KS Badri Narayanan

SEBI recently came out with a new framework on order-to-trade ratio (OTR) for trades executed through algorithms. Under the framework, stock exchanges may be permitted to introduce additional slabs of up to an OTR of 2,000. Currently, exchanges have set the ratio at 500.

Algo trades, mainly used by institutional investors and proprietary traders, currently account for about 45 per cent of the total trades. OTR is computed as the ratio of the total number of order submissions, modifications and cancellations for an order over the number of trades it generates on the exchange. Algo traders tend to place large number of orders within a small interval of time to take benefit of the opportunities that may exist for fractions of a second due to small price movements. High frequency trading (HFT) is a type of algorithmic trading which is latency-sensitive and is characterised by high daily portfolio turnover and high OTR ratio.

Why OTR framework?

The OTR framework was intended to deter traders from placing large (fake) orders without actually executing them to manipulate the order book. Besides, the flooding of orders also puts pressure on the exchange infrastructure. To address concerns regarding order flooding, clogging of the pipeline carrying orders to the exchange infrastructure and denial of opportunity to genuine traders, SEBI, in 2009, came out with OTR penalty to ensure level-playing field. This was initially introduced in equity and currency derivative segments; later it was extended to the cash segment as well.

SEBI also advised exchanges to impose penalty if the order price was beyond 1 per cent of the last traded price (on both up and down sides). The move was aimed at encouraging algo traders to place more orders closer to the LTP, thus bringing meaningful liquidity to the market. This was further reduced to 0.75 per cent later.

Current slabs

While currently, OTR of less than 50 does not attract any penalty, for OTR of 50 to less than 250, traders would be charged 2 paise per algo order, and for OTR of 250 to less than 500, the penalty will be 10 paise an order. However, for OTR of 500 or more during a trading day, besides the penalty of 10 paise an order, the concerned trading member, as a cooling off action, would not be permitted to place any orders for the first 15 minutes on the next trading day.

One has to wait to see how many slabs would be introduced by the exchanges, following the new framework. According to brokers, it may not result in any big changes, as cases of OTR violation are negligible. At best, it could result in a marginal increase in the income of exchanges. However, if the minimum slab is lowered below 50, then that could have some impact on trading, say marketmen.

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