Sebi proposes regulatory checks for algorithm trading
3 min read . Updated: 10 Dec 2021, 12:51 AM IST
PremiumMarkets regulator seeks to place the onus of compliance on regulated brokers and exchanges
MUMBAI : The Securities and Exchange Board of India (Sebi) on Thursday took cognizance of the growing trend of retail algorithm and issued a discussion paper in a bid to prevent the rise of unregulated algorithms and their usage by retail investors.
Retail algorithm is the practise of retail investors authorizing or using an algorithm or computer programme, to set buy and sell orders criteria. The computer program automatically generates orders and some also come with the option to send them to exchange directly, to manage current positions/orders. Algo trading is a technology platform, which allows to execute trades at high speed where institutional investors are typically fighting for a nanosecond advantage.
Retail investors using algo trading democratises the stock market for institutional and retail investors alike. Institutional investors for years have been using the algorithmic trading and so-called colocation facility (allows them to place servers in exchange premises to reduce latency) which always put them at an advantage.
But the growing trend of unregulated algo and hidden risks were a potential grey area which the market regulator is correcting with its discussion paper. Sebi had constituted a working group to deliberate on the large usage of unregulated algo and how to prevent it.
The regulatory proposals firmly place the onus on regulated brokers and exchanges. Exchanges for approval and uniquely identifying all algos and brokers for algos, disputes and third party vendors.
Stock brokers would need to take approval for all algos and even application programming interface or (API) will be treated as algo, Sebi proposed.
“Stock broker needs to take approval of all algos from the exchange. Each Algo strategy, whether used by broker or client, has to be approved by exchange," said the market regulator.
They would need to have suitable technological tools to ensure that appropriate checks are in place to prevent unauthorized altering/tweaking of algos. All algos developed by any entity have to run on the servers of broker.
Also need to have adequate checks in place so that the algo performs in a controlled manner, Sebi added.
Brokerage firms can either provide in-house algo strategies developed by an approved vendor or outsource the services to third party algo provider/vendor.
Sebi is also mulling on whether the algo strategies given by third party vendors can be considered as investment advice or not.
“Since there is limited understanding with respect to the nature of services provided by various algo providers, brokers may obtain from their clients, details of nature and type of services taken from algo providers along with a confirmation as to whether the said services are in the nature of investment advisory services," said Sebi.
Day-by-day Indian markets are inching closer to how trades are happening in the developed economies such as the United States where roughly 90% trades are algo/ internet based trading.
According to Sebi annual report for fiscal 2021 the cash segment the algo trades account for over 82% trades on NSE and on BSE close to 70%. This includes co-location, direct market access, algo, internet based trading and so forth.
The number of non-algo trades for cash segment has fallen down to 17.3% on NSE and on BSE it has fallen down to 30.8%. In 2019-2020 the non-algo trades at NSE stood at 23.5% and on BSE at 37.6%.
In futures and options there is a similar pattern. On NSE, 39.3% trading was through co-location route, followed by non-algo at 18.3%, rest of it is all internet based, direct market access etc. On BSE 68.7% trades were through co-location and algo stood at 24.5%.
Due to lack of standardisation and regulations no two brokerages are currently approaching retail algo the same way.
Some algos help in tailoring a portfolio almost like providing investment advice without being registered as an investment advisor.
There are some algo service providers who will also take authorisation from you to manage your money. Which falls in regulatory grey as only Sebi registered intermediaries can manage your money in securities market.
