NSE tightens surveillance of illiquid options

PALAK SHAH | | Updated on: May 05, 2022

Trading in OTM index and stock options being tracked, says NSE CRO

The National Stock Exchange (NSE) is likely to crack down on manipulative trading in illiquid options. NSE’s Chief Regulatory Officer (CRO) Priya Subbaraman told BusinessLine that NSE has tightened surveillance of less-liquid options where clients are trading in out-of-the-money (OTM) contracts. “We are tracking specific patterns of buying and selling, and will take action,” Subbaraman said.

Trading in OTM index and stock options has been under the SEBI scanner and the Mumbai income tax department for several months now, the sources said. The tax officials believe that OTM options, where the underlying price of the contact is far away from the strike price or the present price, was being used for tax evasion (be generating artificial profit and loss) and other purposes. In the past, the Mumbai tax department had sought data from both the NSE and BSE with regard to trading in illiquid scrips and derivative contracts, the sources said.

Subbaraman said that the NSE has also tightened its surveillance over brokers to ensure investor safety. Around 32 brokers have been declared as defaulters by the NSE since May 2019. NSE says that it is now closely monitoring margins that brokers collect from clients and even settlement of funds. 

Extensive analysis

“For some top brokers, we do a more extensive analysis on an ongoing basis, over and above offsite supervision. System for monitoring client MTM (mark to market) losses to check with ledger balance and value of pledged securities. We will look at client ledgers in specific situations,” Subbaraman said.

In Novermber 2019, it was revealed by BusinessLine that Karvy Stock Brokers, one of the largest retail segment players, had defaulted and also used client shares as collateral to avail bank loans. Stock exchanges and SEBI conduct regular inspections of brokers and are supposed to act on the alerts that are generated during the inspection. In fact, the responsibility of SEBI too is equal to the exchanges with regard to broker inspections, experts say.

However, Subbaraman said that forensic audit can reveal much more details of brokers than the normal course of audits and the exchange was not holding back on ordering detailed probe where they found the alerts. Subbaraman did not answer any question on surveillance of its co-location trading systems, but said that the exchange had deployed checks to detect anomalies in orders coming through algorithmic trading.

Tightening of norms

“Steps that SEBI and NSE have already taken — tightening of the norms, and strict and continuous monitoring, have led to brokers being unable to comply and default. You will also notice that the actions have been taken in a short time-period. We believe that this has led to higher trust in markets,” Subbaraman said.

NSE’s offsite monitoring team detects shortfall, if any, within a few days of reporting by brokers and the exchange also gets information directly from banks and from clearing members and clearing corporations so that “we can match and find inconsistencies”. Further, NSE has implemented a data analytics and visualisation project in collaboration with a data analytics vendor, which helps the inspection teams to get better insights on a large volume of member and trade data.

Other measures

NSE says that it strengthened the first line of defence — internal auditors. “Where auditors should have detected certain practices but have failed to do so, we file complaints with the ICAI, but at the same time provide training support and sampling methodology to auditors to help them. We have recently said that audit firms need to have five years’ experience before they can audit brokers. All interim and final orders are now available on our web site, so that there is transparency. We have stopped new clients for three members in the past two months,” Subbaraman said.

Vikram Kothari, Managing Director, NSE Clearing Ltd, said that they had implemented systems to provide transparency and traceability of collateral, individual collateral segregation and protection for all investors. He said that it was highly likely that NSE would launch initiatives for making portability and quick return of collateral.

NSE says that mystery shopping is another useful tool they had deployed and had also issued caution in three cases recently. Mystery shopping is nothing but a surveillance measure used since the 1940s, where it was mainly utilised in banks and retail stores to check the integrity of employees. In NSE’s case, it is using it to keep the brokers and other associates under check with the indicative method that may improve service provider conduct by signalling conduct issues in the market. The NSE is also considering embedding in social media as part of mystery shopping framework. NSE said it will look at back-office vendor registration and monitoring to curb any practices of ledger manipulation.

Published on May 05, 2022
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