Evolution Of Global And Indian Financial Market

Global Financial Market

The earliest known organized market dates back to the second century BC. The Roman Empire had developed many characteristics similar to modern capitalism. Markets flourished because the contemporary Roman law allowed the following activities:

• • Free transfer of property was permitted.
  • Money could be lent based on interest charges.
  • Money changers were allowed to deal in foreign currency.
  • Payment across the Roman territories could be made through banker’s draft.

The above activities enabled free flow of funds between those with excess funds and entities to those that required capital. Traders used to assemble at the Forum, near the Temple of Castor in Rome and buy [or sell] the following:

• • Shares and bonds of farming companies.
  • Various goods on cash and on credit.
  • Farms and estates in Italy.
  • Ships.
  • Storehouses.
  • Cattle and other livestock.

There is even a mention of the personality of traders – in line with the bulls and bears of the modem markets. Shares were classified into large executive share holdings and smaller share holdings. Investors used to send couriers for obtaining information, to evaluate performance of shares.

In the later Middle-Ages, several Italian city-states commenced issuing marketable Government Securities. In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351, the Venetian Government outlawed spreading rumors intended to lower the price of government funds. There were people in Pisa, Verona, Genoa and Florence who also began trading in government securities during the 14th century. Later, the fairs conducted in Northern Europe used to be centers of trading activity in shares. In the 15th century, shares of German mining companies were traded. Fairs at St. Germaine near Paris, allowed trading in municipal bonds and bills of exchange.

The fairs in Antwerp were conducted throughout the year subsequent to permission of free trade. In the middle of the sixteenth century, the first settled bourse was established in Antwerp. The word “bourse” owes its origin to the “House de Bourse“, where traders assembled for exchange of securities. This development gradually spread across many centers in Europe – including Amsterdam in Holland. The Dutch commenced the joint stock companies, which let shareholders invest in business ventures and get a share of their profits [or losses]. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds.

In the seventeenth and eighteenth century, the French Revolution and Napoleonic wars resulted in the destruction of the securities markets in Amsterdam and Paris. This gave an impetus to the securities markets in London. In 1801, London stock dealers who were trading in coffee houses formally established the London Stock Exchange. One of the most famous market bubbles of all time reportedly occurred in Holland during the early 1600’s. Speculation increased the value of tulip bulbs. At the height of the bull market, the rarest tulip bulbs traded for as much as six to ten times the average person’s annual salary. The tulip was brought to Europe in the middle of the sixteenth century from the Ottoman Empire. Holland’s upper classes competed for the rarest bulbs as tulips became a status symbol. By 1636, Tulip bulbs were traded on the stock exchanges of numerous Dutch towns and cities, encouraging all members of society to speculate in the markets. Many people traded or sold possessions to participate in the tulip market mania. Like any bubble, it all came to an end in 1637, when prices dropped and panic selling began. Tulip bulbs were soon trading at a fraction of what they once had, leaving many people in financial ruin.

On May 17, 1792, twenty-four supply broker signed the Buttonwood Agreement outside the premises of the address, No. 68, Wall Street in New York underneath a buttonwood tree. On March 8, 1817, the exchange was renamed as New York Stock & Exchange Board. In the 19th century, exchanges commenced trading in forward contract and subsequently by 1864, in future contracts.

Following are some of the major events and milestone in the process of evolution of the Global Financial Markets:

• • 2nd Century BC: The first organized financial markets was established in the Roman Empire.
  • 13th Century: Venetian Bankers traded in Government Securities.
  • 15th Century: Fairs in Northern Europe traded in shares.
  • 1632-37: First recorded asset bubble in trading of “Tulip” flowers.
  • 1792: Formation of the New York Stock Exchange heralded the emergence of the exchange markets for equity trading.
  • 1848: Formation of Chicago Board of Trade for trading in forward contracts in commodities.
  • 1850: Industrial revolution led to economic growth and development.
  • 1864: Commencement of the first futures contract transaction traded on Chicago Board of Trade.
  • 1870 To 1932: Establishment of the Gold Standard to link the currency value to Gold.
  • 1919: Formation of Chicago Mercantile Exchange.
  • 1929: The Great Depression.
  • 1944: Establishment of the Bretton Woods agreement and led to the formation of the IMF and World Bank [formerly referred to as the International Bank for Reconstruction and Development].
  • 1960-1970: Eurodollar Market – Dollars held outside the United States came to be known as Eurodollars. In the 1960s taxes and regulation in Unites States of America [USA] made it cheaper to borrow and lend US Dollars in Europe than in USA. This gave rise to a large market for Eurodollars.
  • 1972: Commencement of Trading In Financial Futures at The Chicago Mercantile Exchange.
  • 1973: Abolition of the fixed exchange rates and dissolution of the Bretton Woods agreement.
  • 1986: Capital Investment Decisions emerged as a key to infrastructure development [after success of the infrastructure project for building the tunnel
    under the English Channel].
  • 1988: Mergers – The 1980s saw a wave of takeovers culminating in the USD 25
    billion takeover of RJR Nabisco. This event established a benchmark for mergers and acquisitions.
  • 1990’s: Inflation-Indexed Debt – United States Treasury issued 10-year Inflation-Indexed notes. Many other countries, including Britain and Israel had done so previously.
  • 1997: Asian Financial Crisis – Originated from Thailand and spread to South East Asian countries.
  • 2000: Collapse of the Dot-com Bubble.
  • 1999: Launch of Euro as a common currency in the European Economic Area (EEA).
  • 2001: Recession in USA due to collapse of Dot Com Bubble and Accounting Scandals.
  • 2003 Onwards: Increase in Global Commodity Prices due to increasing growth in emerging BRIC countries.
  • 2007: Peaking of the Stock Indices world wide.
  • Dec 2007 Onwards: Sub-prime crisis and collapse of the housing bubble.
  • 2008: Global Stock Markets enter into a bear phase. China becomes the largest producer of Gold, overtaking South Africa.
  • March 2009 Onwards: Commodity and Equity Markets bounce back in a rally, largely due to extensive imports by China.
  • September 2009: Signals of revival of the global economies.

Today’s Global Financial Markets have evolved over several centuries. The processes and systems have also developed over the decades. With the advent of information technology, automation has facilitated efficient capital flows across Global Financial Markets.

 

Indian Financial Markets

The following sections discuss the details about the evolution of Indian Financial Markets since the post independence era.

Pre-Independence Period

Equity brokerage industry in India is one of the oldest in Asia. India had an active stock market for about 150 years that played a significant role in developing risk markets as well as promoting enterprise and supporting growth of industry.

The foundations of the modern-day stock markets in India commenced in the 1860s. The American Civil War that led to a sudden surge in the demand for cotton from India resulted in establishment of a number of joint stock companies that issued securities to raise finance. This trend was similar to the rapid growth of securities markets in Europe and North America in the background of expansion of railroads and exploration of natural resources and land development.

Historical records show that as early as 1864, there were approximately 1000 brokers with the stock markets functioning at two locations in Mumbai:

• • Between 9 am to 7 pm at the junction of Meadows Street and Rampart Row.
  • From day break till 9 am and from 7 pm to early hours of next morning at Bazaar gate.

Share prices of specific companies increased many times during this period. Mumbai [Formerly Bombay] was a major financial center with 31 banks, 20 insurance companies and 62 joint stock companies.

An ordinary broker in 1864 earned about Rs. 200 per day, a huge sum in those days. In July 1865, the stock market bubble collapsed. This ended the “Share Mania” that was prevalent in those days. An interesting aspect of the trading activity during this period is that despite the creation of such a huge crisis, most of the brokers met their commitment.

India’s securities markets has transformed into one of the leading and dynamic marketplaces for wealth creation. In earlier times, buyers and sellers used to assemble at stock exchanges to transact shares in open outcry format [floor trading]. Stock exchanges were initially established by association of brokers. Equity trading in the pre independence days was focused on shares from the banking sector. Formation of exchanges provided the issuers of stock to source capital from investors. This facilitated faster growth and development.

In the aftermath of the stock market crash in 1865, banks refused to permit brokers from using their premises for trading purpose. Thus, the brokers identified a place for themselves called the “Dalal Street“.

In the early days, brokers used to do business under a banyan tree. Later a group of about 300 brokers formed the stock exchange in July 1875. This led to the formation of a trust in 1887 known as the “Native Share and Stock Brokers Association” – which is popularly known today as the Bombay Stock Exchange.

A unique feature of the stock market development in India was that it was entirely driven by local enterprise. This was unlike banks which were owned and operated by the British in the pre-independence period. The establishment of the first stock exchange in Mumbai was followed by the formation of stock exchanges in other major cities in India: Ahmedabad [1894], Kolkata [1908], Chennai [1937], Uttar Pradesh and Nagpur [1940], Hyderabad [1944], Bangalore Stock Exchange [1963], and Vadodara Stock Exchange [1990]. The stock markets gained from the boom in several industries such as Jute [1870s], Tea [1880 and 1890s], Coal [1904 and 1908] etc. The Bombay Stock Exchange is reportedly the oldest exchange established in Asia.

The first reform enacted in India was the Bombay Securities Contract Act of 1925. However, these reforms were opposed by the brokers as they believed that it would hamper their direct interest in stock exchange. Finally, with the promulgation of the Securities Contract Regulation Act, 1956 [SCRA] led to the regulation of the Capital Markets in India. Active trading in shares as well as commodities was occurring at all exchanges across India, until the partition of pre-independent India.

 

Post-Independence Period

The depression that followed independent India led to the closure of several exchanges. This situation continued until mid-1950. The Government of India which was formed after independence decided to institute reform in the Financial Markets. Regulation of securities market was formalized through the Securities Contracts [Regulation] Act, 1956 [also known a C(R)A, 1956]. Only recognized stock exchanges could operate. Under the SC(R)A, stock exchanges are tightly regulated as self regulatory organizations.

In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the SC(R)A. Other exchanges in Madras [Chennai], Calcutta [Kolkata], Ahmedabad, Delhi, Hyderabad, Bangalore and Indore were also recognized under the new Act. As the economy improved with establishment of Development Financial Institutions, trading activity started increasing gradually. In 1970s, the introduction of Foreign Exchange [Regulation] Act [commonly known as FERA] led to divestment of foreign equity by the multinational companies, resulting in increased trading in equity markets.

Until the middle of 1980’s, the long term credit requirements of corporate sector, was met predominantly by Development Financial Institutions [DFI] as well as LIC and UTI. The financial markets did not facilitate a major role in raising capital. The entry of Reliance Group in the early 1980s heralded the growth of a new and vigorous equity culture that spread across the country. Not only was the importance of creating effective and efficient secondary market institutions realized, but also strict regulatory framework was identified as the foundation for the success of Indian Financial Markets.

With the renewed vigor for raising capital in financial markets, new stock exchanges were established in 1980’s. Following is the list of these exchange :

• • Cochin Stock Exchange [1980]
  • Uttar Pradesh Stock Exchange Association Limited [Kanpur, 1982]
  • Pune Stock Exchange Limited [1982]
  • Ludhiana Stock Exchange Association Limited [1983]
  • Guwahati Stock Exchange Limited [1984]
  • Kanara Stock Exchange Limited [Mangalore, 1985]
  • Magadh Stock Exchange Association [Patna, 1986]
  • Jaipur Stock Exchange Limited [1989]
  • Bhubaneswar Stock Exchange Association Limited [1989]
  • Saurashtra Kutch Stock Exchange Limited [Rajkot, 1989]
  • Vadodara Stock Exchange Limited [Baroda, 1990]
  • Coimbatore Stock Exchange
  • Meerut Stock Exchange

A new set of economic and financial sector reforms that began in the early 1990s gave further impetus to the growth of the stock markets in India. As a part of the reform process, it became imperative to strengthen the role of capital markets. Several measures were taken to implement the processes and systems. Market infrastructure was established to facilitate Indian Financial System to grow further and mature. The importance of efficient and transparent market infrastructure came into focus following the incidence of market abuses in securities and banking markets in 1991.

The Securities and Exchange Board of India [SEBI] which was established in 1988, was given statutory powers with the enactment of SEBI Act, 1992. The broad objectives of the SEBI include:

• • Protection of interests of investors in securities markets.
  • Promote development of securities markets.
  • Regulate securities markets.

The scope and functioning of the SEBI have widely expanded with the rapid growth of securities markets in India in the last two decades. The Central Government or the Securities Markets Regulator SEBI can appoint up to 3 members to a stock exchange’s board. It has also the right to regulate the functioning of stock exchanges. The rules, bye-laws and regulations of exchanges need to be approved by SEBI. SEBI also supervises the activities of intermediaries and register Foreign Investors trading in Indian markets.

In 1990s, following the recommendations of a High Powered Study Group on “Establishment of New Stock Exchanges“, National Stock Exchange of India [NSE] was established. NSE was promoted by financial institutions with the objective of providing access of markets to all investors across India.

NSE was incorporated in November, 1992 as a tax paying company. This was the first such instance, because the stock exchanges established until 1992 were formed as Trusts being run on no-profit basis. NSE was recognized as a stock exchange under the Securities Contracts [Regulations] Act [1956] in April, 1993. It commenced operations in wholesale debt segment in June, 1994 and capital market segment [equities] in November, 1994. The setting up of the National Stock Exchange brought to Indian capital markets several innovations. Some of these are as follows:

• • Nationwide Trading Network.
  • Electronic Trading.
  • Greater Transparency In Price Discovery.
  • Process Driven Operations.

These developments had significant bearing on the future growth of the stock markets in India.

Faster and efficient securities settlement system is an important ingredient of successful stock markets. To speed the securities settlement process, The Depositories Act [1996] was enacted. This allowed dematerialization [and re-materialization] of securities in depositories and the transfer of securities through electronic book entry.

The National Securities Depository Limited [NSDL] which was established by leading financial institutions, commenced operations in October, 1996. Regulations governing selection of various types of market intermediaries as depository participants were instituted. Subsequently, the Central Depository Services Limited [CDSL] promoted by Bombay Stock Exchange and other financial institutions was also established.

Presently, due to the advent of state-of-the-art Information Technology Systems and Software, the entire operations of NSE and BSE are automated. Trades are executed electronically, with increased transparency. Now, investors do not have to gather at the Exchanges, and can trade freely from their home or office through Internet.

As of today, there are 24 recognized stock exchanges in India, including the Over the Counter Exchange of India for providing trading access to small and new companies and Inter Connected Stock Exchange of India Limited – which is an exchange formed by 15 Regional Stock Exchanges.

The key function of the Stock Exchanges is to provide nation-wide services to investors and to facilitate the issue and redemption of securities and other financial instruments.

In spite of the formation of many regional exchange, the launch of automated trading in NSE resulted in decreasing volumes in regional exchanges. This is because traders located in remote geographical regions can access NSE through internet.

The transformation of the Indian Financial Markets was heralded by the following major events:

• • Rapid expansion in the funds raised through capital issues.
  • Increase in number of investors subscribing to issues in the primary markets.
  • Automation of stock exchanges and trading activity.
  • Increased regulation – formation of SEBI.
  • Increase in listed stocks; trading in financial instruments such as futures and options on index and stock.
  • Increase in market capitalization and volume of trade in secondary markets.
  • Entry of Foreign Institutional Investors and Mutual funds.

The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE to measure overall performance of the exchange. In the year 2000, the BSE used this index to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE’s trading platform. Historically, an open outcry floor trading exchange, the Bombay Stock Exchange switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transition.

National Stock Exchange [NSE] has overtaken BSE to become India’s leading stock exchange. The fully automated screen-based trading system provides national reach. The exchange has brought about unparalleled transparency, speed, efficiency, safety and market integrity. It has established facilities that serve as a benchmark for the securities industry in terms of systems, practices and procedures. Within a short span of time [just one year], NSE became the largest exchange in India in terms of volumes transacted.

NSE has played a catalytic role in reforming the Indian securities market in terms of best industry practices. Today, the market uses state-of-art information technology to provide the following:

• • Efficient and transparent trading platform.
  • Automated clearing and settlement mechanism.

NSE’s products and services offerings are unique when it commenced operations in 1990’s. It innovated to transform the way in which traders can transact. Some of the most important innovations are as follows:

• • Demutualization of stock exchange governance [to separate ownership from
    management].
  • Screen based trading.
  • Compression of settlement cycles.
  • Dematerialization and electronic transfer of securities.
  • Professionalization of trading members.
  • Exchange risk management systems using Value at Risk and SPAN models.
  • Emergence of clearing corporations to assume counterparty risks [process of
    novation].
  • Market of debt and derivatives instruments.
  • Extensive use of information technology.

Trading volumes in the equity segment have grown rapidly on NSE, due to the prior mentioned innovative practices. NSE has registered the maximum volume of transactions in stock futures in the world, as per data compiled by the World Federation of Exchanges up to April, 2009.

More recently, SEBI has also given recognition to the MCX Stock Exchange based in Mumbai. MCX Stock Exchange is a subsidiary of Multi Commodity Exchange of India Limited [MCX], India’s No. 1 Commodity Exchange with daily turnover of more than Rs. 20,000 crores in Commodity Futures contracts. MCX Stock Exchange commenced operations on October 7, 2008 in currency futures. NSE has also commenced trading in currency futures, effective from August 29, 2008. Both MCX-SX and NSE presently have daily volumes exceeding Rs. 6,000 crores each in the Exchange-traded Currency Futures segment.

 

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