First, the Indian markets must be very illiquid. If Rs. 650 crores ($ 122 million) can make every index stock collapse (the index assigns more weightage to the most liquid stocks - crudely put), the market isn't deep at all. And that too at the market which is substantially larger than its competitor, the BSE.
Second, the SEBI rule mandates a market halt at 10% levels (not a halt on receipt of new orders, but also execution of past orders). Why did the market fall to 15.5% levels. If the system takes that long to react, maybe it's time to slow down the system so it can cope with the clearly stated law. The SEBI mandate is clear and I'm not sure an officer of SEBI can relax it (assuming it was relaxed by a phone conversation). I have copied the SEBI Master Circular below this piece.
Third, the trading halt means stopping of not just orders but of the execution machine. In the flash crash, only orders were stopped and that too late. The old orders continued on the rampage and the fall continued upto some 19% levels. That is not what should have happened. At 10% both orders and execution should have stopped. When you touch a live wire in a house the circuit breaker is supposed to shut the current nearly instantaneously - it is no good to stop it after a person is paralysed.
Fourth, the NSE derivatives market should also have shut. There is no discretion to shut only part of the market. In fact, even BSE should have shut down as a rule (see below the exact words). SEBI needs to ensure that the exchanges connect electronically and everything is shut down - or create narrow exceptions for certain situations.
Fifth, the market needs to be shut for 2 hours after such a fall (not one hour since the fall was over 15%) - it was in fact shut only for 15 mins.
Sixth, isn't there any exchange system which can figure that an error trade or even a disruptive trade has occurred and stop the order? If arbitrageurs can make money in 5 seconds from the erroneous trades, shouldn't the exchange computers have figured this out in a fraction of a second?
All these raise important exchange design issues and clearly SEBI needs to step in to ensure that the systems are tightened, so that clearly stated rules are followed. I don't subscribe to the rule that the computers take that long to react - if computers can match order in one thousandth of a second or a millionth of a second, why can't they shut the system in an even shorter time frame. The software has to be written with the law in mind not the other way around. As I said to the Financial Times today: “I don’t see this as an excuse at all,” “If you can’t handle milliseconds, don’t have milliseconds. The regulations are clear. To shut at 10 per cent means to shut at 10 per cent.”
NSE has done a great job as an exchange all these years, but that is no reason not to take responsibility for their mistakes and commit to introspection. After all a market designed to protect investors would also protect itself from potential liabilities. I would of course like to hear from NSE and if they have a different version - I will be happy to post them on the blog.
2.1 Index based Market wide circuit filter
These circuit breakers are used to stop adverse movements either way. The circuit breakers are applied at three stages of the index movement either way at 10%, 15% and 20%. The market wide circuit breakers would be triggered by movement of either BSE Sensex or the NSE S&P CNX Nifty whichever is breached earlier.
i. In case of a 10% movement of either of these indices, there would be a 1 hour market halt if the movement takes place before 1 pm. In case the movement takes place at or after 1 pm but before 2:30 pm there will be a trading halt for ½ hour. In case the movement takes place at or after 2:30 pm there will be no trading halt at the 10% level and the market will continue trading.
ii. In case of a 15% movement of either index, there will be a 2 hour halt if the movement takes place before 1 pm. If the 15% trigger is reached on or after 1 pm but before 2 pm, there will be a 1 hour halt. If the 15% trigger is reached on or after 2 pm the trading will halt for the remainder of the day.
iii. In case of a 20% movement of the index, the trading will be halted for the remainder of the day.
These percentages are translated into absolute points of index variations on a quarterly basis and at the end of each quarter these absolute points of index variations are revised and applicable for the next quarter.[All emphases are mine]
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