Pledging refers to delivering an asset as security for the payment of a debt. This asset will be forfeited if there is failure to deliver payment or fulfill the promise. For instance, in the case of a housing loan, a person can borrow money from a financial institution or bank to buy an apartment or construct a house. The collateral, in this case, is the house itself. The bank / financial institution usually provides a loan of up to 90% of the value of the apartment/house.
Hence, if the cost of the house is ₹25 lakhs, an amount of approximately ₹22.5 lakhs is available as a loan. In case the loan is not paid back in due time, the lender has a legal right to acquire the property, sell the same and realize the proceeds.
Pledging of shares works in a similar manner. Here the shares of a listed company are pledged. Anybody who owns shares of a public company can pledge the same and obtain a loan. However, investors need to take notice of the same when promoters of the company are pledging their holdings.
The Securities Exchange Board of India (SEBI) has issued new guidelines regarding pledging of stocks as collateral to receive margins for trading purposes.
The sequence of reformative steps introduced by the market watchdog aims to safeguard the interests of investors, bring in transparency and prevent brokerages from exploiting the client’s securities. These reforms came out in February and were initially scheduled to be implemented from June 1, 2020. The deadline was subsequently extended to August 1, 2020 and thereafter to September 1, 2020. While brokers continually requested for more time to make their systems ready, SEBI refused to further extend the deadline.
Earlier, one had to move their shares to the broker’s account from their demat account for the purpose of pledging. However, as per the new rules, shares will have to be pledged by following a process where the pledge is registered against the customer’s holdings in the records of the clearing corporation. Here is the procedure for pledging the stocks:
· The customer accesses the demat account to view the shareholdings and their respective haircut percentage and amount available as margin. Haircut percentage will differ from company to company. So, one needs to choose the shares that he or she wants to pledge and the amount of margin that will be available if those shares are pledged.
- Pledge request: In case of an online demat and trading account offered by brokers, the request can be made online. The customer needs to select the shares and their quantity to be pledged and submit the online request. Once the request is submitted, the customer receives an email from the clearing corporation. The customer then needs to authorize the pledge request to be able to activate it. On clicking the link received in the email, the customer will be required to enter PAN number and generate OTP. The OTP will have to be entered to be able to authorize the pledge request.
·- Charges for pledging: Pledging of shares entails some charges levied by the broker for each pledge request. It is important to check the charges in advance.
·- Pledge requests are then processed in batches through previously decided time slots by the clearing corporation.
·- Customers need to carry out this activity of pledge authentication for all the shares that were earlier placed for margin with the broker.
However the new guidelines have led to quite some ambiguity as is expected from any new procedure.
All the old pledges had to be removed and the new pledges were to be created from September 1. Brokers had managed to get extensions twice. They thought SEBI would give another extension, but the regulator refused. The new systems with the depositories were not in place. Brokers said the new system at the depositories could not take the load of the new share pledges.
While shares were pledged, it did not show up on brokers’ systems, denying investors opportunities to trade. Investors, who pledged their shares as per the new system, were unable to remove the shares from the pledge. As the crisis deepened, client reports from the clearing members could not be generated accurately. A joint statement by depositories and clearing corporations on Friday, clarified that a significant number of margin pledges were seamlessly processed September 1, 2020 onwards. The statement further elaborated that the new margin pledge process should stabilize in the coming week and normalize shortly.” Many Brokers have however pointed out that the initial disruptions continued even on Friday.
The new norms have become a topic of heated debate among brokers and investors. They are apprehensions that the stock trading process might become cumbersome and discourage many day traders from trading aggressively. However many experts also pointed out that these steps will lay down the solid foundation for a stronger and more transparent system.