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Evolution of the Indian Securities Markets
David Winkler University of Iowa Center for
International Finance and Development
Securities Market Development under
British Colonization 1833 1947
  • Companies Act 1956
  • The 1956 Companies Act effectively abolished the
    managing agency system. The Act still somewhat
    tracked the English Companies Act however, it
    also contained provisions that severely
    restricted investment.
  • It prohibited, individual firm, group,
    constituents of a group, body corporate or bodies
    corporate under the same management to
    accumulate more than 25 of the shares of any
  • The Act granted the government power to prevent
    the transfer of 10 or more of shares if the
    transfer would alter the board of directors and
    is prejudicial to the interest of the company or
    the public interest.
  • It prohibited individuals from transferring
    shares to foreign firms.
  • Securities Contracts (Regulation) Act 1956
  • The Securities Contracts Act heavily regulated
    the stock exchanges and prohibited the trading of
    options. The Acts preamble stated its purpose
    as, An Act to prevent undesirable transactions
    in securities by regulating the business of
    dealings in therein, by prohibiting options and
    by providing for certain other matters connected
    therewith. It emphasized investor protection
    and government control and placed little emphasis
    on market development.
  • Controller of Capital Issues Abolition
  • The most significant reform involving capital
    markets was the governments abolition of the
    Controller of Capital Issues in 1992. After the
    government abolished the Act, companies were free
    to set the price of their issues.
  • Formation of Securities and Exchange Board of
    India (SEBI)
  • The SEBI received legislative backing in 1992.
    The SEBIs mandate included the promotion and
    development of the securities markets. This was a
    dramatic shift from the focus of the Securities
    Contracts Act of 1956, which primary focused on
    investor protection through heavy regulation and
    disregarded market promotion. The Act granted the
    SEBI the responsibility of registering and
    regulating market participants.
  • Formation of the National Stock Exchange (NSE)
  • The Indian government formed the NSE in 1992.
    Prior to the NSEs formation, the Sensex was a
    monopoly and it was plagued with manipulative
  • The government created the NSE to compete with
    the Sensex and drive down transaction costs.
  • The NSE was set up as an automated electronic
    exchange allowing stock brokers from all over the
    country to link to the NSE computers and trade
    with automatic buy and sell order matching.
  • Fraud Hits
  • Howard Mehta Scam
  • The first securities market fraud struck almost
    immediately following economic liberalization.
    Between December 1991 and April 1992, the Sensex
    rose by nearly 150. A fraud involving
    manipulating settlement practices helped fuel the
    rally. The fraudulent settlement practices
    induced large banks to unknowingly make unsecured
    loans to smaller banks that then made money
    available to brokers. This diverted substantial
    sums of money from the banking sector to
    the stock market. After the fraud was discovered,
    the Sensex fell nearly 40.
  • Vanishing Companies 1992 1994
  • Vanishing companies also plagued the primary
    Indian securities markets, destroying investor
    confidence in the markets. Between July 1993 and
    September 1994 the Indian stock market gained
    120. Hundreds of companies took advantage of the
    hot IPO market and raised substantial sums of
    money. Several of these companies then proceeded
    to vanish after raising the capital.
  • Multinationals
  • In 1994, multinationals took advantage of the
    lack of a developed regulatory structure by
    issuing preferential equity allotments to
    controlling shareholders at steep discounts to
    prevent takeovers. These issuances substantially
    diluted minority shareholders.

Satyam and the Credit Crisis
During the global financial crisis, Indian
companies lost 64 of their market
capitalization. Near the height of the global
credit crisis, a major accounting scandal
Satyam - threatened the entire Brand India and
its stock markets. Satyam was a
globally-recognized information technology
  • Indian corporate and securities law has its roots
    in English common law. England passed a
    homogenous set of company laws throughout the
    British Colonies to assist British entrepreneurs
    via a common investment framework.
  • Managing Agency System
  • British owners used a governing structure known
    as the managing agency system.
  • This system operated as a holding company that
    held and controlled several companies across
    several industries.
  • A managing agency house had control over
    promotional, financial, and managerial functions.
  • Boards of Directors performed very few
    decision-making functions.
  • This gave the shareholders in the holding company
    effective control over the subsidiaries even
    though their equity stake was often very small.
  • Companies Act of 1856
  • India modeled the Indian Companies Act of 1856
    after the English Companies Act of 1855. The
    Indian Companies Act of 1856 introduced limited
    liability for the first time.
  • Fraud Uncovered
  • In December 2008, Satyams Board of Directors
    approved the purchase of two companies unrelated
    to the IT sector in which the CEO, B. Ramalinga
    Raju, owned significantly larger stakes than in
    Satyam. Company shareholders viewed the
    transaction as a way for Mr. Raju to siphon money
    out of Satyam and into the hands of the Raju
    family. The Board of Directors quickly aborted
    the transactions after the

investors revolted. On January 7th, Merrill Lynch
sent a letter to the Sensex stating that it had
to withdraw from its engagement with Satyam
because it had discovered material accounting
irregularities. Hours later, Mr. Raju informed
the Board of Directors about the fraud. Mr. Raju
apparently perpetrated the fraud by creating
fictitious bank accounts on his personal
Securities Markets from 1960 1980s
Beginnings of Dalal Street During the 1850s and
1860s, stockbrokers gathered around Banyan Trees
across from city hall in Bombay to trade stocks.
The self proclaimed cotton king of India,
Premchand Roychand, set trading rules and
assisted in organizing trading. In 1875, a group
of stockbrokers formally organized the modern day
Sensex as the Native Share and Stock Brokers
Association. The picture to the left is a banyan
tree in Bombay under which trading took place in
the 1860s and 1870s. The stock exchange is the
oldest stock exchange in Asia.
  • Maintaining Control
  • From the mid-1960s until the economic reforms of
    1991, the government viewed the financial system
    as a source of public finance. During this time,
    the government controlled the banks and their
    lending decisions and used this to control
    competition. Commercial and cooperative banks
    provided companies with working capital. Indian
    development banks and a few government-funded
    financial institutions provided most of the
    medium- to long-term financing of companies.
  • 1969 Monopolies and Restrictive Trade Practices
  • The Act placed additional licensing restrictions
    on the private sector, further limiting
    competition and restricting investment. The Act
    defined a monopoly based on asset size instead of
    on market share.
  • Aftermath
  • The Sensex dropped 7.3 on the day the fraud was
    announced as investors lost confidence in Indian
    markets. In April, the Board successfully sold
    the company.
  • Responsible Parties
  • The following parties share responsibility for
    the fraud as each either was directly responsible
    or missed red flags
  • Company Management (CEO Mr. Raju, Internal
    Auditor, CFO)
  • the Board of Directors and
  • Global Accounting Firm Price Waterhouse Coopers
  • Corporate Governance Challenges and Reform
  • The Satyam scandal revealed some persistent
    corporate governance problems in India.
  • Family business groups dominate the ownership of
    Indian corporations, controlling approximately
    50 of the largest 500 Indian companies.
  • Independent directors often succumb to serve the
    interests of the family over the minority
  • Indian corporations are often organized within a
    pyramid structure, allowing groups to control
    more of the operations than their equity claims
  • This makes it difficult for outside shareholders
    to monitor performance.
  • Following Satyam, several experts called for
    increasing internal control monitoring by
    adopting something similar to U.S. Sarbanes Oxley
    Section 404.
  • The government has resisted attempting to reform
    corporate governance in a comprehensive manner,
    and instead has taken a piecemeal approach.
  • Policies from 1960s 1991
  • The government prohibited the development of an
  • equity market through control directed by the
    Controller of Capital Issues.
  • Public financial institutions such as the Unit
  • Trust of India, the General Insurance
  • Corporation, and development financial
  • institutions such as the Industrial Finance
    Corporation of India and the Industrial
    Development Bank of India were the

The period under colonization was marked by the
defrauding of Indian shareholders and operating
inefficiencies. One prominent scholar, Radhe
Shyam Rungta, commented, The Acts provide
examples of a complete disregard and an utter
failure on the part of legislatures to take into
account the peculiarities of conditions in India.
If there is any underlying theme running through
the company legislation of a full half-century in
Indiait is a steadfast adherence to the policy
that what was good for Britain must also be good
for India.
Reform in the mid-1990s
Securities Markets from 1947 1960
The capital markets went through a series of
minor reforms during the mid-1990s. Several of
these efforts including improving transparency
and corporate governance. The SEBI did not have
many enforcement or investigatory powers under
the original SEBI Act. Through a series of
reforms, the government significantly
strengthened SEBIs enforcement and regulatory
power. As the chart below shows, the number of
investigation and enforcement actions increased
dramatically after the reforms.
  • largest shareholders of all major Indian
  • holding approximately 40-45 of share
  • Large state ownership resulted in an
    underperforming corporate structure as the state
    institutions failed to monitor the corporations
  • This prolonged the inefficiencies of the managing
    agency system, as promoters often had effective
    control over companies with little investment.
  • High tax rates encouraged fraudulent accounting
    practices and the manipulation of earnings.

Independence Nationalism through
Self-Sufficiency Indias culture had a strong
sense of nationalism when it gained independence.
India desired to become self sufficient and
adopted socialism and central planning as a means
of accomplishing that goal. Prime Minister Nehru
believed that state control of foreign investment
was necessary to prevent foreign capital, foreign
interests, and foreign businesses from dominating
India. Developing the Framework for Control
Securitization in India
Investigation and Enforcement by the SEBI over
the years
  • Capital Issues Controls Act 1947
  • The Act provided government with the power to
    regulate equity issuance. It required companies
    to obtain approval from the Controller of Capital
    Issues to raise money. The government restricted
    the price of equity issuances to a complex
    accounting formula rather than letting the market
    set the price. The government used the control
    over equity issuances to ensure companies that
    raised money served the governments goals and
  • Industries and Development Regulation Act of
  • The Act restricted investment by requiring all
    existing and proposed industrial units to acquire
    licenses from the central government. Business
    owners that had existing companies and political
    connections used the licensing regime to extract
    monopolistic and oligopolistic privileges in new
    and existing industries. The licensing
    requirements grew stricter over the years as the
    government thrust itself into an increasingly
    central planning role.
  • Industry Policy Resolution 1956
  • The Act mandated that the public sector would
    dominate the economy and specified industries in
    which the state increasingly or exclusively would
    assume responsibility. This severely restricted
    both private industrial development and the
    development of equity markets.

Securities Market Liberalization
1991 2007
The securitization market in India is still in
its early stages of development. Currently, the
Indian securitization market consists primarily
of single loan collateralized obligation
securities (CLO) and asset backed securities
(ABS). There are three broad types of ABS
securitized in India 1) vehicle loans,
two-wheeler loans, three-wheeler loans, 2)
construction and agricultural equipment loans,
and 3) unsecured personal and consumer durable
loans. In 2007, the government passed an
amendment to the Securities Contracts
(Regulation) Act vesting the SEBI with regulatory
powers over the market in an attempt to encourage
its development. Significant regulatory hurdles
still exist that are preventing the rapid
development of the securitization market. The
credit crisis also caused the Indian
Source Securities Market Regulations Lessons
from US and Indian Experience (Bose)
  • Rapid Liberalization
  • Sri Lankan Tamil rebels assassinated Prime
    Minister Ghandi in May 1991. Following the
    assassination of the Prime Minister, India chose
    P.V. Narashimha Rao as the new Prime Minister.
    During this time Indias financial system faced a
    foreign exchange crisis and its economy was in
    shambles. The new administration immediately
    began liberalization efforts in capital and
  • Initial reforms
  • The first major liberalization effort occurred
    when the Indian government issued a new
    Industrial Policy Act on June 24, 1991. The act
    repealed most industrial licensing requirements,
    relaxed the restrictions on foreign investments,
    and replaced the Monopolies and Restrictive Trade
    Practices Act of 1969. The removal of licensing
    requirements allowed private firms to make
    decisions without government input and allowed
    private industries to compete with state-owned
  • Corporate Governance Reform and Clause 49
  • After the series of frauds shook investor
    confidence, the Confederation of Indian Industry
    formed a task force to improve corporate
  • In April 1997, the task force published a draft
    of Desirable Corporate Governance, A Code, and
    defined good corporate governance as
    maximizing long term shareholder value.
  • The SEBI adopted Clause 49 in 1999, making many
    of the Codes recommendations mandatory.
  • Clause 49 requires at least 50 of the Board to
    be independent when the CEO is also the chairman
    of the board.
  • It works in coordination with company listing
    standards on exchanges.
  • The clause requires the CEO and CFO to certify
    the financial statements.
  • The standard mandates meeting requirements for
    the audit committee.

Securitization Issue by Asset Type
government to moderate its market development
efforts. As part of its review of monetary policy
in 2009, the RBI asserted its desire to avoid
adopting the originate- to-distribute model. It
proposed both a seasoning requirement and
retention criteria.
Source IRCA and (Wells , Zibel)