Sebi proposes blocking of funds for trading in secondary market; seeks comments

Capital markets regulator Sebi has floated a consultation paper on 'blocking of funds for trading in secondary market', which will help investors protect their money against any misuse and default by stock brokers.

The paper says blocking funds for trading in the secondary market will allow investors to trade in the secondary market based on blocked funds in one’s bank account.

It'll eliminate the need to transfer funds to a stock broker, in addition to providing client-level settlement visibility, both pay-in and pay-out, to a clearing corporation (CC) by a direct settlement of funds and securities between investors and CC.

This process, says Sebi, will by design safeguard "clients’ assets from misuse/brokers’ default and consequent risk to their capital".

Sebi says its consultation paper follows a series of talks held with stakeholders, including clearing corporations, NPCI (National Payments Corporation of India), stock brokers and banks. Sebi's special focus on retail investors comes as the securities market in India sees tremendous growth in the past couple of years.

As per the existing framework, clients' assets pass from the stock broker to the clearing member to the clearing corporation (CC). The current structure also allows retention of a certain portion of collateral at every level i.e. collateral can be retained by the stock broker, CM and CC.

Client’s assets, whether funds collateral or funds/securities settlement pay-in, pass through the stock broker and clearing member before reaching CC. The pay-out released by CC also follows a similar cycle. While CC provides final settlement instructions to members each day, it is the stock broker who settles obligations with clients.

Sebi says in the current process, there is a possibility that a client’s collateral retained with a stock broker or CM can be "misused" or it could be at the risk of "defaults" by a stock broker or fellow client.

Sebi says the proposed framework will allow identification of ownership of cash collateral available to CCs; it'll eliminate custody risk of client collateral and direct settlement with CC. It'll also ensure the hassle-free and immediate return of the client's funds and securities in case of default.

Sebi has sought comments from all the stakeholders latest by February 16, 2023. The regulator says the Unified Payments Interface (UPI) mandate of a single block and multiple debits can be integrated with the secondary markets to provide a block mechanism (similar to pledge-like mechanism securities). In this, clients will be able to block funds in their bank account for trading in the secondary market, instead of transferring them upfront to the trading member.

The funds will remain in the account of a client but will be blocked in the favour of the CC till the expiry date of the block mandate or till the block is released by the CC, whichever is earlier. Further, while a UPI block upon creation will be considered towards collateral, the same will be available for settlement purposes, says Sebi.