Securities and Exchange Board of India (SEBI) has a primary responsibility of regulating and supervising the capital market. It has introduced a number of reforms for the control and supervision of capital market and investors protection.
Primary Market Reforms by the SEBI
The Securities and Exchange Board of India (SEBI) has introduced various guidelines and regulatory measures for capital issues for healthy and efficient functioning of capital market in India. The issuing companies are required to make material disclosure about the risk factors, in their offer documents and also to get their debt instruments rated. Steps have been taken to ensure that continuous disclosures are made by firms so as to enable to investors to make a comparison between promises and performance. The merchant bankers now have greater degree of accountability in the offer document and the issue process. The due diligence certificate by the lead manager regarding disclosure made in the offer document, has been made a part of the offer document itself for better accountability and transparency on the part of the lead managers.
New reforms by SEBI, in the primary market, include improved disclosure standards. introduction of prudential norms and simplifications of issue procedures. Companies are now required to disclose all material facts and specific risk factors associated with their projects while making public issues. SEBI has also introduced a code for advertisement for public issues for ensuring fair and true picture. In order to reduce the cost of issue, the underwriting of issues has been made optional subject to the conditions that if the subscription is less than 90% f the amount offered, the entire amount collected would be refunded to the investors.
The book-building process in the primary market has been introduced with a view to further strengthen the price fixing process. Indian companies have been allowed to raise funds from abroad by issue of ADR/GDR/FCCB, etc.
SEBI formulated the following guidelines for primary markets:
- Disclosure and Investor Protection (DIP) guidelines: as per this regulation all the information pertaining to and available with an issuer is provided so as the investor takes an informed decision whether to invest or not to invest.
- Eligibility Criteria for issuers (DIP-2000): Companies eligible to make an issue can decide on their standard denomination and price of a security. Some parameters that need to be in offer documents are minimum holding by promoters, size of public issue, issue expenses, information disclosure and advertisement etc.
- Transparency: SEBI makes available all the offer documents filed with it on its website and also through process release. Companies are invited from the public within 21 days of filing.
- Free Pricing of Securities: issuer is free to determine the level of security price. The process of Book-building helps discover price and assist small investor to take an investment decision.
- Number of Financial Instruments: issuer would like to have an optimum capital structure that reduces cost of capital. Today Indian Capital Market consists of almost all financial products available in most of the developed Capital Market, thus the choice to both issuer and investor has become wider.
- Issue process: the following process is used in the Indian Capital Market:
- Public issue — an invitation by a company to the public to subscribe to the securities offered through prospects. It is an Initial Public Offer (IPO).
- Rights Issue – issue of capital under Sec-I (81) Companies Act 1956 to be offered to existing shareholders.
- Offer for Sale – It is a public invitation by a sponsoring intermediary, such as bank or broker, to buy new or existing securities. It contrasts with an offer for subscription which is an invitation to subscribe direct from the issuer.
- Book-building – it refers to a process of ascertaining demand for and price of securities through bids, before the Actual issue. Book building process is mandatory when the company does not have track record for three out of preceding five years. 60% allotment to qualified institutional buyers is mandatory under the book building process.
- Compulsory Demat – All Initial public offerings was compulsory traded in dematerialized form. But the investors have been allowed to exercise option of either subscribing to securities in its physical or dematerialized form.
- Employee stock option — means option given to the whole time employee of a company right to purchase or subscribe securities at a future date.
- Buy-back — section 77 (A) Companies Act and SEBI regulation allow companies to buy back shares to enhance the wealth of shareholder.
- Prohibiting insider trading in securities, with the imposition of monetary penalties, on defaulter market intermediaries.
- Foreign Institutional Investors are allowed to invest in Indian Capital Markets after registration with the SEBI.
- Indian companies permitted to access international Capital Markets through Euro issues.
- The National Stock Exchanges (NSE) with nationwide stock trading and electronic display, clearing and settlement facilities, established several regional Stock Exchanges change over from floor based grading to screen based trading.
- Private Mutual Funds permitted.
- The practice of making preferential allotment of shares at prices unrelated to the prevailing market prices stopped and fresh guidelines are issued by SEBI.
- Badla System was been abolished.
- A system of rolling settlements introduced and SEBI is thinking about the introduction of T+1 settlement plan for the Capital Market
- The SEBI (credit rating Agencies) Regulations, 1999 issued for regulating new credit rating agencies as well as introducing a code of conduct for all credit rating agencies operating in India.
Further primary market reforms by SEBI;
- The improved disclosure standards, introduction of prudential norms, and simplification of issue procedures.
- Companies required disclosing all material facts and specific risk factors associated with their projects while making public issues.
- Listing agreements of stock exchanges amended to require listed companies to furnish annual statement to the exchanges showing variations between financial projections and projected utilization of funds in the offer document and actual figures. This is to enable shareholders to make comparisons between performance and promises.
- SEBI introduces a code of advertisement for public issues to ensure fair and truthful disclosures.
- Disclosure norms further strengthened by introducing cash flow statements.
- New issue procedures introduced–book building for institutional investors–aimed at reducing costs of issuing shares.
- SEBI introduces regulations governing substantial acquisition of shares and takeovers and lays down conditions under which disclosures and mandatory public offers are to be made to the shareholders.
Secondary Market Reforms by the SEBI
Since the establishment of Securities and Exchange Board of India (SEBI) in 1992, the decades old trading system in stock exchanges has been under review. The main deficiencies of the system were found in two areas: (i) the clearing and settlement system in stock exchanges whereby physical delivery of shares by the seller and the payment by the buyer was made, and (ii) procedure for transfer of shares in the name of the purchaser by the company. The procedure was involving a lot of paper work, delays in settlement and non-transparency in costs and prices of the transactions. The prevalence of ‘Badla’ system had often been identified as a factor encouraging speculative activities. As a part of the process of establishing transparent rules for trading, the ‘Badla’ system was discontinued in December 1993. The SEBI directed the stock exchanges at Mumbai, Kolkata, Delhi and Ahmadabad to ensure that all transactions in securities are concluded by delivery and payments and not to allow any carry forward of the transactions.
The floor-based open outcry system has been replaced by on-line electronic system. The period settlement system has given way to the rolling settlement system. Physical share certificates system has been outdated by the electronic depository system. The risk management system has been made more comprehensive with different types of margins introduced. FII’s have been allowed to participate in the capital market. Stringent steps have been taken to check insider trading. The interest of minority shareholders has been protected by introducing takeover code. Several types of derivative instalments have been introduced for hedging.
As a result of the reforms/initiatives taken by Government and the Regulators, the market structure has been refined and modernized. The investment choices for the investors have also broadened. The securities market moved from T+3 settlement period to T+2 rolling settlement with effect from April 1, 2003. Further, straight through processing has been made mandatory for all institutional trades executed on the stock exchange. Real time gross settlement has also been introduced by RBI to settle inter-bank transactions online real time mode.
SEBI initiates the development of informed investor class, legal and regulatory environment, institutional investors, world class security trading and payment and settlement systems. It also includes promoting investor associations, self-regulatory organizations (SROs), and setting up of depository’s surveillance system. As another step towards this, SEBI has introduced new financial instruments (derivatives) into the Capital Market. Derivatives are financial contracts, or financial instruments, whose prices are derived from the price of something else (known as the underlying). The underlying price on which a derivative is based can be that of an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI), or other items. Credit derivatives are based on loans, bonds or other forms of credit. Futures and options belong to the family of derivative financial products. The name is coined from the fact that the price of these products can be derived from the price of a so called underlying product. Derivative products of BSE are futures and options contracts. These can play a vital role in promoting market efficiency through better price discovery and risk transfer. SEBI granted approval to NSE and BSE to start trading in index futures contract in April 2000 and May 2000 respectively. SEBI also approved the proposal of NSE and BSE to start trading in index options contracts in June 2001.