Foreign portfolio investors are lobbying for faster access to stock exchanges through direct server connections. According to reports from The Economic Times, the proposal was 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. The proposal would allow FPIs to directly link their servers with exchange systems, bypassing the current system where buy or sell orders are routed through broker's co-location servers. Under the new proposal, 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 existing co-location facility permits brokers to place their servers right next to an exchange's matching engine, reducing latency in order execution. As reported by The Economic Times, such microsecond gains provide speed advantages to FPIs and large local traders using high-frequency and algorithmic trading strategies. FPIs believe connecting directly with the exchange without intermediaries would minimize trade information compromise risk and eliminate paperwork for new co-location deals while switching brokers. A custodian official noted that co-location already creates some structural disparity, suggesting that direct access without brokers could be explored for large institutions with risk management capabilities and willingness to let SEBI inspect their systems.
SEBI is examining the FPI proposal while considering whether preferential treatment can be given to one investor category, according to a person familiar with the matter cited by The Economic Times. Sandeep Parekh from Finsec Law Advisors noted that under the Securities Contracts (Regulation) Act, only recognized stock exchange members can access trading systems, and SEBI's algorithm framework makes brokers principally accountable for every algorithm. The only legal route to disintermediation involves becoming a member with all capital, registration and compliance obligations. While the regulator and ministry have been making registration and KYC easier, they would tread carefully on sensitive matters such as direct access and co-location.
Co-location trading accounts for 34-38% of cash market volumes and about 60% of high-frequency algo derivative trades, as reported by The Economic Times. Rajesh Gandhi from Deloitte India suggested that while direct exchange links could enable FPIs to have tighter control and gain more efficiency, tax law amendments would be needed to clarify that this wouldn't risk creating a 'permanent establishment' or additional tax liability for FPIs in India. A custodian official emphasized that the exact outcome would depend on the operating model adopted by the FPI, while noting that foreign investors must evaluate potential tax implications. Brokers currently follow SEBI's order execution and risk management rules, with their systems rejecting algo orders that don't meet regulatory criteria.
Richie Sancheti from Richie Sancheti Associates emphasized that while the proposal is primarily discussed from a market infrastructure perspective, foreign investors must evaluate potential tax implications. According to The Economic Times, if FPIs receive the access they want, their systems must also have built-in checks, similar to the current broker framework. The proposal implies that FPIs would link their own co-location servers placed on exchange premises with the exchange system, providing direct connectivity without intermediaries. This would enable trades to be quicker while minimizing trade information compromise risk and avoiding paperwork for new co-location deals while switching brokers.
