Incorrect details of brokerage collateral invites scrutiny from NSE

Includes uploading of multiple files with same data, undisclosed granular numbers, and not reporting client data

Brokerages often share incorrect details of the collateral that their clients maintain while trading in the stock market.

The National Stock Exchange has drawn attention to multiple issues in the way that stockbrokers are reporting collateral details. This includes the uploading of multiple files with the same data, not providing granular numbers based on the segment of operation, and in some cases, not reporting the data for certain clients.

The collateral is used to cover capital requirements if the market moves against a trader. It helps safeguard the brokerage against client defaults since the collateral can be used to make up the shortfall. This also helps avoid settlement issues in the market. The stock exchange has pointed out to brokerages that the exchange uses this broker data to effectively supervise the market.

A senior executive with a domestic brokerage said that any deliberate obfuscation of collateral collection practices would be restricted to smaller players, rather than the very large ones who are now under increasing scrutiny due to their client base.

“Bigger brokers now would be very careful,” said the person.

The head of a traditional Dalal Street brokerage said that some smaller entities may have made some inadvertent mistakes. These are unlikely to be malicious, according to the person, and would mostly be ‘genuine errors’.

The Securities and Exchange Board of India (Sebi) has been tightening the screws on client collateral and its management. In addition to reducing the leverage in the market, the regulator had also moved to ensure that client funds are not misused by brokerages following multiple broker defaults in recent years.

The regulator had required brokerages to disclose collateral details on a daily, client-wise basis with a break-up of the assets involved. This became effective in July 2021. The regulator also moved to ensure that client funds are only used to settle the obligations of the client who provided the collateral, from May 2022.

Brokerages still have access to client funds, according to details from a June 2023 Sebi board meeting. It noted that these funds are placed as fixed deposits with banks. This is used by stockbrokers as collateral. Some use this capital to raise bank guarantees for an amount higher than the underlying fixed deposit receipt (FDR).

“Reports suggest that banks also provide other funded and non-funded facilities to brokers on the basis of these client-funded FDRs and other account balances. Across all this, there is a significant risk of misuse of client funds in the ecosystem,” said the minutes of the board meeting.

The tightening collateral requirements were expected to reduce the float income of brokerages, according to a February 2023 report from rating agency ICRA.

Float is a term which refers to the unutilised client funds. Lower interest income from the unutilised capital could result in brokerages increasing their charges, which, in turn, could spark consolidation in favour of larger players, according to the ICRA report.

The stock exchange, in its communication to brokerages last week, noted nearly a dozen ways in which collateral continues to be misreported. It has asked brokerages to ensure better oversight and ‘strict compliance’.