Mumbai: India’s markets regulator will introduce an early-warning system to caution people about the risks of investing in stocks of overvalued companies, those with unsustainable business models and ones that may go bankrupt, said two people aware of the development.

The proposed system would rate a stock on a numeric scale or a colour-coded system which will allow investors to easily identify risks associated with a stock on account of its trading pattern or owing to the condition of the company’s business, said the people, which includes a Securities and Exchange Board of India (Sebi) official. Mutual funds have a similar system called a riskometer.

Sebi officials went on a study tour of Singapore and Hong Kong last month to study similar systems, said one of the two people cited earlier. Singapore has a system of automatic “trade with caution" alerts which are generated when trading activity in a stock cannot be explained based on publicly available information.

“Since the equity market is rising steadily, investors are prone to take higher unwarranted risks while attempting to gain from the bull market. Three departments at Sebi are working on creation of an early-warning system," the person said. “Over the past few years insolvency cases have increased, the number of initial public offerings have gone up and instances of shell companies started emerging."

Sebi is also considering asking listed firms to disclose certain additional details on a quarterly basis. These may include human resource data, cost-cutting details, changes in remuneration of top management, details of loans availed and their usage, and plans to service debts as well, the person added.

“Abnormalities in the business could be assessed from certain balance sheet items too," said the second person.

According to Sebi’s plan, the public will be shown a company’s business-related risks by comparing its data with the industry benchmark or the average of its listed peer group.

Apart from this, market-related risks, too, will be indicated to the investor, the people said.

“Sebi wants to ensure that whenever there is concentration in trading, at least some percentage of the trade results in compulsory delivery to indicate the trade is genuine. At present, there is no such criteria," said the first person.

Sebi is likely to publish a consultation paper on the market-warning system within the next six months, while the first set of rules are likely to be announced by the second half of fiscal year 2019, said the first person.

The present financial reporting system has to move towards some sort of evaluative reporting regime, according to P.R. Ramesh, chairman of consulting firm Deloitte India.

“Room occupancy trends in the hotel industry; passenger kilometres for a company in the aviation industry; average revenue per user in a telecom company; order book in a construction company; unfulfilled-orders in an automobile company etc. are important information. All this may prove to be critical warning signals but are not coming along with the quarterly financials right now, and so the investor is unable to correlate the non-financial factors with the quarterly results," said Ramesh. “To begin with, companies should be asked to publish at least a few evaluative ratios along with financials to help investors take better investment decisions."

Sebi has consulted fund managers, investment bankers, consulting firms and top chartered accountants to develop the early-warning system.

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