This article is written by Rashmi Birmole, pursuing a Certificate Course in Capital Markets, Securities Laws, Insider Trading and SEBI Litigation from LawSikho.
In what was considered an enabling regulatory measure by most, a proposal to allow direct overseas listing of companies incorporated in India was approved by the Union Cabinet earlier this year. The purpose of introducing the concept of securities market with an illustration of a contemporary change is to simply demonstrate its dynamic nature. With the securities market undergoing rapid changes on the regulatory front and companies tapping into the international markets for their capital needs, understanding the multiple segments of the market has become all the more relevant. Simply put, the role of a lawyer in facilitating a capital markets transaction is indispensable. In this article, an attempt has been made to explain the segmentation in the securities market.
Industrial Securities Market
The securities market is instrumental in helping companies raise capital for their expansion and operational needs. It allows companies access to funding and liquidity through the issuance of publicly traded and transferable shares and debt securities. The market price of the shares is a reflection of the financial performance and corporate actions of the company, providing a listed company with the opportunity to enhance its market capitalization and reputation. Concurrently, the securities markets permit individuals to participate in the profits of a company, execute trades on the stock exchange and subscribe to the shares of a listed company.
Broadly, the industrial securities market consists of two segments, i.e., The Primary or the New Issue Market and the Secondary or the Stock exchange market.
The primary market deals with securities which are issued for the purpose of inviting subscription to the shares of a listed company. On the allocation of shares under a primary market issuance, the public investors become registered members of the company and are allowed to exercise voting rights. The application money and price of the shares issued is directly received and employed by the issuing company as per the objectives of the issue. Companies are also permitted to issue and list non-convertible debentures without going through the Initial Public Offer route. Issuances of equity and debt securities made in the capital markets are governed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”) and SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (“ILDS Regulations”), respectively.
Public issue of securities is crucial in mobilizing capital and converting savings into long term or short-term investment. On account of the involvement of public investors and the need to protect market integrity, public issues are subject to greater scrutiny and extensive disclosure requirements by the Securities and Exchange Board of India (“SEBI”), the regulator. Companies undertaking a public issue are required to conform to the prescribed eligibility requirements and maintain a degree of transparency with respect to their financials to ensure fair dealings in the market. Companies are precluded from making a public issue without a prospectus or an offering memorandum which contains vital disclosures about the company and is often prepared and verified meticulously to avoid any misrepresentations which may invite regulatory penal action. Companies are mandatorily required to work with a number of registered market intermediaries such as lead managers, underwriters, registrar to the issue, etc to carry out the multiple processes associated with a public issue. In case of a public issue of non-convertible debt securities, companies are required to obtain a credit rating from credit rating agencies and also appoint a debenture trustee, among other obligations.
In a rights issue, additional shares are issued and offered to the existing shareholders in proportion to their existing holding or on a “pro-rata basis”. In a bid to raise fresh capital in circumstances where traditional funding may not be a feasible option, existing shareholders are invited to subscribe to additional shares at a discounted price. The rights entitlement also carries a complementary right to renounce the shares acquired under the issue in the favour of a third person, if such renunciation is not restricted under the article of association of the company. The rights issue method is also preferred by companies because such issuances enjoy autonomy in determination of the price and exemption from filing a prospectus.
Initial Public Offer (IPO)
Popularly known as “going public”, an initial public offer or an “IPO” is the process by which an unlisted private or public company invites the public to subscribe to specified securities through a public offer. An initial public offer is often a milestone for an unlisted company and offers greater market visibility, liquidity, better avenues for raising capital and an opportunity to assess the worth of the company in the capital markets.
For the purposes of an initial public offer, the company may choose to make a fresh issuance of securities or offer existing shares for sale to the public. The pricing of the shares offered is determined through what is known as a ‘book building process’ in consultation with the appointed lead manager. To ensure equal allocation among all classes of investors, percentages of the net offer are reserved for allotment to retail individual investors, non-institutional investors and qualified institutional buyers respectively. For an initial public offer to be successful, 90% of the issued securities have to be subscribed on the date of closure of the offer.
Over the years, private placement has remained an important source of long-term finance for both listed and unlisted entities. The private placement is a primary market transaction that involves the issuance of securities to an identified and selected group of individuals, limited to 200 individuals per financial year. It is made through a private placement letter addressed specifically to the identified individuals and cannot be publicly advertised. If the limit of 200 individuals is exceeded, the private placement will be deemed a public offer and treated similarly. A prime example of the same is the Supreme Court’s judgement in Sahara India vs. SEBI, when an issuance of optionally convertible debentures to more than 30 million investors was deemed to be a public offer.
Commonly, unlisted entities and start-ups target venture capital and strategic investors such as angel investors, high net worth individuals and institutional investors and private placement are often one of the limited means available to a company who is found to be in its early stages and is considered high risk. For a listed entity, a private placement is in the nature of a secondary stock offering and a method used to allot securities to buyers under a qualified institutional placement (QIP).
A secondary market differs from a primary market in the sense that previously issued and listed securities are bought, sold, or traded by the investors in the market. It offers investors the opportunity to capitalize by evaluating risks and returns of holding the security of a certain company in line with market trends. The price of a security on the secondary market reflects the realistic valuation of the security in accordance with market forces. Broadly, in secondary market ownership passes between investors with no effect on the issuing entity.
Under the Securities Contracts (Regulation) Act, 1956, a stock exchange is defined as an association, organization or body of individuals constituted for the purpose of assisting or regulating the business of buying, selling, or dealing in securities. In simple terms, stock exchanges provide a platform enabling investors to execute trades in listed securities through registered stock brokers and trading members who pass the buy order to the exchange which is then matched with a sell order. Stock exchanges have a well -defined area of operation and are subject to SEBI’s regulatory oversight.
In common parlance, speculation refers to anticipation of an uncertain happening or event sometime in the future. In the securities market, speculation is known as anticipation of future price movement and is known for its high-risk, high-reward character. In a speculative transaction, trades are not settled by the actual delivery of the securities but rather by the price difference between the contracted price and the prevailing market price. Some common examples of speculative transactions are margin trading, short selling, derivatives such as futures, options, forward, etc.
Measures taken to expand the Secondary Securities market in India
- Rajiv Gandhi Equity Savings Scheme
The Rajiv Gandhi Equity Savings Scheme was first introduced in an attempt to encourage greater participation in equity trading by novice investors. The benefits under the scheme were notified in the form of the insertion of Section 80 CCG in the Income Tax Act, offering tax deductions of 50% up to Rs. 50,000 on the first investment to individuals with gross annual income below the limit of Rs. 12 lakhs.
- SME Exchange/Platform
With small and medium enterprises mushrooming across the country, gaining visibility and recognition has become paramount to their success. In 2012, the Government recognized the need to augment the growth of such entities and introduced an SME Platform catering to and exclusively listing the shares of small and medium enterprises. The need to introduce an SME Exchange arose out of difficulty faced by such enterprises in getting listed and attracting sufficient trading volumes. The SME Exchanges introduced by NSE and BSE, known as Emerge and BSEMSE respectively, allow such enterprises to migrate to the main Board of the stock exchange on becoming eligible, without making an initial public offer.
- Expansion of Qualified Foreign Investors (QFIs) Scheme
Following the recommendations of the UK Sinha Committee, a new class of foreign investors, Qualified Foreign Investors (“QFI”) were permitted to invest directly in the Indian securities market. In August 2011, the SEBI and Reserve Bank of India released a circular permitting non-resident foreign investors or QFIs who meet the KYC requirements of SEBI to invest in the rupee denominated units of mutual funds in India. Consequently, the scheme was expanded in 2012 to direct investment in the equity market and corporate bonds within the prescribed cap without having to seek compulsory registration with SEBI. Only QFIs from FATF compliant jurisdictions were eligible under this scheme.
- Initiatives to attract FII Investment
Foreign Institutional Investment is critical in financing investment in emerging economies and has helped the Indian economy to recover from losses in the capital markets arising out of COVID-19 which have turned out as the net buyers, with inflow of foreign capital amounting to $3.08 billion dollars in August 2020. FIIs were first allowed to invest in financial instruments with restrictions in 1992, with a number of enabling regulatory measures which followed suit. Initially, the overall limit for FII investment was prescribed as USD 1 billion was subsequently revised to USD 1.75 billion and corporate bonds and government securities fell within the permissible investment for FIIs. Over the next couple of years, a major initiative included the simplification of FII investment in debt securities in 2013. With the introduction of the SEBI (Foreign Portfolio Investors) Regulations, 2014, FIIs and QFIs were consolidated into one class – Foreign Portfolio Investor. A key amendment to the above regulations was passed in 2019 which permitted the Central Government to notify non-FATF countries eligible for FPI registration, which shall widen the foreign investor base in India.
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