The Securities and Exchange Board of India (Sebi) has prohibited stock brokers and clearing members (CMs) from creating bank guarantees (BGs) from clients’ funds with effect from May 1. Existing BGs created out of clients’ funds will have to be wound down by September 30 this year.
“Currently brokers and clearing members pledge client’s funds with banks, which in turn, issue BGs to clearing corporations for higher amounts. This implicit leverage exposes the market and especially the client’s funds to risks,” Sebi said in a circular.
The stock exchanges and clearing corporations will have to take stock of the current position of the BGs issued out of clients’ funds by brokers and CMs and monitor the wind down to ensure implementation of the circular without any disruption of services to clients. For the purpose, stock exchanges and clearing corporations will put in place periodic reporting mechanisms for brokers and CMs.
“Brokers were taking excessive leverage using clients’ funds. By virtue of this circular, Sebi has ensured that such leverage comes to a halt,” said Jimeet Modi, Founder and CEO, SAMCO Securities.
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According to him, today, for a fund of Rs 100 lying in client’s account, brokers can create a fixed deposit of Rs 100 and then take an additional BG of Rs 100 on it, taking the total collateral to Rs 200. In this excess bank guarantee of Rs 100, though the funds used were that of the clients, the leverage is on the books of brokers. “This could result potentially in the Black Swan event, where a broker could go bust and guarantee could be invoked,” said Modi.
Stock exchanges and clearing corporations have been asked to verify the compliance of the provisions of the circular in their periodic inspections and reporting.