Media has faithfully reported SEBI’s decision to change F&O eligibility criteria as a move to curb manipulation. But nobody has asked what was NSE doing all this while? Moneylife has highlighted brazen manipulation in creating the F&O list several times in the past

On Tuesday market regulator Securities and Exchange Board of India (SEBI) announced changes in the benchmarks for scrips to be eligible for trading in the derivatives or futures & options (F&O) segment. As a result, 51 stocks have been dropped from the F&O list. Every single media outlet reported this event as a simple regulatory move to curb market manipulation. None of them have asked what it says about the role of the stock exchanges, which have the primary responsibility of curbing manipulation. The fact is, SEBI’s move is really a slap on the face of National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), both of which have been in an unhealthy competition to boost volumes at any cost with the NSE, a private entity running a monopoly public utility, leading the way in creating frothy volumes to keep playing the “valuation game”.
 

Even as SEBI has stepped in to change the eligibility criteria for F&O nobody seems to have gone into what is, on paper, the role and responsibility of the stock exchanges. Indeed, in a supreme irony, while SEBI’s move is designed at checking manipulation by doing away with illiquid stocks, the bourses have either encouraged manipulation or turned a benign eye towards them.
 

According to the new norms, scrips with a minimum trading volume of Rs10 lakh and market-wide position limit (MWPL) or market capitalisation of Rs300 crore would be eligible for entry into the F&O segment, SEBI said in a circular. From now on the minimum Median Quarter Sigma Order Size (MQSOS), which indicate liquidity or order size in a scrip, has been revised to Rs10 lakh, from Rs5 lakh at present, for it to be included in the F&O segment. Scrips which fail to maintain a minimum MWPL requirement of Rs200 crore would cease to be in the F&O segment. Earlier this limit was a mere Rs60 crore. The scrip would exit the derivative segment if MQSOS falls below Rs5 lakh. Earlier this limit was only Rs2 lakh.

How lax were the earlier norms? Currently, 220 scrips trade in the F&O segment in NSE. After the new norms, more than half will have to be dropped.
 

This is not a surprise for us. Our columnists R Balakrishnan and Sucheta Dalal and readers Sham Shekar and Hemant Gupta and also this have pointed out how the eligibility criteria for F&O list is so flawed that a host of dubious stocks have found easy entry into them. We have heard of promoters and large speculators bragging that they know how to get a stock included in F&O.
 

As Ms Dalal wrote “From time to time, the occasional analyst or trader has dared to talk about the dubious quality of several stocks that have been admitted to the Futures & Options (F&O) segment. The inclusion triggers frenzied speculation, which also impacts the underlying cash prices of these scrips. Who chooses these stocks? And, if there is a statistical rationale to the selection, why isn’t it being re-examined to eliminate shares that represent doubtful corporate antecedents? Stock exchanges happily disclaim any responsibility—they say that SEBI chose to take away their decision-making power in this regard.”
 

Earlier, R Balakrishnan had written that “price manipulation starts with the lack of application of mind by the exchanges while adding stocks to the list of Futures & Options (F&O). When a stock with a small free float is included in the F&O list, someone with deep enough pockets can take it on a one-way ride. Regular punters who think that the stock is genuinely overvalued will come in and go short on the futures. Those with money can squeeze the shorts very easily and the stock can shoot up further. Since a majority of the stocks in the current F&O list should not have been there, you can imagine the magnitude of the problem…

“Today, the futures prices often move the prices of underlying shares, because many stocks in the F&O segment often have such poor liquidity that you cannot buy or sell even a few thousand shares without impacting the price. The other strange thing is that we have seen even newly listed companies being included in the list of stocks that forms a part of the F&O list. Of course, brokers love the current system as much as the NSE, since most run a casino-type operation where the staple is intraday trades from habitual die-hard clients, proprietary trades by the brokers themselves—and retail punters dealing in small lots in F&O… It is also common for most businessmen to have their ‘house’ broker “make a market” in their company’s stock futures and facilitate benami trades to help the promoter… SEBI should step in and clean the mess. The F&O list should include only stocks with a 5-10 year history, free float of at least 40% of paid-up capital and a minimum of 100,000 shareholders. Also, it has to ensure that there is a thriving and efficient stock-lending mechanism for F&O stocks.”

Hemant Gupta a high net worth investor who knows market players very well corroborated Mr Balakrishnan’s comments with this stinging example. “Ispat Industries has recently been included in F&O category. Almost everyone in India will agree that few companies match the wretched track record of this company. At a time, when the steel industry was witnessing highest buoyancy, Ispat was still not showing profits. There have been several allegations about diversion of funds by promoters and inflation of project costs. Their loss-making record is a pointer in that direction. There are whispers in the market about cash sales as well.  I agree that liquidity/floating stock should be a major criterion for eligibility in F&O section. However, should it be the only criterion? Is it not the moral duty of decision-making authorities to give some weightage to promoters’ or company’s track record?
 

It appears that SEBI is intent on encouraging speculation and protecting investors from fraudulent promoters (through pre-emptive measures) is never a priority. Could there be a bigger travesty? If a small-cap (or any company listed on the BSE) company wants to list on the NSE, it must have a two-year dividend-payment record. NSE has refused to list several companies that have paid one dividend even if they are willing to declare an interim dividend for the next year to meet the two-dividend criterion. Does this mean that the bourse believes that big is honest and small is dishonest?

Worryingly, there is more to this than meets the eye. Bringing strange new scrips into the F&O segment appears to be a big scam. It was common knowledge in the stock market since September 2007 that Ispat will come in F&O when share price was hardly Rs15. I had dismissed such talks as implausible. Does this mean that there are hidden hands working at getting particular scrips transferred to F&O after a good two-three-month interval to allow knowledgeable people to buy low and make a killing? The F&O inclusion by SEBI needs investigation.”