NSE’s rocky road to transformation

Overlooking the Mumbai skyline at the plush Chambers conference room of Taj Land’s End in Bandra, the atmosphere seemed tense when National Stock Exchange’s top executives met on Saturday evening. The exchange has been in the news for all the wrong reasons in the recent past, with its former chief executive and her top deputy currently under federal arrest.

Events have moved rapidly in the five years since chief executive Chitra Ramkrishna’s abrupt exit in 2017, with a new board and a new CEO -- Vikram Limaye -- taking charge. The exchange also took a series of measures to prevent the kind of mis-steps that ended in the co-location scam. On Saturday, this correspondent joined a stock-taking meeting at the hotel’s 25th floor, where CEO Limaye, chief regulatory officer Priya Subbaraman and chief technology officer Shiv Bhasin met to review the exchange’s transformation in the past five years.

The interaction happened just a day after the NSE board invited applications for a new CEO. Limaye’s five-year term ends in July -- he is eligible for a five-year extension, but it is not known if he will apply. The board has taken the services of headhunter firm Kon Ferry, and a candidate will be finalized by an external three-member panel and the NSE board.

It has been a rocky five years for Limaye, who was brought in after Ramkrishna’s abrupt resignation in the middle of a probe into alleged lapses in NSE’s co-location platform. Limaye steered the exchange through a messy, multidisciplinary probe, and defended it against Securities and Exchange Board of India (Sebi) orders. The exchange has also rolled out a number of changes in the past three years to safeguard investors from broker mischief.

On Sunday night, Ramkrishna was arrested in the co-location scam by the Central Bureau of Investigation (CBI). The case pertains to certain brokers getting unfair access to its systems while they used NSE’s co-location facility. Co-location refers to the practice of traders placing their terminals in exchange premises for faster access to market data and trading, and it is typically used by high frequency traders (HFT).

“Significantly improving stakeholder relationships was a top priority in 2017-18 and continues to be an important area of focus. This was achieved based on transparency, strong governance, collaboration and accessibility,” Limaye told Mint.

For about half of his tenure, the world was grappling with the coronavirus pandemic and lockdowns. During this time, the number of investors in Indian markets doubled to 70 million, raising the responsibility on exchanges to ensure the markets function without hiccups.

By and large, India’s two premium exchanges - BSE and NSE - have been successful in ensuring smooth operations through these years. The exceptions: A three-hour shutdown at NSE in February last year, and a one-hour disruption in broadcasting market prices on Monday morning across broker terminals.

“A lot of work has gone into ensuring that our exchanges are equipped to handle the increased volume,” said Bhasin, CTO. “NSE has set up ‘points of presence’ or PoPs in 25 cities to ensure that the latency for these cities is reduced,” he added.

“It has been coupled with enhanced regulatory supervision,” said Priya Subbaraman, CRO. “Due to steps taken towards regulatory supervision, the size and nature of problems with respect to broker lapses and defaults have steeply gone down,” she said.

According to Limaye, regulatory and technology are top priority groups for NSE’s board and management. “Allocation of human and financial capital for these two groups is never a constraint. Serious attention is paid towards them,” Limaye said.

Since 2019, NSE has seen at least 20 broker defaults; yet, this is a steep reduction from the previous years due to new systems of information reconciliation, tracking investor securities, and information standardization.

For instance, what could be found only in annual inspections can now be spotted in a matter of days. Cases of missing client securities are identified early on, and information about funds is received directly from banks. All this has led to the number of broker defaults going down to two in FY22, with the amount involved ₹18-19 crore.

The increased surveillance is also due to changes in Sebi norms for margin, collateral and pledging and re-pledging of shares. Now, client securities cannot be used for unauthorized purposes.

NSE has filed over 50 complaints with Institute of Chartered Accountants in India (ICAI) against the auditors of brokers who failed to detect issues in the books of the brokers they audit. It has also incorporated a listing investigation department which tracks lapses at listed entities. It is based on an early alert generation system, set up in collaboration with a fintech firm.

“There are a series of red flags that have been set up; for instance, if the top line is growing but it is not accompanied by any tangible incremental change in the business. These references are made to Sebi for further investigations,” said a person familiar with the matter.

Before the pandemic, NSE was clearing 2 billion orders every day, which has increased to 12 billion now. NSE’s Project Hercules works to tackle this load, and it has been largely successful in managing the number of investors that swelled from 35 million before the pandemic in February 2020 to 70 million by January 2022.

NSE has 1,200 racks in its co-location facility where brokers can place their servers. Since it is a Local Area Network (LAN), the order connectivity and market data connectivity is provided on a 10 GBPS port, which is much faster compared to brokers whose servers are situated outside exchange premises. The average latency is at 1,744 nano seconds. These rack spaces are taken up by 200-odd brokers out of the 1,400 brokers/ trading members trading on NSE.

This is one of the biggest revenue-generators for the exchange, and each rack is sold for ₹12 lakh per annum. Brokers can also buy half a rack and a quarter rack. It caters to deep-pocketed trading members and brokers, and has often been criticized as being unfair.

To further democratize the colocation facility, NSE opened co-location as a service or (CaaS) in 2018, where a fraction of rack can be purchased at much affordable rates. Yet, the number of users has hardly increased. In 2021, NSE allowed purchasing a quarter of the rack.

“Users of such data will be limited. For long-only funds, such nano-second price advantage does not make sense. It is meant for intra-day HFT traders,” said the person cited above.

NSE has faced criticism that some employees indicted by Sebi over co-location and governance lapses continue at the exchange in different roles. Some have retired or left and faced no consequence.

Suprabhat Lala, NSE’s former AVP of trading operations, was barred by Sebi in April 2019 from associating with any exchange or market infrastructure institute for two years over conflict of interest. NSE had granted a project to compute Liquidity Index (LIX) to Infotech Financial Services Ltd, where one of the directors was Sunita Thomas, Lala’s wife.

Further, the data given to Infotech for research of LIX was misused to develop algorithm trading products. Sebi had relied on an email conversation between Ajay Shah, NSE’s senior researcher who accessed data for LIX, and Thomas, who also happens to be Shah’s sister-in-law.

“The data that we are getting out of NSE for VIX and LIX is being used for algorithmic trading work - it would be a severe problem if this fact comes to light since NSE has not given anyone else this data,” said Sebi in its order passed in April 2019.

Lala continues to be with the exchange. A person familiar with the matter said that all officials have obtained a stay from the Securities Appellate Tribunal (SAT).

“Since he and others such as Devi Prasad (who used to head co-location) obtained a stay from SAT, NSE could not take any further action. However, Sebi had asked NSE to shift these officers away from core operations to non-core posts, which NSE has done. For instance, Lala has been shifted to KYC and mutual funds division,” said this person, declining to be named.

The NSE management is clear that issues related to former management are affairs of the past and does not impact the current situation at the exchange. Today, NSE commands a market share of about 95% in trading.

The only impact has been the damage to its reputation. In 2016, the exchange was valued at ₹40,000 crore the valuation has since risen to ₹2 trillion. Perhaps this alone demonstrates how valuable the exchange is.