In a circular issued by SEBI today (25th April 2023), brokers will no longer be able to create Bank Guarantees (BGs) out of clients' funds, a practice that continues to exist till today. Brokers/Clearing Members have been pledging clients' funds with banks and creating BGs to meet margin requirements, perhaps fund clients' trades or take speculative positions in the market under their proprietary trading book. It's hard to ascertain how such BG limits are utilized, but these are the best-known avenues. It's hard to say how this impacted the market apart from it, resulting in implicit leverage and increased risk exposure of client funds. To safeguard the interests of investors, SEBI has decided to implement the following measures:
From May 1 onwards, brokers/CMs cannot create BGs out of clients' funds.
Existing BGs from clients' funds shall be wound down by September 30, 2023.
Proprietary funds of brokers will not be affected by this framework. Brokers must provide a certificate from their statutory auditor confirming the implementation of this circular by October 16, 2023. The Exchanges and CCs will monitor this circular's performance and put periodic reporting mechanisms in place for brokers to prevent any future violations by regular inspections/reporting and evolve adequate mechanisms to address cases of brokers who do not comply with the provisions of the circular by the stipulated dates.
This move will reduce leverage in the system, especially in the 50-50 cash to collateral margin funding where traders take funding from brokers, which could be made available due to this route. It will prevent traders from being exposed to brokers' proprietary trading and funding activities and help protect investors' interests in the stock market.
How does this impact retail traders?
It helps reduce the risk exposure of client funds and prevents brokers from using clients' funds for their proprietary trading and funding activities. So, overall it's a welcome move. You will benefit form it unknowingly. Traders should be aware that the implications of this circular will not affect their day-to-day trading in any way other than the possibilities that I have highlighted such as 50-50 cash to collateral margins, etc. and that too if the BG limits are utilized for such purposes. If not, you won't feel a pinch.
Peak margin rules require traders to pay full margins upfront even intraday trading. So, this will mostly be a non-event unless you're using leverage in some way, shape or form to fund your F&O positions other than what's mentioned in Point No. 1. Other than that, you have no reason to worry, in my opinion.
I look forward to posting actively in the regulatory section to help spread knowledge about the evolving regulatory space. I'd happily clarify your doubts and respond to queries in the comments section. Btw, I've attached the circular if you're interested to read it.
Disclaimer: FYERS has never created BGs our of client funds at any time in the past. I'm not suggesting that it is practiced by most brokers either. I assume that some might be doing it and hence the reason for this new regulation.