The market watchdog, the Securities and Exchange Board of India (Sebi), has come out with a strict guideline to curb the practice of some brokers, who provide algorithmic trading (algo trading) facilities, to lure investors with the promise of high returns. The guideline bars them from referring to past or future returns.
The Sebi circular says, “Stock Brokers who provide services relating to algorithmic trading shall not directly or indirectly make any reference to the past or expected future performance of the algorithm.”
Some brokers have been luring investors, saying algo trading has the potential to give high returns. “It noticed that unregulated platforms are offering algorithmic trading services or strategies to investors for automated execution of trades. Such services and strategies are being marketed with ‘claims’ of high returns on investment,” says the circular.
The regulator believes that such claims are misleading and may amount to mis-selling of services and strategies. In June 2022, Sebi had cautioned investors against dealing with unregulated platforms for algo trading. It had also cautioned them against share any sensitive personal details with these platforms.
What Is Algo Trading?
Unlike manual trading where investors themselves need to punch the order for buy and sell, algo trading uses programming to carry out significant trades in the market. The computer uses the created code which may be based on the price, time or any other factor, through a mathematical formula.
Sebi first permitted algo trading in 2008. Back then, it was restricted to institutional investors such as mutual funds, hedge funds and insurance companies. As it gained popularity, eventually retail traders also started using it. Many fintech and broker companies provide Application Programming Interfaces (APIs) that let customers create their own strategies or select from pre-existing ones. Now it has been extended to be used by individual investors too.
Where Does The Problem Lie?
Post-Covid, trading volumes by retail investors have been shooting through the roof. Brokers are luring investors by providing them cutting-edge technology and services. Algo trading is one of the services that attracts investors as it claims that it can generate higher returns because of its automation features unlike manual trading which take times to punch order manually.
To be in the race, some brokers have tied up with unregulated algo trading facility service providers. “It has also come to notice of Sebi that stock brokers provide algorithmic trading facility to investors through such platforms,” says the guideline.
The regulator has specifically mentioned that stock brokers who provide services relating to algorithmic trading shall not directly or indirectly associate with any platform providing any reference to past or expected future return or performance of the algorithm.
It has directed the brokers to remove, within seven days, any such claims of higher returns from their websites and disassociate themselves from the platforms providing such references.
Onus on Exchanges
Stock exchanges have been directed to take necessary steps and put in place necessary systems and procedures for the implementation of this Sebi ruling. They have also been directed to take confirmation from stock brokers whether they have submitted the compliance report to Sebi, within 60 days.