To protect retail investors and ensure a level playing field with institutional players, the Securities and Exchange Board of India (SEBI) has introduced stricter rules for algo trading starting August 1. This allows retail traders to use SEBI’s Direct Market Access (DMA) facility through brokers, which was previously available only to institutional investors

What is SEBI’s direct market access facility?

The DMA facility was introduced in 2008, allowing brokers to offer clients direct access to the exchange trading system through the broker’s infrastructure without manual intervention by them. Otherwise, clients would have to contact brokers to give their buy\sell orders and it is only after manual entries by the broker that the order got executed. However, the DMA facility was restricted to institutional investors and investment managers until now. 

How does the SEBI rule providing direct market access to retail investors impact them?

Retail investors will enjoy immediate execution of trade orders, which is particularly essential for algo trading. For example, an algo could be based on a programme designed to detect an arbitrage opportunity between the cash and the futures market, and place orders on exchanges in real time. So, by automating the trade order process, DMA provides investors greater and quicker control over trading execution and strategies. DMA also helps reduce transaction costs and brokerage fees as the intermediary goes away.

What are the safeguards SEBI has put in place? 

The new rules mandate brokers to only on-board algo providers registered with the bourses, and they must handle any investor complaints related to the algorithms. Brokers must also get approval from the exchanges for any algos they offer. Even an algo created by retail traders has to be registered with the exchanges if it exceeds a certain order-per-second threshold. All algo orders will also be tagged with a unique identifier by the exchanges to establish an audit trail. The regulator has also mandated full disclosures of the subscription charges and brokerage fees collected by algo providers from clients. These measures aim to protect retail investors from risks such as faulty algorithms, market manipulation, and operational failures.

What are brokers’ responsibilities?

Brokers must enable two-factor authentication for all Application Programming Interfaces (APIs) — which are a set of rules and protocols that allow a trading algorithm to directly connect and access data from a stock exchange or brokerage platform. They need approval for any changes or modifications to approved algos and must block open APIs. Brokers should only allow access through a special API key for each client and a fixed IP address they approve, to make sure they can track and identify both the algorithm provider and the investor. Brokers must also differentiate between algo and non-algo orders. As a result, brokers may face increased costs for technology, compliance, and handling algorithm-related failures or losses, said Feroze Azeez, deputy CEO at Anand Rathi Wealth.

What are the responsibilities of stock exchanges?

Exchanges will oversee algo trading, including registering algo traders and setting eligibility criteria for brokers to on-board algo providers.They will also establish a standard procedure for testing algos, defining rules for brokers and algo providers. Exchanges will monitor algo orders and have the authority to “kill” orders from specific algo IDs if needed. They may also expedite registration for certain algos by setting specific turnaround times.

How will algos be categorised?

Algos will be divided into two distinct types -– replicable and non-replicable algos, to be called white box and black box algos, respectively. Execution or white box algos are those where the logic is disclosed and replicable, and in case of black box algos, the user remains unaware of the logic and the system is not replicable. For black box algos, the provider must register as a research analyst and maintain a detailed report documenting the algorithm’s functionality and impact. Additionally, the provider must register the algo as a fresh algo when the logic governing it changes and subsequently maintain a detailed research report.

Published on February 6, 2025