Sebi looking for better risk management

Mulls safeguard against flash crash

Market regulator Sebi is looking to strengthen the risk management framework of Indian stock market to ring-fence it against a ‘flash crash’ like scenario — where value of a stock or index get severely beaten within seconds due to a punching error or even a manipulative trade.

The Indian markets have witnessed at least three cases in the past few days when the value of a stock or index plunged sharply within a few seconds.

Although top officials at Sebi and stock exchanges are not willing to call them ‘flash crash’ cases, as a recovery was quite fast in those cases, a consensus has emerged that systems need to be strengthened to avoid any similar, or even worse, cases in the future, sources said.

In most likelihood, these were cases of ‘fat-finger trade’ — a term used for punching error or wrong pressing of orders on the trading terminals, a senior official said.

The upcoming guidelines for stress testing of stock exchanges would ensure that appropriate systems are in place to safeguard the interest of investors from any ‘flash crash’ like scenario, he added.

On Friday, April 20, the Nifty futures witnessed a sharp plunge of nearly 7 per cent for a few seconds, and some market players put the blame on a huge sell order executed by mistake. The day also saw a sharp plunge in Infosys futures. However, the recovery was fast, limiting the estimated loss from the two freak trades at less than Rs 10 crore.

Later, NSE clarified that the trading systems worked normally and all the trade executions were within the price limits prescribed by Sebi.

“The Exchange is examining the causes for the sudden fall in the Nifty, as part of normal investigation procedure. NSE further clarified that no trades were cancelled or annulled by the Exchange,” it said in a statement.

However, these two freak trades came within days of the two benchmark indices Nifty and Sensex witnessing a sharp plunge for a few minutes, which is widely expected to have been caused by huge sell orders in some blue-chip stocks. Also, last year on Diwali day on October 26, 2011, the BSE had to annul all its derivatives trade executed during its Muhurat Day trading after some freak trades were noticed.

Earlier on June 1, 2010, a presumably freak trade pulled down the share price of Reliance Industries by nearly 20 per cent, while the benchmark index Sensex also fell by more than 400 points within minutes to a one-year low.

The US markets witnessed a far worse ‘flash crash’ on May 6, 2010, when its benchmark Dow Jones index fell by over 900 points, or about 9 per cent.

While there have been no major ramifications so far from various ‘freak’ trades in the Indian market, the regulator wants to put in place a robust system to safeguard the markets against any across-the-board panic sale due to sharp plunge in one individual security. The stress test would prepare the bourses for handling situations where any sharp fall in share prices of one stock, possibly because of a freak or wrongly-entered trade order, can result in panic-selling by investors.