Trading and Settlement

Trading Mechanism of Secondary Market:

The secondary market overcame the geographical barriers by moving to screen based trading. The trading terminals is now accessed through 10,000 trading terminals spread across more than 400 cities and towns in the Indian sub-continent and also through the Internet and hand held mobile devices from all over the world.

The exchanges provide a fully automated on-line screen based trading system (SBTS) where a member can punch into the computer quantities of securities and the prices at which he likes to transact and the transaction is executed as soon as it finds a matching order from a counter party.

SBTS electronically match orders on a strict price/time priority and hence cuts down on time, cost, risk of error, as well as on fraud thereby resulting in improved operational efficiency. It allows faster incorporation of price sensitive information into prevailing prices, thus increasing the informational efficiency of markets.

It enables market participants to see the full market on real time basis, making the market transparent. It allows a large number of participants, irrespective of their geographical locations, to trade with one another simultaneously, improving the depth and liquidity of the market.

It provides full anonymity, by accepting orders, big or small from members without revealing their identity, thus providing equal access to everybody. Trading platform is also accessible to an investor through the Internet and mobile devices such as WAP. It also provides a perfect audit trail, which helps to resolve disputes by logging in the trade execution process in entirety.

Insider Trading:

Insider trading means dealing in securities of a company by insiders which includes Directors, Officers and Employees of the Company who are connected with the Company and/or reasonably expected to have access to Unpublished Price Sensitive Information (UPSI) in respect of securities of the Company or who had access to such UPSI.

Such dealings by Insiders erode the investors’ confidence in the fairness and integrity of the management. Rampant insider trading deters investment from capital market which in turn affects growth of economy.

The Securities and Exchange Board of India (SEBI), as part of its efforts to protect the interests of investors in general, had issued the SEBI (Insider Trading) Regulations, 1992 under the powers conferred on it by the SEBI Act 1992. Applicable to all listed companies, these Regulations came into force with effect from 19th November 1992.

Under the Regulations, it is mandatory for every listed company/entity to adopt a Code of Conduct for Prevention of Insider Trading, for its Directors, Officers and Employees in terms of Schedule I to the Regulations. The Directors, officers and employees of the Company owe a fiduciary duty to all the stakeholders of the Company.

The interests of such stakeholders have to be placed above the interests of the said Directors, officers and employees. In view of this, this Code lays down that these persons shall deal in the securities of the Company in a manner that does not create any conflict of interest.

Price Bands:

Stock market volatility is generally a cause of concern for both policy makers as well as investors. To curb excessive volatility, SEBI has prescribed a market wide circuit breaker system which brings about coordinated trading halt in all equity and equity derivatives markets nationwide, when the index moves either way by 10%, 15% and 20%.

The movement of either Standard & Poor CNX Nifty or Sensex, whichever is breached earlier, triggers the trading halt. As an additional measure of safety, exchanges have imposed individual scrip wise price bands as high as 20% in some securities. However, in respect of securities for which derivative products are available, a daily price limit of 10% is applicable.

Demat Trading:

Dematerialization has been introduced. “Demat” is a process whereby securities like shares, debentures etc., are converted into electronic data and stored in Computers by a Depository. The securities on Dematerialization appear as balances in depository account. These balances are transferable like physical shares.

Depository functions like a securities bank, where the dematerialized physical securities are traded and held in custody. This facilitates faster, risk free and low cost settlement. Depository is much like a bank and performs many activities that are similar to a bank. At present there are two depositories in India, National Securities Depository Ltd. (NSDL) and Central Depository Services Limited (CDSL).

NSDL carries out its activities through various functionaries called business partners who include Depository Participants (DPs), Issuing corporates and their Registrars and Transfer Agents, Clearing corporations/Clearing Houses etc. NSDL is electronically linked to each of these business partners via a satellite link through Very Small Aperture Terminals (VSATs).

The entire integrated system (including the VSAT linkups and the software at NSDL and each business partner’s end) has been named as the “NEST” [National Electronic Settlement & Transfer] system. The investor interacts with the depository through a depository participant of NSDL. A DP can be a bank, financial institution, a custodian or a broker.

Transacting the depository way has several advantages over the traditional system of transacting using share certificates. Some of the benefits are – Trading in Demat segment completely eliminates the risk of bad deliveries, which in turn eliminates all cost and wastage of time associated with follow up for rectification.

This reduction in risk associated with bad delivery has led to reduction in brokerage to the extent of 0.5% by quite a few brokerage firms. In case of transfer of electronic shares, there is no stamp duty and one also avoid the cost of courier/notarization/the need for further follow-up with the broker for shares returned due to company objection.

The problems associated with certificates lost in transit or share certificates become mutilated or misplaced, are completely eliminated in the demat form. The investor can also receive his bonuses and rights into his depository account as a direct credit, thus eliminating risk of loss in transit.

Banks charge a lower interest charge for loans taken against demat shares as compared to the interest for loan against physical shares. RBI has increased the limit of loans against dematerialized securities as collateral to Rs.2 million per borrower as against Rs. 1 million per borrower in case of loans against physical securities.

RBI has also reduced the minimum margin to 25% for loans against dematerialized securities as against 50% for loans against physical securities. The speed of transaction is very fast. The clients can now do their transactions on the Internet also.

The depositories operate under the Depositories Act, 1996 and SEBI (Depositories and Participants Regulations) 1996. The admission to a depository for dematerialisation of securities has been made a prerequisite for making a public or rights issue or an offer for sale. It has also been made compulsory for public listed companies making IPO of any security for Rs. 10 crore or more to do the same only in dematerialised form. All new IPOs are compulsorily traded in demat form.

Clearing and Settlement of Securities in Secondary Market:

All kinds of securities, debt and equity, government and corporate are traded on exchanges side by side. Trades enjoy counter-party guarantee. The trading cycle shortened to a day and trades are settled within 2 working days, while all deferral products were banned. It is the first major market to have implemented T+2 rolling settlement.

Physical security certificates almost disappeared. The settlement complies with the Committee on Payment and Settlement Systems and International Organisation of Securities Commissions (CPSS-IOSCO) recommendations and the Group of Thirty’s (often abbreviated to G30, an international body of leading financiers and academics which aims to deepen understanding of economic and financial issues) recommendations in letter and spirit.

The trades accumulate over a trading cycle of one day and at the end of the day, these are clubbed together, and positions are netted and payment of cash and delivery of securities settle the balance after two working days. All trades executed on day ‘T’ are settled on T+2 day.

Trades are executed on screen and matched details are linked to settlement system electronically, and hence matching and confirmation of trades for direct participants are instantaneous. All communications relating to securities settlement is fully electronic and automated.

For instance, the clearing agency downloads the obligations and pay-in advices of funds/securities to members electronically through secured networks. It also sends electronic advice to clearing banks and depositories to debit the members’ accounts to the extent of their obligations.

The banks and the depositories debit accounts of members and credit the account of the clearing agency electronically. The reverse happens when the funds/securities are paid out to members. The exchange is connected electronically to the clearing and settlement agency, which in turn is connected electronically to clearing banks, depositories, custodians and members.

The depositories have electronic communication with depository participants, clearing agency, custodians, clients and exchanges. Most of these electronic communications are interactive.

Except at the stage of entering orders into trading system, no data is entered manually or electronically in the entire value chain. No fresh inputting of data takes place at any stage. Data flows seamlessly among the entities viz. from exchanges to clearing agency and from clearing agency to clearing banks, depository, members and custodians.

Once a trade is executed, it has to be settled. There is no way that it can be cancelled. The clearing corporations/houses have been allowed to borrow and settle the trades on behalf of the brokers who fail to deliver securities. Though the largest exchange uses the services of a clearing corporation to clear and settle the trades, all exchanges are being required to transfer these functions to a clearing corporation.