Market regulator the Securities and Exchange Board of India (SEBI) proposes facilitating the participation of retail investors in algorithmic trading (algo trading) which allows faster order execution and liquidity.
In a consultation paper, SEBI proposes to extend the existing regulatory framework, with additional safeguards, to facilitate the participation of retail investors in algo trading. "The evolving nature of algo trading, particularly with the increasing demand for algo trading by retail investors, has necessitated a further review and refinement of the regulatory framework so that retail investors are also able to participate in algo trading with proper checks and balances."
SEBI says, "The evolving nature of algo trading, particularly with the increasing demand for algo trading by retail investors, has necessitated a further review and refinement of the regulatory framework so that retail investors are also able to participate in algo trading with proper checks and balances. These provisions are expected to fill in the void for retail investors who want to trade using algos with adequate safeguards."
The market regulator undertook extensive consultations with relevant stakeholders, including the intermediary advisory committee and Brokers Industry Standards Forum (BISF), to extend the existing regulatory framework, with additional safeguards, to facilitate the participation of retail investors in algo trading.
In 2012, the market regulator provided broad guidelines on algo trading where orders are generated using automated execution logic. Later, measures were introduced to strengthen controls around algo trading.
To enhance market efficiency and transparency, SEBI introduced algo trading through direct market access (DMA) facility which provided significant advantages such as faster order execution, reduced transaction costs, greater transparency, better audit trails and improved liquidity. However, access to these facilities has been limited to institutional investors.
With its benefits, algo trading also requires intermediaries and market infrastructure institutions (MIIs) for better market surveillance, risk management and investor protection.
SEBI says its proposal for allowing retail investors to use algo trading, if implemented, is expected to fill the void for retail investors who want to trade using algos with adequate safeguards.
SEBI defines algorithmic trading as any order generated using automated execution logic, where an open application programming interface (API) allows an individual to access brokers' trading platforms without logging in manually.
According to SEBI, its regulatory environment envisaged is aimed at spelling out the rights and responsibilities of the main stakeholders of the trading ecosystem like investors, stock brokers, algo providers and vendors and MIIs so that the retail investors can avail algo facilities with requisite safeguards.
SEBI proposes that the facility of algo trading should be provided by the stock broker only after obtaining the requisite permission from the stock exchange for each algo. "All algo orders shall be tagged with a unique identifier provided by the stock exchange in order to establish an audit trail and the broker shall seek approval from the exchange for any modification or change to the approved algos or systems used for algos."
For algo trading through APIs, SEBI says brokers should be the principal, while any algo-provider, fin-tech, or vendor should act as its agent while using the API provided by the broker.
All orders, above the specified order per second threshold, originating or flowing through API extended by brokers to their clients or service-providers, should be treated as algo orders and shall be tagged with a unique identifier provided by the stock exchange. This is in addition to orders already tagged as algo orders.
According to the proposed framework, algos developed by tech-savvy retail investors themselves, using programming knowledge, should also be registered with the exchange through their broker. Further, the same registered algo should be permitted to be used by such retail investors for their family, including self, spouse, dependent children and dependent parents.
As
Moneylife pointed out, as retail algos exploded, unscrupulous algo-writers began to lure newly minted investors with the promise of high returns. Many algo platforms falsely promise 'consistent and astronomical' returns. Some have back-testing of strategies that is 'curve-fitted' to mislead investors about returns; there are poor risk disclosures; there is no clarity on whether customer data (shared between brokers and algo-writers) is misused for proprietary trading and front-running a certain strategy deployment. (
Read: Who Is against SEBI's Move To Regulate Retail Algos? Are Their Fears Justified?)
