March 04, 2013 / 15:28 IST
Santosh Nair
Moneycontrol.com
The recent wave of selling in midcap shares could have partly to do with promoters and brokers exploiting a regulatory loophole in rules for margin financing of shares by non-banking finance companies (NBFCs), say some market players. That could prompt the RBI to tighten rules for capital market exposure by NBFCs when the recommendations on the Usha Thorat Committee (NBFC guidelines) are considered.
In margin financing, an investor puts up part of the money required to buy a stock, while the lender puts up the rest of the money.
Market sources say promoters of quite a few midcaps have been ramping up the price of their stocks using fronts to buy the shares on margin.
Sebi has clear rules for margin financing of by stock brokers, and also the shares they can lend against. Brokers can finance only 50 percent of the transaction value, and the position has to be disclosed on the stock exchange Web site.
But there are no clear guidelines as far as margin financing by NBFCs, which lend up to 70 percent of the transaction value. Also, there are no restrictions on the stocks that can be funded and the positions need not to be disclosed on the stock exchange Web site, since NBFCs are regulated by the RBI and not by Sebi.
Not surprising then that margin financing by broking firms never took off in a big way. But brokerages have managed to work their way around it and provide margin funding to clients who require it.
Most broking firms have their own NBFC arm or have tie-ups with NBFCs.
The client opens an account with the broking firm and signs up with the NBFC affiliated to the brokerage. In addition, the client opens a bank account as well as a demat account, and gives the Power of Attorney for both accounts to the NBFC.
Typically, the client puts 30 percent into the bank account and the balance is funded by the NBFC for purchase of shares. The shares go into demat account on which the NBFC has the Power of Attorney. This arrangement ensures that the NBFC can sell the shares if the price falls below a certain level and the client is unable to meet the margin call. The PoA on the
Some brokerages even specialize in providing “investors” to promoters who want to boost their stock price.
In August last year, Sebi banned 19 entities for allegedly trying to hammer the prices of Pipavav Defence, Glodyne, Parsvnath Developers and Tulip Telecom. Since then, the regulator has reversed its ruling on some of the entities. The common thread in the submissions by these entities to the regulator is that the shares were sold by brokers without even informing them once they were unable to meet margin calls. In most cases, the positions had been built on margin funding.
Both Sebi and RBI are aware that the loophole is being exploited, but the joint action needed to plug the loophole has not come so far. In fact, a Sebi order on a high profile stock market investor in August 2006 clearly said that the investor and his associates were violating RBI guidelines on NBFC lending to capital markets. But Sebi said it could not take any action as it was for the RBI to look into the violation.
Maybe it is time that RBI gave some serious thought to the matter.
These are what the Usha Thorat Committee has recommended:1.Risk weights for NBFCs that are not sponsored by banks or that do not have any bank as part of the Group may be raised to 150 per cent for capital market exposures (loan against shares, margin funding).
2.NBFCs should be subject to similar regulations as banks while lending to stock brokers and merchant banks. Further they could be subject to similar regulation as stipulated by SEBI for stock brokers while undertaking margin financing.
The moves if implemented, could spell trouble for brokerage firms with NBFC arms. With income from the broking business drying up, it is income from the lending business that has been sustaining these firms.
