Sebi spotlight on BSE, NSE dark fibre the controversy at NSE: Did some brokers get special benefit? Sebi to find out

The Union finance ministry has asked market regulator Securities and Exchange Board of India (Sebi) to probe the alleged "dark fibre links" between the BSE and the NSE, and has been informed, in turn, that a "preliminary fact finding" exercise is already underway.

The BSE and the NSE have also been asked to provide inputs.

NSE dark fiber

When asked about the issue, the former declined to comment, and the latter said the allegations were baseless.

Business Standard has reviewed the letters sent by the finance ministry to the Sebi over the past few months, along with the internal notes, which were obtained under the Right to Information (RTI).

The documents showed that the ministry swung into action after receiving, in November, a whistle-blower account that talked about the "dark fibres" and other issues in high frequency trading (HFT).

According to the ministry note sent to the Sebi, "The recent letter from the whistle-blower dated October 3, 2015, talks about 'dark fibre' links between the NSE and the BSE that is available to select investors. This puts ordinary investors as well as large institutional investors at a serious disadvantage. It also opens the stock exchanges to unknown and unforeseen risk during periods of extreme price volatility."

The ministry note added "proper investigation" is needed "to help save ordinary investors from 'risks and dangers' due to HFT or algo trading".

The whistle-blower's letter describes a dark fibre as "a dedicated fibre link, which has no switching equipment in its path". In tech parlance, a dark fibre is an unused, surplus optic fibre line with a service provider, who leases it out for private use. The October letter is the third the Singapore-based anonymous whistle-blower has written on algo trading since January last year.

The first one alleged manipulations in the NSE between 2011 and 2014. It led to Sebi circulars, tightening regulations on collocation servers and became the subject of a Bombay High Court case. The second letter in August talked about the steps Sebi should take to prove the alleged manipulation and take action. The letters were addressed to Sebi and senior financial journalist Sucheta Dalal.

In response to an email seeking comments about the probe, the NSE spokesperson said, "As you know we avoid giving comments to any matter that is being heard legally."

A letter from an anonymous whistle-blower in Singapore has prompted the authorities to investigate alleged ‘dark fibre’ links between BSE and NSE:
2015: Jan 14: First letter from whistle-blower, alleging manipulation in the NSE collocation centre
Aug 10: Second letter; focusing on steps to be taken by the Sebi to prove manipulation
Oct 3: Whistle-blower writes about ‘dark fibre’ links between the BSE and the NSE
Nov 18: Joint secretary of financial markets writes to Sebi chairman
Dec 14: Reminder sent from ministry to Sebi
Dec 30: Sebi replies; says fact-finding exercise underway. Matter discussed in Technical Advisory Committee
2016: Feb 17: Another reminder from the ministry
Sources: RTI documents, whistle-blower’s letters

The NSE spokesperson added the exchange and market participants used standard protocols as might be available from time to time. "Regarding your query with regard to our reply to the regulator, we always have clarified issues whenever asked for. Since such communications are bilateral, the same cannot be revealed. We have told you earlier also that NSE has always implemented fair practices and allegations as indicated in your email are baseless."

A BSE spokesperson declined to comment.

According to the whistle-blower, a trading firm called AlphaGrep Securities benefitted from this 'dark fibre' link and managed to treble its market share in a few months.

AlphaGrep describes itself a proprietary trading firm focused on high frequency algorithmic trading in asset classes across the globe. It has offices in Mumbai, Bengaluru, Singapore and Hong Kong. "We are one of the largest firms by trading volume on Indian exchanges, and have significant market share on several large global exchanges as well," the firm claimed on its website.

The whistle-blower said, "AlphaGrep figured out that major telcos would not be able to give faster access. It found a cable operator who had a fibre optic network a was willing to provide a 'dark fibre'. A dark fibre is a dedicated fibre link which has no switching equipment in its path.
Sebi spotlight on BSE, NSE dark fibre

In the cash market segment, the BSE is a clear follower of prices at the NSE. It has less than 15 per cent volume of the NSE, and as a result all price changes first happen at the NSE, and are subsequently reflected at BSE.
If a trader can know the price at the NSE before others at the BSE collocation, he could benefit immensely.
AlphaGrep was able to achieve this by hiring a service provider who could provide this fibre optic link between Bandra-Kurla Complex, where the NSE is located, and Fort, where the BSE is housed.
According to the whistle-blower, this ‘dark fibre’ link between Fort and BKC (about 15 km) helped Alpha trade at a fifth of latency as the rest of the market helping it treble market share to 15 per cent between April and August 2015.

"In this case they found Sampark Infotainment which was willing to provide a near 'dark fibre' with minimal switching equipment. Sampark was, however, not a regular ISP and hence could not technically have access to NSE colo. It is NSE policy that they allow links to be terminated only by approved vendors (i.e ISPs) on dedicated MUX equipment at NSE colo. AlphaGrep with its muscle of volume and good contacts managed something no one is supposed to. It got its near 'dark fibre' terminated across NSE and BSE colo without Sampark being an empanelled vendor in April/May 2015. "At the BSE end their job was even easier as BSE does not own its collocation which is managed by a third party which does not have to follow any standards for link termination. The order of latency which they could get across the link was around 400 micro seconds. This was one fifth of what all others were having. If they could trade at one fifth the latency of the market the benefit is not hard to fathom.

"From April to August 2015, the market share of AlphaGrep rose from around five per cent to 15 per cent of BSE turnover. This speaks for itself," the whistle-blower wrote.

The arrangement was legitimised post facto through an agreement with another empanelled service provider after other algo traders cried foul, the whistle-blower added. The AlphaGrep website claims that it has experience in development of low latency systems. "We are a team of curious engineers, mathematicians, and statisticians who like to solve challenging problems. We have past experience in quantitative trading and low latency trading system development at global proprietary trading firms and investment banks." When contacted, Mohit Mutreja, managing director, AlphaGrep, said he was not aware of the letter.

In an emailed response to queries, Mutreja added five-year old AlphaGrep's average daily traded volumes over the past one year represented two to three per cent of daily BSE volumes.

"AlphaGrep does not have any commercial relationship with Sampark Infotainment. AlphaGrep only contracts with exchange-empanelled vendors for exchange connectivity," Mutreja said.

An email seeking comments sent to Prakash D'Souza, managing director, Sampark Infotainment, did not elicit any response.

The RTI documents showed the first letter to Sebi was written by the ministry in mid-November.

After a reminder from the ministry a month later, Sebi on December 30, 2015, informed that a "preliminary fact finding exercise is already underway". The matter has also been discussed in the Technical Advisory Committee of Sebi, the regulator told the ministry.

On March 19, Business Standard had reported that the TAC had submitted a report on the matter, which some people described as "hard-hitting."

The role of the National Stock Exchange (NSE) officials in the ‘dark fibre’ controversy has come under the scanner of the Securities and Exchange Board of India (Sebi), with the regulator probing how non-internet service providers (ISPs) were allowed to lay fibres in the NSE premises to service certain trading members.
A sub-committee appointed by Sebi is already probing the issue and is learnt to have requested the NSE to provide more information about the lapse, sources told FE.
The investigation was initiated after a Singapore-based anonymous whistle blower wrote to the regulator and the finance ministry alleging a collusion between NSE officials and some of its members. The letter alleged that the NSE had violated the norms of fair access and allowed some brokers to benefit by providing a prioritised access through these dark fibers.
“As per the policy of the NSE, links could be terminated only by approved ISPs.
However, few trading members were allowed to terminate their links through non-ISPs. This provided an advantage to those trading members over others, especially in the aspect of multi-legged orders,” said a lawyer who is part of various consultative committees of Sebi.
A dark fibre is a dedicated communication line without any switch or multiplexer (MUX) and carriers data faster compared to a regular line laid by an ISP which works on the transmission control protocol/Internet protocol (TCP/IP) architecture of communication.
This is not the first instance wherein the exchange has been accused of providing unfair access to select trading members. Last year, Moneylife magazine had published a letter written by an anonymous whistle blower alleging that the NSE had provided a few traders access to its servers via co-location. Such access typically gives traders an advantage of 10-15 milliseconds – which is a significant time period in high-frequency trading(HFTs).
The NSE had filed a Rs 100-crore defamation case in the Bombay High Court against Moneylife on the issue.
Did some brokers get special benefit

Market participants have been requesting Sebi to regulate the algorithm trading and HFTs. The markets regulator had released broad guidelines for algorithm trading in 2013.
As per the guidelines, stock brokers and traders who deal with algorithm trading are required to undergo system audits once in six months to ensure that the system programmes are in line with regulations of the Sebi or the stock exchanges .
Sebi is currently working on the final guidelines for algo trading. The possible restrictions that could be placed on algo trading include determination of the resting period and fixing a benchmark for order-to-trade ratio, sources told FE.
These measures are expected check volatility, price manipulation and ensure level playing field between those using algorithms for their trades and those who don’t.

Sources : Business Standard & Financial Express

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