The Securities and Exchange Board of India (Sebi) has flagged risks of tax evasion and misuse arising from Client Code modifications (CCMs) and Custodian Participant (CP) code allocations in the securities market, and as per sources, during a recent discussion, the regulator said while it is keen to allow flexibility for correcting genuine errors, particularly in institutional trades, it must also ensure that such relaxations do not compromise market integrity.
In financial markets, Client Code Modifications (CCMs) refer to changing a client's identification code after a trade has been executed, mainly to correct punching errors and mistakes during order entry.
One of the regulator’s key concerns is that modifications of client codes, either on the exchange or at clearing corporation level, should not facilitate tax evasion. In the case of Foreign Portfolio Investors (FPIs), intra-group reallocations across different Permanent Account Numbers (PANs) could amount to a change in beneficial ownership.
Similarly, allowing multiple client codes per PAN with a trading member raises risks of circular trading and artificial volume creation. Currently, allocation of CP codes for banks, mutual funds, pension funds, insurers, and public financial institutions is done at the clearing corporation level, however, it is not monitored for changes in beneficial ownership.
Sebi has also flagged off inconsistencies in the penalty framework at exchange and clearing corporation level in such cases.
As per sources, Sebi is exploring whether exchanges should permit multiple client codes per PAN with safeguards, strengthen monitoring of CP allocations, and adopt uniform penalties for modifications beyond FPI families.
The regulator is also examining the exemptions to ETF market makers for transferring trades to asset management companies (AMCs), and whether the definition of “genuine errors” should be broadened.
Stakeholders have argued that penalties - currently levied at one percent of trade value - are disproportionate to errors, especially given the large volumes handled by FPIs and institutional clients. They have also sought clarity on expanding the scope of genuine errors. Past instances where exchanges allowed CCMs between unrelated institutional investors have already drawn regulatory scrutiny, highlighting the need for consistent oversight.
Client Code Modification and Concerns
Client code is a unique trading identifier assigned to investors, which sometimes require modification when manual errors occur during an order entry. For example, a broker may mistakenly record Client X’s order under Client Y’s code. Such corrections are particularly common in the institutional segment, where brokers execute trades on behalf of clients and later transfer the securities to the rightful account. Similarly, a mutual fund company may purchase a share under one scheme and subsequently reallocate it to another.
However, over the years, client-code modifications have come under Income Tax Department’s radar as they have also been misused as a tool for tax evasion. In some cases, investors have shifted positions to others for the purpose of booking artificial losses, which can then be set off against capital gains, thereby distorting the true picture of market transactions.
Way Forward
Sebi is now of the view that a principle-based approach can be adopted towards identification of client categories for which multiple client codes are linked to same PAN, and a subsequent modification may be allowed for operational reasons without penalty. Exchanges can decide the list of such client categories based on approval from their Regulatory and Oversight Committee. However, exchanges must ensure that it should not compromise on market integrity such as tax evasion and misuse, like circular trading.
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