No room for CASual volatility

The Sensex plunged 2,000 points in minutes on Thursday, while a Bankex option soared 14,700% - a bout of extreme volatility that should worry everyone, except perhaps high-frequency traders who live for such moments. At the centre of one of the most debated topics in the Indian equities market is the Closing Auction Session (CAS), a new way of arriving at the end-of-day price of securities. It was aimed at helping MFs in their asset value calculations, but has ended up creating mayhem for the rest.

Every new system will have teething troubles, and so will be the case with CAS. No doubt the system is prevalent in some developed markets, but the question is whether it was introduced after a controlled-environment experiment, or the market is being used as a laboratory. That Sebi penalised two entities, including one from JPMorgan, for manipulating CAS is an admission that the system has flaws and needs fixing. One of the essential conditions for CAS to succeed is to have a vibrant securities lending and borrowing mechanism, which is almost absent in India. Sebi and the I-T department must clarify the tax implications of stock lending. Furthermore, the regulator and stock exchanges need to incentivise institutions to participate in CAS.

It is no secret that access to tools to trade in the derivatives market is uneven. Sebi has been warning about retail participation in futures and options, where its studies have shown them losing thousands of crores of rupees. An average retail trader from Bhopal and Jane Street are in the same ring together, and CAS is aggravating the losses of the less literate and amplifying gains for those with colocation facilities. This month-end will also witness the rebalancing of the MSCI Index, which could cause enormous volatility, and Sebi would face the blame for that. There is little reason not to have CAS in India, but it needs to be suspended temporarily and brought back with the necessary market conditions and rules in place.