Via Mint :

Announcing the long-awaited guidelines for so-called algorithmic trading, or “algo” as it’s popularly known, India’s capital market regulator on Friday insisted on a stringent and advanced risk management system to provide support for such trades as their speed and volume entail a higher risk. Automated execution logic enables the rapid execution of a large number of trade orders. Stock exchanges have been given three months to complete the approval process for brokers currently executing orders through algos.

The Securities and Exchange Board of India (Sebi) directed the bourses to ensure that a consistent response time is followed for all stock brokers, and also asked exchanges to continuously upgrade their systems to stay on top of the speed and volume of trades. On 26 October, BSE Ltd had to cancel all derivative trades during the Muhurat (auspicious) session after volumes spiked to about Rs27,000 crore, almost 10 times the average daily volumes on BSE’s cash segment then. This prompted Sebi to order a review of the risk management system with regard to algorithmic trading and launch an investigation into the matter.

To avoid a recurrence, Sebi asked exchanges to put in place effective economic disincentives related to stock brokers’ high daily order-to-trade ratios. Further, the stock exchange will require a monitoring system to identify and initiate measures to avoid any instance of order flooding by algos. Domestic exchanges typically set position limits on the basis of margins deposited by a trading member. This curbs the liabilities of the exchanges and their clearing houses in case a delivery fails due to insufficient funds or shares for executing the delivery.

Sebi also wants all algorithmic orders to be tagged with a unique identifier provided by the bourse to establish an audit trail. It also said the minimum order-level risk controls must include a price check and a quantity limit check. For securities that do not have price bands, dummy filters have to be used to serve as an early warning system to detect any sudden surge in prices. Further, the quantity quoted in the order will not violate the maximum permissible quantity per order as set by the exchange for a given share or a security. The exchange must be capable of identifying algos that may lead to a “loop” or runaway situation. If the situation demands, the stock exchange should be able to shut down the broker’s terminal, according to the guidelines. Moreover, all stock exchanges that plan to accommodate algo trades have to synchronize their system clock with the atomic clock before the start of market to at least one microsecond and accuracy of at least one millisecond