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Home / Markets / Stock Markets /  Why Sebi’s algo trading proposals worry brokers and fintechs

The Securities and Exchange Board of India (Sebi) has issued a discussion paper on regulating algorithmic trading, or trades generated out of automatic execution and logic. Mint examines why the paper has spooked fintech players and brokerages.

What does Sebi propose and why?

A working group constituted by Sebi lays the responsibility with the brokers as intermediaries and the exchange as the first-line regulator when retail investors subscribe to algo services. This is a sensible approach to curtail the growth of unauthorized algorithms targeted at retail investors. Almost all fintech brokerages such as Zerodha and Upstox provide such services to retail investors. However, the number of investors subscribing to algo services via these Sebi-registered intermediaries is small. Unregistered platforms, at times, provide investment advice, which is a breach of regulatory norms.

What worries fintechs and brokerages?

Currently, all algos need to be approved by the exchanges. Sebi’s paper reinforces that. Further, the market regulator has labelled all application programme interfaces (API) as algo. Therefore, APIs may need approval from exchanges. Many brokers outsource their algo services to third-party vendors. According to the paper, brokers will be responsible for them as well. If there is a slight tweak in the algo strategy—for instance, if a trader wants to change the price level to exit a particular stock— even that will require exchange approval. All this may increase the cost of compliance.

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Can intellectual property (IP) be compromised?

Third-party tech platforms and traders will need to share their algo and APIs with brokers for approvals. The fear: there is a possibility some brokerages could replicate the algo strategy. This can compromise tech firms’ IP. Traders are averse to running their trading strategies at brokers’ end as it offers little control during market hours if things go wrong.

What is Sebi’s broader concern?

The covid-19 pandemic led to the rise of retail participation through algorithms. Many experts say the paper reinforces the market regulator’s belief that retail investors must be kept away from the little-known risks of algos for their own good. Some of the algos being offered to retail investors are fairly simple. For instance, ‘buy 100 stocks of Reliance Industries Ltd (RIL) when the price is 1,000’. If this stops, the investor will need to manually check the charts for buy and sell signals.

What is the way forward?

Sebi has sought feedback on the paper till 15 January next year. The regulator is open to making tweaks to ensure that innovation and market evolution is not stalled at the cost of investor protection. However, Sebi could bring in steps to ensure that brokers do not mis-sell or falsely advertise algo trading that guarantees returns to retail investors. Having said that, the simplest way in which Sebi and exchanges can safeguard retail investors’ interest is through education.

 

 

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