Mumbai, November 29, 2017

The Securities and Exchange Board of India (Sebi) plans to introduce rules on the participation of retail investors in algorithmic trading, a system widely regarded as giving its sophisticated institutional practitioners an edge.

The capital markets regulator is in the process of determining the extent to which individual investors should be allowed to use this automated trading system.

Algo trading uses advanced mathematical models and computer programmes to create nimble trading strategies. Decisions are made and executed in fractions of a second at magnitudes a human being couldn’t handle. This advantage over manual methods is a concern for regulators around the world.

The thinking in Sebi is that domestic individual investors should also be given an opportunity to take advantage of algo trades.

It has asked exchanges to gather feedback from brokers to firm up rules on the subject, said two people with knowledge of the matter.

“Just like institutional investors, retail investors should have a fair share of algorithmic trading,” said a senior Sebi official. “We have asked exchanges to put together a list of dos and don’ts to ensure risk practices are in place.”

There are no rules currently on algo trading for retail investors though some brokers are offering it as a product. The regulator is uncomfortable with retail investors engaging in automated trading in the absence of regulations.

“Most players have stayed away from offering algo trading to retail investors due to lack of rules,” said Shubham Agarwal, chief executive officer, Quantsapp, an algorithm analytics firm. “It is better to bring in regulations for retail investors’ algo trades because they ensure sound risk management practices and KYC (know your client) mechanisms.”

Sebi was among the first regulators to issue a discussion paper proposing strengthening of rules on algo trading in August 2016. It produced a set of seven proposals aimed at creating a level playing field between institutional investors using colocation facilities offered by the stock exchanges and retail investors. But it did not go ahead with regulations due to lack of clarity on the impact of such rules on the market. Colocation is the practice of placing the servers of the big institutional investors adjacent to those of the exchange.

Had the proposals been implemented, it could have squeezed trading volumes, said market participants.

Algo trades account for over 43% of India’s stock market turnover. In the US, where retail investors also engage in algo trades, 90% of the turnover is from automated systems. The global average is 75%.

With rules in place, algo trades in India will rise to the global average, market participants said. “There are a lot of startups in this space waiting to enter once rules are in place. This will be a big boost for algo trading,” said Agarwal.

The broker community is, however, divided on the extent to which retail investors should be allowed to engage in algo trading. While some believe that brokers should be allowed to launch them as a product for everyone, a section of them believes it should not be accessible to all.

“The rules should be such that only APIs (application programming interfaces) should be allowed,” said a top official of a retail broking firm. APIs allow traders to create their own automated rule-based software that is connected to the broker’s systems.

“This will ensure that only knowledgeable individuals who understand programming and risks get involved in algo trading. Else, it will be a mess and lead to a lot of mis-selling,” the brokerage official said.

[The Economic Times]