Project on Indian Financial Market Structure
[Source: RBI Report on Currency and Finance 1999-2000 dated January 29, 2001]

Capital Market Structure (Contd)
Structure of Informational Flows

Market microstructure is concerned with information and disclosures. There is a broad agreement that transparency affects the information and price discovery. A company offering securities in the Indian capital market is required to make a public disclosure of all relevant information through its offer documents, as indicated earlier. After a security is issued to the public and subsequently listed on a stock exchange, the stock exchange requires the issuing company to make continuing disclosures under the listing agreement. In India, all listed companies are now required to furnish to the stock exchanges and also publish mandated unaudited financial results on a quarterly basis. India is one of the few countries in the world to have a system of quarterly disclosures and it has served a useful purpose in that price-sensitive information on earnings and revenues is now available at greater frequency. The publication of half-yearly corporate results on the basis of limited review by its auditors has also been made mandatory for listed companies. The disclosures of material information, which would have a bearing on the performance/operations of the company, are now required to be made available to the public immediately. Recently, a decision has been taken that the companies would be required to make decisions regarding dividend, bonus and rights announcements or any material event within 15 minutes of the conclusion of the board meeting where the decisions are taken. Following the international practices, companies in India are also required to provide shareholders with cash flow statements in the prescribed format along with the complete balance-sheet and profit and loss statement. Companies are also required to furnish to the stock exchanges on a quarterly basis, a statement on the actual utilisation of funds and actual profitability, as against projected utilisation of funds and projected profitability. As part of better corporate governance practices, disclosures about segment reporting, related party transactions and consolidated balance sheet are also expected to be introduced.

The SEBI has been mandated under its Act to prohibit insider trading in securities. In 1992, the SEBI formulated the Insider Trading Regulations prohibiting insider trading and made it a criminal offence punishable in accordance with the provisions under the SEBI Act, 1992. The Regulations define an insider as a person who has access to price-sensitive non-public information with regard to a company. Such a person is prohibited from trading in the securities of such a company under the regulations. The violation of the regulations can result in prosecution of the person guilty of such violation. During 1999-2000, of the 56 cases investigated by SEBI, 47 related to price rigging and manipulation. There are now separate regulations in place governing substantial acquisition of shares and takeovers of companies. The regulations are aimed at making the takeover process more transparent and to protect the interests of minority shareholders.

In India, different stock exchanges have so far followed their own practices relating to settlement procedures creating segmentation of the market. While stock exchanges continue to follow different systems, certain developments have resulted in better integration of the various segments of the Indian securities market. The two major stock exchanges, viz., BSE and NSE, have expanded their operations in different locations, thus, providing investors across the country with the facility to trade in the stocks listed/permitted in these stock exchanges. The Inter-connected Stock Exchange of India Ltd. (ICSI) has been set up as an inter-connected market system and provides its trading members a facility to trade on the national market in addition to the trading facility at the regional stock exchanges. This has integrated the various regional stock exchanges, although the trading activity in the ICSI has not been very significant. Many regional stock exchanges have also become members of BSE and NSE, which further strengthened the integration process of various stock exchanges in the country. Equity market is also increasingly integrating with the Government securities and private corporate sector debt market. The interest rate structure of Government securities and securities issued by the corporate entities is better aligned at present than in the past.

The changing structure of capital market has had some positive impact on the volatility, liquidity and transaction cost.

Volatility plays a key role in assessing the risk/return trade-offs and forms an important input in asset allocation decisions. It is widely accepted that large fluctuations in market returns carry important negative effects on risk-averse investors. Besides, they have important economic implications, especially for the overall domestic investment, and for the flow of funds from abroad. Volatility is caused by a number of factors ranging from technical or short-term to fundamentals. These, inter alia, include trading practices like the length of the settlement period, the facility for carry-forward of transaction, announcements of corporate results, measures announced in the Government budgets, industrial production, the overall economic condition including the policy stance, and the extent of openness of the economy. Several macroeconomic variables like inflation, money supply, interest rates, etc. also affect the movements in share prices directly or indirectly. The market microstructure too wields influence on volatility.

An analysis of the volatility of the Indian stock markets as measured in terms of co-efficient of variation (CV) in the BSE Sensex suggests that although stock markets continue to be highly volatile, the volatility has tended to decline in the recent years. Co-efficient of variation at 25.93 per cent during the period from April 1991 to March 2000 was lower as compared with 33.43 per cent during the 6-year period from April 1985 to March 1991. The CV declined further to 17.51 per cent during the period from April 1995 to March 2000. Volatility in recent years has been affected by the trends in the NASDAQ market.