Since transparent disclosure is critical for any investment decision, it is not surprising investor attention should be focused on the risk factors listed by NSE in its draft red herring prospectus (DRHP) for an IPO which is estimated to be looking to raise R10,000 crore for a 20-25% stake in the exchange. Given the severity of the charges made against the exchange, you wouldn’t have thought the first internal risk listed in the DRHP would be “we may not be able to maintain or increase our trading volumes” or the second “broad market trends and other factors beyond our control could significantly reduce demand for our products and services”, but that’s the way NSE has categorised the risk factors.
It is, of course, the third risk factor that is the most important since it deals with the charges Sebi is investigating, charges that NSE allowed preferential access to certain brokers who got market information earlier than others and were able to steal a march over the others due to this. While Sebi had forwarded these charges, made by a whistleblower, to the exchange in early 2015, in March this year, it gave the exchange the interim observations of a report on it and asked for a response to the findings—among others, the DRHP says, the report found “that our co-location facilities and tick-by-tick, or TBT, architecture were vulnerable to manipulation and abuse, violated norms of fair access and compromised market fairness and integrity, as certain select trading members who availed of our co-location facilities were able to gain materially from the exploitation of our market feed dissemination architecture to receive market data more quickly than other trading members”.
On Sebi’s suggestion, NSE got a forensic audit conducted (by Deloitte India)—while that confirmed much of what the earlier report had, it said “it is not in a position to comment on whether this would amount to collusion or connivance”; the Deloitte report was given to Sebi last week.
The question for potential shareholders, however, is the impact of this on the exchange. Will the damage be limited to the R145.5 crore the exchange earned from the trades placed through the co-location facilities in September-November 2016—NSE has put them aside in a separate bank account.
The amount is not insignificant since, as the DRHP says, these revenues add up to 25-30% of the exchange’s turnover. Naturally, losing this revenue steam is a possibility NSE alerts potential investors to. But, the question is, will the damage be limited to a financial penalty, and will there be a larger responsibility that will be determined or will Sebi accept the view that only a few employees were responsible, and that the top management was not involved? Given the impact of the regulator’s action on shareholder value, and the fact that investors—as opposed to punters—are not in a position to take an informed decision on the likely regulatory fallout just based on the DRHP, the sooner Sebi is able to finalise its penalty, the better it will be for all concerned.