INTRODUCTION
When it comes to stock exchanges, surveillance measures are put in place to monitor and regulate trading activities. These safeguards ensure that trades are fair and transparent, while also identifying and preventing market manipulation, insider trading, and other fraudulent activities.
Market integrity, investor interests, and market stability are all critically protected by surveillance measures. By spotting and stopping fraudulent activities, transparent and ethical trading is encouraged. SEBI and stock exchanges have been introducing various surveillance measures to improve market integrity and protect investor interests.
The main objective of these measures is twofold. First and foremost, they inform and encourage investors to proceed with caution when dealing with these kinds of securities. By raising awareness, investors are urged to exercise extreme caution and perform extensive due research in order to make wise investment decisions. Secondly, the measures encourage market participants to use the required caution when dealing with these securities. The surveillance measures aid in fostering a more responsible and knowledgeable trading environment by enticing market players to be watchful and proactive in their trading activity.
In addition to existing measures such as Additional Surveillance Measures (ASM) and Graded Surveillance Measures (GSM), SEBI and stock exchanges have decided to implement the Enhanced Surveillance Measure (ESM) framework. This framework which has been introduced exclusively for Micro-Small Companies listed on the main board having a market capitalization of less than ₹ 500 crores has been brought into effect from June 5, 2023. (NSE Circular no. NSE / SURV / 56948 dated June 02, 2023 and BSE Notice No. 20230602-44 dated June 02, 2023)
SHORTLISTING CRITERIA
The following are the specific criteria used in the ESM framework to choose stocks:
ESM STAGE I:
The shortlisting criteria are met if either of the following conditions is satisfied:
1. High-Low Price Variation1 (based on corporate action adjusted prices) over a period of 3 months, 6 months, or 12 months is equal to or exceeds 1 standard deviation of the High-Low variation of all Micro-Small Cap Companies*. The minimum threshold for High-Low variation is as follows:
– 3 months: > 75%
– 6 months: > 100%
– 12 months: > 150%
2. Close-to-Close Price Variation2 (based on corporate action adjusted prices) over a period of 3 months, 6 months, or 12 months is equal to or exceeds 1 standard deviation of the Close-to-Close Price variation of all Micro-Small Cap Companies* as defined above. The minimum threshold for Close-to-Close variation is as follows:
– 3 months: > 50%
– 6 months: > 75%
– 12 months: > 100%
ESM STAGE II:
Securities that are already in Stage I satisfying the following conditions:
a) In 5 consecutive trading days: The Close-to-Close Variation2 (based on corporate action adjusted prices) is equal to or exceeds 15%. Or
b) On a monthly basis: The Close-to-Close Variation2 (based on corporate action adjusted prices) is equal to or exceeds 30%.
Nevertheless, there is no need for concern among Public Sector Enterprises, Public Sector Banks, or Securities offering derivative products, as these are specifically exempted from the ESM framework.
* Micro-Small Companies which are listed on the main board of the stock exchange with a market capitalization of less than ₹ 500 crores.
1 High-Low Price Variation refers to the difference between the highest and lowest prices at which a security is traded within a specific period. It is calculated by subtracting the lowest price from the highest price observed during that period. This variation provides an indication of the price range within which the security has fluctuated over the given timeframe.
Example: Suppose we have a stock called FMSL. Let’s assume the highest trading price during the three-month period was ₹160, and the lowest trading price was ₹100.
High-Low Price Variation = ((160 – 100) / 100) * 100 = 60%
This value is lower than the minimum threshold of 75% for the 3-month period, indicating that FMSL would not meet the criteria for the 3-month period in terms of High-Low Price Variation.
2 Close-to-Close Price Variation refers to the percentage change in the closing price of a security from one trading day to the next. It is calculated by comparing the closing price of the security on the current trading day with the closing price on the previous trading day and expressing the difference as a percentage.
Example: Suppose we have a stock called FMSL. Over the past three months, the closing prices of FMSL’s shares have been as follows:
Day 1: ₹100; Day 2: ₹120; Day 3: ₹90; Day 4: ₹80; Day 5: ₹110
Close-to-Close Price Variation for Day 2: (120 – 100) / 100 = 20%
Close-to-Close Price Variation for Day 3: (90 – 120) / 120 = -25%
Close-to-Close Price Variation for Day 4: (80 – 90) / 90 = -11.11%
Close-to-Close Price Variation for Day 5: (110 – 80) / 80 = 37.5%
(Assuming there are only 5 trading days in last three months period)
Average Close-to-Close Price Variation = (20% + (-25%) + (-11.11%) + 37.5%) / 4 = 21.39% / 4 = 5.3%
Therefore, in this example, the average Close-to-Close Price Variation over the three-month period is 5.1%. Since this value is less than the minimum threshold of 50%, FMSL would not meet the criteria for the 3-month period in terms of Close-to-Close Price Variation.
THE EFFECTS OF SCRIPS ENTERING INTO THE ESM FRAMEWORK
Securities that meet the criteria for the ESM can be transferred from the Rolling Settlement segment to the Trade-for-Trade (TFT) segment. For the scrips that are in:
ESM STAGE I:
The applicable margin for these securities will be 100% from T+2 day. Additionally, the trade settlement for these securities will be conducted under a price band of either 5% or 2% (if the scrip is already in the 2% band)
ESM STAGE II:
For these stocks, trade settlement will be conducted under a price band of 2%. Additionally, trading will be permitted once a week with a Periodic Call Auction. However, with effect from July 24, 2023, the applicable margin for these securities will be 100% and trade settlement will be conducted under a price band of 2% on all trading days under Periodic Call Auction. (NSE Circular no. NSE/SURV/57609 and BSE Notice no. 20230718-46 dated July 18, 2023, respectively.)
Once any security enters the ESM framework, it will remain in the framework for a minimum of 90 calendar days. However, if any security is in Stage II of the framework, it will be retained in Stage II for a minimum of 1 month. After the completion of 1 month, during the weekly stage review, if the close-to-close price variation of the security is less than 8% within that month, it can move to stage 1 of the framework. Securities that complete 90 calendar days in the framework (provided they meet the aforementioned condition) are eligible for a stage-wise exit, as long as they do not meet the entry criteria specified in the Shortlisting criteria for Stage I.
SEVERAL CONCERNS:
Entering the ESM can have several downsides for companies.
Firstly, companies in the ESM will face restrictions on trading, including trade settlement under stricter conditions and narrower price bands. These restrictions can limit trading liquidity and potentially impact price volatility, making it challenging for investors.
Secondly, although according to Exchanges, “shortlisting of securities under ESM is purely on account of market surveillance, and it should not be construed as an adverse action against the concerned company / entity.”, being placed in the ESM may create a negative perception among investors and market participants, raising concerns about the company’s financial health, governance practices, or compliance issues. Such negative perceptions can affect investor confidence and potentially impact the company’s reputation in the market.
Lastly being restricted access to capital and financing options. Being placed in the ESM can make it more challenging for companies to raise funds through capital markets. The negative perception associated with being in the ESM, coupled with the trading restrictions and increased regulatory scrutiny, can deter investors and make it harder for the company to attract necessary investments. This limited access to capital can hinder the company’s growth opportunities, expansion plans, and ability to meet financial obligations, potentially affecting its overall financial stability and competitive position in the market.
One of the major issues here is that once any security becomes part of the ESM framework, it remains in that state for a duration of 90 calendar days which is approximately about 60 to 62 trading days if there are no major holidays or disruptions. This extended period presents a significant drawback as there are no available actions to expedite the process. Moreover, if the security moves to Stage II, an additional month, equivalent to approximately 20 trading days, is added to the timeline.
An important question that arises is whether it is fair to restrict trading and almost diminish liquidity for companies that have paid listing fees for an entire year. On one side, the exchanges state that these restrictions are necessary for surveillance purposes, which ultimately protect investors. However, on the other hand, bynarrowing the price band, and moving the stock to the TFT segment, the liquidity of these companies is significantly reduced. Moreover, it raises the question of why such stringent measures were introduced when the Additional Surveillance Measure (ASM) and Graded Surveillance Measure (GSM) already exist.
Recently, M/s. Mercury EV-Tech Ltd, a company listed on BSE, which is currently in ESM Stage II, has challenged the framework at the Hon’ble Securities Appellate Tribunal (SAT). Prior to being included in the ESM, this stock’s weekly trading volumes typically ranged from 1 to 3 million. However, since its inclusion, the trading volumes have significantly declined, now ranging between 20,000 and 50,000.
CONCLUSION:
In conclusion, the implementation of the ESM presents a mixed bag of advantages and disadvantages for companies listed on the stock exchanges. On the positive side, the ESM serves an important purpose by fostering fair and transparent trading practices, actively detecting instances of market manipulation, and safeguarding the interests of investors. The heightened regulatory scrutiny that comes with the ESM contributes to maintaining market integrity and ensuring a level playing field.
However, it’s important to acknowledge the potential drawbacks for companies subjected to the ESM. One significant challenge arises from the trading restrictions imposed, which can have implications for liquidity. The narrower price bands and stricter trade settlement conditions can impact the ease of trading and potentially disrupt price volatility. Consequently, these restrictions may influence investor perception, raising concerns about the financial health, governance practices, or compliance of the affected companies. The negative perceptions stemming from ESM inclusion can have a ripple effect, dampening investor confidence and impeding access to capital.
For regulators and exchanges, finding the delicate balance between effective market surveillance and providing growth opportunities for companies is crucial. Striking this balance will ensure that investor protection is maintained without unduly hindering the ability of companies to raise funds, expand operations, and foster sustainable growth. Companies operating under the ESM should proactively manage their reputation and actively engage with investors to address any concerns and maintain trust in the market.
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