Why has NSE 'unfair access' issue dragged so long?

A look at key sequence of events in the NSE unfair access issue

Sebi gets three complaints letters in January 2015, August 2015 and October 2015 highlighting flaws in the National Stock Exchange’s (NSE’s) algorithm trading systems. The letters also make allegations of “unfair access” to certain brokers at the exchange's collocation facility. The letter says between 2011 and 2014, the set up at NSE allowed certain brokers (who connected first to the exchange’s system) received data ahead of others and thus were able to react to information before anybody else.   

Following the letters, Sebi sets up a team to do fact finding of the complaints in late 2015. Based on the preliminary finding, the Technical Advisory Committee of Sebi constitutes a committee led by Professor Om Damani of IIT Bombay to further examine the allegations against the country’s largest stock exchange.  

In March 2016, the expert committee submits its report to Sebi. The committee makes critical observations against the bourse. It says NSE has violated norms of fair access by allowing some brokers to benefit. It also alleges that the exchange didn't immediately initiate any steps to check possibility of collusion between its staff and brokers. The expert committee also highlighted that NSE’s systems were prone to manipulation and as a result one OPG Securities was able to gain exploit its systems.

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

In August 2016, the TAC examines NSE’s response. Later in September 2016, Sebi directed NSE’s board to set up an independent examination, including a forensic audit, to address all concerns highlighted by Sebi expert committee. In the interim, Sebi asked NSE to set aside all the revenues emanating from colocation facility in an escrow account. The market regulator gave the exchange three months to complete the investigation and submit a comprehensive report.

In November 2016, NSE appoints Deloitte to conduct the forensic investigation, seeks time till December 2016 to submit its report. The exchange also informs the market regulator that it has transferred around Rs 166 crore into escrow account—transaction charges from colocation facility between September 2016 and November 2016.

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

Based on its internal TAC report and Deloitte report, Sebi reaches a conclusion that some brokers exploited the lacunae in NSE’s system (called tick-by-tick architecture). Sebi also concludes that there could be some collusion between NSE employees and stock brokers. 

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

The market regulator at its board meeting held on February 11, 2017 examines the NSE reply and mulls over future course of action. 

Meanwhile, Sebi also launches a special inspection into  OPG Securities, the firm that allegedly got unfair access. The market regulator also launches similar investigations against few other brokers. The objective of the investigation was to establish if any of them made any illicit gains. Interestingly, neither Sebi’s TAC nor Deloitte audit was able to establish any monetary gains by those involved nor able to establish any malafide.

When queried about the NSE issue at his last press conference, UK Sinha, former chairman of Sebi said, “Sebi got its own examination conducted and based on that has given certain directions. The majority of those directions have been implemented while some are yet to be implemented. Sebi is following up this matter with the concerned agency and matter will be taken to its logical conclusion.”

Before logging out of Sebi, Sinha directs NSE to conduct carry out an audit on its currency derivatives and cash segment to check whether the systems used in these categories are also prone to manipulation.

Earlier this month, NSE appoints consultant EY to carry out the said audit. EY is expected to complete its audit by mid-April.

Just when the market regulator was to deliver its verdict on the issue, there was a change of guard at Sebi with Ajay Tyagi replacing Sinha as the chairman.

People with the knowledge of the development say the market regulator should be able to pass an order on the matter soon.

The issue has become critical as NSE is in the process of launching an Initial Public Offer (IPO). The exchange has already submitted the offer document to Sebi and is waiting approval. Sinha had hinted that the exchange can proceed with its IPO even if the unfair access issue doesn’t reach its conclusion. However, the exchange has to set aside revenues (about Rs 50 crore a month) from its colocation facility into a separate escrow till gets resolved. Market players say this could weigh on the investor sentiment towards the exchange and its necessary that Sebi issues an order in the matter before the exchange can proceed with its IPO.

There has also been a change of guard at NSE with Chitra Ramkrishna stepping down as the MD & CEO. The exchange has appointed IDFC’s Vikram Limaye as its next MD & CEO. It is awaiting Sebi’s nod on the appointment. If approved Limaye is to take charge in May. 

With two fresh people at the helm of Sebi and NSE, all stakeholders are hoping the issue reaches its logical conclusion soon.