Open for public feedback until January 3, 2025, the proposal emphasizes inclusivity while strengthening market integrity through stringent safeguards.
Decode the proposal
Sebi’s draft framework outlines key measures to make algo trading accessible yet accountable. Retail investors can participate through brokers, who must obtain approvals for each algorithm before deploying. Each algorithm is assigned a unique identifier for effective monitoring and auditing. To improve security, brokers must implement robust application programming interfaces (APIs) with two-factor authentication, ensuring system integrity and preventing unauthorized access.
In addition, tech-savvy private investors can register self-developed algorithms for personal or family trading through brokers. Sebi has also classified algorithms into two types: ‘white box’ (transparent logic) and ‘black box’ (undisclosed logic). Black box algorithms face stricter standards, including mandatory registration of algo providers as research analysts and detailed reporting of strategies.
Leveling the playing field
The framework represents an important step in the democratization of India’s capital markets by equipping retail investors with tools previously reserved exclusively for institutions. Algorithmic trading’s ability to execute trades in milliseconds based on pre-programmed logic allows retail investors to overcome delays inherent in manual decision-making.
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For example, algorithms can track market variables such as price movements, trading volumes and global trends in real time, automatically executing trades when specific conditions are met. This ensures timely action, a crucial advantage in rapidly changing markets.
Market expert Sunil Subramaniam points out that institutional investors have long used algo trading to quickly respond to macroeconomic events such as US Federal Reserve policy changes or inflation data. Extending these capabilities to retail investors can help them seize opportunities and manage risk effectively, even if they are not actively monitoring the market.
In addition to speed, algorithms can also automate strategies such as stop-loss orders and profit booking, ensuring disciplined risk management. By bridging the gap in time-to-action, Sebi’s framework enables retail investors to accurately respond to market dynamics, creating a more level playing field in an increasingly competitive environment.
Market integrity: the cornerstone
A key focus of Sebi’s proposal is market integrity, aimed at preventing misuse of algorithms for market manipulation or other systemic risks. The use of unique identifiers ensures traceability, while strict approval processes reduce the chance of reckless use of algos.
Sebi’s stricter controls on black box algorithms minimize opacity and protect the market from disruptions caused by rogue strategies. Stock exchanges are charged with overseeing implementation and ensuring compliance, while ‘kill switches’ are proposed to halt trades caused by malfunctioning algorithms, adding an extra layer of security. Together, these measures are intended to promote confidence and stability in Indian capital markets.
A global perspective
India’s cautious approach to regulating algo trading is in stark contrast to the relatively lighter approach in developed markets. In the US, regulations emphasize post-trade transparency and penalties for abuse, but problems have also arisen, such as the Flash Crash of 2010, which exposed the systemic risks of poorly controlled algorithms. Reforms in the US introduced measures such as circuit breakers to curb market disruptions.
Similarly, the European Markets Financial Instruments Directive II (MiFID II) prescribes pre-trade controls, kill switches and robust risk management systems for firms engaged in algo trading.
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Sebi’s focus on approval-based implementation and unique identifiers reflects a deliberate approach to prioritizing stability. If successfully implemented, this framework could become a model for other emerging markets looking to democratize algo trading while maintaining system integrity.
Conclusion
Sebi’s initiative to expand algo trading to retail investors marks a transformative moment in Indian financial markets. By prioritizing transparency, accountability and innovation, the framework aims to empower retail investors without compromising market stability.
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The success of this initiative will depend on its effective implementation and the cooperation of brokers, exchanges and investors. If properly implemented, Sebi’s proposal could not only level the playing field but also strengthen confidence and stability in India’s capital markets, thereby promoting a more inclusive and efficient trading ecosystem.
Simarjeet Singh is an Assistant Professor (Accounting and Finance) at Great Lakes Institute of Management, Gurgaon. Opinions expressed are personal.
