SEBI crackdown on broker malpractices is welcome, but piecemeal changes disrupt markets

| Updated on August 04, 2020 Published on August 04, 2020

It will be better if SEBI takes a hard look at the regulatory framework for the entire trading eco-system and makes the necessary changes in one go

The scandal involving Karvy Stock Broking last year has been quite effective in drawing the attention of the market regulator towards malpractices by stock brokers. The flurry of regulatory changes announced since then have been well-intentioned, designed to serve investors’ interest and to stop dereliction of fiduciary responsibility by stock brokers. But the Securities and Exchange Board of India needs to think through the consequences of these regulations on trading volumes and market efficiency, and implement the changes in a manner that is least disruptive. Also, instead of bringing about regulatory changes in a piecemeal manner, it will be better if SEBI takes a hard look at the regulatory framework for the entire trading eco-system and makes the necessary changes in one go. Over the years, regulatory loopholes have been exploited by some stock brokers to provide excessive leverage to clients; they misuse clients’ securities and funds for proprietary trading. There have also been reports of some brokerages trading on behalf of clients after promising them some fixed returns. It is certainly imperative to halt such practices, to retain credibility of the market infrastructure.

The changes should, however, be enforced in such a way that the functioning of trading segments are not impacted. A couple of regulatory changes, that came into effect from August 1, are going to be quite unsettling for markets. The first is the implementation of the new framework for collection of upfront margins. The new rules will penalise brokers who fail to collect margins up-front for intra-day trades. This will end the practice of brokers allowing clients to conduct leveraged intra-day trading in cash segment, without depositing the required margins. The clearing corporations are now required to communicate the client-wise margin requirement at least four times a day. While the intention of the regulator is to protect retail investors from a loss that they can incur through this leverage, the consequence will be a sudden sharp reduction in cash trading volumes, which can impair price discovery in cash and derivatives. The other significant regulatory change is that from this month, brokers cannot consider securities lying in client demat accounts, for which PoA has been obtained, as trading margin. The pledge and re-pledge mechanism for securities lying with brokers is also being streamlined from this month, ensuring that clients do not pledge clients’ securities to raise money.

While these moves are necessary, the regulator needs to pay heed to the practical problems faced in implementing these changes. The old and new system of pledging, re-pledging of shares can continue in tandem until depositories are ready to implement this. A comprehensive review needs to be undertaken on the trading process in all segments — stocks, currency and commodities. The malpractices of the intermediaries need close scrutiny and a new set of regulations has to be adopted after receiving feedback from all stakeholders. While discussions can commence on these rules, the implementation can be deferred till the worst of the Covid-19 pandemic is over.

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Published on August 04, 2020
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