The Indian stock market is a dynamic and volatile environment, where regulatory mechanisms play a crucial role in ensuring transparency, investor protection, and market integrity. One such regulatory framework introduced by the Securities and Exchange Board of India (SEBI) and stock exchanges is the Enhanced Surveillance Measure (ESM).

This article explores the concept of ESM, its objectives, criteria for shortlisting stocks, the different stages of surveillance, implications for listed companies, and its impact on investors. Understanding these measures will help investors make informed decisions while navigating the complexities of the stock market.

What is the Enhanced Surveillance Measure (ESM)?

The Enhanced Surveillance Measure (ESM) is a monitoring framework implemented by stock exchanges such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The primary objective of ESM is to safeguard investors by identifying stocks that exhibit high volatility, speculative trading patterns, and unusual price movements.

ESM serves as a preventive mechanism rather than a punitive one. It does not imply wrongdoing by the company but aims to regulate speculative activity, ensuring that investors do not fall prey to sudden price fluctuations or market manipulation.

Objectives of ESM

The key objectives behind the implementation of the Enhanced Surveillance Measure are:

1. Protecting Retail Investors

• ESM aims to minimize the risk of price manipulation in small and mid-cap stocks, which are often targeted for speculative trading.
• Retail investors are often more vulnerable to market volatility and speculative price movements.

2. Reducing Excessive Volatility

• By imposing restrictions on trading, ESM helps stabilize stocks experiencing abnormal price movements.
• Market fluctuations due to manipulation or rumors can be controlled through surveillance measures.

3. Ensuring Market Transparency

• Investors are made aware of securities under enhanced surveillance, allowing them to make informed investment decisions.
• Transparency in market regulation ensures fair trading practices.

4. Preventing Speculative Trading

• By limiting intraday trading and enforcing strict margin requirements, ESM discourages speculative activities that could harm investors.
• Stocks under ESM are subjected to trade-for-trade settlement, preventing artificial price inflation.

Criteria for Shortlisting Stocks Under ESM

A stock is included in the ESM list based on market-based dynamic parameters. These parameters assess a stock’s price volatility, market capitalization, and trading patterns. Some key criteria include:

1. Price Variation

• Stocks that exhibit abnormal price movements over a certain period may be placed under ESM.
• High fluctuations without any fundamental changes in the company may trigger surveillance.

2. Standard Deviation of Returns

• Stocks with a high standard deviation (indicating extreme price movements) are more likely to be shortlisted.
• The greater the price swings, the higher the chances of inclusion in the ESM list.

3. Market Capitalization

• Companies with a market capitalization below ₹500 crores are more vulnerable to price manipulation and are therefore monitored more closely.
• Small-cap stocks often have lower trading volumes, making them susceptible to artificial price inflation.

4. Trading Volumes

• A sudden surge or drop in trading volumes without any company-specific news or fundamental changes may lead to inclusion in the ESM list.
• Unusual trading activity is a strong indicator of potential speculative behavior.

5. Illiquid Stocks

• Stocks with low liquidity, meaning fewer shares are traded, can be easily manipulated. Such stocks are often brought under ESM.
• Illiquid stocks may have wider bid-ask spreads, making them riskier for investors.

Stages of ESM and Their Implications

Once a stock is placed under ESM, it goes through different stages of surveillance, with increasing levels of restrictions to curb volatility and speculative trading.

Stage I

• 100% Margin Requirement: Investors must provide a 100% margin for trades involving ESM-listed stocks, reducing leveraged speculation.
• Shift to Trade-for-Trade Segment: The stock is moved from the Rolling Settlement segment (EQ series) to the Trade-for-Trade segment (BE series), meaning all trades must result in delivery. Intraday trading is not allowed.

Stage II

• Additional Restrictions: Stocks entering Stage II face even stricter controls:
  • Lower Price Bands: A 2% circuit limit is imposed to restrict large price swings.
  • Reduced Trading Frequency: Trading is allowed only once per week through a Periodic Call Auction mechanism, making it difficult for speculators to drive up prices artificially.

Impact of ESM on Investors

1. Trading Limitations

• Stocks under ESM cannot be traded intraday, and all trades must result in delivery.
• In Stage II, trading is only permitted once per week, limiting the ability to enter or exit positions quickly.

2. Increased Margins

• The requirement for 100% upfront margins means investors cannot buy these stocks on leverage, reducing speculative trading.

3. Liquidity Concerns

• Due to restrictions, investors may find it difficult to exit positions, particularly if the stock does not have enough buyers.

4. Price Movements

• Limited trading frequency can lead to sudden price gaps, either upward or downward, making the stock riskier for short-term traders.

How to Check if a Stock is Under ESM?

Investors can check whether a stock is under ESM by visiting the official websites of Indian stock exchanges. These platforms provide regularly updated lists of stocks under various surveillance mechanisms.

• NSE ESM List: NSE Website
• BSE ESM List: BSE Website

Comparison: ESM vs. ASM (Additional Surveillance Measure)

The Enhanced Surveillance Measure (ESM) is an essential regulatory tool used by Indian stock exchanges to curb speculation, reduce volatility, and protect investors. While it imposes restrictions on trading, these measures help maintain transparency and market stability.

By staying informed and exercising due diligence, investors can navigate the complexities of the stock market more effectively and avoid potential pitfalls associated with volatile stocks under surveillance.