SEBI’s stance on algorithmic trading not encouraging for trading firms
SEBI plans to introduce within two months new norms to regulate algorithmic trading. “Algorithm-based trade or high frequency trades are prone to high risks. We are examining a number of options to bring down these risks,” said SEBI Chairman U.K. Sinha.
These are trading systems that utilize advanced mathematical models for transaction decisions in financial markets. As of May, 15.1 per cent of the BSE turnover came through the algo route. These trades account for 19.8 per cent of the total on the National Stock Exchange, with an additional 24.3 per cent of volumes coming through co-located servers.
SEBI wants slower algorithms
According to two sources familiar with the matter, among the points under consideration are means to slow down the pace of trading through introduction of measures, including a minimum resting time for orders before execution, and randomizing the time priority of orders an exchange receives.
The regulator has been holding discussions on rules which could help create a more level playing field for non-algo players too, by placing some restrictions on how fast algorithms can trade in India.
“In the past, SEBI has consulted exchanges regarding concerns relating to fairness, transparency and equal access in view of increased usage of algo trading, co-location facility of the stock exchanges. There is thought within the regulatory body to have more checks in place,” said a source. To eliminate “fleeting orders” or those that appear and then disappear within a short period, a mechanism might be introduced to prevent cancellation or modification of an order until some time from its submission. “We are mulling to introduce a minimum resting period of 500–600 milliseconds,” said a source.
The introduction of a minimum resting time could help eliminate the potential for misuse inherent in ‘fleeting’ orders, said the technology in-charge at one of the top five brokerages.
Such orders, which are created and cancelled in short periods can create the impression of artificial liquidity and affect the behavior of the rest of the market. This can have an impact akin to price manipulation. Introducing a measure to eliminate such a possibility would be a positive said the person, on condition of anonymity.
The regulator is also looking at randomizing all orders received within a set period, say within two seconds. All the orders received within that period would arrive at the exchange in a random manner. Those in the algorithmic trading space say such moves would have a significant impact on operations.
Hitesh Hakani, director of Greeksoft Technologies, said randomization of orders could severely impact the utility of co-location servers. These servers are located within the exchange premises to execute trades faster by shaving off the fractions of a second that an order takes to travel to the exchange. “There would be no point in availing of co-location servers if there is to be randomization between co-location and non co-location orders…These moves would have a major impact on algorithmic trading players who are now significant liquidity providers in the markets. Every millisecond counts for them,” he said. Under the rule of randomization, orders received during a period (say one to two seconds) could be modified to have a new priority and sequencing. “Such a move would slow down algorithmic trading engines and make redundant existing systems such as co-location and high speed networks. They would serve little purpose if orders are to be slowed down and randomized,” said Naveen Kumar, founder and chief executive officer at QuantXpress Technologies.
Non-algo players see some of the moves as positives.
Says A Balakrishnan, chief technology officer at Geojit BNP Paribas Financial Services, “They are building latency. Often when an opportunity arises in the market, algo traders can take advantage of it faster than manual ones. This would look to bring them more on par with each other.” He estimated it takes around 300–400 milliseconds for a retail investor’s order to get processed. The introduction of a resting time of 500 milliseconds or more could be to bring the latency on a par with that of a non-algorithmic trader, according to him. This new moves if implemented could also create issues for algorithms, which trade in different markets. “If there is an institution, which invests across different markets, for example in India and Singapore, then they will have to recalibrate their systems if latency is going to be introduced into the market,” said Balakrishnan. The bulk of trades on the National Stock Exchange and the BSE happen via the algo route. As of May, 15.09 per cent of the BSE turnover came through the algo route. Algorithmic trading accounts for 19.83 per cent on the National Stock Exchange, with an additional 24.26 per cent of volumes coming in through co-located servers.
RBI has it’s own worries
The Reserve Bank of India had recently cautioned against these trades. “The increased complexities of algo coding and reduction in latency due to faster communication platforms need focused monitoring, as they may pose risks in the form of increased possibilities of error trades and market manipulation,” it had said in June.
opularity of superfast algorithm trading, saying its complex coding and ultra-low latency due to its advanced communication platforms increase risks of erroneous trades and manipulations in stock markets. “The increased complexities of algorithm coding and reduction in latency due to faster communication platforms need focused monitoring as they may pose risks in the form of increased possibilities of error trades and market manipulation,” said Financial Stability Report released by RBI late last week. FSR says the volumes in algo trading and high frequency trading (HFT) have increased substantially over the past few years in the cash segment from 17 per cent on NSE and 11 per cent on BSE in 2011, respectively, to around 40 per cent of total trades in both the exchanges by March 2015. Algorithm (algo) trading refers to the use of electronic platforms for entering trading orders with a computer programme (algorithm) determining the decisions on aspects such as the timing, price, or quantity of the order or in many cases initiating the order without human intervention. The market watchdog Sebi allowed introduction of algo trading in April 2008 with the introduction of direct market access, a facility that allows clients to directly access a broker’s trading infrastructure, linked to the exchange trading system, without any manual intervention by brokers. Reduced latency with respect to trading refers to network connections used by financial intermediaries to connect to exchanges and electronic communication networks to execute financial transactions at a very fast pace. “The fact that the share of algo orders in total orders and the share of cancelled algo orders in the total number of cancelled orders is around 90 per cent creates concerns relating to systemic risks,” the FSR report highlighted. There have been certain instances of abnormal market movements which have been attributed, by market experts, to algo trading. The increasing volume of algo trades and their attendant risks have forced regulators the world over to have a closer look at gaps in the existing regulations and explore ways of strengthening them, FSR said.