Pre-set rules for freak trades will be welcome: FinSec Law

On Friday morning, a freak trade at the NSE halted operations for about 15 minutes. It was later clarified that erroneous orders placed by a broker, Emkay Global had resulted in the problem. Sandeep Parekh of FinSec Law Advisors is unsure why the circuit filters were not triggered at 10 percent levels and started only at 15.5 percent. As several unintended consequences are associated with these trades, world over these sessions are generally annulled. However, there is no clear law on annulment, added Parekh.

Also read: Erroneous orders from broker led to freak trade: NSE

Freak trade to cost Emkay Rs 51 cr; in talks with brokers

In order to avoid similar circumstances in future, Parekh believes, "Pre-set rules on this would be a welcome step and hopefully, SEBI will push for this and not just the exchanges."

Here is the edited transcript of the interview on CNBC-TV18.

Q: What does the law states on circuit filters? Is there any room for discretion at all? Should exchanges shut every time the 10 percent cut happens? That’s the first question and secondly what has justified the discretion that was applied on Friday?

A: I am not sure why it did not start at 10 percent levels and why it started at 15.5 percent levels. I do not think there has been any explanation why the exchange has not done that. What they have said is that they kind of tinkered with the reopening time, which is okay. They said instead of half an hour we reopen 15 minutes because it was an error-based halt rather than some kind of sudden precipitous drop because of the economic factors etc.

The reopening bid is a fair thing to do. It is supposed to be an algorithm in the system so it should have triggered off at 10 percent levels whether it is an error or not. Even more so if it is an error as opposed to an economic news. I am not sure at all why it didn’t stop at that level. I think it would have done the economy a well of a good if it would have actually stopped.

Q: Any particular reason why only one exchange was shut, that's the NSE cash and Sensex was trading. Even the NSE Futures was trading. Any particular reason why that happened and going forward what should be the correct way to deal with such a scenario?

A: I think the fall happened probably only on the NSE. I am not sure whether it happened on BSE as well which is why those markets have been shut and which I think is a fair outcome unless of course the BSE had fallen by more than 10 percent, which I do not think actually occurred. I think market-wise it is fine.

Q: It did happen only on the NSE. The trade got executed there. But the point is what does the rule say? Should it not play across exchanges, because it would still allow arbitragers and therefore, unfair gain and unfair loss to some pockets of the trading system of traders. I would assume the law already says that if it is 10 percent on one exchange, it should be across the board. But if that did not happen should not the law say that, because otherwise you are creating a lot of unintended casualties?

A: In fact there are lots of unintended consequences and what you mentioned is only one of the various unintended consequences. World over what happens is typically you annul these trades. You say that these trades are freak trades.

If you want to buy a flat in Napean Sea Road for Re 1, we are not going to allow that. Tokyo Stock Exchange and both BSE and NSE have done it in the past. New York Stock Exchange very recently did that. I think it is a fair marketplace activity to annul these trades and say that okay we will pretend that those five seconds did not exist at all.

I don’t have a very clear and positive view on whether it should have impacted all exchanges or not. You can argue both ways on whether to have that kind of a system or not. Clearly the error was here and there was no error or problem in other exchanges, so they did not shut. So you could argue both ways. There are lots of unintended consequences.

_PAGEBREAK_

Q: The annulment was not possible because other exchanges had traded and arbitrage trades had happened across futures and cash and therefore an annulment was not possible. Considering that normally across major exchanges a wrong trade is annulled, here the annulment was not possible primarily because people had traded on the basis of those trades, whole host of exchanges and levels and stocks. Therefore, would you say that the law needs to be changed now if it doesn’t make it compulsory?

A: Firstly, there is no clear law on annulment. The law does not state that annulments have to take place if X, Y and Z happen. There is a clause in the NSE bylaws which says that if there is a material mistake then it can be annulled. And again you have to look at the fairness of the whole thing. There is no rigid black and white on how and when this should happen.

Just to give you the same example, if you buy a flat on Nepean Sea Road for Re 1 and you sell it immediately in 5 seconds for Rs 5 crore, shouldn’t you annul the first leg of the trade? Is there equity in the person who has made this profit or is it to say that we will annul the previous deal?

Q: It is the gravity of the situation. If it is Rs 630 crore or Rs 650 crore, it is quite possible that somebody wantonly wants to sell something like that and that can have a big impact across exchanges. Would you just say that this 10 percent filter needs to be mandatory, not discretionary and should be applied to all exchanges? Would that be your conclusion or you think that it needs to be debated?

A: I think the later part needs to be debated. There is a sudden fall which is error based on one exchange and whether the solution should apply to all exchanges or it shouldn’t. But I think it is very clear that 10 percent levels should in fact shut down and it should not go beyond 15-20 percent which we have seen in the case where the problem exceeded everybody’s imagination.

Within 5 seconds you had Nifty stocks which are supposed to be the most liquid falling by 20 percent ease. I think the consequences are very grave.

Q: So should there be some law which governs whether it should be annulled or should it be left at the discretion?

A: That's an excellent question and lots of exchanges have very detailed rules on when something needs to be annulled. I looked at the total stock exchange rules and regulations and it is extremely detailed about when something needs to be annulled and whether it is an error or not.

If it is an error then what kind of errors and what is the difference? So some people say that the first 10 percent departure from the market price you take the hit and beyond 10 percent the exchange will annul. So pre set rules on this would be a welcome step and hopefully, SEBI will push for this and not just the exchanges.