On the Karvy Issue

November 23, 2019
Why Zerodha?

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.

Nithin Kamath

CEO @ Zerodha and partnering startups through Rainmatter to help grow and improve the capital market ecosystem in India. Love playing poker, basketball, and guitar. @Nithin0dha on Twitter.

66 comments

  1. Nitish kumar says:

    These kind of timely updates builds more trust in zerodha.

  2. Pramodh says:

    Thanks for sharing a detailed post to give confidence to the investors.

    Based on recent SEBI rules, if a broker needs to do margin funding, do they need to borrow on merit of their own balance sheet and fund if they want to fund more than their accruals?

  3. Venki says:

    Many thanks for publishing this info. It helps a lot and builds more confidence in Zerodha.

  4. Gopi says:

    Karvy invested heavily in Andhra new capital Amaravati …they bought huge land by hoping Chandrababu return to power and Jagan in power changed rules for capital city …so the Karvy is in trouble….so we should not invest based on political party because people mandate is always true ….

  5. Vishwa says:

    Hey Nitin, this is a great, well-detailed article.

    Just a small query – Zerodha also seems to allow clients to pledge their shares for taking derivative positions. Could you please shed some light on this aspect in the article?

    • Currently, the pledging we allow is clients pledging their securities to NSCCL (National clearing corp) which allows them to get margins for trading F&O. This fund can’t be used for anything apart from FO margin. We are just being a conduit in this case for clients to pledge it with NSCCL.

  6. Deepak Shenoy says:

    Explained clearly in a manner in which a layman can understand.

  7. Srikanth says:

    Thanks Nithin. Enhanced my trust in zerodha.

  8. Keshav Nayak says:

    Thanks Nitin. Your view point is well taken.

  9. Kamesh says:

    Hi Nithin
    Recently I saw that all stocks that.I have pledged for collateral have been credited to my demat.
    I called customer support they told me that As per sebi guidelines all pledged securities has to be credited once in three months.

    My question is can we know it in advance because I may have positions in the market based on my collateral and suddenly without any intimation. All stocks are back in my Demat. If we know in advance I can avoid creating positions.

    And finally as you said Zerodha console pledging and un pledging is of such ease in Zerodha.Thanks for creating such wonderful platform for retail traders.

  10. Jitendra singh says:

    Hey nitin…when ll zerodha come up with fixed monthly or yearly plans?

  11. Anshul GOEL says:

    Thanks for the Clarification Nithin. 🙂

  12. Ram says:

    Zerodha is my kinda fist broker. Varsity is my first and base source of capital market knowledge. My assumption is that a sizeable chunk of zerodha’s clients are like me.
    I still, and planning to for a foreseeable future, trust zerodha and also referring my friends towards it.
    However, when ever an issue pops up, Nithin comes up with a clean, “it could never happen with us”, explanation. The first thing I learnt in stock markets is “never say never”. We can only mitigate the risk.
    The funny things is, most of the people who are satisfied with the explanation have zero to little understanding in capital markets prior to zerodha, and their base source of knowledge is Varsity and also the letter itself in the z-connect. By reading the z-connect newsletters we folks become more smarter and start taking risk to the next level.
    While we all want to have the hero from grass root level, we often forget how much struggle one had to undergo from the existing toppers, to reach that level, especially when the size of pi itself is small.
    Until the day I come across that story about zerodha, I can never understand this “never to us” explanations.
    I maybe and wish to be wrong.

    • Of course things can go wrong at our end us well, like the tech issues we had couple of times in the last 1 year when everyone was out for our blood. When we say, it won’t happen to us, we say it only when we are not doing that activity at all.

  13. Hemant Taneja says:

    Well timed clarification nitin sir.. It really helps reinforcing trust with brand zerodha that we already have.. Keep doing the good work 👍

  14. Senthil says:

    I have total trust on zerodha. In my humble opinion they give the best services and highly trustworthy

    Many brokers are going broke bcos of high competition.for example lThe way brokerages are giving leverage is mind boggling. They go up to 40 times.

    SEBI is highly lethargic and don’t do anything constructive to protect small investors money but they do fire fighting after all damages done.

  15. Gopallal Laxminarayan Bangur says:

    Dear Nitin
    Unfair work is done by any human being is greedy ness. That what happened at karvy. So what we must learn is controlling greedy ness is very tough and challenging for every one. Remember the scam of Harshad Mehta. Future is future any thing can happen at any where so Beware of Greedy ness.

  16. Girish says:

    Thanks a lot for this detailed post and explaining the facts and mandatory requirements that’s expected from Brokers. It’s informative and educative as well.

  17. Prakash says:

    Hi Nitin,
    Thanks for writing this piece was expecting something like this from you. Because we had started feeling worried about our accounts, but you clarifying things and maintaining the transperancy builds confidence further.
    Keep up the good work and instilling confidence in your clients.
    Regards.

  18. Chandra BV says:

    Dear nithin,

    You were there, are and will be with us, when we need you without asking us. That shows how commited and focused about us. I liked your commitment, Zerodha never made me disappointed in all my trading expectations and aspects.

    Keep rocking zerodha.

    Yours happy customer,
    Chandra BV

  19. Amar says:

    Thanks for this update…
    Thanks Zerodha..

  20. Gaurav Agrawal says:

    Just one simple question whether zerodha is involved in prop trading or not

  21. Chintan Shah says:

    Hi,

    Thanks for the article Nithin.

    Just a small query, apart from Zerodha console, which website can I check my pledge shares (like NSCCL/NSDL/CDSL in our case).

    Thanks,
    Chintan

  22. Anoop says:

    Tanks a lot Nithin sir for timely updating…

  23. Srinath jayanna says:

    Can we check our holdings in NSDL or CDSL directly for the regular confirmation of our securities in our demat.

  24. Ajith says:

    Nithin, A very good post but youve forgotten to address one point : Say there is a client whose funds are parked in Zerodha say 1 Lakh Rs, un-utilised and sitting idle in Zerodha. Can that money be used by Zerodha to buy Liquid funds for itself and benefit itself from such interest rate provided by liquid funds. So while the clients Zerodha account shows 1 Lakh in reality that 1 Lakh is deployed in Liquid funds and benefits taken by Zerodha. Can such a thing happen?

  25. Ravitej says:

    Can we expect zerodha to come up with combined ledger(mcx+nse) in near future??

  26. Harish says:

    Nitin,

    Just explain one more time the last point in your blog… 25% of own funds..if Zerodha is not in margin funding, then what that 25% funds require / invested for? A quick word shall be appreciated.

    • There are working capital requirements. For example – funds transferred using the payment gateway is settled with us only on T+1 day, but we provide the margins instantly to customers. Intraday leverage is provided using this. We were using it for prop trading, but we have stopped that now. And like I have mentioned in the post, we intend to start margin funding soon, it has been delayed for quite a bit now. The delay in a way has helped us as we can do margin funding the way SEBI wants after the new circulars.

    • Venu says:

      There are times when clients take derivative positions with 100% collateral margins. However, when the Exchanges blocks margin, they require 50% of the margins to be in the form of cash. That’s another instance where our own cash gets deployed.

  27. Vikram says:

    Thank you for this post.
    How can I subscribe to Z-connect so as to get all new posts by email?

  28. Sriharan says:

    Hi Nitin,
    Can you please explain how to transfer stocks from Karvy to Zerodha. My mom had account with karvy and I have account with zerodha.

  29. Vishal says:

    There are limits for borrowing…. its 5X

  30. Sandeep says:

    Hi Nithin, I have a large qty of liquid funds on Coin pledged with u for availing F&O margin. Can u elaborate on the exact workflow for the pledging ? Do they lie in my demat with a lien marked on them ? Or in your pool acct ? Or with NSCCL ? What’s the chance of these being siphoned off and me remaining unaware about it ? Apologies for being frank

    • Venu says:

      Hey Sandeep, you’re in every right to ask questions pertaining to the safety of your account, nothing to be apologetic about.

      When you intend to offer your shares to obtain margins in the Derivative segment, the shares move from your demat account to Zerodha’s ‘Client collateral account’. From the Client collateral account the shares are transferred to Zerodha’s ‘Collateral Account’ from where a lien is marked to NSE’s clearinghouse – NCL. This is the prescribed process by the Exchanges for any client availing margins from Stocks in the Derivative segment. Here’s the link to the relevant circular: https://nseindia.com/content/circulars/INSP42229.zip and here’s the extract:

      What’s the chance of these being siphoned off and me remaining unaware about it
      All brokers are required to upload the details of client fund balances and securities pledged to the Exchanges on a monthly basis. The Exchange then forwards these details to the investor on the registered email ID. Here’s what the report looks like

      Based on the information uploaded by the member, the Exchange reconciles this data with the actual availability of the stock balance in the demat account. If there’s a mismatch, the Exchange seek clarification.

      For example: Say you’ve pledged 1000 units of Liquidbees. These units should either be in the broker’s client collateral account or the collateral account. In the monthly report uploaded by the broker, they upload your details and mention that they’re holding 1000 units of Liquidbees belonging to you. The Exchange reconciles this data on whether such units are actually available or not. As brokers, we’re required to upload information of all the demat accounts opened by us to the Exchanges. In the event that the units aren’t available, the Exchanges raise an early warning and seek clarification from the member.

      In the event that the broker doesn’t mention that he’s holding your 1000 units despite you having pledged the units, the report forwarded to you by the Exchange will have no mention of the units pledged by you. This should caution you and you’ve to immediately seek an explanation from your broker.

      While the regulator will actively take steps to make the markets safer for all of us, there’s onus on the client too to verify the information received to ensure there’s no room for malpractice.

      • Sandeep says:

        Hey Venu, Thanks for the detailed clarification. A doubt – Any mismatch that the exchange finds between the broker uploaded details and the actual demat balance is only post-facto right ? If the broker has already sold off the units, then isn’t it too late ? Or can’t the broker sell these units because there’s a lien to NCL ?

        • Venu says:

          can’t the broker sell these units because there’s a lien to NC
          If there’s a lien marked, only NCL can invoke the lien if there’s a need, a broker can’t. A broker can still remove the lien and sell if he wants to.

          is only post-facto right
          Yup, while its post-facto, just being aware of the transactions happening on your account allows you to fix any wrongdoings. Most instances where clients end up getting defrauded are where they’ve paid no heed to the information shared pertaining to their account.

  31. Mukunda krishna says:

    Thanks for sharing .

  32. Piyush Yadav says:

    Funny and how opportune timing. Your platform just duped me by purchasing shares from my account at a price 20 INR higher than the market price on a simple AMO at market prices. And your support team was so helpful that they did not even read the problem, forget resolving it, before sending me a template article. Let’s see if you’re a man of your words, here’s the ticket # 20191123606719. I’ve already raised a complaint with BSE, your article reminded me I should keep SEBI in the loop as well, thanks!

    • Matti says:

      Hi Piyush, all trades are matched and filled on the exchange. The broker has no control over this. You can verify your trade on BSE here: https://www.bseindia.com/static/investors/Trade_confirm.aspx

      • Piyush Yadav says:

        Exactly the behavior shown by your support staff. At least it’s clear where this culture flows from. That still doesn’t tell me what order was communicated by Zerodha to the exchange. Now I understand why your platform doesn’t show the order history details, to perpetrate these random trades and then just keep sending links to random articles. What a fraud company man, seriously. I can bet you haven’t even read the issue that I’ve raised

        • Matti says:

          Piyush, since you’ve placed a market order, it is sent as such to the exchange. There is no price associated with a market order. It simply hits the exchange orderbook as a market order and gets executed at the best available price. In the case of pe-market orders, there isn’t a “best bid” or “best order” as such. The price discovery happens during this session and orders can be filled at any price. The mechanism of the pre-market session is explained in this presentation by NSE.

          As I’ve said in my previous comment, the broker has no control over what price an order gets filled at. If you place a limit order, the order is filled at the limit price or a better price. If you place a market order, the order can be filled at any price within the circuit limits for the stock.

  33. Rahul says:

    Hi Nithin,

    Zerodha made me sign POA while opening an account. Technically you can do the same as other brokers who are defaulting and selling the pledged share. Clarification on that?

  34. Dinesh Jain says:

    Dear Nithin ,

    Have gone thru the above details given in the blog . Still Have few questions :

    a) I was made to sign POA ( power of attorney ) while opening an account with Zerodha . Does this document gives you a right to pledge my security for your business purpose . If no then in what context Karvy clause is different here . Would like to understand little better

    b) Till the time my securities are used only to settle my obligations for dealing on your platform , it is ok but if it is open to be used for your business purpose then we have to evaluate pros and cons .

    Request your views basis what is written in POA document . It is a different issue whether it is used or misused by broker firms .

    Regards

    • Like I have mentioned in the post above, we never pledge any client securities. The POA document doesn’t give us the right to pledge. What SEBI circular says is that securities were moved out using the POA and then pledged, so essentially misused. The only reason why we use the POA is to debit shares from your demat and transfer to the exchange when you have sold them on the exchange.

  35. Dinesh Jain says:

    Dear Nithin ,

    I am reproducing the point no 4 in POA signed by me with Zerodha :

    4. To issue instructions relating, executing delivery/receipt instructions, pledge creation instructions, pledge closure instructions, lending and borrowing instructions, to operate the depository account by issue and receipt of instructions for the above mentioned purpose and such other authorization given by me/us severally on behalf of all of us, or all/any of us jointly, in any electronic form, in any format and at any time either through the portal of Zerodha or through the internet will be validly constituted attorney to intimate the same to the Depository Participant for the purpose of debiting or crediting my account opened with the Depository Participant.

    To me this is quite an open power taken to do anything which you want to do . This is not restricted for my own transaction purpose . By virtu of this you can pledge my security for your business purpose . It is a different matter that you do not use this power voluntarily but then why this unlimited power is taken in POA and why should it not be restrict for my transaction purpose only .

    Please clarify .

    Regards

  36. dushyant says:

    Regularly getting update from BSE/NSE, so hope all good.

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