Sebi wants bourses to charge higher for illiquid stocks

Mumbai: In an effort to discourage the common public from investing in potentially shell companies in the listed space, the Securities and Exchange Board of India (Sebi) wants exchanges to charge higher transaction fees for trading in stocks of firms that are illiquid (thinly-traded) or not held by too many shareholders.

Two persons, including a regulatory official confirmed this.

Typically, any stock with an average daily turnover of less than Rs2 lakh for two previous quarters is termed as illiquid.

“Illiquid stocks are extremely volatile and the risk of losing money is very high. If the transaction fee is higher than conventional stocks, people will not trade in such illiquid stocks unless they fully understand the risks and the Sebi norms. So, it is desirable that exchanges charge higher transaction costs and levy stricter margins and collaterals for trading in illiquid stocks,” said the first person.

“There was a proposal earlier that the margins for illiquid stocks should be five times the normal margin charged for trading in ordinary liquid stocks. Additionally, there is a surveillance and compliance cost incurred by the exchanges for keeping stocks listed. For illiquid companies these costs are proportionately higher. So it makes absolute sense for an exchange to charge higher fees for illiquid stocks,” added the first persons.

Asia’s oldest bourse BSE Ltd. has a monopoly in illiquid stocks. The exchange has been charging higher transaction fees from clients for trading in such stocks and between financial 2012-2014 and 2017, BSE’s transaction charges have increased from Rs29.4 crore to Rs110 crore.

“The increase in transaction charges was largely due to the increase in average daily traded value…The increase in transaction revenues in FY16, in spite of lower volumes in FY16, is due to the increase in transaction charges, especially for illiquid equity shares and a significant contribution of illiquid equity revenue in FY17 along with increased cash equity volumes,” said a recent Nomura report.

The report named—Illiquid securities: a dark horse; but is it sustainable—says BSE has a monopoly in illiquid stocks with 1,200-1,500 actively traded exclusive securities listed on BSE.

“With buoyancy in stock market volumes in the illiquid securities has been picking up from Rs15 crore in value traded in FY14 to over Rs30,000 crore in FY17,” said the report.

Illiquidity is mostly found in penny stocks (those that trade at a very low price and have very low market capitalization).

“Sebi’s primary concern is to protect investors from penny stocks, which are mostly illiquid and may potentially be associated with so-called shell companies,” said the first person cited above.

On 10 January, Mint reported that Sebi is planning to impose a limit on the minimum market capitalization for companies to remain listed in an effort to weed out so-called penny stocks. Sebi has found that out of around 5,000 odd firms listed on exchanges, at least 1,000 appear to be penny stocks with only a few investors and infrequent trading.

Over the past few years insolvency cases have increased, the number of initial public offerings have gone up and instances of shell companies have started emerging. In August last year, Sebi had imposed a partial trading ban on 331 firms termed as shell firms by the ministry of corporate affairs.

J.N. Gupta, managing director at Stakeholders Empowerment Services, a proxy advisory firm, supports higher fees for illiquid stocks and said higher charges should automatically raise an alarm to potential investors to seek a reason for such charges and take an informed decision assessing the risk.

“Illiquid stocks are riskier than normal stocks. Higher trading charges in illiquid securities are required to discourage common investors from entering dubious and potentially shell companies. Also, exchanges spend a lot of money on surveillance even on these firms, so it is fair for them to charge higher fees to cover such costs,” said Gupta.

BSE has increased charges in the illiquid securities in FY16 from Rs125 per Rs1 crore of trade to Rs10,000 per Rs1 crore of trade, taking advantage of the monopoly. “This has led to a sharp jump in the illiquid cash equity revenue in FY17, which now contributes over 50% of the total cash equity transaction revenue. In addition to this, BSE has also started a super exclusive group since 17 July where it charges Rs1 lakh per Rs1 crore of transaction value, which has contributed another Rs4 crore in the second quarter of financial year 2018,” said Nomura.

BSE has been steadily increasing transaction and listing prices in the past 3-4 years, which has increased its revenues.

Charges from illiquid securities contribute about 50% of BSE’s transaction revenues now. Over financial year 2014 to 2017, BSE saw its earnings jumping by 29%. “While such a sharp uptick is surprising, a large part of this was led by the illiquid securities segment, which may be unsustainable given higher volatility in this area,” added the Nomura report.

Excluding the transaction income from illiquid securities, BSE’s core earnings growth has been 4% between FY2014 and 2017.

In a recent investor presentation, BSE itself mentioned that during the financial year 2017, there was a significant increase in transaction charges income, mainly due to differential charging of transaction charges on select exclusive group of securities with effect from 1January, 2016 at the rate of 0.1% on value traded.

The exchange’s transaction charges has grown from Rs30.9 crore in financial year 2013 to Rs117 crore in financial year 2017. During the 9-month period ending on 31 December 2017, the transaction charge income stood at Rs103 crore as compared to Rs73.9 crore during the same period of last year.

However, the Nomura report warned that the sustainability of revenue from illiquid scrips is always going to be at risk because in a weak market, trading volumes in this segment may reduce dramatically.