Can day trading be done if DVP is introduced?

The stock market is likely to step up the migration to Delivery Versus Payment (DVP) system in a more robust risk management regime following the fiasco triggered by the default of National Savings Bank (NSB).

Daily FT learns the DVP as well as a more robust risk management system came up for discussion at a joint meeting between Securities and Exchange Commission (SEC), Colombo Stock Exchange (CSE) and Colombo Stock Brokers Association (CSBA) officials on Friday.

In place of the current Trade+3 market days (T+3) settlement system, the DVP has been proposed and has been on the cards for several years.

During the bizarre events connected to NSB’s purchase of a 13% stake in The Finance Plc (TFC) from a consortium of sellers via Taprobane Securities Ltd., most capital market stakeholders were unanimous that DVP could have minimised the damage to the credibility of the stock market and integrity of the settlement system.

At present, CSE is getting technical expertise from the National Stock Exchange (NSE) of India, which already has a DVP system.

Analysts said that there needs to be a robust risk management system in place and proper procedures as well as rules as a precursor to the DVP with a Clearing House acting as a Central Counterparty (CCP).

Furthermore, all market participants including brokers need to be aligned and ready as well.
A joint committee of the SEC and CSE has been working on this for some time, but analysts expect all stakeholders to move faster towards DVP. Previously expectations were that it would be in place this year but fresh indications are early next year.

At Friday’s meeting the issue of recourse to the SEC’s Settlement Guarantee Fund in the event of a development such as the NSB-TFC deal was also discussed. As at end 2010 the balance lying credit to the Fund was Rs. 332 million.

The Rs. 390 million deal on 27 April saw firstly NSB, despite being a Custodial Bank, failing to reject the 13% buy within the permitted T+1 window, in which case the shares would have devolved back to the selling broker and secondly Sampath Bank settling sellers without having confirmed receipt of funds from the buyer NSB. Though NSB didn’t pay, TFC shares had gone in to its Custodial Account.

The bizarre development was after NSB withdrew from the trade, subsequently reversing its previous decision to buy and go ahead with the investment in TFC. NSB’s decision to purchase 7.8 million shares of TFC at Rs. 50 each drew widespread flak as it was tantamount to paying a hefty premium for a share which has a negative net worth of Rs. 23.

Triple A credit rated and Rs. 400 billion asset-rich NSB’s default, irrespective of reasons cited for backing out of the deal, remains contentious and a thorny issue in the financial services industry.

However, the settlement risk of the transaction was resolved on Friday via off the floor private transfers (nearly three weeks after the original trade), by the SEC as per provisions within its Act. This was after all parties to the transaction expressing in writing their willingness.

SEC said this approval was granted under exceptional circumstances for the smooth functioning and the system stability of the payment and settlement cycle of the capital market.

“It is stressed that the SEC will not consider this instance of granting approval to conduct a trade of this nature off the Floor of the CSE as creating a precedence,” it added.

Whilst some stakeholders including the UNP had suggested that NSB pay for the transaction and conclude the deal and re-sell later on, even if it meant back to the original sellers, legal experts said that given the complexity and sensitivities, the private transfer method on Friday was the best option.

“Technically there was no other way,” they claimed. Great care was taken to ensure minimum impact to the ordinary course of trading as well as settlement and clearing market.

Friday’s resolution was preceded by a spate of assurances in writing among involved parties to the transaction. It was pending approval until SEC Chairman Tilak Karunaratne returned on late Thursday from his trip to International Organization of Securities Commissions (IOSCO) annual conference in Beijing.

SEC in its statement on Friday said Taprobane Securities (Pvt) Ltd. (TSL) and the National Savings Bank (NSB) by letters dated 11 May 2012 made an application to the Securities and Exchange Commission of Sri Lanka (SEC) seeking prior approval under Section 28 (1) of the SEC Act to transfer The Finance Company PLC (TFC) shares purchased by NSB on 27 April 2012 on the Colombo Stock Exchange (CSE) to persons identified by TSL outside the Trading Floor of the CSE.

TSL in its application undertook to pay Sampath Bank PLC the consideration due on this transaction including the interest due thereon in settlement of the monies due to Sampath Bank for the settlement services rendered by Sampath Bank on the share purchases done by NSB of TFC on the Trading Floor of the CSE on 27 April 2012.

NSB in its application also agreed to transfer TFC shares purchased on 27 April 2012 in its entirety to the persons identified by TSL outside the Trading Floor of the CSE. NSB agreed to allow TSL to pay Sampath Bank the consideration sum due on this share transfer in satisfaction of the amounts due to Sampath Bank for the settlement services rendered on the share purchases transacted by them on the CSE on 27 April 2012.

Sampath Bank too intimated to SEC that the bank would discharge NSB and all parties connected with the impugned transaction, if TSL as undertaken by its letter paid Sampath Bank all sums due to them including interest/levies due thereon.

In terms of Section 28 (1), the SEC has the discretionary power to approve transfers outside the trading procedure of the CSE.

In this backdrop the SEC has granted approval to allow NSB to transfer TFC shares purchased on 27 April 2012 in its entirety to the persons identified by TSL outside the Trading Floor of the CSE.
The SEC also said it is separately investigating the NSB-TFC transaction and the parties involved in it. “Firm action will be taken against all those who are found to have violated the SEC Act,” it added.

The SEC is also currently studying this entire issue and expects to take a series of appropriate measures, rules and procedure changes to prevent such incidents in the future. The SEC will also intensify its efforts in implementing the Central Counter Party (CCP) for the CSE which will be the final solution to address settlement failure risk.

At the joint SEC, CSE and CSBA meeting on Friday afternoon, the outcome of which was described as positive, an anomaly in the broker credit rule, greater promotion of stock market via local and international road shows were also discussed. Prior to meeting with SEC, brokers had their routine dialogue with CSE earlier in the week as well.

The Colombo stock market is besieged by low activity whilst the 14% year-to-date negative return and rising interest rates on fixed income investment options along with scepticism over future prospects for the economy and corporate earnings have dampened the outlook for the Colombo Bourse.
http://www.ft.lk/2012/05/21/fast-tracked-dvp-likely-after-nsb-tfc-fiasco/

Friends, SEC is considering the introduction of Delivary Versus Payment Schem(DVP) together with Central Counter Party System early next year as a precaution to future share scams like NSB/TS. This is a good move but it should not affect day trading facility operative at present. Once it is in force it is doubtful that day trading can be allowed because we will not be able to sell any share unless payment is made the same day and shares are delivered to your CDS account.

Please express your concerns now so that the SEC could take such concerns in to consideration when the DVP is introduced.

You can sell as much as you can, as long as you can see buying orders in the order book! No one can put orders if they don't have money in their account!

BTW There's no point if the brokers still have their ATSs after implementing DVPS! Good news is you can sell short (long awaited move )

Broker credit/margins should qualify as buying power else if whatever day/short term trading is curtailed due to this, market will be in more big trouble. short term traders are the people who move market prices.

slstock wrote:

Broker credit/margins should qualify as buying power else if whatever day/short term trading is curtailed due to this, market will be in more big trouble. short term traders are the people who move market prices.

Yes slstock, the day traders-market movers, may be wiped out if DVP is implemented without proper mechanism to facilitate smooth day-trading. It appears that we are in for another rude shock once DVPS is operative. Regualater should look into this possibility prior to implementation of the new DVPS system.

wgsaman wrote:

At present you can buy shares and sell the same the same day without making any payment & incurring a lesser cost(nearly half the cost of the two transactions). The broker will pay you your profit after deducting the fees/sharges for one of the transactions which ever is large. If buy order is larger than the sell order of the same share fees will be charged only for the buy order and fees for the sell order is wiaved off. This is called day trading. You make money without blocking any money & incurring lesser cost than normal trading. This could be done because delivery of shares is instant on buying. Delivery is done prior to making any payment. Day traders are considered market movers. ?What will be the fate of the CSE without market movers.

However, once the proposed new system-i.e. Delivery verses Payment System(DPS) is on, there is a likely hood of errasing this facility because all shares bought will not be delivered to your CDS account instantly unless you make the payment for the shares, thus effectively preventing day-trading facility as operative at present.

I am bit confused about this discussion. Can any body please explain how how day trading is impossible ubder DVP.

hariesha wrote:I am bit confused about this discussion. Can any body please explain how how day trading is impossible ubder DVP.

Day trading is possible if delivery of shares to your CDS account is done instantly prior to payment. This is what happens right now. If Delivery Verses Payment System (DVPS) is introduced you cannot sell what you buy unless you make the payment instantly and your CDS account is credited with the shares bought- i.e. you canot sell what is not in your CDS account. You have to wait untill your CDS account gets the shares bought. I think this might clear your doubt.

K.Haputantri wrote:

hariesha wrote:I am bit confused about this discussion. Can any body please explain how how day trading is impossible ubder DVP.

Day trading is possible if delivery of shares to your CDS account is done instantly & prior to payment. This is what happens right now. If Delivery Verses Payment System (DVPS) is introduced you cannot sell what you buy unless you make the payment instantly and your CDS account is credited with the shares bought- i.e. you canot sell what is not in your CDS account. I think this might clear your doubt.

I think people have misunderstood the DVPS system as well as day trading.
Here payment is from the buying broker to selling broker. Currently there is no entity to guarantee the payment. It operates on trust, which got breached on TFC/NSB deal for the 1st time in CSE history.

DVPS operates with a clearing house, similar to what is there in the interbank clearing house. Here instead of banks it's among brokers.

So there's no restriction on day trading. Only thing is you can't buy over and above your allocated margin, thereby reducing the market risk. If there are day traders now, who trades without any money or shares in their account, they are not day traders. They are fraudsters who are putting everyone at risk and should be clearly avoided. Clearly it’s not a day trade. What we say a day trade is actually a trader/investor who has a cash balance or unutilized margin buys shares with prevailing opportunities in the market and sells on the same day when he is at a profit.

Ie : Today TWOD came down to 14/- due to some panic. Those who saw the opportunity bought and sold at 14.50-14.60 levels.

If no opportunity arises traders should be able and have power to hold.

Exactly!

hariesha wrote:

K.Haputantri wrote:

hariesha wrote:I am bit confused about this discussion. Can any body please explain how how day trading is impossible ubder DVP.

Day trading is possible if delivery of shares to your CDS account is done instantly & prior to payment. This is what happens right now. If Delivery Verses Payment System (DVPS) is introduced you cannot sell what you buy unless you make the payment instantly and your CDS account is credited with the shares bought- i.e. you canot sell what is not in your CDS account. I think this might clear your doubt.

I think people have misunderstood the DVPS system as well as day trading.
Here payment is from the buying broker to selling broker. Currently there is no entity to guarantee the payment. It operates on trust, which got breached on TFC/NSB deal for the 1st time in CSE history.

DVPS operates with a clearing house, similar to what is there in the interbank clearing house. Here instead of banks it's among brokers.

So there's no restriction on day trading. Only thing is you can't buy over and above your allocated margin, thereby reducing the market risk. If there are day traders now, who trades without any money or shares in their account, they are not day traders. They are fraudsters who are putting everyone at risk and should be clearly avoided. Clearly it’s not a day trade. What we say a day trade is actually a trader/investor who has a cash balance or unutilized margin buys shares with prevailing opportunities in the market and sells on the same day when he is at a profit.

Ie : Today TWOD came down to 14/- due to some panic. Those who saw the opportunity bought and sold at 14.50-14.60 levels.

If no opportunity arises traders should be able and have power to hold.

I agree with you that those who have no portfolio or cash balance has no buying power, hence they cannot do day trading. You don't need margin facility if you trade with-in your buying power. All what I wanted to say was that you need not necessarily block your money for a particular day trade under day trading. Of course you use your buying power. That is not fraude as suggested.

Say, I have a portfolio of Rs: 1 million & my buying power is Rs: 500,000/= . I want to day trade with Greg:N which I don't have in my portfolio. ?Can I day trade with GREG:N which I do not have in my portfolio under DVPS. I ca'nt because the DVPS effectively prevents delivery of shares to my account unless I make the payment for GREG:N I bought. You can'not sell what you do not have in your account. This is based on the legal concept applicable here. However, shorting is not operative at present & it is not day trading. I don't know whether shorting will be available Under the new rules. Any way, it is a different style of trading alien to the established legal concept-you can't sell what you do not own.

Hapu,

So ur issue is DVPS Vs Current 50% Buying Power!
It's totally depending on how our policy makers implement DVPS in Sri Lanka!
Theoretically we'll not have a buying power if there is a DVPS

It's all about CHANGE boss!
That's why SL cant move in to such systems overnight!

Friends,

First we have to understand what a margin facility is. There are two types.

1. A properly arranged margin facility from a margin provider - Usually a bank or a finance company authorized by the CBSL to operate as a margin provider. Here you get a completely different CDS account which we called a slash account. ( ie: XXXX-LC/0) Margin provider will decide the margin amount and it will be your buying power.

2. A casual margin facility with your broker - Your broker will allocate a margin against your portfolio, and it will be your buying power.
Somewhere in last year SEC suspended above no 2 but later allowed it.


In both cases provider will lay down the conditions with regards to margin amount, the instruments that can pledge for the margin, etc.

ie: Some providers will exclude warrants in the portfolio for margin calculations, some may set aside all instruments of a company considering as high risk.

So what happen when you buy shares utilizing above options - Your broker will pay to the selling broker irrespective of you made the settlement to your broker or not provided you are within the margin.

Now this settlement is done on T+3 and T+2 system, meaning all purchases are settled in T+2 and sales are settled within T+3.

So what will happen in DVPS -

Instead of T+3 and T+2 it will be instant and through the clearing house. Clearing house will credit the selling brokers account and debit the buying brokers account with relevant to the transaction amount.

Clearly it will not affect day trading. There will be not any risk of default in regular transactions, as all systems used by users will not allow buying more than the margin. Currently though online users are not allowed to purchase more than the buying power, those who have access to ATS can do this, but with the implementation of DVPS this facility in the AST have to be blocked.

Why I say regular transactions in above is to, exclude mega transactions when even now buyer is paying in advance.

ie: JKH sale by EPF - Malaysian party has deposited the money before the actual transaction. But this didn't happen in NSB/TFC deal, and that's why it went wrong allowing buyer to refuse the payment.

Thanks hareisha for the lengthy explanation. You seem to be an expert on these systems.