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[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]
Introduction
Algorithmic trading (Algo Trading), stands as an automated mechanism that executes securities transactions based on pre-programmed rules and instructions. Algo Trading, officially streamlined in 2008 in India, has metaphorised the Indian Securities Market by leveraging high-speed, automated transactions through technologies like Direct Market Access (DMA). Presently, almost 55% of orders placed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) account for Algo Trading. The Securities and Exchange Board of India (SEBI) has played a pivotal role in regulating this space since 2012, ensuring market integrity with robust guidelines.
Although Algo Trading accounts for the majority of trades in India, retail investors have always been excluded from Algo trading and have always been pre-dominated by institutional investors. However, SEBI decided to change the regulatory face of algorithmic trading by releasing a circular titled “Safer participation of retail investors in Algorithmic trading” (Circular) dated 4th February 2025, aiming to bridge this gap. The Circular is introduced with the aim of enabling retail investors to engage in algo trading while maintaining market integrity and transparency at the same time. The Circular outlines key roles for brokers, algo providers, and Market Infrastructure Institutions (MIIs), introducing multiple mandates. However, the circular raises critical questions about operational efficiency, broker liability, and intellectual property safeguards.
The aim of this article is to critically assess SEBI’s Circular on retail investor participation in algorithmic trading. With algo trading constituting more than 50% of India’s market orders but mostly being available to institutional players, widening its access to retail investors is opportune and necessary. The article discusses the necessity of balancing innovation with regulation, preserving market integrity while promoting inclusivity. The article starts with an overview of algo trading in India, followed by a brief overview of the circular. A clause-by-clause analysis of its provisions, cost-benefit analysis, and a conclusion with suggestions form the organization.
Algorithmic Trading in India
Algorithmic trading was officially adopted as a trading method in India in 2008, and it has been in use since 2011. After approving a technology called DMA, SEBI approved Algo Trading in India in 2008. DMA is a technology that enables a trader to access the stock exchange network through a broker’s interface. The Indian Securities Market Regulator, SEBI, published guidelines to control algo trading activity in India and allowed the NSE and BSE to offer their members algorithmic trading capabilities as per SEBI circular on “Broad Guidelines on Algorithmic Trading” dated March 30th 2012.
SEBI oversees the regulation of Algo Trading, and India is one of the few nations with strict regulations in place to control Algo Trading-based orders. Through a discussion paper titled ‘Strengthening of the Regulatory Framework for Algorithmic Trading & Co-location’, SEBI asked market makers’ opinions in August 2016 about the impact and regulation of Algo Trading.
Algo Trading’s structure in India is restricted to proprietary traders. It is anticipated that these traders would reveal their algorithmic techniques and obtain regulatory approval. SEBI would not allow such algorithms that negatively impact market liquidity. However, in April 2018, SEBI requested that stock exchanges implement “managed co-location services”, which would give vendors space in addition to technical know-how and other experience, to help small- and medium-sized trading members.
Overview of the Circular
SEBI released a Circular titled “Safer participation of retail investors in Algorithmic trading” on February 4, 2025, in order to seek comments on a regulatory framework concerning the participation of retail investors in Algorithmic Trading in India. With the Circular, SEBI aims to refine the existing regulatory framework in a way that enables retail investors to participate in algo trading while maintaining the security and integrity of the market. The proposed framework outlines the roles and responsibilities of key stakeholders, including investors, stockbrokers, algo providers, and MIIs.
The framework makes a mandate-based system for stockbrokers, where they can provide algo services only after getting approval from the stock exchange. Orders executed via Application Programming Interfaces (APIs) will be categorized as algo orders if they exceed a specified threshold. Retail investors who tailor their own algos must register them through their brokers, which can be used only by limited people. Further, the Circular also mentions empaneling of algo providers with the stock exchange to increase transparency and ensure accountability in the financial market.
Further, Algo trading has been categorised into two parts- White Box (Execution Algos) with disclosed logic, and Black Box (proprietary, undisclosed logic). Black Box Algos are described as having logic unknown to users, yet they are expected to be registered with a research report. In the case of Black Box Algos, a research report must be backed up and maintained by a registered analyst. Meanwhile, Stock Exchanges will maintain transparency in order to protect investors through measures such as audit trails and a “kill switch” to prevent malfunctions. The Circular emphasizes a structured and transparent approach to retail algo trading, ensuring investor protection while promoting technological advancements in the securities market.
Analysis
The SEBI Circular is a commendable step toward fostering financial inclusion and innovation in India’s securities market. Extending algo trading opportunities beyond institutional investors promotes greater market efficiency and accessibility. The framework introduces crucial safeguards, ensuring transparency, investor protection, and regulatory oversight. However, despite its well-intended objectives, certain provisions may impose operational inefficiencies, excessive compliance burdens, and potential barriers to innovation. To strike a balance between robust regulation and seamless market functioning, this section critically examines the Circular and proposes necessary refinements to enhance its effectiveness while preserving market integrity.
[1.] Broker as principal
Clause 5(I)(a) of the Circular provides that “brokers shall be the principal while any algo provider or fintech/vendor shall act as its agent while using the API provided by the broker”. This clause establishes a clear principal-agent relationship, which enhances accountability. However, it imposes excessive liability on brokers for the actions of algo providers as principals. This may discourage brokers from engaging with smaller or emerging fintech firms, resulting in hindering innovation.
Suggestion-
SEBI should consider defining the extent of a broker’s liability to prevent excessive burdens while maintaining adequate safeguards.
[2.] Tagging of Algo Order
Clause 5(I)(c) of the Circular provides that “In addition to orders tagged as algo orders, the orders above the specified order per second threshold shall also be treated as algo orders”.
Tagging algo orders with a unique identifier will aid the auditing process and ensure traceability of the trades. However, SEBI must clarify how the “specified order per second threshold” will be determined instead of allowing the Broker’s Industry Standards Forum to determine the limit. It will ensure uniformity across brokers and exchanges and reduce the chances of delay, keeping the uniqueness of algo trading over non-algo trading (Page 92). Moreover, the requirement to categorise and tag orders might lead to operational delays, especially for brokers with high trading volumes and a growing obligation to follow the T+1 settlement cycle.
Suggestion-
To address the issue, uniform standards for defining the specified order-per-second threshold across brokers must be mandated through collaboration with SEBI and stock exchanges. They must ensure the unique identifier tagging by the Stock Exchange is automated and seamlessly integrated into broker systems to prevent errors or delays. Implement real-time oversight mechanisms to monitor and flag non-compliant API order flows, which ensures accountability and consistency.
[3.] Algos developed by retail investors
Clause 5(I)(c) of the Circular provides that “Algos developed by tech-savvy retail investors shall also be registered with the Exchanges by their brokers and be eligible for use by their family”. Allowing retail investors to develop and register their own algorithms to promote inclusivity and innovation. However, the requirement to register algorithms through brokers adds an additional layer of complexity and makes the process tedious for the retail investor.
Furthermore, defining “family” as dependents is a reasonable approach, as the invention should be allowed for their family’s use. However, the potential misuse of this provision for unauthorised sharing should be addressed through stringent monitoring mechanisms. Moreover, the circular fails to mention compliance in the case of use by the family of the inventor of algos.
Retail investors often utilize simpler algorithms with lower trading volumes, sometimes motivated by personal rather than institutional targets (Here). Imposing the same severe rules on retail traders as institutions raises barriers to entry which would overwhelm regular investors, prohibiting them from investigating algorithmic trading.
Suggestion-
To address the gaps, retail investors must undergo a basic certification process before registering self-developed algos, ensuring compliance with regulatory standards. Mandate brokers to verify and monitor these algos periodically for safe and ethical use. Extend the definition of ‘family’ to include specific documentation, ensuring clarity and preventing misuse.
The process of Algo trading can become more decentralised if investor-developed algos, upon approval by suitable authorities, are allowed to be used by other investors as well. This will reduce the skepticism investors have about the algo facility provided by brokers and build trust in the system. This will also promote investor participation and stakeholder inclusivity since the investors can develop algos, which can be used on a wider scale by other investors as well.
[Note- The article is divided into two parts. The second part of the article can be found- Here]
