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Algo restrictions: Trading volumes may see shift to Nifty derivatives on SGX

by April 13, 2016 General

At a time when markets regulator Sebi is working on the final guidelines to regulate high frequency trading (HFT) and algorithm trading, market participants have expressed concerns that such regulations would lead to a migration of the trading volumes to Nifty derivatives listed on the Singapore Exchange (SGX). These concerns come at a time when foreign funds investing in Indian markets are preferring the SGX platform instead of trading on the Indian bourses due to uncertainty over general anti-avoidance rules (GAAR).

The Securities and Exchange Board of India (Sebi) does not have jurisdiction over Nifty derivatives listed on SGX. Instead, these derivatives are regulated through the laws enacted by the Monetary Authority of Singapore (MAS) and the Commercial Affairs Department (CAD).

“All the institutional investors, foreign portfolio investors (FPI) and hedge funds use algo trading and HFTs extensively. As they trade in high volumes, even a price point change would have a significant impact. Hence, these investors would consider shifting to SGX,” said the head of derivative operations of a leading domestic brokerage.

In the last five years, the trading interest in the Nifty futures has shifted consistently towards SGX as the rollout of GAAR had been delayed. GAAR is an anti-tax avoidance regulation which was proposed in the Direct Taxes Code 2010 and targeted at arrangement made specifically to avoid taxes. Currently, derivatives in SGX contribute to about one fourth of the total trading volume in the NSE.

The possible measures that could be incorporated in the final Algo-regulations include determination of the resting period and fixing a benchmark for order-to-trade ratio, sources told FE. These measures are expected check volatility, price manipulation and level the playing field between those using algorithms for their trades and those who don’t.

The resting period is the period after which an order punched can be cancelled. This would help eliminate fleeting orders — those appear and disappear within microseconds. The resting period would prevent traders from cancelling or modifying an order immediately after its submission.

The order-to-trade ratio is the ratio between number of orders placed and those that get traded. These days, in order to lower the entry price, some algorithms enter big bids and immediately cancel them to create artificial weakness in a stock. By fixing a high order to trade ratio, Sebi can curb such practices.

Sebi’s initiative to regulate high speed trading comes after the Reserve Bank of India (RBI) raised concerns about algorithm trading and HFTs in its annual financial stability report released last year. The RBI had observed that the complex coding and ultra-low latency increase risks of erroneous trades and manipulations in stock markets due to advanced communication platforms. Sebi had released a discussion paper on regulating Algorithm trading in 2013.