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Algo trading: Sebi proposals and market concerns

Algorithmic trading refers to orders generated at superfast speed by the use of advanced mathematical models that involve automated execution of trade.

Written by George Mathew , Edited by Explained Desk | Mumbai |
Updated: December 17, 2021 3:25:34 pm
Batting for API and algo trading, some market experts say that algo trading will deepen the stock markets and aid retail investors who are not full-time engaged in stock trading.

Market regulator Securities and Exchange Board of India (Sebi), on December 9, proposed that all orders emanating from application programming interface (API) of stockbrokers should be treated as algorithmic trading, or algo, raising concern that such restrictions will hamper the growth of algo trading in India.

What has Sebi proposed?

In a consultation paper, Sebi said there is a need to create a regulatory framework for algo trading. All orders emanating from an API should be treated as an algo order and be subject to control by stock broker and the APIs to carry out algo trading should be tagged with the unique algo ID provided by the stock exchange granting approval for the algo, according to the Sebi. Stock broker needs to take approval of all algos from the exchange. Each algo strategy, whether used by broker or client, has to be approved by exchange and as is the current practice, each algo strategy has to be certified by Certified Information Systems Auditor (CISA)/ Diploma in Information System Audit (DISA) auditors, Sebi paper says.

Sebi says stock exchanges have to develop a system to ensure that only those algos which are approved by the exchange and having unique algo ID provided by the Exchange are being deployed. All algos developed by any entity have to run on the servers of brokers wherein the broker has control of client orders, order confirmations and margin information. Two factor authentication should be built in every such system which provides access to an investor for any API/algo trade, it says.

What are the concerns?

While the services of these third-party applications or algo providers and vendors are being increasingly used by investors (especially retail investors), such algos, based on APIs, are being deployed without taking requisite approvals from the exchanges as per the extant provisions. For the algos deployed by retail investors using APIs, neither exchanges nor brokers are able to identify if the particular trade emanating from API link is an algo or a non-algo trade. This kind of unregulated and unapproved algos pose a risk to the market and can be misused for systematic market manipulation as well as to lure the retail investors by guaranteeing them higher returns. The potential loss in case of failed algo strategy is huge for retail investors. Since these third-party algo providers and vendors are unregulated, there is also no investor grievance redressal mechanism in place.

Market perspective

Batting for API and algo trading, some market experts say that algo trading will deepen the stock markets and aid retail investors who are not full-time engaged in stock trading. However, as getting the requisite permission from the stock exchanges is a tedious process, brokers may have to stop using the API system. However, there’s a chance that investors might shift to some other system if API is not allowed, said a market source, adding, “putting restrictions will impact development of the market.”

However, a section of the market community says the step taken by SEBI is in the right direction as far as retail investors are concerned. “It will ensure that the interest of retail investors is protected and it will boost investors’ confidence to undertake algo trading. With a set of rules in place, there won’t be any price manipulations and the investors will not incur any heavy losses in the process. Additionally, it might be a blessing in disguise for brokers to scale up their technological prowess and expand their clientele,” said Rahul Jain, President & Head- Personal Wealth, Edelweiss Wealth Management.

What is algo trading?

Algorithmic trading refers to orders generated at superfast speed by the use of advanced mathematical models that involve automated execution of trade. Even a split-second faster access is considered capable of bringing huge gains to a trader. The algo runs on the broker’s systems and not on the investors system. Whenever the algo generates a signal, an order automatically gets fired on the investor’s account with no human involvement from either the broker or the investor. The algo trading system automatically monitors the live stock prices and initiates an order when the given criteria are met. This frees the trader from having to monitor live stock prices and initiate manual order placement.

What does API do?

Many brokers in India have started providing Application Programming Interface (API) access to their clients which establishes an online connection between a data provider (stock broker) and an end-user (client). API access enables the investors to use a third-party application that suits their feature needs or investors who have technological capabilities to build their own front-end features. These third-party applications help an investor analyse market data or back-test a trading or investment strategy. These APIs are being used by the investors for automating their trades. Presently, though the broker can identify the orders emanating from an API, they are unable to differentiate between an algo and non-algo order emanating from an API, Sebi paper says.

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