How Stock Exchanges in India Work: A Beginner’s Legal Guide to BSE and NSE

Abstract

This research paper provides a comprehensive beginner’s legal guide to understanding how stock exchanges in India operate, with a focus on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). It begins by defining stock exchanges as regulated marketplaces where securities are traded, highlighting their critical role in mobilizing capital, facilitating liquidity, and supporting economic growth. The paper traces the evolution of India’s stock exchanges, detailing the historical significance of the BSE as Asia’s oldest exchange and the rise of the technologically advanced NSE, which revolutionized trading through electronic platforms and nationwide accessibility.

The legal framework governing stock exchanges is examined in depth, emphasizing the Securities Contracts (Regulation) Act, 1956 (SCRA) and the regulatory oversight of the Securities and Exchange Board of India (SEBI). These laws ensure that only recognized exchanges operate, enforce transparency, and protect investor interests through strict compliance and enforcement mechanisms. The paper explains the operational aspects of stock exchanges, including the trading process, the roles of brokers, clearing corporations, and depositories, as well as the procedures for listing and delisting companies.

Real-life examples such as the listing of Tata Consultancy Services (TCS) and the impact of the Harshad Mehta scam illustrate the practical and regulatory dynamics of the market. The conclusion synthesizes how legal regulation maintains market integrity, safeguards investors, and facilitates economic growth by fostering a transparent and efficient securities market. This paper serves as an essential resource for law students and beginners seeking to understand the intersection of law, finance, and market operations in India’s capital markets.

Keywords- Stock Exchanges, Securities Contracts (Regulation) Act, 1956 (SCRA), Securities and Exchange Board of India (SEBI), Bombay Stock Exchange (BSE), National Stock Exchange (NSE)

I. Introduction

A stock exchange is a regulated marketplace where financial securities, such as shares, bonds, and derivatives, are bought and sold. It provides a centralised platform that connects buyers and sellers, ensuring transparent and fair transactions under the oversight of regulatory bodies like the Securities and Exchange Board of India (SEBI). Only companies listed on a stock exchange can have their securities traded there, and trading is typically conducted electronically through an order-driven system that matches buy and sell orders automatically.

Stock exchanges play a critical role in the economic development of a country. They facilitate the mobilisation of capital by enabling companies to raise funds from a wide pool of investors through the issuance of shares and bonds. This process not only helps businesses expand but also channels household and institutional savings into productive investments, thereby contributing to overall economic growth. Additionally, stock exchanges provide liquidity, price discovery, and transparency, making it easier for investors to buy and sell securities efficiently. By offering a regulated and secure environment, they protect investors’ interests and foster confidence in the financial system.

India’s securities market is anchored by two primary stock exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The BSE, established in 1875, is Asia’s oldest stock exchange and has evolved into a modern electronic platform. The NSE, founded in 1992, introduced advanced trading technology and risk management systems, further modernising India’s capital markets. Both exchanges operate under SEBI’s supervision and are pivotal in shaping India’s position as one of the world’s fastest-growing financial markets.

II. Evolution of Stock Exchanges in India

History of the Bombay Stock Exchange (BSE)

The Bombay Stock Exchange (BSE), established in 1875, is not only India’s oldest stock exchange but also the oldest in Asia. Its origins trace back to informal gatherings of stockbrokers under a banyan tree in Mumbai’s Fort area as early as the 1850s. These meetings gradually formalized, and by 1875, a group of 25 brokers led by Premchand Roychand founded the “Native Share & Stock Brokers’ Association,” which later became the BSE. Over the decades, the BSE grew rapidly, moving to Dalal Street and becoming a central hub for capital market activities in India. It was officially recognized by the Indian government in 1957 under the Securities Contracts Regulation Act, further cementing its legitimacy and role in the financial system. Today, BSE is among the world’s largest exchanges by market capitalization, with over 6,000 listed companies and a significant impact on India’s economic development. 

Establishment of the National Stock Exchange (NSE)

The National Stock Exchange (NSE) was established in 1992 as a response to the need for greater transparency, efficiency, and investor protection in the Indian securities market. Unlike the BSE’s traditional open outcry system, the NSE introduced a fully automated, electronic trading platform from its inception, revolutionizing the way securities were traded in India. The NSE commenced operations in 1994 and quickly gained prominence by offering nationwide access and a modern, technology-driven approach to stock trading.

Why NSE became popular

The NSE’s popularity soared due to several key factors:

• It introduced a fully electronic, screen-based trading system, which ensured transparency, speed, and efficiency in trade execution.
• Its nationwide network made stock market participation accessible to investors across India, not just those in Mumbai.
• The NSE implemented robust risk management systems and standardized settlement cycles, increasing investor confidence.
• It fostered competition, leading to lower transaction costs and improved services for market participants.

These innovations helped the NSE rapidly gain market share and become a dominant force in the Indian securities market, often surpassing the BSE in trading volumes and technological advancement. Today, both the BSE and NSE play pivotal roles in India’s capital markets, offering diverse products and services to a broad spectrum of investors.

III. Legal Framework Governing Stock Exchanges in India

Role of the Securities Contracts (Regulation) Act, 1956 (SCRA)

The Securities Contracts (Regulation) Act, 1956, is a foundational statute enacted by the Indian Parliament to regulate the functioning of stock exchanges and securities contracts in India. The Act aims to prevent undesirable speculative activities and ensure orderly trading of securities. It provides the legal framework for the recognition and regulation of stock exchanges, the listing and trading of securities, and the licensing and supervision of stockbrokers and sub-brokers. Under the SCRA:

• Only recognized stock exchanges are permitted to operate, and trading in securities is mandated to occur on these exchanges to protect investors and maintain market integrity.
• The Central Government, in consultation with SEBI, grants recognition to stock exchanges after ensuring that their rules and by-laws promote fair dealing and protect investors’ interests.
• The Act empowers the government to withdraw recognition if an exchange is found to be acting against public interest or market integrity.
• It also regulates contracts in securities and prohibits trading outside recognized exchanges unless specifically permitted.

Thus, the SCRA establishes the legal basis for the registration, recognition, and regulation of stock exchanges, ensuring that they operate transparently and fairly. 

How SEBI Regulates Stock Exchanges

The Securities and Exchange Board of India (SEBI) was established in 1992 under the SEBI Act, 1992, as the primary regulatory authority overseeing India’s securities markets, including stock exchanges. SEBI’s powers and functions include:

• Registration and regulation of stock exchanges, brokers, merchant bankers, and other market intermediaries.
• Conducting inspections and audits of stock exchanges to ensure compliance with laws and regulations.
• Promoting investor protection through enforcement against unfair trade practices, insider trading, and market manipulation.
• Framing detailed regulations covering capital issuance, disclosures, takeovers, insider trading, and corporate governance.
• Holding quasi-judicial powers to investigate, conduct hearings, issue penalties, and take enforcement actions.

SEBI’s regulatory framework ensures that stock exchanges operate transparently, maintain fair trading practices, and protect investor interests. It also mandates continuous disclosures by listed companies and enforces compliance with listing obligations. 

Concept of Registration and Recognition of Exchanges

Stock exchanges in India must obtain formal recognition from the Central Government, based on the provisions of the SCRA. The process involves:

• Submission of an application by the stock exchange, along with its rules and bylaws, to the government.
• The government conducts a detailed inquiry to verify that the exchange’s rules align with investor protection and fair trading principles.
• Recognition is granted if the exchange satisfies all regulatory requirements and agrees to comply with conditions imposed by the government.
• Only recognized stock exchanges are legally authorized to operate, and contracts made on non-recognized exchanges are void.
• The government, with SEBI’s advice, may withdraw recognition if an exchange acts against public interest or undermines market integrity, after providing due notice and opportunity for hearing.

SEBI also plays a key role in supervising recognized exchanges post-recognition, including annual inspections and monitoring compliance with regulatory norms.

This legal framework, comprising the SCRA, the SEBI Act, and related regulations, creates a robust regulatory environment that governs the operation, supervision, and enforcement of stock exchanges in India, thereby fostering a transparent, efficient, and investor-friendly securities market.

IV. How Stock Exchanges Operate (In Simple Terms)

Trading Process (Buying/Selling Shares)

The trading process on stock exchanges like the BSE and NSE involves several clear steps that enable investors to buy or sell shares efficiently:

1. Selection of a Broker: To participate in the stock market, an investor must first select a SEBI-registered stockbroker who is a member of the exchange. Brokers act as intermediaries between investors and the stock exchange, executing buy or sell orders on behalf of their clients.
2. Opening a Demat Account: Investors must open a Demat (dematerialized) account through a depository participant, such as a bank or brokerage firm. This account holds the investor’s securities in electronic form, eliminating the need for physical share certificates. The two main depositories in India are NSDL and CDSL.
3. Placing the Order: Once the Demat account is active, the investor places an order to buy or sell shares through the broker, either via online trading platforms or by communicating through phone, email, or other means. The order specifies the security, quantity, and price.
4. Order Matching and Execution: The stock exchange’s electronic trading system matches buy orders with corresponding sell orders based on price and time priority. When a match is found, the trade is executed instantly, and a confirmation is sent to the broker and investor.
5. Contract Note Issuance: Within 24 hours of trade execution, the broker issues a contract note to the investor. This legal document details the transaction, including the number of shares traded, price, date, brokerage fees, and other charges.
6. Settlement: The settlement cycle in India follows a T+2 system, meaning the transfer of shares and payment occurs two working days after the trade date. On settlement, the buyer’s Demat account is credited with the shares, and the seller receives payment. The clearing corporation of the exchange guarantees the settlement, reducing counterparty risk. 

Role of Brokers, Clearing Corporations, and Depositories

• Brokers: Brokers are licensed intermediaries who facilitate trading on behalf of investors. They execute buy and sell orders, provide market access, and issue contract notes. Brokers also help investors comply with regulatory requirements and offer advisory services.

• Clearing Corporations: Each stock exchange has a clearing corporation that acts as the central counterparty to all trades. It ensures the smooth clearing and settlement of transactions by managing risks and guaranteeing payment and delivery obligations. This reduces the risk of default by either party in a trade.

• Depositories: Depositories like NSDL and CDSL hold securities in electronic form and facilitate their transfer between buyers and sellers. They maintain Demat accounts for investors and ensure the safe custody of securities. When shares are bought or sold, the depositories update the ownership records accordingly, enabling seamless and paperless transactions. 

Listing and Delisting of Companies

• Listing: Listing refers to the process by which a company’s shares are admitted to trading on a stock exchange. To get listed, a company must meet eligibility criteria set by the exchange and SEBI, including minimum capital requirements, disclosure norms, and corporate governance standards. Listing provides companies with access to capital markets, enhances visibility, and allows their shares to be traded publicly.
• Delisting: Delisting is the removal of a company’s shares from the stock exchange, either voluntarily or involuntarily. Voluntary delisting occurs when a company chooses to withdraw its shares, often due to strategic reasons or mergers. Involuntary delisting happens when a company fails to comply with regulatory requirements or listing norms. Delisting restricts public trading of the company’s shares and may affect liquidity and investor confidence.

This simplified explanation outlines the core operational mechanisms of stock exchanges in India, highlighting how trades are conducted, the roles of key market participants, and the processes governing company listings. Understanding these fundamentals is essential for anyone beginning to navigate India’s capital markets.

V. Real-Life Examples & Interesting Facts

A Major Company’s Listing on NSE/BSE: Tata Consultancy Services (TCS)

Tata Consultancy Services (TCS), one of India’s largest IT companies, made its historic debut on both the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) on August 25, 2004, following a highly successful initial public offering (IPO). The shares were issued at a face value of Re 1 with a premium of Rs 849 per share. Since its listing, TCS has consistently been among the most valued companies in India, often vying with Reliance Industries for the top spot in terms of market capitalisation. For instance, in 2021, TCS briefly became the world’s most valued IT company, surpassing Accenture, and reached a market capitalisation of $170 billion. In the Indian market, TCS and Reliance Industries frequently alternate as the most valued firms, reflecting their significant influence on the Indian stock exchanges. 

Regulatory Changes Brought by Famous Scams:

One of the most infamous episodes in Indian stock market history is the Harshad Mehta scam of the early 1990s. Mehta, a stockbroker, exploited loopholes in the banking system to manipulate stock prices, leading to a massive bull run followed by a market crash. The scam exposed serious deficiencies in the regulatory framework and prompted sweeping reforms in India’s securities markets. In response, the Securities and Exchange Board of India (SEBI) was granted greater powers, electronic trading was introduced, and risk management systems were strengthened. These changes significantly improved transparency, accountability, and investor protection in the functioning of stock exchanges. 

Fun Fact: BSE is Asia’s Oldest Stock Exchange

The Bombay Stock Exchange (BSE), established in 1875, holds the distinction of being Asia’s oldest stock exchange. It began as informal gatherings of stockbrokers under a banyan tree in Mumbai and has since evolved into a modern, fully electronic exchange, playing a pivotal role in the development of India’s capital markets and serving as a model for other exchanges in the region.

VI. Conclusion

Stock exchanges in India, primarily the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), serve as vital pillars of the country’s financial infrastructure by providing a structured and regulated marketplace for the trading of securities. At their core, stock exchanges function as centralized platforms where buyers and sellers of securities, such as shares, bonds, and derivatives, can transact in a transparent, efficient, and orderly manner. The entire trading process, from order placement to settlement, is facilitated through a network of intermediaries, including brokers, clearing corporations, and depositories, each playing a critical role in ensuring the smooth execution and finalization of trades.

The legal framework governing these stock exchanges is robust and multifaceted, primarily anchored by the Securities Contracts (Regulation) Act, 1956 (SCRA) and the regulatory oversight of the Securities and Exchange Board of India (SEBI). The SCRA establishes the statutory basis for the recognition, registration, and regulation of stock exchanges, mandating that only recognized exchanges can legally facilitate trading. SEBI, as the apex regulatory body, enforces comprehensive rules and regulations that cover market conduct, investor protection, disclosure requirements, and the licensing of market participants. This dual framework ensures that stock exchanges operate within a well-defined legal environment designed to uphold market integrity and fairness.

One of the most critical functions of legal regulation is the protection of investors. By mandating transparency in trading operations, enforcing timely disclosures by listed companies, and curbing malpractices such as insider trading and market manipulation, the regulatory regime fosters investor confidence. This confidence is indispensable for the healthy functioning of capital markets, as it encourages greater participation from retail and institutional investors alike. The introduction of electronic trading, risk management systems, and centralized clearing mechanisms further reinforces the safety and efficiency of the market, reducing counterparty risks and ensuring the timely settlement of trades.

Beyond investor protection, stock exchanges play a fundamental role in supporting the broader economy. They facilitate the mobilization of savings into productive investments by enabling companies to raise capital through initial public offerings (IPOs) and follow-on public offerings. This capital formation is essential for business expansion, innovation, and job creation, all of which contribute to economic growth. Moreover, stock exchanges provide price discovery mechanisms that reflect the real-time valuation of companies, helping allocate resources efficiently across sectors. The liquidity provided by exchanges allows investors to convert their holdings into cash quickly, enhancing the attractiveness of equity investments.

The evolution of India’s stock exchanges, marked by landmark events such as the Harshad Mehta scam, underscores the importance of continuous regulatory vigilance and reform. The lessons learned from past market failures have driven the development of a more resilient and transparent regulatory architecture, which balances the need for market innovation with the imperative of investor protection. Today, the legal framework ensures that stock exchanges not only facilitate capital market activities but also act as guardians of market integrity.

In conclusion, the functioning of stock exchanges in India is a complex interplay of technology, market participants, and stringent legal oversight. The regulatory framework, led by SEBI and supported by laws like the SCRA, is indispensable in maintaining transparency, fairness, and efficiency in the securities market. This legal supervision safeguards investor interests, mitigates systemic risks, and fosters a stable environment conducive to economic growth. For beginners and seasoned investors alike, understanding this legal and operational structure is crucial to navigating India’s dynamic capital markets confidently and responsibly. The continued evolution of regulatory policies will remain key to ensuring that stock exchanges adapt to emerging challenges while upholding the principles of transparency and investor protection that form the foundation of India’s financial markets. 

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