Stock brokers can no more play the ‘no limit game’. The National Stock Exchange (NSE) has asked brokers to pre-define order limits, based on various criteria, of each terminal through which they operate in both the cash and derivatives segments, across asset classes.
This is after the recent flash crash that saw the benchmark S&P CNX Nifty index of the NSE crash 16 per cent in two minutes, due to a freak trade in the cash segment. Earlier this month, a trader with Mumbai-based Emkay Global Financial Services punched an erroneous order, which got executed in 59 trades at lower prices pulling the market down in the cash segment. The order got punched for more number of shares than the trader intended, leading to chaos. The order was worth nearly Rs 650 crore.
The NSE has 200,000 trading terminals across the country and around 1,500 members. Though NSE terminals require brokers to define their orders, most trading houses had put their terminals on ‘no limit’ mode, as a matter of convenience for quick execution of large institutional orders.
Following the flash crash, the exchange had stressed that brokers should have checks and balances at their level, too. But experts had criticised NSE and expressed a view that exchanges should have checks and balances to handle crises if brokers’ risk management systems fail.
NSE has said trading members will now have to pre-define the limit of each order based on quantity, value, user, branch and spreads for every terminal. Spread is the difference between two ticks. This will allow the exchange to undertake better risk management in case of punching or other erroneous trades.
The Bombay Stock Exchange (BSE) said their BOLT terminal already requires brokers to specify limits. This apart, the exchange also requires collateral of 10 times the order size if the trade value is more than Rs 30 lakh. Even NSE follows strict collateral norms.
However, trading experts say there is further scope for tightening risk management in the derivatives segment.
“Exchanges in India do not have a circuit breaker for stocks in the derivative segment and order limits for futures and options are unduly high. More, exchanges should have cumulative order limits per minute or per second to contain risk. The is due to the fact that if exchanges do not manage order limits per minute or per second, then even small erroneous orders going through high frequency trading can cause chaos,” said the head of a trading technology company that caters to members of both NSE and BSE.
However, NSE had recently tightened the criteria for choosing stocks for the derivatives segment. The key idea was to allow only liquid counters to be traded in the futures and options segment.
According to NSE, a broker can, at any time review his pre-defined limits according to requirements but will have to submit a certificate to the exchange on a quarterly basis. The certificate should include details of limits after assessing the risks of the terminal user, which should be done keeping the capital adequacy ratio of the member in mind.
This is the second attempt so far this year at tightening risk management systems by stock exchanges in India. In July, both BSE and NSE had imposed a fee on algorithm trading to curb excessive speculation. This trading fee on pre algo order discourages arbitrageurs, who speculated in a huge way to take advantage of the one to two paise price spreads. In June, the Infosys share had crashed by 20 per cent, pulling down the benchmark index S&P CNX Nifty of NSE. Algo trading was found to be the catalyst for this crash.
In the US and Europe, regulators are still discussing ways to curb excessive speculation through algo trading. While exchanges in Europe may soon be asked to impose trading fee on large algo orders, the US exchanges recently implemented circuit breakers for their indices. For many years now, exchanges in India have had circuit breakers for indices. Only, US exchanges were more liquid and such a measure was not required till now. But this belief was challenged by the flash crash of May 2010.
