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After the unprecedented trading halt on 24 February, the National Stock Exchange (NSE) has been accused of a number of things, including inefficiency, poor communication and a general apathy towards the plight of market participants.

The gravest charge came from rival BSE, which said: “It was anti-competitive and unethical on the part of NSE Clearing Ltd (NCL) to stop its operations to preserve NSE’s monopoly and hold the market to ransom."

The reference is to the alleged inability of market participants to shift trading to BSE’s platform using the interoperability function permitted by the Securities and Exchange Board of India (Sebi). “The troubles at NCL prevented the market from shifting to BSE’s trading platform. The NSE-owned clearing corporation stopped functioning and ensured all brokers who clear through them couldn’t place orders on BSE," a spokesperson for BSE said in an email. NSE didn’t respond to an email seeking comment on the allegations.

With the interoperability function, trading members can use collateral posted with the clearing corporation of one exchange to trade on another. The process can work smoothly as long as the clearing corporations of all exchanges are able to talk to one another. So, prima facie, BSE’s complaint makes sense, as NCL had indeed stopped operations. But note that trading was halted on NSE because of troubles at NCL and not the other way around.

“We received communication of instability of all links from both the (telecom) service providers. While there was no impact to the trading system, this instability resulted in an impact to the online risk management system," NSE said in a statement early on Thursday. The online risk management system is housed in NCL, as it is a clearing function.

Why NCL stopped operations may still be an open-ended question as the root-cause analysis report is awaited, but a suggestion that it was because of anti-competitive reasons is inaccurate. Of course, there is still much left to be desired in NSE’s decisions on 24 February, and one decision in particular related to interoperability.

Going by NSE’s statement, it had an issue with its clearing function, but none with its trading engine. As such, it could have well left its trading platform on, even though its clearing and risk management were not functioning smoothly. It would have been able to do this simply because of interoperability, as trading members could have used collateral posted with BSE’s clearing corporation to trade on NSE.

One could argue that NCL accounts for the majority of collateral posted by members across platforms. But to rule out the possibility of members using BSE’s actively functioning clearing corporation to trade on NSE isn’t an exchange’s call to make. By permitting interoperability, Sebi has already ruled that this is how things should be. In fact, it raises questions on the whole idea of interoperability if NSE isn’t able to trust BSE’s clearing corporation to clear trades executed on its platform.

“When an entity shuts its trading system because its clearing operations aren’t functioning, it goes against the core principle of interoperability. A trading platform that is not facing any operational issues should keep functioning as long as at least one clearing corporation capable of clearing its trades is functional. Similarly, a clearing corporation that is not facing operational issues should keep functioning as long as at least one exchange that can use its clearing facilities is up and running. In this case, since BSE Clearing was functioning, NSE trading could have been kept on," says J.R. Varma, a professor of finance at IIM-Ahmedabad and a former Sebi whole-time member.

The silver lining on 24 February was that interoperability worked to some extent.

“The framework of interoperability put in place by Sebi facilitated market participants to continue transactions at other stock exchanges, thereby allowing them to seamlessly trade/square off existing positions," Sebi said in a note. But it wasn’t seamless for everyone. Only some trading firms and brokers with sufficient collateral at NCL were able to execute on BSE.

“Our firm was able to square off positions, given the interoperability between clearing corporations, as we had more than sufficient collateral with NCL," says Rajesh Baheti, managing director, Crosseas Capital Services Pvt. Ltd.

Since NCL wasn’t functional and trading members couldn’t post fresh collateral with it, some trading firms that hadn’t deposited sufficient capital ahead of the outage were affected.

“We were able to square off positions of clients using intra-day products, thanks to the interoperability function. However, as the front-end systems used by most brokers haven’t yet adapted to this regime, clients couldn’t place these square-off trades on their own," said Nithin Kamath, chief executive of discount broker Zerodha.

Clients using brokers that provide offline services were better placed as some of their trades were squared off after consultation with their broker. Online brokers, on the other hand, use an automatic square-off function, which resulted in high losses for some clients. Kamath’s comment on front-end systems shows India’s trading ecosystem isn’t yet fully geared for interoperability, even though it was permitted by the regulator about 20 months ago. Many broker risk-management systems, too, are out of date and do not free up client margins when trades are squared off on another exchange using interoperability.

24 February was the first big test for interoperability in India, and while there were a few success stories, there were many letdowns as well.

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