A REPORT

ON

RISK MANAGEMENT IN INDIAN STOCK MARKET:

HOW EFFICIENT IT IS? -AN ANALYSIS

By

RICHA TIWARY, 13BSPHH010508

IBS Hyderabad
 A REPORT

ON

RISK MANAGEMENT IN INDIAN STOCK MARKET:

HOW EFFICIENT IT IS ? -AN ANALYSIS

By
RICHA TIWARY, 13BSPHH010508

BHUBANESWAR STOCK EXCHANGE

A report submitted in partial fulfillment of the requirements of

MBA program of IBS Hyderabad

16TH MAY 2014

 ACKNOWLEDGEMENTS
The 3 months of summer internship gave me a very good opportunity for learning new things,
with timely and successful completion of project. These all have been made possible by the
efforts of many individuals and therefore it is necessary for me to express my sincere thanks to
each one of them.

First, I would like to thank Mr. Debraj Biswal, MD and CEO of Bhubaneswar Stock Exchange
for allowing us to conduct our summer internship project in the organization.

I express my sincere gratitude to my company guide, Mr. Bipin Dutta, Assistant Manager,
Bhubaneswar Stock Exchange, for his wonderful guidance on the topic of the project undertaken
by me and also for his immense support by giving enough clarifications to my doubt whenever it
was required, throughout the journey of my internship. Without his direction, it would have been
impossible for me to proceed and give my best. He has significantly contributed in making
concepts related to my work simple to understand. Every time he kept motivating me to come up
with something new in my study.

I am also very much thankful to my faculty guide, Dr. Suresh Chandra Bihari, for suggesting me
to undertake internship in Bhubaneswar Stock Exchange. He has constantly motivated me to
deliver my best and also gave right information in the quickest possible time. I am thankful to
him for inspiring me to do case study or research work which made me enthusiastic for my work.

At last, I would like to thank my seniors and family members, who gave me nice support in
making this project successful.
 TABLE OF CONTENTS
Authorization xi.
Abstract xii.
1. Introduction 1
1.1 Objective of study 3
1.2 Data sources 3
1.3 Research Methodology 3
2. Company Analysis 4
2.1 Company Profile 4
2.2 Business Model of BhSE 4
2.3 SWOT Analysis of BhSE 7
3. Investment in securities and role of stock exchange 8
3.1 Confidence of investors. How securities market define it 8
3.2 Investment in securities rest on 3 objectives 11
4. Risk Management engines of stock exchange for equity market 13
4.1 At trading level 13
4.2 At trader’s level 32
4.3 At investors’ level 37
5. Investors to take care of risk 43
5.1 Contract Note 43
5.2 Other responsibilities 45
6. Case Study 46
Caselet 1:Harshad Mehta Scam 47
Caselet 2:Ketan Parekh Scam 51
Caselet 3: A ‘parallel’ crisis in Calcutta Stock Exchange-SGF to
rescue 55
Caselet 4: North Star Gems (India) Limited- Market manipulation and
price rigging 57
Caselet 5: Maruti Organics Ltd- Not compliance with KYC norms &
Margin Requirements 57
Caselet 6: Market Surveillance 58

7. Findings 60
7.1 Analysis of Mehta scam 60
7.2 Analysis of Parekh scam & Payment crisis at CSE 62
7.3 Analysis of Exceptional Market Scenarios 64
8. Conclusion 66
9. References 67
 AUTHORIZATION

This is to certify that this report “ Risk Management in Indian Stock Market: How efficient it is-
An analysis” is prepared in partial fulfillment of the program

ABSTRACT

Securities market is an essential platform for the growth and development of any economy.
Securities market offers individuals, large, small and medium-scale enterprises with a broader
menu of financial services and financial instruments like equities, debentures, government debt,
derivatives and other securities. Further, since retail investors place an increasing proportion of
their money in mutual funds, other collective investment vehicles, stocks etc., securities market
therefore plays an important role for the growth of individual wealth. However, securities market
requires a sound and effective risk management system that is necessary in building up the
investors’ confidence in the market by ensuring fair and efficient transactions and also reducing
systemic risk, so that investors do not hesitate to invest because of risks involved in stock market
operations.

The paper aims to study risk management framework of stock exchanges and how it works and
also, at which level, what kind mechanism is implemented.

Finally, the paper presents a detailed case analysis on “Different securities scams happened in
Indian Stock Market” and analysis of each scam to understand impact on stock market and
investors.
 1. INTRODUCTION

Financial Markets are broadly classified into money market and capital market. Money market is
associated with trading of instruments for raising of short term funds, having maturity period of
less than 1 year, whereas capital market is associated with trading of instruments for raising long
term funds having maturity of more than 1 year. Capital market/Securities market is in turn
divided into primary and secondary market, also called as stock market.

In primary market, creation and sale of new issues takes place, whereas in secondary market,
securities already issued in the primary market are traded. There are 3 kinds of participants in
securities market: the issuer of securities, the investor in securities, and the intermediaries. The
issuers issue securities to raise funds, the investors invest their savings in the securities for
getting returns in the form of some income either as a fixed regular income of dividends /interest
or capital gains in future. The role of intermediaries is to act as agents or middlemen to bring
together users and suppliers of funds, in return for a commission. There are large variety and
number of intermediaries providing various services in the Indian securities market. Indian
securities market has two major Market Infrastructure Institutions i.e. BSE (Bombay Stock
Exchange, Ltd) and NSE (National Stock Exchange, Ltd.). They provide platform for trading of
securities.

However the process of mobilizing the resources needs to be carried out under the supervision of
the regulators. The regulators develop fair market practices and take responsibility of protecting
the interests of the investors. The Market Regulator, Securities and Exchange Board Of India
(SEBI) has taken several measures to improve the integrity, fairness and transparency at both
new issue and trading levels. At trading level in particular, SEBI has, from time to time, put in
place various risk containment measures to address the risks involved in the cash and derivatives
market. These measures have successfully addressed the market risks. However, to keep up with
the dynamic state of the market, risk management systems cannot remain static and has to
constantly address the changing risk profile of the market. Now the question is, why one should
be interested in knowing what are the risks and how stock exchanges take care of such risk.
Since a common man invests his money in stock market, his interest has to be protected and any

1
kind of obligations should be fulfilled. We can say that Risk Management is necessary at 3
particular levels for obvious reasons -

At Trading Level

* Business continuity

* Smooth and faster settlement of transactions

* Countering high degree volatility

* Countering insider trading

* Combating information asymmetry and market vagaries

* Safer market for investment

At Trader Level

* Fulfillment of business obligation

* Avoidance of risk of default

At Investor Level

* Timely receipt of claim

* Protection of interest

* Receipt of legitimate claim against a defaulter

* Redressal of grievance

* Reliance on the market

At each level, to address different issues, stock exchange is equipped with different risk
management engines.

2
1.1 Objective of study

Following are the objectives of study:

 To understand the stock market operations, covering equity market

 Risk management techniques operating in equity market.

 Study of scams and their origination.

 To analyse how present risk management framework can avoid such scams.

 To analyse how efficient present risk management framework is.

1.2 Data sources

Data has been collected from secondary sources, i.e from stock exchanges website mainly
from National Stock Exchange of India Ltd. and Bombay Stock Exchange Ltd. and
Securities & Exchange Board of India (SEBI).

1.3 Methodology

The methodology used in this study is case based and some real time incidents data.

3
 2. Company Analysis
2.1 Company profile

Bhubaneswar Stock Exchange Ltd. (BhSE) has been functioning as a recognized Stock
Exchange in the state of Orissa for about 20 years. It was initially incorporated on 17 April,1989
as a Public Company, limited by guarantee with an objective to facilitate, assist, regulate or
control the business of buying, selling or dealing in stocks, shares and like securities. Govt. of
India granted recognition to the BhSE on 5 June,1989 under the provisions of the Securities
Contracts (Regulation) Act,1956 for an initial period of five years. Thereafter, the recognition of
BhSE is being renewed from time to time by Securities and Exchange Board of India (SEBI).
Subsequent to the amendment to the Securities Contracts (Regulation) Act,1956 during the year
2004 by the Govt. of India in order to provide for corporatisation and demutualization of the
stock exchanges in the country, BhSE, first in order to become a corporatised entity, was
converted from a company limited by guarantee to a company limited by shares on 9 December,
2005 by way of fresh incorporation under the Companies Act,1956. Further, during the year
2007 BhSE successfully diluted its share capital to public in compliance with the requirement of
demutualization in order to ensure at least 51% of paid up share capital are held by the persons
other than the stock-broker
shareholders.

2.2 Business Model of BhSE

Inter-connectivity
BhSE has played an instrumental role, among others, in mooting the idea of establishing of an
Inter-connected Market System (ICMS). This effort resulted in establishing “Inter-connected
Stock Exchange of India of Ltd. (ISE)” at Navi Mumbai. The object of establishing ISE was to
provide a nationwide equity market through the trading members of participating Stock
Exchanges. Trading operation was carried out on the ISE segment for quite sometimes.
However, in the presence of nationwide terminals provided by National Stock Exchange (NSE)
and Bombay Stock Exchange (BSE), ISE trading activities did not go a long way in absence of
liquidity in its segment. ISE, as an alternative measure to provide active trading segments in the
securities market to the trading members of its participating Stock Exchanges as well as its

4
dealers, floated a wholly owned subsidiary company, namely, ISE Securities & Services Ltd.
(ISS) which in turn obtained the trading membership of NSE and BSE. At present the trading
members of BhSE are conducting trading on NSE and BSE segments as the registered sub-
brokers of ISS.
Management: The affairs of the BhSE are controlled and supervised by the Board of Directors.
The day to day affairs are managed by the Managing Director of the Stock Exchange. The Board
of Directors of the Stock Exchange comprises of 8 Directors which includes, 4 Public Interest
Directors nominated by SEBI and 4 Shareholder Directors appointed by the shareholder of the
BhSE and Managing Director who is the ex-officio Director of the Board.
Trading Operation: The trading and settlement operation of the BhSE was computerized since
inception. The Exchange switched over from “out-cry system” of trading to “Screen Based
Trading” with effect from 20 May,1997. However, the trading on the BhSE segment is presently
dispensed with the instruction of SEBI in the want of adequate market infrastructure
and regulatory mechanism.
Settlement System: The settlement at the Exchange is carried out on “Daily Rolling Basis”
(T+2) as per the SEBI Guidelines. Pay-in/pay-out, in terms of Settlement, is carried out well in
time through the centralized banking system of the Stock Exchange. BhSE has established
Branch of Canara Bank, within its campus to facilitate the pay-in/pay-out activities as well as the
banking transactions of the Stock Exchange and its trading members.
Clearing House: BhSE has its own Clearing House. The transactions conducted by the trading
members are settled by the Clearing House of the Stock Exchange in accordance with the
prescribed settlement program under a “Centralized Delivery and Payment System”.
Depository Participant Services
BhSE is a registered Depository Participant (DP) of Central Depository Services (India)
Ltd. (CDSL) and has been providing DP services to the investors in securities.
Listing of Securities
The total companies listed with BhSE are 46. Pursuant to enforcement of liberal regulatory norm
i.e delisting guidelines, 2003 issued by SEBI and subsequent withdrawal of mandatory provision
requiring for listing of securities of companies on their respective regional stock exchange , by
the Government of India, many companies have sought delisting of their securities from the
exchange causing an adverse impact on the revenue of the exchange.

5
Primary Market
BhSE has been playing an active role for the growth of primary market activities with the
support of its trading members. The Stock Exchange ensures promotional steps for participation
of investing public at a large scale in the Initial Public Offers (IPOs)/Public Issues of several
companies.
Customers’ Protection Fund
BhSE has established a Statutory Fund namely, “Bhubaneswar Stock Exchange Customers’
Protection Fund” with an objective to protect the customers from the risk of defaulter trading
members. As per the Rules, presently a customer is entitled to be indemnified to the extent of
Rs.50,000/- towards his legitimate claim against a defaulter trading member of the Stock
Exchange. The size of the corpus as on 31 March ,2013 was Rs. 53, 90,399
Investors’ Service Cell
BhSE has an “Investors’ Service Cell” to redress the investors’ grievances ,ensuring protection
of the investors. It promptly attends the complaints lodged by the investors against companies as
well as the trading members of the Stock Exchange. The Investors’ Service Cell undertakes due
care to build up confidence of the common investors in the securities market.
Settlement Guarantee Fund
The stock exchange in terms of its Bye- laws, has established Settlement Guarantee Fund(SGF)
with the approval of SEBI. The corpus of SGF as at 31 March ,2013 was Rs. 1,67,57,457
Current Activities other than trading operation
Apart from trading operation, BhSE is engaged in promotion and development of securities
market in the interest of the investing public in a big way such as –
Investors’ Awareness Programme
BhSE is conducting investors’ awareness programmes by way of seminars/workshop from time
to time for education and awareness of investing public in securities. The aim of the BhSE is to
have at least 5-6 awareness programmes in a year at different location of the State of Orissa.
Securities Market Training Programme
BhSE is providing a Certificate Course, namely, “Basics of Capital Market”. With the expansion
of capital market, BhSE aims at undertaking practical oriented training programmes for the
students of Commerce and B-Schools in a big way for the youths who want to make their career

6
in securities market. At present, BhSE is engaged in imparting training to the students of various
management institutes.
Students Assistance Programme
The students of a number of Institutes and B-Schools visit BhSE either directly or sponsored by
their institutes every year for assistance in preparation of their project papers. BhSE assists and
supports those students in their project work by providing necessary guidance and securities
market information.

2.3 SWOT Analysis of BhSE

STRENGTHS WEAKNESSES

 Provides smooth clearing and  Only 46 companies are listed in the

settlement process. exchange generating less revenue for
 Has adequate internal checks and exchange.
internal control systems which are
commensurate with its size and nature  Very few employees.
of its business.
 The exchange has corpus of SGF of Rs.
1,67,57,457 & IPF of Rs. 53,90,399.
 Provides other services like Investors’
Awareness Programme, Securities
Market Training Programme, Students
Assistance Programme.

OPPORTUNITIES THREATS

 Business tie-up with other national level  Continuous decrease in profit, making
stock exchange. difficult for exchange to survive, which
 Merger /consolidation of the exchange with subsequently may cause to shift in other
other exchanges viz. MCX-SX, Calcutta business.
Stock Exchange and Inter-Connected Stock
Exchange of India.
 Alternate business plans for survival of the
entity.

7
 3. Investment in securities and role of stock exchange
Though the primary role of any stock exchange is to provide platform for trading of securities
and raising funds through the way of debt and equity but its importance is not limited only up to
this point.

The role of stock exchange is varied and it plays a major role in the development of economy of
a country. Following are the important roles of Stock market:

Raising capital for businesses

The stock market is a place where entrepreneurs can raise funds for setting up new business or
for expansion of existing business by issuing of shares and securities.

Platform for investment

The people can deploy their savings by investment in shares. Shares are lucrative investments
giving higher returns to investors. At the same time investors’ money can be used by company
for further investments resulting in overall growth of company. These funds can be directed for
benefits of several economic sectors such as agriculture, commerce and industry thereby leading
to a stronger economic growth and higher productivity levels and firms.

Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines, increase distribution

channels, hedge against volatility, increase its market share, or acquire other necessary business
assets. A takeover bid or a merger agreement through the stock market is one of the simplest and
most common ways for a company to grow by acquisition or fusion.

Creating investment opportunities for small investors

Investing in shares is open to both the large and small equity investors because a person buys the
number of shares that he can afford. A Stock Exchange provides opportunity for small investors
to own shares of the same companies as large investors.

Government capital-raising for development projects

Government also sometimes to finance the infrastructure projects like construction of roads,
bridges, and etc. approach debt market of stock exchange to raise funds and start selling bonds
thus taking loan from public.

Barometer of the economy

8
The stock market indices may go up or down. When index rises, we say share prices of most of
the companies have gone up which means most of the companies or sectors are doing well. This
implies that our economy also doing well and growing. Whereas in case of economic recession,
depression, or financial crisis, stock market crash and share prices fall. Therefore, the movement
of the stock index can be an indicator of the general trend in the economy.

List of Stock Exchanges in India.

Sr.No. Name of Exchange Valid upto

1 Ahmedabad Stock Exchange Ltd. PERMANENT

2 Bombay Stock Exchange Ltd. PERMANENT

3 Bangalore Stock Exchange Ltd. PERMANENT

4 Bhubaneswar Stock Exchange Ltd. 04-JUN-2014

5 Calcutta Stock Exchange Ltd. PERMANENT

6 Cochin Stock Exchange Ltd. 07-NOV-2013

7 Delhi Stock Exchange Ltd. PERMANENT

8 Gauhati Stock Exchange Ltd. 30-APR-2013

9 Inter-Connected Stock Exchange of India 17-NOV-2014

Limited.

10 Jaipur Stock Exchange Ltd. 08-JAN-2015

11 Ludhiana Stock Exchange Ltd. 27-APR-2014

12 MCX SX Exchange Limited. 15-SEP-2014

13 Madhya Pradesh Stock Exchange Ltd. PERMANENT

14 Madras Stock Exchange Ltd. PERMANENT

15 Magadh Stock Exchange Ltd (SEBI vide

order dated September 3, 2007 refused to
renew the recognition granted to Magadh
Stock Exchange Ltd.)

16 Mangalore Stock Exchange (As per DEREGOGNISED

9
 Securities Appellete Tribunal order dated
October 4, 2006, the Mangalore Stock
Exchange is a de-recognized Stock
Exchange under Section 4 (4) of SCRA)

17 National Stock Exchange of India Ltd. PERMANENT

18 OTC Exchange of India 22-AUG-2014

19 Pune Stock Exchange Ltd. 1-SEP-2014

20 The Vadodara Stock Exchange Ltd. 3-JAN-2015

21 U.P Stock Exchange Limited. 02-JUN-2014

22 United Stock Exchange of India Limited. 21-MAR-2015

3.1 Confidence of investors. How does securities market define it?

Investors may be an individual or institutions who subscribe to the securities issued in stock
market. The interest of investors needs to be protected so as to generate confidence among them.
If investors do not have confidence in the stock market or on its regulatory mechanism, then they
may hesitate to invest their money in any kind of securities. People would rather prefer to keep
their money in the banks in the form of safe fixed deposit and may not even turn to stock market
Companies will also find it difficult to raise funds. As a result, not enough investments will not
take place in economy. Finally, both private and public corporate sectors will not grow in the
absence of investment and this will lead an economy to suffer a lot. Therefore, a prudent
regulatory framework has been designed to enjoy such confidence of investors. To ensure fair,
efficient, transparent market, securities markets are governed by 5 main Acts.

 The SEBI Act, 1992; which provides power to SEBI for protecting the interests of
investors in securities, promoting the development of the securities market, and
regulating the securities market. Its regulatory power extends over corporate in the
issuance of capital and transfer of securities, and also to all intermediaries and persons
associated with the securities market. It can conduct enquiries, audits, and inspection for
all concerned reasons. It has the powers to register and regulate all market intermediaries,

10
 as well as to penalize them in case of violations of the provisions of the Act, Rules, and
Regulations.
 The Companies Act, 1956, which sets the code of conduct for the corporate sector in
relation to issuance, allotment, and transfer of securities, and disclosures to be made in
public issues.
 The Securities Contracts (Regulation) Act, 1956, which provides for the regulation of
transactions in securities through control over stock exchanges.
 The Depositories Act, 1996 which provides for electronic maintenance and transfer of
ownership of demit (dematerialized) shares. The Act ensures free transferability of
securities with speed, accuracy, and security.
 The Prevention of Money Laundering Act, 2002, which provides measures to prevent
money laundering and prescribes the punishment for such offence.

3.2 Investment in securities rest on three objectives

3.2.1 Investors’ Protection

Investors should be protected from misleading, manipulative or fraudulent practices, including

insider trading, front running and the misuse of client assets.

Full disclosure of information which might be important for an investor to make investment
decisions is the most important means for ensuring investors’ interest protection.

3.3.2 Ensuring fair, transparent and efficient market

Efficient market is one where investors have fair access to market or have correct information
about the prices of securities. Also not a single investor is able to influence the market or share
price. In a fair, transparent and efficient market, dissemination of any relevant information is
widespread and gets reflected in the share price or price formation process. Market structure does
not unduly favor some market users over others. In violation of these, Regulation should detect,
prevent and penalize market manipulations and any other unfair trading practices.

3.3.3 Reduction of Systemic Risk

Regulation should seek to reduce the impact of failure of any market intermediary in fulfilling its
obligations. Market intermediaries should, therefore, be subject to adequate and ongoing capital

11
and other important requirements. If necessary, an intermediary should be able to wind up its
business without making loss or any damage to its customers and counterparties. Prudent
supervision and effective utilization of risk management tools are essential to ensure efficient
clearing and settlement process in the interest of the market as well as of investors.

12
 4. Risk Management Engines of Stock Exchange for Equity Market
An effective risk management technique is very essential for efficient and smooth functioning of
stock market. Risk containment measures are therefore implemented from all possible sides or
levels, i.e at trading level, traders’ level and investors’ level.

4.1 At Trading level

 Segregation of trading and settlement from each other

 Market surveillance

 Circuit Filters/Breakers

 Price Band

 Settlement through dematerialized securities

 Settlement/Trade Guarantee Fund (SGF/TGF) to guarantee settlement of transactions

 Defaults Committee

 Plan for business continuity and site for disaster management

4.2 Trader’s level

 Base Minimum Capital (BMC) and Additional Capital Deposit with Stock Exchange or
Clearing Corporation.

 Time to time deposits of various margins with Stock Exchange

4.3 At Investor’s level

 Compliance of KYC Norms by the investors

 Investor Protection Fund to compensate legitimate claims of investors against a defaulter

stock-broker

 Investor Service Centre

 Investor Grievance Committee

13
 4. AT TRADING LEVEL

4.1.1 Segregation of trading, clearing and settlement from each other

“Systems for clearing and settlement of securities transaction should be subjected to regulatory
oversight and designed to ensure that they are fair, effective and efficient and that they reduce
systemic risk” is one of the 30 principles of securities regulation enunciated by IOSCO.

The transactions in the secondary market pass through three distinct phases—trading, clearing,
and settlement. Whereas as stock market provides platform for trading, Clearing Corporation
takes the responsibility of effective ,smooth and complete settlement of trades by ensuring
fulfillment of obligations by the counterparties. Clearing and settlement process ensures that
trades executed between the two parties are settled smoothly without any loss to either of them
which means, there will be no default from either parties (one who has bought the securities will
make payment and the other who has sold securities will deliver the securities)

Several entities, such as the Clearing Corporation, Clearing Members, Custodians, Clearing
Banks, and Depositories are involved in the process of clearing and settlement.

A safe and stable settlement system is important to reduce the systemic risks and to preserve the
health of the domestic and global financial market. The role of each of these entities is explained
below.
Clearing Corporation: The National Securities Clearing Corporation Ltd. (NSCCL), a wholly
owned subsidiary of the NSE, was the first clearing corporation to be established in the country
and to guarantee settlement of every transactions taking place at exchange. The NSCCL was
incorporated in August 1995. Clearing Corporation is responsible for post-trade activities i.e
clearing and settlement of trades by determining and exchange of obligations. Every Stock
Exchange has clearing house.
Clearing Members (CM): Clearing Members are responsible for fulfilling their obligations
determined by the Clearing Corporation. Clearing members make the funds / securities available
with the clearing banks/ depositories, which is later transferred to the designated account of
clearing corporation on the day of settlement.
Custodians: They are clearing members but not the trading members. Custodians do not have
trading rights. They settle trades on behalf of clearing members. Custodians need to confirm that

14
they accept to settle trades. Once they confirm, clearing corporation imposes obligations on
them.
Clearing Banks: They act as interface between clearing members and clearing corporation.
Each clearing member needs to open so called clearing account with the clearing banks. Clearing
member makes the fund available in the clearing account for pay-in and receives funds in case of
pay-out. There are 13 clearing banks of the NSE, namely, Axis Bank Ltd., Bank of India Ltd.,
Canada Bank Ltd., Citibank N.A., HDFC Bank Ltd., HSBC Ltd., ICICI Bank Ltd., IDBI Bank
Ltd., IndusInd Bank Ltd., Kotak Mahindra Bank, Standard Chartered Bank, State Bank of India,
and Union Bank of India.
Depositories: A depository holds the securities in a dematerialized form for the investors in their
beneficiary accounts. Each clearing member is required to open a clearing pool account with the
depositories. They are required to make the required securities available in the designated
account on settlement day. The depository runs an electronic file to transfer the securities from
the accounts of the custodians/clearing member to that of the NSCCL (and vice versa) as per the
schedule of allocation of the securities. The two depositories in India are the National Securities
Depository Ltd. (NSDL) and the Central Depository Services (India) Ltd. (CDSL).

The steps involved in clearing and settlement are as follows:

a) Trade Recording: The key details about the trades are recorded to provide the basis for
settlement. These details are automatically recorded in the electronic trading system of the
exchanges.
b) Trade Confirmation: Trades that are meant for settlement by the custodians are indicated with
a custodian participant code, and the same is subject to confirmation by the respective custodian.
The custodian is required to confirm the settlement of these trades on T+1 day by the cut-off
time of 1:00 pm.
c) Determination of Obligation: The next step is the determination of obligation of two parties
on the settlement date. The clearing corporation interposes itself as a central counterparty for the
counterparties to any trade and net the positions so that a member has a security-wise net
obligation to receive or deliver a security, and has to either pay or receive funds. The settlement
process begins as soon as the members’ obligations are determined through the clearing process.

15
The settlement process is carried out by the clearing corporation with the help of clearing banks
and depositories.
d) Pay-in of Funds and Securities: This requires the members to bring in their funds/securities to
the clearing corporation. The CMs make the securities available in the designated accounts with
the two depositories (the CM pool account in the case of the NSDL, and the designated
settlement accounts in the case of CDSL). The depositories move the securities available in the
pool accounts to the pool account of the clearing corporation. Likewise, the CMs with funds
obligations make the funds available in the designated accounts with the clearing banks. The
clearing corporation sends instructions to the clearing banks to debit the designated CMs’
accounts to the extent of the payment obligations. The banks process these instructions, debit the
accounts of the CMs, and credit the accounts of the clearing corporation. This constitutes the
pay-in of funds and securities.
e) Pay-out of Funds and Securities: After processing for shortages of funds/securities and
arranging for the movement of funds from surplus banks to deficit banks through RBI clearing,
the clearing corporation sends electronic instructions to the depositories/clearing banks to release
the pay-out of securities/funds. The depositories and clearing banks debit the accounts of the
clearing corporation and credit the accounts of CMs. This constitutes the pay-out of funds and
securities.

16
 The clearing and settlement process for transactions in securities on the NSE is presented in
Chart

NSE

DEPOSITORIES NSCCL CLEARING BANK

CM

17
4.1.2 Market Surveillance

Market Surveillance refers to continuous monitoring or keeping a watch on all the activities
taking place in the and in case of any abnormality, initiating timely and pro-active measures to
detect suspected or alleged market manipulations.
The effectiveness of surveillance system depends on its ability to promptly and accurately detect
any suspicious trading.

Why Market Surveillance is important

Let’s consider following scenarios and try to understand the need of market surveillance system
in stock exchanges.
 A series of transactions that give an impression of price movement in a security.
 Intentionally increasing bid for a security to increase its price.
 Buying of securities at higher price and then selling it to retail investors at inflated price.
 Engaging in trading activities (buying and selling of shares) at closing time of market to
affect the closing price of shares.
 Front running
 Improper transactions in which there is no change in actual ownership of the security.
 Dissemination of false or misleading market information through various media.
 Trading on the basis of un-published price sensitive information.
All such activities will affect the market, which could be beneficial for few investors but harmful
for other innocent investors. In such scenarios, market cannot be declared as fair, efficient and
transparent. Here comes the Surveillance department of Stock Exchange.
Stock Exchanges from time to time may adopt various measures to check the suspicious
activities which could have abnormal or unusual effect on the market. The main objective of
surveillance department of a stock exchange is to help maintain a fair and efficient securities
market.
A market can be considered fair if all participants face the same market conditions of trading and
no entity is in a position to trade on information that is publicly unavailable. A market can be
considered efficient if no single entity or group of entities can influence the price discovery
based on available information and / or demand and supply.

18
Working of Surveillance System
Every stock exchange has its own surveillance cell. For example, NSE has Automated
Surveillance system as a tool for monitoring real-time trading activities. The Alert system
compares the movements of price and trading volume for each security with the parameters
based on preset values. If there is an unusual change in the price or trading volume or both, for
any security, the alert system generates an alert so that online securities monitoring team will be
able to promptly investigate the reason of that unusual change in price or trading pattern of
securities. The different types of alerts generated are as follows:
Online Real Time Alerts
Intraday price movement related alerts or abnormal trade quantity related alerts or value related
alerts are the examples of real time alerts. These alerts are based on the trade related information
during the trading hours. The objective of these alerts is to identify any abnormality as soon as it
happens.
Online Non real Time Alerts
These alerts are based on the trade related information at the end of the day and the available
historical information. The objective of these alerts is to analyze the price, volume and value
variations over a period.
Alerts to Trading Members
Trading members are warned to be alert or to exercise due diligence by the exchange, in dealing
with securities which have shown abnormal deviation in prices and volume of transactions. The
Exchange on the basis of pre-determined parameters identify such securities and sends alert to
the trading members.
Verification of rumor and news

In case of any rumor or news appearing in print media in relation to any listed company,
exchange shall first ask for necessary clarification from the concerned company. The information
shall be disseminated to the market through electronic media by the Exchange as soon as
possible from the time such confirmation or clarification is received.
Dissemination of Price Sensitive Information to Market/Public
Positive information relating to dividend, bonus, rights and/or any other privilege in favor of
shareholders or any negative information, such as strike, lock-out, closing of any unit,
downgrading by CRISIL etc. are considered to be price sensitive information because these

19
information if published, are capable of influencing the share prices. Such information on being
received from a company shall be disseminated to the market or public through electronic
display, as soon as possible, as may be provided in the relevant Regulations from time to time.

4.1.3 Circuit Breaker/Filter

Stock price is influenced by number of reasons. For example information on financial results of
company, procurement of huge order or new deal or intension to pay dividends, major expansion
plan, etc. are quite logical to affect share price but sometimes stock prices may move up or down
drastically, accelerated mostly due to fear or greed by speculators. Such movements can bring
heavy fluctuations in stock prices contributing to excess volatility which is harmful for stock
market.

To curb the excess volatility, Exchanges implement circuit breakers. They are measures that are
used by a stock exchange authorities when there is a need to avert a sense that something
harmful is about to happen. Trading is then stopped for some time to let the market become cool.
When the buying and selling of shares gets too wild or frenzied, a circuit breaker is triggered.

Circuit breakers were introduced in Indian Trading System in July 2002. There are separate
circuit breakers for the indices and individual stocks. Circuit breakers ensure sanity of the stock
market and protect investors. There are circuit limits and price bands depending on what limit is
applied. When limit is applied to index, it is called index-based circuit breaker and when the
limit is applied on individual scrip, it is called securities specific circuit breaker or price band.

When the volatility of a stock breaks a certain limit as decided by the exchange, trading in that
stock is stopped for some time. The limit is fixed as a percentage of the stock’s price by the stock
exchange. The rules for circuit breaking are decided by the Securities and Exchange Board of
India (SEBI).

For example if the regulators decide that the circuit limit for a stock is 10%, then, trading in that
stock will be halted for the day, if the stock price moves up or down 10% in one day.

20
Circuit limit for Sensex and Nifty

There are 3 circuit limits for indices – 10%, 15% and 20%.Circuit filter is applied to Sensex or
Nifty whichever is breached first. The trigger of circuit limits also depends on the time at which
it occurs.

Trigger Trigger time Market halt Pre-open call auction session post
limit duration market halt

Before 1:00 45 Minutes 15 Minutes

pm.

10%
At or after 1:00 15 Minutes 15 Minutes
pm upto 2.30
pm

At or after 2.30 No halt Not applicable

pm

Before1 pm 1 hour 45 15 Minutes

minutes

At or after 1:00 45 Minutes 15 Minutes

15%
pm before 2:00
pm

On or after Remainder of Not applicable

2:00 pm the day

20% Any time Remainder of Not applicable

during market the day
hours

21
Daily Market Wide Circuit Filter

CNX NIFTY Closing 7123.15

As on 15-May-2014
Index Circuit Filter Equivalent Point (+/-)
Trigger Limit for 16-May-2014
10% 712.30
15% 1068.45
20% 1424.65

The above percentage is calculated on the closing value of the Sensex or the Nifty on the last day
of the immediate preceding quarter. So, for deciding the circuit limit for the Jan-march 2014
period, the closing value of the indices on December 31, 2013 would be used.

Few instances of Circuit Breaker leading to Trading Halt

a) Incidents of Lower Circuit Breaker

17 October 2007: Banning of P-Notes & FII

On 16 October 2007, SEBI (Securities & Exchange Board of India) proposed to curb
issuance of participatory notes which accounted for roughly 50% of FII investment , on
the account of rupee appreciation to record level and stock market creating new highs .
(P-notes is an instrument which allows foreign institutional investors to invest into stock
market.) This created panic into stock market and BSE Sensex crashed by almost 1700
points in a day which was the biggest intra-day fall in Indian stock markets. This led to
the automatic suspension of trade for one hour. However after the clarifications from
Finance Minister P. Chidambaram, that the government was not against FIIs and not
immediately banning PNs, the index saw a comeback and ended the day at 18715.82,
down 336.04 from the previous day's close.

22 January 2008: Onset of global recession.

On 21 January 2008, the SENSEX witnessed its highest ever loss of 1,408 points at the
end of the session. High volatility was caused because investors’ panic due to fears of a
recession in the US. The next day (22 January 2008), the BSE SENSEX index went into a

22
free fall as soon as the markets opened. The index hit the lower circuit breaker
suspending the trading for an hour. On reopening at 10.55 am IST, the market saw its
biggest intra-day fall when it hit a low of 15,332, going down 2,273 points. However,
after reassurance from the Finance Minister of India, the market bounced back to close at
16,730 with a loss of 875 points.

5 October 2012: Emkay Global’s 59 Erroneous Orders in NSE caused Stock Plunge

Nifty on the National Stock Exchange hit its lower circuit breaker in early trade on Friday
leading to a halt in trade briefly. The BSE Sensex, however, traded without
interruption.The Nifty suddenly dropped by over 900 points to a session low of 4,888.20,
a drop of 15.5 per cent below Thursday's closing level. lower circuit breaker was
triggered halting the trade for about 15 minutes on the NSE. Trade on the BSE was
normal though the Sensex was also affected by the sharp fall in Nifty prices initially. The
NSE attributed the sharp drop in cash market to erroneous orders, which resulted in
multiple trades at low prices. "The market circuit filter got triggered due to entry of 59
erroneous orders which resulted in multiple trades for an aggregate value of over Rs. 650
crores," NSE said in a statement. A single dealer terminal at Emkay placed 59 erroneous
orders for an institutional client, resulting in trades worth over Rs.650 crore. Spot trading
was halted on the NSE for 15 minutes from 9.50 a.m. to 10.05 a.m. The idea behind
halting was that temporary trading halt would help in checking for erroneous trades and
would also help investors ascertain reason for the sharp movement in share price.Trading
was not stopped on the BSE. All Nifty-50 stocks plunged during the freak trade. For
example, Reliance Industries shares plunged 20 per cent to an intra-day low of Rs. 682.
However, individual shares also recovered with the Nifty. Market regulator Securities
and Exchange Board of India initiated a probe into the crash. SEBI examined whether
adequate safeguard mechanism was in place to avoid a flash crash like situation. It also
examined the role of technology in trading.

23
 b) Incidents of Upper Circuit Breaker

Sensex created history: two upper circuits in one day after election result

On May 18 2009, Markets stopped trading for the day as the benchmarks hit another
upper circuit as soon as the trade resumed after 2 hour break. Investors were very happy
and enthusiastic, after the results of election in 2009 in which United Progressive
Alliance emerged victorious. Bombay Stock Exchange's Sensex went up by 17.24 per
cent, where as National Stock Exchange's Nifty by 17.33 per cent. Marketmen were
given the fact that there will be no interference by the Left Parties and other regional
parties in day-to-day functioning of the government and there would be less number of
allies leading to a stable government which would run its course of five years. Also the
new government was expected to come-out with full budget within 45 days of resuming
office. Reforms in the banking sector, divestment of public sector undertakings,
infrastructure, retail sector and insurance sector were on top of the priority list.

4.1.4 Price Band

Stock specific circuit filters are applied in both BSE and NSE index. The percentage for circuit
filter limit is 2%, 5%, 10%, 20%. Not all stocks fall in the circuit limit category. There are stocks
to which circuit limits are not applicable. For newly listed companies, there is a circuit limit of
20% from the issue price.

4.1.5 Settlement through dematerialized securities

For all trades executed on the T day, the clearing corporation determines the cumulative
obligations of each member on the T+1 day, and transfers the data to the clearing members
(CMs). All trades executed on trading date are settled on a designated settlement day, i.e., T+2
day. In the case of short deliveries on the T+2 day in the normal segment, the clearing
corporation conducts a buy-in auction on the T+2 day, and the settlement for the same is
completed on the T+3 day.

24
4.1.6 Settlement/Trade Guarantee Fund (SGF/TGF) to guarantee settlement of
transactions.

The Settlement Guarantee Fund operates like a self-insurance mechanism and provides a cushion
for any residual risk. The Settlement Guarantee Fund was first introduced at National Stock
Exchange (NSE) for ensuring complete settlement of transactions at any cost. The clearing
corporation or Exchange either jointly or separately maintain Settlement Guarantee Fund as
prescribed by the Relevant Authority from time to time. Here clearing members themselves
contribute and provide a deposit from time to time as determined by Relevant Authority towards
Settlement Guarantee Fund. The total amount of base minimum capital, additional base capital,
margin money and any other money, deposited and maintained by a clearing member with the
Clearing Corporation or the Exchange, in any form as specified, form part of the Settlement
Guarantee Fund. Deposits can be maintained towards Settlement Guarantee Fund, in the form of
either cash, fixed deposit receipts, securities, bank guarantees or in other form or method
subjected to terms and conditions, as may be specified by the Relevant Authority from time to
time.

Whenever a clearing member fails to meet his settlement obligations, arising out of his clearing
and settlement operations of his transactions, the exchange may utilize the funds available in the
Settlement Guarantee Fund, to the extent necessary to fulfill his obligations.
The Settlement Guarantee Fund thus ensures full confidence in market, that the settlement will
take place in time and will be completed irrespective of default by stock exchange trading
members.
The Settlement Guarantee Fund in National Stock Exchange, as on 31st March 2013, was Rs
4,731.76 crore and Rs 1,67,57,457 in Bhubaneswar Stock Exchange

Incident when brokers defaulted on their payment and SGF was used for trade settlement.
In March 2001, 10 brokers at Calcutta Stock Exchange (CSE) became defaulter for their
payment of Rs 120 crore in three consecutive weekly settlements. The CSE officials had to use
Settlement Guarantee Fund (SGF) which decreased the SGF at CSE by Rs 48 crores and
depleted the general reserves to the extent of Rs.20 crore.

25
4.1.7 Defaults Committee
Every Stock Exchange has set up a statutory committee known as Defaulters’ Committee to
administer the assets in respect of the defaulters or expelled members vesting in the Exchange.
The Defaulters' Committee distributes the amount available in the defaulter's account to the
admitted claims on pro-rata basis as per the priority laid out under its Rules/Regulations/Bye-
Laws of the Exchange. The Defaulters' Committee calls in and realises the security deposits,
margin money, other amounts lying to the credit of and securities deposited by the defaulter and
also recover all moneys, securities and other assets due, payable or deliverable to the defaulter.

The Committee shall have the power to declare a member as defaulter

 If he is unable to fulfill his obligations or

 If he admits his inability to fulfill his duties, obligations and liabilities or
 If he fails or is unable to pay within the specified time the damages and the money
difference due on a closing-out effected against him under these Bye Laws, Rules and
Regulations or
 If he fails to comply with the provisions of bye-laws and regulations relating to
settlement of contracts through the Clearing House or
 If he fails to pay any sum due to the Exchange or to submit or deliver to the Exchange on
the due date, delivery and receive orders, statement of differences and securities, balance
sheet and such other clearing forms and other statements as the relevant authority may
from time to time prescribe or
 if he fails to abide by the arbitration proceedings as laid down under the Bye Laws, Rules
and Regulations.

If a Trading Member is declared a defaulter by any recognized Stock Exchange of which he is a

Member or if the registration certificate is cancelled by SEBI, the said Trading Member shall be
expelled from the Exchange.

26
Few instances when members became defaulter

Vaishali Stock And Shares Ltd: Vaishali Stock and Shares Ltd was a member of the Over the
Counter Stock Exchange of India (OTCEI) and a stock broker registered with the Securities and
Exchange Board of India. OTCEI, informed SEBI that they declared the said broker as a
defaulter for non-payment of dues and that he was no more a member of OTCEI w.e.f.
19.09.2001. After an enquiry conducted by SEBI, the certificate of registration of Vaishali Stock
And Shares Ltd was cancelled.

SB Stock Works Pvt Ltd: was a member of the Calcutta Stock Exchange (CSE) and a stock
broker registered with the Securities and Exchange Board of India .CSE, informed SEBI that
they declared the said broker as a defaulter in pay-in and that he ceased to be a member of CSE
.After an enquiry conducted by SEBI, the certificate of registration of SB Stock Works Pvt Ltd
,as a stock broker was cancelled.

4.1.8 Plan for business continuity and site for disaster management

Securities Market is heavily dependent on IT. Break down of IT and IT infrastructure could
occur from major disasters such as earthquakes, floods, fires, riots or war etc., leading to
interruptions in business functions. In the past, there have been a couple of occurrences of such
disasters in India due to which it is very essential that the Trading Members establish a well
defined Business Continuity/Disaster Recovery (DR) plan.
To ensure business continuity, generally, market participants creates business continuity plan
which broadly include identifying procedures relating to an emergency or significant business
disruption that are designed to enable the member to meet its existing obligations to customers.
Normally, at a broad level, the BCP/DR plan addresses areas like Data back-up and recovery
mission critical systems, Financial and operational assessments, alternate communications
between the member, its customers and employees, alternate back-up site from where business
operations could resume and function, customer protective measures assuring prompt access to
their funds and securities in the event that the member determines that it is unable to continue its
business etc.,

27
Various disaster scenarios

Minor Outage Case: Scenarios like link connectivity being temporarily down, switch or router
port failures, System or network CPU failures, System Fan failures, System or Network Power
supply failures, Ethernet card failures may cause business processes to run at a sub-standard
level.
Moderate Outage Case: In this scenario, business processes may experience moderate damage
due to faults in the equipments or in system required for running the business. Processes may not
continue or may run at a degraded level. An alternate site may not be required for continuing
business but alternate equipment may be required depending on the criticality of the business
process and infrastructure.
Some of the examples of are
 Equipment damage due to power.
 ISDN/VSAT/Circuit router failure
 Core access layer switch failure
 LAN switch or router failure.
 Temporary outage of power.

Disaster Scenario: In this scenario, the entire infrastructure may go down because of severe
disaster resulting in the total shutdown of business processes. Processes like Trading, Risk
Management, Settlement Systems etc. from that location and related infrastructure may not work
at all. Office premises may become inaccessible to key personnel. There may also be non-
availability of key resources in the building.
Some of the examples are:
 Flood / Rain/ Fire making building and datacenters inaccessible.
 Riots /war etc., at a location near one of the offices or within the premises of the
members making office premises inaccessible.
 Complete power shutdown due to unavailability of generators.
Under this scenario, members require to switch their business over to the BCP site. Key factors
which will determine the Recovery Time would be availability of key personnel, resilient IT
infrastructure and robust BCP processes.

28
Catastrophe:

In this scenario, a major disaster results in disruption of services. Full processing capability
cannot be achieved for a substantial period of time. An alternate processing site as well as offsite
offices for employees over an extended period of time would be required for continuing the
business processes.
Some of the examples of such scenarios can be

 War
 Earthquake
 Extended Communal Riots etc

NSE –Can’t go down in disaster:

Even during a disaster, National Stock Exchange's trading, clearing and settlement operations
continue normally, because of well-devised business continuity plan and Disaster Recovery (DR)
site at Chennai. Due to very high volume of trade and settlement transactions being carried out
every day at National Stock Exchange, NSE can't afford to be down for a moment, because this
will result in losing of revenue and reputation. The exchange runs critical applications like
trading, clearing and settlement, surveillance, position monitoring, and risk management. In
terms of spread of business, NSE's operations in 360 cities connect to brokerage houses, banks,
and two depositories.

To ensure uninterrupted service, the exchange implemented adequate measures to support

business recovery, which includes a DR site in another city. NSE.IT Limited is an organization
which implements all IT-related projects at NSE. NSE has set up and manages its own DR site in
Chennai. All the critical applications and hardware are replicated at the site, which works as
backup in case of any unwanted event at the primary site. This has made NSE the only exchange
in India with a live DR site.

To understand the loss of business NSE may suffer in case of a disaster, let's look at the areas
that NSE has to manage.

 The Wholesale Debt Market (WDM) with a daily turnover of Rs 2,900 crore
 The Capital Market (CM)/secondary market with a daily turnover of Rs 2,500 crore

29
  The derivatives market having daily turnover of Rs 2,600 crore
 The entire retail debt market

Analyzing impact of disaster and importance of Business Continuity Plan/DR site.

 The daily turnover-based revenue in WDM, CM, and derivatives will be affected
resulting in tremendous loss, overall.

 Average brokerage of 0.5 percent on daily trading will be lost. Earnings of the
exchange's business partners like clearing corporations, depositories, and clearing banks
will be affected.
 There'll be a large loss to the trading members due to loss of trading opportunity. It will
be a loss of image for NSE, the Indian securities market, and the nation at large.
Customer base and goodwill will suffer.
 In the absence of Business Continuity Plan and Disaster Recovery infrastructure, the
recovery time would be unpredictable.

30
 4.2 AT TRADER’S LEVEL

4.2.1 Capital Adequacy

The Exchange prescribes appropriate capital adequacy norms for the different trading segments,
which shall be in accordance with the requirements, as may be prescribed by SEBI from time to
time.
4.2.2 Base Minimum Capital and Additional Base Capital
Every trading member/clearing member is required to maintain base minimum capital at all
times as provided under the relevant Rule. A trading member/clearing member, according to his
business requirements, may deposit additional base capital at any point of time in the form and in
proportion, prescribed in the relevant Regulations from time to time, and such deposit shall be
withheld or released to the trading member / clearing member, as may be decided by the
Relevant Authority from time to time.

4.2.3 Margin Requirements

Just as we face day to day uncertainties pertaining to weather, health, traffic etc and take steps to
minimize the uncertainties, so also in the stock markets, there is uncertainty in the movement of
share prices.
This uncertainty leads to risk and is addressed by margining systems of stock markets. Securities
transactions are subjected to stringent margin requirements and every trading member/ clearing
member are required to deposit or pay such amount of margins and in a form, as may be
prescribed by SEBI or the Exchange or Clearing Agency and in turn collect such margins from
their clients.
Why is margin required?

Suppose an investor, purchases 1000 shares of ‘xyz’ company at Rs.100/- on January 1, 2014.
Investor has to give the purchase amount of Rs.1,00,000/- (1000 x 100) to his broker on or before
January 2, 2014. Broker, in turn, has to give this money to stock exchange on January 3, 2014.

But there is always a small chance that the investor may not be able to bring the required money
by required date. As an advance for buying the shares, investor is required to pay a portion of the
total amount of Rs.1,00,000/- to the broker at the time of placing the buy order. Stock exchange

31
in turn collects similar amount from the broker upon execution of the order. This initial token
payment is called margin.

Now, for every buyer there is a seller and if the buyer does not bring the money, seller may not
get his / her money.

Margin is imposed on the seller also to ensure that he / she gives the 100 shares sold to the
broker who in turn gives it to the stock exchange. Margin payments ensure that each investor is
serious about buying or selling shares.

In the above example, assume that margin was 20%. That is investor has to give Rs.20,000/-
(20% of Rs.1,00,000/) to the broker before buying. Now suppose that investor bought the shares
at 10 am on January 1, 2014. Assume that by the end of the day price of the share falls by Rs.25/-
That is total value of the shares has come down to Rs.75,000/-. That is buyer has suffered a
notional loss of Rs.25,000/-. But the buyer has paid Rs.20,000/- as margin but the notional loss,
because of fall in price, is Rs.25,000/-. That is notional loss is more than the margin given.

In such a situation, the buyer may not want to pay Rs.1,00,000/ - for the shares whose value has
come down to Rs.75,000/-. Similarly, if the price has gone up by Rs.25/-, the seller may not want
to give the shares at Rs.1,00,000/-. To ensure that both buyers and sellers fulfill their obligations
irrespective of prices movements, notional losses are also need to be collected.

Prices of shares may keep on moving every day. Margins ensure that buyers bring money and
sellers bring shares to complete their obligations even though the prices have moved down or up.

Margins in the cash market segment comprise of the following three types:

1) Value at Risk (VaR) Margin

2) Extreme loss Margin

3) Mark to market Margin

VaR margin:

While historical volatility tells us how the security price moved in the past, VaR answers the question,
“How much is it likely to move over next one day?” VaR is a technique used to estimate loss of value of

32
an asset or group of assets based on the statistical analysis of historical price and volatilities with a given
probability.

A VaR measure has three components: a time period, a confidence level and a loss amount (or
loss percentage). Keeping these three parts in mind, VaR answers:

“With 99% confidence, what is the maximum value that an asset or portfolio may lose over the
next day? “
Example

Consider shares of a company. Its market value today is Rs.5 lakhs but its market value
tomorrow is obviously not known. An investor holding these shares may, based on VaR
methodology, say that 1-day VaR is Rs.1 lakhs at 99% confidence level. This implies that under
normal trading conditions the investor, with 99% surity, can say that the value of the shares
would not decline by more than Rs.1 lakhs within next 1-day.

In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss (in
%) that may be faced by an investor for his / her shares (both purchases and sales) on a single
day with a 99% confidence level. The VaR margin is collected on an upfront basis (at the time of
trade).

Calculation of VaR Margin for TCS Stock

VaR is computed using exponentially weighted moving average (EWMA) methodology. Based
on statistical analysis, 94% weight is given to volatility on ‘T-1’ day and 6% weight is given to
‘T’dayreturns.
σ 2t =λ *( σt-1)2 +(1- λ) * r t2
where σ 2t =variance
λ=lambda factor=0.94
r=returns of the securities for the day
t=time
rt =LN(It/It-1 ), It is the security price at time t.

33
Return on TCS stock on 10th April, 2014, can be calculated as LN( price of Stock on 10th
April/price of stock on 9th April)
With this Return=LN(2130.70/2140.40)
Return= -0.197
σ 2t =λ *( σt-1)2 +(1- λ) * r t2
on putting values we get, 0.94* 0.01497^2+0.06* (-0.197)^2=5.03%
standard deviation=2.24%
Now to arrive at VaR margin rate, companies are divided into 3 categories based on how regularly their
shares trade and on the basis of liquidity .

Group I consists of shares that are regularly traded that is, on more than 80% of the trading
days in the previous six months and have high liquidity (that is, impact cost less than 1%).
Group II consists of shares that are regularly traded (again, more than 80% of the trading
days in the previous six months but with higher impact cost (that is, more than 1 %). All
other shares are classified under Group III.

For Group I shares, the VaR margin rate would be higher of

• 3.5 times volatility or

• 7.5% of value

For Group II shares, the VaR margin rate would be higher of

• 3.5 times volatility or

• 3.0 times volatility of index

The volatility of index is taken as the higher of the daily Index volatility based on S&P
CNX NIFTY or BSE SENSEX. At any point in time, minimum value of volatility of index
is taken as 5%.

For Group II shares, the number arrived at as above, is multiplied by 1.732051 (that is,
square root of 3). The number so obtained is the VaR margin rate.
For Group III securities VaR margin rate would be 5.0 times volatility of the Index multiplied by
1.732051 (that is, square root of 3).
TCS belongs to Group 1 shares , applicable VaR margin rate=3.5* 2.24=7.85%

34
If an investor buy 1 share of TCS on 10th April 2014, he needs to pay margin amount of Rs
167.26 per share and total amount=Share Price+ Margin
( 2130.70+167.26)= Rs.2,297.95

No of shares=1
VaR Margin Rate=7.85%
Margin Amount=Rs 167.26
Total amount including Only VaR Margin =Rs 2297.95

Extreme Loss Margin: The Extreme Loss Margin for any stock shall be higher of 5% or 1.5
times the standard deviation of daily logarithmic returns of the stock price in the last six months.
The value is calculated at the end of each month by taking the price data for the past six months
and the resulting value is applied for the next month.

Analyzing Broker’s outstanding position with respect to margin deposit in case of buying
position & selling position –An Illustration

Trading Stocks Quantity Price Traded VaR ELM Total

Day(T) Value Margin Margin Margin
Rate Rate
(7.5%) (5%)
14 , May TCS 1 Rs.2,217.50 2,217.50 166.31 110.88 277.19
2014
14 , May WIPRO 2 Rs. 523.80 1,047.60 78.57 52.38 130.95
2014
14 , May HDFC BANK 1 Rs. 774.70 774.7 58.1 38.74 96.84
2014
14 , May ONGC 3 Rs. 367.60 1102.8 82.71 55.14 137.85
2014
14 , May DRREDDY 1 Rs. 2520.00 2520 189 126 315
2014

a) In case of buying position

35
 Clients Securities Position Margin

Client TCS Long(Buy) 277.19

X
Client WIPRO Long 130.95
Y
Client HDFC Long 96.84
Z BANK
Client ONGC Long 137.85
A
Client DRREDDY Long 315
B

Total Margin deposit on T+1 day, i.e 15, May 2014 would be net of his outstanding positions
across all the 5 clients , which is sum of the margin requirements for individual clients.

Broker’s total margin deposit with clearing corporation for his outstanding position is
summarized below:

Total Traded Value Total Margin Deposit Released margin date (T+1
day)

7,662.60 957.82 15 May 2014

b) In case of selling position

Clients Securities Position Margin

Client TCS Short(Sell) 277.19

X
Client WIPRO Short 130.95
Y
Client HDFC Short 96.84
Z BANK
Client ONGC Short 137.85
A
Client DRREDDY Short 315
B

36
 4.3 AT INVESTORS’ LEVEL

4.3.1 Investor Protection Fund to compensate legitimate claims of investors

Every Stock Exchange maintains an Investors' Protection Fund to protect the interests of the
clients in case when trading members of the Exchange, are declared defaulter or expelled, under
the provisions of the Rules, Bye-laws and Regulations of the Exchange. The Investors’
Protection Fund compensate any client, who has made a legitimate claim such as non-receipt of
the securities bought from a trading member for which the payment has been made by the client
to the trading member or has not received the payment for the securities sold and delivered to the
trading member or has not received any amount or securities which is/are legitimately due to
such client from the trading member, who is either declared a defaulter or expelled by the
Exchange. The Investor Protection Fund Trust, after the recommendations of the Defaulters'
Committee, provides compensation to the investors to the extent of funds found insufficient in
Defaulters' account to meet the admitted claim, subject to a maximum limit as prescribed by
SEBI for different stock exchanges. Bombay Stock Exchange was first exchange to set up an
Investor Protection Fund (IPF) on July 10, 1986.
Every trading member of the Exchange is required to contribute such amount, as may be
determined by the Relevant Authority from time to time, to constitute the corpus of the
Investors’ Protection Fund.
Corpus of Fund:
 The Members contribute Rs. 1 % per Rs.1 lakh of gross turnover.
 Stock Exchange, on a quarterly basis contributes, 1% of the listing fees collected by it.
 The 100 % interest earned by stock exchange on 1% security deposit kept with it by
companies making public/rights issues is transferred to the fund.
 As per the SEBI directive, auction proceeds that have been impounded in certain cases
where price manipulation / rigging was suspected are transferred to the Fund.
 5% of the surplus amount lying in the account of the defaulters after meeting their
liabilities on stock exchange is transferred to this Fund.
 The interest received on amounts invested from the corpus of the fund is credited to the
fund at the end of each financial year.

37
In case of any shortfall in the corpus of the Investors’ Protection Fund, the Relevant Authority
has power to call for additional contributions. The Investors’ Protection Fund is held in trust and
vest in the Exchange or any other entity, as may be specified by the Relevant Authority from
time to time. The Investors’ Protection Fund are managed by the Trustees appointed under the
Trust Deed. The Trustees of the Fund are guided by the Committee for Settlement of claims
against defaulters, who investigate each of the claims placed before them for consideration after
due screening by the officials of the Exchange and also by an Independent Chartered
Accountant, if needed, for satisfying that each claim meets the requirements.
Following claims are entertained by Default committee.
 Claims are eligible for consideration irrespective of whether the claimant produces a copy
of contract note as proof or otherwise, if order was recorded on the ATS of the Exchange.
 If a trading member is declared a defaulter or expelled, either directly or through a sub-
broker, claim is to be supported with necessary and sufficient proof of payment or
delivery of securities made to the trading member, otherwise claim shall not be
entertained.
 A claim will be eligible for payment to the extent of the actual loss suffered by an
investor and the actual loss would include any difference receivable by the claimant
arising out of the transactions. Claim for damages or interest or notional loss shall not be
entertained.
 In case of a claim where trades have not been recorded on ATS and also there is no proof
of payment or delivery of securities to trading member, the Relevant Authority may
require the claimant/s to produce necessary documents or other evidence in regard to the
issues, substantiating that the actual amount paid and/or securities delivered were towards
a trade on the Exchange and not towards a deposit, loan or otherwise.
 The claimant had regular transactions through the defaulter or expelled member, for a
reasonable period of time and claimant can substantiate this by a copy of the accounts,
proof of payment of money or delivery of securities, contract notes, order execution
details, or such other relevant material available.
 The claimant had already lodged complain with the Exchange, in case a trading member
is declared a defaulter or expelled.

38
At present Bombay Stock Exchange compensate to the maximum extent of Rs. 15,00,000/- per
investor per defaulter/expelled member from its Investors Protection Fund (IPF). National Stock
Exchange compensates to the extent of Rs1 crore.

Incident when SEBI came forward for protection of Investors’ Interest

ABS Industries is an Indian based chemical manufacturing company which started its operations
in 1978 in coating, adhesives & polycarbonates. In September 1996, the Managing Director of
the company Mr. Rakesh Agarwal met with the officials of a German company, ‘Bayer AG’
having business of Chemicals & Pharmaceuticals. Due to similar kind of business, a proposal
was made to work in a joint venture. Bayer AG had made a clause that they would take 51 %
holdings but nothing was finalized then. When Mr. Agarwal returned to India, he purchased
1,85,200 shares of the company from open market through his brother- in-law during the period
6th September to 1st October. Till this time the announcement of joint venture of the two
companies was not made to the public. The Securities and Exchange Board of India (SEBI)
charged Mr. Agarwal for Insider Trading alleging that he had purchased the company’s shares
prior to the announcement of the Joint Venture. Post announcement, the company’s shares price
had risen and Agarwal made profit of Rs.34lakhs. SEBI ordered Mr. Agarwal to deposit Rs.34
lakhs to compensate ABS investors. Agarwal challenged the SEBI in Securities Appellate
Tribunal (SAT) which gave the decision in Agarwal’s favor. In turn, SEBI Challenged SAT
order in Supreme Court and won the case in 2004, after which as per SEBI direction Rakesh had
to deposit Rs. 34, 00,000 with Investor Education & Protection Funds of BSE and NSE in equal
proportion to compensate any investor who may make any claim subsequently.

4.3.2 Investor Service Centre

To cater to the needs of investors, Stock Exchanges establish their Investor Service Cell at
various locations. For example NSE has investor service centre located at Mumbai, Chennai,
Kolkata, New Delhi, Ahmedabad, Hyderabad, Indore, Kanpur, Pune, Bangalore and Jaipur. BSE
has investor service cell at Ahmedabad, Bangalore, Chennai, New Delhi, Hyderabad, Indore,
Jaipur, Kanpur, Kolkata, Mumbai, Pune.

39
The Investor Services Cell facilitates resolution of complaints of investors against the listed
companies or Stock exchange members. Stock Exchanges give high priority for resolution of
investor complaints.

Investor Services Cell of the Exchange deals with the complaints of investors against the Trading
Members of the Exchange or against the listed companies. Investors could lodge their complaints
in the format prescribed by the Exchange along with the supporting documents either by
registering their complaints in electronic mode through website or may send in their complaints
to the nearest investor service centre.

Investors’ grievance against listed companies:

Investors' complaints against listed companies are forwarded to the concerned companies, by
stock exchange, with a copy sent to the complainant. The investors are advised to inform stock
exchange, whether or not the complaints are resolved within 30 days. If a company fails to
resolve the complaint within 30 days, stock exchange sends a reminder to the company. Stock
exchange follows-up with the companies and / or their Registrar & Transfer Agents, to resolve
complaints. If the total number of pending complaints against a company exceeds 25 and remain
unresolved by the company for more than 45 days, then steps like suspension of trading in the
securities of such company until the complaints are resolved or imposition of fine on company
are initiated by stock exchange. For example stock exchange transfers such scrips to “Z”group.
"Z" category company indicates that company has not complied with various provisions of the
listing agreement including non-resolution of investors' complaints. Through imposition of "Z'
category, stock exchange warns investors to be more careful in their investments in such
companies.

Complaints against Listed Companies fall in following categories:

 Public / Further offerings: Complaint regarding non-receipt of

i. Allotment Advice, securities allotted, refund order

ii. Interest on delay in Redemption / Refund Amount

iii. Sale Proceeds of Fractional Entitlement

40
 iv. Composite Application Form (CAF) for Rights offer/ Rights for (CAF)
Application

v. Securities purchased through a Rights Offer

vi. Letter of offer for Buyback

 Corporate Actions: Complaint regarding non-receipt of

i. Dividend

ii. Interest on Debentures, Bonds or other Debt Instruments

iii. Securities on account of a Bonus / De-merger / Merger / Stock Split

iv. Redemption Amount

 Transfer of Securities: Complaint regarding non-receipt of

i. Securities after Dematerialization

ii. Securities after Transfer/Transmission

iii. Duplicate Certificate relating to Securities

 Miscellaneous: Complaint regarding non-receipt of copy of the Annual Reports.

Investors’ grievance against Stock Exchange Member:

The complaints against stock exchange trading member's are forwarded to the concerned trading
members for resolution. Trading Members are required to reply to complain within 3 working
days from receipt of the complaint from stock exchange. In case Trading Member does not reply
or the reply received from the Trading Member does not satisfy the complainant, the complain is
placed before Investors' Grievances Redressal Committee (IGRC). Stock Exchange provides
services of IGRC which, in its meetings, mediates and counsels the disputing parties for finding
friendly solution, for which the Exchange sends Notice to both parties to remain present before
the IGRC. In cases, where a friendly solution cannot be reached, IGRC suggests the complainant

41
to opt for an arbitration if they desire. It records the final outcome of the matter in the form of
minutes, a copy of which is handed over to the parties or mailed to an absent party. The
Exchange imposes penalties on the Trading Member for not replying to the complaints within the
specified period or not attending the IGRC meetings. The complaints amounting to less than Rs.
25,00,000/- is heard by the IGRC comprising of one member' and those amounting to more than
Rs. 25,00,000/- are heard by the IGRC comprising of three members.

Complaints against Trading Members of Stock Exchange:

 On Non-Issuance of the Documents by the Trading Member

 On Execution of Trades without Consent
 When Excess Brokerage is charged by Trading Member / Sub-broker
 On non-receipt of funds / securities
 On Non-receipt of margin/security deposit given to the Trading Member
 When Non-Receipt of Corporate Benefit (Dividend / Interest / Bonus etc.)
 When Non-receipt of credit balance as per the statement of account is there
 Non-Receipt of Funds / Securities kept as margin is there
 On auction value / close out value received or paid

4.3.3 Investor Grievance Committee

At each Investor Service Centre, exchange constitutes Investor Grievance Resolution Panel
(IGRP) or Investor Grievance Committee. All complaints which do not get resolved within sixty
days from the date of lodging the complaints with Exchange or cases where parties are aggrieved
by the resolution are referred to IGRP.

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 5. Investors to Take Care of Risk in Trade
5.1 Contract note:

A contract note is something which imposes a legal relationship between the client and trading
member with respect to purchase/sale of securities and settlement of trades. It is an important
document for investors which keeps the legal record of client’s transaction carried on a stock
exchange through a broker. After verifying the details contained in contract note, the client keeps
one copy and returns the second copy to the trading member duly acknowledged by him. Only
broker can issue contract notes. A broker is supposed to send the contract note to its client within
24 hours.

A contract note contains following important details:

 Name, address and SEBI Registration number of the Member broker.

 Name of partner /proprietor /Authorized Signatory.
 Dealing Office Address/Tel No/Fax no, Code number of the member given by the
Exchange.
 Unique Identification Number
 Contract number, date of issue of contract note, settlement number and time period for
settlement.
 Constituent (Client) name/Code Number.
 Order number and order time corresponding to the trades.
 Trade number and Trade time.
 Quantity and Kind of Security brought/sold by the client.
 Brokerage and Purchase /Sale rate are given separately.
 Service tax rates and any other charges levied by the broker.
 Securities Transaction Tax (STT) as applicable.
 Appropriate stamps have to be affixed on the original contract note or it is mentioned that
the consolidated stamp duty is paid.
 Signature of the Stock broker/Authorized Signatory.

43
Why receipt of contract note from the broker in respect of buying or selling of shares, is very
essential.
 It will help an investor to lodge complaint against his broker in case his claim is not
received.
 It will also help an investor in getting his legitimate claims against a defaulter stock
broker.
 Contract Note is a confirmation of trades done on a particular day by a trading member
on behalf of its client.
 A contract note not only records transactions but it also provides the details of the
transaction in writing.
 The contract note contains details that enable the investor to spot a particular transaction
among the thousands of transactions taking place on the stock exchange and further
cross-check the trade information with that provided by the stock exchange.
 Investor should always check the contents of the contract note and seek clarifications
from brokers for discrepancies.
 Contract notes tell investors /clients what they have transacted into. There are instances
where companies with similar names trade on bourses or multiple instruments issued by
one company trade on exchange.
 Bad communication between investor / client and the broker at the time of trading may
result in wrong securities bought or sold.
 Contract note helps arbitrators for settlement of disputes if any arising out of transactions.
 By going through the contract note investors get to know what they have bought or sold.
The contract note can be used to check the demat holdings and ascertain the exact
brokerage paid.
 Contract notes are also useful to ascertain the capital gains tax payable.

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5.2 Other Responsibilities:
 May or may not execute Power of Attorney (PoA) in favour of stock broker as this is
not mandatory for opening a trading account or for dealing in shares and securities.
 Ensure PoA is not mis-utilized if it is given in favour of the stock broker
 Make payment, if any, to the broker only through cheque
 Ensure receiving SMS/ e-mail alerts from the stock exchange in respect of buying or
selling of shares, if any.
 Ensure receiving SMS/ e-mail alerts from the Depositories in respect of credit or
debit to the Demat A/c. consequent to buying or selling of shares, if any
 Check the holding status in Demat A/c. regularly.
 Ensure settlement of your claim by the stock broker in time in respect of buying or
selling of shares, if any.
 Don’t engage in excess day trading and try to become a long term investor in right
stocks.
 Don’t be panic while buying or selling shares and try to select good stocks for
investment.
 Be careful in investing in high volatile market.

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 6. CASE STUDY
During the late nineteen eighties, the share mania spread so rapidly that many new Stock
Exchanges came into existence. There was a hectic boom in the primary market activities with a
number of existing and new companies floating issues. The number of companies getting listed
on the exchange increased steadily. Investments and trading picked up such a speed that it gave
birth to some of major scams in the secondary market during 1990s.
Analysis of such scams sometimes becomes necessary to understand what were the loopholes
present in the system earlier, how did market respond, what market regulators did to overcome
those loopholes and last but not the least to check how present risk containment measures
adopted by our stock exchanges can possibly avoid any further scams and any exceptional
market scenarios to ensure safety & integrity of entire financial system.

46
CASELET 1: Harshad Mehtas Scam
In the year 1992, the rise in BSE Sensex raised many questions. The man behind all this was
Harshad Mehta.
Who was Harshad Mehta
Harshad Shantilal Mehta was a high-profile Indian stock broker who grabbed the headlines for
making Bombay Stock Exchange, one of the victims of biggest security scam till ever. He was
accused of massive stock manipulation by the help of worthless bank receipts. In reality he
actually exposed the loopholes in the Bombay Stock Exchange (BSE) transaction system, Indian
Banking System and SEBI, which further introduced new rules to overcome those loopholes.
Mehta was convicted by the Bombay High Court and Supreme Court of India for financial
scandal valued Rs 4,999 crore , which took place on the Bombay Stock Exchange (BSE). He was
tried for 9 years, until he died in the late 2001.
Early life and Career: Mehta was born on 29 July,1954 in a lower middle-class Gujarati Jain
family & had spent his early childhood in Mumbai where his father was a small businessman.
After doctors advice to Mehta’s father to shift to a drier place on account of his health, the family
relocated to Raipur in Chhattisgarh. Mehta studied from Holy Cross Higher Secondary School,
Byron Bazar, Raipur. By profession, Mehta was Graduate in commerce.
His journey from a stock broker to big market bull
During 1980s, for a period of 10 years, Mehta worked at the position of increasing
responsibilities in several brokerage firms. He left his job at The New India Assurance Company
in 1980 and got new one with BSE-affiliated stockbroker P. Ambalal. In 1981, Mehta became a
sub-broker for stockbrokers J.L. Shah and Nandalal Sheth. After gaining considerable experience
as a sub-broker, he started a new venture called Grow More Research and Asset Management
Company Limited with his brother Sudhir. When the BSE auctioned a broker’s card, the Mehta’s
company bid for it with the financial support of J.L. Shah and Nandalal Sheth. By year 1990,
Mehta had become a prominent name in the Indian stock market. He started buying shares
heavily, especially the shares of India's foremost cement manufacturer, Associated Cement
Company (ACC). Due to heavy trading in ACC, price of the cement company rose from 200 to
9000 (approx.) implying a 4400% increase in its price. It was later revealed that Mehta used the
replacement cost theory to justify the reasons for price rise. Replacement cost theory, basically
states that the older companies should be valued on the basis of the amount of money that would

47
be needed to create another similar company and by help of this theory he stated that stock had
been undervalued and the market had simply corrected it when it revalued the company again by
taking this theory into account. By the latter half of 1991, Mehta earned a nick name of ‘Big
Bull’ as people credited him for having initiated the bull run in stock market.

The making of 1992 security scam: Indian banking system was not very strong at that time,
that’s why he was able to misuse the system. Mehta and his associates took the advantages of
loopholes and diverted the funds involved in interbank transactions into the stock market,
between April 1991 to May 1992. They were buying shares heavily across many industries at
premium. Indian Stock Exchange Index (Sensex), which was hovering around the 800 mark in
early 1990, flared up past 3500 by April 1992.

The exposure of 1992 security scam and its outcome:

Harshad Mehta scam’s was exposed on April 23,1992 , when veteran columnist Sucheta Dalal
wrote an article in The Times of India. Dalal’s column read: “The crucial mechanism through
which the scam was effected was the ready forward (RF) deal. The RF is a secured short-term
(typically 15-day) loan from one bank to another. Crudely put, the bank lends against
government securities just as a pawnbroker lends against jewelers. The borrowing bank actually
sells the securities to the lending bank and buys them back at the end of the period of the loan,
typically at a slightly higher price. It was this ready forward deal that Mehta and his associates
used with great success to channel money from the banking system.”
In a ready-forward deal, a broker usually brings two banks together and earns a commission for
this. Although the broker does not handle the cash or the securities, this was not the case in the
prelude to the Mehta scam. Mehta and his associates used this RF deal with great success for
channelizing money through banks.
The securities and payments were delivered through the broker in the settlement process. The
role of the broker was to function as intermediary. A broker received the securities from the
seller and money in form of cheque from the buyer. He handed over those securities to the buyer
and subsequently made the payment to the seller. However such a settlement process meant that
,both the buyer and the seller may not even know each other from whom they have traded with
and only the broker would know both the parties. The brokers could manage this method

48
expertly as they had already become market makers by then and had started trading on their
account.
Another instrument used by Mehta and his associates in this scam was the Bank Receipt (BR). A
BR is a receipt for the money received by the selling bank and pledges to deliver the securities to
the buyer. A BR thus confirmed the sale of securities. In this scam, no securities were being
traded in reality but the seller gave the buyer a BR .
Ready with such dangerous game plan, Mehta started searching for banks which would readily
issue fake BRs. His search ended when he found that the, two small and little known lenders,
Bank of Karad (BOK), Mumbai and the Metropolitan Co-operative Bank (MCB), were willing to
do such things in return for a fee. These two banks agreed to issue BRs as and when required.
Once they issued the fake BRs, Mehta passed them on to other banks who in turn lent him
money under false assumption that they were lending money against government securities. Now
this money was used by Mehta and his associates for buying shares in stock market and driving
up the prices of stock by buying them at low prices. When the time for returning money to the
bank came, the shares were sold for significant profits and the BRs were retired and banks also
got their money back.

Outcome: There were serious consequences of this scam. When the scam was exposed, it caused
many problems in the capital market and money market. Upon the exposure of the scam several
banks found that they were holding BR of no value at all, as they all were fake. Banks started
demanding their money back, which caused Sensex to fall almost dramatically the way it had
risen. However by this time the whole banking system had already suffered a loss of Rs 4,000
crore. The scam was taken in the Indian Parliament, leading to Mehta's imprisonment. The
scam’s exposure led to the death of the Chairman of the Vijaya Bank who reportedly committed
suicide by jumping from his office roof. He was guilty of having issued checks to Mehta and
knew accusations and shame he would have to face from the public.

Mehta was charged with 72 criminal offences, out of which he was convicted for only one. On 9
November 1992, CBI arrested Mehta and his associates, for allegedly misappropriating more
than 2.8 million shares (2.8 million) of about 90 companies, including ACC and Hindalco and
later banned from the stock market with investigators holding them responsible for causing a loss
to various entities. However, in September 1999, Bombay High Court convicted and sentenced

49
him to five years rigorous imprisonment and a fine of Rs. 25000. On 14 January 2003, Supreme
Court of India confirmed High Court's judgment. He died of heart ailment, at the age of 47, on
31st December 2001. Nine years after the death of Harshad Mehta, the IT department and public
sector banks (PSBs) have successfully recovered a significant portion of their claims. The
Supreme Court directed the Custodian to liquidate the assets of the Harshad Mehta Group
(HMG) in March 2011 to make payments of Rs1,995.66 crore to the IT department and Rs
199.25 crore to the State Bank of India (SBI), making the two institutions two of the earliest
claimants to recover their dues.

While the SBI’s total principal amount claim of Rs 1,000 crore have been largely settled,
financial institutions have also received some money. However, Standard Chartered Bank, which
had claim of Rs 500 crore, has yet to recover its dues. Although the total claim over the HMG is
of more than Rs 20,000 crore, the supreme court has said that for the present, it would only
consider claims towards the principal amount.
Measures taken post scam:
 Post Mehta scam, Government of India, passed “SEBI Act 1992” and conferred statutory
powers to it.
 Suspended brokers who were directors and other officials of BSE for alleged insider
trading.
 Imposed additional volatile 10% margin on Group ‘A’ shares.
 Imposed margin on net outstanding selling position of FIIs, financial institution, bankers
and mutual funds.
 Rolling settlement system was made compulsory.
 Launched trade guarantee fund to guarantee settlement of all transactions.
 Reduced gross exposure limit for brokers on base minimum capital to 10 times in NSE
and 15 times for other stock exchange.

QUESTION FOR DISCUSSION

1) Analyze this case first and its impact.

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CASELET 2) Ketan Parekh’s Scam- A BIG HIT TO SMALL INVESTORS
“I have left with zero saving. I don’t know how to feed my family.”
This was the sentence used by small innocent investors during this scam. Many people were left
with zero saving, as their money had no value. Some suicide cases were also reported during this
time. But what happened in this scam? …………..

A Crash that became “Talk of Nation”:

On March 1, 2001 the Bombay Stock Exchange Sensitive Index (Sensex) fell by 176 points
which shocked the government, stock market and the indian investors because just one day
before the Finance Minister, Mr. Jaswant Sinha had issued budget in the parliament which had
prompted a 177 point rise in the sensex. This sudden crash in the stock market prompted the
Securities & Exchange Board of India (SEBI) to start immediate investigations for checking
sudden high volatility of stock market. Reserve Bank of India (RBI) also ordered some banks to
furnish data related to their capital market exposure. Media reports revealed that private sector
banks have exceeded their prudential norms of capital exposure, thereby contributing to the stock
market volatility.
The man behind this scam was Ketan Parekh [KP]. The Sensex crashed further by 147.18 points
after the arrest of Ketan Parekh by the Central Bureau of Investigation (CBI) on 30 March, 2001.
Ketan Parekh ,was a chartered accountant by profession and used to manage his small family
business NH securities started by his father. He was a trainee of Harshad Mehta and also known
as “Bombay Bull” having connections with movie stars, politicians and leading international
entrepreneurs. Over the years, KP had built a network of companies, involved in stock market
operations, mainly in Mumbai.
The birth of scam
The stocks of Information, Communications, and Entertainment sector were rising all over the
world in early 1999 which led to a rise of the Indian stock markets as well.
KP invested in the stocks of Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips
and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global),
Zee Telefilms, Crest Communications, and PentaMedia Graphics. According to media reports,
KP took advantage of low liquidity in these stocks, which eventually came to be known as the
'K-10' stocks. These shares were held through KP's company.From January to July 1999, the K-

51
10 stocks went on rising. HFCL and Global were major gainers. He started trading of these
shares within the network of his own companies with the intention of creating buying pressure
for shares of K-10. Continuous trading by Ketan Parekh made other brokers in the market to
suspect that something is happening inside K-10. Thus brokers started buying shares of K-10 for
themselves and also urged their clients to buy these shares.
Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks,
and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top
five traded stocks in the exchanges. HFCL's traded volumes went up from 80,000 to 1,047,000
shares. Global's total traded value in the Sensex was Rs 51.8 billion.
KP had formed a network of brokers from smaller exchanges such as the Allahabad Stock
Exchange and the Calcutta Stock Exchange. He used to buy shares in the fictitious names of poor
people living in Mumbai, though KP was a successful broker, he did not have the money to large
purchase. According to a report, 12 lakh shares of Global would have cost KP around Rs 200
million and Aftek Infosys would have cost him Rs 50 million, while the Zee and HFCL stakes
would have cost Rs 250 million each. Analysts claimed that KP borrowed funds from various
companies and banks. He bought shares when their prices were low and continuously saw the
prices going up in the bull market because of continuous trading. When the prices were high
enough, he pledged the shares with banks as collateral for funds and carry on this process.
A small Ahmedabad-based bank, Madhavapura Mercantile Cooperative Bank (MMCB) was
trapped in KP’s game. MMCB issued funds to KP without proper collateral security and even
crossed its capital market exposure limits. Parekh and his associates secured Rs 1,000 crore as
loan from the Madhavpura Mercantile Co-operative Bank despite RBI regulations that the
maximum amount a broker could get as a loan was Rs15 crore. Hence, it was clear that KP’s
motive was to inflate shares of selected companies in collusion with their promoters.
Lady luck disfavours Parekh! :
Just a day after the presentation of the Union Budget in February 2001, Parekh appeared to have
run out of luck. It’s interesting to know how this happened. KP's strategy of raising loans by
offering shares as collateral security to the banks worked well in accordance with the continuous
rise in share price, but it changed just the other way round, when the markets started declining in
March 2000. Due to fall in the NASDAQ, K-10 stocks also started declining. KP was asked to
either keep more shares as collateral or return some of the borrowed money to banks. In either

52
case, it put financial pressure on him. In the next two months, when the Sensex fell by 23% and
the NASDAQ by 36%, K-10 stocks saw fell hugely by 67%. However, with improvements in the
global technology the K-10 stocks began moving up once again in May 2000. In December
2000, the NASDAQ crashed again and this time technology stocks were top losers. Such
uncertainty created doubts regarding the future of technology stocks causing prices to fall across
the globe. This created panic among many investors / traders / mutual funds / brokers. A team of
traders, Shankar Sharma, Anand Rathi and Nirmal Bang, known as the “bear cartel”
subsequently placed sell orders on K-10 stocks, and crushed their inflated prices. KP began to
have liquidity problems and payment crisis.
The payment crisis at Calcutta Stock Exchange (CSE) came as one of the biggest setbacks for
KP. KP had network of brokers at CSE who used to buy shares at KP's behest. By February
2001, the scrips held by KP's brokers at CSE were reduced to half from their initial worth of Rs
12 billion. The situation worsened as KP's badla payments of Rs 5-6 billion were not honored on
time for the settlement and about 70 CSE brokers, including the top three brokers of the CSE
(Dinesh Singhania, Sanjay Khemani and Ashok Podar) became defaulter on their payments. By
mid-March, the value of stocks held by CSE brokers further became half. The CSE brokers
started pressurizing KP for payments. KP again turned to MMCB to get loans. But the outflow of
funds from MMCB had already crossed the limits from January 2001. Now the all the
borrowings of KP put together also could not rescue him.

The Exposure of scam and outcome: Ketan Parekh's fraudulent practices were first exposed
by veteran columnist Sucheta Dalal. Sucheta's column read, “It was yet another black Friday for
the capital market. The BSE sensitive index crashed another 147 points and the Central Bureau
of Investigation (CBI) finally ended Ketan Parekh’s two-year dominance of the market by
arresting him in connection with the Bank of India (BoI) complaint. Many people in the market
are not surprised with Parekh’s downfall because his speculative operations were too large, he
was keeping dubious company, and he was dealing in too many shady scrips.”

Who were major victims: Public, Buyers of shares of companies, UTI, MMCB, Bank of India,
State Bank of India, Global Trust Bank, Calcutta Stock Exchange were major victims of this
scam. When the prices of selected shares started constantly rising, innocent investors were

53
buying such shares believing that the market was genuine. Soon after the scam was exposed, the
prices of these stocks came down to the fraction of the values at which they had been bought.
When the scam was fully burst, the rigged shares lost their values so heavily that few people lost
their life time savings.

Consequences: The Global Trust Bank and the Madhavpura Cooperative Bank became
bankrupt. MMCB was liquidated. Some banks including Bank of India lost significant amounts
of money. The small investors felt that all parties in the functioning of the market were
responsible for the scams. They opined that the broker-banker-promoter nexus, was the main
reason for the scams in the Indian stock markets.
Parekh was held on charges of draining out Rs 1,370 million from Bank of India (BOI) through
pay orders issued by Madhavpura Mercantile Co-operative Bank in Ahmedabad, Gujarat The
CBI registered a case against Parekh after BOI filed a complaint Parekh had defrauded it. Preakh
was convicted in 2008 and he is banned from trading till 2017. KP still owes Rs 400 crore to its
stockholder.
SEBI actions to control damages: Some of the steps taken by SEBI post scam were
The trading cycle was cut short from a week to a day.
A historical decision to ban carry-forward system in stock trading called ‘BADLA’ was taken ,
effectively from July 2001.
SEBI introduced forward trading in the form of exchange-traded derivatives to ensure a well-
regulated futures market.
Withdrew broker control over stock exchanges.
SEBI also banned trading by all stock exchange presidents, vice-presidents and treasurers.

QUESTIONS FOR DISCUSSION

1. Identify the loopholes in the entire financial system which set platform for KP to plan
such scam.
2. Do you think steps initiated by SEBI were right. What else SEBI could have done.
3. Considering present risk management measures that are available now, comment on how
this scam could have been prevented by taking each measure into account.

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CASELET 3: A ‘parallel’ crisis in Calcutta Stock Exchange-Settlement Guarantee Fund to
rescue.

In March 2001, Calcutta Stock Exchange (CSE) was trapped in Country’s worst ever payment
crisis, making for CSE difficult to survive, when its 10 brokers were defaulted in their payment
for the amount of Rs 120 crore in three consecutive weekly settlements. Crisis was a
consequence of scam by Ketan Parekh.

The CSE officials had to use Settlement Guarantee Fund (SGF) which decreased the SGF at CSE
by Rs 48 crores and depleted the general reserves to the extent of Rs.20 crore. Three elected
broker members - Dinesh Kumar Singhania, a director on the CSE board, Harish Biyani and
Ashok Kumar Poddar were made to resign. Till February-end CSE had average daily turnover of
Rs.1,500 crores, but the volume shrink to less than Rs.100 crores in the second half of March.
The total loss was for Rs. 800 for all the parties and more than 70 % of brokers especially small
and medium brokers lost their life time savings. Abhisekh Banka, a 22 years old sub-broker was
reported to commit suicide by drowning. His wife killed herself by jumping off a multi-storied
building.

The crisis at CSE originated due to Ketan Parekh’s scam in the same year. The Mumbai-based
bull trader Ketan Parekh had connections with chain of brokers at several small stock exchanges
including Calcutta Stock Exchange mainly, who used to buy shares on Parekh’s behest for his
official and unofficial deals in the ICE (information, communication and entertainment) shares.
The fall in the technology stocks, made it difficult for Ketan Parekh to fulfill his payment
obligations , as a result, the whole gang of brokers also got engulfed in payment crisis in parallel
and became big defaulters to the exchange.

According to Tapas Dutta, executive director of CSE, there was a shortfall of Rs 32crore in
settlement no.148, which was for the first time, a very huge default at any major exchange of the
country. Defaults were mainly in the HCFL scrip and the DSQ software scrip. According to CSE
officials, the pay-in shortfall was a rare phenomenon and even if there was a shortfall, it was
never more than few lakhs and such shortfalls were recovered from margin deposits –a kind of
advance payment or collateral against outstanding position, of defaulted brokers.

55
CSE attempted to bridge the gap by encashing the bank guarantee and fixed deposits of default
brokers kept with the exchange as margin, which were around Rs.70 crore. It even sold the
shares bought by the brokers, but could not fulfill the gap. After utilizing these funds and
Settlement Guarantee Fund on March 15, there was still a shortfall of Rs 13.08 crore for the
settlement no.149. On March 22, 40 more brokers became unable to fulfill their commitment
towards the settlement no.150 as they all were hit by chain reaction of earlier defaults of
Singhania, Biyani and Poddar. CSE officials used the same method as in earlier two settlements
and bridged the gap of shortfall.

On March 26, the CSE formally declared 10 brokerages owned by Singhania, Biyani and Poddar
as defaulters.

The CSE authorities were blamed for not being able to prevent the crisis and "allowing it to blow
out of proportion". One broker blamed the lack of regulations and surveillance on the bourse
allowed a highly illegal and volatile badla business. Ajit Day ,former president of the CSE said:
"It is obvious that the CSE authorities did not anticipate that things will take such a turn." The
majority of the brokers demanded the resignation of the elected directors of the CSE. On March
30, the eight elected members - president Kamal Parekh, vice-president K.K. Daga and six
directors resigned., A new management sub-committee comprising of six public representatives,
three SEBI nominees and the executive director was formed by the governing committee on
April 2, who decided first to replenish the depleted SGF. If not replenished according to SEBI
guidelines, it would be end of CSE. The main concern of the management now was to restore the
CSE's financial position to establish CSE as demutualised entity by separating the ownership and
management. However, Ajit Day was afraid believing dark future of the CSE as the payment
crisis had created confusion in the market and a drop in business.

QUESTIONS FOR DISCUSSION

1) Analyze the importance of Settlement Guarantee Fund.
2) Should the pay-in/pay-out to client be done through the broker /TM or directly through
Professional Clearing member (PCM) or should it be made mandatory for all TMs to tie-
up with designated PCM for providing this service to their clients ?

56
CASELET 4: North Star Gems (India) Limited- Market manipulation and price rigging

The abnormal rise in price and volume in the scrip of North Star Gems (India) Limited, just after
its public issue prompted SEBI to conduct an investigation which revealed that a group of
persons with the help of its associate entities operated in the scrip with a view to manipulate the
prices. This group of persons in collusion with the promoters of the company cornered the shares
offered in the public issue and through secondary market purchases. The buying pressure created
a false market in the scrip and some of the investors were induced to sell short at the higher level
of prices. This resulted in auction and closeout at abnormally high prices. On completion of
investigations, the SEBI ensured that the manipulators in any case, would not receive ill-gotten
gains arising out of such market manipulations and hence directed amount of Rs. 1.75 to be
transferred to the Investor Protection Fund of the concerned stock exchange. Enquiry
proceedings were initiated against the stock brokers involved in the case and against the registrar
to the Issue. Show cause notices were issued to the non-intermediaries including the promoters
of the company.

CASELET 5: Maruti Organics Ltd- Not compliance with KYC norms & Margin
Requirements

In June, 1996, NSE alleged that there was an attempt to defraud the clearing corporation of NSE
by some brokerage firms who were trading in the scrips of Maruti Organics Ltd (MOL).
Investigations revealed that the brokers at whose terminal buying position were created were not
acting diligently and enrolled clients without making any meaningful enquiries and failed to
verify details like, bank a/c or address etc. of the their clients. The buying position was built up
across the country i.e. at Ahmedabad, Bangalore, Mumbai, Hyderabad, Chennai, etc. Clients
dealt with the broker and when the time for pay in had come, they escaped without paying
brokers for the purchase made by them. As Settlement Guarantee Fund of NCCL guarantees
settlement/payment for each trade entered at the Exchange, in the event of failure of the buyer to
pay, NCCL would have to pay the sellers. NSE, from its investigations, held that these
transactions in MOL were collusive trades and ordered dismissal of the same. Brokers were
accused of not taking enough precaution by allowing unknown clients, to build up huge buying
position in a scrip which was volatile and illiquid without collecting sufficient margins from
them and which was beyond their financial capacity and also for their carelessness which put the

57
settlement system of the Exchange at risk. On these facts, violation of SEBI (Stock Broker &
Sub-Broker) Regulations, 1992, enquiry proceedings were initiated against the broker.

CASELET 6: Market Surveillance-Handling exceptional market conditions

During 1996-97, stock market witnessed several periods of volatility and turbulence. For
example, the BSE Sensex decreased sharply by 5.45 per cent and 6.52 per cent on January 16,
1997 and March 31, 1997 respectively. On January 16, 1997, intra-day volatility of 357 points
was witnessed at the Stock Exchange, Mumbai. However the market remained safe during these
periods of volatility because of the risk containment measures that were in place.

During 1997-98 also, the market witnessed certain periods of volatility. Due to large currency
depreciation in Asian economy, since July 1997, countries like Thailand, Malaysia, Philippines,
Indonesia as well as South Korea were severely affected. The fall out on Indian securities
markets exhibited unusual price volatility on some occasions during this period when the BSE
Sensex fell by more than 3 per cent to 7 per cent against an annual average intra-day price
volatility of around 1.9 per cent. On August 20, 1997 the intra-day price volatility of the Sensex
was exceptionally high at 3.4 per cent. On October 28, 1997, The Stock Exchange, Mumbai was
closed due to festive holidays. However, the National Stock Exchange of India Ltd,(NSEIL)
remained open and the Nifty fell by 7.9 per cent on a single day. The relatively steep decline on
this day was affected by events in other developed markets specially the decline in equity prices
in Hong Kong. Equity prices in the United States, Japan and Europe fell on October 27, 1997,
causing Dow Jones Industrial Average of U.S stocks to decline by 7.1 per cent on the same day.
This fall in the Dow affected sentiments in the Asian markets when they opened on October 28,
1997. Indian market took cue. On this day, the scrip specific price bands were imposed on 294
securities out of 1350 securities which were traded on the NSEIL. Apart from the strict
monitoring of market movements and positions of brokers which is now being done
automatically in the stock exchanges, the SEBI took pro-active action after discussing with the
stock exchanges to arrest the fall. The NSEIL reduced the daily price band from the standard 10
per cent level to 7 per cent level. This measure along with exposure limits helped in stabilizing
the market. On January 15,1998, the Indian securities markets again witnessed high level of
activity and the intra-day price volatility of the BSE Sensex was close to 3 per cent. On the

58
following day, the market improved reversing the previous day’s trend. Also there was not a
single default or failure in the market and market remained stable.

Other regulatory measures taken by the SEBI and the stock exchanges to stabilize the markets
during the period of exceptional market volatility have been stringent administration of mark to
market margining system and adherence to prudential exposure norms. In Indian securities
markets, securities specific circuit breakers and price bands are followed. Experience has shown
that scrip related circuit breakers and price bands were more appropriate when compared to
index related circuit breakers. It ensured that the market remained open and only those counters
where volatile scrips which touched the lower of the daily band of 10 per cent or weekly band of
25 per cent, were closed. On account of such measures the panic that had set in all over the world
could not aggravate the market conditions in India. In fact the situation was well under control.

QUESTIONS FOR DISCUSSION

1) Discuss various risk containment measures that have been used in above cases.
2) Discuss the role of market surveillance in case of volatility.
3) Why security specific circuit breaker or price band is more appropriate.

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 7. FINDINGS

Analysis of Harshad Mehta’s Scam

Market capitalization of listed companies in BSE
Year BSE (Market Turnover) AllIndia Market
Amount in Rs crore Capitalisation (Rs crore)
1990-91 36012 110273
1991-92 71777 354106
1992-93 45696 228780
1993-94 84526 400077

As per the data ,we can see that the BSE Market turnover had declined from Rs.71777 crores in
the year 1991-92 to Rs.45696 crore in the year 1992-93. Simultaneously there was an impact on
the Market capitalisation of the economy during the same year.
Difference before and after scam
Before & During Scam After Scam
Effect on Market Around 4500 points Fell to 2500 points.
(Sensex)
Market Capitalization Fell by Rs 100,000 crore
Investors wealth Continuous Rise in share price Shares became “Tainted’
leading to rise in investors wealth
also
Share price Prices of share were soaring. Drop in share price by 40%
Liquidity in stock Greater Liquidity was imparted to Liquidity decreased as
market stock market during the scam investors were afraid of
investments after such scams.
Brokers role/ Brokers got involved in inter- Control over brokers was
outstanding position banking transactions just like stock implemented.
market operations. They took
positions in market.

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Clearing and Brokers started playing role in Clearing corporation was set
Settlement system settlement process & managed to get across exchanges and
cheques in their account. Clearing House of stock
exchanges took the
responsibility of settlement
guarantee.
Settlement Period Settlement Cycle was a period of 15 Settlement period was
days. shortened to 1 week
Money Laundering The scam is one of the cases of “The Prevention of Money
money laundering. Laundering Act” was passed
in 2002
Loss Rs.4000 Crore to banking
sector and overall loss of Rs.
5000 crore .

Before the scam, the Sensex was hovering around 4500 which fell to 2500 points in April
1992 on exposure of scam. The market capitalization fell by Rs 100,000 crores. Let’s go
through the performance of stock market just before this scam.

 1000 points, 25 July 1990- On 25 July 1990, the SENSEX closed at 1,001 which
was a four-digit number on the account of a good monsoon and excellent
corporate results.
 2000 points , 15 January 1992- On 15 January 1992, the SENSEX crossed the
2,000 mark and closed at 2,020 after the liberal economic policy initiatives
undertaken by the then finance minister and Prime Minister of India Dr
Manmohan Singh.
 3000 points, 29 February 1992 - On 29 February 1992, the SENSEX crossed
3,000 mark on the account of market-friendly budget announced by Manmohan
Singh.
 4000 points, 30 March 1992- On 30 March 1992, the SENSEX crossed the 4,000
mark and closed at 4,091 on the expectations of a liberal export-import policy.

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Investors who had bought shares through brokers who accused in this scam, suffered
huge loss as their shares were declared “tainted “ shares. “Tainted” shares means, shares
which do not have value, they are just piece of share and cannot be delivered in market.
Share price of most of the stocks fell by 40%. Clearing and settlement process was done
through brokers. A lot of brokers were involved. Generally government securities were
traded directly between the two transacting banks, and brokers role was to bring the two
banks together. Brokers should not have handled cash or securities. But here brokers took
active position just like operations in stock market. Brokers managed to get cheques in
their account. This opened the way of money laundering, which facilitated the diversion
of the funds into stock market. Brokers imparted greater liquidity in the market. Even if
we consider clearing and settlement process, it was 15 days which gave enough time to
these brokers to keep money with them.

Some fluctuations had caused sensex to fall to 2,037 points by April 1993. However after
the entry of foreign institutional investors (FIIs), the index started rising again from mid-
1993, and by February 1994 it recovered much of the losses and reached 4,286. By
December 1994, the index reached the 4,631 points which was post-scam high.

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Analysis of Ketan Parekh’s case & Payment Crisis at Calcutta Stock Exchange

Effect on market (Sensex) Fell by 176 points

Was this an Insider trading case ? Yes
What was Brokers role ? Creating large buying position in selected
stocks across various locations.
What happened to share price ? Only k-10 stocks prices rising up
What was unusual price movement and Remained unchecked.
Volatility status ?
How was Market Surveillance System ? Poor
What about the Liquidity in stock market ? Greater liquidity was imparted to stock
market.
What happened to Capital exposure limit of Exceeded
Banks ?
How was Banking System ? Poor and weak.
What was Funding Mechanism ? Simple Borrowing & BADLA system
How long was Settlement period ? 1 week
What about Record and Margins ? Lack of records and margins at Calcutta
Stock Exchange.
How Pay-in/pay-out was done? Brokers and Trading members. No PCM
were involved.

There was a fall in sensex by 176 points immediately after the exposure of scam and
further by 147 points post arrest of accused Ketan Parekh. I would relate this case not
only with money laundering but also with the “insider trading” to some extent because in
this scam company promoters were together involved with the brokers.

Brokers had created large buying positions at various locations. Brokers had formed a
chain of networks across exchanges, and persuaded innocent investors to buy selected
stocks and built up large buying positions. SEBI ignored such things. When huge trading
order for these stocks were getting placed and prices of selected k-10 stocks were rising,

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SEBI watched it as normal activity over the period of 18 months. It could have raised a
question or doubt that why only the prices of K-10 stocks were rising. When whole
Information, Communication, Entertainment sector was booming, why didn’t the prices
of stocks of companies belonging to same sector also increased. Moreover the annual
report to look into growth and earning prospectus of K-10 companies were not asked by
SEBI or Bombay Stock Exchange. This clearly shows that investment in such stocks
were done deliberately, to inflate their prices and hence Market Surveillance System of
stock exchange was also poor which did not act diligently. Greater liquidity was imparted
to stock market, as some banks had exceeded their capital market exposure limit.
Banking system was also poor and weak as, it allowed to give loans without proper
collateral. Settlement period was still 1 week thus giving enough time in movement of
securities and funds. There was lack of record and margins at Calcutta stock Exchange,
due to which CSE was engulfed in payment crisis. CSE officials used Settlement
Guarantee Fund to settle the transactions and come out from the payment crisis of its
defaulter brokers. If SGF would not have been there, CSE would have died.

Analysis of Exceptional Market Conditions/Price Rigging Cases/Margin Deposits

Following risk scenarios have been identified from the cases and measures that could
help best have been suggested.

Scenarios Effective Measures

Checking of Intra-day price movement of Applying security specific circuit breaker
particular security. rather than index-based circuit breaker. A
security specific circuit breaker will halt the
trading in that security only but index-based
trading will halt the trading in entire market,
i.e market will be closed.
To avoid risk to settlement and to ensure Collection of sufficient margins from the client
smooth clearing and settlement process. on upfront basis, according to volatility of
stock and its trading frequency.
To keep track record of client until Obtaining basic details and verification of

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transaction is settled. details by brokers / trading members.
To check any unusual price movement or A Pro-active Market Surveillance System
unusual trading pattern in any scrip.
Ensuring continuous online monitoring with
immediate generation of alert to trading
members.

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 8. CONCLUSION
As the objective of this project was to analyze the whole risk management framework of Indian
stock market and how much efficient it is, so in regard to this, some of the strengths and
weakness in this framework have been identified , after going through all the incidents and cases
taken in the study. They have been mentioned below:

Strength or Efficiency of present risk management framework lies in following:

 The way Index-based Circuit breaker / Securities specific price band has been
implemented by our stock exchanges, which have been proven efficient in
checking volatility and protect market in some of the exceptional scenarios faced
by stock market in past.
 Time to time margin Deposits as a collateral from the client on their open position
and at broker level, it is gross of all the net positions across all the clients, thereby
ignoring any netting-off that may occur between client-client and client
proprietary positions.
 Segregation of trading and clearing and settlement process by the way of clearing
corporation has guaranteed the smooth settlement of all the transactions taking
place at exchange.
 The need for sufficient Settlement Guarantee Fund across all the stock exchanges,
has proven to be good way to reduce any systemic risk. With the help of STF
,CSE had managed to overcome the payment crisis.

Margining framework that has evolved for mitigation of risk to CC has given rise to another risk,
the risk of clients losing their collateral in the event of default/bankruptcy of the broker or
TM,CM, and accordingly there is a need to take steps to mitigate this. However, even in presence
of such measures implemented, the various scams that have occurred in the past shows that our
risk management framework is still not very much efficient and there can be further
improvement. Areas where improvement needed is
 Broker s’ role
 Settlement period.
 Checking /prevention of insider trading.

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 9. REFERENCES
1. National Stock Exchange of India Ltd, 2014.Trading. [online] Available from:
http://www.nseindia.com/products/content/equities/equities/trading.htm [Accessed 28
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[Accessed 3 March 2014]
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10. SEBI, 2012. Stock exchanges. [online] Available from:
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