Traders say that the recently proposed norms to regulate algo trading will put the final nail in the coffin of a common but illegal practice of managing or helping manage their extended family's money.
This is a clincher because of two earlier directions from the regulator, one which required generating a daily token to connect the algo to the brokerage platform and the second that required that the token capture the machine ID and the IP address linked to the order. These, along with the latest suggestion, will make it nearly impossible for an algo provider to share the algo with others or take trades for others through the algo, said insiders.
Consultation paper
In a consultation paper released on December 13, the Securities and Exchange Board of India (SEBI) suggested a review of regulations that govern retail trading using algorithms.
Some market insiders welcomed this, saying that the new norms could shut the door on a lot of informal but illegal portfolio management services (PMS) that put investors' capital at risk. But several traders also warn that the new norm may lead to more illegal PMS operations and even more dangerous forms of that, where one person's money is wholly transferred to another's account only to have access to the registered algo.
One of the suggestions is on algos developed by tech-savvy retail investors. In the consultation paper, SEBI suggests that these traders get their algos registered with the exchange through their brokers and that they share these only with their immediate family.
As the paper says, 'family' for this purpose would mean self, spouse, dependent children and dependent parents.
But several traders' extended families are also known to use the algos developed in-house.
That is, an uncle, aunt or a cousin may use the algos a retail trader has developed. There are also arrangements where the not-immediate relative may grant the retail trader his/her account details to make the trades on their behalf, which would fall under the category of portfolio management and is a violation of the SEBI code. The regulatory code requires that anyone managing another person's money take a suitable registration such as that of a PMS.
There may or may not be a token payment for these arrangements in families, and in case of such payment, more often than not in the form of profit sharing.
This practice could come to a halt with the new norms.
An algo provider said that the earlier directions—of generating a token and for that token to capture the machine ID and the IP address—could be got around by registering the different trading accounts with different brokers. The PMS or the unregulated algo provider would go undetected because each broker will be alerted only to one trade linked to the same token and same machine and IP address details.
But the latest norms suggest that the broker act as the 'principal' and that the algo provider be the 'agent'. This means that the algo can only be used for trading accounts linked to that brokerage.
With the earlier directives in place, the brokerage will now be able to catch if trades from multiple accounts are being fired from the same machine ID and the same IP address as suspicious PMS activity.
Suggested improvement
An algo trader said that the new norms are welcome in not allowing extended families that include uncles, aunts or cousins to use the algos developed by a trader. The only suggestion he had for the norms was that the regulator should consider including the spouse's parents to the 'family' definition.
"Often the wife's (spouse's) parents are also dependent on the trader's family for an additional income. So it would be good that they are included in the definition," he said. "Otherwise it is a good call for the regulator to not include other relatives because it would be difficult for the regulator to check the legitimacy of all these relations."
Also read: SEBI proposes that black-box algo providers register as RAs, keep research reports
Possible fallouts
Another trader said that the new norm may result in a more dangerous familial arrangement, where the money is transferred to the trading accounts of relatives who have access to the algo. For example, a cousin could transfer the money to the spouse of the trader and thus lose any say in the management of that capital.
As the trader said, "If the money is held in the investor's account, then the investor can change the login details and cut off access to the algo. If the investor transfers money to the relative's account, only to trade through the algo that has been giving decent returns, the investor loses all control over the money."
There is also a business consideration for algo providers who are just starting out. An algo provider pointed out that many traders approach their families for their initial clients because they need to prove themselves before they find a larger client base. The new norms may come in the way of this.
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