SEBI’s New Regulatory Framework for Retail Algorithmic Trading

Posted On - 27 February, 2025 • By - Asha Kiran Sharma

Introduction

Algorithmic trading has witnessed an evolution from being just a tool mainly used by institutional investors to an area of significant interest among retail traders. Such trading allows for automated execution of trades and provides speed and efficiency. However, concerns over market integrity, investor protection, and misuse have been brought to light. This has prompted SEBI to impose stricter controls over the years.

SEBI has now recognized the increasing demand from retail participants and introduced a structured approach to ensure safe access while mitigating risks. The recent circular lays down clear roles and responsibilities for investors, brokers, algo providers, and stock exchanges. It aims to balance innovation with regulatory oversight and market stability.[1]

Background

  • SEBI issued broad guidelines on Algorithmic Trading (“Algo Trading”) via a Circular dated March 30, 2012.[2]
  • Over time, SEBI has introduced stricter controls around algo trading to maintain market integrity.
  • Algorithmic trading offers benefits like timed and programmed execution of orders, primarily used by institutional investors.
  • There is growing demand from retail investors for algo trading.
  • To facilitate safer participation of retail investors while ensuring risk management, SEBI has reviewed and refined the existing regulatory framework.

Regulatory Objectives

Define the rights and responsibilities of key stakeholders, including:

  • Investors
    • Brokers
    • Algo Providers/Vendors
    • Market Infrastructure Institutions (MIIs)

Ensure retail investors can participate in algo trading with adequate safeguards.

Development of the New Regulatory Framework

  • SEBI issued a discussion paper on December 9, 2021, regarding algo trading by retail investors, API access, and automation of trades.[3]
  • Consultations were held with:
    • Stock Exchanges
    • Stock Brokers
    • Algo Providers
    • Intermediary Advisory Committee
    • Broker’s Industry Standards Forum (ISF)
  • After extensive deliberations, SEBI has now introduced a comprehensive regulatory framework for retail algo trading.

Key Provisions in the Circular

Use of Application Programming Interface (API) for Algo Trading

  • Brokers will act as the principal, while Algo Providers (fintechs/vendors) will act as their agents.
  • All algo orders routed through APIs provided by brokers must be tagged with a unique identifier issued by the stock exchange.
  • Retail investors developing their own custom algo strategies must register their algos with the stock exchange if they cross the specified order-per-second threshold.
  • Registered algos can be used by the retail investor and their family members (self, spouse, dependent children, dependent parents), but not for other investors.
  • Brokers’ obligations:
    • Detect and categorize all orders above the threshold as algo orders.
    • Disallow open APIs—access permitted only through vendor-client-specific API keys and static IP whitelisting.
    • Use OAuth (Open Authentication) as the only authentication method; all other methods to be discontinued.
    • Enforce two-factor authentication for API access.
    • Empanel only registered algo providers and handle all investor complaints, as algo providers will be considered agents of brokers.

Roles & Responsibilities of Stock Brokers

  • Brokers must obtain stock exchange permission before offering algo trading facilities.
  • Each algo order must be tagged with a unique identifier for audit purposes.
  • Any modifications or updates to approved algos require prior exchange approval.
  • Brokers will be solely responsible for:
    • Handling investor grievances related to algo trading.
    • Monitoring API activity to prevent prohibited practices.

Empanelment & Registration of Algo Providers

  • SEBI will not regulate algo providers directly, but they must be empanelled with stock exchanges for better oversight.
  • Stock exchanges will establish empanelment criteria for algo providers.
  • Brokers must conduct due diligence before onboarding an empanelled algo provider.
  • Revenue-sharing model:
    • Algo providers and brokers can share subscription charges and brokerage fees collected from clients.
    • However, brokers must provide clear disclosures of all charges to clients.
    • The arrangement must not create conflicts of interest.

Role & Responsibilities of Stock Exchanges

  • Stock exchanges remain responsible for supervising algo trading and must ensure:
    • Standard Operating Procedures (SOPs) for algo testing.
    • Surveillance of algo orders and market monitoring, including simulation testing.
    • Ability to use a “kill switch” to disable malfunctioning algos.
    • Clear definition of brokers’ and algo providers’ roles, responsibilities, and empanelment processes.
  • Exchanges must inspect brokers to verify their ability to distinguish between algo and non-algo orders.
  • Exchanges will issue detailed FAQs and operational guidelines, covering:
    • Brokers’ risk management systems for API orders.
    • Roles & criteria for empanelment of algo providers.
    • Registration process for algos and conditions for requiring re-approval.
    • Confidentiality safeguards for retail algo trading strategies (NDAs, encryption, etc.).
    • Data flow mechanisms between algo providers, brokers, and stock exchanges.
  • Exchanges will define a Turnaround Time (TAT) for algo registration:
    • Execution algos (White Box) may be registered on a fast-track basis.
    • Other algos may require normal registration timeframes.

Categorization of Algos

SEBI has introduced two categories of algos:

  • Execution Algos (White Box Algos): Transparent logic, fully replicable by users.
  • Black Box Algos: Logic is not visible or replicable by the user. Algo providers offering Black Box algos must:
    • Register as Research Analysts (RA).
    • Maintain a detailed research report for each algo.
    • If an algo’s logic changes, it must be re-registered and a new research report must be maintained.

Compliance with Existing Algo Trading Regulations and Implementation Timelines

  • Brokers and exchanges must continue to comply with all existing algo trading regulations issued by SEBI.
  • By April 1, 2025 – The Broker’s Industry Standards Forum (under SEBI and stock exchanges) will finalize implementation standards.
  • By August 1, 2025 – The provisions of this circular will become fully applicable.

Conclusion

This recent circular by SEBI has reshaped algo trading. It has attempted to a strike a balance between innovation and regulatory oversight. It clear defines the roles of brokers, algo providers, and retail investors, which ensures accountability and at the same time also allows controlled access. It places certain restrictions on open APIs, mandatory registration of algos, and enhanced broker responsibilities, which mitigate risks such as market manipulation and unauthorized automation.

It further adds another layer of protection for investors by requiring that Black Box algo providers register as Research Analysts. These measures give rise to clarity and security, but at the same time, also raise compliance costs for brokers and fintecs, which need to be addressed.

[1] https://www.sebi.gov.in/legal/circulars/feb-2025/safer-participation-of-retail-investors-in-algorithmic-trading_91614.html.

[2] https://www.sebi.gov.in/sebi_data/attachdocs/1333109064175.pdf.

[3] https://www.sebi.gov.in/reports-and-statistics/reports/dec-2021/consultation-paper-on-algorithmic-trading-by-retail-investors_54515.html.