Draft Report of the High Level Group on Services Sector

6.2.5 Financial markets

The development of deep and liquid financial markets, comprising equity, debt, currency and commodity derivative markets, is essential for the healthy growth of the financial sector and the economy as a whole, as they facilitate lower transaction costs in economic activity and efficient diffusion of risk. In India, the various markets are at different stages of development. The key recommendations in this regard are:

1. 
   Increasing penetration: Early success due to the introduction of electronic trading in the 1990s should not lead to complacency as the number of participants in the capital markets, whether directly or through the mutual fund route, is still small relative to the earning population of the country. An active and coordinated programme of investor education and spreading financial literacy is recommended. Some of the steps that can be undertaken to start the programme could be: using the unclaimed dividends and redemption amounts of mutual funds for the investor education campaign, amending the SEBI Act to provide that all fines and penalties levied by SEBI remain with SEBI for investor education, mutual fund industry setting apart a portion of their asset management fee annually for the campaign, mutual fund distributors contributing a certain percentage of their commission income and the Ministry of Finance making a budgetary provision for investor awareness and placing the funds at the disposal of SEBI.
   

2. 
   Developing debt capital market: The bond market in India remains limited whether in terms of instrument types and maturities, issuer diversity, investor participation and liquidity. The report of the committee chaired by Dr. R. H. Patil submitted in early 2006, which contains several recommendations for the development of bond markets, remains largely unimplemented. The key recommendations are rationalization and uniformity in stamp duties levied by various states on debt instruments, freedom to banks to issue bonds of various maturities including long-term bonds to finance long-term assets, market making in corporate bonds, reducing time and cost of issuance and expanding the investor base by enhancing the ability of provident/ pension/ gratuity funds and insurance companies to invest in corporate bonds.
   

Securitisation is an important tool for bridging the gap between mobilisers of savings and originators of debt. It can be used to create instruments of varying yield and maturity to suit the needs of different investor classes. It is recommended that the securitization market be developed through affordable and uniform rates and levels of stamp duty, listing of securitization paper and pass through tax treatment to securitization SPVs similar to mutual funds. Further, securitization SPVs should also be permitted to act as counterparties in derivative transactions.

The shelf registration option for debt issuances is available only to a defined category of financial institutions. This may be extended to other issuers, subject to such criteria including rating that the market regulator may consider appropriate.

3. 
   Developing derivative market: The currency and interest rate derivative market is, along with a deep and liquid bond market, the key “missing market” in India. Presently, only over-the-counter (OTC) derivative contracts are available in India and there are no exchange traded derivatives (ETDs). ETDs play a complementary role to OTC derivatives in the development of derivative markets. It is recommended that steps should be taken for trading of vanilla derivative products on existing exchanges, to enhance the liquidity and depth of the derivative market, while structured and exotic products may continue to be transacted on an OTC basis. In particular, exchange traded interest rate futures are imperative to create a meaningful medium term yield curve, as the existing benchmarks are primarily overnight or short-term. Banks and other market participants should be permitted to trade in interest rate futures to impart liquidity to the market.
   

Currently, banks are not permitted to participate in equity derivatives. This may be considered as it would permit banks to better manage risks in their equity portfolios and would also enhance market liquidity. Similarly, banks are not permitted to participate in the commodity derivatives market. This is essential to bring depth and liquidity to the commodity derivatives market.