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VIEWPOINT
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Investor protection — whose baby is it anyway?
Deena
A Mehta
The Reserve Bank of India (RBI) has announced margin trading
rules. In view of the 60-day review and the general tendency
of nationalised banks to stay away from capital markets, there
are hardly any takers for the scheme within the banking industry.
However, the share markets have taken this announcement as introduction
of credit facilities/financing in the markets. A leading finance
company has inserted leaflets in the newspapers about the provision
of margin trading facility for their clients.
Most leading newspapers have carried stories about how financing
is being done in the markets and have talked about the return
of badla in a new, unorganised form. As per newspaper reports,
the borrower of funds can keep his position open in the market,
irrespective of rolling settlement, and settle the same as and
when he deems fit. Margins are paid on initial position and
mark-to-market margins are paid once a week. The lender lends
the money and the shares are transferred in his demat account
as collateral. Upon the liquidation of position by the borrower,
the shares are delivered to the market and funds released to
the lender. An agreement is signed by the borrower in which
the terms of borrowing are stipulated. Similarly, a lender also
signs an agreement outlining the terms of lending.
In a falling interest rate climate, where citizens are sitting
on liquid cash without any avenue of reasonable return, margin
trading is an option which investors find difficult to resist.
Of course, the facility is being offered only to select clients
and not all customers can enjoy this facility. However, it is
only a matter of time when this facility will be widespread
and reach a level of, say, Rs 1,000 crore, which is about 10
per cent of ALBM (Automated Borrowing and Lending Mechanism)
and BLESS peak volume.
What is the risk associated with this system? In absence of
any clarification from either the Securities and Exchange Board
of India (Sebi) or the stock exchange, each borrower and lender
would have their own terms of agreement, which would be mainly
guided by the brokers views on the matter. The lender is given
the shares as collateral. But if the price of the share goes
down, is the lender protected against such depreciation in asset?
Will he have to make the call for fall in collateral or will
the broker suo motu give him the additional security, since
he is tracking the same. If the depletion in collateral is not
made good, when should the lender sell the security? Will he
have to give a notice for the same? What will be the period
of notice? One can argue that these would be specified in terms
of lending, but would this agreement be a complete document?
In event of disputes ,every thing is open to infinite number
of interpretations. If the lender disposes off the security
who will pay the loss? Will he make a claim on the broker or
will he independently pursue his recovery from the borrower?
Will the borrower’s name be transparent to the lender? The broker
may simply take a loan in his books and not disclose the borrower
to the lender.
Similarly, in case of the borrower, what are his rights if the
price of the share goes up and the lender refuses to return
the shares or the lender has appropriated the security for some
other purpose and delivery is not timely. Who will bear the
loss if there are auctions? Since the shares stand in the name
of lender even after delivering, the sales proceeds go to his
name and he may refuse to part with the difference.
In an organised market, the terms of lending and borrowing are
standardised. There are accepted norms of the rights and obligations
of each party to the contract, and in the event of dispute,
these norms serve as guiding principles for deciding the dispute.
Sebi has not made any announcements regarding the rules of lending
and borrowing. It appears that this is only an RBI baby and
the other participants have a hands-off attitude towards the
whole scheme.
Should it then be construed that brokers and investors can borrow
from the banks only and in absence of rules private finance
is not allowed? Is it illegal for a broker to do the business
of margin trading? Or is it legal, so long as no entries come
in the broker’s books and the borrower and lender deal with
each other directly? It is high time Sebi provided these answers
and came out with a policy statement.
Pending any guidance note from Sebi, it should be clearly understood
by the investors that the bye-laws of the exchanges do not provide
for any margin trading rules. In the event of a default by the
borrower, the only recourse is to the general legal system and
not the arbitration machinery of the exchanges. It should be
understood that the exchanges assists in settlement of only
those disputes that result from ‘bona fide’ transactions done
on the floor/system of the exchange, and margin trading, as
of now, does not fall within the purview of the same. Further
it is an established law that loans given to brokers are also
not guaranteed by the exchange. The customer protection funds
are also not available in event of default.
Buyers beware
The whole announcement of margin trading was projected as a
step to revive the market. That does not mean that legal infrastructure
is in place for investor protection. It is not clear whether
private financiers can participate in the system. Brokers should
also exercise caution in the matter. Investor protection is
not a subject that has been addressed by the creators of margin
trading.
(The writer is former vice-president, The Stock Exchange,
Mumbai. E-mail: deena.mehta@envestmentz.co.in) |
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