Here are further details regarding SEBI’s draft circular on algorithmic trading for retail investors:
Key Provisions:
• Broker Responsibility:
- Brokers are required to obtain permission from the stock exchange for each algorithm they intend to use for trading. This includes both algorithms they develop in-house and those sourced from third-party vendors.
• Unique Identifier for Orders:
- Every algo order must be tagged with a unique identifier issued by the stock exchange, enhancing traceability and audit capabilities. This measure helps in tracking the performance and compliance of each algorithm.
• API and Algo Orders:
- Orders placed through APIs at a certain frequency (above a specified order per second threshold) will be automatically classified as algo orders. This ensures that all high-frequency trades are monitored under the algo trading rules.
• Distinction Between Algo and Non-Algo Trades:
- Brokers must have systems in place to differentiate between algo and non-algo trades, ensuring proper categorization and oversight.
• Security Measures:
- Two-factor authentication is mandatory for accessing APIs used for algo trading, increasing security against unauthorized access.
- Brokers are encouraged to use OAuth-based authentication for APIs, phasing out other less secure methods.
• Empanelment of Algo Providers:
- Algo providers must be empaneled with exchanges, which will set criteria for eligibility. This helps in regulating who can provide algo services, ensuring they meet certain standards of reliability and integrity.
• Retail Algo Development:
- Retail investors who develop their own algorithms must register these with exchanges via their brokers. However, these self-developed algos can only be used by the investor and their immediate family, preventing widespread commercial use without oversight.
• Performance Validation:
- For black box algos, creators must register as research analysts and maintain detailed research reports. Any modifications to these algorithms require re-registration and updated reports, ensuring ongoing accountability.
• Market Integrity Measures:
- Exchanges must implement a kill switch for algos, allowing for immediate cessation of trades from a malfunctioning algorithm to prevent market disruption or manipulation.
- There’s an emphasis on post-trade monitoring to catch any irregularities or manipulations after trades have been executed.
• Public Participation:
- The draft circular invites public comments until January 3, 2025, highlighting SEBI’s commitment to a transparent regulatory process.
• Future Implementation:
- SEBI aims to implement these changes in 2025, following the review of feedback and further consultations with market participants to refine the framework.
These provisions are designed to ensure that while retail investors gain access to sophisticated trading tools, there are robust checks in place to safeguard market integrity, investor interests, and to prevent potential misuse of algorithmic trading technologies.