According to a new circular released by the market regulator, stock brokers and clearing members will no longer be permitted to create bank guarantees using clients’ cash as of today, May 1, 2023. The Securities and Exchange Board of India (SEBI) has requested that any bank guarantees that have already been issued using customer cash be terminated by September 30, 2023. The action tries to prevent the exploitation of investment funds.

Typically, banks provide bank guarantees to stock exchanges for security deposits and margin needs on behalf of stockbrokers. These assurances are provided to clearing companies, who subsequently decide the trading limitations for the brokers. However, brokers frequently deposit their clients’ money with banks, who then issue bank guarantees for larger sums.

According to the circular, starting on May 1, 2023, no new BGs may be formed using customer funds. Current BGs established with client funds must be closed by September 30, 2023.

According to reports, some brokers receive bank guarantees worth twice as much as the fixed deposits they have purchased with clients’ money, which results in a big discrepancy between their genuine net worth and the guarantees they use for trading. The market and clients’ funds are in danger due to this practice, according to Sebi, which has raised its worry.

Brokers’ need for working capital will increase due to Sebi’s requirement to utilise their funds to acquire higher Clearing Corporation limitations.

Since systemic risks may be associated with the collateral system, the Reserve Bank of India (RBI) and Sebi have been closely monitoring it. With the new regulation, these risks should be reduced, and investors’ money will be better protected.

The working capital requirements for stock brokers have increased due to SEBI’s action. This only applies to brokers who regularly utilise client money to fund BG for their own use, increasing client leverage and risk exposure. The proprietary funds of stock brokers and clearing members in any segment and those of stock brokers deposited with clearing members in the role of a customer will not be subject to the new set of restrictions, nonetheless.

SEBI will monitor and report any violations of this circular and ensure that brokers comply with the provisions within the stipulated timeframe to ensure everyone follows the rules.