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[February 18, 2013]
Call auction versus continuous market
Feb 19, 2013 (Mint - McClatchy-Tribune Information Services via COMTEX) -- Securities and Exchange Board of India (Sebi) has decided to extend the use of call auctions. They are currently used to determine the opening prices of stocks that are part of the National Stock Exchange's (NSE) Nifty and the Bombay Stock Exchange's (BSE) Sensex, as well as newly listed stocks. Sebi has decided to extend the pre-open call auction market to all listed stocks. Additionally, it has said that 'illiquid' stocks will cease being traded in the current continuous market, and will only trade in periodic call auctions.
At first, this looks like a premature move, especially considering that volumes in the pre-open call auction market for Nifty and Sensex stocks are themselves quite low. Indian traders, clearly, haven't warmed up to the call auction mechanism. Even so, one can't disregard the large amount of empirical evidence that call auctions have worked well in a number of markets to determine opening and closing prices of stocks, as well as the fact that they are better suited for illiquid stocks vis-a-vis a continuous market.
Sebi has defined illiquid stocks as those where the average daily traded volume in a quarter is less than 10,000 shares, as well as where the average daily number of trades is less than 50 in a quarter. Stocks where both of these conditions apply on each of the exchanges they are listed on will move to the call auction system. A reasonably large number of stocks will, therefore, move to the call auction system; especially on BSE, where the number of listed stocks are far higher than the number of stocks that actually trade. But since these will anyway be stocks that aren't traded frequently, not many may complain. One way to look at Sebi's move is that there's no harm in trying a new method, since the continuous market hasn't served the interests of investors well either.
The only quibble, however, is that Sebi should leave this trial-and-error approach to the exchanges -- just as it should leave a number of other decisions such as product design and market timings to exchanges. NSE, in its small and medium enterprises (SME) exchange, called Emerge, is currently experimenting with both a normal continuous market and call auction market. The SME platform has two listed stocks, one of which trades in a call auction, while the other trades in a continuous market. The call auction generates far lesser volumes, although it must be noted that both these stocks have been listed relatively recently, and it's difficult to come to any conclusions.
But considering that it's still some time before Sebi gives exchanges these freedoms, the regulator must be open to changing its stance on call auction norms if the market doesn't embrace them.
STT and CTT News reports suggest that representatives from the banking industry have suggested that the finance minister must introduce a commodity transaction tax (CTT) in the upcoming budget. Ever since, there have been a number of reports that such a move will lead to a shift from the current exchange-traded commodity futures market to unorganized markets, also referred to as 'dabba' trades.
This is in line with anecdotal reports about large 'dabba' trades on equities are true. The right solution, therefore, is to abolish securities transaction tax (STT) in the equities market as well. But few people expect this, given that collections through this route aren't insignificant and also considering the state of the government's finances.
In this backdrop, the representatives of the banking industry have raised a valid point, and one that is clearly evidenced by the data on turnover of India's various exchanges. Over 80% of organized trading now occurs in contracts such as equity options, commodity futures and currency futures, where the incidence of STT is either very low or nil. Trading in the equity cash market has remained stagnant, despite a rise in both the number of listed stocks as well as the market capitalization. If anything, government policy should encourage investments in equity as it is an important avenue for companies to raise funds. But on the contrary, the government has created an outlandish scenario, where equity trading is discouraged. It stands to reason that this anomaly should be corrected.
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