CAPITAL MARKET INSTRUMENTS
Dr JAYENDRA KASTURE
VIT School of law - Chennai
CAPITAL MARKETS AND SECURITIES REGULATION
FINANCIAL INSTRUMENTS
INTRODUCTION
Financial instruments innovation has been a continuous and
integral part of growth of the capital markets.
A variety of factors such as fluctuation in interest rate,
volatility in price, change in tax structures and regulatory
changes etc. plays an important part in financial innovation.
In finance, innovation involves adapting and improvising on
existing products and concepts.
Advances emerge initially as either products or processes .
FINANCIAL INSTRUMENTS
In general, it refers to the creating and marketing of new types
of securities by the issuers for raising funds from the investor.
A financial instrument is a combination of characteristics such
as promised yield, liquidity, maturity period, security and risk.
Financial Instruments that are used for raising capital
resources in the capital market are known as capital market
instruments.
The capital market instruments are usually used by the
Government and Companies.
CLASSIFICATION OF INSTRUMENTS
Pure Instruments -
Instruments which are issued with their basic characteristics in
tact without mixing features of other classes of instruments are
called Pure instruments.
e.g
Equity shares
Preference shares and
Debentures
CLASSIFICATION OF INSTRUMENTS
Hybrid instruments - are those which are created by
combining the features of equity with bond,
preference and equity etc.
Examples of Hybrid instruments are:
Convertible preference shares,
convertible debentures,
partly convertible debentures,
partly convertible debentures with Khokha (buy-back
arrangement) etc.
CLASSIFICATION OF INSTRUMENTS
Derivatives Instruments
Derivatives are contracts which derive their values from the
value of one or more of other assets (known as underlying
assets).
The derivative itself is merely a contract between two or more
parties.
Its value is determined by fluctuations in the underlying asset.
The most common underlying assets include stocks, bonds,
commodities, currencies, interest rates and market indexes.
Some of the most commonly traded derivatives are futures,
forward, options and swaps.
EQUITY SHARES
Equity shares, commonly referred to as ordinary
share.
It also represents the form of fractional ownership .
A shareholder, as a fractional owner, undertakes the
maximum entrepreneurial risk associated with a
business venture.
The holder of such shares is the member of the
company and has voting rights.
EQUITY SHARES
Equity share capital - with reference to any company
limited by shares, means all share capital which is not
preference share capital.
Equity share capital
(i) with voting rights, or
(ii) with differential rights as to dividend, voting or
otherwise in accordance with such rules as may be
prescribed.
CHARACTERISTICS OF EQUITY SHARES
Equity shares, have voting rights at all general meetings
of the company.
These votes have the affect of the controlling the
management of the company.
Equity shares have the right to share the profits of the
company in the form of dividend (cash) and bonus shares.
When the company is wound up, payment towards the
equity share capital will be made to the respective
shareholders only after payment of the claims of all the
creditors and the preference share capital.
CHARACTERISTICS OF EQUITY SHARES
Equity share holders enjoy different rights as
members under the Companies Act, 2013 such as
The right to vote on every resolution placed before
the company – (Section 47).
Right to appoint proxy to attend and vote at the
meeting on his behalf – (Section 105)
Right to receive copy of annual accounts of the
company – (Section 136)
CHARACTERISTICS OF EQUITY SHARES
Right to receive notice of the meeting of members –
(Section 101)
Right to inspection of various statutory registers
maintained by the company – (Section 94)
Right to requisition extraordinary general meeting of
the company – (Section 100)
SHARES WITH DIFFERENTIAL
VOTING RIGHTS (DVRs)
Differential voting rights (DVR) refer to equity shares
holding differential rights as to dividend and/or
voting.
The Companies Act, 2013 (Companies Act) allows a
company limited by shares to issue DVRs as part of
its share capital. (Sec – 43)
Introduced for the first time in 2000, DVRs are seen
as a viable option for raising investments and
retaining control over the company at the same time.
SHARES WITH DIFFERENTIAL
VOTING RIGHTS (DVRs)
ISSUE OF DVRs - Section 43(a)(ii) of the Companies Act,
2013, authorized equity share capital with differential rights as
to dividend, voting or otherwise in accordance with rule 4 of
Companies (Share Capital and Debentures) Rules, 2014 which
prescribes the following conditions for issue of DVRs
(a) the articles of association of the company authorizes the issue
of shares with differential rights.
(b) the issue of shares is authorized by ordinary resolution passed
at a general meeting of the shareholders.
(c) the company having consistent track record of distributable
profit for the last three years
SHARES WITH DIFFERENTIAL
VOTING RIGHTS (DVRs)
(d) the company has not defaulted in filing financial statements
and annual returns for three financial years immediately
preceding the financial year in which it is decided to issue such
shares.
(e) the company has no subsisting default in the payment of a
declared dividend to its shareholders or repayment of its
matured deposits or redemption of its preference shares or
debentures that have become due for redemption or payment
of interest on such deposits or debentures or payment of
dividend;
SHARES WITH DIFFERENTIAL
VOTING RIGHTS (DVRs)
(f) the company has not defaulted in payment of the dividend on
preference shares or repayment of any term loan.
(g) the company has not been penalized by Court or Tribunal
during the last three years of any offence under the Reserve
Bank of India Act, 1934, Securities and Exchange Board of
India Act, 1992, Securities Contracts (Regulation) Act, 1956,
the Foreign Exchange Management Act, 1999 or any other
special Act under which such companies being regulated by
sectoral regulators.
(h) The explanatory statement to be annexed to the notice of the
general meeting should contain the disclosures as mentioned in
the rules.
SHARES WITH DIFFERENTIAL
VOTING RIGHTS (DVRs)
(i) The Board of Directors shall disclose in the Board’s Report for
the financial year in which the issue of equity shares with
differential rights was completed.
(j) The company shall not convert its existing share capital with
voting rights into equity share capital carrying differential
voting rights and vice-versa.
(k) The holders of the equity shares with differential rights shall
enjoy all other rights such as bonus shares, rights shares etc.,
which the holders of equity shares are entitled to, subject to the
differential rights with which such shares have been issued.
PREFERENCE SHARES
According to explanation (ii) to Section 43 of Companies Act,
2013 ‘preference share capital’, with reference to any company
limited by shares, means that part of the issued share capital of
the company which carries or would carry a preferential right
with respect to –
- to claim dividends during the lifetime of the company and
- to claim repayment of capital or repayment in case of winding
up.
KINDS OF PREFERENCE SHARES
Cumulative preference shares
Non-cumulative preference shares
Convertible preference shares
Redeemable preference shares
Participating preference share
Non participating preference shares
DEBENTURE
Section 2(30) of the Companies Act, 2013 defines
debentures. ‘Debenture’ includes
debenture stock, bonds or any other instrument of a
company
evidencing a debt or acknowledging it
whether constituting a charge on the assets of the
company or not;
Debentures are issued for cash at par
CATEGORIES OF DEBENTURES
Fully Convertible Debentures
These are converted into equity shares of the company with or
without premium as per the terms of the issue, on the expiry of
specified period or periods.
Interest will be payable on these debentures upto the date of
conversion as per transfer issue.
Non Convertible Debentures (NCDs)
These debentures do not carry the option of conversion into
equity shares and are therefore redeemed on the expiry of the
specified period or periods.
CATEGORIES OF DEBENTURES
Partly Convertible Debentures (PCDs)
These may consist of two kinds namely -convertible
and non-convertible.
The convertible portion is to be converted into equity
shares at the expiry of specified period.
However, the non convertible portion is redeemed at
the expiry of the stipulated period.
SWEAT EQUITY SHARES
Sweat Equity Shares - Section 2 (88) of the Companies Act,
2013
means such equity shares as are issued by a company to
its directors or
employees
at a discount or for consideration, other than cash,
for providing their know-how or making available rights in
the nature of intellectual property rights or value additions, by
whatever name called.
SWEAT EQUITY SHARES
Conditions For Issue
The issue is authorized by a special resolution passed by the
company in the general meeting.
The resolution specifies the number of shares, current market
price, consideration if any and the class or classes of directors
or employees to whom such equity shares are to be issued.
The sweat equity shares of a company whose equity shares are
listed on a recognised stock exchange are issued in accordance
with the regulations made by SEBI in this regard.
SHARE WARRANTS
Share warrants are a common source of funding used by
companies, both public and private.
Share warrant is an option
issued by the company that gives the warrant holder a
right to subscribe equity shares at a pre determined price on
or after a pre determined time period.
Share warrants entitle the issuer to take advantage of
future appreciation in the price of stock.
DERIVATIVES
Generally belonging to the realm of advanced
investing
derivatives are secondary securities whose value is
solely based (derived) on the value of the primary
security that they are linked to.
In and of itself a derivative is worthless.
Futures contracts, forward contracts, options, swaps
and warrants are commonly used derivatives.
DERIVATIVES
Financial institutions and corporations use derivative
financial instruments to hedge their exposure to
different risks, including commodity risks, foreign
exchange risks, and interest rate risks.
A futures contract for example, is a derivative
because its value is affected by the performance of
the underlying asset. Similarly, a stock option is a
derivative because its value is "derived" from that of
the underlying stock.