Why Small And Mid-cap Stocks Crashed Badly
Collateral damage caused by overzealous regulatory circular, but selling may largely subside, experts say
Most small and mid-cap stocks are on a crash course having declined between 20 per cent to 60 per cent in a matter of a few days. So what fundamentals have changed suddenly for them?
Stock markets are a game of demand and supply. A new rule by the exchanges, clearing corporations and market regulator SEBI has suddenly impacted the demand and supply of around 1010 small and mid-cap stocks, which is causing a sudden collateral damage to the whole of India's stock market.
As per a recent regulatory circular, 1010 stocks, mostly in the small and mid-cap category were taken-off from the list of 'collaterals' acceptable as margin pledges for availing loans from banks and brokerages and MTF (Margin Trading Facility) from clearing corporations. Till October, clearing corporations of exchanges were accepting some 1730 stocks as a pledge against margin for trading. But come November, the list may be shortened to just around 700 stocks. Also, banks and NBFCs (non-banking finance companies) will not accept these stocks for giving loans or giving less amount of money on higher pledges. When the circular came, at its peak, the MTF book of stockbrokers stood at around Rs73,500 crore and the stocks that investors had pledged as collateral with brokers were impacted. Along with these, the stocks purchased using the pledged money too got impacted as most investors may not be in a position to bring additional margin to fulfil the shortfall.
In India, high-net-worth individuals and big traders are often known to build huge leveraged positions by pledging their existing holdings with banks or NBFCs. Typically, traders brought 20 per cent or 30 per cent margin and brokers financed the rest 70 per cent margin for further play in the market. These are high financing deals where the interest rates range from 10 per cent to 14 per cent but help traders build big positions by keeping their existing positions intact. As nearly 1000 stocks became useless in terms of not being able to generate leverage for traders due to their lack of acceptance as collateral, there was a huge unwinding of positions in these stocks, brokers say. The selling in these stocks also led to further market-wide collateral damage causing a rout in the small and mid-cap segment. In addition, exchanges periodically put stocks under their graded surveillance measures and curb their circuit filters, which leads to selling them. In a nutshell, the overall game of demand and supply in small and mid-cap stocks was hugely impacted by regulatory measures, experts say.
A circular to cull the list of collaterals was issued in July by the exchanges. There was no sudden impact as the margin of hair cut compared to the full amount of collateral deposited, was hiked gradually. For instance, stocks where trading limits or loans to the tune of 80 per cent and 75 per cent were granted, came down to 40 per cent in the subsequent months, following the circular. But in November, the value of loans on several stocks will go down to nil leading to panic. Simply put, for many stocks worth Rs 100 where the trading margin or loan extended stood at Rs 75 or Rs 80 in July, it came down to Rs 40 in October and may go to Nil from November. Hence in the past few days the unwinding of positions, in the nearly 1000 stocks and also those stocks that were purchased using the limits based on the 1000 stocks as collateral, has led to a precarious situation.
The regulatory circular pushed out stocks like the market favourite Adani Power, Tata Investments, HUDCO etc. Among the other stocks where no or very little leverage will be extended include YES Bank, Suzlon, Bharat Dynamics, Paytm, Pilani Investments And Industries (Birla Group Holding Co And NBFC), Autumn Investments, Atul Auto, AllCargo, IRB Infrastructure, NBCC, Go Digit, Inox Wind, Jupiter Wagons, KIOCL, Jyoti CNC Automation, JBM Auto, Hatsun Agro Product, Tejas Networks and many other well known small and mid-cap companies that generated high trader interest.
