Pension Funds, NSC, Insurance policy etc.
B. (i) Cash Assets : Cash assets are those assets that may readily be converted to cash. These assets often
retain high levels of liquidity and may be used to ensure the financial ability of a company or individual to conduct
daily operations. E.g. cash, money market funds, commercial papers.
(ii) Debt Asset : Debt asset is issued by a variety of organizations for the purpose of raising their debt capital.
There are different ways of raising debt capital. E.g.- issue of debentures, raising of term loans, working capital
advances etc.
(iii) Stock Asset : Stock asset is issued by business organizations for the purpose of raising their fixed capital.
There are two types of stock namely equity and preference.
Lesson 1
Economic Framework of Capital Market
3
FINANCIAL INTERMEDIARIES
The term financial intermediaries include all kinds of organizations which intermediate and facilitate financial
transactions of both individuals and corporate customers. Thus, it refers to all kinds of FIs and investing institutions
which facilitate financial transactions in financial markets. They may be in the organized sector or in the
unorganized sector and may be further classified into two types :
(i) Capital Market Intermediaries: These intermediaries mainly provide long term funds to individuals
and corporate customers. They consist of term lending institutions like financial corporations and
investment institutions like Life Insurance Corporation of India (LIC).
(ii) Money Market Intermediaries: Money market intermediaries supply only short term funds to individuals
and corporate customers. They consist of commercial banks, cooperative bank.
FINANCIAL MARKETS
A financial market is a market where financial assets and financial liabilities are bought and sold. Financial
Markets perform the essential economic function of channeling funds from savers who have an excess of funds
to spenders who have a shortage of funds. This function is shown schematically in figure below:
Flow of funds through the financial system:-
INDIRECT FINANCE
Financial
Intermediaries
F
U
N
D
S
Lender-Saver
1. Households
2. Business Firms
3. Government
4. Foreigners
FUNDS
Financial
Markets
DIRECT FINANCE
FUNDS
Borrowers-Spenders
1. Business Firms
2. Government
3. Households
4. Foreigners
Financial markets can perform this basic function either through direct finance in which borrowers borrow funds
directly from lenders by selling them securities or through indirect finance, which involves a financial intermediary
who stands between the lender-savers and borrower-spenders and helps transfer funds from one to the other.
This channelising of funds improves the economic welfare of everyone in the society because it allows funds to
move from people who have no productive investment opportunities to those who have such opportunities,
thereby contributing to increased efficiency in the economy.
CLASSIFICATION OF FINANCIAL MARKETS
The financial markets in India can be classified as follows :
(a) Unorganized Markets : In unorganized markets, there are a number of money lenders, indigenous
bankers, traders, etc. who lend money to the public. Indigenous bankers also collect deposits from the
4 PP-CC&MM
public. There are also private finance companies, chit funds etc whose activities are not controlled by
the RBI. The RBI has already taken some steps to bring unorganized sector under the organized fold.
(b) Organized Markets : In the organized markets, there are standardized rules and regulations governing
their financial dealings. There is also a high degree of institutionalization and instrumentalization. These
markets are subject to strict supervision and control by the RBI or other regulatory bodies. These organized
markets can be further classified into two types. They are:
(i) Capital Market and
(ii) Money Market.
(i) Capital Market
The capital market is a market for financial assets which have a long or indefinite maturity. Generally, it deals
with long term securities which have a maturity period of more than one year. Capital market may be further
divided into three types namely :
1. Industrial Securities Market
2. Government Securities Market and
3. Long-term Loans Market.
1. Industrial Securities Market
As the very name implies, it is a market for industrial securities, namely : (i) equity shares (ii) Preference shares
and (iii) Debentures or bonds. It is a market where industrial concerns raise their capital or debt by issuing
appropriate instruments. It can be further subdivided into two types. They are
(a) Primary market or New Issue Market,
(b) Secondary market or Stock Exchange.
2. Government Securities Market
It is otherwise called Gilt-Edged Securities Market. It is a market where government securities are traded. In
India there are many kinds of Government securities – short term and long term. Long-term securities are
traded in this market while short term securities are traded in money market. The secondary market for these
securities is very narrow since most of the institutional investors tend to retain these securities until maturity.
3. Long-term Loans Market
Development banks and commercial banks play a significant role in this market by supplying long term loans to
corporate customers. Long term loans market may further be classified into – (i) Term loans, (ii) Mortgages and
(iii) Financial Guarantees markets.
(ii) Money Market
Money market is a very important segment of a financial system. It is the market for dealing in monetary assets
of short-term nature. Short-term funds up to one year and financial assets that are close substitutes for money
are dealt in the money market. Money market instruments have the characteristics of liquidity (quick conversion
into money), minimum transaction cost and no loss in value. Excess funds are deployed in the money market,
which in turn is availed of to meet temporary shortages of cash and other obligations. Money market provides
access to providers and users of short-term funds to fulfill their investments and borrowings requirements
respectively at an efficient market clearing price. It performs the crucial role of providing an equilibrating mechanism
to even out short-term liquidity, surpluses and deficits and in the process, facilitates the conduct of monetary
policy. The money market is one of the primary mechanism through which the Central Bank influences liquidity
and the general level of interest rates in an economy. The Bank’s interventions to influence liquidity serve as a
Lesson 1
Economic Framework of Capital Market
5
signaling-device for other segments of the financial system.
The money market functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
Funds are available in this market for periods ranging from a single day upto a year. Mostly government, banks
and financial institutions dominate this market. It is a formal financial market that deals with short-term fund
management.
Features of Money Market
The money market is a wholesale market where the volumes of transactions is very large and is settled on a
daily basis. Trading in the money market is conducted over the telephone, followed by written confirmation
through e-mails, texts from the borrowers and lenders.
There are a large number of participants in the money market: commercial banks, mutual funds, investment
institutions, financial institutions and finally the Reserve Bank of India. The bank’s operations ensure that the
liquidity and short-term interest rates are maintained at levels consistent with the objective of maintaining price
and exchange rate stability. The Central bank occupies a strategic position in the money market. The money
market can obtain funds from the central bank either by borrowing or through sale of securities. The bank
influences liquidity and interest rates by open market operations, REPO transactions changes in Bank Rate,
Cash Reserve Requirements and by regulating access to its accommodation. A well-developed money market
contributes to an effective implementation of the monetary policy. It provides:
1. A balancing mechanism for short-term surpluses and deficiencies.
2. A focal point of central bank intervention for influencing liquidity in the economy, and
3. A reasonable access to the users of short-term funds to meet their requirements at realistic/reasonable
price or cost.
CAPITAL MARKET
Capital Market may be defined as a market for borrowing and lending long-term capital funds required by
business enterprises. Capital Market is the market for financial assets that have long or indefinite maturity.
Capital Market offers an ideal source of external finance. It refers to all the facilities and the institutional
arrangements for borrowing and lending medium-term and long-term funds. Like any market, the Capital Market
is also composed of whose who demand funds (borrowers) and those who supply funds (lenders).
Transfer of resources from those with idle resources to others who have a productive need for them is perhaps
most efficiently achieved through the Capital Markets. Stated formally, Capital Markets provide channels for
reallocation of savings to investments and entrepreneurship 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. Savings are
linked to investments by a variety of intermediaries through a range of complex financial products called “securities”.
There are a set of economic units who demand securities in lieu of funds and others who supply securities for
funds. These demand for and supply of securities and funds determine, under competitive market conditions in
both goods and Securities Market, the prices of securities which reflect the present value of future prospects of
the issuer, adjusted for risks and also prices of funds.
It is not that the users and suppliers of funds meet each other and exchange funds for securities. It is difficult to
accomplish such double coincidence of wants. The amount of funds supplied by the supplier may not be the
amount needed by the user. Similarly, the risk, liquidity and maturity characteristics of the securities issued by
the issuer may not match preference of the supplier. In such cases, they incur substantial search costs to find
each other. Search costs are minimised by the intermediaries who match and bring the suppliers and users of
funds together. These intermediaries may act as agents to match the needs of users and suppliers of funds for
6 PP-CC&MM
a commission, help suppliers and users in creation and sale of securities for a fee or buy the securities issued by
users and in turn, sell their own securities to suppliers to book profit.
The Capital Market, thus, has essentially three categories of participants, namely
(i) the issuers of securities,
(ii) investors in securities and
(iii) the intermediaries.
The issuers and investors are the consumers of services rendered by the intermediaries while the investors are
consumers (they subscribe for and trade in securities) of securities issued by issuers. In pursuit of providing a
product to meet the needs of each investor and issuer, the intermediaries churn out more and more complicated
products. They educate and guide them in their dealings and bring them together. 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 by 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 suppliers of funds. The regulator ensures a high standard of service from
intermediaries and supply of quality securities and non-manipulated demand for them in the market.
The market does not work in a vacuum; it requires services of a large variety of intermediaries. The
disintermediation in the Capital Market is in fact an intermediation with a difference; it is a risk-less intermediation,
where the ultimate risks are borne by the savers and not the intermediaries.
The Capital Market has two interdependent and inseparable segments, the new issues (primary market) and
the stock (secondary) market.
PRIMARY MARKET
The Primary Market provides the channel for sale of new securities. Primary Market provides opportunity to
issuers of securities; government as well as corporates, to raise resources to meet their requirements of investment
and/or discharge some obligation.
They may issue the securities at face value, or at a discount/premium and these securities may take a variety of
forms such as equity, debt etc. They may issue the securities in domestic market and/ /or international market.
The Primary Market issuance is done either through public issues or private placement. A public issue does not
limit any entity in investing while in private placement, the issuance is done to select people.
There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity
instruments (shares, debentures, etc.), while the governments (central and state governments) issue debt
securities (dated securities, treasury bills). The price signals, which subsume all information about the issuer
and his business including associated risk, generated in the secondary market, help the Primary Market in
allocation of funds.
SECONDARY MARKET
Secondary Market refers to a market where securities are traded after being initially offered to the public in the
Primary Market and/or listed on the Stock Exchange. Majority of the trading is done in the Secondary Market.
Secondary Market comprises of equity markets and the debt markets.
The Secondary Market enables participants who hold securities to adjust their holdings in response to changes
in their assessment of risk and return. They also sell securities for cash to meet their liquidity needs. The
Secondary Market has further two components, namely the over-the-counter (OTC) market and the exchangetraded market. OTC is different from the market place provided by the Over The Counter Exchange of India
Lesson 1
Economic Framework of Capital Market
7
Limited. OTC markets are essentially informal markets where trades are negotiated. Most of the trades in
government securities are in the OTC market. All the spot trades where securities are traded for immediate
delivery and payment take place in the OTC market. The exchanges do not provide facility for spot trades in a
strict sense. Closest to spot market is the cash market where settlement takes place after some time. Nearly
100% of the trades settled by delivery are settled in demat form. A variant of Secondary Market is the forward
market, where securities are traded for future delivery and payment. Pure forward is outside the formal market.
The versions of forward in formal market are futures and options. In futures market, standardised securities are
traded for future delivery and settlement. These futures can be on a basket of securities like an index or an
individual security. In case of options, securities are traded for conditional future delivery. There are two types of
options–a put option permits the owner to sell a security to the writer of options at a predetermined price while a
call option permits the owner to purchase a security from the writer of the option at a predetermined price. These
options can also be on individual stocks or basket of stocks like index.
The past few years in many ways have been remarkable for Capital Market in India. It has grown exponentially
as measured in terms of amount raised from the market, number of stock exchanges and other intermediaries,
the number of listed stocks, market capitalisation, trading volumes and turnover on stock exchanges, and investor
population. Along with this growth, the profiles of the investors, issuers and intermediaries have changed
significantly. The market has witnessed fundamental institutional changes resulting in drastic reduction in
transaction costs and significant improvements in efficiency, transparency and safety.
What is Transaction Cost?
Transaction cost for a market is important for several reasons. It is a key parameter to measure the impact of
modernization of market infrastructure, institutionalisation of the market and market regulation. Besides,
transaction cost directly impacts the profits of investors and affects the return on their investments. Investors
therefore, seek continuous reduction in transaction cost. Reduction in transaction cost induces investors to
trade more frequently resulting in higher volumes.
Transaction cost can be classified into two categories :
(A) Explicit costs
(B) Implicit costs
(A) Explicit costs are observable and measurable. They can be easily measured and are directly borne by
the investors. These costs include :
(i) Brokerage commission
(ii) Stamp duty
(iii) Service tax
(iv) Custody charges; and
(v) Regulatory chargesSome of these charges, such as stamp duty and service tax are also levied in
few other markets.
(B) The implicit costs include :
(i) Bid-ask spreads
(ii) Realised spreads
(iii) Opportunity cost of delayed execution (timing costs) or non-execution.
There are certain additional components of implicit costs peculiar to the Indian markets, which arise on
account of existence of physical securities and the process of registration of securities. The risks associated
8 PP-CC&MM
with physical securities such as bad deliveries and delays in transfer, result in loss of liquidity and add to the
opportunity costs for the investors.Transaction costs can also be categorised into:
(1) cost of search and information,
(2) cost of contracting and monitoring,
(3) cost of incentive problems between buyers and sellers of financial assets.
(i) Costs of search and information are defined in the following way:
Search cost fall into categories of explicit cost and implicit cost. Information cost is associated with
assessing a financial instrument’s investment attributes. In a price efficient market, prices reflect
the aggregate information collected by all market participants.
(ii) Cost of contracting and monitoring is related to the cost necessary to resolve information asymmetry
problems, when the two parties entering into the transaction possess limited information on each
other and seek to ensure that the transaction obligations are fulfilled.
(iii) Cost of incentive problems between buyers and sellers arise, when there are conflicts of interest
between the two parties, having different incentives for the transactions involving financial asset.
Transaction cost is one of the most important factor which affects the investors and determines the decision
making process. Reduction in transaction costs is one of the phenomena which characterizes an efficient
financial market and affects the level of market development. This means that, other things being equal, the
investors’ preference is to invest in markets which have the least transaction costs as the investor aims to
maximize profit by incurring the least possible cost.
FUNCTIONS OF CAPITAL MARKET
The main functions of Capital Market are:
1. Allocation Function
2. Liquidity Function
3. Other Function
1. Allocation Function
Capital Market allows for the channelization of the saving of innumerable investors into various productive
avenues of investments. Accordingly, the current savings for a period are allocated amongst the various users
and uses. The market attracts new investors who are willing to make new funds available to business. It also
allocates and rations funds by a system of incentives and penalties.
2. Liquidity Function
Capital Market provides a means whereby buyers and sellers can exchange securities at mutually agreed
prices. This allows better liquidity for the securities that are traded.
3. Other Functions
In addition to the functions of funds allocation and liquidity, Capital Market also renders the following functions:
1. Indicative Function– A Capital Market acts as a barometer showing not only the progress of a company,
but also of the economy as a whole through share price movements.
2. Savings & Investment Function– Capital Market provides a means of quickly converting long-term
investment into liquid funds, thereby generating confidence among investors and speeding up the process
of saving and investment.
Lesson 1
Economic Framework of Capital Market
9
3. Transfer Function– Capital Market facilitates the transfer of existing assets – tangible and intangible
among individual economic units or groups.
4. Merger Function– Capital Market encourages voluntary or coercive take-over mechanism to put the
management of inefficient companies into more competent hands.
ROLE OF CAPITAL MARKET IN RESOURCE ALLOCATION
Capital Market plays an important role in mobilising resources, and diverting them towards productive channels.
In this way, it facilitates and promotes the process of economic growth in the country as discussed below:
1. Link between Savers and Investors:
The Capital Market functions as a link between savers and investors. It plays an important role in mobilising the
savings and diverting them in productive investment. In this way, Capital Market plays a vital role in transferring
the financial resources from surplus and wasteful areas to deficit and productive areas, thus increasing the
productivity and prosperity of the country.
2. Encouragement to Saving:
With the development of Capital Market, the banking and non-banking institutions provide facilities, which
encourage people to save more. In the less- developed countries, in the absence of a Capital Market, there are
very little savings and those who save often invest their savings in unproductive and wasteful directions, i.e., in
real estate (like land, gold, and jewellery) and conspicuous consumption.
3. Encouragement to Investment:
The Capital Market facilitates lending to the businessmen and the Government and thus encourages investment.
It provides facilities through banks and nonbank financial institutions. Various financial assets, e.g., shares,
securities, bonds, etc., induce savers to lend to the Government or invest in industry. With the development of
financial institutions, capital becomes more mobile, interest rate falls and investment increases.
4. Promotes Economic Growth:
The Capital Market not only reflects the general condition of the economy, but also smoothens and accelerates
the process of economic growth. Various institutions of the Capital Market, like non-bank financial intermediaries,
allocate the resources rationally in accordance with the development needs of the country. The proper allocation
of resources results in the expansion of trade and industry in both public and private sectors, thus promoting
balanced economic growth in the country.
5. Stability in Security Prices:
The Capital Market tends to stabilise the values of stocks and securities and reduce the fluctuations in the prices
to the minimum. The process of stabilisation is facilitated by providing capital to the borrowers at a lower interest
rate and reducing the speculative and unproductive activities.
6. Benefits to Investors:
The Capital Market helps the investors, i.e., those who have funds to invest in long-term financial assets, in
many ways:
(a) It brings together the buyers and sellers of securities and thus ensure the marketability of investments,
(b) By advertising security prices, the Stock Exchange enables the investors to keep track of their investments
and channelize them into most profitable lines,
(c) It safeguards the interests of the investors by compensating them from the Stock Exchange’s Investor
Protection Fund in the event of fraud and default.
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CAPITAL FORMATION
Capital formation is regarded as a key to economic development. It is because capital formation leads to an
increase in the supply of machinery, equipments, plants, and also an increase in human capital. This increases
production and productivity in an economy. This in turn increases employment opportunities and standard of
living of people. Thus, capital formation is considered very important.
The chart below indicates the capital formation process.
Increase in Saving
Mobilisation of Saving
Investment of Saving
Capital Formation
STAGES OF CAPITAL FORMATION
Capital formation process has three stages which are described below:1. Increase in Savings
Capital formation depends on saving. According to J.M. Keynes “Saving is the excess of income over consumption
expenditure”. To be more precise, saving is a part of income that is not spent on current consumption. If consumers
spend their entire incomes on consumers’ goods, there could be no accumulation of capital goods. If, on the
other hand, consumers decide to save part of their incomes, country’s resources can be devoted to making
capital goods. Thus, the production of capital goods depends on saving as shown in the following chart:Total Income
Amount Spent
Amount Saved
Production of
Consumer’s Goods
Production of
Producer’s Goods
(Investment)
In economics, the term investment is used to mean the actual production of capital goods. So it can be said that
investment depends on saving. Capital accumulation depends on volume of saving. The volume of saving in
turn depends broadly on three factors–power to save, will to save and facilities to save.
2. Mobilization of savings
The second stage of capital formation is the mobilization of available savings. The act of mobilizing savings is
done by the financial institutions such as commercial banks, finance companies, insurance companies, cooperative
societies and so on. These institutions collect deposits from general public, provide security to savings, provide
liquidity to savers, and also provide income in the form of interest. Due to this, people like to save through
financial institutions. These institutions mobilize the savings collected toward productive investments. Saving
and investment are done by different classes of people. Financial institutions act as intermediaries between
savers and investors. This leads to the increase in capital formation.
Lesson 1
Economic Framework of Capital Market
11
3. Investment of Savings
The third stage of capital formation is the investment of savings. Investment creates capital goods. The act of
investment is done by entrepreneurs. Therefore, a large number of bold and skilled entrepreneurs are
indispensable for increasing capital formation in the country. Entrepreneurs acquire surplus funds from financial
institutions and the Capital Market and make productive investment in various types of industries. Investments
create and increase machinery and equipments. This leads to the increase in the national income of the country.
ROLE OF CAPITAL MARKET IN CAPITAL FORMATION
Capital Market has a crucial significance to capital formation. For a speedy economic development adequate
capital formation is necessary. The significance of Capital Market in economic development is explained below:
1. Mobilisation of Savings and Acceleration of Capital Formation :In Capital Market, various types of securities helps to mobilise savings from various sectors of population. The
twin features of reasonable return and liquidity in stock exchange are definite incentives to the people to invest
in securities. This accelerates the capital formation in the country.
2. Raising Long-Term Capital :The existence of a stock exchange enables companies to raise permanent capital. The investors cannot commit
their funds for a permanent period but companies require funds permanently. The stock exchange resolves this
clash of interests by offering an opportunity to investors to buy or sell their securities, while permanent capital
with the company remains unaffected.
3. Promotion of Industrial Growth :The stock exchange is a central market through which resources are transferred to the industrial sector of the
economy. The existence of such an institution encourages people to invest in productive channels. Thus it
stimulates industrial growth and economic development of the country by mobilising funds for investment in the
corporate securities.
4. Ready and Continuous Market :The stock exchange provides a central convenient place where buyers and sellers can easily purchase and sell
securities. Easy marketability makes investment in securities more liquid as compared to other assets.
5. Technical Assistance :An important shortage faced by entrepreneurs in developing countries is technical assistance. By offering advisory
services relating to preparation of feasibility reports, identifying growth potential and training entrepreneurs in
project management, the financial intermediaries in Capital Market play an important role.
6. Reliable guide to Performance :The Capital Market serves as a reliable guide to the performance and financial position of corporates, and
thereby promotes efficiency.
7. Proper channelisation of funds :The prevailing market price of a security and relative yield are the guiding factors for the people to channelise
their funds in a particular company. This ensures effective utilisation of funds in the public interest.
8. Provision of variety of services :The financial institutions functioning in the Capital Market provide a variety of services such as grant of long term
and medium term loans to entrepreneurs, provision of underwriting facilities, assistance in promotion of companies,
participation in equity capital, giving expert advice etc.
12 PP-CC&MM
9. Development of backward areas :Capital Markets provide funds for projects in backward areas. This facilitates economic development of backward
areas. Long term funds are also provided for development projects in backward and rural areas.
10. Foreign Capital :Capital Markets makes possible to generate foreign capital. Indian firms are able to generate capital funds from
overseas markets by way of bonds and other securities. Government has liberalised Foreign Direct Investment
(FDI) in the country. This not only brings in foreign capital but also foreign technology which is important for
economic development of the country.
11. Easy liquidity :With the help of secondary market investors can sell off their holdings and convert them into liquid cash.
Commercial banks also allow investors to withdraw their deposits, as and when they are in need of funds.
12. Revival of Sick Units :The Commercial and Financial Institutions provide timely financial assistance to viable sick units to overcome
their industrial sickness. To help the weak units to overcome their financial industrial sickness banks and FIs
may write off a part of their loan.
LESSON SUMMARY
– An efficient functioning of the financial system facilitates the free flow of funds to more productive
activities and thus promotes investment. Thus, the financial system provides the intermediation between
savers and investors and promotes faster economic development.
– Financial assets are assets, such as stocks or bonds, whose benefit to the owner depends on the
issuer of the asset meeting certain obligations.
– Financial assets can be classified differently under different circumstances. E.g. : A. (i) Marketable
assets and (ii) Non-marketable assets, B. (i) Money/cash asset (ii) Debt asset and (iii) Stock assets.
– The term financial intermediaries include all kinds of organizations which intermediate and facilitate
financial transactions of both individuals and corporate customers.
– Financial Markets perform the essential economic function of channeling funds from savers who have
an excess of funds to spenders who have a shortage of funds.
– Capital Market may be defined as a market for borrowing and lending long-term capital funds required by
business enterprises. Capital Market is the market for financial assets that have long or indefinite maturity.
– Capital Market plays an important role in mobilising resources, and diverting them in productive channels.
In this way, it facilitates and promotes the process of economic growth in the country.
– Capital formation is regarded as a key to economic development. It is because capital formation leads
to an increase in the supply of machinery, equipments, plants, and also an increase in human capital.
This increases production and productivity in an economy. This in turn increases employment
opportunities and standard of living of people. Thus, capital formation is considered very important.
– Capital formation process has three stages-(i) Increase in savings (ii) Mobilization of savings (iii)
Investment of savings.
– Capital Market has a crucial significance to capital formation. For a speedy economic development
adequate capital formation is necessary.
Lesson 1
Economic Framework of Capital Market
13
– Transaction cost is a key parameter to measure the impact of modernization of market infrastructure,
institutionalisation of the market and market regulation. Besides, transaction cost directly reduces the
profits of investors and affects the return on their investments.
– Transaction cost can be classified into two categories: (A) Explicit costs (B) Implicit costs.
– Transaction cost is one of the most important factors which affect the investors and determines the
decision making process; because the investors need to be compensated for the risk and transaction
cost involved in the buying and selling process.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is financial market? Briefly discuss about various types of Financial Market.
2. Explain the various functions of Capital Market.
3. What do you understand by capital formation? Discuss various stages of capital formation.
4. What is a transaction cost? How does it impact an investor?
14 PP-CC&MM
Lesson 2
Legal Framework of Capital Market
Lesson 2
Legal Framework
LESSON OUTLINE
15
LEARNING OBJECTIVES
– Introduction
Securities Market is an important mobilizer of
resources for the corporate sector. Investors’
confidence is key to the healthy developments
of Securities Market, it is necessary that
comprehensive and adequate laws exists to
regulate security industry to protect investors
interests and rights.
– Department of Economic Affairs (DEA)
– Capital Market Division
– Ministry of Corporate Affairs
– Company Law Board
– Reserve Bank of India
– Securities and Exchange Board of
India(SEBI)
Further, the investor need protection from the
various malpractices and unfair practices made
by the corporate and intermediaries. For this
purpose, the Government of India has developed
a strong legal and regulatory framework that
governs and regulates the business, corporate
transaction and the intermediaries.
– Legislations
– Grievance Redressal Mechanism
– Grievance Rederessal Mechanism at
Stock Exchanges
– Grievance Rederessal Mechanism at
SEBI
Keeping this in view, this lesson will enable the
students to give an overview of the legal
framework of the Securities Market in India, the
agencies involved in regulating the Securities
Market, and the investigations agencies
involved in initiating proceedings against money
laundering.
– Securities Appellate Tribunal
– Prevention of Money Laundering Act,
2002
– Investigating Agencies in case of PMLA,
2002
– Diretorate of Enforcement
– Central Bureau of Investigation
– Financial Intelligence Unit – India
(FIU-IND)
– The Financial Action Task Force (FATF)
– FATF Recommendations 2012
– LESSON ROUND UP
– SELF TEST QUESTIONS
15
16 PP-CC&MM
INTRODUCTION
The Securities Market operations promote the economic growth of the country. More efficient is the Securities
Market, the greater is the promotion effect on economic growth. It is, therefore, necessary to ensure that Securities
Market operations are more efficient, transparent and safe. In this context, the investors need protection from
the various malpractices and unfair practices made by the corporate and intermediaries. As the individual investors’
community and the investment avenues are on the rise, it is necessary to protect the investors through various
legislations. Securities Market in general are to be regulated to improve the market operations in fair dealings
and easy to access the market by corporates and investors.
Successive Corporate scams also have prompted Government around the world including in India to develope
a strong legal and regulatory framework that governs and regulates business and corporate transactions. Some
of the central issue while regulating the working of corporations, include rules and regulations, roles and
responsibilities and jurisdiction of regulatory institutions and co-ordination among regulatory bodies.
The following agencies have a significant regulatory influence, directly or indirectly, over the Securities Markets
in India currently. These are:
– Department of Economic Affairs (DEA) which is responsible for the economic management of the country
and is the arm of the government that is concerned with the orderly functioning of the financial markets
as a whole.
– Ministry of Corporate Affairs (MCA) which is at the apex of a three tier structure that has responsibility
for the registration and oversight of incorporated entities which fall under the regulatory purview of the
Companies Act.
– The Company Law Board (CLB) which is a quasi judicial body that exercises some of the quasi
judicial and judicial powers under the Act previously exercised by the High Court and the Central
Government.
– The Reserve Bank of India (RBI) which is primarily responsible, inter alia, for the supervision of banks
and Money Markets.
– Securities and Exchange Board of India (SEBI) which is responsible for the regulation of Capital Markets
and the various participants and activities therein; and
Of the above, the agency that is directly charged with the supervision of the Capital Market in India is SEBI. The
role and function of each agency has been discussed below:
DEPARTMENT OF ECONOMIC AFFAIRS (DEA)
The DEA is the nodal agency of the Union government to formulate and monitor the country's economic policies
and programmes that have a bearing on domestic and international aspects of economic management. Apart
from forming the Union Budget every year, it has other important functions like:
(i) Formulation and monitoring of macro-economic policies, including issues relating to fiscal policy and
public finance, inflation, public debt management, and the functioning of Capital Market, including stock
exchanges. In this context, it looks at ways and means to raise internal resources through taxation,
market borrowings, and mobilization of small savings.
(ii) Monitoring and raising of external resources through multilateral and bilateral development assistance,
sovereign borrowings abroad, foreign investments, and monitoring foreign exchange resources, including
balance of payments.
Lesson 2
Legal Framework of Capital Market
17
(iii) Production of bank notes and coins of various denominations, postal stationery, postal stamps, cadre
management, career planning, and training of the Indian Economic Service (IES).
Capital Market Division
In India, the Capital Markets is regulated by the Capital Markets division of the DEA, Ministry of Finance. The
Capital Markets Division of DEA comprises various sections. The sections along with the work handled by them
are:
(i) Primary Market (PM)
– Primary Market Related Intermediaries & Participants
– SEBI Board Meeting (primary responsibility)
– SEBI Act
– Related Rules and Regulations
– Corporate Debt Market Development
– Collective Investment Schemes (CIS) including Mutual Funds
– Sectoral Charge of Ministry of Corporate Affairs
– Budget related matters
– National Institute of Securities Market (NISM)
(ii) Secondary Market (SM)
– Securities Contracts (Regulations) Act, 1956
– Depositories Act, 1996
– Related Rules and Regulations
– Taxes and Stamp Duties in Securities Markets
– Database relating to Securities Markets
– Monitoring of Stock Market Movements / Financial Markets
– Related Intermediaries & Participants like Depositories, Stock Exchanges, Clearing Corporations,
Governance of such institutions
– Self Regulatory Organisations
– SME Exchange
– SEBI Board Meeting (secondary responsibility)
(iii) External Markets (EM)
– International Financial Market
– Mumbai International Financial Center
– FEMA and Rules & Regulations
– FATF Cell (Financial Action Task Force)
18 PP-CC&MM
– Liaison / Branch Offices
– High Level Coordination Committee (HLCC) on Financial Markets
– Sectoral (Legal Affairs, Legislative Department and Parliamentary Affairs) Charge
– Foreign Travels of State Govt/UT functionaries
(iv) External Commercial Borrowings (ECB)
– ECB/FCCB (Foreign Convertible Currency Bond)
– American Depository Receipts (ADR)/ Global Depository Receipts (GDR )
– Foreign Institutional investment (FII)
The principal subjects dealt with in the Capital Market Division are the following:
– Policy matters relating to the Securities Markets, related intermediaries and participants;
– Policy matters relating to the regulation and development of the Securities Markets and investor protection ;
– The main Acts/Rules being administered by Capital Markets Division are:– Depositories Act, 1996 and Rules made thereunder
– Securities Contracts (Regulation) Act, 1956 and rules made thereunder
– Securities and Exchange Board of India Act, 1992 and rules made thereunder
– Rules made under the above Acts
– Securities and Exchange Board of India (Terms and Conditions of Services of Chairman and
Members) Rules, 1992
– Securities Appellate Tribunal (Services, Allowance and other Terms and Conditions of Presiding
Officers and other Members) Rules, 2003
– Foreign Exchange Management Act (FEMA), 1999
– Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002.
Ministry of Corporate Affairs
The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act, 1956,
other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the
corporate sector in accordance with law. It exercises supervision over the three professional bodies, namely,
Institute of Chartered Accountants of India(ICAI), Institute of Company Secretaries of India(ICSI) and the
Institute of Cost Accountants of India (ICAI) which are constituted under three separate Acts of the Parliament
for proper and orderly growth of the professions concerned. The Ministry of Corporate Affairs also has the
responsibility of carrying out the functions of the Central Government relating to administration of Partnership
Act, 1932, the Companies (Donations to National Funds) Act, 1951 and Societies Registration Act,
1980.
Company Law Board
The Company Law Board addresses the investor grievances & it can proceed against a company on its own.
The CLB is a quasi-judicial body, set up by the Central Government u/s 10E of the Companies Act, 1956
exercising equitable jurisdiction, which was earlier being exercised by the High Court or the Central Government.
The Board has powers to regulate its own procedures. The Company Law Board has framed “Company Law
Lesson 2
Legal Framework of Capital Market
19
Board Regulations 1991” prescribing the procedure for filing the applications/petitions before it. The Central
Government has also prescribed the fees for making applications/petitions before the Company Law Board,
under the “Company Law Board, (Fees on applications and Petitions) Rules 1991”.
Reserve Bank of India
The Reserve Bank of India (RBI) was established on 1.4.1935, in accordance with the provisions of the RBI Act,
1934. The main functions of RBI are :
(i) operating monetary policy with the aim of maintaining economic and financial stability and ensuring
adequate financial resources for development purposes;
(ii) meeting the currency requirement of the public;
(iii) promotion of an efficient financial system;
(iv) foreign exchange reserve management;
(v) the conduct of banking and financial operations of the government.
The Reserve Bank has systematically focussed on developing and regulating the financial markets in view of
the cross-linkages with other sectors of the economy. Further, a healthy, robust and vibrant financial market is
crucial for stronger monetary policy transmission. To enable the smooth functioning of the market and to
contain systemic risks that can adversely impact the real economy, the Reserve Bank continues to play a
strategic role.
RBI controls the monetary policy of India by controlling cash liquidity in the country. Frequent alteration of the
values of financial tools like Cash Reserve Ratio (CRR), Repo Rate, Reverse Repo Rate, and Statutory Liquidity
Ratio (SLR), restricts the cash flow within the country. As an anti-inflationary measure, RBI limits huge foreign
capital inflows to stabilize the Rupee value. RBI regulates the foreign exchange inflow and outflow, by the
Foreign Exchange Management Act, 1999 of RBI. All money transfer out of India is subject to limits defined by
the RBI. To maintain the exchange rate of Indian Rupee versus foreign currencies like the US Dollar, Euro,
Pound sterling, and Japanese yen, RBI buys and sells foreign currencies. The Reserve Bank of India has the
power to influence the volume of credit created by banks in India, which means that it is the controller of credit.
Carrying out open market operations or changing the Bank rate helps RBI to achieve this. Through quantitative
and qualitative measures, it controls the credit operations of other banks. The gold trade is also regulated by the
Reserve Bank of India.
Securities and Exchange Board of India (SEBI)
SEBI was brought into existence by the Securities and Exchange Board of India Act, 1992 which came into
effect on January 30, 1992. The preamble to the act describes the purpose of the Act in broad terms as “an act
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”.
The Securities and Exchange Board of India (SEBI) is the regulator charged with the orderly functioning of the
Securities Market in India, protect the interests of investors and ensure development of the Securities Market.
Since the establishment of SEBI in 1992, the Indian Securities Market has grown enormously in terms of volumes,
new products and financial services.
SEBI has full autonomy and authority to regulate and develop the Capital Market. The government has framed rules
under the Securities Contracts (Regulation) Act (SCRA), the SEBI Act and the Depositories Act. The SEBI has framed
regulations under the SEBI Act and the Depositories Act for registration and regulation of all market intermediaries, for
prevention of unfair trade practices, and insider trading. SEBI issue notifications, guidelines and circulars which need
to be complied with by market participants. All the rules and regulations are administered by the SEBI.
20 PP-CC&MM
LEGISLATIONS
The four main legislations governing the Securities Market are: (a) the SEBI Act, 1992 which establishes SEBI
to protect investors and develop and regulate Securities Market; (b) 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; (c) the Securities Contracts (Regulation) Act, 1956, which provides for regulation of
transactions in securities through control over stock exchanges; and (d) the Depositories Act, 1996 which provides
for electronic maintenance and transfer of ownership of demat securities.
(a) SEBI Act, 1992: The provisions of the SEBI Act define its role in more specific terms. These broadly relate to
(i) Regulating the business in stock exchanges and any other Securities Markets (ii) Registration and regulation
of a range of financial intermediaries and trade participants (iii) Prohibiting practices that are considered to be
unhealthy for development of the Securities Market such as insider trading and fraudulent and unfair trade
practices for promoting and regulating self regulatory organizations (iv) Promoting investors education and
training of intermediaries of Securities Markets (v) Inspection and calling for information from various regulated
entities referred to in (ii) above (vi) Conducting research (viii) Collecting fees or other charges for carrying out
the purposes of this section and (ix) Performing such other functions as may be prescribed.
(b) 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.
(c) 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.
(d) 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.
GRIEVANCE REDRESSAL MECHANISM
The Capital Market can grow only when investors find it safe for them to invest and they are assured that the
rules governing the market are fair and just for all the players. For gaining the confidence of investors in the
Capital Market there should be a series of systematic measures which would build their confidence in the
systems and processes and protect the interest of investors. An effective mechanism for resolutions of disputes
and grievances is required to be in place.
Grievance Rederessal Mechanism at Stock Exchange
Investors who are not satisfied with the response to their grievances received from the brokers/Depository
Lesson 2
Legal Framework of Capital Market
21
Participants/listed companies, can lodge their grievances with the Stock Exchanges or Depositories. In case of
unsatisfactory redressal, the Stock exchange has designated Investor Grievance Redressal Committees (IGRCs),
or Regional Investor Complaints Resolution Committees (RICRC). This forum acts as a mediator to resolve the
claims, disputes and differences between entities and complainants. Stock Exchanges provide a standard format
to the complainant for referring the matter to IGRC/RICRC. The committee calls for the parties and acts as a
nodal point to resolve the grievances. If the grievance is still not resolved, an investor can file arbitration under
the Rules, Bye laws and Regulations of the respective Stock Exchange/Depository. If the investor has an account
with the broker or a depository participant (DP), he/she can choose arbitration to settle disputes. The investor
generally cannot pursue an issue through arbitration if it is barred by limitation prescribed. When deciding
whether to arbitrate, the investor has to bear in mind that if the broker or DP goes out of business or declares
bankruptcy, he/she might not be able to recover money even if the arbitrator or court rules in his/her favor.
However, with certain restriction to the nature of transactions, Stock Exchanges may settle on case to case
basis the claim of an investor up to a limit prescribed in the “Investor protection fund” guidelines of the respective
Stock Exchange.
Investor Protection Fund
Investor Protection Fund (IPF) or Customer Protection Fund (CPF) is the fund set up by the Stock Exchanges to
meet the legitimate investment claims of the clients of the defaulting members that are not of speculative nature.
SEBI has prescribed guidelines for utilisation of IPF at the Stock Exchanges. The Stock Exchanges have been
permitted to fix suitable compensation limits, in consultation with the IPF/CPF Trust. It has been provided that
the amount of compensation available against a single claim of an investor arising out of default by a member
broker of a Stock Exchange shall not be less than ` 1 lakh in case of major Stock Exchanges and ` 50,000/- in
case of other Stock Exchanges.
Grievance Rederessal Mechanism at SEBI
SEBI has a dedicated department viz., Office of Investor Assistance and Education (OIAE) to receive investor
grievances and to provide assistance to investors by way of education. Investors who are not satisfied with the
response to their grievances received from the Stock Exchanges/Depositories can lodge their grievances with
SEBI. Grievances pertaining to stock brokers and depository participants are taken up with respective stock
exchange and depository for redressal and monitored by SEBI through periodic reports obtained from them.
Grievances pertaining to other intermediaries are taken up with them directly for redressal and are continuously
monitored by SEBI. Grievances against listed company are taken up with the respective listed company and are
continuously monitored. The company is required to respond in prescribed format in the form of Action Taken
Report (ATR). Upon the receipt of ATR, the status of grievances is updated. Where the response of the company
is insufficient / inadequate, follow up action is initiated. If the progress of redressal of investor grievances by an
entity, is not satisfactory, appropriate enforcement actions (adjudication, direction, prosecution etc.) are initiated
against such entity.
SEBI has a web based centralized grievance redress system called SCORES which enables investors to lodge
and follow up their complaints and track the status of redressal of such complaints online from the website
SCORES (http://scores.gov.in) from anywhere. This enables the market intermediaries and listed companies to
receive the complaints online from investors, redress such complaints and report redressal online. All the activities
starting from lodging of a complaint till its closure by SEBI would be online in an automated environment and the
complainant can view the status of his complaint online. An investor, who is not familiar with SCORES or does
not have access to SCORES, can lodge complaints in physical form at any of the offices of SEBI. Such complaints
would be scanned and also uploaded in SCORES for processing.
Investor Protection and Education Fund
To protect the interest of investor and shareholder SEBI has set up an Investor Protection and Education Fund.
22 PP-CC&MM
SEBI has notified regulations for administration of the fund which is used solely for the purpose to educate the
investor, to conduct the awareness programme and other incidental matters. These regulations are called the
SEBI (Investor Protection and Education Fund) Regulations, 2009. The following amounts shall be credited to
the Fund:
(a) contribution as may be made by SEBI to the Fund;
(b) grants and donations given to the Fund by the Central Government, State
(c) Government or any other entity approved by SEBI for this purpose;
(d) proceeds in accordance with the sub-clause (ii) of clause(e) of sub-regulation (12) and the sub- regulation
(13)of regulation 28 of the Securities and Exchange Board of India (Substantial Acquisition of Shares
and Takeovers) Regulations, 1997;
(e) security deposits, if any, held by stock exchanges in respect of public issues and rights issues, in the
event of de-recognition of such stock exchanges;
(f) amounts in the Investor Protection Fund and Investor Services Fund of a stock exchange, in the event
of de-recognition of such stock exchange;
(g) interest or other income received out of any investments made from the Fund;
(h) such other amount as SEBI may specify in the interest of investors.
SECURITIES APPELLATE TRIBUNAL
Securities Appellate Tribunal (SAT) is a statutory body established under the provisions of Section 15K of the
SEBI Act, 1992 to hear and dispose of appeals against orders passed by SEBI or by an adjudicating officer
under the Act and to exercise jurisdiction, powers and authority conferred on the Tribunal by or under SEBI Act
or any other law for the time being in force.
Any Securities Market intermediary/person aggrieved by an order of an adjudicating officer/SEBI has a right to
appeal to Securities Appellate Tribunal (SAT). The appeal must be filed within a period of 45 days from the date
of receipt of the order by the adjudicating officer/SEBI. The SAT can entertain an appeal after the expiry of 45
days for sufficient cause. It can confirm/modify/set aside the order appealed against within six months from the
date of receipt of appeal.
In order to enable the SAT to dispose off appeals expeditiously, it is not bound by the procedure laid down by the
criminal procedure code; instead it is guided by the principle of natural justice. It has the powers to regulate its
own procedure including the place of sitting. For the purpose of discharging its functions, the SAT has the same
powers as are vested in a civil court under the civil procedure code while trying a suit in respect of : (a) summoning
and enforcing the attendance of any person and examining him on oath; (b) requiring the delivery and production
of documents; (c) receiving evidence on affidavits; (d) issuing commission for the examination of witness/
documents; (e) reviewing the decisions; (f) dismissing an application for default or deciding it ex-parte; (g)
setting aside any order of dismissal of any application for default or any order passed by it ex-parte and (h) any
other mater which may be prescribed.
Any proceeding before the SAT is deemed to be a judicial proceeding under the Indian Penal Code and the SAT
is deemed to be a civil court under the Code of Criminal Procedure.
No civil court has jurisdiction over the adjudicating officers and the SAT. The only remedy available to any aggrieved
party against the decision/order of the SAT is an appeal within 60 days from the date of communication to the decision
or order of the Securities Appellate Tribunal on any question of fact or law arising out of such order to a Supreme
Court. It has been provided that the Supreme Court may, if it is satisfied that the applicant was prevented by sufficient
cause from filing the appeal within the said period, allow it to be filed within a further period not exceeding 60 days.
Lesson 2
Legal Framework of Capital Market
23
PREVENTION OF MONEY LAUNDERING ACT, 2002
The Prevention of Money Laundering Act (PMLA), 2002 was enacted in January, 2003. The Act along with the
Rules framed thereunder have come into force with effect from 1st July, 2005.
Section 3 of PMLA defines offence of money laundering as 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 and projecting it as untainted property shall be guilty of offence of money-laundering. It
prescribes obligation of banking companies, financial institutions and intermediaries for verification and
maintenance of records of the identity of all its clients and also of all transactions and for furnishing information
of such transactions in prescribed form to the Financial Intelligence Unit-India (FIU-IND). It empowers the Director
of FIU-IND to impose fine on banking company, financial institution or intermediary if they or any of its officers
fails to comply with the provisions of the Act as indicated above.
PMLA empowers certain officers of the Directorate of Enforcement to carry out investigations in cases involving
offence of money laundering and also to attach the property involved in money laundering. PMLA envisages
setting up of an Adjudicating Authority to exercise jurisdiction, power and authority conferred by it essentially to
confirm attachment or order confiscation of attached properties. It also envisages setting up of an Appellate
Tribunal to hear appeals against the order of the Adjudicating Authority and the authorities like Director FIU-IND.
PMLA envisages designation of one or more courts of sessions as Special Court or Special Courts to try the
offences punishable under PMLA and offences with which the accused may, under the Code of Criminal Procedure
1973, be charged at the same trial. PMLA allows Central Government to enter into an agreement with Government
of any country outside India for enforcing the provisions of the PMLA, exchange of information for the prevention
of any offence under PMLA or under the corresponding law in force in that country or investigation of cases
relating to any offence under PMLA.
Objective
The PML Act seeks to combat money laundering in India and has three main objectives:
– To prevent and control money laundering
– To confiscate and seize the property obtained from the laundered money; and
– To deal with any other issue connected with money laundering in India.
Offence of Money-Laundering
Section 3 of the Prevention of Money Laundering Act, 2002 defines offence of money laundering as under:
“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 and projecting it as untainted property
shall be guilty of offence of money laundering."
Punishment for Money-Laundering
Section 4 of the Prevention of Money Laundering Act, 2002 specifies punishment for money laundering as
under:
Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term
which shall not be less than three years but which may extend to seven years and shall also be liable to fine
which may extend to five lakh rupees.
Provided that where the proceeds of crime involved in money-laundering relates to any offence specified under
paragraph 2 of Part A of the Schedule, the provisions of this section shall have effect as if for the words "which
may extend to seven years", the words "which may extend to ten years" had been substituted."
24 PP-CC&MM
Obligations of Banking Companies, Financial Institutions and Intermediaries of Securities
Market
Section 12 of the Prevention of Money Laundering Act, 2002 lays down following obligations on banking
companies, financial institutions and intermediaries.
Every banking company, financial institution and intermediary shall –
(a) maintain a record of all transactions, the nature and value of which may be prescribed, whether such
transactions comprise of a single transaction or a series of transactions integrally connected to each
other, and where such series of transactions take place within a month;
(b) furnish information of transactions referred to in clause (a) to the Director within such time as may be
prescribed;
(c) verify and maintain the records of the identity of all its clients, in such a manner as may be prescribed.
Provided that where the principal officer of a banking company or financial institution or intermediary, as the
case may be, has reason to believe that a single transaction or series of transactions integrally connected to
each other have been valued below the prescribed value so as to defeat the provisions of this section, such
officer shall furnish information in respect of such transactions to the Director within the prescribed time.
The records referred above is required to be maintained for a period of ten years from the date of transactions
between the clients and the banking company or financial institution or intermediary, as the case may be.
The records referred to in clause (c) shall be maintained for a period of ten years from the date of cessation of
transactions between the clients and the banking company or financial institution or intermediary, as the case
may be.
Intermediary under PMLA includes following persons registered under Section 12 of SEBI Act:(i) Stock brokers
(ii) Sub-brokers
(iii) Share transfer agents
(iv) Bankers to an issue
(v) Trustees to trust deed
(vi) Registrars to issue
(vii) Merchant bankers
(viii) Underwriters
(ix) Portfolio Managers
(x) Investment advisers
(xi) Depositories and Depository Participants
(xii) Custodian of securities
(xiii) Foreign institutional investors
(xiv) Credit rating agencies
(xv) Venture capital funds
(xvi) Collective investment schemes including mutual funds
Lesson 2
Legal Framework of Capital Market
25
Cash Transaction Reports
The Prevention of Money-laundering Act, 2002, and rule thereunder require every banking company, financial
institution and intermediary, to furnish to FIU-IND information relating to A. All cash transactions of the value of more than rupees ten lakhs or its equivalent in foreign currency;
B. All series of cash transactions integrally connected to each other which have been valued below rupees
ten lakhs or its equivalent in foreign currency where such series of transactions have taken place within
a month;
Suspicious Transaction Reports
Every banking company, financial institution and intermediary shall furnish to FIU-IND information of all suspicious
transactions whether or not made in cash.
Suspicions Transaction means a transaction including an attempted transaction, whether or not made in
cash which, to a person acting in good faith –
(a) gives rise to a reasonable ground of suspicion that it may involve proceeds of an offence specified in
the Schedule to the Act, regardless of the value involved; or
(b) appears to be made in circumstances of unusual or unjustified complexity; or
(c) appears to have no economic rationale or bonafide purpose; or
(d) gives rise to a reasonable ground of suspicion that it may involve financing of the activities relating to
terrorism.
Broad categories of reason for suspicion and examples of suspicious transactions for a banking company
are indicated as under:
Identity of client
– False identification documents
– Identification documents which could not be verified within reasonable time
– Accounts opened with names very close to other established business entities
Background of client
– Suspicious background or links with known criminals
Multiple accounts
– Large number of accounts having a common account holder, introducer or authorized
Signatory with no rationale
– Unexplained transfers between multiple accounts with no rationale
Activity in accounts
– Unusual activity compared with past transactions
– Sudden activity in dormant accounts
– Activity inconsistent with what would be expected from declared business
Nature of transactions
– Unusual or unjustified complexity
26 PP-CC&MM
– No economic rationale or bonafide purpose
– Frequent purchases of drafts or other negotiable instruments with cash
– Nature of transactions inconsistent with what would be expected from declared business
Value of transactions
– Value just under the reporting threshold amount in an apparent attempt to avoid reporting
– Value inconsistent with the client’s apparent financial standing
Broad categories of reason for suspicion and examples of suspicious transactions for an intermediary
are indicated as under:
Identity of Client
– False identification documents
– Identification documents which could not be verified within reasonable time
– Non-face to face client
– Doubt over the real beneficiary of the account
– Accounts opened with names very close to other established business entities
Suspicious Background
– Suspicious background or links with known criminals
Multiple Accounts
– Large number of accounts having a common account holder, introducer or authorized
Signatory with no rationale
– Unexplained transfers between multiple accounts with no rationale
Activity in Accounts
– Unusual activity compared to past transactions
– Use of different accounts by client alternatively
– Sudden activity in dormant accounts
– Activity inconsistent with what would be expected from declared business
– Account used for circular trading
Nature of Transactions
– Unusual or unjustified complexity
– No economic rationale or bonafide purpose
– Source of funds are doubtful
– Appears to be case of insider trading
– Investment proceeds transferred to a third party
– Transactions reflect likely market manipulations
– Suspicious off market transactions
Lesson 2
Legal Framework of Capital Market
27
Value of Transactions
– Value just under the reporting threshold amount in an apparent attempt to avoid reporting
– Large sums being transferred from overseas for making payments
– Inconsistent with the clients apparent financial standing
– Inconsistency in the payment pattern by client
– Block deal which is not at market price or prices appear to be artificially inflated/deflated.
Agreements with foreign countries
Section 56 of the Prevention of Money Laundering Act, 2002 provides for agreements with foreign countries to
facilitate exchange of information with them.
– The Central Government may enter into an agreement with the Government of any country outside
India for(i) enforcing the provisions of this Act;
(ii) exchange of information for the prevention of any offence under this Act or under the corresponding
law in force in that country or investigation of cases relating to any offence under this Act.
and may, by notification in the Official Gazette, make such provisions as may be necessary for
implementing the agreement.
– The Central Government may, by notification in the Official Gazette, direct that the application of this Act
in relation to a contracting State with which reciprocal arrangements have been made, shall be subject
to such conditions, exceptions or qualifications as are specified in the said notification.
As per the PMLA, the officers of the Directorate of Enforcement have been given powers to investigate cases of
Money Laundering. The enforcement agency has extensive powers to discharge its duties under the Act. The
officers have also been authorised to initiate proceedings for attachment of property and to launch prosecution
in the designated Special Court. Financial Intelligence Unit-India (FIU-IND) is the authority to implement the
provisions of the Act. The application of AML measures by market intermediaries has been emphasized by
International Regulatory agencies as a key element in combating money laundering. Financial Action Task
Force (FATF) is the agency who evaluates the member countries and certify whether they are compliant or not.
India has been confirmed as one of the country that is compliant with AML regulations during December 2010.
Apart from the FIU and FATF, Central Bureau of Investigation(CBI) is also empowered to investigate cases
relating to Money Laundering.
INVESTIGATING AGENCIES IN CASE OF PMLA, 2002
The following investigating agencies are involved in case of PMLA, 2002
Directorate of Enforcement
The Directorate of Enforcement, with its Headquarters at New Delhi is headed by the Director of Enforcement.
In case of money laundering investigation can be initiated only by authorities designated by Central Government
such as Directorate of Enforcement. These authorities can carry out interim measures such as the survey,
search, seizure and arrest of the accused. Section 13 of the Prevention of Money Laundering Act, 2002, confers
power on the Director (appointed by the Central Government and entrusted with powers of a civil court) to
ensure compliance and to call for records and make appropriate inquiries when necessary.
Functions
The main functions of the Directorate are as under :
28 PP-CC&MM
1. Investigate contraventions of the provisions of Foreign Exchange Management Act, 1999 (FEMA).
Contraventions of FEMA are dealt with by way of adjudication by designated authorities of Enforcement
Directorate (ED) and penalties upto three times the sum involved can be imposed.
2. Investigate offence of money laundering under the provisions of Prevention of Money Laundering Act,
2002 (PMLA) and to take actions of attachment and confiscation of property if the same is determined
to be proceeds of crime derived from a Scheduled Offence under PMLA, and to prosecute the persons
involved in the offence of money laundering. There are 156 offences under 28 statutes which are
Scheduled Offences under PMLA.
3. Adjudicate Show Cause Notices issued under the repealed Foreign Exchange Regulation Act, 1973
(FERA) upto 31.5.2002 for the alleged contraventions of the Act which may result in imposition of penalties.
Pursue prosecutions launched under FERA in the concerned courts.
4. Sponsor cases of preventive detention under Conservation of Foreign Exchange and Prevention of
Smuggling Activities Act, 1974 (COFEPOSA) in regard to contraventions of FEMA.
5. Render cooperation to foreign countries in matters relating to money laundering and restitution of assets
under the provisions of PMLA and to seek cooperation in such matters.
Central Bureau of Investigation
Investigating in CBI was conducted by its Economic Offences Wing, a separate division in the CBI for investigating
of economic offences.
CBI derives its powers of investigation from Delhi Special Police Establishment Act (DSPE) and investigates
cases notified U/S 3 of the DSPE Act, 1946. However, as the law and order is a State subject and basic
jurisdiction to investigate crimes lies with the State Police, the CBI suo moto investigates cases against
employees of Central Government/Public Sector Undertakings of the Government of India in the Union
Territories. Investigation in respect of them is conducted in the States with the consent of concerned State U/
S 6 of the DSPE Act.
As regards economic offences, CBI is empowered to investigate offences which are also notified U/S 3 of the
DSPE Act in the Union Territories and such offences can be investigated in the State with the consent of the
State Government as required U/S 6 of the DSPE Act.
Therefore, in terms of Economic Offences, CBI can investigate : –
(i) Cases of fraud, cheating, embezzlement and the like relating to companies in which large funds are
involved and some other cases when committed by organized gangs or professionals having ramifications
in several States.
(ii) Cases having inter-state and international ramifications and involving several official agencies where it
is considered necessary that a single investigating agency like CBI should be in charge of investigation.
Financial Intelligence Unit – India (FIU-IND)
FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the
Finance Minister of India. Financial Intelligence Unit – India (FIU-IND) was set by the Government of India vide
O.M. dated 18th November 2004 as the central national agency responsible for receiving, processing, analyzing
and disseminating information relating to suspect financial transactions. FIU-IND is also responsible for
coordinating and strengthening efforts of national and international intelligence, investigation and enforcement
agencies in pursuing the global efforts against money laundering and related crimes.
Lesson 2
Legal Framework of Capital Market
29
Functions of FIU-IND
The main function of FIU-IND is to receive cash/suspicious transaction reports, analyse them and, as appropriate,
disseminate valuable financial information to intelligence/enforcement agencies and regulatory authorities . The
functions of FIU-IND are:
1. Collection of Information: Act as the central reception point for receiving Cash Transaction reports (CTRs)
and Suspicious Transaction Reports (STRs) from various reporting entities.
2. Analysis of Information: Analyze received information in order to uncover patterns of transactions suggesting
suspicion of money laundering and related crimes.
3. Sharing of Information: Share information with national intelligence/law enforcement agencies, national
regulatory authorities and foreign Financial Intelligence Units.
4. Act as Central Repository: Establish and maintain national data base on cash transactions and suspicious
transactions on the basis of reports received from reporting entities.
5. Coordination: Coordinate and strengthen collection and sharing of financial intelligence through an effective
national, regional and global network to combat money laundering and related crimes.
6. Research and Analysis: Monitor and identify strategic key areas on money laundering trends, typologies
and developments.
The Financial Action Task Force (FATF)
Financial Action Task Force (FATF) was established in July 1989 by a Group of Seven (G-7) Summit in Paris,
initially to examine and develop measures to combat money laundering. The objectives of the FATF are to set
standards and promote effective implementation of legal, regulatory and operational measures for combating
money laundering, terrorist financing and other related threats to the integrity of the international financial system.
The FATF is therefore a “policy-making body” which works to generate the necessary political will to bring about
national legislative and regulatory reforms in these areas.
The FATF has developed a series of Recommendations that are recognised as the international standard for
combating of money laundering and the financing of terrorism and proliferation of weapons of mass destruction.
They form the basis for a co-ordinated response to these threats to the integrity of the financial system and help
ensure a level playing field. First issued in 1990, the FATF Recommendations were revised in 1996, 2001, 2003
and most recently in 2012 to ensure that they remain up to date and relevant, and they are intended to be of
universal application.
The FATF monitors the progress of its members in implementing necessary measures, reviews money
laundering and terrorist financing techniques and counter-measures, and promotes the adoption and
implementation of appropriate measures globally. In collaboration with other international stakeholders, the
FATF works to identify national-level vulnerabilities with the aim of protecting the international financial system
from misuse.
FATF Recommendations 2012
The FATF Recommendations are the basis on which all countries should meet the shared objective of tackling
money laundering, terrorist financing and the financing of proliferation. The FATF calls upon all countries to
effectively implement these measures in their national systems.
A – AML/CFT POLICIES AND COORDINATION
1 - Assessing risks & applying a risk-based approach
2 - National cooperation and coordination
30 PP-CC&MM
B – MONEY LAUNDERING AND CONFISCATION
3 - Money laundering offence
4 - Confiscation and provisional measures
C – TERRORIST FINANCING AND FINANCING OF PROLIFERATION
5 - SRII Terrorist financing offence
6 - SRIII Targeted financial sanctions related to terrorism & terrorist financing
7 - Targeted financial sanctions related to proliferation
8 - Non-profit organisations
D – PREVENTIVE MEASURES
9 - Financial institution secrecy laws
Customer due diligence and record keeping
10 - Customer due diligence
11 - Record keeping
Additional measures for specific customers and activities
12 - Politically exposed persons
13 - Correspondent banking
14 - Money or value transfer services
15 - New technologies
16 - Wire transfers
Reliance, Controls and Financial Groups
17 - Reliance on third parties
18 - Internal controls and foreign branches and subsidiaries
19 - Higher-risk countries
Reporting of suspicious transactions
20 - Reporting of suspicious transactions
21 - Tipping-off and confidentiality
Designated non-financial Businesses and Professions (DNFBPs)
22 - DNFBPs: Customer due diligence
23 - DNFBPs: Other measures
E – TRANSPARENCY AND BENEFICIAL OWNERSHIP OF LEGAL PERSONS AND ARRANGEMENTS
24 - Transparency and beneficial ownership of legal persons
25 - Transparency and beneficial ownership of legal arrangements
F – POWERS AND RESPONSIBILITIES OF COMPETENT AUTHORITIES AND OTHER INSTITUTIONAL
MEASURES
Regulation and Supervision
Lesson 2
Legal Framework of Capital Market
31
26 - Regulation and supervision of financial institutions
27 - Powers of supervisors
28 - Regulation and supervision of DNFBPs
Operational and Law Enforcement
29 - Financial intelligence units
30 - Responsibilities of law enforcement and investigative authorities
31 - Powers of law enforcement and investigative authorities
32 - Cash couriers
General Requirements
33 - Statistics
34 - Guidance and feedback
Sanctions
35 - Sanctions
G – INTERNATIONAL COOPERATION
36 - International instruments
37 - Mutual legal assistance
38 - Mutual legal assistance: freezing and confiscation
39 - Extradition
40 - Other forms of international cooperation
LESSON ROUND UP
– The Securities Market operations promote the economic growth of the Country. More efficient is the
Securities Market, the greater is the promotion effect on economic growth.
– The Department of Economic Affairs is the nodal agency of the Union Government to formulate and
monitor the country's economic policies and programmes that have a bearing on domestic and
international aspects of economic management.
– The Ministry of Corporate Affairs is primarily concerned with administration of the Companies Act, 1956,
other allied Acts and rules & regulations framed there-under mainly for regulating the functioning of the
corporate sector in accordance with law.
– The CLB is a quasi-judicial body, exercising equitable jurisdiction, which was earlier being exercised by
the High Court or the Central Government.
– RBI regulates the foreign exchange inflow and outflow, by the Foreign Exchange Management Act,
1999 of RBI. All money transfer out of India is subject to limits defined by the RBI.
– The Securities and Exchange Board of India (SEBI) is the regulator charged with the orderly functioning
of the Securities Market in India, protect the interests of investors and ensure development of the
Securities Market.
32 PP-CC&MM
– The four main legislations governing the Securities Market are: (a) the SEBI Act, 1992 (b) the Companies
Act, 1956 (c) the Securities Contracts (Regulation) Act, 1956 (d) the Depositories Act, 1996.
– The Stock Exchange has designated Investor Grievance Redressal Committees (IGRCs), or Regional
Investor Complaints Resolution Committees (RICRC). This forum acts as a mediator to resolve the
claims, disputes and differences between entities and complainants.
– Investor Protection Fund (IPF) or Customer Protection Fund (CPF) is the fund set up by the Stock
Exchanges to meet the legitimate investment claims of the clients of the defaulting members that are
not of speculative nature.
– SEBI has a dedicated department viz., Office of Investor Assistance and Education (OIAE) to receive
investor grievances and to provide assistance to investors by way of education. Investors who are not
satisfied with the response to their grievances received from the Stock Exchanges/Depositories can
lodge their grievances with SEBI.
– To protect the interest of investor and shareholder SEBI has set up an Investor Protection and Education
Fund.
– Any Securities Market intermediary/person aggrieved by an order of an adjudicating officer/SEBI has a
right to appeal to Securities Appellate Tribunal (SAT).
– The Prevention of Money Laundering Act (PMLA), 2002 was enacted in January, 2003.
– Section 3 of PMLA defines offence of money laundering as 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 and projecting it as untainted property shall be guilty of offence of
money-laundering.
– PMLA empowers certain officers of the Directorate of Enforcement to carry out investigations in cases
involving offence of money laundering and also to attach the property involved in money laundering.
– CBI derives its powers of investigation from Delhi Special Police Establishment Act (DSPE) and
investigates cases notified U/S 3 of the DSPE Act, 1946.
– Financial Intelligence Unit – India (FIU-IND) was set by the Government of India as the central national
agency responsible for receiving, processing, analyzing and disseminating information relating to suspect
financial transactions.
– Financial Action Task Force (FATF) was established in July 1989 by a Group of Seven (G-7) Summit in
Paris, initially to examine and develop measures to combat money laundering.
– The FATF Recommendations are the basis on which all countries should meet the shared objective of
tackling money laundering, terrorist financing and the financing of proliferation.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly explain about the legislations governing Securities Market in India.
2. Discuss about the Grievance Redressal Mechanism at Stock Exchanges.
3. Explain the procedure relating to filing an appeal with SAT against an order passed by an adjudicating
officer or SEBI ?
4. What are the Obligations of Banking Companies, Financial Institutions and Intermediaries of Securities
Market under the Prevention of Money Laundering Act, 2002?
5. Describe the various functions of Financial Intelligence Unit – India (FIU-IND).
Lesson 2
Legal Framework of Capital Market
33
34 PP-CC&MM
Lesson 3
Framework of Market Infrastructure Institutions
Lesson 3
Framework of Market Infrastructure
Institutions
LESSON OUTLINE
35
LEARNING OBJECTIVES
– Introduction
Stock Exchanges and other institutions like
– Securities Contract(Regulation)( Stock
Exchanges and Clearing Corporations)
Regulations, 2012
Depositories and Clearing Corporations which
– Recognition of Stock Exchanges and
Clearing Corporations
country’s financial development and serve as
are as much a vital part of the market
infrastructure, are systemically important for the
the infrastructure necessary for the Securities
Market. SEBI has prescribed various Act and
– Networth Requirements
Regulations which have been modified from
– Ownership of Stock Exchanges
time to time as to respond to the needs of the
– Ownership of Clearing Corporations
technological advancement world over.
market and in keeping with financial and
The main objective of this lesson is to enable
– Governance of Stock Exchanges and
Clearing Corporations
the students to understand the Regulatory
Fram ework
– Listing of Securities
governing
the
the
Stock
Exchanges, Clearing Corporations and
Depositories in India.
– Procedural Norms
– Depositories Act, 1996
– Securities Contracts (Regulation) Act, 1956
– LESSON ROUND UP
– SELF TEST QUESTIONS
35
36 PP-CC&MM
FRAMEWORK OF MARKET INFRASTRUCTURE INSTITUIONS
Introduction
Stock Exchanges in India have a long history of more than 175 years. Stock Exchanges have witnessed drastic
change in their ownership and governance structure over time, from a purely closed club of trading members to
full demutualization, and from an organization resembling more a self regulatory organization to a SEBI regulated
entity. Changes have been made from time to time in the management and functioning of the stock exchanges
to serve the overarching objective of market development, financial inclusion, transparency, developing and
operating and risk free trading system. Along with stock exchanges other institutions (depositories and clearing
corporations) which are as much a vital part of the market infrastructure, for achieving the above objectives also
developed. These institutions (i.e., stock exchanges, depositories and clearing corporations) are systemically
important for the country’s financial development and serve as the infrastructure necessary for the securities
market. These institutions are collectively referred to as Market Infrastructure Institutions (MIIs). SEBI has
prescribed various Act and Regulations from time to time for the smooth functioning of these MIIs. These Acts
and Regulations have been modified from time to time as to respond to the needs of the market and in keeping
with financial and technological advancement world over.
SECURITIES CONTRACT (REGULATION) (STOCK EXCHANGES AND CLEARING
CORPORATIONS) REGULATIONS, 2012
SEBI notified the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations) Regulations,
2012 (“SECC Regulations“) on June 20, 2012 to regulate recognition, ownership and governance in Stock
Exchanges and Clearing Corporations and matters connected therewith or incidental thereto.
These Regulations provides for recognition, ownership, governance and listing provisions with respect to Stock
Exchanges as well as Clearing Corporations. The important provisions of the new Regulations are discussed
here under:
Recognition of Stock Exchanges and Clearing Corporations
As per the provisions of these Regulations, all Stock Exchanges and Clearing Corporations are required to
apply for recognition by the SEBI. The Stock Exchanges which have been recognized under the Act as on the
date of commencement of these Regulations shall be deemed to have been recognized under these Regulations
and all the provisions shall be applicable on them. The existing Clearing Corporations will continue for a period
of 3 months from the date of applicability of these Regulations until an application made for the recognitions is
disposed of. The Regulations provides for manner of making application, fees, documents required and
consideration for grant of recognition by SEBI. The Regulations also provides for the period of recognition,
regulatory fees as well as provisions with respect to renewal and withdrawal of recognition.
Networth Requirements
Stock Exchanges and Clearing Corporations are required to maintain minimum networth requirements of ` 100
crores at all times. The existing recognized Stock Exchanges and Clearing Corporations are required to fulfill the
networth requirement within a maximum period of 3 years from the date of commencement of these Regulations.
The limit is not to apply to an applicant performing clearing functions of a recognized stock exchange on the date
of commencement of these regulations. It is further provided that the recognized Stock Exchange or the recognized
Clearing Corporation shall not distribute profit in manner to its shareholders until specified networth limit is met.
The manner of calculation of networth is also prescribed which vary in case of Stock Exchange and Clearing
Corporations.
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Ownership of Stock Exchanges
As per the provisions of the Regulations, the shareholding or ownership of a stock exchange shall be as following:
Shareholder
Equity share holding limit
Equity Share Capital to be held by Public
Atleast 51% total
Individual resident in India (either directly or indirectly and either
individually or with Person Acting in Concert (PAC))
Not more than 5% individually
Further
Not more than 15% individually
– Stock exchange
– Depository
– Banking company
– Insurance company
– Public financial Institution
(either directly or indirectly and either individually or with PAC)
All the residents outside India taken together
Not more than 49% total
An Individual resident outside India (either directly or indirectly and
either individually or with PAC)
Not more than 5% individually
Total holding of residents outside India through FDI route
Not to exceed 26% in total
Total holding of Foreign Institutional Investors (no shares to be
acquired other than through secondary market)
Not to exceed 23% in total
No Clearing Corporation shall hold any right, stake or interest in any recognized Stock Exchange.
Any person who directly or indirectly and either individually or with PAC acquires 2% or more in equity capital
would require to apply for approval of SEBI within 15 days of such acquisition. If the approval is not granted
the shares so acquired shall be forthwith divested. Shareholders of existing recognized Exchange holding
more than 2% equity may apply for approval within 90 days of commencement of these Regulations.
Stock exchange, Depository, Banking company, Insurance company, Public financial Institution allowed to
hold upto 15% equity capital, cannot acquire either directly or indirectly and either individually or with PAC
any holding over and above 5% without the prior approval from SEBI.
Every shareholder of the recognized Stock Exchange is required to be a Fit & Proper person.
Ownership of Clearing Corporations
The provisions with respect to ownership and shareholding of recognized Clearing Corporations as similar to
the aforesaid provisions as applicable to recognized Stock Exchanges except for as following:
– 51% or more equity share capital to be held by one or more recognized Stock Exchanges.
– A single Stock Exchange cannot hold more than 15% of equity share capital in one Clearing Corporation.
Governance of Stock Exchanges and Clearing Corporations
The provisions with respect to management and governance of recognized Stock Exchanges as well as Clearing
Corporations are also provided in the Regulation broadly covering the following:
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– Composition of Governance Board
– Guidelines for election of chairperson as well as number of public interest directors, appointment of
Shareholder director, etc on the Governing Board.
– Conditions for appointment of Directors and the Managing Director.
– Code of conduct for Directors and Key Managerial Personnel.
– Compensation and Tenure for Key Managerial Personnel.
– Segregation of regulatory department from other departments.
– Constitution of Oversight committee
To address conflicts of interest in respect of member regulation, listing functions and trading and surveillance
function.
– Constitution of Advisory Committee
To advice governing board on non regulatory and operational matters including product design,
technology, charges and levies.
– Constitution of Risk Management committee (in case of clearing corporations)
– To formulate and implement a comprehensive detail risk management policy.
– Appointment of compliance officer
– Transfer of Profits
– Transfer of penalties
– Disclosure and Corporate Governance norms.
Listing of Securities
As per the provisions of the Regulations, a recognized stock exchange can apply for the listing of its securities
on any recognized stock exchange other than itself if:
– It complies with the provisions of these regulations.
– It has completed 3 years of continuous trading operations immediately preceding the date of application
of listing.
– It has the approval of the board.
Though as per the provisions of these Regulations, the securities of a recognized Clearing Corporation shall not
be listed on a stock exchange.
The Regulations also requires securities of both the recognized Stock Exchanges as well as Clearing Corporations
to be held in dematerialized form.
PROCEDURAL NORMS
To facilitate the implementation of the SECC Regulations and provide guidelines to Stock Exchanges and Clearing
Corporations for their operations in accordance with the terms of SECC Regulations, SEBI has issued procedural
norms on recognition, ownership and governance for Stock Exchanges and Clearing Corporations dated
December 13, 2012.
The Procedural Norms are divided into four (4) parts as Parts A to D which are discussed in brief as follows:
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Part A: Recognition
For the purpose of granting in principle approval in terms of regulation 7(5) of the SECC Regulations, SEBI is
entitled to consider inter alia the following information in relation to an application made under regulation 4 of
the SECC Regulations:
– Business feasibility plan for the next five years;
– Net worth certificate/ financial books and bank account details;
– Detailed write-up on each of its functions;
– Details of authorized officials along with specimen signatures of the authorized signatories;
– Proposed organizational structure;
– Necessary undertakings;
– Manpower planning;
– Background and necessary information (as specified herein) to establish that its shareholders/promoters
are fit and proper persons, Information regarding its Office set-up, Appointment of Managing Director
after following due process;
Paragraph 2 of the Procedural Norms provides that a Clearing Corporation shall make bye-laws providing inter
alia for the following:
– The timings for pay-in and pay-out of funds and securities;
– Rules for clearing and settlement;
– Risk management mechanism;
– Process of netting, novation and guarantee for settlement of trades;
– Norms for contribution into and utilization of the Fund in terms of regulation 39 of SECC Regulations;
– Rights and obligations of the clearing members vis a vis the clearing Corporation, other clearing members,
the trading members and clients of such trading members;
– Criteria for admission and regulation of clearing members;
– Default handling mechanism;
– Committees as mentioned in paragraph 7 of the Procedural Norms;
– Any other matter as may be specified by SEBI.
Part B : Action Plan for achieving Networth
– In terms of regulation 14 of SECC Regulations a recognized stock exchange is required to have a net
worth of ` 100 crore. However, in case of a stock exchange having a net worth less than ` 100 crore
such stock exchange is required to submit a plan duly approved by its shareholders to achieve such net
worth in accordance with the terms of regulation 14 of the SECC Regulations. This plan has to be
submitted within a period of ninety days from the date of issue of the Procedural Norms.
– A clearing corporation which has made application for recognition in terms of Regulation 3 of SECC Regulations
and has a networth of less than ` 300 crore shall submit its plan duly approved by its shareholders to SEBI
for achieving its networth withhin 90 days from the date of issue of the Procedural Norms.
Ownership
– In terms of Regulation 17(2) of the SECC Regulations except no person resident in India is allowed to
hold or acquire more than 5% of the paid up equity capital in a stock exchange.
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– However, a stock exchange, depository, banking company, insurance company and a public financial
institution may acquire or hold up to 15% of the paid up equity capital in a stock exchange.
– Despite the SECC Regulations providing a threshold of 5% for the shareholding, the Procedural Norms
state that a shareholder holding more than 2% of the paid up equity capital in a stock exchange is
required to obtained SEBI’s prior approval.
– Under paragraph 5 of the Procedural Norms, the stock exchange/clearing corporation is required to put
in place a monitoring mechanism to ensure compliance with the shareholding requirements at all times.
The stock exchange/clearing corporation is also required to:
– Disseminate on its website the number of shares available in non-public, FII and FDI category. The
same shall also be disseminated by the stock exchange where shares of such stock exchange/clearing
corporation are listed;
– Check the shareholding pattern of the stock exchange/clearing corporation from time to time to ensure
compliance with the SECC Regulations;
– Upon breach of shareholding limits, same shall be intimated to SEBI within seven days.
Part C: Governance
– Paragraph 6.2.1 of the Procedural Norms states that for the purpose of appointment of CEO/Managing
Director/Executive Director the Stock Exchange/Clearing Corporation shall constitute a committee which
shall oversee the appointment. In this regard the managing director shall be selected through open
advertisement in all editions of at least one national daily from amongst persons qualified in the fields of
capital markets/ finance/ management and possessing sufficient experience.
– Under paragraph 6.3.1 of the Procedural Norms the Board of the Stock Exchange/Clearing Corporation
may forward a minimum of two names for each vacancy of public interest directors. In terms of paragraph
6.3.3 chairperson of the Stock Exchange/Clearing Corporation shall be appointed with the prior approval
of SEBI. In terms of paragraph 6.3.4 public interest directors are not permitted to simultaneously hold
positions on the board of other Stock Exchanges/Clearing Corporations or their subsidiaries.
– Paragraph 6.4 deals with shareholder directors. Names of persons nominated for appointment as
shareholder directors shall be sent to SEBI after approval of such names from the Board of the Stock
Exchange/Clearing Corporations and Shareholders’ approval of the Stock Exchange/Clearing
Corporation.
– The Board shall appoint trading members/ clearing members to the advisory committee after being
satisfied that they are fit and proper persons in terms of regulation 20 of the SECC Regulations. The
Board shall also appoint a compliance officer in terms of regulation 32 of the SECC Regulation. The
Board shall ensure that all key management persons are fit and proper as per regulation 20 of SECC
Regulations.
– Paragraph 7 requires the formation of various statutory committees. Stock exchanges are required to
have committees such as Investor Grievance Redressal Committee, Defaulters’ Committee, Investor
Services Committee, Advisory Committee, Ethics Committee, Arbitration Committee, and Independent
Oversight Committee of the Governing Board for Trading and Surveillance Function, etc. and Clearing
Corporation to have Advisory Committee, Risk Management Committee, and Ethics Committee.
– Paragraph 8 provides for Norms for Compensation Policy. Regulation 27 of SECC Regulations mandates
that the Compensation Policy for Key Management Personnel of Stock Exchange/Clearing Corporation
shall be in accordance with the norms specified by SEBI.
– Paragraph 9 of the Procedural Norms mandates the segregation of regulatory departments from other
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departments in Stock Exchanges. Some of the key regulatory departments are surveillance, listing,
member registration, compliance, inspection, enforcement, investor protection, etc. Similarly such a
separation is mandated for clearing corporations. Some of the key regulatory departments in clearing
corporations are risk management, member registration, compliance, inspection, enforcement, default,
investor protection, etc.
Part D of the Procedural Norms deals with Miscellany including procedural aspects such as amendments to the
bye laws of Stock Exchanges/Clearing Corporations, internal manual for conflict resolution, disclosure of securities
transactions by directors and parties related thereto, other clarifications, etc.
THE DEPOSITORIES ACT, 1996
The Depositories Act, 1996 provides for the establishment of single or multiple depositories. Any body to be
eligible for providing depository services must be formed and registered as a company under the Companies
Act, 1956 and seek registration with SEBI and obtain a Certificate of Commencement of Business from SEBI on
fulfilment of the prescribed conditions.
Objectives
The depositories legislation as per the Statement of objects and reasons appended to the Depositories Act,
1996 aims at providing for:
– A legal basis for establishment of depositories to conduct the task of maintenance of ownership records
of securities and effect changes in ownership records through book entry;
– Demateralisation of securities in the depositories mode as well as giving option to an investor to choose
between holding securities in physical mode and holding securities in a dematerialized form in a
depository;
– Making the securities fungible;
– Making the shares, debentures and any interest thereon of a public limited company freely transferable;
and
– Exempting all transfers of shares within a depository from stamp duty.
Eligibility condition for Depository Services
Any company or other institution to be eligible to provide depository services must:
– be formed and registered as a company under the Companies Act, 1956.
– be registered with SEBI as a depository under SEBI Act, 1992.
– has framed bye-laws with the previous approval of SEBI – has one or more participants to render
depository services on its behalf.
– has adequate systems and safeguards to prevent manipulation of records and transactions to the
satisfaction of SEBI.
– complies with Depositories Act, 1996 and SEBI (Depositories and Participants) Regulations, 1996.
– meets eligibility criteria in terms of constitution, network, etc.
Eligible Securities required to be in the Depository Mode
Section 8 of the Depositories Act gives the option to the investors to receive securities in physical form or in
depository mode.
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It is not necessary that all eligible securities must be in the depository mode. The investor has the choice of
holding physical securities or opt for a depository based ownership record.
However in case of fresh issue of securities all securities issued have to be in dematerialized form. However
after that investor will also have the freedom to switch from depository mode to non-depository mode and vice
versa. The decision as to whether or not to hold securities within the depository mode and if in depository mode,
which depository or participant, would be entirely with the investor.
Fungibility
Section 9 states that securities in depositories shall be in fungible form.
The Act envisages that all securities held in depository shall be fungible i.e. all certificates of the same security
shall become interchangeable in the sense that investor loses the right to obtain the exact certificate he surrenders
at the time of entry into depository. It is like withdrawing money from the bank without bothering about the
distinctive numbers of the currencies.
Immobilisation of securities in a depository mode refers to a situation where the depository holds securities in
the form of physical paper side by side with electronic evidence of ownership. In such a case the transfers are
not accompanied by physical movement of securities but securities are in existence in the custody of the depository.
However, the Depositories Act, envisages dematerialisation in the depository mode. In such a case the securities
held in a depository shall be dematerialized and the ownership of the securities shall be reflected through book
entry only. The securities outside the depository shall be represented by physical scrips. Hence, the depository
legislation envisages partial dematerialisation, i.e. a portion of the securities in dematerialized form and the
other portion in physical form. Sections 153, 153A, 153B, 187B, 187C and 372 (now 372A) of Companies Act,
1956 shall not apply to a depository in respect of shares held on behalf of beneficial owners in depositories.
Rights of Depositories and Beneficial Owner
A depository should be deemed to be the registered owner for the purposes of effecting transfer of ownership of
security on behalf of a beneficial owner. The depository as a registered owner should not have any voting rights
or any other rights in respect of securities held by it. The beneficial owner is entitled to all the rights and benefits
and be subjected to all the liabilities in respect of his securities held by a depository.
Register of beneficial owner
Every depository is required to maintain a register and an index of beneficial owners in the manner provided in
the Companies Act.
Pledge or hypothecation of securities held in a depository
A beneficial owner may with the previous approval of the depository create a pledge or hypothecation in respect
of a security owned by him through a depository. Every beneficial owner should give intimation of such pledge or
hypothecation to the depository and such depository is required to make entries in its records accordingly. Any
entry in the records of a depository should be evidence of a pledge or hypothecation.
Pledge and Hypothecation
If the lender (pledgee) has unilateral right (without reference to borrower) to appropriate the securities to his
account if the borrower (pledgor) defaults or otherwise, the transaction is called a pledge. If the lender needs
concurrence of the borrower (pledgor) for appropriating securities to his account, the transaction is called
hypothecation. The Depositories Act, 1996 permits the creation of pledge and hypothecation against securities.
Securities held in a depository account can be pledged or hypothecated against a loan, credit, or such other
facility availed by the beneficial owner of such securities. For this purpose, both the parties to the agreement,
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i.e., the pledgor and the pledgee must have a beneficiary account with Depository. However, both parties
need not have their depository account with the same DP. The nature of control on the securities offered as
collateral determines whether the transaction is a pledge or hypothecation.
Procedure for Pledge/Hypothecation
The pledgor initiates the creation of pledge/hypothecation through its DP and the pledge instructs its DP to
confirm the creation of the pledge. The pledge/hypothecation so created can either be closed on repayment
of loan or invoked if there is a default. After the pledgor has repaid the loan to the pledgee, the pledgor
initiates the closure of pledge/hypothecation through its DP and the pledgee instructs its DP to confirm the
closure of the pledge/hypothecation. If the pledgor defaults in discharging his obligation under the agreement,
the pledgee may invoke the pledge/ hypothecation. This has to be done after taking the necessary steps
under the terms of the agreement with the pledgor and the Bye-Laws of Depository and rules and regulations
framed by SEBI.
Furnishing of information and records by depository and issuer
Every depository is required to furnish to the issuer information about the transfer of securities in the name of
beneficial owners at such intervals and in such manner as may be specified by the bye-laws of depository. Every
issuer should make available to the depository copies of the relevant records in respect of securities held by
such depository.
Option to opt out in respect of any security
Section 14 of the Depository Act provides that if a beneficial owner seeks to opt out of a depository in respect of
any security he should inform the depository accordingly. After the receipt of intimation the depository should
make appropriate entries in its records and also inform the issuer. Every issuer may, within thirty days of the
receipt of intimation from the depository and on fulfilment of such conditions and on payment of such fees as
may be specified by the regulations, issue the certificate of securities to the beneficial owner or the transferee,
as the case may be.
Depositories to indemnify loss in certain cases
Any loss caused to the beneficial owner due to the negligence of the depository or the participant, would be
indemnified by the depository to such beneficial owner. Where the loss due to the negligence of the participant
is indemnified by the depository, the depository has the right to recover the same from such participant.
ENQUIRY AND INSPECTION
Power of SEBI
Section 18 of the Depositories Act provides that SEBI in the public interest or in the interest of investors
may by order in writing to 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 authorise any
person to make an enquiry or inspection in relation to the affairs of the issuer, beneficial owner, depository
or participant, who shall submit a report of such enquiry or inspection to it within such period as may be
specified in the order.
Sub-section (2) to Section 18 provides that every director, manager, partner, secretary, officer or employee of
the depository or issuer or the participant or beneficial owner shall on demand produce before the person
making the enquiry or inspection all information or such records and other documents in his custody having a
bearing on the subject matter of such enquiry or inspection.
If after making or causing to be made an enquiry or inspection, SEBI is satisfied that it is necessary in the
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interest of investors, or orderly development of securities market; or to prevent the affairs of any depository or
participant being conducted in the manner detrimental to the interests of investors or securities market, SEBI
may issue such directions to any depository or participant or any person associated with the securities market;
or to any issuer as may be appropriate in the interest of investors or the securities market.
Power of SEBI to give directions
Section 19 provides that after making an enquiry or inspection, SEBI if satisfied, can issue directions:
(a) to any depository or participant or any person associated with the securities market; or
(b) to any issuer
as may be appropriate in the interest of investors or the securities market.
The power to issue directions under Section 19 shall include and always be deemed to have been
included the power to direct any person, who made profit or averted loss by indulging in any transaction
or activity in contravention of the provisions of this Act or regulations made thereunder to disgorge
an amount equivalent to the wrongful gain made or loss averted by such contravention.
PENALTY
Penalty for failure to furnish information/return etc.
Section 19A provides that any person, who is required under Depositories Act or any rules or regulations or
bye¬laws made there under –
(a) to furnish any information, document, books, returns or report to SEBI, fails to furnish the same within
the time specified therefore fails to furnish the same within specified time;
(b) to file any return or furnish any information, books or other documents within the time specified therefore
in the regulations or bye-laws, fails to file return or furnish the same within the time specified therefore;
(c) to maintain books of account or records, fails to maintain the same;
he shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to enter into agreement
Section 19B provides that if a depository or participant or any issuer or its agent or any person, who is a
registered intermediary with SEBI and is required under this Act or any rules or regulations made there under, to
enter into an agreement, fails to enter into such agreement, such intermediary shall be liable to a penalty of one
lakh rupees for each day during which such failure continues or one crore rupees, whichever is less for every
such failure.
Penalty for failure to redress investors' grievances
Section 19C lays down that if any depository or participant or any issuer or its agent or any person, who is
registered intermediary with SEBI, after having been called upon by the SEBI in writing, to redress the grievances
of the investors, fails to redress such grievances within the time specified, such depository or participant or
issuer or its agents or intermediary shall be liable to a penalty of one lakh rupees for each day during which such
failure continues or one crore rupees, whichever is less.
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Penalty for delay in dematerialisation or issue of certificate of securities
Section 19D stipulates that if any issuer or its agent or any person, who is a registered intermediary, fails to
dematerialise or issue the certificate of securities on opting out of a depository by the investors, within the time
specified under this Act or regulations or bye-laws made there under or abets in delaying the process of
dematerialisation or issue the certificate of securities on opting out of a depository of securities, such intermediary
shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to reconcile records
Section 19E provides that if a depository or participant or any issuer or its agent or any person, who is a
registered intermediary, fails to reconcile the records of dematerialised securities with all the securities issued
by the issuer as specified in the regulations, such depository or participant or issuer or its agent or intermediary
shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore
rupees, whichever is less.
Penalty for failure to comply with directions issued by SEBI
Section 19F requires that if any person fails to comply with the directions issued by SEBI under section 19,
within the time specified by it, he shall be liable to a penalty of one lakh rupees for each day during which such
failure continues or one crore rupees, whichever is less.
Penalty for contravention where no separate penalty has been provided
Section 19G provides that whoever fails to comply with any provision of this Act, the rules or the regulations or
bye-laws made or directions issued by SEBI thereunder for which no separate penalty has been provided, shall
be liable to a penalty which may extend to one crore rupees.
Thing You May Know
Every intermediary in the Capital Market is required to be registered with SEBI under Seciton 12 of the SEBI
Act, 1992.
Power to adjudicate
Section 19H provides that for the purpose of adjudging, SEBI shall appoint any officer not below the rank of a
Division Chief of SEBI to be an adjudicating officer for holding an inquiry in the prescribed manner after giving
any person concerned a reasonable opportunity of being heard for the purpose of imposing any penalty. While
holding an inquiry, the adjudicating officer shall have power to summon and enforce the attendance of any
person acquainted with the facts and circumstances of the case to give evidence or to produce any document,
which in the opinion of the adjudicating officer, may be useful for or relevant to the subject matter of the inquiry
and if, on such inquiry, he is satisfied that the person has failed to comply with the provisions of any of the
sections specified in this Act, he may impose such penalty as he thinks fit in accordance with the provisions of
any of those sections.
Factors to be taken into account by Adjudicating Officer
Accroding to Section 19 I, while adjudging the quantum of penalty, the adjudicating officer shall have due regard
to the following factors, namely–(a) the amount of disproportionate gain or unfair advantage, wherever quantifiable,
made as a result of the default; (b) the amount of loss caused to an investor or group of investors as a result of
the default; (c) the repetitive nature of the default.
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Settlement of Administrative Civil Proceedings
Section 19-IA stipulates that any person, against whom any proceedings have been initiated or may be initiated
under section 19, section 19H, as the case may be, can file an application in writing to SEBI proposing for
settlement of the proceedings initiated or to be initiated for the alleged defaults.
SEBI may, after taking into consideration the nature, gravity and impact of defaults, agree to the proposal
for settlement, on payment of such sum by the defaulter or on such other terms as may be determined by SEBI
in accordance with the regulations made under the SEBI Act, 1992.
The settlement procedure will be as provided in SEBI Act, 1992.
No appeal shall lie under section 23A against any order passed by SEBI or the adjudicating officer, as the case
may be, under this section.
Recovery of amounts
1. 19-IB provides that if a person fails to pay the penalty imposed by the adjudicating officer or fails to comply
with a direction of disgorgement order issued under Section 19 or fails to pay any fees due to SEBI, the Recovery
Officer may draw up under his signature a statement in the specified form specifying the amount due from the
person (such statement being hereafter in this Chapter referred to as certificate) and shall proceed to recover
from such person the amount specified in the certificate by one or more of the following modes, namely:(a) attachment and sale of the person’s movable property;
(b) attachment of the person’s bank accounts;
(c) attachment and sale of the person’s immovable property;
(d) arrest of the person and his detention in prison;
(e) appointing a receiver for the management of the person’s movable and immovable properties.
For this purpose, the provisions of section 221 to 227, 228A, 229, 231, 232, the Second and Third Schedules to
the Income-tax Act, 1961 and the Income-tax (Certificate Proceedings) Rules, 1962, as in force from time to
time, in so far as may be, apply with necessary modifications as if the said provisions and the rules thereunder
were the provisions of this Act and referred to the amount due under this Act instead of to income-tax under the
Income-tax Act, 1961.
“Recovery Officer” means any officer of SEBI who may be authorised, by general or special order in
writing, to exercise the powers of a Recovery Officer.
2. The Recovery Officer shall be empowered to seek the assistance of the local district administration while
exercising the powers.
3. The recovery of amounts by a Recovery Officer under this Section pursuant to noncompliance with any
direction issued by SEBI under section 19, shall have precedence over any other claim against such person.
Explanation 1
For the purpose of this sub-section, the person's movable or immovable
property or monies held in bank accounts shall include any property or monies held
in bank accounts which has been transferred directly or indirectly on or after the
date when the amount specified in certificate had become due, by the person to
his spouse or minor child or son’s wife or son's minor child, otheiveise than for
adequate consideration, and which is held by, or stands in the name of, any of the
persons aforesaid; and so far as the movable or immovable property or monies
held in bank accounts so transferred to his minor Mild or his son's minor child is
concerned, it shall, even after the date of attainment of majority by such minor child
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or son's minor child, as the case may be, continue to be included in the person's
movable or immovable property or monies held in bank accounts for recovering
any amount due from the person under this Act
Explanation 2
Explanation 3
Explanation 3
Any reference under the provisions of the Second and Third Schedules to the Incometax Act, 1961 and the Income-tax (Certificate Proceedings) Rules, 1962 to the
assessee shall be construed as a reference to the person specified in the certificate.
Any reference to appeal in Chapter XVIID and the Second Schedule to the Incometax Act, 1961, shall be construed as a reference to appeal before the Securities
Appellate Tribunal under Section 23A of this Act.
Crediting of penalties to consolidated fund of India
All sums realised by way of penalties under this Act shall be credited to the Consolidated Fund of India.
OFFENCES
Section 20 provides that without prejudice to any award of penalty by the adjudicating officer under this Act, if
any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of
any rules or regulations or bye-laws made there under, he shall be punishable with imprisonment for a term
which may extend to ten years, or with fine, which may extend to twenty-five crore rupees, or with both. If any
person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his directions or
orders, he shall be punishable with imprisonment for a term which shall not be less than one month but which
may extend to ten years, or with fine, which may extend to twenty-five crore rupees, or with both.
Offences by companies
Section 21 requires, that where an offence under this Act has been committed by a company, every person who
at the time the offence was committed was in charge of, and was responsible to, the company for the conduct of
the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be
liable to be proceeded against and punished accordingly. The proviso to the section also provides that nothing
contained in this sub-section shall render any such person liable to any punishment provided in this Act, if he
proves that the offence was committed without his knowledge or that he had exercised all due diligence to
prevent the commission of such offence. Where an offence under this Act has been committed by a company
and it is proved that the offence has been committed with the consent or connivance of, or is attributable to any
neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager,
secretary or other officer shall also be deemed to be guilty of the offence and shall be liable to be proceeded
against and punished accordingly.
48 PP-CC&MM
Cognizance of offences by Courts
According to Section 22 a court should not take cognizance of any offence punishable under this Act or any
rules or regulations or bye-laws made there under except on a complaint made by the Central Government or
State Government or SEBI.
Composition of certain offences
Section 22A provides that any offence punishable under this Act, not being an offence punishable with imprisonment
only, or with imprisonment and also with fine, may either before or after the institution of any proceeding, be
compounded by a Securities Appellate Tribunal or a court before which such proceedings are pending.
Power to grant immunity
Section 22B empowers the Central Government to grant immunity, on recommendation by SEBI, if the Central
Government is satisfied, that any person, who is alleged to have violated any of the provisions of this Act or the rules
or the regulations made there under, has made a full and true disclosure in respect of alleged violation, grant to such
person, subject to such conditions as it may think fit to impose, immunity from prosecution for any offence under this
Act, or the rules or the regulations made there under or also from the imposition of any penalty under this Act with
respect to the alleged violation. No such immunity shall be granted by the Central Government in cases where the
proceedings for the prosecution for any such offence have been instituted before the date of receipt of application for
grant of such immunity and the recommendation of SEBI is not binding upon the Central Government in this case.
The immunity granted to a person may, at any time, be withdrawn by the Central Government, if it is satisfied
that such person had, in the course of the proceedings, not complied with the condition on which the immunity
was granted or had given false evidence, and thereupon such person may be tried for the offence with respect
to which the immunity was granted or for any other offence of which he appears to have been guilty in connection
with the contravention and shall also become liable to the imposition of any penalty under this Act to which such
person would have been liable, had not such immunity been granted.
SPECIAL COURT
Establishment of Special Courts
Section 22 C provides that the Central Government may, for the purpose of providing speedy trial of offences
under this Act, by notification, establish or designate as many Special Courts as may be necessary.
A Special Court shall consist of a single judge who shall be appointed by the Central Government with the
concurrence of the Chief Justice of the High Court within whose jurisdiction the judge to be appointed is working.
A person shall not be qualified for appointment as a judge of a Special Court unless he is, immediately before
such appointment, holding the office of a Sessions Judge or an Additional Sessions Judge, as the case may be.
Offences triable by Special Courts
Section 22D says that all offences under this Act committed prior to the date of commencement of the Securities
Laws (Amendment) Ordinance, 2013 or on or after the date of such commencement, shall be taken cognizance
of and triable by the Special Court established for the area in which the offence is committed or where there are
more Special Courts than one for such area, by such one of them as may be specified in this behalf by the High
Court concerned.
Appeal and Revision
Section 22E stipulates that the High Court may exercise, so far as may be applicable, all the powers conferred
by Chapters XXIX and XXX of the Code of Criminal Procedure, 1973 on a High Court, as if a Special Court within
the local limits of the jurisdiction of the High Court were a Court of Session trying cases within the local limits of
the jurisdiction of the High Court.
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Application of Code to proceedings before Special Court
Section 22F stipulates that the provisions of the Code of Criminal Procedure, 1973 shall apply to the proceedings
before a Special Court and for the purposes of the said provisions, the Special Court shall be deemed to be a
Court of Session and the person conducting prosecution before a Special Court shall be deemed to be a Public
Prosecutor within the meaning of clause (u) of section 2 of the Code of Criminal Procedure, 1973.
The person conducting prosecution should have been in practice as an Advocate for not less than seven years
or should have held a post, for a period of not less than seven years, under the Union or a State requiring special
knowledge of law.
Transitional provisions
Under Section 22, any offence committed under this Act, which is triable by a Special Court shall, until a Special
Court is established, be tried by a Court of Session exercising jurisdiction over the area, notwithstanding anything
contained in the Code of Criminal Procedure, 1973.However, nothing contained in this section shall affect the
powers of the High Court, under section 407 of the Code to transfer any case or class of cases taken cognizance
by a Court of Session under this Section.
APPEALS
Section 23 provides that any person aggrieved by an order of SEBI made under this Act, or the regulations
made thereunder may prefer an appeal to the Central Government within such time as may be prescribed.
No appeal shall be admitted if it is preferred after the expiry of the period prescribed therefor. However, an
appeal may be admitted after the expiry of the period prescribed therefor if the appellant satisfies the Central
Government that he had sufficient cause for not preferring the appeal within the prescribed period.
Every appeal made under this section shall be made in such form and shall be accompanied by a copy of the
order appealed against and by such fees as may be prescribed. The procedure for disposing of an appeal shall
be such as may be prescribed. However, before disposing of an appeal, the appellant shall be given a reasonable
opportunity of being heard.
Appeal to Securities Appellate Tribunal
Section 23A provides that, any person aggrieved by an order of SEBI or by an adjudicating officer under this Act
may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter. Every appeal shall be
filed within a period of forty-five days from the date on which a copy of the order made by SEBI is received by the
person and it shall be in such form and be accompanied by such fee as may be prescribed:
The Securities Appellate Tribunal may entertain an appeal after the expiry of the said period of forty-five days if
it is satisfied that there was sufficient cause for not filing it within that period.
On receipt of an appeal, the Securities Appellate Tribunal may, after giving the parties to the appeal an opportunity
of being heard, pass such orders thereon as it thinks fit, confirming, modifying or setting aside the order appealed
against.
The Securities Appellate Tribunal shall send a copy of every order made by it to SEBI and parties to the appeal.
The appeal filed before the Securities Appellate Tribunal shall be dealt with by it as expeditiously as possible
and endeavour shall be made by it to dispose of the appeal finally within six months from the date of receipt of
the appeal.
The provisions of Limitations Act, 1963, will apply to an appeal made to a Securities Appellate Tribunal.
50 PP-CC&MM
Procedure and powers of Securities Appellate Tribunal
Section 23B provides that the Securities Appellate Tribunal shall not be bound by the procedure laid down by the
Code of Civil Procedure, 1908, but shall be guided by the principles of natural justice and, subject to the other
provisions of this Act and of any rules, the Securities Appellate Tribunal shall have powers to regulate their own
procedure including the places at which they shall have their sittings. The Securities Appellate Tribunal shall
have, for the purpose of discharging their functions under this Act, the same powers as are vested in a civil court
under the Code of Civil Procedure, 1908, while trying a suit, in respect of the following matters, namely –
(a) summoning and enforcing the attendance of any person and examining him on oath;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits;
(d) issuing commissions for the examination of witnesses or documents;
(e) reviewing its decisions;
(f) dismissing an application for default or deciding it ex parte;
(g) setting aside any order of dismissal of any application for default or any order passed by it ex parte; and
(h) any other matter which may be prescribed.
Every proceeding before the Securities Appellate Tribunal shall be deemed to be a judicial proceeding
within the meaning of sections 193 and 228, and for the purposes of section 196 of the Indian Penal
Code and the Securities Appellate Tribunal shall be deemed to be a civil court for all the purposes of
section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973.
Appeal to Supreme Court
Section 23F provides that any person aggrieved by any decision or order of the Securities Appellate Tribunal
may file an appeal to the Supreme Court within sixty days from the date of communication of the decision or
order of the Securities Appellate Tribunal to him on any question of law arising out of such order. However, the
Supreme Court may, if it is satisfied that the appellant was prevented by sufficient cause from filing the appeal
within the said period, allow it to be filed within a further period not exceeding sixty days.
Right to legal representation
Section 23C stipulates that the appellant may either appear in person or authorise one or more Chartered
Accountants or Company Secretaries or Cost Accountants, in practice or Legal Practitioners or any of its officers
to present his/its case before the Securities Appellate Tribunal.
Civil Court not to have Jurisdiction
According to Section 23E, a Civil Court shall not have jurisdiction to entertain any suit or proceeding in respect
of any matter which a Securities Appellate Tribunal is empowered by or under this Act to determine and no
injunction can be granted by any court or other authority in respect of any action taken or to be taken. In
pursuance of any power conferred by or under this Act.
Areas on which rules may be framed by the Central Government
The Central Government under Section 24, may frame Rules to provide, inter alia, for:
– the manner of inquiry under Section 19H(1).
– the time within which an appeal may be preferred from the orders of SEBI under Section 23(1).
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– the form in which an appeal may be preferred and the fees payable in respect of such appeal.
– the procedure for disposing of an appeal.
– the form in which an appeal may be filed before the Securities Appellate Tribunal under Section 23A and
the fees payable in respect of such appeal.
SECURITIES CONTRACTS (REGULATION) ACT, 1956
The SCRA, 1956 provides for direct and indirect control of virtually all aspects of the securities trading including
the running of stock exchanges which aims to prevent undesirable transaction in securities. It gives the Central
Government 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 the requirements prescribed by the Central Government. The stock exchange
frame their own listing regulations in consonance with the minimum listing criteria set out in Securities contracts
Regulation Rules 1956. Power to recognize Stock Exchange vests with Central Government. However, central
Government has delegated the powers to SEBI vide its notification No. F. No.1/57/SE/93 dated 13.9.1994.
Application for recognition of stock exchanges
Section 3 of the Act requires that, any stock exchange, which is desirous of being recognised for the purposes
of this Act, may make an application in the prescribed manner to the Central Government.
Every application must contain such particulars as may be prescribed, and shall be accompanied by a copy of
the bye-laws of the stock exchange for the regulation and control of contracts and also a copy of the rules
relating in general to the constitution of the stock exchange and in particular, to—
(a) the governing body of such stock exchange, its constitution and powers of management and the manner
in which its business is to be transacted;
(b) the powers and duties of the office bearers of the stock exchange;
(c) the admission into the stock exchange of various classes of members, the qualifications for membership,
and the exclusion, suspension, expulsion and re-admission of members therefrom or thereinto;
(d) the procedure for the registration of partnerships as members of the stock exchange in cases where the
rules provide for such membership; and the nomination and appointment of authorised representatives
and clerks.
Grant of recognition to stock exchanges
Section 4 lays down that if the Central Government is satisfied, after making such inquiry as may be necessary
in this behalf and after obtaining such further information, if any, as it may require,—
(a) that the rules and bye-laws of a stock exchange applying for registration are in conformity with such
conditions as may be prescribed with a view to ensure fair dealing and to protect investors;
(b) that the stock exchange is willing to comply with any other conditions (including conditions as to the
number of members) which the Central Government, after consultation with the governing body of the
stock exchange and having regard to the area served by the stock exchange and its standing and the
nature of the securities dealt with by it, may impose for the purpose of carrying out the objects of this Act;
and
(c) that it would be in the interest of the trade and also in the public interest to grant recognition to the stock
exchange; it may grant recognition to the stock exchange subject to the conditions imposed upon it as
aforesaid and in such form as may be prescribed.
52 PP-CC&MM
The conditions which the Central Government may prescribe for the grant of recognition to the stock exchanges
may include, among other matters, conditions relating to,—
(i) the qualifications for membership of stock exchanges;
(ii) the manner in which contracts shall be entered into and enforced as between members;
(iii) the representation of the Central Government on each of the stock exchange by such number of persons
not exceeding three as the Central Government may nominate in this behalf; and
(iv) the maintenance of accounts of members and their audit by chartered accountants whenever such
audit is required by the Central Government.
Every grant of recognition to a stock exchange under section 4 shall be published in the Gazette of India and
also in the Official Gazette of the State in which the principal office as of the stock exchange is situate, and such
recognition shall have effect as from the date of its publication in the Gazette of India.
An application for the grant of recognition shall not be refused except after giving an opportunity to the stock
exchange concerned to be heard in the matter; and the reasons for such refusal shall be communicated to the
stock exchange in writing. No rules of a recognised stock exchange shall be amended except with the approval
of the Central Government.
Withdrawal of recognition
Section 5 stipulates that if the Central Government is of opinion that the recognition granted to a stock exchange
under the provisions of SCR Act should, in the interest of the trade or in the public interest, be withdrawn, the
Central Government may serve on the governing body of the stock exchange a written notice that the Central
Government is considering the withdrawal of the recognition for the reasons stated in the notice and after giving
an opportunity to the governing body to be heard in the matter, the Central Government may withdraw, by
notification in the Official Gazette, the recognition granted to the stock exchange.
However, no such withdrawal shall affect the validity of any contract entered into or made before the date of the
notification, and the Central Government may, after consultation with the stock exchange, make such provision
as it deems fit in the notification of withdrawal or in any subsequent notification similarly published for the due
performance of any contracts outstanding on that date.
Where the recognised stock exchange has not been corporatised or demutualised or it fails to submit the
scheme within the specified time therefor or the scheme has been rejected by SEBI the recognition granted to
such stock exchange under section 4, shall, notwithstanding anything to the contrary contained in this Act, stand
withdrawn and the Central Government shall publish, by notification in the Official Gazette, such withdrawal of
recognition.
Further, no such withdrawal shall affect the validity of any contract entered into or made before the date of the
notification, and SEBI may, after consultation with the stock exchange, make such provisions as it deems fit in
the order rejecting the scheme published in the Official Gazette.
Power of Central Government to call for periodical returns or direct inquiries to be made
Section 6 provides that every recognised stock exchange shall furnish to SEBI such periodical returns relating
to its affairs as may be prescribed.
Every recognised stock exchange and every member thereof shall maintain and preserve for such periods not
exceeding five years such books of account, and other documents as the Central Government, after consultation
with the stock exchange concerned, may prescribe in the interest of the trade or in the public interest, and such
books of account, and other documents shall be subject to inspection at all reasonable times by SEBI.
If SEBI is satisfied that it is in the interest of the trade or in the public interest so to do, may, by order in writing,—
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(a) call upon a recognised stock exchange or any member thereof to furnish in writing such information or
explanation relating to the affairs of the stock exchange or of the member in relation to the stock exchange
as SEBI may require; or
(b) appoint one or more persons to make an inquiry in the prescribed manner in relation to the affairs of the
governing body of a stock exchange or the affairs of any of the members of the stock exchange in
relation to the stock exchange and submit a report of the result of such inquiry to SEBI within such time
as may be specified in the order or, in the case of an inquiry in relation to the affairs of any of the
members of a stock exchange, direct the governing body to make the inquiry and submit its shall be
bound to produce before the authority making the inquiry all such books of account, and other documents
in his custody or power relating to or having a bearing on the subject-matter of such inquiry and also to
furnish the authorities within such time as may be specified with any such statement or information
relating thereto as may be required of him.
Annual reports to be furnished to Central Government by stock exchanges
Section 7provides that every recognised stock exchange shall furnish the Central Government with a copy of
the annual report, and such annual report shall contain such particulars as may be prescribed.
Power of recognised stock exchange to make rules restricting voting rights, etc
According to Section 7A a recognised stock exchange may make rules or amend any rules made by it to provide
for all or any of the following matters, namely :—
(a) the restriction of voting rights to members only in respect of any matter placed before the stock exchange
at any meeting;
(b) the regulation of voting rights in respect of any matter placed before the stock exchange at any meeting
so that each member may be entitled to have one vote only, irrespective of his share of the paid-up
equity capital of the stock exchange;
(c) the restriction on the right of a member to appoint another person as his proxy to attend and vote at a
meeting of the stock exchange;
(d) such incidental, consequential and supplementary matters as may be necessary to give effect to any of
the matters specified in clauses (a), (b) and (c).
No rules of a recognised stock exchange made or amended in relation to any matter referred to in clauses (a) to
(d) of sub-section (1) shall have effect until they have been approved by the Central Government and published
by that Government in the Official Gazette and, in approving the rules so made or amended, the Central
Government may make such modifications therein as it thinks fit, and on such publication, the rules as approved
by the Central Government shall be deemed to have been validly made, notwithstanding anything to the contrary
contained in the Companies Act, 1956.
Power of Central Government to direct rules to be made or to make rules
Section 8 lays down that Where, after consultation with the governing bodies of stock exchanges generally or
with the governing body of any stock exchange in particular, the Central Government is of opinion that it is
necessary or expedient so to do, it may, by order in writing together with a statement of the reasons therefore
direct recognised stock exchanges generally or any recognised stock exchange in particular, as the case may
be, to make any rules or to amend any rules already made in respect of all or any of the matters specified in
section 3 within a period of two months from the date of the order.
If any recognised stock exchange fails or neglects to comply with any order made under this Act within the
period specified therein, the Central Government may make the rules for, or amend the rules made by, the
54 PP-CC&MM
recognised stock exchange, either in the form proposed in the order or with such modifications thereof as may
be agreed to between the stock exchange and the Central Government.
Where in pursuance of this section any rules have been made or amended, the rules so made or amended shall
be published in the Gazette of India and also in the Official Gazette or Gazettes of the State or States in which
the principal office or offices of the recognised stock exchange or exchanges is or are situate, and, on the
publication thereof in the Gazette of India, the rules so made or amended shall, notwithstanding anything to the
contrary contained in the Companies Act, 1956, or in any other law for the time being in force, have effect as if
they had been made or amended by the recognised stock exchange or stock exchanges, as the case may be.
Clearing Corporation
Section 8A stipulates that a recognised stock exchange may, with the prior approval of SEBI, transfer the duties
and functions of a clearing house to a clearing corporation, being a company incorporated under the Companies
Act, 1956 , for the purpose of—
(a) the periodical settlement of contracts and differences thereunder;
(b) the delivery of, and payment for, securities;
(c) any other matter incidental to, or connected with, such transfer.
Every clearing corporation shall, for the purpose of transfer of the duties and functions of a clearing house to a
clearing corporation, make bye-laws and submit the same to SEBI for its approval.
SEBI may, on being satisfied that it is in the interest of the trade and also in the public interest to transfer the
duties and functions of a clearing house to a clearing corporation, grant approval to the byelaws submitted to it
and approve the transfer of the duties and functions of a clearing house to a clearing corporation.
Power of SEBI to make or amend bye-laws of recognised stock exchanges
Section 10 requires that SEBI may, either on a request in writing received by it in this behalf from the governing
body of a recognised stock exchange or on its own motion, if it is satisfied after consultation with the governing
body of the stock exchange that it is necessary or expedient so to do and after recording its reasons for so doing,
make bye-laws for all or any of the matters specified in section 9 or amend any bye-laws made by such stock
exchange under that section.
Where in pursuance of this section any bye-laws have been made or amended the bye-laws so made or amended
shall be published in the Gazette of India and also in the Official Gazette of the State in which the principal office
of the recognised stock exchange is situate, and on the publication thereof in the Gazette of India, the bye-laws
so made or amended shall have effect as if they had been made or amended by the recognised stock exchange
concerned.
Notwithstanding anything contained in this section, where the governing body of a recognised stock exchange
objects to any bye-laws made or amended under this section by SEBI on its own motion, it may, within two
months of the publication thereof in the Gazette of India apply to SEBI for revision thereof, and SEBI may, after
giving an opportunity to the governing body of the stock exchange to be heard in the matter, revise the bye-laws
so made or amended, anywhere any bye-laws so made or amended are revised as a result of any action taken
under this section, the byelaws so revised shall be published and shall become effective as provided in this
section.
The making or the amendment or revision of any bye-laws shall in all cases be subject to the condition of
previous publication. However, if the SEBI is satisfied in any case that in the interest of the trade or in the public
interest any bye-laws should be made, amended or revised immediately, it may, by order in writing specifying
the reasons therefor, dispense with the condition of previous publication.
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Power of Central Government to supersede governing body of a recognised stock exchange
Section 11 provides that without prejudice to any other powers vested in the Central Government under this Act,
where the Central Government is of opinion that the governing body of any recognised stock exchange should
be superseded, then, notwithstanding anything contained in any other law for the time being in force, in the
Central Government may serve on the governing body a written notice that the Central Government is considering
the supersession of the governing body for the reasons specified in the notice and after giving an opportunity to
the governing body to be heard in the matter, it may, by notification in the Official Gazette, declare the governing
body of such stock exchange to be superseded, and may appoint any person or persons to exercise and
perform all the powers and duties of the governing body, and, where more persons than one are appointed, may
appoint one of such persons to be the chairman and another to be the vice-chairman thereof.
On the publication of a notification in the Official Gazette under this section, the following consequences shall
ensue, namely:—
(a) the members of the governing body which has been superseded shall, as from the date of the notification
of supersession, cease to hold office as such members;
(b) the person or persons appointed may exercise and perform all the powers and duties of the governing
body which has been superseded;
(c) all such property of the recognised stock exchange as the person or persons appointed may, by order
in writing, specify in this behalf as being necessary for the purpose of enabling him or them to carry on
the business of the stock exchange, shall vest in such person or persons.
Notwithstanding anything to the contrary contained in any law or the rules or bye-laws of the recognised stock
exchange the governing body of which is superseded, the person or persons appointed shall hold office for such
period as may be specified in the notification published and the Central Government may from time to time, by
like notification, vary such period.
The Central Government may at any time before the determination of the period of office of any person or
persons appointed under this section call upon the recognised stock exchange to re-constitute the governing
body in accordance with its rules and on such re-constitution all the property of the recognised stock exchange
which has vested in, or was in the possession of, the person or persons appointed shall re-vest or vest, as the
case may be, in the governing body so re-constituted.
However, until a governing body is so re-constituted, the person or persons appointed shall continue to exercise
and perform their powers and duties.
Power to suspend business of recognised stock exchanges
According to Section 12, if in the opinion of the Central Government an emergency has arisen and for the
purpose of meeting the emergency the Central Government considers it expedient so to do, it may, by notification
in the Official Gazette, for reasons to be set out therein, direct a recognised stock exchange to suspend such of
its business for such period not exceeding seven days and subject to such conditions as may be specified in the
notification, and, if, in the opinion of the Central Government, the interest of the trade or the public interest
requires that the period should be extended, may, by like notification extend the said period from time to time.
However, where the period of suspension is to be extended beyond the first period, no notification extending the
period of suspension shall be issued unless the governing body of the recognised stock exchange has been
given an opportunity of being heard in the matter.
Penalty
Section 23G deals with penalty for failure to furnish periodical returns, etc by a recognised stock exchange. If a
56 PP-CC&MM
recognised stock exchange fails or neglects to furnish periodical returns to SEBI or fails or neglects to make or
amend its rules or bye-laws as directed by SEBI or fails to comply with directions issued by SEBI, such recognised
stock exchange shall be liable to a penalty which may extend to twenty-five crore rupees.
Section 23H deals with penalty for contravention where no separate penalty has been provided. Whoever fails
to comply with any provision of this Act, the rules or articles or bye- laws or the regulations of the recognised
stock exchange or directions issued by SEBI for which no separate penalty has been provided, shall be liable to
a penalty which may extend to one crore rupees.
LESSON ROUND UP
– Stock Exchanges, Clearing Corporations and Depositories are systemically important for the country’s
financial development and serve as the infrastructure necessary for the securities market. These
institutions are collectively referred to as Market Infrastructure Institutions (MIIs).
– SEBI has prescribed various Act and Regulations from time to time for the smooth functioning of these
MIIs.
– SEBI notified the Securities Contract (Regulation) (Stock Exchanges and Clearing Corporations)
Regulations, 2012 (“SECC Regulations”) on June 20, 2012 to regulate recognition, ownership and
governance in stock exchanges and clearing corporations and matters connected therewith or incidental
thereto.
– These Regulations provides for recognition, ownership, governance and listing provisions with respect
to Stock Exchanges as well as Clearing Corporations.
– To facilitate the implementation of the SECC Regulations and provide guidelines to stock exchanges
and clearing corporations for their operations in accordance with the terms of SECC Regulations,
SEBI has issued procedural norms on recognition, ownership and governance for stock exchanges
and clearing corporations dated December 13, 2012.
– The Depositories Act, 1996 provides for the establishment of single or multiple depositories. Any body
to be eligible for providing depository services must be formed and registered as a company under the
Companies Act, 1956 and seek registration with SEBI and obtain a Certificate of Commencement of
Business from SEBI on fulfillment of the prescribed conditions.
– Section 23 provides that any person aggrieved by an order of SEBI made under Depositories Act, or
the regulations made thereunder may prefer an appeal to the Central Government within such time as
may be prescribed.
– The SCRA, 1956 provides for direct and indirect control of virtually all aspects of the securities trading
including the running of stock exchanges which aims to prevent undesirable transaction in securities.
– Section 3 of the SCRA, 1956 requires that, any stock exchange, which is desirous of being recognised
for the purposes of this Act, may make an application in the prescribed manner to the Central
Government.
– Section 23G deals with penalty for failure to furnish periodical returns, etc by a recognised stock
exchange. If a recognised stock exchange fails or neglects to furnish periodical returns to SEBI or fails
or neglects to make or amend its rules or bye-laws as directed by SEBI or fails to comply with directions
issued by SEBI, such recognised stock exchange shall be liable to a penalty which may extend to
twenty-five crore rupees.
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Framework of Market Infrastructure Institutions
57
SELF TEST QUESTIONS
1. Describe the provisions relating to maintenance of networth by a Stock Exchange and Clearing
Corporations under SECC Regulations.
2. What do you understand by Pledge and Hypothecation of Securities? Explain the procedure for pledge
or Hypotecation of Securities which is in demat account.
3. Briefly explain the provision relating to Appeal to be made under the Depositories Act, 1996.
58 PP-CC&MM
Lesson 4
Financial Intermediaries Framework
Lesson 4
Financial Intermediaries Framework
LESSON OUTLINE
59
LEARNING OBJECTIVES
– Introduction
Intermediaries are service providers and are an
integral part of any financial system. SEBI
regulates various intermediaries in the primary
and secondary markets through its Regulations
for these respective intermediaries. SEBI has
defined the role of each of the intermediary, the
eligibility criteria for granting registration, their
functions and responsibilities and the code of
conduct to which they are bound. These
Regulations also empower SEBI to inspect the
functioning of these intermediaries and to collect
fees from them and to impose penalties on
erring entities.
– SEBI (Merchant Bankers) Regulations,
1992
– SEBI (Registrars to an Issue and Share
Transfer Agents) Regulations, 1993
– SEBI (Underwriters) Regulations, 1993
– SEBI (Bankers to an Issue) Regulations,
1994
– SEBI (Debenture Trustees) Regulations,
1993
– SEBI (Stock Brokers and Sub Brokers)
Regulations, 1992
The main objective of this lesson is to give the
detailed framework of the Market Intermediaries
as prescribed by SEBI.
– SEBI (Portfolio Managers) Regulations,
1993
– SEBI (Custodian of Securities) Regulations,
1996
– SEBI (Foreign Institutional Investors)
Regulations, 1995
– SEBI (Investment Advisers) Regulations,
2013
– SEBI (Credit Rating Agencies) Regulations,
1999
– Guideline for Market Maker
– SEBI ( Depositories and Participant)
Regulations, 1996
– Qualified Depository Participants
– LESSON ROUND UP
– SELF TEST QUESTIONS
59
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INTRODUCTION
The Market Regulator, SEBI regulates various intermediaries in the primary and secondary markets through its
Regulations for these intermediaries. SEBI has defined the role of each of the intermediary, the eligibility criteria
for granting registration, their functions and responsibilities and the code of conduct to which they are bound.
These Regulations also empower SEBI to inspect the functioning of these intermediaries and to collect fees
from them and to impose penalties on erring entities. As per Section 11 of SEBI Act, it is the duty of SEBI to
register and regulate the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue,
trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment
advisors and such other intermediaries who may be associated with securities market in any manner.
SEBI has issued regulations in respect of each intermediary to ensure proper services to be rendered by them
to the investors and the capital market.
PRIMARY MARKET INTERMEDIARIES
The following market intermediaries are involved in the Primary Market:
– Merchant Bankers/Lead Managers
– Registrars and Share Transfer Agents
– Underwriters
– Bankers to issue
– Debenture Trustees
MERCHANT BANKER
‘Merchant Banker’ means any person engaged in the business of issue management by making arrangements
regarding selling, buying or subscribing to securities or acting as manager/consultant/advisor or rendering
corporate advisory services in relation to such issue management.
SEBI (MERCHANT BANKERS) REGULATIONS, 1992
The activities of the merchant bankers in the Indian capital market are regulated by SEBI (Merchant Bankers)
Regulations, 1992. Regulation 3 of SEBI (Merchant Bankers) Regulations, 1992 lays down that an application by a
person desiring to become merchant banker shall be made to SEBI in the prescribed form seeking grant of a certificate
of initial registration alongwith a non-refundable application fee as specified in Schedule II of the Regulations.
Regulation 4 and 5 deal with the methodology for application and furnishing of information, clarification and
personal representation by the applicant. Incomplete or non-conforming applications shall be rejected after
giving an opportunity to remove the deficiencies within a time specified by SEBI.
Regulation 6 lists out the following considerations for being taken into account by SEBI to grant the certificate of
registration.
(a) the applicant shall be a body corporate other than a non-banking financial company as defined under
clause(f) of section 45-I of the RBI Act, 1934;
(b) the applicant has the necessary infrastructure like adequate office space, equipments and manpower to
effectively discharge his activities;
(c) the applicant has in his employment a minimum of two persons who have the experience to conduct the
business of the merchant banker;
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(d) a person directly or indirectly connected with the applicant has not been granted registration by SEBI;
(e) the applicant fulfills the capital adequacy requirement;
(f) the applicant, his partner, director or principal officer is not involved in any litigation connected with the
securities market which has an adverse bearing on the business of the applicant;
(g) the applicant, his director, partner or principal officer has not at any time been convicted for any offence
involving moral turpitude or has been found guilty of any economic offence;
(h) the applicant has the professional qualification from an institution recognised by the Government in
finance, law or business management;
(i) the applicant is a fit and proper person;
(j) grant of certificate to the applicant is in the interest of investors.
Capital Adequacy
Regulation 7 prescribes that the capital adequacy requirement shall be a networth of not less than five crore
rupees.
‘Networth’ means the sum of paid-up capital and free reserves of the applicant at the time of making
application.
Regulation 8, 9A and 10 deal with procedure for registration, renewal of certificate conditions of registration and
procedure where registration is not granted.
Regulation 11 stipulate that on refusal of registration by SEBI, the applicant shall cease to carry on any activity
as a merchant banker from the date of receipt of SEBI’s refusal letter.
Regulation 12 provides for payment of fees and consequences of failure to pay annual fees. It provides that
SEBI may suspend the registration certificate if merchant banker fails to pay fees.
General Obligations and Responsibilities of Merchant Banker
Chapter III of the Regulations containing Regulations 13 to 28 deal with general obligations and responsibilities
of Merchant Bankers.
Regulation 13 stipulates that every merchant banker shall abide by the code of conduct which has been specified
in Schedule III. The code of conduct as provided in the schedule is as under:
CODE OF CONDUCT FOR MERCHANT BANKERS
1. A merchant banker shall make all efforts to protect the interest of investors.
2. A merchant banker shall maintain high standards of integrity, dignity and fairness in the conduct of its business.
3. A merchant banker shall fulfil its obligations in a prompt, ethical, and professional manner.
4. A merchant banker shall at all times exercise due diligence, ensure proper care and exercise independent
professional judgement.
5. A merchant banker shall endeavour to ensure that –
(a) inquiries from investors are adequately dealt with;
(b) grievances of investors are redressed in a timely and appropriate manner;
(c) where a complaint is not remedied promptly, the investor is advised of any further steps which may be
available to the investor under the regulatory system.
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6. A merchant banker shall ensure that adequate disclosures are made to the investors in a timely manner in
accordance with the applicable regulations and guidelines so as to enable them to make a balanced and informed
decision.
7. A merchant banker shall endeavour to ensure that the investors are provided with true and adequate information
without making any misleading or exaggerated claims or any misrepresentation and are made aware of the
attendant risks before taking any investment decision.
8. A merchant banker shall endeavour to ensure that copies of the prospectus, offer document, letter of offer or
any other related literature is made available to the investors at the time of issue or the offer.
9. A merchant banker shall not discriminate amongst its clients, save and except on ethical and commercial
considerations.
10. A merchant banker shall not make any statement, either oral or written, which would misrepresent the
services that the merchant banker is capable of performing for any client or has rendered to any client.
11. A merchant banker shall avoid conflict of interest and make adequate disclosure of its interest.
12. A merchant banker shall put in place a mechanism to resolve any conflict of interest situation that may arise
in the conduct of its business or where any conflict of interest arises, shall take reasonable steps to resolve the
same in an equitable manner.
13. A merchant banker shall make appropriate disclosure to the client of its possible source or potential areas of
conflict of duties and interest while acting as merchant banker which would impair its ability to render fair,
objective and unbiased services.
14. A merchant banker shall always endeavour to render the best possible advice to the clients having regard to
their needs.
15. A merchant banker shall not divulge to anybody either orally or in writing, directly or indirectly, any
confidential information about its clients which has come to its knowledge, without taking prior permission
of its clients, except where such disclosures are required to be made in compliance with any law for the
time being in force.
16. A merchant banker shall ensure that any change in registration status/any penal action taken by the SEBI or
any material change in the merchant banker’s financial status, which may adversely affect the interest of clients/
investors, is promptly informed to the clients and any business remaining outstanding is transferred to another
registered intermediary in accordance with any instructions of the affected clients.
17. A merchant banker shall not indulge in any unfair competition, such as weaning away the clients on assurance
of higher premium or advantageous offer price or which is likely to harm the interest of other merchant bankers
or investors or is likely to place such other merchant bankers in a disadvantageous position while competing for
or executing any assignment.
18. A merchant banker shall maintain arms length relationship between its merchant banking activity and any
other activity.
19. A merchant banker shall have internal control procedures and financial and operational capabilities which
can be reasonably expected to protect its operations, its clients, investors and other registered entities from
financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or omissions.
20. A merchant banker shall not make untrue statement or suppress any material fact in any documents, reports
or information furnished to the SEBI.
21. A merchant banker shall maintain an appropriate level of knowledge and competence and abide by the
provisions of the Act, regulations made thereunder, circulars and guidelines, which may be applicable and
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relevant to the activities carried on by it. The merchant banker shall also comply with the award of the Ombudsman
passed under the Securities and Exchange Board of India (Ombudsman) Regulations, 2003.
22. A merchant banker shall ensure that the Board is promptly informed about any action, legal proceedings,
etc., initiated against it in respect of material breach or non-compliance by it, of any law, rules, regulations,
directions of the Board or of any other regulatory body.
23. (a) A merchant banker or any of its employees shall not render, directly or indirectly, any investment
advice about any security in any publicly accessible media, whether real-time or non-real-time, unless a
disclosure of his interest including a long or short position, in the said security has been made, while rendering
such advice.
(b) In the event of an employee of the merchant banker rendering such advice, the merchant banker shall
ensure that such employee shall also disclose the interest, if any, of himself, his dependent family members and
the employer merchant banker, including their long or short position in the said security, while rendering such
advice.
24. A merchant banker shall demarcate the responsibilities of the various intermediaries appointed by it clearly
so as to avoid any conflict or confusion in their job description.
25. A merchant banker shall provide adequate freedom and powers to its compliance officer for the effective
discharge of the compliance officer’s duties.
26. A merchant banker shall develop its own internal code of conduct for governing its internal operations and
laying down its standards of appropriate conduct for its employees and officers in carrying out their duties. Such
a code may extend to the maintenance of professional excellence and standards, integrity, confidentiality,
objectivity, avoidance or resolution of conflict of interests, disclosure of shareholdings and interests, etc.
27. A merchant banker shall ensure that good corporate policies and corporate governance are in place.
28. A merchant banker shall ensure that any person it employs or appoints to conduct business is fit and proper
and otherwise qualified to act in the capacity so employed or appointed (including having relevant professional
training or experience).
29. A merchant banker shall ensure that it has adequate resources to supervise diligently and does supervise
diligently persons employed or appointed by it in the conduct of its business, in respect of dealings in securities
market.
30. A merchant banker shall be responsible for the Acts or omissions of its employees and agents in respect of
the conduct of its business.
31. A merchant banker shall ensure that the senior management, particularly decsions makers have access to
all relevant information about the business on a timely basis.
32. A merchant banker shall not be a party to or instrument for –
(a) creation of false market; or
(b) price rigging or manipulation; or
(c) passing of unpublished price sensitive information in respect of securities which are listed and proposed
to be listed in any stock exchange to any person or intermediary in the securities market.
Regulation 13A provides that no merchant banker other than a bank or a public financial institution who has
been granted a certificate of registration shall carry on any business other than that of the securities market.
However, a merchant banker who has been granted certificate of registration under these regulations may
ensure market making in accordance with Chapter XB of SEBI (ICDR) Regulations, 2009.
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Regulations 14 to 17 deal with maintenance of books of accounts, records, submission of half-yearly results,
rectifying deficiencies pointed out in the auditor’s report etc.
Responsibilities of Lead Manager
Regulation 20 provides that no lead manager shall agree to manage or be associated with any issue unless his
responsibilities relating to the issue mainly those of disclosures, allotment and refund are clearly defined, allocated
and determined and a statement specifying such responsibilities is furnished to SEBI at least 1 month before the
opening of the issue for subscription but where there are more than 1 lead merchant banker to the issue the
responsibility of each such lead merchant banker shall clearly be demarcated and the statement specifying
such responsibilities shall be furnished to SEBI at least 1 month before the opening of the issue for subscription.
Regulation 21 stipulates that a lead merchant banker shall not associate himself with any issue if a merchant
banker not holding a certificate from SEBI is associated with the issue.
Merchant Banker not to Act as such for an Associate
Regulation 21A provides that a merchant banker shall not lead manage any issue or be associated with any
activity undertaken under any regulations made by SEBI, if he is a promoter or a director or an associate of the
issuer of securities or of any person making an offer to sell or purchase securities. However, a merchant banker
who is an associate of such issuer or person may be appointed, if he is involved only in the marketing of the
issue or offer.
Here, a merchant banker shall be deemed to be an “associate of the issuer or person” if:
(i) either of them controls, directly or indirectly through its subsidiary or holding company, not less than
15% of the voting rights in the other; or
(ii) either of them, directly or indirectly, by itself or in combination with other persons, exercises control over
the other; or
(iii) there is a common director, excluding nominee director, amongst the issuer, its subsidiary or holding
company and the merchant banker.
Minimum Underwriting Obligation
Regulation 22 lays down that in respect of every issue to be managed, the lead merchant banker holding a
certificate under Category I shall accept a minimum underwriting obligation of 5% of the total underwriting
commitment or ` 25 lakhs whichever is less but if the lead merchant banker is unable to accept the minimum
underwriting obligation, that lead merchant banker shall make arrangement for having the issue underwritten to
that extent by a merchant banker associated with the issue and shall keep SEBI informed of such arrangement.
In case of issue made in accordance with Chapter XB of SEBI (ICDR) Regulations, 2009, the merchant banker
shall itself or jointly with other merchant bankers associated with the issues, underwrite atleast 15% of the issue
size.
Prohibition to Acquire Shares
Regulation 26 lays down that no merchant banker or any of its directors, partners or manager or principal officer
shall either on their own account or through their associates or relatives, enter into any transaction in securities
of bodies corporate on the basis of unpublished price sensitive information obtained by them during the course
of any professional assignment either from the clients or otherwise.
Regulation 27 requires every merchant banker to submit to SEBI complete particulars of any transaction for
acquisition of securities of any body corporate whose issue is being managed by that merchant banker, within
15 days from the date of entering into such transaction. In case of any transaction for acquisition of securities
made in pursuance of underwriting or market making obligation in accordance with Chapter XB of SEBI
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(ICDR) Regulations, 2009, the complete particulars of the transaction shall be submitted to SEBI on quarterly
basis.
Regulation 28 provides that a merchant banker is required to disclose to SEBI, as and when required, the
following information, namely:
(i) his responsibilities with regard to the management of the issue;
(ii) any change in the information or particulars previously furnished, which have a bearing on the certificate
granted to it;
(iii) the names of the body corporate whose issues he has managed or has been associated with;
(iv) the particulars relating to the breach of the capital adequacy requirement;
(v) relating to his activities as a manager, underwriter, consultant or adviser to an issue, as the case may
be.
The merchant banker shall submit a periodic report in such manner as may be specified by SEBI from time to
time.
Appointment of Compliance Officer
Regulation 28A requires every merchant banker to appoint a compliance officer who shall be responsible for
monitoring the compliance of the Act, rules and regulations, notifications guidelines, instructions etc. issued by
SEBI or Central Government and for redressal of investor grievances. Compliance officer is required to immediately
and independently report to SEBI, any non-compliance observed by him and ensure that observations made or
deficiencies pointed out by SEBI on/in the draft prospectus or letter of offer as the case may be, do not occur.
Procedure for Inspection
Chapter IV containing Regulations 29 to 34 lays down the procedure for inspection of the merchant bankers
offices and records by SEBI.
Regulation 29 empowers SEBI to appoint one or more persons as inspecting authority to undertake inspection
of books of accounts, records and documents etc. of the merchant banker:
(a) to ensure that such books and records are maintained in the prescribed manner;
(b) the provisions of SEBI Act and the rules and regulations thereunder are complied with;
(c) to investigate into complaints from investors, other merchant bankers or other persons on any matter
having a bearing on the activities of the merchant banker; and
(d) to investigate suo-moto in the interest of the securities business or investors interest into the working of
the merchant banker.
Regulation 30 and 31 authorise SEBI to undertake such inspection with or without notice and the obligations of
the merchant bankers in relation to such inspection.
Regulation 32 provides for the submission of an inspection report to SEBI by the inspecting authority on completion
of inspection. Regulation 33 requires that SEBI or chairman shall after consideration of inspection or investigation
report take such action as SEBI or chairman may deem fit and appropriate including action under Chapter V of
the SEBI (Intermediaries) Regulations, 2008.
Regulation 34 permits SEBI to appoint a qualified auditor to investigate into the books of accounts or the affairs
of the merchant banker and such auditor shall have the same powers of the inspecting authority referred to
above.
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Procedure for Action against Merchant Banker in case of Default
Chapter V containing Regulation 35 deals with the procedure for taking action against the merchant banker in
case of default. Regulation 35 provides that a merchant banker who contravenes any of the provisions of the
Act, rules or regulations, framed thereunder shall be liable for one or more actions specified therein including the
action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS
The Registrars to an Issue and Share Transfer Agents constitute an important category of intermediaries in the
primary market. They render very useful services in mobilising new capital and facilitating proper records of the
details of the investors, so that the basis for allotment could be decided and allotment ensured as per SEBI
Regulations.
SEBI (REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS) REGULATIONS, 1993
SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 were notified by SEBI on 31st May,
1993 in exercise of the powers conferred by Section 30 of SEBI Act,1992, with the approval of Central Government.
Chapter I of the Regulations contains preliminary items and Chapter II consisting of Regulations 3 to 12 dealing
with procedure for applying for registration as Registrar to an Issue (RTI) and Share Transfer Agents (STA),
either as Category-I to carry on both the activities of RTA and STA or Category-II to carry on the activity either as
Registrar to an Issue or as a Share Transfer Agent. The application should be complete and conform to the
requirements otherwise it will be rejected. But an opportunity will be given to remove the objections as may be
indicated by SEBI. In case of failure the application may be rejected.
Criteria for Registration
Regulation 6 lays down that SEBI shall take into account the following matters while considering the applications
for registration. It shall assess whether the applicant:
(a) has the necessary infrastructure like adequate office space, equipments and manpower to effectively
discharge his activities;
(b) has any past experience in the activities;
(c) any person directly or indirectly connected with him has been granted registration by SEBI under the
Act;
(d) Fulfils the capital adequacy requirement;
(e) has been subjected to any disciplinary proceedings under the Act;
(f) any of its director, partner or principal officer is or has at any time been convicted for any offence
involving moral turpitude or has been found guilty of any economic offence;
(g) is a fit and proper person.
Regulation 7 stipulates the capital adequacy requirement (networth) for category I ` 50,00,000 lacs and category
II ` 25,00,000 lacs.
Regulations 8 to 10 lay down the procedure for registration, renewal of certificate, conditions of registration,
period of validity of certificate and the procedure where registration is not granted. It is made clear that the
applicant will be given due opportunity of being heard before rejection of his application.
Regulation 11 says that in case of refusal to grant or renew a certificate of registration, the concerned person
shall cease to carry on any activity as registrar or share transfer agent. Regulation 12 prescribes payment of
fees and indicates the consequences of failure to pay fees. In the latter case SEBI may suspend the certificate
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with the consequence that the RTA shall cease to carry on his activity from the date of suspension of the
certificate.
General Obligations and Responsibilities
Chapter III consisting of Regulations 13 to 15 lays down the general obligations and responsibilities of RTAs.
Regulation 13 lays down that the RTA holding a certificate shall at all time abide by the Code of Conduct
specified below:
CODE OF CONDUCT
1. A Registrar to an Issue and share transfer agent shall maintain high standards of integrity in the conduct of its
business.
2. A Registrar to an Issue and share transfer agent shall fulfil its obligations in a prompt ethical and professional
manner.
3. A Registrar to an Issue and share transfer agent shall at all times exercise due diligence, ensure proper care
and exercise independent professional judgement.
4. A Registrar to an Issue and share transfer agent shall exercise adequate care, caution and due diligence
before dematerialisation of securities by confirming and verifying that the securities to be dematerialised have
been granted listing permission by the stock exchange/s.
5. A Registrar to an Issue and share transfer agent shall always endeavour to ensure that—
(a) inquiries from investors are adequately dealt with;
(b) grievances of investors are redressed without any delay;
(c) transfer of securities held in physical form and confirmation of dematerialisation/rematerialisation requests
and distribution of corporate benefits and allotment of securities is done within the time specified under
any law.
6. A Registrar to an Issue and share transfer agent shall make reasonable efforts to avoid misrepresentation and
ensure that the information provided to the investors is not misleading.
7. A Registrar to an Issue and share transfer agent shall not reject the dematerialisation/rematerialisation requests on
flimsy grounds. Such request could be rejected only on valid and proper grounds and supported by relevant documents.
8. A Registrar to an Issue and share transfer agent shall avoid conflict of interest and make adequate disclosure
of its interest.
9. A Registrar to an Issue and share transfer agent shall put in place a mechanism to resolve any conflict of
interest situation that may arise in the conduct of its business or where any conflict of interest arises, shall take
reasonable steps to resolve the same in an equitable manner.
10. A Registrar to an Issue and share transfer agent shall make appropriate disclosure to the client of its possible
source or potential areas of conflict of duties and interest which would impair its ability to render fair, objective
and unbiased services.
11. A Registrar to an Issue and share transfer agent shall not indulge in any unfair competition, which is likely to
harm the interest of other Registrar to the Issue and share transfer agent or investors or is likely to place such
other registrar in a disadvantageous position in relation to the Registrar to Issue and share transfer agent while
competing for or executing any assignment.
12. A Registrar to an Issue and share transfer agent shall always endeavour to render the best possible advice
to the clients having regard to their needs.
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13. A Registrar to an Issue and share transfer agent shall not divulge to other clients, press or any other person any
confidential information about its clients which has come to its knowledge except with the approval/ authorisation
of the clients or when it is required to disclose the information under any law for the time being in force.
14. A Registrar to an Issue or share transfer agent shall not discriminate amongst its clients, save and except on
ethical and commercial considerations.
15. A Registrar to an Issue and share transfer agent shall ensure that any change in registration status/any
penal action taken by the Board or any material change in financials which may adversely affect the interests of
clients/investors is promptly informed to the clients.
16. A Registrar to an Issue and share transfer agent shall maintain the required level of knowledge and competency
and abide by the provisions of the Act, rules, regulations, circulars and directions issued by the Board. The
Registrar to an Issue and share transfer agent shall also comply with the award of the Ombudsman passed
under Securities and Exchange Board of India (Ombudsman) Regulations, 2003.
17. A Registrar to an Issue and share transfer agent shall co-operate with the Board as and when required.
18. A Registrar to an Issue and share transfer agent shall not neglect or fail or refuse to submit to the Board or
other agencies with which he is registered, such books, documents, correspondence, and papers or any part
thereof as may be demanded/requested from time to time.
19. A Registrar to an Issue and share transfer agent shall ensure that the Board is promptly informed about any
action, legal proceeding, etc. initiated against it in respect of any material breach or non-compliance by it, of any
law, rules, regulations, directions of the Board or of any other regulatory body.
20. A Registrar to an Issue and share transfer agent shall take adequate and necessary steps to ensure that
continuity in data and record keeping is maintained and that the data or records are not lost or destroyed.
Further, it shall ensure that for electronic records and data, up-to-date back up is always available with it.
21. A Registrar to an Issue and share transfer agent shall endeavour to resolve all the complaints against it or in
respect of the activities carried out by it as quickly as possible.
22. (a) A Registrar to an Issue and share transfer agent 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 nonreal-time, unless a disclosure of its long or short position in the said security has been made, while rendering
such advice.
(b) In case an employee of a Registrar to an Issue and share transfer agent is rendering such advice, the
Registrar to an issue and share transfer agent shall ensure that it also discloses its own interest, the interests of
his dependent family members and that of the employer including their long or short position in the said security,
while rendering such advice.
23. A Registrar to an Issue and share transfer agent shall handover all the records/data and all related documents
which are in its possession in its capacity as a Registrar to an Issue and/or share transfer agent to the respective
clients, within one month from the date of termination of agreement with the respective clients or within one
month from the date of expiry/cancellation of certificate of registration as Registrar to an Issue and/or share
transfer agent, whichever is earlier.
24. A Registrar to an Issue and share transfer agent shall not make any exaggerated statement, whether oral or
written, to the clients either about its qualifications or capability to render certain services or about its achievements
in regard to services rendered to other clients.
25. A Registrar to an Issue and share transfer agent shall ensure that it has satisfactory internal control procedures
in place as well as adequate financial and operational capabilities which can be reasonably expected to take
care of any losses arising due to theft, fraud and other dishonest acts, professional misconduct or omissions.
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26. A Registrar to an Issue and share transfer agent shall provide adequate freedom and powers to its compliance
officer for the effective discharge of its duties.
27. A Registrar to an Issue and share transfer agent shall develop its own internal code of conduct for governing
its internal operations and laying down its standards of appropriate conduct for its employees and officers in
carrying out its duties as a Registrar to an Issue and share transfer agent and as a part of the industry. Such a
code may extend to the maintenance of professional excellence and standards, integrity, confidentiality, objectivity,
avoidance of conflict of interests, disclosure of shareholdings and interests, etc.
28. A Registrar to an Issue and share transfer agent shall ensure that good corporate policies and corporate
governance are in place.
29. A Registrar to an Issue and share transfer agent shall ensure that any person it employs or appoints to
conduct business is fit and proper and otherwise qualified to act in the capacity so employed or appointed
(including having relevant professional training or experience).
30. A Registrar to an Issue and share transfer agent shall be responsible for the acts or omissions of its employees
and agents in respect of the conduct of its business.
31. A Registrar to an Issue and share transfer agent shall not, in respect of any dealings in securities, be party
to or instrumental for –
(a) creation of false market;
(b) price rigging or manipulation;
(c) passing of unpublished price sensitive information in respect of securities which are listed and proposed
to be listed in any stock exchange to any person or intermediary.
Regulation 13A prohibits an RTA from acting as such Registrar in case he or it is an associate of the body
corporate issuing the securities. For the purposes of this regulation, Registrar to an Issue or the body corporate,
as the case may be, shall be deemed to be an associate of other where –
(i) he or it controls directly or indirectly not less than10% of the voting power of the body corporate or of Registrar
to an issue, as the case may be or he or any of his relative is a director or promoter of the body corporate or of
the Registrar to an issue, as the case may be. The term ‘relative’ shall have the same meaning as assigned to
it under Section 6 of the Companies Act, 1956.
The RTA has to maintain of three preceeding financial years proper books and records as prescribed in Regulation
14 and preserve the account books and other records for a minimum period of 3 years. Regulation 15A provides
that every Registrar to an Issue and share transfer agent shall appoint a compliance officer who shall be
responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions
etc. issued by SEBI or Central Government and for redressal of investor grievances. Compliance officer shall
immediately and independently report to SEBI any non-compliance observed by him.
Procedure for Inspection
Chapter IV containing Regulation 16 to 21 deals with procedure for inspection by SEBI appointed inspecting
authority to ensure that the books of accounts and documents are maintained as prescribed and that the
provisions of SEBI Act and the rules and regulations thereunder are complied with. Investigation may be
undertaken on the basis of complaints received from the investors, other registrars or any other intermediaries
in respect of RTA.
Regulation 17 lays down the procedure and Regulation 18 indicates the obligations of the RTA in relation to
such inspection/investigation.
Regulations 19 and 20 stipulate that the inspecting authority shall on the conclusion of his inspection submit a
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report to SEBI. SEBI after considering the inspection or investigation report take such action as SEBI or chairman
may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
Regulation 21 authorises SEBI to appoint an Auditor to investigate into the books of account or the affairs of the
RTA and STA. The Auditor shall have the same powers as SEBI appointed inspecting authority.
Liability for Action in case of default
A registrar to an Issue who –
(i) fails to comply with any conditions subject to which registration has been granted.
(ii) Contravenes any of the provisions of the Act, rules or regulations.
(iii) Contravenes the provisions of the SCRA and the rules made thereunder, provisions of the Depositories
Act or rules made thereunder, the rules, regulations or bye laws of the stock exchange, shall be dealt
with in the manner provided in Chapter V of the Securities and Exchange Board of India (Intermediaries)
Regulations, 2008.
UNDERWRITERS
Underwriters represent one of the key elements among the capital market intermediaries. They facilitate raising
of capital by assuring to take up the unsubscribed portion upto a specified limit. Underwriting is an arrangement
whereby certain parties assure the issuing company to take up shares, debentures or other securities to a
specified extent in case the public subscription does not amount to the expected levels. For this purpose, an
arrangement (agreement) will be entered into between the issuing company and the assuring party such as a
financial institution, banks, merchant banker, broker or other person.
SEBI (UNDERWRITERS) REGULATIONS, 1993
These regulations were notified by SEBI in exercise of the powers conferred by Section 30 of SEBI Act, 1992
with the approval of Central Government. They came into force from 8th October, 1993.
Chapter I contains preliminary matters including definitions.
Chapter II deals with the procedure for registration of underwriters and it contains Regulations 3 to 12.
Regulation 3 lays down that the applicant seeking the certificate shall apply to SEBI in form A. Every Stock
Broker or Merchant Banker holding a valid certificate of registration under section 12 of SEBI Act shall be
entitled to act as an underwriter without obtaining a separate certificate under these regulation. Regulation 4
and 5 requires the applicant to furnish further information and clarification to SEBI regarding matters relevant to
underwriting. If SEBI on receipt of further information is of the opinion that the information so furnished is not
sufficient to decide on the application and seeking further information through correspondence may delay the
matter, it may require the applicant or its principal officer to appear before SEBI in order to give an opportunity to
the applicant to give further clarifications on the application.
Regulation 5 provides that an application not complete in all respects and not conforming to instructions specified
in the form would be rejected. The applicant would be given an opportunity to remove within one month, the
objections as may be indicated by SEBI. SEBI may however extend the time by another one month in order to
enable the applicant to comply with the requirements of SEBI.
Regulation 6 prescribes the following conditions for consideration of the application:
1. the applicant shall have necessary infrastructure like adequate office space, equipments and manpower and
past experience in underwriting, employing at least two persons with such experience. No person directly or
indirectly connected with the applicant should have been granted registration by SEBI.
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SEBI shall take into account whether a previous application for a certificate of any person directly or indirectly
connected with the applicant has been rejected by SEBI or any disciplinary action has been taken against such
person under the Act or any rules/regulations.
2. the applicant should be a fit and proper person, fulfilling the capital adequacy requirements and no director,
partner or principal officer should have been at any time convicted for an offence involving moral turpitude or
found guilty of any economic offence.
Regulation 7 prescribes for the following capital adequacy requirement:
1. The networth should not be less than ` 20 lakhs.
2. The stock broker–underwriter should have capital adequacy as prescribed by the stock exchange.
3. The merchant banker-underwriter shall fulfill capital adequacy as laid down in Merchant Banker’s
Regulations.
Regulations 8 and 9, 9A, 9B deal with procedure for registration and renewal of certificate, conditions of registration,
period of validity of certificate.
Regulations 10 and 11 deal with the procedure where registration is not granted and the effect of refusal to grant
or renew the certificate. Regulation 12 prescribes fees payable and consequences of failure to pay fees.
Obligations and Responsibilities of Underwriters
Chapter III consisting of Regulation 13 to 18 deals with these matters. Every underwriter shall abide by the code
of conduct at all times.
Regulations 14 and 15 contain provisions regarding the matters on which every underwriter shall enter into an
agreement with the body corporate and his general responsibilities.
The contents of the agreement shall include the period of agreement, the amount of underwriting obligations,
the period by which the underwriter should subscribe, the amount of commission/brokerage payable, and other
details for fulfilling the underwriting obligations. The general responsibilities of the underwriter are as follows:
1. The underwriter shall not derive any direct or indirect benefit from underwriting the issue other than the
commission or brokerage payable under an agreement for underwriting.
2. The total underwriting obligations under all the agreements shall not exceed 20 times the networth.
3. Every underwriter, in the event of being called upon to subscribe for securities of a body corporate
pursuant to an agreement shall subscribe to such securities within 45 days of the receipt of such
intimation from such body corporate.
Regulation 16 to 18 relate to maintenance of proper accounts, books and records and their preservation for 5
years and SEBI’s power call for and obtain information from the underwriter.
Appointment of Compliance Officer
Regulation 17A requires every underwriter to appoint a compliance officer responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the
Central Government and for redressal of investors’ grievances. The compliance officer is required to report to
SEBI immediately and independently any non-compliance observed by him.
Inspection and Disciplinary Proceedings
Chapter IV containing Regulations 19 to 24 makes provisions on this subject. SEBI is empowered to appoint
inspectors to ensure that books of accounts, records etc. are maintained properly and the Act along with the
rules and regulations are duly complied with. SEBI is also empowered to investigate into complaints from investors,
72 PP-CC&MM
other underwriters etc. as well as under their own power to investigate suo moto in the interest of securities
business and the investors. Regulations 20 and 21 lay down the procedure for inspection and obligations of
underwriter during such inspections.
Regulations 22 relate to submission of inspection report to SEBI.
Regulation 23 provides that SEBI Board or chairman after the consideration of inspection or investigation report
may take action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
Regulation 24 authorise SEBI to appoint a qualified auditor to investigate into the affairs and the accounts of the
underwriter with the same powers as applicable in the case of SEBI appointed inspector.
Procedure for Action in Case of Default
Chapter V containing Regulation 25 to 32 lays down the procedure for action in case of default. An underwriter
or a stock broker or a merchant banker entitled to carry on business of underwriting who fails to comply with any
conditions subject to which certificate has been granted and who contravenes any of the provisions of the Act,
rules or regulations, shall be dealt with in the manner provided under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
BANKER TO AN ISSUE
Banker to an Issue means a scheduled bank carrying on all or any of the following activities :
– Acceptance of application and application monies;
– Acceptance of allotment or call monies;
– Refund of application monies;
– Payment of dividend or interest warrants.
SEBI (BANKER TO AN ISSUE) REGULATION, 1994
SEBI notified these regulations effectiveness from 14th July, 1994 in exercise of the powers conferred by Section
30 of SEBI Act, 1994 after approval by the Central Government.
Chapter I deal with preliminary matters and definitions.
Chapter II containing Regulations 3 to 11 deals with registration of Bankers to an Issue with SEBI.
Regulations 3 to 5 prescribe that the application by a scheduled bank for grant of certificate as a banker to an
issue should be made to SEBI in Form A conforming to the instructions therein failing which, it shall be rejected
after giving due opportunity to remove such defects within specified time. SEBI may call for and obtain further
information or clarification from the applicant.
Consideration of Application
Regulation 6 prescribes the matters that are considered by SEBI in relation to the application:
(a) the applicant has the necessary infrastructure, communication and data processing facilities and
manpower to effectively discharge his activities;
(b) the applicant or any of its directors is not involved in any litigation connected with the securities market
and which has an adverse bearing on the business of the applicant or has not been convicted of any
economic offence;
(c) the applicant is a scheduled bank and a fit and a proper person;
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(d) the applicant is a fit and proper person;
(e) grant of certificate to the applicant is in the interest of investors.
Procedure for Registration
Regulations 7, 8, 8A and 8B deal with the procedure for registration and renewal of the certificate, conditions of
registration and period of validity of certificate. Regulation 9 relates to the procedure where the registration is not
granted, leading to the rejection of the application after giving an opportunity to the applicant to be heard. The
applicant has right to appeal for reconsideration and SEBI shall reconsider the application and communicate its
decision to the applicant in writing.
Regulation 10 lays down that the applicant whose application is refused by SEBI shall cease to carry on any
activity as a banker to an issue from the date on which he receives the communication of refusal.
Regulation 11 imposes the duty on the applicant to pay the fees as prescribed. Non-payment of fees may result
in suspension of the registration and the applicant shall cease to carry on the activity as a banker to the issue
during the period of suspension.
General Obligations and Responsibilities
Regulation 12 requires every banker to an issue to maintain the following records:
(a) the number of applications received, the names of the investors, the dates on which the applications
were received and the amounts so received from the investors;
(b) the time within which the applications received from the investors were forwarded to the body corporate
or registrar to an issue as the case may be;
(c) the dates and amount of the refund monies paid to the investors;
(d) dates, names and amount of dividend/interest warrant paid to the investors.
The Banker to an issue shall intimate SEBI about the place where these documents are kept and shall preserve
them for a minimum period of 3 years.
Regulation 13 requires the banker to inform SEBI as to the number of issues for which he was engaged as
banker and certain other additional information regarding the monies received, the refunds made and the dividend/
interest warrant paid.
Regulation 14 requires the banker to issue to enter into an agreement with the body corporate for whom he is
acting as an banker to issue with regard to the following matters:
(a) the number of centres at which the application and the application monies of an issue of a body corporate
will be collected from the investors;
(b) the time within which the statements regarding the applications and the application monies received
from the investors investing in an issue of a body corporate will be forwarded to the registrar to an issue
of the body corporate, as the case may be;
(c) the daily statement will be sent by the designated controlling branch of the bankers to the issue to the
registrar to an issue indicating the number of body corporate and the amount of application money
received.
Regulation 15 requires the banker to inform SEBI about disciplinary action taken, if any by the RBI against him
in relation to issue payment work. If as a result of such action the banker is prohibited from carrying on the
activities, the certificate shall be deemed to have been cancelled or suspended as the case may be.
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CODE OF CONDUCT
Regulation 16 prescribes that every banker to an issue shall abide by the Code of Conduct as specified in
Schedule III of the Regulations.
Compliance Officer
Regulation 16A provides that every banker to an issue is required to appoint a compliance officer responsible for
monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by
SEBI or Central Government. He shall also be entrusted with the responsibility of redressal of investors’ grievances.
He is required to immediately and independently report to SEBI regarding any non-compliance observed by
him.
Procedure for Inspection
Chapter IV containing Regulation 17 to 22 deals with inspection of Banker to an Issue.
Regulation 17 and 18 authorise SEBI to request RBI to undertake inspection of the books of accounts, records
and documents of the banker, to ensure their proper maintenance, and compliance with SEBI Act, Rules and
Regulations, to investigate into the complaints received from investors, body corporates or any other person in
relation to the work of the banker as a banker to an issue and to investigate into any other matter referred by
SEBI.
Regulation 19 lays down that RBI shall on receipt of the request from SEBI take appropriate steps to undertake
inspection of Bankers to an Issue for such purposes as may be required by SEBI.
Regulation 20 requires that the banker shall offer all assistance and cooperation to RBIs inspecting officers to
facilitate the inspection.
Regulation 21 stipulates that the RBI shall furnish to SEBI, copy of the inspection report along with copies of
other relevant documents in support of the observations made by the inspecting authority.
Action on Inspection or Investigation Report
SEBI Board or the Chairman after consideration of inspection or investigation report may take such action as the
Board or SEBI may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
Procedure for Action in Case of Default
Regulation 23 provides that banker to an Issue who contravenes any of the provisions of the Act, rules or
regulations framed thereunder, shall be dealt with in the manner provided under Chapter V of the SEBI
(Intermediaries) Regulations, 2008.
DEBENTURE TRUSTEES
Debenture trustee means a trustee of a trust deed for seeing any issue of debentures of a body corporate.
Debentures, Bonds and other hybrid instruments in most cases unless otherwise specified, carry securities for
the investors unlike in the case of equity and preference shares. It is necessary that the company makes proper
arrangements to extend assurances and comply with legal requirements in favour of the investors who are
entitled to this type of security. Intermediaries such as Trustees who are generally Banks and Financial Institutions
render this service to the investors for a fee payable by the company. The issuing company has to complete the
process of finalising and executing the trust deed or document and get it registered within the prescribed period
and file the charge with the Registrar of Companies (ROC) in respect of the security offered.
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SEBI (DEBENTURE TRUSTEES) REGULATIONS, 1993
These regulations were notified by SEBI effective from 29th December, 1993 in exercise of the powers conferred
by Section 30 of SEBI Act, 1992 after previous approval of the Central Government.
Chapter I contains preliminary matters and definitions.
Chapter II consisting Regulations 3 to 12 deals with the procedure for initial or permanent registration of debenture
trustees.
Regulation 3 stipulates that the application shall be made in Form A these Regulation. An application for registration
made shall be accompanied by a non-refundable application fee as prescribed in these Regulation. Regulation
4 authorises SEBI to call for and obtain further information from the applicant before granting the registration.
The applicant or its principal officer may, if so required, appear before SEBI for personal representation. Regulation
5 stipulates that an application which is incomplete and does not conform to instructions shall be rejected after
giving an opportunity to the applicant to remove such objections within time specified.
Regulation 6 lays down that SEBI shall take into account the following matters in considering the application,
namely that the applicant:
(1) has the necessary infrastructure like adequate office space, equipments, and manpower to effectively discharge
his activities;
(2) has any past experience as a debenture trustee or has in his employment minimum two persons who had the
experience in matters which are relevant to a debenture trustee; or
(3) any person, directly or indirectly connected with the applicant has not been granted registration by SEBI
under the Act;
(4) has in his employment at least one person who possesses the professional qualification in law from an
institution recognised by the Government; or
(5) any of its director or principal officer is or has at any time been convicted for any offence involving moral
turpitude or has been found quality of any economic offence.
(6) is a fit and proper person;
(7) fulfils the capital adequacy requirements specified in Regulation 7A of SEBI Regulations.
Regulation 7 lays down that to be a debenture trustee the applicant shall be a scheduled bank carrying on
commercial activity, a public financial institution, an insurance company or a body corporate.
Regulation 7A of the Regulations provide that the capital adequacy requirement of debenture trustee shall not
be less than the networth of ` 1 crore.
Regulations 8 and 9A deal with the procedure for registration and the renewal thereof, conditions of registration,
time period for disposal of application and period of validity of certificate.
Regulation 10 lays down that if an applicant does not fulfil the requirements of Regulation 6 above, it may be
rejected after giving reasonable opportunity to the applicant for being heard. The rejection shall be conveyed in
writing by SEBI and the applicant may again apply for reconsideration of SEBI. After due reconsideration SEBI
shall communicate its bindings in writing to the applicant.
Regulations 11 and 12 deal with effect of refusal to grant certificate of permanent registration by SEBI and nonpayment of fees by the applicant. In the absence of a valid certificate the trustee shall cease to act as a debenture
trustee.
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Responsibilities and Obligations of Debenture Trustees
Chapter III containing Regulations 13 to 18 deals with this topic. Regulation 13 lays down that no debenture
trustee who has been granted a certificate by SEBI shall act as debenture trustee unless he enters into a written
agreement with the body corporate before the opening of the subscription list for issue of debentures and the
agreement inter alia contains that debenture trustee has agreed to act as such under the trust deed for securing
an issue of debentures for the body corporate and the time limit within which the security for the debentures
shall be created.
Regulation 13A stipulates that no debenture trustee shall act as such for any issue of debentures in case:
(a) it is an associate of the body corporate; or
(b) it has lent and the loan is not yet fully repaid or is proposing to lend money to the body corporate.
Regulation 14 provides that every debenture trustee shall amongst other matters accept the trust deed which
contains the matters specified in Schedule IV to the Regulations.
Duties of Debenture Trustees
Regulation 15 casts the following duties on the debenture trustees:
(1) call for periodical reports from the body corporate;
(2) take possession of trust property in accordance with the provisions of the trust deed;
(3) enforce security in the interest of the debenture holders;
(4) do such acts as necessary in the event the security becomes enforceable;
(5) carry out such acts as are necessary for the protection of the debenture holders and to do all things
necessary in order to resolve the grievances of the debenture holders;
(6) ascertain and specify that:
(a) in case where the allotment letter has been issued and debenture certificate is to be issued after
registration of charge, the debenture certificates have been despatched by the body corporate to
the debenture holders within 30 days of the registration of the charge with ROC;
(b) debenture certificates have been despatched to the debenture holders in accordance with the
provisions of the Companies Act;
(c) interest warrants for interest due on the debentures have been despatched to the debenture holders
on or before the due dates;
(d) debentureholders have been paid the monies due to them on the date of redemption of the
debentures;
(7) ensure on a continuous basis that the property charged to the debenture is available and adequate at
all time to discharge the interest and principal amounts payable in respect of the debentures and that
such property is free from any other encumbrances save and except those which are specifically agreed
to by the debenture trustee.
(8) exercise due diligence to ensure compliance by the body corporate, with the provisions of the Companies
Act, the listing agreement of the stock exchange or the trust deed;
(9) to take appropriate measures for protecting the interest of the debenture holders as soon as any breach
of the trust deed or law comes to his notice;
(10) to ascertain that the debentures have been converted or redeemed in accordance with the provisions
and conditions under which they are offered to the debenture holders;
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(11) inform SEBI immediately of any breach of trust deed or provision of any law;
(12) appoint a nominee director on the Board of the body corporate in the event of :
(i) two consecutive defaults in payment of interest to the debentures; or
(ii) default in creation of security for debentures; or
(iii) default in redemption of debentures.
(13) communicate to the debenture holders on half yearly basis the compliance of the terms of the issue by
the body corporate, defaults, if any, in payment of interest or redemption of debentures and action taken
therefore;
(14) The debenture trustee shall –
(a) obtain reports from the leading bank regarding the progress of project.
(b) monitor utilization of funds raised in the issue.
(c) obtain a certificate from the issuer’s auditors.
(i) in respect of utilization of funds during the implementation period of the project; and
(ii) in the case of debentures issued for financing working capital at the end of accounting year.
(15) A debenture trustee may call or cause to be called by the body corporate a meeting of all the debenture
holders on –
(a) a requisition in writing signed by at least one-tenth of the debentureholders in value for the time
being outstanding.
(b) the happening of any event, which constitutes a default or which in the opinion of the debenture
trustees affects the interest of the debentureholders.
(16) No debenture trustee should relinquish its assignment in respect of the debenture issue of any body
corporate, unless and until another debenture trustee is appointed in its place by the body corporate.
(17) A debenture trustee is required to maintain the networth requirements on a continuous basis. He is
under an obligation to inform SEBI immediately in respect of any shortfall in the networth. He is also
not entitled to undertake new assignments until it restores the networth to the level of specified requirement
within the time specified by the Board.
(18) Debenture trustee may inspect books of accounts, records, registers of the body corporate and the trust
property to the extent necessary for discharging its obligations.
Code of Conduct
Regulation 16 requires that every debenture trustee shall abide by the code of conduct as specified in Schedule
III to the Regulations.
Maintenance of Records
Regulations 17 and 18 deal with maintenance of books of accounts, records and documents relating to trusteeship
functions for a period of not less than five financial years preceding the current financial year. Every debenture
trustee would inform SEBI about the place where the books of accounts records and documents are maintained
and furnishing of various information to SEBI by the debenture trustee.
Appointment of Compliance Officer
Every debenture trustee is required to appoint a compliance officer responsible for monitoring the compliance of
78 PP-CC&MM
the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or Central Government.
He is also responsible for redressal of investor grievances. Compliance officer is under an obligation to immediately
and independently report to SEBI any non-compliance observed by him. He would also report any non-compliance
of the requirements specified in the listing agreement with respect to debenture issues and debentureholders,
by the body corporate to SEBI.
Information to SEBI
Debenture trustee is required to submit the following information and documents to SEBI, as and when SEBI
may require –
(a) The number and nature of the grievances of the debentureholders received and resolved.
(b) Copies of the trust deed.
(c) Non-Payment or delayed payment of interest to debentureholders, if any, in respect of each issue of
debentures of a body corporate.
(d) Details of despatch and transfer of debenture certificates giving therein the dates, modes etc.
(e) Any other particular or document which is relevant to debenture trustee.
Inspection and disciplinary Proceedings
Chapter IV consisting of Regulation 19 to 24 deals with inspection and disciplinary proceedings.
Regulation 19 authorises SEBI to appoint one or more persons as inspecting authority to undertake the inspection
of books of accounts, records and documents of the debenture trustee to ensure their proper maintenance and
compliance with SEBI Act, Rules and Regulation, disposal of investors complaints promptly and to investigate
suo moto in the interest of the securities business or investors interest into the affairs of the debenture trustee.
Regulations 20 to 22 deal with procedure for inspection, obligations of the trustee to fully assist and co-operate
in the inspection, submission of report by the inspecting authority.
Action on Inspection or Investigation Report
SEBI Board or chairman may after consideration of inspection or investigation report take such action as the
Board or chairman may deem fit and appropriate including action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
Regulation 24 permits SEBI to appoint a qualified auditor to investigate the records and affairs of the debenture
trustee with the same powers given to the inspecting authority.
Procedure for Action in Case of Default
Regulation 25 of Chapter V lays down that a debenture trustee would be dealt with in the manner provided
under Chapter V of SEBI (Intermediaries) Regulations, 2008, if he fails to comply with the conditions of registration,
contravenes the provisions of SEBI Act/Companies Act, Rules and Regulations.
SECONDARY MARKET INTERMEDIARIES
The following market intermediaries are involved in the secondary market:
– Stock brokers
– Sub-brokers
– Portfolio managers
– Custodians
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– Foreign Institutional Investors
– Investment Advisers
STOCK BROKERS AND SUB-BROKER
A stock-broker plays a very important role in the secondary market helping both the seller and the buyer of the
securities to enter into a transaction.
A sub-broker is one who works along with the main broker and is not directly registered with the stock exchange
as a member. He acts on behalf of the stock broker as an agent or otherwise for assisting the investors in
buying, selling or dealing in securities through such stock brokers.
No stock broker or sub-broker shall buy, sell or deal in securities unless he holds a certificate of registration
granted by SEBI under the Regulations made by SEBI in relation to them.
SEBI (STOCK BROKERS & SUB-BROKERS) REGULATIONS, 1992
SEBI (Stock Brokers & Sub-Brokers) Regulations, 1992 were notified by SEBI in exercise of the powers conferred
by section 30 of SEBI Act, 1992 and came into effect on 23rd October, 1992.
Chapter II of the Regulations containing Regulations 3 to 10 deal with registration of Stock Brokers. An application
by a stock broker for grant of a certificate of registration shall be made in Form A through the Stock exchange or
stock exchanges, as the case may be, of which he is admitted as a member. The stock exchange shall forward
the application form to SEBI as early as possible but not later than 30 days from the date of its receipt. SEBI may
require the applicant to furnish such further information or clarifications regarding the dealings in securities and
related matters to consider the application for granting a certificate of registration. The applicant or its principal
officer shall, if so required, appear before SEBI for personal representation.
SEBI shall take into account the following aspects before granting a certificate:
(a) whether the stock broker is eligible to be admitted as a member of a stock exchange;
(b) whether he has the necessary infrastructure like adequate office space, equipment and manpower to
effectively discharge his activities;
(c) whether he has any past experience in the business of buying, selling or dealing in securities;
(d) whether he was subjected to disciplinary proceedings under the rules, regulations and bye-laws of a
stock exchange with respect to his business as a stock broker involving either himself or any of his
partners, directors or employees; and
(e) whether he is a fit and proper person.
SEBI, on being satisfied that the stock broker is eligible, shall grant a certificate of registration to him and send
an intimation to that affect to the stock exchange or stock exchanges as the case may be. However, subject to
the conditions as stipulated by SEBI for registration, a stock broker holding a certificate of registration with
respect to membership of a recognised stock exchange having nationwide trading terminals shall be eligible for
trading on SME platform established by such stock exchange without obtaining a separate certificate of registration
for trading on the SME platform. Regulation 6A lays down the conditions of registration. The stock broker holding
a certificate shall at all times abide by the Code of Conduct as specified in Schedule II of the Regulations.
Rejection of Application of Brokers
Where an application for grant of a certificate does not fulfil the requirements, as prescribed in the Regulations,
SEBI may reject the application after giving a reasonable opportunity of being heard. The refusal to grant the
registration certificate shall be communicated by SEBI within 30 days of such refusal to the concerned stock
80 PP-CC&MM
exchange and to the applicant stating therein the grounds on which the application has been rejected. An
applicant may, being aggrieved by the decision of SEBI, may apply within a period of 30 days from the date of
receipt of such intimation, to SEBI for reconsideration of its decision. SEBI shall reconsider an application made
and communicate its decision as soon as possible in writing to the applicant and to the concerned stock exchange.
The stock broker whose application for grant of a certificate has been refused by SEBI shall not, on and from the
date of the receipt of SEBI’s communication, buy, sell or deal in securities as a stock broker.
Every applicant eligible for grant of a certificate of registration shall pay such fees and in such manner as
specified in Schedule III to the regulations. However SEBI may on sufficient cause being shown, permit the
stock broker to pay such fees at any time before the expiry of 6 months from the date on which such fees
become due. Where a stock broker fails to pay the fees as provided, SEBI may suspend the registration certificate,
where upon the stock broker shall cease to buy, sell or deal in securities as a stock broker.
Registration of Sub-brokers
Chapter III of the Regulations containing Regulations 11 to 16 deal with registration of sub-brokers. A sub-broker
cannot act such unless he holds a certificate granted by SEBI. Where a sub-broker merely charges his affiliation
from one stock broker to another stock broker being a member of the same stock exchange. There is no
requirement of obtaining fresh certificate. Again there is no need of obtaining fresh certificate where a registered
stock broker is affiliated to stock broker who is eligible to trade on SME platform.
Regulation 11A lays down that an application by a sub-broker for the grant of certificate shall be made in
Form- B. Such application from the sub-broker applicant shall be accompanied by a recommendation letter in
Form-C from a stock broker of a recognised stock exchange with whom the former is to be affiliated along with
two references including one from his banker. The application form shall be submitted to the stock exchange of
which the stock broker with whom he is to be affiliated is a member.
The stock exchange on receipt of an application shall verify the information contained therein and shall also
certify that the applicant is eligible for registration as per criteria specified below:
(1) In the case of an individual:
(a) the applicant is not less than 21 years of age;
(b) the applicant has not been convicted of any offence involving fraud or dishonesty;
(c) the applicant has at least passed 12th standard equivalent examination from an Institution recognised
by the Government. However, SEBI may relax this criterion on merits having regard to the applicant’s
experience;
(d) the applicant is a fit and proper person.
(2) In the case of partnership firm or a body corporate, the partners or directors as the case may be shall
comply with the requirements stated above. It is also to be assessed whether the applicant has necessary
infrastructure like adequate office space, equipment and manpower to effectively discharge his activities.
The applicant should be person recognised by the stock exchange as a sub-broker affiliated to a member
broker of the stock exchange. The stock exchange shall forward the application form of such applicants,
alongwith recommendation letter issued by the stock broker with whom he affiliated alongwith a recognition
letter issued by the stock exchange to SEBI within 30 days from the date of its receipt.
SEBI on being satisfied that the sub-broker is eligible, shall grant a certificate in Form-E to the sub-broker and send
an intimation to that affect to the stock exchange or exchanges as the case may be. SEBI may grant a certificate
of registration to the applicant subject to the terms and conditions as laid down by SEBI in Regulation 12A.
Regulation 12A lays down the conditions of registration. Any registration granted by SEBI shall be subject to the
following conditions: –
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(a) he shall abide by the rules, regulations and bye-laws of the stock exchange which are applicable to him;
(b) he shall pay fees charged by SEBI;
(c) he shall take adequate steps for redressal of grievances, of the investors within one month of the date
of receipt of the complaint and keep SEBI informed about the number, nature and other particulars of
the complaints received from such investors; and
(d) he is authorized in writing by a stock-broker being a member of a stock exchange for affiliating himself
in buying, selling or dealing in securities.
Where an application for grant of a certificate does not fulfil the requirements mentioned in Regulation 11A,
SEBI may reject the application after giving a reasonable opportunity of being heard. The refusal to grant the
certificate shall be communicated by SEBI within 30 days of such refusal to the concerned stock exchange and
to the applicant in writing stating therein the grounds on which the application has been rejected. An applicant
being aggrieved by the decision of SEBI may, within a period of 30 days from the date of receipt of such
intimation apply to SEBI for reconsideration of the decision.
SEBI shall reconsider an application made and communicate its decision to the applicant in writing and to the
concerned stock exchange as soon as possible.
A person whose application for grant of a certificate has been refused by SEBI shall, on and from the date of
communication of refusal cease to carry on any activity as a sub-broker. The sub-broker has the following
general obligations:
(a) pay the fees as per Schedule III;
(b) abide by the Code of Conduct specified in Schedule II;
(c) enter into an agreement with the stock broker for specifying the scope of his authority and responsibilities;
(d) comply with the rules, regulations and bye laws of the stock exchange;
(e) not be affiliated to more than one stock broker of one stock exchange.
The sub-broker shall keep and maintain the books and documents specified in the Regulations.
No director of a stock broker can act as a sub-broker to the same stock broker.
The general obligations and responsibilities, procedure for inspection and for taking action in case of default
shall be the same for both stock brokers and sub-brokers.
Registration of Trading and Clearing Members
Chapter IIIA consisting of Regulation 16A to 16I deals with registration of trading and clearing members. Regulation
16A on the procedure for application for registration requires that an application for grant of certificate of registration
by a trading member of a derivatives exchange or derivatives segment of a stock exchange shall be made in
Form-AA of Schedule-I, through the concerned derivatives exchange or derivatives segment of a stock exchange
of which he is a member. Similarly an application for grant of certificate of registration by a clearing member or
self clearing member of the clearing corporation or clearing house of a derivatives exchange or derivatives
segment of a stock exchange shall be made in Form-AA of Schedule-I, through the concerned clearing corporation
or clearing house of which is he a member. However, a trading member who also seeks to act as a clearing
member or self clearing member shall make separate applications for each activity. The concerned exchange
shall forward the application to SEBI as early as possible but not later than 30 days from the date of its receipt.
SEBI may require the applicant or the concerned stock exchange or segment or clearing house or corporation
to furnish such other information or clarification regarding the trading and settlement in derivatives and matters
connected thereto, to consider the application for grant of a certificate. The applicant or its principal officer, if so
required shall appear before SEBI for personal representation.
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SEBI shall take into account the following aspects while considering the application, namely –
1 whether the applicant is eligible to be admitted as a trading member or a clearing member as the case
may be;
2 whether the applicant has the necessary infrastructure like adequate office space, equipment and man
power to effectively undertake his activities; and
3 whether he is/was subjected to disciplinary procedures under the rules, regulations and bye-laws of any
stock exchange with respect to his business, involving either himself or any of his partners, directors or
employees;
4 whether the applicant has any financial liability which is due and payable to the SEBI.
The applicant shall also have a net worth as may be specified from time to time and the approved user and sales
personnel of the trading member shall have passed a certification programme approved by SEBI. An applicant
who desires to act as a clearing member shall also have a minimum net worth of ` 300 lakhs and shall deposit
at least a sum of ` 50 lakhs or higher amount with a clearing corporation or a clearing house of the derivatives
exchange or derivatives segment in the form specified from time to time. An applicant who derives to act as a
self clearing member, in addition shall complying with the requirement of minimum networth of ` 100 lakhs and
shall deposit atleast a sum of ` 50 lacs or higher amount with the clearing corporation or clearing house of the
derivatives exchange or derivatives segment in the form specified from time to time.
Net worth in this context shall mean paid up capital plus free reserves and other securities approved by SEBI
from time to time (but does not include fixed assets, pledged securities, value of members card, non allowable
securities which are unlisted, bad deliveries, doubtful dates and advances of more than three months and debt/
advances given to the associate persons of the members), pre-paid expenses, losses, intangible assets and
30% value of marketable securities.
Registration Procedure for Trading and Clearing Member
On being satisfied that the applicant is eligible, SEBI shall grant a certificate in Form-DA of Schedule-I to the
applicant and send an intimation to that effect to the derivative segment of the stock exchange or derivatives
exchange or clearing corporation or clearing house as the case may be. Where an application does not fulfil the
requirements, SEBI may reject the application after giving a reasonable opportunity to the applicant of being
heard. The refusal to grant such certificate shall be communicated by SEBI within 30 days of such refusal to the
concerned segment of stock exchange or clearing corporation or clearing house and to the applicant stating
therein the grounds on which the application has been rejected. If aggrieved by the decision of SEBI as referred
to above, the applicant may apply within a period of 30 days from the date of receipt of such information to SEBI
for reconsideration of its decision. SEBI shall reconsider the application and communicate its decision as soon
as possible in writing to the applicant and to the concerned segment of stock exchange or clearing house or
corporation. If certificate of registration is refused to an applicant he shall not from the date of receipt of SEBI’s
letter of rejection deal in or settle the derivatives contracts as a member of the derivatives exchange as a
member of derivatives exchange, segment, clearing corporation or clearing house. Every applicant eligible for
grant of certificate as a trading or clearing member or self clearing member, shall pay such fee as may be
specified. If the fee is not paid, SEBI may suspend or cancel the registration after giving an opportunity of being
heard where upon the trading or clearing member shall cease to deal in and settle the derivatives contract.
Registration of Trading and Clearing Members of Currency Derivatives Segment
Chapter IIIB containing Regulation 16J to 16R deals with registration of trading and clearing member of currency
derivative segment. Regulation 16J provide that the application for grant of certificate of registration by a trading
member of currency derivatives segment of a stock exchange shall be made in Form AB of Schedule I, through
the concerned currency derivatives segment of a stock exchange of which he is a member. An application for
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grant of certificate of registration by a clearing member of the clearing corporation or clearing house of currency
derivatives segment of a stock exchange, shall be made in Form AB of Schedule I, through the concerned
clearing corporation or clearing house of which he is a member: However, a trading member who also seeks to
act as a clearing member shall make separate applications for each activity in Form AB of Schedule I.The
currency derivatives segment or clearing house or corporation, as the case may be, shall forward the application
to the Board as early as possible but not later than thirty days from the date of its receipt.
SEBI may require the applicant or the concerned stock exchange or segment or clearing house or corporation
to furnish such other information or clarifications, regarding the trading and settlement in currency derivatives
and matters connected thereto, to consider the application for grant of a certificate. The applicant or its principal
officer shall, if so required, appear before SEBI for personal representation.
SEBI shall take into account for considering the grant of a certificate all matters relating to dealing and settlement
in currency derivatives and in particular the following, namely –
(a) Whether the applicant is eligible to be admitted as a trading member or a clearing member
(b) Whether the applicant has the necessary infrastructure like adequate office place, equipment and
manpower to effectively undertake his activities;
(c) Whether he is subjected to disciplinary proceedings under the rules, regulations and bye-laws of any
stock exchange with respect to his business involving either himself or any of his partners, directors or
employees;
(d) Whether the applicant has any financial liability which is due and payable to the Board under these
regulations.
An applicant shall also have a net worth of ` 1 Crore and shall ensure that its approved user and sales personnel
have passed a certification programme approved by SEBI. An applicant who desires to act as a clearing member,
shall have a minimum net worth of ` 10 crore and shall deposit at least a sum of ` 50 lacs or higher amount with
the clearing corporation or clearing house of the currency derivatives segment in the form specified from time to
time.
Registration Procedure
On being satisfied that the applicant is eligible, SEBI shall grant a certificate in Form DB of Schedule I, to the
applicant and send an intimation to that effect to the currency derivatives segment of the stock exchange or
clearing corporation or clearing house, as the case may be. Where an application for the grant of a certificate
does not fulfil the requirements SEBI may reject the application of the applicant after giving a reasonable
opportunity of being heard. The refusal to grant the certificate of registration shall be communicated by SEBI
within 30 days of such refusal to the currency derivatives segment of the stock exchange, or clearing house or
corporation and to the applicant stating therein the grounds on which the application has been rejected. An
applicant may, if aggrieved by the decision of SEBI as referred to above, the applicant may apply within a period
of thirty days from the date of receipt of such information to SEBI for reconsideration of its decision. SEBI shall
reconsider an application made and communicate its decision as soon as possible in writing to the applicant and
to the currency derivatives segment of the stock exchange or clearing house or corporation.
An applicant, whose application for the grant of a certificate of registration has been refused by SEBI shall not on
and from the date of receipt of the communication deal in or settle the currency derivatives contracts as a
member of the currency derivatives segment of the stock exchange or clearing corporation or clearing house.
Code of Conduct
The code of conduct specified for the stock broker as stipulated in Schedule-II shall be applicable mutatis
mutandis to the trading member, clearing member and self-clearing member and such members shall at all
times abide by the same. The trading member shall obtain details of the prospective clients in “know your client”
84 PP-CC&MM
format as specified by SEBI before executing an order on behalf of such client. The trading member shall
mandatorily furnish “risk disclosure document” disclosing the risk inherent in trading in derivatives to the prospective
clients in the form specified. The trading or clearing member shall deposit a margin money or any other deposit
and shall maintain position or exposure limit as specified by SEBI or the concerned exchange or segment or
clearing corporation or clearing house from time to time.
General Obligations and Responsibilities
Regulation 17 and 18 deal with the general obligations and responsibilities of stock brokers. It lays down that
every stock broker shall keep and maintain books of accounts, records and documents namely – Register of
Transactions (Sauda book); clients ledger; general ledger; journals; cash book; bank pass book; documents
register including particulars of securities received and delivered in physical form and the statement of account
and other records relating to receipt and delivery of securities provided by the depository participants in respect
of dematerialised securities, members contract books showing details of all contracts entered into by him 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 consents of clients in
respect of contracts entered into as principals; margin deposit book; registers of accounts of sub-brokers; an
agreement with sub-broker specifying scope of authority, and responsibilities of the stock brokers as well as
sub-brokers and an agreement with the sub-broker and with the client of sub-broker to establish privity of
contract between the stock broker and the client of the sub-broker.
Every stock broker shall intimate to SEBI the place where the books of accounts, records and documents are
maintained. He shall, after the close of each accounting period, furnish to SEBI if so required, as soon as
possible but not later than 6 months from the close of the said period, a copy of the audited balance sheet and
profit and loss account for the said accounting period.
If this is not possible, the stock broker shall keep SEBI informed of the same together with the reasons for the
delay and the period of time by which such documents would be furnished to SEBI. Every stock broker shall
preserve the books of accounts and other records for a minimum period of 5 years. Stock broker shall not deal
with any person as sub-broker unless such person has been granted certificate of registration by SEBI.
Compliance Officer
Every stock broker is required to appoint a compliance officer who shall be responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or Central
Government and for redressal of investors’ grievances. Compliance officer shall immediately and independently
report to SEBI any non-compliance observed by him.
Procedure for Inspection of Stock Brokers’ Offices
Regulations 19 to 24 provides for procedure for inspection. It is provided that where it appears necessary to
SEBI, it may appoint one or more persons as inspecting authority to undertake inspection of the books of
accounts other records and documents of the stock brokers:(a) to ensure that the books of account and other books are being maintained in the manner required,
(b) that the provisions of the Act, rules and regulations as well as the provisions of the Securities Contracts
(Regulation) Act, 1956 and the rules made thereunder are being complied with,
(c) to investigate into the complaints received from investors, other stock brokers, sub-brokers or any other
person on any other matter having a bearing on the activities of the stock brokers, and
(d) to investigate suo moto in the interest of securities business or investors interest into the affairs of the
stock broker.
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Before undertaking inspection, SEBI shall give a reasonable notice to the stock broker. However, if SEBI is
satisfied that in the interest of the investors or in public interest, no such notice should be given, it may by an
order in writing, direct that the inspection be taken up without such notice to the stock broker. On being empowered
by SEBI, the inspecting authority shall undertake the inspection and the stock broker concerned shall be bound
to discharge his obligations to facilitate and co-operate for the conduct of inspection by the said authority.
Obligations of Stock Broker on Inspection by SEBI
It shall be the duty of every director, proprietor, partner, officer and employee of the stock broker who is being
inspected, to produce to the inspecting authority such books, accounts and other documents in his custody or
control and furnish him with the statements and information relating to the transactions in securities market
within such time as the inspecting authority may require.
The stock broker shall allow the inspecting authority to have reasonable access to the premises occupied by
such stock broker or by any other person on his behalf and also extend reasonable facility for examining any
books, records, documents and computer data in the possession of the stock broker or any other person and
also provide copies of documents or other materials which in the opinion of the inspecting authority are relevant.
The said authority in the course of inspection shall be entitled to examine or record statements of any member,
director, partner, proprietor and employee of the stock broker. It shall be duty of every director, proprietor,
partner, officer and employee of stock broker to give the said authority all assistance in connection with the
inspection, which the stock broker may be reasonably expected to give.
The inspecting authority shall as soon as possible submit an inspection report to SEBI who shall after consideration
of inspection or investigation report take such action as it may deem fits and appropriate including action under
Chapter V of SEBI (Intermediaries) Regulations, 2008.
SEBI is also empowered to appoint a qualified auditor to investigate into the books of accounts or the affairs of
the stock broker. The auditor so appointed shall have the same powers of the inspecting authority as enumerated
above and the obligations of the stock broker as detailed above shall be applicable to the investigation.
Procedure for Action in Case of Default
A stock broker or a sub-broker who contravenes any of the provisions of the Act, rules or regulations framed
thereunder shall be liable for any one or more of the following actions –
(i) Monetary penalty under Chapter VIA of the Act.
(ii) Penalties as specified under Chapter V of SEBI (Intermediaries) Regulations, 2008 including suspension
or cancellation of certificate of registration as a stock broker or a sub-broker.
(iii) Prosecution under Section 24 of the Act.
Liability for Monetary Penalty
A stock broker or a sub-broker shall be liable for monetary penalty in respect of the following violations, namely –
(i) Failure to file any return or report with SEBI.
(ii) Failure to furnish any information, books or other documents within 15 days of issue of notice by SEBI.
(iii) Failure to maintain books of account or record as per the Act, rules or regulations framed thereunder.
(iv) Failure to redress the grievances of investors within 30 days of receipts of notice from SEBI.
(v) Failure to issue contract notes in the form and manner specified by the Stock Exchange of which such
broker is a member.
(vi) Failure to deliver any security or make payment of the amount due to the investor within 48 hours of the
settlement of trade unless the client has agreed in writing otherwise.
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(vii) Charging of brokerage which is in excess of brokerage specified in the regulations or the bye-laws of
the stock exchange.
(viii) Dealing in securities of a body corporate listed on any stock exchange on his own behalf or on behalf of
any other person on the basis of any unpublished price sensitive information.
(ix) Procuring or communicating any unpublished price sensitive information except as required in the ordinary
course of business or under any law.
(x) Counselling any person to deal in securities of any body corporate on the basis of unpublished price
sensitive information.
(xi) Indulging in fraudulent and unfair trade practices relating to securities.
(xii) Execution of trade without entering into agreement with the client under the Act, rules or regulations
framed thereunder or failure to maintain client registration form or commission of any irregularities in
maintaining the client agreement.
(xiii) Failure to segregate his own funds or securities from the client’s funds or securities or using the securities
or funds of the client for his own purpose or for purpose of any other client.
(xiv) Acting as an unregistered sub-broker or dealing with unregistered sub-brokers.
(xv) Failure to comply with directions issued by SEBI under the Act or the regulations framed thereunder.
(xvi) Failure to exercise due skill, care and diligence.
(xvii) Failure to seek prior permission of SEBI in case of any change in its status and constitution.
(xviii) Failure to satisfy the net worth or capital adequacy norms, if any, specified by SEBI.
(xix) Extending use of trading terminal or any unauthorized person or place.
(xx) Violations for which no separate penalty has been provided under these regulations.
Liability for Action under the Enquiry Proceeding
A stock broker or a sub-broker shall be liable for any action as specified in SEBI (Intermediaries) Regulations,
2008 including suspension or cancellation of his certificate of registration as a stock broker or a sub-broker, as
the case may be, if he –
(i) ceases to be a member of a stock exchange; or
(ii) has been declared defaulter by a stock exchange and not readmitted as a member within a period of six
months; or
(iii) surrender his certificate of registration to SEBI; or
(iv) has been found to be not a fit and proper person by SEBI under these or any other regulations; or
(v) has been declared insolvent or order for winding up has been passed in the case of a broker or subbroker being a company registered under the Companies Act, 1956; or
(vi) or any of the partners or any whole-time director in case a broker or sub-broker is a company registered
under the Companies Act, 1956 has been convicted by a court of competent jurisdiction for an offence
involving moral turpitude; or
(vii) fails to pay fee as per Schedule III of these regulations; or
(viii) fails to comply with the rules, regulations and bye-laws of the stock exchange of which he is a member;
or
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(ix) fails to co-operate with the inspecting or investigating authority; or
(x) fails to abide by any award of the Ombudsman or decision of the Board under the Securities and
Exchange Board of India (Ombudsman) Regulations, 2003; or
(xi) fails to pay the penalty imposed by the Adjudicating Officer; or
(xii) indulges in market manipulation of securities or index; or
(xiii) indulges in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations, 1992; or
(xiv) violates SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003; or
(xv) commits violation of any of the provisions for which monetary penalty or other penalties could be imposed;
or
(xvi) fails to comply with the circulars issued by SEBI; or
(xvii) commits violations specified in Regulation 26 which in the opinion of SEBI are of a grievous nature.
Liability for Prosecution
A stock broker or a sub-broker shall be liable for prosecution under Section 24 of the Act for any of the following
violations, namely –
(i) Dealing in securities without obtaining certificate of registration from the Board as a stock broker or a
sub-broker.
(ii) Dealing in securities or providing trading floor or assisting in trading outside the recognized stock exchange
in violation of provisions of the Securities Contract (Regulation) Act, 1956 or rules made or notifications
issued thereunder.
(iii) Market manipulation of securities or index.
(iv) Indulging in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations, 1992.
(v) Violating SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003.
(vi) Failure without reasonable cause –
(a) to produce to the investigating authority or any person authorized by him in this behalf, any books,
registers, records or other documents which are in his custody or power; or
(b) to appear before the investigating authority personally or to answer any question which is put to him
by the investigating authority; or
(c) to sign the notes of any examination taken down by the investigating authority.
(vii) Failure to pay penalty imposed by the adjudicating officer or failure to comply with any of his directions
or orders.
A CASE STUDY ON FRAUDULENT DEALINGS
Bishwanath Murlidhar Jhunjhunwala v. SEBI
SEBI noticed a spurt in the volume in the trading of the scrip of Snowcem India Ltd. (SIL), both at NSE and BSE.
Though the scrip was not very liquid, it was observed that during June 1999 to August 1999, price of the scrip
ranged between `55 to `127. The Appellant, a stock broker of BSE himself was found to have registered himself
as a client with a broker of NSE and placed orders in large quantities in the scrip of SIL to the tune of 2,87,400
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shares which amounted to 5.59 percent of the total volume traded at NSE between June 1999 and August 1999.
Orders placed by the Appellant were matched with those orders placed by Kosha Investment Ltd. (KIL). Further,
the Appellant had not traded in his own account at BSE. The conduct of the Appellant was in violation of Regulation
4(a), (b) and (d) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market)
Regulations, 2003 in view of which he was prohibited from accessing capital market for a period of 2 years.
Upholding the impugned order in its totality, the Hon’ble SAT noted that, “It is a fact that the persons who operate
in the market are required to maintain high standards of integrity, promptitude and fairness in the conduct of
business dealings.
Submission of Annual Returns
As part of the continued compliance, National Stock Exchange of India requires its Members to submit Annual
Returns i.e. details in respect of shareholding, directors, etc. in the prescribed format to the Exchange. Members
having financial year ending other than March 31, are required to submit the said documents within a period of
6 months from the end of their respective financial year. Accordingly, such members are required to inform the
Exchange about the financial year followed by them on or before October 31 every year. In case any member
has changed its financial year from the one followed earlier, it shall convey such details to the Exchange on or
before October 31. Trading Members are required to file the prescribed information/documents in electronic
form over and above the submission in hard form.
Bombay Stock Exchange of India also requires its all active members including Representative members of
Cash segment, Limited Trading members & Trading and/or Clearing members of the Derivatives segment of the
Bombay Stock Exchange to submit Networth Certificate to the Exchange.
CERTIFICATION BY PRACTICING COMPANY SECRETARY
1. Internal Audit for Stock Brokers/Trading Members/ Clearing Members
SEBI has authorized the Practicing Company Secretary to carry out complete internal audit of stock brokers/
trading members/clearing members on a half yearly basis. The circular states that stock brokers/trading members/
clearing members shall carry out complete internal audit on a half yearly basis by chartered accountants, company
secretaries or cost and management accountants who are in practice and who do not have any conflict of
interest. The scope of such audit covers, inter alia, the existence, scope and efficiency of the internal control
system, compliance with the provisions of the SEBI Act, 1992, Securities Contracts (Regulation) Act 1956, SEBI
(Stock Brokers and Sub-Brokers) Regulations, 1992, circulars issued by SEBI, agreements, KYC requirements,
Bye Laws of the Exchanges, data security and insurance in respect of the operations of stock brokers/clearing
members. The objective of internal audit is –
(i) to ensure that the books of account, records (including telephone records and electronic records) and
documents are being maintained in the manner required under SEBI Act, 1992, SCR Act, 1956 and
SEBI (Stock brokers and Sub-brokers) Regulations, 1992.
(ii) to ascertain as to whether adequate internal control systems, procedures and safeguards have been
established and are being followed by the intermediary to fulfill its obligations within the scope of the audit.
(iii) to ascertain as to whether any circumstances exist which would render the intermediary unfit or ineligible.
(iv) to ascertain whether the provisions of the securities laws and the directions or circulars issued thereunder
are being complied with.
(v) to ascertain whether the provision of stock exchange bye-laws, notices, circulars, instructions or orders
issued by stock exchanges are being complied with.
(vi) to inquire into the complaints received from investors, clients, other market participants or any other
person on any matter having a bearing on the activities of the stock broker.
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PORTFOLIO MANAGER
Portfolio manager means any person who pursuant to contract or arrangement with the client, advises or directs
or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management
or administration of a portfolio of securities or the funds of the clients as the case may be. “Discretionary portfolio
manager” is defined as one who exercises or may exercise, under a contract relating to portfolio management,
any degree of discretion as to the investment or the management of the portfolio of the securities or the funds of
the client. “Portfolio” means the total holdings of securities belonging to any person.
A portfolio manager thus, with professional experience and expertise in the field, studies the market and adjusts
the investment mix for his client on a continuing basis to ensure safety of investment and reasonable returns
therefrom.
SEBI (PORTFOLIO MANAGERS) REGULATIONS, 1993
SEBI issued SEBI (Portfolio Managers) Regulations, 1993 in exercise of the powers conferred by Section 30 of
SEBI Act, 1992. These regulations took effect from 7th January, 1993.
Regulation 3A lays down that an application by a portfolio manager for grant of the certificate shall be made to
SEBI in the prescribed form-A and shall be accompanied by a non-refundable application fee, as specified in
Clause (1) of Schedule II, to be paid in the manner specified in Part B thereof. Incomplete applications shall be
rejected after the applicant is given an opportunity to remove within the time specified such objections on the
application as may be indicated by SEBI. Before disposing the application, SEBI may require the applicant to
furnish further information or clarification and the applicant or its principal officer who is mainly responsible for
the activities as a portfolio manager, shall appear before SEBI to make a personal representation, if required.
Norms for Registration as Portfolio Managers
The requirements to be satisfied by the applicant for getting the certificate of registration as mentioned in Regulation
6 are as follows:
(a) the applicant is a body corporate;
(b) the applicant has the necessary infrastructure like adequate office space, equipments and the manpower
to effectively discharge the activities of a portfolio manager;
(c) the principal officer of the applicant has the professional qualifications in finance, law, accountancy or
business management from an institution recognised by the Government or a foreign university or an
experience of at least 10 years in related activities in the securities market including in a portfolio manager,
stock broker or as a fund manager;
(d) the applicant has in its employment minimum of two persons who, between them, have at least five
years experience as portfolio manager or stock broker or investment manager or in the areas related to
fund management;
(e) any previous application for grant of certificate made by any person directly or indirectly connected with
the applicant has been rejected by SEBI;
(f) any disciplinary action has been taken by the Board against a person directly or indirectly connected
with the applicant under the Act or the Rules or the Regulations made thereunder.
The expression ‘person directly or indirectly connected’ means any person being an associate, subsidiary,
inter-connected company or a company under the same management within the meaning of Section
370(1B) of the Companies Act, 1956 or in the same group;
(g) the applicant fulfils the capital adequacy requirements;
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(h) the applicant, its director, principal officer or the employee as specified in Clause (d) is involved in any
litigation connected with the securities market which has an adverse bearing on the business of the
applicant;
(i) the applicant, its director, principal officer or the employee as specified in Clause (d) has at any time
been convicted for any offence involving moral turpitude or has been found guilty of any economic
offence;
(j) the applicant is a fit and proper person;
(k) grant of certificate to the applicant is in the interests of investors.
Capital Adequacy Requirement
Portfolio manager must have capital adequacy requirement of not less than networth of two crore rupees.
However the portfolio manager shall fulfill capital adequacy requirement under these regulations, separately
and independently of capital adequacy requirements if any for each activity undertaken by it under the relevant
regulations. Networth for the purpose means the aggregate value of paid-up equity capital plus free reserves
(excluding reserves created out of revaluation) reduced by the aggregate value of accumulated looses and
deferred expenditure not written off, including miscellaneous expenses not written off.
SEBI on being satisfied that the applicant fulfils the requirement specified above shall send an intimation to the
applicant. On payment of the requisite fees by the applicant in accordance with Clause 1A of Schedule II of the
Regulations, he will be granted a certificate of Registration in Form-B.
Renewal of Certificate
A portfolio manager may make an application for renewal of his registration at least three months before the
expiry of the validity of his certificate.
SEBI, in addition to the information furnished in form A along with fees specified in Clause 1 of Schedule II has
prescribed for certain additional information to be submitted by the applicant while seeking registration/ renewal
as portfolio managers. The applicant has been required to furnish the additional detailed information in the
following areas:
1. Memorandum and Articles of Association of the applicant
2. Details of Directors & shareholding pattern
3. Details of Promoters & shareholding pattern
4. Details of applicant registered with SEBI as any other intermediary
5. Details of the Principal Officer
6. Details of Key personnel
7. Details of infrastructure facilities
8. Details of the proposed Schemes
9. Details of facility for safe custody
10. Details of facility for equity research
11. Financial Accounts of the applicant
12. Report from principal bankers
13. List of brokers
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14. Details regarding applicant registered with RBI (if any)
15. Details of associated registered intermediaries
16. Declaration by at least two directors
17. Declaration for fit and proper person
18. Director’s Declaration under regulation 6.
The applicant has been advised to note that furnishing of incomplete information would delay the processing of
the application. The applicant has also been advised to keep the Board informed of all the consequent changes
in the information provided to the board.
Conditions of Registration
Any registration granted or any renewal granted under these regulation shall be subject to the following conditions
namely:
(a) where the portfolio manager proposes to change its status or constitution, it shall obtain prior approval
of the Board for continuing to act as such after the change;
(b) it shall pay the fees for registration or renewal, as the case may be, in the manner provided in these
regulations;
(c) it shall take adequate steps for redressal of grievances of the investors within one month of the date of
the receipt of the complaint and keep the Board informed about the number, nature and other particulars
of the complaints received;
(d) it shall maintain capital adequacy requirements specified in these regulation at all times during the
period of the certificate or renewal thereof;
(e) it shall abide by the regulations made under the Act in respect of the activities carried on by it as portfolio
manager.
Period of Validity of Certificate
The certificate of registration granted and its renewal granted under these regulation shall be valid for a period
of three years from the date of its issue to the applicant.
Procedure Where Registration is not Granted
Where the applicant does not satisfy the requirement of registration, SEBI may reject the application after giving
an opportunity of being heard. The refusal shall be communicated by SEBI within 30 days of such refusal
indicating the grounds for rejection. An applicant if aggrieved by SEBI’s rejection may apply within a period of 30
days from the date of receipt of rejection letter to SEBI for reconsideration. SEBI shall reconsider the matter and
communicate its final decision as soon as possible in writing to the applicant. The applicant shall cease to carry
on activity as portfolio manager on receipt of rejection of his application. If the portfolio manager fails to pay the
fees as provided in Schedule II, SEBI may suspend the certificate and during the period of suspension the
portfolio manager shall not carry on activity as such portfolio manager.
Code of Conduct
Regulation 13 lays down that every portfolio manager shall abide by the code of conduct as specified in Schedule
III to the Regulations which is as follows:
1. A portfolio manager shall, in the conduct of his business, observe high standards of integrity and fairness in all
his dealings with his clients and other portfolio managers.
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2. The money received by a portfolio manager from a client for an investment purpose should be deployed by
the portfolio manager as soon as possible for that purpose and money due and payable to a client should be
paid forthwith.
3. A portfolio manager shall render at all times high standards of service, exercise due diligence, ensure proper
care and exercise independent professional judgement. The portfolio manager shall either avoid any conflict of
interest in his investment or disinvestment decision, or where any conflict of interest arises, ensure fair treatment
to all his customers. He shall disclose to the clients, possible sources of conflict of duties and interests, while
providing unbiased services. A portfolio manager shall not place his interest above those of his clients.
4. A portfolio manager shall not make any statement or become privy to any act, practice or unfair competition,
which is likely to be harmful to the interests of other portfolio managers or is likely to place such other portfolio
managers in a disadvantageous position in relation to the portfolio manager himself, while competing for or
executing any assignment.
5. A portfolio manager shall not make any exaggerated statement, whether oral or written, to the client either
about the qualification or the capability to render certain services or his achievements in regard to services
rendered to other clients.
6. At the time of entering into a contract, the portfolio manager shall obtain in writing from the client, his interest
in various corporate bodies which enables him to obtain unpublished price-sensitive information of the body
corporate.
7. A portfolio manager shall not disclose to any clients or press any confidential information about his client,
which has come to his knowledge.
8. The portfolio manager shall where necessary and in the interest of the client take adequate steps for registration
of the transfer of the clients’ securities and for claiming and receiving dividends, interest payments and other
rights accruing to the client. He shall also take necessary action for conversion of securities and subscription/
renunciation of/or rights in accordance with the clients’ instruction.
9. A portfolio manager shall endeavour to –
(a) ensure that the investors are provided with true and adequate information without making any misguiding
or exaggerated claims and are made aware of attendant risks before any investment decision is taken
by them;
(b) render the best possible advice to the client having regard to the client’s needs and the environment,
and his own professional skills;
(c) ensure that all professional dealings are effected in a prompt, efficient and cost effective manner.
10. (1) A portfolio manager shall not be a party to –
(a) creation of false market in securities;
(b) price rigging or manipulation of securities;
(c) passing of price sensitive information to brokers, members of the stock exchanges and any other
intermediaries in the capital market or take any other action which is prejudicial to the interest of the
investors.
(2) No portfolio manager or any of its directors, partners or manager shall either on their respective accounts or
through their associates or family members and relatives enter into any transaction in securities of companies
on the basis of unpublished price sensitive information obtained by them during the course of any professional
assignment.
11. (a) A portfolio manager or any of his employees shall not render, directly or indirectly any investment advice
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about any security in the publicly accessible media, whether real-time or non-real-time, unless a disclosure of
his long or short position in the said security has been made, while rendering such advice.
(b) In case an employee of the portfolio manager is rendering such advice, he shal 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.
12. (a) The portfolio manager shall abide by the Act, and the Rules, Regulations made thereunder and the
Guidelines/Schemes issued by the Board.
(b) The portfolio manager shall comply with the model code of conduct specified in SEBI (Prohibition of Insider
Trading) Regulations, 1992.
(c) The portfolio manager shall not use his status as any other registered intermediary to unduly influence the
investment decision of the clients while rendering portfolio management services.
Contract with Clients and Disclosures
The portfolio manager, before taking up an assignment of management of funds or portfolio of securities on
behalf of a client, enter into an agreement in writing with such client clearly defining the inter se relationship and
setting out their mutual rights, liabilities and obligations relating to the management of funds or portfolio of
securities containing the details as specified in Schedule IV to the Regulations:
The agreement between the portfolio manager and the client shall, inter alia, contain:
(i) the investment objectives and the services to be provided;
(ii) areas of investment and restrictions, if any, imposed by the client with regard to the investment in a
particular company or industry;
(iii) type of instruments and proportion of exposure;
(iv) tenure of portfolio investments;
(v) terms for early withdrawal of funds or securities by the clients;
(vi) attendant risks involved in the management of the portfolio;
(vii) period of the contract and provision of early termination, if any;
(viii) amount to be invested subject to the restrictions provided under these regulations;
(ix) procedure of settling client’s account including form of repayment on maturity or early termination of
contract;
(x) fees payable to the portfolio manager;
(xi) the quantum and manner of fees payable by the client for each activity for which service is rendered by
the portfolio manager directly or indirectly (where such service is outsourced);
(xii) custody of securities;
(xiii) in case of a discretionary portfolio manager a condition that the liability of a client shall not exceed his
investment with the portfolio manager;
(xiv) the terms of accounts and audit and furnishing of the reports to the clients as per the provisions of these
regulations; and
(xv) other terms of portfolio investment subject to these regulations.
The portfolio manager shall provide to the client, the Disclosure Document as specified in Schedule V, along
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with a certificate in Form C as specified in Schedule I, at least two days prior to entering into an agreement with
the client as referred to in Sub-regulation
(1). The Disclosure Document, shall inter alia contain the following –
(i) the quantum and manner of payment of fees payable by the client for each activity for which service is
rendered by the portfolio manager directly or indirectly (where such service is outsourced);
(ii) portfolio risks;
(iii) complete disclosures in respect of transactions with related parties as per the accounting standards
specified by the Institute of Chartered Accountants of India in this regard;
(iv) the performance of the portfolio manager :
Provided that the performance of a discretionary portfolio manager shall be calculated using weighted
average method taking each individual category of investments for the immediately preceding three
years and in such cases performance indicators shall also be disclosed;
(v) the audited financial statements of the portfolio manager for the immediately preceding three years.
The contents of the Disclosure Document would be certified by an independent chartered accountant.
The portfolio manager is required to file with SEBI, a copy of the Disclosure Document before it is circulated or
issued to any person and every six months thereafter or whenever any material change is effected therein
whichever is earlier, along with the certificate in Form C as specified in Schedule I. The portfolio manager shall
ensure that the disclosure document is given to clients along with the account opening form atleast 2 days in
advance of signing of the agreement. The portfolio manager shall charge an agreed fee from the clients for
rendering portfolio management services without guaranteeing or assuring, either directly or indirectly, any
return and the fee so charged may be a fixed fee or a return based fee or a combination of both.
The portfolio manager may, subject to the disclosure in terms of the Disclosure Document and specific permission
from the client, charge such fees from the client for each activity for which service is rendered by the portfolio
manager directly or indirectly (where such service is outsourced).
Responsibilities of a Portfolio Manager
Regulation 15 lays down that the discretionary portfolio manager shall individually and independently manage
the funds of each client in accordance with the needs of a client in a manner which does not partake the
character of a mutual fund, whereas the non discretionary portfolio manager shall manage the funds in accordance
with the directions of the client.
(a) The portfolio manager shall not accept from the client, funds or securities worth less than five lacs
rupees.
(b) The portfolio manager shall act in a fiduciary capacity with regard to the clients funds.
(c) He shall transact in securities within the limitation placed by the client for dealing in securities under the
provisions of RBI Act, 1934.
(d) He shall not derive any direct or indirect benefit out of the clients funds or securities.
(e) The portfolio manager shall not accept from the client, funds or securities worth less than five lacs
rupees. However, the minimum investment amount per client shall be applicable for new clients and
fresh investment by existing clients.
The portfolio manager shall keep the funds of all clients in a separate account to be maintained by it in a
Scheduled Commercial Bank. He shall ensure proper and timely handling of complaints from his clients and
take appropriate action promptly.
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Investment of Clients Money
(1) The money or securities accepted by the portfolio manager shall not be invested or managed by the portfolio
manager except in terms of the agreement between the portfolio manager and the client.
(2) Any renewal of portfolio fund on maturity of the initial period shall be deemed as a fresh placement.
(3) The funds or securities can be withdrawn or taken back by the client before the maturity of the contract under
the following circumstances, namely –
(a) voluntary or compulsory termination of portfolio management services by the portfolio manager or the
client.
(b) suspension or cancellation of the certificate of registration of the portfolio manager by the Board.
(c) bankruptcy or liquidation of the portfolio manager.
(4) The portfolio manager shall invest funds of his clients in money market instruments or derivatives or as
specified in the contract:
However, leveraging of portfolio shall not be permitted in respect of investment in derivatives further the portfolio
manager shall not deploy the clients’ funds in bill discounting, badla financing or for the purpose of lending or
placement with corporate or non-corporate bodies. “Money market instruments” includes commercial paper,
trade bill, treasury bills, certificate of deposit and usance bills.
(5) The portfolio manager shall not while dealing with clients’ funds indulge in speculative transactions that is, he
shall not enter into any transaction for purchase or sale of any security which is periodically or ultimately settled
otherwise than by actual delivery or transfer of security except the transactions in derivatives.
(6) The portfolio manager shall, ordinarily purchase or sell securities separately for each client. However, in the
event of aggregation of purchases or sales for economy of scale, inter se allocation shall be done on a pro rata
basis and at weighted average price of the day’s transactions. The portfolio manager shall not keep any open
position in respect of allocation of sales or purchases effected in a day. Any transaction of purchase or sale
including that between the portfolio manager’s own accounts and client’s accounts or between two clients’
accounts shall be at the prevailing market price.
(7) The portfolio manager shall segregate each clients’ funds and portfolio of securities and keep them separately
from his own funds and securities and be responsible for safekeeping of clients’ funds and securities.
(8) The portfolio manager shall not hold the listed securities, belonging to the portfolio account, in its own name
on behalf of its clients either by virtue of contract with clients or otherwise. The portfolio managers, may, subject
to authorization by the client in writing, participate in securities lending.
Foreign institutional investors and sub accounts registered with SEBI may avail of the services of a portfolio
manager.
(9) Every portfolio manager shall appoint a custodian in respect of securities managed or administered by it.
However, this regulation shall not apply to a portfolio Manager who has total assets under management of value
less than five hundred crore rupees; or who performs purely advisory functions.
Accounting by Portfolio Managers
Regulations 17 to 20 deal with books of accounts, records, accounts and audit.
Regulation 17 lays down that every portfolio manager shall keep and maintain the following books of accounts,
records and documents, namely -a) a copy each of balance sheet, profit and loss account and the auditor’s
account in respect of each accounting period b) a statement of financial position and c) records in support
of every investment transaction or recommendation which will indicate the data, facts and opinions leading
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to that investment decision. Every portfolio manager shall intimate to SEBI where the books of accounts,
records or documents are maintained. Every portfolio manager shall after the end of each accounting
period furnish to SEBI copies of the balance sheet, profit and loss account and such other documents as
are required by the regulations. Regulation 18 provides that portfolio manager should furnish to SEBI halfyearly unaudited financial results when required by SEBI with a view to assist in monitoring the capital
adequacy of the portfolio manager.
The portfolio manager shall preserve the books of account and other records and documents mentioned in any
of the regulations mentioned under this chapter for a minimum period of five years.
Regulation 20 lays down that the portfolio manager shall maintain separate client-wise accounts. The funds
received from the clients, investments or disinvestments and all the credits to the account of the client like
interest, dividend, bonus or any other beneficial interest received on the investment and debits for expenses if
any shall be properly accounted for and details thereof shall be reflected correctly in the clients accounts. The
tax deducted at source as required under the Income Tax Act, 1961 shall be recorded in the portfolio account.
The books of account will be audited by a qualified auditor to ensure that portfolio manager has followed proper
accounting methods and procedures and that he has performed the duties in accordance with the law. A certificate
to this effect shall, if so specified be submitted to SEBI within 6 months of the close of the portfolio managers
accounting period.
The portfolio accounts of the portfolio manager shall be audited annually by an independent chartered accountant
and a copy of the certificate issued by the chartered accountant shall be given to the client.
The client may appoint a chartered accountant to audit the books and accounts of the portfolio manager relating
to his transactions and the portfolio manager shall co-operate with such chartered accountant in course of the
audit.
Reports by Portfolio Manager to the Client
Regulation 21 lays down that the portfolio manager shall furnish periodically a report to the client as agreed to in
the contract but not exceeding a period of 6 months and such report shall contain the following details, namely–
(a) the composition and the value of the portfolio, description of security, number of securities, value of
each security held in a portfolio, cash balance and aggregate value of the portfolio as on the date of
report.
(b) transactions undertaken during the period of report including dates of transaction and details of purchases
and sales.
(c) beneficial interest received during that period in respect of interest, dividend, bonus shares, rights shares
and debentures.
(d) expenses incurred in managing the portfolio of the client.
(e) details of risk foreseen by the portfolio manager and the risk relating to the securities recommended by
the portfolio manager for investment or disinvestment.
Regulation 21(1A) provides that the report may be made available on the website of the portfolio manager with
restricted access to each client.
The portfolio manager shall also furnish to the client documents and information relating only to the management
of a portfolio. On termination of the contract, the portfolio manager shall give a detailed statement of accounts to
the client and settle the account with the client as agreed in the contract. The client has the right to obtain details
of his portfolio from the portfolio manager.
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Action on Auditor’s Report and Disclosure to SEBI
Every portfolio manager shall within two months from the date of the auditor’s report take steps to rectify the
deficiencies made out in such report. A portfolio manager shall disclose to SEBI as and when required the
information, namely -Particulars regarding the management of a portfolio; any change in the information or
particulars previously furnished; which have a bearing on the certificate granted to him; the names of the clients
whose portfolio he has managed; and particulars relating to the capital adequacy requirement.
Compliance Officer
Every portfolio manager is required to appoint a compliance officer responsible for monitoring the compliance of
the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the Central Government
and for redressal of investors’ grievances. The compliance officer should independently and immediately report
to SEBI for any non-compliance observed by him.
Inspection and Disciplinary Proceedings
Regulations 24 to 29 contain provisions on this subject.
Regulation 24 empowers SEBI to appoint one or more persons as inspecting authority to undertake the inspection
of the books of accounts, records and documents of the portfolio manager to ensure that they are being maintained
in the manner required, that the provisions of the Act, Rules and Regulations are being complied with. The
inspecting authority shall investigate into the complaints received from the investors, other portfolio managers or
any other person on any matter having a bearing on the activities of the portfolio manager and investigate suo
moto in the interest of securities business or investors interest into the affairs of the portfolio manager.
Notice before Inspection
SEBI shall give a reasonable notice to the portfolio manager before undertaking an inspection. However, where
SEBI is satisfied that in the interest of the investors, no such notice should be given it may by an order in writing
direct that the inspection of the affairs of the portfolio manager be taken up without such notice. During the
course of the inspection the portfolio manager against whom an inspection is being carried out shall be bound to
discharge his obligations as stated below:
Obligations of Portfolio Manager
(1) It shall be the duty of every director, proprietor, partner, officer and employee of the portfolio manager who is
being inspected, to produce to the inspecting authority such books of accounts and documents in his custody or
control and furnish him with the statements and information relating to these activities within such time as the
inspecting authority may require.
(2) The portfolio manager shall allow the inspecting authority to have reasonable access to the premises occupied
by the former or by any other person on his behalf and also extend reasonable facility for examining any books,
records, documents and computer data in his possession or in the possession of any other person and also
provide copies of documents or other material which in the opinion of the inspecting authority are relevant for the
purposes of the inspection.
(3) In the course of inspection, the inspecting authority shall be entitled to examine or record statements of any
principal officer, director, partner, proprietor and employee of the portfolio manager.
(4) It shall be the duty of each such person to give to the inspecting authority all assistance in connection with
the inspection which the portfolio manager may reasonably be expected to give.
The inspecting authority shall submit an inspection report to SEBI as soon as it is possible. SEBI or chairman
shall after consideration of the inspection or investigation report take such action as SEBI or its chairman may
deem fit and appropriate including action under Chapter V of SEBI (Intermediaries) Regulations, 2008.
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Appointment of Auditor
SEBI may appoint a qualified auditor to investigate into the books of accounts or the affairs of the portfolio
manager. The auditor so appointed shall have the same powers of the inspecting authority outlined above and
the obligation of the portfolio manager and his employees in connection therewith shall be applicable also to the
investigation under this Regulation.
Liability for Action in Case of Default
A portfolio manager who contravenes any of the provisions of the Act, Rules or Regulations framed there under
shall be liable for one or more action specified therein including the action under Chapter V of SEBI (Intermediaries)
Regulations, 2008.
INTERNAL AUDIT OF PORTFOLIO MANAGER
Every Portfolio manager is required to appoint a Practising Company Secretary or a Practising Chartered
Accountant for conducting the internal audit. The Portfolio manager is required to report the compliance of the
aforesaid requirement to SEBI while submitting the half yearly report.
The report is to be submitted twice a year, as on 31st of March and 30th of September. The report should reach
SEBI within thirty days of the period to which it relates.
No precise period has been prescribed for the PCS to submit his report to the Board of the company. However,
it would be advisable for the PCS to give the audit report to the Portfolio Manager sufficiently well in advance to
enable the Company to report the compliance of the same to SEBI.
The scope of the internal audit would comprise the checking of compliance of SEBI (Portfolio Managers)
Regulations 1993 and circulars notifications or guidelines issued by SEBI and internal procedures followed by
the Portfolio Manager.
CUSTODIAN OF SECURITIES
Custodian of securities means any person who carries on or proposes to carry on the business of providing
custodial services. The term “custodial services” in relation to securities of a client or gold or gold related
instruments held by a mutual fund in accordance with the SEBI (Mutual Funds) Regulations, 1996 means
safekeeping of securities or gold or gold related instruments and providing services incidental thereto, and
includes –
(i) maintaining accounts of securities or gold or gold related instruments or title deeds of real estate assets;
(ii) undertaking activities as a Domestic Depository in terms of the Companies (Issue of Indian Depository
Receipts) Rules, 2004.
(iii) collecting the benefits or rights accruing to the client in respect of securities or gold or gold related
instruments;
(iv) 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; and
(v) maintaining and reconciling records of the services referred to in points (i) to (iii).
SEBI (CUSTODIAN OF SECURITIES) REGULATIONS, 1996
In exercise of the powers conferred by section 30 of SEBI Act, 1992 (15 of 1992) SEBI issued SEBI (Custodian
of Securities) Regulations, 1996 on May 16, 1996.
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Application for Grant of Certificate
Regulation 3(1) provides that any person proposing to carry on business as custodian of securities on or after
the commencement of these regulations shall make an application to SEBI for grant of a certificate. SEBI may,
however in special cases, where it is of the opinion that it is necessary to do so for reasons to be recorded in
writing, may extend the period upto a maximum of six months from the date of such commencement.
Any person who fails to make an application for grant of certificate within the period or the extended period
specified therein, shall cease to carry on any activity as custodian of securities and shall be subject to the
directions of the Board with regard to the transfer of records, documents or securities relating to his activities as
custodian of securities.
Application to Conform to Requirements
An application which is not complete in all respects or which does not conform to the instructions specified
therein will be rejected. However before rejecting any such application, SEBI would give the applicant an
opportunity to remove the objection, within such time as may be specified.
Furnishing of Information
SEBI may require the applicant to furnish such further information or clarification regarding matters relevant to
the activities of a custodian of securities for the purpose of consideration of the application. The applicant or his
authorised representative may, if so required, appear before SEBI for personal representation, in connection
with the grant of certificate.
Consideration of Application for Grant of Certificate
SEBI, while granting the Certificate shall take into account following matters which are relevant to the activities
of a custodian of securities:
(a) the applicant fulfils the capital requirement;
(b) the applicant has the necessary infrastructure, including adequate office space, vaults for safe custody
of securities and computer systems capability, required to effectively discharge his activities as custodian
of securities;
(c) the applicant has the requisite approvals under any law for the time being in force, in connection with
providing custodial services in respect of gold or gold related instruments of a mutual fund, or title deeds
of real estate assets held by a real state mutual funds scheme where applicable;
(d) the applicant has in his employment adequate and competent persons who have the experience, capacity
and ability of managing the business of the custodian of securities;
(e) the applicant has prepared a complete manual, setting out the systems and procedures to be followed
by him for the effective and efficient discharge of his functions and the arms length relationships to be
maintained with the other businesses, if any, of the applicant;
(f) the applicant is a person who has been refused a certificate by SEBI or whose certificate has been
cancelled by SEBI;
(g) the applicant, his director, his principal officer or any of his employees is involved in any litigation connected
with the securities market;
(h) the applicant, his director, his principal officer or any of his employees has at any time been convicted of
any offence involving moral turpitude or of any economic offence;
(i) the applicant is a fit and proper person; and
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(j) the grant of certificate is in the interest of investors.
Also SEBI shall not consider an application unless the applicant is a body corporate.
Capital Requirement
Regulation 7(1) provides for the capital adequacy requirement. It provides that the applicant must have a net
worth of a minimum of rupees fifty crores. The term “net worth” means the paid up capital and the free reserves
as on the date of the application. However any custodian of securities which has been approved by SEBI under
the provisions of SEBI (Mutual Fund) Regulations, 1993 or SEBI (Foreign Institutional Investors) Regulations,
1995, or the Government of India Guidelines for Foreign Institutional Investors dated September 14, 1992, even
if it does not have the networth specified in above may continue to function as a custodian of securities and shall
within a period of one year from the date of commencement of these regulations raise its networth as specified.
The period specified above may be extended by SEBI upto a maximum of 5 years.
Any applicant is permitted to fulfil his capital adequacy requirements within one month of the receipt of certificate.
Procedure and Grant of Certificate
Regulation 8(1) of the Regulation provides that after considering the application, if SEBI is satisfied that all
particulars sought have been furnished and the applicant is eligible for the grant of a certificate, it will send an
intimation of the same to the applicant.
On receipt of an intimation the applicant shall pay to SEBI specified registration fee. SEBI shall thereafter grant
a certificate to the applicant on receipt of the registration fee. It has been provided that SEBI may restrict the
certificate of registration to providing custodial services either in respect of securities or in respect of gold or gold
related instruments of a client or title deeds of real estate assets held by a real estate mutual fund scheme.
A custodial of securities holding a certificate of registration may provide custodial services in respect of gold or
gold related instruments of a mutual fund and in respect of title deeds of real estate assets held by a real estate
mutual fund scheme, only after taking prior approval of the SEBI.
Conditions of Certificate
The certificate granted to the custodian of securities may be subject to the following conditions, namely:
(a) it shall not commence any activities as custodian of securities unless it fulfils the capital requirement;
(b) it shall abide by the provisions of the Act and these regulations in the discharge of its functions as
custodian of securities;
(c) it shall enter into a valid agreement with its client for the purpose of providing custodial services;
(d) it shall pay annual fees as specified in the manner specified;
(e) if any information previously submitted by it to SEBI is found by it to be false or misleading in any
material particular, or if there is any change in such information, it shall forthwith inform SEBI in writing;
and
(f) besides providing custodial services, it shall not carry on any activity other than activities relating to
rendering of financial services.
Period of Validity
Regulation 9A of the Regulations provide that every certificate granted under these regulation shall be valid for
a period of three years from the date of grant.
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Renewal of Certificate
Regulation 9B of the Regulations provide that a custodian of securities, desirous of having its certificate renewed
shall make an application to SEBI for renewal of the certificate in Form A, not less than three months before the
expiry of its period of validity under Regulation 9A. The application for renewal of certificate shall be dealt with,
as far as may be, as if it were an application for the grant of a fresh certificate and shall be accompanied with the
application fee as specified in Schedule II. However, no registration fee is payable by a custodian in case of a
renewal of certificate.
Procedure where Certificate is not Granted
Regulation 10(1) of the Regulations provide that after considering an application for grant of certificate, if SEBI
is satisfied that a certificate should not be granted, SEBI may reject the application after giving the applicant a
reasonable opportunity of being heard.
The decision of SEBI rejecting the application shall be communicated within thirty days of such decision to the
applicant in writing, stating therein the grounds on which the application has been rejected. An applicant, aggrieved
by the decision of SEBI may within a period of thirty days from the date of receipt of communication apply to
SEBI for re-consideration of its decision.
SEBI shall, as soon as possible, in the light of the submissions made in the application for re-consideration and
after giving the applicant a reasonable opportunity of being heard, convey its decision in writing to the applicant.
Effect of Refusal to Grant Certificate
Any custodian of securities whose application for grant of certificate has been rejected by SEBI shall, on and
from the date of the receipt of the communication ceases to carry on any activity as custodian of securities and
shall be subject to the directions of SEBI with regard to the transfer of records, documents or securities that may
be in its custody or control relating to its activity as custodian of securities.
Code of conduct
Every custodian of securities shall abide by the Code of Conduct as specified in the Third Schedule to the Regulations.
Segregation of Activities
Regulation 13 provides that where a custodian of securities is carrying on any activity besides that of acting as
custodian of securities, then the activities relating to his business as custodian of securities shall be separate
and segregated from all other activities and its officers and employees engaged in providing custodial services
shall not be engaged in any other activity carried on by him.
Mechanism for Monitoring Review
Regulation 14(1) provides that every custodian of securities shall have adequate mechanisms for the purposes
of reviewing, monitoring and evaluating the custodian’s controls, systems, procedures and safeguards. The
custodian of securities shall cause to be inspected annually the mechanism by an expert and forward the
inspection report to SEBI within three months from the date of inspection.
Prohibition of Assignment
No custodian of securities shall assign or delegate its functions as a custodian of securities to any other person
unless such person is a custodian of securities.
However, a custodian of securities may engage the services of a person not being a custodian, for the purpose
of physical safekeeping of gold belonging to its client being a mutual fund having a gold exchange traded fund
scheme, subject to the following conditions:
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(a) the custodian shall remain responsible in all respects to its client for safekeeping of the gold kept with
such other person, including any associated risks;
(b) all books, documents and other records relating to the gold so kept with the other person shall be
maintained in the premises of the custodian or if they are not so maintained, they shall be made available
therein, if so required by SEBI;
(c) the custodian of securities shall continue to fulfil all duties to the clients relating to the gold so kept with
the other person, except for its physical safekeeping.
Separate Custody Account
Every custodian of securities is required to open a separate custody account for each client, in the name of the
client whose securities are in its custody and ensure that the assets of one client would not be mixed with those
of another client.
Agreement with the Client
Every custodian of securities is required to enter into an agreement with each client on whose behalf it is acting
as custodian of securities and every such agreement shall provide for the following matters, namely:
(a) the circumstances under which the custodian of securities will accept or release securities, assets or
documents from the custody account;
(b) the circumstances under which the custodian of securities will accept or release monies from the custody
account.
(c) the circumstances under which the custodian of securities will receive rights or entitlements on the
securities of the client;
(d) the circumstances and the manner of registration of securities in respect of each client;
(e) details of the insurance, if any, to be provided for by the custodian of securities.
Internal Controls
Every custodian of securities is required to have adequate internal controls to prevent any manipulation of
records and documents, including audits for securities and rights or entitlements arising from the securities held
by it on behalf of its client. Every custodian of securities would take appropriate safekeeping measures to
ensure that such securities, assets or documents are protected from theft and natural hazard.
Maintenance of Records and Documents
Regulation 19(1) provides that every custodian of securities is required to maintain the following records and
documents, containing details of:
(a) securities, assets or documents received and released on behalf of each client;
(b) monies received and released on behalf of each client;
(c) rights or entitlements of each client arising from the securities held on behalf of the client;
(d) registration of securities in respect of each client;
(e) ledger for each client;
(f) instructions received from and sent to clients; and records of all reports submitted to SEBI.
The Custodian of securities would intimate to SEBI the place where the records and documents are maintained and
custodian of securities shall preserve the records and documents maintained for a minimum period of five years.
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Appointment of Compliance Officer
Regulation 19A(1) provides that every custodian of securities would appoint a compliance officer responsible for
monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by
SEBI or the Central Government. He is under an obligation for redressal of investors’ grievances.
The compliance officer is required to immediately and independently report to SEBI any non-compliance observed
by him.
Information to SEBI
SEBI may, at any time, call for any information from a custodian of securities with respect to any matter relating
to its activity as custodian of securities. Where any information is called for by SEBI, it shall be the duty of the
custodian of securities to furnish such information, within such reasonable period as SEBI may specify.
Inspection and Audit
SEBI may appoint one or more persons as inspecting officer to undertake inspection of the books of accounts,
records and documents of the custodian of securities for any of the following purposes, namely:
(a) to ensure that the books of account, records and documents are being maintained by the custodian of
securities in the manner specified in these regulations;
(b) to investigate into complaints received from investors, clients or any other person, on any matter having
a bearing on the activities of the custodian of securities;
(c) to ascertain whether the provisions of the Act and these regulations are being complied with by the
custodian of securities; and
(d) to investigate suo moto into the affairs of the custodian of securities, in the interest of the securities
market or in the interest of investors.
Notice Before Inspection
SEBI, before ordering inspection shall give not less than ten days notice to the custodian of securities. Where the
Board is satisfied that in the interest of the investors no such notice should be given, it may by an order in writing
direct that the inspection of the affairs of the custodian of securities be taken up without such notice. The custodian
of securities against whom the inspection is being carried out is under an obligation to discharge his obligations.
Obligations of Custodian
It is the duty of the custodian of securities whose affairs are being inspected, and of every director, officer and
employee thereof, to produce to the inspecting officer such books, securities, accounts, records and other
documents in its custody or control and furnish him with such statements and information relating to his activities
of the custodian of securities, as the inspecting officer may require, within such reasonable period as the inspecting
officer may specify.
The custodian of securities is required to allow the inspecting officer to have reasonable access to the premises
occupied by such custodian or by any other person on his behalf and also extend reasonable facility for examining
any books, records, documents and computer data in the possession of the custodian of securities or such other
person and also provide copies of documents or other materials which, in the opinion of the inspecting officer
are relevant for the purposes of the inspection.
The inspecting officer, in the course of inspection, is entitled to examine or to record the statements of any
director, officer or employee of the custodian of securities. It is the duty of every director, officer or employee of
the custodian of securities to give to the inspecting officer all assistance in connection with the inspection, which
the inspecting officer may reasonably require.
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Submission of Report to SEBI
The inspecting officer shall, as soon as possible, on completion of the inspection submit an inspection report to
SEBI and that if directed by SEBI, he may submit an interim report.
SEBI or the Chairman shall after consideration of inspection or investigation report take such action as the
Board or Chairman may deem fit and appropriate including action under Chapter V of the Securities and Exchange
Board of India (Intermediaries) Regulations, 2008.
Liability for Action in Case of Default
A custodian of securities who contravenes any of the provisions of the Act, the rules framed there under or these
regulations or fails to furnish any information relating to his activity as custodian of securities as required by
SEBI or furnishes to SEBI information which is false and misleading in any material particular or does not submit
periodic returns or reports as required by SEBI or does not co-operate in any enquiry or inspection conducted by
SEBI or fails to update its systems and procedures as recommended by SEBI or fails to resolve the complaints
of clients or fails to give a satisfactory reply to SEBI in this behalf or is guilty of misconduct or makes a breach of
the Code of Conduct specified in the Third Schedule or fails to pay annual fees, shall be dealt with in the manner
provided under Chapter V of SEBI (Intermediaries) Regulations, 2008.
FOREIGN INSTITUTIONAL INVESTOR
“Foreign Institutional Investor” means an institution established or incorporated outside India which proposes to
make investment in India in securities. No person can buy, sell or otherwise deal in securities as a Foreign
Institutional Investor unless he holds a certificate granted by SEBI under these regulations. An application for
the grant of certificate should be made to SEBI in the prescribed form.
SEBI (FOREIGN INSTITUTIONAL INVESTORS) REGULATIONS, 1995
In exercise of the powers conferred by Section 30 of SEBI Act, 1992 SEBI made these regulations.
SEBI may require the applicant to furnish such further information or clarification as SEBI considers necessary
regarding matters relevant to the activities of the applicant for grant of certificate. The applicant or his authorised
representative, if so required by SEBI, appear before SEBI for personal representation in connection with the
grant of a certificate. An application, which is not complete in all respects and does not conform to the instructions
specified in the form or is false or misleading in any material particular, should be rejected by SEBI. However
before rejecting any such application, the applicant should be given a reasonable opportunity to remove, within
the time specified by SEBI, such objections as may be indicated by SEBI.
Consideration of Application
While granting certificate of Registration, SEBI should take into account the following matters:
(i) the applicant’s track record, professional competence, financial soundness, experience, general
reputation of fairness and integrity;
However, in case of a newly established fund, the track record of the investment manager of the fund
who has promoted it may be taken into consideration. However, investment manager shall furnish the
details in respect of disciplinary action, if any, taken against it.
(ii) whether the applicant is regulated by an appropriate foreign regulatory authority;
However, university funds, endowments, foundations, charitable trusts and charitable societies may be
considered for registration even though they are not regulated by a foreign regulatory authority.
(iii) whether the applicant has been granted permission under the provisions of the Foreign Exchange
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Financial Intermediaries Framework 105
Regulation by the Reserve Bank of India for making investments in India as a Foreign Institutional
Investor;
(iv) whether the applicant is –
(a) an institution established or incorporated outside India as Pension Fund, Mutual Fund or Investment
Trust, Insurance Company or reinsurance company;
(aa) a international or multilateral organisation or an agency thereof or a Foreign Governmental Agency,
Sovereign Wealth Fund, or a Foreign Central Bank;
(b) an Asset Management Company, Investment Manager or Advisor, Bank or Institutional Portfolio
Manager, established or incorporated outside India and proposing to make investments in India on
behalf of broad based funds and its proprietary funds, if any; or
(c) a trustee of a trust established outside India and proposing to make investments in India on behalf
of broad based funds and its proprietary funds, if any;
(d) university fund, endowments, foundations or charitable trusts or charitable societies. However while
considering the application from SEBI may take into account the following namely:
– whether the applicant has been in existence for a period of atleast 5 years.
– whether it is legally permissible for the applicant to invest in securities outside the country of its
incorporation or establishment;
– whether the applicant has been registered with any statutory authority in the country of their
incorporation or establishment;
– whether any legal proceeding has been initiated by any statutory authority against the applicant.
– whether the applicant has been serving public interest.
“Broad based fund” means a fund, established or incorporated outside India, which has at least
twenty investors, with no single individual investor holding more than forty-nine per cent of the
shares or units of the fund. However if the broad based fund has institutional investor(s), it shall
not be necessary for the fund to have twenty investors: However that if the broad based fund
has an institutional investor who holds more than forty nine percent of the shares or units in the
fund, then the institutional investor must itself be a broad based fund.
1 whether the grant of certificate to the applicant is in the interest of the development of the securities
market.
2 whether the applicant is a fit and proper person.
Procedure for Grant of Certificate
SEBI, if satisfied that the application is complete in all respects, all particulars sought have been furnished and
the applicant is found to be eligible for the grant of certificate, grant a certificate subject to payment of fees with
in three months from the documents furnished. However SEBI may exempt from the payment of fees, an applicant
such as the World Bank and other institutions established outside India for providing aid, and which have been
granted privileges and immunities from the payment of tax and duties by the Central Government. It has been
provided further that SEBI should refund the fees already collected from the institutions which are exempted
from the payment of fees.
Validity of Certificate
Subject to the compliance of the provisions of the Act, these regulations, the circulars issued there under and
the obligation to pay fees as specified in these regulation, any registration granted by SEBI shall be permanent
106 PP-CC&MM
unless suspended or cancelled by SEBI. Foreign institutional investor or a sub-account, having a certificate
specified in this regulation shall file information in the prescribed form as the case may be, at least three months
prior to the expiry of period of certificate. A foreign institutional investor or a sub account may surrender the
certificate of registration granted to it by SEBI. While accepting a surrender of registration, SEBI may impose
such conditions upon the foreign institutional investor or the sub account as it deems fit.
Grant of Certificate
The grant of certificate to the Foreign Institutional Investor may be subject to the following conditions:
(i) he shall abide by the provisions of these regulations;
(ii) if any information or particulars previously submitted to the Board are found to be false or misleading, in
any material respect, he shall forthwith inform SEBI in writing;
(iii) if there is any material change in the information previously furnished by him to SEBI, which has a
bearing on the certificate granted by SEBI, he shall forthwith inform to SEBI;
(iv) he shall appoint a domestic custodian and before making any investments in India, enter into an
agreement with the domestic custodian providing for custodial services in respect of securities;
(v) he shall, before making any investments in India, enter into an arrangement with a designated bank for
the purpose of operating a special non-resident rupee or foreign currency account;
(vi) before making any investments in India on behalf of a sub-account, if any, he shall obtain registration of
such sub-account, under these regulations.
Procedure where Certificate is not Granted
SEBI may reject the application where an application for grant of a certificate does not satisfy the requirements
after giving the applicant a reasonable opportunity of being heard. The decision to reject the application should
be communicated by SEBI to the applicant in writing stating therein the grounds on which the application has
been rejected. The applicant, who is aggrieved by the decision of SEBI may, within a period of thirty days from
the date of receipt of communication apply to SEBI for reconsideration of its decision. SEBI may, in the light of
the submissions made in the application for reconsideration and after giving a reasonable opportunity of being
heard, convey its decision in writing to the applicant.
Application for Registration of Sub-accounts
A Foreign Institutional Investor should seek from SEBI registration of each sub-account on whose behalf he
proposes to make investments in India. However, before making an application for registration on behalf of a
proposed sub-account being a foreign corporate, the foreign institutional investor shall verify the necessary
details and documents and satisfy itself about the identity of the proposed sub-account after applying its know
your client procedure. Any sub-account that has been granted approval prior to the commencement of these
regulations by SEBI should be deemed to have been granted registration as a sub-account by SEBI under these
regulation. An application for registration as sub-account shall be made in Form AA.
Procedure and Grant of Registration of Sub-accounts
SEBI may take into account the following matters which are relevant to the grant of such registration to the subaccount:
(a) the applicant falls into any of the following categories, namely:
(i) broad based fund or portfolio which is broad based, incorporated or established outside India; or
(ii) proprietary fund of a registered foreign institutional investor; or
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(iii) foreign corporate; or
(iv) foreign individual; or
(v) university fund, endowment, foundation, charitable trust or charitable society who are eligible to be
registered as a foreign institutional investor under these regulations.
(b) the applicant is a fit and proper person;
(c) the Foreign Institutional Investor through whom the application for registration is made to SEBI holds a
certificate of registration as Foreign Institutional Investor;
(d) the Foreign Institutional Investor through whom an application for registration of sub-account is made,
is authorised to invest on behalf of the sub-account;
(e) the applicant and the foreign institutional investor through whom the application for registration is made,
have submitted joint undertakings as required by Form AA of First Schedule of the Regulations;
(f) the sub-account has paid registration fees as specified.
SEBI on receipt of the undertakings and the registration fees as may grant registration to the sub-account. A
sub-account granted registration in accordance with the regulation should be deemed to be registered as a
Foreign Institutional Investor with SEBI for the limited purpose of availing of the benefits available to FIIs under
Section 115AD of Income Tax Act, 1961.
Responsibility of FIIs
A foreign institutional investor shall be responsible and liable for all acts of commission and omission of all its
sub-accounts and other deeds and things done by such sub-accounts in their capacity as sub-accounts under
these regulations. However, it shall not be deemed to detract from any responsibility or liability of the subaccount under these regulations or under any other law for the time being in force. It shall have effect irrespective
of whether the foreign institutional investor exercises discretion in respect of funds of the sub account or not.
Investment Conditions and Restrictions
Regulation 14 provides that a Foreign Institutional Investor cannot make any investments in securities in India
without complying with the provisions. A Foreign Institutional Investor can invest only in the following:
(a) securities in the primary and secondary markets including shares, debentures and warrants of companies
unlisted, listed or to be listed on a recognised stock exchange in India; and
(b) units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a
recognised stock exchange or not, units of scheme floated by a collective investment scheme.
(c) dated Government Securities.
(d) derivatives traded on a recognised stock exchange.
(e) commercial paper.
(f) security receipts.
(g) Indian Depository Receipts
Where a foreign institutional investor or sub-account holds equity shares in a company whose shares are not
listed on any recognised stock exchange, and continues to hold such shares after initial public offering and
listing thereof, such shares shall be subject to lock-in for the same period, if any, as is applicable to shares held
by a foreign direct investor placed in similar position, under the policy of the Central Government relating to
foreign direct investment for the time being in force.
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Sub-regulation (2) of Regulation 15 the total investments in equity and equity related instruments (including fully
convertible debentures, convertible portion of partially convertible debentures and tradable warrants) made by
a Foreign Institutional Investor in India, whether on his own account or on account of his sub-accounts, should
not be less than seventy per cent of the aggregate of all the investments of the Foreign Institutional Investor in
India, made on his own account and on account of his sub-accounts. However it may apply to any investment of
the foreign institutional investor either on its own account or on behalf of its sub-accounts in debt securities
which are unlisted or listed or to be listed on any stock exchange if the prior approval of SEBI has been obtained
for such investments. These Regulations further provide that SEBI may while granting approval for the investments
impose conditions as are necessary with respect to the maximum amount which can be invested in debt securities
by the foreign institutional investor on its own account or through its sub accounts. The conditions mentioned in
sub-regulation (2) shall not apply to investments made by foreign institutional investors in security receipts
issued by securitisation companies or asset reconstruction companies under the Securitisation and Reconstruction
of Financial Assets and Enforcement of Security Interest Act, 2002 and the rules made thereunder.
Further, no FII shall invest in Security Receipts on behalf of its sub-account. A foreign corporate or individual is
not be eligible to invest through the hundred percent debt route. In respect of investments in the secondary
market, additional conditions also provided by these regulations shall apply.
The Regulations clarify that unless otherwise approved by SEBI, securities shall be registered in the name of
the Foreign Institutional Investor, provided the Foreign Institutional Investor is making investments on his own
behalf; or in his name on account of his sub-account, or in the name of the sub-account, in case he is investing
on behalf of the sub-account. However the names of the sub-accounts on whose behalf the Foreign Institutional
Investor is investing are required to be disclosed to SEBI by the Foreign Institutional Investor.
The purchase of equity shares of each company by a Foreign Institutional Investor investing on his own account
should not exceed ten percent of the total issued capital of that company. In respect of a Foreign Institutional
Investor investing in equity shares of a company on behalf of his sub-accounts, the investment on behalf of each
such sub-account shall not exceed ten percent of the total issued capital of that company. However in case of
foreign corporates or individuals, each of such sub-account shall not invest more than 5% of the total issued
capital of the company in which such investment is made. The investment by the Foreign Institutional Investor is
also subject to Government of India Guidelines. A Foreign Institutional Investor or sub-account may lend securities
through an approved intermediary in accordance with stock lending scheme of SEBI.
Conditions for Issuance of Offshore Derivative Instruments
A foreign institutional investor cannot issue, or otherwise deal in offshore derivative instruments, directly or
indirectly, unless the following conditions are satisfied:
(a) such offshore derivative instruments are issued only to persons who are regulated by an appropriate
foreign regulatory authority;
(b) such offshore derivative instruments are issued after compliance with ‘know your client’ norms.
A foreign institutional investor shall ensure that no further issue or transfer is made of any offshore derivative
instruments issued by or on behalf of it to any person other than a person regulated by an appropriate foreign
regulatory authority. A sub-account cannot, directly or indirectly, issue offshore derivative instruments:
‘Offshore derivative instrument’ means any instrument, by whatever name called, which is issued overseas by a
foreign institutional investor against securities held by it that are listed or proposed to be listed on any recognised
stock exchange.
“Person regulated by an appropriate foreign regulatory authority” means and includes the following, namely:
(i) any person that is regulated/supervised and licensed/registered by a foreign central bank;
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(ii) any person that is registered and regulated by a securities or futures regulator in any foreign country or
state;
(iii) any broad based fund or portfolio incorporated or established outside India or proprietary fund of a
registered foreign institutional investor or university fund, endowment, foundation, charitable trust or
charitable society whose investments are managed by a person covered above.
General Obligations and Responsibilities
A Foreign Institutional Investor or a global custodian acting on behalf of the Foreign Institutional Investor, should
enter into an agreement with a domestic custodian to act as custodian of securities for the Foreign Institutional
Investor. The Foreign Institutional Investor should ensure that the domestic custodian takes steps for:
(a) monitoring of investments of the Foreign Institutional Investor in India;
(b) reporting to SEBI on a daily basis the transactions entered into by the Foreign Institutional Investor;
(c) preservation for five years of records relating to his activities as a Foreign Institutional Investor; and
(d) furnishing such information to SEBI as may be called for by SEBI with regard to the activities of the
Foreign Institutional Investor and as may be relevant for the purpose of this regulation.
A Foreign Institutional Investor may appoint more than one domestic custodian with prior approval of SEBI, but
only one custodian may be appointed for a single sub-account of a Foreign Institutional Investor. A Foreign
Institutional Investor should appoint a branch of a bank approved by the Reserve Bank of India for opening of
foreign currency denominated accounts and special non-resident rupee accounts. A Foreign Institutional Investor
or any of his employees should 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 long
or short position in the said security has been made, while rendering such advice. In case, an employee of the
Foreign Institutional Investor is rendering such advice, he should 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.
Maintenance of Proper Books of Accounts, Records, Etc.
Every Foreign Institutional Investor should keep or maintain the following books of accounts, records and
documents:
(a) true and fair accounts relating to remittance of initial corpus for buying, selling and realising capital gains
of investment made from the corpus;
(b) accounts of remittances to India for investments in India and realising capital gains on investments
made from such remittances;
(c) bank statement of accounts;
(d) contract notes relating to purchase and sale of securities; and
(e) communication from and to the domestic custodian regarding investments in securities.
The Foreign Institutional Investor should intimate to SEBI in writing the place where such books, records and
documents will be kept or maintained. Every Foreign Institutional Investor should preserve the books of accounts,
records and documents as specified for a minimum period of five years.
Appointment of Compliance Officer
Every Foreign Institutional Investor should appoint a compliance officer who is responsible for monitoring the
compliance of the Act, rules and regulations, notifications, guidelines, instructions etc. issued by SEBI or the
110 PP-CC&MM
Central Government. The compliance officer should immediately and independently report to SEBI any noncompliance observed by him.
Information to SEBI
Every Foreign Institutional Investor as and when required by SEBI or the Reserve Bank of India, would submit
any information, record or documents in relation to his activities.
Foreign Institutional Investors are required to fully disclose information concerning the terms of and parties to
off¬shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other such instruments,
by whatever names they are called, entered into by it or its sub-accounts or affiliates relating to any securities
listed or proposed to be listed in any stock exchange in India, as and when and in such form as SEBI may
require.
Procedure for Action in Case of Default
A Foreign Institutional Investor who contravenes any of the provisions of the Act, rules or regulations framed
thereunder shall be liable for one or more actions specified therein including the action under Chapter V of the
SEBI (Intermediaries) Regulations, 2008.
Code of Conduct
(1) A Foreign Institutional Investor and its key personnel should observe high standards of integrity, fairness and
professionalism in all dealings in the Indian securities market with intermediaries, regulatory and other government
authorities.
(2) A Foreign Institutional Investor is required at all times to render high standards of service, exercise due
diligence and independent professional judgement.
(3) A Foreign Institutional Investor should ensure and maintain confidentiality in respect of trades done on its
own behalf and/or on behalf of its sub-accounts/clients.
(4) A Foreign Institutional Investor is required to ensure clear segregation of its own money/ securities and subaccounts’ money/securities and arms length relationship between its business of fund management/ investment
and its other business.
(5) A Foreign Institutional Investor has to maintain an appropriate level of knowledge and competency and abide
by the provisions of the Act, regulations made there under and the circulars and guidelines, which may be
applicable and relevant to the activities carried on by it.
(6) Every Foreign Institutional Investor has to comply with award of the Ombudsman and decision of the Board
under SEBI (Ombudsman) Regulations.
(7) A Foreign Institutional Investor should not make any untrue statement or suppress any material fact in any
documents, reports or information furnished to the Board.
(8) A Foreign Institutional Investor is required to ensures good corporate policies and corporate governance.
(9) A Foreign Institutional Investor should ensure that it does not engage in fraudulent and manipulative
transactions in the securities listed in any stock exchange in India.
(10) A Foreign Institutional Investor should not, either through its/his own account or through any associate or
family members, relatives or friends indulge in any insider trading.
(11) A Foreign Institutional Investor shall not be a party to or instrumental for creation of false market in securities
listed or proposed to be listed in any stock exchange in India, price rigging or manipulation of prices of securities
listed or proposed to be listed in any stock exchange in India and for passing of price sensitive information to any
person or intermediary in the securities market.
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QUALIFIED FOREIGN INVESTORS (QFIS)
Foreign Capital inflows to India have significantly grown in importance over the years. These flows have been
influenced by strong domestic fundamentals and buoyant yields reflecting robust corporate sector performance.
In the present arrangement relating to foreign portfolio investments, only FIIs/sub-accounts and NRIs are allowed
to directly invest in Indian equity market. In this arrangement, a large number of Qualified Foreign Investors
(QFIs), in particular, a large set of diversified individual foreign nationals who are desirous of investing in Indian
equity market do not have direct access to Indian equity market. In the absence of availability of direct route,
many QFIs find difficulties in investing in Indian equity market.
The Central Government, vide press release dated January 1, 2012 has announced its decision to allow QFIs to
directly invest in Indian equity market in order to widen the class of investors, attract more foreign funds, reduce
market volatility and to deepen the Indian capital market. SEBI decided that the Foreign investors (termed as
Qualified Foreign Investors/ QFI) who meet prescribed Know Your Customer (KYC) requirements may invest in
equity shares listed on the recognized stock exchanges and in equity shares offered to public in India. In order
to enable this they will hold equity shares in a demat account opened with a SEBI registered qualified Depository
Participant.
Qualified Foreign Investors
"QFI shall mean a person who fulfils the following criteria:
(i) Resident in a country that is a member of Financial Action Task Force (FATF) or a member of a group
which is a member of FATF; and
(ii) Resident in a country that is a signatory to IOSCO’s MMOU or a signatory of a bilateral MOU with SEBI.
Provided that the person is not resident in a country listed in the public statements issued by FATF from time to
time on-(i) jurisdictions having a strategic Anti-Money Laundering/Combating the Financing of Terrorism (AML/
CFT) deficiencies to which counter measures apply, (ii) jurisdictions that have not made sufficient progress in
addressing the deficiencies or have not committed to an action plan developed with the FATF to address the
deficiencies.
Provided further such person is not resident in India. Provided further that such person is not registered with
SEBI as Foreign Institutional Investor or Sub-account or Foreign Venture Capital Investor.
Permissible transactions allowed for QFI’s investing into Indian securities
QFIs can transact only in the following:
(a) Purchase/subscription of mutual fund units through Demat Account mode (Direct Route) and Unit
Confirmation Receipt (UCR) [Indirect Route].
(b) Purchase of equity shares in public issues, to be listed on recognised stock exchange(s).
(c) Purchase of listed equity shares through SEBI registered stock brokers, on recognized stock exchanges
in India.
(d) Redemption of mutual fund units purchased/subscribed through direct and indirect route.
(e) Sale of equity shares which are held in their demat account through SEBI registered stock brokers.
(f) Subscription of equity shares against rights issues.
(g) Receipt of bonus shares or receipt of shares on stock split/ consolidation.
(h) Receipt of equity shares due to amalgamation, demerger or such other corporate actions, subject to the
investment limits.
112 PP-CC&MM
(i) Receipt of dividends and interest payments.
(j) Tender equity shares in open offer in accordance with SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011.
(k) Tender equity shares in open offer in accordance with SEBI (Delisting of Equity Shares) Regulations,
2009.
(l) Tender equity shares in case of buy-back by listed companies in accordance with SEBI (Buyback of
Securities) Regulations, 1998
(m) Purchase and sale of corporate debt securities listed on recognized stock exchange(s);
(n) Purchase of corporate debt securities through public issues, if the listing on recognized stock exchange(s)
is committed to be done as per the extant provisions of the Companies Act, 1956;
(o) Sale of corporate debt securities by way of buyback or redemption by the issuer;
(p) Purchase and sale of units of debt schemes of Indian mutual funds.
INVESTMENT ADVISER
“Investment Adviser” means any person, who for consideration, is engaged in the business of providing investment
advice to clients or other persons or group of persons and includes any person who holds out himself as an
investment adviser, by whatever name called.
“Investment advice” means advice relating to investing in, purchasing, selling or otherwise dealing in securities
or investment products, and advice on investment portfolio containing securities or investment products, whether
written, oral or through any other means of communication for the benefit of the client and shall include financial
planning:
However, investment advice given through newspaper, magazines, any electronic or broadcasting or
telecommunications medium, which is widely available to the public shall not be considered as investment
advice for the purpose of these regulations;
SEBI (INVESTMENT ADVISERS) REGULATIONS, 2013
In exercise of the powers conferred by sub-section (1) of Section 30 read with clause (b) of sub-section (2) of
Section 11 of SEBI Act, 1992, SEBI made these regulations.
Registration of Investment Advisers
Regulation 3 deals with the application for grant of certificate by SEBI. A person shall not act as an investment
adviser or hold itself out as an investment adviser unless he has obtained a certificate of registration from
SEBI.
However, a person acting as an investment adviser immediately before the commencement of these regulations
may continue to do so for a period of six months from such commencement or, if it has made an application for
a certificate within the said period of six months, till the disposal of such application. An application for grant of
certificate of registration shall be made in Prescribed Form and shall be accompanied by a non refundable
application fee to be paid in the manner specified in these regulations.
Exemption from registration
Regulation 4 provides that certain persons are exempted from the requirement of registration under Regulation
3 subject to the fulfilment of the conditions stipulated therefore, —
(a) Any person who gives general comments in good faith in regard to trends in the financial or securities
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market or the economic situation where such comments do not specify any particular securities or
investment product;
(b) Any insurance agent or insurance broker who offers investment advice solely in insurance products and
is registered with Insurance Regulatory and Development Authority for such activity;
(c) Any pension advisor who offers investment advice solely on pension products and is registered with
Pension Fund Regulatory and Development Authority for such activity;
(d) Any distributor of mutual funds, who is a member of a self regulatory organisation recognised by SEBI
or is registered with an association of asset management companies of mutual funds, providing any
investment advice to its clients incidental to its primary activity;
(e) Any advocate, solicitor or law firm, who provides investment advice to their clients, incidental to their
legal practise;
(f) Any member of Institute of Chartered Accountants of India, Institute of Company Secretaries of India,
Institute of Cost and Works Accountants of India, Actuarial Society of India or any other professional
body as may be specified by SEBI, who provides investment advice to their clients, incidental to his
professional service;
(g) Any stock broker or sub-broker registered under SEBI (Stock Broker and Sub Broker) Regulations,
1992, portfolio manager registered under SEBI (Portfolio Managers) Regulations, 1993 or merchant
banker registered under SEBI (Merchant Bankers) Regulations, 1992, who provides any investment
advice to its clients incidental to their primary activity: However, such intermediaries shall comply with
the general obligation(s) and responsibilities as specified in Chapter III of these regulations. Further the
existing portfolio manager offering only investment advisory services may apply for registration under
these regulations after expiry of his current certificate of registration as a portfolio manager;
(h) Any fund manager, by whatever name called of a mutual fund, alternative investment fund or any other
intermediary or entity registered with SEBI;
(i) Any person who provides investment advice exclusively to clients based out of India: However, persons
providing investment advice to Non-Resident Indian or Person of Indian Origin shall fall within the purview
of these regulations;
(j) Any representative and partner of an investment adviser which is registered under these regulations.
However, such representative and partner shall comply with these regulations;
(k) Any other person as may be specified by SEBI.
Qualification & Certification
– Investment Advisers will be required to hold a professional qualification or post-graduate degree or post
graduate diploma in finance, accountancy, business management, commerce, economics, capital market,
banking, insurance or actuarial science. Alternatively, advisors having a graduate in any discipline with
experience of at least five years in financial advisory or securities or fund or asset or portfolio management
are also qualified.
– Investment Advisers, their partners and their representatives should have a certification on financial planning
or fund or asset or portfolio management or investment advisory services from NISM or from any other
organization or institution including Financial Planning Standards Board India (FPSB) or stock exchange
provided that such certification is accredited by NISM.
– Existing investment advisers and their representatives seeking registration under these regulations will
have to obtain certification within two years from the date of commencement of advisor regulations. Investment
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advisers whose existing certificates which are due for expiry need to also obtain the above mentioned
certification to continue their practice.
Capital adequacy
SEBI has also laid down capital adequacy requirements for corporate and individual distributors. Corporate
distributors will require a minimum net worth of ` 25 lakh while individuals and partnership firms will require to
posses tangible assets worth at least ` 1 lakh.
Registration
After complying with the investment advisers regulations, Investment advisers would need to register with SEBI
by paying a non-refundable application fee of ` 5,000. Individual advisors will have to shell out a registration fee
of ` 10,000 while corporate will have to cough up ` 1 lakh in addition to the application fee. This certificate will be
valid for a period of five years.
General Obligations and Responsibilities
Regulation 15 deals with the general obligation of Investment Advisers.
– An investment adviser shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of
interests as and when they arise.
– An investment adviser shall not receive any consideration by way of remuneration or compensation or in
any other form from any person other than the client being advised, in respect of the underlying products or
securities for which advice is provided.
– An investment adviser shall maintain an arms-length relationship between its activities as an investment
adviser and other activities.
– An investment adviser which is also engaged in activities other than investment advisory services shall
ensure that its investment advisory services are clearly segregated from all its other activities.
– An investment adviser shall ensure that in case of any conflict of interest of the investment advisory activities
with other activities, such conflict of interest shall be disclosed to the client.
– An investment adviser shall not divulge any confidential information about its client, which has come to its
knowledge, without taking prior permission of its clients, except where such disclosures are required to be
made in compliance with any law for the time being in force.
– An investment advisor shall not enter into transactions on its own account which is contrary to its advice
given to clients for a period of fifteen days from the day of such advice.
However, during the period of such fifteen days, if the investment adviser is of the opinion that the situation has
changed, then it may enter into such a transaction on its own account after giving such revised assessment to
the client at least 24 hours in advance of entering into such transaction.
– An investment advisor shall follow Know Your Client procedure as specified by SEBI from time to time.
– An investment adviser shall abide by Code of Conduct as specified in Third Schedule.
– An investment adviser shall not act on its own account, knowingly to sell securities or investment products
to or purchase securities or investment product from a client.
– In case of change in control of the investment adviser, prior approval from SEBI shall be taken.
– Investment advisers shall furnish to SEBI information and reports as may be specified by SEBI from time to
time.
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– It shall be the responsibility of the Investment Adviser to ensure that its representatives and partners, as
applicable, comply with the certification and qualification requirements under these Regulation at all times.
Code of Conduct for Investment Adviser
1. Honesty and fairness: An investment adviser shall act honestly, fairly and in the best interests of its clients
and in the integrity of the market.
2. Diligence: An investment adviser shall act with due skill, care and diligence in the best interests of its clients
and shall ensure that its advice is offered after thorough analysis and taking into account available alternatives.
3. Capabilities: An investment adviser shall have and employ effectively appropriate resources and procedures
which are needed for the efficient performance of its business activities.
4. Information about clients: An investment adviser shall seek from its clients, information about their financial
situation, investment experience and investment objectives relevant to the services to be provided and maintain
confidentiality of such information.
5. Information to its clients: An investment adviser shall make adequate disclosures of relevant material
information while dealing with its clients.
6. Fair and reasonable charges: An investment adviser advising a client may charge fees, subject to any
ceiling as may be specified by SEBI, if any. The investment adviser shall ensure that fees charged to the clients
is fair and reasonable.
7. Conflicts of interest: An investment adviser shall try to avoid conflicts of interest as far as possible and when
they cannot be avoided, it shall ensure that appropriate disclosures are made to the clients and that the clients
are fairly treated.
8. Compliance: An investment adviser including its representative(s) shall comply with all regulatory requirements
applicable to the conduct of its business activities so as to promote the best interests of clients and the integrity
of the market.
9. Responsibility of senior management: The senior management of a body corporate which is registered as
investment adviser shall bear primary responsibility for ensuring the maintenance of appropriate standards of
conduct and adherence to proper procedures by the body corporate.
Maintenance of records
An investment adviser shall maintain the following records,
(a) Know Your Client records of the client;
(b) Risk profiling and risk assessment of the client;
(c) Suitability assessment of the advice being provided;
(d) Copies of agreements with clients, if any;
(e) Investment advice provided, whether written or oral;
(f) Rationale for arriving at investment advice, duly signed and dated;
(g) A register or record containing list of the clients, the date of advice, nature of the advice, the products/
securities in which advice was rendered and fee, if any charged for such advice.
All records shall be maintained either in physical or electronic form and preserved for a minimum period of five
years. However, where records are required to be duly signed and are maintained in electronic form, such
records shall be digitally signed.
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Liability for action in case of default
An investment adviser who –
(a) contravenes any of the provisions of the Act or any regulations or circulars issued thereunder;
(b) fails to furnish any information relating to its activity as an investment adviser as required by SEBI;
(c) furnishes to SEBI information which is false or misleading in any material particular;
(d) does not submit periodic returns or reports as required by SEBI;
(e) does not co-operate in any enquiry, inspection or investigation conducted by the SEBI;
(f) fails to resolve the complaints of investors or fails to give a satisfactory reply to SEBI in this behalf,
shall be dealt with in the manner provided under the Securities and Exchange Board of India (Intermediaries)
Regulations, 2008
Audit of Investment Adviser
According to Regulation 19(3) an investment adviser shall conduct yearly audit in respect of compliance with
these regulations from a member India or Institute of Company Secretaries of India.
SEBI (CREDIT RATING AGENCIES) REGULATIONS, 1999
SEBI regulations for Credit Rating Agencies (CRAs) cover rating of securities only and not rating of fixed deposits,
foreign exchange, country ratings, real estates etc. CRAs can be promoted by public financial institutions,
scheduled commercial banks, foreign banks operating in India, foreign credit rating agencies recognised in the
country of their incorporation, having at least five years experience in rating, or any company or a body corporate
having continuous net worth of minimum `100 crore for the previous five years. CRAs would be required to have
a minimum net worth of ` 5 crore. A CRA cannot rate a security issued by its promoter. No Chairman, Director or
Employee of the promoters shall be Chairman, Director or Employee of CRA or its rating committee. A CRA
cannot rate securities issued by any borrower, subsidiary, an associate promoter of CRA, if there are common
Chairman, Directors and Employees between the CRA or its rating committee and these entities. A CRA cannot
rate a security issued by its associate or subsidiary if the CRA or its rating committee has a Chairman, Director
or Employee who is also a Chairman, Director or Employee of any such entity. CRAs would have to carry out
periodic reviews of the ratings given during the lifetime of the rated instrument. For ensuring that corporates
provide correct/ adequate information to CRAs, a clause would be incorporated in the listing agreement of the
stock exchanges requiring the companies to co-operate with the rating agencies in giving correct and adequate
information. Issuers coming out with a public/rights issue of debt securities would be required to incorporate an
undertaking in the offer documents promising necessary co-operation with the rating agency in providing true
and adequate information.
Registration of Credit Rating Agencies
(1) Any person proposing to commence any activity as a credit rating agency should make an application to
SEBI for the grant of a certificate of registration for the purpose.
(2) Any person, who before the said date carrying on any activity as a credit rating agency, should make an
application to SEBI for the grant of a certificate within a period of three months from such date. However SEBI
may, where it is of the opinion that it is necessary to do so, for reasons to be recorded in writing, extend the said
period upto a maximum of six months from such date.
(3) An application for the grant of a certificate should be made to SEBI accompanied by a non-refundable
specified application fee.
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(4) Any person who fails to make an application for the grant of a certificate within the period specified in that
sub-regulation, ceases to carry on rating activity.
Promoter of Credit Rating Agency
SEBI should not consider an application unless the applicant is promoted by a person belonging to any of the
following categories, namely:
(i) a public financial institution;
(ii) a scheduled commercial bank;
(iii) a foreign bank operating in India with the approval of the Reserve Bank of India;
(iv) a foreign credit rating agency recognized under Indian Law and having at least five years experience in
rating securities;
(v) any company or a body corporate, having continuous net worth of minimum rupees one hundred crores
as per its audited annual accounts for the previous five years in relation to the date on which application
to SEBI is made seeking registration.
Eligibility Criteria
SEBI shall not consider an application for the grant of a certificate unless the applicant satisfies the following
conditions, namely:
(a) the applicant is set up and registered as a company under the Companies Act, 1956;
(b) the applicant has, in its Memorandum of Association, specified rating activity as one of its main objects;
(c) the applicant has a minimum net worth of ` 5 crores. However a credit rating agency existing at the
commencement of these regulations, with a net worth of less than ` 5 crores, shall be deemed to have
satisfied this condition, if it increases its net worth to the said minimum within a period of three years of
such commencement.
(d) the applicant has adequate infrastructure, to enable it to provide rating services in accordance with the
provisions of the Act and these regulations;
(e) the applicant and the promoters of the applicant, have professional competence, financial soundness
and general reputation of fairness and integrity in business transactions, to the satisfaction of SEBI;
(f) neither the applicant, nor its promoter, nor any director of the applicant or its promoter, is involved in any
legal proceeding connected with the securities market, which may have an adverse impact on the
interests of the investors;
(g) neither the applicant, nor its promoters, nor any director, of its promoter has at any time in the past been
convicted of any offence involving moral turpitude or any economic offence;
(h) the applicant has, in its employment, persons having adequate professional and other relevant experience
to the satisfaction of the SEBI;
(i) neither the applicant, nor any person directly or indirectly connected with the applicant has in the past
been –
(i) refused by SEBI a certificate under these regulations or
(ii) subjected to any proceedings for a contravention of the Act or of any rules or regulations made
under the Act.
(j) the applicant, in all other respects, is a fit and proper person for the grant of a certificate;
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(k) grant of certificate to the applicant is in the interest of investors and the securities market.
Application to Conform to the Requirements
Any application for a certificate, which is not complete in all respects or does not conform to the requirement or
instructions as specified should be rejected by SEBI. However before rejecting any application, the applicant
should be given an opportunity to remove, within thirty days of the date of receipt of relevant communication,
from SEBI such objections as may be indicated by SEBI. It has been further provided that SEBI may on sufficient
reason being shown, extend the time for removal of objections by such further time, not exceeding thirty days to
enable the applicant to remove such objections.
Furnishing of Information, Clarification and Personal Representation
SEBI may require the applicant to furnish such further information or clarification as it consider necessary, for
the purpose of processing of the application. SEBI if so desires, may ask the applicant or its authorised
representative to appear before SEBI for personal representation in connection with the grant of a certificate.
Grant of Certificate
SEBI grants a certificate after getting satisfied that the applicant is eligible for the grant of a certificate of registration.
The grant of certificate of registration should be subject to the payment of the specified registration fee in the
manner prescribed.
Conditions of Certificate
The certificate granted is subject to the condition that the credit rating agency should comply with the provisions
of the Act, the regulations made thereunder and the guidelines, directives, circulars and instructions issued by
SEBI from time to time on the subject of credit rating. The credit rating agency should forthwith inform SEBI in
writing where any information or particulars furnished to SEBI by a credit rating agency is found to be false or
misleading in any material particular; or has undergone change subsequently to its furnishing at the time of the
application for a certificate.
Procedure where Certificate is not granted
SEBI may reject the application if after considering an application is of the opinion that a certificate should not be
granted or renewed, after giving the applicant a reasonable opportunity of being heard. The decision of SEBI not
to grant or not to renew the certificate should be communicated by SEBI to the applicant within a period of thirty
days of such decision, stating the grounds of the decision. Any applicant aggrieved by the decision of SEBI
rejecting his application may, within a period of thirty days from the date of receipt by him of the communication
apply to SEBI in writing for re-consideration of such decision. Where an application for re-consideration is made,
SEBI should consider the application and communicate to the applicant its decision in writing, as soon as may
be.
Effect of Refusal to Grant Certificate
An applicant whose application for the grant of a certificate has been rejected should not undertake any
rating activity. An applicant, whose application for the grant of a certificate has been rejected by SEBI,
should on and from the date of the receipt of the communication ceases to carry on any rating activity. If
SEBI is satisfied that it is in the interest of the investors, it may permit the credit rating agency to complete
the rating assignments already entered into by it, during the pendency of the application or period of validity
of the certificate. SEBI in order to protect the interest of investors may issue directions with regard to the
transfer of records, documents or reports relating to the activities of a credit rating agency, whose application
for the grant or renewal of a certificate has been rejected and for this purpose also determines the terms
and conditions of such appointment.
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Code of Conduct
Every credit rating agency is required to abide by the Code of Conduct as per SEBI Regulations:
(1) A credit rating agency in the conduct of its business should observe high standards of integrity, dignity and
fairness in all its dealings with its clients.
(2) A credit rating agency should fulfil its obligations in an ethical manner.
(3) A credit rating agency should render at all times high standards of service, exercise due diligence, ensure
proper care and exercise independent professional judgement. It shall wherever necessary, disclose to the
clients, possible sources of conflict of duties and interests, while providing unbiased services.
(4) The credit rating agency should avoid any conflict of interest of any member of its rating committee participating
in the rating analysis. Any potential conflict of interest shall be disclosed to the client.
(5) A credit rating agency should not indulge in unfair competition nor they wean away client of any other rating
agency on assurance of higher rating.
(6) A credit rating agency should not make any exaggerated statement, whether oral or written, to the client
either about its qualification or its capability to render certain services or its achievements in regard to services
rendered to other clients.
(7) A credit rating agency should always endeavour to ensure that all professional dealings are effected in a
prompt and efficient manner.
(8) A credit rating agency should not divulge to other clients, press or any other party any confidential information
about its client, which has come to its knowledge, without making disclosure to the concerned person of the
rated company/client.
(9) A credit rating agency should not make untrue statement or suppress any material fact in any documents,
reports, papers or information furnished to SEBI or to public or to stock exchange.
(10) A credit rating agency should not generally and particularly in respect of issue of securities rated by, it be a
party –
(a) to creation of false market
(b) passing of price sensitive information to brokers, members of the stock exchanges, other players in the
capital market or to any other person or take any other action which is unethical or unfair to the investors.
(11) A credit rating agency should maintain an arm’s length relationship between its credit rating activity and any
other activity. A credit rating agency or any of his employees should 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 long or short position in the said security has been made, while rendering such advice.
In case an employee of the credit rating agency is rendering such advice, he should also disclose the interest of
his dependent family members and the employer including their long or short in the said security, while rendering
such advice.
(12) A credit rating agency is required to abide by the provisions of the Act, regulations and circulars which may
be applicable and relevant to the activities carried on by the credit rating agency.
Agreement with the Client
Every credit rating agency is required to enter into a written agreement with each client whose securities it
proposes to rate, and every such agreement should include the following provisions, namely:
(a) the rights and liabilities of each party in respect of the rating of securities shall be defined;
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(b) the fee to be charged by the credit rating agency shall be specified;
(c) the client shall agree to a periodic review of the rating by the credit rating agency during the tenure of the
rated instrument and to co-operate with the credit rating agency in order to enable the latter to arrive at,
and maintain, a true and accurate rating of the clients’ securities and shall in particular provide to the
latter, true, adequate and timely information for the purpose;
(d) the credit rating agency shall disclose to the client the rating assigned to the securities of the latter
through regular methods of dissemination, irrespective of whether the rating is or is not accepted by the
client;
(e) the client shall agree to disclose the rating assigned to the client’s listed securities by any credit rating
agency during the last three years and any rating given in respect of the client’s securities by any other
credit rating agency, which has not been accepted by the client in the offer document;
(f) the client shall agree to obtain a rating for any issue of debt securities in accordance with the relevant
regulations
Monitoring of Ratings
Credit rating agency should during the lifetime of securities rated by it continuously monitor the rating of such
securities. It should also disseminate information regarding newly assigned ratings, and changes in earlier
rating promptly through press releases and websites, and, in the case of securities issued by listed companies,
such information should also be provided simultaneously to the concerned to all the stock exchanges where the
said securities are listed.
Procedure for Review of Rating
Every credit rating agency should carry out periodic review of all published ratings during the lifetime of the
securities. If the client does not co-operate with the credit rating agency so as to enable the credit rating agency
to comply with its obligations, the credit rating agency should carry out the review on the basis of the best
available information.
However, it has been provided that if owing to such lack of co-operation, a rating has been based on the best
available information, the credit rating agency should disclose to the investors the fact that the rating is so
based. A credit rating agency should not withdraw a rating so long as the obligations under the security rated by
it are outstanding, except where the company whose security is rated is wound up or merged or amalgamated
with another company.
Internal Procedures to be Framed
Credit rating agency should frame appropriate procedures and systems for monitoring the trading of securities
by its employees in the securities of its clients, in order to prevent contravention of SEBI (Insider Trading)
Regulations, 1992; SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market)
Regulations, 2003; and other laws relevant to trading of securities.
Disclosure of Rating Definitions
Credit rating agency should make public the definitions of the concerned rating, along with the symbol and state
that the ratings do not constitute recommendations to buy, hold or sell any securities. It should also make
available to the general public information relating to the rationale of the ratings, which shall cover an analysis of
the various factors justifying a favourable assessment, as well as factors constituting a risk.
Submission of Information
In case any information is called by SEBI from a credit rating agency including any report relating to its activities,
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Financial Intermediaries Framework 121
the credit rating agency is required to furnish such information to SEBI within a period specified or if no such
period is specified, then within a reasonable time. It should also furnish to SEBI, copies of its balance sheet and
profit and loss account at the close of each accounting period,
Every credit rating agency is required to comply with such guidelines, directives, circulars and instructions as
issued by SEBI from time to time.
Appointment of Compliance Officer
It is under an obligation to appoint a compliance officer who will be responsible for monitoring the compliance of
the Act, Rules and Regulations, notifications, guidelines, instructions etc issued by SEBI or the Central
Government. The compliance officer should immediately and independently report to SEBI any non-compliance
observed by him.
Maintenance of Books of Accounts Records, etc.
Credit rating agency should keep and maintain, for a minimum period of five years, the following books of
accounts, records and documents, namely:
(i) copy of its balance sheet, as on the end of each accounting period;
(ii) a copy of its profit and loss account for each accounting period;
(iii) a copy of the auditor’s report on its accounts for each accounting period.
(iv) a copy of the agreement entered into, with each client;
(v) information supplied by each of the clients;
(vi) correspondence with each client;
(vii) ratings assigned to various securities including upgradation and down gradation (if any) of the ratings
so assigned;
(viii) rating notes considered by the rating committee;
(ix) record of decisions of the rating committee;
(x) letter assigning rating;
(xi) particulars of fees charged for rating and such other records as SEBI may specify from time to time.
Credit rating agency is required to intimate to SEBI, the place where the books of account, records and documents
required to be maintained under these regulations are being maintained.
Steps on Auditor’s Report
Credit rating agency should within two month’s from the date of the auditor’s report, take steps to rectify the
deficiencies if any, made out in the auditor’s report, in so far as they relate to the activity of rating of securities.
Confidentiality
Every credit rating agency shall treat, as confidential, information supplied to it by the client and no credit rating
agency shall disclose the same to any other person, except where such disclosure is required under any law.
Rating Process
Credit rating agency should specify the rating process and file a copy of the same with SEBI for record and also
file with SEBI any modifications or additions made therein from time to time. It should in all cases follow a proper
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rating process. Credit rating agency is required to have professional rating committees, comprising members
who are adequately qualified and knowledgeable to assign a rating. All rating decisions, including the decisions
regarding changes in rating, should be taken by the rating committee. Credit rating agency should be staffed by
analysts qualified to carry out a rating assignment. Credit rating agency should inform SEBI about new rating
instruments or symbols introduced by it. Credit rating agency, while rating a security should exercise due diligence
in order to ensure that the rating given by the credit rating agency is fair and appropriate. A credit rating agency
should not rate securities issued by it. Rating definition, as well as the structure for a particular rating product,
should not be changed by a credit rating agency, without prior information to SEBI. A credit rating agency should
disclose to the concerned stock exchange through press release and websites for general investors, the rating
assigned to the securities of a client, after periodic review, including changes in rating, if any.
Restrictions on Rating of Securities Issued by Promoter and Certain Entities, Connected with
A Promoter, or Rating Agency
Credit rating agency shall not rate a security issued by its promoter:
(1) No credit rating agency should rate a security issued by an entity,
(a) which is a borrower of its promoter or
(b) a subsidiary of its promoter or
(i) an associate of its promoter, if there are common Chairman, Directors between credit rating
agency and these entities,
(ii) there are common employees,
(iii) there are common Chairman, Directors, Employees on the rating committee.
(2) No credit rating agency should rate a security issued by its associate or subsidiary, if the credit
rating agency or its rating committee has a Chairman, director or employee who is also a Chairman,
director or employee of any such entity.
However, these conditions do not apply to securities whose rating has been already done by a credit rating
agency before the commencement of these regulations, and such securities may, subject to the provisions of
the other Chapters of these regulations, continue to be rated, without the need to comply with the restrictions
imposed by the regulations.
Procedure for Inspection and Investigation
SEBI can appoint one or more persons as inspecting officers, to undertake inspection or investigation of the
books of account, records and documents of the credit rating agencies, for any of the purposes specified in the
regulations. The purposes referred to in regulation should be to ascertain whether the books of account, records
and documents are being maintained properly, to ascertain whether the provisions of the Act and these regulations
are being complied with, to investigate into complaints received from investors, clients or any other person on
any matter having a bearing on activities of the credit rating agency and in the interest of the securities market
or in the interest of investors. The inspections ordered by SEBI should not ordinarily go into an examination of
the appropriateness of the assigned ratings on the merits. Inspections to judge the appropriateness of the
ratings may be ordered by SEBI, only in case of complaints which are serious in nature to be carried out either
by the officers of SEBI or independent experts with relevant experience or combination of both.
Notice of Inspection or Investigation
SEBI shall give ten days written notice to the credit rating agency before ordering an inspection or investigation.
SEBI in the interest of the investors may order in writing, direct that the inspection or investigation of the affairs
of the credit rating agency to be taken up without such notice. During the course of an inspection or investigation,
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the credit rating agency against whom the inspection or investigation is being carried out should be bound to
discharge all its obligations as provided in this regulation.
Obligations of Credit Rating Agency
It should be the duty of credit rating agency whose affairs are being inspected or investigated, and of every
director, officer or employee thereof, to produce to the inspecting or investigating officer such books, accounts
and other documents in its or his custody or control and furnish him with such statements and information
relating to its rating activities, as the inspecting officer may require within such reasonable period as may be
specified by the officer. The credit rating agency should allow the inspecting officer to have reasonable access
to the premises occupied by such credit rating agency or by any other person on its behalf and extend to the
inspecting officer reasonable facility for examining any books, records, documents and computer data in the
possession of the credit rating agency and to provide copies of documents or other materials which, in the
opinion of the inspecting officer, are relevant for the purposes of the inspection or investigation, as the case may
be. The inspecting officer, in the course of inspection or investigation, should be entitled to examine, or record
the statements, of any officer, director or employee of the credit rating agency for the purposes connected with
the inspection or investigation. Every director, officer or employee of the credit rating agency is bound to render
to the inspecting officer all assistance in connection with the inspection or investigation which the inspecting
officer may reasonably require.
The inspecting officer should as soon as possible, on completion of the inspection or investigation, submit a
report to SEBI. However if directed to do so by SEBI, he may submit an interim report. SEBI after considering
the inspection report or the interim report referred to in regulation communicate the findings of the inspecting
officer to the credit rating agency and give it a reasonable opportunity of being heard in the matter. SEBI may
call upon the credit rating agency on receipt of the explanation, if any to take such measures as it may deem
fit in the interest of the securities market and for due compliance with the provisions of the Act and the
regulations.
Action in case of Default
A credit rating agency which –
(a) fails to comply with any condition subject to which a certificate has been granted;
(b) contravenes any of the provisions of the Act or these regulations or any other regulations made under
the Act; shall be dealt with in the manner provided under Chapter V of the Securities and Exchange
Board of India (Intermediaries) Regulations, 2008.
MARKET MAKER
“Market-Maker” means a trading member of the Stock Exchange registered as such as per the Rules and Byelaws of the Stock Exchange. A market-maker is responsible for enhancing the demand supply situation in securities
such as stocks and futures & options.
Market-making means infusing liquidity in securities that are not frequently traded on stock exchanges.
GUIDELINES FOR MARKET MAKER
SEBI issued ‘Guidelines for Market Makers on Small and Medium Enterprise (SME) Exchange/separate platform
of existing Exchange having nationwide terminal’. As per the circular, market making has been made mandatory
in respect of all scrips listed and traded on SME Exchange.
Registration of the Market Maker
Any member of the Exchange would be eligible to act as Market Maker provided the criteria laid down by the
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exchange are met. The member brokers desirous of acting as Market Maker in this exchange shall apply to the
concerned stock exchange for registration as Market Makers unless already registered as a Market Maker.
The Obligations and Responsibilities of Market Makers
The Market Maker shall fulfil the following conditions to provide depth and continuity on this exchange:
(a) The Market Maker shall be required to provide a 2-way quote for 75% of the time in a day. The same
shall be monitored by the stock exchange. Further, the Market Maker shall inform the exchange in
advance for each and every black out period when the quotes are not being offered by the Market
Maker.
(b) The minimum depth of the quote shall be `1,00,000. However, the investors with holdings of value less
than ` 1,00,000 shall be allowed to offer their holding to the Market Maker in that scrip provided that he
sells his entire holding in that scrip in one lot along with a declaration to the effect to the selling broker.
(c) Execution of the order at the quoted price and quantity must be guaranteed by the Market Maker, for the
quotes given by him.
(d) There would not be more than five Market Makers for a scrip. These would be selected on the basis of
objective criteria to be evolved by the Exchange which would include capital adequacy, networth,
infrastructure, minimum volume of business etc.
(e) The Market Maker may compete with other Market Makers for better quotes to the investors;
(f) Once registered as a Market Maker, he has to start providing quotes from the day of the listing / the day
when designated as the Market Maker for the respective scrip and shall be subject to the guidelines laid
down for market making by the exchange.
(g) Once registered as a Market Maker, he has to act in that capacity for a period as mutually decided
between the Merchant Banker and the market maker.
(h) Further, the Market Maker shall be allowed to deregister by giving one month notice to the exchange,
subject to (g) above.
Dissemination of Information
The exchange should disseminate the list of Market Makers for the respective scrip to the public.
Number of Shares per Market Maker
The number of companies in whose shares a Market Maker would make market should be linked to his capital
adequacy as decided by the exchange.
Risk Containment Measures and Monitoring for Market Makers
All applicable margins should be levied and collected without any waiver/exemption.
Capital Adequacy
The exchanges would prescribe the capital adequacy requirement for its members to commensurate with the
number of companies which Market Maker proposes to make market. Further, the stock exchange may lay
down additional criteria also for Market Makers as risk containment measures. The same shall be monitored by
the stock exchange
Monitoring
All the requirements with regard to market making shall be monitored by the stock exchange and any violation
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Financial Intermediaries Framework 125
of these requirements would be liable for punitive action to be taken by the Disciplinary Action Committee (DAC)
of the Exchange, which may also include monitory penalty apart from the trade restriction as decided by the
DAC under intimation to the Merchant Banker.
Price Band and Spreads
The exchanges shall prescribe the maximum spread between bid and ask price. The exchange, may at its
discretion also prescribe the price bands for the same. Further, in case of new issue the spread shall also be
specified in the offer document with the prior approval of the exchange.
SEBI (DEPOSITORIES AND PARTICIPANTS) REGULATIONS, 1996
SEBI had issued SEBI (Depositories and Participants) Regulations, 1996 on 16th May, 1996 which apply to
depositories and its participants.
These regulations also contain provisions for operations and functioning of depositories, form for application
and certificates used and schedule of fees for participants, etc. It also contains provisions for registration of
depository and depository participants, rights and obligations of various users and constituents, inspection and
procedure for action in case of default.
Entities desiring to become depository participants must apply to the depository and are required to be
recommended to SEBI by the depository. If approved and registered by SEBI, the depository participant can be
admitted on the depository. The depository has to formulate its own set of criteria for selection of participants.
Every participant holding a certificate is required at all times to abide by the specified Code of Conduct.
The regulations require the depository to list out, through its Bye-laws, the securities which are eligible to be
admitted to the depository for dematerialization. Equity shares, debentures, warrants, bonds, units of mutual
funds, etc. are part of the list of eligible securities. The depository is empowered to set its own criteria for
selection of securities and make securities eligible to be maintained in the form of electronic holdings on the
depository. Further, the regulations stipulate that agreements should be entered into by the following entities:
– depository and every participant
– participant and every client
– depository, issuer company and the Registrar
The draft of these agreements are to be included in the Bye-laws and to be approved by SEBI. The depository
is required to ensure that sufficient safeguards are in place to protect the data available with it and with the
participants. To reduce risk in operations, the regulations stipulate that adequate insurance cover be provided
by the depository and by the depository participants as well.
The regulations also require for reconciliation to be carried out on a daily basis. Further, the depository and the
registrar will also reconcile balances on a daily and a periodic basis.
Rights and Obligations of Depositories and its Constituents
This Regulations deal with rights and obligations of depositories and every depository has to state in its bye¬laws
the eligible securities for dematerialisation which include shares, scrips, stock, bonds, debentures stock, etc.,
and include units of mutual funds, rights under collective investment schemes and venture capital funds,
commercial paper, certificate of deposit, securitised debt, money market instruments and even unlisted securities.
Every depository is required to enter into an agreement with the issuer in respect of securities disclosed as
eligible to be held in demat form. No agreement is required to be entered into where the depository itself is an
issuer of securities.
The depository is also required to enter into a tripartite agreement with the issuer, its transfer agent and itself
126 PP-CC&MM
where company has appointed a transfer agent. Every depository is required to maintain continuous connectivity
with issuers, registrars and transfer agents, participants and clearing house or clearing corporations. Depositories
should take adequate measures including insurance to protect the interest of the beneficial owners.
Every depository is required to maintain the following records and documents namely:
– records of securities dematerialised and rematerialised;
– the names of the transferor, transferee, and the dates of transfer of securities;
– a register and an index of beneficial owners;
– details of holding of the securities of the beneficial owners as at the end of the each day;
– records of instruction(s) received from and sent to participants, issuers’ agents and beneficial owners;
– records of approval, notice, entry and cancellation of pledge or hypothecation, as the case may be;
– details of participants;
– details of securities declared to be eligible for dematerialisation in the depository; and
– such other records as may be specified by SEBI for carrying on the activities as a depository.
Every depository has to intimate SEBI the place where the records and documents are maintained. Subject to
the provisions of any other law, the depository shall preserve records and documents for a minimum period of
five years. Participants are required to enter into an agreement with beneficial owners. It is required that separate
accounts are to be opened by every participant in the name of each of the beneficial owner and the securities of
each beneficial owners are to be segregated and shall not be mixed up with the securities of other beneficial
owners or with the participant’s own securities. The participants are obliged to reconcile the records with every
depository on a daily basis.
Participants are required to maintain the following records for a period of five years:
– records of all the transactions entered into with a depository and with a beneficial owner;
– details of security dematerialised, rematerialised on behalf of beneficial owners with whom it has entered
into an agreement;
– records of instructions received from beneficial owners and statements of account provided to beneficial
owners; and
– records of approval, notice, entry and cancellation of pledge or hypothecation as the case may be.
GOVERNANCE OF DEPOSITORY
Governing Board, Disclosures and Corporate Governance
– Regulations deal with the composition of Governing Board of a Depository –
– The governing board of every depository is required to include:
(a) shareholder directors;
(b) public interest directors; and
(c) managing director.
– Any employee of a depository may be appointed on the governing board in addition to the managing director,
and such director shall be deemed to be a shareholder director.
– The chairperson shall be elected by the governing board from amongst the public interest directors Subject
to prior approval of SEBI.
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Financial Intermediaries Framework 127
– The number of public interest directors shall not be less than the number of shareholder directors in a
depository.
– The managing director shall be an ex-officio director on the governing board and shall not be included in
either the category of public interest directors or shareholder directors.
The disclosure requirements and corporate governance norms as specified for listed companies shall mutatis
mutandis apply to a depository.
Investor Protection Fund
Every depository is required to establish and maintain an Investor Protection Fund for the protection of interest
of beneficial owners. Every depository should credit twenty five per cent of its profits every year to the Investor
Protection Fund.
AUDIT UNDER SEBI (DEPOSITORIES AND PARTICIPANTS) REGULATIONS, 1996
Regulation 55A of SEBI (Depositories and Participants) Regulations, 1996 provides that every issuer shall
submit audit report on a quarterly basis to the concerned stock exchanges audited by a Practicing Company
Secretary or a qualified Chartered Accountant, for the purposes of reconciliation of the total issued capital,
listed capital and capital held by depositories in dematerialized form, the details of changes in share capital
during the quarter and the in-principle approval obtained by the issuer from all the stock exchanges where it is
listed in respect of such further issued capital.
The audit report is required to give the updated status of the register of members of the issuer and confirm that
securities have been dematerialized as per requests within 21 days from the date of receipt of requests by the
issuer and where the dematerialization has not been effected within the said stipulated period, the report would
disclose the reasons for such delay.
The issuer is under an obligation to immediately bring to the notice of the depositories and the stock exchanges,
any difference observed in its issued, listed, and the capital held by depositories in dematerialized form.
INTERNAL AUDIT OF OPERATIONS OF DEPOSITORY PARTICIPANTS
The two Depository service providers in India, viz., National Securities Depository Ltd. (NSDL) and Central
Depository Services (India) Limited (CDS) have allowed Company Secretaries in Whole-time Practice to undertake
internal audit of the operations of Depository Participants (DPs).
NSDL has vide its circular No. NSDL/SG/II/010/99 dated 26th March 1999 notified amendment of its Bye Law
10.3.1 of Chapter 10 as follows:
10.3.1 “Every Participant shall ensure that an internal audit in respect of the operations of the Depository is
conducted at intervals of not more than three months by a qualified Chartered Accountant or a Company
Secretary holding a certificate of Practice and a copy of the internal audit report shall be furnished to the
Depository.”
CDSL has vide its letter dated September 28, 1999 notified amendment of its Bye Laws 16.3.1 as follows:
16.3.1 “Every Participant shall ensure that an internal audit shall be conducted in respect of the participant’s
operations relating to CDS by a qualified Chartered Accountant in accordance with the provisions of the
Chartered Accountants Act, 1949 or by a Company Secretary in practice in accordance with the provisions of
the Company Secretaries Act, 1980, at such intervals as may be specified by CDS from time to time. A copy
of Internal Audit report shall be furnished to CDS.”
128 PP-CC&MM
CONCURRENT AUDIT
National Securities Depository Limited vide its Circular No. NSDL/POLICY/ 2006/0021 dated June 24, 2006
provides for concurrent audit of the Depository Participants. The Circular provides that w.e.f. August 1, 2006, the
process of demat account opening, control and verification of Delivery Instruction Slips (DIS) is subject to.
Depository Participants have been firm of qualified Chartered Accountant(s) or Company Secretary(ies) holding
a certificate of practice for conducting the concurrent audit. However, the participants in case they so desire,
may entrust the concurrent audit to their Internal Auditors.
In respect of account opening, the auditor should verify all the documents including KYC documents furnished
by the Clients and verified by the officials of the Participants. The scope of concurrent audit with respect to
control and verification of DIS cover the areas given below:
(I) Issuance of DIS
The procedure followed by the Participants with respect to:
(a) Issuance of DIS booklets including loose slips.
(b) Existence of controls on DIS issued to Clients including pre-stamping of Client ID and unique preprinted
serial numbers.
(c) Record maintenance for issuance of DIS booklets (including loose slips) in the back office.
(II) Verification of DIS
The procedure followed by the Participants with respect to:
(a) Date and time stamping (including late stamping) on instruction slips.
(b) Blocking of used/reported lost/stolen instruction slips in back office system/ manual record.
(c) Blocking of slips in the back office system/manual record which are executed in DPM directly.
(d) Two step verification for a transaction for more than ` 5 lakh, especially in case of off-market transactions.
(e) Instructions received from dormant accounts.
The Concurrent Auditor should conduct the audit in respect of all accounts opened, DIS issued and controls on
DIS as mentioned above, during the day, by the next working day. In case the audit could not be completed
within the next working day due to large volume, the auditor should ensure that the audit is completed within a
week’s time.
Any deviation and/or non-compliance observed in the aforesaid areas should be mentioned in the audit report of
the Concurrent Auditor. The Management of the Participant should comment on the observations made by the
Concurrent Auditor.
The Concurrent Audit Report should be submitted to NSDL, on a quarterly basis, in a hard copy form. If the
Auditor for Internal and Concurrent Audit is the same, consolidated report may be submitted.
QUALIFIED DEPOSITORY PATICIPANTS
A Depository Participant that has taken approval from / registered with SEBI to offer services to Qualified Foreign
Investor (QFI) is called Qualified Depository Participants (QDP).
Eligibility criteria
To become a qualified Depository Participant, a SEBI registered DP shall fulfil the following:
Lesson 4
Financial Intermediaries Framework 129
(i) DP shall have net worth of ` 50 crore or more.
(ii) DP shall be either a clearing bank or clearing member of any of the clearing corporations;
(iii) DP shall demonstrate that it has systems and procedures to comply with the FATF Standards, Prevention
of Money Laundering (PML) Act, Rules and SEBI circulars issued from time to time; and
(iv) DP shall obtain prior approval of SEBI before commencing the activities relating to QFI.
Role and responsibilities of QDP
– The qualified DPs are required to comply with the extant laws, rules and regulations of jurisdictions where
they carry out their operations in the capacity of qualified DP, such as solicitation of investments.
– In case of any violations by QFI a qualified DP is obliged to bring such instances to the notice of concerned
depository and SEBI.
– The qualified DP shall not perform any acts or deeds with regard to QFI that puts any of his other client(s) at
an disadvantageous position. The qualified DP shall deal with its QFI clients in a fair and impartial manner.
– The qualified DP shall obtain appropriate declarations/undertakings as prescribed by depositories from time
to time.
– The qualified DP shall report QFI holdings in the format prescribed by the depositories from time to time.
– The qualified DP will route the order of QFI to the broker only after checking applicable limits.
Responsibilities on the QDP with respect to the regulator
(i) Each day QDP should provide QFI wise, ISIN wise and company wise buy / sell information and any other
transaction or any related information to their respective depositories as per time lines stipulated by depositories.
(ii) Notify information of any penalty, pending litigations or proceedings, findings of inspections or investigations
for which action may have been taken or is in the process of being taken by an overseas regulator against the
QDP / QFI forthwith, to the attention of SEBI, depositories and stock exchanges.
Concern need to be taken by QDP while registering a QFI
(i) QDP shall ensure that only those entities are allowed to open demat account as QFI whose ultimate/ end
beneficial ownership is not resident in India.
(ii) The entities having opaque structure(s) such that the details of ultimate/ end beneficiary are not accessible or
where the beneficial owners are ring fenced from each other or where the beneficial owners are ring fenced with
regard to enforcement shall not be allowed to open demat account as QFI.
(iii) In case of any direct/ indirect change in structure or beneficial ownership of the QFI, the QFI shall bring the
same to the notice of its QDP, forthwith. The QDP shall assess the eligibility of that QFI afresh, before allowing
it to undertake any further transactions.
(iv) The QDP shall open a demat account for the QFI only after ensuring compliance with all the requirements as
per PML Act, rules and regulations, FATF standards and SEBI circulars issued in this regard, from time to time
and shall also ensure that QFI comply with all these requirements on an ongoing basis.
(v) The QDP shall, at all times, ensure compliance with laws, rules and regulations of the jurisdictions where the
QFI are based.
Undertakings that the QDP's need to obtain from the QFI's
(i) QFI does not hold any other demat account in any capacity whatsoever in India.
130 PP-CC&MM
(ii) The ultimate / end beneficial ownership is not a person resident in India.
(iii) Entities with an opaque structure are prohibited from opening a demat account in India. In effect, the ultimate
beneficiary details need to be fully disclosed.
(iv) The QFI shall keep the QDP informed of any changes in the structure or beneficial ownership of the entity,
directly or indirectly. Each time there are changes in the beneficial ownership, the QDP shall assess afresh
before allowing the QFI to undertake any further transactions.
(v) Authorize the QDP to furnish such QFI information as may be required by any of the Indian Regulators from
time to time.
(vi) At all times, the QFI shall, in relation to their activities as QFI in India, be subject the Indian laws, rules,
regulations, circulars etc. as applicable from time to time.
(vii) QFI to furnish, on an ongoing basis, details of any penalties, litigations or proceedings, findings of inspections
or investigations by any overseas regulator.
(viii) The QFI is prohibited from issuing any offshore derivatives instruments / participatory notes against the
shares held by the QFI in Demat account in India.
(ix) QFI to authorize the QDP to disinvest holdings in excess of prescribed limits should a situation so arise.
(x) QFI to transact only through one bank account.
Apart from this, all the securities market Intermediaries are also required to comply with the SEBI
(Self Regulatory Organisations) Regulations, 2004 , SEBI (Intermediaries ) Regulations, 2008 and
SEBI {KYC(Know Your Client) Registration agency(KRA)}, Regulations, 2011 which have already
been elaborated at the executive level.
LESSON ROUND UP
– SEBI has issued regulations in respect of each intermediary to ensure proper services to be rendered
by them to the investors and the capital market.
– Regulation 3 of SEBI (Merchant Bankers) Regulations, 1992 lays down that an application by a person
desiring to become merchant banker shall be made to SEBI in the prescribed form seeking grant of a
certificate of initial registration alongwith a non-refundable application fee as specified in Schedule II of
the Regulations.
– The Registrars to an Issue and Share Transfer Agents constitute an important category of intermediaries
in the primary market.
– Underwriting is an arrangement whereby certain parties assure the issuing company to take up shares,
debentures or other securities to a specified extent in case the public subscription does not amount to
the expected levels.
– Banker to an Issue means a scheduled bank carrying on all or any of the following activities:
– Acceptance of application and application monies;
– Acceptance of allotment or call monies;
– Refund of application monies;
– Payment of dividend or interest warrants.
– Regulation 25 of Chapter V of SEBI (Debenture Trustees) Regulations, 1993 lays down that a debenture
Lesson 4
Financial Intermediaries Framework 131
trustee would be dealt with in the manner provided under Chapter V of SEBI (Intermediaries) Regulations,
2008, if he fails to comply with the conditions of registration, contravenes the provisions of SEBI Act/
Companies Act, Rules and Regulations.
– SEBI has authorized the Practicing Company Secretary to carry out complete internal audit of stock
brokers/ trading members/clearing members on a half yearly basis.
– Every Portfolio Manager is required to appoint a Practising Company Secretary or a Practising Chartered
Accountant for conducting the internal audit.
– Any person proposing to carry on business as custodian of securities on or after the commencement
of these regulations shall make an application to SEBI for grant of a certificate.
– “Foreign Institutional Investor” means an institution established or incorporated outside India which
proposes to make investment in India in securities.
– “Investment Adviser” means any person, who for consideration, is engaged in the business of providing
investment advice to clients or other persons or group of persons and includes any person who holds
out himself as an investment adviser, by whatever name called.
– SEBI regulations for Credit Rating Agencies (CRAs) cover rating of securities only and not rating of
fixed deposits, foreign exchange, country ratings, real estates etc.
– “Market-Maker” means a trading member of the Stock Exchange registered as such as per the Rules
and Bye-laws of the Stock Exchange.
– SEBI (Depositories and Participants) Regulations, 1996, contain provisions for operations and
functioning of depositories, form for application and certificates used and schedule of fees for participants,
etc.
– A Depository Participant that has taken approval from/registered with SEBI to offer services to Qualified
Foreign Investor (QFI) is called Qualified Depository Participant (QDP)
SELF TEST QUESTIONS
1. Briefly discuss the general obligations and responsibilities of the merchant banker and due diligence
certificate issued by the merchant banker.
2. Explain the code of conduct prescribed by SEBI for Investment Advisers.
3. Explain general obligations of Credit Rating Agencies under Chapter III of SEBI (Credit Rating Agencies)
Regulations, 1999.
4. What do you understand by a Qualified Depository Participant (QDP)? Describe the Eligibility Criteria
required to be fulfiled to become a QDP.
5. Enumerate the provisions relating to Reconciliation of Share Capital Audit under SEBI (Depositories
and Participants) Regulations, 1996.
132 PP-CC&MM
Lesson 5
Primary Market
LESSON OUTLINE
Lesson 5
Primary Market 133
LEARNING OBJECTIVES
– Introduction
One of the important segment in the financial
system is the primary market which is seen as
an excellent avenue for companies to raise huge
amount of money as the investment directly
made to the issuer by tapping a cross section
of investors and using different fund raising
methods. Public issue of securities whether it
is being in the form of rights issue, bonus issue
or through Qualified Institutional Placement
(QIP)or Institutional Placement Programme
(IPP), it has to comply with the SEBI (ICDR)
Regulations, 2009.
– Types of Issue
– Offer for Sale
– Difference between Offer for Sale (OFS)
process and IPOs/FPOs
– SEBI Guidelines on Offer for Sale of
shares by promoters through the Stock
Exchange Mechanism
– Different form of prospectus
– Filing of offer Document
– Lead manager
– Pre-issue management
The main objective of this lesson is to give a
detailed view of provisions relating to SEBI
(ICDR) Regulations, 2009 pertaining to different
types of public issue of securities. Apart from
this, this lesson will also provides how basis of
allotment is finalised, book building process,
Green Shoe Option, Due diligence carried out
in IPO/FPO and the time based and event based
compliances required under Listing Agreement
etc.
– Post-issue management
– Underwriting
– Due Diligence
– Due Diligence in IPO/FPO
– Basis of Allotment
– Book Building
– Alternate Method of book Building
– Green Shoe Option Facility
– Pre-issue activities
– Rights Issue
– Bonus Issue
– Preferential Issue
– Qualified Institutional Placement
– Institutional Placement Programme
– Listing Agreement
– LESSON ROUND UP
– SELF TEST QUESTIONS
133
134 PP-CC&MM
INTRODUCTION
Primary Market is a Market for new issues or financial claims. Hence it is also called new issue market. Primary
Market deals with those securities which are issue to the public for the first time. Primary Market provides
opportunity to issuers of securities, Government as well as corporates, to raise resources to meet their
requirements of investment and/or discharge some obligation. The issuers create and issue fresh securities in
exchange of funds through public issues and/or as private placement. When equity shares are exclusively
offered to the existing shareholders it is called ‘Rights Issue’ and when it is issued to selected mature and
sophisticated institutional investors as opposed to general public it is called ‘Private Placement Issues’. Issuers
may issue the securities at face value, or at a discount/premium and these securities may take a variety of forms
such as equity, debt or some hybrid instruments.
Types of Issue
Public Issue of shares means the selling or marketing of shares for subscription by the public by issue of
prospectus. For raising capital from the public by the issue of shares, a public company has to comply with the
provisions of the Companies Act, the Securities Contracts (Regulation) Act, 1956 including the Rules made
thereunder and the guidelines and instructions issued by the concerned Government authorities, the Stock
Exchanges and SEBI etc.
A company can raise funds from the primary market through different method.
(a) Public issue: When an issue/offer of securities is made to new investors for becoming part of
shareholders’ family of the issuer it is called a public issue. Public issue can be further classified into
Initial public offer (IPO) and Further public offer (FPO). The significant features of each type of public
issue are illustrated below:
(i) Initial public offer (IPO): When an unlisted company makes either a fresh issue of securities or
offers its existing securities for sale or both for the first time to the public, it is called an IPO. This
paves way for listing and trading of the issuer’s securities in the Stock Exchanges.
(ii) Further 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 FPO.
(b) Right issue (RI): 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.
(c) Bonus issue: When an issuer makes an issue of securities to its existing shareholders as on a record date,
without any consideration from them, it is called a bonus issue. The shares are issued out of the Company’s
free reserve or share premium account in a particular ratio to the number of securities held on a record date.
(d) Private placement: When an issuer makes an issue of securities to a select group of persons not
exceeding 49, and which is neither a rights issue nor a public issue, it is called a private placement.
Private placement of shares or convertible securities by listed issuer can be of two types:
(i) Preferential allotment: When a listed issuer issues shares or convertible securities, to a select group
of persons in terms of provisions of Chapter VII of SEBI (ICDR) Regulations, it is called a preferential
allotment. The issuer is required to comply with various provisions which inter alia include pricing,
disclosures in the notice, lock in etc., in addition to the requirements specified in the Companies Act.
(ii) Qualified institutions placement (QIP): When a listed issuer issues equity shares or securities
convertible in to equity shares to Qualified Institutions Buyers only in terms of provisions of Chapter
VIII of SEBI (ICDR) Regulations, it is called a QIP.
Lesson 5
Primary Market 135
Issues
Public Issue
Rights Issue
IPO
FPO
Fresh Issue
Fresh Issue
Offer for sale
Offer for sale
Bonus Issue
Private Placement
Preferential Issue
Qualified Institutional
Placement
OFFER FOR SALE
Offer for Sale (OFS) is another form of share sale, very much similar to Further Public Offer (FPO). OFS mechanism
facilitates the promoters of an already listed company to sell or dilute their existing shareholdings through an
exchange based bidding platform.
Except the promoters of the company, all market participants like individuals, mutual funds, foreign institutional
investors (FIIs), insurance companies, corporates, other Qualified Institutional Bidders (QIBs), HUFs etc. can
bid/participate in the OFS process or buy the shares. The promoters of the company can only participate as the
sellers in the process.
OFS PROCESS
The following is the process for offer for sale:
(i) The sellers are required to deposit the offered shares with the exchange before 11.00 a.m. on T–1 day,
where ‘T’ is the day of OFS.
(ii) Once the OFS starts, one can participate in the process himself using online trading accounts by
placing bids under the ‘OFS’ section of their respective broking websites.
(iii) Investors, who do not have online trading accounts, can place their bids by directing the dealer of their
broking company to do it on their behalf. The investor can modify or cancel their bids during the offer
timings except in the last 60 minutes i.e. till 2:30 p.m.
(iv) The exchange will announce the “Indicative Price” only during the last 60 minutes of the OFS. Indicative
Price is the volume weighted average price of all the valid/confirmed bids. e.g. There are total 1000
shares in an offer for sale with ` 200 as the floor price. If the investors bid for 200 shares at ` 210 and
800 shares at ` 200, the indicative price for the offer would be [(200*210)+(800*200)]/1000 = ` 202.
(v) No leverage is provided to the investors against the stock margin available in the trading accounts and
thus, they are required to deposit 100% of the order value in cash to bid for it. Also, the funds allocated for
OFS cannot be utilised for other investment purposes or against any other obligation of the trading member.
(vi) Once the bidding gets over, allotment price is fixed and allocation is done. The successful bidders will
136 PP-CC&MM
be allotted shares directly into their demat account on T+1 basis the very next day. In case of partial
allotment or no allotment, the refunds will be made on the same day itself. This makes the OFS process
really fast, just like buying shares of the company from the open market.
(vii) During the offer timings or once the offer gets completed, the investor can monitor the quantity and price
of bids received etc. from the website of the Stock Exchange.
Difference between Offer for Sale (OFS) process and IPOs/FPOs
(i) Physical Application: Unlike IPOs/FPOs, no physical application forms are issued to apply for shares in the
OFS process. OFS process is completely platform based.
(ii) Time Period: While IPOs/FPOs remain open for 3-4 days, OFS gets over in a single trading day as the
markets gets closed for trading at 3:30 p.m.
(iii) Price Band: Under IPOs/FPOs, there is a price band in which the investors need to bid for the shares or
simply give their consent to buy the shares at the “Cut-Off” price. With OFS, there is a “Floor Price”. As the name
suggests, it is the minimum price at which the investor can bid for the shares under OFS. An investor will not be
able to place an order below the floor price as it will not be accepted by the system.
Though it is not mandatory to disclose the floor price before the issue opens, the promoters usually disclose it
prior to the share sale in almost all of the issues. Alternatively, the promoters can submit the floor price in a
sealed envelope to the exchange which will be disclosed post closure of the offer. In case the floor price is not
disclosed to the public, the investors can place their bids at any price they want.
(iv) Charges: Investors are not required to pay any kind of charges over and above the ‘Fixed Price’ in an IPO or
FPO. But, the OFS process involve certain transaction charges including the brokerage, Securities Transaction Tax
(STT) and other charges, which the investors normally pay when they buy shares of a company in the cash market.
On the OFS day, normal trading in the shares of the company will continue even when the bidding process is
‘ON’. The investors have the option to either buy the shares of the company in the normal market or place their
bids for the shares on sale in the OFS. The investors can place only ‘Limit’ orders under the OFS facility as
‘Market’ orders are not allowed.
SEBI GUIDELINES ON OFFER FOR SALE (OFS) OF SHARES BY PROMOTERS THROUGH THE
STOCK EXCHANGE MECHANISM
SEBI has detailed guidelines on how the offer-for-sale should be followed which is discussed below:
1. Eligibility
(a) Exchanges
The facility of offer for sale of shares shall be available on Bombay Stock Exchange (BSE) and National Stock
Exchange (NSE).
(b) Sellers
(i) All promoter(s)/ promoter group entities of such companies that are eligible for trading and are required to
increase public shareholding to meet the minimum public shareholding requirements in terms of Rule 19(2)(b) and
19A of Securities Contracts (Regulation) Rules, 1957 (SCRR), read with clause 40A (ii) (c) of Listing Agreement.
(ii) All promoters/promoter group entities of top 100 companies by market capitalisation in any of the last four
completed quarters, market capitalisation being calculated as average market capitalisation in a quarter.
For (i) and (ii) above, the promoter/promoter group entities should not have purchased and/or sold the shares of
the company in the 12 weeks period prior to the offer and they should undertake not to purchase and/or sell
shares of the company in the 12 weeks period after the offer. However, within the cooling off period of +12
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weeks, the promoter(s)/promoter group entities can offer their shares only through OFS/ Institutional Placement
Programme (IPP) with a gap of 2 weeks between successive offers. The above shall also be applicable on
promoter(s) /promoter group entities who have already offered their shares through OFS/IPP.
(c) Buyers
All investors registered with the brokers of the aforementioned stock exchanges other than the promoter(s)/
promoter group entities.
2. Definitions
"Single Clearing Price” is the price at which the shares are allocated to the successful bidders in a
proportionate basis methodology.
“Multiple Clearing Prices” are the prices at which the shares are allocated to the successful bidders in a
price priority methodology.
“Indicative Price” is the volume weighted average price of all the valid bids.
“Floor Price” is the minimum price at which the seller intends to sell the shares.
3. Size of Offer for sale of shares
The size of the offer shall be a minimum of ` 25 crores. However, size of offer can be less than `25 crores so as
to achieve minimum public shareholding in a single tranche.
4. Advertisement and offer expenses
(a) Advertisements about the offer for sale of shares through stock exchange(s) , if any, shall be made after the
announcement/ notice of the offer for sale of shares to the stock exchanges in accordance with para 5 (b)
below and its contents shall be restricted to the contents of the notice as given to the stock exchange under
Para 5 (b).
(b) All expenses relating to offer for sale of shares through stock exchange(s) shall be borne by the seller(s).
5. Operational Requirements
(a) Appointment of Broker
The Seller(s) will appoint broker(s) for this purpose. The Seller’s broker(s) may also undertake transactions on
behalf of eligible buyers.
(b) Contents of the announcement/ Notice of the Offer for sale of shares
Seller(s) shall announce the intention of sale of shares at least on the day prior to the offer for sale, along with
the following information:
(i) Name of the seller(s) (promoter/ promoter group) and the name of the company whose shares are
proposed to be sold.
(ii) Name of the Exchange(s) where the orders shall be placed. In case orders are to be placed on both
BSE and NSE, one of them shall be declared as the Designated Stock Exchange (DSE).
(iii) Date and time of the opening and closing of the offer.
(iv) Allocation methodology i.e. either on a price priority (multiple clearing prices) basis or on a proportionate
basis at a single clearing price.
(v) Number of shares being offered for sale.
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(vi) The maximum number of shares that the seller may choose to sell over and above the offer made at
point (v) above. The name of the broker(s) on behalf of the seller(s).
(vii) The date and time of the declaration of floor price, if the seller(s) chooses to announce it to the market.
Alternatively, a declaration to the effect that the floor price will be submitted to the DSE in a sealed
envelope that shall be disclosed post closure of the offer.
(viii) Conditions, if any, for withdrawal or cancellation of the offer.
(c) Floor price
(i) In case the seller chooses to disclose the floor price, the seller(s) shall declare it after the close of
trading hours and before the close of business hours of the exchanges on T-1 day else the seller(s)
shall give the floor price in a sealed envelope to DSE before the opening of the offer. (T day being the
day of the offer for sale)
(ii) The floor price if not declared to the market, shall not be disclosed to anybody, including the selling
broker(s).
(iii) Sealed envelope shall be opened by the DSE after the closure of the offer for sale and the floor price
suitably disseminated to the market.
(d) Timelines
(i) The duration of the offer for sale shall be as per the trading hours of the secondary market and shall not
exceed one trading day.
(ii) Orders shall be placed during trading hours.
(e) Order Placement
(i) A separate window for the purpose of sale of shares through OFS shall be created. The following orders
shall be valid in the OFS window:
A. Orders with 100% of margin paid upfront by institutional investors and non-institutional investors.
Such orders can be modified or canceled at any time during the trading hours.
B. Orders without paying upfront margin by institutional investors only. Such orders cannot be modified
or cancelled by the investors or stock brokers, except for making upward revision in the price or
quantity.
(ii) Cumulative bid quantity shall be made available online to the market throughout the trading session at
specific intervals in respect of orders with 100% upfront margin and separately in respect of orders
placed without any upfront margin. Indicative price shall be disclosed to market throughout the trading
session. The indicative price shall be calculated based on all valid bids/orders.
(iii) If the security has a price band in the normal segment, the same shall not apply for the orders placed in
the offer for sale. Stock specific tick size as per the extant practice in normal trading session shall be
made applicable for this window.
(iv) In case of shares under offer for sale, the trading in the normal market shall also continue. However, in
case of market closure due to the incidence of breach of ‘Market wide index based circuit filter’, the offer
for sale shall also be halted.
(v) Only limit orders/ bids shall be permitted.
(vi) Multiple orders from a single buyer shall be permitted.
(vii) In case floor price is disclosed, orders/ bids below floor price shall not be accepted.
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6. Risk Management
(a) Clearing Corporation shall collect 100% margin in cash from non-institutional investors. In case of
institutional investors who place orders/bids with 100% of margin upfront, custodian confirmation shall
be within trading hours. In case of institutional investors who place orders without upfront margin, custodian
confirmation shall be as per the existing rules for secondary market transactions. The funds collected
shall neither be utilized against any other obligation of the trading member nor co-mingled with other
segments.
(b) In case of order/bid modification or cancellation, such funds shall be released/ collected on a real time
basis by clearing corporation.
(c) The seller(s) shall deposit the entire quantity of shares offered for sale including the additional shares
disclosed at Para 5(b)(vi) as pay-in with the clearing corporation/clearing house of DSE prior to the
commencement of the offer. No other margin shall be charged on the seller(s).
7. Allocation
(a) Minimum of 25% of the shares offered shall be reserved for mutual funds and insurance companies,
subject to allocation methodology. Any unsubscribed portion thereof shall be available to the other
bidders.
(b) The orders shall be cumulated by the DSE immediately on close of the offer. Based on the methodology
for allocation to be followed as disclosed in the notice, the DSE shall draw up the allocation. i.e. either
on a price priority (multiple prices) basis or on a proportionate basis at a single clearing price.
(c) No allocation will be made in case of order/ bid is below floor price.
(d) No single bidder other than mutual funds and insurance companies shall be allocated more than 25%
of the size of offer for sale.
(e)
The allocation details shall be shared by the DSE with the other exchange after the allocation is
crystallized.
8. (i) Settlement
(a) The allocation and the obligations resulting thereof shall be intimated to the brokers on T day.
(b) Settlement shall take place on trade for trade basis. For non-institutional orders/bids and for institutional
orders with 100% margin, settlement shall take place on T+1 day. In case of orders/bids of institutional
investors with no margin, settlement shall be as per the existing rules for secondary market.
(c)
Funds collected from the bidders who have not been allocated shares shall be released after the
download of the obligation.
(d) On T+1 day, to the extent of obligation determined, the clearing Corporation/ Clearing house of DSE
shall transfer such number of shares to the clearing corporation/clearing house of the other stock
exchange, without consideration of money. Excess shares, if any, shall be returned to seller broker(s).The
direct credit of shares shall be given to the demat account of the successful bidder provided such
manner of credit is indicated by the broker/bidder.
(ii) Handling of default in pay-in
(a) In case of default in pay-in by any investor, 10% of the order value shall be charged as penalty from the
investor and collected from the broker. This amount shall be credited to the Investor Protection Fund of
the stock exchange.
(b) The price at which allotments have been made based on the allocation on T day shall not be revised as
a result of any default in pay-in.
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(c) Issuer shall have the option to cancel in full or conclude the offer.
(d) Allotment details after settlement shall also be disseminated by the exchange.
(e) Allocation details after settlement shall be consolidated by the DSE and excess shares, if any, shall be
returned by the respective Clearing Corporation/ Clearing house to the seller(s) broker(s).
(f) Settlement Guarantee Fund shall not be available for OFS through stock exchange mechanism.
9. Issuance of Contract Notes
The brokers shall be required to issue contracts note to its clients based on the allotment price and quantity in
terms of conditions specified by the exchange.
10. Withdrawal of offer
The offer for sale may be withdrawn prior to its proposed opening. In such a case there will be a cooling off
period of 10 trading days from the date of withdrawal before an offer is made once again. The stock exchange(s)
shall suitably disseminate details of such withdrawal.
11. Cancellation of offer
Cancellation of offer shall not be permitted during the bidding period. If the seller(s) fails to get sufficient demand
at or above the floor price, he may choose to either conclude the offer or cancel it in full. The seller may also
choose to conclude the offer or cancel it in full, in case of defaults in settlement obligation.
UNDERSTANDING THE GUIDELINE STEP WISE
Step 1 – The seller (promoter) appoints a broker for the offer-for-sale.
Step 2 – The seller announces his intention to sell shares at least one trading day before the offer-for-sale
opens.
It will have the details of seller, designated stock exchange, date and time of offer open and close. It also has
details of number of shares offered, allocation methodology, maximum offer size over and above offer-for-sale
size, name of seller’s broker(s). Finally, it should have details on the date and time of declaration of floor price.
Step 3 – The seller shall declare the floor price after trading hours and before close of business hours to the
designated stock exchange a day before the offer-for-sale date (Trade date minus one day). This is applicable
if the seller chooses to declare the floor price.
Otherwise, the floor price is given in a sealed envelope to the stock exchange and not disclosed to anybody,
including the selling broker.
The stock exchange disseminates it to the market after the offer-for-sale closes.
The offer duration will coincide with trading hours in the secondary market (9 a.m. to 3.30 p.m.). Order processing
and funds pay-in shall occur only during trading hours on the exchange platform.
For institutional trades, custodians are expected to conclude bid confirmation with available funds latest by half
an hour post the session.
Orders can be placed in a separate window created by the exchange. Order modification is allowed only for bids
with 100 per cent upfront margins. Orders cannot be modified in the last 60 minutes of the offer-for-sale.
Information on bid quantity shall be made available by the exchanges at specified time intervals. Exchanges
shall disclose the indicative price only during the last 60 minutes of the offer-for-sale.
Price band for the scrip in the normal segment would not be applicable to the offer-for-sale. However, standard
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tick sizes would apply. Tick size is the minimum price by which share prices can move up or down.
Though normal market trading for scrips under the offer-for-sale would continue, it would be halted if the scrip
hits the circuit in the normal market.
Only limit orders are permitted and buyers are allowed to place multiple orders. Orders below floor price (if
disclosed) would not be accepted.
Step 4 – All non-institutional investors have to bring in 100 per cent upfront margin. Institutions are allowed to
pay either 25 per cent or 100 per cent as upfront margin. The seller has to deposit the entire quantity of shares
under the offer to the clearing corporation as pay–in before the offer-for-sale starts.
Step 5 – One fourth of shares of OFS is reserved for mutual funds and insurance companies. The stock exchange
allocates shares either on price priority (in case of multiple clearing prices) or proportionate basis (in case of
single clearing price).
Orders below floor price are not taken up for allocation. No single bidder other than mutual funds and insurance
companies would be allocated over 25 per cent.
Step 6 – The allocation and obligations are intimated to brokers on the trade date (T). Trades are settled on the
T+1 date. The clearing corporation will transfer shares into the demat accounts of successful bidders.
Step 7 – Bidders will forfeit 10 per cent of their bid value to the investor protection fund if they default on the payin amount. Allotment price on the T day would not change due to any default pay-in.
Issuer has the option to conclude the offer or cancel it in full. The settlement guarantee fund is not available for
this facility through stock exchange mechanism.
Step 8 - Brokers would issue contract notes to their clients based on the allotment price and quantity.
DIFFERENT FORM OF PROSPECTUS
A company is required to issue a prospectus each time it accesses the capital market. The different forms of
prospectus are discussed below:
Offer Document
“Offer document” means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a right
issue, which is filed with Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all
the relevant information to help an investor to make his/ her investment decision.
Draft Offer Documents
“Draft Offer document” means the offer document in draft stage. The draft offer documents are filed with SEBI,
atleast 30 days prior to the filing of the Offer Document with ROC/SEs. SEBI may specifies changes, if any, in
the Draft Offer Document and the Issuer or the Lead Merchant banker shall carry out such changes in the draft
offer document before filing the Offer Document with ROC/SEs. The Draft Offer document is available on the
SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI.
RHP (Red Herring Prospectus)
“ Red Herring Prospectus” is a prospectus, which does not have details of either price or number of shares being
offered, or the amount of issue. This means that in case price is not disclosed, the number of shares and the
upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the
number of shares are determined later. An RHP for an FPO can be filed with the ROC without the price band and
the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to
the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot
be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring
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prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding
process, the details of the final price are included in the offer document. The offer document filed thereafter with
ROC is called a prospectus.
Shelf Prospectus
Shelf prospectus means a prospectus issued by any financial institution or bank for one or more issues of the
securities or class of securities specified in that prospectus. Section 60A of the Companies Act, 1956 enable
public financial institutions, public sector banks, and scheduled banks, whose main object is to make loans to, or
subscribe for securities of private industrial enterprises engaged in infrastructure financing to issue shelf
prospectus. Section 60 A lays down that– Any public financial institution, public sector bank or scheduled bank whose main object is financing
shall file a shelf prospectus.
– A company filing a shelf prospectus with the Registrar shall not be required to file prospectus afresh at
every stage of offer of securities by it within a period of validity of such shelf prospectus.
– A company filing a shelf prospectus shall be required to file an information memorandum on all material
facts relating to new charges created, changes in the financial position as have occurred between the
first offer of securities, previous offer of securities and the succeeding offer of securities within such
time as may be prescribed by the Central Government, prior to making of a second or subsequent offer
of securities under the shelf prospectus.
– An information memorandum shall be issued to the public along with shelf prospectus filed at the stage
of the first offer of securities and such prospectus shall be valid for a period of one year from the date of
opening of the first issue of securities under that prospectus:
Provided that where an update of information memorandum is filed every time an offer of securities is made,
such memorandum together with the shelf prospectus shall constitute the prospectus.
Filing of Offer Document
An issuer company cannot make any public issue of securities, unless a draft offer document has been filed with
SEBI through a Merchant Banker, at least 30 days prior to registering the prospectus with the Registrar of
Companies (ROC) or filing the letter of offer with the designated stock exchange.
However, if SEBI specifies changes or issues observations on the draft Prospectus within 30 days from the date
of receipt of the draft Prospectus by SEBI the issuer company or the Lead Manager to the Issue shall carry out
such changes in the draft Prospectus or comply with the observations issued by SEBI before filing the Prospectus
with ROC.
SEBI may specify changes or issue observations, if any, on the draft prospectus within 30 days from the later of
the date of receipt of the draft offer document or the date of receipt of satisfactory reply from the lead merchant
bankers. Where SEBI has sought any clarification or additional information from them or the date of receipt of
clarification or information from any regulator or agency, where SEBI has sought any clarification or information
from such regulator or agency or the date of receipt of a copy of in-principal approval letter issued by the
recognized stock exchanges.
The lead merchant banker should while filing the offer document with SEBI, file a copy of such document with
the recognized stock exchanges where the specified securities are proposed to be listed and a soft copy of the
offer document should also be furnished to SEBI.
LEAD MANAGER
The public issue of corporate securities involves marketing of capital issues of new and existing companies,
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additional issues of existing companies including rights issue and dilution of shares by letter of offer,. The public
issues are managed by the involvement of various agencies i.e. underwriters, brokers, bankers, advertising
agency, printers, auditors, legal advisers, registrar to the issue and merchant bankers providing specialized
services to make the issue of the success. However merchant banker is the agency at the apex level than that
plan, co-ordinate and control the entire issue activity and direct different agencies to contribute to the successful
marketing of securities.
Merchant bankers are independent financial institution appointed by the company going public. Companies
appoint more then one lead manager to manage IPO's. They are known as Book Running Lead Manager and
Co Book Running Lead Managers. Their main responsibilities are to initiate the IPO processing, help company
in road shows, creating draft offer document and get it approve by SEBI and stock exchanges and helping
company to list shares at stock market. The procedure of the managing a public issue by a merchant banker is
divided into two phases, viz;
– Pre-issue management
– Post-issue management
Pre-Issue Management
Steps required to be taken to manage pre-issue activity is as follows:(1) Obtaining stock exchange approvals to memorandum and articles of associations.
(2) Taking action as per SEBI Regulations
(3) Finalizing the appointments of the following agencies:
– Co-manager/Advisers to the issue
– Underwriters to the issue
– Brokers to the issue
– Bankers to the issue and refund Banker
– Advertising agency
– Printers and Registrar to the issue
(4) Advise the company to appoint auditors, legal advisers
(5) Drafting of prospectus
(6) Obtaining approvals of draft prospectus from the company’s legal advisers, underwriting financial institutions/
Banks
(7) Obtaining consent from parties and agencies acting for the issue to be enclosed with the prospectus.
(8) Approval of prospectus from SEBI.
(9) Filing of the prospectus with Registrar of Companies.
(10) Making an application for enlistment with Stock Exchange along, with copy of the prospectus.
(11) Publicity of the issue with advertisement and conferences.
(12) Open subscription list.
Post-issue Management
Steps involved in post-issue management are:-
144 PP-CC&MM
(1) To verify and confirm that the issue is subscribed to the extent of 90% including devolvement from
underwriters in case of under subscription.
(2) To supervise and co-ordinate the allotment procedure of registrar to the issue as per prescribed Stock
Exchange guidelines.
(3) To ensure issue of refund order, allotment letters / certificates within the prescribed time limit after the
closure of subscription list.
(4) To report periodically to SEBI about the progress in the matters related to allotment and refunds.
(5) To ensure the listing of securities at Stock Exchanges.
(6) To attend the investors grievances regarding the public issue.
Co-ordination with Intermediaries
– The Post-issue lead merchant banker shall maintain close co-ordination with the Registrars to the Issue
and arrange to depute its officers to the offices of various intermediaries at regular intervals after the
closure of the issue to monitor the flow of applications from collecting bank branches, and/or self certified
syndicate banks processing of the applications including application form for applications supported by
blocked amount and other matters till the basis of allotment is finalised, despatch of security certificates
and refund orders are completed and securities are listed.
– Any act of omission or commission on the part of any of the intermediaries noticed during such visits
shall be duly reported to SEBI.
– In case there is a development on underwriters, the merchant banker is required to ensure that the
notice for development containing the obligation of the issuer is issued within a period of 10 days from
the date of closure of the issue.
– In case of undersubscribed issues, the merchant bank is required to furnish information in respect of
underwriters who have failed to meet their underwriting development to SEBI in the format specified in
these regulations.
– The post-issue merchant banker is required to confirm to the bankers to the issue by way of copies of
listing and trading approval that all formalities in connection with the issue have been completed and
that the banker is free to release the money to the issuer or refund it in case of failure of the issue.
UNDERWRITING
Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate
when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to
them.
(1) Where the issuer making a public issue (other than through the book building process) or rights issue,
desires to have the issue underwritten, it shall appoint the underwriters in accordance with SEBI (Underwriters)
Regulations, 1993.
(2) Where the issuer makes a public issue through the book building process, such issue shall be underwritten
by book runners or syndicate members.
However, 75 % of the net offer to public proposed to be compulsorily allotted to qualified institutional buyers
cannot be underwritten.
(3) The issuer shall enter into underwriting agreement with the book runner, who in turn shall enter into underwriting
agreement with syndicate members, indicating therein the number of specified securities which they shall subscribe
to at the predetermined price in the event of under subscription in the issue.
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(4) If syndicate members fail to fulfill their underwriting obligations, the lead book runner shall fulfill the underwriting
obligations.
(5) The book runners and syndicate members shall not subscribe to the issue in any manner except for fulfilling
their underwriting obligations.
(6) In case of every underwritten issue, the lead merchant banker or the lead book runner shall undertake
minimum underwriting obligations as specified in the SEBI (Merchant Bankers) Regulations, 1992.
(7) Where 100% of the offer through offer document is underwritten, the underwriting obligations shall be for the
entire 100% of the offer through offer document and shall not be restricted upto the minimum subscription level.
In respect of an underwritten issue, the lead merchant banker shall ensure that the relevant details of underwriters
are included in the offer document as follows:
Underwriting of the issue:
(a) Names and addresses of the underwriters and the amount underwritten by them
(b) Declaration by board of directors of the issuer company that the underwriters have sufficient resources
to discharge their respective obligations.
In case of under subscription at an issue, the Lead Merchant Banker responsible for underwriting arrangements
shall invoke underwriting obligations and ensure that the underwriters pay the amount of development and the
same shall be incorporated in the inter-se allocation of responsibilities accompanying the due diligence certificate
submitted by the Lead Merchant Banker to the SEBI.
Due Diligence
Due diligence is a detailed investigation of the affairs of a business. As such, it spans investigation into all
relevant aspects of the past, present and predictable future of the business of a target company. Due diligence
is a process of a thorough and objective examination that is undertaken before corporate entities enter into
major transactions such as mergers and acquisitions, issuing new stock or other securities, project finance,
securitization, etc.
One of the key objectives of due diligence is to minimize and to the maximum extent practicable, the possibility
of there being unknown liabilities or risks. The exercise is multi-dimensional and involves investigation into the
business, tax, financial, accounting and legal aspects of an issuer. The aim of due diligence is to identify problems
within the business, particularly any issues which may give rise to unexpected liabilities in the future.
Due Diligence in IPO/FPO
When the due diligence is carried out as part of the steps leading to an IPO, the exercise takes on added
meaning and encompasses a wider scope, as it identifies the areas or the issues where the company exhibits
weaknesses and the due diligence process becomes a tool, which shows the company the way to optimize its
potential and thereby increasing its value to potential investors. Pre-IPO due diligence process will result in a
gap analysis between the present status of the company and the company that should be floated i.e., a gap is
an expectations gap created as a result of how the market expects a listed company to conduct its affairs. In
this scenario, once these gaps have been highlighted the due diligence exercise should not stop there but
should include advice given by the advisors to the company on the processes and activities which are required
to fill the gaps identified. In an IPO the due diligence exercise is a broader, fuller exercise which apart from
identifying the weaknesses also looks at resolving them with the purpose of increasing the value of the
company.
146 PP-CC&MM
The due diligence process aspires to achieve the following:
– to assess the reasonableness of historical and projected earnings and cash flows;
– to identify key vulnerabilities, risk and opportunities;
– to gain an intimate understanding of the company and the market in which the company operates such
that the company’s management can anticipate and manage change;
– to set in motion the planning for the post-IPO operations.
It will result in a critical analysis of the control, accounting and reporting systems of the company and a critical
appraisal of key personnel. It will identify the value drivers of the company thus enabling the directors to understand
where the value is and to focus their efforts on increasing that value.
Due diligence spans the entire public issue process. The steps involved in due diligence are given broadly
below:
1. Decision on public issue
2. Business due diligence
3. Legal and Financial Due Diligence
4. Disclosures in Prospectus
5. Marketing to Investors
6. Post issue compliance
Key areas to be focused:
(a) the financial statements – to ensure their accuracy;
(b) the assets – confirm their value, condition existence and legal title;
(c) the employees – identification and evaluation of the key movers and shakers;
(d) the sales strategy – analyzing the policies and procedures in place and assessing what works and what
does not;
(e) the marketing – what is driving the business and is it effective?
(f) the industry in which the company operates – understand trends and new technologies;
(g) the competition – identify the threats;
(h) the systems – how efficient are they? Are upgrades required?
(i) legal and corporate and tax issues – is the shareholding structure robust? Are there any tax issues
which need to be resolved?
(j) company contracts and leases – identify what the risks and obligations are;
(k) suppliers – are they expected to remain around?
Illustrative list of documents/information to be examined during due-diligence process:
(i) Basic documents
Review of basic corporate documents like:
– Memorandum and Articles of Association of the Company
– Copies of Incorporation Certificate/Commencement of Business Certificate/ Change of Name
certificate (if applicable)
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– Registered office address of the company
– History/businesses of the company
– Special rights available to any persons through shareholder or other Agreements.
(ii) Promoters/Personnel
1. Promoters’ bio-data with special reference to qualification and experience. Track record of the promoters
in the capital market – public issue by other group companies, violation of securities laws.
2. Directors’ & Key Personnel – details bio-data including father’s name, address, occupation, year-wise
experience. Background of the Directors – including examining the list of willful defaulters periodically
prepared by RBI.
3. Constitution of Audit Committee, remuneration Committee etc., Terms of reference of these committees.
4. Organization Chart.
5. Key Personnel/Employees/Directors left in the last two years with reasons.
6. Break-up of Employees – whether any agreement are entered into with employee – If so, copy of
agreement.
7. Details of Pay scales/Bonus (including performance)/PF/Gratuity etc.
8. Employment of contract labour – no. of workers, copy of contract.
(iii) Financials
1. Projections of combined operations (existing + proposed) for 5 years including the following:
– Income details including prices
– Cash flow and Balance Sheet
– Capacity utilization details
– Interest calculation – Assn. of rate/Repayment schedule
– Depreciation – Book & I.T.
– Tax
– Tax etc.
– Assumptions w.r.t. cost items
– Commencement of commercial production (Year to be mentioned)
– IT depreciation table for past OR (in case projections have to be prepared)
– Latest provisional accounts with all schedules
– Latest income Tax Depreciation calculation
– Input-Output ration (consumption norms) for each segment alongwith prices and input prices
– Services-wise capacity & Capacity utilization projects for the next 5 years
– Working Capital norms
– Basis for working out various expenses
– Month from which the commercial production will commence for the new project
– IT depreciation table for past.
148 PP-CC&MM
2. Bankers to the Company – name & addresses.
3. Details of Banks Loan, Term Loan, Promissory notes, Hundis, Credit Agreements, Lease, Hire Purchase,
Guarantees or any other evidences of indebtedness, Copies of Sanction letters, Original amount, Interest
rate, Amount outstanding, Repayment schedule.
4. Details of default/reschedulements, if any – copy of correspondence with lenders.
5. Accounts for last 3 years and latest unaudited accounts.
6. Associate/Group Companies’ concerns accounts for last 3 years. Also give: Profile of the concerns.
7. Audited Balance Sheet, P&L Account for last 3 years of the promoter company (i.e. if promoter is a Co.)
8. In case any liabilities are not disclosed in the Balance Sheet, details thereof, or any secret reserves.
9. Age-wise analysis of stocks, debtors, creditors and loans & advances given
10. Terms of various loans & advances given
11. If names of any associates/related units are present in the debtors or parties to whom loans & advances
have been given
12. Details of contingents liabilities including guarantees given by Co./directors
13. Trends in profit ratios.
(iv) Project Information
1. Project Feasibility report
2. Reports/documents prepared by independent research agencies in respect of the state of the industry
and demand and supply for the company’s products
3. Break-up of Cost of Project:
– Land – Locational site & map, area, copy of documents i.e. Sale/lese Deed for land, Soil Test
Report, Order for converting land into Industrial land etc.
– Building – Details break-up from Architect, Approval details from Municipality etc. and Valuation
Report from a chartered engg. (for existing building and suitability of site)
– Equipments – Invoices/Quotations of main items. (Indicate Imported mach. Separately)
– Margin Money for Working Capital – Margin Money for Working Capital (calculation)
– Preliminary & Pre-operative expenses – break-up
– Provision for contingencies – break-up
4. Schedule of Implementation.
5. Status of Project as on a recent date – Amount spent & sources
6. Promoter’s contribution till date (supported by Auditor’s certificate if possible)
7. Current & proposed Shareholding pattern
8. Sanctions received by the issuer from bankers/institutions for debt financing in the project
9. Notes on the following: Technical process, utilities (power, water, transport, effluent treatment), location,
land building, Plant & Machinery).
(a) Manpower
Lesson 5
Primary Market 149
(i) Break-up of employees – whether any agreements are entered into with employee – If so, copy
of agreement
(ii) Details of Pay scales/bonus (including performance bonus)/PF/ Gratuity etc.
(iii) Employment of contract labour – no. of workers, copy of contract.
(b) Quality Control facilities, Research & Development.
10. Market (Demand/supply with sources alongwith copies),
11. Marketing & Distribution (network etc.) & relevant documents wherever applicable.
12. Arrangements and strategy of the company for marketing its products
13. Discussions with important customers, suppliers, Joint Venture partners, collaborators of the company.
(v) General Information
1. Details on Litigation, Disputes, overdue, statuary dues, other Material development and tax status of
Company & promoters.
2. Copies of IT returns of the Company along with copies of Assessment orders for last three years.
3. Copies of IT/Wealth tax returns of the promoters along with copies of Assessment orders for last three
years.
4. Copy of documents for Collaborations/Marketing Tie-ups/Other Tie-ups if any.
5. NOC/Approval/Sanctions from SEB/SPCB or copy of application.
6. Copy of SIA Registration/SSI Regn./EOU License/LOI or License.
7. Incentives if any – such as subsidy, Sales tax loans/exemption/concession/ power subsidy (Copy of
Booklet or notification).
8. List of existing plant & machinery with cost & age & type of ownership (lease etc.)
9. R&D (if any) cost for the project for the last three years. (Sources of any outside R&D funds including
any joint venture agreements)
10. Summary of Bad Debts experience for the last five years.
11. Approvals from company’s Board of Directors/Shareholders to issue securities to the public.
12. Copies of documents filed with Registrar of Companies.
13. Names of stock exchanges where shares of the Co. are listed.
14. Stock Market quotation of share, wherever applicable, as on recent date.
15. Special legislation applicable, if any, and compliance thereof (e.g. NBFCs etc.)
(vi) Third Parties
1. Brochure on collaborators, copy of Government approval for collaboration.
2. Copy of Agreement with Consultants, Copy of Government approval in case of foreign consultants.
3. Copies of important Agreements/Contracts of any sort with all the parties concerned with the company.
4. Copy of FIPB/RBI approvals (NRI/Foreign participant etc.), wherever applicable.
5. Details of Patents, Trademarks, Copyrights, Licenses etc., if any.
6. List of major customers/clients (attach copies of main pending orders).
150 PP-CC&MM
7. Competitors & Market shares for Company’s products (with sources, wherever possible).
8. Sales arrangements, terms & conditions.
9. Main suppliers – terms & conditions.
Pre-issue-Due Diligence Certificates
According to SEBI (ICDR) Regulations, 2009, the lead merchant baker is required to submit due diligence
certificate with SEBI at the time of:– Filing of draft offer document with SEBI.
– At the time of registering prospectus with ROC.
– Immediately before opening of the issue.
– After the opening of the issue and before its closure before it closes for subscription.
Post issue diligence
– The lead merchant banker shall exercise due diligence and satisfy himself about all the aspects of the
issue including the veracity and adequacy of disclosure in the offer documents.
– The lead merchant banker shall call upon the issuer, its promoters or directors or in case of an offer for
sale , the selling shareholders, to fulfil their obligations as disclosed by them in the offer document and
as required in terms of these regulations.
– The post –issue merchant banker shall continue to be responsible for post issue activities till the
subscribers have received the securities certificates, credit to their demat account or refund of application
moneys and the listing agreement is entered into by the issuer with the stock exchanges and listing/
trading permission is obtained.
BASIS OF ALLOTMENT
After the closure of the issue, for e.g a book built public issue, the bids received are aggregated under different
categories i.e 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. Thus allotment to each investor
is done based on proportionate basis in both book built and fixed price public issue.
Example-Allocation to retail Investor
CARE IPO had total 71,99,700 equity shares on offer in the IPO, at an issue price of ` 750 per share. 35% of the
offer was available for allocation to the retail individual bidders in accordance with the SEBI Regulations, which
makes it 25,19,895 equity shares.
When the investors apply for a company’s shares in an IPO, there is a bid ‘lot’ system. With CARE IPO, the bid
lot size was in multiples of 20 shares and the retail investors had the option to apply for a maximum of 13 lots
(260 shares) and a minimum of 1 lot (20 shares). So, the minimum investment in the CARE IPO was ` 15,000
and ` 1,95,000 as the maximum.
Retail investors have been allotted only 20 shares irrespective of their application size i.e. whether they applied
for 20 shares or 260 shares or any number of shares in between, they got only 20 shares allotted in the ratio of
101:256 i.e. only 101 applicants got these 20 shares out of 256 applicants.
Lesson 5
Primary Market 151
Actually, a total of 3,19,350 retail individual applicants applied for it, in varying number of bid lots i.e. between 1
to 13 bid lots and only 1,25,994 applicants got the shares allotted in the ratio of 101:256.
Allocation to Retail Individual Bidders (after technical rejection)
No. of
Shares
Applied
No.of
% of Total
Applications
Received
Total No. of
Equity Shares
Applied
% of
Total
No. of
Equity
Shares
Allocated
Ratio of
Allottees to
Applicants
Total No. of
Equity
Shares
Allocated
20
245680
76.93
4913600
32.58
20
101:256
1938580
40
15853
4.96
634120
4.20
20
101:256
125100
60
9199
2.88
551940
3.66
20
101:256
72580
80
4505
1.41
360400
2.39
20
101:256
35540
100
5832
1.83
583200
3.87
20
101:256
46020
120
7892
2.47
947040
6.28
20
101:256
62280
140
3831
1.20
536340
3.56
20
101:256
30220
160
1223
0.38
195680
1.30
20
101:256
9660
180
657
0.21
118260
0.78
20
101:256
5180
200
2324
0.73
464800
3.08
20
101:256
18340
220
480
0.15
105600
0.70
20
101:256
3780
240
843
0.26
202320
1.34
20
101:256
6660
260
21031
6.59
5468060
36.26
20
101:256
165940
Total
319350
100
15081360
100
N.A.
N.A.
2519880
In the table above, there were 2,45,680 applicants who applied for 20 shares with each of their applications. Out
of these 2,45,680 applicants, 96,929 applicants have been allotted 20 shares each or total of 19,38,580 shares.
2,45,680 * 101/256 = 96,929 * 20 shares = 19,38,580
Similarly, 15,853 * 101/256 = 6,255 * 20 shares = 1,25,100
9,199 * 101/256 = 3,629 * 20 shares = 72,580 and so on.
BOOK BUILDING
Book Building means a process undertaken to elicit demand and to assess the price for determination of the
quantum or value of specified securities or Indian Depository Receipts, as the case may be.
The book building process in India is very transparent. All investors including small investors can see on an
hourly basis where the book is being built before applying. According to this method, share prices are determines
on the basis of real demand for the shares at various price levels in the market.
1. An issuer company may, subject to the requirements specified make an issue of securities to the public
through a prospectus through 100% of the net offer to the public through book building process.
2. Reservation to the extent of percentage specified in these Regulations can be made only to the following
categories:
152 PP-CC&MM
(a) employees and in case of a new issuer, persons who are in permanent and full time employment
of the promoting companies excluding the promoter and the relative of promoter of such
companies
(b) ‘shareholders of the listed promoting companies in the case of a new company and shareholders of
listed group companies in the case of an existing company’ on a ‘competitive basis’ or on a ‘firm
allotment basis’ excluding promoters. However, if the promoting companies are designated financial
institutions or state or central financial institutions, the shareholder of such promoting companies
shall be excluded for this purpose.
(c) persons who, on the date of filing of the draft offer document with SEBI, have business association,
as depositors, bondholders and subscribers to services, with the issuer making an initial public
offering.
However, no reservation can be made for the issue management team, syndicate members, their
promoters, directors and employees and for the group/associate companies of issue management
team and syndicate members and their promoters, directors and employees.
3. The issuer company is required to enter into an agreement with one or more of the Stock Exchange(s)
which have the requisite system of on-line offer of securities. The agreement would cover inter-alia, the
rights, duties, responsibilities and obligations of the company and stock exchange (s) inter se. The
agreement may also provide for a dispute resolution mechanism between the company and the stock
exchange.
The company may also apply for listing of its securities on an exchange other than the exchange through
which it offers its securities to public through the on-line system.
4. The Lead Merchant Banker shall act as the Lead Book Runner.In case the issuer company appoints
more than one merchant banker,the names of all such merchant bankers who have submitted the due
diligence certificate to SEBI, may be mentioned on the front cover page of the prospectus. A disclosure
to the effect that “ the investors may contact any of such merchant bankers, for any complaint pertaining
to the issue” is required to be made in the prospectus, after the “risk factors.
5. The lead book runner/issuer may designate, in any manner, the other Merchant Bankers if the inter-se
allocation of responsibilities amongst the merchant bankers is disclosed in the prospectus on the page
giving the details of the issue management team and a co-ordinator has been appointed amongst the
lead book runners, for the purpose of co-ordination with SEBI. However the names of only those merchant
bankers who have signed the inter-se allocation of responsibilities would be mentioned in the offer
document on the page where the details of the issue management team is given.
6. The primary responsibility of building the book is of the Lead Book Runner. The Book Runner(s) may
appoint those intermediaries who are registered with SEBI and who are permitted to carry on activity as
an ‘Underwriter’ as syndicate members. The Book Runner(s)/syndicate members shall appoint brokers
of the exchange, who are registered with SEBI, for the purpose of accepting bids, applications and
placing orders with the company and ensure that the brokers so appointed are financially capable of
honouring their commitments arising out of defaults of their clients/investors, if any. However, in case of
Application Supported by Blocked Amount, Self Certified Syndicate Banks shall accept and upload the
details of such application in electronic bidding system of the stock exchange.
7. The brokers, and self certified syndicate banks accepting applications and application monies, are
considered as ‘bidding/collection centres’. The broker/s so appointed, shall collect the money from his/
their client for every order placed by him/them and in case the client/investors fails to pay for shares
allocated as per the Regulations, the broker shall pay such amount.
Lesson 5
Primary Market 153
8. In case of Applications Supported by Blocked Amount, the Self Certified Syndicate Banks shall
follow the procedure specified by SEBI in this regard. The company shall pay to the broker/s/
Self Certified Syndicate Banks a commission/fee for the services rendered by him/them. The
exchange shall ensure that the broker does not levy a service fee on his clients/investors in lieu of
his services.
The draft prospectus containing all the disclosures except that of price and the number of securities to
be offered to the public shall be filed by the Lead Merchant Banker with SEBI. The total size of the issue
shall be mentioned in the draft prospectus
9. The red herring prospectus shall disclose, either the floor price of the securities offered through it or a
price band along with the range within which the price can move, if any.
However, the issuer may not disclose the floor price or price band in the red herring prospectus if the
same is disclosed in case of an initial public offer, at least two working days before the opening of the bid
and in case of a further public offer, at least one working day before the opening of the bid, by way of an
announcement in all the newspapers in which the pre-issue advertisement was released by the issuer
or the merchant banker;
Further, the announcement shall contain the relevant financial ratios, computed for both upper and
lower end of the price band and also a statement drawing attention of the investors to the section titled
“basis of issue price” in the offer document.
Where the issuer opts not to make the disclosure of the price band or floor price in the red-herring
prospectus in terms of the foregoing proviso, the following shall be additionally disclosed in the redherring prospectus:
(a) a statement that the floor price or price band, as the case may be, shall be disclosed atleast two
working days (in case of an initial public offer) and atleast one working day (in case of a further
public offer) before the opening of the bid;
(b) a statement that the investors may be guided in the meantime by the secondary market prices in
case of public offer;
(c) names and editions of the newspapers where the announcement of the floor price or price band
would be made;
(d) names of websites (with address), journals or other media in which the said announcement will be
made.
Where the issuer decides to opts for price band instead of floor price, the lead book runner shall ensure
compliance with the following conditions:
(a) The cap of the price band should not be more than 20% of the floor of the band; i.e., cap of the price
band shall be less than or equal to 120% of the floor of the price band.
(b) The price band can be revised during the bidding period in which case the maximum revision on
either side shall not exceed 20% i.e floor of price band can move up or down to the extent of 20% of
floor of the price band disclosed in the red herring prospectus and the cap of the revised price band
will be fixed in accordance with Clause (a) above;
(c) Any revision in the price band shall be widely disseminated by informing the stock exchanges, by
issuing press release and also indicating the change on the relevant website and the terminals of
the syndicate members.
154 PP-CC&MM
(d) In case the price band is revised, the bidding period shall be extended for a further period of three
days, subject to the total bidding period not exceeding ten working days.
(e) The manner in which the shortfall, if any, in the project financing, arising on account of lowering of
price band to the extent of 20% will be met shall be disclosed in the red herring prospectus. It shall
also be disclosed that the allotment shall not be made unless the financing is tied up.
10. In case of appointment of more than one Lead Merchant Banker or Book Runner for book building, the
rights, obligations and responsibilities of each should be delineated. In case of an under subscription in
an issue, the shortfall shall have to be made good by the Book Runner(s) to the issue and the same
shall be incorporated in the inter se allocation of responsibility as provided in the Regulations.
11. The issuer company shall circulate the application forms to the Brokers.
12. The pre-issue obligations and disclosure requirements shall be applicable to issue of securities through
book building unless stated otherwise in these regulations.
13. The Book Runner(s) and the issuer company shall determine the issue price based on the bids received
through the ‘Syndicate Members’ and ‘Self Certified Syndicate Banks’.
14. Retail individual investors may bid at “cut off” price instead of their writing the specific bid prices in the
bid forms.
15. On determination of the price, the number of securities to be offered shall be determined i.e. issue size
divided by the price which has been determined.
16. Once the final price (cut-off price) is determined all those bidders whose bids have been found to be
successful shall become entitle for allotment of securities.
17. No incentive, whether in cash or kind, shall be paid to the investors who have become entitled for
allotment of securities.
18. The broker may collect an amount to the extent of 100% of the application money as margin money
from the clients/investors before he places an order on their behalf. The margin collected shall be
uniform across all categories of investors.
19. Bids for securities beyond the investment limit prescribed under relevant laws shall not be accepted by
the syndicate members/brokers from any category of clients/investors.
20. The lead book runner may reject a bid placed by a Qualified Institutional Buyer for reasons to be recorded
in writing provided that such rejection shall be made at the time of acceptance of the bid and the
reasons therefor shall be disclosed to the bidders. Necessary disclosures in this regard shall also be
made in the offer document.
21. On determination of the entitlement, the information regarding the same i.e. the number of securities
which the investor becomes entitled shall be intimated immediately to the investors.
22. The final prospectus containing all disclosures as per SEBI ICDR Regulations including the price and
the number of securities proposed to be issued shall be filed with the Registrar of Companies.
23. Arrangement shall be made by the issuer for collection of the applications by appointing mandatory
collection centres as per these Regulations.
24. The bidding terminals shall contain a online graphical display of demand and bid prices updated at
periodic intervals not exceeding 30 minutes. The book running lead manager shall ensure the availability
of adequate infrastructure with syndicate members for data entry of the bids in a timely manner.
Lesson 5
Primary Market 155
25. The investors who had not participated in the bidding process or have not received intimation of entitlement
of securities may also make an application.
Example
Let's take an example.
Number of shares issued by the company = 100.
Price band = ` 30 - ` 40.
Now let's check what individuals have bid for.
Bid
Number of shares
Price per share
1
20
` 40
2
10
` 38
3
20
` 37
4
30
` 36
5
20
` 35
6
20
` 33
7
20
` 30
The shares will be sold at the Bid 5 price of 20 shares for ` 35.
Because Bidders 1 to 5 are willing to pay at least ` 35 per share. The total bids from Bidders 1 to 5 ensure all
100 shares will be sold (20 + 10 + 20 + 30 + 20). The cut-off price is therefore Bid 5's price = ` 35.
Bidders 1 to 5 get allotments at that price. Bidders 6 and 7 don't get an allotment because their bids are below
the cut-off price. On allotment, the extra amount paid will be refunded to the investor. Since the cut-off price is `
35, the 10 shares will cost ` 350 (10 x ` 35). The balance ` 50 will be refunded to the investor.
BOOK BUILDING PROCESS THROUGH A FLOWCHART
Issuer Company
Agreement with Stock Exchange
for online offer of securities
Application for In-principle
Approval
Appoints Lead Book Runners/Co
Book Runners
Lead Merchant Banker (LMB) to
act as Lead Book Runner. If more
than one LBM/LBR, inter-se,
allocation of Responsibilities to
be decided
156 PP-CC&MM
LBR Appoints Syndicate Numbers
(SN)
LBR/SN to underwrite/sub
underwrite
LBR/SN to finalise Bidding/
Collection Centres who are either
SEBI Regd. Stock Broker
Self certified Syndicate Bank
(for ASBA facility)
Filing of Draft offer document with
SEBI
Red Herring Prospectus with ROC
Pre issue Advertisement
Issue opens
Investor submits forms at bidding
centres
Electronic Bidding Process
Determination of price
Registration of final prospectus
with RoC
Allocation/Manner of Allotment
Application for Listing
Bidding and allocation for Anchor
Investors one day before opening
of issue
Lesson 5
Primary Market 157
ADDITIONAL DISCLOSURES IN CASE OF BOOK BUILDING
Apart from meeting the disclosure requirements as specified in SEBI ICDR Regulations, the following disclosures
shall be suitably made:
(i) The particulars of syndicate members, brokers, self certified syndicate banks, registrars, bankers to the
issue, etc.
(ii) The following statement shall be given under the ‘basis for issue price’:
“The issue price has been determined by the Issuer in consultation with the Book Runner(s), on the
basis of assessment of market demand for the offered securities by way of Book-building.”
(iii) The following accounting ratios shall be given under the basis for issue price for each of the accounting
periods for which the financial information is given:
1. EPS, pre-issue, for the last three years (as adjusted for changes in capital).
2. P/E pre-issue
3. Average return on net-worth in the last three years.
4. Net-Asset value per share based on last balance sheet.
5. Comparison of all the accounting ratios of the issuer company as mentioned above with the industry
average and with the accounting ratios of the peer group (i.e companies of comparable size in the
same industry. (Indicate the source from which industry average and accounting ratios of the peer
group has been taken)
6. The accounting ratios disclosed in the offer document shall be calculated after giving effect to the
consequent increase of capital on account of compulsory conversions outstanding, as well as on
the assumption that the options outstanding, if any, to subscribe for additional capital shall be
exercised)
(iv) The proposed manner of allocation among respective categories of investors, in the event of under
subscription.
Procedure for Bidding
The process of bidding should be in compliance of the following requirements:
(a) Bidding process shall be only through an electronically linked transparent bidding facility provided by
recognised stock exchange(s).
(b) The lead book runner shall ensure the availability of adequate infrastructure with syndicate members
for data entry of the bids in a timely manner.
(c) The syndicate members shall be present at the bidding centres so that at least one electronically linked
computer terminal at all the bidding centres is available for the purpose of bidding.
(d) During the period the issue is open to the public for bidding, the applicants may approach the stock
brokers of the stock exchange/s through which the securities are offered under on-line system or Self
Certified Syndicate Banks, as the case may be, to place an order for bidding for the specified securities.
(e) Every stock broker shall accept orders from all clients/investors who place orders through him and
every Self Certified Syndicate Bank shall accept Applications Supported by Blocked Amount from ASBA
investors.
(f) Applicants who are qualified institutional buyers shall place their bids only through the stock brokers
who shall have the right to vet the bids;
158 PP-CC&MM
(g) The bidding terminals shall contain an online graphical display of demand and bid prices updated at
periodic intervals, not exceeding thirty minutes.
(h) At the end of each day of the bidding period, the demand including allocation made to anchor investors,
shall be shown graphically on the bidding terminals of syndicate members and websites of recognised
stock exchanges offering electronically linked transparent bidding facility, for information of public.
(i) The retail individual investors may either withdraw or revise their bids until finalization of allotment.
(j) The issuer may decide to close the bidding by qualified institutional buyers one day prior to the closure
of the issue subject to the following conditions:
(i) bidding shall be kept open for a minimum of three days for all categories of applicants;
(ii) disclosures are made in the red herring prospectus regarding the issuer’s decision to close the
bidding by Qualified Institutional Buyers one day prior to closure of issue.
(k) The Qualified Institutional Buyers and the non-institutional investors shall neither withdraw nor lower
the size of their bids at any stage .
(l) The identity of Qualified Institutional Buyers making the bidding shall not be made public.
(m) The stock exchanges shall continue to display on their website, the data pertaining to book built issues
in an uniform format, inter alia giving category-wise details of bids received, for a period of at least three
days after closure of bids.
Alternate Method of Book Building
In case of further public offers, the issuer may opt for an alternate method of book building, subject to the
following:
(a) Issuer shall follow the procedure laid down in Part A of Schedule XI of SEBI (ICDR) Regulations, 2009.
(b) The issuer may mention the floor price in the red herring prospectus or if the floor price is not mentioned
in the red herring prospectus, the issuer shall announce the floor price at least one working day before
opening of the bid in all the newspapers in which the pre-issue advertisement was released.
(c) Qualified Institutional Buyers shall bid at any price above the floor price.
(d) The bidder who bids at the highest price shall be allotted the number of securities that he has bided for
and then the bidder who has bided at the second highest price and so on, until all the specified securities
on offer are exhausted.
(e) Allotment shall be on price priority basis for qualified institutional buyers.
(f) Allotment to retail individual investors, non-institutional investors and employees of the issuer shall be
made proportionately .
(g) Where, however the number of specified securities bided for at a price is more than available quantity,
then allotment shall be done on proportionate basis.
(h) Retail individual investors, non-institutional investors and employees shall be allotted specified securities
at the floor price.
(i) The issuer may:(A) place a cap either in terms of number of specified securities or percentage of issued capital of the
issuer that may be allotted to a single bidder;
(B) decide whether a bidder be allowed to revise the bid upwards or downwards in terms of price and/
or quantity;
Lesson 5
Primary Market 159
(C) decide whether a bidder be allowed single or multiple bids.
GREEN SHOE OPTION FACILITY
“Green Shoe Option” means an option of allocating shares in excess of the shares included in the public issue
and operating a post-listing price stabilizing mechanism in accordance with the provisions of Regulation 45 of
SEBI (ICDR) Regulations, 2009.
GSO in the system of IPO using book-building method was recognised by SEBI in India through its new guidelines
on 14th August 2003 (vide SEBI/ CFD/DIL/DIP/ Circular No. 11). ICICI bank was the first to use Green Shoe
Option in its public issue through book building mechanism in India.
A company desirous of availing this option, should in the resolution of the general meeting authorising the public
issue, seek authorisation also for the possibility of allotment of further shares to the ‘Stabilising Agent’ (SA) at the
end of the stabilisation period. The company should appoint one of the merchant bankers or book runners,
amongst the issue management team, as the “stabilising agent” (SA), who will be responsible for the price
stabilisation process, if required. The SA shall enter into an agreement with the issuer company, prior to filing of
offer document with SEBI, clearly stating all the terms and conditions relating to this option including fees
charged/expenses to be incurred by SA for this purpose.
The SA should also enter into an agreement with the promoter(s) or pre-issue shareholders who will lend their
shares under the provisions of this scheme, specifying the maximum number of shares that may be borrowed
from the promoters or the shareholders, which shall not be in excess of 15% of the total issue size.
The details of the agreements mentioned above should be disclosed in the draft prospectus, the draft Red
Herring prospectus, Red Herring prospectus and the final prospectus. The agreements should also be included
as material documents for public inspection. The lead merchant banker or the Lead Book Runner, in consultation
with the SA, shall determine the amount of shares to be over-allotted with the public issue, subject to the
maximum number specified above.
The draft prospectus, draft Red Herring prospectus, the Red Herring prospectus and the final prospectus should
contain the following additional disclosures:
(a) Name of the SA.
(b) The maximum number of shares (as also the percentage vis-a-vis the proposed issue size) proposed to
be over-allotted by the company.
(c) The period, for which the company proposes to avail of the stabilisation mechanism.
(d) The maximum increase in the capital of the company and the shareholding pattern post issue, in case
the company is required to allot further shares to the extent of over-allotment in the issue.
(e) The maximum amount of funds to be received by the company in case of further allotment and the use
of these additional funds, in final document to be filed with ROC.
(f) Details of the agreement/arrangement entered into by SA with the promoters to borrow shares from the
latter which inter alia shall include name of the promoters, their existing shareholding, number and
percentage of shares to be lent by them and other important terms and conditions including the rights
and obligations of each party.
(g) The final prospectus shall additionally disclose the exact number of shares to be allotted pursuant to the
public issue, stating separately therein the number of shares to be borrowed from the promoters and
over-allotted by the SA, and the percentage of such shares in relation to the total issue size.
In case of an initial public offer by a unlisted company, the promoters and pre-issue shareholders and in case of
public issue by a listed company, the promoters and pre-issue shareholders holding more than 5% shares, may
160 PP-CC&MM
lend the shares subject to the provisions of this scheme. The SA should borrow shares from the promoters or
the pre-issue shareholders of the issuer company or both, to the extent of the proposed over-allotment. However,
the shares so referred shall be in dematerialized form only.
The allocation of these shares should be on pro rata basis to all the applicants.
The stabilisation mechanism should be available for the period disclosed by the company in the prospectus,
which shall not exceed 30 days from the date when trading permission was given by the exchange(s).
The SA should open a special account with a bank to be called the “Special Account for GSO proceeds of………
company” (hereinafter referred to as the GSO Bank Account) and a special account for securities with a depository
participant to be called the “Special Account of GSO shares of……….. company” (hereinafter referred to as the
GSO Demat Account).
The money received from the applicants against the over-allotment in the green shoe option should be kept in
the GSO Bank Account, distinct from the issue account and shall be used for the purpose of buying shares from
the market, during the stabilisation period.
The shares bought from the market by the SA, if any during the stabilisation period, should be credited to the
GSO Demat Account.
The shares bought from the market and lying in the GSO Demat Account should be returned to the promoters
immediately, in any case not later than 2 working days after the close of the stabilisation period.
The prime responsibility of the SA should be to stabilise post listing price of the shares. To this end, the SA
should determine the timing of buying the shares, the quantity to be bought, the price at which the shares are to
be bought etc.
On expiry of the stabilisation period, in case the SA does not buy shares to the extent of shares over-allotted by
the company from the market, the issuer company shall allot shares to the extent of the shortfall in dematerialized
form to the GSO Demat Account, within five days of the closure of the stabilisation period. These shares shall be
returned to the promoters by the SA in lieu of the shares borrowed from them and the GSO Demat Account shall
be closed thereafter. The company shall make a final listing application in respect of these shares to all the
exchanges where the shares allotted in the public issue are listed. The provisions relating to preferential issues
shall not be applicable to such allotment.
The shares returned to the promoters as above, as the case may be, shall be subject to the remaining lock-inperiod as provided in lock-in or pre-issue share capital of an unlisted company.
The SA shall remit an amount equal to (further shares allotted by the issuer company to the GSO Demat
Account) (issue price) to the issuer company from the GSO Bank Account. The amount left in this account, if
any, after this remittance and deduction of expenses incurred by the SA for the stabilisation mechanism, shall be
transferred to the investor protection fund(s) established by SEBI. The GSO Bank Account shall be closed soon
thereafter.
The SA should submit a report to the stock exchange(s) on a daily basis during the stabilisation period. The SA
should also submit a final report to SEBI in the format specified in Schedule XII. This report shall be signed by
the SA and the company. This report shall be accompanied with a depository statement for the “GSO Demat
Account” for the stabilisation period, indicating the flow of the shares into and from the account. The report shall
also be accompanied by an undertaking given by the SA and countersigned by the depository(ies) regarding
confirmation of lock-in on the shares returned to the promoters in lieu of the shares borrowed from them for the
purpose of the stabilisation.
The SA shall maintain a register in respect of each issue having the green shoe option in which he acts as a SA.
The register shall contain the following details of:
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– in respect of each transaction effected in the course of the stabilising action, the price, date and time.
– the details of the promoters from whom the shares are borrowed and the number of shares borrowed
from each; and
– details of allotments made.
The register must be retained for a period of at least three years from the date of the end of the stabilising period.
For the aforesaid, over allotment shall mean an allotment or allocation of shares in excess of the size of a public
issue, made by the SA out of shares borrowed from the promoters or the pre-issue shareholders or both, in
pursuance of green shoe option exercised by the company in accordance with the provisions of the scheme.
ILLUSTRATION
Consider a company planning an IPO of say, 100,000 shares, at a book-built price of ` 100/-, resulting in an IPO
size of ` 100,00,000. As per the ICDR Regulations, the over-allotment component under the Green Shoe
mechanism could be up to 15% of the IPO, i.e. up to 15,000 shares, i.e. Green Shoe shares. Prior to the IPO, the
stabilising agent would borrow such number of shares to the extent of the proposed Green Shoe shares from
the pre-issue shareholders. These shares are then allotted to investors along with the IPO shares. The total
shares issued in the IPO therefore stands at 115,000 shares. IPO proceeds received from the investors for the
IPO shares, i.e. `100,00,000–100,000 shares at the rate of R100 each, are remitted to the Issuer Company,
while the proceeds from the Green Shoe Shares (` 15,00,000/-, being 15,000 shares x ` 100/-) are parked in a
special escrow bank account, i.e. Green Shoe Escrow Account. During the price stabilisation period, if the
share price drops below ` 100, the stabilising agent would utilise the funds lying in the Green Shoe Escrow
Account to buy these back shares from the open market. This gives rise to the following three situations:
– Situation #1 - where the stabilising agent manages to buyback all of the Green Shoe Shares, i.e.,15,000 shares;
– Situation #2 - where the stabilising agent manages to buyback none of the Green Shoe Shares;
– ituation #3 - where the stabilising agent manages to buy-back some of the Green Shoe Shares, say 10,000
shares.
Let us examine each of these situations separately:
Situation #1 – where all Green Shoe Shares are bought back: In this situation, funds in the Green Shoe Escrow
Account (` 15,00,000, in this case) would be deployed by the stabilising agent towards buying up shares from
the open market. Given that the prices prevalent in the market would be less than the issue price of ` 100, the
stabilising agent would have sufficient funds lying at his disposal to complete this operation. Having bought back
all of the 15,000 shares, these shares would be temporarily held in a special depository account with the
depository participant (Green Shoe Demat Account), and would then be returned back to the lender shareholders,
within a maximum period of two days after the stabilisation period.
Situation #2 – where none of the Green Shoe Shares are bought back: This situation would arise in the (very
unlikely) event that the share prices have fallen below the Issue Price, but the stabilising agent is unable to find
any sellers in the open market, or in an event where the share prices continue to trade above the listing price,
and therefore there is no need for the stabilising agent to indulge in price stabilisation activities. In either of the
above-said situations, the stabilising agent is under a contractual obligation to return the 15,000 shares that had
initially been borrowed from the lending shareholder(s). Towards meeting this obligation, the issuer company
would allot 15,000 shares to the stabilising agent into the Green Shoe Demat Account (the consideration being
the funds lying the Green Shoe Escrow Account), and these shares would then be returned by the stabilising
agent to the lending shareholder(s), thereby squaring off his responsibilities.
Situation #3 – where some of the Green Shoe Shares are bought back, say 10,000 shares: This situation could
arise in an event where the share prices witness a drop in the initial stages of the price stabilisation period, but
162 PP-CC&MM
recover towards the latter stages. In this situation, the stabilising agent has a responsibility to return 15,000
shares to the lending shareholder(s), whereas the stabilising activities have yielded only 10,000 shares.
Similar to the instance mentioned in Situation #2 above, the issuer company would allot the differential 5,000
shares into the Green Shoe Demat Account to cover up the shortfall, and the Stabilising Agent would discharge
his obligation to the lending shareholder(s) by returning the 15,000 shares that had been borrowed from them.
Both in Situation #2 and #3, the issuer company would need to apply to the exchanges for obtaining listing/
trading permissions for the incremental shares allotted by them, pursuant to the Green Shoe mechanism.
Any surplus lying in the Green Shoe Escrow Account would then be transferred to the Investor Protection and
Education Fund established by SEBI, as required under Regulation 45(9) of the ICDR Regulations and the
account shall be closed thereafter.
GREEN SHOE OPTION PROCESS
Company obtains shareholder approval for exercising Green Shoe Option
Appointment of stabilizing Agent
Agreement with stabilizing Agent
Agreement with promoter for borrowing shares
Opening special Account with Bank and Depository
Company over allots
Commencement of Trading
Yes
Drop in Prices
No
Stabilizing agent process shares
from open market
Issuer allots shares to
stabilizing agent
Shares borrowed are returned
SA return shares
Excess in any transferred
to SEBI IEPF fund
Separate listing application
for shares issued
PRE-ISSUE ACTIVITIES
1. Signing of MoU: Signing of MoU between the client company and the merchant banker-issue management
activities marks the award of the contract.
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2. Obtaining appraisal note: An appraisal note containing he details of the proposed capital outlay of the
project and the sources of funding is either prepared in-house or is obtained from external appraising agencies
viz., financial institutions/banks etc. A project may be funded either by borrowing money from outside agencies
or by injecting capital.
3. Optimum capital structure: The level of capital that would maximize the shareholders value and minimize
the overall cost of capital has to be determined. This has to be done considering the nature and size of the
project. Equity funding is preferable especially when the project is capital intensive.
4. Convening meeting: A meeting of the board of directors of the issuing company is convened. This is followed
by an EGM of its members. The purpose of these meetings is to decide the various aspects related to the issue
of securities. An application to RBI, seeking its permission is made, where capital issue of shares is to be offered
to NRIs/OCBs or FIIs.
5. Appointment financial Intermediary: Financial intermediaries such as Underwriters, Registrars, etc. have
to be appointed. Necessary contracts need to be made with the underwriter to ensure due subscription to offer.
Similar contracts when entered into with the Registrars to an issue, will help in share allotment related work,
appointment of bankers to an issue for handling the collection of applications at various centers, printers for bulk
printing of Issue related stationery, legal advisors and advertising agency. Simultaneously consents from various
experts such as auditors, solicitors, legal advisors etc has to be obtained under Section 58 of the Companies
Act, 1956.
6. Preparing documents: As part of the issue management procedure the documents to be prepared are initial
applications of submission to those stock exchanges where the issuing company intends to get its securities
listed. MoU with the registrar, with bankers to the issue, with advisors to the issue and co-managers to the issue,
agreement for purchase of properties etc. This has to be sent for inclusion in the prospectus.
7. Due diligence certificate: The lead manager issue a due diligence certificate which certifies that the company
has scrupulously followed all legal requirements has exercised utmost care while preparing the offer document
and has made a true fair and adequate disclosures in the draft offer document
8. Submission of offer document: The draft offer document along with the due diligence certificate is filed with
SEBI. The SEBI in turn makes necessary corrections in the offer document and returns the same with relevant
observations, if any within 21 days from the receipt of the offer document.
9. Finalization of collection centers: In order to collect the issue application forms from the prospective investors
to lead manager finalizes the collection centers.
10. Filing with RoC: The offer document completed in all respects after incorporating SEBI observation is filed
with Registrar of Companies (RoC) to obtain acknowledgement.
11. Launching the issue: The process of marketing the issue starts once legal formalities are completed and
statutory permission for issue of capital is obtained. The lead manager has to arrange for the distribution of
public issue stationary to various collecting banks, brokers, investors etc. The issue is opened for public
immediately after obtaining the observation letter from SEBI. Conducting press conferences, brokers’ meets,
issuing advertisements in various newspapers and mobilizing brokers and sub-brokers marks the launching of
a public issue. The announcement regarding opening of issue is also required to be made through advertising in
newspapers, 10 days before the opening of the public issue.
12. Promoters’ contribution: A certificate to the effect that the required contribution of the promoters has been
raised before opening the issue, has to be obtained from a Chartered Accountant, and duly filed with SEBI.
13. Issue closure: An announcement regarding the closure of the issue should be made in the newspaper.
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RIGHTS ISSUE
Rights issue as identified in the SEBI ICDR Regulations is an issue of capital under Section 81(1) of the Companies
Act, 1956 to be offered to the existing shareholders of the company through a letter of offer. This regulation is not
applicable to the rights issue where the aggregate value of securities offered does not exceed ` 50 lakhs.
– A listed issuer company can not make any rights issue of securities, where the aggregate value of such
securities, including premium, if any, exceeds ` 50 lakhs unless a draft letter of offer has been filed with
SEBI, through a Merchant Banker, at least 30 days prior to the filing of the letter of offer with the Designated
Stock Exchange (DSE).
However, in case of the rights issue where the aggregate value of the securities offered is less than `50
Lakhs, the company shall prepare the letter of offer in accordance with the disclosure requirements
specified in SEBI ICDR and file the same with SEBI for its information and for being put on the SEBI
website.
– An issuer company can not make any public issue of securities, unless a letter of offer has been filed
with SEBI through a Merchant Banker, at least 30 days prior to the filing of the Prospectus with the
Registrar of Companies (ROC).
However, if SEBI specifies changes or issues observations on letter of offer within 30 days from the date
of receipt of the draft Prospectus by SEBI the issuer company or the Lead Manager to the Issue shall
carry out such changes or comply with the observations issued by SEBI before filing the letter of offer
with ROC.
– SEBI may specify changes or issue observations, if any, on the letter of offer only after receipt of copy of
in-principle approval from all the stock exchanges on which the issuer company intends to list the
securities proposed to be offered through the letter of offer.
– A Company can not make a rights issue of equity share or any security convertible at later date into
equity share, unless all the existing partly paid-up shares have been fully paid or forfeited.
– A company can not make a rights issue of securities unless firm arrangements of finance through
verifiable means towards 75% of the stated means of finance, excluding the amount to be raised through
proposed Public/Rights issue, or through identifiable internal accruals have been made.
– A listed company whose equity shares are listed on a stock exchange, may freely price its equity shares
and any security convertible into equity at a later date, offered through a rights issue.
– In case of a rights issue, issue price or price band may not be disclosed in the draft letter of offer filed
with SEBI. The issue price may be determined anytime before fixation of the record date, in consultation
with the Designated Stock Exchange
– An eligible company shall be free to make public or rights issue of equity shares in any denomination
determined by it in accordance with Sub-section (4) of Section 13 of the Companies Act, 1956 and in
compliance with the following and other norms as may be specified by SEBI from time to time:
– In case of rights issue the promoters shall disclose their existing shareholding and the extent to which
they are participating in the proposed issue, in the offer document.
– A company cannot make an issue of security through a public or rights issue unless a Memorandum of
Understanding has been entered into between a lead merchant banker and the issuer company specifying
their mutual rights, liabilities and obligations relating to the issue.
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– In case a rights issue is managed by more than one Merchant Banker the rights, obligations and
responsibilities of each merchant banker shall be demarcated as specified in Chapter VI.
– In the case of rights issues, lead merchant banker shall ensure that the abridged letters of offer are
dispatched to all shareholders at least three days before the date of opening of the issue.
However, if a specific request for letter of offer is received from any shareholder, the Lead Merchant
Banker shall ensure that the letter of offer is made available to such shareholder.
– A disclosure to the effect that the securities offered through this rights issue shall be made fully paid up
or may be forfeited within 12 months from the date of allotment of securities in the manner specified in
SEBI ICDR Regulations.
– A Company can not make any further issue of capital during the period commencing from the submission
of offer document to SEBI on behalf of the company for rights issues, till the securities referred to in the
said offer document have been listed or application moneys refunded on account of non-listing or under
subscription etc. unless full disclosures regarding the total capital to be raised from such further issues
are made in the draft offer document.
– A Company can not issue any shares by way of rights unless it has made reservation of equity shares
of the same class in favour of the holders of outstanding compulsorily convertible debt instruments ,if
any, in proportion to the convertible part.
– The share so reserved for the holders of fully or partially compulsorily convertible debt instruments shall
be issued at the time of conversion of such convertible debt instruments on the same terms at which the
equity shares offered in the rights issue were issued may be issued at the time of conversion(s) of such
debentures on the same terms on which the rights issue was made.
– The Lead Merchant Banker shall ensure that in case of a rights issue, an advertisement giving the date
of completion of despatch of letters of offer, shall be released in at least in an English National Daily with
wide circulation, one Hindi National Paper and a Regional language daily circulated at the place where
registered office of the issuer company is situated at least 3 days before the date of opening of the issue
– An issuer company shall not withdraw rights issue after announcement of record date in relation to such
issue.
– In cases where the issuer has withdrawn the rights issue after announcing the record date, the issuer
company shall not make an application for listing of any securities of the company for a minimum period
of 12 months from the record date.
However, shares resulting from the conversion of PCDs/ FCDs/ Warrants issued prior to the announcing
of the record date in relation to rights issue may be granted listing by the concerned Stock exchange
– Rights issues shall be kept open for at least 15 days and not more than 30 days.
– The quantum of issue whether through a rights or a public issue, shall not exceed the amount specified
in the prospectus/ letter of offer.
However, an oversubscription to the extent of 10% of the net offer to public is permissible for the purpose
of rounding off to the nearer multiple of 100 while finalising the allotment.
– If the issuer company does not receive the minimum subscription of ninety per cent. of the issue (including
devolvement of underwriters where applicable), the entire subscription shall be refunded to the applicants
within fifteen days from the date of closure of the issue.
166 PP-CC&MM
– If there is delay in the refund of subscription by more than 8 days after the company becomes liable to
pay the subscription amount (i.e. fifteen days after closure of the issue), the issuer company will pay
interest for the delayed period, at rates prescribed under sub-sections (2) and (2A) of Section 73 of the
Companies Act, 1956.
– The time period for finalization of basis of allotment in the rights issues is 15 days from the date of
closure of the issue.
– The issuer company may utilise the funds collected in the rights issue only after the basis of allotment is
finalized.
STEPS INVOLVED IN ISSUE OF RIGHTS SHARES
The various steps involved for issue of rights share are enumerated below:
1. Check whether the rights issue is within the authorised share capital of the company. If not, steps should be
taken to increase the authorised share capital.
2. In case of a listed company, notify the stock exchange concerned the date of Board Meeting at which the
rights issue is proposed to be considered at least 2 days in advance of the meeting.
3. Rights issue shall be kept open for at least 15 days and not more than 30 days.
4. Convene the Board meeting and place before it the proposal for rights issue.
5. The Board should decide on the following matters:
(i) Quantum of issue and the proportion of rights shares.
(ii) Alteration of share capital, if necessary, and offering shares to persons other than existing holders of
shares in terms of Section 81(1A).
(iii) Fixation of record date.
(iv) Appointment of merchant bankers and underwriters (if necessary).
(v) Approval of draft letter of offer or authorisation of managing director/ company secretary to finalise the
letter of offer in consultation with the managers to the issue, the stock exchange and SEBI. The letter of
offer should conform to the disclosures prescribed in Form 2A under Section 56(3) of the Companies
Act (memorandum containing the salient features of prospectus) also contents as specified in SEBI
regulations. Full justification and parameters used for issue price should clearly be mentioned in the
letter of offer.
6. Immediately after the Board Meeting notify the concerned Stock Exchanges about particulars of Board’s
decision.
7. If it is proposed to offer shares to persons other than the shareholders of the company, a General Meeting
has to be convened and a resolution is to be passed for the purpose in terms of Section 81(1A) of the Companies
Act.
8. Forward 6 sets of letter of offer to concerned Stock Exchange(s).
9. Despatch letters of offer to shareholders by registered post.
10. Check that an advertisement giving date of completion of despatch of letter of offer has been released in at
least an English National Daily, one Hindi National Paper and a Regional Language Daily where registered
office of the issuer company is situated.
11. Check that the advertisement contains the list of centres where shareholders or persons entitled to rights
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may obtain duplicate copies of composite application forms in case they do not receive original application form
alongwith the prescribed format on which application may be made.
12. The applications of shareholders who apply both on plain paper and also in a composite application form are
liable to be rejected.
13. Make arrangement with bankers for acceptance of share application forms.
14. Prepare a scheme of allotment in consultation with Stock Exchange.
15. Convene Board Meeting and make allotment of shares.
16. Make an application to the Stock Exchange(s) where the company’s shares are listed for permission of
listing of new shares.
BONUS ISSUE
A company may, if its Articles provide, capitalize its profits by issuing fully-paid bonus shares. The issue of bonus
shares by a company is a common feature. When a company is prosperous and accumulates large distributable
profits, it converts these accumulated profits into capital and divides the capital among the existing members in
proportion to their entitlements. Members do not have to pay any amount for such shares. They are given free.
The bonus shares allotted to the members do not represent taxable income in their hands. [Commissioner of
Income Tax, Madras v. A.A.V. Ramchandra Chettiar (1964) 1 Mad CJ 281]. Issue of bonus shares is a bare
machinery for capitalizing undistributed profits. The vesting of the rights in the bonus shares takes place when
the shares are actually allotted and not from any earlier date.
Advantages of Issuing Bonus Shares
1. Fund flow is not affected adversely.
2. Market value of the Company’s shares comes down to their nominal value by issue of bonus shares.
3. Market value of the members’ shareholdings increases with the increase in number of shares in the company.
4. Bonus shares is not an income. Hence it is not a taxable income.
5. Paid-up share capital increases with the issue of bonus shares.
Pursuant to the provisions of Section 78 of the Companies Act, 1956, securities premium account can be used
in paying up unissued shares of the company to be issued to its members as fully-paid bonus shares. Other free
reserves created from out of the profits actually earned during earlier years like general reserve, capital redemption
reserve account [Section 80(5)], devolvement rebate reserve etc. can be utilised by company for issue of fully
paid bonus shares to its members.
There are no guidelines on issuing bonus shares by private or unlisted companies. However, SEBI has notified
Regulations for Bonus Issue which are contained in Chapter IX of SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 with regard to bonus issues by listed companies.
When a company has accumulated free reserves and is desirous of bridging the gap between the capital and
fixed assets, it issues bonus shares to its equity shareholders. Such an issue would not place any fresh funds in
the hands of the company. On the contrary, after a bonus issue it would become necessary for the company to
earn more to effectively service the increased capital. The shareholder will, however, be benefitted by way of
increased return on investment and increased number of shares in their hands.
The following conditions must be satisfied before issuing bonus shares:
(a) Bonus Issue must be authorised by the articles of the company. Such a provision is generally there in articles
of almost all the companies as they adopt Table A of Schedule 1 of the Companies Act (Regulation 96).
168 PP-CC&MM
(b) Bonus Issue must be sanctioned by shareholders in general meeting on recommendation of the Board
of directors of the company.
(c) Regulations issued by SEBI must be complied with.
(d) Authorised Capital must be increased where necessary.
SEBI Regulations Pertaining to Bonus Issue
1. Rights of FCD/PCD holders
The proposed bonus issue should not dilute the value or rights of the fully or partly convertible debentures.
A company shall not make a bonus issue of equity shares unless it has made reservation of equity shares of the
same class in favour of the holders of outstanding compulsorily convertible debt instruments ,if any, in proportion
to the convertible part thereof.
The equity shares so reserved for the holders of fully or partly compulsorily convertible debt instruments shall be
issued at the time of conversion of such convertible debt instruments on the same terms or same proportion at
which the bonus shares were issued.
2. Out of Free Reserves
The bonus issue is to be made out of free reserves built out of the genuine profits or securities premium collected
in cash only.
3.Revaluation Reserves
The reserves created by revaluation of fixed assets should not be capitalised. These reserves are in fact capital
reserves. However, if the assets are subsequently sold and the profits are realised, such profits could be utilised
for capitalisation purposes. In fact the Government has in the past approved issue of bonus shares out of capital
reserves representing realised capital profits.
4. Bonus Issue not to be in lieu of Dividend
Bonus issue should not be made in lieu of dividend.
5. Fully Paid Shares
If there are any partly paid-up shares outstanding on the date of allotment, these shares should be made fully
paid-up before the bonus issue is made.
6. No Default in respect of Fixed Deposits/Debentures
The company should not have defaulted in the payment of any interest or principal in respect of its fixed deposits,
debt securities issued by it.
7. Statutory Dues of the Employees
The company should not have defaulted in the payment of its statutory dues to the employees such as contribution
to provident fund, gratuity, bonus.
8. Implementation of Proposal within fifteen days
A company which announces bonus should implement bonus issue within fifteen days issue after the approval
of board of directors and does not require shareholders’ approval for capitalisation of profits or reserves for
making bonus issue as per the Articles of Association and shall not have the option of changing the decision.
However, where the company is required to seek shareholders’ approval for capitalisation of profits or reserves
for making bonus issue as per the Articles of Association, the bonus issue should be implemented within two
months from the date of the meeting of the board of directors wherein the decision to announce bonus was
taken subject to shareholders’ approval.
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9. Provision in Articles of Association
The Articles of Association of the Company should provide for capitalisation of reserves and if not a General
Body Meeting of the company is to be held and a special resolution making provisions in the Articles of Association
for capitalisation should be passed.
10. Authorised Capital
If consequent upon the issue of bonus shares, the subscribed and paid-up capital of the company exceed the
authorised share capital, a General Meeting of the company should be held to pass necessary resolution for
increasing the authorised capital.
Steps involved in Issue of Bonus Shares
A company issuing bonus shares should ensure that the issue is in conformity with the Regulations for bonus
issue laid down by SEBI (ICDR) Regulations, 2009.
The procedure for issue of bonus shares by a listed company is enumerated below:
1. Ensure that if conversion of FCDs/PCDs is pending, similar benefit has been extended to the holders of
such FCDs/PCDs, through reservation of shares in proportion of such convertible part of FCDs/PCDs.
The shares so reserved may be issued at the time of conversion(s) of such debentures on the same
terms on which the bonus issue was made.
2. Ensure that bonus issue has been made out of free reserves built out of the genuine profits or securities
premium collected in cash only.
3. Ensure that reserves created by revaluation of fixed assets are not capitalised.
4. Ensure that the company has not defaulted in payment of interest or principal in respect of fixed deposits
or debt securities issued by it or in respect of the payment of statutory dues of the employees such as
contribution to provident fund, gratuity, bonus etc.
5. Ensure that the bonus issue is not made in lieu of dividend.
6. There should be a provision in the articles of association of the company permitting issue of bonus
shares; if not, steps should be taken to alter the articles suitably.
7. The share capital as increased by the proposed bonus issue should be well within the authorised capital
of the company; if not, necessary steps have to be taken to increase the authorised capital.
8. Finalise the proposal and fix the date for the Board Meeting for considering the proposal and for authorising
the taking up of incidental and attendant matters.
9. If there are any partly paid-up shares, ensure that these are made fully paid-up before the bonus issue
is recommended by the Board of directors.
10. The date of the Board Meeting at which the proposal for bonus issue is proposed to be considered
should be notified to the Stock Exchange(s) where the company’s shares are listed.
11. Hold the Board Meeting and get the proposal approved by the Board.
12. The resolution to be passed at the General Meeting should also be approved by the Board in its meeting.
The intention of the Board regarding the rate of dividend to be declared in the year after the bonus issue
should be indicated in the resolution for bonus issue to be passed by members in general meeting.
13. Immediately after the Board meeting intimate the Stock Exchange(s) regarding the outcome of the
Meeting.
14. Ensure that the company has announced bonus issue after the approval of Board of Directors and did not
170 PP-CC&MM
require shareholders’ approval for capitalization of profits or reserves for making bonus issue as per the
Article of Association, had implemented bonus issue within fifteen days from the date of approval of the
issue by the board of directors of the company and must not have the option of changing the decision.
However, where the company was required to seek shareholders’ approval for capitalization of profits or
reserves for making bonus issue as per the Article of Association, the bonus issue has implemented
within two months from the date of the meeting of the Board of Directors where in the decision to
announce bonus was taken subject to shareholders’ approval.
15. Arrangements for convening the general meeting should then be made keeping in view the requirements
of the Companies Act, with regard to length of notice, explanatory statement etc. Also three copies of
the notice should be sent to the Stock Exchange(s) concerned.
16. Hold the general meeting and get the resolution for issue of bonus shares passed by the members. A
copy of the proceedings of the meeting is to be forwarded to the concerned Stock Exchange(s).
17. In consultation with the Regional Stock Exchange fix the date for closure of register of members or
record date and get the same approved by the Board of directors. Issue a general notice under Section
154 of Companies Act in respect of the fixation of the record date in two newspapers one in English
language and other in the language of the region in which the Registered Office of the company is
situated.
18. Give 7 days notice to the Stock Exchange(s) concerned before the date of book closure/record date.
19. After the record date process the transfers received and prepare a list of members entitled to bonus
shares on the basis of the register of members as updated. This list of allottees is to be approved by the
Board or any Committee thereof. The list usually serves as allotment list and on this basis the allotment
is to be made to the eligible members.
20. File return of allotment with the Registrar of Companies within 30 days of allotment (Section 75 of the
Companies Act). Also intimate Stock Exchange(s) concerned regarding the allotments made.
21. Ensure that the allotment is made within fifteen days of the date on which the Board of directors approved
the bonus issue.
22. Submit an application to the Stock Exchange(s) concerned for listing the bonus shares allotted.
PREFERENTIAL ISSUE
Preferential issue means issuance of equity shares to promoter group or selected investors. It covers allotment
of fully convertible debentures, partly convertible debentures or any other financial instruments that could be
converted into equity shares at a later date. The investors could be institutional investors, private equity investors,
high net-worth individuals, or companies.
Preferential issue is one of the key sources of funding for companies. It has its own advantages and disadvantages.
One of the biggest advantages of a preferential issue is that the company can raise money quickly and cheaply
compared with other means of raising money, say IPO or issue of shares on a rights basis.
On the other hand, preferential issues and private placement is only for selected class of investors and not for
the retail investors. It is like a wholesale market, where institutions with financial clout are allowed to participate.
This deprives investment opportunity to the retail investors.
SEBI ICDR Regulations, 2009 Pertaining to Preferential Issue
1. Applicability
The preferential issue of equity shares/Fully Convertible Debentures (FCDs)/ Partly Convertible Debentures
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(PCDs) or any other financial instruments which would be converted into or exchanged with equity shares at a
later date, by listed companies whose equity share capital is listed on any stock exchange, to any select group
of persons under Section 81(1A) of the Companies Act 1956 on private placement basis is governed by these
Regulations.
2. Pricing of the issue
(i) Where the equity shares of the company have been listed on a stock exchange for a period of twenty six
weeks or more as on the relevant date, the issue of equity shares on preferential basis is being made at
a price not less than higher of the following:
(a) The average of the weekly high and low of the closing prices of the related equity shares quoted on
the stock exchange during the twenty six weeks preceding the relevant date;
OR
(b) The average of the weekly high and low of the closing prices of the related equity shares quoted on
a stock exchange during the two weeks preceding the relevant date.
(ii) Where the equity shares of a company have been listed on a stock exchange for a period of less than
twenty six weeks as on the relevant date, the issue of shares on preferential basis has been made at a
price not less than the higher of the following:
(a) The price at which shares were issued by the company in its IPO or the value per share arrived at
in a scheme of arrangement under Section 391 to 394 of the Companies Act, 1956, pursuant to
which shares of the company were listed , as the case may be;
OR
(b) The average of the weekly high and low of the closing prices of the related shares quoted on the
stock exchange during the period shares have been listed preceding the relevant date;
OR
(c) The average of the weekly high and low of the closing prices of the related shares quoted on a stock
exchange during the two weeks preceding the relevant date.”
W here the price of the equity shares is determined in terms of provision (ii), such price shall be recomputed
by the issuer on completion of twenty six weeks from the date of listing on a recognized stock exchange
with reference to the average of weekly high and low of the closing prices of the related equity shares
quoted on the recognized stock exchange during these twenty six weeks and if such recomputed price
is higher than the price paid on allotment, the difference shall be paid by the allottees to the issuer.
An issue of shares on preferential basis to Qualified Institutional Buyers not exceeding five in numbers
all be made at a price not less than the average of the weekly high and low of the closing prices of the
related shares quoted on a stock exchange during the two weeks preceding the relevant date.
Relevant date means the date thirty days prior to the date on which the meeting of general
body of shareholders is held, in terms of Section 81(1A) of the Companies Act, 1956.
3. Upfront Payment on warrants
(i) A an amount equivalent to at least twenty five per cent of price of shares fixed should be paid on the date
of their allotment.
(ii) This amount would be adjusted against the price payable subsequently on acquisition of shares by
exercising an option for the purpose.
(iii) If the option to acquire shares is not exercised, the amount so paid would stand forfeited.
172 PP-CC&MM
4. Disclosures
The explanatory statement to the notice for the general meeting contains the details about the objects of the
issue through preferential offer, intention of promoters/directors/key management persons to subscribe to the
offer, shareholding pattern before and after the offer, proposed time within which the allotment shall be complete,
identity of the proposed allottees and the percentage of post-preferential issue capital that may be held by them.
5. Tenure of Convertible Securities
The tenure of the convertible securities of the issuer does not exceed beyond 18 months from the date of their
allotment.
6. Lock-in-period
(i) The specified securities allotted on a preferential basis to the promoter or promoter group and the equity
shares allotted to such promoter or promoter group pursuant to exercise of options attached to warrants
issued on preferential basis are subjected to lock in period of three years from the date of their allotment.
However, not more than 20% of the total capital of the company, should be locked in for a period of three
years from the date of allotment.
Further the equity shares allotted in excess of twenty percent pursuant to exercise of options attached
to warrants issued on preferential basis to promoter/promoter group of the issuer, should be locked-in
for a period of one year from the date of their allotment
(ii) The specified securities allotted on preferential basis and the equity shares allotted pursuant to exercise
of options attached to warrants issued on preferential basis to any person other than the promoter/
promoter group of the issuer should be locked in for a period of one year from the date of their allotment.
(iii) Shares acquired by conversion of the convertible instruments other than warrants should be locked in for a
period as reduced by the extent the convertible instrument other than warrants have already been locked in.
(iv) The lock-in period in respect of shares issued on preferential basis pursuant to a scheme approved
under Corporate Debt Restructuring framework of Reserve Bank of India, shall commence from the
date of allotment and has been continued for a period of one year and in case of allotment of partly paid
up shares the lock-in period shall commence from the date of allotment and continue for a period of one
year from the date when shares become fully paid up.
(v) No listed company shall make preferential issue of equity shares/ warrants/ convertible instruments to
any person unless the entire shareholding of such persons in the company, if any, is held by him in
dematerialized form.
(vi) The entire pre preferential allotment shareholding of such allottees shall be under lock-in from the
relevant date upto a period of six months from the date of preferential allotment.
(vii) The shares/ warrants/ convertible instruments shall be issued on preferential basis, the shareholders
who have sold their shares during the six months period prior to the relevant date shall not be eligible for
allotment of shares on preferential basis.
7. Allotment Pursuant to Shareholders Resolutions
(i) Allotment pursuant to any resolution passed at a meeting of shareholders of a company granting consent
for preferential issues of any financial instrument shall be completed within a period of fifteen days from
the date of passing of the resolution.
However, where any application for exemption for the allotment on preferential basis is pending on
account of pendency of any approval of such allotment by any regulatory authority or the Central
Government; the allotment shall be completed within 15 days from the date of such approval.
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However, SEBI has granted relaxation to the issuer in terms of the SEBI (Substantial Acquisition of
Shares and Takeovers) Regulations, 2011, the preferential allotment of shares, fully convertible
debentures and partly convertible debentures, shall be made by it within such time as may be specified
by SEBI in its order granting relaxation.
(ii) The equity shares and securities convertible into equity shares at a later date, allotted in terms of the
above said resolution shall be made fully paid up at the time of their allotment
However payment in case of warrants shall be made in terms of these Regulations.
(iii) Nothing contained in the above mentioned shall apply in case of allotment of shares and securities
convertible into equity shares at a later date on preferential basis pursuant to a scheme of Corporate
Debt Restructuring framework specified by the Reserve Bank of India.
(iv) If allotment of instruments and dispatch of certificates is not completed within fifteen days from the date
of such resolution, a fresh consent of the shareholders shall be obtained.
8. Compliance Certificate
(i) A certificate is obtained from the statutory auditors of Issuer Company certifying that the preferential
issue of instruments is being made in accordance with the requirements of SEBI Regulations.
(ii) The auditor certificate shall be placed before the meeting of shareholders convened to consider the
proposed issue.
9. Submission of Valuation Report
In case of preferential allotment of shares to promoters, their relatives, associates and related entities, for
consideration other than cash, valuation of assets in consideration for which the shares are proposed to be
issued, shall be done by an independent qualified valuer. The valuation report has been submitted to the
exchanges on which shares of issuer company are listed.
10. Use of Issue Proceeds
The details of all monies utilised out of the preferential issue proceeds should be disclosed under an appropriate
head in the balance sheet of the company indicating the purpose for which such monies have been utilised. The
details of unutilised monies should also be disclosed under a separate head in the balance sheet of the company
indicating the form in which such utilised monies have been invested.
11. Other Requirements
– A special resolution is required to be passed by its shareholders.
– All the equity shares if any, held by the proposed allottees in the issuer are in dematerialise form.
– An issuer cannot make preferential issue of securities to any person who has sold any equity shares of
the issuer during the six months proceeding the relevant date.
– A listed company shall not make any preferential issue of specified securities unless it is in compliance
with the conditions for continuous listing.
– A listed company shall not make any preferential allotment of specified securities unless it has obtained
the Permanent Account Number of the proposed allottees.
Non-Applicability
(1) These regulations are not applicable in case of the following:
(a) pursuant to conversion of loan or option attached to convertible debt instruments in terms of Subsections (3) and (4) of Sections 81 of the Companies Act, 1956.
174 PP-CC&MM
(b) pursuant to a scheme approved by a High Court under Section 391 to 394 of the Companies Act, 1956.
(c) in terms of the rehabilitation scheme approved by the Board of Industrial and Financial Reconstruction
under the Sick Industrial Companies (Special Provisions) Act, 1985.
(2) Pricing and lock-in provisions of ICDR Regulations shall not apply to equity shares allotted to any financial
institution within the meaning of sub-clauses (ia) and (ii) of Clause (h) of Section 2 of the Recovery of Debts due
to Banks and Financial Institutions Act, 1993.
(3) Disclosure and pricing relating to a preferential issue of equity shares and compulsorily convertible debt
instruments, whether fully or partly, where the Board has granted relaxation to the issuer in terms of the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011, if adequate disclosures about the plan
and process proposed to be followed for identifying the allottees are given in the explanatory statement to notice
for the general meeting of shareholders.
(4) Criteria relating to Lock –in and selling of equity shares during six months preceding the preferential issue
shall not apply to preferential issue of specified securities where the proposed allottee is a Mutual Fund registered
with the Board or Insurance Company registered with Insurance Regulatory and Development Authority.
QUALIFIED INSTITUTIONS PLACEMENT
A Qualified Institutions Placement means allotment of eligible securities by a listed issuer to qualified institutional
buyers on private placement basis in terms of SEBI (ICDR) Regulations. This QIP is different from offer of
securities to qualified institutional buyers in an IPO.
Qualified Institutional Buyer
(i) A mutual fund, venture capital fund and foreign venture capital investor registered with SEBI;
(ii) A foreign institutional investor and sub-account (other than a sub-account which is a foreign corporate
or foreign individual), registered with SEBI;
(iii) A public financial institution as defined in section 4A of the Companies Act, 1956;
(iv) A scheduled commercial bank;
(v) A multilateral and bilateral development financial institution;
(vi) A state industrial development corporation;
(vii) An insurance company registered with the Insurance Regulatory and Development Authority;
(viii) A provident fund with minimum corpus of twenty five crore rupees;
(ix) A pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by the Government of India published in the Gazette of India;
(xi) Insurance funds set up and managed by army, navy or air force of the Union of India;
(xii) Insurance funds set up and managed by Department of Posts, India.
Eligible securities for the purpose of QIP
Eligible Securities include equity shares, non-convertible debt instruments along with warrants and convertible
securities other than warrants.
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Relevant date
In case of allotment of equity shares, the date of the meeting in which the board of directors or the committee
of directors duly authorised by the board of directors of the issuer decides to open the proposed issue .In
case of allotment of eligible convertible securities, either the date as mentioned above or the date on which
the holders of such convertible securities become entitled to apply for the equity shares.
Conditions for making QIP
A listed issuer can make qualified institutions placement subject to the following conditions:
– A special resolution approving the issue is required to be passed by its shareholders.
– Prior to the date of issuance of notice to its shareholders for convening the meeting to pass the special
resolution, the equity shares of the same class, which are proposed to be allotted through QIP, are listed
on a recognised stock exchange having nation wide trading terminal for a period of at least one year.
– If an issuer, being a transferee company in a scheme of merger, de-merger, amalgamation or arrangement
sanctioned by a High Court under sections 391 to 394 of the Companies Act, 1956, makes QIP, the
period for which the equity shares of the same class of the transferor company were listed on a stock
exchange having nation wide trading terminals are also eligible to be considered for the purpose of
computation of the period of one year.
– It is in compliance with the requirement of minimum public shareholding specified in the listing agreement
with the stock exchange.
– In the special resolution, it shall be, among other relevant matters, the resolution must specify the
relevant date and the also specify that the allotment is proposed to be made through QIP.
Intermediaries involved in QIP and their roles
A Qualified Institutions Placement is required to be managed by merchant banker(s) who will exercise due diligence.
While seeking in-principle approval for listing of the eligible securities issued under qualified institutions placement,
the merchant banker furnishes to each stock exchange on which the same class of equity shares of the issuer
are listed, a due diligence certificate regarding compliance of ICDR regulations and stating that the eligible
securities are being issued under qualified institutions placement.
Placement document
‘Placement Document’ means document prepared by Merchant Banker for the purpose of Qualified Institutions
Placement and contains all the relevant and material disclosures to enable QIBs to make an informed decision.
Disclosures required to be made in Placement Document
– The qualified institutions placement is required to be made on the basis of a placement document which
contains all material information, including those specified in ICDR Regulations.
– The placement document needs to be serially numbered and copies are required to be circulated only
to select Investors.
– The issuer, while seeking in-principle approval from the recognised stock exchange is require to furnish
a copy of the placement document, a certificate confirming compliance with the provisions ICDR
Regulations along with any other documents required by the stock exchange.
– The placement document is required to a be placed on the website of the issuer and concerned stock
exchange with a disclaimer to the effect that it is in connection with a Qualified Institutions Placement
and that no offer is being made to the public or to any other category of investors.
176 PP-CC&MM
Time period for filing the copy of placement document with SEBI
A copy of the placement document is required to be filed with SEBI for its record within thirty days of the
allotment of eligible securities.
Pricing
The Qualified Institutions Placement is required to be made at a price not less than the average of the weekly
high and low of the closing prices of the equity shares of the same class listed on the stock exchange during the
two weeks preceding the relevant date.
If the eligible securities are convertible into or exchangeable with equity shares the issuer is require to determine
the price of such equity shares allotted pursuant to such conversion or exchange taking the relevant date as
decided and disclosed by it while passing the special resolution.
Issue of partly paid-up securities
An issuer can not allot partly paid up eligible securities. In case of allotment of equity shares on exercise of
options attached to warrants, such equity shares shall be fully paid up. However, on allotment of non convertible
debt instruments along with warrants, the allottees can pay the full consideration or part thereof payable with
respect to warrants, at the time of allotment of such warrants.
The prices determined for Qualified Institutions Placement are subject to appropriate adjustments in certain
cases. If the issuer :
– makes an issue of equity shares by way of capitalization of profits or reserves, other than by way of a
dividend on shares.
– makes a rights issue of equity shares.
– consolidates its outstanding equity shares into a smaller number of shares.
– divides its outstanding equity shares including by way of stock split.
– re-classifies any of its equity shares into other securities of the issuer.
– is involved in such other similar events or circumstances, which in the opinion of the concerned stock
exchange, requires adjustments.
Here stock exchange means any of the recognised stock exchanges in which the equity shares of the
same class of the issuer are listed and in which the highest trading volume in such equity shares has
been recorded during the two weeks immediately preceding the relevant date.
Restrictions on allotment
– Minimum 10% of eligible securities is required to be allotted to mutual funds. In case the mutual funds
do not subscribe to said minimum percentage or any part thereof, such minimum portion or part thereof
can be allotted to other qualified institutional buyers.
– An allotment can not be made, either directly or indirectly, to any qualified institutional buyer who is a
promoter or any person related to promoters of the issuer.
– A qualified institutional buyer who does not hold any shares ‘in the issuer and who has acquired the said
rights in the capacity of a lender can not be deemed to be a person related to promoters.
– In a qualified institutions placement of non-convertible debt instrument along with warrants, an investor
can subscribe to the combined offering of-non- convertible debt instruments with warrants or to the
individual securities, that is, either non- convertible debt instruments or warrants.
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Here a Qualified Institutional Buyer who has any of the following rights is deemed to be a person related to the
promoters of the issuer:
(a) rights under a shareholders’ agreement or voting agreement entered into with promoters or persons
related to the promoters.
(b) veto rights or
(c) right to appoint any nominee director on the board of the issuer.
Do you know?
The applicants in Qualified Institutions Placement can not withdraw their bids after the closure of the issue.
Minimum numbers of allottees
– If the size of the issue is less than of equal to 250 crore rupees minimum two allottees for each placement
and where the issue size is greater than 250 rupees minimum of five allottees required.
– A single allottee can not be allotted more than 50% of the issue size.
– The qualified institutional buyers belonging to the same group or who are under same control are
deemed to be a single allottee.
Here Qualified Institutional Buyers belonging to the same group are assigned the same meaning as derived
from sub-section (11) of section 372 of the Companies Act, 1956.
Validity of the special resolution
An allotment pursuant to the special resolution approving the proposed QIP is required to be completed within a
period of twelve months from the date of passing of the resolution.
The issuer can not make subsequent Qualified Institutions Placement until expiry of six months from the date of
the prior qualified institutions placement made pursuant to one or more special resolutions.
Do you know ?
Allotment to QIBs is to be made with in 12 months of passing Special Resolution approving such allotment.
Restriction on amount raised
The aggregate of the proposed QIP and all previous QIPs made by the issuer in the same financial year should
not exceed five times the net worth of the issuer as per the audited balance sheet of the previous financial year.
Tenure
The tenure of the convertible or exchangeable eligible securities issued through qualified institutions placement
should not be more than sixty months from the date of allotment.
Transferability of Securities
The eligible securities allotted can not be sold by the allottee for a period of one year from the date of allotment,
except on a recognised stock exchange.
INSTITUTIONAL PLACEMENT PROGRAMME
“Institutional Placement Programme” means a further public offer of eligible securities by an eligible seller, in
178 PP-CC&MM
which the offer, allocation and allotment of such securities is made only to Qualified Institutional Buyers in terms
of Chapter VIII A of SEBI ICDR Regulations, 2009.
SEBI vide its notification dated January 30, 2012 has amended the Issue of Capital and Disclosure Requirements
Regulations, 2009 whereby Chapter VIII-A - Institutional Placement Programme (IPP) has been inserted.
The provisions of this Chapter shall apply to issuance of fresh shares and or offer for sale of shares in a listed
issuer for the purpose of achieving minimum public shareholding in terms of Rule 19(2)(b) and 19A of the
Securities Contracts (Regulation) Rules, 1957.
Conditions for Institutional Placement Programme
– An institutional placement programme may be made only after a special resolution approving the
institutional placement programme has been passed by the shareholders of the issuer in terms of
section 81(1A) of the Companies Act, 1956.
– No partly paid-up securities shall be offered.
– The issuer shall obtain an in-principle approval from the stock exchange(s).
Appointment of Merchant Banker
An institutional placement programme shall be managed by merchant banker(s) registered with the Board who
shall exercise due diligence.
Offer Document
– The institutional placement programme shall be made on the basis of the offer document which shall
contain all material information.
– The issuer shall, simultaneously while registering the offer document with the Registrar of Companies,
file a copy thereof with the Board and with the stock exchange(s) through the lead merchant banker.
– The issuer shall file the soft copy of the offer document with SEBI, along with the fee.
– The offer document shall also be placed on the website of the concerned stock exchange and of the
issuer clearly stating that it is in connection with institutional placement programme and that the offer is
being made only to the Qualified Institutional Buyers.
– The merchant banker shall submit to SEBI a due diligence certificate, stating that the eligible securities
are being issued under institutional placement programme and that the issuer complies with requirements
of this Chapter.
Pricing and Allocation/allotment
– The eligible seller shall announce a floor price or price band at least one day prior to the opening of
institutional placement programme.
– The eligible seller shall have the option to make allocation/allotment as per any of the following methods – proportionate basis;
– price priority basis; or
– criteria as mentioned in the offer document.
– The method chosen shall be disclosed in the offer document.
– Allocation/allotment shall be overseen by stock exchange before final allotment.
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Restrictions
– The promoter or promoter group who are offering their eligible securities should not have purchased
and/ or sold the eligible securities of the company in the twelve weeks period prior to the offer and they
should undertake not to purchase and / or sell eligible securities of the company in the twelve weeks
period after the offer. However, such promoter or promoter group may , within the twelve weeks period
offer eligible securities held by them through institutional placement programme or offer for sale through
stock exchange mechanism subject to the condition that there shall be a gap of minimum two weeks
between the two successive offer(s) and /or programme(s)
– Allocation/allotment under the institutional placement programme shall be made subject to the following
conditions:
– Minimum of twenty five per cent of eligible securities shall be allotted to mutual funds and insurance
companies. However, if the mutual funds and insurance companies do not subscribe to said minimum
percentage or any part thereof, such minimum portion or part thereof may be allotted to other
qualified institutional buyers;
– No allocation/allotment shall be made, either directly or indirectly, to any qualified institutional buyer
who is a promoter or any person related to promoters of the issuer. However, a qualified institutional
buyer who does not hold any shares in the issuer and who has acquired the rights in the capacity of
a lender shall not be deemed to be a person related to promoters.
– The issuer shall accept bids using ASBA facility only.
– The bids made by the applicants in institutional placement programme shall not be revised downwards
or withdrawn.
Restrictions on size of the offer
– The aggregate of all the tranches of institutional placement programme made by the eligible seller shall
not result in increase in public shareholding by more than ten per cent or such lesser per cent as is
required to reach minimum public shareholding.
– Where the issue has been oversubscribed, an allotment of not more than ten percent of the offer size
shall be made by the eligible seller.
Period of Subscription and display of demand
– The issue shall be kept open for a minimum of one day or maximum of two days.
– The aggregate demand schedule shall be displayed by stock exchange(s) without disclosing the price.
Withdrawal of offer
The eligible seller shall have the right to withdraw the offer in case it is not fully subscribed.
Transferability of eligible securities
The eligible securities allotted under institutional placement programme shall not be sold by the allottee for a
period of one year from the date of allocation/allotment, except on a recognised stock exchange.
LISTING AGREEMENT
Listing means admission of securities to dealings on a recognised stock exchange. The securities may be of
any public limited company, Central or State Government, quasi governmental and other financial institutions/
corporations, municipalities, etc.
180 PP-CC&MM
Benefits of listing
The following benefits accrue to a company whose securities are listed on the stock exchange–
(1) Public image of the company is enhanced.
(2) The liquidity of the security is ensured making it easy to buy and sell the securities in the stock exchange.
(3) Tax concessions are available both to the investors and the companies.
(4) Listing procedure compels company management to disclose important information to the investors
enabling them to make crucial decisions with regard to keeping or disposing of such securities.
(5) Listed companies command better support such as loans and investments from Banks and FIs.
Listing Agreement
Listing Agreement means a document which a company signs when being listed on the Stock Exchange, in
which the company promises to abide by stock exchange regulations, bye laws.
Laws governing Listing
– Securities Contracts (Regulation) Act, 1956
– Securities Contracts (Regulation) Rules, 1957
– Companies Act, 1956
– Guidelines issued by SEBI and
– Rules, Bye-laws and Regulations of respective Stock Exchange.
– Listing Agreement
Event based and time based Compliance under Listing Agreement
EVENT BASED COMPLIANCES
Sl.
No.
Clause
No. of
Listing
Agreement
Particulars of Compliance
Advance Notice/Intimation
1.
13
Intimation of particulars of the securities affected
due to the prohibitory orders restraining the
company from transfer.
Promptly notify the
Exchange
2.
16
Date of closure of transfer books/ record date.
7 working days advance
notice required,.
Notice of Corporate action like mergers, demergers,
split and bonus sahres
Atleast 7 working days
notice is required.
3.
19 (a)
Prior Intimation of Board Meeting having agenda of
Buy back, dividend, Rights Issue, Bonus Shares,
issue of Convertible debentures.
2 working days advance
notice required.
4.
19 (e)
Intimation of Board meeting regarding the FPO to
be made through fix price route.
Atleast 48 hours in advance
of the board meeting.
5.
20
Intimation by phone, fax, telegram, e-mail, details
Within 15 minutes of
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of dividend/cash bonuses, buy back of securities,
the total turnover, gross profit/ loss, provision for
depreciation, tax provisions and net profits for the
year (with comparison with the previous year) and
the amounts appropriated from reserves, capital
profits, accumulated profits of past years or other
special source to provide wholly or partly for the
dividend even if this calls for qualification that
such information is provisional or subject to audit.
conclusion of Board
Meeting.
Intimate by phone, fax, telegram, e-mail, short
particulars of increase in share capital, alteration in
capital, re-issue of forfeited shares etc.
Within 15 minutes of
conclusion of Board
Meeting.
6.
22
7.
24 (d)
SEBI acknowledgement card/ observations received
on draft prospectus, certificate from lead merchant
banker ensuring positive compliance with SEBI
ICDR regulations 2009.
Immediately on the receipt
of acknowledgement card
from SEBI.
8.
24 (f)/24 (i)
File copy of Scheme/Petition proposed to be filed
before any Court under section 391/394 & 101 of
Companies Act, 1956 along with auditor’s certificate
ensuring compliance with all Accounting Standards
Specified by the Central Government in Section
211(3c) of Companies Act, 1956.
1 month before it is
presented to the court.
9.
25
Intimation regarding details of granting option by the
company, if any.
Promptly notify the
Exchange.
10.
26
Intimation with respect to the redemption of securities
otherwise than pro rata or lot basis, if any.
Promptly notify the
Exchange.
11.
27
Actions resulting redemption cancellation, retirement,
drawing of securities and date of drawing and period
of the closing of transfer books for such drawing.
Promptly notify the
Exchange.
12.
28
Prior intimation of change in the form of nature of any
of the securities of the company.
Promptly notify the
Exchange.
13.
29
Intimation about any proposed change in the general
character or nature of its business.
Notify promptly the
Exchange.
14.
30
Notification of change in Board of Directors, MD,
Notify promptly the
Managing agents, secretaries, treasurers, and auditors Exchange.
etc.
15.
31
Six copies of the Statutory and Directors’ Annual
Reports, Balance Sheets and Profits & Loss Accounts
and of all periodical and special reports, all notices,
circulars relating to new issue.
Three copies of all the notices, call letters or any other
circulars including notices of meetings convened u/s
391 or Section 394 read with Section 391 of the
Companies Act, 1956 together with Annexures.
Forward promptly to the
Exchange.
182 PP-CC&MM
Copy of proceedings of all AGM/EGM.
16.
33
File 6 copies of amended AOA & MOA (one of which
will be certified) and copies of all notices sent to the
shareholders with respect to such amendments.
As soon as the
amendments to the MOA
and AOA are approved in
the general meeting.
17.
35
Filing of shareholding pattern separately for each class
of equity shares/security.
Corporate restructuring of the company resulting in a
change exceeding +/- 2% of the total paid-up capital.
One day prior to listing of its
securities on the stock
exchanges.
On a quarterly basis, within
21 days from the end of
each quarter.
Within 10 days of any
corporate restructuring.
18.
35A
Submit details of the voting results of the AGM/EGM.
Within 48 hours of the
conclusion of the AGM/
EGM.
19.
36
Intimation of events/happenings having important
Notify the Exchange on
bearings and which are likely to materially affect the
Occurrence and after the
financial performance of the Company and its stock
Event.
prices like strikes, lock-outs, closure of units for any
reason, disruption of operations due to natural calamity,
litigation/dispute having material impact. Any price
sensitive information like acquisition, merger,
amalgamation, delisting, share forfeiture etc;
20.
43
Furnishing the details indicating the variations between On a quarterly basis.
projected utilisation of funds and/ or projected
profitability statement made by it in its prospectus or
letter of offer and the actual utilisation of funds and/or
actual profitability.
21.
43A
Furnish a statement indicating material deviations, if
any, in the use of proceeds of a public or rights issue
from the objects stated in the offer document.
On a quarterly basis.
Intimation about any deviation in the use of the
proceeds or any other reservations about the end use
of fund given by the monitoring agency.
Immediately without any
delay after receiving the
reservations from the
monitoring agency.
22.
47 (a)
The Company is required to appoint a Compliance
Officer.
Inform on appointment and
as and when there is
change in the Compliance
Officer.
23.
47 (e)
Submit copy of MOU executed with RTA
Within 48 hours of
execution of MOU
24.
52
Electronic filing of information through Corporate Filing
Information as may be
Lesson 5
25.
53
Primary Market 183
and Dissemination System(CFDS)
specified by the
participating exchanges.
Intimation to the exchange when entered into agreement
with media companies about :
– The shareholding (if any) of such media companies/
associates in the issuer company.
Immediately upon entering
into agreement with media
companies or their
associates.
– Details of nominee of the media companies on the
Board of the issuer company, any management control
or potential conflict of interest arising out of such
agreements, etc.
– Any other back to back treaties/contracts/agreements/
MoUs or similar instruments entered into by the issuer
company with media companies and/or their associates
for the purpose of advertising, publicity, etc.
26.
55
Listed entities shall submit, as part of their Annual
Reports, Business Responsibility Reports, describing
the initiatives taken by them from an environmental,
social and governance perspective, in the format
prescribed by SEBI.
Promptly to the stock
exchange as soon as the
annual report is issued
TIME BASED COMPLIANCES
Sl.
No.
Particulars of Compliance
Clause
of Listing
Agreement
Due Date
For 1st Quarter ended 30th June
1.
Submit quarterly Corporate Governance Compliance reports.
49 (VI)(ii)
15th July
2.
Submit Shareholding Pattern as at the end of quarter.
35
21st July
3.
Notice to Stock Exchange for holding Board Meeting to approve
Unaudited Financial Results along with limited review report for the
1st Quarter
41
6th August
4.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
6th August
5.
To hold Board Meeting for approval of Unaudited Financial Results
41
14th August
6.
Approved Unaudited Financial Results submitted to Stock Exchange 41
within 15 minutes of conclusion of the Board Meeting
14th August
7.
Publish approved Unaudited Financial Results within 48 hours of
Board Meeting
41
16th August
For 2nd Quarter ended 30th Sept & AGM
8.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th October
9.
Submit Shareholding Pattern as at the end of quarter.
35
21st October
184 PP-CC&MM
10.
Notice to Stock Exchange for holding Board Meeting to approve
Un-audited Financial Results along with limited review report for
the 2nd Quarter
41
7th November
11.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of
the Company is situated).
41
7th November
12.
To hold Board Meeting for approval of Un-audited Financial Results
41
15th November
13.
Approved Un-audited Financial Results submitted to Stock Exchange
within 15 minutes of conclusion of the Board Meeting
41
15th November
14.
Publish approved Unaudited Financial Results within 48 hours of
Board Meeting
41
17th November
15.
Submit Certificate obtained from Practising Company Secretary
certifying that all certificates have been issued within one month
of lodgement for transfer, sub-division etc. for the half year ended
30th September.
47(c)
30th Oct.
For 3rd Quarter ended on 30th December
16.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th Jan.
17.
Submit Shareholding Pattern as at the end of quarter.
35
21st Jan
18.
Notice to Stock Exchange for holding Board Meeting to approve
Un-audited Financial Results for the 3rd Quarter
41
6th February
19.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of
the Company is situated).
41
22nd Jan
20.
To hold Board Meeting for approval of Un-audited Financial Results
41
14th February
21.
Approved Un-audited Financial Results submitted to Stock
Exchange along with limited review report for the 3rd Quarter
within 15 minutes of conclusion of the Board Meeting
41
14th February
22.
Publish approved Un-audited Financial Results within 48 hours of
Board Meeting held.
41
16th February
For 4th Quarter ended on March 31st
23.
Submit quarterly Corporate Governance Compliance reports.
49 (VI) (ii)
15th April
24.
Submit Shareholding Pattern as at the end of quarter.
35
21st April
25.
Pay Annual Listing fee.
38
30th April
26.
Submit half yearly Certificate obtained from Practising Company
Secretary.
47(c)
30th April
27.
Notice to Stock Exchange (SE) for holding Board Meeting (BM)
to approve Un-audited Financial Results(UAFR), subject to Limited
Review Report (LRR) by Statutory Auditors, for the quarter ended
on 31st March
41
7th May
Lesson 5
Primary Market 185
28.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
7th May
29.
To hold Board Meeting for approval of un-audited financial results.
41
15th May
30.
Submit un-audited financial results to the SE within 15 minutes of
conclusion of the BM.
41
15th May
31.
Publication of un-audited financial results in atleast one English
daily newspaper and one daily regional newspaper within 48 hours
of conclusion of Board Meeting.
41
17th May
32.
Notice to Stock Exchange (SE) for holding Board Meeting (BM) to
approve Audited Financial Results
41
22nd May
33.
Publication of Notice in 2 Newspapers (one English language
circulating in substantially whole of India and in one Regional
Language newspaper of the State in which Registered Office of the
Company is situated).
41
22nd May
34.
To hold Board Meeting for approval of financial results.
41
30th May
35.
Submit audited Financial Results to the Stock Exchange within 15
minutes of conclusion of the Board Meeting
41
30th May
36.
Publication of financial results in atleast one English daily newspaper
and one daily regional newspaper within 48 hours of conclusion of
Board Meeting.
41
June 1st
37.
Submit shareholding pattern, annual Corporate Governance Report, 52
Quarterly Results, Half yearly financial statements, Statement of
action taken against the company by any regulatory agency and full
version of annual report on SEBI www.corpfiling.co.in
Within such time
as specified by
SEBI.
LESSON ROUND UP
– Public Issue of shares means the selling or marketing of shares for subscription by the public by issue
of prospectus.
– Public Issue of shares are regulated by SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009.
– Offer for Sale (OFS) is another form of share sale, very much similar to Follow–On Public Offer (FPO).
OFS mechanism facilitates the promoters of an already listed company to sell or dilute their existing
shareholdings through an exchange based bidding platform.
– SEBI has detailed guidelines on Offer for sale (OFS) of Shares by Promoters Through stock Exchange
Mechanism.
– A company is required to issue a prospectus each time it accesses the capital market. The different form
of prospectus are Offer document, Draft Offer document, Red Herring Prospectus, Shelf prospectus etc.
– Their main responsibilities of Lead Manager is to initiate the IPO processing, help company in road
shows, creating draft offer document and get it approve by SEBI and stock exchanges and helping
company to list shares at stock market.
186 PP-CC&MM
– Underwriting means an agreement with or without conditions to subscribe to the securities of a body
corporate when the existing shareholders of such body corporate or the public do not subscribe to the
securities offered to them.
– Due diligence is a process of a thorough and objective examination that is undertaken before corporate
entities enter into major transactions such as mergers and acquisitions, issuing new stock or other
securities, project finance, securitization, etc.
– Book Building means a process undertaken to elicit demand and to assess the price for determination
of the quantum or value of specified securities or Indian Depository Receipts, as the case may be.
– “Green Shoe Option” means an option of allocating shares in excess of the shares included in the
public issue and operating a post–listing price stabilizing mechanism in accordance with the provisions
of Regulation 45 of SEBI (ICDR) Regulations, 2009.
– A company may, if its Articles provide, capitalize its profits by issuing fully–paid bonus shares.
– Preferential issue means issuance of equity shares to promoter group or selected investors. It covers
allotment of fully convertible debentures, partly convertible debentures or any other financial instruments
that could be converted into equity shares at a later date.
– A Qualified Institutions Placement means allotment of eligible securities by a listed issuer to qualified
institutional buyers on private placement basis in terms of SEBI (ICDR) Regulations.
– Institutional Placement Programme means a further public offer of eligible securities by an eligible
seller, in which the offer, allocation and allotment of such securities is made only to qualified institutional
buyers in terms of Chapter VIII A of SEBI ICDR Regulations, 2009.
– Listing Agreement is a document which a company signs when being listed on the Stock Exchange, in
which the company promises to abide by stock exchange regulations, bye laws.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly discuss the different methods of raising funds from Primary Market.
2. Distinguish between Offer For Sale Process and IPO/FPO.
3. Define Shelf Prospectus. Enumerate the provisions relating to Shelf Prospectus.
4. What do you understand by Due Diligence? Describe the pre–issue and post–issue due diligence in
public issue.
5. Explain how basis of allotment is determined.
6. Explain Green Shoe Option with the help of an example.
Lesson 5
Primary Market 187
188 PP-CC&MM
Lesson 6
Lesson 6
Secondary Market
LESSON OUTLINE
Secondary Market 189
LEARNING OBJECTIVES
– Introduction
Secondary Market refers to a market where
– Corporate Actions
securities are traded after being initially offered
– Continuous Listing
to the public in the primary market and/or listed
– Material Events under Listing Agreement
on the Stock Exchange. Majority of the trading
– Price sensitive Information
is done in the Secondary Market. When a
com pany listed its securities on Stock
– Submission of Interim and Annual
Financial Results under Listing
Agreement
Exchange it has to com ply with certain
conditions of the Stock Exchange under the
listing agreement. Further Stock Exchange is
– Disclosures under Listing Agreement
an essential part of Secondary Market. The
– Corporate Governance
stock exchanges along with a host of other
– Regulatory Framework of Corporate
Governance in India
intermediaries provide the necessary platform
– Clause 49
clearing and settlement.
– Arbitration Mechanism
The objective of this lesson is to give a detailed
– Arbitration
Exchanges
Mechanism
at
for trading in Secondary Market and also for
view of the compliance requirement need to be
Stock
fulfilled by a company with respect to the
Corporate Action, Disclosure, Price sensitive
– Margining
information, Corporate Governance Norms.
– Trading of Securities
Further, after going through this lesson a student
– Settlement System
will be able to understand the arbitration
– Clearing and settlement
mechanism at the stock exchanges, Trading
Clearing and Settlement process at Stock
– Trade Guarantee Fund
Exchanges. Basics of Stock indices, Calculation
– Trading Software
Methodology of index etc.
– Stock Market Indices
– Sensex
– CNX Nifty
– Investible Weight Factors (IWFs)
– LESSON ROUND UP
– SELF TEST QUESTIONS
189
190 PP-CC&MM
INTRODUCTION
Secondary market refers to a market where securities are traded after being initially offered to the public in the
primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market.
For the general investor, the Secondary Market provides an efficient platform for trading of his securities. For the
management of the company, Secondary Markets serve as a monitoring and control conduit—by facilitating
value-enhancing control activities, enabling implementation of incentive-based management contracts, and
aggregating information (via price discovery) that guides management decisions. When a company list its
securities on the Stock Exchange, it has to comply with various conditions of the Listing Agreement of the Stock
Exchange such as notice to be given under Corporate Action, continuous listing requirements, Disclosure of
Price Sensitive Information, Material events, Submission of Financial results to the Stock Exchange etc. These
compliance requirements are discussed below.
CORPORATE ACTIONS
Corporate action is a process by which a company gives benefits to the investors who are holding securities of
the company. Corporate actions are classified in to two main categories Cash and Non-cash corporate actions.
– Cash corporate action results in investors getting benefits in form of cash. Examples of cash corporate
actions are payment of interest / dividend.
– Non cash corporate actions result in the investors getting benefits in form of securities. Examples of non
cash corporate action are bonus, rights, merger, split etc.
Corporate actions tend to have a bearing on the price of a security. When a company announces a corporate
action, it is initiating a process that will bring actual change to its securities either in terms of number of shares
increasing in the hands on the shareholders or a change to the face value of the security or receiving shares of
a new company by the shareholders as in the case of merger or acquisition etc. By understanding these different
types of processes and their effects, an investor can have a clearer picture of what a corporate action indicates
about a company’s financial affairs and how that action will influence the company’s share price and performance.
Corporate actions are typically agreed upon by a company’s Board of Directors and authorized by the
shareholders.
REQUIREMENT UNDER LISTING AGREEMENT FOR CORPORATE ACTION
A listed company is required to give notice for corporate action under clause 16 of the Listing agreement.
– The Company is required to close its transfer books at least once a year at the time of the Annual
General Meeting if they have not been otherwise closed at any time during the year.
– The Company must ensure that there is a gap of at least 30 days between 2 book closure and/or record
date.
– The Company shall give an advance notice of at least 7 working days (Excluding the date of the intimation
and record date/book closure start date) to the Stock Exchange for corporate actions (Book closure/
Record date) fixed for the purpose of corporate benefits like mergers, de-mergers, split , bonus, dividend,
rights etc.
CONTINUOUS LISTING
The Securities Contract Regulation Rules, 1957(SCRR) prescribes the requirements which have to be satisfied
by companies for the purpose of getting their securities listed on any stock exchange in India. Rule 19(2) (b)
Prescribes for requirements with respect to the listing of Securities on a recognised stock exchanges and 19A
prescribes the requirement for continuous listing.
Lesson 6
Secondary Market 191
Rule 19(2)(b)
Rule 19(2)(b) lays down that –
(i) At least twenty five per cent. of each class or kind of equity shares or debentures convertible into equity
shares issued by the company was offered and allotted to public in terms of an offer document; or
(ii) At least ten per cent of each class or kind of equity shares or debentures convertible into equity shares
issued by the company was offered and allotted to public in terms of an offer document if the post issue
capital of the company calculated at offer price is more than four thousand crore rupees.
Provided that the requirement of post issue capital being more than four thousand crore rupees shall not apply
to a company whose draft offer document is pending with the Securities and Exchange Board of India on or
before the commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, if it satisfies the
conditions prescribed in clause (b) of sub-rule 2 of rule 19 of the Securities Contracts (Regulation) Rules, 1956
as existed prior to the date of such commencement:
Provided further that the company, referred to in sub clause (ii), shall increase its public shareholding to at least
twenty five per cent, within a period of three years from the date of listing of the securities, in the manner
specified by the Securities and Exchange Board of India
Rule 19A
Rule 19A provides for Continuous Listing Requirement which stipulates that –
(1) Every listed company other than public sector company shall maintain public shareholding of at least
twenty five per cent.
Provided that any listed company which has public shareholding below twenty five per cent, on the
commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, shall increase its
public shareholding to at least twenty five per cent, within a period of three years from the date of such
commencement, in the manner specified by the Securities and Exchange Board of India.
Explanation: For the purposes of this sub-rule, a company whose securities has been listed pursuant to
an offer and allotment made to public in terms of sub-clause (ii) of clause (b) of sub-rule (2) of rule 19,
shall maintain minimum twenty five per cent, public shareholding from the date on which the public
shareholding in the company reaches the level of twenty five percent in terms of said sub-clause.
(2) Where the public shareholding in a listed company falls below twenty five percent at any time, such
company shall bring the public shareholding to twenty five percent within a maximum period of twelve
months from the date of such fall in the manner specified by the Securities and Exchange Board of
India.
(3) Notwithstanding anything contained in this rule, every listed public sector company shall maintain public
shareholding of at least ten per cent :
Provided that a listed public sector company –
(a) which has public shareholding below ten per cent, on the date of commencement of the Securities
Contracts (Regulation) (Second Amendment) Rules, 2010 shall increase its public shareholding to
at least ten per cent, in the manner specified by the Securities and Exchange Board of India, within
a period of three years from the date of such commencement;
(b) whose public shareholding reduces below ten per cent, after the date of commencement of the
Securities Contracts (Regulation) (Second Amendment) Rules, 2010 shall increase its public
shareholding to at least ten per cent, in the manner specified by the Securities and Exchange
Board of India, within a period of twelve months from the date of such reduction.
192 PP-CC&MM
The provision quoted above require all listed companies in the private sector to achieve and maintain public
shareholding of 25% of each class or kind of equity shares or debentures convertible into equity shares issued
by such companies. Those companies with public shareholding of less than 25 % are required to achieve the
same, within a period of 3 years from the date of commencement of the first amendment in the manner specified
by SEBI.
In order to align the requirement in the listing agreement with the requirement specified in Rule 19 (2) (b) and 19
A of SCRR and to specify the manner in which public shareholding may be raised to prescribe minimum level,
SEBI issued a circular on December 16, 2010 to amend Clause 40A of Listing Agreement for complying with the
minimum public shareholding which is as under:
“Where the company is required to achieve the level of public shareholding as specified in Rule 19(2) and/
or 19A of the Rules, it shall adopt any of the following methods to raise the public shareholding to the
required level:
(a) issuance of shares to public through prospectus; or
(b) offer for sale of shares held by promoters to public through prospectus; or
(c) sale of shares held by promoters through the secondary market.
For adopting methods as specified at point (c) the company agrees to take prior approval of the Specified
Stock Exchange, which may impose such conditions as it may deem fit.”
SEBI issue another circular dated February 8, 2012 which provided that listed company may achieve the minimum
public shareholding requirement through Institutional Placement Programme (IPP). Further to facilitate listed
entities to comply with the minimum public shareholding requirements within the time specified in Securities
Contracts (Regulation) Rules, 1957 SEBI issued a circular on August 29, 2012 specified the following additional
methods:(a) Rights Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue.
(b) Bonus Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue.
(c) any other method as may be approved by SEBI, on a case to case basis.
Clause 40A of Listing Agreement
Minimum level of public shareholding
(i) The issuer company agrees to comply with the requirements specified in Rule 19(2) and Rule 19A of the
Securities Contracts (Regulation) Rules, 1957.
(ii) Where the issuer company is required to achieve the minimum level of public shareholding specified in
Rule 19(2)(b) and/or Rule 19A of the Securities Contracts (Regulation) Rules, 1957, it shall adopt any of
the following methods to raise the public shareholding to the required level:(a) issuance of shares to public through prospectus; or
(b) offer for sale of shares held by promoters to public through prospectus; or
(c) sale of shares held by promoters through the secondary market in terms of SEBI circular CIR/MRD/
DP/05/2012 dated February 1, 2012; or
(d) Institutional Placement Programme (IPP) in terms of Chapter VIIIA of SEBI (Issue of Capital and
Disclosure Requirements) Regulations, 2009, as amended; or
Lesson 6
Secondary Market 193
(e) Rights Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue; or
(f) Bonus Issues to public shareholders, with promoter/promoter group shareholders forgoing their
entitlement to equity shares, whether present or future, that may arise from such issue; or
(g) any other method as may be approved by SEBI, on a case to case basis.
40 B – Take Over Offer
Under this clause, it is a condition for continued listing that whenever the take-over offer is made or there is any
change in the control of the management of the company, the person who secures the control of the management
of the company and the company whose shares have been acquired shall comply with the relevant provisions of
the SEBI (Substantial Acquisition of Shares and Take-overs) Regulations, 2011.
Points to Remember
A listed company as a continuous listing requirement has to comply with Rule 19 (2)(b) and 19 A of the SCRR,
1957 along with Clause 40A and 40 B of the Equity Listing Agreement.
MATERIAL EVENTS UNDER LISTING AGREEMENT
Clause 36 of the listing agreement deals with the material events which are required to be intimated to the stock
exchange by a company. It provides that a company is required to intimate the stock exchange about the major
events such as strikes, lock outs, closure on account of power cuts, etc. and all events which will have a bearing
on the performance / operations of the company as well as price sensitive information both at the time of
occurrence of the event and subsequently after the cessation of the event in order to enable the security holders
and the public to appraise the position of the Issuer and to avoid the establishment of a false market in its
securities. In addition, on request of the stock exchange the company may provide such information as required
by the stock exchanges. The material events may be events such as:
– Change in the general character or nature of business
The company will promptly notify the Exchange of any material change in the general character or nature of
its business where such change is brought about by the Issuer entering into or proposing to enter into any
arrangement for technical, manufacturing, marketing or financial tie-up or by reason of the Issuer, selling or
disposing of or agreeing to sell or dispose of any unit or division or by the Issuer, enlarging, restricting or
closing the operations of any unit or division or proposing to enlarge, restrict or close the operations of any
unit or division or otherwise.
– Disruption of operations due to natural calamity
The company will soon after the occurrence of any natural calamity like earthquake, flood or fire disruptive
of the operation of any one or more units of the Issuer keep the Exchange informed of the details of the
damage caused to the unit thereby and whether the loss/damage has been covered by insurance and
without delay furnish to the Exchange an estimate of the loss in revenue or production arising therefrom,
and the steps taken to restore normalcy, in order to enable the security holders and the public to appraise
the position of the issue and to avoid the establishment of a false market in its securities.
– Commencement of Commercial Production/Commercial Operations
The company will promptly notify the Exchange the commencement of commercial/production or the
commencement of commercial operations of any unit/division where revenue from the unit/division for a full
year of production or operations is estimated to be not less than ten per cent of the revenues of the Issuer
for the year.
194 PP-CC&MM
– Developments with respect to pricing/realisation arising out of change in the regulatory framework
The company will promptly inform the Exchange of the developments with respect to pricing of or in realisation
on its goods or services (which are subject to price or distribution, control/restriction by the Government or
other statutory authorities, whether by way of quota, fixed rate of return, or otherwise) arising out of modification
or change in Government's or other authorities’ policies provided the change can reasonably be expected to
have a material impact on its present or future operations or its profitability.
– Litigation /dispute with a material impact
The comapany will promptly after the event inform the Exchange of the developments with respect to any
dispute in conciliation proceedings, litigation, assessment, adjudication or arbitration to which it is a party or
the outcome of which can reasonably be expected to have a material impact on its present or future operations
or its profitability or financials.
– Revision in Ratings
The company will promptly notify the Exchange, the details of any rating or revision in rating assigned to any
debt or equity instrument of the Issuer or to any fixed deposit programme or to any scheme or proposal of
the Issuer involving mobilisation of funds whether in India or abroad provided the rating so assigned has
been quoted, referred to, reported, relied upon or otherwise used by or on behalf of the Issuer.
– Any other information having bearing on the operation/performance of the company as well as price
sensitive information.
Price Sensitive Information (PSI)
Clause 36 of the listing agreement also defines price sensitive information. Price sensitive information which
includes but not restricted to:
1. Issue of any class of securities.
2. Acquisition, merger, de-merger, amalgamation, restructuring, scheme of arrangement, spin off of setting
divisions of the company, etc.
3. Change in market lot of the company's shares, sub-division of equity shares of the company.
4. Voluntary delisting by the company from the stock exchange(s).
5. Forfeiture of shares.
6. Any action which will result in alteration in the terms regarding redemption/cancellation/retirement in
whole or in part of any securities issued by the company.
7. Information regarding opening, closing of status of ADR, GDR or any other class of securities to be
issued abroad.
8. Cancellation of dividend/rights/bonus, etc.
SEBI (Prohibition of Insider trading) Regulations, 1992 also defines price sensitive information. Under the
regulation Price Sensitive Information means any information which relates directly or indirectly to a company
and which if published is likely to materially affect the price of securities of a company. The following shall be
deemed to be price sensitive information:– periodical financial results of the company;
– intended declaration of dividends (both interim and final);
– issue of securities or buy-back of securities;
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– any major expansion plans or execution of new projects;
– amalgamation, mergers or takeovers;
– disposal of the whole or substantial part of the undertaking;
– any significant changes in policies, plans or operations of the company.
SUBMISSION OF INTERIM AND ANNUAL FINANCIAL RESULTS UNDER LISTING AGREEMENT
Every Listed Company under Clause 41 of the Listing Agreement is required to furnish unaudited quarterly
results on a quarterly basis in the prescribed format to the concerned Stock Exchanges within forty five days of
the end of the quarter. Under Clause 41, listed companies have been given the option to furnish either audited
or unaudited results within forty-five days from the end of the respective quarter (other than the last quarter).
Thus, Companies which are ready with audited financial results within forty five days after the end of the respective
quarter will be able to disclose such results without bothering to first disclose unaudited results. However, the
audited results shall be accompanied by the audit report. The following relevant provisions should be noted:—
– The company shall intimate to the Stock Exchange (normally through Fax, e-mail etc.) within 15 minutes
of the closure of the Board meeting in which the unaudited/audited financial results are placed.
– Further the company shall publish within 48 hours of the said meeting the unaudited/audited results in
the prescribed format in at least one national English newspaper and one Regional language daily
newspaper.
– The Board of Directors or its sub-committee should take on record the un-audited/audited quarterly
results, which shall be signed by chairman or managing director or a whole time director. The Audit
Committee which comprises mostly of independent directors need to review the results before the
same is taken up by the board.
– The company shall inform the Stock Exchange where its securities are listed about the date of the Board
Meeting at least 7 days in advance and shall also issue immediately a press release in at least one
national English newspaper and one regional language newspaper about the date of the aforesaid
Board or its sub-committee meeting.
– The company will furnish segment wise revenue, results and capital employed along with the quarterly
unaudited financial results after the ending of quarters as per the prescribed format.
– In case of change of name of the company, the new activity of business, turnover and the income from
the said new activity shall be separately disclosed for a period of three years from the date of such
change.
– The quarterly report should be prepared on the basis of accrual accounting policy and in accordance
with the uniform accounting practices adopted for all quarters.
– The listed companies are required to provide explanation for variation between items of unaudited and
audited quarterly/year to date/annual results only in respect of net profit or loss after Tax and for
exceptional/extraordinary items. Further, the such variation should not be more than 10% or ` 10 lakh
whichever is higher.
– The company will have the option to publish consolidated quarterly results in addition to the unaudited
quarterly results of the parent company.
– The quarterly unaudited results are subject to limited review by the Statutory Auditors of the company, to
be submitted within 45 days from end of the quarter.
– In respect of the half yearly results, if the company intimates in advance to the Stock Exchange/s that
it will publish audited half yearly financial results within two months of the close of the half year then
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in such a case unaudited results and limited review need not be published/given to the stock exchange/
s.
– As a part of its audited or unaudited financial results for the half-year, the company shall also submit by
way of a note, a statement of assets and liabilities as at the end of the half-year.
– In respect of results for the last quarter of the financial year, if the company intimates in advance to the
stock exchange/s that it will publish audited results within a period of 60 days from the end of the last
quarter of the financial year, in such a case unaudited results for the last quarter need not be published/
given to the Stock Exchange/s. The intimation of the decision to submit audited results should be send
within 45 days from the end of the quarter.
However, when a company opts to submit un-audited financial results for the last quarter of the financial
year, it shall, submit a statement of assets and liabilities as at the of financial year only along with the
audited financial results for the entire financial year, as soon as they are approved by the Board.
– The manufacturing and trading/services companies which have followed functional (secondary)
classification of expenditure in the Annual Profit & Loss Account in their most recent Annual report may
furnish results on a quarterly basis in this alternative format.
– In case the company has subsidiaries and it opts to submit consolidated financial result as mentioned at
(e) above, it may submit the consolidated financials as per the International Financial Reporting Standards
(IFRS) notified by the International Accounting Standards Board.
– The company shall ensure that the limited review/audit reports submitted to the stock exchanges on a
quarterly/annual basis shall be given only by an auditor who has subjected himself to the peer review
process of Institute of Chartered Accountants of India (ICAI) and holds a valid certificate issued by the
Peer Review Board of the ICAI.
DISCLOSURES UNDER LISTING AGREEMENT
Disclosure relating to shareholding pattern (Clause 35)
A company is required to file the details of their shareholding pattern with stock exchange separately for each
class of equity shares/security in the formats Prescribed, in compliance with the following timelines, namely :
(a) One day prior to listing of its securities on the stock exchanges.
(b) On a quarterly basis, within 21 days from the end of each quarter.
(c) Within 10 days of any capital restructuring of the company resulting in a change exceeding +/-2% of the
total paid-up share capital”
The following details are required to be disclosed to the stock exchange:
– Statement showing shareholding Pattern of the company
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
belonging to the category “Promoter and Promoter Group”
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
belonging to the category “Public” and holding more than 1% of the total number of shares
– Statement showing holding of securities (including shares, warrants, convertible securities) of persons
(together with Persons Acting in Concert (PAC)) belonging to the category “Public” and holding more
than 5% of the total number of shares of the company
– Statement showing details of locked-in shares
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– Statement showing details of Depository Receipts (DRs)
– Statement showing holding of Depository Receipts (DRs), where underlying shares held by ‘promoter/
promoter group’ are in excess of 1% of the total number of shares
– Statement showing the voting pattern of shareholders, if more than one class of shares/securities is
issued by the issuer.
Disclosure under Clause 41
– The company shall disclose the auditor’s qualification or other reservation and impact of the same on
the profit or loss,
– If the company has changed its name, it shall disclose the net sales or income, expenditure and net
profit or loss after tax figures pertaining to the said new line of business separately in the financial
results.
– If the company had not commenced commercial production or commercial operations during the
reportable period, the company shall disclose the details of amount raised, the portions thereof which is
utilized and that remaining unutilized, the details of investment made pending utilisation, brief description
of the project which is pending completion, status of the project and expected date of commencement of
commercial production or commercial operations.
– All items of income and expenditure arising out of transactions of exceptional nature shall be disclosed.
– Extraordinary items or changes in accounting standard, if any, shall be disclosed in accordance with
Accounting Standard 5 issued by ICAI/Company (Accounting Standards) Rules, 2006, whichever is
applicable.
– Companies, whose revenues are subject to material seasonal variations, shall disclose the seasonal
nature of their activities. In addition, they may supplement their financial results with information for the
12 months period ending on the last day of the quarter for the current and preceding years on a rolling
basis.
– The company shall disclose any event or transaction which occurred during or before the quarter that is
material to an understanding of the results for the quarter including but not limited to completion of
expansion and diversification programmes, strikes and lock-outs, change in management and change
in capital structure. The company shall also disclose similar material events or transactions that take
place subsequent to the end of the quarter.
– The company shall disclose the following in respect of dividends paid or recommended for the year,
including interim dividends:
– amount of dividend distributed or proposed for distribution per share; the amounts in respect of
different classes of shares shall be distinguished and the nominal values of shares shall also be
indicated;
– where dividend is paid or proposed to be paid pro-rata for shares allotted during the year, the date
of allotment and number of shares allotted, pro-rata amount of dividend per share and the aggregate
amount of dividend paid or proposed to be paid on pro-rata basis.
– The company shall disclose the effect on the financial results of material changes in the composition of
the company, if any, including but not limited to business combinations, acquisitions or disposal of
subsidiaries and long term investments, any other form of restructuring and discontinuance of operations.
– The company shall also disclose the number of investor complaints pending at the beginning of the quarter,
those received and disposed of during the quarter and those remaining unresolved at the end of the quarter.
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Disclosure regarding agreements with media companies (Clause 53)
This clause requires disclosure of agreements entered into between the listed entities and the media companies.
As per clause 53, the listed entities are required to disclose details of such agreements on their websites and
also notify the concerned stock exchange.
CORPORATE GOVERNANCE
Corporate Governance may be defined as a set of systems, processes and principles which ensure that a
company is governed in the best interest of all stakeholders. It is the system by which companies are directed
and controlled. It is about promoting corporate fairness, transparency and accountability. In other words, 'good
corporate governance' is simply 'good business'. It ensures:
– Adequate disclosures and effective decision making to achieve corporate objectives;
– Transparency in business transactions;
– Statutory and legal compliances;
– Protection of shareholder interests;
– Commitment to values and ethical conduct of business.
The fundamental objective of corporate governance is to enhance shareholders' value and protect the interests
of other stakeholders by improving the corporate performance and accountability. Hence it harmonizes the need
for a company to strike a balance at all times between the need to enhance shareholders' wealth whilst not in
any way being detrimental to the interests of the other stakeholders in the company. Further, its objective is to
generate an environment of trust and confidence amongst those having competing and conflicting interests.
REGULATORY FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA
Good corporate governance practices are a sine qua non for sustainable business that aims at generating long
term value to all its shareholders and other stakeholders. Some aspects of corporate governance have been
enshrined in the law that is administered by the Ministry of Corporate Affairs, SEBI and other sectoral regulators.
The important legislations for regulating the various aspects of governance in companies are Companies Act,
1956 and Companies Bill, 2012. These laws have been introduced and amended, from time to time, to bring
more transparency and accountability in the provisions of corporate governance. The SEBI Act, 1992 empowers
SEBI to frame regulations, pursuant to which the regulator has introduced a comprehensive set of guidelines
on insider trading, mergers and takeovers, fraudulent practices, etc all of which have a significant impact on
corporate governance in the country. SEBI, as a market regulator, also decides the terms and conditions of
listing agreement which govern the arrangement between stock exchanges and companies listed on the
stock exchange. The corporate governance standards are elaborated in Clause 49 of the listing agreement.
Regulators such as the Reserve Bank of India (“RBI”) and the Insurance Regulatory Development Authority
(“IRDA”) also prescribe corporate governance guidelines applicable for banking and insurance companies,
respectively.
The various legislations governing the corporate governance in companies are discussed below:
Companies Act, 1956
The main provisions dealing with Corporate Governance in the Indian Companies Act are given in the table
below:Section 217(2AA) Directors Responsibility Statement to be included in the Director’s Report.
Section 299
Requires every director of a company to make disclosure, at the board meeting, of the
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nature of his concern or interest in a contract or arrangement (present or proposed)
entered by or on behalf of the company.
Section 292A
Requires every public company having paid up capital of ` 5 Crore or more to constitute
a committee of the board called the Audit Committee.
Section 309(1)
Requires the remuneration payable both to the executive as well as non-executive
directors is required to be determined by the Board in accordance with and subject to the
provisions of sec 198 either by the articles of the company or by resolution or if the article
so require by a special resolution, passed by the company in general meeting.
Schedule VI
Requires disclosure of Director’s remuneration and computation of net profit for that
purpose.
CORPORATE GOVERNANCE -VOLUNTARY GUIDELINES 2009
The ‘Corporate Governance -Voluntary Guidelines 2009’, being proposed for voluntary adoption by the Corporate
Sector have taken into account the recommendations of the Task Force set up by Confederation of Indian
Industry (CII) under chairmanship of Shri Naresh Chandra in February, 2009 to recommend ways to further
improve corporate governance standards and practices. Base on the report of the Task Force of CII on corporate
governance headed by Shri Naresh Chandra and the recommendations of the Institute of Company Secretaries
of India for strengthening corporate governance framework the Ministry of Corporate Affairs issued “Corporate
Governance -Voluntary Guidelines 2009” which provides for a set of good practices which may be voluntarily
adopted by the Public companies.The guidelines are recommendatory in nature.
GUIDELINES ON CORPORATE GOVERNANCE FOR CENTRAL PUBLIC SECTOR ENTERPRISES
Department of Public Enterprises has issued Guidelines on Corporate Governance for Central Public Sector
Enterprises (CPSEs) which were revised by a notification no. 18(8)/2005-GM dt. 14th May 2010. The guidelines
on Corporate Governance for listed and unlisted CPSEs are being dealt in separate chapters under the following
headings.
– Board of Directors
– Audit Committee
– Remuneration Committee
– Subsidiary Companies
– Disclosures
– Report, Compliance and Schedule of Implementation
Applicability
For the purpose of the guidelines the public sector enterprises have been categorized in two groups; (a) listed
entities and (b) Non-listed entities.
CPSEs listed on Stock Exchanges:
All listed CPSEs are required to follow the SEBI Guidelines on Corporate Governance. In addition, they shall
follow those provisions of these Guidelines which do not exist in the SEBI Guidelines and also do not contradict
any of the provisions of the SEBI Guidelines.
Non-listed CPSEs
Each CPSE should strive to institutionalize good Corporate Governance practices broadly in conformity with the
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SEBI Guidelines. The guidelines provide that the provisions shall also be applicable to all the unlisted CPSE’s
on mandatory basis.
NATIONAL VOLUNTARY GUIDELINES ON SOCIAL, ENVIRONMENTAL & ECONOMIC
RESPONSIBILITIES OF BUSINESS, 2011
On 8 July 2011, the Ministry of Corporate Affairs launched the National Voluntary Guidelines on Social,
Environmental & Economic Responsibilities of Business. The Guidelines, directed at all business types and
sizes, provide a basic framework that may be adopted voluntarily in order to address the interests of various
stakeholders, including employees, customers and investors. The original 2009 Voluntary Guidelines were revised
following consultations with business and civil society representatives which demonstrates the government’s
continued commitment to sustainable business. While the 2011 Guidelines identify the areas where responsible
practices need to be adopted, the accompanying Reporting Framework provides a standard disclosure template
which can be used to report on performance in these areas.
These guidelines contain comprehensive principles to be adopted by companies as part of their business practices
and a structured business responsibility reporting format requiring certain specified disclosures, demonstrating
the steps taken by companies to implement the said principles.
COMPANIES BILL, 2012
In the Companies Bill 2012, various new provisions have been included (which are not provided for in Companies
Act, 1956) for better governance of the companies. Some of those new provisions are:
– Requirement to constitute Remuneration and nomination committee and Stakeholders Grievances
Committee
– Granting of More powers to Audit Committee
– Specific clause pertaining to duties of directors
– Mode of appointment of Independent Directors and their tenure
– Code of Conduct for Independent Directors
– Rotation of Auditors and restriction on Auditor's for providing non-audit services
– Enhancement of liability of Auditors
– Disclosure and approval of RPTs
– Mandatory Auditing Standards
– Enabling Shareholders Associations/Group of Shareholders for taking class action suits and
reimbursement of the expenses out of Investor Education and Protection Fund
– Constitution of National Financial Reporting Authority, an independent body to take action against the
Auditors in case of professional mis-conduct
– Requirement to spend on CSR activities
EVOLUTION OF CLAUSE 49 OF LISTING AGREEMENT
Corporate governance denotes the process, structure and relationship through which the Board of Directors
oversees what the management does. It is also about being answerable to different stakeholders.
CII constituted a Committee to recommend a Code of Corporate Governance to be observed by corporates in
their functioning. The Committee further recommended a Code popularly known as “Desirable Corporate
Governance Code” which defined Corporate Governance as follows:
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“Corporate governance deals with laws, procedures, practices and implicit rules that determine a
company’s ability to take informed managerial decisions vis-a-vis its claimants – in particular, its
shareholders, creditors, customers, the State and employees. There is a global consensus about the
objective of ‘good’ corporate governance: maximising long-term shareholder value.”
The Kumar Mangalam Birla Committee Constituted by SEBI has observed that:
“Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important
instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and
high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting
structure.”
N.R. Narayana Murthy Committee on Corporate Governance constituted by SEBI has observed that:
“Corporate Governance is the acceptance by management of the inalienable rights of shareholders as the
true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about
commitment to values, about ethical business conduct and about making a distinction between personal and
corporate funds in the management of a company.”
The Institute of Company Secretaries of India has also defined the term Corporate Governance as under:
“Corporate Governance is the application of best management practices, compliance of law in true letter and
spirit and adherence to ethical standards for effective management and distribution of wealth and discharge
of social responsibility for sustainable development of all stakeholders.”
Good Governance in capital market has always been high on the agenda of SEBI. Corporate Governance is
looked upon as a distinctive brand and benchmark in the profile of Corporate Excellence. This is evident from
the continuous updation of guidelines, rules and regulations by SEBI for ensuring transparency and accountability.
In the process, SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri
Kumar Mangalam Birla. The Committee in its report observed that “the strong Corporate Governance is
indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is
the blood that fills the veins of transparent corporate disclosure and high quality accounting practices. It is the
muscle that moves a viable and accessible financial reporting structure.”
Based on the recommendations of the Committee, the SEBI had specified principles of Corporate Governance
and introduced a new clause 49 in the Listing agreement of the Stock Exchanges in the year 2000. These
principles of Corporate Governance were made applicable in a phased manner and all the listed companies
with the paid up capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history
of the company, were covered as of March 31, 2003.
SEBI, as part of its endeavour to improve the standards of corporate governance in line with the needs of a
dynamic market, constituted another Committee on Corporate Governance under the Chairmanship of Shri N.
R. Narayana Murthy to review the performance of Corporate Governance and to determine the role of companies
in responding to rumour and other price sensitive information circulating in the market in order to enhance the
transparency and integrity of the market. The Committee in its Report observed that “the effectiveness of a
system of Corporate Governance cannot be legislated by law, nor can any system of Corporate Governance be
static. In a dynamic environment, system of Corporate Governance need to be continually evolved.”
With a view to promote and raise the standards of Corporate Governance, SEBI on the basis of recommendations
of the Committee and public comments received on the report and in exercise of powers conferred by Section
11(1) of the SEBI Act, 1992 read with section 10 of the Securities Contracts (Regulation) Act 1956, revised the
existing clause 49 of the Listing agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated August 26,
2003.
SEBI vide circular number SEBI/CFD/ DIL/CG/1/2004/12/10 dated October 29, 2004 again revised the existing
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Clause 49 of the Listing Agreement directing all the Stock Exchanges to amend the Listing Agreement by
replacing the existing Clause 49 of the Listing Agreement. As per the Circular, the provisions of the Clause 49
were to be implemented as per the schedule of implementation given below:
(a) For entities seeking listing for the first time, at the time of seeking in-principle approval for such listing.
(b) For existing listed entities which were required to comply with Clause 49 which is being revised i.e.
those having a paid up share capital of ` 3 crores and above or net worth of ` 25 crores or more at any
time in the history of the company, by April 1, 2005.
However noticing that large number of companies were not in the state of preparedness to be fully compliant
with the requirements of revised Clause 49 of the listing agreement, SEBI allowed more time to corporates to
conform to Clause 49 of the listing agreement and extended the date for ensuring compliance with the Clause
49 of the listing agreement to December 31, 2005. Now as on date, Clause 49 is applicable.
CLAUSE 49
Clause 49 of the Equity Listing Agreement consists of mandatory as well as non-mandatory provisions. Those
which are absolutely essential for corporate governance can be defined with precision and which can be enforced
without any legislative amendments are classified as mandatory. Others, which are either desirable or which
may require change of laws are classified as non-mandatory. The non-mandatory requirements may be
implemented at the discretion of the company. However, the disclosures of the compliance with mandatory
requirements and adoption (and compliance) / non-adoption of the non-mandatory requirements shall be made
in the section on corporate governance of the Annual Report.
Gist of Cause 49 is as follows:
Mandatory provisions comprises of the following:
– Composition of Board and its procedure - frequency of meeting, number of independent directors, code
of conduct for Board of directors and senior management;
– Audit Committee, its composition, and role
– Provision relating to Subsidiary Companies
– Disclosure to Audit committee, Board and the Shareholders
– CEO/CFO certification
– Quarterly report on corporate governance
– Annual compliance certificate
Non-mandatory provisions consist of the following:
– Constitution of Remuneration Committee
– Despatch of Half-yearly results
– Training of Board members
– Peer evaluation of Board members
– Whistle Blower policy
Composition of Board of Directors
As per the Listing Agreement, the Board of Directors of the company shall have an optimum combination of
executive and non executive directors. Further-
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– not less than 50 per cent of the board of directors shall comprise of non-executive directors;
– the number of independent directors would depend on whether the chairman is executive or nonexecutive;
– if the Board has a Non-Executive Chairman, at least one third of the Board should comprise of independent
directors;
– if the Board has an Executive Chairman, at least half of the Board should comprise of independent
directors.
If the non-executive Chairman is a promoter or is related to promoters or persons occupying management
positions at the board level or at one level below the board, at least one-half of the board of the company should
consist of independent directors. The expression “related to any promoter” means:
(a) If the promoter is a listed entity, its directors other than the independent directors, its employees or its
nominees shall be deemed to be related to it;
(b) If the promoter is an unlisted entity, its directors, its employees or its nominees shall be deemed to be
related to it.
Definition of Independent Director
‘Independent director’ shall mean non-executive director of the company who –
(a) apart from receiving director’s remuneration, does not have any material pecuniary relationships or
transactions with the company, its promoters, its directors, its senior management or its holding company,
its subsidiaries and associates which may affect the independence of the director;
(b) is not related to promoters or persons occupying management positions at the board level or at one
level below the board;
(c) has not been an executive of the company in the immediately preceding three financial years;
(d) is not a partner or an executive or was not partner or an executive during the preceding three years, of
any of the following:
(i) the statutory audit firm or the internal audit firm that is associated with the company;
(ii) the legal firm(s) and consulting firm(s) that have a material association with the company.
(e) is not a material supplier, service provider or customer or a lessor or lessee of the company which may
effect the independence of the director;
(f) is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting
shares; and
(g) is not less than 21 year age.
An independent director who resigns or is removed from the Board of the Company shall be replaced by a
new independent director within a period of not more than 180 days from the day of such resignation or
removal, as the case may be. However, if the company fulfils the requirement of independent directors in its
Board even without filling the vacancy created by such resignation or removal, as the case may be, the
requirement of replacement by a new independent director within the period of 180 days would not apply.
Nominee Directors to be treated as Independent Director
The clause provides that Nominee directors appointed by an institution which has invested in or lent to the
company shall be deemed to be independent directors.
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Non Executive Directors’ Compensation and Disclosures
The clause provides that all fees/compensation, if any paid to non-executive directors, including independent
directors, shall be fixed by the Board of Directors and require previous approval of shareholders in general
meeting. The requirement of obtaining prior approval of shareholder in general meeting is not applicable to
payment of sitting fees to non-executive directors, if made within the limits prescribed under the Companies Act,
1956 for payment of sitting fees, without approval of the Central Government.
Disclosures on Remuneration of Directors
The specific disclosures on the remuneration of directors regarding all elements of remuneration package of
individual directors summarized under major groups such as salary, benefits, bonuses, pensions, stock options
etc., details of fixed component and performance linked incentives, along with performance criteria, service
contracts, notice period, severance fees, stock option details, if any, and whether issued at a discount as well as
the period over which accrued and over which exercisable, should be made in the section on Corporate
Governance of the Annual Report.
Limits on Membership of Committees
A director shall not be a member in more than 10 committees or act as chairman of more than five committee
across all companies in which he is a director.
For the purpose of considering the limit of the committees on which a director can serve, Chairmanship/
membership of the Audit Committee and the Share-holders' Grievance Committee alone are to be considered.
Code of Conduct
The clause states that all Board members and senior management personnel shall affirm compliance with the
code of conduct laid down by the Board on an annual basis and the Annual Report of the company shall contain
a declaration to this effect signed by the CEO.
Board of Meetings
The Board shall meet at least four times a year with a maximum time gap of four months between any two
meetings.
Audit Committee
(i) The requirement of giving terms of reference of the Audit Committee is a must.
(ii) There should be minimum three members as directors.
(iii) It further provides that 2/3rd of the members of audit committee shall be independent directors.
(iv) The clause provides that all members of audit committee shall be financially literate and at least one
member shall have accounting or related financial management expertise.
(v) The clause provides that the term “financially literate” means the ability to read and understand basic
financial statements i.e. balance sheet, profit and loss account, and statement of cash flows.
(vi) It further provides that a member will be considered to have accounting or related financial management
expertise if he or she possesses experience in finance or accounting, or requisite professional certification
in accounting, or any other comparable experience or background which results in the individual’s
financial sophistication, including being or having been a chief executive officer, chief financial officer, or
other senior officer with financial oversight responsibilities.
(vii) Calling of executives is optional. The finance director, head of internal audit and representative of statutory
auditor may be present as invitees for the meetings of the audit committee.
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(viii) The Chairman of the audit committee should be an independent director and should also be present at
the Annual General Meeting to answer shareholder queries.
(ix) The company secretary should act as the secretary to the committee.
Quorum of Audit Committee
The quorum for the Audit Committee meeting shall be either two members or one-third of the members of the
Audit Committee; whichever is greater but there should be a minimum of two independent directors present.
Powers of the Audit Committee
The powers of the Audit Committee shall include the following:
(i) To investigate any activity within its terms of reference.
(ii) To seek information from any employee.
(iii) To obtain outside legal or other professional advice.
(iv) To secure attendance of outsiders with relevant expertise, if it considers necessary.
The powers of the Audit Committee specified above are illustrative and apart from the above, the Board may
delegate such other powers, as it may deem fit and proper.
Meetings and Role of Audit Committee
There is requirement of holding atleast four meetings in a year. The clause also provides that not more than four
months shall elapse between the two meetings of audit committee. The role of the audit committee include the
following:
1. Oversight of the company’s financial reporting process and the disclosure of its financial information to
ensure that the financial statement is correct, sufficient and credible.
2. Recommending to the Board, the appointment, re-appointment and, if required, the replacement or removal
of the statutory auditor and the fixation of audit fees.
3. Approval of payment to statutory auditors for any other services rendered by the statutory auditors.
4. Reviewing, with the management, the annual financial statements before submission to the board for approval,
with particular reference to:
(a) Matters required to be included in the Director’s Responsibility Statement to be included in the Board’s
report in terms of clause (2AA) of section 217 of the Companies Act, 1956.
(b) Changes, if any, in accounting policies and practices and reasons for the same.
(c) Major accounting entries involving estimates based on the exercise of judgment by
management.
(d) Significant adjustments made in the financial statements arising out of audit findings.
(e) Compliance with listing and other legal requirements relating to financial statements.
(f) Disclosure of any related party transactions.
(g) Qualifications in the draft audit report.
5. Reviewing, with the management, the quarterly financial statements before submission to the board for approval.
5A. Reviewing, with the management, the statement of uses/application of fund raised through an issue (public
issue, right issue, preferential issue, etc.), the statement of funds utilized for purposes other than those stated in
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the offer document/prospectus/notice and the report submitted by the monitoring agency monitoring the utilization
of proceeds of a public or rights issue, and making appropriate recommendations to the Board to take steps in
this matter.
6. Reviewing, with the management, performance of statutory and internal auditors, adequacy of the internal
control systems.
7. Reviewing the adequacy of internal audit function, if any, including the structure of the internal audit department,
staffing and seniority of the official heading the department, reporting structure coverage and frequency of
internal audit.
8. Discussion with internal auditors any significant findings and follow up there on.
9. Reviewing the findings of any internal investigations by the internal auditors into matters where there is
suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the
matter to the board.
10. Discussion with statutory auditors before the audit commences, about the nature and scope of audit as well
as post-audit discussion to ascertain any area of concern.
11. To look into the reasons for substantial defaults in the payment to the depositors, debenture holders,
shareholders (in case of non payment of declared dividends) and creditors.
12. To review the functioning of the Whistle Blower mechanism, in case the same is existing.
12A. Approval of appointment of CFO (i.e. the whole-time finance Director or any other person heading the
finance function or discharging that function) after assessing the qualification, experience and back of mind, etc.
of the candidate.
13. Carrying out any other function as is mentioned in the terms of reference of the Audit Committee
Review of Information by Audit Committee
The Audit Committee is required to mandatorily review the following information:
(a) Management discussion and analysis of financial condition and results of operations;
(b) Statement of significant related party transactions (as defined by the audit committee), submitted by the
management;
(c) Management letters/letters of internal control weaknesses issued by statutory auditors;
(d) Internal audit reports relating to internal control weaknesses; and
(e) The appointment, removal and terms of remuneration of the Chief internal auditor shall be subject to
review by the Audit Committee.
SUBSIDIARY COMPANY
(i) At least one independent director on the Board of Directors of the holding company shall be a director on the
Board of Directors of material non-listed Indian subsidiary company.
(ii) The Audit Committee of the listed holding company shall also review the financial statements, in particular the
investments made by the unlisted subsidiary company.
(iii) The minutes of the Board meetings of the unlisted subsidiary company is required to be placed at the Board
meeting of the listed holding company.
(iv) The management should periodically bring to the attention of the Board of Directors of the listed holding company,
a statement of all significant transactions and arrangements entered into by the unlisted subsidiary company.
Lesson 6
Secondary Market 207
(v) The term “material non-listed Indian subsidiary” means an unlisted subsidiary, incorporated in India, whose
turnover or net worth (i.e. paid up capital and free reserves) exceeds 20% of the consolidated turnover or net
worth respectively, of the listed holding company and its subsidiaries in the immediately preceding accounting
year.
(vi) The term “significant transaction or arrangement” means any individual transaction or arrangement that
exceeds or is likely to exceed 10% of the total revenues or total expenses or total assets or total liabilities, as the
case may be, of the material unlisted subsidiary for the immediately preceding accounting year.
(vii) Where a listed holding company has a listed subsidiary which is itself a holding company, the above provisions
also apply to the listed subsidiary insofar as its subsidiaries are concerned.
SHAREHOLDERS/INVESTORS GRIEVANCE COMMITTEE
A Board Committee under the Chairmanship of a non-executive director shall be formed to specifically look into
redressal of shareholder and investors complaints like transfer of shares non-receipt of balance sheet, nonreceipt of declared dividends etc. Committee shall be designated as ‘Shareholders/Investors Grievance
Committee’. The number of meetings of the Shareholders/Investors Grievance Committee should be in
accordance with the exigencies of business requirements.
DISCLOSURES
The following disclosures are required to be made under this clause:
– Basis of related Party Transactions
– Disclosure of Accounting Treatment
– Risk Management
– Proceeds from public issues, Rights issues, preferential issues etc.
– Remuneration of Directors
– Management
– Shareholders
CEO/CFO CERTIFICATION
The CEO, i.e. the Managing Director or Manager appointed in terms of the Companies Act, 1956 and the CFO
i.e. the whole-time Finance Director or any other person heading the finance function discharging that function
shall certify to the Board that:
(a) They have reviewed financial statements and the cash flow statement for the year and that to the best
of their knowledge and belief :
(i) these statements do not contain any materially untrue statement or omit any material fact or contain
statements that might be misleading;
(ii) these statements together present a true and fair view of the company’s affairs and are in compliance
with existing accounting standards, applicable laws and regulations.
(b) There are, to the best of their knowledge and belief, no transactions entered into by the company during
the year which are fraudulent, illegal or violative of the company’s code of conduct.
(c) They accept responsibility for establishing and maintaining internal controls for financial reporting and
that they have evaluated the effectiveness of the internal control systems of the company pertaining to
financial reporting and they have disclosed to the auditors and the Audit Committee, deficiencies in the
208 PP-CC&MM
design or operation of such internal controls, if any, of which they are aware and the steps they have
taken or propose to take to rectify these deficiencies.
(d) They have indicated to the auditors and the Audit committee –
(i) significant changes in internal control over financial reporting during the year;
(ii) significant changes in accounting policies during the year and that the same have been disclosed in
the notes to the financial statements; and
(iii) instances of significant fraud of which they have become aware and the involvement therein, if any,
of the management or an employee having a significant role in the company’s internal control system
over financial reporting.
REPORT ON CORPORATE GOVERNANCE
The companies shall submit a quarterly compliance report to the stock exchanges within 15 days from the close
of quarter as per the format prescribed in the clause. The report is required to be signed either by the Compliance
Officer or the Chief Executive Officer of the company.
Compliance Certificate
The practising Company Secretaries have also been recognised to issue Certificate of Compliance of Conditions
of Corporate Governance. The clause provides that the company shall obtain a certificate from either the auditors
or practicing company secretaries regarding compliance of conditions of corporate governance as stipulated
in this clause and annex the certificate with the directors’ report, which is sent annually to all the shareholders of
the company. The same certificate shall also be sent to the Stock Exchanges along with the annual report filed
by the company.
Non-mandatory Requirements
The following non-mandatory requirements have additionally been provided:
(1) The Board
A non-executive Chairman may be entitled to maintain a Chairman’s office at the company’s expense and also
allowed reimbursement of expenses incurred in performance of his duties.
Independent Directors may have a tenure not exceeding, in the aggregate, a period of nine years, on the Board
of a company. The company shall ensure that the person who is being appointed as an independent director has
the requisite qualifications and experience which would be of use to the company and which in the opinion of the
company would enable aim to contribute effectively the company in his capacity as an independent director.
(2) Remuneration Committee
(i) The board may set up a remuneration committee to determine on their behalf and on behalf of the shareholders
with agreed terms of reference, the company’s policy on specific remuneration packages for executive directors
including pension rights and any compensation payment.
(ii) To avoid conflicts of interest, the remuneration committee, which would determine the remuneration packages
of the executive directors may comprise of at least three directors, all of whom should be non-executive directors,
the Chairman of committee being an independent director.
(iii) All the members of the remuneration committee could be present at the meeting.
(iv)The Chairman of the remuneration committee could be present at the Annual General Meeting, to answer
the shareholder queries. However, it would be up to the Chairman to decide who should answer the queries.
Lesson 6
Secondary Market 209
(3) Shareholder Rights
A half-yearly declaration of financial performance including summary of the significant events in last six-months,
may be sent to each household of share-holders.
Audit qualifications
Company may move towards a regime of unqualified financial statements.
Training of Board Members
A company may train its Board members in the business model of the company as well as the risk profile of the
business parameters of the company, their responsibilities as directors, and the best ways to discharge them.
Mechanism for evaluating non-executive Board Members
The performance evaluation of non-executive directors could be done by a peer group comprising the entire
Board of Directors, excluding the director being evaluated and Peer Group evaluation could be the mechanism
to determine whether to extend/continue the terms of appointment of non-executive directors.
Whistle Blower Policy
The company may establish a mechanism for employees to report to the management concerns about unethical
behaviour, actual or suspected fraud or violation of the company’s code of conduct or ethics policy. This mechanism
could also provide for adequate safeguards against victimization of employees who avail of the mechanism and
also provide for direct access to the Chairman of the Audit committee in exceptional cases. Once established,
the existence of the mechanism may be appropriately communicated within the organization.
STOCK EXCHANGE MECHANISM
Stock Exchange is an integral part of Secondary Market. The Stock Exchange is a key institution facilitating the
issue and sales of various types of securities and for this the Stock Exchange has mechanism like trading of
securities, clearing and settlement of securities through which buying and selling takes place. Further, Stock
Indices are an important part of stock market representing the performance of stock market and reflecting
investor sentiment on the state of economy. When the stock exchange opens at 9.00 a.m., there is flurry of
orders that are keyed - in from all over the world and from all strata of economic background. In this hurly burly,
turbulent and apprehensive market scenario, there are bound to be mistakes, differences and disputes. These
disputes can be between a broker, sub broker, constituents, clearing member, depositories, authorized persons,
etc. To deal with such disputes, stock exchanges have devised a dispute resolution mechanism in accordance
with the guidelines issued by SEBI from time to time.
ARBITRATION MECHANISM
Arbitration is a quasi judicial process of settlement of disputes between trading member, investor, clearing
member, sub brokers, authorized persons etc. Arbitration aims at quicker resolution of the disputes. When either
of the parties is not satisfied with the complaint resolution process or the complaint is not resolved amicably
between parties, the parties may choose the route of arbitration.
Kinds of disputes covered under Exchange Arbitration Mechanism
All disputes arising out of transactions done on the Exchange by the parties are eligible for arbitration mechanism
provided by the exchange.
Legal framework for Arbitration Mechanism provided by Exchange
Arbitration framework at Exchange is governed by the rules, Byelaws, Regulations & Circular issued by the
210 PP-CC&MM
exchange and SEBI, from time to time. SEBI issued circulars dated August 11, 2010 and August 31, 2010,
bringing about sweeping amendments to the manner in which arbitrations were being conducted by the stock
exchanges.
Arbitration Mechanism at Stock exchanges
A stock exchange shall provide an arbitration mechanism for settlement of disputes between a client and a
member through arbitration proceedings in accordance with the provisions of this Circular read with Section 2(4)
of the Arbitration and Conciliation, Act, 1996.
Maintenance of a Panel of Arbitrators
– A stock exchange shall maintain a panel of arbitrators. The number of arbitrators in the panel shall be
commensurate to the number of disputes so that an arbitrator handles a reasonable number of references
simultaneously and all arbitration references are disposed of within the prescribed time.
– The stock exchange shall have a set of fair and transparent criteria for inclusion of names in the panel
of arbitrators.
– While deciding to include a particular person in the panel of arbitrators, the stock exchange shall take
into account the following factors:
(i) age,
(ii) qualification in the area of law, finance, accounts, economics, management, or administration, and
(iii) experience in financial services, including securities market.
– The name of a person shall be included in the panel after obtaining:
(i) a declaration that he has not been involved in any act of fraud, dishonesty or moral turpitude, or
found guilty of any economic offence,
(ii) disclosure of the nature of his association with securities market,
(iii) disclosure of the names of his dependents associated with the securities market as member, subbroker or authorized person, and
(iv) an undertaking that he shall abide by the code of conduct as prescribed by SEBI.
– The stock exchange shall provide at least seven days of continuing education to every arbitrator each
year.
– The stock exchange shall have a mechanism to appraise the performance of arbitrators and reconstitute
the panel based on such appraisal atleast once a year.
– List of Arbitrators on the panel of all stock exchanges having nation-wide trading terminals shall be
pooled and will be called a 'Common Pool'. This list shall be made publicly available including by way of
display on websites of the stock exchanges.
– 'Common pool' of Arbitrators will consist of Arbitrators listed on the panels of all stock exchanges having
nation-wide trading terminals. The pooling of arbitrators will be done centre-wise. To illustrate, the list of
arbitrators on the panel of all stock exchanges for the region covered by the Delhi centre will be pooled.
This would enable an applicant from the region to choose any arbitrator from the 'Common Pool' for
Delhi.
– If the client and member (stock broker, trading member or clearing member) fail to choose the Arbitrator(s)
from the Common Pool, the Arbitrator(s) will be chosen by an 'Automatic Process' wherein neither the
parties to arbitration (i.e. client or member) nor the concerned Stock Exchanges will be directly involved.
Lesson 6
Secondary Market 211
– The 'Automatic Process' will entail a randomized, computer generated selection of Arbitrator, from the
list of Arbitrators in the 'Common Pool'. The selection process shall be in chronological order of the
receipt of arbitration reference i.e. only after selecting an arbitrator for the former arbitration reference
received, selection for the latter shall be taken up.
– The 'Automatic Process' will send a system generated, real time alert (sms, email etc.) to all entities
involved in the particular case. Further, the communication for the appointment of the Arbitrator will be
sent immediately and in any case not later than the next working day from the day of picking of the
Arbitrator. This communication will be sent by the stock exchange on which the dispute had taken place,
to all concerned entities including clients, arbitrators, members, stock exchanges etc.
Code of Conduct for Arbitrators
An arbitrator shall –
(i) act in a fair, unbiased, independent and objective manner;
(ii) maintain the highest standards of personal integrity, truthfulness, honesty and fortitude in discharge of
his duties;
(iii) disclose his interest or conflict in a particular case, i.e., whether any party to the proceeding had any
dealings with or is related to the arbitrator;
(iv) not engage in acts discreditable to his responsibilities;
(v) avoid any interest or activity which is in conflict with the conduct of his duties as an arbitrator;
(vi) avoid any activity that may impair, or may appear to impair, his independence or objectivity;
(vii) conduct arbitration proceedings in compliance with the principles of natural justice and the relevant
provisions of the Arbitration and Conciliation Act, 1996, the SEBI Act, 1992, the Securities Contracts
(Regulation) Act, 1956 and the Rules, Regulations and Bye-laws framed thereunder and the circulars,
directions issued by the Government / SEBI;
(viii) endeavour to pass arbitral award expeditiously and in any case not later than the time prescribed in this
circular; and
(ix) pass reasoned and speaking arbitral awards.
Arbitration
– The limitation period for filing an arbitration reference shall be governed by the law of limitation, i.e., The
Limitation Act, 1963.
– An arbitration reference for a claim / counter claim up to `25 lakh shall be dealt with by a sole arbitrator
while that above `25 lakh shall be dealt with by a panel of three arbitrators.
– The stock exchange shall ensure that the process of appointment of arbitrator(s) is completed within 30
days from the date of receipt of application from the applicant.
– The arbitration reference shall be concluded by way of issue of an arbitral award within four months
from the date of appointment of arbitrator(s).
– The Managing Director/ Executive Director of the stock exchange may for sufficient cause extend the
time for issue of arbitral award by not more than two months on a case to case basis after recording the
reasons for the same.
212 PP-CC&MM
Appellate Arbitration
– A party aggrieved by an arbitral award may appeal to the appellate panel of arbitrators of the stock
exchange against such award.
– An appeal before the appellate panel of arbitrators may be filed within one month from the date of
receipt of arbitral award.
– The appellate panel shall consist of three arbitrators who shall be different from the ones who passed
the arbitral award appealed against.
– The stock exchange shall ensure that the process of appointment of appellate panel of arbitrators is
completed within 30 days from the date of receipt of application for appellate arbitration.
– The appeal shall be disposed of within three months from the date of appointment of appellate panel of
such appeal by way of issue of an appellate arbitral award.
– The Managing Director/ Executive Director of the stock exchange may for sufficient cause extend the
time for issue of appellate arbitral award by not more than two months on a case to case basis after
recording the reasons for the same.
– A party aggrieved by the appellate arbitral award may file an application to the Court of competent
jurisdiction in accordance with Section 34 of the Arbitration and Conciliation Act, 1996.
Arbitration Fees
– Each of the parties to arbitration shall deposit an amount, as may be prescribed by the stock exchange,
at the time of making arbitration reference. The deposits (exclusive of statutory dues – stamp duty,
service tax, etc.) shall not exceed the amount as indicated under:
Amount of Claim/
of Counter Claim,
whichever is higher
(`)
If claim is filed within
six months
If claim is filed after six
months
<10,00,000
1.3% subject to a minimum of
`10,000
3.9% subject to a minimum of `30,000
>10,00,000 - <
25,00,000
` 13,000 plus 03%
amount above `10 lakh
` 39,000 plus 0.9% amount above `
10 lakh
>25,00,000
` 17,500 plus 0.2% amount
above ` 25 5 lakh subject to
maximum of `30,000
` 52,500 plus 0.6% amount above `
25 lakh subject to maximum of `
90,000
Note: six months shall be computed from the end of the quarter during which the disputed transaction(s)
were executed/ settled, whichever is relevant for the dispute.
– A client, who is a party to the arbitration for a claim/counter claim upto ` 10 lakh, shall be exempt from
the deposit provided the arbitration reference for the same is filed within six months from the end of the
quarter during which the disputed transaction(s) were executed/ settled.
– On issue of the arbitral award, the stock exchange shall refund the deposit, if any, to the party in whose
favour the award has been passed and appropriate the deposit, if any, made by the party, against whom
the award has been passed, towards arbitration fees.
– A party filing an appeal before the appellate panel shall pay a fee not exceeding ` 30,000,as may be
prescribed by the stock exchange, in addition to statutory dues (stamp duty, service tax, etc) along with
the appeal.
Lesson 6
Secondary Market 213
Place of Arbitration
– The Stock Exchanges having nationwide terminals, such as National Stock Exchange of India Ltd.,
Bombay Stock Exchange Ltd., MCX Stock Exchange Ltd., and United Stock Exchange of India Ltd.,
shall provide arbitration facility (arbitration as well as appellate arbitration) at all four regional centres
(Delhi, Mumbai, Kolkata and Chennai). The arbitration and appellate arbitration shall be conducted at
the regional centre nearest to the client.
– The application under Section 34 of the Arbitration and Conciliation Act, 1996, if any, against the decision
of the appellate panel shall be filed in the competent Court nearest to such regional centre.
– Other stock exchanges shall provide the arbitration facility, including appellate arbitration, at the place
where it is located.
Implementation of Arbitral Award in favour of Clients
– In case the arbitral / appellate arbitral award is in favour of the client, the stock exchange shall, on
receipt of the same, debit the amount of the award from the security deposit or any other monies of the
member (against whom an award has been passed) and keep it in a separate escrow account.
– The stock exchange shall implement the arbitral award, by making payment to the client, along with
interest earned on the amount that has been set aside, as soon as the time for preferring an appeal
before the appellate panel of arbitrators has expired and no appeal has been preferred.
– The stock exchange shall implement the appellate arbitral award, by making payment to the client,
along with interest earned on the amount that has been set aside, as soon as:
(a) the time for making an application to a Court to set aside such appellate arbitral award under
Section 34 of the Arbitration and Conciliation Act, 1996 has expired, and no application has been
made, or
(b) when an application to a Court to set aside such appellate arbitral award under Section 34 of the
Arbitration and Conciliation Act, 1996, having been made, it has been refused by such Court, or
(c) an application to a Court to set aside such appellate arbitral award under Section 34 of the Arbitration
and Conciliation Act, 1996, having been made, but where no stay has been granted by such Court
within a period of three months from the date on which the party making that application had received
the appellate arbitral award.
Record and Disclosures
– The stock exchange shall preserve the following documents related to arbitration:
(i) the arbitral and appellate arbitral award with acknowledgements, confirming receipt of award by the
disputing parties, permanently;
(ii) other records pertaining to arbitration for five years from the date of arbitral award, appellate arbitral
award or Order of the Court, as the case may be; and
(iii) register of destruction of records relating to (ii) above, permanently.
– The stock exchange shall disclose on its website, details of disposal of arbitration proceedings as per
the format prescribed by SEBI and details of arbitrator-wise disposal of arbitration proceedings as per
format prescribed by SEBI.
– The stock exchange shall continue to disclose on their website the arbitration awards (issued since April
1, 2007)
214 PP-CC&MM
Things You May Know
What happens if the appellate tribunal award is in favour of the Investor?
When the appellate tribunal is passed in favour of investor:
– Trading member may settle the award and confirm the same to the Exchange.
– Trading member can further file petition in High court under section 34 of the Arbitration and Conciliation
Act 1996. In case court dismisses the application or does not grant stay within three months from date
of filing petition , then the award amount will be released to the investor.
In which court the petition under Section 34 of the Arbitration and Conciliation Act 1996 filed?
The petition under section 34 of the Arbitration and Conciliation Act 1996 shall be filed in the competent court
nearest to regional arbitration centre situated near to the place of constituent.
MARGINING
Just as we are faced with day to day uncertainties pertaining to weather, health, traffic etc and take steps to
minimize the uncertainties, so also in the stock markets, there is uncertainty in the movement of share prices.
This uncertainty leading to risk is sought to be addressed by margining systems of stock markets.
Suppose an investor, purchases 1000 shares of ‘xyz’ company at `100/- on January 1, 2013. Investor has to
give the purchase amount of `1,00,000/- (1000 x 100) to his broker on or before January 2, 2013. Broker, in turn,
has to give this money to stock exchange on January 3, 2013.
There is always a small chance that the investor may not be able to bring the required money by required date.
As an advance for buying the shares, investor is required to pay a portion of the total amount of `1,00,000/- to
the broker at the time of placing the buy order. Stock exchange in turn collects similar amount from the broker
upon execution of the order. This initial token payment is called margin.
For every buyer there is a seller and if the buyer does not bring the money, seller may not get his / her money
and vice versa. Therefore, margin is levied on the seller also to ensure that he / she gives the 100 shares sold
to the broker who in turn gives it to the stock exchange. Margin payments ensure that each investor is serious
about buying or selling shares.
In the above example, assume that margin was 15%. That is investor has to give `15,000/-(15% of `1,00,000) to
the broker before buying. Now suppose that investor bought the shares at 11 am on January 1, 2013. Assume that
by the end of the day price of the share falls by `25/-. That is total value of the shares has come down to `75,000/
-. That is buyer has suffered a notional loss of `25,000/-. In this example buyer has paid `15,000/- as margin but
the notional loss, because of fall in price, is `25,000/-. That is notional loss is more than the margin given.
In such a situation, the buyer may not want to pay `1,00,000/- for the shares whose value has come down to
`75,000/-. Similarly, if the price has gone up by `25/-, the seller may not want to give the shares at `1,00,000/.
To ensure that both buyers and sellers fulfill their obligations irrespective of price movements, notional losses
are also need to be collected.
Prices of shares keep on moving every day. Margins ensure that buyers bring money and sellers bring shares to
complete their obligations even though the prices have moved down or up.
To execute a margin transaction, it is necessary to establish a margin account. It is opened either in the form of
cash or securities. Margin credit can be obtained from a broker or a banker, although nearly all margin trading is
done through brokers.
The broker will retain any securities purchased on margin as collateral for the loan. There are basically two
types of margin requirements: initial margin and maintenance margin.
Lesson 6
Secondary Market 215
Initial Margin
Initial margin stipulates the minimum amount of equity that must be provided by the investor at the time of
purchase. It is used to prevent overtrading and excessive speculation. Generally, it is this margin requirement
that investors refer to when discussing margin trading. Any security that can be margined has a specific initial
requirement, although these can be changed by the authorities from time to time.’
As long as the margin in an account remains at a level equal to or greater than prevailing initial requirements, the
investor is free to use the account in any way he or she sees fit. If the value of the investor’s holdings declines,
the margin in his or her account will also drop.
This situation can lead to what is known as a restricted account, one whose equity is less than the initial margin
requirement. It does not mean that the investor must put up additional cash or equity, but it does require the
investor to bring the margin back to the initial level when securities are sold while the account is restricted.
Maintenance Margin
Maintenance margin is the absolute minimum amount of margin (equity) that an investor must maintain in the
margin account at all times. If the margin falls below the maintenance margin, the broker is authorized to sell
enough of the securities to bring the account back up to standard.
When an insufficient amount of maintenance margin exists, an investor will receive a margin call to remedy the
situation. This call gives the investor a short period of time to find some means to bringing the equity up to the
required level. If this is not done, the broker has no alternative but to sell enough of the investor’s margined
holdings to bring the equity in the account up to this level.
The maintenance margin protects both the brokerage house and investors: Brokers avoid having to absorb
excessive investor losses, and investors avoid being wiped out. The maintenance margin on equity securities
rarely changes, although it is often set slightly higher by brokerage houses for the added protection of both
brokers and their customers. For straight debt securities, generally there is no official maintenance margin
except that set by the brokerage houses themselves.
TYPES OF MARGINS IN CASH AND DERIVATIVE SEGMENT
Margins in the cash market segment comprise of the following three types:
– Value at Risk (VaR) margin
– Extreme loss margin
– Mark to market Margin
Value at Risk (VaR) margin
VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example
a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities.
A VaR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage).
Example
Let us assume that an investor bought shares of a company. Its market value today is `50 lakhs. Obviously, we
do not know what would be the market value of these shares next day. An investor holding these shares may,
based on VaR methodology, say that 1-day VaR is `4 lakhs at the 99% confidence level. This implies that under
normal trading conditions the investor can, with 99% confidence, say that the value of the shares would not go
down by more than `4 lakhs within next 1-day.
In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss (in %) that may be
216 PP-CC&MM
faced by an investor for his / her shares (both purchases and sales) on a single day with a 99% confidence level.
The VaR margin is collected on an upfront basis (at the time of trade).
Extreme Loss Margin
The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins. The
Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LN (Natural Log) returns
of the stock price in the last six months or 5% of the value of the position.
This margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis for the past
six months.
Things You May Know
LN Return
LN is a natural log function in excel, it is used in calculating daily returns of a stock price.
Example
The VaR margin rate for shares of ABC Ltd. is 13%. Suppose that standard deviation of daily LN returns of the
security is 3.1%. 1.5 times standard deviation would be 1.5 x 3.1 = 4.65. Then 5% (which is higher than 4.65%)
will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13%
VaR Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR margin + extreme loss margin) on
a trade of `10 lakhs would be 1,80,000/-.
Mark-to-Market (MTM) margin
MTM is calculated at the end of the day on all open positions by comparing transaction price with the closing
price of the share for the day.
Example
A buyer purchased 1000 shares @ `100/- at 11 am on January 1, 2013. If close price of the shares on that day
happens to be `75/-, then the buyer faces a notional loss of `25,000/- on his buy position. In technical terms this
loss is called as MTM loss and is payable by January 2, 2013 (that is next day of the trade) before the trading
begins.
In case price of the share falls further by the end of January 2, 2013 to ` 70/-, then buy position would show a
further loss of `5,000/-. This MTM loss is payable by next day.
In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position is zero, but there
could still be a notional loss / gain (due to difference between the buy and sell values), such notional loss also is
considered for calculating the MTM payable.
MTM Profit/Loss = [(Total Buy Qty X Close price) – Total Buy Value] - [Total Sale Value - (Total Sale Qty X Close
price)]
DERIVATIVES SEGMENT
There are 3 types of margin levied by the exchanges in case of derivative contracts.
– Initial Margin
– Exposure Margin
– Premium Margin
Lesson 6
Secondary Market 217
Initial Margin
This margin is calculated on a portfolio basis and not on individual scrip basis. The margin calculation is done
using SPAN (Standard Portfolio Analysis of Risk) a product developed by Chicago Mercantile Exchange. The
margin is levied at trade level on real-time basis. The rates are computed at 5 intervals one at the beginning of
the day 3 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, inter-month risk and
inter-commodity risk.
Initial margin requirements are based on 99% value at risk over a one-day time horizon. However, in the case of
futures contracts (on index or individual securities), where it may not be possible to collect mark to market
settlement value, before the commencement of trading on the next day, the initial margin may be computed over
a two-day time horizon, applying the appropriate statistical formula.
Exposure Margin
This 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.
Premium Margin
In case of option purchase the margin levied will be equivalent to the premium amount. This margin will be levied
till the time premium settlement is complete.
TRADING OF SECURITIES
The act of buying and selling of securities on a stock exchange is known as stock market trading. Following are
the steps involved in the trading of securities at a stock exchange :
Order Placing
The first and foremost step in the trading of securities is placement of an order by an investor with the broker
concerned either to buy or sell certain number of scrips at a certain specified price.
There are various kinds of orders. For instance, where in an order, the client places a limit on the price of the
security; it is a case of ‘limit order’. Where the order is to be executed by the broker at the best price, such an
order takes the name of ‘Best Rate Order’. An ‘Immediate or Cancel Order’ is one that has to be executed
immediately and may have to be cancelled if the order is not executed immediately. A Limited Discretionary
Order allows the broker to buy and sell within the specified price range and/or within the given time period as per
the best judgement of the broker. Where the client orders the broker to sell as the price reaches a particular
level, it is a case of ‘Stop Loss Order’. Under the ‘Open Order’, the client does not fix any price limit or time limit
on the execution of the order and relies on the judgement of the broker.
Order Execution
Brokers execute the orders placed by the clients for the purchase or sale of scrips. The execution takes place
during the trading hours and during the working days of the exchange. However, the trading after the normal
working hours may also take place and this is termed ‘as kerb trading’.
Entry to the trading floor of the exchange is restricted only to the identified and regular members of the exchange.
Such a member is called a ‘single jobber’ or ’tarawaniwala’ for a particular script. In respect of actively traded
scripts that involve a huge volume of business, there could be more than one jobber. Jobbers offer two-day
218 PP-CC&MM
quotes for scripts they deal in. This way, jobbers act as market-makers and provide liquidity to the market. The
order is executed either by auction or negotiation. Settlement of a transaction takes place by a mutual agreement
of the price between the parties concerned. Such prices are published in the newspaper every day.
Contract Note Preparation
When once an agreement is reached between the parties concerned as regards price, a contract note is made
out between the broker and the client. Such a note forms the basis of the transactions recorded in the ‘Pucca
Sauda Book’ after the execution of the order. Particulars such as the price, number of scrips, date of transaction,
names of parties, brokerage, etc. are found in the note
Delivery and Clearing
After the preparation of the contract note, delivery of share takes place through the instrument known as ‘transfer
deed’. The transfer deed is signed by the transferor (seller) and is authenticated by a witness. It contains the
details of the transferee, besides bearing the stamp of the selling broker. There different kinds of delivery. For
instance, in the case of ‘spot delivery,’ the transaction is settled by delivery and payment takes place on the date
of the contract or the next day. In the case of ‘hand delivery’, delivery and payment are completed within 14 days
from the date of contract. Delivery and payment may be completed after 14 days as specified at the time of the
bargain in the case of ‘specified or special delivery’. Delivery and clearing of security takes place through a
clearance house.
Share Transfer
For the purpose of effecting the transfer in the name of the transferee, the share certificate and the transfer deed
are lodged with the Company. The parties also pay necessary stamp duty. The company issues the share
certificate bearing a new ledger folio number, transfer number, date and buyer’s name at the reverse of the
certificate. The appropriate authority of the company endorses these particulars.
SETTLEMENT SYSTEM
Settlement is the process of netting of transactions and actual delivery or receipt of securities against receipts of
payment of agreed amounts. It is necessary to make a settlement to know the net effect of a series of transactions
during a given period.
There are two types of settlement systems that can be adopted in stock exchanges – Accounting period system
and rolling settlement system. Now-a-days, stock exchange in India adopts rolling settlement only.
(a) Accounting period settlement systems – There is a predetermined period of usually 7 – 12 days, over which total trades are aggregated.
– Cumulative net obligations of each member are calculated on last day of cycle.
– It is more speculative than the rolling settlements. It may lead to payment crisis in case of wide fluctuations
in the market.
(b) Rolling Settlement
In this system, each day constitutes the settlement period (T+2 System). Under rolling settlements, unlike the
account period settlements the trades done on a particular day are settled after a given number of business
days instead of settling all trades done during an account period of a week or fortnight. In case of Rolling
Settlements, pay-in and pay-out of both funds and securities is completed on the same day. Each trading day is
considered as a trading period and trades executed during the day are settled to obtain the net obligations for
the day in a rolling settlement.
Lesson 6
Secondary Market 219
CLEARING AND SETTLEMENT
The transactions in secondary market pass through three distinct phases, viz., trading, clearing and settlement.
While the stock exchanges provide the platform for trading, the clearing corporation determines the funds and
securities obligations of the trading members and ensures that the trade is settled through exchange of obligations.
The clearing banks and the depositories provide the necessary interface between the custodians/clearing
members for settlement of funds and securities obligations of trading members. Several entities, like the clearing
corporation, clearing members, custodians, clearing banks, depositories are involved in the process of clearing.
The role of each of these entities is explained below:
– Clearing Corporation: The clearing corporation is responsible for post-trade activities such as risk
management and clearing and settlement of trades executed on a stock exchange.
– Clearing Members(CM): Clearing Members are responsible for settling their obligations as determined
by the clearing corporation. They do so by making available funds and/or securities in the designated
accounts with clearing bank/ depositories on the date of settlement.
– Custodians: Custodians are clearing members but not trading members. They settle trades on behalf
of trading members, when a particular trade is assigned to them for settlement. The custodian is required
to confirm whether he is going to settle that trade or not. If the custodian confirm to settle that trade, then
clearing corporation assigns that particular obligation to him.
– Clearing Banks: Clearing banks are a key link between the clearing members and Clearing Corporation
to effect settlement of funds. Every clearing member is required to open a dedicated clearing account
with one of the designated clearing banks. Based on the clearing member’s obligation as determined
through clearing, the clearing member makes funds available in the clearing account for the pay-in and
receives funds in case of a pay-out.
– Depositories: Depository holds securities in dematerialized form for the investors in their beneficiary
accounts. Each clearing member is required to maintain a clearing pool account with the depositories.
He is required to make available the required securities in the designated account on settlement day.
The depository runs an electronic file to transfer the securities from accounts of the custodians/clearing
member to that of Clearing corporation and vice-versa as per the schedule of allocation of securities.
CLEARING & SETTLEMENT PROCESS
The clearing process involves determination of what counter-parties owe, and which counter-parties are due to
receive on the settlement date, thereafter the obligations are discharged by settlement. The clearing and settlement
process comprises of three main activities- clearing, settlement and risk management.
The clearing and settlement process for transaction in securities is given below:
1. Trade details from Exchange to Clearing Corporation (real-time and end of day trade file).
2. Clearing Corporation notifies the consummated trade details to clearing members/custodians who affirm
back. Based on the affirmation, Clearing Corporation applies multilateral netting and determines
obligations.
3. Download of obligation and pay-in advice of funds/securities.
4. Instructions to clearing banks to make funds available by pay-in time.
5. Instructions to depositories to make securities available by pay-in-time.
6. Pay-in of securities (Clearing Corporation advises depository to debit pool account of custodians/CMs
and credit its account and depository does it)
220 PP-CC&MM
7. Pay-in of funds (Clearing Corporation advises Clearing Banks to debit account of custodians/CMs and
credit its account and clearing bank does it)
8. Pay-out of securities (Clearing Corporation advises depository to credit pool account of custodians/
CMs and debit its account and depository does it)
9. Pay-out of funds (Clearing Corporation advises Clearing Banks to credit account of custodians/CMs
and debit its account and clearing bank does it)
10. Depository informs custodians/CMs through DPs.
11. Clearing Banks inform custodians/CMs.
The core processes involved in clearing and settlement include:
(a) Trade Recording: The key details about the trades are recorded to provide basis for settlement. These
details are automatically recorded in the electronic trading system of the exchanges.
(b) Trade Confrmation: The parties to a trade agree upon the terms of trade like security, quantity, price,
and settlement date, but not the counterparty which is the Clearing Corporation. The electronic system
automatically generates confirmation by direct participants.
(c) Determination of Obligation: The next step is determination of what counter-parties owe, and what
counterparties are due to receive on the settlement date. The Clearing Corporation interposes itself as
a central counterparty between the counterparties to trades and nets the positions so that a member
has security wise net obligation to receive or deliver a security and has to either pay or receive funds.
The settlement process begins as soon as members’ obligations are determined through the clearing
process. The settlement process is carried out by the Clearing Corporation with the help of clearing
banks and depositories. The Clearing Corporation provides a major link between the clearing banks
and the depositories. This link ensures actual movement of funds as well as securities on the prescribed
pay-in and pay-out day.
(d) Pay-in of Funds and Securities: This requires members to bring in their funds/securities to the clearing
corporation. The CMs make the securities available in designated accounts with the two depositories
(CM pool account in the case of NSDL and designated settlement accounts in the case of CDSL). The
depositories move the securities available in the pool accounts to the pool account of the clearing
corporation. Likewise CMs with funds obligations make funds available in the designated accounts with
clearing banks. The clearing corporation sends electronic instructions to the clearing banks to debit
designated CMs’ accounts to the extent of payment obligations. The banks process these instructions,
debit accounts of CMs and credit accounts of the clearing corporation. This constitutes pay-in of funds
and of securities.
(e) Pay-out of Funds and Securities: After processing for shortages of funds/securities and arranging for
movement of funds from surplus banks to deficit banks through RBI clearing, the clearing corporation
sends electronic instructions to the depositories/clearing banks to release pay-out of securities/funds.
The depositories and clearing banks debit accounts of the Clearing Corporation and credit accounts of
CMs. This constitutes pay-out of funds and securities. Settlement is deemed to be complete upon
declaration and release of pay-out of funds and securities.
TRADE GUARANTEE FUND
Trade or Settlement Guarantee Fund means a fund whose objective is to provide the necessary funds and
ensure timely completion of settlements in cases of failure of member brokers to fulfill their settlement obligations.
Thus establishment of such funds would give greater confidence to investors in the settlement and clearing
procedures of the stock exchanges. Keeping this objective in view, SEBI had advised all stock exchanges to set
Lesson 6
Secondary Market 221
up a Trade or Settlement Guarantee Fund to ensure that the market equilibrium is not disturbed in case of
payment default by the members. Accordingly Stock Exchange have instituted a system to guarantee settlement
of bonafide transactions of Members which form part of the settlement system.
TRADING SOFTWARE
Trading software means computer programs that facilitate trading of financial products such as stocks and
currencies. Software is usually provided by brokerage firms that enable their clients to trade financial products
and manage their accounts. Different brokerages will have different software which determines the interface in
which trades are made and information is searched. Other software can be purchased from third parties to
enhance or add to what a brokerage provides. Trading software is aimed to help investors improve their stock
picking decisions through its fundamental analysis and advanced technical analysis. Stock market trading software
is relied on by traders to pick out shares quickly and is highly recommend to all types of traders.
STOCK MARKET INDICES
Stock Indices represents the performance of stock market and by proxy, reflects investor sentiment on the state
of the economy. An Index is used to give information about the price movements of products in the financial,
commodities or any other markets. A stock market index is created by selecting a group of stocks that are
representative of the whole market or a specified sector or segment of the market.
Stock indices are barometers to measure general economic performance of an particular country / sector. It’s
updated every second throughout on every trading so as to reflect the exact picture of the economy. It’s also a
permanent record of the history of markets – it’s highs and lows, booms and crashes. A stock index is created by
selecting a group of high performing stocks. Irrespective of the type of index, the purpose of any index is the
same. It provides to the public, a quick view of how the economy (based on which the index is constructed) is
functioning. An index is calculated with reference to a base period and a base index value.
TYPES OF INDICES
There are different types of indices. Stock indices can be constructed –
– For the entire world (global indices) – For an entire continent (regional indices – for example S&P Latin
America 40)
– For an entire country (national indices – for example Sensex & Nifty for India)
– For a particular sector in a country – (sectoral indices – for example BSE BANKEX which tracks top
banking companies in India)
– For any other theme / group of economy / companies (example Dow Jones Islamic world market index)
BSE Indices
– Broad Indices- S&P BSE SENSEX, S&P BSE MID CAP, S&P BSE SMALL CAP, S&P BSE 100, S&P
BSE 200, S&P BSE 500
– Investment Strategy Indices- S&P BSE IPO, S&P BSE SME IPO, S&P BSE DOLLEX 30, S&P BSE
DOLLEX 100, S&P BSE DOLLEX 200
– Volatility Indices- S&P BSE REALVOL-1MTH, S&P BSE REALVOL-2MTH, S&P BSE REALVOL-3MTH
– Thematic Indices- S&P BSE GREENEX, S&P BSE CARBONEX
– Sectoral Indices- S&P BSE AUTO, S&P BSE BANKEX, S&P BSE CAPITAL GOODS, S&P BSE
CONSUMER DURABLES, S&P BSE FMCG, S&P BSE HEALTHCARE, S&P BSE IT, S&P BSE METAL,
S&P BSE OIL & GAS, S&P BSE POWER, S&P BSE PSU, S&P BSE REALTY, S&P BSE TECK
222 PP-CC&MM
NSE Indices
– Broad Market Indices- CNX Nifty, CNX Nifty Junior, LIX 15, CNX 100, CNX 200, CNX 500, Nifty Midcap
50, CNX Midcap, CNX Smallcap
– Sectoral Indices- CNX Auto, CNX Bank, CNX Energy, CNX Finance, CNX FMCG, CNX IT, CNX Media,
CNX Metal, CNX Pharma, CNX PSU Bank, CNX Realty
– Thematic Indices- CNX Commodities, CNX Consumption, CNX Infrastructure, CNX MNC, CNX PSE,CNX
Service Sector, S&P ESG india Index
– Strategy Indices- CNX 100 Equal Weight, CNX Alpha Index, CNX Dividend Opportunities, CNX High
Beta Index, CNX Low Volatility Index, CNX Nifty Dividend
BSE INDICES
Sensex stands for "sensitive index", it represents BSE (Bombay Stock Exchange). Sensex indicates all major
companies of BSE. Sensex is calculated using share prices of 30 major companies which are listed in BSE. If
the Sensex goes up it means that share values of most of the major companies have gone up and vice versa.
The launch of SENSEX in 1986 was followed up in January 1989 by introduction of BSE National Index (Base:
1983-84 = 100). It comprised 100 stocks listed at five major stock exchanges in India - Mumbai, Calcutta, Delhi,
Ahmedabad and Madras. The BSE National Index was renamed BSE-100 Index from October 14, 1996 and
since then, it is being calculated taking into consideration only the prices of stocks listed at BSE. BSE launched
the dollar-linked version of BSE-100 index on May 22, 2006.
With a view to provide a better representation of the increasing number of listed companies, larger market
capitalization and the new industry sectors, BSE launched on 27th May, 1994 two new index series viz., the
‘BSE-200’ and the ‘DOLLEX-200’. Since then, BSE has come a long way in attuning itself to the varied needs of
investors and market participants. In order to fulfill the need for still broader, segment-specific and sectorspecific indices, BSE has continuously been increasing the range of its indices. BSE-500 Index and 5 sectoral
indices were launched in 1999. In 2001, BSE launched BSE-PSU Index, DOLLEX-30 and the country’s first
free-float based index - the BSE TECk Index. Over the years, BSE shifted all its indices to the free-float methodology
(except BSE-PSU index).
Sensex
Things You May Know
Market Capitalisation
Market capitalization is the total worth of all outstanding (issued) shares of a company. It represents the total
worth of a company.
Market Capitalization= No. of shares outstanding x Market price of share
S&P BSE SENSEX, first compiled in 1986, was calculated on a “Market Capitalization-Weighted” methodology
of 30 component stocks representing large, well-established and financially sound companies across key sectors.
The base year of S&P BSE SENSEX was taken as 1978-79. S&P BSE SENSEX today is widely reported in both
domestic and international markets through print as well as electronic media. It is scientifically designed and is
based on globally accepted construction and review methodology. Since September 1, 2003, S&P BSE SENSEX
is being calculated on a free-float market capitalization methodology. The “free-float market capitalization-weighted”
methodology is a widely followed index construction methodology on which majority of global equity indices are
based; all major index providers like MSCI, FTSE, STOXX, and Dow Jones use the free-float methodology.
Lesson 6
Secondary Market 223
Index Specification
Base Year
1978-79
Base Index Value
100
Date of Launch
01-01-1986
Method of calculation
Launched on full market capitalization method and effective September 01,
2003, calculation method shifted to free-float market capitalization.
Number of scrips
30
SENSEX - Scrip Selection Criteria
The general guidelines for selection of constituents in SENSEX are as follows:
1. Listed History:The scrip should have a listing history of at least 3 months at BSE. Exception may be
considered if full market capitalization of a newly listed company ranks among top 10 in the list of BSE
universe. In case, a company is listed on account of merger/ demerger/ amalgamation, minimum listing
history would not be required.
2. Trading Frequency:The scrip should have been traded on each and every trading day in the last three
months at BSE. Exceptions can be made for extreme reasons like scrip suspension etc.
3. Final Rank:The scrip should figure in the top 100 companies listed by final rank. The final rank is
arrived at by assigning 75% weightage to the rank on the basis of three-month average full market
capitalization and 25% weightage to the liquidity rank based on three-month average daily turnover &
three-month average impact cost.
4. Market Capitalization Weightage:The weightage of each scrip in SENSEX based on three-month
average free-float market capitalization should be at least 0.5% of the Index.
5. Industry/Sector Representation:Scrip selection would generally take into account a balanced
representation of the listed companies in the universe of BSE.
6. Track Record:In the opinion of the BSE Index Committee, the company should have an acceptable
track record.
S & P BSE SENSEX Calculation Methodology
S&P BSE SENSEX is calculated using the “Free-float Market Capitalization” methodology, wherein, the level of
index at any point of time reflects the free-float market value of 30 component stocks relative to a base period.
The market capitalization of a company is determined by multiplying the price of its stock by the number of
shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine
the free-float market capitalization.
The base period of S&P BSE SENSEX is 1978-79 and the base value is 100 index points. This is often indicated
by the notation 1978-79=100. The calculation of S&P BSE SENSEX involves dividing the free-float market
capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to
the original base period value of the S&P BSE SENSEX. It keeps the Index comparable over time and is the
adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During
market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to
calculate S&P BSE SENSEX on a continuous basis.
Definition of Free-float
Shareholdings of investors that would not, in the normal course, come into the open market for trading are
224 PP-CC&MM
treated as ‘Controlling/ Strategic Holdings’ and hence not included in free-float. Specifically, the following categories
of holding are generally excluded from the definition of Free-float:
– 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 shareholders fall under the Free-float category.
Example
Company “XYZ Ltd’ issues 10000 shares, out of which 2000 shares held by government, 5000 shares by
directors of the company and remaining 3000 shares are available in the open market for trading. Market price
of share is ` 100
Here;
Total Shares = 10000
Shares Held by Government = 2000
Shares Held by Directors = 5000
Shares available in the Open Market = 3000 Market price of share = ` 100
Here total market capitalization of the company is 10,000 X ` 100 = ` 10,00,000 and Free float market capitalization
of the company is 3000 X ` 100 = ` 300,000
According to the rules of BSE any shares which do not fall under the following categories are considered as free
float (open market) shares.
– Government holding shares as promoters Holdings by Directors/ Founders Holdings through the FDI
route
– Stakes held by private corporate bodies or individuals.
– Any cross holdings i.e. equity held by associate or group companies. Equity held by employee welfare
trust.
Understanding Free-float Methodology Concept
Free-float Methodology refers to an index construction methodology that takes into consideration only the
free-float market capitalization of a company for the purpose of index calculation and assigning weight to
stocks in the Index. Free-float market capitalization takes into consideration only those shares issued by the
company that are readily available for trading in the market. It generally excludes promoters’ holding,
government holding, strategic holding and other locked-in shares that will not come to the market for trading
in the normal course. In other words, the market capitalization of each company in a Free-float index is
reduced to the extent of its readily available shares in the market. Subsequently all BSE indices with the
exception of BSE PSU index have adopted the free-float methodology.
Lesson 6
Secondary Market 225
Major Advantages of Free-float Methodology
– A Free-float index reflects the market trends more rationally as it takes into consideration only those
shares that are available for trading in the market.
– Free-float Methodology makes the index more broad-based by reducing the concentration of top few
companies in Index.
– A Free-float index aids both active and passive investing styles. It aids active managers by enabling
them to benchmark their fund returns vis-à-vis an investible index. This enables an apple-to-apple
comparison thereby facilitating better evaluation of performance of active managers. Being a perfectly
replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive managers as it
enables them to track the index with the least tracking error.
– Free-float Methodology improves index flexibility in terms of including any stock from the universe of
listed stocks. This improves market coverage and sector coverage of the index. For example, under a
full-market capitalization methodology, companies with large market capitalization and low free-float
cannot generally be included in the Index because they tend to distort the index by having an undue
influence on the index movement. However, under the free-float Methodology, since only the free-float
market capitalization of each company is considered for index calculation, it becomes possible to include
such closely held companies in the index while at the same time preventing their undue influence on the
index movement.
– Globally, the free-float Methodology of index construction is considered to be an industry best practice
and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same. MSCI, a
leading global index provider, shifted all its indices to the Free-float Methodology in 2002. The MSCI
India Standard Index, which is followed by Foreign Institutional Investors (FIIs) to track Indian equities,
is also based on the Free-float Methodology. NASDAQ-100, the underlying index to the famous Exchange
Traded Fund (ETF) - QQQ is based on the Free-float Methodology.
Determining Free-float Factors of Companies
BSE has designed a Free-float format, which is filled and submitted by all index companies on a quarterly basis.
BSE determines the Free-float factor for each company based on the detailed information submitted by the
companies in the prescribed format. Free-float factor is a multiple with which the total market capitalization of a
company is adjusted to arrive at the Free-float market capitalization. Once the Free-float of a company is
determined, it is rounded-off to the higher multiple of 5 and each company is categorized into one of the 20
bands given below. A Free-float factor of say 0.55 means that only 55% of the market capitalization of the
company will be considered for index calculation.
Free-float Bands
% Free-Float
Free-Float Factor%
Free-Float
Free-Float Factor
>0 – 5%
0.05
>50 – 55%
0.55>
5 – 10%
0.10
>55 – 60%
0.60
>10 – 15%
0.15
>60 – 65%
0.65
>15 – 20%
0.20
>65 – 70%
0.70
>20 – 25%
0.25
>70 – 75%
0.75
>25 – 30%
0.30
>75 – 80%
0.80
>30 – 35%
0.35
>80 – 85%
0.85
226 PP-CC&MM
>35 – 40%
0.40
>85 – 90%
0.90
>40 – 45%
0.45
>90 – 95%
0.95
>45 – 50%
0.50
>95 – 100%
1.00
Formula for Calculation of Index
All BSE indices (except BSE-PSU index) are calculated using following formula:
Free-float market capitalization of index constituents/ Base Market capitalization * Base Index Value
Example
Suppose BSE index (SENSEX) consist of only two stocks such as ‘X’ and ‘Y’
Company ‘X’ has 10000 outstanding shares out of which only 5000 are available for trading in open market.
Market price of share is `100.
Company ‘Y’ has 5000 outstanding shares out of which 2000 shares are held by promoters and remaining 3000
are free float shares (open market shares). Market price of share is `10.
Calculation of Market Capitalization
Stock
Issued Stocks
Market price
Market Cap.
X
10000
100
1000000
Y
5000
50
250000
Calculation of Free Float market capitalization
Stock
Open Market Stocks
Market price
Market Cap.
X
5000
100
500000
Y
2000
50
100000
Here;
Sum of free float market cap of company X and company Y is 500000+100000 = 600000. Assume market cap
during 1978-79 is 500000.
Now Applying formula;
600000*100/500000 = 120
For calculation of BSE-PSU index, full market capitalization of index constituents is considered instead of freefloat market capitalization. Dollex-30, Dollex-100 and Dollex-200 are dollar-linked versions of SENSEX, BSE100 and BSE-200 index.
BSE IPO index & BSE TASIS Shariah 50 Index is calculated using following formula:
Capped market capitalization of index constituents/ Base Market capitalization * Base Index Value
Where capped market capitalisation for scrips in BSE IPO Index and BSE TASIS Shariah 50 Index is arrived by
multiplying free-float adjusted market capitalisation of individual scrip with its respective capping factor. Such
capping factor is assigned to the index constituent to ensure that no single scrip based on its free-float market
capitalisation exceeds weightage of 20% in case BSE IPO Index and 8% in case of BSE TASIS Shariah 50
Index at the time of rebalancing. In case, weightage of all the constituents in the index is below 20% & 8%
respectively, each company would be assigned capping factor of 1.
Lesson 6
Secondary Market 227
Index Closure Algorithm
The closing index value on any trading day is computed taking the weighted average of all the trades of index
constituents in the last 30 minutes of trading session. If an index constituent has not traded in the last 30
minutes, the last traded price is taken for computation of the index closure. If an index constituent has not traded
at all in a day, then its last day’s closing price is taken for computation of index closure. The use of index closure
algorithm prevents any intentional manipulation of the closing index value.
Maintenance of BSE Indices
One of the important aspects of maintaining continuity with the past is to update the base year average. The
base year value adjustment ensures that replacement of stocks in Index, additional issue of capital and other
corporate announcements like ‘rights issue’ etc. do not destroy the historical value of the index. The beauty of
maintenance lies in the fact that adjustments for corporate actions in the Index should not per se affect the index
values.
The Department of BSE Indices does the day-to-day maintenance of the index within the broad index policy
framework set by the BSE Index Committee. Department of BSE Indices ensures that all BSE Indices maintain
their benchmark properties by striking a delicate balance between frequent replacements in index and maintaining
its historical continuity. The BSE Index Committee comprises capital market expert, fund managers, market
participants, members of BSE Governing Board.
On - Line Computation of the Index
During trading hours, value of the indices is calculated and disseminated on real time basis. This is done
automatically on the basis of prices at which trades in index constituents are executed.
Adjustment for Bonus, Rights and Newly Issued Capital
Index calculation needs to be adjusted for issue of bonus and rights issue. If no adjustments were made, a
discontinuity would arise between the current value of the index and its previous value despite the non-occurrence
of any economic activity of substance. At the BSE Index Cell, the base value is adjusted, which is used to alter
market capitalization of the component stocks to arrive at the index value.
The BSE Indices Department keeps a close watch on the events that might affect the index on a regular basis
and carries out daily maintenance of all BSE Indices.
– Adjustments for Rights Issues
When a company, included in the compilation of the index, issues right shares, the free-float market
capitalization of that company is increased by the number of additional shares issued based on the
theoretical (ex-right) price. An offsetting or proportionate adjustment is then made to the Base Market
capitalization.
– Adjustments for Bonus Issue
When a company, included in the compilation of the index, issues bonus shares, the market capitalization
of that company does not undergo any change. Therefore, there is no change in the Base Market
capitalization; only the ‘number of shares’ in the formula is updated.
– Other Issues
Base Market capitalization Adjustment is required when new shares are issued by way of conversion of
debentures, mergers, spin-offs etc. or when equity is reduced by way of buy-back of shares, corporate
restructuring etc.
228 PP-CC&MM
Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows:
New Base Market capitalization = Old Base Market
capitalization
New Market capitalization
x
—————————————
Old Market capitalization
To illustrate, suppose a company issues additional shares, which increases the market capitalization of the
shares of that company by say, `100 crore. The existing Base Market capitalization (Old Base Market
capitalization), say, is `2450 crore and the aggregate market capitalization of all the shares included in the index
before this issue is made is, say `4781 crore. The “New Base Market capitalization” will then be:
2450 x (4781+100)
—————————
4781
=
` 2501.24 crores
This figure of ` 2501.24 crore will be used as the Base Market capitalization for calculating the index number
from then onwards till the next base change becomes necessary.
CNX NIFTY
The CNX Nifty is the flagship index on the National Stock Exchange of India Ltd. (NSE). The Index tracks the
behavior of a portfolio of blue chip companies, the largest and most liquid Indian securities. It includes 50 of the
approximately 1600 companies listed on the NSE, captures approximately 65% of its float-adjusted market
capitalization and is a true reflection of the Indian stock market. The CNX Nifty covers 21 sectors of the Indian
economy and offers investment managers exposure to the Indian market in one efficient portfolio. The Index has
been trading since April 1996 and is well suited for benchmarking, index funds and index-based derivatives. It is
calculated using base year 1995 and base index value 1000.
Selection Criteria for CNX Nifty
Selection of the index set is based on the following criteria:
– Liquidity: For inclusion in the index, the security should have traded at an average impact cost of 0.50
% or less during the last six months, for 90% of the observations.
Impact cost is the cost of executing a transaction in a security in proportion to its index weight, measured
by market capitalization at any point in time. This is the percentage mark up suffered while buying/
selling the desired quantity of a security compared to its ideal price — (best buy + best sell)/2.
– Float -Adjusted Market Capitalization: Companies eligible for inclusion in the CNX Nifty must have at
least twice the float-adjusted market capitalization of the current smallest index constituent.
– Float: Companies eligible for inclusion in the CNX Nifty should have at least 10% of its stock available
to investors (float). For this purpose, float is stocks which are not held by the promoters and associated
entities (where identifiable) of such companies.
– Domicile: The company must be domiciled in India and trade on the NSE.
– Eligible Securities: All common shares listed on the NSE (which are of equity and not of a fixed income
nature) are eligible for inclusion in the CNX Nifty index. Convertible stock, bonds, warrants, rights, and
preferred stock that provide a guaranteed fixed return are not eligible.
– Other Variables .A company which comes out with an IPO is eligible for inclusion in the index if it fulfills
the normal eligibility criteria for the index — impact cost, float-adjusted market capitalization and float —
Lesson 6
Secondary Market 229
for a three-month period instead of a six-month period.
Price Index Calculations Formula
The CNX Nifty is computed using market capitalisation weighted method wherein the level of the Index reflects
the total market value of all the stocks in the Index relative to the base period November 3,1995.
Free Float Market Capitalization = Equity Capital * Price * IWF (Investible Weight Factors)
Index Value = Current Market Value / Base Market Capital * Base Index Value (1000)
Base market capital of the Index is the aggregate market capitalisation of each scrip in the Index during the base
period. The market cap during the base period is equated to an Index value of 1000 known as the base Index
value.
INVESTIBLE WEIGHT FACTORS (IWFS)
IWF as the term suggests is a unit of floating stock expressed in terms of a number available for trading and
which is not held by the entities having strategic interest in a company. Higher IWF suggest greater number of
shares held by the investors as reported under public category within a shareholding pattern reported by each
company.
The IWFs for each company in the index are determined based on the public shareholding of the companies as
disclosed in the shareholding pattern submitted to the stock exchanges on quarterly basis. The following categories
are excluded from the free float factor where identifiable separately:
– Shareholding of promoter and promoter group
– Government holding in the capacity of strategic investor
– Shares held by promoters through ADR/GD`
– Strategic stakes by corporate bodies
– Investments under FDI category
– Equity held by associate/group companies (cross-holdings)
– Employee Welfare Trusts
– Shares under lock-in category
Example
For XYZ Ltd.
Total Shares
Shares
%
1,00,00,000
100.00
Shareholding of promoter and promoter group
Government holding in the capacity of strategic investor
Shares held by promoters through ADR/GDRs.
Equity held by associate/group companies (cross-holdings)
Employee Welfare Trusts
Shares under lock-in category
Shares
%
19,75,000
19.75
50,000
0.50
2,50,000
2.50
12,575
0.13
1,45,987
1.46
14,78,500
14.79
230 PP-CC&MM
IWF = [1,00,00,000 – (19,75,000 + 50,000 +2,50,000 +12,575 +1,45,987 +14,78,500)] / 1,00,00,000. =0.60870
LESSON ROUND UP
– Secondary market refers to a market where securities are traded after being initially offered to the
public in the primary market and/or listed on the Stock Exchange.
– Corporate action is a process by which a company gives benefits to the investors who are holding
securities of the company.
– A company is required to give notice for corporate action under clause 16 of the Listing agreement.
– A listed company as a continuous listing requirement has to comply with Rule 19 (2)(b) and 19 A of the
SCRR, 1957 along with Clause 40A and 40 B of the Equity Listing Agreement.
– Clause 36 of the listing agreement deals with the material events which are required to be intimated to
the stock exchange by a company.
– Every Listed Company under Clause 41 of the Listing Agreement is required to furnish unaudited
quarterly results on a quarterly basis in the prescribed format to the concerned Stock Exchanges
within forty five days of the end of the quarter.
– Corporate Governance may be defined as a set of systems, processes and principles which ensure
that a company is governed in the best interest of all stakeholders. It is the system by which companies
are directed and controlled.
– Arbitration is a quasi judicial process of settlement of disputes between trading member, investor,
clearing member, sub brokers, authorized persons etc.
– Arbitration framework at Exchange is governed by the rules, Byelaws, Regulations &Circular issued
by the exchange and SEBI, from time to time.
– VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for
example a share or a portfolio of a few shares), based on the statistical analysis of historical price
trends and volatilities.
– The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR
margins.
– Mark-to-Market (MTM) margin is calculated at the end of the day on all open positions by comparing
transaction price with the closing price of the share for the day.
– The act of buying and selling of securities on a stock exchange is known as stock market trading.
– Settlement is the process of netting of transactions and actual delivery or receipt of securities against
receipts of payment of agreed amounts.
– The transactions in secondary market pass through three distinct phases, viz., trading, clearing and
settlement.
– Trade or Settlement Guarantee Fund means a fund which objective is to provide the necessary funds
and ensure timely completion of settlements in cases of failure of member brokers to fulfill their settlement
obligations.
– Stock Indices represents the performance of stock market and by proxy, reflects investor sentiment on
the state of the economy.
– Sensex is calculated using share prices of 30 major companies which are listed in BSE.
Lesson 6
Secondary Market 231
– The CNX Nifty is the flagship index on the National Stock Exchange of India Ltd.
– Investible Weight Factors (IWFs) as the term suggests is unit of floating stock expressed in terms of
number available for trading and which is not held by the entities having strategic interest in a company.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What do you understand by Corporate Action? Discuss the compliances required for Corporate Action
under the Listing Agreement.
2. Briefly explain the provisions relating to price sensitive Information.
3. What is Corporate Governance? Give a brief on the mandatory and non-mandatory provisions of
Clause 49 under listing agreement.
4. What is settlement system? Discuss the various types of settlement system.
5. What do you understand by Investible Weight Factors (IWFs)? Explain with the help an example.
232 PP-CC&MM
Lesson 7
Capital Market Investment Institutions 233
Lesson 7
Capital Market Investment Institutions
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Financial Sector plays an indispensable role
– National Level Institutions
in the overall development of a country. The
– All India Development banks
most important constituent of this sector is the
– Specialised financial Institutions
financial institutions, which act as a conduit for
– Investment Institutions
the transfer of resources from net savers to
net borrowers, that is, from those who spend
– State Level Institutions
less than their earnings to those who spend
– Qualified Institutional Buyers
more than their earnings. These institutions
provide a variety of financial products and
– Private Equity
services to fulfil the varied needs of the
– Types of Private Equity
commercial sector. Besides, they provide
– Venture Capital
assistance to new enterprises, small and
– Stages of Investment Financing
medium firms as well as to the industries
established in backward areas. Financial
– Angel Funds
institutions can be of different types e.g.
– Pension Funds
Insurance Companies, Pension Fund, Mutual
– Foreign Institutional Investor
Fund, Capital Market Intermediaries etc.
– Qualified Foreign Investor
Keeping in view the role played by the institutions
– Mutual Fund
in the developement of Capital Market, this lesson
will give an overview of different categories of
– Types of Mutual Fund schemes
Investment Institutions like Venture Capital,
– Alternative Investment Fund
Private Equity, Hedge Funds, Qualified Institutional
– Hedge Funds
Buyer, Pension Funds, Foreign Institutional
– LESSON ROUND UP
Investor etc. which are active participant in the
Financial Market.
– SELF TEST QUESTIONS
233
234 PP-CC&MM
INTRODUCTION
Financial sector plays an indispensable role in the overall development of a country. The most important constituent
of this sector is the financial institutions, which act as a conduit for the transfer of resources from net savers to
net borrowers, that is, from those who spend less than their earnings to those who spend more than their
earnings. In any economy, financial Institutions play an important role because all the financial dealings and
matters are handled and monitored by such Institutions. The major components of financial Institutions are
banks, insurance companies, investment companies, consumer finance companies, and other specialized financial
institutes. These institutions provide a variety of financial products and services to fulfil the varied needs of the
commercial sector. Besides, they provide assistance to new enterprises, small and medium firms as well as to
the industries established in backward areas. Thus, they have helped in reducing regional disparities by inducing
widespread industrial development.
The Government of India, in order to provide adequate supply of credit to various sectors of the economy, has
evolved a well developed structure of financial institutions in the country. These financial institutions can be
broadly categorised into All India institutions and State level institutions, depending upon the geographical coverage
of their operations. At the national level, they provide long and medium term loans at reasonable rates of interest.
They subscribe to the debenture issues of companies, underwrite public issue of shares, guarantee loans and
deferred payments, etc. Though, the State level institutions are mainly concerned with the development of
medium and small scale enterprises, but they provide the same type of financial assistance as the national level
institutions.
National Level Institutions
A wide variety of financial institutions have been set up at the national level. These institutions cater to the
diverse financial requirements of the entrepreneurs. They include all India development banks like IDBI, SIDBI,
IFCI Ltd, IIBI; specialised financial institutions like IVCF, ICICI Venture Funds Ltd, TFCI ; investment institutions
like LIC, GIC, UTI; etc.
1. All-India Development Banks (AIDBs):- Includes those development banks which provide institutional
credit to not only large and medium enterprises but also help in promotion and development of small
scale industrial units.
– Industrial Development Bank of India (IDBI):- It was established in July 1964 as an apex financial
institution for industrial development in the country. It caters to the diversified needs of medium and
large scale industries in the form of financial assistance, both direct and indirect. Direct assistance
is provided by way of project loans, underwriting of and direct subscription to industrial securities,
soft loans, technical refund loans, etc. While, indirect assistance is in the form of refinance facilities
to industrial concerns.
– Industrial Finance Corporation of India Ltd (IFCI Ltd):- It was the first development finance
institution set up in 1948 under the IFCI Act in order to pioneer long-term institutional credit to
medium and large industries. It aims to provide financial assistance to industry by way of rupee and
foreign currency loans, underwrites/subscribes the issue of stocks, shares, bonds and debentures
of industrial concerns, etc. It has also diversified its activities in the field of merchant banking,
syndication of loans, formulation of rehabilitation programmes, assignments relating to amalgamations
and mergers, etc.
– Small Industries Development Bank of India (SIDBI):- It was set up by the Government of India
in April 1990, as a wholly owned subsidiary of IDBI. It is the principal financial institution for promotion,
financing and development of small scale industries in the economy. It aims to empower the Micro,
Lesson 7
Capital Market Investment Institutions 235
Small and Medium Enterprises (MSME) sector with a view to contributing to the process of economic
growth, employment generation and balanced regional development.
– Industrial Investment Bank of India Ltd (IIBI):- It was set up in 1985 under the Industrial
reconstruction Bank of India Act, 1984, as the principal credit and reconstruction agency for sick
industrial units. It was converted into IIBI on March 17, 1997, as a full-fledged development financial
institution. It assists industry mainly in medium and large sector through wide ranging products and
services. Besides project finance, IIBI also provides short duration non-project asset-backed financing
in the form of underwriting/direct subscription, deferred payment guarantees and working capital/
other short-term loans to companies to meet their fund requirements.
2. Specialised Financial Institutions (SFIs):- These are the institutions which have been set up to serve
the increasing financial needs of commerce and trade in the area of venture capital, credit rating and
leasing, etc.
– IFCI Venture Capital Funds Ltd (IVCF):- IVCF formerly known as Risk Capital & Technology Finance
Corporation Ltd (RCTC), is a subsidiary of IFCI Ltd. It was promoted with the objective of broadening
entrepreneurial base in the country by facilitating funding to ventures involving innovative product/
process/technology. Initially, it started providing financial assistance by way of soft loans to promoters
under its 'Risk Capital Scheme' . Since 1988, it also started providing finance under 'Technology
Finance and Development Scheme' to projects for commercialisation of indigenous technology for
new processes, products, market or services. Over the years, it has acquired great deal of experience
in investing in technology-oriented projects.
– ICICI Venture Funds Ltd:- Formerly known as Technology Development & Information Company
of India Limited (TDICI), it was founded in 1988 as a joint venture with the Unit Trust of India.
Subsequently, it became a fully owned subsidiary of ICICI. It is a technology venture finance company,
set up to sanction project finance for new technology ventures. The industrial units assisted by it are
in the fields of computer, chemicals/polymers, drugs, diagnostics and vaccines, biotechnology,
environmental engineering, etc.
– Tourism Finance Corporation of India Ltd. (TFCI):- It is a specialised financial institution set up
by the Government of India for promotion and growth of tourist industry in the country. Apart from
conventional tourism projects, it provides financial assistance for non-conventional tourism projects
like amusement parks, ropeways, car rental services, ferries for inland water transport, etc.
3. Investment Institutions:- These are the most popular form of financial intermediaries, which particularly
catering to the needs of small savers and investors. They deploy their assets largely in marketable
securities.
– Life Insurance Corporation of India (LIC):- It was established in 1956 as a wholly-owned corporation
of the Government of India. It was formed by the Life Insurance Corporation Act, 1956, with the
objective of spreading life insurance much more widely and in particular to the rural area. It also
extends assistance for development of infrastructure facilities like housing, rural electrification, water
supply, sewerage, etc. In addition, it extends resource support to other financial institutions through
subscription to their shares and bonds, etc.
– Unit Trust of India (UTI):- It was set up as a body corporate under the UTI Act, 1963, with a view to
encourage savings and investment. It mobilises savings of small investors through sale of units and
channelises them into corporate investments mainly by way of secondary capital market operations.
Thus, its primary objective is to stimulate and pool the savings of the middle and low income groups
and enable them to share the benefits of the rapidly growing industrialisation in the country. In
December 2002, the UTI Act, 1963 was repealed with the passage of Unit Trust of India (Transfer of
236 PP-CC&MM
Undertaking and Repeal) Act, 2002, paving the way for the bifurcation of UTI into 2 entities, UTI-I
and UTI-II with effect from 1st February 2003.
– General Insurance Corporation of India (GIC) :- It was formed in pursuance of the General
Insurance Business (Nationalisation) Act, 1972(GIBNA ), for the purpose of superintending, controlling
and carrying on the business of general insurance or non-life insurance. Initially, GIC had four
subsidiary branches, namely, National Insurance Company Ltd ,The New India Assurance Company
Ltd , The Oriental Insurance Company Ltd and United India Insurance Company Ltd . But these
branches were delinked from GIC in 2000 to form an association known as 'GIPSA' (General
Insurance Public Sector Association).
State Level Institutions
Several financial institutions have been set up at the State level which supplement the financial assistance
provided by the all India institutions. They act as a catalyst for promotion of investment and industrial development
in the respective States. They broadly consist of 'State financial corporations' and 'State industrial development
corporations'.
– State Financial Corporations (SFCs) :- These are the State-level financial institutions which play a
crucial role in the development of small and medium enterprises in the concerned States. They provide
financial assistance in the form of term loans, direct subscription to equity/debentures, guarantees,
discounting of bills of exchange and seed/ special capital, etc. SFCs have been set up with the objective
of catalysing higher investment, generating greater employment and widening the ownership base of
industries. They have also started providing assistance to newer types of business activities like
floriculture, tissue culture, poultry farming, commercial complexes and services related to engineering,
marketing, etc. There are 18 State Financial Corporations (SFCs) in the country.
– State Industrial Development Corporations (SIDCs) :- These have been established under the
Companies Act, 1956, as wholly-owned undertakings of State Governments. They have been set up
with the aim of promoting industrial development in the respective States and providing financial assistance
to small entrepreneurs. They are also involved in setting up of medium and large industrial projects in
the joint sector/assisted sector in collaboration with private entrepreneurs or wholly-owned subsidiaries.
They are undertaking a variety of promotional activities such as preparation of feasibility reports;
conducting industrial potential surveys; entrepreneurship training and development programmes; as
well as developing industrial areas/estates.
QUALIFIED INSTITUTIONAL BUYERS
Generally QIBs are investment institutions who buy the shares of a company on a large scale. Qualified Institutional
Buyers are those Institutional investors who are generally perceived to possess expertise and the financial
muscle to evaluate and invest in the Capital Markets. According to SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009, “Qualified Institutional Buyer” means:
(i) a mutual fund, venture capital fund, Alternative Investment Fund and foreign venture capital investor
registered with SEBI;
(ii) a foreign institutional investor and sub-account (other than a sub-account which is a foreign corporate
or foreign individual), registered with SEBI;
(iii) a public financial institution as defined in section 4A of the Companies Act, 1956;
(iv) a scheduled commercial bank;
(v) a multilateral and bilateral development financial institution;
(vi) a state industrial development corporation;
Lesson 7
Capital Market Investment Institutions 237
(vii) an insurance company registered with the Insurance Regulatory and Development Authority;
(viii) a provident fund with minimum corpus of twenty five crore rupees;
(ix) a pension fund with minimum corpus of twenty five crore rupees;
(x) National Investment Fund set up by resolution no. F. No. 2/3/2005-DDII dated November 23, 2005 of
the Government of India published in the Gazette of India;
(xi) insurance funds set up and managed by army, navy or air force of the Union of India;
(xii) insurance funds set up and managed by the Department of Posts, India;
SEBI has laid down certain criteria in SEBI (ICDR) Regulations, 2009, under which a QIB is entitled to get the
shares in a public issue to the extent it is specified by SEBI.
Anchor Investor
Anchor investor means a Qualified Institutional Buyer (QIB) who makes an application for a value of ten crore
rupees or more in a public issue made through the book building process. An Anchor Investor is also an Investment
Institution as it means a QIB which is again a Financial Institutions.
PRIVATE EQUITY
Private equity is essentially a way to invest in some assets that isn't publicly traded, or to invest in a publicly
traded asset with the intention of taking it private. Unlike stocks, mutual funds, and bonds, private equity funds
usually invest in more illiquid assets, i.e. companies. By purchasing companies, the firms gain access to those
assets and revenue sources of the company, which can lead to very high returns on investments. Another
feature of private equity transactions is their extensive use of debt in the form of high-yield bonds. By using debt
to finance acquisitions, private equity firms can substantially increase their financial returns.
Private equity consists of investors and funds that make investments directly into private companies or conduct
buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from
retail and institutional investors, and can be used to fund new technologies, expand working capital within an
owned company, make acquisitions, or to strengthen a balance sheet. The major of private equity consists of
institutional investors and accredited investors who can commit large sums of money for long periods of time.
Private equity investments often demand long holding periods to allow for a turn around of a distressed company
or a liquidity event such as IPO or sale to a public company. Generally, the private equity fund raise money from
investors like Angel investors, Institutions with diversified investment portfolio like –pension funds, insurance
companies, banks, funds of funds etc.
Types of Private Equity
Private equity investments can be divided into the following categories:
Leveraged Buyout (LBO): This refers to a strategy of making equity investments as part of a transaction in
which a company, business unit or business assets is acquired from the current shareholders typically with the
use of financial leverage. The companies involved in these transactions are typically more mature and generate
operating cash flows.
Venture Capital: It is a broad sub-category of private equity that refers to equity investments made, typically in
less mature companies, for the launch, early development, or expansion of a business.
Growth Capital: This refers to equity investments, most often minority investments, in companies that are
looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without
a change of control of the business.
238 PP-CC&MM
VENTURE CAPITAL
Venture Capital is one of the innovative financing resource for a company in which the investor has to give up
some level of ownership and control of business in exchange for capital for a limited period, say, 3-5 years.
Venture Capital is generally equity investments made by Venture Capital funds, at an early stage in privately
held companies, having potential to provide a high rate of return on their investments. It is a resource for
supporting innovation, knowledge based ideas and technology and human capital intensive enterprises.
Essentially, a venture capital company is a group of investors who pool investments focused within certain
parameters. The participants in venture capital firms can be institutional investors like pension funds, insurance
companies, foundations, corporations or individuals. Unlike banks, which seek their return through interest
payments, venture firms seek for capital appreciation. Generally Venture Capital firms look for a return of five to
ten times the original investment.
Areas of Investment
Different venture groups prefer different types of investments. Some specialize in seed capital and early expansion
while others focus on exit financing. Biotechnology, medical services, communications, electronic components
and software companies seem to be attracting the most attention from venture firms and receiving the most
financing. Venture capital firms finance both early and later stage investments to maintain a balance between
risk and profitability.
In India, software sector has been attracting a lot of venture finance. Besides media, health and pharmaceuticals,
agribusiness and retailing are the other areas that are favored by a lot of venture companies.
STAGES OF INVESTMENT FINANCING
Venture capital firms finance both early and later stage investments to maintain a balance between risk and
profitability. Venture capital firms usually recognise the following two main stages when the investment could be
made in a venture namely:
A. Early Stage Financing
i. Seed Capital & Research and Development Projects.
ii. Start Ups
ii. Second Round Finance
B. Later Stage Financing
i. Development Capital
ii. Expansion Finance
iii. Replacement Capital
iv. Turn Arounds
v. Buy Outs
A. EARLY STAGE FINANCING
I. Seed Capital and R & D Projects: Venture capitalists are more often interested in providing seed finance i. e.
making provision of very small amounts for finance needed to turn into a business. Research and Development
activities are required to be undertaken before a product is to be launched. External finance is often required by
the entrepreneur during the development of the product. The financial risk increases progressively as the research
phase moves into the development phase, where a sample of the product is tested before it is finally
Lesson 7
Capital Market Investment Institutions 239
commercialised venture capitalists/ firms/ funds are always ready to undertake risks and make investments in
such R & D projects promising higher returns in future.
II. Start Ups: The most risky aspect of venture capital is the launch of a new business after the Research and
Development activities are over. At this stage, the entrepreneur and his products or services are as yet untried.
The finance required usually falls short of his own resources. Start-ups may include new industries / businesses
set up by the experienced persons in the area in which they have knowledge. Others may result from the
research bodies or large corporations, where a venture capitalist joins with an industrially experienced or corporate
partner. Still other start-ups occur when a new company with inadequate financial resources to commercialise
new technology is promoted by an existing company.
III. Second Round Financing: It refers to the stage when product has already been launched in the market but
has not earned enough profits to attract new investors. Additional funds are needed at this stage to meet the
growing needs of business. Venture Capital Institutions (VCIs) provide larger funds at this stage than at other
early stage financing in the form of debt. The time scale of investment is usually three to seven years.
B. LATER STAGE FINANCING
Those established businesses which require additional financial support but cannot raise capital through public
issue approach venture capital funds for financing expansion, buyouts and turnarounds or for development
capital.
I. Development Capital: It refers to the financing of an enterprise which has overcome the highly risky stage
and have recorded profits but cannot go public, thus needs financial support. Funds are needed for the purchase
of new equipment/ plant, expansion of marketing and distributing facilities, launching of product into new regions
and so on. The time scale of investment is usually one to three years and falls in medium risk category.
II. Expansion Finance: Venture capitalists perceive low risk in ventures requiring finance for expansion purposes
either by growth implying bigger factory, large warehouse, new factories, new products or new markets or
through purchase of exiting businesses. The time frame of investment is usually from one to three years. It
represents the last round of financing before a planned exit.
III. Buy Outs: It refers to the transfer of management control by creating a separate business by separating it
from their existing owners. It may be of two types.
i. Management Buyouts (MBOs): In Management Buyouts (MBOs) venture capital institutions provide funds to
enable the current operating management/ investors to acquire an existing product line/business. They represent
an important part of the activity of VCIs.
ii. Management Buy-ins (MBIs): Management Buy-ins are funds provided to enable an outside group of
manager(s) to buy an existing company. It involves three parties: a management team, a target company and an
investor (i.e. Venture capital institution). MBIs are more risky than MBOs and hence are less popular because it
is difficult for new management to assess the actual potential of the target company. Usually, MBIs are able to
target the weaker or under-performing companies.
IV. Replacement Capital: VCIs another aspect of financing is to provide funds for the purchase of existing
shares of owners. This may be due to a variety of reasons including personal need of finance, conflict in the
family, or need for association of a well known name. The time scale of investment is one to three years and
involve low risk.
V. Turnarounds: Such form of venture capital financing involves medium to high risk and a time scale of three
to five years. It involves buying the control of a sick company which requires very specialised skills. It may
require rescheduling of all the company’s borrowings, change in management or even a change in ownership.
A very active “hands on” approach is required in the initial crisis period where the venture capitalists may appoint
its own chairman or nominate its directors on the board.
240 PP-CC&MM
ANGEL FUND
Angel investments are typically the earliest equity investments made in start up companies. Angel Investors are
almost always healthy individuals and commonly band together in investor networks. Often these networks are
based on regional, industry in investor or academic affiliation. Angel Investors are often former entrepreneurs
themselves, and typically enjoy working with companies at the earliest stages of business formation.
The most effective Angels help entrepreneurs shape business models, create business plans and connect to
resources - but without stepping into a controlling or operating role. Often Angels are entrepreneurs who have
successfully built companies, or have spent a part of their career coaching young companies.
Less is known about angel investing than venture capital because of the individuality and privacy of the
investments. However, every success story can track its initial entry into the market to an Angel or group of
Angels that provided the needed knowledge and capital to launch and gone that company.
TYPES OF ANGEL INVESTORS
There are several types of angel investors, and fall into the following main categories:
Core Angels
These angel investors are individuals with extensive business experience who have operated and owned successful
businesses of their own. Such Angel Investors possess a diversified portfolio that encompasses all industries, including
public and private equity and real estate. They serve as valuable mentors and advisors to their invested firms.
High-tech Angels
These angel investors may have less experience than core angels, but invest significantly in the latest trends
of modern technology. Their investments primarily depend on the value of their other high-tech holdings,
which can vary considerably.
Return On investment (ROI) Angels
ROI angel investors are primarily concerned with the financial reward of high-risk investments. Their motivation
behind investing is their perception of what other angel investor gross income may be. Return on investment
angels tend to stay away from investing when market performance is poor and emerge once the market shows
stability and improvement. They view each of their investments as another company added to their diversified
portfolio and rarely become actively involved in the invested firms.
Enthusiast Angels
These angel investors are older (age 65 and above) businessmen who are independently wealthy before their
investments. They often invest small amounts of capital in many different enterprises and view investing as a
mere hobby. They do not take an active role in management.
Micromanagement Angels
These individuals are considered to be serious angel investors. They often demand a board position and are
known to impose the same strategies they have used with their own companies towards their invested companies.
Professional Angels
These angel investors are professionally employed as doctors, lawyers, accountants, etc. who invest in companies
in their related field. Professional angels invest in many companies at the same time. They may also provide
services to their invested firm (legal, accounting or financial) at a discounted rate. Professional angel investors
are of tremendous value for initial needed capital and rarely make follow-on investments.
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PENSION FUND
Pension Fund means a fund established by an employer to facilitate and organize the investment of employees'
retirement funds contributed by the employer and employees. The pension fund is a common asset pool meant
to generate stable growth over the long term, and provide pensions for employees when they reach the end of
their working years and commence retirement. Pension funds are commonly run by some sort of financial
intermediary for the company and its employees, although some larger corporations operate their pension funds
in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors
in many nations. Pension funds nowadays in India play a huge role in development of the economy and it play
active role in the Indian equity markets. A change both in their investment attitudes and in the regulatory climate,
encouraging them to increase their investment levels in equities and would have a massive impact on capital
market and on the economy as a whole.
Pensions broadly divided into two sector:
A-Formal sector Pensions
B-Informal sector Pensions
A. Formal sector Pensions
Formal sector pensions in India can be divided into three categories; viz those schemes that come under an Act
or Statute, Government pensions and voluntary pensions.
Pensions under an Act
There are three defining Acts for pensions in India.
1. Pensions under the EPF&MP Act 1952: These include the Employees Provident Fund, Employees
Pension Scheme, and Employees Deposit Linked Insurance Scheme,
2. Pensions under the Coal mines PF&MP Act 1948: These include Coal mines provident fund, Coal
mines pension scheme & Coal mines linked insurance scheme.
3. Gratuity under the Payment of Gratuity Act, 1972.
There are other provident funds in India like Assam Tea Plantations PF, J&K PF, and Seamens PF etc.
Government Pension
Government pensions in India are defined under the Directive Principles of State policy and are therefore not
under a Statute. The Government amended the regulations to put in place the new pension system. The old
scheme continues for the existing employees (i.e. those who joined service prior to January 1, 2004). Pensions
for government employees would include employees of the central as well as the state governments.
(A) Central Government Pensions like Civil servants pensions, Defences, Railways, Posts.
(B) State Government Pensions, Bank pensions like Reserve Bank of India (RBI), Public Sector Banks,
National Bank for Agriculture and Rural Development (NABARD) and other banks pensions.
Superannuation schemes are also sold in the market. These are typically plans sold by Mutual funds and
Insurance companies (Life Insurance & Postal Life Insurance).
Pension Fund Management
Pension Fund is regulated by Pension Fund Regulatory and Development Authority (PFRDA). Pension Funds
are managed by Pension Fund Administrators and they are responsible for taking investment decisions but in
some jurisdictions, pension fund management can be managed by asset management and insurance companies
242 PP-CC&MM
and some management decisions may be the responsibility of Boards of Trustees in some corporate organisations.
Pension Fund Custodians are those who keep custody of pension funds. Regulations of pension funds require
the appointment of a custodian, depository institution or trustee, standards of conduct and minimum suitability of
the operators of pension funds, the rights of investors to withdraw funds and the right of investors to full, timely
and accurate information disclosure. Regulations required promoting both the performance and the financial
security of pension assets. Main goals of pension investment are to ensure adequate, affordable and sustainable
benefits to contributors, secure safety & security of funds and ensure adequate liquidity to pay all pension
benefits of contributors as and when due risk management for pension assets established on quantitative limits
which is maximum limits for individual, class or class of mix assets.
FOREIGN INSTITUTIONAL INVESTOR
Foreign Institutional Investor (FII) means an entity established or incorporated outside India which proposes to
make investment in India in securities and which is registered as a FII in accordance with the SEBI (Foreign
Institutional Investor) Regulations 1995.
Foreign Institutional Investor (FII) is used to denote an investor - mostly of the form of an institution or entity,
which invests money in the financial markets of a country different from the one where in the institution or entity
was originally incorporated.
Entities covered by the term ‘FII’ include “Overseas pension funds, mutual funds, investment trust, asset
management company, nominee company, bank, institutional portfolio manager, university funds, endowments,
foundations, charitable trusts, charitable societies etc.(fund having more than 20 investors with no single investor
holding more than 10 per cent of the shares or units of the fund).
FIIs can invest their own funds as well as invest on behalf of their overseas clients registered as such with SEBI.
These client accounts that the FII manages are known as ‘sub-accounts’.
Why FIIs Required?
FIIs contribute to the foreign exchange inflow as the funds from multilateral finance institutions and FDI (Foreign
direct investment) are insufficient. Following are the some advantages of FIIs.
– It lowers cost of capital, access to cheap global credit.
– It supplements domestic savings and investments.
– It leads to higher asset prices in the Indian market.
– And has also led to considerable amount of reforms in capital market and financial sector.
Investment by FIIs
There are generally two ways FIIs can invest.
(i) Equity Investment : 100% investments could be in equity related instruments or up to 30% could be
invested in debt instruments i.e.70 (Equity Instruments): 30 (Debt Instruments)
(ii) 100% Debt: 100% investment has to be made in debt securities only.
Equity Investment Route
In case of Equity route the FIIs can invest in the following instruments:
A. Securities in the primary and secondary market including shares which are unlisted, listed or to be listed
on a recognized stock exchange in India.
B. Units of schemes floated by the Unit Trust of India and other domestic mutual funds, whether listed or
not.
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Capital Market Investment Institutions 243
C. Warrants
100% Debt Route:
In case of Debt Route the FIIs can invest in the following instruments:
A. Debentures (Non Convertible Debentures, Partly Convertible Debentures etc.)
B. Bonds
C. Dated government securities
D. Treasury Bills
E. Other Debt Market Instruments
It should be noted that foreign companies and individuals are not be eligible to invest through the 100% debt
route.
Investment by FIIs under Portfolio Investment Scheme
The RBI has given general permission to SEBI-registered FIIs/sub-accounts to invest under the Portfolio
Investment Scheme (PIS).
– The total holding of each FII/sub-account under this scheme should not exceed 10 percent of the total
paid up capital or 10 percent of the paid-up value of each series of convertible debentures issued by the
Indian company.
– The total holding of all the FIIs/sub-accounts put together should not exceed 24 percent of the paidup capital or the paid-up value of each series of convertible debentures. This limit of 24 percent can
be increased to the sectoral cap/statutory limit as applicable to the Indian company concerned, by
passing a resolution of its Board of Directors, followed by a special resolution to that effect by its
General Body.
– A domestic asset management company or portfolio manager who is registered with the SEBI as an FII
for managing the funds of a sub-account can make investments under the scheme on behalf of:
– A person resident outside India who is a citizen of a foreign state; or
– A corporate body registered outside India.
However, such investment should be made out of the funds raised, collected, or brought from outside through a
normal banking channel. The investments by such entities should not exceed 5 percent of the total paid-up
equity capital or 5 percent of the paid-up value of each series of convertible debentures issued by an Indian
company, and should also not exceed the overall ceiling specified for FIIs.
QUALIFIED FOREIGN INVESTOR
A Qualified Foreign Investor (QFI) means a non-resident investor (other than SEBI registered FII and SEBI
registered Foreign Venture Capital Investor) who meets the KYC requirements of SEBI for the purpose of making
investments in accordance with the regulations/orders/circulars of RBI/SEBI.
QFls are permitted to invest through SEBI registered Depository Participants (DPs) only in equity shares of
listed Indian companies through recognized brokers on recognized stock exchanges in India as well as in
equity shares of Indian companies which are offered to public in India in terms of the relevant and applicable
SEBI guidelines/regulations. QFls are also permitted to acquire equity shares by way of right shares, bonus
shares or equity shares on account of stock split / consolidation or equity shares on account of amalgamation,
demerger or such corporate actions subject to the prescribed investment limits. QFIs are allowed to sell the
equity shares so acquired subject to the relevant SEBI guidelines.
244 PP-CC&MM
The individual and aggregate investment limits for the QFls shall be 5% and 10% respectively of the paid up
capital of an Indian company. These limits shall be over and above the FII and NRI investment ceilings prescribed
under the Portfolio Investment Scheme for foreign investment in India. Further, wherever there are composite
sectoral caps under the extant FDI policy, these limits for QFI investment in equity shares shall also be within
such overall FDI sectoral caps.
Dividend payments on equity shares held by QFls can either be directly remitted to the designated overseas
bank accounts of the QFIs or credited to the single non-interest bearing Rupee account. In case dividend
payments are credited to the single non-interest bearing Rupee account they shall be remitted to the
designated overseas bank accounts of the QFIs within five working days (including the day of credit of such
funds to the single non-interest bearing Rupee account). Within these five working days, the dividend
payments can be also utilized for fresh purchases of equity shares under this scheme, if so instructed by
the QFI.
MUTUAL FUND
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial
goal. Anybody with an investible surplus of as little as a few hundred rupees can invest in Mutual Funds.
These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and
strategy.
The money thus collected is then invested by the fund manager in different types of securities. These could
range from shares to debentures to money market instruments, depending upon the scheme’s stated objectives.
The income earned through these investments and the capital appreciation realised by the scheme are shared
by its unit in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment
for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost. In India, Mutual Fund is regulated by SEBI (Mutual Funds) Regulations, 1996.
According to these regulations “Mutual Fund means a fund established in the form of trust to raise monies
through the sale of units to the public or a section of public under one or more schemes for investing in
securities including the money market instruments or gold or gold related instruments.”
Types of Mutual Fund Schemes
(A) By Structure
(i) Open-Ended Schemes: These type of scheme do not have a fixed maturity. The key feature is liquidity. The
investor can conveniently buy and sell units at Net Asset Value(NAV) related prices, at any point of time.
(ii) Close Ended Scheme: Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are
called close ended schemes. The investor can invest in the scheme at the time of the initial issue and thereafter
he/she can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price
at the stock exchange could vary from the scheme’s NAV on account of demand and supply situation, unitholders’
expectations and other market factors. One of the characteristics of the close-ended schemes is that they are
generally traded at a discount to NAV; but closer to maturity, the discount narrows.
Some close-ended schemes give the investor an additional option of selling the units to the Mutual Fund through
periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are
provided to the investor under the close ended schemes.
(iii) Interval Schemes: These combine the features of open-ended and close-ended schemes. They may be
traded on the stock exchange or may be open for sale or redemption during predetermined intervals at NAV related
prices.
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Capital Market Investment Institutions 245
(B) By Investment Objective
(i) Growth Schemes: Aim to provide capital appreciation over the medium to long term. These schemes normally
invest a majority of their funds in equities and are willing to bear short term decline in value for possible future
appreciation. These schemes are not for investors seeking regular income or needing their money back in the
short term.
(ii) Income Schemes: Aim to provide regular and steady income to investors. These schemes generally invest
in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may
be limited.
(iii) Balanced Schemes: Aim to provide both growth and income by periodically distributing a part of the income
and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in
their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace or fall
equally when the market falls.
(iv) Money Market / Liquid Schemes: Aim to provide easy liquidity, preservation of capital and moderate
income. These schemes generally invest in safer, short term instruments such as treasury bills, certificates of
deposit, commercial paper and interbank call money. Returns on these schemes may fluctuate, depending
upon the interest rates prevailing in the market.
(v) Other Schemes: Tax Saving Schemes (Equity Linked Saving Scheme - ELSS): These schemes offer tax
incentives to the investors under tax laws as prescribed from time to time and promote long term investments in
equities through Mutual Funds.
(vi) Special Schemes: This category includes index schemes that attempt to replicate the performance of a
particular index such as the BSE Sensex, the NSE 50 (NIFTY) or sector specific schemes which invest in
specific sectors such as Technology, Infrastructure, Banking, Pharma etc.
Besides, there are also schemes which invest exclusively in certain segments of the capital market, such as
Large Caps, Mid Caps, Small Caps, Micro Caps, 'A' group shares, shares issued through Initial Public Offerings
(IPOs), etc.
Fixed Maturity Plans
Fixed Maturity Plans (FMPs) are investment schemes floated by mutual funds and are close ended with a fixed
tenure, the maturity period ranging from one month to three/five years. These plans are predominantly debtoriented, while some of them may have a small equity component. The objective of such a scheme is to generate
steady returns over a fixed-maturity period and protect the investor against market fluctuations. FMPs are
typically passively managed fixed income schemes with the fund manager locking into investments with maturities
corresponding with the maturity of the plan. FMPs are not guaranteed products.
Exchange Traded Funds (ETFs)
Exchange Traded Funds are essentially index funds that are listed and traded on exchanges like Index fund
schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Globally,
ETFs have opened a whole new panorama of investment opportunities to retail as well as institutional investors.
ETFs enable investors to gain broad exposure to entire stock markets as well as in specific sectors with relative
ease, on a real-time basis and at a lower cost than many other forms of investing.
An ETF is a basket of stocks that reflects the composition of an index, like S&P CNX Nifty, BSE Sensex, CNX
Bank Index, CNX PSU Bank Index, etc. The ETF's trading value is based on the net asset value of the underlying
stocks that it represents. It can be compared to a stock that can be bought or sold on real time basis during the
market hours. Benchmark Nifty Bees was the first ETF in India.
246 PP-CC&MM
Capital Protection Oriented Schemes
Capital Protection Oriented Schemes are schemes that endeavour to protect the capital as the primary objective
by investing in high quality fixed income securities and generate capital appreciation by investing in equity /
equity related instruments as a secondary objective. Franklin Templeton Capital Protection Oriented Fund was
the first Capital Protection Oriented Fund in India.
Gold Exchange Traded Funds (GETFs)
Gold Exchange Traded Funds offer investors an innovative, cost-efficient and secure way to access the gold
market. Gold ETFs are intended to offer investors a means of participating in the gold bullion market by buying
and selling units on the Stock Exchanges, without taking physical delivery of gold. Benchmark GETF was the
first Gold ETF in India and listed on the NSE.
Quantitative Funds
A quantitative fund is an investment fund that selects securities based on quantitative analysis. The managers of
such funds build computer based models to determine whether or not an investment is attractive. In a pure
"quant shop" the final decision to buy or sell is made by the model. However, there is a middle ground where the
fund manager will use human judgment in addition to a quantitative model. Lotus Agile Fund was the first Quant
based Mutual Fund Scheme in India.
Funds Investing Abroad
With the opening up of the Indian economy, Mutual Funds have been permitted to invest in foreign securities/
American Depository Receipts (ADRs) / Global Depository Receipts (GDRs). Some of such schemes are
dedicated funds for investment abroad while others invest partly in foreign securities and partly in domestic
securities. While most such schemes invest in securities across the world there are also schemes which are
country specific in their investment approach.
Fund of Funds (FOFs)
Fund of Funds are schemes that invest in other mutual fund schemes. The portfolio of these schemes comprise
only of units of other mutual fund schemes and cash / money market securities/ short term deposits pending
deployment. The first FOF was launched by Franklin Templeton Mutual Fund on October 17, 2003. Fund of
Funds can be Sector specific e.g. Real Estate FOFs, Theme specific e.g. Equity FOFs, Objective specific e.g.
Life Stages FOFs or Style specific e.g. Aggressive/ Cautious FOFs etc.
ALTERNATIVE INVESTMENT FUNDS
Alternative investment funds (AIFs) are defined in Regulation 2(1)(b) of SEBI (Alternative Investment Funds)
Regulations, 2012. It refers to any privately pooled investment fund, (whether from Indian or foreign sources), in
the form of a trust or a company or a body corporate or a Limited Liability Partnership(LLP) which are not
presently covered by any Regulation of SEBI governing fund management (like, Regulations governing Mutual
Fund or Collective Investment Scheme)nor coming under the direct regulation of any other sectoral regulators in
India-IRDA, PFRDA, RBI. Hence, in India, AIFs are private funds which are otherwise not coming under the
jurisdiction of any regulatory agency in India.
The text of the Regulation 2(1) (b) is as under:
“Alternative Investment Fund” means any fund established or incorporated in India in the form of a trust or a
company or a limited liability partnership or a body corporate which,(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign,
for investing it in accordance with a defined investment policy for the benefit of its investors; and
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Capital Market Investment Institutions 247
(ii) is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes)
Regulations, 1999 or any other regulations of SEBI to regulate fund management activities:
Provided that the following shall not be considered as Alternative Investment Fund for the purpose of
these regulations, –
(i) family trusts set up for the benefit of ‘relatives’ as defined under Companies Act, 1956;
(ii) ESOP Trusts set up under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase
Scheme), Guidelines, 1999 or as permitted under Companies Act, 1956;
(iii) employee welfare trusts or gratuity trusts set up for the benefit of employees;
(iv) ‘holding companies’ within the meaning of Section 4 of the Companies Act, 1956;
(v) other special purpose vehicles not established by fund managers, including securitization trusts,
regulated under a specific regulatory framework;
(vi) funds managed by securitisation company or reconstruction company which is registered with the
Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002; and
(vii) any such pool of funds which is directly regulated by any other regulator in India;
Thus, the definition of AIFs includes venture Capital Fund, hedge funds, private equity funds, commodity funds,
Debt Funds, infrastructure funds, etc., while, it excludes Mutual funds or collective investment Schemes, family
trusts, Employee Stock Option / purchase Schemes, employee welfare trusts or gratuity trusts, ‘holding companies’
within the meaning of Section 4 of the Companies Act, 1956, securitization trusts regulated under a specific
regulatory framework,and funds managed by securitization company or reconstruction company which is
registered with the RBI under Section 3 of the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002. One AIF can float several schemes. Investors in these funds are
large institutions, high net worth individuals and corporates.
In India AIF is regulated by SEBI (Alternative Investment Funds) Regulations, 2012 .
Types of AIFs
AIFs are categorized into the following three categories, based on their impact on the economy and the regulatory
regime intended for them:
– Category I AIF are those AIFs with positive spillover effects on the economy, for which certain
incentives or concessions might be considered by SEBI or Government of India; Such funds generally
invests in start-ups or early stage ventures or social ventures or SMEs or infrastructure or other
sectors or areas which the government or regulators consider as socially or economically desirable.
They cannot engage in any leverage except for meeting temporary funding requirements for not
more than thirty days, on not more than four occasions in a year and not more than ten percent
of the corpus.eg. Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure
Funds.
– Category II AIF are those AIFs for which no specific incentives or concessions are given. They do not
undertake leverage or borrowing other than to meet the permitted day to day operational requirements,
as is specified for Category I AIFs. eg. Private Equity or debt fund.
– Category III AIF are funds that are considered to have some potential negative externalities in certain
situations and which undertake leverage to a great extent; These funds trade with a view to make short
term returns. These funds are allowed to invest in Category I and II AIFs also. They receive no specific
incentives or concessions from the government or any other Regulator.eg. Hedge Funds (which employs
248 PP-CC&MM
diverse or complex trading strategies and invests and trades in securities having diverse risks or complex
products including listed and unlisted derivatives).
Where an AIF can Invest
An AIF is allowed to invest in following:
– In securities of companies incorporated outside India subject to such conditions as may be prescribed
by SEBI and RBI;
– Co-investment in an investee company by a Manager or Sponsor shall not be on terms more favourable
than those offered to the AIF;
– Category I and II AIFs are not allowed to invest not more than twenty five percent of the corpus in one
Investee Company;
– Investee company includes an LLP, meaning an AIF can also invest in LLPs.
– Category III AIF are allowed to invest up to ten percent of the corpus in one Investee Company;
– AIFs are allowed to invest in associates subject to approval of seventy five percent of investors;
– Un-invested portion of the corpus may be invested in liquid mutual funds or bank deposits or other
liquid assets of higher quality such as Treasury bills, Collateralised Borrowing and Lending Obiligations
(CBLOs), Commercial Papers, Certificates of Deposits, etc. till deployment of funds as per the investment
objective;
Category wise Investment Condition
Investment conditions for Category 1: Category 1 AIFs are allowed to invest in SPVs, LLPs, investee companies,
venture capital undertakings and even in units of other AIFs of category 1. The AIFs in this category are not allowed
to borrow funds directly or indirectly or engage in any leverage except for meeting temporary funding requirements
for not more than thirty days, on not more than four occasions in a year and not more than ten percent of the
corpus. Additional conditions have been prescribed for Venture Capital Funds (VCFs) under this category:
– The same were previously there in the VCF Regulations.
– Investments in SME segment (in listed or proposed to be listed SME companies) have been permitted
by the new Regulations which were not allowed earlier.
– Limited investment through Qualified Institutional Placement in preferential allotment is allowed in equity
linked instruments of listed entities.
Additional conditions provided for SME Funds:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or partnership interest
of venture capital undertakings or investee companies which are SMEs or in companies listed or proposed
to be listed on SME exchange or SME segment of an exchange.
Additional condition for Social Welfare Funds include:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or partnership interest
of social ventures.
– Such funds may accept grants, provided that such utilization of such grants shall be restricted to clause
mentioned above.
Additional conditions for Infrastructure Funds:
– Atleast seventy five percent of the corpus shall be invested in unlisted securities or units or partnership
Lesson 7
Capital Market Investment Institutions 249
interest of venture capital undertaking or investee companies or special purpose vehicles, which are
engaged in or formed for infrastructure projects
– These funds may also invest in listed securitized debt instruments or listed debt securities of investee
companies or special purpose vehicles, engaged in infrastructure projects.
Conditions for Category II AIFs
These shall primarily invest in unlisted investee companies or in units of other AIFs of Category I and II. May not
borrow funds directly or indirectly and shall not engage in leverage except for meeting temporary funding
requirements for not more than thirty days, not more than four occasions in a year and not more than ten percent
of the corpus. Category II AIFs may engage in hedging, subject to guidelines as specified by SEBI.
Conditions for Category III AIFs
These AIFs may invest in securities of listed or unlisted investee companies or derivatives or complex or structured
products and in units of other AIFs of Category I and II. Such AIFs may engage in leverage or borrow subject to
consent from the investors in the fund and subject to a maximum limit, as may be specified by SEBI.
HEDGE FUNDS
Hedge funds, are unregistered private investment partnerships funds or pools that may invest and trade in many
different markets, strategies and instruments (including securities, non-securities and derivatives) and are not
subject to the same regulatory requirements as mutual funds.
The term can also be defined by considering the characteristics most commonly associated with hedge funds.
Usually, hedge funds:
– are organized as private investment partnerships or offshore investment corporations;
– use a wide variety of trading strategies involving position-taking in a range of markets;
– employ as assortment of trading techniques and instruments, often including short-selling, derivatives
and leverage;
– pay performance fees to their managers; and
– have an investor base comprising wealthy individuals and institutions and relatively high minimum
investment limit (set at US $1,00,000 or higher for most funds).
Domestic Hedge Fund
Domestic hedge funds are usually organized (in USA) as limited partnerships to accommodate investors that
are subject to U.S. income taxation. The fund’s sponsor typically is the general partner and investment adviser.
Hedge funds may also take the form of limited liability companies (LLC) or business trusts. LLPs, LLCs and
business trusts are generally not separately taxed and, as a result, income is taxed only at the level of the
individual investors. Each of three firms also limits investors liability; LLCs offer the additional benefit of limited
liability for fund advisors (general partners).
Offshore Hedge Fund
Offshore hedge funds are typically organized as corporations in countries such as the Cayman Islands, British
Virgin Islands, the Bahamas, Panama, The Netherlands Antilles or Bermuda. Offshore funds generally attract
investments of US. tax exempt entities, such as pension funds, charitable trusts, foundations and endowments,
as well as non-U.S. residents. U.S. tax-exempt investors favour investments in offshore hedge funds because
they may be subject to taxation, if they invest in domestic limited partnership hedge funds.
250 PP-CC&MM
A Taxonomy of Hedge Fund Strategies
Strategy
Description
Directional Trading
Based upon speculation of market direction in multiple asset classes. Both modelbased systems and subjective judgment are used to make trading decisions.
Relative Value
Focus on spread relationships between pricing components of financial assets. Market
risk is kept to minimum and many managers use leverage to enhance returns.
Specialist Credit
Based around lending to credit sensitive issuers. Funds in this strategy conduct a
high level of due diligence in order to identify relatively inexpensive securities.
Stock Selection
Combine long and short positions, primarily in equities, in order to exploit under and
overvalued securities. Market exposure can vary substantially.
Market Benefits of Hedge Funds
Hedge funds can provide benefits to financial markets by contributing to market efficiency and enhance liquidity.
Many hedge fund advisors take speculative trading positions on behalf of their managed hedge funds based
extensive research about the true value or future value of a security. They may also use short term trading
strategies to exploit perceived mis-pricings of securities. Because securities markets are dynamic, the result of
such trading is that market prices of securities will move toward their true value. Trading on behalf of hedge
funds can thus bring price information to the securities markets, which can translate into market price efficiency.
Hedge funds also provide liquidity to the capital markets by participating in the market.
Hedge funds play an important role in a financial system where various risks are distributed across a variety of
innovative financial instruments. They often assume risks by serving as ready counter parties to entities that
wish to hedge risks. For example, hedge funds are buyers and sellers of certain derivatives, such as securitised
financial instruments, that provide a mechanism for banks and other creditors to un-bundle the risks involved in
real economic activity. By actively participating in the secondary market for these instruments, hedge funds can
help such entities to reduce or manage their own risks because a portion of the financial risks are shifted to
investors in the form of these tradable financial instruments. By reallocating financial risks, this market activity
provides the added benefit of lowering the financing costs shouldered by other sectors of the economy. The
absence of hedge funds from these markets could lead to fewer risk management choices and a higher cost of
capital. Hedge fund can also serve as an important risk management tool for investors by providing valuable
portfolio diversification. Hedge fund strategies are typically designed to protect investment principal. Hedge
funds frequently use investment instruments (e.g. derivatives) and techniques (e.g. short selling) to hedge
against market risk and construct a conservative investment portfolio – one designed to preserve wealth.
In addition, hedge funds investment performance can exhibit low correlation to that of traditional investments in
the equity and fixed income markets. Institutional investors have used hedge funds to diversify their investments
based on this historic low correlation with overall market activity.
LESSON ROUND UP
– The most important constituent of financial sector is the financial institutions, which act as a conduit for
the transfer of resources from net savers to net borrowers, that is, from those who spend less than
their earnings to those who spend more than their earnings.
– All-India Development Banks (AIDBs) Includes those development banks which provide institutional
credit to not only large and medium enterprises but also help in promotion and development of small
scale industrial units.
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Capital Market Investment Institutions 251
– Specialised Financial Institutions (SFIs) are the institutions which have been set up to serve the increasing
financial needs of commerce and trade in the area of venture capital, credit rating and leasing, etc.
– Investment Institutions are the most popular form of financial intermediaries, which particularly catering
to the needs of small savers and investors. They deploy their assets largely in marketable securities.
– Several financial institutions have been set up at the State Level which supplements the financial
assistance provided by the all India institutions.
– Qualified Institutional Buyers (QIB) means those buyers who are recommended by SEBI and generally
perceived to possess expertise and the financial muscle to evaluate and invest in the Capital Market.
– Private equity is essentially a way to invest in some assets that isn't publicly traded, or to invest in a
publicly traded asset with the intention of taking it private.
– Venture Capital is one of the innovative financing resource for a company in which the investor has to
give up some level of ownership and control of business in exchange for capital for a limited period,
say, 3-5 years.
– Angel Investors are often former entrepreneur themselves and typically enjoy working with companies
at the earliest stages of business formation.
– Pension Fund means a fund established by an employer to facilitate and organize the investment of
employees' retirement funds contributed by the employer and employees.
– Foreign Institutional Investor (FII) means an entity established or incorporated outside India which
proposes to make investment in India in securities and which is registered as a FII in accordance with
the SEBI (Foreign Institutional Investor) Regulations 1995.
– A Qualified Foreign Investor (QFI) means a non-resident investor (other than SEBI registered FII and
SEBI registered Foreign Venture Capital Investor) who meets the KYC requirements of SEBI for the
purpose of making investments in accordance with the regulations/orders/circulars of RBI/SEBI.
– Mutual Fund means a fund established in the form of trust to raise monies through the sale of units to
the public or a section of public under one or more schemes for investing in securities including the
money market instruments or gold or gold related instruments.
– In India AIF is regulated by SEBI (Alternative Investment Funds) Regulations, 2012.
– Hedge funds play an important role in a financial system where various risks are distributed across a
variety of innovative financial instruments. They often assume risks by serving as ready counter parties
to entities that wish to hedge risks.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. Briefly explain about different types of national level financial institutions.
2. What do you understand by private equity? Discuss about different categories of private equity.
3. Discuss about different stages of venture capital financing.
4. Discuss the provisions relating to Investment made by FIIs under portfolio management scheme.
5. Define Alternative Investment Fund under SEBI (Alternative Investment Funds) Regulations, 2012.
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Lesson 8
Capital Market Instruments 253
Lesson 8
Capital Market Instruments
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Financial instruments that are used for raising
– Equity Shares
capital resources in the capital market are
– Shares with Differential Voting Rights
(DVRs)
known as Capital Market Instruments. Capital
– Preference Shares
Market instruments are responsible for
– Fully Convertible Cumulative Preference
Share (Equipref)
and governments. These are used by the
generating funds for companies, corporations
– Debentures
investors to make a profit out of their respective
– Non Convertible Debentures with Put and
Call Option
number of capital market instruments playing
markets based on their needs. There are a large
in the market namely Equity shares, Preference
– Bonds
shares, Bonds, Debentures, variants of equity
– Sweat Equity Shares
shares etc. Again, the capital markets have
– Warrant
continued to produce a multitude of new
– Share Warrant
products, including various new forms of
– Secured Premium Notes
derivatives.
– Equity Shares with detachable warrants
Keeping this in view, it is imperative for a student
– Foreign Currency Convertible Bonds
(FCCBs)
to know the various types of Capital Market
– Foreign Currency Exchangeable Bonds
(FCEBs)
Instruments as well as financial innovation
– American Depository Receipts(ADRs)/
Global Depository Receipts(GDRs)
complete overview of various financial
– Indian Depository Receipts(IDRs)
debentures and new form of Derivatives like
– Derivatives
Interest Rate Futures, Currency Futures,
– Futures
Exchange Traded Funds etc. and companies
prevailing in the market .This lesson will give a
instruments like equity, preference shares,
issuing such instruments.
– Options
– Index Futures & options
– Currency Futures
– Interest Rate Futures
– Exchange Traded Funds (ETFs)
– LESSON ROUND UP
– SELF TEST QUESTIONS
253
254 PP-CC&MM
INTRODUCTION
Financial instruments that are used for raising capital resources in the capital market are known as Capital
Market Instruments. Capital Market Instruments are responsible for generating funds for companies, corporations
and sometimes governments. These are used by the investors to make a profit out of their respective markets.
The changes in the regulatory framework of the capital market and fiscal policies have resulted in newer kinds
of financial instruments (securities) being introduced in the market. Also, a lot of financial innovation by companies
who are now permitted to undertake treasury operations, has resulted in newer kinds of instruments - all of
which can be traded being introduced. The variations in all these instruments depend on the tenure, the nature
of security, the interest rate, the collateral security offered and the trading features, etc. While all Capital Market
Instruments are designed to provide a return on investment, the risk factors are different for each and the
selection of the instrument depends on the choice of the investor.
There are a large number of Capital Market Instruments playing in the market namely Equity Shares, Preference
Shares, Bonds, Debentures, Derivative Products like Futures, Options, , Interest rate derivatives etc. The different
types of Capital Market Instruments are explained below:
EQUITY SHARES
Equity shares, commonly referred to as ordinary share also represents the form of fractional ownership in which
a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business
venture. The holder of such shares is the member of the company and has voting rights.
Equity capital and further issues of equity capital by a company are generally based on the condition that they
will rank pari passu along with the earlier issued share capital in all respects. However, as regards dividend
declared by the company such additional capital shall be entitled to dividend ratably for the period commencing
from the date of issue to the last day of the accounting year, unless otherwise specified in the articles or in the
terms of the issue.
CHARACTERISTICS OF EQUITY SHARES
Equity shares, other than non-voting shares, have voting rights at all general meetings of the company. These
votes have the affect of the controlling the management of the company. Equity shareholdes have the right to
share the profits of the company in the form of dividend (cash) and bonus shares. However even equity
shareholders cannot demand declaration of dividend by the company which is left to the discretion of the Board
of Directors. When the company is wound up, payment towards the equity share capital will be made to the
respective shareholders only after payment of the claims of all the creditors and the preference share capital.
The important provisions relating to the rights of an equity shareholder are laid down in Companies Act, 1956.
Equity share holders enjoy different rights as members such as:
(a) right of pre-emption in the matter of fresh issue of capital. (Section 81)
(b) right to apply to the court to set aside variations of their rights to their detriment. (Section 107)
(c) right to receive a copy of the statutory report before the holding of the statutory meeting by public
companies. (Section 165)
(d) right to apply to Central Government to call for the Annual General Meeting, if the company fails to call
such a meeting. (Section 167)
(e) right to apply to Company Law Board for calling for an extra-ordinary general meeting of the company.
(Section 186)
Lesson 8
Capital Market Instruments 255
(f) right to receive annual accounts along with the auditors report, directors report and other information
(Section 210, 217 & 219).
[The rights mentioned at (b), (c), (d), (e) and (f) are also available to the preference shareholders. The right of
pre-emption in the matter of fresh issue of capital is available only to the equity shareholders vide Section
81(1)(a)].
Equity shareholders, other than non-voting shares are entitled to voting rights in all matters, whereas preference
shareholders are entitled to voting rights if the assured dividend to which they are entitled has been in arrears for
a specified period. In the normal course where there is no dividend in arrears to be paid to them they have no
voting rights except in a class meeting convened for preference share holders for specific purpose.
SHARES WITH DIFFERENTIAL VOTING RIGHTS
Where the voting rights on new shares are different from the voting rights on the equity shares already issued,
the new shares are known as Differential Voting Rights Shares (DVRS).
As per section 2(46A) of Companies Act, 1956 a share with differential rights means a share that is issued with
differential rights in accordance with the provisions of section 86 of the Act. The equity shares with differential
rights include equity shares with differential rights as to – (a) voting; (b) dividend; and (c) otherwise. Neither the
Act nor the Rules define the term – "otherwise", which may include any other right attached to equity shares.
Owners of this kind of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid
regularly before dividend can be paid in respect of equity shares. They also enjoy privity over the equity
shareholders in payment of surplus. But in the event of liquidation their claims rank below the claims of company’s
creditors, bondholders/debenture holders.
A company can issue new equity shares with higher or lower voting rights as compared to the rule of one share
one vote applicable for the existing equity shares. Section 86 of the Companies Act permits the issue of equity
shares with DVRs, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential
Voting Rights) Rules, 2001.
Pre-conditions for issue of DVRS
Rules 3 of the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001 enables companies
limited by shares to issue shares with differential rights as to dividend, voting or otherwise, subject to fulfilment
of certain conditions. The conditions are :
(1) It has distributable profits in terms of section 205 of the Companies Act, 1956 for three financial years
preceding the year in which it was decided to issue such shares.
(2) It has not defaulted in filing annual accounts and annual returns for three financial years immediately
preceding the financial year in which it was decided to issue such shares.
(3) The company has not failed to repay its deposits or interest thereon on due date or redeem its debentures
on due date or pay dividend.
(4) The Articles of Association of the company must authorize the issue of shares with differential
voting rights. If the Articles do not authorize, they have to be altered before the issuance of such
shares.
(5) The company has not been convicted of any offence arising under SEBI Act, 1992, Securities Contracts
(Regulation) Act, 1956, Foreign Exchange Management Act, 1999.
(6) The company has not defaulted in meeting investors’ grievances.
(7) The company has obtained the approval of the shareholders in general meeting by passing resolution
256 PP-CC&MM
as required under the provision of sub-clause (a) of sub-section (1) of Section 94 read with sub-section
(2) of Section 94 of the Companies Act.
(8) The listed company has obtained the approval of the shareholders in a postal ballot. The Companies
(Passing of Resolution by Postal ballot) Rules, 2001 will govern the aforesaid condition.
(9) The notice of the meeting at which resolution is proposed to be passed is accompanied by an explanatory
statement stating(a) the rate of voting rights which the equity share capital with differential voting right shall carry;
(b) the scale or in proportion to which voting rights of such class or type of such shares will vary;
(c) the company shall not convert its equity capital with voting rights into equity share capital with differential
voting rights and the shares with differential voting rights into equity share capital with voting rights;
(d) the shares with differential voting rights shall not exceed 25% of the total share capital issued;
(e) that a member of the company holding any equity shares with differential voting rights shall be entitled
to bonus shares, rights shares of the same class;
(f) the holders of equity shares with differential voting rights shall enjoy all other rights to which the holder
is entitled to excepting the right to vote as indicated in (a) above.
Examples
Pantaloons Retail India Ltd. (PRIL)
In July 2008, PRIL, India’s leading retailer, was the first to issue bonus shares with a DVR option. The company
made a bonus issue of 1: 10 shares with differential voting rights and 5% additional dividends as well. Although
there is no fund-raising involved in a bonus issue of shares, the idea was to get the markets familiar with such
instruments and create another alternative to raise funds in the future.
Tata Motors
In October 2008, Tata Motors became the first Indian company to make a rights issue of shares carrying differential
voting rights (DVR) (issue size: `1960.42 crores). DVR shares had 1/10th of voting rights of ordinary shares and
offer a 5% higher rate of dividend over the normal shares. It issued these shares at `305 i.e., about 10% lower
than the issue of normal rights at `340.
PROHIBITION ON SUPERIOR RIGHTS – CLAUSE 28 A
Clause 28A of the Listing Agreement, provides that a listed company cannot issue shares in any manner which
may confer on any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares which are
already listed.
Anand Jaiswal v. Jagatjit Industries Limited- Case Law
Karamjit Jaiswal and his unlisted firm, LP Jaiswal and Sons Pvt. Ltd, together owned 23.59% (8.59% by Karamjit
Jaiswal and 15% by his firm) in liquor firm Jagatjit Industries. In pursuance to an approval by the Board and
shareholders of Jagatjit Industries, LP Jaiswal and Sons Pvt. Ltd. subscribed to 2.5 million shares in Jagatjit
Industries, increasing its stake to 19.1% from 15%. However, each of these 2.5 million shares carried 20 voting
rights. Karamjit Jaiswal later acquired around 2.19 million ordinary shares, increasing his stake to 13% from
8.59%. With this, he and LP Jaiswal together owned a combined 32.1% in Jagatjit Industries Ltd. However,
because of the differential voting rights of the shares acquired by LP Jaiswal and Sons, this minority holding had
corresponding voting rights of 62%, giving Karamjit Jaiswal complete control over the company. In 2006, LP
Jaiswal and Sons Pvt. Ltd. along with associated persons, after their holding crossed 15% made a public
Lesson 8
Capital Market Instruments 257
announcement of open offer to the extent of 20% of the voting capital of Jagatjit Industries as required under
SEBI Takeover Regulations. Meanwhile Anand Jaiswal and Jagatjit Jaiswal, who together own 12% in Jagatjit
Industries filed a petition before SEBI challenging that the pricing of differential voting shares has been done in
an inappropriate manner. Moreover, they also contended that the in-principle approval from stock exchanges
has not been received and the provisions of Companies Act have been violated. SEBI held in its order that it is
not competent to decide the present issue. The powers of SEBI have been enumerated under Section 55A of
the Companies Act, 1956. At present, section 55A of the Companies Act, 1956 confers upon SEBI the right to
administer certain provisions relating to the issue and transfer of securities and non-payment of dividend in the
case of listed public companies and those companies that intend to get their securities listed. Since Section 86
of the Act doesn’t come under the purview of the Section 55A, SEBI left it to the Company Law Board to decide
upon.
Ruling by Company Law Board
Mr. Anand Jaiswal and Jagatjit Jaiswal had petitioned before the Company Law Board to declare a resolution
passed at the company’s Extraordinary General Meeting on June 16, 2004 as null and void through which 2.5
million preferential shares were allotted to LP Jaiswal & Sons, each share containing 20 voting rights. The
Company Law Board upheld the validity of the resolution passed at the meeting thus stating that issue of
differential voting shares is permissible under Section 86 of the Companies Act read with the Rules prescribed
by Central Government. The Company Law Board directed Karamjit Singh and associated persons to buy out,
on behalf of the Company, Mr. Anand and Jagatjit Jaiswal’s stake in the company for around ` 73 crores. The
company would acquire the stake as buyback of shares in cash, and consequently the equity share capital,
would stand reduced to that extent. The transaction is to be completed within three months from the date of the
order of Company Law Board.
Reform by SEBI
Subsequent to the ruling by Company Law Board in the case of Jagatjit Industries Limited, SEBI came up with
some changes vis-a-vis shares with superior voting rights in a SEBI Board Meeting on Primary Market Reforms
on June 18, 2009. It proposed that no listed company can issue shares with superior voting rights. This was
brought in to prevent the possible misuse by the persons in control to the detriment of public shareholders.
Moreover, SEBI apprehended that the precedence set by JIL may be followed by the promoters of other listed
companies also to increase their voting power through preferential allotment of DVRS. Further, the pricing
formula for preferential allotment of shares, i.e., average of the closing price of the shares at the stock exchange
during the last 26 weeks or last two weeks preceding the relevant date, whichever is higher, cannot be applied
as it is for the issue of DVRS because the issue of superior voting rights shares on preferential basis considerably
dilutes the voting power of the other shareholders vis-a-vis the promoter group.
SEBI issued a Circular on July 21, 2009 instructing the stock exchanges to amend the equity listing agreement
by inserting a new clause 28A thereby prohibiting issue of shares which may confer on any person, superior
rights as to voting or dividend vis-a-vis the rights on equity shares that are already listed.
In other words, the listed companies have been forbidden from issuing not only superior voting rights shares but
also inferior voting rights shares if such inferior voting rights shares confer on the holders thereof superior
dividend rights. Inferior voting rights shares would always carry higher dividend rate in order to make them
attractive for the investors, otherwise why would investors subscribe to such shares? It may be noted that
whenever higher dividend rate would be offered on new shares with inferior voting rights, it would tantamount to
contravention of clause 28A of the listing agreement because clause 28A prohibits issue of shares which would
confer on the holder superior rights as to dividend vis-a-vis the dividend on the already listed equity shares.
Thus, the aforesaid amendment has not only altogether banned the issue of superior voting rights shares but
also marred to a great extent the possibility of issue of inferior voting rights shares. Although the DVRS issued
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by Tata Motors and Pantaloon Retail entitle the holders thereof to an additional 5 per cent dividend over and
above the dividend paid on the normal equity shares, nonetheless they are valid since they were issued before
the amendment in the listing agreement. However, henceforth no listed company can issue DVRS on the same
terms and conditions, as issued by Tata Motors and Pantaloon, because although these DVRS would carry
fewer voting rights (1:10) but they would entitle their holder to 5 per cent additional dividend every year over and
above the dividend paid on the normal equity shares.
PREFERENCE SHARES
Sec. 85(1) of the Companies Act, 1956, defines preference shares as those shares which carry preferential
rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the
company.
CUMULATIVE PREFERENCE SHARES
In this type of preference shares the dividend payable every year becomes a first claim while declaring dividend
by the company. In case the company does not have adequate profit or for some reason the company does not
want to pay preference dividend, it gets accumulated for being paid subsequently. Such arrears of preference
dividend will be carried forward and paid out of the profits of the subsequent years, before payment of equity
dividend. However, if a company goes into the liquidation no arrears of preference dividend will be payable
unless the Articles of Association of the issuing company contains a specific provision to make such payment
even in winding up.
NON-CUMULATIVE PREFERENCE SHARES
In the case of these preference shares, dividend does not accumulate. If there are no profits or the profits are
inadequate in any year, the shares are not entitled to any dividend for that year. Unless there is a specific
provision in the Articles of Association of the company, the preference shareholders have no right to participate
in the surplus profits or in the surplus assets in a winding up. They are entitled to payment of the declared
preference dividend in any particular year and to the repayment of their preference capital in the event of
winding up before payment to the equity shareholders.
CONVERTIBLE PREFERENCE SHARES
If the terms of issue of preference shares includes a right for converting them into equity shares at the end of a
specified period they are called convertible preference shares. In the absence of such condition or right, the
preference shares are not converted into equity shares to become eligible for various rights such as voting,
higher dividend, bonus issue etc. as in the case of equity shares. These shares are sometimes referred to as
quasi equity shares in common parlance. Companies may even charge a premium as part of the terms of
conversion of preference shares, as they do sometimes while converting debentures into equity shares.
REDEEMABLE PREFERENCE SHARES
If the articles of a company so authorize, redeemable preference shares can be issued. This is in contrast to the
principle that the company normally can not redeem or buy back its own shares vide Section 77 of the Companies
Act, except by following the procedure for reduction of capital and getting the sanction of the High Court in
pursuance of Sections 100 to 104 or of Section 402. With effect from 31st October, 1998 a new Section 77A was
inserted in the Act empowering companies to purchase its own securities under certain circumstances and
subject to certain conditions.
Section 80 regulates the redemption of redeemable preference shares as follows:
1. The partly paid shares, if any, must be made fully paid up.
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Capital Market Instruments 259
2. The shares are to be redeemed only out of the profits of the company, which would otherwise be
available for distribution of dividend or out of the proceeds of a fresh issue of shares made for the
purpose.
3. The premium, if any payable, on redemption should be provided for out of the profits of the company or
its security premium account.
4. Where redemption is made out of profits, a sum equal to the nominal value of the shares redeemed,
must be transferred to a capital redemption reserve account which can be utilised only to pay up unissued
shares of the company to be issued as fully paid bonus shares.
According to section 80(5A) of Companies Act, 1956, a company limited by shares shall not issue any preference
shares which is irredeemable or is redeemable after the expiry of a period of 20 years from the date of its issue.
PARTICIPATING PREFERENCE SHARES
Preference shareholders are not entitled to dividend more than what has been indicated as part of the terms of
issue, even in a year in which the company has made huge profits. Subject to provision in the terms of issue
these shares can be entitled to participate in the surplus profits left, after payment of dividend to the preference
and the equity shareholders to the extent provided therein. Subject to provisions in the terms of issue such
preference shares can be entitled even to bonus shares.
NON PARTICIPATING PREFERENCE SHARES
Unless the terms of issue indicate specifically otherwise, all preference shares are to be regarded as non
participating preference shares.
FULLY CONVERTIBLE CUMULATIVE PREFERENCE SHARE (EQUIPREF)
This instrument is in two parts A & B. Part A is convertible into equity shares automatically and compulsorily on
the date of allotment without any application by the allottee, and Part B is redeemed at par/ converted into equity
after a lock in period at the option of the investor, at a price 30% lower than the average market price. The
dividend is given only for part B shares. The dividend on fully convertible cumulative preference shares is fixed
and shall be given only for the portion that represents second part shares.
DEBENTURES
Section 2(12) of the Companies Act, 1956 defines debentures as follows:
“Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a
charge on the assets of the company or not.”
Debenture is a document evidencing a debt or acknowledging it and any document which fulfills either of these
conditions is a debenture.
Features of Debentures
The important features of a debenture are:
1. It is issued by a company as a certificate of indebtedness.
2. It usually indicates the date of redemption and also provides for the repayment of principal and payment
of interest at specified date or dates.
3. It usually creates a charge on the undertaking or the assets of the company. In such a case the lenders
of money to the company enjoy better protection as secured creditors, i.e. if the company does not pay
interest or repay principal amount, the lenders may either directly or through the debenture trustees
260 PP-CC&MM
bring action against the company to realise their dues by sale of the assets/undertaking earmarked as
security for the debt.
Types of Debentures
(a) Naked or unsecured debentures
Debentures of this kind do not carry any charge on the assets of the company. The holders of such
debentures do not therefore have the right to attach particular property by way of security as to repayment
of principal or interest.
(b) Secured debentures
Debentures that are secured by a mortgage of the whole or part of the assets of the company are called
mortgage debentures or secured debentures. The mortgage may be one duly registered in the formal
way or one which is secured by the deposit of title deeds in case of urgency.
(c) Redeemable debentures
Debentures that are redeemable on expiry of certain period are called redeemable debentures. Such
debentures after redemption can be reissued in accordance with the provisions of Section 121 of the
Companies Act, 1956.
(d) Perpetual debentures
If the debentures are issued subject to redemption on the happening of specified events which may not
happen for an indefinite period, e.g. winding up, they are called perpetual debentures.
(e) Bearer debentures
Such debentures are payable to bearer and are transferable by mere delivery. The name of the debenture
holder is not registered in the books of the company, but the holder is entitled to claim interest and principal
as and when due. A bonafide transferee for value is not affected by the defect in the title of the transferor.
(f) Registered debentures
Such debentures are payable to the registered holders whose name appears on the debenture certificate/
letter of allotment and is registered on the companies register of debenture holders maintained as per
Section 152 of the Companies Act, 1956.
Classification of Debentures based Upon Convertibility
Based on convertibility, debentures can be classified under three categories:
1. Fully Convertible Debentures (FCDs)
2. Non Convertible Debentures (NCDs)
3. Partly Convertible Debentures (PCDs)
Basic Features of Convertible Debentures
– Debentures are issued for cash at par.
– They are converted into specified or unspecified number of equity shares at the end of the specified period.
The ratio at which the convertible debentures are exchanged for equity shares is known as conversion price
or conversion ratio which is worked out by dividing the face value of a convertible debenture by its conversion
price. For instance if the face value of a convertible debenture is `100 and it is convertible into two equity
shares, the conversion price is `50 and the conversion ratio is 2. The difference between the conversion
price and the face value of the equity share is called conversion premium.
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Capital Market Instruments 261
– Convertible debentures may be fully or partly convertible. In case it is fully convertible the entire face value
is converted into equity shares on expiry of the stipulated period. If partly convertible, the convertible portion
is converted into equity shares on expiry of the specified period and the non convertible portion is redeemed
at the expiry of certain period.
– Conversion into equity shares may take place in one or more stages at the end of specified period or periods
in the case of fully or partly convertible debentures.
– If one or more parts of the debentures are convertible after 18 months, a company should get a credit rating
done by a credit rating agency approved by SEBI. Fresh rating is required if debentures are rolled over.
– Convertible debentures of public companies can be listed on the stock exchanges to assure liquidity to the
holders.
Advantages of Convertible Debentures
Advantages to the company
The advantages of convertible debentures to the company are –
1. Capitalisation of interest cost till the date of commissioning of the project is allowed in accordance with
accounting principle. If the conversion of the debentures is duly linked with the commissioning of the
project the entire interest cost can be capitalised, without charging the interest to profit & loss account
and pulling down the profits of the company.
2. Convertible debentures carry lower interest as compared to the rate charged by the Banks and Financial
Institutions.
3. From the point of view of the debt equity ratio the convertible part of the debentures is treated as equity
by financial institutions. The company is thus enabled to have a high degree of flexibility in financing its
future projects.
4. Equity capital gets increased after each conversion, facilitating easier servicing of equity by payment of
dividend.
5. Tax benefits are higher as interest on debentures is allowed as a deduction in computation of taxable
income of the company. Additionally a company having a proven track record and future earning potential
will be able to reasonable premium at the time of conversion. This will result in reducing the servicing
cost of equity.
6. This is a popular form of financing in companies as the interest rates are cheaper than those charged by
Financial Institutions on term loans.
7. In the case of term loans from Financial Institutions (FIs) and Banks they usually impose many conditions
on management including placing their representative on the Board. In the case of convertible debentures
there is thus a greater degree of autonomy for the companies.
Advantages to the Investor
The advantages of the convertible debentures to the investors are –
1. The investor is assured of a fixed return by way of interest on the debentures till conversion. On conversion
equity shares the investor becomes entitled to receive dividend declared on equity shares. The advantage
to the investor is that he receives a fixed return on his investment by way of interest even during the
gestation period and project implementation period.
2. As price of equity shares tends to rise on completion of the project of the company, the investor gets
value appreciation on his investment, if converted into equity share.
262 PP-CC&MM
3. In most cases, debentures carry security with a charge on all or a part of movable/immovable properties
of the company. This assures prompt payment of principal and interest by invoking the assistance of a
debenture trustee. However in terms of SEBI Regulations where the debentures have a maturity period
of 18 months or less it is mandatory for the company to create security on the debentures.
4. A fair amount of liquidity is enjoyed by convertible debentures listed on the stock exchanges depending
on the track record of the companies. Even if debentures are not traded as actively as equity shares,
convertible debentures of good companies command reasonable liquidity. Where a debenture has several
parts, each part of the convertible debentures can be traded separately or in full on the stock exchanges.
5. The following options are available to the investor who has bought convertible debentures issued in
several parts:
(a) To sell all the parts immediately on allotment;
(b) To sell one or more parts and retain other or others till conversion and to obtain equity shares for
retention or sale.
Fully Convertible Debentures With Interest (Optional)
In this case there is no interest payment involved say for the first 6 months. Then the holder can exercise option
and apply for securities at a premium without paying additional amount. However interest will be payable at a
determined rate from the date of first conversion to second/final conversion and in lieu thereof equity shares are
issued. Upon conversion of each part, the face value stands reduced proportionately on the date of conversion.
NON CONVERTIBLE DEBENTURES (NCDs) WITH PUT AND CALL OPTIONS
Put Options in NCD
A “put” option means that the investor has an option to surrender the debenture if he wants to, and get back the
principal. A put option gives a lot of flexibility to the investor – if interest rates go up, he can get better rates from
the market. He can exercise the put option and get back the money and invest it elsewhere.
Call Option in NCD
A “call” option means that the company has an option to ask the investor to surrender the debenture, and pay
back the principal to the investor. A call option gives flexibility to the company – if interest rates go down, and the
company can get funds at lower rates from the market, it can exercise the call option and give the money back
and can raise money from the market at lower rates.
Example
TATA Capital has issued Non Convertible Debentures in the year 2009 and the rate of interest offered by the
issue was 12% compounded per annum. The company has offered that the NCD holder can exercise put or
call option after completion of 36 months of the issue. As interest rates offered in 2009 was higher than in
March 2012( Option exercising period) the company decided to offer revised interest rates, if not agreed then
investors can exercise put option and exit from the NCDs with principal and accumulated interest (if any) as
on the date.
BONDS
Bonds are the debt security where an issuer is bound to pay a specific rate of interest agreed as per the terms
of payment and repay principal amount at a later time. The bond holders are generally like a creditor where a
company is obliged to pay the amount. The amount is paid on the maturity of the bond period. Generally these
bonds duration would be for 5 to 10 years.
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Capital Market Instruments 263
Characteristics of a Bond
A bond, whether issued by a government or a corporation, has a specific maturity date, which can range from a
few days to 20-30 years or even more. Based on the maturity period, bonds are referred to as bills or short-term
bonds and long-term bonds. Bonds have a fixed face value, which is the amount to be returned to the investor
upon maturity of the bond. During this period, the investors receive a regular payment of interest, semi-annually
or annually, which is calculated as a certain percentage of the face value and know as a 'coupon payment.'
Types of Bond
There are various types of bonds in India:
(1) Government Bonds: These are the bonds issued either directly by Government of India or by the
Public Sector Units (PSU’s) in India. These bonds are secured as they are backed up with security from
Government. These are generally offered with low rate of interest compared to other types of bonds.
(2) Corporate Bonds: These are the bonds issued by the private corporate companies. Indian corporates
issue secured or non secured bonds. E.g. IIFL bonds issue which came up during Sep-2012 was
unsecured bond and Shriram city union bond issue in Sep-2012 was a secured bond issue.
(3) Banks and other financial institutions bonds: These bonds are issued by banks or any financial
institution. The financial market is well regulated and the majority of the bond markets are from this
segment. However care to be taken to consider the credit rating given by Credit Rating Agencies before
investing in these bonds. In case of poor credit rating, better to stay away from such bonds.
(4) Tax saving bonds: In India, the tax saving bonds are issued by the Government of India for providing
benefit to investors in the form of tax savings. Along with getting normal interest, the bond holder would
also get tax benefit.
In India, all these bonds are listed in National Stock Exchange and Bombay Stock Exchange in India, hence they
can be easily liquidated and sold in the open market.
SWEAT EQUITY SHARES
Sweat Equity Shares means equity shares issued by the company to employees or directors at a discount or for
consideration other than cash for providing know how or making available rights in the nature of intellectual
property rights or value additions, by whatever name called. Since these shares are issued at a discount or for
consideration other than cash, the company will generally select those employees and directors as per norms
approved by the Board of Directors, based on the know how provided or intellectual property rights created and
given for value additions made by such directors and employees to the company.
According to section 79A of Companies Act, 1956, a public company may issue sweat equity shares of a class
of shares already issued if the following conditions are fulfilled:
(a) The issue of sweat equity share is authorized by a special resolution passed by the company in the
general meeting.
(b) The resolution specifies the number of shares, current market price, consideration if any and the class
or classes of directors or employees to whom such equity shares are to be issued.
(c) Not less than one year has been elapsed at the date of the issue, since the date on which the company
was entitled to commence business.
(d) The sweat equity shares of a company whose equity shares are listed on a recognised stock exchange
are issued in accordance with the regulations made by SEBI in this regard.
However, in the case of a company whose equity shares are not listed on any recognised stock exchange, the
sweat equity shares are to be issued in accordance with the guidelines as may be prescribed.
264 PP-CC&MM
All the limitations, restrictions and provisions relating to equity shares are also applicable to such sweat equity
shares issued under Section 79A. Apart from this SEBI has issued the SEBI (Issue of Sweat Equity) Regulations,
2002 that is applicable to issue of sweat equity shares by listed companies and MCA has notified Unlisted
Companies( Issue of Sweat Equity) Rules, 2003 for unlisted companies.
WARRANT
Warrant means an option issued by a company whereby the buyer is granted the right to purchase a number of
shares (usually one) of its equity share capital at a given exercise price during a given period.
The holder of a warrant has the right but not the obligation to convert into equity shares. Thus in the true sense,
a warrant signifies optional conversion. In case the investor benefits by capital gains, he will convert the warrants,
else he may simply let the warrant lapse. Thus in such cases, there is no possibility of the investor suffering any
capital losses.
For example if the conversion price of the warrant is ` 70/- and the current market price is `110/-, then the
investor will convert the warrant and enjoy the capital gain of `40/-. In case the conversion is at ` 70/- and the
current market price is `40/-, then the investor will simply let the warrant lapse without conversion.
SHARE WARRANT
A share warrant is a bearer document of title to the specified shares. As per Section 114 and 115 of the Companies
Act, 1956, share warrants can be issued only by public limited companies and that to against fully paid up
shares only. A share warrant cannot be issued by a private company, because the share warrant states that its
bearer is entitled to a number of shares mentioned there in. It is a negotiable document and is easily transferable
by mere delivery to another person. The holder of the share warrant is entitled to receive dividend as decided by
the company.
Position of the Holder of a share warrant
When a share warrant is issued in respect of any shares, the company must strike out from the register of
members the names of the members who held the shares, now comprised in the share warrant and should
enter into the register:
– The fact of the issue of share warrant;
– A statement of the shares included in the warrant , distinguishing each share by its number; and
– The date of issue of the warrant.
Since the name of the shareholder has been removed from the register of members, the company is no more in
a position to know who the shareholder is and who is entitled to dividends. For this reason, a share warrant is
accompanied by attached coupons showing the date for the payment of future dividends.
Conditions for the issue of a share warrant
– Share warrant can be issued by the public limited companies. It cannot be issued by private companies.
– A share warrant is only issued against share certificate of fully paid up shares.
– There must be a provision in the Articles of Association regarding the issue of share warrant. If there is a
provision, the company can issue a share warrant. If there is no provision in the Articles, the company
cannot issue a share warrant.
– Prior permission from the Central Government is necessary for the issue of share warrant.
– Share warrant is not issued originally at the time of initial issue.
Lesson 8
Capital Market Instruments 265
A share warrant is issued at the request of the Shareholders/member and not by the company at its own
initiative.
SECURED PREMIUM NOTES (SPN)
These instruments are issued with detachable warrants and are redeemable after a notified period say 4 to 7
years. The warrants enable the holder to get equity shares allotted provided the secured premium notes are fully
paid. During the lock in period no interest is paid. The holder has an option to sell back the SPN to the company
at par value after the lock in period. If the holder exercises this option, no interest/premium is paid on redemption.
In case the holder keeps it further, he is repaid the principal amount along with the additional interest/premium
on redemption in installments as per the terms of issue. The conversion of detachable warrants into equity has
to be done within the specified time.
Example
TISCO in the year 1992 wanted to raise money for its modernization program without expanding its equity
excessively in the next few years. The company made the issue to the existing shareholders on a rights basis
along with the rights issue. The salient features of the TISCO issue were as follows :
(a) Face value of each SPN was `300.
(b) No interest was payable during the first three years after allotment.
(c) The redemption started at the end of the fourth year of issue.
(d) Each of the SPN of `300 was repaid in four equal amount instalments of `75 which comprised of the
principal, the interest and the relevant premium. (Low interest and high premium or high interest and
low premium, at the option to be exercised by the SPN holder at the end of the third year.
(e) Warrant attached to each SPN entitled the holder the right to apply for or seek allotment of one equity
share for cash payment of `80 per share. Such a right was exercisable between first year and one-anda-half year after allotment by which time the SPN would be fully paid-up.
The instrument tremendously benefited TISCO, as there was no interest outgo. This helped TISCO to meet the
difficulties associated with the cash generation. In addition, the company was able to borrow at a cheap rate of
13.65 per cent as against 17 to 18 per cent offered by most companies. This enabled the company to start
redemption earlier through the generation of cash flow by the company’s projects. The investors had the flexibility
of tax planning while investing in SPNs. The company was also equally benefited as it gave more flexibility.
EQUITY SHARES WITH DETACHABLE WARRANTS
The holder of the warrant is eligible to apply for the specified number of shares on the appointed date at the
predetermined price. These warrants are separately registered with the stock exchanges and traded separately.
The practice of issuing non convertible debentures with detachable warrants also exists in the Indian market.
FOREIGN CURRENCY CONVERTIBLE BONDS (FCCBs)
The FCCBs are unsecured, carry a fixed rate of interest and an option for conversion into a fixed number of
equity shares of the issuer company. Interest and redemption price (if conversion option is not exercised) is
payable in dollars. FCCBs shall be denominated in any freely convertible Foreign Currency. However, it must be
kept in mind that FCCB, issue proceeds need to conform to ECB end use requirements.
Foreign investors also prefer FCCBs because of the Dollar denominated servicing, the conversion option and,
the arbitrage opportunities presented by conversion of the FCCBs into equity shares at a discount on prevailing
Indian market price.
266 PP-CC&MM
In addition, 25% of the FCCB proceeds can be used for general corporate restructuring.
Example
Suppose a company ‘A’ issues bonds with following terms –
Issue Price of the Bond
Coupon rate
Maturity
` 1000
2%
2 years
Convertible into equity shares @ ` 800 per share
Now suppose an investor subscribes to 4 of these bonds. Thus the total investment is ` 4000. On this investment,
he is entitled to get an interest @2% for 2 years. On the maturity date, i.e. after 2 years, the investor will have an
option – to either claim full redemption of the amount from the company or get the bonds converted into fully paid
equity shares @ ` 800 per share. Thus if he goes for the conversion he will be entitled to 5 (4000/800) equity
shares. The choice he makes will depend on the market price of the share on the date of conversion.
If the shares of the company ‘A’ is trading at lower than ` 800, let’s say ` 500, the investor will be better off by
claiming full redemption of his bonds and buying the shares from the market. In this case, he will get 8 (4000/
500) equity shares as against 5 which he was getting on conversion. Similarly if the market price of the share is
higher than ` 800, the investor will benefit by getting its shares converted. Thus, on the day of maturity, an
investor will seek full redemption if the conversion price is higher than the current market price, and will go for
conversion if the conversion price is less than the current market price.
FOREIGN CURRENCY EXCHANGEABLE BONDS (FCEBs)
The FCEB is used to raise funds from the international markets against the security and exchangeability of
shares of another company. Foreign Currency Exchangeable Bond (FCEB) means –
(i) a bond expressed in foreign currency,
(ii) the principal and the interest in respect of which is payable in foreign currency
(iii) issued by an issuing company, being an Indian company
(iv) subscribed by a person resident outside India
(v) Exchangeable into equity shares of another company, being offered company which is an Indian company.
(vi) Either wholly or partly or on the basis of any equity related warrants attached to debt instruments.
It may be noted that issuing company to be the part of promoter group of offered company and the offered
company is to be listed and is to be eligible to receive foreign investment. Under this option, an issuer company
may issue FCEBs in foreign currency, and these FCEBs are convertible into shares of another company (offered
company) that forms part of the same promoter group as the issuer company. E.g., company ABC Ltd. issues
FCEBs, then the FCEBs will be convertible into shares of company XYZ Ltd. that are held by company ABC Ltd.
and where companies ABC Ltd. and XYZ Ltd. form part of the same promoter group. Unlike FCCBs that convert
into shares of issuer itself, FCEBs are exchangeable into shares of Offered Company (OC). Also, relatively,
FCEB has an inherent advantage that it does not result in dilution of shareholding at the OC level.
AMERICAN DEPOSITORY RECEIPTS(ADR) / GLOBAL DEPOSITORY RECEIPTS (GDR)
ADR
An American Depository Receipt (ADR) is a dollar denominated form of equity ownership in the form of
depository receipts in a non-US company. It represents the foreign shares of the company held on deposit by
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Capital Market Instruments 267
a custodian bank in the company’s home country and carries the corporate and economic rights of the foreign
shares.
Advantages of ADRs
– Cost-effective - ADRs are an easy and cost-effective way to buy shares in a foreign company. They
save money by reducing administration costs and avoiding foreign taxes on each transaction.
– Diversification - Investor gains the potential to capitalize on emerging economies by investing in different
countries.
– More US exposure – Foreign entities favour ADRs because they get more US exposure, allowing them
to tap into the wealthy North American equity markets
GDR
GDRs have access usually to Euro market and US market. The US portion of GDRs to be listed on US exchanges
to comply with SEC requirements and the European portion are to be complied with EU directive.
Listing of GDR may take place in international stock exchanges such as London Stock Exchange, New York
Stock Exchange, American Stock Exchange, NASDAQ, Luxemburg Stock Exchange etc.
Advantages to issuing company
– Accessibility to foreign capital markets
– Increase in visibility of the issuing company
– Rise in the capital because of foreign investors
Advantages to investor
– Helps in diversification, hence reducing risk
– More transparency since competitor’s securities can be compared
– Prompt dividend and capital gain payments.
Difference between American Depository Receipts (ADR) and Global Depository Receipts (GDR)
– ADR are US $ denominated and traded in US.
– GDRs are traded in various places such as New York Stock Exchange, London Stock Exchange, etc.
INDIAN DEPOSITORY RECEIPTS (IDRs)
IDRs is an instrument denominated in Indian Rupees in the form of a depository receipt created by a domestic
depository (Custodian of securities registered with SEBI) against the underlying equity of issuing company to
enable foreign companies to raise funds from the Indian securities markets.
In an IDR, foreign companies would issue shares, to a domestic (Indian) depository, which would in turn issue
depository receipts to investors in India. The actual shares underlying the IDRs would be held by an Overseas
Custodian, which shall authorize the Indian depository to issue the IDRs. To that extent, IDRs are derivative
instruments because they derive their value form the underlying shares.
Benefits of IDRs
Issuing Company: Any foreign company listed in its home country and satisfying the eligibility criteria can issue
IDRs. A company which has significant business in India can increase its value through IDRs by breaking down
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market segmentations, reaching trapped pools of liquidity, achieving global benchmark valuation, accessing
international shareholder base and improving its brands presence through global visibility.
Investors: IDRs can lead to better portfolio management and diversification for investors by giving them a
chance to buy into the stocks of reputed companies abroad.
DERIVATIVE
A derivative is a financial instrument that derives its value from an underlying asset. This underlying asset can
be stocks, bonds, currency, commodities, metals and even intangible, assets like stock indices. Derivatives can
be of different types like futures, options, swaps, caps, floor, collars etc. The most popular derivative instruments
are futures and options.
FUTURES
A futures contract is an exchange traded forward contract to buy or sell a predetermined quantity of an asset on
a predetermined future date at a predetermined price. Contracts are standardized and there’s centralized trading
ensuring liquidity.
There are two positions that one can take in a future contract:
– Long Position- This is when a futures contact is purchased and the buyer agrees to receive delivery of
the underlying asset. (Stock/Indices/Commodities).
– Short Position- This is when a futures contract is sold and the seller agrees to make delivery of the
underlying asset. (stock/Indices/Commodities)
OPTIONS
Options Contract give its holder the right, but not the obligation, take or make delivery on or before a specified
date at a stated price. But this option is given to only one party in the transaction while the other party has an
obligation to take or make delivery. Since the other party has an obligation and a risk associated with making the
good the obligation, he receives a payment for that. This payment is called as option premium.
Option contracts are classified into two types on the basis of which party has the option:
– Call option- A call option is with the buyer and gives the holder a right to take delivery.
– Put option- The put option is with the seller and the option gives the right to take delivery.
Option Contracts are classified into two types on the basis of time at which the option can be exercised:– European Option- European style options are those contacts where the option can be exercised only on
the expiration date.
– American Option- American style options are those contacts where the option can be exercised on or
before the expiration date.
Example
Case 1
Rajesh purchases 1 lot of Infosys Technologies MAY 3000 Put and pays a premium of ` 250. This contract
allows Rajesh to sell 100 shares of Infosys at ` 3000 per share at any time between the current date and the end
of May. In order to avail this privilege, all Rajesh has to do is pay a premium of ` 25,000 (` 250 a share for 100
shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.
Lesson 8
Capital Market Instruments 269
Case 2
If an investor is of the opinion that a particular stock say "Ray Technologies" is currently overpriced in the month
of February and hence expect that there will be price corrections in the future. However he doesn't want to take
a chance, just in case the prices rise. So the best option for the investor would be to take a Put option on the
stock.
Lets assume the quotes for the stock are as under:
Spot
` 1040
May Put at 1050
` 10
May Put at 1070
` 30
So the inevstor purchases 1000 "Ray Technologies" Put at strike price of `1070 and Put price of ` 30/-. The
investor pay ` 30,000 as Put premium.
The position of investor in two different scenarios have been discussed below:
1. May Spot price of Ray Technologies = `1020
2. May Spot price of Ray Technologies = `1080
In the first situation you have the right to sell 1000 "Ray Technologies" shares at ` 1,070/- the price of which is
` 1020/-. By exercising the option the investor earn ` (1070-1020) = ` 50 per Put, which amounts to ` 50,000/.
The net income in this case is ` (50000-30000) = ` 20,000.
In the second price situation, the price is more in the spot market, so the investor will not sell at a lower price by
exercising the Put. He will have to allow the Put option to expire unexercised. In the process the investor only
lose the premium paid which is ` 30,000.
INDEX FUTURES & OPTIONS
An Index Future is a future contract with the index as the underlying asset. There is no underlying security or a
stock, which is to be delivered to fulfill the obligations as index futures are cash settled. They can be used for
hedging against an existing equity position, or speculating on future movements of the index. E.g., futures
contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying
index.
Index Option is an option contract where the option holder has the call or put option on the index. However,
unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the
underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised
/ assigned only on the expiry date.
An index, in turn derives its value from the prices of securities that constitute the index and is created to represent
the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the
whole market are broad based indices and those that represent a particular sector are sectoral indices. In the
beginning futures and options were permitted only on S&P Nifty and BSE Sensex. Subsequently, sectoral indices
were also permitted for derivatives trading subject to fulfilling the eligibility criteria. Derivative contracts may be
permitted on an index if 80% of the index constituents are individually eligible for derivatives trading. However,
no single ineligible stock in the index shall have a weightage of more than 5% in the index. The index is required
to fulfill the eligibility criteria even after derivatives trading on the index have begun. If the index does not fulfill
the criteria for 3 consecutive months, then derivative contracts on such index would be discontinued. By its very
nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these
contracts are essentially cash settled on Expiry.
270 PP-CC&MM
CURRENCY FUTURES
A currency futures contract is a standardized forward contract that is traded on an exchange. It is an agreement
to buy or sell a particular currency in the future at a specified rate and at a specified date. E.g., buying one lot of
December, 200X, USD/INR at 49.50 on 17th November, 200X, means the buyer has agreed to buy USD 1,000
at the rate of INR 49.50 per USD on 29th December, 200X, assuming 29th December, 200X, is the maturity date
for December 200X USD/INR Futures.
A country's currency exchange rate is typically affected by the supply and demand for the country's currency in
the international foreign exchange market. The demand and supply dynamics is principally influenced by factors
like interest rates, inflation, trade balance, and the state of economic and political affairs in the country. The level
of confidence in the economy of a particular country also influences the currency of that country. Currency
futures are standardized depending on what is being traded, the quantity, delivery time and delivery location for
each specific commodity. They consist of secondary markets and can also be dealt numerous times much like
a bond and opposed to a bank loan.
INTEREST RATE FUTURES (IRFs)
On August, 2009, RBI issued directions for trading of Interest Rate futures on Currency Derivative segment of a
Recognized Stock Exchange. The term “Interest Rate Futures” has been defined in the Regulation as:Interest Rate Futures means a standardized interest rate derivative contract traded on a recognized stock
exchange to buy or sell a notional security or any other interest bearing instrument or an index of such instruments
or interest rate at a specified future date, at a price determined at the time of the contract.
Products that can be traded in the market are futures on long bond (10 year notional G-Secs) and T- bills (91
days notional) and any other product which is approved by RBI.
Interest rate futures on 91-day treasury bill are interest rate-driven derivative products that help banks, mutual
funds and primary dealers to hedge their interest rate exposure on treasury bills. Financial institutions can lock
in the interest rate or the yield on the 91-day treasury at a given date when counter parties enter into the interest
rate futures contract.
The 91-day T-bill interest rate futures are cash settled. In case of the 91-day treasury bill, the final settlement
price of the futures contract is based on the weighted average price/ yield obtained in the weekly auction of the
91-day treasury bills on the date of expiry of the contract. But in case of interest rate futures on the 10-year
benchmark government security, the contract is physically settled.
STOCK FUTURES AND STOCK OPTIONS
Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is
an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed
upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day,
unit of price quotation, tick size and method of settlement.
In stock options, the option buyer has the right and not the obligation, to buy or sell the underlying share. In
case of stock futures, both the buyer and seller are obliged to buy/sell the underlying share. Risk-return
profile is symmetric in case of single stock futures whereas in case of stock options payoff is asymmetric.
Also, the price of stock futures is affected mainly by the prices of the underlying stock whereas in case
of stock options, volatility of the underlying stock affects the price along with the prices of the underlying
stock.
Pricing of Stock Futures
The theoretical price of a future contract is sum of the current spot price and cost of carry. However, the actual
Lesson 8
Capital Market Instruments 271
price of futures contract very much depends upon the demand and supply of the underlying stock. Generally, the
futures prices are higher than the spot prices of the underlying stocks.
Futures Price = Spot Price + Cost of Carry
Cost of carry is the interest cost of a similar position in cash market and carried to maturity of the futures contract
less any dividend expected till the expiry of the contract.
Example
Spot Price of Infosys = 1600, Interest Rate = 7% p.a. Futures Price of 1 month contract=1600 + 1600*0.07*30/
365 = 1600 + 11.51 = 1611.51
EXCHANGE TRADED FUNDS (ETFs)
Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a
sectoral fund but trades like a stock on an exchange. It is similar to a close-ended mutual fund listed on stock
exchanges. ETF's experience price changes throughout the day as they are bought and sold.
There are different types of ETFs:
(i) Equity ETFs – Equity ETF is a basket of stocks that reflects the composition of an Index, like S and P
CNX Nifty or S&P BSE SENSEX. The ETFs trading value is based on the net asset value of the underlying
stocks that it represents. Think of it as a Mutual Fund that one can buy and sell in real-time at a price that
change throughout the day.
(ii) Gold ETFs – Gold ETFs are units representing physical gold which may be in paper or dematerialized
form. These units are traded on the exchange like a single stock of any company.
(iii) Liquid ETFs – Liquid ETFS are funds whose unit price is derived from money market securities comprising
of government bonds, treasury bonds, call money market etc. The funds seek to deliver reasonable
market related returns with lower risk and higher liquidity through portfolio of debt and money market
instruments.
LESSON ROUND UP
– Financial instruments that are used for raising capital resources in the capital market are known as
Capital Market Instruments.
– Equity shares have the right to share the profits of the company in the form of dividend (cash) and bonus
shares.
– Where the voting rights on new shares are different from the voting rights on the equity shares already
issued, the new shares are known as Differential Voting Rights Shares (DVRS).
– Sec. 85(1) of the Companies Act, 1956, defines preference shares as those shares which carry preferential
rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of
the company.
– Debenture includes debenture stock, bonds and any other securities of a company, whether constituting
a charge on the assets of the company or not.
– A share warrant is a bearer document of title to the specified shares. It is a negotiable document and is
easily transferable by mere delivery to another person. The holder of the share warrant is entitled to
receive dividend as decided by the company.
272 PP-CC&MM
– Sweat Equity Share is an instrument permitted to be issued by specified Indian companies, under
Section 79A of Companies Act, 1956.
– Derivatives are contracts which derive their values from the value of one or more of other assets (known
as underlying assets).
– An Index Future is a future contract with the index as the underlying asset. There is no underlying
security or a stock, which is to be delivered to fulfill the obligations as index futures are cash settled.
– Index Option is an option contract where the option holder has the call or put option on the index.
– Interest Rate Futures means a standardized interest rate derivative contract traded on a recognized
stock exchange to buy or sell a notional security or any other interest bearing instrument or an index of
such instruments or interest rate at a specified future date, at a price determined at the time of the
contract.
– Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or
a sectoral fund but trades like a stock on an exchange.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a warrant? Briefly discuss.
2. Briefly explain about equity shares with detachable warrants.
3. Explain Non convertible Debentures with call and put option.
4. What is an Option contract? Explain it with the help of an example.
5. What do you understand by Exchange Traded Funds? Briefly discuss the various types of ETFs traded
on the Stock Exchanges.
Lesson 9
Resource Mobilization Through International Markets 273
Lesson 9
Resource Mobilization Through
International Markets
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Increased globalization and investor appetite for
– American Depository Receipts (ADRs)
diversification, offer a unique opportunity to
– Types of ADRs
companies looking to tap a new investor base to
– Global Depository Receipts (GDRs)
raise capital. Indian companies are allowed to
– Advantage of ADRs and GDRs
raise equity capital in the international market
– Process involved in Issue of ADR/GDR
through the issue of GDR/ADR in accordance
– Sponsored ADR/GDR Issue
with the Scheme for issue of Foreign Currency
– Two-way Fungibility Scheme
– Issuance of Shares under ADR/GDR
Convertible Bonds (FCCBs) and Ordinary Shares
– Statutory Approvals Required for issue of
GDR/ADR
(Through Depository Receipt Mechanism)
Scheme, 1993 and guidelines issued by the
– Agencies involved in ADR/GDR issue
Central Government there under from time to
– Agreements and related Documents
time.
– Procedural Requirements
The objective of this lesson is to give a complete
– Procedure for issue of ADR/GDR
overview of the advantages, structure, issuance
– Reporting of ADR/GDR issue
and fungibility of ADR/GDR, choice of stock
– Foreign Currency Convertible Bonds and
Ordinary Shares (Through Depository
Receipt Mechanism) Scheme, 1993
exchanges for cross-listing of companies,
criteria for Listing on NASDAQ, London stock
Exchange, New York Stock Exchange.
– Listing of GDR
– London Stock Exchange
– Listing on Main Market
– Listing on Professional Security Market
– Listing on AIM
– Luxembourg Stock Exchange
– Listing of ADR
– NASDAQ
– The NASDAQ Global Select Market
– The NASDAQ Capital Market
– The NASDAQ Global Market
– NewYork Stock Exchange (NYSE)
– LESSON ROUND UP
– SELF TEST QUESTIONS
273
274 PP-CC&MM
INTRODUCTION
Companies either raise funds from the domestic market or through international market. For international funding,
the most popular source amongst the Indian companies in the recent times has been American Depository
Receipts (ADR) and Global Depository Receipts (GDR).
AMERICAN DEPOSITORY RECEIPT
An American Depository Receipt (ADR) is a negotiable security representing ownership in some underlying
shares of a non-US company, which can be traded on US stock exchanges. ADRs are denominated in US
dollars and function on the lines of the shares of a US company in terms of trading and dividend payment.
Example I
The following example would clear the mechanism of the working of an ADR and the parties involved.
1. Suppose there is a broker, say Mr. X. He buys the shares of a company, say Reliance Industries Ltd. (RIL)
from the Bombay Stock Exchange.
2. He then goes to his custodian bank, say ICICI, to hold the shares for the issuance of ADRs.
3. He then goes to another bank, called the Depository bank, say JP Morgan and asks them to issue ADRs on
the basis of shares in the custody of ICICI.
Note: In case of sponsored ADRs, the company (RIL in this case) can itself have a designated depository
for issuance of ADRs, bypassing the custodian.
4. JP Morgan then confirms the shares held by ICICI and issues ADRs to Mr. X.
5. An ADR issued can represent a fraction of a share (say 1 ADR=1/2 a share of RIL), 1 single share or multiple
shares (say 10 shares of RIL make 1 ADR).
6. These ADRs then can be traded on the US stock exchanges in a way similar to the trading of stocks of US
companies.
The diagram below will make the working of an ADR clear :
ICICI Bank
(Custodian)
Confirmation
Requested
Confirmation
Given
US Stock
(Markets)
J P Morgan
(Depository Bank)
Get the
ADRs
Requests for
ADRs on the
basis of shares
deposited
with ICICI
Deposits RIL Shares brought
from BSE
Mr. X
(Broker)
ADRs traded on
US stock markets
Buys RIL Shares
Bombay Stock
Exchange
Lesson 9
Resource Mobilization Through International Markets 275
Example II
Let us take Infosys example – trades on the Indian stock market at around ` 2000/– This is equivalent to US$ 40 – assume for simplicity
– Now a US bank purchases 10000 shares of Infosys and issues them in US in the ratio of 10:1
– This means each ADR purchased is worth 10 Infosys shares.
– Quick calculation means 1 ADR = US $400
– Once ADR are priced and sold, its subsequent price is determined by supply and demand factors, like
any ordinary shares.
ADR RATIO
– Single: 1 ADR = 1 SHARE
ADR Ratio = 1:1
– Multiple : 1 ADR = 5 SHARES
ADR Ratio = 1:5
– Fraction : 1 ADR = ½ SHARE
ADR Ratio = 2:1
Types of ADRs
ADRs can be classified into two broad categories:
Unsponsored ADRs: In such ADRs, the company has got no agreement with the custodian or depository bank
for the issuance of ADRs. These are traded on the over-the-counter (OTC) market and are issued according to
the market demand forces. Unsponsored ADRs can be issued by a number of depository banks. Each depository
services only the ADRs issued by it.
Sponsored ADRs: These are the ADRs which are sponsored by the company itself. In this case, the foreign
company itself wants to issue ADRs and it does so by designating a depository bank that will issue ADRs in the
foreign market on its behalf. It is of the following types:
(a) Level 1 Sponsored ADRs: These are the lowest level of sponsored ADRs. These are traded only on the
OTC market. The company is supposed to adhere to minimal US Securities and Exchange Commission
(SEC) requirements and is not required to publish reports in accordance to US GAAP standards.
(b) Level 2 Sponsored ADRs: In level 2 ADRs, the ADRs are listed on a recognized US stock exchange
and can be traded thereafter. The stock exchanges in which these ADRS can be traded are New York
Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). In such ADRs, the
company is supposed to adhere to higher level of SEC regulations and is also required to publish
annual reports in accordance with US GAAP or IFRS (International Financial reporting Standards).
(c) Level 3 Sponsored ADRs: These are the highest level of sponsored ADRs. As such, it requires adherence
to stringent rules and regulations similar to the US companies. In this type of ADRs, the company rather
than letting its shares from the home market to be deposited in for the ADR program, actually issues
fresh shares in the form ADRs to raise capital from the US market.
GLOBAL DEPOSITORY RECEIPTS
Global Depository Receipts (GDRs) came into existence long after the American Depository Receipts and function
276 PP-CC&MM
on the same lines. GDRs were first issued by Citibank in 1990. Samsung Corporation, a Korean trading company,
wanted to raise equity capital in the United States through a private placement, but also had a strong European
investor base that it wanted to include in the offering. The GDR issue allowed Samsung to raise capital in the
US and Europe through one security issued simultaneously into both markets.
The mechanism of the operations of Global Depository Receipts is similar to that of the ADRs, the modulation
being they can be traded anywhere in the world (or most of the stock exchanges in the world for that matter).
GDRs are usually listed in the Luxembourg Stock Exchange and in the London Stock Exchange. They are
usually traded on the International Order Book (IOB) which is normally 1 GDR = 10 Shares.
Since one type of security can be issued anywhere in the world, GDRs are inherently very flexible. Like ADRs,
GDRs can be unsponsored and sponsored. Sponsored GDRs, again like ADRs, are of the three types mentioned
previously with similar features.
Difference between American Depository Receipts (ADR) and Global Depository Receipts (GDR)
ADR are US $ denominated and traded in US.
GDRs are traded in various places such as Luxembourg Stock Exchange, London Stock Exchange, etc.
ADVANTAGE OF ADRS AND GDRS
To the Investors
– Easy to purchase and hold.
– Investor doesn’t need to go through the hassles of govt. regulations and currency conversion to buy
stocks of foreign companies.
– Trades and settles in the same manner as any other security available in the investor’s home country’s
stock markets.
– Facilitates portfolio diversification by inclusion of foreign stocks.
– Better comparison between stocks of various companies.
– Since GDRs are denominated in the investors home currency (like ADR in US Dollars), they tend to
reduce foreign exchange risks.
To the Issuers
– Broadens investor base.
– Increases global presence.
– More avenues to raise funds.
– Price parity with global competitors.
– Facilitates mergers and acquisitions.
Point to Remember
An Indian corporate can raise foreign currency resources abroad through the issue of GDR/ADR. Regulation
4 of Schedule I of FEMA Notification no. 20 issued by RBI, allows an Indian company to issue its Rupee
denominated shares to a person resident outside India being a depository for the purpose of issuing ADRs/
GDRs.
Lesson 9
Resource Mobilization Through International Markets 277
Process involved in Issue of ADR/GDR
ADR/GDR
It is basically a receipt against
the security
Issued by
Indian Company also deliver the
share certificate to the domestic
custodian bank
Indian Company
To
Instructed
Non-resident Investor
Bank/depository outside India to
issue receipt to
Non-resident Investor
The shares are traded on various
Foreign Stock Exchange(s)
ADR
GDR
If the depository
receipt are traded in
USA, it is called an
ADR
If the depository receipt
is traded in a country
other than USA, it is
called an GDR
SPONSORED ADR/GDR ISSUE
An Indian company can also sponsor an issue of ADR / GDR. Under this mechanism, the company offers its
resident shareholders a choice to submit their shares back to the company so that on the basis of such shares,
ADRs / GDRs can be issued abroad. The proceeds of the ADR / GDR issue are remitted back to India and
distributed among the resident investors who had offered their Rupee denominated shares for conversion.
These proceeds can be kept in Resident Foreign Currency (Domestic) accounts in India by the resident
shareholders who have tendered such shares for conversion into ADRs / GDRs.
278 PP-CC&MM
TWO-WAY FUNGIBILITY SCHEME
A limited two-way Fungibility scheme has been put in place by the Government of India for ADRs / GDRs. Under
this Scheme, a stock broker in India, registered with SEBI, can purchase shares of an Indian company from the
market for conversion into ADRs/GDRs based on instructions received from overseas investors. Re-issuance of
ADRs / GDRs would be permitted to the extent of ADRs / GDRs which have been redeemed into underlying
shares and sold in the Indian market.
TERM ONE SHOULD KNOW
One way fungibility – Here investors could cancel their depository receipt and recover the proceeds by
selling the underlying shares in the Indian market; DRs once redeemed could not be converted into shares.
Two way fungibility – It means that the shares so released can be reconverted by the company into DRs
for purchase by the overseas investors. It implies that the re-issuance of DRs would be permitted to the
extent of DRs that have been redeemed and underlying shares are sold in domestic market.
Sponsor – It is a process of disinvestment by the Indian shareholders of their holding in overseas market.
ISSUANCE OF SHARES UNDER ADR/GDR
(i) Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in
accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of
India thereunder from time to time.
(ii) A company can issue ADRs / GDRs, if it is eligible to issue shares to person resident outside India under
the FDI Scheme. However, an Indian listed company, which is not eligible to raise funds from the Indian
Capital Market including a company which has been restrained from accessing the securities market by
SEBI will not be eligible to issue ADRs/GDRs.
(iii) Unlisted companies, which have not yet accessed the ADR/GDR route for raising capital in the
international market, would require prior or simultaneous listing in the domestic market, while seeking to
issue such overseas instruments. Unlisted companies, which have already issued ADRs/GDRs in the
international market, have to list in the domestic market on making profit or within three years of such
issue of ADRs/GDRs, whichever is earlier.
(iv) After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated in the RBI
Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from time to time. The company is
also required to file a quarterly return in Form DR- Quarterly as indicated in the RBI Notification ibid.
(v) There are no end-use restrictions except for a ban on deployment / investment of such funds in real
estate or the stock market.
(vi) Erstwhile Overseas Corporate Bodies (OCBs) which are not eligible to invest in India and entities
prohibited to buy / sell or deal in securities by SEBI will not be eligible to subscribe to ADRs / GDRs
issued by Indian companies.
(vii) The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at a price determined
under the provisions of the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary
Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the
Government of India and directions issued by the Reserve Bank, from time to time.
(NOTE: There is no monetary limit up to which an Indian company can raise ADRs / GDRs.)
Resource Mobilization Through International Markets 279
Lesson 9
This can be understood with the help of the following diagram:
ADR/GDR
Listed Company
Unlisted Company
Indian companies can
raise foreign currency
through ADR/GDR in
accordance with the
guidelines issued by the
Government and through
deposited receipt
mechanism scheme
However
Those companies which
have not issued ADR/
GDR yet
An Indian Company which is not
eligible to raise funds from the Indian
Capital Market will not be eligible to
raise ADR/GDR
Those companies which
have already issued ADR/
GDR
Would require prior or
simultaneous listing in the
domestic market
Have to list in the domestic
market on making profit or
within 3 year of such issue of
ADR/GDR whichever is earlier
ADR/GDR are issued on the basis of ratio worked out by the
Indian Company through lead manager to the issue
The pricing of ADR/GDR would be determined
As per scheme of issue of FCCB
and ordinary shares scheme
(Through Depository Receipt
Mechanism) Scheme, 1993
Guideline issed by Government
of India & RBI
Statutory Approvals Required for issue of GDR/ADR
(i) Approval of the Foreign Investment Promotion Board (FIPB)
Under the Foreign Exchange Management (Transfer or issue of security by a person resident outside India)
Regulations, 2000, a person resident outside India may purchase shares of an Indian company under the
foreign direct investment scheme, subject to the terms and conditions specified in Schedule I of the Regulations.
Schedule I provides that an issuer company which is engaged or proposes to engage in any activity specified in
this regard or beyond the specified sectoral cap, shall only issue shares to a person resident outside India,
provided it has secured prior approval of Secretariat for Industrial Assistance (“SIA”) or, as the case may be of
FIPB of the Government of India and the terms and conditions of such an approval are complied with.
280 PP-CC&MM
(ii) Approval of Reserve Bank of India
The issuer company has to obtain approvals from Reserve Bank of India under circumstances specified under
the guidelines issued by the concerned authorities from time to time. The issuing company is required to furnish
a statement to the Exchange Control Department of RBI, Central Office, Mumbai, within thirty (30) days from the
date of closing, stating details of the issue such as number of GDRs issued, number of underlying fresh shares
issued, capital structure before and after the issue, etc.
(iii) In-principle consent of Stock Exchanges for listing of underlying shares
In principal approval from the Stock Exchanges in India where the shares of the Company are listed, is required
prior to listing on the Overseas Exchange. The issuing company has to make a request to the domestic stock
exchange for in-principle consent for listing of underlying shares which shall be lying in the custody of domestic
custodian. These shares, when released by the custodian after cancellation of GDR, are traded on Indian stock
exchanges like any other equity shares.
(iv) Filings with SEBI
Issue of shares requires the filing of an Offering Circular with SEBI for its information and records.
(v) In-principle consent of Financial Institutions
Prior to the launch of its issue the company must obtain in-principle consent on the broad terms of the proposed
issue. Where term loans have been obtained by the company from the financial institutions, the agreement
relating to the loan contains a stipulation that the consent of the financial institution has to be obtained.
Agencies involved in ADR/GDR issue
The following agencies are normally involved in the issue of ADR/GDR:
(i) Lead Manager (ii) Co-Lead/Co-Manager (iii) Overseas Depository Bank (iv) Domestic Custodian Banks (v)
Listing Agent (vi) Legal Advisors (vii) Printers (viii) Auditors (ix) Underwriter(x) Escrow Agent
(i) Lead Manager
The company has to choose a competent lead manager to structure the issue and arrange for the marketing. Lead
managers usually charge a fee as a percent of the issue. The issues related to public or private placement, nature
of investment, coupon rate on bonds and conversion price are to be decided in consultation with the lead manager.
(ii) Co-Lead/Co-Manager
In consultation with the lead manager, the company has to appoint co-lead/co-manager to coordinate with the
issuing company/lead manager to make the smooth launching of the issue.
(iii) Overseas Depository Bank
It is the bank which is authorised by the issuing company to issue Depository Receipts against issue of ordinary
shares of issuing company.
(iv) Domestic Custodian Bank
This is a banking company which acts as custodian for the ordinary shares of an Indian company, which are
issued by it. The domestic custodian bank functions in co-ordination with the depository bank. When the shares
are issued by a company the same are registered in the name of depository and physical possession is handed
over to the custodian. The beneficial interest in respect of such shares, however, rests with the investors.
(v) Listing Agent
The appointment of listing agent is necessary to co-ordinate with issuing company for listing the securities on
Overseas Stock Exchanges.
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Resource Mobilization Through International Markets 281
(vi) Legal Advisors
The issuing company should appoint legal advisors who will guide the company and the lead manager to
prepare offer document, depository agreement, indemnity agreement and subscription agreement.
(a) Indian Legal advisors – It is a firm that undertakes the Legal and Financial Due Diligence of the Issuing
Companies on behalf of the Lead Manager. It also assists the Company in preparation of the Information
Memorandum/ offer document for submitting it with the Overseas Stock Exchange.
(b) Overseas Legal Advisor – An overseas legal person who on the basis of the Due Diligence Report of the
Indian Counsel submits its report to the Overseas Stock Exchange. They also assist the Lead Manager
in preparation of the various documents such as the Deposit Agreement, Subscription Agreement and
vet the Information Memorandum (IM).
(vii) Printers
The issuing company should appoint printers of international repute for printing Offer Circular.
(viii) Auditors
The role of issuer company’s auditors is to prepare the auditors report for inclusion in the offer document,
provide requisite comfort letters and reconciliation of the issuer company’s accounts between Indian GAAP/UK
GAAP/US-GAAP and significant differences between Indian GAAP/UK GAAP/US GAAP.
(ix) Underwriters
It is desirable to get the issue underwritten by banks and syndicates. Usually, the underwriters subscribe for a
portion of the issue with arrangements for tie-up for the balance with their clients. In addition, they will interact
with the influential investors and assist the lead manager to complete the issue successfully.
(x) Escrow Agent
An Overseas Bank where an Escrow Account has to be opened for deposit of the monies received from Investors
against the ADR/ Issue till the Final Listing Approval is obtained from the Overseas Stock Exchange.
Agreements and related Documents
The following principal documents are involved: (i) Subscription Agreement (ii) Depository Agreement (iii)
Custodian Agreement (iv) Escrow Agreement (v) Offering Circular.
(i) Subscription Agreement
Subscription Agreement provides that Lead Managers and other managers agree, severally and not jointly, with
the company, subject to the satisfaction of certain conditions, to subscribe for GDRs at the offering price set
forth. It may provide that obligations of managers are subject to certain conditions precedent.
Subscription agreement may also provide that for certain period from the date of the issuance of GDR the
issuing company will not (a) authorise the issuance of, or otherwise issue or publicly announce any intention to
issue; (b) issue offer, accept subscription for, sell, contract to sell or otherwise dispose off, whether within or
outside India; or (c) deposit into any depository receipt facility, any securities of the company of the same class
as the GDRs or the shares or any securities in the company convertible or exchangeable for securities in the
company of the same class as the GDRs or the shares or other instruments representing interests in securities
in the company of the same class as the GDRs or the shares.
Subscription agreement also provides, an option to be exercisable within certain period after the date of offer
circular, to the lead manager and other managers to purchase upto a certain prescribed number of additional
GDRs solely to cover over-allotments, if any.
282 PP-CC&MM
(ii) Depository Agreement
Depository agreement lays down the detailed arrangements entered into by the company with the Depository,
the forms and terms of the depository receipts which are represented by the deposited shares. It also sets forth
the rights and duties of the depository in respect of the deposited shares and all other securities, cash and other
property received subsequently in respect of such deposited shares. Holders of GDRs are not parties to deposit
agreement and thus have no contractual rights against or obligations to the company. The depository is under
no duty to enforce any of the provisions of the deposit agreement on behalf of any holder or any other person.
Holder means the person or persons registered in the books of the depository maintained for such purpose as
holders. They are deemed to have notice of, be bound by and hold their rights subject to all of the provisions of
the deposit agreement applicable to them. They may be required to file from time to time with depository or its
nominee proof of citizenship, residence, exchange control approval, payment of all applicable taxes or other
governmental charges, compliance with all applicable laws and regulations and terms of deposit agreement, or
legal or beneficial ownership and nature of such interest and such other information as the depository may
deem necessary or proper to enable it to perform its obligations under Deposit Agreement.
The company may agree in the deposit agreement to indemnify the depository, the custodian and certain of their
respective affiliates against any loss, liability, tax or expense of any kind which may arise out of or in connection
with any offer, issuance, sale, resale, transfer, deposit or withdrawal of GDRs, or any offering document.
Copies of deposit agreement are to be kept at the principal office of Depository and the Depository is required to
make available for inspection during its normal business hours, the copies of deposit agreement and any notices,
reports or communications received from the company.
(iii) Custodian Agreement
Custodian works in co-ordination with the depository and has to observe all obligations imposed on it including
those mentioned in the depository agreement. The custodian is responsible solely to the depository. In the case
of the depository and the custodian being same legal entity, references to them separately in the depository
agreement or otherwise may be made for convenience and the legal entity will be responsible for discharging
both functions directly to the holders and the company.
Whenever the depository in its discretion determines that it is in the best interests of the holders to do so, it may,
after prior consultation with the company terminate, the appointment of the custodian and in such an event the
depository shall promptly appoint a successor custodian, which shall, upon acceptance of such appointment,
become the custodian under the depository agreement. The depository shall notify holders of such change
promptly. Any successor custodian so appointed shall agree to observe all the obligations imposed on him.
(iv) Escrow Agreement
An escrow agreement includes information such as specifying the appointed escrow agent, and specific sections
for each of the following: descriptions of any definitions pertinent to the agreement, the escrow fund and release
of funds, and the acceptable use of funds by the escrow agent, the duties and liabilities of the escrow agent, the
escrow agent's fees and expenses, and the jurisdiction and venue in the event of a legal action etc .
(v) Offering Circular
Offering Circular is a mirror through which the prospective investors can access vital information regarding the
company in order to form their investment strategies.
It is to be prepared very carefully giving true and complete information regarding the financial strength of the
company, its past performance, past and envisaged research and business promotion activities, track record of
promoters and the company, ability to trade the securities on Euro capital market.
The Offering Circular should be very comprehensive to take care of overall interests of the prospective investor.
The Offering Circular for Euro-issue offering should typically cover the following contents:
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Resource Mobilization Through International Markets 283
(i) Background of the company and its promoters including date of incorporation and objects, past
performance, production, sales and distribution network, future plans, etc.
(ii) Capital structure of the company-existing, proposed and consolidated.
(iii) Deployment of issue proceeds.
(iv) Financial data indicating track record of consistent profitability of the company.
(v) Group investments and their performance including subsidiaries, joint venture in India and abroad.
(vi) Investment considerations.
(vii) Description of shares.
(viii) Terms and conditions of Global Depository Receipt and any other instrument issued along with it.
(ix) Economic and Regulatory policies of the Government of India.
(x) Details of Indian Securities Market indicating stock exchange, listing requirements, foreign investments
in Indian securities.
(xi) Market price of securities.
(xii) Dividend and capitalisation.
(xiii) Securities regulations and exchange control
(xiv) Tax aspects indicating analysis of tax consequences under Indian law of acquisition, membership and
sale of shares, treatment of capital gains tax, etc.
(xv) Status of approvals required to be obtained from Government of India.
(xvi) Summary of significant differences in Indian GAAP, UK GAAP and US GAAP and expert’s opinion.
(xvii) Report of statutory auditor.
(xviii) Subscription and sale.
(xix) Transfer restrictions in respect of instruments.
(xx) Legal matters etc.
(xxi) Other general information not forming part of any of the above.
A copy of the Offering Circular is required to be sent to the Registrar of Companies, the SEBI and the Indian
Stock Exchanges for record purposes.
PROCEDURAL REQUIREMENTS
The procedural requirements for issue of GDRs/ADRs are briefly set out here below:
(i) Preliminary Meetings
The Issuer generally holds preliminary discussions and meets with different global merchant/ investment bankers
(who would act as the Lead Manager, Co- Managers, Underwriters), Legal Advisors (Indian and Foreign), Auditors,
and other intermediaries before deciding to float a GDR/ADR Issue.
(ii) Authorization by the Board of Directors
– The Issuer is required to pass a Board Resolution approving the proposed GDR/ADR issue.
– The Issuer's Board should also approve the notice calling for a General Meeting of the shareholders for
the purpose.
284 PP-CC&MM
– It is advisable to constitute a Committee of Directors and confer on it necessary powers for approving
various matters/ documents connected with the Euro issue, once the Board of Directors (the “Board”) of
the Issuer has decided to float GDRs/ADRs in the global market. The following matters /documents
could then be approved by the Committee of Directors, namely:
(a) Offering Circular
(b) Escrow Agreement to be executed by the Escrow Agent
(c) Agreement to be executed by the Lead Manager and the Issuer
(d) Deposit Agreement to be executed by the Depository
(e) Allotment of shares in favour of the Depository
(f) Opening of bank account outside India and operation of the said account
(g) Making/filing the necessary applications of the Securities and Exchange Commission, U.S., and /or
making applications to Luxembourg Stock Exchange or other exchanges
(h) Signing and executing any deed, document, writing, confirmation, undertaking, indemnity in favour
of any party including, Lead Manager, Co- Managers, Underwriters, Legal Advisors, Accountants
and others who may be related to the issue.
– As per the listing agreement of the stock exchanges, the Issuer should notify the stock exchange, the
date of the Board Meeting at which the proposal will be considered and also inform it of the decision of
the Board of Directors.
(iii) Organizational Meetings
The Issuer formally appoints the Lead Manager, Co- Managers, Underwriters to market the issue and organize
the road shows, printers, Legal Advisors (Indian and Foreign), Depository (to issue GDRs/ADRs to the Underwriters
to arrange to place them with the ultimate investors), the Custodian (who physically holds the shares of the
Issuer on behalf of the Depository) and the overseas bankers.
The Issuer gives the necessary details about the Issue to the Lead Manager, Co- Managers and other
intermediaries. It also provides the relevant clarifications to the Indian and foreign Legal Advisors relating to
legal matters of the company and the issue. The Issuer will, along with the Lead Manager to the issue decide the
following issues, namely:
1. Public private placement
2. The number of GDRs/ADRs to be issued
3. The issue price
(iv) Authorization by shareholders
– The shareholders must approve the proposed foreign issues of GDR/ADRs by a special resolution passed
at the general meeting according to the provisions of section 81 (1A) of the Companies Act.
– Approvals should be also taken from the Issuer's shareholders with regard to Section 94 (increase in
authorized share capital), Section 16 (alteration of Capital Clause of the Memorandum of Association for
change in authorised share capital) and Section 31 (alteration of Share capital Clause in Articles of Association)
of the Companies Act, 1956, if required.
ROADSHOWS
Roadshows represent meetings of issuers, analysts and potential investors. Details about the company are
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Resource Mobilization Through International Markets 285
presented in the roadshows and such details usually include the following information about the company making
the issue:
– History
– Organisational structure
– Principal objects
– Business lines
– Position of the company in Indian and international market
– Past performance of the company
– Future plans of the company
– Competition - domestic as well as foreign
– Financial results and operating performance
– Valuation of shares
– Review of Indian stock market and economic situations.
Thus at road shows, series of information presentations are organised in selected cities around the world with
analysts and potential institutional investors. It is, in fact, a conference by the issuer with the prospective investors.
Road show is arranged by the lead manager by sending invitation to all prospective investors.
STEPWISE PROCEDURE FOR ISSUE OF ADR/GDR
1. Convene a Board Meeting to approve the proposed Issue for not exceeding certain value in foreign currency.
2. Convene the Extra ordinary General Meeting for the approval of the shareholders for the proposed GDR
Issue under Sec 81(1A) of the Companies Act, 1956.
3. Identify the Agencies.
4. Convene a Board Meeting to approve the Agencies.
5. Appoint the Agencies and sign the Engagement Letters.
6. The Indian Legal Counsel to undertake the Due Diligence.
7. Prepare the first draft of the Information Memorandum (IM) in consultation with the Indian Legal Counsel
and submit the same to various Agencies for their comments thereon.
8. Prepare the 2nd/3rd draft of IM incorporating the comments.
9. The Listing Agent to submit the IM with the overseas Stock Exchange for their comments and In principle
Listing Approval.
10. Simultaneously submit draft IM to the Indian Stock Exchanges where the Issuing Company’s shares are
listed for In principle approval for listing of the underlying share.
11. Hold Board Meeting to approve the Deposit Agreement, Subscription Agreement and the Escrow Agreement.
12. On receipt of the comments on the IM from the Overseas and Indian Stock Exchanges incorporate the same
and file the final IM with Overseas Stock Exchange and obtain Final Listing.
13. The Issuing Company can open the Issue for the ADR/GDR on receipt of the In principle Listing Approval
from the Overseas and the Indian Stock Exchanges.
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14. Open the Escrow Account with the Escrow Agent and execute the Escrow Agreement.
15. In consultation with the Lead Manager to finalize
(a) whether the issue will be through public or a private placement,
(b) the number of ADR/ GDRs to be issued.
(c) the issue price.
(d) number of underlying shares to be issued against each ADR/ GDR.
16. On the day of the opening of the Issue execute the Deposit and Subscription Agreements.
17. The Issue should be kept open for a minimum period of 3 working days.
18. Immediately on closing of the Issue convene a Board/ Committee Meeting for allotment of the underlying
shares against the Issue of the GDRs.
19. Then Deliver the share certificate to the Domestic Custodian Bank who will in terms of the Agreement
instruct the Overseas Depository Bank to Issue the ADR/ GDR to Non Resident Investor against the shares
held by the Domestic Custodian Bank.
20. On receipt of Listing Approval from Overseas Stock Exchange submit the required documents for Final In
principle Listing Approval from Indian Stock Exchange.
21. After GDRs are listed the Lead Manager to instruct the Escrow Agent to transfer the Funds to the Company’s
Account.
22. The Company can either remit the entire funds or in part as per its discretion.
23. On obtaining the Final Approval from Indian Stock Exchanges admit the underlying shares to the depository
i.e., NSDL and CDSL.
24. Obtain Trading approval.
25. Intimate the Custodian for converting the physical shares into Demat.
26. Within 30 days of the closing of the issue, details of the ADR/ GDR Issue along with the IM should be
submitted to
(a) the Ministry of Finance.
(b) the Registrar of Companies
(c) SEBI
27.Return of Allotment in Form 2 is to be filed with ROC within 30 days of Allotment.
28.Annexure 9 is to be filed with RBI, Central office within 30 days of closure of the ADR/ Issue.
REPORTING OF ADR/GDR ISSUES
The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full details of such issue in the
Form as Annex 9 specified in Schedule I of Foreign Exchange Management (Transfer or issue of security by a
person resident outside India) Regulations, within 30 days from the date of closing of the issue. The company
should also furnish a quarterly return in the Form Annex 10 as specified in Schedule I of the said regulation, to
the Reserve Bank within 15 days of the close of the calendar quarter. The quarterly return has to be submitted
till the entire amount raised through ADR/GDR mechanism is either repatriated to India or utilized abroad as per
the extant Reserve Bank guidelines.
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After completing the transaction, the Issuer would be required to furnish the following information to RBI:
– Details of the purpose for which the GDRs/ADRs have been raised. If funds are deployed for overseas
investment, details thereof;
– Details about the Depository, Lead Manager, Sub-Mangers to the Issue, Indian Custodian;
– Details of the FIPB Approval or the relevant NIC Code in case of automatic route;
– Details of Authorized and Issued paid up capital before the issue and after the issue;
– In case of private placement, details of investors and ADRs/GDRs issued to each of them:
– Number of GDRs/ADRs issued
– Ratio of GDRs/ADRs to the underlying shares
– Details of Issue related expenses
– Details of listing arrangements
– Amount raised and the amount repatriated
Points to Remember
The GDR holders shall not have any voting rights.
FCCB AND ORDINARY SHARES (THROUGH DEPOSITORY RECEIPT MECHANISM) SCHEME,
1993
Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in accordance with
the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt
Mechanism) Scheme, 1993 and guidelines issued by the Government of India thereunder from time to time.
Eligibility
An issuing company desirous of raising funds by issuing Global Depository Receipts is required to obtain prior
permission of the Department of Economic Affairs, Ministry of Finance, Government of India.
An Indian company, which is not eligible to raise funds from the Indian capital market including a company which
has been restrained from accessing the securities market by the SEBI is not eligible to issue shares under this
scheme.
Transfer and redemption
A non-resident holder of Global Depository Receipts may transfer those receipts, or may ask the Overseas
Depository Bank to redeem those receipts. In the case of redemption, Overseas Depository Bank shall request
the Domestic Custodian Bank to get the corresponding underlying shares released in favour of the non-resident
investor, for being sold directly on behalf of the non-resident, or being transferred in the books of account of the
issuing company in the name of the non-resident.
In case of redemption of the Global Depository Receipts into underlying shares, a request for the same is to be
transmitted by the Overseas Depository Bank to the Domestic Custodian Bank of India, with a copy of the same
being sent to the issuing company for information and record. On redemption, the cost of acquisition of the
shares underlying the Global Depository Receipts shall be reckoned as the cost on the date on which the
Overseas Depository Bank advises the Domestic Custodian Bank for redemption. The price of the ordinary
shares of the issuing company prevailing in the Bombay Stock Exchange or the National Stock Exchange on the
date of the advice of redemption shall be taken as the cost of acquisition of the underlying ordinary shares.
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Taxation on shares issued under Global Depository Receipt Mechanism
(1) Under the provisions of the Income-tax Act, income by way of dividend on shares is taxed at the rate of 10 per
cent. The issuing company is required to transfer the dividend payments net after deducting tax at source to the
Overseas Depository Bank.
(2) On receipt of these payments of dividend after taxation, the Overseas Depository Bank is required to distribute
them to the non-resident investors proportionate to their holdings of Global Depository Receipts evidencing the
relevant shares. The holders of the Depository Receipts may take credit of the tax deducted at source on the
basis of the certification by the Overseas Depository Bank, if permitted by the country of their residence.
(3) All transactions of trading of the Global Depository Receipts outside India, among non-resident investors, are
free from any liability to income tax on India on Capital Gains therefrom.
(4) If any capital gains arise on the transfer of the aforesaid shares in India to the non-resident investor, he will
be liable to income-tax under the provisions of the Income-tax Act. If the aforesaid shares are held by the nonresident investor for a period of more than twelve months from the date of advice of their redemption by the
Overseas Depository Bank, the capital gains arising on the sale thereof will be treated as long-term capital gains
and will be subject to income-tax at the rate 10 per cent under the provisions of Section 115AC of the Income-tax
Act. If such shares are held for a period of less than twelve months from the date of redemption advice, the
capital gains arising on the sale thereof will be treated as short-term capital gains and will be subject to tax at the
normal rates of income-tax applicable to non-residents under the provisions of the Income-tax Act.
(5) After redemption of the Depository Receipts into underlying shares, during the period, if any, during which
these shares are held by the redeeming non-resident foreign investor who has paid for these shares in foreign
exchange at the time of purchase of the Global Depository Receipt, the rate of taxation of income by way of
dividends on these shares would continue to be at the rate of 10 per cent, in accordance with Section 115AC(1)
of the Income-tax Act. The long term capital gains on the sale of these redeemed underlying shares held by nonresident investors in the domestic market shall also be charged to tax at the rate of 10 per cent, in accordance
with the provisions of Section 115 AC(1).
(6) When the redeemed shares are sold on the Indian Stock Exchanges against payment in rupees, these
shares shall go out of the purview of the Section 115 AC of the Income-tax Act and income therefrom shall not be
eligible for the concessional tax treatment provided thereunder
After the transfer of shares where consideration is in terms of rupees payment, the normal tax rates would apply
to the income arising or accruing on these shares.
(7) Deduction of tax at source on the amount of capital gains accruing on transfer of the shares would be made
in accordance with sections 195 and 196C of the Income-tax Act.
Application of Avoidance of Double Taxation Agreement in case of Global Depository Receipts
During the period of fiduciary ownership of shares in the hands of the Overseas Depository Bank, the provisions
of Avoidance of Double Taxation Agreement entered into by the Government of India with the country of residence
of the Overseas Depository Bank are applicable in the matter of taxation of income from dividends from underlying
shares and interest on Foreign Currency Convertible Bonds. During the period, if any, when the redeemed
underlying shares are held by the non-resident investor on transfer from fiduciary ownership of the Overseas
Depository Bank, before they are sold to resident purchasers, the Avoidance of Double Taxation Agreement
entered into by the Government of India with the country of residence of the non-resident investor will be applicable
in the matter of taxation of income from the dividends from the said underlying shares, or interest on Foreign
Currency Convertible Bonds, or any capital gain arising out of transfer of underlying shares.
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Resource Mobilization Through International Markets 289
LISTING OF GDR
In order to list equity securities on a stock exchange, or to maintain a listing once admitted to trading, an issuer
must meet certain criteria. These requirements vary from exchange to exchange.
LONDON STOCK EXCHANGE
The London Stock Exchange (LSE) is one of the world's most international equity markets with international
companies representing more than 55 countries currently listed and traded.
The LSE has several different trading markets for negotiable equity instruments. GDRs can trade on three
markets: the Main Market, the Professional Securities Market (known as the PSM) and, in certain circumstances,
the Alternative Investment Market (known as AIM). Most GDRs have chosen to list on the Main Market, which is
the most highly regulated of the three.
The UK financial markets are regulated by the Financial Services Authority (FSA), an independent nongovernmental body. The FSA, often known amongst issuers as UKLA (UK Listing Authority), reviews and approves
prospectuses and other documents required for the listing. The UKLA grants securities listed status on regulated
markets. However, the LSE is responsible for admitting a security to the exchange to trade. When applying to
the LSE for admission, the Company specifies the market on which it would like its GDRs to trade.
Different ways in which a company can list in London
When considering a capital raising and listing in London, companies have two choices:
(i) Public offer: GDRs are offered to institutional investors and are usually underwritten. A public offering is
generally used by companies seeking to raise substantial amounts of capital or looking to raise their
profile in the London market. This is the most expensive option.
(ii) Placing: A placing is usually a more selective process whereby GDRs are offered to a small number of
institutions. While this route gives the Company more control over the distribution, it can restrict the
shareholder base and inherently limit liquidity.
LISTING ON THE MAIN MARKET
Prior to starting the formal listing process, the Company will first spend time organizing itself thoroughly. Once
the formal listing process begins, it usually takes no more than approximately 24 weeks. However, these
timeframes are largely governed by the ability of the issuer and its advisors to prepare the required documents
and complete the due diligence process.
Sponsor
The sponsor plays a pivotal role as an advisor, liaising with the Exchange and UK Listing Authority (UKLA) and
coordinator and working with other advisers. The sponsor is normally an investment bank, corporate finance
house, stockbroker or accountancy firm. The UKLA has a list of approved sponsors. It is important to note that
this is a different role from that of the Depository Bank, which manages the DR program.
FSA’s requirements for a company to receive listed status
Before starting work on the forms and documents, such as the prospectus, a company must be in compliance
with, or willing to comply with, the following requirements:
1. Company’s incorporation status
The Company must be validly incorporated and operating in conformity with its constitution as well as complying
with the following:
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(i) Authorization and Validity of Shares
The shares which will underly the GDRs must:
(a) Confirm with the law of the Company’s place of incorporation,
(b) Be duly authorized in accordance with the Company’s statutes, and
(c) Have any other necessary legal or corporate consents.
(ii) Transferability of the Underlying Shares
The shares underlying the GDRs must be freely transferable, fully paid and free from any restrictions on transfer.
2. GDR requirements
In order to be able to validly list the GDRs, the FSA requires that the Company must be willing to ensure that the
GDRs comply with the need for any legal or statutory consents as well as:
(i) Free float requirement : 25% of the GDRs (not total share capital) must be in public hands. The
Company will need to notify the FSA that this requirement has been met. Therefore, if at any time the
Company becomes aware it will not be able to comply with this rule, an additional conversation with the
FSA should take place. This 25% should not include any investor taking more than 5%.
(ii) Authorization of GDRs : GDRs must:
(a) Confirm with the law of the Depository’s place of incorporation and
(b) Be duly authorized according to the requirements of the Depository’s constitution.
(iii) Admission to trading : The GDRs must be admitted to trading on a Recognized Investment Exchange,
such as the LSE for listed securities.
(iv) Transferability : To be listed, GDRs must be fully paid, freely transferable and free from any liens and
restriction.
(v) Market capitalization : The expected aggregate market value of all GDRs to be listed must be at least
£700,000 unless there are shares of the same class already listed on the LSE. Please note, the FSA
may modify this rule to admit shares of a lower value if it is satisfied there will be an adequate market for
the securities concerned.
(vi) Whole class to be listed : An application for listing of securities of any class must relate to all securities
of that class, issued or proposed to be issued. If already listed, the application must relate to further
securities of that class to be issued.
(vii) No additional obligations to be imposed on the Depository by the GDRs: The GDRs must not
impose obligations on the Depository except to the extent necessary to protect the GDR holders’ rights
to and the transmission of entitlements of the Shares.
3. Continuing Obligations
The issuer must be willing to comply with ongoing continuing obligations and market reporting requirements.
3.1 Prospectus
A published prospectus is a condition for admittance to the LSE. This prospectus must be approved by the
relevant competent authority. The prospectus is the company’s information and sales document, analyzed by
market participants as they create opinions and decide whether to participate in the offering.
(i) Information
A GDR prospectus must include the necessary information that enables investors to make an informed
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Resource Mobilization Through International Markets 291
assessment of (i) the assets and liabilities, financial position, profits and losses and prospects of the Company
and, (ii) the rights attached to the GDRs. This information must take into account the particular nature of GDRs
and the Company. The prospectus must be presented in a form which is comprehensible and easy to analyze.
(ii) Accounting standard
Companies should prepare their accounts in accordance with IFRS (International Financial Reporting
Standards) or an equivalent standard.
(iii) Financial information
An operating and financial review, audited financial information for the last three financial years or such
shorter period as the Company has been in operation. In the event the prospectus is more than nine months
after the end of the last financial year, unaudited half year accounts will be included as well. The prospectus
also requires details of any material contracts.
(iv) Risk summary
Management will write a summary describing the Company that includes any risks associated with investing
in the Company. The UKLA requires that the Company draft this in non-technical language that can be
easily understood by investors. When preparing the summary, the Company should be aware that this
summary must use the same data as the rest of the prospectus, and it cannot be misleading or contradict
what has been written in the rest of the document.
3.2 Block listing
The number of shares “listed” when the GDRs are admitted to the LSE is the maximum number that can be
issued without approval and publication of another prospectus. Therefore, most issuers choose to list the maximum
number of GDRs that can be created and traded on the LSE, which is likely to be greater than the number of
GDRs issued at the time of the original listing. In some cases this may be 100% of the share capital, while in
others it might be 20% due to local restrictions on foreign ownership.
3.3 Documents required to be provided to the FSA
The FSA requires that it receives the following documents, in final form, by midday two business days before the
FSA is to consider the application:
(i) A completed Application for Admission of Securities to the Official List ;
(ii) One of the following:
(a) The prospectus or listing particulars that have been approved by the FSA; or,
(b) A copy of the prospectus, a certificate approval and (if applicable) a translation of the summary of
the prospectus, if another EEA State is the home Member State for the securities; and
(c) Any approved supplementary prospectus or approved supplementary listing particulars, if applicable.
3.4 Documents to be provided on the day of the listing
A company must submit, in final form, the following documents to the FSA before 9 am on the day the FSA is to
consider the application:
(i) A copy of the resolution of the board authorizing the issue of the securities or
(ii) Written confirmation from the applicant that the board has authorized the issue of the securities.
3.5 Documents to be provided after the listing
The following documents must be submitted in final form to the FSA as soon as practicable after the FSA has
considered the application:
292 PP-CC&MM
(i) A statement of the number of securities that were issued and
(ii) A completed Issuer’s Declaration.
4. Continuing obligations on the Main Market
By listing on the Main Market, the Company is agreeing to abide by the ongoing obligations to the market and to
the exchange. These include:
(i) Publishing an annual financial report within six months of its year end. The annual financial report must
include audited financial statements, a management report and responsibility statements and must
remain publicly available for at least five years.
(ii) Publishing an unaudited semi-annual financial report within four months of the end of the financial
period.
(iii) Publication of price sensitive information. By keeping the market informed in a timely manner through
press releases and other announcements, the Company allows all investors on all its markets to trade
in a knowledgeable manner. Further, if the Company believes information has been leaked regarding a
confidential or price sensitive corporate matter, it will be important to communicate with the market to
remove uncertainty regarding the stock.
LISTING ON PROFESSIONAL SECURITY MARKET
The Professional Security Market (PSM) is part of the London Stock Exchange and is operated within the scope
of its status as a Recognized Investment Exchange. This means that the same regulatory standards currently
applied to its markets, in respect of on-going monitoring and enforcement, also apply to the PSM.
The Professional Security Market (PSM) was created in 2005 to enable those companies only interested in
accessing the “wholesale” market to be able to do so without the regulatory requirements of the Main Market.
The PSM is a more restricted access market, and as such, the FSA is able to exercise flexibility in the
implementation of the Directives.
1. Requirement of prospectus
The prospectus required by the PSM does not require historical financial information in IFRS (International
Financial Reporting Standards) or an EU approved equivalent standard, either in listing documents or as a
continuing obligation requirement. This may be a cost saving for many companies as re-stating or providing
additional disclosure as required by the Prospectus could be very expensive. However, issuers may need to
provide a description of the key differences between their local accounting standards and IFRS.
Issuers choosing the PSM will have their listing particulars approved by the UK Listing Authority and be admitted
to listing, so a key requirement for investment by funds and institutional investors will have been met. Further,
although IFRS does not apply, disclosure obligations for listed companies do apply to companies represented
on the PSM. Therefore, important regulatory information, such as annual reports and on-going disclosure, needs
to be readily available to investors.
2. Key eligibility criteria
Issuers wishing to list on the PSM must meet the following criteria:
(i) Minimum of 25% of shares in public hands
(ii) Latest three years of audited accounts (or such shorter period as the issuer has been operating)
(iii) Minimum GDR market capitalization of £700,000
(iv) National GAAP may be used in the preparation of the prospectus
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Resource Mobilization Through International Markets 293
3. Admission process
Admitting securities to the PSM is a two part process. The first part is to submit listing particulars to the UK
Listing Authority (UKLA) for approval and admission to the Official List. Next, the Company applies to the LSE for
admission of the DRs to trade on the PSM.
4. Trading
DRs admitted to the PSM are traded on the International Order Book.
5. Key continuing obligations
Issuers admitted to trading on the PSM must meet certain continuing obligations, including:
(i) Disclosing inside information to the market as soon as possible
(ii) Publishing an annual report and accounts within six months of the year end
(iii) Preparing and maintaining a list of people considered insiders.
LISTING ON AIM
AIM is the London Stock Exchange's international market for smaller growing companies. AIM was designed to
be a highly flexible public market. As such, it offers many unique attributes to both companies and investors.
With respect to listing GDRs on AIM, the LSE has stated that a listing of GDRs would only be appropriate if the
relevant company is incorporated in a jurisdiction which prohibits or unduly restricts the offering or trading of its
underlying securities outside that country.
1. Admissions criteria
(i) The main requirement is that a company coming to AIM must have a Nominated Adviser (Nomad) at all
times
(ii) No minimum size of company
(iii) No minimum proportion of shares to be in public hands
(iv) No trading record requirement
(v) No prior shareholder approval for the majority of transactions
(vi) No requirement to be incorporated in the UK.
2. Nominated Advisers (Nomads)
All Nomads are approved by the London Stock Exchange. To be authorized to act as Nomads, these investment
banks, corporate finance firms or brokers must demonstrate that they have the experience and ability to assess
whether a company is suitable and ready for admission to AIM and to act as that company’s formal 'mentor' once
it has been admitted to the market.
The Nomad will:
(i) Undertake extensive due diligence to ensure the Company is suitable for AIM
(ii) Guide the Company through the flotation process
(iii) Administer the admission documents and financial statements
(iv) Act as the Company’s 'referee' throughout its time on AIM
Along with company directors, a Nomad is responsible for ensuring that the business adheres correctly to AIM's
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rules and regulations. Its role also includes keeping the Company abreast of AIM Notices and rule revisions and
making sure the Company honors the continuing obligations of being a public company once the Company is
trading.
3. Admission process
The Company must announce its intention to float on the market via the Exchange at least 10 business days
before the start of trading of the shares (or 20 business days where they are joining from a designated market).
The application form signed by the applicant company and the admission document signed by the Nomad must
then be submitted at least three business days before the Company’s admission to trading. Unlike the other
exchanges, there is no pre-vetting of documents by the exchange.
4. Key continuing obligations
Issuers admitted to trading on the AIM must meet certain continuing obligations (with all documents produced in
English or with English translations), including:
(i) Disclosing inside information to the market as soon as possible
(ii) Annual report and accounts must be published within six months of the year end and prepared in
accordance with US or UK GAAP or with International Accounting Standards (IAS)
(iii) Issuers are required to prepare and maintain a list of people considered insiders.
LUXEMBOURG STOCK EXCHANGE
Like London Stock Exchange, Luxembourg Stock Exchange offers issuers a choice of venue: either the
Luxembourg Stock Exchange Main Market or the Euro Multilateral Trading Facility Market known as Euro MTF.
The listing requirements for the Main Market are very similar to the London Stock Exchange while the Euro MTF
is more akin to the PSM.
1. Listing requirements
Most of the listing and prospectus requirements are similar to the other main exchanges with access to the
general public:
(i) Minimum public free float of 25%
(ii) Minimum market value of at least €1,000,000
(iii) Three years operating history
2. Continuing obligations
The full list of continuing obligations are contained in the Rules and Regulations of the Luxembourg Stock
Exchange and include:
(i) Inside information, corporate actions and significant transactions disclosed as soon as possible.
(ii) Annual report and accounts published as soon as possible. The EU Transparency Directive requires
four months.
(iii) Half yearly reports must be published as soon as possible. The Transparency Directive requires two
months.
LISTING OF ADR
Many public offerings by non-U.S. companies are in the form of depositary receipts, usually as American Depositary
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Resource Mobilization Through International Markets 295
Receipts (ADRs). Non-US companies seeking to raise capital in the US do not necessarily have to become registered
with the SEC. An exemption called Rule 144A entitles a company to offer securities for sale or resale to certain
institutional investors without requiring registration of the offer or sale with the SEC. As a result, companies can
raise capital in the US without having to meet the ongoing reporting requirements associated with a SEC registration.
Financing objectives, costs and timing are among the many factors that need to be considered in deciding whether
to initiate a public or private offering. A public issue allows a company to establish a wider trading market for its
securities, as well as broader exposure to the business and investing public than is possible in a private offering.
The advantages of a private issue include potentially lower costs of preparing the offering document and faster
processing. Companies commonly use private offerings as an interim step to going public. Such private offerings
may come with registration rights to enhance post closing liquidity of the securities sold in the offering. Registration
rights are rights given to investors to sell or register with SEC unregistered shares.
There are a number of stock exchanges in the US, but the majority of foreign and domestic companies want to
be traded on the New York Stock Exchange (“NYSE”) or the National Association of Securities Dealers Automated
Quotations (“NASDAQ”). Each exchange has minimum entry listing requirements, including profit history,
shareholders’ equity, size of market capitalization, number of expected shareholders and corporate governance
as discussed below.
NASDAQ
There are three distinct markets within NASDAQ: the NASDAQ Global Market (NGM), the newly created NASDAQ
Global Select Market (NGSM) and the NASDAQ Capital Market (NCM). The NGSM mandates the highest initial
listing requirements of any market in the world, while its maintenance requirements are identical to those of the
NGM. The NGM, in turn, has more stringent quantitative listing and maintenance requirements than does the
NCM. The quantitative listing and maintenance criteria applicable to non-Canadian foreign private issuers for
the NGM, NGSM and NCM are identical to those of US domestic and Canadian issuers. Foreign Private Issuers
(FPI) (including Canadian issuers) may, however, elect to follow home country practice in lieu of compliance
with the NASDAQ corporate governance requirements.
THE NASDAQ GLOBAL SELECT MARKET (NGSM)
NGSM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
An issuer that satisfies all of the requirements for listing on the NGM will be eligible for listing on the NGSM if it
meets the additional liquidity and financial requirements described below. Each October, NASDAQ will review
the qualifications of all securities listed on the NGM to determine if any security meets the initial listing requirements
of the NGSM. Securities meeting the requirements of the NGSM at such time will be transferred to the NGSM in
January of the following year. In addition, an issuer of a security listed on either the NGM or NCM may, at any
time, apply to transfer the respective security to the NGSM.
(a) Liquidity Requirements
The security must demonstrate either:
– a minimum of 550 beneficial shareholders and an average monthly trading volume during the prior
12 months of at least 1.1 million shares per month; or a minimum of 2,200 beneficial shareholders;
or
– a minimum of 450 beneficial shareholders where the issuer lists in connection with a court-approved
reorganization under the federal bankruptcy laws or comparable foreign laws, or where the issuer is
an affiliate of another company listed on the NGSM.
296 PP-CC&MM
– In computing each of the above, the number of beneficial shareholders excludes shares held by an
officer, director or 10 percent shareholder of the issuer.
– The security must have 1.25 million publicly held shares; and
– The publicly held shares must have either:
(a) a market value of at least $110 million; or
(b) a market value of at least $100 million so long as the issuer has stockholders’ equity of at least $110
million; or
(c) a market value of at least $70 million where the issuer is listing in connection with an initial public
offering or where the issuer is an affiliate of, or a spin-off from, another company listed on the
NGSM.
(b) Financial Requirements
The issuer must meet one of the following financial standards:
Standard 1:
– aggregate income from continuing operations before income taxes of at least $11 million over the prior
three fiscal years; and
– positive income from continuing operations before income taxes in each of the prior three fiscal years;
and
– at least $2.2 million in income from continuing operations before income taxes in each of the two most
recent fiscal years.
Standard 2
– aggregate cash flows of at least $27.5 million over the prior three fiscal years; and
– positive cash flows in each of the prior three fiscal years; and
– both average market capitalization of at least $550 million over the prior 12 months and total revenue of
at least $110 million in the previous fiscal year.
Standard 3
– average market capitalization of at least $850 million over the prior 12 months; and
– total revenue of at least $90 million in the previous fiscal year.
– In addition, other than an issuer listed on the NGM that transfers its listing to the NGSM, the issuer shall
have a minimum bid price for the security of $5 per share.
2. Quantitative Maintenance Requirements
Once an issuer has been listed on the NGSM, it is subject to the same maintenance standards as issuers listed
on the NGM, as described below.
An issuer, whether a domestic issuer or Foreign Private Issuer (FPI), must generally meet all the criteria under
atleast one of the four financial standards and the liquidity requirements stated below:
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Financial and Qualitative
Requirements
Standard 1
Resource Mobilization Through International Markets 297
Standard 2
Standard 3
Minimum total revenue in the previous fiscal year
US$ 110 million
US$ 90 million
Minimum average market capitalization at the time
of listing
US$ 550 million
US$ 850 million
Standard 4
US$ 160 million
Bid price
US$ 4
US$ 4
US$ 4
US$ 4
Market makers
3 or 4
3 or 4
3 or 4
3 or 4
Corporate governance
Yes
Yes
Yes
Yes
Other
Minimum income
from continuing
operations before
income taxes of:
• US$ 11 million over
the prior three fiscal
years in aggregate and
Minimum cash flows of:
• US$ 27.5 million over
the prior three fiscal
years in aggregate
• Positive cash flows in
each of the prior
three fiscal years
US$ 80 million of total
assets and US$ 55
million of stockholders
equity in the most
recent publicly reported
financial statements
• US$ 2.2 million in
each of the two most
recent fiscal years
Positive income from
continuing operations
before income tax in
each of the prior three
fiscal years
Liquidity Requirement for New Company Listings (IPOs)
Round lot shareholders
or total shareholders
450 or 2,200
450 or 2,200
450 or 2,200
450 or 2,200
Publicly held shares
1.25 million
1.25 million
1.25 million
1.25 million
Market value of publicly
held shares
US$ 45 million
US$ 45 million
US$ 45 million
US$ 45 million
THE NASDAQ CAPITAL MARKET (NCM)
NCM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
For initial listing on NCM, an issuer must have:
– either: stockholders’ equity of at least $5 million, a market value of publicly held shares of at least $15
million and an operating history of at least two-years; or
– stockholders’ equity of at least $4 million, a market value of listed securities (i.e., securities listed on
NASDAQ or another national securities exchange) of at least $50 million and a market value of publicly
held shares of at least $15 million; or
– income from continuing operations of at least $750,000 in the most recently completed fiscal year or in
two of the last three most recently completed fiscal years and a market value of publicly held shares of
at least $5 million;
298 PP-CC&MM
– at least 300 round lot shareholders;
– at least 1 million publicly held shares;
– a minimum bid price of $4 per share;
– at least three registered and active market makers;
– in the case of ADRs, at least 400,000 issued.
2. Maintenance Requirements
For continued listing on NCM, an issuer must maintain:
– either (i) stockholders’ equity of at least $2.5 million, (ii) a market value of listed securities of at least $35
million or (iii) net income from continuing operations of at least $500,000 in the most recently completed
fiscal year or in two of the last three most recently completed fiscal years;
– at least 300 round lot shareholders;
– at least 500,000 publicly held shares;
– a market value of publicly held shares of at least $1 million;
– a minimum bid price of $1 per share; and
– at least three registered and active market makers.
As is the case for securities listed on the NGM, a failure to meet the continued listing requirements will be determined
to exist only if the deficiency continues for a period of either 10 or 30 consecutive business days (depending on the
requirement with respect to which there is a deficiency)125 and in each case an issuer will have a period after
notification by NASDAQ of the failure in which to achieve compliance with the applicable requirement.
An issuer, whether a domestic issuer or FPI, must meet all the criteria under at least one of the following
financial standards
Requirements
Net Income
Standard
Equity
Standard
Market Value of Listed
Securities Standard
Stockholders’ equity
US$ 4 million
US$ 5 million
US$ 4 million
Bid price
US$ 4
US$ 4
US$ 4
Market makers
3
3
3
Corporate governance
Yes
Yes
Yes
Total shareholders (round
lot shareholders)
300
300
300
Publicly held shares
1 million
1 million
1 million
Market value of publicly held shares
US$ 5 million
US$ 15 million
US$ 15 million
Other
US$ 0.75 millon of net
income from continuing
2 years of
operating history
US$ 50 million of market
value of listed securities
operations in latest
fiscal year or in two of
last three fiscal years
at least
Lesson 9
Resource Mobilization Through International Markets 299
THE NASDAQ GLOBAL MARKET (NGM)
NGM Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
An issuer, whether a US domestic issuer or a foreign private issuer, generally must meet the following standards
to be listed on the NGM.
(a) Entry Standard 1
An issuer must have:
– annual pre-tax income from continuing operations of at least $1 million in the most recently completed
fiscal year or in two of the last three most recently completed fiscal years;
– at least 1.1 million publicly held shares;
– market value of publicly held shares (i.e., excluding shares held by directors, officers and 10 percent
shareholders) of at least $8 million;
– bid price per share of $5 or more;
– stockholders’ equity of at least $15 million;
– at least 400 round lot shareholders (i.e., a holder of a normal unit of trading); and
– at least three registered and active market makers with respect to the security.
(b) Entry Standard 2
An issuer must have:
– stockholders’ equity of at least $30 million;
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $18 million;
– bid price per share of $5 or more;
– at least three registered and active market makers with respect to the security;
– a two-year operating history; and
– at least 400 round lot shareholders.
(c) Entry Standard 3
An issuer must have:
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $20 million;
– a bid price per share of $5 or more;
– at least four registered and active market makers with respect to the security;
– at least 400 round lot shareholders; and
300 PP-CC&MM
– either a market capitalization of $75 million or total assets and total revenue of $75 million each for the
most recently completed fiscal year or two of the last three most recently completed fiscal years.
2. Quantitative Maintenance Requirements
Once an issuer has been listed on the NGM, it must continue to satisfy one of the following maintenance
standards.
(a) Maintenance Standard 1
An issuer must maintain:
– at least 750,000 publicly held shares;
– market value of publicly held shares of at least $5 million;
– stockholders’ equity of at least $10 million;
– at least 400 round lot shareholders;
– a bid price per share of $1 or more; and
– at least two registered and active market makers with respect to the security.
(b) Maintenance Standard 2
An issuer must maintain:
– at least 1.1 million publicly held shares;
– market value of publicly held shares of at least $15 million;
– a bid price per share of $1 or more;
– at least 400 round lot shareholders;
– at least four registered and active market makers with respect to the security;and
– either a market value of listed securities of $50 million or total assets and total revenue of $50 million
each for the most recently completed fiscal year or two of the last three most recently completed fiscal
years.
(c) Failure to Meet Maintenance Requirements
A failure to meet the maintenance requirements will be determined to exist only if the deficiency continues for a
period of either 10 or 30 consecutive business days (depending on the requirement with respect to which there
is a deficiency), and an issuer will have a period after notification by NASDAQ of the failure in which to achieve
compliance with the applicable requirement.
An issuer, whether a domestic issuer or FPI, must meet all the criteria under at least one of the following
financial standards:
Lesson 9
Resource Mobilization Through International Markets 301
Requirements
Income
Standard
Equity
Standard
Market Value
Standard
Total Assets/Total
Revenue
Stockholders’ equity
US$ 15 million
US$ 30 million
–
–
Bid price
US$ 4
US$ 4
US$ 4
US$ 4
Market makers
3
3
4
4
Corporate governance
Yes
Yes
Yes
Yes
Total shareholders (round
lot shareholders)
400
400
400
400
Publicly held shares
1.1 million
1.1 million
1.1 million
1.1 million
Market value of publicly
US$ 8 million
US$ 18 million
US$ 18 million
US$ 18 million
US$ 1 millon of income
2 years of
US$ 75 million
US$ 75 million of total
continuing operations
before income taxes in
operating history
of market value
assets and US$ 75
of listed securities million of total revenue
held shares
Other
lates fiscal year or in two
of last three fiscal years
in latest fiscal year or
in two of last three
fiscal years
NEWYORK STOCK EXCHANGE (NYSE)
The NYSE’s requirements for initial listing and listing maintenance are set forth below. The foreign private
issuers may satisfy either the general NYSE listing standards applicable to US domestic issuers or the NYSE’s
Alternate Listing Standards for foreign private issuers, which are specifically designed for Foreign Private Issuers
(FPI) with a broad, liquid market for their securities in their country of origin.
A. NYSE Quantitative Listing and Maintenance Standards
1. Quantitative Initial Listing Standards
Under the NYSE’s initial listing standards, an issuer typically must meet the following minimum distribution and
market value criteria and must meet one of the two financial standards described below.
(a) Minimum Distribution and Market Value Criteria (must satisfy each of the following requirements)
Minimum Distribution Requirements:
(i) IPOs: An IPO issuer must have 400 holders of 100 shares or more and 1.1 million publicly held shares.
(ii) Transfer or Quotation: An issuer seeking to transfer to the NYSE or list its existing securities must have
either:
(a) 400 holders of 100 shares or more and 1.1 million publicly held shares; or
(b) 2,200 total stockholders, an average monthly trading volume of 100,000 shares for the most recent
six months and 1.1 million publicly held shares; or
(c) 500 total stockholders, an average monthly trading volume of 1 million shares for the most recent
12 months and 1.1 million publicly held shares.
Market Value of Publicly Held Shares:
– The aggregate market value of publicly held shares must be at least $60 million for IPO issuers or $100
million for issuers seeking to transfer to the NYSE or list their existing securities.
302 PP-CC&MM
(b) Financial Standards (must satisfy one of the following requirements)
Earnings Test:
(i) An issuer’s pre-tax earnings (from continuing operations and after minority interest, amortization and
equity in the earnings or losses of investees, subject to certain adjustments) must total:
(ii) at least $10 million in the aggregate for the last three fiscal years including a minimum of $2 million in
each of the two most recent fiscal years and positive amounts in all three years; or
(iii) at least $12 million in the aggregate for the last three fiscal years including a minimum of $5 million in the
most recent fiscal year and $2 million in the next most recent fiscal year; or
Valuation/Revenue Test:
An issuer must have:
(i) Valuation/Revenue with Cash Flow Test: At least $500 million in global market capitalization, at least
$100 million in revenues during the most recent 12-month period, and at least $25 million aggregate
cash flows for the last three fiscal years and with positive cash flows in all three fiscal years (subject to
certain adjustments); or
(ii) Pure Valuation/Revenue Test: At least $750 million in global market capitalization, and at least $75
million in revenues during the most recent fiscal year.
2. Initial Alternate Listing Standards for Foreign Private Issuers
Under the NYSE’s initial Alternate Listing Standards, a foreign private issuer typically must meet the following
minimum distribution and market value criteria and must meet one of the two financial standards described below.
(a) Minimum Distribution and Market Value Criteria (must satisfy each of the following requirements)
– Minimum Distribution Requirements
A foreign private issuer must have 5,000 worldwide holders of 100 shares or more; and 2.5 million
shares held publicly worldwide.
– Market Value of Publicly Held Shares
The aggregate worldwide market value of publicly held shares of the foreign private issuer must be at
least $100 million.
(b) Financial Standards (must satisfy one of the following requirements)
– Earnings Test:
The pre-tax earnings (from continuing operations and after minority interest, amortization and equity in
the earnings or losses of investees, subject to certain adjustments) of the foreign private issuer must be
at least $100 million in the aggregate for the last three fiscal years, including a minimum of $25 million
in each of the most recent two fiscal years; or
– Valuation/Revenue Test
A foreign private issuer must have
(i) Valuation/Revenue with Cash Flow Test
At least $500 million in global market capitalization, at least $100 million in revenues during the most
recent 12-month period, and $100 million in the aggregate cash flows for the last three fiscal years
including $25 million in each of the two most recent fiscal years (subject to certain adjustments); or
(ii) Pure Valuation/Revenue Test
At least $750 million in global market capitalization and $75 million in revenues during the most recent
fiscal year.
Lesson 9
Resource Mobilization Through International Markets 303
3. Quantitative Maintenance Requirements
In order to maintain its listing on the NYSE, a US domestic issuer or a foreign private issuer must meet certain
quantitative maintenance standards which are summarized below:
(a) Minimum Distribution and Financial Standards
Minimum Distribution Requirements:
The NYSE may promptly initiate suspension and delisting procedures against an issuer if:
(i) the total number of stockholders is less than 400;
(ii) the total number of stockholders is less than 1,200 and the average monthly trading volume for the most
recent 12 months is less than 100,000 shares; or
(iii) the number of publicly held shares is less than 600,000.
Minimum Financial Standards:
The NYSE will consider an issuer to be below compliance (and thus eligible for suspension and delisting) if:
(i) an issuer qualified to list under the Earnings Test, and its average global market capitalization over a
consecutive 30 trading-day period is less than $75 million and, at the same time, total stockholders'
equity is less than $75 million;
(ii) an issuer qualified to list under the Valuation/Revenue with Cash Flow Test and:
– average global market capitalization over a consecutive 30 trading-day period is less than $250
million and, at the same time, total revenues are less than $20 million over the last 12 months
(unless the issuer qualifies as an original listing under one of the other original listing standards); or
– average global market capitalization over a consecutive 30 trading–day period is less than $75
million; and
– an issuer qualified to list under the Pure Valuation/Revenue Test and:
– its average global market capitalization over a consecutive 30 trading-day period is less than $375
million and, at the same time, its total revenues are less than $15 million over the last 12 months
(unless the issuer qualifies as an original listing under one of the other original listing standards); or
– its average global market capitalization over a consecutive 30 trading–day period is less than $100 million.
(b) Other Maintenance Requirements
The NYSE may in its sole discretion subject an issuer to suspension and delisting on a number of additional
grounds, including:
– a substantial reduction in operating assets and/or scope of operations;
– the failure of an issuer to make timely, adequate and accurate disclosures of information to its shareholders
and the investing public; and
– the failure to observe good accounting practices in reporting of earnings and financial position.
An issuer, whether a domestic issuer or FPI, must meet minimum distribution and market value criteria and one
of the following financial standards:
304 PP-CC&MM
NYSE quantitative listing standards
applicable to Domestic Issuers and
Foreign Private Issuers’
NYSE Alternate Listing Standards for
Foreign Private Issuers
Minimum distribution and market
value criteria:
Number of holders of 100 shares
400
or more or of a unit of trading if less
than 100 shares
5,000 worldwide
Number of publicly held shares
1.1 million
2.5 million worldwide
Aggregate market value of publicly
held shares
US$ 40 million
US$ 100 million worldwide
Price at the time of listing
US$ 4
US$ 4
US $10 million in the aggregate for the
last three fiscal years, together with
a minimum of US $2 million in each
of the two most recent fiscal years,
and positive amounts in all three
years
OR
US $100 million in the aggregate for the
last three fiscal years, together with a
minimum of US $25 million in each of the
two most recent fiscal years
Financial standards (must satisfy
one of the following requirements):
Earnings Test:
Income before tax from continuing
operations and after minority
interest, amortization and equity
in the earnings or losses of
investees (subject to certain
adjustments) must total at least
US$ 12 million in the aggregate for the
three fiscal years, together with a
minimum last of US$ 5 million in the
most recent fiscal year and US$ 2
million in the next most recent fiscal
year
OR
Valuation/Revenue Test:
Valuation/Revenue with Cash
Flow Test Issuer must have at least
1) US$ 500 million in global market
capitalization,
1) US$ 500 million in global market
capitalization,
2) US$ 100 million in revenues
2) US$ 100 million in revenues during the
during the most recent 12 month period, most recent 12 month period, and
and
3) US$ 25 million in aggregate cash
flows for the last three fiscal years with
positive amounts in all three years
(subject to certain adjustments)
Pure Valuation./Revenue Test
Issuer must have at least
3) US$ 100 million in aggregate cash
flows for the last three fiscal years,
where each of the two most recent years
is reported at a minimum of US$ 25 million
(subject to certain adjustments)
1) US$ 750 million in global market capitalization, and
2) US$ 75 million in revenues during the most recent fiscal year
OR
Assets and Equity Test
Issuer must have at least
Corporate governance
1) US$ 150 million in global market
capitalization,
2) US$ 75 million in total assets together
with at least US$ 50 million in
stockholders‘ equity (in each case
subject to certain adjustments)
Yes
Yes
Lesson 9
Resource Mobilization Through International Markets 305
LESSON ROUND UP
– Companies either raise funds from the domestic market or through international market. For international
funding, the most popular source amongst the Indian companies in the recent times has been American
Depository Receipts (ADR) and Global Depository Receipts (GDR).
– An American Depository Receipt (ADR) is a negotiable security representing ownership in some
underlying shares of a non-US company, which can be traded on US stock exchanges.
– GDRs are usually listed in the Luxembourg Stock Exchange and in the London Stock Exchange.
– An Indian corporate can raise foreign currency resources abroad through the issue of GDR/ADR.
Regulation 4 of Schedule I of FEMA Notification no. 20 issued by RBI allows an Indian company to
issue its Rupee denominated shares to a person resident outside India being a depository for the
purpose of issuing ADRs/ GDRs.
– Indian companies can raise foreign currency resources abroad through the issue of ADRs/GDRs, in
accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the Government of
India thereunder from time to time.
– The following agencies are normally involved in the issue of ADR/GDR: (i) Lead Manager (ii) Co-Lead/
Co-Manager (iii) Overseas Depository Bank (iv) Domestic Custodian Banks (v) Listing Agent (vi) Legal
Advisors (vii) Printers (viii) Auditors (ix) Underwriter(x) Escrow Agent.
– The following principal documents are involved: (i) Subscription Agreement (ii) Depository Agreement
(iii) Custodian Agreement (iv) Escrow Agreement (v) Offering Circular.
– The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full details of such
issue in the Form enclosed as Annex 9 in Schedule I of Foreign Exchange Management (Transfer or
issue of security by a person resident outside India) Regulations, within 30 days from the date of
closing of the issue.
– In order to list equity securities on a stock exchange, or to maintain a listing once admitted to trading,
an issuer must meet certain criteria. These requirements vary from exchange to exchange.
– The London stock Exchange has several different trading markets for negotiable equity instruments.
GDRs can trade on three markets: the Main Market, the Professional Securities Market (known as the
PSM) and, in certain circumstances, the Alternative Investment Market (known as AIM).
– Many public offerings by non-U.S. companies are in the form of depository receipts, usually as American
Depository Receipts (ADRs).
– There are three distinct markets within NASDAQ: the NASDAQ Global Market (NGM), the newly created
NASDAQ Global Select Market (NGSM) and the NASDAQ Capital Market (NCM).
– The NGSM mandates the highest initial listing requirements of any market in the world, while its
maintenance requirements are identical to those of the NGM.
– The NGM, has more stringent quantitative listing and maintenance requirements than does the NCM.
– The quantitative listing and maintenance criteria applicable to non-Canadian foreign private issuers
for the NGM, NGSM and NCM are identical to those of US domestic and Canadian issuers.
– The foreign private issuers may satisfy either the general NYSE listing standards applicable to US
domestic issuers or the NYSE’s Alternate Listing Standards for foreign private issuers, which are
specifically designed for foreign private issuers with a broad, liquid market for their securities in their
country of origin.
306 PP-CC&MM
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation)
1. What do you mean by American Depository Receipts(ADRs) ? Discuss various types of ADRs.
2. What are the advantages of Issuing ADR/GDR?
3. Briefly enumerate the provisions relating to issuance of shares under ADR/GDR.
4. Explain the information required to be furnished to RBI with respect to issue of ADR/ GDR .
5. Discuss briefly the criteria required to be fulfilled by a company to be listed on London Alternative
Investment Market (AIM).
Lesson 10
Economics of Commodities Marketing 307
Lesson 10
Economics of Commodities Marketing
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
A commodity may be defined as an article, a
product or material that is bought and sold in
an establish market between willing buyers and
sellers. Commodity Market is an important
constituent of the financial markets of any
country. This helps investors to hedge their
commodity risks, take speculative positions in
commodities and exploit arbitrage opportunities
in the market.
– Types of Commodities
– Commodities Market
– Marketing of Agricultural Commodities
– Direct Marketing
– Indirect Marketing
– Contract Farming
In this lesson the student will be able to
understand what commodity means; Different
types of commodities available; Marketing of
agricultural commodities; Variance of
commodities; Using hedge mechanism for price
risk management etc.
– Storage
– Warehousing
– Variance in Commodity Market
– Weather Derivatives
– Freight Derivatives
– Electricity Derivatives
– Catastrophe Derivatives
– Carbon Derivatives
– Hedging
– Hedging Risks
– Understanding Basis Risk
– LESSON ROUND UP
– SELF TEST QUESTIONS
307
308 PP-CC&MM
INTRODUCTION
A Commodity is an economic good, tradable good, product or article of commerce; something for which there is an
established market where the commodity can be bought and sold in commercial transactions between willing
buyers and sellers. One of the important characteristics of a commodity is that its price is determined as a function
of its market as a whole. So a commodity is understood to mean a good that has the following properties :
– Is usually produced and/or sold by many different producers
– Is uniform in quality between producers that produce and sell it.
– Is traded at a price resulting from its demand and supply.
TYPES OF COMMODITIES
Commodities can be perishable or non –perishable. Non-perishable commodities such as metals are called
hard commodities. Perishable commodities such as agricultural commodities are called soft commodities. Hard
commodities are typically natural resources that must be mined or extracted (gold, rubber, oil, etc.), whereas
soft commodities are agricultural products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.)
Agricultural Products
Industrial Metals
Precious Metals
Energy
Oil & Oil Seeds
Copper
Gold
Crude Oil
Spices
Nickel
Silver
Natural Gas
Pulses
Zinc
Platinum
Furnace Oil
Cereals
Aluminum
Aviation Turbine Fuel (ATF)
Plantations
Palladium
Power
Fibers
Lead
Potato
Tin
Sugar
Steel
Livestock
Sponge Iron
COMMODITY MARKETS
Every commodity that is produced (or grown) must eventually come to a market place where it can be bought
and sold. It is in this marketplace that all the elements of commerce will come together to settle a price at which
the commodity will get traded. For a commodity market to be established there must be very broad consensus
on the variations in the product that make it acceptable for one purpose or another. Such goods are raw or partly
refined materials whose value mainly reflects the costs of finding, gathering, or harvesting them; they are traded
for processing or incorporation into final goods. E.g. include crude oil, cotton, rubber, grains, and metals and
other minerals.
The two core participants in a commodity market are the sellers and the buyers. They meet each other in the
market, with sellers representing the supply side and buyers representing the demand side of this market. The
market functions as a price discovery mechanism, prices being determined by the supply of and demand for the
commodity. The prices are discovered through an auction mechanism such that sellers asking for a certain
price, and buyers offering them a price, come around to setting upon one mutually agreeable price. Most often,
sellers and buyers may participate in the market through intermediaries or agents, called brokers. Commodity
Markets have existed for centuries around the world because producers and buyers of good products and other
Lesson 10
Economics of Commodities Marketing 309
items have always needed a common place to trade. Though the place of trade and many of the detailed
mechanisms have changed, the basics of commodity trading remain the same.
The trading of commodities in commodity markets consists of direct physical trading (spot trading) and derivatives
trading. A market in which goods are sold for cash and delivered immediately is called the physical market.
Deals in these markets are immediately effective. The physical market is also known as the cash market or spot
market, because prices are settled in cash on the spot at current market prices, as opposed to forward prices. In
the physical markets, participation is restricted to people who are involved with that commodity, say, the farmer,
processor, wholesaler, etc. Since transactions take place directly between principals, there is a high degree of
flexibility in these transactions.
The most popular physical commodities contracts can be broken down into metals, energy, grains, livestock,
food and fiber and exotic commodities. Trading is delivery based, and is typically done through brokers and
other intermediaries. For most commodities that are physically traded, there is no market in a central meeting
place, and where it exists, it typically handles only a small part of the total trade.
The spot price or spot rate of a commodity is the price that is quoted in the physical market for immediate or spot
settlement (payment and delivery). Spot settlement is normally one or two business days from trade date. This
is in contrast with the forward price established in a forward contract or futures contract, where contract terms
(price) are set now, but delivery and payment will occur at a future date. Depending on the item being traded,
spot prices can indicate market expectations of future price movements in different ways. For a non-perishable
commodity like good, spot price reflects market expectations of future price movements. In theory, the difference
in spot and forward prices should be equal to the finance charges, plus any earnings due to the holder of the
commodity, according to the cost of carry mode. In contrast, a perishable commodity does not allow this arbitragethe cost of storage is effectively higher than the expected future price of the commodity. As a result, spot prices
will reflect current supply and demand, not future price movements. Spot prices can therefore be quite volatile
and move independently from forward prices.
MARKETING OF AGRICULTURAL COMMODITIES
Agricultural marketing includes the movement of agricultural produce from the farm where it is produced to the
end-consumers or manufacturers. This covers physical handling and transport, initial processing and packing to
simplify handling and reduce wastage, grading and quality control to simplify sales transactions and meet different
consumers’ requirements, and holding over time to match concentrated harvest seasons with the continuing
demands of consumers throughout the year.
For the farmer, the vital function of the marketing system is to offer him a suitable outlet for his produce at a
remunerative price. To the consumers and the manufacturers of products based on agricultural raw materials,
assured and steady supply at a reasonable price is the critical service. The agricultural marketing system in
India operates primarily according to the forces of supply and demand in the private sector. Prices are determined
through a free market process by negotiations at rural purchasing, wholesale and retail stages, and represent a
balance between the consumers’ ability to pay and the farmers’ need for an incentive to produce. An efficient
marketing system is also vital to (a) provide an incentive to the farmer to produce more; (b) convey the changing
production needs of the economy to the producers to enable production planning; (c) foster true competition
among the traders and (d) eliminate the exploitation of farmers, particularly the small and marginal ones.
India is one of the largest agrarian economies of the world. Its agriculture sector is at the core of the economy’s
purchasing power. The agriculture produce sector is the most important component of the Indian commodity
sector. India’s commodity sector comprises activities, regulations, institutions and producers, consumers,
intermediaries, service providers and marketplaces that collectively cause and explain some part of the economy’s
total output.
Government intervention is aimed at protecting the interests of producers and consumers and promoting organized
310 PP-CC&MM
marketing of agricultural commodities. The Indian government has adopted various measures to improve
agricultural marketing. These steps include establishing regulated markets, constructing warehouses, grading
and standardizing produce, standardizing weights and measures and providing information on agricultural prices
over the national radio network. The government also provides assistance in the establishment of infrastructure
for regulated markets, and in the setting up of rural warehouses.
(i) Various Central Government organizations are involved in agricultural marketing, including the
Commission for Agricultural Costs and Prices, the Food Corporation of India, the Cotton Corporation of
India, and the Jute Corporation of India. There also are specialized marketing boards for rubber, coffee,
tea, tobacco, spices, coconut, oilseeds, vegetable oil and horticulture.
(ii) The National Agricultural Cooperative Marketing Federation of India, the apex body of the state marketing
federations, handles much of the domestic and most of the export marketing for its member organizations.
(iii) A network of cooperatives at the local, state, and national levels assist in agricultural marketing in India.
The major commodities handled are food grains, jute, cotton, sugar, milk, and areca nuts.
(iv) The Directorate of Marketing and Inspection of the Ministry of Agriculture administers all laws related
with the marketing of agricultural produce, besides carrying out market research. The directorate also
works closely with states to provide agricultural marketing services that constitutionally are a matter of
state purview.
(v) The Central Warehousing Corporation, an entity of the Central Government, operates warehouses at
major points within its jurisdictions, and cooperatives operate warehouses in towns and villages.
Due to the characteristics of agricultural produce, such as small production from scattered farms, seasonality
and perishability of products, transportation and communication bottlenecks, etc., a large number of intermediaries
are required between the producer and the end-consumer. These intermediaries participate in the assembling
and distribution of agricultural products. Broadly, the methods adopted for marketing of agricultural produce can
be classified as :
Direct Marketing
The process of direct marketing enables farmers to meet the specific demands of wholesalers or traders from
the farmer’s inventory of graded and certified produce on one hand and of consumers based on consumers
preference on the other hand. This helps the farmers to reduce marketing costs and, thus, improve their net
margins. Besides helping farmers to improve price realization, some farmers have discovered that adding
value or marketing some minimally processed farm products directly to the consumer is another way of
enhancing financial viability. A farmer selling his produce directly to a supermarket is one example of this form
of marketing.
Indirect Marketing
In this form of marketing, rather than the agricultural commodities directly passing from producers to endconsumers, they move from producers to end-consumers through a chain of intermediaries or middlemen. The
number of intermediaries may vary from one to many, and may include several levels of wholesale dealers
(local/provincial/national) and then the retailers. Indirect marketing makes it necessary for the farmer to haul
produce to regulated markets for sale. There are three marketing functions involved in this chain of indirect
marketing, i.e., assembling, packing and distribution. Farmers going to the mandis and selling their produce
through traders is an example of indirect marketing.
Contract Farming
The process of contract farming is a newer concept that involves cultivating and harvesting for and on behalf of
big business establishments or Government agencies and forwarding the produce at a pre-determined price. In
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Economics of Commodities Marketing 311
return, the contracted farmers are offered high price against their farm produce. This stipulates a commitment
on the part of the farmers to provide a specific commodity in terms of quality and quantity as determined by the
purchaser and commitment on the part of company to support the farmer for production through inputs and
other technical support. The role of contract farming in Indian economy is becoming important, since organized
farming practice has become the need of the hour in the world of rapid industrialization. Some of the success
stories include National Dairy Development Board and PEPSICO.
Recently, India’s commodity exchanges have also set-up national-level electronic spot markets, the Spot
Exchanges, in recognition of the need to help farmers increase their income from farm and non-farm activities.
These spot exchanges provide a platform where farmers can sell their produce at the best possible rate and the
end-users can buy at the most competitive price, and in addition, provide services like quality certification,
storage of goods and other customized value-added services. As a result, the Indian farmers have multiple
options to sell their produce and are no longer dependent on Agricultural Produce Market Committees. The spot
exchanges also create a market where the processors end users, exporters, corporates (both private and
government) and other traders can procure agricultural produce at the most competitive price, without any
counter-party and quality risk.
STORAGE
Storage is an important marketing function, which involves holding and preserving goods from the time they are
produced until they are needed for consumption. The storage of goods, therefore, from the time of production to
the time of consumption, ensures a continuous flow of goods in the market. Storage protects the quality of
perishable and semi-perishable products from deterioration;
Some of the goods e.g., woolen garments, have a seasonal demand. To cope with this demand, production on
a continuous basis and storage become necessary; It helps in the stabilization of prices by adjusting demand
and supply. Storage is necessary for some period for performance of other marketing functions.
TYPES OF STORAGE
Underground Storage Structures
Underground storage structures are dugout structures similar to a well with sides plastered with cowdung. They
may also be lined with stones or sand and cement. They may be circular or rectangular in shape. The capacity
varies with the size of the structure.
Advantages
– Underground storage structures are safer from threats from various external sources of damage, such
as theft, rain or wind.
– The underground storage space can temporarily be utilized for some other purposes with minor
adjustments; and
– The underground storage structures are easier to fill up owing to the factor of gravity.
Surface storage structures
Foodgrains in a ground surface structure can be stored in two ways - bag storage or bulk storage.
I. Bag storage
– Each bag contains a definite quantity, which can be bought, sold or dispatched without difficulty;
– Bags are easier to load or unload.
– It is easier to keep separate lots with identification marks on the bags.
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– The bags which are identified as infested on inspection can be removed and treated easily; and
– The problem of the sweating of grains does not arise because the surface of the bag is exposed to the
atmospheres.
II. Bulk or loose storage
– The exposed peripheral surface area per unit weight of grain is less. Consequently, the danger of
damage from external sources is reduced; and
– Pest infestation is less because of almost airtight conditions in the deeper layers.
– The Government of India has made efforts to promote improved storage facilities at the farm level.
– Improved grain storage structures
WAREHOUSING
Warehouses are scientific storage structures especially constructed for the protection of the quantity and quality
of stored products.
Importance of warehousing
(i) Scientific storage: The product is protected against quantitative and qualitative losses by the use of such
methods of preservation as are necessary.
(ii) Financing: Warehouses meet the financial needs of the person who stores the product. Nationalized Banks
advance credit on the security of the warehouse receipt issued for the stored products to the extent of 75 to 80%
of their value.
(iii) Price Stabilization: Warehouses help in price stabilization of agricultural commodities by checking the
tendency to make post-harvest sales among the farmers.
(iv) Market Intelligence: Warehouses also offer the facility of market information to persons who hold their
produce in them.
Working of Warehouses
(i) Acts: The warehouses (CWC and SWCs) work under the respective Warehousing Acts passed by the Central
or State Govt.
(ii) Eligibility: Any person may store notified commodities in a warehouse on agreeing to pay the specified
charges.
(iii) Warehouse Receipt (Warrant): This is receipt/warrant issued by the warehouse manager/owner to the
person storing his produce with them. This receipt mentions the name and location of the warehouse, the date
of issue, a description of the commodities, including the grade, weight and approximate value of the produce
based on the present prices.
(iv) Use of Chemicals: The produce accepted at the warehouse is preserved scientifically and protected against
rodents, insects and pests and other infestations. Periodical dusting and fumigation are done at the cost of the
warehouse in order to preserve the goods.
(v) Financing: The warehouse receipt serves as a collateral security for the purpose of getting credit.
(vi) Delivery of produce: The warehouse receipt has to be surrendered to the warehouse owner before the
withdrawal of the goods. The holder may take delivery of a part of the total produce stored after paying the
storage charges.
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TYPES OF WAREHOUSE
1. On the basis of Ownership
(i) Private warehouses: These are owned by individuals, large business houses or wholesalers for the storage
of their own stocks. They also store the products of others.
(ii) Public warehouses: These are the warehouses, which are owned by the Govt. and are meant for the
storage of goods.
(iii) Bonded warehouses: These warehouses are specially constructed at a seaport or an airport and accept
imported goods for storage till the payment of customs by the importer of goods. These warehouses are licensed
by the Govt. for this purpose. The goods stored in this warehouse are bonded goods. Following services are
rendered by bonded warehouses:
– The importer of goods is saved from the botheration of paying customs duty all at one time because he
can take delivery of the goods in parts.
– The operation necessary for the maintenance of the quality of goods - spraying and dusting, are done
regularly.
– Entrepot trade (re-export of imported goods) becomes possible.
2. On the basis of Type of Commodities Stored
General Warehouses: These are ordinary warehouses used for storage of most of foodgrains, fertilizers, etc.
Special Commodity Warehouses: These are warehouses, which are specially constructed for the storage of
specific commodities like cotton, tobacco, wool and petroleum products.
Refrigerated Warehouses: These are warehouses in which temperature is maintained as per requirements and
are meant for such perishable commodities as vegetables, fruits, fish, eggs and meat.
WAREHOUSING IN INDIA
Central Warehousing Corporation (CWC)
This corporation was established as a statutory body in New Delhi on 2nd March 1957. The Central Warehousing
Corporation provides safe and reliable storage facilities for about 120 agricultural and industrial commodities.
Functions
– To acquire and build godowns and warehouses at suitable places in India.
– To run warehouses for the storage of agricultural produce, seeds, fertilizers and notified commodities.
for individuals, co-operatives and other institutions.
– To act as an agent of the Govt. for the purchase, sale, storage and distribution of the above commodities.
– To arrange facilities for the transport of above commodities.
– To subscribe to the share capital of State Warehousing Corporations and
– To carry out such other functions as may be prescribed under the Act.
The Central Warehousing Corporation is running air-conditioned godowns at Calcutta, Bombay and Delhi, and
provides cold storage facilities at Hyderabad. Special storage facilities have been provided by the Central
Warehousing Corporation for the preservation of hygroscopic and fragile commodities. The corporation has
also evolved techniques for the storage of spices, coffee, seeds and other commodities.
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State Warehousing Corporations (SWCs)
State Warehousing Corporations are also set up in different States of the Indian Union. The areas of operation
of the State Warehousing Corporations are centres of district importance. The total share capital of the State
Warehousing Corporations is contributed equally by the concerned State Govt. and the Central Warehousing
Corporation.
Food Corporation of India (FCI)
Apart from CWC and SWCs, the Food Corporation of India has also created storage facilities. The Food
Corporation of India is the single largest agency which has a capacity of 26.62 million tonnes.
VARIANCE IN COMMODITY MARKET
Contracts traded on the commodity exchanges are no longer limited to traditional commodities and standardized
contracts have come to be traded on the ever-increasing range of products and indices-like electricity, freight
rates, carbon dioxide and even weather, besides the conventional base metals, soft commodities oil, gas etc.
During the past several decades, the global derivatives industry has grown manifold and derivatives contracts
on a progressively diverse array of underlying products have been launched by exchanges. The past several
decades have witnessed the emergence and rapid developments and innovations in the filed of financial
engineering and derivatives. In fact, the concept of ‘commodity’ has been stretched beyond the traditional tangible
physical products to contracts that are based on an increasing range of physical commodities, market instruments
and indices (whether settled by physical delivery or in cash). The diverse range of potential underlying assts and
payoff alternatives leads to a huge range of derivatives contracts available for trading in the market. Today,
derivatives contracts are traded on Commodity Exchange Markets around the globe, based on the following
commodities (among others) :
– Agricultural crops and livestock
– Metals, both precious and industrial
– Energy, including electricity
– Interest rates
– Freight rates
– Equities and indices
– Foreign Exchange
– Insurance
– Carbon emissions
– Weather.
Variety is the very essence of commodity trading, and depends on the ability to build liquid and transparent
derivatives in emerging asset classes. Agriculture is a risk-prone sector. Combating risk in agriculture has been,
and continues to be, one of the major challenges to scientists and policy makers. Notable among the risk
sources plaguing agriculture include a host of weather-related risks. These include extreme rainfall, temperature
events, as well as natural disasters. Economic losses from weather risks have tended to increase in the past few
decades. The energy and shipping markets also operate in an environment exposed to a variety of risks
responsible for high volatility in the prices of oil, natural gas, electricity and freight rates. The need to control this
price volatility has promoted the development of risk management methods for weather, energy assets and their
derivatives, analogous to those widely used in fixed income, equity and foreign exchange markets. A totally
different class of markets and derivatives with exotics underlying has emerged.
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Economics of Commodities Marketing 315
WEATHER DERIVATIVES
Weather Derivatives are financial instruments that seem like an insurance policy but are more like options. They
are unique in that there is no physical underlying asset. The underlying asset is any measureable weather
factor, that is, temperature measured in degrees Celsius or Fahrenheit, rainfall measured in centimeters, or
snowfall measured in inches. On the Chicago Mercantile Exchange, the values of these contracts are calculated
based on a weather index. Most temperature contracts in current practice are based on a Heating Degree Day
(HDD) for winter protection, or a Cooling Degree day (CDD) for summer protection. Pay-off is based on a
measurable index like HDD or CDD, and it performs relative to the strike value (not the actual loss). Coverage
has a defined maximum limit.
Heating degree days are one of the most common types of weather derivatives. HDD is the difference between
the baseline temperature and the average temperature for a day in winters. The baseline temperature is fixed;
it is 65 degrees Fahrenheit in the U.S. and 18 degrees Celsius in Europe.
HDD = Max (0.65F-average temperature in a day)
The value of the contract would be a multiple of the HDD. The contract can be valued on a daily basis, or can be
valued on a weekly, fortnightly or monthly basis, or for a season, depending on the contract specifications.
Typical terms for a HDD contract could be: for the November to March period, for each day when the temperature
falls below 65 degrees Fahrenheit, or 18 degrees Celsius, keep a cumulative count of its difference from the
average daily temperature. Depending upon whether the option is a put option or a call option, it pays out a set
amount per heating degree day that the actual count differs from the strike.
Weather Derivatives contracts are being used successfully by farmers, theme parts, ski resorts, ice-cream
manufacturers, energy and utilities companies, etc., for over a decade now. Gas and power companies may use
HDD or CDD contracts to smooth earnings.
For example, a ski resort located in Auli may buy a put option by paying a premium of `1,00,000 to buy a right to
receive `20,000 for every inch of snow below the strike amount of say, 50 inches, offsetting somewhat the loss
in revenues due to insufficient snowfall. The ski resort could also sell a call option by receiving a premium of
`1.20,000 and paying `30,000 for every inch of snow over the strike of 50 inches, again assuming higher
revenue for the resort with heavy snowfall,.
The index could also be based on rainfall. In 2005, NCDEX launched a rain day index for Mumbai city for
informational purposes only, though it can very well be used as an alternative form of crop insurance that makes
payments, based not on measures of farm yields, but rather on some objective weather event, such as rainfall.
Similarly, MCX also has rainfall indices-RAINDEXMUM, RAINDEXIDR and RAINDEXJAI-that record rainfall at
Mumbai (Colaba), Indore and Jaipur, respectively, and are designed to also consider normal rainfall in Mumbai,
Indore and Jaipur.
FREIGHT DERIVATIVES
Just as weather is a source of risk for farmers, organizations and individuals, freight rates can also cause harm
to the revenues of organizations by impacting their shipping costs adversely. This is freight market risk. Given
the current volatility of the freight markets, managing freight market risk is a significant issue for the shipping
industry. Volatility in freight rates drives the need for financial tools for risk management, and attracts speculation
on the future price movements of freight. The ability to hedge the cost of freight permits traders to price their
businesses with greater degree of certainty and long-term stability.
Freight Derivatives are financial instruments used by organizations and individuals as part of their risk management
strategy to counter the negative economic effects of freight rate alterations that harm the financial prospect of a
company. Freight derivatives are financial contracts between two parties to settle upon an agreed future price
for carrying commodities at sea. The freight derivatives market began with the trading of voyage rates for certain
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‘dry’ cargo routes in the early 1990s, and was later expanded to include ‘wet’ tanker routes. Dry cargo is of solid,
dry material, rather than liquid or gas, and generally does not require special temperature controls. Wet cargo
consists of liquids or gases that may also require special temperature conditions. Recently, with commodities
now standing at the forefront of international economics, large financial trading houses, including banks and
hedge funds, have entered this market. Freight derivatives are primarily used by ship-owners and operators, oil
companies, trading companies and grain houses, as tools for managing freight rate risk.
Take the case of a trader who has agreed in August 2012 to ship 3000 tonnes of sugar from Brazil to Japan in
April, 2013. Assume that in August 2012, for this route, the freight rate per tonne of sugar is $90 per tonne. The
trader expects the rates to go up. He can book a ship now, for April loading, but the ship owner may not want to
commit for so far into the future. The trader can, alternatively, purchase a contract for settlement in April 2013, at
$92 per tonne, and lock in this rate. The settlement is against an index, like the Baltic Dry Index (BDI) which is a
daily average of prices paid by an end customer to have a shipping company transport dry raw materials across
26 different routes throughout the world averaged into one index. BDI is based on January 1985 as 1,000, and
is made up of an average of the Baltie Supramax, Panamax, and Capesize indices. If in April 2013, the freight
index is $95 per tonne, the trader makes a profit of $3 per tonne, which is offset by the increased cost of
shipping. If the freight index has fallen to $88 per tonne, then the trader makes a loss of $4 per tonne, which is
offset by the now lower cost of shipping.
ELECTRICITY DERIVATES
Energy derivatives are derivative instruments with the underlying asset being any energy product, including oil,
natural gas and electricity, which trade either on an exchange or over-the counter. Like other derivative products,
energy derivatives can be used as a form of insurance to protect against the often volatile changes of energy
prices. Electricity futures are one type of energy derivatives. They can be options, futures or swap agreements,
among others. The value of a derivative will vary based on the changes in the price of the underlying energy
product. Electricity is a commodity characterized by :
– Seasonality of demand
– High volatility of prices
– Non-elasticity of demand
– Limited transportability
– Non-storability
In fact, electricity derivatives were visualized as hedging instruments for suppliers and users of electricity in the
United States, where electricity suppliers charge the consumers a variable tariff; the per unit rate depending on
weather, which determines the levels of electricity consumption. A need was felt for derivatives because consumers
preferred paying a fixed rate. To meet the requirement of both the parties, an intermediary structured an
arrangement with the electricity supplier to collect a fixed amount from each consumer based on an average
energy consumption pattern in the past. This is how the arrangement would work.
Electricity sector reforms initiated in the early nineties in India led to the commencement of power trading. The
Electricity Act, 2003, recoginsed power trading as a distinct licensed activity. Open access regulations and inter State
trading regulations made power trading in India a reality. The Power Trading Corporation (PTC) played the role of a
trader by purchasing power from surplus units and selling it to deficit state electricity boards (SEBs) at mutually
agreed rates. The growth in volumes necessiated a natural market based platform that would encourage Liquidity.
The Central Electricity Regulatory Commission (CERC), in 2007, granted in principle approval to commence
exchange trading, and also issued guidelines for setting up and operation of the power exchange. Indian energy
Exchange (IEX), promoted by MCX became India’s first nation-wide automated online electricity platform to
trade spot electricity, to indentify the supply side, and to act as an effective price discovery mechanism. This was
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Economics of Commodities Marketing 317
followed by Power Exchange of India Ltd. (PXIL), promoted by NCDEX and NSE. Power Exchange for Electricity
trading held streamline power trading along with standardizing electricity as tradable product, by acting as a
platform for buying, selling and trading of electricity.
MCX, with an existing basket of energy products-including crude oil, furnace oil, natural gas and aviation turbine
fuel-in January 2009 received the approval from Forward Market Commisson (FMC) for the launch of weekly
and monthly electricity contracts. The exchange launched eight weekly contracts and four monthly contracts for
trading. The contract trading unit is 1MWx24 hours with tick size as `1 per MWh. The delivery is optional for both
buyers and sellers, and due date rate is the average of daily system prices of day-ahead market of Indian
Energy Exchange (IEX) for delivery during the contract week/month.
With the launch of electricity futures, the industry has a platform to manage price risk on energy-related raw
material or output better. The launch of electricity futures will even-out the price curve in the medium-to-long run
that will help the market participants to facilitate price discovery and take an informed decision after looking at
the future prices.
CATASTROPHE DERIVATIVES
Insurers are exposed to the risk of natural and man-made Catastrophes, and need to effectively insure themselves
by fixing their projected catastrophic loss ratios irrespective of the magnitude and frequency of Catastrophes.
They have been able to protect themselves against such losses by opting for reinsurance. Whenever a primary
insurer has exposure to excessive underwriting risk, it can pass on some of this risk to reinsurers. Reinsurance
agreements can be on a pro-rata agreement wherein the primary insurer gives a portion of its premium income
to a reinsurer, and the reinsurer agrees to pay roughly the same portion of the former’s losses. There can also
be an excess-of-loss basis wherein the reinsurer agrees to pay all losses incurred by the primary insurer in
excess of a certain amount, in exchange for a flat premium from the latter.
Catastrophes represent a major source of risk for property/casualty underwriters. This is a Catastrophe risk. The
Catastrophe Derivatives market was developed in response to the need of insurance, reinsurance and other
financial companies to manage their bottom line exposure to major seasonal weather events, such as hurricanes,
that cause significant material damage.
Insurers, acting as hedgers, will buy CAT futures or CAT call options. Sellers of CAT derivatives are normally
construction companies, reinsurance companies and speculators willing to take risk for profits. Speculators are
attracted to CAT derivatives because they are perfect diversification instrument, like zero-beta assets that have
low correlation to financial markets.
CARBON DERIVATIVES
Carbon Derivatives are financial contracts with carbon dioxide emissions as the underlying. Since carbon credits
are earned by reduction in CO2 emissions, the Carbon Derivatives derive their value from these reductions.
Member firms that do not have enough allowances to cover their emissions must either make reductions or buy
another firm’s spare credits. Members with extra allowances can choose to either sell them or stock them for
future use. This is what forms the basis for the functioning of carbon derivatives markets. Market forces drive the
prices of credits.
A carbon exchange operates like a stock exchange for pollution. The Chicago Climate Exchange (CCX) was the
world’s first carbon exchange when it started in 2003. It now has over 300 members, including Intel and Kodak.
Currently, emissions-related trading is dominated by the European Climate Exchange, the world’s largest platform
for carbon emissions trading and the Chicago Climate Exchange. The establishment of the European Union’s
Emission Trading Scheme (EUETS), which commits most big businesses and airlines to emission caps, has led
to London becoming the global carbon centre, with all major investment banks running carbon trading desks
alongside traditional commodity desks.
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After China, India is the leading net seller of Certified Emission Reductions in the world, and will benefit from the
carbon credit trade. In India, MCX launched carbon trading for the first time in January 2008 through a strategic
alliance with Chicago Climate Exchange (CCX). There are five contracts of carbon credits with expiry on 15th of
respective expiry months, starting from December 2008 through December 2012. The trading unit for a contract
is of 200 tonnes, where each tonne carbon credit (carbon dioxide emission allowance) being an entitlement to
emit one tonne of carbon dioxide equivalent gases. NCDEX started carbon trading in April 2008, with each
contract of 500 tonnes.
HEDGING
Hedging is the most common method of price risk management. Hedging means reducing or controlling risk. It
entails using the futures market to take a position that balances the position in the physical market with the
objective of reducing or limiting risks associated with price changes. Hedging is a two-step process. A gain or
loss in cash position due to the changes in price levels will be countered by changes in value of future position
due to changes in future position. For instance, a wheat-grower can sell wheat futures to protect the value of his
crop prior to harvest. If there is a fall in price, the loss in cash market position will be countered by a gain in
futures position.
HEDGING RISKS
Hedging implies taking a position to reduce your risk. There are several risks inherent in business transactions.
These risks can be managed more efficiently by unbundling the risks and allowing hedging by the use of
derivatives. These risks can be separated for different businesses.
For instance, if we buy and keep copper with us as inventory, we take following risks :
Price risk : Copper prices may go up or down due to any specific reasons, If it goes down, value of our inventory
goes down.
Liquidity risk : If our position is very large, we may not be able to cover our position at the prevailing price
(called impact cost). Liquidating the position may cause loss in value as price goes down.
Counterparty (credit risk) : It may happen that after negotiating the deal and receiving the prices, the supplier
goes bankrupt or even that after the delivery, we realize that the quality is significantly different.
Once you have the physical copper with you, you can hedge by going short on the copper futures. The credit risk
will be absorbed by the exchange in this case.
In the case of a hedger seeking to offset the price risk on his holding of inventory of commodities by selling
futures in the same, his position will be as follows :
Hedging in the futures market is a two-step process. Depending upon the hedger’s cash market situation, he
either will buy or sell futures first. For instance, if he is going to buy a commodity in the cash market at a later
time, his first step is to buy futures contracts. Or if he is going to sell cash commodity at a later time, his first step
is to sell futures contracts. The second step occurs when the cash market transaction takes place. At this time,
the futures position is no longer needed for price protection and should be offset (closed out). If the hedger was
initially long (long hedge), he would offset his position by selling the contract. If he was initially short (short
hedge), he would buy back the futures contract. Both the opening and closing positions must be for the same
commodity, number of contracts, and delivery month.
However, here we have assumed that the farmer expects and finally produces the output in the same quantity.
But what in real markets do not happen is the quantity matching. There is always a gap between expected and
actual output. This is defined as a quantity risk.
If the output on the maturity is lesser, the quality mismatch may affect the hedge. Besides, it will also affect the
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Economics of Commodities Marketing 319
final revenue that the producer generates. Even with the hedging plan using futures contract, the producer is not
able to cover the losses. But unfortunately, such risk cannot be hedged using the commodity derivative.
UNDERSTANDING BASIS RISK
The primary definition of basis is the difference between cash price and futures price.
Basis = Cash Price – Futures Price
Basis is used to determine :
(i) The best time to buy or sell
(ii) When to use the futures market to hedge a purchase or sale
(iii) The futures month in which to place a hedge.
(iv) When to accept a supplier’s offer or a buyer’s bid.
(v) Resale bids.
Basis is the difference between the local cash price of a commodity and the price of a specific futures contract
of the same commodity at any given point in time.
Local cash price
`2400
Jan futures price
`2600
Basis
`200 Jan
In such case, the cash price is `200 lower than the January futures price. In market terms, it will said that the
basis is “200 under January”, On the other hand, if the cash price is `200 higher than the January futures price,
you had say the basis is “200 over January”.
Local cash price
`2800
Jan futures price
`2600
Basis
`200 Jan
In a normal (contango) market, basis is always under but in an inverted market (backwardation) it is over.
If a futures contract does not exist for a specific commodity, the price of a related futures contract may be used;
e.g., a Crude oil future is used to calculate the basis for jet fuel. We can call basis as “localizing” a futures price.
The futures market price represents the single nation/International price for commodity and is used as a benchmark
in determining the value of grain at the local level. Because basis reflects local market conditions, it is directly
included by several factors including transportation costs, local supply and demand conditions, such as quality,
availability, need local weather, storage costs, handling costs and profit margins.
LESSON ROUND UP
– A Commodity is an economic good, tradable good, product or article of commerce; something for
which there is an established market where the commodity can be bought and sold in commercial
transactions between willing buyers and sellers.
– Commodities can be perishable or non-perishable. Non-perishable commodities such as metals are
called hard commodities. Perishable commodities such as agricultural commodities are called soft
commodities.
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– Every commodity that is produced (or grown) must eventually come to a market place where it can be
bought and sold. It is in this marketplace that all the elements of commerce will come together to settle
a price at which the commodity will get traded.
– The trading of commodities in commodity markets consists of direct physical trading (spot trading) and
derivatives trading.
– Agricultural Marketing includes the movement of agricultural produce from the farm where it is produced
to the end-consumers or manufacturers.
– The process of Direct Marketing enables farmers to meet the specific demands of wholesalers or
traders from the farmer’s inventory of graded and certified produce on one hand and of consumers
based on consumers preference on the other hand.
– In Indirect Marketing, rather than the agricultural commodities directly passing from producers to endconsumers, they move from producers to end-consumers through a chain of intermediaries or
middlemen.
– Variety is the very essence of commodity trading, and depends on the ability to build liquid and
transparent derivatives in emerging asset classes.
– Weather Derivatives are financial instruments that seem like an insurance policy but are more like
options. The underlying asset is any measureable weather factor, that is, temperature measured in
degrees Celsius or Fahrenheit, rainfall measured in centimeters, or snowfall measured in inches.
– Freight Derivatives are financial instruments used by organizations and individuals as part of their risk
management strategy to counter the negative economic effects of freight rate alterations that harm the
financial prospect of a company.
– Energy derivatives are derivative instruments with the underlying asset being any energy product,
including oil, natural gas and electricity, which trade either on an exchange or over-the counter.
– The Catastrophe Derivatives Market was developed in response to the need of insurance, reinsurance
and other financial companies to manage their bottom line exposure to major seasonal weather events,
such as hurricanes, that cause significant material damage.
– Carbon Derivatives are financial contracts with carbon dioxide emissions as the underlying. Since
carbon credits are earned by reduction in CO2 emissions, the Carbon Derivatives derive their value
from these reductions.
– Hedging is the most common method of price risk management. Hedging means reducing or controlling
risk. It entails using the futures market to take a position that balances the position in the physical
market with the objective of reducing or limiting risks associated with price changes.
SELF TEST QUESTION
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a commodity? What are its properties?
2. Explain various types of commodities.
3. What is contract farming? Briefly discuss.
4. What do you understand by Weather Derivative? Briefly explain how it works?
5. What is Hedging? How risk can be reduced by using hedge mechanism?
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Lesson 11
Commodities Market Operations 323
Lesson 11
Commodities Market Operations
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
Commodity Markets are an important aspect of
– Role of Commodity Exchanges
economic growth in most of the emerging
markets. Commodity Markets in India have also
– Evolution of Commodity Exchanges
witnessed rapid growth in the recent period. The
Forward Markets Commission (FMC), the
– Origin of Commodity Market in India
regulatory authority entrusted with the regulation
– Regulatory Framework
and development of commodity markets in India
– Forward Market Commission
has created
an extensive framework of
– Commodity Exchanges in India
development of institutions and intermediaries
regulation and market conduct along with
that led to impressive growth of commodity
– Participants/ Players
markets, including spot and futures exchanges,
– Trading in Commodity Market
warehouses and delivery points, quality
standards and specifications, specialized
– Order Types
investors, risk management products and
processes, and hedging tools and techniques.
– Electronic Spot Exchanges
In this background, it becomes important that
– Exchange Membership
awareness, information, and education on the
– Clearing and Settlement
functioning of commodity markets be required
to be provided to the students.
– Entities involved in phsical settlement
This lesson will enable the students to
– Instruments available for Trading
understand the knowhow of the Commodity
Market i.e. participants in the Commodity
– Using Commodity Exchanges for
Hedging, Speculation and Arbitrage
Market, Trading, Clearing and Settlement
Systems and Mechanisms at Commodity
– LESSON ROUND UP
Exchanges, instruments available for trading,
regulatory framework of Commodity Market in
– SELF TEST QUESTIONS
India etc.
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INTRODUCTION
Commodity Exchanges are defined as centers where futures trade is organized in a wider sense; it is taken to
include any organized market place where trade is routed through one mechanism, allowing effective competition
among buyers and among sellers. This would include auction-type exchanges, but not wholesale markets,
where trade is localized, but effectively takes place through many non-related individual transactions between
different permutations of buyers and sellers.
ROLE OF COMMODITY EXCHANGES
Commodity Exchanges provide platforms to suit the varied requirements of customers. Firstly, they help in price
discovery as players get to set future prices which are also made available to all participants. Hence, a farmer in
the southern part of India would be able to know the best price prevailing in the country which would enable him
to take informed decisions.
Secondly, these exchanges enable actual users (farmers, agro processors, industry where the predominant
cost is commodity input/output cost) to hedge their price risk given the uncertainty of the future - especially in
agriculture where there is uncertainty regarding the monsoon and hence prices. This holds good also for nonagro products like metals or energy products as well where global forces could exert considerable influence.
Purchasers are also assured of a fixed price which is determined in advance, thereby avoiding surprises to
them. It must be borne in mind that commodity prices in India have always been woven firmly into the international
fabric. Today, price fluctuations in all major commodities in the country mirror both national and international
factors and not merely national factors.
Thirdly, Commodity Exchanges provide liquidity and buoyancy to the system by involving the group of Investors
and Speculators.
Lastly, the arbitrageurs play an important role in balancing the market as arbitrage conditions, where they exist,
are ironed out as arbitrageurs trade with opposite positions on different platforms and hence generate opposing
demand and supply forces which ultimately narrows down the gaps in prices.
It must be pointed out that while the monsoon conditions affect the prices of agro-based commodities, the phenomenon
of globalization has made prices of other products such as metals, energy products, etc., vulnerable to changes in
global politics, policies, growth paradigms, etc. This would be strengthened as the world moves closer to the resolution
of the WTO impasse, which would become a reality shortly. Commodity exchanges would provide a valuable hedge
through the price discovery process while catering to the different kind of players in the market.
EVOLUTION OF COMMODITY EXCHANGES
Most of the Commodity Exchanges, which exist today, have their origin in the late 19th and earlier 20th century.
The first central exchange was established in 1848 in Chicago under the name Chicago Board of Trade. The
emergence of the derivatives markets as the effective risk management tools in 1970s and 1980s has resulted
in the rapid creation of new Commodity Exchanges and expansion of the existing ones. At present, there are
major Commodity Exchanges all over the world dealing in different types of commodities.
ORIGIN OF COMMODITY MARKET IN INDIA
Cotton was the first commodity to attract futures trading in the country leading to the setting up of the Bombay
Cotton Trade Association Ltd in 1875. It was the first organized futures market. Bombay Cotton Exchange Ltd.
was established in 1893 following the widespread discontent amongst leading cotton mill owners and merchants
over functioning of Bombay Cotton Trade Association. The Futures trading in oilseeds started in 1900 with the
establishment of the Gujarati Vyapari Mandali, which carried on futures trading in groundnut, castor seed and
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Commodities Market Operations 325
cotton. Futures trading in wheat was existent at several places in Punjab and Uttar Pradesh. But the most
notable futures exchange for wheat was Chamber of Commerce at Hapur set up in 1913. Futures trading in
bullion began in Mumbai in 1920. Calcutta Hessian Exchange Ltd. was established in 1919 for futures trading in
raw jute and jute goods. But organized futures trading in raw jute began only in 1927 with the establishment of
East Indian Jute Association Ltd. These two associations amalgamated in 1945 to form the East India Jute &
Hessian Ltd. to conduct organized trading in both Raw Jute and Jute goods. Forward Contracts (Regulation) Act
was enacted in 1952 and the Forwards Markets Commission (FMC) was established in 1953 under the Ministry
of Consumer Affairs and Public Distribution.
India was in an era of physical controls since independence. Agricultural commodities were associated with the
poor and were governed by policies such as Minimum Price Support and Government Procurement. Further, as
production levels were low and had not stabilized, there was the constant fear of misuse of these platforms
which could be manipulated to fix prices by creating artificial scarcities. This was also a period which was
associated with wars, natural calamities and disasters which invariably led to shortages and price distortions.
Hence, in an era of uncertainty with potential volatility, the government banned futures trading in commodities in
the 1960s. The Khusro Committee which was constituted in June 1980 had recommended reintroduction of
futures trading in most of the major commodities, including cotton, kapas, raw jute and jute goods and suggested
that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate
time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few
markets in Punjab and Uttar Pradesh.
With the gradual trade and industry liberalization of the Indian Economy pursuant to the adoption of the economic
reform package in 1991, Government of India constituted another committee on Forward Markets under the
chairmanship of Prof. K.N. Kabra. The committee recommended that some of the existing commodity exchanges
particularly the ones in pepper and castor seed, may be upgraded to the level of international futures markets.
The Expert Committee on Strengthening and Developing Agricultural Marketing (Guru Committee: 2001)
emphasized the need for and role of futures trading in price risk management and in marketing of agricultural
produce. This Committee's Group on Forward and Futures Markets recommended that it should be left to
interested exchanges to decide the appropriateness/usefulness of commencing futures trading in products (not
necessarily of just commodities) based on concrete studies of feasibility on a case-to-case basis. It, however,
noted that all the commodities are not suited for futures trading. For a commodity to be suitable for futures
trading it must possess some specific characteristics.
The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement
and distribution channel necessitated setting in place a market mechanism to perform the economic functions of
price discovery and risk management. The National Agriculture Policy announced in July 2000 and the
announcements of Hon'ble Finance Minister in the Budget Speech for 2002-2003 were indicative of the
Governments resolve to put in place a mechanism of futures trade/market. As a follow up, the Government
issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of these notifications
futures trading is not prohibited in any commodity. Options trading in commodity is, however presently
prohibited.
The year 2003 is a landmark in the history of commodity futures market witnessing the establishment and
recognition of three new national exchanges National Commodity and Derivatives Exchange of India Ltd. (NCDEX),
Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity Exchange of India Ltd. (NMCE)
with on-line trading and professional management. Not only was prohibition on forward trading completely
withdrawn, the new exchanges brought capital, technology and innovation to the market.
REGULATORY FRAMEWORK
After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated forward
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contracts in commodities all over India. The Act applies to goods, which are defined as any movable property
other than security, currency and actionable claims. The Act prohibited options trading in goods along with cash
settlements of forward trades. Under the Act, only those associations/exchanges, which are granted recognition
by the Government, are allowed to organize forward trading in regulated commodities. The Act envisages threetier regulation: (i) The Exchange which organizes forward trading in commodities can regulate trading on a dayto-day basis; (ii) the Forward Markets Commission provides regulatory oversight under the powers delegated to
it by the central Government, and (iii) the Central Government - Department of Consumer Affairs, Ministry of
Consumer Affairs, Food and Public Distribution - is the ultimate regulatory authority.
THREE-TIER REGULATORY SYSTEM
First tier: Central Government
Central Government has been given with highest authority to control FMC as well as Exchanges.
(a) It has powers to grant / withdraw recognition of Exchanges.
(b) It notifies the commodities under section 15,17 and 18(3).
(c) It supersedes the governing body of recognized association or exchange.
Second tier: Forward Market Commission
Forward Market Commission comes under the second tier of the authority hierarchy. It has control over Exchanges
and it works under the control of Central Government. In brief, it
(a) Approves Rules and Bye-laws of Exchanges.
(b) Grants trading permissions subject to appropriate regulatory.
(c) Monitors and surveys the markets.
(d) Conducts inspection of Exchanges and their Members.
(e) Appoints independent directors on the boards of Exchanges.
(f) May suspend a Member of the Exchange.
(g) Informs and assists Police Authorities in investigation and prosecution for illegal irregular trading.
Third tier: Exchanges
Functions of the exchanges are, –
(a) Conduct trading on the basis of the articles, Bye laws approved by the commission
(b) May take action against any intermediary.
FORWARD MARKET COMMISSION OF INDIA
The Forward Markets Commission is a regulatory body for Commodity Markets in India. The forward contracts
in commodities are regulated as per F.C.(R) Act, 1952 by this body. Inherent objective is to achieve price stability
by means of price discovery and risk management. The Commission also collects information regarding the
trading conditions in respect of goods to which any of provisions of Act is made applicable. It also advises
Central Government regarding recognition of associations.
Functions of Forward Market Commission of India
(a) To advice the Central Government in respect of the recognition or withdrawal of recognition from any
association. It also advices Government about any other matter arising out of the administration of this act.
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Commodities Market Operations 327
(b) Second function of the act includes the task of keeping forward markets under observation and take
necessary actions. The actions taken should be according to powers given to the commission by the
“Forward Contract Regulation Act”.
(c) To collect information regarding the trading conditions in respect of goods (to which any of the provisions
of this Act is made applicable) including information regarding supply, demand and prices. And publish
information whenever the Commission thinks it necessary,
It also performs the task of submitting to the Central Government periodical reports on the operation of
this Act and on the working of forward markets relating to such goods.
(d) To make recommendations generally with a view to improving the organization and working of forward
markets
(e) To undertake the inspection of the accounts and other documents of any recognized association or
registered association or any member of such association whenever it considers it necessary.
(f) To perform such specified duties and exercise assigned powers by the “Forward Contract Regulation
Act”.
Powers of Forward Market Commission
1. The Commission shall, in the performance of its functions, have all the powers of a civil court under the Code
of Civil Procedure, 1908, while trying a suit in respect of the following matters, namely:
(a) Summoning and enforcing the attendance of any person and examining him on oath
(b) Requiring the discovery and production of any document.
(c) Receiving evidence on affidavits.
(d) Requisitioning any public record or copy thereof from any office.
(e) Any other matters which may be prescribed.
2. The Commission shall have the power to require any person, subject to any privilege which may be claimed
by that person under any law for the time being in force, to furnish information on such points or matters as in
the opinion of the Commission may be useful for, or relevant to any matter under the consideration of the
Commission and any person so required shall be deemed to be legally bound to furnish such information within
the meaning of Sec. 176 of the Indian Penal code, 1860.
3. The Commission shall be deemed to be a civil court and when any offence described in Sections. 175, 178,
179, 180 or Sec. 228 of the Indian Penal Code, 1860 , is committed in the view or presence of the Commission,
the Commission may, after recording the facts constituting the offence and the statement of the accused as
provided for in the Code of Criminal Procedure, 1898 forward the case to a Magistrate having jurisdiction to try
the same and the Magistrate to whom any such case is forwarded shall proceed to hear the complaint against
the accused as if the case had been forwarded to him under Section 482 of the said Code.
4. Any proceeding before the Commission shall be deemed to be a judicial proceeding within the meaning of
Sections. 193 and 228 of the Indian Penal Code, 1860.
COMMODITY EXCHANGES IN INDIA
There are more than 20 recognised commodity futures exchanges in India under the purview of the Forward
Markets Commission (FMC). The country's commodity futures exchanges are divided majorly into two categories:
– National exchanges
– Regional exchanges
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The six exchanges operating at the national level are:
(i) National Commodity and Derivatives Exchange of India Ltd. (NCDEX)
(ii) National Multi Commodity Exchange of India Ltd. (NMCE)
(iii) Multi Commodity Exchange of India Ltd. (MCX)
(iv) Indian Commodity Exchange Ltd. (ICEX)
(v) Ace Derivatives and Commodity Exchange Limited
(vi) Universal Commodity Exchange Ltd.
The leading regional exchange is the National Board of Trade (NBOT) located at Indore. There are 16 regional
Commodity Exchanges in India.
Features
Some of the features of national and regional exchanges are listed below:
National Exchanges
– Compulsory online trading
– Transparent trading
– Exchanges to be de-mutualised
– Exchange recognised on permanent basis
– Multi commodity exchange
– Large expanding volumes
Regional Exchanges
– Online trading not compulsory
– De-mutualisation not mandatory
– Recognition given for fixed period after which it could be given for re regulation
– Generally, these are single commodity exchanges. Exchanges have to apply for trading each commodity.
– Low volumes in niche markets.
PARTICIPANTS/PLAYERS
Broadly, the participants in commodity market can be classified as Hedgers, Arbitraguers and Speculators. In
other words, manufacturers, traders, farmers, exporters and investors are all participating in this market.
HEDGERS
Hedger is the person who basically wants to avoid risk and enters into a contract with speculator. Hedger is a user of
the market, who enters into futures contract to manage the risk of adverse price fluctuation in respect of his existing
or future asset. Hedgers are those who have an underlying interest in the commodity and are using futures market to
insure themselves against adverse price fluctuations. Examples could be stockists, exporters, producers, etc
Hedging means taking a position in the futures or option market that is opposite to a position in the physical
market. It reduces or limits risks associated with unpredictable changes in price. The objective behind this
mechanism is to offset a loss in one market with a gain in another.
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Commodities Market Operations 329
Hedging is a mechanism by which the participants in the physical/ cash markets can cover their price risk.
Theoretically, the relationship between the futures and cash prices is determined by cost of carry. This enables
the participants in the physical/ cash markets to cover their price risk by taking opposite position in the futures
market.
Hedging is a mechanism of avoiding exposure to risk of fluctuating prices in futures markets will be effective only
when the following requirements are met.
– Driven by the demand and supply over a period the prices of cash and futures markets tend to move
together
– As the maturity date approaches, cash and futures prices tend to converge or reach a predictable
difference called the basis.
Hedging in the futures market in general is a two-step process, depending upon the hedger's cash market
situation
First step: If the hedger is going to buy a commodity in the cash market at a later time, his first step is to buy
futures contracts. Or if he is going to sell cash commodity at a later time, his first step in the hedging process is
to sell futures contracts.
Second step: when the cash market transaction takes place, the futures position is no longer needed for price
protection and should therefore be offset (closed out). Depending on the initial position taken long (long hedge)
or short (short hedge), hedger would offset his position by selling or buying back the futures contract. Both the
opening and closing positions must be for the same commodity, number of contracts, and delivery month.
For example, in June if a farmer expects an output of 100 tonnes of soyabean in October. Soyabean prices in
October are expected to rule relatively lower as it is harvesting season for soya bean. In order to hedge against
the price fall, the farmer/producer sells 100 contracts of one tonne each at ` 1347 on June 22. On a fall of price
to ` 1216 per tonne in October he makes a profit of ` 131 per tonne.
SPECULATOR
A trader, who trades or takes position without having exposure in the physical market, with the sole intention of
earning profit is a speculator. Speculators are those who may not have an interest in the ready contracts, etc. but
see an opportunity of price movement favourable to them. They are prepared to assume the risks, which the
hedgers are trying to cover in the futures market. They provide depth and liquidity to the market. They provide a
useful economic function and are an integral part of the futures the market. It would not be wrong to say that in
absence of speculators the market will not be liquid and may at times collapse.
A speculator is one who enters the market to profit from the future price movements. He does not have any
physical exposure. Speculators accept the risk that hedgers seek to avoid, giving the required liquidity to the
market.
Contrary to the hedging, speculation involves risk but no offsetting of cash market position. Speculators on the
other hand, wish to take risk that hedgers want to avoid with a motive to make profits and provide the necessary
liquidity through bids and offer that result into a continuous flow of transactions. Commodities are becoming
increasingly attractive to investor and hedge fund managers as an alternative asset class that may allow reduction
in overall risk of financial portfolio and enhance returns.
For example if an investor wants to diversify his investment portfolios, he can chose commodities as a bright
option. Unlike in spot markets, he has to invest only a margin amount instead of the total amount and can gain
profits to the total extent.
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Need of speculators in futures market
Participants in physical markets use futures market for price discovery and price risk management. In fact, in the
absence of futures market, they might speculate on prices in unorganized markets. Futures market helps them
to avoid speculation by entering into hedge contracts. It is however extremely unlikely for every hedger to find a
hedger counterpart with matching requirements. The hedgers intend to shift price risk, which they can only if
there are participants willing to accept the risk. Speculators are such participants who are willing to take risk of
hedgers in the expectation of making profit. Speculators provide liquidity to the market, therefore, it is difficult to
imagine a futures market functioning without speculators.
Difference between a speculator and gambler
Speculators are not gamblers, since they do not create risk, but merely accept the risk, which already exists in
the market. The speculators are the persons who try to assimilate all the possible price-sensitive information, on
the basis of which they can expect to make profit. The speculators therefore contribute in improving the efficiency
of price discovery function of the futures market.
ARBITRAGEURS
Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the
buying price by more than the transaction cost, resulting in risk-less profit to the arbitrageur. Arbitrage is making
purchases and sales simultaneously in two different markets to profit from the price differences prevailing in
those markets. The factors driving arbitrage are the real or perceived differences in the equilibrium price as
determined by supply and demand at various locations.
A third category of market participants is the arbitrageurs. Arbitrage is a risk-less profit realized by simultaneous
trading in two or more markets. However, arbitrage opportunities are very desirable but not easy to uncover, as
they do not last longer since the prices get adjusted soon with buying and selling
Arbitrage is possible when one of the three conditions is met:
– The same asset must trade at the different prices on all markets.
– Two assets with identical cash flows must trade at different prices.
– An asset with a known price in the future, must trade today at a different price than its future price
discounted at the risk-free interest rate.
COMMODITY PRODUCERS/CONSUMERS
These participants have natural underlying outright long (producers) and short (consumers) positions in the
relevant commodity. The inherent risk-exposure drives the use of commodity derivatives by producers and
users.
The application of commodity derivatives in frequently driven by the pattern of cash flows. Producers must
generally make significant capital investments (sometime significant in scale) to undertake the production of the
commodity. This investment must generally be made in advance of production and sale of the commodity. This
means that the producer is exposed to the price fluctuations in the commodity.
If prices decline sharply, then revenues may be insufficient to cover the cost of servicing the capital investment
(including debt service). This means that there is a natural tendency for producers to hedge at levels that ensure
adequate returns without seeking to optimize the potential returns from higher returns. This may also be
necessitated by the need to secure financing for the project.
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Commodities Market Operations 331
Commodity Processors
These participants have limited outright price exposure. This reflects the fact that the processors have a spread
exposure to the price differential between the cost of the input and the cost of the output. For example, oil
refiners are exposed to the differential between the price of the crude oil and the price of the refined oil products
(diesel, gasoline, heating oil, aviation fuel, etc.). The nature of the exposure drives the types of hedging activity
and the instruments used.
Commodity Traders
Commodity Markets have complex trading arrangements. This may include the involvement of trading companies.
Where involved, the traders act as an agent or principal to secure the sale/purchase of the commodity. Traders
increasingly seek to add value to pure trading relationship by providing derivative/risk management expertise.
Traders also occasionally provide financing and other services. Commodity traders have complex hedging
requirements, depending on the nature of their activities.
A trader as a pure agent will generally have no price exposure. Where a trader acts as a principal, it will generally
have outright commodity price risk that requires hedging. Where traders provide ancillary services such as
commodity derivatives as the principal, the market risk assumed will need to be hedged or managed.
Financial Institution/Dealers
Dealer participation in Commodity Markets is primarily as a provider of finance or provider of risk management
products. The dealers’ role is similar to that in the derivative market in other asset classes. The dealers provide
credit enhancement, speed, immediacy of execution and structural flexibility. Dealers frequently bundle risk
management products with other financial services such as provision of finance.
Investors
This covers financial investors seeking to invest in commodities as a distinct and a separate asset class of
financial investment. The gradual recognition of commodities as a specific class of investment assets is an
important factor that has influenced the structure of commodity derivatives markets.
TRADING IN COMMODITY MARKET
These are few important terms and its explanations which are essential for any person entering to trade in
commodities market.
Margin money
Margin money is the security deposit given by the trading members to the exchange in order to deal in different
contracts listed over there. The clients deposit this money with the members who in turn transfer it to the
respective exchanges.
The aim of margin money is to minimize the risk of default by either counter party. The amount of initial margin
is so fixed as to ensure that the probability of loss on account of worst possible price fluctuation (which cannot
be met by the amount of ordinary/initial margin) is very low. The Exchanges fix rates of ordinary/initial margin
keeping in view need to balance high security of contract and low cost of entering into contract.
In futures trading, the entire value of a contract need not be paid, rather a margin that is typically between 2 per
cent and 10 per cent of the total value of the contract need to be paid while entering into the contract.
It is part of the risk management system as prescribed by the market regulator, Forward Markets Commission
(FMC).
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Different types of margins payable on futures
Different margins payable on futures contracts are:
(i) ordinary/initial margin,
(ii) mark-to-market margin,
(iii) special margin,
(iv) volatility margin
(v) delivery margin
(i) Initial/ordinary margin: It is the amount required to be deposited by the market participants in his margin
account with clearing house before they can place order to buy or sell futures contracts. This must be maintained
throughout the time their position is open and is returnable at delivery, expiry or closing out.
When a futures trader enters into a futures position, he or she is required to post initial margin of an amount
specified by the exchange or clearing organization. Thereafter, the margin becomes "marked-to-market" and
the margin account will be adjusted automatically according to the changes in futures price
(ii) Mark-to-Market (MTM or M2M): At the end of every trading day, the margin account of the trader / client is
adjusted to reflect the participant’s gain or loss. The price changes on the close of every trading day may result
in some gain or loss as compared to the previous day’s closing price. These price variations are netted into the
daily margin account. This process is known as marking to the market.
Mark-to-market margins (MTM or M2M) are payable based on closing prices at the end of each trading day.
These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is
worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that
day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline
and pays to the sellers and vice versa.
Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when
futures price moves only in one direction. Hence the risk of default is reduced. Also, the participants are required to
pay less upfront margin - which is normally collected to cover the maximum, say, 99.9%, of the potential risk during
the period of mark-to-market, for a given limit on open position. Alternatively, for the given upfront margin the limit
on open position would have to be reduced, which has the effect of restraining the trade and liquidity.
(iii) Special Margin/Additional Margin: It is the additional margin imposed by the exchange to curb excess
volatility in the market. Again, this varies from commodity to commodity.
(iv) Maintenance margin: The minimum level at which the equity in a futures account must be maintained. If the
equity in an account falls below this level, a margin call will be issued, and funds must be added to bring the
account back to the initial margin level. The maintenance margin level generally is normally 75 per cent of the
initial margin requirement. If the amount of money in the margin account falls below the specified maintenance
margin, the futures trader will be required to post additional variation margin to bring the account up the initial
margin level and if the futures position is profitable, the profits will be added to the margin account.
(v) Delivery period margin: It is the extra margin imposed by the exchange on the contracts when it enters the
concluding phase (starts with tender period and goes up to delivery / settlement). This amount is applicable on
both the outstanding buy and sell positions.
ORDER TYPES
An electronic trading system allows the trading members to enter orders with various conditions attached to
them as per their requirements. These conditions are broadly divided in to the following categories.
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Commodities Market Operations 333
(i) Time conditions
(ii) Price conditions
(iii) Other conditions
(i) Time condition
Good till day order (GTO): A day order as the name suggests is an order which is valid for the day one which it
is entered . If the order is not executed during the day , the system cancels the order automatically at the end of
the day.
Good till cancelled (GTC) :GTC order remains in the system until the user cancels it. Consequently, it spans
trading days, if not traded on the day the order is entered.
Good till date (GTD): A GTD order allows the user to specify the date till which the order should remain in the
system if not executed.
Immediate or cancel ( IOC)/Fill or kill order: An IOC order allows the user to buy or sell a contract as soon as the
order is released in to the system,failing which the order is cancelled from the system . Partial match is possible
for the order, and the unmatched portion of the order is cancelled immediately.
(ii) Price condition
Limit order : An order to buy or sell a stated amount of commodity at a specified price , or at a better price , if
obtainable at the time of execution.
Stop loss order : A stop loss order is an order , placed with the broker , to buy or sell a particular futures contract
at the market price if and when the price reaches a specified level.Futures traders often use stop orders in an
effort to limit the amount they might lose if the futures price moves against their position.
(iii) Other Conditions
Market price : Market orders are orders for which no price is specified at the time the order is entered (Price is
market price).
Trigger price : Price at which an order gets triggered from stop loss book.
Spread order : A simple spread order involves two positions , one long and one short. They are taken in a same
commodity with different months( calendar spread) or in closely related commodities.
ELECTRONIC SPOT EXCHANGES
Electronic Spot Exchanges is an emerging phenomenon in the country .These spot exchanges provide real
time, online, transparent and vibrant spot platform for commodities. The contracts allow participants from all
over the country to buy and sell, thereby enabling producers and users to discover best price.
The Government has allowed the National Commodity Exchanges to set up three spot exchanges in the country,
namely the National Spot Exchange Ltd. (NSEL), NCDEX Spot Exchange Ltd. (NSPOT) and National Agriculture
Produce Marketing Company of India Ltd. (NAPMC). During 2009, there was significant expansion of spot
exchanges trading facilities in India. These spot exchanges have created an avenue for direct market linkage
among farmers, processors, exporters and end users with a view to reducing the cost of intermediation and
enhancing price realization by farmers. They will also provide the most efficient spot price inputs to the futures
exchanges. The spot exchanges will encompass the entire spectrum of commodities across the country and will
bring home the advantages of an electronic spot trading platform to all market participants in the agricultural and
non-agricultural segments. On the agricultural side, the exchanges would enable farmers to trade seamlessly
on the platform by providing real-time access to price information and a simplified delivery process, thereby
ensuring the best possible price. On the buy side, all users of the commodities in the commodity value chain
334 PP-CC&MM
would have simultaneous access to the exchanges and be able to procure at the best possible price. Therefore,
the efficiency levels attained as a result of such seamless spot transactions would result in major benefits for
both producers and consumers. In order to overcome current inefficiencies in the commodities spot market and
to bring transparency in trading in commodity spot markets, National Commodity and Derivatives Exchange
Limited (NCDEX) has set up an electronic spot exchange called NCDEX Spot Exchange Limited.
EXCHANGE MEMBERSHIP
The Commodity Exchange membership is open to any person, association of persons, partnerships, co-operative
societies, companies etc. that fulfills the eligibility criteria set by the Exchange. FIs, NRIs, Banks, MFs etc are
not allowed to participate in Commodity Exchanges at the moment. All the members of the Exchange have to
register themselves with the competent authority before commencing their operations. The members of commodity
exchange fall into following categories:
1. Trading cum Clearing Member (TCM) : Members can carry out the transactions (Trading, clearing and
settlement) on their own account and also on their clients' accounts. Applicants accepted for admission as TCM
are required to pay the requisite fees/ deposits and also maintain net worth as specified by the commodity
exchange.
2. Professional Clearing Members (PCM): Members can carry out the settlement and clearing for their clients
who have traded through TCMs or traded as TMs. Applicants accepted for admission as PCMs are required to
pay the requisite fee/ deposits and also maintain net worth.
3. Trading Member (TM ): Member who can only trade through their account or on account of their clients and
will however clear their trade through PCMs/STCMs.
4. Strategic Trading cum Clearing Member (STCM): This is up gradation from the TCM to STCM. Such
member can trade on their own account, also on account of their clients. They can clear and settle these trades
and also clear and settle trades of other trading members who are only allowed to trade and are not allowed to
settle and clear.
CLEARING AND SETTLEMENT
Most futures contracts do not lead to the actual physical delivery of the underlying asset. The settlement is done
by closing out open positions, physical delivery or cash settlement. All these settlement functions are taken care
of by an entity called clearing house or clearing corporation.
CLEARING
Clearing of trades that take place on an Exchange happens through the Exchange Clearing House. A clearing
house is a system by which Exchanges guarantee the faithful compliance of all trade commitments undertaken
on the trading floor or electronically over the electronic trading systems. The main task of the clearing house is
to keep track of all the transactions that take place during a day so that the net position of each of its members
can be calculated. It guarantees the performance of the parties to each transaction. Typically it is responsible for
the following:
1. Effecting timely settlement.
2. Trade registration and follow up.
3. Control of the open interest.
4. Financial clearing of the payment flow.
5. Physical settlement (by delivery) or financial settlement (by price difference) of contracts.
Lesson 11
Commodities Market Operations 335
6. Administration of financial guarantees demanded by the participants.
The clearing house has a number of members, who are responsible for the clearing and settlement of commodities
traded on the Exchange. The margin accounts for the clearing house members are adjusted for gains and
losses at the end of each day (in the same way as the individual traders keep margin accounts with the broker).
Everyday the account balance for each contract must be maintained at an amount equal to the original margin
times the number of contracts outstanding. Thus depending on a day's transactions and price movement, the
members either need to add funds or can withdraw funds from their margin accounts at the end of the day. The
brokers who are not the clearing members need to maintain a margin account with the clearing house member
through whom they trade.
Clearing Mechanism
Only clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts
through the clearing house. The clearing mechanism essentially involves working out open positions and
obligations of clearing members. This position is considered for exposure and daily margin purposes. The open
positions of PCMs are arrived at by aggregating the open positions of all the Trading Members clearing through
him, in contracts in which they have traded. A Trading-cum-Clearing Member's (TCM) open position is arrived at
by the summation of his clients' open positions, in the contracts in which they have traded. Client positions are
netted at the level of individual client and grossed across all clients, at the member level without any set-offs
between clients. Proprietary positions are netted at member level without any set-offs between client and
proprietary positions. After the trading hours on the expiry date, based on the available information, the matching
for deliveries takes place firstly, on the basis of locations and then randomly, keeping in view the factors such as
available capacity of the vault/ warehouse, commodities already deposited and dematerialized and offered for
delivery etc. Matching done by this process is binding on the clearing members. After completion of the matching
process, clearing members are informed of the deliverable/ receivable positions and the unmatched positions.
Unmatched positions have to be settled in cash. The cash settlement is only for the incremental gain/ loss as
determined on the basis of final settlement price.
Clearing Banks
Commodity exchange has designated clearing banks through whom funds to be paid and/ or to be received must
be settled. Every clearing member is required to maintain and operate a clearing account with any one of the
designated clearing bank branches. The clearing account is to be used exclusively for clearing operations i.e., for
settling funds and other obligations to commodity exchange including payments of margins and penal charges. A
clearing member having funds obligation to pay is required to have clear balance in his clearing account on or
before the stipulated pay-in day and the stipulated time. Clearing members must authorise their Clearing Bank to
access their clearing account for debiting and crediting their accounts as per the instructions of commodity exchange,
reporting of balances and other operations as may be required by commodity exchange from time to time.
The clearing bank will debit/ credit the clearing account of clearing members as per instructions received from
Commodity Exchange.
Depository participants
Every clearing member is required to maintain and operate two CM pool account each at NSDL and CDSL
through any one of the empanelled depository participants. The CM pool account is to be used exclusively for
clearing operations i.e., for effecting and receiving deliveries from Commodity Exchange.
SETTLEMENT
Settlement involves payments (Pay-Ins) and receipts (Pay-Outs) for all the transactions done by the members.
Trades are settled through the Exchange's settlement system.
336 PP-CC&MM
Future contracts have two types of settlements, the Mark-to-Market (MTM) settlement which happens on a
continuous basis at the end of each day, and the final settlement which happens on the last trading day of the
futures contract. For Instance, on the NCDEX, daily MTM settlement and final MTM settlement in respect of
admitted deals in futures contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the
respective clearing bank. All positions of a CM, either brought forward, created during the day or closed out
during the day, are marked to market at the daily settlement price or the final settlement price at the close of
trading hours on a day.
(i) Daily settlement price: Daily settlement price is the consensus closing price as arrived after closing session
of the relevant futures contract for the trading day. However, in the absence of trading for a contract during
closing session, daily settlement price is computed as per the methods prescribed by the Exchange from time to
time.
(ii) Final settlement price: Final settlement price is the polled spot price of the underlying commodity in the
spot market on the last trading day of the futures contract. All open positions in a futures contract cease to exist
after its expiration day.
Settlement Mechanism
Settlement of commodity future contracts is a little different from settlement of financial futures which are mostly
cash settled. The possibility of physical settlement makes the process a little more complicated.
(i) Daily mark to market settlement
Daily mark to market settlement is done till the date of the contract expiry. This is done to take care of daily price
fluctuations for all trades. All the open positions of the members are marked to market at the end of the day and
the profit/ loss is determined as below:
– On the day of entering into the contract, it is the difference between the entry value and daily settlement
price for that day.
– On any intervening days, when the member holds an open position, it is the difference between the daily
settlement price for that day and the previous day's settlement price.
– On the expiry date if the member has an open position, it is the difference between the final settlement
price and the previous day's settlement price.
The following explains the MTM for a member who buys one unit of December expiration Chilli contract at `6435
per quintal on December 15.
MTM on a long position in Chilli Futures
Date
Settlement Price
MTM
December 15
6320
-115
December 16
6250
-70
December 17
6312
+62
December 18
6310
-2
December 19
6315
+5
The unit of trading is 5 MT and each contract is for delivery of 5 MT. The member closes the position on December
19. The MTM profit/ loss per unit of trading show that the member makes a total loss of 1
` 20 per quintal of trading.
So upon closing his position, he makes a total loss of 6
` 000, i.e (5 x 120 x 10) on the long position taken by him.
The MTM profit and loss is settled through pay in/ pay out on T+1 basis, T being the trade day.
Lesson 11
Commodities Market Operations 337
(ii) Final settlement
On the date of expiry, the final settlement price is the closing price of the underlying commodity in the spot
market on the date of expiry (last trading day) of the futures contract. The spot prices are collected from polling
participants from base centre as well as other locations. The poll prices are bootstrapped and the mid-point of
the two boot strapped prices is the final settlement price. The responsibility of settlement is on a trading cum
clearing member for all trades done on his own account and his client's trades. A Professional Clearing Member
is responsible for settling all the participants' trades which he has confirmed to the Exchange. Members are
required to submit delivery information through delivery request window on the trader workstations provided by
commodity exchange for all open positions for a commodity for all constituents individually. This information can
be provided within the time notified by Exchange separately for each contracts. The commodity exchange on
receipt of such information matches the information and arrives at a delivery position for a member for a commodity.
A detailed report containing all matched and unmatched requests is provided to members through the extranet.
Pursuant to regulations relating to submission of delivery information, failure to submit delivery information for
open positions attracts penal charges as stipulated by the Commodity Exchange from time to time.
SETTLEMENT METHODS
Settlement of futures contracts on the commodity exchange can be done in two ways - by physical delivery of
the underlying asset and by closing out open positions. All contracts materialising into deliveries are settled in
a period as notified by the Exchange separately for each contract. The exact settlement day for each commodity
is specified by the Exchange through circulars known as 'Settlement Calendar'.
(a) Physical delivery of the underlying asset
If the buyer/seller is interested in physical delivery of the underlying asset, he must complete the delivery marking
for all the contracts within the time notified by the Exchange.
The following types of contracts are presently available for trading on the exchange Platform.
1. Compulsory Delivery
– Staggered Delivery
– Early Delivery
2. Seller's Right
3. Intention Matching
1. Compulsory Delivery Contract
Compulsory Delivery Contracts of Commodities are the contracts in which all the open positions on the expiry
date need to be compulsory settled through physical delivery.
On expiry of a compulsory delivery contract, all the sellers with open position shall give physical delivery of the
commodity. That is, the sellers need to deliver the commodity and buyers need to accept the delivery. To allocate
deliveries in the optimum location for clients, the members need to give delivery information for preferred location.
The information for delivery can be submitted during the trading hours of 3 trading days in advance of the expiry
date and up to 6 p.m. on the last day of marking delivery intention. For example, for contracts expiring on the
20th of the month, delivery intentions window will be open from the 18th and will close on the 20th.Clients can
submit delivery intentions up to the maximum of their open positions. In case the delivery intention is not marked
the seller would tender delivery from the base location.
Members will be allowed to submit one-time warehouse preference (default location). They can give even
multiple warehouse preferences. The same will be sent by the members to the Exchange. This preference will
338 PP-CC&MM
be applicable for all outstanding long and short client positions in that commodity. If the member does not mark
any specific location, the default preference will be applied for all open positions. Members can change the
default location preference on any day except the last 5 days before the expiry of the contract. For those
members, who have not submitted the preference of the default location, delivery will be marked on the base
location specified for the commodity.
After the trading hours on the expiry date, based on the available information, the delivery matching is done. All
corresponding buyers with open position as matched by the process put in place by the Exchange shall be
bound to settle his obligation by taking physical delivery. The deliveries are matched on the basis of open
positions and delivery information received by the Exchange. In the event of default by the seller, penalty as may
be prescribed by the Exchange from time to time would be levied. The sub-types of Compulsory Delivery Contracts
are (i) Staggered Delivery (ii) Early Delivery.
2. Sellers Right Contract
In Seller's Right contracts, delivery obligation is created for all valid sell requests received by the Exchange.
Simultaneously, the deliveries are allocated to the buyers with open positions on a random basis, irrespective of
whether a buy request has been submitted or not. While allocating the deliveries, preference is given to those
buyers who have submitted buy requests.
The information for delivery can be submitted during the trading hours of 3 trading days prior to 5 working days
of expiry of contracts. For example, for contracts expiring on the 20th of the month, delivery intentions window
will be open from the 13th and will close on the 15th. Clients can submit delivery intentions up to the maximum
of their open positions. All open positions of those sellers who fail to provide delivery intention information for
physical delivery shall be settled in cash.
In settling contracts that are physically deliverable, the clearing house:
– Assigns longs to shorts (no relationship to original counterparties)
– Provides a delivery venue
Successful matching of requests with respect to commodity and warehouse location results in delivery on
settlement day. After completion of the matching process, clearing members are informed of the deliverable/
receivable positions.
3. Intention Matching Contract
The delivery position for intention matching contract would be arrived at by the Exchange based on the
information to give/take delivery furnished by the seller and buyer as per the process put in place by the
Exchange for effecting physical delivery. If the intentions of the buyers and sellers match, the respective
positions would be settled by physical deliveries. The information for delivery can be submitted during the
trading hours of 3 trading days prior to 5 working days of expiry of contracts. For example, for contracts
expiring on the 20th of the month, delivery intentions window will be open from the 13th and will close on the
15th. Clients can submit delivery intentions up to the maximum of their open positions. On the expiry of the
contract, all outstanding positions not resulting in physical delivery shall be closed out at the Final Settlement
Price as announced by the Exchange.
(b) Closing out by offsetting positions
Most of the contracts are settled by closing out open positions. In closing out, the opposite transaction is effected
to close out the original futures position. A buy contract is closed out by a sale and a sale contract is closed out
by a buy. For example, an investor who took a long position in two gold futures contracts on January 30 at
`16090 per 10 grams, can close his position by selling two gold futures contracts on February 13, at `15928. In
this case, over the period of holding the position, he has suffered a loss of `162 per 10 grams. This loss would
Lesson 11
Commodities Market Operations 339
have been debited from his account over the holding period by way of MTM at the end of each day, and finally
at the price that he closes his position, that is `15928, in this case.
(c) Cash settlement
In the case of intention matching contracts, if the trader does not want to take/ give physical delivery, all open
positions held till the last day of trading are settled in cash at the final settlement price and with penalty in case
of Sellers Right contract. Similarly any unmatched, rejected or excess intention is also settled in cash. When a
contract is settled in cash, it is marked to the market at the end of the last trading day and all positions are
declared closed. For example, Paul took a short position in five Silver 5kg futures contracts of July expiry on
June 15 at `21500 per kg. At the end of 20th July, the last trading day of the contract, he continued to hold the
open position, without announcing delivery intention. The closing spot price of silver on that day was `20500 per
kg. This was the settlement price for his contract. Though Paul was holding a short position on silver, he did not
have to actually deliver the underlying silver. The transaction was settled in cash and he earned profit of ` 5000
per trading lot of silver.
ENTITIES INVOLVED IN PHYSICAL SETTLEMENT
Physical settlement of commodities involves the following three entities - an accredited warehouse, registrar &
transfer agent and an assayer.
Accredited Warehouse
The commodity exchange specifies accredited warehouses through which delivery of a specific commodity can
be effected and which will facilitate for storage of commodities. For the services provided by them, warehouses
charge a fee that constitutes storage and other charges such as insurance, assaying and handling charges or
any other incidental charges. Following are the functions of an accredited warehouse:
1. Earmark separate storage area as specified by the Exchange for the purpose of storing commodities to be
delivered against deals made on the Exchange. The warehouses are required to meet the specifications prescribed
by the Exchange for storage of commodities.
2. Ensure and co-ordinate the grading of the commodities received at the warehouse before they are stored.
3. Store commodities in line with their grade specifications and validity period and facilitate maintenance of
identity. On expiry of such validity period of the grade for such commodities, the warehouse has to segregate
such commodities and store them in a separate area so that the same are not mixed with commodities which
are within the validity period as per the grade certificate issued by the approved assayers.
Approved Registrar and Transfer agents (R&T agents)
The Exchange specifies approved R&T agents through whom commodities can be dematerialized and who
facilitate for dematerialization/rematerialization of commodities in the manner prescribed by the Exchange from
time to time. The R&T agent performs the following functions:
1. Establishes connectivity with approved warehouses and supports them with physical infrastructure.
2. Verifies the information regarding the commodities accepted by the accredited warehouse and assigns the
identification number (ISIN) allotted by the depository in line with the grade, validity period, warehouse location
and expiry.
3. Further processes the information, and ensures the credit of commodity holding to the demat account of the
constituent.
4. Ensures that the credit of commodities goes only to the demat account of the constituents held with the
Exchange empanelled DPs.
340 PP-CC&MM
5. On receiving a request for re-materialization (physical delivery) through the depository, arranges for issuance
of authorisation to the relevant warehouse for the delivery of commodities.
R&T agents also maintain proper records of beneficiary position of constituents holding dematerialized
commodities in warehouses and in the depository for a period and also as on a particular date. They are
required to furnish the same to the Exchange as and when demanded by the Exchange. R&T agents also do the
job of co-ordinating with DPs and warehouses for billing of charges for services rendered on periodic intervals.
They also reconcile dematerialized commodities in the depository and physical commodities at the warehouses
on periodic basis and co-ordinate with all parties concerned for the same.
Approved assayer
The Exchange specifies approved assayers through whom grading of commodities (received at approved
warehouses for delivery against deals made on the Exchange) can be availed by the constituents of clearing
members. Assayers perform the following functions:
1. Make available grading facilities to the constituents in respect of the specific commodities traded on the
Exchange at specified warehouse. The assayer ensures that the grading to be done (in a certificate format
prescribed by the Exchange) in respect of specific commodity is as per the norms specified by the Exchange in
the respective contract specifications.
2. Grading certificate so issued by the assayer specifies the grade as well as the validity period up to which the
commodities would retain the original grade, and the time up to which the commodities are fit for trading subject
to environment changes at the warehouses.
INSTRUMENTS AVAILABLE FOR TRADING
Forward Contract
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the
parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified
future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on
the same date for the same price. Other contract details like delivery date, price and quantity are negotiated
bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. The
salient features of forward contracts are:
1. They are bilateral contracts and hence exposed to counterparty risk.
2. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the
asset type and quality.
3. The contract price is generally not available in public domain.
4. On the expiration date, the contract has to be settled by delivery of the asset.
5. If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty, which
often results in high prices being charged.
However, forward contracts in certain markets have become very standardized, as in the case of foreign exchange,
thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches
its limit in the organized futures market.
Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of
an exporter who expects to receive payment in dollars three months later. He is exposed to the risk of exchange
rate fluctuations. By using the currency forward market to sell dollars forward, he can lock on to a rate today and
reduce his uncertainty. Similarly an importer who is required to make a payment in dollars two months hence
can reduce his exposure to exchange rate fluctuations by buying dollars forward.
Commodities Market Operations 341
Lesson 11
If a speculator has information or analysis, which forecasts an upturn in a price, then he can go long on the
forward market instead of the cash market. The speculator would go long on the forward, wait for the price to
rise, and then take a reversing transaction to book profits.
Limitations of Forward Markets
Forward markets world-wide are afflicted by several problems:
– Lack of centralization of trading,
– Illiquidity and
– Counterparty risk
In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a
real estate market in that any two consenting adults can form contracts against each other. This often makes them
design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable.
Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two
sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade standardized
contracts, and hence avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.
FUTURES
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an
agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike
forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the
futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract
with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be
delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement.
A futures contract may be offset prior to maturity by entering into an equal and opposite transaction.
The main standardized items in a futures contract are:
– Quantity of the underlying
– Quality of the underlying
– The date and the month of delivery
– The units of price quotation and minimum price change
– Delivery center
Distinction between Futures and Forward Contracts
Forward contracts are often confused with futures contracts. The confusion is primarily because both serve
essentially the same economic functions of allocating risk in the presence of future price uncertainty. However,
futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer
more liquidity. This can be clearly understood with the following:
Futures
Forward
1. Trade on an Organised Exchange
1.
OTC in nature
2. Standardized Contract terms
2.
Customised Contract terms
3. Hence mere liquid
3.
Hence less liquid
4. Required Margin Payments
4.
No Margin Payments
5. Follows daily settlement
5.
Settlement happens at end of period
342 PP-CC&MM
Futures Terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the futures market.
Contract cycle: The period over which a contract trades. The commodity futures contracts on the commodity
exchange have one month, two months, three months etc (not more than a year) expiry cycles. For example:
Most of the agri commodities futures contracts of NCDEX expire on the 20th day of the delivery month. Thus,
a January expiration contract expires on the 20th of January and a February expiration contract ceases to
exist for trading after the 20th of February. If 20th happens to be a holiday, the expiry date shall be the
immediately preceding trading day of the Exchange, other than a Saturday. New contracts for agri commodities
are introduced on the 10th of the month.
Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be
traded, at the end of which it will cease to exist.
Delivery unit: The amount of asset that has to be delivered under one contract. For instance, the delivery
unit for futures on Soybean on the NCDEX is 10 MT. The delivery unit for the Gold futures contract is 1 kg.
Basis: Basis is the difference between the futures price and the spot price. There will be a different basis for
each delivery month for each contract. In a normal market, futures prices exceed spot prices. Generally, for
commodities basis is defined as spot price -futures price. However, for financial assets the formula, future
price -spot price, is commonly used.
Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what
is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the
asset.
Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first
entered into is known as initial margin.
Marking-to-market (MTM): In the futures market, at the end of each trading day, the margin account is
adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking
to market.
Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance
in the margin account never becomes negative. If the balance in the margin account falls below the
maintenance margin, the investor receives a margin call and is expected to top up the margin account to the
initial margin level before trading commences on the next day.
OPTIONS
Options are fundamentally different from forward and futures contracts. An option gives the holder of the option
the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures
contract, the two parties have committed themselves in doing something. Whereas it costs nothing except
margin requirements to enter into a futures contract, the purchase of an option requires an up-front payment.
There are two basic types of options: call options and put options:
(i) Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for
a certain price.
(ii) Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for
a certain price.
Lesson 11
Commodities Market Operations 343
Option Terminology
Commodity options: Commodity options are options with a commodity as the underlying. For instance, a
gold options contract would give the holder the right to buy or sell a specified quantity of gold at the price
specified in the contract.
Stock options: Stock options are options on individual stocks. Options currently trade on over 500 stocks in
the United States. A contract gives the holder the right to buy or sell shares at the specified price.
Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but
not the obligation to exercise his option on the seller/ writer.
Writer of an option: The writer of a call/ put option is the one who receives the option premium and is
thereby obliged to sell/ buy the asset if the buyer exercises on him.
Option price: Option price is the price which the option buyer pays to the option seller. It is also referred to
as the option premium.
Expiration date: The date specified in the options contract is known as the expiration date, the exercise
date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the strike price or the exercise price.
American options: American options are options that can be exercised at any time upto the expiration date.
Most exchange-traded options are American.
European options: European options are options that can be exercised only on the expiration date itself.
In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to
the holder if it were exercised immediately. A call option on the index is said to be in-the- money when the
current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much
higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is
below the strike price.
At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow, if it were
exercised immediately. An option on the index is at-the money when the current index equals the strike price
(i.e. spot price = strike price)
Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative
cash flow, if it were exercised immediately. A call option on the index is out-of-the-money when the current
index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much
lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is
above the strike price.
Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value
and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its
intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max [0; (St - K)] which means the
intrinsic value of a call is the greater of 0 or (St - K). Similarly, the intrinsic value of a put is Max[0;K - St],i.e.
the greater of 0 or (K - St). K is the strike price and St is the spot price.
Time value of an option: The time value of an option is the difference between its premium and its intrinsic
value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the
maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an
option's time value, all else equal. At expiration, an option should have no time value.
344 PP-CC&MM
USING COMMODITY EXCHANGES FOR HEDGING, SPECULATION AND ARBITRAGE
For a market to succeed, it must have all three kinds of participants - hedgers, speculators and arbitrageurs. The
confluence of these participants ensures liquidity and efficient price discovery in the market. Commodity markets
give opportunity for all three kinds of participants.
HEDGING
Many participants in the commodity futures market are hedgers. They use the futures market to reduce a particular
risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals
in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price
of wheat around the time that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by
locking in to a predetermined price. Hedging does not necessarily improve the financial outcome; What it does
however is, that it makes the outcome more certain. Hedgers could be government institutions, private corporations
like financial institutions, trading companies and even other participants in the value chain, for instance farmers,
extractors, millers, processors etc., who are influenced by the commodity prices.
Basic Principles of Hedging
When an individual or a company decides to use the futures markets to hedge a risk, the objective is to take a
position that neutralizes the risk as much as possible. Take the case of a company that knows that it will gain
`1,00,000 for each 1 rupee increase in the price of a commodity over the next three months and will lose
`1,00,000 for each 1 rupee decrease in the price of a commodity over the same period. To hedge, the company
should take a short futures position that is designed to offset this risk. The futures position should lead to a loss
of `1,00,000 for each 1 rupee increase in the price of the commodity over the next three months and a gain of
`1,00,000 for each 1 rupee decrease in the price during this period. If the price of the commodity goes down, the
gain on the futures position offsets the loss on the commodity. If the price of the commodity goes up, the loss on
the futures position is offset by the gain on the commodity.
There are basically two kinds of hedges that can be taken. A company that wants to sell an asset at a particular
time in the future can hedge by taking short futures position. This is called a short hedge. Similarly, a company
that knows that it is due to buy an asset in the future can hedge by taking long futures position. This is known as
long hedge.
Short Hedge
A short hedge is a hedge that requires a short position in futures contracts. A short hedge is appropriate when
the hedger already owns the asset, or is likely to own the asset and expects to sell it at some time in the future.
For example, a short hedge could be used by a cotton farmer who expects the cotton crop to be ready for sale
in the next two months. A short hedge can also be used when the asset is not owned at the moment but is likely
to be owned in the future. For example, an exporter who knows that he or she will receive a dollar payment three
months later. He makes a gain if the dollar increases in value relative to the rupee and makes a loss if the dollar
decreases in value relative to the rupee. A short futures position will give him the hedge he desires.
Example: Assume that today is the 15th of January and that a refined soy oil producer has just negotiated a
contract to sell 10,000 Kgs of soy oil. It has been agreed that the price that will apply in the contract is the market
price on the 15th April. The oil producer is therefore in a position where he will gain `10000 for each 1 rupee
increase in the price of oil over the next three months and lose `10000 for each one rupee decrease in the price
of oil during this period. Suppose the spot price for soy oil on January 15 is `450 per 10 Kgs and the April soy oil
futures price on the commodity exchange e.g. NCDEX is `465 per 10 Kgs. The producer can hedge his exposure
by selling 10,000 Kgs worth of April futures contracts (1 unit). If the oil producers closes his position on April 15,
the effect of the strategy would be to lock in a price close to `465 per 10 Kgs. On April 15, the spot price can
either be above `465 or below `465.
Lesson 11
Commodities Market Operations 345
Case 1: The spot price is ` 455 per 10 Kgs. The company realises `4,55,000 under its sales contract. Because
April is the delivery month for the futures contract, the futures price on April 15 should be very close to the spot
price of ` 455 on that date. The company closes its short futures position at ` 455, making a gain of `465 - `455
= `10 per 10 Kgs, or ` 10,000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about ` 465 per 10 Kgs, `4,65,000 in total.
Case 2: The spot price is `475 per 10 Kgs. The company realises `4,75,000 under its sales contract. Because
April is the delivery month for the futures contract, the futures price on April 15 should be very close to the spot
price of `475 on that date. The company closes its short futures position at ` 475, making a loss of `475 - `465
= `10 per 10 Kgs, or ` 10,000 on its short futures position. The total amount realized from both the futures
position and the sales contract is therefore about ` 465 per 10 Kgs, ` 4,65,000 in total.
Long Hedge
Hedges that involve taking a long position in a futures contract are known as long hedges. A long hedge is
appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a
price now.
Suppose that it is now January 15. A firm involved in industrial fabrication knows that it will require 300 kgs of
silver on April 15 to meet a certain contract. The spot price of silver is `26800 per kg and the April silver futures
price is ` 27300 per kg. A unit of trading is 30 kgs. The fabricator can hedge his position by taking a long position
in ten units of futures on the NCDEX. If the fabricator closes his position on April 15, the effect of the strategy
would be to lock in a price close to ` 27300 per kg. On April 15, the spot price can either be above ` 27300 or
below ` 27300 per kg.
Case 1: The spot price is ` 27800 per kg. The fabricator pays ` 83,40,000 to buy the silver from the spot market.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very close to
the spot price of ` 27800 on that date. The company closes its long futures position at ` 27800, making a gain of
`27800 - `27300 = `500 per kg, or ` 1,50,000 on its long futures position. The effective cost of silver purchased
works out to be about ` 27300 per Kg, or `81,90,000 in total.
Case 2: The spot price is ` 26900 per Kg. The fabricator pays `80,70,000 to buy the silver from the spot market.
Because April is the delivery month for the futures contract, the futures price on April 15 should be very close to
the spot price of ` 26900 on that date. The company closes its long futures position at ` 26900, making a loss of
`27300 - `26900 = `400 per kg, or `1,20,000 on its long futures position. The effective cost of silver purchased
works out to be about ` 27300 per Kg, or `81,90,000 in total.
Advantages of Hedging
Besides the basic advantage of risk management, hedging also has other advantages:
1. Hedging stretches the marketing period. For example, a livestock feeder does not have to wait until his
cattle are ready to market before he can sell them. The futures market permits him to sell futures
contracts to establish the approximate sale price at any time between the time he buys his calves for
feeding and the time the fed cattle are ready to market, some four to six months later. He can take
advantage of good prices even though the cattle are not ready for market.
2. Hedging protects inventory values. For example, a merchandiser with a large, unsold inventory can sell
futures contracts that will protect the value of the inventory, even if the price of the commodity drops.
3. Hedging permits forward pricing of products. For example, a jewellery manufacturer can determine the
cost for gold, silver or platinum by buying a futures contract, translate that to a price for the finished
products, and make forward sales to stores at firm prices. Having made the forward sales, the
manufacturer can use his capital to acquire only as much gold, silver, or platinum as may be needed to
make the products that will fill its orders.
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SPECULATION
An entity having an opinion on the price movements of a given commodity can speculate using the commodity
market. While the basics of speculation apply to any market, speculating in commodities is not as simple as
speculating on stocks in the financial market. For a speculator who thinks the shares of a given company will
rise, it is easy to buy the shares and hold them for whatever duration he wants to. However, commodities are
bulky products and come with all the costs and procedures of handling these products. The commodities futures
markets provide speculators with an easy mechanism to speculate on the price of underlying commodities.
To trade commodity futures on the commodity exchange , a customer must open a futures trading account with
a commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables futures
traders to take a position in the underlying commodity without having to actually hold that commodity. With the
purchase of futures contract on a commodity, the holder essentially makes a legally binding promise or obligation
to buy the underlying security at some point in the future (the expiration date of the contract). We look here at
how the commodity futures markets can be used for speculation.
Speculation: Bullish Commodity, Buy Futures
Take the case of a speculator who has a view on the direction of the price movements of gold.If He knows that
towards the end of the year due to festivals and the upcoming wedding season, the prices of gold are likely to
rise, he would like to trade based on this view. Gold trades for ` 16000 per 10 gms in the spot market and he
expects its price to go up in the next two-three months. How can he trade based on this belief? In the absence
of a deferral product, he would have to buy gold and hold on to it. Suppose he buys a 1 kg of gold which costs
him ` 16,00,000. Suppose further that his hunch proves correct and three months later gold trades at ` 17000
per 10 grams. He makes a profit of ` 1,00,000 on an investment of ` 16,00,000 for a period of three months. This
works out to an annual return of about 25 percent.
Today a speculator can take exactly the same position on gold by using gold futures contracts. Let us see how
this works. Gold trades at ` 16,000 per 10 gms and three-month gold futures trades at ` 16,650 per 10 gms. The
unit of trading is 1 kg and the delivery unit for the gold futures contract on the commodity exchange is 1 kg. He
buys one kg of gold futures which have a value of ` 16,65,000. Buying an asset in the futures market only
require making margin payments. To take this position, suppose he pays a margin of ` 1,66,500. Three months
later gold trades at ` 17,000 per 10 gms. On the day of expiration, the futures price converges to the spot price
(else there would be a risk-free arbitrage opportunity). He closes his long futures position at ` 17,000 in the
process making a profit of ` 35,000 on an initial margin investment of ` 1,66,500. This works out to an annual
return of 85 percent. Because of the leverage they provide, commodity futures form an attractive tool for
speculators.
Speculation: Bearish Commodity, Sell Futures
Commodity futures can also be used by a speculator who believes that there is likely to be excess supply of a
particular commodity in the near future and hence the prices are likely to see a fall. How can he trade based on
this opinion? In the absence of a deferral product, there wasn't much he could do to profit from his opinion.
Today all he needs to do is sell commodity futures.
Let us understand how this works:
Simple arbitrage ensures that the price of a futures contract on a commodity moves correspondingly with the
price of the underlying commodity. If the commodity price rises, so will the futures price. If the commodity
price falls, so will the futures price. Now take the case of the trader who expects to see a fall in the price of
pepper. Suppose price of pepper is `14000 per quintal and he sells two pepper futures contract which is for
delivery of 2 MT of pepper (1MT each). The value of the contract is ` 2,80,000. He pays a small margin on the
same. Three months later, if his hunch was correct the price of pepper falls. So does the price of pepper
Lesson 11
Commodities Market Operations 347
futures. He close out his short futures position at ` 13000 per quintal i.e. ` 2,60,000 making a profit of `
20,000.
ARBITRAGE
A central idea in modern economics is the law of one price. This states that in a competitive market, if two assets
are equivalent from the point of view of risk and return, they should sell at the same price. If the price of the same
asset is different in two markets, there will be operators who will buy in the market where the asset sells cheap
and sell in the market where it is costly. This activity termed as arbitrage, involves the simultaneous purchase
and sale of the same or essentially similar security in two different markets for advantageously different prices.
The buying cheap and selling expensive continues till prices in the two markets reach an equilibrium.
Overpriced Commodity Futures: Buy Spot, Sell Futures
An arbitrager notices that gold futures seem overpriced. How can he cash in on this opportunity to earn risk less
profits? Say for instance, gold trades for ` 1600 per gram in the spot market. Three month gold futures on the
commodity exchange trade at `1685 per gram and seem overpriced. He could make risk less profit by entering
into the following set of transactions.
On day one, borrow ` 1,60,05,100 at 6% per annum to cover the cost of buying and holding gold. Buy 10 kgs of
gold on the cash/ spot market at ` 1,60,00,000. Pay `5100 (approx) as warehouse costs.
Simultaneously, sell 10 gold futures contract at ` 1,68,50,000.
Take delivery of the gold purchased and hold it for three months.
On the futures expiration date, the spot and the futures price converge. Now unwind the position.
Say gold closes at ` 1635 per gram in the spot market. Sell the gold for ` 1,63,50,000.
Futures position expires with profit of ` 5,00,000.
From the ` 1,68,50,000 held in hand, return the borrowed amount plus interest of ` 1,62,46,986.
The result is a risk less profit of ` 6,04,014.
If the cost of borrowing funds to buy the commodity is less than the arbitrage profit possible, it makes sense to
arbitrage. This is termed as cash-and-carry arbitrage. Exploiting an arbitrage opportunity involves trading on the
spot and futures market. In the real world, one has to build in the transactions costs into the arbitrage strategy.
Underpriced Commodity Futures: Buy Futures, Sell Spot
An arbitrageur notices that gold futures seem underpriced. How can he cash in on this opportunity to earn risk
less profits? Say for instance, gold trades for `1600 per gram in the spot market. Three month gold futures on
the commodity exchange trade at ` 1620 per gram and seem underpriced. If he happens to hold gold, he could
make risk less profit by entering into the following set of transactions.
On day one, sell 10 kgs of gold in the spot market at ` 1,60,00,000.
Invest the ` 1,60,00,000 plus the `5100 saved by way of warehouse costs for three months 6%.
Simultaneously, buy three-month gold futures on NCDEX at `1,62,00,000.
Suppose the price of gold is `1635 per gram. On the futures expiration date, the spot and the futures price of
gold converge. Now unwind the position.
The gold sales proceeds grow to ` 1,62,46,986.
The futures position expires with a profit of ` 1,50,000.
Buy back gold at `1,63,50,000 on the spot market.
348 PP-CC&MM
The result is a risk less profit of ` 46,986.
When the futures price of a commodity appears underpriced in relation to its spot price, an opportunity for
reverse cash and carry arbitrage arises. It is this arbitrage activity that ensures that the spot and futures prices
stay in line with the cost-of-carry.
LESSON ROUND UP
– Commodity exchanges are defined as centers where futures trade is organized in a wider sense; it is
taken to include any organized market place where trade is routed through one mechanism, allowing
effective competition among buyers and among sellers.
– The year 2003 is a landmark in the history of commodity futures market witnessing the establishment
and recognition of three new national exchanges National Commodity and Derivatives Exchange of
India Ltd. (NCDEX), Multi Commodity Exchange of India Ltd (MCX) and National Multi Commodity
Exchange of India Ltd. (NMCE)] with on-line trading and professional management.
– The Forward Markets Commission is a regulatory body for Commodity Markets in India.
– There are more than 20 recognised commodity futures exchanges in India under the purview of the
Forward Markets Commission (FMC).
– Broadly, the participants in commodity market can be classified as Hedgers, Arbitraguers and
Speculators.
– An electronic trading system allows the trading members to enter orders with various conditions attached
to them as per their requirements.
– Electronic spot exchanges is an emerging phenomenon in the country .These spot exchanges provide
real time, online, transparent and vibrant spot platform for commodities.
– The Commodity Exchange membership is open to any person, association of persons, partnerships,
co-operative societies, companies etc. that fulfills the eligibility criteria set by the Exchange.
– The settlement is done by closing out open positions, physical delivery or cash settlement. All these
settlement functions are taken care of by an entity called clearing house or clearing corporation.
– Settlement of commodity futures contracts is a little different from settlement of financial futures which
are mostly cash settled.
– Futures contracts have two types of settlements, the Mark-to-Market (MTM) settlement which happens
on a continuous basis at the end of each day, and the final settlement which happens on the last
trading day of the futures contract.
– Physical settlement of commodities involves the following three entities - an accredited warehouse,
registrar & transfer agent and an assayer.
– There are various instruments available for trading on Commodity exchange like forward, future, options
etc.
SELF TEST QUESTION
(These are meant for recapitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is a Commodity Exchange? Briefly discuss the role of a Commodity Exchange.
2. Discuss about the various participants involved in Commodity Market.
Lesson 11
Commodities Market Operations 349
3. What is an Electronic Spot Exchange? Explain the important functions performed by them.
4. Briefly explain about the various entities involved in physical settlement of commodities.
5. What is long hedge? Explain with the help of an example.
350 PP-CC&MM
Lesson 12
Money Market
LESSON OUTLINE
Lesson 12
Money Market 351
LEARNING OBJECTIVES
– Introduction
The Money Market is a market for short term
funds with maturity ranging from overnight to
one year and includes instruments that are
deemed to be close substitutes of money. The
Money Market is a key component of the
financial system as it is the fulcrum of the
monetary operations conducted by the RBI in
its pursuit of monetary policy objectives. As the
Central Bank, RBI regulates the Money Market
in India and injects liquidity in the banking
system. Important institutions operating in the
money market are central banks, commercial
banks, acceptance house, non-banking
financial institutions, bill brokers etc.
– Features of Money Market
– Money Market vs. Capital Market
– Growth of Money Market
– Structure and Institutional Development
– Money Market Instruments
– Government Securities
– Gift edged (Govt.) Securities
– Call Money and Notice Money
– Term Money
– Bill Discounting
– Bill Rediscounting Scheme(BRD)
The objective of this lesson is to provide the
students with basic understanding of Money
Market, its distinct features, various instruments
available in the Money Market, .difference
between Money Market and Capital Market,
instruments used in financing import and export
etc.
– Repurchase Agreements
– Banker’s Acceptance
– Treasury Bills
– Certificate of Deposit
– Inter-Corporate Deposit
– Commercial Bills
– Commercial Paper
– Money Market Mutual Funds(MMMFs)
– Factoring
– Letter of Credit
– Bills of Exchange
– LESSON ROUND UP
– SELF TEST QUESTIONS
351
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INTRODUCTION
Money Market is a very important segment of a financial system. It is the market for dealing in monetary assets
of short-term nature. Short-term funds up to one year and financial assets that are close substitutes for money
are dealt in the Money Market. Money Market instruments have the characteristics of liquidity (quick conversion
into money), minimum transaction cost and no loss in value. Excess funds are deployed in the Money Market,
which in turn is availed of to meet temporary shortages of cash and other obligations. Money Market provides
access to providers and users of short-term funds to fulfill their investments and borrowings requirements
respectively at an efficient market clearing price. It performs the crucial role of providing an equilibrating mechanism
to even out short-term liquidity, surpluses and deficits and in the process, facilitates the conduct of monetary
policy. The Money Market is one of the primary mechanism through which the Central Bank (RBI) influences
liquidity and the general level of interest rates in an economy. The Bank’s interventions to influence liquidity
serve as a signaling-device for other segments of the financial system.
The Money Market functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
Funds are available in this market for periods ranging from a single day upto a year. Mostly Government, banks
and financial institutions dominate this market. It is a formal financial market that deals with short-term fund
management.
Though there are a few types of players in Money Market, the role and the level of participation by each type of
player differs largely.
Government is an active player in the Money Market and in most of the economies; it constitutes the biggest
borrower in this market. Both, Government securities (G-secs) and Treasurybill (T-bill) is a security issued by
RBI on behalf of the Government of India to meet the latter’s borrowing for financing fiscal deficit. Apart from
functioning as a banker to the government, the central bank (RBI) also regulates the Money Market and issues
guidelines to govern the Money Market operations.
Another dominant player in the Money Market is the banking industry. Banks mobilize deposits of savers in
lending to investors of the economy. This process is known as credit creation. However, banks are not allowed
to lent out the entire amount for extending credit for investment. In order to promote certain prudential norms for
healthy banking practices, most of the developed economies require all commercial banks to maintain minimum
liquid and cash reserves in form of Statutory Liquid Ratio (SLR) and Cash Reserve Ratio (CRR) framed under
the policies of central banks. The banks are required to ensure that these reserve requirements are met before
directing deposits on their credit plans. If banks fall short of these statutory reserve requirements, the deficit
amount can be raised using the Money Market.
Other institutional players like financial institutions, corporates, mutual funds (MFs), Foreign Institutional Investors
(FIIs) etc. also transact in Money Market to fulfill their respective short term finance deficits and short falls.
However, the degree of participation of these players depends largely on the regulations formulated by the
regulating authorities in an economy. For instance, the level of participation of the FIIs in the Indian Money
Market is restricted to investment in Government securities only.
FEATURES OF MONEY MARKET
The Money Market is a wholesale market where the volumes of transactions is very large and is settled on a
daily basis. Trading in the Money Market is conducted over the telephone, followed by written confirmation
through e-mails, texts from the borrowers and lenders.
There are a large number of participants in the Money Market: commercial banks, mutual funds, investment
institutions, financial institutions and finally the Reserve Bank of India. The bank's operations ensure that the
liquidity and short-term interest rates are maintained at levels consistent with the objective of maintaining price
Lesson 12
Money Market 353
and exchange rate stability. The Central Bank occupies a strategic position in the Money Market. The Money
Market can obtain funds from the central bank either by borrowing or through sale of securities. The bank
influences liquidity and interest rates by open market operations, REPO transactions changes in Bank Rate,
Cash Reserve Requirements and by regulating access to its accommodation. A well-developed Money Market
contributes to an effective implementation of the monetary policy. It provides:
1. A balancing mechanism for short-term surpluses and deficiencies.
2. A focal point of central bank intervention for influencing liquidity in the economy, and
3. A reasonable access to the users of short-term funds to meet their requirements at realistic/reasonable price
or cost.
Things You May Know
CRR : Cash Reserve Ratio is the cash parked by the banks in their specified account maintained with RBI.
SLR : Statutory Liquid Ratio is in the form of cash (book value), gold (current market value) and balances in
unencumbered approved securities.
MONEY MARKET Vs. CAPITAL MARKET
The Money Market possesses different operational features as compared to Capital Market. Money Market is
distinguished from Capital Market on the basis of the maturity period, credit instruments and the institutions:
(i) Maturity Period: The Money Market deals in the lending and borrowing of short-term finance varying for one
year or less, while the Capital Market deals in the lending and borrowing of long-term finance for more than one
year.
(ii) Credit Instruments: The main credit instruments of the Money Market are Call Money, Treasury Bills,
Commercial Bills, Commercial Papers, and Bills of Exchange. On the other hand, the main instruments used in
the Capital Market are Stocks, Shares, Debentures, Bonds, Corporate Deposits etc.
(iii) Institutions: Important institutions operating in the Money Market are central banks, commercial banks,
acceptance houses, non banking financial institutions, bill brokers, etc. Important institutions of the Capital
Market are stock exchanges, commercial banks and non banking institutions, such as insurance companies,
mortgage banks, etc.
(iv) Purpose of Loan: The Money Market meets the short-term credit needs of business; it provides working
capital to the industrialists. The Capital Market, on the other hand, caters the long-term credit needs of the
industrialists and provides fixed capital to buy land, machinery, etc.
(v) Risk and Liquidity: The degree of risk is small and that of liquidity is higher in the Money Market as compared
to the higher risk and lower liquidity in the Capital Market.
(vi) Role of Central Bank: The central bank closely and directly has impact on the Money Market and its participants
by framing its regulations and deciding various rates of interests that has impact on the parameters of an economy,
while in case of Capital Market, Central Bank has an indirect link through other regulators like SEBI.
(vii) Market Regulation: In the Money Market, commercial banks are closely regulated. In the Capital Market,
the institutions are not much regulated.
GROWTH OF MONEY MARKET
Post reforms period in India has witnessed tremendous growth of the Indian Money Markets. Banks and other
financial institutions have been able to meet the high expectations of short term funding of important sectors like
the industry, services and agriculture. Functioning under the regulation and control of the Reserve Bank of India
(RBI), the Indian Money Market have also exhibited the required maturity and resilience over the years.
354 PP-CC&MM
The organization and structure of the Money Market has undergone a sea change in the last decade in India.
This was accompanied by a growth in quantitative terms also.
Up to 1987, the Money Market consisted of 6 facets :
1. Call Money Market;
2. Inter Bank Term Deposit/Loan Market;
3. Participation Certificate Market;
4. Commercial Bills Market;
5. Treasury Bills Market; and
6. Inter-corporate Market.
The market had 3 main deficiencies:
1. It had a very narrow base with RBI, Banks, LIC and UTI as the only participants lending funds while the
borrowers were large in number;
2. There were only few Money Market instruments.
3. The interest rates were not market determined but were controlled either by RBI or by a voluntary
agreement between the participants through the Indian Banks Association (IBA).
To set right these deficiencies, the recommendations of Chakravarthy Committee (1985) and the Vaghul Committee
(1987) laid foundation for systematic development of the Indian Money Market. The implementation of the
suggestions of the respective committees has widened and deepened the market considerably by increasing
the number of participants and instruments and introducing market determined rates as against the then existing
administered or volunteered interest rates.
Further, an active secondary market for dealings of Money Market instrument was created which positively
impacted the liquidity of these instruments. For this purpose, the Discount and Finance House of India Limited
(DFHI) was formed as an autonomous financial intermediary in April, 1988 to embellish the short-term liquidity
imbalances and to develop an active secondary market for the trading of instruments of the Money Market. The
DFHI plays the role of a market maker in Money Market instruments. With the relaxation of the regulatory
framework and the arrival of new instruments and participants, DFHI occupies a key role in ushering a more
active and de-regulated Money Market.
STRUCTURE AND INSTITUTIONAL DEVELOPMENT
The following diagram depicts the important segments and inter-relation in the Money Market:
Bankers’
Acceptances
Market
Commercial
Paper
Market
Treasury
Bill
Market
Call
Money
Market
|
|
|
|
|
|
|
|
|
|
|
|
MO N EYMAR KET
The Indian Money Market consists of two types of segments: an organized segment and an unorganized segment.
In the unorganized segment interest rates are much higher than that in the organized segment.
Lesson 12
Money Market 355
The organized segment consists of the Reserve Bank of India, State Bank of India with its associate Banks,
Public Sector Banks, Private Sector Commercial Banks including Foreign Banks, Regional Rural Banks, NonScheduled Commercial Banks, apart from Non-banking Financial Intermediaries such as LIC, GIC etc.
The unorganized segment essentially consists of indigenous bankers, money lenders and other non-bank financial
intermediaries such as Chit Funds. The share of the unorganized sector in providing trade finance has greatly
diminished after the Nationalization of Bank and expansion thereof into the length and breadth of the country.
Money Market
Organised Segment
RBI, SBI, Associate banks, Public Sector Banks,
Private Sector Commercial Banks,
Foreign banks, Regional Rural Banks,
Non Schedule Commercial Banks,
LIC, GIC, UTI etc.
Unorganised Segment
Indigenous Bankers, Money Lenders,
Non-bank financial intermediaries
such as chit funds.
MONEY MARKET INSTRUMENTS
Money Market instruments mainly include Government securities, securities issued by private sector and banking
institutions –
– Government Securities
– Gilt-edged (Government ) Securities
– Repo Market
– Money at Call and Short Notice
– Bills Rediscounting
– Money Market Mutual Funds
– Call Money Market and Short-term Deposit Market
– Treasury Bills
– Certificates of Deposits
– Inter-Corporate Deposits
– Commercial Bills
– Commercial Paper
GOVERNMENT SECURITIES
The Reserve Bank of India issues securities on behalf of the Government. The term Government Securities
includes Central Government Securities, State Government Securities and Treasury Bills. The different types of
Government Securities are –
356 PP-CC&MM
Dated
Zero
Partly Paid
Floating Rate
Capital Indexed
Securities
Coupon Bonds
Stock
Bonds
Bonds
Issued at
Issued at
Issued at face
Issued at
Issued at
face value
discount to the
face value
value, but paid
in installments
face value
face value
over a period
Interest or
Do not carry
Interest or coupon
Interest rate is
Interest rate is fixed
coupon rate is
fixed at the
any interest rate
rate is fixed at the
time of issuance,
fixed as a
percentage over a
as a percentage
over the
time of issuance,
and remains
and remains
constant till
predefined
benchmark rate
wholesale
price index at
constant till
redemption of
redemption of
the security
which may be
Treasury bill, bank
the time of
issuance.
the security
rate etc at the
time of issuance
The tenor
of security
The tenor
of security
The tenor
of security
The tenor
of security
The tenor
of security
is fixed
is fixed
is fixed
is fixed
is fixed
The security
The security
The security
The security
The principal
is redeemed at
par (face value)
is redeemed at
par (face value)
is redeemed at
par (face value)
is redeemed at
par (face value)
redemption is
linked to the
on its
maturity date
on its
maturity date
on its
maturity date
on its
maturity date
Wholesale
Price Index.
GILT-EDGED (GOVERNMENT) SECURITIES
Gilt-edged (Government) Securities have great demand by the banks to maintain the Net Demand and Time
Liquidities (NDTL) position of the bank through its buying and selling. These securities are issued by Governments
such as Central and State Governments, Semi-Government Authorities, Municipalities etc. They are long dated
securities and held by the RBI. These issues are notified a few days before opening for subscription and offer is
kept open for two to three days. The rate of interest is lower but it is payable half yearly.
CALL MONEY AND NOTICE MONEY
Call Money is a Money Market instrument wherein funds are borrowed / lent for a tenor of one day overnight
(excluding Sundays/holidays). Notice Money is a Money Market instrument, where the tenor is more than 1 day
but less than 15 days. The borrower/lender must convey his intention to repay/recall the amount borrowed/lent
with at least 24 hours notice.
Features
– Interest is calculated on Actual / 365 day basis.
– Interest payable to be rounded off to the nearest rupee.
– Interest on the amount borrowed/lent =
Amount borrowed/lent *No. of days * Rate of Interest
365 * 100
Lesson 12
Money Market 357
Settlement
The borrower of funds will collect the cheque and hand over the deposit receipt to the lender on the value date
of the deal. On the due date, the lender will give back the deposit receipt to and collect the cheque from the
borrower.
TERM MONEY
Money lent for a fixed tenor of 15 days or more is called Term Money.
Features
– Interest to be calculated on Actual / 365 day basis.
– Interest payable to be rounded off to the nearest rupee.
– Periodicity for payment of interest can be Quarterly/Half Yearly/on redemption, as agreed to at the time
of the deal.
– Interest on the amount borrowed/lent =
Amount borrowed/lent *No. of days * Rate of Interest
365 * 100
– Premature cancellation after 14 days can be done by mutual consent on mutually agreed terms.
– No loan/overdraft can be granted against Term Money.
Settlement
The borrower of funds will collect the cheque and hand over the deposit receipt to the lender on the value date
of the deal. On the due date, the lender will give back the deposit receipt to and collect the cheque from the
borrower. In case the maturity of term money falls on a holiday, the repayment will be made on the next working
day. Additional interest will be paid for such period on the amount borrowed (principal only) at the contracted
rate.
BILL DISCOUNTING
Bill Discounting is a short tenure financing instrument for companies willing to discount their purchase / sales
bills to get funds for the short run and as for the investors, it is a good instrument to park their spare funds for a
very short duration.
Bills discounting is of two types:
1. Purchase bills discounting and
2. Sales bill discounting.
A purchase bill discounting means that the investor discounts the purchase bill of the company and pays the
company, who in turn pay their supplier. The investor gets his money back from the company at the end of the
discounting period.
A sales bills discounting means the investor discounts the sales bill of the company and pays directly to the
company. The investor gets his return from the company at the end of the discounting period.
The funds generally required for this type of transaction start from ` 300,000 to upto ` 2 million. The tenure,
generally, ranges from 60 days to upto 180 days.
358 PP-CC&MM
Procedure of Bill Discounting
The procedure is that a broker will contact the investor with proposals to discount bills of different companies at
different rates of discounting. The better companies command discounting rates of 13% to 15%, while the lesser
known, by size and by safety, have to pay discounting rates of 17% to as high as 28%.
When an investor and the company agree to a particular bill discounting transaction, the following is what the
company gives to the investor:
– The original copies of bills to be discounted;
– A hundi / promissory note;
– Post Dated Cheque (PDC).
The investor simply has to issue a cheque. The amount of cheque is arrived at after deducting the discount rate.
The post-dated cheque that the company gives is of the full amount of the transaction. This can be better
explained with an example as follows.
Company A wants to discount its purchase bill of ` 2,00,000 for a period of three months. Investor P agrees to do
so at a discount rate of 21%. The deal is mutually agreed. Now, the investor will issue a cheque of ` 1,89,500.
This figure is arrived at as follows:
= 200,000 x 21% x 3/12
Thus the investor gets his/her interest before the end of the period on discounting. The company on its part will
issue a post-dated cheque of `2,00,000 for three months period.
Here the investor benefits in two ways:
He gets the interest element at the first day of issuing the cheque. i.e. he does not include that part in his cheque
amount. Thus he can earn interest on this interest for a three-month period. Even a simple bank fixed deposit on
it will earn @5% p.a. By investing `1,89,500 for three months, the investor earns `10,500 on it. A return of
22.16%.
Discount Rates
The rates depend on the following factors:
(i) The Broker: The broker has a good influence on the rates offered by companies. His relations with the
company and the investor, do make a difference of a couple of percentage point in discounting rates.
(ii) Market Liquidity: Liquidity crunch in the market tends to hike up the rates even in the best of the
companies. Since this instrument is a short tenure one, short-term changes in the market liquidity greatly
affect the discount rates.
(iii) Volume/Value of Discounting: When the volume/value of discounting done by the investor is high, he
is looking at security more than returns. The company on its part is looking at savings by way of reduced
legal paper work and a higher amount of dedicated funds for a said period and hence on the whole
reduced costs to the company.
(iv) Frequency: An investor who is regular bills discounter for the company may get upto 1% to 1.5% points
higher interest rates than a new investor. As for the investor he is trying it out with a new company and
will agree to a lesser rate to ensure safety.
(v) Company’s finance resources: This is one of the biggest factors that decide the discount rates. A
Public limited company generally tends to have a cheaper source of finance as against any other form
of company. Working capital financing of companies to a large extent manipulates the rates the companies
are willing to discount their bills at.
Lesson 12
Money Market 359
BILL REDISCOUNTING SCHEME (BRD)
Bill Rediscounting Scheme is the rediscounting of trade bills, which have already been purchased by /discounted
with the bank by the customers. These trade bills arise out of supply of goods/services.
Features
– The banks normally rediscount the bills that have already been discounted with them or raise usance
promissory notes in convenient lots and maturities and rediscount them.
– Rediscount of bills should be for a minimum period of 15 days and for a maximum period of 90 days.
– RBI has clarified to FIMMDA that in case a holiday is declared under the Negotiable Instruments Act,
1881, subsequent to the rediscounting of the bill, and the payment is to be made on the preceding
working day (as per the Negotiable Instruments Act), such payment on the preceding working day
would not be regarded as a violation of RBI’s guidelines.
– Discount is calculated on Actual/365 day basis.
– The amount payable to the borrower is the principal amount less the discount/interest.
– While discounting a bill, the amount of discount is to be deducted at the time the bill is issued.
– The discount is rounded off to the nearest rupee.
– On maturity the borrower would repay the principal amount.
Example:
Transaction Amount : ` 10,00,00,000/- (Rupees Ten Crore)
(Principal amount)
No. of Days :
45 days
Rate of Discount :
10.25% p.a.
Discount :
Transaction Amount * No . of days * Rate of interest/discount
365 * 100
=
=
Amount payable:
10,00,00,000 *45 * 10.25
365 * 100
` 12,63,699 (rounded off)
Transaction Amount – Discount/Interest
i.e. 10,00,00,000 - 12,63,699
i.e. ` 9,87,36,301/-
Amount to be repaid on maturity : ` 10,00,00,000/-
REPURCHASE AGREEMENTS
Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which two
parties agree to sell and repurchase the same security. They are usually used for overnight borrowing. Repo/
Reverse Repo transactions can be done only between the parties approved by RBI and in RBI approved securities
viz. Government of India (GoI) and State Govt Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc.
Under repurchase agreement the seller sells specified securities with an agreement to repurchase the same at
360 PP-CC&MM
a mutually decided future date and price. Similarly, the buyer purchases the securities with an agreement to
resell the same to the seller on an agreed date at a predetermined price. Such a transaction is called a Repo
when viewed from the perspective of the seller of the securities and Reverse Repo when viewed from the
perspective of the buyer of the securities. Thus, whether a given agreement is termed as a Repo or Reverse
Repo depends on which party initiated the transaction. The lender or buyer in a Repo is entitled to receive
compensation for use of funds provided to the counterparty. Effectively the seller of the security borrows money
for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security
who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate. The Repo rate is
negotiated by the counterparties independently of the coupon rate or rates of the underlying securities and is
influenced by overall Money Market conditions.
BANKER’S ACCEPTANCE
It is a short term credit investment created by a non financial firm and guaranteed by a bank to make payment.
It is simply a bill of exchange drawn by a person and accepted by a bank. It is a buyer’s promise to pay to the
seller a certain specified amount at certain date. The same is guaranteed by the banker of the buyer in exchange
for a claim on the goods as collateral. The person drawing the bill must have a good credit rating otherwise the
Banker’s Acceptance will not be tradable. The most common term for these instruments is 90 days. However,
they can very from 30 days to180 days. For corporations, it acts as a negotiable time draft for financing imports,
exports and other transactions in goods and is highly useful when the credit worthiness of the foreign trade party
is unknown. The seller need not hold it until maturity and can sell off the same in secondary market at discount
from the face value to liquidate its receivables.
TREASURY BILLS
Treasury Bills are Money Market instruments issued by RBI to finance the short term requirements of the
Government of India. These are discounted securities and thus are issued at a discount to face value. The
return to the investor is the difference between the maturity value and issue price.
In the short term category of investment instruments, the treasury bill carry the lowest risk. RBI issues these at
a prefixed date and of a fixed amount.
Treasury Bills are very useful instruments to deploy short term surpluses depending upon the availability and
requirement. Even funds which are kept in current accounts can be deployed in treasury bills to maximise
returns. Banks do not pay any interest on fixed deposits of less than 15 days, or balances maintained in current
accounts, whereas treasury bills can be purchased for any number of days depending on the requirements. This
helps in deployment of idle funds for very short periods as well. Further, since every week there is a 91 days
treasury bills maturing and every fortnight a 364 days treasury bills maturing, one can purchase treasury bills of
different maturities as per requirements so as to match with the respective outflow of funds. At times when the
liquidity in the economy is tight, the returns on treasury bills are much higher as compared to bank deposits even
for longer term. Besides, better yields and availability for very short tenors, another important advantage of
treasury bills over bank deposits is that the surplus cash can be invested depending upon the staggered
requirements.
Example
Suppose party A has a surplus cash of ` 200 crore to be deployed in a project. However, it does not require the
funds at one go but requires them at different points of time as detailed below:
Funds Available as on 1.1.2013
` 200 crore
Deployment in a project
`200 crore
Lesson 12
Money Market 361
As per the requirements
06.1.2013
` 50 crore
13.1.2013
` 20 crore
02.2.2013
` 30 crore
08.2.2013
` 100 crore
Out of the above funds and the requirement schedule, the party has following two options for effective cash
management of funds:
Option I
Invest the cash not required within 15 days in bank deposits. The party can invest a total of ` 130 crore only,
since the balance ` 70 crores is required within the first 15 days.
Assuming a rate of return of 6% paid on bank deposits for a period of 31 to 45 days, the interest earned by the
company works out to ` 76 lacs approximately.
Option II
Invest in Treasury Bills of various maturities depending on the funds requirements. The party can invest the
entire ` 200 crore in treasury bills as treasury bills of even less than 15 days maturity are also available. The
return to the party by this deal works out to around ` 125 lacs, assuming returns on Treasury Bills in the range
of 8% to 9% for the above periods.
There are four types of treasury bills :
(a) 14-day T bill
The Maturity is in 14 days. Its auction is on every Friday of every week. The notified amount for this auction is
` 100 crores.
(b) 91-day T bill
The Maturity is in 91 days. Its auction is on every Friday of every week. The notified amount for this auction is
` 100 crores.
(c) 182-day T bill
The Maturity is in 182 days. Its auction is on every alternate Wednesday (which is not a reporting week). The
notified amount for this auction is ` 100 crores.
(d) 364-day T bill
The Maturity is in 364 days. Its auction is on every alternate Wednesday (which is a reporting week). The
notified amount for this auction is ` 500 crores.
A considerable part of the government's borrowings is financed through T-bills of various maturities. Based on
the bids received at the auctions, RBI decides the cut off yield and accepts all bids below this yield. The usual
investors in these instruments are banks who invest not only to invest their short-term surpluses but also to get
benefitted for maintaining the Statutory Liquid Ratio (SLR) requirements in T-bills is reckoned for the purpose of
statutory reserves. FIIs so far have not been allowed to invest in this instrument.
These T-bills which are issued at a discount can be traded in the market. Most of the time, unless the investor
requests specifically, these are issued not as securities but as entries in the Subsidiary General Ledger (SGL)
which is maintained by RBI. The transactions cost on T-bill are non-existent and trading is considerably high in
each bill, immediately after its issue and immediately before its redemption.
362 PP-CC&MM
The yield on T-bills is dependent on the rates prevalent on other investment avenues open for investors. For
instance, low yield on T-bills as a result of high liquidity in banking system due to by low call rates, would divert
the funds from T-bills market to other markets. This would particularly be so, if banks already hold the minimum
stipulated amount of (SLR) in government instrument.
Benefits of Investing in Treasury Bills
(a) No tax deducted at source
(b) Zero default risk being sovereign paper
(c) Highly liquid Money Market instrument
(d) Better returns especially in the short term
(e) Transparency
(f) Simplified settlement
(g) High degree of tradability and active secondary market facilitates meeting unplanned fund requirements.
Features of Treasury Bills
(a) Form
The treasury bills are issued in the form of promissory note in physical form or by credit to Subsidiary General
Ledger (SGL) account or Gilt account in dematerialized form.
(b) Minimum Amount of Bids
Bids for treasury bills are to be made for a minimum amount of ` 25000/- only and in multiples thereof.
(c) Eligibility
All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate
bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident
Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to bid and purchase
Treasury bills.
(d) Repayment
The treasury bills are repaid at par on the expiry of their tenure at the office of the Reserve Bank of India.
(e) Availability
All the treasury Bills are highly liquid instruments available both in the primary and secondary market.
(f) Day Count
For treasury bills the day count is taken as 365 days for a year.
(g) Yield Calculation
The yield of a Treasury Bill is calculated as per the following formula:
Y=
(100 – P) X 365 X 100
PXD
Wherein
Y = Discounted yield
P = Price
D = Days to maturity
Lesson 12
Money Market 363
Example
A co-operative bank wishes to buy 91 Days Treasury Bill on Oct. 12, 2012 which is maturing on Dec. 6, 2012.
The rate quoted by seller is ` 99.1489 per ` 100 face values. The YTM can be calculated as following:
The days to maturity of Treasury bill are 55 (October – 20 days, November – 30 days and December – 5 days)
Yield to Maturity (YTM) = (100-99.1489) x 365 x 100/(99.1489*55) = 5.70%
Similarly if the YTM is quoted by the seller, price can be calculated by inputting the price in above formula.
Primary Market
In the primary market, treasury bills are issued by auction technique.
Salient Features of the Auction Technique:
(a) The auction of treasury bills is done only at Reserve Bank of India, Mumbai.
(b) Bids are to be submitted on Negotiated Dealing System (NDS) by 2:30 PM on Wednesday. If Wednesday
happens to be a holiday then bids are to be submitted on previous day (Tuesday).
(c) Bids are submitted in terms of price per `100. For example, a bid for 91-day Treasury bill auction could
be for ` 97.50 for per unit of T-bill of face valuer of `100.
(d) Auction committee of Reserve Bank of India decides the cut-off price and results are announced on the
same day.
(e) Bids above the cut-off price receive full allotment; bids at cut-off price may receive full or partial allotment
and bids below the cut-off price are rejected.
Things You May Know
Negotiated Dealing System
An electronic trading platform, operated by the RBI, used to facilitate the exchange of Government Securities
and other Money Market instruments. The Negotiated Dealing System is also responsible for hosting new
issues of Government Securities.
Secondary Market
The participants can also trade T-bills held from primary market in the secondary market established for the
purpose. The major advantages of dealing in treasury bill secondary market are: Market related yields, ideal
matching for funds management particularly for short-term tenors of less than 15 days, Transparency in operations
as the transactions would be put through Reserve Bank of India’s SGL or Client’s Gilt account only, two way
quotes offered by primary dealers for purchase and sale of treasury bills and certainty in terms of availability,
entry and exit.
Types of Auction
There are two types of auction for treasury bills:
(i) Multiple Price Based or French Auction: Under this method, all bids equal to or above the
cut-off price are accepted. However, the bidder has to obtain the treasury bills at the price quoted by
him. This method is followed in the case of 364 days treasury bills and is valid only for competitive
bidders.
(ii) Uniform Price Based or Dutch Auction: Under this system, all the bids equal to or above the cut-off
price are accepted at the cut- off level. However, unlike the Multiple Price based method, the bidder
obtains the treasury bills at the cut-off price and not the price quoted by him. This method is applicable
364 PP-CC&MM
in the case of 91 days treasury bills only. The system of Dutch auction has been done away with by the
RBI w.e.f 08.12.2002 for 91 day T Bill.
What is Dutch auction?
When all the bids accepted are equal to or above the cut off price it is known as Dutch Auction.
What is French Auction?
When all the bids accepted at the cut off level it is known as French Auction.
CERTIFICATES OF DEPOSITS
Certificate of Deposits (CDs) is a negotiable Money Market instrument and issued in dematerialised form or as
Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time
period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of
India, as amended from time to time.
Eligibility
CDs can be issued by:
(i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs);
(ii) selected all-India Financial Institutions that have been permitted by RBI to raise short-term resources
within the umbrella limit fixed by RBI.
Aggregate Amount
The amount of CDs allowed to be issued by:
(i) Banks: varying according to the requirements keeping in limits the CRR and SLR requirements as
stipulated by RBI.
(ii) Financial Institutions: may issue CDs within the overall umbrella limit fixed by RBI. As per the prevailing
guidelines issued by RBI, an FI can issue CDs together with other instruments viz., term money, term
deposits, commercial papers and inter corporate deposits, not exceeding 100 per cent of its net owned
funds, as per the latest audited balance sheet.
Minimum Size of Issue and Denominations
Minimum amount of a CD should be `1 lakh i.e., the minimum deposit that could be accepted from a single
subscriber should not be less than `1 lakh and in the multiples of ` 1 lakh thereafter. CDs can be issued to
individuals, corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also
subscribe to CDs, but only on non-repatriable basis which should be clearly stated in the Certificate. Such CDs
cannot be endorsed to another NRI in the secondary market.
Maturity
The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. The FIs
can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.
Discount/Coupon Rate
CDs may be issued at a discount on face value. Banks/FIs are allowed to issue CDs on the basis of floating rate
basis provided the methodology of computing the floating rate is predefined objective in nature, transparent and
market based. The issuing bank/FI is free to determine the discount/coupon rate. The interest rate on floating
rate CDs would have to be reset periodically in accordance with a pre-determined formula that indicates the
spread over a transparent benchmark.
Lesson 12
Money Market 365
Reserve Requirements
Banks have to maintain the appropriate reserve requirements, i.e., Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR), on the issue price of the CDs.
Transferability
– Physical CDs are freely transferable by endorsement and delivery.
– Demat CDs can be transferred as per the procedure applicable to other demat securities.
– There is no lock-in period for the CDs.
– Banks/FIs cannot grant loans against CDs.
– Furthermore, they cannot buy-back their own CDs before maturity.
Trades In CDs
All OTC trades in CDs shall be reported within 15 minutes of the trade on the FIMMDA reporting platform.
Format Of CDs
Banks/FIs should issue CDs only in the dematerialised form. However, according to the Depositories Act, 1996,
investors have the option to seek certificate in physical form. Accordingly, if the investor insists on physical
certificate, the bank/FI may inform to Monetary Policy Department, Reserve Bank of India about such instances
separately. Further, issuance of CD will attract stamp duty. There will be no grace period for repayment of
CDs. If the maturity date happens to be holiday, the issuing bank should make payment on the immediate
preceding working day. Banks/FIs may, therefore, so fix the period of deposit that the maturity date does not
coincide with a holiday to avoid loss of discount / interest rate.
Security Aspect
Since physical CDs are freely transferable by endorsement and delivery, it will be necessary for banks to see
that the certificates are printed on good quality security paper and necessary precautions are taken to guard
against tempering with the document. They should be signed by two or more authorized signatories.
Payment of Certificate
Since CDs are transferable, the physical certificate may be presented for payment by the last holder. The
question of liability on account of any defect in the chain of endorsements may arise. It is, therefore, desirable
that banks take necessary precautions and make payment only by a crossed cheque. Those who deal in these
CDs may also be suitably cautioned. The holders of dematted CDs will approach their respective depository
participants (DPs) and have to give transfer/delivery instructions to transfer the demat security represented by
the specific ISIN to the ‘CD Redemption Account’ maintained by the issuer. The holder should also communicate
to the issuer by a letter/fax enclosing the copy of the delivery instruction it had given to its DP and intimate the
place at which the payment is requested to facilitate prompt payment. Upon receipt of the demat credit of CDs in
the “CD Redemption Account”, the issuer, on maturity date, would arrange to repay to holder/transferor by way
of Banker’s cheque/high value cheque, etc.
Issue of Duplicate Certificates
In case of the loss of physical CD certificates, duplicate certificates can be issued after compliance of the
following conditions:
(a) A notice is required to be given in at least one local newspaper;
(b) Lapse of a reasonable period (say 15 days) from the date of the notice in the newspaper; and
366 PP-CC&MM
(c) Execution of an indemnity bond by the investor to the satisfaction of the issuer of CD.
The duplicate certificate should only be issued in physical form. No fresh stamping is, required as a duplicate
certificate is issued against the original lost CD. The duplicate CD should clearly state that the CD is a Duplicate
one stating the original value date, due date, and the date of issue (as “Duplicate issued on______”).
Accounting
Banks/FIs may account the issue price under the Head “CDs issued” and show it under deposits. Accounting
entries towards discount will be made as in the case of “cash certificates”. Banks/FIs should maintain a register
of CDs issued with complete particulars.
INTER-CORPORATE DEPOSITS
Apart from CDs, corporates also have access to another market called the Inter Corporate Deposits (ICD)
market. An ICD is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for low
rated corporates, this market allows corporates with surplus funds to lend to other corporates facing shortage of
funds. Another aspect of this market is that the better-rated corporates can borrow from the banking system and
lend in this market to make speculative profits. As the cost of funds for a corporate in much higher than that of a
bank, thus, the rates in this market are higher than those in the other markets. ICDs are unsecured, and hence
the risk inherent is high. The ICD market is an unorganised market with very less information available publicly
about transaction details.
COMMERCIAL BILLS
Commercial bills are basically negotiable instruments accepted by buyers for goods or services obtained by
them on credit. Such bills being bills of exchange can be kept upto the due maturity date and encashed by the
seller or may be endorsed to a third party in payment of dues owing to the latter. The most common practice is
that the seller who gets the accepted bills of exchange discounts it with the Bank or financial institution or a bill
discounting house and collects the money (less the interest charged for the discounting).
The volume of bills both inland and foreign, which are discounted accounted, forms a substantial part of the total
scheduled commercial bank credit. Over the years this is coming down. The Reserve Bank has been attempting
to develop a market for commercial bills. The bill market scheme was introduced in 1942 and a new scheme
called Bill Rediscount Scheme with several new features was introduced in November, 1970. Under the latter
scheme the RBI rediscount bills at the bank rates or at rates specified by it at its discretion. Since the rediscounting
facility has been made restrictive, it is generally available on a discretionary basis.
The difficulties which stand in the way of bill market development are, the incidence of stamp duty, shortage of
stamp paper, reluctance of buyers to accept bills, predominance of cash credit system of lending and the
administrative work involved in handling documents of title to goods. To be freely negotiable and marketable, the
bills should be first class bills i.e. those accepted by companies having good reputation. Alternatively, the bills
accepted by companies should be co-accepted by banks as a kind of guarantee. In the absence of these
criteria, bill market has not developed in India as the volume of first class bills is very small.
COMMERCIAL PAPER
Commercial Paper (CP) is an unsecured Money Market instrument issued in the form of a promissory note. CP, as
a privately placed instrument, was introduced in India in 1990 with a view to enable highly rated corporate borrowers
to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently,
primary dealers (PDs), satellite dealers and all-India financial institutions were also permitted to issue CP to enable
them to meet their short-term funding requirements for their operations. Guidelines for issue of CP are presently
governed by various directives issued by the Reserve Bank of India, as amended from time to time.
Lesson 12
Money Market 367
The guidelines for issue of CP are given below:
Eligible issuers of CP
Corporates, PDs and all-India financial institutions (FIs) that have been permitted to raise short-term resources
under the umbrella limit fixed by the Reserve Bank of India (RBI) are eligible to issue CP.
A corporate would be eligible to issue CP provided:
(a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than ` 4 crore.
(b) the company has been sanctioned working capital limit by bank/s or FIs.
(c) the borrowal account of the company is classified as a Standard Asset by the financing bank/institution.
(i) Rating Requirements
All eligible participants shall obtain credit rating for issuance of CP from any one of the following credit rating
agencies (CRAs), viz. the Credit Rating Information Services of India Ltd. (CRISIL), the Investment Information
and Credit Rating Agency of India Ltd. (ICRA), the Credit Analysis and Research Ltd. (CARE), the FITCH
Ratings India Pvt. Ltd. and such other CRAs as may be specified by the RBI from time to time, for the purpose.
The minimum credit rating shall be ‘A2’ [as per rating symbol and definition prescribed by SEBI]. The issuers
shall ensure at the time of issuance of the CP that the rating so obtained is current and has not fallen due for
review.
(ii) Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date
of issue. The maturity date of the CP should not go beyond the date up to which the credit rating of the issuer is
valid.
(iii) Denominations
CP can be issued in denominations of `5 lakh or multiples thereof. Amount invested by a single investor should
not be less than `5 lakh (face value).
(iv) Limits and the Amount of Issue of CP
The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the
quantum indicated by the CRA for the specified rating, whichever is lower. Banks and FIs will, however, have the
flexibility to fix working capital limits, duly taking into account the resource pattern of company’s financing,
including CPs.
The total amount of CP proposed to be issued should be raised within a period of two weeks from the date on
which the issuer opens the issue for subscription. CP may be issued on a single date or in parts on different
dates provided that in the latter case, each CP shall have the same maturity date. Every issue of CP, including
renewal, should be treated as a fresh issue.
(v) Issuing and Paying Agent (IPA)
Only a scheduled bank can act as an IPA for issuance of CP.
(vi) Investment in CP
CP may be issued to individuals, banking companies, other corporate bodies (registered or incorporated in
India) and unincorporated bodies, Non-Resident Indians and Foreign Institutional Investors (FIIs). However,
investment by FIIs would be within the limits set for them by SEBI.
368 PP-CC&MM
(vii) Trading in CP
All OTC trades in CP shall be reported within 15 minutes of the trade to the Fixed Income Money Market and
Derivatives Association of India (FIMMDA) reporting platform.
(viii) Mode of Issuance
CP can be issued either in the form of a promissory note or in a dematerialised form through any of the depositories
approved by and registered with SEBI. CP will be issued at a discount to face value as may be determined by
the issuer. No issuer shall have the issue of CP underwritten or co-accepted.
(ix) Preference for Dematerialisation
While option is available to both issuers and subscribers to issue/hold CP in dematerialised or physical form,
issuers and subscribers are encouraged to opt for dematerialised form of issue/holding. However, banks, FIs
and PDs are required to make fresh investments and hold CP only in dematerialised form.
(x) Payment of CP
The initial investor in CP shall pay the discounted value of the CP by means of a crossed account payee cheque
to the account of the issuer through IPA. On maturity of CP, when CP is held in physical form, the holder of CP
shall present the instrument for payment to the issuer through the IPA. However, when CP is held in demat form,
the holder of CP will have to get it redeemed through the depository and receive payment from the IPA.
PROCEDURE FOR ISSUANCE
Every issuer must appoint an IPA for issuance of CP. The issuer should disclose to the potential investors, its
financial position as per the standard market practice. After the exchange of deal confirmation between the
investor and the issuer, issuing company shall issue physical certificates to the investor or arrange for crediting
the CP to the investor’s account with a depository. Investors shall be given a copy of IPA certificate to the effect
that the issuer has a valid agreement with the IPA and documents are in order.
Role and Responsibilities
The role and responsibilities of issuer, IPA and CRA are set out below:
(a) Issuer
With the simplification in the procedures for issuance of CP, issuers would now have greater flexibility. However,
they have to ensure that the guidelines and procedures laid down for CP issuance are strictly adhered to.
(b) Issuing and Paying Agent (IPA)
(i) IPA would ensure that the issuer has the minimum credit rating as stipulated by RBI and the amount mobilised
through issuance of CP is within the quantum indicated by CRA for the specified rating or as approved by its
Board of Directors, whichever is lower.
(ii) IPA has to verify all the documents submitted by the issuer, viz., copy of board resolution, signatures of
authorised executants (when CP in physical form) and issue a certificate that documents are in order. It should
also certify that it has a valid agreement with the issuer.
(iii) Certified copies of original documents, verified by the IPA, should be held in the custody of IPA.
(iv) All scheduled banks, acting as IPAs should submit the data pertaining to CP issuances on the Online Returns
Filing System (ORFS) module within two days from the date of issuance of CP.
(c) CRA
(i) Code of Conduct prescribed by the SEBI for CRAs for undertaking rating of Capital Market instruments shall
be applicable to CRAs for rating CPs.
Lesson 12
Money Market 369
(ii) The CRAs would henceforth have the discretion to determine the validity period of the rating depending upon
its perception about the strength of the issuer. Accordingly, they shall, at the time of rating, clearly indicate the
date when the rating is due for review.
(iii) While the CRAs can decide the validity period of credit rating, they would have to closely monitor the rating
assigned to issuers vis-à-vis their track record at regular intervals and would be required to make their revision
in the ratings public through their publications and website.
The amount of CDs allowed to be issued by:
(i) Banks: varying according to the requirements keeping in limits the CRR and SLR requirements as
stipulated by RBI.
(ii) Financial Institutions: may issue CDs within the overall umbrella limit fixed by RBI. As per the prevailing
guidelines issued by RBI, an FI can issue CDs together with other instruments viz., term money, term
deposits, commercial papers and inter corporate deposits, not exceeding 100 per cent of its net owned
funds, as per the latest audited balance sheet.
MONEY MARKET MUTUAL FUNDS (MMFS)
One of the recent development in the sphere of Money Market is the establishment of Money Market Mutual
Funds, the guidelines of which have been prescribed by the Reserve Bank of India. Money Market Mutual
Funds (MMFs) can be set up by the banks and public financial institutions. There can also be Money Market
Deposit Account (MMDAs).
(a) Limit : The limit for raising resources under the MMMF scheme should not exceed 2% of the sponsoring
bank’s fortnightly average aggregate deposits. If the limit is less than `50 crores for any bank, it may join
with some other bank and jointly set up MMMF. In the case of public financial institutions, the limit
should not exceed 2% of the long-term domestic borrowings as indicated in the latest available audited
balance sheets.
(b) Eligibility : MMMFs are primarily intended for individuals investors including NRIs who may invest on a
non-repatirable basis. MMMFs would be free to determine the minimum size of the investment by a
single investor.
(c) Minimum rate of return : There is no guaranteed minimum rate of return.
(d) Lock-in-period : The minimum lock in period would be 46 days.
(e) Deployment of capital : The resources mobilized by MMMFs should be invested exclusively in various
Money Market instruments.
(f) Money Market Mutual Fund investment limits :
(i) Treasury bills and dated government securities having an unexpired maturity upto one year – Minimum
25%.
(ii) Call/notice money – Minimum 30%.
(iii) Commercial Paper – Maximum 15%. The exposure to CP issued by an individual company should
not be more than 3%.
(iv) Commercial bills accepted/co-accepted by Banks – Maximum 20%.
(v) Certificate of deposits – No limit.
FACTORING
Factoring is a financial transaction where an entity sells its receivables to a third party called a ‘factor’, at
370 PP-CC&MM
discounted prices. Factoring is a financial option for the management of receivables. In simple definition it is the
conversion of credit sales into cash. In factoring, a financial institution (factor) buys the accounts receivable of a
company (Client) and pays up to 80%(rarely up to 90%) of the amount immediately on formation of agreement.
Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when
the customer pays the debt. Collection of debt from the customer is done either by the factor or the client
depending upon the type of factoring. The account receivable in factoring can either be for a product or service.
Examples : factoring against goods purchased, factoring for construction services (usually for government
contracts where the government body is capable of paying back the debt in the stipulated period of factoring.
Contractors submit invoices to get cash instantly), factoring against medical insurance etc.
Parties in Factoring
The factoring transaction involves three parties:
(i) The Seller, who has produced the goods/services and raised the invoice.
(ii) The Buyer, the consumer of goods/services and the party to pay.
(iii) The Factor, the financial institution that advances the portion of funds to the seller.
FACTORING PROCESS
The steps involved in factoring are listed below:
(i) The seller interacts with the funding specialist/broker and explains the funding needs.
(ii) The broker prepares a preliminary client profile form and submits to the appropriate funder for consideration.
(iii) Once both parties agree that factoring is possible, the broker puts the seller in direct contact with the
funder to ask/answer any additional questions and to negotiate a customized factoring agreement,
which will meet the needs of all concerned.
(iv) At this point, the seller may be asked to remit a fee with formal application to cover the legal research
costs, which will be incurred during "due diligence". This is the process by which the buyer’s credit
worthiness is evaluated through background checks, using national database services.
(v) During the next several days, the funder completes the "due diligence" process on the seller, further
verifies invoices and acknowledges any liens, UCC filings, judgments or other recorded encumbrances
on the seller’s accounts receivables.
(vi) The seller is advised of the facility and is asked to advise the buyers of the Factor by letter and submit
an acknowledged copy of the same to the Factor for records.
(vii) A detailed sanction letter is given to the seller and their acceptance on the same taken, with the required
signatories. (Authorized signatories would be mentioned in the “Signing Authorities” section of the Proposal
presented by seller).
(viii) Sanction terms must contain the following.
(a) All Facilities covered under the sanction.
(b) The period for which the sanction is valid
(c) When the Facility comes into effect e.g. (if Facility is dated 1/07/2013, it can state that invoices
raised from or after 15/07/2013 only would be Factored).
(d) Who the authorized signatories are for signing invoices for factoring.
(e) The limits.
(f) The seller has to advise the buyer of the Factoring agreement.
(g) Copy of such advice acknowledged by the buyer should be submitted to them Factor. Buyer’s
consent is not required to decide on the Factor.
Lesson 12
Money Market 371
(viii) The discounting rates, charges fixed.
(ix) In case of discounts given by the seller to the buyer, which value would be financed by the factor (since
the factored amount should never exceed the amount actually payable by buyer).
(x) Usually within 7 to 10 days of the initial contact with the factor, agreements are signed, customers are
notified, UCC forms filed and the first advance is forwarded to the company. This advance can vary
between 70 - 80% of the face value of the invoices being factored. In the construction industry, the advances
may be in the range of 60 - 70%. The remaining amount is called the "reserve" which is held by the factor
until the invoices are paid. The factor then deducts his fee and returns the remaining funds to the seller.
(xi) The seller performs services or delivers products, thus creating an invoice.
(xii) The seller sends or faxes a copy of the invoice directly to the factor.
(xiii) The funder verifies the invoice and the advance is sent to the seller as per the agreement with the factor.
In certain cases, the funder wires the funds to the seller’s account for an additional fee.
(xiv) The buyer pays the factor. The factor then returns any remaining reserve, minus the fee, which has
been predetermined in the negotiated agreement.
Advantages for the Seller
– Seller gets funds immediately after the sale is effected and on presentation of accepted sales invoices and
Promissory notes.
– Major part of paper work and correspondence is taken care of by the factor.
– Follow-up, for recovery of funds, is done mainly by the factor.
– Interest rates are not as high as normal discounting.
– Increased cash flow to meet payroll.
– Immediate funding arrangements.
– No additional debt is incurred on balance sheet.
– Other assets are not encumbered.
– Approval is not based on seller’s credit rating.
Customer
Credit sale of
goods
Client
Invoice
Pays the balance
amount
Pays the amount (In recourse
type customer pays through
client)
Submit invoice
copy
Payment up to
80% initially
Factor
372 PP-CC&MM
TYPES OF FACTORING
Factoring
Full
Factoring
Recourse
Factoring
Maturity
Factoring
Advance
Factoring
Undisclosed
Factoring
Invoice
Discounting
Non-Recourse or Full factoring
Under this type of factoring the bank takes all the risk and bear all the loss in case of debts becoming bad debts.
Recourse Factoring
Under this type of factoring the bank purchases the receivables on the condition that any loss arising out or bad
debts will be borne by the company which has taken factoring.
Maturity Factoring
Under this type of factoring bank does not give any advance to the company rather bank collects it from customers
and pays to the company either on the date of collection from the customers or on a guaranteed payment date.
Advance Factoring
Under advance factoring arrangement the factor provides an advance against the uncollected and non-due
receivables to the firm.
Undisclosed Factoring
Under this type of factoring, the customer is not informed of the factoring arrangement. The firm may collect
dues from the customer on its own or instruct to make remit once at some other address.
Invoice Discounting
Under this type of factoring the bank provide an advance to the company against the account receivables and in
turn charges interest rate from the company for the payment which bank has given to the company.
LETTER OF CREDIT
A letter of credit is a written understanding given by the buyer’s bank (the issuing bank) on behalf of and at the
request of its customer (the applicant) routed through the agency of a bank in the seller’s country (advising
bank) to the seller beneficiary that it (issuing bank) guarantees to pay the seller for the goods within a specified
time provided that the conditions laid down in documentary credit are fully satisfied.
Reasons for using LC
In international trade, buyer and seller being located in different countries may not know each other well. The
two countries will have different legal systems, currencies, trade and exchange regulations. Due to this fact both
the Buyer and Seller, need some conditions to be fulfilled, to suit their requirements, before releasing the payments
and goods respectively. The buyer and seller want the following:(a) Seller would want:
(i) To be paid as soon as he ships the goods.
(ii) An assurance that he will be paid by the buyer or his bank as per contractual obligations.
(iii) Convenience of receiving payments in his own country.
Lesson 12
Money Market 373
(b) Buyer would want:
(i) To pay for the goods only after they are shipped by the seller.
(ii) An assurance that seller will ship the goods ordered for and deliver them in time.
BASIC FORMS OF LCS
Basic forms of LCs are enumerated below:(a) Revocable letter of credit.
(b) Irrevocable letter of credit.
(c) Confirmed letter of credit.
(d) Revolving letter of credit
(a) Revocable Letter of Credit.
A revocable letter of credit is one which may be amended or cancelled by the issuing bank at any moment
without prior notice to the beneficiary. Therefore such a type of letter of credit does not give complete sense of
security to the beneficiary. However when the revocable letter of credit is made available at a branch of a bank
concerned, the notice of amendment or cancellation is effective only upon receipt of such notice. If such a bank
has undertaken liability (i.e. Paid, negotiated or accepted) against documents, which appear on the face of it to
be in conformity with the terms and conditions of the credit before notice of amendment/cancellation, then the
issuing Bank is bound to reimburse such a bank. If the letter of credit is silent as to whether it is revocable or
irrevocable, the credit is deemed as IRREVOCABLE.
(b) Irrevocable Letter of Credit
When the issuing Bank gives a definite, absolute and irrevocable undertaking to honour its obligations provided
the beneficiary complies with all the terms and conditions such a credit is known as an irrevocable letter of
credit. That means that the letter of credit cannot be amended, cancelled or revoked without the consent of the
parties to the letter of credit. This gives the beneficiary definite protection.
(c) Confirmed Letter of Credit
A confirmed letter of credit is one when another Bank in the beneficiary’s country adds its confirmation at the
request of the issuing Bank. This undertaking of the confirming Bank to pay/negotiate/accept is in addition to the
undertaking of the issuing bank. This is an added protection to the beneficiary. This is not to be agreed as it
undermines the credibility of our Nationalized Banks.
(d) Revolving Letter of Credit
In such credits, the amount is restored, after it has been utilized, to the original amount. Such credits are used
when the buyer is to receive partial shipment of goods at specific intervals for a long duration. It can be cumulative
or noncumulative in nature. It avoids opening letter of credit for each and every consignment.
WORKING MECHANISM
The following is a step-by-step description of a typical Letter of Credit transaction:
1. An Importer (Buyer) and Exporter (Seller) agree on a purchase and sale of goods where payment is
made by Letter of Credit.
2. The Importer completes an application requesting its bank (Issuing Bank) to issue a Letter of Credit in
favour of the Exporter. It is important to note that the Importer must have a line of credit with the Issuing
Bank in order to request that a Letter of Credit be issued.
3. The Issuing Bank issues the Letter of Credit and sends it to the Advising Bank by telecommunication or
registered mail in accordance with the Importer’s instructions. A request may be included for the Advising
Bank to add its confirmation. The Advising Bank is typically located in the country where the Exporter
carries on business and may be the Exporter’s bank but it does not have be.
374 PP-CC&MM
4. The Advising Bank will verify the Letter of Credit for authenticity and send a copy to the Exporter.
Issuance of Letter of Credit
Buyer/Importer
Beneficiary/Exporter
1
Purchase & Sales
Agreement
2
Request for a
Letter of Credit
4
Advice of
Letter of Credit
Request to Advise and
possibly confirm the Letter
of Credit
Issuing Bank
3
Advising/Confirming
Bank
5. The Exporter examines the Letter of Credit to ensure:
(a) it corresponds to the terms and conditions in the purchase and sale agreement;
(b) documents stipulated in the Letter of Credit can be produced; and
(c) the terms and conditions of the Letter of Credit may be fulfilled.
6. If the Exporter is unable to comply with any term or condition of the Letter of Credit or if the Letter of Credit
differs from the purchase and sale agreement, the Exporter should immediately notify the Importer and request
an amendment to the Letter of Credit.
7. When all parties agree to the amendments, they are incorporated into the terms of the Letter of Credit and
advised to the Exporter through the Advising Bank.
8. The Exporter arranges for shipment of the goods, prepares and/or obtains the documents specified in the
Letter of Credit and makes demand under the Letter of Credit by presenting the documents within the stated
period and before the expiry date to the “available with” Bank. This may be the Advising/Confirming Bank. That
bank checks the documents against the Letter of Credit and forwards them to the Issuing Bank. The drawing is
negotiated, paid or accepted as the case may be.
9. The Issuing Bank examines the documents to ensure they comply with the Letter of Credit terms and conditions.
The Issuing Bank obtains payment from the Importer for payment already made to the “available with” or the
Confirming Bank.
Payment under a Letter of Credit
Applicant/Importer
Beneficiary/Exporter
1
Shipment of Goods
2
3
2
Document
Payment
Document
Issuing Bank
Payment
3
2
Document
3
Payment
Advising/Confirming
Bank
Lesson 12
Money Market 375
BILL OF EXCHANGE
The Negotiable Instruments Act, 1881, defines the Bill of Exchange as “an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to
the order of, a certain person or to the bearer of the instrument.”
There are five important parties to a Bill of Exchange:
(i) The Drawer : The drawer is the person who has issued the bill. The drawer is the creditor to whom the
money is owned.
(ii) The Drawee : The drawee is the person to whom the bill is addressed or against whom the bill is drawn.
In other words, the drawee is the debtor who owes money to the drawer, the creditors.
(iii) The Payee : The payee is the person to whom the bill is payable. The bill can be drawn payable to the
drawee or his Bank.
(iv) The Endorser : The endorser of a bill is the person who has placed his name and signature at the back
of the bill signifying that he has obtained title to the bill and payment is due to him on his own account or
on account of the original payee.
(v) The Endorsee : The endorsee is the person to whom the bill is endorsed. The endorsee can obtained
payment from the drawee.
There are the following important types of Bill of Exchange :
(i) Sight Bill of Exchange : A sight or demand Bill of Exchange is one which is required to be paid by the
draweee immediately on presentation of the Bill.
(ii) Usance Bill of Exchange : In case of the usance or time Bill of Exchange, there is maturity period
called the tenor, and the payment is to be made only on the maturity of the bill.
Generally speaking, the due date of payment of the usance bill is calculated from the date of presentation
or sighting of the bill by the drawee. Such a bill is called after sight usance bill. But sometimes the date
of maturity is calculated from the date of drawing of the bill. Such a bill is known as after date usance bill.
(iii) Clean Bill of Exchange : A Bill of Exchange not accompanied by the relative shipping documents is
known as a clean Bill of Exchange. In respect of the clean Bill of Exchange, the documents are sent to
the consignee directly, and he can take delivery of the goods on their arrival at the port of destination.
(iv) Documentary Bill of Exchange : A documentary Bill of Exchange is a Bill of Exchange accompanied
by the relative shipping documents such as the bill of lading, marine insurance policy, commercial
invoice, certificate of origin, etc. The documents accompanying the bill are delivered to the importer by
the bank only upon either acceptance or payment of the bill. The former is called documents against
acceptance and the latter is called documents against payment. It is the documentary Bill of Exchange
that is commonly used in foreign trade transactions.
Upon shipment of the goods, the exporter may draw a bill of exchange on the importer or, more frequently, on
bank acting for the importer. The exporter usually draws the bill payable to his own order, or to that of his bank.
He then endorses the bill and sells it to, or discounts it at, his bank. In this way the exporter receives his money
immediately upon the shipment of the goods. The bank sends the bill and the documents to its foreign branch or
correspondent bank which, upon arrival, promptly notifies the importer and presents the bill to him for payment
or acceptance. Until the importer has accented the bill or made arrangements for payments he cannot receive
the bill of lading, which is his title to the goods.
376 PP-CC&MM
FIMMDA
FIMMDA stands for The Fixed Income Money Market and Derivatives Association of India (FIMMDA). It is an
Association of Commercial Banks, Financial Institutions and Primary Dealers. FIMMDA is a voluntary market
body for the bond, Money And Derivatives Markets.
Objectives of FIMMDA
– To function as the principal interface with the regulators on various issues that impact the functioning of
these markets.
– To undertake developmental activities, such as, introduction of benchmark rates and new derivatives
instruments, etc.
– To provide training and development support to dealers and support personnel at member institutions.
– To adopt/develop international standard practices and a code of conduct in the above fields of activity.
– To devise standardized best market practices.
– To function as an arbitrator for disputes, if any, between member institutions.
– To develop standardized sets of documentation.
– To assume any other relevant role facilitating smooth and orderly functioning of the said markets.
FOREIGN EXCHANGE DEALER'S ASSOCIATION OF INDIA
Foreign Exchange Dealer's Association of India (FEDAI) was set up in 1958 as an Association of banks dealing
in foreign exchange in India (typically called Authorised Dealers - ADs) as a self regulatory body and is incorporated
under Section 25 of The Companies Act, 1956. It's major activities include framing of rules governing the conduct
of inter-bank foreign exchange business among banks vis-à-vis public and liaison with RBI for reforms and
development of forex market.
Presently some of the functions of FEDAI are as follows:
– Guidelines and Rules for Forex Business.
– Training of Bank Personnel in the areas of Foreign Exchange Business.
– Accreditation of Forex Brokers
– Advising/Assisting member banks in settling issues/matters in their dealings.
– Represent member banks on Government/Reserve Bank of India/Other Bodies.
– Announcement of daily and periodical rates to member banks.
Due to continuing integration of the global financial markets and increased pace of de-regulation, the role of selfregulatory organizations like FEDAI has also transformed. In such an environment, FEDAI plays a catalytic role
for smooth functioning of the markets through closer co-ordination with the RBI, other organizations like FIMMDA,
the Forex Association of India and various market participants. FEDAI also maximizes the benefits derived from
synergies of member banks through innovation in areas like new customized products, bench marking against
international standards on accounting, market practices, risk management systems, etc.
Lesson 12
Money Market 377
LESSON ROUND UP
– The Money Market is a Market for dealing in monetory assets of short term nature. The Money Market
functions as a wholesale debt market for low-risk, highly liquid, short term instruments.
– Government is an active player in the Money Market and in most of the economies; it constitutes the
biggest borrower in this market.
– The Money Market possesses different operational features as compared to Capital Market. Money
Market is distinguished from Capital Market on the basis of the maturity period, credit instruments and
the institutions.
– The Indian Money Market consists of two types of segments: an organized segment and an unorganized
segment.
– The Reserve Bank of India issues securities on behalf of the Government. The term Government
Securities includes Central Government Securities, State Government Securities and Treasury Bills.
– Call Money is a Money Market instrument wherein funds are borrowed / lent for a tenor of one ay/
overnight (excluding Sundays/holidays).
– Money lent for a fixed tenor of 15 days or more is called Term Money.
– Bill discounting is a short tenure financing instrument for companies willing to discount their purchase
/ sales bills to get funds for the short run and as for the investors in them, it is a good instrument to park
their spare funds for a very short duration.
– Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which
two parties agree to sell and repurchase the same security.
– Treasury Bills are Money Market instruments issued by RBI to finance the short term requirements of
the Government of India.
– Certificate of Deposits (CDs) is a negotiable Money Market instrument and issued in dematerialised
form or as Usance Promissory Note, for funds deposited at a bank or other eligible financial institution
for a specified time period.
– An Inter Corporate Deposits (ICD) is an unsecured loan extended by one corporate to another. Existing
mainly as a refuge for low rated corporates, this market allows corporates with surplus funds to lend to
other corporates facing shortage of funds.
– Commercial bills are basically negotiable instruments accepted by buyers for goods or services obtained
by them on credit.
– Commercial Paper (CP) is an unsecured Money Market instrument issued in the form of a promissory
note.
– One of the recent development in the sphere of Money Market is the establishment of Money Market
Mutual Funds, the guidelines of which have been prescribed by the Reserve Bank of India. Money
Market Mutual Funds (MMFs) can be set up by the banks and public financial institutions.
– Factoring is a financial transaction where an entity sells its receivables to a third party called a ‘factor’,
at discounted prices. Factoring is a financial option for the management of receivables.
– A Letter of Credit is a written understanding given by the buyer’s bank (the issuing bank) on behalf of and
at the request of its customer (the applicant) routed through the agency of a bank in the seller’s country
(advising bank) to the seller beneficiary that it (issuing bank) guarantees to pay the seller for the goods
within a specified time provided that the conditions laid down in documentary credit are fully satisfied.
378 PP-CC&MM
– The Negotiable Instruments Act, 1881, defines the Bill of Exchange as “an instrument in writing containing
an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money
only to, or to the order of, a certain person or to the bearer of the instrument.”
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. Briefly discuss about Call money and Notice Money Market.
2. Explain Treasury Bills as an effective Cash Management product and state how yield of Treasury Bill
is calculated.
3. What is Banker’s Acceptance? Discuss.
4. Explain briefly about Money Market Mutual funds.
5. How credit transaction takes place in a Letter of Credit? Explain with step wise description.
6. Discuss the various objective of FIMMDA.
Lesson 13
Insider Trading
LESSON OUTLINE
Insider Trading 379
LEARNING OBJECTIVES
– Introduction
In simple terms ‘insider trading’ is buying or
selling a security, in breach of a fiduciary duty
or other relationship of trust, and confidence,
while in possession of material, non public
information about the security. Therefore,
preventing such transactions is an important
obligation for any capital market regulatory
system, because insider trading undermines
investor confidence in the fairness and integrity
of the securities markets.
– SEBI (Prohibition of Insider Trading)
Regulation, 1992
– Important Definitions
– Prohibition on Dealing Communication or
Counselling on Matters Relating to Insider
Trading
– Code of Internal Procedures and Conduct
for Listed Companies and other Entities
– Disclosure of interest or holding by certain
persons
A Company Secretary being a Compliance
Officer of the company plays an important role
to prevent Insider Trading by establishment of
policies and procedures and over all supervision
in this regard.
– Model Code of Conduct for Prevention of
Insider Trading for Listed Companies
– Model Code of Conduct for Prevention of
Insider Trading for Other Entities
This lesson will enable the students to have the
basic understanding of the Insider Trading
Regulations prevailing in India, the disclosures
required to be made by the company, employee,
directors, promoters, etc., the duty of
compliance officer, Model Code of Conduct,
Code of Corporate Disclosure Practices, the
Penal provisions for Insider Trading etc.
– Code of Corporate Disclosure Practices
for Prevention of Insider Trading
– Investigation by SEBI
– Penalty Provisions for violations of the
Regulations
– Appeal to Securities Appellate Tribunal
– Role of Company Secretary
Compliance Requirements
Lesson 13
in
– SEBI’s view on the Role of the
Compliance Officer in case of Insider
Trading
– LESSON ROUND UP
– SELF TEST QUESTIONS
379
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INTRODUCTION
The practice of Insider Trading came into existence ever since the very concept of trading of securities of a
company became prevalent among the investors worldwide and has now become a formidable challenge for
investors all over the world.
The history of Insider Trading in India relates back to the 1940’s with the formulation of government committees
such as the Thomas Committee of 1948, which evaluated inter alia, the regulations in the US on short swing
profits under Section 16 of the Securities Exchange Act, 1934. Thereafter in India provisions relating to Insider
Trading were incorporated in the Companies Act, 1956 under Sections 307 and 308, which required shareholding
disclosures by the directors and managers of a company.
Due to inadequate provisions of enforcement in the companies Act, 1956, the Sachar Committee in 1979, the
Patel Committee in 1986 and the Abid Hussain Committee in 1989 proposed recommendations for a separate
statute regulating Insider Trading. The Patel committee in 1986 in India defined Insider Trading as,
“Insider trading generally means trading in the shares of a company by the persons who are in the management
of the company or are close to them on the basis of undisclosed price sensitive information regarding the
working of the company, which they possess but which is not available to others.”
The concept of Insider Trading in India started fermenting in the 80’s and 90’s and came to be known and
observed extensively in the Indian Securities market. The rapidly advancing Indian Securities market needed a
more comprehensive legislation to regulate the practice of Insider Trading, thus resulting in the formulation of
the SEBI (Insider Trading) Regulations in the year 1992, which were amended in the year 2002 after the
discrepancies observed in the 1992 regulations in the cases like Hindustan Levers Ltd. vs. SEBI, Rakesh Agarwal
vs. SEBI, etc. to remove the lacunae existing in the Regulations of 1992. The amendment in 2002 came to be
known as the SEBI ([Prohibition of] Insider Trading) Regulations, 1992.
The regulations of 1992 seemed to be more punitive in nature. The 2002 amendment regulations on the other
hand are preventive in nature. The amendment requires all the listed companies, market intermediaries and
advisers to follow the new regulations and also take steps in advance to prevent the practice of insider trading.
SEBI (PROHIBITION OF INSIDER TRADING) REGULATIONS, 1992
The SEBI (Prohibition of Insider Trading) Regulation 1992, comprise of four chapters and three schedules
encompassing the various regulations related to insider trading. Chapter I deal mainly with the definitions used
in regulation. Chapter II provides for prohibitions on dealing, communicating or counselling by insider. It also
contains the defences available to a company in proceeding against it on allegation of Insider Trading. Chapter
III narrates the investigating powers of SEBI under the regulation and also enumerates the prohibitory orders or
directions that it can issue against the guilty in the interest of the capital market regulation. Chapter IV deals with
the code of internal procedure and conduct to be followed by listed companies and other entities, disclosure
requirements be followed by company. It also contains appeal provisions which an aggrieved person may like to
follow against the orders of SEBI.
IMPORTANT DEFINITIONS
Dealing in securities
It means an act of subscribing buying, selling or agreeing to subscribe to buy, sell or deal in any securities by any
person either as principal or agent.
Insider
“Insider” means any person who, is or was connected with the company or is deemed to have been connected
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with the company, and who is reasonably expected to have access, to unpublished price sensitive information in
respect of securities of company, or who has received or has had access to such unpublished price sensitive
information.
Connected Person
“Connected Person” means any person who –
(i) is a director, as defined in clause (13) of section 2 of the Companies Act, 1956 of a company, or is
deemed to be a director of that company by virtue of sub-clause (10) of section 307 of that Act or
(ii) occupies the position as an officer or an employee of the company or holds a position involving a
professional or business relationship between himself whether temporary or permanent and the company
and who may reasonably be expected to have an access to unpublished price sensitive information in
relation to that company;
It may be noted that “connected person” means any person who is a connected person six months prior to an
act of insider trading.
Person deemed to be connected person
“Person is deemed to be a connected person”, if such person –
(i) is a company under the same management or group, or any subsidiary company thereof within the
meaning of sub-section (1B) of section 370, or sub-section (11) of section 372, of the Companies Act,
1956 or sub-clause (g) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969 as the
case may be; or
(ii) is an intermediary as specified in section 12 of the Act, 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;
(iii) is a merchant banker, share transfer agent, registrar to an issue, debenture trustee, broker, portfolio
manager, Investment Advisor, sub-broker, Investment Company or an employee thereof, or is member
of the Board of Trustees of a mutual fund or a member of the Board of Directors of the Asset Management
Company of a mutual fund or is an employee thereof who have a fiduciary relationship with the company;
(iv) is a Member of the Board of Directors or an employee of a public financial institution as defined in
section 4A of the Companies Act, 1956; or
(v) is an official or an employee of a Self-Regulatory Organisation recognised or authorised by the Board of
a regulatory body; or
(vi) is a relative of any of the aforementioned persons;
(vii) is a banker of the company.
(viii) relatives of the connected person; or
(ix) is a concern, firm, trust, Hindu undivided family, company or association of persons wherein any of the
connected persons mentioned in sub-clause (i) of clause (c), of this regulation or any of the persons
mentioned in sub-clause (vi), (vii) or (viii) of this clause have more than 10 per cent of the holding or
interest;
Price Sensitive Information
“Price sensitive information” means any information which relates directly or indirectly to a company and which
if published is likely to materially affect the price of securities of company;
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The following shall be deemed to be price sensitive information:– periodical financial results of the company;
– intended declaration of dividends (both interim and final);
– issue of securities or buy-back of securities;
– any major expansion plans or execution of new projects;
– amalgamation, mergers or takeovers;
– disposal of the whole or substantial part of the undertaking;
– any significant changes in policies, plans or operations of the company.
Unpublished
“unpublished” means information which is not published by the company or its agents and is not specific in
nature.
Explanation : - Speculative Reports in print or electronic media shall not be considered as published
information.
PROHIBITION ON DEALING COMMUNICATION OR COUNSELLING ON MATTERS RELATING
TO INSIDER TRADING
Regulation 3 provides that insider shall not either on his own behalf or on behalf of any other person, deal in
securities of a company listed on any stock exchange when in possession of any unpublished price sensitive
information; or communicate, counsel or procure, directly or indirectly, any unpublished price sensitive information
to any person who while in possession of such unpublished price sensitive information shall not deal in securities.
However, above provisions shall not applicable to any communication required in the ordinary course of business
or profession or employment or under any law.
Under Regulation 3A no company shall deal in the securities of another company or associate of that other
company while in possession of any unpublished price sensitive information. Any insider, who deals in securities
in contravention of the provisions of regulation 3 or 3A shall be guilty of Insider trading.
Regulation 3A not to apply in certain cases
Regulation 3B lays down that in a proceeding against a company in respect of regulation 3A, it shall be a
defence to prove that it entered into a transaction in the securities of a listed company when the unpublished
price sensitive information was in the possession of an officer or employee of the company, if :
(a) the decision to enter into the transaction or agreement was taken on its behalf by a person or persons
other than that officer or employee; and
(b) such company has put in place such systems and procedures which demarcate the activities of the
company in such a way that the person who enters into transaction in securities on behalf of the company
cannot have access to information which is in possession of other officer or employee of the company;
and
(c) it had in operation at that time, arrangements that could reasonably be expected to ensure that the
information was not communicated to the person or persons who made the decision and that no advice
with respect to the transactions or agreement was given to that person or any of those persons by that
officer or employee; and
(d) the information was not so communicated and no such advice was so given.
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Insider Trading 383
In a proceeding against a company in respect of regulation 3A which is in possession of unpublished price
sensitive information, it shall be defence to prove that acquisition of shares of a listed company was as per SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
Violation of provisions relating to insider trading
Regulation 4 provides that any insider who deals in securities in contravention of the provisions of regulation 3
or 3A shall be guilty of insider trading.
CODE OF INTERNAL PROCEDURES AND CONDUCT FOR LISTED COMPANIES AND OTHER
ENTITIES
Regulation 12 provides that all listed companies and organisations associated with securities markets including
the intermediaries as mentioned in section 12 of the Act, asset management company and trustees of mutual
funds; the self regulatory organisations recognised or authorised by the SEBI; the recognised stock exchanges
and clearing house or corporations; the public financial institutions as defined in Section 4A of the Companies
Act, 1956; and the professional firms such as auditors, accountancy firms, law firms, analysts, consultants, etc.,
assisting or advising listed companies, shall frame a code of internal procedures and conduct as near there to
the Model Code specified in these Regulations.
DISCLOSURE OF INTEREST OR HOLDING IN A LISTED COMPANIES BY CERTAIN PERSONS
Initial Disclosure
Regulation 13(1) provides that any person who holds more than 5% shares or voting rights in any listed company
shall disclose to the company, in the prescribed form, the number of shares or voting rights held by such person,
on becoming such holder, within 2 working days of the receipt of intimation of allotment of shares or the acquisition
of shares or voting rights, as the case may be.
Regulation 13(2) lays down that any person who is a director or officer of a listed company, shall disclose to the
company, in the prescribed form, the number of shares or voting rights held and positions taken in derivatives by
such person and his dependents (as defined by the company), within 2 working days of becoming a director or
officer of the company.
Sub-regulation 2A requires that any person who is a promoter or part of promoter group of a listed company
shall disclose to the company in prescribed Form, the number of shares or voting rights held by such person,
within two working days of becoming such promoter or person belonging to promoter group.
Continual Disclosure
Sub-regulation 3 of Regulation 13 provides that any person who holds more than 5% shares or voting rights in
any listed company shall disclose to the company in prescribed form the number of shares or voting rights held
and change in shareholding or voting rights, even if such change results in shareholding falling below 5%, if
there has been change in such holdings from the last disclosure made under sub-regulation (1) or under this
sub-regulation; and such change exceeds 2% of total shareholding or voting rights in the company.
Any person who is a director or officer of a listed company, shall disclose to the company and the stock exchange
where the securities are listed, in prescribed form the total number of shares or voting rights held and change in
shareholding or voting rights, if there has been a change in such holdings of such person and his dependents
(as defined by the company) from the last disclosure made and the change exceeds ` 5 lac in value or 25,000
shares or 1% of total shareholding or voting rights, whichever is lower. [Regulation 13(4)]
Any person who is a promoter or part of promoter group of a listed company, is required to disclose to the
company and the stock exchange where the securities are listed in prescribed Form, the total number of shares
or voting rights held and change in shareholding or voting rights, if there has been a change in such holdings of
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such person from the last disclosure made under Listing Agreement or under these regulations, and the change
exceeds ` 5 lakh in value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.
[Regulation 13(4A)]
The disclosure shall be made within 2 working days of the receipt of intimation of allotment of shares, or the
acquisition or sale of shares or voting rights, as the case may be.
Disclosure by Company ot Stock Exchange
Every listed company, within 2 working days of receipt of the information mentioned above is required to disclose
to all stock exchanges on which the company is listed.
Disclosure Through E-Filing
The disclosures required under this regulation may also be made through electronic filing in accordance with the
system devised by the stock exchange.
MODEL CODE OF CONDUCT FOR PREVENTION OF INSIDER TRADING FOR LISTED
COMPANIES
Part A of schedule I of these Regulations deals with Model Code of Conduct for Prevention of Insider Trading for
Listed Companies as discussed below :
Compliance Officer
The listed company has appointed a compliance officer (senior level employee) who shall report to the Managing
Director/Chief Executive Officer.
The compliance officer shall be responsible for setting forth policies, procedures, monitoring adherence to the
rules for the preservation of “Price Sensitive Information”, pre-clearing of designated employees’ and their
dependents’ trades (directly or through respective department heads as decided by the company), monitoring of
trades and the implementation of the code of conduct under the overall supervision of the Board of the listed
company.
The compliance officer shall maintain a record of the designated employees and any changes made in the list of
designated employees.
The compliance officer shall assist all the employees in addressing any clarifications regarding the Securities
and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 and the company’s code of
conduct.
Preservation of “Price Sensitive Information”
Employees/ directors shall maintain the confidentiality of all Price Sensitive Information. Employees/ directors
shall not pass on such information to any person directly or indirectly by way of making a recommendation for
the purchase or sale of securities.
Need to Know
Price Sensitive Information is to be handled on a “need to know” basis, i.e., Price Sensitive Information should
be disclosed only to those within the company who need the information to discharge their duty.
Limited access to confidential information
Files containing confidential information shall be kept secure. Computer files must have adequate security of
login and password etc.
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Insider Trading 385
Prevention of misuse of “Price Sensitive Information”
All directors/ officers and designated employees of the company shall be subject to trading restrictions as
enumerated below :
Trading window
– The company shall specify a trading period, to be called “Trading Window”, for trading in the company´s
securities. The time for commencement of closing of trading window shall be decided by the company.
– The trading window shall be opened 24 hours after the following information is made public.
– The trading window shall be closed at the time of:(a) Declaration of Financial results (quarterly, half-yearly and annual)
(b) Declaration of dividends (interim and final)
(c) Issue of securities by way of public/ rights/bonus etc.
(d) Any major expansion plans or execution of new projects
(e) Amalgamation, mergers, takeovers and buy-back
(f) Disposal of whole or substantially whole of the undertaking
(g) Any changes in policies, plans or operations of the company.
– When the trading window is closed, the employees / directors shall not trade in the company’s securities
in such period.
– All directors/ officers/designated employees of the company shall conduct all their dealings in the securities
of the Company only in a valid trading window and shall not deal in any transaction involving the purchase
or sale of the company´s securities during the periods when trading window is closed or during any
other period as may be specified by the Company from time to time.
– In case of ESOPs, exercise of option may be allowed in the period when the trading window is closed.
However, sale of shares allotted on exercise of ESOPs shall not be allowed when trading window is
closed.
Pre-clearance of trades
– All directors/officers/designated employees of the company and their dependents as defined by the
company who intend to deal in the securities of the company (above a minimum threshold limit to be
decided by the company) should pre-clear the transaction as per the pre-dealing procedure as described
hereunder.
– An application can be made in such form as the company may notify in this regard, to the Compliance
Officer indicating the estimated number of securities that the designated employee/officer/director intends
to deal in, the details as to the depository with which he has a security account, the details as to the
securities in such depository mode and such other details as may be required by any rule made by the
company in this behalf.
– An undertaking shall be executed in favour of the company by such designated employee/director/
officer incorporating, inter alia, the following clauses, as may be applicable :
(a) That the employee/director/officer does not have any access or has not received “Price Sensitive
Information” upto the time of signing the undertaking.
(b) That in case the employee/director/officer has access to or receives “Price Sensitive Information”
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after the signing of the undertaking but before the execution of the transaction he/she shall inform
the Compliance Officer of the change in his position and that he/she would completely refrain from
dealing in the securities of the company till the time such information becomes public.
(c) That he/she has not contravened the code of conduct for prevention of insider trading as notified by
the company from time to time.
(d) That he/she has made a full and true disclosure in the matter.
Other restrictions
– All directors/officers/designated employees and their dependents (as defined by the company) shall
execute their order in respect of securities of the company within one week after the approval of
preclearance is given. If the order is not executed within one week after the approval is given, the
employee/ director must pre-clear the transaction again.
– All directors/ officers/ designated employees who buy or sell any number of shares of the company shall
not enter into an opposite transaction i.e. sell or buy any number of shares during the next six months
following the prior transaction. All directors/ officers/ designated employees shall also not take positions
in derivative transactions in the shares of the company at any time.
– In the case of subscription in the primary market (initial public offers), the above mentioned entities shall
hold their investments for a minimum period of 30 days. The holding period would commence when the
securities are actually allotted.
– In case the sale of securities is necessitated by personal emergency, the holding period may be waived
by the compliance officer after recording in writing his/her reasons in this regard.
Reporting Requirements for transactions in securities
All directors/officers/designated employees of the listed company shall be required to forward following details
of their securities transactions including the statement of dependent family members (as defined by the company)
to the Compliance Officer:
(a) all holdings in securities of that company by directors/officers/designated employees at the time of
joining the company;
(b) periodic statement of any transactions in securities (the periodicity of reporting may be defined by the
company. The company may also be free to decide whether reporting is required for trades where
preclearance is also required); and
(c) annual statement of all holdings in securities.
The Compliance Officer shall maintain records of all the declarations in the appropriate form given by the directors/
officers/designated employees for a minimum period of three years. The Compliance Officer shall place before
the Managing Director/Chief Executive Officer or a committee specified by the company, on a monthly basis all
the details of the dealing in the securities by employees/director/officer of the company and the accompanying
documents that such persons had executed under the pre-dealing procedure as envisaged in this code.
Penalty for contravention of code of conduct
– Any employee/officer/director who trades in securities or communicates any information for trading in
securities in contravention of the code of conduct may be penalised and appropriate action may be
taken by the company.
– Employees/officers/directors of the company who violate the code of conduct shall also be subject to
disciplinary action by the company, which may include wage freeze, suspension, ineligible for future
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Insider Trading 387
participation in employee stock option plans, etc.
– The action by the company shall not preclude SEBI from taking any action in case of violation of SEBI
(Prohibition of Insider Trading) Regulations, 1992.
Information to SEBI in case of violation of SEBI (Prohibition of Insider Trading) Regulations,
1992
In case it is observed by the company/Compliance Officer that there has been a violation of SEBI (Prohibition of
Insider Trading) Regulations, 1992. SEBI shall be informed by the company.
MODEL CODE OF CONDUCT FOR PREVENTION OF INSIDER TRADING FOR OTHER ENTITIES
Part B of Schedule I deals with Model Code of Conduct for Prevention of Insider Trading for other Entities. All the
compliance requirements as explained in Model Code of Conduct for Listed companies are also applicable for
other entities. There are certain addition compliance requirement for Other entities which is discussed below:
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 “inside areas” from those areas which deal with sale/marketing/investment
advise or other departments providing support services, considered “public areas”.
– The employees in the inside area shall not communicate any Price Sensitive Information to
– any one in public area.
– The employees in inside area may be physically segregated from employees in public area.
– Demarcation of the various departments as inside area may be implemented by the organisation/firm.
– In exceptional circumstances employees from the public areas may be brought “over the wall” and
given confidential information on the basis of “need to know” criteria, under intimation to the compliance
officer.
Restricted/Grey list
– In order to monitor chinese wall procedures and trading in client securities based on inside information,
the organisation/firm shall restrict trading in certain securities and designate such list as restricted/grey
list.
– Security of a listed company shall be put on the restricted/grey list if the organisation/firm is handling
any assignment for the listed company or is preparing appraisal report or is handling credit rating
assignment and is privy to Price Sensitive Information.
– Any security which is being purchased or sold or is being considered for purchase or sale by the
organisation/firm on behalf of its clients/schemes of mutual funds, etc. shall be put on the restricted/grey
list.
– As the restricted list itself is a highly confidential information it shall not be communicated directly, or
indirectly to anyone outside the organisation/firm. The Restricted List shall be maintained by Compliance
Officer.
– When any securities are on the Restricted List-trading in these securities by designated employees/
directors/partners may be blocked or may be disallowed at the time of pre-clearance.
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Other restrictions
– All directors/designated employees/partners shall execute their order within one week after the approval
of pre-clearance is given. If the order is not executed within one week after approval is given the employee/
director/partners must pre clear the transaction again.
– All directors/officers/designated employees/partners shall hold their investments for a minimum period
of 30 days in order to be considered as being held for investment purposes.
– The holding period shall also apply to purchases in the primary market (IPOs). In the case of IPOs, the
holding period would commence when the securities are actually allotted.
– In case the sale of securities is necessitated by personal emergency, the holding period may be waived
by the Compliance Officer after recording in writing his/her reasons in this regard.
– Analysts, if any, employed with the organisation/firm while preparing research reports of a client
company(s) shall disclose their shareholdings/interest in such company(s) to the Compliance Officer.
– Analysts who prepare research report of a listed company shall not trade in securities of that company
for thirty days from preparation of such report.
Things You May Know
The intermediaries such as Credit Rating Agencies, Asset Management Companies, or broking
companies etc. whose securities are listed in recognised stock exchange shall comply with both
Part A and Part B of Schedule I in respect of its own securities and client’s securities.
CODE OF CORPORATE DISCLOSURE PRACTICES FOR PREVENTION OF INSIDER TRADING
CORPORATE DISCLOSURE POLICY
To ensure timely and adequate disclosure of price sensitive information, the following norms shall be followed
by listed companies: –
– Prompt disclosure of price sensitive information
Price sensitive information shall be given by listed companies to stock exchanges and disseminated on
a continuous and immediate basis. Listed companies may also consider ways of supplementing
information released to stock exchanges by improving Investor access to their public announcements.
– Overseeing and co-ordinating disclosure
Listed companies shall designate a senior official (such as compliance officer) to oversee corporate
disclosure. This official shall be responsible for ensuring that the company complies with continuous
disclosure requirements. Overseeing and co-ordinating disclosure of price sensitive information to stock
exchanges, analysts, shareholders and media and educating staff on disclosure policies and procedure.
Information disclosure/dissemination may normally be approved in advance by the official designated
for the purpose. If information is accidentally disclosed without prior approval, the person responsible
may inform the designated officer immediately, even if the information is not considered price sensitive.
– Responding to market rumours
Listed companies shall have clearly laid down procedures for responding to any queries or requests for
verification of market rumours by exchanges. The official designated for corporate disclosure shall be
responsible for deciding whether a public announcement is necessary for verifying or denying rumours
and then making the disclosure.
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Insider Trading 389
– Timely Reporting of shareholdings/ownership and changes in ownership
Disclosure of shareholdings/ownership by major shareholders and disclosure of changes in ownership
as provided under any Regulations made under the Act and the listing agreement shall be made in a
timely and adequate manner.
– Disclosure/dissemination of Price Sensitive Information with special reference to Analysts,
Institutional Investors
Listed companies should follow the guidelines given hereunder while dealing with analysts and institutional
investors : –
(i) Only Public information to be provided - Listed companies shall provide only public information to
the analyst/research persons/large investors like institutions. Alternatively, the information given to
the analyst should be simultaneously made public at the earliest.
(ii) Recording of discussion - In order to avoid misquoting or misrepresentation, it is desirable that at
least two company representative be present at meetings with Analysts, Brokers or Institutional
Investors and discussion should preferably be recorded.
(iii) Handling of unanticipated questions - A listed company should be careful when dealing with analysts’
questions that raise issues outside the intended scope of discussion. Unanticipated questions may
be taken on notice and a considered response given later. If the answer includes price sensitive
information, a public announcement should be made before responding.
(iv) Simultaneous release of Information - When a company organises meetings with analysts, the
company shall make a press release or post relevant information on its website after every such
meet. The company may also consider live webcasting of analyst meets.
– Medium of disclosure/dissemination
(i) Disclosure/dissemination of information may be done through various media so as to achieve
maximum reach and quick dissemination.
(ii) Corporates shall ensure that disclosure to stock exchanges is made promptly.
(iii) Corporates may also facilitate disclosure through the use of their dedicated Internet website.
(iv) Company websites may provide a means of giving investors a direct access to analyst briefing
material, significant background information and questions and answers.
(v) The information filed by corporates with exchanges under continuous disclosure requirement may
be made available on the company website.
– Dissemination by stock exchanges
(i) The disclosures made to stock exchanges may be disseminated by the exchanges to investors in a
quick and efficient manner through the stock exchange network as well as through stock exchange
websites.
(ii) Information furnished by the companies under continuous disclosure requirements, should be
published on the website of the exchange instantly.
(iii) Stock exchanges should make immediate arrangement for display of the information furnished by
the companies instantly on the stock exchange website.
INVESTIGATION BY SEBI
Chapter III of these Regulations deals with the investigations made by SEBI.
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Power to make inquiries and inspection
Regulation 4A provides that if SEBI suspects that any person has violated any provision of these regulations, it
may make inquiries with such persons or any other person as deemed fit, to form a prima facie opinion as to
whether there is any violation of these regulations.
SEBI’s right to investigate
Regulation 5 empowers SEBI to investigate into the complaints received from investors, intermediaries or any
other person on any matter having a bearing on the allegations of insider trading; and to investigate suo-moto
upon its own knowledge or information in its possession to protect the interest of investors in securities against
breach of these regulations.
Before undertaking an investigation under regulation 5 SEBI shall give a reasonable notice to insider for that purpose.
However, where SEBI is satisfied that in the interest of investors or in public interest no such notice should be given,
it may by an order in writing direct that the investigation be taken up without such notice (Regulation 6).
Obligations of Insider on Investigation by SEBI
Regulation 7 deals with the obligations of an insider on investigation made by SEBI.
– It shall be the duty of every insider who is being investigated or any other person mentioned in clause (i)
of sub-section (1) of section 11 of the Act, to produce to the investigating authority such books, accounts
and other documents in his custody or control and furnish the authority with the statements and information
relating to the transactions in securities market within such time as the said authority may require.
– The insider or any other person in clause (i) of sub-section (2) of section 11 of the Act] shall allow the
investigating authority to have reasonable access to the premises occupied by such insider and also
extend reasonable facility for examining any books, records, documents and computer data in the
possession of the stock-broker or any other person and also provide copies of documents or other
materials which in the opinion of the investigating authority are relevant.
– The investigating authority, in the course of investigation, shall be entitled to examine or record statements
of any member, director, partner, proprietor and employee of the insider or any other person mentioned
in clause (i) of sub-section (2) of section 11 of the SEBI Act.
– It shall be the duty of every director, proprietor, partner, officer and employee of the insider to give to the
investigating authority all assistance in connection with the investigation, which the insider or any other
person mentioned in clause (i) of sub-section (2) of section 11 of the Act may be reasonably expected to
give.
Directions by SEBI
Regulation 11 stipulates that SEBI may without prejudice to its right to initiate criminal prosecution under the Act,
to protect the interests of investors and in the interests of the securities market and for due compliance with the
provisions of the Act, Regulations made thereunder issue any or all of the following order, namely:– directing the insider or such person not to deal in securities in any particular manner;
– prohibiting the insider or such person from disposing of any of the securities acquired in violation of
these Regulations;
– restraining the insider to communicate or counsel any person to deal in securities;
– declaring the transaction(s) in securities as null and void;
– directing the person who acquired the securities in violation of these regulations to deliver the securities
back to the seller;
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Insider Trading 391
However, in case the buyer is not in a position to deliver such securities, the market price prevailing at
the time of issuing of such directions or at the time of transactions whichever is higher, shall be paid to
the seller;
– directing the person who has dealt in securities in violation of these regulations to transfer an amount or
proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor
protection fund of a Recognised Stock Exchange.
PENALTY PROVISIONS FOR VIOLATIONS OF THE REGULATIONS
Without prejudice to the directions under regulation 11, if any person violates the provisions of these Regulations,
he shall be liable for appropriate action under Sections 11, 11 B, 11D, Chapter VIA and Section 24 of the SEBI Act.
Regulation 11 & 14 of the SEBI (Prohibition and Insider Trading) Regulations, empowers the SEBI to issue
following directions to the violators without prejudice to its right to initiate criminal prosecution under section 24
or any action under Chapter VIA of the SEBI Act, to protect the interests of investor and in the interests of the
securities market and for due compliance with the provisions of the Act, regulation made there under issue any
or all of the following order, namely:
(a) directing the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the Act
not to deal in securities in any particular manner;
(b) prohibiting the insider or such person as mentioned in clause (i) of sub-section (2) of section 11 of the
Act from disposing of any of the securities acquired in violation of these regulations;
(c) restraining the insider to communicate or counsel any person to deal in securities;
(d) declaring the transaction(s) in securities as null and void;
(e) directing the person who acquired the securities in violation of these regulations to deliver the securities
back to the seller:
However, in case the buyer is not in a position to deliver such securities, the market price prevailing at
the time of issuing of such directions or at the time of transactions whichever is higher, shall be paid to
the seller;
(f) directing the person who has dealt in securities in violation of these regulations to transfer an amount or
proceeds equivalent to the cost price or market price of securities, whichever is higher to the investor
protection fund of a recognised stock exchange.
Penalty for insider trading under SEBI Act, 1992:
Section 15G of the SEBI Act, 1992, lays down that –
If any insider who, –
(i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed
on any stock exchange on the basis of any unpublished price-sensitive information; or
(ii) communicates any unpublished price-sensitive information to any person, with or without his request
for such information except as required in the ordinary course of business or under any law; or
(iii) counsels, or procures for any other person to deal in any securities of any body corporate on the basis
of unpublished price-sensitive information shall be liable to a penalty of twenty-five crore rupees or
three times the amount of profits made out of insider trading, whichever is higher.
Section 24 of the SEBI Act, 1992 provides as under:
(1) Without prejudice to any award of penalty by the adjudicating officer under this Act, if any person
392 PP-CC&MM
contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any
rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may
extend to ten years, or with fine which may extend to twenty-five crore rupees or with both.
(2) If any person fails to pay the penalty imposed by the adjudicating officer or fails to comply with any of his
directions or orders, he shall be punishable with imprisonment for a term which shall not be less than
one month but which may extend to ten years, or with fine, which may extend to twenty-five crore
rupees or with both.
Thus violation of the provisions of the regulations attract huge monetary penalty and may lead to criminal
prosecution. However those aggrieved by an order of SEBI, may prefer an appeal to the Securities Appellate
Tribunal within a period of forty-five days of the order. The persons aggrieved can also apply to SEBI for consent
order under the scheme announced by it in which case the case is considered by a High Power Committee
constituted under the SEBI Act, 1992.
ROLE OF COMPANY SECRETARY IN COMPLIANCE REQUIREMENTS
The obligations cast upon the Company Secretary in relation to the insider trading regulations can be summarized
as under:
1. To frame a code of internal procedures and conduct in line with the Model Code specified in the Schedule
I of the regulations and get the same approved from the Board of Directors of the Company.
2. To place before the Board the “Code of Corporate Disclosure Practices for Prevention of Insider Trading”
as enumerated in the Schedule II of the regulations.
3. The Company Secretary has to place before the Board for their consideration and approval the following:
(i) closing period for trading window.
(ii) minimum threshold limit beyond which it would be mandatory for the directors/officers/designated
employees to obtain pre-clearance from the compliance officer before they trade in the company’s
securities.
(iii) format of application form for pre-clearance.
(iv) format of undertaking to be attached with pre-clearance application.
(v) internal guidelines as to the circumstances when the holding period may be waived by the compliance
officer.
(vi) periodicity at which the directors/officers/designated employees are required to submit periodic
statement of transaction in securities of the company to comply with the Code of Corporate Disclosure
Practices.
(vii) To identify and declare the designated employees for the purpose of the regulations.
4. In case of unlisted company the company secretary is required
(i) To prepare the Chinese wall policy for adoption in the company.
(ii) To prepare Restricted/ Grey List of securities from time to time.
5. To frame and then to monitor adherences to the rules for the preservation of “Price Sensitive information”.
6. To monitor and confirm whether transactions for which pre- clearance has been granted were executed
within one week.
7. To suggest any improvements required in the policies, procedures, etc to ensure effective implementation
of the code.
Lesson 13
Insider Trading 393
8. To maintain a record of all directors, officers and persons covered within the ambit of the term ‘designated
employee’ and any changes in the same.
9. To assist in addressing any clarifications regarding SEBI (Prohibition of Insider Trading) Regulations,
1992 and the company’s code of conduct.
10. To maintain a list of all information termed as ‘price sensitive information’.
11. To maintain a record of names of files containing confidential information deemed to be price sensitive
information and persons in charge of the same.
12. To ensure that computer data is adequately secured.
13. To keep records of periods specified as ‘close period’ and the ‘Trading Widow’.
14. To ensure that the ‘Trading Window’ is closed at the time of:
(i) Declaration of Financial results (quarterly, half-yearly and annual).
(ii) Declaration of dividends (interim and final)
(iii) Issue of securities by way of public /right/ bonus etc.
(iv) Any major expansion plans or execution of new projects.
(v) Amalgamation, mergers, takeovers and buy-back.
(vi) Disposal of whole or substantially whole ‘of the undertaking.
(vii) Any change in policies, plans or operations of the company.
(viii) Considering ay other matter which could be construed as price-sensitive information.
(ix) All other events as specified under clause 36 of the Listing Agreement.
15. To ensure that the trading widow is opened 24 hours after the information mentioned in para 4 is made
public.
16. To ensure that the trading restrictions are strictly observed and that all directors/officers/designated
employees conduct all their dealings in the securities of the company only in a valid trading window and
do not deal in the company’s securities during the period when the trading window is closed.
17. To ensure that no sale of shares allotted on exercise of ESOPs is made during a close period.
18. To receive initial disclosure from any person holding more than 5% shares or voting rights in the company
in the prescribed form within two working days of:
(i) the receipt of information of allotment of shares; or
(ii) the acquisition of shares or voting rights, as the case may be
19. To procure initial disclosure of the number of shares or voting rights held by any person who is a director
or officer is a promoter or part of promoter group of the listed company in the prescribed form within two
working days of becoming a director or officer of the company.
20. To receive from any person continual disclosures of the number of shares or voting rights held in the
company and changes (purchase or sales or otherwise) therein, even if the shareholding falls below 5%
since the last disclosure made under para 18 or this para, and such change exceeds 2% of the total
shareholding or voting rights in the prescribed form within 2 working days of:
– the receipt of intimation of allotment of shares; or
– the acquisition or sale of shares or voting rights, as the case may be.
394 PP-CC&MM
21. To procure from any person who is a director or officer or is a promoter or part of promoter group of the
listed company, continual disclosures of the total number of shares or voting rights held and change in
shareholding or voting rights, if there has been a change in such holdings from the last disclosure made
under para 19 above or this para, and the change exceeds ` 5 lac in value or 25000 shares or 1% of
total shareholding or voting rights, whichever is lower, in the prescribed form within 4 working days of:
– the receipt of intimation of allotment of shares; or
– the acquisition or sale of shares or voting rights, as the case may be.
22. To inform all stock exchanges on which the company’s securities are listed, the information received
under para 18, 19, 20and 21 within five days of receipt.
23. To process the applications received for pre-clearance of transactions from the directors/officers/
designated employees.
24. To confirm whether the directors/ officers/ designated employees executed their order in respect of
securities of the company within one week after the approval of pre- clearance is given.
25. To ensure that a minimum holding period as specified by the company, which is not less than 30 days is
observed by all directors/officers/ designated employees.
26. To waive the requirement of holding period under certain circumstances.
27. To receive and maintain records of periodic and annual statement of holdings from directors/officers/
designated employees and their dependant family members.
28. To maintain records of all disclosures made by directors/officers/designated employees for a minimum
period of three years.
29. To place before the Managing Director or Chief Executive Officer or Committee of directors, as may be
specified for the purpose, on a monthly basis all the details of the dealings in the securities by directors/
officers of the company and the accompanying documents that such persons had executed under the
pre-clearance procedure.
30. To implement the punitive measures or disciplinary action prescribed for any violation or contravention
of the code of conduct.
External Reporting by the Company Secretary as Compliance Officer
1. To disclose within two working days of receipt, to all stock exchanges on which the company is listed, the
information received under regulation 13.
2. To inform the SEBI the violation of the SEBI (Prohibition of Insider Trading) Regulations, 1992 if any committed
by any person. But before bringing it to the notice of SEBI, the compliance officer has to inform the Managing
Director/ Chief Operating Officer and the Board of the Company.
3. In addition to the above he is also required to liaison with other authorities and the shareholders of the
Company.
SEBI’s VIEW ON THE ROLE OF THE COMPLIANCE OFFICER IN CASE OF INSIDER TRADING
SEBI Adjudication Order dated 27th July 2012 in respect of Mr. G Jayaraman in the matter of
Satyam Computer Services Ltd.
– Vide the aforesaid Order, SEBI has held the erstwhile compliance officer of Satyam Computer Services Ltd,
Mr. G Jayaraman, liable for not enforcing the safeguards under the Model Code during the period of December
2008 – January 2009. It may be noted that Mr. G Jayaraman was the Company Secretary of Satyam.
Lesson 13
Insider Trading 395
– The particular safeguard which the said Compliance Officer had failed to enforce was to close the
trading window after becoming aware of certain “price sensitive information” relating to Satyam, i.e. The
potential merger of Maytas with Satyam, which was not yet confirmed by the Board of Satyam.
– In the context of the facts of the case, under paragraph 20 of the said Order, SEBI has stated that
despite the Compliance Officer being under the overall supervision of the Board of Directors of the
company, he should have closed the trading window even without obtaining prior approval of the board.
SEBI has further stated that if the Compliance Officer were to always wait for instructions from the Board
to close the trading window as contended by him then the provisions contained in the Model Code of
Conduct get defeated as the provisions clearly emphasizes upon the role of the Compliance Officer who
shall, inter alia, be responsible for implementing the Code under the overall supervision of the Board. As
Compliance Officer, he cannot raise the defence that internal approvals were not available. As stated
earlier, such contention if accepted would render the stipulation of appointment of Compliance Officer
meaningless and goes against the spirit of the Prohibition of Insider Trading Regulations.
– At paragraph 29 of the said Order, SEBI summarised the role that a Compliance Officer is expected to
play in the securities market. An extract is given below:“For orderly and fair functioning of the securities market, it is essential for every market player
to fulfil the requirements mandated in the law. The duty weighs even more on a person like
Compliance Officer, who is conferred upon with key responsibilities in a company. Hence, the
violation by the Noticee needs to be viewed seriously.”
SEBI imposed a penalty of ` 5,00,000/- (Rupees Five Lakhs only) on Mr. G Jayaraman.
LESSON ROUND UP
– To curb insider trading SEBI formulated SEBI (Prohibition of Insider Trading) Regulations, 1992 and
which prescribes code of conduct and corporate disclosure practices to be followed by listed companies
and entities connected with them.
– The Insider Trading Regulations Comprises of four chapter and three schedules encompassing the
various regulations relating to Insider Trading.
– Insider means and includes deemed to be a connected person. The definition of deemed to be a
connected person is very elaborate.
– The regulations not only seeks to curb dealing in securities, they also seek to curb communicating or
counselling about securities by the insiders.
– Regulation 3 provides that insider shall not either on his own behalf or on behalf of any other person,
deal in securities of a company listed on any stock exchange when in possession of any unpublished
price sensitive information; or communicate, counsel or procure, directly or indirectly, any unpublished
price sensitive information to any person who while in possession of such unpublished price sensitive
information shall not deal in securities.
– Regulation 4A provides that if SEBI suspects that any person has violated any provision of these
regulations, it may make inquiries with such persons or any other person as deemed fit, to form a
prima facie opinion as to whether there is any violation of these regulations.
– The regulations provide for initial as well as continual disclosures by members of the company after a
threshold limit of holding and by the directors/ employees/ designated employees/promoter/promoter
group at regular interval.
– Any person who holds more than 5% shares or voting rights in any listed company shall disclose to the
company, in the prescribed form the number of shares or voting rights held by such person, on becoming
396 PP-CC&MM
such holder, within 2 working days of the receipt of intimation of allotment of shares or the acquisition
of shares or voting rights, as the case may be.
– The disclosure shall be made within 2 working days of the receipt of intimation of allotment of shares,
or the acquisition or sale of shares or voting rights, as the case may be.
– The compliance officer shall be responsible for setting forth policies, procedures, monitoring adherence
to the rules for the preservation of “Price Sensitive Information”, pre-clearing of designated employees’
and their dependents’ trades (directly or through respective department heads as decided by the
company), monitoring of trades and the implementation of the code of conduct under the overall
supervision of the Board of the listed company.
– The company shall specify a trading period, to be called “Trading Window”, for trading in the company´s
securities. The time for commencement of closing of trading window shall be decided by the company.
– Without prejudice to the directions under regulation 11, if any person violates provisions of these
regulations, he shall be liable for appropriate action under Sections 11, 11 B, 11D, Chapter VIA and
Section 24 of the SEBI Act.
– Any person aggrieved by an order of SEBI under these regulations can prefer an appeal to the Securities
Appellate Tribunal.
SELF TEST QUESTIONS
(These are meant for recapitulation only. Answer to these questions are not to be submitted for evaluation.)
1. What are the compliances required to be made by a company under SEBI (Prohibition of Insider
Trading) Regulations, 1992?
2. Describe the obligations cast upon the company under SEBI (Prohibition of Insider Trading) Regulations,
1992.
3. What are the Initial Disclosure Required to be made by a person under SEBI (Prohibition of Insider
Trading ) Regulations, 1992?
4. What are the Penalties for Insider Trading under SEBI Act?
5. Briefly explain the duty of Compliance Officer under these Regulations.
Lesson 14
Substantial Acquisition of Shares and Takeovers 397
Lesson 14
Substantial Acquisition of Shares and Takeovers
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction
The globalization and initiation of various
economic reforms in India during early nineties
opened up the opportunities for International
Mergers and Acquisitions and began the
process of transformation of entire business
scenario. This new weapon of M&A, though
proved to be beneficial for growth, also created
a need for some regulations to protect the
interest of investors, especially in case of widely
held companies. Accordingly, SEBI came out
with SEBI Takeover Regulations, 1994 which
was later substituted by SEBI Takeover
Regulations, 1997 and now replaced by SEBI
Takeover Regulations, 2011.
– Important Definitions
– Trigger Point for making an open offer by
an acquirer
– Open Offer
– Open Offer Process
– Public Announcement
– Offer Price
– Provision of Escrow
– Mode of Payment
– Disclosures
SEBI Takeover Regulations plays a major role
in driving the acquisition and restructuring
exercises of listed companies of India. The
regulations have been developed to enshrine
the interest of various concerned entities viz.
by facilitating a guide to corporate sector in
exploiting the business opportunities by way of
acquisitions without prejudicing the interest of
investors and by providing an instrument to
investors to ensure that their funds vests in the
same hands in which they have been bestowed.
– Exemptions
– LESSON ROUND UP
– SELF TEST QUESTIONS
The objective of this lesson is to give an insight
into SEBI Takeover Regulations, 2011. This
lesson will help the students to understand the
key concepts of New Takeover Regulations.
397
398 PP-CC&MM
INTRODUCTION
The globalization and initiation of various economic reforms in India during early nineties opened up the
opportunities for International Mergers and Acquisitions and began the process of transformation of entire
business scenario. To compete at the world platform, the scale of businesses in India was needed to be increased.
This new weapon of M&A in the armory of corporate, though proved to be beneficial for growth, also created a
need for some regulations to protect the interest of investors, especially in case of widely held companies, so
that the process of M&A is used to develop the securities market and not to sabotage it.
Accordingly, in the year 1994, SEBI came out with SEBI Takeover Regulations, 1994 which was later substituted
by SEBI Takeover Regulations, 1997.
SEBI Takeover Regulations plays a major role in driving the acquisition and restructuring exercises of listed
companies of India. The regulations have been developed to enshrine the interest of various concerned entities
viz. by facilitating a guide to corporate sector in exploiting the business opportunities by way of acquisitions
without prejudicing the interest of investors and by providing an instrument to investors to ensure that their funds
vests in the same hands in which they have been bestowed.
SEBI Takeover Regulations, 1997 have been amended a number of times to address the changing business
scenario. To review the SEBI Takeover Regulations, 1997, SEBI constituted an expert committee, Takeover
Regulations Advisory Committee (or TRAC) under the chairmanship of Late Sh. C. Achuthan that released its
report on July 19, 2010. Finally, on September 23, 2011, SEBI has notified the much awaited New Takeover
Regulations i.e. SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 that came into
force on the 30th day from the date of their publication in the Official Gazette i.e. w.e.f. October 22, 2011.
SEBI Takeover Regulations, 2011 aims at protecting interest of the investors in securities of a listed company
providing amongst others, an opportunity for the public shareholders to exit where there is a substantial acquisition
of shares or voting rights or control over a listed company, consolidation of holdings by existing shareholders
and related disclosures and penalties for non- compliance etc. These Regulations requires an acquirer to make
an offer to shareholders of the target company on acquiring shares exceeding stipulated thresholds. It also
contains provisions relating to open offer size and price, time bound process for making an open offer, exemption
from making an open offer etc.
What is Takeover and Substantial Acquisition of Shares ?
When an “Acquirer” takes over the control of the “Target Company”, it is termed as Takeover. When an
acquirer acquires “substantial quantity of shares or voting rights” of the Target Company, it results into substantial
acquisition of shares.
Important Definitions
To understand the concept of the takeover code, it would be pertinent to first go through some of the Definitions:
Acquirer
“Acquirer” means any person who, directly or indirectly, acquires or agrees to acquire whether by himself, or
through, or with persons acting in concert with him, shares or voting rights in, or control over a target company.
Acquisition
“Acquisition” means, directly or indirectly, acquiring or agreeing to acquire shares or voting rights in, or control
over, a target company.
Lesson 14
Substantial Acquisition of Shares and Takeovers 399
Control
“control” includes the right to appoint majority of the directors or to control the management or policy decisions
exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of
their shareholding or management rights or shareholders agreements or voting agreements or in any other
manner.
Provided that a director or officer of a target company shall not be considered to be in control over such target
company, merely by virtue of holding such position.
Enterprise Value
Enterprise value means the value calculated as market capitalization of a company plus debt, minority interest
and preferred shares, minus total cash and cash equivalents.
Enterprise Value= Market capitalization+ Debt+ Minority Interest and Preferred Shares- Total Cash
and Cash Equivalents
Frequently Traded Shares
Frequently traded shares means shares of a target company, in which the traded turnover on any stock exchange
during the twelve calendar months preceding the calendar month in which the public announcement is made, is
at least ten per cent of the total number of shares of such class of the target company.
Provided that where the share capital of a particular class of shares of the target company is not identical
throughout such period, the weighted average number of total shares of such class of the target company shall
represent the total number of shares.
Identified Date
“Identified date” means the date falling on the tenth working day prior to the commencement of the tendering
period, for the purposes of determining the shareholders to whom the letter of offer shall be sent.
Offer Period
“Offer period” means the period between the date of entering into an agreement, formal or informal, to acquire
shares, voting rights in, or control over a target company requiring a public announcement, or the date of the
public announcement, as the case may be, and the date on which the payment of consideration to shareholders
who have accepted the open offer is made, or the date on which open offer is withdrawn, as the case may be.
Persons Acting in Concert
“Persons acting in concert" means, –
(1) persons who, with a common objective or purpose of acquisition of shares or voting rights in, or exercising
control over a target company, pursuant to an agreement or understanding, formal or informal, directly
or indirectly co-operate for acquisition of shares or voting rights in, or exercise of control over the target
company.
(2) Without prejudice to the generality of the foregoing, the persons falling within the following categories
shall be deemed to be persons acting in concert with other persons within the same category, unless
the contrary is established, –
(i) a company, its holding company, subsidiary company and any company under the same management
or control;
(ii) a company, its directors, and any person entrusted with the management of the company;
400 PP-CC&MM
(iii) directors of companies referred to in item (i) and (ii) of this sub-clause and associates of such
directors;
(iv) promoters and members of the promoter group;
(v) immediate relatives;
(vi) a mutual fund, its sponsor, trustees, trustee company, and asset management company;
(vii) a collective investment scheme and its collective investment management company, trustees and
trustee company;
(viii) a venture capital fund and its sponsor, trustees, trustee company and asset management company;
(ix) a foreign institutional investor and its sub-accounts;
(x) a merchant banker and its client, who is an acquirer;
(xi) a portfolio manager and its client, who is an acquirer;
(xii) banks, financial advisors and stock brokers of the acquirer, or of any company which is a holding
company or subsidiary of the acquirer, and where the acquirer is an individual, of the immediate
relative of such individual:
Provided that this sub-clause shall not apply to a bank whose sole role is that of providing normal
commercial banking services or activities in relation to an open offer under these regulations;
(xiii) an investment company or fund and any person who has an interest in such investment company or
fund as a shareholder or unitholder having not less than 10 per cent of the paid-up capital of the
investment company or unit capital of the fund, and any other investment company or fund in which
such person or his associate holds not less than 10 per cent of the paid-up capital of that investment
company or unit capital of that fund:
Provided that nothing contained in this sub-clause shall apply to holding of units of mutual funds registered with
SEBI.
Target Company
Target Company means a company and includes a body corporate or corporation established under a Central
legislation, State legislation or Provincial legislation for the time being in force, whose shares are listed on a
stock exchange.
Tendering Period
Tendering period means the period within which shareholders may tender their shares in acceptance of an open
offer to acquire shares made under these regulations.
"Volume weighted average market price"
volume weighted average market price means the product of the number of equity shares traded on a stock
exchange and the price of each equity share divided by the total number of equity shares traded on the stock
exchange.
Number of shares traded on the Stock Exchange on a particular day: X, Market Price: Y
Volume weighted Average Market Price =
X1*Y1+X2*Y2+X3*Y3………
____________________________
X1+X2+X3……………..
Lesson 14
Substantial Acquisition of Shares and Takeovers 401
"Volume weighted average price"
volume weighted average price means the product of the number of equity shares bought and price of each
such equity share divided by the total number of equity shares bought.
Number of shares bought on a particular day: A, Market Price: B
Volume weighted Average Price =
A1*B1+A2*B2+A3*B3………
____________________________
A1+A2+A3……………..
TRIGGER POINT FOR MAKING AN OPEN OFFER BY AN ACQUIRER
25% Shares or Voting Rights
An acquirer, along with Persons Acting in Concert( PAC) , if any, who intends to acquire shares which along with
his existing shareholding would entitle him to exercise 25% or more voting rights, can acquire such additional
shares only after making a Public Announcement (PA) to acquire minimum twenty six percent shares of the
Target Company from the shareholders through an Open Offer.
Creeping Acquisition Limit
An acquirer who holds 25% or more but less than maximum permissible non-public shareholding of the Target
Company, can acquire such additional shares as would entitle him to exercise more than 5% of the voting rights
in any financial year ending March 31 only after making a Public Announcement to acquire minimum twenty six
percent shares of Target Company from the shareholders through an Open Offer.
For Example
Name
Pre Holding
Creeping
Acuisition
Post
Holding
Applicability of SEBI Takeover
Regulations, 2011
A
23%
3%
26%
Open Offer Obligations
B
7%
%
9%
–
On analysis of the above Table, it can be seen that although the acquisition made by promoters as a group is
within the creeping acquisition limit, however, pursuant to the above acquisition of shares, the shareholding of A
is increased beyond 25% of the total voting rights of the Target Company. Accordingly, in terms of SEBI Takeover
Regulations, 2011, the above acquisition of shares by A would result into triggering the open offer obligations.
OPEN OFFER
SEBI Takeover Regulations, 2011 provides certain trigger events wherein the Acquirer is required to give Open
Offer to the shareholders of the Target Company to provide them exit opportunity.
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Open Offer
Mandatory Offer
Acquisition of Shares
(Reg. 3)
Acquisition of Control
(Reg. 4)
Voluntary Offer
(Reg. 6)
Indirect acquisition of
shares Control (Reg. 5)
I. Mandatory Open Offer
SEBI Takeover Regulations, 2011 provides a threshold for mandatory Open Offer. The regulations provides that
whenever an acquirer acquires the shares in excess of the threshold as prescribed under regulation 3 and 4 of
SEBI Takeover Regulations, 2011, then the acquirer is required to make a public announcement of offer to the
shareholders of the Target Company.
Regulation 3 of the SEBI Takeover Regulations, 2011 provides that the Acquirer to give an open offer to the
shareholders of Target Company on the acquisition of shares or voting rights entitling the Acquirer along with the
Persons Acting in Concert with him to exercise 25% or more voting rights in the Target Company.
Further any Acquirer who holds shares between 25%-75%, together with PACs can acquire further 5% shares
as creeping acquisition without giving an Open Offer to the shareholders of the Target Company upto a maximum
of 75%. The quantum of acquisition of additional voting rights shall be calculated after considering the following:
(a) No Netting off allowed:
For the purpose of determining the quantum of acquisition of additional voting rights, the gross acquisitions
without considering the disposal of shares or dilution of voting rights owing to fresh issue of shares by the target
company shall be taken into account.
(b) Incremental voting rights in case of fresh issue
In the case of acquisition of shares by way of issue of new shares by the target company, the difference between
the pre-allotment and the post-allotment percentage voting rights shall be regarded as the quantum of additional
acquisition. [Regulation 3(2)]
The most important point to be noted here is that the individual Acquirer shareholding shall also be considered
for determining the Open Offer Trigger points apart from consolidated shareholding of Acquirer and Persons
Acting in Concert. [Regulation 3(3)]
Regulation 4 of the SEBI Takeover Regulations, 2011 specifies that if any acquirer including person acting in
concert acquires control over the Target Company irrespective of the fact whether there has been any acquisition
of shares or not, then he has to give public announcement to acquire shares from shareholders of the Target
Company. [Regulation 4]
II. Voluntary Open Offer
Voluntary Open Offer means the Open Offer given by the Acquirer voluntarily without triggering the mandatory
Open Offer obligations as envisaged under the regulations. Voluntary Offers are an important means for substantial
shareholders to consolidate their stake and therefore recognized the need to introduce a specific framework for
such Open Offers.
Lesson 14
Substantial Acquisition of Shares and Takeovers 403
Regulation 6 of the Takeover Regulations provides the threshold and conditions for making the Voluntary Open
Offer which are detailed below:
– Eligibility
(i) Prior holding of atleast 25% shares
To be eligible for making a Voluntary Open Offer, the regulations mandates the prior holding of atleast
25% stake in the Target Company by the Acquirer along with the PACs.
(ii) Shareholding of the Acquirer and PACs post completion of Open Offer
Post completion of the Open Offer, the shareholding of the Acquirer along with PACs shall not exceed
the “maximum permissible non-public shareholding”.
– Acquisition of shares prior to the Voluntary Open Offer
The Acquirer shall become ineligible to make a Voluntary Open Offer if during the preceding 52 weeks,
the Acquirer or PACs with him has acquired shares of the Target Company without attracting the obligation
to make a Public Announcement of an Open Offer. This condition is given because the Voluntary Open
Offer is permitted as an exception to the general rule on the offer size, thus the ability to voluntarily make
an Open Offer should not be available if in the proximate past, any of such persons have made acquisitions
within the creeping acquisition limits permitted under the Regulations.
– Prohibition on the acquisition of shares during the Offer Period
SEBI Takeover Regulations, 2011 prohibits the acquirer who has made a Voluntary Open Offer from
further acquiring the shares during the Offer Period otherwise than under the Open Offer.
– Restriction of the acquisition of shares post completion of Voluntary Open Offer
An acquirer and PACs who have made a Voluntary Open Offer shall not be entitled to further acquire
shares for a period of 6 months after completion of the Open Offer except pursuant:
(a) To another Voluntary Open Offer.
(b) To Competing Open Offer to the Open Offer made by any other person for acquiring shares of the
Target Company.
– Offer size
The Voluntary Open Offer shall be made for the acquisition of at least ten per cent (10%) of the voting
rights in the Target Company and shall not exceed such number of shares as would result in the postacquisition holding of the acquirer and PACs with him exceeding the maximum permissible non-public
shareholding applicable to such Target Company.
Conditional Offer
An offer in which the acquirer has stipulated a minimum level of acceptance is known as a conditional offer.
Minimum level of acceptance implies minimum number of shares which the acquirer desires under the said
conditional offer. If the number of shares validly tendered in the conditional offer, are less than the minimum level
of acceptance stipulated by the acquirer, then the acquirer is not bound to accept any shares under the offer. In
a conditional offer, if the minimum level of acceptance is not reached, the acquirer shall not acquire any shares
in the target company under the open offer or the Share Purchase Agreement which has triggered the open
offer.
404 PP-CC&MM
OPEN OFFER PROCESS
These Regulations provides certain triggering events wherein the Acquirer is required to give Open Offer to the
shareholders of the Target Company to provide them exit opportunity. The objective behind giving opportunity to
the shareholders of the Target Company is to safeguard their interest in the event of change in management
and control of the Target Company or where the promoters desires to consolidate their shareholding to the
maximum permissible level. The whole process of Open Offer is divided into three parts:
1. Pre Open Offer
2. During the Open Offer
3. Post Open Offer
Pre Open Offer
1. Triggering Event: The process of open offer starts from the date of happening of triggering event itself.
The triggering event may be signing of Share Purchase Agreement or actual acquisition of shares from
the market or the Board Meeting held for considering the preferential issue of Equity Shares or acquisition
of control over Company. Thus as soon as the intention of acquirer to acquire the shares of Target
Company beyond the prescribed threshold limits is expressed clearly, the process of Takeover Offer is
initiated provided the acquisition is not exempted under regulation 10 of these regulations.
2. Appointment of Merchant Banker: As soon as the triggering event happens as mentioned above, the
acquirer is required to appoint a Merchant Banker registered with SEBI, who is responsible for executing
the entire open offer process. [Regulation 12]
3. Public Announcement: A Public Announcement shall be made to concerned stock Exchange, SEBI
and Target Company.
4. Escrow Account: The Acquirer shall open an escrow account atleast two working days prior to the date
of detailed public statement and deposit an amount aggregating to 25% of the consideration on first ‘
500 crore and additional amount of 10% on the balance consideration. [Regulation 17(1)].
5. Publication of Detailed Public Statement: A Detailed Public Statement shall be made by the Acquirer
within 5 working days from the date of Public Announcement. Such detailed public statement is required
to be published in all editions of any one English national daily with wide circulation, any one Hindi
national daily with wide circulation, and any one regional language daily with wide circulation at the
place where the registered office of the Target Company is situated and one regional language daily at
the place of the stock exchange where the maximum volume of trading in the shares of the Target
Company are recorded during the sixty trading days preceding the date of the public announcement.
[Regulation 13(4) read with Regulation 14(3)]
6. Submission of Draft Letter of Offer: The Acquirer shall submit a draft letter of offer to SEBI within 5
working days from the date of detailed public statement along with a non-refundable fee. [Regulation
16(1)]
Simultaneously, a copy of the draft letter of offer shall be send to the Target Company at its registered
office and to all the Stock Exchanges where the shares of the Company are listed. [Regulation 18(1)]
7. Identified Date: The Acquirer shall fix a date for determining the names of the shareholders to whom
the letter of offer would be send which shall be a date falling on the tenth working day prior to the
commencement of the tendering period. [Regulation 2(1) (l)]
8. Dispatch of letter of offer: The Acquirer shall ensure that the letter of offer is dispatched to the
shareholders whose names appear on the register of members of the Target Company as on the
Lesson 14
Substantial Acquisition of Shares and Takeovers 405
identified date, and to the custodian of shares underlying depository receipts of the Target Company
within maximum 7 working days from the date of receipt of communication of comments from SEBI or
where no comments are offered by SEBI, within 7 working days from the expiry 15 working days from
the date of receipt of draft letter of offer by SEBI. [Regulation 18(2)]
9. Upward Revision: The Acquirer is allowed to make upward revision to the Offer Price and the number
of shares sought to be acquired under the Open Offer, at any time prior to the commencement of last
three working days before the initiation of the tendering period. [Regulation 18(4)]
10. Recommendation by the Independent Directors: On the receipt of detailed public statement, the
Board of Directors of the Target Company shall constitute a committee of Independent Directors to
provide reasoned recommendations on the Open Offer to the shareholders of the Target Company and
such recommendations shall be published at least two working days before the commencement of the
tendering period, in the same newspapers where the public announcement of the Open Offer was
published and a copy of the same shall also be sent to SEBI, all Stock Exchanges where the shares of
the Target Company are listed and to Manager to the Offer. [Regulation 26 (6) and (7)]
11. Tendering Period: The tendering period shall start not later than 12 working days from the date of
receipt of comments from SEBI and shall remain open for 10 working days. [Regulation 18(8)]
During the Offer
1. Disclosure during Offer Period: The acquirer shall disclose during the offer period every acquisition
made by the acquirer or persons acting in concert with him of any shares of the Target Company to each
of the stock exchanges on which the shares of the Target Company are listed and to the Target Company
at its registered office within twenty-four hours of such acquisition. . [Regulation 18(6)]
2. Restriction on Acquisition of Shares: The acquirer and persons acting in concert with him shall not
acquire or sell any shares of the Target Company during the period between three working days prior to
the commencement of the tendering period and until the expiry of the tendering period. [Proviso of
Regulation 18(6)]
Post Open Offer
1. Completion of requirements: Within 10 working days from the last date of the tendering period, the
acquirer shall complete all requirements as prescribed under these regulations and other applicable
law relating to the Open Offer including payment of consideration to the shareholders who have accepted
the open offer. [Regulation 18(10)]
2. Post offer Advertisement: The acquirer shall issue a post offer advertisement in such form as may be
specified within five working days after the offer period, giving details including aggregate number of
shares tendered, accepted, date of payment of consideration. [Regulation 18 (12)]
3. Report to SEBI by Manager to the Offer: The manager to the Open Offer shall file a report with SEBI
within fifteen working days from the expiry of the tendering period, in such form as may be specified,
confirming status of completion of various Open Offer requirements. [Regulation 27 (7)]
4. Restriction on acquisition: The acquirer shall not acquire any shares of the Target Company for a
period of 26 weeks after the tendering period at a price higher than the offer price paid except by way
of another Open Offer, or SEBI Delisting Regulations, or open market purchases made in the ordinary
course on the stock exchanges, not being negotiated acquisition of shares of the Target Company
whether by way of bulk deals, block deals or in any other form. [Regulation 8(10)]
406 PP-CC&MM
ACTIVITY CHART FOR OPEN OFFER
S.
No.
Particulars
Timeline
(Legal)
1.
Public announcement through notice to Stock Exchange
X
2.
Opening of Bank Escrow & Securities Escrow
3.
Deposit of Escrow Amount in Escrow A/c
4.
Detailed Public Statement in Newspaper
X+5 Working Days
5.
Draft letter of offer to be submitted to SEBI and sent to Target Company
X+10 Working Days
6.
Receipt of comments from SEBI on draft letter of offer
X+25 Working Days
7.
Identified date for determining name of shareholders to whom the
letter of offer should be sent
X+27 Working Days
8.
Dispatch of the Letter of Offer to shareholder
X+32 Working Days
9.
Upward revision in offer
X+33 Working Days
10.
Comments on the offer by independent directors of Target Company
X+34 Working Days
11.
Issue of advertisement announcing the schedule of activities for open offer
X+36 Working Days
12.
Date of opening of offer
X+37 Working Days
13.
Date of closing of offer
X+46 Working Days
14.
Payment of Consideration
X+56 Working Days
15.
Filing of report to SEBI by Merchant Banker
X+61 Working Days
X+2 Working Days
(This is the minimum timeline as prescribed under SEBI Takeover Regulations, 2011)
PUBLIC ANNOUNCEMENT
SEBI (SAST) Regulation, 2011 (SAST Regulations) provides that whenever an Acquirer acquires the shares or
voting rights of the Target Company in excess of the limits prescribed under Regulation 3 and 4, then the
Acquirer is required to make an Open Offer to the shareholder of the Target Company. During the process of an
Open Offer, the Acquirer is required to give Public Announcement and publish Detailed Public Statement.
Regulation 14 of SAST Regulations prescribed the manner in which Public Announcement and Detailed Public
Statement is to be made.
Submission of Public Announcement (PA)
Within the time specified under Regulation 13 of SAST Regulations, the Public Announcement shall be sent to
all the stock exchanges on which the shares of the Target Company are listed. Further, a copy of the same shall
also be sent to SEBI and to the Target Company at its registered office within one working day of the date of the
public announcement.
Lesson 14
Substantial Acquisition of Shares and Takeovers 407
Submission of PA
Stock Exchanges
SEBI (Board)
Target Company
Publication and Submission of Detailed Public Statement
A detailed public statement shall be published by the acquirer through the manager to the open offer not later
than five working days of the public announcement in the following newspaper:
PUBLICATION OF DETAILED PUBLIC STATEMENT
One English national
daily with wide circulation
One Hindi national
daily with wide circulation
One Regional language daily
with wide circulation at the place
where the registered office of the
target company is situated
One Regional language daily of the stock exchange
where the maximum volume of trading in the shares
of the target company are recorded during the sixty
trading days preceding the date of the public announcement
Simultaneously with the publication in the newspaper, a copy of the same shall be sent to:
1. SEBI
2. All the Stock Exchanges on which the shares of the Target Company are listed; and
3. The Target Company at its registered office.
Contents of Public Announcement and Detailed Public Statement
The public announcement shall contain such information as may be specified, including the following(a) name and identity of the acquirer and persons acting in concert with him;
(b) name and identity of the sellers, if any;
(c) nature of the proposed acquisition such as purchase of shares or allotment of shares, or any other
408 PP-CC&MM
means of acquisition of shares or voting rights in, or control over the target company;
(d) the consideration for the proposed acquisition that attracted the obligation to make an open offer for
acquiring shares, and the price per share, if any;
(e) the offer price, and mode of payment of consideration; and
(f) offer size, and conditions as to minimum level of acceptances, if any.
The detailed public statement pursuant to the public announcement shall contain such information as may be
specified in order to enable shareholders to make an informed decision with reference to the open offer.
NOTE: The public announcement of the open offer, the detailed public statement, and any other statement,
advertisement, circular, brochure, publicity material or letter of offer issued in relation to the acquisition
of shares under these regulations shall not omit any relevant information, or contain any misleading
information.
Procedure of Filing PA and DPS
Submission of Public Announcement in accordance with the manner prescribed with the
Stock Exchange(s), SEBI and at the registered office of the Target Company within the time specified
Stock Exchange shall disseminate such PA on its website forthwith
Publication of Detailed Public Statement in the Newspapers prescribed within the specified time
Submission of the copy of the Detailed Public Statement with the SEBI,
Stock Exchange(s) and at the registered office of the Target Company
OFFER PRICE
Offer price is the price at which the acquirer announces to acquire shares from the public shareholders under
the open offer. The offer price shall not be less than the price as calculated under Regulation 8 of the SAST
Regulations, 2011 for frequently or infrequently traded shares.
If the target company’s shares are frequently traded then the open offer price for acquisition of shares under the
minimum open offer shall be highest of the following :
– Highest negotiated price per share under the share purchase agreement (“SPA”) triggering the offer;
– Volume weighted average price of shares acquired by the acquirer during 52 weeks preceding the
public announcement (“PA”),
– Highest price paid for any acquisition by the acquirer during 26 weeks immediately preceding the PA;
Lesson 14
Substantial Acquisition of Shares and Takeovers 409
– Volume weighted average market price for sixty trading days preceding the PA.
If the target company’s shares are infrequently traded then the open offer price for acquisition of shares under
the minimum open offer shall be highest of the following:
– Highest negotiated price per share under the share purchase agreement (“SPA”) triggering the offer;
– Volume weighted average price of shares acquired by the acquirer during 52 weeks preceding the PA;
– Highest price paid for any acquisition by the acquirer during 26 weeks immediately preceding the PA;
The price determined by the acquirer and the manager to the open offer after taking into account valuation
parameters including book value, comparable trading multiples, and such other parameters that are customary
for valuation of shares of such companies.
It may be noted that SEBI may at the expense of the acquirer, require valuation of shares by an independent
merchant banker other than the manager to the offer or any independent chartered accountant in practice
having a minimum experience of 10 years.
The shares of the target company will be deemed to be frequently traded if the traded turnover on any stock
exchange during the 12 calendar months preceding the calendar month, in which the PA is made, is at least
10% of the total number of shares of the target company. If the said turnover is less than 10%, it will be
deemed to be infrequently traded.
PROVISION OF ESCROW
Not later than two working days prior to the date of the detailed public statement of the open offer for acquiring
shares, the acquirer shall create an escrow account towards security for performance of his obligations under
these regulations and deposit in escrow account such aggregate amount as per the following scale:
Sl.
Consideration payable
Escrow Amount
No. under the Open Offer
(a)
On the first five hundred crore rupees
an amount equal to twenty-five per cent of the consideration
(b)
On the balance consideration
an additional amount equal to ten per cent of the balance
consideration
However, where an open offer is made conditional upon minimum level of acceptance, hundred percent of the
consideration payable in respect of minimum level of acceptance or fifty per cent of the consideration payable
under the open offer, whichever is higher, shall be deposited in cash in the escrow account.
The escrow account may be in the form of,(a) cash deposited with any scheduled commercial bank;
(b) bank guarantee issued in favour of the manager to the open offer by any scheduled commercial bank; or
(c) deposit of frequently traded and freely transferable equity shares or other freely transferable securities
with appropriate margin.
MODE OF PAYMENT
The offer price may be paid, –
(a) in cash;
(b) by issue, exchange or transfer of listed shares in the equity share capital of the acquirer or of any person
acting in concert;
410 PP-CC&MM
(c) by issue, exchange or transfer of listed secured debt instruments issued by the acquirer or any person
acting in concert with a rating not inferior to investment grade as rated by a credit rating agency registered
with SEBI;
(d) by issue, exchange or transfer of convertible debt securities entitling the holder thereof to acquire listed
shares in the equity share capital of the acquirer or of any person acting in concert; or
(e) a combination of the mode of payment of consideration stated in clause (a), clause (b), clause (c) and
clause (d):
Where any shares have been acquired or agreed to be acquired by the acquirer and persons acting in concert
with him during the fifty-two weeks immediately preceding the date of public announcement constitute more
than ten per cent of the voting rights in the target company and has been paid for in cash, the open offer shall
entail an option to the shareholders to require payment of the offer price in cash, and a shareholder who has not
exercised an option in his acceptance shall be deemed to have opted for receiving the offer price in cash. In
case of revision in offer price the mode of payment of consideration may be altered subject to the condition that
the component of the offer price to be paid in cash prior to such revision is not reduced
DISCLOSURES
In SEBI Takeover Regulations, 2011, the obligation to give the disclosures on the acquisition of certain limits is
only on the acquirer and not on the Target Company. Further as against the Open Offer obligations where the
individual shareholding is also to be considered, the disclosure shall be of the aggregated shareholding and
voting rights of the acquirer or promoter of the target company or every person acting in concert with him.
Regulation
No.
Triggering Point
To and by whom
Time Period
EVENT BASED DISCLOSURES
29(1)
Acquisition of 5% or more
shares or voting rights
To the Target Company and
Stock Exchange by the
Acquirer
Within 2 working days of:
(a) Receipt of intimation of
allotment of shares; or
(b) The acquisition of shares
or voting rights.
29(2)
Acquirer already holding
5% or more shares or
voting rights, On
acquisition/ disposal of
2% or more shares or
voting rights.
To the Target Company and
Stock Exchange by the
Acquirer/Seller
Within 2 working days of such
acquisition/disposal.
CONTINUAL DISCLOSURES
30(1)
Any person holding 25% or
more shares or voting rights
Target Company & Stock
Exchange by such person
Within 7 working days from
the end of each financial
year
30(2)
Promoter /Person having
control over the Target
Company
Target Company & Stock
Exchange by Promoter
Within 7 working days from
the end of each financial
year
Lesson 14
Substantial Acquisition of Shares and Takeovers 411
DISCLOSURE OF PLEDGED/ENCUMBERED SHARES
31(1)
On the encumbrance of
shares by the promoter
or person acting in
Concert with him
Target Company & Stock
Exchange by the promote
Within 7 working days from
the date of creation of
encumbrance
31(2)
On the invocation of or
release of such
encumbrance by the
promoter
Target Company & Stock
Exchange by the promoter
Within 7 working days from
the date of invocation of
encumbrance
Points to Remember
The important point to be noted here is that the acquisition and holding of any convertible security shall also
be regarded as shares and disclosures of such acquisition and holdings is also to be made accordingly.
EXEMPTIONS
Regulation 10 of the SEBI Takeover Regulations, 2011 provides the Acquirer automatic exemptions from the
applicability of making Open Offer to the shareholders of the Target Company in respect of certain acquisitions
subject to the compliance of certain conditions specified therein.
Further Regulation 11 of SEBI Takeover Regulations, 2011 provides the provisions whereby the acquirer can
apply to SEBI for availing the exemption from the Open Offer obligations and the Target Company can apply for
relaxation from strict compliance with any procedural requirement relating to Open Offer as provided under
Chapter III and IV of these regulations.
Exemptions
Automatic Exemptions
(Regulation 10)
Exemptions by SEBI
(Regulation 11)
Regulation 11(1)
Exemption from the open
offer obligation
Regulation 11(2)
Relaxation from Procedural
Requirements relating to
open offer
REGULATION 10 - AUTOMATIC EXEMPTIONS
Some of the important exemptions provided therein along with their conditions for exemption are detailed below:
The following acquisitions shall be exempt from the obligation to make an open offer under Regulation 3 and
Regulation 4:
(1) (a) acquisition pursuant to inter se transfer of shares amongst qualifying persons, being, –
(i) immediate relatives;
(ii) persons named as promoters in the shareholding pattern filed by the target company in terms of the
listing agreement or these regulations for not less than three years prior to the proposed acquisition;
412 PP-CC&MM
(iii) a company, its subsidiaries, its holding company, other subsidiaries of such holding company, persons
holding not less than fifty per cent of the equity shares of such company, other companies in which such
persons hold not less than fifty per cent of the equity shares, and their subsidiaries subject to control
over such qualifying persons being exclusively held by the same persons;
(iv) persons acting in concert for not less than three years prior to the proposed acquisition, and disclosed
as such pursuant to filings under the listing agreement;
(v) shareholders of a target company who have been persons acting in concert for a period of not less than
three years prior to the proposed acquisition and are disclosed as such pursuant to filings under the
listing agreement, and any company in which the entire equity share capital is owned by such shareholders
in the same proportion as their holdings in the target company without any differential entitlement to
exercise voting rights in such company:
However, for purposes of availing of the exemption under this clause, –
(i) If the shares of the target company are frequently traded, the acquisition price per share shall not be
higher by more than twenty-five per cent of the volume-weighted average market price for a period of
sixty trading days preceding the date of issuance of notice for the proposed inter se transfer, as
traded on the stock exchange where the maximum volume of trading in the shares of the target
company are recorded during such period, and if the shares of the target company are infrequently
traded, the acquisition price shall not be higher by more than twenty-five percent of the price determined;
and
(ii) the transferor and the transferee shall have complied with applicable disclosure requirements set out in
these regulations.
(b) acquisition in the ordinary course of business by, –
(i) an underwriter registered with SEBI by way of allotment pursuant to an underwriting agreement in terms
of the SEBI ICDR Regulations, 2009;
(ii) a stock broker registered with SEBI on behalf of his client in exercise of lien over the shares purchased
on behalf of the client under the bye-laws of the stock exchange where such stock broker is a member;
(iii) a merchant banker registered with SEBI or a nominated investor in the process of market making or
subscription to the unsubscribed portion of issue in terms of Chapter XB of SEBI ICDR Regulations,
2009;
(iv) any person acquiring shares pursuant to a scheme of safety net in terms of SEBI ICDR Regulations,
2009;
(v) a merchant banker registered with SEBI acting as a stabilising agent or by the promoter or pre-issue
shareholder in terms of SEBI ICDR Regulations, 2009;
(vi) by a registered market-maker of a stock exchange in respect of shares for which he is the market maker
during the course of market making;
(vii) a Scheduled Commercial Bank, acting as an escrow agent; and
(viii) invocation of pledge by Scheduled Commercial Banks or Public Financial Institutions as a pledgee.
(c) acquisitions at subsequent stages, by an acquirer who has made a public announcement of an open offer for
acquiring shares pursuant to an agreement of disinvestment, as contemplated in such agreement:
However, (i) both the acquirer and the seller are the same at all the stages of acquisition; and (ii) full disclosures
of all the subsequent stages of acquisition, if any, have been made in the public announcement of the open offer
and in the letter of offer.
Lesson 14
Substantial Acquisition of Shares and Takeovers 413
(d) acquisition pursuant to a scheme, –
(i) made under section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985 or any statutory
modification or re-enactment thereto;
(ii) of arrangement involving the target company as a transferor company or as a transferee company, or
reconstruction of the target company, including amalgamation, merger or demerger, pursuant to an
order of a court or a competent authority under any law or regulation, Indian or foreign; or
(iii) of arrangement not directly involving the target company as a transferor company or as a transferee
company, or reconstruction not involving the target company’s undertaking, including amalgamation,
merger or demerger, pursuant to an order of a court or a competent authority under any law or regulation,
Indian or foreign, subject to, –
(A) the component of cash and cash equivalents in the consideration paid being less than twenty five
per cent of the consideration paid under the scheme; and
(B) where after implementation of the scheme of arrangement, persons directly or indirectly holding at
least thirty-three per cent of the voting rights in the combined entity are the same as the persons
who held the entire voting rights before the implementation of the scheme.
(e) acquisition pursuant to the provisions of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002;
(f) acquisition pursuant to the provisions of SEBI (Delisting of Equity Shares) Regulations, 2009;
(g) acquisition by way of transmission, succession or inheritance;
(h) acquisition of voting rights or preference shares carrying voting rights arising out of the operation of subsection
(2) of section 87 of the Companies Act, 1956.
(2) The acquisition of shares of a target company, not involving a change of control over such target company,
pursuant to a scheme of corporate debt restructuring in terms of the Corporate Debt Restructuring Scheme
notified by the Reserve Bank of India vide Circular No. B.P.BC 15/21.04, 114/2001 dated August 23, 2001, or
any modification or re-notification thereto provided such scheme has been authorised by shareholders by way
of a special resolution passed by postal ballot, shall be exempted from the obligation to make an open offer
under regulation 3.
(3) An increase in voting rights in a target company of any shareholder beyond the limit attracting an obligation
to make an open offer under sub-regulation (1) of regulation 3, pursuant to buy-back of shares shall be exempt
from the obligation to make an open offer provided such shareholder reduces his shareholding such that his
voting rights fall to below the threshold referred to in sub-regulation (1) of regulation 3 within ninety days from the
date on which the voting rights so increase.
(4) The following acquisitions shall be exempt from the obligation to make an open offer under sub-regulation (2)
of regulation 3, –
(a) acquisition of shares by any shareholder of a target company, upto his entitlement, pursuant to a rights
issue;
(b) acquisition of shares by any shareholder of a target company, beyond his entitlement, pursuant to a
rights issue, subject to fulfillment of the following conditions, –
(i) the acquirer has not renounced any of his entitlements in such rights issue; and
(ii) the price at which the rights issue is made is not higher than the ex-rights price of the shares of the
target company, being the sum of, –
414 PP-CC&MM
(A) the volume weighted average market price of the shares of the target company during a period
of sixty trading days ending on the day prior to the date of determination of the rights issue
price, multiplied by the number of shares outstanding prior to the rights issue, divided by the
total number of shares outstanding after allotment under the rights issue.
However, such volume weighted average market price shall be determined on the basis of
trading on the stock exchange where the maximum volume of trading in the shares of such
target company is recorded during such period; and
(B) the price at which the shares are offered in the rights issue, multiplied by the number of shares
so offered in the rights issue divided by the total number of shares outstanding after allotment
under the rights issue:
(c) increase in voting rights in a target company of any shareholder pursuant to buy-back of shares.
However, (i) such shareholder has not voted in favour of the resolution authorising the buyback of securities under section 77A of the Companies Act, 1956; (ii) in the case of a shareholder
resolution, voting is by way of postal ballot; (iii) where a resolution of shareholders is not required
for the buyback, such shareholder, in his capacity as a director, or any other interested director
has not voted in favour of the resolution of the board of directors of the target company authorising
the buy-back of securities under section 77A of the Companies Act, 1956; and
(iii) the increase in voting rights does not result in an acquisition of control by such shareholder over the
target company. However, where the aforesaid conditions are not met, in the event such shareholder
reduces his shareholding such that his voting rights fall below the level at which the obligation to
make an open offer would be attracted under sub-regulation (2) of regulation 3, within ninety days
from the date on which the voting rights so increase, the shareholder shall be exempt from the
obligation to make an open offer;
(d) acquisition of shares in a target company by any person in exchange for shares of another target
company tendered pursuant to an open offer for acquiring shares under these regulations;
(e) acquisition of shares in a target company from state-level financial institutions or their subsidiaries or
companies promoted by them, by promoters of the target company pursuant to an agreement between
such transferors and such promoter;
(f) acquisition of shares in a target company from a venture capital fund or foreign venture capital investor
registered with the Board, by promoters of the target company pursuant to an agreement between such
venture capital fund or foreign venture capital investor and such promoters.
(5) In respect of acquisitions under clause (a) of sub-regulation (1), and clauses (e) and (f) of sub-regulation (4),
the acquirer shall intimate the stock exchanges where the shares of the target company are listed, the details of
the proposed acquisition in such form as may be specified, at least four working days prior to the proposed
acquisition, and the stock exchange shall forthwith disseminate such information to the public.
(6) In respect of any acquisition made pursuant to exemption provided for in this regulation, the acquirer shall file
a report with the stock exchanges where the shares of the target company are listed, in such form as may be
specified not later than four working days from the acquisition, and the stock exchange shall forthwith disseminate
such information to the public.
(7) In respect of any acquisition of or increase in voting rights pursuant to exemption provided for in clause (a) of
sub-regulation (1), sub-clause (iii) of clause (d) of sub-regulation (1), clause (h) of sub-regulation (1), subregulation (2), sub-regulation (3) and clause (c) of sub-regulation (4), clauses (a), (b) and (f) of sub-regulation
(4), the acquirer shall, within twenty-one working days of the date of acquisition, submit a report in such form as
may be specified along with supporting documents to SEBI giving all details in respect of acquisitions, along with
a non-refundable fee of rupees twenty five thousand by way of a , banker’s cheque or demand draft payable in
Mumbai in favour of SEBI.
Lesson 14
Substantial Acquisition of Shares and Takeovers 415
REGULATION 11 - EXEMPTION BY SEBI
Regulation 11(1) provides that on an application being made by the acquirer in writing giving the details of the
proposed acquisition and grounds on which the exemption is sought along with duly sworn affidavit, SEBI may
grant exemption to the acquirer from the Open Offer obligations subject to the compliance with such conditions
as it deems fits. For instance, in case where the exemptions is sought from the Open Offer obligations which has
been triggered pursuant to the issue of shares by way preferential allotment, SEBI may require that the approval
of shareholders should be obtained by way of postal ballot. Further, along with the application, the acquirer is
also required to pay a non refundable fee of ` 50,000 by way of banker‘s cheque or demand draft in payable in
favour of Mumbai.
However, it is to be noted that the Acquirer is not exempted from making other compliances related to the
disclosure requirements as provided under regulation 29, 30 and 31 of the SEBI Takeover Regulations, 2011.
Regulation 11(2) provides that the acquirer may also be granted the relaxation from the procedural requirements
relating to Open Offer by SEBI on an application being made in writing by the Target Company giving the details
of the proposed acquisition and grounds on which the relaxation is sought alongwith duly sworn affidavit. The
purpose and intent of regulations is to safeguard the interest of investor and not to act as an impediment in the
furtherance of their interest.
The SEBI has been given the power to relax the procedural requirements under Chapter III and IV, subject to
such conditions as it deems fit on being satisfied that:
I. The Central Government or State Government or any other regulatory authority has removed the Board
of Directors of the Target Company and has appointed new directors to hold office as directors under
any law for the time being in force if:
(a) such Board of Directors has devised a plan which provides transparent, open, and competitive
process for acquisition of shares or voting rights or control over the Target Company to secure the
smooth and continued operation of the target company in the interests of all stakeholders of the
target company and such plan does not further the interests of any particular acquirer;
(b) The conditions and requirements of the competitive process are reasonable and fair;
(c) The process adopted by the Board provides for details including the time when the public offer
would be made, completed and the manner in which the change in control would be effected;
II. The provisions of Chapter III and Chapter IV are likely to act as impediment to implementation of the
plan of the Target Company and exemption from strict compliance with one or more of such provisions
are in interest of public, investors and the securities market.
416 PP-CC&MM
Procedure for filing the application under Regulation 11
File an application with SEBI supported by duly sworn affidavit giving the details of the proposed
acquisition and the grounds on which the exemption has been sought along with non-refundable fee of
` 50,000 by way of a banker’s cheque or demand draft payable in Mumbai in favour of SEBI
SEBI may constitute a panel of experts to make recommendations on the application
made under Regulation 11(1)
SEBI will give reasonable opportunity of being heard to the concerned parties
After considering the recommendation of the panel and giving the reasonable opportunity of being heard
to the concerned parties, SEBI shall pass an order giving the reasons for accepting or rejecting the
applications as expeditiously as possible
SEBI shall publish the order passed by it on its official website
LESSON ROUND UP
– SEBI Takeover Regulations, 2011, aims at protecting interest of the investors in securities of a listed
company providing amongst others, an opportunity for the public shareholders to exit where there is a
substantial acquisition of shares or voting rights or control over a listed company, consolidation of
holdings by existing shareholders and related disclosures and penalties for non- compliance etc.
– The Takeover Regulations, 1997 stand repealed from October 22, 2011, i.e. the date on which SEBI
(SAST)Regulations, 2011 come into force.
– SEBI Takeover Regulations, 2011 provides certain trigger events wherein the Acquirer is required to
give Open Offer to the shareholders of the Target Company to provide them exit opportunity.
– Regulation 6 of the Takeover Regulations provides the threshold and conditions for making the Voluntary
Open Offer.
– An offer in which the acquirer has stipulated a minimum level of acceptance is known as a conditional
offer.
– Regulation 10 & 11 provides for automatic exemptions and exemptions by SEBI.
– The public announcement shall be sent to all the stock exchanges on which the shares of the target
company are listed, and the stock exchanges shall forthwith disseminate such information to the public.
Lesson 14
Substantial Acquisition of Shares and Takeovers 417
– In SEBI Takeover Regulations, 2011, the obligation to give the disclosures on the acquisition of certain
limits is only on the acquirer and not on the Target Company.
SELF TEST QUESTIONS
(These are meant for re-capitulation only. Answers to these questions are not to be submitted for evaluation.)
1. What is the meaning of Person Acting in Concert under SEBI Takeover Regulations, 2011?
2. What are the conditions for making Voluntary open offer?
3. What are the provisions relating to Public Announcement under the Takeover Regulations?
4. Discuss about the continuous Disclosure required to be made under these Regulations.
5. Briefly explain the conditions on which SEBI can grant exemption to an acquirer.
418 PP-CC&MM
Report of the Committees on Capital Market 419
REPORT OF THE COMMITTEES ON CAPITAL MARKET
INTRODUCTION
The Capital Market is a dynamic market and ever evolving. To keep pace with the developments of Capital
Market in the country, the Government regularly comes up with a consultative process to collate the views of
market experts and various stakeholders through the respective regulators towards formulation of industry
friendly regulatory prescriptions. In this line various Committees had been formed from time to time by the
Government to deal with particular areas or issues or concern which is outdated and crying for reform. The
Committee carries out research, investigation, empirical study and analyse the objective for which it is established.
After completion of its rigorous task assigned to it by the Government through the respective regulator, the
Committee formed an opinion and prepare a fair and unbiased report in line with the domestic as well as
international development/practice which suit the Indian situation, meet the stakeholder expectations and can
be effectively applied to various development schemes which would bolster the Indian Economy and the general
public will get benefits. The gist of Recommendation of some of the eminent Committees of recent origin has
been discussed below for the easy understanding of the students.
REPORT OF FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION
Financial Sector Legislative Reforms Commission (FSLRC) was set up by the Indian Government in pursuance
of the announcement made in Union Budget 2010-11, to help rewriting and harmonizing the financial sector
legislation, rules and regulations so as to address the contemporaneous requirements of the sector. The resolution
notifying the FSLRC was issued on March 24, 2011. FSLRC had a two year term. The Commission was chaired
by Supreme Court Justice (Retired) B. N. Srikrishna, and had ten members with expertise in the fields of finance,
economics, law and other relevant fields. The secretariat was placed at National Institute of Public Finance and
Policy (NIPFP). Secretariat consisted of a Secretary at the level of Joint Secretary to the Government of India
and other officials and support staff.
The establishment of the FSLRC is the result of a realisation that the institutional foundation (laws and
organizations) of the financial sector in India needs to be looked afresh to assess its soundness for addressing
the emerging requirements in a rapidly changing world. Today, India has over 60 Acts and multiple Rules/
Regulations that govern the financial sector. Many of them have been written several decades back. For example,
the RBI Act and the Insurance Act are of 1934 and 1938 vintage respectively and the Securities Contract
Regulation Act, which governs securities transactions, was legislated in 1956 when derivatives and statutory
regulators were unknown in the financial system. A Large number of amendments were, therefore, made in
these Acts and regulations at different points of time to address various needs. But these have also resulted in
their fragmentation, often adding to the ambiguity and complexity of regulations in the financial sector.
The Financial Sector Legislative Reforms Commission (FSLRC), constituted by the Ministry of Finance was
asked to comprehensively review and redraw the legislations governing India’s financial system. According to
the FSLRC, the current regulatory architecture is fragmented and is fraught with regulatory gaps, overlaps,
inconsistencies and arbitrage. To address this, the FSLRC submitted its report to the Ministry of Finance on
March 22, 2013, containing an analysis of the current regulatory architecture and a draft Indian Financial Code
to replace the bulk of the existing financial laws which is summarised as below.
The Draft Indian Financial Code
The draft Code is a non-sectoral, principles-based law bringing together laws governing different sectors of the
financial system. It addresses nine components, which the FSLRC believes any financial legal framework should
address:
Consumer protection: Regulators should ensure that financial firms are doing enough for consumer protection.
420 PP-CC&MM
The draft Code establishes certain basic rights for all financial consumers and creates a single unified Financial
Redressal Agency (FRA) to serve any aggrieved consumer across sectors. In addition, the FSLRC considers
competition an important aspect of consumer protection and envisages a detailed mechanism for co-operation
between regulators and the Competition Commission.
Micro-prudential regulation: Regulators should monitor and reduce the failure probability of a financial firm.
The draft Code specifies five powers for micro-prudential regulation: regulation of entry, regulation of risk-taking,
regulation of loss absorption, regulation of governance and management, and monitoring/supervision.
Resolution: In cases of financial failure, firms should be swiftly and sufficiently wound up with the interests of
small customers. A unified resolution corporation, dealing with various financial firms, should be created to
intervene when a firm is close to failure. The resolution corporation would charge a fee to all firms based on the
probability of failure.
Capital controls: While the FSLRC does not hold a view on the sequencing and timing of capital account
liberalisation, any capital controls should be implemented on sound footing with regards to public administration
and law. The FSLRC sees the Ministry of Finance creating the ‘rules’ for inbound capital flows and the RBI
creating the ‘regulations’ for outbound capital flows. All capital controls would be implemented by the RBI.
Systemic risk: Regulators should undertake interventions to reduce the systemic risk for the entire financial
system. The FSLRC envisages establishing the Financial Stability and Development Council (FSDC) as a statutory
agency taking a leadership role in minimizing systemic risk.
Development and redistribution: Developing market infrastructure and process would be the responsibility of
the regulator while redistribution policies would be under the purview of the Ministry of Finance.
Monetary policy: The law should establish accountability mechanisms for monetary policy. The Ministry of
Finance would define a quantitative target that can be monitored while the RBI will be empowered with various
tools to pursue this target. An executive Monetary Policy Committee (MPC) would be established to decide on
how to exercise the RBI’s powers.
Public debt management: The draft Code establishes a specialised framework for public debt management with
a strategy for long run low-cost financing. The FSLRC proposes a single agency to manage government debt.
Contracts, trading and market abuse: The draft Code establishes the legal foundations for contracts, property
and securities markets.
Regulators
With respect to regulators, the FSLRC stresses the need for both independence and accountability. The draft
Code adopts ownership neutrality whereby the regulatory and supervisory treatment of a financial firm is the
same whether it is a private or public company.
The draft Code seeks to move away from the current sector-wise regulation to a system where the RBI regulates
the banking and payments system and a Unified Financial Agency subsumes existing regulators like SEBI,
IRDA, PFRDA and FMC, to regulate the rest of the financial markets.
Regulators will have an empowered board with a precise selection-cum-search process for appointment of
members. The members of a regulatory board can be divided into four categories: the chairperson, executive
members, non-executive members and Government nominees. In addition, there is a general framework for
establishing advisory councils to support the board. All regulatory agencies will be funded completely by fees
charged to the financial system. Finally, the FSLRC envisages a unified Financial Sector Appellate Tribunal
(FSAT), subsuming the existing Securities Appellate Tribunal (SAT), to hear all appeals in finance.
The following chart provides an outline of the FSLRC’s proposed regulatory architecture.
Report of the Committees on Capital Market 421
Present
Proposed
RBI
RBI
SEBI
FMC
IRDA
PFRDA
United financial
agency (UFA)
Securities Appellate
Tribunal (SAT)
Functions
Monetary policy regulation and
supervision of banks;
regulation and supervision of
payments system.
Regulation and supervision of
all non-bank and payments related
markets
FSAT
Hear appeals against RBI, the
UFA and FRA.
Deposit Insurance and
Credit Guarantee
Corporation (DICGC)
Resolution
Corporation
Resolution work across the entire
financial system
Financial Stability
Development Council (FSDC)
FSDC
Statutory agency for systemic risk
and development.
Debt Management
Agency
An independent debt
management agency.
Financial Redressal Agency
Consumer complaints.
New entities
Report of the Takeover Regulations Advisory Committee under the Chairmanship of Mr. C.
Achuthan
The SEBI Act, 1992 expressly mandated SEBI to regulate substantial acquisition of shares and takeovers by
suitable measures. Accordingly, SEBI provided a legal framework by making the Takeover Regulations of 1994,
which came into force on November 4, 1994.
In November 1995, SEBI appointed a committee to review the Takeover Regulations of 1994 under the chairmanship
of Justice P.N. Bhagwati (the Bhagwati Committee). The said committee submitted its report in January 1997.
Taking into consideration its recommendations, the Takeover Regulations of 1997 were notified by SEBI on February
20, 1997, repealing the Takeover Regulations of 1994. These regulations were periodically amended in response
to events and developments in the marketplace, regulatory and judicial rulings as well as evolving global practices
as considered appropriate. In 2001, a review of the Takeover Regulations of 1997 was carried out by a reconstituted
committee chaired by Justice P.N. Bhagwati. The reconstituted Bhagwati committee submitted its report in May
2002. Based on the same, further amendments were made to the Takeover Regulations of 1997.
There has been a steady increase in corporate restructuring by Indian companies to adapt to the evolving competitive
landscape. Taking into consideration the growing level of M&A activity in India, the increasing sophistication of takeover
market, the decade-long regulatory experience and various judicial pronouncements, it was felt necessary to review
the Takeover Regulations of 1997. Accordingly, SEBI on September 4, 2009, constituted a multi-disciplinary expert
committee, Takeover Regulations Advisory Committee (TRAC) under the chairmanship of Mr. C. Achuthan, to examine
the existing Takeover Code which related to substantial acquisitions and takeovers of Indian listed companies. The
Committee framed the Takeover Regulations keeping in view the interest of public shareholders on one side and that
of the Strategic Investors, Private Equity Players, Target Company and Promoters on the other side.
On 28th July 2011, SEBI took certain key decisions on takeover regulations based on the recommendations of
TRAC. Some of the notable decisions involve increasing the initial open offer trigger threshold, increasing the
mandatory open offer size and determination of the open offer price.
Summary of Key Recommendations of the Committee
Considering the substantive changes recommended upon review of the existing law governing substantial
acquisition of the shares and takeovers, the Committee has recommended comprehensive reform of the
regulations. Some of the main recommendations of the Committee alongwith the Provisions of Takeover
Regulations, 1997 provisions are summarized below:
422 PP-CC&MM
Summary of Recommendations of the Achuthan Committee and the Provisions in the Takeover
Regulations, 1997
S.No.
Issue
1.
Offer Size and Minimum Public
Shareholding Requirement
Provisions of the Takeover
Regulations, 1997
Committee Recommendations
– Offer Size
On acquisition resulting in
triggering regulations 10, 11&
12, the acquirer is mandatorily
required to make an open offer
for a minimum of 20% of the
voting capital (reckoned as on
the 15th day after closure of the
offer).
– Every open offer pursuant to a
substantial acquisition of shares
in, or change of control over a
target company under the
Takeover Regulations ought to
be for every share held by all the
shareholders of the target
company, as on the expected
date of the close of the tendering
period.
–
Minimum
Public
Shareholding Requirement
If the acquisition made pursuant
to an open offer results in the
public shareholding in the target
company falling below the
minimum level required as
per the listing agreement, the
acquirer shall take necessary
steps to facilitate compliance
with the relevant provisions
thereof, within the time period
specified therein.
– Holders of equity linked
instruments eligible to be
converted into equity shares
prior to the aforementioned date
may do so and tender their
equity shares in the open offer.
– The target Company should stand
delisted, should the acquirer have
stated its intention to delist the
target company and the response
to the open offer is such that the
acquirer’s shareholding crosses
the delisting threshold.
– In the event the shares of the
target company stand delisted
pursuant to the open offer, every
shareholder who has not
tendered an acceptance of the
open offer shall be entitled to
require the acquirer to acquire his
shares at the offer price at any
time within a period of twelve
months from the fifteenth day on
which the shares are delisted from
the stock exchanges. This exit
window would also be available
to the holders of all equity- linked
instruments in the company. The
company and the acquirer shall
Report of the Committees on Capital Market 423
take necessary steps to facilitate
the provisions of an option to such
holders to accelerate the
conversion/vesting of such
instruments during the period of
this exit window.
– Should
the
acquirer ’s
shareholding and the delisting
threshold, such acquirer be
given
an
option
to
proportionately reduced would
be those under the open offer,
the agreement (if any) and
immediate past purchases
(except acquisitions due to
allotments by the target
company). Such reductions
would enable the acquirer not to
breach
the
maximum
permissible
non-public
shareholding.
2
Thresholds for Open Offers
– Initial Threshold
If an acquirer acquirers or
agrees to acquire shares or
voting rights such that his voting
rights exceed 15% of the voting
capital of the target company,
he is required to make an open
offer.
– Initial acquisition threshold for a
mandatory open offer be raised
to 25% of the voting capital of
the target company.
– Creeping Acquisitions
If an acquirer already holds
more than 15% but less than
55%, he may acquire additional
shares carrying not more than
5% of the voting rights within a
financial year without having to
make an open offer.
– An acquirer holding 25 % or
more voting rights in a target
company is allowed to acquire
additional voting rights in the
target company up to 5 % within
a financial year, without making
an open offer.
If holding is above 55% but less
than 75%, a one time allowance
to increase their shareholding by
5% through market purchases
or pursuant to a Buy back by the
target Company, without having
to make a open offer, has been
permitted, provided that post
acquisition holding of acquirer
does not go beyond 75%.
424 PP-CC&MM
– Voluntary Offers
3.
4.
Control
Offer Price
Consolidation of shareholding
by an acquirer who is desirous
of maximizing his shareholding
without breaching the minimum
public
shareholding
requirements. The offer size for
an open offer under this
provision is the lower of 20%
or the maximum permissible
acquisition without breaching
the
minimum
public
shareholding requirement.
– Acquirers collectively holding
shares entitling them to exercise
25% or more voting rights in the
target company may voluntarily
make an open offer to
consolidate their shareholdings.
Control shall include the right
to appoint majority of directors
or to control the management
or policy decisions exercisable
by a person or persons acting
individually or in concert,
directly or indirectly, including
by virtue of their shareholding
or management rights or
shareholder agreements or
voting agreements or in any
other manner.
– Definition of “Control” be
modified to include “ability” in
addition to “right” to appoint
majority of the directors or to
control the management or
policy decisions would constitute
control.
Provides the parameters to be
considered for determining the
minimum offer price depending
on whether or not the shares
of the target company are
“frequently traded” (shares
which have annualized trading
volume of 5% or more of the
listed share capital during a
period of 6 calendar months
preceding the month in which
the public announcement is
made). For “infrequently
traded” shares, the Takeover
Regulations require the
computation of the offer price
on the basis of financial
parameters such as return on
net worth, industry priceearnings multiples and the like,
– The minimum offer price for
direct acquisitions should be the
highest of:
– The Committee proposed a
minimum open offer size of 10%
consistent with the rationale of
consolidation option outside the
creeping route. Voluntary offers
should not, however, be of a size
that could lead to breach of the
maximum permissible on-public
shareholding.
– A director or officer of the target
company would not be regarded
as being in control merely by
virtue of holding such position.
(a) The highest negotiated price
per share of the target company
for any acquisition under the
agreement attracting the
obligation to make a public
announcement of an open offer.
(b) The volume- weighted
average price paid or payable for
any acquisition, whether by the
acquirer or by any person acting
in concert with him during the
fifty-two weeks immediately
preceding the date of the public
announcement ; and
(c) the highest price paid or
payable for any acquisition,
Report of the Committees on Capital Market 425
apart from any price actually
paid by the acquirer or persons
acting in concert during the look
back period, or in the
transactions that triggers the
open offer obligation.
The Takeover Regulations also
require addition to the open offer
price, of any amount paid
towards non-compete fee in
excess of 25% of the open offer
price.
whether by the acquirer or by
any person acting in concert with
him during the twenty-six weeks
immediately preceding the date
of the public announcement; and
(d) The volume- weighted
average market price, for
frequently traded shares, during
60 trading days immediately
preceding the date of the public
announcement, computed
based on market prices on the
stock exchange where the
shares of the company are most
frequently traded during the
period.
– Frequently traded shares having
a trading volume of 10% or more
of the total number of the shares
during a period of 12 calendar
months preceeding the month in
which the public announcement
is made.
– Clause relating to non-compete
fee be deleted from the Takeover
Regulations,
and
any
considerations paid in any form
inclusive of all ancillary and
collateral agreements shall form
part of the negotiated price.
5.
Indirect Acquisitions
– Trigger for indirect
acquisitions
The acquirer has to make an
open offer for shares of the
target company when there is
direct or indirect change of
control of the target company
irrespective of any direct
acquisition of shares of the
target company. The regulations
also provide for deferment of
open offer obligations till
consummation of the original
transaction.
– Irrespective of whether the target
company is material to the
parent transaction, open offer
obligations have to be triggered.
Where a change in control over
the target company occurs,
shareholders of the target
company ought to rightfully get
an adequate exit opportunity.
– Timing and offer Price
In case of indirect acquisition of
shares or change of control, a
public announcement may be
– Where the proportionate net
asset value, or the sales
turnover, or the market
426 PP-CC&MM
made by the acquirer at any
time from the date of the initial
announcement of the intention
to acquire or entering in to the
acquisition agreement, until
completion of three months
after the consummation of
such acquisition or change in
control or restructuring of the
parent or the company holding
shares of or control over the
target company.
Takeover Regulations currently
do not differentiate between
open offers arising due to
direct acquisitions vis-a-vis
indirect acquisitions for
computation of offer price and
the same offer price formula
prescribed
for
direct
acquisitions is used for indirect
acquisitions as well, and the
practice is to compute the offer
price as of the date of the
announcement of primary
acquisition and as of the date
of the public announcement for
the target company, whichever
is higher.
capitalization of the indirectlyacquired listed company
represents more than 80 % of the
net asset value, sales turnover
or the deal value for the parent
business or company, the
acquirer must specify the value
of the stake in the Indian
company and the basis of such
valuation that would have been
factored in, and the Takeover
Regulations would treat such
acquisitions as if they were direct
acquisitions in all respects.
– For indirectly acquired target
companies, the minimum offer
price ought to be the highest of:
(a) The highest negotiated price
per share, if any, of the target
company for any acquisition
under the agreement attracting
the obligation to make a public
announcement of an open offer;
i. Where the proportionate net
asset value, or the sales turnover,
or the market capitalization of the
indirectly acquired listed company
represents more than 15 % of the
net asset value, or the sales
turnover, or the deal value for the
parent business or company, the
acquirer shall be required to
compute and disclose the per
share value of the target company
taken into account for the
acquisition of the parent business
or company and the basis of such
valuation.
ii. Where the proportionate net
asset value, or the sales turnover,
or the market capitalization of the
indirectly acquired listed company
represents less than 15 % of the
net asset value, or the sales
turnover, or the deal value for the
parent business or company, the
acquirer shall not be necessarily
Report of the Committees on Capital Market 427
required to make the computation
as above, but to factor in the
same if the same has been
carried out.
(b) The volume-weighted average
price paid or payable for any
acquisition, whether by the
acquirer or by any person acting
in concert with him during the fiftytwo weeks immediately preceding
the date on which the intention or
the decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into;
(c) The highest price paid or
payable for any acquisition,
whether by the acquirer or by any
person acting in concert with him
during the twenty-six weeks
immediately preceding the date
on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into ; and
The highest price paid or payable
for any acquisition, whether by the
acquirer or by any person acting
in concert with him between the
date on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into and the date of
the public announcement;
– For frequently traded shares, the
volume-weighted
average
market price on the stock
exchange for a period of 60
trading days preceding the date
on which the intention or the
decision to make the primary
acquisition was announced in the
public domain or any agreement
was entered into, as traded on
the stock exchange where the
maximum volume of trading in
the shares of the target company
428 PP-CC&MM
are recorded during such period.
– The price offered as of the date
of public announcement (to be
calculated as detailed above)
shall have to be increased by 10
% per annum for the period
between the announcement of
primary acquisition and date on
which the detailed public
statement is actually made.
– For transactions where the
proportionate net asset value, or
the sales turnover, or the market
capitalization of the indirectlyacquired listed company
represents more than 80 % of the
net asset value, sales turnover
or the deal value for the parent
business or company, the public
announcement be made on the
earlier of the date on which the
intention or the decision to make
the primary acquisition was
announced in the public domain
or any agreement was entered
into. In all other cases, the public
announcement can be made
within four business days of such
date, and in such cases the
detailed public statement should
be issued within five business
days of the consummation of the
primary acquisition.
6.
Withdrawl of Open Offer
No open offer, once made,
shall be withdrawn except
under
the
following
circumstances:
(a) the statutory approval(s)
required have been
refused;
(b) the sole acquirer, being
a natural person, has
died;
(c) Such circumstances as
in the opinion of SEBI
merit withdrawal.
In addition to the grounds currently
existing, an open offer may be
withdrawn where any condition
stipulated in the agreement for
acquisition attracting the obligation to
make the open offer is not met for
reasons outside the reasonable
control of the acquirer, and such
agreement is rescinded, subject to
such conditions having been
disclosed in the detailed public
statement and the letter of offer.
Report of the Committees on Capital Market 429
7.
Competing Offer
Provide the opportunity to any
person other than the acquirer
to make a competing offer
within 21 days of the public
announcement of the first
offer. Also provide that any
competitive offer by an
acquirer shall be for such
number of shares which, when
taken together with shares
held by him shall be at least
equal to the holding of the first
bidder including the number of
shares for which the present
offer by the first bidder has
been made.
– A competing offer may be made
within 15 business days from the
date of the original detailed public
statement instead of 21 calendar
days from the date of the original
public announcement. No further
offer should be allowed to be
made after the expiry of the said
period of 15 business days until
the completion of all the
competing offers.
– An open offer made by a competing
acquirer shall not be regarded as a
voluntary open offer and therefore
all provisions of Takeover
Regulations, including relating to
offer size, shall apply accordingly.
– An acquirer who has made a
competing offer, shall be entitled
to acquire the shares acquired by
the other competing acquirers in
their respective competing open
offers within 21 business days of
the expiry of the offer period
without attracting an obligation to
make another open offer.
– An acquisition mentioned above
shall not be made at a price
exceeding the offer price in the
competing offer made by the
acquirer who buys shares in such
transaction. Moreover, such an
acquisition ought not to take the
shareholding of the acquirer
beyond the maximum permissible
non-public shareholding limit.
– Other Recommendations:
a. During the pendency of
competing offers, no appointment
of additional directors ought to be
made on the board of directors of
the target company.
b. The ability of an acquirer to
proportionately reduce his
acquisitions such that the holding
does not exceed the maximum
430 PP-CC&MM
permissible
non-public
shareholding ought not to be
available where competing offers
are underway. This is critical to
ensure that competing acquirers
compete on an identical endobjective and shareholders are
truly able to compare them on the
offer price.
c. Unless the open offer first
made is an open offer conditional
as to the minimum level of
acceptances, no open offer
made by a competing acquirer
may be conditional as to the
minimum level of acceptances.
d. The schedule of activities and
the tendering period for all
competing offers shall be carried
out with identical timelines and
the dates for tendering shares
shall be revised to the dates for
tendering shares in acceptance
of the competing offer last made.
8.
9.
Obligation of the Traget
Company
– Material Actions
The target company shall not,
during the offer period sell,
transfer,
encumber
or
otherwise dispose of assets of
the company or its subsidiaries
or enter into any material
contracts.
– The Committee recommends
retaining restrictions on the target
company during the offer period
from carrying out material
transactions outside the ordinary
course of business except with
the consent of the shareholders
through a special resolution. The
Committee recommends that
such restrictions would also
cover the subsidiaries of the
target company, and such
actions in respect of subsidiaries
would also require approval of
the shareholders of the target
company.
Composition of the Board
Till the offer formalities are
completed, the target company
shall be precluded from
inducting any person or person
nominated by the acquirer or
– The acquirer or persons acting
in concert with him may be
represented on the board only
after the expiry of a period of 15
business days from the date of
Report of the Committees on Capital Market 431
belonging to his group into the
board of the target company
other than in cases, where
acquirer
deposits
full
consideration in an escrow
account.
the detailed public statement and
provided the entire consideration
payable under the open offer is
cases, where acquirer deposits
full consideration in an escrow
account. Deposited in cash in
the escrow account required
under the Takeover Regulations
and the offer is not subject to any
conditions other than regulatory
approvals.
– If a competing offer is made,
there ought to be no
appointments of directors during
the offer period, and only casual
vacancies arising out of death or
incapacitation may be filled with
prior approval of shareholders.
10.
Timelines for the Open Offer
process
The Committee discussed the
current timelines for an open
offer under the existing
Takeover Regulations and
reviewed the same with a view
to shorten the timelines.
– A short public announcement
should be made on the same date
as the date of transaction which
triggered the open offer through a
notice to the Stock Exchange,
followed by a detailed public
statement within 5 business days
of the public announcement.
– Post submission of draft letter of
offer, all timelines are dependent
on issue of comments by SEBI,
thus the Committee recommends
to link timelines (post submission
of draft letter of offer) to the date
of receipt of SEBI comments on
the draft letter of offer.
– The letter of offer should be sent
to the most recent set of
shareholders. Therefore, the
Committee recommends that
date for reckoning the
shareholders to whom the letter
of offer shall be sent should be
ten business days prior to
commencement of the tendering
period.
– Most shareholders tender their
shares on the last few days of
432 PP-CC&MM
the offer period, after the date of
final revision in price has been
carried out, and hence the initial
part of the offer period is virtually
redundant. Hence, the overall
time frame of the tendering period
has been reduced to ten business
days, and the last date for upward
revision of offer price has been
moved up to three business days
prior to commencement of the
tendering period.
– Since the last date of upward
revision is prior to the opening of
the open offer, shareholders are
expected to be in receipt of all
information to enable them to
decide on the open offer.
Therefore, there
is
no
requirement to permit withdrawal
of shares tendered in response
to the open offer. This would also
make the process more efficient.
– The acquirer shall issue an
advertisement, 1 business day
prior to the opening of the
tendering period announcing the
schedule and procedure for
tendering acceptances.
– The entire open offer process
from the public announcement to
the payment of consideration can
now be done within fifty seven
business days.
– The
committee
also
recommended revised timelines
and activity chart for an open offer
pursuant to a direct acquisition.
11.
Mode of payment
Offer consideration shall be
payable either :
(a) by way of cash;
(b) by issue, exchange and, or
transfer of shares (other
than preference shares) of
acquirer company, if the
person seeking to acquire
– The offer price may be paid in the
form of cash or securities like
shares, convertibles, secured
debt instruments of the acquirer
or of persons acting in concert
with him or a combination of
these modes.
– To ensure that the equity shares
Report of the Committees on Capital Market 433
the shares is a listed body
corporate; or
(c) by issue, exchange and, or
transfer
of
secured
instruments of acquirer
company with a minimum A‘
grade rating from a Credit
Rating Agency registered
with the Board; or
(d) a combination of clause (a),
(b) or (c).
given in consideration for the
open offer are liquid, eligibility
conditions have been stipulated.
– If shares of the target company
carrying more than 10% voting
rights have been acquired for
cash in the preceding 52 weeks,
shareholders to whom the open
offer is made may opt to receive
the offer price only in cash.
12.
Exemption from open offer
obilgations
The Takeover Regulations
currently provide for fourteen
categories of transactions which
are exempted from the
requirement to make an open
offer subject to satisfying the
conditions specified therein, if
any, without the need to seek
SEBI‘s approval for the same.
Further, for the transactions that
are not covered in the aforesaid
fourteen categories, an
application can be made for
seeking exemption from SEBI.
Such applications are referred to
a takeover panel for its
recommendations.
SEBI
considers the recommendations
received and passes an
appropriate order.
– The Committee has classified the
exemptions on the basis of the
specific charging provisions
which deal with the obligation to
make an open offer, and has
sought to distinguish between
acquisitions involving change in
control and those involving only
consolidation of shareholding.
The deliberations in brief and the
recommendations of the
Committee on the same are
discussed below under separate
heads.
13.
Recommendation by the
independent directors of the
Target Company
The Board of Directors of the
Target Company may, if they so
desire, send their unbiased
comments
and
recommendations on the
offer(s) to the shareholders,
keeping in mind the fiduciary
responsibility of the directors to
the shareholders.
– Independent directors on the
Board of Directors of the target
company ought to make a
reasoned recommendation on
the open offer.
– For the making of such
recommendation, the board of
the target company ought to
appoint a committee of
independent directors with
freedom to consult and engage
external advisors such as
merchant bankers, chartered
accountants and lawyers at the
expense of the target company.
434 PP-CC&MM
– Such committee of independent
directors ought to make a
reasoned recommendation and
such recommendation ought to
be sent to all the stock exchanges
where the shares of the target
company are listed and be
published in the same
newspapers where the relevant
detailed public statement of the
open offer was published.
14.
15.
Obligations of the Acquirer
– Disposal of assets of the
Target Company
Where the acquirer has not
stated his intention to dispose
of or otherwise encumber any
assets of the target company
except in the ordinary course
of business of the target
company, the acquirer shall be
debarred from disposing of or
otherwise encumbering the
assets of the target company
for a period of 2 years from the
date of closure of the public
offer.
– Unless acquirer has declared an
intention in the detailed public
statement and the letter of offer,
the acquirer shall be debarred
from alienating any material
assets of the target company
(including its subsidiaries) for a
period of two years after the offer
period. However, where such
alienation is necessary despite
no such intention having been
expressed by the acquirer, the
target company shall require a
special resolution passed by the
shareholders by way of a postal
ballot.
Obligations of the Merchant
Banker
The merchant banker shall
ensure compliance of the
Takeover Regulations and any
other laws or rules as may be
applicable in this regard and
provide
other
specific
obligations under Regulations
24 of the Takeover Regulations,
1997.
– The merchant banker would be
expected to demonstrate the
application of due skill, care and
diligence in the discharge of
professional duties cast on him
and the obligations of the
merchant banker ought to be
construed accordingly.
– It is perhaps likely that despite
following best practices and full
application of diligence, skill and
care, an acquirer could end up
defaulting under the Takeover
Regulations.
In
such
circumstances, the Committee
believes that, in the least, the
expectation from a merchant
banker would be a demonstration
of the bona fide efforts undertaken
Report of the Committees on Capital Market 435
16.
Disclosure Obligations
The
current
Takeover
Regulations obligate any
acquirer who crosses the
specified thresholds to disclose
at every stage his aggregate
shareholding or voting right to
the company concerned and to
the stock exchanges where
shares of the company are
listed. It also obligates a
promoter / majority shareholder
to annually disclose to the
company and the concerned
stock exchange regarding the
number and percentage of
shares or voting rights held by
him along with PACs.
by him in professionally and
diligently discharging the role
envisaged for the merchant
banker under the regulations.
– The acquirer promoter /
shareholders shall be asked to
disclose their acquisition on
periodic as well as transaction
specific basis upon crossing the
limits specified therein to the
Stock Exchange.
– Such disclosures shall be of the
aggregated shareholding and
voting rights of the acquirer and
every person acting in concert
with him.
– The acquisition and holding of
any security or instrument that
would entitle the acquirer to
receive shares in the target
company, including warrants and
convertible debentures, shall also
be required to be disclosed.
17.
Present Tax Regime
An open offer transaction is
considered akin to an offmarket deal.
– There is a need to bring parity in
the tax treatment given to the
shareholders who tender their
shares in an open offer and those
who are selling the same in the
open market. SEBI may like to
suitably take up this issue with the
concerned authorities in the
Government.
On September 23, 2011, SEBI notified the New Takeover Regulations i.e. SEBI (Substantial Acquisitions of
Shares and Takeovers) Regulations, 2011 that came into force w.e.f. October 22, 2011.
REPORT OF JUSTICE DHANUKA COMMITTEE ON SECURITIES LAWS
On 28th February, 1997, SEBI had appointed a Committee under the Chairmanship of Justice D.R. Dhanuka,
former judge of the High Court of Bombay to examine areas of deficiency in the SEBI Act,1992, SC(R) Act,1956
and the Depositories Act,1996 to suggest the amendments to the provisions of the SEBI Act,1992; SC(R) Act,1956,
Depositories Act,1996 with a view to enable SEBI to regulate and develop the Securities Market and protect the
interests of investors and to examine the provisions of the Companies Act,1956 and to make recommendations
for amendments in the Companies Act in order to enable SEBI to better regulate issue of capital, listing of
securities, transfer of securities and to protect the interests of investors.
436 PP-CC&MM
Executive Summary of Principal Recommendations
Part - I A: Pertaining to Draft Securities Bill and Draft Depositories (Amendment) Act 1998.
1. Consolidation of Securities Contracts (Regulation) Act, 1956 and SEBI Act 1992 into a composite securities
legislation and consequent repeal of SCR Act and SEBI Act. SEBI should be the sole regulatory agency for
securities market, including in relation to certain provisions in the Companies Act.
2. Several additional provisions introduced in the consolidated Securities Act so as to provide for the statutory
basis for regulation of a number of aspects relating to the Securities Market. Some of these features are referred
below:
2.1 - Long arm jurisdiction provided so as to make the Act applicable to an entity outside India dealing directly or
indirectly in securities in India.
2.2 - Several new definitions including that of “derivatives” “fraudulent and unfair trade practices”, “insider trading”,
“intermediaries”, “issuer”, “mutual fund”, “offer documents”, “private placement”, “qualified institutional investors”,
“self regulatory organsiations” and “venture capital funds” have been statutorily introduced.
The insertion of definition of “qualified institutional investor” enables identification of a class of “qualified institutional
investors” who may be subject to a more liberal, enabling regulation regime. This would be particularly relevant
in the context of private placements.
Provision has been made for comprehensive definition of “securities”. This now includes derivatives, plantation
companies, time shares, securitised instruments, etc.
Some existing definitions, have also been modified to make the same more comprehensive. Insertion /
modifications of these definitions will provide the basis for promoting of trading in “derivatives”, statutory regulation
and punishment of insider trading and fraudulent and unfair trade practices as also, regulations of private
placements.
The same also includes regulation of issuer and improving disclosure standards to be followed by the issuer.
3. Powers and functions of SEBI rationalised. Provision is made for power to issue general and special directions
including those for enforcement of such directions and recovery of money as arrears of land revenue.
3.1 Scope of SEBI’s powers to issue directions, is expressly extended also to investors or any other person,
rather than merely intermediaries.
4. Statutory provision is made for restriction of professionals practicing in the securities market including advocates,
chartered accountants also who act as experts if they are found to be guilty of malpractices. This is without
prejudice to the Advocates Act as the autonomy of the bar and the Chartered Accountant Act is maintained and
is in furtherance of the strong desire of the Committee to encourage raising of professional standards and
creation of a larger force of securities market professionals.
5. A new Chapter for recognition and regulations of self regulatory organisations is inserted. The encouragement
of self regulatory organisations and the statutory regulation thereof are the key recommendations of this Committee.
5.1 The right to carry on business as intermediary has been linked to membership of an SRO.
6. The scope of recognition and regulation of stock exchange, also a form of SRO has now been rationalised.
6.1 The definition of stock exchange has been extended to include “exchanges promoted by other exchanges.”
6.2 Concept of “territoriality” with reference to recognition of exchanges has been abandoned. SEBI’s approval
for additional trading floors will still be required.
6.3 In case of supersession of the governing board, some members may continue till reconstitution of new
governing body.
Report of the Committees on Capital Market 437
7. Strict provisions made for the regulation of the issuer, particularly, in relation to issue of securities and disclosure
standards.
8. Consequential provisions are prescribed for mis-statement in terms of civil and criminal consequences.
9. Non company issuers are also to be included in the regulatory net.
10. Parallel action under the SEBI Act can be also taken in case of mis-statements in offer documents and action
is not confined to mis-statement in prospectus, under Companies Act.
11. Provision has been made for establishment of a clearing corporation and the regulation thereof.
12. Provision has been made for recovery of the listing fees. Directors or persons in management are personally
liable for payment of listing fees which can be recovered as land revenue from the issuer, management in case
of default.
13. Parameters are prescribed for delisting of securities. Voluntary de-listing to be permitted by stock exchanges
and SEBI only with the consent of the prescribed majority of the shareholders and also upon specific conditions.
14. Provisions regarding contracts and options in securities are streamlined.
14.1 Hence, dealing in securities may take place in any of three ways.
(1) through members of the stock exchange
(2) spot delivery contracts
(3) special exceptions such as repos in Government securities, securities of private companies, private
shareholder agreement, deliveries as per takeover code, etc. These may take place other than through
members of stock exchanges and not necessarily as spot delivery contracts.
15. The business of spot deliveries to be strictly regulated. Hence, share shoppes to be prohibited unless
licensed.
16. Compulsory dematerialisation for new issue of securities exceeding rupees 10 crores in value.
17. UTI to be regulated as a Mutual Fund notwithstanding the provisions of UTI Act, 1963.
18. New Chapter inserted for empowering SEBI and its officials for Investigation and Enforcement on lines of
other economic legislations including powers, examination of persons, search and seizure, etc.
19. Provision inserted to take approver, evidence and to offer consequential immunity for prosecution.
20. To prevent abuse of power necessary safeguards for prevention of vexatious searches, draconian exercise
of powers provided for. SEBI to follow settled principles of administrative law subject to judicial review.
21. Provisions as to penalty and adjudication are rationalised.
22. New categories of penalties for mis-statement in offer documents and other documents. In relation to offences
of insider trading and unfair trade practices, persons who knowingly benefit are also liable for penalty.
23. Provisions related to a single Appellate Authority i.e. Securities Appellate Tribunal has been rationalised.
24. Power to make rules and regulations, rationalised in the new context.
25. Intermediaries to hold securities or funds of investor as trustee pending executions of contract.
Part I B: Dematerialisation / Depositories Act, 1996 - Amendments
26. Issuer not to resile or withdraw from agreement with depository after dematerlisation of its securities.
27.Option to issuer to enter into agreement with anyone of the depository in case of several depositories.
438 PP-CC&MM
28.Nomination facility to the beneficial owner in respect of dematerialised security.
29.In case of pledge of dematerialised securities, the provisions of Contract Act not to be applicable.
30.Bankers Book Evidence Act, 1879 applicable also to the statement issued by “participant”.
31.Depository to indemnify the beneficial owner only for its own negligence and fraud and not generally.
32.Contravention of direction of the Board is made punishable.
33.Appeal to lie to Securities Appellate Tribunal from the order of the Board.
34.Jurisdiction of Consumer Forum barred in relation to dispute relating to dematerialised securities.
35.Depository Act to override memorandum and articles of association of companies.
36.Exemption from stamp duty in respect of issue and transfer of dematerialised security.
37.Participants to hold securities of beneficial owner as trustee pending dematerialisation .
*Special problems - Plantation companies
PART II - PERTAINING TO WORKING DRAFT OF COMPANIES BILL, 1997
– Definition of the expression “security” be restructured. The expressions “derivative” and “option in
securities” can be more appropriately defined in SC(R) Act.
– As per the Working Draft Report, only Part III is proposed to be administered by SEBI. It is recommended
that all the provisions relating to listed companies in so far as they relate to subject matter of capital
market and issuance or dealing in securities wherever found in Companies Act be administered by
SEBI. SEBI should be the sole authority for framing regulations in relation to the subjects entrusted to it
under the new legislation.
– Provisions relating to prospectus, shelf-prospectus and red herring prospectus require several
modifications.
– Private Placement should be regulated. Broad parameters should be laid down in the Act. Details to be
determined by SEBI.
– Provisions made in the Working Draft for buy back of securities require several modifications.
(i) The provision for buy-back should be restricted to “shares” only.
(ii) The company should not be allowed to utilise proceeds of “prior issue” for purpose of “buy-back”.
(iii) The company should be allowed to re-issue the shares which are bought back, subject to safeguards
and stipulations which may be laid down.
(iv) Implications relating to insider trading to be considered.
– Penal provisions of the Act be made deterrent.
– Listing period be reduced from 10 weeks to 30 days. It should not be mandatory to have the securities
listed on the regional stock exchange.
– Clauses 94-98 of the Working Draft require several amendments. SEBI may be authorised by the Act to
frame regulations relating to transfer of securities of listed companies, etc.
– Obtaining of duplicate share certificate and issue thereof as a result of fraud or collusion be made a
serious criminal offence.
– If a person is found guilty of contravening the provisions of SEBI Act, SC(R) Act or depository Act, or is
Report of the Committees on Capital Market 439
penalised by the adjudicating officer under the SEBI Act, he should be disqualified from becoming the
director of the company. The Committee has formulated amendments.
– Securities audit be made compulsory.
– Monetary penalty concept be introduced so that investors can seek remedy of claiming compensation,
damages, etc.
– In order to enhance corporate democracy, the concept of Postal Ballot to be introduced to enable
shareholders to vote through postal ballot.
– The blank transfer deeds should not be permitted.
– SEBI should have power of inspection of books of accounts, records of the listed companies.
– Rights issue with right of renounciation be treated as public issue.
– Printing of share certificates be regulated and technical standards to be prescribed.
– Verification of transfer deeds by companies on payment of nominal fees before lodgment of certificate
of transfer.
– Company’s right to refuse transfer limited to be limited to violation of SEBI Act and regulations, or any
other law and not on “sufficient cause” as presently prescribed under section 111A.
– The concept of deemed public company be reintroduced. Section 43A of existing Act is a useful provision
in the Act and it should not be deleted.
– The Reserve Bank of India should have power to freeze voting rights in respect of “shares under transfer”
concerning Banking Companies pending consideration of Application for Acknowledgment. If the shares
of a Banking Company are transferred in violation of Banking Regulation Act, 1949 or the circulars /
guidelines issued by Reserve Bank having the force of law, the Reserve Bank should have locus standii
to apply to Company Law Board for rectification of Register on par with SEBI and other authorities.
– Companies making initial public offer of securities for a sum of `10 crores or more to be issued only in
dematerialised form through a depository.
Recommendation for Issue of an Ordinance for Moving of an Urgent Bill To Curb The Growing
Evil Emanating From Collective Investment Schemes
The Government of India issued press release dated 18/11/1997 that the Collective Investment Schemes based
on issuing instruments like Agro Bonds, Plantation Bonds, etc. are within the purview of SEBI Act,1992 and
particularly the provisions of law contained in Section 11(2)(c) of the SEBI Act. The said sub-clause was
incorporated in the Act by the Securities Laws (Amendment) Act, 1995 with effect from 25/1/1995 for “Collective
Investment Schemes”.
Section 11(1) of the Act provides that it shall be the duty of the Board 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
deems fit. Section 11(2)(c) of the said Act provides that the generality from the provisions, the measure referred
to therein may provide for restructuring and regulating the working of venture capital funds and collective
investment schemes, including mutual funds.
SEBI was facing writ petitions in the Hon’ble Courts where content of one writ petition is that the plantation
companies, etc. are not within the jurisdiction of SEBI in as much as such companies do not operate in the
securities market and the bonds issued by such companies do not constitute securities.
The Committee was of the view that as a measure of the abundant caution, clarificatory provision should be
made in the new legislation restructuring the definition of securities so as to specifically provide that Agro Bonds,
440 PP-CC&MM
Plantation Bonds, etc. be expressly included in definition of the expression securities. The existing definition of
the expression “securities” contained in Section 2(h) of Securities Contracts (Regulation ) Act,1956 is an inclusive
definition and the same definition has been adopted in SEBI Act,1992 by Section 2(i) thereof.
The clarificatory definition of the expression security should not indicate any change in law as such but should
in terms clarify and provide that the collective investment schemes were within the range of the definition of the
expression securities and whatever be the nature of document issued by these companies, these documents
would constitute securities. The Committee had prepared draft of an extensive definition of the expression
“security” for being included in the proposed Securities Act, 1998. Above draft of a consolidated legislation was
prepared by the Committee after holding about 22 meetings. In the draft-Bill of the securities, the definition of
securities was widened. The committee was of the view that the said definition be taken into consideration by
the authorities concerned while drafting new legislation in the form of an Ordinance or the Bill as may be deemed
fit.
The Committee made a few suggestions / recommendations indicating the nature of powers, duties and obligations
to be conferred on the regulatory body for giving better protection to investors whose interests are in jeopardy.
A list of such provisions is particularly indicated hereinafter.
1. Power of making enquiry and investigation. Thus, the power to issue summons and record statements of
individuals, suspected of fraud and malpractices - power to search the premises, to seize the records - power to
appoint a Chartered Accountant or any other officer to take inspection of the records of the company concerned.
2. Power to take-over the management of the entity concerned for a limited duration.
3. Power to appoint Chairman or additional directors as Government nominees or as SEBI nominees with
special obligations to protect the interest of the investors and make report to the authorities including authority
to perform Bank Accounts.
4. Power to make inventory inspection of the assets of the company. Appointment of receiver or freeze assets of
the company including Bank Accounts where the regulatory authority has reason that the company is indulging
in activities prejudicial in the interest of the investors or is dealing with the assets in a manner prejudicial or
manipulating in activities in accordance with law.
5. Power to prosecute the manipulators and persons who are prima - facie suspected fraud after investigation.
6. Power to issue directions including directives in respect of freezing the assets of the company and such other
directions as are deemed necessary in the interest of the investors.
7. In case the company or the unit is found insolvent or the interests of the investors are in jeopardy or it is primafacie deemed just and equitable to seek winding up of such companies to make necessary applications for
winding up of the company.
Test Papers 441
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
PP-CC&MM/2013
TEST PAPERS
This Test Paper set contains three test papers Test Paper 1/2013, 2/2013 and 3/2013. The maximum time
allowed to attempt each test paper is 3 hours. Students are advised to attempt atleast one Test Paper
from Test Papers 1/2013 or 2/2013 or 3/2013 and send the response sheet for evaluation to make him/
her eligible for Coaching Completion Certificate. However, students may, if they so desire, may send more
response sheets for evaluation. While writing answers, students should take care not to copy from the
study material, text books or other publications. Instances of deliberate copying from any source will be
viewed very seriously.
442 PP-CC&MM
WHILE WRITING THE RESPONSE SHEETS TO THE TEST PAPERS GIVEN AT END OF THIS STUDY
MATERIAL, THE STUDENTS SHOULD KEEP IN VIEW THE FOLLOWING WARNING AND DESIST FROM
COPYING.
WARNI NG
Time and again, it is brought to our notice by the examiners evaluating response sheets that some students
use unfair means in completing postal coaching by way of copying the answers of students who have
successfully completed the postal coaching or from the suggested answers/study material supplied by the
Institute. A few cases of impersonation by handwriting while answering the response sheets have also
been brought to the Institute’s notice. The Training and Educational Facilities Committee has viewed seriously
such instances of using unfair means to complete postal coaching. The students are, therefore, strongly
advised to write response sheets personally in their own hand-writing without copying from any original
source. It is also brought to the notice of all students that use of any malpractice in undergoing postal or
oral coaching is a misconduct as provided in the explanation to Regulation 27 and accordingly the studentship
registration of such students is liable to be cancelled or terminated. The text of regulation 27 is reproduced
below for information :
“27. Suspension and cancellation of examination results or registration
In the event of any misconduct by a registered student or a candidate enrolled for any examination conducted
by the Institute, the Council or the Committee concerned may suo motu or on receipt of a complaint, if it is
satisfied that, the misconduct is proved after such investigation as it may deem necessary and after giving
such student or candidate an opportunity to state his case, suspend or debar the person from appearing in
any one or more examinations, cancel his examination result, or studentship registration, or debar him
from future registration as a student, as the case may be.
Explanation - Misconduct for the purpose of this regulation shall mean and include behaviour in a disorderly
manner in relation to the Institute or in or near an Examination premises/centre, breach of any regulation,
condition, guideline or direction laid down by the Institute, malpractices with regard to postal or oral tuition
or resorting to or attempting to resort to unfair means in connection with the writing of any examination
conducted by the Institute”.
Test Paper 1/2013 443
PROFESSIONAL PROGRAMME
CAPITAL, COMMODITY AND MONEY MARKET
TEST PAPER 1/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt All Questions
1. Write short note on any four of the following:
(a) Private Equity
(b) Warrant
(c) Shelf prospectus
(d) Suspicious Transaction Report
(e) Price Sensitive Information (PSI)
(5 marks each)
2. What do you meant by Voluntary Open Offer? Briefly discuss the conditions required to be fulfilled by an
acquirer for making Voluntary Open Offer under the SEBI Takeover Regulations, 2011.
(10 marks)
3. (a) Discuss the various types of American Depository Receipts (ADRs)?
(b) What is Bill Discounting? Explain.
(6 marks)
(4 marks)
4. The Executive Committee of a recognized Stock Exchange desires to transfer certain duties and functions
of a clearing house to a recently set up Clearing Corporation, incorporated as a company under the
Companies Act, 1956. Examining the provisions of the Securities Contracts (Regulation) Act, 1956:
(i) State the purpose for which such transfer of duties and functions can be made to Clearing
Corporation?
(ii) What is the procedure to be adopted for such transfer of duties and functions?
(10 marks)
5. Distinguish between the following:
(a) Offer for Sale and Initial Public Offer
(b) Accounting Period Settlement and Rolling Settlement
(5 marks each)
6. What is Investible Weight Factors (IWFs)? How IWFs can be calculated, explain with the help of an
example.
(10 marks)
7. Enumerate the provisions relating to alternate method of Book Building under SEBI (ICDR) Regulations,
2009.
(10 marks)
8. What are the obligations on banking companies, financial institutions and intermediaries under the
Prevention of Money Laundering Act, 2002?
(10 marks)
9. Explain different categories of Angel Investors?
(10 marks)
444 PP-CC&MM
TEST PAPER 2/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt all Questions
1. Write short note on any four of the following:
(a) Qualified Foreign Investors
(b) Transaction cost
(c) NCD with Call and Put Option
(d) London Stock Exchange (LSE)
(e) Conditional Offer
(5 marks each)
2. What do you understand by an Investment Adviser? Explain the Code of Conduct prescribed by SEBI
for an Investment Adviser.
(10 marks)
3. What is Letter of Credit (LC)? Enumerate the various forms of Letter of Credit.
(10 marks)
4. Distinguish between the following:
(a) Forward and Futures
(b) Currency futures and Interest rate futures
(5 marks each)
5. What is trading window? Briefly explain the provisions relating to trading window under SEBI (Prohibition
of Insider Trading) Regulations, 1992?
(10 marks)
6. Discuss the concept of storage with respect to commodities .Explain various types of storage systems
used for preserving commodities.
(10 marks)
7. What do you mean by Institutional Placement Programme (IPP)? Discuss the restrictions laid down
under SEBI ICDR Regulations, 2009 on a company for making an IPP.
(10 marks)
8. (a) Examine with reference to the provisions of the Securities Contracts (Regulation) Act, 1956 whether
it is possible for City Stock Exchange Limited, a company incorporated under the Companies Act, 1956
and a recognized Stock Exchange, to insist that its members should appoint only other members as
their proxies to attend and vote at the meeting of the Stock Exchange.
(6 marks)
(b) Complaints of unethical practices have been received against members of a recognized Stock
Exchange by the Government. Examine whether the government has any power to suspend the business
of such a recognized Stock Exchange.
(4 marks)
9. Briefly enumerate the provisions under Rule 19A of SCRR, 1957, relating to minimum public shareholding
required to be maintained by a company for the purpose of continuous listing requirements.(10 marks)
Test Paper 3/2013 445
TEST PAPER 3/2013
(This Test Paper is based on entire Study Material)
Time Allowed : 3 Hours
Maximum Marks : 100
Attempt all Questions
1. Write short note on any four of the following:
(a) State Financial Corporations
(b) Speculator
(c) Mobilization of Savings
(d) Trade Guarantee Fund
(e) Term Money
(5 marks each)
2. Briefly describe the Offer for Sale mechanism in a stepwise manner in accordance with SEBI Guidelines.
(10 marks)
3. Explain the procedure for issue of ADR/ GDR in a stepwise description.
(10 marks)
4. What are the different types of entities involved in physical settlement of commodities? Discuss.
(10 marks)
5. What are the agencies involved in investigating cases of Money Laundering? Give a brief of each
investigating agency.
(10 marks)
6. Define “Bill of Exchange”? Enumerate various types of Bill of Exchange.
(10 marks)
7. Discuss briefly the ground on which SEBI can grant exemption from the open offer obligation to an
acquirer under SEBI Takeover Regulations 2011.
(10 marks)
8. Explain the various obligations and responsibilities cast on a market maker under the SEBI Guidelines.
(10 marks)
9. State in the light of requirement of clause 49 of the listing agreement as to whether the following persons
can be appointed as independent directors on the Board :
(i) Krishan, who is an executive of the company since its inception.
(ii) Soumitro, who holds 1.5% of the equity shares of the company having voting rights.
(iii) Pradeep, who is already a director of 14 companies.
(iv) Shalini, who is appointed by a financial institution which has lent funds to the company.
(10 marks)
NOTES
