Mumbai: The Securities and Exchange Board of India (Sebi) is looking at ways to limit the advantages of co-location and high-frequency trading (HFT), according to two people familiar with the developments.
Discussions to create a level-playing field for those not using algorithmic trading (algo trading), which have been going on for more than a year now, could lead to the regulator introducing ‘non-disruptive restrictions’ on such trading.
This would mean that while Sebi’s actions may not clamp down on algo trading, it would try and restore some level of parity between those who use such trading technologies and those who don’t.
“The facility of algo trades and co-location is available to only a few set of investors which keeps large retail investors at a disadvantage," said one of the two people cited above explaining the regulator’s thought process. He requested anonymity as discussions are ongoing.
Algorithmic trading or HFT refers to the use of electronic systems, which can potentially execute thousands of orders on the stock exchange in less than a second.
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 farther away.
“Access to colo (co-location) and HFT gives certain traders differential advantage such as display of market data, viewing order book prior to order execution. These are the issues that the market regulator wishes to tackle. However, no final decision would be taken without prior consultation with market participants," said the second person cited above also requesting anonymity.
The regulator is also exploring the possibility of order randomization to limit the advantages enjoyed by these entities which have a speed advantage over others. All the orders received within a set period (for example: two seconds) would arrive at the exchange only after randomisation, said the second person. Since the period is small, there would be limited impact on non-algorithmic trading players. This will, however, reduce the advantage of speed enjoyed by algorithmic traders since all orders would be intermingled before execution.
An email sent to the regulator Saturday remained unanswered.
These new curbs assume importance in the wake of the recent report by Sebi’s technical advisory committee (TAC) which found that certain brokers in the algorithmic trading segment had allegedly been able to misuse National Stock Exchange of India Ltd’s (NSE) infrastructure and gain an unfair advantage.
“The issues of unfair advantage to certain brokers was also partially due to lack of regulations between 2011-2014 (the period when certain brokers allegedly gained unfair advantage)...(and absence of) tools such as randomisation. Having some regulations in that context would help," said the first person cited in the story.
In the same report, Sebi’s technical advisory committee had suggested that a framework should be established within Sebi and stock exchanges to detect any abuse of the system by algo traders.
Hitesh Hakani, director of Greeksoft Technologies, a consulting and development services provider, believes that restrictions on algorithm trades could impact liquidity.
“The introduction of randomisation between algorithmic and non-algorithmic orders would make co-location ineffective. The delay would negate any speed advantage. Algorithmic traders account for a significant portion of volumes and their share is only rising. If there are restrictions placed on it, then this would have an impact on liquidity. Impact cost would go up for the market as a whole," said Hakani.
According to data available with the market regulator, the share of HFT as a percent of total orders and turnover has been rising steadily.
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. The share of turnover has risen from 22% to 56%.
In an email BSE Ltd said that it doesn’t own its co-location facilities to remove any conflict of interest. BSE has invited several co-location data centre vendors to set up their data centres at BSE building. BSE is currently also looking at providing space to any additional data centre vendor to promote competition, said a BSE spokesperson adding that the exchange will cooperate fully with regulatory authorities in this regard.
An email sent to NSE on Monday seeking their responses on the changes remained unanswered.