MC Exclusive| API norms: How Sebi plans to crack down on unregulated algo sellers, illegal PMS

The US inflation print for January came in higher than market expectations.

The market regulator may finally crack down on unregulated algo sellers and illegal portfolio management services (PMS) using the biggest weapon in its arsenal: traceability of trades.

The regulator has been concerned about people selling algos over various social-media platforms and marketplaces, which promise unrealistic returns to investors. In October 2023, at an event for registered investment advisors, Securities and Exchange Board of India (Sebi) chairperson Madhabi Puri Buch said: "We all know algo players claim 300 percent returns per annum by using their algo. You really think Sebi is so dumb?"

Also read: MC Exclusive: Sebi trying to regulate algo sellers with API norms, not hinder retail traders

According to people aware of the developments, with API norms being worked out, Sebi wants stockbrokers to locate the source of API (application programming interface)-based algo trades and trades from several accounts with unregistered PMS that originate from a single IP address.

Under the framework, brokerages will be asked to track trades to the platform – algo marketplaces such as Tradetron or Algobulls – or the IP address from which a trade is fired.

API is a set of protocols that enable different software components to communicate and transfer data. Algo trading refers to orders generated using automated execution logic software.

Ending grey-market algos

People usually buy unregulated algos from marketplaces such as Tradetron and Algobulls and then get the help of these marketplaces to integrate the algos with broking accounts. After this, the trader only needs to log into these marketplace-and-integrator platforms to activate the algos, which will then take the trades through the broking platform.

If the orders can be traced to these integrator platforms, which are brought under Sebi's regulatory framework, then the sale of these algos can be controlled. The platforms can be asked not to enable algos that have not been cleared by the exchanges and not to enable algos promising unrealistic returns.

A market source told Moneycontrol that the heads of these enabler/integrator platforms have been participating in discussions on API norms.

Algo sellers on these platforms can be asked to comply with the requirement of getting an algo’s performance validated by an agency that Sebi is setting up. Sebi proposed in a consultation paper in September the setting up of the Performance Validation Agency that would help regulated entities showcase their metrics to expand their services.

People also buy unregulated algos from standalone vendors and integrate them into their broking accounts using their coding skills or by hiring coders. Brokers supposedly allow this without asking any questions. Under the new norms being considered, the brokers may be required to ask traders to get their algos approved by the exchanges.

This is worrying for traders using algos because the approval process is cumbersome. According to an insider, the approval process was set up for high-frequency trading. Under the new norms, the approval will be simplified to accommodate algos used by retail traders. This is also so as not to inconvenience those who are designing strategies for their personal use and not for selling.

Tejas Khoday, co-founder of brokerage FYERS, applauded Sebi’s move to regulate algo sellers.

“Algo marketplaces had made it easy for people to go shop for algos, enticed by big returns, without really understanding trading. The regulator seems to be cracking down on this ecosystem. People who design their own strategies and want to run them for personal use won’t be affected as far as I know,” he told Moneycontrol.

Also read: SEBI considering two models to regulate API based algo trading: sources

Crackdown on illegal PMS

Sebi also plans to regulate unregistered PMS by getting brokers to flag trades from several accounts that originate from a single IP address.

There are many unregistered portfolio management services in the market that operate through various models. In one business model, clients are asked to share their trading account log-in details and then trades are taken through the client's accounts. This is done for several clients from one location.

An insider told Moneycontrol that if trades can be traced to the IP address, then this business can be dealt a severe blow. Under the new API norms, the brokerage may be asked to flag an IP address from which trades for several user accounts are taken. Then the brokerage may blacklist this IP address and the user account and report them to the exchange.

This could hit people who manage several brokerages’ prop accounts. If trades for several prop accounts come from the same IP address, the brokerage may have to follow the same procedure.