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Sebi comes out with new proposal for segregation, monitoring of collateral at client level

Karvy Stock Broking crisis where clients' shares had been pledged illegally as collateral against loan.

May 11, 2021 / 07:44 AM IST
SEBI headquarters | Representative image

SEBI headquarters | Representative image

Markets regulator Sebi on Monday comes out with a fresh proposal for segregation and monitoring of collateral at client level amid instances of misuse of client collateral by trading members. Also, it has proposed to build a mechanism for reporting, dissemination and usage of information pertaining to collateral other than securities collateral received by way of pledge or repledge mechanism.

Issuing a consultation paper, Sebi said that the proposed framework is aimed at ensuring protection of client collateral. The proposal comes in the wake of Karvy Stock Broking crisis where clients' shares had been pledged illegally as collateral against loan.

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Segregation of client collateral refers to the procedures that enable identification and protection of client collateral from misuse by trading or clearing member and protection from default of such member or other clients. In the past, there have been instances of misuse of client collateral by trading member (TM) or clearing member (CM). This becomes even more accentuated at the time of default of a TM/CM, Sebi noted.

In such a scenario, not only confidence of investors in market integrity is shaken, but it also brings disrepute to the entire ecosystem of trading, it added. "It is, therefore, desirable to put in place a framework that ensures identification of each client's collateral. This would help ensure utilization of a client's collateral towards the margins of that client only," Sebi noted.

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Also, in case of default by a TM/CM, such readily available collateral information will also help ensure expeditious return of collateral to each non-defaulting clients after adjustment of any dues of the respective clients, it added. Under the proposal, the Securities and Exchange Board of India (Sebi) has suggested the process for providing collateral towards margin obligations and sought comments from public till June 24 on the proposed framework.

Clients, generally, provide collateral to the TM or the CM. In case of collateral provided to the TM, the TM may retain some collateral with itself and pass on some collateral to the CM, the regulator suggested. Similarly, CM may retain some collateral with itself and pass on some collateral to the clearing corporation (CC), it added.

"When collateral is provided onwards, it may be in the same form or in some other form (e.g. CM may receive cash but create a fixed deposit from the cash and lien mark it to the CC)," Sebi said. In case of securities provided as collateral through the margin pledge/re-pledge.

in the depository system, there is no change in the form of collateral and details regarding quantity of securities provided at each stage, retained and passed on is available with the market infrastructure institutions (MIIs) for monitoring of pledge and re-pledge. For such collateral pledged/ repledged to the level of CC, Sebi said that clearing corporation has visibility of the client to whom such securities belong to, and accordingly is able to assign the value of the securities collateral, based on applicable haircut, to that client's account.

The regulator has suggested to build a mechanism for reporting, dissemination and usage of information pertaining to collateral other than securities collateral received by way of pledge/ repledge. The proposed mechanism would capture the information pertaining to collateral provided by clients to TMs and subsequent onward submission of collateral and retention of collateral at every stage (i.e. by the TM and CM).

This would also make available the holistic information regarding the collateral at various levels to the clients. With a view to providing visibility of client-wise collateral (for each client) at all levels — TM, CM and CC — Sebi suggested that a reporting mechanism, covering both cash and non-cash collateral, should be specified by the clearing corporation.

Under this, trading members should report disaggregated information (asset type wise break-up) on collaterals to the clearing member. Further, clearing member should report disaggregated information on collaterals up to the level of clients of TM and proprietary collaterals of the TMs to the exchange and clearing corporations.

This information should be required to be reported on a daily basis. Besides, a web portal facility should be provided by the clearing corporations/ exchanges to allow clients to view disaggregated collateral reporting by TM/CM. Also, Sebi has suggested framework on collateral deposit and allocation; collateral valuation, blocking of margin, withdrawal of collateral and default and default management process.
PTI

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