NSE Exploring ‘Unsupervised Machine Learning Model’ to Detect Anomalies in Algorithm Orders

Eyeing a major technological leap, the National Stock Exchange (NSE) is exploring an “unsupervised machine learning model” to plug anomalies in algorithmic orders. The machine learning algorithms or algo monitor trade results and detect patterns that determine if stock prices go up or down.

In its annual report for 2021-22, the exchange said that it has developed well-curated market surveillance mechanisms backed by robust technology architecture over the years. The bourse’s surveillance systems identify malpractices and ensure timely management of identified breaches.

In order to upgrade and strengthen its surveillance-linked capabilities, the exchange has rolled-out key initiatives in 2021-22 including deployment of alerts to detect market abuse practice in equity stock options OTM (over-the market) contracts, capture multi-leg reversal cases as well as market abuse practices where option contracts are traded at away prices without change in the underlying.

Moreover, “Exchange is exploring with an ‘Unsupervised Machine Learning model’ to detect anomalies in algo orders,” the annual report noted.

Algorithmic trading or ‘Algo’ in market parlance refers to orders generated at a super-fast speed by use of advanced mathematical models that involve automated execution of the trade, and it is mostly used by large institutional investors.

In addition, the exchange is aiming to modernise its trading platform to “build highly scalable, resilient and fault tolerant trading application components to process 1 million orders/sec”.

Apart from technological advancement measures, the exchange has paid Rs. 25 lakh to SEBI “without admission of any lapse on the part of NSE” in the case pertaining to technical glitch that happened in February last year. This matter is pending before the capital markets regulator for further proceedings and discussions.

On February 24, 2021, NSE suffered a four-hour long halt in its trading system due to a technical glitch. The exchange’s trading system was halted due to certain issues in the links with telecom service providers which in turn impacted the Storage Area Network (SAN) system of the company, resulting in the primary SAN becoming inaccessible to the host servers.

This also resulted in the risk management system of NSE Clearing Limited (NCL) and other systems such as clearing and settlement, index and surveillance systems becoming unavailable.

“SEBI vide its letter dated July 2, 2021, directed NSE and NCL to pay financial disincentive of Rs 25 lakhs each. The said amount was paid by the NSE on July 12, 2021 and NCL on July 14, 2021,” the annual report noted.

Further, the exchange said it has followed Standard Operating Procedure (SOP) as communicated in SEBI’s correspondences and SOP communicated to all Market Infrastructure Institutions (MIIs) — stock exchanges, clearing corporations and depositories — for reporting of technical glitches by MIIs and imposition of financial disincentives.

Apart from this, few other matters pertaining to the exchange are also pending before the Securities and Exchange Board of India (SEBI).

In April 2019, the regulator had returned the consent application filed by NSE and had passed orders in respect of the three show cause notices pertaining to the bourse colocation facility, dark fibre and governance and conflict of interest matter.

Under the first order, SEBI had passed a direction on NSE to disgorge Rs 625 crore, along with interest, which has since been remitted by the exchange to an interest bearing account, and certain restrictive directions.

In the second order, it had asked to deposit Rs 62.58 crore, along with interest, which has been remitted by NSE to an interest bearing and in the third order it had passed certain non-monetary and remedial directions on NSE.

NSE appealed in all the three orders before the Securities Appellate Tribunal (SAT). These appeals are pending for a final hearing, except for the colocation matter, which has been heard by SAT and is reserved for orders. Additionally, NSE also received adjudication notices covering the three orders.

“SEBI, in the colocation adjudication matter, has passed direction levying a penalty of Rs 1 crore, the said order has been challenged by NSE before SAT and the SAT has stayed the said direction. The second and third matters are pending before SEBI,” the report noted.