Algo trading. SEBI mulls norms to regulate algo trading by retail investors

Algorithmic (algo) traders in the retail segment of the stock market are likely to face curbs in the coming months as the Securities and Exchange Board of India (SEBI) has proposed to mandate them to get their trading strategies and software approved by the bourses.

Experts say such a move could drastically curtail algo trading since several strategies and software may find it difficult to pass muster.

“If these regulations go through, every broker and stock exchanges are likely to lose a certain proportion of their business. There are scores of third-party vendors that offer algo-based trading strategies and they all will be affected too,” said Nitin Kamath, co-founder and CEO, Zerodha.

Protecting investors

SEBI said the new rules are being brought to prevent losses to investors.

“Unregulated/unapproved algos pose a risk to the market and can be misused for systematic market manipulation as well to lure the retail investors by guaranteeing them higher returns. The potential loss in case of failed algo strategy is huge for the retail investors,” the regulator said.

More than 50 per cent of trading is currently through algo strategies, brokers say. While broking platforms providing algo trading to clients have already been approved by the exchanges, the strategies coded by third parties have been a grey area as these were sold off the shelf to traders without much scrutiny.

There has been a concern of mis-selling of algo trading strategies too, which could come under scrutiny now. Vendors such as Algobaba, Algo Bridge and AlgoBulls are some of the coders involved in selling algo trading strategies in India.

SEBI has said that there should be clarity on whether the services offered by the third-party algo providers are in the nature of investment advisory services based on research and analysis done by them. SEBI has separate norms for investment advisors that will have to be followed by these algo coders too.

Algo or automated trading is based on a defined set of instructions, wherein computers execute the trade at breakneck speed or frequency.

Under the new proposed rules, stock brokers need to take the approval for all algos from the exchange. Each algo strategy, whether used by the broker or the client, has to be approved by the exchange, and as is the current practice, each algo strategy has to be certified by Certified Information Systems Auditor (CISA)/ Diploma in Information System Audit (DISA) auditors.

Unauthorised tweaks

SEBI wants exchanges to develop a system to ensure that only those algos which are approved and have a unique ID are being deployed. Brokers will also have to deploy suitable technological tools to ensure that appropriate checks are in place to prevent unauthorised altering/tweaking of algos.

All algos developed by any entity have to run on the servers of a broker, wherein the broker has control of client orders, order confirmations, margin information etc, SEBI said in its White Paper that has been put out for public comments.

The market watchdog has said that stock brokers need to have adequate checks in place so that the algo performs in a controlled manner.

Stock brokers can either provide in-house algo strategies developed by an approved vendor or outsource the services to third-party algo provider/vendor by entering into a formal agreement with each third party algo provider/vendor whose services are being availed of by the broker.

A stock broker is responsible for all algos emanating from its Application Programming Interface (APIs) and redressal of any investor disputes.

Obligations of a stock broker, an investor and a third party algo provider/vendor need to be separately defined.

“The stock broker is responsible for assessing the suitability of investors prior to offering algo facilities. No recognition will be given by the exchange to the third party algo provider/vendor creating the algo,” SEBI said.

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