Secondary Market

The secondary market is where securities once issued are bought and sold between investors.

The instruments traded in secondary markets include securities issued in the primary market as
well as those that were not issued in the primary market, such as privately placed debt or equity
securities and derivatives of primary securities created and traded by financial intermediaries.

Transactions in the secondary market do not result in additional capital to the issuer as funds are
only exchanged between investors.

The role of secondary market

The role of this market is to support the capital raising function of the primary market by
providing liquidity, price identification, information-signaling, and acting as a barometer of
economic activity.

1. Liquidity

Secondary markets provide liquidity and marketability to existing securities. If an

investor wants to sell off equity shares or debentures purchased earlier, it can be done in
the secondary market.

Alternately, if new investors want to buy equity shares or debentures that have been
previously issued, sellers can be found in the secondary market. Investors can exit or
enter any listed security by transacting in the secondary markets.

2. Price Discovery

Secondary markets enable price discovery of traded securities. Each buy or sell
transaction reflects the individual assessment of investors about the fundamental worth of
 the security. The collective opinions of various investors are reflected in the real time
trading information provided by the exchange.

The continuous flows of price data allow investors to identify the market price of equity
shares. If an issuing company is performing well or has good future prospects, many
investors may try to buy its shares. This will pull up its market price.

If an issuing company is performing poorly or is likely to face some operating distress in

the future, there are likely to be more sellers than buyers of its shares. This will push
down its market price.

3. Information Signaling

Market prices provide instant information about issuing companies to all market
participants. This information-signaling function of prices works like a continuous
monitor of issuing companies, and in turn forces issuers to improve profitability and
performance. Efficient markets are those in which market prices of securities reflect all
available information about the security.

A large number of players trying to buy and sell based on information about the listed
security tend to create a noisy and chaotic movement in prices, but also efficiently
incorporate all relevant information into the price. As new information becomes
available, prices change to reflect it.

4. Indicating Economic Activity

Secondary market trading data is used to generate benchmark indices that are widely
tracked in the country. A market index is generated from market prices of a
representative basket of equity shares. Movements in the index represent the overall
market direction. The S&P BSE-Sensex and the NSE-Nifty50 are the most popularly
watched indices in India.
 A stock market index is viewed as a barometer of economic performance. A sustained
rise in key market indices indicate healthy revenues, profitability, capital investment and
expansion in large listed companies, which in turn implies that the economy is growing
strongly. A continuous decline or poor returns on indices is a signal of weakening
economic activity.

5. Market for Corporate Control

Stock markets function as markets for efficient governance by facilitating changes in

corporate control. If management is inefficient, a company could end up performing
below its potential. Market forces will push down share prices of underperforming
companies, leading to their undervaluation. Such companies can become takeover targets.
Potential acquirers could acquire a significant portion of the target firm’s shares in the
market, take over its board of directors, and improve its market value by providing better
governance. An actual takeover need not happen; even the possibility of a takeover can
be an effective mechanism to ensure better governance.

Types of secondary markets for different securities

1. Secondary market for equities:

The platform for trading of equity shares in the secondary market is provided by stock
exchanges. A stock exchange is classified as a market infrastructure institution (MII) and
is regulated by SEBI. Stock exchanges allow trading of those securities that are listed on
the exchange. Example BSE and NSE.

2. Secondary market for debt securities:

The secondary market for debt securities can be classified into the government securities
(G-sec) market, which is regulated by the RBI, and the corporate bond market, which is
regulated by SEBI.
 Prior to 2005, the G-sec market was mainly an over-the-counter (OTC) market. Buy and
sell orders were placed telephonically through approved G-sec brokers. This system was
slow, inefficient and prone to operational and default risks.

The Clearing Corporation of India Ltd (CCIL) was set up in 2001 by banks and financial
institutions at the behest of the RBI with the objective of improving the clearing and
settlement process and to broaden and deepen the G-sec market.

SEBI has taken several measures to streamline the functioning of the secondary market
for corporate bonds. These include mandatory reporting of OTC corporate bond trades on
the stock exchanges, creation of a centralized database of corporate bonds, compulsory
clearing and settlement of corporate bond trades by clearing corporations of exchanges
and introduction of a dedicated debt segment on stock exchanges. Example NSE and BSE

3. Secondary market for commodities:

Commodity is any good having commercial value, which can be produced, bought, sold,
and consumed. Example Mustard, Cotton Fiber, Crude oil, metals etc.

A commodity market is a type of marketplace that lets an individual indulge in buying,

selling, and trading raw materials or even primary products.

Ordinarily, it is a marketplace for investors that permits trading in commodities such as

crude oil, precious metals, natural gas, spices, etc.

A commodity market facilitates an exchange of physical goods among residents in a

country.

Examples of Commodity Market

 Multi Commodity Exchange (MCX)

 Indian Commodity Exchange (ICEX)

  National Commodity and Derivatives Exchange (NCDEX)

 National Multi Commodity Exchange (NMCE)

The spot market for commodities is regulated by individual state governments. The
government launched electronic National Agricultural Market (e-NAM) in 2016.

Market Structure and Participants

The secondary market consists of the following participants:

1. Stock Exchange

The core component of any secondary market is the stock exchange. The stock exchange
provides a platform for investors to buy and sell securities from each other in an organized and
regulated manner. The three national level stock exchanges in India are the Bombay Stock
Exchange (BSE), the National Stock Exchange (NSE) and the Metropolitan Stock Exchange of
India Ltd (MSEI). The trading terminals of these exchanges are present across the country.

2. Investors

If investors buy and sell shares among themselves, such trades are called “off-market” and do
not enjoy the benefits of regulatory and redressal provisions of the law.

In order to get a competitive price and a liquid market in which transactions can be completed
efficiently, investors come to the stock exchange through their brokers.

3. Issuers

Issuers are companies and other entities that seek admission for their securities to be listed on the
stock exchange. Equity shares, corporate bonds and debentures as well as securities issued by the
government (G-secs and treasury bills) are admitted to trade on stock exchanges.

There are specific eligibility criteria to list securities on the stock market. These can be in terms
of size, extent of public shareholding, credit rating, ownership pattern, etc.
Issuers must pay a listing fee and comply with requirement for disclosure of information that
may have a bearing on the trading prices of the listed securities.

4. Intermediaries involved in Trading, Clearing and Settlement

Secondary market transactions have three distinct phases:

 Trading
 Clearing
 Settlement.

To trade in shares is to buy and sell them through the stock exchanges. Stock exchanges in India
feature electronic order-matching systems that facilitate efficient and speedy execution of trades.

Clearing is the process of identifying what is owed to the buyer and seller in a trading
transaction.

Settlement is the mechanism of settling the obligations of counter parties in a trade.

SEBI, in order to further shorten the settlement cycle, has reduced the settlement cycle to T+1
day.

5. Risk Management

Stock exchanges have risk management systems to insure against the event that members of the
exchange may default on payment or delivery obligations.

Strategies such as maintenance of adequate capital assets by members and regular imposition of
margin payments on trades ensure that damages through defaults are minimized. Exchanges thus
enable two distinct functions: high liquidity in execution of trades and guaranteed settlement of
executed trades.

6. Clearing Corporation

In the modern structure of secondary markets, clearing corporations are set up as independent
fully-owned subsidiaries of stock exchanges. They function as counter-parties for all trades
executed on the exchange they are affiliated with. So all buyers pay funds to the clearing
corporation, and all sellers deliver securities to the clearing corporation. Specialized
intermediaries called clearing members complete these transactions.

The clearing corporation completes the other leg of the settlement by paying funds to sellers and
delivering securities to buyers.

7. Depositories and Depository Participants (DPs)

For a security to be eligible to trade in the secondary markets, it should be held in electronic or
dematerialized form. Issuers get their securities admitted to the depositories, where they are held
as electronic entries against investor names, without any paper certificate.

National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL)
are the two depositories in India.

Depository participants (DPs) are the members of depository. It provides the services of
depositories to the investors. Example Demat A/c.

8. Custodians

Custodians are institutional intermediaries, who are authorised to hold funds and securities on
behalf of large institutional investors such as banks, insurance companies, mutual funds, and
foreign portfolio investors (FPIs). They settle the secondary market trades for institutional
investors.

9. Regulator

Secondary markets are regulated under the provisions of the Securities Contracts (Regulation)
Act, 1956 and Securities Contracts (Regulation) Rules, 1957. SEBI is authorized by law to
implement the provisions of this act and its rules.

Trade Execution

The sequence of trade execution is as follows:

a. Placing of an order to buy or sell with the broker

b. Routing of order by broker to trading system

c. Display of order on the trading screen

d. Matching of order electronically

e. Confirmation of trade

f. Generation of contract note

Trading on stock exchanges is conducted from Monday to Friday, from 9.15 am to 3.30 pm.
Different timings may be adopted for non-equity segments. For example, trading on the Debt
Market segment on NSE starts at 9.00 am and closes at 5.15 pm. There are no trades on
Saturdays, Sundays and public holidays.

Bull And Bear Run

Stock markets are subject to bull and bear cycles. A bull market is when buyers are willing to
pay higher and higher prices, as the overall optimism for better future performance of stocks is
high. This happens when businesses are expanding, growing at an above average rate, face
favorable and growing demand for their products and services, and are able to price them
profitably. The returns to equity investors go up as stock prices appreciate to reflect this
optimism. But a bull market can overdo its exuberance. As buyers pay a higher and higher price
for a stock, prices move beyond what can be justified by the underlying intrinsic value. Also,
businesses tend to overarch themselves, borrowing to fund expansion based on optimistic
forecasts. Input costs for raw materials and labour and interest costs for capital increase as the
bull market reaches its peak. Unrealistic expansion in prices tends to correct itself with a crash.

The bull market paves way to a bear market when stock prices fall and correct themselves. A
downturn in economic cycles can lead to stress for several businesses, when they face lower
demand for their products and services, higher input and labour costs, lower ability to raise
capital, and in many cases risks of survival. When the economic conditions change, several
businesses that began profitably may come under stress and begin to fail. Bear markets in equity
reflect this pessimism, stocks prices fall. Sellers quit in despair, accepting a lower price and a
loss on their stocks. As prices may fall well below intrinsic values, buyers who find the valuation
attractive will start coming into stocks that now are priced reasonably, or lower. Lower interest
rates lead to investment, and slowly the bear cycle gives way to the next bull cycle.