What is a Securities Market and why does it need regulating?
Market, for our reference, is the term used to denote to a place where buyers and sellers come together to partake in economic transactions. A financial market is where parties engage in transactions involving financial instruments.
Securities Market is a subset of Financial Market, another subset is the money market. Securities Market, inter alia, provides an institutional framework for the efficient flow of capital from investors to enterprises. Such a space is necessitated to facilitate this flow of surplus household savings to fulfil the capital requirement of enterprises.
Securities are financial instruments issued by companies, financial institutions or by the government to raise funds. These are purchased by investors having surplus savings, with an aim to convert these savings into financial assets providing returns. The objective of issuer and investors are complimentary and the securities market provides a secure platform to mutually satisfy their goals.
The Securities Market encompasses two segments, the Primary Market and the Secondary Market. The Issuer entity lists securities on the stock exchange in the Primary Market to raise money from the public. Through the exchange, the issuer provides information about its activities and financial performance, which aids in efficient evaluation and assumption of risk and return by investors. As the securities are listed on the exchange, they become marketable. In Secondary Market (Stock Exchange), investors can sell and buy these listed securities with other investors and, inter alia, transfer risk.
Various other market participants partake in the process of a securities market transaction to coordinate between the issuer and the investor. These participants are known as Intermediaries. Examples of intermediaries include Merchant Bankers, Stock Brokers, Asset Management Companies, Underwriters, Portfolio Managers, Investment Advisers etc.
Recommended Read: SEBI’s educational arm ‘National Institute of Securities Markets’ offers a Valuable ‘Securities Market Foundation Course’ about the Securities, Securities Market and its participants.
Why does the Securities Market need regulating?
The purpose of Regulation is to address and deal with human evils such as manipulation, fraud, insider trading, tunnelling etc. Indian Securities market has seen its share of securities market scams including popular NSEL Scam, Harshad Mehta Scam, Ketan Parekh Scam, etc. Quoting Professor Robert Shiller at Yale University, “It is not that people are bad, but that people are constrained by the market”. What Professor means to say is that in order to survive a competitive market with a narrow profit margin, market participants end up doing something simply because they need to survive. Take for example, when faced with the charge of illegally pledging client securities, Karvy Stock Broking Limited claimed among other things that pledging of shares as long as the money was due to the firm by the individual investors was a practice that was adopted by every broker. However, SEBI taking note for this practice had earlier that year barred this practice and KSBL was found to have been in violation of the concerned circular.
Several times, the SEBI is criticized for its seemingly cumbersome list of regulations which leave businesses with several compliance and disclosure requirements to comply with. Howsoever, it is pertinent to comprehend the importance of such a body of norms as SEBI addresses various complicated issues in a massive industry affecting the legitimate interests of several participants.
It is but natural for businesses to oppose specific regulations that harm some interest of theirs. However, businesses would rather comply and work with the regulator as against a system of anarchy where they would be required to do things not in the public interest, as discussed above, merely to survive. Securities Regulation provides a healthy competitive environment that encourages good conduct and thwarts evils such as fraud, manipulation and unfair trade practices.
Regulation is also required to ensure the smooth working of the securities market and to facilitate systematic development. Initially, the financial market in India was highly segmented. Reforms were brought in by establishing SEBI and by corporatization and demutualization of stock exchanges. SEBI by its subsidiary regulations governs all aspects and participants of the securities market.
Tiers of Regulation
For ease of understanding, securities regulation has been divided into tiers.
Tier 3: Corporate Governance
The lowest tier of Securities Regulation is Corporate Governance. Board of Directors of a company are appointed from persons of stature and such persons usually have a reputable track record and standing in the community. The idea behind this is that persons like these would not compromise for any devious scheming occurring within the company. The Companies Act, 2013 governs appointment of Directors and various other norms that are applicable to all businesses incorporated thereunder.
Often times, cronies with significant shareholding can masquerade financial or securities fraud (against the company itself) by disguising it in business complexities so as to cloud anyone who attempts to take action. Actions part of tunnelling involve taking assets or value out of the company for personal gains. Examples include selling company property below market price to a friend who would return the favour later, overpaying for services with other company belonging to the relative, excessive executive compensation, inter-corporate loans to a crony corporation knowing that the loan will not be paid back. Insider trading is also, in a way a form of tunnelling. It is the Board of Directors’ duty to prevent these activities. Directors have a duty to care for the company and to act prudently, reasonably and rationally while doing so. A company comprises of its shareholders and thus, the Board of Directors is expected to prevent these activities of benefitting insiders at shareholders’ expense. This concludes the lowest tier of securities market regulation.
Tier 2: Stock Exchange
Stock Exchanges exercise regulatory function along with and under the guidance of SEBI. Stock Exchanges are required to be recognized by SEBI to start functioning. Stock Exchanges are required to notify rules, regulations and bye-laws that govern the activities on the respective exchange platforms. These norms govern the registration of broking members, the listing of securities, monitoring of transactions, investor protection. In addition to this, Stock exchanges also constantly monitor compliance by market participants with the SEBI Act and subsidiary regulations.
Topmost Tier: SEBI
SEBI was set up to protect the interests of investors in securities and to promote the development of, and to regulate the securities market. In order to protect investors, SEBI notified several regulations governing all aspects of the securities market. It requires issuers to constantly disclose information about their doings for the public to view. Their balance sheets and account statements undergo scrutiny and are published regularly. The idea behind the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 and Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 is to ensure that investors remain updated constantly about the working of the companies invested in. In turn, it is hoped that this transparency helps expose manipulation and fraud and reduces such activities. Fraud and manipulation, as well as other unfair trade practices in securities markets, are covered under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003.
SEBI requires every market participant to register with itself, all intermediaries, even the Stock Exchange are to be registered with it. All such participants are monitored by SEBI and bound by the regulations including code of conduct norms.
When insiders to a company trade on company secrets, it deters investors as they are disadvantaged of information. SEBI regulates Insider Trading by virtue of the SEBI (Prohibition of Insider Trading) Regulations, 2015.
Thus, Securities Market Regulation is indeed crucial and indispensable for a fair and competitive functioning securities market which it ensures by thwarting misdoings and ensuring orderly development of the market.
 SEBI has usually learnt from these scams and modified or added norms in order to ensure that such events never occur in future.
Note: This is a basic understanding of the Securities Market and its Regulation. Both the market and its Regulation involve various complex intricacies that require a deeper understanding, but the concepts discussed above stand at the base of it all.