SEBI issues Guidelines on Retail Participation in Algorithmic Trading
On February 04, 2025, the Securities and Exchange Board of India (“SEBI”) issued a circular on ‘Safer participation of retail investors in Algorithmic trading’ outlining the framework for algorithmic trading by persons using Application Programming Interfaces (“APIs”) provided by brokers. The key provisions of the circular are described below.
(A) Use of APIs for Algo Trading
Introduction of algo providers
SEBI has introduced “algo providers”, i.e., entities who provide the facility of algo trading through APIs extended to them by the stockbroker. While using the API provided by a broker, such algo providers would be considered to be acting as an agent of the broker. All algo orders originating/flowing through API extended by brokers to algo providers must be tagged with a unique identifier provided by the exchange. Notably, the tagging of algo orders at the broker level using exchange-specified identifiers is also carried out for algorithms offered by brokers to their clients. Such tagging enables brokers and exchanges to establish an audit trail and identify and monitor orders emanating from algorithms, which are subject to higher risk controls, such as price, quantity, order value and position limit checks.
Algos developed by retail investors
Algos developed by retail investors must also be registered with the exchange, through their broker, only if they cross the specified order per second threshold evolved by the Broker’s Industry Standards Forum, under the aegis of the stock exchanges and in consultation with SEBI (“OPS Threshold”). Further, the circular also allows for the same registered algo to be used by such retail investors for their family, i.e., self, spouse, dependent children and dependent parents, but not any other investors.
Responsibilities of stockbrokers
Brokers must deal only with empaneled algo providers and handle all related complaints. Further, brokers must develop systems and procedures to detect and categorize all orders above the OPS threshold as algo orders. Through the circular, SEBI has limited API access, which can only be provided by brokers through a unique vendor client specific API key and static IP whitelisted by the broker. Brokers are required to authenticate API access only through two-factor authentication. Further, all authentication mechanisms would be discontinued save for Open Authentication, i.e., a secure authorization framework that allows third-party applications to access user data without requiring users to share their login credentials or other sensitive information.
(B) Empanelment of Algo Providers
SEBI has clarified that algo providers would not be regulated by SEBI directly but would be required to be empaneled with exchanges. The process and criteria for empanelment is yet to be specified by exchanges. The requirement to empanel with the exchange bears similarity with empaneled vendors that develop and supply algorithms to brokers, which are hosted on the broker’s servers and offered to their clients. A broker would also be obligated to undertake due diligence before onboarding an algo provider and extending API access. Sharing of subscription charges and brokerage collected from the client between brokers and algo providers is permissible. However, prominent and complete disclosures of all the charges must be made to the client. The broker is also required to ensure that such arrangements do not result in any conflict of interest.
(C) Roles and responsibilities of stock exchanges
The circular reiterates that the exchanges will continue to be responsible for the supervision of algorithmic trading, including ensuring that brokers can distinguish between algo and non-algo orders. They must put in place a comprehensive Standard Operating Procedure (“SOP”) for testing of algos, which would include the turnaround time (“TAT”) for registration of algos. The TAT for registration of certain types of algos (for instance, execution algos) may be on a fast-track basis whereas other algos may be registered on a normal basis. Exchanges are required to surveil algo orders at all times, including through simulation testing of all algos. They must have the ability to automatically halt all orders emanating from a particular algo ID based on predefined conditions.
Detailed operational modalities in relation to inter-alia the roles and responsibilities of brokers, responsibilities and empanelment criteria for algo providers, registration process for algos and the circumstances in which a re-approval would be required, measures to enhance the confidentiality of retail algo strategies and data flow between the algo provider, broker and the exchange will be issued by the exchanges, in consultation with SEBI, in due course.
(D) Categorization of algos
Under the circular, algos are categorized into two categories: (a)“execution” or “white box” algos, which are essentially automated trading strategies that execute orders based on fully transparent algorithms, where the logic, decision making processes and underlying rules are accessible and understandable to users; and (b)“black box” algos, which are the algos where the internal workings and rationale / logic of the algo is not known to the user and is not replicable.
Algo providers providing black box algos must register as research analysts with SEBI and maintain a detailed research report for each such algo and confirm to the exchanges that such report has been maintained. In case of any change in the logic governing the algo, such algo must be registered afresh, a detailed research report must be maintained for the new algo, and a confirmation must be provided to the stock exchanges that such report has been maintained.
Our view:
With this directive, SEBI has formally recognized automating the placement of orders through broker APIs as algorithmic trading and carved out the responsibilities of the stakeholders involved. Before this move, while the practice of trading through broker APIs had become commonplace in the market, it was difficult to classify orders routed through such APIs as ‘algo orders’ in the absence of an express legal framework. Without such classification, orders placed automatically through APIs could not be monitored as algo orders and the exchanges had no visibility on the originating algorithm, leading to concerns around the systemic risk posed by potential malfunction or irregular behavior of such algorithm.
The existing framework recognized algo trading only in the context of proprietary algo trading carried out by brokers, or algo trading facilities offered by brokers to their clients, both of which operated within a clear set of guidelines, enhanced risk controls and testing requirements. By bringing API-based trading within the existing exchange-administered systems for algo trading, SEBI has clarified its expectations from all the participants in the ecosystem, which will help mitigate systemic risks around API-based trading and encourage retail participation in algo trading.However, certain aspects of the guidelines warrant further clarification. For instance, it is not very clear whether the OPS Threshold would apply only to algos developed by retail investors for the purpose of seeking registration with the exchange, or also for determining whether the API-based trading done through algo providers constitutes ‘algo trading’ in the context of the circular. Considering that several processes, criteria and standards are yet to be specified by the exchanges and the industry body, we can expect greater clarity on the framework once they are released.
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