MCX Stock Exchange (MCX-SX) has alleged that the National Stock Exchange’s (NSE) policy of waiving fees for its currency derivatives segment amounts to “predatory pricing". It has lodged a complaint with the Competition Commission of India (CCI). MCX-SX is part of the Financial Technologies group, but is a separate corporate entity. All of its revenues currently are linked to the currency derivatives segment, since it hasn’t got permission from the Securities and Exchange Board of India (Sebi) to trade other products. NSE, meanwhile, runs a highly profitable equity cash and derivatives business, where it has a near-monopoly. The charge is that it can afford to keep waiving fees in the currency derivatives segment till competition is killed.

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Meanwhile, the Bombay Stock Exchange (BSE) has complained to Sebi that NSE is going painfully slow in approving a basic algorithmic trading strategy called smart order routing that involves both exchanges. Because many Indian stocks are dual-listed on BSE and NSE and trade at slightly different prices, a trader would like to find which the best venue to execute an order is. At any given point, it may make sense to execute an order on one of the two exchanges or in part on the two exchanges. A smart order routing program can make this decision at machine speed, and is hence a desired feature for many brokers and traders. BSE will likely gain more from this feature, since it currently has a much lower share of order flow. BSE’s head of market development James Shapiro said at a recent technology conference, FixGlobal Face2Face Forums, “It’s strange that my competitor has to approve my member to use one of the most basic algos—smart order routing."

NSE’s perspective on the issue is completely different—the reason smart order routing hasn’t taken off lies with BSE. With both exchanges not being able to see eye to eye on this issue, there’s a clear need for some mediation. Shapiro said at the Fix conference Sebi isn’t seeing managing competition as a central part of its mandate. He says the regulator needs to have a competition policy that will prevent practices that hold back the development of the market.

Rahul Singh, assistant professor, National Law School, Bangalore, and a member of CCI’s advisory committee on regulation, differs: “According to the Sebi Act, the stock market regulator’s mandate is protection of investors, regulation and development of the securities market. Sebi does not have a mandate to look into competition issues. Nonetheless, the Competition Act stipulates that CCI must work along with sector-specific regulators. The way ahead is for the two regulators to work in consultation with each other."

Coming back to the issue of smart order routing or for that matter any algorithmic program, exchanges shouldn’t be involved in approvals at all. They can maintain market integrity through other means such as monitoring position limits and margins, which they are already doing. Being able to see algorithms of broker members creates a new set of conflicts of interest, like the one when an exchange official joins a rival trading firm. The way for Sebi to intervene here would be to say that exchanges needn’t approve algorithms anymore.

The predatory pricing charge is, of course, best left to CCI. Now that the Competition Act has been notified and important positions in the commission have been filled up, CCI is in a reasonably good position to decide on antitrust matters. As Singh suggests, the best solution would be for CCI to work together with Sebi.

But there is a larger issue the stock exchange industry in India is struggling with. Each of India’s stock exchanges has an ownership in or an affiliation to a front-end trading solutions provider. They are, hence, involved in not only providing exchange services but also distribution of these services. In developed markets, distribution is done by third-party providers. MCX-SX is owned by Financial Technologies India Ltd, which is the largest player in the distribution space. NSE acquired a stake in Omnesys Technologies Pvt. Ltd, which not only distributes its own products but has helped NSE develop an Internet-based solution called NOW (NSE on the Web). Earlier this year, BSE acquired Marketplace Technologies Pvt. Ltd, another distribution company.

Barring NOW, each of the front-end trading solutions distributes feeds of not only their promoter/subsidiary exchange, but also those of rival exchanges. This results in a clear conflict of interest. The solution provider could well discriminate against competitors when disseminating market data. Stale data can put off broker members who would then shift their volumes to the exchange the trading solutions provider is supporting. This is not to say that any of the distribution companies are doing this, but it is possible and is, hence, an issue for Sebi to look into.

Already, NSE and Financial Technologies are in court over a related issue. Besides, BSE and NSE are at loggerheads over the former enabling its feeds to be accessed through the NOW platform. NOW’s servers are based in NSE’s headquarters and the concern is that this would naturally lead to faster data transmission for NSE’s feeds vis-à-vis those of BSE.

Given the obvious conflict of interest in owning distribution companies, Sebi would do well to have a policy framework for them. There are some issues related to competition that Sebi shouldn’t ignore.

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