Capital Markets: Challenges and Developments
On the need for a different framework for passive Mutual Funds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Passive mutual fund;
Mains level: Liberalisation of mutual funds;
Why in the News?
On September 30, the Securities and Exchange Board of India (SEBI) launched the liberalized Mutual Funds Lite (MF Lite) framework specifically for passively managed schemes.
What is a Passive Mutual Fund?
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Key highlights of the liberalized Mutual Funds Lite (MF Lite) framework:
- Separate Framework for Passive Funds: It is tailored for passively managed schemes, which are less risky and require minimal active management.
- Relaxed Entry Requirements: Lowered net worth requirement (₹35 crore), simplified criteria for sponsor eligibility (profitability, track record).
- Encouraging New Players: It provides easier entry for new AMCs (Asset management companies) and market players in the passive fund segment.
- Governance Flexibility: It has reduced oversight for trustees; operational responsibilities shifted to AMC boards, focusing on fees, expenses, and tracking error.
- Cost Efficiency Focus: It emphasizes on lowering Total Expense Ratio (TER) and minimizing tracking error for better returns.
- Simplified Disclosures: The Scheme Information Documents (SID) are simplified to focus on key metrics like benchmark index, TER, and tracking error.
- Risk Management: Audit committees of AMCs can handle risk management duties due to the lower risk profile of passive funds.
Why a Separate Framework for MF Lite is Needed?
- Lower Risk Profile: Passively managed funds are generally less risky because they track established benchmarks like BSE Sensex or Nifty50, reducing the need for active decision-making.
- Minimal Asset Manager Discretion: Unlike actively managed funds, asset managers of passive funds have limited discretion in asset allocation and investment objectives. They simply mirror the performance of the benchmark index.
- Inapplicability of Existing Regulations: The current framework is designed primarily for actively managed funds, which involve more risks and require more oversight. It is less suitable for passive funds, which operate with predefined, transparent rules.
- Cost-Effective Market Entry: To encourage new players and make the passive fund industry more competitive, SEBI introduced relaxed regulations regarding eligibility, net worth, and profitability.
What about risks and disclosures?
- Success depends on Total Expense Ratio (TER) and tracking error. Lower costs and minimal deviation from the benchmark are crucial for performance.
- Scheme Information Documents (SID) focus on key metrics like the benchmark name, TER, and tracking error, leaving out complex strategies.
- Risk management responsibilities are streamlined, allowing the audit committee of the AMC to handle oversight, reflecting the lower risks of passive funds.
Way forward:
- Enhance Investor Education: Develop targeted educational initiatives to inform retail investors about the benefits, risks, and operational aspects of passive mutual funds, fostering informed investment decisions.
- Ongoing Regulatory Evaluation: Establish a framework for periodic assessment and adaptation of the MF Lite regulations to ensure they remain effective and relevant, promoting competition while safeguarding investor interests.
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Capital Markets: Challenges and Developments
F&O: How will Sebi’s new rules affect traders and brokers?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: FandO Trading
Why in the News?
SEBI has introduced a six-step framework to protect investors and curb speculative trading, specifically targeting futures and options (F&O) trading by reducing volumes on expiry days and limiting retail participation.
What are the Future and Options (F&O)?
- Futures are contracts to buy or sell an asset (like stocks, indexes, or commodities) at a predetermined price on a future date.
- Options give the right, but not the obligation, to buy or sell an asset at a set price before a certain date.
SEBI’s Six-Step F&O Framework (Effective November 2024 – April 2025):In response to concerns about rising speculative trading, SEBI has outlined six key measures aimed at reducing retail interest in F&O trading:
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Key Changes for Retail Investors:
- Upfront Collection of Options Premiums: Retail investors must now pay the full premium upfront, limiting their ability to use high leverage in options trading.
- Increased Contract Size: The minimum contract size for index derivatives is raised to ₹15 lakhs, reducing speculative retail participation by making it costlier to enter.
- Rationalization of Weekly Expiries: Only one benchmark index per exchange can have weekly expiries, lowering speculative trading opportunities and intraday volatility.
- Removal of Calendar Spread Benefits: Calendar spreads are no longer allowed on expiry days, discouraging aggressive trading strategies.
Impact on Brokers and Revenue:
- Decline in Trading Volumes: Brokers reliant on F&O trading will see reduced volumes due to fewer retail participants and higher barriers to entry.
- Revenue Drop in Options Trading: Firms like Zerodha may face a 30-50% revenue drop as retail participation in options decreases.
- Shift to Equity Trading: Retail investors may move towards equity trading, causing brokers to adapt their offerings.
- Adaptation for Brokers: Brokers with a balanced mix of cash and derivatives will be less impacted, while those focused on F&O need to shift strategies.
PYQ:[2021] With reference to India, consider the following statements: 1. Retail investors through demat account can invest in ‘Treasury Bills’ and ‘Government of India Debt Bonds’ in primary market. 2. The ‘Negotiated Dealing System-Order Matching’ is a government securities trading platform of the Reserve Bank of India. 3. The ‘Central Depository Services Ltd.’ Is jointly promoted by the Reserve Bank of India and the Bombay Stock Exchange. Which of the statements given above is/are correct? (a) 1 only (b) 1 and 2 only (c) 3 only (d) 2 and 3 only |
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Capital Markets: Challenges and Developments
House Panel includes SEBI review in agenda, likely to summon Buch
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Market Economy; SEBI; Public Accounts Committee (PAC)
Mains level: Market Economy; Issues related to regulatory bodies;
Why in the News?
The Public Accounts Committee (PAC) has included a review of SEBI’s performance, amid political controversy surrounding chairperson Madhabi Puri Buch following Hindenburg Research’s allegations.
What are the allegations against SEBI?
- Conflict of Interest: SEBI chairperson Madhabi Puri Buch faces conflict of interest allegations due to her past ICICI Bank role amid Adani investigations.
- Toxic Work Environment: Reports have surfaced from approximately 500 SEBI employees claiming that the work culture at the regulatory body is “toxic and fearful.” This has led to demands for an impartial inquiry into the alleged workplace issues and the overall management of SEBI.
- Response to Allegations: Buch and SEBI have denied wrongdoing, asserting that all necessary disclosures and recusal norms have been followed diligently.
Significance and Functions of the Public Accounts Committee (PAC)The PAC was introduced in 1921 after its first mention in the Government of India Act, 1919 (Montford Reforms).
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How SEBI can improve its regulation considering recent challenges? (Way forward)
- Enhanced Disclosure Regulations: SEBI has already made progress with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2023, but further refinement is needed.
- It should focus on clarifying the scope of disclosures required from companies, particularly regarding financial irregularities and conflicts of interest.
- Bolstering Whistleblower Protections: SEBI should strengthen its whistleblower protection framework to encourage the reporting of internal issues or malpractices, ensuring accountability and protection for informants.
- Improving Internal Governance and Work Culture: SEBI can address concerns about a toxic work environment by conducting independent reviews of its internal governance, improving employee welfare, and fostering a transparent, positive work culture.
- Collaborating with Global Regulatory Bodies: SEBI can work more closely with global financial regulators to align with international best practices and enhance cross-border market oversight, ensuring that India’s markets remain resilient and transparent.
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Capital Markets: Challenges and Developments
On the allegations against the SEBI chief
Note4Students
From UPSC perspective, the following things are important :
Mains level: Applicability of Office of Profit on SEBI Chairperson;
Why in the News?
Hindenburg Research has alleged SEBI Chairperson Madhabi Puri Buch and her husband held stakes in Adani-linked offshore funds, implying bias in SEBI’s Adani investigation.
Accusations Against SEBI Chairman Madhabi Puri Buch
- Hindenburg Research has accused SEBI Chairman Madhabi Puri Buch of conflicts of interest related to offshore funds tied to the Adani Group, financial opacity regarding a consulting firm transferred to her husband, and potential favoritism towards Blackstone, where her husband is a senior advisor.
Status of the Ongoing Investigation by SEBI
- Supreme Court Oversight: The Supreme Court has directed SEBI to investigate the allegations made by Hindenburg Research.
- Show Cause Notice by SEBI: In June 2024, SEBI issued a show cause notice to Hindenburg Research, indicating that the regulator is actively pursuing the matter.
About SEBI’s Code on Conflict of Interest:According to SEBI’s Code on Conflict of Interest, board members, including the Chairperson, are prohibited from holding any other office of profit or engaging in professional activities that involve receiving a salary or professional fees.It can constitute a number of different things that need to be disclosed by the concerned board member:
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Way forward:
- Enhance stricter disclosure requirements: SEBI should implement stricter disclosure requirements for all board members, including the Chairperson, ensuring transparency about their financial interests, past affiliations, and potential conflicts.
- Establishing an Independent Ethics Committee: An independent ethics committee should be created to oversee and review any potential conflicts of interest involving SEBI board members.
Mains PYQ:
Q In the light of Satyam Scandal (2009), discuss the changes brought in the corporate governance to ensure transparency and accountability. (2015)
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Capital Markets: Challenges and Developments
What is the Sovereign Gold Bond Scheme?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SGB Scheme
Why in the News?
Recent reports suggest that the government might reduce or discontinue the Sovereign Gold Bond (SGB) scheme due to its high cost.
Decline in Popularity of SGB:
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About Sovereign Gold Bonds (SGBs)
| Details | |
| Launch | 2015 |
| Nature |
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| Objective | Reduce dependence on gold imports and shift savings from physical gold to paper form. |
| Eligibility | Resident in India, including individuals, HUFs, trusts, universities, and charitable institutions. |
| Denomination and Tenor |
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| Investment Limits |
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| Benefits |
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| Add-ons |
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PYQ:[2016] What is/are the purpose/purposes of Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’?
Select the correct answer using the codes given below: (a) 1 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 |
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Capital Markets: Challenges and Developments
SEBI’s proposed measures to curb F&O speculation
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Types of derivatives
Mains level: Measures taken by SEBI related to derivatives
Why in the news?
SEBI has proposed a series of measures to curb speculative trading in the index derivatives segment due to concerns over the exponential increase in trading volumes in futures and options, especially among individual investors.
What are the different types of derivatives?
| Note: Derivatives are financial contracts deriving their value from an underlying asset such as stocks, commodities, or currencies. |
- Futures:
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- Futures are standardized contracts obligating the buyer to purchase an underlying asset (such as stocks, commodities, or currencies) at a predetermined price on a specified future date. They are traded on exchanges, with daily settlements based on market price changes.
- Futures contracts have margin requirements and are marked to market daily, ensuring liquidity and reducing credit risk.
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- Options:
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- Options give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price within a specified time frame. Unlike futures, options are not obligatory; the buyer can choose whether to exercise the option.
- Options can be traded on exchanges or over-the-counter (OTC) and require the payment of a premium by the buyer.
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- Forwards:
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- Forward contracts are similar to futures but are privately negotiated agreements between two parties to buy or sell an asset at a future date and price. They are customizable and traded over the counter, which allows for flexibility but introduces counterparty risk.
- Settlement occurs at the maturity date, and forward contracts do not have standardization like futures.
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- Swaps:
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- Swaps involve the exchange of cash flows or financial instruments between two parties, often based on interest rates or currencies. Common types include interest rate swaps and currency swaps, which allow participants to manage exposure to interest rate fluctuations or gain access to different currencies.
- Swaps are typically traded over the counter and can be tailored to meet the specific needs of the parties involved.
What measures have the SEBI proposed?
- Increase in minimum contract size for index derivatives from Rs 5-10 lakh to Rs 15-20 lakh, which can be further increased to Rs 20-30 lakh after six months.
- Upfront collection of option premiums by brokers from clients.
- Intraday monitoring of position limits for index derivative contracts by Market Infrastructure Institutions (MIIs).
- Providing only one weekly options contract on a single benchmark index of an exchange.
- Removal of calendar spread benefits on the expiry day for positions involving any of the contracts expiring on the same day.
- Rationalisation of options strikes, with a uniform interval up to a fixed coverage of 4% near the prevailing index price and an increased interval as the strikes move away from the prevailing price.
- Increasing margins on the expiry day and the previous day to address the issue of high implicit leverage in options contracts near expiry.
Why have these measures been proposed?
- The measures aim to enhance investor protection and promote market stability in the derivative markets, amidst concerns about an exponential rise in the volume of trade in the futures and options (F&O) segment, particularly by individual investors.
- In the Union Budget 2024-25, the Securities Transaction Tax (STT) on F&O of securities was doubled to 0.02% and 0.1%, respectively, effective October 1, 2024.
- Data shows that in FY 2023-24, 92.50 lakh unique individuals and proprietorship firms traded in the NSE index derivatives segment and cumulatively incurred a trading loss of Rs 51,689 crore, with only 14.22 lakh investors (about 15%) making a net profit.
Way forward:
- Enhancing Investor Education and Awareness: To mitigate the risks associated with speculative trading in index derivatives, it is essential to implement comprehensive investor education programs.
- Strengthening Regulatory Oversight and Compliance: SEBI should enhance its regulatory framework by implementing robust monitoring systems that ensure compliance with the proposed measures.
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Capital Markets: Challenges and Developments
New Asset Class proposed by SEBI
Note4Students
From UPSC perspective, the following things are important :
Prelims level: New Asset Class, Mutual Funds, Portfolio Management Services (PMS)
Why in the News?
- The markets regulator, SEBI, has proposed a new asset class designed to offer investment products positioned between mutual funds (MFs) and portfolio management services (PMS).
- This new category aims to fill an opportunity gap for investors and offer greater flexibility in portfolio construction.
Note:
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About the New Asset Class
- The new asset class aims to provide an intermediate option with more flexibility in portfolio construction, helping investors avoid unregistered and unauthorized schemes.
- It will have a risk-return profile between MFs and PMS, targeting investors with higher risk tolerance and larger investment amounts than those typical of MFs but lower than PMS.
- The current range of investment products includes:
- MF schemes: Focused on retail investors,
- PMS: For HNIs, and
- Alternative investment funds (AIF): For sophisticated investors.
How will investments in the new asset class work?
- The new asset class will be introduced under the MF structure with necessary relaxations in prudential norms.
- The minimum investment amount is proposed to be Rs 10 lakh per investor within the asset management company (AMC)/MF.
- This high threshold is intended to deter retail investors while attracting those with investible funds between Rs 10 lakh and Rs 50 lakh.
Significance of the New Asset Class:
- SEBI noted that the gap between investment opportunities in MFs and PMS has led some investors towards unauthorized investment avenues.
- The new asset class will help curb the proliferation of unregistered investment products and provide a structured and regulated option for investors.
- SEBI emphasized that the new asset class would offer a regulated and structured investment suited to investors looking for opportunities between MFs and PMS.
Investment Strategies:
- Like MF schemes, the new asset class will provide options for Systematic Investment Plan (SIP), Systematic Withdrawal Plan (SWP), and Systematic Transfer Plan (STP).
- AMCs can offer ‘investment strategies’ under a pooled fund structure with tailored redemption frequencies (daily, weekly, monthly, etc.).
PYQ:[2021] Indian Government Bond Yields are influenced by which of the following?
Select the correct answer using the code given below. (a) 1 and 2 only |
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Capital Markets: Challenges and Developments
Decline in popularity of Equity Linked Savings Schemes (ELSS)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Equity Linked Savings Schemes (ELSS); Section 80C of the Income Tax Act.
Why in the News?
- Equity Linked Savings Schemes (ELSS) are mutual fund schemes that offer tax benefits under Section 80C of the Income Tax Act.
- Recently, ELSS has seen a decline in popularity, with more money being withdrawn from these schemes than invested.
What is Section 80C of the Income Tax Act?
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About Equity Linked Savings Schemes (ELSS)
- An ELSS fund or an equity-linked savings scheme is the only kind of mutual funds eligible for tax deductions under the provisions of Section 80C of the Income Tax Act, 1961.
- Investors can claim a tax rebate of up to Rs 1,50,000 and save up to Rs 46,800 a year in taxes by investing in ELSS mutual funds.
- ELSS mutual funds’ asset allocation is mostly (65% of the portfolio) made towards equity and equity-linked securities such as listed shares.
- They may have some exposure to fixed-income securities as well.
- These funds come with a lock-in period of 3 years only, the shortest among all Section 80C investments.
- Being market-linked, they are subject to market risk, but may offer potentially higher returns compared to traditional tax-saving instruments like National Savings Certificate (NSC) or Public Provident Fund (PPF).
Recent Trends in ELSS
- In the past few months, more money has been taken out of ELSS than put in.
- For example, last month ₹445 crore was withdrawn, while in April it was ₹144 crore.
- In the last fiscal year, only ₹1,041 crore was invested in ELSS, compared to ₹7,744 crore the previous year.
Impact of the New Tax Regime
- A new tax regime was introduced in 2020-21, which is now the default option.
- The old tax regime offered various tax exemptions and deductions, helping to reduce income tax.
- These benefits are not available under the new tax regime, making ELSS less attractive to investors.
PYQ:[2021] Indian Government Bond Yields are influenced by which of the following?
Select the correct answer using the code given below. (a) 1 and 2 only |
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Capital Markets: Challenges and Developments
Surge in Silver Imports from UAE through Gift City
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Silver Imports in India, GIFT City
Why in the News?
- India’s majority of silver imports are now handled by few private players from Dubai through the India International Bullion Exchange (IIBX), Gift City.
- This trend, aimed at reducing import duties by the traders, poses potential long-term revenue losses for India.
India’s Silver Imports
- India imported a record 4,172 metric tons of silver in the first four months of 2024, far exceeding the total of 3,625 tons imported in all of 2023.
- In February 2024 alone, India imported a record 2,295 metric tons of silver, up from 637 tons in January. This represents a 260% increase.
- The surge in imports has been driven by increasing demand from the Solar panel industry as well as a rise in Speculative Investment, with investors betting on silver outperforming gold.
- Nearly half of India’s silver imports in 2024 so far have come from the United Arab Emirates (UAE) due to a lower import duty under the India-UAE Comprehensive Economic Partnership Agreement (CEPA).
- India generally imposes a 15% import duty on silver.
- However, because of the CEPA signed between India and the UAE in 2022, allows private traders to import silver through the India International Bullion Exchange (IIBX) paying 9% duty, and an extra 3% in value-added tax.
- The government is now concerned about the 647-fold spike in silver imports from the UAE and plans to discuss the issue with Abu Dhabi.
- The Gift City exchange, while clearing imports from Dubai since December 2023, is under scrutiny for potential violations of these rules compared to imports from other ports.
About India International Bullion Exchange (IIBX)
Regulations and Setup:
Operational Framework
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Recommendations for Addressing Challenges
- Renegotiation of CEPA Terms: The Global Trade Research Initiative (GTRI) advocates for revising CEPA terms to curb duty arbitrage and enforce stricter checks on value addition claims by Gift City exchange.
- Enhanced Regulatory Oversight: GTRI proposes limiting silver imports to RBI/DGFT-nominated agencies to mitigate risks associated with mis-declared imports and ensure compliance with CEPA conditions.
- Investigation and Oversight: There is a call for a thorough investigation into relationships between export and import firms to identify and mitigate conflicts of interest or familial ties that could influence import practices.
PYQ:[2016] What is/are the purpose/purposes of Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’?
Select the correct answer using the code given below: (a) 1 only |
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Capital Markets: Challenges and Developments
Indian Government Bonds in JP Morgan index: how much funds could flow into India?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: JP Morgan index
Mains level: Benefits of Higher Inflows from the Inclusion of Indian Government Bonds in JP Morgan’s Emerging Markets Bond Indices
Why in the news?
JP Morgan is including Indian Government Bonds in its emerging markets bond indices starting June 28. This move is expected to attract significant foreign investment, boosting India’s bond market and economic stability.
What would be India’s weight in the index?
- India is poised to achieve a maximum weighting of 10% in the GBI-EM Global Diversified Index. This increased allocation is anticipated to attract greater investment from global investors into Indian debt, with analysts projecting monthly inflows of $2-3 billion.
Benefits of Higher Inflows from the Inclusion of Indian Government Bonds in JP Morgan’s Emerging Markets Bond Indices
- Increase in Foreign Exchange Reserves: The inflows from foreign investments will directly boost India’s foreign exchange reserves, providing a stronger buffer against external economic shocks.
- Strengthening the Rupee: The surge in foreign investment will enhance demand for the rupee, leading to its appreciation and contributing to a more stable and robust currency.
- Enhanced External Financial Management: With increased foreign exchange reserves, India will have greater flexibility and resilience in managing its external financial obligations and mitigating balance of payment issues.
- Reduction in Borrowing Costs: Higher reserves and a stronger rupee can lead to improved credit ratings and reduced risk premiums, lowering borrowing costs for the government and corporates.
- Promotion of Economic Confidence: The inflows signify international investor confidence in India’s economic prospects, boosting overall economic sentiment and encouraging further investments.
What about the impact on inflation as RBI mops up the dollars and releases an equivalent amount in rupees?
- Liquidity Injection: When the RBI mops up dollars from the market, it releases an equivalent amount of rupees into the financial system. This injection of liquidity can potentially increase the supply of money circulating in the economy.
- Demand-Pull Inflation: Increased liquidity can stimulate demand for goods and services, potentially leading to demand-pull inflation if the production capacity of the economy does not keep pace with the increased demand.
- Asset Price Inflation: The influx of liquidity can also inflate asset prices such as real estate and stocks, impacting affordability and potentially creating asset price inflation.
- Exchange Rate Stability: On the flip side, mopping up dollars can help stabilize the exchange rate by reducing downward pressure on the rupee due to excessive inflows.
- RBI’s Policy Response: The RBI has various monetary policy tools, such as open market operations, repo rates, and reserve requirements, to manage liquidity and inflationary pressures arising from such inflows. It may use these tools to absorb excess liquidity and stabilize inflation.
Way forward:
- Prudent Monetary Policy Management: The RBI should continue to employ effective monetary policy measures, such as open market operations and repo rate adjustments, to carefully manage liquidity and inflationary pressures stemming from increased foreign inflows.
- Enhanced Economic Diversification: India should use the influx of foreign investment to diversify its economy further, focusing on infrastructure development, technological advancements, and sustainable growth initiatives to bolster long-term economic resilience and stability.
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Capital Markets: Challenges and Developments
Why has SEBI accused Hindenburg of breaking Indian law?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SEBI Function and Power
Mains level: Challenges related to the Capital Market
Why in the news?
Hindenburg Research received a SEBI show cause notice for short-selling Adani Enterprises Ltd stock before and after their report accusing Adani of fraud.
What is the Hindenburg Report on Adani?
- On January 24, 2023, the New York-based Hindenburg Research accused the Adani Group of “brazen stock manipulation and accounting fraud scheme over the course of decades.”
- The report led to a significant drop in the shares of Adani companies and the calling off of Adani Enterprises Ltd’s Rs 20,000-crore follow-on Public Offer (FPO). Adani Group denied all allegations, claiming the report was a “calculated attack on India.”
What is SEBI’s show cause notice about?
- Hindenburg received a show-cause notice from SEBI on June 27, 2024.SEBI alleged that Hindenburg colluded with certain entities to use non-public information to short-sell Adani Enterprises Ltd (AEL) stock before and after the release of its report, making profits.
- The notice named Hindenburg, its founder Nathan Anderson, investor Mark Kingdon, and related entities, accusing them of sharing the report draft and building short positions in AEL futures.
How has Hindenburg responded to the show cause notice?
- Hindenburg dismissed the notice as an attempt to silence those exposing corruption. They stated their investment stance was legal and disclosed, and criticized SEBI for targeting them instead of investigating the Adani Group’s alleged malpractices.
- Accusations: Hindenburg accused SEBI of pressuring brokers to close short positions in Adani stocks to protect the stock prices.
Where does Kotak come into this picture?
- Involvement of Kotak: SEBI’s notice did not name Kotak Bank, which Hindenburg claims created the offshore fund structure used for shorting Adani stocks.
- Response: Kotak Mahindra Bank stated that Hindenburg has never been a client and that their KYC procedures were followed with regard to clients, with investments made by Kingdon as a principal.
How much profit did Hindenburg earn by short selling Adani stocks?
- Revenue: Hindenburg earned approximately $4.1 million in gross revenue through gains related to Adani shorts from its investor relationship.
- Own Short Position: Hindenburg made about $31,000 from their short of Adani US bonds.After legal and research expenses, Hindenburg indicated they might only slightly come out ahead of break-even on their Adani short.
Way forward:
- Conduct Investigation: SEBI should initiate an independent, comprehensive investigation into the allegations against both Adani Group and Hindenburg Research. This investigation should be conducted by a neutral third party to ensure impartiality and transparency.
- Policy Review: SEBI could review and possibly update its regulations on short-selling and market manipulation to prevent similar incidents in the future. This could include stricter disclosure requirements for short sellers and enhanced monitoring of market activities.
Mains PYQ:
Q The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify.(UPSC IAS/2013)
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Capital Markets: Challenges and Developments
Regulator SEBI expands promoter definition for IPO-bound companies
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SEBI and its regulatory functions
Mains level: Issue Over Subjective Definition
Why in the news?
- SEBI expands promoter definition for IPO-bound companies, including founders holding 10% or more, and their immediate relatives.
- According to current SEBI regulations, a promoter is someone who controls the affairs of the company or can appoint the majority of directors or is named as such in an offer document.
What is an IPO?
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What Norms Say
- Expanded Definition of Promoter: The definition of a promoter has been expanded for companies preparing for an IPO. A promoter is someone who controls the company’s affairs, can appoint the majority of directors, or is named as such in an offer document.
- Previous Criteria: Founders holding 25% were previously deemed promoters due to their negative control and power to block special resolutions.
- New Criteria: Founders holding 10% or more must classify themselves as promoters if they are key managerial personnel (KMP) or directors in the company. Immediate relatives on the company board or KMP will also be classified as promoters, even if they hold just 1%.
About Declassification and 31A of LODR (Listing Obligations and Disclosure Requirements) Regulations
- Declassification Difficulty: The current regulations do not provide an easy path for declassifying a promoter as a public shareholder.
- Rule 31A of LODR Regulations: To be declassified, a person must not hold more than 10% in the listed company along with their relatives.
- Restrictive Nature: This restrictive rule makes declassification almost impossible for immediate relatives who are classified as promoters by virtue of their relationship, especially problematic for married daughters with no active role in the company.
Issue Over Subjective Definition
- Subjective Nature of Promoter Definition: The definition of a promoter has been historically subjective, leading to varying interpretations and legal disputes.
- Court Rulings: There have been several court rulings addressing the subjective nature of who qualifies as a promoter, highlighting inconsistencies and complexities.
- Complex Criteria: Accounting standards and regulatory criteria for determining control and influence in a company are often complicated and can be interpreted in multiple ways.
- Need for Objectivity: Experts argue for a more objective test to ascertain control and promoter status, which would provide clearer guidelines and reduce disputes.
- Example: Vinod Kothari, Director at Vinod Kothari Consultants, points out that moving towards an objective test is a positive step, given the current complexities in determining control.
Way forward:
- Standardised Guidelines: Develop clear and standardised guidelines for identifying promoters, reducing subjectivity and ensuring consistency.
- Detailed Disclosures: Mandate detailed disclosures from companies about their promoters, including shareholding patterns, roles, and influence in decision-making.
Mains PYQ:
Q In the light of Satyam Scandal (2009), discuss the changes brought in corporate governance to ensure transparency and accountability. (UPSC IAS/2015)
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Capital Markets: Challenges and Developments
SEBI forms panel for reviewing economic structure of clearing corporations
Note4Students
From UPSC perspective, the following things are important :
Prelims level: What is a Clearing Corporation?
Mains level: Significance of Usha Thorat Committee Reviewing the Ownership and Economic Structure of Clearing Corporations
Why in the news?
SEBI forms a committee to review clearing corporations’ ownership and economic structure, aiming to enhance resilience, independence, and neutrality as risk managers.
About the Securities and Exchange Board of India (SEBI):
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What is a Clearing Corporation?
- A clearing corporation is a central counterparty (CCP) that provides clearing and settlement services for trades executed on various exchanges.
- It acts as an intermediary between buyers and sellers, guaranteeing the completion of transactions and managing counterparty risk.
- Clearing corporations ensure the smooth functioning of financial markets by facilitating the timely settlement of trades and reducing systemic risk.
About Usha Thorat Committee on Reviewing the Ownership and Economic Structure of Clearing Corporations:
- SEBI has formed a committee chaired by Usha Thorat, former Deputy Governor of the Reserve Bank of India (RBI), to review the ownership and economic structure of clearing corporations.
- The committee’s mandate includes examining the ownership structure and finances of clearing corporations to ensure their resilience, independence, and neutrality as risk managers.
- It will assess the feasibility of broadening the list of eligible investors allowed to hold stakes in clearing corporations and suggest categories of investors who can acquire such stakes.
- The committee will also explore alternative ownership structures and shareholding patterns suited to an interoperable environment, where clearing corporations provide services across multiple exchanges.
- It aims to propose alternatives that address the periodic capital needs of clearing corporations and ensure sufficient capital and liquidity during market-wide systemic stress.
- The current ownership structure of clearing corporations is dominated by the parent exchange, which exposes them to the expectations of shareholders of the parent exchange.
Conclusion: The Usha Thorat Committee aims to enhance the resilience and independence of clearing corporations by exploring alternative ownership structures and suggesting measures to ensure adequate capital and liquidity.
Mains PYQ:
Q The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify.(UPSC IAS/2013)
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Capital Markets: Challenges and Developments
Can domestic MFs invest in their overseas counterparts?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Function of SEBI
Mains level: Market Regulations in India;
Why in the news?
SEBI issued a consultation paper, proposing a framework to enable domestic Mutual Funds (MFs) to invest in their overseas counterparts or Unit Trusts (UTs) that allocate a portion of their assets to Indian securities.
About the Framework for Facilitating Investments by Domestic Mutual Funds (MFs)
- Aim: To clarify the process and regulations surrounding such investments to encourage domestic MFs to diversify globally while maintaining limited exposure to Indian securities.
About the Proposals:
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Impacts of the Regulation
- Diversification of Opportunities: The framework provides a structured path for Indian MFs to invest in overseas instruments, enhancing diversification opportunities for Indian investors.
- Market Transparency: The requirement for periodic public disclosures of portfolios will increase transparency and investor confidence in overseas investments.
- Risk Management: The 20% exposure cap and autonomous management of investments help mitigate risks associated with excessive exposure to Indian securities and conflicts of interest.
- Compliance Burden: The need to adhere to strict regulations and rebalance portfolios within specified periods may increase the compliance burden on domestic MFs.
- Potential for Growth: By facilitating global investments, the framework can potentially attract more investors to Indian mutual funds, contributing to the growth of the mutual fund industry in India.
What are the concerns associated with this framework?
- RBI’s Upper Limit: The Reserve Bank of India’s (RBI) upper limit for overseas investment by mutual funds poses a concern. RBI Governor Shaktikanta Das indicated there are no plans to increase this limit, which means the overall industry limit for overseas investments is already exhausted.
- Practical Impact: As the industry limit for overseas investments is effectively exhausted, the changes to regulations may not have an immediate practical impact, limiting the diversification opportunities for Indian investors.
- Implementation and Compliance: Ensuring compliance with the 20% exposure cap and other regulations may pose challenges for domestic MFs, requiring careful monitoring and management of their overseas investments.
Conclusion: Need to establish collaborations with global investment firms to gain insights and best practices in managing overseas investments. Learning from established global players can help Indian mutual funds navigate the complexities of international markets more effectively.
Mains PYQ:
Q The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify. (UPSC IAS/2013)
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Capital Markets: Challenges and Developments
Cost Inflation Index (CII) for FY25 to compute Capital Gains
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Cost Inflation Index (CII); Long Term Capital Gains
Why in the News?
- The Income Tax Department has notified the cost inflation index (CII) for the current fiscal to calculate long-term capital gains arising from the sale of immovable property, securities and jewellery.
- The CII is used by a taxpayer to compute gains arising out of the sale of capital assets after adjusting for inflation.
CII Values:
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What is Cost Inflation Index (CII)?
- CII is a measure used by the Income Tax Department of India to account for inflation when calculating the capital gains on the sale of long-term capital assets.
- It helps to adjust the purchase price of assets to reflect the effect of inflation.
- CII adjusts the cost of acquisition of assets to the price level inflation at the time of sale.
- This ensures that taxpayers pay taxes on the real gains rather than on the inflationary component of the price rise.
- It is defined under Section 48 of the Income-tax Act, 1961.
- The index is revised annually to keep up with inflation, with the base year being periodically reset (currently the base year is 2001-02 in India).
Application of CII
- CII is used to compute the indexed cost of acquisition of a capital asset that has been held for more than 36 months (considered as long-term capital assets).
- Different holding periods apply for certain types of assets like immovable property and listed securities.
Tax Calculation:
- The formula used is:
- This formula helps determine the adjusted cost basis from which any sale proceeds are subtracted to calculate capital gains.
Back2Basics: Long Term Capital Gains
Definition of Long-Term Capital Assets
Taxation of Long-Term Capital Gains
Calculation of Long-Term Capital GainsThe general formula for calculating LTCG is:
Full Value of Consideration is the sale price of the asset. Indexed Cost of Acquisition is the purchase price adjusted by the CII. Indexed Cost of Improvement refers to the cost of any improvements made to the asset, adjusted by the CII. Cost of Transfer includes expenses directly related to the sale or transfer of the asset. Exemptions and Deductions
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PYQ:[2015] Which reference to inflation in India, which of the following statements is correct? (a) Controlling the inflation in India is the responsibility of the Government of India only (b) The Reserve Bank of India has no role in controlling the inflation (c) Decreased money circulation helps in controlling the inflation (d) Increased money circulation helps in controlling the inflation |
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Capital Markets: Challenges and Developments
Regulatory Challenges in Alternative Investment Funds (AIFs)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: AIFs and their regulation; Benefits offered.
Why in the News?
In response to tightening regulations impacting operations, the RBI has recommended that investments exceeding 50% of Alternative Investment Funds (AIFs) units by a person resident outside India be treated as Indirect Foreign Investment.
BACK2BASICS:What are Alternative Investment Funds (AIFs)?
Who can invest in an AIF?
Categories of an applicant who can seek registration as an AIF:
Note: Investment by an Indian company (which is owned or controlled by foreigners) into another Indian entity is considered as Indirect Foreign Investment (IFI). It is also known as downstream investment. |
Present Regulatory Landscape:
- Regulatory Ambiguity: Recent regulatory notes have instilled mistrust in the industry, particularly regarding Foreign Direct Investment (FDI) policy surrounding AIFs, spooking investors and prompting reconsideration of fund deployment strategies.
- Changing Stance: The regulatory stance has evolved, with amendments in 2015-16 allowing AIFs to attract foreign capital through the automatic route, promoting onshore management and incentivizing Indian fund managers to relocate to India.
Offshore Alternatives:
- Reason for Offshoring: Offshore funds benefit from a more stable regulatory environment, with considerations for tax implications necessitating careful structuring.
- Attractive Destination: Gujarat International Finance Tec-City (GIFT City) has emerged as an attractive alternative for managers due to regulatory stability, tax incentives, and proximity to India.
PYQ:[2020] With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic? (a) It is the investment through capital instruments essentially in a listed company. (b) It is a largely non-debt-creating capital flow. (c) It is the investment which involves debt-servicing. (d) It is the investment foreign institutional investors make in Government securities. |
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Capital Markets: Challenges and Developments
SEBI board approves amendment to Mutual Funds rules
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Mutual Funds and its regulations
Mains level: NA
Why in the news?
- The Securities & Exchange Board of India (SEBI) has recently approved amendments to SEBI (Mutual Funds) Regulations, 1996, aimed at enhancing the regulatory framework for Asset Management Companies (AMCs).
- These amendments mandate AMCs to establish institutional mechanisms to deter potential market abuse, including front-running, following recent instances observed by the market regulator.
What are Mutual Funds?
- A mutual fund is a pool of money managed by a professional Fund Manager.
- It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.
- And the income / gains generated from this collective investment is distributed proportionately amongst the investors after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV.
- SEBI regulates mutual funds through the SEBI (Mutual Funds) Regulations, 1996.
Categories of Mutual Funds:
- An actively managed fund is a mutual fund scheme in which the fund manager “actively” manages the portfolio and continuously monitors the fund’s portfolio, deciding on which stocks to buy/sell/hold and when, using his/her professional judgement, backed by analytical research.
- A passively managed fund, by contrast, simply follows a market index, i.e., in a passive fund , the fund manager remains inactive or passive inasmuch as, he/she does not use his/her judgement or discretion to decide as to which stocks to buy/sell/hold , but simply replicates / tracks the scheme’s benchmark index in exactly the same proportion.
Fund Structure
- Mutual funds in India operate under a three-tier structure, comprising the
- Asset Management Company (AMC),
- Trustees, and
- Custodians.
- The AMC manages the fund’s investments, the Trustees oversee the operations, and the Custodians safeguard the fund’s assets.
Key highlights of the recent update:
- Institutional Mechanism: AMCs are required to implement enhanced surveillance systems, internal controls, and escalation processes to identify and address specific types of misconduct, such as front-running, insider trading, and misuse of sensitive information.
- Whistleblower Mechanism: To foster transparency, AMCs are mandated to have a whistleblower mechanism.
- Recording of Communication: SEBI has exempted face-to-face interactions during market hours from the requirement of recording all communication by dealers and fund managers. This exemption will be effective upon the implementation of the institutional mechanism by AMCs.
- Prudential Norms for Passive Schemes: SEBI has streamlined prudential norms for passive schemes, allowing equity passive schemes to invest up to the weightage of constituents in the underlying index, subject to a 35% cap on investment in sponsor group companies.
PYQ:[2014] What does venture capital mean? (a) A short-term capital provided to industries (b) A long-term start-up capital provided to new entrepreneurs (c) Funds provided to industries at times of incurring losses (d) Funds provided for replacement and renovation of industries |
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Capital Markets: Challenges and Developments
What are the new Green Credit Programme rules? | Explained
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Green Credit Programme;
Mains level: Sustainable Growth; GCP stoked controversy;
Why in the news?
On April 12, the Environment Ministry issued further guidelines on its Green Credit Programme (GCP)
What is the Green Credit Programme?
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Features of the Green Credit Programme:
- Open-Platform: Participants, including individuals, organizations, and both public and private companies, can invest in these environmental initiatives and receive ‘green credits’ in return. These credits are earned based on the environmental impact of the invested activities.
- Public sector companies such as Indian Oil, Power Grid Corporation of India, National Thermal Power Corporation, Oil India, Coal India, and National Hydropower Corporation have reportedly registered to invest in the GCP.
- Set with Priority: The Ministry has prescribed rules for the first initiative under the GCP, focusing on afforestation. Participants can pay for afforestation projects in degraded forest and wasteland areas, with tree planting conducted by State forest departments.
- The Indian Council of Forestry Research and Education (ICFRE), an autonomous body of the Environment Ministry, is responsible for administering the GCP. They define methodologies to calculate green credits and manage a trading platform for credit exchange.
- Regional Participation: Thirteen state forest departments have offered 387 land parcels totaling nearly 10,983 hectares of degraded forest land for afforestation projects under the GCP.
- Enhanced Decision-Making: Successful participants will receive estimates of the costs involved in their chosen afforestation projects, facilitating informed decision-making and planning.
Why has the GCP stoked controversy?
- Commodification of Environmental Conservation: Critics argue that the GCP turns environmental conservation into a commodity, potentially undermining the spirit of India’s forest conservation laws.
- Forest Diversion Concerns: The GCP’s provision for companies to “exchange” green credits for complying with compensatory afforestation requirements raises concerns that it could be exploited by industries seeking to ease forest diversion requirements, particularly in sectors like mining and infrastructure.
- Ecological Impact: Planting trees as a part of afforestation efforts does not guarantee ecosystem improvement. India’s diverse forest types require specific approaches, and planting the wrong types of trees could lead to the proliferation of invasive species or disrupt sustainable ecosystems.
- Monoculture Threat: There’s a risk that the GCP may promote the replacement of natural forests with invasive monocultures, potentially harming biodiversity and ecological balance.
- Carbon Trading Controversy: The GCP allows green credits resulting from carbon storage (e.g., tree planting) to be used for carbon trading. However, the methodology for equating these activities is unclear, raising doubts about the effectiveness and legitimacy of such carbon trading schemes.
Conclusion: The Green Credit Programme in India, faces criticism for potentially commodifying conservation, raising forest diversion concerns, posing ecological risks like monoculture, and lacking clarity in carbon trading methodologies. So there is a need for rigorous oversight and adaptation.
Mains PYQ
Q Explain the purpose of the Green Grid Initiative launched at World Leaders Summit of the COP26 UN Climate Change Conference in Glasgow in November, 2021. When was this idea first floated in the International Solar Alliance (ISA)?
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Capital Markets: Challenges and Developments
Why has India allowed FIIs to invest in its Green Bonds? | Explained
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Green Bond;
Mains level: FIIs; Green Bonds; Sovereign Green Bonds Framework (2022);
Why in the News?
On April 5 the Reserve Bank of India (RBI) greenlighted investments in the country’s Sovereign Green Bonds (SGrBs) by Foreign Institutional Investors (FIIS).
- These are the investors such as insurance companies, pension funds, and nation-states’ sovereign wealth funds.
What is the Sovereign Green Bond?
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Why has India allowed FIIs to invest in its Green Bonds?
- For attracting Foreign Investments: By allowing FIIs to invest in green bonds, India attracts foreign capital into its green projects.
- For Widening the Pool of Capital: Allowing FIIs to invest in India’s green projects expands the sources of funding available for the country’s ambitious climate goals, including achieving net zero emissions by 2070 and increasing the share of non-fossil fuel-based energy sources to 50%.
- For Meeting Climate Commitments: Prime Minister Narendra Modi pledged at COP26 in Glasgow in 2021 to reduce India’s carbon emission by 45% and increase the share of renewable energy in the country’s energy mix.
- For Diversification of Investments: FIIs are looking to diversify their portfolios and seek opportunities in green investments due to regulatory support, particularly in developed countries.
- India’s Sovereign Green Bonds Framework (2022), addresses concerns about greenwashing by providing a credible framework for green investments.
Limitation For Govt. of India:
- Limited credibility of projects: The absence of specific regulations for green bonds leaves investors unable to assess the financial risk associated with the projects.
- Higher costs of issuing: The high cost of issuing green bonds in India poses a challenge for the market. Green bonds are initially costly but provide long-term cost savings.
- Greenwashing may not be resolved: Greenwashing, which is the deceptive promotion of a company’s eco-friendly image, is prevalent in the green bond industry. Some bonds are labeled as “green” despite not meeting the specified criteria.
Way Forward:
- Establish Clear Regulations: The government should establish clear and stringent regulations for green bonds, outlining specific criteria for eligible projects.
- Enhance Project Credibility: Implement mechanisms for independent verification and certification of green projects to ensure their credibility.
- Lower Issuance Costs: Explore options to reduce the issuance costs of green bonds, such as providing incentives or subsidies to issuers.
BACK2BASICS:About India’s Sovereign Green Bonds Framework:
How they are issued?
What is the Eligibility for Repurchase Transactions (Repo)?
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Mains PYQ
Q Explain the purpose of the Green Grid Initiative launched at the World Leaders Summit of the COP26 UN Climate Change Conference in Glasgow in November 2021. When was this idea first floated in the International Solar Alliance (ISA)?
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Capital Markets: Challenges and Developments
SEBI unveils SCORES 2.0 to Strengthen Investor Redressal
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SCORES 2.0, SEBI
Mains level: NA
Why in the news?
The Securities and Exchange Board of India (SEBI) unveiled the upgraded version of the SEBI Complaint Redress System (SCORES 2.0) marking a significant advancement in the investor complaint redressal mechanism in the securities market.
About Securities and Exchange Board of India (SEBI)
|
What is SCORES 2.0?
- SCORES 2.0 refers to the upgraded version of the SEBI Complaint Redress System (SCORES) launched by the Securities and Exchange Board of India (SEBI).
- SCORES is an online platform designed to facilitate the lodging and resolution of complaints by investors in the securities market.
- Complaints can be lodged for any issues covered under the:
- SEBI Act, 1992
- Securities Contract Regulation Act, 1956
- Depositories Act, 1966
- Companies Act, 2013
Complaints on SCORES 2.0 can be launched against:
- Listed companies / registrar & transfer agents
- Brokers / stock exchanges
- Depository participants / depository
- Mutual funds
- Portfolio Managers
- Other entities (KYC Collective investment scheme, Merchant banker, Credit rating, Foreign institutional investor etc.)
Features of SCORES 2.0:
- Reduced Timelines: SCORES 2.0 implements reduced and standardized timelines for addressing investor grievances, ensuring a maximum redressal period of 21 calendar days from the date of complaint receipt.
- Auto-Routing and Escalation: The new version incorporates an auto-routing mechanism to swiftly direct complaints to the relevant regulated entity. Additionally, it introduces a two-tier review process, with complaints undergoing review first by the designated body and subsequently by SEBI if investors remain dissatisfied with the resolution provided.
- Integration with KYC Database: SCORES 2.0 is seamlessly integrated with the KYC Registration Agency database, streamlining the registration process for investors onto the platform.
- Enhanced Efficiency: Through features such as auto-routing, auto-escalation, and stricter monitoring protocols, SCORES 2.0 aims to enhance the efficiency and effectiveness of the investor complaint redressal process.
Significance of SCORES 2.0
- Improved Regulatory Oversight: By introducing stricter timelines and oversight mechanisms, SEBI aims to enhance regulatory efficiency and transparency, fostering a more accountable and responsive market ecosystem.
- Technological Advancements: The integration of advanced technological features, such as auto-routing and KYC database linkage, reflects SEBI’s proactive approach towards harnessing digital innovations to modernize regulatory processes and services.
PYQ:2013: The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify.
Practice MCQ:Consider the following statements about the SCORES 2.0 Platform recently launched by the Securities and Exchange Board of India (SEBI): 1. It is an online platform designed to facilitate the lodging and resolution of complaints by investors in the securities market. 2. It addresses complaints pertaining to the SEBI Act, 1992 only. 3. It ensures a maximum redressal period of 21 calendar days. How many of the above statements is/are correct? (a) One (b) Two (c) Three (d) None |
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Capital Markets: Challenges and Developments
T + 0 Settlement System kick starts today
Note4Students
From UPSC perspective, the following things are important :
Prelims level: T+0 Settlement Cycle
Mains level: NA
Why in the news?
India’s stock market will begin the with a ‘beta version’ of T+0 settlement system (same day settlement) from today. This is the world’s fastest stock settlement system.
About T+0 Settlement Cycle
- SEBI has planned to introduce the shorter cycle in two phases:
- T+0 Settlement Details: In Phase 1, trades executed until 1:30 PM will be settled by 4:30 PM on the same day.
- Instant Settlement Mechanics: Phase 2 envisages immediate trade-by-trade settlement, with trading continuing until 3:30 PM.
Features of the T+0 Settlement Mechanism
- Early Pay-In Trend: A large percentage of retail investors already make early pay-ins of funds and securities, indicating readiness for instant settlement.
- Instant Receipt Benefits: The mechanism enables instant receipt of funds and securities, reducing settlement shortages and enhancing investor control.
- Investor Protection: Direct crediting of funds and securities into investors’ accounts, especially for UPI clients, strengthens investor protection.
Settlement Cycle: A Quick History
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Scope and Implementation of T+0
- Initially, the T+0 settlement will be available for the top 500 listed equity shares based on market capitalization, implemented in three tranches.
- The same surveillance measures applicable in the T+1 cycle will apply to the T+0 cycle.
- Trade-for-trade settlement securities will NOT be eligible for T+0.
Rationale behind T+O Cycle
- Market Growth and Efficiency: With the significant growth in market volumes and participants, SEBI aims to enhance market efficiency and safety, especially for retail investors.
- Technological Advancements: The evolution of payment systems like UPI and the sophistication of market infrastructure support the feasibility of shorter settlement cycles.
- Investor Attraction: Faster transactions, reliability, and low costs are key factors that attract investors, making Indian securities a more appealing asset class.
Benefits of the New Mechanism
- Flexibility for Clients: The new mechanism offers faster payouts of funds to sellers and securities to buyers, providing greater flexibility and control.
- Market Ecosystem Advantages: The faster settlement cycle is expected to enhance the operational efficiency of the securities market, benefiting the entire ecosystem.
PYQ:2017: The term ‘Digital Single Market Strategy’ seen in the news refers to a) ASEAN b) BRICS c) EU d) G20
Practice MCQ: With reference to the T+0 Settlement Cycle, consider the following statements: 1. Trades executed until 1:30 PM will be settled by 4:30 PM on the same day. 2. Trade-for-trade settlement securities will also be eligible for T+0. Which of the given statements is/are correct? a) Only 1 b) Only 2 c) Both 1 and 2 d) Neither 1 nor 2 |
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Capital Markets: Challenges and Developments
SEBI’s directive on Overseas ETF Investments
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Exchange Traded Funds (ETFs)
Mains level: NA
What is the news?
SEBI has instructed mutual fund houses to halt new inflows into schemes investing in overseas exchange-traded funds (ETFs) from April 1, 2024.
What are Exchange Traded Funds (ETFs)?
- ETFs are marketable securities that track various assets, including indices, commodities, or bonds, and trade on stock exchanges like regular stocks.
- ETFs were started in 2001 in India.
- Types of ETFs: Equity ETFs, bonds ETFs, commodity ETFs, international ETFs, and sectoral/thematic ETFs cater to diverse investment preferences.
Market dynamics of ETFs
- ETFs can be purchased or sold on a stock exchange in the same way that regular stocks can, unlike the mutual funds.
- The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange.
- The trading value of an ETF is based on the net asset value of the underlying stocks that it represents.
- These funds offer higher liquidity, lower fees, and tax efficiency compared to traditional mutual funds, appealing to individual investors.
Reasons behind SEBI’s Directive
- Cap Proximity: The mutual fund industry has nearly reached 95% of the $1 billion investment limit in overseas ETFs, prompting SEBI’s intervention.
- Temporary Measure: SEBI’s directive aims to temporarily curb inflows into these schemes until the investment limit is revised or additional measures are implemented.
- Existing Caps: Currently, mutual funds are subject to an overall cap of $7 billion for investments in overseas stocks or mutual funds, with a specific limit of $1 billion for ETFs.
PYQ:
2013: The product diversification of financial institutions and insurance companies, resulting in overlapping of products and services strengthens the case for the merger of the two regulatory agencies, namely SEBI and IRDA. Justify.
2020: With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic?
- It is the investment through capital instruments essentially in a listed company.
- It is a largely non-debt creating capital flow.
- It is the investment which involves debt-servicing.
- It is the investment made by foreign institutional investors in the Government securities.
Practice MCQ:
With reference to the Exchange Traded Funds (ETFs), consider the following statements:
- ETFs are marketable securities that track various assets, including indices, commodities, or bonds, and trade on stock exchanges like regular stocks.
- ETFs were started in 2021 in India.
- ETFs can be purchased like the mutual funds.
How many of the given statements is/are correct?
- One
- Two
- Three
- None
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Capital Markets: Challenges and Developments
India to stay alert for ‘Hot Money’ inflows
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Hot Money
Mains level: Read the attached story
Introduction
- India’s recent inclusion into JPMorgan’s emerging market debt index marks a significant milestone for its financial markets.
- However, with this inclusion comes the risk of volatile capital flows, particularly ‘hot money,’ which can exert pressure on currency and bond markets.
What is ‘Hot Money’?
- Definition: ‘Hot money’ refers to funds controlled by investors seeking short-term returns. It is the flow of funds from one country to another to earn a short-term profit on interest rate differences.
- Typical Investments: Investors often seek high-interest, short-term opportunities like certificates of deposit (CDs).
- Foreign portfolio investment (FPI): FPI is often referred to as “hot money” because it tends to flee at the first signs of trouble in an economy.
Mechanics of ‘Hot Money’
- Attracting ‘Hot Money’: Banks offer short-term CDs with above-average interest rates to attract ‘hot money.’
- Rapid Movement: Investors swiftly withdraw funds and transfer them to institutions offering higher rates when interest rates change.
- Cross-Border Movements: Investors may shift funds between countries to capitalize on favorable interest rates.
Economic hazards posed by Hot Money
- Volatility: Hot money causes rapid price swings, risking market stability.
- Speculative Bubbles: Inflated asset prices lead to market crashes when bubbles burst.
- Currency Depreciation: Hot money influxes can cause currency value swings, harming exports.
- Interest Rate Volatility: Central banks may struggle to stabilize rates due to hot money flows.
- Financial Instability: Herd behavior from hot money can cause market panics.
- Capital Flight: Short-term hot money exits strain a nation’s financial reserves.
- Speculative Attacks: Hot money inflows attract attacks from profit-driven investors.
- Macroeconomic Imbalances: Over-reliance on hot money leads to unsustainable economic patterns.
RBI’s position
- Monitoring Foreign Fund Flows: India will closely monitor inflows of foreign funds to prevent excessive ‘hot money’ influx.
- Regulating Interest Rates: Measures will be taken to manage interest rates to discourage short-term speculative investments.
- Maintaining Financial Stability: Proactive measures aim to prevent excessive volatility in currency and bond markets.
Back2Basics: Hot Money vs. Cold Money
| Hot Money | Cold Money | |
| Nature | Short-term capital that flows in and out of markets quickly. | Long-term investments that remain stable and less volatile. |
| Movement | Rapid movement, often driven by short-term profit opportunities. | Relatively stable movement, focused on long-term returns. |
| Risk | High risk due to volatility and susceptibility to market changes. | Lower risk as it is less influenced by short-term market fluctuations. |
| Purpose | Often seeks quick returns, capitalizing on market trends and speculation. | Invested with long-term objectives, such as retirement planning or wealth preservation. |
| Impact on Markets | Can create volatility and instability, leading to sudden market fluctuations. | Provides stability and liquidity, contributing to long-term economic growth. |
| Examples | Hedge funds, currency traders, speculative investors. | Pension funds, mutual funds, long-term investors. |
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Capital Markets: Challenges and Developments
SEBI strengthens regulations for Alternate Investment Funds (AIFs)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Alternate Investment Funds (AIFs)
Mains level: NA
Introduction
- The Securities and Exchange Board of India (SEBI) has implemented its decisions, introducing significant changes to the regulations governing Alternate Investment Funds (AIFs).
- These include extending the mandatory custodian appointment to smaller AIFs and requiring the dematerialization of AIF investments.
About Alternative Investment Funds (AIFs)
| Details | |
| Definition | AIFs are privately pooled investment vehicles established in India, collecting funds from sophisticated investors for investing. |
| Regulation | Governed by the SEBI (Alternative Investment Funds) Regulations, 2012. |
| Formation | Can be formed as a company, Limited Liability Partnership (LLP), trust, etc. |
| Investor Profile | Aimed at high rollers, including domestic and foreign investors in India. Generally favored by institutions and high net worth individuals due to high investment amounts. |
| Categories of AIFs | Category I: Invests in start-ups, early-stage ventures, SMEs, etc. Includes venture capital funds, angel funds, etc.
Category II: Includes funds not in Category I/III, like real estate funds, debt funds, etc. No leverage or borrowing except for operational requirements. Category III: Employs complex trading strategies, may use leverage. Includes hedge funds, PIPE Funds, etc. |
| Fund Structure | Category I and II AIFs must be close-ended and have a minimum tenure of three years.
Category III AIFs can be open-ended or close-ended. |
Extended Custodian Appointment Requirements
- Previous Norms: Earlier, the mandatory custodian appointment was required for Category III AIFs and Category I and II AIFs with a corpus exceeding ₹500 crore.
- New Extension: As of January 5, this requirement has been extended to all AIFs, regardless of their corpus size.
Mandatory Dematerialization of Investments
- Amendment to AIF Regulations: SEBI has amended its 2012 AIF Regulations to mandate that AIFs hold securities of their investments only in dematerialized form, with certain exceptions.
- Exceptions: These include investments in instruments not eligible for dematerialization and those held by a liquidation scheme of AIF not available in dematerialized form.
- Future Provisions: SEBI has also reserved the right to specify other investments or schemes that may be exempt from this dematerialization requirement.
New Conditions for Custodian Appointment
- Restrictions on Associates: AIFs can appoint a Custodian who is an Associate of a Manager or a Sponsor of an alternate fund only under specific conditions.
- Net Worth and Independence Requirements: These conditions include the Sponsor or Manager having a minimum net worth of ₹20,000 crore and ensuring the Custodian’s independence from the Sponsor or Manager.
Closing Regulatory Gaps
- Addressing Past Breaches: The latest changes aim to close various regulatory gaps that previously allowed breaches in the spirit of the law and the use of investment vehicles to escape regulatory oversight.
- RBI’s Complementary Measures: The Reserve Bank of India (RBI) has also tightened norms for banks and NBFCs investing in AIFs to prevent potential ever-greening and other regulatory circumventions.
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Capital Markets: Challenges and Developments
Decoding the Adani-Hindenburg Judgment
Note4Students
From UPSC perspective, the following things are important :
Prelims level: NA
Mains level: Adani-Hindenburg Judgment
Introduction
- Recent Order: The Supreme Court’s recent order on the Adani-Hindenburg matter focused on the inquiries conducted by the Securities and Exchange Board of India (SEBI).
- No Regulatory Failure Found: The apex court concluded that there was no regulatory failure on SEBI’s part, negating the need for a Special Investigating Team (SIT).
SEBI’s Investigations and the Supreme Court’s Stance
- Status of Investigations: Out of 24 investigations related to the Adani-Hindenburg matter, SEBI has completed 22.
- Supreme Court’s Trust in SEBI: The court accepted SEBI’s status report without delving into the details of the investigations, trusting SEBI to bring them to a logical conclusion.
Concerns and Criticisms of the Supreme Court Judgment
- Lack of Transparency: The findings of the completed SEBI investigations have not been made public, raising questions about the transparency and accountability of the process.
- ‘Chicken-and-Egg’ Inquiry: The Supreme Court did not address the “chicken-and-egg situation” where SEBI’s inability to identify the ultimate beneficial owners of certain overseas entities has stalled the investigation.
- Overlooked Statutory Violations: The judgment did not consider the alleged dilution of regulations that could facilitate the concealment of beneficial ownership, which might be violative of the SEBI Act.
Implications of the Judgment
- Continued SEBI Investigation: SEBI has been given an additional three months to conclude its inquiry into the alleged violation of minimum shareholding norms by the Adani group companies.
- Potential Subversion of Ongoing Investigations: The deficiencies in the Supreme Court judgment could potentially undermine the ongoing investigations into the Adani group.
- Hindenburg and OCCRP Reports: The judgment has seemingly dismissed the reports by Hindenburg and OCCRP as unrelated or inconclusive, despite their revelations about the Adani group’s financial dealings.
Historical Context and Ongoing Concerns
- Past Allegations: The Adani group has faced similar allegations of share price manipulation and round-tripping in the past, with SEBI itself filing a criminal complaint 15 years ago.
- Current Investigations: Despite ongoing investigations for over three years, no criminal complaint has been registered against the Adani promoters for the recent allegations.
Conclusion
- Need for Reevaluation: The deficiencies in the Supreme Court judgment warrant a reconsideration in the interest of justice and transparency.
- Public Interest and Justice: Ensuring that the findings of SEBI’s investigations are made public and acted upon is crucial for upholding regulatory integrity and public trust.
- Future of Adani Investigations: The outcome of the ongoing SEBI investigations and the handling of the Hindenburg and OCCRP reports will be pivotal in determining the course of justice in this high-profile case.
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Capital Markets: Challenges and Developments
Rise in Participatory Notes Investment
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Participatory Notes
Mains level: NA
Central Idea
- Indian capital markets witnessed a significant increase in investments through participatory notes (P-notes), reaching ₹1.31 lakh crore by the end of November.
What are Participatory Notes?
| Details | |
| Nature of Instrument | Offshore derivative instruments with Indian shares as underlying assets. |
| Issuers | Issued by registered Foreign Institutional Investors (FIIs) to overseas investors. |
| Purpose | To allow foreign investors to invest in Indian stock markets without direct registration. |
| Anonymity | Provide anonymity for foreign investors; beneficiary details are not disclosed to Indian regulators. |
| Regulatory Oversight | Governed by the Securities and Exchange Board of India (SEBI). |
| Compliance | FIIs issuing P-Notes are required to adhere to KYC norms and other regulatory standards. |
| Controversies | Associated with risks of money laundering and contributing to market volatility. |
| Regulatory Reforms | SEBI has tightened norms over time, including enhanced KYC and disclosure requirements. |
| Economic Impact | Significant source of foreign portfolio investment; influences market sentiment and foreign investor behavior. |
| Impact of Regulatory Changes | Changes in regulations have affected the flow of investments through P-Notes. |
Correlation with FPI Flows
- P-Notes and FPI Trends: The investment through P-notes typically mirrors the trends in foreign portfolio investor (FPI) flows.
- Global Risk Influence: In times of global risk, investment through P-notes tends to increase, and the opposite occurs when the risk subsides.
Factors Influencing the Recent Increase
- U.S. Treasury Bond Yields: The decline in U.S. treasury bond yields is believed to have redirected FPIs’ attention to the Indian market for potentially higher returns.
- IPO Attraction: The listing of Initial Public Offerings (IPOs) in India has also been a factor in attracting foreign investors back to the market.
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Capital Markets: Challenges and Developments
SEBI’s Proposal for T+0 Instant Settlement Cycles
Note4Students
From UPSC perspective, the following things are important :
Prelims level: One-Hour Trade Settlement, T+1 Settlement Cycle
Mains level: Read the attached story
Central Idea
- The Securities and Exchange Board of India (SEBI) has proposed introducing T+0 (same day) and instant settlement cycles in the equity cash segment, alongside the existing T+1 cycle.
Current Settlement Cycle
- Evolution: SEBI shortened the settlement cycle from T+5 to T+3 in 2002, and then to T+2 in 2003. The T+1 cycle was introduced in 2021 and fully implemented by January 2023.
- T+1 Cycle: Currently, the settlement of funds and securities occurs on the next day after the trade.
About T+0 Settlement Cycle
- Phased Implementation: SEBI plans to introduce the shorter cycle in two phases: Phase 1 with T+0 Settlement and Phase 2 with Instant Settlement.
- T+0 Settlement Details: In Phase 1, trades executed until 1:30 PM will be settled by 4:30 PM on the same day.
- Instant Settlement Mechanics: Phase 2 envisages immediate trade-by-trade settlement, with trading continuing until 3:30 PM.
Scope and Implementation
- Initial Focus: Initially, the T+0 settlement will be available for the top 500 listed equity shares based on market capitalization, implemented in three tranches.
- Surveillance Measures: The same surveillance measures applicable in the T+1 cycle will apply to the T+0 cycle. Trade-for-trade settlement securities will not be eligible for T+0.
Rationale behind Introducing a Shorter Settlement Cycle
- Market Growth and Efficiency: With the significant growth in market volumes and participants, SEBI aims to enhance market efficiency and safety, especially for retail investors.
- Technological Advancements: The evolution of payment systems like UPI and the sophistication of market infrastructure support the feasibility of shorter settlement cycles.
- Investor Attraction: Faster transactions, reliability, and low costs are key factors that attract investors, making Indian securities a more appealing asset class.
Features of the Proposed T+0 Settlement Mechanism
- Early Pay-In Trend: A large percentage of retail investors already make early pay-ins of funds and securities, indicating readiness for instant settlement.
- Instant Receipt Benefits: The mechanism enables instant receipt of funds and securities, reducing settlement shortages and enhancing investor control.
- Investor Protection: Direct crediting of funds and securities into investors’ accounts, especially for UPI clients, strengthens investor protection.
Benefits of the New Mechanism
- Flexibility for Clients: The new mechanism offers faster payouts of funds to sellers and securities to buyers, providing greater flexibility and control.
- Market Ecosystem Advantages: The faster settlement cycle is expected to enhance the operational efficiency of the securities market, benefiting the entire ecosystem.
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Capital Markets: Challenges and Developments
India’s Growing Influence on the MSCI Emerging Markets Index
Note4Students
From UPSC perspective, the following things are important :
Prelims level: MSCI EM Index
Mains level: NA
Central Idea
- India’s presence on the MSCI Emerging Markets (EM) Index is set to expand with the inclusion of nine new stocks, effective from 30th November.
- This development will elevate India’s weightage on the index to 16.3%, reaching an all-time high representation of 131 Indian stocks.
What is MSCI EM Index?
- MSCI is a globally recognized index listed on the NYSE.
- It is released and maintained by MSCI Inc., a leading provider of global equity indices, investment analytics, and other financial data and services.
- Its stock indices are closely monitored by global asset managers, hedge funds, banks, corporations, and insurance companies.
- They rely on these indices to allocate funds across global stock markets.
- MSCI indices serve as a foundation for passive investments through exchange-traded funds (ETFs), index funds, and certain fund of funds.
India’s Progress on the EM Index
- Increasing Weight: India’s weightage on the MSCI EM Index has steadily grown, poised to double to 16.3% from four years ago with the upcoming rebalancing.
- Second to China: India ranks second, trailing only China (29.89%), on the EM Index, outperforming countries like Taiwan (15.07%), South Korea (11.78%), and Brazil (5.42%).
- Strong Performance: As an independent entity, India has excelled in generating net returns, boasting a 4.75% return in the year through October compared to MSCI EM’s -2.14%. Over the long term, India has achieved an annualized 8.33% return over ten years versus MSCI EM’s 1.19%.
Inclusion Criteria for Stocks
- Market Capitalization-Based Weightage: Stocks’ weights on the EM index are determined by free-float market capitalization, which represents shares available for foreign investors to trade. Higher market capitalization leads to greater weight and allocation by investors.
- Top Indian Stocks: Prominent Indian stocks on MSCI EM include Reliance Industries (weight 1.34%), ICICI Bank (0.91%), and Infosys (0.87%).
Impact of Increased Representation
- Passive Inflows: Passive foreign trackers are expected to inject $1.5 billion into the nine newly included Indian stocks and other Indian counters with increased weights.
- Stock Rebalancing: MSCI’s adjustments involve increasing the weights of stocks like Zomato, Hindustan Aeronautics, and Jio Financial Services, potentially attracting around $160 million in passive inflows. However, heavyweight stocks like Reliance may experience minor weight reductions.
- Overall FPI Investment: The increase primarily benefits passive trackers, and it may not necessarily lead to a surge in overall foreign portfolio investment (FPI) flows. Nonetheless, it boosts investor sentiment, as passive investments tend to offer higher returns over extended periods due to lower expenses and reduced human error.
- Positive Sentiment: MSCI EM’s positive review of India comes shortly after Morgan Stanley upgraded India to the status of the most preferred emerging market, further enhancing India’s appeal to global
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Capital Markets: Challenges and Developments
What are Active and Passive Equity Funds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Active and Passive Equity Funds
Mains level: NA
Central Idea
- Mutual fund investors are currently favouring active equity funds over passive funds, according to a recent study.
Active vs. Passive Equity Funds
Active Equity Funds |
Passive Equity Funds(Index Funds/ETFs) |
|
| Investment Strategy | Actively managed by fund managers | Passively track a specific benchmark index |
| Research and Analysis | In-depth research and analysis to select individual stocks | No active stock selection or market timing; follow benchmark index composition |
| Portfolio Turnover | Higher turnover; frequent buying and selling of stocks | Lower turnover; minimal changes to match index composition |
| Fees and Expenses | Higher management fees and expense ratios | Lower management fees and expense ratios |
| Performance | Performance varies widely; aims to outperform the benchmark | Seeks to match benchmark index performance |
| Diversification | Diversification depends on the fund’s holdings and strategy | Offers broad diversification based on benchmark index |
| Tax Implications | Potential capital gains tax from frequent trading | Generally lower capital gains tax due to lower turnover |
| Suitability | Suited for investors seeking potential alpha (outperformance) | Suited for cost-conscious investors seeking index-like returns |
| Active Management Risk | Subject to fund manager’s stock-picking skills and market timing | Minimal active management risk; returns closely track the index |
| Investor Involvement | Less hands-on; rely on fund manager’s decisions | Passive investing; no need for frequent monitoring |
| Examples | Mutual funds with active management | Index mutual funds, Exchange-Traded Funds (ETFs) |
| Common Benchmarks in India | Sensex, Nifty 50, BSE 100, etc. | Sensex, Nifty 50, Nifty Next 50, etc. |
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Capital Markets: Challenges and Developments
Direct Listing on Foreign Stock Exchanges
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Direct Listing, IPO
Mains level: NA
Central Idea
- In a landmark move, the Indian government has opened doors for select Indian companies to directly list on designated foreign stock exchanges.
- This strategic decision aims to provide these companies with access to global capital markets and boost capital outflows, marking a significant step in India’s financial evolution.
Direct Listing vs. Initial Public Offers (IPO)
| IPO | Direct Listing | |
| Share Issuance | New shares are created and sold. | No new shares are created or sold. |
| Underwriters | Typically involves underwriters. | No underwriters involved. |
| Price Determination | Price determined through negotiations. | Market-driven pricing at launch. |
| Lock-Up Period | Common for insiders post-IPO. | Typically no lock-up period. |
| Regulatory Compliance | Extensive financial disclosures. | Regulatory requirements met. |
| Capital Raising | Primary goal is to raise capital. | Provides liquidity to shareholders. |
Implementation of Companies (Amendment) Act, 2020
- Government Notification: The Ministry of Corporate Affairs (MCA) recently issued a notification, effectively putting into action the provisions outlined in the Companies (Amendment) Act, 2020.
- Key Enabler: This allows both listed and unlisted domestic companies to directly list their equity shares on the International Financial Services Centre (IFSC) in Ahmedabad.
- Empowering Provision: Section 5 grants the central government the authority to permit specific classes of public companies to list specified classes of securities on foreign stock exchanges, including GIFT IFSC, Ahmedabad.
- Streamlined Procedures: The government retains the flexibility to exempt such listings from certain procedural requirements, such as prospectus, share capital, beneficial ownership, and dividend distribution.
Current Listing Mechanism for Foreign Bourses
- Depository Receipts: Previously, Indian companies desiring overseas listings relied on depository receipts, such as American Depository Receipts (ADR) or Global Depository Receipts (GDR). These receipts were issued to foreign investors through Indian custodians.
- Past Utilization: Between 2008 and 2018, 109 companies successfully raised Rs 51,847.72 crore via the ADRs/GDRs route. However, after 2018, no Indian company pursued overseas listings.
Advantages of Direct Foreign Listing
- Enhanced Fundraising: Direct foreign listing empowers domestic companies to access foreign markets for fundraising, offering improved valuations and exposure to foreign currencies like the US dollar.
- Startup and Unicorn Growth: This initiative may prove particularly beneficial for startups and unicorns, providing an additional avenue for capital raising and heightened global visibility.
- Boosting Forex Reserves: The move contributes to India’s foreign exchange reserves, strengthening the nation’s economic stability.
- Simplified Accounting: Indian Accounting Standards (IndAS) closely align with global accounting norms, reducing the need for extensive and costly accounting preparations following US Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
Challenges in Direct Foreign Listing
- Valuation Discrepancies: A key challenge lies in whether global investors will assign similar valuations as Indian markets. Assessing the commercial advantages of foreign listings will be a crucial consideration for Indian companies.
- Clarity and Details: More detailed information is essential. This includes clarity on eligible company classes, types of listed securities, permitted foreign jurisdictions and stock exchanges, and exemptions related to procedural compliance.
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Capital Markets: Challenges and Developments
Finfluencers: What You Need to Know
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Finfluencers
Mains level: Capital markets manipulation issue
Central Idea
- A recent front-page advertisement in a business daily, featuring a financial influencer (finfluencer), YouTube’s logo, and the IT Ministry’s logo, has stirred controversy and raised concerns about the role of finfluencers and their impact.
Understanding Finfluencers
- Finfluencers are individuals with a significant presence on social media platforms who offer financial advice, share personal experiences related to money management, and discuss various investment topics.
- Their general discussion includes stocks, budgeting, property, cryptocurrency, and financial trends.
- Finfluencers often have a large following, and their advice and recommendations can influence the financial decisions of their audience.
- However, concerns arise regarding their qualifications and the potential risks associated with their recommendations.
Why discuss them?
- The advertisement in question featured a popular finfluencer, alongside the tagline, “Trust only the real experts,” and logos of YouTube and the IT Ministry.
- It directed viewers to a YouTube playlist on online safety and content verification.
- The advertisement generated criticism due to the perceived endorsement of expertise by finfluencers or a specific social media platform.
- Given ongoing regulatory scrutiny of finfluencers, this raised concerns about the message being conveyed.
Regulatory Context
- The Securities and Exchange Board of India (SEBI), the country’s markets regulator, has been examining the activities of finfluencers.
- Investors have expressed concerns about unsolicited stock tips and investment advice provided by finfluencers without proper registration as investment advisers.
- Many finfluencers lack clear educational or professional qualifications in finance, raising questions about their competence to provide financial advice.
- The absence of transparency regarding financial relationships between finfluencers and promoted entities is also concerning.
Government’s Response
- The MEITY clarified that the advertisement did not endorse any individual or platform.
- He emphasized the need for private platforms to exercise caution when using government logos in advocacy ads to avoid misinterpretation.
Broader Industry Concerns
- ASCI’s Guidelines violated: The Advertising Standards Council of India (ASCI) has issued guidelines for social media influencers and advertisers regarding virtual digital assets (VDAs), including cryptocurrencies and non-fungible tokens (NFTs).
- Non-Compliance: ASCI’s recent half-yearly report highlighted cases of non-compliance by social media influencers with advertising guidelines.
- Celebrity endorsements: A prominent Bollywood actor was among those found in violation, particularly in advertisements related to financial instruments and cryptocurrencies.
Conclusion
- The controversial advertisement featuring a finfluencer has ignited a debate about the role and responsibilities of financial influencers in India.
- Regulatory authorities are increasingly focusing on the activities of finfluencers, and the industry is grappling with questions of transparency, qualifications, and investor protection.
- The ongoing scrutiny reflects the evolving landscape of financial advice and investment in the digital age.
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Capital Markets: Challenges and Developments
India to unveil 50-year Government Bonds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Government Bonds
Mains level: Not Much
Central Idea
- India is set to make history by issuing it’s first-ever 50-year government bonds and 30-year green bonds.
- These offerings have piqued the interest of insurance companies and provident funds seeking avenues to invest their long-term funds.
Why such move?
- Ambitious Target: India aims to mobilize ₹6.55 trillion ($78.73 billion) through bond sales from October to March. This includes a significant ₹300 billion allocation to the 50-year security, marking the central government’s maiden auction of such bonds.
- Natural Demand: Long-term investors, particularly insurers, find the 50-year bonds appealing due to their alignment with asset-liability management requirements.
Government Bonds in India
- Government Bonds in India, fall under the broad category of Government Securities (G-Sec) and are primarily long term investment tools issued for periods ranging from 5 to 40 years.
- It can be issued by both Central and State governments of India. Government bonds issued by State Governments are also called State Development Loans (SDLs).
- The GB interest rates, also called a coupon, can either be fixed or floating and disbursed on a semi-annual basis.
- In most cases, GOI issues bonds at a fixed coupon rate in the market.
Types:
| Fixed-Rate Bonds | Offer a fixed interest rate throughout the investment tenure, providing clarity with the coupon rate mentioned. |
| Floating Rate Bonds (FRBs) | Subject to periodic interest rate adjustments, often with a base rate and fixed spread determined through auctions. |
| Sovereign Gold Bonds (SGBs) | Allow investments in gold without physical possession, with tax-exempt interest and prices linked to gold’s value. |
| Inflation-Indexed Bonds | Adjust both principal and interest based on inflation, using indices like CPI or WPI, tailored for retail investors. |
| 7.75% GOI Savings Bond | Features a 7.75% interest rate and available to individuals, minors with legal guardians, and Hindu Undivided Families. |
| Bonds with Call/Put Option | Permit either issuer or investor to buy back or sell bonds, respectively, on specified dates, after 5 years from issuance. |
| Zero-Coupon Bonds | Generate earnings from the difference between issuance and redemption prices, as they do not provide interest income. |
Advantages offered
- Sovereign Guarantee: Government bonds are backed by the government’s commitment, offering stability and assured returns.
- Inflation-Adjusted: Inflation-indexed bonds protect investors from rising prices, maintaining the real value of their investments.
- Regular Income: Government bonds provide semi-annual interest disbursements, offering investors a source of regular income.
Limitations
- Lower Income: Apart from 7.75% GOI Savings Bonds, government bonds typically offer lower interest rates.
- Lack of Relevance: With maturity tenures ranging from 5 to 40 years, government bonds may lose relevance over time, particularly in the face of inflation.
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Capital Markets: Challenges and Developments
India’s Inclusion in Government Bond Index-Emerging Markets (GBI-EM)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Government Bond Index-Emerging Markets (GBI-EM)
Mains level: Not Much
Central Idea
- In a groundbreaking development, JPMorgan has announced the inclusion of Indian government bonds in its Government Bond Index-Emerging Markets (GBI-EM), slated to commence from June 2024.
- This decision could pave the way for substantial inflows of billions of dollars into local currency-denominated government debt.
What is Government Bond Index-Emerging Markets (GBI-EM)?
| Definition | An index that tracks the performance of government bonds issued by emerging market countries.
It reflects the returns of local-currency-denominated sovereign bonds. |
| Purpose | To provide a benchmark for measuring the performance of emerging market government bonds, helping investors assess the attractiveness of these bonds for investment. |
| Issuer | J.P. Morgan |
| Components | Includes government bonds issued by various emerging market countries.
The composition may change over time based on eligibility criteria. |
| Coverage | Covers a broad range of emerging market countries and their local currency government bonds.
Different GBI-EM indices may have specific regional or maturity focuses. |
| Currency | Denominated in the local currencies of the respective emerging market countries. |
India’s inclusion in GBI-EM
- Long-Awaited Discussion: India’s consideration for inclusion in global indexes began in 2013. However, limitations on foreign investments in domestic debt impeded progress.
- Fully Accessible Route (FAR): In April 2020, the Reserve Bank of India introduced select securities exempt from foreign investment restrictions through the “fully accessible route” (FAR), rendering them eligible for inclusion in global indexes.
- Index-Eligible Bonds: Currently, there are 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion that meet index eligibility criteria, according to JPMorgan.
- Investor Support: Approximately 73% of benchmarked investors voted in favor of India’s inclusion in the index, marking a significant endorsement.
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Capital Markets: Challenges and Developments
SEBI to introduce One-Hour Trade Settlement
Note4Students
From UPSC perspective, the following things are important :
Prelims level: One-Hour Trade Settlement, T+1 Settlement Cycle
Mains level: NA
Central Idea
- SEBI aims to implement a One-Hour trade Settlement by March 2024.
- Additionally, an Application Supported by Blocked Amount (ASBA)-like facility for secondary market trading is anticipated to launch in January 2024.
Do you know?
India is the first jurisdiction in the globe that has moved to T+1 settlement (trade plus one day). We are now talking about one-hour settlement and that will be a stepping-stone to instantaneous settlement.
Understanding Trade Settlement
- Trade settlement involves the exchange of funds and securities on the settlement date.
- It is considered complete when purchased securities are delivered to the buyer, and the seller receives the funds.
- India transitioned to a T+1 settlement cycle earlier this year, facilitating faster fund transfers, share deliveries, and operational efficiency.
SEBI’s Stance
- SEBI believes that achieving instantaneous trade settlement will take additional time due to necessary technology development.
- Therefore, SEBI plans to implement a one-hour trade settlement before the instantaneous settlement.
- SEBI expects instantaneous trade settlement to be launched by the end of 2024.
Benefits of One-Hour Trade Settlement
- In the current T+1 settlement cycle, the seller receives funds in their account the day after a trade.
- With one-hour settlement, the seller would receive funds within an hour of selling shares, and the buyer would have shares in their demat account within an hour.
Back2Basics: T+1 Settlement Cycle
- The T+1 settlement cycle means that trade-related settlements must be done within a day, or 24 hours, of the completion of a transaction.
- For example, under T+1, if a customer bought shares on Wednesday, they would be credited to the customer’s demat account on Thursday.
- This is different from T+2, where they will be settled on Friday.
- As many as 256 large-cap and top mid-cap stocks, including Nifty and Sensex stocks, come under the T+1 settlement.
- Until 2001, stock markets had a weekly settlement system.
- The markets then moved to a rolling settlement system of T+3, and then to T+2 in 2003.
- In 2020, Sebi deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors.
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Capital Markets: Challenges and Developments
Decoding the OCCRP’s Adani Report
Note4Students
From UPSC perspective, the following things are important :
Prelims level: NA
Mains level: Financial frauds
Central Idea
- Following a Supreme Court directive in March 2023, the Securities and Exchange Board of India (SEBI) was tasked with investigating allegations related to the Adani-Hindenburg matter.
- The Organized Crime and Corruption Reporting Project (OCCRP) has recently unveiled new allegations against the Adani Group, adding to the scrutiny.
OCCRP’s allegations against Adani Group
- OCCRP’s report alleges stock manipulation by the Adani Group.
- The report cites exclusive documents indicating that investors connected to the Adani family influenced Adani companies’ stock prices.
- The Adani Group has strongly denied these allegations, attributing them to “Soros-funded interests.”
What is OCCRP?
- The Organized Crime and Corruption Reporting Project (OCCRP) is a global network of investigative reporters.
- Founded by Drew Sullivan and Paul Radu in 2006, OCCRP focuses on investigating organized crime and systemic corruption.
- OCCRP has grown to over 150 journalists in 30 countries and collaborates with regional partners and organizations like the Global Investigative Journalism Network.
OCCRP’s Impact
- OCCRP’s investigative efforts have led to numerous official investigations, arrests, resignations, and substantial fines.
- It played a pivotal role in high-profile probes, including investigations on Russia’s oligarchs and the Panama Papers project.
- The organization has been nominated for the Nobel Peace Prize for its contributions in unmasking political corruption and organized crime.
SEBI’s Investigation
- SEBI was directed by the Supreme Court to investigate Rule 19A violations, non-disclosure of related party transactions, and stock price manipulation.
- The OCCRP investigation alleges that Mauritius-based funds, connected to the Adani family, invested in Adani companies’ stocks.
- A UAE-based firm, linked to Adani, purportedly received advisory fees from the investment funds.
- The OCCRP’s evidence, along with the Hindenburg report, suggests potential regulatory breaches and contraventions by the Adani Group.
Decoding Rule 19A
- Rule 19A is a significant provision of the Securities Contracts (Regulation) Rules, 1957.
- It mandates that any company listed on the Indian stock market must maintain a minimum of 25 per cent public shareholding.
- “Public” in this context refers to individuals other than the “promoter and promoter group.” These terms encompass immediate family members and subsidiaries or associates of the company.
- This rule ensures that a sufficient number of a listed company’s shares are available for trading, promoting price discovery.
SEBI’s Response and Expert Committee
- SEBI is conducting investigations into Adani-Hindenburg matters, with some investigations still ongoing.
- The Expert Committee has reported regulatory loopholes facilitating the concealment of “ultimate beneficiary ownership” and transactions with “related parties.”
- SEBI’s handling of alerts generated in relation to Adani stocks and its evaluation of suspected FPIs have raised questions about its role.
Conclusion
- OCCRP’s investigation provides further allegations against the Adani Group, accentuating regulatory concerns.
- The complex web of potential regulatory violations and economic crimes warrants a thorough forensic audit by an independent auditor.
- SEBI’s role in the investigation, regulatory amendments, and handling of alerts requires scrutiny to ensure transparency and accountability.
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Capital Markets: Challenges and Developments
SEBI’s Amendments to boost REITs and InvITs
Note4Students
From UPSC perspective, the following things are important :
Prelims level: REITs and InvITs
Mains level: Not Much
Central Idea
- The Securities and Exchange Board of India (SEBI) has recently approved crucial changes to the regulations governing real estate investment trusts (REITs) and infrastructure investment trusts (InvITs), aimed at enhancing their appeal to investors.
- These investment vehicles function similarly to mutual funds, pooling capital to invest in real estate or infrastructure projects.
What are REITs and InvITs?
| Real Estate Investment Trusts (REITs) | Infrastructure Investment Trusts (InvITs) | |
| Structure | Investment trusts owning real estate properties | Investment trusts owning revenue-generating infrastructure projects |
| Regulation | Regulated by SEBI | Regulated by SEBI |
| Assets | Commercial real estate properties (no residential) | Operational infrastructure projects |
| Units | Units issued to investors, traded on stock exchanges | Units issued to investors, traded on stock exchanges |
| Distribution | Mandatory distribution of a significant portion of income as dividends | Mandatory distribution of a certain percentage of cash flows as dividends |
| Tax Benefits (Dividends) | Dividend distribution exempt from DDT | Dividend distribution exempt from DDT |
| Taxation (Investor’s Dividends) | Taxable as per investor’s income tax slab | Taxable as per investor’s income tax slab |
| Asset Focus | Commercial properties: office buildings, malls, etc. | Operational infrastructure projects |
| Purpose | Income generation and capital appreciation | Income generation and capital appreciation |
| Project Type | Income-generating properties | Operational brownfield projects |
| Examples in India | Embassy Office Parks REIT, Mindspace Business Parks REIT | IndiGrid Trust, IRB InvIT Fund, Sterlite Power Grid Ventures InvIT |
Importance of REITs and InvITs
- Investment Pooling: REITs and InvITs operate as investment pooling vehicles, allowing sponsors to invest in real estate or infrastructure projects.
- Affordable Ownership: REITs offer retail investors access to income-generating real estate properties that would otherwise be unaffordable.
- Direct Investment: InvITs enable both individual and institutional investors to directly invest in infrastructure projects, spanning transport, energy, and communication sectors.
Performance of REITs and InvITs
- Growing Popularity: Since their launch in 2019, REITs have gained traction, demonstrating resilience during challenges such as the pandemic.
- Rising Interest: InvITs have a broader scope, with multiple listings, including IRB InvIT Fund and Embassy Office Parks Reit.
- Assets Under Management: As of the beginning of 2023, REITs and InvITs registered with Sebi managed assets exceeding ₹3.5 trillion.
Sebi’s Amendments Explained
- Unit Holder Nomination Rights: Sebi has granted board nomination rights to unit holders of InvITs and REITs, allowing them greater influence.
- Minimum Unit Holding Change: The minimum unit holding requirement for sponsors has been revised, enhancing flexibility.
- “Self-Sponsored Investment Managers”: Sebi introduced the concept of self-sponsored investment managers, enabling them to assume Reit sponsor responsibilities.
Importance of the Changes
- Enhanced Corporate Governance: These amendments are designed to bolster corporate governance and streamline the functioning of InvITs and REITs.
- Retail Unit Holder Rights: The changes empower retail unit holders by giving them a voice and ensuring accountability through the Stewardship Code.
- Sponsor Commitment: Sponsors are now required to maintain a minimum number of units throughout the lifespan of the Reit or InvIT.
- Self-Sponsored Investment Managers: This concept provides flexibility for Reit sponsors and potential exit options.
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Capital Markets: Challenges and Developments
What is Offer-for-Sale (OFS)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Offer for Sale (OFS)
Mains level: Not Much
Central Idea
- The government’s stake sale in Rail Vikas Nigam Ltd (RVNL) through an offer-for-sale (OFS) received an enthusiastic response from institutional investors.
About Offer for Sale (OFS)
- OFS is a method of share sale introduced by India’s securities market regulator SEBI in 2012.
- The primary aim was to facilitate promoters of listed companies to reduce their holdings and comply with the minimum public shareholding norms within the stipulated time frame.
- This mechanism gained popularity among both state-run and private listed companies as a means to adhere to SEBI’s order.
- Subsequently, the government also embraced OFS to divest its shareholding in public sector enterprises.
Key Features of Offer for Sale:
- Stake Dilution: In an OFS, the promoters of a company reduce their stake by selling existing shares to retail investors, companies, Foreign Institutional Investors (FIIs), and Qualified Institutional Buyers (QIBs) through an exchange platform.
- Restriction on Fresh Issuance: Unlike a follow-on public offering (FPO), where companies can raise funds through issuing fresh shares or promoters can sell their existing stakes (or both), OFS is used exclusively for the sale of existing shares.
- Eligibility Criteria: Only promoters or shareholders holding more than 10% of the share capital in a company can conduct an OFS.
- Limited to Top 200 Companies: The OFS mechanism is available to the top 200 companies based on market capitalization.
- Reserved Quota for Institutions: A minimum of 25% of the shares offered in an OFS is reserved for mutual funds (MFs) and insurance companies. Additionally, no single bidder, other than MFs and insurance companies, can be allocated more than 25% of the offering size.
- Retail Investor Participation: A minimum of 10% of the offer size is reserved for retail investors, encouraging their participation in the share sale.
- Discount Provision: Sellers have the option to offer a discount to retail investors either on the bid price or on the final allotment price.
- Timely Notification: The company must inform the stock exchanges about its intention to conduct an OFS at least two banking days prior to the event.
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Capital Markets: Challenges and Developments
What are AT-1 Bonds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: AT-1 Bond
Mains level: NA
Central Idea
- Subscription Disappointment: State Bank of India (SBI)’s additional tier-1 (AT-1) bond issue saw a very low response from investors, raising ₹3,101 crore against an issue size of ₹10,000 crore.
- Market Sentiment Impact: The lackluster response is expected to dampen market sentiment and make fundraising more challenging for other PSU banks, potentially leading to delays in their fundraising plans.
What are AT1 Bonds?
- Definition: AT-1 bonds, or Additional Tier-1 bonds, are unsecured, perpetual bonds issued by banks to strengthen their core capital base in compliance with Basel-III norms.
- Complex Hybrid Instruments: AT-1 bonds are complex instruments suited for institutions and knowledgeable investors who can analyze their terms and determine if the higher rates compensate for the higher risks involved.
- Face Value: Each AT-1 bond typically carries a face value of ₹10 lakh.
- Acquisition Routes: Retail investors can acquire these bonds through initial private placement offers by banks or by purchasing already-traded AT-1 bonds in the secondary market based on broker recommendations.
Key Features and Importance of AT1 Bonds
- Perpetual Nature: AT-1 bonds do not have a maturity date. Instead, they include call options that allow banks to redeem them after a specific period, usually five or ten years. Banks can choose to pay only interest indefinitely without redeeming the bonds.
- Flexibility in Interest Payments: Banks issuing AT-1 bonds can skip interest payouts or even reduce the bonds’ face value if their capital ratios fall below certain thresholds specified in the offer terms.
- Regulatory Intervention: If a bank faces financial distress, the RBI has the authority to ask the bank to cancel its outstanding AT-1 bonds without consulting the investors.
Back2Basics: Basel Norms
- Basel is a city in Switzerland and the headquarters of the Bureau of International Settlement (BIS).
- The BIS fosters cooperation among central banks to achieve financial stability and common standards of banking regulations.
- Basel guidelines are broad supervisory standards formulated by the Basel Committee on Banking Supervision (BCBS).
- The Basel accord is a set of agreements by the BCBS that primarily focuses on risks to banks and the financial system.
- The purpose of the Basel accord is to ensure that financial institutions maintain sufficient capital to meet obligations and absorb unexpected losses.
- India has accepted the Basel accords for its banking system.
| Basel I | Basel II | Basel III | |
| Year Introduced | 1988 | 2004 | 2010 |
| Focus | Credit Risk | Credit, Market, Operational Risks | Capital, Leverage, Funding, Liquidity |
| Capital Requirement | Fixed at 8% of Risk-Weighted Assets (RWA) | Minimum Capital Adequacy Requirement of 8% of Risk Assets | Strengthening capital requirements |
| Pillars | – | 1. Capital Adequacy Requirements 2. Supervisory Review 3. Market Discipline | – |
| Objective | Define capital and risk weights for banks | Encourage better risk management and disclosure | Promote a more resilient banking system |
| Implementation in India | Adopted in 1999 | Yet to be fully implemented | March 2019 (postponed to March 2020 due to COVID-19) |
| Key Parameters | – | – | Capital: 12.9% capital adequacy ratio, Tier 1 and Tier 2 capital ratios, capital conservation buffer, and counter-cyclical buffer; Leverage: minimum 3% leverage rate; Funding and Liquidity: LCR and NSFR ratios |
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Capital Markets: Challenges and Developments
Supreme Court seeks SEBI’s explanation FPI Amendments
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Foreign Portfolio Investments (FPI)
Mains level: NA
Central Idea
- The Supreme Court has asked the Securities and Exchange Board of India (SEBI) to clarify why amendments were made in 2018 to the Foreign Portfolio Investors (FPI) Regulations.
- These amendments had eliminated crucial clauses aimed at preventing opacity in FPI ownership structures.
Why discuss this?
- A judicial inquiry report has stated that SEBI’s investigation into allegations against the Adani Group by Hindenburg Research had been hindered by FPI ownership amendments.
- The report highlighted the challenges faced by SEBI in determining the “ownership” of 13 overseas entities, including the FPIs mentioned in the Hindenburg report, due to the lack of clarity in their ownership chain.
What are FPIs?
- Foreign Portfolio Investments (FPI) refer to investments made by foreign individuals, institutional investors, pension funds, sovereign wealth funds, and other entities in financial instruments of a foreign country.
- These investments typically involve the purchase of securities such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other tradable financial assets.
Key characteristics of foreign portfolio investments include:
- Indirect Ownership: FPIs involve indirect ownership of financial instruments rather than direct ownership of physical assets or businesses. Investors hold portfolios of securities issued by companies, governments, or other entities in the target country.
- Diversification: FPIs allow investors to diversify their investment portfolios internationally. By investing in different countries and asset classes, investors can reduce risks associated with a concentration in a single market or asset type.
- Liquidity: FPIs offer high liquidity as they involve trading in financial instruments that can be easily bought or sold in the secondary market. Investors have the flexibility to enter or exit their positions quickly based on market conditions or investment objectives.
- Market Access: FPIs provide foreign investors with access to the securities markets of other countries. This enables them to participate in the economic growth and potential returns of different markets and take advantage of investment opportunities that may not be available domestically.
- Regulatory Framework: FPIs are subject to regulations and guidelines set by the regulatory authorities of the target country. These regulations may include registration requirements, investment limits, disclosure obligations, and compliance norms to ensure market integrity and investor protection.
- Market Impact: Large FPI flows can have a significant impact on the target country’s financial markets. They can influence stock prices, bond yields, exchange rates, and overall market sentiment. As a result, FPIs are closely monitored by regulatory bodies and policymakers.
Key Issue: FPI Regulations Amendment
The Foreign Portfolio Investors (FPI) Regulations were first introduced in 2014 by the Securities and Exchange Board of India (SEBI).
- Removal of “opaque structure” provision: The 2018 amendments eliminated provisions in the FPI Regulations that addressed opaque structures and required FPIs to disclose every ultimate natural person in the ownership chain.
- Justice Sapre panel’s observations: The expert committee report stated that the removal of these provisions had put SEBI in a “chicken-and-egg situation” in its investigation of the 13 overseas entities suspected of having opaque structures.
- Need for information on ultimate economic ownership: The report emphasized that SEBI’s investigation required information about the ultimate economic ownership, rather than just beneficial owners, of the entities under scrutiny.
Supreme Court’s Query and SEBI’s Response
- Court’s inquiry on the amendments: The Chief Justice asked SEBI to explain the circumstances and reasons behind the changes made to the provisions dealing with opaque structures.
- SEBI’s assertion on ongoing investigation: The Solicitor General, representing SEBI, stated that the investigation was progressing at full speed and that the agency was working diligently to meet the extended deadline set by the court.
- Petitioners’ arguments on fatal impact: The petitioners argued that the amendments made in 2018 had rendered SEBI’s current investigation ineffective, as the definition of opaque structure was removed. They claimed that these amendments were intended to prevent fraud exposure.
Court’s Concerns and Request for Explanation
- Court’s curiosity about the amendments: The Chief Justice expressed the court’s interest in understanding the reasons behind the changes made by SEBI in 2018.
- Potential impact on the investigation: The court acknowledged the argument that the amendments might restrict SEBI from delving into the layers of transactions, potentially hindering the investigation.
Conclusion
- The court seeks clarification on the circumstances surrounding these changes and their impact on SEBI’s investigation into the Adani Group.
- The court’s concern lies in understanding the potential limitations these amendments may have imposed on SEBI’s ability to explore the ownership chain and layers of transactions.
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Capital Markets: Challenges and Developments
GIFT NIFTY: Connecting India and Singapore’s Capital Markets
Note4Students
From UPSC perspective, the following things are important :
Prelims level: GIFT NIFTY
Mains level: NA
Central Idea
- GIFT NIFTY (formerly known as SGX NIFTY) commenced trading from GIFT City in Gujarat, marking the first cross-border initiative between India and Singapore’s capital markets.
- The trading session witnessed over 30,000 trades, signifying the growing significance of this collaboration.
What is GIFT NIFTY?
- The migration to GIFT NIFTY was initiated by PM Modi in July 2022.
- GIFT NIFTY plays a crucial role in expanding GIFT IFSC’s reach to foreign investors and enhancing the capital market ecosystem in GIFT City.
- The collaboration between SGX and NSE strengthens the connection between two rapidly growing economies.
- NSE IX is restricted from entering similar arrangements with other exchanges, providing stability to the partnership.
- The initial five-year contract can be extended for an additional two years.
Operating time
- GIFT NIFTY establishes a trading link where trading and matching take place in India, while clearing and settlement occur in Singapore.
- It operates from 6:30 am to 3:40 pm in the Asia time zone.
- The second session, from 4:35 pm to 2:45 am (next day), targets investors from the United States and Europe.
Deal between SGX and NSE
- Revenue sharing: The five-year contract establishes a 50:50 revenue-sharing arrangement between Singapore Exchange (SGX) and NSE International Exchange (NSE IX).
- Initial revenue split: For Singapore-generated business, SGX will receive 75% of the revenue, while NSE will receive the remaining 25%.
- IFSC business: NSE will retain 75% of the International Financial Service Centre (IFSC) business, with the remaining 25% going to SGX.
- Future volume-based sharing: Once a “threshold volume” is reached, the revenue sharing will be equally split between both entities.
Shift to GIFT NIFTY
- Ceasing SGX NIFTY: On June 30, trading on SGX NIFTY in Singapore ended, with the entire trading volume and liquidity transitioning to GIFT IFSC.
- Rechristened GIFT NIFTY: The trading platform was renamed GIFT NIFTY, offering four products: GIFT Nifty 50, GIFT Nifty Bank, GIFT Nifty Financial Services, and GIFT Nifty IT derivatives contracts.
Back2Basics: GIFT City, Gandhinagar
- GIFT city is India’s first operational smart city and international financial services centre (much like a modern IT park).
- The idea for GIFT was conceived during the Vibrant Gujarat Global Investor Summit 2007.
- The initial planning was done by East China Architectural Design & Research Institute (ECADI).
- Currently approximately 225 units/companies are operational with more than 12000 professionals employed in the City.
Key features
- The entire city is based on the concept of FTTX (Fibre to the home/office).
- The fiber optic is laid in fault-tolerant ring architecture so as to ensure maximum uptime of services.
- Every building in GIFT City is an intelligent building.
- There is piped supply of cooking gas. India’s first city-level DCS (district cooling system) is also operational at GIFT City.
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Capital Markets: Challenges and Developments
What are Global Depository Receipts (GDRs)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Global Depository Receipts (GDRs)
Mains level: Not Much
Central Idea: Tata Consumer Products has announced its decision to delist its global depository receipts (GDRs) from the London Stock Exchange and Luxembourg Stock Exchange.
What are GDRs?
- GDRs are financial instruments used by companies to raise capital from international investors.
- They represent a bundle of shares in the company and are typically listed and traded on international stock exchanges.
- GDRs provide a way for companies to access global capital markets and attract investments from foreign investors without directly listing their shares on multiple stock exchanges around the world.
GDR Regulation in India
- In India, GDRs can be issued by Indian companies that meet the eligibility criteria set by the SEBI.
- SEBI sets guidelines and regulations for companies wishing to issue GDRs typically include the following:
- Listing: The company must be listed on a recognized stock exchange in India.
- Track Record: The company should have a track record of profitability for a certain period as specified by SEBI.
- Good Corporate Governance: The company must comply with corporate governance norms and disclose relevant financial and non-financial information.
- Regulatory Compliance: The company must comply with all applicable laws and regulations, including those related to securities and foreign exchange.
- Approval from Regulatory Authorities: The company needs to obtain necessary approvals from SEBI and other relevant authorities for the issuance of GDRs.
Need for GDR
- Capital Raising: GDRs offer a means for companies to raise capital from international investors, helping them finance investments, expansion projects, acquisitions, or debt repayment.
- Global Investor Base: GDRs allow companies to access a diverse range of international investors, including institutional investors, hedge funds, and retail investors, thereby expanding their shareholder base.
- Cost Efficiency: GDRs can be a cost-effective alternative to traditional methods of listing shares on multiple exchanges, as they enable companies to tap into global capital markets without the need for separate listings in different countries.
- Simplified Trading and Settlement: GDRs facilitate easy trading and settlement for international investors, as they eliminate the need to navigate local market regulations and procedures.
- Risk Mitigation: GDRs can provide a degree of risk mitigation for companies by reducing their exposure to local market fluctuations and volatility, as they offer access to a more diversified investor base.
- Arbitrage Opportunities: GDRs can create arbitrage opportunities for investors who can exploit price discrepancies between the GDRs and the underlying shares listed on the domestic stock exchange.
Benefits offered
- Access to Global Capital: GDRs enable Indian companies to access a larger pool of international capital and diversify their funding sources beyond domestic markets.
- Increased Liquidity: Listing GDRs on international exchanges provides Indian companies with broader exposure and enhances the liquidity of their shares, as they become accessible to a wider range of investors.
- Enhanced Global Visibility: GDRs help raise the profile of Indian companies on a global scale, increasing their visibility and attracting the attention of international investors and analysts.
- Currency Diversification: GDRs can also provide an opportunity for Indian companies to diversify their exposure to foreign currencies, as GDRs are often denominated in a currency other than the company’s home currency.
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Capital Markets: Challenges and Developments
Europe de-recognizes 6 Indian clearing corporations
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Clearing Corporations
Mains level: NA
Central Idea
- The European Securities and Markets Authority (ESMA) has de-recognised 6 clearing corporations in India as Third Country Central Counterparty (TC-CCP) with effect from April 30.
- However, it allowed European banks to continue business with them till April 2023 without penal consequences.
What are Clearing Corporations?
- Clearing corporations, also known as central counterparties (CCPs), are financial institutions that act as intermediaries between buyers and sellers in financial markets.
- They help to manage the risk of default by ensuring that each party involved in a trade has the necessary funds or securities to fulfil their obligations.
- Clearing corporations also ensure that trades are settled in a timely and efficient manner.
- In the context of this article, clearing corporations refer to those involved in the clearing and settlement of trades in India’s cash and derivatives market.
Decisions by ESMA
- ESMA has withdrawn recognition of six Indian clearing corporations including- CCIL, Indian Clearing Corporation Ltd, NSE Clearing Ltd, Multi Commodity Exchange Clearing, India International Clearing Corporation, and NSE IFSC Clearing Corporation.
- ESMA asked Indian regulators to sign an agreement to give it the power to monitor and supervise the clearing corporations.
- Indian regulators refused to give supervisory power to foreign entities in Indian clearing corporations.
- ESMA recognised these clearing corporations as Third Country Central Counterparty (TC-CCP) in the EU region.
India’s rebuttal
- ESMA had asked the RBI and the Securities and Exchange Board of India (SEBI) to sign an agreement giving it the power to monitor and supervise the clearing corporations.
- Indian regulators did not agree to give supervisory power to a foreign entity on Indian clearing corporations.
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Capital Markets: Challenges and Developments
Dabba Trading and its impact on the Economy
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Dabba Trading
Mains level: Read the attached story
Central idea
- The National Stock Exchange (NSE) has issued a series of notices warning retail investors about entities involved in ‘dabba trading’.
- The NSE cautioned investors not to subscribe or invest using these products offering indicative, assured or guaranteed returns in the stock market as they are prohibited by law.
- The entities involved in dabba trading are not recognized as authorized members by the exchange.
What is Dabba Trading?
- Dabba (Box) trading refers to informal trading that takes place outside the purview of the stock exchanges.
- It involves betting on stock price movements without incurring a real transaction to take physical ownership of a particular stock as is done in an exchange.
- In simple words, it is gambling centred around stock price movements.
How does it work?
- In dabba trading, investors place bets on stock price movements at a certain price point.
- If the price point rises, they make a gain, and if it falls, they have to pay the difference to the dabba broker.
- The broker’s profit from the investor’s loss, and vice versa.
- Transactions are facilitated using cash and unrecognised software terminals or informal records, which helps traders stay outside the regulatory mechanism.
What are the problems with dabba trading?
- Since dabba traders do not maintain proper records of income or gain, they are able to escape taxation, which results in a loss to the government exchequer.
- The use of cash also means that they are outside the purview of the formal banking system.
- Investors in dabba trading do not have formal provisions for investor protection or grievance redressal mechanisms available within an exchange, which exposes them to the risk of broker defaults or insolvency.
- Dabba trading also perpetuates a parallel economy, potentially encouraging the growth of black money and criminal activities.
What is the current scenario?
- Industry observers have reported that dabba brokers harass clients for default payments and refuse payments upon profit.
- Potential investors are lured by aggressive marketing, ease of trading using apps with quality interfaces, and lack of identity verification.
- Brokers keep their fees and margins open to negotiation depending on an individual’s trading profile.
- The mechanism could potentially induce volatility and cause losses for the regulated bourse when dabba brokers look to hedge their exposures.
What are the legal implications?
- Dabba trading is recognised as an offence under Section 23(1) of the Securities Contracts (Regulation) Act (SCRA), 1956.
- Upon conviction, it can invite imprisonment for a term extending up to 10 years or a fine up to ₹25 crore, or both.
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Capital Markets: Challenges and Developments
Scrapping Tax Benefit for Debt Mutual Funds: Analysis
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Facts related to mutual funds
Mains level: Mutual funds, debt mutual funds, tax benefits, etc
Central Idea
- The Finance Bill 2023, passed by the Lok Sabha with 64 amendments, includes the controversial decision to remove the tax benefit for debt mutual funds. While the aim is to remove the advantage of debt funds over bank deposits, this decision will have far-reaching consequences that need to be examined.
Mutual Funds
- Investment decisions on behalf of the investors: Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. Mutual funds are managed by professional fund managers who make investment decisions on behalf of the investors in the fund.
- Diversified portfolio of securities: Investors in a mutual fund own a proportional share of the fund’s underlying assets, and the value of their investment rises or falls in response to changes in the value of the securities held by the fund. Mutual funds can provide investors with access to a diversified portfolio of securities, which can help to mitigate the risk of investing in individual securities.
Key differences between Mutual funds and debt mutual funds
- Mutual funds and debt mutual funds are both types of investment funds, but there are some key differences between them
| Comparison | Mutual Funds | Debt Mutual Funds |
| Types of Investments | Stocks, bonds, commodities, and other asset classes | Fixed-income securities such as bonds, debentures, treasury bills, and commercial papers |
| Risk | Generally higher risk due to the inclusion of stocks and other volatile assets | Generally lower risk due to the focus on fixed-income securities |
| Returns | Potentially higher returns over the long term, but subject to more volatility | Lower returns compared to equity mutual funds, but also come with lower risk |
| Investment Objective | Can vary widely depending on the type of fund | Provide regular income to investors while preserving capital |
| Liquidity | Can be less liquid than debt mutual funds due to volatility in underlying securities | Generally considered more liquid due to less volatility in underlying securities |
The Debate Over Scrapping Tax Benefit for Debt Mutual Funds
- Removal of the tax benefit for debt mutual funds: The Finance Bill 2023 passed by voice vote in the Lok Sabha last week with 64 amendments, including the removal of the tax benefit for debt mutual funds.
- What it means: This change means that investors in debt mutual funds cannot avail the benefit of indexation for the calculation of long-term capital gains. From April 1, such investments will now be taxed at income tax rates applicable to an individual’s tax slab.
- Motive: This move aims to remove the advantage that such debt funds have over bank deposits. However, the consequences of this decision need to be carefully examined.
The Impact of Removing Tax Benefit
- Impact on flow of funds: The removal of the tax benefit will lead to investors reassessing their allocations to debt mutual funds, which may impact flows into these funds.
- Impact on bond market: This, in turn, may impact the growth and development of the bond market in India since debt mutual funds channel funds into the bond market.
- For instance: According to a report by Crisil, 70% of the investment in debt funds flows from institutional investors, while individual investors, including high net worth individuals, accounted for 27% as of December 2022.
- Impact on corporate debt: This change in rule may trigger a shift in investments away from debt mutual funds to other instruments, which will possibly affect flows to the corporate bond market, and demand for corporate debt is likely to be impacted.
The Need for Rationalization
- There is a need to acknowledge the finer points of differentiation between bank deposits and debt funds since bank deposits are insured up to Rs 5 lakh while debt mutual funds carry risk depending on the risk profile of the bonds they hold.
- It has been argued that the capital gains architecture in India needs to be reexamined and reconfigured.
- Not only are there different rates of taxation for different asset classes, but even the holding period for differentiating between short- and long-term capital gains varies across assets. Thus, rationalisation with regard to the tax rate and/or the holding period is desirable.
Conclusion
- While the removal of the tax benefit for debt mutual funds may remove the advantage of such funds over bank deposits, its far-reaching consequences need to be carefully examined. There is a need to acknowledge the finer points of differentiation between bank deposits and debt funds, as well as rationalisation of the tax architecture in India. Therefore, there is a need for broader discussions and debates on these issues.
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Capital Markets: Challenges and Developments
SEBI approval to launch Social Stock Exchange
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Social Stock Exchange (SSE)
Mains level: Not Much
The National Stock Exchange (NSE) has received final approval from the Securities and Exchange Board of India (SEBI) to set up a Social Stock Exchange (SSE) as a separate segment of the NSE.
What is a Social Stock Exchange?
- Social Stock Exchange (SSE) is a platform that connects social enterprises with investors who are looking for social impact along with financial returns.
- Social enterprises are organizations that prioritize social impact over profits.
- SSE aims to provide these organizations with access to capital markets and raise awareness about social investment opportunities.
Who can get listed for SSEs?
- Any social enterprise, Non-Profit Organisation (NOPs) or For-Profit Social Enterprises (FPEs), that establishes its primacy of social intent can get registered or listed on the Social Stock Exchange segment.
- Eligible NPOs can begin by registering on the SSE segment.
- After onboarding, NPOs can initiate the fund mobilization process by issuing instruments such as Zero Coupon Zero Principal (ZCZP) via a public issue or private placement.
- Currently, the regulations have prescribed a minimum issue size of Rs 1 crore and a minimum application size for the subscription of Rs 2 lakhs for ZCZP issuance.
How will SSE work?
- The SSE will be a separate segment on the NSE, where social enterprises can list their securities.
- These securities will be available for trading to investors who are interested in social impact investing.
- The SSE will also provide a range of services such as capacity building, impact measurement, and reporting to help social enterprises improve their operations and measure their social impact.
Benefits of SSE
- For social enterprises, SSE will provide access to capital markets and help them raise funds for their social projects.
- For investors, SSE will provide a platform to invest in social enterprises and contribute to social impact.
- SSE will also create a transparent marketplace where investors can assess the social impact of their investments.
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Capital Markets: Challenges and Developments
The National Land Monetisation Corporation (NLMC)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: NLMC
Mains level: Land Monetization
The National Land Monetisation Corporation (NLMC) has decided to involve international property consultancy firms to speed up the process of making money by selling or leasing the land owned by the government.
What is NLMC?
- NLMC is a Special Purpose Vehicle (SPV) announced in the Union Budget 2021-22 to carry out monetisation of government and surplus land holdings of public sector undertakings (PSU).
- It falls under the administrative jurisdiction of the Ministry of Finance and is set up with an initial authorised share capital of ₹5,000 crore and a paid-up capital of ₹150 crore.
- It is a firm, fully owned by the government, to carry out the monetisation of government and public sector assets in the form of surplus, unused or underused land assets.
Aims and objectives
- Monetize underutilised or unused land parcels of Central Public Sector Enterprises (CPSEs)
- Facilitate the monetisation of assets belonging to PSUs that have ceased operations or are in line for a strategic disinvestment.
- Transfer of revenue rights: When the government monetises its assets, it essentially means that it is transferring the revenue rights of the asset (could be idle land, infrastructure, PSU) to a private player for a specified period of time.
- Govt as facilitator: In such a transaction, the government gets in return an upfront payment from the private entity, regular share of the revenue generated from the asset, a promise of steady investment into the asset, and the title rights to the monetised asset.
Significant outcomes of land monetization
- Maximum value realization: It will help monetise them in an efficient and professional manner, maximizing the scope of value realisation.
- Speed up the process: The setting of the NLMC will speed up the closure process of the CPSEs and smoothen the strategic disinvestment process.
- Capitalize land assets: It will also enable productive utilisation of these under-utilized assets by setting in motion private sector investments.
- Economic revitalization: It will boost new economic activities such as industrialisation, boosting the local economy by generating employment and generating financial resources for potential economic and social infrastructure.
- Advisory to the govt: Besides managing and monetising, the NLMC will act as an advisory body and support other government entities and CPSEs in identifying their surplus non-core assets.
Need for land monetization
There are different reasons why the government monetizes its assets.
- New sources of revenue: One of them is to create new sources of revenue essential to fulfil the government’s target of achieving a $5 trillion economy.
- Plummeting underutilized assets: Monetisation is also done to unlock the potential of unused or underused assets by involving institutional investors or private players.
- Capital generation: It is also done to generate resources or capital for future asset creation, such as using the money generated from monetisation to create new infrastructure projects.
Possible challenges for NLMC
(1) Volatile market situation
- The performance and productivity of the NLMC will also depend on the government’s performance on its disinvestment targets.
- In FY 2021-22, the government has hardly been able to raise expected amounts through various forms of disinvestment.
(2) Issues with transfer of rights
- The process of asset monetisation does not end when the government transfers revenue rights to private players.
- Identifying profitable revenue streams for the monetised land assets, ensuring adequate investment by the private player and setting up a dispute-resolution mechanism are also important tasks.
(3) Unattractiveness of PPP Model
- Posing as another potential challenge would be the use of Public Private Partnerships (PPPs) as a monetisation model.
- For instance, the results of the Centre’s PPP initiative launched in 2020 for the Railways were not encouraging.
(4) Red tapism
- The success of the initiative will depend on a range of factors, including the availability of suitable land parcels, market demand etc.
- It will be highly dependent upon the ability of the government to execute the transactions efficiently.
Conclusion
- The government’s move to monetize its vast land assets is aimed at reducing the fiscal burden and boosting infrastructure development in the country.
- By bringing in international property consultants to help with the process, the government hopes to improve efficiency and transparency, and maximize the returns on its land assets.
- If successful, the government’s land monetization drive could provide a much-needed boost to the economy and create new opportunities for private investment in the real estate sector.
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Capital Markets: Challenges and Developments
How is the Stock Market regulated in India?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SEBI, Stock Market, Shares
Mains level: Read the attached story
The Supreme Court asked the Securities and Exchange Board of India (SEBI) and the government to produce the existing regulatory framework in place to protect investors from stock market volatility.
Central idea
- After short-seller Hindenburg Research published a report accusing the Adani Group of stock market manipulation and accounting fraud, its shares plummeted.
- Investors were reported to have lost lakhs of crores.
Laws governing the Indian Stock Market
- The securities market in India is regulated by four key laws —
- Securities and Exchange Board of India Act, 1992 (SEBI Act)
- Securities Contracts (Regulation) Act, 1956 (SCRA) and
- Depositories Act, 1996
- Companies Act, 2013
- The framing of these laws reflect the evolution and development of the capital market in India.
Brief explanation of each acts-
(1) Securities and Exchange Board of India Act, 1992 (SEBI Act)
(2) Securities Contracts (Regulation) Act, 1956 (SCRA)
- The SCRA empowers SEBI to recognise (and derecognise) stock exchanges, prescribe rules and bye laws for their functioning, and regulate trading, clearing and settlement on stock exchanges.
(3) Depositories Act, 1996
- As part of the development of the securities market, Parliament passed the Depositories Act and SEBI made regulations to enforce the provisions.
- This Act introduced and legitimised the concept of dematerialised securities being held in an electronic form.
- Today almost all the listed securities are held in dematerialised form.
(4) Companies Act, 2013
- It is an Act of the Parliament on Indian company law that regulates incorporation of a company, responsibilities of a company, directors, and dissolution of a company.
- It stipulates the type of Companies that can be formed such as- Public Ltd., Pt. Ltd., One Person Company ex.
Key role-player: SEBI
- SEBI set up the infrastructure for doing this by registering depositories and depository participants.
- The depository regulations empower SEBI to regulate functioning of depositories and depository participants by prescribing eligibility conditions, periodic inspections and powers to impose penalties including suspending or cancelling the registration as well as monetary penalties.
You should know this!Shares and stocks both represent ownership in a company, but they are not the same thing
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Can SEBI step in to curb market volatility?
- No direct meddling: While SEBI does not interfere to prevent market volatility, exchanges have circuit filters — upper and lower — to prevent excessive volatility.
- Issue directions: SEBI can issue directions to those who are associated with the market, and has powers to regulate trading and settlement on stock exchanges. Using these powers, SEBI can direct stock exchanges to stop trading, totally or selectively.
- Instant regulation: It can also prohibit entities or persons from buying, selling or dealing in securities, from raising funds from the market and being associated with intermediaries or listed companies.
What about stock exchanges?
- The SCRA has empowered SEBI to recognise and regulate stock exchanges and later commodity exchanges in India; this was earlier done by the Union government.
- In fact, the term “securities” is defined in the SCRA and powers to declare an instrument as a security remain vested in SEBI.
- The rules and regulations made by SEBI under the SCRA relate to listing of securities like equity shares, the functioning of stock exchanges including control over their management and administration.
- These include powers to determine the manner in which a settlement is done on stock exchanges (and to keep them with the times for e.g. T+1) etc.
- It seeks to protect the interests of investors by creating an Investor Protection Fund for each stock exchange.
Safeguards against fraud
- Fraud undermines regulation and prevents a market from being fair and transparent. To prevent the two key forms of fraud, market manipulation, and insider trading, SEBI notified-
- Prohibition of Fraudulent and Unfair Trade Practices Regulations, 1995
- Prohibition of Insider Trading Regulations, 1992
- These regulations, read with provisions of the SEBI Act, define species of fraud, who is an insider and prohibit such fraudulent activity and provide for penalties including disgorgement of ill-gotten gains.
- It must be noted that violation of these regulations are predicate offences that can lead to a deemed violation of the Prevention of Money Laundering Act.
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Capital Markets: Challenges and Developments
What is Additional Surveillance Mechanism (ASM)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Additional surveillance mechanism (ASM)
Mains level: Not Much
The National Stock Exchange (NSE) placed very famous enterprises of business tycoons under the additional surveillance mechanism (ASM).
Why in news?
- The Adani Group has shed $108 billion in market value since Hindenburg Research accused it of stock manipulation and accounting fraud.
What is Additional Surveillance Mechanism (ASM)?
- 2018 saw the establishment of the Additional Surveillance Measure (ASM), a measure by SEBI and recognised stock exchanges to control the incredibly volatile stocks on the Indian stock market.
- ASM in the stock market functions as a control measure for speculative trading to safeguard the interests of retail investors and keep them out of potentially dangerous trading situations.
- There are two parts of additional margins:
- Long-term ASM
- Short-term ASM
What is ASM list in the stock market?
- ASM list means a collection of securities currently under observation owing to variables like price volatility, volume variation, etc.
- Investors are alerted to unexpected price movement by stocks that have been shortlisted for the ASM list.
- These equities are subject to various trading restrictions to halt any speculation.
- The regulations that apply to stocks on the ASM list are more stringent.
- They are prohibited from being pledged and using intraday leverages like bracket and cover orders, among others.
How does it work?
- For instance, the stock will be moved to a 5% price band the day it joins the ASM list; from then on, it may only move 5% up or down from the previous day’s closing level.
- As a result of this limit violation, the stock can no longer trade on the market once this limit is violated.
- In addition, the investor ought to have 100% margin money to trade the stock as of the fifth day.
- The selected securities will be monitored further, based on predetermined criteria and transferred into Trade to Trade settlement once the criterion is met.
Criteria to determine ASM list stocks
The following criteria are used to select stocks for inclusion in ASM and were mutually decided upon by SEBI and Exchanges:
- Close-to-Close Price Variation
- Market Capitalisation
- Volume Variation
- Delivery Percentage
- High Low Variation
- Client Concentration
- of Unique PANs
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Capital Markets: Challenges and Developments
New T+1 Settlement Cycle comes into effect
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Account settlement, T+1
Mains level: Not Much
After China, India will become the second country in the world to start the ‘trade-plus-one’ (T+1) settlement cycle in top-listed securities today.
What’s the T+1 settlement plan?
- The T+1 settlement cycle means that trade-related settlements must be done within a day, or 24 hours, of the completion of a transaction.
- For example, under T+1, if a customer bought shares on Wednesday, they would be credited to the customer’s demat account on Thursday.
- This is different from T+2, where they will be settled on Friday.
- As many as 256 large-cap and top mid-cap stocks, including Nifty and Sensex stocks, will come under the T+1 settlement from Friday.
What was the earlier settlement system?
- Until 2001, stock markets had a weekly settlement system.
- The markets then moved to a rolling settlement system of T+3, and then to T+2 in 2003.
- In 2020, Sebi deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors.
What are the benefits of T+1?
- T+1 system brings operational efficiency, faster fund remittances, share delivery, and ease for stock market participants.
- In the T+1 format, if an investor sells a share, she will get the money within a day, and the buyer will get the shares in her demat account also within a day.
- The shorter trade settlement cycle augurs well for the Indian equity markets from a liquidity perspective.
- This will also help investors in reducing the overall capital requirements with the margins getting released on T+1 day, and in getting the funds in the bank account within 24 hours of the sale of shares.
- The shift will boost operational efficiency as the rolling of funds and stocks will be faster.
Issues with T+1 system
- T+1 is being implemented despite opposition from foreign investors.
- The United States, United Kingdom and Eurozone markets are yet to move to the T+1 system.
Why are foreign investors opposed?
- Foreign investors have some operational issues as they operate from different geographies.
- Among the issues raised by them were time zone differences, information flow processes, and foreign exchange problems.
- Foreign investors said they would also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system.
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Capital Markets: Challenges and Developments
RBI says no Foreign Investment cap on Sovereign Green Bonds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Sovereign Green Bonds
Mains level: Not Much
The sovereign green bonds issued by the Indian government will not have any restrictions on foreign investment, the Reserve Bank of India (RBI) said.
What are Sovereign Green Bonds?
- A bond is an instrument to raise debt.
- Since 2007, a market for bonds specifically self-labeled or designated as ‘green’ has emerged.
- This label differentiates a green bond from a regular bond, which signifies a commitment to exclusively use funds raised to finance or re-finance “green” projects, assets, or business activities.
- When these bonds carry guarantees related to the repayment of principal and payment of interest by the sovereign or the government, they are called sovereign green bonds (SGrB).
How are the projects for green bonds selected?
- A project is classified “green” on the basis of four key principles. These include-
- Encouraging energy efficiency in resource utilisation
- Reducing carbon emissions and greenhouse gases
- Promoting climate resilience and
- Improving natural ecosystems and biodiversity, especially in accordance with SDG (Sustainable Development Goals).
When is the first sovereign green bond likely to be issued?
- In her Budget speech early this year, Finance Minister announced that sovereign green bonds will be issued for mobilising resources for green infrastructure.
- The proceeds will be deployed in public sector projects that help in reducing the carbon intensity of the economy.
- These green bonds would be available in 5-year and 10-year tenure.
How are they different from conventional government bonds?
- Government bonds or government securities (G-Secs) are normally categorised into two — Treasury Bills and dated or long-term securities.
- These bonds carry coupon rates and are tradable in the securities market.
- SGrB is one form of dated security. It will have a tenor and interest rate.
- Money raised through SGrB is part of overall government borrowing.
Who are likely to be the buyers of these bonds?
- Both domestic and international investors are expected to be interested in SGrB.
- However, one thinking is foreign investors may be slightly hesitant due to currency risk.
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Capital Markets: Challenges and Developments
What are Additional Tier-1 (AT-1) Bonds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: AT1 Bonds
Mains level: NA
The Bombay High Court has quashed the write-off of Additional Tier-1 (AT1) bonds worth Rs 8,400 crore issued by Yes Bank Ltd, bringing relief to investors.
What are AT1 bonds?
- AT-1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
- AT-1 bonds are complex hybrid instruments, ideally meant for institutions and smart investors who can decipher their terms and assess if their higher rates compensate for their higher risks.
- They carry a face value of ₹10 lakh per bond.
- There are two routes through which retail folk have acquired these bonds — initial private placement offers of AT-1 bonds by banks seeking to raise money; or secondary market buys of already-traded AT-1 bonds based on recommendations from brokers.
Why are they important?
AT-1 bonds have several unusual features lurking in their fine print, which make them very different from plain bonds.
- One, these bonds are perpetual and carry no maturity date. Instead, they carry call options that allow banks to redeem them after five or 10 years. But banks are not obliged to use this call option and can opt to pay only interest on these bonds for eternity.
- Two, banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels. These thresholds are specified in their offer terms.
- Three, if the RBI feels that a bank is tottering on the brink and needs a rescue, it can simply ask the bank to cancel its outstanding AT-1 bonds without consulting its investors. This is what has happened to YES Bank’s AT-1 bond-holders who are said to have invested ₹10,800 crore.
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Capital Markets: Challenges and Developments
RBI to issue first-ever Sovereign Green Bonds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Green Bond
Mains level: Read the attached story
The RBI would issue Sovereign Green Bonds (SGrBs) in two tranches of ₹8,000 crore each on January 25 and February 9.
What are Sovereign Green Bonds?
- A bond is an instrument to raise debt.
- Since 2007, a market for bonds specifically self-labelled or designated as ‘green’ has emerged.
- This label differentiates a green bond from a regular bond, which signifies a commitment to exclusively use funds raised to finance or re-finance “green” projects, assets, or business activities.
- When these bonds carry guarantees related to the repayment of principal and payment of interest by the sovereign or the government, they are called sovereign green bonds (SGrB).
How are the projects for green bonds selected?
- A project is classified “green” on the basis of four key principles. These include-
- Encouraging energy efficiency in resource utilisation
- Reducing carbon emissions and greenhouse gases
- Promoting climate resilience and
- Improving natural ecosystems and biodiversity, especially in accordance with SDG (Sustainable Development Goals).
When is the first sovereign green bond likely to be issued?
- In her Budget speech early this year, Finance Minister announced that sovereign green bonds will be issued for mobilising resources for green infrastructure.
- The proceeds will be deployed in public sector projects that help in reducing the carbon intensity of the economy.
- These green bonds would be available in 5-year and 10-year tenure.
How are they different from conventional government bonds?
- Government bonds or government securities (G-Secs) are normally categorised into two — Treasury Bills and dated or long-term securities.
- These bonds carry coupon rates and are tradable in the securities market.
- SGrB is one form of dated security. It will have a tenor and interest rate.
- Money raised through SGrB is part of overall government borrowing.
Who are likely to be the buyers of these bonds?
- Both domestic and international investors are expected to be interested in SGrB.
- However, one thinking is foreign investors may be slightly hesitant due to currency risk.
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Capital Markets: Challenges and Developments
What is Social Stock Exchange (SSE)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Social Stock Exchange
Mains level: Read the attached story
The National Stock Exchange of India (NSE India) received an in-principle approval from the Securities Exchange Board of India (SEBI) to set-up Social Stock Exchange (SSE) as a separate segment.
What is Social Stock Exchange (SSE)?
- SSE is a novel idea in India, and a stock exchange of this kind is intended to benefit the private and non-profit sectors by directing more capital to them.
- During her Budget speech for the fiscal year 2019–20, Finance Minister first proposed the concept of SSE.
- The Securities Contracts (Regulation) Act, 1956 was then invoked by the government, which subsequently published a gazette notification announcing a new security as “zero coupon zero principal”.
- The SSE will function as a distinct division of the current stock exchanges under the new regulations.
Who can list on SSE?
- The SSE will be a distinct division of the current stock exchanges under the new regulations.
- Not-for-profit organisations (NPOs) and for-profit social enterprises with social intent and impact as their primary goal will be eligible to participate in the SSE.
- Additionally, such an intent should be shown by its emphasis on social goals that are appropriate for under-served or less privileged populations or areas.
- The social enterprises will have to engage in a social activity out of 16 broad activities listed by the regulator.
The eligible activities include-
- Eradicating hunger poverty, malnutrition and inequality
- Promoting healthcare, supporting education, employability and livelihoods
- Gender equality empowerment of women and LGBTQIA communities
- Supporting incubators of social enterprise
Who are not eligible?
- Corporate foundations, political or religious organisations or activities, professional or trade associations, infrastructure companies, and housing companies, with the exception of affordable housing, will not be eligible to be identified as social enterprises.
- According to SEBI’s framework, minimum issue size of ₹1 crore and a minimum application size for subscription of ₹2 lakh are currently required for SSE.
Minimum requirements for sustenance
- NPO needs to be registered as a charitable trust and should be registered for at least three years, must have spent at least ₹50 lakh annually in the past financial year.
- They should have received a funding of at least ₹10 lakh in the past financial year.
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Capital Markets: Challenges and Developments
CDSL: India’s registered share depository
Note4Students
From UPSC perspective, the following things are important :
Prelims level: CDSL
Mains level: NA
Certain services at CDSL (Central Depositories Services India Ltd) were disrupted due to a suspected cyber-attack over the weekend.
What is CDSL?
- CDSL, or Central Depositories Services India Ltd, is a government-registered share depository, alongside its other state-owned counterpart National Securities Depository Ltd (NSDL).
- It was founded in 1999.
- It is a Market Infrastructure Institution or MII that is deemed as a crucial part of the capital market structure, providing services to all market participants, including exchanges, clearing corporations, depository participants, issuers and investors.
- Share depositories hold shares in an electronic or dematerialised form and are an enabler for securities transactions, playing a somewhat similar role to what banks play in handling cash and fixed deposits.
- While banks help customers keep their cash in electronic form, share depositories help consumers store shares in a dematerialised form.
Functions of CDSL
- CDSL facilitates holding and transacting in securities in the electronic form and facilitates settlement of trades done on stock exchanges.
- These securities include equities, debentures, bonds, Exchange traded Funds (ETFs), units of mutual funds, units of Alternate Investment Funds (AIFs), Certificates of deposit (CDs), commercial papers (CPs), Government Securities (G-Secs), etc.
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Capital Markets: Challenges and Developments
New Account Settlement System for Stock Trading
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Account settlement, T+1
Mains level: NA
Beginning October 1, the new account settlement system for the stock broking industry will kick in under the new guidelines issued by the Securities and Exchange Board of India (SEBI).
What is Settlement of Accounts?
- The SEBI mandates stockbrokers to settle i.e., transfer the available credit balance from trading account to bank account, at least once in a quarter (90 days) or 30 days.
- The process of transferring the unutilised funds back into the bank account is called ‘Running Account Settlement’ or ‘Quarterly Settlement of Funds’.
- The funds are transferred back to the primary bank account of the customer that is linked to the trading account.
- As per the latest guidelines, the settlement will now be done on the first Friday of the quarter or the month depending upon the option selected by the customer.
What are SEBI’s new settlement guidelines?
- On July 27, SEBI issued new guidelines on running accounts of client funds and securities lying with the broker.
- As per the new guidelines, with effect from October 1, 2022, the settlement of running account of clients’ funds will be done by the trading members after considering the end of the day (EOD) obligation of funds.
- In cases where the client has opted for a monthly settlement process, then the running account shall be settled on the first Friday of every month.
How will it impact investors and traders?
- Changes in settlement brought in by SEBI over the last few years have had the aim of protecting the investor and preventing the misuse as money lying in trading accounts of investors for long periods.
- SEBI’s move will give certainty to investors and trading members.
- It will help brokers develop a system just like banks, which credit interest in the accounts of their customers at the end of the quarter.
- Another advantage would be that if a customer has more than one demat account with different brokers, having one settlement date for the entire industry will make it easier for her to keep track of her funds.
Back2Basics: Securities and Exchange Board of India (SEBI)
- The SEBI is the regulatory body for securities and commodity market in India under the jurisdiction of Ministry of Finance Government of India.
- It was established on 12 April 1988 and given Statutory Powers on 30 January 1992 through the SEBI Act, 1992.
Jurisdiction of SEBI
- SEBI has to be responsive to the needs of three groups, which constitute the market:
- Issuers of securities
- Investors
- Market intermediaries
SEBI has three powers rolled into one body: quasi-legislative, quasi-judicial and quasi-executive.
- It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity.
- Though this makes it very powerful, there is an appeal process to create accountability.
- There is a Securities Appellate Tribunal which is a three-member tribunal and is currently headed by Justice Tarun Agarwala, former Chief Justice of the Meghalaya High Court.
- A second appeal lies directly to the Supreme Court.
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Capital Markets: Challenges and Developments
An orchestra of multiple instruments is required to deal with the continuing high inflation
Context
- It seems that inflation may hover around 7 per cent despite RBI’s tightening of monetary policy in the months to come.
What is a simple definition for inflation?
- Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).
Inflation Rate
- Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.
- Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100
Types of Inflation
Creeping Inflation
- Creeping or mild inflation is when prices rise 3% a year or less. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That’s how mild inflation drives economic expansion.
Walking Inflation
- This type of strong, or pernicious, inflation is between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow’s much higher prices. This drives demand even further so that suppliers can’t keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people.
Galloping Inflation
- When inflation rises to 10% or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can’t keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs.
Hyperinflation
- Hyperinflation is when prices skyrocket more than 50% a month. It is very rare. In fact, most examples of hyperinflation have occurred only when governments printed money to pay for wars. Examples of hyperinflation include Germanyin the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s. The last time America experienced hyperinflation was during its civil war.
Core Inflation
- The core inflation rate measures rising prices in everything except food and energy. That’s because gas prices tend to escalate now and then. Higher gas costs increase the price of food and anything else that has large transportation costs.
Consumer Price Index
- CPI is used to monitor changes in the cost of living over time. When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living. The economic term used to define such a rising prices of goods and services is Inflation.
Whole sale Price Index
- WPI is used to monitor the cost of goods and services bought by producer and firms rather than final consumers. The WPI inflation captures price changes at the factory/wholesale level.
GDP Deflator
- Another important measure of calculating standard of living of people is GDP Deflator. GDP Deflator is the ratio of nominal GDP to real GDP. The nominal GDP is measured at the current prices whereas the real GDP is measured at the base year prices. Therefore, GDP Deflator reflects the current level of prices relative to prices in a base year. Example, In India the base year of calculating deflator is 2011-12.
Factors fuelling inflation in India
- Falling rupee: Inflation is here to stay because it has much to do with the decline in value of the rupee that has fallen to its lowest, which makes imports of oil and gas more expensive.
- Ukraine crisis: The war in Ukraine has the same effect and pushes the price of some food items upward.
- Poor inflation management: With inflation, as measured by the consumer price index, in August going back to 7 per cent, and the wholesale price index coming in at 12.4 per cent, one thing is clear India is not out of the woods on inflation management.
Rising inflation have these implications
- Impact on the poor: This upsurge of inflation is affecting the poor more because some of the commodities whose prices are increasing the most represent a larger fraction of the budget of the most vulnerable sections of society.
- Rising inequality: As a result, inequalities which were already on the rise are increasing further. Recently, the State of Inequality in India report showed that an Indian making Rs 3 lakh a year belonged to the top 10 per cent of the country’s wage earners.
- Inequality in healthcare: India’s spending on healthcare is among the lowest in the world. Decent level of healthcare is available only to the ones who can afford it because of increasing out-of-pocket expenditure the payment made directly by individuals for the health service, not covered under any financial protection scheme. Overall, these out-of-pocket expenses on healthcare are 60 per cent of the total expenditure on public health in India, which is one of the highest in the world.
Need for bold steps on three fronts to tackle inflation
- Unless bold and innovative steps are taken at least on three fronts, GDP growth and inflation both are likely to be in the range of 6.5 to 7.5 per cent in 2022-23.
1] Tightening of loose monetary policy: The Reserve Bank of India (RBI) is mandated to keep inflation at 4 per cent, plus-minus 2 per cent.
- The RBI has already started the process of tightening monetary policy by raising the repo rate, albeit a bit late.
- It is expected that by the end of 2022-3, the repo rate will be at least 5.5 per cent, if not more.
- It will still stay below the likely inflation rate and therefore depositors will still lose the real value of their money in banks with negative real interest rates.
- That only reflects an inbuilt bias in the system — in favour of entrepreneurs in the name of growth and against depositors, which ultimately results in increasing inequality in the system.
2] Prudent fiscal policy: Fiscal policy has been running loose in the wake of Covid-19 that saw the fiscal deficit of the Union government soar to more than 9 per cent in 2020-21 and 6.7 per cent in 2021-22, but now needs to be tightened.
- Government needs to reduce its fiscal deficit to less than 5 per cent, never mind the FRMB Act’s advice to bring it to 3 per cent of GDP.
- However, it is difficult to achieve when enhanced food and fertiliser subsidies, and cuts in duties of petrol and diesel will cost the government at least Rs 3 trillion more than what was provisioned in the budget.
3] Rational trade policy: Export restrictions/bans go beyond agri-commodities, even to iron ore and steel, etc. in the name of taming inflation.
- But abrupt export bans are poor trade policy and reflect only the panic-stricken face of the government.
- A more mature approach to filter exports would be through a gradual process of minimum export prices and transparent export duties for short periods of time, rather than abrupt bans, if at all these are desperately needed to favour consumers.
Conclusion
- Though the government is opting for market-based economics, currently, India needs a mixed solution that comprises price stability via government channels and subsidies.
Mains question
Q. What are the fuelling factors for inflation? Discuss what steps should be taken to tackle inflation.
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Capital Markets: Challenges and Developments
Untitled
Capital Markets: Challenges and Developments
India’s first Global Bullion Exchange unveiled
Note4Students
From UPSC perspective, the following things are important :
Prelims level: IIBX
Mains level: Gold exchange
Prime Minister has launched India’s first International Bullion Exchange (IIBX) at the Gujarat International Finance Tec-City (GIFT City) near Gandhinagar.
What is Bullion?
- Bullion refers to physical gold and silver of high purity that is often kept in the form of bars, ingots, or coins.
- It can sometimes be considered legal tender and is often held as reserves by central banks or held by institutional investors.
When was the IIBX announced?
- During her 2020 budget speech, Finance Minister announced the setting up of India International Bullion Exchange (IIBX) at International Financial Services Center (IFSC) at GIFT City in Gandhinagar.
- The International Financial Services Centres Authority (Bullion Exchange) Regulations, 2020, was notified in December 2020 for trading of precious metals, including gold and silver.
- These regulations also cover bullion exchange, clearing corporation, depository and vaults.
What is the IIBX?
- India for the first time had liberalised gold imports through nominated banks and agencies in the 1990s.
- Now, the eligible qualified jewellers in India have been allowed to directly import gold through IIBX.
- For this, jewellers will have to become a trading partner or a client of an existing trading member.
- In addition, the exchange has set up necessary infrastructure to store physical gold and silver.
- The exchange will sell physical gold and silver and aims to be set up on the lines of the Shanghai Gold Exchange and Borsa Istanbul in order to make India a key regional hub for bullion flows.
How will it work?
- The thought process behind setting this up is to enable the trading of commodities on an exchange.
- Since this is international exchange, trading can take place in US dollars as well.
- India has positioned itself as one of the biggest trading hubs in Asia.
- Because of the competitive pricing on IIBX, international players will be happy to use our vaulting services.
- Moreover, with this being a free trade zone, no duty will be paid.
What was the practice up until now?
- Currently, gold in India is imported on a consignment model into different cities by nominated banks and agencies approved by the RBI and then supplied to traders/jewellers.
- The banks and other agencies get a fee from the gold exporter for handling, storage, etc, and also add a premium to the gold while transacting with domestic buyers.
- The buyer passes this charge on to the value chain until it reaches the end customer.
What change did IIBX bring?
- With the IIBX becoming operational today, qualified domestic buyers can, through a branch in Gift City, purchase the bars and coins.
- This purchase can be done from an international supplier who is a member of the IIBX.
What is the advantage of an exchange?
- Through the dis-intermediation by facilitating transactions through an anonymously traded exchange platform, bullion is made available across special economic zones (SEZs) at International Financial Services Centres Authority (IFSCA)-approved vaults.
- This means the growth of IIBX is not just limited to GIFT City but across jewellery manufacturing hubs nationwide.
- The qualified jeweller allowed to import gold through IIBX, or a jeweller who is a client of an IIBX member, can view the available stock and place the order.
- This shall nudge jewellers towards just-in-time inventory management.
- It will also result in greater transparency in pricing, and order sequencing, thereby removing any room for unfair preference by supplier, importing or logistics agency.
Which jewellers have come on board?
- So far, 64 big jewellers have come onboard and more applications are in the pipelines.
- Some of the big names include Malabar Gold Pvt Ltd, Titan Company Ltd, Bangalore Refinery Pvt Ltd, RBZ Jewellers Pvt Ltd, Zaveri and Company Pvt Ltd.
What are the new RBI guidelines for importing gold?
- Banks may now allow qualified Jewellers to remit advance payments for 11 days for import of gold through IIBX in compliance to the extant Foreign Trade Policy and regulations issued under IFSC Act.
- According to the RBI, all payments by qualified jewellers for imports of gold through IIBX shall be made through the exchange mechanism as approved by IFSCA.
Who can enrol on the exchange?
- Non-Resident Individual / Proprietorship Firm
- Registered Partnership Firm
- Private Limited Company
- Public Limited Company
- Qualified Jewellers
- Branches of IBU at GIFT City
- Foreign Bullion Suppliers who follow OECD guideline
- In order to become a qualified jeweller, entities require a minimum net worth of Rs 25 crore.
- And 90 per cent of the average annual turnover in the last three financial years through deals in goods categorised as precious metals.
- NRIs and institutes will also be eligible to participate in the exchange after registering with the International Financial Services Centre Association (IFSCA).
- Jewellers will be able to transact on IIBX only as trading members or as clients of a trading member.
- If one wants to become a trader, a qualified jeweller will have to establish a branch or a subsidiary in IFSC (international financial services centre) and apply to the IFSCA.
What products does IIBX offer?
- IIBX offers a diversified portfolio of products and technology services at a cost which is far more competitive than the Indian exchanges as well as other global exchanges in Hong Kong Singapore, Dubai, London and New York.
- Gold 1 kg 995 purity and gold 100 gm 999 purity with a T+0 settlement (100% upfront margin) are expected to trade at IIBX initially.
- All contracts will be listed, traded and settled in US Dollar
- The exchange will have three vaults – one operated by Sequel Global (ready and approved), the second one to be operated by Brinks India is ready and awaiting final approval and the third is under construction.
- Once the gold is imported by the authorised entities it will be deposited at one of the vaults which will issue bullion depository receipts.
- These receipts will then be traded in dollars on the exchange.
Significance of IIBX
- The IIBX shall be the “Gateway for Bullion Imports into India”, wherein all the bullion imports for domestic consumption shall be channelized through the exchange.
- The exchange ecosystem is expected to bring all the market participants to a common transparent platform for bullion trading.
- It would provide efficient price discovery, assurance in the quality of gold, and enable greater integration with other segments of financial markets.
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Capital Markets: Challenges and Developments
What are External Commercial Borrowings (ECBs)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: ECB
Mains level: Not Much
The Reserve Bank of India has relaxed norms for companies raising external commercial borrowings (ECBs), as part of a set of measures to stem the slide in the rupee.
What are ECBs taken by Indian companies?
- ECBs are commercial loans that eligible resident entities can raise from outside India, i.e. from a recognized non-resident entity.
- ECBs can be buyer’s credit, supplier’s credit, foreign currency convertible bonds, foreign currency exchangeable bonds, loans etc.
- ECBs can be raised via the automatic route where cases are examined by the Authorized Category Dealer, or the approval route where borrowers are mandated to forward their request to RBI through their authorized dealers.
- Borrowers must follow norms on minimum maturity period, maximum all-in-cost ceiling, end-uses etc.
What is the relaxation offered by the RBI?
- RBI earlier had raised borrowing limit under the automatic route from $750 million or its equivalent per financial year to $1.5 bn up till up to 31 December, 2022.
Why such move?
- The objective was to increase the supply of foreign exchange reserves.
- This in turn would thereby prevent the fast depreciation of the rupee witnessed over the last few months.
What clarity do foreign lenders want from RBI?
- Lenders want to know whether the investment grade needs to be rated by domestic or international agencies.
- If it is only by global agencies, it would limit the number of potential borrowers.
- This is because companies which might be rated high domestically might not necessarily have made the investment grade when rated by international agencies.
Why do Indian firms go for ECBs?
- Low cost: ECBs give companies the benefit of borrowing abroad at lower interest rates.
- Long term repayment: They are also an avenue to borrow a large volume of funds for a relatively long period of time.
- Surpassing exchange fluctuation: Also, borrowing in foreign currencies enables companies to pay for their machinery import etc., thereby nullifying the impact of varying exchange rate.
- Long term profitability: ECBs can help diversify the investor base and funds available at lower cost, helping improve profitability of companies.
- Better credit ratings: ECB interest rates are also a function of their ratings in the international market.
What are the risks for firms raising ECBs?
- Though companies get attracted to ECBs due to lower interest rates, the comfort level of the borrower depends on how stable the rate of exchange is.
- Depreciation of the rupee will raise debt servicing burden as compared to what has been worked out at the time of availing of the ECB facility.
- Thus, the companies might need to incur hedging costs (amount equal to the aggregate costs, fees, and expenses) to cover the exchange rate risk.
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Capital Markets: Challenges and Developments
What are G-Sec Yields?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: G-Secs
Mains level: Read the attached story
Government Securities (G-Secs) yields are at an all-time high.
What are G-Secs?
- These are debt instruments issued by the government to borrow money.
- The two key categories are:
- Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
- Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years
Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.
Why G-Secs?
- Like bank fixed deposits, g-secs are not tax-free.
- They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
- However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
- Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).
How are G-sec yields calculated?
- G-sec yields change over time; often several times during a single day.
- This happens because of the manner in which G-secs are structured.
- Every G-sec has a face value, a coupon payment and price.
- The price of the bond may or may not be equal to the face value of the bond.
- Here’s an example: Suppose the government floats a 10-year G-sec with a face value of Rs 100 and a coupon payment of Rs 5.
- If one were to buy this single G-sec from the government, it would mean that one will give Rs 100 to the government today and the government will promises to 1) return the sum of Rs 100 at the end of tenure (10 years), and 2) pay Rs 5 each year until the end of this tenure.
- At this point, the face value of this G-sec is equal to its price, and its yield (or the effective interest rate) is 5%.
How do G-sec yields go up and down?
- Imagine a scenario in which the government floats just one G-sec, and two people want to buy it.
- Competitive bidding will ensue, and the price of the bond may rise from Rs 100 (its face value) to Rs 105.
- Now imagine another lender in the picture, which pushes the price further up to Rs 110.
What do G-sec yields show?
- If G-sec yields (say for a 10-year bond) are going up, it would imply that lenders are demanding even more from private sector firms or individuals; that’s because anyone else is riskier when compared to the government.
- It is also known that when it comes to lending, interest rates rise with the rise in risk profile.
- As such, if G-sec yields start going up, it means lending to the government is becoming riskier.
- If you read that the G-sec yields are going up, it suggests that the bond prices are falling. But the prices are falling because fewer people want to lend to the government.
- And that in turn happens when people are worried about the government’s finances (or its ability to pay back).
- The government’s finances may be in trouble because the economy is faltering and it is unlikely that the government will meet its expenses.
- By the reverse logic, if a government’s finances are sorted, more and more people want to lend money to such a G-sec.
- This in turn, leads to bond prices going up and yields coming down.
Try this PYQ:
Consider the following statements:
- The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
- Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
- Treasury bills offer are issued at a discount from the par value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 Only
(c) 2 and 3 only
(d) 1, 2 and 3
Post your answers here.
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Capital Markets: Challenges and Developments
Understanding SEBI Rules on Passive Funds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Passive Funds
Mains level: Not Much
The Securities and Exchange Board of India (SEBI) recently issued a circular on passive funds covering matters related to transparency, liquidity and operational aspects of exchange-traded funds (ETFs) and index funds.
What are Passive Funds?
- A passive fund is an investment vehicle that tracks a market index, or a specific market segment, to determine what to invest in.
- Unlike with an active fund, the fund manager does not decide what securities the fund takes on.
- This normally makes passive funds cheaper to invest in than active funds, which require the fund manager to spend time researching and analysing opportunities to invest in.
- Tracker funds, such as ETFs (exchange traded funds) and index funds fall under the banner of passive funds.
What is a passive ELSS scheme?
- Passive funds mimic an underlying index. By contrast active funds are actively managed by fund managers.
- The SEBI has now introduced a passive equity-linked saving schemes (ELSS) category, which will give taxpayers another investment option to avail of tax benefits.
- According to the circular, the passive ELSS scheme will be based on any index comprising equity shares from the top 250 companies in terms of market capitalization.
- Beginning 1 July, a fund house will be able to either have an active ELSS scheme or a passive ELSS scheme, but not both.
What are the norms for debt ETFs?
- Passive debt funds are now divided into three categories:
- Corporate debt funds with exposure to corporate bonds
- G-Sec funds investing in government securities, and
- Hybrid funds where allocation is a combination of corporate bonds and government securities
- Currently, debt funds in the passive category invest only in AAA-rated instruments.
- The Sebi circular introduces norms for each debt fund category, including portfolio exposure limits to each sector, the issuer (based on rating) and group.
- Application of these provisions should help mitigate concentration risk in debt ETFs/ index funds.
What about tracking error?
- As per Sebi’s circular, passive funds must disclose ‘tracking error’ and ‘tracking difference’ in their monthly fact sheets.
- These metrics indicate how different the performance of the fund is compared to its underlying index—an effort to keep investors better informed.
- The circular specifies limits for tracking error and tracking difference, which passive funds must follow.
What is the mandate on disclosing NAVs?
- Because of poor liquidity for ETFs in the secondary market in India, ETF prices could differ widely from the net asset value (NAV) of the fund.
- The NAV of the fund represents the value of the underlying asset of the ETF.
- The Sebi circular mandates disclosure of NAV (indicative) on a continuous basis throughout the day on the stock exchange.
- While the practice is already in existence, Sebi rules institutionalize it.
- Checking the NAV can help one avoid making a transaction at a significant premium or discount.
Can one execute ETF transactions directly?
- Investors can buy or sell units of ETFs only on stock exchanges.
- But, large buy or sell transactions can also be directly placed with the fund house.
- Sebi now says orders greater than ₹25 crore alone can be placed for redemption or subscription directly with the asset management company (AMC).
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Capital Markets: Challenges and Developments
What are Participatory and Non-Participatory Funds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Participatory and Non-Participatory Funds
Mains level: NA
The amendment to Section 24 of the LIC Act, brought prior to commencing the IPO, segregated the previously single ‘Life Fund’ into the participatory and non-participatory fund.
What are Participatory and Non-Participatory Funds?
- Under a participatory policy, a policyholder can get a share of the profits of the company.
- This is received as a bonus. Examples of such products offered by LIC include Jeevan Labh and Bachat Plus.
- No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as Saral Pensionand Nivesh Plus.
- As all insurance companies do, LIC also reinvests premium monies that policyholders pay.
- The profits or surplus that comes about, as a result, was till September last year held in one single fund. This was the Life Fund.
- The surplus was divided in the 95:5 ratio between policyholders (in the form of bonuses) and shareholders (in the form of dividends).
What has the Amendment changed?
- But the amendment to Section 24 of the LIC Act has necessitated the segregation of the Life Fund into participatory and non-participatory funds, depending on the nature of the policies they support.
- The amendment stipulates terms on how surplus is to be shared with respect to participatory and non-participatory funds.
- As for non-participating funds, surplus from the non-participating business would be transferred to shareholders.
- Surplus from participatory business, however, would be shared between policyholders and shareholders.
How does this change impact the shareholder?
- The change, especially the one that has enabled 100% of the surplus in non-participatory funds to flow to the shareholder, has led to a massive jump in the Indian Embedded Value, or IEV.
- IEV is a measure of future cash flows in life insurance companies and the key financial gauge for insurers.
- The embedded value will help establish the market valuation of LIC and determine how much money the government raises in the flotation.
- That will be crucial for the government to help meet its divestment targets and keep its fiscal deficit in check.
Why is it a risk, then?
- LIC has stated in the document that a significant portion of its business premiums come from participating and single premium products.
- It added, should the participating products generate lower than expected returns for policyholders, it could lead to increased surrenders.
- This could also potentially bother their financial condition, operations, and cash flows.
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Capital Markets: Challenges and Developments
Back in news: LIC Disinvestment
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Life Insurance Corporation of India (LIC)
Mains level: Disinvestment in India
The Union government has filed a draft document with the stock market regulator for selling 5% of its shares in the Life Insurance Corporation (LIC) of India.
Details of the IPO
- The IPO is a 100% OFS [offer for sale] by the Government of India and entails no fresh issue of shares by LIC.
- 6 Crore shares are on offer representing 5% of the government’s equity in the firm.
- As much as 10% of the offer could be reserved for LIC policyholders, as per the regulatory filing, and another 5% of the shares may be reserved for employees.
About Life Insurance Corporation of India (LIC)
- LIC is an Indian state-owned insurance group and investment corporation owned by the Government of India.
- It was founded in 1956 when the Parliament of India passed the Life Insurance of India Act that nationalized the insurance industry in India.
- Over 245 insurance companies and provident societies were merged to create the state-owned LIC.
Why LIC?
- LIC is India’s largest financial institution.
- When listed on stock exchanges, it could easily emerge as the country’s top listed company in terms of market valuation, overtaking current leaders Reliance and TCS.
- It is also the largest investor in government securities and stock markets every year.
- On average, LIC invests Rs 55,000 crore to Rs 65,000 crore in stock markets every year and emerges as the largest investor in Indian stocks.
- LIC also has huge investments in debentures and bonds besides providing funding for many infrastructure projects.
Impacts of listing of LICs
- Profit-making for govt: The government is trying to make the most of the brand value of LIC, given that it is one of the few remaining profit-making entities owned by the state.
- Better returns: Listing will boost LIC’s efficiency and thereby policy returns.
- Reforming the insurance sector: LIC will also become more competitive. This will put pressure on its peers to innovate, benefitting policyholders in terms of pricing, product features, and services.
- Better financial position: Less govt interference will be a positive for LIC’s financial health.
- Risk-free: As long as a sovereign guarantee over the maturity proceeds and the sum assured to continue, policyholders won’t perceive any risk.
Various challenges
- Structural challenges: LIC can even evolve into a bank like many of its global peers like Axa, Berkshire, and Munich Re.
- Market hurdles: LIC’s own issues are not the only challenge the company would face in going public. It also remains to be seen if the Indian share market is ready to absorb such a large public issue.
- Impact on growth: The size of the IPO will determine the extent of liquidity it will suck out, but Indian markets do not have the depth to take the issue of a very size.
- Fears of disclosure: The Company’s books and operations have been opaque for far too long but it is trusted by 250 million policyholders.
- Investors trust at risk: Being one of the biggest financial institutions of the country, the move to privatize LIC will shake the confidence of the common man and will be an affront to our financial sovereignty.
Way Forward
- Over the years, LIC has become the lender of last resort to the Government of India.
- Confronted with an unprecedented fiscal deficit and worried by an economy in crisis, the government has to find resources.
- This disinvestment is also a preferred option for ideological and practical reasons.
- The government could utilize the money gained by selling off its stakes to improve services in public goods like infrastructure, health, and education.
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Capital Markets: Challenges and Developments
SEBI tweaks share sale norms for IPOs
Note4Students
From UPSC perspective, the following things are important :
Prelims level: IPO
Mains level: Not Much
The Securities & Exchange Board of India (SEBI) has approved amendments to a slew of regulations to tighten the Initial Public Offering (IPO) process and norms governing the utilization of IPO proceeds by promoters.
What is an IPO?
- Every company needs money to grow and expand.
- They do this by borrowing or by issuing shares.
- If the company decides to opt for the second route of issuing shares, it must invite public investors to buy its shares.
- This is its first public invitation in the stock market and is called the Initial Public Offering (IPO).
What does it mean for investors to buy shares?
- When one buys such shares, he/she makes an IPO investment.
- He/she gets ownership in the company, proportionate to the value of your shares.
- These shares then get listed on the stock exchange.
- The stock exchange is where you can sell your existing shares in the company or buy more.
How does an IPO work?
- The Securities and Exchange Board of India (SEBI) regulates the entire process of investment via an IPO in India.
- A company intending to issue shares through IPOs first registers with SEBI.
- SEBI scrutinizes the documents submitted, and only then approves them.
Who can hold IPOs?
- It could be a new, young company or an old company that decides to be listed on an exchange and hence goes public.
What are the recent regulations?
- In its board meeting, SEBI approved conditions for sale of shares by significant shareholders in the Offer-For-Sale (OFS) process via an IPO and has extended the lock-in period for anchor investors to 90 days.
- Shares offered for sale by shareholders with more than 20% of pre-issue shareholding of the issuer, should not exceed 50% of their holding.
- If they hold less than 20%, then the offer for sale should not exceed 10% of their holding of the issue.
- These changes are as per proposals recommended by SEBI’s Primary Market Advisory Committee.
Also read:
Try this question from CSP 2019:
Q.In India, which of the following review the independent regulators in sectors like telecommunications, insurance, electricity, etc.?
- Ad Hoc Committees set up by the Parliament
- Parliamentary Department Related Standing Committees
- Finance Commission
- Financial Sector Legislative Reforms Commission
- NITI Aayog
Select the correct answer using the code given below:
(a) 1 and 2
(b) 1, 3 and 4
(c) 3, 4 and 5
(d) 2 and 5
Post your answers here.
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Capital Markets: Challenges and Developments
SEBI suspends Futures Trading in key farm crops
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Derievatives, Commodity trading
Mains level: NA
Market regulator Securities & Exchange Board of India (SEBI) has issued an order suspending futures trading in paddy (non-basmati), wheat, Bengal gram (chana dal), mustard seeds and its derivatives, soyabean and its derivatives, crude palm oil and green gram (moong dal) for a year.
What are Derivatives?
- A derivative is a contract between two parties which derives its value/price from an underlying asset.
- The value of the underlying asset is bound to change as the value of the underlying assets keep changing continuously.
- Generally, stocks, bonds, currency, commodities and interest rates form the underlying asset.
Types of Derivatives
The most common types of derivatives are futures, options, forwards and swaps:
(1) Futures
- Futures are standardized contracts that allow the holder to buy/sell the asset at an agreed price at the specified date.
- The parties to the futures contract are under an obligation to perform the contract. These contracts are traded on the stock exchange.
- The value of future contracts is marked to market every day.
- It means that the contract value is adjusted according to market movements till the expiration date.
(2) Options
- Options are derivative contracts that give the buyer a right to buy/sell the underlying asset at the specified price during a certain period of time.
- The buyer is not under any obligation to exercise the option.
- The option seller is known as the option writer. The specified price is known as the strike price.
(3) Forwards
- Forwards are like futures contracts wherein the holder is under an obligation to perform the contract.
- But forwards are unstandardized and not traded on stock exchanges.
- These are available over-the-counter and are not marked-to-market.
- These can be customized to suit the requirements of the parties to the contract.
(4) Swaps
- Swaps are derivative contracts wherein two parties exchange their financial obligations.
- The cash flows are based on a notional principal amount agreed between both parties without the exchange of principal.
- The amount of cash flows is based on a rate of interest.
- One cash flow is generally fixed and the other changes on the basis of a benchmark interest rate.
- Swaps are not traded on stock exchanges and are over-the-counter contracts between businesses or financial institutions.
What are Agri-Futures?
Like equity, currency or interest rate futures, they allows to buy or sell an underlier at a preset price on a future date. All agri contracts end in compulsory delivery.
- Agri products available for trade include wheat, sugar, chana, soyabean, castor, chilli , jeera futures, etc. Edible oil seeds and oils, spices and items like guar are among the more liquid contracts.
- An objective of futures trading is gains reaching farmers, by establishing an efficient price-discovery platform.
- This has been achieved to a large extent on NCDEX, in products such as castor, chana, soy complex, mustard, guar, cumin, etc.
National Commodity & Derivatives Exchange Limited (NCDEX) is an Indian online commodity and derivative exchange. It is under the ownership of Ministry of Finance.
What are the reasons for this ban?
(1) To cool off Food Inflation
- India’s retail inflation rose to a three-month high of 4.91 % in November from 4.48 % in the previous month primarily because of a rise in food inflation to 1.87 % from 0.85 % over this period.
(2) Double Digits WPI
- Wholesale Price Index-based inflation has remained in double digits for eight consecutive months beginning in April, mainly because of the surging prices of food items.
- In November, the wholesale price-based inflation surged to a record high of 14.23 % amid the hardening of prices of mineral oils, basic metals, crude petroleum, and natural gas.
(3) To insulate future Price Shock
- In view of Rabi Output that might be affected morbidly because of fertilizer shortage faced in many parts of the country.
- By banning future’s trade, the government is trying to insulate any price shock the market might feel in the days to come in case the production is not up to par.
What will be the impact?
(1) The imports in such commodities, especially edible oils, would reduce in the short term as traders will not have a hedging platform.
- Hedging, which is speculative in nature, has been made difficult.
- This will lead to the release of blocked local produce supplies into the market, which should cool the prices.
- Imports of commodities for speculative gains will be discouraged.
(2) It is believed that speculators have a role in jacking up prices and this needed to be discouraged to curb inflation and support growth as the economy is recovering from the COVID-19 impact.
(3) India is the world’s biggest importer of vegetable oil and this measure will make it difficult for edible oil importers and traders to transact business since they use Indian exchanges to hedge their risk.
(4) Agri-futures, driven mainly by NCDEX, have a checkered history with bans often pushing NCDEX back.
- Such frequent bans are not a good development for the market as it affects confidence levels.
- Often, a contract that is banned may not return to the table, which were very effective in price-discovery.
- Even when the contracts are restored, traders hesitate because of the fear of bans.
- As it involves losses for market participants with open positions as they must square off contracts before maturity.
What are the other steps taken?
- Supply-side interventions by the Government had limited the fallout of continuing high international edible oil prices on domestic prices.
- The Union Government substantially reduced taxes on imports of palm, soy and sunflower oil.
- Union and State Governments had also recently reduced excise duty and VAT on petrol and diesel, aimed at bringing down inflation.
- It has both direct effects as well as indirect effects operating through fuel and transportation costs.
Way Forward
- The ban is expected to be lifted by March when the next mustard crop starts hitting the market and prices cool down.
- If the weather remains benign in the coming weeks, India is on course to harvest a bumper 11 million tonnes of mustard in 2021-22, up from 8.5 million tonnes in 2020-21.
- The way out is not to ban any contract, but make sure to correct any serious aberration through a combination of higher margins so that if at all the price is getting distorted due to market manipulation, the correction takes place immediately.
- Further, talking to potential wrongdoers is another way out, provided trading patterns noticed by the exchange reveal such tendencies.
- Position limits can be changed to ensure undue influence is not exerted by any set of traders.
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Capital Markets: Challenges and Developments
What are Non-convertible Debentures?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Non-convertible Debentures
Mains level: Not Much
Several companies have announced public issues to raise funds through non-convertible debentures.
What are Debentures?
- Debentures are long-term financial instruments issued by a company for specified tenure with a promise to pay fixed interest to the investor.
- They can be held by individuals, banking companies, primary dealers other corporate bodies registered or incorporated in India and unincorporated bodies.
- Their types include:
- Convertible debentures (CDs): They are a type of debentures that can be converted into equity shares of the company.
- Non-convertible debentures (NCDs): They are defined as the type of debentures that cannot be converted into equity shares of the company.
What are NCDs?
- Some debentures have a feature of convertibility into shares after a certain point of time at the discretion of the owner.
- The debentures which can’t be converted into shares or equities are called non-convertible debentures (or NCDs).
- They are debt financial instruments that companies use to raise medium- to long-term capital.
Benefits offered by NCDs
- At a time when fixed deposit rates are in low single digits, these NCD offerings look lucrative.
- NCDs offer interest rates between 8.25–9.7%.
Risks posed
- Although NCDs are generally considered safe fixed-income instruments, some recent defaults have made investors cautious.
- NCDs can be either secured by the issuer company’s assets, or unsecured.
- Certain issuers, with credit rating below investment grade, had in the past issued both a secured NCD and another unsecured one through the same offer document, with different credit ratings.
- The risk is high in the case of unsecured NCDs, even though they offer high-interest rates.
- Credit rating of the issuer is a key factor to consider before investing in any NCD.
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Capital Markets: Challenges and Developments
Infrastructure Investment Trusts (InvITs)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: InvITs
Mains level: Not Much
The National Highway Authority of India’s first infrastructure investment trust has raised more than Rs 5,000 crore, informed the Ministry of Road Transport and Highways of India.
What are InvITs?
- InvITs are like a mutual fund, which enables direct investment of small amounts of money from possible individual/institutional investors in infrastructure to earn a small portion of the income as return.
- They work like mutual funds or real estate investment trusts (REITs) in features.
- They can be treated as the modified version of REITs designed to suit the specific circumstances of the infrastructure sector.
How are they notified in India?
- SEBI notified the Sebi (Infrastructure Investment Trusts) Regulations, 2014 on September 26, 2014, providing for registration and regulation of InvITs in India.
- The objective of InvITs is to facilitate investment in the infrastructure sector.
Their structure
- InvITS are like mutual funds in structure. InvITs can be established as a trust and registered with Sebi.
- An InvIT consists of four elements:
- Trustee: He inspects the performance of an InvIT is certified by Sebi and he cannot be an associate of the sponsor or manager.
- Sponsor(s): They are people who promote and refer to any organisation or a corporate entity with a capital of Rs 100 crore, which establishes the InvIT and is designated as such at the time of the application made to SEBI, and in case of PPP projects, base developer.
- Investment Manager: It is an entity or limited liability partnership (LLP) or organisation that supervises assets and investments of the InvIT and guarantees activities of the InvIT.
- Project Manager: It is the person who acts as the project manager and whose duty is to attain the execution of the project and in case of PPP projects.
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Capital Markets: Challenges and Developments
[pib] GoI Floating Rate Bonds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Floating Rate Bonds
Mains level: Not Much
The Government of India has announced the Sale (Re-issue) of Floating Rate Bonds, 2028’.
What are Bonds?
- Bonds are investment securities where an investor lends money to a company or a government for a set period of time, in exchange for regular interest payments.
- Generally, bonds come with a fixed coupon or interest rate. For example, you can buy a bond of Rs 10,000 with a coupon rate of 5%.
- Once the bond reaches maturity, the bond issuer returns the investor’s money.
- Fixed income is a term often used to describe bonds, since your investment earns fixed payments over the life of the bond.
Why are bonds launched?
- Companies sell bonds to finance ongoing operations, new projects or acquisitions.
- Governments sell bonds for funding purposes, and also to supplement revenue from taxes.
What are Floating Rate Bonds?
- A floating rate bond is a debt instrument that does not have a fixed coupon rate, but its interest rate fluctuates based on the benchmark the bond is drawn.
- Benchmarks are market instruments that influence the overall economy.
- For example, repo rate or reverse repo rate can be set as benchmarks for a floating rate bond.
How do floating rate bonds work?
- Floating rate bonds make up a significant part of the Indian bond market and are majorly issued by the government.
- For example, the RBI issued a floating rate bond in 2020 with interest payable every six months. After six months, the interest rate is re-fixed by the RBI.
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Capital Markets: Challenges and Developments
What are Electronic Gold Receipts?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Electronic Gold Receipts
Mains level: NA
The board of the Securities and Exchange Board of India (SEBI) has approved the framework for a gold exchange as well as for vault managers. This approval paves the way for gold exchanges to be set up for trading in ‘Electronic Gold Receipt’ (EGR).
What is EGR?
- SEBI’s concept paper proposes issuing an electronic gold receipt in exchange pf physical gold (similar to equity shares), deposited with a vault manager (like a depositary participant) and this receipt can then be traded.
- The government wants India’s outsized influence in the physical market for gold to be visible in the financial market for gold as well.
Why need EGRs?
- EGI is a way of getting people to not hoard gold, by creating an exchange that provides transparent pricing and liquidity (to cash or back to gold).
- India is a net importer of gold. We are price takers and not price setters. The whole idea is to move from being price takers to be price setters.
- Price discovery at the exchanges will thus lead to transparency in gold pricing.
- The gold exchanges would provide transparent price discovery, investment liquidity and assurance in the quality of gold.
What is the SEBI regulation?
- SEBI has also proposed a regulatory framework for setting up a gold exchange.
- Existing stock exchanges will be allowed to provide the platform for trading of EGRs.
- The denomination for trading of EGR and conversion of EGR into gold will be decided by the stock exchange with the approval of SEBI.
- The clearing corporation will settle the trades executed on the stock exchanges by way of transferring EGRs and funds to the buyer and seller, respectively.
How will EGR work?
- EGR holders, at their discretion, can withdraw the underlying gold from the vaults after surrendering the EGRs.
- SEBI-accredited vault managers will be responsible for the storage and safekeeping of gold deposits, creation of EGRs, withdrawal of gold, grievance redressal and periodic reconciliation of physical gold with the records of depository.
- The vault manager will have a networth of at least ₹50 crore.
Back2Basics: Securities and Exchange Board of India (SEBI)
- The SEBI is the regulatory body for securities and commodity market in India under the jurisdiction of Ministry of Finance Government of India.
- It was established on 12 April 1988 and given Statutory Powers on 30 January 1992 through the SEBI Act, 1992.
Jurisdiction of SEBI
- SEBI has to be responsive to the needs of three groups, which constitute the market:
- Issuers of securities
- Investors
- Market intermediaries
SEBI has three powers rolled into one body: quasi-legislative, quasi-judicial and quasi-executive.
- It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity.
- Though this makes it very powerful, there is an appeal process to create accountability.
- There is a Securities Appellate Tribunal which is a three-member tribunal and is currently headed by Justice Tarun Agarwala, former Chief Justice of the Meghalaya High Court.
- A second appeal lies directly to the Supreme Court.
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Capital Markets: Challenges and Developments
SEBI introduces T+1 Settlement System
Note4Students
From UPSC perspective, the following things are important :
Prelims level: T+1, T+2 settlement
Mains level: NA
The Capital markets regulator Securities and Exchange Board of India (SEBI) has introduced T+1 settlement cycle for completion of share transactions on optional basis in a move to enhance market liquidity.
What is T+1 Settlement System?
- T+1 means that settlements will have to be cleared within one day of the actual transactions taking place.
- Currently, trades on the Indian stock exchanges are settled in two working days after the transaction is done (T+2).
- In April 2002, stock exchanges had introduced a T+3 rolling settlement cycle. This was shortened to T+2 from April 1, 2003.
What has Sebi allowed?
- SEBI has allowed stock exchanges to start the T+1 system as an option in place of T+2.
- If it opts for the T+1 settlement cycle for a scrip, the stock exchange will have to mandatorily continue with it for a minimum 6 months.
- Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s advance notice to the market.
- Any subsequent switch (from T+1 to T+2 or vice versa) will be subject to a minimum period.
- A stock exchange may choose to offer the T+1 settlement cycle on any of the scrips, after giving at least one month’s advance notice to all stakeholders, including the public at large.
Why T+1 settlement?
- Reduced settlement time: A shortened cycle not only reduces settlement time but also reduces and frees up the capital required to collateralize that risk.
- Quick settlement: T+1 also reduces the number of outstanding unsettled trades at any instant, and thus decreases the unsettled exposure to Clearing Corporation by 50%.
- Speedy recovery of assets: The narrower the settlement cycle, the narrower the time window for a counterparty insolvency/bankruptcy to impact the settlement of a trade.
- Risk reduction: Systemic risk depends on the number of outstanding trades and concentration of risk at critical institutions such as clearing corporations, and becomes critical when the magnitude of outstanding transactions increases.
How does T+2 work?
- If an investor sells shares, settlement of the trade takes place in two working days (T+2).
- The broker who handles the trade will get the money, but will credit the amount in the investor’s account only.
- In effect, the investor will get the money only after three days.
- In T+1, settlement of the trade takes place in one working day and the investor will get the money on the following day.
- The move to T+1 will not require large operational or technical changes by market participants, nor will it cause fragmentation and risk to the core clearance and settlement ecosystem.
Why are foreign investors opposing it?
- Foreign investors operating from different geographies would face time zones, information flow process, and foreign exchange problems.
- Foreign investors will also find it difficult to hedge their net India exposure in dollar terms at the end of the day under the T+1 system.
- In 2020, SEBI had deferred the plan to halve the trade settlement cycle to one day (T+1) following opposition from foreign investors.
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Back2Basics: SEBI
- The SEBI is the regulatory body for securities and commodity market in India under the jurisdiction of Ministry of Finance Government of India.
- It was established on 12 April 1988 and given Statutory Powers on 30 January 1992 through the SEBI Act, 1992.
Jurisdiction of SEBI
- SEBI has to be responsive to the needs of three groups, which constitute the market:
- Issuers of securities
- Investors
- Market intermediaries
SEBI has three powers rolled into one body: quasi-legislative, quasi-judicial and quasi-executive.
- It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity.
- Though this makes it very powerful, there is an appeal process to create accountability.
- There is a Securities Appellate Tribunal which is a three-member tribunal and is currently headed by Justice Tarun Agarwala, former Chief Justice of the Meghalaya High Court.
- A second appeal lies directly to the Supreme Court.
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Capital Markets: Challenges and Developments
National Financial Reporting Authority (NFRA)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: NFRA
Mains level: Not Much
Audit regulator National Financial Reporting Authority (NFRA) wants to be positioned as a regulator for the entire gamut of financial reporting, covering all processes and participants in the financial reporting chain.
What is NFRA?
- NFRA is an independent regulator to oversee the auditing profession and accounting standards in India under Companies Act 2013.
- It came into existence in October 2018.
- After the Satyam scandal took place in 2009, the Standing Committee on Finance proposed the concept of the National Financial Reporting Authority (NFRA) for the first time in its 21st report.
- Companies Act, 2013 then gave the regulatory framework for its composition and constitution.
Functions
- NFRA works to improve the transparency and reliability of financial statements and information presented by listed companies and large unlisted companies in India.
Powers & duties
- NFRA is responsible for recommending accounting and auditing policies and standards in the country.
- It may undertake investigations, and impose sanctions against defaulting auditors and audit firms in the form of monetary penalties and debarment from practice for up to 10 years.
- Since 2018, the powers of the NFRA were extended to include the governing of auditors of companies listed in any stock exchange, in India or outside of India, unlisted public companies above certain thresholds.
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Capital Markets: Challenges and Developments
Indian bond trading is in need of better market making
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Bond market
Mains level: Paper 3- Issues with bond markets in India
Context
The Indian market for corporate debt needs buoyancy and this has been high on the agenda of our regulator
Background
- The Reserve Bank of India (RBI) stopped the automatic monetization of the fiscal deficit in 1997 and made the government borrow money from the market.
- There are primary dealers or PDs, who pick up the Centre’s bond and provide buy and sell quotes in the secondary market for government bonds and thus help ensure sufficient liquidity.
- The PDs came to be known as market makers and are paid a commission for playing that role.
Liquidity challenge in the corporate bond market
- Unlike the market for government bonds, in the case of the country’s corporate bond market, the challenge is different.
- It’s typically remunerative for a buyer to buy a security and hold on to it till its maturity.
- Therefore, insurance companies, provident funds, and pension funds hold such long-term paper, as they can match the tenure of their assets with liabilities.
- But this does not add liquidity to the market, and anyone buying a corporate bond today may not find someone to sell it to tomorrow as this market has little trading depth.
- Even in the G-Sec market, where we assume plenty of liquidity, it is a thinly-traded market, even though the perception is that it is very liquid.
Why do we need market makers for the corporate bond market
- To deal with the lack of depth and liquidity in the corporate debt market, the Securities and Exchange Board of India’s (Sebi) idea of creating market makers holds immense significance.
- The fundamental problem here is that a bond is different from a share.
- A company’s share can be exchanged seamlessly because every share in the market is the same slice of ownership.
- Lack of quotes for different bonds of different tenure: In the case of bonds, however, there are several issuances of a company.
- A single financial institution or non-bank financial company could have as many as 10 issuances a year of varying maturities and interest rates, making each of them a unique instrument.
- Company XYZ may have issued in October 2015 a bond with a face value of ₹100 that pays 6% interest and is due for redemption in 2030, which will be quoted on exchanges for trading (if it’s being traded).
- But, in 2021, it is no longer a 15-year bond, but a 9-year paper.
- Therefore, the security loses importance, as the market normally uses benchmarks like 5 or 10 or 15 years; and every bond drops in the pecking order once it crosses these thresholds.
- Therefore, we need to have market makers who will offer quotes for all major securities and thereby ensure that critical bonds are still available for trading.
Suggestions
- Provide waivers: Playing market maker will involve a cost and hence there should be certain waivers provided to them on trading fees.
- Preferential access: They can be given preferential access to new issuances, so as to build up an inventory.
- Waiver of mark-to-market: The mark-to-market (MTM) rules could be waived for a specified period, as valuation differences can affect their profit and loss accounts.
- Capital at lower cost: Capital can be made available at a lower cost to market makers, as they require funding for the same.
- Fifth, trade among market makers can be awarded benefits in terms of fees or easier taxes on gains made.
- Create bond index: We need to have tradable-bond indices that reflect the price movements of a basket of bonds that they track.
- Made public, such indices will provide appropriate arbitrage opportunities for investors to come in, and this should generate liquidity in the market for these bonds.
Consider the question “Why bond market in India lacks the depth as compared to equity markets. What are the factors responsible for this? Suggest the way forward.”
Conclusion
Market makers are a way out. While success cannot be guaranteed, the idea should be adopted nonetheless, as with credit default swaps. It’s a work-in-progress. Let’s speed it up.
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Back2Basics: Automatic monetization of deficit
- The monetization of deficit was in practice in India till 1997, whereby the central bank automatically monetized government deficit through the issuance of ad-hoc treasury bills.
- Two agreements were signed between the government and RBI in 1994 and 1997 to completely phase out funding through ad-hoc treasury bills.
- And later on, with the enactment of the FRBM Act, 2003, RBI was completely barred from subscribing to the primary issuances of the government from April 1, 2006.
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Capital Markets: Challenges and Developments
[pib] International Bullion Exchange
Note4Students
From UPSC perspective, the following things are important :
Prelims level: International Bullion Exchange
Mains level: Not Much
The International Financial Services Centres Authority (IFSCA) has inaugurated the pilot run/soft launch of the International Bullion Exchange scheduled to go live on October 1, 2021.
What is Bullion?
- Bullion is gold and silver that is officially recognized as being at least 99.5% and 99.9% pure and is in the form of bars or ingots.
- Bullion is often kept as a reserve asset by governments and central banks.
- To create bullion, gold first must be discovered by mining companies and removed from the earth in the form of gold ore, a combination of gold and mineralized rock.
- The gold is then extracted from the ore with the use of chemicals or extreme heat.
- The resulting pure bullion is also called “parted bullion.” Bullion that contains more than one type of metal, is called “unparted bullion.”
The Bullion Market
- Bullion can sometimes be considered legal tender, most often held in reserves by central banks or used by institutional investors to hedge against inflationary effects on their portfolios.
- Approximately 20% of mined gold is held by central banks worldwide.
- This gold is held as bullions in reserves, which the bank uses to settle the international debt or stimulate the economy through gold lending.
- The central bank lends gold from their bullion reserves to bullion banks at a rate of approximately 1% to help raise money.
- Bullion banks are involved in one activity or another in the precious metals markets.
- Some of these activities include clearing, risk management, hedging, trading, vaulting, and acting as intermediaries between lenders and borrowers.
What is International Bullion Exchange?
- This shall be the “Gateway for Bullion Imports into India”, wherein all the bullion imports for domestic consumption shall be channelized through the exchange.
- The exchange ecosystem is expected to bring all the market participants to a common transparent platform for bullion trading.
- It would provide efficient price discovery, assurance in the quality of gold, enable greater integration with other segments of financial markets and help establish India’s position as a dominant trading hub in the World.
Answer this PYQ:
What is/are the purpose/purposes of the Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’?
- To bring the idle gold lying with India households into the economy
- To promote FDI in the gold and jewellery sector
- To reduce India’s dependence on gold imports
Select the correct answer using the code given below:
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Post your answers here.
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Capital Markets: Challenges and Developments
India’s equity market bubble
Note4Students
From UPSC perspective, the following things are important :
Prelims level: FPI and FDI
Mains level: Paper 3- Equity market bubble
Context
Even as the real economy returns to the doldrums after being hit by the second wave of COVID-19 infections, the continuing bull run in India’s equity market in the April-June quarter has baffled many observers.
V-shaped recovery of equity market
- The benchmark BSE Sensex had nosedived to below 28,000 in March-April 2020, following the nationwide lockdown.
- The equity market posted a sharp V-shaped recovery in 2020-21.
- The Sensex surged beyond 50,000 in February 2021 and is currently closing on the 53,000 level.
Factors suggesting bubble in equity market
- There was an 81%-plus growth in the Sensex between April 2020 and March 2021 in the backdrop of real GDP growth plummeting to -7.3% during the same period.
- While output contraction had reversed from the third quarter of 2020-21, the inflation rate also rose and remained way ahead of the real GDP growth rate in the last two quarters (Chart 1).
- It is difficult to find any rationality behind the skyrocketing BSE Sensex in the context of such stagflation in the real economy.
- Just like the fall in the equity prices was driven by the exit of foreign portfolio investors (FPI), the return of massive FPI inflows has driven the Indian equity bubble since then (Chart 2).
- Net FPI inflows clocked an unprecedented ₹2.74 lakh crore in 2020-21, the previous high being ₹1.4 lakh crore in 2012-13.
- The Reserve Bank of India (RBI)’s annual report (2020-21) to state stated that: “This order of asset price inflation in the context of the estimated 8 per cent contraction in GDP in 2020-21 poses the risk of a bubble.”
Global factors
- The global liquidity glut, following the expansionary, easy money policies adopted by the fiscal and monetary authorities of the OECD and G20 countries, has led to equity price inflation in several markets driven by FPIs, especially in Asia.
- Following cues from the U.S. and the U.K., Asian equity markets in Singapore, India, Thailand, Malaysia and Hong Kong are currently witnessing price-earnings (P/E) ratios significantly above their historic means.
- The BSE Sensex’s P/E ratio of 32 in end-June 2021 is way above its historic mean of around 20.
What could burst the bubble?
- Change in monetary policy: With COVID-19 vaccination and economic recovery proceeding apace in the U.S., the U.K. and Europe, fiscal and monetary policy stances will change soon.
- Exit of FPIs: Once the U.S. Federal Reserve and other central banks start raising interest rates, the direction of FPI flows will invariably change bringing about corrections in equity markets across Asia.
- India remains particularly vulnerable to a major correction in the equity market because of two reasons.
- Low pace of vaccination: The pace of COVID-19 vaccination in India, given the vast population, lags behind most large countries.
- In the absence of a substantial increase in the vaccination budget and procurement, large segments of the Indian population will remain vulnerable to a potential third wave of COVID-19, with its attendant deleterious impact on the real economy.
- Weak fiscal stimulus: India’s economic recovery from the recession will remain constrained by the weak fiscal stimulus that has been delivered by the Central government.
- Data from the IMF clearly show that while the total global stimulus consisted of additional public spending or revenue foregone measures amounting to 7.4% of global GDP, India’s fiscal measures amounted to 3.3% of GDP only.
Consider the question “What are the factors driving equity market boom globally? What are the factors that could threaten such boom with a major correction?”
Conclusion
With all agencies, including the RBI, downsizing India’s growth projections for 2021-22, it remains to be seen how long India’s equity bubble lasts.
Back2Basics: P/E ratio
- The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).
- The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.
- To determine the P/E value, one simply must divide the current stock price by the earnings per share (EPS).
P/E Ratio=Earnings per share / Market value per share
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Capital Markets: Challenges and Developments
SEBI needs to adopt dual approval system for independent directors
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Independent director
Mains level: Paper 3- Dual approval system for independent directors
Context
While the regulators have taken giant strides to enhance board independence in India, one significant conundrum persists about appoint and removal process of the independent directors.
How appointment and removal process affects the independence of independent directors?
- Independent directors are appointed just like other directors through shareholder voting by a simple majority.
- This confers a significant power in the hands of significant shareholders to handpick the independents.
- In case of family-owned companies, it is not uncommon to appoint “friendly” independent directors.
- As for public sector undertakings, there is a demonstrable affiliation between independent directors and the ruling political parties.
Dual Approval System: Way forward
- The above trends suggest that unless independent directors owe their allegiance to the shareholder body as a whole, independence is likely to remain largely in form and not function.
- In its consultation paper, SEBI proposed a “dual approval” system.
- Under this system, the appointment of an independent director required the satisfaction of two conditions:
- First, the approval by a majority of all shareholders.
- Second, the approval of a “majority of the minority”, namely the approval of shareholders other than the promoters.
- SEBI recommended the same “dual approval” system for the removal of independent directors as well.
- SEBI drew inspiration from Israel and the premium-listed segment of the United Kingdom, which confers greater power to minority shareholders in installing or dethroning independent directors.
- SEBI has not yet made any mention of implementing the dual approval system.
Issues with Dual Approval System
- The first issue is that it militates against the majority rule principle that is intrinsic in a corporate democracy.
- While understandable, that is hardly an immutable rule as corporate law does make exceptions in cases involving oppression of minority shareholders.
- The second concern is that placing too much power in the hands of minority shareholders would be counterproductive, as it could result in a tyranny of the minority.
- However, the dual approval system instead represents the best of both worlds. It does not negate the promoter’s involvement in the process of appointing or removing independent directors.
- Only consensus candidates would end up becoming independent directors.
- The third issue is one of shareholder apathy: Will minority shareholders be motivated to exercise an informed and meaningful choice?
- Minority shareholders tend to be passive when they are unable to influence the outcome of shareholding voting.
- However, where they do have a significant say, like in the “majority of the minority” process, they are likely to be more active in exercising their franchise.
Consider the question “How far has the provision of appointing independent directors to safeguard the interest of minority shareholders succeeded in its objectives? Suggest the changes to improve the challenges faced by the independent directors.”
Conclusion
In all, the appointment and removal system continues to undermine the independence and efficacy of corporate boards. The SEBI needs to implement the dual approval system at the earliest.
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Capital Markets: Challenges and Developments
Investors should not be tempted to ignore macroeconomic factors
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Not much
Mains level: Paper 3- Stock market and risks involved for individual investors
Despite gloom in the economy, financial markets are scaling new highs. The situations calls for diligence on the part of individual investors. The deals with this issue.
What influences investors’ decision
- Investors may not necessarily be always sensible or even capable of perceiving the larger picture.
- Nobel laureate Daniel Kahneman argues that humans usually use the ‘first system’ of ‘fast thinking’ to hurriedly act and perceive their environment.
- Consequently, they are susceptible to the ‘priming effect’, ‘framing bias’, ‘anchoring effect’, ‘overconfidence bias’ and ‘availability heuristic’.
- These phenomena, thus, play their part in pervading optimistic market conditions.
- As a result, investors often end up ignoring or overlooking uncertainties and risks involved in their decision.
- At the same time, investors’ decision choices could be significantly influenced by ‘nudging’.
- It is a deliberate tactics and method of behaviour modification by which it is the ‘choice architect’ that decides who does what and who does so, as argued by the Nobel laureate, Richard H. Thaler.
- The present surge in the Indian stock market is indeed nudging individual investors to trade more.
What makes individual investors vulnerable
- National Stock Exchange data indicate following trends:
- The share of the non-institutional individual investors in equity trading volume has risen to one half of the total turnover. in 2021.
- It was around a third in 2016.
- In contrast, the share of Foreign Institutional Investors (FIIs) in the total trading volume has shrunk to just about a tenth, it used to be one fifth in 2016.
- Trading in the stock market, the sudden rise, the intraday moves, etc., are, thus, attributable largely to individual traders now.
- However, despite their large trading volumes, individual investors have actually contracted their holding of the market capitalisation.
- The FIIs currently own around half of the free float of all Indian companies.
- Apparently, the retail investors have constantly sold their stake to end up holding less than 20% shares now.
- Trading, thus, seems to be the mainstay of retail investors and this is what makes them more vulnerable to the vagaries of the market.
Market is ignoring macroeconomic factors
- Centre for Monitoring Indian Economy Pvt. Ltd. data of the listed companies reveal a rise in their profit, due to rationalisation and cost-cutting.
- Investors might be tempted to ignore macroeconomic factors and invest in such stock believing that it is the profit that impels the stock prices.
- In reality, however, share price is expected to ascend if a company declares to cut its wage bill.
- This probably explains why stock markets around the world have been on the rise amidst the novel coronavirus pandemic; demand may have declined but profits have been least impacted.
- At the larger economic level, however, real wages have plunged.
- Clearly, the market has not entirely decoupled itself from the economic indicators.
- Established wisdom suggests that corporates cannot sustain contraction in the economy for long.
- Sustained decline in demand caused by waning disposable household income would catch them soon.
- Robert J. Shiller attributes this phenomenon of creating a possible bubble to irrational exuberance.
- When bubbles burst, they cause a kind of financial earthquake, in turn destabilising public trust in the integrity of the financial system.
- Critically, as the past portrays, individual investors, with all their vulnerabilities, suffer the most devastating consequences.
- Retail investors are as well susceptible to overreaction when negative news hits the market.
Consider the question “What are the factors driving the financial markets up despite the weak macroeconomic foundations? What are the risks involved in such situation for the individual investors?”
Conlcusion
History of financial markets is replete with bubbles and bursts. Most affected in such burst are the individual investors. Informed decisions based on information and risks involved should form the basis of investment by individual investors.
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Capital Markets: Challenges and Developments
SEBI proposes framework for Gold Exchange
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Gold Exchange
Mains level: Gold Exchange and its trading
The Securities & Exchange Board of India (SEBI) has floated a consultation paper on the proposed framework for Gold Exchange in India.
Why such a move?
- According to SEBI, the proposed exchange would bring in more transparency in the gold trading market in terms of spot price discovery, quality of the gold and enable greater integration with the financial markets.
What is a Gold Exchange?
- As the name suggests, this would offer trading facilities in the precious metal.
- Entities like retail investors, banks, foreign portfolio investors (FPIs), jewellers and bullion dealers among others would be allowed to trade on the exchange.
- While there are existing commodity exchanges that offer trading in gold contracts, those are derivative instruments while the proposed gold exchange would allow trading akin to the spot market.
- This move assumes significance as India is the second-largest consumer of gold – after China – with an annual demand of around 800-900 tonnes.
Answer this PYQ:
Q.What is/are the purpose/purposes of the Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’?
- To bring the idle gold lying with India households into the economy
- To promote FDI in the gold and jewellery sector
- To reduce India’s dependence on gold imports
Select the correct answer using the code given below
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
What are the ways in which one can invest in gold now?
- For those wanting to buy physical gold, a visit to the neighbourhood jeweller would suffice.
- Meanwhile, there are online platforms such as Paytm, Kuvera and Indiagold among others that allow an individual to buy gold in digital form.
- The advantage of buying gold in digital form is that one can put in a very small amount as well with some platforms allowing a minimum investment of just Rs 100.
- Digital gold products have become quite popular among millennials. Then there are sovereign gold bonds issued by the government.
- One can even look at Gold ETFs or gold funds by mutual funds.
- Even gold derivative contracts traded on the exchanges have the option of physical settlement, which means investors can get physical delivery of gold.
How can one trade on a gold exchange?
- The SEBI has proposed an instrument called ‘Electronic Gold Receipt’, or EGR.
- The gold exchange, along with intermediaries like the vault manager and the clearing corporation, would facilitate the creation of EGR and its trading.
- So, participants can convert their physical gold into EGR, which can then be bought or sold on the exchange like any normal equity share of a listed company.
- The EGR can even be converted back into physical gold. As part of the draft regulations, SEBI has proposed three denominations of EGR – one kilogram, 100 grams and 50 grams.
- It has, however, added that EGRs of five grams or 10 grams can also be allowed for trading to increase the liquidity of the market and attract more participants.
How can one convert physical gold into EGRs?
- An entity that intends to convert physical gold into EGR will have to go to a ‘Vault Manager’.
- According to the proposed framework, any entity registered in India and with a net worth of at least Rs 50 crore can apply to become a vault manager.
- After the receipt of the gold, the vault manager would create an EGR for which the depository will assign an International Securities Identification Number, or ISIN, which is a unique code to identify the specific security.
- Once the ISIN is issued, the EGR can be traded on the gold exchange just like any other tradable security.
Can EGRs be again converted into physical gold?
- To convert an EGR into physical gold, the owner of the EGR will have to surrender the EGR to the vault manager who will deliver the gold and extinguish the electronic receipt.
- Considering the logistics and delivery challenges, it has been proposed that conversion of an EGR into physical gold should be allowed only if a minimum of 50 grams of gold has been accumulated in electronic form.
Issues with gold exchange
- Since the EGRs would be traded on an exchange, Securities Transaction Tax (STT) would be levied. Also, GST would be applicable when EGRs are converted into physical gold for withdrawal.
- If in case the buyer and seller are from different states then levying state GST could be cumbersome. SEBI is mulling if only IGST or Integrated Goods and Services Tax can be levied to resolve this issue.
- As far as transactions are concerned, SEBI working groups have suggested that an entire transaction be divided into three tranches.
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Capital Markets: Challenges and Developments
SEBI tightens rules for provisional debt rating
Note4Students
From UPSC perspective, the following things are important :
Prelims level: SEBI
Mains level: Paper 3- Regulation of credit rating agencies
New framework for debt instrument
- The new framework requires that a rating will be considered provisional in cases where certain compliances that are crucial to the assignment of credit rating are yet to be complied with at the time of rating.
- Under the new framework, all provisional ratings (‘long term’ or ‘short term’) for debt instruments need to be prefixed as ‘provisional’ before the rating symbol.
- In no case shall a rating, including provisional rating, be assigned by a credit rating agency for an issuer or client evaluating strategic decisions such as funding mix for a project, acquisition, debt restructuring, scenario-analysis in loan refinancing,” SEBI said.
- On validity period, SEBI said provisional rating will be converted into a final rating within 90 days from the date of issuance of the instrument.
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Capital Markets: Challenges and Developments
Understanding the issues with bond market in India
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Not much
Mains level: Paper 3- Issues with bond market in India and its effect on cost of borrowing of the government
What explains the Indian government borrowing at a higher interest rate than the interest rates for a home loan? The answer lies in the structural shortage in demand for government bonds.
How the government’s cost of borrowing matter
- Interest on government debt is a transfer from taxpayers to savers who own government bonds.
- As the government bondholders are primarily domestic, interest paid by the government is just a transfer from one hand to the other within the economy.
- However, the government’s cost of borrowing does matter.
- The large increase in interest costs limits the government’s ability to spend elsewhere.
- But more importantly, this rate also affects the cost of borrowing for large parts of the economy.
Understanding the term premium and credit spread
- The RBI sets the repo rate, which is the short-term risk-free rate.
- That is, the loan must be repaid in a few days and there is almost no risk of default.
- The rate at which the government borrows is the long-term risk-free rate.
- But the lender wants higher returns given the longer duration of the loan.
- The difference between the repo rate and government’s borrowing cost, say on a 10-year loan, is called the term premium.
- When a private firm takes a 10-year loan, it would have some credit risk too, which means a credit spread is added to the 10-year risk-free rate.
Challenge posed by term premium
- From an average rate of 73 basis points since 2011 (one basis point is one-hundredth of a per cent), and 120 basis points in 2018 and 2019, the 10-year term premium is currently 215 basis points.
- In other words, the interest rate for a 10-year period borrowing is 2.15 per cent higher than the current repo rate.
How this is related to dysfunction in bond market in India
- Financial markets are forward-looking, and as the collective expression of the views of thousands of participants, efficient ones can occasionally “predict” what comes next.
- But the Indian bond market is not one such: The view some hold, that the rise in term premium reflects future rate hikes by the monetary policy committee (MPC), is mistaken.
- The Indian bond market is still too illiquid and not diverse enough to predict future trends.
- Even though some pandemic-driven measures are being withdrawn, the MPC continues to be accommodative, and for several months at least, headline inflation is unlikely to force an abrupt change.
- In any case, the spurt in yields after the budget points to the causality being fiscal instead of inflation-related.
- But even the fiscal rationale seems weak.
- The Centre’s tax collection for FY2020-21 has been substantially ahead of target, and state governments have also borrowed Rs 60,000 crore less than expected.
- Also, the14 states, accounting for three-fourths of all state deficits, have budgeted FY2021-22 deficits at 3.3 per cent, far lower than the 4 per cent average expected earlier.
- Just these factors suggest that total bonds issued by the central and state governments should be lower than what the market had feared before the union budget was presented.
- And yet, government borrowing costs have not returned to pre-budget levels.
- This reflects dysfunction in the market.
- Why else would a government be borrowing at a higher cost than a mortgage on a house?
What is the reason for dysfunction in bond market
- Dysfunction can be traced to residential mortgages being among the most competitive of loan categories.
- On the other hand, there is a structural shortage in demand for government bonds.
- In such a market where there is a structural shortage in demand the marginal buyer holds all the cards, and as any buyer would, demands higher returns.
- Over 15 years, the share of banks in the ownership of outstanding central government bonds has fallen from 53 per cent to 40 per cent now.
- But no alternative buyer of size has emerged to fill the space vacated.
- The RBI sometimes buys bonds to inject money into the economy, but of late this space has been used to buy dollars to save the rupee from appreciation.
Solutions
- The solution to the problem of bond market may lie in getting new types of buyers.
- The RBI opening up direct purchases by retail investors is a step in this direction, though it may not become meaningful for a few years.
- That leaves us with tapping foreign savings.
- The limit on share of government bonds that foreign portfolio investors (FPIs) can buy has been raised steadily.
- But without Indian bonds being included in global bond indices, these flows may not be meaningful, and would be volatile, as they have been over the past year.
- To enable inclusion in bond indices, the RBI and the government have earmarked special-category bonds which are fully accessible (FAR) by foreign investors.
- The FTSE putting India on a watch-list for “potential future inclusion” in the Emerging Markets Government Bonds Index is a step forward, and, one hopes, triggers similar actions by other index providers.
Consider the question “How the lack of retailness in the bond market affects the cost of borrowing of the government as well as the private borrowers? Suggest the measures to deal with the issues.”
Conclusion
The issues with bond markets in India highlights the urgency to find new buyers for government bond as it has implications not just for the government’s own fiscal space, but also for the cost of borrowing in the economy.
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Capital Markets: Challenges and Developments
What are AT1 Bonds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: AT1 Bonds
Mains level: Not Much
The decision of the Securities and Exchange Board of India (SEBI) to slap restrictions on mutual fund (MF) investments in additional tier-1 (AT1) bonds has raised a storm in the MF and banking sectors.
What are AT1 Bonds?
- AT1 Bonds stand for additional tier-1 bonds. These are unsecured bonds that have perpetual tenure. In other words, the bonds have no maturity date.
- They have a call option, which can be used by the banks to buy these bonds back from investors.
- These bonds are typically used by banks to bolster their core or tier-1 capital.
- AT1 bonds are subordinate to all other debt and only senior to common equity.
- Mutual funds (MFs) are among the largest investors in perpetual debt instruments and hold over Rs 35,000 crore of the outstanding additional tier-I bond issuances of Rs 90,000 crore.
What action has been taken by the Sebi recently and why?
- In a recent circular, the Sebi told mutual funds to value these perpetual bonds as a 100-year instrument.
- This essentially means MFs have to make the assumption that these bonds would be redeemed in 100 years.
- The regulator also asked MFs to limit the ownership of the bonds to 10 per cent of the assets of a scheme.
- According to the Sebi, these instruments could be riskier than other debt instruments.
Try this PYQ:
Consider the following statements:
- The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
- Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
- Treasury bills offer are issued at a discount from the par value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 Only
(c) 2 and 3 only
(d) 1, 2 and 3
How MFs will be affected?
- Typically, MFs have treated the date of the call option on AT1 bonds as the maturity date.
- Now, if these bonds are treated as 100-year bonds, it raises the risk in these bonds as they become ultra long-term.
- This could also lead to volatility in the prices of these bonds as the risk increases the yields on these bonds rises.
- Bond yields and bond prices move in opposite directions and therefore, the higher yield will drive down the price of the bond, which in turn will lead to a decrease in the net asset value of MF schemes holding these bonds.
- Moreover, these bonds are not liquid and it will be difficult for MFs to sell these to meet redemption pressure.
What’s the impact on banks?
- AT1 bonds have emerged as the capital instrument of choice for state banks as they strive to shore up capital ratios.
- If there are restrictions on investments by mutual funds in such bonds, banks will find it tough to raise capital at a time when they need funds in the wake of the soaring bad assets.
- A major chunk of AT1 bonds is bought by mutual funds.
Why has the Finance Ministry asked Sebi to review the decision?
- The FM has sought withdrawal of valuation norms for AT1 bonds as it might lead to mutual funds making losses and exiting from these bonds, affecting capital raising plans of PSU banks.
- The government doesn’t want a disruption in the fund mobilization exercise of banks at a time when two PSU banks are on the privatization block.
- Banks are yet to receive the proposed capital injection in FY21 although they will need more capital to face the asset-quality challenges in the foreseeable future.
- Fitch’s own estimate pegs the sector’s capital requirement between $15 billion-58 billion under various stress scenarios for the next two years, of which state banks account for the bulk.
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Capital Markets: Challenges and Developments
What are Government Securities (G-Secs)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Government Securities (G-Secs), T-Bills etc
Mains level: Government Securities (G-Secs)
The RBI has said that it would allow retail investors and other small investors direct access to its government securities trading platform.
What are G-Secs?
- These are debt instruments issued by the government to borrow money.
- The two key categories are:
- Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
- Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years
Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.
Why G-Secs?
- Like bank fixed deposits, g-secs are not tax-free.
- They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
- However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
- Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).
Who can invest in Corporate Bonds and Government Securities?
- Pension Funds: Pension funds can also invest in both corporate bonds and government securities to ensure long-term stability and growth in their investment portfolio. .
- Retail Investors: Retail investors, including individual investors, can invest in both corporate bonds and government securities.
- Insurance Companies: Insurance companies can invest in both corporate bonds and government securities as part of their investment portfolio. The search results indicate that insurance companies often invest in a mix of low-risk and high-yield assets, with government securities providing lower risk and corporate bonds offering higher returns.
Retail investors and G-Secs
- Small investors can invest indirectly in g-secs by buying mutual funds or through certain policies issued by life insurance firms.
- To encourage direct investment, the government and RBI have taken several steps in recent years.
- Retail investors are allowed to place non-competitive bids in auctions of government bonds through their Demat accounts.
- Stock exchanges act as aggregators and facilitators of retail bids.
Try this PYQ:
Consider the following statements:
- The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
- Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
- Treasury bills offer are issued at a discount from the par value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 Only
(c) 2 and 3 only
(d) 1, 2 and 3
Why the current proposal?
- The g-sec market is dominated by institutional investors such as banks, mutual funds, and insurance companies. These entities trade in lot sizes of Rs 5 crore or more.
- So, there is no liquidity in the secondary market for small investors who would want to trade in smaller lot sizes.
- In other words, there is no easy way for them to exit their investments.
- Thus, currently, direct g-secs trading is not popular among retail investors.
What will the current proposal do?
- The details are not out yet. However, the RBI’s intention is to make the whole process of g-sec trading smoother for small investors.
- By allowing people to open accounts in RBI’s e-kuber system, it is hoping to create a market of small investors who will invest in these instruments.
Why such a move?
- The RBI is the debt manager for the government.
- In the forthcoming financial year, the government plans to borrow Rs 12 lakh crore from the market.
- When the government demands so much money, the price of money (i.e., the interest rate) will move up.
- It is in the government’s and RBI’s interest to bring this down.
- That can only happen by broadening the base of investors and making it easier for them to buy g-secs.
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Capital Markets: Challenges and Developments
Mutual Funds Risk-o-Meter
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Mutual Funds
Mains level: Mutual Funds and associated market risks
The capital markets regulator Securities and Exchange Board of India (SEBI) has made it mandatory for mutual funds to assign a risk level to schemes, based on certain parameters.
Try this PYQ:
Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
What are Mutual Funds?
- A Mutual Fund is a trust that collects money from a number of investors who share a common investment objective.
- Then, it invests the money in equities, bonds, money market instruments and/or other securities.
- Each investor owns units, which represent a portion of the holdings of the fund.
- The income/gains generated from this collective investment are distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV.
- It is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
- All funds carry some level of risk. With mutual funds, one may lose some or all of the money invested because the securities held by a fund can go down in value.
What is the risk-o-meter?
- All mutual funds shall beginning January 1, assign a risk level to their schemes at the time of launch, based on the scheme’s characteristics.
- SEBI’s decision on the “risk-o-meter”, characterizes the risk level of the schemes on a six-stage scale from “Low” to “Very High”.
- The risk-o-meter must be evaluated on a monthly basis.
A compulsory mandate
- Fund houses are required to disclose the risk-o-meter risk level along with the portfolio disclosure for all their schemes on their own websites as well as the website of the Association of Mutual Funds in India (AMFI) within 10 days of the close of each month.
- Any change in the risk-o-meter reading with regard to a scheme shall be communicated to the unit-holders of that scheme.
How will the level of risk be assigned?
- Which one of the six risk levels — low, low to moderate, moderate, moderately high, high, and very high — would apply, would depend upon the risk value (less than 1 for low risk to more than 5 for very high risk) calculated for the scheme.
- So if the risk value of a scheme is less than 1, its risk level would be low, and if it is more than 5, the risk will be very high on the risk-o-meter.
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Capital Markets: Challenges and Developments
What are Municipal Bonds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Municipal Bonds
Mains level: Fund raising mechanisms for local bodies
Bonds issued by the Lucknow Municipal Corporation (LMC) got listed on the Bombay Stock Exchange. It’s the ninth city in the country to raise capital through municipal bonds.
Find out the rest eight cities issuing Municipal Bonds in India. Do let us know in the comment box.
What are Municipal Bonds?
- A municipal bond or muni bond is a debt instrument issued by municipal corporations or associated bodies.
- These local governmental bodies utilise the funds raised through these bonds to finance projects for socio-economic development through building bridges, schools, hospitals, providing proper amenities to households, et al.
- Such bonds come with a maturity period of three years, whereby municipal corporations provide returns on these bonds either from property and professional tax collected or from revenues generated from specific projects or both.
- The Securities and Exchange Board of India (SEBI) revised the guidelines related to the issuance of municipal bonds in 2015 in an attempt to enable ULBs or local government bodies to raise finances from such sources.
- Following this measure, different cities have capitalized on the new guidelines to fund initiatives such as Atal Mission for Rejuvenation and Urbanisation Transformation (AMRUT) and Smart Cities Mission.
Their types
There are primarily two types of municipal bonds in India, categorised as per their usage. These are –
(1) General Obligation Bonds
- These are issued to raise finances for general projects such as improving the infrastructure of a region.
- Repayment of the bond, along with interest, is processed through revenue generated from different projects and taxes.
(2) Revenue Bonds
- These are issued to raise finance for specific projects, such as the construction of a particular building.
- Repayment of such bonds (principal and accrued interest) shall be paid through revenues explicitly generated from the declared projects.
Advantages of such Bonds
There are multiple advantages of investing in municipal bonds which include –
(1)Transparency
Municipal bonds that are issued to the public are rated by renowned agencies such as CRISIL, which allows investors transparency regarding the credibility of the investment option.
(2)Tax benefits
In India, municipal bonds are exempted from taxation if the investor conforms to certain stipulated rules. In addition to such conformation, interest rates generated on such investment tools are also exempt from taxation policy.
(3) Minimal risk
Municipal bonds are issued by municipal authorities, implying involvement of minimal risk with these securities.
Their limitations
The disadvantages of municipal bonds are enumerated below –
(1) Long maturity period
- Municipal bonds come with a lock-in period of three years, imposing a burden on the liquidity requirements of investors.
(2) Low-interest rates
- Even though interest rates on municipal bonds, in some cases, are higher than other debt instruments, these rates are considerably low when compared to returns from market-linked financial instruments such as equity shares.
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Capital Markets: Challenges and Developments
What are Negative-Yield Bonds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Negative-Yield Bonds
Mains level: Not Much
China recently sold negative-yield debt for the first time, and this saw high demand from investors across Europe.
Try this PYQ:
Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
What are Negative-Yield Bonds?
- These are debt instruments that offer to pay the investor a maturity amount lower than the purchase price of the bond.
- These are generally issued by central banks or governments, and investors pay interest to the borrower to keep their money with them.
Why do investors buy them?
- Negative-yield bonds attract investments during times of stress and uncertainty as investors look to protect their capital from significant erosion.
- At a time when the world is battling the Covid-19 pandemic and interest rates in developed markets across Europe are much lower.
- Hence, investors are looking for relatively better-yielding debt instruments to safeguard their interests.
Why is there a huge demand?
- While Europe, the US and other parts of the world are facing a second wave of Covid-19 cases, China has demonstrated that it has controlled the spread of the pandemic and is therefore seen as a more stable region.
- Many feel that European investors are also looking to increase their exposure in China, and hence there is a huge demand for these bonds.
- The fact that the 10-year and 15-year bonds are offering positive returns is a big attraction at a time when interest rates in Europe have dropped significantly.
- As against minus —0.15% yield on the 5-year bond issued by China, the yields offered in safe European bonds are much lower, between –0.5% and —0.75%.
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Capital Markets: Challenges and Developments
What are Hybrid Funds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Hybrid funds
Mains level: Not Much
This newscard is an excerpt from an originally FAQ published in TH.
Try this PYQ:
Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Hybrid Fund
- A hybrid fund is one that invests in both equity and bonds. So, such funds ought to help investors with their asset allocation decision.
- This refers to how you allocate your annual savings between equity and bond investments.
- Suppose you are unsure of the proportion of equity and bond investments to have in your portfolio.
- By investing in a hybrid fund, you could outsource your asset allocation decision to the manager of the fund, so the argument goes.
- The issue is that each goal you pursue requires different asset allocation. For instance, the asset allocation for your child’s education portfolio must be different from your retirement portfolio.
- Hybrid funds cannot consider your individual goal requirement as it is a collective investment vehicle.
Tax efficiency of the fund
- Based on current tax laws, a hybrid fund that holds 65% or more in equity is considered as an equity fund.
- So, if you redeem your units in such hybrid funds after a holding period of more than 12 months, you have to pay long-term capital gains tax of 10%.
- If a hybrid fund holds less than 65% in equity, you have to pay 20% capital gains tax with indexation if you sell your units after a holding period of more than 36 months.
Back2Basics: Stocks vs. Bonds vs. Equity
- A stock represents a collection of shares in a company which is entitled to receive a fixed amount of dividend at the end of the relevant financial year which are mostly called Equity of the company.
- Bonds term is associated with debt raised by the company from outsiders which carry a fixed ratio of return each year and can be earned as they are generally for a fixed period of time.
- Bonds are actually loans that are secured by a specific physical asset.
- It highlights the amount of debt taken with a promise to pay the principal amount in the future and periodically offering them the yields at a pre-decided percentage.
- Equity is ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of an asset.
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Capital Markets: Challenges and Developments
What are the ESG funds?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: ESG funds
Mains level: Not Much
ESG funds are witnessing a growing interest in the Indian mutual fund industry these days.
Try this PYQ:
Sustainable development is described as the development that meets the needs of the present without compromising the ability of future generations to meet their own needs. In this perspective, inherently the concept of sustainable development is intertwined with which of the following concepts?
(a) Social justice and empowerment
(b) Inclusive Growth
(c) Globalization
(d) Carrying capacity
What are the ESG funds?
- ESG means using Environmental, Social and Governance factors to evaluate companies and countries on how far advanced they are with sustainability.
- ESG investing is used synonymously with sustainable investing or socially responsible investing.
- While selecting a stock for investment, the ESG fund shortlists companies that score high on the environment, social responsibility and corporate governance, and then looks into financial factors.
- So, the scheme focuses on companies with environment-friendly practices, ethical business practices and an employee-friendly record.
- They imbibe the environment, social responsibility and corporate governance in their investing process.
Why so much focus on ESG now?
- Modern investors are re-evaluating traditional approaches and look at the impact their investment has on the planet.
- As a result of this paradigm change, asset managers have started incorporating ESG factors into investment practices.
- Companies with good ESG scores tick most of the checkboxes for investing, tend to mitigate environmental and social risks and tends to have stronger cash flows, lower borrowing costs and durable returns.
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Capital Markets: Challenges and Developments
What is Infrastructure Investment Trusts (InvITs)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: REITs, INVITs
Mains level: Not Much
The National Highways Authority of India (NHAI) has come up with its Infrastructure Investment Trust (InvIT) issue.
Try this PYQ:
Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Significance of the issue
- The issue will enable NHAI to monetize its completed National Highways that have a toll collection track record of at least one year.
- The NHAI reserves the right to levy a toll on identified highways and it will help the company raise funds for more road development across the country.
What are InvITs?
- Infrastructure investment trusts are institutions similar to mutual funds, which pool investment from various categories of investors and invest them into completed and revenue-generating infrastructure projects, thereby creating returns for the investor.
- Structured like mutual funds, they have a trustee, sponsor(s), investment manager and project manager.
- While the trustee (certified by Sebi) has the responsibility of inspecting the performance of an InvIT, sponsor(s) are promoters of the company that set up the InvIT.
- In the case of Public-private partnership (PPP) projects, it refers to the infrastructure developer or a special purpose vehicle holding the concession.
- While the investment manager is entrusted with the task of supervising the assets and investments of the InvIT, the project manager is responsible for the execution of the project.
How will it work for NHAI?
- NHAI’s InvIT will be a Trust established by NHAI under the Indian Trust Act, 1882 and SEBI regulations.
- The InvIT Trust will be formed the objective of investing primarily in infrastructure projects.
- The fund raised can be invested in the project SPVs by way of an issue of debt.
- The trust can utilise it to repay their loans or even for prepayment of certain unsecured loans and advances.
Why does NHAI need fund?
- At a time when private sector investment in the economy has declined, fund-raising by NHAI and spending on infrastructure will not only provide a fillip to the economy but will also crowd-in private sector investment.
- So NHAI’s InvIT offer is a way for the government to tap alternative sources of financing to boost public spending in the roads and infrastructure sector.
- It is important to note that in October 2017, the Centre had launched Bharatmala Pariyojana, its flagship highway development programme, for development of 24,800 km of roads.
- In order to complete the projects, NHAI needs adequate funds and one of the options is to monetize the completed and operational NH assets.
How does it benefit the investor?
- Retail or even large financial investors may not be typically able to invest in infrastructure projects such as roads, power, energy etc.
- InvITs enable these investors to buy a small portion of the units being sold by the fund depending upon their risk appetite.
- Given that such trusts comprise largely of completed and operational projects with positive cash flow, the risks are somewhat contained.
- The investors can benefit from the cash flow that gets distributed as well as in capital appreciation of the units.
- Unitholders also benefit from favourable tax norms, including exemption on dividend income and no capital gains tax if units are held for more than three years.
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Capital Markets: Challenges and Developments
What are Interest Rate Derivatives (IRDs)?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Foreign portfolio investment (FPI)
Mains level: Not Much
The RBI has proposed allowing foreign portfolio investors (FPIs) to undertake exchange-traded rupee interest rate derivatives transactions subject to an overall ceiling of ₹5,000 crores.
Every year, there is a question on a capital market instruments. Make note of all such separately. Also, try this PYQ:
Q. Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (CSP 2019)
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Interest Rate Derivatives (IRDs)
- An IDR is a financial instrument with a value that is linked to the movements of an interest rate or rates.
- These may include futures, options, or swaps contracts.
- They are often used by institutional investors, banks, companies, and individuals to protect themselves against changes in market interest rates.
- The proposed directions by RBI are aimed at encouraging higher non-resident participation, enhance the role of domestic market makers in the offshore market, improve transparency, and achieve better regulatory oversight, according to the central bank.
Back2Basics: Foreign portfolio investment (FPI)
- FPI involves holding financial assets from a country outside of the investor’s own.
- FPI holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and exchange-traded funds.
- Along with foreign direct investment (FDI), FPI is one of the common ways for investors to participate in an overseas economy, especially retail investors.
- Unlike FDI, FPI consists of passive ownership; investors have no control over ventures or direct ownership of property or a stake in a company.
FPI vs FDI
- With FPI—as with portfolio investment in general—an investor does not actively manage the investments or the companies that issue the investments.
- They do not have direct control over the assets or the businesses.
- In contrast, foreign direct investment (FDI) lets an investor purchase a direct business interest in a foreign country.
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Capital Markets: Challenges and Developments
What is the Business Responsibility Report?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: BRR
Mains level: Not Much
In efforts to have a single source for all non-financial disclosures by corporates, a government-appointed panel has made various proposals on business responsibility reporting, including putting in place two formats for disclosing information.
Try this PYQ:
Which one of the following is not a feature of Limited Liability Partnership firm? (CSP 2010)
(a) Partners should be less than 20
(b) Partnership and management need not be separate
(c) Internal governance may be decided by mutual agreement among partners
(d) It is corporate body with perpetual succession
What is the Business Responsibility Report (BRR)?
- Business Responsibility Report is a disclosure of the adoption of responsible business practices by a listed company to all its stakeholders.
- This is important considering the fact that these companies have accessed funds from the public, have an element of public interest involved, and are obligated to make exhaustive disclosures on a regular basis.
- BSR is to be submitted as a part of the Annual Report.
- It contains a standardized format for companies to report the actions undertaken by them towards the adoption of responsible business practices.
- It has been designed to provide basic information about the company, information related to its performance and processes, and information on principles and core elements of the BSR.
SEBI recommendations for BSR
- As per the report, reporting may be done by top 1,000 listed companies in terms of their market capitalization or as prescribed by markets regulator SEBI.
- The reporting requirement may be extended by MCA (Ministry of Corporate Affairs) to unlisted companies above specified thresholds of turnover and/ or paid-up capital.
- The panel has suggested two formats for disclosures — a comprehensive format and a “lite version” — and also called for the implementation of the reporting requirements in a gradual and phased manner.
- Smaller unlisted companies may adopt a lite version of the format, on a voluntary basis.
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Capital Markets: Challenges and Developments
What are Social Stock Exchanges?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Social Stock Exchanges (SSEs)
Mains level: NGOs and their funding issues
A working group constituted by the Securities and Exchange Board of India (SEBI) on Social Stock Exchanges (SSEs) has recommended allowing non-profit organisations to directly list on such platforms.
Practice questions for mains:
Q. What are Social Stock Exchanges? Discuss how it will help finance social enterprises in India.
What are Social Stock Exchanges (SSEs)?
- An SSE is a platform which allows investors to buy shares in social enterprises vetted by an official exchange.
- The Union Budget 2019 proposed setting up of first of its kind SSE in India.
- The SSE will function as a common platform where social enterprises can raise funds from the public.
- It will function on the lines of major stock exchanges like BSE and NSE. However, the purpose of the Social Stock Exchange will be different – not profit, but social welfare.
- Under the regulatory ambit of SEBI, a listing of social enterprises and voluntary organizations will be undertaken so that they can raise capital as equity, debt or as units like a mutual fund.
Why SSEs?
- India needs massive investments in the coming years to be able to meet the human development goals identified by global bodies like the UN.
- This can’t be done through government expenditure alone. Private enterprises working in the social sector also need to step up their activities.
- Currently, social enterprises are very active in India. However, they face challenges in raising funds.
- One of the biggest hurdles they face is, apparently, the lack of trust from common investors.
Benefits
- There is a great opportunity to unlock funds from donors, philanthropic foundations and CSR spenders, in the form of zero-coupon zero principal bonds. These bonds will be listed on the SSE.
- At first, the SSE could become a repository of social enterprises and impact investors.
- The registration could be done through a standard process.
- The SEs could be categorized into different stages such as- Idea, growth stage and likewise, investors can also be grouped based on the type of investment.
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Capital Markets: Challenges and Developments
Minimum Public Shareholding (MPS) Requirement
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Minimum Public Shareholding (MPS)
Mains level: Not Much
The Securities and Exchange Board of India (SEBI) has relaxed the 25 per cent minimum public shareholding norm and advised exchanges not to take penal action till August 2020 in case of non-compliance.
A statement based question can be asked about the SEBI in the prelim asking-
If it is a statutory or quasi-judicial body ; Scope of its regulation; Appointment of its chairman etc..
What is a Public Shareholding Company?
- A Public Shareholding Company is a company whose capital is divided into shares of equal value, which are transferable.
- Shareholders of a Public Shareholding Company are not liable for the company’s obligations except for the amount of the nominal value of the shares for which they subscribe.
What is MPS requirement?
- The 25 per cent MPS norms were introduced in 2013, whereby no listed company was permitted to have more than 75 per cent promoter stake.
- The rules were aimed at improving liquidity and better stock price discovery by making higher float available with public.
- The average promoter holding in India is among the highest globally.
- Last year, the government had proposed to increase the minimum public float from the current 25 per cent to 35 per cent. It had met with opposition, forcing the government to drop the plan.
Why ease MPS norms?
- The Sebi move is aimed at easing such compliance rules amid the disruptions caused by the coronavirus pandemic.
- The decision has been taken after receiving requests from listed entities and industry bodies as well as considering the prevailing business and market conditions.
- As per the norms, exchanges can impose a fine of up to Rs 10,000 on companies for each day of non-compliance with MPS requirements.
- Besides, exchanges can intimate depositories to freeze the entire shareholding of the promoter and promoter group. This circular will come into force with immediate effect.
Back2Basics: Securities and Exchange Board of India (SEBI)
- The SEBI is the regulator of the securities and commodity market in India.
- It was first established in 1988 as a non-statutory body for regulating the securities market.
- It became an autonomous body on 12 April 1992 and was accorded statutory powers with the passing of the SEBI Act 1992.
- SEBI has to be responsive to the needs of three groups, which constitute the market:
1) issuers of securities
2) investors
3) market intermediaries
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Capital Markets: Challenges and Developments
Sovereign Gold Bonds: A substitute for physical gold
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Sovereign Gold Bonds
Mains level: Not Much
Gold bond prices rise to near record highs after the second tranche of subscription were closed.
Questions based on capital markets are quite frequent these years. Consider this-
Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (CSP 2019)
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
What is a Sovereign Gold Bond (SGB)?
- SGB is a substitute for holding physical gold.
- The bonds are issued by the RBI on behalf of the government and are a bond denominated in gold.
- The government issues such bonds in tranches at a fixed price that investors can buy through banks, post offices and also in the secondary markets through the stock exchange platform.
What are the benefits of buying SGB?
- These bonds are backed by a sovereign guarantee and can also be held in Demat form.
- Further, they are priced as per the underlying spot gold prices.
- Hence, investors who want to invest in gold can buy the bonds without worrying about the safekeeping of physical gold along with locker charges, making charges or purity issues.
- Plus, these bonds offer interest at the rate of 2.5% per annum on the principal investment amount.
- While the interests on the bonds are taxable, the capital gains at the time of redemption are exempt from tax.
- These bonds can also be used as collateral for availing loans from banks and NBFCs.
How are the bonds structured?
- SGB has a fixed tenure of eight years, though early redemption is allowed after the fifth year from issuance.
- Since the bonds are listed on the exchange, these can be transferred to other investors as well.
- The bonds are priced in rupees based on the simple average of the closing price of gold of 999 purity which published by the India Bullion and Jewellers Association.
- At the time of redemption, cash equivalent to the number of units multiplied by the then prevailing price would be credited to the bank account of the investor.
Are there any risks in investing in SGB?
- A capital loss is a risk since the bond prices would reflect any change in gold prices.
- If gold prices fall, the principal investment would fall proportionately.
Why need such bonds?
- The gold demand rises in times of uncertainty or high inflation.
- Gold demand is mostly met through imports
- Years of high imports are ones of high current account deficits which, in turn, have weakened the rupee.
- It is to reduce this huge import bill that, in November 2015, the government tried to introduce gold bonds.
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Capital Markets: Challenges and Developments
Indian Debt market, that never was
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Asset-to-liability mismatch, Types of debt markets, Priority sector lending certificates, roll-over etc.
Mains level: Paper 3- What is the importance of debt market for the economy of a country? What are the factor responsible for the shallowness of the India's debt market?
India’s bond market suffers from several issues. This article discusses such issues, and also highlights the recent positive trends seen in the debt market owing to several steps taken by the government.
The Indian debt market, primarily of the fixed-income variety, can be broadly classified into:
- 1. Money Market
- Where the borrowing is for a tenor of less than a year.
- Different types of money market instruments: Inter-Bank Term Money, repo transactions, Certificate of Deposits, Commercial Papers, T-Bills, etc. are some of the money market instruments.
- Through these instruments, short term requirement of funds is met by banks, institutions and the state and central governments.
- 2. Bank and Corporate Deposits
- Bank fixed deposits (FDs) have been popular and widely subscribed to, as the feeling of no-default-risk.
- Corporate deposits are FDs issued by a company (non-bank).
- 3. Government Securities
- G-Secs are sovereign-rated debt papers, issued by the government with a face value of a fixed denomination.
- 4. Corporate & PSU Bond Market
- Corporate bonds are issued by public sector undertakings (PSUs) and private firms.
- These bonds are issued for a wide tenor between 1 year – 15 years.
- These bonds carry a different risk profile and hence will have associated rating.
Debt market plays a significant role in the economy of a country. But India’s debt market suffers from shallowness. Some of the steps taken by the government to improve the situation have been showing positive trends. In the light of this development, the UPSC can frame a direct question, for ex. “What are the factors responsible for the shallowness of the debt market in India? Suggest ways to increase the depth of the debt market in India.”
What are the problems of India’s debt market?
- Wholesale market: The Indian debt market is largely a wholesale market.
- It is a wholesale market in a sense that a majority of institutional investors comprises of mainly banks, financial institutions, mutual funds, EPFO, insurance companies and corporates.
- The concentration of these large players has resulted in the debt markets being fairly skewed, evolving into a wholesale & bilaterally-priced trades.
- Lack of retail sell and transparency: It also lacks the retailness and the contractual transparency that the Indian capital markets have been able to build in the past 2 decades.
- Skewed towards G-secs: Structurally, the debt market remains firmly skewed towards government securities (G-secs).
- Also, the largest investor group in the G-secs market are the banks, due to their regulatory requirement to invest in SLR.
- Low and unstable trading in the corporate bond market: The Indian corporate bond market has low & unstable trading volumes.
- Sadly, the corporate bond market remains largely about top-rated financial and public sector issuances.
- The domestic debt managers have forgotten that the logic of the business of finance is “to price the risk”.
Regulation and comparison with other countries
- RBI regulates money markets & G-secs.
- SEBI regulates the Corporate debt market & bond markets.
- The domestic debt market in India amounts to about 67% of GDP.
- The size of India’s corporate bond market is a mere 16% of GDP — compared with 46% in Malaysia, and 73% in South Korea.
The recent positive trend in the debt market
- In the past few years, the domestic corporate bond market had seen increasing volumes, largely due to financial investments going into it, including retail participation.
- Also, the banks had ceded space to NBFCs over past many years.
- This is because banks found it easier to buy securitisation pools to achieve their PSL targets rather than develop competencies that NBFCs had built-in serving affinity groups, in smaller cities & towns.
- And post the ILFS crisis, the markets have started shunning non-banks again.
- Policy initiative by the government: The various policy initiatives undertaken in the last few years would take time to fructify and to stabilise.
- These include the IBC, SEBI’s bond market policies, RBI’s large borrower framework for enhancing credit supply.
- Some of these have already seen changes/addendums to the original draft, with the intent being to course-correct, for the stability of the markets.
Roll over of debt papers in India
- We have seen liquidity problems in our markets every few years.
- The concept of “roll-over” of debt paper was usual as our markets did not build long term papers.
- With the ILFS slowdown, it was easy for name-calling on “ALM mismatch” concept.
- Not much had been anyways done before and later to address the availability of debt to reduce the Asset-to-Liability mismatches.
- Also, we have played it safe so far by even lending for large infra projects with shorter paper and hoped to roll it over at the end of the debt term.
Conclusion
This is the time that our regulators need to work along with the various governments, especially the states, for smoother ironing of fiscal hiccups and use this to redress any structural glitches. It’s time that there is actual intent to deepen the domestic debt market and to listen to the industry about their requirements.
Back2Basics: What is ASM?
- Banks’ primary source of funds is deposits, which typically have short- to medium-term maturities.
- They need to be paid back to the investor in 3-5 years.
- In contrast, banks usually provide loans for a longer period to borrowers.
- Home loans, for instance, can have a tenure of up to 20 years.
- Providing such loans from much shorter maturity funds is called an asset-liability mismatch.
- It creates risks for banks that need to be managed.
- The most serious consequences of asset-liability mismatch are interest rate risk and liquidity risk.
- Because deposits are of shorter maturity they are repriced faster than loans.
- Every time a deposit matures and is rebooked if the interest rates have moved up the bank will have to pay a higher rate on them.
- But the loans cannot be repriced that easily. Because of this faster adjusting of deposits to interest rates asset-liability mismatch affects net interest margin or the spread banks earn.
Priority Sector Lending (PSL)
- Priority Sector Lending is an important role given by the (RBI) to the banks for providing a specified portion of the bank lending to few specific sectors like agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low-income groups and weaker sections etc.
Roll over of debt
- When debt becomes due there is a need to either repay the principal or alternatively, to enter into a new agreement.
- Structurally, funds from the second debt are used to repay the first debt.
- Then you repay the second debt as required. Quite often these new terms will be agreed with the initial lender.
- In essence, you’re ‘rolling’ the repayment obligation from one period into the next.
- This all leads to rollover risk, which is the risk you that you won’t be able to find anyone willing to lend the value of the outstanding debt and/or offer a comparable rate as the first principle repayment obligation approaches.
- This may be due to either movement in the borrowers perceived credit status and/or changes to the broader credit environment.
- This was a key theme during the financial crisis of 2007 – 2008.
- The reasons for refinancing may include the above, but also other themes such as debt consolidation (which doesn’t directly imply a change to the debt term).
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Capital Markets: Challenges and Developments
What is Operation Twist?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Operation Twist, OMOs
Mains level: Operation Twist
The Reserve Bank of India (RBI) has announced simultaneous purchase and sale of government bonds in a bid to soften long-term yields under its Operation Twist.
Operation Twist
- Operation Twist is a move taken by U.S. Federal Reserve in 2011-12 to make long-term borrowing cheaper.
- It first appeared in 1961 as a way to strengthen the U.S. dollar and stimulate cash flow into the economy.
- It is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds.
- The operation describes a form of monetary policy where the bank buys and sells short-term and long-term bonds depending on their objective.
Its genesis
- The name “Operation Twist” was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the shape of the yield curve.
- If we visualize a linear upward sloping yield curve, this monetary action effectively “twists” the ends of the yield curve, hence, the name Operation Twist.
- To put another way, the yield curve twists when short-term yields go up and long-term interest rates drop at the same time.
Back2Basics: Open Market Operations
- Open market operations are the sale and purchase of government securities and treasury bills by RBI or the central bank of the country.
- The objective of OMO is to regulate the money supply in the economy.
- When the RBI wants to increase the money supply in the economy, it purchases the government securities from the market and it sells government securities to suck out liquidity from the system.
- OMO is one of the tools that RBI uses to smoothen the liquidity conditions through the year and minimise its impact on the interest rate and inflation rate levels.
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Capital Markets: Challenges and Developments
How a dollar swap line with US Fed can help in uncertain times?
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Currency Swap
Mains level: Currency Swap and its significance
India is working with the US to secure a dollar swap line that would help in better management of its external account and provide an extra cushion in the event of an abrupt outflow of funds.
What are Currency Swaps?
- A currency swap, also known as a cross-currency swap, is an off-balance sheet transaction in which two parties exchange principal and interest in different currencies.
- The purpose of a currency swap is to lower exposure to exchange rate risk or reduce the cost of borrowing a foreign currency.
Why do we need dollars?
- According to RBI data, 63.7% of India’s foreign currency assets — or $256.17 billion — are held in overseas securities, mainly in the US treasury.
- While FPIs investors looking for safer investments, the current global uncertainty over COVID outbreak have led to a shortfall in Indian stock markets.
- This has pulled down India’s foreign exchange reserves.
- This means that the government and the RBI cannot lower their guard on the management of the economy and the external account.
How does a swap facility work?
- In a swap arrangement, the US Fed provides dollars to a foreign central bank, which, at the same time, provides the equivalent funds in its currency to the Fed, based on the market exchange rate at the time of the transaction.
- The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even three months later, using the same exchange rate as in the first transaction.
- These swap operations carry no exchange rate or other market risks, as transaction terms are set in advance.
Benefits of currency swap
- The absence of an exchange rate risk is the major benefit of such a facility.
- This facility provides India with the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.
- currency swaps between governments also have supplementary objectives like promotion of bilateral trade, maintaining the value of foreign exchange reserves with the central bank and ensuring financial stability (protecting the health of the banking system).
Recent examples
- India already has a $75 billion bilateral currency swap line with Japan, which has the second-highest dollar reserves after China.
- The RBI also offers similar swap lines to central banks in the SAARC region within a total corpus of $2 billion.
Note: Relate all other terminologies related to USD-INR convertiblity viz. Current Account, BoP etc.
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Capital Markets: Challenges and Developments
Euro Zone ‘Coronabonds’
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Coronabonds, Eurozone
Mains level: Not Much
The coronavirus pandemic has revived the acrimonious debate between euro zone countries about jointly issuing debt through instruments called Coronabonds.
Coronabonds
- Coronabonds are proposed debt instruments amongst EU member states, with the aim of providing financial relief to Eurozone countries battered by the coronavirus.
- They aim to meet healthcare needs and address the deep economic downturn that is set to follow.
- The funds would be mutualised and supplied by the European Investment Bank, with the debt taken collectively by all member states of the European Union.
- The euro zone jointly issues debt through its bailout fund, the European Stability Mechanism, which borrows on the market against the security of its paid-in and callable capital provided by euro zone governments.
Back2Basics
What is Eurozone?
- The Eurozone officially called the euro area is a monetary union of 19 of the 27 European Union (EU) member states which have adopted the euro as their common currency and sole legal tender.
- The monetary authority of the Eurozone is the Eurosystem.
- It consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
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Capital Markets: Challenges and Developments
India VIX Index
Note4Students
From UPSC perspective, the following things are important :
Prelims level: India VIX Index
Mains level: Impact of coronovirus outbreak on Economy
The India VIX Index, an indicator of the volatility of the stock market has been plunging after the outbreak of novel coronavirus.
What is Volatility Index?
- Volatility Index is a measure of the market’s expectation of volatility over the near term.
- Volatility is often described as the “rate and magnitude of changes in prices” and in finance often referred to as risk.
- It is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualized volatility, denoted in percentage e.g. 20%) based on the order book of the underlying index options.
India VIX Index
- India VIX is a volatility index based on the NIFTY Index Option prices.
- From the best bid-ask prices of NIFTY Options contracts, a volatility figure (%) are calculated which indicates the expected market volatility over the next 30 calendar days.
- “VIX” is a trademark of Chicago Board Options Exchange, Incorporated (“CBOE”) and Standard & Poor’s.
- The firm has granted a license to NSE to use such mark in the name of the India VIX and for purposes relating to the India VIX.
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Capital Markets: Challenges and Developments
Short Selling of Stocks
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Short selling of stocks
Mains level: Stock prices volatility: Various causative factors
The stock exchanges have clarified that the Securities and Exchange Board of India (SEBI) was not considering any proposal regarding a ban on short selling to curb the ongoing volatility and equity sell-off.
What is Short Selling?
- Short-selling allows investors to profit from stocks or other securities when they go down in value.
- In order to do a short sale, an investor has to borrow the stock or security through their brokerage company from someone who owns it.
- The investor then sells the stock, retaining the cash proceeds.
- The short-seller hopes that the price will fall over time, providing an opportunity to buy back the stock at a lower price than the original sale price.
- Any money left over after buying back the stock is profit to the short-seller.
When does short-selling makes sense?
- Most investors own stocks, funds, and other investments that they want to see rise in value.
- Over time, the stock market has generally gone up, albeit with temporary periods of downward movement along the way.
- For long-term investors, owning stocks has been a much better bet than short-selling the entire stock market.
- Sometimes, though, you’ll find an investment that you’re convinced will drop in the short term (as in case of COVID 19 outbreak).
- In those cases, short-selling can be the easiest way to profit from the misfortunes that a company is experiencing.
- Even though short-selling is more complicated than simply going out and buying a stock, it can allow making money when others are seeing their investment portfolios shrink.
The risks of short-selling
- Short-selling can be profitable when one makes the right call, but it carries greater risks than what ordinary stock investors experience.
- When we buy a stock, the most we can lose is what you pay for it. If the stock goes to zero, we suffer a complete loss, but will never lose more than that.
- By contrast, if the stock soars, there’s no limit to the profits one can enjoy. With a short sale, however, that dynamic is reversed.
Example:
- For instance, say you sell 100 shares short at a price of $10 per share. Your proceeds from the sale will be $1,000.
- If the stock goes to zero, you’ll get to keep the full $1,000. However, if the stock soars to $100 per share, you’ll have to spend $10,000 to buy the 100 shares back.
- That will give you a net loss of $9,000 — nine times as much as the initial proceeds from the short sale.
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Capital Markets: Challenges and Developments
The circuit breaker in the stock market
The stock markets in India are witnessing historic single-day falls with an increase in the number of COVID-19 cases. Since the indexes plunged more than 10 per cent each day earlier, a circuit breaker was triggered for the first time since 2009 halting trading.
What are circuit breakers?
- In June 2001, the SEBI implemented index-based market-wide circuit breakers.
- Circuit breakers are triggered to prevent markets from crashing, which happens when market participants start to panic induced by fears that their stocks are overvalued and decide to sell their stocks.
- This index-based market-wide circuit breaker system applies at three stages of the index movement, at 10, 15 and 20 per cent.
- When triggered, these circuit breakers bring about a coordinated trading halt in all equity and equity derivative markets nationwide.
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Capital Markets: Challenges and Developments
AT-1 bonds
Note4Students
From UPSC perspective, the following things are important :
Prelims level: AT-1 Bonds
Mains level: Read the attached story
India’s fourth-largest private lender YES bank was placed under a moratorium by RBI and its perpetual debt additional tier-1 (AT1 bonds) would become worthless if RBI does ask mutual funds to write down their value.
What are AT1 bonds?
- AT-1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
- AT-1 bonds are complex hybrid instruments, ideally meant for institutions and smart investors who can decipher their terms and assess if their higher rates compensate for their higher risks.
- They carry a face value of ₹10 lakh per bond.
- There are two routes through which retail folk have acquired these bonds — initial private placement offers of AT-1 bonds by banks seeking to raise money; or secondary market buys of already-traded AT-1 bonds based on recommendations from brokers.
Why are they important?
AT-1 bonds have several unusual features lurking in their fine print, which make them very different from plain bonds.
- One, these bonds are perpetual and carry no maturity date. Instead, they carry call options that allow banks to redeem them after five or 10 years. But banks are not obliged to use this call option and can opt to pay only interest on these bonds for eternity.
- Two, banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels. These thresholds are specified in their offer terms.
- Three, if the RBI feels that a bank is tottering on the brink and needs a rescue, it can simply ask the bank to cancel its outstanding AT-1 bonds without consulting its investors. This is what has happened to YES Bank’s AT-1 bond-holders who are said to have invested ₹10,800 crore.
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Capital Markets: Challenges and Developments
Dividend Distribution Tax (DDT)
Note4Students
From UPSC perspective, the following things are important :
Prelims level: DDT
Mains level: Not Much
Finance Minister announced abolition of DDT to be paid by companies in her budget speech.
What is DDT?
- A dividend is a return given by a company to its shareholders out of the profits earned by the company in a particular year.
- Dividend constitutes income in the hands of the shareholders which ideally should be subject to income tax.
- However, the income tax laws in India provide for an exemption of the dividend income received from Indian companies by the investors by levying a tax called the DDT on the company paying the dividend.
Who were required paid DDT?
- Any domestic company which is declaring/distributing dividend is required to pay DDT at the rate of 15% on the gross amount of dividend as mandated under Section 115O of the Income Tax Act.
- DDT was also applicable on mutual funds.
Why it is scrapped?
- Every MNE investing in India is faced with the question of tax-efficient repatriation of profits that accumulate here.
- The dividend that the holding company would receive would have already suffered substantial tax in India, although indirectly.
- The foreign company would normally be required to pay tax on the dividend so received in its home jurisdiction.
- DDT being a tax in the Indian company and the foreign company not paying taxes directly on such dividend income in India, it would not be able to claim foreign tax credit in its home jurisdiction.
- This resulted in a double whammy for foreign companies as, at a group level, they suffered double taxation.
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Capital Markets: Challenges and Developments
InvITs and REITs
Note4Students
From UPSC perspective, the following things are important :
Prelims level: InvITs and REITs
Mains level: Not Much
Markets regulator SEBI has put in place a framework for the rights issue of units by listed REIT and InvITs.
What are InvITs and REITs?
Infrastructure Investment Trusts (InvIT)
- An Infrastructure Investment Trust (InvITs) is like a mutual fund, which enables direct investment of small amounts of money from possible individual/institutional investors in infrastructure to earn a small portion of the income as return.
- InvITs work like mutual funds or real estate investment trusts (REITs) in features.
- InvITs can be treated as the modified version of REITs designed to suit the specific circumstances of the infrastructure sector.
- They are similar to REIT but invest in infrastructure projects such as roads or highways which take some time to generate steady cash flows.
Real Estate Investment Trusts (REIT)
- A REIT is roughly like a mutual fund that invests in real estate although the similarity doesn’t go much further.
- The basic deal on REITs is that you own a share of property, and so an appropriate share of the income from it will come to you, after deducting an appropriate share of expenses.
- Essentially, it’s like a group of people pooling their money together and buying real estate except that it’s on a large scale and is regulated.
- The obvious pitch for a REIT is that it enables individuals to generate income and capital appreciation with money that is a small fraction of what would be required to buy an entire property.
- However, the resemblance to either mutual funds or to owning property ends there.
- According to Indian regulation on REITs, these are meant to primarily own finished and rented out commercial properties –– 80 per cent of the investments must be in such assets. That excludes a real estate that is under development.
Why need InvITs and REITs?
- Infrastructure and real estate are the two most critical sectors in any developing economy.
- A well-developed infrastructural set-up propels the overall development of a country.
- It also facilitates a steady inflow of private and foreign investments, and thereby augments the capital base available for the growth of key sectors in an economy, as well as its own growth, in a sustained manner.
- Given the importance of these two sectors in the country, and the paucity of public funds available to stimulate their growth, it is imperative that additional channels of financing are put in place.
What did SEBI rule?
- SEBI said the issuer will have to disclose objects of the issue, related-party transactions, valuation, financial details, review of credit rating and grievance redressal mechanism in the placement document.
- The SEBI had first notified REITs and InvIT Regulations in 2014, allowing setting up and listing of such trusts which are popular in some advanced markets.
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Capital Markets: Challenges and Developments
[op-ed of the day] Revisiting the NBFC Crisis
Note4Students
From UPSC perspective, the following things are important :
Prelims level: Types of NBFC.
Mains level: Paper 3- NBFC crisis.
Context
While India was trying to deal with the problems arising out of the large NPA accumulated by the commercial banks, the Indian financial sector was dealt with another blow in the form of the NBFC crisis.
Effects of IL&FS and DHFL collapse:
- Balance sheets affected: The collapse of these two big entities affected the balance sheets of banks and mutual fund companies.
- Credit crunch: It also resulted in a credit crunch that dampened demand and pushed a slowing economy towards recession.
- Tarnished image of NBFCs: Being leaders in the industry, their failure has tarnished the image of the NBFC sector as a whole.
Types of NBFCs and their numbers
- Total number: As of September 2019 there were a total 9,642 NBFCs in India.
- Deposit-taking NBFC (NBFCs-D): Only 82 of India’s NBFCs were deposit-taking institutions (NBFCs-D) permitted to mobilise and hold deposits.
- Non-deposit taking NBFCs (NBFCs-ND): The rest of the NBFCs which are not deposit-taking, are categorised as non-deposit taking NBFCs.
- They did not have access to the savings of ordinary households.
- For this reason, the majority of these institutions were not considered to be entities that needed strict regulation
- Systematically important (NBFCs-ND-SI): Of a large number of non-deposit taking NBFCs (NBFCs-ND), only 274 were identified as being systematically important (NBFCs-ND-SI), by virtue of having an asset size of ₹500 crores or more.
Significance of NBFCs as expressed by assets holdings
- A significant player in the financial markets: As at the end of March 2019, these two sets-NBFCs-D and NBFC-ND-SI- held assets that amounted to almost a fifth of that held by the scheduled commercial banks.
- This made them significant players in the web of credit, as well as large enough as a group to affect the health of the financial sector.
- Non-deposit taking NBFCs must rely on resources garnered from the “market,” including the banking system, besides the market for bonds, debentures, and short-term paper.
- Extension of financial entities: Individual investors would only be marginally involved in direct investment in these instruments.
- So, the NBFCs are essentially extensions of the activity of other financial entities such as banks, insurance companies, and mutual funds.
Concentrated lending by NBFCs
- Industry getting lion’s share: Industry accounted for the biggest chunk of lending, amounting to 57% of gross advances in September 2019.
- Much of this lending to industry went to the infrastructural sector.
- At second place-retail sector: A second major target for lending by the NBFCs was the retail sector, with retail loans accounting for 20% of gross advances.
- Within the retail sector, vehicle/auto loans accounted for as much as 44% of loans.
What went wrong?
- Diversification by commercial banks: Following a surge in capital flows into India which began in 2004, banks were flush with liquidity.
- Under pressure to lend and invest to cover the costs of capital and intermediation and earn a profit, banks were looking for new areas into which they could move
- Increase in retail lending by banks: The pressure resulted in a significant increase in retail lending, with lending for housing, automobiles and consumer durables.
- There was also a substantial increase in lending to the infrastructural sector and commercial real estate.
- Why NBFCs flourished even in the face of competition by banks? What the growth of the NBFCs indicates is that banks were unable to exhaust the liquidity at their disposal.
- Banks were also unable to satisfy the potential for lending to these sectors, providing a space for NBFCs to flourish.
- The willingness of NBFCs suited the banks: The willingness of the NBFCs to enter these areas suited the banks in two ways.
- First, it permitted the banks to use their liquidity even when they themselves were stretched and could not discover, scrutinise and monitor new borrowers.
- Banks could lend to the NBFCs, which could then take on the tasks associated with expanding the universe of borrowers to match the increased access to liquid funds.
- The second was that it helped the banks to move risks out of their own books.
- Short term lending to NBFCs, and long-term lending by NBFCs: Banks accepts short term deposits, so there is limit in their ability to lend that short term deposits as a long term debt.
- On the other hand, these were the sectors to which additional credit could be easily pushed.
- Lending to NBFCs that in turn lent to these sectors, appeared to be a solution to the problem.
- Bank lending to the NBFCs was short term, and the latter used these short-term funds to provide long-maturity loans
- NBFCs expected that they would be able to roll over much of these loans so that they were not capital short.
- Role of rating agencies: What they needed for the purpose were ratings that ranked their instruments as safe.
- The ratings companies were more than willing to provide such ranks.
- The two risks involved in this model: The NBFC-credit build-up was an edifice that was burdened with two kinds of risks.
- First risk: A possible default on the part of borrowers.
- The probability of which only increases as the universe of borrowers is expanded rapidly to exhaust the liquidity at hand.
- The second risk: The second was the possibility that developments in the banking sector and other segments of the financial sector would reduce the appetite of these investors for the debentures, bonds and commercial paper issued by the NBFCs
- Since the NBFCs banked on being able to roll-over short-term debt to sustain long-term lending.
- A slowdown in or halt to the flow of funds would lead to a liquidity crunch that can damage the balance sheet of these institutions.
- Which of the two risks is involved in the present crisis? The crisis that affected the NBFCs was a result of both kinds of setbacks.
- First setback: Loans to areas like infrastructure, commercial real estate and housing went bad.
- Second setback: With the non-performing assets problem in the commercial banking sector curtailing their access to bank lending.
- Why the problem turned systemic? Given the importance of ratings and “image” in ensuring access to capital, some firms with the requisite image were able to mobilise large sums of capital and expand their business.
- When entities like that go bust, the response of lenders and investors to the event tends to be drastic, with systemic effects on the sector as a whole.
Conclusion
The episode was a shadow banking crisis that has had far-reaching consequences for the economy as a whole. Therefore, its high time that measures are taken to avoid the occurrence of such a crisis in the future.
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