Tighter norms coming for algorithmic strategy providers and brokers

Market regulator Securities and Exchange Board of India (SEBI) is considering tougher norms for Algorithmic strategy providers and brokers who provide this facility to clients. In a long meeting held on Tuesday with SEBI top officials, exchange officials, algo makers, and select discount brokers and brokers who are known for providing such facilities, were called to discuss and deliberate wider issues related to algorithmic trading. As per people aware of the development, the regulator is in no mood to let it go unchecked. 

Brokers must know who is using the API

In the meeting, the regulator made it clear that brokers can be asked anytime to share the details of, where, and who is using their Application Programme Interfaces (API). It has also been told to brokers that they are not allowed to give open APIs if they have no idea where it's being used. 

What is the regulation under consideration?

To streamline their regulation, SEBI discussed two types of models. First, brokers suggested that brokers should get approval for their algo platforms, just like they are taking approvals for their other platforms. In this case, brokers will have to take all the responsibility including, but not limited to, cyber security and data security. 

The second model suggests that algo platforms be a fully regulated entity. In this scenario algo platform and strategy provider both have to be registered entities. The matter is likely to be taken to Brokers Industry Standard Forum (BISF)  soon, where brokers will be asked to suggest ways to deal with the issue in a non-disruptive manner. 

Exam for algo strategy providers? 

As per sources, SEBI also discussed if the condition of passing of exam can be made mandatory for algo strategy providers. Currently, algo providers have more expertise in the technical and data analysis field than the financial world. If a combination of financial subject and technical expertise can be made mandatory for such algo strategy providers also came up in discussion.  
 

Returns and Performance Validation

SEBI again reiterated that algo strategy providers and brokers must not advertise or post their past returns. To verify the claims of such strategy providers, the leading exchange has been advised to create a Performance Validation Agency (PVA). PVA will be tasked to audit the algo strategies. The tentative timeline for issuance of the circular is March, and three months after that for compliance will be given. The actual timeline will depend on how quickly the BISF comes up with suggestive measures.
 

SEBI's biggest concern

SEBI had expressed its core concern about the increasing trend of algo trades by retail investors in a committee paper in June 2023. The SEBI paper said that unregulated algos pose a risk to the market and can be misused for market manipulation as well as to lure retail investors by guaranteeing higher returns. The potential loss in a failed algo strategy is huge for retail investors. As the third-party algo providers are unregulated, there is no investor grievance redressal mechanism. 

What regulation says

As per the circulars issued from time to time by SEBI, brokers must provide algo trading facility only after obtaining permission of exchange and such trades shall be routed through broker servers located in India. But it was understood that in some cases the brokers did not take exchange permission.