Sebi bans brokers from creating bank guarantees on clients' funds

Capital markets regulator Sebi prohibited stock brokers and clearing members from creating new bank guarantees on clients' funds beginning May 1

Capital markets regulator Sebi on Tuesday prohibited stock brokers and clearing members from creating new bank guarantees on clients' funds beginning May 1 and directed them to wind down all existing bank guarantees by September-end.

This is part of Sebi's effort to curb the possible misuse of investors' money by stock brokers.

At present, stock brokers (SBs) and clearing members (CMs) pledge client's funds with banks which in turn issue Bank Guarantees (BGs) to clearing corporations for higher amounts. This implicit leverage exposes the market and especially the client's funds to risks.

"Beginning May 1, 2023, no new BGs shall be created out of clients' funds by SBs/CMs. Existing BGs created out of clients' funds shall be wound down by September 30, 2023," Sebi said in a circular.

The framework will not be applicable for proprietary funds of stock brokers and clearing members in any segment and SB's proprietary funds deposited with CM in the capacity of a client.

In addition, the regulator has directed stock exchanges and clearing corporations to take stock of the current position of the BGs issued out of clients' funds by brokers and clearing members, and monitor the wind down to ensure implementation of the framework without any disruption of services to clients.

For this purpose, stock exchanges and clearing corporations have to put in place periodic reporting mechanisms for stock brokers and clearing members.

Sebi asked stock exchanges and clearing corporations to submit the name of the stockbroker, nature of the entity, total bank guarantee amount as collateral, total bank guarantee (out of client's funds) as collateral, and total bank guarantee (out of proprietary funds) as collateral to it on fortnightly basis, starting June 1 this year.

In February, the regulator proposed to stop trading members and clearing members from retaining any part of client funds at the end of the day and move the entire funds to the clearing corporation on the same day.

Currently, when an investor places funds with a broker a portion of such money is retained by the broker, and a part by the clearing member, before passing the remaining amount to the clearing corporation.