Vijay Kumar Gaba

A random walk through the settlement statistic of NSE for past two decade and half decades provided some interesting insights into the market evolution over past two decades. It is interesting to note the things that have changed and the things that have not. Regardless, it is comforting to note that Indian markets are maturing well and the systemic risk appears to have subsided materially. The best part was to observe that our markets have become more democratic with deeper and wider participation.

(All data is sourced from www.nseindia.com)

Indian market maturing well

The latest bull market has shown that the Indian investors and traders are maturing very well. The tendency to recklessly over trade that was witnessed during dotcom bubble, and to some lesser extent during credit bubble of 2007-08, seems to have been reigned well now.

To give it some perspective, at the peak of the dotcom bubble, the average daily turnover of NSE was close to 0.8% of the total market capitalization in FY01. In FY08-FY09 it remained in the range of 0.3-0.4% of the total market cap. However, in the latest bull market, it peaked close to 0.3% in FY20-FY21.

In fact FY21 average daily turnover (ADT) as percentage of market cap has seen marginal decline over FY20, despite a 60% rise in the value of ADT.

Definitely, the changes in ownership pattern of Indian equity may have been at play in this. The institutional and promoter ownership is now much higher as compared to FY01. Nonetheless, there are clear signs of sensibility in day trading patterns, as depicted by the tremendous rise in the option volumes in past 10years. The traders now definitely prefer options more than the stocks, where they can better control their exposure in accordance with their risk tolerance.

A reliable evidence of the rationalization of speculative tendencies over past 20years is available in the form of lower interest in low value (penny) stocks.

In FY01, at peak of the dotcom bubble, in value terms only 8.4% of the traded value resulted into delivery of shares, while 91.6% value was intraday trading. Moreover, when we see the total number of shares traded resulting in delivery, it was 16.5%. This implies that traders were not only overtrading, they were trading more in low priced (penny) stocks.

The share of delivery in the value of trades increased to 27.6% in FY08, and this time the almost 25% of shares traded resulted in delivery; implying that the trading in penny stocks was much lower in FY08.

In FY21, the percentage of delivery has reduced materially to ~17% both in terms of value trade and number of shares traded; implying that traders continue to be cautious about penny stocks and focusing more on mid and large cap stocks for taking delivery.

Another evidence of market maturity comes from the share of smaller companies in the overall market activity.

In FY01, at the peak of dotcom bubble, numerous small, hitherto unknown and often unsustainable businesses were the top traded shares on the stock exchanges. In top 10 most active securities, 7 had market cap of 1% or less of the total market cap of NSE, with 4 having a market cap that was less than 0.1% of the total market cap.

In that year, on NSE the top 10 most active securities accounted for an insane 73% of the total traded value; whereas these securities accounted for just 13% of the total market cap. Himachal Futuristic (HFCL) with just 0.17% of the total market cap was the most active security accounting for over 15% of the total market turnover. Two other small cap companies Global Telesystem (0.11% of total market cap) and DSQ Software (0.05% of total market cap) accounted for 9% and 6.5% of total turnover respectively. To put this in perspective, the company with the largest market cap (Reliance Industries, 6.25% of total market cap) accounted for just 4% of the total turnover; and IT bellwether Infosys with 4.1% of total market cap, accounted for 8.1% of the total market turnover.

In FY08 also, 4 companies accounting for less than 1% of total market cap of NSE figured in the top 10 most active securities. The 6 top most active securities were Reliance group companies. But, the top 10 most active securities accounted for just 27% of the total turnover. Reliance Industries with 6.8% of total market cap contributed just 5% to the total turnover. IFCI was the only microcap stock in top 10 most active securities list.

Things improved significantly in FY20, when top 10 most active securities accounted for 20% of the market cap and 26% of the total turnover. Though this year also 4 companies with less than 1% of the total market cap figured in the list, the skew of share in total turnover was much smoother. Reliance Industries was again the top traded stock, but now accounting for just 3.6% of total turnover.

 

Systemic risks lower now

The stricter compliance norms, improved surveillance and disclosure practice and wisdom gained through hindsight have resulted in materially lower systemic risks in the markets.

Though the common man had started to participate in the stock markets from early 1990s as the economy was opened up, the development of Information Technology industry in late 1990s provided the real impetus. A large number of IT workers came from middle and lower middle strata of the society and had an opportunity to work in global companies. Young professionals from the smaller towns migrated to metropolis and foreign countries. ESOPs became popular and that laid foundation for a deeper and wider participation in the stock markets. The understanding about the financial investments however did not grew in tandem with the understanding of complex IT algorithms.

Besides, a large number of new entities, dealing in new economy businesses and services, came into existence. Many of these companies did not survive the test of solvency for long. Consequently, about one third of the companies listed on NSE in March 2000 had vanished by March 2004.

This was not repeated in 2008-09 and 2020 market crashes. The number of companies available for trading on NSE increased by 25% during the period from March 2007 to March 2010. During the period between March 2020 and March 2021 also the number of companies available for trading has increased by 1.5%.

Democratization of Indian markets

A key development in the stock market has been the democratization of the markets. Not long ago in the history of Indian stock market, the market participants were a small privileged group of people, mostly from established industrial families or senior corporate executives.

Common household investors had begun meaningful investment in listed equity in late 70’s at the time of forced dilution of foreign owned companies operating in India, under the provisions of a stricter Foreign Exchange Regulation Act (FERA). These companies now known as MNCs were then referred to as FERA companies in common market parlance.

Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^nd lot of household investors. IT boom of late 90’s drew the 3^rd and the largest set of new investors to the listed equity. However, the participants were mostly concentrated in the few larger cities of some industrialized states. The four top cities accounted for more than 80% of investment amount and investors.

Anecdotal evidence point to the fact that Covid19 enforced lockdown has drawn the latest set of investors to the equity markets. 2020 was the period when many businesses were either locked down or their workers were operating from home, whereas equity markets were functioning uninterrupted. This was one trading business that could be done from the comfort of homes and without any additional investment in infrastructure or facility building.

Since, traders and small business owner had no work to do; and bank deposit and bond returns were falling; many of them deployed their working capital in the equity trading. Many small and micro businesses which were declining since demonetization and GST implementation also shut down during this period, with their owner shifting their focus on financial investments.

Thanks to the significantly improved accessibility due to the financial inclusion efforts, technology and Fintech popularity, the participation in stock market is now much deeper and wider. People from across the country and wider spectrum of socio-economic background are participating in the equity investing.

One glimpse of this democratization process could be seen from the average trade size on the stock exchanges. In mid 1990s the average trade size on NSE was in excess of Rs1,00,000. This fell below Rs20,000 by FY12. In FY21 it has increased to above Rs 33,000, (higher than the past five year average of Rs26,000), but has again declined to around Rs29000 in past couple of months.

In a market with total market cap of Rs250trn, where the delivery percentage is just 17% of the total value and number of share traded on daily basis, an average trade size of Rs29000 is a stronger indication of democratization of market than the number of trading & depository accounts opened or mutual fund portfolios created.

The new margining norms proposed to be implemented from 1 August 2020, in respect of the equity market trades done on stock exchanges are a cause for worry for one simple reason, i.e., this highlights for the n^th time that the securities market regulation in India lacks a robust conceptual framework.

It is important to understand that regulation of securities market is like salt in a dish - any excess or less magnitude of regulation could make the dish unpalatable.

Any market participant would vouch for the fact that the regulators understanding of the risk management needs in the securities market is inadequate, as it relies more on adhoc methods rather than a strong conceptual framework. In the event of a crisis, comes out like a brave fire fighter and douses the fire with whatever tools it has. Unfortunately, there is little empirical evidence to highlight that SEBI has taken enough preventive measures to stop frequent occurrences of crisis in the market. We frequently witness the cases of blatant price manipulation, malpractices, and unethical conduct by corporates, intermediaries and large traders (called "operators" in the common market parlance). In past 28yrs of SEBI existence as statutory market regulator, there has been little diminution in the frequency or intensity of these instances.

The market participants will also vouch how much detrimental has been the SEBI's intervention in the matter of securities' classification for the purposes of categorization of mutual fund schemes. Ideally, the regulator should have flagged its concerns to the industry and self regulatory organization governing the industry, and let them evolve the optimum solution. Not relying upon the industry and imposing rules which made little sense caused tremendous pain to the industry and investors, and benefitted almost none.

One primary reason for this in my view is the lack of a robust conceptual framework for securities'' market regulation. For example, let us consider the instant case of revision in margining norms.

Minimizing the systemic risk is one of the paramount concerns of the securities' market regulation. Imposing prudent margining requirement for traders is one of most popular and effective method of managing the systemic risk. However, it defeats its purpose if margins become excessive or impractical. It is important to understand that margins are used to mitigate systemic risk of default on settlement obligation and not for the purposes like managing the trading volume etc.

There are two types of margins imposed in cash market, viz., (i) Value at Risk Margin (VaR) and (ii) Extreme Loss Margin (ELM). VaR is calculated based on historical volatility and trading pattern. This covers the normal expected adverse movement in the stock price in one day. ELM is used to cover exceptional volatility due to some extreme event. These margins should be adequate to cover 99.999% of cases of payment defaults.

When, an investor sells shares in the market, the default counterparty is the clearing corporation (e.g., NSCCL). Thus, the clearing corporation guarantees the settlement of all the trades executed on a recognized stock exchange. The moment trade is executed and securities are delivered to the clearing corporation as pre pay-in, the VaR for the seller  defaulting on its obligation becomes Nil. Since the counterparty is clearing corporation, the risk of counter party default for the seller is also Nil. Not allowing seller to use the sale proceeds for buying other securities is certainly no prudent risk management. This in fact creates doubts about the infallibility of clearing corporation itself, which in turn makes the whole argument of trade guarantee and secure settlement system suspicious.

There are also chances that some of the traders may move to grey market (dabba market in common market parlance) for trading, thus exposing themselves to larger risk of default.