SEBI Plans To Enable Retail Investors' Access To Algorithmic Trading

SEBI proposed a draft circular on December 13, 2024, that aims to significantly enhance retail investor involvement in the stock market. By making algorithmic (algo) trading accessible, which was previously only available to institutional investors, SEBI hopes to improve the Indian market's inclusiveness and efficiency. The public can comment on the proposed circular until January 3, 2025.

Algo trading uses computer programs to execute trades automatically based on pre-set criteria such as price and volume. As institutional investors have had access to this technology for many years, ordinary traders have encountered entrance restrictions. SEBI's initiative to attract retail investors into this arena is intended to enable access to these efficient instruments, which include built-in protections to promote transparency and market integrity.

Under the new framework outlined in SEBI's circular, retail investors will access algo trading through brokers. Brokers will be responsible for ensuring that the algorithms comply with SEBI guidelines and are approved by stock exchanges. Also, every algorithm order will be given a distinct identification number, guaranteeing openness and avoiding market manipulation by creating a transparent audit trail.

The circular outlines two categories of algorithms: White Box and Black Box. White-box algorithms are transparent, enabling users to comprehend and duplicate the transactions' underlying logic. Black-box algorithms which are proprietary, conceal the reasoning that goes into their judgments. In order to enforce more stringent rules for black-box algorithms, SEBI suggests that providers provide research reports and re-register algorithms whenever they undergo modifications.

Retail investors who wish to develop their own algorithms will also be able to do so, provided they register these self-developed algos through brokers. However, these can only be used for personal trading or within the investor’s immediate family, including spouses and dependent children.

It is important that SEBI has addressed access to algo trading APIs. For the purpose of algo trading, brokers will need to ensure safe API access by allowing whitelisted IP addresses and unique API keys for access. This prevents illicit trade and ensures only that authorized users have access. Additionally, two-factor authentication will be mandatory for secure access, further strengthening protection for investors.

The draft circular emphasizes that stock exchanges will monitor algo trading and can activate a “kill switch” if a malfunctioning algorithm disrupts the market, ensuring stability.

After taking into account public input, SEBI intends to put these reforms into effect by 2025. The objective is to incorporate cutting-edge trading technologies into the market while upholding investor protection and fairness.