In the past couple of weeks, the Securities and Exchange Board of India (Sebi) has set a scorching pace on capital market reform to eliminate major distortions in the primary and secondary markets. Its latest action provides much needed legitimacy to bulk deals, by allowing large inter-institutional trades to be done in a clean and transparent manner.
Sebi has chosen to adopt the practice followed by countries like Korea, Australia and Singapore, of allowing bulk deals through a separate 35-minute window that will open before regular trading. It has also mandated that all bulk trades be delivery-based and priced within a 1% band of the previous closing price. A bulk trade has been defined as one for a minimum of 500,000 shares or Rs 5 crore. All deals in the bulk segment will be disclosed to the public the same day, after market hours.
Though block deals can sometimes be misused, it is now accepted that they have significant advantages, allowing clean transfer of large blocks of shares without distorting or destabilising prices. However, Sebi chose to ban all negotiated deals in 1999 through regulatory fiat, causing all-round confusion and encouraging manipulation. Since it refused to recognise any bulk deals, even genuine institutional investors were forced to resort to dubious synchronised trades to buy or sell shares in bulk.
Scores of block deals that hit media headlines, especially in the past few months, were making the regulator look ridiculous. Especially since it was an open secret that these trades could only happen when the buyer and seller negotiated the price and synchronised trade execution, by hitting the confirmation button at the exact same instant through a telephonic countdown. Traders also came up with simple tricks, such as allowing a part of the deal to leak to other investors, to make it difficult for Sebi to establish block deals.
These practices evolved after the 1999 order, where Sebi decreed that all trades must occur through the anonymous, order-matched trading system. Ingenious brokers immediately beat the system by inventing synchronised trades. These were rampant in the scam of 2000-01. Sebi started a probe into these deals, but five years down the line, couldn’t decide if these were legal or not. So, it came up with a bizarre guide, saying synchronised trades were not, per se, illegal, but could be probed for intent. Thus indirectly legitimising synchronised trades.
Over time, it also mandated that block deals must be disclosed to the public through a separate window. This drew media attention to block deals even while their legality remained a grey area. Stock exchanges feared that legitimising block deals and giving these a separate trading window could affect market liquidity and increase volatility. Hence, as recently as July, Sebi was asking trading members to ensure compliance in large transactions that are in the form of block deals. And threatening them with strict action if they violated the rules by negotiating deals in advance and executing synchronised trades.
Sebi’s decision to create a pre-market window for bulk deals, with pricing restrictions, is similar to the practice in Hong Kong, Singapore, Australia and Korea. The regulator has discovered the Hong Kong SE allows a 45-minute trading window for bulk deals, with price bands linking the trades to the previous closing price of the exchange. The Australian SE has a similar window. Singapore has what are apparently known as cross trades; these have to be reported within 10 minutes of execution or can be conducted in the first half hour of trading. Korea has two trading windows for block deals and also permits deals during the session, subject to stringent price and reporting requirements.
Only the players in American financial markets seems to follow a non-transparent system, where brokers are forced to route block trades through smaller bourses. But the US today is hardly the model the world needs to emulate. The biggest advantage of legitimising block deals is that Sebi can now separate the genuine traders from potential manipulators. Instead of forcing all investors, including institutions, into synchronised and manipulated trading, Sebi has finally made the system open and transparent. And ensured large transactions that deliberately avoid the legitimate bulk deal window would immediately attract regulatory scrutiny and can be investigated for motive, intent or manipulative effect.