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Unit 2: Securities Market: An Overview

implement trading discipline in derivative instruments. The SC(R)A was amended further in Notes
December 1999 to expand the definition of securities to include derivatives so that the whole
regulatory framework governing trading of securities could apply to trading of derivatives
also. A three-decade old ban on forward trading, which had lost its relevance and was hindering
introduction of derivatives trading, was withdrawn and derivatives trading took off in
June 2000. The Mini derivative Futures & Options contract was introduced for trading on S&P
CNX Nifty on January 1, 2008 while the long-term option contracts on S&P CNX Nifty were
introduced for trading on March 3, 2008.

Demutualisation

Historically, brokers owned, controlled and managed stock exchanges. In case of disputes, the
self often got precedence over regulations leading inevitably to conflict of interest. The regulators,
therefore, focused on reducing dominance of members in the management of stock exchanges
and advised them to reconstitute their governing councils to provide for at least 50%
non-broker representation. This did not materially alter the situation. In face of extreme volatility
in the securities market, Government proposed in March 2001 to corporatise the stock exchanges
by which ownership, management and trading membership would be segregated from one
another. Government offered a variety of tax incentives to facilitate corporatisation and
demutualization of stock exchanges.
NSE, however, adopted a pure demutualised governance structure where ownership,
management and trading are with three different sets of people. This completely eliminated any
conflict of interest and helped NSE to aggressively pursue policies and practices within a public
interest (market efficiency and investor interest) framework. Currently, there are 19 demutualised
stock exchanges.

Depositories Act

The earlier settlement system on Indian stock exchanges gave rise to settlement risk due to the
time that elapsed before trades are settled. Trades were settled by physical movement of paper.
This had two aspects. First, the settlement of trade in stock exchanges by delivery of shares by
the seller and payment by the purchaser. The stock exchange aggregated trades over a period of
time to carry out net settlement through the physical delivery of securities. The process of
physically moving the securities from the seller to the ultimate buyer through the seller’s
broker and buyer’s broker took time with the risk of delay somewhere along the chain. The
second aspect related to transfer of shares in favour of the purchaser by the company. The system
of transfer of ownership was grossly inefficient as every transfer involved physical movement
of paper securities to the issuer for registration, with the change of ownership being evidenced
by an endorsement on the security certificate. In many cases the process of transfer took much
longer, and a significant proportion of transactions ended up as bad delivery due to faulty
compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities
were rampant, and in addition the issuer had the right to refuse the transfer of a security. All this
added to costs, and delays in settlement, restricted liquidity and made investor grievance redressal
time consuming and at times intractable.
To obviate these problems, the Depositories Act, 1996 was passed to provide for the establishment
of depositories in securities with the objective of ensuring free transferability of securities with
speed, accuracy and security by (a) making securities of public limited companies freely
transferable subject to certain exceptions; (b) dematerialising the securities in the depository
mode; and (c) providing for maintenance of ownership records in a book entry form. In order to
streamline both the stages of settlement process, the Act envisages transfer of ownership of
securities electronically by book entry without making the securities move from person to
person. In order to promote dematerialisation, the regulator mandated trading and settlement

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