On June 20, 2019, SEBI issued a circular (Circular) laying down a new set of rules to enhance regulation related to the management/use of clients’ securities by trading members (TMs) and clearing members (CMs). The current legal framework already provides for several rules on how TMs can deal with the securities/funds of their clients. For instance, a TM is required to keep the securities of its clients in accounts separate from its own. Further, a TM must ensure that securities in a pool account are transferred to the beneficiary account of its client within 1 working day after the pay-out day. Furthermore, a client’s securities cannot be used by a TM for any purpose apart from meeting the client’s margin requirements/pay-in obligations. However, there have been several instances where TMs/CMs have pledged securities of their clients with banks/NBFCs to borrow funds to meet margin requirements of other clients and for proprietary trades. In light of the above, SEBI issued the Circular to bring greater clarity and uniformity on how TMs and CMs can manage/deal with the securities of their clients.
The Circular reconfirms that securities received on the pay-out day for which payments have been cleared by clients have to be transferred to the demat account of the respective clients within 1 working day of the pay-out. Further, securities for which clients have not made full payment will have to be transferred from the pool account to a separate account titled ‘client unpaid securities account’. Such securities can be transferred to the demat account of the clients only upon full payment. However, in the event the client fails to pay the appropriate amount within 5 days from the pay-out date, the TM/CM would be mandatorily required to dispose of the securities in the market. To ensure compliance, the Circular stipulates that in case the clients’ securities are kept in the ‘client unpaid securities account’ beyond a period of 7 trading days from the pay-out date, the depositories are required to impose appropriate penalties on the concerned TMs/CMs.
To prevent misuse of investors’ securities, the Circular has imposed a bar on TMs/CMs to raise funds from pledging securities of clients lying in the ‘client collateral account’, ‘client margin trading securities account’ and ‘client unpaid securities account’ even with their consent. Further, TMs and CMs have been directed to close all client securities accounts except for ‘pool account’, ‘client margin trading securities account’, ‘client unpaid securities account’ and ‘client collateral account’. TMs and CMs have been given time till August 30, 2019, to comply with the conditions laid down in the Circular.
Share prices of several TMs fell after the issuance of the Circular as it has introduced an absolute bar on TMs from pledging securities of their clients, restricting the flexibility enjoyed by former to raise funds. On account of the blanket ban, TMs will now have to extend credit facilities to their clients from their own resources or clients will have to raise their own funds from alternate sources. This may adversely impact the business operations of TMs in the future. However, overall, the Circular is a move in the right direction to prevent TMs/CMs from fraudulently and manipulatively misusing the securities of their clients.
