Evolution of Securities and Investment Laws in India

The evolution of securities and investment laws in India has been a transformative journey, mirroring the country’s economic growth and globalisation.

From its early days marked by limited regulation and a nascent financial market to the modern, robust regulatory framework that governs the Indian securities and investment landscape today, this article explores the significant milestones, key legislations and the impact of regulatory changes.

Securities and Investment Laws Before Independence

The evolution of securities and investment laws in India can be traced back to the 18th century when loan securities of the East India Company were traded informally. However, formal regulation was virtually nonexistent during this period, leading to several instances of fraud and market manipulation.

The Indian Contract Act, 1872

One of the earliest legal foundations for securities transactions was laid by the Indian Contract Act, which established the basic legal framework for contracts, including those related to securities.

The Companies Act, 1913

This Act introduced statutory provisions for the issuance and trading of securities by companies. It established regulatory oversight by requiring companies to file prospectuses with the Registrar of Companies.

Before India gained independence, the history of the securities market in the country is not well-documented. However, some trading activities related to loan securities of the East India Company were observed towards the late 18th century. In the 1830s, trading in bank shares also began. This trading in loan securities and bank shares continued until around 1850 and it mostly took place under a Banyan Tree in front of the Town Hall.

In 1850, the first Joint Stock Company Act was enacted, introducing the concept of limited liability. This new law significantly boosted trading volumes. In 1861, due to the American Civil War, there was a surge in demand for cotton from India, leading to the establishment of numerous new ventures.

Between 1863 and 1865, these new ventures managed to raise nearly Rs.30 crore in paid-up capital and almost Rs. 38 crore in premiums. The end of the Civil War and economic depression disrupted the securities market and paved the way for a more formal market system. Traders eventually congregated at Dalal Street and formed an informal organisation known as the “Native Shares or Stock Brokers Association,” which later became the Bombay Stock Exchange, formally recognised by the government in 1965 under the SCRA, 1956. The Ahmedabad Stock Exchange was established in 1874, primarily trading in shares of textile mills. To resolve disputes arising from fluctuations in the prices of jute, tea and coal, as well as trading in their shares, the Calcutta Stock Exchange was established in 1908.

Capital Issues

During World War II, the Indian government needed to channel capital to support the war effort. In 1943, the government issued the Control of Capital through the Defence of India Rules under the Defence of India Act, 1939, to regulate the flow of capital. These rules were later replaced by the Capital Issues (Continuance of Control) Act in April 1947.

Concerns about the lack of regulation in associations were raised by the Atlay Committee and in response to the market crash of June 1925, the Bombay Securities Contracts Control Act of 1925 was introduced. However, this legislation proved to be inadequate and there were financial crises in 1928, 1930, 1933, 1935 and 1936. To address these issues, the Morrison Committee was formed, leading to the addition of new regulations in 1938.

With the enforcement of the Indian Constitution, the regulation of securities and the forward market became the exclusive domain of the central government.

The Birth of SEBI

In the post-independence period, the Bombay Stock Exchange (BSE) held the majority of trading volume. However, due to issues like low transparency and unreliable clearing and settlement systems, as well as other macroeconomic factors, the need for a financial market regulator became evident. In response, the Securities and Exchange Board of India (SEBI) was established in 1988 as a non-statutory body and later granted statutory status in 1992.

In 1952, the government banned cash settlement and options trading, causing derivatives trading to shift to an informal forward market. Over time, the government adopted a more market-based pricing mechanism and showed greater acceptance of derivatives trading. In the early 2000s, restrictions on futures trading in various commodities were lifted and national electronic exchanges were established.

During the 1980s, stockbroking services were primarily accessible to the wealthy. However, with the advent of the Internet, these services became accessible to the common man and major organisations became involved in stockbroking activities.

The SEBI Act, 1992

The SEBI Act granted SEBI statutory powers, transforming it into the primary regulatory body for India’s securities market. It empowered SEBI to oversee and regulate various market participants, ensure investor protection and promote market transparency.

The Securities Contracts Regulation Act (SCRA), 1956

This act laid the foundation for regulating stock exchanges and securities contracts in India. It granted recognition to stock exchanges and established certain rules for stock trading.

Harshad Market Scam

In the 1980s, stockbroking services were mainly accessible to the affluent. However, with the proliferation of the Internet, stockbroking became more widely accessible to the general public.

During the 1990s, the Indian stock market faced a series of crises, including market manipulation on the secondary market. Some of the key incidents that prompted reforms in the stock market during this period were:

1992: Harshad Mehta Scam – This was the first major stock market scam in India, involving both government bonds and equity markets. It was primarily based on inefficiencies in the settlement system for government bond market transactions. The scam led to significant inflation in the equity markets, with the market index rising by 143% between September 1991 and April 1992. The total amount involved in this crisis was Rs 54 billion.

This marked another phase in the evolution of securities and investment laws in India.

Harshad Mehta Scam and Thereafter

Following the Harshad Mehta scam in 1992, there was a need for another stock exchange capable of competing with BSE and bringing transparency to the stock market. This led to the establishment of the National Stock Exchange (NSE) in 1992. It received recognition as a stock exchange in 1993 and began electronic trading in 1994, becoming the first exchange to do so. In response to this competition, BSE also introduced its electronic trading system, BSE Online Trading (BOLT), in 1995.

Subsequently, BSE introduced the Sensex in 1986, now known as the S&P BSE Sensex. This index, based on the 1978-79 as the base year, consists of 30 companies and serves as a benchmark stock index, reflecting the overall performance of the exchange. Equity derivatives were introduced by BSE in 2000, followed by index options in June 2001, stock options in July 2001 and stock futures in November 2001. India’s first free-float index, BSE Teck, was launched in July 2001.

On the other hand, NSE introduced its benchmark exchange, the CNX Nifty (now Nifty 50), in 1996. Comprising 50 stocks, it functions as a performance indicator for the exchange. NSE surpassed BSE in electronic screen-based trading and derivatives by introducing innovative products and services.

Market Modernisation and Liberalisation

The late 1990s and early 2000s marked a period of significant modernisation and liberalisation in the further evolution of securities and investment laws in India.

Derivatives Trading

The introduction of derivatives trading, including futures and options, brought new opportunities for investors and hedgers. It enabled risk management and speculation, enhancing market liquidity.

Depositories Act, 1996

The Depositories Act paved the way for the establishment of central depositories like NSDL and CDSL, revolutionising the way securities were held and transferred.

SEBI’s Role in Market Development

SEBI introduced a series of reforms, including streamlined IPO processes, enhanced corporate governance norms and stringent disclosure requirements.

Foreign Institutional Investors (FIIs)

The government eased restrictions on foreign investment, attracting FIIs and boosting capital inflows into India.

The 2008 Global Financial Crisis and Regulatory Response

The global financial crisis of 2008 had a significant impact on India’s securities and investment landscape. The evolution of securities and investment laws in India saw a new phase.

SEBI’s Measures

SEBI took proactive measures to enhance market stability and investor protection during the crisis. It introduced circuit breakers, revised margin requirements and tightened risk management norms.

Introduction of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)

In 2014, SEBI introduced regulations for REITs and InvITs, offering new avenues for investment in real estate and infrastructure sectors.

Recent Developments and Digital Transformation

The last decade has witnessed a slew of regulatory changes to adapt to the evolving investment landscape, characterised by digitisation and innovative financial products.

Goods and Services Tax (GST)

The implementation of GST in 2017 brought uniform taxation across India, positively impacting businesses and investment decisions.

SEBI’s Digital Initiatives

SEBI embraced digital transformation by introducing e-IPOs, paperless dematerialisation of securities and regulatory sandboxes to encourage fintech innovation.

Insolvency and Bankruptcy Code (IBC), 2016

The IBC streamlined the resolution process for stressed assets, offering clarity to investors and creditors.

Aadhaar-Based KYC

The use of Aadhaar for KYC (Know Your Customer) verification simplified the onboarding process for investors.

Challenges and Future Outlook

Despite remarkable progress, India’s securities and investment landscape faces ongoing challenges.

• Market Volatility: Managing market volatility and ensuring market stability remains a challenge, especially during global economic uncertainties.
• Investor Education: Enhancing financial literacy and investor awareness is essential to protect retail investors from risks associated with complex financial products.
• Regulating New Technologies: Regulators must adapt to innovations like blockchain, cryptocurrencies and digital assets while ensuring they are aligned with regulatory frameworks.
• Corporate Governance: Maintaining high corporate governance standards is crucial to fostering investor confidence and protecting minority shareholders’ interests.

Conclusion

The evolution of securities and investment laws in India reflects the nation’s journey from a nascent financial market to a dynamic and thriving ecosystem. With SEBI at its helm, the regulatory framework has matured over the years, aligning with global best practices and accommodating technological advancements.

As India continues its growth trajectory, the regulatory landscape will play a pivotal role in ensuring investor protection, market integrity and sustainable economic development.