Understanding Securities Markets and Performance

1Where securities markets sit in the financial system

The financial market is made up of the money market, the securities market and the currency (foreign exchange) market. The securities market gives a regulated channel through which the savings of households, companies and the government flow to businesses and governments that need capital.

Securities are financial instruments issued by companies, financial institutions or governments to raise money. Investors buy them and so turn their savings into financial assets.

Example A family saves ₹10,000 a month and buys shares and bonds. That money reaches a company building a factory through the securities market, instead of sitting idle.

Remember

• Three parts of the financial market: money, securities, currency.
• Securities link savings (investors) with investment (issuers).

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2What the law calls a "security"

"Securities" are defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA). The definition includes shares, bonds, debentures and other marketable securities of a company or pooled investment vehicle; derivatives; units of collective investment schemes and mutual funds; security receipts; units of pooled investment vehicles such as REITs and InvITs; securitised debt instruments; government securities; rights or interest in securities; and anything else the Central Government declares to be a security, such as Electronic Gold Receipts and Zero Coupon Zero Principal instruments issued on Social Stock Exchanges.

Unit-linked insurance policies (ULIPs) are excluded, even though they invest in markets, because they combine life cover with investment and are issued by insurers.

Exam trap Bank fixed deposits, company deposits, chit funds, insurance policies and provident or pension fund contributions are not securities. They are one-to-one contracts that cannot be transferred freely.

Remember

• Definition: Section 2(h) of SCRA, 1956.
• ULIPs are specifically excluded; mutual fund units are included.

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3Features of a security

A security sets out the terms on which money changes hands between an issuer and an investor. Its key strength is transferability: the investor can sell it to someone else before maturity at a price both agree on.

• The issuer sets the terms (interest, tenure, rights).
• The investor gets rights such as ownership, a say in management or a claim on assets, and the right to information about the issuer.
• Securities are broadly equity (ownership) or debt (borrowing). They differ in rights, risk and return.
• Return is the benefit the investor expects; risk is the chance that it does not arrive.

Example A 1-year bank deposit can only be repaid to the depositor and breaking it early may cost a penalty. A 1-year certificate of deposit from the same bank is a security: the holder can sell it to another investor at the current market rate, and whoever holds it on maturity collects the money.

Remember

• Transferability is what makes a security more flexible than a deposit.
• Equity = ownership; debt = a loan to the issuer.

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4Structure of the market and its participants

The securities market has two linked parts:

• Primary market (new issue market): issuers raise fresh capital by selling new securities to investors.
• Secondary market (stock exchanges): investors trade securities that already exist. Risk passes from seller to buyer, and investors get an exit.

The primary market creates financial assets; the secondary market makes them marketable. A stock exchange's role in the primary market is limited to listing.

The three building blocks are investors (supply capital), issuers (demand capital) and intermediaries (bring them together), all under regulatory supervision.

Investors are either retail (individuals investing their own money) or institutional (mutual funds, banks, insurers, pension funds and others with large sums and formal processes for selecting, monitoring and managing risk).

Issuers include companies, central and state governments, municipalities, banks and financial institutions, public sector companies (through disinvestment), mutual funds, and trusts such as REITs, InvITs and AIFs. Government agencies issue only debt, never equity. Since the mid-1990s securities are issued in electronic (demat) form; converting old paper certificates into electronic form is called dematerialisation.

Exam trap A mutual fund buying shares is an institutional investor; a mutual fund selling units of its scheme is an issuer. The same entity can play different roles.

Remember

• Primary market creates securities; secondary market gives liquidity.
• Governments raise money only through debt.

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5The intermediaries and what each one does

The SEBI (Intermediaries) Regulations, 2008 list the market intermediaries. All must be registered with SEBI and follow a code of conduct built on investor protection, fair and skilled service, no collusion, timely information and adequate infrastructure.

• Asset management companies pool investors' money in schemes and issue units. Portfolio managers manage each client's portfolio separately; they cannot pool money or issue securities.
• Merchant bankers (lead managers) plan, structure, price and manage an issue until listing. They may also underwrite, promising to buy whatever investors do not take up. Underwriters in the government bond market are called primary dealers.
• Stock brokers are trading members of exchanges; all exchange trades must go through them. Authorised persons (formerly sub-brokers) are their registered agents.
• Trading members put trades through; clearing members settle money and securities for completed trades.
• Bankers to an issue collect applications and money during a new issue.
• Registrars and share transfer agents (RTAs) keep the issuer's record of who owns its securities, so dividends and interest reach the right person.
• Depository participants (DPs) open demat accounts for investors and act as agents of the depositories, which hold securities at the company level.
• Custodians (usually large banks) hold securities and settle trades for institutional investors.
• Trustees protect beneficiaries who cannot supervise managers directly: mutual fund trustees supervise the AMC; debenture trustees protect lenders.
• Credit rating agencies give an opinion on an issuer's ability to pay interest and principal.
• Investment advisers recommend investments based on the client's needs, horizon and risk capacity, and build financial plans.
• KYC registration agencies (KRAs) hold investors' KYC records centrally. KYC done once with any SEBI-registered intermediary is valid across the capital market, and KRAs share data with each other. KRAs validate Aadhaar with UIDAI, mobile and email by OTP, and PAN with the Income Tax database.

Example You buy shares through your broker. The broker's clearing member settles the trade, the shares arrive in your demat account with your DP, the depository records the change, and the company's RTA now pays your dividends to you.

Remember

• AMC pools money; portfolio manager cannot pool.
• DPs are agents of the depositories.
• One KYC is valid across all SEBI-registered intermediaries.

6Who regulates the markets

• SEBI (statutory body under the SEBI Act, 1992, functioning under the Ministry of Finance) is the main regulator. It recognises and regulates stock exchanges and administers the SCRA; frames regulations such as ICDR Regulations, 2018 for public and rights issues, QIPs and preferential issues, and the Non-Convertible Securities Regulations, 2021 for debt; inspects and investigates intermediaries; can call for information, summon people, search and seize, and impose penalties including suspension, fines and prosecution; and enforces the insider-trading rules.
• RBI regulates the money market, foreign exchange market and government securities market, manages the government's borrowing and regulates banks.
• Ministry of Corporate Affairs administers the Companies Act, which governs how companies are formed, run and audited, and their issue of securities.
• Ministry of Finance: its Department of Economic Affairs looks after capital markets; its Department of Financial Services oversees banking, insurance and pension sectors.
• IRDAI (1999 Act) regulates insurance; PFRDA (2013 Act) regulates pension funds and the NPS; IBBI (2016) oversees insolvency proceedings and insolvency professionals; IFSCA (2020, GIFT City) is the unified regulator for International Financial Services Centres.

Exam trap Government securities are "securities" under SCRA, but their market is regulated by the RBI, not SEBI.

Remember

• SEBI: securities market. RBI: money, forex and G-sec markets.
• MCA: Companies Act. IFSCA: GIFT City.

7Why securities markets matter

A well-developed securities market goes with strong economic growth. It:

• Channels funds in an orderly way from many savers to borrowers. Companies can raise money directly by issuing bonds or commercial paper instead of borrowing from banks; this shift is called financial disintermediation.
• Generates productive investment, pooling small savings into large projects such as a steel plant.
• Provides liquidity: investors can sell when they need cash, which makes them willing to commit to long-term securities.
• Discovers prices: the fair price is set by the actions of many buyers and sellers, not dictated by a regulator.
• Signals information: news about a company or sector shows up quickly in prices, which helps small investors with little access to information.

Example Rains are expected to be poor, so fertiliser sales are likely to fall. Fertiliser company share prices drop before any results are announced. That is information signalling through prices.

Remember

• Five roles: orderly channel, productive investment, liquidity, price discovery, information signalling.
• Disintermediation = raising money directly in the market instead of through banks.

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8Technology, cyber security and sandboxes

Trading moved from open-outcry "pit" trading to screen-based electronic trading in the 1990s, and then to online and mobile trading. This made markets faster but exposed them to cyber-attacks.

SEBI's Cyber Security and Cyber Resilience Framework (CSCRF) applies to all SEBI regulated entities. It treats stock exchanges, depositories, clearing corporations, KRAs and qualified RTAs as Market Infrastructure Institutions. Cyber security is about preventing attacks; cyber resilience is the ability to prepare for, keep working through and recover from an attack. The framework has five resilience goals: Anticipate, Withstand, Contain, Recover and Evolve, mapped to functions: governance, identify, protect, detect, respond and recover. Entities need a board-approved policy, a list of critical systems, access on a need-to-know basis, incident reporting through SEBI's portal, a Cyber Crisis Management Plan, root cause analysis and periodic audits by CERT-In empanelled auditors. Entities remain accountable for their vendors.

SEBI also runs two sandboxes:

• Innovation Sandbox: fintech firms, start-ups and even individuals not regulated by SEBI can test ideas offline, away from the live market, using market data from exchanges, depositories and RTAs.
• Regulatory Sandbox: SEBI-registered entities can test innovations live, with a limited number of customers for a limited time, under supervision. SEBI may relax some rules, but never investor protection, KYC or anti-money-laundering rules. The idea was first used by the UK's FCA in 2015.

Exam trap Innovation sandbox = offline testing, open to unregulated entities. Regulatory sandbox = live testing, only for SEBI-registered entities.

Remember

• Five CSCRF goals: Anticipate, Withstand, Contain, Recover, Evolve.
• No relaxation of KYC, AML or investor protection in the regulatory sandbox.

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