SEBI Circular Explained: Retail Investor Participation in Algorithmic Trading
The Securities and Exchange Board of India (SEBI) has put forward a draft circular for public feedback on the involvement of retail investors in algorithmic trading. This step is geared towards enhancing market efficiency, boosting liquidity, and granting retail investors access to the benefits of algorithmic trading, which was previously limited to institutional investors. With the ever-changing landscape of financial markets and the growing demand for algorithmic trading, SEBI’s aim is to establish a regulatory framework that permits retail investors to engage in algorithm-based trading with proper safeguards in place.
One of the key aspects outlined in the draft circular is the responsibilities of brokers under the suggested framework. Some of these responsibilities include obtaining permission from stock exchanges before offering algorithmic trading services to retail investors, tagging all algo orders with a unique identifier for auditing purposes, and obtaining approval from the stock exchange for any modifications to approved algorithms. Additionally, brokers must have mechanisms in place to identify and classify all orders above a specified threshold as algo orders and restrict access to algo trading to identified vendors and users without allowing open APIs.
The draft circular also suggests that brokers facilitate algorithmic trading through Application Programming Interfaces (APIs). APIs serve as software bridges that enable different systems to communicate and share information. By utilizing APIs, brokers can enable third-party algorithmic trading providers to offer services to retail investors in a controlled and supervised manner. To ensure security and traceability, brokers are required to manage API access securely through unique vendor-client specific API keys and static IPs, implement Two-Factor Authentication (2FA) for enhanced security, and empanel compliant algo providers who meet eligibility criteria set by stock exchanges.
The role of stock exchanges in supervising algorithmic trading activities is also highlighted in the draft circular. Stock exchanges will monitor algorithmic trades, ensure compliance with regulatory requirements, have a “kill switch” mechanism in place to halt trading in case of algo malfunctions, and categorize algorithms into “white-box” and “black-box” categories based on transparency. The focus of the new framework is on risk management, with safeguards in place to identify and mitigate risks associated with algorithmic trading, hold brokers and algo providers accountable for any malfunctions, and require registration of self-developed algorithms by retail investors through their brokers.
The proposed regulatory framework is anticipated to take effect in 2025, allowing exchanges and brokers time to make necessary adjustments to their systems and procedures. SEBI is actively working with industry stakeholders to finalize implementation standards. For more detailed information, the complete draft circular can be downloaded in PDF format.
