Allied Fin-Citi case could test segregation of brokers’ collateral and clients’ assets

PALAK SHAH Mumbai | Updated on July 15, 2019 Published on July 15, 2019

Currently, there is no system in place for clearing corporations to distinguish between the assets of brokers and client collateral

Is there any system that clearing corporations follow to segregate client assets from those of collateral placed by the broker? The question has gained significance in the wake of the recent ₹400-crore clearing and settlement dispute involving counter-parties such as Citibank and Morgan Stanley, experts told BusinessLine.

Allied Financial, a brokerage, had taken positions in Nifty options and sold off mutual fund units belonging to a client to settle its own derivative trading obligation. Citi and other large investors who made a profit on their bet were the counter-party to Allied.

“The way Allied used the assets of its client as its own shows that there is no system currently in place where a clearing corporation can distinguish between the assets of brokers and client collateral,” said a risk management official at a foreign brokerage house.

Experts say this is dangerous as clearing corporations of both the NSE and the BSE put together have total assets in excess of ₹60,000 crore and the question could open a Pandora’s box. Many brokers are renting demat accounts of clients and placing client collateral or security in the demat accounts as their own margin. On this, there is no data with exchanges or clearing corporations to show how much of actual collateral is the broker’s own or belongs to the client, market experts said.

“Are there more brokers like Allied who have used client assets to top-up their own trading margins? There is no way to know until segregated figures are available or till there is a default,” said a securities lawyer.

Rules are clear, but...

The margin trading system in India’s derivative market requires brokers to deposit some initial money with the clearing houses of exchanges, which then allocate position limits. As per regulations, an exchange cannot touch client money for default at broker level. But if there is no segregation, how is this possible? Currently, clearing corporations just take an undertaking from brokers that the collateral put up by them is their own and not of the client.

“While the Allied matter has reached the court, the fact of the point is that if the clearing corporation stood guarantee to all the trades it should be upheld for all legitimate purposes for those who have entered into genuine trades. SEBI regulations say that settlement guarantee is up to client level but will now be put to the test in the Allied matter,” said the lawyer.

Citi too states in its plea to SAT that delay in squaring-off valid trades was not only resulting in huge losses for them, but will also shake confidence in risk management products in India. Citi has also argued that refusal for settlement of its trades which were genuine will not only put the counter-parties at a huge loss, but will also have a cascading effect on its own clients, whose claims it will have to settle.

NSE Clearing Corporation wants SEBI to decide the on matter as it is a guarantor to Citi and other investors and will be in a precarious situation if it cannot recover its money from Allied due to fraud and legal complications. SEBI, meanwhile has moved court to step aside in the matter citing lack of jurisdiction and wants clearing corporations to take a call.

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Published on July 15, 2019
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