The Buck Really Stops at SEBI and Not the NSE

The panic triggered by the malfunction of the National Stock Exchange (NSE) on 10th July, when its prices were not updating and the Exchange was forced to remain shut for nearly three hours was, by no means, a ‘black swan’ event, as chairman Ashok Chawla described it. His statement not only trivialises the meaning of ‘black swan’ but also suggests that the NSE has been working flawlessly since its inception over 23 years ago. This is not true either of the NSE or any of the top exchanges in the world; even the Bombay Stock Exchange (BSE) faced an issue in 2014. Stock market glitches, that bring trading to a halt, have occurred at many top exchanges around the world. In the past five years, there have been issues at NASDAQ (in July 2017 and 2013); New York Stock Exchange (in 2016, 2015 and 2012); Intercontinental Stock Exchange (2015); Singapore Stock Exchange (2014); Chicago Mercantile Exchange and Tokyo Stock Exchange in 2012 and others. There is nothing ‘black swan’ here.

The fact is, in the past, the NSE has always used its enormous clout with the finance ministry, under P Chidambaram, to bypass the rules, bury issues or ram through solutions that were even contrary to the laid down policy of the Securities and Exchange Board of India (SEBI). Its advertising muscle and haughty attitude towards the media ensured that there was very little discussion in the public domain until 2015, after Moneylife broke the algo scam and the NSE’s attempt to gag us through a defamation suit failed. This time, with a new board of directors, the NSE has done well to show humility and ‘deeply apologise’ for the breakdown.

Contrast this with May 2012, when a wrong order punched by a dealer of Emkay Global, caused a 900-point drop in the NSE Nifty (16%). The NSE tried to whitewash the episode by blaming brokers; it was never openly asked to explain why its market-wide circuit filters failed. Instead, such was NSE’s clout that it could have SEBI’s April 2012 guidelines set aside and reopen the cash market without the mandatory cooling period; the derivatives segment wasn’t closed at all. SEBI also ordered the BSE to fall in line. The NSE got away with a mere warning. Contrast this with May 2012, when a wrong order punched by a dealer of Emkay Global, caused a 900-point drop in the NSE Nifty (16%). The NSE tried to whitewash the episode by blaming brokers; it was never openly asked to explain why its market-wide circuit filters failed. Instead, such was NSE’s clout that it could have SEBI’s April 2012 guidelines set aside and reopen the cash market without the mandatory cooling period; the derivatives segment wasn’t closed at all. SEBI also ordered the BSE to fall in line. The NSE got away with a mere warning.

At the time of writing this column, we understand that SEBI’s surveillance department as well as its technical advisory committee (TAC) will be looking into the issue of 10th July. Tata Consultancy Ltd, which provided the trading software, has been asked for an explanation. There will also be some inquiry into other rumours floating around, including cyber-attack (already overruled by SEBI), internal sabotage, problems with Chinese equipment (according to a newspaper report, the home ministry is looking into this possibility), etc.

NSE’s malfunction on 10th July, although quickly contained, is really a red-alert for the government. Media reports say that SEBI plans to review trading systems, back-up arrangements and disaster recovery plans of all stock exchanges, including vulnerability to cyber, or ransomware, attacks. That is all very well; but the regulator needs to show some speed in ending management uncertainty at the NSE first.

SEBI, even under chairman Ajay Tyagi, seems to imagine that its slow approach in asking NSE to conduct its own internal investigation and pin responsibility for the algo-trading scam is less destabilising for the bourse. In fact, it is causing more harm. What is the point in piling pressure on the same set of executives for the 10th July glitch, without fixing their role in the algo-trading scam first? Here are some issues that SEBI needs to address, and quickly.

• Several senior executives, who have been served a show-cause notice by SEBI in May 2017 for the algo scam, continue to run the bourse from critical technical positions. One of them, Ravi Varanasi, chief of business development, was the spokesperson for the Exchange on 10th July. SEBI is now questioning him and others for the 10th July malfunction as well. This only leads to confusion over reporting and accountability in an institution of national importance.

• That NSE is headless at the time of a technical crisis is also at SEBI’s door. After Chitra Ramakrishna controversially quit as NSE’s managing director on 2 December 2016 (her close associate, group operation officer Subramanian Anand also quit in October 2016), SEBI has been in no hurry to push the NSE to fill up the vacancy, or to ensure a proper management clean up and succession plan. Vikram Limaye was selected as NSE’s managing director in February 2017, but SEBI did not clear his appointment for several months. He is expected to take charge sometime next month after completing his assignment with the Board of Cricket Control of India (BCCI). Were there really no suitable candidates available to take charge of the crisis-hit NSE immediately? What does it say about the selection committee that SEBI put together to decide this important appointment?

• Remember, Mr Limaye neither has experience of running a complex, technology-intensive bourse, nor has he ever been in a regulatory function (since the NSE is also a first-level regulator). We don’t know if the selection committee considered this factor or decided that experience was not relevant for the managing director’s post, even though Mr Limaye will be taking over in very difficult circumstances. After all, the three previous incumbents were all part of NSE’s founding team, had helped build the Exchange from scratch and were around for 23 years. Since NSE’s tech team is already under a cloud, does it have plans for lateral appointments with experience in technology, surveillance, etc?

• After a series of whistleblowers’ letters pointed to the complete breakdown in NSE’s human resources (HR) and recruitment policies, irregular senior appointments with lavish perks, misreporting to SEBI, lack of transparency as well as the power enjoyed by ‘consultants’ close to the top management, the NSE had assured SEBI of a clean-up by absorbing those who were eligible and letting others go. This has been implemented only partly. Meanwhile, the HR head has also been asked to leave. After a series of whistleblowers’ letters pointed to the complete breakdown in NSE’s human resources (HR) and recruitment policies, irregular senior appointments with lavish perks, misreporting to SEBI, lack of transparency as well as the power enjoyed by ‘consultants’ close to the top management, the NSE had assured SEBI of a clean-up by absorbing those who were eligible and letting others go. This has been implemented only partly. Meanwhile, the HR head has also been asked to leave.

• NSE’s original capital came from a set of government-owned entities—banks, insurance companies and development finance institutions. Over the years, it has sold shares to foreign institutional investors (FIIs), two venture capital funds, corporate bodies, individuals and foreign direct investors, at steep valuations. The process has been opaque; but even they have been pushing the NSE to list the bourse. These investors are also left in limbo by SEBI’s failure to get the Exchange back on its feet.

• Two letters by a whistleblower, who claims to be an ex-employee (and calls himself Jamie Jones), have levelled some serious charges about conflict of interest between top employees of the NSE, consultants and firms who signed up for algo trading. These charges have been the subject of open speculation among market players. SEBI has the ability to call for information, check documents and establish whether any of these allegations is true and act on them. Key issues raised by the letters are about NSE’s consultants having profit-sharing consultancy agreements with brokerage firms that benefited from the algo scam and royalty paid on the NSE indices to some academics/consultants. Has SEBI bothered to investigate?

Meanwhile, following SEBI’s last board meeting, chairman Ajay Tyagi described NSE’s co-location issue as a ‘serious matter’. He said that it was for the bourse to decide whether they need to file a revised prospectus for the initial public offering (IPO). Now that there is another investigation into the technical glitch on 10th July, the IPO begins to look even more distant. Clearly, this state of limbo cannot continue. The onus on ensuring a full and proper investigation and swift action is on SEBI. In fact, it is the regulator who is on test here.