What Is Co location meaning and what is the controversial co location case of NSE all about?
The case relates to the alleged differential access given to certain broking firms in the form of 'dark fibre' at NSE, to connect across the colocation facilities before other members. Through this brief explainer, we try to simplify the meaning of colocation and decode what the colocation case is all about.
Co location Meaning
In co-location, a system popular with traders using sophisticated trading programmes, stock exchanges allow market participants to set up a server on exchange premises. The intention is to allow them to maintain their servers closest to the exchange servers. In India, the main exchange servers are in Mumbai but the brokerages using them are spread across the country. Using normal internet connection to access these systems leads to delay in transmission of real time data.
As the delay is a few milliseconds, this might not impact retail investors. But it makes a big difference to big traders, who take huge bets on such minor price moves. It is not possible for humans to capitalize on these price movements manually. Hedge funds and proprietary desks, which rent out the co-location facility, use computer-assisted pre-decided algorithms to execute trades at high speeds.
What Is Co location Case Of NSE?
NSE provides real time trade data to market participants on the basis of the package they have chosen. The Tick-by-Tick (TBT) data feed, which is the most advanced, is the one used by those using the co-location facility. It is disseminated through the Transmission Control Protocol/ Internet Protocol ("TCP/IP"). Under this protocol, TBT data is delivered one after another in the sequence that brokers logged into the server.
This meant the first one who logged into the least crowded server would get data faster than others by a few milliseconds and would be able to execute trades faster. The Sebi investigation found that some brokers gamed the system by being among the first to enter the server, which was the fastest. Broker OPG Securities, one of the accused in the case, understood this loophole.
It was alleged that the firm with tip-offs from an NSE employee knew when the NSE servers would start and would be the first to connect to the least crowded server. The Sebi investigation also alleged that OPG also attempted to crowd out other participants.
Some brokers also continuously logged into the less-crowded emergency back-up server of NSE, which is not allowed without the exchange's permission. When markets were running smoothly, there would be no traffic on the backup server. Despite NSE's warnings, the brokers continued to log into these servers to gain the edge.
How did OPG Securities allegedly benefit from the loophole?
Back in 2010, a company named Omnesys was handling the technology for NSE. The exchange was also a major shareholder in Omnesys until 2013.
Since Omnesys was an integral part of managing the trading systems, the firm’s officials had an in-depth understanding of the exchange’s servers. Sebi alleged that OPG hired a former employee of Omnesys to figure out which of the NSE servers was most effective. It was also alleged that NSE insiders helped the broker with knowing what time the server would start every day in the morning and when to move to the fastest server.
Does NSE still use the TBT data feed through TCP/IP?
Since 2014, the exchange has shifted to the Multicast TBT (MTBT) system at its co-location facility. This has resulted in reducing the benefits of being first in the queue. The Sebi investigation said after the NSE switched MTBT, the market share of OPG, which benefited the most from logging into the server early, declined.
Summary
In general, co location meaning (or Colo) refers to the establishment of a shared facility to store IT equipment and specialized hardware of multiple individuals or companies. In high-frequency trading (HFT), colocation refers to a dedicated space within a data center belonging to stock exchanges. Its primary purpose is to locate computers owned by HFT traders and firms in the same building as the stock exchange servers.
The concept of colocation gained traction in the past decade, giving birth to a new kind of business. Some say that the growing demand for colocation services explains why stock traders are creating bigger data centers close to major stock exchange servers.
