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Note- The article is divided into two parts. The first part of the article can be found Here
[Arihant Sethia is a fourth-year B.Com. LLB student at Gujarat National Law University, and Bijendra Shandilya is a fourth-year BBA. LLB student at IIM Rohtak]
[4.] Potential Intellectual Property concerns
5 (I)(c) read with 5 (I)(d) of the Circular deals with the registration of Algos developed by retail investors. The algo developed by the investor shall be registered with the exchange through their broker. This means that brokers have material information about these algos. Also, algo providers are deemed to be agents of brokers, who will be liable for them. The issue is that these brokers can use the programming idea of these tech-savvy investors’ algo to improve upon the algo of these algo providers, make them more efficient, and reduce the chance of malfunctioning (free-riding effect). This might give rise to Intellectual Property issues.
Suggestion-
Safeguards must be implemented to ensure that Intellectual Property issues do not arise and brokers do not misuse the information. This can be done by framing rules for the brokers.
[5.] Requisite permission from the stock exchange
Clause 5(II)(a) of the Circular provides that “The facility of algo trading shall be provided by the stock broker only after obtaining requisite permission of the stock exchange for each algo”. The clause doesn’t mention how the requisite permission shall be obtained if the broker is a member of multiple stock exchanges.
Specifying the affiliated stock exchange makes it clear which exchange’s permission is required, particularly if the broker is a member of multiple exchanges. This avoids confusion over jurisdiction and ensures the broker knows exactly where to seek approval. It ensures that the approval process aligns with the specific regulations of the exchange where the broker operates.
Suggestion-
The clause shall be re-drafted as “The facility of algo trading shall be provided by the stock broker only after obtaining requisite permission from the affiliated stock exchange for each algo.”
[6.] Permission for modification of algos
Clause 5(II)(b) of the Circular provides that “the broker shall seek approval from the Exchange for any modification or change to the approved algos or systems used for algos”. Requiring stock exchange approval for any changes or modifications in already approved algos may lead to operational inefficiencies, particularly for minor tweaks or improvements in existing algorithms. Stock exchange approval for each modification may create delays and hinder innovation.
Suggestion-
The phrase “any modification or change” should be changed to “material changes or modifications to the approved algos or systems”.
[7.] Disclosures about Black-box Algos to Exchange
5 (V) of the Circular proposes categorising algorithms into White-box and Black-box types and raises concerns about the practicality of requiring Black-box Algo providers to register as Research Analysts and maintain static research reports, given the iterative nature of algorithm development. This obligation could hinder innovation and operational agility in algo trading, particularly in a competitive and dynamic market.
Additionally, the absence of clear guidelines on what constitutes a “change in logic” may lead to ambiguities and inconsistent enforcement. This generates a paradox in which users have to depend solely on the provider’s guarantees without insight into the algorithm’s inner workings. Such reports may be very technical, inaccessibly so, or even deceptive to end users and regulators. The need to re-register algos following logic modifications is bound to bring about delays and administrative costs, particularly if exchanges or brokers do not comply with the prescribed turnaround times (TATs). If the use of APIs is to become pivotal to retail algo trading, over-automation can cause market disruption. The ban on open APIs without discussing alternatives for independent developers can dampen innovation in the retail segment.
Further, the requirement that exchanges verify the availability of research reports seems to impose administrative costs on exchanges, which could take away from their fundamental regulatory and monitoring role. Further, the circular does not effectively deal with data privacy and intellectual property issues related to Black-box algorithms. Demanding detailed documentation and reporting could make proprietary techniques vulnerable to unnecessary scrutiny, raising the risk of misuse or competitive harm. These considerations could discourage Algo providers from engaging in the Indian market, thus affecting market efficiency and liquidity.
Suggestion-
The requirement of registration can be substituted with a mechanism of self-certification, where Algo providers from time to time certify compliance with SEBI’s principles of fairness, accountability, and transparency. In lieu of mandatory research reports for every algorithm, SEBI may require an annual third-party compliance audit to strike a balance between the flexibility of operation and regulatory intervention.
Moreover, SEBI should provide clear definitions and thresholds for what constitutes a “change in logic” to minimise ambiguity. Data privacy safeguards should also be explicitly outlined to protect proprietary trading strategies, thereby fostering trust and encouraging innovation. Such refinements would align regulatory requirements with industry realities while upholding market integrity and investor protection.
[8.] Other Challenges
The document does not emphasise a clear or streamlined dispute resolution process for retail investors facing issues with algo providers or brokers. This is critical, as retail participants may struggle to navigate complex grievance systems. The responsibilities placed on brokers, such as categorisation of all orders, empanelment of algo providers, and ensuring compliance could lead to higher operational costs. This may discourage smaller brokers from offering algo trading services, reducing competition and innovation.
Suggestion-
SEBI shall formulate the due process for dealing with disputes and incorporate it into the existing framework. The dispute resolution mechanism must be swift, effective and cost-efficient in order to reduce transaction costs for retail investors.
Cost-Benefit Analysis
Cost-benefit analysis is a systematic approach to evaluating the strengths and weaknesses of a proposed project or decision by measuring the expected costs against the potential benefits. The framework outlined by SEBI for retail algo investors aims to enhance transparency and increase investor protection at the same time. By mandating brokers to categorise algo orders, SEBI aims to strengthen market surveillance and protect investors from any manipulation. However, the framework presents significant challenges that may outweigh its benefits. Further, the categorisation of algorithms into White-box and Black-box types aims to provide clarity, with Black-box algo providers required to register as Research Analysts. These measures are expected to instil confidence among retail investors and enhance market efficiency.
First, the administrative burden for the brokers is greater, and they must apply for approval for each algorithm and each variation, thereby imposing administrative delays. Second, brokers are principals to algorithm providers and thus become more liable and less willing to cooperate with smaller fintech firms.
Third, retail investors who design their own algorithms must register them via brokers, increasing complexity and making the entire process less welcoming. Fourth, order tagging and API-based trading impositions may cause liquidity fragmentation, reducing trading volumes and speed of execution, especially under the T+1 settlement regime.
In addition, intellectual property concerns are raised by the requirement that brokers must register retail investors’ algorithms at the exchanges since it can expose proprietary techniques to exploitation. The requirement that black-box algorithm sellers keep research reports can discourage innovation and deter fintech firms. Finally, the architecture is not clear on the mechanism for resolving disputes, thus leaving retail traders in doubt.
While SEBI’s initiative enhances oversight, the excessive compliance costs, operational inefficiencies, and potential liquidity fragmentation could deter market participants. The drawbacks may surpass the benefits unless SEBI refines the framework to strike a better balance between regulation and innovation.
Conclusion
In conclusion, SEBI’s Circular on retail investor participation in algorithmic trading in India is a forward-thinking move toward democratizing access to cutting-edge trading technologies. It seeks to increase transparency and investor protection by requiring broker approvals, classifying algo orders, and differentiating between White-box and Black-box algos.
Nevertheless, the framework is highly challenging, with operational slowdowns due to approval needs for algos and alterations, excessive broker liability to deter cooperation with fintech companies, and intellectual property issues for retail-developed algos. The imprecision in describing dispute resolution mechanisms and the facility for liquidity fragmentation under the T+1 settlement regime add to the implementation woes.
Although the intentions of the framework are noble, the present form of the framework runs the risk of inducing high compliance costs and discouraging innovation. To address these concerns, SEBI should make changes in the framework by identifying affiliated stock exchanges for permissions, permitting minor algo changes without approval, establishing broker liability, intellectual property protection, and effective dispute resolution. Through the balance of regulation and innovation, SEBI can develop a more inclusive and efficient algo trading environment that benefits retail investors, brokers, and the wider market.
