NSE 'unfair access' probe reaches critical stage

A man walks past the NSE (National Stock Exchange) building in Mumbai (Photo: PTI)
Markets regulator Securities and Exchange Board of India’s (Sebi’s) probe against the National Stock Exchange (NSE) in the preferential access controversy has reached a crucial stage. In June, the exchange will have to deal with the findings of an internal probe and a forensic audit by EY on its currency and cash segment.

Exchange will also have to reply to the show-cause notices issued by Sebi last week. The internal committee set up by the NSE to pin responsibility for the lapses at its co-location facility is expected to submit its report soon. The report will be first submitted to the managing director and the board and later, it could be submitted to Sebi as well. 

Also, EY’s forensic audit report on the NSE’s currency derivatives and cash segment will be submitted in June. Meanwhile, the NSE and its 14 officials, who have been served notices by the Sebi, will have to submit their replies and may even have to appear for a personal hearing. Sources say the NSE’s board could soon meet to take stock of the situation and prepare its defence before the Sebi. After studying the NSE’s replies, the Sebi is likely to pass a final order in the matter, in which the exchange has been embroiled in since 2015.

What has happened so far?

The case dates back to 2015 when the markets regulator received three letters highlighting flaws in the NSE’s algorithm trading systems. The letters also made allegations of “unfair access” to certain brokers at the exchange's co-location facility, a service that allows traders or brokers to place servers on the NSE’s premises and gain direct and faster access to the trading exchange’s systems.

According to the letters submitted between 2011 and 2014, the set-up at the NSE allowed certain brokers (those connecting first) to receive data ahead of others. This enabled them to react to information before anybody else.   

Following the letters, the Sebi set up fact-finding team in late 2015 to probe the allegations. Based on the preliminary finding, the regulator’s technical advisory committee (TAC) constituted an expert panel to further examine the allegations against the country’s largest stock exchange.  

In March 2016, the panel submitted its report to the Sebi. The committee made some critical observations against the bourse. It said the NSE violated norms of fair access by allowing some brokers to benefit. It also alleged that the exchange didn't immediately initiate steps to check the possibility of collusion between its staff and brokers. The expert committee also highlighted that the NSE’s systems were prone to manipulation and, as a result, broking outfit OPG Securities was able to exploit its systems.

The Sebi asked the NSE to respond to allegations made by the TAC-constituted panel. In its replies in May 2016 and June 2016, the exchange said it had addressed various issues raised by the expert committee. It further said it would work closely with the TAC to make further improvements.

In September 2016, the Sebi directed the exchange’s board to set up an independent examination, including a forensic audit, to address all concerns highlighted by regulator’s expert committee. The regulator also directed the NSE to set aside all the revenues emanating from the co-location facility in a separate escrow account.
In November 2016, the NSE appointed Deloitte to conduct the forensic investigation.

On December 3, 2016, Chitra Ramkrishna unexpectedly quit as the chief executive officer (CEO) of the exchange. The exchange appointed Group President J Ravichandran as interim CEO.

The NSE submitted Deloitte’s report to the Sebi on December 23, 2016. The report also suggested the NSE’s systems were prone to manipulation.  It also said there was lack of documented policies and protocols on dissemination of data and data retention, among other things.

The exchange also filed an offer document for its initial public offering (IPO) with the Sebi. The NSE mentioned the co-location controversy in the risk factors.

In January 2017, the Sebi directed the NSE to submit a comprehensive action plan to address the issues and findings raised in the forensic report.  It also asked the bourse to submit a road map in two weeks on technological and procedural changes required at the NSE. The exchange submitted the report to the Sebi on the new systems and process put in place.

In February 2017, former Sebi chairman U K Sinha, at a press conference, said the majority of directions issued had been implemented by the NSE. A few days later, the NSE selected IDFC’s Vikram Limaye as its new managing director and CEO. The exchange sought the Sebi’s nod on the appointment, but the regulator is yet to approve it. 

Before demitting office, Sinha had ordered the NSE to conduct another audit, this time on its currency derivatives and cash segment, to check whether the systems used in these categories were also prone to manipulation. The exchange appointed consultancy firm EY to carry out the said audit.

In April, Sebi Chairman Ajay Tyagi had said the co-location issue would take a few months’ time to get addressed. Tyagi also said the approval for the NSE’s IPO would happen only after the co-location controversy was settled. 

Earlier this month, the Sebi appointed an enquiry officer to work on the matter and within days issued show-cause notices to the NSE and 14 officials, asking them to respond to the allegations in the TAC and Deloitte reports.

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