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Two decades after margin collection by brokers for derivatives trading came into play, market regulator SEBI now proposes to segregate the funds collected by brokers and identify them in the name of each client. So far, the clearing corporation (CC) of stock exchanges, which settle the trades, identified all the margin collected as that of the trading (brokers) or clearing members (CM) even if it belonged to clients.
A ₹460-crore default by a broker of IL&FS led to a crisis as the clearing arm of the National Stock Exchange 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. The exchanges did not seek a client-wise distinction of the margin deposited.
A Supreme Court Bench of Justices Mohan Shantanagoudar and Sanjiv Khannahad 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.
Protecting clients
Defining what its proposed changes will mean, SEBI said segregation of client collateral refers to identifying and protecting client collateral from misappropriation, misuse by trading/clearing members or in case of defaults.
“In past, there have been instances of misuse of client collateral and it becomes accentuated at the time of defaults. Investor confidence, market integrity is shaken and it brings disrepute to the entire ecosystem. Therefore, a framework can ensure identification of each client’s collateral and its utilisation towards margins of that client only. Also, readily available collateral information will expedite return of collateral to each non-defaulting client after adjustment of their dues,” SEBI said in its proposal.
SEBI has proposed that when clients provide collateral to the trading (TM) or clearing member (CM), they may retain a portion and pass the rest to clearing corporations (CCs). A CC will have visibility of the client to whom such securities belong and accordingly it will assign the value of the securities collateral, based on applicable haircut, to that client’s account.
Mechanism on cards
SEBI proposes to build a mechanism for reporting, dissemination and usage of information pertaining to collateral other than securities collateral received by way of pledge/re-pledge mechanism. “This reform was much required and has been long delayed. But now its implementation should not be delayed,” a legal expert said.
SEBI has also proposed procedures for reporting, collateral deposit and allocation, valuation, blocking of margins, various levels of monitoring, settlement, withdrawal of collateral, default management process and other such probabilities.
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