The Securities and Exchange Board of India’s (Sebi) investigation work and enforcement has improved considerably since C.B. Bhave took over a little over two years ago. The recent order in the HDFC mutual fund front-running case is testimony to this.
But while things have improved, there is ample room for further change. The HDFC MF front-running case, in which four individuals were penalized, pertained to trades done between April and July 2007. There is a clear case for Sebi to invest much more in the areas of supervision and enforcement, in order that such financial crimes are detected and dealt with more rapidly.
Last week, this column referred to the case made by J.R. Varma of Indian Institute of Management, Ahmedabad, for Sebi to take over the market surveillance function from exchanges. Varma says that exchanges are run as for-profit businesses and this can clash with their regulatory role of market surveillance. He adds that an exchange looking only at the trading in its own system has only a very limited view of what is happening in the market as a whole, since the same asset trades across different venues.
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For instance, a trader could engage in market abuse, such that one leg of his/her trade is on one exchange and the other leg is on another. Both the exchanges would not be able to detect this form of market abuse. But Sebi, which can access trade data from all exchanges, would be able to have a consolidated view of the market and detect such market abuse.
Sebi already has an Integrated Market Surveillance System (IMSS), and has been building on this lately. It has budgeted about Rs20 crore in this fiscal year (6% of its total expenditure budget) to beef up IMSS by procuring a data warehousing and business intelligence system. Still, IMSS’s scope can be increased considerably. To start with, it works with near-time data and not real-time data. Giles Nelson, deputy chief technology officer at Progress Software Corp., points out that regulators generally adopt a rear-view mirror approach to market surveillance, as opposed to using real-time information, which can be used to stop fraudulent behaviour. Prevention, as they say, is better than cure.
Illustration: Shyamal Banerjee/Mint
Not all regulators use the rear-view mirror approach. The UK’s Financial Services Authority (FSA), in fact, uses Progress Software’s Apama Event Processing Platform to power its transaction monitoring and market abuse detection system. This is part of the overall Sabre (Surveillance Analysis of Business Reporting) market surveillance system the UK financial services industry regulator uses. Nelson points out that this is an attempt by the regulator to use the same technology used by market participants, to be in step with the markets. Apama, in fact, is also sold as a platform for algorithmic trading and market surveillance to market participants.
With the increasing adoption of algorithmic trading, the markets now move at alarming speeds and any contagion spreads fast. The “flash crash” on 6 May in the US markets demonstrated this clearly. It also highlighted the need for integrated market surveillance as well as the need for surveillance system that process data as fast as systems used by market participants. Progress’ chief technology officer, John Bates, wrote recently in a blog post, “It is now possible to apply high frequency techniques to not just trading—but also to market monitoring, surveillance and pre-trade risk checks—for regulators, exchanges and brokers. The technology is out there—with proven approaches built on next generation platforms such as complex event processing and it needn’t be expensive.” Bates was recently appointed on a technology advisory committee by the US Commodity Futures Trading Commission.
Needless to say, beefing up the market surveillance function would involve much higher investments in information technology (IT) and manpower. But like Bates points out, it needn’t be expensive. FSA’s spending on IT (including IT delivery outsourcing costs) amounted to only about 6% of its total expenditure budget. Of course, FSA would also be spending on people involved in surveillance, but it does seem like the total cost of surveillance wouldn’t be very high. In Sebi’s case, the software and systems investment may be higher because of the fact that it would be dealing with far more data compared with the UK markets. In terms of the number of messages that are sent to exchanges, the National Stock Exchange generates about 100 times more data compared with the London Stock Exchange, which FSA regulates. And volumes are growing at a more rapid pace in India. This would require systems that can process extremely high amount of data and are scalable so that increasing amounts of data can be captured.
It would certainly be worth the investment since it would thwart many crises that stem from market abuse. A reasonable part of the investment would be recovered from fines that are collected from erring market participants.
As pointed out in this column last week, there’s more than one benefit when the market regulator takes over the primary role of market surveillance. The surveillance function, itself, will be performed more effectively. Besides, exchanges can be left to run as for-profit businesses. This will remove the concerns that arise when a for-profit exchange performs a regulatory function.
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