Under the current framework for settling a client’s buy transaction, the clearing corporation credits the securities to the broker’s pool demat account, after which the broker transfers them to the respective client’s demat account.
I have a piece with Manas Dhagat and Shivaang Maheshwari on SEBI's proposal to make direct payout of securities accounts without passing through the broker. The risks of a broker's negligence and given some past cases, even crooked behaviour, this will be a great step forward for both the efficiency, speed and safety of payment systems in the securities markets clearance and settlement. The full piece is as below:
SEBI, in a recent consultation paper, has proposed to mandate direct payout of securities to clients’ demat account without any involvement of the stock broker’s pool account. Under the current framework for settling a client’s buy transaction, the clearing corporation credits the securities to the broker’s pool demat account, after which the broker transfers them to the respective client’s demat account. While the mechanism of direct payout of securities to clients was envisaged way back in 2001, the consultation paper has now proposed making it mandatory for all transactions with the objective of enhancing operational efficiency and reducing the risk to clients’ securities.
The process would involve a clearing corporation or a clearing house reaching out to each clearing member (usually the stock broker) to obtain the beneficiary account details of the clients who are scheduled to receive a payout of securities. Once these details are obtained, the clearing member would send a payout instruction to the depositories, directing the credit of securities directly in the client’s demat account without any involvement of a broker’s pool account. The consultation paper also proposes that clearing corporations introduce a mechanism for clearing members to identify unpaid securities (i.e., securities that have not been paid for in full by the clients) or funded stocks under the margin trading facility, to provide clarity to stock brokers regarding the status of securities, ensuring they have up-to-date information on unpaid and funded stocks.
The current process involves multiple entries, tracking, and reconciliation efforts on part of the stock broker while transferring securities from its pool account to the client’s demat account. With the direct credit of securities to the client’s demat account, the intermediary step of transferring from the pool account is eliminated, which significantly reduced the complexity of the brokers’ operational workflow. Handling transfers from the pool account to individual client accounts can be prone to discrepancies or potentially fraudulent activities by stock brokers. A number of cases have also been observed wherein the brokers were involved in misuse of clients’ securities kept in the pool account. Direct credit of securities reduces the touchpoints and hence the opportunities for errors and fraud, leading to more secure and accurate transactions. Additionally, brokers need robust IT systems to manage the complexities of transferring securities from pool accounts to individual client accounts, including handling exceptions and resolving issues. With a more straightforward process, the IT infrastructure can be simplified as well. Systems can be optimized for direct credit operations, reducing the need for complex transfer mechanisms and the associated support and maintenance.
This is not the first time SEBI has acted upon protecting an investor’s interest from a potential default by a stock broker. Last year, with a view to prevent misuse of clients’ funds, SEBI introduced a process for trading in the secondary market based on blocked funds in a client’s bank account. Under this process, funds would remain in the bank account of the client but will be blocked in favour of the clearing corporation, which will only be debited towards obligations arising out of the trading activity of the client. Thus, instead of transferring the funds upfront to the broker, funds are blocked in the bank account of the client itself, ensuring enhanced protection of cash collateral and preventing the misuse of clients’ funds by the broker. Similarly, the application supported by blocked amount (ASBA) method has been provided for retail individual investors for applying in an IPO. Under this process, funds are blocked in the bank account of the investor till the finalization of allotment, post which the amount equivalent to allotted shares would be debited or, in cases of no allotment or partial allotment, the balance amount will be unblocked.
A similar block mechanism has also been prescribed for undertaking sale of securities wherein clients’ securities lying in the demat account of a client are blocked in favour of the clearing corporation till such time a sell order is executed. If the sale transaction is not executed, securities would continue to remain in the client’s demat account and will be unblocked. This mechanism was introduced to do away with the movement of shares from client’s demat account for early pay-in and back to client’s demat account if the trade is not executed.
These steps taken by SEBI indicate a paradigm shift with less reliance on the broker for handling the securities and funds of its client and an enhanced focus on the clearing corporations to ensure smooth and transparent settlement processes. The direct crediting of securities to clients’ demat accounts represents a significant move towards increased market integrity and investor protection. Clearing corporations will now take on a more central role in the settlement ecosystem, overseeing the direct transfer of securities and ensuring that all transactions are accurately and efficiently processed. Clearing corporations will need to develop and implement robust systems to manage this increased responsibility. This includes upgrading technology to support real-time processing and direct crediting of securities, enhancing risk management frameworks to address any new risks associated with direct transfers and working closely with depositories to ensure seamless integration and synchronization of data, ensuring accurate and timely settlement.
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