The Securities and Exchange Board of India has issued a consultation paper for the public on strengthening safeguards to customer funds with various stock brokers and clearing members.
The paper floated on January 17 seeks comments from stakeholders on Sebi’s proposal to strengthen further the safety measures for investor funds in view of continued vulnerabilities and potential misuse.
It noted that on January 6, 2023, the day of the last running account settlement, stock brokers and CMs had around Rs 46,000 crore in client funds, suggesting it may be even higher on other days.
Currently, there are 1,355 stock brokers and financial institutions dealing with investor funds, and they are subject to all regulatory safeguards.
In another consultation paper on the same day, the capital market regulator floated the idea of “blocking funds for trading in the secondary market”. If implemented, it will reduce the volume of surplus investor funds with stock brokers, finally fully eliminating such surpluses.
Sebi said the aim is to mitigate the fund-related risk by “mandating daily upstreaming of all investor funds from stock brokers and CMs to Clearing Corporations (CCs)”.
The Proposal
The investor funds in surplus of exchange margin requirements, or the unutilised cash collateral, should be placed by CCs in low-risk and liquid overnight money market instruments.
The proposal also envisages independent daily confirmation to investors about their daily fund’s position in the securities market.
It could reduce the float income “implicitly enjoyed by brokers and CMs”, which will help reduce the risk of fund misuse substantially.
In addition, investors will have the flexibility to improve returns on their surplus funds using other authorised suitable financial service providers.
Sebi said it floated the proposal for wider consultation after its “extensive discussions” with stock exchanges, CCs, Sebi Intermediaries Advisory Committee (IAC), comprising brokers, etc.
Issue At Hand
As the participation of retail investors in securities markets has risen significantly in recent years, it puts a greater onus on the market regulator to strengthen the protection process.
Sebi issues regular guidelines to safeguard clients’ funds routed through stock brokers and CMs and ensure transparency in the process.
Recent Rules
In a circular on July 20, 2021, Sebi asked all stock brokers to disclose daily client-wise and asset-wise collateral received from each client and the amount passed on to a CC.
Investors can also access the information of their funds from a CC portal, ensuring “transparency and mitigating the risk of any misreporting by stock brokers”. These rules came into force on October 1, 2021.
Clearing Corporations must also ensure the collateral is used only for meeting clients’ needs, based on the client-wise breakup of collateral data. This rule came into effect on May 2, 2022.
Sebi has also provided guidelines on independent monitoring of clients’ funds with stock brokers. For example, stock brokers are required to upload client data on stock exchange platforms, and any shortfall in funds is monitored and highlighted to Sebi by the exchanges.
Sebi noted that the clients’ surplus with stock brokers and CMs may still be vulnerable to misappropriation; hence it mooted a framework to minimise the risk.
Framework To Minimise Risk
For instance, stock brokers should place the entire clients’ funds with a CM with segment-wise and Unique Client Code (UCC)-wise distribution under the proposed cash collateral allocation. In turn, the CM will place the funds with a CC allocated against the concerned client, marking them as cash collateral against the respective clients.
For pay-in obligations from clients, the brokers can transfer a portion of the client’s unutilised collateral with CC to meet the daily pay-in. However, in the event of insufficient unutilised collateral to satisfy the pay-in obligation, the client must provide additional funds to the stockbroker, and the same shall be placed with a CC through CM.
A stockbroker must also request for the release of funds daily via a CM to meet the client funds pay-out requests/settlement of Bill-to-Bill clients, transfer to other CCs, etc., “and any remaining balance end of the day towards the client’s payables shall be placed back with a CC on the same day to ensure stock brokers retain no client funds.”
Sebi has also proposed several other changes to the existing rules relating to the treatment of brokerage and additional charges, brokers providing a 3-in-1 account facility, compliance and monitoring of the proposed mechanism, etc.
