Monday, April 15, 2013

SEBI's new baby - rules for illiquid stocks

I am sure most of you must have heard of SEBI's new rules for trading in what it calls 'illiquid stocks' which came into effect from 8th April 2013. Some of you may not have heard of it because surprisingly, the media has just not highlighted the issue! Perhaps there is not much incentive for the media to get involved here! ;-) These rules hit more than 2100 hundred companies among the listed space, as can be seen in the annexure to this notice. SEBI has not explained exactly why this has been done, but supposedly it has been to control manipulation in smaller companies. In my very humble opinion, the new rules can be best described as insane! (To put it mildly).

Lets see what all this is about..

I think it all started when, in 2010, an academician decided to write a paper on how call auction system can be implemented to solve certain difficulties in the capital market. The paper can be downloaded here. The author is an extremely accomplished academician and a highly educated individual and is a member of SEBI's SMAC from January 2009. Her CV can be viewed here.
Well, it seems like SEBI really liked the paper and decided to take a cue from it and thus were born rules for call auctions in illiquid stocks. In it, firstly, SEBI defines what it means by 'illiquid stocks' by prescribing few quantitative criteria..


Criteria for illiquidity – For the purpose of this circular, a scrip, whether trading 
in normal market or trade for trade settlement, shall be classified as illiquid on 
a stock exchange if all the following conditions are met:
2.2.1. The average daily trading volume of a scrip in a quarter is less than 
10000;
2.2.2. The average daily number of trades is less than 50 in a quarter; 
2.2.3. The scrip is classified as illiquid at all exchanges where it is traded.


All those stocks which come under this will not be traded in the normal fashion. Instead, they will be traded through an auction mechanism which goes like this..


2.6. Number of auction sessions – Periodic call auction sessions of one hour each 
shall be conducted throughout the trading hours with the first session starting 
at 9:30am.
2.7. Session duration - The call auction session duration shall be one hour, of 
which 45 minutes shall be allowed for order entry, order modification and order 
cancellation, 8 minutes shall be for order matching and trade confirmation and 
remaining 7 minutes shall be a buffer period for closing the current session 
and facilitating the transition to next session. The session shall close randomly 
during last one minute of order entry between the 44th & 45th minute. Such 
random closure shall be system driven.
2.8. Un-matched orders- All un-matched orders remaining at the end of a call 
auction session shall be purged.


Fancy!!! But practically speaking, it has merely made investors like me miserable.

1. Investors now have to track and keep a watch on the market (stocks) the whole day. They are being encouraged to always keep tracking the market, which is a big negative as far as long term investing is concerned.
2. Every hour, a fresh order has to be placed. I think my broker would now hate me more than he hates his mother-in-law.
3. Since a lot of market participants are clueless as to what is all this, there has been extremely low participation and volume in the affected stocks. People must surely be feeling 'trapped' in certain stock, since virtually no exit is available.
4. Practically, this whole section of the listed space will now be closed to institutions, since I am sure they will have better things to do!!! Such lower participation does not help proper price discovery.
5. Also, will promoters take advantage of lower liquidity and panic selling to shore up their holding at lower prices?

I suppose that all this was done to curb manipulation. But setting up quantitative criteria for this purpose does not help. Manipulators can just ensure that these criteria are met and their stocks remain out of the net! But in the process, a lot of genuine companies with genuine shareholders will suffer.

I am no-one to preach on this. What is right/what is wrong is immaterial. Laws are laws and rules are rules. So what can be done about it?

1. I am hoping that as time passes, the market participants will get slowly used to the new method and some bit of sense will return to this section of the market. Otherwise, effectively, this section of the market is practically dead. The stocks covered by these rules for illiquid stocks have become more illiquid than they were earlier!!!
2. I tried viewing this as an opportunity. Probably some panic selling due to absence of liquidity may help us get some good stocks at lower prices. Somehow, that just hasnt happened till now. Lets see what the future holds.
3. I feel it is best to try and adapt to the new system, instead of cribbing or complaining about it. Have a good talk with your broker and ensure his cooperation without frustration in this matter. If instructed properly, the broker can handle the order placing and monitoring part, without much botheration to us.

In a nutshell, this is surely a huge negative for people who invest in small, unknown companies with a lot of value. If price discovery is hampered, returns just cannot be earned. I am keeping my fingers crossed and hoping that over a period of time, all the problems associated with this will be ironed out. After all, we must accept finite disappointment, but never lose infinite hope!! - Martin Luther King, Jr.

Cheers and happy illiquid investing!!

P.S. One may also like to read about this whole issue in Moneylife.




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3) As a professional investor, I may have positions in stocks discussed.
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15 comments:

Anonymous said...

Broker will hate U more than his mother in law...good one.

Anil Kumar Tulsiram said...

My opinion is mixed. I agree that the provisions have made life miserable but many of the difficulties can be overcome by some more simple amendments:

1) Automatic rollover of order in the next session.
2) order book visible in much more detail, just like when auction is conduced for price discovery on last day in case of spin-offs.

In the past I have seen attempts to keep the prices within the band. Eg. wt average price might be say 9, but because of one or two transaction at the end price may jump back to 10. Now it will be difficult to manipulate stock prices of small caps at the beginnings and end of the session.

On the negatives 1) Volumes in small and micro caps will remain go down further. Earlier when the results were good it was possible to acquire shares at slight premium. But now with one hour bank it might become difficult. Also I guess order book will be visible to everyone for one hour. The moment anyone see huge order book he will prefer to sell next day

So SEBI amendment might not be as bad as it sounds, but DEFINITELY needs some amendments and CANNOT work in its current form.

Jigam Gandhi said...

Hi Neeraj,

I agree that we have lost volumes in stocks, which have been transferred to Call auction.

Do visit my blog http://gandhijigam.blogspot.in/
for more insight on this issue.

Regards

Jigam Gandhi


Abhi said...

The one of the goals of any stock market exchange would be to make stocks liquid, have more transaction, make more money on transaction and support he brokers.

This would be also in longer interest of SEBI to have healthy exchanges.

By putting in rules like call auction, how does sebi ensure illiquid stocks are incentivize to become liquid? These stock will remain illiquid for ever.

Neeraj Marathe said...

Thnx Anil and Jigam for your views..

Abhi, i also have the same question in my mind my friend :)

cheers!
Neeraj

JM said...

It is asinine behavior on the part of a person and or group to have reco and implemented it. Many investors will not buy these stocks due to this new rule.

JM

Prashanth said...

So, now we buy stocks at auction?! This move ensures that 'liquidity' as an attribute is 'priced' at premium!
Discarding value traps becomes much more tougher! :(

Neeraj Marathe said...

Hello JM..yes, i am afraid so.. :(

Hi Prashanth..superb last line..very very true..

cheers!
Neeraj

ZeeNut said...

Neeraj,

I agree that the rules are insane (mildly speaking).

I have written a very long (and hopefully sensible) article on the subject which can be read here (posting link because as you will see , when i say long, i do mean long) : http://zeenut.blogspot.in/2013/04/periodic-call-auctions-for-illiquid.html

I differ with you in your conclusion that it is better to adapt rather than crib. I feel that if this rule sticks in it's current form, it will destroy the small cap market & many small investors too.

Many more stocks will enter the iliquid list every quarter based on current criteria , if the bear market continues. So investors who are not feeling the pain just yet will feel it soon.

Consider an investor who needs money for a medical emergency in the family - only to find he cannot convert his stock into money - not even at circuit down :-( Truly the distress small investors are going to face will be horrendous.

- Bosco

ZeeNut said...

Neeraj,

I agree that the rules are insane (mildly speaking).

I have written a very long (and hopefully sensible) article on the subject which can be read here (posting link because as you will see , when i say long, i do mean long) : http://zeenut.blogspot.in/2013/04/periodic-call-auctions-for-illiquid.html

I differ with you in your conclusion that it is better to adapt rather than crib. I feel that if this rule sticks in it's current form, it will destroy the small cap market & many small investors too.

Many more stocks will enter the iliquid list every quarter based on current criteria , if the bear market continues. So investors who are not feeling the pain just yet will feel it soon.

Consider an investor who needs money for a medical emergency in the family - only to find he cannot convert his stock into money - not even at circuit down :-( Truly the distress small investors are going to face will be horrendous.

- Bosco

Neeraj Marathe said...

Thnx a lot for your view Bosco.
Anybody reading up on this topic should read your post, which is very indepth and much more serious than the tp crap i write..
I respect the point that you differ with my conclusion. You are much more optimistic than me about SEBI and the law of the land! I tend to be much more pessimistic, i must say
cheers and all the best to us all!
Neeraj

Anonymous said...


Hi Neeraj,

Are you buying any of these stocks?
With new additions of stocks every quarter, the rule makes me worried.

Is is better to sell the stocks in this list or which can get into this list in coming quarters?

Also where can I check the number of trades happening everyday in a stock? (criteria 2)

Regards,
Jatin

Neeraj Marathe said...

Hi Jatin,
Yes, i am trying to buy stocks in this category too, where i think there is value. I havnt managed to buy a lot though..there is virtually no liquidity.
I dont think a selling decision should be taken using ONLY this criteria..
You can get the info of trades happening on the exchanges website, in the particular stock..
cheers!
Neeraj

ZeeNut said...

MoneyLife had reported last week on the absurdity of PCAS in the following article : http://www.moneylife.in/article/sebis-call-auction-absurdity-a-trade-of-1-share-wipes-off-rs172-crore-of-market-cap/33272.html

Following comments from readers, Sucheta Dalal has suggested filing a PIL in the matter.
Investors willing to be part of this exercise need to add their names in the comments section of the above thread, giving the following details :
1. City that they belong to

2. Willingness to contribute financially

3. Willingness to add their name as petitioners

4. Willingness to attend court hearings when free

Ms Dalal points out that everybody need not say okay to each requirement - but a broad consensus & sufficient numbers will help MoneyLife decide whether this is worth the effort.
So readers interested in being part of this may kindly do the needful.

Dexter Louis said...

I needed to know about the rules of illiquid stocks. I’m starting illiquid stocks business on international level. Hope these tips will help me.
VCT