4

Services of Intermediaries

Stock market intermediaries link the various players in the field. Market intermediation helps in enabling a smooth functioning of the stock market. In a characteristic stock market, all the investors may not be present at any point of time. Also, all the investors need not necessarily be uniformly skilled at analysing investment information. Especially when the marketplace is quite large and involves several players in terms of groups as well as numbers, intermediation becomes a requisite function. Stock market intermediaries, at present, perform the requisite services of order matching, portfolio advice, investment advice, providing market liquidity, market making, stock lending, retail broking, merchant banking, online trading, equity research, besides depository and other related services. A list of the participants in the Indian market is given in Table 4.1.

The major market intermediaries, according to the functions that they perform in the market that are discussed in this chapter, are as follows.

• Brokers
• Investment advisors

 

Table 4.1 Market Participants in India

Market Participant	31.3.2000	31.3.2001
Securities Appellate Tribunal	1	1
Regulators	4	4
Depositories	2	2
Stock exchanges
With equity trading	23	23
With debt market segment	1	1
With derivative trading	2	2
Listed securities	9,871	9,922
Brokers	9,192	9,782
Foreign brokers	38	38
Corporate brokers	3,316	3,808
Sub-brokers	5,675	9,957
FIIs	506	527
Portfolio managers	23	40
Custodians	14	14
Share transfer agents	242	186
Primary dealers	15	15
Merchant bankers	186	233
Bankers to an issue	68	69
Debenture trustees	38	37
Underwriters	42	56
Venture capital funds	22	35
Foreign venture capital investors	0	1
Mutual funds	38	39
Collective investment schemes	0	4

• Fund managers
• Merchant bankers
• Credit rating agencies
• Investment banks
• Regulatory bodies
• Auditing bodies
• Stock depositories
• Technology providers/Internet providers

BROKERS

A broker executes investment orders in the stock market on behalf of an investor. He is a legal agent of the investors. A broker is different from a dealer in the stock market. A dealer specifically takes a position in the security, that is, the dealer buys and holds a security or sells from this holding of the security. A broker, on the other hand, simply executes the buy or sell orders of his clients in the stock market. For this service, the broker charges a commission; this is one of the transaction costs for the investor in getting the investment activity executed.

A broker may appoint a sub-broker to reach a wider client base. The sub-brokers act on behalf of the brokers and pass on the buy/sell orders of their clients to the concerned broker. Thus, a sub-broker is a sub-agent for the investor.

Every stockbroker has to maintain a register of transactions (sauda book), client’s ledger, general ledger, journals, cash book, bank passbook, and documents register that includes particulars of shares and securities received and delivered. The list also includes members’ contract books showing details of contracts with other members, counterfoils or duplicates of contract notes issued to clients, the written consent of clients in respect of contracts entered into as principals, and margin deposit book. Registers of accounts of sub-brokers, an agreement with a sub-broker specifying the scope of authority and responsibilities of the stockbroker and such sub-broker has to be maintained additionally by the broker.

Every stockbroker is required to appoint a compliance officer who is responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, and so, issued by SEBI or the Central Government and for redressal of investors’ grievances.

A stockbroker is expected to maintain high standards of integrity, promptness, and fairness and has to act with due skill, care, and diligence in the conduct of all business transactions. A stockbroker must not indulge in manipulative, fraudulent, or deceptive transactions or schemes or spread rumours with a view to distorting market equilibrium or making personal gains. A stockbroker cannot create a false market either singly or together with others or indulge in any act detrimental to the investors’ interest or which leads to interference with the fair and smooth functioning of the market. Stockbrokers cannot be involved in excessive speculative business in the market beyond reasonable levels that are not in tune with their financial soundness.

A stockbroker, in his dealings with the clients and the general investing public, is expected to execute the orders for buying and selling of securities at the best available market price and not refuse to deal with a small investor merely on the ground of the volume of business involved. A stockbroker has to promptly inform clients about the execution or non-execution of an order, and make prompt payment in respect of securities sold and arrange for prompt delivery of securities purchased by clients. A stockbroker has to issue, without delay, to clients a contract note for all transactions in the form specified by the stock exchange. A stockbroker cannot disclose or discuss with any other person or make improper use of the details of his clients’ personal investments and other information of a confidential nature. A stockbroker cannot encourage sales or purchases of securities with the sole object of generating brokerage or commission. A stockbroker additionally cannot furnish false or misleading quotations or give any other false or misleading advice or information to clients with a view of encouraging business in particular securities that help to increase personal income through brokerage or commission.

A stockbroker, when dealing with a client, has to disclose the nature of the relationship, that is, as a principal or as an agent, and has to ensure that no conflict of interest arises due to this relationship. In the event of a conflict of interest, the client has to be informed and there cannot be a gain, a direct or indirect personal advantage from the situation. When a defaulted client transacts with another stockbroker, upon such information the broker cannot deal or transact business with that client.

A stockbroker cannot advertise his business publicly unless permitted by the stock exchange. A stockbroker cannot resort to unfair means of luring clients away from other stock-brokers. A stockbroker has to submit the required returns and not make any false or misleading statement on any returns submitted to SEBI and the stock exchange.

A stockbroker, or any employee of the stockbroker, cannot render any investment advice about any security in the publicly accessible media, whether real-time or non real-time. When an employee of the stockbroker is rendering such an advice, a disclosure of the interest of dependent family members and the employer, including their long or short position in the said security, has to be made. A stockbroker should have adequately trained staff and arrangements to render fair, prompt, and competent service to clients.

A stockbroker cannot knowingly and wilfully render bad delivery, and has to co-operate with the other contracting party for the prompt replacement of documents which are declared as bad delivery. A stockbroker has to extend the fullest co-operation to other stockbrokers in protecting the interests of clients with respect to their rights to dividends, bonus shares, right shares, and any other right related to such securities.

A sum of Rs 5,000 is to be paid by the broker as registration charges for each financial year to the stock exchange when the annual turnover does not exceed Rs 1 crore during any financial year. Where the annual turnover of the stockbroker exceeds Rs 1 crore during any financial year, a sum of Rs 5,000 plus one-hundredth of one per cent of the turnover in excess of Rs 1 crore for each financial year has to be paid as registration charges.

If brokers conduct transactions in securities without reporting them to the stock exchange, those transactions have to be taken into account for the purpose of turnover and fees computations at the rate of one-hundredth of one per cent of the turnover.

In respect of jobbing transactions (that is, all transactions which are squared off during the same day) which have not been undertaken by the broker on behalf of clients, the fees has to be computed at the rate of two-hundredth of one per cent. The computation will be based only on the sale side of such transactions.

In respect of transactions in government securities, the bonds issued by any public sector undertaking and units traded in a similar manner, the fee payable has to be computed at the rate of one-thousandth of one per cent of the turnover;

In case of subsidiary of a stock exchange that has become a stock broker of another stock exchange, the turnover of the stock broker dealing through the subsidiary cannot be counted as part of the turnover.

The trade put through on other stock exchanges has to be included in the turnover of that exchange if the market for that security does not exist on the exchange of which the broker is a member. The fee is computed at the rate of one-hundredth of one per cent of this computed turnover.

Activity of the broker such as underwriting and collection of deposits cannot be taken into account for the purpose of calculating the turnover.

After the expiry of five financial years from the date of initial registration as a stockbroker, the broker has to pay a sum of Rs 5,000 for every two blocks of five financial years after the date of grant of initial registration to keep the registration in force.

Sub-broker

The eligibility criteria for registration as a sub-broker in case of an individual is that the applicant should not be less than 21 years of age, not been convicted of any offence involving fraud or dishonesty, passed the class 12 or equivalent examination from an institution recognised by the government.

A sub-broker has to cooperate with his broker in comparing unmatched transactions. A sub-broker cannot knowingly and wilfully deliver documents that constitute bad delivery. A sub-broker has to cooperate with the other contracting party for prompt replacement of documents that are declared as bad delivery. A sub-broker has to extend the fullest cooperation to the stockbroker in protecting the interests of their clients with respect to their rights to dividends, right or bonus shares, or any other rights attached to such securities. A sub-broker cannot fail to carry out stockbroking transactions with the broker or fail to meet business liabilities or show negligence in completing the settlement of transactions with them. A sub-broker has to execute an agreement or contract with affiliating brokers, which would clearly specify the rights and obligations of the sub-broker and the principal broker. A sub-broker cannot advertise business publicly unless permitted by the stock exchange. A sub-broker cannot resort to unfair means of inducing clients from other brokers.

A sub-broker cannot indulge in reprehensible conduct on the stock exchange nor wilfully obstruct the business of the stock exchange. Towards this purpose, compliance with the rules, by-laws, and regulations of the stock exchange has to be ensured. A sub-broker has to submit such books, special returns, correspondence, documents, and papers or any part thereof as may be required by SEBI or the concerned stock exchange. A sub-broker cannot neglect or fail or refuse to submit the required returns and not make any false or misleading statement on any returns submitted to SEBI or the stock exchanges. A sub-broker cannot indulge in manipulative, fraudulent, or deceptive transactions or schemes, or spread rumors with a view to distorting market equilibrium or making personal gains. A sub-broker cannot create a false market either singly or in concert with others or indulge in any act detrimental to public interest or which leads to interference with the fair and smooth functioning of the market mechanism of the stock exchanges.

A sub-broker has to pay a fee of Rs 1,000 for each financial year for an initial period of five years. After the expiry of the five years, the sub-broker has to pay a fee of Rs 500 for each financial year to ensure that the certificate remains in force.

Dealing/Trading Member of a Derivative Segment

An applicant who desires to act as a trading member has to have a networth as may be specified by the stock exchange and the approved user and sales personnel of the trading member should have passed a certification programme approved by SEBI.

INVESTMENT MANAGEMENT COMPANY

For becoming an investment management company, at the time of making the application the applicant has to have a minimum net worth of Rs 3 crores which has to be increased to Rs 5 crores within three years from the date of grant of registration. At least half of the directors of an investment management company must consist of persons who are independent and are not directly or indirectly associated with the persons who have control over the investment management company.

The investment management company has to undertake only the management of the scheme; act as a trustee of any scheme; launch any scheme for the purpose of investing in securities but not invest in any schemes floated by it.

Every investment management company is responsible for managing the funds or properties of the scheme on behalf of the unit holders. It has to take all reasonable steps and exercise due diligence to ensure that the scheme is managed in accordance with SEBI regulation, the offer document and the trust deed; and exercise care in managing the assets and funds of the scheme. The company is responsible for the acts of commission and omission by its employees or the persons whose services have been availed by it. The company remains liable to the unit holders for its acts of commission or omission.

The investment management company has to appoint a registrar and share transfer agents; issue receipts for all the monies received by it; and give a report to SEBI every month, particularly of receipts and payments. It has to hold a meeting of the Board of Directors to consider the affairs of the scheme at least twice in every three months. It also has to ensure that its officers or employees do not make improper use of their position or information to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to the scheme. It has to obtain adequate insurance against the property of the scheme and comply with the guidelines, directives, circulars, and instructions of SEBI.

An investment management company appoints a trustee who holds the assets of the scheme for the benefit of unit holders. Only persons registered with SEBI as trustees under SEBI can be appointed as trustees of collective investment scheme. The trustee and the investment management company enter into an agreement for managing the scheme.

The investment management company may launch only schemes that are approved by the trustee. The scheme has to obtain a rating from a credit rating agency. The company has to get the scheme appraised by an appraising agency.

The investment management company has to issue unit certificates to accepted scheme applicants at the most six weeks from the date of closure of the subscription list. A unit certificate issued under the scheme is freely transferable. The investment management company, on production of the instrument of transfer, together with relevant unit certificates, registers the transfer and returns the unit certificate to the transferee within 30 days of the date of such production.

The investment management company cannot invest the funds of the scheme for purposes other than the objective of the scheme as disclosed in the offer document. It cannot invest the corpus of a scheme in other schemes. It cannot transfer funds from one scheme to another scheme. The units of every scheme have to be listed immediately after the date of allotment of units, not later than six weeks from the date of closure of the scheme on each of the stock exchanges as mentioned in the offer document. It has to despatch to the unit holders the dividend warrants within 42 days of the declaration of the interim returns and the redemption proceeds within 30 days of the closure or the winding up of the scheme. No scheme can provide guaranteed or assured returns.

Every investment management company has to maintain and preserve, for a period of five years after the close of each scheme, its books of accounts, records, and documents.

FUND MANAGERS

Open-ended investment companies are commonly referred to as mutual fund management companies. These companies usually have a continuous selling and redemption of their units. Fund managers sell the units of funds to investors at the net asset value (NAV) and are also ready to purchase units from the investors at the net asset value. In case of a “no-load” fund, the fund manager sells the units by mail to the investors. Since there are no other intermediaries, this type of fund does not have a sales commission. In terms of a loaded fund, the units are sold through a salesperson.

When investors purchase units, a part of the investor’s equity is removed as the load at the beginning of the contract. This is called the front-end loading. By adding the commission at the time of sale of units by the investors, exit fees or back-end loading can also be charged. The commission to be paid to the salesperson is added to the net asset value. Apart from this, the fund managers also charge a management fee for the cost of operating the portfolios. These costs include expenses that will be borne by the fund manager such as brokerage fees, transfer costs, bookkeeping expenses, and fund managers’ salaries.

Funds can be categorised in terms of their main objectives. Thus, the fund could be a growth fund, income fund, balanced fund, industry-specific (tech fund, pharma fund, and so on) fund, or security-specific (index fund, money-market fund, bond fund, and so on) fund.

To be established as a fund manager, the sponsor should have a sound track record and general reputation of fairness and integrity in all business transactions. In the case of an existing mutual fund, such a fund should be in the form of a trust approved by SEBI.

The fee structure for setting up a fund management company is as follows:

Fees	Amount in Rupees
Application fees	25,000
Registration fees	25,00,000
Service fees	2,50,000
Filing fees for offer document	25,000

 

An asset management company, or any of its officers or employees, is not eligible to act as a trustee of any mutual fund. A trustee of a mutual fund cannot be appointed as a trustee of any other mutual fund unless such a person is an independent trustee and prior approval of the mutual fund has been obtained for such an appointment.

Before the launch of any scheme the trustee has to ensure that the asset management company has the necessary infrastructure such as back office, dealing room, and accounting systems. The trustee has to ensure that an asset management company has been diligent in enlisting the services of brokers, in monitoring securities transactions with brokers, and avoiding undue concentration of business with any broker. The trustee has to ensure that the asset management company has not given any undue or unfair advantage to any associates or dealt with any of the associates of the asset management company in any manner detrimental to the interest of the unitholders. The trustee has to ensure that the transactions entered into by the asset management company are in accordance with SEBI regulations. The trustee has to ensure that the asset management company has been managing the mutual fund schemes independently of other activities and have taken adequate steps to ensure the interest of investors.

The trustees are accountable for, and are custodians of, the funds and property of the respective schemes and have to hold the same in trust for the benefit of the unit holders in accordance with the regulations and the provisions of the trust deeds. The trustees have to take steps to ensure that the transactions of the mutual funds are in accordance with the provisions of the trust deeds. The trustees have to be responsible for the calculation of any income due to be paid to a mutual fund and also of any income received in the mutual fund for the holders of the units of any scheme in accordance with SEBI regulations and the trust deed. The trustees have to obtain the consent of the unit holders whenever required to do so by SEBI or on the requisition made by three-fourths of the unit holders of any scheme; or when the majority of the trustees decide to wind up or prematurely redeem the units.

A written communication has to be sent to the unit holders if the trustees need to change the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affect the interest of the unit holders. The unit holders have to be given an option to exit at the prevailing net asset value without any exit load if they do not agree to the change.

The asset management company has to exercise due diligence and care in all its investment decisions as would be exercised by other persons engaged in the same business. The asset management company is responsible for the acts of commissions or omissions by its employees or the persons whose services have been procured by the asset management company. The asset management company has to submit to the trustees quarterly reports of each year on its activities and the compliance with SEBI regulations. An asset management company cannot purchase or sell securities, which is on an average of 5 per cent or more of the aggregate purchases and sale of securities made by the mutual fund in all its schemes unless it has recorded in writing the justification for exceeding the limit. This limit of 5 per cent applies for a block of three months.

The mutual fund has to appoint a custodian to carry out the custodial services for the schemes of the fund and send intimation of the same to SEBI within 15 days of the appointment of the custodian.

The asset management company may, at its option, repurchase or reissue the repurchased units of a close-ended scheme. The units of a close-ended scheme may be converted into an open-ended scheme if the offer document of such scheme discloses the option and the period of such conversion; or the unit holders are provided with an option to redeem their units in full.

The asset management company has to specify in the offer document, the minimum subscription amount it seeks to raise under the scheme; and in case of oversubscription, the extent of subscription it may retain. The mutual fund and the asset management company are liable to refund the application money to the applicants if the mutual fund fails to receive the minimum subscription amount or if the receipt from the applicants for units are in excess of the subscription.

As regards the issue of unit certificates, investment of scheme funds, and so on the regulations applicable to the investment management company are also applicable to the mutual fund management companies.

Every mutual fund has to compute the net asset value of each scheme by dividing the net assets of the scheme by the number of units outstanding on the valuation date. The NAV of the scheme has to be calculated and published at least in two daily newspapers at intervals not exceeding one week. The NAV of any scheme for special target segment or any monthly income scheme which are not required to be listed on any stock exchange, may publish the NAV at monthly or quarterly intervals as may be permitted by SEBI.

All expenses and incomes accrued up to the valuation date are to be considered for the computation of the net asset value. For this purpose, while major expenses such as management fees and other periodic expenses are accrued on a day-to-day basis, other minor expenses and income need not be so accrued, provided the non-accrual does not affect the NAV calculations by more than 1 per cent. Any changes in securities and in the number of units are to be recorded in the books not later than the first valuation date following the date of transaction. If this is not possible given the frequency of the NAV disclosure, the recording may be delayed up to a period of seven days following the date of the transaction. As a result of this non-recording, it must be ensured that the NAV calculations should not be affected by more than 1 per cent.

In case the NAV of a scheme differs by more than 1 per cent, due to non-recording of the transactions, the difference in amount has to be paid to the investors. The asset management company may also recover the difference from the investors later.

The asset management company charges the mutual fund with investment and advisory fees which are fully disclosed in the offer document. When net assets do not exceed Rs 100 crores, the fees will be 1¼ per cent of the weekly average net assets outstanding. Where net assets exceed Rs 100 crores, the fees charged for the first Rs 100 crores can be the aforesaid percentage and for the excess amount over Rs 100 crores, 1 per cent of the excess amount.

For schemes launched on a no-load basis, the asset management company is entitled to collect an additional management fee not exceeding 1 per cent of the weekly average net assets outstanding in each financial year. In addition to the fees, the asset management company may charge the mutual fund with the following expenses.

1. Initial expenses of launching schemes.
2. Recurring expenses including (i) marketing and selling expenses including agents’ commission, if any; (ii) brokerage and transaction cost; (iii) registrar services for transfer of units sold or redeemed; (iv) fees and expenses of trustees; (v) audit fees; (vi) custodian fees; and (vii) costs related to investor communication; (viii) costs of fund transfer from location to location; (ix) cost of providing account statements and dividend/redemption cheques and warrants; (x) insurance premium paid by the fund; (xi) winding up costs for terminating a fund or a scheme; (xii) costs of statutory advertisements; and (xiii) such other costs as may be approved by SEBI.

The total expenses of the scheme excluding issue or redemption expenses, whether initially borne by the mutual fund or by the asset management company, but including the investment management and advisory fee has to be subject to the following limits.

Weekly Average Net Assets	Management and Advisory Fee
First Rs 100 crores	2.5%
Next Rs 300 crores	2.25%
Next Rs 300 crores	2.0%
Balance of the assets	1.75%

 

Recurring expenses have to be at least 0.25 per cent lesser than of the weekly average net assets outstanding in each financial year in respect of a scheme investing in bonds. Any expenditure in excess of the limits specified has to be borne by the asset management company or by the trustee or sponsors.

The price at which the units may be subscribed or sold and the price at which such units may at any time be repurchased by the mutual fund have to be made available to the investors. While determining the prices of the units, the mutual fund has to ensure that the repurchase price is not lower than 93 per cent of the NAV and the sale price is not higher than 107 per cent of the NAV. The repurchase price of the units of a close-ended scheme cannot be lower than 95 per cent of the NAV. The difference between the repurchase price and the sale price of the unit cannot exceed 7 per cent calculated on the sale price.

For the purposes of the financial statements, a mutual fund has to mark all investments to market and carry investments in the balance sheet at market value. However, since the unrealised gain arising out of appreciation on investments cannot be distributed, provision has to be made for exclusion of this item when arriving at the distributable income. The dividend income earned by a scheme will be recognised, not on the date the dividend is declared, but on the date the share is quoted on an ex-dividend basis. For investments, which are not quoted on the stock exchange, the dividend income must be recognised on the date of declaration. In respect of all interest-bearing investments, income must be accrued on a day-today basis as it is earned. Therefore, when such investments are purchased, the interest paid for the period from the last interest due date up to the date of purchase cannot be treated as a cost of purchase but must be adjusted as interest-recoverable amount. Similarly, interest received at the time of sale for the period from the last interest due date up to the date of sale cannot be treated as an addition to sale value but must be included in the interest-recoverable amount.

Transactions for the purchase or sale of investments are recognised as of the trade date and not as of the settlement date, so that the effect of all investments traded during a financial year are recorded and reflected in the financial statements for that year. Where investment transactions take place outside the stock market, such as acquisitions through private placement or purchases or sales through private negotiations, the transaction is recorded in the event of a purchase/sale.

When open-ended scheme units are sold, the difference between the sale price and the face value of the unit, if positive, is added to reserves and if negative is deducted from reserves, the face value being added to a capital account. Similarly, when in respect of such a scheme, units are repurchased, the difference between the purchase price and face value of the unit, if positive is deducted from reserves and, if negative, is added to reserves, the face value being deducted from the capital account.

In a close-ended scheme, which provides unit holders the option for an early redemption or repurchase of their own units, the face value of the unit has to be deducted from the capital account. The difference between the purchase price and the face value, if positive, is added to reserves. If the difference is negative, it is deducted from reserves.

MERCHANT BANKERS

Merchant banking, as the term has evolved in Europe from the 18th century, pertains to an individual or a banking house whose primary function is to facilitate the business process between a product and the financial requirements for its development. The merchant banker acts as a capital source whose primary activity is directed towards a business enterprise needing capital. The role of the merchant banker, who has the expertise to understand a particular transaction, has to arrange the necessary capital and ensure that the transaction would ultimately produce profits. Often, the merchant banker also becomes involved in the actual negotiations between a buyer and seller of capital in a transaction between corporate enterprises.

When companies raise capital by issuing securities in the market, merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase these securities. Merchant banking is the financial intermediation that matches the entities that need capital and those that have capital. It is a function that facilitates the transfer of capital in the market.

Merchant banking helps in channelising the financial surplus of the general public into productive investment avenues. It helps to coordinate the activities of various intermediaries to the share issue such as the registrar, bankers, advertising agency, printers, underwriters, brokers, and so on. It also helps to ensure the compliance with rules and regulations governing the securities market.

Registration with SEBI is mandatory to carry out the business of merchant banking in India. The applicant should be a body corporate. The applicant should have a minimum net worth of Rs 5 crores. The applicant should not carry on any business other than those connected with the securities market. The applicant should have the necessary infrastructure such as office space, equipment, manpower, and so on. The applicant must have at least two employees with prior experience in merchant banking. Any associate company, group company, subsidiary, or interconnected company of the applicant should not have been a registered merchant banker. The applicant should not have been involved in any securities scam or proved guilty for any offence.

Figure 4.1 describes the main functions of a merchant banker.

Issue Management

The management of debt and equity offerings forms the main function of the merchant banker. A merchant banker assists companies in raising funds from the market. The main areas of work in this regard include instrument designing, issue pricing, registration of the offer document, underwriting support, marketing of the issue, allotment and refund, and listing on stock exchanges.

The merchant banker helps in distributing various securities such as equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper, and so on. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions, and so on. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with individual investors.

Advisory Services

Corporate advisory services Merchant bankers offer customised solutions to their client’s financial problems. Financial structuring for a client involves determining the right debt-equity ratio. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds.

Another area of advice is rehabilitation and turnaround management. In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. Advising the client on different hedging strategies and suggesting appropriate strategy also is a sought after service.

Project advisory services Merchant bankers help their clients in various stages of any project undertaken by the clients. They assist clients in conceptualising the project idea in the initial stage. Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed project. They also assist the client in preparing necessary documents such as a detailed project report.

Financial Services

Loan syndication Merchant bankers arrange to tie up loans for their clients. This takes place in a series of steps. First, they analyse the pattern of the client’s cash flows, based on which the terms of the borrowing are defined. Then the merchant banker prepares a detailed report, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending on the basis of which the final allocation is done.

Market Operations

Merchant bankers perform market operations for their clients in the form of dealing in the buyback arrangements of the company from the stock market, offloading venture capital holdings in the market, and so on.

CREDIT RATING AGENCIES

Credit rating is a fee-based financial advisory service for the evaluation of a specific instrument (especially debt, share, and so on), and is intended to grade different instruments in terms of the credit risk associated with the particular instrument. Rating is only an opinion expressed by an independent professional organisation following a detailed study of all the relevant factors. It does not amount to a recommendation to buy, hold, or sell an instrument as it does not take into consideration factors such as market prices, personal risk preferences of an investor, and other factors that influence an investment decision. Credit rating is beneficial to investors, companies, banks, and financial institutions.

SEBI will grant registration to a credit rating agency if a public financial institution, a bank, or a foreign credit rating agency having at least five years experience in rating securities promotes the applicant. A company or a body corporate having continuous net worth of minimum Rs 100 crores as per its audited annual accounts for the preceding five years may also promote the credit rating agency.

Every credit rating agency must enter into a written agreement with each client whose securities it proposes to rate. The agreement deals with the rights and liabilities of each party in respect of the rating of securities, the fee to be charged by the credit rating agency, and a periodic review of the rating. The client has to agree to cooperate with the credit rating agency in order to enable the latter to arrive at, and maintain, a true and accurate rating of the client’s securities and in particular provide true, adequate, and timely information for the purpose.

The credit rating agency must disclose to the client the rating assigned to its securities through regular methods of dissemination, irrespective of whether the rating is or is not accepted by the client. A credit rating agency cannot withdraw a rating so long as the obligations under the security rated by it are outstanding, except where the company whose security is rated is wound up or merged or amalgamated with another company.

Every credit rating agency has to make public the definitions of the concerned rating, along with the symbol, and also state that the ratings do not constitute a recommendation to buy, hold, or sell any security. The credit rating agency has to give the public information relating to the rationale of the ratings, which covers an analysis of the various factors justifying a favourable assessment, as well as factors constituting a risk.

The rating agency also has to comply with the requirement of maintaining books of accounts and other relevant information as per SEBI regulations. The credit rating agency has to treat as confidential, information supplied to it by the client and it cannot disclose the same to any other person, except where such disclosure is required or permitted by law.

No credit rating agency can rate a security issued by its promoter. In case the promoter is a lending institution, its chairman, director, or employees cannot be a chairman, director, or employees of the credit rating agency or its rating committee. No credit rating agency can rate a security issued by a borrower or a subsidiary or an associate of its promoter, if the chairman, directors, or employees are common. The credit rating agency cannot rate a security issued by its associate or subsidiary, if the credit rating agency or its rating committee has a chairman, director or employee who is also a chairman, director or employee of any such entity.

INVESTMENT BANKS

An investment banker is a total solutions provider as far as any corporate, desirous of mobilising capital, is concerned. The services range from investment research to investor service on the one hand and from preparation of offer documents to legal compliance and post-issue monitoring on the other. There exists a long lasting relationship between the company and the investment banker.

The major activities of investment banks are (1) raising capital for clients; (2) making markets and providing brokerage services; (3) advising on and executing mergers and acquisitions; (4) trading and investing for the bank’s own account; and (5) managing third-party assets. Investment banks are regulated by the Reserve Bank of India.

REGULATORY BODIES

There are four regulatory bodies for the Indian capital market. The main capital market regulator is the Securities and Exchange Board of India. The other regulators are the Reserve Bank of India (RBI), Department of Company Affairs (DCA), and Department of Economic Affairs (DEA). These regulators monitor and help in the smooth and uninterrupted flow of activities in the capital market. Though SEBI has been empowered with more powers and is directly linked to the regulation of stock market, it also works with other regulators to govern the capital market.

AUDITING BODIES

The auditing system in India is very comprehensive and well supported by law. Every effort has been made to ensure the impartiality, objectivity, and independence of the statutory auditors. Despite an independent audit, many a time irregularities, leakages, and accounting manipulations go unnoticed, due to inadequate access to information about the company, lack of appropriate communication between the auditor and the company, and ineffective internal control system.

The statutory auditors have to report whether the company has an internal control system commensurate with its size and the nature of its business. However, it was felt that there should be greater interaction and link between the auditors, both statutory and internal, and the top level of the management. Therefore, the necessity arose for an audit committee of the Company’s Board of Directors. The statutory and the internal auditor, through the audit committee, are expected to have a greater opportunity to bring forth any problem or difficulty faced by them, particularly deviations, abnormalities, and fraud. The audit committee is also expected to directly interact with the auditors, discuss matters of concern, and take remedial measures wherever required.

The Companies (Amendment) Act, 2000, has, among others, provided for the formation and functioning of an audit committee. Similarly, the listing agreement lays down this requirement for listed companies in a stock exchange.

Good corporate governance recommends that all public companies having a paid-up capital of Rs 5 crores or more have to constitute a committee of the Board of Directors known as the audit committee which will consist of not less than three directors. At least two-thirds of the total number of the members of such a committee should not be managing or whole time directors. The members have to elect a chairman from amongst themselves.

The annual report of the company has to disclose the composition of the committee. The auditors, internal auditor, and director in-charge of finance have to attend and participate in the meeting of the committee though they do not have any voting right at the meeting. The committee has to periodically discuss the internal control system, scope of audit including the observations of the auditors, and the half-yearly and annual financial statement reviews with the auditors.

Meetings of the committee have to be held at least three times a year. One meeting has to be held before the finalisation of annual accounts and one every six months.

The powers of the audit committee includes investigation, seeking information from any employees, procuring of legal/professional advice from external sources. The role of the audit committee includes, overseeing the company’s financial reporting process and disclosure of its financial information and recommending appointment/removal of statutory auditors.

The audit committee also reviews the annual financial statements prior to their being placed before the Board. It also examines the adequacy of the internal control system, internal audit function, findings of internal investigation relating to suspected fraud, and the company’s financial and risk management policy. The audit committee looks into the reasons for substantial defaults by the company in payment to depositors, shareholders, creditors, and so on.

The constitution of the audit committee is expected to bring greater transparency and better reporting, thereby making the investors the overall beneficiaries.

The recommendation of the committee on any matter relating to financial management and the audit report is binding on the Board. If the Board does not accept such recommendations, it has to record the reasons for the non-acceptance and communicate them to the shareholders. The chairman of the audit committee attends the annual general meeting of the company to provide any clarification on matters relating to audit.

STOCK DEPOSITORIES

A major development in the Indian capital market has been the setting up of depositories. The objective of a depository is to provide for the maintenance/transfer of ownership records of securities in an electronic book entry form and enable scripless trading in stock exchanges, thereby reducing settlement risk. SEBI has granted registration to two depositories, namely, the National Securities Depository Limited (NSDL) and the Central Depository Services (India) Limited under the Depository Act, 1996.

The following securities are eligible for being held in dematerialised form in a depository:

1. Shares, bonds, debentures, or other marketable securities of a like nature of any incorporated company or other body corporate; and
2. Units of mutual funds, rights under collective investment schemes and venture capital funds, commercial paper, certificates of deposit, securitised debt, money market instruments, government securities and other unlisted securities.

The depository must maintain a continuous electronic means of communication with all its participants, issuers, or issuers’ agents, clearing houses, and clearing corporations of the stock exchanges and with other depositories.

The depository has to satisfy SEBI that it has a mechanism in place to ensure that the interest of the persons buying and selling securities held in the depository are adequately protected. The depository must register the transfer of a security in the name of the transferee only after the depository is satisfied that payment for such a transfer has been made. The fee for registration as a depository is given below.

Payer	Mode of Payment	Amount of Fees
Sponsor or	A demand draft or bankers’ cheque	Application fees (sponsor) Rs 50,000
Depository	payable to SEBI at Mumbai.	Registration fees (depository) Rs 25,00,000 Annual fees (depository) Rs 10,00,000

 

Every depository has to maintain records of securities dematerialised and rematerialised, the names of the transferor, transferee, and the dates of transfer of securities. A register and an index of beneficial owners, details of the holdings of the securities of the beneficial owners as at the end of each day, records of instructions received from and sent to participants, issuers, issuers’ agents, and beneficial owners is to be kept. Other records of approval, notice, entry, and cancellation of pledge or hypothecation, details of participants, details of securities declared to be eligible for dematerialisation in the depository, and other documents necessary for carrying on the activities as a depository has to be kept.

Every depository has to intimate SEBI of the location where the records and documents are maintained. The depository has to preserve records and documents for a minimum period of five years.

Every depository has to extend all such cooperation to the beneficial owners, issuers, issuers’ agents, custodians of securities, other depositories and clearing organisations as is necessary for the effective, prompt, and accurate clearance and settlement of securities’ transactions and conduct of business.

A depository or a participant or any of their employees cannot render, directly or indirectly, any investment advice about any security in the publicly accessible media. In case an employee of the depository or the participant is rendering such advice, disclosure as to the interest of the dependent family members and the employer indicating their long or short position in that security has to be made.

TECHNOLOGY PROVIDERS/INTERNET PROVIDERS

For Internet trading to succeed, it is imperative to have a good business model as well as a comprehensive technology strategy. With net trading in securities and rapid consolidation between multiple stock exchanges, the securities marketplace is fast becoming an international market place. These intermediaries ensure overall satisfactory performance in terms of the trading system, bandwidth, and integration capabilities for efficient performance.

Bandwidth Optimisation

In the Indian context since the availability of a sufficient bandwidth is limited, the application software optimises the available bandwidth by deploying advanced technologies.

Scalability and Robustness of the Trading System

The fundamental difference between the Internet as a transaction medium and the conventional closed user group network is that Internet is a universal platform providing concurrent access to infinite users at any given point in time. Consequently, it becomes imperative for any net-based application to have a proven capability for scalability and robustness which ensures the ability to handle and process requests from multiple users at any given point of time.

Integration with Third Party Systems

A true Internet trading system should deliver cost-effective transaction fulfillment at a single point. In a net-based economy, it is both prudent and essential for a broker/intermediary to offer total solution to the clients at a single point. Total solutions mean offering interfaces with banks, depositories, information feeds, and so on for efficiency in trade completion. The service providers hence go beyond the stage of mere order execution and emerge as information providers.

International marketplaces are already witnessing realignments and changes with the emergence of electronic communication networks (ECNs) such as INSTINET and ISLAND, which are already contributing substantial business volumes to exchanges such as NASDAQ and NYSE. Concurrently, exchanges worldwide are looking at striking strategic alliances such as the Global Equity Market (GEM). Therefore, the challenge for the technology providers is to develop and deploy advanced e-trading tools and applications using electronic straight through processing technologies (STP).

Straight through processing technology permits financial software products to directly interact with the stock exchange system by communicating with the exchange message structures. This is achieved by developing what are known as the application-programming interface (API) that communicates with the central system of the exchange.

Some of the technologies that have already made their mark in the capital market are broadband, narowband technologies, Electronic Communications Network (ECN), and e-Customer Relationship Management (eCRM). These technologies will influence the way online brokers deal with customers, segment their markets, execute financial transactions, enhance their offerings, develop their businesses, diversify their revenue streams, and differentiate themselves from their competitors.

Broadband

Broadband typically consists of two offerings—cable modem and digital subscriber line (DSL). Most consumers can install cable or DSL for around the same price as having a second phone line installed. But the real benefit of these technologies is the speed at which they will be able to deliver to households. DSL and cable will increase connectivity speeds tenfold at least, and by a much higher factor in many cases.

Narrowband

Narrowband refers to any non-broadband connection, such as wireless Internet technology. It means any hardware or software that enables the transmission of data through a wireless network to or from a wireless device such as a mobile phone or personal digital assistant (PDA) such as a palm device or two-way pager.

Electronic Communications Networks

ECNs are large networks set up like large limit order books that “match” stock market orders electronically.

e-Customer Relationship Management

eCRM is a general term for software and services that provide sales force automation, customer service support, Internet-based self-service, email routing and management systems, and so on.

SUMMARY

Market intermediaries bridge the investment gap for the capital market participants, especially investors. Intermediary services that have become essential are the technology support services, stock depositories, auditing bodies, and credit rating agencies.

Brokers, sub-brokers, investment advisors, merchant bankers, and investment banks are the other stock market intermediaries who have rendered valuable assistance to the capital market.

However, with advances in technology, the role of the players such as sub-brokers have become redundant. The online access to market movements have made the marketplace more sophisticated and investors have to be knowledgeable to gain from the market.

CONCEPTS

• Broker	• Sub-broker
• Investment management company	• Merchant bankers
• Credit rating agency	• Depository
• Fund managers	• Online services

SHORT QUESTIONS

1. Who are stock brokers?
2. What is credit rating?
3. What is a mutual fund?
4. What is an online service?
5. What are depositories?

ESSAY QUESTIONS

1. Critically examine the services of stockbrokers.
2. Explain the services provided by depositories.
3. Explain the services provided by credit rating agencies.
4. Explain the characteristics of online services.

APPENDIX

Illustrative Stock Market Service Providers

5Paisa.com: Online trading, live stock quotes, and market research

AKI Finance: Stockbroking and trading

ARK Securities: Stockbroker

Acumen Securities: Online trading, stock quotes, coroporate news, and so on

Advani Share Brokers: Share broking and market research services

Agroy Finance: Online trading, news, views, equity research, and so on

Amit Nalin Securities: Online stockbroker

Anand Rathi Securities: Portfolio management, corporate finance, equity and fixed income brokerage services

Apple Industries: Hire purchase, stockbroking, asset management, and housing finance

BSEwebx: Online stock trading services

Birla Sun Life Securites: Stock broking and security services

Brescon Group: Advisory and broking services

Buy India: Technical anaylsis of Indian stocks

CIL Securities: Stock broking and merchant banking services

CRN India: Trends of stock market, trading tips, chat, and so on

Centaur Financial Services: Stock broking and investment management

Churiwala Securities: Stock trading, quotes, and market analysis

Coimbatore Capital Market Services: Retail clients dealings

Concept Securities: Stock and mutual fund investment services

DSP Merrill Lynch: Investment banking and brokerage services

Dalmia Securities: Stock broking and depository services

Dutt Stock Broking: A brokerage house

Eastern Financiers: Stock broking, bill discounting, NRI investment services, and so on

Equity Gossip: Tips on shares and trading

Equity Trade: Stock trading, company news, and market research

Exponential: Online trading and stock quotes

First Equity Call: Online trading

Gandhi Securities: Stock broking and investment services

Geojit Securities: Stock broking, trading, investment planning, and portfolio management services

Gilt Securities Trading Corporation: Developing active secondary market for government securities

Gogia Capital Services: Stock broking and market analysis

Hasmukh Lalbhai: Stock trading services

Idafa Investments: Stock broking services

India Market Access: Stock broking, portfolio management, and investment banking services

Indira Securities: Share broking services

Integrated Enterprises India: Fund mobilisation, merchant banking, and stock broking serevices

Investnet Securities: Stock broking and portfolio management services

Investsmart India: Personal finance advisory and online brokerage services

J Thomas Investment Services: Stock broking and portfolio advisory services

KBS Capital: Brokerage, corporate finance, and mergers

Kisan Ratilal Choksey Shares: Stock broking and e-trading services

Kotak Securities: Brokerage services and retail distributor of financial securities

Kotak Street.com: Online broking, market news, and stock quotes

LA Funds Investments: Offers investment services to NRIs

Mackertich: Stock broking, taxation, mergers and acquisition advisory services

Madan & Co: Financial consultants and stockbrokers

Manubhai Mangaldas Securities: Stock broking and market analysis

Mata Securities: Debt broking, corporate finance, equities, futures and options.

Moneypore: Investment and broking services

Mont Blamc: Share broking and portfolio advisory services

Motilal Oswal: Online trading, live BSE and NSE quotes

Navia Markets: Stock broking, IPO, and mutual funds services

Parag Parikh: Stock broking and portfolio management

Parsoli Corporation: Investment management and stock trading services

Pratibhuti Viniyog: Stock broking services

Prudential: Investment management services

Pushpdin: Stock prices, market analysis, news and investment consultancy services

Quantum Securities: Broking and portfolio management services

SCICI Securities: Broking and portfolio management services

SSKI Securities: Broking and portfolio management services

Sajag Securities: Services related to secondary markets, personal and corporate finance

Sanchay Finvest: Share trading and investment services

Satco Securities: Stockbrokers

Share Badla: Stock broking services

Share Bajaar: Online share trading brokerage services

Share Trading: Stocks trading and consultancy

Shilpa Securities: Buying and selling of shares and debentures

Sivan Securities: Services related to investment banking and stock broking with a focus on South India.

Skindia Finance: GDR arbitrage, equities, and debt

Smart Investment Consultants: Online trading, stock broking, portfolio management, and so on

Stock Holding Corporation of India: Custody management, safekeeping, and stock broking services

Stock Markit.com: Stock quotes, news, market indicators, and so on

Stockmanta: Stock quotes and online trading

Stotz Blacksmith: Stock broking and online trading

Sunidhi Consultancy: Stock broking, portfolio management, and equity research

Swapnil Securities: Stock lending, retail broking, and portfolio management

Sykes and Ray Equities: Services related to retail segment of secondary market stock broking activity.

Tata TD Waterhouse: Online trading, research and news

Techno Shares: Stock broking and portfolio management

Trading Pundit: Stock quotes, trading, and news

ULJK Securities: Stock trading and mutual fund investment services

UTI Securities: Securities broking, investment banking, and equity research services

VJR Group: Stock broking and investment banking services

Valia Consultancy: Stock investment and trading consultancy

Way2Wealth: Trading, mutual funds, and investment services

Yatish Securities: Stock trading services