This damning SEBI order against Karvy has come as a shock to everyone in the capital market ecosystem. While the press is going to start reporting its interpretations, we should reserve judgement and allow the regulatory investigations to complete, and all facts to emerge.
In the meanwhile, many have written to us on our support and social media channels, asking if they should be worried about their accounts with Zerodha. I am certain it’s going to continue as the press covers this episode. Hence this post explaining why there is no reason for any concerns at Zerodha.
The SEBI order
The SEBI order primarily talks about improper handling of client securities.
- Pledging of client securities and booking funds into non-client accounts.
- Selling of securities from non-client accounts, and debiting client demat account, and receiving proceeds in non-client accounts.
- Off-market transfer of securities from client demat accounts to non-client accounts.
Strong new regulations on handling client securities
In the past 12 months, SEBI has brought in a number of new regulations to improve the health of the broking industry. While regulations may sometimes seem harsh, it is indeed a complex balancing act, making rules for bad actors who look at every possible way to break rules for monetary gains compromising clients interest.
A new, strong, regulation that was brought in June 2019 barred brokers from pledging client securities to other NBFCs. Many brokerage firms until then used this route to do their margin funding business. Essentially, when a broker allows clients to buy more stocks than the money in their accounts for many days, the broker, instead of using their own capital to fund the transaction, will pledge the client’s security which is unpaid for, with another NBFC and in turn utilise those funds. This not only means higher brokerage income as the trade size is bigger, but also an interest income – differential of the rate charged by the NBFC and what is charged to the client. Starting June, brokers have to put their own capital, which means they can lend only their own free cash, which isn’t much for most brokerage firms. The regulation also required all brokers to unwind any such already existing positions with NBFC’s by Aug 31st 2019, which meant that the broker had to return funds to the NBFC and then release the pledge on the shares. This has affected several brokers, especially those whose business model revolved around margin funding.
We have never done margin funding and this regulation does not affect us.
No need for concern at Zerodha
The conspiracy theories that we are subjected to is never-ending. We had recently shared this blog post trying to answer them. If you haven’t read it, please do. Coming back to the above particular issue on client securities, we operate in a completely transparent manner, and here is why you needn’t be concerned.
- Zero debt: Firstly, most financial irregularities have debt as the main catalyst – borrowed money that needs to be repaid. We at Zerodha have had zero debt right from the beginning.
- We have done no margin funding till date and when we start, we will have no legacy issues in following the SEBI June 2019 circular that requires funding to be only through own funds.
- Forget pledging client securities to NBFCs, we do not even keep client securities in our pool account. All client securities are always in their respective Demats at all times.
- We have one single brokerage deal for all our customers. We don’t distinguish HNIs from others. We have never advised or sold any product promising returns. The only thing we do as a business is to offer execution platforms for someone who has an intent to buy/sell. No conflict of interest.
- By having a single deal for all, our operational risks are reduced significantly.
- We have never had issues in terms of securities not being credited to our clients’ Demat accounts, securities being moved out without authorization, or with client fund payouts.
- Our own funds are over 25% of all our client funds put together. This has to be among the highest in the industry in terms of skin in the game, all accrued from organic revenue. Zero external funding or borrowing.
I sincerely hope the Karvy issue gets resolved without any damage to their customers and the health of the industry as a whole. Once again, let us reserve judgement until all facts emerge and the regulator completes their investigation.