SEBI clarifies SOR rules, as CS starts on-boarding race

The Securities and Exchange Board of India (SEBI), the country's securities regulator, has clarified that smart order routing (SOR) between the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) is not restricted to particular order types.
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The Securities and Exchange Board of India (SEBI), the country's securities regulator, has clarified that smart order routing (SOR) between the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) is not restricted to particular order types.

Following SEBI's initial circular permitting SOR in India's cash equities markets, issued on 27 August, the NSE issued guidelines to brokers that imposed a number of additional restrictions, such as limiting order routing only to immediate-or-cancel (IOC) order types. But a follow-up circular from the regulator, dated 9 December, rejected NSE's position. According to SEBI, stock exchanges “shall permit smart order routing for all orders, without restricting any specific type of order”.

This is not the first time the NSE has tried to protect its dominant position. The exchange has banned firms that use its co-location capabilities from using algorithms that route to the BSE, but it has been forced to relent by SEBI in the case of algorithms with SOR capabilities.

Last week, broker Credit Suisse’s Alternative Execution Services (AES) division, announced its first SOR trades in India, claiming to have achieved price improvement of six basis points by splitting orders across both exchanges. But SOR's price impact may not be its most significant legacy, according to Murat Atamer, head of product, AES, Asia-Pacific at Credit Suisse. “The added benefit will be lower signalling risk. India is a very hard market to trade because the order book is extremely tight. SOR will result in lower signalling risk by sending orders to more than one exchange,” he said.

The broker is now in the early stages of onboarding institutional clients to use its SOR functionality, but faces competition from other sell-side firms that are also developing and seeking exchange approval for their own SOR capabilities. Atamer says Credit Suisse's SOR capabilities in India will evolve with practice. “Now starts the process of refining how firms trade across both markets. Our SOR technology, which utilises dynamic heat maps for best prices and liquidity which we've build up over the years, will allow us to get better prices for clients,” he said.

After SEBI gave the green light for SOR, both major Indian exchanges were required to outline their arrangements for auditing brokers' SOR capabilities, a process that SEBI insisted should take no more than 30 calendar days. The NSE currently commands an 80% market share of Indian equities trading compared to the BSE's 20%. Despite this, a study released in August 2010 by Credit Suisse AES asserted that better prices could be found on the BSE around 35% of the time.

Jim Shapiro, head of market development, BSE, expects trading behaviour to change on the BSE as orders flow more freely across exchanges. “As volumes grow, we may look to introduce more aggressive maker-taker pricing or introduce other measures to fill up the book,” he says. “But we're already seeing a lot of passive market making-like activity from new market participants. One reflection of this is that our order-to-trade ratio has exploded in the last four-to-five months. SOR is an important part of the BSE's return as a viable competitor to the NSE because fewer participants will be forced to chose between exchanges.”

The rollout of broker SOR capabilities is seen as a first step toward price competition between the two leading exchanges, but further changes to India's equity market infrastructure are also required. For example, there is currently no central, independent data source to verify which exchange has the best price at any given point in time. “Regulators and market participants need to be able to piece together the timing of trades so they can demonstrate that SOR is working without market bias. The only way to do that is to have a centralised timestamp for orders across the exchanges,” says James Rae, head of AES sales for south-east Asia at Credit Suisse.

Moreover, there is no interoperability between India's two clearing houses, the BSE’s Bank of India Shareholding and the NSE’s and National Securities Clearing Corporation, which currently keeps post-trade costs high. Competition and interoperability already exists between Central Depository Services (India), the central securities depository (CSD) partly owned by the BSE, and National Securities Depository, the CSD in which NSE has a stake. Shapiro believes clearing will follow suit. “There is no reason why India cannot have interoperability between the two clearing houses, but it will take some time, and probably regulatory leadership, to force such a large change,” he says.

The BSE has already undergone significant change since a new chairman and board were installed around 18 months ago. It has made significant technology investments while also building out its product range and incentivising greater trading volumes on its existing markets. The exchange is in dialogue with SEBI on new market making and liquidity incentives for equities derivatives, for example, but no agreement has been finalised as yet.

There is also potential for stock lending and borrowing to grow after the two main exchanges recently introduced new platforms. It is also likely that both exchanges will replace their core trading systems. “The technology here and at the NSE is around 15 years old,” says Shapiro. “While it works well, in the sense that we process millions of trades a day and speed and capacity are adequate, if you were to start from scratch there are cheaper and better systems available. I would expect both exchanges to move in the direction of substantial technology upgrades over the next two years.”