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DEFINITION Equity market, or stock market, is a system through which company shares are traded. Equity market is a public market for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The equity market offers investors an opportunity to participate in a company's success through an increase in its stock price. An equity market is a public market for the trading of company equity stock and derivatives at an agreed price. The equity market which comprises of primary market as well as secondary market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate. The worldwide equity market grew rapidly in the late 20th century, rising from $1 trillion in market capitalization in 1974 to $16 trillion in 1997. The worldwide equity market benefited from freer markets, government privatizations, and companies seeking an alternative to debt.
Indian Equity Market
The Indian Equity Market is more popularly known as the Indian Stock Market. The Indian equity market has become the third biggest after China and Hong Kong in the Asian region. According to the latest report by ADB, it has a market capitalization of nearly $600 billion. As of March 2009, the market capitalization was around $598.3 billion (Rs 30.13 lakhs crore) which is one-tenth of the combined valuation of the Asia region. The market was slow since early 2007 and continued till the first quarter of 2009. A stock exchange has been defined by the Securities Contract (Regulation) Act, 1956 as an organization, association or body of individuals established for regulating, and controlling of securities. The Indian equity market depends on three factors y y y
Funding into equity from all over the world Corporate houses performance Monsoons
The stock market in India does business with two types of fund namely private equity fund and venture capital fund. It also deals in transactions which are based on the two major indices - Bombay Stock Exchange (BSE) and National Stock Exchange of India Ltd (NSE). The equity market is also affected through trade integration policy. The country has advanced both in foreign institutional investment (FII) and trade integration since 1995. This is a very attractive field for making profit for
medium and long term investors, short-term swing and position traders and very intraday traders. The Indian market has 22 stock exchanges. The larger companies are enlisted with BSE and NSE. The smaller and medium companies are listed with OTCEI (Over The counter Exchange of India). The functions of the Equity Market in India are supervised by SEBI (Securities Exchange Board of India). HISTORY The history of the Indian equity market goes back to the 18th century when securities of the East India Company were traded. Till the end of the 19th century, the trading of securities was unorganized and the main trading centers were Calcutta (now Kolkata) and Bombay (now Mumbai). The Indian Equity Market was not well organized or developed before independence. After independence, new issues were supervised. The timing, floatation costs, pricing, interest rates were strictly controlled by the Controller of Capital Issue (CII). For four and half decades, companies were demoralized and not motivated from going public due to the rigid rules of the Government. In the 1950s, there was uncontrollable speculation and the market was known as 'Satta Bazaar'. Speculators aimed at companies like Tata Steel, Kohinoor Mills, Century Textiles, Bombay Dyeing and National Rayon. The Securities Contracts (Regulation) Act, 1956 was enacted by the Government of India. Financial institutions and state financial corporation were developed through an established network. In the 60s, the market was bearish due to massive wars and drought. Forward trading transactions and 'Contracts for Clearing' or 'badla' were
banned by the Government. With financial institutions such as LIC, GIC, some revival in the markets could be seen. Then in 1964, UTI, the first mutual fund of India was formed. In the 70's, the trading of 'badla' resumed in a different form of 'hand delivery contract'. But the Government of India passed the Dividend Restriction Ordinance on 6th July, 1974. According to the ordinance, the dividend was fixed to 12% of Face Value or 1/3 rd of the profit under Section 369 of The Companies Act, 1956 whichever is lower. This resulted in a drop by 20% in market capitalization at BSE (Bombay Stock Exchange) overnight. The stock market was closed for nearly a fortnight. Numerous multinational companies were pulled out of India as they had to dissolve their majority stocks in India ventures for the Indian public under FERA, 1973. The 80's saw a growth in the Indian Equity Market. With liberalized policies of the government, it became lucrative for investors. The market saw an increase of stock exchanges, there was a surge in market capitalization rate and the paid up capital of the listed companies. The 90s was the most crucial in the stock market's history. Indians became aware of 'liberalization' and 'globalization'. In May 1992, the Capital Issues (Control) Act, 1947 was abolished. SEBI which was the Indian Capital Market's regulator was given the power and overlook new trading policies, entry of private sector mutual funds and private sector banks, free prices, new stock exchanges, foreign institutional investors, and market boom and bust. In 1990, there was a major capital market scam where bankers and brokers were involved. With this, many investors left the market. Later there was a securities scam in 1991-92 which revealed the inefficiencies and inadequacies of the Indian
financial system and called for reforms in the Indian Equity Market. Two new stock exchanges, NSE (National Stock Exchange of India) established in 1994 and OTCEI (Over the Counter Exchange of India) established in 1992 gave BSE a nationwide competition. In 1995-96, an amendment was made to the Securities Contracts (Regulation) Act, 1956 for introducing options trading. In April 1995, the National Securities Clearing Corporation (NSCC) and in November 1996, the National Securities Depository Limited (NSDL) were set up for demutualised trading, clearing and settlement. Information Technology scripts were the major players in the late 90s with companies like Wipro, Satyam, and Infosys. In the 21st century, there was the Ketan Parekh Scam. From 1st July 2001, 'Badla' was discontinued and there was introduction of rolling settlement in all scripts. In February 2000, permission was given for internet trading and from June, 2000, futures trading started.
CURRENT MARKET SCENARIO
Introduction Primary market is the market for First Time Issuance of shares and they being listed on the major stock exchange. The company raises funds for their development and expansion activities through Debt or Equity. Primary Market also called the new issue market. It is the market for issuing new securities. Many companies, especially small and medium scale, enter the primary market to raise money from the public to expand their businesses. They sell their securities to the public through an initial public offering. In the primary market securities are issued on an exchange basis. The underwriters, that is, the investment banks, play an important role in this market: they set the initial price range for a particular share and then supervise the selling of that share.
Features of primary markets are:
This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).
In a primary issue, the securities are issued by the company directly to investors.
The company receives the money and issues new security certificates to the investors.
Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.
The primary market performs the crucial function of facilitating capital formation in the economy.
The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as "going public."
The financial assets sold can only be redeemed by the original holder.
Methods of issuing securities in the primary market are:
y y y
Initial public offering; Rights issue (for existing companies) Preferential issue.
When private limited company was tapping the capital market for either expansion or developmental reason then this company must be listed on any one of the stock exchange.
Kinds of issues
The different kinds of issues which can be made by an Indian company in India: a) Public Issue i. ii. Initial Public Offer Further Public Offer
b) Right Issue c) Bonus Issue d) Private Placement
a) Public Issue 1) Initial Public Offer when a company offers to sell its shares to the public for the very first time it is referred to as an Initial Public Offering (IPO). The shares now available for trading on the stock exchange where it is listed. Reasons for IPO 1. Need for funds 2. Disinvestments of public sector units 3. Banks to enhance their capital adequacy
4. Expansion or diversification 5. Finance specific projects for a specific objective BENEFITS OF GOING PUBLIC: The potential advantages that seem to prod companies to go public are as follows: 1) Access to Capital ± The principal motivation for going public is to have access to larger capital. A company that does not tap the public financial market may find it difficult to grow beyond a certain point for want of capital. 2) Respectability ± Many entrepreneurs believe that they have ³arrived´ in some sense if their company goes public because a public company may command greater respectability. Competent and ambitious executives would like to work for growth. Other things being equal, public companies offer greater growth potential compared to nonpublic companies. Hence, they can attract superior talent. 3) Window of Opportunity ± As suggested by Jay Ritter and others that there are periods in which stocks are overpriced. Hence, when a nonpublic company recognizes that other companies in its industry are overpriced, it has an incentive to go public and exploit that opportunity. 4) Benefit of Diversification ± When a firm goes public those who have investment in it ± original owners, investors, managers, and others ± can cash out of the firm and build a diversified portfolio. 5) Signals from the Market ± Stock prices represent useful information
to the managers. Every day, investors render judgments about the prospects of the firms. Although the market may not be perfect, it provides a useful reality check. 6) Complements Product Marketing: Going public attracts media attention. Newspapers and magazines are most likely to focus on public companies on which information is readily available. This publicity can be harnessed and used towards marketing the product of the company. 7) Competitive position: Many companies use their increased availability of capital as a public company to enhance their competitive position. Additional capital available to a public company permits greater market penetration. 8) Expands Business Relationship: Once a company is public company, information on that company is readily available. Prospective suppliers, distributors and partners could easily garner information and forge a relationship with such company. 9) Ability to take advantage of market price fluctuations: Once public, a company can take advantage of market price fluctuations to sell stock when the markets are hot, buy back the stock when the market is cold. This can often be an effective and low cost way to raise significant capital.
FLOW CHART OF IPO PROCESS The issue of securities to members of the public through a prospectus involves a fairly elaborate process, the principal steps of which are briefly described below: Approval of Board An approval of the board of directors of the company is required for raising capital from the public.
Appointment of Lead Managers The lead manager is a merchant banker who orchestrates the issue in consultation with the company. The lead manager must be selected carefully.
Appointment of Other Intermediaries Several intermediaries facilitate the public issue process. A cop-manager is appointed to share the work of the lead manager and an advisor to provide counsel. An underwriter is appointed who agrees to subscribe to a given number of shares in the event the public does not subscribe to them. The underwriter, in essence, stands guarantee for public subscription in consideration for the underwriting commission. Bankers
are appointed to collect money on behalf of the company from the applicants. Brokers are appointed to the issue to facilitate its subscription. Only members of recognized Stock Exchanges can be appointed as brokers. The number of brokers appointed has to bear a reasonable relationship to the size of the issue. A company may, if such a need is felt, appoint a principal broker to coordinate the work of brokers. Registrars are appointed to the issue to perform a series of tasks from the time the subscription is closed to the time the allotment is made. They may be selected on the basis of experience, expertise, credibility, and cost.
Filing of the Prospectus with SEBI The prospectus or the offer document communicates information about the company and the proposed security issue to the investing public. All companies seeking to make a public issue have to file their offer document with SEBI. If SEBI or the public does not communicate its observations within 21 days from the filing of the offer document, the company can proceed with its public issue. The prospectus and application form (along with Articles and Memorandum of Association) must be forwarded to the concerned stock exchange, where the issue is proposed to be listed, for approval.
Filing of the Prospectus with the Registrar of Companies Once the prospectus is approved by the concerned stock exchange and
consents obtained from the bankers, auditors, legal advisors, registrars, underwriters, and others, the prospectus, signed by the directors, must be filed with the Registrar of Companies, along with requisite documents as required by the Companies Act, 1956.
Filing of Initial Listing Application Within ten days of filing the prospectus, the initial listing application must be made to the concerned stock exchanges, along with the initial listing fees.
Promotion of the Issue The promotional campaign typically commences with the filing of the prospectus with the Registrar of Companies and ends with the release of the statutory announcement of the issue. To promote the issue the company holds conferences for brokers, press and investors.
Advertisements are also released in newspapers and periodicals to generate interest among potential investors.
Statutory Announcement The statutory announcement of the issue must be made after seeking the approval of the lead stock exchange. This must be published at least ten days before the opening of the subscription list.
Collection of Applications The statutory announcement (as well as the prospectus) specifies when the subscription would open, when it would close, and the banks where the applications can be made. During the period the subscription is kept open, the bankers to the issue collect application money on behalf of the company and the managers to the issue, with the help of the registrars to the issue, monitor the situation. Information is gathered about the number of applications received in various categories, the number of shares applied for, and the amount received.
Processing of Applications The applications forms received by the bankers are transmitted to the registrars of the issue for processing. This mainly involves scrutinizing the applications, coding the applications, preparing a list of applications with all relevant details.
Establishing the Liability of Underwriters If the issue is under subscribed, the liability of the underwriters has to be established.
Allotment of Shares
According to SEBI guidelines, one-half of the net public offers have to be reserved for applications up to 1000 shares and the balance one-half for larger applications. For each of these segments, the ³proportionate´ system of allotment is to be followed.
Listing of the Issue The detailed listing application should be submitted to the concerned stock exchanges along with the listing agreement and the listing fee. The allotment formalities should be completed within 30 days after the subscription list is closed or such extended period as permitted by the lead stock exchange.
BOOK BUILDING The principal parties involved in the Book Building Process are: (1) The Company (2) The Selling Shareholder (3) The Book Running Lead Managers (BRLMs) (4) The Syndicate Members, who are intermediaries registered with SEBI and eligible to act as underwriters, appointed by the BRLMs. (5) The Registrar to the office.
THE BOOK BUILDING PROCESS y The Issuer who is planning an IPO nominates a lead merchant banker as a µbook runner¶. y The Issuer specifies the number of securities to be issued and the price band for orders. y The Issuer also appoints syndicate members with whom orders can be placed by the investors. y Investors place their order with syndicate members who input the orders into the µelectronic book¶. This process is called µbidding¶ and is similar to open auction. y A Book should remain open for a minimum period of at least three working days and not more than seven working days which may be extended to a maximum of ten working days in case the price band is revised. y Bids cannot be entered at less than the floor price y Bids can be revised by the bidder before the issue closes. y On the close of the book building period the µbook runner evaluates the bids on the basis of the evaluation criteria which may include. o Price Aggression o Investor quality o Earliness of bids, etc. y The book runner and the company conclude the final price at which they are willing to issue and allocate of securities.
y Generally, the issue size gets frozen based on the price per shares discovered through the book building process. y Allocation of securities is made to the successful bidders.
2) Further public offer When already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, it is called FPO.
b) Right Issue
A rights issue is a way in which a company can sell new shares in order to raise capital. Shares are offered to existing shareholders in proportion to their current shareholding, respecting their pre-emption rights. The price at which the shares are offered is usually at a discount to the current share price, which gives investors an incentive to buy the new shares ² if they do not, the value of their holding is diluted. A rights issue to fund expansion can usually be regarded somewhat more optimistically, although, as with acquisitions, shareholders should be suspicious because management may be empire-building at their expense (the usual agency problem with expansion). The rights are normally a tradable security themselves (a type of short dated warrant). This allows shareholders who do not wish to purchase new shares to sell the rights to someone who does. Whoever holds a right can choose to buy a new share (exercise the right) by a certain date at a set price. Some shareholders may choose to buy all the rights they are offered in the rights issue. This maintains their proportionate ownership in the expanded company, so that an x% stake before the rights issue remains an x% stake
after it. Others may choose to sell their rights, diluting their stake and reducing the value of their holding. If rights are not taken up the company may (and in practice does) sell them on behalf of the rights holder. c) Bonus Shares The term bonus means an extra dividend paid to shareholders in a joint stock company from surplus profits. When a company has accumulated a large fund out of profits - much beyond its needs, the directors may decide to distribute a part of it amongst the shareholders in the form of bonus. Bonus can be paid either in cash or in the form of shares. Cash bonus is paid by the company when it has large accumulated profits as well as cash to pay dividend. Many a time, a company is not in a position to pay bonus in cash in spite of sufficient profits because of unsatisfactory cash position or because of its adverse effects on the working capital of the company. In such a position, the company pays a bonus to its shareholders in the form of shares; a free share thus issued is known as a bonus share. A bonus share is a free share of stock given to current/existing shareholders in a company, based upon the number of shares that the shareholder already owns at the time of announcement of the bonus. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant.
Whenever a company announces a bonus issue, it also announces a "Book Closure Date" which is a date on which the company will ideally temporarily close its books for fresh transfers of stock. Read "Book Closure" for a better understanding. An issue of bonus shares is referred to as a bonus issue. Depending upon the constitutional documents of the company, only certain classes of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to other classes. bonus share is free share in fixed ratio to the shareholders. for exp..reliance ind. ltd. issue bonus share in 1:1 ratio and Rs.13.00 as dividend/share Sometimes a company will change the number of shares in issue by capitalising its reserve. In other words, it can convert the right of the shareholders because each individual will hold the same proportion of the outstanding shares as before. Main reason for issuance is the price of the existing share has become unwieldy. Purpose: Usually bonus shares are issued with the intent of rewarding the investor, although having said that the ex-bonus (post bonus) price of the share is adjusted to bonus ratio. So for e.g, if the price of a share before bonus is Rs.100 and a bonus of 1:1 is issued, then ex-bonus share price would adjust to Rs. 50, which means that the total market value will remain the same. There is generally a case where the price of the share increases after bonus effect is incorporated.
Ratios' Impact: The main financial effect of bonus share is that it increases the number of shares outstanding and reduces the earnings per share (EPS). Basic EPS = (Net Profit after tax / no. of equity shares outstanding). d) Private placement Private placement occurs when a company makes an offering of securities not to the public, but directly to an individual or a small group of investors. Such offerings do not need to be registered with the Securities and Exchange Commission (SEC) and are exempt from the usual reporting requirements. Private placements are generally considered a cost-effective way for small businesses to raise capital without "going public" through an initial public offering (IPO). "Although most business owners dream of taking their company public someday, many have had to wait years for a traditional public offering," Gary D. Zeune and Timothy R. Baer explained in an article for Corporate Cashflow Magazine. "For them, a private placement of equity or debt has been a quicker, less expensive way to raise a limited amount of capital from a limited number of investors. A private placement has been appropriate when a company still lacks the financial strength or reputation to appeal to a broad base of investors and cannot afford the expense of a public offering."
Advantages and Disadvantages
Private placements offer small businesses a number of advantages over IPOs. Since private placements do not require the assistance of brokers or underwriters, they are considerably less expensive and time consuming. In addition, private placements may be the only source of capital available to risky ventures or start-up firms. "With loan criteria for commercial bankers and investment criteria for venture capitalists both tightening, the private placement offering remains one of the most viable alternatives for capital formation available to companies," Andrew J. Sherman wrote in his book The Complete Guide to Running and Growing Your Business. A private placement may also enable a small business owner to hand-pick investors with compatible goals and interests. Since the investors are likely to be sophisticated business people, it may be possible for the company to structure more complex and confidential transactions. If the investors are themselves entrepreneurs, they may be able to offer valuable assistance to the company's management. Finally, unlike public stock offerings, private placements enable small businesses to maintain their private status. Of course, there are also a few disadvantages associated with private placements of securities. Suitable investors may be difficult to locate, for example, and may have limited funds to invest. In addition, privately placed securities are often sold at a deep discount below their market value. Companies that undertake a private placement may also have to relinquish more equity, because investors want compensation for taking a greater risk
and assuming an illiquid position. Finally, it can be difficult to arrange private placement offerings in multiple states. Restrictions Affecting Private Placement The SEC formerly placed many restrictions on private placement transactions. For example, such offerings could only be made to a limited number of investors, and the company was required to establish strict criteria for each investor to meet. Furthermore, the SEC required private placement of securities to be made only to "sophisticated" investors²those capable of evaluating the merits and understanding the risks associated with the investment. Finally, stock sold through private offerings could not be advertised to the public and could only be resold under certain circumstances. In 1992, however, the SEC eliminated many of these restrictions in order to make it easier for small companies to raise capital through private placements of securities. The rules now allow companies to promote their private placement offerings more broadly and to sell the stock to a greater number of buyers. It is also easier for investors to resell such securities. Although the SEC restrictions on private placements were relaxed, it is nonetheless important for small business owners to understand the various federal and state laws affecting such transactions and to take the appropriate procedural steps. It may be helpful to assemble a team of qualified legal and accounting professionals before attempting to undertake a private placement. Many of the rules affecting private placements are covered under Section 4(2) of the federal securities law. This section provides an exemption for
companies wishing to sell up to $5million in securities to a small number of accredited investors. Companies conducting an offering under Section 4(2) cannot solicit investors publicly, and the majority of investors are expected to be either insiders (company management) or sophisticated outsiders with a preexisting relationship with the company (professionals, suppliers, customers, etc.). At a minimum, the companies are expected to provide potential investors with recent financial statements, a list of risk factors associated with the investment, and an invitation to inspect their facilities. In most respects, the preparation and disclosure requirements for offerings under Section 4(2) are similar to Regulation D filings. Regulation D²which was adopted in 1982 and has been revised several times since²consists of a set of rules numbered 501 through 508. Rules 504, 505, and 506 describe three different types of exempt offerings and set forth guidelines covering the amount of stock that can be sold and the number and type of investors that are allowed under each one. Rule 504 covers the Small Corporate Offering Registration, or SCOR. SCOR gives an exemption to private companies that raise no more than $1 million in any 12-month period through the sale of stock. There are no restrictions on the number or types of investors, and the stock may be freely traded. The SCOR process is easy enough for a small business owner to complete with the assistance of a knowledgeable accountant and attorney. It is available in all states except Delaware, Florida, Hawaii, and Nebraska. Rule 505 enables a small business to sell up to $5 million in stock during a 12-month period to an unlimited number of investors, provided that no more than 35of them are non-accredited. To be accredited, an investor must have sufficient assets or income to make such an investment. According to the
SEC rules, individual investors must have either $1 million in assets (other than their home and car) or $200,000 in net annual personal income, while institutions must hold $5million in assets. Finally, Rule 506 allows a company to sell unlimited securities to an unlimited number of investors, provided that no more than 35of them are non-accredited. Under Rule 506, investors must be sophisticated. In both of these options, the securities cannot be freely traded
The equity that is created in a company or some other asset as a direct result of hard work by the owner(s). Sweat equity is a term used to describe the contribution made to a project by people who contribute their time and effort. It can be contrasted with financial equity which is the money contributed towards the project. It is used to refer to a form of compensation by businesses to their owners or employees. The term is sometimes used in partnership agreements where one or more of the partners contributes no financial capital. In the case of a startup company, employees might, upon incorporation, receive stock or stock options in return for working for below-market salaries (or in some cases no salary at all). The term is sometimes used to describe the efforts put into a start-up company by the founders in exchange for ownership shares of the company. This concept, also called "stock for services" and sometimes "equity compensation" or "sweat equity" can also be seen when startup companies use their shares of stock to entice service providers to provide necessary corporate services in exchange for a discount or for deferring service fees until a later date, see e.g. "Idea Makers and Idea Brokers in High
Technology Entrepreneurship" by Todd L. Juneau et al., Greenwood Press, 2003, which describes equity for service programs involving patent lawyers and securities lawyers who specialize in start-up companies as clients. The term can also be used to describe the value added to real estate by owners who make improvements by their own toil. The more labor applied to the home, and the greater the resultant increase in value, the more sweat equity that has been used. In a successful model used by Habitat for Humanity, families who would otherwise be unable to purchase their own home (because their income level does not allow them to save for a down payment or qualify for an interestbearing mortgage offered by a financial institution) contribute up to 500 hours of sweat equity to the construction of their own home, the homes of other Habitat for Humanity partner families or by volunteering to assist the organization in other ways. Once moved into their new home, the family makes monthly, interest-free mortgage payments into a revolving "Fund for Humanity" which provides capital to build homes for other partner families. Secondary market After the securities are issued in the primary market, they are traded in the secondary market by the investors. The securities are traded, cleared and settled within the regulatory framework prescribed by the Exchanges and the SEBI Definition Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the
Stock Exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets.
Role For the general investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company, Secondary equity markets serve as a monitoring and control conduit-by facilitating value-enhancing control activities, enabling implementation of incentivebased management contracts, and aggregating information (via price discovery) that guides management decisions Difference
In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading venue in which already existing/pre-issued securities are traded among investors. Secondary market could be either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
A stock exchange is an entity which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks. A stock exchange, securities exchange or (in Europe) bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but
trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks.There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly, stock exchanges are part of a global market for securities.
Stock exchange in India
EVOLUTION OF STOCK EXCHANGES IN INDIA The origin of the stock market relates back to the year 1494, when the Amsterdam Stock Exchange was set up. In India it dates back to the 18th century, an era when the East India Company was a dominant Institution in India. "The Bombay Stock Exchange" (BSE) was founded in the year 1875. "The Ahmedabad Shares and Stock Association" was formed in the year 1894. The Calcutta Stock Exchange Association was formed by about 150 brokers on 15th June 1908. In the year 1920, one stock exchange was established in Northern India and one in Madras called "The Madras Stock Exchange". "The Madras Stock Exchange Association Pvt. Ltd." was established in the
year 1941. On 29th April 1959, it was reorganized as a company limited by guarantee under the name and style of "Madras Stock Exchange" (MSE). The Lahore Stock Exchange was formed in the year 1934. However in the year 1936 after the Punjab Stock Exchange Ltd. came into existence, the Lahore Stock Exchange merged with it. In Calcutta, a second Stock Exchange by name "The Bengal Share & Stock Exchange Ltd." was established in the year 1937 and likewise once again in the year 1938, Bombay also witnessed a rival Stock Exchange formed in the name of "Indian Stock Exchange Ltd." The U.P. Stock Exchange was formed in Kanpur and the Nagpur Stock Exchange Ltd. in Nagpur in the year 1940. The Hyderabad Stock Exchange Ltd. was incorporated in the year 1944. Two stock exchanges which came into being in Delhi by the name "The Delhi Stock & Share Brokers Association Ltd." and "The Delhi Stocks & Shares Exchange Association Ltd." were amalgamated into "The Delhi Stock Exchange Association Ltd." in the year 1947. Subsequently the Bangalore Stock Exchange was registered in the year 1957 and recognized in the year 1963. The third stock exchange in the state of Gujarat the "Vadodara Stock Exchange Ltd." was incorporated in 1990. The Over the Counter Exchange of India (OTCEI) broadly based on the lines of NASDAQ (National Association of Securities Dealers Automated Quotation) of the USA was promoted and approved on August 1989. The National Stock Exchange of India Ltd. was incorporated in November 1992. Today there are 23 Stock Exchanges in India, including the 3 Stock Exchanges in Mumbai - Bombay Stock Exchange (BSE), National Stock Exchange (NSE) and Over the Counter Exchange of India (OTCEI).
Introduction Stock Exchanges are structured marketplace where affiliates of the union gather to sell firm's shares and other securities. India Stock Exchanges can either be a conglomerate/ firm or mutual group. The affiliates act as intermediaries to their patrons or as key players for their own accounts. Stock Exchanges in India also assist the issue and release of securities and other monetary tools incorporating the fortification of revenues and dividends. The book keeping of the trade is centralized but the buying and selling is associated to a particular place as advanced marketplaces are mechanized. The buying and selling on an exchange is only open to its affiliates and brokers
Bombay Stock Exchange
Bombay Stock Exchange is the oldest stock exchange in Asia What is now popularly known as the BSE was established as "The Native Share & Stock Brokers' Association" in 1875. Over the past 135 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient capital raising platform.Today, BSE is the world's number 1 exchange in the world in terms of the number of listed companies (over 4900). It is the world's 5th most active in terms of number of transactions handled through its electronic trading system. And it is in the top ten of global exchanges in terms of the market capitalization of its listed companies (as of December 31, 2009). The companies listed on BSE command a total market capitalization of USD Trillion 1.28 as of Feb, 2010. BSE is the first exchange in India and the second in the world to obtain an ISO 9001:2000 certification. It is also the first Exchange in the country and second in the world to receive Information Security Management System Standard BS 7799-2-2002 certification for its BSE On-Line trading System (BOLT). Presently, we are ISO 27001:2005 certified, which is a ISO version of BS 7799 for Information Security. The BSE Index, SENSEX, is India's first and most popular Stock Market benchmark index. Exchange traded funds (ETF) on SENSEX, are listed on BSE and in Hong Kong. Futures and options on the index are also traded at BSE.
National Stock Exchange
The National Stock Exchange of India Limited has genesis in the report of the High Powered Study Group on Establishment of New Stock Exchanges. It recommended promotion of a National Stock Exchange by financial institutions (FIs) to provide access to investors from all across the country on an equal footing. Based on the recommendations, NSE was promoted by leading Financial Institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company unlike other stock exchanges in the country. On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment commenced in June 2000. The following years witnessed rapid development of Indian capital market with introduction of internet trading, Exchange traded funds (ETF), stock derivatives and the first volatility index - IndiaVIX in April 2008, by NSE. August 2008 saw introduction of Currency derivatives in India with the launch of Currency Futures in USD INR by NSE. Interest Rate Futures was introduced for the first time in India by NSE on 31st August 2009, exactly after one year of the launch of Currency Futures.With this, now both the retail and institutional investors can participate in equities, equity
derivatives, currency and interest rate derivatives, giving them wide range of products to take care of their evolving needs.
Trading at NSE
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Fully automated screen-based trading mechanism Strictly follows the principle of an order-driven market Trading members are linked through a communication network This network allows them to execute trade from their offices The prices at which the buyer and seller are willing to transact will appear on the screen
When the prices match the transaction will be completed A confirmation slip will be printed at the office of the trading member
Advantages of trading at NSE
Integrated network for trading in stock market of India Fully automated screen based system that provides higher degree of transparency Investors can transact from any part of the country at uniform prices Greater functional efficiency supported by totally computerized network
Over the counter exchange of India (OTCEI)
Traditionally, trading in Stock Exchanges in India followed a conventional style where people used to gather at the Exchange and bids and offers were made by open outcry. This age-old trading mechanism in the Indian stock markets used to create many functional inefficiencies. Lack of liquidity and transparency, long settlement periods and became transactions are a few examples that adversely affected investors. In order to overcome these inefficiencies. OTCEI was incorporated in 1990 as a Section 25 company under the Companies Act 1956 and is recognized as a stock exchange under Section 4 of the Securities Contracts Regulation Act, 1956. The Exchange was set up to aid enterprising promoters in raising finance for new projects in a cost effective manner and to provide investors with a transparent & efficient mode of trading. OTCEI is the first screen based nationwide stock exchange in India created by Unit Trust of India, Industrial Credit and Investment Corporation of India, Industrial Development Bank of India, SBI Capital Markets, Industrial Finance Corporation of India, General Insurance Corporation and its subsidiaries and Can Bank Financial Services. Modeled along the lines of the NASDAQ market of USA, OTCEI introduced many novel concepts to the Indian capital markets such as screen-based nationwide trading, sponsorship of companies, market making
and scrip less trading. As a measure of success of these efforts, the Exchange today has 115 listings and has assisted in providing capital for enterprises that have gone on to build successful brands for themselves like VIP Advanta, Sonora Tiles & Brilliant mineral water, etc.
A successful market for technology & growth companies has to : y demonstrate an understanding for new technology and concepts y provide capital formation opportunities for young companies without a track record y be national in order to reach and service entrepreneurs and investors y enable access to a wide spectrum of financial intermediaries y be cost effective for issuers y provide an exit route to venture capital & private equity funds for their investments y adopt state of art trading systems and practices in tune with international norms y be well regulated to promote transparent and fair market practices OTCEI, by virtue of its unique position, is well suited to service the requirements of these companies, making it the natural choice for the emerging technology and growth stocks. In fact, consumer favourites like VIP Advanta, Sonora tiles and Brilliant Mineral Water are made by high growth companies that have benefited by listing on OTCEI.
Introduction The merchant bankers are those financial intermediaries involved with the activity of transferring capital funds to those borrowers who are interested in borrowing. y They guarantee the success of issues by underwriting them. y Merchant Banks are popularly known as ³issuing and accepting houses´. y Unlike in the past, their activities are now primarily non-fund based (Fee based). y They offer a package of financial services. The basic function of merchant banks is marketing corporate and other securities that are guaranteeing sales and distribution of securities and also other activities such as management of customer services, portfolio management, credit syndication, acceptance credit, counseling, insurance, etc. Definition of a Merchant Banker The Notification of the Ministry of Finance defines merchant banker as ³Any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager-consultant, advisor or rendering corporate advisory services in relation to such issue management´
The Amendment Regulation specifies that issue management consist of Prospectus and other information relating to issue, determining financial structure, tie-up of financiers and final allotment and refund of the subscriptions, underwriting and portfolio management services. In the words of Skully ³A Merchant Bank could be best defined as a financial institution conducting money market activities and lending, underwriting and financial advice, and investment services whose organization is characterized by a high proportion of professional staff able to able to approach problems in an innovative manner and to make and implement decisions rapidly.´ Merchant banks offer consultancy services for mergers & acquisitions and financial restructuring, and the associated financing (raising the necessary funds). Merchant banks are banks that specialize in activities that facilitate trade and commerce. This typically involves international finance, long term loans to companies and underwriting. Merchant banks do not offer usual banking services to the general public The merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors.
Merchant Banking in India
Merchant banking activity was formally initiated into the Indian capital Markets when Grindlays bank received the license from reserve bank in 1967. Grindlays started with management of capital issues, recognized the needs of emerging class of Entrepreneurs for diverse financial services ranging from production planning and system design to market research. Even it provides management consulting services to meet the Requirements of small and medium sector rather than large sector. Citibank Setup its merchant banking division in 1970. The various tasks performed by this divisions namely assisting new entrepreneur, evaluating new projects, raising funds through borrowing and issuing equity. Indian banks Started banking Services as a part of multiple services they offer to their clients from 1972. State bank of India started the merchant banking division in 1972. In the Initial years the SBI's objective was to render corporate advice And Assistance to small and medium entrepreneurs. Merchant banking activities is of course organized and undertaken in several forms. Commercial banks and foreign development finance institutions have organized them through formation divisions, nationalized banks have formed subsidiaries companies and share brokers and consultancies constituted themselves into public limited companies or registered themselves as private limited Companies. Some merchant banking outfits have entered into collaboration with merchant bankers abroad with several branches
Registration of Merchant bankers with SEBI
It is mandatory for a merchant banker to register with the SEBI. Without holding a certificate of registration granted by the Securities and Exchange Board of India, no person can act as a merchant banker in India.
1) Only a body corporate other than a non-banking financial company shall be eligible to get registration as merchant banker. 2) The applicant should not carry on any business other than those connected with the Securities market. 3) All applicants for Merchant Bankers should have qualification in Finance, law or Business Management. 4) The applicant should have infrastructure like office space, equipment, manpower etc. 5) The applicant must have at least two employees with prior experience in merchant banking. 6) Any associate company, group company, subsidiary or interconnected company of the applicant should not have been a registered merchant banker 7) The applicant should not have been involved in any securities scam or proved guilt for any offence 8) The applicant should have a minimum net worth of Rs.5 Crores.
The various categories for which registration can be obtained are:
1) Category I ±To carry on the activity of issue management and to act as adviser, consultant, manager, underwriter, portfolio manager.
2) Category II - to act as adviser, consultant, co-manager, underwriter, portfolio manager.
3) Category III - to act as underwriter, adviser or consultant to an issue.
4) Category IV ± to act only as adviser or consultant to an issue
The capital requirement for carrying on activity as merchant banker:
The capital requirement depends upon the category. The minimum net worth requirement for acting as merchant banker is given below: Category Category Category Category I II III IV ± ± ± ± Rs. Rs. Rs. Rs. 5 crores 50 lakh 20 lakh Nil
Procedure for getting registration:
An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied, issues a certificate of registration in Form B of the SEBI (Merchant Bankers) Regulations, 1992.
Registration fee payable to SEBI:
Rs.5 lakhs which should be paid within 15 days of date of receipt of intimation regarding grant of certificate. Validity period of certificate of registration is three years from the date of issue. Three months before the expiry period, an application along with renewal fee of 2.5 lakhs should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied renew certificate of registration for a further period of 3 years. Role of merchant banker in a primary market issue management Merchant banker is the intermediary appointed by companies in the primary market issue. It has to look at the entire issue management and work as the Manager to the Public Issue. Principal steps that Merchant bankers have to perform in a bringing up a Public issue are as follows :
Vetting of Prospects: The prospectus is a document to communicate information about the company and the proposed security issue to the investing public. The draft prospectus containing the disclosures has to be vetted by SEBI before a public issue is made.
Appointment of Underwriters: An underwriter agrees to subscribe to a given number of shares in the event the public do not subscribe to them. The underwriter, in essence, stands guarantee for public subscription in consideration for the underwriting commission.
Appointment of bankers: The bankers to the issue collect money on behalf of the company from the applicants.
Appointment of Registrars: The registrars to issue perform a series of tasks from the time the subscription is closed to the time the allotment is made.
Appointment of Brokers and Principal Brokers: The brokers to the issue facilitate its subscription. Filing of the Prospectus with the Registrar of Companies
Printing and dispatch of prospectus and application form: After the prospectus is filed with the Registrar of Companies, the company should print the prospectus and the application form.
Filing of Initial Listing Application: Within ten days of filing the prospectus, the initial listing application must be made to the concerned stock exchanges, along with the initial listing fees.
Promotion of the Issue: The promotional campaign typically commences with the filing of the prospectus with the Registrar of Companies and ends with the release of the statutory announcement of the issue.
Statutory Announcement: The statutory announcement of the issue must be made after seeking the approval of the lead stock exchange. This must be published at least ten days before the opening of the subscription list
Collection of Applications: The statutory announcement (as well as the prospectus) specifies when the subscription would open when it would close, and the banks where the applications can be made. Processing of Applications: The application forms received by the bankers are transmitted to the registrars to the issue for processing.
Establishing the Liability Underwriters: If the issue is undersubscribed, the liability of the underwriters has to be established.
Allotment of Shares: If the issue is under-subscribed or just fully subscribed, the company may allot shares applied for by the applicants after securing the formal approval of the concerned stock exchanges(s)
Listing of the Issue: The detailed listing application should be submitted to the concerned stock exchanges along with the listing agreement and the listing fee.
Costs of Public Issue: The cost of public issue is normally between 8 and 12 per cent depending on the size of the issue and the level of marketing effort. The important expenses incurred for a public issue are Underwriting Expenses, Brokerage, Fees to the Managers of the Issue, Fees for Registrars to the Issue, Printing Expenses, Postage Expenses, Advertising and Publicity
Expenses, Listing fees, Stamp duty. In addition to the above procedural matter, the most important issue relates to the pricing of the issue. The merchant banker has to see that the issue is priced properly.
Canara Bank is also one of the leading Merchant Bankers in India, offering specialized services to Banks, PSUs, State owned Corporations, Local Statutory bodies and Corporate sector.We are SEBI registered Category I Merchant Banker to render Issue Management (Public / Rights / Private Placement Issues), Underwriting, Consultancy and Corporate Advisory Services etc. We also hold SEBI registration Certificate to act as "Bankers to an Issue" with network of exclusive Capital Market Service Branches and over 100 designated CBS Branches to handle collecting / Refund / Paying Banker assignments. We do undertake "project appraisals" with linkage to resource raising plans from Capital Market / Debt Markets and facilitate tie-ups with Banks / Financial Institutions and Potential Investors.
Our uniqueness is extending services under single window concept covering the following areas: 1. Merchant Banking 2. Commercial Banking 3. Investments 4. Bankers to Issue - Escrow Bankers 5. Underwriting 6. Loan Syndication As leading Merchant Bankers in India, we have associated with issues ranging from Rs.1 crore to Rs.1500 crores, involving various types of
industries, banks, statutory Bodies etc. and have an edge in handling Private Placement issues ± both retail & HNIs. SPECTRUM OF SERVICES:
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Equity Issue (Public/Rights) Management Debt Issue Management Private Placements Project Appraisals Monitoring Agency Assignments IPO Funding Security Trustee Services Agriculture Consultancy Services Corporate Advisory Services Mergers and Acquisitions Buy Back Assignments Share Valuations Syndication ESOS Certification
ISSUE MANAGEMENT SERVICES:
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Project Appraisal Capital structuring Preparation of offer document Tie Ups (placement) Formalities with SEBI / Stock Exchange / ROC, etc.
y y y y y y y
Underwriting Promotion /Marketing of Issues Collecting Banker / Banker to an issue Post Issue Management Refund Bankers Debenture Trusteeship Registrar & Transfer Agency (our Subsidiary)
We constantly update the list of Potential Investors - Institutions, Provident, Pension & Gratuity Funds, High Net Worth Individuals and others and continuously assess their investment appetites and help issuers in effective marketing of the products.
The merchant banker plays a vital role in channelising the financial surplus of the society into productive investment avenues. Hence before selecting a merchant banker, one must decide, the services for which he is being approached. Selecting the right intermediary who has the necessary skills to meet the requirements of the client will ensure success. It can be said that this project helped me to understand every details about Merchant Banking and in future how it¶s going to get emerged in the Indian economy. Hence, Merchant Banking can be considered as essential financial body in Indian financial system. Market development is predicted on a sound, fair and transparent regulatory framework. To sustain the growth of the market and crystallize the growing awareness and interest into a committed, discerning and growing awareness and interest into an essential to remove the trading malpractice and structural inadequacies prevailing in the market, and provide the investors an organized, well regulated.
Innovative Financial instruments
A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.
Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in Euros.
American Depositary Receipt
Introduction ADR is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction. American depositary receipt (ADR) was introduced in 1927 as a more convenient way for investors to buy and sell shares of foreign corporations. Put simply, ADRs represent a specific number (or fractions) of a share in a company that doesn¶t already have a stock listed on the US stock exchanges and trade like a stock in the open market. Background of ADR Back in the days, it was very complicated to buy shares in different countries, which involved dealing with tax and currency issues. Subsequently, ADR was introduced to let U.S. banks buy shares from a foreign company and re-issue them on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the Nasdaq. During the introduction, the bank will also determine how many shares will correspond to each home country share. The reason why it isn¶t a 1 to 1 relationship is due to the fact that banks want to price shares of ADR high enough to perceive substantial value and low enough for individual investors to take advantage. For example, exchange rates can make certain stock look like a
penny stock, which will have a negative psychological effect on investors in the U.S. ADRs mean for us ADRs provides investors a great way to diversify into foreign markets because it¶s highly liquid, easy to manage and it trades just like any other stock. While there are brokerage firms like Etrade that will allow you to buy stocks in foreign countries, ADRs are available for everyone provided that the company you want to invest in has an ADR set up. As an average investor who picks individual stocks, there is no reason why you shouldn¶t look into ADRs. If you haven¶t taken advantage yet, you are missing out since the additional diversification and ease of management is well worth it. Types of ADR program When a company establishes an American Depositary Receipt program, it must decide what exactly it wants out of the program, and how much time, effort and resources they are willing to commit. For this reason, there are different types of programs that a company can choose. Unsponsored shares Unsponsored shares are a form of Level I ADRs that trade on the over-thecounter (OTC) market. These shares are issued in accordance with market demand, and the foreign company has no formal agreement with a depositary bank. Unsponsored ADRs are often issued by more than one depositary bank. Each depositary services only the ADRs it has issued.
Due to a recent SEC rule change making it easier to issue Level I depositary receipts, both sponsored and unsponsored, hundreds of new ADRs have been issued since the rule came into effect in October 2008. The majority of these were unsponsored Level I ADRs, and now approximately half of all ADR programs in existence are unsponsored. Level I (OTC) Level 1 depositary receipts are the lowest level of sponsored ADRs that can be issued. When a company issues sponsored ADRs, it has one designated depositary who also acts as its transfer agent. A majority of American depositary receipt programs currently trading are issued through a Level 1 program. This is the most convenient way for a foreign company to have its equity traded in the United States. Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile. Companies with shares trading under a Level 1 program may decide to upgrade their program to a Level 2 or Level 3 program for better exposure in the United States markets.
Level II (listed) Level 2 depositary receipt programs are more complicated for a foreign company. When a foreign company wants to set up a Level 2 program, it must file a registration statement with the US SEC and is under SEC regulation. In addition, the company is required to file a Form 20-F annually. Form 20-F is the basic equivalent of an annual report (Form 10-K) for a U.S. company. In their filings, the company is required to follow U.S. GAAP standards or IFRS as published by the IASB. The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). While listed on these exchanges, the company must meet the exchange¶s listing requirements. If it fails to do so, it may be delisted and forced to downgrade its ADR program. Level III (offering) A Level 3 American Depositary Receipt program is the highest level a foreign company can sponsor. Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies. Setting up a Level 3 program means that the foreign company is not only taking steps to permit shares from its home market to be deposited into an ADR program and traded in the U.S.; it is actually issuing shares to raise
capital. In accordance with this offering, the company is required to file a Form F-1, which is the format for an Offering Prospectus for the shares. They also must file a Form 20-F annually and must adhere to U.S. GAAP standards or IFRS as published by the IASB. In addition, any material information given to shareholders in the home market, must be filed with the SEC through Form 6K. Foreign companies with Level 3 programs will often issue materials that are more informative and are more accommodating to their U.S. shareholders because they rely on them for capital. Overall, foreign companies with a Level 3 program set up are the easiest on which to find information. ADRs' Special Risks Of course, even though they trade in US dollars and can, at least on the surface, closely mimic the look and feel of American stocks, ADRs come with their own set of special considerations to keep in mind. Currency risk: If the value of the US dollar rises against the value of the company's home currency, a good deal of the company's intrinsic profits might be wiped out in translation. Conversely, if the US dollar weakens against the company's home currency, any profits it makes will be enhanced for a US owner. For more information on how this could damage or inflate your results, read The Danger of Investing in International Bonds. Political risk: ADR status does not insulate a company's stock from the inherent risk of its home country's political stability. Revolution, nationalization, currency collapse or other potential disasters may be greater
risk factors in other parts of the world than in the US, and those risks will be clearly translated through any ADR that originates in an affected nation. Inflation risk: Countries around the globe may be more, or less, prone to inflation than the US economy is at any given time. Those with higher inflation rates may find it more difficult to post profits to an US owner, regardless of the company's underlying health. In other words, ADRs are just what they seem: a representation of a foreign stock, rather than an actual holding in the company. Because of all of the considerations listed above, an ADR of a foreign company in the US. may trade a little ahead or a little behind the price the company commands in its own currency in its own home base. But it's safe to say that buying an ADR is the closest an American investor can come to participating directly in the rest of the world's GDR (Global Depository Receipts) A GDR is issued and administered by a depositary bank for the corporate issuer. The depositary bank is usually located, or has branches, in the countries in which the GDR will be traded. The largest depositary banks in the United States are JP Morgan, the Bank of New York Mellon, and Citibank. A GDR is based on a Deposit Agreement between the depositary bank and the corporate issuer, and specifies the duties and rights of each party, both to the other party and to the investors. Provisions include setting record dates, voting the issuer¶s underlying shares, depositing the issuer¶s shares in the
custodian bank, the sharing of fees, and the execution and delivery or the transfer and the surrender of the GDR shares. A separate custodian bank holds the company shares that underlie the GDR. The depositary bank buys the company shares and deposits the shares in the custodian bank, then issues the GDRs representing an ownership interest in the shares. The DR shares actually bought or sold are called depositary shares. The custodian bank is located in the home country of the issuer and holds the underlying corporate shares of the GDR for safekeeping. The custodian bank is generally selected by the depositary bank rather than the issuer, and collects and remits dividends and forwards notices received from the issuer to the depositary bank, which then sends them to the GDR holders. The custodian bank also increases or decreases the number of company shares held per instructions from the depositary bank. The voting provisions in most deposit agreements stipulate that the depositary bank will vote the shares of a GDR holder according to his instructions; otherwise, without instructions, the depositary bank will not vote the shares.
Advantages & disadvantages
GDRs, like ADRs, allow investors to invest in foreign companies without worrying about foreign trading practices, different laws, or cross-border transactions. GDRs offer most of the same corporate rights, especially voting rights, to the holders of GDRs that investors of the underlying securities enjoy.
Other benefits include easier trading, the payment of dividends in the GDR currency, which is usually the United States dollar (USD), and corporate notifications, such as shareholders¶ meetings and rights offerings, are in English. Another major benefit to GDRs is that institutional investors can buy them, even when they may be restricted by law or investment objective from buying shares of foreign companies. GDRs also overcome limits on restrictions on foreign ownership or the movement of capital that may be imposed by the country of the corporate issuer, avoids risky settlement procedures, and eliminates local or transfer taxes that would otherwise be due if the company¶s shares were bought or sold directly. There are also no foreign custody fees, which can range from 10 to 35 basis points per year for foreign stock bought directly. GDRs are liquid because the supply and demand can be regulated by creating or canceling GDR shares. GDRs do, however, have foreign exchange risk if the currency of the issuer is different from the currency of the GDR, which is usually USD. The main benefit to GDR issuance to the company is increased visibility in the target markets, which usually garners increased research coverage in the new markets; a larger and more diverse shareholder base; and the ability to raise more capital in international markets. GRD Market As derivatives, depositary receipts can be created or canceled depending on supply and demand. When shares are created, more corporate stock of the
issuer is purchased and placed in the custodian bank in the account of the depositary bank, which then issues new GDRs based on the newly acquired shares. When shares are canceled, the investor turns in the shares to the depositary bank, which then cancels the GDRs and instructs the custodian bank to transfer the shares to the GDR investor. The ability to create or cancel depositary shares keeps the depositary share price in line with the corporate stock price, since any differences will be eliminated through arbitrage. The price of a GDR primarily depends on its depositary ratio (aka DR ratio), which is the number of GDRs to the underlying shares, which can range widely depending on how the GDR is priced in relation to the underlying shares; 1 GDR may represent an ownership interest in many shares of corporate stock or fractional shares, depending on whether the GDR is priced higher or lower than corporate shares. Most GDRs are priced so that they are competitive with shares of like companies trading on the same exchanges as the GDRs. Typically, GDR prices range from $7 - $20. If the GDR price moves too far from the optimum range, more GDRs will either be created or canceled to bring the GDR price back within the optimum range determined by the depositary bank. Hence, more GDRs will be created to meet increasing demand or more will be canceled if demand is lacking or the price of the underlying company shares rises significantly. Most of the factors governing GDR prices are the same that affects stocks: company fundamentals and track record, relative valuations and analysts¶
recommendations, and market conditions. The international status of the company is also a major factor. On most exchanges GDRs trade just like stocks, and also have a T+3 settlement time in most jurisdictions, where a trade must be settled in 3 business days of the trading exchange. The exchanges on which the GDR trades are chosen by the company. Currently, the stock exchanges trading GDRs are the: 1. London Stock Exchange, 2. Luxembourg Stock Exchange, 3. Dubai International Financial Exchange (DIFX), 4. Singapore Stock Exchange, 5. Hong Kong Stock Exchange. Companies choose a particular exchange because it feels the investors of the exchange¶s country know the company better, because the country has a larger investor base for international issues, or because the company¶s peers are represented on the exchange. Most GDRs trade on the London or Luxembourg exchanges because they were the 1st to list GDRs and because it is cheaper and faster to issue a GDR for those exchanges. Many GDR issuers also issue privately placed ADRs to tap institutional investors in the United States. The market for a GDR program is broadened by including a 144A private placement offering to Qualified Institutional Investors in the United States. An offering based on SEC Rule 144A eliminates the need to register the offering under United States security laws, thus saving both time and expense. However, a 144A offering must, under
Rule 12g3-2(b), provide a home country disclosure in English to the SEC or the information must be posted on the company¶s website.
Indian Depository Receipt (IDR)
Definition According to Companies (Issue of Indian Depository Receipts) Rules, 2004, IDR is an instrument in the form of a Depository Receipt created by the Indian depository in India against the underlying equity shares of the issuing company. In an IDR, foreign companies would issue shares, to an Indian Depository (say National Security Depository Limited ± NSDL), which would in turn issue depository receipts to investors in India. The actual shares underlying the IDRs would be held by an Overseas Custodian, which shall authorize the Indian Depository to issue the IDRs. The IDRs would have following features: 1) Overseas Custodian : It is a foreign bank having branches in India and requires approval from Finance Ministry for acting as custodian and Indian depository has to be registered with SEBI. 2)Approvals for issue of IDRs : IDR issue will require approval from SEBI and application can be made for this purpose 90 days before the issue opening date. 3)Listing : These IDRs would be listed on stock exchanges in India and would be freely transferable.
Eligibility conditions for overseas companies to issue IDRs: Capital : The overseas company intending to issue IDRs should have paid up capital and free reserve of atleast $ 100 million. Sales turnover : It should have an average turnover of $ 500 million during the last three years. Profits/dividend : Such company should also have earned profits in the last 5 years and should have declared dividend of at least 10% each year during this period. Debt equity ratio : The pre-issue debt equity ratio of such company should not be more than 2:1. Extent of issue : The issue during a particular year should not exceed 15% of the paid up capital plus free reserves. Redemption : IDRs would not be redeemable into underlying equity shares before one year from date of issue. Denomination : IDRs would be denominated in Indian rupees, irrespective of the denomination of underlying shares. Benefits : In addition to other avenues, IDR is an additional investment opportunity for Indian investors for overseas investment
Indian Depository Receipt (IDR): A Background
An IDR is an instrument denominated in Indian Rupees in the form of a depository receipt created by a µDomestic Depository¶ (custodian of securities registered with SEBI) against the underlying equity of the issuing company in order to enable foreign companies to raise funds from the Indian securities markets. The receipts are based on a ratio of shares equivalent to depository receipts. Eligible companies resident outside India are allowed to issue IDRs through a Domestic Depository pursuant to Circular No. SEBI / CFD / DIL / DIP / 20 /2006 / 3 / 4 dated April 3, 2006 and the provisions of Issue of Capital and Disclosure Requirements (³ICDR´) Regulations 2009 (which replaced the SEBI (Disclosure and Investor Protection) Guidelines, 2000). In addition, the Circular and the ICDR Regulations 2009, permit persons resident in India and outside India to purchase, possess, transfer and redeem IDRs. Qualifying companies resident outside India issue IDRs through a Domestic Depository subject to compliance with the Companies (Issue of Depository Receipts) Rules, 2004 and subsequent amendments made thereto and the ICDR Regulations, 2009. In addition, the regulations state that in the case of raising of funds through the issuance of IDRs by financial/banking companies having a presence in India, either through a branch or subsidiary, the approval of the sectoral
regulator(s) should be obtained before the issuance of IDRs. Therefore, the approval of the Reserve Bank of India (RBI) will need to be obtained for the Standard Chartered IDR. The SEBI guidelines permit only those companies listed in their home market for at least three years and which have been profitable for three of the preceding five years to make IDR issues. As the issuance of the IDR by SCP would be the first IDR ever undertaken, there will be a number of challenges including the structure of the instrument, how one trades in it, what kind of returns can be made on the instrument, and what are the risks involved.
Benefits of IDRs for Indian Investors and Rights
No resident Indian individual can hold more than $200,000 worth of foreign securities purchased per year as per Indian foreign exchange regulations. However, this will not be applicable for IDRs which gives Indian residents the chance to invest in an Indian listed foreign entity. Additional key requisites for investing in foreign securities such as a securities trading account outside India to hold foreign securities, know your customer norms (KYC) with foreign broker and foreign bank account to hold funds are generally too cumbersome for most Indian investors. Such requirements are avoided in holding IDRs. Whatever benefits accrue to the shares, by way of dividend, rights, splits or bonuses would be passed on to IDR holders also, to the extent permissible under Indian law.
Benefits for International Issuers
The main benefit would be in terms of branding, besides allowing foreign companies to access Indian capital. IDRs also allow the creation of acquisition currency and a management incentive tool. Issuers have the option to reserve a proportion of the issue for their employees.
Challenges for IDRs
There is the possibility of IDR issues being undersubscribed if they are not well marketed or fail to catch the imagination of investors. In addition, the challenges mentioned below are certain challenges with respect to the issuance of IDRs. 1. Stringent eligibility norms: The stringent eligibility criteria, disclosure and corporate governance norms (Although in the investor¶s interests, they compare unfavorably with listing norms on other tier II global exchanges such as Luxembourg, London¶s Alternate Investment Market (AIM) and Dubai. This could result in higher compliance costs for companies seeking to tap the Indian capital markets). 2. Fungibility: Current regulations do not provide for the exchange of equity shares into IDRs after the initial issuance i.e. reverse fungibility is not allowed. 3. Tradability of IDRs: How one trades in the instrument/how the instruments are traded.
4. Returns on IDRs: What kind of returns would be made on the instrument. 5. Risks: What risks are involved given that the same shares would be simultaneously trading in London and Hong Kong. 6. Taxation: Lack of clarity on taxation. It is not clear whether IDRs are exempt from capital gains tax. 7. Voting Rights: It is not entirely clear whether IDR holders will have voting rights or not ± the SEBI guidelines do not specifically mention voting rights, it leaves that to the discretion of the issuer. 8. Market: Indian financial markets are still considered volatile and contain emerging market risk.
Tax issues: Related to IDRs
Indian investors need to consider the tax implications of investment in the IDRs. While Section 605A of the Companies Act, 1956 (the ³Companies Act´) discusses IDRs, there are no specific provisions regarding capital gains taxation of IDRs in the Companies Act or in the Income Tax Act, 1961. Therefore, the general rules relating to capital gains taxation apply and no benefits for long term holders of IDRs (ie. if the Securities Transaction Tax is paid, there is no capital gains tax on long term holders of listed securities) are available. It is possible that the upcoming Direct Tax Code may clarify the issue but as of now the capital gains tax treatment of IDRs is not favorable.
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