My respones to SEBI's Consultation Paper on Algorithmic Trading by Retail Investors

Below is an excerpt from my response to SEBI's "Consultation Paper on Algorithmic Trading by Retail Investors" published on 9 Dec 2021 in SEBI website.

My responses were sent to The General Manager, Market Intermediaries Regulation and Supervision Department, Securities and Exchange Board of India on 14 December 2021 via email.

Abridged Version of My response

As an ex-market participant, observer and researcher of the Indian Stock Market, I would like to express my dissent with some of the provisions proposed under the consultation paper titled "Algorithmic Trading by Retail Investors", published on 9 Dec 2021 in SEBI website.

WHAT I AGREE/ SUPPORT

1. I broadly share SEBI's concern about financial technology platforms / third-parties selling unregulated and unaudited off-the-shelf algo-trading strategies to retail participants. [Ref. 4.6, 4.7]
2. In many cases, the retail buyers of these so-called "proven and back-tested" algorithms do not understand the risks and limitations of those algorithms. [Ref. 4.9]
3. Therefore, I feel if a financial technology platform / individual / third-party algo providers want to commercialize their algorithms (as paid products) and solicit retail customers for the same, these algorithms must be vetted, audited and regulated by SEBI. [Ref. 4.10, Ref 7.1 through 7.3]

WHAT I DO *NOT* AGREE/ SUPPORT

It is incorrect to treat all API orders as Algo Trading orders

All Algo trades use API. But all API usage is not for algo trading. Scheduling of future orders, e.g. squaring-off open positions for weekly derivative contracts before market closure; is a good example of API usage but it is not for algo trading. There are many other such examples.
APIs are utilities used for algo trading but they are not synonymous to Algo trading.

Regulating APIs can not stop Algo trading

For a sufficiently motivated individual or firm, it is possible to still perform algorithmic trading even if brokers do not provide APIs. For example, it is possible to automate trading using Selenium (https://www.selenium.dev/) by automating the browser-based order execution. APIs exist only for convenience purposes. If SEBI starts regulating API usage, it is only going to hurt the small retailers as institutions as large players can always find ways to automate trade flows via other means.

Regulating the APIs are particularly unfavorable for Retailers

Modern trade setup requires dynamic monitoring of multiple parameters that are not possible to be tracked manually. While large trading houses can set up their own signal generators and employ dedicated employees for trade executions, retail traders can not afford to do so. However, automating the decision making process via APIs presents a great level ground for retailers. Instead of employing full time traders, retail participants can codify their decision making process and take quick, timely decisions.

Proprietary Reasons

While it is important that SEBI approves the algorithm for a third-party algo seller with commercial offerings, it is not practical to expect a retail trader will divulge his algorithm to the broker and SEBI due to proprietary reasons. Also, these algorithms undergo multiple changes on a daily basis. It is just impractical to vet all such changes on a day to day basis.

SUMMARY

1. Usage of broker-provided trading APIs should not be regulated by the market regulators as long as the APIs are created in accordance with the established trading protocols provided by the exchanges.
2. Third-party algo sellers / fintech platforms soliciting retail customers should be regulated/approved by SEBI.
3. Brokers should provide appropriate means to identify the trade orders that are placed via APIs.
4. Retail traders using trading APIs for trade automation, scheduling, efficiency, etc. should not come under SEBI's regulation and should not be required to disclose algorithms to their brokers or to regulators due to proprietary reasons.

NOTE

The above response constitutes my personal opinion only as an ex-market participant, observer and researcher. I do not have any affiliation with any group, organization or individual.

Response to the same whitepaper from Indian Association of Investment Professionals (IAIP), a member society of the CFA can be found here.