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Business News/ Opinion / Emkay freak trade: Will the real culprit please stand up?
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Emkay freak trade: Will the real culprit please stand up?

The freak trade case has brought to light a number of issues in the Indian markets

Jayachandran/MintPremium
Jayachandran/Mint

The Securities and Exchange Board of India (Sebi) has censured the National Stock Exchange of India Ltd (NSE) for its conduct in the Emkay Global Financial Services Ltd freak trade case. While the exchange hasn’t been penalized, the regulator has used strong language in its order. It said that NSE hadn’t adhered to the provisions/spirit behind the provisions of two Sebi circulars. It also went so far as to say that the exchange’s systems are not robust, as the mistakes of one trading firm ended up bringing the entire system to a halt.

The last comment is interesting. Last year, while celebrating its 25th anniversary, Sebi chairman U.K. Sinha said in an interview that India’s market infrastructure was among the world’s best. This isn’t the only inconsistency in the Sebi order.

For perspective, in October 2012, a so-called fat finger trade by an Emkay dealer wreaked havoc on the NSE, causing the Nifty index to fall by over 15%. According to Sebi rules, exchanges must halt trading when the index falls by 10%. But while NSE applied the brakes on its trading engines when the Nifty fell by 10%, the pre-existing buy orders in its system got matched against Emkay’s large sell order. By the time the market actually halted, the Nifty had fallen by over 15%.

Sebi’s case, according to last week’s order, is that NSE should have run a tight ship and ensured that prices didn’t fall beyond the 10% level. The exchange has now taken measures to ensure that the time taken between the index hitting the +/- 10% level and trade matching engines being brought to a complete halt is at the bare minimum. But to censure it for not having such a system in place during the Emkay episode seems a bit harsh.

In May 2009, the Nifty index had rallied by over 10%, causing both the BSE and the NSE to shut down markets. Even back then, there was a time gap of quite a few seconds until trading engines were actually stopped. The Sebi board reviewed this the same year and noted that exchange systems take a “finite time to complete their internal process of stoppage of acceptance of fresh orders from broker terminals and shutting down the order matching system".

The Sebi order now states that falling back on the 2009 experience doesn’t make sense: “There is no detail as to whether NSE made any attempts to improve the systems or approached Sebi with a request to redefine the parameters in the light of actual experience." Of course, there is no mention of whether other stock exchanges have systems in place to ensure quicker halts.

According to an expert in market microstructure, the regulator will do well to lay down a minimum standard which all exchanges should be asked to comply with. He adds that the current arrangement, where Sebi has asked NSE to consult an expert to make its systems more robust, means that there remains a level of ambiguity about this area. Sebi might say that the time lag should be zero; but, of course, that is impossible, as there will be some time taken for the exchange’s index system to communicate about index levels being breached. If there are pre-existing orders in the system, they could well get matched in the time taken for the actual shutdown.

It must also be noted here that after the Emkay episode, Sebi had issued a circular where it mandated a maximum value of 10 crore for every order that comes into an exchange, apart from narrowing certain price filters and imposing further restrictions on brokers who are about to exhaust their collateral with exchanges. Each of these measures were taken to avoid a repeat.

In other words, Sebi is closely involved in framing market microstructure rules. So when it reprimands an exchange for not having robust systems, it is a poor reflection on the regulator itself. After all, the regulator does also take credit, like it did last year, for the positives in the market’s infrastructure.

Meanwhile, the Securities Appellate Tribunal (SAT) has asked the NSE to review its order against two trading members who were among the counter-parties against the Emkay sell order. NSE has withheld the gains made by these firms, as their clients took very large positions without having requisite margins and adequate net worth. Sebi has reprimanded the exchange for failing to ensure that these risk management requirements were met. Again, since collateral requirements are checked on a post-trade basis, it is difficult to ensure compliance only on the basis of orders submitted by trading firms.

Even so, if this has been a practice with these firms, then the regulator and exchanges must find ways to ensure that it is not repeated. Also, given the very large variance between the collateral/net worth and the orders submitted by these entities, the regulator itself must consider acting against these firms for engaging in practices that threaten the integrity of the markets.

As far as Emkay’s case goes, the firm had approached SAT to get the exchange to annul the trades. But its appeal has been quashed. The best it can now expect is to receive the gains made by the above-mentioned firms by the exchange.

In sum, the freak trade case has brought to light a number of issues in the Indian markets. While the regulator and exchanges have taken many measures to ensure a repeat doesn’t happen, there is still ambiguity with respect to some areas such as trade annulment and the time taken by an exchange to halt its trading engines.

We welcome your comments at inthemoney@livemint.com

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Published: 13 Oct 2014, 07:57 PM IST
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