Maintaining Vibrant Competition Among Exchanges – A Key Driver of the Rapid Development of the Indian Financial Markets

The Greatest Risk
At the moment, one of the greatest risks to India’s continued development into Asia’s leading global financial center is the emergence of a single exchange monopoly. Exchange competition in India is driving innovation, pushing exchanges to build capacity to attract new participants in the market (such as high frequency traders), and putting considerable downward pressure on trading costs, which in turn is attracting greater volume and liquidity. Should any exchange solidify its market position into an effective monopoly, many of these benefits will fade and India will be far less attractive to market participants, particularly foreign ones. Two contentious issues have emerged in recent months that demonstrate how the exercise of market power can unbalance a level playing field, disrupt the development of the market and hold back innovation.
Approval/Disapproval of Algo Trading
One exchange in India, the NSE, has implemented an approval process for members who wish to deploy automated or algorithmic trading strategies (including automated market making and smart order routing). This approval process has a feature which I believe is objectionable from a regulatory point of view. NSE insists, on the one hand, that no member can deploy an algorithmic trading strategy on its market unless they seek prior approval of the algorithm used. On the other hand, they also insist that no algorithm will be approved if it involves trading or analytics involving trading on an exchange which competes with the NSE.
In my view, NSE’s regulatory stance on algo trading is holding back the development of the Indian market because – among other things — it has effectively banned firms from deploying smart order routing strategies, which are standard market practice in other markets around the world with competing exchanges or trading platforms. Smart order routing (SOR) helps firms get their customers the best price – automatically – wherever that price may be. It also disciplines pricing across markets and makes them more efficient.
More importantly, this intrusion into the legitimate activities of firms retards the development of the Indian market because it allows one exchange to prevent a firm from trading on other competitor exchanges, by exploiting its market power and regulatory authority. In practice, if a firm does not refrain from using algorithmic trading to trade on BSE, NSE will NOT approve its algorithm to trade on the NSE. This is significant because algorithmic trading is one of the fastest growing segments of trading in India, by both foreign and domestic firms and by new smaller members.
Co-location Services
As demand for accessing markets with automated high-frequency trading strategies grows in India, the demand by firms to co-locate their computer servers closer to the exchanges also continues to grow. Both exchanges now offer firms the ability to co-locate servers on exchange premises. NSE imposes a condition on any firm that wishes to co-locate at the NSE facility – you must promise that you will not use your computer server to send an order to any exchange except the NSE.
This restrictive stance of NSE regarding users of their co-location facility is also holding back the development of the Indian market, in my view, for a number of reasons. First, it significantly raises the costs and complexity for a firm that wishes to engage in algo trading on other exchanges – because it requires that firm to set up a separate infrastructure and makes it impossible to route all orders to Indian exchanges through one server. Second, it holds back development of the market by restricting the ability of firms to trade on the exchange of their choosing at any point in time, depending on opportunities that arise. In effect, NSE uses its market power and regulatory power to lock up firms and prevent them from trading on competitor exchanges in the future.