Pending cap on India block-trading raises fears

Sebi is set to impose limits on block-crossing, but brokers and traders say it won’t be effective in preventing a flash crash and will likely hurt execution and exacerbate volatility.
Pending cap on India block-trading raises fears

Buy-side traders and brokers fear that a cap on block trades set to be imposed on India’s exchanges within weeks could drive up execution costs and ultimately damage the market.

In mid-December, the Securities and Exchange Board of India (Sebi) stated that outside of the 30-minute morning window allowed for block-crossing once the market opens, all orders for stocks, exchange-traded funds and futures should be capped at Rs10 crore ($1.8 million).

It is expected to be introduced as early as the middle of this month, as one of a series of risk controls ordered by Sebi in response to the “Nifty crash” of October 5 last year. According to reports, broker Emkay Global Financial placed a series of sell orders worth $125 million courtesy of a “fat-finger” error that saw the S&P CNX Nifty Index sink 16% in minutes.

Even as things stand, the 30-minute window for institutional block-crossing, which is limited to an unrealistically tight price band of +/-1% from the previous day’s close, has long frustrated foreign buy-side traders.

Brokers have resorted to timing such buy and sell orders in the open market outside of the window as a way to get around it, even though this often subjects investors to slippage in price and quantity.

As one head of cash equity trading in Hong Kong notes, it is very difficult to guarantee that the two sides of the trade will meet without other market participants jumping in.

However, buy-side traders and brokers say the new cap to be imposed by Sebi will not necessarily cause them to rethink how they use the 30-minute window, unless the regulator and the nation’s two exchanges can find a way to improve the mechanism.

Rather, they suggest that investors will simply resort to using algorithms to slice block orders up into multiple pieces capped at Rs10 crore, which in itself could cause even higher slippage and exacerbate market volatility – the opposite of what Sebi intends to achieve.

“This $1.8 million limit per order implies that a broker would have to input [their order] multiple times, hence the market slippage will be even bigger for us,” notes an equity trading head at one Hong Kong asset manager.

Typically algos that seek to keep a constant participation in the market, such as percentage of volume (PoV), do not engage with block trades, which are privately negotiated and matched away from an exchange’s order books.

But in India, since block trades are often crossed on the open market but are not identified as blocks, brokers who help investors with electronic execution have had to build their own thresholds so their algos can identify blocks and not participate.

Because this cap would likely force investors to change their trading style, that means brokers would have to reconfigure their thresholds accordingly. 

“For the rest of the market, it means it will become more difficult for brokers to recalibrate their algos to detect block crosses,” says an electronic trading head at one investment bank, highlighting the potential for increased market volatility.

“While algo strategies offered by brokers have worked in global markets, often they do not work in India,” he notes. “It takes too long to get around restrictions on implementing algos, with the risk that they do not get approved or certified by regulators and exchanges at all.”

Murat Atamer, Asia-Pacific director for Credit Suisse’s AES trading platform, is also pessimistic the new cap will be effective in preventing erroneous orders and mitigating market disruption.

He notes that while the Rs10 crore cap could prevent a single order caused by a manual mistake, it wouldn’t capture smaller orders sent to the market in quick succession (either by human traders or algos).

“Additionally, the Rs10 crore size limit could be too large for some stocks and too restrictive for large-cap liquid names, especially on ‘event days’ such as index rebalances and earnings announcements,” he adds.

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