Thursday, December 19, 2013

Rationalisation of Rules in Periodic Call Auctions for Illiquid Scrips

Today SEBI came out with revised guidelines for Periodic Call Auction (PCAS) in equity market (Here).

Also before we understand, what changes are done and how it would impact the stock criteria, I would request you to please refer my previous blog on this topic for smooth continuation (Here).

With this circular, SEBI has rationalised criteria for stock becoming eligible for PCAS. Effectively SEBI has bought down the eligible universe to only small cap and illiquid stocks.

Impact of New Circular :

a) All Stocks which has a daily turnover of more than Rs 1 Million will not come under PCAS. (Effectively SEBI has moved from selection criteria of Quantity and Number of trades to Value of trades. A very rational move)

b)  All Stocks which has a market cap of more than Rs 10 Crore will not come under PCAS.

c) All consecutive dividend paying companies will not come under PCAS (For last 2 years out of 3 years)

d) All companies which are profitable consecutively will not come in PCAS (For last 2 years out of 3 years) along with less pledge of share (Not more than 20%)  and Book value of more than 3 time the face value.

e) Previously If stock goes in PCAS, It has to be in PCAS for 2 quarters, which is now reduced to 1 quarter only

f) All Un-executed orders in PCAS can be carried forwarded to next PCAS auction for same day.

Well, SEBI has effectively kept only small cap, penny stocks in PCAS, Which are illiquid and also non profitable in the ambit of PCAS. So most of the stock will be out of PCAS now. 

So now PCAS will be a dead segment and now It will die a natural death in long run, because now there wont be many companies in PCAS and they would be very illiquid.

As stated in my previous blog, SEBI has to make amendments in rules of PCAS segment, but now they have liberalised most companies out of PCAS

This is not a recommendation to anybody whatsoever to buy OR sell this share, but it is my thought process and views on this topic.

I welcome your critical comments and suggestions.


Monday, February 18, 2013

Periodic Call Auctions for Illiquid Scrips

SEBI recently came out with circular (here) asking exchanges to transfer all illiquid stocks in call auctions from 1st April, 2013.

In this circular SEBI has said that
a) Allow Pre-opening Session in all liquid stocks.
b) Transfer all illiquid stocks in Periodic call auction.

From 1st April, 2013 all stocks, if they are liquid, would be available in Pre-opening session, which is a welcome move.

Also all illiquid stocks will be available only in call Auction. Let us first understand the meaning , features, advantages,dis-advantages and deficiency  of Call Auction and also its impact on price discovery.

What is Call Auction ?

Call Auction is trading mechanism where all buy and sell orders are pooled together and trade takes place at a equilibrium price at which maximum buyers and sellers are ready to trade. There is only a single discovered price for every call auction. The Price discovery process for call auction is same in Pre-opening session, except that you have more time for order placing, modification and cancellation.

There are around 260 Stocks which are illiquid as per latest NSE circular.

What are Illiquid Stock :

Illiquid stocks are stock which are infrequently traded and generates lesser trading volume. Generally stocks which have low equity, low Floating stocks , Stable stocks, or the companies which do not have more of speculative interest are mostly illiquid stocks,  but we should not infer that all stock which are illiquid are not fundamentally good companies. That may be true for some companies.

NSE criteria for illiquid stocks are High Bid - Ask Spread, Low Volumes, Higher Impact Cost, infrequent trades etc. SEBI has defined a broad criteria that Stocks which have average daily volumes of less than 10000 shares, and which have daily average of less than 50 trades are considered illiquid on all exchanges where the stock is traded. 

When would a stock become liquid from illiquid :

When the above mentioned parameter are not met by stock, it becomes liquid stock and it will be transferred to normal segment, but once stock becomes illiquid, it will be in call auction category for at least 2 quarters

The Salient Features of call auction as per SEBI circular are :

a) Call Auction for illiquid stocks would take place every hour during trading session. Out of 1 hour, 45 min will be allowed for order placing, next 8 minutes will be for order matching and last 7 minutes will be buffer / cooling off period. To avoid fake orders to distort price, the closing time of call auction will be random between 44th and 45th minute.

b) After the closure of each call auction, pending orders will be purged / cancelled.

c) Price bands will be applicable as per Risk Management rules of exchanges and It may also settled on trade to trade basis.

d) There is penalty on people generating false volumes by simultaneously being a buyer and a seller at the same price.

Are there advantages of Call Auction : Yes

a) Call Auction leads to better price discovery , also thereby reducing outlier trades.
b) A bigger order book can be generated using call auction.
c) It reduced volatility in stocks due to illiquidity.

Are there any Dis - advantages / Lacunae in Call Auction :

a) The Computation for Illiquid Stock of SEBI is flawed, because it looks only at volumes and not on any other parameters like Bid - Ask spread, Impact Cost etc. Most High value stock would tend to become illiquid as they may not pass the test of average 10000 shares

b) There are many prop desk who have different people working at different locations and on different strategies at the same time on different mandates, also their decision making is decentralized. They may also have Chinese wall between traders. In such scenarios it may happen that some trader at one office of a prop desk may be selling that stock and another trader of that same prop desk may be buying at the same time. Though such trades may not be artificial volumes but such trades will attract penalties.

c) The pending orders are cancelled after every call auction, hence a buyer or sell will lose his priority in case of UP or Down circuit. Also it will be cumbersome to give new orders and track trades after every call auction.

d) Intraday trading in this stocks will be marginalised.

e) Margins will be higher in call auction segment comparatively.

f) Disclosed quantity in orders are not allowed in call auction, hence bulk order and block orders will be disclosed in market before the deal taking place, which may put parties looking to buy or sell big quantities in disadvantage.

Once the bulk order or block order is discovered on stock, many traders would try to create nuisance value. The traders would try chasing the bulk or block deal.

Conclusion : Call auction are there in many international market and academics prefer call auction to normal trading in illiquid stocks and I would need to read more of academic papers to speak on international experiences. But I would like to put suggestion and experience about the same

a) Whenever in India if a stock is transferred in T2T segment, the stock most of the times tend to drift downwards, because liquidity players would not give quotes, Call Auction also reduces speculative element from such stock. So maybe we can see the price of stock always trading at discount to its fair value, till the time it is traded in call auction.

b) Can we look for Market Maker in such illiquid stock rather that trading in call auction. Many developed markets including US prefer market makers.

c) There is only one stock as of now which is listed on SME segment of exchanges, there is hardly any volume in the stock. These stock is only traded in call auction, can we get a pre-cursor of the happening. I would want to qualify that the view can be biased as there is only one stock as of now.

We should be happy that SEBI is working for better market place and  I am sure we can expect some amendments in current call auction procedure to make it more market friendly

This is not a recommendation to anybody whatsoever to buy OR sell this share, but it is my thought process and views on this topic.

I welcome your critical comments and suggestions.