Context:
The Sebi has released a new framework of regulation designed to make retail algorithmic trading safer and transparent. This newly developed framework for regulating algorithmic trading will promote the interest of the retail investors and also will not harm market integrity.
What is Algorithmic Trading?
Some Major Changes
- Tightening Up Risk Management Measures
- Stockbrokers, exchanges, and algorithmic trading providers will need to agree on more stringent risk management.
- The brokers will be responsible for making available the provision of algorithmic trading using APIs.
- Role of Brokers and Algo Providers
- The role of the brokers is that they would be the principal party in a transaction. Therefore, the responsibility of all the algo trades to be properly reported and followed shall lie on the brokers.
- Algorithm providers (including fintechs and vendors) will be agents when using the broker’s API to trade.
- Registration and Monitoring of Trades
- All algorithmic orders should be tagged with unique identifiers assigned by the stock exchanges for monitoring and auditing.
- Brokers will be responsible for compliance and investor protection in connection with algorithmic trading activities.
- Additional Security Measures
- Stronger security protocols, such as OAuth-based authentication and two-factor authentication, must be adopted to safeguard the trading systems against unauthorized access.
New Algorithm Classification:
- Sebi introduces concepts of “white box” and “black box” algorithms
- White box algos
- Those are transparent; the logic behind them is visible and replicable. It’s safer for the retail investor.
- Black box algos
- These deploy hidden logic, hence, must be subjected to more rigorous tests, including registering as a research analyst and keeping the most detailed research reports.
Potential Impact
- Benefits
- The framework is geared toward increasing retail algo trading a fast expanding area that individual investors widely use regarding transparency, safety, and accountability.
- It saves the investors for which the obligation rests on brokers because of duties with respect to the compliance and supervisory actions.
- Challenges
- Increased cost in operations is an offshoot if compliance burdens weigh heavily upon brokers.
- Because there would be few innovations occurring due to complexity that black boxes come with requiring tough registration procedures followed by harder over sights.
