Periodic call auction bad for investors: Chugh explains why

The Securities and Exchange Board of India (SEBI) has introduced a trading system of periodic call auction starting from April 8, 2013. Investment analyst Ashish Chugh shares his views on SEBI’s move and its impact on the market/investors. 

Below is an excerpt of his comments on CNBC-TV18.

Under the periodic call auction, SEBI has a certain criteria for classifying the stocks as illiquid. There is a volume criteria and there is a number of trades criteria. In this trading system, there are six sessions of one hour each during the trading hours. The first 45 minutes of the one hour session is dedicated toward order entry, order modification and cancellation. The next seven to eight minutes are for order matching and the balance seven minutes is the cool off period for going to the next session.

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Now, the objective of the new trading system is (1) to curb manipulation in the smallcaps; 2) to reduce price volatility and impact cost for smallcaps and 3) to enhance liquidity in these stocks. The impact of this system has been that this system makes it very difficult for investors and brokers to trade in these stocks. Since unexecuted orders after one hour get cancelled every hour, investors have to place the bid every hour and monitor it especially during the end of the order placement sessions to have the best chance of the trade getting executed. So it’s a practical problem for both -- the investors and the brokers.

One of the objectives of this system is to curb manipulation in these stocks. In reality, out of the 2,050 stocks, which have been put in this place, there maybe a few dozen stocks, which are actually being manipulated. Now, the manipulators will ensure that these stocks may come out of this category. It is very easy to do volumes in these kinds of stocks. So, what is going to happen is: liquidity will fall further as these stocks may come out but for other stocks which are not being manipulated, the investors may avoid these stocks. So the non-manipulated stocks, which is the vast majority of these stocks, which stay in the list for a long time barring a change in criteria.

This in effect punishes the vast majority of investors along with the small minority of manipulators. If you see the volumes of the stocks which they have traded in the last one month and compared them with the volumes which were traded one month before they were put in this category, you will find a sharp drop in volumes of anywhere between 50-80 percent. You will find a large number of stocks which go without registering a volume of even one share. It is plain common sense that if you apply this trading system to the most liquid stocks in the Indian stock market, say if you put Reliance, TCS and Infosys in this category of trading, it doesn’t require to be a genius to say that the volumes in these stocks will also drop. So I think as far as the objective of enhancing liquidity is concerned, it is proving to be counter productive.

Another thing is that lot of companies, which are good companies, which have got a 20 year dividend track record, have been put in this category. You obviously can’t expect a company like a Narmada Gelatine or Acrysil India to clog the same kind of volumes as a Reliance or TCS because of different equity and different public float. So, putting all these stocks in one category may not be fair to the investors. We have seen wild movements in stocks which clock high volumes also, the recent case being NHPC down from Rs 32 to Rs 18 in a matter of two days, I am sure this is not entirely because of the fundamental factors of the stock. I think SEBI's intensions maybe good but the idea they have chosen I would say is not a practical idea and it may do more harm than good. I think this is the time when they need to generate more confidence to the retail investors to invest in the Indian market. I think the new system is scaring away the investors from investing in smallcaps and discouraging long term investing and encouraging punting or trading and speculation in the Indian market. I think the objective which SEBI is working towards can be fulfilled through surveillance mechanisms only. Trading restrictions may not be the answer to this. So I believe that this is a system which requires a serious rethinking from SEBI.