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All orders emanating from an API should be treated as an algo order and be subject to control by a stockbroker, capital market regulator SEBI proposes

Using API and algo-trade in the same statement is not good for Indian capital markets which need to be forward-looking in a tech-first world, says industry players

SEBI has published a consultation paper in this regard and is seeking comments and feedback from stakeholders latest by January 15, 2021

Having allowed algo(rithmic) trading in 2008 by non-retail traders, India’s capital market regulator Securities and Exchange Board of India has now proposed a regulatory framework for algo trading done by retail investors.

An algo trading system automatically initiates an order based on set criteria of livestock prices.

“For example, assume you have a simple strategy to buy a stock if the stock price goes above its 20-day moving average and sell if it goes below the moving average. If you don’t use a program, you will have to manually look at the charts to figure out the P&L of this strategy in the past and then track the charts for the buy and sell signals. Doing this manually is tough and almost impossible to scale since tracking beyond a couple of charts manually is impossible,” explains Zerodha cofounder and CEO Nithin Kamath in his blog.

SEBI has published a consultation paper and is seeking comments and feedback from stakeholders by January 15, 2021. However, the very definition of algo-trading has irked several retail brokerage firms and their founders, including Zerodha’s Kamath.

Currently, dozens of fintech startups such as Zerodha, Paytm Money, Upstox, Kuvera, Fyers and many others offer retail trading services and essential technologies in this regard. While Zerodha claims to be the largest platform with over seven million users, Upstox has over five million users and Kuvera has over a million users.

Operating on low or zero brokerage charges, many of these platforms have gained huge traction in the form of small retail first time investors and jitters if an increase in compliance cost may result in losing such users.

What’re SEBI’s Concerns

Currently, exchanges are providing approval for the algo submitted by brokers. However, for the algos deployed by retail investors using APIs, neither exchanges nor brokers can identify if the particular trade emanating from API link is an algo or a non-algo trade, says SEBI.

SEBI has further expressed its concerns over such unregulated/unapproved algos that pose a risk to the market and could be misused for systematic market manipulation and to lure the retail investors by guaranteeing them higher returns.

As a result, the regulator has proposed that all orders emanating from an API should be treated as an algo order and should be subject to control by a stockbroker and the APIs to carry out.  Algo trading should be tagged with the unique algo ID provided by the Stock Exchange granting approval for the algo, the regulator said.

This will increase the compliance cost for brokerage platforms and as a result, they might lose a significant number of retail investors, believe numerous stakeholders. This has also caused confusion among founders.

Nitish Narang, founder of Delhi-based intraday and time-based backtesting platform Stockmock tweeted:

“Can someone help me understand this pls. does every algo has to be approved by sebi first, through broker? example: 920 straddle with 20% sl and 25% sl are both different strategies and both need separate approval? is this what they are planning? or I misunderstood.”

All Orders From An API Can’t Be Termed As Algo Trading’

“Zerodha (Kite Connect) and many other online brokers allow customers programmatic access via API to their own accounts…Since APIs are meant for computer programmers primarily, unsurprisingly, less than 0.05% of our customers use APIs, and an even smaller fraction use them to place orders,” Nithin Kamath said.

In its paper, SEBI has put the onus of algo trading on brokerage platforms.

Kamath, in his blog, points out that It is impossible to determine if an order from a customer was placed by them, someone on their behalf, or by a program running on their computer. Currently, regulations don’t recognise algos that run on customers’ computers. Even if there were regulations, it is impossible to regulate or enforce what customers run on their computers or whether a human or a program is clicking buy or sell buttons on a trading platform on a customer’s computer.

Demarcate Automated Strategies From Consent-Based Workflows

In a tech-first world where everything is run over APIs, including the broker’s trading app is powered by an authenticated REST API, paper (SEBI’s) should have demarcated between automated algo strategies powered by APIs versus login/consent based workflows build to execute trades by customers themselves, said Ujjwal Jain, founder and CEO of WealthDesk.

Using API and algo-trade in the same statement is not good for Indian capital markets which needs to be forward-looking in a tech-first world.

Jain further elaborated that algo strategies created by self-proclaimed unlicensed entities and folks and distributed through any platform with guaranteed returns should be dealt with regulations and be brought under RIA/RA regulations or whatever deemed fit. The regulation should work around this. It will also ensure automated trades are also curbed when being distributed over the internet.

A Proposal Is Not A Ban

Clarifying over the buzz that SEBI might ban algo trading for retail investors, Pravin Jadhav, founder and CEO of Raise Finance said, “Algo trading is the future, and so is API based transactions. If you think or your stock broker is saying that SEBI will ban it – this is wrong or misleading. Regulators in India are more aligned towards innovations & technology than possibly anywhere else in the world.”

SEBI wants Stock Exchanges to know which orders are coming from where and how; as a regulator, it is a very fair ask. If you are worried because you are doing something wrong, then you shouldn’t be doing that in the first place, Jadhav added.