Sebi floats consultation paper on algorithm trading for retail investors; chalks out 11 things under proposed framework

The Securities and Exchange Board of India (SEBI) today floated a consultation paper on algorithmic trading being done by retail investors to seek comments/views from various stakeholders, including market intermediaries and the public. 

The views and comments on algorithmic trading, which also includes the use of API access and automation of trades, must be sent by 15 January 2022.  

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SEBI defines algorithmic trading as any order that is generated using automated execution logic. The market regulator has been providing broad guidelines on it from time to time, the consultation paper said. 

The algo trading system automatically monitors the livestock prices and initiates an order when the given criteria are met. This frees the trader from having to monitor livestock prices and initiate manual order placement.  

As per the current provisions, the facility of algo trading shall be provided by the stockbroker after obtaining permission from the stock exchange. All algo orders shall necessarily be routed through broker servers located in India and the stock exchange should have an appropriate risk controls mechanism to address the risk emanating from algo orders. 

SEBI constituted an internal working group that deliberated on the issue of unregulated algos being used by investors especially retail investors and ways to prevent the same.  

The working group held meetings with various market participants submitted its recommendations based on deliberations. 

What is proposed under the framework? 

1) All orders emanating from an API should be treated as an algo order and be subject to control by stockbroker 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.  

2) Stockbroker needs to take the 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.  

3) 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. Brokers shall also deploy suitable technological tools to ensure that appropriate checks are in place to prevent unauthorized altering/tweaking of algos.  

4) All algos developed by any entity have to run on the servers of the broker wherein the broker has control of client orders, order confirmations, margin information, etc.  

5) Stockbrokers need to have adequate checks in place so that the algo performs in a controlled manner.  

6) Stockbrokers can either provide in-house algo strategies developed by an approved vendor or outsource the services of third-party algo provider/vendor by entering into a formal agreement with each third party algo provider/vendor whose services are being availed by the broker.

7) Stock broker is responsible for all algos emanating from its APIs and redressal of any investor disputes.  

8) Obligations of stock broker, investor and third party algo provider/vendor need to be separately defined. Stock broker is responsible for assessing suitability of investor prior to offering algo facility.  No recognition shall be given by the exchange to the third party algo provider/vendor creating the algo.  

9) Stock brokers shall ensure that only those third party algo provider/vendor, with whom broker had entered into an agreement with, shall use the name of the broker as part of their testimonial, provided Exchange prescribed advertisement guidelines are met.  

10) Two factor authentication should be built in every such system which provides access to an investor for any API/algo trade. The software to be used to create the strategies should be approved by the Exchange.

11) Stock brokers shall include a specific report on algorithm checks implemented by them as a part of annual system audit report submitted to the Exchanges and format for the same shall be prescribed by the Exchanges.