Stock exchanges up scrutiny of traders whose exposure exceeds income

NSE asks asked brokers to check for suspicious transactions as derivative activity surges

Exchange authorities have flagged a mismatch between the declared wealth and earnings of some traders and the exposure they have taken on the stock exchange.

A circular by the National Stock Exchange has asked brokers to check for suspicious transactions and ensure that the source of funding is clear. Meanwhile, some brokerage officials feel that more clarity on the degree of violations that should be reported may be needed to help address issues.

“…it has come to the notice of the Exchange that, pay-in/ pay-out obligations/ margin/ exposure for some clients are not consistent with the income level/ net worth uploaded by the Trading Member for such clients…(the existing set of norms)… includes provisions of disciplinary actions for non-fulfilment of surveillance obligations of trading members,” said the exchange circular to brokerages.

There is a lack of clarity on the nature of transactions or mismatch that should invite additional scrutiny, according to senior officials from two separate brokerages.

It is possible that some traders may be borrowing money from others to trade in the market, said one brokerage official. The exposure would be high relative to income because of this borrowed money. It is not clear at which level of leverage exchange authorities expect brokerages to flag such transactions, said the person. The person’s organisation uses a threshold of four times' annual income and twice their net worth. The brokerage seeks clarity on changes to client wealth or income profile if exposure exceeds these levels.

“That is an internal calculation. It doesn’t even go to the client. If it breaches that, we go to the client,” he said.

“They are saying that if you come across such a case then you flag it off as a suspicious transaction report (STR) and escalate to us,” said an official with another brokerage. The issue has come up previously as well, he added.

There may be situations where clients have not updated their details, though they are required to do so. A person who opened a brokerage account a decade ago may have a very different income level, now, according to one person.  

A recent study by the Securities and Exchange Board of India (Sebi) had noted a significant rise in futures and options (F&O) segment trading activity in financial year 2021-22 (FY 2021-22) compared to pre-pandemic times.

“There has been a significant increase of over 500% in the number of individual traders in the equity F&O segment in FY2021-22, as compared to FY2018-19… 9 out of 10 individual traders in the  equity F&O segment incurred  net  losses during both the years FY 2018-19 and FY 2021-22,” said a Sebi statement at the time the report entitled, ‘Analysis of Profit and Loss of Individual Traders dealing in Equity F&O Segment,’ was released in January 2023.

The report noted that the top 10 brokerages had 4.5 million clients trading during the financial year 2021-22 (FY22). The overall number of active clients across brokerages had slipped to 4.3 million clients as of December 2022; shows the latest exchange data.  

There were only 1.5 million who recorded any short-term capital gains in 2017-18, shows an analysis of the last available income tax data, or less than five per cent of the 31.9 million investment accounts active at the time.