Uncoupling Brokers from your Money

By – Prisha Khandelwal

Whenever we want to invest in the stock market, it is a prerequisite to transfer funds from our bank account to our broker’s account, who then initiates the trade after deducting his brokerage fees and forwarding the money to the clearing house. A clearing house is an entity that is associated with an exchange, such as BSE’s ICCL and NSE’s clearing. Its functions include handling settlements, confirmations, and deliveries in a trading transaction. Once the money is transferred, the securities are credited to the investor’s Demat account.

The huge amount that investors transfer to trade can also lead to unutilized cash lying with the stock brokers. For many generations, brokers have misused these funds as a means to generate additional income through different means, such as reinvesting these funds in the stock market to earn higher profits, fulfilling their working capital requirements, meant for the daily operations of their business, and directing these funds to other businesses in the  form of investment. A similar case was encountered in 2019 with Karvy Stock Brokers Ltd., the poster boy of bad brokers, which was charged with money laundering by illegally pledging their clients’ shares worth about Rs 2,800 crore for bank loans that were later diverted to other group companies, mainly real estate firms.

Since 2019, SEBI has been working to end brokers’ access to investors’ money and shares. Initiated by former SEBI Chief Ajay Tyagi and taken forward by current Chief Madhabi Puri Buch, these regulations aim at a paradigm structural shift that has the potential to alter the brokerage business in the country. This system would reduce the investor’s money secured with their respective brokers permanently, therefore breaking the chain by reducing the role of a broker from a mediator to just an advisor. Limiting access to clients’ securities would lead to a revenue hit for the brokers by reducing their ability to earn interest from the unused funds until they are sent back once every one to two months.

The incredible role of UPI has also been introduced in this system, wherein the investor will simply instruct the broker to execute the trade, who would then initiate the order to the clearing house, which in turn would block the funds required for the trade in the investor’s bank account through UPI. The order would then be processed, and the money would be debited through UPI when the securities were credited into the investor’s account. This new system would have many benefits, from reducing brokers’ access to investors’ money to preventing shady brokers from giving investors more control, which would minimise disputes between the brokers and the investors.

But this process comes with its constraints: The primary market works on the strategy of one-time block and one-time debit, which makes this strategy a hurdle for it, whereas the secondary market, which is also the target market, works on the strategy of one-time block and multiple debits, making this system more compatible with the secondary market transactions. Secondly, this system will require the banks and clearing to function more systematically with a mechanism for transparency of the whole banking system, which is a prior issue of the sector.

An amendment has been introduced in the name of the Quarterly Account Settlement Process in October 2022 that binds the stock brokers to compulsorily transfer the unused funds of the investors to their bank accounts at the end of every quarter. This move has led to an increase in the working capital requirement of the stock brokers because now they are required to provide their clients with the facility to trade immediately after selling their stocks, which is compensated by their capital, making the efficiency of a stock broker dependent upon the working capital requirements that he could assure to his clients.

Assuming that 50% of the more informed investors opt for the blocking chain mechanism, this will be a hard blow on the revenue and profitability of the brokers. They would have to rely on brokerage fees, which has also shrunk quite a lot in the past few years. If their income is not keeping up with their expenses, then brokers will have to shut their business or look for alternative streams of revenue. These new amendments have jolted the brokers inside out. With their avenues to earn revenues narrowed, many of them are feeling at the land’s end, and not in a very good way. SEBI has tried several times to emphasise the fact that they are not against the brokerage community as such, but they just want to make investing in equity markets a safe experience for investors.