A Scam Unfolds – Extract from ‘Absolute Power’
Sucheta Dalal, the legendary financial journalist who has uncovered several mega scams – including the Harshad Mehta scam and the Ketan Parekh scam in Mumbai’s financial markets – has written a book along with her husband Debashis Basu. Titled “Absolute Power”, the book is about the spectacular rise of the NSE through the late 1990s and early years of this century and then the onset of arrogance and corruption in the same institution. Whilst many of us would like to believe that the NSE has indeed put these problems behind us, given the central role that the NSE plays in the functioning of our stockmarket, everybody who is interested in India’s financial markets should read this book.
The website leaflet has published an extract from the book. The extract focuses on how SEBI, India’s financial services regulator, got whiff of the co-location (‘colo’ in brief) scandal which was the first sign to the wider world that all was not well at the NSE: “Little did we know that the brown paper envelope that landed on Sucheta’s desk on a cool afternoon in January 2015 would, over the next two years, rip open the cosy cabal of market manipulators that functioned right inside India’s biggest exchange. The envelope contained a letter to BK Gupta, SEBI’s deputy general manager, in the market supervision division. It was copied to Sucheta.
What the whistle-blower wrote, using a pseudonym Ken Fong, was highly technical but explosive. It described in great detail a sophisticated market manipulation operation, at NSE’s Colo facility, that had gone on for over three years between 2011 and 2014 ‘with collaboration of NSE data centre staff’. “The NSE’s management team have chosen to hush up the matter,” he alleged. Fong claimed that he worked in the technology team of a Singapore-based hedge fund, with a large exposure to Indian stock markets. Its operations employed complex algorithms or algos, which are the heart of superfast automated trading.”
Dalal & Basu then help the reader get to the heart of the colo scandal: “NSE runs two data streams to disseminate market information. One is called snapshot, which goes out to retail/wholesale brokers and TV channels and, eventually, to investors every few seconds. This contains pending buy and sell orders and the number of shares against those orders. The second stream of information, called tick-by-tick (TBT), is far more granular and contains every single order and trade, and is disseminated to large investors at the Colo servers located at NSE’s premises. These servers are available on hire for a steep rent. So, by default, information is received by high-frequency traders in the Colo server farm, a few seconds before other investors.
Fong alleged that, within the Colo facility, some traders were getting market data ahead of others by a few microseconds due to the limitations of the TBT system. This was in connivance with NSE’s technology staff. TBT, which spewed new orders one by one, was based on old technology called TCP/IP and it offered data on a first-come- first-served basis. Some traders, with the help of NSE staff, ensured that they were the first to log in every day. The firm connecting first to the server would get price information ahead of the others and thus enjoy an unfair advantage. This cycle would be repeated for every bit of price information, putting that firm ahead of others throughout the day. No global exchange in the world was using this architecture; they used an alternate architecture called multicast, which ensures dissemination of data to all users at the exact same time.”
So why did the NSE do something so egregiously unfair? Why did the regulatory authorities look the other way for so long? Who benefited from these? Some of these questions haven’t still been answered fully but to the extent the answers are known, they are in “Absolute Power”.