Market participants have flagged higher risks emanating from the proposal of the Securities and Exchange Board of India (Sebi) to upstream clients’ funds to clearing corporations (CCs).
The proposals mandate daily upstreaming of all investor funds from stock brokers and clearing members to CCs. About Rs 1 trillion of client funds could be upstreamed to CCs if the new proposals come into play, according to industry estimates.
Client funds, at present, are spread across 1,300 stock brokers, NCL and smaller CCs, resulting in lower risks, said experts.
As of November last year, NCL’s core settlement guarantee fund (SGF) stood at Rs 4,352 crore, while BSE’s CC ICCL’s core SGF had Rs 730 crore as on December 31 last year.
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As per current norms, CCs are required to have a core SGF to guarantee the settlement of trades executed in the respective segments.
NCL had Rs 15,075 crore pertaining to settlement obligation and margin money from members as on September 30 last year. This would be the deposit of investors which stock brokers send or keep with CCs in the form of cash. ICCL had Rs 1,580 crore.
“The proposed framework mandates concentration of all client funds into a single CC, leading to a massive concentration risk. NCL is not protected by any government guarantee and is a private entity,” said an industry official on condition of anonymity.
He added that risks a CC faces today was limited to the extent of investor cash balances lying with it. The core SGF would cover roughly 33% of investor money in case of NCL and 80% in case of ICCL, according to the official. In the new system, however, the investor funds on the CC balance sheet would balloon to about Rs 1 trillion, but the core SGF put together would hardly be a few thousand crore, he said.
An email sent to the NSE, BSE and Sebi did not get a response.
Sebi’s proposal also allows CCs to place investor funds (in surplus of exchange margin requirements) in liquid, overnight and money market instruments. This could be riskier than the current practice of brokers parking their money as fixed deposits with CCs, said experts.
To be sure, NSE and NCL (combined) remain well capitalised with a net worth of Rs 14,378 crore as on September 30, 2022, according to a report by Crisil Ratings. The agency has highlighted that the strong risk management practices and higher core SGF provide comfort to the majority of institutional clients getting clearing and settlement done through NSE Clearing.
Opposition from clients
Several individual investors have opposed the move to upstream client funds directly to CCs, according to people in the know. Brokers pass back the interest earned on fixed deposits with CCs to some wealthy investors, who stand to lose this income if the new regulation comes to pass. Most clients, however, provide this interest-free float to stock brokers because of which stock brokers are able to give low brokerage rates.
“Without the float income, stock brokers will have to increase their brokerage charges which means increased cost to investors. So, investors loose interest income, the broker cost increases, and stock brokers loose money,” said an official.
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Under the current framework, investors post collateral with their stock brokers before executing trades. Stock brokers do the same with their clearing members (CMs) and carry out settlement of funds or securities through them. CMs, in turn, post collateral with CCs for their trades and that of their clients.
The existing framework allows for retention of a certain portion of collateral at every level. So, when a client or investor posts funds with a broker, a part of such funds can be retained by the broker, and a part by the CM, before passing on the balance to the CC.