August 11, 2016 7:50 pm JST

India's steps to regulate algorithmic trade may hurt liquidity, traders say

MUMBAI (NewsRise) -- India's capital markets regulator recently proposed measures to tighten regulations on algorithmic trading to ensure equal and fair access to all market participants, but traders are concerned the steps may pose a threat to prevalent liquidity available on the exchanges.

A chunk of algorithmic trading today consists of high frequency trading (HFT), which leverages high-speed financial data and sophisticated technology for quicker access to stock prices and to place a large number of orders at speeds faster than ordinary investors. The practice, which includes placing servers as close to the exchanges as possible - called colocation, has been widely criticized the world over for giving such traders an unfair advantage.

Global market watchdogs have been debating methods to make such traders more accountable without affecting price discovery and liquidity.

The Securities and Exchange Board of India (SEBI) on Friday said it is examining a number of options to limit unfair access to trading systems of the exchanges. However, market participants are skeptical about the efficacy and possible repercussions of such checks.

"While the intent of SEBI to provide fair trading practices is laudable, the measures need to take into account the effect it will have on the available liquidity," said Kunal Nandwani, Head of uTrade Solutions, which offers multi-asset trading platforms for investors.

India's markets regulator said it is considering a number of options, including "speed bumps" - that will cause random order processing delays by a few milliseconds, separate queues for colocation orders and non-colocation orders and steps to prevent traders from cancelling an algorithmic order before it is confirmed by the exchange.

"There is a risk of alienating foreign investors, who will likely seek for alternative destinations in Singapore and Dubai, if the measures are too restrictive and dampen liquidity expectations," Nandwani said.

Algorithmic orders now account for about 40% percent of trades executed in exchanges in Asia's fourth-largest stock market, according to the nation's capital markets regulator.

The average daily turnover on India's NSE in the fiscal year ended March 2016 stood at 2,624 billion rupees in the derivatives segment and 171 billion rupees in the cash segment. On the BSE, the corresponding figures stood at 180 billion rupees and 30 billion rupees.

The watchdog issued broad guidelines on high-frequency trading in 2012 and 2013.

Global capital market regulators have been working towards incorporating rules and standards for high frequency trading in recent years. The need to provide a level playing field across investors has gathered importance amid concerns that it increases systemic risk and adds to market vulnerability.

However, most countries are yet to finalize norms for automated trading.

The European Commission recently published technical standards on high frequency trading and other activities with a possible implementation date set in 2018, while the U.S. Securities and Exchange Commission is likely to release rules on algorithmic trading, order routing and disruptive trading before 2017, according to a report by Bloomberg in April.

Concerns about the misuse of algorithmic trade have also plagued regulators. Last year, a high-frequency trader was arrested for his alleged role in the 2010 "flash crash" in New York that caused the Dow Jones Industrial Average to shed more than 1,000 points intraday.

"SEBI has taken the right steps in opening discussions for this aspect, which has been a source of controversy in global markets," said Praveen Gupta, CEO of Symphony Fintech, an automated trading systems provider. "But implementation of any steps, which could significantly affect the overall market liquidity or make it difficult for traders to exploit arbitrage opportunities, will affect price discovery."

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