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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