Currently one of the most successful capital market institutions, the NSE is embroiled in a bit of controversy, allegedly providing preferential access or co-location to a set of brokers who might have benefited with the speeding up of their orders.

While the jury is still not out as to whether the NSE management faltered or the beneficiaries capitalised on the ignorance of the management, it’s worth brooding over the genesis of the incident.

NSE has been run very professionally by a set of accomplished managers and is built on the credibility of objectivity and orderly functioning, which led to the shifting of trades in hordes from the one-time unassailable BSE to its platform.

Keeping up Currently, there’s unbridled innovation on planet earth. Technological advancements are transforming the way people think, act and manage affairs. Fintech is running miles ahead of other areas of advancement.

Market micro-structure enables the process of exchange of goods and services. Its design also focuses on the relationship between buyers, sellers and intermediaries. Changes in the social, political and economic order impact the ways of life in society, which eventually influence market forces.

The fusion of society’s behaviour, ever-mounting aspirations, and technology are fuelling the rapidity and profundity of the changes. It is, therefore, important that market micro-structure undergoes re-engineering and refurbishing on an ongoing basis, because it is not possible to shoot a moving target with a static gun position. Capital markets across geographies have since been besieged with high frequency trades, flash orders, the proliferation of dark pools, naked access, co-location and co-hosting, et al . These coupled with the advances and sophistication of algorithms and machine learnings have been enabling (mis)adventures in the marketplace.

Further, the search for alpha has led to creating an opportunity if one cannot be discovered before the next bonus becomes due. In a price-time priority seamless trading ethos when transactions take place with the speed of light, even a millisecond matters to benefit from lower latencies and speed of execution of trades.

Together all these are also prone to creating a high degree of asymmetry in information, which can disrupt fairness in the execution of voluntary transactions.

Ensuring integrity of the market and fairness in dealings has thus become a serious challenge for the statutory as also subordinate regulators (exchanges) across geographies.

Timely action Following the lessons learned from the Ketan Parekh scam, Indian capital market micro-structure underwent a comprehensive overhaul like contraction of the settlement cycle from T+5 to T+2, from the account period to the rolling settlement, dynamic and upfront margining, real-time monitoring of broker positions and automatic disablement of terminals and compulsory straight through processing for corporate trades, etc. There have been marginal tweakings periodically ever since, but the even settlement cycle has remained stuck at T+2 for over a decade notwithstanding the rise in volumes in the cash and derivatives segments many times over. The open positions have been rising but the financial strength of central counterparty — Clearing Corporation — has not grown correspondingly. Eventually, the depth of settlement risk has magnified. A couple of years back, UK Sinha who was chairman of SEBI, had invited past chairmen for their views on building perspectives for architecturing a pragmatic strategic action plan.

I had recommended revisiting market micro-structure in light of the looming clouds of flash orders, algo and high-frequency trading. A couple of incidents of flash orders disruption and accusations against NSE have since occurred. It is understood that SEBI seized those issues and dealt with them appropriately. Likewise, instances have occurred in banking and insurance as well.

The Indian economy is undergoing structural adjustments. Fintech advances and mind games are pervading banking, capital market, mutual funds and even insurance. Whereas the physical and social infrastructure remain works-in-progress, technological breakthroughs and their deployment, particularly in the past three years, have seen phenomenal progress.

The enactment of the Aadhaar Act paving the way for the multi-purpose use of unique identity, and expansion of Aadhaar-enabled services, over 28 million Jan Dhan accounts, expansion of the digital network, mobile telephones in the hands of every Indian, and the upsurge of payment gateways — Paytm, Bank Apps, BHIM — along with legislation preventing cash transactions exceeding ₹2 lakh is all changing the way Indian financial markets will operate.

No room for complacency The economy is poised to become more formal than informal albeit with a lag bringing greater volumes to transaction platforms. Global participation in search of returns and stability is growing substantially.

It’s time to revisit the financial market micro-structure for all the segments, including the bandwidth of the platforms itself so that chinks in the highway of transactions do not get erected. A review is also needed to prevent the collapse of platforms, market abuse, insider trading, market manipulation, intermediary-client conflict, and lack of confidentiality and threat to the security of assets of customers .

Indian financial markets went through a confidence shake-up in 1992 and 2000-01 (the Harshad Mehta and Ketan Parikh scams, respectively) when the banking and securities markets were adversely impacted, eventually driving down the growth of the economy for several years.

Complacency can be disastrous. While it is important to understand the root cause of market misconducts and failures, reorientation of the regulatory framework in consonance with the emerging environment cannot be postponed. In fact, it is essential to create forces of accountability to act as firewalls to obviate skirmishes.

While creating a progressive and competitive ecosystem across the country, the strength of the market micro-structure has to be ensured so that the process and outcome of the exchange of assets happen under explicit trading rules. The technology and algorithms operate within the framework of integrity and fairness. The regulatory frame prevents abuse. The financial markets operate on trust.

Hence, self-seeking professional traders have to be prevented from working against long-term retail and institutional investors. Then alone can the financial markets continue to help speed up the momentum of growth.

The writer was chairman of SEBI and LIC

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