o/l flon'ble Snri {l<.sinha, Chairman y' Securities a/dexchange Board of India SEBI Bh,/vanPlot No.C-4 A, G Block BanQ6-Kurla Complex mbai-400051 Association nges Members of India 29,2015 Respected Sir, l. This is with reference to a very serious issue affecting all brokers, especially those using algorithmic trading. We have several members against whom SEBI has passed orders imposing penalty for entering in inadvertent self trades. There are many others who have been issued multiple show cause notices for entering into self trades. These orders and notices are adversely affecting the operations and reputation of our members and consequently, hindering the development of the securities market. ' 2. There are several brokers, largely in proprietary trading, whose main business is the activity of arbitrage/jobbing. These brokers carry out the activity of arbitrage/jobbing through a number of traders/dealers employed by them, who are connected to the Exchanges server through multiple seryers. Since each of the traders/dealers adopt an independent strategy, it is quite possible that a self trade may occur at the member level. For example, suppose that at a certain point of time, Dealer 1 sees a significant divergence between NSE and BSE prices of a security, with higher price on NSE and lower price on BSE. He, thus, sends a buy order on - BSE, and a sell order on NSE to pursue his arbitrage strategy. Dealer 2, at the same time, places a buy order on NSE in pursuit of his bullish strategy on the same security. 3. The likelihood of inadvertent and incidental self trades occurring is even more when the proprietary trading f,rrm uses algorithmic software. It is globally well accepted that self trades are a natural consequence of algorithmic trading. The Australian Securities Exchange in its review of Algorithmic Trading and Market Access Arrangements dated February 8, 2010 has also explained that the relationship between increased wash trades and increased algorithmic trading is that as brokers and clients employ an increasing range of different trading strategies (connecting many different algorithms to a trading platform at a given time), thelikelihood that bids and offers entered from those algorithms will inadvertently execute against each other in the market increases. 1, 304-A, veena chamber, opp. BSE, 21, Datatstreet, Fort, Mumbai.#tJl?if:;i3,iiH'*8 / 6636 o4lt. Fax: +s1 (o) 226636 0486. Emair: anmiwr@anmi.in iloriherii I]IDIA REGIONAL GOUNCIL EASIERiI IiIDIA REGIOI{AL COUI{CIL 613 New Delhi House, Martin Burn Building, 27 Bara Khamba Road, Mezzaine Floor, Room No. 4, New Delhi 110001. Telefax: 011-2371 5131 I 32 Email: anminr@bol net in Email: anmieirc@vsnl net 1 R N Mukherjee Rd, Kolkata 700 001. No.9, Nungambakkam High Road, Teletax:035-22438214 Chennai - 600 034 Tel No.: 044-391 894481 449 Email: hozefa@naviamarkets com Website : www.anmi.in SoUTHERN INDIA REGlol{Ar CoUl{Crr (T.K.K. CHAPTER) SoUTHEB]{ tndta REG onal CoUNCtt (A.p CHAPTER) M/s. Navia Markets Limited C/o Sakeeta Consultants Ltd Ganga Griha, 4th and Sth Floor, 34-61611,llnd Floor, Paragaon Tailors Lane, Narayanaguda, Hyderabad - 500 029. Tel: 040 66775678 Faxi 040 27562182 Mobile: 09848023565 Email: cirao saaketa@rediffmail com
4. Additionally, orders fired by algorithms used by brokers are a function of the market price. The broker only provides the parameters of the algorithm but the order, which is placed by the algorithm depends upon the changes in the market price dictated by orders of the rest of the market. The Bombay High Court has also recognized that algorithms anticipate changes in the market and respond to those changes, without any human intervention. In the matter of National Stock Exchange of India Ltd. v. Moneywise Media Private Ltd. & Ors. (Order dated 9th September, 2015), it has been observed by the Hon'ble Bombay High Court that: "...Algo trades are the product of very high end mqthematical modelling. These are models devised specifically to anticipate the most microscopic changes in markets and to respond to those changes in a matter of seconds.this is done not through any humart intervention, an aspect that is totally eliminated, but in a wholly automated fashion by computer-generated or triggered transactions. " In view of the above, it is important to appreciate that the dealers of the brokers using algorithms input the strategylparameters, but not the actual price at which the trade occurs' The algorithm decides the price at which the trade ultimately occurs, after taking a cue from the market. Global Approach towards Self Trades 5. 6. To deal with self trades, there have been two approaches which have been adopted globally. The first approach that some regulators have taken the view that self trades that are not fraudulent or intentional in nature should not be penalized. This approach has been adopted in the United States and United Kingdom. ANMI had prepared a White Paper on Regulation and Prevention of Self-Trades, which dealt with the international regulatory framework on self trades. A copy of the White Paper is enclosed with this letter. In the Meeting of the Secondary Market Advisory Committee (SMAC) of SEBI held on January 30, 2014, in which I was a member, the proposal on prevention of self trade was discussed. It was felt by the Committee that self trades could be possible in the scenario when multiple traders in a broking house may be placing buy and sell orders in same scrip for different clients or multiple ALGO orders of the same broker get matched, without any intent of self execution, creation of artificial volume, manipulation, etc. There are two Executive Directors of SEBI who are members of the SMAC and other senior ofhcials of SEBI and the Exchanges also attended this rneeting of SMAC. Therefore, the Committee, including the SEBI officers on the SMAC, had recommended to SEBI that it may allow self
trades while considering imposing penalty for occurrence of only manipulative self trades. Unfortunately, it seems that the recommendation is not being followed by SEBI as our members continue to receive show cause notices for inadvertent and incidental self trades, rather than manipulative self trades. 7. 'Ihe suggested approach that SEBI may take in these self trades matters should be consistent with SEBI's proceedings in cases of premeditated and synchronized trading leading to price manipulation, where it finds that there was an intention to commit fraud, and such activity led to illegitimate profits.such practices, irrespective of whether achieved by way of self trades or otherwise should be punished. On the other hand, mere occurance of selftrades that fail the above test need to be condoned. Role of the Exchanses in Preventins Self Trades 8. The second approach that the other regulators and exchanges have mandated that the market should adopt Self Trade Prevention Mechanisms implemented at the Exchange-level to ensure that self tlades do not occur. Several exchanges including the NYSE, CME, Euronext, Canadian Securities Exchange, ICE, NASDAQ have implemented self-trade prevention mechanisms that alert the traders to the occurrence of a self-trade from the same member, and let them make a choice to either, cancel the resting order, or the aggressive order. 9. ANMI made a number of representations to NSE asking it to implement the Self Trade Prevention Mechanisms since it was not possible for the brokers to prevent such self trades at their level, without such a mechanism being provided by the Exchange. Both NSE and BSE have now adopted the Self Trade Prevention Mechanism, and the brokers are now in a position to use the current technology provided by the Exchange to ensure that self trades. don't occur. If it were possible for brokers to prevent self trades, then NSE and BSE would never have adopted the Self Trade Prevention Mechanism at their level. ln fact, BSE has adrnitted in one of the matter before the Tribunal that the self trades which occurred were accidental in nature. 10. Due to the delay in adoption of the Self Trade Prevention Mechanism at the level of the Exchanges, there are several large traders who are suffering. Recently, SEBI has taken action and penalized many brokers/large traders for self trades which occurred before 2015 (i.e. before the Self Trade Prevention Mechanism was made available by the Exchanges). SEBI has taken the stand that the brokers should have adopted a business model that would have prevented self trades from occurring. This stand is impractical since the broker has no control over who the counterparty is at the time of matching of that trade as the trading engine finds and matches orders based on price time priority. 3
ll.additionally, under the SEBI circulars dealing with algorithmic trading, there are specific roles assigned to the market participants in the algorithmic trading. The Stock Exchanges have a major role to play in facilitating and regulating algorithmic trading. For example, the Stock Exchanges are required to have appropriate risk controls mechanism to address the risk emanating from algorithmic orders and trades. Since the Fxchanges didn't provide the Self Trade Prevention Mechanism earlier, it was not technologically feasible for algo traders to prevent incidental self trades. Development of the Market 12. One of the mandates of SEBI is to promote the development of the securities market. For the development of the securities market, it is important that the market participants are encouraged to come up with innovative and cutting-edge ideas and products. The approach of SEBI in these self trades matters is discouraging to say the least, and is going to hinder future innovation in the market as it is unnecessarily penalizing an entire class of market participants for something that they could not have prevented at their level. 13. At present, the enforcement actions taken by SEBIon the issue of self trades appear to be antithesis to the globally accepted approach of dealing with self trades resulting from algorithmic trading and large scale proprietary trading. Mr. Ajay Shah, a respected policy analysticritic has also published written a blog on this issue, which is enclosed with this letter. 14. Moreover, this problem is particularly disturbing as many of our members have entered in self trades in hundreds of scrips because it was an incidental side effect of their main business. SEBI is currently issuing show cause notices to each member for every violation. Therefore, it is possible that a member could get hundreds of show cause notice because these incidental self trades occurred very frequently, prior to the implementation of the Self Trade Prevention Mechanism at the Exchange-level. The members are in effect being penalized multiple times due to the interpretation adopted by SEBI. i5. It is humbly submitted that some but not all self trading is market abuse. Financial regulators elsewhere in the world have obtained greater precision in enforcing against market abuse while not punishing legitimate actions. It is suggested that NSE and SEBI may consider writing to these global exchanges and their respective securities markets regulators to seek guidance on how they have dealt with the issue of incidental self trades, and the criteria used by them to distinguish rnanipulative and non-manipulative self trades.
16. We, therefore, request SEBI to kindly take corrective action in these matters by: (i) immediately dropping all pending Show Cause Notices in cases involving accidental/incidental self trades; (ii) settling all such maffers that are pending in the Securities Appellate Tribunal; and (iii) ensuring that there are no further regulatory actions taken against brokers who have entered into accidental/incidental self trades. In all the cases in which self trades have occurred, an undertaking may be taken from the members that they would use the Exchange-provided Self Trade Prevention Mechanism to ensure that inadvertent self trades do not occur in the future. 17. We also request you to kindly provide an appoirrt-"nt for discussing these issues with you in person. Thanking You. For Association of National Exchanges Members of India Mr. K Suresh Chairman, SEBI Affairs Committeeof ANMI With a copy to: Shri Shaktikanta Das, Secretary Department of Economic Affairs, Ministry of Finance, North Block, New Delhi - 100 001,\Q7dn.i ( ' whole Time Member Rajeev Kumar Agarwal SEBI Bhavan Plot No.C-4 A, G Block Bandra-Kurla Complex Mumbai-400051 Shri Arun P. Saathe, Advocate Part-time Member 6lg2Kitab IMh Dr D N Road Fort, Mumbai, Maharashtra 400001.rAtrri Prashant Saran Whole Time Member?\e SEBI Bhavan PlotNo.C-4 A, G Block Bandra-Kurla Complex Mumbai-400051