Sebi mulls guardrails for retail algo trades to address regulatory gaps

Proposes mandatory empanelment of algo providers, restriction on open API use

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The Securities and Exchange Board of India (Sebi) has proposed measures to regulate algorithmic (algo) trading by retail investors, introducing new checks and balances for stock brokers and exchanges. Currently, algo trading is dominated by institutional investors, who have “direct market access”, potentially giving them an edge over smaller investors.

 

While retail traders also have been using algo tools, the market regulator’s proposals are aimed at introducing more guardrails and filling the gaps in the regulations.

 

Under the new proposals, stock brokers will only permit algo providers or platforms that are empaneled with stock exchanges. Exchanges will set eligibility criteria for empanelment.

 

Algorithms developed by retail investors will need to be registered with exchanges through their brokers. Once registered, the algo can be used by the investor or their immediate family members.

 

Algo trading involves executing trades based on pre-programmed instructions linked to variables like price movement, volumes, and more. These tools use logic to automatically buy or sell securities based on their programming.

 

Additionally, brokers will also not be allowed to permit open APIs (Application Programming Interfaces). APIs can be used for various functions in algo trading such as placing orders, obtaining data like live prices, and back-testing of strategies.

 

Brokers will also be able to deal only with empaneled algo providers and handle all related complaints. They will further have to put in place measures to ensure identification and traceability of the vendor and end use. 

 

“The facility of algo trading shall be provided by the stock broker only after obtaining requisite permission of 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 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,” noted Sebi.

 

Some players are welcoming of the proposals given the spike in retail algo trading post-Covid.

 

“There has been a spurt of algo platforms, and algo developers, which are neither empaneled nor regulated, but are still active in the ecosystem. If any challenges arose, they were beyond the immediate jurisdiction to address directly,” said Kunal Nandwani, co-founder & chief executive officer (CEO) of uTrade.

 

Sebi has also proposed that orders exceeding a specified threshold, placed through brokers' APIs, will be classified as algo orders and tagged with a unique identifier provided by stock exchanges.

 

The measures have been brought as many algo orders were coming through APIs and were not being tagged as algo, said industry players. These measures would ensure identification of any “misfire” in the market, before curbing the same.

 

The specified threshold will be decided by the brokers’ body in consultation with Sebi.

 

The market regulator has also proposed mandatory registration of those algo providers as research analysts where the logic is not known to the users.

 

Such algo providers will have to make a fresh registration in case of any change in the logic governing the algo, and maintain a research report for the new algo.

 

In the last few months, Sebi has been scrutinising brokers whose clients were using plugins from algo platforms promising guaranteed returns.

 

A circular issued by Sebi in 2022 had prohibited stockbrokers from any association with platforms offering assured returns.