The Securities and Exchange Board of India (SEBI) has revised its guidelines for algo trading and published the results of a ‘Review of Ownership and Governance of Market Infrastructure Institutions’, which opens up the possibility of Indian exchanges listing themselves on other bourses.
Recognising the rise in algo trading on its exchanges, SEBI has set out a series of regulations to control and oversee electronic trading. Algo and co-location trading accounted for about 25% of derivatives volume and around 30% of equities volume on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) last year, and SEBI has expressed concern about the drive for ever lower latency.
“At the moment in India, we have a delay of eight microseconds and there are still demands for it to come down. At some stage, this has to stop,” said SEBI chairman U. K. Sinha last month. “You have to ask the question, what is it you are gaining in eight microseconds versus 20 microseconds? And also, do the exchanges and SEBI have the capacity to regulate eight microsecond issues? I doubt it. It will take quite some time.”
The new regulations will mandate exchanges to have systems in place to cope with algo trading, including blocking order flooding and creating financial disincentives to discourage high order-to-trade ratios from brokers.
All algo orders will have to be routed through broker servers located within India, and exchanges are required to implement ‘appropriate risk control mechanisms’.
The exchanges must install systems to identify ‘dysfunctional algos’ that lead to a ‘loop or a runaway situation’ and shut down brokers’ terminals if necessary. Exchanges must also be able to manually enable the terminals of brokers which have been disabled due exhaustion of collateral.
Price checks and quantity limit checks must be implemented to ensure orders don’t violate price bands defined by exchanges, or the maximum quantity of a stock in an order, as defined by the exchange. Where price bands don’t exist for a stock, ‘dummy filters’ must be put in place.
Other measures include requirements for exchanges to track and report algo trading, as well as synchronising exchanges’ system times with an atomic clock.
“There’s nothing sinister in the new regulations. They should be broadly welcomed and bring India largely in line with best global practices,” says Hirander Misra, former COO of Chi-X Europe and now acting as a consultant for Indian exchanges.
“The quantity limit checks address ‘fat finger’ errors but I think a percentage of turnover safeguard would be more robust,” suggests Misra. “They also don’t have any circuit breakers in place, nor are they looking at that yet.”
Reform of the clearing house set-up is also in the works. SEBI announced a committee to look into whether a central clearing house or multiple interoperable venues was preferable. Clearing houses too are to be able to float and attract investors, though ownership curbs will apply.
Meanwhile, SEBI’s review of governance of exchanges themselves has cleared the way for them to float on other bourses. Overseas investors holding stakes in Indian exchanges, including Deutsche Borse and SGX, which own 5% of BSE, now have an exit route, making the bourses potentially more appealing to foreign capital.
Nevertheless, restrictions on ownership will continue, and ‘no single investor will be allowed to hold more than 5% except the Stock Exchange, Depository, Insurance Company, Banking Company or public financial institution which may hold up to 15%.’
The Indian market is currently dominated by the two Mumbai-based exchanges: NSE and BSE, with the newly revived Delhi Stock Exchange looking to make a comeback through its agreement to use LSE’s MillenniumIT platform.
“There are about 16 regional exchanges with hardly any volume and which mainly trade on BSE and NSE through their broker dealer subsidiaries,” points out Misra.
SEBI has stipulated that those exchanges have three years to achieve a net worth of 100 crores (US$20 million) and annual trading volumes of 1,000 crores, or face being closed down.