Sebi's revamp of ESM framework welcomed as a relief for quality smallcaps

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In a move seen as a significant relief for fundamentally strong small and microcap companies, the Securities and Exchange Board of India (Sebi), in collaboration with stock exchanges, has overhauled the Enhanced Surveillance Measure (ESM) framework to include valuation-based filters. Market experts have welcomed the changes, calling them a well-calibrated step to curb speculation while protecting quality companies from unnecessary regulatory burden.

Sunny Agrawal, head of fundamental equity research at SBI Capital Markets, said the move brings long-awaited relief. “Earlier, every stock under Rs 1,000 crore market cap was at risk of stricter surveillance, regardless of its financial health. The revised norms will help profitable companies with reasonable valuations avoid Stage II, where trading restrictions are far more severe,” he noted.

Under the revised guidelines, only stocks already in Stage I and trading at a price-to-earnings (PE) ratio of zero or below, or exceeding twice the PE ratio of the Nifty 500 index, will now be eligible to move to Stage II. The updated framework takes effect from July 28 and applies to companies with a market capitalisation of less than Rs 1,000 crore.

Ajay Bagga, independent market analyst, praised Sebi’s dynamic regulatory approach. “This update sends a clear message: the regulator welcomes growth, but not at the cost of fundamentals. It preserves market efficiency while cracking down on valuation excesses,” he said. Bagga added that the framework strikes the right balance by not penalising all microcaps, but targeting only those showing red flags in price behaviour and valuation.

According to the National Stock Exchange (NSE) circular, a stock may be placed under Stage I if it falls below Rs 1,000 crore in market cap and exhibits abnormal price volatility over a three-, six-, or twelve-month period—particularly when price fluctuations exceed one standard deviation compared to its peers.

Additionally, a consistent rise in closing prices over the past three months has been added as a new parameter, signalling possible speculative activity. Once listed under Stage I, the stock faces enhanced measures such as 100 percent margin requirements from T+2 day, trade-for-trade settlement, and tighter price bands of 5 percent or 2 percent.

For progression to Stage II, a stock must first gain at least 15 percent over five consecutive trading sessions or 30 percent in one month. Only then is it evaluated against the new valuation filter.

Market observers believe the inclusion of PE as a screening tool is a decisive shift. “A PE of zero or negative typically indicates a loss-making company, while more than 2x the Nifty 500 PE suggests valuation froth,” one analyst explained. “Sebi is essentially signalling that price rallies unsupported by earnings or fundamentals won’t escape scrutiny.”

The ESM framework, originally meant for small and microcap surveillance, was extended last year to include mainboard companies below Rs 1,000 crore in market cap. With retail investor participation rising in microcap segments—often drawn by the promise of multibagger returns—experts agree that this enhanced vigilance is both necessary and timely.