A total of 39 broker defaults occurred between 2017 and 2022. One such episode in 2019 impacted millions of investors—their accounts were frozen and there were delays in transacting their rightfully owned securities and funds. Despite a provision allowing a change of broker, there was no way these investors could access their securities and funds through another broker. Multiple reasons were cited—the broking firm was not transferring the shares from pool account to DP holding account, payout requests were not being honoured, etc. Primarily, it was misuse of client’s securities and funds that added to the complexity.
Notably, after that episode, a commendable wave of reforms swept the Indian securities markets. The rightful use of clients’ securities and funds was made compulsory. This entailed segregation of client’s funds from those of the broker; collateral usage provided by clients only for their own purpose was mandated, and ASBA was introduced in the secondary market .
In addition to these, portability of brokers is a much awaited reform in the course of investor protection efforts. This would ensure seamless transfer of trading account from one broker to another, in case of a broker default,without causing any inconvenience to the investors. Portability would imply transfer of contractual positions, funds, or securities from one party to another.
Broker default episodes, when there is no broker portability, is marked by forced liquidations that creates risk exposures and eliminates potential risk-taking market participants who are capable of tolerating market risk at a critical time. Their elimination thus exacerbates price volatility, stresses markets and questions the efficient risk management model of securities markets. With portability, the positions of clients will not be liquidated but transferred to other non-defaulting clearing members.
In countries such as the UK, US, Europe, Australia and Japan, the segregation of client funds and securities has been the prerequisite for allowing broker portability. This facilitates easier portability than co-mingled accounts. One factor that significantly affects portability is the margining system. According to a survey by the IOSCO and Bank of International Settlement (BIS), in practice, the central clearing counterparty (CCP) has been successful in porting both gross and net margined accounts following a significant brokerage default.
A transition towards gross margined accounts instead of net margined accounts is recommended to enable portability. In gross margined accounts, clients should individually have sufficient collateral with the CCP to fully margin their positions. Thus, while porting such clients, no additional collateral would be required by receiving trading member/brokerage. Despite the transfer, margin requirements would not change in this scenario. The CCPs that transferred net margined accounts found it challenging and noted that significant effort was required by stakeholders to reconcile client positions. Other constraints cited in portability have been KYC and anti-money laundering requirements. However, in the US, temporary waivers are provided to facilitate portability and thus lessons follow for India.
The current reforms illustrates India’s preparedness towards broker portability. Already, Sebi has laid down parameters for designating qualified stock brokers (QSBs) and has formulated a framework for their orderly winding down in case of closure of business or due to their inability of providing services to clients or any other reason. This would result in seamless portability of clients to other Sebi-registered stock brokers. Thus, an effective portability mechanism for stock brokers is much desired—it will contribute to market efficiency and safeguard client’s money.
Rasmeet Kohli is working with the National Institute of Securities Markets.
Updated: 01 Aug 2023, 09:53 PM IST