The Hindu Business Line : SEBI must keep both eyes on the bull

TRADING volumes on the stock exchanges have spurted sharply over the last three months. The combined volume of the spot and derivative markets — at about Rs 15,200 crore per day — outpaces the numbers of the last bullish phase three years ago.

These trends call for a higher degree of diligence on the part of the Securities and Exchange Board of India (SEBI), and the two stock exchanges that matter — the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Surveillance, timely crackdown on price manipulation, stringent penal action and a close tab on fund flows are necessary to ensure a healthy market and to protect investor interest.

If there is a repeat of the crash due to abnormal factors (as in 1991-2000 period), it may dent the confidence not only of retail investors, but also that of institutional players — an outcome that would be detrimental to the market and the economy. SEBI's task is that much more difficult now, as the action is spread across a range of sectors and stocks, unlike in 2000 when a small number of information technology, media and telecom stocks were in the eye of the storm.

Nothing may be amiss and the ongoing rally may be driven, to some extent, by the wide-ranging improvement in fundamentals and, to a larger extent, by liquidity — especially the strong FII flows.

But SEBI cannot afford to take its eyes off the day-to-day trading patterns in different segments of the stock market.

Turning a blind eye: In 2000, the warning signals barely raised eyebrows among the regulator fraternity. At the height of the then-bullish phase, SEBI's actions were confined largely to satisfying itself with the views of the NSE and the BSE that nothing was amiss. But SEBI missed the larger picture completely, including the abuse of the market system, especially in Kolkata. The subsequent meltdown is well-known.

In the same manner, funds from the banking system were diverted to equities in a highly improper manner, with Mr Ketan Parekh as the conduit.

Perhaps the most noticeable aspect of SEBI's reluctance was evident in the manner in which it stalled the introduction of the rolling settlement system.

Pluses but... : The crash in 2000 and the controversies surrounding it have led to a marked improvement in the market structure. The key changes were :

the introduction of rolling settlement for all major stocks;

the tightening of the settlement cycle to a T+2 basis;

the improvement in the clearing and settlement systems on the BSE (this was never a problem at the NSE);

the virtual winding down of the Kolkata stock exchange, where close to 99 per cent of trading was speculative in nature, with the unofficial badla market running amok; and

the introduction of stock options, futures and index options with systemic changes that make this market more transparent than the badla market and automated lending and borrowing mechanism (which was the NSE's effort to have its share of badla-market-like transactions).

These changes have made the stock market a much safer place than at any time in the past, though this cannot be a reason to be complacent.

In this context, SEBI's moves to rein in routing of transactions by brokers through terminals not located in the head-offices suggest that it is trying to keep pace with sharp market practices.

No regulatory body can move lock-step with the market, barring the odd pro-active move or two spaced over a period.

Unlike in 2000, the trading and settlement systems the regulatory framework and the disclosure requirements are vastly superior.

Areas to focus

AS TRADING volumes move to higher levels (prices or sustainability of valuation levels of stocks need not be a regulatory concern), the following are some key areas that need to be watched closely, to ensure that the right checks and balances are in place:

The action in the stock futures and options' market. This is a new terrain for SEBI and the NSE. The last four months mark the first occasion when activity in these markets coincided with a bullish phase in stock prices.

The scope for leverage is high, as the outlay for taking positions is a fraction of what would be required in the spot market. With derivative volumes now outpacing the spot market consistently, and contracts and open positions spurting manifold in a number of stocks over the past three months, a close look at the action is crucial.

The source of liquidity flows into the market continues to be a grey area.

Improvement to the disclosure requirements to cover flows from hedge funds, overseas bodies, banking system, lending against shares and domestic corporate bodies, to name a few, is an area unattended despite the bitter experiences of 1991-92 and 1999-2000. This has to be the second stop as the ongoing rally is largely liquidity-driven.

There is a familiar ring to the company-specific new flows, especially from the second- and third-run of companies, and the advertisements placed by quite a few corporates in frontline media. A throwback to the earlier bullish phases — when active promoter/operator nexus as the common thread — is evident here as companies try to keep the positive news flow going to support the momentum in stock price trends.

The manner in which the 1,000-odd stocks resurfaced to the active trading list on the BSE should engage attention, as room for considerable abuse — especially through the lure of day trading that could leave late entrants high and dry — exists in such stocks.

It does not take much to create an impression of prospects for big-ticket gains through trading in such stocks. Word-of-mouth price targets is adequate to the job, and there appears to be much of it going around.

Insider and informed trading and attendant price manipulation is an area where SEBI is still groping in the dark.

If the recent action against Mr Samir Arora, formerly of Alliance Capital, is a starting point, it augurs well (even if the case still appears to rest on a rather weak footing, and may be difficult to prove with a legal-tenable finality).

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