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All you need to know about the NSE Co-location Scam

The NSE co-location fraud involves market manipulation at India’s largest stock exchange, the National Stock Exchange of India. The Central Bureau of Investigation (CBI) arrested former National Stock Exchange CEO Chitra Ramkrishna in this case just weeks after arresting former Group Operating Officer (GOO) Anand Subramanian.

The CBI stepped into action when the market regulator- the Securities and Exchange Board of India (SEBI) recently issued a report exposing alleged abuse of authority by the then-top brass of the National Stock Exchange. 

The CBI has been investigating the co-location scandal against a Delhi-based stock broker since 2018. According to the article, Ramkrishna, who became the exchange’s MD and CEO on April 1, 2013, sought personal and professional advice from a spiritual guru in the Himalayan ranges for 20 years.

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What exactly is a co-location server?

Let us first define the co-location of servers before discussing the claims against Ramkrishna and others. Co-location facilities are dedicated spaces with IT infrastructure for high-frequency and algo trading that may be rented by a third party. Traders can rent such spaces and use them to set up their trading systems or programmes.

In August 2009, the NSE, the country’s major stock exchange, began offering co-location services. Traders at these facilities had an edge over others due to their closeness to stock exchange servers, since they had faster access to the price feed (buy/sell quotes) supplied by the stock exchange. Faster data access allowed traders to receive the quote first and execute the trade faster, resulting in enormous profits. Furthermore, due to the high cost of these services, only large brokers could afford to rent such a space.

What exactly is the NSE co-location scam?

Some brokers, allegedly in collusion with insiders, took advantage of the NSE’s “first come, first served” data delivery system to reap windfall gains. That is, a trader who signed in to the NSE server with the least load first would get information such as a buy/sell order, order cancellation, and order modification first, as opposed to other traders who came in later. This is known as the NSE co-location scam.

This was known as the ‘Tick-By-Tick’ (TBT) data feed, which distributed information in the sequence in which the brokers connected or signed in to the server, as opposed to a broadcast, in which everyone receives pricing information at the same time.

The servers and ports to which brokers at the co-location facility can connect to access the price feeds are supplied to them. According to a whistleblower in the case, OPG Securities was able to find out which server had the least load so that they could connect to the NSE server faster with the aid of certain personnel in the NSE’s IT department.

The trader reportedly mapped many IP addresses to a single server to gain access to the first two or three connections to the exchange server and therefore crowd out other members.
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What happened once the accusations surfaced?

The Securities and Exchange Board of India (SEBI) launched an investigation into the matter in early 2015 after a whistleblower revealed that some brokers were allegedly getting preferential access through co-location facilities, early login, and ‘dark fibre,’ which allows a trader to access to data feed a fraction of a second faster.

SEBI had set up a cross-functional team to investigate the situation at first, and the regulator’s Technical Advisory Committee (TAC) later proposed the formation of an expert committee, which delivered its findings to the regulator in March 2016. It was discovered that the NSE had broken fair access rules and benefited some brokers.

Also, when a complaint was originally made to the NSE, its management ignored it and took no action to investigate the likelihood of collaboration with the exchange’s workers. 

The panel requested the NSE board to launch an independent investigation, including a forensic investigation by an external agency. The exchange was also directed to put its co-location revenues in an escrow account, including any fibre link from the broker’s co-location facility to their offices.

What steps have been taken so far?

SEBI has tightened regulations overtime to close loopholes and address concerns about algo trading and co-location facilities, such as making TBT feed free to all trading members and requiring exchanges to provide ‘managed co-location service’ through eligible vendors to ensure low-cost services to all interested brokers.

SEBI fined Ramkrishna Rs 3 crore, NSE, Subramanian, and former MD and CEO Ravi Narain Rs 2 crore each, and V R Narasimhan, the chief regulatory officer and compliance officer, Rs 6 lakh.

Furthermore, Ramkrishna and Subramanian have been barred from associating with any SEBI-registered market infrastructure institution or intermediary for three years, while Narain has been barred for two years.

SEBI has also ordered NSE to forfeit Ramkrishna’s excess leave encashment of Rs 1.54 crore and delayed bonus of Rs 2.83 crore, which the exchange had kept, and deposit the funds in its Investor Protection Fund Trust within six days. In addition, for the next six months, SEBI has prohibited NSE from releasing any new product.

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Who is the mysterious ‘yogi’?

Since May 2018, the CBI has been investigating the case, but no substantial evidence has been uncovered to identify the mysterious Himalayan “yogi” with whom Ramkrishna revealed confidential information.

Subramanian, who advised Ramkrishna from 2013 to 2015 before becoming Group Operations Officer and Advisor to the MD from 2015 to 2016, was purportedly referred to as the “yogi” in the forensic audit, but SEBI dismissed the assertion in its final report. Subramanian had watched his yearly income rise from Rs 15 lakh to Rs 1.68 crore, then to Rs 4.21 crore, while working as a mid-level manager at Balmer & Lawrie. Subramanian was suspected by the CBI of being the mystery “yogi,” but the agency did not confirm it.

Did you know about the NSE co-location scam?

Image Credits: The Indian Express

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