)
Stock brokers are said to be opposed to a regulatory proposal to take control of client collateral away from them and into the hands of Professional Clearing Members (PCMs).
The Securities and Exchange Board of India (Sebi) had suggested the idea to ensure clients' interests aren't not affected a broker defaults, as had happened in the case of international brokerage MF Global. The firm reportedly used client funds to meet own liquidity needs. It later filed for bankruptcy.
The use of PCMs ensures the collateral remains with entities without trading rights. A clearing member helps ensure that trades on stock exchanges are honoured. However, this might adversely affect broker interests in case the client defaults, since the collateral will no longer be with the broker or trading member (TM), argue brokers.
The topic was discussed at a meeting of the regulator's Secondary Market Advisory Committee, according to two people who attended it.
Sebi has said more views will be taken before a final decision, said one person at the meeting, held in the first half of April.
In a subsequent discussion paper, Sebi had suggested a model for risk management which would involve the use of a PCM that would keep client collateral in segregated accounts. They seem, in doing so, to have noted the brokers' objections.
"While the model protects interests of client on broker/TM default, it should not be at the cost of ignoring broker/TM interests on client default," said the discussion paper.
Adding: "In case PCM does not release collateral to broker/TM pending dispute, broker/TM will have to use own assets to fulfill obligation towards CC (clearing corporation) on account of client trades. It will be fair not to release collateral even to client in case of dispute, thereby affecting both the parties equally. Will this be unfair to broker/TM?"
Brokers say the proposal to set up PCMs will hamper the risk management system of brokers. "For the risk management system to work, a broker needs to have unconditional right on the security of the client," said a person present at the meeting.
Today, if a client defaults, a broker is able to square off his other positions and make the payout to the exchange. If it is a disputed trade, the matter is decided by an arbitration process but, meanwhile, the payout cannot stop.
"However, if shares are kept with a PCM instead of the broker, the risk management system could go for a toss. Brokers will not have direct control over them, as the PCM will hold client shares in a fiduciary capacity," said the person.
As a PCM will have a fiduciary agreement with the client, it won't release the shares in the case of a dispute where the client says it didn't initiate the trade, since it is only supposed to listen to the client and not the broker. And, while the broker might not get access to the client's shares, which would be with the PCM, he will still have to pay the exchange.
This is likely to cause brokers to be more cautious in extending margins to clients, as they will not have control over the shares.
Brokers have also argued that this will make it more expensive for investors active in the equity market. "There is an additional cost associated with using a PCM," said another person present at the meeting.
COLLATERAL CONTROL
- Sebi mulls parking client shares and capital with separate entities
- Stock brokers want control over client collateral
- Oppose proposal at secondary market advisory committee meeting
- Argue that risk management will take a hit
- Affect settlement of trades, since they will no longer be able to sell-off other client positions if he defaults
- Broker will have to bear the cost of such defaults
- Also suggest it will increase costs for investors
- Sebi has said it would consider all opinions before arriving at a decision
