Neha Dave and Anubhav Sahu
The Indian capital markets showed tremendous resilience during the pandemic. Smooth functioning of exchanges and market participants at the time of lockdown is praise worthy. However, yesterday’s outage at NSE exposes the systemic fragilities in the capital markets that need to be addressed.
The trading halt for more than 3 hours, making it longest ever trading stoppage, is an embarrassment for the country’s leading exchange with around 94.4% market share in cash equities and a 100% share in equity derivatives as at end-December.
The market regulator SEBI has asked the exchange to carry out a detailed root-cause analysis of the halt and explain why trading didn’t migrate to its disaster recovery site. The outage was reportedly caused by issues with telecom links of two of NSE’s service providers.
Were retail investors at the receiving end?
The glitch comes at a time when the Nifty has crossed a new milestone of 15,000 and retail participation has shot through the roof. Since many brokers, especially discount brokers, had a hard stop for intraday trades, cash and F&O positions were squared off around 4 and 4.15 pm respectively. NSE opened the extended trading hours at 3.45 pm, leaving very little time for traders to prepare.
Note that average daily turnover for the F&O segment has been on an uptick since Q4 FY20 and that the cash segment had seen a sharp jump from Q1 FY21 onwards. NSE daily equity cash turnover was in the range of Rs 40,000 crore till March 2020 and has swelled to more than Rs 70,000 crore recently. This gives an idea about the impact on the exchange’s business.
Table: NSE Average daily turnover (ADT) comparison
If we compare the cash segment’s 24th Feb data with that of average trading values in Jan’21, there was a 37 percent drop in both volume and value of traded contracts. This implies a business turnover impact of about Rs 27,000 crore. Since the value and volume contraction is the same, that is the average size of transaction remains same, it is difficult to infer if there is a disproportionate impact on the retail segment.
Given that institutional investors are better equipped on the funds’ front, it would be reasonable to expect that that retail investors suffered more due to the issue.
Institutional investors also have the added advantage of being able to hedge in the derivatives’ market. In fact, the data from the F&O segment does suggest that they resorted to that risk management tactic, particularly in futures, on what was a very unusual trading day. That’s perhaps why the F&O segment is giving a mixed picture and should not be given too much importance in understanding the impact of this event on retail participants.
Impact on market efficiency?
Another issue during trading hours of 24th Feb is that the latency of the order messages was higher than usual. The mean time was almost 50 percent higher than usual days. In layman’s terms, latency is measured as the complete round trip for an order message (includes new, modification and cancel) within the exchange trading infrastructure. This would have also led to weak price discovery/order execution for traders. However, the financial impact of this aspect on retail participants is very difficult to estimate.
Effect on other businesses
The incident has not only left a bad taste among retail investors but also had knock-on effects on several other businesses. For instance, many service providers have systems tied to prices on the exchange. All these came to standstill. NSE earns around 3% of its revenue as data feed charges.
How did the BSE stand out?
BSE was a clear beneficiary as the trading in its cash segment jumped to Rs 40,700 crore – way higher than their daily metric by about 6x and closer to that of its stronger peer – NSE. This figure, of course, would have been even higher if brokerages that were mapped to the BSE were of a similar order as that to the NSE. This brings a business takeaway for financial intermediaries, to have a backup arrangement with the BSE for rare days like this.
To be fair, trading stoppages are a common occurrence globally and reasons have ranged from software and hardware glitches, cyberattacks and even hungry squirrels. The NASDAQ faced an outage in the early nineties as a squirrel chewed through a power line and a backup power system failed to kick in.
As a matter of fact, there have been a series of high-profile outages in CY20 across the globe. Tokyo Stock Exchange endured in October its worst ever outage, prompting the chief executive to resign a month later.
While outages do occur, there is need for standardization of response for such events.
While the post-issue analysis and follow-on measures might help, the incident also puts the regulator (SEBI) in the spotlight for lack of proper communication during the incident. A clear communication and trading protocol needs to be established. For instance, the decision for extension of trading on the NSE was taken quite late and was bit abrupt. And by that time various brokers had already initiated closing of client positions. SEBI can also consider ways to compensate the retail investors for losses endured due to technical failure. For that, it can levy hefty fines/penalties for such events. This is similar to what brokerages are sometimes liable to pay in case of glitches at their end.
The NSE incident underscores the concerns that technology and digitisation presents to the financial world. Increased frequency of such incidences can roil markets and shake investor confidence. It calls for tighter standards for not only exchanges but also other key market intermediaries like depositories, brokers, banks and others to prepare and avoid for technology failures.
In an unrelated but similar event the largest private sector bank HDFC Bank was pulled up by RBI for frequent outages in its digital infrastructure (internet banking and mobile app). RBI has appointed an external firm to audit HDFC bank’s IT infrastructure and placed an embargo on their new digital launches as well sourcing new business.
SEBI should could take a cue from the same and take appropriate actions to strengthen the digital infrastructure of capital markets.