An Introduction to the Indian Stock Market The BSE and NSE

Dr Ritesh Srivastava

Most of the trading in the Indian stock market takes place on its two stock
exchanges: the Bombay Stock Exchange (BSE) and the National Stock
Exchange (NSE). The BSE has been in existence since 1875. The NSE, on the
other hand, was founded in 1992 and started trading in 1994. However, both
exchanges follow the same trading mechanism, trading hours, settlement process,
etc. At the last count, the BSE had about 4,700 listed firms, whereas the rival NSE
had about 1,200. Out of all the listed firms on the BSE, only about 500 firms
constitute more than 90% of its market capitalization; the rest of the crowd consists
of highly illiquid shares.
Almost all the significant firms of India are listed on both the exchanges. NSE
enjoys a dominant share in spot trading, with about 70% of the market share, as of
2009, and almost a complete monopoly in derivatives trading, with about a 98%
share in this market, also as of 2009. Both exchanges compete for the order flow
that leads to reduced costs, market efficiency and innovation. The presence
of arbitrageurs keeps the prices on the two stock exchanges within a very tight
range.
Trading at both the exchanges takes place through an open electronic limit order
book, in which order matching is done by the trading computer. There are
no market makers or specialists and the entire process is order-driven, which
means that market orders placed by investors are automatically matched with the
best limit orders. As a result, buyers and sellers remain anonymous. The advantage
of an order driven market is that it brings more transparency, by displaying all buy
and sell orders in the trading system. However, in the absence of market makers,
there is no guarantee that orders will be executed.
All orders in the trading system need to be placed through brokers, many of which
provide online trading facility to retail customers. Institutional investors can also
take advantage of the direct market access (DMA) option, in which they use
trading terminals provided by brokers for placing orders directly into the stock
market trading system. (For more, read Brokers And Online Trading: Accounts
And Orders.)
Settlement Cycle and Trading Hours
Equity spot markets follow a T+2 rolling settlement. This means that any trade
taking place on Monday, gets settled by Wednesday. All trading on stock
exchanges takes place between 9:55 am and 3:30 pm, Indian Standard Time (+ 5.5
hours GMT), Monday through Friday. Delivery of shares must be made in
dematerialized form, and each exchange has its own clearing house, which
assumes all settlement risk, by serving as a central counterparty.
Market Indexes
The two prominent Indian market indexes are Sensex and Nifty. Sensex is the
oldest market index for equities; it includes shares of 30 firms listed on the BSE,
which represent about 45% of the index’s free-float market capitalization. It was
created in 1986 and provides time series data from April 1979, onward.
Another index is the S&P CNX Nifty; it includes 50 shares listed on the NSE,
which represent about 62% of its free-float market capitalization. It was created in
1996 and provides time series data from July 1990, onward. (To learn more about
Indian stock exchanges please go to http://www.bseindia.com/ and http://www.nseindia.com/.)
Market Regulation
The overall responsibility of development, regulation and supervision of the stock
market rests with the Securities & Exchange Board of India (SEBI), which was
formed in 1992 as an independent authority. Since then, SEBI has consistently
tried to lay down market rules in line with the best market practices. It enjoys vast
powers of imposing penalties on market participants, in case of a breach.
Who Can Invest In India?
India started permitting outside investments only in the 1990s. Foreign
investments are classified into two categories: foreign direct investment (FDI)
and foreign portfolio investment (FPI). All investments in which an investor takes
part in the day-to-day management and operations of the company, are treated as
FDI, whereas investments in shares without any control over management and
operations, are treated as FPI.
For making portfolio investment in India, one should be registered either as
a foreign institutional investor (FII) or as one of the sub-accounts of one of the
registered FIIs. Both registrations are granted by the market regulator, SEBI.
Foreign institutional investors mainly consist of mutual funds, pension funds,
endowments, sovereign wealth funds, insurance companies, banks, asset
management companies etc. At present, India does not allow foreign individuals to
invest directly into its stock market. However, high-net-worth individuals (those
with a net worth of at least $US50 million) can be registered as sub-accounts of an
FII.
Foreign institutional investors and their sub accounts can invest directly into any of
the stocks listed on any of the stock exchanges. Most portfolio investments consist
of investment in securities in the primary and secondary markets, including
shares, debentures and warrants of companies listed or to be listed on a recognized
stock exchange in India. FIIs can also invest in unlisted securities outside stock
exchanges, subject to approval of the price by the Reserve Bank of India. Finally,
they can invest in units of mutual funds and derivatives traded on any stock
exchange.
An FII registered as a debt-only FII can invest 100% of its investment into debt
instruments. Other FIIs must invest a minimum of 70% of their investments in
equity. The balance of 30% can be invested in debt. FIIs must use special nonresident rupee bank accounts, in order to move money in and out of India. The
balances held in such an account can be fully repatriated.
Restrictions/Investment Ceilings
The government of India prescribes the FDI limit and different ceilings have been
prescribed for different sectors. Over a period of time, the government has been
progressively increasing the ceilings. FDI ceilings mostly fall in the range of 26-
100%
Investment Opportunities for Retail Foreign Investors
Foreign entities and individuals can gain exposure to Indian stocks through
institutional investors. Many India-focused mutual funds are becoming popular
among retail investors. Investments could also be made through some of
the offshore instruments, like participatory notes (PNs) and depositary receipts,
such as American depositary receipts (ADRs), global depositary receipts (GDRs),
and exchange traded funds (ETFs) and exchange-traded notes (ETNs).
As per Indian regulations, participatory notes representing underlying Indian
stocks can be issued offshore by FIIs, only to regulated entities. However, even
small investors can invest in American depositary receipts representing the
underlying stocks of some of the well-known Indian firms, listed on the New York
Stock Exchange and Nasdaq. ADRs are denominated in dollars and subject to the
regulations of the U.S. Securities and Exchange Commission (SEC). Likewise,
global depositary receipts are listed on European stock exchanges. However, many
promising Indian firms are not yet using ADRs or GDRs to access offshore
investors.
Retail investors also have the option of investing in ETFs and ETNs, based on
Indian stocks. India ETFs mostly make investments in indexes made up of Indian
stocks. Most of the stocks included in the index are the ones already listed on
NYSE and Nasdaq. As of 2009, the two most prominent ETFs based on Indian
stocks are the Wisdom-Tree India Earnings Fund (NYSE: EPI
The Bottom Line
Emerging markets like India, are fast becoming engines for future growth.
Currently, only a very low percentage of the household savings of Indians are
invested in the domestic stock market, but with GDP growing at 7-8% annually
and a stable financial market, we might see more money joining the race. Maybe
it’s the right time for outside investors to seriously think about joining the India