Securities and Exchange Board of India (SEBI) has come out with a framework for segregation and monitoring of collateral at client level amid instances of misuse of client collateral by trading members. The move comes in the wake of a host of broker defaults
on the National Stock Exchange (NSE), many of which were similar to Karvy where the clients' shares had been pledged illegally as collateral against loan.
As per the circular, the market regulator has also put in place a reporting mechanism that will entail disaggregated information -- segment-wise and asset type wise break-up -- of each client collateral.
The framework pertaining to reporting mechanism and collateral deposit as well as allocation will come into effect from 1st October, while other provisions will become effective from 1 December 2021.
SEBI has also laid down guidelines on collateral deposit and allocation, collateral valuation, blocking of margin, withdrawal of collateral and default and default management process.
The measures will help in further strengthening the mechanism of protection of client collateral from misuse by trading member (TM) or clearing member (CM) and default of such members and other clients.
Segregation of client collateral refers to the procedures that enable identification and protection of client collateral from misuse by trading or clearing member and protection from default of such member or other clients.
With the objective of providing visibility of client-wise collateral (for every client) at all levels-- trading member, clearing member, and clearing corporation (CC), SEBI stated that a reporting mechanism covering both cash and non-cash collateral will be specified by the clearing corporations.
As per this reporting mechanism, the TM would report disaggregated information on collaterals up to the level of its clients to the CM.
Further, clearing member would report disaggregated information on collaterals up to the level of clients of TM and proprietary collaterals of the TMs to the exchanges and clearing corporations. This information would be required to be reported daily.
Additionally, a web portal facility would be provided by the clearing corporations or exchanges to allow clients to view disaggregated collateral reporting by TM and CM.
In case of securities collateral provided to CC through margin pledge or re-pledge in the depository system, the CC has visibility of the client to whom such securities belong to, and accordingly can assign the value of the securities collateral, based on applicable haircut, to that client's account.
Likewise, for other forms of collateral placed with the CC, the CCs will provide a facility to CMs for upfront segment-wise allocation of collateral to a TM and client or CM's own account.
The CC will ensure that the collateral allocated to a client is used towards the margin obligation of that client only by making use of such collateral allocation information.
There will be no change in the procedures pertaining to placing of securities as collateral through the margin pledge or re-pledge mechanism in the depository system, and this collateral will be identified as belonging to a client or as being proprietary securities of the TM or CM, as per the existing procedures, SEBI confirmed.
According to SEBI, allocation provided by the CM to CC and by TM to CM will be considered as final by the CC and CM respectively for the purpose of granting exposure and utilisation during default.
"Any false allocation by members shall be treated as a violation and disciplinary action shall be taken against the members," SEBI noted.
The TM and CM will have to ensure that sufficient collateral is allocated to clients to cover their margin requirements.
However, if the client margin applicable at the CC for a client in a segment exceeds the collateral allocated to the client plus the securities collateral re-pledged to CC (from that client's account) in the respective segment, then the proprietary collateral of the TM and CM will be blocked.
In February this year, SEBI put in place a framework of ‘margin obligations to be given by way of pledge or re-pledge in the depository system’ to mitigate the risk of misappropriation or misuse of client’s securities available with the TM, CM and depository participant (DP) including use of one client’s securities to meet the exposure, margin or settlement obligations of another client or of the TM / CM.
In order to further strengthen the mechanism of protection of client collateral from misappropriation or misuse by TM and CM and default of TM or CM and other clients, SEBI issued a consultation paper on 10th May requesting market participants to provide their comments and views on the proposed framework for segregation and monitoring of collateral at client level. It is after discussions with the stakeholders, SEBI decided to adopt this framework for segregation and monitoring of collateral at client level.