Why do brokers, fintechs worry about different proposals from SEBI?

What is SEBI’s proposal and why?

When retail investors subscribe to algo services, a working group constituted by SEBI gives responsibility to the brokers as intermediaries and to the exchange as the first line regulator. This is a sensible approach to reduce the development of unauthorized algorithms targeted at retail investors. Almost all fintech brokerages like Zerodha and Upstox provide such services to retail investors. However, the number of investors subscribing to algo services through these SEBI-registered intermediaries is small. Unregistered platforms, at times, provide investment advice, which is in violation of regulatory norms.

What worries fintechs and brokerages?

Currently, all algos need to be approved by exchanges. The SEBI paper confirms this. Further, the market regulator has labeled all application program interfaces (APIs) as algos. Therefore, the API may require approval from exchanges. Many brokers outsource their algo services to third party vendors. According to the paper, the broker will be responsible for these too. For example, if there is a slight change in the algo strategy, if a trader wants to change the price level to exit a particular stock, that would also require the approval of the exchange. All of this can drive up the cost of compliance.

Can Intellectual Property (IP) be Compromised?

Third-party tech platforms and traders will be required to share their algos and APIs with brokers for approval. Fear: Chances are that some brokerages may repeat the algo strategy. It can compromise the IPs of tech firms. Traders are against brokers running their trading strategies on the end because it provides little control during market hours if things go wrong.

What is the broader concern of SEBI?

The COVID-19 pandemic increased retail participation through algorithms. Many experts say the paper reinforces the market regulator’s belief that retail investors should be kept away from the little-known risks of algos for their own good. Some of the algorithms being offered to retail investors are quite simple. For example, ‘Buy 100 shares of Reliance Industries Limited (RIL)’ when the price is 1,000′. If it stops, the investor will have to manually check the chart for buy and sell signals.

What is the way forward?

SEBI has sought feedback on the paper by January 15 next year. The regulator is ready to make changes to ensure that innovation and market growth are not stalled at the expense of investor protection. However, SEBI may take steps to ensure that the broker does not falsely promote or promote return guaranteed algo trading to retail investors. Having said this, the easiest way for SEBI and the exchange to protect the interests of retail investors is through education.