Keeping A Hawks Eye

Updated: Jun 30 2002, 05:30am hrs
It was on February 19, 2002, that Gyanendra Nath (GN) Bajpai took over as the chairman of the Securities and Exchange Board of India (Sebi). His first announcement was to bring back the investor to the market and to restore confidence of the small investors.

The confidence of the investor in the domestic market has been shaken as the level of market abuse reached its peak due to repeated scams in the recent past. It is in this context, and also from the point of view of reach of the market, that safety and surveillance come into the picture.

The stock market in India has grown beyond the city limits, particularly with the advent of the National Stock Exchange (NSE). Together with its prime competitor, The Stock Exchange, Mumbai (BSE), both the bourses have spread throughout the country making surveillance of the markets a much more difficult task.

Market surveillance is the responsibility of the respective stock exchanges (SEs) along with the market regulator. The SEs, working as self regulatory organisations (SRO), have to keep vigil up to the member-broker level as part of their surveillance activities. It is difficult for them to monitor positions up to the client level of brokers because its a very cumbersome process and also a resource-intensive exercise. The market participants expect that it is the regulator which has to undertake the surveillance of the client and at the sub-broker levels as it commands powers. However, this expectation is not often met.

The problem of poor surveillance level in the Indian stock market is primarily the outcome of a lack of co-ordination between bourses and the regulator, feel the capital market intermediaries. Many a times, both the regulator and SROs indulge in buck passing instead of shouldering responsibility. Another reason for lack of creditworthiness about the surveillance activities of these organisations is the time taken by both these agencies to book the culprits. Investigations carried out by the regulator some times take years to close.

Derivatives Market Surveillance

Areas of Focus:
Abnormal fluctuation in the prices of a series
Market movement (cash vis-a-vis derivatives)
Member concentration (cash vis-a-vis
derivatives)
Closing price manipulation (cash & derivatives)

The legal case of the securities scam of 1992 is still on while the investigations into the collapse of ING Barings, that occurred around the same time, are not only over but the main culprit Nick Leeson has even completed his jail term.

Internationally, the surveillance department of the regulator works in conjunction with the SROs like SEs and thus, the regulator is more successful in tackling the issue of market abuse. Though the SEs overseas also reach the member level, the regulator, which has the powers to reach the client level, co-ordinates the investigation work with the exchanges and also takes assistance of independent agencies.

Corporates overseas fear the regulator whereas in India, the regulators actions are taken very casually. A classic case being that of Reliance Industries Ltd (RIL) seeking to pay off a penalty of Rs 5 lakh on charges of violation of the Takeover Regulations in the sale of its entire holding in L&T to Grasim Industries, merely to avoid any unnecessary controversy. RIL had said that it was ready to pay Sebi even before the regulator concluded its investigation. However, Mr Bajpai is set to change all this and is striving to give a facelift to the image of Sebi.

Before we conclude about the status of the surveillance function in the Indian markets, it is very necessary for us to understand how the exchanges are required to control market abuse and the tools available at their disposal.

What Is Market Surveillance

Surveillance implies keeping a check on various market abuses that could be undertaken by market participants. Market abuse is a broad term which includes abnormal price/volume movements, artificial transactions, false or misleading impressions, insider trading etc. In order to detect the aberrant behaviour/movement, it is necessary to know the normal market behaviour.

Off-Line Surveillance

The off-Line surveillance system
comprises of the various reports based on
different parameters and scrutiny thereof
High/ low difference in prices
Percentage change in prices over a
week/fortnight/month
Top N scrips by turnover
Infrequently traded stocks hitting
new high / low

The surveillance actions or investigations are initiated in the scrips identified from the above-stated reports

The surveillance department of SEs use various tools to determine normal and abnormal market behaviour. The necessary actions are initiated like impositions of special margin, reduction of circuit filters, trade-to-trade settlement, suspension of trading as an extreme step to control the abnormal market behaviour.

The surveillance department also carries out investigations, if necessary, based on a preliminary examination and suitable actions are taken against members involved based on the evidence gathered during the investigation.

The functioning of the surveillance department of the SE is broadly divided into on-line and off-line surveillance, derivatives market surveillance, investigations, surveillance actions, rumour verifications and pro-active measures.

With the help of on-line surveillance systems, the SEs are able to detect potential market abuse at a very nascent stage, improve the risk management system and strengthen the self-regulatory mechanism of the exchange.

On-line Surveillance System

One of the most important tools of the surveillance is the On-line Real Time Surveillance system with the main
objective of detecting potential market abuses at a nascent stage to reduce the ability of the market participants to unduly influence the price and volumes of the scrips traded at the exchange, improve the risk management system and strengthen the self regulatory mechanism at the exchange. The system has a facility to generate the alerts on-line, in real time, based on certain preset parameters like price and volume variations in scrips, members taking unduly large positions not commensurate with their financial position or having large concentrated position(s) in one or few scrips, etc. An alert is a measure of abnormal behaviour. An alert occurs in the surveillance system when a metric behaves significantly differently from its benchmark. The benchmark is the normal behaviour of a metric over a period of time. The system provides facility to set different benchmark for each scrip/ member based on its historical movement/ trading pattern. The alerts generated by the system during the trading hours are analysed and corrective action based on further investigations is taken in such cases. The system also provides facility to access trades and orders of members on-line.

The system can generate alerts on-line, based on preset parameters like price and volume variations in stocks, members taking unduly large positions (exposure) not commensurate with their financial position or having large concentrated positions on certain stocks, etc. An alert is a measure of abnormal behaviour and occurs in the surveillance system when a metric behaves differently from its benchmark. The benchmark is normal behaviour of a metric over a period of time. The system provides the facility to set different benchmarks for each stock/members based on its historical movement/trading pattern. The alerts generated by the system during the trading hours are analysed and corrective action based on further investigations is taken in such cases. The on-line surveillance system also provides facility to access trades and orders of members on-line.

The on-line surveillance system can generate on-line and off-line alerts for price movements, volume and member positions, generate on-line and off-line exception reports for settlement related information and real-time graphic valuation. The system also provides data warehouse techniques to instantly construct graphic and tabular analysis and summaries of vast volumes of post-trade data and visual benchmarking.

This system must not only be foolproof but also should have some security features. The system that BSE has installed has biometric access control, ie, access to surveillance room is checked by a thumb reader as well as proximity card. The surveillance room also has voice recording system where all the incoming as well as outgoing calls are continuously recorded. Close circuit cameras are installed to monitor the activities in the surveillance room.

The off-line surveillance system of SEs comprises the various reports based on different parameters and scrutiny thereof. As a part of the off-line vigilance, the surveillance department keeps an eye on difference in high and low prices of a stock, percentage change in prices of a stock over certain period like a week/fortnight/month. The department keeps an eye on top securities by turnover. It also monitors those infrequently traded stocks which witness sudden spurt in their trading volumes and stocks that hit new highs and lows. All these are translated into reports on the basis of which actions/investigations are initiated. The regulator also directs SEs to monitor stocks that have risen or fallen down significantly within a short period on the basis of which investigations are launched.

As far as surveillance of the derivatives market is concerned, abnormal fluctuation in the prices of series, market movement (cash vis-a-vis derivatives), member concentration (cash vis-a-vis derivatives) and closing price manipulation (cash and derivatives) are observed.

The surveillance department conducts in-depth investigations in phases which include identification of stock to be investigated based on the alerts thrown by the on-line system and off-line reports, identification of members from whom the client details have to be called for, preparation of company profile including corporate news and financial results, compilation of client and other relevant details, analysis of the information/data available and preparation of investigation report. Also, in case irregularities are found, necessary actions are initiated and/or the investigation case is forwarded to Sebi, if necessary.

Surveillance actions by the exchanges can vary, depending upon the nature of market abuse. The exchange authorities can impose special margins on the stocks that witness abnormal price behaviour coupled with significant rise in the volume. The department also resorts to reduction in the circuit filters in case of illiquid or low volume stocks as a price containment measure. The circuit filter could be reduced to 8 per cent or 4 per cent, as the case may be, based on the criteria decided by the department.

As another measure of surveillance, the department shifts the stock to trade-to-trade basis in which abnormal market behaviour is observed. In this mode of settlement, the stock would result in giving/taking delivery of shares at the gross level with no intra-day/settlement netting-off/square-off facility being permitted.

The stocks which form part of Z group in BSE are compulsorily settled on a trade-to-trade basis. In addition to this, the surveillance department transfers various stocks from time to time on a trade-to-trade settlement to contain excessive volatility and volumes on a counter.

The department also resorts to suspension of trading in the stock in exceptional cases pending the investigation. If the stock of a particular company is suspended by any other exchange then it has to be suspended from all the other stock exchanges where it is listed as a surveillance measure.

The surveillance department of the exchange also issues warning (written or oral) to its members when market manipulation in the stock is suspected.

As the stiffest measure, the department could resort to imposing penalty/suspension/de-activation of terminals based on the input/evidence available from investigation report or as directed by Sebi.

The department also undertakes rumour verification exercise. It liaises with compliance officers of the companies to obtain comments of the company on various price sensitive corporate news items appearing in select newspapers. The comments received from the companies are disseminated by the department to the market through the trading terminal and/or to its members through notices. The exchange authorities issue show-cause notices to companies which do not reply promptly to the queries. The investigations are also carried out by the exchanges based on rumours, if required, to detect cases of suspected insider trading.

All said and done, though the vigilance mechanism is in place, market abuse continues unabated. The most important deterrent, a strict regulator and strong surveillance from the SEs is lacking. The regulator requires more powers which it is expected to get as soon as the row between the Department of Company Affairs and the finance ministry is resolved.

Consequently, the maximum penalty Sebi can impose will rise to Rs 25 crore from the present paltry sum of Rs 5 lakh. In addition to this, the regulator is also expected to get search and seizure powers, which will make its investigation process more meaningful. However, even after being "empowered," as Mr Bajpai loves to say, it will be interesting to watch how far he and his team succeed in containing the market abuses.