India is in lockdown to halt the spread of Covid-19, and people are asking whether the stock markets should remain open. My answer is simple: the stock markets should remain open at least as long as the banks and ATMs are open; in fact, they should shut just before the online payment systems go down. There might be some short-lived extreme emergencies in which it would be appropriate to shut down the entire financial sector—including the markets and the payment systems—but right now, we are far from being there, and I hope we never get there. I would also emphasise that while extreme emergencies that warrant complete financial shutdown would likely be very short-lived, the current social distancing restrictions could be expected to last for several weeks if not months. A shutdown of the stock markets for such prolonged periods would be unnecessary and undesirable.
The fight against Covid-19 is all about restricting the movement and assembly of people to block the spread of the disease. Modern securities trading is completely electronic and does not need the movement of people or things.
In purely technological terms, people should be able to trade stocks and bonds sitting at home without creating any risk of spreading the dreaded disease.
It is true that regulators around the world have created stupid barriers to achieving the seamless remote trading that is technologically possible, but that only means that these obsolete and dysfunctional rules need to be changed. I will come to that in a moment.
This Moment, More Than Most, Needs Functioning Markets
Before getting into more details about how to keep the markets open, I turn to why we need a functioning stock market almost as long as the payment systems are running. We need to remember that even as many economic activities shutdown, both individuals and companies have bills falling due. For businesses, revenues have evaporated but expenses have not. They still need to pay rents, salaries, interest and utility bills. The organised workforce might be still receiving wages and salaries, but in the informal sector and for the self-employed, income has collapsed. Monthly expenses still have to be met from some source or the other. Individuals and businesses, therefore, need to draw down their liquidity reserves, liquidate assets and raise new debt to keep making payments as they fall due. The only alternative would be a sweeping moratorium on all debt servicing and bill payments. The world has not reached that point yet, though some countries might need to consider that at some future stage.
Equities and bonds—or mutual funds holding equities and bonds— are the assets that are being liquidated today to meet the bills. Over the last five years, a large amount of retail savings has flowed into equity and balanced funds through Systematic Investment Plans.
Shutting down the stock markets would freeze all these savings at the time when they are needed most.
Similarly, businesses will need equity markets to bolster their balance sheets; rights issues, preferential allotments, loan against shares might all have a role in keeping these companies afloat. The United States has been discussing a fiscal stimulus that includes a budget for the bailout of critical large businesses that are impacted by Covid-19, and India might also need similar measures. Such rescue packages also need a functioning stock market to price and calibrate such injections of taxpayer money.
While companies would be trying to borrow, the environment does not permit normal due diligence. Many lenders would rely substantially on information revealed in the equity markets because these markets are much more liquid than bond markets. Shutting down equity markets would indirectly shut down parts of the bond market also as information channels get blocked.
Over-Centralised Systems
Finally, let me turn to the regulatory obstacles to trading from home. These regulatory obstacles have arisen because global security regulators, beginning with the U.S. Securities and Exchange Commission, have been asleep at the wheel for the last two decades.
Back in 2001, the 9/11 tragedy in New York demonstrated that stock markets had become so excessively centralised that the destruction of a small part of a single city forced the United States to shut down the entire national stock market. More than a decade ago, I blogged about a similar situation in India where local elections in Mumbai led to the shutdown of the stock markets nation-wide.
Stock exchanges around the world have been obscenely profitable, and yet securities regulators have not forced them to invest sufficiently in business continuity.
In the case of the European Central Bank’s real-time gross settlement system Target2, the main site has a hot backup site with a synchronous copy in the live region, and, in addition, there is an asynchronous copy to two other sites in a separate testing region; all the four sites spread across three countries are permanently staffed. Compared with that, the business continuity planning of most stock exchanges across the world is a joke.
Securities regulators have made things worse by compliance requirements that encourage intermediaries to centralise key functions in a single geographic location. Regulators forgot that we must not create any single point of failure in systemically important securities markets. Keeping the markets open in difficult times like today will force the regulators to sweep out the whole cobweb of dysfunctional rules that stand in the way of a robust and resilient securities market infrastructure. When Covid-19 has passed into the history books, securities intermediaries should also be forced to rectify the deficiencies that come to light at their end during these troubled times.
Let us all hope that regulators in India will have the courage to keep the stock markets open and that the liquidity and price discovery in these markets will contribute their tiny little bit to help individuals and businesses to cope with the economic distress that is emerging today.
JR Varma is Professor of Finance and Accounting at IIM Ahmedabad. He was a full-time member of the Securities and Exchange Board of India.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
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