The SEBI says it has drawn the regulatory framework to make algo trading safe, protect retail investors’ interest and prevent any possible manipulations in the market. Currently, exchanges provide approval for algo trading, which are designed and coded by the brokers.
The Securities and Exchange Board of India (SEBI)’s recent consultation paper on algorithmic trading by retail investors, including the usage of application programming interface (API), has drawn much attention. This is not the first time that the capital market regulator has come up with proposals for safeguarding the interest of market participants and bringing transparency.
Algorithmic trading, or algo trading as it is commonly known, monitors live stock prices and executes a trade upon fulfillment of a specific criteria. This method frees the traders from having to monitor stock prices on the go and initiate an order.
The Need for Formulating a Regulatory Framework
The SEBI says it has drawn the regulatory framework to make algo trading safe, protect retail investors’ interest and prevent any possible manipulations in the market.
Currently, exchanges provide approval for algo trading, which are designed and coded by the brokers. However, for trading done using APIs by retail investors, neither brokers nor exchanges can identify if the particular trade is an algo or non-algo trade.
The regulator fears that this poses a serious threat to the markets and puts retail investors in a vulnerable position. Miscreants can use this loophole to lure retail investors into algo trading using APIs in lieu of high returns. In cases where the algo strategy misfires or fails to work in a desired manner, the consequences can lead to huge losses for retail investors. This is coupled with the risk that as most of the third-party algo providers are unregulated, there is no grievance redressal mechanism for a retail investor.
To mitigate the threat, the SEBI has proposed that all orders coming from an API must be treated as algo orders and controlled by the stockbroker. Also, APIs carrying out algo trading should have a unique algo ID, which will be provided by the exchange after being cleared by an approval mechanism.
Brokers need to deploy suitable and adequate technological tools to ensure that there are appropriate checks and controls to ensure no unauthorised tweaking of algos takes place. Two-factor authentication has been proposed to get access to algo trading using APIs.
Impact on Businesses
For brokers offering APIs to customers to craft their own algo trading strategies, it’s an opportunity in disguise to strengthen their technological prowess and expand their client base. With chances of manipulation going down by several notches, they can reach out to more customers and assist their investment needs by helping them customise their trading strategies.
At the same time, it will allow brokerage houses to offer algorithmic services to their retail clients, instead of only institutional investors, who are currently covered by regulations. Also, given the disruption that technology has brought into the world of investment, the days are not far when a major section of retail investors would want to tailor their trading experience according to their liking.
A proper framework would enable them to do so with much ease without worrying about capital loss or being caught off guard. Brokerages that fail to offer this will fall behind the competition, which would affect their bottom lines. They might have to miss out on a large section of consumers, something which they can least afford to do in a hyper-competitive environment.
Impact on Retail Investors
The proposal is definitely a step in the right direction as far as the interests of retail investors are concerned. The regulation ensures that retail investors are protected and it ensures their suitability as well. The regulation will increase the confidence of retail investors who wish to undertake algo trading. With a set of rules in place, there won’t be any price manipulations and the investors may not have to incur any heavy losses in the process.
The SEBI has sought public opinion on the proposed framework by January 15, 2022. The regulator will consider the views of all the participants before the final framework is rolled out for implementation.
(The author, Rahul Jain is President & Head- Personal Wealth at Edelweiss Wealth Management. Views are his own.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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