If you have started or planning to start services for algo based advisory, chances are you will find yourself at complete sea as to which SEBI regulations do you fall under.
Is it the SEBI Investment Advisers regulations?
Or the SEBI Research Analysts regulations?
Or the SEBI Portfolio Manager (PMS) regulations?
Well, frankly, I have found it to be a grey area too.
Let’s see why that is the case.
In 2013, SEBI introduced regulations for investment advisors and financial planners. Subsequently, in 2014, SEBI introduced regulations for the research analysts.
Just to give you a brief, an Investment Adviser provides personalized advice to their clients as well as provide portfolio services including rebalancing strategies. The advice is given based on the risk profile and investment requirements of the client.
A Research Analyst provides buy / sell recommendations on stocks (and other securities) along with a detailed report containing rationale for the recommendation.
A Portfolio Manager manages clients’ money on a discretionary or a non-discretionary basis.
Now, there is a certain class of advisors who want to provide automated advice to investors; which is neither personalized nor given by a human.
Automated advice can be provided either through Robo-advisory or through algorithmic advisory, commonly known as “algo trading”.
What is Robo-advisory?
Robo-advisory works with a pre-defined algorithm and analytics, and calculates the best returns and plans for each individual as per his/her requirements and preferences.
What is Algo advisory?
Algo trading is a computerized trade mechanism where the coder or the owner of the algos feeds specific instructions / rules into a software and the entry and exit levels or signals are determined.
Once the subscriber accepts any algo-trading strategy, the trades are automatically placed at prices determined by predefined rules for that particular security. We can say that it is like a discretionary service where the algo software has the discretion.
So, there is no human involvement in algo advisory and trading except for writing of algos.
How different is algo trading from Robo-advisory?
Robo-advisory is comparatively more comprehensive and flexible where the investors get an option to go ahead with the advice and approve execution of trades. Whereas in algo trading the investors may not have any control on the frequency of the trades for a particular security as they get executed automatically.
Robo-advisors may provide personalized portfolios whereas in algo trading there is no personalization of advice. In algo trading the subscribers subscribe to a particular strategy based on the description given by the algo owners.
My general observation is that advisors who want to advise on mutual funds or want to provide a portfolio use the Robo-advisory route. Whereas, traders and advisors on stocks and indices use algo trading.
A fee is charged under both mechanisms for providing advice.
So where does “Robo-advisory” fall in terms of regulations?
There is no definite regulation governing Robo-advisors.
However, as per the Consultation Paper on Amendments/Clarifications to the SEBI (Investment Advisers) Regulations, 2013 dated October 7, 2016, “Under IA Regulations, there is no express prohibition for use of automated advice tools by SEBI registered investment advisers”.
The consultation paper also proposed compliance requirements for investment advisers providing online investment advisory services using automated tools in addition to the compliance with the existing provisions of IA Regulations.
Although this was not added in the amendment regulations, we now know what SEBI thinks about Robo-advisors. We can safely assume that Robo-advisors come under Investment Advisers regulations.
Click here to know more on Robo-advisors registration with SEBI.
But where does advisory through “algo trading” fall in terms of regulations?
There is no standalone regulation governing algo trading.
If you were to pick from within the current set of regulations SEBI has for advisory business, you can end up quite confused.
Let’s try and fit in.
– Investment Advisers regulations – There is no personalized service. Though advice is given but it is not given for the benefit of the client. There is no risk profile or suitability assessment done for any client. The algo owners do not assume any fiduciary responsibility. So, no.
– PMS regulations – Can’t be as there is no money being managed. The subscriber decides in advance about the money to be invested and / or the lot size to be bought. The trades are executed automatically at the broker’s end based on the levels determined by the algo software which no one has control on. Again, the algo owners do not assume any fiduciary responsibility.
– Research Analyst regulations – Possibly, as there are recommendations given in the form of signals based on technical research and analysis. However, there is no research report issued to the subscribers. The algo owners also may not give detailed information about their “secret” strategies in the form of a report. The trades get executed at the broker’s end based on the signals given by the algo software.
You see where I am getting to.
It’s a grey (or blue or green) area. The service providers need better clarity from SEBI.
In my view, if you are offering algo based services today, the most reasonable regulation for now is the Research Analyst regulations.
It appears to cover some aspects:
- There is no personalized service.
- There is some technical research and analysis while writing algos.
- The signals may be termed as buy / sell recommendations.
- Some algo owners do provide some basic information about the parameters in the strategy used along with price charts which can be made in the form of a research report.
- The research analyst regulations do not put any fiduciary responsibility on the research analysts which holds good for algo traders too.
Remember though, if you as an algo owner get registered as Research Analysts, you will have to take care of the restrictions on your personal trading. You also cannot charge a fee as a percentage of profits.
Finally, don’t ignore the regulations. You must register specially if you are charging fees.