SEBI proposes framework for retail algo trading, seeks feedback by January 3 – CNBC TV18

The Securities and Exchange Board of India (SEBI) has issued a draft circular inviting public comments on its proposal to allow retail investors to participate in algorithmic (algo) trading. The regulatory changes aim to balance accessibility with safeguards to protect investors and market integrity.

Algorithmic trading uses computer programs to execute trades based on pre-set parameters like price, timing, and volume. Historically, algo trading has been limited to institutional investors, leaving retail traders with manual execution.

The proposed framework will allow retail investors to use approved algos through brokers, provided these systems are vetted and registered by stock exchanges. This democratisation could empower retail traders with tools previously exclusive to large players.

SEBI’s draft circular divides algos into two distinct categories:

White Box Algos: These are transparent algorithms where the logic, decision-making process, and underlying rules are fully disclosed to the user. Retail investors can understand and replicate these strategies, making them suitable for those seeking clarity and control.

Black Box Algos: These are proprietary systems where the logic is hidden from users. Often used by algo providers or institutions, these strategies rely on complex and undisclosed methods to generate trades. SEBI proposes stringent oversight for black box algos, requiring their creators to register as research analysts and maintain detailed research reports for each algo. Any modifications would necessitate re-registration and updated reports, ensuring accountability.

How retail access will work?

Retail investors can use algo trading via brokers who will act as the principal facilitators. To ensure security, brokers must authenticate access through robust methods like two-factor authentication and allow API (Application Programming Interface) access only to authorised users via unique API keys and whitelisted IP addresses.

Retail investors can also develop their own algos but must register them with exchanges. These self-developed algos can only be used by the investor and immediate family members.

Safeguards and oversight:

Stock exchanges will play a critical role in monitoring algo trades post-execution and ensuring compliance. They will also have a “kill switch” mechanism to halt malfunctioning algos to prevent market disruptions. Additionally, brokers must categorise orders accurately and ensure their systems distinguish between algo and non-algo trades.

The draft circular has been issued for public comments, which can be submitted until January 3, 2025. SEBI plans to implement these changes by 2025, following further consultations with stakeholders.

This initiative represents a leap forward in levelling the playing field for retail investors, allowing them to leverage advanced trading technologies while maintaining market integrity and investor protection.