The issue of preferential access to select clients for executing market orders — which came to the fore a few years ago with the NSE’s colocation case — was cited again by Ashok Jhunjhunwala, chairman of Sebi’s technical advisory committee (TAC).
Speaking at an event organised by the Securities and Exchange Board of India (Sebi) and National Institute of Securities Markets (NISM) via video call on Thursday, Jhunjhunwala hinted that co-location and high-speed trading were prone to manipulation and fraud, and that traders could game the system in connivance with market players to get faster access to price-sensitive information.
An issue that the capital markets regulator had grappled with time and again, he said, was the fairness with respect to processing and executing trades.
“Price-time priority is the mantra of any exchange, which basically says that orders will be executed strictly on ‘first come first served’ basis. But is there fairness in processing? Does every customer get a fair chance to execute the order based on price-time priority?” asked Jhunjhunwala, also a professor at IIT Madras.
The principle of price/time priority refers to how orders are prioritised for execution. Orders are first ranked according to their price; orders of the same price are then ranked depending on when they were entered.
“Today all technology systems have multiple gates and each of them have separate queues. It’s very difficult to say that price-time priority is being strictly followed,” Jhunjhunwala said.
According to him, a person sitting in Assam or a far-flung corner of the country may take longer in reaching the exchange gate than someone who is in Mumbai. Traders who are near or within the exchange building are closer and will reach the entry gate faster. Co-location computers housed within the exchange building will be the fastest.
“Co-location and high speed computers can place thousands of orders in 10 milliseconds. So if I am in Chennai and place an order in say 5-8 milliseconds, someone with a colocation facility can place thousands or orders in that time,” said Jhunjhunwala.
“So, traders are spending huge amount of money to stay micro or nano seconds away from the exchange leaving those who trade in milli seconds or in seconds far behind. This is basically unfair.”
One second is equal to 1,000 milli seconds and 1 milli second is equal to 1,000 micro seconds. 1 micro second is equal to 1,000 nano seconds.
By some estimates, algo and high-frequency trading contribute about a third of market volumes in India.
The argument in favour of colo or high-speed trading was that it boosted liquidity and encouraged investor participation, especially from institutional investors. Be that as it may, the exchange has a bias in promoting such trades considering that such activity is monetarily rewarding for the exchange, Jhunjhunwala observed.
“There is a tendency to cheat and manipulate if I can get ahead of others and make more money,” said Jhunjhunwala, adding that the challenge was to increase liquidity without compromising on fairness.
Denial of service by intermediaries such as brokers, particularly if done deliberately, was another serious issue that the regulator needed to look into, he said. If the market goes up, for instance, and investors cannot sell it’s a lost opportunity. TAC had, in its 2016 report, concluded that there were systemic lapses at the NSE, and had asked the market regulator to probe ‘collusion’ at different levels in the exchange.