Amidst instances of misuse of client collateral by trading members, market regulator Securities and Exchange Board of India (SEBI) has issued a new proposed framework for segregation and monitoring of collateral at client level. The proposal comes in the wake of the Karvy Stock Broking crisis
where clients' shares had been pledged illegally as collateral against loan.
The regulator has proposed to build a mechanism for reporting, dissemination and usage of information pertaining to collateral other than securities collateral received by way of pledge or re-pledge mechanism.
While issuing the consultation paper, SEBI says the proposed framework is aimed at ensuring protection of client collateral. SEBI has sought public comments on the proposal by 24 June 2021.
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. In the past, there have been instances of misuse of client collateral by trading member (TM) or clearing member (CM). This becomes even more accentuated at the time of default of a TM or CM. In such a scenario, not only confidence of investors in market integrity is shaken, but it also brings disrepute to the entire ecosystem of trading, SEBI noted in the discussion paper.
"It is, therefore, desirable to put in place a framework that ensures identification of each client's collateral. This would help ensure utilisation of a client's collateral towards the margins of that client only," the market regulator says.
This would help ensure utilisation of a client’s collateral towards the margins of that client only. SEBI also indicated that in case of possible default by a trading or clearing member such readily available collateral information will also help ensure expeditious return of collateral to each non-defaulting client after adjustment of any dues of the respective clients.
Under the proposed process, clients would have to provide collateral to the trading or clearing member. In case of collateral provided to the trading member, it would have to retain some collateral with itself and pass on some collateral to the clearing member. Similarly, clearing members would have to retain some collateral with themselves and pass on some collateral to the clearing corporation (CC).
“When collateral is provided onwards, it may be in the same form or in some other form (e.g. Clearing members may receive cash but create a fixed deposit from the cash and lien mark it to the clearing corporation),” SEBI says.
In the depository system, there is no change in the form of collateral and details regarding quantity of securities provided at each stage, retained and passed on is available with the market infrastructure institutions (MIIs) for monitoring of pledge and re-pledge.
For such collateral pledged or re-pledged to the level of clearing corporation, SEBI says clearing corporation 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.
The proposed mechanism would capture the information pertaining to collateral provided by clients to TMs and subsequent onward submission of collateral and retention of collateral at every stage by the TM and CM.
This would also make available the holistic information regarding the collateral at various levels to the clients. With a view to providing visibility of client-wise collateral (for each client) at all levels — TM, CM and CC — SEBI recommended that a reporting mechanism, covering both cash and non-cash collateral, should be specified by the clearing corporation.