MC Exclusive| Algo sellers working out illegal arrangements with RAs to get around new SEBI norms

Algo sellers are worried that RA Regulations will be hard to comply with, and therefore prefer trying out such agreements before taking the plunge.

With the new algorithmic trading norms out, the market is already working out dicey arrangements to circumvent them.

It involves a Research Analyst (RA) 'renting out' his/her registration to an unregistered algo seller, for a fee. According to insiders, preliminary discussions show 'rental' charges involve a regular payment of over Rs 20,000 per month. There could also be profit-sharing arrangements, but as an insider said tongue-in-cheek, "that may not take off because the RA needs to believe that algo sellers can make a profit".

On February 4, the Securities and Exchange Board of India (SEBI) had issued a circular titled "Safer participation of retail investors in Algorithmic trading".

It issued a regulatory framework under which investors can access algos for trading, but with safeguards in place to protect market integrity and to protect investors from unregistered algo sellers.

Once the norms become effective, from August 1, 2025, algo sellers will need to be empanelled with exchanges.

Also read: SEBI impounds Rs 53.67 cr from Asmita Patel Global School of Trading; could go after Rs 104.6 cr earned as fee

Once empanelled, they can become agents of a broker and sell either white-box algos or black-box algos. White-box algos are ones of which the logic is  disclosed and replicable, and black box algos' logic is closed to users and is not replicable.

To sell black-box algos, the algo provider will need an RA licence and will have to follow compliance procedures, such as maintaining a detailed research report for each algo and registering an existing algo as a new algo if the logic governing it has changed.

Also, RAs are restricted from taking trades that they recommend to clients. According to RA Regulations, an RA or his associate cannot deal or trade any securities that the RA recommends or follows within 30 days before and 5 days after the publication of a research report on the subject company.

This, according to some algo providers, will dissuade clients who want to know that the algo seller has 'skin in the game'.

To avoid all of this, algo providers and RAs are working on a 'business arrangement'.

What is the arrangement?

It involves the RA hiring the algo seller as an employee and even paying the latter a salary. Then the algo seller will freely sell his/her product and give a cut to the RA or make a regular payment, and return the salary through back channels.

Back channels in such arrangements involve making the payment through cash transactions or paying a related entity.

Under this arrangement, the algo providers will need to take a certification from the National Institute of Securities Markets (NISM), according to the RA Regulations. But once the certification is in place, the algo seller can sell his/her product under the RA's registration, without the RA being involved in any way except to collect the regular kickbacks.

What about the RA who isn't allowed to take the same trades as clients? That isn't a worry, said a market insider, since the RA will merely hold the registration. The real business will be done by the algo sellers and they will provide the RA with the necessary research reports, which will be needed in case there is a SEBI inspection.

Genuine RAs concerned

RAs who are already struggling to comply with the new SEBI norms, and are in discussions with the regulator to ease some of them, are worried that such practices by a few entities will make it harder for the industry as a whole.