Client collateral system to be more investor-friendly

Sebi to create independent entity to hold collateral instead of letting it remain in brokers' hands

To safeguard client assets, the Securities and Exchange Board of India (Sebi) is finalising guidelines proposing a central collateral facility for these. According to sources in know, the regulator is in favour of creating a single holding entity.

Currently, client collateral is deposited with the brokers who uses it to meet the respective client margin and pay-in requirement. Brokers maintain an audit trail of client collateral utilisation and issue a daily statement.

Sebi had floated a similar idea in May last year, but met tremendous resistance from the broking community. The regulator later agreed to hold discussions with market participants. However, the broking community’s arguments have failed to convince Sebi, which is now moving ahead with the proposal.

The regulator feels the present system doesn’t offer adequate safeguards for investor assets because the individual separation of client assets is only at broker level. The issue arises when the broker posts the collateral with clearing corporations (CC) and the segregation of the client collateral is lost due to lack of recognition of end client. The CC ends up viewing all the collateral as broker collaterals.

“Clients in the present situation run the risk of losing collateral due to default credit risk of brokers,” said a source.

According to Sebi’s concept note, if a broker defaults, the portability of client position as well as related collateral becomes difficult.

The market watchdog feels through a central collateral holding facility, the brokers and CCs will be able to directly recognise such collateral and give exposure.

Who should hold the client collateral had been a perpetual area of confusion as there had been policy changes several times, say sources.

“This would be the fourth time that the regulator is planning to change the policy around collateral holdings,” said a market participant.

In the draft proposal, Sebi has said this move would be specifically for the futures and options segment.

“We look forward to every move to make the markets efficient. However, the challenge in this proposal would lie in the drafting of a practically implementable five-member agreement between the client, the trading member, the clearing member, the proposed custodian and the clearing corporation,” said Uttam Bagri, secretary, BSE Brokers Forum.

If this proposal by the market watch dog is cleared, then in case of broker default, the client collateral present at the central facility will be safe and available for client positions. In case of client default, such collateral along with executing broker collateral will be available to CC for meeting client obligations.

According to brokers, losing control over collateral will require a change in the existing risk management practices.

“Today, if a client defaults, a broker is able to square off other positions and make the payout to the exchange but the same cannot happen if collaterals are no longer with brokers,” said a leading broker.

SAFETY AGAINST BROKER DEFAULT

• Sebi proposes central collateral holding facility
• Clients to directly deposit collateral with the central holding entity
• Currently, client collateral is deposited with the broker who uses it to meet client margin and pay-in requirements
• According to Sebi, clients currently run the risk of losing their collateral
• The proposal will safeguard clients in case of broker default