SEBI Proposes New Rules for Retail Participation in Algo Trading

Markets regulator Securities and Exchange Board of India (SEBI) on December 13 issued a draft circular over algorithmic trading by retail investors to improve market integrity. It proposed new rules to facilitate the participation of retail investors in algorithmic trading through stock brokers.

The regulator said the facility of algo trading should be provided by the stock broker only after obtaining the requisite permission of the stock exchange for each algo.

In addition, all algo traders must be tagged with a unique identifier issued by the exchange to ensure and audit trail.

“All algo orders shall be tagged with a unique identifier provided by the stock exchange in order to establish an audit trail and the broker shall seek approval from the Exchange for any modification or change to the approved algos or systems used for algos,” the circular said.

Regarding the use of the Application Programming Interface (API), SEBI said that brokers should be the principal. At the same time, any algo provider or fintech/vendor shall act as its agent while using the API provided by the broker.

The draft circular, titled “Participation of Retail Investors in Algorithmic Trading,” follows the discussion paper titled “Algorithmic Trading by Retail Investors,” which was released on December 9, 2021. The circular focused on the use of API access and the automation of trades.

The move comes amid the evolving nature of algo trading, particularly with the increasing demand for algo trading by retail investors. SEBI introduced algo trading through the Direct Market Access (DMA) Facility, which provided significant advantages to institutional investors, such as faster order execution, reduced transaction costs, greater transparency, better audit trails and improved liquidity.

The draft circular seeks public comments by January 3, 2025.

Categorization of Algos:

Algos are proposed to be categorized into two categories:

1. Execution or White box algos are where logic is disclosed and replicable

2. Black box algos are where logic is not known to the user and is not replicable

Role and Responsibilities of Exchanges:

According to SEBI, exchanges shall continue to be responsible for supervising algorithmic trading while ensuring post-trade monitoring of algorithmic orders and trades including putting in place a Standard Operating Procedure (SOP) for testing of Algos.

In addition, exchanges should define the roles and responsibilities of brokers and empaneled vendors, as well as the criteria and process for vendor empanelment.