Increased surveillance by Sebi, stock exchanges ruins microcap party

Nearly two-thirds of sector stocks have underperformed smallcap index so far this year

An upward-trending market, heightened retail participation, and ample liquidity provide fertile ground for stocks in the micro- and small-cap universe to rally. However, increased surveillance measures undertaken by stock exchanges and the capital markets regulator Securities and Exchange Board of India (Sebi) have helped keep sentiment in check and limit excessive speculative activity, according to market observers.

At the start of the year, the micro-cap universe — stocks with a market capitalisation (m-cap) of less than Rs 500 crore — comprised nearly 1,750 stocks. Nearly two-thirds of them have underperformed the small-cap index so far this year.

While the average gain for this universe, or the National Stock Exchange Nifty Microcap 250 Index, is in line with that of the Nifty Smallcap 250 stocks, if not for tight regulatory oversight, the micro-caps or so-called penny stocks could have seen irrational price action, say experts.

“Many companies in this space ended up here after a significant loss in m-cap. Sebi has implemented restrictions like enhanced surveillance measures (ESM), and that has contained speculative action,” says Chokkalingam G, founder, Equinomics Research & Advisory.

Sebi introduced an ESM framework for ‘micro-small companies’ (stocks with an m-cap of less than Rs 500 crore) in June.

Although some of the provisions were later relaxed, a monitoring mechanism for stocks showing high price variations was implemented. Some of the restrictions included a 100 per cent upfront margin and moving stocks that met certain criteria to the trade-for-trade settlement where shares traded have compulsory delivery.

“There is heightened vigilance amongst exchanges. Even if a stock shows unusual movement for three or four days, it comes under surveillance. Most of the activity in this segment is speculative, but now, with these surveillance measures, the action has shifted to the small and medium-sized enterprise (SME) exchange. Many of these initial public offerings that came out in the past two years in the SME segment have become multibaggers,” says Ambareesh Baliga, an independent equity analyst.

A K Prabhakar, head of research at IDBI Capital, says the incentive for short-term trading has been taken away with the new measures.

“Moreover, we are at the start of a bull run; it may take time for the action to shift to these micro-cap stocks,” he observes.

While the ESM framework has helped curb speculative activity, the initial set of rules was considered draconian, leading to lawsuits and forcing exchanges to dilute the framework.

Earlier, stocks placed under stage-II of ESM were permitted to be traded only once a week within a specific price band. In July, the rules were relaxed to permit trading on all days within a 2 per cent price band and with a 100 per cent margin requirement.

BSE-listed Mercury Ev-Tech even moved the Securities Appellate Tribunal for relief against the new framework. The company had stated that placing them in stage-II had rendered its scrip illiquid, causing a loss to it and its investors.

Market players believe that while the ESM framework is curbing speculative activity, it is also draining liquidity, and new arrangements can be considered.

Deven Choksey, managing director of KRChoksey, says the regulator should facilitate the creation of market makers who will provide transparent two-sided quotes for small micro-caps.

“There are some liquidity issues in this segment, and some high networth individuals take advantage of that. Many of the mutual funds, especially small-caps, don’t take exposure until the company crosses the Rs 1,000 crore m-cap," says Choksey.

“At any point in time, the market should have a sufficient amount of depth on both the supply and demand sides. It is the lack of depth that triggers wild swings,” he adds.