[FAQs] Structure of Capital Market

Following are the main points of distinction between money market & securities market:

Following are the important statutes, which governs the Indian securities markets:

• • Securities Exchange Board of India Act, 1992
  • Securities Contracts (Regulation) Act, 1956
  • Depositories Act, 1996
  • Companies Act, 2013
  • Foreign Exchange Management Act, 1999 (FEMA)

Agencies involved in relation of securities market are:

• • Ministry of Finance
  • Ministry of Corporate Affairs (MCA)
  • Department of Economic Affairs (DEA)
  • The Reserve Bank of India (RBI)
  • The Securities & Exchange Board of India (SEBI)
  • Stock Exchanges

Primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new shares or bond issue. The primary market is the market where the securities are sold for the first time. Therefore, it is also called the New Issue Market.

Features of Primary Markets:

• • This is the market for new long term equity capital.
  • In a primary issue, the securities are issued by the company directly to investors.
  • The company receives the money and issues new security certificates to the investors.
  • Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.
  • The primary market performs the crucial function of facilitating capital formation in the economy.

The primary market is of great significance to the economy of a country. It is through the primary market that funds flow for productive purposes from investors to entrepreneurs. The latter use the funds for creating new products and rendering services to customers in India & abroad. The Strength of the economy of a country is gauged by the activities of the stock exchanges. The primary market creates and offers the merchandise for the secondary market.

The Indian financial system has two major components:

(1) Money Market: Money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs. It is the market for dealing in monetary assets of short-term nature. Funds are available in this market for periods ranging from a single day up to a year.
Instruments used in money market are generally had:

• • • Low default risk.
    • Maturities below 1 year.
    • High marketability.

(2) Capital Market: Capital Market is a market for financial investments that are direct or indirect claims to capital. It is wider than the securities market and embraces all forms of lending and borrowing. It is a market, where business enterprises and governments can raise long-term funds.

Securities Market: Securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. The main instruments used in the securities market are stocks, shares, debentures, bonds, securities of the government. Securities market has following two interdependent and inseparable segments:

(a) Primary Market: Primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new shares or bond issue. The primary market is the market where the securities are sold for the first time. Therefore it is also called the New Issue Market (NIM).
Issue of securities by companies can take place in any of the following methods:

• • • • Initial public offer
      • Further issue of capital
      • Rights issue
      • Firm allotment
      • Offer to public
      • Bonus issue

(b) Secondary Market: The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold.
The stock market or secondary market ensures free marketability, negotiability and price discharge. Secondary market has further two components:

• • • • Spot Market: Where securities are traded for immediate delivery and payment.
      • Futures Market: Where the securities are traded for future delivery and payment.

The Capital Market is a market for financial investments that are direct or indirect claims to capital. It is wider than the securities market and embraces all forms of lending and borrowing, whether or not evidenced by the creation of a negotiable financial instrument. The capital market comprises the complex of institutions and mechanisms through which intermediate term funds and long term funds are pooled and made available to business, government and individuals. The capital market also encompasses the process by which securities already outstanding are transferred.

The capital market and in particular the stock exchange is referred to as the barometer of the economy. Government’s policy is so moulded that creation of wealth through products and services is facilitated and surpluses and profits are channelized into productive uses through capital market operations. Reasonable opportunities and protection are afforded by the Government through special measures in the capital market to get new investments from the public and the Institutions and to ensure their liquidity.

The instruments used by the corporate sector to raise funds are selected on the basis of –

(i) Investor preference for a given instrument and
(ii) The regulatory framework, where under the company has to issue the security.

Investor preferences vary with their attitude towards risk, and their investment goals and investment horizon.

The tax liability of the investor too affects the choice of investment media.

The firm on the other hand, is affected by the debt-equity ratio permissible, SEBI Regulations on issue of capital, and the formalities to be complied with while raising an issue.

The tax liability of the company, the purpose for which funds are required, debt servicing ability and willingness to broad base the shareholding of the company, all influence the choice of the instrument.

The corporate sector and financial/investment institutions have been issuing new instruments to attract investors. However, the range of instruments used is still very narrow.

Convertible debenture is the most popular instrument in the current scenario to raise funds from the markets.

The attraction for the instrument for both the corporate sector and the investor lies in –

(a) The investor gets a reasonable return during the initial years, followed by equity participation on conversion, and
(b) The issue involves lower post-tax cost of capital, thereby entailing a lesser strain on liquidity.

A securities market is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. The securities market has two segments viz. primary market & secondary market.

Various functions performed by securities markets are follows:

(1) Continuous & ready market for securities: Securities market provides a ready and continuous market for purchase and sale of securities. It provides ready outlet for buying and selling of securities.

(2) Evaluation of securities: Securities market is useful for the evaluation of securities. This enables investors to know the true worth of their holdings at any time. Comparison of companies in the same industry is possible through securities market price list.

(3) Encourages capital formation: Securities market accelerates the process of capital formation. It creates the habit of saving, investing and risk taking among the investing class and converts their savings into profitable investment. It acts as an instrument of capital formation.

(4) Safety in dealings: Securities market provides safety in dealings as transactions are conducted as per well defined Rules and Regulations. The managing body of the exchange keeps control on the members. Fraudulent practices are also checked effectively.

(5) Regulates company management: Listed companies have to comply with rules and regulations of concerned securities market and work under the vigilance of various authorities.

(6) Public borrowing: Securities market serves as a platform for marketing Government securities. It enables government to raise public debt easily and quickly.

(7) Clearing house facility: Securities market provides a clearing house facility to members. It settles the transactions among the members quickly and with ease. The members have to pay or receive only the net dues because of the clearing house facility.

(8) Healthy speculation: Normal speculation is not dangerous but provides more business to the exchange. However, excessive speculation is undesirable as it is dangerous to investors & the growth of corporate sector.

(9) Economic barometer: Securities market indicates the state of health of companies and the national economy. It acts as a barometer of the economic conditions.

(10) Bank lending: Banks easily know the prices of quoted securities. They offer loans to customers against corporate securities.

A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Private equity funds concentrate their investments in unregistered (and typically illiquid) securities. Like hedge funds, private equity funds also rely on the exemption from registration of the offer and sale of their securities. The investors in private equity funds and hedge funds typically include high net worth individuals and families, pension funds, endowments, banks and insurance companies. Private equity funds, however, differ from hedge funds in terms of the manner in which contribution to the investment pool is made by the investors.

Private equity investors typically commit to invest a certain amount of money with the fund over the life of the fund, and make their contributions in response to “capital calls” from the fund’s general partner. Private equity funds are long term investments, provide for liquidation at the end of the term specified in the fund’s governing documents and offer little, if any, opportunities for investors to redeem their investments. A private equity fund may distribute cash to its investors when it sells its portfolio investment, or it may distribute the securities of a portfolio company.

Venture capital fund means an Alternative Investment Fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model and shall include an angel fund.
Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.

A firm engaged in providing venture capital and related service is referred to a venture capitalist. Venture Capital firms are generally private partnership, or closely held private companies, funded by private pension funds. Venture Capital is also referred as Risk Capital.

A private equity fund, like a hedge fund, is an unregistered investment vehicle in which investors pool money to invest. Private equity funds concentrate their investments in unregistered (and typically illiquid) securities. Like hedge funds, private equity funds also rely on the exemption from registration of the offer and sale of their securities. The investors in private equity funds and hedge funds typically include high net worth individuals and families, pension funds, endowments, banks and insurance companies. Private equity funds, however, differ from hedge funds in terms of the manner in which contribution to the investment pool is made by the investors.

Private equity investors typically commit to invest a certain amount of money with the fund over the life of the fund, and make their contributions in response to “capital calls” from the fund’s general partner. Private equity funds are long term investments, provide for liquidation at the end of the term specified in the fund’s governing documents and offer little, if any, opportunities for investors to redeem their investments. A private equity fund may distribute cash to its investors when it sells its portfolio investment, or it may distribute the securities of a portfolio company.

Alternative Investment Fund means any fund established in the form of a trust or a company or a LLP or a body corporate.

It is a privately pooled investment vehicle that collects funds from investors for investing it in accordance with a defined investment policy for the benefit of its investors.

Following shall not be considered as AIF:

• • Mutual funds
  • Collective Investment Schemes
  • Family trusts set up for the benefit of ‘relatives’.
  • ESOP Trusts.
  • Employee welfare trusts or gratuity trusts.
  • Holding companies
  • Other special purpose vehicles including securitization trusts
  • Funds managed by securitisation company or reconstruction company which is registered with the RBI u/s 3 of the Securitisation & Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and
  • Any funds which are directly regulated by other regulator in India.

Social venture fund means an Alternative Investment Fund which invests primarily in securities or units of social ventures and which satisfies social performance norms laid.

Registration of Alternative Investment Funds [Regulation 3] : No entity or person shall act as an Alternative Investment Fund unless it has obtained a certificate of registration from the SEBI.
Alternative Investment Funds shall seek registration in one of the categories mentioned below:

(a) Category-I AIF: It invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME funds, social venture funds, infrastructure funds and such other AIF as may be specified.

(b) Category-II AIF: It does not fall in Category-I and III and which does not undertake leverage or borrowing other than to meet day-to-day operational requirements.

(c) Category-III AIF: It employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

An application for grant of certificate shall be made in Form A as specified in the First Schedule and shall be accompanied by a non-refundable application fee as specified in Part A of the Second Schedule to be paid in the manner specified in Part B thereof.

Alternative Investment Funds are very similar in structure compared to Mutual Funds. However, the AIF regulations ensure that AIF remain within reach of only the sophisticated and knowledgeable investors, while Mutual Funds are targeted at mainly retail investors.

Thus, AIF have freedom to structure the fees, can undertake leverage and have no capital requirements as they can only be brought by knowledgeable investors. Following are the key areas of differences between AIF and MF:

Private equity is a type of equity (finance) and one of the asset classes who takes securities and debt in operating companies that are not publicly traded on a stock exchange. Private equity is essentially a way to invest in some assets that are not publicly traded, or to invest in a publicly traded asset with the intention of taking it private.

Unlike stocks, mutual funds, and bonds, private equity funds usually invest in more illiquid assets. By purchasing companies, the firms gain access to those assets and revenue sources of the company, which can lead to very high returns on investments.

Another feature of private equity transactions is their extensive use of debt in the form of high-yield bonds. By using debt to finance acquisitions, private equity firms can substantially increase their financial returns.

Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet. The major of private equity consists of institutional investors and accredited investors who can commit large sums of money for long periods of time.

Private equity investments often demand long holding periods to allow for a turnaround of a distressed company or a liquidity event such as IPO or sale to a public company. Generally, the private equity fund raise money from investors like Angel investors, Institutions with diversified investment portfolio like – pension funds, insurance companies, banks, funds of funds etc.

Types of Private Equity: Private equity investments can be divided into the following categories:

(a) Leveraged Buyout (LBO): This refers to a strategy of making equity investments as part of a transaction in which a company, business unit or business assets is acquired from the current shareholders typically with the use of financial leverage. The companies involved in these types of transactions that are typically more mature and generate operating cash flows.

(b) Venture Capital: Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.
A firm engaged in providing venture capital and related service is referred to a venture capitalist. Venture Capital firms are generally private partnership, or closely held private companies, funded by private pension funds. Venture Capital is also referred as Risk Capital.

(c) Growth Capital: This refers to equity investments, mostly minority investments, in the companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business.

This refers to a strategy of making equity investments as part of a transaction in which a company, business unit or business assets is acquired from the current shareholders typically with the use of financial leverage. The companies involved in these types of transactions that are typically more mature and generate operating cash flows.

Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic powerhouses.

A firm engaged in providing venture capital and related service is referred to a venture capitalist. Venture Capital firms are generally private partnership, or closely held private companies, funded by private pension funds. Venture Capital is also referred as Risk Capital.

Venture Capitalists:

• • Finance new and rapidly growing companies.
  • Purchases equity shares
  • Assist in the development of new products or services
  • Add value to the enterprise through active participation in management.

Venture Capitalists invest in:

• • First generation businesses promoted by first generation entrepreneurs.
  • Untried products and untested products and technology.
  • High risk projects that have high risk but if successful have enormous rewards.

Pension Fund means a fund established by an employer to facilitate and organize the investment of employees’ retirement funds which is contributed by the employer and employees. The pension fund is a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement. Pension funds are commonly run by some sort of financial intermediary for the company and its employees like NPS scheme is managed by UTIAMC (Retirement Solutions), although some larger corporations operate their pension funds in-house. Pension funds control relatively large amounts of capital and represent the largest institutional investors in many nations.

Pension funds play a huge role in development of the economy and it play active role in the Indian equity market. This pension fund ensures a change in their investment attitudes and in the regulatory climate, encouraging them to increase their investment levels in equities and would have a massive impact on capital market and on the economy as a whole.

Pensions broadly divided into two sector:

• • Formal sector Pensions
  • Informal sector Pensions

High Net-worth Individuals (HNIs) is a class of individuals who are distinguished from other retail segment based on their net wealth, assets and investible surplus. While there is no standard put forth for the classification, the definition of HNIs varies with the geographical area as well as financial markets and institutions.

Though there is no specific definition, generally in the Indian context, individuals with over ` 2 Crore investible surplus may be considered to be HNIs while those with investible wealth in the range of ` 25 lakh to ` 2 Crore may be deemed as emerging HNIs.

If you are applying for IPO of equity shares in an Indian company, generally, if you apply for amounts in excess of ` 2 lakh, you fall under the HNI category. On the other hand, if you apply for amounts under ` 2 lakh, you are considered as a retail investor. There may be so many ways in which HNIs are categorized and defined; there is no single bracket that could put them under.

As per Regulation 7(2) of the SEBI (Alternative Investment Funds) Regulations, 2012,

“An Alternative Investment Fund which has been granted registration under a particular category cannot change its category subsequent to registration, except with the approval of the SEBI.”

In this regard the SEBI has issued circular CIR/IMD/DF/12/2013 dated August 7, 2013 which provides following conditions for change in category subsequent to registration.

(1) Only AIFs who have not made any investments under the category in which they were registered earlier shall be allowed to make application for change in category.

(2) Any AIF proposing to change its category shall make an application to SEBI for the same along with application fees of ` 1 lakh. The application shall include the updated Form A, other updated supporting documents, if any and rationale for the proposed change. Registration fees shall not apply for such applications.

(3) If the AIF has received commitments/raised funds prior to application for change in category, the AIF shall be required to send letters/emails to all its investors providing them the option to withdraw their commitments/funds raised without any penalties/charges. Any fees collected from investors seeking to withdraw commitments/funds shall be returned to them. Partial withdrawal may be allowed subject to compliance with the minimum investment amount required under the AIF Regulations.

(4) The AIF shall not make any investments other than in liquid funds/banks deposits until approval for change in category is granted by SEBI.

(5) On approval of the request from SEBI, the AIF shall send a copy of the revised placement memorandum and other relevant information to all its investors.

As per Regulation 5 of the SEBI (Foreign Portfolio Investors) Regulations, 2019, an applicant shall seek registration as a foreign portfolio investor in one of the categories mentioned below:

(a) Category-I FPI: It shall include –

(i) Government and Government related investors such as central banks, sovereign wealth funds, international or multilateral organizations or agencies including entities controlled or at least 75% directly or indirectly owned by such Government and Government related investor.

(ii) Pension funds and university funds.

(iii) Appropriately regulated entities such as insurance or reinsurance entities, banks, asset management companies, investment managers, investment advisors, portfolio managers, broker dealers and swap dealers.

(iv) Entities from the Financial Action Task Force member countries, or from any country specified by the Central Government by an order or by way of an agreement or treaty with other sovereign Governments, which are –

I. Appropriately regulated funds.

II. Unregulated funds whose investment manager is appropriately regulated and registered as a Category-I foreign portfolio investor. However, the investment manager undertakes the responsibility of all the acts of commission or omission of such unregulated fund.

III. University related endowments of such universities that have been in existence for more than 5 years.

(v) An entity whose investment manager is from the Financial Action Task Force member country and such an investment manager is registered as a Category-I foreign portfolio investor; OR which is at least 75% owned, directly or indirectly by another entity, eligible under sub-clauses (ii), (iii) and (iv) of clause (a) and such an eligible entity is from a Financial Action Task Force member country. However, such an investment manager or eligible entity undertakes the responsibility of all the acts of commission or omission of the applicants seeking registration under this sub-clause.

(b) Category-II FPI: It shall include all the investors not eligible under Category-I foreign portfolio investors such as –

(i) Appropriately regulated funds not eligible as Category-I foreign portfolio investor
(ii) Endowments and foundations
(iii) Charitable organizations
(iv) Corporate bodies
(v) Family offices
(vi) Individuals
(vii) Appropriately regulated entities investing on behalf of their client, as per conditions specified by the SEBI from time to time
(viii) Unregulated funds in the form of limited partnership and trusts.

Explanation: An applicant incorporated or established in an International Financial Services Centre shall be deemed to be appropriately regulated.

Regulation 19A of the SEBI (Alternative Investment Funds) Regulations, 2012 makes the following provisions for angel funds.

Angel Fund: Angel fund means Venture Capital Fund under Category I-AIF that raises funds from angel investors and invests in accordance with the provisions of the SEBI (Alternative Investment Funds) Regulations, 2012.

Angel Investor: Angel investor means any person who proposes to invest in an angel fund and satisfies one of the following conditions:

(a) An individual investor who has net tangible assets of at least ` 2 Crore excluding value of his principal residence and who:

– has early stage investment experience, or
– has experience as a serial entrepreneur, or
– is a senior management professional with at least 10 years experience;

(b) A body corporate with a net worth of at least ` 10 Crore; or
(c) An AIF or Venture Capital Fund.

Foreign Portfolio Investment (FPI) is investment by non-residents in Indian securities including shares, government bonds, corporate bonds, convertible securities, infrastructure securities etc. The classes of investors who make investment in these securities are known as Foreign Portfolio Investors.

FPI is induced by differences in equity price scenario, bond yield, growth prospects, interest rate, dividends or rate of return on capital in India’s financial assets.
Foreign Portfolio Investors includes investment groups of Foreign Institutional Investors (FIIs), Qualified Foreign Investors (QFIs) and sub-accounts etc. NRI’s doesn’t come under FPI.

After the new SEBI guidelines, the RBI stipulated that Foreign Portfolio Investors include Asset Management Companies, Banks, Pension Funds, Mutual Funds, and Investment Trusts as Nominee Companies, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies etc.

Venture Capital is money provided by professionals who invest alongside investment, in young, rapidly growing companies that have the potential to develop into economic power houses.

A firm engaged in providing venture capital and related service is referred to a venture capitalist. Venture Capital firms are generally private partnership, or closely held private companies, funded by private pension funds. Venture Capital is also referred as Risk Capital.

Areas of Investment: Different venture groups prefer different types of investments. Some specialize in seed capital and early expansion while others focus on exit financing. Biotechnology, medical services, communications, electronic components and software companies seem to be the most likely attraction of may venture firms and receiving the most financing. Venture capital firms finance both early and later stage investments to maintain a balance between risk and profitability.

In India, software sector has been attracting a lot of venture finance. Besides media, health and pharmaceuticals, agri-business and retailing are the other areas that are favoured by a lot of venture companies.