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India's stock markets go
gray
By Indrajit Basu
KOLKATA
- India's feverish stock-market activity, which has
driven volumes to record levels and strained the
capacity of official bourses to handle the business, is
involuntarily resuscitating decades-old outlaw trading
rackets that Securities and Exchange Board of India
(SEBI) officials banned more than two years ago.
No one knows the volume of such gray trading,
which regularly in the past caused chaotic market
crashes, but it has grown so large that last week the
National Stock Exchange and SEBI, alarmed that it could
endanger legitimate markets, launched a nationwide
crackdown to try to stop it. One official estimates that
outlaw trading volumes are bigger than those on the
official exchanges.
"Although we have not been
able to arrive at the extent of this illegal trading,
confiscated data lead us to believe that the volume is
huge," a SEBI official said.
The SEBI-NSE
crackdown on July 21 closed down the nationwide
activities of Bansal Sharevest Securities Pvt Ltd, which
investigators allege was a prime mover in illegal
trading, using sophisticated support software capable of
running what amounted to a parallel exchange. The raid
demonstrated that the regulators' newly acquired teeth
(through recent amendments to the SEBI Act) could be
used to go after illegal trading nationally and showed
the regulator's willingness to go after what it felt to
be a prime mover of so-called dabba trading.
Among the outlawed practices investigators are
seeking to stop are curb trading, in which shares are
traded unofficially after exchanges close; badla
or unofficial margin financing; and, most extensively,
dabba trading, which is widespread, organized
and, in Bansal Sharevest Securities' case, alleged to
have been conducted on a high-tech
information-technology network just like the official
system.
Dabba trading operates in essence
like the US bucket shops of the 1920s, which existed
before the US Securities and Exchange Commission (SEC)
was established. Bucket shops got their name from
buckets that customers threw their orders into.
Bucket-shop brokers quoted certain prices to customers,
but waited to settle the ticket when a price discrepancy
made the trade advantageous to the firm, and kept the
difference. In the same way, the name dabba
derives from the ancient tin and iron trunks that
denoted the "bank" run by the dabbawallah or
dabba operator. The operator allows investors to
trade and settle transactions in cash, permitting both
spot deals and carry-forward trades.
Some market
sources say that daily dabba trading volume, at
about US$1.4 billion, tops the combined volumes of
official trading on India's two largest bourses, the
National Stock Exchange and the Bombay Stock Exchange.
However, market analyst Sucheta Dalal puts the figure at
much less, perhaps $450 million to $650 million per day.
"Basically dabba traders are gamblers, so
under ordinary circumstances, we needn't worry about
them," Sucheta Dalal said. "But since the volume of
dabba trading has now reached huge levels, a
collapse in the dabba or parallel market could
therefore destabilize India's official stock markets."
Certainly, illegal operations have a definite
bearing on the official traded prices because a small
fraction - about 1 percent - of all unofficial deals are
conducted on the official exchange to arrive at a
benchmark price and for accounting purposes. "Moreover,
dabba traders hurt genuine price discovery, and
hampers the reflection of the true state of affairs in
the market," said Pratip Kar, executive director of
SEBI.
Dabba trading, however, is not the
only menace in Indian stock markets. Other forms of
banned older trading systems, such as curb trading and
badla, are thriving too. Curb trading takes place
outside the purview of exchanges and after official
trading hours, and badla financing is nothing but
margin financing, in which private and unorganized
financiers lend money to speculators against collateral
of the shares they fund, at margin (at anywhere between
30 and 40 percent) in lieu of interest, which is always
much higher than the market interest rate.
The
new version of curb trading operates just like the older
version, although today it is much faster. Curb trading
now takes two hours, whereas in its earlier form it
began after the closing of official trading. Strike
prices are based on the closing prices at the Kanpur
Stock Exchange, a regional bourse in Kanpur, near New
Delhi. Unofficial agreement is converted into an
official transaction by putting the trade price and
quantity agreed by the seller and buyer into the
official system simultaneously. The official trades,
which follow the unofficial agreements on the previous
day, are mostly recorded on the NSE, with a few being
punched on the Bombay exchange.
The most daring
recent curb deals came during the initial public
offering (IPO) for car maker Maruti Udyog, India's most
successful ever and its most hotly sought after. Brokers
said that the most active curb buyers for the shares in
the Suzuki joint venture were some of India's most
prestigious financial institutions and insurance
companies. These institutions are said to have chosen
the curb route because Maruti's allotment policy favored
retail shareholders for what was then India's most
sought-after auto IPO. "The inability of the
institutions to subscribe Maruti shares in large
quantities left them with the only option of curb
deals," said a source.
"The recent bull run and
revival of volumes in Indian markets can to a large
extent be attributed to [the return of parallel trade],"
said Kirti Sanghvi, chief dealer at the Kolkata-based
Accord Capital. Turnover - volume of business - of the
Bombay Stock Exchange and the National Stock Exchange,
for instance, soared to a three-year high last week.
"Private (badla) financiers are back with
a bang in the regional bourses, which have now turned
into sanctuaries for scores of small brokers, for whom
badla used to their only source of bread,"
Sanghvi said.
Badla now exists with a
difference, though. Earlier, brokers paid interest on
the borrowed amount until they liquidated their
positions and returned capital and interest if any. "The
uniqueness of the new working arrangement is that shares
financed through this route are compulsorily transferred
to the demat account [in which all shares and securities
are held electronically], unlike the past system where
it mostly stayed on the brokers' books," said Nilangshu
Joshi, an independent fund adviser.
The question
today, after the regulators' raid on Bansal, is whether
India and SEBI can permanently squash illegal trading in
stock markets. It seems unlikely. "In India the black
economy - the section of the economy run by money hidden
from revenue officials - is huge," said Sucheta Dalal,
who, as an ex-stock-market sleuth was instrumental in
unearthing India's biggest stock-market fraud, the
"Harshad Mehta Scam", about a decade back, which even
caused the downfall of the ruling government.
"In fact, the country's black economy is
reportedly as big as its gross domestic product. So when
there is so much of black money floating in the country,
most holding that kind of money will operate in cash to
invest their hidden - from revenue officials - money and
avoid the modern day's complex stock-trading systems."
"No matter how much you try, dark sides will
always remain," she added.
Even the market
regulator admits that it can't stop the menace, at least
absolutely. "India is a huge country," said SEBI's
Partip Kar. "It is very difficult for SEBI to go and
investigate and unearth illegal trading in all nooks and
corners of the country. All we can do is to take
immediate action when illegal activities are reported."
Advice, thus, for those who still find illegal
trading thrilling: Carry on by all means. But see to it
that you don't do it loudly and SEBI doesn't get to
know. In the 1930s, nobody, for instance, thought that
the fledgling SEC would ever be able to shut down the
bucket shops. There may still be some around. But they
have been marginalized.
(Copyright 2003 Asia
Times Online Co, Ltd. All rights reserved. Please
contact content@atimes.com for
information on our sales and syndication policies.)
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