Sebi to regulate trading through co-location systems

With an aim to avoid any undue benefits to certain brokers due to physical proximity of their systems with that of the bourses, Sebi on Friday proposed to bring in parity between the brokerages operating through systems placed within exchange premises and those at other locations.

Commonly known as 'co-location or co-hosting' in the market parlance, this service offered by the stock exchanges to  stock brokers and data vendors allow them to locate their trading and other systems within the exchange premises. Issuing a discussion paper for framing new norms to regulate this co-location service, Sebi said that investors residing at places closer to the trading pit enjoy low latency (measure of time delay experienced in a system) on account of physical proximity to the stock exchange's trading system.

A stock broker situated in Mumbai and connected through leased line observes an average roundtrip latency of 8 milliseconds, as against 33 milliseconds for a stock broker in New Delhi.

However, the co-location facility cuts down the average roundtrip latency to just about two milliseconds. To ensure fairness among the co-location and other brokers, Sebi proposed that the stock exchanges can implement an order handling system comprising of two separate queues forco-located and other orders, such that orders are picked up from each queue alternatively.

"It is expected that such architecture will provide orders generated from a non-colocated space a fair chance of execution and address concerns related to being crowded-out by orders placed from colocation," Sebi said

Sebi has also proposed that stock exchanges should ensure that the size of the co-located/proximity hosting space is sufficient to accommodate all the stock brokers and data vendors that are desirous of availing the facility.

Besides, the bourses should avoid situation of monopolizing of rack space by certain stock brokers or data vendors, it said. As per Sebi data for NSE, co-location orders accounted for 73.88 percent of total orders in the cash equity segment, 94.16 percent in equity derivatives segment and 26.05 percent in currency derivatives in the month of February 2013.

At the BSE, the co-location orders accounted for 7.06 percent of cash market orders and 17.96 percent in equity derivates, while the MCX-SX co-location orders were 6.55 percent in cash equity segment, 15.71 percent in equity derivatives and 27.34 percent in currency derivatives.

The regulator is of the view that the need to regulate co-location services, which facilitates high-frequency trades, is also underlined by the flash-crash cases witnessed in the markets, including in the US.

India has also witnessed some cases of flash crashes in the past couple of years. Seeking public comments on the proposed measures till May 31, Sebi said that the technology innovations having market-wide implications can not be left unregulated and proper guidelines are necessary to serve investors' interest.