(this article first appeared on livemint.com)
The National Stock of Exchange of India Ltd (NSE) has hired accounting firm Deloitte India to do a forensic audit and to examine allegations of unfair access to some brokers in algorithmic trading.
“Deloitte has been appointed, NSE will adhere to Sebi directions,” said a spokesperson for NSE in an emailed response to a query. A spokesperson for Deloitte declined to comment.
This comes after a Securities and Exchange Board of India-appointed (Sebi-appointed) committee found instances of fair access violation by the exchange and certain brokers. On 9 September, Sebi wrote to the board of the exchange to commission a forensic audit of its co-location facility and algorithmic trading platform by a third party, Mint reported.
The audit would cover the exchange’s co-location facility, algorithmic trading platform, brokers and vendors who access or are connected with NSE’s co-location facility. It will also examine allegations of collusion between NSE officials, vendors and brokers and gather evidence if any violations are found, said two of the people cited earlier.
Algorithmic trading or high-frequency trading (HFT) refers to the use of electronic systems which can potentially execute thousands of orders on the stock exchange in less than a second. Trading firms that have faster access tend to have an edge over others.
The allegations against NSE pertain to members who co-locate their servers on the premises of the exchange for low latency. “Based on the forensic audit NSE would examine its systems, take corrective action and submit its final report to Sebi,” said a person familiar with the development who spoke on condition of anonymity.
The forensic audit would examine if certain brokers got unfair access or were able to manipulate NSE’s existing system to get preferential access, said a second person familiar with the development.
“As part of the forensic audit or fact-finding exercise, Deloitte would be examining the trade data, time stamps and verifying it against the broker code to gauge whether certain brokers got unfair preferential access,” this person added.
“Deloitte, as a firm, is best known for examining financial frauds and has a fair amount of expertise in examining dealer room frauds,” he added, declining to be named.
It is not uncommon for regulators to get exchange systems audited when issues of misconduct are highlighted.
For instance, systems of National Commodity and Derivatives Exchange (NCDEX) were audited when a settlement crisis cropped up in it castor contracts which were later suspended. NCDEX submitted its final report which included excerpts from the report submitted by the audit firm Mukund M. Chitale & Co.
However, when the Forward Markets Commission (FMC) had asked for an audit of Multi Commodity Exchange of India Ltd (MCX) in 2013, the auditor was directly reporting to FMC.
“The audit at this juncture may be able to examine the current NSE system and not the systems prevailing in 2012 when these allegations cropped up. HFT and co-location are specific technology-driven issues where you may need expertise of people who are good with data,” said the head of a firm which provides algo solutions, on condition of anonymity.
The unfair access issue first came to light when a whistle-blower who went by the pseudonym Ken Fong wrote to the regulator alleging that NSE’s systems were being misused, and that some people consistently enjoyed an advantage to the detriment of others.
