MC Exclusive: SEBI checkmates illegal algo providers with a tweak in final norms

Tech savvy investors who develop algos need to register these algo with the exchange only if they cross the specified order per second threshold.

The market regulator has made one small but critical change in the algorithmic-trading norms, closing a loophole that was available to illegal algo providers. This is a change from the consultation paper circulated earlier.

With this tweak, SEBI has plugged the loophole while still retaining ease-of-operations for retail traders.

After the consultation paper was released on December 13, 2024, Moneycontrol had highlighted the loophole - which was essentially a threshold over which orders would be recognised as algo orders.

In the norms released on February 4, the Securities and Exchange Board of India (SEBI) has addressed this by saying that all orders coming through the Application Programming Interface (API) extended by brokers to algo providers need to be tagged as an algo order with a unique identifier provided by the stock exchange.

This is very different from what the consultation paper had suggested, which was to tag only those orders that crossed the threshold. The consultation paper had said: "All orders, above the specified order per second threshold, orginating/flowing through Application Programming Interface (API) extended by brokers to their clients/service providers, shall be treated as algo orders and shall be tagged with a unique identifier provided by the Stock Exchange".

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Therefore, according to the consultation paper, only those orders that are fired at a certain speed needed to be tagged as an algo. But, as industry insiders had told Moneycontrol, this would have left many illegal algo providers go scot free.

This is because most of their algos take much fewer orders, sometimes two to three orders in an hour or even that many in a day. They rarely, if ever, fire multiple orders in a second.

Therefore, their unregistered algos would have gone undetected and without regulatory oversight.

As Moneycontrol had written, if these orders were to 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.

In the final draft, this concern has been addressed.

Ease for retail traders
According to industry insiders, the consultation paper had tried to offer ease of operations to retail traders by providing the threshold clause. That is, if there are retailers who want to automate their strategy, then they should be able to do so without having to go through all the regulatory hassle since their algos would fire smaller orders and are not really a threat to market integrity.

In the final draft, the regulator has managed to combine both these requirements - of keeping out illegal operators and giving retail traders ease of operations - by putting the threshold only for retail traders.

That is, tech savvy investors who develop algos need to register these algo with the exchange only if they cross the specified order per second threshold.