Moneycontrol Pro Panorama | Over-policing is bad for markets

Unable to pinpoint malpractices, the regulator and exchanges decided to use a draconian method called the Enhanced Surveillance Measure (ESM) framework.

Dear Reader,

The Securities and Exchange Board of India (SEBI) and stock exchanges have a well-defined process of allowing companies to tap the primary market and get listed on the bourses.

These companies’ shares are then freely traded in the secondary market with the regulator and exchanges keeping a close watch on their movement. There are enough checks and balances to prevent any suspicious price movement in a stock. If stock sees a buying frenzy or a sharp fall, there are circuit filters to control its movement. The regulator has approved a step-wise circuit filter which starts with a 20 percent move on either side, then becomes more restrictive at 10 percent and progressively comes down to two percent. At the lowest level, a share is not allowed to fluctuate by more than 2 percent a day.

It has been seen that whenever a stock enters the circuit filter mechanism, the volume in the counter falls. Traders are aware that the regulator is keeping a closer eye on the counter and any attempt to manipulate the stock would be risky. As the circuit filter narrows down from 20 percent to 2 percent, volume in the stock dries up considerably, as traders like to play in high-volatility shares and a 2 percent movement in a day does not interest them.

Despite these restrictions, the regulators feel that stocks are still getting manipulated. Unable to pinpoint malpractices, the regulator and exchanges decided to use a draconian method called the Enhanced Surveillance Measure (ESM) framework. On June 4, markets regulator SEBI and the exchanges jointly decided to introduce the ESM framework for highly volatile "micro-small" companies. Here, trading for securities under the ESM will be permitted once a week (Monday or the first trading day of the week), with periodic call auctions.

The reason for bringing the stocks under the ESM framework is that the stock has continuously moved higher despite the 2 percent filter. No case of circular trading is seen or else the regulator and exchanges would have raised a red flag and taken harsher action.

By allowing trading for only one day a week, genuine companies and investors are being penalised. Since companies that are being put under ESM are classified as “micro-small” or those with a market capitalisation of less than Rs 500 crore, chances are high that most investors may not have discovered it. As liquidity is low in small stocks, any large quantity of buying or selling can cause sharp price movements.

For no fault of theirs, even innocent companies, promoters and shareholders are getting penalised. Most brokers do not allow shares under ESM to be traded at their terminals.

Companies are not paying listing fees only to see their stock being delisted for most of the week. On top of it, a company under ESM will be tainted for a long time and investors may not touch it. Even banks would look at such companies with suspicion, thus affecting business and survival of the company.

If regulators and exchanges believe that a stock is being manipulated, they have enough mechanisms in place to rectify it. Disallowing trading for most part of the week serves no purpose.

Thankfully, the regulator has realised its mistake and has revised surveillance actions, but only after a company, Mercury EV Tech, challenged the framework at the Securities Appellate Tribunal.

Such ad-hoc action does not augur well for the regulator or the exchanges and is not healthy for the market. Proper discussion with all stakeholders including companies should be in place before such policies are put in place.

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