SEBI’s New Rule: Stock Brokers cannot use their clients’ funds for bank guarantees

According to a Securities and Exchange Board of India (SEBI) ruling, stock brokers and clearing members in India would no longer be allowed to use their clients’ funds for bank guarantees from May 1, 2023.

Typically, banks give bank guarantees to stock exchanges on behalf of stockbrokers for security deposits and margin requirements. These assurances are provided to clearing firms, who define the trading restrictions of the brokers. Brokers, on the other hand, frequently pledge their clients’ funds with banks, which give bank guarantees for larger amounts. Banks issue BG at twice the amount committed by the broker, putting the market at danger.

According to the circular, no new BGs would be created using client funds after May 1, 2023. Existing BGs established with client funds will be liquidated by September 30, 2023.

Sebi is concerned that this practise puts the market and clients’ funds at danger. According to reports, some brokers secure bank guarantees for twice the amount of fixed deposits they have made with clients’ assets, resulting in a considerable gap between their genuine net worth and the guarantees used for trading.

Sebi has ordered that brokers utilise their own working capital to achieve bigger Clearing Corporation limitations, hence raising their working capital demand. Additionally, Sebi has ordered brokers to wind down any existing bank guarantees created using clients’ funds by September 30, 2023.

Because of the possible systemic concerns posed by the practise, the Reserve Bank of India (RBI) and Sebi have been closely monitoring the collateral system. The new rule is intended to reduce these risks and provide greater safety for investors’ assets.

Tradeplus applauds SEBI’s recent decision to prohibit the use of customer funds in the production of Bank Guarantees.

SEBI’s action increases stock brokers’ working capital requirements even more. This will only affect brokers who have a practise of pledging client funds to produce BG for their own use, hence increasing clients’ leverage and risk exposure. This circular would be of academic interest to brokers who have already implemented Segregated Margin Reporting and online client wise / segment wise allocation of client collaterals.

The new requirement is interesting to notice, especially as the debates are on with the regulator’s plans to adopt ASBA and upstreaming of customer money.

Brokers must ensure that their own funds are not affected by this new framework. To make sure everyone plays by the rules, Sebi will monitor and report on any violations of this circular and ensure that brokers comply with the conditions within the stipulated timeframe.

This move by Sebi is a positive step towards greater accountability in the securities industry and preserving investors‘ interests.