Mumbai: In an effort to prevent flash crashes on stock exchanges due to erroneous orders or manipulation by brokers, India’s capital market regulator on Thursday imposed pre-trade order limits on exchanges and enhanced risk-management controls for the bourses.
The order follows a 5 October flash crash on Nifty, the 50-stock benchmark index of the National Stock Exchange Ltd (NSE). An erroneous order worth Rs.650 crore by a broker led to a 900-point crash on the index, leading to a 10-minute halt of trade.
A late evening release by the Securities and Exchange Board of India (Sebi) directed the exchanges to reject orders above Rs.10 crore for trade execution on equity, exchange-traded funds (ETFs) and derivatives.
Additionally, the exchanges need to ensure that required checks for value and quantity of orders are implemented by the stock brokers according to their clients’ risk profile. At present, there is no such limit on orders.
Stock exchange executives welcomed the curbs as a prudential measure but said the threat of such crashes won’t be completely eliminated unless issues over algorithmic trading are addressed. Algorithmic trading is automated high-frequency trading that’s capable of executing large orders rapidly.
Sebi also tightened the initial price threshold for stocks under dynamic price bands.
Some stocks, typically large ones, are excluded from the requirement of price bands and stock exchanges have implemented a mechanism of dynamic price bands or dummy filters that prevent the acceptance of orders for execution that are placed beyond the price limits. This dynamic price band is currently fixed at 20%.
Such dynamic price bands are typically relaxed by exchanges in accordance with market-wide movements in either direction.
The capital market regulator ordered the exchanges to reset the dynamic price bands from 20% to 10% of the previous closing price for stocks on which derivatives are traded, stocks on indices on which derivatives are available, index futures and stock futures.
However, this initial dynamic price band can be relaxed by stock exchanges in increments of 5% in the event of a market trend in either direction.
The regulator has also directed the stock exchanges to ensure that stock brokers put in place a mechanism to limit the cumulative value of all unexecuted orders placed from their terminals to a threshold set by them. Stock exchanges will have to ensure that such limits are effective by monitoring them closely.
The exchanges will also have to put stock brokers on the so-called “risk-reduction mode” when 90% of the collateral available for adjustment against margins kept with clearing corporations is utilized. All unexecuted orders will be cancelled once the stock broker breaches the 90% collateral utilization level.
The stock exchanges may prescribe more stringent norms, based on their assessment, if desired, the Sebi release said.
In March, Sebi directed stock exchanges to ensure that the trading algorithms of the stock brokers have a client-level, cumulative open-order value check.