FINANCIAL MARKETS

FINANCIAL MARKETS

To prepare for INDIAN ECONOMY for any competitive exam, aspirants have to know about the Financial Markets. It gives an idea of all the important topics for the IAS Exam and the Economy syllabus (GS-II.). Important Financial Marketsterms are important from Economy perspectives in the UPSC exam. IAS aspirants should thoroughly understand their meaning and application, as questions can be asked from this static portion of the IAS Syllabus in both the UPSC Prelims and the UPSC Mains exams.

Financial market refers to a place where buyers and sellers participate in the trade. It is platform that facilitates traders to buy and sell financial instruments/securities.

 

Importance	Helps in acceleration of economic growth of country Helps savers to become investors Helps businesses to raise money/capital to expand their businesses.
Functions	Price determination and discovery Mobilization of funds Capital formation Ensures liquidity Saves time and money Determines capital formation rate

 

Important Definitions :

Money Markets	Market for overnight to short-term funds and instruments having a maturity period of 1 or less than 1 year.
Capital Market	Market for long-term funds–both equity and debt–that have maturity period greater than year
Equity Market	Market where equities (stocks)are traded or issued
Debt Market/Fixed Income Markets	Market where debt instruments (bonds, debentures, etc) are issued or traded
Securities	A ‘Security’ means a certificate/document indicating that its holder is eligible to receive a certain amount of money at a particular time. This could be a debt (bond/debenture) or equity (Share certificates)

Types of financial (or securities) market

Tenure	Money Market (for period of less than 1 year of maturity) Capital Market (one year or above maturity)
Freshness	Primary Market (where new securities are issued for the first time). Helps a company /government to connect with the investor. It has no separate physical existence but classified as such for economic analysis. Secondary Market (where the old securities are resold). It has physical existence such as Bombay Stock Exchange (BSE) at Dalal Street, Mumbai. Provides liquidity & confidence to investors to buy new securities in Primary Market.
On the basis of Settlement	Future Market – Where parties write contract today to buy/sell something at specific price on a future date Spot Market – if bought & sold for immediate delivery.
Asset	Depending on what asset is traded, market can be divided into Bond (Debt) market, Share (Equity) market, Gilt-Edged Securities Market, Foreign Currency Market, Commodity Market etc. If there was a supermall where all these products were available in one place it will be called “Universal Exchange”. SEBI permitted BSE & NSE to launch such thing (2018).
Nature of claims	Equity market Debt market

Financial Market Money Market Capital Market Debt Equity

 

 

Money Market	Capital Market
Short Term, less than 365 days Short term fixed income instruments are traded. ex. T-Bills, bill of exchange, promissory notes, call money etc Players involve financial companies, banks, central bank, Government, chit funds etc (limited players) Informal in nature and over the counter More liquid Low Risk Maintains liquidity in businesses (mainly financial system) Regulated by RBI	Long Term in Nature Long term debt instruments or equity is traded ex. Bonds, debentures, equity shares etc Players involve banks, listed companies, brokers, insurance companies, underwriter, stock exchanges, investors etc More formalized, generally exchange traded Less Liquid High Risk Creates investments and maintains stability in market Regulated by SEBI

 

Debt	Equity
Bonds Fixed Income/Interest Principle has to be returned No Ownership Loss Considered Less Risky Short and Long Term Higher Preference while liquidation	Shares Variable Income/Dividends Nothing returned Ownership loss Considered more risky Only Long Term Lower Preference while liquidation

 

DEBT INSTRUMENTS

• Debt Market deals with Bonds/Debentures
• Debt instruments are creditors to company. This instruments facilitates and ensures the first claim during liquidation of an asset.
• These instruments accrues assured interest irrespective of profit of company. These debt instruments can be classified into –

DEBT INSTRUMENTS Short-term Long-term

Short term debt instruments

• Short-term debt, also called current liabilities, is a firm’s financial obligations that are expected to be paid off within a year.
• Tenure for short term debt instruments are less than 1 year.
• Short term debt instruments are usually ‘unsecured’ because not backed by any asset.
• These instruments usually sold at discount and re-purchased at Par value/Face value.
• The difference between these two prices is the interest earned by investor. Another synonym for this process: “rediscount the bills.”
• Short term debt instruments are traded at Money Market and are (usually) ‘negotiable and transferable’ in nature i.e. lender can sell to third party, and third party can demand money from borrower.
• Near Money is an asset that is highly liquid and can be readily converted into cash.

 

Borrower	Short term debt instrument
Government	State govt’s treasury bills (14 days). However it was stopped since 2001. Union govt’s treasury bills (91, 182 and 364 days) Cash Management bills (CMB: upto 90 days, started in 2009) – Issued by RBI on behalf of GOI to meet the temporary mismatches in the cash flow of the Government. Issued at a discount and redeemed at face value at maturity. Investment in CMB’s is also counted in investments for SLR. WMA (ways and means advances): It is the mechanism through which RBI lends money to Govt, for temporary short term needs when there is mismatch in receipt and expenditure of Govt. This WMA is not counted in Fiscal Deficit formula.
Company	Bill of Exchange– A bill of exchange is defined as an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument. Hundi – A Hundi is written order made by a person directing another to pay a certain sum of money to a person named in an order – bearer of the communication. Commercial Papers – CP is issued by a corporation, also called unsecured promissory note since the issuer makes a promise to pay back the face value after the maturity period but that promise is unsecured. CP is issued at a discount to face value. Promissory Notes – A promissory note is a legal, financial tool declared by a party, promising another party to pay the debt on a particular day. It is a written agreement signed by drawer with a promise to pay the money on a specific date or whenever demanded. Currency Note is a ‘Promissory Note’ issued by RBI Governor however, he is not bound to pay any interest. Just promises to exchange it with other currency notes and coins of equal face value.
Merchant to bank	Commercial Bill – CBs are drawn by the seller (drawer) on the buyer (drawee) for the value of goods delivered by him. These Bills are of 30 days, 60 days or 90 days maturity. If the seller is in need of funds before the maturity date, he can also approach the bank to accept the bill.
Banks / NBFC	Certificate of Deposits – A type of tradable Certificate against time deposit issued by Commercial Banks and Financial institutions. CD is tradeable and transferable. Offers slightly higher yield than T-Bills due to risk of default present in case of banks. CDs are issued by banks during periods of tight liquidity, at relatively high interest rates. Banks resort to CD when the deposit growth is sluggish but credit demand is high.
Call Money	Call Money is required mostly by Financial Intermediaries (Banks/Non-Banks) to borrow money without collateral from other banks to maintain a minimum cash balance known as CRR(Cash Reserve Ratio). Under call money market, funds are transacted on overnight basis. An over-the-counter (OTC) market without the intermediation of brokers.
Notice Money	Under notice money market, funds are borrowed/lent for a period between 2-14 days.
LIBOR	London Inter-Bank Offered Rate (LIBOR) is the average interest rate at which banks in London give short term loans to each other. It serves a benchmark, using which Global banks decide their call money /notice money rates.
MIBOR (Mumbai Inter-Bank Offer Rate)	NSE developed and launched the NSE Mumbai Inter-Bank Bid Rate (MIBID) and Mumbai Inter-Bank Offer Rate (MIBOR) for the overnight money market in 1998. The MIBID/MIBOR rate is use as benchmark rate for majority of the deals.
CBLO (Collateralized Borrowing and Lending Obligation)	Clearing Corporation of India Ltd (CCIL) helps Financial Intermediaries (FI) to get short term loans through this instrument.
Repo and Reverse Repo	Repo – It is an instrument for borrowing funds by selling securities with an agreement to repurchase the securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed. Reverse Repo – It is an instrument for lending funds by purchasing securities with an agreement to resell the securities on a mutually agreed future date at an agreed price which includes interest for the funds lent. Used for absorption of liquidity.
TReDS (Trade Receivables Electronic Discounting System)	An online mechanism. MSME sellers pledge their (unpaid) invoices made to corporates → MSME receive (short-term) finance from Banks and NBFCs. Budget-2019 – we will make amendments in Factoring Regulation Act, 2011 to allow all NBFCs to directly participate on the TReDS platform.

 

Q. Find Correct statements:(CSE-2018) The Reserve Bank of India manages and services Government of India Securities, but not any State Government Securities. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments. Treasury bills offer are issued at a discount from the par value. Ans Codes: (a) 1 and 2 only (b) 3 only (c) 2 and 3 only (d) 1, 2 and 3

 

Long Term Debt Instruments

• Long Term Debt Instruments have tenure 1 year or above. Further sub-division based on who is the Borrower.

 

Methods by Colonial era Govt. to borrow money :

Coupon Bonds	Contain detachable coupons. Coupons are presented to the issuer to claim the interest. Therefore, bond interest rate is also called ‘coupon rate’.
Zero Coupon Bonds	These bonds are sold on discount and repurchased at face value, do not have any coupons.
Bearer Bonds	Not linked to a PAN card, Aadhar card or passport, voter card or social security number. Anyone who presents it to the issuer, will get interest and principal. Usually issued during the war time.

 

Modern methods to borrow money

• Dated Securities – Dated G-Sec are long term securities or bonds of the government that carries a fixed or floating coupon (interest rate).
• Government Securities – G-Sec are financial instruments and securities issued by a government towards raising a loan from the public. It is also called Gilt Edged Securities because repayment is assured by Government. (But then, they give lower interest rate because of low risk to the investor).
• Sovereign bonds – It is a specific debt instrument issued by the government. They can be denominated in both foreign and domestic currency.
• Global Credit Rating Agencies gives ‘rating’ to sovereign bonds. “AAA” is the best and highest given to US Treasury Bonds. India’s rating is ~“BAA” which implies moderate risk of default.
• World’s top three credit rating agencies – Fitch, Moody’s and Standard & Poor have pro- US/EU allegiance. Critics allege these 3 agencies do not give adequate upgradation to the Govt bonds of India, China, Russia despite the economic growth.
• Pertaining to above issues, India has proposed the BRICS group to set up its own independent credit rating agency.

 

Bonds by Govt. to Reduce Gold Consumption (so import)

• Real Interest Rate is Nominal Interest minus Inflation. When Real Interest is negative, purchasing power decrease despite increase in money quantity in bank account. Then people prefer to park money in gold/real estate- which is not very beneficial to economy.

 

Inflation Indexed Bonds	RBI launched in 1997, 2013, 2018 to provide positive real interest rate to household, thereby reducing the Gold consumption & Current account Deficit (CAD) & weakening of rupee against dollar.
Sovereign Gold Bond (2015)	They are denominated in gold grams. Annual interest 2.5-2.75% (depending on which year you bought), and after 8 years you get the amount equivalent to prevailing gold prices at that time.

 

Long term debt instruments by Companies:

Bonds (British Term)	Debentures (American Term)
A financial instrument showing the indebtedness of the issuing body towards its holders.	A debt instrument used to raise long term finance.
Generally secured by collateral	Can be secured or unsecured
Low interest rates	High rate of interest
Issued by Govt. financial institutions and corporations, etc.	Issued by companies.
SIMILARITIES
Source of debt finances
Periodical payments

 

Junk Bonds	A junk bond is debt that has been given a low credit rating by a ratings agency, below investment grade. As a result, these bonds are riskier since chances that the issuer will default or experience a credit event are higher. The Credit Rating Company will mark it as Junk Bonds (“BB to D” Grade) e.g. IL&FS. Such company will have to offer a very high interest rate when issuing bonds next time.
Redeemable Bonds	Will repay regular interest and will return principal on maturity.
Irredeemable Bonds	Will pay only interest but no principal returned. Sometimes issued by PSB to meet BASEL-capital requirements. Although in reality they offer ‘redemption’ after 5-10 years when holder has ‘option’ to redeem principal & exit.
Non-convertible Bond/Debenture	Cannot be converted into shares.
Hybrid instruments	Issued as “Bond” but can be converted into Share. E.g. Optionally Fully Convertible Debentures (OFCD).

 

Other issuers of Long Term Debt Instruments

Issuers	Objective
Urban Local Bodies	Urban Local Bodies Issue Municipal bonds to borrow money from public.
BRICS Bond	2014- BRICS Nations had setup the New Development Bank (NDB, HQ: Shanghai, China). Later it launched BRICS Bonds to mobilize money for its infrastructure loans. (Denomination in US Dollars)
World Bank	2018: launched world’s first Blockchain Offered New Debt Instrument called Bond-i. Sold in Australia using ETHEREUM blockchain technology. Local Manager: Commonwealth Bank of Australia (CBA) Tenure of 2 years at ~ 2% interest. Denomination in Australian Dollars, hence also called “Kangaroo Bond”.

 

Other Long term debt instruments:

Masala Bonds

• Masala Bonds are rupee-denominated bonds, i.e, the funds would be raised from overseas market in Indian rupees.
• World Bank’s sister agency International Financial Corporation (IFC) launched ‘Masala Bonds’ to help Indian public sector and private sector companies.
• According to RBI-
• Any corporate and Indian bank is eligible to issue rupee denominated bonds overseas.
• The money raised through such bonds cannot be used for real estate activities other than for development of integrated township or affordable housing projects.
• It also cannot be used for investing in capital markets, purchase of land and on-lending to other entities for such activities as stated above.
• The rupee denominated bonds can only be issued in a country and subscribed by a resident of such country that is a member of the financial action task force (FATF) and whose securities market regulator is a member of the International Organisation of Securities Commission.
• The minimum maturity period for masala bonds raised up to rupee equivalent of USD 50 million in a financial year should be 3 years and for bonds raised above USD 50 million equivalent in INR per financial year should be 5 years.

2015	RBI allowed Indian entities to launch such Masala Bonds.
2019	Kerala became the first state to issue Masala Bonds. Its Kerala Infrastructure Investment Fund Board (KIIFB) issued Masala Bond at the London Stock Exchange.

 

Q. With reference to `IFC Masala Bonds’, sometimes seen in the news, which of the statements given below is/are correct? (CSE-2016) The International Finance Corporation, which issues them, is an arm of the World Bank. They are the rupee-denominated bonds and are a source of debt financing for the public and private sector. Answer Code: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither1 nor 2

Panda Bonds

• Panda bonds are Chinese Renminbi (yuan) -denominated bondsfrom a non-Chinese issuer, sold in the People’s Republic of China.
• The first two Panda bonds were issued in October 2005 by the International Finance Corporation and the Asian Development Bank on the same day.

 

Kangaroo Bonds

• A kangaroo bond is a type of foreign bondissued in the Australian market by non-Australian firms and is denominated in Australian currency.
• The bond is subject to the securities regulations of Australia. A kangaroo bond is also known as a “matilda bond.”

Maharaja Bond

• Better rating than Govt of India bonds but lower interest rate.
• It is Rupee denominated bond.
• Tenure is 5 / 10 years.
• Issued within India’s domestic financial market.

 

Long Term Debt Instruments – Special purpose Bonds

Elephant Bonds (Proposed)

• A High Level Advisory Group on Trade Policy (HLAG) headed by Surjit S Bhalla (Committee ‘to improve India’s share in global trade’) has recently suggested the govt. to issue ‘Elephant Bonds’.
• This will help India to recover up to $500 billion of black money that is stashed overseas.
• An Elephant Bond is a Rupee denominatedbond with 25 years maturity; and its fund is to be used exclusively for
• The committee has recommended making investment in such bonds compulsory for the people declaring undisclosed income.
• People declaring undisclosed income will have to mandatorily invest 50% of that amount in these securities.
• The move is also expected to bring down the real interest rate. It will also strengthen the rupee.

 

Green bonds

• A green bond is a type of fixed-income instrument that is specifically earmarked to raise money for climate and environmental, renewable energy, pollution control projects.
• There is no standard definition of green bonds as of now.
• Green bonds are issued by multilateral agencies such as World Bank, corporations, govt. agencies and municipalities.
• Green bonds are open for investment by insurance companies, mutual fund companies, pension funds among others.
• SEBI’s indicative list for investment – clean transportation, sustainable water management, climate change adaptation, energy efficiency, sustainable waste management and land use, biodiversity conservation.

 

2007	World’s first Green Bond launched by World Bank
2015	India’s first Green Bond launched by Yes Bank
2016	BRICS Bank (New Development Bank) issued Yuan- denominated green Bonds
2018	Indian Renewable Energy Development Agency (IREDA) launched India’s first Masala Green Bond at London Stock Exchange

 

Blue Bond

• It is a debt instrument issued by governments, development banks etc to raise capital from investors to finance marine and ocean-based projects.
• It will help in expansion of marine protected areas, improved governance of priority fisheries and the development of the blue economy.
• The blue bond is a sub-type of green bond.
• Seychelles issued world’s first ‘Blue Bond,’ in 2018 to expand its marine protected areas and fisheries sector.

 

Catastrophe Bond

• Catastrophe bonds, also known as Cat bonds, allows the transfer of risks to bond investors.
• For the issuer – typically governments, insurers, and reinsurers – cat bonds signify financial protection in case of a major natural catastrophe, such as a hurricane or an earthquake.
• For the investor, buying the bonds means they may get high returns for their investment, which is not subject to financial market fluctuations.
• In case a qualifying catastrophe or event occur the investors will lose the principal they invested.
• If disaster doesn’t happen then principal will be returned.

 

Social Impact Bonds

• A Social Impact Bond, also known as Pay for Success Financing, a Pay for Success Bond or a Social Benefit Bond is a contract with the public sector in which a commitment is made to pay for improved social outcomes that result in public sector savings
• Social Impact Bond bonds will be offered to High Net worth Individuals (HNI), Impact Investors (rich people interested in ‘indirect’ social service) etc. Investors will earn 3% annual interest rate for tenure of 5 years.
• In 2019 SIDBI issued ₹ 300 cr. worth Women’s Livelihood Bonds with the help of World Bank, UN Women org etc.

Electoral bonds

• Announce in Budget 2017 (Dept. of Economic Affairs, Finance)
• These bonds are on the lines of bearer bonds or promissory notes wherein the issuer (bank) is be the custodian and pays the one who holds the bonds (political party).
• Characteristics of Electoral bonds
• These bonds are issued by notified banks (SBI at present) in multiples of1,000, Rs.10,000, Rs.1,00,000, Rs.10,00,000 and Rs.1,00,00,000
• Only an Indian citizen or Company registered in India can purchase bond by depositing money in their bank account and use that money to buy Electoral Bond. So, Electoral Bond can’t be bought anonymously or directly with cash.
• The political party has to encash it into the account which is registered (Under RPA 1951) with the Election Commission of India and which has secured 1 percent or above votes polled in last Lok Sabha or Vidhan Sabha elections.
• Validity of the bond will be only of 15 days from date of purchase. Within that time, buyer must donate, and political party must deposit in its SBI (current) bank account. However, No interest payable on the bond.

Relationship between Bond Price, Yield and Interest Rate

• Price of bond is inversely related to Interest Rates
• Price of Bond is inversely related to yields
• Yields are directly related to Interest Rates

EQUITY INSTRUMENTS

• Equity holders are called as owners of the company.
  If company makes profit, they will get dividend. However, during liquidation of an company, their claim will be at last.
• Shares and shareholders – Shares are the units into which the absolute share capital of a firm is split into or divided into. Therefore, the share is a fractional portion of the share capital and comprises the ground of ownership interest in a company. The persons who contribute money through shares are called shareholders.

Authorized Capital	It is the maximum amount of the capital for which shares can be issued by the Company to shareholders. The Authorised capital is mentioned in the Memorandum of Association of company under heading of “Capital Clause” The Authorised capital can be increased at any time in future.
Paid Up Capital	Paid- up capital is the amount paid by the shareholders for the shares held by them in the company. It is the actual fund that the company receives from the issue of shares
Ordinary shares (Equity shares)	Have voting power in the meetings of shareholders. Equity shareholders are given dividend only after paying it to the preference shareholders. Last claim during liquidation.
Preferential Shares	These are shares of an enterprise’s stock with dividends that are paid out to the members before equity shares dividends are circulated. During liquidation, these investors will be given money before the ordinary (equity) shareholders.
Sweat Equity Share	Sweat Equity Share given at discount to directors & employees for their value addition to company.
Penny stocks	Penny stocks are those that trade at a very low price, have very low market capitalisation, are mostly illiquid, and are usually listed on a smaller exchange.
Blue Chip stocks	A blue-chip stock is a huge company with an excellent reputation. Shares of a nationally recognized, well-established and financially sound company with a history of generating good dividend.
Venture capital funds (VCF)	Venture capital is a type of private equity, a form of financing that is provided by firms or funds to small, early-stage (seed), emerging firms that are deemed to have high growth potential, or which have demonstrated high growth.
Angel Investors	Group of individuals or an individual itself who invest their own money in the early (concept) Stages of the company and in return take a share in the company. They invest typically less money than the Venture Capitalists
Corporate Strategic Investor	Invests in start-up company with goal of acquiring the company or its technology at later date.
Share Pledging	When promoter of a company pledges his shares as collateral to borrow loans from a bank / NBFC.
Market capitalization	Sum of the market value of all the stocks derived by multiplying the price of the share by the number of equity shares out- standing Full Market Capitalization Method – In this case the market capitalization is found out by total number of Shares * Price of Each Share Free-Float Market Capitalization – Shares which are not free float such as shares held by government or promoters or locked under Employees Stock Option are excluded while calculating market capitalization

 

Angel investor viz-a-viz Venture capital

ANGEL INVESTOR	VENTURE CAPITAL
They usually invest less than one million dollar . They usually don’t involve with company. They invest in early stage of business or we can say start ups They use their own money they don’t demand board seat which leads to quick decision making.	They usually invest more than one million dollar They usually involve with company They unlikely to invest in start ups They use fund providers money They demand board seat which leads to delay in decision making.

 

METHODS OF ISSUING SHARES

• Share have printed price on the certificate called Face Value or Par Value. If they are sold at higher price than face value, it’s called “Premium Value”.
• Share Price – Market Price of Trade based on demand supply
• Face Value – Book Value
• Discount – When share issued above face value

Types of Market Primary Market Secondary Market

 

Primary Market	Secondary Market
When Company directly issues shares to people or certain private individuals Enables company to tap sources of funding for capital requirement. Leads to price Discovery	Market where one person buy/sell shares from another person Leads to discovery of valuation of the company

 

Public Issue – This issue is for retail investors to buy the shares of the company

Public Issue (methods) Initial Public Offer (IPO) Further Public Offer (FPO)

 

Initial Public Offer (IPO)	When an unlisted company decides to go public. Company hires an underwriter (usually, a merchant bank, investment bank) for a fee. Underwriter invites application from public & sells them shares at face value or higher. If less subscription, then underwriter will buy the unsold securities by himself.
Further Public Offer (FPO)	Already listed company generates further funds (to obtain more capital) by issuing shares.   Rights issue: Company issues additional shares but gives first right to existing shareholders to buy them, if they refuse then offered to outsiders.

 

Economic Survey 2020: No of IPO issuing Companies have declined: 134 (2017) → 103 (2018) → 47 (2019). Which indicates problems like protectionism (trade war), NPA, slowdown in consumer demand are preventing some of the companies from expanding further. Although the total amount of raised has increased.

 

2019: Saudi Arabia’s public sector oil company Aramco issued world largest IPO worth more than $25 trillion USD. It was listed at Riyadh’s Tadawul Stock Exchange.

 

American Depository Receipt /Global Depository Receipt

• It is an Indian shares in foreign (Videshi) locker.
• An Indian (or any non-American) company wants to mobilize money from American share market but does not want to go through the process of registration with the American share market regulator.
• Then Indian company gives the Indian shares to an American bank. Based on those Indian shares, the American bank will create American Depositary Receipts (ADR) & sell them to American investors. Denomination would be in USD.
• Global Depositary Receipt (GDR): Same as above, but when single bank issues receipts for investors in multiple countries. Denomination: USD or Euro.

 

Share issuing company	Deposits his company’s shares in a bank of →	That bank issues — in local market in — currency
Non-American	America	ADR (in $)
Non-Indian	India	Bharat / Indian depositary receipt (IDR) (in Rupees)

 

Initial Coin Offering (ICO)

• Suppose, a company wants to raise investors’ money for launching new cryptocurrency, or service/app related to an existing cryptocurrency.
• Then, it will issue Initial Coin Offering (ICO) → Investor subscribes to it, and receives ‘tokens’ (and not SHARES). Investors can use the ‘tokens’ to buy companies coins/services or may sell it to a third party.
• RBI has cautioned Indians not to invest in such instruments, because of the dangers and issues.

 

Clearing House

• A organisation which registers, monitors, matches and guarantees the trade of its members and carries out all final settlements of all transactions on a stock exchanges.
• Clearing corporations maintains fund for guaranteeing trades, settlements and in case a seller or buyer defaults.
• A clearing house is often central counterparty to all trades, that is, the buyer to every seller and the seller to every buyer.
• g. NSCCL, ICCL and MCX-SX clearing corporation ltd.
• Clearing corp. are designed as Market Infrastructure Institution (MII) for oversight considering its systemic importance in security markets regulated by SEBI.
• They are also subject to rules and regulations that are based on International Organisation of Securities Commission (IOSCO) principle.

 

DIFFERENCE BETWEEN FDI AND FII

• FDI is involved in setting up firms to produce goods and services. Because of this, they called as “Direct Investment”.
• Foreign Institutional Investment (FII) on other hand, buys financial assets for profits.
• In order to remove the ambiguity that prevails over what is FDI an what is FII, it was decided to follow the international practice and laid down a broad principle that, wherein an investor has a stake of 10 percent or less in a company, it will be treated as FII.
• On other hand, wherein an investor has a stake of more than 10 percent in a company, it will be treated as FDI.

 

STOCK EXCHANGES

• Share market or Stock Exchange is a stock market place that facilitates buying and selling of stocks either between Company and Shareholders (Primary) or between different shareholders (Secondary), commonly known as secondary market.
• SEBI (Securities and Exchange Board of India) regulator of stock markets in India.
• Stock exchanges also have their electronic platforms for trading. E.g. BOLT (BSE’s On-line Trading System) and NEAT (National Exchange for Automated Trading). They run using internet facility from VSAT (Very Small Aperture Terminal) Satellite.

 

World’s Oldest: Amsterdam Stock exchange, Netherlands (1602)

Asia’s Oldest: Bombay Stock Exchange (1875). SENSEX (Sensitivity Index) is the benchmark index of BSE.

NSE (National Stock Exchange) – Setup in 1992 (HQ-Mumbai). NIFTY (National Fifty) is the benchmark index of NSE. NIFTY comprises of 50 stocks from different sectors such as IT, Automobile, Cement, Pharma, Electronic Goods etc. with highest Market Capitalization. These are large, well-established and financially sound companies from main sectors.

 

Importance of stock exchange-

• Attracts foreign investments
• Another vehicle for investors savings
• Investment in backward regions for job creation
• An efficient medium for raising long term resources for businesses.
• Help raise savings from general public by the way of issue of equity/debt capital.
• Exercise discipline on companies and make them strive to be profitable.

 

Stock exchanges in india

Bombay Stock Exchange (BSE)

National Stock Exchange (NSE)

United Stock Exchange (USE)

MCX Stock Exchange Ltd. (MCX-SX)

India International Exchange (INX)

 

Sensitive Index (SENSEX) is the weighted average of Free Float Market Capitalization (FFMC) of 30 companies, selected by BSE’s “Index Cell”.

 

SENSEX – Up	SENSEX – Down
RBI’s soft monetary policy facilitates cheap loan & credit cards which leads to more spending by consumers. So this resulted into more profitability of company All above developments gives more dividend: investor thinks “better I buy more shares to get more dividend” – Bullish behaviour	RBI’s tight monetary policy
Peace, Economic boom/prosperity, Political Stability	War, recession, political instability – Bearish market.
When govt. hikes foreign investment limits	Vice-versa
Merger-Acquisition, New product launched, Environmental clearance given to factory.	CEO/MD arrest or FIR, Courts slapping fine, media exposing scandal and other detrimental eventualities.

 

• Inter-Connected Stock Exchange of India (ISE) – Stock exchange of exchanges i.e. many Regional Stock Exchanges combined together to come up with ISE
• Broker – They bring the buyers and sellers to the stock exchange platform, to enabling trading in securities.
• Budget-2019: Envisaged setting up a Social Stock Exchange (SSE) under SEBI’s regulation. SSE will help social enterprises and voluntary organizations to raise capital as equity, debt or mutual funds. SEBI setup Ishaat Hussain panel to study it.

De-Materialized (D-MAT) Account

• Depositary is an organization that stores the physical securities in its vault and allows investors to trade them in electronic form.
• Trading of the shares and bonds in paper-form leads to sluggish transactions and prone to the risk of theft, forgery and fire.
• Customer must open a “Demat” account in a depository-partner (DP) which can be a bank or an NBFC.
• SEBI is the regulator under the Depositories Act 1996. Notable examples are Central Depository services Limited (CDSL) and National securities depository Limited (NSDL).
• NSDL also has license of the RBI to operate as Payment bank.

• Investor Protection Fund (IPF) – Maintained by NSE for investor claims/payments arising out of non- payment/non- receipt of securities to the investor from the trading member who has been declared a defaulter. The maximum amount of claim payable from the IPF to the investor is Rs.10 Lakhs

• ISIN Number – International Securities Identification Number (ISIN) is a Unique 12 characters, consisting of both letters and numbers. ISIN is a serial code to identify securities. Prevents mistakes in buying/selling shares/bonds of companies with similar sounding names.

 

TYPES OF INVESTORS

Based upon buying capacity
Qualified Institutional Buyers (QIB)	QIBs are the institutional investors who are perceived to possess expertise and the financial muscle to evaluate and invest in the stock markets. They must be registered with SEBI as QIBs Anchor investors: – These are sub-type of qualified institutional buyers who buy a large chunk of shares a day before an IPO process opens. They help arriving at an approximate benchmark price for share sales and generate confidence among retail investors. The anchor investor would be a qualified institutional buyer (QIB) and an issuer can allot up to 60 per cent of Quota for QIBs
Retail Investors	An individual investor who is not a QIB. Underwriter will keep quota for each category of investors, as per SEBI norms.
Non-Institutional Investor	Investor which is neither Retail not QIB would be called Non-Institutional Investor
Depending on Buying Behaviour
STAG (Male Deer)	He buys newly issued securities from primary market & sells them in secondary market for quick profit.
Bull	Optimistic speculator who hopes share prices will rise, so purchases (to sell them later at much higher price). The bull speculator stimulates the price to rise.
Jobbers	Full time engaged in buying / selling securities using money from their own pockets. (Whereas brokers / commission agents buy/sell using money/shares of their clients).
Bear	A pessimistic speculator who fears prices will fall so, he sells. A bear usually presses its victim down to ground. Similarly, the bear speculator tends to force down the prices of securities.
Intra-day trading	Individuals buy and sell shares over the Internet over a period of a single day’s trading, with the speculative intention of profiting from small price fluctuations.

 

COMMODITY MARKET

• A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures.
• g. Food grains, cotton, precious metals or energy resources (oil / gas), jute, sugar, rubber, gold etc.
• Commodity Futures – It is a type of contract for future delivery and settlement of commodity.

 

Commodity exchanges were under a statutory regulator Forward Market Commission (FMC) under the Ministry of Consumer Affairs and Public Distribution. However, Jignesh Shah generated fake receipts without any commodities in the warehouses & traded at NSEL (commodity exchange). This led to transfer of FMC to Finance Ministry initially and later on, FMC ultimately merged with SEBI (2015).

 

INVESTMENT FUNDS

Mutual funds

• A mutual fund collects money from investors and invests the money, on their behalf, in securities (debt, equity or both). It charges a small fee for managing the money.
• Mutual fund sectors are one of the fastest growing sectors in Indian economy that have potential for sustained future growth.
• The advantages of the mutual funds include professional management, diversification, variety, liquidity, convenience as well as strict government regulations and full disclosure.
• Mutual funds are compulsorily registered with SEBI.
• A mutual fund is run by a group of qualified people who form a company, called an asset management company (AMC-NBFC) and the operations of the AMC are under the guidance of another group of people, called trustees.
• Whatever dividend/ interest is generated from the portfolio, it is distribute among investors in the proportion of their units.
• Investor has to pay Entry Load (fees for joining) and Exit Load (fees for quitting). SEBI regulates these fees.
• Due to low deposit rates in banks, people invested money in mutual funds however post– IL&FS crisis, charm declining because mutual funds are subject to such market risks.

DIFFERENCES

MUTUAL FUND	HEDGE FUNDS
Investors pool money to invest in basket of securities.	High network investors come together to buy the securities
Any one having legal age can invest here.	Due to high risk, only accredited investors can invest.
Comparatively these face more regulation	There are comparatively less regulations & compliances
These generally do not invest in derivatives	These generally invests in the derivatives
Minimum investment is small in amount	Here, minimum investment amount is huge
Pricing is done daily based on market price.	There is no requirement of daily pricing.
The managers are less aggressive with pre-defined objectives	Manager here have aggressive management style
No contribution from fund managers	Managers here have personal investment in funds.
Involve less tax saving strategies as do not fall under tax bracket.	Deploy more efficient tax saving strategies
These are available in the secondary market	These are not available in the secondary markets
There is lot of disclosure requirement under Mutual Fund	There are comparatively less disclosure requirements.
Investors can usually enter and exit at their wish.	Here there are restrictions on entry and exit.

 

	Banks	Mutual Funds
Leverage	Banks have leverage – can borrow funds at a fixed rate of interest	Have no debt in their capital structures – cannot borrow funds
Incentive	Investment quality is signaled through the market value of equity. Banks risk (invest) their own capital (borrowed from depositors at a fixed rate) which gives them strong incentives to invest wisely	Managers collect fees and do not own equity; There is no incentive alignment with investors based on performance of the investments. Profits and losses are simply passed through.
Transparency	Investments (loan portfolios) are opaque	Investments are relatively transparent, with investment advisors required to list their portfolios at certain intervals
Types of investment	Banks cannot invest in equity securities – conflicts of interest may develop	Mutual funds do not negotiate loans. They may purchase loans if securitized
Ownership	Managers of the firm can also be owners (stock and/or options) which promotes incentive alignment	Mutual Fund managers cannot invest in their own fund, and since they do not risk their own capital, are not incentive aligned.

 

TYPES OF MUTUAL FUNDS
Open Ended Fund	Close-ended Fund
An open-ended fund is the one which is usually available from a mutual fund on an ongoing basis that is an investor can buy or sell as and when they intend to at a Net Asset Value-based price.	A close-ended fund usually issue units to investors only once, when they launch an offer, called new fund offer (NFO) in India.
Exchange Traded Funds (ETFs) are a mix of open-ended and close-ended schemes.

 

Hedge Fund

• Hedge fund is a private investment partnership and funds pool that uses varied and complex proprietary strategies and invests or trades in complex products, including listed and unlisted derivatives.
• Hedge fund is special type of Mutual Fund which tries to hedge risks to investor’s capital against market volatility by employing alternative investment approaches.
• Hedge fund investors typically include high net worth individuals (HNIs) and families, endowments and pension funds, insurance companies, and banks.
• The minimum ticket size for investors putting money in these hedge funds is Rs 1 crore.

 

Sovereign Wealth Fund (SWF)

• SWF is a State owned investment fund, wherein central bank, finance ministry and other public sector financial intermediaries park their surplus fund. Pooled/parked money is used for investment.
• The SWFs are funded by the foreign exchange reserves that are held by the central bank.
• g. Singapore’s GIC sovereign wealth fund, Abu Dhabi Investment Authority (ADIA)’s funds, Qatar Investment Authority (QIA) etc.

 

Some of the major objectives of the Sovereign Wealth Fund (SWF) are mentioned below:

• Protecting and stabilizing the economy and budget of a country from excess volatility in exports.
• To earn greater returns than the foreign exchange reserves.
• To assist the monetary authorities to dissipate any unwanted liquidity.
• To increase savings for future generations.
• Providing funds for the social and economic development of a country.
• To provide a sustainable long term capital growth for the targeted countries.

 

InvITs

• The SEBI had first notified REITs and InvIT Regulations in 2014, allowing setting up and listing of such trusts which are popular in some advanced markets.
• It is like a mutual fund, which enables direct investment of small amounts of money from possible individual/institutional investors in infrastructure to earn a small portion of the income as return.
• InvITs can be treated as the modified version of REITs designed to suit the specific circumstances of the infrastructure sector.
• They are similar to REIT but invest in infrastructure projects such as roads or highways which take some time to generate steady cash flows.

REITs

• A REIT is roughly like a mutual fund that invests in real estate although the similarity doesn’t go much further.
• The basic deal on REITs is that you own a share of property, and so an appropriate share of the income from it will come to you, after deducting an appropriate share of expenses.
• Essentially, it’s like a group of people pooling their money together and buying real estate except that it’s on a large scale and is regulated.
• According to Indian regulation on REITs, these are meant to primarily own finished and rented out commercial properties – 80 per cent of the investments must be in such assets. That excludes a real estate that is under development.

 

Need of InvITs and REITs

• Infrastructure and real estate are the two most critical sectors in any developing economy.
• A well-developed infrastructural set-up propels the overall development of a country.
• It also facilitates a steady inflow of private and foreign investments, and thereby augments the capital base available for the growth of key sectors in an economy, as well as its own growth, in a sustained manner.
• Given the importance of these two sectors in the country, and the paucity of public funds available to stimulate their growth, it is imperative that additional channels of financing are put in place.

 

CPSE – Exchange Traded Funds (ETF)

• An ETF is a basket of securities that trade on an exchange, just like a stock.
• ETF reflects the composition of an Index, like BSE Sensex. Its trading value is based on the Net Asset Value (NAV) of the underlying stocks (such as shares) that it represents.
• ETF share prices fluctuate all day as it is bought and sold. This is different from mutual fundsthat only trade once a day after the market closes.
• An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector.
• Besides being cost efficient, ETFs offer a diversified investment portfolio to investors.
• A bondis an instrument that represents a loan made by an investor to a borrower (typically corporate or governmental).
• Disinvestment: government sells it shares from Central Public Sector Enterprises (CPSE) but does not reduce its shareholding below 51%.
• If Govt’s shareholding reduced below 51%, then it is called Privatization, although NITI prefers the term ‘Strategic Disinvestment’.

 

BHARAT-22:

• Bharat-22 ETF is the second ETF from Govt. of India after CPSE-ETF, hence it is attracting investors in the stock market.
• Bharat 22 is an ETF that will track the performance of 22 stocks, which the government plans disinvest.
• The index will be rebalanced annually.
• The Bharat 22 ETF has more than double the 10 stocks in the CPSE ETF and much wider sector coverage.
• Investors response to Bharat-22 was initially lukewarm attributed to NPA problem of PSB and resultant poor dividends. So BHARAT-22 not giving good returns.

 

Bharat Bond (Debt) ETF (2019-Dec)

• Bond ETFs are a type of ETFs which may include government bonds, corporate bonds, and state and local bonds—called municipal bonds.
• The ETF will comprise a basket of bonds issued by the CPSEs, CPSUs, CPFIs, and other government organisations.
• The unit size of the bond has been kept at just ₹1,000so that even retail investors can invest.
• Each ETF will have a fixed maturity date and initially they will be issued in two series, of 3 years and 10 years. Each series will have a separate index of the same maturity series.
• Index will be constructed by an independent index provider – National Stock Exchange.

 

Advantages of Bharat bond ETF

• The Bharat Bond ETF will ensure broader investor base through the participation of retail and High Net worth Individuals (HNI).
• This will lead to an increase in the demand for bonds, thus reducing the cost of borrowing for borrowers i.e. government organizations.
• The Bond ETF will provide safety, liquidity and predictable tax efficient returns.
• The launch of this ETF is expected to eventually increase the size of bond ETFs in India leading to achieving key objectives at a larger scale – deepening bond markets, enhancing retail participation and reducing borrowing costs.

Budget-2020: Given success of Bharat bond ETF, we are planning to launch another debt-ETF containing G-sec. This will help the retail investors to invest in G-sec.

 

Alternative Investment Funds (AIF)

• An alternative investment is a financial asset that does not fall into one of the conventional equity/income/cash categories.

 

DERIVATIVES

• Derivatives is a financial instruments that derive their value from some underlying asset. They are usually generated by the process of ‘securitization’. E.g. NHB taking loan papers from banks, using them to generate new Mortgage Backed Securities.

 

Underlying Asset could be –

Bond Currency Interest Rates Commodities Equity Share

Types Of Derivatives Forward Future Option Swaps

 

FORWARD CONTRACTS

• Forward is bilateral contract between two parties – Buyer and Seller wherein buyer agrees to buy the underlying asset at a future date on a price agreed upon today.
• In such contracts, there is a risk of other party not honoring commitment if he’s getting better deal elsewhere in the future.
• So, for protecting (hedging) themselves, buyer/ seller may buy “Option” from a third party by paying fees.

FUTURE CONTRACTS

• Futures contracts are like Forward contracts as in initial so the contract obligates the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price with the only difference that these are traded on futures exchanges.
• Contract is not sell directly between the parties as in forwards. Futures mitigate Counter Party Risk.
• Exchange takes margin money or initial margin (performance bond margin) from the seller as well as buyer to participate in the futures trade. Futures Contract is a standardized contract designed by the Exchange.

 

 

FORWARD	FUTURE
Not traded on the exchanges.	It is an exchange-traded contract.
Terms of the contracts differ from trade to trade (tailor made contract) according to the need of the participants	Terms of the contracts are standardized
Counter-party risk exists	Clearing agency associated with exchanges becomes the counter-party to all trades assuring guarantee on their settlement
Low Liquidity, as contracts are tailor made	High Liquidity
Price discovery not efficient	Efficient
Physical or Cash Settlement	Only Cash

 

OPTION CONTRACTS

• Option is a contract which gives the buyer (the owner or holder of the option) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price prior to or on a specified date, depending on the form of the option.

Types Of Option Call Options Put Options

 

Call options	Allow the holder to buy the asset at a stated price within a specific timeframe.
Put options	Allow the holder to sell the asset at a stated price within a specific timeframe.

 

Spot Price	Refers to the current price of the underlying asset.
Future Price	Refers to the price at which the two participants in the forwards contract agree to transact at on the Settlement Date
Final Settlement Date/Expiry Date	Refers to the date at which two parties have agreed to execute the forwards contract i.e. to buy or sell the underlying asset

 

SWAPs

• A swap is an agreement between two parties to exchange sequences of cash flows for a set period of time. Swap originates from two different kind of needs. Swaps are customized contracts. Swap contains Counter Party risk.g. Currency Swap Agreement between two countries to protect themselves against dollar volatility.
• There are Credit Default Swap (CDS) agreement against the risk of default, Interest swap agreement to protect against volatility in interest rates.

Types Of Swaps Currency Swap Interest swap

 

PARTICIPATORY NOTES (P-NOTES)

• P-Notes are instruments used by foreign funds and investors not registered with the SEBI to invest in Indian securities.
• They are generally issued overseas by associates of India based Foreign Institutional Investor (FPIs) and domestic institutional investors.
• Technically, P-Notes are Offshore Derivative Instruments (ODIs) issued by FPIs and their subaccounts against underlying Indian securities (like shares).

 

Q. Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (CSE-2019) Certificate of Deposit Commercial Paper Promissory Note Participatory Note

Problems with P-Notes

• It hides the identity of the investor
• Hence is generally used as an instrument of investing black money into Indian market.
• Hence norms pertaining to P -Notes have been tightened continuously by SEBI.
• If P-Note owner sells his P-Notes to another foreign investor, Government of India may be deprived of taxes.

In May 2016, SEBI has extended the KYC norms and anti-money laundering norms to the PN subscribers also. Similarly, back in April 2014, SEBI banned unregulated entities in foreign countries (so called Category III FPIs in India) from subscribing P-Notes.

Regulation of Derivatives

• Currency and Interest Rate Derivatives are regulated by RBI and SEBI
• Regulation of Stocks and Commodity Derivatives is done by only SEBI.
• Foreign Exchange Management Act, 1999 regulates Currency Derivatives which comes under the purview of RBI
• Trading of all the derivatives (currency, stock, commodity and Interest rate) is governed by the provisions contained in the Securities Contracts (Regulation) Act- 1956, the Securities Exchange Board of India Act-1992

 

TYPES OF COMPANIES

Chartered Companies	Setup by a charter given by a king / queen. E.g. East India Company in 1600.
Statutory Companies	Setup by special acts of Parliament or State legislature. E.g. SEBI, SBI, RBI etc.
Registered Companies	Registered under the Companies Act, 1956 (and later 2013) E.g. Wipro, Mahindra, TCS etc.
Holding Company	A company that owns majority shares in another company. E.g. Tata Sons ltd. holds majority shares of Tata Consultancy Services (TCS), Tata Steel, Tata Sky etc.
Private Sector	When private parties own 51% or above. E.g. Mahindra
Government / Public Sector	When Government owns 51% or above shares. E.g. Steel Authority of India (SAIL)
Subsidiary Company	A company that is controlled by a parent holding company. E.g. TCS, Tata Steel, Tata Sky are subsidiaries of Tata Sons.

 

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

• SEBI was constituted by an executive order in 1988 as an interim administrative body under the Finance Ministry.
• Four years later, on 4th April 1992 a notification awarding statutory powers to SEBI was issued (Securities and Exchange Board of India Act, 1992).
• Securities and Exchange Board of India is a quasi-legislative, quasi-judicial and quasi-executive body
• SEBI can draft regulations, conduct inquiries, pass rulings and impose penalties.
• Amendments in 2014 enabled SEBI to initiate order search and seizure, attachment of properties, arrest and detention.
• SEBI Board Composition: Chairman + 1 officer from RBI + 2 officers from Union Government + 5 members appointed by Union Government.
• Chairman: upto 5 years / 65 age, whichever earlier. Reappointment is eligible.
• Securities Appellate Tribunal – SAT has been constituted to protect the interest of entities that feel aggrieved by any of SEBI’s decision – Endowed with powers of civil court. Appeal against SAT lies in Supreme Court.
• Same SAT also hears appeals against the orders passed by Insurance Regulatory Development Authority of India (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA).

 

“SCORES” à online portal for complaint management.

 

SEBI Regulates
Process	Regulates Process of issuing securities (Bonds, Shares, IPO, ETF, ReIT, INVITs, etc.) using the Securities Contracts Regulation Act, 1956.
Places	Depositories, Stock exchanges, Commodity Exchanges etc.
Persons	Investors, Brokers, Fund Managers, Public Limited companies etc.
Collective investment scheme	Any Collective Investment Scheme (CIS) of Rupee 100 cr or above (In the aftermath of SAHARA scam & Chit Fund scams.)

 

Reforms Introduced By SEBI

• De-materialization of share certificates (1999).
• Banned entry loads for mutual fund schemes in 2009.
• CIRCUIT BRAKER System à Whenever the fluctuation in the share prices is more than “specific percentage” than previous day then stock exchange must stop trading for “specific minutes or hrs”.
• Discontinuing Carry forward system (Badla System) in 2001 and introduced (T+2) rolling settlement systeme. after trade is conducted, the parties must settle it within two working days.
• SEBI made PAN Card (issued by Income Tax Dept) compulsory for opening DEMAT Accounts.
• ASBA (APPLICANT SUPPORTED BY BLOCKED AMOUNT) – It allows the underwriter to block the amount in IPO investor applicant’s bank account, but only if shares allotted to the applicant, his bank money will be deducted
• Investor Protection Fund – SEBI requires Stock exchanges (BSE, NSE etc) and commodity exchanges (NSEL, MCX etc) to setup IPF. IPF covers investors’ non-speculative’ type of e.g. if the other party is not delivering shares because of some court case. IPF also promotes investor education and awareness.
• Dabba Trading (Bucketing / Box Trading) – While share trade occurs at stock exchange linked with DEMAT accounts, the Dabba Trades occur in the unofficial books/ledgers of an unscrupulous broker. He may or may not execute those orders in actual DEMAT account. Investor prone to scam, govt deprived of taxes. So, SEBI declared it illegal.
• Insider Trading – Whenever company launches new products, wins unique patents, or undergoes merger and acquisition – its share prices will increase. If a person associated with company uses such confidential information for buying/selling shares to make windfall gains. Such insider trading is illegal.
• ALGO Trading – Some large brokers / companies use algorithmic trading computer programmes to automatically buy / sell securities at a speed and frequency that is impossible for a human trader. This can be misused for manipulating the share prices. While SEBI has not banned it, but issued technical measures e.g. a single broker / investor can’t place more than 100 online orders per second.
• Securities and Exchange Board of India distinguishes itself from other regulators in India as it is a financially independent regulator with its own sources of revenue.

NATIONAL FINANCIAL REPORTING AUTHORITY (NFRA) – 2018

• NFRA is an Indian body provided in Companies Act 2013 for the establishment and enforcement of accounting and auditing standards and oversight of the work of auditors.
• As per the Companies Act, 2013 the NFRA is tasked with the job of recommending accounting and auditing standards, ensuring compliance with them and overseeing the quality of service of the accounting and audit professions.
• Composition – Chairman + 3 full time members + 9 part time members. Tenure would be 3 year or 65 years which is earlier. Only one time reappointment.
• Appeal against NFRA will be lies in NFRA Appellate Authority (NFRAA)
• NFRA sets standards for Auditors and Charter Accountants, in listed companies and large unlisted companies.
• NFRA is endowed with powers of civil court under CrPC.
• In case of any malpractices, NFRA investigate and debar them.

INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)

• ICAI is the national professional accounting body of India.
• It was established to regulate the profession of Accountancy.
• It is the only licensing cum regulating body of the financial audit and accountancy profession in India.
• ICAI recommends the accounting standards to be followed by companies in India to National Advisory Committee on Accounting Standards (NACAS).
• Members of the Institute are known as Chartered Accountants (CA)
• The ICAI is the second largest professional body of Chartered Accountants in the world, with a strong tradition of service to the Indian economy in public interest.

 

INDIAN ACCOUNTING STANDARDS (Ind AS)

• The RBI has deferred the implementation of the new accounting norms, Ind AS, indefinitely, as necessary amendments to the relevant law are yet to be made.
• Ind-AS govern the accounting and recording of financial transactions as well as the presentation of statements such as profit and loss account and balance sheet of a company.
• For long, there has been a heated debate about Indian companies moving to the globally accepted International Financial Reporting Standards (IFRS) for their accounts.
• Ind AS has been evolved as a compromise formula that tries to harmonize Indian accounting rules with the IFRS.

GIFT City and IFSC

• CONTEXT à The Union Cabinet has approved establishment of a unified authority for regulating all financial services in International Financial Services Centres (IFSCs) in India through International Financial Services Centres Authority Bill, 2019.
• An IFSC enables bringing back to India the financial services and transactions that are currently carried out in offshore financial centers by Indian corporate entities and overseas branches / subsidiaries of financial institutions (FIs) by offering business and regulatory environment that is comparable to other leading international financial centers in the world like London and Singapore.
• It would provide Indian corporates easier access to global financial markets.
• IFSC would also compliment and promote further development of financial markets in India.
• The first IFSC in India has been set up at GIFT City, Gandhinagar, Gujarat.

 

Need For Unified Regulator

• Currently, the banking, capital markets and insurance sectors in IFSC are regulated by multiple regulators, i.e. RBI, SEBI and IRDAI.
• The dynamic nature of business in the IFSCs necessitates a high degree of inter-regulatory coordination. The development of financial services and products in IFSCs would require focussed and dedicated regulatory interventions.
• It also requires regular clarifications and frequent amendments in the existing regulations governing financial activities in IFSCs
• Further, this would also be essential from an ease of doing business perspective.
• This would also generate significant employment in the IFSCs in particular as well as financial sector in India as a whole.
• Hence, a need is felt for having a unified financial regulator for IFSCs in India to provide world class regulatory environment to financial market participants.

FSDC (2010)	Financial Stability & Development Council is Chaired by – Union Finance Minister. Other members – 1. RBI Governor 2. SEBI head 3. IRDAI head 4. PFRDA head 5. IBBI head & govt officials Functions – Supervision of the economy & large financial conglomerates, coordination among the financial regulators, financial literacy and financial inclusion. Secretariat assistance offered by: Dept. of Economic Affairs (Min. of Finance)
FSB (2009)	Financial Stability Board is a brainchild of G20. HQ – BASEL (Switzerland) Function – Financial monitoring at global level, Coordination between national financial regulators bodies. India have 3 seats in FSB – 1) Secretary of Department of Economic Affairs (IAS) 2) Dy. Governor of RBI 3) SEBI chairperson
FATF (1989)	Financial Action Task Force is a brainchild of G7 HQ – Paris. India became member in 2010. Function – Combating Money laundering and terror finance.
IOSCO	International Organization of Securities Commissions (IOSCO) is the international body of world’s securities regulators. SEBI is a member of IOSCO. It’s known for its IOSCO Guidelines for Investors Protection and systematic risk in global economy.

CORPORATE GOVERNANCE- ISSUES & REFORMS

• Corporate governance is the system of rules, practices and processes by which a firm is directed and controlled.
• Corporate governance essentially involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.

Principles of corporate governance

Sustainable development of all stakeholders Effective management and Distribution of wealth Application of best management practices Discharging social responsibility Adherence to ethical standards Compliance of law in letter and spirit

Need of corporate governance

• Balancing the ownership structure
• Widespread of investor with various backgrounds
• To prevent corporate scams or scandals
• Greater expectations of society from the corporate sector
• Avoid and mitigate hostile take-overs
• Huge increase in top management compensation
• Liberalisation, Privatisation and Globalisation
• Deregulation and capital market integration

 

Instances of failure of corporate governance in India

• Absence of Corporate Governance leads to fraud, embezzlement, erosion of investors’ confidence.

Case	Issues involved
Harshad Mehta case	Role of regulator
Satyam Scam	failure of auditing
ICICI bank	Conflict of Interest
PNB fraud	Internal Mechanism
Tata Case	Role of promoter
Infosys Case	Role of Independent Director

 

Corporate governance ensures following compliances

Compliances	Example
Legal- Regulatory	Company obtaining Legal Entity Identifier (LEI) number as mandated by RBI. Company setting up ‘Internal Complaints Committee’ as mandated by Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013 / “POSH Act”
Technical	Companies keeping balance sheets as per the Ind-AS accounting standards. Automobile company producing car engines as per BHARAT- Stage emission norms.
Moral-Ethical	Gillette scrapping the ad-contract with cricketer Hardik Pandya for his sexist comments against women on koffee with Karan Show.

 

Legislation to improve corporate governance

Legislation	Details
The Companies Act, 1956	All listed and unlisted companies in India are governed by the Companies Act 1956 and itis administrated by Department of Companies Act (now it is ministry of corporate affairs).
The Securities Contracts Act, 1956	It covers all types of tradable government paper, shares, stocks, bonds, debentures, and other forms of marketable securities issued by companies.
The SEBI Act, 1992	It established SEBI as an independent capital market regulatory authority.
Indian Companies Act 2013	Maximum number of members (shareholders) permitted for a Private Limited Company is increased to 200 from 50. Section 135 of the Act which deals with Corporate Social Responsibility. Women empowerment in the corporate sector Fast Track Mergers and cross border merger Company Law Tribunal and Company Law Appellate Tribunal.
The Companies (Amendment) Bill, 2017	Addressing difficulties in implementation of companies act 2013 Facilitating ease of doing business in order to promote growth with employment Harmonization with the Accounting Standards, the Securities and Exchange Board of India Act 1992 and the regulations made thereunder, the Reserve Bank of India Act, 1934 and the regulations made thereunder; Rectifying omissions and inconsistencies in the Act

 

Regulatory framework on corporate governance

SEBI Guidelines	SEBI is a regulatory authority having jurisdiction over listed companies and which issues regulations, rules and guidelines to companies to ensure protection of investors.
Standard Listing Agreement of Stock Exchanges	For companies whose shares are listed on the stock exchanges.
Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI)	ICAI is an autonomous body, which issues accounting standards providing guidelines for disclosures of financial information.
Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI)	ICSI is an autonomous body, which issues secretarial standards in terms of the provisions of the New Companies Act

 

Committees on corporate governance

Rahul Bajaj committee(1995)	The Confederation of Indian Industries (CII) had set up a task force under Rahul Bajaj. The CII came up with a voluntary code called “Desirable Corporate Governance” in 1998.
Kumar Mangalam Birla committee report (2000)	Committee was set up by SEBI Committee covers the issues such as protection of investor interest, promotion of transparency, building international standards in terms of disclosure of information. The SEBI implemented the recommendations of the Birla committee through the enactment of Clause 49.
Naresh Chandra Committee Report	It extensively cover Auditor-company relationship.
R. Narayana Murthy Committee (2003)	The committee was set up by SEBI to review the performance of corporate governance in India and make appropriate recommendations.
Uday kotak Panel (2017)	In light of Tata and Infosys corporate governance episodes, SEBI appointed Uday Kotak panel to enhance corporate governance in India.

 

Important recommendations of Uday Kotak committee

• A listed company should have at least six directors on its board.
• The panel has suggested at least one independent director be a woman.
• An independent director cannot be in more than eight listed companies and a managing director can hold the post of an independent director in only three listed companies.
• Every board meeting would require the presence of an independent director.
• The committee has proposed to increase the number of meetings to five a year.
• The committee has recommended that the number of independent directors on a company board be increased from 33% to 50%.
• An audit committee is being proposed with the mandate to look into utilization of funds infused by a listed entity into unlisted subsidiaries including foreign subsidiaries.
• The committee has also recommended that SEBI should have clear powers to act against auditors under the securities law.
• For government companies, the committee has recommended that the board have final say on the appointment of independent directors and not the nodal ministry.

 

Challenges

• It is common for friends and family of promoters and management to be appointed as board members.
• In India, founders’ ability to control the affairs of the company has the potential of derailing the entire corporate governance system. Unlike developed economies, in India, identity of the founder and the company is often merged.
• Women director appointed are primarily from family in most of the companies which negates the whole reform.
• Appointed independent directors is questionable as it is unlikely that Independent Directors will stand-up for minority interests against the promoter. In the Tata case, these directors normally toe the promoter’s line.
• Conflict of Interest – The ICICI Bank Ltd fiasco demonstrates the challenge of managers potentially enriching themselves at the cost of shareholders in the absence of a promoter.
• Data protection is an important governance issue. In this era of digitalisation, a sound understanding of the fundamentals of cyber security must be expected from every director.

 

Way forward

• For the good corporate governance focus should be shift from independent director to limiting the power of promoters.
• Promote women from diverse background rather than from family as board of director.
• Strengthening the power of SEBI, ICAI, and ICSI to handle the corporate failure.
• CSR projects should be managed with much interest and vigour.
• The board must invest a reasonable amount of time and money in order ensure the goal of data protection is achieved.