Addressing the rise in algo trade

FMC norms ahead of those of Sebi, provide some cues on where regulations could be headed

At a time when the equity markets regulator is reviewing the policy on algorithmic trading, the norms followed by the commodity market’s regulator could provide some cues.

The Reserve Bank of India has raised concerns on market stability with the rising share of algo trading.

The regulations for algo trade in commodities are comparatively tighter. Yet, the share of algo trading is rising there, too.

On the Multi Commodity Exchange (MCX), a leading commodities derivatives bourse, the share of algo trade last December was 24.6 per cent; it is now 31.3 per cent.

On the National Commodity and Derivatives Exchange, a leading trade platform in agriculture derivatives, the share was 5.7 per cent and is now 9.4 per cent. In gold and silver contracts, it is between 80 and 90 per cent.

With algo trading increasing, MCX has asked the Forward Markets Commission (FMC, the regulator for commodity derivatives) to be allowed to offer co-location facilities, as permitted by stock exchanges. FMC’s guidelines on algo trade, issued in January 2013, do not permit this, as that puts some members (those away from exchange servers) at a disadvantage.

An international advisory board, set up to advise the Securities and Exchange Board of India (Sebi) on global practices regarding market regulations, had at its latest meeting in May recommended, “retail investors are prone to be faced with unequal treatment in the market as a result of increasing algo trades and high-frequency trading (HFT) by sophisticated traders.

In this context, Sebi needs to revisit the regulatory framework governing algo trades/HFT from time to time, to provide a level playing field to retail investors vis-à-vis HFT and algo trading, and also to protect them from potential flash crash events”.

Sebi, said sources, was working on this. There was also a complaint by an investor on a flash trade on the National Stock Exchange some months earlier.

Though nothing came of that complaint, the authorities have decided to be vigilant on future impact, as Indian markets in general are still not liquid enough to accommodate large HFT trades, sources said.

FMC does not permit immediate or cancellation types of algo orders. FMC also has dis-incentivised certain trades; it wants the exchanges to charge if the order to trade ratio, which means more orders placed per second but less traded, is higher.

Many algo traders place huge orders to show high liquidity and create a wrong impression and later cancel these, also known as ‘pinging’. FMC also doesn’t allow algo trading in mini contracts.

MCX, looking at the increasing interest, offered high bandwidth lines for algo traders, from two mbps to 10 mbps, for accommodating more orders and speed.

From next month, MCX has decided to provide ‘tick by tick’ trading market data to members. This will show market feed on systems and improve transparency, it says.