Sebi's move to tighten share pledging norms will improve customer security

The new rule requiring brokers to sell shares if they are not paid for in five days will make margin trading less attractive

Many stockbrokers like Amrapali Aadya Trading & Investment, Kassa Finvest, Unicon and F6 Finserve have defaulted over the past couple of years, resulting in losses to their clients. Many of these defaulters had misused their clients’ shares and funds that were lying with them. The Securities and Exchange Board of India (Sebi) on June 20 came up with a circular aimed at curbing such malpractices. 

The circular reiterates that stockbrokers must segregate the securities and money of clients from their own and that of other clients. “Segregation of funds and securities will allow for better supervision by the exchanges and depositories,” says Tejas Khoday, co-founder and chief executive officer, Fyers Securities.

Shares the broker receives from the exchange must be transferred from the broker’s pooled account to the client’s demat account within one working day. “Many medium and small-sized brokers would earlier not transfer the shares. The chances of misuse get minimised when shares are lying in the client’s account,” says Shrey Jain, founder, SAS Online, a Delhi-based discount broking firm.

If a client has not paid for the shares he has purchased, the broker may retain them in a separate account (that must be opened by each broker) called “client unpaid securities account”. A broker will be able to retain such shares only for five days after receiving them from the exchange. If the client does not pay within five days, he must liquidate them. Profit or loss on sale will be borne by the client. If the broker does not sell those shares within five days, he could be penalised, and he will not be permitted to recover this cost from the client.

The biggest point in the circular pertains to pledging shares. The regulator has said that clients’ securities lying with the broker cannot be pledged with banks or non-banking financial companies (NBFCs) to raise funds. If a broker wants to do margin funding, he must do so out of his own funds and not by pledging clients’ shares. Earlier, brokers played the interest rate arbitrage game. They would raise funds at a lower rate from a bank or NBFC by pledging shares and offer the margin trading facility at a higher interest rate to clients. This new ruling will definitely add to the safety of clients. However, there could be some adverse fallout also. “It will become more difficult for brokers to offer margin trading. The new ruling could affect volumes in the cash market,” says Vikas Singhania, executive director, Trade Smart Online.

The ruling regarding selling shares within five days if the broker has not been paid for them could also reduce the attractiveness of margin trading. “Earlier, the broker would charge an interest from the client and retain those shares until the client got a favourable price. Now, if he has to compulsorily sell them, the client could incur a loss. Many people may not engage in margin trading, or may reduce their volume of trading,” says Singhania.

With an important source of funding closed, many smaller brokerages may go out of business. “Only stronger entities with adequate capital may survive,” says Jain.

While these regulations will enhance investor security, investors still need to be on the lookout for deviations. “If there is a delay in transfer of securities to your demat account, or in the transfer of money from the trading account to your bank account, that is a red flag,” says Jain.

Khoday warns against dealing with a broker who provides unreasonably high leverage or funding for stocks.