Brokers fund options traders through NBFC arms, bypass SEBI rule

Brokers are offering this facility for low-risk options trading and only to high networth traders with a proven track record and corporate treasuries.

A few domestic brokers are funding big-ticket options traders through their non-banking finance company (NBFC) arms, two people from the broking industry aware of the arrangement told Moneycontrol. This is in violation of the Securities and Exchange Board of India (SEBI) rule that forbids brokers from funding client positions either directly or through NBFC arms.

The brokers are offering this facility specifically for low-risk options trading and only for high networth traders with a proven track record and corporate treasuries.

“The brokers are funding options trades for as low as 4-5 percent annually because the risk is low and there is a lot of interest from high-volume traders,” said one of the two people mentioned above.

Though the market is at record high levels, the average daily cash turnover of around Rs 60,000 crore in May and June is still around 25 percent lower than the peak of Rs 81,000 crore in October 2021 when the Nifty last peaked.

On the other hand, turnover in the options segment has been steadily increasing. In FY23, options turnover on the National Stock Exchange (NSE) was Rs 120 trillion, almost twice the turnover of the previous year.

Moneycontrol has sent a query to SEBI and will update the copy when the regulator responds.

Modus operandi 

A client with Rs 10 crore goes to broker X who has an NBFC arm. The client opens a bank account for which the power of attorney will be with the broker. Into this account, the NBFC arm of the broker will transfer Rs 20 crore or more as unsecured loan, with the amount depending on the broker’s confidence in the client. Of the Rs 30 crore, Rs 10 crore is deposited with the broker as margin money.

“The is an unwritten agreement between the broker and the client that if losses exceed a certain threshold, say Rs 5 crore, then either the broker deducts that sum from the margin money or the client makes up for the margin shortfall by bringing in funds from other sources,” the source said.

“And since the strategies are low risk, the probability of losses exceeding the amount deposited as margin (by the client) is low, making it a cosy deal for both the broker and the client.”

Technically, while brokers can use the same arrangement for intra-day cash market trades as well, they do not do so as such transactions are easier for SEBI to detect.

“Previously brokers used to offer the facility for intra-day trades, but during inspection, it was easy to notice that every day the client’s ledger with the broker would show an inflow in the morning and by the end of the day, it would be zero after the funds were withdrawn.

“With F&O trades stretching over a settlement cycle or even two, it is harder for SEBI to prove a link between the broker’s NBFC arm and the client unless SEBI digs deeper for the source of funding,” the person said.

But this is not the only game in town. Because of the explosive growth in options trading over the last couple of years, many brokers are coming up with innovative arrangements to woo high-volume options traders.

Market participants say quite a few of the lesser-known brokerages have entered into deals with options traders who use algorithm-driven strategies.

The brokers offer their application programming interface (API) feed to their clients, giving them access to real-time prices and the clients run their algorithms on the broker’s trading platform.

These trades are passed off as proprietary transactions by the brokers, which in reality are being done by the clients. Such an arrangement allows brokers to give a much higher leverage to clients than would otherwise be possible under the regulations.