New system soon for disclosure of shares pledged with NBFCs

Capital markets regulator Sebi today said it is in touch with RBI to frame a new mechanism for disclosure by NBFCs of details about listed companies' shares pledged with them.
"The guidelines of SEBI and RBI need to be aligned in this regard and we are in touch with the central bank on this issues," Sebi Chairman U K Sinha told reporters on the sidelines of an event here today.
"The way to understand it is that Sebi had a margining system, the system prevalent for RBI was different. Sebi was in dialogue with RBI and we're happy that RBI has recognised the need to provide some sort of semblance in the two types of regulations and now they have come out with it. What we're now looking at is how in collaboration with RBI we can implement it and we're in that direction," he added.

The Sebi move follows a decision taken in this regard by the Reserve Bank, which has also taken steps to restrict the amount that NBFCs can lend against shares pledged with them.
"The status is that RBI has notified its own set of rules, which we think are very helpful. Now, we're working along with RBI on how we can implement it better and if we're finding any violations or if we're getting any leads. That is the direction we are at," Sinha said.
The disclosure would need to be made by all major NBFCs (Non Banking Finance Companies) on the stock exchange platform.

Sebi is in the process of putting in place a necessary mechanism to ensure that all NBFCs, with asset size of Rs 100 crore and above, disclose to the stock exchanges about shares pledged with them.

In a widespread practice, NBFCs provide funds to the stock brokers, promoters of listed companies and stock market operators as 'margin funding' to help them trade in equities and make profits in lieu of commissions or profit-sharing.
As Sebi has put in place strict guidelines for margin funding by brokers, they generally involve friendly or related NBFCs (which may be part of same group) to provide such financing through 'unofficial' channels.

Margin funding typically involves an investor, trader or operator putting up a small part of the money required for the trade, while the lender provides the balance amount. There have been cases where NBFCs have provided margin funding of as high as 70-80 per cent.
While this 'unofficial' practice has been continuing for decades, it led to a sharp meltdown in share prices, especially of small and mid-cap companies, between 2011 and 2013 after NBFC financiers dumped the pledged shares following defaults by their borrowers.
In most cases, it was observed that such margin funding was provided by NBFCs unofficially and in violation of prudent lending practices. Many of them were suspected to have indulged in a 'pump and dump' practice of first luring the borrowers into pushing up the price and then dumping the pledged stocks to make twin profits -- by lending to traders as well as by trading in stocks.

Prior to RBI's crackdown in August this year, the lending against shares carried out by NBFCs was not subject to any specific instructions apart from general prudential norms.