Reforms of secondary market, Organization and Management
The purpose of a stock exchange or secondary securities market is to enable buyers and sellers to affect their transactions more quickly and cheaply than they could do otherwise. But in our country, this secondary market suffered from serious deficiencies. The general functioning of stock exchanges was not satisfactory.
Trading members were also not adequately capitalized. Insider trading was rampant and was one of the major causes of excessive speculative activity, leading to default by stock brokers, frequent payment crises and disruption of market activity. The stock exchanges followed inefficient and outdated trading systems.
This in turn led to lack of transparency in trading operations, besides resulting in long and uncertain settlement cycles. The risk management system in the market was also not satisfactory.
Though the margin system was operative, the margins were inadequate and the system of collection of margins was not enforced strictly. Post trade settlement procedures also suffered from some serious draw backs, such as, high share of bad deliveries, delayed settlements, clubbing of settlements etc.
The capital market regulator Securities and Exchange Board of India (SEBI) initiated various reform measures in the secondary market with the aim of improving market efficiency, enhancing transparency, preventing unfair trade practices and building investor confidence in the securities market.
It is an accepted fact that SEBI’s procedures have helped building up well-regulated entities of intermediaries in the securities market with distinctive roles, duties and responsibilities. One of the major reforms—the introduction of T + 2 settlement, the investors’ problems with intermediaries (brokers), their participation in derivatives trading and their knowledge about Trade Guarantee Fund.
Settlements in Reforms of Secondary Market:
The term settlement in stock market indicates the system whereby the positions of brokers accumulated till the end of a specific period are settled on the basis of netted out positions with respect to every security. It may be an accounting period settlement or a rolling settlement.
Accounting Period Settlement:
The Indian stock market has historically adopted accounting period settlement. The accounting period settlement indicates the system whereby the positions of brokers accumulated till the end of a specific accounting period are settled on the basis of netted out positions with respect to every security.
The accumulation of position during the settlement period gave scope for speculative activities thus, increased the possibility of default by participants. To overcome the deficiencies of the accounting period settlement system, rolling settlement system was introduced in a phased manner.
Under the Rolling settlement system, any transaction made on a particular day necessarily results in delivery after a fixed number of days. For example, under T + 5 rolling settlement system, any transaction made on a particular day i.e., Transaction day—T, necessarily results in delivery after five working days.
T + 5 (Transaction + 5 Days) Settlement:
The rolling settlement on a T + 5 basis was introduced in select scrips numbering Ten in January 2000 and then increased the number of scrips in phased manner to 163 by May 2000. The announcement made by the Finance Minister in March 2001 to introduce rolling settlement in 200 scrips, gave rolling settlement a further boost.
SEBI thereafter announced a list of 251 scrips for compulsory rolling settlement from July 2, 2001 on all exchanges. With effect from December 31, 2001 rolling settlement was extended to the remaining scrips on all exchanges. In December 2001, SEBI announced the shortening of settlement cycle to T + 3 basis for all securities.
With that the Indian securities market complied with the standard for clearing and settlement laid down by the Joint Committee of Clearing and Payment System of the Bank of International Settlements and the International Organisation for Securities Commission.
T + 2 Settlement:
From 2003 the settlement cycle has further been reduced to T + 2 for all securities. The trades accumulate over a trading cycle of one day and at the end of the day, these are clubbed together, and positions are netted and payment of cash and delivery of securities settle the balance after 2 working days. All trades executed on a day ‘T’ are settled on T + 2 day.
Exchange Management of Secondary Market:
Only three exchanges (Mumbai, Ahmedabad and Madhya Pradesh) are organised in the form of “Association of Persons”, while the remaining are organized as companies, either limited by guarantee or by shares. Except National Stock Exchange (NSE), all other exchanges, whether corporates or association of persons, are not-for-profit organizations.
Most of the stock exchanges in the country are organised as “mutuals” which was considered beneficial in terms of tax benefits and matters of compliance. The trading members, who provide brokering services, also own, control and manage the exchanges.
This is not an effective model for self-regulatory organisations as the regulatory and public interest of the exchange conflicts with private interest. In contrast, in a demutualised exchange, the ownership and management and trading membership are segregated and vested with different sets of persons.
This model eliminates conflicts of interest and helps the exchange to pursue market efficiency and investor interest aggressively. On realising the limitations of mutual structure and discovering the advantages of demutual structure, the authorities and exchanges are working to demutualise all the non-demutualised exchanges.
The exchanges (except two exchanges NSE and OCTEI which are already demutualised) have been mandated by the Securities Laws (Amendment) Act, 2004 to demutualise and corporatise themselves by an appointed date.
Membership of Secondary Market:
The trading platform of an exchange is accessible only to brokers. They execute trades on exchanges either on their own account or on behalf of their clients. Demutualised exchanges allow free entry and exit of brokers, while others have limitations on the number of brokers.
The standards for admission of members lay emphasis on factors such as corporate structure, capital adequacy, track record, education, experience etc., and reflect a conscious endeavour to ensure quality broking services.
No stockbroker is allowed to buy, sell or deal in securities, unless he or she holds a certificate of registration granted by SEBI. A broker/sub-broker complies with the code of conduct prescribed by SEBI. Over time, number of brokers’ proprietor firms and partnership firms have converted themselves into corporate. Out of 9,339 brokers registered with SEBI at the end of March 2006, 3787 brokers, accounting for nearly 40.4% of the total, were corporate entities.
At the end of March 2006, there were 23,479 sub-brokers registered with SEBI. The small exchanges have floated subsidiaries, which have trading membership on bigger exchanges, and about 2600 brokers of small exchanges trade as sub-brokers through these subsidiaries. During 2003-04 they accounted for about 7% of the cash market turnover on exchanges.
Listing of Securities in Secondary Market:
A company seeking listing satisfies the exchange that at least 10 percent of the securities, subject to a minimum of 20 lakh securities, were offered to the public for subscription, the size of the net offer to the public (i.e., the offer price multiplied by the number of securities offered to the public, excluding reservations, firm allotment and promoters’ contribution) was not less than Rs. 100 crore and the issue is made only through book building method with allocation of 60% of the issue size to the qualified institutional buyers.
Otherwise, it is required to offer at least 25% of the securities to the public. The company is also required to maintain the minimum level of non-promoter holding on a continuous basis.
Before making an application for listing to any stock exchange, a corporate body, Mutual Fund or Collective Investment Scheme, is required to obtain a letter of recommendation for listing from the Central Listing Authority. The basic norms for listing of securities on stock exchanges are uniform for all exchanges.
These norms are specified in the listing agreement entered between the company and the exchange concerned. The listing agreement prescribes a number of requirements to be continuously complied with by the issuers for continued listing and such compliance is monitored by the exchanges.
It also stipulates the disclosures to be made by the companies and the corporate governance practices to be followed by them. SEBI has been issuing guidelines/circulars prescribing certain norms to be included in the listing agreement and to be complied with by the companies.
A listed security is available for trading on the exchange. 9,359 securities were listed on exchanges at the end of March 2004. A security listed on other exchanges is also permitted for trading. The stock exchanges levy listing fees i.e., initial fees and annual fees from the listed companies.
It had been a major source of income for many exchanges till recently. With the withdrawal of requirement of listing on regional exchanges, liberalisation of delisting, and virtually no trades on exchanges, no new company is seeking listing on regional exchanges and the existing companies too are getting delisted.
Buy Back of Shares in Secondary Market:
Shares bought back by a company from its shareholders is termed as buy back of shares. The main objectives of buy back of shares are to improve liquidity, enhance shareholders’ wealth, increase promoters holding, increase earnings per share, rationalise the capital structure by writing off capital not represented by available assets, support share value, to thwart takeover bid to pay surplus cash not required by business. In pursuance of the amendments in the company law regulations in 1998, Securities Exchange Board of India [SEBI], has formulated buy-back regulations for listed companies.
Under this law, a company is permitted to buy back its shares:
(a) From the existing shareholders on a proportionate basis through the tender offer i.e., by means of offer document,
(b) From open market through stock exchanges, and book building process, and
(c) From shareholders holding odd lot shares.
Delisting of Securities in Secondary Market:
According to Delisting guidelines, a listed company can voluntarily delist its securities from stock exchange after providing an exit opportunity to holders of securities at a price determined through reverse book building. An exit opportunity is not necessary, if the security remains listed on an exchange having nationwide trading terminals.
According to the recent amendment in the Securities Contract Regulation Act, a stock exchange may delist securities on any of the grounds as may be prescribed in the rules, after giving the company concerned an opportunity of hearing.