MC exclusive: Illegal algorithm providers could get around SEBI's proposed norms; the trick lies in a set threshold

If these orders go undetected as algo orders, then the algo providers will not have to abide by any of the suggested norms to safeguard investors

The capital-markets regulator, Securities and Exchange Board of India (SEBI), has proposed algorithmic-trading norms, which are not likely to stop the sale of unregistered, illegal services to retail investors, according to market insiders.

However, the proposed norms will help tech-savvy retail traders code their strategies and run their algorithms without having to worry about cumbersome compliance norms. With the new norms, these traders can be better served by their brokerages who can  have clarity on which trades need to be tagged and monitored as algorithmic exercises.

On December 13, the SEBI issued a consultation paper on regulations to help retail investors use algorithm-trading with adequate safeguards.

One of the suggestions is to treat orders originating above a specified order per second threshold originating/flowing through Application Programming Interface (API) extended by brokers to be be treated as algorithmic order.

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That is, if orders are fired at a particular frequency or at a speed above a specified threshold, then these orders will be treated as an algorithm order. Once it is tagged as an algorithm order the rest of the norms that would govern these orders would come in to play.

But, according to market insiders , orders fired using unregistered, illegal algorithms are rarely (if ever) at such speeds.

"Most of these retail algorithms fire a few orders per day or in a few hours. If the threshold is set at seconds, then these orders will go undetected," said an insider.

If these orders go undetected as algorithm orders, then those providers will not have to abide by any of the suggested norms to safeguard investors' interests. They could even sell strategies that are not understood by the end user, which essentially translates to selling unregistered investment advice.

Only entities that will be recognised as algorithm traders under the proposed norms and those sold by them whose logic is not understood by the end-user — or black-box algorithm — will need to register as research analysts (RA).

For better oversight, the consultation paper also suggests that algorithms need to be registered with exchanges and sellers need to be empanelled with exchanges. This would make these algorithm sellers answerable to regulators.

The good aspect of the proposed norm— of tagging only orders that come at a certain frequency as an algorithm trade —is that they will make it easier for tech-savvy investors. They can code their own strategies without having to worry about registering them with the exchanges.

The proposed norms maintain that investors who want to code their own algorithms need to get them registered with the exchanges but only if the orders are being fired at higher frequencies.