The Securities and Exchange Board of India (Sebi) has put a stop to the practice of brokers creating bank guarantees using client funds. It said on Tuesday that such practices will be barred from May 1 and all existing bank guarantees have to be terminated by September 30.
This is part of a series of steps taken by the capital market regulator to safeguard clients’ funds and securities from misuse by brokers.
“This is a great step that has been implemented by Sebi because brokers were taking excessive leverage using clients’ funds. By virtue of this circular Sebi has ensured that such leverage comes to a halt,” said Jimeet Modi, founder and chief executive officer of Samco Securities.
Sebi said the practice of pledging client funds in lieu of bank guarantees of higher amounts exposed the market and the funds to risks.
“Earlier, if there was Rs 100 lying in a client’s account, brokers used to create a fixed deposit of Rs 100 and take additional bank guarantee of Rs 100 on it, taking the total collateral to Rs 200. In this excess bank guarantee, though the funds used were that of the client, the leverage was on brokers’ books. This could potentially result in a Black Swan event, where a broker could go bust and the guarantee could be invoked,” added Modi.
The outstanding value of existing bank guarantees could not be ascertained immediately.
Also Read
Stock exchanges and clearing corporations have been asked to monitor the process and update on a fortnightly basis the details of total bank guarantees made on client funds and proprietary funds. Stock brokers will be able to continue to create guarantees on their own funds.
Brokers have been directed to submit a certificate issued by a statutory auditor on the implementation by October 16.
Though industry players welcomed the decision, they said it might lead to some strain on their balance sheets.
“The move will have an immediate impact on working capital requirements for brokers. Brokers will now have to arrange funds either through internal accruals or external borrowings. Though it will put a strain on the balance sheet, the decision will make our markets stronger and more transparent,” said Prakarsh Gagdani, CEO of 5paisa.
Other moves
This latest move comes on the back of other such measures introduced recently. Last year, Sebi had mandated quarterly settlement of funds by stock brokers, and mandated transferring of unused funds back to the client’s bank account. These settlements were over Rs 30,000 crore in the first cycle.
At its latest board meeting, Sebi also approved a framework for daily upstreaming of clients’ funds by brokers and non-bank clearing members to clearing corporations. The first phase of this framework will come into effect on July 1.
The market regulator has further approved an optional ASBA-like mechanism for the secondary market, which will reduce the client holdings at the broker’s end.
Move to impact smaller brokers using BG facility; industry expects impact on working capital and margins
Brokers also need to upstream client funds to clearing corporations daily from July 1
