Mumbai: In a move that will usher in algorithmic trading and transform the Indian stock market, the country’s capital market regulator on Thursday allowed direct market access (DMA) to institutional investors. Foreign institutional investors (FIIs) and domestic institutions such as mutual funds and insurance firms can now directly execute their buy and sell orders without any manual intervention by their brokers.
However, brokers aren’t entirely out of the picture because the trades will still be executed through their systems.
The Securities and Exchange Board of India (Sebi) has not specified any time frame to kick off the new system but said brokers would need to have software and systems in place that support direct access and take approval from the stock exchanges. All orders placed through DMA will be routed through the brokers’ trading system. The brokers will need to maintain a separate database of the orders executed and maintain an audit trail for five years.
Algorithmic trading or program trading refers to orders that are automatically placed in the market by software programs, built on certain mathematical models. In its simplest form, algorithmic trading could be based on a program designed to detect an arbitrage opportunity between the cash and the futures market and place orders on exchanges in real time.
DMA refers to electronic facilities offered by brokers to their clients, which will enable them to place orders directly into an exchange-traded system. Currently, all investors— both institutional as well as retail—place their orders with brokers and the brokers, in turn, enter them into the exchange’s system. This loss of time, or “high latency” in market parlance, substantially reduces the profit-makingpotential of program traders and arbitrageurs who do not have direct access. With DMA, clients who engage in such trades are given equal opportunity vis-a-vis proprietary desks, who already enjoydirect access.
Arbitrageurs are traders who attempt to profit from pricing inefficiencies in the market by making two or more trades that offset each other and capture risk-free profit.
As of now, the DMA facility will be open to institutional investors and the exchanges will have the discretion to allow other category of investors access to this in due course, a Sebi release said.
The Sebi release said one of the advantages of DMA is that “clients can make better use of hedging and arbitrage opportunities through the use of decision support tools/algorithms for trading.” This makes it clear that algorithmic trading will be allowed. Earlier this year, Sebi had cleared the registration of the world’s largest hedge fund, Renaissance Technologies, which is an algorithmic trader.