Mumbai: Amid growing concerns around high frequency trading (HFT) or algorithmic (algo) trading, the Securities and Exchange Board of India (Sebi) on Wednesday said that new regulations to ensure level-playing field and fair access will take shape before the end of the year.
The regulator also said that it will look at increasing penalties on HFT firms which have a high order-to-trade ratio.
“We will take steps to reduce the possible risk emerging from algo or HFT trading. A discussion paper proposing new regulations will be put up for public comments in the next three months," U.K. Sinha, chairman of Sebi, told reporters in Mumbai.
HFT 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 them an advantage over conventional traders.
To create a level-playing field and to tackle market-wide concerns emerging from the algo-trading segment, Sebi has been in talks with external advisers before finalizing regulations. Internally, the markets regulator is debating options such as introducing speed bumps, order randomization, order bunching of trades and limiting access to co-location facilities.
In addition, regulatory penalties on dubious algo trades may also be revised upwards to deter market players from placing orders that are manipulative in nature.
Firms that have a high order-to-trade ratio would also be penalised to deter players from canceling orders, Sinha added.
The markets have been anticipating a change in regulations for algo trading for almost a year but divergent views and the complexity of the issue have prevented the regulator from finalizing guidelines so far.
Not everyone is in favour of increased regulation and those in the business say that Sebi should consider the positive impact of algo trading on market liquidity.
“The regulator should concentrate on orders, whether algo or not, that reduce the liquidity in the market. HFT orders have so far been contributing in making the market more liquid so any new regulation should be balancing act of maintaining market sanctity and liquidity," said Naveen Kumar, director, First Futures Software Engineering, a company that provides electronic trading solutions.
According to Kumar, a number of algo traders are market makers and therefore have a high order-to-trade ratio.
“An estimated 20-30% of HFT players are providing market making and tend to have high order-to-trade ratio. Penalizing them may not serve an adequate purpose," said Kumar.
“One way of ensuring a level-playing field would be to make co-location facilities accessible to all brokers. Co-location gives considerable advantage to brokers. Due to high costs involved, the small brokers are not able to access it," said the proprietor of a brokerage firm providing algo trading services on the condition of anonymity.
Co-location involves setting up servers on the exchange premises.
This reduces the time it takes for an order to travel to the exchange, giving them a speed advantage over those who are located farther away.
According to a 13 April Mint report, the share of HFT trading as a percentage of overall trading has been growing consistently. In 2011-12, HFT orders as a percentage of overall orders in the cash equity segment was at 65%.
This has gone up to 94% in 2015-16. HFT turnover as a percentage of overall turnover in the cash equity segment has gone up from 25% to 42% over the same period. In the equity derivatives segment, the percentage of HFT orders has gone up from 78% to 98% between fiscal 2012 and fiscal 2016.