A Brief Overview of the Indian Financial Markets - Pt 2

Financial Markets

Unit 2 Financial Markets (Money Market, Debt Market, Capital Market, Foreign
Exchange Market, Commodities Market) (17 lectures)

Money Markets

A well – developed money market has an important role to play in the process of
industrialization and economic development. The India money market is a monetary system that
involves the lending and borrowing of short-term funds. Money markets play a key role in
banks’ liquidity management and the transmission of monetary policy. By providing the
appropriate instruments and partners for liquidity trading, the money market allows the
refinancing of short and medium-term positions and facilitates the mitigation of a business’
liquidity risk. The banking system and the money market represent the exclusive setting
monetary policy operates in. A developed, active and efficient interbank market enhances the
efficiency of central bank’s monetary policy, transmitting its impulses into the economy best.
The development of the money market helps the progress of financial intermediation and boosts
lending to economy, hence improving the country’s economic and social welfare.

Functions:

 Financing Trade – The money market provides financing to local and international
traders who are in urgent need of short-term funds. It provides a facility to discount bills
of exchange, and this provides immediate financing to pay for goods and services.
International traders benefit from the acceptance houses and discount markets. The
money market also makes funds available for other units of the economy such as
agriculture and small-scale industries.
 Central Bank Policies - The central bank is responsible for guiding the monetary policy
of a country and taking measures to ensure a healthy financial system. Through the
money market, the central bank can perform its policy-making function efficiently. Also,
the integrated money markets help the central bank to influence the sub-markets and
implement its monetary policy objectives.
 Growth of Industries - The money market provides an easy avenue where businesses can
obtain short-term loans to finance their working capital needs. Due to the large volume of
transactions, businesses may experience cash shortages related to buying raw materials,
paying employees, or meeting other short-term expenses. Through commercial paper and
finance bills, they can easily borrow money on a short-term basis. Although the money
market does not provide long-term loans, it influences the capital market and can also
help businesses obtain long-term financing. The capital market benchmarks its interest
rates based on the prevailing interest rate in the money market.
  Liquidity for commercial banks - The money market provides commercial banks with a
ready market where they can invest their excess reserves and earn interest while
maintaining liquidity. The short-term investments such as bills of exchange can easily be
converted to cash to support customer withdrawals. Also, when faced with liquidity
problems, they can borrow from the money market on a short-term basis as an alternative
to borrowing from the central bank.

Drawbacks of the Indian Money Market:

 Dichotomic Structure: It has a simultaneous existence of both the organized money

market as well as unorganized money markets. The organized money market consists of
RBI, all scheduled commercial banks and other recognized financial institutions.
However, the unorganized part of the money market comprises domestic money lenders,
indigenous bankers, trader, etc.
 Seasonality: The demand for money in Indian money market is of a seasonal nature.
India being an agriculture predominant economy, the demand for money is generated
from the agricultural operations.
 Multiplicity of Interest Rates: In Indian money market, there are numerous interest
rates. They differ from bank to bank from period to period and even from borrower to
borrower. Again, in both organized and unorganized segment the interest rates differ.
 Lack of Organized Bill Market: In the Indian money market, the organized bill market
is not prevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and
then New Bill Market Scheme in 1970, still there is no properly organized bill market in
India.
 Absence of Integration: This is a very important feature of the Indian money market.
RBI has full control over the components in the organized segment but it cannot control
the components in the unorganized segment. There is a lack of coordination among the
different components of the money market.
 High Volatility in Call Money Market: The call money market is a market for very
short-term money, where the demand for call money comes from the commercial banks.
Institutions such as the GIC, LIC, etc suffer huge fluctuations in their funds and thus it
has remained highly volatile.
Instruments of the Indian Money Market –

 Treasury Bills – This is a market for sale and purchase of short term government
securities. These securities are called as Treasury Bills which are promissory notes or
financial bills issued by the RBI on behalf of the Government of India. There are two
types of treasury bills. (i) Ordinary or Regular Treasury Bills and (ii) Ad Hoc Treasury
Bills. The maturity period of these securities range from as low as 14 days to as high as
364 days.
 Cash Management Bills (CMBs) are short term bills issued by central government to
meet its immediate cash needs. The bills are issued by the RBI on behalf of the
government. The CMBs have the generic character of Treasury Bills as the CMBs are
issued at a discount and redeemed at face value at maturity. CMBs are eligible as SLR
securities. Investment in CMBs is also recognized as an eligible investment in
Government securities by banks for SLR purpose. CMBs are issued first on May 12,
2010. The purpose of the mechanism is to enable the government to get short term
money.
 Call and Notice Money - It is also called inter bank loan market. In this market money is
demanded for extremely short period. The duration of such transactions is from few hours
to 14 days. Banks borrow and lend money to one another on the interbank market in
order to maintain appropriate, legal liquidity levels, and to meet reserve requirements
placed on them by regulators. Interbank rates are made available only to the largest and
most creditworthy financial institutions. The Mumbai Interbank Offer Rate (MIBOR) is
one iteration of India's interbank rate, which is the rate of interest charged by a bank on a
short-term loan to another bank. As India's financial markets have continued to develop,
India felt it needed a reference rate for its debt market, which led to the development and
introduction of the MIBOR. It is basically located in the industrial and commercial
locations such as Mumbai, Delhi, Calcutta, etc. These transactions help stock brokers and
dealers to fulfill their financial requirements. The rate at which money is made available
is called as a call rate. Thus, rate is fixed by the market forces such as the demand for and
supply of money and generally follows the MIBOR.
 Collateralized Borrowing and Lending Obligation - The CBLO product is introduced by
the CCIL especially for those participants who have not been to participate in the call and
notice money market. It is a discounted instrument which is issued in electronic book
form (e.g. demat form). As per the RBI guidelines, this instrument can be made available
up to one year. However, in practice this instrument is considered for the maturity period
ranging from 1 day to 90 days. It is an obligation on the part of borrower to repay the
money borrowed at its face value at a specified future date. It is an authority on the part
of the lender to receive money at a specified future date. The lender has option or
privilege to transfer the authority to receive money to another lender for value received.
A charge is created on the collateral securities held in account with the CCIL for the
amount borrowed or lent.
 Certificate of Deposits - The certificate of deposits is issued by the commercial banks.
They are worth the value of Rs. 25 lakh and in multiple of Rs. 25 lakh. The minimum
subscription of CD should be worth Rs. 1 Crore. The maturity period of CD is as low as 3
months and as high as 1 year. These are the transferable investment instrument in a
money market. The government initiated a market of CDs in order to widen the range of
instruments in the money market and to provide a higher flexibility to investors for
investing their short term money.
 Commercial Papers - Commercial paper (CP) is an investment instrument which can be
issued by a listed company having working capital more than or equal to Rs. 5 cr. They
can be issued in multiples of Rs. 25 lakhs. However the minimum subscription should at
least be Rs. 1 cr. The maturity period of a CP is a minimum of 3 months and maximum 6
months. This was introduced by the government in 1990.

 Interbank Participatory Certificates - Banks troubled with capital constraints sell their
“excess baggage” of loans assets to other banks in the form of ‘Inter Bank Participation
Certificate (IBPC). These IBPC transactions are aimed to fill short-term requirements of
banks and are typically bought back by the seller bank within three to four months,
depending on the agreement. Reserve Bank of India has permitted foreign banks and
private sector banks to treat their investments in interbank participatory certificate (IBPC)
to treat it as direct lending to the priority sector. A bank missing its target for priority
sector lending target will be able to reach the target by buying IBPCs issued by the fellow
banks that have already exceeded in achieving their regulatory targets of priority sector
advances and issued IBPCs for excess of lending under various categories of priority
sector. There are two types of Inter-Bank Participation certificates (IBPCs); one on risk
sharing basis and the other without risk sharing. In case of IBPC without risk sharing, a
bank missing the target can always buy IBPC instrument issued by another bank at a
price for a month or so. Later, the seller bank can buy back the portfolio. The IBPC on
risk sharing can be issued for 91-180 days and only in respect of advances classified
under standard Status where the conduct of account is satisfactory, the safety of advance
is not in doubt, and all the terms and conditions are complied with.
 Repurchase Agreements - Under repurchase agreement the seller sells specified securities
with an agreement to repurchase the same at a mutually decided future date and price.
Similarly, the buyer purchases the securities with an agreement to resell the same to the
seller on an agreed date at a predetermined price. Such a transaction is called a Repo
when viewed from the perspective of the seller of the securities and Reverse Repo when
viewed from the perspective of the buyer of the securities.
i. Buy-Sell repo: In buy-sell repo the security is sold outright and bought back
simultaneously by the holder of security (borrower) for settlement on a later date.
The investor (lender) actually takes possession of the collateral and hence he
retains any coupon interest due on the bonds. The forward price of the bond is set
 in advance by adjustment of repo interest/ coupon yield earned by the investor on
the underlying security.
ii. Classic repo: In this type of repo transaction the seller repurchases the financial
assets at the same price at which it was sold and makes a separate payment of
interest. Here the securities actually are only collateral for the loan amount and
coupon income will be accrued to the seller of the security.
iii. Hold in custody repo: In this type of repos the counterparties enter into agreement
wherein the seller holds the custody of sold securities intended for the buyer until
maturity of the repo. Thus, the process of hold in custody repo eliminates
settlement requirements.
iv. Bond lending/borrowing transaction: The investor on the bonds lends his bonds
for an open ended or fixed period in return for a fee. The fee charged would
depend on the term of the loan, credit rating of the counter party and type of
underlying securities and its size. The counterparties enter into an agreement in
this type of securities lending. The cash or other securities of equal value could be
offered as collateral in the transactions.
v. Tri – party repos (TREPS) - Tri-party repo or TREPS is a type of repo contract
where a third entity (apart from the borrower and lender), called a tri-party agent,
acts as an intermediary between the two parties to the repo to facilitate services
like collateral selection, payment and settlement, custody and management during
the life of the transaction. Clearcorp provides the triparty repo dealing system.
The triparty repo dealing system facilitates the dealing and trading on an
anonymous basis i.e. where the identity of the original counterparties to a trade
will not be disclosed at any time either on a pre-order and/ or a post-trade basis.
Once a lender and a borrower notifies the CCIL on the transactions, it matches the
transaction amount, conditions and, if successful, processes the transaction. It
automatically selects from the securities of account of the seller, sufficient
collateral that satisfies the credit and liquidity criteria set by the buyer.
vi. Bankers Acceptance - It is a buyer’s promise to pay to the seller a certain
specified amount at certain date. The same is guaranteed by the banker of the
buyer in exchange for a claim on the goods as collateral. The most common term
for these instruments is 90 days. However, they can vary from 30 days to180
days. For corporations, it acts as a negotiable time draft for financing imports,
exports and other transactions in goods and is highly useful when the credit
worthiness of the foreign trade party is unknown. The seller need not hold it until
maturity and can sell off the same in secondary market at discount from the face
value to liquidate its receivables.
vii. Pass Through Certificates - This is an instrument with cash flows derived from
the cash flow of another underlying instrument or loan. The issuer is a special
purpose vehicle (SPV), which only receives money, from a multitude of may be
 several hundreds or thousands, underlying loans and passes the money to the
holders of the PTCs. This process is called securitization. Legally speaking PTCs
are promissory notes and hence tradable freely with no stamp duty payable on
transfer. Most PTCs have 2-3 year maturity because the issuance stamp duty rate
makes shorter duration PTCs unviable.
viii. Money Market Mutual Fund (MMMFs): In order to provide additional short-
term investment revenue, the RBI encouraged and established the Money Market
Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to
corporate and individuals.

Role of Central Bank in Money Market

Reforms of the Indian Money Market

The Vaghul working group recommended a four pronged strategy, as under, to activate the
money market.

 Attempt to be made to widen and deepen the market by a selective increase in the number
of participants.
 An endeavor to be made to activate the existing instruments and to develop new
instruments so as to have well diversified mix of instruments suited to different
requirements of borrowers and lenders.
 A gradual shift from administered interest rates to market determined interest rates.
 To create an active secondary market for money and securities through a process of
establishing new sets of institutions, which would impart sufficient liquidity into the
system.

On the recommendations of the Chakravarty Committee and Vaghul Committee, RBI initiated
number of measures, as under during the period 1985-91.

 With a view to encouraging secondary market activity, the maximum coupon rate. which
was as low as 6.5 per cent in 1977-78 was raised in stages to 1 1.5 per cent in 1985-86.
Along with it the maximum maturity period was reduced from 30 years to 20 years.
 RBI introduced in November 1986, for the first time issue of I82-day Treasury Bill on
monthly auction basis. The Discount and Finance House of India Ltd (DFHI) was set up
in April 1988 as a money market institution jointly by RBI, Public Sector Banks and All
India Financial Institutions. The setting up of DFHI was a major step towards developing
a secondary market for money market instruments and providing liquidity to these
instruments. 'The interest rate ceiling on call money was freed in stages from October,
 1988. First. operations of DFHI in the call/notice money market were excluded from the
interest rate ceiling in 1988 and in May 1989 the interest rate ceiling was completely
withdrawn for all operations in the call/notice money market and on inter-bank tern1
money transaction and also on rediscounting of commercial bills. In May 1990 RBI
allowed GIC', IDRI md NABARD to enter the call money markets as Ienders. 13 other
institutions, which were already operating in the bills rediscounting scheme, were granted
entry into the call money market as lenders in October 1990.
 Certain other non-bank institutions were permitted in October 1991 to participate in the
call money market through DFHI, as lenders only.
 In addition to 182-day Treasury bill on auction basis, a number of other instruments were
developed to provide depth to the money market. Certificates of Deposits (CD),
commercial paper (CP) and Inter-bank participation certificates (PC) all entered the scene
in 1989-90, at the initiative of the RBI which framed guidelines for issuance of these
instruments.

Reforms by RBI:

 Development of Money Market Instruments - In order to widen and diversify the

Indian money market RBI has introduced many new money market instruments such as
182-days treasury bills, 364-day treasury bills, CDs & CPs. Through these instruments
the government, commercial banks, financial institutions and corporate can raise funds
through the money market. They also provide investors additional instruments for
investments. In order to expand the investor base for CDs and CPs the minimum amount
of investment and the minimum maturity periods are reduced by RBI. The call and notice
money market is an inter-bank market the world over and therefore the Narsimham
Committee has recommended that we adopt the same in India. However RBI in the past
had given permission to non-bank institutions to participate in the call money market as
lenders. As per the recommendations of Narsimham Committee RBI in 2001-02 has
underlined the need for transforming the call money market into a pure inter-bank money
market. RBI introduced repos in government securities in December 1992 and reverse
repos in November 1996. Repos and reverse repos help to even out short-term
fluctuations in liquidity in the money market. They also provide a short-term avenue to
banks to park their surplus funds. Through changes in repo and reverse repo rates RBI
transmits policy objectives to entire money market.
 Reintroduction of 182 day T – Bills
 Deregulation of Interest rates - from May 1989, the ceiling on interest rates on the call
money, inter-bank short-term deposits, bills rediscounting and inter-bank participation
was removed and the rates were permitted to be determined by the market forces. Thus,
the system of administered interest rates is being gradually dismantled.
 Institutional Development - The RBI Act was amended in 1997 to provide for a
comprehensive regulation of NBFC sector. According to the amendment, no NFBC can
 carry on any business of a financial institution, including acceptance of public deposit,
without obtaining a Certificate of Registration (CoR) from RBI. The CCIL was registered
on April 30, 2001 under the Companies Act, 1956, with the State Bank of India as the
chief promoter. The CCIL clears all transactions in government securities and repos
reported on the Negotiated Dealing System (NDS) of RBI.
 Setting up DFHI - In order to impart liquidity to money market instruments and help the
development of secondary market in such instruments, DFHI was set up in 1988 jointly
by RBI, public sector banks and financial institutions.
 Money Market Mutual Funds - RBI introduced MMMFs in April 1992 to enable the
individual investors to participate in money market. To make the scheme flexible and
attractive, RBI has brought about many modifications. The important features of this
scheme as of now are:(i) It can be set up by commercial banks, financial institutions and
private sector. (ii) Individual investors, corporates and others can invest in MMMFs.(iii)
Resources mobilized through this scheme can be invested in money market instruments
as well as rated corporate bonds and debentures with a maturity period upto one year. (iv)
The minimum lock in period is now 15 days.
 Permission to Foreign Institutional Investors -
 Changing Monetary Policy Framework - RBI has introduced LAF from June 2000 as
an important tool for adjusting liquidity through repos and reverse repos. Thus, in the
recent years RBI is using repos and reverse repos as a policy to adjust liquidity in the
money market and therefore, to stabilize the short-term interest rates or call rates. LAF
has, therefore, emerged as a major instrument of monetary policy.
 Screen Based Trading

Primary Dealers

Role of Primary Dealers in the government securities market are:

PDs are expected to play an active role in primary the government securities market, both in its
primary and secondary segments. A Primary Dealer will be required to have a standing
arrangement with RBI based on the execution of an undertaking and the authorisation letter
issued by RBI covering inter-alia the following aspects:

 A Primary Dealer will have to commit to aggregative bid for Government of India dated
securities on an annual basis of not less than a specified amount and auction Treasury
Bills for specified percentage for each auction. The agreed minimum amount/ percentage
of bids would be separately indicated for dated securities and Treasury Bills.
 A Primary Dealer would be required to achieve a minimum success ratio of 40 per cent
for dated securities and 40 per cent for Treasury Bills.
 Underwriting of Dated Government Securities: Primary Dealers will be collectively
offered to underwrite up to 100% of the notified amount in respect of all issues where the
amounts are notified.
 A Primary Dealer can offer to underwrite an amount not exceeding five times of its net
owned funds. The amount so arrived at should not exceed 30% of the notified amount of
the issue. If two or more issues are floated at the same time, the limit of 30% is applied
by taking the notified amounts of both the issues together.
 In the case of devolvement, allotment of securities will be at the competitive cut-off
price/yield decided at the auction or at par in the case of pre-determined coupon
floatation. Obligations under items (i) to (iii) above would be confined for the present
only to Central Government dated securities and obligations under items (i) to (ii) to
Treasury Bills.
 Treasury bill issues are not underwritten. Instead, Primary Dealers are required to commit
to submit minimum bids at each auction. The commitment of Primary Dealer’s
participation in treasury bills subscription works out as follows:
I. Each Primary Dealer individually commits, at the beginning of the year, to
submit minimum bids as a fixed percentage of the notified amount of treasury
bills, in each auction.
II. The minimum percentage of the bids for each Primary Dealer is determined by
the Reserve Bank through negotiation with the Primary Dealer so that the entire
issue of treasury bills is collectively apportioned among all Primary Dealers.
III. The percentage of minimum bidding commitment determined by the Reserve
Bank remains unchanged for the entire financial year or till furnishing of
undertaking on bidding commitments for the next financial year, whichever is
later. In determining the minimum bidding commitment, the Reserve Bank takes
into account the offer made by the Primary Dealer, its net owned funds and its
track record.
 A Primary Dealer shall offer firm two-way quotes either through the Negotiated Dealing
System or over the counter telephone market or through a recognized Stock Exchange of
India and deal in the secondary market for Government securities and take principal
positions.
 A Primary Dealer shall maintain the minimum capital standards at all points of time.
 A Primary Dealer shall achieve a sizeable portfolio in government securities before the
end of the first year of operations after authorization.
 The annual turnover of a Primary Dealer in a financial year shall not be less than 5 times
of average month end stocks in government dated securities and 10 times of average
month end stocks in Treasury Bills.
 A Primary Dealer shall maintain physical infrastructure in terms of office, computing
equipment, communication facilities like Telex/Fax, Telephone, etc. and skilled
 manpower for efficient participation in primary issues, trading in the secondary market,
and to advise and educate the investors.
 A Primary Dealer shall have an efficient internal control system for fair conduct of
business and settlement of trades and maintenance of accounts.
 A Primary Dealer will provide access to RBI to all records, books, information and
documents as may be required,

RBI will have access to records and accounts of an authorised Primary Dealer and the right to
inspect its books. A Primary Dealer will be required to submit prescribed returns to RBI, IDM
Cell a daily report on transactions and market information, monthly report of transactions in
securities, risk position and performance with regard to participation in auctions, quarterly return
on capital adequacy, an annual report on its performance together with annual audited accounts
and such other statements and returns as are prescribed either specifically or generally by
Reserve Bank of India vide any of its institutions/circulars/ directives.

Further, PDs are required to meet such registration and other requirements as stipulated by
Securities and Exchange Board of India (SEBI) including operations on the Stock Exchanges.
Authorised PDs are expected to join self-regulatory organisations (SROs) like Primary Dealers
Association of India (PDAI) and Fixed Income Money Market and Derivatives Association
(FIMMDA) and abide by the code of conduct framed by them and such other actions initiated by
them in the interests of the securities markets.

Discounting and Financing House of India - Pursuant to the Vaghul Working Group
recommendation for setting up an institution to provide enhanced liquidity to the money market
instruments, the RBI set up the Discount and Finance House of India (DFHI) jointly with public
sector banks and the all-India financial institutions. DFHI was incorporated in March 1988 and it
commenced operation in April 1988. The main objective of this money market institution is to
facilitate smoothening of the short-term liquidity imbalances by developing an active secondary
market for the money market instruments. Its authorized capital is Rs. 250 crores. Treasury bills
are not bought back by the RBI before maturity. Similarly, except at the fortnightly auctions
these cannot be purchased from the RBI. DFHI fills this gap by buying and selling these bills in
the secondary market. The presence of DFHI in the secondary market has facilitated corporate
entities and other bodies to invest their short-term surpluses and to encash them when necessary.

CCIL stands for Clearing Corporation of India Limited. It is a reputed Indian organization which
was set up in April 2001 to provide guaranteed clearing and settlement functions for transactions
in money, foreign exchange and derivative markets. It was incorporated with the authorized
Equity Share Capital of Rs. 50 Crores. A core committee was appointed at the behest of Reserve
Bank of India (RBI) to set up CCIL. This committee identified six core promoters for CCIL
which are State Bank of India, IDBI Bank Ltd., ICICI Bank Ltd, Life Insurance Corporation of
India (LIC), Bank of Baroda and HDFC Bank Ltd. CCIL acts as a central counterparty in
various segments of the financial markets regulated by the RBI viz. the government securities
segment, collateralised borrowing and lending obligations (CBLO) - a money market instrument,
USD-INR and forex forward segments. Moreover, CCIL provides non-guaranteed settlement in
the rupee denominated interest rate derivatives like Interest Rate Swaps/Forward Rate
Agreement market. It also provides non-guaranteed settlement of cross currency trades to banks
in India through Continuous Linked Settlement (CLS) bank by acting as a third party member of
a CLS Bank settlement member. CCIL also acts as a trade repository for OTC interest rate and
forex derivative transactions.

Negotiated Dealing System- Order Matching (NDS-OM): NDS-OM is owned by the RBI and is
operated by CCIL on behalf of the RBI. NDS-OM is an electronic, screen based, anonymous,
order driven trading system for dealing in Government securities which was introduced in 2005.
The NDS-OM ensures complete anonymity among the participants and brings transparency in
secondary market transactions in Government securities. The NDS-OM facilitates straight-
through-processing (STP) as all the trades on the system are automatically sent to the CCIL for
settlement. With the efficiency and ease of its operations, the NDS-OM today accounts for
around 90 per cent of the trading volume in Government securities.

NDS Call - The screen based negotiated quote driven system (NDS-Call) was introduced in
September 2006 in respect of dealings in call and notice money market. It does not require
separate reporting. If the deals are not done through NDS-Call system then such deals must be
reported within 15 minutes on Negotiated dealing system (NDS) screen. The interest rates in call
and notice money market are determined by the market participants based on demand and supply
of funds.

Real Time Gross Settlement System (RTGS): RTGS system was implemented in March 2004.
RTGS system is owned and operated by the RBI. It is a Systemically Important Payment System
(SIPS) where the inter-bank payments settle on a 'real' time and on gross basis in the books of the
RBI. RTGS system also settles Multilateral Net Settlement Batch (MNSB) files emanating from
other ancillary payment systems including the systems operated by the Clearing Corporation of
India Limited. RBI is in the process of implementing the Next Generation RTGS (NG-RTGS)
built on ISO20022 standards with advance liquidity management functions, future date
functionality, scalability, etc.

Securities Settlement Systems (SSS): The Public Debt Office (PDO) of the RBI, Mumbai
manages and operates the Securities Settlement Systems for the Government securities, both for
outright and repo transactions conducted in the secondary market. Government securities
(outright) are settled using DVP model 3 mechanism on a T+1 basis. Repos are settled on T+0 or
T+1 basis. Additionally, the PDO system also acts as depository for dematerialized government
securities. With implementation of the Core Banking Solution (CBS) in the RBI, the securities
settlement system has been migrated to the CBS platform.
Secondary Trading Corporation of India Limited - In May 1994, STCI Finance Limited was
promoted by RBI with the main objective of fostering an active secondary market in Government
of India Securities and Public Sector bonds. RBI owned a majority stake of 50.18% in the paid
up share capital of the company. In 1996, the Company was accredited as the first Primary
Dealer in the India. As one of the leading Primary Dealers in the country, the Company was a
market maker in government securities, corporate bonds and money market instruments. Its other
lines of activities included trading in interest rate swaps and trading in equity - cash &
derivatives segment. In order to diversify into new activities, the Company hived off its Primary
Dealership business to its separate 100% subsidiary, STCI Primary Dealer Limited (STCI-PD) in
June 2007. Since year 2007, the Company has been undertaking lending and investment
activities with its main focus on lending/ financing activities. STCI PD This company is a wholly
owned subsidiary of STCI Finance Limited established consequent to the hiving off of the
Company's primary dealership business in line with the Reserve Bank of India guidelines on
diversification of business activities by primary dealers. The Company undertakes trading in
government securities, corporate bonds, money market instruments, interest rate swaps and
trading in equity.

Liquidity Adjustment Facility

As a part of open market operations, the RBI is carried out regularly repo transactions in the
Government Securities. The main objectives behind repo transactions under LAF are to ensure
adequate liquidity in the system and to transmit interest rate signals to the market. Thus, the LAF
is used as an instrument for implementing effective monetary policy. Only banks and primary
dealers have been permitted to avail liquidity support from the RBI under LAF. The current repo
rate and reverse rate are 7.25 per cent and 6.25 per cent respectively. In other words, under repo
transactions banks and PDs are permitted to borrow funds from the RBI against their own
investment in Government securities at 7.25 per cent interest. Similarly, under reverse repo
transactions banks and PDS can lend funds to the RBI at 6.25 per cent interest rate. The LAF
offers various benefits. The few of these benefits are mentioned below:-

i) It has helped the RBI to shift from direct instruments of monetary policy to indirect
instruments
ii) It has provided the RBI much more flexibility in determining both the quantum of
adjustment in the availability of Liquidity as well as in the repo and reverse repo rates
iii) It helps the RBI to control supply of funds on a daily basis to meet day-to-day
liquidity mismatches in case of individual banks and primary dealers.
iv) It enables the RBI to bring desire changes in the demand for funds through changes in
repo and reverse repo rates. Thus, LAF is an important tool of monetary policy and
enable the RBI to transmit interest rate signals to the market.
Operation of LAF through repos by means of daily auctions has provided the benchmark for
collateralized lending and borrowing in the money market. The call rate is expected to be largely
within a corridor set by repo and reverse repo rates. This mechanism has helped in providing
liquidity to the government securities market as well as imparting greater stability in the financial
markets.

Capital Market

Capital market is the market for medium- and long-term funds. It refers to all the facilities and
the institutional arrangements for borrowing and lending term funds (medium-term and long-
term funds). The demand for long-term funds comes mainly from industry, trade, agriculture and
government. Capital market is a platform where investors and buyers get into the trade of
financial securities, including stocks, bonds, commodities and so on. The transactions may be is
carried out by participants, such as individuals or even institutions. It may be of two types –
Primary and Secondary Market. It may be further split up into different types on the basis of the
securities issued.

Capital market has a crucial significance to capital formation. Adequate capital formation is
indispensable for a speedy economic development. The main function of capital market is the
collection of savings and their distribution for industrial development. This stimulates capital
formation and hence, accelerates the process of economic development. A sound and efficient
capital market facilitates the process of capital formation and thus contributes to economic
development. The significance of capital market in economic development is given:

1. Mobilization of Savings: Capital market is an organized institutional network of financial

organizations, which not only mobilizes savings through various instruments but also
channelizes them into productive avenues. By making available various types of financial assets,
the capital market encourages savings. By providing liquidity to these financial assets through
the secondary markets capital market is able to mobilize large amount of savings from various
sections of the people such as individuals, families, and associations. Thus, capital market
mobilizes these savings and make the same available for meeting the large capital needs of
industry, trade and business.

2. Channelization of Funds into Investments: Capital market plays a crucial role in the economic
development by channelizing funds in accordance with development priorities. The financial
intermediaries in the capital market are better placed than individuals to channel the funds into
investments which are more favorable for economic development.

3. Industrial Development: Capital market contributes to industrial development in the following

ways:(a) It provides adequate, cheap and diversified finance to the industrial sector for various
purposes. (b) It provides funds for diversified purposes such as for expansion, modernization,
upgradation of technology, establishment of new units etc.(c) It provides a variety of services to
entrepreneurs such as provision of underwriting facilities, participating in equity capital, credit
rating, consultancy services, etc. This helps to stimulate industrial entrepreneurship.

4. Modernization and Rehabilitation of Industries: Capital market can contribute towards

modernization, rationalization and rehabilitation of industries. For example, the setting up of
development financial institutions in India such as IFCI, ICICI, IDBI and so on has helped the
existing industries in the country to adopt modernization and replacement of obsolete machinery
by providing adequate finance.

5. Technical Assistance: An important bottleneck faced by entrepreneurs in developing countries

is technical assistance. By offering advisory services relating to the preparation of feasibility
reports, identifying growth potential and training entrepreneurs in project management, the
financial intermediaries in the capital market play an important role in stimulating industrial
entrepreneurship. This helps to stimulate industrial investment and thus promotes economic
development.

6. Encourage Investors to invest in Industrial Securities: Secondary market in securities

encourage investors to invest in industrial securities by making them liquid. It provides facilities
for continuous, regular and ready buying and selling of securities. Thus, industries are able to
raise substantial amount of funds from various segments of the economy.

7. Reliable Guide to Performance: The capital market serves as a reliable guide to the
performance and financial position of corporate, and thereby promotes efficiency. It values
companies accurately and toes up manager compensation to stock values. This gives incentives
to managers to maximize the value of companies. This stimulates efficient resource allocation
and growth.

Reforms in the Primary Capital Market

 Abolition of Controller of Capital Issues: The Capital Issues (Control) Act, 1947
governed capital issues in India. The capital issues control was administered by the
Controller of Capital Issues (CCI). The Narasimham Committee (1991) had
recommended the abolition of CCI and wanted SEBI to protect investors and take over
the regulatory function of CCI. Thus, government replaced the Capital Issues (Control)
Act and abolished the post of CCI. Companies are allowed to approach the capital market
without prior government permission subject to getting their offer documents cleared by
SEBI.
  Securities and Exchange Board of India (SEBI): SEBI was set up as a non-statutory body
in 1988 and was made a statutory body in January 1992. SEBI has introduced various
guidelines for capital issues in the primary market. Merchant bankers, and other
intermediaries such as mutual funds, portfolio managers, registrars to an issue, share
transfer agents, underwriters, debenture trustees, bankers to an issue, custodian of
securities, and venture capital funds have been brought under the purview of SEBI.
 Disclosure Standards: Companies are required to disclose all material facts and specific
risk factors associated with their projects. SEBI has also introduced a code of
advertisement for public issues for ensuring fair and truthful disclosures.
 Underwriting Optional: To reduce the cost of issue, underwriting by
 the issuer is made optional. It is subject to the condition that if an issue was not
underwritten and was not able to collect 90% of the amount offered to the public, the
entire amount collected would be refunded to the investors.
 Accessing Global Funds Market: Indian companies are allowed to aces global finance
market and benefit from the lower cost of funds. They have been permitted to raise
resources through issue of American Depository Receipts (ADRs), Global Depository
Receipts (GDRs), Foreign Currency Convertible Bonds (FCCBs) and External
Commercial Borrowings (ECBs). Indian companies can list their securities on foreign
stock exchanges through ADR/GDR issues.
 Credit Rating Agencies: Various credit rating agencies such as Credit Rating Information
Services of India Ltd. (CRISIL – 1988), Investment Information and Credit Rating
Agency of India Ltd. (ICRA – 1991). Cost Analysis and Research Ltd. (CARE – 1993)
and so on were set up to meet the emerging needs of capital market.

Reforms of the Indian Secondary Market –

A number of measures have been taken by the government and SEBI for the growth of secondary
capital market in India. The important reforms or measures are explained below.

1. Setting up of National Stock Exchange (NSE): NSE was set up in November 1992 and started
its operations in 1994. It is sponsored by the IDBI and co-sponsored by other development
finance institutions, LIC, GIC, Commercial banks and other financial institutions.

2. Over the Counter Exchange of India (OTCEI): It was set in 1992. It was promoted by a
consortium of leading financial institutions of India including UTI, ICICI, IDBI, IFCI, LIC and
others. It is an electronic national stock exchange listing an entirely new set of companies which
will not be listed on other stock exchanges.
3. Disclosure and Investor Protection (DIP) Guidelines for New Issues: In order to remove
inadequacies and systematic deficiencies, to protect the interests of investors and for the orderly
growth and development of the securities market, the SEBI has put in place DIP guidelines to
govern the new issue activities. Companies issuing capital in the primary market are now
required to disclose all material facts and specify risk factors with their projects.

4. Screen Based Trading: The Indian stock exchanges were modernized in the 90s, with
Computerised Screen Based Trading System (SBTS). It electronically matches orders on a strict
price / time priority. It cuts down time, cost, risk of error and fraud, and therefore leads to
improved operational efficiency.

5. Depository System: A major reform in the Indian Stock Market has been the introduction of
depository system and scripless trading mechanism since 1996. Before this, the trading system
was based on physical transfer of securities. A depository is an organization which holds the
securities of shareholders in electronic form, transfers securities between account holders,
facilitates transfer of ownership without handling securities and facilitates their safekeeping.

6. Rolling Settlement: Rolling settlement is an important measure to enhance the efficiency and
integrity of the securities market. Under rolling settlement all trades executed on a trading day
are settled after certain days.

7. The National Securities Clearing Corporation Ltd. (NSCL): The NSCL was set up in 1996. It
has started guaranteeing all trades in NSE since July 1996. The NSCL is responsible for post-
trade activities of the NSE. Clearing and settlement of trades and risk management are its central
functions.

8. Trading in Central Government Securities: In order to encourage wider participation of all

classes of investors, including retail investors, across the country, trading in government
securities has been introduced from January 2003. Trading in government securities can be
carried out through a nationwide, anonymous, order-driver, screen-based trading system of stock
exchanges in the same way in which trading takes place in equities.

9. Mutual Funds: Emergence of diversified mutual funds is one of the most important
development of Indian capital market. Their main function is to mobilize the savings of general
public and invest them in stock market securities. Mutual funds are an important avenue through
which households participate in the securities market.

Post the reforms of the secondary market, the Indian Secondary Market acquired a 4 tier form –
  Regional Stock Exchanges
 National Stock Exchanges
 Over the Counter Exchange of India
 Interconnected Stock Exchange of India

Indian Debt Market –

This market is comprised of the Government securities and corporate debt securities. The
Government debt securities market is the most dominant segment of the Indian debt market.

The Government debt market is regulated by the Reserve Bank of India (RBI). It manages the
public debt issue (i.e. issue of Government securities) on behalf of the Central and State
Governments. As a result of this, the cost of borrowing (i.e. interest rate), timing of issue and
framework (i.e. other terms and conditions) of raising of loans by the Governments are decided
by the RBI. The Government debt Securities are issued on the basis of liquidity conditions in the
market, the proposed Government borrowings program and expectations of the market. The RBI
has special interest in the development of the Government securities market. The regulation of
this market helps the RBI to manage its monetary policy more efficiently and effectively.
Therefore, the objective before the RBI is to ensure better coordination between monetary policy
and debt management.

Challenges of Indian Debt Market

 Lack of Liquidity in respect of many Debt Instruments in the Secondary Market

 Increasing the Number of Participants
 Need for Change in Attitude of Retail Investors
 Need for innovative instruments
 Stringent reporting requirements for privately placed debt.

Types of Debt Instruments –

 Fixed and Floating Rate Instruments - Debt instruments are issued either at a fixed or
floating rate of interest. In case of fixed rate debt instruments, interest rate is fixed and
paid periodically (semiannually or annually). The fixed rate of interest, which is always
stated on the annual basis, is called the coupon rate and the payment itself is called the
coupon. The coupon rate of the instrument is fixed at the time of issuance which remains
constant throughout the tenor of the instrument. The coupon is determined by a number
of factors which includes the credit rating of instrument, tax benefits, the collateral
securities offered to secure the issue, overall interest rate scenario in the market and
special features offered to the investors. Debt instruments are also issued at a floating
interest rate. In such case the floating interest rate is periodically changed reflecting
 changes in market conditions particularly changes in rate of interest payable on the gilt
securities or changes in the base rate. The interest rate on such instruments is linked with
benchmark or base rate such as primary market cut-off yield of the 91-day-Treasury bills
or 182 day Treasury-bills. Such instruments are also known as adjustable rate or variable
interest rate debt instruments.
 Debt Instruments with Call and Put Option - The issuer exercises call option when
general interest rates are lower than the coupon or interest rate on the existing debt
instruments thereby retiring existing expensive debt instrument and refinancing at a lower
interest rate. As against this, put option allows the bond holder or investor to sell the
bonds to the issuer at a predetermined price before maturity date. The holder of such debt
instrument will exercise the put option when prevailing interest rates on new issue of
bonds are higher than the coupon on the existing debt instruments.
 Zero Coupon Debt Instruments - Such instruments are issued or sold at its discounted
value and accordingly have zero interest rate. The best example is of treasury bills which
are issued at discounted value. The difference between the discounted value and face
value of the instrument is the gain or income for the investors. In other words, investors
are not entitled to any interest income and thus are entitled to receive only repayment of
face value of the security on the maturity date. The zero interest debt instruments are
beneficial both to the issuers because of the deferred payment of interest and to the
investors because of the lucrative yield and absence of reinvestment risk.
 Non-Convertible v/s Convertible Debt Instruments - A debt instrument can be issued
either with non-convertible clause or with convertible clause. A non-convertible debt
instrument is that instrument which cannot be converted into equity at all. This means
non-convertible debt instrument remains as a debt instrument throughout its tenor. The
holder of convertible debt instrument can exercise the right to convert whole of debt
instrument or its portion into equity. On conversion of debt instrument into equity, the
investors will receive equity shares in place of existing convertible bonds. Once this is
done then the investors will receive dividend income instead of interest Such instruments
are issued either as fully convertible or partly convertible debt instruments.
 Irredeemable and Redeemable Debt Instruments - Debt instruments can be classified
according to its irredeemable and redeemable characteristics. The irredeemable debt
instruments are those which can be redeemed only at the time of liquidation of an issuer
entity. The redeemable debt instruments are those which are issued for a specified period
and thus are redeemed once that period gets over. The common practice is to issue debt
instruments as redeemable debt instruments. Under the company law provisions
companies are not allowed to issue irredeemable debt instruments. They are allowed to
issue debt instruments like debentures as redeemable debt instrument with a maximum
period of 10 years. A company engaged in the setting up of infrastructure projects like
road, power, etc. is allowed to issue secured debentures up to thirty years. This means
such debentures cannot be issued as irredeemable debentures.
  Secured Debentures v/s Unsecured Debentures - The secured debentures are those that
are secured by a charge on the fixed assets belonging to the issuing company. In view of
this, even if the issuer ails to return money to the debenture holders on maturity, the
issuer’s assets on which charge is created can be sold to repay dues of the debenture
holders. The unsecured debentures are those where if payment is not made to the
debenture holders on maturity, then their dues are considered along with other unsecured
creditors of the issuing company.

Government Debt Market – This market is comprised of debt instruments issued by the
Government of India (GOI) and various State Governments. This is also called as the
Government Securities Market.

Type of Government Debt Securities –

 T Bills
 Government of India dated securities - Such securities may be issued for various tenors
ranging from two to thirty years or even for more than 30 years. However, in practice,
such securities are issued for a minimum period of five years. The RBI publishes
calendar for issue of GOI dated securities after every six months (twice in a year.) These
securities are issued either at a fixed interest rate or floating interest rate. The coupon is
paid semiannually. The coupons offered on dated Government securities are either pre-
determined by RBI or arrived through competitive bidding or auction process. As
mentioned earlier, the RBI has issued variety of dated Government securities such as
fixed coupon bonds, bonds with put and call options, zero coupon bonds, floating rate
bonds, etc.
 State Government Securities - State Government securities are nothing but State
Government loans. Such securities by and large are issued for a minimum period of four
years and maximum period of ten years at fixed coupon. The state Government debt
securities are issued by the RBI on behalf of various State Governments. Such securities
like dated Government securities are issued either through auctions or with pre-
announced coupon rates. There has been significant increase in the market borrowings by
the State governments. Some State Governments like West Bengal, Andhra Pradesh,
Kerala and Tamil Nadu raised funds from the market more frequently. The increase in the
market borrowings of the State Governments has been mainly on account of additional
allocation of funds for various projects, higher fiscal deficit and inadequate collection of
tax revenues.

Secondary Market of Debt

Most of the deals in the secondary market of Government debt securities are negotiated between
market participants like banks, PDs, having Subsidiary General Ledger accounts with the RBI.
Such deals are negotiated directly by participants themselves or negotiated through brokers. The
RBI has introduced Negotiated Dealing System (NDS) and accordingly members of NDS have
been provided connectivity. Negotiated Dealing System (NDS) is an electronic platform for
facilitating deals in the Government securities and other money market instruments. If the
members of NDS have executed deals outside NDS system (i.e. over telephone or through
brokers) then such deals have to be reported on NDS within 15 minutes of concluding such
deals. Thus NDS is also used to report transactions in the secondary market of Government
securities. There are types of participants in NDS-OM namely direct and indirect. Direct
members are permitted to open current and SGL accounts with RBI and hence can directly settle
their trades on NDS-OM electronic platform. At present, direct members include banks, primary
dealers (PDS), insurance companies, mutual funds and large provident funds. These entities have
current and SGL accounts with the RBI and therefore can directly trade on NGS-OM electronic
trading system. Indirect members are those who do not have current and SGL accounts with the
RBI such members cannot trade directly on NDS-OM trading system. Such members are
NBFCs, smaller provident funds, pension funds, co-operative banks, Regional Rural Banks
(RRBs), companies and foreign institutional investors (FIIs).

Trading on the stock Exchange.

Both National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) through their
Wholesale Debt Market (WDM) segment have introduced trading in Government securities. (All
Government securities and Treasury bills are deemed to be listed automatically as and when they
are issued.) Trades on the National Stock Exchange (NSE) and the Bombay Stock Exchange
(BSE) are anonymous, order driven and screen based. Since this is a part of wholesale trading,
investors like banks, PDs can participate in such trading. The trading system is market driven
and order matching and therefore participants require to quote price and quantity. The settlement
is on T (Trade date) + 1 basis. The transactions in Government securities through stock
exchanges are settled through NDS-CCIL platform.

Corporate Debt Market

 Bonds Issued by Public Sector Undertakings - The gradual withdrawal of budgetary

support to PSUs by the Government has forced many PSUs to depend heavily on the
bond market for mobilizing long term resources. Even though these bonds does not have
any Government guarantee nevertheless bonds have become attractive mainly because of
the tax exempt status and the high coupon rates.
 Bonds Issued by Financial Institutions - Financial institutions which cannot accept
demand deposits comprising of savings and current deposits depend on bond instruments
to raise funds from the bond market. Because of higher rating from rating agency, these
institutions issue bonds at lower interest rates. In the past many financial institutions like
 SIDBI, NABARD, IFCI, raised funds through various bonds such as capital gain bonds,
deep discount bonds, floating rate bonds, etc.
 Corporate Debentures - he private corporate enterprises issue debentures to raise funds
for longer period. However, the companies cannot issue any debentures carrying voting
rights. Further, the companies have to issue secured debentures. In recent past the
Companies have issued various types of debentures such as convertible debentures,
debentures with put and call options, floating rate debentures etc., a very large proportion
of such debts instruments have been issued to the institutional investors such as banks,
mutual funds, insurance companies, etc., through private placement. The companies also
issues debentures through public offer to the institutional as well as retail investors.

Issue of Debt through Private Placement

The issuers take the help of merchant bankers to place debt instruments with institutional
investors like banks, insurance companies and mutual funds, etc. As banks and financial
institutions as per the RBI guidelines require to invest only in rated debt instruments, the issuers
are forced to obtain credit rating in case of issue of debt instrument through private placement
from a recognized credit rating agency. Further, the issuers have to issue debt instruments in
demat form. For taking help of a merchant banker for private placement issuer pays commission
for the same.

Private Placement

Companies can raise resources through public issue, rights issues and private placement. Private
placement is the allotment of securities to a specific number of investors through the
merchant banks. The investors may be financial institutions, corporates, banks and high net
worth individuals. It is faster and cheaper than public and rights issue. It also has lesser
disclosure and compliance requirements. Private placement can be of equity shares, warrants,
partly convertible debentures, preference, fully convertible debentures, or any other financial
instruments that may be converted to equity in the future.

Secondary Market of Corporate Debt in India –

The secondary market for corporate debt securities consist of over the counter (OTC) as well as
stock exchange. Deals in respect of privately placed debt instruments (which are not listed on a
stock exchange) are executed in the OTC market. In case of listed debt instruments, trades are
executed according to the guidelines of stock exchange. Therefore, participants have a choice of
platform. They may trade in OTC or on a stock exchange trading platform where debt
instruments are listed. Existing stock exchanges provide facilities for trading of listed corporate
debt securities. Both National stock exchange (NSE) and Bombay stock exchange (BSE) have
been permitted to provide trading platform for this purpose.

Trading in Corporate Debt Securities: The National Stock Exchange (NSE) provides a distinct
platform for trading in debt securities and has created a separate segment for the same, which is
called as Wholesale Debt Market (WDM) segment. This segment commenced operations on
June 30, 1994. This segment caters to large players in the market, like banks, institutions, etc.The
NSE-WDM segment provides a trading platform for trading in various debt securities such as
PSU bonds, corporate debentures, bonds issued by financial institutions, etc. Trades in debt
securities are executed through the National Exchange for Automated Trading (NEAT) system
which is an automatic system that provides trading and reporting facilities. NSE’s trading
platform has a screen based, order driven and automated order matching system. The Bombay
Stock Exchange (BSE) has introduced trading in all types of debt instruments in the Wholesale
Debt Market (WDM) segment through GILT System. This system is an automatic online trading
system. Trading members and participants have identified as entities in the system. Trading
members (brokers) are admitted on the exchange with trading rights. Trading members execute
trades on GILT system for entities like banks, financial institutions, mutual funds, statutory
corporations, etc. Even individuals can also transact in corporate debt securities through the
members of BSE who have been permitted to undertake deals in debt securities.

Reporting and settlement of Trade in Debt Securities: In April 2007, the SEBI permitted both
the BSE and the NSE to put in place corporate bond trading platforms to enable efficient price
discovery and reliable clearing and settlement facility having following characteristics:a)Trade
matching platform shall be order driven with essential features of OTC market. b)System of
anonymous order. In August 2007, the SEBI granted approval to the Fixed Income Money
Market Derivatives Association (FIMMDA) for starting corporate bond trade reporting system.
Accordingly, in September 2007, the FIMMDAs reporting platform became operational as the
third reporting platform after BSE and NSE. For reporting of OTC trades, the concerned parties
are free to opt for reporting their trades on any one of the three reporting platforms. The trades in
corporate bonds in OTC market are settled through the clearing corporation of stock exchanges
i.e. the Indian Clearing Corporation Limited (ICCL) and the National Securities Clearing
Corporation Ltd. (NSCCL). All trades in corporate bonds which are executed in demat mode and
reported on anyof the specified reporting platform like FIMMDA and NSE-WDM can be settled
through the NSCCL. To facilitate this, buyers and sellers in corporate bond market are required
to indicate their intention to settle such deals through the NSCCL.

NSE Clearing Limited (National Clearing) formerly known as National Securities Clearing
Corporation Limited (NSCCL), a wholly owned subsidiary of NSE, was incorporated in August
1995. It was the first clearing corporation to be established in the country and also the first
clearing corporation in the country to introduce settlement guarantee.
Trading and Settlement Process in the Indian Stock Exchanges –

Step 1: Details of trade (real-time and end of day trade file) from Exchange to National
Securities Clearing Corporation Limited (NSCCL).

Step 2: National Securities Clearing Corporation Limited (NSCCL) notifies the details of trade
to clear members or custodians who affirm back. Based on the affirmation, it applies netting and
determines obligations.

Step 3: Download of pay-in advice of funds or securities and obligation which are sent by
NSCCL to clearing members or custodians.

Step 4: Clearing members or Custodians gives instructions to make funds available by pay-in
time for clearing banks. Clearing Member means a member of the Clearing Corporation who
clears and settles deals through the Clearing Corporation. The Clearing Member clears and
settles deals for a segment in a manner and mode and subject to such terms and conditions and
procedures prescribed for them. Further, a Clearing Member may clear and settle deals either on
their own account or on behalf of their clients subject to the terms and conditions prescribed by
the Clearing Corporation. In the Capital market Segment, all trading members of the Exchange
are required to become the Clearing Member of the Clearing Corporation.

Custodians are clearing members but not trading members. They settle trades on behalf of their
clients that are executed through other trading members. A trading member may assign a
particular trade to a custodian for settlement. The custodian is required to confirm whether he is
going to settle that trade or not. If the custodian confirms the trade, NSE Clearing assigns the
obligation to the custodian. If the custodian rejects the trade, the obligation is assigned back to
the trading member. E.g. – Axis Bank, Citibank, DBS Bank etc,

Step 5: Clearing members or Custodians gives instructions to make securities available by pay-
in-time to depositories. Pay-in of securities (NSCCL directs to debit pool account of custodians
or Clearing members and credit its account to depository and depository do it). Pay-in of funds
(NSCCL directs to the debit account of custodians or Clearing members and credit its account to
Clearing Banks and clearing bank do it).

Pay-in of funds and securities requires members to carry in their funds or securities to the
clearing corporation. The Clearing members sort the funds or securities available in designated
accounts with the two depositories. The depositories transfer the funds or securities available in
the pool accounts, to the pool account of the clearing corporation. Likewise, Clearing members
with funds obligations make funds available in the designated accounts with clearing banks.
Electronic instructions are sent to the clearing banks by clearing corporation to debit clearing
members accounts to the extent of payment obligations. The banks process these guidelines,
debit accounts of Clearing members and credit accounts of the clearing corporation. This
establishes pay-in of funds and securities.

Step 6: Pay-out of securities (NSCCL directs to credit pool account of custodians or Clearing
members and debit its account to depository and depository do it). Pay-out of funds (NSCCL
directs to credit account of custodians or Clearing members and debit its account to Clearing
Banks and clearing bank do it).

Clearing corporation sends electronic instructions to the depositories or clearing banks to release
pay-out of securities after processing for shortages of securities and ordering for movement of
securities from surplus banks to deficit banks through Reserve Bank of India (RBI) clearing. The
depositories and clearing banks debit accounts of the Clearing Corporation and credit accounts of
clearing members. This institutes pay-out of funds and securities. The settlement is deemed to be
complete upon declaration and release of pay-out of funds and securities.

Step 7: Depository informs custodians or Clearing members through DPs. Clearing Banks
inform custodians or Clearing members. There are two depositories in India they are National
Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL).
Securities of investors in their dematerialized accounts are held by these Depositories in India.
Every clearing member must maintain a clearing pool account with the depositories, and he must
make available the required securities in the designated account on the settlement day. The
depository runs an electronic file to transfer the securities from accounts of the
custodians/clearing member to that of NSCCL and vice-versa as per the Schedule of allocation of
securities.
All the securities are being traded and settled within T+2 rolling settlement. NSCCL notifies the
relevant trade details to custodians or clear members on the trading day (T), which are affirmed
on T + 1, to NSCCL. Based on this, NSCCL nets the positions of counterparties to determine
their obligations. A clearing member has to pay-in or pay-out securities and funds.

The obligations are netted for members across all securities to determine fund obligations, and
has to either receive or pay funds. Members pay-in or pay-out obligations are determined latest
by T+1 and these are forwarded to them on the same day so they can settle their obligations on
T+2. The securities or funds are paid-in or paid-out on T+2 day to the members clients and the
settlement is complete within 2 days from the end of the trading day.

Settlement Process in the Indian Capital Market

Important Regulators for the Indian Capital Markets –

FIMMDA - Fixed Income Money Market and Derivatives Association of India (FIMMDA) is an
association of Scheduled Commercial Banks, Public Financial Institutions, Primary Dealers and
Insurance Companies in India representing the Market for the Bond, Money and Derivatives
Products. It functions as the principal interface and works closely with the regulators, RBI, SEBI,
Ministry of Finance, IRDA and other important domestic and International associations. It has
120 members as on date.

Objectives of FIMMDA –

 To function as the principal interface with the regulators on various issues that impact the
functioning of these markets.
 To undertake developmental activities, such as, introduction of benchmark rates and new
derivatives instruments, etc.
 To provide training and development support to dealers and support personnel at member
institutions.
 To adopt/develop international standard practices and a code of conduct in the above fields of
activity.
 To devise standardized best market practices.
 To function as an arbitrator for disputes, if any, between member institutions.
 To assume any other relevant role facilitating smooth and orderly functioning of the said
markets.

Securities Exchange Board of India - Regulator for the Indian Corporate Debt Market is the
Securities and Exchange Board of India (SEBI). SEBI controls bond market and corporate debt
market in cases where entities raise money from public through public issues. It regulates the
manner in which such moneys are raised and tries to ensure a fair play for the retail investor. It
forces the issuer to make the retail investor aware, of the risks inherent in the investment, by way
and its disclosure norms. SEBI is also a regulator for the Mutual Funds, SEBI regulates the entry
of new mutual funds in the industry. It also regulates the instruments in which these mutual
funds can invest. SEBI also regulates the investments of debt FIIs. Apart from the two main
regulators, the RBI and SEBI, there are several other regulators specific for different classes of
investors, eg the Central Provision Fund Commissioner and the Ministry of Labour regulate the
Provident Funds. Religious and Charitable trusts are regulated by some of the State governments
of the states, in which these trusts are located.

Indian Equity Market

Equity market is an important segment of the financial markets. This market helps the corporate
to raise funds with long and indefinite maturity and this facilitates the capital formation in the
country. The funds raised through issue of equity shares are used mainly for purchase of fixed
assets. The investors invest their surplus funds in equity shares for better return and capital
appreciation. The economic growth of a country largely depends on the growth in equity market.
This market is comprised of primary and secondary market.

Primary Market –

A primary market is a market where new securities are brought and sold for the first time. It is
called as the New Issues Market (NIM) or the Initial Public Issue (IPI) market. In other words,
the first public offering of equity shares or convertible securities (like convertible debentures) by
a company, which is followed by the listing of company’s shares on a stock exchange, is known
as Initial Public Offering (IPO). The primary market also includes issue of further capital by
existing companies whose shares are already listed on the stock exchange, such as rights or -
bonus issue.

Advantages of Listing

Listing is advantageous both to the company as well as to the investors. In this regard the
following points may be considered.

 To provide ready marketability and impart liquidity (listed shares can be easily sold in
stock market through a stock broker at a market determined price). The prices of listed
securities are determined on the basis of demand and supply, market perception on true
value of securities.
 To ensure proper supervision and control of dealings therein.
 To protect the interests of shareholders and of general investing public.
 It helps the listed companies to mobilize more resources from shareholders through rights
issue or from market for expansion of existing business or undertake new projects
without depending on banks and financial institutions for line of credit. It helps
companies to enjoy tax concession under the Income Tax Act as the listed companies are
subject to lower income tax rate.
 Listed securities can be used to obtain loans from lending institutions like banks and non-
banking finance companies. The investors having investment in listed shares can obtain
credit facilities from lending institutions.
 The listing agreement between a company and stock exchange ensures that the listed
company will disclose its full financial information that include dividend, issue of bonus
and right shares, buy-back of shares, quarterly financial results. This brings transparency
and improves corporate governance practices in listed securities.
  Public Issue - When shares are offered to the public or new investors through issue of
offer document then it is called a public issue. issue can be further categorized into initial
public offer (IPO) and further public offer. In case of initial public offer, shares are
offered first time to the public. Such offer is made by an unlisted company. Initial public
offer can be at fixed price or at a price which is determined through book building
process. In case of issue of shares at fixed price, issuer in consultation with a merchant
banker decides about the price which is fixed and accordingly are invited from the
prospective investors, through an offer document. as prospectus. As against this, equity
shares can be offered through book building method. Under this method share are not
issued at fixed price. Instead, floor price or minimum price is fixed and accordingly price
band (where cap or maximum price should not be more than 120 per cent of the floor
price) is fixed. In this method, offers or bids are invited from the public stating the price
as well as numbers of shares to be purchased.

Further/Follow On Public Offer

When existing listed company issues or offers new shares to the public then it is called as further
public issue. The company cannot offer shares to the public through public issue unless it enters
into an agreement with a depository for dematerialization of shares already issued or proposed to
be issued to the public.

Offer for Sale

Instead of offering shares to the public at large, companies sell securities to the merchant
bankers, who will offer such securities subsequently for sale to the institutional or retail
investors. The difference between the issue price fixed by the issuer and offer price by the
merchant banker is the gain for the merchant bankers. The unlisted companies use this method
for raising of funds through issue of shares. The public sector undertakings (PSUs) use this
method for selling of part of equity to the investors through disinvestment process.

Issue through Private Placement

In this case, the issuing company does not offer shares through public issue or rights issue, to the
investors. Instead, issuer offers shares to the select group of investors. Both listed and unlisted
companies can issue shares through private placement. A listed Company can allot shares under
private placement in the following ways –

 Preferential Allotment - A listed company may like to issue shares to a select group of
persons keeping in view provisions of Chapter VII of SEBI (ICDR) Regulations, 2009.
The issuer has to comply with various norms relating to the pricing, disclosures, lock-in-
period, etc.
  Qualified Institutional Placement A listed company is allowed to issue new shares to the
qualified institutional buyers in terms of provisions of Chapter VIII of SEBI (ICDR)
Regulations, 2009.

QIBs are defined as –

Qualified Institutional buyers are those institutional investors who are generally
perceived to possess expertise and the financial muscle to evaluate and invest in the
capital markets. In terms of clause 2.2.2 B (v) of DIP guidelines, a ‘Qualified Institutional
Buyer’ shall mean : a)public financial institution as defined in section of the Companies
Act, 2013; b)scheduled commercial banks; c)mutual funds registered with SEBI;
d)foreign institutional investor registered with SEBI; e)multilateral and bilateral
development financial institutions; f)venture capital funds registered with SEBI g)foreign
venture capital investors registered with SEBI h)state Industrial Development
Corporations i)Insurance companies registered with the Insurance Regulatory and
Development Authority (IRDA) j)provident funds with minimum corpus of Rs. 25 crore
k)pension funds with minimum corpus of Rs. 25 crore. l)insurance funds set up and
managed by army, navy or air force of the Union of India. m)insurance funds set-up and
managed by the Development of Posts etc.

 Institutional Placement Programme (IPP) A listed company may like to make public offer
of new shares to the qualified institutional buyers in terms of Chapter VIII of SEBI
(ICDR) regulations 2009 to achieve minimum public shareholding.

Rights Issue – It is the offering of new shares by the existing companies to their existing
shareholders. Such shares are offered on pro-rata basis in a particular ratio to the existing
shareholders. Such shares are issued as per the company law provisions.

Book Building

As per the SEBI guidelines, the book building method can be defined as under : “Book building
is a process undertaken by which a demand for the securities proposed to be issued by a
corporate body is elicited and built up and the price for such securities is assessed for the
determination of the quantum of such securities to be issued by means of a notice, circular,
advertisement, document or information memoranda or offer document.” The book building
method is looked upon as an aid for price discovery in respect of issue of new securities. The
issuer with the help of merchant banker sets a floor or base price and a price band within which
the investor is allowed to bid for shares. The investor has to submit a bid for a quantum of share
which he intends to subscribe at a price which falls within the price band. The spread between
the floor price and cap of the price band shall not be more than 20 per cent. In other words, the
cap price cannot be more than 120 per cent of the floor price. While using book building method
for issue of securities, the issuing company has to appoint a merchant banker who will manage
the public issue and thus will act as a book running lead manager (BRLM). The order book
which is maintained by a merchant banker is built around investor’s bid for number of the
securities along with a quoted price (which happens to be within a price band). Thus, in other
words, a book runner on receipt of offers records the price and quantity of shares to which the
investors are willing to subscribe at that price. Book building method is used by companies for
issue of securities to raise large amount. Price for issue of securities is arrived on the basis of
bids submitted by various investors. By and large uniform price method is followed in this
regard. The price band is worked out and accordingly bids are invited from prospective retail as
well as institutional investors. In case of book building method, red herring prospectus is
prepared. It includes only floor price or price band but does not include the final price at which
securities are allotted. Once a cut-off price is finalized; the final prospectus with all the details
including the final issue price and issue size is filed with ROC. The issuer as well as merchant
banker has to follow book building method for issue of securities as per the guidelines issued by
the SEBI.

Secondary Capital Market of Equity

The secondary market is a place where shares which are already issued are bought and sold.
Such shares are traded on a stock exchange. Therefore, stock exchanges are an integral part of
the secondary market. A stock exchange means anybody of individuals which is incorporated for
the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities. Stock exchanges have to be organized and managed keeping in view its overall role
and importance in the economy.

Section 19 of the Securities Contracts (Regulations) Act, 1956, prohibits formation of a stock
exchange unless it is recognized by the Central Government. A stock exchange becomes a
recognized stock exchange on its being granted a recognition by the Central Government under
Section 4 of the Securities Contracts (Regulations) Act, 1956. The Central Government has
delegated the power to recognize the stock exchange to the SEBI. The trading members of stock
exchange are essentially the middlemen who transact in shares on behalf of investors for a
commission or on their own behalf. In view of shortcomings of existing stock exchanges which
were established as mutual organizations, the Government of India has taken a policy decision
for corporatization of stock exchanges by which ownership, management and trading
membership of stock exchanges would be segregated
from each other. This arrangement will help to bring transparency in trade deals and will not
allow brokers to have an access to sensitive financial information about listed companies. In
view of segregation of management from trading membership, stock brokers will not be able to
misuse their positions for their own benefits.

Functions of the Stock Exchange –

 Channelization of savings into investment.

 Market Place
 Continuous price formation

Reforms in the Indian Secondary Equity Market

 Corporatization and Computerization of Stock Exchanges The SEBI has decided to have
stock exchanges in the form of Joint Stock Company. Accordingly the BSE stock
exchange was converted into a corporate entity with Limited Liability. New stock
exchanges were formed as Joint Stock Company registered under companies Act. This
has made stock exchanges to have two types of members namely shareholders and
trading members. The trading members have been permitted to trade in the listed
securities on stock exchange. But they are not allowed to participate in the administration
of stock exchanges. This policy has helped to eliminate the possibility of having inside
trading in the listed securities. Further the SEBI has directed all stock exchanges to have
all operations including trading fully computerized. Accordingly, all stock exchanges
have opted for full computerization of their operations. This has helped to introduce on
line trading in electronic form and to display market information on line basis. This has
resulted into increase in turnover and speedy settlement of transactions.
 Expansion of Trading Terminals of Stock ExchangesThe SEBI has permitted stock
exchanges like BSE Ltd. and NSE Ltd. to open their trading terminals at different places
in the country. Because of this, it has become possible for investors and traders to trade in
various listed securities through using trading terminals at different places.
 Trading in Demat form In the past trading in securities was in physical form. Now a days
trading in securities is done in demat or in electronic form. The financial instruments like
equity shares are issued in demat form. The investors use depository services to facilitate
holding and trading of such securities in electronic form. It provides following
advantages:a)It eliminates various drawbacks of holding and trading of physical security
such as bad delivery, fake certificate etc. b)It does not involve postal charges and stamp
duty. c)It ensures that securities are held in safe and are transferred immediately. d)It
involves minimum paper work. e)The payment of dividend and interest as well as other
 benefits like issue of bonus shares are credited directly to the investors depository
account with depository participant.
 Introduction of Derivative Trading in stock linked derivative products on stock
exchanges In order to develop the secondarymarket for equity shares and help investors
for managing price risk in their equity portfolio; the SEBI has introduced equity etc. All
these derivative products have been designed by stock exchanges. Therefore, these
derivative products are called exchange traded derivative products. As on March 31,
2013, only two exchanges namely BSE & NSE were allowed to offer equity linked
derivative products. Institutional investors like mutual funds, financial institutions,
insurance companies and retail investors are quite active participants in equity linked
derivatives market. The participants in this market use such products both for hedging as
well as for speculative purposes. The size of derivative segment in equity market is much
more as compared to the size of cash segment.
 Focus on Corporate Governance for Listed Companies The SEBI has emphasized on
corporate governance in the listed companies. In order to achieve this; necessary
provisions are made by the GOI in the Companies Act of 2013, appropriate clauses are
inserted in the listing Agreement with stock exchange and guidelines are issued by the
SEBI.

BSE Ltd.

The BSE Ltd. was set up in 1875. It is the oldest stock exchange in India. In 1957, the
Government of India granted permanent recognition to BSE as a stock exchange under Securities
Contracts (Regulation) Act (SCRA). The BSE which was set up in the form ofmutual association
was incorporated as a limited company under existing companies Act. It became a corporate
entity on August 19, 2005. The SEBI issued notification on June 29, 2007 for recognizing BSE
Ltd as a corporatization and demutualization stock exchange. It has broad shareholders base that
includes global stock exchanges like Deutsche Bourse and Singapore exchange. Besides
providing efficient and transparent trading in listed securities like equity, debt, derivatives etc., it
also provides a platform for trading in equity shares issued by small and medium size enterprises.
The shares of more than 5500 companies are listed on the BSE Ltd. It has established Central
Depository Services Ltd. to provide depository services to the investors. The BSE’s popular
equity index-the S & P BSE Sensex is India’s most widely watched and reported stock market
benchmark index.

NSE Ltd.

The National Stock Exchange (NSE) was established in 1992 with the following objectives :1.to
establish a nationwide trading for equities and debt instruments 2.to provide a fair, efficient and
transparent securities market and 3.to meet the international standards of securities market. The
NSE is completely professionally managed. Initially the NSE had set up two segments i.e. the
Wholesale Debt Market (WDM) and the Capital Market Segment. The WDM segment deals with
pure debt instruments such as Government securities, treasury bills, public sector bonds,
corporate debentures, commercial papers, institutional bonds, certificate of deposits, etc. The
capital market segment deals with equities, convertible debentures, warrants, units of mutual
funds etc. The NSE introduced trading and settlement of deals in dematerialized securities in
1996. It had set up National Securities Clearing Corporation Ltd (NSCCL) to carry out the
clearing and settlement of trades executed in the equity, and other securities including derivatives
segments of the NSE. Trading system of the NSE known as NEAT (National Stock Exchange for
Automated Trading) is a fully automated screen based trading system. This system supports to
develop order driven market. In addition to having capital market segment and WDM segment,
the NSE has introduced third segment namely for derivative products like futures and options. At
present more than 1300 securities are traded on the NSE. It launched CNX NIFTY index in
1996.

Listing of Shares on Stock Exchanges Listing of shares is nothing but registration of shares on
the stock exchange. A company who has decided to list its shares on the stock exchange must
apply to the concerned executive of the stock exchange providing required details of shares and
other information along with listing fees. Such companies have to comply with the guidelines on
listing of shares issued by the SEBI as well as the stock exchange. A public limited company,
which has made public issue of shares must apply to the stock exchange for listing of its shares.

Indian Foreign Exchange Markets –

The Indian foreign exchange market is a decentralised multiple dealership market comprising
two segments – the spot and the derivatives market. In the spot market, currencies are traded at
the prevailing rates and the settlement or value date is two business days ahead. The two-day
period gives adequate time for the parties to send instructions to debit and credit the appropriate
bank accounts at home and abroad. The derivatives market encompasses forwards, swaps and
options. Though forward contracts exist for maturities up to one year, majority of forward
contracts are for one month, three months, or six months. Forward contracts for longer periods
are not as common because of the uncertainties involved and related pricing issues. A swap
transaction in the foreign exchange market is a combination of a spot and a forward in the
opposite direction. As in the case of other EMEs (emerging market exchange), the spot market is
the dominant segment of the Indian foreign exchange market. The derivative segment of the
foreign exchange market is assuming significance and the activity in this segment is gradually
rising.
A derivative contract is an enforceable agreement between two parties where the value of the
contract is based or derived from the value of an underlying as-set. The underlying asset can be a
commodity, stock, precious metal, currency, bond, interest rate, index, etc. Some of the widely
used derivative contracts are as following: Forwards: A forward contract is a non-standardized or
customized contract be-tween two parties to undertake an exchange of the underlying asset at a
specific future date at a pre-determined price. It is a bilateral agreement whose terms are
negotiated and agreed upon between two parties. It is transacted over-the-counter and is not
traded on an exchange. The contract is executed by both parties on the due date by delivery of
asset by the seller and payment by the buyer. A derivative contract is an enforceable agreement
between two parties where the value of the contract is based or derived from the value of an
underlying as-set. The underlying asset can be a commodity, stock, precious metal, currency,
bond, interest rate, index, etc. Some of the widely used derivative contracts are as following:

Forwards: A forward contract is a non-standardized or customized contract be-tween two parties

to undertake an exchange of the underlying asset at a specific future date at a pre-determined
price. It is a bilateral agreement whose terms are negotiated and agreed upon between two
parties. It is transacted over-the-counter and is not traded on an exchange. The contract is
executed by both par-ties on the due date by delivery of asset by the seller and payment by the
buyer.

Futures: Futures contracts are agreements made on a futures ex-change to buy or sell a
commodity at a pre-determined price in the future. The futures contracts are traded on regulated
exchanges and the terms of the contract are standardized by the exchange. What is negotiated by
the counter parties (buyer and seller of a futures contract) is only the price. The price is
discovered through the offers and bids process.

Options: Commodity options are contracts that give the owner the right, but not the obligation, to
buy or sell an agreed amount of a commodity on or before a specified future date.

Swaps: A swap is an agreement between two parties to exchange cash (flows) on or before a
specified future date based on the underlying value of commodity, currency, stock or other
assets. Unlike futures, swaps are not exchange-traded instruments. Swaps are usually designed
by banks and financial institutions that also arrange the trading of these bilateral contracts.

Participants

Players in the Indian market include (a) ADs, mostly banks who are authorised to deal in foreign
exchange, (b) foreign exchange brokers who act as intermediaries, and (c) customers –
individuals, corporates, who need foreign exchange for their transactions. Though customers are
major players in the foreign exchange market, for all practical purposes they depend upon ADs
and brokers. In the spot foreign exchange market, foreign exchange transactions were earlier
dominated by brokers. Nevertheless, the situation has changed with the evolving market
conditions, as now the transactions are dominated by ADs. Brokers continue to dominate the
derivatives market. Foreign Exchange Dealers’ Association of India (FEDAI) plays a special role
in the foreign exchange market for ensuring smooth and speedy growth of the foreign exchange
market in all its aspects. All ADs are required to become members of the FEDAI and execute an
undertaking to the effect that they would abide by the terms and conditions stipulated by the
FEDAI for transacting foreign exchange business. The FEDAI is also the accrediting authority
for the foreign exchange brokers in the inter-bank foreign exchange market. All merchant
transactions in the foreign exchange market have to be necessarily undertaken directly through
ADs. However, to provide depth and liquidity to the inter-bank segment, ADs have been
permitted to utilise the services of brokers for better price discovery in their inter-bank
transactions. The customer segment of the foreign exchange market comprises major public
sector units, corporates and business entities with foreign exchange exposure. It is generally
dominated by select large public sector units such as Indian Oil Corporation, ONGC, BHEL,
SAIL, Maruti Udyog and also the Government of India (for defence and civil debt service) as
also big private sector corporates like Reliance Group, Tata Group and Larsen and Toubro,
among others. In recent years, foreign institutional investors (FIIs) have emerged as major
players in the foreign exchange market.

Regulation of Foreign Exchange Market

Foreign Exchange Regulation Act - An issue related to the guaranteed settlement of

transactions by the CCIL has been the extension of this facility to all forward trades as well.
Member banks currently encounter problems in terms of huge outstanding foreign exchange
exposures in their books and this comes in the way of their doing more trades in the market.
Risks on such huge outstanding trades were found to be very high and so were the capital
requirements for supporting such trades. Hence, many member banks have expressed their desire
in several fora that the CCIL should extend its guarantee to these forward trades from the trade
date itself which could lead to significant increase in the liquidity and depth in the forward
market.

Trading Platform

A variety of trading platforms are used by dealers in the EMEs (Emerging Market Exchanges)
for communicating and trading with one another on a bilateral basis. They conduct bilateral
trades through telephones that are later confirmed by fax or telex. Some dealers also trade on
electronic trading platforms that allow for bilateral conversations and dealing such as the Reuters
Dealing 2000-1 and Dealing 3000 Spot systems. Bilateral conversations may also take place over
networks provided by central banks and over private sector networks (Brazil, Chile, Colombia,
Korea and the Philippines). Reuters’ Dealing System has been the most popular trading platform
in EMEs. In the Indian foreign exchange market, spot trading takes place on four platforms, viz.,
FX CLEAR of the CCIL set up in August 2003, FX Direct that is a foreign exchange trading
platform launched by IBS Forex (P) Ltd. in 2002 in collaboration with Financial Technologies
(India) Ltd., and two other platforms by the Reuters - D2 platform and the Reuters Market Data
System (RMDS) trading platform that have a minimum trading amount limit of US $ 1 million.
FX-CLEAR and FX Direct offer both real time order matching and negotiation modes for
dealing. The Real Time Matching system enables real time matching of currency pairs for
immediate and auto execution in both the spot and forward segments. In the Negotiated Dealing
System, on the other hand, participant is free to choose and negotiate with his counter-party on
all aspects of the transaction, thereby offering him flexibility to select the underlying currency as
well as the terms of trade. These trading platforms cover the US dollar-Indian Rupee (USD-INR)
transactions and transactions in major cross currencies (EUR/USD, USD/JPY, GBP/USD etc.),
though USD-INR constitutes the most of the foreign exchange transactions in terms of value. It
is the FXCLEAR of the CCIL that remains the most widely used trading platform in India. This
platform has been given to members free of cost. The main advantage of this platform is its offer
of straight-through processing (STP) capabilities as it is linked to CCIL’s settlement platform. In
the forward segment of the Indian foreign exchange market, trading takes place both over the
counter (OTC) and in an exchange traded market with brokers playing an important role. The
trading platforms available include FX CLEAR of the CCIL, RMDS from Reuters and FX Direct
of the IBS.

In pursuance of the recommendations of the Sodhani Committee, the Reserve Bank had set up
the Clearing Corporation of India Ltd. (CCIL) in 2001 to mitigate risks in the Indian financial
markets. The CCIL commenced settlement of foreign exchange operations for inter-bank USD-
INR spot and forward trades from November 8, 2002 and for inter-bank USD-INR cash and tom
trades from February 5, 2004.The CCIL undertakes settlement of foreign exchange trades on a
multilateral net basis through a process of novation and all spot, cash and tom transactions are
guaranteed for settlement from the trade date. Every eligible foreign exchange contract entered
between members gets novated or replaced by two new contracts – between the CCIL and each
of the two parties, respectively. Following the multilateral netting procedure, the net amount
payable to, or receivable from, the CCIL in each currency is arrived at, member-wise. An issue
related to the guaranteed settlement of transactions by the CCIL has been the extension of this
facility to all forward trades as well. Member banks currently encounter problems in terms of
huge outstanding foreign exchange exposures in their books and this comes in the way of their
doing more trades in the market. Risks on such huge outstanding trades were found to be very
high and so were the capital requirements for supporting such trades. Hence, many member
banks have expressed their desire in several fora that the CCIL should extend its guarantee to
these forward trades from the trade date itself which could lead to significant increase in the
liquidity and depth in the forward market.

Commodity Market in India

Commodities are products that can be bought, sold or traded in different kinds of markets. In the
global markets, there are four categories of commodities in which trading takes place - Energy
(e.g., crude oil, heating oil, natural gas and gasoline), Metals (e.g., precious metals such as gold,
silver, platinum and palladium; base metals such as aluminium, copper, lead, nickel, tin and zinc;
and industrial metals such as steel),Livestock and meat (e.g., lean hogs, pork bellies, live cattle
and feeder cattle),Agricultural (e.g., corn, soybean, wheat, rice, cocoa, coffee, cotton and sugar).
There are two types of commodity markets: spot (physical) and derivatives (such as futures,
options and swaps). In a spot market, a physical commodity is sold or bought at a price
negotiated between the buyer and the seller. The spot market involves buying and selling of
commodities in cash with immediate delivery. There are spot markets for individual consumers
(retail market) and the business-to-business (wholesale market) category. Spot markets also
include traditional markets such as Delhi’s Azadpur Mandi that deal in fruits and vegetables. On
the other hand, a commodity can be sold or bought via derivatives contract as well. A futures
contract is a pre-determined and standardized contract to buy or sell commodities for a particular
price and for a certain date in the future. For instance, if one wants to buy 10 tonne of rice today,
one can buy it in the spot market. But if one wants to buy or sell 10 tonne of rice at a future date,
(say, after two months), one can buy or sell rice futures contracts at a commodity futures
exchange. The futures contracts provide for the delivery or receipt of a physical commodity of a
specified amount at some future date. Under the physically settled con-tract, the full purchase
price is paid by the buyer and the actual commodity is delivered by the seller. But in a futures
contract, actual delivery takes place later. However, under the cash-settled futures contract, the
farmer and the miller would simply exchange the difference between the spot price of rice on the
settlement date and the agreed upon price as mentioned in the futures contract and there would
be no actual delivery of rice.

Broadly speaking, there are two groups of derivative contracts – exchange-traded and over-the-
counter (OTC) – based on the manner in which they are traded in the market. Exchange-traded
derivatives are those instruments (such as futures and options) that are traded on derivatives
exchanges. The last decade has witnessed tremendous growth in this segment. OTC commodity
derivatives are used for non-standardized contracts that can meet specific demands of the
contracting parties. The OTC derivative market is the largest market in the world of which the
commodity OTC derivatives are the smallest part and the interest rate and foreign exchange
derivatives contracts are the most significant.
Regulators of Commodities Market

 Forwards Market Commission – The relevant legislation named ‘The Forward Contracts
(Regulation) Act 1952, effective from August 1953 and amended in 1953,1957 and 1960,
aims at establishing well-organised futures markets in different centers of the country.
Forward Market Commission (FMC) was formed for regulating the commodity
exchanges in the Indian commodity market. In 2015, FMC was merged with the
Securities and Exchange Board of India (SEBI). Building a stronger regulatory system
was the aim of the merger. The regulatory system remains stringent with regulatory
guidelines and frameworks for transparency of deliveries and to ensure that malpractices
are kept at bay in the market. Other advances include the development and regulation of
warehouses through a separate regulator, introduction of options contracts in select
commodities and recognition of all exchanges as stock exchanges.
 Ministry of Consumer Affairs - The Department pertaining to consumer affairs is
responsible for the formulation of policies for the monitoring prices, Consumer
Movement in the country, Controlling of statutory bodies (Bureau of Indian Standards
(BIS) and Weights and Measures), Internal Trade, Control Act, 1955 (39 of 1955).,
Control of Futures Trading- the Forward Contracts (Regulations) Act, 1952 (74 of 1952)
etc.

Commodities Futures

The two major economic functions of a commodity futures trading are price risk management
and price discovery. A futures exchange carries out these twin functions by providing a trading
platform that brings buyers and sellers together. The price risk management (also called hedging)
is considered to be the most important function of a commodity futures market. The hedging is
used to manage price risks. It allows transfer of price risk to other agents who are willing to bear
such risks. The hedgers, in principle, buy futures contracts for protection against rising
commodity prices and sell futures for protection against falling prices or to get a guaranteed
price in the future. Hedgers use futures market to protect themselves against price adverse
changes and are often interested in taking or making physical delivery of the underlying
commodity at a specified price. The premise of hedging is the key reason behind the existence of
commodity futures exchanges. It is important to note that the commodity futures price, the price
agreed upon by the parties for the future transaction, is a market estimate about the future price
of the underlying commodity. It reflects the price expectations of both buyers and sellers for a
time of delivery in the future. It may be higher or lower than the spot price of the commodity in
the spot market. Thus, the futures price could be used as an estimate of the spot price of a
commodity at some future date. However, futures prices keep changing until the last date of the
futures contract subject to additional information about demand and supply.
Commodity exchange (also called bourse) is an organized physical or virtual marketplace where
various tradable securities, commodities and derivatives are sold and bought. Commodity
derivatives exchanges are places where trading of commodity futures and options contracts are
conducted.

Participants of Indian Commodities Futures Markets

As per the existing regulatory framework, banks in India are allowed to trade in financial
instruments (shares, bonds and currencies) in the securities market. But the Banking Regulation
Act, 1949, prohibits banks (domestic and foreign) from trading in goods. Resident Indians,
companies and traders are allowed to trade in Indian commodity markets. Mutual funds, pension
funds, insurance companies and foreign institutional investors (FIIs) are not allowed to trade in
Indian commodity futures markets.

Major Commodities Exchange in India

The Government of India permitted establishment of National-level Multi-Commodity

exchanges in the year 2002-03 and accordingly following exchanges have come into picture.
They are – Multi Commodities Exchange (MCX) Multi-National Commodity and Derivatives
Exchange of India, Mumbai (NCDEX), National Multi Commodity Exchange, Ahmedabad
(NMCE), Indian Commodity Exchange (ICEX), ACE Derivatives & Commodity Exchange Ltd.
However, there are regional commodity exchanges functioning all over the country.
Case Study on Green Shoe Option:
Dematerialisation Process:
Rematerialisation Process: