Understand stock market reforms in India since 1992, covering SEBI, NSE, liberalisation, and key financial modernisation for UPSC Economics

Principal Reform Measures Undertaken in Indian Stock Market Since 1992

• Establishment of SEBI

  Under the Capital Issues (Control) Act, 1947, any firm wishing to issue securities required Central Government approval for the amount, type, and price of the issue.

  In alignment with the Liberalisation policy of 1991, this Act was repealed in 1992, and the Securities and Exchange Board of India (SEBI) was established. SEBI was entrusted with:

  • (a) Protecting the interests of investors, especially small investors in securities,

  • (b) Promoting the development of the securities market, and

  • (c) Regulating the securities market.

  SEBI was given concurrent/delegated powers under certain provisions of the Companies Act and the Securities Contracts (Regulation) Act. Many provisions in the Companies Act relating to the securities market are administered by SEBI.

• Market Determined Allocation of Resources and Investor Protection

  With the repeal of the Capital Issues Act and the establishment of SEBI, government control over capital issues, pricing, premiums, and interest rates on debentures ended. Resource allocation was left to the market.

  In the interest of investors, SEBI introduced the Disclosure and Investor Protection (DIP) guidelines outlining requirements for issuers and intermediaries. SEBI:

  • (i) Specifies mandatory disclosures and their standards

  • (ii) Issues directions to intermediaries and others for orderly market development

  • (iii) Ensures investors receive full information about the issue, issuer, and securities

  This enables investors to make informed investment decisions.

  The Department of Economic Affairs (DEA), Department of Company Affairs (DCA), and SEBI have set up investor grievance cells. Stock exchanges also maintain:

  • - Investor protection funds

  • - Consumer protection funds

  • - Trade guarantee funds

  These ensure compensation for investor claims due to non-settlement of trades. The DCA has also set up an Investor Education and Protection Fund to promote awareness and safeguard investor interests.

Demutualisation and Establishment of NSE

• The idea of the National Stock Exchange (NSE) was seriously considered in 1993. At the time, OTCEI was the recent state-sponsored exchange but had a poor performance record. There was hesitation due to the anticipated competition with the established liquidity of BSE.

• In response to the need for a demutualised exchange, equity trading at NSE commenced in November 1994. Within a year, NSE became India's most liquid stock market, which was a remarkable achievement.

• The BSE responded quickly by adopting similar technology in March 1995. This transition brought:

  • (i) Greater transparency

  • (ii) Anonymity in trade execution

  • (iii) Increased competition in the brokerage industry

  • (iv) Enhanced operational efficiency

• To strengthen demutualisation, regulators aimed to reduce member dominance in stock exchange management by mandating:

  • (i) Reconstitution of governing councils with at least 50% non-broker representation

• However, as these measures didn’t bring significant change, the government in March 2001 proposed full corporatisation of stock exchanges, separating:

  • (i) Ownership

  • (ii) Management

  • (iii) Trading membership

• Several exchanges initiated the demutualisation process, supported by tax incentives provided by the government.

Screen Based Trading

• To enhance efficiency, liquidity and transparency, NSE introduced a nationwide online, fully-automated Screen Based Trading System (SBTS).

• Members could input trade quantities and prices into a terminal, and execution occurred automatically upon finding a matching counter-order.

• This solved major inefficiencies of the open outcry system in infrastructure and trading practices.

• By 1994, all Indian stock exchanges had shifted from floor trading to anonymous electronic trading, making India comparable with global markets.

Risk Containment at the Clearing Corporation

• To address credit risk and ensure guaranteed settlement, NSE introduced novation and created the National Securities Clearing Corporation Ltd. (NSCCL), operational from April 1996.

• Key features included:

  • (i) A fine-tuned risk management system

  • (ii) On-line position monitoring and automatic disablement

  • (iii) A substantial Settlement Guarantee Fund to cushion residual risk

• To encourage corporatisation, capital gains tax was waived on the transfer of individual exchange membership to a corporate entity.

Risk Management in Capital Markets

• To prevent market failures and protect investors, the regulator and exchanges have developed a comprehensive risk management system. This system is constantly monitored and upgraded by the Exchanges and the regulators. It includes:

  • (i) Capital adequacy of members

  • (ii) Net-worth criteria

  • (iii) Adequate margin requirements (initial margin, daily mark-to-market margin, variation margin)

  • (iv) Limits on exposure and turnover

  • (v) Indemnity insurance

  • (vi) Online position monitoring and automatic disablement on crossing limits

• Exchanges also maintain an efficient market surveillance system to detect and prevent excessive volatility and price manipulations.

• They have also established trade/settlement guarantee funds to meet shortages due to non-fulfilment or partial fulfilment of fund obligations by members during settlement.

Dematerialisation

• The Depositories Act, 1996 facilitated the shift from physical to electronic securities through the creation of depositories like NSDL and CDSL.

• This enabled:

  • (i) Free transferability of securities with speed, accuracy, and security

  • (ii) Dematerialisation of securities into electronic form

  • (iii) Book-entry maintenance of ownership records

• The stamp duty on transfer of demat securities was waived, making all actively traded scrips held, traded, and settled in demat form. Over 99.9% of turnover is now settled via dematerialised delivery.

• Before this shift, SEBI received over 50,000 complaints annually, with a total of 2.7 million complaints in a decade, primarily due to non-transfer of shares. Dematerialisation drastically reduced these issues.

• Mandatory demat trading was enforced for all IPOs, rights issues, and public offers worth Rs. 10 crore or more. This requirement ensures transparency and prevents re-entry of physical certificates into the system.

Derivatives Trading in India

• The SC(R) Act, 1954 was amended in 1999 to lift the three-decade-old ban on forward trading, enabling the introduction of derivatives trading.

• Based on recommendations of the L. C. Gupta Committee, derivatives trading officially began in June 2000 on the NSE and BSE.

• The derivatives market currently offers:

  • (i) Index futures and index options on two indices

  • (ii) Stock options and stock futures on selected stocks

  • (iii) Recently introduced interest rate futures on the NSE

Globalisation of Indian Capital Market

• Indian companies have been allowed to raise resources from abroad through:

  • (i) American Depository Receipts (ADRs)

  • (ii) Global Depository Receipts (GDRs)

  • (iii) Foreign Currency Convertible Bonds (FCCBs)

  • (iv) External Commercial Borrowings (ECBs)

• ADRs and GDRs have two-way fungibility. Indian companies can list their securities on foreign stock exchanges by sponsoring ADR/GDR issues against block shareholding.

• Non-Resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) are allowed to invest in Indian companies.

• Foreign Institutional Investors (FIIs) are permitted to invest in all types of securities, including government securities. Their investments enjoy full capital account convertibility.

• FIIs can invest in a company under the portfolio investment route up to 24% of the paid-up capital, extendable up to the sectoral/statutory ceiling with the company’s board and general body approval.

• Indian stock exchanges can now set up trading terminals abroad. Their platforms are accessible globally through the Internet.

• Mutual Funds are allowed to set up offshore funds for investment in foreign equities and in ADRs/GDRs of Indian companies.

Rolling Settlement and Ban on Deferral Products

• Before reforms, the long trading cycle of 14 to 30 days led to high counterparty risk, defaults, and settlement risks.

• The badla system or modified carry-forward mechanism allowed leveraged trading and delayed settlements.

• In 2001, India banned future-style deferral mechanisms and introduced rolling settlement.

• Rolling settlement on a T+5 basis was first introduced in 1998 for specified scrips, reducing the trading cycle.

• A uniform weekly trading cycle was made mandatory across exchanges for scrips not under rolling settlement.

• By December 2001, all scrips were moved to rolling settlement. In April 2002, T+3 settlements replaced T+5, and eventually T+1 was introduced for some categories.

• These reforms improved market efficiency, reduced settlement risk, and built investor confidence.

• Authorities introduced reforms incrementally based on detection of market irregularities or malpractice. Though progress has been made, securities market reforms are still ongoing.