3 min read.Updated: 19 Sep 2020, 10:22 AM ISTNeelam Rani,Ishan Pandey
As per the new system, a client can individually pledge securities directly to the clearing corporation, and the securities will continue to remain in the client's account
Karvy Stock Broking Ltd. fiasco saw the brokers breach their clients' trust by illegally pooling securities across clients without any authorization. The episode compelled the Securities and Exchange Board of India (Sebi) to ban the pooling system in February 2020 and direct the brokers to maintain individual accounts for clients. Sebi's concerted efforts to bring about transparency fuelled the modification's genesis in the margin pledge/repledge rules. The changes were initially slated to come into effect in June but eventually came into effect on 1st September 2020 after being deferred twice. This move of Sebi came at the cost of the pleas of brokers and participants who had requested a further extension on preparatory grounds.
The new system aims to safeguard clients' interest as doing away with the earlier practices of Power of Attorney, and pooled accounts ensure that a client's margins are being used to serve his/her interest as opposed to someone else's.
As per the new system, a client can individually pledge securities directly to the clearing corporation, and the securities will continue to remain in the client's account. Clients will need to authorize a pledge request in favour of their broker, who will then repledge it with clearing corporations for allowing margin benefits to the clients.
Moreover, the waiting period for settlement of the transaction would block the usage of proceeds for that settlement window. The client will not be able to use the notional proceeds for a new trade instantaneously. Intraday profits used by clients to take new positions on the same trading day will now not be available until the delivery of shares in their accounts, which would be on T+2 day.
Cash margins, which were earlier looked after by the brokers and the non-requirement of upfront margins in the case, has been replaced by a mandatory collection of upfront margins by brokers. The collection has to be made in the client’s account for purchase and sale transactions, failure in compliance to which will attract a penalty.
The earlier norm wherein the clients had to meet margin requirements in their account at the end of the day has now been tweaked to ensure that the requirements are met prior to the deal.
Envisaged impacts of the modifications in the rule have been met by some brokers urging their clients to pledge 100% of shares upfront. The rationale is to counter the delay in pledging benefits and, consequently, empower the clients to pounce upon the market's opportunities. As far as brokers are concerned, their operational efficiency will be put to the test.
Brokers rolling on legacy IT systems will have to adapt quickly to the changing landscape as they have already begun feeling its sting. This challenging task becomes Herculean under the pandemic's present scenario, which hinders the potential support of IT vendors to these legacy brokers.
The absence of comingling support under the pooled security system is bound to create supply shocks, which stands to disrupt the volumes of daily trading. The initial volatility is expected to be further amplified if the high-volume traders, who are the bedrock of liquidity, decide to hold back on their trading activities. In case liquidity is reduced in the market; the impact cost for institutional investors will become tangible.
The hiccups of implementing the changes appear to be short-term in nature. Still, the ambiguity of the word "short" seems to be hinged not only on the adaptability of brokers to the system but also the speed at which investors are educated about the nuances and their consequent impacts. How far does this systematic change succeed in shielding the investors against fraudulent activities and whether the pay-off for both clients and members will be worth the cost of transparency? We shall live to find out!
Neelam Rani is an Associate Professor (Finance) at IIM Shillong and Ishan Pandey is PGP 19 at IIM Shillong. Views expressed are their own.