Algorithmic Trading Audit
SEBI mandates that stock brokers and proprietary trading firms using algorithmic or automated order routing systems undergo an annual systems audit conducted by a SEBI-empanelled auditor to verify algorithmic controls, risk management systems and order log integrity.
The algorithmic trading audit requirement emerged from SEBI's broader efforts to ensure market integrity as electronic and algorithmic trading grew to account for the majority of exchange volumes. SEBI's circular framework for algorithmic trading, periodically updated since the initial guidelines in 2012 and the comprehensive framework in 2013, introduced the mandatory annual systems audit as a cornerstone of oversight.
The scope of the algorithm audit covers multiple dimensions. Risk controls are a primary focus: the auditor verifies that hard limits on order quantities, order values, order-to-trade ratios and maximum open positions are embedded in the trading system and cannot be overridden without authorisation. The kill switch mechanism — the ability to immediately halt all algorithmic activity — must be tested for functionality and response time. Latency parameters, order routing logic and co-location arrangements are also reviewed.
System log integrity is a critical component of the audit. Trading systems must maintain comprehensive, time-stamped logs of every order generated, modified or cancelled, including the algorithmic logic that triggered the action. These logs must be preserved for several years and be available to exchanges and SEBI upon demand. The audit verifies that logging is complete, tamper-proof and correctly timestamped.
SEBI requires that the auditor be from a panel of information systems auditors maintained by the exchanges. The audit report must be submitted to the relevant exchange within a prescribed timeline, and material non-compliances must be rectified and reported. Exchanges review audit reports and may take supervisory action, including restricting algorithmic access, for persistent non-compliance.
For technology and trading infrastructure providers, the annual audit creates a recurring compliance workload. For institutional investors running proprietary algorithms or accessing market data for automated strategies, understanding the audit requirements is essential for structuring technology arrangements with their brokers. The audit framework has evolved to also cover direct market access (DMA) clients, placing compliance obligations on both the broker offering DMA and the institutional client using it.