Market regulator Sebi released stringent norms on Thursday at the bourses to ensure that brokers implement appropriate risk checks before executing a trade to prevent a flash-crash. Some of the key norms include stock exchanges not to execute orders exceeding Rs 10 crore on orders placed on stocks, exchange traded funds (ETFs), index futures and stock futures.
Deena Mehta of Asit C Mehta Investments explains to CNBC-TV18 that the Rs 10-crore limit on order was not an adequate deterrent to prevent the occurrence of a flash-crash. Mehta also advises retail investors to be alert to the fact that if the broker breaches the margin limits, all the orders will be cancelled. She calls for guidelines on the annulment of trade and placement of margins on institutional trades.
Below is an edited transcript of the analysis on CNBC-TV18
Q: Is the Rs 10-crore limit the way forward?
A: You have to start with some limit. Ideally, the Securities and Exchange Board of India (Sebi) should study the highest order-value which comes into the system and then decide on a limit. But since I don’t have access to data, I do not know whether Rs 10 crore is a good limit. And this limit needs to be reviewed so that most of the orders go smoothly.
In terms of being a deterrent, this limit is not significant as a big order can always be broken down into smaller and more numerous orders to cause significant damage.
Q: The Sebi measures also include the introduction of a dynamic price band? How different is it from the existing circuit filters and how effective will this dynamic price band be?
A: Actually, the dynamic price band was already implemented by BSE to the best of my knowledge. In a dynamic price band system, every time an order comes in, it is checked with the previous price and does not bring trading to a halt like a circuit filter. Each order is checked against a dynamic band and if there are indications of a change in market trend, the band-limit will be modified accordingly.
The band previously used to caution investors if the limit was breached but now the system has been made stricter and after being first implemented in the cash segment, the system has been deployed in the index and across all segments. The system has moved from marketwide limits to stock-specific limits.
Q: What do you make of the fact that it is now applicable to derivative changes? Will that therefore control the kind of mischief or losses that can be created by unintended trades?
A: Unintended trades can happen with any order.
Q: Do you think this restricts the extent of the damage? Do you welcome the fact that it is applicable?
A: Yes I mean some amount of sense has to be put into the way things are going so I think some capping was required. One more thing you have not discussed which is very relevant to the investors and that is if a broker reaches 90 percent of his margins, then all the orders of the brokers will be thrown out of the system.
This is very important fact which retail investors need to note because when you have placed a stop-loss order with the broker who reaches his margin-limits, then all your orders could get cancelled. And then the broker has to bring down the margin and the orders have to be replaced.
There are two more aspects which I hooped that the Sebi circular would have covered. Firstly, there is a need for guidelines on annulment of trade. Annulment of trade was a considerable fallout of the freak trade where a concerned broker lost the money, somebody else gained the money and an annulment of trade stripped the broker of the profits that were made and this needs to be addressed by Sebi.
In, fact on Thursday Nasdaq had to annul certain trades. Annulment of trade is not the solution to mistakes in placing trades and there has to be some guidelines for redressal.
The Sebi guidelines do not have any mention of resolving the glitches in institutional trade. The heart of the problem in Emkay was that it placed an institutional trade that did not necessitated margin requirements and the trade went through.
So there needs to be some discussion on the need for placing margins on institutional trades. All these restrictions should be implemented only at brokers’ offices and not overload the exchange system. That needs to be kept in mind when these decisions will be implemented as it could overload and impact the efficiency of the system.
Q: Your are right, it is surprising that the Sebi circular on annulment of trade is silent on. The Sebi guidelines are also silent on the adherence to the synchronised closure of all exchanges when the circuit limits are broken. Do you think adherence to synchronised closure at that time of the freak trade perhaps perpetrated or increased the damage?
A: To be very honest, it is very challenging to implement a synchronised closure of all the exchanges as trades occur in micro seconds.