The market regulator has finally laid down its arms in the battle against algorithmic trading in India. For the changes announced to algo trading rules in SEBI’s recent Board Meeting are mainly aimed at addressing the complaints of the users of stock exchanges’ colocation facilities, from where most algo programs are run. These facilities allow trading members and other institutional players to place their servers right next to the exchange server so that their latency-sensitive strategies can work effectively. There were allegations that some users of NSE’s colocation facility gained unfair access that allowed their program to be ahead of others in the order execution queue. SEBI’s ruling that exchanges should publish minimum, maximum and mean latencies within the colocation facility appears aimed at bringing parity among these users and to increase transparency. The proposal to introduce shared colocation facilities could allow smaller members to rent rack space on these facilities.
The Board has also proposed that Tick-by-Tick Data feed that includes all the orders entered in to the exchange trading system along with order alterations, cancellations and executions be made available to all trading members, free of charge by exchanges. This data can however be used only by machines since the human mind is not capable of scanning through this voluminous data to spot trading opportunities. This data will therefore be useful only to programs run from colocation facilities. A few other proposals of SEBI are intended to improve the regulatory framework for algo trading in India. These include, stipulating that each algorithm approved by the exchange should have a unique identifier and that all the orders generated by the algorithm should carry the unique identifier. This could help identify the algorithms that flood the exchange server with orders, so that they can be checked. Levy of penalty on algo orders placed 0.75 per cent above or below the market price will make it more difficult for these programs to influence market price.
With algorithmic trades accounting for more than 40 per cent of the cash and derivative turnover and almost 80 per cent of the orders, curbing them can have a deleterious effect on market liquidity. SEBI is acknowledging this fact by stopping short with ensuring that these programs function smoothly without de-stabilising market operations. It is also good that the proposals put forth in the SEBI discussion paper released in 2016 to slow down algo trades have not been accepted. Since these trades depend on speed of execution, slowing down these trades would lead to users moving away from the Indian stock market. While it is true that retail investors, who are not allowed to use colocation facilities, are at a disadvantage compared to the programs nesting there, speed of order execution is not material to long-term investors. This is perhaps SEBI’s signal to small traders to leave the trading floor to larger players and to take the indirect route to equity investments.