Margin of safety

Source– The post is based on the article “Margin of safety” published in the Business Standard on 19th January 2023.

Syllabus: GS3- Indian economy and mobilisation of resources

Relevance– Issues related to money and capital markets

News– The article explains the recently released consultation paper “Blocking of Funds for Trading in Secondary Market” for public comment by SEBI

It seeks to extend the application supported by the blocked amount (ASBA) system to the secondary market.

What is ASBA In the Primary market?

When an investor applies for shares in an IPO, a security is placed on the requisite funds. It remains in the investor’s bank account and generates interest. If the allotment occurs, the funds are transferred. If it doesn’t occur, the money goes to investor

What is the reason behind this move of SEBI?

The objective is to eliminate the need to transfer funds in advance to a broker. Therefore, it reduces chances of misuse or losses caused by broker defaults.

In the secondary market, investors have to submit collateral or transfer funds in advance to the broker before executing a trade. This results in brokerages holding substantial sums. This practice also places the investor’s funds at risk in case the broker defaults.

What method has been suggested by SEBI for creating ASBA mechanism for the secondary market?

The regulator believes that it can use the new multiple debits facility for the Unified Payments Interface  to create a new ASBA mechanism.

This will allow investors to block funds in their bank account for trading in the secondary market, instead of transferring upfront to the broker. When the trade occurs, the funds would be transferred directly to the clearing corporation.

Brokerage and securities transaction tax may be deducted by the clearing corporation and passed on to brokers, or paid directly by investors to them.

What are the main concerns related to this new proposal?

There is a need to ensure a level playing field. Brokerages that are subsidiaries of banks can offer 3-in-1 accounts. The brokerage can access the funds and demat account when the need arises.

Standalone brokerages currently compete by charging lower fees, offering more advisory support and more flexible margins. The ASBA for the secondary market may be in favour of bank-backed brokerages.

The technicalities are much more complex for secondary market trades. An IPO is a static process. There is only one security involved and only one agency handling allotment. Reconciling IPO accounts is not difficult.

Secondary-market operations involve far more stakeholders and far more instruments, including equities, derivatives, and forex and commodity futures. Each has different prices and different margins.

A trade may be placed simultaneously on both exchanges.There are massive volumes of such highly dynamic trades. The secondary ASBA mechanism would have to be well designed and stress-tested to prevent slowdowns, and glitches in practice.