[Nishi Doshi is a final-year student at ILS Law College, Pune]

The prime function of the Securities and Exchange Board of India (SEBI), is to protect the interest of its investors. With the circular dated February 25, 2020, SEBI has yet again tried to fulfill its function of protecting the interest of the investors by revising the procedure for margin obligations in the cash market. The Circular discontinued the existing system of creating a Power of Attorney (POA) in the favour of Trading Members (TM) and Clearing Members (CM) for compliance with the margin obligations.


One of the inferences that can be drawn, from the issuance of this Circular is, it might be SEBI’s attempt to tackle the problem of misuse of POA as seen in the Karvy Stock Broking Case, where Karvy Stock Broking Ltd. misused the POA given by the client, at the time of opening a Demat account, to use the securities in its client’s account, without his knowledge, as collateral for a loan from the banks. This loan money was then invested in the subsidiary of Karvy Stock Broking Ltd. Thus, the investors lost not only the securities held by them but also the money to be received against these securities which were rightfully theirs. Therefore it could be stipulated that SEBI, by introducing a system of margin pledging of securities, is attempting to fill the loopholes of POA system.


According to this Circular margin obligations, the acceptance of collateral before buying or selling shares, by the TM is now to be fulfilled by pledging the securities held by the client, in the depositories system. These pledged securities are to be re-pledged with the CM who is in turn required to endorse the same securities with the Clearing Corporation (CC). The whole process of pledging the securities of the client is required to be conducted through an independent Demat account under the name of ‘Client Securities Margin Pledge Account’, which is to be maintained by the TM/CM.

For instance, if a person wants to buy/sell shares of a company, he needs to deposit a certain amount in cash or pledge some of his existing shares in the favour of a TM as a margin. On receiving such a request to buy/sell shares, the TM will initiate the transaction by first pledging the securities of the client as a margin. The client for whom this transaction is being carried out will receive an OTP on his mobile number or his email id. Upon receiving the OTP, the client is required to share the same with the TM. This will confirm the transaction from the client’s end. After this, TM is required to re-pledge the securities of the client in the favour of CM, who will further pledge it in favour of CC. Once the transaction is completed, the margin is released.

The Circular also clarified that the funded stocks related to margin trading facility can be held by TM/CM only through pledge under a different Demat account, ‘Client Securities under Margin Funding Account’. The Circular also has two annexures. Annexure A pertains to the operating mechanism of the pledging of securities to oblige with the margin requirements and Annexure B pertains to the manner in which the pledged securities are to be used.


While the Circular shows a promising decline in the level of risk of expropriation of client’s securities and seems theoretically sound, its implementation and actual ground level benefits of the Circular can be questionable.

Although pledging of securities as a margin obligation is a routine practice in the Futures & Options market (F&O), it may not be as uncomplicated in the cash segment of Exchanges. The cash market, by its very nature, is suitable for retail traders. The simplicity of the cash market allows people from all walks of life to invest their money in securities at a low brokerage rate. Initially, the process of trading on the cash segment only included a phone call from the client giving the TM instructions as to what shares to buy/sell. However, the introduction of pledging securities to fulfill the margin obligations adds complications to the straightforward cash market system.

The Circular introduces an OTP based system for margin pledge on buying and selling of securities. Annexure A of the Circular dealing with operational mechanism provides that after making a request for margin pledge, the process of pledging the securities will commence, however, it can be only furthered when the client gives his confirmation through an OTP received by him on his registered email id or mobile phone number. As stated earlier, this theoretically sound system may not be efficiently functional in real-time, mainly because by the time the whole process goes through the Client might lose the rate at which he actually wants to trade and may not go ahead with the trade itself, which in turn might cause loss of brokerage to the TM/CM.

With the stock market being dynamic in nature, the prices of a stock are always fluctuating, sometimes within seconds, thus making it a time-sensitive matter. The incentive for a person to trade in the stock market is the perceived right price of the shares, and if the person is unable to transact at a particular price, he may lose his money as well as interest. Thus, the TM may lose business as their income is in the form of the brokerage on every transaction made.

Moreover, the TM/CM may lose on both potential clients as well as the existing small clients as the idea of depositing money or securities as collateral before every transaction might not fit in well with the clients, partly because a client may be from almost any background and may not necessarily understand the nitty-gritty of the entire procedure of pledging. Trading on the stock market does not necessarily require formal education, neither did it, up until now require a client to use any form of technology other than making a call. Thus, making it tricky for the TM/CM to not only explain their client, the procedure of margin pledging along with the mechanism being used to conduct the said margin pledging but also guiding them to get accustomed to technology. Given the diversity of people trading in the cash segment of the Exchanges, the investors may not be even accustomed to the usage of emails, thus creating an extra burden on the Brokers to first familiarize their clients to systems of email and then the use of email to give their approval as required by the OTP based system of margin pledge.

It is also pertinent to note that margin pledging is likely to increase the cost for a TM/CM. The direct cost that the TM/CM may have to incur will be of setting up the software for margin pledging and updating their database in respect of the client information. Some members might have to incur the expense of hiring new staff for the existing number of clients as the client handling time is likely to increase as the procedure of trading will become more tedious and complicated with the introduction of this OTP based pledge system.


The Circular was originally set to come into effect from June 01, 2020; however, according to the SEBI’s circular dated July 29, 2020, an extension was given to the TM/CM to align all their systems by August 01, 2020, and trade according to the current system up to August 31, 2020. This extension was given keeping in mind the global pandemic of COVID-19. The Brokers wanted a further extension and made repeated requests for the same but SEBI refused to give any further extensions. However, SEBI, considering the difficulties faced by the Brokers, Exchanges and the Depositories, postponed the levy of penalties till September 15, 2020.

The Circular might not prove to be as effective as intended as it is not only ignorant of the fact that trading is a time-sensitive matter but also pays no heed to the investor's lack of technological knowledge. The most probable impact of this Circular is the decrease in the volume of trading on the cash Segment of Exchanges; however, the real and actual difficulties will unveil themselves as and when the Circular comes into effect.

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©2020 by The Competition and Commercial Law Review.