On Dec 17, 2018, SEBI had issued a circular on Early Warning Mechanism to prevent
diversion of client securities.
The main purpose of this circular was to protect the investor's money who pledged the securities for their margin requirements as collateral to their brokers. Now some brokers misused the pool account and transferred these securities to the prop account (own account) and used them for their purposes of margin requirement in case of shortfall etc.
This issue came to light when stockbrokers failed to meet the margin/settlement obligations to stock exchanges/clearing corporation.
So, the regulator decided to make an early warning mechanism that includes the signal list that detects the diversion of the client’s securities by the stockbroker at an early stage.
It was decided that the Stock Exchanges, Depositories, and Clearing Corporation shall decide the threshold for such early warning signals with mutual consultation.
The regulator also said that alerts triggered at one stock exchange, clearing corporation, or depository through an early warning mechanism should be immediately shared with others concerning the stockbroker or depository participant concerned
This circular was implemented on Feb 01, 2019.
On January 11, 2019, SEBI issued a circular on a uniform membership structure across all the segments with a single registration for TM/CM.
On July 01, 2020, SEBI came with another circular that directs the Standard Operating Procedure in the cases of Trading Member / Clearing Member leading to default.
The regulator said," With the introduction of uniform membership structure of Trading Member (“TM”) and Clearing Member (“CM”) across all segments, the TM shall make good the default of its clients to the CM and the CM shall make good the default of its clients / TM to the CC. The default of TM may not necessarily lead to default of CM, if the CM continues to fulfill the settlement obligation with the CC.
To protect the interest of non-defaulting clients of a TM and /or non-defaulting clients / TM(s) of the CM, in the likely event of default by TM / CM, there is a need for a Standard Operating Procedure (“SoP”) enumerating the steps to be taken by the SEs / CCs / Depositories in such cases where SE / CC is of the view that TM / CM is likely to default in repayment of funds or securities to its clients"
On analysis of early warning signals or any of the following triggers, if the Stock Exhange / Clearing Corporation is of the view that the TM / CM is likely to default in the repayment of funds / securities to its clients and / or fail to meet the settlement obligations to CM / CC, where:
a) There is shortage of funds / securities payable to the clients by Rs. 10 crores (SE may have their criteria) and/or
b) TM / CM has failed to meet the settlement obligations to CM / CC and / or
c) There is a sudden increase in the number of investor’s complaints against the TM / CM for non-payment of funds and/or transfer of securities,
Then actions shall be taken by Initiating Stock Exchange (ISE) / SEs / CCs and Depositories as per the timeline & process given in the circular.
Now On May 27, 2022, the watchdog of the market modifies the 4.25th point of the circular which was issued in July 2020.
Specifies how the amount is to be paid to investors out of the Base Minimum Capital (BMC) margin which is available with stock exchanges/clearing corporation after clearing all dues of SEs/CC.
"Balance amount to be utilized for settling the credit balance of investors starting from the smallest amount. Such amount shall be paid in full to all such investors having a credit balance up to the amount of Rs. 25,00,000/- (Rupees twenty-five lakh), subject to availability of funds. Further, investors having a credit balance of more than Rs. 25,00,000/- (Rupees twenty-five lakh) shall be paid on a pro-rata basis from the remaining funds" as per the new circular.
Source: https://www.sebi.gov.in/
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