Near the bottom of the financial meltdown of 2008, Indian markets received the much-needed booster dose from none other than its regulator Securities and Exchange Board of India (SEBI). When brokers around the country were closing shop on account of defaulting clients and lack of business, the regulator gave clearance to a system which not only revived the broking community, stock exchanges but also the banks that were dealing with the exchanges.
The Game Changer
On April 3, 2008, SEBI allowed Direct Market Access or electronic interaction which allows buying or selling of orders by institutional clients without manual intervention. Direct Market Access allows clients to access the exchange trading system through brokers’ infrastructure. Earlier a manual intervention or confirmation was needed to execute the trade, but the 2008 notification changed the way algorithmic trading takes place in India.
Such was the impact of the notification that within two months most of the leading Indian brokers had signed up for starting algo trading. By February 2009, the platform was opened for foreign institutional brokers who lapped up at the opportunity and within months most were registered.
Within a few month of opening up, many foreign brokers started trading operations in the country thus reviving market volume. This, in turn, had an overall impact on the market which saw many investors entering the market and reviving it. The timing also coincided with coordinated quantitative easing by various central banks across the world which saw money entering Indian markets to capitalize on the opportunity in the country.
Slowly algorithmic trading started picking up and captured market shares from conventional broking and arbitrage. In less than a decade they now account for nearly half of all volume that is traded on the bourses. Over the last five years, its market share which was around 6-7 percent has increased to around 50 percent. This is the highest market share in the equity markets among the developing world.
World Class Infrastructure
The jewel in the crown for India in terms of algorithmic trading is that the Bombay Stock Exchange (BSE) is the fastest exchange in the world with a processing time for trades at 6 microseconds.
Both the bourses in India – BSE and NSE have introduced co-location services that allow traders to put their computers in exchange data centers in order to execute faster. In a game where trades are completed in Micro and Milli seconds, speed and high-speed access to data are a game changer. The stock exchanges have ensured that they are among the best in the world.
These exchanges have set up systems that do not require fund managers to be present in India, trades can be executed at a fast speed even if the fund manager is sitting abroad through a Financial Information Exchange (FIX) protocol. This allows standardization of order flow irrespective of the way in which the fund managers put their orders globally.
World Class Resource Base
India is known for its mathematical and computation capability around the world. These are the two main ingredients required for algorithmic trading. Many fund managers in algo trading companies are Indian. This augurs well for algo trading’s future in the country, especially when viewed from the point of view of a fund that plans to set shop in India.
Further, the banking system and the support system of registrar and custodian which already supports big players in the world gives confidence to those new international players who will have no apprehension before setting shop in India.
The very fact that computer based trading accounts for nearly half the volume on the exchanges suggests the potential of algorithmic trading in India. Most of the top names in the world of algo trading are either operational in India or are contemplating entry in the country.
Critics however say that Indian rules for trading are cumbersome. Market regulator and the finance ministry are working closely to ease the entry and exit of funds in India.
However, the biggest drawback for algo trading is India is that the country is one of the costliest places to trade. A number of taxes and charges that are built up on each trade is the highest in the world. Exchanges in order to incentivize algo traders generally waive their charges or reduce it.
Further, Indian exchanges and the regulator has put in stringent risk management systems where each fund has to undergo stringent tests which check the orders placed per second, maximum order that can be placed and maximum quantities that can be traded in a day by the fund. Given the size of the Indian market as compared to others globally, these measures are necessary. There are voices that are asking for tighter norms to prevent over exposure of algo traders in Indian markets.
Having said that, Indian markets are geared up for the best in class traders in the world with sophisticated technology and seamless infrastructure, smart order routing system and enough liquidity to absorb the volume.
Opportunities for algo trading in India are also possible with the growth of commodity markets in the country. With the possibility of arbitrage between India – one of the biggest commodity consuming market and other markets across the globe algo trading has a bright future in the country.
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With more funds getting attracted to algo trading and training institutions being set up to teach the subject, India has the potential of being one of the biggest resource for algo traders across the world.
All the ingredients needed for resources future of algo trading is in place in the country. If the cost of trading is brought down and the country goes in for capital account convertibility of its currency, algo trading can pick up further.