Zerodha raises concerns over Sebi’s proposed checks on algo trading

Mumbai: Zerodha, India’s biggest stock broker, raised concerns over some of the capital markets regulator’s proposals to tighten rules on algorithmic trading by retail investors. The firm’s founder Nithin Kamath wrote in a blog that the Securities and Exchange Board of India in the discussion paper published on Thursday has categorised every order placed by an Application Programming Interface (API) as an algo order, which will not stop mis-selling of algos to retail traders.

In stock trading, APIs help establish a connection between automated trading models or algorithms and a broker platform to execute transactions. Earlier, traders used one application to narrow down trading opportunities and executed trades on the broker’s platform separately. These days, savvier traders use APIs facilitated by brokers to connect such trading applications to brokers’ trading platforms that fire orders with minimum human intervention.

While Sebi‘s paper said orders emanating from an API should be treated as an algo order and be subject to control by stock brokers, it also proposed that brokers must take approval of all algos from the exchange.

Securing exchange approvals for any algo is an “extremely tedious and complex process” and all brokers will have to stop offering APIs if these proposals are implemented, wrote Kamath.

“While customers using APIs today is a very small percentage of the business (0.05% of our business), disallowing it will mean our capital markets taking two-step backwards in a technology-first world,” he said in the blog.

The regulator’s proposals to tighten rules on API-fueled algo trades come in the wake of an increase in unregulated third party algo trading service providers, which is feared to be resulting in growing cases of market manipulation. These algos do not have the approval of exchanges but they end up using the broker’s API to execute such trades.

“There’s no way brokers will be able to validate if an order has come from a client or a third party algo software, which the client has subscribed to,” Kamath told ET. “If Sebi wants to clean up this space, algo trading platforms will have to be regulated by getting them to comply with the RIA rules. That will stop practices such as promises of huge returns.” RIA, or Registered Investment Advisors, provide investment advice to clients as per Sebi norms.

Kamath said strict restrictions on algos driven through APIs can be bypassed through third party automation tools, which are much less sophisticated and cannot be regulated.

“Sebi could also regulate APIs that drive algo trades by bringing in checks and balances,” said Kamath. “Sebi could mandate rate limits, restrict market orders to ensure that any risk of algos going rogue is covered for.”