Home / Markets / Stock Markets /  What Zerodha co-founder said on Sebi's proposed move to regulate algo trading
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Market regulator Securities and Exchange Board of India (Sebi) decision to regulate algorithmic trading, a move that may impact dozens of low-cost fintech-based brokerages that are adding millions of new clients, has evoked mixed responses from the industry.

The Sebi broadly defines algorithmic trade as a system where the machine tracks prices and initiates trades. Under the proposals, brokerages need stock exchange approval for each of their algos and any derived trade must be tagged with a unique ID provided by the bourse.

The brokerages’ servers will have to host the algo, and primary responsibility for redressal would rest with the broker, Sebi proposed in a consultation paper Thursday. It invited public comments through Jan. 15.

The impact of the move could be two-fold: First, it may increase compliance costs for Robinhood-type brokerages that are seeing an influx of new clients because they offer cheap trading based on machine-generated strategies. Second, it will allow traditional brokerages to offer algorithmic services to their retail clients, as opposed to only hedge funds and other institutions that are covered by regulations so far, according to Deven Choksey, chief executive officer at brokerage K.R. Choksey.

“While Sebi’s intention is right, its decision to consider all API-based trades as algos can be bad for the entire ecosystem" and stifle innovation, said Nikhil Kamath, co-founder of India’s largest retail brokerage Zerodha. Instead, the regulator should impose oversight on unregulated algo writing platform by classifying them as investment advisers, he added.

About 0.5% of Zerodha’s overall business uses API, Kamath said.

Nithin Kamath co-founder and CEO of Zerodha said Sebi has put a consultation paper with the intent of curbing unregulated algo platforms that promise guaranteed returns. But the way it's planned will mean brokers will have to stop offering APIs. This will be two steps back in a tech-first future.

Kamath further urged investors to send in feedback and suggestions.

The objective of Sebi's paper is to seek comments from various stakeholders including market intermediaries and the public on algorithmic trading being done by retail investors including use of API access and automation of trades using the same.

Sebi had earlier constituted an internal working group which deliberated on the issue of unregulated algos being used by investors especially retail investors and ways to prevent the same. The working group held meetings with various market participants and based on deliberations, the working group submitted their recommendations.

In its consultation paper, the regulator has proposed framework for algo trading done by retail investors including use of Application Programming Interface (API) access and automation of trades. Currently, exchanges are providing approval for the algo submitted by the broker.

However, for the algos deployed by retail investors using APIs, neither exchanges nor brokers are able to identify if the particular trade emanating from API link is an algo or a non-algo trade.

"This kind of unregulated/unapproved algos pose a risk to the market and can be mis-used for systematic market manipulation as well as to lure the retail investors by guaranteeing them higher returns.

The potential loss in case of failed algo strategy is huge for retail investor," Sebi said.

Since these third-party algo providers/vendors are unregulated, there is also no investor grievance redressal mechanism in place, it added.

Under the proposal, Sebi suggested that all orders emanating from an API should be treated as an algo order and be subject to control by stock broker and the APIs to carry out algo trading should be tagged with the unique algo ID provided by the stock exchange granting approval for the algo.

It, further, said that 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 and as is the current practice, each algo strategy has to be certified auditors.

Also, brokers will deploy suitable technological tools to ensure that appropriate checks are in place to prevent unauthorized altering or tweaking of algos.

They need to have adequate checks in place so that the algo performs in a controlled manner. All algos developed by any entity have to run on the servers of broker wherein the broker has control of client orders, order confirmations, margin information among others.

Sebi suggested that brokers can either provide in-house algo strategies developed by an approved vendor or outsource the services of third party algo provider/vendor. Stock brokers should be responsible for all algos emanating from its APIs and redressal of any investor disputes.

The regulator said that obligations of stock broker, investor and third party algo provider need to be separately defined. Stock broker is responsible for assessing suitability of investor prior to offering algo facility.

"No recognition shall be given by the exchange to the third party algo provider/vendor creating the algo," Sebi said. The regulator proposed that two factor authentication should be built in every such system which provides access to an investor for any API/algo trade.

(With inputs from agencies)

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