30 Overview and Role of Stock Exchanges

Ravi Singla

  1. Learning Outcomes

After studying this module you shall be able to understand:

 

(i)   Meaning of stock exchanges

 

(ii)   An overview of stock exchanges in India

 

(iii)  Regulation of stock exchanges in India

 

(iv)   Role of stock exchanges

 

2.    Introduction

 

Stock exchange is an organised market place where the securities are bought and sold freely by the investors. These are the entities where the stocks and other securities are listed and traded. The stock exchange may be either a mutual organisation or a corporation which brings its members together to participate in the buying and selling of shares and other securities. These members of the exchange can either trade on the behalf of their clients or own their own account. Stock exchange facilitates the trade of securities that already exist in the market. Thus stock exchange is also known as ‘secondary market’ for the securities. The existence of stock exchange provides investors a ready market for their holdings.

 

According to Sec 2(j) of the Securities Contract Regulation Act 1956 the term “stock exchange” means- 1[

 

(a)    any body of individuals, whether incorporated or not, constituted before corporatisation and demutualisation under sections 4A and 4B, or

 

(b)   a body corporate incorporated under the Companies Act , 1956 (1 of 1956) whether under a scheme of corporatisation and demutualisation or otherwise,

 

for the purpose of assisting, regulating or controlling the business of buying selling or dealing in securities.]

 

According to Sec 2 (aa) of the SCRA 1956 the term 2[“Corporatisation” means the succession of a recognised stock exchange, being a body of individuals or a society registered under the Society Registration Act, 1860 (21 of 1860), by another exchange, being a company incorporated for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities carried on by such individuals or society.]

 

According to Section 2 (ab) of SCRA 1956 the term 3[“demutualisation” means the segregation of ownership and management from the trading rights of the members of a recognised stock exchange in accordance with a scheme approved by Securities Exchange Board of India.]

 

1. Substituted by Securities Laws (Amendment) Act, 2004 (w.e.f. 12-10-2004). Prior to the substitution the clause (j) read as under-(j) “ ‘Stock exchange’ means any body of individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying selling or dealing in securities.”

 

2. Inserted by the Securities Laws (Amendment) Act, 2004 (w.e.f. 12-10-2004).

 

3.  Inserted by the Securities Laws (Amendment) Act, 2004 (w.e.f. 12-10-2004).

 

 

The above definition clearly specifies that earlier the stock exchange in India can be formed as mutual organisation, that is, an organisation where the management rights and the trading rights as a broker are bundled with the ownership of the share of the exchange. Such a structure of exchange invited mammoth criticism due to the number of drawbacks like – lack of transparency and professional management, lack of strict vigilance on the market and the consequent manipulation of markets by brokers for their personal interests. The happening of two major scams – Harshad Mehta Scam in 1992 and Ketan Parekh Scam in 2001 also highlighted the significance of demutualisation of the stock exchanges. Moreover such a structure of exchanges was also facing cash crunch for their technological up gradation and modernisation as they could not raise money by issue of equity shares to others. In view of these shortcomings of the ‘mutual stock exchanges’ SCRA was amended in 2004 to corporatize and demutualise the stock exchanges in India. Demutualisation is the process of converting exchanges from member oriented non profit organisations to for profit, investor oriented corporations. Corporatisation is the process of converting the organisational structure of the exchange from non corporate to corporate. Section 4A of SCRA 1956 ensures that all recognised stock exchanges shall be demutualised and corporatized as per the procedure mentioned in Section 4B of the Act within the specified time. The process of demutualisation and corporatisation ensured that the ownership, management and the trading rights are in different hands like a commercial entity. It enabled the exchanges to raise the much needed funds to fight global competition and to attain growth.

 

Today there exist a wide variety of securities that are allowed to trade on stock exchanges. Section 2(h) of the SCRA 1956 states that the term securities include-

 

(i)  shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

 

4[(ia) derivative;

 

(ib) unit or any other instrument issued by any collective investment scheme to the investors in such schemes;]

 

5[(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;]

 

6[(id) units or any other such instrument issued to the investors under any mutual fund scheme;] 7(ii) Government Securities;

 

(iia) such other instruments as may be declared by the central government to be securities; and (iii) rights or interest in securities;

 

4. Inserted by Securities Laws Amendment Act, 1999 (w.e.f. 22-02-2000).

 

5.Inserted by Securitisation and Reconstruction of Financial Assets and Enforcement by Security Interest Act, 2002 (w.e.f. 21-06-2002).

 

6. Inserted by the Securities Laws (Amendment) Act, 2004 (w.e.f. 12-10-2004).

 

7. Substituted by Act 15 of 1992, (w.e.f. 30-01-1992).

 

From the above explanation of the term securities it is clear that Stock exchange provides a market place for purchase and sale of almost every type of industrial security.

 

3.  Stock Exchanges in India: Following are the two major stock exchanges in India

 

3.1    BSE (Formerly Bombay Stock Exchange):

 

Bombay Stock Exchange was formally organised in the year 1875. It was earlier known as Native Share and Stockbrokers Association. It is the oldest stock exchange in Asia. It is the first exchange to be recognised under the Securities Contract (Regulation) Act in 1956. In 1986, Bombay Stock Exchange developed BSE Sensex (Sensitive Index), an index of 30 companies (with base year 1978-79=   100) to measure the overall performance of the exchange. In 1992, Govt. of India established Securities Exchange Board of India under the SEBI Act to protect, develop and regulate the securities market. In 1995 the BSE introduced its Online Trading system called BOLT. On 9th June 2000, the equity derivates got introduced at the Bombay Stock Exchange followed by the launch of index options on 1st June 2001, stock options on 9th July 2001, stock futures on 1st Nov. 2001, currency derivatives and interest rate derivatives on 28th Nov. 2013. BSE was corporatized and demutualised on 8th August 2005 under the SEBI announced BSE (Corporatisation and Demutualisation) Scheme, 2005. Today BSE Ltd. is a corporatized and demutualised entity with a broad shareholder base. The shareholders’ list of BSE includes two leading global exchanges namely Deutsche Bourse and Singapore Exchange as its strategic partners. BSE provides an efficient and transparent mechanism for trading in equity and debt instruments, derivative contracts, mutual funds etc. BSE is the world’s

 

No. 1 exchange in terms of listed securities. As on 26th Feb. 2016, a total of 5787 entities are listed on the BSE and the total market capitalisation of BSE listed companies amounted to Rs. 86,34,614 crore. (Source: www.bseindia.com). BSE also provides other services like risk management, clearing and settlement, market data and education to the capital market participants. Trades done on BSE are cleared and settled through Indian Clearing Corporation Limited (ICCL) a wholly owned subsidiary of BSE. The exchange provides depository services through its depository arm – Central Depository Services Limited (CDSL).

 

3.2   National Stock Exchange of India Limited (NSE):

 

National Stock Exchange of India limited was set up as the first electronically traded stock exchange in India. From the day one, NSE got the form of a demutualised stock exchange, that is, its ownership, management and trading rights are in the hands of three different sets of people. Its ownership is in the hands of leading financial institutions, insurance companies, banks etc. Its management is in the hands of professionals who do not trade on the exchange. Board of NSE includes senior executives from promoter institutions, eminent professionals in different fields like accountancy, economics, law etc., nominees of SEBI and one full time executive. NSE owes its origin to the recommendations made by High Powered Study Group on establishment of new stock exchanges in India. Based on the recommendations of the group, the leading Financial Institutions of the country promoted National Stock Exchange on behest of the Government of India. Consequentially NSE got incorporated as a tax paying company in November 1992. Soon after a few years of its operations, in October 1995, NSE became the largest stock exchange of the nation. The three important segments of the National Stock Exchange trading platform got established one after the other. The Wholesale Debt Market Segment (WDM) of NSE went live in June 1994 and the Capital Market Equity Segment in November 1994. Finally, the Futures and Options Segment of NSE started its operations in Index Futures in June 2000, followed by index options trading in June 2001, Stock Options trading in July 2001 and Stock Futures trading in November 2001. The derivative segment of NSE expanded its operations further with the launch of Currency Derivatives on 29th August 2008 and Interest Rate Futures on 30th August 2009. Today NSE operates a nation-wide electronic market, offering trading in capital market segment including equity, mutual funds and exchange traded funds, derivative market segment including equity, currency and interest rate derivatives, Debt Market Segment including Wholesale Debt Market (WDM), Retail Debt Market (RDM) and Corporate Bonds. Trades done on NSE are cleared and settled through National Securities Clearing Corporation Limited (NSCCL) a wholly owned subsidiary of NSE. The prominent index of NSE, that is, NIFTY 50 was launched in April 1996. It is a well diversified index comprising companies from 13 different sectors of the economy. The index represents nearly 66.17% of the free float market capitalisation of the companies listed on the exchange as on March 2015. National Stock Exchange is the market leader today with average daily turnover in capital Market segment of Rs. 17604 Cr. based on January 2016 figures and average daily turnover in Equity Futures and Options of Rs. 228,833.14 Cr. based on 2014-2015 figures.

 

3.3  Metropolitan Stock Exchange of India Limited (MSEI)

 

It is formerly known as MCX Stock Exchange Limited. It is recognised by SEBI under Section 4 of Securities Contract (Regulation) Act, 1956. It is notified as recognised stock exchange by Government of India on December 21, 2012. It is promoted by major public sector banks, private sector banks and financial institutions and has an independent professional management. MSEI offers trading in Capital Market, Futures & Options, Currency Derivatives and Debt Market. MSEI commenced operations in Currency Derivatives on 7th October 2008, capital market segment and F&O Segment on February 11, 2013 followed by trading in Debt Segment from June10, 2013 and cash settled Interest Rate Futures on 10 Year Government of India Security from January 20, 2014. Trades done on MSEI are cleared and settled through MCX-SX Clearing Corporation Limited. SX40 is the flagship index of the exchange with a base value of 10000 and a base date of March 31, 2010. The exchange has meagre trading volumes in its various segments.

 

3.4 Other Stock Exchanges:

 

Besides the above three exchanges there exits Over the Counter Exchange of India, Inter Connected Stock Exchange of India (ISE) and some Regional Stock Exchanges like Calcutta Stock Exchange, Delhi Stock Exchange, Ahmedabad Stock Exchange and a few others. However all of these stock exchanges are facing great difficulties in surviving. As per the new norms introduced by SEBI every Stock Exchange should have a minimum networth of Rs. 100 Cr. at all times. Further the SEBI norms provide that a stock exchange can apply for voluntary surrender of recognition and exit if it reports an annual turnover of less than Rs. 1000 Cr. on its platform. Also a bourse which fails to achieve a required annual turnover of Rs 1,000 crore, would be subject to compulsory exit. Consequently Hyderabad Securities and Enterprises Ltd (erstwhile Hyderabad Stock Exchange), Coimbatore Stock Exchange Ltd, Saurashtra Kutch Stock Exchange Ltd ,Mangalore Stock Exchange, Inter-Connected Stock Exchange of India Ltd, Cochin Stock Exchange Ltd, Bangalore Stock Exchange Ltd , Ludhiana Stock exchange Ltd, Gauhati Stock Exchange Ltd, Bhubaneswar Stock Exchange Ltd, Jaipur Stock Exchange Ltd, OTC Exchange of India , Pune Stock Exchange Ltd, Madras Stock Exchange Ltd, U.P. Stock Exchange Ltd, Madhya Pradesh Stock Exchange Ltd and Vadodara Stock Exchange Ltd are allowed by SEBI to exit the capital market space.

 

4.Regulation of Stock Exchanges in India

 

Stock exchanges in India are regulated by the provisions of Security Exchange Board of India (SEBI), Security Contract Regulation Act, 1956, Bye laws of the Exchange and the Ministry of Finance through the Department of Economic affairs – Capital Market Division. The division is responsible for formulating policies relating to orderly growth and development of security markets as well as protecting the interest of investors. The division administers rules and legislations made under the Depository Act (1996), SCRA (1956) and SEBI Act (1992).

 

4.1 Security Exchange Board of India (SEBI): It is the main regulator of stock exchanges in India. It was enacted on April 12, 1992 under the SEBI Act 1992. The prime objective of SEBI is to protect the interest of investors and to promote and develop the securities market in India. All financial intermediaries, whether domestic or foreign, who participates in the Indian securities market are governed by the SEBI regulations. Under the provisions of the SEBI Act it is the duty of the SEBI board to adopt appropriate measures for the protection of investors’ interest and for the promotion and development of security markets in India. For more information please refer to SEBI website www.sebi.com.

 

5.  Role of Stock Exchanges

 

Stock Exchanges play a number of important roles in the economy of the country. These are discussed below:

 

1.  Barometer of the economy: Stock exchanges are considered to be the barometer of the economy of a nation. It is one of the important leading indicators of the country’s economy.

 

Movements in the stock market indices represent the aggregate response of all the investors towards the future expected state of different industries, sectors or the overall economy. A rise in the stock market generally indicates better future growth in the country’s economy and vice versa.

 

2. Ready Market: Stock exchange provides investors an opportunity to sell their securities on real time basis at the best quoted price and without involving much effort. Thus stock exchange provides ready market to the investors to sell their investments.

 

3.  Effective mobilisation of savings: Stock exchanges facilitate the trading of securities that are listed on the stock exchange and thereby provides liquidity to the various types of investment of individuals. It is primarily the availability of liquidity feature that encourages the millions of investors, whether individuals or institutions, to park their surplus funds in needy companies through the route of Initial Public Offer (IPO) or Follow on Public Offer (FPO). In this way stock exchanges helps in channelizing the idle funds of investors into the deficit corporate units to meet their productive requirements.

 

4. Capital Formation: Funds mobilised through stock exchanges are provided to different companies engaged in the production of goods and services. This leads to capital formation in the nation.

 

5. Optimum Resource Allocation: Stock exchange constantly does the evaluation of whole corporate sector of the nation and keeps on distinguishing between leaders and laggards. This evaluation process of the stock exchange ensures that the surplus funds of the nation are parked into the most promising ventures thereby assures the optimal utilisation of the scarce national resources.

 

6.Wide Investment Avenues: Stock exchanges provide ample investment opportunities to the investors with surplus funds. Companies from diverse sectors issue various kinds of equity and debt offerings in the market to meet their requirements. The various kinds of instruments are made available on the exchanges to suit the varying objectives of the different class of investors.

  1. Risk Management: The availability of derivative instruments on the various underlying assets provides investors and companies an efficient mode of risk management. The future and option contracts available on equity shares and equity indices enable the investors in Indian equity market to manage their investment risks. The availability of Currency future and option contracts enable the importers, exporters and other companies expecting a foreign currency inflow or outflow to manage their exchange rate risk. Further the Interest Rate Derivative Market enables the companies to hedge their interest rate risk.
  1. Speculation: Speculation aids liquidity to the market, thus its existence is must for the effective and efficient working of the stock exchanges. The derivative segment of stock exchange provides an opportunity to investors to take a long or short position in a contract only by the payment of margin money. Such speculative trades boost liquidity on the bourses, which could not be otherwise provided by the delivery based trades. Moreover the capital market segment of the exchange also provide speculative traders an opportunity to settle their trades on the same day without paying for the full amount of the trade, thereby boosts liquidity on the exchange.
  1. Price Discovery: Stock exchange helps companies in determining the fair worth of their shares. A company coming with an IPO can look at the prevailing price of already listed similar companies on the exchange to determine their issue price. Further a company planning to come with a FPO can look at the price of its existing shares in the market to decide the appropriate price of its FPO.
  1. Safety to investors: Stock exchanges are regulated by their bye laws, SCRA 1956 and the regulations of Securities Exchange Board of India. These regulations keeps a constant check on the manipulation, price rigging and other fraudulent practices on the exchange which may cause unfair loss to the investors. Moreover these stock exchanges also maintain an investors’ protection fund to protect the interest of the clients of those trading members who have defaulted or has been expelled under the provisions of any rules, bye laws or regulations of the exchange.
  1. Investor Education: The stock exchange also performs the function of educating the investors to widen the share ownership base, especially in developing countries like India. The stock exchanges run several investor education programs that help the investors in understanding the features of different types of securities and instruments.

Books

 

  1. Bhole, L.M. and Mahakud Jitendra. Financial Institutions and Markets: Structure, Growth and Innovations. 5th Ed., McGraw Hill Education (India) Pvt. Ltd.
  2. Tripathy, Nalini Prava. Financial Services. PHI Learning Pvt. Ltd.
  3. Das, Subhash Chandra. The Financial System in India: Markets, Instruments, Institutions, Services and Regulations. PHI Learning Pvt. Ltd.
  4. Machiraju, H.R. Indian Financial System. 4th Ed. Vikas Publishing House.

 

Web References

 

  1. www.nseindia.com (Official Website of National Stock Exchange of India Limited)
  1. www.bseindia.com (Official Website of BSE Limited)
  1. www.msei.in/index.aspx (Official website of Metropolitan Stock Exchange of India Limited (MSEI
  1. www.sebi.gov.in (Official website of Securities Exchange Board of India)