Sebi mulls specialised fund for handling defaults as existing SGFs fail stress test

Written by Ashish Rukhaiyar | Mumbai | Updated: Aug 28 2013, 15:08pm hrs
The Securities and Exchange Board of India (Sebi) is evaluating if the current structure of the settlement guarantee fund (SGF) can be done away with and a corpus more suited to meet even large instances of defaults in the equity markets can be introduced.

According to persons familiar with the development, the capital market regulator recently conducted stress tests on the existing SGFs of all stock exchanges and arrived at a conclusion that the respective funds would fail to meet the settlement obligations of large broker members in case they default. It was felt that though the funds were big in size, they primarily comprised margins collected from all the brokers.

Instead, Sebi is said to be mulling a special default fund. Sources add that it is of the view that the stock exchange, along with its clearing corporation, should account for bulk of the default fund with clearing members also contributing in proportion to the quantum of trades done by their trading members.

The idea is that the stock exchange, along its clearing corporation, should be primarily responsible for the fund, which is meant only to handle instances of default, said a person familiar with the development. In the current scenario, exchanges end up using the margin of A broker to fulfill the obligations of B broker who has defaulted. This is not the best practice for risk management, he said, wishing not to be named as a final decision has not yet been taken.

Interestingly, the stress tests conducted by Sebi was based on a hypothetical scenario wherein two of the largest broker members default and the SGF is used to meet the settlement obligations. The idea was to remove the contribution of all non-defaulting members and, then, checking if the fund is able to cover the quantum of payout, say sources, adding that the SGFs failed to pass the stress tests.

Meanwhile, a committee under the chairmanship of former ICICI Bank chief KV Kamath is already looking into this issue. The committee was formed after three stock exchanges NSE, BSE and MCX-SX unanimously opposed the Sebi proposal of bourses transferring 25% of their profits to SGF every year.

As the name suggests, SGF guarantees the settlement of the trade at a time when the member defaults on the payment obligations. If a member is declared a defaulter, then his assets are seized and any outstanding beyond that is paid out of the SGF.