In a ground-breaking move, the Securities and Exchange Board of India (Sebi) has proposed a new settlement mechanism for stock trades set to take effect from January 1. This transformative initiative, akin to the Application Supported by Blocked Amount (ASBA) facility for Initial Public Offering (IPO) applicants, aims to enhance investor protection, eliminate fund misuse by stock brokers, and mitigate the risk of broker defaults. In this comprehensive exploration, we delve into the intricacies of the proposed settlement facility, its implications, and the broader context of this paradigm shift.
Understanding the New Settlement Facility by SEBI
- Core Concept
The crux of the proposed settlement by SEBI mechanism lies in ensuring that investors’ funds only depart from their bank accounts upon the completion of trades. This represents a departure from the current model where funds are transferred to stockbrokers, introducing a more secure and streamlined process.
- Application to Equity Cash Segment
Initially, the new settlement facility will be applicable exclusively to the equity cash segment. However, there is potential for its extension to other market segments in the future.
Examining the Current Process
- Broker-Mediated Payments
In the current system, brokers play a pivotal role in coordinating payments between the clearing corporation and investors during the stock market settlement process. Investors transfer funds to the broker, who, in turn, facilitates the transfer to the clearing corporation through a clearing member.
- Pre-Funded Purchases
Taking a closer look at a typical scenario, a client pre-funds a purchase by transferring a specific amount to the stockbroker. The broker retains the funds, allocates collateral, and completes net settlement with the clearing corporation.
The Proposed Process
- Unified Payments Interface (UPI) Integration
Sebi envisions the integration of the UPI mandate service with the secondary market, introducing a blocking mechanism. Under this system, clients can block funds in their bank accounts specifically for trading in the secondary market, eliminating the need for upfront transfers to brokers.
- Dual Advantage – Blocking and Earning Interest
The proposed mechanism by SEBI allows for the creation of blocks in favor of the clearing corporation, securing funds in the client’s account until the completion of trades. Importantly, this arrangement allows clients to earn interest on the blocked funds while eliminating the necessity of transferring funds to brokers.
- Collateral and Settlement Adjustment
Funds blocked through UPI will serve as collateral, available for settlement purposes. The clearing corporation can deduct funds from the client’s account, adhering to the specified block amount. This innovative approach ensures that clients’ funds are protected and used exclusively for settlement obligations.
- Multiple Blocks and Settlement Obligations
For clients opting to block lump sum amounts, the proposed system by SEBI allows funds to be debited multiple times for settlement obligations across days. This not only streamlines the process but also maximizes the utilization of funds for the investor.
Key Features of the Framework
- Investor Optionality
Availing the UPI block facility will be at the discretion of the investor, introduced as a non-mandatory feature by stockbrokers. Investors, who often maintain trading accounts across multiple brokers, can choose this facility under some brokers while opting for non-UPI-based trading under others.
- Segment-Wise Collateral and Settlement
The proposed framework maintains the existing structure of collateral and settlement being segment-wise. This ensures that the differentiation between various market segments is upheld.
- Single Block Limit
A single block limit of ₹5 lakh will be in place, mirroring the current limit applicable for UPI-based securities market transactions. However, multiple blocks can coexist, subject to the overall limit applicable in UPI.
The Broader Context: Significance and Implications
- Safeguarding Investor Funds
At its core, the proposed settlement mechanism by SEBI is a significant step towards safeguarding investor funds. By ensuring that funds remain in the client’s account until trade completion, the risk of misuse by stockbrokers is substantially reduced.
- Mitigating Broker Default Risks
The innovative approach of direct settlement with the clearing corporation minimizes the risk of broker defaults, providing a more secure environment for investors.
- Interest Earning Potential
The dual advantage of blocking funds for trading while earning interest on the blocked amount represents a progressive approach. This aligns with investor interests and introduces a financial incentive for participation.
- Future Expansion Possibilities
While initially applicable to the equity cash segment, the proposed mechanism opens the door for potential expansion to other market segments. This adaptability reflects a forward-looking approach to enhance market efficiency.
Sebi’s proposed settlement mechanism signifies a paradigm shift in the landscape of stock trade settlement. By leveraging technology, streamlining processes, and prioritizing investor protection, this initiative aligns with global best practices. As India moves towards a more sophisticated and investor-friendly market, the proposed changes herald a new era in the country’s financial ecosystem. As the January 1 implementation date approaches, market participants eagerly await the tangible impact and benefits this transformative move will bring to India’s securities market.