An independent audit of National Stock Exchange’s algorithmic trading practices found the systems of the country’s largest stock exchange prone to manipulations and also indicated that some brokers may have had unfair access to NSE’s servers.
The exchange has been under regulatory scanner with the Securities and Exchange Board of India (SEBI), in September, ordering NSE to audit its high-speed algorithmic trading practices. NSE had appointed Deloitte for the audit. Deloitte has completed the audit and has submitted its report to Sebi.
“The system architecture of the company’s TCP-IP based TBT (tick-by-tick) system was prone to manipulation. The independent agency’s analysis highlighted trends for certain periods where a few stock brokers appear to be the first to connect to specific servers significantly more often than others,” NSE said in its draft red herring prospectus for its proposed IPO, basing this disclosure on the audit report. The IPO is likely to raise around Rs 10,000 crore.
The audit of NSE also observed indications of potential preferential treatment to a few stock brokers. One particular stock broker almost consistently connected first to the fall back or secondary server during the period from December 10, 2012 to May 30, 2014 and this may not have been possible without the knowledge of certain employees identified in the report, who did not take any action despite consistent connections to the fall back servers against protocol. NSE didn’t disclose the names of the employees in the DRHP.
“The independent agency observed lack of documented policies and protocols with respect to various aspects of the functioning of the TBT system,” it said.
NSE launched colocation services in January 2010. Co-location means the server of the trader/broker will be located in the same data centre as that of the exchange for a fee. With the traders’ servers in proximity to those of the exchange, there is faster data movement.
A significant order flow of the exchange is now passing through the co-location facility especially for algorithmic trading and direct market access.
NSE said revenue from co-location services for the financial year 2015-16 was at Rs 554 crore, constituting 29.7% of revenue from operations, up from Rs 451 crore in 2014-15.
Until receipt of final findings by Sebi or directed otherwise, the revenues generated from co-location business since September 1, 2016 are required be transferred to a separate bank account and NSE will not have access to such revenues.
The findings of the report will cast a cloud on NSE’s proposed IPO, which is expected to be the biggest since 2010, when state run Coal India raised Rs 14,500 crore. Sebi has to approve the NSE IPO.
NSE IPO is essentially an offer for sale, which will give an exit opportunity to some of its investors. Tiger Global Five Holdings, Aranda Investments (Mauritius) Pte, Norwest Venture Partners, Citigroup Strategic Holdings, IDBI Bank, GS Strategic Investments, SBI, PI Opportunities Fund, and IFCI are some of the selling shareholders in the IPO.