Sucheta Dalal :Catching The Culprits
Sucheta Dalal

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Catching The Culprits  

Jun 7, 2004

By Sucheta Dalal

The last few months have seen a set of market operators creating profit opportunities for themselves by deliberately inducing volatility in stock prices through concerted buying or selling of select stock. Much of this activity is in the derivatives segment, but it has an immediate impact on cash market prices and creates profit opportunities everyday.

Inducing sharp price swings that cause a 100 to 150 point intra-day movement of the Sensex is beyond the capability of retail traders, even if they act as a group. The market meltdown on May 17 (when stock prices crashed over 15% in under 30 minutes) did smack of a mob reaction, but there is no evidence of this happening on a daily basis.

On June 3, the situation was very different. The Sensex crashed a steep 106 points just after the finance minister’s (FM) speech, but the day traders were not in a mood to sell that day. On the previous evening, the FM had met the top Mumbai brokers (ranked by trading volumes) for the first time. The group included six brokerage firms that account for the maximum intra-day retail trading activity. All of them were charged by the meeting and had signalled that the market would remain buoyant for a few days.

Consequently, the collapse in stock prices after the FM’s speech caught most investors by surprise; and it has intensified the furore over the persistent and easy manipulation of our markets. If market opinion is confident that there is rampant price manipulation, why is the regulator unable to isolate rouge traders and punish them? This is where the picture gets confusing.

Stock exchange sources insist that they have examined, dissected and analysed trading data during periods of concerted activity but see no discernable patterns and cannot pinpoint specific operators. This has been going on for nearly six months.

Market operators, on the other hand, insist that the mischief emanates from the derivatives segment, especially the operations of Foreign Institutional Investors (FIIs). It does not mean that all FIIs are destabilising our markets for quick profits. On the contrary, reputed foreign funds investing in India are subject to the same restrictions as Indian mutual funds — they can only participate in the derivatives market to hedge their cash market investments. So, genuine FIIs are just as concerned about market volatility as Indian investors.

For a while, the change in government had led to speculation that hedge funds were exiting India in a hurry; especially after a couple of large global firms lowered their India rating and FIIs withdrew over Rs 3,000 crore of investments in May. In fact, fears of hedge funds exiting were supposedly the main trigger for the mayhem on May 17. But there is no evidence of a sustained pull-out by hedge funds or other FIIs. The emerging consensus is that intra-day manipulation is engineered by tainted Indian brokers and portfolio advisers, who are using the FII route to play the Indian derivatives market on behalf of high networth foreign investors and Non-resident Indians. They see a quick profit opportunity in our slow regulatory system and the reluctance to investigate foreign investments for fear of exposing shady political connections. A former banker, who headed a leading international bank and is now based in Singapore, apparently advises one such cabal of investors.

The BJP-led government was, for various reasons, uninterested in examining the nature of investment coming in through Participatory Notes (PNs) issued abroad. In fact, it relaxed PN rules to ensure the success of its public sector equity offerings last March. Even now, several politicians are believed to be in cahoots with the operators who route funds through PNs.

Large Indian investors have some interesting theories regarding the activity of rogue operators. A compilation of the net outstanding trading position of FIIs in Nifty Futures, stock futures and the cash market just before the meltdown on May 17, reveals FII selling in excess of Rs 5,000 crore. Of this, the net outstanding in Nifty futures alone was over Rs 2,000 crore.

Clearly, some dubious FIIs had built up speculative positions and created conditions for a panic on May 17; however, the extent of the crash, that too on very thin volumes, seems to have unnerved them too. Instead, the sharp intra-day manipulation by beating down select index heavyweight stocks provides safer profit opportunities on a daily basis. The growing consensus about concerted manipulation by select FIIs begs the question about the regulator’s ability to track such mischief. But before blaming the regulator, one needs to examine the quality of information available to it.

For instance, many fund managers and large market players are extremely suspicious about the accuracy of FII data that is reported to the public. The RBI collates FII data, and it is not clear if all FIIs report their trades in the exact same manner. One must remember that the RBI was similarly in charge of registering Overseas Corporate Bodies (OCBs) before Scam 2000, and it allowed entry to completely shady companies (with a capital of as little as $10), forgot to regulate them, and let them play havoc with the market. A good starting point would be to put SEBI in charge of collating FII investment data and verifying its accuracy.

The second issue is whether SEBI has the expertise to analyse trading patterns, or is it entirely dependent on individual stock exchanges to do the job. My suspicion is that SEBI is almost entirely dependent on the efforts of stock exchanges and one is not even sure that it has the expertise to analyse and correlate information furnished by the two national bourses.

Finally, effective supervision is possible when number crunching and analytical skills of various regulatory agencies are supplemented with real market intelligence. The switch to automated trading has made our capital market more efficient, transparent and safe, but there is a clear disconnect with market participants, which is a serious handicap in effective supervision.

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-- Sucheta Dalal