SEBI's Algo Trading Proposal Decoded
In a recent consultation paper, the Securities and Exchange Board of India (SEBI) reiterated the need for a regulatory framework for Algo trading and the use of application programming interfaces (API). The capital market regulator has proposed to safeguard market participants' interests and enhance transparency.
What is Algo Trading?
Algorithmic trading is the automated execution of trade orders generated at superfast speeds using advanced mathematical algorithms. The algorithm runs on the broker's systems instead of the investors'. When the algorithm generates a signal, an order is automatically placed on the investor's account without the need for the broker or the investor to intervene. When the specified requirements are met, the algorithm trading system automatically monitors live stock prices and place the order. This eliminates the need for a trader to track live share prices and place manual trades.
The Need for a Regulatory Framework
SEBI's new regulatory framework makes Algo trading safer and protects individual investors' interests against market manipulation. At present, exchanges permit Algo trading, created and coded by brokers. However, neither broker nor exchange can determine if a trade is executed using APIs by retail investors is an algo or non-algo transaction. The regulator is apprehensive that this poses a substantial threat to the market and puts retail investors at risk. When an algo strategy goes wrong or fails to perform as expected, it can suffer huge losses for retail investors. This is aggravated by the concern that, since most third-party algo providers are unregulated, there is no mechanism for a retail investor to lodge a complaint. The SEBI has proposed that all orders originating from an API be treated as algo orders and regulated by the stockbroker to limit the threat. Furthermore, algo trading APIs should have a unique algo ID, which will be provided by the exchange after an approval mechanism has been completed.
Impact on Businesses:
1. Customers who are using APIs to build their own algo trading strategies are missing out on a tremendous opportunity to improve their technological prowess and expand their customer base. With the risk of manipulation reduced, they can reach out to more consumers by providing them with their investing needs by customizing their trading strategies.
2. Simultaneously, it will allow brokerage firms to provide algorithmic solutions to their retail clients besides institutional investors. Moreover, given the disruption that technology has introduced to the investment market, the days are not far behind when a substantial percentage of retail investors want to customize their trading experience to their interests.
3. A suitable framework would make it much easier for them to do so without fear of losing money or being caught off guard. Brokerages that do not provide it will fall behind the competitors, which will have a negative impact on their earnings. They may have to miss out on a substantial market segment, which is something they can barely afford in today's hyper-competitive environment.
Future Outlook:
By January 15, 2022, the SEBI is seeking public feedback on the new framework. Before the final framework is put out for implementation, the regulator will consider all stakeholders' perspectives.
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