There is nothing India’s stock market regulators can do to stop high-frequency trading strategies since these trades make up too much exchange volume, so rather than ban them it might be better to put better market safeguards in place to prevent potential market disruptions.
In a recent editorial in the Hindu BusinessLine, the editor said that the Securities and Exchange Board of India seems to be caught between a rock and a hard place on the issue of regulating algorithmic and high frequency trading (HFT) on Indian bourses. The piece pointed to a recent Reserve Bank of India report that flagged the systemic risks from such trades and that a few market participants have alleged that it has allowed large players to manipulate stock prices.
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“However, high-speed trades are today such an integral part of market activity that stringent regulatory action – such as an outright ban – will do more harm than good to market and investor interests,” the report noted. “There is no doubt that the co-location facility offered by exchanges allows a select club of deep-pocketed traders an advantage over others, not on the basis of superior knowledge or skills, but because of access to expensive technology.”
The editorial continued that after episodes such as the U.S. Flash Crash, it is accepted that high-speed trades pose systemic risks to the market by multiplying the impact of erroneous trades or flooding the market with hoax orders. But having acknowledged this, most global regulators are reluctant to come down heavily on such trades because of their sizeable contribution to price discovery and market liquidity. “The Indian situation is no different.”
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Algo trading made its debut in India in 2008 and co-location facilities have been around since 2010. As the contribution of algos and HFT to market volumes is already more than 40 per cent, SEBI has taken a piecemeal approach to regulating them. Nevertheless, the checks and balances that exist against rogue algos and high-speed trades are not insignificant.
The editorial said that programmed traders are already required to get all their algorithms vetted by exchanges before they deploy them. Also, each trade is subject to price, quantity and value filters set by exchanges. Regulations also penalize players with high order-to-trade ratios to discourage frivolous orders.
Furthermore, a recent SEBI notice has made it compulsory for exchanges to offer co-location facilities in a fair and transparent manner to all those who demand them.
But more might be needed to keep HFT on the up and up.
The editiorial pointed out that SEBI is also considering other measures, such as minimum waiting times for high-speed trades and a random priority for orders, to level the playing field; but the worry is this will impact market liquidity.
“All in all, we have no choice but to live with high-speed and algo trading, despite their potential to aggravate market risks. While SEBI can do very little to whittle away the edge that high-speed traders have in intra-day trades, it can certainly do more to prevent the same traders from manipulating the markets by exploiting insider information or indulging in front-running. These have the potential to harm long-term investors in equity.”
Also, “It should also ensure that mutual funds, insurance companies and pension funds make active use of execution algos and co-location facilities for more efficient trades. Arming these institutions with technology may be the best way to reduce the handicap that the small investor suffers vis-a-vis high-speed traders in the equity sweepstakes.”
This op-ed article was originally published on August 10, 2015
