Market regulator Securities and Exchange Board of India (SEBI) has implemented new rules with effect from 1 August 2022 according to which brokers are required to report individual client-level allocation of funds. This means one customer’s funds cannot be used for another’s margin requirements.
Brokers have to now start uploading client-level balances to the clearing corporations, based on which the latter will set client-wise limits. Until now, limits were set at the broker level or combined client levels, and not at individual client levels. The issue with this was that one customer’s funds could intentionally or inadvertently be used for another’s margin requirements.
Globally, pooled funds are the norm in almost all financial services businesses—banks, deposit-taking NBFCs, brokers, etc. The Indian broking industry is probably among the first globally to implement fund allocation at the client level to ensure that one customer’s funds cannot be used by another.
While the industry will become safer for customers, the changes are expected to increase the working capital requirements for brokerage firms.
As of now, if the broker’s overall margin utilisation across all clients exceeded 90%, the broker would be put in a risk reduction mode (RRM) by the exchanges. That is if the total customer margin utilisation is over 90% of the total overall funds the broker has placed with a clearing corporation. When in RRM, the broker’s customers are only allowed to exit positions, but not take new positions. However, since all customers are highly unlikely to use all funds at the same time, brokers could easily avoid being in RRM mode. Earlier there would just be excess cash in other clients so there was no impact overall. The broker would have to recover from the client but the exchange didn't have to care. Now exchange does, and it will block any individual client that exceeds limits.
However, starting 1st August, RRM is at the client level. This means, either the broker will have to disallow the customer from utilising more than 90% of funds in the account or provide for the remaining 10% from the broker’s own capital. Consider a case where a customer has Rs1 lakh in the trading account, the broker should allow the customer to trade only up to a maximum of Rs90,000 or provide Rs10,000 from their funds, which means the broker’s working capital requirement goes up.
"Penalties for brokers for not maintaining adequate working capital requirements kick in from 1st Aug. The second phase of the SEBI circular requiring brokers to provide a client-level allocation of funds to avoid one customer’s funds from being used by another goes into effect. This regulation was originally introduced in May 2022," discount broker Zerodha said in a blog
Further, if stocks are pledged as a margin for trading F&O, the customer must provide 50% of the margins used in cash. If they don’t, the broker’s capital will get blocked from fulfilling the cash component requirement by the clearing corps from 1st August.
Zerodha also highlighted that if a customer explicitly takes an F&O trade that causes their account to go into a debit resulting in a negative margin balance intraday or overnight, for example, exiting a hedged position, then the brokerage charges for orders placed during the duration where the account had negative margins, will be Rs40 instead of Rs20.
"This does not change anything for the vast majority of the customers. To ensure that this scenario doesn’t apply, simply ensure sufficient margin when taking trades," Zerodha said.
While customers get time till the next trading day to transfer marked-to-market losses, any margin increase must be available in the account immediately. Now, if a customer’s account has insufficient margins, it will start blocking from the broker’s funds.
The new rules are expected to change the game substantially for brokers as, if you can't commingle cash, then brokers will have to put up cash from their balance sheets.