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Sunday, March 7, 2021

New pledge system is a good start, can we think of real-time settlement now?

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There have been three truly watershed moments in the history of Indian capital markets. The first one came in 1994 with the launch of NSE, which enabled the migration from a physical outcry trading floor for equities to a complete electronic trading platform. The second, in 1996, was the dematerialisation of securities, which rid us of the pain of physical share certificates and manual shares transfer. And the third was when the Indian regulator decided to ban the indigenously evolved traditional stock financing system called ‘badla’ and later replaced it with the options & futures market in 2001.

Apart from bringing in transparency, these developments undoubtedly did wonders by increasing trading volumes and lending more depth and resilience to the market. They offered a seamless and transparent trading backbone, providing great ease of access to investors. The common underlying factor driving all these changes was the use of technology.

Having witnessed the implementation of all these path-breaking initiatives, I would say each time the regulator introduced such offbeat and progressive ideas, there is usually a general discomfort in the trading community. Murmurs about the havoc such changes could trigger are always abound. This is quite understandable, as these are revolutionary and unconventional steps.

The current Sebi decision to streamline the margin money mechanism through a pledge and re-pledge (PRP) system is another such radical use of technology. The requirement for pledge of securities arises because investors and brokers need to provide upfront margin money for every trade they do. This margin money can be in the form of cash, idle shares lying in a demat account that could be pledged, government securities or bank fixed deposits.

The question that comes up is why did we need this change? In the earlier system, brokers used to take a power of attorney (PoA) from their clients, which allowed them to access their clients’ demat accounts. This was required for the brokers to move the shares from client accounts to a separate account for the purpose of collateral for margin money. The shares were further transferred to the clearing corporation as margin. Unfortunately, this arrangement was prone to misuse, and there were situations of such nature. Therefore, Sebi’s decision to replace the PoA system with the PRP system is a definite step forward towards creating a more robust process.

Under the new system, clients just need to pledge the shares lying in their depository accounts with NSDL or CDSL in favour of the broker and the same become available for repledge to the clearing members. Thus, the securities would now remain in the client’s account with the depositories and need not be transferred out to any other account. In some way, it’s a clone of the ASBA process followed in IPO bidding.

There are several advantages of this new system. First, now the shares or securities of one investor cannot be used as margin money for any other investor. There is no possibility of intermingling of securities. Secondly, shares or securities of unknowing or inactive investors cannot be pledged to banks/NBFCs to finance another account. Finally, since the securities would not leave the actual owner’s demat account, the corporate benefit on them would continue to accrue to the owner.

As it often happens in the implementation of any new system, there has been teething problems in the initial rollout, which have led to a drop in trading volumes. Of course, it is compounded by the fact that some market intermediaries were expecting a deferral of the new process and were not entirely prepared for it. I believe as an immediate action this is a good attempt by Sebi to streamline this area of concern using technology.

In my view, though, in the long term this is still the penultimate step. The way we took the lead in moving the entire trading platform online, the way we moved from physical to electronic shares, we need to move to a real-time securities settlement (RTSS) system. Though I am no expert of technology, taking a cue from real-time gross settlement (RTGS) in place for transfer of funds, this seems doable. And given the brilliant track record this government has had with digital initiatives like Aadhar, digital health record, faceless income-tax assessment and appeals, I am sure this can be conceptualised and executed seamlessly. It will surely be another big feather in the cap of our capital markets, which have already become one of the most efficient markets in the world.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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