Timeline of SEBI regulations on algorithmic trading.

Initial Guidelines and Framework (2008-2012)

March 2008: Introduction of Guidelines for Algorithmic Trading

In March 2008, SEBI took its first major step towards regulating the burgeoning field of algorithmic trading. At that time, algorithmic trading was responsible for a small fraction of total market volumes but was rapidly gaining popularity due to its speed and efficiency.

SEBI’s guidelines required that any market participant engaging in algorithmic trading must implement robust risk control systems, including automated checks to prevent erroneous trades and systems to monitor compliance with regulatory requirements.

The guidelines also mandated that traders maintain logs of all trading activities, ensuring traceability in case of disputes. This was the first time in India that a regulatory framework specifically addressed the use of technology in trading, reflecting SEBI’s proactive approach to market regulation.

September 2012: Co-Location Norms for Transparency

By September 2012, co-location services had become a critical feature for high-frequency traders (HFTs) in India. SEBI’s introduction of co-location norms was a response to the increasing dominance of HFTs, which accounted for about 30-40% of the total trading volume on Indian exchanges at that time.

The co-location norms required exchanges to provide equal access to their infrastructure, ensuring that no single market participant could gain an unfair advantage through superior technology.

SEBI also mandated that exchanges disclose the number of orders placed from co-located servers to enhance transparency. This move was crucial in maintaining a level playing field as the use of algorithmic trading systems continued to grow, with HFT volumes expected to increase by 20% annually.

Enhancing Risk Management (2014-2016)

March 2014: Specifying Risk Management Norms

In March 2014, SEBI introduced a set of risk management norms designed to address the complexities of algorithmic trading. These norms were part of SEBI’s ongoing efforts to mitigate risks associated with high-frequency trading, which by then accounted for over 50% of trading volumes on the National Stock Exchange (NSE).

The new regulations included a mandatory order-to-trade ratio, which was set at a maximum of 50:1. This meant that for every 50 orders placed, at least one trade had to be executed, thereby discouraging market manipulation through excessive order placements. SEBI also introduced the concept of ‘order randomization,’ where the exact time of order execution was randomized within a millisecond to prevent traders from gaming the system.

These measures were critical in reducing the incidence of flash crashes and other market anomalies caused by aggressive algorithmic strategies.

2016: Direct Market Access (DMA) Regulations

In 2016, SEBI formalized regulations around Direct Market Access (DMA), which had been informally in use since 2008.

By 2016, DMA trades accounted for nearly 10-15% of the total trading volume on Indian exchanges, primarily driven by institutional investors seeking faster execution and lower transaction costs.

SEBI’s regulations required that brokers offering DMA services put in place pre-trade risk controls to prevent erroneous trades, such as fat-finger errors, which could lead to significant market disruptions.

Additionally, SEBI mandated that all DMA trades be monitored in real-time to ensure compliance with existing market regulations. These regulations helped streamline the use of DMA, allowing institutional investors to leverage advanced trading strategies while safeguarding market integrity.

Strengthening the Regulatory Framework (2020-2022)

March 2020: Circular on Algorithmic Trading

In March 2020, SEBI issued a landmark circular that significantly expanded the regulatory framework for algorithmic trading, which by then was responsible for more than 60% of the total market volume.

The circular introduced stringent requirements for testing and certifying algorithms, making it mandatory for all algorithms to undergo thorough back-testing and validation before deployment. SEBI also required market participants to maintain audit trails of all algorithmic trades for a minimum of five years, allowing for post-trade analysis in case of market anomalies.

Furthermore, SEBI introduced real-time monitoring protocols, which enabled exchanges to detect and flag suspicious trading patterns immediately. These measures were crucial in ensuring that the rapid growth of algorithmic trading did not compromise market stability or investor protection.

November 2022: Guidelines for Alternative Trading Systems

In November 2022, SEBI introduced guidelines for Alternative Trading Systems (ATS), which had gained traction as non-traditional trading venues. By 2022, ATS platforms, including dark pools, accounted for approximately 10% of total trading volumes in India, with an increasing number of institutional investors using these platforms to execute large trades with minimal market impact.

SEBI’s guidelines required all ATS platforms to register with the regulator and comply with strict operational standards, including transparency in trade reporting and the implementation of robust surveillance systems.

The guidelines also stipulated that ATS platforms must provide real-time data to SEBI, ensuring that the regulator could monitor trading activities closely. These measures were essential in mitigating the risks associated with opaque trading venues, which had been linked to market manipulation in other jurisdictions.

Establishing Performance Validation Agency: Examining SEBI’s Consultation Paper (31 August 2023)

August 2023: Proposal for Performance Validation Agency

On 31 August 2023, SEBI released a consultation paper proposing the establishment of a Performance Validation Agency (PVA) to oversee the testing and validation of algorithmic trading strategies.

This move was driven by growing concerns about the integrity and accuracy of claims made by algorithmic trading service providers, especially as algorithmic trading volumes were expected to account for over 70% of total market transactions by 2024.

SEBI’s proposal outlined that the PVA would be an independent body tasked with evaluating and certifying the performance of algorithmic strategies before they could be deployed in the market.

The PVA would use a standardized testing framework, including back-testing and stress testing across various market conditions, to ensure that the strategies were robust and did not pose systemic risks.

The consultation paper also suggested that the PVA would periodically review live trading strategies to monitor their real-time performance against certified parameters, adding an extra layer of oversight. The introduction of the PVA was seen as a significant step towards enhancing transparency and accountability in the rapidly evolving landscape of algorithmic trading.

Cybersecurity Framework for Market Infrastructure Institutions (MIIs) (October 2023)

October 2023: Introduction of Cybersecurity Framework

In October 2023, SEBI introduced a comprehensive cybersecurity framework for Market Infrastructure Institutions (MIIs), reflecting the growing threat of cyberattacks on financial markets globally.

At the time, cyber threats were estimated to cost the global financial industry over $1 trillion annually, with increasing incidents targeting exchanges and trading platforms.

SEBI’s framework required MIIs to implement multi-layered security protocols, including advanced encryption, real-time threat monitoring, and regular penetration testing.

Additionally, MIIs were mandated to report any significant cybersecurity incidents to SEBI within 24 hours and to conduct a detailed forensic analysis of any breaches. The framework also required MIIs to have robust disaster recovery plans in place, ensuring that trading operations could continue with minimal disruption in the event of a cyberattack.

These measures were crucial in safeguarding the integrity of India’s financial markets, which had become increasingly reliant on digital infrastructure.

Proposed Regulations for Retail Algo Trading (2024)

February 2024: Tightening Regulations for Retail Algo Trading

In February 2024, SEBI proposed new regulations aimed at tightening oversight of algorithmic trading by retail investors.

By then, retail participation in algo trading had grown significantly, with an estimated 15-20% of retail trades being executed through automated systems. SEBI’s proposed regulations included mandatory approvals for all algorithmic strategies used by retail clients, with each strategy requiring registration and certification by SEBI.

Additionally, SEBI proposed the implementation of unique algorithm identifiers (algo IDs) for all API orders, a move designed to enhance traceability and accountability.

These proposals were part of SEBI’s broader efforts to protect retail investors, who often lacked the resources and expertise to fully understand the risks associated with algorithmic trading. By requiring rigorous oversight and transparency, SEBI aimed to prevent retail investors from falling victim to high-risk trading strategies.

Tightened Ownership Norms for Foreign Portfolio Investors (FPIs) (February 2024)

February 2024: Enhanced Ownership Disclosure Requirements

In February 2024, SEBI introduced tightened ownership norms for Foreign Portfolio Investors (FPIs), a move that reflected growing concerns about the opacity of foreign investments in Indian markets.

By this time, FPIs held over Rs 35 lakh crore ($420 billion) in Indian equities, representing approximately 20% of the total market capitalization. The new norms required FPIs to disclose the identities of all entities holding ultimate beneficial ownership, particularly those classified as high-risk, such as hedge funds with complex ownership structures.

SEBI also mandated that FPIs managing more than Rs 25,000 crore ($3 billion) in Indian equities, or those with over 50% of their AUM invested in a single corporate group, provide detailed information on their investment strategies and ownership structures.

These regulations aimed to enhance transparency and prevent the use of Indian markets for money laundering or other illicit activities, ensuring that foreign investments were aligned with regulatory standards.

Restrictions on Advertising for Trading Services (April 2024)

April 2024: Updated Advertising Guidelines

In April 2024, SEBI updated its guidelines for advertising related to trading services, reflecting its commitment to protecting investors from misleading and aggressive marketing tactics.

At the time, the financial services advertising market in India was valued at approximately Rs 1,500 crore ($180 million) annually, with a significant portion of this spend directed at promoting trading platforms and services.

SEBI’s new guidelines required that all advertisements related to trading services, including those promoting algorithmic trading platforms, be reviewed and approved by the regulator before publication.

The guidelines emphasized that advertisements must present balanced and accurate information, avoiding exaggerations or promises of guaranteed returns.

SEBI also required that advertisements include clear disclaimers about the risks associated with trading, particularly for retail investors. These restrictions were part of SEBI’s broader efforts to ensure that investors made informed decisions and were not unduly influenced by aggressive marketing.

Amendments to Insider Trading Regulations (June 2024)

June 2024: Reduction in Insider Trading Waiting Period

In June 2024, SEBI announced significant amendments to its Insider Trading Regulations, which were first introduced in 1992 and had been revised multiple times to address evolving market dynamics.

The key amendment was the reduction in the waiting period for insiders to trade after the public disclosure of a trading plan, from six months to 120 calendar days.

This change was aimed at providing insiders with greater flexibility while maintaining transparency and regulatory oversight. The amendments also eliminated the requirement for insiders to maintain a minimum 12-month trading period, a move that aligned SEBI’s regulations with international best practices.

Bibliography:-https://www.sebi.gov.in/, https://www.marketfeed.com/read/en/what-are-sebis-key-regulations-on-algo-trading, https://www.thehindubusinessline.com/markets/sebi-may-tighten-rules-for-algo-trading/article67810710.ece