Technical Conundrums In Stock Exchanges

With the ever increasing dependency on technology all the way from order entry to matching to trade confirmation and finally settlement of trades, SEBI the apex market regulator felt the need to issue standardized guidelines/ Standard Operating Procedures ("SOP") for MIIs based on past experiences specially in the backdrop of a technical glitches observed atleast once every year in July 2017 (NSE stopped trading for three hours as feeds were not updating), May 2018, September 2019 (NSE again witnessed certain technical glitches in the closing deal due to connectivity issues), June 2020 (Bank Nifty options prices were not being reflected accurately) , February 2021 and the latest on March 07, 2022, hence a need was felt by SEBI to issue guidelines/ SOP to handle such matters. SEBI vide Circular dated March 22, 2021^[1] had issued guidelines for business continuity plan ("BCP") and disaster recovery ("DR") for MIIs. SEBI mandated MIIs to have in place BCP and DR, further such DRS should be setup in different seismic zones. SEBI also mandated that manpower deployed at such at such DR sites should have the same knowledge of processes and operation as available at primary data centers .SEBI has also mandated carrying out DR drills on a quarterly basis.

The worst glitch was encountered by The National Stock Exchange of India ("NSE") on February 24, 2021 due to certain issues with its two telecom service providers which halted operations for more than four hours, at first reading, four hours may not sound relevant however in securities market where time is of the essence, any delay in executing trades can have damaging effects on the sentiments of various market participants. It was stated that there were millions of unexecuted order that were in abeyance during such glitch hence investors lost money when the stock prices dropped when trading resumed. In earlier instances pending orders have also been cancelled before trading resumed.

It is pertinent to know that leading exchanges throughout the world have also experienced similar glitches. The National Association of Securities Dealers Automated Quotation ("Nasdaq"), which is the second largest exchange in terms of market capitalisation, experienced a glitch in May 2012 during Facebook's public issue that left many investors in the dark regarding status of their pending orders. Subsequently in March 2013 a plan submitted by Nasdaq to compensate investors to the tune of $62 million was approved by Securities Exchange Board ("SEC") for the glitch. Subsequently Tokyo exchange, London Stock exchange have also been affected in the past.

SEBI based on its previous experiences in glitches and based on international practises had on July 05, 2021 issued certain SOPs for handling technical glitches by MIIs. The genesis for issuing such SOP's were the ccriticality of smooth functioning of systems of MIIs hence specifying a pre-determined threshold for downtime of systems became very important. SEBI vide this SOP provided certain financial disincentives not only on the MIIs but also on their Managing Director and Chief Technology Officer for any downtime or unavailability of services beyond a pre-defined time. The SOP also laid down that a comprehensive root cause analysis report outlining the reasons for the glitch will also have to submitted, further any delay in submitting the same shall attract a penalty of 1,00,00 per day. Further any failure on part of such MIIs to address such glitches will attract a penalty of 2, 00,000 per day of the first 15 days 3, 00,000 per day for the next 15 days and 25 lakhs thereafter.

Further on December 2021, NSE and Bombay Stock Exchange ("BSE") had both issued comprehensive guidelines for handling technical glitches at members' end in order to prevent disruptions with harsh penalties on members. Under the new framework, members would have to pay twenty thousand per day in case of failure to report any incident to the exchanges within required time limits. The Guidelines have laid down technology infrastructure requirements and system requirements that members should put in place and adhere to in order to prevent any incident of business disruption resulting from technical glitches. Further the Guidelines laid down certain Standard Operating Procedures ("SOP") for reporting technical glitches by members for reporting technical glitches, handling business disruption, management of such business disruption, including declaration of disaster and framing of provisions for disciplinary action in case of non-compliance in reporting or inadequate management of business disruption. The Exchanges had further asked members to intimate them about the incident within two hours from the start of the glitch.

The next question is whether investors could claim compensation for such tech glitches in case they do suffer any losses. It is pertinent to note that claim for such compensation would be extremely tough because of lack of precedents for the same, simultaneously if such claims are maintainable stock exchanges and brokers could become dysfunctional as the volume and value of transactions run into trillions. As per SEBI's Master Circular for Stock Brokers, it excludes claims against stock brokers and exchanges, clause 9 of the said Circular expressly declares that "The client is aware that trading over the internet involves many uncertain factors and complex hardware, software, systems, communication lines, peripherals, etc. are susceptible to interruptions and dislocations. The Stock broker and the Exchange do not make any representation or warranty that the Stock broker's IBT Service will be available to the Client at all times without any interruption". Clause 10 of the said Circular also reads as " The Client shall not have any claim against the Exchange or the Stock broker on account of any suspension, interruption, non-availability or malfunctioning of the Stock broker's IBT System or Service or the Exchange's service or systems or non - execution of his orders due to any link/system failure at the Client/ Stock brokers/Exchange end for any reason beyond the control of the stock broker/ Exchanges".^[2]

The National Stock Exchange ("NSE") is the No. 1 Stock Exchange in India and one of the largest stock exchanges in the world, it is the largest derivative exchange in the world in terms of contracts traded, second largest derivatives exchange in the world in terms of currency futures traded and the fourth largest exchange in the world in the capital market cash segment. Being such a behemoth stock exchange, the number of trades executed and the numbers of market participants on the exchange are humongous, hence even if any miniscule technical glitch is observed on the exchanges it can have huge reverberating effect on various market participants both domestically and internationally. NSE in particular has been susceptible to much more glitches than its competitor BSE the latest being on March 07, 2021 whereby NIFTY and BANKNIFT weren't being broadcasted as required, operation data of closing prices from March 04, 2022 were being displayed on March 07, 2022. NSE escaped in the past from its earlier glitches, however since the guidelines have been out it will be interesting to know how SEBI treats this glitch and what measures will be taken against NSE in the coming days post submission of its various reports as mandated under the above guidelines.

The next important question is how Stock exchanges can actually prevent occurrence of such breakdowns in their systems. Due to the ever increasing presence of disruptive technology, it has become very important for SEBI as well as stock exchanges to plan and prepare for such discrepancies. In addition to that the rise in cyber-crime, the presence of artificial intelligence, machine learning and big data are ever increasing on a day to day basis in the securities market. In financial markets, there are software analysing voice patterns of recorded calls which can be used to identify new patterns of trading or system abuse. The introduction of robo advisors that use millions of algorithms in order to provide millions of trading scenarios are now all available at the tip of a person's fingers.

Adoption of blockchain technology the most hackneyed phase of 2020, would provide significant boost to the security systems and in ensuring authenticity of transactions. Move towards cloud services from the more traditional methods of storing data would contribute to more unprecedented access to innovation and decreased time to market, use of distributed ledgers would help in reducing information asymmetry, promote greater compliance and increase resiliency through predictive maintenance of IT systems. ^[3]

In a Report published by PWC^[4] , it was stated that by the year 2030 India would be only behind China in terms of number of new issuers of securities and would account to almost 45% of the total of new securities issued globally and would be third in terms of funds raised globally. In the same report NSE and BSE came in fourth in respect to which exchanges issuers would consider beyond their own home exchange in 2030 when planning for an IPO.

The most important step going forward for securities market in general would be to automate non-trading operations which would contribute to a larger digital transformation which would help in reducing overall cost, increased efficiency and support future growth, further embracing and understand new technologies would be a major factor in order to stay relevant with the changing technology needs, technology has indeed shaped the stock market and will continue shaping the future of the stock market.

Views are personal.

[1] Guidelines for Business Continuity Plan and Disaster Recovery of MII - https://www.sebi.gov.in/legal/circulars/mar-2021/guidelines-for-business-continuity-plan-bcp-and-disaster-recovery-dr-of-market-infrastructure-institutions-miis-_49601.html