Questions over circuit breakers

An eight-year-old Sebi circular on circuit breakers, which halted trading on both bourses after the Sensex and the Nifty jumped dramatically, came under close scrutiny today especially when derivatives of an Indian index — the SGX CNX Nifty index futures — traded unbridled in the Singapore Exchange throughout the day.

The SGX Nifty futures closed at 4,390, up 67 points compared with the Nifty spot price of 4,323.15 at the time trading was halted. In SGX, the futures hit a high of 4,436. Though this gives some idea of the likely momentum in the markets tomorrow, it also makes many investors feel short-changed and locked in uncomfortable positions.

Sebi's June 28, 2001, circular on circuit filters had stipulated that the index-based market-wide circuit breaker system would come into effect at three stages of index movement -– at 10 per cent, 15 per cent and 20 per cent -– irrespective of whether the market moves up or down. These percentages are translated into absolute points of index variations on a quarterly basis. For the current quarter, applicable Sensex points are 975 for 10 per cent, 1,450 points for 15 per cent and 1,950 points for 20 per cent. Similarly, applicable Nifty points are 300 for 10 per cent, 450 points for 15 per cent and 600 points for 20 per cent.

Today, within a few seconds of the market opening, the Sensex went up 1,789.88 points and the Nifty by 531.65 points, thereby crossing 15 per cent circuit breaker for both the Sensex and the Nifty. This led to the equity and equity derivatives markets being closed for a period two hours as prescribed in the Sebi circular.

Subsequently, after reopening at 11.55 am, the Sensex rose 2,110.79 points higher and the Nifty went further up by 651.50 points. Both the indexes thus crossed the limit of 20 per cent and, as per the Sebi circular, equity and equity derivatives markets were closed for the rest of the day.

When circuit breakers shut down Nifty futures trading on the NSE, some of the order flow would have naturally migrated to SGX. "When an onshore market suffers from interruptions of service while an offshore competitor does not, this is a competitive disadvantage for us," says Ajay Shah, senior fellow at National Institute of Public Finance and Policy (NIPFP).

The peculiar situation also queers the pitch for investors in India. For instance, if a person had call options and wanted to encash these and book profits, he had no option but to wait for the next day. And

it is not entirely impossible that the

markets see similar momentum tomorrow too. Also, if someone had a short

position, he would be left high and dry without being able to cover it.

In short, it becomes impossible to hedge positions if an investor does not have an account to trade in the SGX. This does call for some regulatory changes. "Looking forward, two positions can be taken in reforming the system. The first is that there is nothing wrong with a continuous market; market-wide closures should not be done. This is a reasonable position and should be carefully considered," says Ajay Shah.

According to Shah, if it is felt that in times of extreme movement, market participants really deserve a pause to ponder, there is a superior alternative to closure. This is the 'call auction' market. "We could have a rule saying that when Nifty moves by more than 10 per cent, we will go into a call auction for 15 minutes," he says. In a call auction, buyers and sellers place or modify their orders, and the system continuously shows a provisional price, at which the supply and demand curves intersect. When the 15 minutes end, the market-clearing price that is discovered reflects a large number of orders and is hence more trustworthy.

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