SEBI puts in place tighter norms to prevent client securities' misuse

Markets regulator Sebi on Tuesday banned transfer of clients' securities to demat accounts of trading and clearing members, as part of efforts to prevent misuse of such securities.

The new framework has been devised after extensive consultations with stock exchanges, clearing corporations, depositories and industry representatives of trading and clearing members, and depository participants, according to a circular.

Against the backdrop of Karvy Stock Broking Ltd (KSBL) incident, the watchdog has now put in place stringent norms to prevent misuse of clients' securities that are available with trading and clearing members, and depository participants.

"With effect from June 01, 2020, TM (Trading Member) / CM (Clearing Member) shall, inter alia, accept collateral from clients in the form of securities, only by way of 'margin pledge', created in the depository system...," the circular said.

The watchdog made it clear that any procedure followed other than as specified under Sebi norms for creating pledge of the dematerialised securities is prohibited.

It is clarified that an off-market transfer of securities leads to change in ownership and shall not be treated as pledge, the circular said.

In November, the watchdog barred KSBL from taking new brokerage clients after it was found that the brokerage firm had allegedly misused clients' securities of more than Rs 2,000 crore.

Sebi said that depositories should provide 'margin pledge' for pledging client’s securities as margin to the TM/CM. The latter should open a separate demat account for accepting such margin pledge, which should be tagged as 'Client Securities Margin Pledge Account'.

"For the purpose of providing collateral in form of securities as margin, a client shall pledge securities with TM, and TM shall re-pledge the same with CM, and CM in turn shall re-pledge the same to Clearing Corporation (CC).

"The complete trail of such re-pledge shall be reflected in the de-mat account of the pledgor," the circular said.

Providing a detailed framework, Sebi said the TM should re-pledge securities to the CM's 'Client Securities Margin Pledge Account' only from the TM’s 'Client Securities Margin Pledge Account’'

"The CM shall create a re-pledge of securities on the approved list to CC only out of 'Client Securities Margin Pledge Account'," it added.

In the case of funded stocks held by the TM/ CM under the margin trading facility, those should be held only way of pledge.

For this purpose, the TM/ CM has to open a separate demat account tagged 'Client Securities under Margin Funding Account' in which only funded stocks in respect of margin funding should be kept/ transferred.

Further, securities lying in 'Client Securities under Margin Funding Account' should not be available for pledge with any other bank/ NBFC.

"The TM / CM shall be required to close all existing demat accounts tagged as 'Client Margin/ Collateral' by June 30, 2020. The TM/ CM shall be required to transfer all client’s securities lying in such accounts to the respective clients' demat accounts.

"Thereafter, TM/ CM are prohibited from holding any client securities in any beneficial owner accounts of TM/ CM, other than specifically tagged accounts," the circular said.

On February 17, Sebi chief Ajay Tyagi said it would soon come out with a circular to prevent incidents like KSBL.

"Transfer of securities to the demat account of the TM/CM for margin purposes (ie. title transfer collateral arrangements) shall be prohibited.

"In case, a client has given a power of attorney in favour of a TM/CM, such holding of power of attorney shall not be considered as equivalent to the collection of margin by the TM / CM in respect of securities held in the demat account of the client," the circular said.

The misappropriation or misuse would include use of one client's securities to meet the exposure, margin or settlement obligations of another client or of the TM/ CM.