Introduction to the Indian Capital Market — the two segments, five laws and four regulators

Where this chapter sits

Chapter 1 carries 5% of the paper. It is the shortest substantive chapter and almost entirely conceptual — three lists, learned properly, cover it.

The three lists are: the participants in each market segment, the five legislations, and the four regulators.

1.1 Why securities markets exist

Transfer of resources from those with idle resources to others who have a productive need for them is perhaps most efficiently achieved through the securities markets.

Stated formally: securities markets provide channels for allocation of savings to investments and thereby decouple these two activities.

And the consequence of that decoupling: 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.

That is the whole economic case in one sentence. A person with money need not have a business idea, and a person with a business idea need not have money. The market lets each rely on the economy's capacity rather than their own.

Who is in it: a financial market consists of investors (buyers of securities), borrowers (sellers of securities), intermediaries and regulatory bodies.

1.2 The capital market — two segments

The capital market has two interdependent segments, the primary market (new issuers) and secondary market (stock market).

The primary market is used by issuers for raising fresh capital from the investors by making initial public offers or rights issues or offers for sale of equity or debt.

On the other hand, the secondary market provides liquidity to these instruments, through trading and settlement on the stock exchanges.

And the crucial link between them: 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.

In plain words: people buy new shares because they know they can sell them later. The secondary market is that exit.

Read that carefully, because it is a favourite exam sentence. Nobody would subscribe to an IPO if there were no way out afterwards. The secondary market is what makes the primary market possible — which is why the two are called interdependent.

Who plays where

Notice what appears only in the primary list — merchant bankers. And what appears only in the secondary list — stock exchanges and stock brokers.

Four participants sit in both: mutual funds, financial institutions, FPIs and individual investors.

And a third group serves 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.

That last sentence is where this chapter connects to the rest of the workbook — the depository is infrastructure for both segments.

1.3 The five legislations

The securities market transactions are subject to regulations under the four main legislations viz.:

The workbook says "four main legislations" and then lists five — the PMLA being the addition. Learn all five.

SEBI Act, 1992

The SEBI Act, 1992 vests SEBI with statutory powers for:

• (a) protecting the interests of investors in securities market.
• (b) promoting the development of the securities market.
• (c) regulating the securities market.

Three functions — protect, promote, regulate.

Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities and all intermediaries and persons associated with securities market.

It can conduct enquiries, audits and inspection of all concerned and adjudicate offences under the Act. It has powers to register and regulate all market intermediaries and also to penalise them in case of violations of the provisions of the SEBI Act, Rules and Regulations.

SEBI has full autonomy and authority to regulate and develop an orderly securities market.

Securities Contracts (Regulation) Act, 1956

The SC(R)A, 1956 provides for direct and indirect control of virtually all aspects of securities trading and the running of stock exchanges and aims at preventing undesirable transactions in securities.

Three heads of jurisdiction. It gives the central government and SEBI regulatory jurisdiction over:

• (a) stock exchanges through a process of recognition and continued supervision.
• (b) contracts in securities.
• (c) listing of securities on stock exchanges.

On recognition: as a condition of recognition, a stock exchange complies with prescribed conditions from the central government. Organised trading activity in securities takes place on a specified recognised stock exchange.

On listing: the stock exchanges determine their own listing regulations which have to conform to the minimum listing criteria set out in the Securities Contracts Rules.

Each exchange writes its own listing rules, but within a floor set centrally.

Depositories Act, 1996

The Depositories Act, 1996 provides for the establishment of depositories in securities market with the objective of ensuring free transferability of securities with speed, accuracy and security by:

• (a) making securities freely transferable subject to certain exceptions.
• (b) dematerialisation of the securities in the depository mode.
• (c) providing for maintenance of ownership records in a book entry form.

The purpose in five words: speed, accuracy and security — and free transferability.

In order to streamline the settlement process, the Act envisages transfer of ownership of securities electronically by book entry.

And note what the Act took away from companies: the Act has made the securities of all companies freely transferable in the depository mode, restricting the company's right to use its discretion in effecting the transfer of securities. The other procedural and the transfer deed requirements stated in the Companies Act have also been dispensed with.

No transfer deed, and no company discretion. Those two changes are what made electronic settlement possible.

Companies Act, 2013

The Companies Act 2013 deals with issue, allotment and transfer of securities and various aspects relating to company management.

The Act provides for standard disclosures 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.

And: Act also provides for Insolvency and NCLT/NCLAT provisions.

Prevention of Money Laundering Act, 2002

The PMLA 2002 is a Central Act to prevent money laundering and to provide for confiscation of property derived from money laundering.

Laundering means making dirty money look clean. The law tries to stop it.

What anti-money laundering means: a set of procedures, laws or regulations designed to stop/curb the practice of generating income through illegal actions/criminal activity such as drug trafficking, terrorist funding and bringing the same into mainstream making it appear to have come from a legitimate source.

And its direct effect on a DP's daily work: KYC Guidelines have been introduced in the Capital Market based on this Act.

The record-keeping and reporting duty: this Act requires all the Market participants, Intermediaries and other institutions connected therewith, to maintain a record of all the transactions done through them and to monitor and report suspicious transactions to Financial Intelligence Unit (FIU), Government of India.

FIU — Financial Intelligence Unit, Government of India. That is where suspicious transaction reports go.

1.4 The regulators

The responsibility for regulating the securities market is shared by the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), the Department of Economic Affairs (DEA) of the Ministry of Finance, Ministry of Corporate Affairs (MCA).

Four bodies, one market.

Coordination

In 2010, the Financial Stability and Development Council (FSDC) replaced the High Level Coordination Committee on Financial Markets (HLCCFM) which was earlier facilitating regulatory coordination among the above agencies, though informally.

The secretariat of HLCCFM was in Ministry of Finance (Capital Market Division, Department of Economic Affairs).

FSDC replaced HLCCFM in 2010 — a date and a pair of acronyms worth memorising exactly.

Appeals

The orders of SEBI under the securities laws are appealable before a Securities Appellate Tribunal.

How the powers divide

Under the SCRA: most of the powers under the SCRA are exercisable by DEA while a few others by SEBI. The powers of the DEA under the SCRA are also concurrently exercised by SEBI.

RBI shares some powers too. "Concurrent" simply means two bodies hold the same power at the same time.

RBI's concurrent powers: the powers in respect of the contracts for sale and purchase of securities, gold related securities, money market securities and securities derived from these securities and ready forward contracts in debt securities are exercised concurrently by RBI.

Note the four items in RBI's concurrent list — securities generally, gold related securities, money market securities and securities derived from these, plus ready forward contracts in debt securities.

SEBI's own statutes: the SEBI Act and the Depositories Act are mostly administered by SEBI.

Rules versus regulations — a distinction the exam likes: the rules under the securities laws are framed by the government and regulations by SEBI, and all these are administered by SEBI.

Rules come from the government; regulations come from SEBI; SEBI administers both.

Under the Companies Act: the powers under the Companies Act relating to issue and transfer of securities and non-payment of dividend are administered by SEBI in case of listed public companies and public companies proposing to get their securities listed.

So SEBI, not the MCA, handles those particular powers — but only for listed companies and those proposing to list.

And the self-regulatory layer: the SROs ensure compliance with their own rules as well as with the rules relevant for them under the securities laws.