Major Factors Needed to be considered while Framing the System to Bring Illiquid Stocks
Back to Life through Call Auction Market

The framework of the new system should take into account and redress the drawbacks of the existing continuous screen trading system of the two major exchanges and that of the Regional Stock exchanges, that has resulted in this problem getting aggravated instead of being arrested. The following strategies are suggested.

1. Organize separate segment/trading forum for illiquid stocks. While the RSEs enjoy negligible turnover, the two major bourses (NSE & BSE) have turnover but of restricted trading choice within a narrow list of securities at the cream layer. The bunch of mid-cap stocks lying underneath the stack is not touched. Not that these are rejected suo moto. The fact is that these securities of smaller firms fail to draw investor interest in a particular environment. Small and medium investors play negligible part in these Exchanges. Since high net worth investors speculate on short-term market fluctuations and intend to off-load securities quickly whenever chosen, they give top priority to consideration of liquidity of the stocks to be invested by them. The revised scheme should therefore focus on mid-cap investors who would accept the yardstick of low-risk with moderate to high profitability, as against that of high-risk and high-profitability and liquidity, as envisaged by speculators and high net worth players. Even if the profitability ratio is high, since the securities are low priced in terms of market value, these will not attract speculators and high net worth investors.

2. Price settlement through consensus- The Investor would look for more competitive price (albeit higher profitability) to compensate for the liquidity-deficiency. To quote “The consequent order imbalance can be cleared only if there exist traders who are willing to absorb the excess demand or supply at a price concession, of course. In other words, the traders who want to buy immediately can do so at a higher price and, similarly traders desiring immediate sale have to accept a lower price. In India the liquidity traders do not have this facility at this time, since there are neither any prearranged dealers for the stocks nor a mechanism for aggregating limit orders. Therefore, at a given time, if there were no liquidity-motivated traders on one side of the transaction, then one would expect no trade to occur.”[Liquidity, Stock Returns and Ownership Structure: An Empirical Study of the Bombay Stock Exchange Dr. Venkat R. Eleswarapu, and Dr. Chandrasekar Krishnamurti]. It is this feature/facility that Call Market should now incorporate.

3. Select securities carefully- An ABC analysis of the illiquid securities would reveal the “A” category scrips amongst the group, where the positive features would out- number the negative, where it would be found attractive by investors to invest in these securities even if they were to hold the same for 6 months to 1 year duration. The same forum of call auction market would be available to the buyers to subsequently off-load these securities, and hence they need nurse no fear on this account.

4. Publish relevant/useful information on each such security to enable investors arrive at informed decision on price determination. In this respect the role that the corporates (Issuers of these securities) have to play cannot be minimised. Information about management (indicating the professional content and the level of corporate governance implemented), trading particulars for the last 3 to 5 years indicating EPS (earnings per share) and P/E Ratio (Price/earning ratio) to be disclosed. As information content and quality thereof of an offer document would facilitate the success of a new IPO, the information support of the Issuers is a prime pillar for the success of the scheme to off-load illiquid shares. In fact the illiquid shares would turn liquid, when the management of the firm issuing them turn professional business managers and follow norms corporate disclosures to its entirety

5. The order book (an exclusive nation-wide electronic order book) in this segment should 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.

6. The trading system should be different from the continuous market where a transaction takes place whenever buy and sell quotes are matched automatically in the exchange trading system and where price generally fluctuates as the orders meet. Instead of a continuous market where buy and sell orders are constantly matched, in the call auction system exchanges will match orders, and prices will be determined on a consensus basis.

Effectively, the method of trading should seek to determine a single price at a single point of time for an entire batch of orders. Also, a longer settlement period is being contemplated for this segment. The rationale is to try and stimulate trading in illiquid stocks.