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Management Notes

Central Securities Depository Ltd. (CSDL), Functions, Benefits

indiafreenotesby indiafreenotes3

Central Securities Depository Ltd. (CSDL) is a significant entity in the Indian financial market, playing a pivotal role in the dematerialization of securities and enhancing the efficiency of the securities settlement process. It is responsible for managing the holding and settlement of securities in electronic form, a service that has revolutionized the Indian securities market by facilitating paperless transactions, reducing risks, and promoting transparency.

CSDL was established in 1999 and is one of the two depositories operating in India, the other being the National Securities Depository Limited (NSDL). Both CSDL and NSDL are regulated by the Securities and Exchange Board of India (SEBI), which ensures their compliance with industry standards and governance practices.

Functions of CSDL:

  • Dematerialization of Securities:

CSDL’s primary function is to convert physical securities, such as shares, bonds, and debentures, into electronic form. This process is called dematerialization, and it has significantly reduced the risks associated with physical securities, including theft, forgery, and loss. Investors can hold securities in their demat accounts, and transactions are executed electronically.

  • Settlement of Securities:

CSDL plays a vital role in the settlement of securities transactions in the stock markets. It facilitates the efficient transfer of securities between buyers and sellers by ensuring that securities are transferred electronically upon payment, ensuring seamless and secure transactions.

  • Centralized Custody:

CSDL provides centralized custody of securities, allowing investors to hold their securities in a safe and accessible electronic format. By acting as a custodian, it minimizes the risks of holding securities physically and offers a more transparent, secure, and efficient system.

  • Investor Services:

CSDL offers various services to investors, such as corporate actions (like dividend payments, stock splits, bonus issues, etc.), electronic transfer of securities, and nomination facilities for demat accounts. It also provides an electronic platform for investors to access their holdings, monitor transactions, and update account details.

  • Pledge and Lien Services:

CSDL offers a pledge and lien facility that enables investors to pledge their securities for borrowing purposes. This facility is essential for leveraging securities as collateral in various financial transactions, such as margin funding or loans.

  • Electronic Book Entry System:

CSDL’s electronic book entry system ensures that securities transactions are recorded electronically, ensuring that investors’ holdings are updated and accessible instantly. This system eliminates paperwork, reduces human errors, and accelerates the settlement process.

  • Systematic Investment Plan (SIP):

CSDL has enabled Systematic Investment Plans (SIPs) through mutual fund units. Investors can automatically invest in mutual fund schemes through their demat accounts, which are electronically recorded and tracked by CSDL.

Benefits of CSDL

  • Efficiency and Speed:

By converting physical securities into electronic form, CSDL ensures that securities transactions are processed quickly, reducing the time and effort required for manual paperwork. The settlement time is also significantly reduced, contributing to quicker transfer of securities and funds.

  • Reduced Risk:

CSDL reduces the risks associated with holding physical securities. The chances of theft, damage, or loss of securities are eliminated since all transactions are executed electronically. Additionally, it reduces counterparty risks and the potential for fraud in securities transfers.

  • Cost-Effectiveness:

The dematerialization process eliminates the need for printing and handling physical certificates, leading to reduced administrative and processing costs. Investors also save on expenses like stamp duty and courier charges for physical certificates.

  • Transparency and Security:

The electronic system operated by CSDL ensures greater transparency in the securities market. All transactions are recorded in real-time, making it easier to track ownership and transfer of securities. This system enhances investor confidence and reduces the potential for manipulation.

  • Accessibility:

CSDL provides easy access to securities for investors. They can hold and trade their securities in a convenient manner through their demat accounts. The platform is accessible 24/7, providing a reliable and efficient interface for securities management.

  • Corporate Actions:

CSDL ensures that all corporate actions (such as dividends, bonus issues, stock splits, etc.) are automatically credited to the respective demat accounts of investors. This removes the need for manual intervention and ensures that investors receive their entitlements promptly.

  • Global Access:

CSDL’s services are not limited to Indian investors. It also enables foreign investors to hold Indian securities in demat form, facilitating foreign investment in Indian markets and promoting capital inflows into the country.

Regulatory and Compliance Role:

CSDL is regulated by SEBI, which monitors and ensures that the depository’s operations are in line with Indian securities regulations. This regulatory oversight provides an added layer of trust for investors and ensures that CSDL follows best practices in terms of governance, security, and operational standards. It is also required to comply with International Financial Reporting Standards (IFRS), Anti-Money Laundering (AML) laws, and other industry norms.

Management Notes

National Securities Depository Ltd. (NSDL), Functions, Features, Benefits

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National Securities Depository Ltd. (NSDL) is one of the two central depositories in India, playing a crucial role in the modernization and electronic settlement of securities. NSDL was established in 1996 with the objective of facilitating dematerialization of securities, enhancing the speed and transparency of the Indian financial markets, and providing a secure and efficient infrastructure for securities transactions. It operates under the regulatory framework of Securities and Exchange Board of India (SEBI) and has made significant contributions to the development of India’s capital markets.

Functions of NSDL:

  • Dematerialization of Securities:

The most vital function of NSDL is to convert physical securities (such as shares, bonds, and debentures) into electronic format. This process, known as dematerialization, eliminates the need for paper certificates and reduces risks such as loss, theft, or forgery. Investors hold securities in the form of electronic records in their demat accounts, which are maintained by NSDL.

  • Settlement of Securities:

NSDL plays a vital role in the settlement process by ensuring that securities transactions, whether buy or sell, are completed seamlessly. The transfer of securities and payment settlement is carried out electronically, facilitating faster and more secure transactions compared to the older physical transfer systems.

  • Centralized Custody of Securities:

As a central depository, NSDL offers custody services for dematerialized securities. By maintaining electronic records of securities, it ensures that investors can safely store their holdings, monitor their portfolio, and track any changes in ownership or entitlement without the risks associated with physical certificates.

  • Corporate Actions:

NSDL ensures that corporate actions, such as dividends, interest payments, stock splits, bonus issues, and rights offerings, are seamlessly executed and credited to the investor’s demat account. This reduces paperwork and delays for investors while ensuring that entitlements are accurately credited.

  • Electronic Book Entry System:

NSDL employs an electronic book entry system to record securities transactions. This system makes it possible for securities to be transferred between buyers and sellers electronically, without the need for physical documents. It provides real-time tracking and updates of transactions.

  • Pledge and Loan Facility:

NSDL also offers pledge and lien facilities, allowing investors to pledge their securities as collateral for loans. This facility is essential for investors who wish to leverage their holdings to meet financial needs while maintaining ownership of the securities.

  • Investor Services:

NSDL offers a range of services for investors, including the ability to track their securities holdings, update personal information, and access historical transaction records. It provides online platforms that make it easy for investors to manage their demat accounts.

Features of NSDL:

  • Paperless and Efficient:

NSDL’s transition to a paperless system has significantly reduced the administrative burden on investors, brokers, and financial institutions. Electronic processing is faster, more accurate, and more efficient than manual paperwork. The dematerialization of securities has eliminated issues like lost or stolen certificates, making the market more transparent and secure.

  • Wider Reach:

NSDL services not only cater to domestic investors but also facilitate foreign investment in Indian securities. International investors can hold and trade Indian securities in a demat format through NSDL, which helps attract foreign capital into the Indian economy.

  • Enhanced Security:

The electronic system provides better security than physical securities. With encryption and other security features, NSDL ensures that investor data and securities are protected from fraud, manipulation, or unauthorized access.

  • Accessibility:

Investors can access their accounts, conduct transactions, and perform other account-related activities from anywhere in the world. This makes the system convenient and accessible for investors both in India and abroad.

  • Cost Reduction:

By eliminating paper certificates and reducing manual intervention, NSDL has helped in lowering the costs associated with securities issuance, trading, and settlement. This reduction in costs has benefitted both investors and institutions involved in the securities market.

  • Real-Time Updates:

NSDL provides real-time updates for all securities transactions, making it easy for investors to track their portfolio performance and manage their holdings effectively.

Benefits of NSDL:

  • Faster and Efficient Transactions:

NSDL has reduced the time required for the settlement of securities transactions, bringing down the settlement cycle from several days (T+3) to a more efficient model. This speed is essential for the smooth functioning of the capital markets.

  • Investor Confidence:

The transparency and security offered by NSDL have helped build investor confidence in the Indian securities market. Investors can rely on the integrity and efficiency of the system, knowing that their securities are safely stored and securely traded.

  • Reduced Risk:

By eliminating the risks associated with physical certificates, such as theft, loss, or damage, NSDL has helped mitigate security risks in the market. The electronic system also minimizes errors during securities transactions.

  • Convenient Record-Keeping:

The electronic format allows for efficient record-keeping, tracking, and monitoring of securities. This is beneficial for investors, as it helps them easily view their holdings and transactions.

  • Reduced Operational Costs:

With electronic systems in place, NSDL has helped reduce operational costs for investors, brokers, and institutions involved in the capital markets.

Regulatory Oversight

NSDL operates under the supervision of SEBI, which is responsible for overseeing its compliance with market regulations. NSDL follows the guidelines set by SEBI and other regulatory bodies to ensure that it adheres to the best practices in securities depository operations. It also complies with various international standards in electronic securities settlement.

Bangalore University BBA Notes

Patterns of Trading & Settlement

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1) Selecting a Broker or Sub-broker

When a person wishes to trade in the stock market, it cannot do so in his/her individual capacity. The transactions can only occur through a broker or a sub-broker. So according to one’s requirement, a broker must be appointed.

Now such a broker can be an individual or a partnership or a company or a financial institution (like banks). They must be registered under SEBI. Once such a broker is appointed you can buy/sell shares on the stock exchange.

2) Opening a Demat Account

Since the reforms, all securities are now in electronic format. There are no issues of physical shares/securities anymore. So an investor must open a dematerialized account, i.e. a Demat account to hold and trade in such electronic securities.

So you or your broker will open a Demat account with the depository participant. Currently, in India, there are two depository participants, namely Central Depository Services Ltd. (CDSL) and National Depository Services Ltd. (NDSL).

3) Placing Orders

And then the investor will actually place an order to buy or sell shares. The order will be placed with his broker, or the individual can transact online if the broker provides such services. One thing of essential importance is that the order /instructions should be very clear. Example: Buy 100 shares of XYZ Co. for a price of Rs. 140/- or less.

Then the broker will act according to your transactions and place an order for the shares at the price mentioned or an even better price if available. The broker will issue an order confirmation slip to the investor.

4) Execution of the Order

Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the broker must issue a Contract Note. This document contains all the information about the transactions, like the number of shares transacted, the price, date and time of the transaction, brokerage amount, etc.

Contract Note is an important document. In the case of a legal dispute, it is evidence of the transaction. It also contains the Unique Order Code assigned to it by the stock exchange.

5) Settlement

Here the actual securities are transferred from the buyer to the seller. And the funds will also be transferred. Here too the broker will deal with the transfer. There are two types of settlements,

  • On the Spot settlement: Here we exchange the funds immediately and the settlement follows the T+2 pattern. So a transaction occurring on Monday will be settled by Wednesday (by the second working day)
  • Forward Settlement: Simply means both parties have decided the settlement will take place on some future date. It can be T+% or T+9 etc.

Participants Involved in the Process

  • Clearing Corporation

Clearing corporation is one of the major participants involved in clearing and settlement process in stock market. The responsibility for clearing and settlement of trade executed at the stock exchange lies on the National Securities Clearing Corporation Limited (NSCCL). It is also in charge of risk management and is obligated for meeting all settlement regardless of the member defaults.

  • Clearing Members/Custodians

They are another participant in the clearing and settlement process in Indian stock market. When trading members place deals in the stock exchange, the same is moved to NSCCL, which transfers them to the clearing members. The clearing member is in charge of determining the position of share to suit the trade.

  • Clearing banks

Clearing banks are responsible for the settlement of funds. There are 13 clearing banks, and each clearing member needs to open a clearing account with either one of them. In case of a pay-out, clearing members receive funds in the clearing account and in case of pay-in they need to make funds available.

  • Depositories

There are two depositories in India: National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories hold your Demat account, and clearing members also need to maintain a clearing pool account with them.

Clearing members need to transfer the securities to the clearing pool account they hold with the depositories on the date of settlement.

  • Professional Clearing Members

These are special category members appointed by the NSCCL. However, note that they are not allowed to trade, and they can only clear and settle trades executed for their clients. Professional clearing members generally constitute banks, custodians, etc.

Bangalore University BBA Notes

Speculations in Stock and Types

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Speculation is an important function of the stock exchange. Speculation means purchase or sale of a commodity with a view to earning profit from future price changes.

The word speculation is derived from the Latin word speculare which means to look at from a distance.

Thus all specula­tion represents an attempt on the part of man to peep into the future out of the window of the present. When a speculator anticipates that the price of a commodity is going to rise, he will buy it for selling in future at a profit.

Similarly when the speculator anticipates that the price of commodity is going to fall, he will sell it with a view to buying in the future at lower prices. Thus the speculator anticipates all changes in prices and hopes to earn profits out of it. A speculator is a dealer not in goods but in risks.

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. A person who does not have any influence in the market price but who believes that the price is going to rise or fall independently of his own actions and who buys or sells in an attempt to make profit is a simple or competitive specula­tor.

The competitive speculator, if he is successful, buys cheap and sells dear and thereby makes profit for him-self. But by his actions he shifts goods from points where they are relatively plentiful to others where they are relatively scarce and thereby renders a great service to the society.

When he buys he tends to raise the price conferring a benefit on those from whom he buys; when he sells he tends to lower the price conferring a benefit on those to whom he sells.

By bidding up the price when it is low, he induces other members of the society to consume less and by lowering the price when it is high; he induces other members of the society to consume more. Thus competitive speculation improves upon the distribution of consumption over time.

If there is only one speculator, the whole of the gain from buying cheap and selling dear will be pocketed by him. If there are many speculators they will turn the price against themselves so that their share of the gain becomes relatively small.

If there are enough speculators and if they make cor­rect guesses, the whole of speculative gain might disappear and all the benefits will accrue to con­sumers. This is what is meant by the phrase “per­fect speculation kills itself”.

Speculation should not be confused with gam­bling. Gambling is a bad thing because it involves a sterile transfer of money between individuals, cre­ating no new value. While creating no new value gambling does nevertheless absorb time and re­sources. Gamblers try to make a quick profit by assuming unnecessary risks. They often themselves deliberately create the risks which they bear.

On the other hand a speculator assumes necessary and natural risks. There is a risk in production which must be assumed by somebody if production is to run smoothly. In other words, speculation leads people to take up business dealings which carry risks but it does not encourage people to engage in a blind search from quick and easy gain.

That is why gambling is condemned as anti-social but speculation is considered useful to the producers.

Functions of Speculation:

Speculators perform many important func­tions:

  • First, speculators promote stability of prices by reducing the gap between demand and supply. If at a particular point of time, there is an excess supply of a commodity and the price becomes low, the speculator buys it and holds it for sale in the future when the commodity will be in short sup­ply.

Such action reduces the present supply and prevents prices from falling as much as they would have and increases the future supply thus prevent­ing prices from rising then as high as they would otherwise have. Thus, as a result of the functions of the speculators, the range of price fluctuations becomes less.

  • Secondly, speculators reduce the risks of pro­duction by enabling manufacturers to buy raw materials in the future at current prices. Modern production organisation involves risks. In primi­tive communities, there were practically no risks because each man produced for himself and con­sumed what he produced.

But in a modern society production is carried on in anticipation of future demand. All types of productive activity involve risks and uncertainty. It is the special functions of the speculators to assume these risks and help to increase production.

  • Thirdly, stock exchange speculation performs another social objective. Investment in capital mar­ket is guided by speculation. Since shares can be easily bought and sold, the cause of long-term in­vestment is promoted by the existence of stock markets. Again, if speculators are well informed, the prospects of different classes of industrial es­tablishments will be reflected in the present quota­tions of stock prices.

The ordinary lay investor will thus get a reliable guide in stock market quotations for the proper disposal of his savings. The entre­preneur may also raise fresh capital funds by issu­ing fresh shares through the stock market. Thus stock exchange speculator helps the investor, the manufacturer as well as speculator himself.

Stock Exchange Speculation:

Speculation in shares is an important form of speculation. Security prices change frequently due to the uncertainty of their future yield about which market expectations vary frequently. Security prices also vary owing to the varying liquidity preference of the public. In the stock exchange there are al­ways some speculators who expect that the prices of securities will rise and others who expect that the prices of security will fall.

Those who expect that security prices will rise are known as ‘bulls’ while those who expect that security prices will fall are known as “bears’. If all were bulls and there were no bear’s security prices would go on rising indefi­nitely and there would be no equilibrium level of security prices.

Conversely if all were bears and none was a bull security prices would go on falling down to zero level. But things seldom go on in this way. As prices go on rising, some of those who pre­viously thought prices were too low might be in­duced to revise their expectation? and night be transformed into bears.

Similarly, when prices go on falling, some of those who previously thought that prices were too high might be induced to re­vise their expectations and might be transformed into bulls.

A share market is said to be a bull mar­ket if the bullish sentiment is greater than the bear­ish sentiment and it is said to be a bear market if the bearish sentiment is more powerful than the bullish sentiment. Both bulls and bears are always there in every stock market.

Similar to “futures’ contracts in the commod­ity markets there are dealings in ‘futures’ in the stock market. A speculator in the securities market sells “short’ when he contracts to deliver shares to a buyers at some future date at a price fixed at present. The ‘short seller’ is a bear who expects a fall in the future spot price and who hopes to fulfill his con­tract offer buying shares at the future expected low price.

Just as bears are counter balanced by bulls in the spot market similarly in the futures market the short seller is counter balanced by the “margin buyer’. Margin buying is in effect a contract to de­liver money at a future date in return for shares purchased now. The margin buyer is a bull he ex­pects a future rise in the price of shares and hopes to be able to sell his securities at a profit before the date.

Evils of Speculation:

There are two types of speculation simple or competitive speculation and aggressive or monopo­listic speculation. All the benefits of speculation are the benefits of competitive speculation. But we of­ten come across aggressive or monopolistic specu­lation where rich and powerful persons try to ma­nipulate the market price by their own bulk trans­actions so as to extract profits for themselves.

Such profits constitute a form of tribute which they are able to extort from society. Aggressive speculation does not make for an optimum allocation of re­sources—rather it moves society away from such optimum allocation. Instead of reducing price dif­ferences it aggravates such differences and prevents competitive forces from bringing about an equalisation of prices over time and space.

The remedy for monopolistic speculation is as Prof. Lerner suggests, counter speculation. A Govt. agency may fix up appropriate prices and guarantee them to buyers and sellers and may thus make it impossible for any powerful speculator to manipulate prices. Statutory price fixation backed up by governmental resources alone can save soci­ety from the consequences of the predatory activi­ties of aggressive speculation.

Speculation of the type which is beneficial to society is called legitimate speculation; specu­lation by ill-informed persons and by men who try to rig the market is called illegitimate speculation. Legitimate speculation is beneficial to society and as such requires no control. But illegitimate specu­lation is an evil and as such should be suppressed. The remedies suggested are generally inadequate.

One remedy against illegitimate speculation is the passing of legislation prohibiting such action. But there are loopholes in all legislations. It is for this reason that Prof. Taussig said that the most effec­tive remedy is a better moral standard for all in­dustry and an arousal of public opinion against all kinds of gambling.

According to Lord Keynes stock exchange speculation is responsible for much of the insta­bility of the current economic order. If expert speculators are actually engaged in forecasting the future prospects of a concern, they might confer a great benefit to society. As a matter of fact, few speculators have the intelligence, energy to fore­cast correctly the future prospects of a concern.

The wide fluctuations that often take place in security prices are due to conventional valuation of a large number of ignorant individuals. Keynes has aptly said that speculators may do no harm as bubbles on a steady stream of enterprise.

But the position becomes serious when enterprise becomes the bub­ble on a whirlpool of speculation. When the capi­tal development of country becomes a by-product of the activities of a Casino, the job is likely to be ill-done.

Types of Speculators

The speculators are classified into four categories such as

  • Bull
  • Bear
  • Stag
  • Lame Duck
  1. Bull: A bull is an optimistic speculator. He expects a rise in the price of the securities in which he deals. Therefore, he enters into purchase transactions with a view to sell them at a profit in the future. If his expectation becomes a reality, he shall get the price difference without actually taking delivery of the securities.
  2. Dear: A bear is a pessimistic speculator who expects a sharp fall in the prices of certain securities. He enters into selling contracts in certain securities on a future date. If the price of the security falls as he expects he shall get the price difference.
  3. Stag: A stag is considered as a cautious investor when compared to the bulls or bears. He is a speculator who simply applies for fresh shares in new companies with the sole object of selling them at a premium or profit as soon as he gets the shares allotted.
  4. Lame Duck: When a bear is unable to meet his commitment immediately, he is said to be struggling like a lame duck.
Bangalore University BBA Notes

Trade Settlement Procedures

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In the stock market, there is always a buyer and a seller. So, when a person buys a certain number of shares, there is another trader who sells the shares. This trade is settled only when the buyer receives the shares and the seller receives the money.

There are three phases in a secondary market transaction:

  1. Trading
  2. Clearing
  3. Settlement
  • Trading 

In the stock market, a large number of trades occur simultaneously. The stock exchanges use an electronic order matching system to match ‘buy’ and ‘sell’ orders from different traders. This way, each trade is executed.

For instance, imagine that stock ‘X’ is trading in the stock market.

The buy and sell orders for this stock are as follows:

Here the costliest buy prices are matched against the cheapest available sell prices, and whenever the buy price is less than or equal to the best available sell price a match is done. This of course also depends on the respective quantities available in the market across buys and sells and is known as market depth.

So even if a particular price may result in a match, if there is not enough quantity available at the seller side at that price, the buy order will still not be fully traded.

The market depth is created by brokerages who collect orders from different investors and pass it on to the stock exchanges, most likely to be the two most popular exchanges in India the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). In this process, brokerages act as the intermediary between the investor and the stock exchange.

  • Clearing

Once two orders match and a trade is executed, the clearing process takes place. Clearing is the identification of what security is owed to the buyer and how much money is owed to the seller. The entire process is managed by ‘clearing houses’. These are independent entities.

For example, imagine that there are two traders: Ramesh and Suresh.

However, in the real market scenario, traders tend to conduct multiple transactions. As a result, the clearing house identifies all the transactions and the net amount or net securities owed to the trader are calculated.

  • Settlement

The next step is to fulfil the financial obligations identified in the clearing step. This involves the transaction settlement for the buyers and sellers.

So once the buyer receives the security and the seller receives the payment, the transaction is settled.

Participants Involved in the Process

  • Clearing Corporation

Clearing corporation is one of the major participants involved in clearing and settlement process in stock market. The responsibility for clearing and settlement of trade executed at the stock exchange lies on the National Securities Clearing Corporation Limited (NSCCL). It is also in charge of risk management and is obligated for meeting all settlement regardless of the member defaults.

  • Clearing Members/Custodians

They are another participant in the clearing and settlement process in Indian stock market. When trading members place deals in the stock exchange, the same is moved to NSCCL, which transfers them to the clearing members. The clearing member is in charge of determining the position of share to suit the trade.

  • Clearing banks

Clearing banks are responsible for the settlement of funds. There are 13 clearing banks, and each clearing member needs to open a clearing account with either one of them. In case of a pay-out, clearing members receive funds in the clearing account and in case of pay-in they need to make funds available.

  • Depositories

There are two depositories in India – National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). These two depositories hold your Demat account, and clearing members also need to maintain a clearing pool account with them.

Clearing members need to transfer the securities to the clearing pool account they hold with the depositories on the date of settlement.

  • Professional Clearing Members

These are special category members appointed by the NSCCL. However, note that they are not allowed to trade, and they can only clear and settle trades executed for their clients. Professional clearing members generally constitute banks, custodians, etc.

Bangalore University B.com Notes / Bangalore University BBA Notes

Depositories in Stock Market

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In India, a Depository Participant (DP) is described as an Agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act. In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the sub section 1A of Section 12 of the SEBI Act. As per the provisions of this Act, a DP can offer depository-related services only after obtaining a certificate of registration from SEBI. As of 2012, there were 288 DPs of NSDL and 563 DPs of CDSL registered with SEBI.

SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers, R&T agents and non-banking finance companies (NBFC), for granting them a certificate of registration to act as DPs. If a stockbroker seeks to act as a DP in more than one depository, he should comply with the specified net worth criterion separately for each such depository. No minimum net worth criterion has been prescribed for other categories of DPs; however, depositories can fix a higher net worth criterion for their DPs.

Basics of Depository

Depository is an institution or a kind of organization which holds securities with it in De-Mat form, in which trading is done among shares, debentures, mutual funds, derivatives, F&O and commodities. The intermediaries perform their actions in variety of securities at Depository on behalf of their clients. These intermediaries are known as Depositories Participants (DPs). Fundamentally, there are two sorts of depositories in India. One is the National Securities Depository Limited (NSDL) and the other is the Central Depository Service (India) Limited (CDSL). Every Depository Participant (DP) needs to be registered under this Depository before it begins its operation or trade in the market.

Demat Account Opening

A demat account is opened on the same lines as that of a Bank Account. Prescribed Account opening forms are available with the DP, needs to be filled in. Standard Agreements are to be signed by the Client and the DP, which details the rights and obligations of both parties. Along with the form the client requires to attach Photographs of Account holder, attested copies of proof of residence and proof of identity needs to be submitted along with the account opening form.

In case of Corporate clients, additional attachments required are true copy of the resolution for Demat a/c opening along with signatories to operate the account and true copy of the Memorandum and Articles of Association is to be attached.

Services provided by Depository

  • Dematerialisation (usually known as demat) is converting physical certificates of Securities to electronic form
  • Rematerialisation, known as remat, is reverse of demat, i.e. getting physical certificates from the electronic securities
  • Transfer of securities, change of beneficial ownership
  • Settlement of trades done on exchange connected to the Depository
  • Pledging and Unpledging of Securities for loan against shares
  • Corporate action benefits directly transfer to the Demat and Bank account of customer

No. of Depository in the country

Currently there are two depositories operational in India.

  • National Securities Depository Ltd. – NSDL – Having 2 crores Demat A/c as on 30-06-2020
  • Central Depository Services Ltd. – CDSL – Having 2.3 crores Demat A/c as on 30-06-2020

Depositories Act 1996

The definition of depositories under the Depositories Act, 1996 is that a “depository” is a company registered under the Companies Act, 1956. It would be granted a certificate of registration under Section 12 subsection (1A) of Securities and Exchange Board of India Act (SEBI), 1992. Hence the Depository becomes an organization like a central bank.  The main role of Depositories is to dematerialize the securities which mean converting the securities from physical form to electronic form and enabling transactions in electronic form. The depository needs to obtain a certificate of commencement of business from SEBI. At present two Depositories are functioning in India:

  • National Securities Depository Limited (NSDL)
  • Central Depository Services (India) Limited (CDSL)

Depository Participant (DP)

The Depository Participant is the link between the owner of the securities and the depositors. He is deemed to be an agent of the depository. Accordingly, he is authorized to offer depository services to investors. As per SEBI regulations and Depository Act, a depository cannot interact directly with beneficial owners. He has to deal with its agents called Depository Participant. Neither can the investors directly approach the depository for any services. They have to interact through the DP.

Services provided by a depository

The following services are provided by a depositor through a DP:

  1. Opening a Demat Account

The first step is to open a Demat Account. Demat Account is the short form for Dematerialisation Account. It is the process of holding investments like mutual funds, shares, bonds, government securities, etc. It does away with the hassles of maintenance of physical documents.

  1. Dematerialization

This process is the conversion of physical shares to electronic shares. When a shareholder uses this facility, the Company takes back the physical shares through the depository system and equal numbers of shares are credited into the shareholder’s account.

  1. Rematerialization

This is the exact opposite of Dematerialization. Here physical securities are issued in place of securities in electronic form. 

  1. Other services

Pledging Dematerialized shares

Dematerialized shares can be pledged. After the loan is repaid a request can be made through one’s DP to close the pledge through a standard format.

Initial Public Offerings

Public offer credits can be directly received into the Demat account.

Receipt of cash/non-cash benefits

When rights or bonus or dividend is announced by any corporate event for a particular security, the depository will give the details of all the clients having electronic holdings to the registrar as on that date. The registrar will then calculate the benefits due to all the shareholders.

Stock lending and borrowing

Securities in the Demat form can be easily lent/ borrowed. Instructions are to be given to DP through a standard format (which is available with DP).

Transmission of securities

In case there is a need for transmission of securities due to death, lunacy, bankruptcy, insolvency, or by any other lawful means, it is possible through the depository system. The claimant will have to fill in a transmission request form supported by valid documents.

Freezing Account with DP

If at any time one wishes that no transaction should be effected in one’s account, one may advise one’s DP accordingly. DP will freeze the account of the investor until further instructions.

Dematerialization process

  1. Appointing DP

The investor chooses a DP of his choice and opens an account with him.  The process will be just like opening an account with a bank. The Investor gets an identification number called Client ID. This is just like the bank account number. This no is the reference point for all transactions with DP. Every investor with the help of a DP has to agree with a depository to get his holding dematerialized. This step is necessary whether an investor already has securities or securities are yet to be issued in a fresh issue.

  1. “Demat” Request

The investor makes an application to DP’s in a form called Dematerialisation Request Form is known as DRF.  This form is provided by the DP, the investor hands over his share certificates after cancelling them in writing. The certificates are then surrendered to get dematerialized for Demat. The DP will accept certificates registered only in the investor’s name.

  1. Verification and confirmation by Registrar

The depository electronically intimates the issuer or its Registrar of the dematerialization request. The issuer or the Registrar has to verify the security certificates. He also has to verify that the DRF has been made by the person recorded as a member in its Register of Members. Once the Registrar is satisfied, it dematerializes the scrip and updates its record. The Registrar then authorizes electronic credit for that security in the investor’s favour and informs the depository of the same.

  1. Crediting the Client’s Account

The investor’s account is credited by DP with the number of shares dematerialized. After this, the investor holds the securities in electronic form. The investor gets the information in the form of a statement.  However, in case, there is a rejection then such credit is not given.

Features of the Depository System in India

  1. Securities in dematerialized form

The depository model is more or less similar to holding funds in bank accounts. Transfer of ownership of securities is done through simple account transfer. This method is simpler and avoids cumbersome paperwork.

  1. Fungibility

Fungibility means an asset can be interchanged with another asset of a similar type. The dematerialized securities are not identified by share certificate numbers. Hence all securities which are in the same class can be interchanged.

  1. Registered and beneficial owner

There are two types of ownership of securities. One is a registered owner and the other is a beneficial owner. For all the dematerialized securities, NSDL is the registered owner but ownership rights, duties and liabilities are with beneficial owners.

  1. Easy transferability of shares

The transfer takes place freely through the electronic system and dispenses the procedural formalities related to paperwork.

  1. No stamp duty

For the transfer of physical shares, then the stamp duty of 0.5% is payable on the market value of the shares. However, there is no such duty on the electronic form.

  1. No risk

Physical certificates have issues like loss in transit, theft, bad deliveries, etc. There is hardly any risk involved in the electronic system as compared to physical certificates.

Management Notes

Key differences between Stock Market and Commodities Market

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Stock Market is a platform where shares of publicly listed companies are bought and sold. It enables companies to raise capital by issuing equity, while providing investors the opportunity to earn returns through price appreciation and dividends. The stock market plays a vital role in economic development by facilitating investment and wealth creation. In India, the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are major stock exchanges. Market participants include retail investors, institutional investors, and traders. The stock market operates under strict regulations set by SEBI to ensure transparency, investor protection, and orderly trading practices.

Characteristics of Stock Market:

  • Liquidity

The stock market offers high liquidity, allowing investors to quickly buy or sell securities with minimal price fluctuation. Liquidity ensures that market participants can enter or exit positions with ease, encouraging more participation. Highly liquid markets reduce the risk of holding stocks and promote investor confidence. Stock exchanges like NSE and BSE maintain continuous trading systems and order-matching mechanisms to ensure seamless transactions. Liquidity also helps in accurate price discovery, ensuring that stocks are traded at fair market value based on real-time demand and supply. This makes stock investing more accessible and less risky.

  • Transparency and Regulation

The stock market operates under strict regulation and supervision by the Securities and Exchange Board of India (SEBI). SEBI ensures transparency, investor protection, and fair trading practices. All listed companies are required to disclose financial results, shareholding patterns, and material information regularly. Real-time data on prices, volumes, and market movements are available to the public. These measures foster trust and credibility in the market. Transparency helps investors make informed decisions and keeps manipulative practices like insider trading and market rigging in check, ensuring the integrity and stability of the capital market ecosystem.

  • Price Discovery

Price discovery is a core characteristic of the stock market. It refers to determining the correct price of a stock based on demand and supply dynamics. Prices fluctuate continuously as investors react to company performance, economic indicators, interest rates, global trends, and news. Efficient price discovery ensures that stocks are traded at their intrinsic value, benefiting both buyers and sellers. The open and competitive nature of stock exchanges helps in establishing fair market prices. This feature is crucial for investment analysis, wealth management, and decision-making for all market participants including institutions and retail investors.

  • Risk and Return

The stock market offers potentially high returns but is also associated with risk. Stock prices are volatile and may be affected by factors like economic downturns, company performance, political events, or investor sentiment. While long-term investors may benefit from capital appreciation and dividends, short-term traders face uncertainty. Understanding risk is crucial in building a balanced portfolio. Risk-return tradeoff plays a key role in investment strategies, influencing decisions regarding asset allocation and diversification. Investors must conduct research or seek expert advice to manage risks effectively while pursuing optimal returns in the dynamic stock market environment.

  • Market Indices

Market indices like Nifty 50 and Sensex represent a group of selected stocks and serve as benchmarks to measure overall market performance. These indices reflect investor sentiment and are widely used by fund managers, analysts, and policymakers. Indices help in comparing the performance of a stock, mutual fund, or portfolio with the market. They also serve as the basis for index funds and derivatives trading. Regular updates and reviews ensure the relevance of index composition. By tracking indices, investors can assess broader economic trends and take informed investment decisions based on market direction.

  • Volatility

Volatility refers to the degree of price fluctuation in the stock market. It can be caused by economic reports, corporate earnings, geopolitical tensions, policy announcements, and investor behavior. While high volatility may present profit opportunities for traders, it also increases risk. Market volatility is measured by indicators like the India VIX Index. Stock exchanges use tools like circuit breakers to control extreme fluctuations and maintain market stability. Understanding volatility is essential for risk management and setting realistic return expectations. Both short-term traders and long-term investors must adapt strategies according to market volatility levels.

  • Accessibility

Modern stock markets are highly accessible due to digital platforms and mobile trading apps. Anyone with a demat and trading account can invest or trade in stocks, ETFs, or mutual funds from anywhere. Stockbrokers offer online research, portfolio management tools, and educational resources to assist investors. Lower transaction costs, faster settlements, and real-time updates have made equity markets more inclusive. Regulatory reforms like e-KYC and Aadhaar-based onboarding have further simplified access. As a result, participation from small investors and millennials has increased, promoting financial inclusion and broader capital market development in India.

  • Wide Range of Instruments

The stock market offers a wide variety of instruments such as equities, derivatives (futures and options), ETFs, REITs, and IPOs. Investors can diversify their portfolios based on risk tolerance and investment goals. Equity instruments are suitable for long-term growth, while derivatives cater to hedging and speculation. ETFs and index funds provide low-cost exposure to broad market segments. New-age investment vehicles like Sovereign Gold Bonds and Infrastructure Investment Trusts (InvITs) are also gaining popularity. This diversity attracts different investor classes—retail, institutional, foreign—and contributes to the depth and maturity of Indian capital markets.

Commodities Market:

Commodity Market is a financial marketplace where raw materials or primary products such as gold, silver, crude oil, agricultural goods, and metals are bought and sold. It enables producers, traders, and investors to hedge against price volatility, speculate for profit, and discover fair prices. The market operates through spot markets (immediate delivery) and derivatives markets (futures and options contracts). In India, the major commodity exchanges include Multi Commodity Exchange (MCX) and National Commodity and Derivatives Exchange (NCDEX). The market is regulated by SEBI, ensuring transparency, fair practices, and investor protection in commodity trading.

Characteristics of Commodities Market:

  • Physical and Derivative Trading

The commodities market offers both physical (spot) and derivative (futures and options) trading. Physical trading involves immediate delivery and payment for the commodity, while derivative trading allows participants to speculate or hedge price risks through contracts settled at a future date. Physical markets cater to producers, wholesalers, and industrial users, while derivatives attract speculators and investors. This dual structure makes the commodities market versatile, supporting both real economic needs and financial risk management strategies.

  • Standardization

Commodities traded on organized exchanges like MCX (Multi Commodity Exchange) and NCDEX are standardized. This means that the quality, quantity, and delivery terms of the contracts are fixed and predefined. Standardization ensures uniformity, transparency, and fairness in trading. It also minimizes disputes and simplifies the settlement process. For instance, gold contracts are specified by purity and weight. This standardization makes it easier for market participants to compare contracts, understand pricing, and execute trades confidently.

  • Price Volatility

Commodity prices are highly volatile and influenced by global supply-demand factors, weather conditions, geopolitical tensions, currency fluctuations, and government policies. For example, crude oil prices may spike due to a conflict in the Middle East, while agricultural prices can vary with monsoon conditions. This volatility presents both opportunities and risks. It attracts traders aiming to profit from price movements but also increases uncertainty for producers and consumers, who use derivatives to hedge against adverse price fluctuations.

  • Global Integration

The commodities market is globally integrated, with prices influenced by international benchmarks such as Brent Crude for oil or COMEX for gold. Events in one part of the world can quickly impact prices in another. Indian markets, too, are affected by global demand-supply trends and international political or economic events. Global integration improves liquidity and ensures competitive pricing but also exposes domestic markets to global shocks and volatility, making it essential for participants to stay informed.

  • Hedging Function

One of the key purposes of the commodities market is risk management through hedging. Producers, exporters, importers, and consumers use futures and options contracts to lock in prices and protect themselves from adverse price movements. For example, a farmer may hedge against falling wheat prices, while a jewelry manufacturer may hedge against rising gold prices. This function adds stability to business operations and promotes efficient planning, especially in sectors heavily dependent on raw material costs.

  • Speculation and Arbitrage

The commodities market attracts a large number of speculators who seek to profit from price movements without any intention of physical delivery. Speculation adds liquidity and depth to the market but also increases volatility. Arbitrage opportunities arise when price differences exist between markets or contract maturities, allowing traders to profit by buying low and selling high. These activities contribute to price discovery and market efficiency, though excessive speculation may lead to abnormal price swings.

  • Regulation and Surveillance

The commodities market in India is regulated by SEBI (Securities and Exchange Board of India). It ensures fair trading practices, investor protection, and financial stability. SEBI supervises commodity exchanges, mandates reporting norms, and monitors price movements to detect manipulation or cartelization. Regular audits, trading limits, and margin requirements are part of the regulatory framework. Effective regulation enhances market integrity, boosts investor confidence, and ensures a level playing field for all market participants.

  • Wide Range of Commodities

The commodities market covers a diverse range of products grouped into agricultural commodities (wheat, cotton), metals (gold, silver, copper), and energy products (crude oil, natural gas). This variety allows for portfolio diversification and provides opportunities for different industries and investors. Each commodity has its own pricing dynamics, seasonal trends, and risk factors. The wide product base attracts participants with different risk profiles and goals, contributing to the overall vibrancy and utility of the commodities market.

Key differences between Stock Market and Commodities Market

Aspect

 Stock Market Commodities Market
Asset Type Securities Physical Goods
Product Examples Shares, ETFs Gold, Oil, Wheat
Trading Focus Ownership Price Movement
Delivery No Delivery Physical/Settlement
Regulation SEBI SEBI
Volatility Moderate High
Market Players Investors Hedgers, Traders
Contract Type Equity, Derivatives Futures, Options
Price Influencers Financials, News Supply, Demand
Time Horizon Long-Term Short-Term
Standardization Company-Specific Uniform Contracts
Global Influence Limited

High
Bangalore University BBA Notes

Meaning of commodity and Commodity Markets

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Commodity market facilitates an exchange of physical goods among residents in a country. Individuals aiming to diversify their portfolio can undertake investments in both perishable and non-perishable products, thereby not only mitigating the risk factor, but also providing a hedge against inflation rates in an economy.

Types of Commodities in the market, available for trading are categorized into the following classes, based on their inherent nature:

Hard commodities:

Precious metals: Gold, platinum, copper, silver, etc.

Energy: Crude oil, Natural gas, gasoline, etc.

Soft commodities:

Agriculture: Soybeans, wheat, rice, coffee, corn, salt, etc.

Livestock and meat: Live cattle, pork, feeder cattle, etc.

As of 2019, some examples of commodities in the market that were most commonly traded in major commodity exchanges in India included crude oil and silver. While crude oil acts as one of the most important energy sources required for virtually every industry, silver is one of the most precious metals other than gold with a steady demand.

As crude oil is not domestically available in abundance, almost 82% of it is imported from OPEC and Middle Eastern countries. Similarly, silver is traded in extensive quantities from countries such as Mexico, Peru, etc.

Investing in the Commodity Market

Commodity trading is managed by four major commodity exchanges in India:

  1. Multi Commodity Exchange (MCX)
  2. Indian Commodity Exchange (ICEX)
  3. National Commodity and Derivatives Exchange (NCDEX)
  4. National Multi Commodity Exchange (NMCE)

All activities of such nationwide exchanges come under the regulation of Commodity Derivatives Market Regulation (CDMRD) of Securities and Exchange Board of India, which merged with Forward Market Commission in 2015.

Commodity markets facilitate an exchange of both physical goods and derivative contracts while the physical exchange is undertaken by institutional investors and commodity brokers aiming to realise gains through the resale of the products in the retail sector of the country.

Conversely, a derivative contract does not require a physical store of the goods procured, as individuals can trade commodities online through digitised contracts, making the transaction hassle-free and convenient.

Investors can practice investing in commodity markets through a futures or options contract. While a futures contract dictates individuals to sign a deed stipulating delivery of a product at a later date with respect to a fixed price, an options contract acts as an agreement but not a liability of the same.

Futures contracts

Future derivative trading is most common in the commodity market, wherein sellers sign a futures agreement with brokers/buyers to purchase a stipulated quantity of products at a given price. While a downtrend in the market prices can help sellers realise margin profits, a rising price can help buyers or brokers profit from the transactions.

If such trade is supervised by commodity exchange, it is known as a future derivative contract. Any settlement between two parties without any overseeing exchange is known as over the counter exchange trading.

Both exchange-traded and derivative future contracts are undertaken by two primary classes of investors producers aiming to reduce fluctuations in final good price, and speculators aiming to profit from the volatility of a futures contract.

Options contracts

As of 2017 SEBI regulations, options trading can be practised while investing in top commodities wherein traders enjoy a right but not obligation to purchase/ sell a commodity derivative at a fixed price. Partaking in commodity investment through such agreements help individuals profit from any market fluctuations, as no obligation regarding the purchase or sale of products is imposed on either of the parties, depending upon the type of options contract.

Relationship of the Commodity Market and Stock/Bond Market 

One of the features of a commodity market is that its performance demonstrates an inverse relation with both stock and bond markets, as the bond and stock prices fall when the average price level of goods rise in the economy.

During times of rising aggregate price level or inflation, the prices of commodities traded on respective exchange rises significantly. As extreme inflation has a negative impact on consumers, the government often tries to tackle the situation by increasing the domestic lending rates through a repo rate hike. As the cost of borrowing rises, investors often reduce their speculative demand for stock market investments, making the prices of capital sector plummet.

The bond market is also affected as a result of such a hike in the lending rates levied by scheduled commercial banks, as interests on respective savings tools rise. Consequently, fixed coupon bonds indicate a relatively less profitable investment venture, thereby creating a surplus amount of bonds with reduced demand, causing bond prices to fall.

While bond and stock prices move in the opposite direction as compared to commodity prices, investment in commodities, especially in precious metals and energy sources, tend to generate significant returns for investors.

Traders in a Commodity Market

The commodity markets holds importance for two kinds of individuals based on the commodity market operations they partake in:

Hedgers

Such investors aim to reduce exposure to market volatility by entering into a futures contract with traders. Any change in the price level does not affect the rate at which respective commodities are traded in the market. Most hedgers trade physical goods in the commodities market, as they require the stipulated goods or production or resale purposes.

  • Speculators 

Investors aiming to generate substantial profits from trade in the commodity market are termed as speculators. A prediction regarding the direction of movement of market prices are assumed by such individuals before signing a futures contract, and depending upon accuracy of market forecast, positive or negative returns can be realised, subject to spot prices.

Speculators don’t desire physical possession of the goods traded, and hence, opt for a cash settlement to reduce the hassles of physical trading.

Price Determination

The prices of commodity markets are heavily dependent on the market demand and supply of commodities, both domestically and from foreign sources. Speculative news also affects the commodity prices heavily, as socio-economic conditions deeply influence the productive capacity of respective companies.

The factors affecting commodity prices in an economy are discussed below –

  • Market demand and supply

Market demand and consequent supply of goods traded on a commodity exchange heavily influence the market price. A rising demand (for any reason) can cause prices to rise in the short run, as supply cannot be increased immediately to compensate for the higher demand in the market. Generally, such a rise in demand can be attributed to a pessimistic performance outlook towards the stock market, thereby causing investors to shift towards relatively safer investment avenues.

  • Global scenario 

Global indicators play a crucial role in determining the prices of commodities available internally in a country. For example, any turmoil in the Middle Eastern countries can affect the prices at which crude oil is exported, thereby affecting the prices at which it is traded domestically.

A significant example can be cited in this respect when a supply shock was experienced by all major countries in the world triggered by Iraq-Kuwait tensions in the 1990s.

  • External factors

Any condition affecting the total production of stipulated goods traded in an exchange can cause price changes accordingly. For example, a rise in the cost of production can drive up the prices at which a product is sold in the market, consequently affecting the equilibrium rate.

Also, the performance of the stock and bond market has an effect on the prices of commodities, as a negative viewpoint regarding their performances tends to divert investors towards commodity market securities. Individuals often trade in commodity derivatives to compensate for stock market risks, or to safeguard their portfolio from stock market downturns.

  • Speculative demand

Demand for derivative investing in commodities online can arise from speculative investors, who aim to realise profits through market price fluctuations. Speculators often make predictions regarding the direction of movement of prices and aim to close the contract before the expiration date to realise capital gains on total gains.

Individuals unwilling to take physical delivery of the goods can opt for cash settlement contracts, whereby upon completion of the tenure of the futures contract, the difference between the price in spot trading and price stated in the futures contract has to be paid.

Depending upon the market assumptions, individuals can assume either a short or a long position in a futures contract. Investors expecting the price to drop in the future can undertake a short position (sell the security at a fixed price on a stipulated date) to realise profits through a fall in the market price. On the other hand, if individuals expect the price of a commodity future contract to rise in the future, they can opt to go long (buy the security at a fixed price on a stipulated date) so as to sell the same at higher prices in the future.

Nonetheless, a futures contract tends to merge with the spot price at which a commodity is trading at a future date, as prices adjust automatically at the expected level.

  • Market outlook

Any unforeseen fluctuations in the stock market can cause investors to shift towards commodity trade, as chances of severe fluctuations in prices of certain commodities such as precious metals are low. Hence, commodity market investments are secure in nature and act as a hedge against inflation for risk-averse individuals.

Limitations

  • High risk

The commodity market is volatile, as any fluctuations in the productive capacity, demand, or changing social circumstances readily affect the prices. Due to such high volatility, predicting the movement of commodity prices might be challenging, causing investors to lose out substantial returns due to unforeseen market events.

Hence, individuals need to be well-equipped with both the internal working of an economy as well as external factors such as international trade before choosing to trade in commodities. Additionally, the demand and supply patterns should be kept in mind to mitigate the risk further.

  • Limited returns:

While stock and bond markets have periodic pay-outs such as dividend yields, coupon payments, etc. commodity investment can only generate capital gains.

While commodity market investments can reap significant returns, substantial expertise is required for the same. Nonetheless, individuals can trade in goods through any established commodity exchange by registering with a commodities broker.

Management Notes

Private placements of Shares

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Private placement, the issue is placed directly with a few selected small number of investors. This is also known as non-public offering. Typical investors include large banks, mutual funds, insurance companies and pension funds. The private placement does not have to be registered with the Securities and Exchange Commission.

Private placements are much cheaper than IPOs. However, this method cannot be used for large issues because a small group of investors will have limited risk appetite. Also, these issues are not traded in the secondary market, as opposed to IPO securities, which once listed are traded in the secondary market. This makes it difficult for investors to liquidate these securities.

The term private placement refers to the sale of securities to a small number of private investors to raise capital. These private investors include mutual fund investors, banks, insurance companies and etc. Private placements are different from public issue since in the latter one the shares are sold in the open market to anyone willing to buy them whereas in private placements of shares the shares are sold to specific investors.

Private placement is a method of raising capital in which securities are sold directly to a selected group of investors rather than through a public offering. This targeted approach allows companies to raise funds from a specific set of investors, often institutions or high-net-worth individuals, without the need for public registration. Private placements are regulated by securities laws, and the process involves meticulous planning, compliance, and negotiations between issuers and investors.

Private placement is a valuable tool for companies seeking to raise capital efficiently while maintaining a degree of confidentiality. It provides flexibility in structuring deals, selecting investors, and tailoring terms to meet specific needs. While private placements may not be suitable for all companies, they offer a strategic avenue for raising capital, attracting strategic partners, and fueling growth in a controlled and efficient manner. Companies considering private placements should carefully assess their capital needs, regulatory obligations, and strategic goals before engaging in this form of capital raising.

Features of Private Placement:

  1. Limited Investor Pool:

Private placements involve a restricted number of investors. This targeted approach allows issuers to negotiate terms with a select group, often chosen based on their strategic alignment with the company’s goals.

  1. Exemption from Public Registration:

Unlike public offerings, private placements are exempt from the rigorous public registration process. This exemption is provided under various securities regulations, such as Regulation D in the United States or the SEBI (Securities and Exchange Board of India) guidelines in India.

  1. Negotiable Terms:

Issuers and investors have more flexibility in negotiating the terms of the private placement. This includes aspects such as pricing, the structure of securities, and any covenants or conditions attached to the investment.

  1. Diverse Securities:

Private placements can involve a variety of securities, including equity, debt, convertible securities, or preferred shares. The choice of security depends on the company’s capital needs and the preferences of investors.

  1. Customized Agreements:

The terms and conditions of private placement agreements are often customized to suit the specific needs of both parties. This flexibility allows for tailoring the investment structure to align with the company’s strategy.

  1. Confidentiality:

Private placements offer a level of confidentiality that is not present in public offerings. Companies can raise capital without disclosing sensitive information to competitors or the broader market.

Regulatory Framework for Private Placement:

While private placements offer flexibility, they are subject to regulatory oversight to protect the interests of investors. The regulatory framework varies by jurisdiction, but common elements:

  1. Accredited Investors:

Many jurisdictions restrict private placements to accredited investors, who are deemed to have the financial sophistication to understand and assess the risks associated with these investments.

  1. Exemptions from Registration:

Private placements are exempt from the full registration requirements that public offerings must undergo. However, issuers must comply with specific regulations governing private placements.

  1. Disclosure Requirements:

While private placements provide confidentiality, issuers are still required to provide certain disclosures to investors. These disclosures may include financial statements, risk factors, and other relevant information.

  1. Limited Marketing and Solicitation:

The solicitation of investors in a private placement is limited compared to public offerings. Issuers must be cautious in their approach to avoid violating regulations related to marketing and advertising.

  1. Resale Restrictions:

Investors in private placements may face restrictions on selling their securities in the secondary market. These restrictions help maintain the private nature of the placement.

Advantages of Private Placement:

  1. Efficiency and Speed:

Private placements are generally faster and more cost-effective than public offerings. The absence of extensive regulatory reviews and public registration processes accelerates the capital-raising timeline.

  1. Selective Investor Engagement:

Issuers can choose investors strategically, targeting those with industry expertise, strategic alignment, or specific financial capabilities.

  1. Flexibility in Terms:

The negotiated nature of private placements allows issuers to tailor terms and conditions to meet the specific needs and goals of both the company and investors.

  1. Confidentiality:

Private placements offer a level of confidentiality, allowing companies to raise capital without divulging sensitive information to the public.

  1. Strategic Alignment:

By selectively choosing investors, companies can attract strategic partners who bring not just capital but also industry knowledge, networks, and expertise.

  1. Lower Costs:

The costs associated with private placements are generally lower than those of public offerings due to reduced regulatory requirements and marketing expenses.

Challenges and Considerations:

  1. Limited Capital:

Private placements may not be suitable for companies seeking significant amounts of capital, as the investor pool is restricted.

  1. illiquidity for Investors:

Investors in private placements may face challenges in selling their securities, as these transactions are often subject to restrictions.

  1. Regulatory Compliance:

Companies must navigate complex regulatory requirements to ensure compliance with securities laws. Failure to comply can result in legal consequences.

  1. Market Perception:

Companies choosing private placements may miss out on the visibility and market perception that comes with a public offering.

  1. Negotiation Complexity:

Negotiating terms with a select group of investors can be complex, requiring skilled negotiation and legal expertise to strike a mutually beneficial deal.

Provisions as per Companies Act

(1) A company may, subject to the provisions of this section, make a private placement of securities.

(2)  A private placement shall be made only to a select group of persons who have been identified by the Board (herein referred to as “identified persons”), whose number shall not exceed fifty or such higher number as may be prescribed [excluding the qualified institutional buyers and employees of the company being offered securities under a scheme of employees stock option in terms of provisions of clause (b) of sub-section (1) of section 62], in a financial year subject to such conditions as may be prescribed.

(3) A company making private placement shall issue private placement offer and application in such form and manner as may be prescribed to identified persons, whose names and addresses are recorded by the company in such manner as may be prescribed.

Statutory Provisions for Private Placement of Securities:

Private Placement of Securities is covered under Section 42 of the Companies Act, 2013 and Companies (Prospectus and Allotment of Securities) Rules, 2014. Private Placement is defined as any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through Private Placement Offer-cum-Application.

To whom can a Private Placement offer be made:

Private Placement Offer can be made to a prospective investor or any person who intends to invest a specific amount of funds in the Company against issue of securities. Offer to subscribe for the securities of a Company under Private Placement cannot be made to more than 200 persons in a Financial Year. If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or enters into an agreement to allot, securities to more than the prescribed number of persons, same shall be deemed to be an offer to the public.

Advertisement:

No advertisements, media marketing or distribution channels or agents to be used by the company to inform the public at large about such an issue.

Procedure:

Following procedure should be followed by the Company intending to issue securities under Private Placement:

  • Calling for the meeting of the Board of Directors of the Company to offer securities on Private Placement Basis.
  • Passing of Board Resolution for issue of shares under Private Placement to specified persons and calling for Extra-Ordinary General Meeting of the Company to take members approval.
  • Filing form MGT-14- Board Resolution for issue of shares under Private Placement.
  • Issuing notices to the shareholders for Extra-Ordinary General Meeting of the Company as per timelines or with shorter consents.
  • Passing Special Resolution in the Shareholders meeting for issue and allotment of shares under Private Placement.
  • Sending Offer cum Application Letters in form PAS-4 to identified persons within 30 days of recording the names of the identified persons. Such Offer cum Application Letters can be sent in electronic mode (emails) or by post.
  • Receiving allotment amount in a separate bank account within the offer period as mentioned in the Offer cum Application Letter.
  • The Company shall allot shares to the applicants who has subscribed for the same through application letter and deposited the subscription amount within the offer period.
  • After Closure of Offer Period call a Board Meeting and pass Resolution for Allotment of Securities to the entitled subscribers.
  • Filing of return of allotment in Form PAS-3 within 15 days from the date of the allotment i.e. After passing Board Resolution for allotment
  • Make sure the securities are allotted within 60 days of the receipt of Application amount by the Company.
  • Stamp Duty on allotment shall be paid @ 0.10% through channels as available in respective states. e.g. In Mumbai it can be paid to ESBTR or GRASS MAHAKOSH site
  • The Company will be allowed to utilize the money raised through Private Placement only after Return of Allotment in Form PAS-3 is filed with the Registrar of Companies.
  • Record of Private Placement should be maintained by the Company in prescribed Form PAS-5.
  • The Company should update its Registrar of Members in a proper manner upon completion of allotment.
Management Notes

Share Issue Mechanism

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The share issue mechanism refers to the process by which a company raises capital by issuing shares to investors. It is an important method for companies to fund expansion, operations, or other financial needs. The shares can be issued to the public, private investors, or existing shareholders. Regulatory compliance, pricing, and market conditions play key roles in this mechanism. In India, the process is governed by the Companies Act, SEBI regulations, and listing agreements of stock exchanges.

Types of Share Issues:

There are several types of share issues: public issue, rights issue, bonus issue, and private placement. A public issue involves offering shares to the general public through a prospectus. Rights issues offer existing shareholders the right to purchase additional shares. Bonus issues involve giving free shares to existing shareholders from reserves. Private placement involves selling shares to a select group of investors, often institutions. Each method is chosen based on the company’s objectives and market conditions.

  • Initial Public Offering (IPO)

An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. This is done to raise funds, increase visibility, and enable listing on stock exchanges like NSE or BSE. The company appoints merchant bankers, prepares a Draft Red Herring Prospectus (DRHP), and gets approval from SEBI. Once approved, the issue is opened for subscription. Pricing can be fixed or through a book-building process, depending on market strategies.

  • Rights Issue Mechanism

Rights Issue allows existing shareholders to buy additional shares at a discounted price in proportion to their existing holdings. This is a way to raise capital without diluting control. The company sends offer letters to eligible shareholders with a set deadline. Shareholders can accept, reject, or renounce the rights. This mechanism is regulated by SEBI and does not require shareholder approval through a general meeting. It is faster and more cost-effective than a public issue.

  • Bonus Issue of Shares

In a Bonus Issue, a company issues free shares to existing shareholders by capitalizing its free reserves or securities premium. It rewards shareholders without taking in new funds. Bonus issues increase the number of outstanding shares but do not affect the company’s net worth. SEBI guidelines ensure the bonus issue is made from legitimate sources. The process involves board approval and intimation to stock exchanges. This mechanism enhances investor confidence and signals company strength.

  • Private Placement and Preferential Allotment

Private Placement is the issue of shares to a select group of investors, such as institutional or high-net-worth individuals. Preferential Allotment is a type of private placement where shares are issued to a specific group under SEBI regulations. This method is faster and more flexible but must follow strict disclosure and pricing norms. It is commonly used for strategic partnerships or raising quick capital without undergoing public scrutiny or lengthy approval processes involved in public issues.

Book Building Process

Book Building Process is a price discovery mechanism used during IPOs or follow-on public offers. Investors bid for shares within a price band set by the company. Based on demand, the final price (cut-off price) is determined. There are two types: 75% Book Building and 100% Book Building. This process allows market-driven pricing and helps avoid under or overpricing. SEBI mandates transparency and timely disclosure during the book-building process to protect investor interest.

Role of Intermediaries:

Various intermediaries are involved in the share issue mechanism. These include merchant bankers, registrars, underwriters, legal advisors, and auditors. Merchant bankers manage the entire issue process, draft offer documents, and coordinate with SEBI. Registrars handle applications and allotments. Underwriters assure the company that the issue will be subscribed. These intermediaries ensure compliance, smooth processing, and transparency in the issue. Their role is crucial in maintaining investor trust and ensuring the success of the share issue.

Regulatory Framework in India:

The share issue mechanism in India is regulated by multiple authorities. The Securities and Exchange Board of India (SEBI) lays down guidelines for disclosures, pricing, and eligibility. The Companies Act, 2013 governs corporate approvals and procedures. The Stock Exchanges (BSE/NSE) monitor compliance with listing norms. Additionally, the Depositories Act ensures dematerialization of shares. Companies must comply with these regulations to ensure investor protection and transparency. Violations can lead to penalties or cancellation of issue approvals.

Post-Issue Activities and Listing:

After the share issue, the company undertakes post-issue activities like allotment of shares, refunds (if applicable), credit to demat accounts, and listing on the stock exchange. Listing enables the shares to be traded in the secondary market. The company must submit listing documents and meet all criteria. Post-listing, it must comply with disclosure norms and governance standards. These steps ensure liquidity for investors and credibility for the company in the capital markets.

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