Algo trading and delisting of illiquid stocks

According to this article SEBI is planning to delist several illiquid stocks(4200) from the Indian stock market. India has a large number of stocks listed in the stock exchanges but almost no trading ever happens in quite a lot of them. And some of these stock are used for illegal transactions. I think this is welcome move from SEBI.  the article has also mentioned that SEBI is planning to bring new regulation in Algo-trading which is also a need of the hour in India.

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Entry Fee of Funds in UK

This article in financial times talks about fund are using entry load fee to exploit naive investors and also how UK regulator is looking into the issue. As the article has noted India is ahead of Europe in this issue. Indian regulator SEBI has banned entry load of mutual funds in 2009. I have mentioned this fact in my blog earlier here.

An interesting difference I found in this article between India and UK is that Indian investors are charged less if they directly buy from the fund (direct option) while it is reverse in UK. This doesn’t make sense because if the investor directly approaches the asset management company(AMC),  AMC doesn’t have to pay any amount to the intermediary and they should pass on this benefits to the investor. But it seems European AMCs prefer having investors coming through regular channels.

I think I am missing something in the whole issue. The article does note that the investors directly approaching the AMC will increase costs over the regular channels like exchange but I am still not convinced that the costs increase to that extent. because of the cost structure the investors who are approaching the AMC directly can be considered as naive investors. This is exactly opposite in India. Investors directly investing with the fund management company are considered intelligent!! In fact SEBI has been bringing several new regulations into effect to ensure that investors directly approach AMC rather than regular channels.

NSE controversy – Part 2

This article on mint talks about the response of NSE on allegations about which I have written in this blog here. NSE in its response has completely refuted all allegations against it that it favored few brokers over others.

““NSE’s response is rather comprehensive; they have refuted allegations of collusion. They have highlighted that they did not violate any regulations that were prevalent during the relevant period. The exchange has also spoken about certain factual inaccuracies in report and sought fresh examination of the issue,” said the second person, he too declined to be named considering the sensitivity of the issue.

The allegations against NSE pertain to members who co-locate their servers on the premises of the exchange. Even at these co-located centres, some of the servers themselves might have differing hardware capabilities or workloads.

This issue first came to light when a whistleblower who went by the pseudonym Ken Fong wrote to the regulator alleging that NSE’s systems were being misused, and that some people consistently enjoyed advantages to the detriment of others. The minutes of Sebi’s technical advisory committee said that it had received three such letters from the whistleblower.

After examining the issue, a Sebi panel had recommended action for lapses on the part of NSE and exploitations made by brokerage OPG Securities under the guidance of the panel. The panel further advised Sebi that it may constitute a team comprising people with appropriate background to investigate the collusion aspect between NSE officials and OPG.

The report in question was prepared by a sub-committee constituted by TAC. This sub-committee had six Sebi officials and Om Damani, a professor of computer science and engineering at the Indian Institute of Technology, Bombay. In its report, the sub-committee said the bourse had not provided adequate details to the committee examining the issue.

NSE in the reply has stated that allegation that the bourse had violated norms by allowing non-ISPs such as Sampark (Infotainment) to lay dark fibre on its premises for various members is factually incorrect, said the second person cited above. ISPs refer to Internet service providers. According to NSE, Sampark was a sub-vendor of a registered ISP, the second person said.

Dark fibre refers to a dedicated communication line through which data travels faster than regular lines because of the absence of other traffic. As such, there is nothing illegal about using such faster connectivity infrastructure.

NSE, in its response, has also pointed out there were no clear regulations at the time of alleged violations. Between 2011-2014 the period, when certain brokers allegedly gained unfair advantage, there was an absence of regulations and tools that are currently being used to allow for fair access to market data and exchange platform, NSE has highlighted, said the second person.”

I think the words by people interviewed in the are rather carefully chosen. NSE may not have violated the regulations at that point in time but that does not necessarily mean they have acted in an immoral way. Regulations more often than not lag markets. Even in the present case India is still developing its regulations with respect to algo and high frequency trading. However lack of regulations does not mean that NSE is not responsible.

“The first responsibility of an exchange is fair access of the order book to all investors, if that is being violated then it puts question mark on the integrity of the exchange. The justification that there were no regulations during the relevant period is immaterial as the first principle that is fair access has been violated,” said Shriram Subramanian, founder and managing director, InGovernResearch Services Pvt. Ltd.

Sebi’s technical advisory committee had suggested that a framework should be established within Sebi and stock exchanges to detect any abuse of the system by algo traders.

According to a 17 May Mint report, Sebi has already started implementing the recommendations of the panel which advises it on algo trades. In consultation with Sebi’s technical advisory committee earlier this month, the regulator has decided to have more checks and surveillance at the level of exchanges. To ensure this, NSE and BSE Ltd could be asked to constitute a separate team to keep an eye on algo trades, Mint reported. These checks would be in addition to the existing surveillance systems of exchanges.

 

Side Pocket in Indian Mutual Fund Industry

This article says that SEBI is reluctant to provide rules for creation of side pockets.

“A side pocket is used by fund managers to separate stressed or risky assets from other investments and cash holdings. Fund houses create side pockets to ensure that while a proportion of investor money (in the scheme) linked to stressed assets gets locked until the fund recovers dues from a stressed company, investors are free to redeem the rest of their money if they choose to.”

The rational is that allowing isolation of risky assets from the rest fund would encourage fund managers to to take on more risk.

“Sebi is of the view that mandating the creation of a side pocket, to minimize the redemption pressure on the entire fund arising from their exposure to any particular company, could lead to some fund managers taking unnecessary risks,” said the chief executive officer of a large fund house, requesting anonymity. ”

However lack of rules can also lead to chaos and confusion among the mutual fund managers. Recently when Amtek Auto was downgraded JP Morgan had restricted redemption of Mutual Fund units and created a side pocket to isolate Amtek Auto from the rest of the portfolio.

 

RTA scam

This article talks about a financial fraud which didn’t receive much coverage in the main stream media. Some more coverage can be found here. I have covered the functioning of an RTA in my other article here. However RTA can in general also provide service to companies instead of just mutual funds discussed in the article.

Shares/dividends can remain unclaimed because the initial owner might have died and his family might not have been aware of this; or forgotten; or the ownership documents might have been lost and the owner didn’t want to perceive it because of cost benefit analysis. At times the owner might decide against putting effort to en cash a small dividend.

When a fraudster becomes aware (usually with the help of employees of RTA) of any unclaimed shares/dividends lying around for a long period of time he produces fake documents and claims himself to be the rightful owner. As long as the rightful owners are not aware of this and don’t approach the company there is very little chance of catching these rightful owners. The only way is to put stricter norms for claiming the shares.

Cheating small investors in Mutual Funds

This old article describes a way in which mutual fund distributors  and large investors collude to exploit small investors. Luckily SEBI has taken some measures to reduce this though.

“If the MF has spent 5% of the new fund raised towards the above expenses, effectively only Rs 95 of every Rs 100 will be available for investment. Rs 5 is treated as “asset” for the purpose of computing net asset value (NAV) and is amortized over a period of five years. In open-ended schemes, investors can enter and exit at will.

Such frequent transactions lead to transaction costs, the need to keep some funds in cash (an inefficient form) and liquidity risks or that of the availability of opportunities. But, a survey of entry/exit load structures indicates that, by and large, all funds tend not to charge either entry or exit loads on investments over Rs 5 crore.

Let us examine how this bias works. Suppose, a MF has collected Rs 100 crore and issued 10 crore units of Rs 10 each by spending Rs 5 crore towards marketing the issue. About Rs 30 crore is invested by four investors with an average investment of Rs 7.5 crore.

If there is no exit load, these four investors are free to exit any time at the prevailing NAV. If they exit in two days after the allotment without paying an exit load, the remaining unit holders will have to bear the expense towards marketing activities. The Rs 5 crore will be spread over Rs 70 crore instead of Rs 100 crore.

If any investor with an investment of under Rs 5 crore exits at the same time, s/he will be charged a proportionate cost of the marketing expenses or exit load. Besides, distributors who earn commissions of up to 4% of the funds raised often share this commission with large investors.

This practice induces “flight of investments” from one new fund to another as it is beneficial to both parties, even as the smaller investor suffers silently. The reform introduced by Sebi in the rationalisation guidelines simply puts a full stop to this practice.

They effectively force MFs to levy entry/exit loads on every investor that enters/exits a scheme or absorb the expense in to the fee charged by the MF scheme towards fund management. The new rules subtly introduce a cap on marketing and distribution expenses.

Funds that intend to charge higher entry/exit loads will not be able to garner subscriptions due to which they would like to keep them as low as competition permits. The ability of distributors to demand and extract higher commissions from fund houses will substantially diminish since a MF cannot pay more than the loads collected from investors.”

SEBI looking to reduce algo-trading advantages

This article says that SEBI is contemplating introduction of measures to reduce the advantages of High Frequency traders.

“The regulator is also exploring the possibility of order randomization to limit the advantages enjoyed by these entities which have a speed advantage over others. All the orders received within a set period (for example: two seconds) would arrive at the exchange only after randomization, said the second person. Since the period is small, there would be limited impact on non-algorithmic trading players. This will, however, reduce the advantage of speed enjoyed by algorithmic traders since all orders would be intermingled before execution”

HFT has its own positives and negatives. Research has shown that HFT/algo-trading improves liquidity. However there is a increased threat of flash crashes. Google search on the topic gives some of these articles – here and here.

Frankly very less research has been done on HFT in India and needs a more thorough analysis. Any policy implementation without thorough analysis is not going to give desired results.