Six years after it allowed the National Stock Exchange (NSE) to introduce high frequency trading (HFT) and algorithmic (algo) trading without any debate, rules or regulations, the Securities and Exchange Board of India (SEBI), on 5th August, put out a discussion paper on “Strengthening of the regulatory framework for algorithmic trading & co-location”. The paper is interesting, for several reasons. It comes in the aftermath of a detailed investigation into three letters from a whistle-blower which pointed to serious irregularities in the HFT and algo trading at the NSE. Yet, there is no mention in the discussion paper about the series of events and investigations that were triggered by the publication of these allegations and have led to the attempt to fix HFT and algo problems.
Instead, SEBI’s paper suggests that it is merely reacting to global concerns among regulators to the following: that HFT and algo trading give unfair access to powerful traders at the cost of long-term investors; rogue algorithms seem to trigger flash-crashes that can destabilise markets; and regulators’ own ability to supervise the sophistication of complex algos.
Indeed, global regulators have gone beyond debating the issue of unfair access. In June 2016, Securities Exchange Commission (SEC) approved Brad Katsuyama’s ‘Investors Exchange’ which specifically aims to neutralise the ‘unfair advantage’ gained by high-frequency traders. There is also serious research in the US which challenges the claim by HFT proponents that their trades add volume and liquidity to markets. Clearly, SEBI, as a regulator, needs to stay in step with international developments.
SEBI’s discussion paper puts out various options to allay the fear and concern of unfair and inequitable access and seeks market feedback on the efficacy of each of these. It is almost an attempt to crowd source the best possible mechanism for Indian markets. It is anybody’s guess which of these will finally be prescribed as new rules for HFT. Some of the issues put out for discussion include:
- Review of the tick-by-tick (TBT) data feed and replacing it with ‘structured data’ that will provide a level playing field between high-frequency traders (who use TBT data for a fee) and other traders.
- Introducing a minimum resting time for orders to eliminate ‘fleeting’ orders that vanish in nano seconds in response to price data. If this is introduced, “orders received by the stock exchange would not be allowed to be amended or cancelled before a specified amount of time, viz., 500 milliseconds is elapsed.” If accepted, SEBI will be the first regulator to adopt this check.
- Introducing random speed bumps, through a randomised order processing delay of milliseconds to discourage ‘latency-sensitive strategies’. The paper lists global developments in introducing such random speed bumps.
- Plans for randomisation of orders and the introduction of frequent batch auctions where sell and buy orders on the order book are bunched for a specific length of time (say, 100 milliseconds) and matched at the end of the time interval. This is expected to eliminate the ‘latency advantage’ enjoyed by co-located servers. The paper cautions that would need serious changes in market infrastructure.
- A maximum order-to-trade ratio requiring market participant to execute at least one trade for a set number of order messages sent to a trading venue. This is aimed at ensuring that a viewed quote is available for trade and reducing ‘hyper-active order book participation’.
- There is also a discussion on a two separate queues and order validation mechanism for orders emanating from co-located servers and non-co-located systems. Orders from each queue will be taken up in the order-book in a round-robin fashion. Although the discussion paper says that “co-located participants would still be among the first to receive the market data feeds” due to their proximity to the exchange and use of sophisticated algorithms, this proposal is likely to see the strongest opposition by proxy from bourses.
While SEBI has set a deadline of 31st August for submitting comments to its third discussion paper on HFT and algo trading, there is no timeframe set for implementing the new rules. But, even if SEBI does implement them quickly, there is a problem. Can SEBI simply brush under the carpet the saga that began on 19 June 2015 when Moneylife published a whistleblower’s letter (addressed to SEBI’s surveillance department and copied to me) alleging serious wrongdoing in the HFT or algo trading at the NSE?
The NSE slapped a Rs100-crore defamation suit against us for publishing the letter and tried to gag us through a notice of motion, even while it refused to answer our queries about the letter, despite several reminders. The Bombay High Court, in an excoriating order, described the NSE’s attitude towards Moneylife as ‘egregious arrogance’ and imposed a penalty of Rs50 lakh. The NSE has appealed the order and obtained a stay against the payment. The case has been in limbo for a while and the Exchange is in no hurry to pursue its alleged defamation.
Meanwhile, Moneylife received two more letters from the whistleblower which we brought to the attention of SEBI and the finance ministry. The last one (addressed only to me), made some serious charges about NSE’s violation of its own policy, in allowing a non-registered ISP (internet service provider) called Sampark Infotainment to lay a ‘dark fibre’ in its premises for various members.
SEBI referred these letters to the technical advisory committee. The committee’s findings, widely published by the media and accessed by us, reveal that an investigation by its sub-committee comprising experts from the Indian Institute of Technology, Mumbai, have confirmed most of the allegations of the whistleblower. The committee says it is clear that “NSE violated norms of fair access and allowed some brokers to benefit.” The committee wanted SEBI to initiate “immediate action for lapses on the part of NSE” and constitute a team of people with appropriate background to investigate the collusion aspect between NSE officials and OPG Securities.
Predictably, SEBI has not moved an inch in that direction. The NSE strongly refuted the charges of the SEBI committee too and the issue appears to be in limbo since then. Angry protests by some top institutional investors who felt short-changed also did not lead to a resolution. Instead, the regulator and the government seemed to believe that listing the Exchange (which has been under the control of the same two or three individuals for 25 long years), and tinkering with the composition of its board of directors, is the answer to increasing transparency.
Media reports suggest that the NSE, despite its deep reluctance, may be heading towards listing around the same time as the Bombay Stock Exchange (BSE). We don’t know if that will happen. But how fair is it for a regulator to allow the largest stock exchange to seek public investment even as serious allegations against it remain unresolved? After all, the NSE is a first-line regulator and SEBI cannot take the attitude that mere disclosures about on-going investigation and pending litigation are enough, when it has adopted a far stricter attitude to clearing IPO documents of private companies.
Standard procedure of shoot the messenger is habit of CEO.
Lot needs to be done than marketing Make in India services Mahesh