There is lot of debate on whether the stock markets should be closed. The major arguments combine numerous issues. I have tried below to address some of them based on my knowledge of how markets operate and leveraging experience in handling various crises as a member of the Defaulters Committee, Vice President, and, President of BSE Ltd.
1. Markets are routinely going down – why keep it open?
Upward and downward movement of the market is its inherent nature. Volatility give rise to trading opportunities; Every rise or fall is an opportunity to decide whether to buy or to sell. Markets that open with a downward gap also have the probability of opening with an upward gap. A technical analyst can explain this. In order to prevent such an artificial fall, the market regulator should contain the daily fall by enabling smaller circuit filters. While artificial fall may not be fully eliminated, it is possible to reduce the fall by placing limits on scrip-wise circuit filters and by extending the cooling periods. This will result in lower daily erosion.
2. Only FII are selling:
FII are bringing the markets down, hence they can be prevented by closing the market. However, for every sell, there is a buy. If FIIs are selling, the Domestic Institutional investors are buying. These are mainly mutual funds representing retail investors. There is a lot of interest in buying by retail clients and they are making advance transfer to brokers who typically deal with retail cash segment customers. If we declare closure of the markets, it signals uncertainty to global FIIs. Foreign investors hate uncertainty in market systems. History tells us maximum FII investments flowed into India only after 2004, after the Depositories, online Trading Systems and Settlement Guarantee systems were put in place. Through these mechanisms, Systemic risk has been reduced to near zero; as such, there is assurance of fair price, quality of goods delivered, and timely payments
3. Settlement of Open Interest:
The biggest risk in closing the market abruptly is settlement of Open Interest. Options are open right up to January 2021. The Open Interest (OI) today is about Rs. 2,00,000 crores. A theoretical price will have to be determined in order to close these trades. At the time of placing the trade, the pricing is based on time value of contract period and demand and supply at the time of writing the contract. If the time value is made zero by settling now there could be huge losses to participants in the market. This could also result in customers not honouring the settlement; brokers as well as exchange systems will be unable to handle the resultant risk. This would also result in a lot of litigation due to failure of customers to accept the closing rates. One can always say this is mandated by exchange so must be accepted. But, for instance, the litigation’s from the fall of 2008, when brokers squared off the trades, are still not settled. Moreover, litigation has since multiplied, as customers who lost the arbitration have approached Consumer Courts and local police.
4. Inter-linkages with world markets:
Nifty is traded in other markets such as Singapore. If Indian positions are hedged in Singapore, we could have a bigger mess and earn a lot of ill-will of foreign investors. A number of instruments in US, UK and other European markets also have Indian indices as the underlying basis. This helps overseas investors participate in Indian markets. These are popularly known as Participatory Notes. Today all the countries that matter are keeping their markets open. NSE has been ranked number one in the world in terms of volume, and BSE is also part of top 5 global rankings in terms of volume. Closing such prominent markets arbitrarily only mars the country’s reputation
5. Further Panic Selling:
An announcement to close the markets could lead to further panic selling as investors feel insecure due to non-availability of exit route and uncertainty of markets reopening. The financial year ending in March also puts pressure on the markets since investors have to take care of investments relating to savings and taxation obligations. Liquidity is the biggest function of the stock markets, taking it away mars investor’s confidence.
6. Operational Difficulties:
Despite advisory from the Home Ministry, there are police officers who do not permit movement of employees and citizens who are connected to the stock market and ancillary establishments like CDSL, SEBI etc. This needs to be sorted out and their movement has to be freed up. Clients are unable to give access to funds to their brokers, which results in difficulty in doing settlements. In fact, I think this is the best time for a Digital push. That will allow the brokers to deal only with those customers who make online payments like NEFT. Share movements are all electronic already. At such times a Power of Attorney (POA)is extremely useful for transfer of shares. BSE and NSE have provided BEST and NOW platforms for customers to execute their trades. These are also available on remote access which can be used by brokers and their staff. Risk limits can be set on the remote admin terminal and margin payments can be made. Depositories also permit remote use of their systems to pay-in and pay-out based on specific requests by the participants.
7. Settlement Finance Availability:
In the fall of 2008, the Ministry of Finance (MOF) requested banks to support brokers by providing funds for pay in. Shortage of funds happen when the margins increase to abnormally high levels. Brokers have the collateral in form of shares, fixed deposits, and bank guarantees. Cash has to be arranged on a daily basis to make payment for Mark-to-Market. Since stock exchanges already have sufficient collateral, they must secure limits from Banks, and instead of liquidating the Bank Guarantees and other collateral, must use these limits for Mark-to-Market losses. Similar exercise was done in the fall of 1990 due to Kuwait war, during which, the stock exchange provided credit of Rs. 15 lakhs to each broker against the collateral of shares and completed the pay-in. Of course, now numbers are much larger but a positive attitude in this direction would be helpful. This is a major argument for market closure since money is not moving fast enough.
8. Reliance on Statistical Models:
Exceptional times require pragmatism to lift the market out of crisis. There is a need to review the numbers being thrown up by the standard models for risk management. In the anxiety to show fairness and continuity, these models are uniformly applied. This can be a disaster. For example, in the recent fluctuations, there was a need to increase margins on short selling. Margins have been increased on selling as well as buying since the statistical model which relies on volatility as an important parameter would advise so. Enforcing 40% margins on cash market is also too high. Are we expecting the markets to go down by a further 40%? If that is the case, then we should have 20% margins on Intraday trading and 100% payment if a customer wishes to take delivery. Taking 40% today and the balance of 60% tomorrow in cash market delivery is an operational hassle. During Harshad Mehta’s boom ACC went up from Rs. 400 to Rs. 10,000 in a matter of few settlements. Instead of relying on the margin calculation method it was decided to impound the entire gain in form of increased margin so that in the event of a fast fall, the funds would be available to avoid a settlement default. This was a pragmatic manual intervention.
9.Sovereign Guarantee Fund:
Such a fund should be set up by Government of India to support the market. This development is routinely discussed each time the market falls. There are merits and demerits to this. I am personally against it since any artificial intervention to support or bring down the market is not advisable. Defining the guidelines for the administrative head to operate this fund is difficult. If the rules are transparent and published, investors will expect pepping up of markets at a particular level. Whenever the market goes up selling is expected. Hence markets will start operating between the bands given to Sovereign Fund manager. If the rules are not made public or left to the discretion of the fund manager, there will be doubts cast on him/her. In India mistakes are often treated as fraud. Hence if any decision is taken in this regard it should be well thought out.
10. Way Forward:
The markets are on a roller coaster ride, but if we keep in mind how markets have bounced back in the past, there is hope. Barring the fall of 2001 the total bounce back has occurred in average of 7 months .
I have lot of faith in the markets since I have seen it go down and bounce back every time. In Bhagwad Gita there is a concept of Swadharm, the inherent nature in each individual that makes him/her function. Same applies for the markets as well. They have always behaved predictably. There is a method to the madness. Let us trust it and invest wisely. There is no better time like the present.
Deena A. Mehta
Asit C. Mehta Investment Interrmediates Ltd.