NISM Certification on Securities Operations and Risk Management Workbook PDF

VII Securities Operations and Risk Management NISM Certification on Securities Operations and Risk Management – Workbook Workbook for...

VII Securities Operations and Risk Management NISM Certification on Securities Operations and Risk Management – Workbook Workbook for NISM-Series-VII: Securities Operations and Risk Management Certification Examination National Institute of Securities Markets www.nism.ac.in 1  NISM Certification on Securities Operations and Risk Management – Workbook This workbook has been developed to assist candidates in preparing for the National Institute of Securities Markets (NISM) Certification Examination for Securities Operations and Risk Management. Workbook Version: September 2024 Published by: National Institute of Securities Markets © National Institute of Securities Markets, 2024 Plot 82, Sector 17, Vashi Navi Mumbai – 400 705, India National Institute of Securities Markets Patalganga Campus Plot IS-1 & IS-2, Patalganga Industrial Area Village Mohopada (Wasambe) Taluka-Khalapur District Raigad-410222 All rights reserved. Reproduction of this publication in any form without prior permission of the publishers is strictly prohibited. 2  NISM Certification on Securities Operations and Risk Management – Workbook Foreword NISM is a leading provider of high-end professional education, certifications, training and research in financial markets. NISM engages in capacity building among stakeholders in the securities markets, through professional education, financial literacy, enhancing governance standards and fostering policy research. The NISM certification programs aim at enhancing the quality and standards of professionals employed in various segments of the financial sector. NISM develops and conducts certification examinations and Continuing Professional Education (CPE) programs that aim at ensuring that professionals meet the defined minimum common knowledge benchmark for various critical securities market functions. NISM certification examinations and educational programs service different securities market intermediaries focusing on varied product lines and functional areas. NISM certifications have established knowledge benchmarks for various market products and functions such as equities, mutual funds, derivatives, compliance, operations, advisory and research. NISM certification examinations and training programs provide a structured learning plan and career path to students and job aspirants, wishing to make a professional career in the securities markets. NISM supports candidates by providing lucid and focused workbooks that assist them in understanding the subject and preparing for NISM Examinations. This book covers all important aspects related to the stock brokers operations, starting from client on-boarding to trade life cycle and includes compliance requirements related to report submission and redressal of investor grievances. This book will be immensely useful to all those who want to learn about the various functions of a broker’s operations and risk management in the securities markets. Shashi Krishnan Director 3  NISM Certification on Securities Operations and Risk Management – Workbook Disclaimer The contents of this publication do not necessarily constitute or imply its endorsement, recommendation, or favoring by the National Institute of Securities Market (NISM) or the Securities and Exchange Board of India (SEBI). This publication is meant for general reading and educational purpose only. The statements/explanations/concepts are of general nature and may not have taken into account the particular objective/ move/ aim/ need/ circumstances of individual user/ reader/ organization/ institute. Thus, NISM and SEBI do not assume any responsibility for any wrong move or action taken based on the information available in this publication. Therefore, before acting on or following the steps suggested on any theme or before following any recommendation given in this publication user/reader should consider/seek professional advice. The publication contains information, statements, opinions, statistics, and materials that have been obtained from sources believed to be reliable and the publishers of this title have made best efforts to avoid any errors. However, publishers of this material offer no guarantees and warranties of any kind to the readers/users of the information contained in this publication. Since the work and research is still going on in all these knowledge streams, NISM and SEBI do not warrant the totality and absolute accuracy, adequacy or completeness of this information and material and expressly disclaim any liability for errors or omissions in this information and material herein. NISM and SEBI do not accept any legal liability what so ever based on any information contained herein. While the NISM Certification examination will be largely based on material in this workbook, NISM does not guarantee that all questions in the examination will be from material covered herein. Acknowledgement This workbook has been reviewed by the Certification team of NISM in coordination with Mr. Sunil Gawde, Resource Person, NISM. NISM gratefully acknowledges the contribution of the Examination Committee of NISM Series VII: Securities Operations and Risk Management Certification Examination consisting of Industry Experts. 4  NISM Certification on Securities Operations and Risk Management – Workbook About NISM Certifications NISM is engaged in developing and administering Certification Examinations and Continuing Professional Education (CPE) Programmes for professionals employed in various segments of the Indian securities markets. These Certifications and CPE Programmes are being developed and administered by NISM as mandated under Securities and Exchange Board of India (Certification of Associated Persons in the Securities Markets) Regulations, 2007. The skills, expertise and ethics of professionals in the securities markets are crucial in providing effective intermediation to investors and in increasing the investor confidence in market systems and processes. NISM seeks to ensure that market intermediaries meet defined minimum common benchmark of required functional knowledge through Certification Examinations and CPE Programmes on Mutual Funds, Equities, Derivatives, Securities Operations, Compliance, Portfolio Management etc. These Certifications create quality market professionals and catalyzes greater investor participation in the markets. They also provide structured career paths to students and job aspirants in the securities markets. 5  NISM Certification on Securities Operations and Risk Management – Workbook About the Certification Examination on Securities Operations and Risk Management The examination seeks to create a common minimum knowledge benchmark as the requisite standard for associated persons of a registered stock-broker /trading member / clearing member in recognized stock exchanges, involved in (a) assets or funds of investor or clients (b) redressal of investor grievances, (c) internal control or risk management and (d) activities having a bearing on operational risk. Examination Objectives On successful completion of the examination, the candidate should:  Know the basics of the Indian securities market, the different products traded and the various market participants and the respective roles they play in the Indian securities market.  Understand the regulatory framework and the role of the Securities Exchange Board of India.  Understand the trade life cycle, the steps and participants involved in the trade life cycle.  Know the various functions of the Front Office, Middle Office and Back Office in a Securities Broking Firm.  Understand how the risks are managed in a securities broking firm, the clearing and settlement process.  Understand the various procedures for redress of investor grievances Assessment Structure The examination consists of 100 questions of 1 mark each and should be completed in 2 hours. The passing score on the examination is 50%. There shall be negative marking of 25% of the marks assigned to a question. Examination Structure The exam covers knowledge competencies related to the basics of securities market, the trade life cycle, knowledge about the functioning of the front office, middle office and back office in a broking firm. The risk management practices and the clearing and settlement process for a trade executed in the secondary market. How to register and take the examination To find out more and register for the examination please visit www.nism.ac.in 6  NISM Certification on Securities Operations and Risk Management – Workbook TABLE OF CONTENTS CHAPTER 1: INTRODUCTION TO THE SECURITIES MARKET............................................................................. 9 1.1 INTRODUCTION...................................................................................................................................... 9 1.2 SECURITIES MARKET.............................................................................................................................. 10 1.3 MONEY MARKET................................................................................................................................. 12 1.4 PRODUCTS TRADED IN THE INDIAN SECURITIES MARKET................................................................................. 14 1.5 INTERNATIONAL FINANCIAL SERVICES CENTRES (IFSC)................................................................................... 23 CHAPTER 2: MARKET PARTICIPANTS IN THE SECURITIES MARKET................................................................. 26 2.1 INTRODUCTION.................................................................................................................................... 26 2.2 INVESTORS.......................................................................................................................................... 26 2.3 ISSUERS.............................................................................................................................................. 29 2.4 MARKET STRUCTURE AND PARTICIPANTS.................................................................................................... 31 2.5 REGULATORS....................................................................................................................................... 39 CHAPTER 3: INTRODUCTION TO SECURITIES BROKING OPERATIONS............................................................ 58 3.1 INTRODUCTION TO THE SECURITIES TRADE LIFE CYCLE.................................................................................... 58 3.2 FRONT OFFICE OPERATIONS.................................................................................................................... 65 3.3 MIDDLE OFFICE OPERATIONS.................................................................................................................. 85 3.4 BACK OFFICE OPERATIONS...................................................................................................................... 88 CHAPTER 4: RISK MANAGEMENT............................................................................................................... 103 4.1 RISK MANAGEMENT............................................................................................................................ 103 4.2 COMPLIANCES AND REGULATORY REPORTING............................................................................................ 136 4.3 CORE SETTLEMENT GUARANTEE FUND..................................................................................................... 145 CHAPTER 5: CLEARING PROCESS................................................................................................................ 151 5.1 INTRODUCTION.................................................................................................................................. 151 5.2 ROLE OF THE CLEARING CORPORATION.................................................................................................... 151 5.3 CLEARING BANKS AND THEIR FUNCTION.................................................................................................... 154 5.4 CLEARING MEMBERS AND CUSTODIANS.................................................................................................... 155 5.5 DEPOSITORIES & DEPOSITORY PARTICIPANTS............................................................................................. 156 5.6 CLEARING PROCESS............................................................................................................................. 158 CHAPTER 6: SETTLEMENT PROCESS........................................................................................................... 167 6.1 INTRODUCTION.................................................................................................................................. 167 6.2 DETERMINATION OF SETTLEMENT OBLIGATIONS.......................................................................................... 168 6.3 SETTLEMENT OF FUNDS........................................................................................................................ 171 6.4 SETTLEMENT OF SECURITIES.................................................................................................................. 174 6.5 AUCTION OF SECURITIES....................................................................................................................... 174 6.6 CORPORATE ACTIONS ADJUSTMENT........................................................................................................ 176 CHAPTER 7: INVESTOR GRIEVANCES AND ARBITRATION............................................................................ 182 7.1 INTRODUCTION.................................................................................................................................. 182 7.2 INVESTOR GRIEVANCE.......................................................................................................................... 182 7.3 ONLINE RESOLUTION OF DISPUTES IN THE INDIAN SECURITIES MARKET............................................................ 188 7.4 INVESTOR PROTECTION FUND................................................................................................................ 197 CHAPTER 8: OTHER SERVICES PROVIDED BY BROKERS................................................................................ 201 8.1 INTRODUCTION................................................................................................................................... 201 8.2 IPO APPLICATIONS............................................................................................................................. 202 8.3 TRADING OF MUTUAL FUND UNITS......................................................................................................... 203 8.4 PORTFOLIO MANAGEMENT SERVICE....................................................................................................... 205 8.5 RESEARCH REPORTS........................................................................................................................... 210 7  NISM Certification on Securities Operations and Risk Management – Workbook 8.6 DEPOSITORY SERVICES......................................................................................................................... 210 8.7 MARGIN TRADING.............................................................................................................................. 211 8.8 INTERNET BASED TRADING (IBT) & SECURITIES TRADING USING WIRELESS TECHNOLOGY (STWT)......................... 215 ANNEXURE 1: CODE OF CONDUCT FOR STOCK BROKERS............................................................................ 220 8  NISM Certification on Securities Operations and Risk Management – Workbook CHAPTER 1: INTRODUCTION TO THE SECURITIES MARKET LEARNING OBJECTIVES: After studying this chapter, you should know about:  Meaning of securities market and its role in the Indian Economy  The different segments of securities market  Products traded in Indian securities market  Concept of International Financial Services Centres (IFSC) 1.1 Introduction The financial markets enable efficient transfer and allocation of financial resources for productive activities in the economy. Users of funds include businesses, governments and households who seek funds to run their activities. Households, businesses and governments also act as providers of surplus funds. Intermediaries such as banks, financial institutions, mutual funds and insurance companies, among others, channelize the available surplus funds from lenders to the users. The function of the financial markets is to ensure that economic activity is enabled by providing access of funds to those who need it for consumption or productive activity. They provide a way for aggregation of funds from a large number of investors and make it available for productive economic activity. In the absence of financial markets such aggregation may not be possible. An efficient financial market ensures that the transfer of funds happens at a cost that makes it attractive for savers to save and lend and for users to borrow funds. The markets must enable the dissemination of relevant information to all the participants in the market so that the decision on price of funds is made after integrating all available information. It must also allow the participants to review their funding decisions given new information and to re-allocate the resources accordingly. Therefore, providing liquidity and exit options are an important function of financial markets. Financial market regulations and regulators focus on setting up systems and processes in place to streamline the activities associated with the transfer of funds. The financial market comprises of the money market and the securities markets. The marketplace where buyers and sellers interact with each other and participate in the trading of money, bonds, shares and other assets is the financial market. Financial markets are the centre that facilitate buying and selling of financial instruments, claims or services. It caters to the credit needs of the individuals, firms and institutions. It deals with the financial assets of different types such as currency deposits, cheques, bills, bonds etc. it is defined as a transmission mechanism between investors and the borrowers through which transfer of funds is facilitated. It consists of individual investors, financial institutions and other intermediaries who are linked by a formal trading rules and communication network for trading the various financial assets and credit instruments. Financial markets can be broadly classified as Capital Market (Securities Market) and Money market. 9  NISM Certification on Securities Operations and Risk Management – Workbook In this book however, we are going to focus specifically on securities market. The term “Securities” as defined in the Securities Contract Regulation Act (SCRA), 1956 includes the following: i. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; ii. Derivatives; iii. Units or any other instrument issued by any Collective Investment Scheme; iv. Security receipt as defined in the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; v. Units or any other instrument issued by any pooled investment vehicle; vi. Units or any other such instrument issued to the investors under any mutual fund scheme;1 vii. Any certificate or instrument, issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be; viii. Government Securities ix. Such other instruments as may be declared by the Central Government to be securities, and x. Rights or interest in securities. xi. “Electronic Gold Receipt” means an electronic receipt issued on the basis of deposit of underlying physical gold in accordance with the regulations made by the Securities and Exchange Board of India under section 31 of the said Act. xii. Zero Coupon Zero Principal Instruments Securities market help in transfer of resources from those with idle resources/surplus to others who have a productive need for them. To state formally, securities markets provide channels for allocation of savings to investments and thereby decouple these two activities. As a result, the savers and investors are not constrained by their individual abilities, but by the economy’s abilities to save and invest respectively, which inevitably enhances savings and investment in the economy. 1.2 Securities Market 1 "Securities" shall not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer referred to in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938); 10  NISM Certification on Securities Operations and Risk Management – Workbook The securities market has two interdependent and inseparable segments, viz., the new issues (the primary market) and trading in existing issues (secondary) market. The primary market is used by issuers for raising capital from the investors by making Initial Public Offers or rights issues or Further Public Offer (FPO) or private placement. On the other hand, the secondary market provides liquidity to these instruments, through trading and settlement on the stock Exchanges. An active secondary market promotes the growth of the primary market and capital formation, since the investors in the primary market are assured of a continuous market where they have an option to liquidate their investments. Thus, in the primary market, the issuer has direct contact with the investor, while in the secondary market, the dealings are between two investors and the issuer does not come into the picture. Primary market is the market that ensures availability of adequate capital at reasonable rates to finance expansion, diversification or consolidation of companies. A secondary market on the other hand is the market where the buyer of securities in the primary market can transfer /sell these securities to another buyer. The resources in the primary market can be raised either through the private placement route or through the public issue route by way of Initial Public Offer (IPO) or Follow on Public Offer (FPO). It is a public issue, if anybody and everybody can subscribe for it, whereas, if the issue is made to select group of people then it is termed as private placement. In cases, where fresh shares are issued to existing shareholders at a particular price, it is referred as Rights Issue, whereas if such issues are without involvement of any cost, it is referred as Bonus issue/stock split. The secondary market on the other hand operates through two mediums, namely, the Over- The-Counter (OTC) market and the Exchange Traded Market/Screen Based Trading System (SBTS). OTC markets are the informal type of markets where trades are negotiated. In this type of market, the securities are traded over the counter and settled bilaterally. The other option of trading is through the stock exchange route, where trading and settlement is done through the Stock Exchanges and the buyers and sellers don’t know each other. The settlements of trades are carried out as per a fixed time schedule. The trades executed on the exchange are settled through the clearing corporation, who acts as a counterparty and guarantees settlement. There are several major players in the primary market. These include the merchant bankers, mutual funds, financial institutions, Foreign Portfolio Investors (FPIs), individual investors; the issuers including companies, bodies corporate, lawyers, bankers to the issue, brokers, depositories, self-certified syndicate banks (SCSBs) and depository participants. The stock exchanges are involved to the extent of providing platform for primary issuance and listing of the securities. In the secondary market, there are the stock exchanges, clearing corporations, stock brokers (who are members of the stock exchanges), the mutual funds/asset management companies (AMCs), financial institutions, Foreign Portfolio Investors (FPIs), investment companies, individual investors, depository participants and banks. 11  NISM Certification on Securities Operations and Risk Management – Workbook The Registrars and Transfer Agents, Custodians and Depositories are capital market intermediaries which provide important infrastructure services to both the primary and secondary markets. These would be discussed in detail in the later sections of this workbook. 1.3 Money Market Money Market is a short-term market and handles instrument from 1 day to 1 year. It is mostly used by Government, Banks and other corporate entities to tide over short-term requirements of funds. The entities having excess and the entities with shortage of funds participate in this market. The RBI uses the money market for transmission of its monetary policy direction by changing various Reserve ratios, conducting Open Market Operations, increasing or decreasing of policy rates, etc. Participants in the Indian money market include Central Bank of India (RBI), Public Sector Banks, Private Sector Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers, Bank cum Primary Dealers, Non- Banking Financial Companies (NBFCs), Corporates, Provident / Pension Funds, Payment Banks, Small Finance Banks, etc. The money market deals primarily in short-term debt securities and investments, such as bankers’ acceptances, negotiable certificates of deposit (CDs), commercial papers, repos, Call/Notice/Term money and treasury bills (T-bills). Money market is typically divided into two segments: (a) Borrowing and Lending segment with or without collaterals; (b) Asset Market involving purchase and sale of money market instruments. These are explained briefly below: a) Call Money: The call money market is an avenue for unsecured lending and borrowing of funds. This market is a purely interbank market in India restricted only to Scheduled Commercial Banks (SCBs) and the Primary Dealers (PDs). Call money transactions are dealt/ reported on the Reserve Bank of India’s NDS-CALL (Negotiated Dealing System – Call) platform, which is managed by CCIL, and are predominantly overnight (tenor of borrowing may be extended to account for weekends and holidays). b) Notice Money: This is an extension of the interbank call market with uncollateralized lending and borrowing of funds for a period beyond overnight and up to 14 days. Notice money transactions are dealt / reported on the RBI’s NDS-CALL. c) Term Money: This is an extension of the interbank call market for uncollateralized lending and borrowing of funds for a period between 15 days and 1 year. Term money transactions are dealt / reported on the RBI’s NDS-CALL. d) Market Repo: Repo, also known as a ready forward contract, refers to borrowing funds via sale of securities with an agreement to repurchase the same at a future date with the interest for the borrowings incorporated in the repurchase price. Reverse repo is the exact opposite transaction which is essentially a collateralized lending of funds. Each repo/ reverse repo deal thus has two parts (or, two legs). The repo period (repo tenor) is the time between the two legs. The interest is computed on the actual amount borrowed by the repo seller which is the consideration amount in the repo’s first leg. The lender receives the interest in the second leg when the 12  NISM Certification on Securities Operations and Risk Management – Workbook security is bought back by the borrower at a higher consideration that includes the interest. RBI regulates the repo market in India and major participants are Scheduled Commercial Banks, Primary Dealers, Mutual Funds, NBFCs, Financial Institutions, Insurance Companies, Corporates, Provident / Pension Funds, Payment Banks, Small Finance Banks, etc. Repo transactions are allowed on Government Securities as well as corporate bonds. Repo transactions against G-secs are traded / reported on the Clearcorp Repo Order Matching System (CROMS) electronic platform of the Clearcorp Dealing Systems. These are settled by CCIL along with the G-secs. e) Triparty Repo in Government Securities: "Triparty repo" is a type of repo contract with a third party intermediary between the borrower and lender known as the Triparty Agent (TPA). The TPA does the collateral selection, payment and settlement, custody and management during repo period. Following RBI’s authorization to CCIL to act as a TPA., The Tri Party Repo Dealing System (TREPS), an anonymous order matching trading platform, is provided by Clearcorp Dealing Systems (India) Ltd with CCIL as the Central Counterparty (CCP) for borrowing and lending of funds against government securities in India with a triparty arrangement. All the repo eligible entities can trade on TREPS, and the funds borrowed on TREPS are exempted from RBI’s CRR/SLR computation and the security acquired under the deal is eligible for SLR by the acquiring Bank. Unlike Repo, TREPS facilitate the trading of Repo and the seller of the security has a right to substitute the security. f) Treasury Bills (T-bills): In India, Treasury bills or T-bills are used for short term borrowing by the Government of India and are considered to be a part of the money market as they mature within a year from issue. These are basically zero coupon securities which are issued at a discount and are redeemed at par. Normally RBI conducts weekly auctions (on Wednesday) for three tenors of T-bills: 91, 182 and 364 days. Treasury bills are treaded on NDS-OM platform along with Government Securities. g) Cash Management Bills (CMBs): Essentially very short term T-bills, Cash Management Bills (CMBs) are issued by the Government of India to fund the temporary mismatches in its cash flow. CMBs have maturities less than 91 days. This is issued to absorb excess liquidity in the system after auction for usual Treasury Bills on weekly basis. h) Commercial Paper (CP): A Commercial Paper (CP) is used by Indian corporates to raise short-term unsecured funds. CPs are also discounted instruments like T-bills and are issued for ₹5 lakh and multiples thereof for maturities between 7 days and one year. CP issuances are governed by RBI regulations. Companies, including Non- Banking Finance Companies (NBFCs) and All India Financial Institutions (AIFIs), are eligible to issue CPs subject to the condition that any fund-based facility availed of from bank(s) and/or financial institutions is classified as a standard asset by all financing banks/institutions at the time of issue. Eligible issuers, whose total CP issuance during a calendar year is Rs. 1000 crore or more, shall obtain credit rating for issuance of CPs from at least two CRAs registered with SEBI i) Certificate of Deposit (CD): Certificate of Deposits is a negotiable, unsecured money market instrument issued by a bank2 as a Usance Promissory Note against funds 2 CDs can also be issued by the All India Financial Institution which shall be guided by the specific RBI Directions 13  NISM Certification on Securities Operations and Risk Management – Workbook deposited at the bank for a maturity period upto one year. CDs are also discounted instruments like T-bills and are issued for ₹5 lakh and multiples thereof for maturities between 7 days and one year. j) Repo in Corporate Bond/ Corporate Debt Securities: Repo in corporate bonds was introduced by RBI in 2010 and the eligible securities for CBR include: a. Listed corporate bonds and debentures, (however, participants cannot borrow against the collateral of their own securities or those of related entities); b. CPs and CDs; and c. Units of Debt ETFs. d. Any other security of a local authority as may be specified in this behalf by the Central Government. k) Exchange Traded Tri-party Repo: Tri-party repo on corporate bonds is available for trading on the exchanges. The product is similar to Tri-party repo on government securities except collateral is corporate bond instead of G-Secs and Tri-party repo agent is limited purpose clearing corporation. AMC Repo Clearing Ltd. (ARCL) is a limited purpose clearing corporation (LPCC) acts as a tri-party repo agent. The Tri- party repo product of ARCL is currently traded on Exchange Tri-party repo Market Trading Platform. 1.4 Products Traded in the Indian Securities Market Investors in the Indian securities market have a wide choice of product base to choose from depending upon a person’s risk appetite and needs. The different types of products available in equity, derivatives and debt markets are discussed below. These products are traded on various segment of Exchanges and sometimes on OTC / electronic trading also. In our workbook we will focus mainly on various segment of Stock Exchange and product traded on the same. 1.4.1 Equity / Cash Markets and its Products The equity/cash segment of the stock exchange allows trading in shares, government securities, debentures, warrants, mutual funds and exchange traded funds (ETFs) etc. An Equity Share normally known as ordinary shares represents the form of fractional ownership in a business venture. Equity shareholders collectively own the company. They bear the risk and enjoy the rewards of ownership. Equity shares do not have a maturity date and have variable returns in the form of dividends and capital gains. Equity shareholders are entitled to voting rights. In the event of liquidation of company equities will have last preference. Typically equity securities are riskier as compared to debt securities. Preference Shares, also commonly known as preferred stock, are a special type of share where dividends are paid to shareholders prior to the issuance of equity stock dividends. Preference shareholders hold preferential rights over equity shareholders when it comes to sharing profits. Debentures are instruments for raising debt. Debenture is debt securities which indicate a loan to the company. Debentures typically have a maturity date and have a predefined return in the form of interest payments. Debentures in India are typically secured by 14  NISM Certification on Securities Operations and Risk Management – Workbook tangible assets. There are fully convertible, non-convertible and partly convertible debentures. Fully convertible debentures will be converted into ordinary shares of the same company under specified terms and conditions. Partly convertible debentures (PCDs) will be partly converted into ordinary shares of the same company under specified terms and conditions. Thus, it has features of both debenture as well as equity. Non-Convertible Debentures (NCDs) are pure debt instruments without a feature of conversion. The NCDs are repayable on maturity. Thus, debentures can be pure debt or quasi-equity, as the case may be. Government Securities are also known as “sovereign debt” and are generally issued via auctions and traded in the secondary market. Government bonds issued in local currency are considered risk free as the Government, being a sovereign entity, can print the currency to repay its obligation to bond holders. Government Securities are issued by central and state government. The dated securities issued by state government is known as State Development Loans (SDL). Warrants entitle an investor to buy equity shares after a specified time period at a given price. A Mutual Funds is an investment vehicle that pools money from numerous investors who wish to save or make investments having similar investment objective. A mutual fund invests in different types of securities in consonance with the investment objectives. A mutual fund company pools money from many investors and invests the money in stocks, bonds, money‐market instruments, other securities or assets, or some combination of these investments, depending on the objectives of the fund. There are funds which invest in equities, better known as equity MF schemes which are considered riskier than debt mutual funds. Liquid mutual funds invest mainly in short term and very short term money market instruments. One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of various securities which would be quite difficult to create with a small amount of capital. Mutual Fund schemes are either open ended or close ended. Close ended mutual funds schemes are traded on the equity segment of the Exchange. Exchange Traded Fund : An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. The main difference between ETFs and other types of index funds is that ETFs don't try to outperform their corresponding index, but simply replicate the performance of the Index. Unlike regular mutual funds, an ETF trades like a common stock on a stock exchange. The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange. The trading value of an ETF is based on the net asset value of the underlying stocks that an ETF represents. Indian Depository Receipt (IDR): Foreign companies are not allowed to directly list on the Indian stock exchanges. However, they are allowed to raise capital in Indian currency through an instrument called Indian Depository Receipt (IDR). An IDR is an instrument denominated in Indian Rupees in the form of a depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India (SEBI)) against the underlying equity shares of issuing company to enable foreign 15  NISM Certification on Securities Operations and Risk Management – Workbook companies to raise funds from the Indian securities Markets.3 IDRs are issued by foreign companies to Indian investors. IDRs are depository receipts which have the equity shares of the issuing company as the underlying security. The underlying shares are held by a foreign custodian and the DRs are held in the Indian depository. IDRs are listed in the Indian stock exchanges. The investor can either hold the IDR, trade in them in the stock exchange or request for conversion/redemption into the underlying shares. Redemption/Conversion is permitted after 1 year from the date of listing of the IDRs. Two way fungibility of IDRs is permitted i.e., the depository receipt can be converted into underlying shares and the underlying shares can be converted into depository receipt. However, the number of shares that can be converted into depository receipt should be within the headroom available. The headroom for this purpose shall be the number of IDRs originally issued minus the number of IDRs outstanding, which is further adjusted for IDRs redeemed into underlying equity shares. 1.4.2 Derivative Market and its Products Derivative is a product whose value is derived from the value of an underlying asset or group of assets—a benchmark. The derivative itself is a contract between two or more parties. The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes. Derivative products are in the form of Forwards, Futures, Options and Swaps. Derivatives can trade over-the-counter (OTC) or on an exchange. With Securities Laws (Second Amendment) Act, 1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, 1956 as: a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; b. a contract which derives its value from the prices, or index of prices, of underlying securities; c. commodity derivatives; and d. such other instruments as may be declared by the Central Government to be derivatives; Further Section 18A of the act provides that notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are: o Traded on a recognized stock exchange o Settled on the clearing house of the recognized stock exchange, in accordance with the rules and bye–laws of such stock exchanges. o Between such parties and on such term as the Central Government may, by notification in the Official Gazette specify 3 https://www.sebi.gov.in/sebi_data/commondocs/foreigncos1_p.pdf https://www.sebi.gov.in/legal/circulars/mar-2013/guidelines-for-enabling-partial-two-way-fungibility-of- indian-depository-receipts-idrs-_24379.html 16  NISM Certification on Securities Operations and Risk Management – Workbook Forward contract is a promise to deliver an asset on a pre- determined date in future at a predetermined price. Forward contracts are non-standardised contracts which are traded in OTC4. A Futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are the Exchange traded organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre- specified date which is called the expiry date of the contract. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange traded contracts. Options give the buyer (holder) a right but not an obligation to buy or sell an asset at a predetermined price within or at end of a specified period. Options are of two types - call and put. Call Option give the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price on or before a given future date. Put Option give the buyer the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a given date. Options are traded on stock exchanges as well as on OTC. A swap is an agreement made between two parties, to exchange cash flows in the future, according to a prearranged formula. Swaps are, broadly speaking, series of forward contracts. Swaps help market participants manage risk associated with volatile interest rates, currency exchange rates and commodity prices etc. Swaps are mainly traded in OTC. The two types of exchange traded derivatives instruments are futures and options. In India, futures and options are traded on equity stocks, equity indices, currency, interest rate instrument and commodities. 1.4.2.1 Equity Derivatives: Equity Derivatives are financial instruments whose value is derived from price movements of the underlying asset, where that asset is a stock or stock index. Equity Index Futures and Options: Currently in the Indian markets, future and options contract are available for trading on the indices such as BSE’s SENSEX, MSEI SX40 and NSE’s NIFTY 50 and sectoral indices of banks etc. Index future and option contracts are available with weekly and monthly expiry and options for some indices up to three year’s expiry cycle with quarterly and half-yearly expiries. Weekly Options are the exchange traded options based on an Index with shorter maturity of one or more weeks. Weekly and monthly equity index futures & options contracts expire on the different days of expiry week or month. In case the expiry day is a trading holiday; 4 In case of derivatives, Over-the-counter generally indicate transaction undertaken other than Stock Exchanges and including electronic trading platform. 17  NISM Certification on Securities Operations and Risk Management – Workbook the contracts expire on the previous trading day. A new contract is introduced on the next trading day following the expiry of the near month contract. Monthly index contracts generally have 3-month expiry cycle except for the long dated options contracts which are available up to 3-year expiry cycle with quarterly expiries (March, June, Sept & Dec cycle) and half yearly expiries (Jun, Dec cycle). Generally, all option contracts with expiry of more than 9 months shall be treated as long dated/long term option contracts. A new contract is introduced on the next trading day following the expiry of the near month contract. Weekly option contracts expire on specific day of the week. A new weekly contract is introduced on the next trading day following the expiry of the respective week ‘s contract. All Index future and option contracts are cash settled. Stock Futures and Options: Individual stock futures and options on specific listed stocks are chosen by the stock Exchange based on the guidelines and criteria (such as market capitalization, trading volume, delivery volume etc.) defined by SEBI. Similar to index futures and options, stock futures and option contract available with weekly and monthly expiry. All stock futures and option contracts are physically settled. All monthly stock futures and options contracts expire on the last Thursday of the expiry month. In case the last Thursday is a trading holiday, the contracts expire on the previous trading day. A new contract is introduced on the next trading day following the expiry of the near month contract. 1.4.2.2 Currency Derivatives Currency Derivatives trading was introduced in the Indian financial markets with the launch of currency futures trading in the USD-INR pair in 2008.5 Currently in India, currency futures contracts are traded on four INR pairs i.e., USDINR, EURINR, GBPINR and JPYINR and on three cross currency pairs i.e., EURUSD, GBPUSD and USDJPY on the recognized stock exchanges. Currency futures and options are traded on separate segment namely “Currency Derivatives Segment” of the Exchange. In case of currency futures, the underlying for USD- INR, EURINR, GBPINR and JPYINR pair would be the rate of Exchange between USD and INR, Euro and INR, Great Britain Pound and INR and Japanese Yen and INR respectively. The contract has a maximum of 12 months of trading cycle. The new contract is introduced following the expiry of the current contract. The expiry day/ last day for the trading of the monthly contract shall be two working days prior to the last business day of the expiry month at 12.30 pm. All these contracts are cash settled. The final settlement price for USDINR, EURINR, GBPINR and JPYINR is the FBIL (Financial Benchmarks India Pvt. Ltd.) reference rate. (FBIL)6 is an independent benchmark administrator for interest rates and foreign exchange. The final settlement price for cross currency pairs is derived from crossing respective FCY-INR rates. In case of currency options, monthly as well as weekly contracts are available. In case of monthly contracts, 3 serial monthly contracts followed by 3 quarterly contracts of the cycle March/June/September/December are available for trading. The expiry is two working days 5 Currency futures were launched at the National Stock Exchange of India on August 29, 2008, and subsequently currency trading at BSE was introduced on October 1, 2008, and MSEI (earlier known as MCX-SX) on October 7, 2008. 6 Financial Benchmark India Pvt. Ltd (FBIL) is an independent benchmark administrator for interest rates and foreign exchange. 18  NISM Certification on Securities Operations and Risk Management – Workbook prior to the last business day of the expiry month at 12.30 pm. The final settlement price is the FBIL reference rate on the date of the expiry of the contact. There are weekly futures and options are also available in various Exchanges for certain currency pairs. Generally, such contracts are expired on last day of the week i.e., on Friday at 12:30 pm. Currently, all Exchange Traded Currency Futures and Option contracts are cash settled in INR. 1.4.2.3 Interest Rate Derivatives Interest Rate Derivatives trading was introduced with introduction of Interest rate futures contract. Interest rate option was introduced in 2019. Interest Rate Futures (IRF) are standardized interest rate derivative contracts traded on a recognized stock exchange to buy or sell a notional security or any other interest-bearing instrument or an index of such instruments or interest rates at a specified future date, at a price determined at the time of the contract. Interest Rate Futures include Money Market Futures also. Currently Exchange traded interest rate futures are available on single government of India Securities within maturity basket of 4-8 year, 8-11 year and 11-15 years, 91-day T-Bills and Overnight MIBOR. All these contracts are currently cash settled. Recently SEBI provided guidelines for introduction of future contracts on Corporate Bond Indices. For single bond futures available on GOI securities, the lot size (i.e., the minimum amount that can be traded on the Exchange) is 2000 bonds at the rate of Rs. 100 per bond i.e., with the total face value of Rs.2,00,000. Typically, three Serial monthly contracts followed by three quarterly contracts of the cycle March/June/September/December available for single bond futures. Last trading day is the last Thursday of the expiry month. If the last Thursday is a holiday, previous trading day will be the last trading day. The contract is cash settled. The final settlement price is value weighted average price of the underlying bond based on the prices during the last two hours of the trading on NDS-OM. If less than 5 trades are executed in the underlying bond during the last two hours of trading, then FIMMDA/FBIL price shall be used for final settlement. Interest rate options are currently available on single bond GOI securities. Typically, three Serial monthly contracts followed by three quarterly contracts of the cycle March/June/September/December available for single bond options. Last trading day is the last Thursday of the expiry month. If the last Thursday is a holiday, previous trading day will be the last trading day. These contracts are cash settled. The final settlement price is value weighted average price of the underlying bond based on the prices during the last two hours of the trading on NDS-OM. If less than 5 trades are executed in the underlying bond during the last two hours of trading, then FIMMDA/FBIL price shall be used for final settlement. Interest rate futures and Options are traded on Currency Derivatives segment of the Exchange. Though SEBI allowed physical settlement for interest rate derivatives product, currently all Interest Rate Derivatives traded on Exchanges are cash settled. 19  NISM Certification on Securities Operations and Risk Management – Workbook 1.4.2.4 Commodity Derivatives Commodities Derivatives are derivatives products, the price of which is derived from the underlying commodities. Commodity derivatives facilitate the trading of commodities such as gold, silver, metal, energy and agricultural goods. Commodity derivatives contract can cash settled or physically settled with actual delivery of commodity. Commodity futures and options are traded on separate segment namely “Commodity Derivatives Segment” of the Exchange. 1.4.3 Debt Market and its Products Debt market mainly consists of government securities, money market instruments, bonds and debentures, which provide financing through the issuance of bonds, and enable the subsequent trading thereof. These instruments can be traded in OTC, Electronic Trading Platform or Exchange traded markets. In India, the debt market is broadly divided into two parts: government securities (G-Sec) market and the corporate bond market. Government Securities Market: The Government needs enormous amount of money to perform various functions such as maintaining law and order, justice, national defense, central banking, creation of physical infrastructure etc. For this, it generates money by various ways including borrowing from banks and other financial institutions. A Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments. The major investors in this market are banks, insurance companies, provident funds, mutual funds, state governments, FPIs etc. In the primary market, Government securities & Treasury Bills are issued through auctions (yield based or price based auctions) conducted by RBI. The secondary market for G-Secs in India is very active with diverse groups of market participants. Secondary market trading mainly takes place through Negotiated Dealing System-Order Matching (NDS-OM) of RBI. G- Secs are also traded in OTC market, RBI retail direct portal and Stock Exchanges. Corporate Bond Market: The corporate bond or corporate debt market is a market where debt securities of corporate (non-government entities, municipal corporation etc.) such as corporate bonds, debentures etc. are issued and traded. Corporates adopt either the public offering route or the private placement route for issuing debentures/bonds. Corporate bonds are bonds issued by firms to meet their needs for expansion, modernization, restructuring operations, mergers and acquisitions. The investors in this market are banks, financial institutions, insurance companies, mutual funds, FPIs etc. 20  NISM Certification on Securities Operations and Risk Management – Workbook In India, corporate bonds are issued mainly on private placement basis (more than 95%) and only small part of the total issuances are through public offer. With the majority of corporate debt issuances in India being private placements, SEBI vide its circular of April 21, 2016, facilitate/mandate private placement issuance through electronic book mechanism/electronic bidding platform (EBP) for better and transparent price discovery. SEBI further streamlined the procedure through its revised guidelines in force from April 1, 2018, operational circular dated August 10, 2021, and subsequent guidelines dated October 10, 2022, applicable from January 01, 2023. The EBP guidelines are applicable for debt securities and non-convertible redeemable preference shares as defined under SEBI regulations and ‘Commercial paper’ and/or ‘Certificate of Deposits’ defined under RBI guidelines issued via private placement mechanism. Corporate Bond secondary market is mainly OTC market, where the trades are negotiated between the participants on phone or through intermediaries. The exchanges have a corporate bond reporting platform, in which all regulated entities need to report OTC corporate bond trades within stipulated time. The Exchanges in early 2020 have launched Request for Quote (RFQ) Platform for execution and settlement of trades which will allow market participants to transact in debt securities. The RFQ Platform provides market participants range of options to seek a quote and to respond to a quote, while keeping an audit trail of all the interactions i.e. quoted yield, mutually agreed price, deal terms etc. This has brought pre trade transparency in the transactions of eligible debt securities. RFQ facilitate participant to negotiate various terms of transaction through screen based system. Corporate bonds are also traded on Stock Exchanges. The platform allows regulated entities to transact through brokers or directly while other entities have an option to transact through brokers. 1.4.4 Other Asset Classes Real Estate Investment Trusts (REIT) are trusts registered with SEBI that invest in commercial real estate assets. REIT assets” means real estate assets and any other assets held by the REIT, on a freehold or leasehold basis, whether directly or through a holding company and/or a special purpose vehicle. SEBI (Real Estate Investment Trusts) Regulations, 2014, laid down framework for REITs. The SEBI (Real Estate Investment Trusts) Regulations, 2014 specifies conditions regarding issuance and allotment of units. Few details are given below: A REIT shall make an initial offer of its units by way of public issue only. Any subsequent issue of units by the REIT may be by way of follow-on offer, preferential allotment, qualified institutional placement, rights issue, bonus issue, offer for sale or any other mechanism and in the manner as may be specified by SEBI. The value of the assets owned or proposed to be owned by a REIT coming out with an initial offer will not be less than Rs. 500 crore and the minimum offer size will not be less than Rs.250 crore. The minimum number of unit holders other than sponsor(s), its related parties and its associates forming part of public which shall be not less than two hundred. The maximum subscription from any investor other than sponsors, its related parties and its associates shall not be more than 25 percent of total unit capital. The minimum subscription from any investor in initial and follow-on public offer shall fall in range of ten thousand rupees to fifteen thousand rupees. The units will be listed on the stock exchange. The units of the REIT listed in recognized stock 21  NISM Certification on Securities Operations and Risk Management – Workbook exchanges shall be traded, cleared and settled in accordance with the bye-laws of concerned stock exchanges and such conditions as may be specified by the SEBI. Trading lot for the purpose of trading of units of the REIT shall consist of one unit. Infrastructure Investment Trusts (InvIT) are trusts registered with SEBI that invest in the infrastructure sector. SEBI (Infrastructure Investment Trusts) Regulations, 2014, laid down framework for InvITs. The SEBI (Infrastructure Investment Trusts) Regulations, 2014 specifies conditions regarding issuance and allotment of units. The InvIT can raise funds through public issue and/or through private placement. The value of InvIT assets shall not be less than Rs. 500 crore and the offer size shall be of atleast Rs. 250 crores. If the InvIT raises funds by public issue it shall be by way of initial public offer. Any subsequent issue of units after IPO may be by way of follow-on offer, preferential allotment, qualified institutional placement, rights issue, bonus issue, offer for sale or any other mechanism and in the manner as may be specified by SEBI. The minimum subscription amount from any investor in initial and follow-on offer shall fall within the range of Rs. 10,000 to Rs. 15,000. The maximum subscription from any investor other than sponsors, its related parties and its associates shall not be more than 25 percent of total unit capital. The InvIT shall refund money in case the number of subscribers to the initial offer forming part of public is less than twenty or fails to collect subscription of at least 90% of the issue size. In case InvIT raises fund by way private placement, then it shall be do it through placement memorandum and from institutional investor or body corporate only, whether Indian and foreign. The minimum investment from any investor should be of rupees one crore. Notwithstanding the above, if such privately placed InvIT invests or proposes to invest not less than eighty per cent of the value of the InvIT assets, in completed and revenue generating assets, the minimum investment from an investor shall be Rs. 25 crore. The maximum subscription from any investor other than sponsors, its related parties and its associates shall not be more than 25 percent of total unit capital. The placement from not less than five and not more than one thousand investors. It shall be mandatory for units of all InvITs to be listed on a recognized stock exchange having nationwide trading terminals, whether publicly issued or privately placed. The units of the InvIT listed in the designated stock exchanges shall be traded, cleared and settled in accordance with the bye- laws of designated stock exchanges and such conditions as may be specified by the SEBI. In case of private placement, trading lot for the purpose of trading of units on the designated stock exchange shall be Rs. 1 crore (in certain cases Rs. 2 crores). In case of public issue, trading lot for the purpose of trading of units on the designated stock exchange shall consist of one unit. Sovereign Gold Bond Scheme (SGB) was launched in 2015 to provide an alternative way for investors to take exposure to gold as an investment. SGBs are government securities denominated in grams of gold. The bonds are issued in denomination of one gram of gold and in denominations thereof. The tenor of the bond is 8 years. Each bond investor buys the bonds in Indian rupees and on redemption are paid the maturity value also in Indian rupees. The units (grams) of gold bought by the investor and represented by the bonds is protected. The value of the bond will reflect the price of gold. On maturity the value of the bond may be higher or lower depending upon the prevailing price of gold. The bonds bear an interest rate (currently 2.50% per annum) on the initial investment and is paid semi-annually to the 22  NISM Certification on Securities Operations and Risk Management – Workbook account of the bond holder. Investors can apply for the bond when the issue of each tranche is open. The bonds are available for investment by resident individuals, HUFs, Trusts, Universities, Charitable Trusts and others. The bonds can be held in physical form or in dematerialized form. The bond is tradable on stock exchanges if held in dematerialized form. 1.5 International Financial Services Centres (IFSC) An International Financial Services Centre (IFSC) caters to customers outside the jurisdiction of the domestic economy. These centres are ‘international’ in the sense that they deal with the flow of finance and financial products/services across borders which includes banking, insurance, asset management, and most importantly, a well-structured and fully developed capital market for debt, equities, commodities as well as derivatives. The first IFSC in India has been set up at GIFT City, Gandhinagar, Gujarat. An IFSC is thus a jurisdiction that provides world class financial services to non-residents and residents, to the extent permissible under the current regulations, in a currency other than the domestic currency (Indian rupee) of the location where the IFSC is located. IFSC at GIFT, Gandhinagar is a deemed foreign territory dealing in foreign currency. The entities in IFSC are recognized as non-resident entity under the FEMA regulations of Reserve Bank of India and get benefits which include exemptions from security transaction tax (STT), commodity transaction tax, dividend distribution tax, capital gains waiver and no income tax. As per the SEBI International Financial Services Centres (IFSC) guidelines, 2015, the stock exchanges operating in IFSC was permitted dealing in following types of securities and products, with a specified trading lot size on their trading platform subject to prior approval of SEBI, viz.,  Equity shares of a company incorporated outside India;  Depository receipt(s);  Debt securities issued by eligible issuers;  Currency and interest rate derivatives;  Index based derivatives;  Commodity derivatives;  REITs and InvITs by whatever name called in permissible jurisdictions;  And any other securities as may be specified by SEBI. Currently NSE and BSE both have exchanges at IFSC and offer various products for trading viz., Index derivatives, Stock Derivatives, Currency Derivatives, Commodity Derivatives and Debt Securities. IFSCA (International Financial Services Centres Authority) has issued operating guideline to enable the Bullion Exchange, Bullion Clearing Corporation, Bullion Depository, Vault Manager in as IFSC to operationalize these activities as per IFSCA (Bullion Exchange) Regulations, 2020. 23  NISM Certification on Securities Operations and Risk Management – Workbook As per SEBI (International Financial Services Centres) Guidelines, 2015, only the following persons can deal in securities listed in IFSC:  A person not resident in India;  A non-resident Indian;  A financial institution resident in India who is eligible under FEMA to invest funds offshore, to the extent of permitted outward investment;  A person resident in India who is eligible under FEMA, to invest funds offshore, to the extent allowed under the Liberalized Remittance Scheme of Reserve Bank of India, subject to a minimum investment as specified by the Board from time to time. 24  NISM Certification on Securities Operations and Risk Management – Workbook Sample Questions 1. Which of the following best describes the term “Private Placement”? (a) Issue made to all investors in the Indian securities market. (b) Issue made to select group of people. (c) Issue made to those investors who already hold shares of the company. 2. State which of these statements is true? (a) Call Option gives the buyer the right but not the obligation to buy the underlying asset. (b) Call Option gives the buyer the right but not the obligation to sell the underlying asset. (c) Put Option gives the buyer the right but not the obligation to buy the underlying asset. 3. The fractional ownership in a company is represented by which of the following? (a) Equity Shares (b) Debentures (c) Bonds 4. ___________ Instruments are not allowed to be traded on IFSC? (a) Equity shares of a company incorporated outside India (b) Equity shares of an Indian Companies (c) Currency and interest rate derivatives 25  NISM Certification on Securities Operations and Risk Management – Workbook Chapter 2: Market Participants in the Securities Market LEARNING OBJECTIVES: After studying this chapter, you should know about:  Different types of securities market participants  Different types of investors based on their investment objectives  Issuer and regulations related to issuer  Role of different kinds of intermediaries in the securities markets  Regulatory framework of securities and some key regulations 2.1 Introduction As already discussed in the previous chapter, in every economic system, there are savers (who are surplus-generators) and there are spenders (deficit-generators). Securities market provides a platform for savers (i.e., Investors) to place their surplus funds in financial claims or securities at the disposal of the spenders (i.e., Issuers) and in turn get benefits such as interest, dividend, capital appreciation, bonus etc. These investors and issuers of financial securities constitute two important elements of the securities markets. Another important element of the markets are the intermediaries who act as conduits between the investors and issuers. Regulatory bodies, which regulate the functioning of the securities markets, constitute another significant element of securities markets. The process of mobilization of resources is carried out under the supervision and overview of the regulators. The regulators develop fair market practices and regulate the conduct of issuers of securities, investors and the intermediaries. They are also in-charge of protecting the interests of the investors. The regulator ensures a high service standard from the intermediaries and supply of quality securities and non-manipulated demand for them in the market. Thus, the important participants of securities markets are the investors, the issuers, the intermediaries and regulators. We now discuss these different participants in detail in the following sections. 2.2 Investors An investor is the backbone of the securities market in any economy as he is the one giving surplus resources for funding to companies (for their set-up or for expansion plans) in return for financial gains. Investors in securities market (based on primary public issuance categorization) can be broadly classified into Retail Individual Investors, Institutional Investors and Non-institutional investors (NII). Retail Individual Investors means an individual investor (Resident Indians, non-resident Indians, HUF) who applies or bids for specified securities for a value of not more than two 26  NISM Certification on Securities Operations and Risk Management – Workbook lakhs rupees; Institutional Investors comprises domestic financial institutions (DFIs), banks, insurance companies, mutual funds, and Foreign Portfolio Investors (a FPI is an entity established or incorporated outside India that proposes to make investments in India) and any other entity specified by SEBI as an Institutional. SEBI (Foreign Portfolio Investors) Regulations, 2019, specifies the categories of FPI which are as given below: FPI Category Type of entity Category 1 (i) Government and Government related investors such as central banks, sovereign wealth funds, international or multilateral organizations etc.; (ii) Entities controlled or at least 75% directly or indirectly owned by such Government and Government related investors (iii) Pension funds and university funds; (iv) Appropriately Regulated entities such as insurance or reinsurance entities, banks, asset management companies, investment managers, investment advisors, portfolio managers, broker dealers and swap dealers; (v) Entities from the Financial Action Task Force (FATF) member countries with certain condition (vi) An entity (A) whose investment manager is from the Financial Action Task Force (FATF) member country and such an investment manager is registered as a Category I foreign portfolio investor; or (B) which is at least seventy- five per cent owned, directly or indirectly by another entity, eligible under (ii), (iii)and (iv) and such an eligible entity is from a Financial Action Task Force member country: Category 27 i) Appropriately Regulated funds not eligible as Category-I foreign portfolio investor; ii) Endowments and foundations; iii) Charitable organizations; iv) Corporate bodies; v) Family offices; vi) Individuals; vii) Regulated entities investing on behalf of their client, viii) Unregulated funds in the form of limited partnership and 7 Category-2 FPIs who are corporate bodies, individual and family offices are treated as non-institutional 27  NISM Certification on Securities Operations and Risk Management – Workbook trusts Non-Institutional investor means any investor other than retail individual investor and institutional investor such as Family offices, corporates, partnership firms etc. Accredited Investors 8 The concept of a class of investors who have an understanding of various financial products and the risks- returns associated with them and therefore, are able to take informed decisions regarding their investments, is recognized by many securities and financial market regulators around the globe. These investors are typically termed as Accredited Investors or Qualified Investors or Professional Investors. SEBI has introduced concept of Accredited Investors in Indian Market. Given below some of the details of accredited investor: Eligibility Individuals, HUFs, Family Trusts and sole proprietorships, which meet the criteria as under: (i) Annual Income >= INR 2 Crore; OR (ii) Net Worth >= INR 7.5 Crore, out of which at least INR 3.75 Crore is in the form of financial assets; OR (iii) Annual Income >= INR 1 Crore+ Net Worth >= INR 5 Crore, out of which at least INR 2.5 Crore is in the form of financial assets; Partnership Firms set up under the Indian Partnership Act, 1932 in which each partner independently meets the Accredited Investor criteria for individuals Trusts (other than family trusts) Assets under Management greater than or equal to INR 50 Crore. Body corporate with net worth greater than or equal to INR 50 Crore. Certain agency deemed to be accredited investors for e.g. Central and State Governments, Developmental Agencies set up under Government(s), Qualified Institutional Bidders, funds set up by government etc. Subsidiaries of depositories and stock exchanges or any other institutions which eligibility criteria specified by SEBI will act as “Accreditation Agency” and can issue an accreditation certificate to such investors. Certain benefits for accredited investors To participate in investment products with an investment amount lesser than the minimum amount mandated in the respective Regulations (“lower ticket size”) Relaxation from regulatory requirements applicable to investment products, such as prudential norms, investment conditions, filings with SEBI, frequency of Audit/ valuation/ reporting, etc. (“regulation-light framework”) To participate in investment products designed and offered exclusively to Accredited Investors. Market Maker 8 https://www.sebi.gov.in/sebi_data/meetingfiles/jul-2021/1626434827210_1.pdf 28  NISM Certification on Securities Operations and Risk Management – Workbook Market makers provide liquidity to facilitate efficiency in the functioning of the financial markets. Market maker mainly operates under the guidelines provided by SEBI or by Exchanges. SEBI has issued detailed guidelines for “Liquidity Enhancement Scheme in the Equity Cash and Equity Derivatives Segments”9. It has also provided guidelines for market maker vide circular dated January 20, 2000. In case of regular cash market and derivatives market liquidity scheme is mainly introduced by the Exchanges. However, for Small and Medium Enterprise (SME) Exchange, market making has been made mandatory in respect of all scrips listed and traded on SME Exchange. The main responsibility of market maker is to provide two-way (buy as well as sell) quotes on a continuous basis with certain minimum amount and reasonable bid-ask spread. 2.3 Issuers The public and private sector enterprises, banks and other financial institutions tap the securities market to finance their capital expansion and growth plans. Even mutual funds which are an important investment intermediary mobilizes the savings of the small investors. Funds can be raised in the primary market from the domestic market as well as from international markets. In the domestic market, issuer can raise funds through financial securities like equity shares, preference shares, Debentures, Bonds etc. They can raise funds through public offer and/or through private placement. Indian companies can also raise resources from international capital markets 10 through Global Depository Receipts (GDRs)/American Depository Receipts (ADRs), Foreign Currency Convertible bonds (FCCBs) and External Commercial Borrowings (ECBs) including Masala Bonds. To learn more about the different international market instruments for raising capital from overseas market please see Box 2.1. 9 SEBI circular CIR/MRD/DP/14/2014 dated April 23, 2014 10 The 1991 reforms allowed Indian companies to raise resources by way of equity issues in the international markets. 29  NISM Certification on Securities Operations and Risk Management – Workbook Box 2.1: Instruments for raising capital from overseas markets Global Depository Receipts (GDRs) is a negotiable financial instrument that is issued by a foreign depository bank other than the US representing a specified number of shares of a foreign company’s stock. GDR are generally traded in European Stock Exchanges. American Depository Receipts (ADRs) An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depository bank representing a specified number of shares of a foreign company's stock. The ADR trades on U.S. stock markets similar to any domestic shares. Foreign Currency Convertible Bonds (FCCBs) are bonds issued by Indian companies and subscribed to by a non-resident in foreign currency. They carry a fixed interest or coupon rate and are convertible into a certain number of ordinary shares at a predetermined price. External Commercial Borrowings (ECBs) are commercial loans (in the form of bank loans, buyers credit, suppliers credit, securitized instruments, floating rate notes and fixed rate bonds) availed from any internationally recognized source such as bank, export credit agencies, suppliers of equipment, foreign collaborators, foreign equity holders and international capital market. Indian companies have preferred this route to raise funds as the cost of borrowing is low in the international markets. Masala Bonds are rupee-denominated bonds issued outside India by Indian entities. They are debt instruments which help to raise money in local currency from foreign investors. Foreign companies can raise capital from Indian markets. They can issue IDR (Indian Depository Receipts). This will be in rupee terms. Standard Chartered Bank is the first entity to raise capital through issuing IDR. Regulations for Issuers: To raise resources, issuers have to adhere to different SEBI regulations which have been briefly discussed here:  SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 hereinafter referred to as ICDR Regulations lays down general conditions for capital market issuances like public and rights issuances; eligibility requirements; general obligations of the issuer and intermediaries in public and rights issuances; regulations governing preferential issues, qualified institutional placements and bonus issues by listed companies; issue of IDRs etc. ICDR Regulations also have detailed requirements laid out with respect to disclosure and process requirements for capital market transactions by listed and to be listed companies. While the eligibility and disclosure obligations are applicable to the Issuer, in capital market transactions, the role of the merchant banker/ lead manager/ book runner is extremely important since they are registered entities with SEBI appointed by the issuer to manage the issue and in case of book built issue the lead manager act as Book Running Lead Manager (BRLM) for the purpose of book running  SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 Issuer or the issuing company desirous of listing its securities on a recognized stock exchange shall execute a listing agreement with such stock exchange in terms of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. As per the regulations, 30  NISM Certification on Securities Operations and Risk Management – Workbook the company is required to obtain ‘in-principle approval for listing from the exchanges having nationwide trading terminals where it is listed, before issuing further shares or securities. Where the company is not listed on any exchange having nationwide trading terminals, the in-principle approval is required from all the stock exchange(s) in which the securities of the issuer are proposed to be listed. Where the securities are listed on recognized stock exchange(s) having nationwide trading terminals as well as on the recognized stock exchange(s) not having nationwide trading terminals, from all recognized stock exchange(s) having nationwide trading terminals. The regulation is also providing various disclosures and obligations for listed entities. Other important regulations include, SEBI (Issue and listing of securitized debt instrument and security receipt) Regulations, 2008, Securities and Exchange Board of India (Issue and Listing of Municipal Debt Securities) Regulations, 2015, Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) Regulations, 2021 etc. 2.4 Market Structure and Participants Intermediation is the process of enabling the saver or buyer of securities (through information and facilitation) to buy or sell the securities and help them acquire all the rights related to the security. The intermediaries play a very important role in the securities market; they put together the demands of the buyers with the offers of the security sellers. A large variety and number of intermediaries provide intermediation services in the Indian securities markets. 2.4.1 Market Infrastructure Institutions (Stock Exchange, Clearing Corporations and Depositories) Stock exchanges, depositories and clearing corporations are collectively referred to as securities Market Infrastructure Institutions (MIIs). Stock Exchanges The stock Exchanges provide a trading platform where the buyers and sellers (investors) can meet to transact in securities. Earlier investors and stock-brokers met in the trading hall or the “Ring” of the Stock Exchanges to transact in stocks, whereas in the modern world, on- line trading takes through computers connected through VSATs, leased lines and Internet. The Securities Contract (Regulation) Act, 1956 (SCRA) defines ‘Stock Exchange’ as (a) any body of individuals, whether incorporated or not, constituted before corporatization and demutualization under sections 4A and 4B, or (b) a body corporate incorporated under the Companies Act, 1956 (1 of 1956) whether under a scheme of corporatization and demutualization or otherwise, for the purpose of assisting, regulating or coordinating the business of buying, selling or dealing in securities. Typical functions of Stock Exchanges are: To provide the trading platform Dissemination of information Investor education, awareness and protection Facilitate redressal mechanism 31  NISM Certification on Securities Operations and Risk Management – Workbook Surveillance and Investigation Listing of securities and monitoring compliance of listed companies Inspection and monitoring of member compliance Clearing Corporation Securities Contract (Regulation) (Stock Exchange and Clearing Corporations) Regulations 2018, defines Clearing Corporation as an entity that is established to undertake the activity of clearing and settlement of trades in securities or other instruments or products that are dealt with or traded on a recognized stock exchange and includes a clearing house and a limited purpose clearing corporation (as specified under Chapter IV- A of SECC regulation). A Clearing Corporation performs three main functions, namely: clearing and settlement of all transactions executed in the stock market (i.e., completes the process of receiving and delivering shares/funds to the buyers and sellers in the market) and carrying out risk management. The Clearing Corporation acts as a central counterparty i.e., it provides financial guarantee for all transactions executed on the Exchange. This process is called novation. The clearing agency determines fund/security obligations and arranges for pay-in of the same.11 It collects and maintains margins, processes for shortages in funds and securities. For carrying out settlement of trades, the clearing corporation is helped by the clearing members, clearing banks, custodians and depositories. Thus, these entities are also important intermediaries of securities market. Important Terminologies pertaining to clearing corporations Pay-In is a process whereby a Clearing Member and Custodian (in case of Institutional deals) bring in money and/or securities to the Clearing House/ Corporation. This forms the first phase of the settlement activity. Pay-Out is a process where the Clearing House/ Corporation pays money or delivers securities to the Clearing Member and Custodians. This is the second phase of the settlement activity. Depository A "Depository" is an entity facilitating holding securities in electronic form and enables transfer of securities by book entry. The main objective of depository is to provide maintenance of ownership or transfer records of securities in an electronic book entry form resulting in paper-less trading rather than paper-based trading and to ensure transferability of securities with speed, accuracy and safety. 11The process of delivering securities or funds by the clearing member to the clearing house/corporation to effect settlement of a sale/purchase transaction is known as pay-in. 32  NISM Certification on Securities Operations and Risk Management – Workbook As per the Depositories Act, 1996, a ’depository’ means a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under sub-section (1A) of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992);” There are two Depositories in India, Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL), which were established under the Depositories Act 1996, for the purpose of facilitating dematerialization of securities and assisting in trading of securities in the dematerialized form. The Depository provides its services to clients through its agents called depository participants (DPs). These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, Banks, Financial Institutions, NBFCs, Clearing Corporation, Registrar and Transfer Agents, Custodian of Securities, State Financial Corporation and SEBI registered trading members can become DPs. Besides providing custodial facilities and dematerialization, depositories offer various transactional services to its clients to effect buying, selling, transfer of shares etc. Through a system of paperless securities, depositories have facilitated smooth securities market operations for Stock Exchanges, clearing houses/corporations, stock broking firms, equity issuing companies, share transfer agents etc. 2.4.2 Market Participants 2.4.2.1 Trading Member /Clearing Member An important constituent of the securities market is a trading member/ stock broker12 who is a member of the stock exchange. A trading member is allowed to execute trades on his own account as well as on account of his clients. A trading member can be an individual (sole proprietor), a partnership firm, Limited Liability Partnership, Corporate or a bank who is a member of a Stock Exchange13. Authorized person is not a member of a Stock Exchange but is ‘Any person, individual, partnership firm, LLP or body corporate, who is appointed as such by a Stock Broker (including Trading Member) and who provides access to trading platform of a Stock Exchange as an agent of the Stock Broker’. 14 Clearing Members have clearing and settlement rights in any recognised clearing corporation. Clearing Member help in clearing of the trades of their clients. In India, investors cannot access the Exchange platform directly. They have to compulsorily trade through registered stock brokers/trading member of the Exchanges. Hence, stock brokers/trading members are one of the important intermediaries of securities market. Based on trading and clearing rights membership can be classified as; only trading member, trading cum self-clearing member, trading cum clearing member and professional clearing member. 12 Stock broker" means a person having trading rights in any recognised stock exchange and includes a trading member; 13 Banks are permitted to become member of the currency derivative segment of recognized stock Exchanges subject to fulfillment of minimum prudential requirements. 14 https://www.sebi.gov.in/legal/circulars/aug-2018/role-of-sub-broker-sb-vis-a-vis-authorized-person-ap- _39825.html (Discontinuation of Sub-broker category) 33  NISM Certification on Securities Operations and Risk Management – Workbook Only trading member category of membership entitles allow to execute trades on his own account as well as on account of his clients but, clearing and settlement of trades executed through the trading member would have to be done through a Trading-cum Clearing Member or Professional Clearing Member of the Clearing Corporation. Only trading member does not have clearing and settlement rights. Trading cum Self-clearing member: They have trading as well clearing rights. They clear and settle trades executed by them only, either on their own account or on account of their clients but not for custodian participants. Trading member–cum–clearing member: They have trading as well clearing rights. They clear and settle their own trades as well as trades of other trading members and custodial participants. Professional clearing member: They have only clearing rights and do not have trading rights. They clear and settle trades executed by trading members and custodian participants. SEBI registered custodian and Banks recognized by clearing corporations are eligible to become PCM subject to fulfilling the prescribed criteria. Custodians Custodian means any person/entity who carries on or proposes to carry on the business of providing custodial service. Custodians are also clearing members like PCMs but not trading members. They settle trades on behalf of the clients of the trading members, when a particular trade is assigned to them for settlement. The custodian is required to confirm whether he is going to settle that trade or not. Eligibility Criteria for a Trading Member The membership of the each segment of the Exchange is separate from the membership of the other segments of the Exchange. As per the SEBI (Stock Brokers ) Regulations, 1992:  The stock broker shall have such net worth and shall deposit with the stock exchange such sum as may be specified by the SEBI/ stock exchange from time to time.  The clearing member/ self-clearing member shall have the minimum net worth and shall deposit the minimum sum specified by SEBI or a higher amount with the clearing corporation promoted by the respective stock exchange in the manner specified from time to time.  The quantum of net worth to be maintained by the stock broker/clearing member, as specified in said regulation, shall be reckoned for all segments/stock exchanges. The quantum of deposit to be maintained by the stock broker/clearing member shall be separately calculated segment wise.  The quantum of net worth to be maintained by the stock broker/clearing member, shall be reckoned for all segments/stock exchanges. As per SEBI (Stock Brokers) Regulations, 1992, if a new entity desires to register as a stock broker or clearing member with any stock exchange or clearing corporation, as the case may 34  NISM Certification on Securities Operations and Risk Management – Workbook be, then the entity shall apply to SEBI through the respective stock exchange or clearing corporation in the manner prescribed in the Stock Broker Regulations. The entity shall be issued one certificate of registration by SEBI, irrespective of the stock exchange(s) / clearing corporation(s) or number of segment(s). Further, as per the SEBI (Stock Brokers ) Regulations, 1992, the existing requirement of obtaining registration as stock broker/ clearing member for each stock exchange/ clearing corporation has been done away with and instead a single registration with any stock exchange/ clearing corporation shall be required. For operating in any other stock exchange(s)/ clearing corporation(s), approval will be required from the concerned stock exchange or clearing corporation. The admission as a trading member on the Stock Exchanges is based on the various criteria like age, capital adequacy, financial track record, education, experience and fulfillment of criteria of “fit & proper person” as laid down in the SEBI (Intermediaries) Regulations, 2008. The Exchanges may stipulate additional requirements over and above the SEBI prescribed rules. A. Base Minimum Capital (BMC) BMC is the deposit given by the member of the exchange against which no exposure for trades is allowed. The BMC is maintained based on risk profile of the member. The Base Minimum Capital is discussed in detail in Section 4.1.1.4 of this workbook. B. Eligibility Criteria Eligibility criteria for membership is subject to the regulatory norms and provisions of SEBI and as provided in the Rules, Regulations, Byelaws and Circulars of the Exchanges. Securities Contracts (Regulation) Rules, 1957 has provided details of qualifications for membership of a recognized stock exchange: - Individual trading membership Age Minimum Age: 21 years Status Indian Citizen Education At least HSC or Equivalent qualification Experience Applicant should have an experience of not less than two years as a partner with, or an authorized assistant or authorized remisier or apprentice to