SEBI puts off collateral segregation at client level

SEBI has announced the extension of the timeline for implementing the framework on client segregation and monitoring by about two months. The final date of implementation has been pushed by 2 months but clearly, the regulator does not want to add one more level of regulation when the market is itself in a state of flux and turmoil. The new system, under which the broker will segregate collateral at client level, comes into effect from 02nd May.

Once again, the requests came from the market participants asking for more time to make themselves software ready. Based on these representations, SEBI has decided that the said circular will now come into force with effect from 02nd May only. This will give some relief to the markets as it was expected that this would be more time consuming and also that it could impact volumes and liquidity in the market in the short run.

The background to this circular lies in the Karvy scam that surfaced 2 years ago. That is when SEBI came out with an elaborate framework to segregate and monitor the collateral offered at client level. There were numerous reported instances of misuse of client collateral by trading members. This situation became pressing in the aftermath of the Karvy Stock broking scam where client shares had been illegitimately pledged as collateral against loans.

The intent of the circular is that the segregation of client collateral will help protect client collateral from any form of misuse by trading or clearing members. The new system will necessitate elaborate and far reaching changes to how traders and brokers operate. In fact, in the new system, clients will have to indicate in advance where (cash, derivatives etc) they wish to trade and how to allocate their collaterals to their various positions.

In most cases, the clients provide the entire stock collateral as deposit and don’t offer any cash or cash equivalents. However, the clearing member is expected to maintain minimum 50% of the collateral in cash and cash equivalents at the clearing corporation. As usual, ANMI had made representations to SEBI stating that the broking industry in India was not yet ready to migrate to the new system, in terms of software and manpower readiness.

As of now, it is not yet clear if the regulator would prefer a staggered approach to defining risk reduction at 90% client level. This is not only expensive for brokers but also may not be required given that the peak margin system is already in place. Hence it may become a case of over-margining of the position for the amount of risk implicit in the transaction. The intent is fine from a safety viewpoint but it obviously cannot be at the cost of volumes.

For now, the brokers get some breathing space, but the announcement is eventually coming. On the positive side, it will make the markets safer and ensure that the client collaterals are not misused at any level. This was seen in its most egregious form in the case of Karvy Stock Broking and clearly, SEBI wants to prevent repeat of such instances where the client stake has been held to ransom.