Don’t leave excess cash with your broker

Check the weekly statement on cash balance sent by the exchange and report any discrepancy

Twenty nine brokers have defaulted on the NSE since 2018. Seven have done so this year. The regularity with which brokers default makes it imperative that retail investors entering the capital markets exercise utmost care in choosing this intermediary.

Playing fast and loose with customer assets

The most common reason for broker default is that they may, in the past, have used clients’ securities and cash for proprietary trading, and suffered losses. The other is that the broker may have used one client’s cash or securities to offer enhanced margin to another, who may have suffered losses.

Over the past year and a half, the Securities and Exchange Board of India (Sebi) has tightened regulations, making it harder for brokers to continue with such practices. Reporting norms have also turned more stringent. “The broker is unable to produce his clients’ funds and securities which he is supposed to have. Many such cases have come to light in the new tighter regime, leading to a string of defaults,” says Shrey Jain, founder, SAS Online, a Delhi-based discount broking firm.

According to industry insiders, the rapid pace at which these new norms were implemented meant many brokers were unable to manage the transition to the new, cleaner order. “What we are witnessing now is a cleansing of the system that may continue for some time,” says Vikas Singhania, executive director, Trade Smart Online.

Key reforms of the recent past

The regulator has introduced several reforms that are expected to reduce the frequency of broker defaults in the future.

Peak margin norm: Earlier, a broker was free to give as much leverage to his clients for intraday trading as he desired. In the earlier regime, if a client enrolled with a broker and deposited ~1 lakh, the latter could give him margin of ~1 crore or higher. There was no ceiling on this.

This practice created a lot of risk in the system. Remember, the broker does not get any margin from the exchange. The amount he deposits determines the trading limit the exchange allows him. The broker gave high limits to some clients by using other clients’ money and securities. If these clients lost money, the broker was unable to make good the money and securities belonging to the other clients, causing a default.

Under the new rules, the client gets a limit equal to the amount he deposits. “The 100 per cent margin limit that existed at the exchange level is now being implemented at the broker’s level also,” says Jain.

Margin pledging:

In the Karvy case, the broker pledged clients’ securities with banks to raise money. This happened because brokers had access to clients’ securities earlier.

In the system that Sebi introduced in September last year, if a client wishes to pledge his securities for margin, a lien is marked on them in the client’s account itself. They are no longer moved to the broker’s account. This reform has reduced the scope for misuse of clients’ securities. “The broker does not have custody of the securities. Even if he defaults, the client’s securities are safe with the depository,” says Jimit Modi, founder and chief executive officer (CEO), Samco Securities.

The regulator is now also developing a system that will provide clients with complete visibility of his collateral. “The client will be able to view the status of his pledged securities, thus creating greater transparency,” says Modi.

Upfront cash margin: Earlier, if a broker was acquainted with a client who opened an account with him, he would allow him to start trading without collecting any margin money. If the client suffered a loss, the broker bore the brunt. Now, the client has to deposit 20 per cent margin upfront before a broker can allow him to trade.

Enhanced supervision norms: Brokers now have to upload a weekly report to the exchanges on clients’ funds lying with them. The exchange (and not the broker) shares this information with the client who can spot any discrepancy at once.

Keep an eye on the cash

Owing to the reforms that Sebi has introduced, it has become difficult for brokers to misuse clients’ securities. However, a lot of clients’ cash lies with the broker, which could be misused. “Bank-led brokers, who provide threein-one facility, do not keep customers’ money with themselves. If a customer wants to trade, the money is withdrawn immediately from his account. Sebi needs to find a way to ensure that no money belonging to clients lies with any broker,” says B Gopkumar, managing director and CEO, Axis Securities.

Until recently, the rules pertaining to cash were that the broker had to settle every client’s account and return his cash at least once every quarter. “Now the regulator has stipulated that if a client has been inactive during a month, and he has unutilised cash lying with the broker, the latter must return the money,” says Modi. This is expected to reduce the misuse of cash further.

Nonetheless, customers need to observe a few precautions. “If you don’t trade frequently, then avoid keeping large amounts with your broker,” says Singhania.

Keep your mobile number and email updated. When you receive the weekly report on cash holdings, check to ensure there is no discrepancy between the amount you have kept with the broker and what the latter has reported. “Treat any discrepancy as a red flag,” says Modi.

Delays in payouts and closing down of your broker by the exchange intermittently (because he is unable to meet his margin requirement) are other signs that the broker may be experiencing financial difficulties.