SEBI and Stock Exchanges Revised Enhanced Surveillance Mechanism for Small-Cap Firms Below ₹1,000 Crore Market Cap.

On July 25, 2025, the Securities and Exchange Board of India (SEBI), in coordination with the Bombay Stock Exchange (BSE), National Stock Exchange (NSE), and Metropolitan Stock Exchange of India Ltd (MSEI), announced major changes to the Enhanced Surveillance Mechanism (ESM) framework. These changes aim to protect retail investors while supporting the genuine growth of small-cap firms, and came into effect on July 28, 2025.

      - The revised framework was introduced after SEBI and stock exchanges observed that several fundamentally strong small-cap companies were being wrongly flagged under the older system. To address this, valuation-based criteria were added to the existing surveillance mechanism, ensuring that firms with sound financials are not unnecessarily restricted. The key focus of this update is to strike a balance between investor safety and growth opportunities in India's capital market.

      - Under the revised norms, any company can now be moved from Stage I to Stage II surveillance only if it meets stricter valuation parameters. Specifically, companies will be flagged if their Price-to-Earnings (PE) Ratio is either zero or negative (indicating losses), or if it exceeds twice the PE of the Nifty 500 Index. This ensures only overvalued or loss-making firms face tighter restrictions, not every volatile stock.

      - For inclusion in Stage I, companies must now display abnormal price volatility over 3, 6, or 12 months, along with a rising price trend in the last three months. The stock must also exceed 1 standard deviation in volatility compared to its small-cap peers. This means only stocks with clear speculative momentum are shortlisted.

Main Point :-   (i) In Stage I of SEBI’s (Securities and Exchange Board of India) Enhanced Surveillance Mechanism (ESM), small-cap companies are put under tight control if their stock prices rise too fast. They must follow 100% margin rules from the T+2 day (two days after trade), each trade is settled individually (trade-for-trade), and the price change limit is reduced to ±5% or ±2%. To be moved to Stage II, the company’s stock must increase by 15% in 5 days or 30% in a month, and its valuation (like PE ratio) must also be high, which signals possible price manipulation or overpricing.

      (ii) Stage II of the surveillance framework introduces the highest level of restrictions, where trading is allowed only through Periodic Call Auctions and price movement is tightly capped at ±2%. These measures are designed to slow down speculative activity while ensuring orderly price discovery for small-cap stocks showing excessive volatility and poor valuations.

(iii) This revised ESM framework by SEBI, launched on July 28, 2025, is expected to benefit 28 companies currently under surveillance. First extended in August 2023 to firms below ₹1,000 crore market cap, the latest update introduces valuation-based filters like PE ratio to distinguish genuine small-cap growth stocks from speculative ones.
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