Tech-enabled broking firms like Zerodha raise concerns over SEBI’s views on algo trading

• SEBI has put out a consultation paper on algorithmic trading by retail investors yesterday.
• The market regulator has suggested additional restrictions before executing an algo trade to which online broking firms providing such services have raised their concerns.
• Algo trading means a sell/buy order gets executed automatically when the pre-defined levels are met.

A consultation paper by India’s market regulator Securities and Exchange Board of India (SEBI), that came out on December 9, regarding algorithmic trading by retail investors is a topic of concern for online trading platforms offering automated services to trade in the stock market.

Algorithmic/algo trading means a sell/buy order gets executed automatically when the predefined levels are met. For example: You have 10 stocks of ABC company bought at ₹10 and you feel the stock will move up to ₹20. In such a case you can put an upper limit to the selling price and execute a trade beforehand. This sets you free from monitoring the stock every minute and executing the trade conveniently.

So, definitely it feels like algo trading is the future, but apparently there are many concerns for the regulator regarding the misuse of such automated products especially by retail investors who have a small ticket size (average amount of investment).

"This kind of unregulated/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 investor [sic],” said SEBI in the consultation paper.

Some of the key factors from SEBI consultation paper that indicates it wants to control algo services for retail investors.

• Stock exchanges — BSE, NSE — should approve all algo trades before execution from stock brokers.
• Stock exchanges need 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 unauthorised altering/tweaking of algos.
• All algos developed by any entity have to run on the servers of broker wherein the broker has control of client orders, order confirmations, margin information etc
• Stock brokers need to have adequate checks in place so that the algo performs in a controlled manner.
• Stock broker is responsible for all algos emanating from its application programming interface (APIs) and redressal of any investor disputes.

SEBI has put out the paper to seek comments from various stakeholders including market intermediaries.

One of the online broking platforms that offer algo services to investors says that SEBI may want to control the automated process.

“SEBI has put [out] a consultation paper with the intent of curbing unregulated algo platforms that promise guaranteed returns. But the way it's planned will mean brokers will have to stop offering APIs. This will be 2 steps back in a tech-first future,” said Nithin Kamath, founder and chief executive officer (CEO) of Zerodha in a tweet.

Deepak Shenoy, founder and CEO at wealth management firm Capitalmind said the problem isn’t algorithms, it's the way humans are misusing the technology. “The problem wasn’t the algorithm. It did exactly what it was supposed to do. But the human thinking that technology could save the day was exactly what ruined the day. Too many people blindly relied on technology that didn't know how to deal with the compounding effects of its own actions,” said Shenoy.

Head of investment platform Dhan — Pravin Jadhav — also shared his views on SEBI’s recommendations saying SEBI is not intending to ban it, but wants more accountability on such trades. “SEBI wants stock exchanges to know which orders are coming from where and how; as a regulator it is a very fair ask [sic]. If you are worried because you are doing something wrong, then you shouldn’t be doing that in the first place,” said Jadhav.

SEBI’s growing concerns over misuse of the automated features to trade in stocks is in line with the increasing popularity of algo trading platforms especially for young investors.

In the consultation paper, SEBI is asking brokers to get exchange approvals for every algo trade, which is ‘an extremely tedious and complex process’ as per Kamath. Disallowing APIs will just shift investors from using broker APIs to third party automation tools which aren't in the control of the brokers.

API establishes an online connection between a data provider (i.e., stock broker) and an end-user (i.e., client).

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