NSE controversy – Part 2

This article on mint talks about the response of NSE on allegations about which I have written in this blog here. NSE in its response has completely refuted all allegations against it that it favored few brokers over others.

““NSE’s response is rather comprehensive; they have refuted allegations of collusion. They have highlighted that they did not violate any regulations that were prevalent during the relevant period. The exchange has also spoken about certain factual inaccuracies in report and sought fresh examination of the issue,” said the second person, he too declined to be named considering the sensitivity of the issue.

The allegations against NSE pertain to members who co-locate their servers on the premises of the exchange. Even at these co-located centres, some of the servers themselves might have differing hardware capabilities or workloads.

This issue first came to light when a whistleblower 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 advantages to the detriment of others. The minutes of Sebi’s technical advisory committee said that it had received three such letters from the whistleblower.

After examining the issue, a Sebi panel had recommended action for lapses on the part of NSE and exploitations made by brokerage OPG Securities under the guidance of the panel. The panel further advised Sebi that it may constitute a team comprising people with appropriate background to investigate the collusion aspect between NSE officials and OPG.

The report in question was prepared by a sub-committee constituted by TAC. This sub-committee had six Sebi officials and Om Damani, a professor of computer science and engineering at the Indian Institute of Technology, Bombay. In its report, the sub-committee said the bourse had not provided adequate details to the committee examining the issue.

NSE in the reply has stated that allegation that the bourse had violated norms by allowing non-ISPs such as Sampark (Infotainment) to lay dark fibre on its premises for various members is factually incorrect, said the second person cited above. ISPs refer to Internet service providers. According to NSE, Sampark was a sub-vendor of a registered ISP, the second person said.

Dark fibre refers to a dedicated communication line through which data travels faster than regular lines because of the absence of other traffic. As such, there is nothing illegal about using such faster connectivity infrastructure.

NSE, in its response, has also pointed out there were no clear regulations at the time of alleged violations. Between 2011-2014 the period, when certain brokers allegedly gained unfair advantage, there was an absence of regulations and tools that are currently being used to allow for fair access to market data and exchange platform, NSE has highlighted, said the second person.”

I think the words by people interviewed in the are rather carefully chosen. NSE may not have violated the regulations at that point in time but that does not necessarily mean they have acted in an immoral way. Regulations more often than not lag markets. Even in the present case India is still developing its regulations with respect to algo and high frequency trading. However lack of regulations does not mean that NSE is not responsible.

“The first responsibility of an exchange is fair access of the order book to all investors, if that is being violated then it puts question mark on the integrity of the exchange. The justification that there were no regulations during the relevant period is immaterial as the first principle that is fair access has been violated,” said Shriram Subramanian, founder and managing director, InGovernResearch Services Pvt. Ltd.

Sebi’s technical advisory committee had suggested that a framework should be established within Sebi and stock exchanges to detect any abuse of the system by algo traders.

According to a 17 May Mint report, Sebi has already started implementing the recommendations of the panel which advises it on algo trades. In consultation with Sebi’s technical advisory committee earlier this month, the regulator has decided to have more checks and surveillance at the level of exchanges. To ensure this, NSE and BSE Ltd could be asked to constitute a separate team to keep an eye on algo trades, Mint reported. These checks would be in addition to the existing surveillance systems of exchanges.




This is an interesting article on corruption in mint.

“Kakha Bendukidze, whose reforms took the nation of Georgia from the 124th place in Transparency International’s corruption perceptions index in 2003 to 50th place today, recalled in an interview with Ukrainian journalist Vladimir Fedorin that he once attended a RAND Corporation-organized US-Russian business forum, attended by Donald Rumsfeld and Paul O’Neil, both of whom had leading roles in George W. Bush’s administration.

“Once a Russian participant was complaining about corruption. So Rumsfeld said to that: ‘I think there’s a simple way to combat corruption—you need to pass a law to ban corruption.’ All the Russian participants were rolling around laughing, and the Americans were nodding their heads earnestly: ‘Yes, yes.’”

It may not have happened quite like that, but Bendukidze, known for his sharp wit, seized on an important issue: Western experts stress the institutional, legal and enforcement side, as if unaware that laws can be ignored, institutions subverted and enforcers can become the problem rather than the solution.

Bendukidze’s own solution was not of the kind recommended at international conferences or in IMF papers. “Liberalization and deregulation helped destroy corruption, and the destruction of corruption, in turn, helped liberalization and deregulation,” was how he described the process.

Bendukidze’s theory was that to remove corruption, a government had to get rid of departments that it knew it could do without and reduce contact between citizens and government to a minimum. Thus, he closed down Georgia’s antitrust committee, which, he said, was doing little except taking bribes, and disbanded the notoriously venal traffic police. No one missed either, and monopolization or traffic chaos did not ensue. Georgian culture changed quickly, and the country didn’t slip in the Transparency rankings even after Bendukidze and Saakashvili were driven out of office. Georgia is now the cleanest country in the former Soviet bloc, but no other nation—including post-revolutionary Ukraine—has had the courage to adopt this draconian approach.” …..

“Eradicating corruption in countries where it is the way of life can’t be achieved by following a rule book. Bendukidze’s method probably isn’t the only possible one, but no useful recipe can be based solely on recommendations from law-abiding, orderly Western societies: Post-Communist states, and probably many in Africa and Asia, have deep traditions of subverting and mocking the systems and institutions of power.

According to the IMF, corruption costs the world $1.5 trillion to $2 trillion a year, or 2% of global economic output, mainly by undermining incentives for taxpayers to share their incomes with governments, increasing costs and undermining the quality of public spending, and stifling private investment and productivity. The losses mostly occur in the countries that can least afford them. The West cannot do much to help, either in terms of enforcement or by offering advice. It’s up to each corrupt nation to rip up its bureaucracy and chase away its architects.”

I would like to see interesting anecdotes of mechanisms which successfully reduced corruption in India.


“River Crossing” in Mutual Funds

This economic times article talks about “river crossing” in mutual funds.

“River crossing, or parking or holding period return, is a rampant practice, which takes place mostly at the financial year end when mutual funds connect with cash-rich entities to tide over redemption pressure. Regulators normally consider the practice imprudent since it raises investor risk.”

“This time the redemption pressure was somewhat higher in the middle of the year, triggered by the Amtek Auto fiasco

In September, CD rates had spiked about 25 basis points across maturities as banks aggressively raised money to shore up their deposits ahead of quarterly earnings. But, this time, the rates slid following RBI’s borrowing cost reduction exceeding estimates.

At the same time, mutual funds, the biggest buyer of CDs, face redemption pressure in their liquid and ultra short-term funds as lenders want to avoid setting aside any extra capital for MF exposure to maintain a good capital adequacy ratio.

At this point, some intermediaries or brokers connect with a few cash-rich entities, be it corporates or bankers, which extend funding support to MFs by temporarily buying CDs at higher rate than normal.

Beginning next quarter (October), those financial entities sold back CDs to MFs at a predetermined price. The price is calculated in such a manner that the financing institute gains 10-20% annualised return for 5-10 days.

For instance, state-owned Syndicate Bank’s CD maturing mid-December has been traded at a high of 7.61% against a normal rate of 7.05% on October 1, said two market sources. On October 5, Andhra Bank and Axis Bank CDs yielded 7.63% each with both maturing in November-end.

“It is unwise for mutual funds to participate in this practice,” said Dhirendra Kumar, CEO of mutual fund portal Value Research. “The gains are few and if something goes wrong, the potential damage to reputation is immense. Showing higher asset for a few days can hardly be a big achievement.”

“Such practices could chip away at investor confidence just at a time when they have started reposing faith on the industry,” he said.

Selling and buyback of CDs at pre-determined rates are prohibited if reversal of trades are happening in the secondary at unusual rates,,” said a treasury head of a large bank.”

RTA scam

This article talks about a financial fraud which didn’t receive much coverage in the main stream media. Some more coverage can be found here. I have covered the functioning of an RTA in my other article here. However RTA can in general also provide service to companies instead of just mutual funds discussed in the article.

Shares/dividends can remain unclaimed because the initial owner might have died and his family might not have been aware of this; or forgotten; or the ownership documents might have been lost and the owner didn’t want to perceive it because of cost benefit analysis. At times the owner might decide against putting effort to en cash a small dividend.

When a fraudster becomes aware (usually with the help of employees of RTA) of any unclaimed shares/dividends lying around for a long period of time he produces fake documents and claims himself to be the rightful owner. As long as the rightful owners are not aware of this and don’t approach the company there is very little chance of catching these rightful owners. The only way is to put stricter norms for claiming the shares.

Cheating small investors in Mutual Funds

This old article describes a way in which mutual fund distributors  and large investors collude to exploit small investors. Luckily SEBI has taken some measures to reduce this though.

“If the MF has spent 5% of the new fund raised towards the above expenses, effectively only Rs 95 of every Rs 100 will be available for investment. Rs 5 is treated as “asset” for the purpose of computing net asset value (NAV) and is amortized over a period of five years. In open-ended schemes, investors can enter and exit at will.

Such frequent transactions lead to transaction costs, the need to keep some funds in cash (an inefficient form) and liquidity risks or that of the availability of opportunities. But, a survey of entry/exit load structures indicates that, by and large, all funds tend not to charge either entry or exit loads on investments over Rs 5 crore.

Let us examine how this bias works. Suppose, a MF has collected Rs 100 crore and issued 10 crore units of Rs 10 each by spending Rs 5 crore towards marketing the issue. About Rs 30 crore is invested by four investors with an average investment of Rs 7.5 crore.

If there is no exit load, these four investors are free to exit any time at the prevailing NAV. If they exit in two days after the allotment without paying an exit load, the remaining unit holders will have to bear the expense towards marketing activities. The Rs 5 crore will be spread over Rs 70 crore instead of Rs 100 crore.

If any investor with an investment of under Rs 5 crore exits at the same time, s/he will be charged a proportionate cost of the marketing expenses or exit load. Besides, distributors who earn commissions of up to 4% of the funds raised often share this commission with large investors.

This practice induces “flight of investments” from one new fund to another as it is beneficial to both parties, even as the smaller investor suffers silently. The reform introduced by Sebi in the rationalisation guidelines simply puts a full stop to this practice.

They effectively force MFs to levy entry/exit loads on every investor that enters/exits a scheme or absorb the expense in to the fee charged by the MF scheme towards fund management. The new rules subtly introduce a cap on marketing and distribution expenses.

Funds that intend to charge higher entry/exit loads will not be able to garner subscriptions due to which they would like to keep them as low as competition permits. The ability of distributors to demand and extract higher commissions from fund houses will substantially diminish since a MF cannot pay more than the loads collected from investors.”