Market intermediaries (NISM Series XV, chapter 2)

The cast between the two sides

The previous topics described the securities and the two markets. This one names the institutions that make a trade or an issue actually happen. The exam tends to describe a function and ask who performs it, so learn each intermediary by its job.

Trading and holding

Stock exchanges

Trading platforms for already-issued securities. NSE, BSE and MSEI are nationwide exchanges; trading runs through electronic terminals with anonymous order matching. Exchanges also appoint the clearing and settlement agencies and clearing banks that handle the funds and securities arising from trades.

Depositories

Institutions that hold investors' securities (shares, debentures, bonds, government securities, mutual fund units) in electronic form and provide services for transactions in dematerialised securities. India has two, both registered with SEBI: Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL). Investors reach a depository only through a registered depository participant.

Depository participant (DP)

The depository's agent, through which it interfaces with investors. The DP holds and maintains the investor-level accounts; the depository holds the company-level accounts of the securities each issuer has issued. DPs are appointed by the depository with SEBI's approval. Eligible entities include public financial institutions, scheduled commercial banks, foreign banks operating in India with RBI approval, state financial corporations, custodians, stockbrokers, clearing corporations and clearing houses, NBFCs, and registrars and share transfer agents that meet SEBI's requirements.

Exam trapTwo levels of account

Your demat account is with the DP. The record of how many shares a company has issued and who holds them, at the level of the whole company, is with the depository. An option that has the depository maintaining individual investor accounts has the levels reversed.

Executing trades

Trading members (stock brokers)

Registered members of a stock exchange who execute investors' buy and sell orders. Every secondary market transaction on an exchange must go through a registered broker. Members may be individuals (sole proprietors), partnership firms or corporate bodies that meet minimum prudential requirements.

Authorised person

An individual, partnership, LLP or body corporate appointed by a broker as its agent to reach investors across the country. Each appointment needs specific prior approval from the exchange, and the approval is for a specific segment of that exchange. SEBI decided on 21 June 2018 that sub-brokers would cease to exist as an intermediary from 1 April 2019; existing sub-brokers migrated to become authorised persons or trading members if they met the eligibility criteria.

Custodians

Entities that hold the funds and securities of large clients, typically institutions such as banks, insurance companies and foreign portfolio investors. Beyond safekeeping, a custodian settles the client's transactions, tracks corporate actions, maintains the client's securities and funds accounts, collects the benefits and rights accruing on holdings, and keeps the client informed of actions taken or due on the portfolio.

Making settlement safe

Clearing corporation

Ensures exchange members meet their obligations to deliver funds or securities. It acts as legal counterparty to every trade and guarantees settlement of all transactions on the exchange. It may be part of the exchange or a separate entity.

Clearing banks

The link between clearing members and the clearing corporation. Every clearing member keeps an account with a clearing bank, must have funds there on pay-in day to meet obligations from exchange trades, and receives pay-outs into the same account on pay-out day.

Bringing an issue to market

Merchant bankers

SEBI-registered entities that act as issue managers, investment bankers or lead managers. They are the issuer's single point of contact for a new issue: they assess the capital need, structure the instrument, take part in pricing, manage the whole process until the securities are issued and listed, and coordinate the registrars, brokers, bankers, underwriters and credit rating agencies involved.

Underwriters

Primary market intermediaries who undertake to subscribe to any portion of a public offer that investors do not buy, giving the issuer comfort that the issue will be fully taken up. A commitment made at the early stages of an IPO is hard underwriting. Soft underwriting is a commitment given once the price is determined; shares that devolve on a soft underwriter are usually placed with other financial institutions, which limits the underwriter's risk, and soft underwriting carries a clause allowing exit if specified events occur.

Worked exampleOne issue, several intermediaries

A company appoints a merchant banker to run its IPO. The merchant banker structures the offer, brings in underwriters (hard commitments before pricing, soft ones after), coordinates the registrar and the bankers to the issue, and sees the shares listed on the exchange. After listing, brokers execute trades in those shares, the clearing corporation guarantees settlement, clearing banks move the money, the depository records the holdings at company level and each investor's DP records them at investor level, while institutional investors' custodians settle on their behalf and track every dividend and bonus.

Farmer producer organisations

The syllabus adds one intermediary from the commodity side. A Farmer Producer Organisation is a legally registered collective of farmers (a cooperative, producer company or society) formed to improve bargaining power, market access and economic well-being. By pooling resources and aggregating produce, an FPO negotiates with buyers, processors and exporters more effectively than an individual small farmer can, gains access to credit, technology and government schemes, promotes modern agricultural practices including better seeds, irrigation and post-harvest practices, along with value addition and sustainable farming, reduces dependence on middlemen and brings farmers into organised markets including e-markets.

Exam trapTwo FPOs

In the primary market topic FPO meant follow-on public offer. Here it means Farmer Producer Organisation. Read the question's context before answering anything about an FPO.

Take these into the exam

Exchanges (NSE, BSE, MSEI) run anonymous electronic order matching for issued securities and appoint clearing agencies and clearing banks.
Depositories (CDSL and NSDL) hold securities electronically at the company level; depository participants, their agents, hold the investor-level accounts.
Brokers (trading members) must route every exchange trade; authorised persons are their agents, approved per exchange segment; sub-brokers ceased to exist from 1 April 2019.
Custodians hold institutions' funds and securities and track corporate actions; clearing corporations guarantee settlement; clearing banks hold members' pay-in and pay-out accounts; merchant bankers manage issues; underwriters buy what the public does not, hard (early) or soft (after pricing, with an exit clause).