Come September 2020, the mechanism of trading through use of shares as collateral is going to see a big change. Investors wanting to take exposure by using their Demat holdings, will now have to pledge their holding in favour of the broker through which they trade as against the current mechanism where the shares of the Investors were physically transferred to the collateral account of the broker from the Demat account of the Investor. Let us go through the basic questions as to what was the existing mechanism and how exactly the new mechanism will work
What is the current mechanism?
Currently in case the Investor wishes to trade in the capital market, he/she can do so by either transfer of funds or through transfer of demat holdings towards collateral/margin requirements to create positions. We will focus on the option of transfer of demat holdings as that is the subject matter. This happens through use of POA given to the broker on the demat account whereby the Investor every time need not give an instruction slip to transfer the holdings, instead the broker does so on behalf of the investor as this brings operational ease to the investor. The broker in turn utilizes the Investors collaterals by pledging the same to the CM/CC to get limits/margins for itself to fulfill the margin obligation of the Investor. The current process is been in place for nearly 2 decades.
How would new mechanism work?
In the proposed mechanism, the Investors holdings will not get physically transfer to the collateral account of the broker, instead it will only create a lien in favour of the broker through which the Investor wants to trade/create positions. This leg is referred as Margin Pledge. The broker in turn to get limits will further pledge the holdings in favour of CM/CC which is referred as Margin Repledge. The Investor will be able to view the status in the Demat holding as to how much is pledged and how much in turn is repledged by the broker. To create the pledge, the Investor may initiate request on his/her own or may confirm the request initiated by the broker through use of OTP (One Time Password) feature. The new process will help resolve both the major issues faced in existing mechanism whereby the only use the broker can make is to repledge the pledged shares and not anywhere else and secondly the CM/CC will give limits to the broker only to the extent of Investors margin requirement irrespective of the value of shares repledged by the broker. Apart from this the transparency in the new mechanism will give confidence to the Investors w.r.t. their holdings being safe. Also post the shift to new mechanism, the brokers are mandated to release all the shares lying in their existing collateral account to the respective Investors Demat account and close their collateral account and to take shares through new mechanism only.
Challenges in the proposed system
Many Investors may not have updated their latest Mobile number/ Email ID in the Depositories database which will make it difficult to get the OTP and given the lockdown situation updating the same will be a challenge in itself. Also this will also need a knowledge transfer to the Investors to effectively adopt the OTP culture as this will be applicable to even the old generation Investors who may not be that tech savvy. Apart from the challenges at Investors end, the Depositories too need to be geared up to develop the systems in place and to ensure the feature is made available real-time through use of API. If the pledge instructions are processed with a delay in time, it may end up in Investors not getting limits on real-time basis to trade/create positions and thereby end up executing trades at a different rate altogether. Post implementation by the depositories, the brokers would also need to change their back office and trading platform to adopt the new mechanism to ensure that the Investors are switched over to the new mechanism seamlessly.
To summarize, the new framework would bring lot of transparency in terms of handling the securities and shall surely boost the confidence and comfort at investors end. However this will increase the operational work at client end to transfer the shares marking through OTP for trading. Investors would be required to learn to use the new methodology of OTP framework. The mechanism which was to be effective from June 1 as per original timeline now stands extended to August 1 because of the Pandemic.
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