SEBI slams down on F&O manipulation-II: NSE and BSE as the first line of regulation stand exposed

Some operator-driven stocks in the F&O segment have crashed in response to SEBI’s decision to change the norms. Why had NSE added a bunch of dubious stocks to the F&O list that was open to manipulation and why is BSE silent about manipulation in hundreds of obscure companies? The answer is simple: Bourses are out and out profit-making entities and cannot be relied upon to act as the first line of regulators

The day after the market regulator Securities and Exchange Board of India (SEBI) changed the criteria for choosing stocks that would be eligible for the Futures & Options (F&O) segment, some of the obviously shady companies fell sharply. If this was not enough of a severe indictment of the quality stocks that trades in the NSE’s F&O segment, today some the other dubious F&O stocks crashed. Apparently, large positions in these shady scrips belong to the promoters of these companies themselves and brokers close to them and were pledged with financiers to raise money. SEBI’s moves and recent the market weakness ensured that there were pressures on the financiers who had funded these positions. They have resorted to firesale of pledged shares to recover their cash. Situations like these were inevitable ever since NSE expanded its F&O portfolio with a long list of companies whose business is puffed up and the stocks are run and down by operators and promoters.
It has all been an open secret. Indeed, more than two years ago, one of our Chennai-based readers, Shaym Shekhar, went to the extent of writing a detailed letter to the National Stock Exchange (NSE) which Moneylife forwarded to the Exchange, SEBI chairman and the finance ministry's capital market division. The points raised by him and the flimsy responses of NSE and its joint venture with CRISIL, India Index Services & Products (IISL) were as follows:
1. The Nifty includes a holding company (Reliance Industries) and a subsidiary company (Reliance Petroleum) in which it has controlling interest. What is the logic behind this duplicative representation? The same question holds for Reliance Infrastructure and Reliance Power.
NSE’s response: The top 50 companies listed on the NSE that satisfy the criteria related to market capitalisation, liquidity (impact cost), floating stock and minimum listing criteria are considered for inclusion in the index.
2. When an analyst computes the PEs of an index, earnings of an index’s constituent companies are material to its EPS. Why include Reliance Power and Reliance Petroleum in the Nifty long before they have started commercial production? What is the rationale for giving a company index representation when it has no earnings history?
IISL’s response: Currently, companies are reviewed based on market capitalisation, liquidity (impact cost), floating stock and minimum listing criteria. Profitability is not a current criterion. In case, one was to introduce profitability as a criterion, all companies with long gestation periods (infrastructure, telecom, etc) would not be eligible for inclusion in the index. In such a case, the resultant index would not be truly representative of the underlying market.
3. A company’s price discovery starts when it makes an IPO. The price discovery process would be effective only after a reasonable period. Why did we include a company like DLF within months of listing? DLF’s dominant revenues were from inter se transactions with its own subsidiary or related parties. Had NSE assessed corporate governance at DLF before DLF was brought into its index? How do you justify including DLF in the Nifty with not even a few quarterly results to judge performance or corporate governance? The serious litigation that DLF had with its minority shareholders just months before the IPO and the covertly managed earlier de-listing process reflected abject lack of corporate governance. DLF made hurried out-of-court settlements with the litigant shareholders to raise capital and get re-listed. Were these factors duly considered before giving DLF a presence in the index?
IISL’s response: A company which comes out with an IPO will be eligible for inclusion in the index if it fulfils the normal eligibility criteria like impact cost, market capitalisation and floating stock for a three-month period. This three-month period is reckoned from a cut-off date which is at the end of every quarter. So, typically, an IPO stock will become eligible for inclusion, if it meets all other criteria invariably for a period exceeding three months. Factors related to litigation, etc, are subjective in nature and are not considered while reviewing the index constituents.
4. Reliance Power crashed within minutes on the listing day. Institutional shareholders dumped the stock that day implying that they had been duped on valuation. Yet, NSE included it in the Nifty within months of listing. Implicitly, you made every Nifty index fund buy the stock, which they had chosen to dump months ago. Were you not interfering with the price discovery and forcing investors to buy an out-of-favour stock by giving it index representation?
IISL’s response: The stock from the replacement pool with the highest market capitalisation that satisfies other criteria (mentioned above) are considered or inclusion. Factors related to valuation (correlation between issue price and market price post-listing) are not considered for inclusion in the index. Market capitalisation (and not issue price-related data) is internationally considered as one of the eligibility criteria for inclusion of constituents in the index.
5. NSE included several scrips in the F&O segment like Educomp Systems, Lanco Infra, HDIL, Sobha Developers, AIA and Rajesh Exports, to name a few. These scrips were thinly traded even in the cash segment before they were brought into the F&O. The valuations went up several-fold after that. What is your method of evaluating a company before you include it in F&O? What is your response to my accusation that the futures segment was used to rig the stock prices in several mid-cap companies in 2007-08?
NSE’s response: SEBI prescribes the following criteria for selection of securities for derivatives contracts:
A. The stock should be out of the top 500 in terms of market capitalisation and average daily traded value in the previous six months on a rolling basis.
B. The stock’s median quarter sigma order size over the last six months shall be at least Rs1 lakh. The MWPL (market-wide position limits) of the stock should be at least Rs50 crore. For the above purpose, the MWPL shall be equal to 20% of the non-promoter holding in the stock.
However, as required by SEBI, an application is made for introduction of derivatives contracts using the following more stringent criteria. The stock should be out of the top 500 in terms of market capitalisation and average daily traded value in the previous six months on a rolling basis; the stock’s median quarter sigma order size over the last six months shall be at least Rs5 lakh; the MWPL of the stock should be at least Rs100 crore. Securities, which do not meet the following criteria for consecutive three months, are excluded from derivative list: The stock's median quarter sigma order size is at least Rs1 lakh, while the MWPL of the stock is at least Rs45 crore.
A few years ago, NSE decided to dump as many as 50 scrips from the F&O list. We wrote at that time, “NSE does not say whether it was a mistake to have included them.” It also decided to modify the criteria for selecting the stocks for F&O. The NSE formula was a mumbo-jumbo which allowed it to include poor-quality stocks and those with minimal volumes in F&O for creating higher trading turnover.
As is clear, in practice, all this while, it was NSE which has been deciding which stocks to include in the list. What was the idea? More and more scrips in F&O and that too the scrips that market operators want, meant higher traded volumes which in turn meant higher revenues for the NSE. NSE, remember is a for-profit entity, where a large number of top institutional investors have invested their money. Since cash market volumes are flagging, the NSE management had to create volumes in the speculative segment to create revenue and profit growth like any other business. Everyone except the regulator could see it.
This was NSE’s game but don’t think that BSE is blameless. Thousands of poor quality stocks are listed in the BSE. They are often targets of massive manipulation as we have been writing for the past few years in Moneylife magazine. Stocks of companies with revenues or profits which have gone up multi-fold but BSE and SEBI pretend not to notice it. We intend to put out a longish research piece on this in the magazine soon.
It is intriguing that SEBI has stepped in to cut the F&O list by bringing in stricter criteria. What investors (the few who are left in the market) would like to know is, what will SEBI do about the fundamental issue here? The bourses are for-profit entities where top managers are paid globally competitive compensation. If they are left alone, they can stoop to any level to push their key sources of revenues—traded volumes and listing fees. SEBI’s regulatory action on F&O is laudable but skirts this fundamental rot within the system. 



Sudhir Rao

4 years ago

Replies from NSE sound quite logical; why are they called Flimsy ? It is job of SEBI to monitor, let it do its job well.


Debashis Basu

In Reply to Sudhir Rao 4 years ago

Replies are academic. Hope you are aware what happened to the stocks NSE was putting in F&O. If not, read the two parts again :)

Dayananda Kamath k

5 years ago

there are various other issues also in cpaital market.earlier the price limit was .50rupees for shares below rs.10 today the circuit is 2% for shares quoting at rs.0.20 and surprising ly volume in these shares is in millions daily the brokerage will be more than share value and even if you hold it for whole year and it hits upper circuit everyday after you purchase will not cover the brokerage. the circuit filter norms have to be verified. delay in listing of demerged companies. there are companies which are not listed even after 3 to 4 years of nathseeds.when you have given in principle approval for demrger why there should be so much delay.

sohan modak

5 years ago

congratulation to moneylife team for this incisive analysis and asking the fundamental question which SEBI should answer.

Adi Daruwalla

5 years ago

The bourses were never meant to be the first line of regulators, as you have rightly pointed out that they are business entities solely to make profit.(organisation) Also before the apperance of SEBI on the scene of Capital Markets, the bourses were forced to be regulators but could not as there was conflict of interest, profit or regulate. That time there were DEA (Dept Of Economic Affairs), DCA (Dept of Company Affairs) and now SEBI and for monetary polict RBI. So the original onus was with DCA and DEA to regulate and now all three including SEBI and RBI for monetary policies.


Sucheta Dalal

In Reply to Adi Daruwalla 5 years ago

Actually, the bourses were indeed meant to be first line regulators. In fact, they are still called first line regulators. But since we ape the american corporate model that is focussed on profits coupled with higher and higher CEO salaries and perks - we have the messy situation we see today.

Ramesh Poapt

5 years ago

Excellent article!pl continue the same for the sake of millions of small investors!They will be slaughtered by this merciless casino people and by foreign investors' killing arbitrage strategies and F&O scams!Due to national fiscal/monetary situation and global headwinds, market is gradually moving to a very lower level!Hence kindly alert the investors by such researched eye opening articles!


5 years ago

You have stated many faults, but still not enough. These institutions are FRAUDS, including SEBI. As Dr Bimal Jalan had correctly recommended, the stock exchanges should not be listed and should not be for profit.

State power bodies unable to meet PAT scheme obligations by 2015

The Central Electricity Authority feels that various state electricity boards would not be able to meet its perform, achieve and trade scheme obligation before 2015

Hyderabad: Central Electricity Authority (CEA) has expressed concern over the capabilities of power producing bodies of various state governments to meet the 'perform, achieve and trade' (PAT) scheme obligation before 2015, reports PTI.
The power ministry will be holding meeting on 1st August to discuss ways and means of extending help to state power producers to meet the scheme, said Arvind Singh Bakshi, chairperson of CEA, the statutory body for technical coordination and supervision of power generation programmes in India.
Bureau of Energy Efficiency (BEE) recently notified that under PAT scheme, eight energy intensive sectors such as thermal power plants, iron and steel, cement, fertilizer, aluminum, textile, pulp and paper and chlor-alkali have been included.
There are about 478 numbers of designated consumers in these eight sectors and they account for about 165 million tons oil equivalent of energy consumption annually.
These designated consumers were set target figure for fuel consumption reduction, which will make them energy efficient by March 2015.
The implementation period for PAT cycle is three years, from April 2012 to March 2015. After completion of the first commitment period, the savings will be on an annual basis.
"We are holding an internal meeting on 1st August to see how we hold state electricity boards. Primarily this is for the implementation of PAT because it is difficult for state units," Bakshi told reporters on the sidelines of 'Power Plant Summit-2012' organised by Confederation of Indian Industry.


FMC warns traders against price manipulation

The commodity market regulator has doubled the deposit money that a trader is required to keep with exchanges for trading in turmeric following unusual price movement

New Delhi: Commodity market regulator, Forward Markets Commission (FMC), today said it would not allow traders to manipulate future price of agricultural items and could ban its trading if required in the backdrop of poor monsoon rains affecting kharif crops, reports PTI.
The regulator has doubled the deposit money that a trader is required to keep with exchanges for trading in turmeric following unusual price movement.
“We are keeping a close watch on all agriculture commodities. We will take action as and when required”
“We are going to be very alert and not allow traders to manipulate prices. We will ban if need be. We are aware of deficient monsoon rains impacting crops,” FMC chairman Ramesh Abhishek told reporters.
Mr Abhishek also briefed food minister KV Thomas about price situation of agricultural items in the future market in the backdrop of drought-like situation.
Stating the Commission has been taking steps to check speculation and price volatility, the regulator said, “We saw price movement in turmeric and yesterday we have increased margin on it from 20% to 40%”.
Mr Thomas had yesterday said the regulator was keeping a close watch on all farm commodities and might ban if there is unusual fluctuation in prices.
Monsoon is deficient by 22% so far and the worst-hit states are Karnataka, Maharashtra, Gujarat and Rajasthan. Poor monsoon has affected sowing of kharif crops such as paddy, pulses and oilseeds.
FMC is closely monitoring the price movement of chana, soyabean, soya oil, potato, sugar and wheat, among other commodities.
At present, there are five national and 16 regional level commodity exchanges in the country.


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