Traders urge action on front-running in India

Buy-side head traders will meet with India's markets watchdog next month to discuss how regulators and exchanges can help tackle market information leakage that causes execution slippage. There are hopes that this long-standing issue will be addressed, which would boost confidence in the local market among foreign investors.

The Asia Trader Forum (ATF), which represents 22 head equity traders from asset managers operating in the region, has surveyed its members about India’s market structure and regulatory issues. It presented the results in July to the Securities and Exchange Board of India (Sebi), which has since been discussing them with the ATF, the National Stock Exchange and the Bombay Stock Exchange.

The forum represents more than $500 billion in assets under management and includes staff from firms such as Fidelity, Invesco, State Street and UBS Global Asset Management. More than 90% of respondents said they felt the current on-exchange block-crossing mechanism is a major problem.

This has been exacerbated by the perennial issue of market information leakage, with 92% of members saying Sebi has not done enough to prevent this. They argue that foreign investors, in particular, are left open to the risk of being front-run and having their brokers executing blocks with slippage.

“In India, you have this culture that local Indian funds almost feel as though they have the right to obtain trading information of the foreign institutional investors [FIIs] through their brokers," says one head trader based in Hong Kong. "The brokers in turn fear that they would lose business from their domestic clients if they don’t disclose what they know about foreign clients’ orders."

These brokers tease out buying or selling interest on block trades, often from foreign long-only investors, he notes, by claiming they are looking for a fund manager with a sizeable order only to report the manager has decided not to trade with them, after agreeing to transact in the proposed size.

Meanwhile, a sales trading head in charge of India for an investment bank believes the leakage comes from the settlement process handled by the custodians. 

“Most information leakage comes after the market close; once the trades are booked, there’s leakage in the market place,” he says. “I don’t know how this can be addressed. During the trading sessions, the information leakage was avoided completely.”

This view is echoed by the Hong Kong-based head trader, who says local fund managers are buying trade information from their custodians.

The level of information leakage is such that the exact details of a trade – including which trader it was executed by – is commonly available information 24 hours after a trade. “So if you can work out exactly which fund manager is selling and appears to be liquidating its position," he says, "you can sell ahead of them."

Such leakage has a particular impact on block trades in India, which – unlike in other markets, where managers can negotiate such transactions privately and report executions on the exchange the next day – must be done in the market.

The exchanges operate a 30-minute block-trading window that starts from market opening, and a block trade can only be done in a narrow range of 1% above or below the previous day's closing price. That said, industry players point out that in reality the markets rarely trade only within the 1% band during the window.

Still, theoretically the issue remains. “If an execution broker put a block on offer at 99 rupees, but someone with market information about this block can bid at 99.01 rupees, he will get the block," says another Hong Kong-based head trader. As a result, the buyer expecting to get filled at 99 rupees would not get the shares.

Some slippage is always to be expected in India, however, even when there is both a seller and a buyer in place, due to the effect of retail or related flow, notes a head of cash equity trading at a bank in Hong Kong.

According to Thomson Reuters, year-to-date there were 12 block trades in Indian equities totalling $5.37 billion that were done and priced through banks’ bookbuilding processes; up from eight trades totalling $2.53 billion a year ago.

Year-to-date, India tops all 11 Asian markets tracked by Bloomberg in terms of foreign institutional investor inflow, with $18 billion as of October 18, up 50 times from a year ago.

Investors’ frustration about India’s information leakage and block trading may not be new, but a source says the ATF is seeing a generally open attitude among Sebi officials to improving the market infrastructure. Moreover, the forum hopes the new finance minister, P. Chidambaram, will bring in more market reforms favourable for foreign investors.