Two decades after margin collection by brokers for derivatives trading came into play, SEBI has asked the exchanges to maintain a record of segregated funds collected by brokers for margin-related collateral and identify against each client.

So far, the clearing corporations (CC) of stock exchanges, which settle the trades, identified all the margin collected as that of the trading members (TM, which is a broker) or clearing members (CM), even if it belonged to clients. The CCs will now have to maintain a client-wise account of collateral deposited with them. Billions of dollars are lying with the CCs as client collateral in terms of cash, bank deposits, shares and other financial instruments. But there was no segregation of this collateral with regard to each trader or investor with the CC. Only the broker had the data on the margin provided by each client.

At the CC level, the entire money was in the name of the broker or the clearing member. Thus, when a broker defaulted, the entire collateral deposited with the CC could get frozen and all the clients could suffer for no fault of theirs. However, SEBI has said, “the CCs should provide a facility to CMs for upfront segment-wise allocation of collateral to a TM/client or CM’s own account. The CCs should use such collateral allocation information to ensure that the collateral allocated to a client is used towards the margin obligation of that client only.” Simply put, CCs will have to maintain data on client-wise margin deposits against the broker-wise practices.

IL&FS imbroglio

The ₹460-crore default by a broker of IL&FS in 2019 led to a crisis as the clearing arm of the National Stock Exchange (NSE) froze its entire collateral. Many IL&FS clients complained that their margin collateral was blocked even when they had not defaulted. Most broker defaults have created similar crises where the collateral of one client is used by the broker for another client or even proprietary trading.

Supreme Court’s red flag

The exchanges did not seek a client-wise distinction of the margin deposited. A Supreme Court Bench of Justices Mohan Shantanagoudar and Sanjiv Khanna had come down on SEBI when it was reluctant to probe the IL&FS default, arguing that it did not fall under its jurisdiction. The 2019 case highlighted several deficiencies in collateral management and the absence of SEBI norms.

SEBI has now said a web portal facility should be provided by the CCs or stock exchanges to allow clients to view disaggregated collateral reporting by TM/CM.

“It is a half-hearted attempt by SEBI. The regulator should go a step further and ask CCs to collect and maintain segregated client margin money, instead of just being a record keeper of it. In the past, there have been instances of misuse of client collateral and it becomes accentuated at the time of defaults. Investor confidence and market integrity are shaken and it brings disrepute to the entire ecosystem,” said a lawyer.

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