Sebi takes its investor-protection crusade to algo trading turf

The Securities and Exchange Board of India (Sebi) has unveiled a revised regulatory framework aimed at promoting safer participation of retail investors in algorithmic trading.

The new guidelines, outlined in Sebi’s circular issued on Tuesday, will require stockbrokers, exchanges, and algorithmic trading providers to implement stricter risk management measures. Brokers will be responsible for providing algorithmic trading through application programming interface or API (software connecting applications), and any algo provider or fintech or vendor will act as the agent when using the broker’s API.

This comes after an increasing demand for algo trading by individual investors, a method long used by institutional traders to execute trades through automated logic-based systems. The move seeks to safeguard the interests of retail investors while maintaining the integrity of the market.

“The new framework aims to enhance transparency, security, and accountability in retail algorithmic trading,” said Sonam Srivastava, founder and fund manager at Wright Research. “By requiring brokers to act as the principal entities while algo providers operate as agents, Sebi ensures that brokers take responsibility for compliance and investor protection.”

Brokers will be responsible for ensuring that all algo trades are properly registered and monitored. They will also be tasked with ensuring that algo orders are tagged with unique identifiers provided by stock exchanges to track and audit transactions.

Additionally, brokers will need to implement enhanced security measures, including OAuth-based authentication and two-factor authentication, to prevent unauthorized access to trading systems.

“The increased compliance burden on brokers, who must monitor API activity and handle algo-related complaints, raises operational costs,”, Srivastava said. “While the framework prevents malpractices by enforcing stricter due diligence for algo providers, it may also limit innovation due to complex registration and oversight requirements.”

Algo categorization

Sebi’s framework introduces a unique categorization of algorithms into “white-box” and “black-box” categories.

White-box algos, where the logic is transparent and replicable, are expected to be safer for investors. In contrast, black-box algos, with an undisclosed logic, will require additional scrutiny, including registration as a research analyst and the maintenance of detailed research reports.

Under the new guidelines, brokers will be required to vet and empanel algorithmic trading providers, conducting necessary due diligence to ensure that only trustworthy vendors are integrated into their systems.

Brokers must also ensure that no open APIs are used, and only specific vendor-client APIs are authorized. They will bear the responsibility of handling investor grievances related to algo trading, adding an additional layer of compliance that could increase operational costs.

The empanelment process for algo providers will be overseen by exchanges, with specific criteria for eligibility yet to be finalized.

Srivastava explained that although algo providers will not be directly regulated by Sebi, they will need to register with exchanges and comply with stringent monitoring requirements. “This could slow down innovation, especially for smaller fintech firms, as unclear approval processes may delay market entry.”

Providers of black-box algorithms will be required to submit a detailed research report and seek re-approval from exchanges if they alter the underlying logic of their algorithms.

While the new framework aims to offer greater protection for retail investors, the guidelines may present challenges, particularly for smaller players in the market. Experts believe that retail investors developing their own algorithms must register with exchanges if they exceed a transaction speed threshold, potentially discouraging participation.

Overall, the sentiment seems to be that while this regulatory approach effectively reduces risks associated with retail algo trading, the implementation challenges and potential barriers for smaller firms need to be addressed.

The full implementation of the guidelines is scheduled for August, with Sebi expecting stock exchanges to define specific operational standards by April.

As brokers and algo providers work to adjust their systems to meet these new requirements, Sebi’s goal is to ensure that the risks of algorithmic trading are mitigated without stifling innovation.

“The implementation timeline, with full compliance expected by August 2025, may not provide sufficient time for brokers and algo providers to upgrade their systems and adapt to new rules. These factors could make retail algo trading less accessible, particularly for new entrants,” Srivastava said.