Sebi moots ASBA-like payment system for secondary market stock trade

Proposed payment system aimed at preventing misuse of client funds by brokers

The Securities and Exchange Board of India (Sebi) on Tuesday gave details of a proposed framework for shifting to a new payments system for secondary market trades. The move is primarily aimed at safeguarding investors from potential misuse of their funds by brokers.

According to industry players, the new system, along with the shift to the shorter T+1 settlement cycle, would make the domestic securities market one of the most efficient and sophisticated in the world.

In a discussion paper titled ‘Blocking of funds for trading in secondary market’, the market regulator is aiming to leverage the new multiple debits facility for the Unified Payments Interface (UPI) approved by the Reserve Bank of India (RBI).

“It is felt that the RBI-approved UPI mandate service of a single block and multiple debits can be integrated with the secondary market to provide a block mechanism whereby 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, thereby providing enhanced protection of cash collateral,” Sebi said in a paper inviting public feedback.

At present, an investor has to make an upfront fund transfer to its broker before initiating any trade.

This provides the broker with an extra float, helping it generate extra revenues in terms of interest income. 

According to industry estimates, over Rs 30,000 crore of client floats are available with brokers.

Under the proposed system, client funds would remain blocked in his/her account and would be directly transferred to the clearing corporation. A similar system is implemented for the primary market and is popularly known as ASBA (application supported by blocked amount). For the secondary market, however, the system design is much more complex given various segments, such as cash and derivatives, and different natures of trades, such as buy, sell, and intraday transactions.

At present, bank-backed brokerages provide a so-called 3-in-1 account facility where funds transferred by the broker match the trade value. But, according to Sebi, certain risks remain unaddressed. These include the risk of non-settlement of payouts, wrongful withdrawal of clients’ cash, and wrongful reporting.

According to the market regulator, the new system would safeguard the market from the risks emanating from default by brokers. “While the underlying reason for defaults by stock brokers may be different, the core of the problem lies in the misuse of clients’ funds and/ or securities. Apart from causing monetary loss to a large number of clients, such incidents have the potential to disturb the confidence of investors in the securities market and thus is a cause of concern,” it said, making a case for moving to the new system.

“In order to retain investors’ confidence, it is imperative that investor funds and securities should be adequately protected from the possibility of misuse or default by a stockbroker. The evolving regulatory framework has endeavoured to use technology in identifying early warning signs for any misuse of funds and securities by trading members,” Sebi said.

Under the proposed norms, Sebi has suggested that either the payment obligations, such as brokerage and STT, be deduced by clearing corporations and passed on to brokers or carried out between the customer and the broker directly.

Following a spate of broker defaults, Sebi over the years has taken multiple steps to prevent the misuse of client funds and securities by brokers. In 2020, the regulator introduced a so-called margin pledge and re-pledge mechanism, which stopped brokers from accessing client securities. Later in 2021, it introduced rules around collateral reporting, disclosure and client-level segregation.

Sebi has sought comments on the draft framework by February 16, 2023. The proposed system is seen as one of the most complex initiatives taken by Sebi Chairperson Madhabi Puri Buch.

Quite a change

The current system

1.       Customer transfers funds to brokers

2.       Money goes into pooled account

3.       Broker gives collateral to clearing corporation

4.       Broker is able to retain idle client fund

The proposed system

1. Customer initiates UPI mandate request at the broker interface for blocking of funds

2. Request goes to customer’s bank for blocking funds; confirmation is sent to acquirer bank of clearing corp

3. Clearing corp sends confirmation to intermediaries and investor

4. Broker allows customer to trade