Securities are financial instruments that allow entities to raise capital and enable investors to allocate their surplus funds into predefined investment options. These instruments are structured under regulatory frameworks, offer specific financial features, and are generally liquid in secondary markets. The two primary categories of securities used by capital seekers are equity and debt. When a business needs funds to operate or grow, it must decide between these two.
Equity capital is perpetual. Once invested, the company can use it indefinitely without the obligation to repay. In contrast, debt capital must be returned after a certain period. Equity investors do not have fixed returns or assurance of their principal, whereas debt investors are entitled to regular interest payments and the return of principal upon maturity. Equity holders are considered owners, while debt holders are creditors. This fundamental difference makes equity and debt distinctly separate asset classes. Equity involves higher risk and higher potential returns, while debt provides lower but more stable returns.
Equity investments carry ownership rights, giving shareholders a say in company matters and allowing participation in profits. However, returns are not guaranteed and are tied to the performance of the underlying business. The equity investor’s gains are theoretically unlimited, but losses can also be substantial. In contrast, debt investments are structured to offer fixed returns. Provided the issuing entity does not default, the debt investor receives consistent income. Because equity holders are residual claimants, any surplus earnings after all expenses, including interest payments, benefit them.
For instance, if a company borrows funds at a 12 percent interest rate and earns 14 percent on the investment of those funds, debt investors receive the agreed 12 percent. The extra 2 percent benefits the equity holders. If returns are below the cost of borrowing, the equity holders absorb the shortfall. Therefore, choosing between equity and debt represents a trade-off between risk and return. Conservative investors seeking steady returns typically choose debt, while those aiming for higher returns with a higher tolerance for risk often favor equity. Most investors balance these investments through asset allocation strategies based on their time horizons, risk profiles, and financial goals.
Other Investment Classes Beyond Equity and Debt
While equity and debt are the most commonly known securities, there are additional investment products that serve a variety of purposes and investor preferences. Each has a unique risk-return profile and is suitable for different investor segments.
Hybrid securities are instruments that combine features of both equity and debt. These can offer fixed returns like debt but also provide potential participation in profits or capital gains. Commodities refer to real assets like gold, silver, or agricultural produce. Investment in commodities can occur through direct ownership or through financial products like commodity mutual funds, exchange-traded funds, or derivatives. These financial instruments provide exposure to commodities without requiring physical possession. Retail investors often use commodity ETFs or mutual funds as they are more accessible.
Derivatives are contracts whose value is derived from an underlying asset, such as equities, commodities, or interest rates. They include futures, options, and swaps. Derivatives are heavily traded and offer opportunities for speculation, hedging, or arbitrage. However, due to their complexity and risk, they are better suited for sophisticated investors. Mutual funds pool capital from many investors and invest it across various asset classes, such as debt, equity, or hybrids, depending on their stated mandate. They are considered ideal for retail investors who lack the time, knowledge, or resources to manage a diversified portfolio independently.
Structured products are investment instruments based on a traditional asset, often with embedded derivatives that enhance returns or provide specific payoffs. These can be based on bonds, currencies, or commodities. Due to their customized and often illiquid nature, they are more suitable for high-net-worth individuals with the ability to understand and absorb higher risks.
Distressed securities are issued by companies experiencing financial difficulty, including those in bankruptcy or with a drastically reduced credit rating. These can include bonds, equity shares, or other liabilities. Since traditional investors like banks and mutual funds are often restricted from investing in low-rated or defaulted securities, distressed assets may trade at deep discounts. Specialized investors such as hedge funds target these securities, expecting a turnaround or successful restructuring. However, this asset class demands advanced financial analysis and risk assessment skills and is not suitable for typical retail investors.
Electronic Gold Receipts, or EGRs, are digital representations of physical gold. They allow investors to trade, settle, and eventually convert the receipts into physical gold. These instruments are traded on specially designed exchanges and are backed by regulatory frameworks ensuring quality and secure custody. EGRs offer a convenient method for retail investors to gain exposure to gold without dealing with the logistics of physical storage. Their ecosystem is regulated to include creation, trading, and conversion mechanisms, ensuring transparency and investor protection.
Equity and Debt Financing Choices for Issuers
Entities like companies or governments raise funds through securities for two primary reasons. First is the need for working capital, which refers to funds used for daily operations like salaries, raw materials, and vendor payments. The second is long-term capital, which finances infrastructure, acquisitions, or large-scale expansion. Governments also require funds for similar short- and long-term needs, such as running departments or building public infrastructure.
Short-term financial requirements are generally addressed through the issuance of debt securities like commercial papers or treasury bills. Long-term capital can be raised through either equity or debt. Governments typically issue only debt securities, while companies have the option to choose between both, depending on strategic and financial considerations.
The ability of the business to make regular interest payments plays a crucial role in this decision. If a company generates consistent revenue and profit, it may choose debt to avoid ownership dilution. Debt is particularly attractive because interest payments are tax-deductible, thus reducing the cost of capital. On the other hand, if profitability is unstable or if the company lacks reliable revenue streams, equity financing may be more appropriate as it does not require fixed payments.
Ownership dilution is another major factor. Raising equity means issuing new shares, which reduces the percentage ownership of existing shareholders. Companies where promoters want to retain control often prefer debt financing. However, not all companies can access debt capital easily. Lenders usually require collateral, and service-oriented or early-stage companies may not have sufficient tangible assets to offer as security. In such cases, equity becomes the preferred mode of raising capital.
The duration for which capital is required also determines the choice. For short-term needs, debt financing is common, while for long-term strategic initiatives, companies may choose equity, especially if the returns are not immediate or if lenders are unwilling to commit to long tenures.
Features and Nature of Equity Capital
Equity capital represents ownership in a business. Investors who provide equity capital accept the inherent risk of business operations and uncertain profitability. In return, they gain a stake in the company and potential future earnings. Equity capital is raised by issuing shares with a nominal face value, typically Rs. 1, Rs. 2, Rs. 5, or Rs. 10 per share. Investors become shareholders and collectively own the company. These companies are called joint stock companies because ownership is divided among numerous equity shareholders.
There are two main categories of shareholders. Promoters and institutional investors who invest early are considered inside shareholders. The general public who invests in public issues or through secondary markets is outside shareholders. A shareholder’s ownership is proportional to the number of shares held. For instance, if 10,000 equity shares exist and a promoter holds 5,100 of them, that represents a 51 percent or majority stake. Some companies incentivize employees through Employee Stock Option Plans, giving them an ownership interest in the business and aligning their efforts with company success.
Equity shareholders receive variable returns in the form of dividends. These are paid only if the company generates surplus profit after meeting all other obligations. The amount and frequency of dividends are not guaranteed. Shareholders are last in line when profits or liquidation proceeds are distributed. Government dues, lenders, employees, and preference shareholders are paid before equity holders. Equity capital is perpetual, not expected to be returned during the business’s operational life.
Companies are not obligated to pay dividends annually. In rapidly growing businesses, profits are often reinvested instead of being distributed. These retained earnings increase the company’s reserves, indirectly enhancing shareholder wealth. Retained profits become part of the company’s net worth and are reflected in higher share values. This reinvestment strategy aligns to maximize long-term shareholder value.
Because there is no assured return, equity capital is also called risk capital. Investors take on the possibility of complete loss in exchange for potential high returns if the business succeeds. This dynamic contributes to the volatile nature of stock prices. Share prices are influenced by a range of factors, including company performance, industry trends, and macroeconomic conditions. These factors lead to daily fluctuations, reflecting market perceptions and investor sentiment.
Management and control of the company initially rest with the promoters. As the company grows and shares are sold to public investors, ownership becomes dispersed. It becomes impractical for all shareholders to be involved in daily operations. Instead, the business is managed by a professional board of directors, including independent directors who represent public shareholders. Shareholders retain voting rights and influence major corporate decisions through general meetings or electronic voting platforms.
Equity Capital Variants and Special Types
Companies can issue different types of equity capital. The most common are ordinary shares with full voting rights. Another type includes equity shares with differential voting rights. These shares separate profit participation from control. DVR shareholders receive higher dividends but have limited voting power. This mechanism allows promoters to raise funds without relinquishing significant control.
Preference shares form a special category of equity. They offer a fixed dividend rate and have priority over common equity in terms of dividend payments and capital return in the event of company liquidation. However, they lack voting rights and are not secured by company assets. Preference shares resemble debt instruments due to fixed payouts but are treated as equity because they do not represent a borrowing obligation.
Unlike bonds, the interest on debentures is an expense deducted before profit calculation and taxation. Preference share dividends are paid only from post-tax residual profits. These shares do not offer returns tied to the company’s overall performance, and their market value does not significantly fluctuate. Preference shares may carry cumulative rights, where unpaid dividends accumulate and are paid in the future if company profits allow.
Features of Securities
Securities are complex instruments, but they generally share several common features that distinguish them within financial systems. One of the primary characteristics of securities is that they represent an ownership or creditor relationship with an entity. This can either be in the form of equity (ownership in a company) or debt (a creditor relationship with an issuer). Securities are standardized financial instruments, which means they are issued with specific terms, including face value, maturity date, and interest or dividend payment schedules. Another essential feature is their transferability. Securities can be bought or sold in secondary markets, allowing for liquidity and flexibility. This transferability provides investors with an exit strategy and enhances the attractiveness of these instruments. Most securities are issued in dematerialized form, ensuring easier transfer and custody through electronic platforms. Transparency is another important feature. Regulatory bodies require issuers to disclose necessary financial information to help investors make informed decisions. This includes periodic reports, disclosures on material events, and risk factors. This transparency builds investor confidence and promotes fair dealing in capital markets. Furthermore, securities are subject to market risk. Their prices fluctuate based on market dynamics, including economic indicators, interest rates, geopolitical events, and company-specific news. Therefore, securities carry a certain degree of risk, which investors must assess before making investment decisions. Additionally, securities can be categorized by their tenure. Some have short-term maturity (like Treasury bills), while others are long-term instruments (like bonds or equity shares with indefinite tenure). Depending on the type, some securities offer fixed income (e.g., bonds), while others provide variable returns (e.g., equity dividends). Lastly, securities serve different purposes. While some are used to raise capital, others serve as investment vehicles or instruments for hedging risk. Understanding these features is crucial for investors, financial analysts, and regulators to assess the suitability and performance of various securities.
Primary and Secondary Market Concepts
Securities are traded in two principal markets: the primary market and the secondary market. The primary market, also known as the new issue market, is where securities are issued and sold for the first time. This is the market through which corporations, governments, and other entities raise capital by issuing new financial instruments. When a company issues new shares through an Initial Public Offering (IPO), it does so in the primary market. In this market, investors purchase securities directly from the issuer. The funds raised go directly to the issuing entity, making the primary market essential for capital formation in the economy. Several methods are used in the primary market, including public issues, rights issues, and private placements. Public issues involve offering securities to the general public, whereas rights issues are made to existing shareholders. Private placements involve selling securities to a select group of investors, such as institutional investors. Once securities are issued in the primary market, they begin to trade in the secondary market. The secondary market is where investors buy and sell previously issued securities. Unlike the primary market, transactions in the secondary market do not involve the issuer directly. Instead, the exchange of ownership occurs between investors. The most well-known examples of secondary markets are stock exchanges such as the New York Stock Exchange (NYSE), the London Stock Exchange (LSE), and others. The secondary market provides liquidity, which is essential for investors who want the flexibility to enter or exit positions. It also facilitates price discovery, as securities prices are determined through market supply and demand dynamics. The presence of an efficient secondary market boosts investor confidence and encourages participation in the primary market. Trading in the secondary market can occur through organized exchanges or over-the-counter (OTC) platforms. Exchange trading offers transparency and regulatory oversight, while OTC trading provides customization and flexibility, especially for less liquid or complex securities.
Regulatory Framework of Securities
The regulation of securities is essential for the stability and efficiency of financial markets. Securities regulation serves several objectives: protecting investors, ensuring fair and efficient markets, maintaining market integrity, and reducing systemic risk. In most countries, there is a dedicated regulatory authority that oversees the securities markets. For instance, in the United States, the Securities and Exchange Commission (SEC) is responsible for enforcing securities laws and regulating market participants. In India, the Securities and Exchange Board of India (SEBI) performs a similar function. These regulatory bodies are empowered by law to issue rules, monitor compliance, and take enforcement actions against violators. Securities laws typically require issuers to disclose accurate and timely information about their financial performance, business operations, and risk factors. This disclosure enables investors to make informed decisions. Public companies must file quarterly and annual reports, and any significant corporate events must be reported immediately. Regulation also extends to market intermediaries such as brokers, dealers, investment advisors, and asset managers. These entities must register with the regulator, adhere to conduct standards, and maintain adequate capital and internal controls. Regulatory oversight helps ensure that intermediaries act in the best interest of their clients and maintain market fairness. Insider trading regulations are also critical. They prevent individuals with non-public material information from trading securities, ensuring that no investor has an unfair advantage. Market manipulation, such as spreading false information to influence prices or executing trades to mislead the market, is also strictly prohibited. Another key area is investor protection mechanisms. Regulators often establish investor education programs, complaint redressal systems, and compensation schemes to support retail investors. Regulatory frameworks are also evolving with technological advancements. The rise of algorithmic trading, digital assets, and decentralized finance (DeFi) presents new regulatory challenges, requiring updated policies and international cooperation. Regulatory compliance is enforced through audits, surveillance, investigations, and penalties. Non-compliance can result in fines, suspensions, or criminal proceedings. Thus, the regulatory framework plays a foundational role in maintaining trust and stability in the securities market.
Risks Associated with Securities
Investing in securities involves various types of risk that can impact returns and capital preservation. Understanding these risks is essential for investors to make informed decisions and develop risk management strategies. Market risk is the most common type and refers to the possibility of losing money due to changes in market prices. Factors such as economic downturns, political instability, interest rate changes, and global events can cause securities prices to fluctuate. Equity securities are particularly susceptible to market risk due to their volatility. Credit risk, or default risk, is especially relevant for debt securities. It is the risk that the issuer will fail to meet its debt obligations, such as paying interest or repaying principal. Investors must assess the creditworthiness of issuers using credit ratings and financial analysis. Government bonds generally have lower credit risk compared to corporate bonds. Interest rate risk affects both debt and equity securities. For fixed-income securities like bonds, rising interest rates can lead to a decline in market value, as newer issues offer higher yields. For equities, higher interest rates can impact corporate profits and investor sentiment. Liquidity risk arises when it is difficult to buy or sell a security without affecting its price significantly. Thinly traded securities or those in niche markets may have limited buyers and sellers, leading to price inefficiencies. Inflation risk is the erosion of purchasing power due to rising prices. If the returns on securities do not keep pace with inflation, the real value of investments declines. This is particularly concerning for fixed-income investors who receive constant returns. Currency risk applies to international investments. Fluctuations in exchange rates can affect the value of foreign securities when converted to the investor’s domestic currency. This risk is prominent in emerging markets or during periods of economic instability. Regulatory risk is the possibility of adverse changes in laws or regulations that can impact the value or viability of a security. For instance, new tax laws, environmental regulations, or trade restrictions can affect company performance. Operational risk involves losses due to failures in internal systems, processes, or external events. For example, cybersecurity breaches or technology failures in trading systems can disrupt operations and affect investor confidence. Reinvestment risk affects fixed-income investors who may not be able to reinvest proceeds from interest or principal at the same favorable rates as the original investment. Understanding these risks allows investors to diversify portfolios, conduct proper due diligence, and use risk mitigation tools like hedging or insurance.
Regulatory Framework of Securities in India
In India, the regulation of securities is governed by a robust legal and institutional framework. The primary legislation is the Securities Contracts (Regulation) Act, 1956, along with the SEBI Act, 1992. The Securities and Exchange Board of India (SEBI) is the key regulatory authority established to protect investors and to develop and regulate the securities market. SEBI’s powers include registering and regulating stockbrokers, sub-brokers, merchant bankers, and others involved in the market. It also oversees the functioning of stock exchanges and ensures transparency, fairness, and efficiency in the securities market. SEBI also plays a vital role in investor education and grievance redressal.
Another crucial component of the regulatory framework is the Companies Act, 2013, which contains provisions related to the issue, allotment, and transfer of securities by companies. The Reserve Bank of India (RBI) also plays an important role in regulating government securities and corporate bonds through monetary policy and the management of the Public Debt Office. The Income Tax Act also has a bearing on securities through tax provisions that influence investor behavior.
Regulations concerning listing, delisting, disclosures, insider trading, takeover codes, and the prohibition of fraudulent practices are all designed to maintain market integrity. The Depositories Act, 1996, provides a legal framework for the electronic maintenance and transfer of securities, replacing the erstwhile physical certificates. This act paved the way for the establishment of depositories like NSDL and CDSL, which work closely with SEBI to ensure dematerialization and seamless settlement.
Securities Market Participants
The securities market comprises several key participants, each playing a vital role in its efficient functioning. The primary participants include issuers, investors, intermediaries, and regulators. Issuers are entities such as governments and corporations that raise funds by issuing securities. Investors can be individuals, mutual funds, banks, insurance companies, or foreign institutional investors seeking returns on their investments.
Intermediaries in the securities market include stockbrokers, sub-brokers, merchant bankers, portfolio managers, investment advisers, registrars, underwriters, and custodians. These entities are responsible for facilitating transactions, offering expert advice, underwriting issues, and ensuring compliance with regulatory norms. Depositories and their participants also play a crucial role in holding securities in dematerialized form and enabling efficient transfer and settlement.
Stock exchanges like the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) provide a platform for trading securities and are regulated by SEBI. Clearing corporations associated with these exchanges ensure the timely settlement of trades and manage counterparty risk. Credit rating agencies assess the creditworthiness of issuers and their securities, providing critical information for investors.
Regulatory bodies like SEBI, RBI, and the Ministry of Corporate Affairs work together to ensure orderly conduct in the market. SEBI supervises the functioning of all intermediaries and ensures investor protection, while RBI manages the issuance and trading of government securities. The judiciary also plays a role in interpreting securities law and resolving disputes.
Primary and Secondary Markets
The securities market is divided into two main segments: the primary market and the secondary market. The primary market, also known as the new issue market, is where new securities are issued and sold to investors for the first time. This market helps issuers raise fresh capital for expansion, diversification, or debt repayment. Instruments issued in the primary market include initial public offerings (IPOs), follow-on public offerings (FPOs), rights issues, and private placements.
In the primary market, companies issue securities directly to investors through various mechanisms. IPOs are widely used by companies to raise equity capital from the public. Book building is a popular method for price discovery in IPOs, where bids are collected from investors within a price band. Rights issues offer existing shareholders the opportunity to purchase additional shares at a discounted price. Private placements are offerings made to a select group of investors, often institutions, without a public offering.
Once the securities are issued in the primary market, they become eligible for trading in the secondary market, which is also known as the stock market. The secondary market provides liquidity to investors, allowing them to buy and sell securities at prevailing market prices. The major secondary markets in India include the BSE and NSE, where securities are traded electronically through an order-driven system.
The secondary market helps in price discovery based on demand and supply dynamics. It also facilitates portfolio diversification and wealth creation for investors. The presence of a robust secondary market ensures investor confidence and efficient allocation of capital in the economy. The performance of the secondary market is often considered a barometer of a country’s economic health.
Dematerialization and Depositories
Dematerialization is the process of converting physical certificates of securities into electronic form. This system was introduced in India to address issues related to the handling of paper certificates, such as theft, loss, forgery, and delayed transfer. Dematerialization has significantly enhanced the efficiency, safety, and convenience of trading and holding securities.
The Depositories Act, 1996, laid the foundation for the dematerialized system in India. Two major depositories, the National Securities Depository Limited (NSDL) and the Central Depository Services (India) Limited (CDSL), facilitate this process. These depositories hold securities in electronic form on behalf of investors and enable the transfer and settlement of securities through electronic book entries.
To hold securities in a dematerialized form, investors must open a demat account with a depository participant (DP), who acts as an intermediary between the investor and the depository. The demat account is similar to a bank account but is used to hold securities instead of money. Transactions in securities, such as buying or selling shares, are reflected in the investor’s demat account.
Dematerialization has numerous advantages. It eliminates the risks associated with physical certificates, ensures faster settlement of trades, reduces paperwork, and lowers transaction costs. It also facilitates online trading, portfolio tracking, and automated crediting of corporate benefits like dividends and bonus shares. The system has played a crucial role in modernizing the Indian securities market and aligning it with global standards.
Trading and Settlement Mechanism
The trading and settlement mechanism in the securities market ensures that buy and sell transactions are executed efficiently and settled smoothly. Trading in the secondary market takes place through electronic platforms provided by stock exchanges. Orders are placed by investors through brokers, and these are matched based on price-time priority in an order-driven system.
Trades are executed in real time, and once a trade is matched, it results in an obligation for settlement. The settlement process involves the transfer of securities from the seller to the buyer and the transfer of funds from the buyer to the seller. In India, the settlement cycle follows a T+1 system, which means the trade is settled one business day after the trade date.
Clearing corporations like the National Securities Clearing Corporation Limited (NSCCL) and the Indian Clearing Corporation Limited (ICCL) play a vital role in the settlement process. They act as central counterparties to all trades, ensuring that both parties fulfill their obligations. These corporations manage counterparty risk by guaranteeing settlement and maintaining margin requirements.
The settlement of trades in the dematerialized environment is carried out through the depositories. Once the clearing corporation determines the net obligations, securities are debited from the seller’s demat account and credited to the buyer’s account. Simultaneously, funds are transferred through clearing banks. The entire process is designed to be seamless, secure, and transparent.
The trading and settlement mechanism is governed by SEBI regulations and is supported by robust technological infrastructure. Continuous improvements in this mechanism, such as the introduction of straight-through processing (STP), have enhanced operational efficiency and reduced settlement risk. The aim is to move toward near-instantaneous settlement cycles in the future.
Dematerialization of Securities
Dematerialization refers to the process of converting physical certificates of securities into electronic form. This transition has revolutionized the way securities are held and traded, significantly improving efficiency and reducing risks.
In a dematerialized environment, securities are maintained in an electronic account with a depository participant (DP), much like funds in a bank account. Investors no longer need to worry about physical damage, theft, or forgery of certificates.
The process begins when an investor opens a demat account with a registered depository participant. The investor then submits their physical share certificates along with a dematerialization request form (DRF). The DP sends these documents to the company’s registrar, who verifies and approves the conversion. Once confirmed, the securities are credited electronically to the investor’s demat account.
Dematerialization has led to faster settlements, simplified trading, and increased transparency. It is now a mandatory requirement for trading in most securities on major stock exchanges in India and many other jurisdictions.
Rematerialization of Securities
Rematerialization is the reverse of dematerialization. It involves converting securities held in electronic form back into physical certificates. Although rare in modern financial markets, rematerialization is permitted in certain cases, particularly when investors prefer holding securities in physical form or due to specific regulatory reasons.
To initiate rematerialization, the investor submits a rematerialization request form (RRF) to their DP. The depository processes the request and informs the issuer or the registrar. The registrar then issues physical certificates to the investor.
This process is usually slower and less efficient than electronic holding. It also reintroduces risks like physical loss or theft. As a result, very few investors opt for rematerialization unless necessary.
Role of Depositories and Depository Participants
Depositories are institutions that hold securities in electronic form and facilitate transactions through book entries. In India, the two main depositories are the National Securities Depository Limited (NSDL) and the Central Depository Services (India) Limited (CDSL).
Depository Participants (DPs) act as intermediaries between the investor and the depository. They are authorized entities like banks, brokers, or financial institutions, through which investors can access depository services.
The functions of depositories include dematerialization and rematerialization of securities, settlement of trades, transfer of ownership, pledge and hypothecation of securities, and updating corporate actions such as dividends and bonus issues.
The benefits of the depository system include reduced paperwork, increased speed of transfer, lower transaction costs, and enhanced safety. This system is a cornerstone of modern securities markets, enabling seamless and secure trading.
Pledging of Securities
Pledging of securities refers to using securities as collateral to secure a loan or credit facility. Investors, particularly those trading on margin or requiring liquidity, often pledge their securities to banks or brokers.
To pledge securities, the investor initiates a request with their DP. The DP marks the securities as pledged in the investor’s demat account and informs the depository. The lender then verifies the pledge and approves the loan. Once the loan is repaid, the pledge is released, and the securities become free again.
Pledging allows investors to access funds without selling their securities. However, in case of default, the lender has the right to sell the pledged securities to recover the outstanding amount.
Hypothecation of Securities
Hypothecation is similar to pledging but differs in the sense that the borrower retains ownership and possession of the securities. It is more common in movable assets like vehicles and inventory, but in financial markets, the concept applies when securities are used as collateral without transferring possession.
In hypothecation, a charge is created in favor of the lender, but the borrower can continue to hold and manage the securities. If the borrower defaults, the lender must go through legal channels to enforce the charge and recover the dues.
Though less common in securities compared to pledging, hypothecation plays a role in more complex financial arrangements or structured finance deals.
Fungibility of Securities
Fungibility refers to the interchangeability of securities. In a dematerialized environment, one unit of security is indistinguishable from another of the same kind. For example, all shares of a particular company in electronic form are identical and can be traded without regard to their original certificate numbers.
Fungibility enhances liquidity and market efficiency. It eliminates the need for investors to specify which particular certificate is being sold or transferred. This standardization simplifies settlement processes and reduces administrative burdens.
Non-fungible securities, on the other hand, are unique and not interchangeable, such as certain debt instruments with specific terms or non-fungible tokens (NFTs) in digital markets.
Transfer and Transmission of Securities
Transfer of securities refers to the voluntary change in ownership due to a sale or gift. In dematerialized form, transfer happens through electronic book entries initiated by the DP based on instructions from the investor.
Transmission of securities occurs upon the death of the holder. It is an involuntary process, where the ownership is transferred to the legal heir or nominee. The process involves submission of legal documents like the death certificate, succession certificate, or probate of will, depending on the case.
Unlike transfers, transmissions are not subject to capital gains tax since there is no sale or consideration involved. The legal heir becomes the new holder and can then choose to hold or sell the securities.
Lien on Securities
A lien is a legal claim on securities granted to a creditor to secure the payment of a debt or performance of an obligation. In the securities market, a lien may be exercised by a broker or a financial institution to cover unpaid dues or trading losses.
If a lien is marked on securities, the investor cannot sell or transfer them until the lien is removed. In case of default, the creditor can enforce the lien and liquidate the securities to recover the outstanding amount.
Duly marking a lien requires agreement from the investor and proper documentation. It must also be recorded with the DP to prevent unauthorized transfers.
Corporate Actions and Entitlements
Corporate actions are decisions taken by a company that affect its securities and shareholders. These include dividends, bonus shares, rights issues, stock splits, mergers, and acquisitions.
When a company announces a corporate action, the depository updates the records and credits entitlements to the investors’ demat accounts. For example, in the case of a dividend, the cash is directly credited to the shareholder’s bank account linked to the demat account.
Entitlements refer to the benefits arising from corporate actions. Investors must hold the securities on the record date announced by the company to be eligible. In a dematerialized environment, the process is automatic and efficient.
SEBI Regulations on Securities Market
The Securities and Exchange Board of India (SEBI) is the regulator of the securities market in India. It formulates rules and guidelines to protect investors and ensure the orderly development of the market.
SEBI has framed several regulations covering various aspects of the market, such as:
- SEBI (Depositories and Participants) Regulations
- SEBI (Listing Obligations and Disclosure Requirements) Regulations
- SEBI (Prohibition of Insider Trading) Regulations
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations
- SEBI (Issue of Capital and Disclosure Requirements) Regulations
These regulations govern the functioning of issuers, stock exchanges, intermediaries, and investors. SEBI also monitors market behavior, investigates violations, and imposes penalties when required.
Compliance with SEBI norms is mandatory for all entities operating in the securities market. It enhances transparency, reduces systemic risks, and fosters investor confidence.
Securities Appellate Tribunal (SAT)
The Securities Appellate Tribunal is a quasi-judicial body that hears appeals against orders passed by SEBI or other adjudicating authorities under securities laws. It provides a forum for fair and speedy resolution of disputes.
Any person aggrieved by a SEBI order can appeal to SAT within a specified time. The tribunal has the power to confirm, modify, or set aside the SEBI order. Its decisions can further be appealed in the Supreme Court of India.
SAT plays a critical role in upholding accountability and ensuring that SEBI’s actions are subject to judicial scrutiny. It promotes the rule of law in the securities market.
Conclusion
Securities play a vital role in the modern financial system. They provide a mechanism for raising capital, investing savings, and facilitating trade. With the advent of dematerialization and regulatory oversight, the securities market has become more efficient, transparent, and accessible.
Understanding the types, features, and associated processes such as dematerialization, pledging, transmission, and regulatory frameworks is essential for anyone participating in the market. A well-informed investor is better equipped to make sound decisions, manage risks, and optimize returns.