The Securities and Exchange Board of India (SEBI) released a draft circular on December 13 aimed at enhancing market integrity through algorithmic trading by retail investors. The proposed rules seek to facilitate retail participation in algorithmic trading via stock brokers.
According to SEBI, stock brokers can only offer algorithmic trading services after obtaining the necessary approval from the stock exchange for each algorithm.
“All algorithmic orders must be tagged with a unique identifier from the stock exchange to create an audit trail. Brokers must also seek exchange approval for any modifications or changes to approved algorithms or systems,” the circular states.
Regarding Application Programming Interfaces (APIs), SEBI specified that brokers will be the primary party, while any algorithm provider, fintech firm, or vendor will act as their agent when using the broker's API.
Algorithmic trading involves using computer programs to execute trades based on pre-defined criteria such as price, time, and volume. While historically restricted to institutional investors, this proposed framework would allow retail investors to access approved algorithms through brokers, giving them tools previously available only to larger market players.
The circular introduces two types of algorithms:
White Box Algos: These are transparent algorithms where the logic, decision-making process, and underlying rules are fully disclosed. Retail investors can understand and replicate these strategies, offering clarity and control.
Black Box Algos: These proprietary systems hide their logic and rely on complex, undisclosed methods for trade generation. SEBI proposes stricter oversight for these algorithms, including registration as research analysts and detailed research reports for each algorithm. Any changes would require re-registration and updated reports to ensure accountability.
Stock exchanges will be responsible for monitoring algorithmic trades and ensuring compliance after execution. They will also implement a “kill switch” mechanism to halt malfunctioning algorithms to prevent market disruptions. Brokers will be required to accurately categorise orders and differentiate between algorithmic and non-algorithmic trades.
The draft circular is open for public comment until January 3, 2025. SEBI aims to implement these changes by 2025, after further consultations with stakeholders.
This initiative is a significant step toward levelling the playing field for retail investors, enabling them to use advanced trading technologies while ensuring market integrity and investor protection.