SEBI rules on algo trading make brokers nervous

An Overview

Fear has gripped the Indian equity market trader community. SEBI consultation paper on algorithmic or algo trading is the catalyst. The regulation raises concerns about how algo trading is marketed to novice investors. The old guards are concerned that the regulator would throw the algo baby out with the bathwater and, rather than pursuing the illegal traders, will outright ban algo trading.

Traders believe the SEBI is resurrecting memories of the license raj when individual investors had to pay a high premium to trade equities. As a result, they are looking for further information on the subject. In fact, when the consultation paper was issued on December 9, a Twitter Spaces on the same topic drew about 1,500 listeners at 10 p.m. to learn more about the matter.

Further Key Takeaways

Algorithmic trading isn’t for everyone. Brokers themselves recognise it as a tool for experienced traders. However, one must exercise caution when using it. This is due to the fact that today’s financial markets rely on cutting-edge technology that is being democratized on a daily basis. In simple terms, algorithmic trading refers to the execution of buy and sell orders in the stock market using pre-programmed computer methods that trade at micro-second intervals following predetermined rules.

New and young traders are tech-savvy and at ease with algorithmic trading. In reality, during the previous few years, the use of algo trading has rapidly increased. In general, algo trading accounts for 10% to 13% of total market turnover. When the stock market plummeted in March 2020, this number jumped to nearly 25%. This could have occurred as a result of a contagion effect, in which algos went into a downward spiral. While this is simply a wild notion, SEBI is concerned about these issues, which could lead to more market losses caused by rogue algos.

Traders, on the other hand, feel that Black Swan events are true to their name and that no amount of regulation will be able to stop them. They believe that, in order to safeguard individual investors from market collapses, the regulator will simply enact harsher restrictions, causing the equity markets to regress by a decade.

SEBI’s Proposal

SEBI is suggesting that all algos must be approved by the exchange. Each algo strategy, whether utilized by a broker or a client, must be approved and certified. All orders generated by an API should be classified as algo orders and subject to broker oversight, according to the market regulator. It introduces APIs for algo trading that are tagged with a unique ID issued by the stock exchange that granted approval. It wants stock exchanges to create a system that ensures that only approved algos with unique IDs are used.

SEBI urges brokerages to use technology tools to guarantee that sufficient safeguards are in place to avoid unauthorized algo tweaking. Brokers can either provide in-house algo strategies designed by an approved vendor or outsource third-party algo vendor services by entering into a written agreement with each third-party algo vendor whose services the broker is using.

The broker will also be in charge of any algos that come from its APIs, as well as determining the eligibility of investors before allowing them to use the algo facility. In addition, as part of the yearly system audit report provided to the exchanges, brokers will be required to include a detailed report on algorithm checks they have implemented.

Repercussions

SEBI’s approach, according to experts, will force brokers to quit supplying application programming interfaces (APIs). They are concerned about SEBI’s idea that every order put by an API be classified as an algo order. Experts believe that this will force the broker to obtain exchange approval for any algo, which they describe as a time-consuming and complex process for any customer who uses APIs.

Will the SEBI outlaw algorithmic trading? On the surface, it does not appear to be the case. The market regulator is simply attempting to regulate algorithmic trading. While short-term problems and pressure on some businesses to survive are possible, the regulator’s goal appears to be to protect the retail investor. It is attempting to limit mis-selling, the likelihood of Black Swan events, and even broker front-running.

Frequently Asked Questions (FAQs)

Q1. What is algorithmic trading and how does it work?

Algorithmic trading, often known as Algo trading, is the computer-assisted purchase and sale of equities. Because pre-programmed computer techniques conduct buys and sells trades based on set parameters, instructions, or market patterns and conditions, it’s also known as automated or programmed trading.

Q2. In India, how common is algorithmic trading?

A sophisticated type of algo trading, in which computer programmes execute trade orders based on predefined strategies, accounts for around half of daily trading volume in Indian stock exchanges. Hundreds of third-party algo programmers are already selling their buy and sell techniques to clients, and regular traders are increasingly relying on them.

Disclaimer: This blog is exclusively for educational purposes and does not provide any

advice/tips on investment or recommend buying and selling any stock.