Minimising error trades on the SGX

In a quiet market, with the daily stock turnover regularly falling below the $1 billion mark, it was most unusual to learn of a batch of error trades involving a staggering 52.3 million New Silkroutes Group shares recently.

The explanation, however, was simple: The confusion was the result of some investors who had been unaware of the 500-into-one consolidation of New Silkroutes' shares and were keying in far too low a price to sell the shares just after the opening bell on its first trading day post-consolidation.

The remedy was provided by the Singapore Exchange (SGX), which took swift action to minimise the fallout by cancelling the error trades and making other rectifications to ensure any upcoming share consolidations do not result in such mayhem.

That aside, the New Silkroutes error trades have again highlighted a structural flaw in the SGX's trading system which has long been a bane of the local stockbroking community: An investor really needs to know the exact number of shares he has in the Central Depository (CDP) before he sells.

Otherwise, he runs the risk of accidentally selling "short" - that is selling shares he does not own. That may cost him dearly as the SGX will forcibly buy the shares - at higher prices - on a special market known as the "buying-in" market and deliver them to the buyer.

Now, if you are a foreign trader unfamiliar with the local market, you may wonder why such an outdated and cumbersome practice like "buying in" still exists when the SGX claims to have one of the world's fastest trading engines.

For an explanation, we have to go back 25 years, when trading went scripless on the local stock market.

Back then, in 1990, the painful memories of the 1985 Pan-Electric crisis - which caused five broking houses to collapse and the stock market to be shut down for an unprecedented three days - were still fresh in investors' minds.

So to alleviate concerns over scripless trading, a decision was made to allow investors to hold their shares in a central depository called the CDP to assuage worries - rightly or wrongly - that brokers might be tempted to do something fraudulent with their clients' shares if they had access to them.

But in most other stock markets - including Hong Kong, New York, London and our neighbour Kuala Lumpur - the practice is for an investor to leave his shares in the safekeeping of his broker. That will ensure he will not get his numbers wrong when he sells his shares.

However, keeping the shares in the CDP does have its benefits, even though brokers feel inconvenienced by the practice. One is that it gives investors the flexibility to use different brokerages for their trades, so long as their accounts with these brokerages are linked up with the CDP.

It also gives investors peace of mind: Keeping shares with a brokerage runs the risk of the brokerage trading the shares without the investor's knowledge. There is also the credit risk of the brokerage to bear in mind. The failure of triple-A rated Lehman Brothers seven years ago is a chilling reminder that no investment bank or brokerage is too big to fail.

Since the CDP is far removed from the market, the likelihood of it tampering with the shares in its safekeeping is remote.

There is the added comfort that the CDP comes under the purview of the SGX, which is strictly supervised by the Monetary Authority of Singapore.

Still, despite the obvious benefits of the CDP, the drawback is that there will always be some investors who get "bought in" because they fail to check their CDP accounts before selling their shares.

The "buying-in" list, published on the SGX website daily, shows that, on average, around 20 to 30 counters are "bought in" every day.

Some error trades have been painful. In the early days of scripless trading in the 1990s, one dealer mistakenly keyed in an order to sell 400,000 Jardine Matheson shares when he wanted to sell only 400 shares.

The trade was not cancelled because it had been transacted at market price. It resulted in a massive buying-in exercise stretching over a week as the then Stock Exchange of Singapore, SGX's predecessor, forcibly bought Jardine Matheson shares at ever higher prices on the "buying-in" market to cover the shortfall.

In a worse case, investors who failed to settle their trades after Lehman Brothers collapsed in September 2008 found themselves heavily penalised as the SGX imposed fines of $1,000 or more on them in an attempt to deter "naked" short-selling during a period of near panic in financial markets across the globe.

In implementing scripless trading, the SGX also did away with cash trading, which would have allowed traders to settle outstanding trades on the same day they are executed.

Despite many appeals made over the years, the SGX has stood firm against reintroducing cash trading. One reason is to guard against possible market abuse, such as a trader deliberately depressing a stock by selling shares he does not own and using the cash market to make purchases the next day to cover his "short" positions.

And because shares are kept with the CDP rather than with the brokers, another curious quirk persists here - contra trading, the practice whereby remisiers give up to three days' credit to clients to settle outstanding purchases without their having to put up any cash or stocks as collateral.

In other markets, a brokerage would have simply asked its clients to pledge their shares, already in its safekeeping, as collateral if they are not prepared to remit cash upfront for their purchases.

To try to resolve this problem of giving unsecured credit for stock trading, the regulators want to implement a new rule that will require investors to put up a minimum 5 per cent collateral on unsettled trades by the end of the trading day.

Now, considering that all these issues may have arisen because our shares are kept in a centralised depository, one question to ask is whether the structural fault can be tackled at source, namely the CDP.

When collateralised trading is finally introduced here, the hope is that a way will be found to "earmark" an investor's shares as collateral with the brokerage without the need for the shares to leave his CDP account with the SGX's new post-trade system.

Surely, a way can also be found to reject a sell order if there are insufficient shares in the seller's CDP account.

This is considering that a person's brokerage account must be linked to the CDP in the first place before he can trade.

The digital revolution has made it possible for consumers to use their mobile phones to do a host of transactions via apps, such as checking banking accounts. Surely, it is within the CDP's means to provide a similar service for investors.

Such a service would definitely help in reducing the number of failed trades due to human errors that keep cropping up. It is a New Year resolution worth adopting.

Correction note: An earlier version of this article stated that "the new rule will require investors to put up a minimum 5 per cent collateral on unsettled trades by the end of the next trading day". Investors should do so by the end of the trading day. 

A version of this article appeared in the print edition of The Straits Times on December 28, 2015, with the headline 'Minimising error trades on the SGX'. Print Edition | Subscribe