Algorithmic trading has revolutionized financial markets, offering unparalleled execution speed and efficiency. However, with its rapid growth, concerns around transparency, accountability, and security have emerged. To address these issues, the Securities and Exchange Board of India (SEBI) has introduced a comprehensive regulatory framework aimed at safeguarding retail investors while fostering a fair-trading environment.
In this blog, we delve into SEBI’s latest guidelines, their implications, and why they are a significant step forward for investors.
What is Algo Trading?
Algo trading, which is short for algorithmic trading, involves the use of computer programs to execute trades on a predefined set of rules. This includes price, volume and timing among others. It allows for high speed, efficient and emotionless trading, often utilized in strategies such as arbitrage, market-making, trend following and mean reversion. A subset of algo trading is high-frequency trading (HFT), where trades take place within milliseconds. Algo trading is utilized by hedge funds, investment banks and institutional investors, enhancing market liquidity and efficiency, while also reducing manual interference.
Why SEBI Introduced These Regulations?
The new regulatory framework of SEBI will attempt to level the field in algorithmic trading, an area hitherto the stronghold of institutional players. The new framework will address key concerns like market manipulation, lack of transparency and unauthorised access to trading systems. The primary objectives are:
- Clear Accountability: Defining the Roles and Responsibilities of Brokers Algo Providers and Exchanges.
- Enhanced Transparency: Ensuring that algo orders are tracked and monitored appropriately to prevent misuse.
- Investor Protection: Protecting retail investors from potential risks linked to algo trading.
Retail abetment on algo trading is gaining paramount significance. Hence, these regulations ensure a robust efficient and a fair-trading environment.
Key Provisions of SEBI’s Circular
1. Regulation of API-Based Algo Trading
The backbone of algo trading is the API, which allows automated strategies to talk to brokerage systems. The new Sebi rules have more teeth on this count.
- Responsible broker: The brokers must occupy the position of the principals while the algo providers must act as the agents.
- Unique Identification: Every Algo Order Must Bear A Unique Identifier for Accurate Tracking and Reporting.
- Retail Investor Participation: An algorithm generated by a retail investor has to be registered with the exchange if the order rate of the investor exceeds a threshold specified by the broker through which they operate.
- Secure API Access: Brokers must ensure robust security measures, for example, using proprietary API keys with static IPs to eliminate the possibility of unauthorized access.
2. Brokers’ Enhanced Responsibilities
The role that brokers now play is significant in the context of ensuring compliance and security.
- Exchange Authorized: Each algorithm requires endorsement by the exchanges before it can be traded.
- Threshold Monitoring: Orders from Algos and above the defined threshold level must be classified and monitored closely.
- Recording: Brokers must keep an exhaustive record of algo trades and submit routine reports to regulators.
- Real-Time Surveillance: Real-time monitoring systems are required to be set up by brokers for detecting and preventing market manipulation.
3. Registration of Algo Providers
Algo providers must meet stringent regulatory requirements: –
- Equity Exchanges to Define Norms for Algo Registration.
- Algo providers must be registered through brokers on an exchange.
The compliance assurance of ensuring all regulatory standards is adhered to in all aspects
of the algo are the responsibility of the brokers.
4. Categorization of Algorithms
SEBI has bifurcated algorithms into two main buckets.
- Execution Algos (White Box): Algorithms executing based on rules in an efficient manner.
- Non-Disclosed Algos (Black Box): These are proprietary algorithms with complex undisclosed logic that would require regulatory scrutiny.
This categorization of things is made to ensure a balance of innovation and protection of investors.
Implementation Timeline
SEBI has provided a phased implementation plan to allow market participants sufficient time to adapt:
- Framework Finalization: By April 1, 2025.
- Regulation Enforcement: From August 1, 2025.
This timeline ensures a smooth transition for brokers, exchanges, and algo providers.
Impact on Retail Investors
Expected are the new rules advantages to retail investors benefiting: –
The platform should have strong security in place to protect retail investors from unauthorized and fraudulent algo trading.
Role designation for brokers and algo providers can bring in more accountability. The clear definition of roles can reduce the confusion and risks.
Level playing field is when retail investors can explore algo trading opportunities without fear of unfair practices or market manipulation.
Conclusion
Environment The new algo trading regulations of SEBI have brought the Indian capital markets a step closer to being a transparent, fair, and secure market environment. By addressing key concerns around accountability and transparency, these rules empower retail investors to participate in algo trading with confidence.
In 2025, the framework should be used by traders and should refer to training materials. They will have to collaborate with a broker to ensure compliance with the prescribed regulatory information to be protected, and the trader will have all necessary information to be more inclusive and innovative in order to maintain compliance and take advantage of opportunities
REFERENCE
https://zerodha.com/z-connect/business-updates/explaining-the-latest-sebi-algo-trading-regulations
https://www.sebi.gov.in/legal/circulars/feb-2025/safer-participation-of-retail-investors-in-algorithmic-trading_91614.html
https://www.indialaw.in/blog/civil/sebi-retail-investors-algorithmic-trading/
Author: CS Sheetal Patodiya
Co- Authore: Adyata Mohanty
