Mumbai: India’s financial regulators and stock exchanges have formed a special committee to ensure that sharp swings in financial markets on the day the results of the ongoing general elections come out (Friday, 16 May) do not cause any systemic or liquidity risks.
The Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi) will jointly monitor and review risk management systems for the country’s financial markets through special stress tests for equity, currency and bond markets even as the results come out, according to two people familiar with the matter who asked not to be identified.
In 2009, stock markets celebrated the return to power of the United Progressive Alliance (UPA).
On Monday, 18 May 2009, benchmark equity indices hit the upper circuit within 30 seconds of the market opening for the first time after the results were declared, and trading was halted for two hours. The indices again hit the upper circuit within minutes of the markets re-opening, and trading was called off for the day.
BSE’s 30-stock benchmark Sensex opened up 10.73%, or 1,305.97 points, on the day. On resumption of trading, it shot up another 17.34%, or 2,110.79 points. That day also saw the rupee rise as much as 3.08% while the benchmark 10-year bond yield fell 2.43% or 16 basis points. One basis point is 0.01%.
On 14 May 2004, when the Congress party-led UPA emerged the surprise winner in the general elections, the Sensex fell as much as 6.1% or 329.60 points. It plunged another 11.14% or 564.71 points the next day.
It is only natural that financial markets react to the election results, but the special committee will attempt to prevent any liquidity risks arising out of such volatility in the rupee, bond and equity markets.
“If you are RBI or Sebi, it is only right that you anticipate all possible scenarios and be prepared about it. Back in 2009, when the stock market hit the circuit twice and had to be closed, there was significant margin pressure, and banks had to bail out brokerages. Clearly, the authorities were not prepared that time. It is a smart move that they are going to be prepared now,” said the head of treasury at a foreign bank, speaking on condition of anonymity.
“Overall all the opinion polls are pointing towards one outcome and the market is bullish on that as can be seen in the surge in F&O (futures and options) segment of equities, but just in case the polls turn out to be wrong, there will be significant volatility in the equities segment,” he said.
The committee has met once already and started a review on risk management systems at exchanges and other market places, said one of the persons cited above.
“The work of the committee will include an extensive review of all risk-management aspects of financial markets. The required stress tests for markets have just begun under the committee’s supervision,” this person added. According to him, the committee may continue their work till a few days after the election results are declared.
The index-based market-wide circuit breaker system comes into effect in three stages, in either direction (up or down), at 10%, 15% and 20%. These circuit breakers, when triggered, halt all trading in equity and equity derivative markets nationwide. Trading stops for 45 minutes if the benchmark index moves 10% either way before 1pm and for 15 minutes if it happens between 1pm and 2.30pm. Trades are halted for 1 hour 45 minutes if the benchmark equity index moves 15% either way before 1pm, for 45 minutes if such a movement happens between 1pm and 2pm, and for the day if this happens after 2pm.
If the bellwether index moves 20% either way at any time of the day, trading is halted for the entire day immediately.
The committee will also cross-check all interlinkages between the rupee, bond and equity markets.
“The committee will primarily focus on perceived liquidity risks. If the rupee fluctuates unusually, it will have consequences on equity markets as well. So, one has to be sure about the margin money, line of credit from banks and other backups,” the first person said.
Apart from various types of trade margins every trading member in equity and derivatives is required to maintain a minimum capital of Rs.10 lakh with exchanges.
The foreign banker said he expects volatility, if at all, only in the equity markets. “The rupee has discounted any positive or negative outcomes. The exchange rate is now being driven by trade deficit numbers. But yes, if foreign institutional investors (FIIs) liquidate their equity holdings, there will be some pressure on the exchange rate. In bonds, there won’t be much of an impact because FII play there is fairly restricted.”
A senior official at the Clearing Corp. of India Ltd, which provides exclusive clearing and settlement for transactions in money, treasury bonds and foreign exchange, said that since these are mostly traded in over-the-counter markets, there are no circuit filters applicable.
Currency derivatives also started trading on exchanges from August 2008, but the exchange-traded product was in its infancy at the time of the 2009 elections.
For it and other new exchange-traded products, risk management systems need to be stout, said a market expert who did not want to be identified.
Anup Roy contributed to this story.