We are going through a difficult period. The scale and impact of the Coronavirus on the daily lives of the people as well as the functioning of businesses and governments is unprecedented in recent times. We all must stay resolute in fighting this crisis together. The saving of lives of people is of top importance and we should take whatever steps are required to meet this end.
One of the collateral damages of the spread of Coronavirus has been the sharp corrections in the global financial markets. There is a heightened sense of uncertainty and investors are trying to deal with this. This is not surprising, based on past instances of sharp economic slowdown or big adverse events.
There is also an ongoing vociferous debate on whether the financial markets, especially stock exchanges, should be shut down for some time, till the situation on Coronavirus improves. It is natural for investors and analysts to become emotional and form their views in such times. But we need to evaluate this, just like similar other serious matters, in a reasoned manner. The conclusions should be based on the broad objectives and the facts on the ground.
Let us evaluate the facts.
What is a stock exchange?
A stock exchange is a platform for buyers and sellers of stocks, voluntarily participating in transactions. Modern stock exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are well organised and efficiently operating platforms. They have well-tested systems and processes to operate under normal as well as stressed conditions. However, it is a matter of evaluation as to whether their operations face any risk in these times. There is also risk to the health of the employees in case they have to physically congregate and work from an office space. This is a serious risk, and cannot be ignored by the exchanges.
Both the NSE and BSE have been operating with a robust operational risk management (ORM) framework. This framework is designed exactly to evaluate the kinds of risks mentioned above. They Managements of the Exchanges would be assessing these risks and making a reasoned decision, based on the above. They are best placed, as well as authorised, to make these decisions. Investors and analysts would do well to respect the decision making processes of the exchanges as well as their decisions on whether to continue operating the exchanges.
With the above caveats, let us now consider how important it is to keep the stock exchanges open, if we can.
Market is different from market prices.
Stock prices can go up or down, sharply. A sharp fall in the prices affects the wealth of investors, but should not be mixed up with the health of a stock exchange. An exchange is robust as long as trades can be executed and settled efficiently on its platform. The performance of an exchange and that of the stocks traded on it are two different things and need to be evaluated differently, and, in the most part, independently.
It’s perfectly fine for investors to fret about the any sharp movements in market prices, because it affects their wealth. But, every problem needs a correct solution to address it. For investors it is to focus on managing their portfolios and not the platforms on which their stocks are traded. The opening or closing of an exchange does not affect the value of one’s portfolio. Almost the entire risk of an investor’s portfolio is decided by the investor’s own actions, as against that of the exchange.
Transaction costs are important.
A break in the functioning of an exchange will lead to a higher level of imputed liquidity risk for investors. This, in turn, will raise the immediate as well as longer term transaction cost for the investors. If the investors fear a closure of the exchange, many of them would immediately rush to buy or sell their holdings, thus transacting at potentially exaggerated pricing on either side. In the long term, as well, the investors will price in a possibility of closure of the exchange in case of even a moderately stressful scenario.
So, it is in the interest of all market participants to desire for a continuous market, rather than a break in the functioning of any market or exchange.
Use the opportunity to manage the portfolios
Markets tend to become temporarily inefficient during times of extreme volatility. This provides an opportunity to active and smart portfolio managers for shuffling their stocks during this period. Similarly, passive portfolio managers would like to re-balance their asset allocations during this period.
For both the sets of managers or investors, the assessment of the expected returns and risks on their portfolio is of utmost importance. In order to assess these risks, knowing the prices is imperative.
So, the opening of stock exchanges is very important for investors to assess the performance parameters as well as transact to make any changes in their portfolios.
These are some of the key reasons for keeping the exchanges open. There are also other reasons like maintaining the long term reputation risk of the exchanges and allowing free and efficient movement of capital between various sections of economic agents.
To summarise, the Managements of the stock exchanges are best placed to decide on the matter of opening or temporary closure of the same. For the market participants, however, there are good reasons to favour a continuously open state of exchanges.
Let us stay calm and take decisions that are in the best interests of all stakeholders.
Disclaimer: The views expressed in the article above are those of the authors’ and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.