Mumbai, Oct. 9: The Securities and Exchange Board of India (Sebi) today proposed that stock exchanges should not annul or cancel erroneous trades and should look at applying penalties in the form of fine or suspension of trading rights of the stockbrokers responsible for the erroneous trades.

The suggestions have been made in a discussion paper that the market regulator circulated today and are designed to deal with disruptive and bizarre situations that erupted on four occasions in the past couple of years because of faulty or freak trades.

The latest incident occurred in February when a few erroneous sell orders in Tata Motors and UltraTech Cement saw the stocks plunge nearly 10 per cent.

But the worst incident was the “flash crash” on the National Stock Exchange on October 5 last year where the Nifty plummeted 920 points in just a couple of minutes because of erroneous orders entered by a dealer of brokerage firm Emkay Global.

While such error trades may result from system or human errors, they can impact the price formation of the securities, their derivatives, and exchange traded funds. The ensuing price volatility can also automatically trigger the execution of “stop loss” or “limit” orders.

The market regulator today proposed a slew of measures for the stock exchanges, including well-defined parameters and a time-bound approach, for deciding on the annulment of such freak trades.

Sebi added that in order to provide certainty to the trades executed on the stock exchange’s trading platform, the trades should not be annulled under normal circumstances.

“`Trade annulment should only be considered under exceptional circumstances (fraud, market manipulation, regulatory action, error that impact the sanctity of price discovery). In such cases stock exchange may also suo motu undertake examination of trades for cancellation’’, it observed.

According to the market regulator, the stock exchange should clearly define the circumstances under which request for trade annulment or price reset shall be entertained. This may be done if all the counterparties to the trades (erroneous trades) are in agreement for such an action and there are no apparent concerns of market manipulation.

It also can be done if all the market participants may not be in favour of such action but such erroneous trades may have resulted in severe market disruption.

Significantly, Sebi said stock exchanges shall examine cases of erroneous orders or trades and apply deterrent penalties in the form of fines or suspension of trading rights of the stockbroker.

At present, if there is an erroneous trade, exchanges can annul the trade. However, this is done through a process wherein a member initiates a trade cancellation request and the member on the other side of the trade receives the details of the trade cancellation request in an anonymous manner. Only if the request is accepted by member on the other side, does the exchange go ahead with the cancellation request.

THE PROPOSALS

• Trades should not be cancelled under normal circumstances

• Annulment to be allowed only under exceptional circumstances such as fraud, market manipulation, regulatory action, error that impact the sanctity of price discovery

• A stock exchange should define the circumstances under which request for trade annulment or price reset shall be entertained

• Stock exchanges should apply deterrent penalties in the form of fines or suspension of trading rights of the stockbroker