Introduction to the Securities Market — segments, instruments and the IFSC

Where this chapter sits

Chapter 1 carries 5% of the paper — the smallest chapter in Securities Operations and Risk Management. But it lays the vocabulary for the seven chapters after it, so a weak Chapter 1 costs marks well beyond its own weight.

This exam is unusual and you must plan for it: 120 minutes, 100 marks, 50% to pass, and 25% negative marking. Series VII is the only NISM exam that pairs a 50% pass mark with 25% negative marking. Every wrong answer costs a quarter mark. Do the arithmetic before you panic about that: a pure guess among four options averages 0.25 × 1 − 0.75 × 0.25 = +0.0625 marks — slightly positive, but close to a coin-flip. Eliminate first: knock out one option and a guess is worth about +0.17; knock out two and it is worth +0.375.

What financial markets do

The financial markets enable efficient transfer and allocation of financial resources for productive activities in the economy. Users of funds include businesses, governments and households who seek funds to run their activities, and the same three groups also act as providers of surplus funds. Intermediaries such as banks, financial institutions, mutual funds and insurance companies channelize the available surplus funds from lenders to the users.

Their four functions, as the workbook sets them out:

• Aggregation — they provide a way for aggregation of funds from a large number of investors and make it available for productive economic activity. In the absence of financial markets such aggregation may not be possible.
• Efficient pricing — an efficient financial market ensures that the transfer of funds happens at a cost that makes it attractive for savers to save and lend and for users to borrow funds.
• Information — the markets must enable the dissemination of relevant information to all the participants so that the decision on price of funds is made after integrating all available information.
• Liquidity — markets must allow the participants to review their funding decisions given new information and to re-allocate the resources accordingly. Therefore, providing liquidity and exit options are an important function of financial markets.

The financial market comprises of the money market and the securities markets, and can be broadly classified as Capital Market (Securities Market) and Money market.

What counts as a security

The term "Securities" as defined in the Securities Contract Regulation Act (SCRA), 1956 includes:

And the exclusion, which is regularly tested: "Securities" shall not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer.

Why securities markets matter: they help in transfer of resources from those with idle resources or surplus to others who have a productive need for them. More formally, they provide channels for allocation of savings to investments and thereby decouple these two activities — so the savers and investors are not constrained by their individual abilities, but by the economy's abilities to save and invest respectively.

The two segments

The securities market has two interdependent and inseparable segments, viz., the new issues (the primary market) and trading in existing issues (secondary) market.

The primary market is used by issuers for raising capital from the investors by making Initial Public Offers or rights issues or Further Public Offer (FPO) or private placement. It is the market that ensures availability of adequate capital at reasonable rates to finance expansion, diversification or consolidation of companies.

The secondary market provides liquidity to these instruments, through trading and settlement on the stock Exchanges.

The relationship between them is the point: an active secondary market promotes the growth of the primary market and capital formation, since the investors in the primary market are assured of a continuous market where they have an option to liquidate their investments.

And the difference in who deals with whom: in the primary market, the issuer has direct contact with the investor, while in the secondary market, the dealings are between two investors and the issuer does not come into the picture.

Routes in the primary market

Two mediums in the secondary market

OTC markets are the informal type of markets where trades are negotiated. In this type of market, the securities are traded over the counter and settled bilaterally.

The stock exchange route — the Exchange Traded Market / Screen Based Trading System (SBTS) — is where trading and settlement is done through the Stock Exchanges and the buyers and sellers don't know each other. The settlements of trades are carried out as per a fixed time schedule, and the trades executed on the exchange are settled through the clearing corporation, who acts as a counterparty and guarantees settlement.

Who is present in each

Primary market: merchant bankers, mutual funds, financial institutions, Foreign Portfolio Investors (FPIs), individual investors; the issuers including companies, bodies corporate, lawyers, bankers to the issue, brokers, depositories, self-certified syndicate banks (SCSBs) and depository participants. The stock exchanges are involved to the extent of providing platform for primary issuance and listing of the securities.

Secondary market: stock exchanges, clearing corporations, stock brokers, mutual funds/AMCs, financial institutions, FPIs, investment companies, individual investors, depository participants and banks.

Both: the Registrars and Transfer Agents, Custodians and Depositories are capital market intermediaries which provide important infrastructure services to both the primary and secondary markets.

The money market

Money Market is a short-term market and handles instruments from 1 day to 1 year. It is mostly used by Government, Banks and other corporate entities to tide over short-term requirements of funds.

The RBI uses the money market for transmission of its monetary policy direction by changing various Reserve ratios, conducting Open Market Operations, increasing or decreasing of policy rates.

It is typically divided into two segments: (a) borrowing and lending segment with or without collaterals; (b) asset market involving purchase and sale of money market instruments.

Every instrument, with its tenor

On repo mechanics: each repo/reverse repo deal has two parts (or two legs). The repo period (repo tenor) is the time between the two legs. The interest is computed on the actual amount borrowed by the repo seller — the first leg's consideration — and the lender receives the interest in the second leg when the security is bought back by the borrower at a higher consideration that includes the interest. Reverse repo is the exact opposite transaction, which is essentially a collateralized lending of funds.

Two features that make TREPS distinctive: the funds borrowed on TREPS are exempted from RBI's CRR/SLR computation and the security acquired under the deal is eligible for SLR by the acquiring Bank; and unlike Repo, TREPS facilitates the trading of Repo and the seller of the security has a right to substitute the security.

On CP eligibility, there are two groups.

• Companies, including NBFCs and All India Financial Institutions (AIFIs), are eligible to issue CPs subject to the condition that any fund-based facility availed from banks and/or financial institutions is classified as a standard asset by all financing banks/institutions at the time of issue. In plain words: their bank loans must not have gone bad.
• Other bodies need a net worth of ₹100 crore or higher. This group covers co-operative societies/unions, government entities, trusts, limited liability partnerships and any other body corporate having presence in India.

An Issuing and Paying Agent (IPA) shall be appointed for each CP issuance.

On CDs: All India Financial Institutions can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue — longer than a bank's one-year maximum.

Repo in corporate bonds was introduced by RBI in 2010. Eligible collateral: listed corporate bonds and debentures (but participants cannot borrow against the collateral of their own securities or those of related entities), CPs and CDs, units of Debt ETFs, Municipal Debt Securities, and any other security of a local authority as may be specified by the Central Government.

Exchange Traded Tri-party Repo on corporate debt was introduced to improve liquidity in the corporate bond market. AMC Repo Clearing Ltd. (ARCL) is a limited purpose clearing corporation (LPCC) which acts as a tri-party repo agent for corporate debt securities repo, doing clearing and settlement and providing settlement guarantee.

Products in the equity / cash segment

The equity/cash segment of the stock exchange allows trading in shares, government securities, debentures, warrants, mutual funds and exchange traded funds (ETFs).

Equity shares — normally known as ordinary shares, represent the form of fractional ownership in a business venture. Equity shareholders collectively own the company. They bear the risk and enjoy the rewards of ownership. They do not have a maturity date and have variable returns in the form of dividends and capital gains, are entitled to voting rights, and in the event of liquidation of company equities will have last preference. Typically, equity securities are riskier as compared to debt securities.

Preference shares — also commonly known as preferred stock, are a special type of share where dividends are paid to shareholders prior to the issuance of equity stock dividends. Preference shareholders hold preferential rights over equity shareholders when it comes to sharing profits.

Debentures — debt securities which indicate a loan to the company, with a maturity date and a predefined return in the form of interest payments. Debentures in India are typically secured by tangible assets. Three kinds:

• Fully convertible debentures — converted into ordinary shares of the same company under specified terms and conditions.
• Partly convertible debentures (PCDs) — partly converted into ordinary shares, so they have features of both debenture as well as equity.
• Non-Convertible Debentures (NCDs) — pure debt instruments without a feature of conversion, repayable on maturity.

Government securities — also known as "sovereign debt", generally issued via auctions and traded in the secondary market. Government bonds issued in local currency are considered risk free as the Government, being a sovereign entity, can print the currency to repay its obligation to bond holders. The dated securities issued by state government is known as State Government Securities (SGS).

Warrants — entitle an investor to buy equity shares after a specified time period at a given price.

Mutual funds — an investment vehicle that pools money from numerous investors who wish to save or make investments having similar investment objective. One of the main advantages is that they give small investors access to professionally managed, diversified portfolios of various securities which would be quite difficult to create with a small amount of capital. Close ended mutual fund schemes are traded on the equity segment of the Exchange.

Exchange Traded Fund — a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. The main difference between ETFs and other types of index funds is that ETFs don't try to outperform their corresponding index, but simply replicate the performance of the Index. Unlike regular mutual funds, an ETF trades like a common stock on a stock exchange, and the traded price changes throughout the day.

Indian Depository Receipt (IDR) — the workhorse of many exam questions. Foreign companies are not allowed to directly list on the Indian stock exchanges. However, they are allowed to raise capital in Indian currency through an instrument called Indian Depository Receipt.

• An IDR is an instrument denominated in Indian Rupees in the form of a depository receipt created by a Domestic Depository against the underlying equity shares of the issuing company.
• The underlying shares are held by a foreign custodian and the DRs are held in the Indian depository.
• IDRs are listed in the Indian stock exchanges.
• Redemption/Conversion is permitted after 1 year from the date of listing of the IDRs.
• Two way fungibility of IDRs is permitted — the depository receipt can be converted into underlying shares and the underlying shares can be converted into depository receipt, but the number of shares that can be converted into depository receipt should be within the headroom available.
• The headroom is the number of IDRs originally issued minus the number of IDRs outstanding, further adjusted for IDRs redeemed into underlying equity shares.

Derivatives

Derivative is a product whose value is derived from the value of an underlying asset or group of assets — a benchmark. The most common underlying assets are stocks, bonds, commodities, currencies, interest rates, and market indices.

With the Securities Laws (Second Amendment) Act, 1999, Derivatives has been included in the definition of Securities. The SCRA defines derivative as:

• A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security.
• A contract which derives its value from the prices, or index of prices, of underlying securities.
• Commodity derivatives.
• Such other instruments as may be declared by the Central Government to be derivatives.

Section 18A provides that contracts in derivative shall be legal and valid if such contracts are traded on a recognized stock exchange; settled on the clearing house of the recognized stock exchange, in accordance with the rules and bye-laws of such stock exchanges; and between such parties and on such terms as the Central Government may specify by notification in the Official Gazette.

The four products:

The two types of exchange traded derivatives instruments are futures and options. In India, futures and options are traded on equity stocks, equity indices, currency, interest rate and interest rate instruments and commodities.

Equity derivatives and the expiry rules

Currently in the Indian markets, futures and options contracts are available for trading on the benchmark indices such as BSE's SENSEX, MSEI SX40 and NSE's NIFTY 50 and sectoral indices of banks.

SEBI's guidelines on the Final Settlement Day (Expiry Day):

• Expiries of all equity derivatives contracts of an exchange will be uniformly limited to either Tuesday or Thursday.
• Every exchange will continue to be allowed one weekly benchmark index options contract on their chosen day (Tuesday or Thursday).
• Besides benchmark index options contracts, all other equity derivatives contracts — all benchmark index futures, non-benchmark index futures/options, and all single stock futures/options — will be offered with a minimum tenor of 1 month, and the expiry will be in the last week of every month on their chosen day.
• Exchanges will now seek prior approval of SEBI for modifying the settlement day of their derivatives contracts.

Other expiry mechanics: in case the expiry day is a trading holiday, the contracts expire on the previous trading day. A new contract is introduced on the next trading day following the expiry of the near month contract. Monthly index contracts generally have a 3-month expiry cycle, except long dated options contracts which are available up to a 5-year expiry cycle with quarterly expiries (March, June, September, December) and half yearly expiries (June, December). Generally, all option contracts with expiry of more than 9 months shall be treated as long dated/long term option contracts.

The settlement split — memorise it: all Index future and option contracts are cash settled. All stock futures and option contracts are physically settled.

Eligibility of individual stocks is decided by the exchange based on the guidelines and criteria defined by SEBI — such as market capitalization, the median quarter sigma order size, trading volume, delivery volume.

Currency derivatives

Currency Derivatives trading was introduced in the Indian financial markets with the launch of currency futures trading in the USD-INR pair in 2008.

• Currency futures contracts are traded on four INR pairs — USDINR, EURINR, GBPINR and JPYINR — and on three cross currency pairs — EURUSD, GBPUSD and USDJPY.
• Traded on a separate "Currency Derivatives Segment".
• The contract has a maximum of 12 months of trading cycle.
• The expiry day / last day for trading of the monthly contract shall be two working days prior to the last business day of the expiry month at 12.30 pm.
• All these contracts are cash settled.
• The final settlement price for USDINR, EURINR, GBPINR and JPYINR is the FBIL (Financial Benchmarks India Pvt. Ltd.) reference rate. FBIL is an independent benchmark administrator for interest rates and foreign exchange. The final settlement price for cross currency pairs is derived from crossing respective FCY-INR rates.
• For currency options, 3 serial monthly contracts followed by 3 quarterly contracts of the cycle March/June/September/December are available.
• Weekly futures and options are also available for certain currency pairs, generally expiring on the last day of the week, i.e. on Friday at 12:30 pm.

Interest rate derivatives

Interest Rate Futures (IRF) are standardized interest rate derivative contracts 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 rates at a specified future date, at a price determined at the time of the contract. Interest rate options were introduced in 2019.

• Available on single Government of India securities within maturity baskets of 4–8 year, 8–11 year and 11–15 years, 91-day T-Bills and Overnight MIBOR.
• For single bond futures on GOI securities, the lot size is 2000 bonds at ₹100 per bond, i.e. a total face value of ₹2,00,000.
• Three serial monthly contracts followed by three quarterly contracts of the March/June/September/December cycle.
• Last trading day is the last Thursday of the expiry month. If the last Thursday is a holiday, the previous trading day will be the last trading day.
• The final settlement price is the value weighted average price of the underlying bond based on the prices during the last two hours of trading on NDS-OM. If less than 5 trades are executed in the underlying bond during the last two hours, then the FIMMDA/FBIL price shall be used.
• Interest rate futures and options are traded on the Currency Derivatives segment of the Exchange.
• Though SEBI allowed physical settlement for interest rate derivatives products, currently all Interest Rate Derivatives traded on Exchanges are cash settled.

Commodity derivatives

Commodity derivatives facilitate the trading of commodities such as gold, silver, metal, energy and agricultural goods. A commodity derivatives contract can be cash settled or physically settled with actual delivery of commodity. They trade on a separate "Commodity Derivatives Segment" of the Exchange.

The debt market

In India, the debt market is broadly divided into two parts: the government securities (G-Sec) market and the corporate bond market.

Government Securities Market. A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments. It acknowledges the Government's debt obligation. They are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more).

In India, the Central Government issues both treasury bills and bonds or dated securities, while the State Governments issue only bonds or dated securities. G-Secs carry practically no risk of default and hence are called risk-free gilt-edged instruments. The major investors are banks, insurance companies, provident funds, mutual funds, state governments and FPIs.

In the primary market, Government securities and Treasury Bills are issued through auctions (yield based or price based) conducted by RBI. Secondary market trading mainly takes place through Negotiated Dealing System-Order Matching (NDS-OM) of RBI, and G-Secs are also traded in the OTC market, the RBI retail direct portal and Stock Exchanges.

Access to NDS-OM is now available through direct access, indirect access, or Stock Broker Connect — a mechanism through which a stock broker provides access to NDS-OM to its individual constituents/clients maintaining demat accounts with depositories registered with SEBI. SEBI has advised stock brokers that they may participate under a Separate Business Unit (SBU) of the stock broking entity itself.

Corporate Bond Market. A market where debt securities of corporates (non-government entities, municipal corporations) such as corporate bonds and debentures are issued and traded. Corporate bonds are bonds issued by firms to meet their needs for expansion, modernization, restructuring operations, mergers and acquisitions.

The dominant fact: in India, corporate bonds are issued mainly on private placement basis (around 99%) and only a small part of the total issuances are through public offer.

Because of this, SEBI vide its circular of April 21, 2016 facilitated and mandated private placement issuance through the electronic book mechanism / electronic bidding platform (EBP) based on issue size and existence of issuers, for better and transparent price discovery. An issuer may also choose to access the EBP platform for private placement of securitised debt instruments, security receipts, CPs or CDs, and issuers constituted as REITs, SM REITs and InvITs may also access the EBP platform for private placement of units.

The corporate bond secondary market is mainly an OTC market, where the trades are negotiated between the participants on phone or through intermediaries. The exchanges have a corporate bond reporting platform, in which all regulated entities need to report OTC corporate bond trades within stipulated time.

The Request for Quote (RFQ) Platform, launched by the exchanges in early 2020, allows market participants to transact in debt securities, providing a range of options to seek a quote and to respond to a quote, while keeping an audit trail of all the interactions — quoted yield, mutually agreed price, deal terms. This has brought pre-trade transparency in the transactions of eligible debt securities.

Online Bond Platform means any electronic system, other than a recognised stock exchange or an electronic book provider platform, on which the debt securities which are listed or proposed to be listed are offered and transacted. OBPs provide an avenue for investors, particularly non-institutional investors, to access the bond market, and SEBI has mandated OBPPs to register with SEBI as a stockbroker in the debt segment of a recognized stock exchange.

Other asset classes

REITs

"REIT" or "Real Estate Investment Trust" means a person that pools ₹50 crores or more for the purpose of issuing units to at least 200 investors so as to acquire and manage real estate asset(s) or property(ies), that would entitle such investors to receive the income generated therefrom without giving them the day-to-day control over the management and operation.

Under the SEBI (Real Estate Investment Trusts) Regulations, 2014:

Subsequent issues may be by way of follow-on offer, preferential allotment, qualified institutional placement, rights issue, bonus issue, offer for sale or any other mechanism specified by SEBI.

SM REITs were introduced by SEBI in 2024 and differ from traditional REITs primarily in asset size, minimum investment requirements, and investment structure. Unlike regular REITs, a single SM REIT can launch multiple schemes, each holding different assets, similar to mutual funds. The minimum subscription amount is ₹10 lakhs.

InvITs

Under the SEBI (Infrastructure Investment Trusts) Regulations, 2014, InvITs invest in the infrastructure sector and can raise funds through public issue and/or through private placement.

In a private placement it shall be done through a placement memorandum and from institutional investors or body corporates only, whether Indian or foreign. It shall be mandatory for units of all InvITs to be listed on a recognized stock exchange having nationwide trading terminals, whether publicly issued or privately placed. No InvIT shall raise funds through public issue if any subordinate units have been issued and are outstanding.

Sovereign Gold Bonds

Launched in 2015 to provide an alternative way for investors to take exposure to gold as an investment.

• SGBs are government securities denominated in grams of gold, issued in denomination of one gram of gold and in denominations thereof.
• The tenor of the bond is 8 years.
• Each bond investor buys the bonds in Indian rupees and on redemption is paid the maturity value also in Indian rupees. The units (grams) of gold bought by the investor and represented by the bonds is protected.
• The bonds bear an interest rate (currently 2.50% per annum) on the initial investment, paid semi-annually.
• Available for investment by resident individuals, HUFs, Trusts, Universities, Charitable Trusts and others.
• Can be held in physical form or in dematerialized form, and the bond is tradable on stock exchanges if held in dematerialized form.

Rights Entitlement trading

Rights Entitlement is the right given to eligible shareholders to apply for new shares in a rights issue, in proportion to their existing shareholding. They are mandatorily credited to the demat accounts of eligible shareholders as on the record date in an electronic, dematerialised form, and a separate ISIN is created for the REs to distinguish them from the main shares.

REs are traded on the secondary market platform of stock exchanges similar to regular equity shares. This allows existing shareholders to sell their entitlements if they do not wish to subscribe to the additional shares, or for other investors — even those not existing shareholders — to buy them.

The International Financial Services Centre

An International Financial Services Centre (IFSC) caters to customers outside the jurisdiction of the domestic economy. These centres are 'international' in the sense that they deal with the flow of finance and financial products/services across borders, including banking, insurance, asset management, and most importantly, a well-structured and fully developed capital market for debt, equities, commodities as well as derivatives.

An IFSC is a jurisdiction that provides world class financial services to non-residents and residents, to the extent permissible under the current regulations, in a currency other than the domestic currency (Indian rupee) of the location where the IFSC is located.

The first IFSC in India has been set up at GIFT City, Gandhinagar, Gujarat.

Its legal status is worth memorising precisely: IFSC at GIFT, Gandhinagar is a deemed foreign territory dealing in foreign currency, governed by statutory authority, the International Financial Services Centers Authority (IFSCA) established in 2020. The entities in IFSC are recognized as non-resident entities under the FEMA regulations of the Reserve Bank of India.

The tax position: units operating within the IFSC enjoy significant tax incentives, including a 10-year income tax holiday within a 15-year block. Investors benefit from exemptions on capital gains tax, Securities Transaction Tax (STT), and GST on offshore services.

Direct listing abroad. The "Direct Listing of Equity Shares of Companies Incorporated in India on International Exchanges Scheme" is specified in Schedule XI of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, and provides an overarching framework for issuing and listing of equity shares of public Indian companies, both listed and unlisted, on international exchanges. Prior to this, Indian companies were not allowed to issue or list equity shares abroad. It operates in accordance with the IFSCA Act, 2019 and the IFSCA (Issuance and Listing of Securities) Regulations, 2021.

What may be dealt in on an IFSC exchange, per the SEBI (IFSC) Guidelines, 2015:

• Equity shares of a company incorporated outside India.
• Depository receipts.
• Debt securities issued by eligible issuers.
• Currency and interest rate derivatives.
• Index based derivatives.
• Commodity derivatives.
• REITs and InvITs by whatever name called in permissible jurisdictions.
• Any other securities as may be specified by SEBI.

Currently NSE and BSE both have exchanges at IFSC, offering Index derivatives, Stock Derivatives, Currency Derivatives, Commodity Derivatives and Debt Securities.

Who may deal in securities listed in IFSC:

• A person not resident in India.
• A non-resident Indian.
• A financial institution resident in India who is eligible under FEMA to invest funds offshore, to the extent of permitted outward investment.
• A person resident in India who is eligible under FEMA to invest funds offshore, to the extent allowed under the Liberalized Remittance Scheme of the Reserve Bank of India, subject to a minimum investment as specified by the Board.

For brokers: SEBI has done away with the requirement of obtaining specific approval to undertake securities market related activities in GIFT-IFSC. Stock brokers are permitted to do so under a Separate Business Unit (SBU) of the stock broking entity itself, these activities can also be carried out if the branch qualifies as an SBU, and the existing practice of carrying out such activities through a subsidiary is also allowed.

IFSCA has also issued operating guidelines to enable the Bullion Exchange, Bullion Clearing Corporation, Bullion Depository and Vault Manager in the IFSC, under the IFSCA (Bullion Exchange) Regulations, 2020.