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.

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 that 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, show documents reviewed by BusinessLine.

Illegal in India

Using round-tripped money to trade on Indian exchanges, which is camouflaged as foreign portfolio or institutional investments, 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 centres.

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 set up 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 at a cost of ₹30 lakh.

According to the documents, most traders registered their offshore companies in Dubai, since it had nearly 20 free zones, with the most famous of them being the Dubai Multi Commodities Centre (DMCC).

Why Dubai?

The money was sent via hawala to Dubai and re-routed to all the jurisdictions from there. Sources say that 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 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 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 loss and no or very little tax liability arises after adjustment. The technique is also used vice versa to send money abroad.

“Dubai free zone gives advantage of no taxation, confidentiality and 100 per cent ownership. Such arbitrage firms create in-house trading applications using exchange APIs (application programming interface), locate their servers in third-party data centres, and take point-to-point leased line connectivity from foreign exchanges to third-party data centres.

Then, they take local exchange feeds to the same third-party data centre. Trades in both foreign jurisdictions and in India get triggered from the third party data centre at the same time, giving the traders a benefit of arbitrage,” the probe report says.

The foreign companies have been found to be undisclosed entities in the books of various brokers in India with links to brokers in other jurisdictions. Many such third-party data centres are being run from Mumbai and Delhi.

The APIs or trading software were sold to brokers by high profile NSE insiders, investigations even by market regulator SEBI have shown earlier. “Facts regarding connectivity between various exchanges were also discussed in the e-mails of two NSE employees,” said the probe report.

The probe report, which has also named the two NSE officials, said the modus operandi of “international arbitrage” was illustrated, according to the e-mail between the two officials with the subject ‘offshore arbitrage’, and that NSE was aware of these activities. The probe report also says that the said e-mail was part of the post-search investigations and recovered from NSE servers and not from the brokers.

comment COMMENT NOW