The Securities and Exchange Board of India (SEBI) has put forward a directive to disallow stockbrokers and clearing members from employing their clients’ funds to construct bank guarantees (BGs). SEBI has shown distress regarding the possible risk exposure to the market and the funds of the clients, as brokers secure their clients’ funds with banks, leading to a significant disparity between their factual net worth and the guarantees they employ for trading.
Usually, banks offer stock exchanges with BGs as a security deposit and margin requirements on behalf of stockholders, which are submitted to clearing corporations who then determine the trading limits for brokers. However, brokers frequently secure their clients’ funds with banks, which in return, issue BGs for more significant amounts. Banks issue BGs at a rate that is two times the sum that the broker has secured, thereby exposing the market to threats.
The Securities and Exchange Board of India (SEBI) has issued a circular prohibiting brokers from creating new bank guarantees (BGs) using clients’ funds starting from May 1, 2023. In addition, brokers must close all existing BGs established with clients’ funds by September 30, 2023. The primary objective of this new regulation is to mitigate potential systemic risks and ensure better protection of investors’ funds.
SEBI’s recent mandate will have an impact on the working capital requirements of stockbrokers, only affecting those who have the practice of pledging clients’ funds to create BGs, which in turn increases clients’ leverage and risk exposure. Brokers who have already complied with the recent implementations of Segregated Margin Reporting and online client-wise or segment-wise allocation of client collaterals will not be affected by this circular.
SEBI’s latest directive that prohibits brokers from using their clients’ funds to create Bank Guarantees (BGs) is a significant stride towards the implementation of the Application Supported by Blocked Amount (ASBA) system and the upstreaming of client funds, which are presently under discussion with the regulator. It is imperative that brokers ensure that this new framework does not have an adverse effect on their own funds. SEBI will be vigilant for any infringements of this circular, reporting and ensuring that brokers adhere to the rules within the prescribed time limit.
The Reserve Bank of India (RBI) and SEBI have been monitoring the collateral system closely due to the potential systemic risks this practice may present. The new regulation aims to reduce these risks and guarantee that investors’ funds are safeguarded. SEBI’s mandate that brokers use their own working capital to obtain higher Clearing Corporation limitations will increase their need for working capital.
SEBI’s new requirement is worth noting as it highlights a growing concern regarding the use of clients’ funds in the capital markets. The regulatory authorities are taking steps to ensure that brokers do not use their clients’ funds to obtain higher BGs, thereby exposing their clients to increased risks.
In conclusion, SEBI’s directive prohibiting stockbrokers and clearing members from using clients’ funds to create BGs is a commendable move towards safeguarding investors’ funds and mitigating the potential systemic risks in the collateral system. It is incumbent upon brokers to ensure that they comply with the new regulations and do not use their clients’ funds to obtain higher BGs, thereby subjecting their clients to higher risks. SEBI will be closely monitoring any violations of this circular, ensuring that brokers adhere to the rules within the stipulated timeframe.
