Sebi eyes ways to cut risks from high frequency trading

Mumbai: U.K. Sinha, chairman of capital markets regulator Securities and Exchange Board of India (Sebi) said on Thursday the regulator is in discussions with global experts and regulators on risks from high frequency trading (HFT).

Sebi is also looking at bringing changes in the so-called consent mechanism norms and allowing cases without any market-wide impact to be settled through a mutually agreed fees to the regulator. Sinha was addressing the South Asia Risk summit organized by Thomson Reuters in Mumbai.

“Corporations should be open to a culture of compliance for effective and timely supervision. Sebi and the government are actively working towards streamlining processes and driving use of technology for efficient functioning. Continuous monitoring and supervision is an ongoing challenge but we need to be prepared with robust risk management systems, as we work with the global regulators to build common standards for risk. As a nation, we need to imbibe a culture of appreciating guidelines and regulations, take a forward view and set up systems to analyze early warning signals and alerts which keeps us ahead of the curve,” Sinha said.

On the sidelines of the summit, Sinha said while Sebi has taken cognizance of the potential problems involved with HFT and has put in place some checks and balances already, like other global regulators, a final solution is yet to be arrived at.

HFT, done through dedicated algorithms, refers to the use of electronic systems, which can potentially execute thousands of orders on the stock exchange in less than a second, which gives them an advantage over conventional traders.

For enabling HFT, brokers set up servers on the exchange premises, typically called co-location. This reduces time it takes for an order to travel to the exchange, giving them a speed advantage over those who are farther away.

Sinha said apart from approaching external advisers on HFT, the market regulator is also independently working with its in-house team to recommend norms to take care of risks arising out of rising HFT.

On 27 May, Mint reported that the capital markets regulator is considering hiring an external agency to advise it on ways to mitigate risks from rising HFT.

“Sebi has realized that some norms are required to be introduced to ensure that there is a cooling-off mechanism for HFT orders,” one of the two persons cited in the report had said, adding that increasing use of HFT is putting non-HFT traders and investors at a disadvantage.

According to data available with Sebi, the share of HFT as a percent of total orders and turnover has been rising steadily. In 2011-12, HFT orders as a percentage of overall orders in the cash equity segment was at 65%. This has gone up to 94% in 2015-16. HFT turnover as a percentage of overall turnover in the cash equity segment has gone up from 25% to 42% over the same period.

In the equity derivatives segment, the percentage of HFT orders has gone up from 78% to 98% between fiscal 2012 and fiscal 2016. The share of turnover has risen from 22% to 56%.

According to the Mint report, Sebi may introduce a pilot project for hedging against HFT risks which will include introduction of “speed bumps” for HFT, order-bunching of trades and some sort of call-auction mechanism, similar to the present system followed under pre-market opening mechanism.

A final call on HFT will be taken only after extensive consultations, one of the persons in the report had said.

“If the regulator ensures that the (price) information is broadcasted to all the market players at the same time it would largely address the concerns of few algo players getting unfair market access. Such measures would ensure that there is level-playing field without impacting liquidity,” said Ajit Hakani, manager, Greeksoft Technologies.

On Thursday, the regulator also touched upon planned changes to the consent mechanism.

Sinha said Sebi will allow a case to be settled through consent if the impact of the breach was insignificant on the market. “This will help in clearing off a lot of pending cases. We approved the changes in the form of guidelines. We will soon make it part of regulations to make it more effective,” he said.

On Wednesday, Mint reported that Sebi’s new line of thinking on the so-called consent process could reduce the administrative burden on the stock market regulator and also pave the way for the settlement for some old cases.

According to two people familiar with the matter, the market watchdog is likely to allow most capital market infractions to be settled under the consent mechanism where a fine is paid without any admission of wrongdoing.

Only those violations that have a market-wide impact and where the losses to investors are significant can’t be settled under the mechanism, according to two people cited in the Mint report.

The consent process was introduced in 2007 with the idea of reducing the regulatory time spent on minor violations and avoiding unnecessarily hurting the defaulter’s reputation for small infractions. However, relatively serious violations, such as insider trading, fraudulent and unfair trade practices, among others, cannot be settled via consent.

The latest modifications in the consent and settlement proceedings being considered will be effective for all the cases which await the final order from Sebi.

Sebi has defined “market-wide impact” as those cases that have a bearing on the broader securities market and not just on one listed security and its investors. The second criteria, “substantial impact of default on investors”, depends on the number and quality of complaints.

Irrespective of the quantum of illegitimate gains made by the defaulter, violations that have not had a market-wide impact or not caused substantial loss to investors will be eligible to apply for settlement under consent mechanism.