What is colocation?
This article introduces colocation in stock exchanges. This article is also focused on the evolution of colocation in India especially in NSE and BSE.
In any business, proximity of manufacturers, vendors and markets brings tremendous efficiency. This is the reason why most of the steel manufacturing plants happen to be close to the iron ore mines. Way back in the 90s, India had many regional exchanges. Price discovery was inherently local and there was no single dominant exchange. With the rise of BSE and NSE, the price discovery has moved to centralized exchanges. With the market being centralized in Mumbai, a member in Mumbai got a physical advantage over a member present in, say, Delhi, viz-a-viz the time when the price discovery was local and most of the members were also local. When the exchanges became central, the players were no longer local but spread across the country. This meant that market information from the central source in Mumbai was accessed by members all over the country. A member sitting in Mumbai would possibly get market information well ahead of member sitting in Delhi. This led to information asymmetry.
Soon members from all over the country started opening offices in Mumbai. This not only led to massive concentration of brokers in Mumbai but also alienated brokers situated outside of Mumbai. Most of these members were situated in Fort, Mumbai. This was no co-incidence as BSE was also situated at Fort, Mumbai. All of these players wanted to be as geographically close to BSE as possible. BSE saw a business opportunity and they soon started offering space within BSE premises to these brokers. Now every broker wanted to be inside the BSE premises. In fact, everybody wanted to be on the same floor where the exchange’s matching engine was stationed. There was a mad rush to occupy the offices closest to BSE’s matching engine. Every member was always on a look out to grab these coveted offices one way or another. The limited office space became a major bottleneck for BSE to offer equitable access.
Other exchanges like CME solved this problem way back in the 1980s by offering remote office space called co-location. These co-location spaces were allowed to house members’ servers and other equipment. Not only had the exchange ensured availability of space but also similar access. Now any member situated in any part of the world could get a remote office close to the exchange via co-location. In exchanges where co-location is not offered, rich members engage in monopolistic practices by hogging all offices close to the exchange. On the contrary, co-location eliminates monopoly and provides equal and fair access. Today almost every exchange in the world provides co-location. NSE started co-location in India in 2010 and within five years of its launch already houses more than 400+ members.
Co-location is a worldwide accepted solution to provide equitable and fastest access. Any single member cannot monopolize market access. Co-location is like a business center inside a market hub, where a small office ensures direct market access in a seamless and rapid manner.
Tomorrow I will write about the infamous NSE colocation controversy.
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The author advises market participants in legal matters related to securities markets and has advised some noticees in this matter also.
