Screen Based Trading: The trading on stock exchanges in India used to take place through open outcry

without use of information technology for immediate matching or recording of trades. This was time
consuming and inefficient. This imposed limits on trading volumes and efficiency. In order to provide
efficiency, liquidity and transparency, NSE introduced a nation wide on-line fully-automated screen
based trading system (SBTS) where a member can punch into the computer quantities of securities and
the prices at which he likes to transact and the transaction is executed as soon as it finds a matching sale
or buy order from a counter party. SBTS electronically matches orders on a strict price/time priority and
hence cuts down on time, cost and risk of error, as well as on fraud resulting in improved operational
efficiency. It allows faster incorporation of price sensitive information into prevailing prices, thus
increasing the informational efficiency of markets. It enables market participants to see the full market
on real-time, making the market transparent. It allows a large number of participants, irrespective of
their geographical locations, to trade with one another simultaneously, improving the depth and
liquidity of the market. It provides full anonymity by accepting orders, big or small, from members
without revealing their identity, thus providing equal access to everybody. It also provides a perfect
audit trail, which helps to resolve disputes by logging in the trade execution process in entirety. This
diverted liquidity from other exchanges and in the very first year of its operation, NSE became the
leading stock exchange in the country, impacting the fortunes of other exchanges and forcing them to
adopt SBTS also. As a result, manual trading disappeared from India. Technology was used to carry the
trading platform to the premises of brokers. NSE carried the trading platform further to the PCs in the
residences of investors through the Internet and to hand-held devices through WAP for convenience of
mobile investors. This made a huge difference in terms of equal access to investors in a geographically
vast country like India. Trading Cycle: The trades accumulated over a trading cycle and at the end of the
cycle, these were clubbed together, and positions were netted out and payment of cash and delivery of
securities settled the balance. This trading cycle varied from 14 days for specified securities to 30 days
for others and settlement took another fortnight. Often this cycle was not adhered to. Many things
could happen between entering into a trade and its performance providing incentives for either of the
parties to go back on its promise. This had on several occasions led to defaults and risks in settlement. In
order to reduce large open positions, the trading cycle was reduced over a period of time to a week. The
exchanges, however, continued to have different weekly trading cycles, which enabled shifting of
positions from one exchange to another. Rolling settlement on T+5 basis was introduced in respect of
specified scrips reducing the trading cycle to one day. It was made mandatory for all exchanges to follow
a uniform weekly trading cycle in respect of scrips not under rolling settlement. All scrips moved to
rolling settlement from December 2001. T+5 gave way to T+3 from April 2002 and T+2 since April 2003.
The market also had a variety of deferral products like modified carry forward 22 system, which
encouraged leveraged trading by enabling postponement of settlement. The deferral products have
been banned. The market has moved close to spot/cash market. Derivatives Trading: To assist market
participants to manage risks better through hedging, speculation and arbitrage, SC(R)A was amended in
1995 to lift the ban on options in securities. However, trading in derivatives did not take off, as there
was no suitable legal and regulatory framework to govern these trades. Besides, it needed a lot of
preparatory work- the underlying cash markets strengthened with the assistance of the automation of
trading and of the settlement system; the exchanges developed adequate infrastructure and the
information systems required to implement trading discipline in derivative instruments. The SC(R)A was
amended further in December 1999 to expand the definition of securities to include derivatives so that
the whole regulatory framework governing trading of securities could apply to trading of derivatives
also. A three-decade old ban on forward trading, which had lost its relevance and was hindering
introduction of derivatives trading, was withdrawn and derivatives trading took off in June 2000. The
Mini derivative Futures & Options contract was introduced for trading on S&P CNX Nifty on January 1,
2008 while the long term option contracts on S&P CNX Nifty were introduced for trading on March 3,
2008. Demutualisation: Historically, brokers owned, controlled and managed stock exchanges. In case of
disputes, the self often got precedence over regulations leading inevitably to conflict of interest. The
regulators, therefore, focused on reducing dominance of members in the management of stock
exchanges and advised them to reconstitute their governing councils to provide for at least 50% non-
broker representation. This did not materially alter the situation. In face of extreme volatility in the
securities market, Government proposed in March 2001 to corporatise the stock exchanges by which
ownership, management and trading membership would be segregated from one another. Government
offered a variety of tax incentives to facilitate corporatisation and demutualization of stock exchanges.
NSE, however, adopted a pure demutualised governance structure where ownership, management and
trading are with three different sets of people. This completely eliminated any conflict of interest and
helped NSE to aggressively pursue policies and practices within a public interest (market efficiency and
investor interest) framework. Currently, there are 19 demutualised stock exchanges. Depositories Act:
The earlier settlement system on Indian stock exchanges gave rise to settlement risk due to the time
that elapsed before trades are settled. Trades were settled by physical movement of paper. This had
two aspects. First, the settlement of trade in stock exchanges by delivery of shares by the seller and
payment by the purchaser. The stock exchange aggregated trades over a period of time to carry out net
settlement through the physical delivery of securities. The process of physically moving the securities
from the seller to the ultimate buyer through the seller’s broker and buyer’s broker took time with the
risk of delay somewhere along the chain. The second aspect related to transfer of shares in favour of the
purchaser by the company. The system of transfer of ownership was grossly 23 inefficient as every
transfer involved physical movement of paper securities to the issuer for registration, with the change of
ownership being evidenced by an endorsement on the security certificate. In many cases the process of
transfer took much longer, and a significant proportion of transactions ended up as bad delivery due to
faulty compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities were
rampant, and in addition the issuer had the right to refuse the transfer of a security. All this added to
costs, and delays in settlement, restricted liquidity and made investor grievance redressal time
consuming and at times intractable. To obviate these problems, the Depositories Act, 1996 was passed
to provide for the establishment of depositories in securities with the objective of ensuring free
transferability of securities with speed, accuracy and security by (a) making securities of public limited
companies freely transferable subject to certain exceptions; (b) dematerialising the securities in the
depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order
to streamline both the stages of settlement process, the Act envisages transfer of ownership of
securities electronically by book entry without making the securities move from person to person. In
order to promote dematerialisation, the regulator mandated trading and settlement in demat form in an
ever-increasing number of securities in a phased manner. The stamp duty on transfer of demat
securities was waived. Two depositories, namely, NSDL and CDSL, came up to provide instantaneous
electronic transfer of securities. All actively traded scrips are held, traded and settled in demat form.
Demat settlement accounts for over 99% of turnover settled by delivery. This has almost eliminated the
bad deliveries and associated problems. To prevent physical certificates from sneaking into circulation, it
is mandatory for all IPOs to be compulsorily traded in dematerialised form. The admission to a
depository for dematerialisation of securities has been made a prerequisite for making a public or rights
issue or an offer for sale. It has also been made compulsory for public listed companies making IPO of
any security for Rs.10 crore or more to do the same only in dematerialised form. Risk Management:
Market integrity is the essence of any financial market. To pre-empt market failures and protect
investors, the regulator/exchanges have developed a comprehensive risk management system, which is
constantly monitored and upgraded. It encompasses capital adequacy of members, adequate margin
requirements, limits on exposure and turnover, indemnity insurance, on-line position monitoring and
automatic disablement, etc. They also administer an efficient market surveillance system to curb
excessive volatility, detect and prevent price manipulations. Exchanges have set up trade/settlement
guarantee funds for meeting shortages arising out of non-fulfillment/partial fulfillment of funds
obligations by the members in a settlement. As a part of the risk management system, the index based
market wide circuit breakers have also been put in place. The anonymous electronic order book ushered
in by the NSE did not permit members to assess credit risk of the counter-party necessitated some
innovation in this area. To effectively address 24 this issue, NSE introduced the concept of a novation,
and set up the first clearing corporation, viz. National Securities Clearing Corporation Ltd. (NSCCL), which
commenced operations in April 1996. The NSCCL assures the counterparty risk of each member and
guarantees financial settlement. Counterparty risk is guaranteed through a fine tuned risk management
system and an innovative method of on-line position monitoring and automatic disablement. NSCCL
established a Settlement Guarantee Fund (SGF). The SGF provides a cushion for any residual risk and
operates like a self-insurance mechanism wherein the members contribute to the fund. In the event of
failure of a trading member to meet his obligations, the fund is utilized to the extent required for
successful completion of the settlement. This has eliminated counter party risk of trading on the
Exchange. The market has now full confidence that settlements will take place in time and will be
completed irrespective of default by isolated trading members. In fact such confidence is driving
volumes on exchanges. Traditionally, brokerage firms in India have been proprietary or partnership
concerns with unlimited liabilities. This restricted the amount of capital that such firms can raise. The
growing volume of transactions made it imperative for such firms to be well capitalised and
professional. The necessary legal changes were effected to open up the membership of stock exchanges
to corporates with limited liability, so that brokerage firms may be able to raise capital and retain
earnings. In order to boost the process of corporatisation, capital gains tax payable on the difference
between the cost of the individual’s initial acquisition of membership and the market value of that
membership on the date of transfer to the corporate entity was waived. In response, many brokerage
firms reorganised themselves into corporate entities.