Mumbai: A Securities and Exchange Board of India (Sebi) discussion paper on regulating algorithmic trading released last week has made market participants anxious.
If the measures are implemented, it will hit liquidity, increase cost of trading and traders may shift to using similar products in overseas markets such as Singapore and Dubai, they said.
Algorithmic (or algo) trading (AT) refers to a form of order execution using software programs that automatically place orders based on certain mathematical models. High-frequency trading (HFT) is a subset of algorithmic trading where trading firms primarily compete on speed to profit from arbitrage opportunities.
“The proposed steps may not help much in reducing the concerns of unfair access. However, they can have an adverse effect of reducing liquidity. If these steps are implemented, then it could push the markets to the 2005 era of manual trading and could increase cost of trading," said Kunal Nandwani, founder and CEO, uTrade Solutions Pvt. Ltd, a fintech company providing algo engines.
Another big impact would be migration of foreign institutional investors to other jurisdictions to seek exposure to Indian companies
Sebi on 5 August invited public comments on seven methods to allay the concern that high-frequency traders have unfair access to the trading system of Indian exchanges.
The first proposal from Sebi calls for the introduction of a minimum resting time for orders. Second, Sebi had 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, instead of dealing with them individually in real time.
Third, the regulator is considering speed bumps or random delays of a few milliseconds in order processing. Fourth, Sebi proposes to do away with the current system of sending orders to the matching engine-based on-time priority, and instead randomly decide the place of an order in the queue based on an algorithm. Fifth, Sebi has proposed that the order-to-trade ratio be capped.
Sixth, Sebi is considering the idea of having separate queues for orders coming from co-located servers and those from other servers. Lastly, the regulator also wants to review the practice of disseminating tick-by-tick data feed, which is mainly used only by high-frequency traders.
“If the proposed norms are implemented then it could lead to the disruption of market dynamics by creating unfair arbitrage opportunities. Any physical barrier generally leads to an increase in number of entities who are looking to beat the system to maximize their profits," said Rajesh Baheti, managing director at Crosseas Capital Services Pvt. Ltd, a brokerage firm providing prop trading and running its own algorithm sequences.
Baheti estimates that half of the HFT market would migrate to overseas platforms if the proposals are implemented.
According to Sebi data, HFT accounts for about 40% of turnover in the equity cash segment. In order placements and cancellations, HFT’s share is 94%.
“With volumes getting impacted there would be a loss in even the securities transaction tax collections," said Baheti.
A Sebi spokesperson did not respond to an email seeking comment.
“The industry must understand that this is a discussion paper and these are possible regulations. It is unlikely that all of them will be implemented," said an academic who did not want to be named as he regularly consults with the regulator on market issues.
“Some of the steps suggested are drastic. They could lead to structural changes in trading practices. Algorithmic trading is evolving and in my opinion, it is too premature to regulate it," he added.
A spokesperson for National Stock Exchange of India Ltd (NSE) declined comment, saying the exchange does not comment on regulatory matters as a matter of policy.
A spokesperson for BSE did not respond to an e-mail seeking comment.
However, Ashishkumar Chauhan, chief executive of BSE, in an interview with Reuters on 11 August, said that “well-designed forward looking regulations create better trust" and “it will not impact its business".
While some in the market are looking at these norms as a potential dampener, there are others who say that some of the proposals will help reduce the possibility of manipulation.
Naveen Kumar, founder and CEO at algorithmic trading solutions provider QuantXpress Technologies, said some of the suggestions are welcome. A curb on a high order-to-trade ratio is one of them.
The ratio is a measure of how many of the orders placed in the system are actually executed. Some strategies are said to use a large number of orders to give the appearance of demand without actually executing these orders. This can have a misleading effect on price.
“A high order-to-trade ratio can be used to manipulate the market. It should be held in check," explained Kumar.
In June 2012, NSE decided to levy additional charges if a trader is found to have a high order-to-trade ratio.
Hitesh Hakani, director of Greeksoft Technologies, an algo trading technology firm, pointed out that these suggestions specifically target HFT. The market also has other kinds of algorithms, such as those which focus on executing large sell orders efficiently, which would be less impacted.
The incentive to invest in co-located servers or any other infrastructure that HFT traders require would be limited if the regulator implements the proposed changes, he said.
“Several norms proposed by Sebi do not have precedence anywhere in the world. Some of these steps were proposed in more mature markets that never got around to implement them," said Nandwani.
A new exchange from the IEX Group has a speed bump—random delays before order processing—which is one of Sebi’s proposals.
Other proposals such as minimum resting time have been considered by regulators such as the Australian Securities and Investments Commission and the European Commission but not adopted. Toronto-based TMX Group has introduced a minimum resting period of 1 second. However, this order type is optional. Besides, these changes were implemented voluntarily by the exchanges; they weren’t imposed by a regulator.