Overview: Analysis of Microcaps in Editorial Focus
In July 2025, the Securities and Exchange Board of India (SEBI) and the Bombay Stock Exchange (BSE) announced an update to the Enhanced Surveillance Mechanism (ESM) for micro and small companies in India. The revised ESM framework aims to tighten market surveillance on small-cap and micro-cap stocks with a market cap below ₹1,000 crore, focusing on protecting retail investors from speculative volatility while ensuring that fundamentally strong companies are not unfairly penalized.
The key changes include:
- Refined surveillance criteria: In addition to the earlier focus on high-low price variation, the updated framework includes a new filter requiring securities to show positive close-to-close price momentum over the last three months to be flagged. This helps identify stocks with genuine investor interest, reducing false positives caused by short-term volatility.
- Price-to-Earnings (PE) ratio limits: Introduction of a PE ratio threshold for Stage 2 surveillance, where only stocks with PE ratios not exceeding twice that of the Nifty 500 index will move to this stage. This prevents overvalued stocks from escaping stricter monitoring, aiming to curb speculative price inflations that can harm investors.
- Exclusion of derivative stocks: Stocks with derivatives will be excluded from ESM screening to focus surveillance on underlying equity securities and avoid unnecessary disruptions to derivative-linked stocks.
- Two-stage surveillance approach maintained: The framework preserves a two-tier system but revises entry thresholds and parameters to enable more targeted and proportional interventions aligned with real-time market behavior.
These revisions seek to strike a balance between discouraging manipulative and speculative trading activities in vulnerable small and micro-cap stocks while ensuring healthy liquidity and investor interest, allowing legitimate growth stories to flourish without fear of undue regulatory restrictions. Inclusion in the ESM is clarified as a preventive and protective measure rather than punitive action, reinforcing transparency and investor confidence.
Stocks that are already in stage 1 will be moved into stage 2 only if they display abnormal price moves and the company's PE ratio is less than zero or more than two times that of the Nifty500 index. It is important to note that many companies in this micro-cap segment are genuine and aim to break into the big league.
The Indian listed universe contains approximately 3,700 micro-cap stocks, trading at a market capitalization of less than ₹1,000 crore. The ESM rules have struck a good middle ground, providing adequate protection for investors while allowing these companies to grow and thrive.
Last week, SEBI proposed changes to the ESM rules after consulting the exchanges. The Securities and Exchange Board of India (SEBI) and stock exchanges have struggled to find a balance in surveillance measures for micro and small companies, but these latest updates seem to be in the right direction.
[1] SEBI Press Release, July 2025 [3] BSE Circular, July 2025
- The updates to the Enhanced Surveillance Mechanism (ESM) for micro and small companies in India, announced by SEBI and the Bombay Stock Exchange (BSE), aim to protect retail investors from speculative volatility, while ensuring that fundamentally strong companies are not unfairly penalized.
- The revised ESM framework includes a new filter that requires securities to show positive close-to-close price momentum over the last three months to be flagged, helping to identify stocks with genuine investor interest and reduce false positives caused by short-term volatility.
- The updates also include a Price-to-Earnings (PE) ratio threshold for Stage 2 surveillance, preventing overvalued stocks from escaping stricter monitoring and curbing speculative price inflations that can harm investors.
- To strike a balance, the ESM rules maintain a two-tier system but revise entry thresholds and parameters to enable more targeted and proportional interventions aligned with real-time market behavior.
- The ESM revisions also exclude derivative stocks from ESM screening to focus surveillance on underlying equity securities and avoid unnecessary disruptions to derivative-linked stocks.
- The changes to the ESM rules are a step in the right direction, providing adequate protection for investors while allowing micro and small companies, many of which are genuine and aim to break into the big league, to grow and thrive.
