ESM Framework: Deterrent or spoilsport for microcap investors

ESM Framework
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In a bull market, once the front-line stocks have run up, it is normal to see investors actively searching for hidden gems that are yet to come into the media limelight or the tracking universe of research analysts. Additionally, there is also the quest for large gains, for which some investors prepare to go for lower quality stocks which they hope will become better with time, and subsequently turn out to be multi baggers. In both cases, the market price will be much lower than the front-line stocks, and as this quest gets deeper, it is possible that investors end up exposing themselves to huge risk. Effective 5th June 2023, SEBI decided that there shall be Enhanced Surveillance Measures (ESM) on Micro-Small companies (on main board with market capitalization less than INR500 crores) based on objective parameters like price variation, standard deviation etc. You can read the NSE’s faq on the subject here, or on the exchange’s website.

Let us see some of the key features of this framework.

The shortlisting of securities for placing in ESM framework is based on objective criteria as jointly decided by SEBI and Exchanges covering the following market based dynamic parameters:

  • High low variation
  • Close to close price variation
  • Market Capitalisation
  • Standard Deviation

A Shortlisting Criteria (Stage 1): Either below condition 1 0or 2 is met:

  1. High-Low Price Variation (based on corporate action adjusted prices) in 3 months OR 6 months OR 12 months > 1 standard deviation(of High-Low variation of all Micro-Small cap companies as defined above). AND Minimum threshold of High-Low variation would be as under:
  2. 3 months >75%,
  3. 6 months > 100%,
  4. 12 months >150%
  5. Close-to-close price variation (based on corporate action adjusted prices) in 3 months OR 6 months or 12 months > 1 standard deviation (of Close-to-close price variation of all micro-small cap companies as defined above). AND minimum threshold of close-to-close variation would be as under:
  6. 3 months > 50%,
  7. 6 months > 75%,
  8. 12 months > 100%

The following securities shall be excluded from the process of shortlisting of securities under ESM:

  • Public Sector Enterprises and Public Sector Banks
  • Securities on which derivative products are available
  • Securities already under insolvency and bankruptcy code (IBC)
  • Securities under Graded Surveillance Measure (GSM) Stage II and above.

B. State wise surveillance action after inclusion in EMS:

Review period and exit

i.                     Securities completing 90 calendar days in ESM Framework would be eligible for exit from the framework. However, in case a security is under stage 2 of the Framework, it shall be retained under stage 2 for a minimum period of 1 month. After completion of 1 month, in weekly stage review if such security’s close to close price variation is less than 8% in a month, it can move to stage 1 of the Framework.

ii.                   The stage-wise review of stocks shall be on a weekly basis.

iii.                 Securities completing 90 calendar days (subject to meeting of aforesaid condition in point 2) in the framework shall be eligible for stage wise exit subject to such securities not meeting the entry criteria as laid down in point A.

Impact on market

The restrictions on exit imposed in the ESM framework did not go well with the investors. While the intention to protect investor from volatility is to be lauded, the measure, by way of not having a quality parameter for entry into the ESM list, emerged as a major deterrent to investors for value picking. Since the exit was restricted to once per week, with only call auction method, it appeared to be an exit barrier that could discourage an investor from buying at lower prices, as the ESM framework would cool down further appreciation, once price starts rising and it gets listed under the ESM framework. Consequently, SEBI eased the restrictions, but allowing trading in such stocks on all days, with a price band of 2% in trade for trade for settlement, effective 24th July 2023.

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