Sebi chief flags risk of bubble in stock market

Bubbles in the market are not a good thing for retail investors, and mutual funds could form a common policy to protect investors in this respect, the stock market regulator said, at a time of turbulence in an overheated small and mid-cap space.

The Securities and Exchange Board of India (Sebi) has already asked for results of stress tests from mutual fund trustees, stating the time it would take to liquidate portions of investors’ portfolios.

“There are pockets of froth.....sections of froth in the market,” Sebi chairperson Madhabi Puri Buch said on the sidelines of an event in Mumbai on Monday. “Some people call it a bubble, some may call it froth. The question is, it may not be appropriate to allow that bubble or froth to keep building. Because if it keeps building, it will burst, because by definition, bubbles burst. So, when they burst, they impact the investors adversely; so, that’s not a good thing.”

Buch’s comments come in the backdrop of relentless flows into small and midcap funds, stretching valuations in these segments. For instance, the Nifty Smallcap 250 index has risen almost 60% in the past one year against the benchmark Nifty 50’s 28% return. However, these stocks have seen turbulence in in recent weeks, after the Reserve Bank of India restricted operations of fintech major Paytm, and NBFCs IIFL Finance and JM Financial Products.

On Monday, the smallcap index plunged 2% to 14507.15, while the benchmark Nifty fell 0.72% to 22332.65

In addition to the recent action against NBFCs, the Enforcement Directorate’s ongoing investigation to find if proceeds of crime from the Mahadev betting case were routed into the smallcap and SME segments of the market also contributed to Monday’s carnage. Stocks like Suzlon, NCC, Tata Investment Corp, HFCL and IIFL Finance were the top five contributors to the decline in the smallcap index.

Buch also hinted that MFs could formulate a common policy to protect investors from risks of a bubble.

“Each mutual fund has trustees, who are looking out for the interests of the investors; they should sit down and formulate a policy. If each fund decides to have its policy on how to manage this risk, we are okay with it. We are okay if the industry wants to make a common policy... Our objective is that trustees are responsible for protecting the investors. In case we have to do anything, we will not do it without suitable public consultation,” she said.

Buch said that by 15 March, Sebi will make available a disclosure format on stress testing for small- and mid-cap funds. Investors will benefit from knowing how many days the funds would need to liquidate their underlying portfolios in the event of unfavourable market conditions.

“In terms of the disclosure on stress testing, it is not a nudge, it is a directive. Disclosure is what we do as a fundamental way of operation. We are a disclosure-based regime. The objective is for the investor to take an informed decision. A disclosure format on stress testing for small- and mid-cap funds has been approved that is mandatory and not optional for any mutual fund,” she emphasized.

The stress tests would determine that were there to be significant redemption pressure, how would an MF cope with it if the underlying market for the securities isn’t deep or liquid enough.

“That’s the most significant risk that the mutual fund runs. The assessment was if there is an adverse environment and there is redemption pressure; we don’t know, it could be anything. In such circumstances, while protecting investors, in terms of the first-mover advantage—the first one will always feel that ‘I will have an advantage’, which becomes a vicious cycle of attracting more and more redemption.”

Buch explained that the stress tests would determine how many days MFs would need to liquidate the investors’ portfolios if prices fell and volumes jumped, say, three times above normal.

The regulator also wants small and medium enterprises (SMEs) preparing to go public to disclose risk factors in greater detail to potential investors.

“Some more disclosure in terms of risk factors is required. For investors to understand that the SME segment is different from the mainboard, the regulations are different, the disclosures are different and, therefore, the nature of the risk is different,” Buch said, while expressing concerns about instances of price manipulation in some SME IPOs.

Twenty of 23 Tata Group stocks fell on Monday on reports of group holding company Tata Sons proposing to avoid a listing by September next year. The losses were particularly steep in companies with stake in Tata Sons. Tata Chemicals, which holds 3% in Tata Sons, fell 10.6%, Tata Power (-2.8%), Indian Hotels (2.5%) and Tata Motors (-1.1%).

Separately, the regulator on Monday announced expanding the qualified stock broker (QSB) framework, that will bring more brokers under enhanced obligations. The move aims to bolster trust in the securities market, and strengthen the compliance culture among stock brokers.

Parameters of proprietary trading volumes, compliance and grievance redressal scores will also be taken into account while classifying stock brokers as QSBs, a Sebi circular said. At present, there are five parameters for classifying a stock broker under the QSB framework -- total number of active clients, available total assets of clients, trading volumes of the stock broker (excluding the proprietary trading volume of the stock broker), and the end of day margin obligations of all clients. The regulator said the latest provisions will come into force in a risk-based, staggered manner to ensure smooth adoption and effective implementation for all the QSBs by providing enough time for them, based on their size, for making necessary changes.