Framework to regulate retail Algo trading is overkill: Tejas Khoday, Co-Founder and CEO, FYERS
While regulation brings transparency and releases fair play, overdoing it can kill the fast-growing community in its infancy, elucidates Tejas Khoday, Co-Founder and CEO, FYERS
The recent consultation paper by SEBI to regulate Algo trading identifies its merits by stating that it automatically monitors live stock prices and initiates an order when the criteria are met. This frees the trader from having to monitor live prices and initiate manual order placement. So, there is no doubt that a rule-based approach to trade using API integration with brokers enables traders to manage risk more efficiently and avoid emotional decisions that occur in manual trading.
In the olden days, traders used to visit brokers' offices to trade and give in-person instructions to buy & sell stocks. Over the years, with the advancement of telephonic technology, traders could provide trading instructions over the phone. Years later, trading directly through laptops and smartphones became the norm. The next step is naturally to automate the trading process so that traders can avoid making emotional blunders and approach markets with a better risk management system along with dedicating their time & energy to their primary professions. Creating hurdles for DIY traders taking the right approach to markets can be regressive and demoralise the participants to the point of no return. Imagine if, in the old days, every trade instruction given to a broker had to be approved by the exchange as well as an auditor and validate the rationale; it would de-rail trading participation and repel everybody from investing in the stock markets. In that context, regulating trading strategies can have a similar negative ripple effect on the growth and evolution of trading. Also, there is no guarantee that licenced processes will perform better than unlicenced ones.
When a retail user connects using API provided by a brokerage, he operates with the same OMS & RMS used by web/desktop and mobile apps. The competent authorities have already certified these order management and risk management systems. This is unlike direct market access (DMA), where high-frequency trading (HFT) algorithms connect directly to the exchange. Therefore there is no requirement for re-certifying something that is already certified. Brokers providing APIs have implemented rate limits at their end. This ensures that an API user does not overload the broker's system with unnecessary calls. This model is similar to how exchanges moderate traffic flowing into their systems from brokerages. Pushing regulation onto end users rather than brokerages and businesses will be counterproductive as it will stifle innovation.
If SEBI is concerned about risk management failures due to algo misfiring/fat finger trades, ensuring third-party platforms that offer algo strategy creation & deployment should get the internet-based trading (IBT) approval by the exchanges. This may help the regulator ensure that third-party platforms meet the required risk management checks & balances. Additionally, it makes sense to regulate algo strategy advisors as it aligns with SEBI's broader RIA/RA guidelines. Currently, unlicenced advisories offer their trading tips through a platform that retail traders can subscribe to. These are essentially tech-enabled versions of offline stock tipsters, the usual rotten apples of the ecosystem.
While regulation brings transparency and releases fair play, overdoing it can kill the fast-growing community in its infancy. The regulator cannot possibly scale out to handle retail API licencing. For instance, there may be 10,000 API users today and 10,00,000 in the next five years. SEBI has not shown a plan to process all these applicants smoothly; mainly, if each developer has 10-20 different algorithms!
It's impractical to have every strategy approved by the exchanges, considering that strategies are often required to be changed and refined for optimal performance. Getting all the changes agreed upon every single time is tedious and will create massive bottlenecks at brokerages & exchanges, which cannot be effectively handled. It can cause users to go back to the automation tools used in the pre-API days to automate their rule-based trading techniques. APIs evolved to make it easier for such users to automate their trades, and if disrupted, users will fall back to that model, bypassing SEBI's proposed regulations.
From a larger context, there is no global precedent on how this approach helps make markets more efficient. If at all, it may drive more people away from the stock markets to unregulated, such as cryptos and CFDs, which continue to enjoy regulatory immunity.
Authored by Tejas Khoday, Co-Founder and CEO, FYERS