[Analysis] SEBI’s Game-Changing Move | ‘UPI Block Facility’ to Transform Secondary Market Trading

Table of Content

1. Introduction
2. How UPI Block Facility works?
3. Why UPI Block System is needed?
4. What are the eligibility requirement for UPI Block facility?
5. Features of the framework for UPI Block facility
6. How Settlement- Pay-in/Pay-Out would take place
7. Dealing in Shortage/Shortfalls
8. Applicability
9. Conclusion

1. Introduction

The Securities and Exchange Board of India (SEBI) has introduced a new process for trading in the secondary market called the UPI block facility. This facility aims to enhance the protection of cash collateral by integrating the Reserve Bank of India (RBI) approved Unified Payments Interface (UPI) mandate service of single-block-and-multiple-debits with the secondary market trading and settlement process.

2. How UPI Block Facility works?

Under the UPI block facility, instead of transferring funds upfront to the trading member, the investor’s blocked funds will remain in their bank account. These funds will be blocked or reserved for trading purposes, providing a layer of protection for the investor’s cash collateral.

By integrating UPI with the secondary market trading and settlement process, SEBI aims to simplify and streamline the trading experience while ensuring the safety of investor funds. The UPI block facility will allow for seamless and efficient execution of trades while maintaining the necessary safeguards.

3. Why UPI Block System is needed?

In past, many cases have come up in front of the SEBI regarding manipulation and misuse of clients’ funds by the companies.

In the recent case of IIFL Securities Limited[1], the SEBI found that IIFL Securities did not segregate its own funds from clients’ funds, and misused credit balances in clients’ funds for the benefit of clients having a debit balance.

The SEBI further said that funds were consistently moved from clients’ bank accounts and clients’ dividend accounts to IIFL’s pool accounts. These pool accounts were under IIFL’s management and control, essentially treated as their own bank accounts.

After investigating for over six years, SEBI has found the IIFL Securities Limited guilty. As a result, the company is now prohibited from accepting new clients for two years.

In order to address such cases and to safeguard the rights of investors, the SEBI has introduced the UPI Block facility.

4. What are the eligibility requirement for UPI Block facility?

All investors who are permitted to use RBI’s UPI facility, and meeting the criteria defined by CCs, shall be eligible.

5. Features of the framework for UPI Block facility

5.1 UPI Block facility shall be optional

Availing UPI block facility shall be at the option of the investor. It shall be introduced as a non-mandatory facility to be provided by the stock broker.

5.2 Investor can choose to avail UPI for some broker and non-UPI trading for other

Since an investor is allowed to have trading accounts across multiple stock brokers, an investor can choose to avail UPI block facility under some broker(s) and non-UPI based trading under others. However, once opted for UPI block facility (until they opt out after fulfilling all obligations) under particular broker(s), the following needs to be adhered to in respect of UPI block facility under that broker(s).

• All cash collaterals shall be provided through UPI block only
• Cash equivalent collateral such as bank guarantees and fixed deposits shall not be permitted
• Securities collateral to be provided through pledge/re-pledge system and only those securities can be provided which are in the approved list of CC
• Funds pay-in settlement to be done through UPI block only

5.3 Segment wise classification of collateral & Settlement

Collateral and settlement shall continue to be segment-wise, and the client/TM/CM shall need to transfer/reallocate collateral between segments.

5.4 Accounts of clients using UPI Block facility to be settled on daily basis

Running account settlement shall not be supported. CC shall settle the account of clients using UPI block facility on a daily basis, i.e., any pay-out due to the client shall be paid out to the client on the settlement day.

5.5 Single block limit shall be Rs. 5 lakhs

Single block limit of Rs. 5 lakhs shall apply [currently applicable for UPI based securities market transaction]. However, multiple blocks can co-exist subject to the overall limit applicable in UPI.

6. How Settlement- Pay-in/Pay-Out would take place

Settlement under ASBA facility has two rounds of pay-in and one round of pay-out:

6.1 Pay-in

In Round 1 (Pay-in), settlement obligations will be calculated separately for each client who has opted for the UPI block facility. Obligations cannot be offset between different clients using the UPI block facility. These settlement obligations will include standard statutory charges like securities transaction tax (STT) and stamp duty. The initial deadline for pay-in will be for clients using UPI.

Clients who need to pay funds must provide a UPI block at least equal to their obligations. Clients who need to deliver securities must ensure that the required securities are available by using the Early Pay-in (EPI) block mechanism. This means that the securities given for EPI will be blocked in the client’s demat account for the sale transaction.

Once the pay-in deadline set by the Clearing Corporations (CCs) is reached, clients who have not fulfilled their pay-in requirements will be considered as having a shortage.

Illustration: If a security worth Rs. 100 was not delivered by a client and the last closing price on the settlement day was Rs. 105, the Clearing Corporation (CC) will not pay Rs. 100 to the client. Instead, Rs. 5 will be deducted from the client’s blocked amount. If the blocked amount is not enough, the CC will debit this amount to the Clearing Member (CM).

6.2 Pay-out

Pay-out refers to the distribution of funds and securities to clients after the pay-in process. In this case, the pay-out will occur in a single round following two pay-in rounds.

For clients who have opted for the UPI block facility and have fulfilled their pay-in obligations, the Clearing Corporation (CC) will directly transfer the funds to their bank accounts. The CC will also provide instructions to depositories for securities pay-out, which will be delivered directly to the client’s account without the involvement of the Trading Member (TM) or Clearing Member (CM).

However, for all other clients and the proprietary account of the CM/TM, there will be a single net settlement. This means that the CC will settle the funds and securities with the CM in a consolidated manner, similar to the current process.

The proposed UPI block facility will handle different scenarios, including:

• Prefunded purchase by the client.
• Delivery sale by the client through EPI.
• Purchase/sale by the client with margin support.
• Intraday cash market/derivatives trading.

An analysis will be conducted on how these scenarios will be handled under the proposed UPI block facility.

6.2.1 Scenario 1: Prefunded purchase by client

Current

• When a client transfers Rs. 150 to a member:
• The member can keep the client’s funds and allocate collateral worth 20% of the margin requirement at the Clearing Corporation (CC), let’s say Rs. 30.
• If the client buys a share for Rs. 100, Rs. 20 will be blocked from the client’s allocation as margin collection requirement.
• The collateral is released once the member completes the net settlement with the CC.

Proposed

• The client sets aside Rs. 150 as collateral with the CC. This amount serves as a block.
• The client buys a share worth Rs. 100, and the margin requirement is 20. This requirement is deducted from the block allocated as collateral.
• The STT and stamp duty amount to 11 paise, which is added to the client’s obligation. At the specified time, the CC debits Rs. 100.11 for settlement.
• Once the debit is successfully completed, the CC directly provides the securities that the client is entitled to in their depository account during the settlement pay-out.

6.2.2 Scenario 2: Delivery sale by client by early pay-in

Current

• The client utilizes the block mechanism for early pay-in of securities. The Clearing Corporation (CC) receives early pay-in information from depositories. If a sell order is executed after early pay-in, no margin is applicable at any time. However, if early pay-in is received after the sell order execution, the member’s proprietary collateral will be blocked until the early pay-in is received. During payout to the client, the member may adjust other statutory dues such as stamp duty, STT, and brokerage.

Proposed

• The client must provide securities for early pay-in using the block mechanism only.
• If the early pay-in information is received from the depository before trade execution, no margin is required.
• If the information is received later, the member’s proprietary collateral will be blocked until the early pay-in is received.
• Once the client has completed the settlement, the Clearing Corporation (CC) will directly pay out funds to the client’s account.
• During the funds pay-out, the CC will deduct the Securities Transaction Tax (STT) and stamp duty.

6.2.3 Scenario 3: Purchase/sale by client supported by margins

Current

• Client provides 20% margin to the member. Based on this margin, the client can execute trades on the trade date. However, the client must provide the remaining 80% amount (for purchases) or deliver the security (for sales) by the applicable settlement deadline.

Proposed

• The client may create only partial block to the extent of margin instead of entire upfront value or early pay-in through block mechanism. The client shall need to provide additional block or provide early pay-in till the stipulated time

6.2.4 Scenario 4: Intraday cash market/derivatives trading

Current

• Clients provide margin money to the member for intraday trading or derivatives trading. In these types of trades, there are no obligations for exchanging funds against securities. Instead, only losses or gains are involved. Losses will be deducted from the client’s margin money, while gains may be added to the client’s margin money or paid out.

Proposed

• In case of losses, the Clearing Corporation (CC) will deduct the losses from the client’s blocked amount for client pay-in. In case of gains, the CC will provide the payout directly to the client’s account. The CC will not add the payout to the client’s funds collateral. If the client wishes, they can create a separate block for the payout.

7. Dealing in Shortage/Shortfalls

7.1 Shortage in cash market due to lack of funds:

To handle shortages in the cash market when there is a lack of funds, the Clearing Corporation (CC) shall transfer securities to the client’s account and pledge them to the Trading Member’s (TM) account. The CC will keep track of the shortage, and the TM’s CM will be responsible for settling the shortage with the CC.

The CC shall keep a record of the shortage amount for the client. It becomes the responsibility of the TM’s Clearing Member (CM) to settle the shortage amount with the CC.

If client provides additional block subsequently, the CC shall debit the amount to the extent of shortfall and provide the same to the CM.

If the client fails to provide the necessary amount, the Trading Member has the right to sell the pledged securities held in the Client Unpaid Securities Pledgee Account (CUSPA) or the securities provided as margin pledge and mark early pay-in.

The CC shall maintain and update any remaining outstanding amount owed by the client.

7.2 Shortage in cash market due to lack of securities:

The client shall not receive any funds. Instead, the funds will be kept by CC to cover the shortfall in securities delivered. If the funds required to cover the securities shortage exceed the payout amount, the additional funds will be deducted from the client’s blocked amount. If the blocked amount is insufficient, the responsibility will fall on the clearing member.

Auction shall be conducted to buy the securities short delivered by UPI clients

Illustration: In a situation where a share sold worth Rs. 100 was not delivered, and the last closing price on the settlement day was Rs. 105. In such a case, The Clearing Corporation (CC) will not provide a pay-out of Rs. 100 to the client. Instead, they will deduct Rs. 5 from the client’s blocked amount. In case the blocked amount is insufficient, then CC shall debit this amount to CM

8. Applicability

The framework needs some changes to be made in the systems and processes of various entities like clearing corporations, stock exchanges, depositories, stock brokers, and NPCI. These entities are expected to make the necessary changes and test their systems and processes for effectiveness.
The facility is planned to be operational from January 1, 2024, once these changes and tests are completed successfully.

9. Conclusion

The new framework would eliminate the custody risk of client collateral, which is presently retained by the members and not transferred to the clearing corporation and safeguards clients’ assets from misuse, brokers’ default and consequent risk to their capital. This facility further result in lower working capital requirements for the members.
Moreover, there would not be any adverse impact on client pay-out even in case of member or fellow client default.