“CBI is relying on the ISB (Indian School of Business) Hyderabad, report of 2017 to zero in on the profits or gains made due to lapses in NSE systems. The ISB report listed 30 brokers. These brokers between 2010-14 made profits (from trading) to the tune of ₹2,582.6 crore,” a person with direct knowledge of the matter said, requesting anonymity.
Mint has reviewed a copy of the ISB report, which names these brokers and their trading profits between 2010-14, the period NSE systems were found to be unfair in a Securities and Exchange Board of India (Sebi) order of April 2019. In its order, Sebi found that NSE systems during that period were prone to misuse and manipulation.
Some of these brokers are also part of Sebi’s final investigation examining gains made and losses averted because of unfair access to NSE’s systems.
“The final leg of the Sebi probe involves a deeper examination of the granular data of brokers who were using NSE’s co-location facility. This examination is being done once again by ISB since it understands the NSE systems and the data set,” said a regulatory official declining to be named.
“It is only after the final report will culpability be established. Sebi and ISB have been analysing the data of these brokers to establish whether brokers who made these so-called profits were due to misusing the loopholes in NSE systems and to what extent,” the official said. This suggests that the brokers named so far in the report may not be necessarily culpable.
In response to a right to information (RTI) query on 17 March, the market regulator said “28 brokers were investigated by Sebi regarding NSE co-location matter”, without divulging specifics of the stage of the probe.
Mint could not ascertain names of the two brokerages from the 30 examined by ISB that the regulator excluded. Mint reached out to all the 30 brokers mentioned in the report for responses if any.
ISB’s report submitted in November 2017 analyzed ‘any abnormal economic or financial profits made by logging in first’ by members who were colocated at NSE. It has pegged the total so-called profit made by these 30 brokers from trading at ₹2,582 crore.
According to the report, ISB’s scope was to find out monetary gains made by the 17 members in the Deloitte report. These are the members who had allegedly exploited NSE systems for early log-in advantage. NSE gave ISB a list of additional 13 members to analyse.
Between 2010 and 2014, NSE used to transmit market information to brokers co-located in exchange premises through the so-called unicast system. Under the unicast system, data packets are sent to destination computers of the brokers one by one, with those connecting first getting preference or first login advantage over others. Many members logged-in first by getting unfair access to secondary servers. The report also catalogs the number of times members access NSE systems through the uncrowded secondary servers.
A whistleblower pointed out the flaw in the system in January 2015. Following the complaint, NSE moved to a multicast system that simultaneously broadcasts data to all co-located brokers. Despite cataloging profit figures, ISB made an observation that the early login advantage ‘was not exploited’.
“Such an outcome would have resulted in higher early login profits for the TMs (trading members) alleged to have tried to make unfair profits. This inference is based on the assumption that capital would have flowed to TMs who could earn higher profits than other TMs. The fact that TMs make lower rupee profits while logging in early indicates that the opportunities to make large profits were not taken advantage of. The TMs and the market in general were not aware about the early login status of specific TMs and hence more capital was not invested despite the possibility of higher profits,” said ISB.
The ISB report analyzed intraday and overnight profits made by 30 brokers, including proprietary trades and those done on behalf of clients. These brokers include some leading algo or high-frequency traders, foreign and domestic brokerages. The brokers used NSE’s co-location services, which allowed them to place their servers in exchange premises to reduce latency in receiving or sending information.
“It appears that one TM, OPG Securities, seems to have made higher profits by logging in early. They make higher profits of about close to ₹25 crores when they login early when compared to situations when they do not. OPG Securities’ profits from proprietary trades on days when they log in first are greater than profits from proprietary trades when they do not login first. OPG Securities’ proprietary profits on days of first login is ₹15.55 crore,” said ISB in its report.
OPG Securities is at the centre of a CBI inquiry into alleged misuse of the server architecture in a criminal conspiracy with unknown officials of NSE.
The highest number of log-ins to secondary servers were by OPG Securities, Pace Stock Broking, Crimson Financial Shaastra Broking (now known as Tower Capital) and SMC Global.
Kotak Securities earned a gross income of ₹650 crore in intraday and overnight trading in the 1,327 trading days between 2010 and 2014. To be sure, the final profit figure would need to be adjusted for taxes and operational expenses. Further revenue could also be a function of trading strategy and not just the so-called preferential access. Another domestic firm, Religare Broking Ltd, had intraday gains of ₹135 crore. In response to an email query, Religare disputed the figure and said neither Sebi nor ISB reached out to the firm with any queries. Phillip Capital made a profit in overnight trading of ₹452 crore in the same period.
“OPG Securities and IKM Securities profits from proprietary trading on days when they log in first are greater than when they do not log in first,” ISB said in its report.
Citi Broking, which declined to comment, showed an intraday trading profit of ₹107 crore and overnight trading losses of ₹506 crore. Goldman Sachs, another foreign broker analyzed by ISB, also declined to comment. Barclays, out of the 1,327 trading days, logged in first on 91 days; its trading profits were to the tune of ₹409 crore.
Other firms named in the report include APT Portfolio, AB Financial Services, Way2Wealth, Tower Research (formerly Shaastra Securities), QuadEye, Pace Stock Broking and SMC Global.
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