Mumbai: The Securities and Exchange Board of India (Sebi) has proposed seven new ways to level the playing field between those using high frequency trading (HFT) systems and regular market users. In a discussion paper released on Friday, the capital market regulator said it is “examining various options to allay the fear and concern of unfair and inequitable access to the trading systems of exchanges”.
HFT, carried out through dedicated algorithms, refers to the use of electronic systems that can potentially execute thousands of orders on the stock exchange in less than a second, which gives users an advantage over conventional traders.
HFT turnover as a percentage of the overall turnover in the cash equity segment has gone up from 25% to 42% in the four years to fiscal 2016.
The first proposal from Sebi calls for the introduction of a minimum resting time between HFT orders. Resting time refers to the time between an order’s receipt by the exchange and when it is actually allowed to be executed. Sebi is hoping this will eliminate so-called fleeting orders that appear and then get changed or cancelled within a short period of time.
This fleeting liquidity occurs owing to the ability of trading algorithms to react to new developments faster, allowing users to modify, cancel or place new orders. Sebi said providing such an ability to the trader to modify orders may be prone to market abuse.
Second, Sebi has suggested matching orders under a batch system. Under a batch system, exchanges would accumulate buy and sell orders for a particular length of time, say 100 milliseconds, before matching them. This will eliminate the time advantage that traders who have co-location facilities (essentially having one’s trading server on the same premise as the exchange’s) enjoy.
Third, the regulator wants to introduce random delays of a few milliseconds in order processing. This is again meant to discourage time-sensitive trading strategies. Such a measure would not deter non-algorithm order flow for which delay in milliseconds is insignificant. Mint had reported that Sebi may consider such a step in a 27 April report.
Fourth, Sebi proposes to revise the order queue randomly every 1-2 seconds. This is again to discourage time-sensitive trading strategies and ensure that speed as a stand-alone strategy doesn’t work.
Fifth, Sebi has proposed that the order-to-trade ratio be capped. Typically in high frequency trading, a large number of orders are cancelled in comparison with trades that are actually executed. Sebi wants to ensure that at least one trade is executed for a set number of orders to reduce hyperactive order book participation.
Sixth, Sebi is considering the idea of having separate queues for orders coming from co-located servers and those from other servers. The regulator had suggested this in an earlier paper released in 2013 as well. It also cautioned that despite this measure, co-located participants would still be among the first to receive market data feeds. This, coupled with algorithmic trading, will allow them to quickly react to such market data.
Lastly, the regulator also wants to review the tick-by-tick data feed. Currently, this data-heavy feed, which provides details of all orders and trades on a real-time basis, is subscribed by only HFT users for a fee. Sebi now wants to provide structured data—for example, top 20 or top 30 or top 50 bids/asks, market depth, etc.—to all market participants at a prescribed time interval or as real-time feed to level the playing field.
According to Kunal Nandwani, chief executive of uTrade Solutions, a trading technology provider, Sebi’s suggestions are in line with the regulator’s objective of offering institutional and retail traders a level playing field.
However, this might lead to a situation where the co-location business of exchanges is affected.
“What we need to understand here is that those who avail the latency advantage of co-location are actually paying the exchanges for this benefit. If implemented, no one will see business sense in such co-location facilities,” said Nandwani.
Also, “segregating order queues will possibly fragment the markets unnecessarily and create unintended arbitrage opportunities across the two queues,” he added.
Sebi has sought comments from market participants to its proposals by 31 August.