Co-Location : Issue at the heart of the NSE Scam? : Daily Current Affairs

Relevance: GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation; Important aspects of governance, transparency and accountability.

Key Phrases: Co-location, Stock exchange, Law enforcement agencies, Preferential access, SEBI, Capital markets regulator, Liquidity, Settlement cycle, Listed Company.

Why in News?

  • Multiple agencies are investigating the NSE co-location scam related to the manipulation of the market at the stock exchange, in which several former top officials including former CEOs Chitra Ramakrishna and Ravi Narain are under a cloud.

What is co-location?

  • Co-location is typically associated with a facility where a third party can lease a rack/server space along with other computer hardware. Co-location facility provides infrastructure such as power supply, bandwidth, and cooling for setting up servers and storage of data.
    • In August 2009, the NSE said that it would offer co-location facility to stock brokers who were willing to pay extra. Simply put, brokers could place their IT servers right next to NSE’s servers for a fee. This meant that the prices broadcast by NSE's trading system would first reach the brokers whose servers were closest to NSE's servers.

What is the National Stock Exchange of India “NSE”?

  • The National Stock Exchange of India Limited (NSE) is India's largest financial market.
  • Incorporated in 1992, the NSE has developed into a sophisticated, electronic market, which ranked fourth in the world by equity trading volume.
  • Today, the National Stock Exchange of India Limited (NSE) conducts transactions in the wholesale debt, equity, and derivative markets. One of the more popular offerings is the NIFTY 50 Index, which tracks the largest assets in the Indian equity market.

Benefits of NSE:

  • The National Stock Exchange is a premier marketplace for companies preparing to list on a major exchange. The sheer volume of trading activity and application of automated systems promotes greater transparency in trade matching and the settlement process.
  • This in itself can boost visibility in the market and lift investor confidence. Using cutting-edge technology also allows orders to be filled more efficiently, resulting in greater liquidity and accurate prices.

Technology used by NSE:

  • NSE's trading systems are a state-of-the-art application. It has an uptime record of 99.99% and processes more than a billion messages every day with a sub-millisecond response time.
  • NSE has taken huge strides in technology in 20 years. In 1994, when trading started, NSE technology was handling 2 orders a second. This increased to 60 orders a second in 2001.
  • Today NSE can handle 1,60,000 orders/messages per second, with infinite ability to scale up at short notice on demand, NSE has continuously worked towards ensuring that the settlement cycle comes down. Settlements have always been handled smoothly. The settlement cycle has been reduced from T+3 to T+2/T+1.

What happened at the co-location facility of the NSE that is now being probed by law enforcement agencies?

  • There are allegations that some brokers who had leased space at the NSE co-location facility were able to log on to the NSE’s systems faster with better hardware specifications while engaged in algorithmic trading, which allowed them unfair access and advantage during the period from 2012 to 2014.
  • Even a split-second faster access is believed to result in huge gains for a trader. At that time NSE used to disseminate information through unicast, which is a single, direct request sent from one host to another, with only those hosts interacting over the route.

Though it was not Illegal, but was unfair to those brokers who could not afford it. Non-colocation brokers would receive the prices with a lag, and this lag would be anywhere between a few milliseconds to a second or maybe even more, depending on the physical distance from the exchange's servers.

What did the probe by the capital markets regulator find?

  • The Securities and Exchange Board of India (SEBI) found that preferential access was given to stock brokers at NSE’s co-location faculty.
  • It found that a single stock broker could log on to multiple dissemination servers through multiple IPs assigned to him.
    • o This gave at least 15 brokers preferential access.

As per SEBI:

  • NSE failed to administer the stock exchange with professional competence, fairness, impartiality, efficiency and effectiveness;
  • Failed to maintain the highest standards of personal integrity, truthfulness, honesty and fortitude in discharging their duties and has engaged in acts discreditable to their responsibilities;
  • Failed to perform their duties in an independent and objective manner; and failed to perform their duties with a positive attitude and constructively support open communication”.

What did SEBI do?

  • Following its investigation into the issue, SEBI in 2019 directed NSE to disgorge Rs 624.89 crore, and barred the exchange from accessing the market for funds for six months.
  • Sebi also asked the former NSE CEOs, Ramakrishna and Narain, to disgorge 25 per cent of their respective salaries drawn during a certain period. They were also prohibited from associating with a listed company or a market infrastructure institution or any other market intermediary for a period of five years.

Conclusion:

  • It is true that there has been a systemic and governance failure at NSE and crucial information appears to have been passed to an outsider or outsiders. NSE said there have been several changes at the board and management level at the bourse over the last few years and it has operationalised the directives of Sebi on various matters over the years and has taken measures to further strengthen the control environment, including the technology architecture.
  • The exchange also said it is committed to the highest standards of governance and transparency and will extend full co-operation to the regulator for a satisfactory closure of the matter.

Sources: Indian Express

Mains Question:

Q. What is the National Stock Exchange of India “NSE”?What are its benefits and explain the issues arising out of co-location factor in the NSE scam? [250 words].