Markets regulator Sebi on Tuesday issued a detailed guidelines for regulation of algorithmic trading in the commodity market.
Algorithmic trading or 'algo' in market parlance refers to orders generated at a super-fast speed by use of advanced mathematical models that involve automated execution of trade, and it is mostly used by large institutional investors.
The regulator said that stock exchanges will have to ensure that immediate or cancel orders are not placed through the algo trade route.
To promote fair use of the trading platform, Sebi said there will be some economic disincentives for algo trades based on the order-to-trade ratio.
The regulator said that only a portion of orders placed through trading terminals are executed due to non-fulfilment of certain conditions or cancellation by clients. Based on the daily order-to-trade ratio of the client, an additional charge ranging from 1-5 paise will be imposed on all algo orders.
According to Sebi, commodity exchanges will be able to process 20 orders per second from a user, irrespective of the order size. In case the order-to-trade ratio of a member reaches 500 during a trading day, the member will not be allowed to place any order for the first 15 minutes on the next trading day as a cooling off action.
"As mini and micro contracts are targeted towards small participants, while allowing algorithmic trading in mini and micro contracts exchange should exercise caution and permit algorithmic trading only after taking into account liquidity in the contract and ascertaining that it will not put small participants in disadvantage," Sebi said in a circular.
Co-Location, Co Hosting involves setting up servers on the exchange premises, which puts some members in disadvantageous position vis-a-vis other members would not be allowed.
"Algorithmic trading shall not be permitted from exchange hosted CTCL terminals," Sebi added.
The regulator asked commodities exchanges to submit a monthly report on algo trading, including its percentage in total trade and the number of members of using such trading.
The exchange would have appropriate multi-layer risk control mechanism to address the risk emanating from algo orders and trades.
While approving the algo trading, the exchanges would have to ensure that they would not approve algo trade that may not be conducive to efficient price discovery or fair play.
The exchanges would have arrangements, procedures and system capability to manage the load on their systems in such a manner so as to achieve consistent response time to all members.
The capacity of the trading system of the exchange should be at least four times the peak order load encountered and the exchange system should be upgraded on a regular basis.
The exchanges would have to continuously study the performance of its systems and, if necessary, undertake system upgrade, including periodic upgrade of its surveillance system, in order to keep pace with the speed of trade and volume of data that may arise through algo trading.