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SEBI proposes ring-fencing clients' money if broker goes bust

Last Updated: Thursday, April 18, 2013 - 19:59

Mumbai: With an aim to safeguard investor interest in the event of default or bankruptcy of brokers, market regulator SEBI on Thursday proposed to ring fence clients' money and collaterals from such risks through steps like greater Internet-based trades and faster settlements.

The proposed move, which was issued today by SEBI as a 'discussion paper' inviting public comments, might also have a bearing on sale of pledged shares by large brokers or financiers which often leads to a panic-selling in the market.

SEBI said the current regulatory framework for mitigation of margin-related risks to clearing corporations has "given rise to another risk -- the risk of clients losing their collateral in the event of default/bankruptcy of the broker or TMCM, and accordingly there is a need to take steps to mitigate this."

"Further, the overall risk in the system is dependent on the number of unsettled trades in the system at any point of time. A shorter settlement cycle can go a long way in reducing the risk in the system," SEBI said in the paper, titled 'Risk Management - Safer Markets for Investors'.

The regulator said the extant system of risk management could be fine tuned for more efficient use of capital and enhancing safety of investors.

For the same, SEBI has broadly proposed three steps -- incentivising Internet Based Trading (IBT) models posing minimal risk, mitigation of risk to client collateral, and T+1 settlement as a measure to reduce overall risk in the system.

'T+1' refers to settlement of trades with all the required payments one day after the execution of the trade order. Currently, most of the trades are settled on T+2 basis, meaning two days after the execution of trade.

The risks posed to clearing corporations, which ensure settlement of trades through transfer of shares from seller's account to the buyer's after the payments, are mitigated by the margin requirements for the trading members or brokers.

The brokers or trading members are required to maintain a minimum of 50 percent in cash or cash equivalents including fixed deposits.

As per the existing risk management system, margins calculated on open positions and collateral deposited against it form the first line of defence, while deposit based capital (base minimum capital, liquid networth) maintained by brokers and trading member form the second line of defence against failure of any market entity.

However, the current framework can be misused by the brokers to pass on the collateral received from its clients as its own collateral, although the good practice would be to keep clients' collateral in segregated accounts.

SEBI said the brokers trade in the market for their business, but investors come here to invest their savings.

While the risks associated with the price and the market trends are there for investors, the market structure should be sound enough not to expose clients to other risks like operational risk and credit risk of brokers, SEBI said.

"Changes to this effect will go a long way in further instilling confidence among investors in the securities market framework and facilitate greater market penetration. One such risk incidental to participating in the securities market is the risk to client collateral, and needs to be mitigated," the regulator said.

Inviting inputs and suggestions by May 20, 2013 on the three steps proposed by it to make the Indian markets a safer place for investors, SEBI said the issues for discussion also include impact on cheque payments by retail investors, the costs associated with increased automation of the trading and settlement systems.

Besides, the regulator has also sought suggestions for handing the time-zone issues for foreign investors and cost of standardising communications of institutional trades, in the event of moving to a one-day trading and settlement cycle.

SEBI said that the risks posed to the market vary across various categories of the clients.

For example, internet based trading (IBT), where funds or securities of clients are upfront blocked at the time of order itself, pose no further settlement risk to the market.

Also, the overall risk in the system is dependent on the number of unsettled trades at any point of time. A shorter settlement cycle can go a long way in reducing the risk in the system, SEBI said.

According to the regulator as this internet trade model brings no additional risk to the system, there is a case to provide incentives to the investors to use this model so as to reduce the overall risk in the system.

In this regard the incentives proposed include waiver of any margin requirements by the clearing corporations, that these organisations release any blocked margin for IBT trades as soon as the early pay-in is made and that such trades may be charged lower clearing charges.

"The savings due to such incentives may then be passed on to the end clients in the form of lower brokerage charges or deposit charges thereby incentivizing investors to use the IBT model," SEBI said.

"It is understood that in certain jurisdictions IBT has facilitated the spread of investment culture among retail investors," it added.

SEBI has said the issue for discussions in this regard include the kind of arrangement that can be put in place by large financial institutions in coordination with clearing corporations to ensure legal certainty that funds blocked by broker are without fail made available to the clearing corporations, among other things.


First Published: Thursday, April 18, 2013 - 19:59
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