A rallying cry
Many quality small caps trapped by the illiquid norms
are set to be released by the revised criteria Small-cap stocks are set to fly in 2014. The
Securities and Exchange Board of India (Sebi)
made significant changes in the definition of
illiquid stocks mid December 2013. With
this review, a large number of companies
will come out of the periodic call auction
mechanism devised by the market regulator
to control the menace of price manipulation
and rigging on the trading floor.
Sebi has retained call auction for
illiquid stocks. But the tweaking of the
definition of illiquid stocks will leave only a
few stocks under the mechanism. These
stocks should make no difference to small
investors. This is because the stocks that
remain in the call auction system are too
small, with not-so-impressive record of
operational and financial performance.
The capital market regulator had
announced the launch of call auctions in
February 2013 to discipline punters and
prevent price manipulation. The mechanism
was only applicable to illiquid counters,
which are susceptible to price manipulation
by street-smart traders.
The decision in 2010 to introduce call
auction for illiquid stocks in the pre-opening
session to reduce volatility in prices at the
opening of the market was partially based on
global best practices. The system is deployed
in some leading stock exchanges of the world
such as the New York Stock Exechange, London
Stock Exchange, and Deutsche Bourse AG.
Indeed, the mechanism has several
merits. First, and probably the most
important, advantage is it can reduce
volatility. Illiquid stocks are playgrounds for
punters and volatility could be chilling. The
single price discovered through call auction
takes care of the breathtaking fluctuation.
The next obvious benefit is the lower impact
cost to investors. The transaction takes place
at a single auction price in a particular session.
Another positive is that all the
participants — one with greater information
and a common investor with limited or no
street-smart information — are treated
equally. Again, this is possible because of
single price. In short, there is no danger of
asymmetric information.
There is risk of front-running in
execution of large orders in a normal market.
This pitfall is eliminated in call auction as
the orders are accumulated over a period of
time, matched and executed at a single
auction price.
However, the introduction of the system
killed volumes on the trading floor and
adversely impacted the process of price
discovery as well. Not only share prices of
illiquid stocks, but even companies with
decent track record of profit and dividends
witnessed a sharp drop in volume and price
as well after being branded as illiquid stocks
due to the sweeping definition. Call auction
not only prevented new investors from
coming in but trapped several investors for
want of exit at the right price.
It was an ironic situation of a regulatory
move with good intentions triggering wealth
erosion. Since April 2013, when the call
auction for illiquid stocks became effective,
the situation so emerged was akin to the
medicine being worse than the ailment of
price rigging.
The mechanism was widely criticized.
This was rightly so because several hundred
illiquid stocks witnessed a sharp plunge in
trading volume: a few as high as 90% and
more. This was no less than a death-knell
for a market known to be shallow. Thus,
the annoyance of market participants was
not surprising.
Between 14 February 2013, when the
stock market watchdog announced the call
auction mechanism, and 19 December 2013,
when it was relaxed, the BSE Small-Cap index
corrected 5.6% and the Mid-Cap index
3.3%. The S&P BSE Sensex, the broader
index reflecting the overall market mood,
moved up 6.2% in this period. Clearly, the
call auction mechanism had played havoc
with small-cap stocks.
Post introduction of call auction for
illiquid stocks, Sebi received feedback from
market participants and stock exchanges as
well. Based on the issues raised and their
examination, the Secondary Market
Advisory Committee decided to rationalise
the periodic call auction mechanism.
The significant changes made include a
stock trading in the normal market and not
shifted to trade-for-trade settlement being
classified as liquid subject to few conditions.
In short, this criterion is not applicable to
trade-for-trade stocks.
Second, as per the new guidelines, a
stock can be termed as illiquid if the average
��
Many quality small caps trapped by the illiquid norms
are set to be released by the revised criteria Small-cap stocks are set to fly in 2014. The
Securities and Exchange Board of India (Sebi)
made significant changes in the definition of
illiquid stocks mid December 2013. With
this review, a large number of companies
will come out of the periodic call auction
mechanism devised by the market regulator
to control the menace of price manipulation
and rigging on the trading floor.
Sebi has retained call auction for
illiquid stocks. But the tweaking of the
definition of illiquid stocks will leave only a
few stocks under the mechanism. These
stocks should make no difference to small
investors. This is because the stocks that
remain in the call auction system are too
small, with not-so-impressive record of
operational and financial performance.
The capital market regulator had
announced the launch of call auctions in
February 2013 to discipline punters and
prevent price manipulation. The mechanism
was only applicable to illiquid counters,
which are susceptible to price manipulation
by street-smart traders.
The decision in 2010 to introduce call
auction for illiquid stocks in the pre-opening
session to reduce volatility in prices at the
opening of the market was partially based on
global best practices. The system is deployed
in some leading stock exchanges of the world
such as the New York Stock Exechange, London
Stock Exchange, and Deutsche Bourse AG.
Indeed, the mechanism has several
merits. First, and probably the most
important, advantage is it can reduce
volatility. Illiquid stocks are playgrounds for
punters and volatility could be chilling. The
single price discovered through call auction
takes care of the breathtaking fluctuation.
The next obvious benefit is the lower impact
cost to investors. The transaction takes place
at a single auction price in a particular session.
Another positive is that all the
participants — one with greater information
and a common investor with limited or no
street-smart information — are treated
equally. Again, this is possible because of
single price. In short, there is no danger of
asymmetric information.
There is risk of front-running in
execution of large orders in a normal market.
This pitfall is eliminated in call auction as
the orders are accumulated over a period of
time, matched and executed at a single
auction price.
However, the introduction of the system
killed volumes on the trading floor and
adversely impacted the process of price
discovery as well. Not only share prices of
illiquid stocks, but even companies with
decent track record of profit and dividends
witnessed a sharp drop in volume and price
as well after being branded as illiquid stocks
due to the sweeping definition. Call auction
not only prevented new investors from
coming in but trapped several investors for
want of exit at the right price.
It was an ironic situation of a regulatory
move with good intentions triggering wealth
erosion. Since April 2013, when the call
auction for illiquid stocks became effective,
the situation so emerged was akin to the
medicine being worse than the ailment of
price rigging.
The mechanism was widely criticized.
This was rightly so because several hundred
illiquid stocks witnessed a sharp plunge in
trading volume: a few as high as 90% and
more. This was no less than a death-knell
for a market known to be shallow. Thus,
the annoyance of market participants was
not surprising.
Between 14 February 2013, when the
stock market watchdog announced the call
auction mechanism, and 19 December 2013,
when it was relaxed, the BSE Small-Cap index
corrected 5.6% and the Mid-Cap index
3.3%. The S&P BSE Sensex, the broader
index reflecting the overall market mood,
moved up 6.2% in this period. Clearly, the
call auction mechanism had played havoc
with small-cap stocks.
Post introduction of call auction for
illiquid stocks, Sebi received feedback from
market participants and stock exchanges as
well. Based on the issues raised and their
examination, the Secondary Market
Advisory Committee decided to rationalise
the periodic call auction mechanism.
The significant changes made include a
stock trading in the normal market and not
shifted to trade-for-trade settlement being
classified as liquid subject to few conditions.
In short, this criterion is not applicable to
trade-for-trade stocks.
Second, as per the new guidelines, a
stock can be termed as illiquid if the average
A rallying cry
Many quality small caps trapped by the illiquid norms
are set to be released by the revised criteria Small-cap stocks are set to fly in 2014. The
Securities and Exchange Board of India (Sebi)
made significant changes in the definition of
illiquid stocks mid December 2013. With
this review, a large number of companies
will come out of the periodic call auction
mechanism devised by the market regulator
to control the menace of price manipulation
and rigging on the trading floor.
Sebi has retained call auction for
illiquid stocks. But the tweaking of the
definition of illiquid stocks will leave only a
few stocks under the mechanism. These
stocks should make no difference to small
investors. This is because the stocks that
remain in the call auction system are too
small, with not-so-impressive record of
operational and financial performance.
The capital market regulator had
announced the launch of call auctions in
February 2013 to discipline punters and
prevent price manipulation. The mechanism
was only applicable to illiquid counters,
which are susceptible to price manipulation
by street-smart traders.
The decision in 2010 to introduce call
auction for illiquid stocks in the pre-opening
session to reduce volatility in prices at the
opening of the market was partially based on
global best practices. The system is deployed
in some leading stock exchanges of the world
such as the New York Stock Exechange, London
Stock Exchange, and Deutsche Bourse AG.
Indeed, the mechanism has several
merits. First, and probably the most
important, advantage is it can reduce
volatility. Illiquid stocks are playgrounds for
punters and volatility could be chilling. The
single price discovered through call auction
takes care of the breathtaking fluctuation.
The next obvious benefit is the lower impact
cost to investors. The transaction takes place
at a single auction price in a particular session.
Another positive is that all the
participants — one with greater information
and a common investor with limited or no
street-smart information — are treated
equally. Again, this is possible because of
single price. In short, there is no danger of
asymmetric information.
There is risk of front-running in
execution of large orders in a normal market.
This pitfall is eliminated in call auction as
the orders are accumulated over a period of
time, matched and executed at a single
auction price.
However, the introduction of the system
killed volumes on the trading floor and
adversely impacted the process of price
discovery as well. Not only share prices of
illiquid stocks, but even companies with
decent track record of profit and dividends
witnessed a sharp drop in volume and price
as well after being branded as illiquid stocks
due to the sweeping definition. Call auction
not only prevented new investors from
coming in but trapped several investors for
want of exit at the right price.
It was an ironic situation of a regulatory
move with good intentions triggering wealth
erosion. Since April 2013, when the call
auction for illiquid stocks became effective,
the situation so emerged was akin to the
medicine being worse than the ailment of
price rigging.
The mechanism was widely criticized.
This was rightly so because several hundred
illiquid stocks witnessed a sharp plunge in
trading volume: a few as high as 90% and
more. This was no less than a death-knell
for a market known to be shallow. Thus,
the annoyance of market participants was
not surprising.
Between 14 February 2013, when the
stock market watchdog announced the call
auction mechanism, and 19 December 2013,
when it was relaxed, the BSE Small-Cap index
corrected 5.6% and the Mid-Cap index
3.3%. The S&P BSE Sensex, the broader
index reflecting the overall market mood,
moved up 6.2% in this period. Clearly, the
call auction mechanism had played havoc
with small-cap stocks.
Post introduction of call auction for
illiquid stocks, Sebi received feedback from
market participants and stock exchanges as
well. Based on the issues raised and their
examination, the Secondary Market
Advisory Committee decided to rationalise
the periodic call auction mechanism.
The significant changes made include a
stock trading in the normal market and not
shifted to trade-for-trade settlement being
classified as liquid subject to few conditions.
In short, this criterion is not applicable to
trade-for-trade stocks.
Second, as per the new guidelines, a
stock can be termed as illiquid if the averageexchanges. Bourses may determine the
number of auction sessions. However, to
have the minimum trading sessions and
uniform closing session, there willl be at least
two sessions with one uniform closing
session across exchanges. Previously, they
were stipulated to have six trading sessions
of an hour each, starting from 9:30 a m.
Further, the orders may remain valid
throughout the trading day. Unmatched
orders remaining at the end of a session may
be moved to the next call auction session.
Earlier, all unmatched orders remaining at
the end of a session were purged. The change
could save investors from putting the
unexecuted orders time and again in the
system throughout the day. Stock brokers
declined to take orders for illiquid stocks
that were part of the call auction mechanism
as this segment was not remunerative,
considering the time and efforts put in.
All other stipulations remain. Like
earlier, trading in illiquid stocks will take
place at an equilibrium price at which the
quantity traded is maximum. Stock
exchanges are required to identify illiquid
stocks at the beginning of each quarter.
Besides a maximum price band of 20%
is applicable on illiquid stocks. Stock
exchanges can reduce the circuit limits
uniformly on surveillance-related concerns.
If the market-wide index circuit breaker gets
triggered, the auction session is cancelled
and all orders are purged. The auction
session then resumes once the normal
market starts.
Conclusion
Sebi’s circular relaxing norms for illiquid
stocks will be effective from the next quarter
(January-March 2014). But the market is
already celebrating. Volume reported by the
BSE Mid-Cap index exceeded that of the
Sensex on 20 December 2013 and 23
December 2013, while volume of the BSE
Small-Cap index exceeded that of the Sensex
on 23 December 2013. Certainly, the
regulatory move has been hailed as a positive
development. In several cases, stocks prices
were artificially depressed due to the
regulatory mechanism. Such stocks could
witness a rally.
Though the call auction mechanism for
illiquid stocks failed to deliver, the idea is a
sound one. Anyway, the market regulator
has not completely junked the concept.
May be its implementation was pre-mature.
— S Khedekar
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