Regulators taking stock of the risky algo trading
Financial market regulators, Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) appears to have swung into action against the increasing influence of algorithm trading or high frequency trading (HFT). Last month, Moneylife wrote about algo trading or HFT in India that was possibly going on in National Stock Exchange (NSE). The article, published on 19th June reportedly seems to have alarmed and forced the regulators to take a closer look at gaps in the existing regulations and explore ways of strengthening them. Interestingly, SEBI and the National Stock Exchange (NSE) have maintained a deafening silence on the alarming disclosures in the whistleblowers letter despite multiple reminders by Moneylife before and after publishing the report. We wrote to the SEBI Chairman UK Sinha, NSE chairman Ravi Narain, and managing director Chitra Ramakrishnan seeking their reaction to the letter.
The Financial Stability Report (FSR) for June 2015 released by RBI on 25th June, has warned against the rising popularity of superfast algorithm trading, saying its complex coding and ultra-low latency due to its advanced communication platforms increase risks of erroneous trades and manipulations in stock markets. Further, the fact that the share of algo orders in total orders and the share of cancelled algo orders in the total number of cancelled orders is around 90% creates concerns relating to systemic risks, the FSR says.
According to the report, volumes in algo trading and HFT have increased substantially over the past few years in the cash segment to about 40% of total trades by March 2015 on both exchanges from 17% on NSE and 11% on BSE in 2011. The report is a collective assessment of a sub-committee of the Financial Stability and Development Council that includes all financial market regulators. The report also pointed fingers at certain instances of abnormal market movements in Indian stocks, which have been attributed, by market experts, to algo trading or HFT.
On 6 May 2015, the S&P BSE Sensex and NSE's CNX Nifty fell by over 2% wiping out their entire gains for the year, because of strong selling on algo trading platforms, says a report from Reuters.
Moneylife has repeatedly argued that India has no system of monitoring complex automated systems, leave alone complex trading systems which are based on complex mathematical algorithms. Consequently, organisations that operate such technology have become a law unto themselves, supervised by nobody. Even when there is a major glitch or a fat finger trade, no report is put into the public domain.
Moneylife has a detailed document that came by snail mail from Singapore and addressed to Mr BK Gupta, DGM, SEBI. It is dated 14th January 2015 with a copy to Sucheta Dalal. It is not clear what SEBI has done with it in all these months.
According to media reports, SEBI is working on rules to regulate algo trading. Quoting two sources familiar with the matter, a report from Business Standard, says,"...among the points under consideration are means to slow down the pace of trading through introduction of measures, including a minimum resting time for orders before execution, and randomising the time priority of orders an exchange receives."
"To eliminate 'fleeting orders' or those that appear and then disappear within a short period, a mechanism might be introduced to prevent cancellation or modification of an order until sometime from its submission. We are mulling to introduce a minimum resting period of 500-600 milliseconds," one of the sources told the newspaper.
In April 2008, algo trading was introduced in India with the advent of direct market access (DMA). Though these trades are monitored by SEBI, the FSR report expressed apprehensions that they could result in market manipulation.
Earlier in January, SEBI tightened controls on its circuit breaker mechanism, in addition to the existing coordinated trading halt in all equity and equity derivative markets nationwide on 10%, 15% and 20% movement either way of the Sensex and the Nifty.
Michael Lewis’s best-selling book, 'Flash boys: A Wall Street Revolt', published in March 2014, has triggered a global debate on algo or high frequency trading. The book discusses rise of high frequency trading in US equity markets and argues that the US markets are rigged by the HFT traders.