With an aim to safeguard investor interest in the event of default or bankruptcy of brokers, market regulator Sebi on Thursday proposed to ring fence clients' money and collaterals from such risks through steps like greater Internet-based trades and faster settlements.
The proposed move, which was issued today by Sebi as a 'discussion paper' inviting public comments, might also have a bearing on sale of pledged shares by large brokers or financiers which often leads to a panic-selling in the market.
Sebi said the current regulatory framework for mitigation of margin-related risks to clearing corporations has ‘given rise to another risk -- the risk of clients losing their collateral in the event of default/bankruptcy of the broker or TMCM, and accordingly there is a need to take steps to mitigate this.’
"Further, the overall risk in the system is dependent on the number of unsettled trades in the system at any point of time.
"A shorter settlement cycle can go a long way in reducing the risk in the system," Sebi said in the paper, titled 'Risk Management -- Safer Markets for Investors'.
The regulator said the extant system of risk management could be fine tuned for more efficient use of capital and enhancing safety of investors.
For the same, Sebi has broadly proposed three steps -- incentivising Internet Based Trading models posing minimal risk, mitigation of risk to client collateral, and T+1 settlement as a measure to reduce overall risk in the system.
'T+1' refers to settlement of trades with all the required payments one day after the execution of the trade order.
Currently, most of the trades are settled on T+2 basis, meaning two days after the execution of trade.
The risks posed to clearing corporations, which ensure settlement of trades through transfer of shares from seller's account to the buyer's after the payments, are mitigated by the margin requirements for the trading members or brokers.
The brokers or trading members are required to maintain a minimum of 50 per cent in cash or cash equivalents including fixed deposits.
As per the existing risk management system, margins calculated on open positions and collateral deposited against it form the first line of defence, while deposit based capital (base minimum capital, liquid networth) maintained by brokers and trading member form the second line of defence against failure of any market entity.
However, the current framework can be misused by the brokers to pass on the collateral received from its clients as its own collateral, although the good practice would be to keep clients' collateral in segregated accounts.
Sebi said the brokers trade in the market for their business, but investors come here to invest their savings.