SEBI – Call Auction on Illiquid Securities

BSE and NSE combined have one of the largest number of listed companies in comparison to any other country but that number hides the fact that a lot many of them are very inactive and highly illiquid. This illiquidity is used by unscrupulous brokers / traders to actively manipulate the stock. Much of this is done via round tripping where a set of individuals buy and sell among themselves while at the same time ensuing that the price is on a continuous bullish path. Once the stock reaches a certain level, positive news start to flow about the company and volumes become higher as retail folks enter into the stock. The stock generally does trade higher even as the early entrants make a quick exit and when its finally in the hands of the retail (read weak hands), the stock starts to plummet not due to selling but lack of buying. The concept is known as Pump & Dump and is active and visible in many a stock.

Let me take the example of one company – Starcom Information Technology Ltd earlier known as Jatia Finance Limited. The data I have is from 2008 onwards when the stock was relisted though its original listing happened in 1996. The stock traded in single digits till 2000 when it got suspended (most probably, not sure). It came back in a new avatar in 2008 and got relisted at twice the price of delisting. The stock has no financials backing up but still is currently trading at 344 commanding a market cap of 172 crores. The last results available for December seem to show it having Zero revenue and a loss on account.

More interesting than the fact that it has gone up so much is the way it went up. From last April when it was trading at 87 it has reached the figure of today with an average trade per day of 8.40. Even this average is reached due to a few days of higher number of trades. Of the 195 days it has traded in the above period, it has had 1 or two trades on 52 occasions. It would have been virtually impossible for a retail trader to Buy or Sell such shares.

Such shares are dime a dozen on BSE and in a attempt to ensure liquidity is available, SEBI has now come out with a concept of Call Auction. The Call Auction is not entirely new since markets have been using Call Auction to determine the opening price (this after the lack of time and orders on the day after UPA won the 2^nd time resulted in a upper freeze).

What is Call Auction.

From Investopedia: At a call auction, participants place orders to buy or sell units at certain buying or selling prices. Orders collected during a call auction are matched to form a contract. Call auction rules vary by auction.

Here is what happens in the Indian scenario;

The call auction will be done at every hour starting from 09:30 hours. Following are the steps

Step 1: Clients will be able to place Orders / Modify the same or Cancel the same for the first 45 minutes of the hour. So, from 9:30 to 10:14 to 10: 15, such action will be allowed (the last minute is not known to ensure that its random in nature).

Step 2: Once 45 minutes are up, the entry options are closed and the orders matched. This will last for 8 minutes and end at 10:23.

Step 3: The next 7 minutes are buffer time to purge all existing orders that were not executed as well as closing out the current session and getting the price ready for the next session.

SEBI said stocks having an average daily trading volume of less than 10,000 shares with the average daily number of trades of less than 50 and classified as illiquid by all stock exchanges (where the scrip had been listed) as criteria for illiquidity.

The above setup which is now being implemented seems to have raised some hassles. But I for one believe, this is a positive step that will go a long way in providing liquidity for a great number of shares as also restricting the rampant manipulation that takes place under the current open market operations.

I am personally of the opinion that genuine investors are better off not investing in stocks which are illiquid since when one wants to exit, there may not be a buyer in sight and the slippage cost will be huge.

It does not matter if a stock has gone up 200% if the liquidity is so low that one cannot exit 100 shares without a major slippage. This will be avoided to a certain extent by the above procedure.

The alternative which is practised in most major developed markets is to have market makers who are and shall provide two way quotes at any given point of time. If India too follows such a policy, that shall ensure a decent spread with any investor being sure of an exit when he wants to instead of exiting when the buyer makes an bid.