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SEBI Circular advises stockbrokers to curb mis-selling in relation to algorithmic trading.

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SEBI by a Circular has advised brokers who provide Algorithmic Trading (AT) services to not directly / indirectly share on their website (i) past or expected return of the algorithm or (ii) associate with any platform providing past or expected return of the algorithm. The circular can be seen at: https://lnkd.in/dyyVwHBM

SEBI also directed brokers to remove from their website and / or disassociate themselves from platforms providing such services within 7 days from the date of the circular.

What is Algorithmic Trading?

AT are trading orders generated using “automated execution logic”. It includes “a defined set of instructions in the form of algos to generate trading signals and placing orders”. The algo trading system automatically monitors the live stock prices and initiates an order when the given criteria are met.

In the context of trading violations, one may see how the Bombay High Court and Securities Appellate Tribunal have seen AT in the matter of Crosseas Capital (https://lnkd.in/djVFaqQD).

SEBI Consultation paper

In December of 2021, SEBI had come out with a consultation paper in relation to AT by retail investors. The paper focused on one major aspect which was the use of Application Programming Interface (APIs) by brokers to enable AT for their clients.

APIs are essentially third party applications used by stockbrokers to connect their clients which enable their clients to build their own or test investment strategy.

The issue which SEBI identifies herein is two-fold (i) These APIs are not registered with SEBI / exchanges and (ii) stockbrokers are not able to identify whether a particular trade emanating from an API is an algo trade or not. SEBI notes in its paper that “unregulated/unapproved algos pose a risk to the market and can be mis-used for systematic market manipulation as well as to lure the retail investors by guaranteeing them higher returns”.

In view of the above, SEBI recommended that (i) all trades emanating from APIs should be treated as Algo trades, (ii) brokers need to take approval from the stock exchange for all Algo strategies, and (iii) A higher liability may be imputed on brokers.

SEBI further also discussed whether such APIs are in the nature of investment advisory services as such services provides strategies to the investors based on research and analysis done by them.

With the advent of new technologies and use of AI, AT is increasingly being deployed by traders. Regulating unregulated platforms vs. prohibiting the upcoming platforms with the risk of nipping in bud the innovation remains a challenge for the regulator.

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