This article has been written by Avik Sarkar pursuing the Diploma in M&A, Institutional Finance and Investment Law from LawSikho.
Table of Contents
Introduction
The Co-location facility has been in vogue since 2009. This facility promises to make trading faster with minimal glitches. Here, a broker is allowed to place their server in the data centre of the Stock exchange. And for setting up the server certain consideration shall be paid to the stock exchange. This setup helps the stockbroker receive price feeds faster than the others. Though this facility sounds very promising at the outset, certain reservations remain. There have been competition concerns that have been swirling around it. The same was delved into in the recent case of Manoj K. Sheth v. NSE,. This piece holistically analyses the said dictum and tries to bring out the lacunae in the same.
A brief insight into the concept of Co-Location
The Indian Capital market has always been able to garner the attraction of the small and large enterprises, as it gives them a platform to invest and expand. Since its inception, it has witnessed monumental changes, one of them being the concept of dematerialization. It was after the introduction of the concept of dematerialization the electronic media started playing an instrumental role in purchasing and selling shares. And this computer-automated version of trading is known as High-Frequency Trading (hereinafter referred to as HFT).
High-Frequency Trading is an automated form of trading that strives to increase the efficiency of buying and selling of shares. It employs various ways using which it increases the efficiency of the whole capital market machinery one of them being the Co-location facility.
The concept of Co-location was introduced in the Indian Capital markets regime back in 2009 by National Stock Exchange (hereinafter referred to as NSE). In a colocation facility, a broker is allowed to place their server in the data centre of the Stock exchange. And for setting up the server certain consideration shall be paid to the stock exchange. This setup helps the stockbroker receive price feeds faster than the others. Though this system sounds very convincing at the outset there has been a plethora of conundrums involved with the same. In a recent matter of Manoj K. Sheth v. NSE, a case was filed against NSE under Section 19(1)(a) of the Competition Act, 2002 alleging violation of Sections 4(2)(b)(ii) and 4(2)(c) of the Competition Act, 2002. In this case, the informant had accused NSE of abusing its dominant position by availing the co-location facilities only to select trading members. Though the Competition Commission of India went on to decide the case in favour of NSE the decision was certainly not welcomed by the masses. This piece discusses the judgement holistically and tries to figure out the inaccuracies in the same.
Informant contention
NSE had introduced the co-location facility back in 2009 where it was providing market access to select brokers in their premises. In the present case, the informant had alleged that NSE was providing unfair access to select trading members leaving out all other trading members who had subscribed to the Co-location facility thereby granting them further competitive edge over the rest of the trading members who had paid for the co-location services. The informant had backed his claims based on the complaint of a whistle-blower of NSE before the Securities Exchange Board of India (hereinafter referred to as SEBI) and a subsequent report by the Technical Advisory Committee and Deloitte.
According to a report of SEBI published on 10 February 2021, the SEBI has stated that the Co-location facility is susceptible to market manipulation. And this kind of market manipulation violates Section 41(2) of the Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012.
NSE’s contention
Firstly, the NSE averred that the Co-location facility was introduced in order to have faster dissemination of data at lower costs. And a similar regime of co-location facility has been incorporated by other notable stock exchanges such as NASDAQ, London Stock Exchange, Chicago Stock Exchange etc which has been highly successful.
Secondly, though the informant had alleged that NSE violated section 4 of the Act by colluding with certain trade members to provide them with a further advantage, no such evidence was put forward by the informant. Further, it was contended that SEBI’s findings against NSE on a certain issue are still pending before the Securities Appellate Tribunal (hereinafter referred to as SAT). And the commission carrying on parallel proceedings while SAT already looking into the nuances of the same will go against the judgement given in the case of CCI vs Bharti Airtel and Others.
Thirdly, NSE had succinctly stated that if at all a trading member breaches any guideline, then NSE is not liable for the same. Finally, it was averred by NSE that multiple proceedings were filed by the informant at different forums and non-mention of the same before the CCI will lead to violation of The Competition Commission of India (General) Regulations, 2009.
Dictum of CCI
The commission takes note of Adv. Jitesh Maheshwari v. NSE where similar infractions relating to co-location services were filed. Here the commission had refused to probe into the matter as SEBI was already examining the same. However, the commission agreed with the informant that any pending lis before SAT or any other forum cannot divest CCI from exercising its statutory functions.
The commission delved into two issues:
- Whether NSE has abused its dominant position (Section 4 of the Competition Act).
- Whether giving an unfair advantage to select members out of all the others who availed of the facility is in derogation with Competition Act.
Firstly, the informant had delineated the relevant market to be the securities markets in entirety. However, the commission delineated the relevant market as a ‘market for providing co-location services for Algo-trading insecurities to the trading members.
Secondly, the commission delved into the dominant position that NSE holds in the market. To establish the same commission relied on a) Annual Report 2019-2020′ of SEBI, b) NSE’s Annual Report for 2019-20 and c) decision of CCI in the matter of NSE’s Annual Report for 2019-20.
Thirdly, the commission after satisfying itself with the dominant position of NSE in the market. It goes on to peruse the reports by SEBI where it was stated that NSE didn’t exercise proper due diligence while setting up the tick by tick (TBT) architecture which led to asymmetric dissemination of information. Thus, SEBI held this failure of NSE to grant equality to every trading member amounts to a violation of Regulation 41(2) of SECC Regulations, 2012.
Despite such strong evidence on-record, the CCI absolved NSE of all charges by stating that using a technology that involves the perils of getting manipulated by someone even without colluding with the NSE, doesn’t lead to abuse of dominant position. Thus, bonafide choice of technology doesn’t lead to violation of Section 4 of the Act. And since there was no fraudulent conduct found by SEBI under its SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, CCI closed the matter in absence of any prima facie case.
Analysis
Firstly, after perusing SEBI’s order it can be construed that it had termed the acts of NSE to be “non-equitable”, “denying equal access” which thereby resulted in “information asymmetry”. Further, SEBI had succinctly stated in its order that many traders had gained unfair access to its secondary server without any checks or actions taken by the NSE. And from its report, it could be concluded that NSE has failed to provide equal access to its trade members. And the report was enough for the commission to form a prima facie case but it decided otherwise.
Secondly, NSE has time and again reinstated the fact that the co-location facility has been implemented by other world’s leading stock exchanges. But it must be noted that there were similar allegations against these leading stock exchanges. The Federal Bureau of Investigation (FBI) had bought a class action against leading stock exchanges named Chicago Board Options Exchange, NASDAQ OMX Group for engaging in fraudulent activities which were aimed to manipulate the market. During the investigation, it was found that these stock exchanges were actually involved in providing an unfair advantage to their trade members and stringent actions were taken against the same.
The panacea of the situation may lie in the Essential Facilities Doctrine. According to this doctrine, a dominant market player needs to share its resources with the other market players in order to maintain healthy competition. If the dominant player doesn’t share its resources, then any facility created by the dominant market player will be seen as a barrier for entry to other market players.
Conclusion
To summarise from the above-mentioned statements, it can be perused that a prima facie case did exist and for the further demystification of the matter it should have been referred to the Director-General (DG). And to break NSE’s monopoly and ensure fair play the essential facility doctrine shall be brought into play as the market share of NSE is overarching and can lead to serious market deformities. Further NSE should strive to ensure fairness in the whole system.
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