 "March of the stock markets")
Acting on whistle-blower’s allegations regarding ‘dark fibre links’ and other issues that are faced in high frequency trading (HFT), the Finance Ministry has asked the Securities and Exchange Board of India (SEBI) to probe these links.
An exclusive newsbreak by Business Standard’s N Sundaresha Subramanian reveals the letters sent by the ministry to the markets regulator, along with internal notes, which were obtained through a Right to Information (RTI). One of the notes reveals states, “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.”
While the BSE has declined to comment on the issue, the National Stock Exchange (NSE) has called the allegations baseless.
Here’s a breakdown of the issues involving the use of ‘dark fibre’ and how a trading firm has allegedly reaped benefits from it.
What is a dark fibre?
It is a dedicated fibre link, which has no switching equipment in its path, the whistle-blower’s letter explains. In other words, the dark fibre is an unused, surplus optic fibre line with a service provider, who leases it out for private use.
What is the whistle-blower alleging?
A whistle-blower from Singapore has written three letters, highlighting the issues of manipulations and dark fibre at the NSE.
The first letter spoke about the manipulations at the exchange’s co-location centre between 2011 and 2014. The letter had resulted in circulars from SEBI, that had sought tightening regulations on co-location servers. It had also become a subject of a Bombay High Court case.
A co-location centre is a place where computers owned by HFT firms and proprietary traders are housed in the same premises where an exchange’s computers are kept, explains Investopedia, a financial information websit .
The second letter in August 2015 had stressed on the steps the market regulator must take in order to prove the manipulation and take action.
Meanwhile, the third letter alleges the dark fibre link, which firms have allegedly used to obtain price trends before BSE.
What is happening in this case?
In the cash market segment, the BSE is a clear follower of prices at the NSE. All price changes first happen at the NSE, and are subsequently reflected at the BSE. Hence, if a trader can know the price at NSE before others come to know at the BSE co-location, it is set to benefit immensely.
A trading firm, AlphaGrep, is said to have trebled its market share in a few months due to a dark fibre link. It hired an internet service provider (ISP), Sampark Infotainment, who could provide this link between Bandra-Kurla Complex (BKC), where the NSE is located and Fort, which houses the BSE.
Sampark Infotainment is said to have provided a near ‘dark fibre’ with minimal switching equipment. As per NSE’s policy, links can be terminated only by approved ISPs on dedicated MUX equipment at the exchange’s co-location. Interestingly, this ISP was not an empanelled vendor in April 2015. Even then, AlphaGrep, with its alleged use of volume and good contacts, is said to have got the link terminated across NSE and BSE.
“At the BSE-end, their job was even easier as the BSE does not own its co-location, 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,” the whistle-blower further added.
In an email response to queries, Mohit Mutreja, managing director of AlphaGrep said that the five-year old firm's average daily traded volumes over the past one year represented 2-3% 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 added.
How did AlphaGrep benefit?
The move has resulted in the trading form trade at a fifth of the latency as the rest of the market. It trebled its market share to 15% between April and August 2015.
A lower latency equals faster speed. Therefore, HFTs spend heavily to obtain the fastest computer hardware, software and data lines to execute orders as speedily as possible and gain a competitive edge in trading.
"From April to August 2015, the market share of AlphaGrep rose from around five% to 15% of BSE turnover. This speaks for itself," the whistle-blower wrote.
What is the crackdown?
The finance minister has now asked the market regulator to probe the matter. The regulator, in turn, informed the ministry that a ‘preliminary fact-finding exercise’ is already underway. The matter has also been discussed in the Technical Advisory Committee (TAC) of SEBI.
The BSE declined to comment on the matter. Meanwhile, an NSE spokesperson said, “As you know, we avoid giving comments to any matter that is being heard legally. 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.”
