SEBI Proposal to Introduce Call Auction Market as a Trading Platform
to Deal with Illiquid Stocks

SEBI proposes to introduce call auction market (CAM) at Over the Counter Exchange of India (OTCEI) to provide a trading platform to investors and brokers of the exchange. The introduction of `call auction market' has precedents in other markets and is expected to bring specific advantages to the table in this country. As per SEBI Chairman Call auction is a mode of trading that became ineffective in the pre-computer days but is staging a comeback in an electronic environment. Batching orders for simultaneous execution at a single moment in time at a single price is the essence of call auction trading. Because its determination is based on the full set of orders, the clearing price in a call auction can be thought of as a `consensus value.' This contrasts with a continuous market where a transaction is made any time a buy and sell order meet in price, and where price generally fluctuates as the orders meet.

The order book in this segment will remain open for a longer period for buyers and sellers to give their quotes, in order to match demand and supply for these illiquid stocks. The settlements also will be done over a longer period, instead of the regular three days or T+3. In the call auction market, the exchange batch orders and prices are determined via consensus.

The unique features of Call Auction Market are brought vividly by the book titled “The Electronic Call Auction: Market Mechanism and Trading Building a Better Stock Market” and edited by Robert A. Schwartz - The New York University Salomon Center Series on Financial Markets and Institutions. The author aptly comments-

“Recent advances in computer technology have considerably expanded the call auction's functionality. We suggest that the problems we are facing concerning liquidity, volatility, fragmentation and price discovery are largely endemic to the continuous market, and that the introduction of electronic call auction trading in the U.S. would be the most important innovation in market structure that could be made.”

The above book had its origin in a symposium, Electronic Call Market Trading, that was held at New York University's Salomon Center on April 20, 1995. At the time, three proprietary trading systems based on call auction principles (The Arizona Stock Exchange, Posit, and Instinet's Crossing Network) had been operating for several years and interest already existed in the procedure. Since the symposium, increasing use has been made of call auctions, primarily by the Paris Bourse in its Nouveau Marchi and CAC markets, by Deutsche Börse in its Xetra market, and for fixed income in the U.S. by State Street's Bond Connect. Rather than being used as stand alone systems, however, call auctions are now being interfaced with continuous markets so as to produce hybrid market structures, a development to which considerable attention is given in a number of the chapters in this book.

• OTC Exchange of India (OTCEI), the country’s first screen-based exchange, plans to introduce a separate market called the ‘Single Call Auction Market’ in addition to the normal trading market.

• Unlike the normal market, here the investor will be allowed to place his orders in an allotted time frame. The uniqueness of this market is that the order will start getting executed in a specific allotted time.

• This market will be open for placing orders from 10 am to 3 PM, while matchmaking or price discovery will take place after 3:30 PM. After 3:30 PM, the entire matchmaking process will get executed in a few minutes.

• Participants will have the option to revise or withdraw their orders in the allotted time between 10 am and 3 PM.

• By way of an example: Consider an investor putting an offer (sell order) for scrip X at Rs 10.

• The matchmaking will take place after 3:30 PM and if there is any bid at Rs 10 or above his offer, it will get matched. His offer will, however, get rejected if all the bids are below Rs 10.

OTC Exchange of India proposes to initially introduce about 250-300 scrips in this category. Later, the Bourse would form a different category of Scrips depending upon liquidity, and would also raise the number of auctions in a day in this category.

OTCEI have received the clearance from the Securities and Exchange Board of India (Sebi) during March 2004 and expects to introduce this single call auction market in the next three month’s time. Already, they have 800 brokers and a nation-wide presence and reach

Scrips to be introduced in the Call Auction Market would be selected on the basis of four to five categories. These include the free-float of the stock, track record of the company in the last five years or above, dividend-paying track record — it should be at least once in last three years or two in last five years and the company should have a track record of existence. As investors become comfortable with the system, then an equilibrium price can be set for particular scrip. The scrips to be introduced in this market can either be in the permitted category or listed category.

• CAM provides a market-trading environment, which introduces concentrated visibility and attention on illiquid stocks that would be exclusively traded. Batching orders for simultaneous execution at a single moment at a single price is the essence of call auction trading. Investors would be more comfortable to trade having the information on demand and supply in specific scrip.

• Consequently the regular stock exchanges, brokers, depository participants, depositories, custodians and the regulator are freed of this strain and attend to the normal functions

• This is possible due to segmentation of the large number of stocks that was illiquid and eligible to converted into separate category for CAM.

• As a result, in the continuation market, one has to monitor only a limited number of stocks, which is highly priced with large volumes.

• As a measure to check excess volatility, SEBI proposes that call auction market may set a price band of 20 per cent on either side with reference to the immediately previous closing price