As SEBI’s new directive to tackle manipulation on so called ‘illiquid’ companies goes into enforcement, there has been widespread wealth destruction even amongst good companies which are ‘illiquid’

It is shocking to learn that some of the well-known companies have suffered a nasty downfall in their share prices on their first day of being marked as ‘illiquid’ on the bourses. Shares of companies like Fame India, Advanced Micronic Devices, Thiru Arooran Sugars, Pacific Industries, Bimetal Bearings, Ruchi Strips, Veejay Lakshmi, Medicamen Biotech, Kerala Ayurveda, Vardhman Holding, Premier Explosives, DCM Shriram, all suffered humiliating falls.
 

Check the table below for the prices of the above-mentioned stocks traded on the BSE
 

As you can see, the stocks have been pummeled really badly. Not only did they fall hard, but their trading volumes were battered as well. Notice that their quantity traded on the first day in the new call auction window is far less than their two weeks average (which happens to be reasonably healthy for stocks termed as ‘illiquid’). If prices of fundamentally good companies are slaughtered for no reason, there is also no reason why an investor should stay invested in future should some other good company become ‘illiquid’.

To recap, in the new periodic call auction system, once investors get familiar with the nuances, there will be a concentration of activity in the last few minutes of the 1st part of the session, i.e. the 45 minutes reserved for Order Entry, Modification & Cancellation.

This is because orders can be changed or cancelled till the very end of this 45 minute session, which can result in the shifting of the "equilibruim price" at which the orders will be struck. So the last few minutes of this part of the session, i.e. the business end, is when investors will need to be trading online, or else in contact with their brokers, to be able to react to what other participants are doing, to give their order the best chance to be executed.

So there is bound to be frenetic activity in these few minutes. Some brokers may even refuse to trade in such scrips fearing that market regulators will be onto them for rigging. Some may even decline their customers’ orders on similar grounds. A combination of all this will exacerbate the liquidity scenario. This is also antithesis of free market capitalism where brokers and customers are free to place an order at their time of liking.

Following the close of the 45-minute Order Entry period, next part of the session is the Order Matching & Trade Confirmation Period of 15 minutes (including buffer of upto 7 minutes to facilitate transition between 2 call auction sessions). If the trade is not executed within this period, the trade stands cancelled and the broker has to punch an order once again.
 

The call auction allows trading of such illiquid stocks only for eight minutes every hour. If the trade is not executed within the hour, the trade stands cancelled and the broker has to punch an order once again.
 

Also, such a move may affect the cash segment as a whole. Investors seeking value in small and promising companies (some of them run by entrepreneurial families) will now get discouraged having seen how the first day panned out for good companies. This may lead to gradual erosion of investing in the cash segment of the market. Instead, exchanges are pushing hard for derivatives segment. We also had written about this here: SEBI’s move may reduce liquidity in BSE’s cash segment?
 

As SEBI’s new directive goes into force on 8 April 2013, the exchanges have shifted all the so-called “illiquid” stocks to a separate trading window. As many as 2,050 companies (Bombay Stock Exchange declares 2,050 companies as ‘illiquid’) have been shifted there. Some of the companies mentioned above are part of this list, as well. The exchange will re-evaluate the eligibility of such stocks to be traded in the ‘normal’ segment every quarter.