In a move that will add to the working capital requirements of stock brokers, the Securities and Exchange Board of India (Sebi) has prohibited the utilisation of clients' funds for the creation of bank guarantees.
Per the current prevailing practice, stock brokers and clearing members pledge client funds with banks which in turn issue Bank Guarantees (BGs)to clearing corporations for higher amounts. This implicit leverage exposes the market and especially the client's funds to market risks.
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The market regulator has directed that from the beginning of May, no new BGs shall be created out of clients’ funds by stock brokers and clearing members. Secondly, existing BGs created out of clients’ funds shall be wound down by September 30 of this year.
The regulator has also clarified that the provisions of this framework shall not be applicable to proprietary funds of stock brokers and clearing members in any segment. Any proprietary funds of the stock broker deposited with CM in the capacity of a client will also not attract the provisions of this circular.
Further, additional monitoring and reporting burden has also been imposed on stock exchanges and clearing corporations. Starting from June 1 this year, exchanges and clearing corporations will have to submit collateral data which will concern itself with further classifications, namely, the total BG amount as collateral raised by a broker or clearing member, the portion marked clients funds out of the total raised BGs, and the total portion marked as proprietary funds out of the total raised BGs.
For now, stock brokers and clearing members have been directed to provide a certificate, by a statutory auditor confirming the implementation of this mechanism. The regulator has directed that such a certificate should be submitted to stock exchanges or clearing corporations by October 16 this year.
On the other hand, stock exchanges and clearing corporations have been mandated to verify the compliance of the provisions of the circular in their periodic inspections and reporting. They have also been directed to evolve adequate mechanisms to address cases of stock brokers and clearing members who do not comply with the provisions of the circular by the stipulated dates.
"The circular issued by SEBI is a step in the right direction to safeguard the interests of investors and maintain the integrity of the Indian stock market," Tejas Khoday, Co-founder and CEO of FYERS said. FYERS is a new-age online trading and investment platform.
He added that the practice of brokers pledging clients' funds to create bank guarantees for their own use had the potential to increase leverage and risk exposure for clients, which could have resulted in adverse effects on the market.
"By prohibiting brokers from creating bank guarantees out of clients' funds, SEBI is taking a strong stance against any potential misuse of client funds. The winding down of existing bank guarantees from clients' funds by September 30, 2023, will provide brokers sufficient time to adjust their operations and comply with the new rules," Khoday added.
The CEO of the brokerage house also laid stress on the fact that the circular will not affect day-to-day trading for investors unless the said investors are using leverage to fund their F&O positions other than what is mentioned in the circular.
"Brokers must also ensure that their proprietary funds are not affected by this framework. SEBI's monitoring and reporting mechanisms will help prevent any future violations of this circular and ensure that brokers comply with the provisions within the stipulated timeframe. Overall, this move will help protect the interests of investors and promote a fair and transparent market for all participants," Khoday said.
