Stock Exchange Defined

The Securities Contracts (Regulation) Act 1956 defines a stock exchange as-

"an association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities"

We will analyse the different elements in the above definition to understand more systematically about the framework and functioning of stock exchanges in India.

The Act recognizes stock exchanges with different legal structure. Presently the stock exchanges which are recognised under the Securities Contracts (Regulation) Act in India, could be segregated into two broad groups – 20 stock exchanges which were set up as companies, either limited by guarantees or by shares, and the 3 stock exchanges which are functioning as associations of persons (AOP) viz. BSE, Ahmedabad Stock Exchange and Indore Stock Exchange. The 20 stock exchanges which are companies are: the stock exchanges of Bangalore, Bhubaneswar, Calcutta, Cochin, Coimbatore, Delhi, Gauhati, Hyderabad, Interconnected SE, Jaipur, Ludhiana, Madras, Magadh, Managalore, NSE, Pune, OTCEI, Saurashtra-Kutch, Uttar Pradesh, and Vadodara. Of these, the stock exchanges of Ahmedabad, Bangalore, BSE, Calcutta, Delhi, Hyderabad, Madhya Pradesh, Madras and Gauhati were given permanent recognition by the Central Government at the time of setting up of these stock exchanges. Apart from NSE, all stock exchanges whether established as corporate bodies or Association of Persons (AOPs), are non-profit making organizations.

The Government had announced its proposal to corporatise the stock exchanges by which ownership, management and trading rights would be segregated from each other and legislative changes, if required, would be proposed accordingly to give effect to the corporatisation of stock exchanges. The Finance Minister has also emphasized in his Budget Speech for the year 2002-03 that this process would be completed during the course of the year to implement the decision to separate ownership, management and operation of the stock exchanges. . Accordingly SEBI subsequently in the same year (2002) constituted a group headed by Justice M.H. Kania, former Chief Justice of India on Corporatisation & Demutualisation of Stock Exchanges in India. The Group submitted its report in August 2002 recommending corporatisation and demutualisation of the stock exchanges and the modalities thereof.

The report of the group on Corporatisation and Demutualisation along with the public comments was considered by the SEBI Board and was approved. However some of the recommendation of the Group as approved by the SEBI Board would require legislative changes. SEBI has taken up the said proposal for legislative changes with the Central Government. The process of corporatisation and demutualisation of the stock exchanges have set in motion. Eventually all stock exchanges in India will be incorporated bodies operating for profit. Demutualisation involves the segregation of members' right into distinct segments, viz. ownership rights and trading rights. It changes the relationship between members and the stock exchange. Members while retaining their trading rights acquire ownership rights in the stock exchange, which have a market value, and they also acquire the benefits of limited liability. Division of ownership between members and outsiders can lead to a balanced approach, remove conflicts of interest, create greater management accountability, and take into consideration the interest of other players. Advantages of Corporatisation and Demutualisation are proved by the example of National Stock Exchange established in 1995, which now occupies the first place among the exchanges in India. This topic is further discussed in the article relating to NSE.

The function of the stock exchange as per the definition referred above is "assisting, regulating and controlling business in buying, selling and dealing in securities." Obviously the stock exchange acts as a market for the purchase and sale of listed industrial and financial securities. The securities dealt with at the stock exchange include the shares and debentures of public limited companies, government securities, and bonds and securities issued by Public Utilities (Quasi-Government bodies). Indirectly the stock exchange also acts as a self regulatory organization (SRO) and discharges certain regulatory functions. As Self Regulated Organisations (SRO) the stock exchanges have the responsibility of member compliance, market surveillance and enforcement. The following statement of BSE in its website amply illustrates this.

SEBI as the watchdog of the industry has an important and crucial role in the market in ensuring that the market participants perform their duties in accordance with the regulatory norms. The Stock Exchange as a responsible Self Regulatory Organization (SRO) function to regulate the market and its prices as per the prevalent regulations. SEBI and the Exchange play complimentary roles to enhance the investor protection and the overall quality of the market.

To discharge its regulatory functions the stock exchange has Surveillance and inspection departments as part of its administrative set up. It also has a Disciplinary Action Committee (DAC) which decides on punitive action in disciplinary cases referred to it by the Surveillance and inspection departments

In recent years dramatic changes have occurred in the financial markets. Developments in computing power and applications have changed markets significantly. Technological changes have broken down some of the barriers to entry into the business of making markets in investments. Under the impact the premier stock exchanges of the country, BSE and NSE, have both moved to electronic trading from the traditional outcry system.

The modern stock exchange technology does not need the traditional type of brokers to match investors' orders as they used to do on the physical-trading floor. The automated Trading screens can match buy and sell orders without the intervention of brokers. Today brokers are needed only for settlement responsibilities. NSE introduced a nation-wide VSAT driven screen based trading system

The NSE was established as a corporate body in 1993 with the primary objectives of ensuring nationwide electronic trading, high levels of transparency and faster settlement cycles. Since inception, the exchange has been demutualised, with the ownership, management and trading in the hands of three different sets of people. The NSE has been playing a catalytic role and has significantly contributed to the reforming of the secondary markets in India in terms of microstructure, market practices, trading volumes and use of state-of-the-art technology. The use of satellite communication technology for trading using Very Small Aperture Terminals (VSATs) enabled NSE to rapidly expand across the length and breadth of the country. The aim was to enable NSE to provide nation-wide electronic trading with highest transparency in the market place. Using the client-server architecture, fault-tolerant computing and in-memory database, provided with high visibility and impact. This enabled National Securities Clearing and Settlement system (NSCS) to process settlements for over 172 million trades with a turnover of around Rs 5,08,121 crore during the year 2001-2002.

After NSE, BSE was granted the required site permissions, it expanded its trading facilities to the remote corners of the land. BOLT i.e., BSE's online trading system replaced the manual out-cry method of trading in the ring and went live on March 1995.This enabled BSE to provide floorless and fully automated screen-based trading facilities in capital market (CM) instruments with equal access to investors all over the country. BSE with around 685 members, has seen an average daily turnover of Rs 1,162 crore in July 2002. For further expansion of its activities, BSE has provided web-based trading facility to the members as it was felt that Internet trading would fundamentally change the way exchange and brokers interact with their customers.

Globalisation has brought a large number of Foreign Financial Institutions to invest in Stock Markets in India. As per recent statistics they have invested as much as $ 12 billion.

The process of economic reforms and liberalisation was set in motion in the mid-eighties and its pace was accelerated in 1991. The economic reforms included financial sector reforms, being an integrated process, aimed at deregulation of industry, liberalisation in foreign investment, restructuring and liberalisation of trade, exchange rate, and tax policies, partial disinvestment of Government holding in public sector companies, etc. The Securities market reforms included -

1. repeal of the Capital Issues (Control) Act, 1947;

2. enactment of the Securities Exchange Board of India Act, 1992 to provide for the establishment of Securities & Exchange Board of India (SEBI) to regulate and promote the development of securities market ;

3. setting up of National Stock Exchange of India Ltd. in 1993

4. passing of the Depositories Act, 1996 to provide for maintenance and transfer of ownership of securities in book entry form;

5. amendments to the Securities Contracts (Regulation) Act, 1956 (SCRA) in 199 to provide for the introduction of futures and options.

These measures resulted into free pricing of securities, investor protection measures; widespread use of information technology and telecom services; dematerialisation of securities, improvement in trading practices, evolution of an efficient and transparent regulatory framework, emergence of several innovative financial products and services and specialised financial institutions etc. The process of reforms has resulted in a boost to the growth of financial sector, which is perhaps unparalleled in the history of any country. Securities market has grown exponentially, as figures below would indicate.

The number of public limited companies listed on the stock exchanges in 1946 was 1125, which rose to 4344 in March 1986 and more than doubled to 9922 in March 2001. The market capitalisation was Rs.24,302 in March 1986, which rose to more than 31 times to Rs.7,68,863 crores in March 2001. The volume of business conducted in Indian Stock Exchange Rs.2,03,703 crores during the year 1993-94, which rose to more than 14 times to Rs.28,80,990 crores in the year 200-01.