What is SEBI?

Securities and Exchange Board of India = SEBI

It regulates both the primary and secondary markets. (explained in

my previous article)

It protects the interests of the investors in securities

It promotes the development of the securities market.

SEBI was established in 1988 but was given statutory powers in

1992, and started working effectively since 1993.

Why did the government create SEBI?

As you know that in India, the Government wont do any major reform or
action unless the things get messed up really bad. The same was the case
why SEBI was given the power to control both primary and secondary market
because they were in complete mess. So lets first see, what was the
problems in primary and secondary markets before SEBI came in picture.

The problems in Primary market before SEBI came

primary market was extremely restrictive regulations on the

issuers enforced by the Controller of Capital Issues (CCI)
Now lets assume I'm the big businessman.

Primary market is where i issue my security for the first time.

I can't fix the prices of my shares, as I like, because i've to follow

the rules made by CCI.

but that dude always underprice my issues.

When I put my equity shares for the first time in Primary market =
this is IPO (initial public offering)

but now as you know that I can't fix high prices for my IPO due to
CCI dude.

so my IPO is very cheap.

so lots of people will send application to buy it because its cheap

(= over subscription)

so i'll have to give the IPO shares via lottery only to a few people.

but those who get my cheap IPO via lottery will immediately go to
secondary market and sell it at higher price.

= I lost money (that I could have made if CCI dude allowed me to

sell my IPO @ higer price.)

and those lucky dudes who won the lottery made money without
really doing anything.

As you can see, all this is not good for industrial Development.

The problems in secondary market before SEBI came

Secondary market = where you trade the securities that you purchased from
primary market.
For general understanding- the stock markets = secondary market = where
you sell/buy shares.
So lets see the

problems of Stock markets before SEBI came

first organized stock exchange was established in 1875 in Bombay (now

Mumbai)

there were almost 20 regional stock exchanges in 1992,

but trading was concentrated in Bombay Stock Exchange and it

enjoyed a monopoly

Users from outside Bombay found it extremely difficult to trade in

BSE due to poor technology and high cost of telecommunications.
(they didnt have internet or cellphones with free incoming calls in
1992!)

BSE imposed a high entry barrier, so that competition among

brokers was absent.

Thats why services provided by the brokers were, thus, extremely

inefficient and costly. (its same like Indian railways stinking toilets- you
cant complain because railway dont have much competition.)

Specific problems in Share market before

1992 open outcry system

means trading used to take place in trading ring where nonbrokers were not allowed in.


These traders will shout the prices like we've in vegetable markets.

There wasn't any mechanism to verify the prices at which trading

actually took place.

So, brokers used to charge prices to the investors (buyers and

sellers of securities) that were usually different from the actual prices

=brokers used to report higher than actual prices for buy orders
and lower than actual prices for sell orders).

If investors (buyers or sellers) demanded a more accurate price,

orders often got cancelled (for example, the broker could simply claim
that such a favourable price was not obtained in the market).

The settlement system

payment of money and delivery of securities after trade by the

brokers to both parties (buyer and seller of shares)

it favored the brokers and was to the disadvantage of the

investors.

the settlement was futures-style and was on a fortnightly basis.

means that trading done during a fortnight would be settled at the

end of the fortnight.

system of badla =enabled the brokers to carry forward their

liability (of money or securities) to next settlement.

so, brokers could postpone settlement almost indefinitely, if the

prices were not favorable to them.

This led to a high degree of risks. Large-scale problems arising out

of failure to make payment or deliver shares, would lead to closure of
BSE for days together,

this used to recur at the rate of almost once every other year.

bad delivery of Shares

Even after you buy the shares and get the paper in your handsyou had to send the shares to the registrar of the company to register
the ownership of that share in your name.

At this stage, the problem of bad delivery arose due to a number

of problems

if the signature of the seller did not match with the one maintained
with the registrar, the shares were sent back.

Reasons for inaccurate signature

The seller of the shares, who probably purchased the shares years
back, might unwillingly sign in a different manner.

But in many cases, manipulations by unscrupulous operators were

responsible.


counterfeit shares (wherein any signature were put by the
counterfeiter),

Engineering bad deliveries by selling partys brokers or by the

companies themselves to delay settlement in order to support price
manipulation.

The time lag between buying shares and getting it registered in

the name of the buyer used to take anything between 1-3 months if
everything was alright.

The time lag normally went up to six months on an average in

case of bad delivery.
Anyways so above were the problems with primary + secondary market so
Govt. made a law to give powers to SEBI to control them both. And so CCI
was abolished.
NSE (National stock exchange) was established to end the monopoly of
Bombay Stock Exchange.

NSE (National stock exchange)

NSE was a new exchange promoted and owned by public sector

financial institutions (like IDBI, UTI, LIC, GIC, IFCI, etc.) and banks.

NSE is professionally-managed (as opposed to the other

exchanges that are managed by brokers or members still today)
You saw the problems of BSE ago, and to curb them,

NSE came with 4 innovations

Computerized trading

First, physical, floor-based, brokers-dominated trading outside the

eyes of the investors was replaced by anonymous, computerized order
matching system

where trading is done in front of the investors.


The order-matching system is characterized by strict price-time
priority,

wherein an order is executed according to the price parameters

set by the investors.

The OTCEI, which was set up in 1992, was the first computerised
exchange in India.

NSE started operations in 1994 with electronic trading, while all

other exchanges introduced electronic trading subsequently.

By March 31, 1999, all the 23 stock exchanges in the country had
computerised on-line screen based trading.

Satellite communication

to spread the reach of the exchange to all over the country was
attempted successfully, for the first time, by NSE.

This was in stark contrast to the other exchanges which till then
had the reach limited to their cities of operation for over a century.

Professional managers

the traditional exchanges were and still are managed by the

member brokers.

This gave rise to many malpractices, a conflict of interest being

the most important one. Since the brokers themselves were in charge
of enforcement of rules and regulations, they never took a decision in
favour of the investors that went against their interest.

This gave rise to a conflict of interest between the members as

brokers and members as responsible for enforcement of rules and
regulations.

NSE avoided this problem right from beginning because it was set
up as a limited liability company with brokers as franchisees.

This led to a situation where brokers were not held responsible for
enforcement of rules and regulations, and

those who were entrusted with enforcement (professional

managers) were not brokers.

As a result, NSEs staff is free of pressures from brokers and is

better able to perform regulatory and enforcement functions.

Weekly settlement

If you buy shares from me, youve to give me the money in 1

week and Ive to give you the shares in the same 1 week.

the traditional practice of fortnightly settlement cycle + system of

badla that allowed extension of even this fortnightly cycle was
replaced by a strict weekly settlement cycle without badla.

Result-BSE Is busted

Equity trading at NSE commenced in November 1994.

Within one year of operation, NSE surpassed the BSE in terms of

turnover.

BSE was working since 1875, with monopoly now it had to face
competition with N.S.E

So in March 1995, BSE also adopted similar innovation to keep up

in the race.

All this, lead to 5 good things Stock markets

Improved Transparency:
Investors can see with their own eyes the prices that are currently being
quoted in the market, and choose to trade or not.

Anonymity= no cartels

The electronic trading platform makes trading completely

anonymous.

Traditionally, lack of anonymity in trading in the floor-based

system

gave rise to cartels (of brokers) and made price manipulation easy.
NSE

was a break from this tradition as well and removed much of the
scope for

price manipulation.

More brokers = competition =good for clients

NSE throws open the business of stock broking to all and everyone
(subject to fulfillment of certain criteria).

In contrast, BSE restricted new entry into the brokerage business

until NSE came into picture.


Now More than a thousand brokers entered the market with the
NSE leading to steep increase in competition and the consequent fall in
the brokerages* by a very substantial amount.

This led to a drastic fall in transaction costs. (*the brokers

Commission)

No more bad delivery

Automation of the trading system eliminated all the problems associated
with manual trading (e.g., bad delivery/ signature etc.)

Investors outside Mumbai can earn money

Investors from all over the country have got access to an

exchange on same terms and conditions as investors within Mumbai
for the first time.

Earlier, Bombay stock exchange was the pre-dominant one in the

country,

but investors outside the city found it extremely difficult and costly
to do business in the exchange. (no cellphones with free incoming!)

Thus, true to its name, NSE turned out to be the first national stock
exchange.

This benefited the investors from outside Mumbai more than

perhaps the investors within the city.

National Securities Clearing Corporation

Limited (NSCCL)

Its a subsidiary of N.S.E, to prevent the counter party risk.

(established in August 1995)

counter-party risk means the risk that one of the two parties in a
transaction may fail to honour their commitment to pay cash [buyer] or
stock [seller] on the scheduled settlement date

For every trade (buy or sell) done on the NSE, NSCCL becomes the
counter-party.

means, the seller sells the securities to the NSCCL, and the buyer
buys from the

NSCCL.

Even if a brokerage firm fails to make payment (or deliver

securities), NSCCL makes the payment (or deliver securities).

This has almost eliminated counter-party risk and contained the

recurrence of payment crises that characterised Indian stock markets
for almost a century.

Demat account


You read above, how the bad delivery of shares was engineering by the
brokers.+ the menace of counterfeit shares. And the fear of theft of shares.

To curb this problem, SEBI came up with the novel idea that is
Dematerialization of share holding

This means, youve to get a Demat account in the bank and

when you buy shares, you dont get a piece of paper. That share
gets automatically credited to your demat account.

In November 1996, the National Securities Depository Ltd. (NSDL),

the first depository in India, was established For this purpose.

SEBI played an active role in gradual shifting from physical

certificates to dematerialised holding by introducing a mandatory
element in the process.

Currently almost cent percent trading and settlement are done in a

dematerialised environment.

But things are not that safe and sweet, thanks to IPO scam-Demat
Queen Roopal Panchal