FPIs lobby for faster access to bourses with link to servers

Mumbai: Foreign portfolio investors, which hold sway over equities and currency markets, are lobbying for faster access to stock exchanges.

They have urged the capital market regulator to allow them to directly link their servers with exchange systems for more efficient order execution, among other things.

The proposal - put forward by persons representing large offshore funds and custodians at a recent meeting with officials of the Securities and Exchange Board of India (SEBI) and the finance ministry - implies that buy or sell orders would flow directly from an FPI server to the exchange instead of being routed through a broker's co-location server.


The co-location facility, which permits brokers to place their servers right next to an exchange's matching engine, reduces latency, or tiny delays, in the time it takes for orders to travel. Such microsecond gains give a speed advantage to FPIs and large local traders using high-frequency and algorithmic trading strategies.

FPIs believe connecting directly with the exchange without an intermediary, or linking their own co-location servers placed on exchange premises with the exchange system, would help: trades would be quicker; the risk of trade information being compromised would be minimised; and paperwork to formalise a new co-location deal while switching brokers would be avoided.

The SEBI spokesperson did not comment, but a person familiar with the matter said, "SEBI is examining the proposal from FPIs. The regulator will have to consider whether such preferential treatment can be given to one category of investors, because even retail investors are using algo trading. There cannot be any disparity among different categories of investors."

The desire of algo traders to bypass brokers runs into a statutory wall, said Sandeep Parekh, managing partner of Finsec Law Advisors. "Under the Securities Contracts (Regulation) Act, only members of a recognised stock exchange can access its trading system, and SEBI's new algo framework deliberately makes the broker the principal accountable for every algorithm. The only lawful route to disintermediation is to stop being a client and become a member, with all the capital, registration and compliance obligations that entails," said Parekh.

Co-location servers are often essential for algo trades, which are computer programmes that automatically execute orders when certain conditions are met. Co-location comes in handy as algo trades depend on how quickly market or macroeconomic information is analysed.

"While having a direct link to the exchange could enable FPIs to have tighter control and gain more efficiency, the tax law should ideally be amended as well to clarify that this would not risk the creation of a 'permanent establishment' (PE) or any additional tax liability for FPIs in India," said Rajesh Gandhi, partner, Deloitte India.

Co-location trading accounts for 34-38% of cash market volumes and about 60% of high-frequency algo derivative trades.

While the regulator and the ministry have been hearing out FPIs following the recent sell-off, even making registration and KYC easier, they would tread carefully on sensitive matters such as direct access and co-location. "Co-location already creates some structural disparity. So, direct access without brokers can be explored for large institutions which have risk management capabilities and are willing to let SEBI inspect their systems," said a custodian official.

"The exact outcome would depend on the operating model adopted by the FPI. While the proposal is primarily being discussed from a market infrastructure perspective, foreign investors have to evaluate potential tax implications," said Richie Sancheti, founder, Richie Sancheti Associates.

Brokers have to follow SEBI's order execution and risk management rules. Their systems reject algo orders that do not meet regulatory criteria. If FPIs get the access they want, their systems too must have built-in checks.