MANAGEMENT OF FINANCIAL SERVICES

LESSON 38: STOCK BROKING: AN INTRODUCTION AND SEBI GUIDELINES

Lesson Objectives

To understand the stock broking activity, SEBI regulations related to stock broking activity.

Introduction
In India, stock exchanges were almost self regulatory till 1988, supervised by Ministry of Finance under the Securities Contracts Regulation Act (SCRA). However, the stock exchanges were not discharging their self-regulatory role as well as a result of which malpractices crept into trading, adversely affecting investors interests. SEBI has been setup to ensure that the stock exchanges discharge their self-regulatory role properly. Ever since SEBI began to monitor brokers, stock broking is emerging as a professional advisory service, in tune with the requirements of a mature, sophisticated, screen based, ring-less, automated stock exchanges in the country in sharp contrast to traditional, closed character as inherited family business. So we will discuss, the Indian Stock Broking system here. The stock broking activity consists of various intermediaries. Let us discuss them one by one.

Additional capital related to Volume of Business : The additional or optional capital required from a member should, at any point of time, be such that together with the base minimum capital it is not less than 8% of the gross outstanding business in the exchange defined as the aggregate of up-to-date sales and purchases by a member broker in all the securities put together. Duty to the Investor : The duties of a broker to the investor are i. He should be faithful to the clients in his dealings with them and execute orders as per the instructions.

ii. He should issue to his clients a contract note without any delay for all transactions in the form specified by the SE. iii. To avoid breach of trust, he should not disclose or discuss with any other person details of investment and transaction of clients. iv. He should not mislead clients merely to generate business. v. He should avoid dealing with a client who is a defaulter in his dealings with other brokers. vi. When dealing with a client, he is required to disclose whether he is acting as a principal or as an agent. vii. He should not give investment advice to any client unless sought by him. viii. A stockbroker should have adequately trained staff and arrangements to render fair, prompt and competent services to his clients. ix. He should extend full cooperation to other brokers in protecting the interest of his clients regarding their rights to dividends, bonus shares, rights issues and any other rights related to such securities.

Stock Brokers
Stockbroker is a member of a recognized stock exchange who buys, sells or deals in securities. To work as a stockbroker registration with SEBI is mandatory. SEBI is empowered to impose conditions while granting the certificate of registration. Registration : A broker seeking registration with SEBI, has to apply through the stock exchange of which he is member. For registering SEBI checks - eligibility of the applicant to become the member of stock exchange, has the necessary infrastructure to effectively discharge his duties, past experience etc. Every registered stockbroker is required to pay annual fee @ Rs. 5,000 for turn over up to Rs. 1 crore and 0.01% of turnover exceeding Rs. 1 crore. For calculating turnover underwriting and collection of deposits are not taken into account for the purpose of calculating the turnover. The authenticity of the annual turnover is to be certified by the stock exchange concerned. Capital adequacy norms for brokers : An absolute minimum of Rs. 5 lakh as a deposit with the exchange is to be maintained by the members of the BSE & CSE and Rs. 3.5 lakh for DSE and ASE irrespective of volume of business. In case of other SE the minimum requirement is Rs. 2 lakhs. The security deposit kept by the members in the SE forms part of the base minimum capital; 25% of the base minimum capital is to be maintained in case with the exchange. Another 25% remains in the form of a long term fixed deposit with a bank on which the SE is given free lien. The remaining requirement is being maintained in the form of securities with a 30% margin. The securities should be in the name of the member and are pledged in favor of SE.

Sub Brokers
A sub-broker acts on behalf of a stockbroker as an agent or otherwise for assisting investors in buying, selling or dealing in securities through such brokers but he is not a member of a stock exchange. To act as a sub-broker, registration with SEBI is required. It grants a certificate of registration to a sub-broker subject to the conditions that (a) he has to pay the prescribed fee, (b) he takes adequate steps for redressal of investor grievances within one month of the receipt of the complaint and keeps SEBI informed about the number, nature and other particulars of the complaints (c) he is authorized in writing by a broker for affiliation in buying, selling or dealing in securities. Registration of Sub-brokers : According to SEBI regulations currently in force, a sub-broker is required to submit along with the application (a) recommendation from a stockbroker with whom he will be affiliated and (b) two references, including one from his banker. The individual applicant should not be less than 21 years of age, has not been convicted in any offence

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involving fraud or dishonesty and has passed the equivalent of at least 12th standard from a recognized institution. The annual fee payable by a sub-broker is Rs. 1000 for an initial period of five years. After the expiry of five years, an annual fee of Rs. 500 is payable as long as the certificate remains in force. Duty to the investors : A sub-broker, in his dealings with the clients and the general investing public, should faithfully execute the orders for buying and selling of securities at the best available market price and promptly inform his clients about the execution of an order and make payment in respect of securities sold and arrange for prompt delivery of securities purchased. He should issue promptly to his clients (a) purchase or sale notes for all the transactions entered into by him with his clients, or through the principal broker (b) scrip-wise details. He should not furnish misleading information to his clients to generate business. He should not recommend his clients any scrip / security unless the client has asked for the advice.

Stock Market Trading

We will discuss the stock trading activity with reference to National Stock Exchange Ltd, in short NSE. Before setting up NSE, Indian stock exchanges were operating only in cities in which they were setup. The NSE represented an attempt to overcome the fragmentation of regional markets by providing screen-based system, which transcends geographical barriers. The main objective has been to set up comprehensive facilities for the entire range of securities under a single umbrella. We can describe the main objective as 1. To set up a nationwide trading facility for equities, debt instruments and hybrids. 2. To ensure equal access to investors across the country through an appropriate communication network. 3. To provide a fair, efficient and transparent securities market to investors using the electronic trading system. 4. To ensure shorter settlement cycle and book entry settlement system and 5. To meet the current international standards prevalent in the securities markets. The NSE has two segments for trading in securities: Wholesale Debt Market (WDM) and Capital Market (CM) segments. Separate membership is required for the two segments. Wholesale Debt Market (WDM) Segment : The WDM segment provides a facility for institutions/ body corporate (institutional investors) to enter into high value transactions in instruments such as government securities, T-bills, public sector undertaking bonds, units of mutual funds, certificates of deposits, commercial papers etc. Only trading members can transact in WDM segment. Trading Members : Recognized members of NSE are called trading members. Only body corporate, bank subsidiaries and financial institutions can become Trading members. They must possess a minimum net worth of Rs. 2 crore. The annual fee is Rs. 30 Lakh and a TM cannot withdraw his membership before five years. The applicant must be engaged solely in securities business and not in any fund based activity. The minimum paid up capital should be Rs. 30 lakh. TM can either trade on their own or on behalf of their clients, including participants. Participants : Are the organizations directly responsible for settlement of trade. They are large players in the markets and as such take direct settlement responsibility of their own trades executed through TMs. The participants have access to the NSE trading system to enable to see the breadth and dept of the market through enquiry screens. They are able to monitor all market movements. Capital Market (CM) Segment : It covers trading in equities and retail trade in debt instruments like non-convertible debentures and hybrid instruments. Individuals, registered firms, corporate bodies and institutional members are eligible to become trading members in this segment. The minimum networth requirements for members is (a) individuals and registered firms Rs. 75 lakhs and (b) Corporate bodies Rs. 100 lakh. Trading System : There are separate trading systems for both WDM and CM segments. Let us discuss the two in detail.

MANAGEMENT OF FINANCIAL SERVICES

Foreign Brokers
Foreign institutional investors (FIIs) now play a significant role in the stock markets. With a view to helping the FIIs to follow the procedures and encourage them to invest in India, SEBI has issued a different set of guidelines: Registration with SEBI : It is mandatory for a foreign broker to get registered with SEBI in order to do business in India. While applying for registration, a foreign broker has to disclose to SEBI name(s) and registration number(s) of the stock exchanges where he is registered in the capacity of a broker dealer together with an undertaking that he would operate and assist only on behalf of the registered FIIs and would not deal in securities on his own account as principal in India. On advice from SEBI, the RBI would accord approval to him to open (a) a foreign currency denominated bank account and a rupee account with a designated bank branch and (b) multiple custodian accounts with the approved custodian of all registered FIIs whom he may be assisting or on whose behalf he would be placing orders with a member of Indian stock exchanges. Transaction in Accounts : The foreign currency denominated accounts of registered foreign brokers would be credited with inward remittance brought in by him and inward remittance to make initial payment against the purchase contracts on behalf of registered FIIs. The rupee account will be credited with the commissions / brokerages earned by him in India. Initial payment on account of purchase contract on behalf of registered FIIs would be made through Rupee account. Reimbursement of this initial payment would be made by the designated bank/custodian of the registered FII. The brokers are allowed to freely repatriate commission/ brokerage earned in India after transferring them to the foreign currency denominated account subject to payment of taxes on the basis of conversion of rupees to foreign currency at the prevailing market rates. After discussing the intermediaries in the stock market, now let us discuss the system of stock market trading in India.

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Capital Market Segment : The NSE market is fully automated screen-based trading system which adopts the principle of an order driven market. It provides complete flexibility to members in the kinds of orders that can be placed by them. Orders, as and when they are received, are first time stamped and then immediately processed for potential match. Order matching rules of NSE System : The best buy order match with the best sell order. Members can proactively enter orders in the system which is displayed in the system till another party expresses interest in that order and puts a counter order, alternatively, members may be reactive and put in orders that match with existing orders on the system. Order types and conditions : The trading members can enter various types of orders depending upon his/her requirements. These conditions are broadly of three categories: time-related, price-related and volume-related conditions. Wholesale Debt Market Segment : The full computerized, online trading system has changed the very manner in which trading is perceived in the Indian Stock Market. Besides the fact, that the system has increased trading velocities and cut timeframes. The trading system provides tremendous flexibility to the users in terms of the type of orders that can be placed on the system. Detailed information on the total order depth in a security, the best buys and sells available in the market, the quantity traded in that security, the high, the low and last traded price is available through the various market screens at all point of time.

objective behind the IL segment is to initiate an institutional market where large volume trades take place in institutional board lots. Likewise, TT is meant to cater to institutions who prefer trade for trade settlement as a means of minimizing exposure risks. Settlement Features of WDM Segment : The primary responsibility of settling trades concluded in the WDM segment rests directly with the participants and the exchange monitors the settlements. These trades are settled in Mumbai as per the defined procedure. NSE closely monitors the settlement of transactions through the reporting of settlement details by members and participants. In case of deferment of settlement or cancellation of trade, participants are required to seek its prior approval. For any dispute arising in respect of the trades or settlement, the NSE has established arbitration mechanism for resolving the same.

MANAGEMENT OF FINANCIAL SERVICES

Clearing and Settlement System of NSE

Trading has grown rapidly at NSE, due to short and tight settlement cycles which the NSE operates as per a well defined schedule so that investors are assured of settlement. Settlement Features of Capital Market Segment : The cycles are short and announced well in advance by the NSE. All scrip are handled by the Clearing House. The gap between fund payin and pay-out is only one day. The NSE takes responsibility for rectifying short or bad deliveries and objections by initiating auction buy-in. It assures legal guarantee of transactions and settlement of the NSE. NSE operates on account period for a periodic settlement cycle. Trading period starts on Wednesday and ends on Tuesday of the next week. All trades concluded during a particular period are settled during the next week. At the end of a trading period of the NSE, it multilaterally net obligations and generates delivery statements for members. Securities are paid in on the Monday following the trading period. Funds are paid in on Tuesday. The payout day for both funds and securities is Wednesday. Thus, settlement is completed in eight days from the end of the last day of the trading cycle. The clearing system is automated. Settlement is on a physical basis requiring the delivery and receipt of documents. The NSE has set up a clearing house, namely, National Securities Clearing Corporation Ltd. (NSCCL) for managing settlement of securities. Institutional Market Segment : Two additional market segments have also been set up exclusively for institutions Institutional Lot (IL) and Trade for Trade (TT) segment. The
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