Sebi cracks the whip, tightens algo trading norms

Capital markets regulator Securities and Exchange Board of India (Sebi) on Friday tightened algo trading rules and put the onus on stock exchanges to ensure maintenance of orderly trading in the market.

Putting risk-control measures in place, Sebi has prescribed price filters and caps on trading quantity, which will have to be set by the stock exchanges.

“Exchange shall put in place effective economic disincentives with regard to high daily order-to-trade ratio of algo orders of the stock broker,” said Sebi in a circular.

The regulator has asked the stock exchanges to put in place appropriate risk-control mechanisms to address any risks emanating from algo trades. Exchanges will have to ensure that all orders are routed through servers located in India.

Sebi chairman U K Sinha, in the past, has been critical of ultra high-speed algo trades. Rightly so, as in June 2010, the stock of Reliance Industries Limited had crashed nearly 20 per cent on execution of a large ‘Sell’ order using algo trading methods. The order, which appeared to be a punching error, saw the Sensex plunge more than 600 points the moment it was executed on BSE. Also, on muhurat trading day last year, BSE had to annul all its trades after it reportedly found a Delhi-based trader using algo trading methods, which played havoc with Sensex futures.

According to the new guidelines, which will come into effect in a month, broking firms will need prior approval of stock exchanges to carry out algo trades. Exchanges will also have to ensure a consistent response time to all stock brokers.

Brokers will only get approvals for algo trading after they satisfy the stock exchanges by implementing the minimum level of risk controls. The risk controls include having a check on price, quantity, order value and cumulative open order value check. Brokers will have to give an undertaking to the stock exchanges that it has proper systems and procedures in place. Brokers will also need to have real-time monitoring systems to identify algorithms that may not behave as expected.

Stock exchanges will have to ensure the stock broker provides the facility of algorithmic trading only after receiving permission from the regulator, said the circular.

Any order that is generated using automated execution logic will classify as algo trading, according to Sebi definition. “It has been observed that adoption of technology for the purpose of trading in financial instruments has been on the rise over the past few years. Stock brokers as well as their clients are now making increased use of trading algorithm,” Sebi said in the circular.

The guidelines are based on recommendations made by Sebi’s Technical Advisory Committee and Secondary Market Advisory Committee.