SEBI looks to rein in third-party unregulated algos

The Securities and Exchange Board of India (SEBI) plans to act against the increasing number of unregulated or unapproved algorithmic trading software – algos in popular parlance – that is being widely used in the market, especially by retail investors.

In a consultation paper issued on Thursday, the capital markets regulator said that while the current regulatory framework allows only approved algos to be deployed in the markets, there are many off-the-shelf or third-party algos available that are being used by individual investors and that such software could pose systemic risks as well.

“This kind of 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,” stated the SEBI consultation paper.

“The potential loss in case of failed algo strategy is huge for retail investor. Since these third-party algo providers/vendors are unregulated, there is also no investor grievance redressal mechanism in place,” it added.

This assumes significance as the recent past has seen a spurt in the usage of such third-party algos by retail investors who are able to link such software with their trading account through Application Programming Interface or API.

This is corroborated by the SEBI consultation paper as well.

“Many brokers in India have started providing Application Programming Interface (API) access to their clients which establishes an online connection between a data provider (i.e., Stock Broker) and an end-user (i.e., Client). API access enables the investors to use a third-party application that suits their feature needs or investors who have technological capabilities to build their own front-end features,” stated the SEBI paper.

Meanwhile, to plug the risks, the capital market regulator has proposed that brokers should be able to control any order emanating from an API and that they should take all the requisite approvals from the stock exchange before allowing any such algos to be used in the markets.

The regulator has also proposed making the stock broker responsible for all algos emanating from its APIs, including redressal of any investor disputes.

SEBI has further proposed that exchanges should develop a system wherein only approved algos are able to access the market.

The regulator is also mulling whether it should be made mandatory for such third-party algo providers to get registered as Investment Advisor or Research Analyst.

“There needs to be a clarity on whether the services offered by the third party algo providers/vendors are in the nature of investment advisory services as the nature of their services includes providing strategies to the investors based on research and analysis done by them,” stated the SEBI paper.

It added that brokers should get the necessary information from their clients, which will help the regulator to formulate a policy framework regarding third-party algo providers.

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