SEBI looks to guard market against 'flash crash' situation

SEBI looks to guard market against 'flash crash' situation - The Economic Times
MUMBAI: Capital market regulator the Securities and Exchange Board of India (Sebi) is looking at ways to ring-fence the stock market from freak incidents, like the flash crash that Wall Street experienced last May, when Dow Jones dropped 700 points within a few minutes.

Senior Sebi officials discussed the subject at a meeting a few weeks ago with risk management experts and members of various advisory committees constituted by the regulator.

Flash crash is a serious issue. When large market orders interact with a thin order book, it may result in a crash. Market structure has become fragile and accidents are waiting to happen. Just like banks, we need to stress test markets and make the system robust, said JR Varma of IIM-A who was present at the meeting. A month after the Dow flash crash, shares of Reliance Industries fell 22% in intra-day trades on a small sell order. Since 2000, there have been 60 occasions when the Sensex fell over 5% intra-day . Such stock movements are worrying regulators.

Its a wake-up call to regulators to make the systems more robust. Corrective action is required so that we dont face a bigger market disturbance on a bad day. Best way to do that is to build simulated computer models of the entire market structure, including the most popular trading algorithms and then stress test the whole edifice, adds Mr Varma.

Automated high frequency and programmed trading softwares that FIIs and large operators use can cause havoc in a shallow market. After the May crash, US regulators introduced temporary price ceilings through circuit breakers to slow down big movements without bringing trading to a halt.

Susan Thomas of Indira Gandhi Institute of Development Research ( IGIDR )), who also attended the meeting, however, felt chances of a flash crash were low in India. The US market is different from the Indian market and it most probably will not happen here. The Indian market is very consolidated and all orders are visible instantaneously to everyone while the US market is fragmented across multiple exchanges. Despite the presence of large financial institutions, there is non-transparency . Indian markets are transparent and not so vulnerable.

According to another person present at the meeting, the regulator is taking a close look at high frequency (HF) trading. Sebi wanted to know if additional risk protections should be considered for algorithmic and high-frequency trading, he said. There have been complaints against high frequency trades of unfair advantage to institutional broking firms, which use co-location services with deep pockets over retail investors. While HF trades have been blamed, there is no direct evidence to suggest that, the same source added.

According to media reports, Sebi chairman CB Bhave recently said that the regulator was studying the concept of high frequency trades and whether they give unfair advantage to certain investors over retail investors. I am not sure whether HF trade by itself is a problem or the structure of stock exchanges is the problem, Bhave added. Former BSE president Deena Mehta said, The perception that HF traders have unfair access to markets is affecting investor confidence. Retail investors are left with the second best quote. Regulators , she feels, should look at this carefully to ensure equity among investors.

According an exchange official, unlike US markets, there are a lot of restrictions in terms of price and quantity in India. In case of any abnormal activity, surveillance kicks in, he said. According to a recent report, algorithmic trading accounts for around 20% of the of the overall cash market volumes on Indian exchanges . It could go up to 30% by 2012. But it may be a mistake to think that a flash crash can happen only with automated HF trading. A flash crash can also be triggered by a cascade of stoploss orders on a thin order book. At one level, a stoploss order is also an algorithm , said Verma. Indeed as trading has become quicker, the surveillance capability of regulators has fallen far behind. Serious problem is that regulators dont have the capabilities to analyse high frequency data, he said.