Definition of Security Market: Primary Market

Learning Objectives

After reading this unit you can be able to understand:

Role and functions of primary market

Methods of selling securities in primary market

SEBI guidelines for public issues and Procedures for new issues

Security market or capital market may be defined as a market for borrowing and lending long-term capital funds required by business enterprises. Capital market is the market for financial assets that have long or indefinite maturity. Capital market offers an ideal source of external finance. Capital market forms an important core of a country’s financial systems too.

It refers to all the facilities and the institutional arrangements for borrowing and lending medium-term and long – term funds. Like any market, the capital market is also composed of those who demand funds (borrowers) and those who supply funds (lenders).

Characteristics

Following are the characteristic features of a security market:

Securities Market
The dealings in a capital market are done through the securities like shares, debentures, etc. The capital market is thus called securities market.

Security Prices

The price of securities that are dealt with in the capital market is determined through the general laws of demand and supply. The equilibrium in demand and supply of securities is brought about by the prices. The price depends upon a large number of factors such as the following.

Yield on securities

Extent of funds available from public savings

Level of demand for funds

Flow of funds from the banking system

Price situation in general

Attitude towards liquidity on the part of investors

 Participants

There are many players in the capital market. The participants constitute a plethora of institutions, which provide a wide variety of services of access to capital. The capital is either directly supplied or arranged through financial intermediaries. These intermediaries form the basic edifice of a capital market. The participants in the capital market include:

Financial intermediaries like insurance companies, investment companies, pension funds, etc

Non-financial business enterprises

Ultimate economic units like households and Governments

Location

It is interesting to note that the capital market is not confined to certain specific locations, although it is true that parts of the market are concentrated in certain well-known centers known as Stock Exchanges. It exists all over the economy, wherever suppliers and users of capital get together and do business.

Functions

The functions that are performed by the security market are detailed below:

Allocation Function

Capital market allows for the channelisation of the savings of innumerable investors into various productive avenues of investments. Accordingly, the current savings for a period are allocated amongst the various users and uses. The market attracts new investors who are willing to make new funds available to business. It also allocates and rations funds by a system of incentives and penalties.

Liquidity Function

Capital market provides a means whereby buyers and sellers can exchange securities at mutually satisfactory prices. This allows better liquidity for the securities that are traded.

Other Functions

In addition to the functions of funds allocation and liquidity, capital market also renders the following functions:

Indicative Function

A capital market acts as a barometer showing not only the progress of a company, but also of the economy as a whole through share price movements.

Savings and Investment function Capital market provides a means of quickly converting long-term investment into liquid funds, thereby generating confidence among investors and speeding up the process of saving and investment.

Transfer function Capital market facilitates the transfer of existing assets – tangible and intangible – among individual economic units or groups.

Merger function Capital market encourages voluntary or coercive take-over mechanism to put the management of inefficient companies into more competent hands.

Constituents of Indian Capital Market

The Indian capital market is composed of the following:

The gilt-edged market

The industrial securities market

Gilt-Edged Market

‘Gilt-edged Market’ also known as Government Securities market, is the market for Government and semi-Government securities. An important feature of the securities traded in this market is that they are stable in value and are much sought after by banks.

Some of the special features of the gilt-edged market are as follows:

Guaranteed return on investments

No speculation in securities

Institutional based investors which are compelled by law to invest a portion of their funds in these securities

Predominated by such institutions as LIC, GIC, the provident funds and the commercial banks.

Heavy volume of transactions necessitating negotiation of each transaction.

Industrial Securities Market

The market for industrial securities is known as ‘Industrial Securities Market’. It offers an ideal market for corporate securities such as bonds and equities. Industrial securities market comprises of the following segments:

Primary market

Secondary market

Primary Market

Meaning

Primary market also known as New Issues Market (NIM) is a market for raising fresh capital in the form of shares and debentures. Corporate enterprises, which are desirous of raising capital funds through the issue of securities, approach the primary market.

Issues exchange financial securities for long-term funds. The primary market allows for the formation of capital in the country and the accelerated industrial and economic development.

Modes of Raising Capital

Following are the popular ways by which capital funds are raised in the primary market:

Public issue where the securities are issued to the members of the general public, it takes the form of ‘public issue’. It is the most popular method of raising long-term funds.

Rights issue where the issue of equity shares of a body corporate is made to the existing shareholders as a pre-emptive right, it takes the form of ‘rights issue’. Under this method, additional securities are offered fro subscription to the existing shareholders.

Private placement where the shares of a body corporate are sold to a group of small investors, it takes the form of ‘private placement’.

The Secondary Market

Meaning

A market which deals in securities that have been already issued by companies is known as ‘the secondary market’. It is also called the stock exchange or the share market.

Importance

The importance of the secondary market springs from the fact that it is the base upon which rests the edifice of the primary market. In other words, for the efficient growth of the primary market, a sound secondary market is an essential requirement. This is because the secondary market offers an important facility of transfer of securities.

Methods of Marketing Securities

Following are the various methods being adopted by corporate entities for marketing the securities in the New Issue Market:

Pure Prospectus Method

The method whereby a corporate enterprise mops up capital funds from the general public by means of an issue of a prospectus is called ‘Pure Prospectus Method’. It is the most popular method of making public issue of securities by corporate enterprises.

Features

Exclusive Subscription

Under this method, the new issues of a company are offered for exclusive subscription of the general public. According to the SEBI norms, a minimum of 49 percent of the total issue at a time is to be offered to public.

Issue Price

Direct offer is made by the issuing company to the general public to subscribe to the securities at a stated price. The securities may be issued either at par, of at a discount or at a premium.

Underwriting

Public issue through the ‘pure prospectus method’ is usually underwritten. This is to safeguard the interest of the issuer in the event of an unsatisfactory response from the public.

Prospectus

A document that contains information relating to the various aspects of the issuing company, besides other details of the issue is called a ‘Prospectus’. The document is circulated to the public. The general details include the company’s name and address of its registered office, the names and addresses of the company’s promoters, manager, managing director, directors, company secretary, legal adviser, auditors, bankers, brokers, etc the data of opening and closing of subscription list, contents of Articles, the names and addresses of underwriters, the amount underwritten and the underwriting commission, material details regarding the project, i.e. location, plant and machinery, technology, collaboration, performance guarantee, infrastructure facilities, etc nature of products, marketing set-up, export potentials and obligations, past performance and future prospects, management’s perception regarding risk factor, credit rating obtained from any other recognized rating agency, a statement regarding the fact that the company will make an application to specified stock exchange(s) for listing its securities and so on.

Advantages

The pure prospectus method offers the following advantages to the issuer and the investors alike:

Benefits to Investors

The pure prospectus method of marketing the securities serves as an excellent mode of disclosure of all the information pertaining to the issue. Besides, it also facilitates satisfactory compliance with the legal requirements of transparency, etc. It also allows for good publicity for the issue. The method promotes confidence of investors through transparency and non discriminatory basis of allotment. It prevents artificial jacking up of prices as the issue is made public.

Benefits to Issuers

The pure prospectus method is the most popular method among the large issuers. In addition it provides for wide diffusion of ownership of securities contributing to reduction in the concentration of economic and social power.

Drawbacks

The raising of capital through the pure prospectus method is fraught with a number of drawbacks as specified below:

High Issue Costs

A major drawback of this method is that it is an expensive mode of raising funds from the capital market. Costs of various hues are incurred in mobilizing capital. Such costs as underwriting expenses, brokerage, administrative costs, publici9ty costs, legal costs and other costs are incurred for raising funds. Due to the high cost structure, this type of marketing of securities is followed only for large issues.

Time Consuming

The issue of securities through prospectus takes more time, as it requires the due compliance with various formalities before an issue could take place. For instance, a lot of work such as underwriting, etc should be formalized before the printing and the issue of a prospectus.

Offer for Sale Method

Meaning

Where the marketing of securities takes place through intermediaries, such as issue houses, stockbrokers and others, it is a case of ‘Offer for Sale Method’.

Features

Under this method, the sale of securities takes place in two stages. Accordingly, in the first stage, the issuer company makes an en-block sale of securities to intermediaries such as the issue houses and share brokers at an agreed price. Under the second stage, the securities are re-sold to ultimate investors at a market-related price. The difference between the purchase price and the issue price constitutes ‘profit’ for the intermediaries. The intermediaries are responsible for meeting various expenses such as underwriting commission, prospectus cost, advertisement expenses, etc.

The issue is also underwritten to ensure total subscription of the issue. The biggest advantage of this method is that it saves the issuing company the hassles involved in selling the shares to the public directly through prospectus. This method is, however, expensive for the investor as it involves the offer of securities by issue houses at very high prices.

Private Placement Method

Meaning

A method of marketing of securities whereby the issuer makes the offer of sale to individuals and institutions privately without the issue of a prospectus is known as ‘Private Placement Method’. This is the most popular method gaining momentum in recent times among the corporate enterprises.

Features

Under this method, securities are offered directly to large buyers with the help of share brokers. This method works in a manner similar to the ‘Offer for Sale Method’ whereby securities are first sold to intermediaries such as issues houses, etc. They are in turn placed at higher prices to individuals and institutions. Institutional investors play a significant role in the realm of private placing. The expenses relating to placement are borne by such investors.

Advantages

Private placement of securities offers the following advantages:

Less expensive as various types of costs associated with the issue are borne by the issue houses and other intermediaries

Less troublesome for the issuer as there is not much of stock exchange requirements concerning contents of prospectus and its publicity, etc to be complied with

Placement of securities suits the requirements of small companies

The method is also resorted to when the stock market is dull and the public response to the issue is doubtful

Disadvantages

The major weaknesses of the private placement of securities are as follows:

Concentration of securities in a few hands

Creating artificial scarcity for the securities thus jacking up the prices temporarily and misleading general public

Depriving the common investors of an opportunity to subscribe to the issue, thus affecting their confidence levels

Initial Public Offer (IPO) Method

The public issue made by a corporate entity for the first time in its life is called ‘Initial Public Offer’ (IPO). Under this method of marketing, securities are issued to successful applicants on the basis of the orders placed by them, through their brokers.

When a company whose stock is not publicly traded wants to offer that stock to the general public, it takes the form of ‘Initial Public Offer’. The job of selling the stock is entrusted to a popular intermediary, the underwriter. An underwriter is invariably an investment banking company. He agrees to pay the issuer a certain price for a minimum number of shares, and then resells those shares to buyers, who are often the clients of the underwriting firm. The underwriters charge a fee for their services.

Stocks are issued to the underwriter after the issue of prospectus which provides details of financial and business information as regards the issuer. Stocks are then released to the underwriter and the underwriter releases the stock to the public.

The issuer and the underwriting syndicate jointly determine the price of a new issue. The approximate price listed in the red herring (the preliminary prospectus–often with words in red letters which say this is preliminary and the price is not yet set) many or may not be close to the final issue price. IPO stock at the release price is usually not available to most of the public. Good relationship between the broker and the investor is a pre requisite for the stock being acquired.

Full disclosure of all material information in connection with the offering of new securities must be made as part of the new offerings. A statement and preliminary prospectus

(also known as a red herring) containing the following information is to be filed with the Registrar of Companies:

A description of the issuer’s business

The names and addresses of the key company officers, with salary and a 5 year business history on each

The amount of ownership of the key officers

The company’s capitalization and description of how the proceeds from the offering will be used and

Any legal proceedings that the company is involved in

Applications are made by the investors on the advice of their brokers who are intimated of the share allocation by the issuer. The amount becomes payable to the issuer through the broker only on final allocation. The allotment is credited and share certificates delivered to the depository account of the successful investor.

The essential steps involved in this method of marketing of securities are as follows:

Order: Broker receives order from the client and places orders on behalf of the client with the issuer.

Share allocation: The issuer finalizes share allocation and informs the broker regarding then same.

The client: The broker advises the successful clients of the share allocation. Clients then submit the application forms for shares and make payment to the issuer through the broker.

Primary issue account: The issuer opens a separate escrow account (primary issue account) for the primary market issue. The clearing house of the exchange debits the primary issue account of the broker and credits the issuer’s account.

Certificates: Certificates are then delivered to investors. Otherwise depository account may be credited.

The biggest advantage of this method of marketing of securities is that there is no need for the investors to part with the money even before the shares are allotted in his favor. Further, the method allows for elimination of unnecessary hassles involved in making a public issue. Under the regulations of the SEBI, IPOs can be carried out through the secondary market and the existing infrastructure of stock exchanges can be used for this purpose.

Rights Issue Method

Where the shares of an existing company are offered to its existing shareholders, it takes the form of ‘rights issue’. Under this method, the existing company issues shares to its existing shareholders in proportion to the number of shares already held by them.

The relevant guidelines issued by the SEBI in this regard are as follows:

Shall be issued only by listed companies     

Announcement regarding rights issue once made, shall not be withdrawn and where withdrawn, no security shall be eligible for listing up to 12 month

Underwriting as to rights issue is optional and appointment of Registrar is compulsory

Appointment of category I Merchant Bankers holding a certificate of registration issued by SEBI shall be compulsory

Rights shares shall be issued only in respect of fully paid shares

Letter of Offer shall contain disclosures as per SEBI requirements

Agreement shall be entered into with the depository for materialization of securities to be issued

Issue shall be kept open for a minimum period of 30 days and for a maximum period of 60 days

A minimum subscription of 90 percent of the issue shall be received

No reservation is allowed for rights issue as regards FCDs and PCDs

A ‘No Complaints Certificate’ is to be filed by the ‘Lead Merchant Banker’ with the SEBI after 21 days from the date of issue of offer document

Obligatory for a company where increase in subscribed capital is necessary after two years of its formation or after one year of its first issue of shares, whichever is earlier (this requirement may be dispensed with by a special resolution

Advantages

Rights issue offers the following advantages:

Economy

The issue management procedures connected with the rights issue is easier as only a limited number of applications are to be handled.

Advantage to Shareholders

Issue of rights shares does not involve any dilution of ownership of existing share-holders. Further, it offers freedom to shareholders to subscribe or not to subscribe the issue.

Drawbacks

The method suffers from the following limitations:

Restrictive

The facility of rights issue is available only to existing companies and not to new companies.

Against Society

The issue of rights shares runs counter to the overall societal considerations of diffusion of share ownership for promoting dispersal of wealth and economic power.

Bonus Issues Method

Where the accumulated reserves and surplus of profits of a company are converted into paid up capital, it takes the form of issue of ‘bonus shares’. It merely implies capitalization of existing reserves and surplus of a company. The issue of bonus shares is subject to certain rules and regulations. The issue does not in any way affect the resources base of the enterprise. It saves the company enormously of the hassles of capital issue.

Issued under Section 205 (3) of the Companies Act, such shares are governed by the guidelines issued by the SEBI (applicable to listed companies only) as follows:

SEBI Guidelines

Following are the guidelines pertaining to the issue of bonus shares by a listed corporate enterprise:

Reservation: In respect of FCDs and PCDs, bonus shares must be reserved in proportion to such convertible part of FCDs and PCDs. The shares so reserved may be issued at the time of conversion(s) of such debentures on the same terms on which the bonus issues were made.

Reserves: The bonus issue shall be made out of free reserves built out of the genuine profits or share premium collected in cash only. Reserves created by revaluation of fixed assets are not capitalized.

Dividend mode: The declaration of bonus issue, in lieu of dividend, is not made.

Fully paid: The bonus issue is not made unless the partly paid shares, if any are made fully paid-up.

No default: The Company has not defaulted in payment of interest or principal in respect of fixed deposits and interest on existing debentures of principal on redemption thereof and has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity, bonus, etc.

Implementation: A company that announces its bonus issue after the approval of the Board of Directors must implement the proposal within a period of 6 months from the date of such approval and shall not have the option of changing the decision.

The articles: The Articles of Association of the company shall contain a provision for capitalization of reserves, etc. If there is no such provision in the Articles, the company shall pass a resolution at its general body meeting making provisions in the Articles of Associations for capitalization.

Resolution: Consequent to the issue of bonus shares if the subscribed and paid-up capital exceeds the authorized share capital, the company at its general body meeting for increasing the authorized capital shall pass a resolution.

Rights Issue vs. Bonus Issue

Bonus issue is different from rights issue in the following respects:

Book-Building Method

A method of marketing the shares of a company whereby the quantum and the price of the securities to be issued will be decided on the basis of the ‘bids’ received from the prospective shareholders by the lead merchant bankers is known as ‘book-building method’. Under the book-building method, share prices are determined on the basis of real demand for the shares at various price levels in the market. For discovering the price at which issue should be made, bids are invited from prospective investors from which the demand at various price levels is noted. The merchant bankers undertake full responsibility for the issue.

The option of book-building is available to all body corporate, which are otherwise eligible to make an issue of capital to the public. The initial minimum size of issue through book-building route was fixed at ` 100 crores. However, beginning from December 9, 1996 issues of any size will be allowed through the book-building route.

Book-building facility is available as an alternative to firm allotment. Accordingly, a company can opt for book-building route for the sale of shares to the extent of the percentage of the issue that can be reserved for firm allotment as per the prevailing SEBI guidelines. It is therefore possible either to reserve securities for firm allotment or issue them through the book-building process.

The book-building process involves the following steps:

Appointment of book-runners: The first step in the book-building process is the appointment by the issuer company, of the book-runner, chosen from one of the lead merchant bankers. The book-runner in turn forms a syndicate for the book building. A syndicate member should be a member of National Stock Exchange (NSE) or Over-The-Counter Exchange of India (OTCEI). Offers of ‘bids’ are to be made by investors to the syndicate members, who register the demands of investors. The bid indicates the number of shares demanded and the prices offered. This information, which is stored in the computer, is accessible to the company management or to the book-runner. The name of the book-runner is to be mentioned in the draft prospectus submitted to SEBI.

Drafting prospectus: The draft prospectus containing all the information except the information regarding the price at which the securities are offered is to be filed with SEBI as per the prevailing SEBI guidelines. The offer of securities through this process must separately be disclosed in the prospectus, under the caption ‘placement portion category’. Similarly, the extent of shares offered to the public shall be separately shown under the caption ‘net offer to the public’. According to the latest SEBI guidelines issued in October 1999, the stipulation that at least 25 percent of the securities were to be issued to the public has been done away with. This is aimed at enabling companies to offer the entire public issue through the book-building route.

Circulating draft prospectus: A copy of the draft prospectus filed with SEBI is to be circulated by the book-runner to the prospective institutional buyers who are eligible for firm allotment and also to the intermediaries who are eligible to act as underwriters. The objective is to invite offers for subscribing to the securities. The draft prospectus to be circulated must indicate the price-bank within which the securities are being offered for subscription.

Maintaining offer records: The book-runner maintains a record of the offers received. Details such as the name and the number of securities ordered together with the price at which each institutional buyer or underwriter is willing to subscribe to securities under the placement portion must find place in the record. SEBI has the right to inspect such records.

Intimation about aggregate orders: The underwriters and the institutional investors shall give intimation on the aggregate of the offers received to the book-runner.

Bid analysis: The bid analysis is carried out by the book-runner immediately after the closure of the bid offer date. An appropriate final price is arrived at after a careful evaluation of demands at various prices and the quantity. The final price is generally fixed reasonably lower than the possible offer price. This way, the success of the issue is ensured. The issuer company announces the pay-in-date at the expiry of which shares are allotted.

Mandatory underwriting: Where it has been decided to make offer of shares to public under the category of ‘Net Offer to the Public’, it is incumbent that the entire portion offered to the public is fully underwritten. In case an issue is made through book-building route, it is mandatory that the portion of the issue offered to the public be underwritten. For this purpose, an agreement has to be entered into with the underwriter by the issuer. The agreement shall specify the number of securities as well as the price at which the underwriter would subscribe to the securities. The book-runner may require the underwriter of the net offer to the public to pay in ad-vance all moneys required to be paid in respect of their underwriting commitment.

Filing with ROC: A copy of the prospectus as certified by the SEBI shall be filed with the Registrar of Companies within two days of the receipt of the acknowledgement care from the SEBI.

Bank accounts: The issuer company has to open two separate accounts for collection of application money, one for the private placement portion and the other for the public subscription.

Collection of completed applications: The book-runner collects from the institutional buyers and the underwriters the application forms along with the application money to the securities proposed to be allotted to them or subscribed by them. This is to be done one day before the opening of the issue to the public.

Allotment of securities: Allotment for the private placement portion may be made on the second day from the closure of the issue. The issuer company, however, has the option to choose one date for both the placement portion and the public portion. The said date shall be considered to be the date of allotment for the issue of securities through the book-building process. The issuer company is permitted to pay interest on the application moneys till the date of allotment or the deemed date of allotment provided that payment of interest is uniformly given to all the applicants.

Payment schedule and listing: The book-runner may require the underwriters to the ‘net offer to the public’ to pay in advance all moneys required to be paid in respect of their underwriting commitment by the eleventh day of the closure of the issue. In that case, the shares allotted as per the private placement category will become eligible for being listed. Allotment of securities under the public category is to be made as per the prevailing statutory requirements.

Under-subscription: In the case of under-subscription in the ‘net offer to the public’ category, any spillover to the extent of under-subscription is to be permitted from the ‘placement portion’ category subject to the condition that preference is given to the individual investors. In the case of under-subscription in the placement portion, spillover is to be permitted from the net offer to the public to the placement portion.

Advantages of Book-building

Book-building process is of immense use in the following ways:

Reduction in the duration between allotment and listing

Quick listing in stock exchanges possible

No price manipulation as the price is determined on the basis of the bids received

Stock Option or Employees Stock Option Scheme (ESOP)

A method of marketing the securities of a company whereby its employees are encouraged to take up shares and subscribe to it is known as ‘stock option’. It is a voluntary scheme on the part of the company to encourage employees’ participation in the company. The scheme also offers an incentive to the employees to stay in the company. The scheme is particularly useful in the case of companies whose business activity is dominantly based on the talent of the employees, as in the case of software industry. The scheme helps retain their most productive employees in an industry, which is known for its constant churning of personnel.

SEBI Guidelines

Company whose securities are listed on any stock exchange can introduce the scheme of employees’ stock option. The offer can be made subject to the conditions specified below:

Issue at discount: Issue of stock options at a discount to the market price would be regarded as another form of employee compensation and would be treated as such in the financial statement of the company regardless the quantum of discount on the exercise price of the options.

Approval: The issue of ESOPs is subject to the approval by the shareholders through a special resolution.

Maximum limit: There would be no restriction on the maximum number of shares to be issued to a single employee. However, in cases of employees being offered more than 1 percent shares, a specific disclosure and approval would be necessary in the AGM.

Minimum period: A minimum period of one year between grant of options and its vesting has been prescribed. After one year, the company would de4termine the period during which the option can be exercised.

Superintendence: The operation of the ESOP Scheme would have to be under the superintendence and direction of a Compensation Committee of the Board of Directors in which there would be a majority of independent directors.

Eligibility: ESOP scheme is open to all permanent employees and to the directors of the company but not to promoters and large shareholders. The scheme would be applicable to the employees of the subsidiary or a holding company with the express approval of the shareholders.

Director’s report The Director’s report shall make a disclosure of the following:

Total number of shares as approved by the shareholders

The pricing formula adopted

Details as to options granted, options vested, options exercised and options forfeited, extinguishments or modification of options, money realized by exercise of options, total number of options in force, employee-wise details of options granted to senior managerial personnel and to any other employee who receive a grant in any one year of options amounting to 5 percent or more of options granted during that year

Fully diluted EPS computed in accordance with the IAS

IPO SEBI’s stipulations prohibiting initial public offerings by companies having outstanding options should not apply to ESOP. If any ESOPs are outstanding at the time of an IPO issue by an unlisted company, the promoters’ contribution shall be calculated with reference to the enlarged that would arise if all vested options were exercised

Capital Market Instruments

The changes that are sweeping across the Indian capital market especially in the recent past are something phenomenal. It has been experiencing metamorphic changes in the last decade, thanks to a host of measures of liberalization, globalization, and privatization that have been initiated by the Government. Pronounced changes have occurred in the realm of industrial policy, licensing policy, financial services industry, interest rates, etc.

The competition has become very intense and real in both industrial sector and financial services industry.

As a result of these changes, the financial services industry has come to introduce a number of instruments with a view to facilitate borrowing and lending of money in the capital market by the participants.

Meaning

Financial instruments that are used for raising capital resources in the capital market are known as ‘Capital Market Instruments’.

Types

The various market instruments used by corporate entities for raising resources are as follows:

Preference shares

Equity shares

Nonvoting equity shares

Cumulative convertible preference shares

Company fixed deposits

Warrants

Debentures and Bonds

Preference Shares

Meaning

Shares that carry preferential rights in comparison with ordinary shares are called ‘Preference Shares’. The preferential rights are the rights regarding payment of dividend and the distribution of the assets of the company in the event of its winding up, in preference to equity shares.

Types

Cumulative preference shares: Shares where the arrears of dividends in times of no and/so lean profits can be accumulated and paid in the year in which the company earns good profits.

Noncumulative preference shares: Shares where the carry forward of the arrears of dividends is not possible.

Participating preference shares: Shares that enjoy the right to participate in surplus profits or surplus assets on the liquidation of a company or in both, if the Articles of Association provides for it.

Redeemable preference shares: Shares that are to be repaid at the end of the term of issue, the maximum period of a redemption being 20 years with effect from 1.3.1997 under the Companies Amendment Act, 1996. Since they are repayable, they are similar to debentures. Only fully paid shares are redeemed. Where redemption is made out of profits, a Capital Redemption Reserve Account is opened to which a sum equal to the nominal value of the shares redeemed is transferred. It is treated as paid-up share capital of the company.

Fully convertible cumulative preference shares: Shares comprise two parts, viz. Part A and B. Part A is convertible into equity shares automatically and compulsorily on the date of allotment. Part B will be redeemed at par/converted into equity shares after a lock-in period at the option of the investor, conversion into equity shares taking place after the lock-in period, at a price, which would be 30 percent lower than the average market price. The average market price shall be the average of the monthly high and low price of the shares in a stock exchange over a period of 6 months including the month in which the conversion takes place.

Preference shares with warrants attached: The attached warrants entitle the holder to apply for equity shares for cash, at a ‘premium’, at any time, in or more stages between the third and fifth year from the date of allotment. If the warrant holder fails to exercise his option, the unsubscribed portion will lapse. The holders of warrants would be entitled to all rights/bonus shares that may be issued by the company. The preference shares with warrants would be entitled attached would not be transferred/ sold for a period of 3 years from the date of allotment.

Equity Shares

Meaning

Equity shares, also known as ‘ordinary shares’ are the shares held by the owners of a corporate entity.

Features

Since equity shareholders face greater risks and have no specific preferential rights, they are given larger share in profits through higher dividends than those given to preference shareholders, provided the company’s performance is excellent. Directors declare no dividends in case there are no profits or the profits do not justify dividend. For pervious years even when the company makes substantial profits are subsequent years. Equity shareholders also enjoy the benefit of ploughing back of undistributed profits kept as reserves and surplus for the purposes of business expansion. Often, part of these is distributed to them as bonus shares. Such bonus shares are entitled to a proportionate or full dividend in the succeeding year.

A strikingly noteworthy, namely feature of equity shares is that holders of these shares enjoy substantial rights in the corporate democracy, namely the rights to approve the company’s annual accounts, declaration of dividend, enhancement of managerial remuneration in excess of specified limits and fixing the terms of appointment and election of directors, appointment of auditors and fixing of their remuneration, amendments to the Articles and Memorandum of Association, increase of share capital and issue of further shares of debentures, proposals for mergers and reconstruction, and any other important proposal on which member’s approval is required under the Companies Act.

Equity shares in the hands of shareholders are mainly reckoned for determining in the management’s control over the company. Where shareholders are widely disbursed, it is possible for the management to retain the control, as it is not possible for all the shareholders to attend the company’s meeting in full strength. Furthermore, the management group can bolster its controlling power by acquiring further shares in the open market or otherwise. Equity share may also be offered to financial institutions as part of the private placement exercise. Such a method, however, if fraught with the danger of takeover attempt by financial institutions.

Equity shareholders represent proportionate ownership in a company. They have residual claims on the assets and profits of the company. They have unlimited potential for dividend payments and price appreciation in comparison to the owners of debentures and preference share who enjoy just a fixed assured return in the form of interest and dividend. Higher the risk, higher the return and vice versa.

Share certificates either in physical form or in the demat (with the introduction of depository system in 1996) form are issued as a proof of ownership of the share in a company. Demat facilitates electronic trading. Fully paid equity shares with detachable warrants entitle the warrant holder to apply for a specified number of shares at a determined price. Detachable warrants are separately registered with stock exchanges and traded separately. The company would determine the terms and conditions relating to the issue of equity against warrants.

Voting rights are granted under the Companies Act (Sections 87 to 89) where in each shareholder is eligible for votes proportionate to the number of shares held or the amount of stock owned. A company cannot issue shares carrying disproportionate voting rights. Similarly, voting right cannot be exercised in respect of shares on which the shareholder owes some money to the company.

Capital

Equity shares are of different types. The maximum value of shares as specified in the Memorandum of Association of the company is called the authorized or registered or nominal capital. Issued capital is the nominal value of share offered for public subscription. In case shares offered for public subscription are not taken up, the portion of capital subscribed is called subscribed capital. This is less than the issued capital. Paid-up capital is the share capital paid-up by shareholders which is credited as paid-up on the shares.

Par Value and Book Value

The face value of a share is called its Par value. Although shares can be sold below the par value, it is possible that shares can be issued below the par value. The financial institutions that convert their unpaid principal and interest into equity in sick companies are compelled to do it at a minimum of ` 10 because of the par value concept even though the market price might be much less than ` 10 Par value can also lead to unhealthy practices like price rigging by promoters of sick companies to take market prices above ` 10 to get their new of shares.

Book value is the intrinsic value of a share that is calculated to reflect the net worth of the shareholders of a corporate entity.

Cash Dividends

These are dividends paid in cash. A stable payment of cash dividends is the hallmark of stability of share prices.

Stock Dividends

These are the dividends distributed as shares and issued by capitalized reserves. While net worth remains the same in the balance sheet, its distribution between shares and surplus is altered.

Nonvoting Equity Shares

Consequent to the recommendations of the ‘Abid Hussain Committee’ and subsequent to the amendment to the Companies Act, corporate managements are permitted to mobilize additional capital without diluting the interest of existing shareholders with the help of a new instrument called ‘nonvoting equity shares’. Such share will be entitled to all the benefits except the right to vote in general meetings.

Such nonvoting equity share is being considered as a possible addition to the two classes of share capital currently in vogue. This class of shares has been included by an amendment to the Companies Act as a third category of shares. Corporates will be permitted to issue shares upto a certain percentage of the total share capital.

Nonvoting equity shares will be entitled to rights and bonus issues and preferential offer of shares on the same lines as that of ordinary shares. The objective will be to compensate the sacrifice made for the voting rights. For this purpose, these shares will carry higher dividend rate than that of voting shares. If a company fails to pay dividend, nonvoting shareholders will automatically be entitled to voting rights on a prorata basis until the company resumes paying dividend.

The mechanism of issue of nonvoting share is expected to overcome such problems as are associated with the voting shares as that the ordinary investors are more inclined towards high return on capital through sizeable dividends and capital appreciation through the issue of bonus shares and the inability of corporates to respond to the investors’ just aspiration for reasonable dividends.

Moreover, there is every need for corporate to spend huge sums of money of a variety of non-so-useful items including colorful and costly annual reports. For all these above mentioned reasons, nonvoting equity shares are expected to have a ready and popular market. In effect, this kind of share is similar to preference shares with regard to nonvoting rights but may get the advantage of higher dividends as well as appreciation in share through entitlement to bonus shares which is not available to preference shares.

Convertible Cumulative Prefernce Shares (CCPS)

These are the shares that have the twin advantage of accumulation of arrears of dividends and the conversion into equity shares. Such shares would have to be to the face value of ` 100 each. The shares have to be listed on one or more stock exchanges in the country. The object of the issue of CCP shares is to allow for the setting up of new projects, expansion or diversification of existing projects, expansion or diversification of existing projects, normal capital expenditure for modernization and for meeting working capital requirements.

Debt-Equity Ratio

For the purpose if calculation of debt-equity ratio as may be applicable CCPS are be deemed to be an equity issue.

Compulsory Conversion

The conversion into equity shares must be for the entire issue of CCP shares and shall be done between the periods at the end of the three years and five years as may be decided by the company. This implies that the conversion of the CCP into equity shares would be compulsory at the end of five years and the aforesaid preference shares would not be redeemable at any stage.

Fresh Issue

The conversion of CCP shares into equity would be deemed as being one resulting from the process of redemption of the preference shares out of the proceeds of a fresh issue of shares made for the purposes of redemption.

Preference Dividend

The rate of preference dividend payable on CCP shares would be 10 percent.

Guideline Ratio

The guideline ratio of 1:3 as between preference shares and equity shares would not be applicable to these shares.

Arrears of Dividend

The right of receive arrears of dividend up to the date of conversion, if any, shall devolve on the holder of the equity shares on such conversion. The holder of the equity shares shall be receiving the arrears of dividend as and when the company makes profit and is able to declare such dividend.

Voting Right

CCPS would have voting rights as applicable to preference shares under the Companies Act, 1956.

Quantum

The amount of the issue of CCP shares would be to the extent the company would be offering equity shares to the public for subscription.

Company Fixed Deposits

Fixed deposits are the attractive source of short-term capital both for the companies and investors as well. Corporate favor fixed deposits as an ideal form of working capital mobilization without going through the process of mortgaging assets and the associated rigmaroles of documentation, etc. Investors find fixed deposits a sample avenue for investment in popular companies at attractively reasonable and safe interest rates. Moreover, investors are relieved of the problem of the hassles of market value fluctuation to which instruments such as shares and debentures are exposed. There are no transfer formalities either. In addition, it is quite possible for investors to have the option of premature repayment after 6 months, although such an option entails some interest loss.

Regulations

Since these instruments are unsecured, there is a lot of uncertainty about the repayment of deposits and regular payment of interest. The issue of fixed deposits is subject to the provisions of the Companies Act and the Companies (Acceptance of Deposits) Rules introduced in February 1975. Some of the important regulations in this regard as follows:

Advertisement Issue of an advertisement (with the prescribed information) as approved by the Board of Directors in dailies circulating in the state of incorporation.

Liquid assets Maintenance of liquid assets equal to 15 percent (substituted for 10% by Amendment Rules, 1992) of deposits (maturing during the year ending March

in the form of bank deposits, unencumbered securities of State and Central

Governments or unencumbered approved securities.

Disclosure Disclosure in the newspaper advertisement the quantum of deposits remaining unpaid after maturity. This would help highlight the defaults, if any, by the company and caution the depositors.

Deemed public company Private company would become a deemed public company (from June 1998, Section 43A of the Act) where such a private company, after inviting public deposits through a statutory advertisement, accepts or renews deposits from the public other than its members, directors or their relatives. This provision, to a certain extent, enjoins better accountability on the part of the management and auditors.

Default Penalty under the law for default by companies in repaying deposits as and when they mature for payment where deposits were accepted in accordance with the Reserve Bank directions.

CLB Empowerment to the Company Law Board to direct companies to repay deposits, which have not been repaid as per the terms and conditions governing such deposits, within a time frame and according to the terms and conditions of the order.

Warrants

An option issued by a company whereby the buyer is granted the right to purchase a number of shares (usually one) of its equity share capital at a given exercise price during a given period is called a ‘warrant’. Although trading in warrants are in vogue in the U.S. Stock markets for more than 6 to 7 decades, they are being issued to meet a range of financial requirements by the Indian corporates.

A security issued by a company, granting its holder the right to purchase a specified number of shares, at a specified price, any time prior to an expirable date is known as a ‘warrant’.

Warrants may be issued with either debentures or equity shares. They clearly specify the number of shares entitled, the expiration date, along with the stated/exercise price. The expiration date of warrants in USA is generally 5 to 10 years from the date of issue and the exercise price is 10 to 30 percent above the prevailing market price. Warrants have a secondary market.

The exchange value between the share at its current price and the shares to be purchased at the exercise price represents the minimum value of a warrant. They have no floatation costs and when they are exercised, the firm receives additional funds at a price lower than the current market, yet higher than those prevailing at the time of issue. Warrants are issued by new/growing firms and venture capitalists. They are also issued during mergers and acquisitions. Warrants in the context are called ‘sweeteners’ and were issued by a few Indian companies since 1993.

Both warrants and rights entitle a buyer to acquire equity shares of the issuing company. However, they are different in the sense that warrants have a life span of three to five years whereas; rights have a life span of only four to twelve weeks (duration between the opening and closing date of subscription list). Moreover, rights are normally issued to effect current financing, and warrants are sold to facilitate future financing. Similarly, the exercise price of warrant, i.e. the price at which it can be exchanged for share, is usually above the market price of the share so as to encourage existing shareholders to purchase it. On the other hand, one warrant buys one equity share generally, whereas more than one right may be needed to buy one share. The detachable warrant attached to each share provides a right to the warrant holder to apply for additional equity share against each warrant.

Debentures And Bonds

A document that either creates a debt or acknowledges it is known as a debenture. Accordingly, and document that fulfills either of these conditions is a debenture. A debenture, issued under the common seal of the company, usually takes the form of a certificate that acknowledges indebtedness of the company.

A document that shows on the face of it that a company has borrowed a sum of money from the holder thereof upon certain terms and conditions is called a debenture. Debentures may be secured by way of fixed or floating charges on the assets of the company. These are the instruments that are generally used for raising long-term debt capital.

Features

Following are the features of debenture:

ISSUE: In India, debentures of various kinds are issued by the corporate bodies, Government, and others as per the provisions of the Companies Act, 1956 and under the regulations of the SEBI. Section 117 of the Companies Act prohibits issue of debentures with voting rights. Generally, they are issued against a charge on the assets of the company but at times may be issued without any such charge also. Debentures can be issued at a discount in which case, the relevant particulars are to be filed with the registrar of Companies.

Negotiability: In the case of bearer debentures the terminal value is payable to its bearer. Such instruments are negotiable and are transferable by delivery. Registered debentures are payable to the registered holder whose name appears both on the debenture and in the register of debenture holders maintained by the company. Further, transfer of such debentures should be registered. They are not negotiable instruments and contain a commitment to pay the principal and interest.

Security: Secured debentures create a charge on the assets of the company. Such a charge may be either fixed or floating. Debentures that are issued without any charge on assets of the company. Are called ‘unsecured or naked debentures’.

Duration: Debentures, which could be redeemed after a certain period of time, are called Redeemable Debentures. There are debentures that are not to be returned except at the time of winding up of the company. Such debentures are called Irredeemable Debentures.

Convertibility: Where the debenture issue gives the option of conversion into equity shares after the expiry of a certain period of time, such debentures are called Convertible Debentures. Nonconvertible Debentures, on the other hand, do not have such an exchange facility.

Return: Debentures have a great advantage in them in that they carry a regular and reasonable income for the holders. There is a legal obligation for the company to make payment of interest on debentures whether or not any profits are earned by it.

Claims: Debenture holders command a preferential treatment in the matters of distribution of the final proceeds of the company at the time of its winding up. Their claims rank prior to the claims of preference and equity shareholders.

Kinds

Innovation debt instruments that are issued by the public limited companies in India are described below:

1. Participating debentures

2. Convertible debentures

3. Debt-equity swaps

4. Zero coupon convertible notes

5. Secured premium notes (SNP) with detachable warrants

6. Nonconvertible debentures (NCDs) with detachable equity warrant

7. Zero interest fully convertible debentures (FCDs)

8. Secured zero interest partly convertible debentures (PCDs) with detachable and

separately tradable warrants

9. Fully convertible debentures (FCDs) with interest (optional)

10. Floating rate bonds (FRB)

Participating Debentures

Debentures that are issued by a body corporate which entitle the holders to participate in its profits are called ‘Participating Debentures’. These are the unsecured corporate debt securities. They are popular among existing dividend paying corporates.

Convertible Debentures

Convertible debentures with options are a derivation of convertible debentures that give an option to both the issuer, as well as the investor, to exit from the terms of the issue. The coupon rate is specified at the time of issue

Third party convertible debentures are debts with a warrant that allow the investor to subscribe to the equity of a third firm at a preferential price vis-à-vis market price, the interest rate on the third party convertible debentures being lower than pure debt on account of the conversion option

Convertible debentures redeemable at a premium are issued at face value with a put option entitling investors to sell the bond to the issuer, at a premium later on. They are basically similar to convertible debentures but have less risk

Debt-equity swaps: They are offered from an issuer of debt to swap it for equity. The instrument is quite risky for the investor because the anticipated capital appreciation may not materialize.

Zero-coupon convertible note: These are debentures that can be converted into shares and on its conversion the investor forgoes all accrued and unpaid interest. The zero coupon convertible notes are quite sensitive to changes in the interest rates.

SPN with detachable warrants: These are the Secured Premium Notes (SPN) with detachable warrants. These are the redeemable debentures that are issued along with a detachable warrant. The warrant entitles the holder to apply and get equity shares allotted, provided the SPN is fully paid. The warrants attached to it assure the holder such a right. No interest will be paid during the lock-in period for SPN.

The SPN holder has an option to sell back the SPN to the company at par value after the lock-in period. If this option is exercised by the holder, no interest/premium will be paid on redemption. The holder will be repaid the principal and the additional interest/premium amount in installments as may be decided by the company. The conversion of detachable warrant into equity shares will have to be done within the time limit notified by the company.

NCDs with detachable equity warrants: These are Non convertible debentures (NCDs) with detachable equity warrants. These entitle the holder to buy a specific number of shares from the company at a predetermined price within a definite time frame. The warrants attached to NCDs are issued subject to full payment of the NCDs’ value. The option can be exercised after the specific lock-in period. The company is at liberty to dispose off the unapplied portion of shares if the option to apply for equities is not exercised.

Zero interest FCDs: These are Zero interest Fully Convertible Debentures on which no interest will be paid by the issuer during the lock-in period. However, there is a notified period after which fully paid FCDs will be automatically and compulsorily converted into shares. In the event of a company going in for rights issue prior to the allotment of equity (resulting from the conversion of equity shares into FCDs), it shall do so only after the FCD holders are offered securities.

Secured zero interest PCDs with detachable and separately tradable warrants: These are Secured Zero Interest Partly Convertible Debentures with detachable and separately tradable warrants. They are issued in two parts. Part A is a convertible portion that allows equity shares to be redeemed at par at the end of a specific period from the date of allotment. Part B is a nonconvertible portion to be redeemed at par at the end of a specific period from the date of allotment. Part B which carries a detachable and separately tradable warrant provides the warrant holder an option to receive equity shares for every warrant held, at a price worked out by the company.

Fully Convertible Debentures (FCDs) with interest (Optional): These are the debentures that will not yield any interest for an initial short period after which the holder is given an option to apply for equities at a premium. No additional amount needs to be paid for this. The option has to be indicated in the application form itself. Interest on FCDs is payable at a determined rate from the date of first conversion to the data of second/final conversion and in lieu of it, equity shares will be issued.

Floating Rate Bonds (FRBs): These are the bonds where the yield is linked to a benchmark interest rate like the prime rate in USA or LIBOR in the Euro currency market. For instance, the State Bank of India’s floating rate bond, issue was linked to the maximum interest on term deposits that was 10 percent at that time. The floating rate is quoted in terms of a margin above or below the benchmark rate. Interest rates linked to the benchmark ensure that neither the borrower nor the lender suffer from the changes in interest rates. Where interest rates are fixed, they are likely to be inequitable to the borrower when interest rates fall and inequitable to the lender when interest rates rise subsequently.

Shares vs. Debentures

Shares are different from debentures in the following manner:

Shareholder has a proprietary interest in the company, and debenture holder is only a creditor of the company

Debenture holder is entitled to fixed interest whereas the shareholder is entitled to dividends depending on and varying with profits

Shareholders have voting rights whereas debenture holders do not have voting rights

Debentures may be redeemable whereas shares except preference shares are not redeemable

Debenture holders get priority over shareholders when assets are distributed upon winding up

Global Debt Instruments

Following are some of the debt instruments that are popular in the international financial markets:

Income Bonds

Interest income on such bonds is paid only where the corporate commands adequate cash flows. They resemble cumulative preference shares in respect of which fixed dividend is paid only if there is profit earned in a year, but carried forward and paid in the following year. There is no default on income bonds if interest is not paid. Unlike the dividend on cumulative preference shares, the interest on income bond is tax deductible. These bonds are issued by corporates that undergo financial restructuring.

Asset Backed Securities

These are a category of marketable securities that are collateralized by financial assets such as installment loan contracts. Asset backed financing involves a disintermediating process called securitization, whereby credit from financial intermediaries in the form of debentures are sold to third parties to finance the pool. Respos are the oldest asset backed security in our country. In USA, securitization has been undertaken for the following:

Insured mortgages

Mortgage backed bonds

Student loans

Trade credit receivable backed bonds

Equipments leasing backed bonds

Certificates of automobile receivable securities

Small business administration loans

Credit and receivable securities

Junk Bonds

Junk bond is a high risk, high yield bond which finances either a Leveraged Buyout (LBO) or a merger of a company in financial distress. Junk bonds are popular in the USA and are used primarily for financing takeovers. The coupon rates range from 16 to 25 percent. Attractive deals were put together establishing their feasibility in terms of adequacy of cash flows to meet interest payments. Michael Milken (the junk bond king) of Drexel Burnham Lambert was the real developer of the market.

Indexed Bonds

These are the bonds whose interest payment and redemption value are indexed with movements in prices. Indexed bonds protect the investor from the eroding purchasing power of money because of inflation. For instance, an inflation-indexed bond implies that the payment of the coupon and/or the redemption value increases or decreases according to movements in prices. The bonds are likely to hedge the principal amount against inflation. Such bonds are designed to provide investors an effective edge against inflation so as to enhance the credibility of the anti-inflationary policies of the Government. The yields of an inflation-indexed bond provide vital information on the expected rate of inflation.

United Kingdom, Australia, and Canada have introduced index linked government securities as a segmented internal debt management operation with a view to increase the range of assets available in the system, provide an inflation hedge to investors, reduce interest costs and pick up direct signals, and the expected inflation and real rate of interest from the market.

Zero Coupon Bonds (ZCBs)/Zero Coupon Convertible Debentures

Zero Coupon Bonds first came to be introduced in the U.S. securities market. Initially, such bonds were issued for high denominations. These bonds were purchased by large security brokers in large chunks, who resold them to individual investors, at a slightly higher price in affordable lots. Such bonds were called ‘Treasury Investment Growth Receipts’ (TIGRs) or ‘Certificate of Accruals on Treasury Securities’ (CATSs) or ZEROs as their coupon rate is Zero. Moreover, these certificates were sold to investors at a hefty discount and the difference between the face value of the certificate and the acquisition cost was the gain. The holders are not entitled for any interest except the principal sum of maturity.

Mahindra & Mahindra came out with the scheme of Zero Coupon Bonds for the first time in India along with 12.5 percent convertible bonds for part financing of its modernization and diversification scheme. Similarly, Deep Discount Bonds were issued by IDBI at ` 2,000 for a maturity of ` 1 lakh after 25 years.

These are negotiable instruments transferable by endorsement and delivery by the transferor. IDBI also offered Option Bonds which may be either cumulative or noncumulative bonds where interest is payable either on maturity or periodically. Redemption is also offered to attract investors.

Floating Rate Bonds (FRBs)

Bonds that carry the provision for payment of interest at different rates for different time periods are known as ‘Floating Rate Bonds’. The first floating rate bond was issued by the SBI in the Indian capital market. The SBI, while issuing such bonds, adopted a reference rate of highest rate of interest on fixed deposit of the Bank, provided a minimum floor rate payable at 12 percent p.a. and attached a call option to the Bank after 5 years to redeem the bonds earlier than the maturity period of 10 years at a certain premium. A major highlight of the bonds was the provision to reduce interest risk and assurance of minimum interest on the investment provided by the Bank.

Secured Premium Notes (SPNs)

Secured debentures that are redeemable at a premium over the issue price or face value are called secured premium notes. Such bonds have a lock-in period during which period no interest will be paid. It entitles the holder to sell back the bonds to the issuing company at par after the lock-in period.

A case in point was the issue made by the TISCO in the year 1992, where the company wanted to raise money for its modernization program without expanding its equity excessively in the next few years. The company made the issue to the existing shareholders on a rights basis along with rights issue. The salient features of the TISCO issue were as follows:

Face value of each SPN was ` 300

No interest was payable during the first three years after allotment

The redemption started at the end of the fourth year of issue

Each of the SPN of ` 300 was repaid in four equal annual instalments of ` 75, which comprised of the principal, the interest and the relevant premium. (Low interest and high premium or high interest and low premium, at the option to be exercised by the SPN holder at the end of the third year)

Warrant attached to each SPN entitled the holder the right to apply for or seek allotment of one equity share for cash payment of ` 80 per share. Such a right was exercisable between first year and one-and-a-half year after allotment by which time the SPN would be full paid up
This instrument tremendously benefited TISCO, as there was no interest outgo.

This helped TISCO to meet the difficulties associated with the cash generation. In addition, the company was able to borrow at a cheap rate of 13.65 percent as against 17 to 18 percent offered by most companies. This enabled the company to start redemption earlier through the generation of cast flow by the company’s projects. The investors had the flexibility of tax planning while investing in SPNs. The company was also equally benefited as it gave more flexibility.

Euro-Convertible Bonds

Bonds that give the holders of euro bonds to have the instruments converted into a wide variety of options such as the call option for the issuer and the put option for the investor, which makes redemption easy are called ‘Euro-convertible bonds’. A euro-convertible bond essentially resembles the Indian convertible debenture but comes with numerous options attached. Similarly, a euro-convertible bond is an easier instrument to market than equity. This is because it gives the investor an option to retain his investment as a pure debt instrument in the event of the price of the equity share falling below the conversion price or where the investor is not too sure about the prospects of the company.

Popularity of convertible euro bonds A convertible bond issue allows an Indian company far greater flexibility to tap the Euro market and ensures that the issue has a better market reception than would be possible for a direct equity issue. Moreover, newly industrialized countries such as Korea have chosen the convertible bond market as a stepping-stone to familiarity and acceptance of their industrial companies in the international market.

The convertible bonds offer the following advantages:

Protection: Euro convertible bonds are favored by international investors as it offers them the advantage of protection of their wealth from erosion. This is possible because the conversion is only an option, which the investors may choose to exercise only if it works to their benefit. This facility is not available for equity issues

Liquidity: Convertible bond market offers the benefit of the most liquid secondary market for new issues. Fixed income funds as well as equity investment managers purchase convertible bonds

Flexibility: The feature of flexibility in structuring convertible bonds allows the company to include some of the best possible clauses of investors’ protection by incorporating the unusual features of equity investments. A case in point is the issues made by the Korean corporate sector, which contained a provision in the issue of convertible euro bonds. The provision entitled the holders to ensure the due compliance of the liberalization measures that had already been announced within a specified period of time. Such a provision enabled the investor to opt for a ‘put’ option

Attractive investment: The issue of convertible debentures facilitates removal of many of the unattractive features of equity investment. For investors, convertible bond market makers are the principal sources of liquidity in their securities

Bonds Issue–Indian Experience

In recent times, all-India financial institutions have come to design and introduce special and innovative bond instruments exclusively structured on the investors’ preferences and funds requirement of the issuers.

The emphasis from the issuer’s viewpoint is the resource mobilization and not risk exposure. Several financial institutions such as the IDBI, the ICICI, etc are engaged in the sale of such bonds. A brief description of some these bonds are presented below:

IDBI’s zero coupon bonds, 1996: These bond are sold at a discount and are paid no interest. It is of great advantage to issuers as it is not required for them to make periodic interest payment.

IDBI’s regular income bonds, 1996: These were the bonds issued by the IDBI as 10-year bonds carrying a coupon of 16 percent, payable half-yearly. The bonds provided an annualized yield equivalent to 16.64 percent. The bonds, which were priced at ` 5,000 can be redeemed at the end of every year, after the third year allotment. There was also a call option that entitled the IDBI to redeem the bonds five years from the date of allotment.

Retirement bonds, 1996: The IDBI Retirements Bonds were issued at a discount. The issue targeted investors who are planning for retirement. Under the scheme, investors get a monthly income for 10 years after the expiry of a wait period, the wait period being chosen by the investor. Thereafter, the investors also get a lump sum amount, which is the maturity value of the bond.

IFCI’S bonds, 1996 These bonds include:

Deep Discount Bonds Issued for a face value of ` 1 lakh each

Regular Income and Retirement Bonds: They had five-year tenure, a semi-annual yield of 16 percent and a front-end discount of 4 percent. The bonds had three-year put option and an early bird incentive of 0.75 percent

Step-up Liquid Bonds: The five-year bonds with a put option every year with a return of 16 percent, 16.25 percent, 16.5 percent, 16.75 percent, and 17 percent at the end of every year

Growth Bonds: An investment of ` 20,000 per bond under this scheme entitles investors to a ` 1 lakh face-value bond maturing after 10 years. Put options can be exercised at the end of 5 and 7 years respectively. If exercised, the investor gets ` 43, 500 after 5 years and ` 60,000 after a 7 year period

Lakhpati: Bonds The maturity period of these bonds varied from 5 to 10 years, after which the investor gets ` 1 lakh. The initial investment required was ` 20,000 for 10 years maturity, ` 23,700 for 9 years, ` 28,000 for 8 years, ` 33,000 for 7 years, ` 39,000 for 6 years and ` 46,000 for 5 year period

ICICI’s bonds, 1997 ICICI came out with as many as five bonds in March 1997. These are encash bonds, index bonds, regular income bonds, deep discount bonds, and capital gain bonds. The bonds were aimed at meeting the diverse needs of all categories of investors, besides contributing to the widening of the bond market so as to bring the benefits of these securities to even the smallest investors.

Capital gains bond: Also called infrastructure bonds incorporated the capital gains tax relaxations under Section 54EA of the Income Tax Act announced in the Union Budget for 1997-98. They are issued for 3 and 7 years maturity. 20 percent rebate was available under Section 88 of the I.T. Act for investors on the amount invested in the capital gains bonds upto a maximum of ` 70,000. They can avail benefit under Section 88. the annual interest rate worked out to 13.4 percent while the annual yield came to 20.7 percent. However, investment through stock-invest will not qualify for the rebate.

Encash bond: The five-year encash bonds were issued at a face value of ` 2,000 and can be redeemed at par across the country in 200 cities during 8 months in a year after 12 months. The bond had a step up interest every year from 12 to 18.5 percent and the annualized yield at maturity for the bond works out to 15.8 percent. The encashing facility, however, is available only to the original bondholders. The bonds not only offer higher return but also help widen the banking facilities to investors. The secondary market price of the bonds is likely to be favorably influenced by the step up interest that results in an improved YTM every year.

Index bond: Which gives the investor both the security of the debt instrument and the potential of the appreciation in the return on the stock market. Priced at ` 6,000 the index bond has two parts: Part A is a deep discount bond of the face value of ` 22,000 issued for a 12 year period. Its calculated yield was 15.26 percent. It also has a call and a put option attached to it assuring the investor a return or ` 9,300 after 6 years option is exercised. Part B is a detachable index warrant issued for 12 years and priced at ` 2,000. The yield was linked to the BSE SENSEX. The face value of the bond will appreciate the number of times the SENSEX has appreciated. The investors’ returns will be treated as capital gains.

Tax Free Bonds: The salient features of the tax-free government of India bonds to be issued from October 1, 2002 are as follows:

Interest rate: The bonds will carry an interest rate of 7 percent

Tax exemption: The bonds will be exempt from Income-tax and Wealth-tax

Maturity: The bonds will have a maturity will have no ceiling

Ceiling: The bonds investment will have no ceiling

Tradability: The bonds will not be traded in the secondary market

Investors: The eligible investors include individuals and Hindu Undivided families (HUFs). NRIs are not eligible for investing in these bonds

Issue price: Bonds will be issued for a minimum amount of ` 1,000 and its multiples

Maturity value: The cumulative maturity value of the bond will be ` 1,511 at the end of six years

Form of issue: The bonds will be both in demat form as well as in the traditional form of stock certificates. Option once chosen cannot be changed

Transferability: Bonds will not be transferable except by way of gift to relatives as defined in the Companies Act

Collaterals: The bonds cannot be used as collaterals for obtaining loans from banks, financial institutions and non-banking financial companies

Nomination: A sole holder or a sole surviving holder of the bond being an individual can make a nomination

New Issues Market (NIM)–Conceptual Framework

NIM also known as ‘primary market’ is a market, which is characterized by the presence of a set of all institutions, structures, people, procedures, services, and practices involved in raising of fresh capital funds by both new and existing companies.

NIM and Secondary Markets–An Interface

Both the primary and secondary markets are closely interrelated. This is clear from the following:

Trading

For the purpose of securities to be traded in the secondary market, it is important that they are first issued in the primary market.

Listing

In order that a corporate entity makes a successful issue of security in the primary market, it is incumbent that the terms of such an issue carry a stipulation that the issues are to be listed in a recognized stock exchange and that an application for this purpose has been made already to the stock exchange concerned.

Regulation

The activities in the primary market such as the new issues, etc are greatly influenced by the regulatory norms prescribed by the SEBI and stock exchanges. The object is to bring about orderliness in the new issues market.

Marketability

The advantage of marketability provided by the secondary market greatly helps the subscribers in the primary market. For instance, the positive trends prevailing in the secondary market immensely help the investors to off-load their existing holdings so as to subscribe for fresh issues in the NIM. This liquidity advantage helps in expansion of the NIM.

Prevailing Conditions

The conditions prevailing in the secondary market affect to a very great extent the successfulness or other wise of the issue being made in the NIM. Accordingly, where the conditions are so favorable in the secondary market that high market prices prevail, the issues made in the primary market will turn out to be encouraging and successful. Issues would fetch good premiums.

Survival

The existence and the survival of the secondary market are dependent upon the efficacy of the NIM as an avenue for fund raising. There could be no stock exchanges if there is no NIM, in the same manner that there will be no NIM in the absence of an efficiently functioning stock exchange. An efficient secondary market is therefore, a Sine-qua-non for a growing primary market.

Services of NIM

A brief description of the various services rendered by the new issues market is made below:

The Transfer

An important function rendered by NIM is to allow the transfer of resources from savers to entrepreneurs who establish new companies. It is also called the function of ‘origination’. The transfer function is facilitated by specialist agencies that are engaged in the provision of investigative and advisory services as specified below:

Investigative services The merchant bankers and other agencies provide the investigative services. These include technical analysis, economic analysis financial analysis and analysis of legal and environmental aspects of the proposed business. Merchant bankers provide the above information to investors so as to enable the investors in making a choice as to the type, quality and quantity of the issue.

Advisory services Various advisory services are made available with a view to improving the quality of capital issues. The relevant services include determining the type, the mix, the price, the timing, the size, the selling strategies, the methods of floatation, and the terms and conditions of issue of securities.

The Guarantee

It is the function of ‘underwriting’. Underwriting aims at guaranteeing the subscription of public issue. Underwriters ensure successful subscription of the issue by undertaking to take up the securities in the event of the public failing to subscribe the same. It benefits the issuing company, the investing public and capital market in general. The function of underwriting is undertaken for a fee.
The Distribution

The function that facilitates the sale of securities to ultimate investors is called ‘distribution’. The function of distribution is rendered by the specialized agencies like brokers and dealers in securities. They maintain a constant and a close link with the issuers and the ultimate investors on the one hand, and issuers and other agencies of capital market on the other.

NIM Vs. Secondary Market

NIM is different from the secondary market in the following respects:

Stock Option Norms for Software Companies

The relevant guidelines issued by the SEBI as regards ‘employee’s stock option’ for software companies are as follows:

Minimum issue: A minimum issue of 10 percent of its paid-up capital can be made by a software company which has already floated American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) or a company which is proposing to float these is entitled to issue ADR/GDR-linked stock options to its employees. For this purpose, prior permission from the Department of Economic Affairs is to be obtained.

Mode of issue: Listed stock options can be issued in foreign currency convertible bonds and ordinary shares (through depository receipt mechanism) to the employees of subsidiaries of InfoTech companies.

Permanent employees: Indian IT companies can issue ADR/GDR linked stock options to permanent employees, including Indian and overseas directors, of their subsidiary companies incorporated in India or outside.

Pricing: The pricing provisions of SEBI’s preferential allotment guidelines would not cover the scheme. The purpose is to enable the companies to issue stock options to its employees at a discount to the market price which serves as another form of compensation.

Approval: Shareholders’ approval through a special resolution is necessary for issuing the ESOPs. A minimum period of one year between grant of option and its vesting has been prescribed. After one year, the company would determine the period in which option can bee exercised.

Bought-Out Deals

Meaning

A method of marketing of securities of a body corporate whereby the promoters of an unlisted company make an outright sale of a chunk of equity shares to a single sponsor or the lead sponsor is known as ‘bought-out deals.

Features

Parties: There are three parties involved in the bought-out deals. They are promoters of the company, sponsors and co-sponsors who are generally merchant bankers and investors.

Outright sale: Under this arrangement, there is an outright sale of a chunk of equity shares to a single sponsor or the lead sponsor.

Syndicate: Sponsor forms a syndicate with other merchant bankers for meeting the resource requirements and for distributing the risk.

Sale price: The sale price is finalized through negotiations between the issuing company and the purchaser, the sale being influenced by such factors as project evaluation, promoter’s image and reputation, current market sentiments, prospects of off-loading these shares at a future date, etc.

Fund-based: Bought-out deals are in the nature of und-based activity where the funds of the merchant bankers get locked in for at least the prescribed minimum period.

Listing: The investor-sponsors make a profit, when at a future date, the shares get listed and higher prices prevail. Listing generally takes place at a time when the company is performing well in terms of higher profits and larger cash generations from projects. OTCEI: Sale of these shares at over-the Counter Exchange of India (OTCEI) or at a recognized stock exchanges, the time of listing these securities and off-loading them simultaneously are being generally decided in advance.

Bought-Out Deals Vs. Private Placements

Following are the differences between bought-out deals and private placements:

Benefits

Bought-out deals provide the following benefits:

Speedy sale Bought-out deals offer a mechanism for a speedier sale of securities at lower costs relating to the issue.

Freedom Bought-out deals offer freedom for promoters to set a realistic price and convince the sponsor about the same.

Investor protection Bought-out deals facilitate better investor protection as sponsors are rigorously evaluated and appraised by the promoters before off-loading the issue.

Quality offer Bought-out deals helps enhance the quality of capital floatation and primary market offerings.

Limitations

Bought-out deals pose the following difficulties for the promoters, sponsors and investors:

Loss of control The apprehensions in the minds of promoters, particularly of the private or the closely held companies that the sponsors may usurp control of the company as they own large chunk of the shares of the company.

Loss of sales Bought-out deals pose considerable difficulties in off-loading the shares in times of unfavorable market conditions. This results in locking up of investments and entailing losses to sponsors.

Wrong appraisal Bought-out deals cause loss to sponsors on account of wrong appraisal of the project and overestimation of the potential price of the share.

Manipulation Bought-out deals five great scopes for manipulation at the hands of the sponsor through insider trading and rigging.

No accountability Bought-out deals pose difficult of penalizing the sponsor as there are no SEBI guidelines to regulate offerings by sponsors.

Windfall profits Bought-out deals offer the advantage of windfall profits by sponsors at the cost of small investors.

Loss to investors Where the shares taken up by issue brokers and a coterie of select clients are being bought back by the promoters at a pre-fixed higher price after allotment causing loss to investors of the company.

Several intermediaries carry out activities of different nature in the new issue market.

The intermediaries include:

Merchant bankers/Lead managers

Underwriters

Bankers to the issue

Brokers to the issue

Registrars

Share transfer agent and

Debenture trustees

The legal frame work of operations of these intermediaries as prescribed by the SEBI, is presented below

Merchant Bankers/Lead Managers

Meaning

The intermediaries in the stock market who are responsible for public issues management are known as ‘merchant bankers’ or lead managers.

Category

Merchant bankers are categorized as follows:

Category I: These are the merchant bankers who carry out such functions as relating to new issues as determination of security-mix to be issued, drafting of prospectus, application forms, allotment letters and a host of other documents, appointment of registrars for handling share applicants and transfers, making arrangements for underwriting, placement of shares, selection and appointment of brokers and bankers to the issue, publicity of the issue, etc. Only these merchant bankers are permitted to act as ‘Lead Managers’ to an issue.

Category II: These merchant bankers act as consultants, advisers, portfolio managers and co-managers.

Category IV: These merchant bankers act only as advisers or consultants to an issue.

As per the SEBI guidelines introduced on September 5, 1997, all categories of merchant bankers below category I would stand abolished. The guidelines required those merchant bankers who are functioning below the category I to upgrade themselves to category I. Merchant bankers currently carrying out underwriting and portfolio management, besides issue management, would be required to get separate registrations as portfolio managers, while underwriting could be done without any additional registration. Further, only body corporates with a net worth of `5 crores would be allowed as category I merchant bankers.

Registration – Conditions

Merchant bankers shall compulsorily register with the SEBI in the interest of investors. Following are the conditions to be satisfied by them before registration is done by the SEBI:

Capital Adequacy

Merchant bankers have to fulfill the prescribed minimum capital adequacy norm in terms of its net worth, i.e. Paid-up capital and free reserves.

Infrastructure

Merchant bankers should have adequate and necessary infrastructure, such as adequate office space, equipment and manpower for effective discharge of their duties and responsibilities.

Expertise

Merchant bankers should employ experts having professional qualifications in finance, law or business management competent to handle merchant banking business and who are not involved in any litigation connected with securities market.

Fees

Merchant bankers should make a payment of fee as prescribed by the SEBI.

Undertaking

Merchant bankers shall undertake to fulfill their obligations and responsibilities as may be prescribed by the SEBI from time to time. Further, they should also undertake to adhere to the prescribed code of conduct.

Role and Responsibilities

SEBI has laid down the following responsibilities for a merchant banker:

Contract

A merchant banker shall enter into a contract with the issuing company. The contract invariably specifies their mutual rights, obligations and liabilities relating to the issue, particularly relating to disclosures, allotment and refund. A copy of the above contract is to be submitted to the SEBI at least one month before the opening of the issue for subscription. The merchant banker has the right not to accept the appointment as lead manager, if the issuing company is its associate.

Registration

A registration certificate has to be obtained by the merchant banker from the SEBI

Minimum Underwriting

The merchant banker is duty-bound to accept on his own or through its associate, a minimum underwriting obligation of 5 percent of total underwriting commitment or ` 25 lakhs, whichever is less.

Due Diligence Certificate

The merchant banker has to submit ‘Due Diligence Certificate’ to SEBI at least two weeks before the opening of the issue for subscription. The certificate has to be given on the basis of the verification of the contents of the prospectus/letter of offer regarding the issue and reasonableness of the views expressed therein. For this purpose, the merchant banker should reasonably be satisfied.

That the document contains all details relevant to the issue;

That all legal requirements relating to the issue have been fully complied with; and that all disclosures are true, fair and adequate to enable the investing public to make a well-informed decision regarding investment in the proposed issue.

Documents Submission

The merchant banker shall submit to SEBI various documents containing details such as issue, draft prospectus/letter of offer and other literature to be circulated to the investors/ shareholders, etc at least two weeks before the data of filling them with the Registrar of Companies and regional stock exchanges. It has to ensure that all the modifications and suggestions made by SEBI regarding the above documents have been duly incorporated.

Disclosure to SEBI

The merchant bankers shall make a disclosure of the following to the SEBI:

Its responsibilities regarding the management of the issue

Any change in the information/particulars previously furnished with SEBI having a bearing on certificate of registration granted to it.

Details relating to the breach of capital adequacy norms

Names and addresses of the companies whose issues it has managed or has been associated with and

Information regarding its activities as manager, underwriter, consultant or adviser to the issue.

Other duties In addition to the above, the merchant banker has to fulfill the following obligations too:

Continuing to remain fully associated with the issue till the subscribers have received share/debenture certificates or the refund of excess application money.

not to acquire securities of any company on the basis of unpublished price sensitive information obtained in the course of discharge of his professional assignment.

Underwriter

A set all institution and agencies that provide a commitment to take up issue of securities in the event of a failure of the issue to get full subscription from the public, are known as ‘underwriters’.

They are compensated for their services by a payment of commission as agreed upon between the issuing company and the underwriters and subject to the ceiling under the companies act. Brokers, Investment companies, Commercial Banks and term lending institution provide underwriting services.

Although underwriting of issues in not obligatory, underwriters play a significant role in the development of the primary market. The issuing company in consultation with the merchant bankers/lead managers appoints underwriters. A statement to this effect is also to be incorporated in the prospectus.

Role and Responsibilities

Under the SEBI guidelines, underwriters have the following duties and responsibilities as regards the public issue:

Registration

A certificate of registration has to be obtained by the agencies that wish to carry out underwriting activities from the SEBI. SEBI grants the certificate of registration on the fulfillment of the following conditions:

Availability of adequate and necessary infrastructure like sufficient office space, equipment and manpower to effectively function and discharge his duties.

Previous experience in underwriting or having a minimum of two persons with experience in underwriting

Meeting capital adequacy requirement of a minimum net worth of ` 20 lakhs.

That the applicant (director, principal, officer or partner) has not been convicted of any offence involving moral turpitude or found guilty of any economic offence.

Undertaking to fulfill obligations under the SEBI Act, rules and regulations

Undertaking to abide by the prescribed code of conduct and Payment of the prescribed fee for grant of registration certificate and for its renewal, which is ` 2 lakhs for the first and the second years from the initial grant of certificate and ` 20,000 per annum subsequently for keeping the certificate in force or for its renewal. The Certificate of Registration can be suspended by SEBI in case of failure to pay the fee. Thereupon, the underwriter ceases to act as underwriter.

Agreement

In order that the issues are taken up by the underwriters, an agreement has to be entered into between the underwriter and the issuing company. The agreement should, among others, contain such details as the period during which the agreement will remain in force, the amount of underwriting obligation, the maximum period within which the underwriter will have to subscribe to the offer, after being intimated by or on behalf of the issuing company, the rate and amount of commission/brokerage chargeable by the underwriter, within the limits imposed by the Companies Act, and any other details regarding the arrangements made by the underwriter for fulfilling the underwriting obligations.

Code of Conduct

An underwriting agency shall follow the necessary codes of conduct as framed by the SEBI. These include duty not to derive any other direct or indirect benefit from underwriting the issue except receiving the underwriting commission at the agreed rate, the ceiling for which is 5 percent in case of underwriting of shares and 2.5 percent in case of debentures, duty not to take up total underwriting obligation, at any point of time under all underwriting agreements, exceeding 20 times his net worth and duty to subscribe for securities under the agreement within 45 days of the receipt of information from the issuing company.

Compliance

Underwriters are required to comply with all the formalities regarding registration with SEBI, agreement with the Client Company and general responsibilities. These include ensuring that all terms and conditions regarding disclosure in the prospectus and its filing with ROC have been complied with before signing the underwriting agreement with the issuing company, ensuring that the prospectus is delivered to ROC within 30 days of the underwriting agreement or within such an extended time as approved by the underwriter in writing, subject to the limits within the law, complying with any additional disclosures that may be made in the interest of investors as stipulated by SEBI/lead managers, and such disclosure requirements shall not give any right to the underwriter to avoid or reduce his obligations, unless certified by SEBI as material in nature and essential for underwriting agreement, arranging for sub-underwriting but continues to be responsible for any failure or default on the part of such sub-underwriters, etc.

Termination of agreement An underwriter is entitled to terminate an underwriting agreement at any time before the opening of the issue as notified in the prospectus under such circumstances as where the issuing company has made any incorrect representation or statement to the underwriter, in the application form, in negotiations and correspondences and in the prospectus, where a complete breakdown or dislocation of business has occurred in major financial markets in Mumbai, Calcutta, New Delhi and Chennai and where any other major disturbance such as declaration of war, open and wide insurgency, civic upheaval has taken place which has adversely affected the major financial markets.

Bankers to an Issue

Meaning

Bankers who are engaged in the function of acceptance of applications for shares and debentures along with application money from investors in respect of issue of securities and also refund of application money to the applicants to whom securities could not be allotted, are called ‘bankers to an issue’. They play an important role in the working of the primary market.

Roles and Responsibilities

The intermediary to act as a banker has the following responsibilities as ordained by the SEBI:

Registration Bankers who are desirous of acting as bankers to an issue are required to obtain the necessary certificate of registration from the SEBI. For this purpose, the conditions to be fulfilled include adequacy of the necessary infrastructure such as office space, equipment, communication facilities, data processing facilities and manpower to effectively perform activities relating to the issue, and a stipulation that the banker or any of its directors is not involved in any litigation connected with securities market nor they are convicted for any economic offence. If the applicant is a scheduled bank, the grant of certificate of registration would serve the interest of investors and the applicant pays the registration fee.

Fees to SEBI: Annual registration fee of ` 2.5 lakhs for the first two years is payable to the SEBI by the intending banker and ` 1 lakh is to be paid for the third year. An application for the renewal of the registration can be made three months before the expiry of registration certificate. The renewal fees are ` 1 lakh annually for the first two years and ` 20,000 for the third year.

Contract: The issuer company has to enter into a contract with the banker to an issue. The contract shall include detailed information about the number and address of collection centres at which applications and application money are to be received, the fee for the services and other terms and conditions of the appointment.

Daily statement: A daily statement giving the details regarding the number of applications and amount of money received from the investors shall be submitted by the banker to the issuing company/registrar to an issue.

Information to SEBI Information pertaining to such details as to the profile of the issue, the number of applications and the details of application money received the date-wise details of application money collected and refunds, if any, to the SEBI. Similarly information about any disciplinary action initiated by the RBI entailing the suspension or cancellation of the banker is also to be sent to the SEBI.

Books and records Books of accounts, records and documents pertaining to all matters regarding which the banker may be required to submit details to SEBI shall be maintained by the banker. This is to be done for a minimum period of three years from the completion of the issue.

Code of Conduct

In addition to the code of conduct prescribed for the merchant bankers and underwriters, a banker to an issue has to adhere to the following code of conduct:

Not to keep blank application forms bearing broker’s stamp at the bank premises or at the entrance of the bank

Not to accept applications after office hours, or on bank holidays, or after the date of the closure of the issue.

Not to act at any time in collusion with other agents in a manner detrimental to the interest of small investors and

Abide by all acts, rules, regulations, notifications, directions, circulars, instructions and guidelines issued by the Government, RBI, Indian Banks Association and SEBI that are relevant to his operations as banker to an issue.

RBI’s Role

RBI is empowered to carry out the inspection of the bankers to the issue with a view to protecting the investors instrument and also promoting compliance with SEBI Act, rules and regulations. SEBI may order the suspension of the registration of the banker in such circumstances as the violation of the provisions of SEBI Act, rules and regulations, failure to submit the required information, submission of wrong of false information, failure to resolve investors complaints or give satisfactory reply to SEBI, guilty of misconduct or unprofessional conduct, etc.

Brokers to an Issue

Intermediaries that are responsible for procuring the subscription to the issue from the prospective investors are called ‘brokers to the issue’. They provide a vital connecting link between the prospective investors and the issuer. They assist in the speedy subscription of issue by the public. Appointment of brokers is however not compulsory.

Unless permitted by the stock exchange, the issuing company abides by the prescribed listing requirements and also undertakes to get its securities listed on a recognized stock exchange. Moreover, its members can neither act as managers or brokers to an issue, nor can they make any preliminary arrangement for floatation of an issue.

The brokers to the issue must have an expert knowledge, professional competence and integrity in order to be able to carry out the various functions of an issue. They help the investors make a right choice of the company for making investments. Consent must be obtained from the stock exchange broker to act as the brokers to the issuer company. For this purpose, the approval of stock exchanges is required. Copies of consent letters of brokers are to be filed with ROC along with the copy of prospectus. The names and addresses of the brokers to the issue are to be disclosed in the prospectus.

Brokerage has to be paid by the issuer company according to the provisions in the Companies Act and rules and regulations, the agreement between the broker and the company, and guidelines prescribed by SEBI. Maximum brokerage rate, applicable to all types of industrial securities, whether underwritten or not, is 1.5 percent. The brokers have to meet all mailing costs, canvassing expenses and all other out-of-pocket expenses relating to the subscription of the issue out of their brokerage. The maximum rate of brokerage payable by listed companies on private placement of capital is 0.5 percent.

Registrars to an Issue and Share Transfer Agents

Registrars and transfer agents are of two categories such as category I which carry on activities of both registrars to an issue and also of share transfer agents and category II which carry on activities either of a registrar to an issue or as a share transfer agent.

Functions

Registrars to an issue carry out such functions as keeping a proper record of applications and moneys received from investors, assisting issuing companies in determining the basis of allotment of securities as per stock exchange guidelines and in consultation with stock exchanges, assisting in the finalization of allotment of securities, and processing and dispatching of allotment letters, assisting in processing and dispatching refund orders, share and debenture certificates and other documents related to the capital issue, functioning as Depository Participants (DPs) etc.

Share Transfer Agents perform such functions as maintaining records of holders of securities of the company for and on behalf of the company, handling all matters related to transfer and redemption of securities of the company and functioning as Depository Participants (DPs).

Role and Responsibilities

The role and responsibilities of registrars and share transfer agents are as follows:

Registration

A certificate of registration is to be obtained from the SEBI. For this purpose, the SEBI considers such factors as their ability to discharge their duties with efficiency and integrity, the adequacy of infrastructure and past experience in this line of activity and capital adequacy. Capital adequacy requirement is net worth of ` 6 lakhs for category I and 3 lakhs for category II registrars and share transfer agents. They have to pay an annual fee of ` 15,000 and ` 10,000 respectively for initial registration and annual renewal.

Maintenance of Records

Registrars and share transfer agents shall show such details as applications received from investors relating to the issue, rejected applications together with the reasons for rejection, basis of allotment of securities in consultation with the stock exchanges, terms and conditions of purchase of securities, allotment of securities, list of allottees and non-allottees, refund orders, etc and names of transferors and transferees, and the dates of transfer of securities. Such records and books are to be preserved for three years from the date of issue. SEBI can also ask them to file these books and records with it whenever required.

Absorbing code of conduct Registrars and share transfer agents should adopt those codes of conduct prescribed for merchant bankers and underwriters.

Besides, they should ensure that enquiries from investors are adequately dealt with and adequate steps are taken for proper allotment of securities and refund of excess application money as per law and without delay.

SEBI’s Role

SEBI is empowered to undertake inspection of books of accounts, records and documents of registrars and share transfer agents.

The certificate of registration issued to registrars and share transfer agents will be suspended of their registration by the SEBI under such circumstances as violation of SEBI Act, rules and regulations, violations of SCRA rules and regulations, and stock exchange bye-laws, rules and regulations, failure to furnish information to SEBI, furnishing wrong and false information, non-cooperation in an inspection, investigation or an enquiry, failure to resolve investor complaints, failure to give satisfactory reply to SEBI regarding investor complaints, involvement in manipulation, price rigging and cornering activities, guilty of misconduct, failure to maintain capital adequacy requirement, etc.

The registration of the registrars and transfer agents will be cancelled by the SEBI under such circumstances as repeated defaults leading to suspension of registration certificate, deliberate manipulation, price rigging and cornering activities adversely affecting the securities market and the investor interest, violating provisions relating to insider trading and take over regulations, guilty of fraud, conviction for a criminal offence and violating SEBI Act, rules and regulations.

Debenture Trustees

Meaning

Trustees who are appointed to safeguard the interests of debenture holders are called ‘debenture trustees’. They are to be appointed before issue of debentures by a company. No person can act as debenture trustee unless a certificate of registration has been obtained from SEBI for the purpose.

Eligibility

To be appointed as a debenture trustee, the following are eligible:

A scheduled bank carrying on commercial activity; or

A public financial institution within the meaning of Section 4-A of the Companies Act, 1956; or

An insurance company; or

A body corporate

Role and Responsibilities

Registration: An institution shall be registered with the SEBI to be in a position to function as a debenture trustee. For this purpose, the institution concerned shall have an adequate and necessary infrastructure like adequate office space, equipments and manpower to effectively discharge his activities, relevant experience of a debenture trustee, professional qualification for a debenture trustee from an institution recognized by the government in finance, accountancy, law or business management and the applicant or any of its director or principal officers has not at any time been convicted for any offence involving moral turpitude or has been found guilty of any economic offence.

Consent: Consent in writing must be given to the body corporate to act as debenture trustee before the debenture issue.

Inspection: Debenture trustee shall carry out the inspection of books of accounts, records, registers of the body corporate and the trust property to the extent necessary for discharging his obligations.

Possession: A debenture trustee shall carry out any act as would be necessary for the protection of the interest of and the resolution of grievances of the debenture holders.

Protection of interest: A debenture trustee shall carry out any act as would be necessary for the protection of the interest of and the resolution of grievances of the debenture holders. He must also ensure that debenture certificates have been dispatched to the debenture holders in accordance with the provisions of the Companies Act. Besides, he must also ensure that interest warrants for interest due on the debentures have been dispatched to the debenture holders on or before the due dates.

Due diligence: A debenture trustee should exercise due diligence to ascertain whether or not the assets of the body corporate which are available by way of security or otherwise are sufficient or are likely to be or become sufficient to discharge the claims of debenture holders as and when they become due. It must also inform the Board immediately of any breach of trust deed or provision of any law.

Meeting: A debenture trustee shall call, or cause to be called by the body corporate, a meeting of the entire debenture holders where a requisition for the meeting has been made at least one-tenth of the debenture holders or the happening of any event, which constitutes a default or which in the opinion of the debenture trustees affects the interest of the debenture holders.

Code of conduct: Every debenture trustee shall abide by the prescribed code of conduct.

Maintenance of books of accounts, etc, Subject to the provisions of any law, every debenture trustee has to keep and maintain proper books of accounts, records and documents relating to the trusteeship functions for a period of not less than 5 financial years preceding the current financial year. Every debenture trustee has to intimate to SEBI, the place where the books of accounts, records and documents are maintained.

Information to SEBI Every debenture trustee shall furnish information relating to the following to the SEBI:

Number and nature of the grievances of debenture holders received and resolved

Copies of the trust deed

Non-payment or delayed payment of interest to debenture holders, if any, in respect of each issue of debentures of a body corporate.

Details of dispatch and transfer of debenture certificates giving therein the dates, mode, etc

Inspection and Disciplinary Proceedings and

Any other particulars or documents that are relevant to debenture trustee.

SEBI’s Role

SEBI is empowered to carry out the inspection of the books of accounts, other records and documents of the debenture trustee for the purpose of ensuring that the records and documents which are relevant to debenture trustees are being maintained in the manner required by the Board, that the provisions of the Companies Act, 1956, rules and regulations are being complied with, that there exists any circumstances, which would render the debenture trustee ineligible for grant of registration or continuance thereof, that the complaints received from investors, other debenture trustees are investigated into, and that the interest of the investors is protected.

SEBI can suspend the certificate of registration granted to a debenture trustee under the following circumstances:

Violation of the provisions of the SEBI Act, rules and regulations

Not following the prescribed code of conduct

Failure to furnish information relating to his business as debenture trustee as required by the Board

Furnishing wrong or false information

Not submitting reports as required by SEBI

Non-cooperation in any enquiry conducted by SEBI

Indulging in manipulating or price rigging or cornering activities.

Guilty of misconduct or improper or unbusinesslike or unprofessional conduct Failure to pay the fees.

Violation of the conditions subject to which the certificate has been granted and Violation of the conditions subject to which the certificate has been granted and

Under the following circumstances, SEBI can cancel the certificate of registration granted to debenture trustees:

Repeated defaults of the type leading to suspension of certificate

Indulging in deliberate manipulation or price rigging or cornering activities affecting the securities market and the investors interests.

Guilty of fraud, or is convicted of a criminal offence

Violation of any provision of insider trading regulations.

Trustee being removed by the debenture holders by a resolution passed by not less than 75 percent of the debenture holders.

Unless permitted by the stock exchange, the issuing company abides by the prescribed listing requirements and also undertakes to get its securities listed on a recognized stock exchange. Moreover, its members can neither act as managers or brokers to an issue, nor can they make any preliminary arrangement for floatation of an issue.

The brokers to the issue must have an expert knowledge, professional competence and integrity in order to be able to carry out the various functions of an issue. They help the investors make a right choice of the company for making investments. Consent must be obtained from the stock exchange broker to act as the brokers to the issuer company. For this purpose, the approval of stock exchanges is required. Copies of consent letters of brokers are to be filed with ROC along with the copy of prospectus. The names and addresses of the brokers to the issue are to be disclosed in the prospectus.

Brokerage has to be paid by the issuer company according to the provisions in the Companies Act and rules and regulations, the agreement between the broker and the company, and guidelines prescribed by SEBI. Maximum brokerage rate, applicable to all types of industrial securities, whether underwritten or not, is 1.5 percent. The brokers have to meet all mailing costs, canvassing expenses and all other out-of-pocket expenses relating to the subscription of the issue out of their brokerage. The maximum rate of brokerage payable by listed companies on private placement of capital is 0.5 percent.

Registrars to an Issue and Share Transfer Agents

Registrars and transfer agents are of two categories such as category I which carry on activities of both registrars to an issue and also of share transfer agents and category II which carry on activities either of a registrar to an issue or as a share transfer agent.

Functions

Registrars to an issue carry out such functions as keeping a proper record of applications and moneys received from investors, assisting issuing companies in determining the basis of allotment of securities as per stock exchange guidelines and in consultation with stock exchanges, assisting in the finalization of allotment of securities, and processing and dispatching of allotment letters, assisting in processing and dispatching refund orders, share and debenture certificates and other documents related to the capital issue, functioning as Depository Participants (DPs) etc.

Share Transfer Agents perform such functions as maintaining records of holders of securities of the company for and on behalf of the company, handling all matters related to transfer and redemption of securities of the company and functioning as Depository Participants (DPs).

Role and Responsibilities

The role and responsibilities of registrars and share transfer agents are as follows:

Registration

A certificate of registration is to be obtained from the SEBI. For this purpose, the SEBI considers such factors as their ability to discharge their duties with efficiency and integrity, the adequacy of infrastructure and past experience in this line of activity and capital adequacy. Capital adequacy requirement is net worth of ` 6 lakhs for category I and 3 lakhs for category II registrars and share transfer agents. They have to pay an annual fee of ` 15,000 and ` 10,000 respectively for initial registration and annual renewal

Maintenance of Records

Registrars and share transfer agents shall show such details as applications received from investors relating to the issue, rejected applications together with the reasons for rejection, basis of allotment of securities in consultation with the stock exchanges, terms and conditions of purchase of securities, allotment of securities, list of allottees and non-allottees, refund orders, etc and names of transferors and transferees, and the dates of transfer of securities. Such records and books are to be preserved for three years from the date of issue. SEBI can also ask them to file these books and records with it whenever required.

Absorbing code of conduct Registrars and share transfer agents should adopt those codes of conduct prescribed for merchant bankers and underwriters. Besides, they should ensure that enquiries from investors are adequately dealt with and adequate steps are taken for proper allotment of securities and refund of excess application money as per law and without delay.

SEBI’s Role

SEBI is empowered to undertake inspection of books of accounts, records and documents of registrars and share transfer agents. The certificate of registration issued to registrars and share transfer agents will be suspended of their registration by the SEBI under such circumstances as violation of SEBI Act, rules and regulations, violations of SCRA rules and regulations, and stock exchange bye-laws, rules and regulations, failure to furnish information to SEBI, furnishing wrong and false information, non-cooperation in an inspection, investigation or an enquiry, failure to resolve investor complaints, failure to give satisfactory reply to SEBI regarding investor complaints, involvement in manipulation, price rigging and cornering activities, guilty of misconduct, failure to maintain capital adequacy requirement, etc.

The registration of the registrars and transfer agents will be cancelled by the SEBI under such circumstances as repeated defaults leading to suspension of registration certificate, deliberate manipulation, price rigging and cornering activities adversely affecting the securities market and the investor interest, violating provisions relating to insider trading and take over regulations, guilty of fraud, conviction for a criminal offence and violating SEBI Act, rules and regulations.

Debenture Trustees

Meaning

Trustees who are appointed to safeguard the interests of debenture holders are called ‘debenture trustees’. They are to be appointed before issue of debentures by a company. No person can act as debenture trustee unless a certificate of registration has been obtained from SEBI for the purpose.

Eligibility

To be appointed as a debenture trustee, the following are eligible:

A scheduled bank carrying on commercial activity; or

A public financial institution within the meaning of Section 4-A of the Companies Act, 1956; or

An insurance company; or

A body corporate

Role and Responsibilities

Registration: An institution shall be registered with the SEBI to be in a position to function as a debenture trustee. For this purpose, the institution concerned shall have an adequate and necessary infrastructure like adequate office space, equipments and manpower to effectively discharge his activities, relevant experience of a debenture trustee, professional qualification for a debenture trustee from an institution recognized by the government in finance, accountancy, law or business management and the applicant or any of its director or principal officers has not at any time been convicted for any offence involving moral turpitude or has been found guilty of any economic offence.

Consent: Consent in writing must be given to the body corporate to act as debenture trustee before the debenture issue.

Inspection: Debenture trustee shall carry out the inspection of books of accounts, records, registers of the body corporate and the trust property to the extent necessary for discharging his obligations.

Possession: A debenture trustee shall carry out any act as would be necessary for the protection of the interest of and the resolution of grievances of the debenture holders.

Protection of interest: A debenture trustee shall carry out any act as would be necessary for the protection of the interest of and the resolution of grievances of the debenture holders. He must also ensure that debenture certificates have been dispatched to the debenture holders in accordance with the provisions of the Companies Act. Besides, he must also ensure that interest warrants for interest due on the debentures have been dispatched to the debenture holders on or before the due dates.

Due diligence: A debenture trustee should exercise due diligence to ascertain whether or not the assets of the body corporate which are available by way of security or otherwise are sufficient or are likely to be or become sufficient to discharge the claims of debenture holders as and when they become due. It must also inform the Board immediately of any breach of trust deed or provision of any law.

Meeting: A debenture trustee shall call, or cause to be called by the body corporate, a meeting of the entire debenture holders where a requisition for the meeting has been made at least one-tenth of the debenture holders or the happening of any event, which constitutes a default or which in the opinion of the debenture trustees affects the interest of the debenture holders.

Code of conduct: Every debenture trustee shall abide by the prescribed code of conduct.

Maintenance of books of accounts, etc, Subject to the provisions of any law, every debenture trustee has to keep and maintain proper books of accounts, records and documents relating to the trusteeship functions for a period of not less than 5 financial years preceding the current financial year. Every debenture trustee has to intimate to SEBI, the place where the books of accounts, records and documents are maintained.

Information to SEBI: Every debenture trustee shall furnish information relating to the following to the SEBI:

Number and nature of the grievances of debenture holders received and resolved

Copies of the trust deed

Non-payment or delayed payment of interest to debenture holders, if any, in respect of each issue of debentures of a body corporate.

Details of dispatch and transfer of debenture certificates giving therein the dates, mode, etc

Inspection and Disciplinary Proceedings and

Any other particulars or documents that are relevant to debenture trustee.

SEBI’s Role

SEBI is empowered to carry out the inspection of the books of accounts, other records and documents of the debenture trustee for the purpose of ensuring that the records and documents which are relevant to debenture trustees are being maintained in the manner required by the Board, that the provisions of the Companies Act, 1956, rules and regulations are being complied with, that there exists any circumstances, which would render the debenture trustee ineligible for grant of registration or continuance thereof, that the complaints received from investors, other debenture trustees are investigated into, and that the interest of the investors is protected.

SEBI can suspend the certificate of registration granted to a debenture trustee under the following circumstances:

Violation of the provisions of the SEBI Act, rules and regulations

Not following the prescribed code of conduct

Failure to furnish information relating to his business as debenture trustee as required by the Board

Furnishing wrong or false information

Not submitting reports as required by SEBI

Non-cooperation in any enquiry conducted by SEBI

Indulging in manipulating or price rigging or cornering activities.

Guilty of misconduct or improper or unbusinesslike or unprofessional conduct Failure to pay the fees.

Violation of the conditions subject to which the certificate has been granted and Failure to fulfill the obligations under the trust deed

Under the following circumstances, SEBI can cancel the certificate of registration granted to debenture trustees:

Repeated defaults of the type leading to suspension of certificate

Indulging in deliberate manipulation or price rigging or cornering activities affecting the securities market and the investors interests.

Guilty of fraud, or is convicted of a criminal offence

Violation of any provision of insider trading regulations.

Trustee being removed by the debenture holders by a resolution passed by not less than 75 percent of the debenture holders.

E-Trading

The structure of stock market in India has undergone a vast change due to the liberalization process initiated by the Government. A number of new structures have come to be added to the existing structure of the Indian stock exchange. A brief description of these structures in the Indian stock market system is presented below:

Over-the-Counter Market System

Basically this market is meant for small size companies. The primary objective of this market was to enable the small start-up companies or companies in green field ventures to obtain their capital requirements at the minimum cost. On the basis of the recommendations of the High Powered Committee on Stock Exchange Reforms (G.S. Patel) and Committee (Abid Hussain) on Capital Market Reforms, the Over-The-Counter Exchange of India (OTCEI) was incorporated in October 1990 under the Companies Act, 1956. Granted recognition under section 4 of the Securities Contract (Regulation) Act 1956, the OTCEI was promoted by various public financial institutions like Unit Trust of India (UTI), Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Finance Corporation of India (IFCI), Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC), SBI Capital Market, CanBank Financial Services, etc. Commencing its operations on September 29, 1992 at Bombay, the OTCEI introduced screen-based automatic singular trading system. Although companies enjoy the same status as listed on the other stock exchanges, it is not possible that a company listed at OTCEI can be listed on other stock exchanges.

National Stock Market System (NSMS)

National stock market system was advocated by the “High Powered Group on the Establishment of New Stock Exchanges” headed by Shri. M.J.Pherwani (popularly known as Pherwani Committee). The committee recommended in June 1991, the following three tier-stock market structure:

Principal Stock exchanges comprising 5 major stock exchanges at Bombay, Calcutta, Madras, Delhi and Ahmedabad

Regional stock exchanges like those in major state capitals

Additional Trading Floors (ATFs) sponsored or managed by Principal or Regional stock exchanges

At present the National Stock Market in India comprises the following:

National Stock Exchange of India Limited (NSE)

Stock Holding Corporation of India Limited (SHCIL)

National Clearing and Depository System (NCDS)

Securities Trading Corporation of India (STCI)

National Stock Exchange (NSE)

The National Stock Exchange (NSE) was set up for the purpose of providing a nation wide stock trading facility to investors so as to bring the Indian financial market in line with international financial market. It started its operations by the end of 1993. The NSE used the electronic trading system and computerized settlement system aimed at extending the facility of electronic trading to every corner of the country.

The exchange has two separate segments, viz. capital market segment and money market segment. While the capital market segment is concerned with trading in equity shares, convertible debentures and debt instruments as nonconvertible debentures, the money market segment facilitates high value trading in debts, public sector bonds, mutual fund units, treasury bills, government securities, call money instruments, etc. The main participants, in this market are usually banks, financial institutions, and other financial agencies.

Stock Holding Corporation of India Limited (SHIL)

This Corporation was set up in October 1987, under the Companies Act, by 7 All India financial institutions viz. IDBI, IFCI, ICICI, LIC, GIC, UTI and RBI. The range of services that are made available by this institution includes quick transfer of shares among its member institutions, clearing services, depository services, support services, management information services, and development services. This is a board-managed company and has whole time Managing Director in charge of the day-to-day management of the corporation. It has set up regional centers at New Delhi, Calcutta and Madras. It is providing facilities in the major market centers in India.

National Clearance and Depository System (NCDS)

This system was created chiefly to help overcome the problem of settlement and clearance of transactions consequent to enormous workload on the clearing agencies and share transfer agencies. The problems mainly arose out of systematic risk like counter party risk, credit risk, bad deliveries, long delayed delivery, counterfeit scrips, and forged scrips.

Securities Trading Corporation of India (STCI)

The Reserve Bank of India set up Securities Trading Corporation of India Limited (STCI) in May 1994, under the provisions of the Indian Companies Act, 1956, jointly with public sector banks and All-India financial institutions. The main objective of establishing the Corporation was to foster the development of an active secondary market for Government securities and bonds issued by public sector undertakings. It had an authorized and paid-up capital of ` 500 crores of which, RBI contributed 50.18 percent. The RBI in December 1997 divested part of its equity in STCI in favor of the Bank of India, an existing shareholder of the Company.

Corporitization and Demutualization

Of late, efforts are on by the SEBI to corporatize and demutulize the Indian stock exchanges. For this purpose a Study Group under the Chairmanship of Justice M.H. Kania has been constituted. The object is to put in place a common structural model for the Indian stock market system. Accordingly, stock exchange will have to undergo changes in organizational structure.

Corporitization and Demutualization refer to the process of conversion of a stock exchange from a not-for-profit entity to a for-profit company. The process of transition from ‘mutually-owned’ association to a company ‘owned by shareholders’ is called ‘demutualization’. Demutualization involves the segregation of members’ right into distinct segments, viz. ownership rights and trading rights. It changes the relationship between members and the stock exchange. Members, while retaining their trading rights, acquire ownership rights in the stock exchange, which have a market value, and they also acquire the benefits of limited liability.

Interconnected Stock Exchange of India (ISE)

Genesis

Interconnected Stock Exchange of India Limited (ISE) has been promoted by 15 Regional Stock Exchanges to provide cost-effective trade linkage/connectivity to all the members of the Participating Exchanges, with the objective of widening the market for the securities listed on these exchanges. ISE is a national-level stock exchange which provides trading, clearing, settlement, risk management and surveillance support to its traders and dealers.

ISE aims to address the needs of small companies and retail investors, with the guiding principle of optimizing the existing infrastructure and harnessing the potential of regional markets, so as to transform them into a liquid and vibrant market, through the use of state-of-the-art technology and networking.

The participating Exchanges of ISE. In order to leverage its infrastructure and to expand its nation wide reach, ISE has also appointed around 450 ‘dealers’ across 70 cities other than the Participating Exchange centers. These dealers are administratively supported by the regional offices of ISE at Delhi (north), Kolkata (east), Coimbatore (south) and Nagpur (central), besides Mumbai (west).

ISE has also floated a wholly–owned subsidiary, ISE Securities and Services Limited (ISS), which has taken up corporate membership of the National Stock Exchange of India Ltd. (NSE) in the Capital Market Futures and Options segments and the Stock Exchange, Mumbai, in the Equities segment, so that the traders and dealers of ISE can access other markets, in addition to the ISE market and their local markets. ISE thus provides the investors in smaller cities, a one-stop solution for cost-effective and efficient trading, and settlement in securities.

With the objective of broadbasing the range of its services, ISE has started offering the full suite of DP facilities to its traders, dealers and their clients.

ISE endeavors to consolidate the small, fragmented and less liquid markets into a national-level, liquid market by using state-of-the-art infrastructure and support systems.

Objectives/Features

The Interconnected Stock Exchange of India Limited was constituted to realize the following objectives:

Create a single integrated national-level solution with access to multiple markets for providing high cost-effective service to millions of investors across the country

Create a liquid and vibrant national-level market for all listed companies in general and small capital companies in particular

Optimally utilize the existing infrastructure and other resources of participating stock exchanges, which are under-utilized now

Provide a level playing field to small traders and dealers, by offering an opportunity to participate in a national-market having investment-oriented business

Reduce transaction cost

Provide clearing and settlement facilities to the traders and dealers across the country at their doorstep in a decentralized mode

Spread demat trading across the Country

Achievements

Following are the achievements of ISE:

Network of intermediaries: A broad base of members form the bedrock for any exchange. In this respect, ISE has a large pool of registered intermediaries who can be tapped for any new line of business. As at the beginning of the financial year 2003-04, 548 intermediaries (207 traders and 341 dealers) are registered on ISE.

Robust operational systems: The trading, settlement and funds transfer operations of ISE and ISS are completely automated and state-of-the-art systems have been deployed. The communication network of ISE, which has connectivity with over 400 trading software and settlement software, along with the electronic funds transfer arrangement established with HDFC Bank and ICICI Bank, give ISE and ISS, the required operational efficiency and flexibility, to not only handle the secondary market functions effectively, but also by leveraging them for new ventures.

Skilled and experienced manpower ISE and ISS have experienced and professional staff, which has wide experience in Stock Exchanges/Capital Market institutions. The staff has the skill-set required to perform a wide range of functions, depending upon the requirements from time to time.

Aggressive pricing policy: The philosophy of ISE is to have an aggressive pricing policy for the various products and services offered by it. The aim is to penetrate the retail market and strengthen the position, so that a wide variety of products and services having appeal for the retail market can be offered, using a common distribution channel. The aggressive pricing policy also ensures that the intermediaries have sufficient financial incentive for offering these products and services to the end-clients

Trading, risk management and settlement software systems: The ORBIT (Online Regional Bourses Inter-connected Trading) and AZIS [Automated Exchange Integrated Settlement] software developed on the Microsoft NT platform, with consultancy assistance from Microsoft, are the most contemporary of the trading and settlement software, introduced in the country. The applications have been built on a technology platform, which offers low cost of ownership, facilitates simple maintenance, and supports easy up gradation and enhancement. The software is so designed, that the transaction processing capacity depends on the hardware used; capacity can be enhanced by just adding inexpensive hardware, without any additional software work.

Vibrant subsidiary operations ISS, the wholly owned subsidiary of the biggest exchange subsidiaries in the country, on an average more than 250 registered intermediaries of ISS trade from 46 cities across the length and breadth of the country.

Fine liquidity: ISE is addressing the problem of illiquidity in small capital companies at various exchanges by providing the securities of all such companies, an exposure to a larger investor base across the country. Currently, the ISE participating exchanges, directly account for about 5 percent of the total turnover and this is expected to increase with this integration, as indirectly, the ISE exchanges have been routing large volumes to BSE and NSE. NSE and BSE, both receive 50 percent of their business from outside Mumbai, from the Regional Exchange centers. This indicates the true potential of the ISE Exchanges and it would further increase after Internet trading and on-line IPO distribution systems that are being implemented by ISE.

One-stop solution: ISE provides national reach instantaneously. Listing of shares on ISE helps improve visibility of securities amongst the retail investors across the country. Further, all traders and dealers also have access to NSE, through the ISE Securities and Services Ltd. (ISS), a wholly owned subsidiary of ISE, which is a member of NSE All the traders and dealers who have registered with this subsidiary also act as sub-brokers. Thus, ISE and ISS provide a one-stop multiple market solution to the investors and the listing of securities on ISE would attract instant attention of all its investors.

It would further have the advantage of giving the company a positive image of being an outward looking technology savvy and investor friendly company. This concept of consolidation is now being implemented in U.S. and Europe, because of the advantages of the one-stop solution and cost benefits, which improves the competitiveness of the exchange.

Listing Advantages

Location advantage of ISE, focuses on retail investors, concentration of technology companies within its jurisdiction, and convenience of compliance through decentralized support. It is expected that the ISE would provide the best mix of all features required by a company, to list on any exchange.

ISE offers the advantage of a Regional Exchange, for ‘convenient and cost effective compliance’. This is expected to promote decentralized regional development and internalize the regulatory support as far as possible within that area of jurisdiction. This would make the regions self sufficient, for all regulatory compliance in tune with the decentralization policy of the Government.

ISE, being the most recent exchange, is also the most technology-savvy exchange which is indicated not only from the complexity of the technology it uses, but also from the fact that the exchange is located in an International Technology Park at Vashi, Navi, Mumbai. The exchange is located strategically in this technology park, which has two other technology parks within its vicinity, and this entire corridor between the Vashi, MIDC and Belapur is being treated as ‘technology corridor’ to attract Foreign Direct Investment in technology companies within the State of Maharashtra. Thus, all the companies located in this area are expected to have ISE as the regional exchange.

In addition to the large number of companies that are expected to develop in this area, many other companies spread across the country would also choose to list with ISE as an additional exchange, because of the large reach of ISE amongst the retail investors across the country. ISE has positioned itself as an exchange for the retail investors and it has evinced great interest in attracting listing from the companies during the short period when it started listing securities.

The advantages of a company listing on ISE is unique due to the following reasons:

Moderate fees: ISE is the only national-level recognized Stock Exchange, having moderate listing fees and grants listing and trading permission to the small and medium sized companies having a post public issue paid-up capital, of ` 3 to 5 crores, (subject to the appointment of market-markers) apart from companies above ` 5 crores.

Easy compliance: It would be possible for the companies to do listing compliance from the four metros and Nagpur. This will improve the compliance of listing requirements by the companies, merely due to the convenience and cost of a single compliance.

Improved visibility: Listing on ISE improves visibility of a company across 15 exchanges with convenience and cost of a single compliance.

Infrastructure: ISE infrastructure and the network of large number of traders and dealers are treated as a large distribution channel available for marketing of all financial products. These could be shares, mutual fund units, bonds, etc. All traders and dealers of ISE also have access to NSE, though ISE Securities and Services Ltd. (ISS), a wholly owned subsidiary of ISE, which has taken NSE membership, which ensures continuous attention of investors. Since investors get used to obtaining all services from one intermediary, the success of any company listed with ISE is large, as the intermediaries can sell these issues better and that too directly, to the target audience which improves the success rate of an issue marketed through this system, using our large sales force.

IPO Distribution system: The introduction of the ‘IPO Distribution System’. For offering primary market issue by the ISE, would reduce the time and cost of marketing a new issue. This would be possible once the new system is finally notified by SEBI.

Additional facility: Although the jurisdiction of ISE for listing of companies as Regional Stock Exchange is Navi Mumbai, Maharashtra, securities of companies, which are located elsewhere are also listed.

Investor protection: ISE has set up an ‘Investors Grievance and Service Cell’ which looks after all types of complaints of investors located across the country and provides decentralized support.

Website: The facility of website where the publicly disclosed information on all companies would be placed for easy access by the investors would be a great advantage. In effect, all companies listed on this exchange would be able to update their site independently for greater investor information.

Trading Methodology

Transactions for the ISE segment are routed from the trader’s workstation to the central trading computers, (i.e. Tandem system) installed at ISE’s office in Vashi, through the regional Gate Way Server (GWS) system, installed at the participating Stck Exchanges using a VAST communication network.

As far as the NSE segment is concerned, all orders are forwarded to NSE through the central trading and settlement software that is installed at Mumbai on a high-end Compaq computer. This Compaq computer is connected to the NES trading system through a 2 mbps leased line, as the primary link between ISS and NSE and it also has a VSAT link as a backup. In the case of traders, the existing VAST links connecting the Participating Stock Exchanges with ISE will be used for accessing the NSE segment too. Within the Participating Stock Exchange premises, the trader workstations (TWSs) required for NSE, access would be connected on a separate LAN segment to the VSAT infrastructure already established.

Settlement System

The total delivery-in/delivery-out of traders is computed on a netting basis. After netting of the traders and dealers, the net position of the center is computed. If there is pay-in position of that center, then funds or securities are moved out from one center to another center, having a corresponding pay-out position of funds or securities. The movement is based on a transportation model to ensure minimum distance and delivery time.

Clearing System

ISE has appointed ABN-AMRRO-Vysya Bank consortium and HDFC Bank to provide learning bank services. Act the operational level, pay-in of funds is done by way of direct debit of the pay-in/settlement accounts maintained by the traders and dealers with Vysys Bank or HDFC Bank. Similarly, in case of margins, debits are carried out on T+1, by electronically debiting the pay-in accounts of traders and dealers. The traders/dealers have to keep funds available in their accounts, as required for the purposes of pay-in and margins, in accordance with the statements downloaded to their TWSs, at the end of the settlement.

Indian Public Offering Distribution system

A system whereby market issue of securities in the primary market is made through the stock exchange mechanism, utilizing the network of the stock exchange, the ISE is known as ‘Indian Public Offering Distribution System.’ This would serve as an additional issue system against the present non-computerized public offering system. The aim is to reduce the time taken for allotment of securities to the investors, as well as bring down discrepancies/errors inherent in any manual system

The proposed system would reduce the time taken for allotment of securities from the date of closing of the issue. Under this system, the investor would part with his funds, only when he has been provisionally allocated the securities. There will be no question of refund of the application money.

Mechanism

Appointment of agents: The issuer company appoints members of the stock exchange as agents or collection centers for accepting applications from investors. The agents would place orders on behalf of the client-investor, besides underwriting the issue. Members act as agents when the issue is open to the public for subscription.

Order placement: Interested investors approach their members and place suitable orders for subscribing to the issue. The order placement is done through the Stock Exchange trading network.

Allotment information: Registrars to the issue send information on allotment, to the stock exchange after finalizing the allotment. Members are then informed accordingly. The members in turn inform clients. Details of allotment are also made available on the ISE’s website, which can be accessed by the investors directly.

Application: The applications for shares are filled in by successful applicants, electronically, where the facility of internet is available or in the usual fashion, where the internet facility is unavailable.

Payment: When the application is made through internet, payment for shares allotted, is made through the ‘payment Gateway System’ and through the normal physical instruments in case of other modes.

Actual allotment: The registrar to the issue makes a formal allotment of shares, after receiving the entire data and money in full. Allotment is made both in physical as well as in demats form, depending on the request.

Indonext

Indonext is the proposed common trading platform for regional stock exchanges. It is planned to obey introduced, by the SEBI on the basis of recommendations by the, ‘Justice Kania Committee on Corporatization and Demutalization of Stock Exchanges. Indonext is to be set up as the third National Stock Exchange, on the lines of ‘Euronext’. Indonext is to be established by merging regional stock exchanges with, the Over-The-Counter Stock Exchange (OTCEI). The scheme aims at giving a new lease of life for the regional stock exchanges in India.

Need

The need for setting up Indonext rose, owing to the rapid expansion of the national and Bombay stock exchanges, into small centers and cities, and the struggle of regional exchanges to survive of all the national exchanges, seven of them do not conduct any business at all. Further, the capital market regulator, SEBI, has permitted companies to cut down their multiple listings and to eventually delist from the regional bourses. Good quality stocks started vanishing from the bourses and new stocks are not being listed, due to lack of initial public offerings. The idea behind Indonext is, to have a single trading segment.

Features

Indonext seeks to be different from the ISE in the following respects:

Exclusive trading Indonext aims at offering exclusive trading in the case of companies with paid-up capital of ` 20 lakhs, very small and medium capital companies.

Liquidy Indonext proposes to generate liquidity in the thinly traded stocks so as to ensure survival of small stock exchanges.

Wide trading Trading on Indonext will be open to all members including NSE, BSE, ISEI, OTCEI and regional exchanges.

Trading model Trading segment of all regional exchanges and OTCEI will be modeled along lines of Euronext, Paris of Amesterdam.

Eliminating conflict of interest Indonext seeks to eliminate a conflict of interest among regional stockbrokers by disallowing participating exchanges to retain a separate trading platform. Members will be permitted to trade only on the Indonext platform.

‘S Group’ Companies

The Federation of Indian Stock Exchanges (FISE) representing the regional stock exchanges gave the idea of ‘S Group’ Companies. Corporates such as Alfa Laval, Tata Coffee, Tata Honeywell, Tata Infomedia, Texmaco, Jindal Strips, Crisil, Godfrey Phillips and Forbs Gokak are among the 2,260 scrips that BSE has agreed to be traded on the Indonext. For this purpose, agreement is to be worked out between FISE and BSE, to create a single order book for companies with a paid-up capital of upto ` 20 crores. These companies with small capital single order book for companies with a paid-up capital of Upto ` 20 crores. These companies with small capital bases will be called ‘S Group’ companies. Scrips that are traded on BSE ‘A Group,’ would not be included even if they have a small capital base. Similarly, all ‘Z Group’ scrips at BSE that have not paid listing fee at the regional stock exchanges would be excluded from this group. Once a company is admitted, it cannot come out of the ‘S Group,’ even if its paid-up capital increases beyond ` 20 crores.

Benefits

Indonext offers the advantage of sharing common trading platform, whereby all the shares listed exclusively in the regional stock exchanges are placed on a common order book. This would facilitate trading of shares in all participating exchanges. This would in turn, entail increase of shares traded and also increase the number of players in this segment.

Members of NSE and BSE would be permitted to trade in Indonext through limited trading rights, which could be formed at a low entry price. This would activate the segment with the increase in the number of players, too. Some of the regional stock exchanges that are set to form a common trading platform are the stock exchanges of Madras, Bangalore, Cochin, Coimbatore, Mangalore and Hyderabad.