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Come July 2nd, SEBI will be enforcing some important decisions to streamline market operations. With the introduction of rolling settlement, options on individual stocks and ban of deferral products a new era will be launched in the history of the stock market here in India. After the advent of the NSE and dematerialisation of stocks, this may be the most important set of changes in the stock market. The two most important aspects of the new market would be rolling settlement and derivatives. The introduction of derivative products should make available better risk management products for individuals and institutions.

Rolling settlement is to be introduced in 414 stocks. The deferral products such as ALBM, BLESS and various forms of badla would go. All incremental positions would have to be squared off by July 2, 2001. SEBI would introduce options on individual stocks. All other stocks would be ushered into rolling settlement in a phased manner. These stocks would be under uniform settlement till then. Also at present, there are stock-specific circuit breakers. These would now go and make way for index-linked circuit breakers.

What will be the impact of these changes on the small investor?

The introduction of rolling settlement in 414 stocks is bound to have a disconcerting effect on trading volumes and, to some extent, on prices as well. With rolling settlement in place, investors cannot undertake intra-settlement speculation as they have to settle their account at the end of each trading day. This will invariably bring down speculation in the spot market. Therefore, liquidity dries up. Even in some of better-known stocks where SEBI had introduced rolling settlement, this was the trend. Now bigger names are in the list and the effect may be more pronounced. Liquidity will also be impacted because at the moment it seems like mutual funds cannot write options. The decision is supported by stating that in the US, many funds do not participate in the derivative market except for hedging purposes.

The stocks that are now going into rolling settlement are the ones which speculators and investors cannot avoid. Once the speculative positions are unwound, pricing may start to quickly take place under the new settlement form. This could happen at least in frontline stocks such as Infosys, Hindustan Lever, TISCO, Satyam Computer, Grasim, HDFC, HDFC bank, Reliance Petroleum and Reliance Industries. In other stocks where liquidity levels are lower or speculation has been highly concentrated, the process of price formation under the new system may take time and also entail bigger losses.

In this context, it may be better for investors to stay clear of frontline stocks for the next month-and-a-half and start making commitments later. This should also be largely true for investors through mutual funds. Wait and watch the kind of effect the new system has on prices and look at making investments at least two weeks after the rolling settlement.

However the derivatives market ought to give much more scope to speculators. With a host of products likely to be introduced, including options on individual stocks and indices, a savvy speculator should have plenty of opportunity to speculate. For instance, take the case of an investor with a long position. Under the badla system, an investor pays a badla charge for increasing his delivery maturity. That is, he pays a charge to delay taking delivery of the stock. In effect, he postpones taking delivery of a stock and for that benefit, pays a charge upfront. Now, consider an investor who holds a `call option'. An option on a stock gives him the right to buy a fixed quantity of the shares at a fixed price. For this purpose, the investor pays a premium upfront. Both the systems, result in extending the delivery maturity for the investor. Both the products involve cash outflows (option premium and badla charges). There are subtle, but important, differences that make options
a better product.

For the stocks that are not going into rolling settlement now, SEBI has proposed to introduce uniform settlement -- Monday to Friday. This could lead to major trading pattern changes on the National Stock Exchange which operates on a Wednesday to Tuesday basis. The uniform settlement system could lead to a trimming down on arbitrage linked to different prices at different exchanges. At present, this factor is significant in day-to-day trading patterns. Unlike normal business arbitrage, this is a self-created one by stock exchanges to encourage business.

The one gaping hole in the emerging structure could be the absence an institutionalised lending and borrowing mechanism. This could affect liquidity. Though options would be available, these may not serve the purpose of investors/speculators who want to capitalise on short term price trends. Only the presence of a transparent lending and borrowing mechanism could provide a complete market structure.

By doing away with stock-specific circuit breakers SEBI has taken a measure that was long overdue. The presence of a 12 per cent, 16 per cent and 24 per cent circuit breakers could mean that the effect of any corporate action is spread out over a number of days. In contrast, even a 40 per cent or 50 per cent fall to adjust for corporate effects is common in the US market on a single day. This may be better than a spread out of the same over days, as the latter imposes costs on investors. To go with this move, SEBI could contemplate introducing the concept of a trading halt to enable the market digest news.

But more importantly SEBI seems to have realised that the most important issue would be awareness of new products among investors and is planning to take appropriate steps to increase awareness among investors.

Aru Srivastava

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