NSE Co-lo Probe Highlights Round Tripping of Money
Brief about Co-location (Co-lo) Facility
Co-location allows brokers to operate closer to their servers upon payment of additional fees. It helps brokers secure an advantage over others due to proximity to exchange servers as data transmission takes less time. Orders reach exchange servers faster than those who have not availed of the facility.
Under the NSE co-location facility, trading members can place their servers in the exchange’s data
center, where they get faster access to the price feed, helping in the swift execution of trades. The
NSE’s co-location facility provides access to brokers for a cost to execute trades faster.
Explanation: A dark fiber or unlit fiber, concerning network connectivity, refers to an
already laid but unused/ passive optical fiber, which is not connected to any active
electronics/equipment and does not have other data flowing through it and is available for use in fiber-optic communication.
NSE Co-location: Case in Brief
A whistleblower in 2014-15 complained to the Securities and Exchange Board of India (SEBI)
saying some brokers in collusion with a few top NSE officials had abused the colocation facility.
NSE was then using the so-called tick-by-tick (TBT) server protocol to relay data to members.
The peculiar part about this protocol is how it delivers the information. Normal data protocols
send data to all users connected to the network at the same time. But TBT transmits in the
sequence of orders received. In other words, the user who gets access to the system first
would receive data earlier than the rest. A select set of brokers in collusion with NSE officials and
Onesies Technologies (the company that provided technology to NSE) got the first access to the
NSE’s servers giving them a head start.
In NSE – Dark Fibre case, the Notices (herein referred to the group of individuals to whom notice
were issued by SEBI, unless the context specifies otherwise) have been alleged to have followed
unfair conduct while allowing an unauthorized service provider i.e. Sampark Infotainment
Private Limited (“Sampark”) to provide the Point Point (P2P) connectivity to only a few
selective registered stock brokers to help them gain the undue advantage of latency vis- a- vis
other stock brokers.
* Mahesh Airan, Assistant Director, The ICSI
Views expressed in the Article are the sole expression of the Author and may not express the views of the Institute.
What were the Allegations?
It has been alleged that by permitting an unauthorized service provider i.e. “Sampark”, to
provide the dark fiber connectivity for certain stock brokers, the Notices allowed these
stock brokers to gain more bandwidth and lower latency for their data transmission and
again by allowing “Sampark” to continue the service even after it was found that “Sampark”
did not possess the necessary license from the Department of Telecommunications to
provide the required P2P connectivity to the brokers of NSE.
The Notices have allegedly acted in violation of the NSE circular in which, NSE had authorized
only four (04) specific Telecom Service Providers from whom its brokers could avail of the P2P
connectivity.
The Notices allegedly being the Director and/or KMP of NSE can be held liable thus, the Show
Cause Notice issued to the Notices in the present proceedings broadly covers the following points/issues:
NSE allowed Sampark to lay down P2P connectivity,
By allowing Sampark to provide the P2P connectivity to a stock broker, despite not having the
authorized license for the same, NSE has acted in violation of its own circular no. NSE
/MEM/12985 dated August 31, 2009, which states to inform all the Trading Members about
the introduction of co-location services, to facilitate better use of DMA and ALGO trading.
Preferential treatment granted to certain stock brokers by NSE in accessing its Co-location
facility to install P2P connectivity while refusing the request of some others.
Detailed Background
In NSE – Dark Fibre, the Securities and Exchange Board of India (“SEBI”) received complaints
alleging various irregularities in respect of the Co-location facility provided by NSE. To deal with the
same, a Cross-Functional Team of SEBI officials was constituted to undertake preliminary fact-finding concerning various irregularities alleged in these complaints.
Subsequently, another complaint was received which alleged inter alia, that certain stock brokers
were permitted to avail of Point to Point (“P2P”) dark fiber connectivity from “Sampark”, a non-impaneled service provider, and the P2P connectivity provided by “Sampark” conferred a
latency advantage to a few brokers which resulted in a substantial increase in their turnover
during the period April-August, 2015.
Based upon the preliminary findings on the above complaints, a common Show Cause Notices
was issued to several entities including the Notices covered in the instant proceedings, inter
Alia alleging that:-
NSE system architecture allowed the Tick–by-Tick (“TBT”) price information to be
disseminated sequentially in the order in which the stock brokers were connected/logged into the server. However, multiple TBT servers at NSE have experienced varied loads and
have started at different points in time. Further, the backup servers were allowed to be
accessed by certain stock brokers(s) as the load on such servers was low.
NSE followed a static mapping process for allocating members’ IPs to dissemination servers
due to which a few brokers were able to log on to the fastest dissemination servers. The
above set-up enabled ‘first-to-connect’ stock brokers to receive data ahead of others and
thus, they were able to react to the information earlier than the rest of the stock brokers.
Differential access in the form of ‘dark fiber’ was given to certain brokering firms/
members at NSE, especially to connect across NSE and BSE co-location facilities at least 4-5 months ahead of other members.
In the Show Cause Notice, the Notices were called upon to explain why the direction under
Section 11(1), 11(2) (a), 11(2)(j), and 11B of Securities and Exchange Board of India Act, 1992
(“SEBI Act”) should not be issued to them for acting in breach of the code of ethics prescribed in
regulations 26(2) of SEBI (Stock Exchanges and Clearing Corporations) Regulation, 2012 (“SECC
Regulations”).
A detailed investigation into the complaint was carried out by SEBI to find out possible violations of
provisions of SEBI Act, Securities Contracts (Regulation) Act, 1956 (“SCR Act”), and/ or the Rules
and the Regulations made there-under such as SECC Regulations and SEBI (Prohibition of
Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (“PFUTP
Regulations”). Subsequently, SEBI identified 15 stock brokers for investigation in the case.
Chitra Ramakrishna resigned from the exchange in December 2016, much ahead of the scheduled
completion of her term. Ravi Narain quit in June 2017. In May 2018, the Central Bureau of
Investigation (CBI) registered an FIR against a Delhi-based stock broker, Sanjay Gupta, a promoter
of OPG Securities Pvt Ltd, for allegedly manipulating the NSE system for two years to get first
access to markets when they opened.
Investigation so conducted by SEBI revealed various irregularities in addition to the preliminary
findings cited above and accordingly another show cause Notice was issued to different entities/
persons for violations of different provisions of the SEBI Act, SECC Regulations and PFUTP
Regulations by them. It is observed that NSE allowed Sampark Infotainment Private Limited to
provide lease lines in NSE's co-location facility despite not being an authorized service provider
of NSE. NSE has acted in contradiction to its own policy by allowing an unauthorized service
provider to lay a dark fiber/ lease line.
Given the above, it has been alleged that the Notices covered in the present proceedings
who were Directors/KMPs for discharging various functions at NSE, failed to act in a manner to
ensure fairness, openness, and transparency, and provide fair, equal, unrestricted, and transparent
access to its co-location facilities and trade data etc., to all market participants in conformity with
the SECC Regulations. Consequently, it was alleged that the Notices have not complied with the
Code of conduct specified under Regulation 26(2), of the SECC Regulations, read with SEBI Master
Circular Dated December 31, 2010.
What action had SEBI taken earlier in the case?
On April 30, 2019, SEBI came down heavily on NSE for alleged lapses in high-frequency trading
offered through its co-location facility, directed the exchange to disgorge Rs. 624.89 crores, and
barred it from accessing the market for funds for six months.
SEBI also asked Narain and Ramakrishna to disgorge 25 percent of their salaries drawn during
a certain period. They were also prohibited from associating with a listed company or a market
infrastructure institution, or any other market intermediary for five years.
In an order given on February 10, 2021, a penalty of `1 crore has been imposed on NSE, and `25
lakh each on Ravi Narain and Chitra Ramakrishna.
NSE co-lo probe highlights round-tripping of money
In international scenarios, round-tripping is a method of structuring to evade taxes and
to launder money.
It has come to light that brokers deployed illegal means to set up trading links between the NSE,
MCX, BSE, and other global exchanges such as SHFE Dalian (China); CME, ICE, and CFD (US); DGCX
(West Asia); and LME and CFD (Europe). Their target was derivatives trading which gave them a
wide pool of volumes and an arbitrage opportunity to generate profit or loss in a manner that can
dodge taxes in India.
Investigations into the National Stock Exchange (NSE) co-location scam by various agencies have
shown that Dubai was used as a key conduit for hawala operations and routing money to other
global exchanges in China, the US, the UK, and West Asia for trading.
Using round-tripped money to trade on Indian exchanges, which is camouflaged as a foreign
portfolio or institutional investment, is illegal in India. Yet, the investigations discovered that
trades were routed through third-party servers in India and, hence, the Internet protocol addresses in the forefront were of these data centers.
There are scores of high-frequency traders in top Indian equity and commodity exchanges that
have a step-down subsidiary in India, with parent entities in the US, Mauritius, and other tax-friendly jurisdictions. Entities linked to Indian brokers registered in the British Virgin Islands
(BVI), too, have been found. Investigations have discovered that point-to-point latency (trading
speed) is the lowest between Dubai and Mumbai at approximately 26 milliseconds, with the setup cost at around `18 lakh for some of the traders that were investigated. The same between
China to Mumbai was around 200 milliseconds at a similar cost of `18 lakh. Singapore to Mumbai
was 54 milliseconds at `22 lakh, London-Mumbai 109 milliseconds and cost between `20 lakh
and `22 lakh, and CME-Mumbai was approximately 200 milliseconds for `30 lakh.
The money was sent via hawala to Dubai and re-routed to all the jurisdictions from there. Once
connectivity was established, traders could even transfer money on the exchange platform for
somebody in India to whatever destination as desired by simple transactions.
Such deals are cut in the deep out-of-the-money call and put options, where there is no liquidity and
orders can be matched at any price, and profit/ loss can be shown as per convenience, depending
on the tax liability to arise. In this method, huge black money can be transferred to India as profits in
the books of a broker who already has a loss, and no or very little tax liability arises after
adjustment. The technique is also used and vice versa to send money abroad.
Dubai free zone gives the advantage of no taxation, confidentiality, and 100 percent ownership. Such
arbitrage firms create in-house trading applications using exchange APIs (application
programming interface), locate their servers in third-party data centers, and take point-to-point
leased line connectivity from foreign exchanges to third-party data centers.
Then, they take local exchange feeds to the same third-party data center. Trades in both foreign
jurisdictions and in India get triggered from the third party data center at the same time, giving
the traders benefit from arbitrage.
Article Foreign companies are undisclosed entities in the books of various brokers in India with links to brokers in other jurisdictions. Many such third-party data centers are being run from Mumbai and Delhi. The APIs or trading software was sold to brokers by high-profile NSE insiders, investigations even by SEBI have shown earlier.
References:-
STUDENT COMPANY SECRETARY | JULY 2022 13
Order dated January 16, 2020, in the matter of NSE- Dark Fibre. The detailed order is available
at https://www.sebi.gov.in/enforcement/orders/jan-2020/order-dated-january-16-2020-in-the-matter-of-nse-dark-fibre_45694.html
https://bharattimes.co.in/nse-co-lo-probe-highlights-round-tripping-of-money/
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