SEBI seeks to curb unregulated third-party algorithms

The Securities and Exchange Board of India (SEBI) plans to act against the growing number of unregulated or unapproved algorithmic trading software – algos in popular jargon – that are widely used in the market, especially by investors in detail.

In a consultation paper released on Thursday, the capital markets regulator said that while the current regulatory framework only allows the deployment of approved algos in the markets, there are many out-of-the-box or third-party algos available that are used by individuals. investors and that such software could also present systemic risks.

“This type of unregulated / unapproved algorithms present a risk to the market and can be misused for systematic manipulation of the market as well as to attract retail investors by guaranteeing them higher returns,” the document said. SEBI consultation.

“The potential loss if the algo strategy fails is enormous for retail investors. As these third party algorithm vendors / vendors are unregulated, there is also no investor grievance mechanism in place, ”he added.

This is gaining in importance as the recent past has seen an increase in the use of these third-party algorithms by retail investors who are able to link such software to their trading account through the application programming interface. or the API.

This is also corroborated by the SEBI consultation document.

“Many brokers in India have started providing their clients with access to the application programming interface (API) which establishes an online connection between a data provider (i.e. a securities broker securities) and an end user (i.e. a customer). API access allows investors to use a third-party application that meets their functionality needs or investors who have technological capabilities to build their own front-end functionality, ”the SEBI document said.

Meanwhile, to hide the risks, the capital markets regulator has proposed that brokers be able to vet any order that comes from an API and take all required approvals from the exchange before authorizing the exchange. use of such algorithms in the markets. .

The regulator also proposed to make the stock broker responsible for all algorithms emanating from its APIs, including remedying any disputes between investors.

SEBI further proposed that the exchanges develop a system in which only approved algos can enter the market.

The regulator is also considering whether it should be mandatory for these third-party algorithm providers to register as an investment advisor or research analyst.

“It should be clear whether the services offered by third party algo vendors / providers are in the nature of investment advisory services, as the nature of their services includes providing strategies to investors based on research and advice. analyzes carried out by them ”stated the SEBI document.

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

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