Securities Markets — the ground floor

What a securities market does

Households have savings. Businesses need capital. The securities market is the regulated bridge between the two.

A business issues securities, raises money through a regulated contract, lists them on a stock exchange so they stay liquid, and keeps disclosing its performance. Money flows from households to business, inside an institutional framework.

Without such a market, a family willing to take some risk might have no choice but a bank deposit. With it, they can pick equity or fixed income at the risk level that suits them. The workbook's point: the objectives of issuer and investor are complementary, and the market lets both be met.

The market in which securities are issued, bought by investors and later transferred among investors is the securities market.

What counts as a "security"

The definition is in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA). It includes:

• Shares, scrips, stocks, bonds, debentures, debenture stock and similar marketable securities of a company, pooled investment vehicle or body corporate
• Derivatives
• Units of a collective investment scheme
• Security receipts under the SARFAESI Act, 2002
• Mutual fund units — but not unit linked insurance policies (ULIPs)
• Units of any pooled investment vehicle
• Certificates issued by a special purpose distinct entity holding debt or receivables, including mortgage debt
• Government securities
• Instruments declared by the Central Government — including onshore rupee bonds of multilateral institutions such as the Asian Development Bank and the International Finance Corporation, electronic gold receipts, and zero coupon zero principal instruments
• Rights or interest in securities

The workbook notes the derivatives definition was amended by the Finance Act 2017 and includes commodity derivatives.

A security carries rights for the investor: ownership, participation in management, or claims on assets.

Primary and secondary markets

The two segments are interdependent and inseparable.

• Primary market — also the new issue market. Issuers raise capital by issuing securities for the first time. It creates financial assets.
• Secondary market — trades in already-issued securities. Investors can exit, and new investors can buy in. It gives assets marketability.

In the primary market, issuers deal directly with investors. In the secondary market, dealings are between investors only. An active secondary market helps the primary market grow, because primary investors know they can exit.

Ways to issue securities

To the public

Public issue — open to any eligible member of the public. Primarily a retail issue.

IPO — the first sale of a company's shares to investors at large. Main purpose: raise equity for growth. SEBI's eligibility rules cover net tangible assets, profitability and net worth, plus timelines, mandatory listing on a nationwide exchange, and issue in demat form.

FPO — an already listed company makes a fresh issue or an offer for sale to the public. Used for growth capital, to restructure by retiring debt, or — through an offer for sale — to raise public shareholding to meet regulatory requirements.

To existing shareholders

Rights issue — shares offered to existing shareholders in proportion to their holding. They have a pre-emptive right. They may subscribe fully, partly, or not at all.

Bonus issue — shares to existing shareholders without any consideration. A 1:3 bonus means 1 bonus share for every 3 held. Rules:

• Made out of free reserves built from genuine profits
• Not allowed if the company has defaulted on interest or principal on debt securities or fixed deposits
• Needs board approval; in some cases shareholder approval too
• Once announced, cannot be withdrawn
• All shareholders on the record date are entitled

To a select group

Private placement — to a select group, neither rights nor public. Primarily a wholesale issue to institutions. Per the Companies Act 2013 as quoted in the workbook, an offer to less than 200 persons. SEBI's public issue requirements do not apply. A privately placed security can be listed if it meets SEBI and exchange listing requirements. A company can do this whether or not it has made a public offer.

Preferential issue — a listed issuer issues shares or convertibles to a select group (promoters or non-promoters), complying with SEBI rules on pricing, disclosure and lock-in, plus the Companies Act.

Qualified Institutions Placement (QIP) — a private placement by a listed company to Qualified Institutional Buyers (QIBs) — financial institutions, mutual funds, banks and others. SEBI sets eligibility, quantum and pricing.

The workbook stresses: QIP and preferential allotment are different processes, addressing different investors in different contexts.

Special cases

Offer for Sale (OFS) — shares in an IPO or FPO that are not fresh shares, but existing shares sold by existing shareholders (promoters or large investors). No increase in share capital. Proceeds go to the sellers, not the company. Government disinvestment of PSU shares is an example. The workbook's line: OFS is a secondary market transaction done through the primary market route.

Onshore vs offshore — capital from the domestic market is onshore; from investors outside the country is offshore.

ESOP — lets employees own a small stake as an incentive. Options are exercisable after a lock-in, generally more than one year. The date employees become entitled to exercise is the vesting date. Vesting can be full or partial.

FCCBs — foreign currency (usually dollar) debt raised abroad, with an option to convert into equity before maturity. Interest and principal are paid in foreign currency. The conversion price is usually at a premium to market price. FCCBs let companies borrow at lower rates abroad, and can be quicker than pure foreign debt. A company not eligible to raise equity domestically is not eligible for FCCBs either. Unlisted companies raising FCCBs must list their shares domestically within a stipulated time. Regulated by RBI notifications under FEMA, 1999, with the 1993 scheme for FCCBs and depository receipts laying down guidelines.

Depository receipts — instruments representing shares of a local company but listed abroad, usually in dollars. Shares are lodged with a custodian bank, which authorises the DRs.

Anchor investor — introduced by SEBI in 2009. A QIB applying for ₹10 crore or more in a book-built public issue under the ICDR Regulations. Anchor demand signals the soundness of the offer and gives a benchmark for pricing and QIB interest.

How the secondary market works

Two segments:

• OTC market — trades negotiated and settled directly between counterparties. Each side manages its own credit risk.
• Exchange-traded market — trading and settlement through the exchange, settled by a clearing corporation that guarantees settlement to buyers and sellers.

Trading is the formal contract to buy or sell. Indian exchanges use electronic order matching.

Clearing works out the net obligations of buyers and sellers for a period. Settlement is the next step — paying money (buyers) or delivering securities (sellers).

The clearing corporation gives members an obligation report; missing deadlines means penalties. It provides full novation — it becomes buyer to every seller and seller to every buyer. That substantially reduces operational risk for the trading investor.

Risk management. Guaranteeing every trade exposes the clearing corporation to default. It protects itself with margins:

• Initial (upfront) margin — a percentage of transaction value, based on Value at Risk
• Mark-to-market (MTM) margin — the notional loss an open trade has suffered from price movements over a period

Market infrastructure and intermediaries

Who can be a DP? Public financial institutions, scheduled commercial banks, foreign banks operating in India with RBI approval, state financial corporations, custodians, stock brokers, clearing corporations, NBFCs, and Registrars and Share Transfer Agents — if they meet SEBI's requirements.

Brokers. Can be individuals, partnership firms or corporate bodies. SEBI registers them based on office space, equipment, manpower and experience. SEBI ensures capital adequacy by requiring a base minimum capital deposit and capping gross exposure at a multiple of it.

Sub-brokers. By SEBI circular dated August 3, 2018, all registered sub-brokers had to migrate to act as an Authorised Person and/or Trading Member.

Custodian functions: maintain the client's securities and funds account; collect benefits or rights accruing on securities; keep the client informed of actions on the portfolio.

Hard vs soft underwriting.

• Hard underwriting — commitment at the initial stages of the IPO. If investors do not subscribe, the underwriter must bring in the money.
• Soft underwriting — commitment given once pricing is determined. Devolved shares are usually placed with other financial institutions. Comes with an exit clause for certain events.
• Hard underwriting carries much higher risk.

Institutional participants

• Mutual funds — professionally managed collective schemes; a fund manager with a research team decides.
• Pension funds — pool retirement contributions from employees and employers (or employees only); aim for stable long-term growth and retirement income.
• Insurance companies — huge corpus; among the most important investors in the Indian economy.
• AIFs — under the SEBI (AIF) Regulations 2012: Venture Capital, Angel, Private Equity, Debt, Infrastructure, SME, Hedge and Social Venture Funds.
• FPIs — entities established or incorporated outside India investing in India; must register with SEBI.
• EPFO — statutory body under the Employees' Provident Funds & Miscellaneous Provisions Act, 1952, under the Ministry of Labour and Employment. The workbook says that from 2015 EPFO is allowed to invest up to 15% of incremental deposits in equity or equity-related schemes, and that it does not invest in shares of individual companies.
• NPS — pension-cum-investment scheme, regulated by PFRDA, a defined contribution system. For the Central Government, effective January 1, 2004. Non-government categories: Corporate Sector and All Citizens of India. Invests in equity, corporate bonds and G-Secs.
• Family offices — the ecosystem a family builds to manage its wealth; serve multiple generations of ultra-HNI households.
• Corporate treasuries — increasingly seen as profit centres; traditionally managers of financial risk and liquidity.

The workbook's footnote on pensions: the government moved from defined benefit (same pension by rank, no employee contribution) to defined contribution (employee and employer contribute; pension depends on the fund built up).

Retail participants

Individuals buying and selling for their own account. Under SEBI ICDR Regulations, 2018, a retail individual investor applies for specified securities for not more than ₹2 lakh.