N Sundaresha Subramanian

Mumbai; These are difficult times for the custodians. With the Securities and Exchange Board of India (Sebi) all set to implement its twin moves of allowing shortselling by institutions and requiring them to pay margins on all cash trades from April 21, these least talked-about capital market intermediaries are under tremendous pressure in more ways than one.

A custodian bank, or simply a custodian, holds assets such as equities and bonds on behalf of the institutional investors for a fee. It also arranges settlement of purchases and sales of securities.

At present 14 entities are authorised by Sebi to operate as custodians. These include seven foreign banks — ABN Amro, Citibank, Deutsche, HSBC, JP Morgan, StanChart and DBS; five Indian banks —- SBI, ICICI Bank, UTI Bank, Kotak Mahindra and HDFC Bank; and IL&FS and Stock Holding Corporation Foreign institutional investors, mutual funds and domestic financial institutions such as the Life Insurance Corporation and banks utilise their services.

These entities could face pressure on their own margins because of the new margin rule. At present, though there is no margin required to be paid by institutions to the exchange or broker before any trade, the custodians demand upfront payment from clients.

Suppose a client wants to buy 10,000 shares of V-Guard at Rs 64 on Monday. He needs to transfer Rs 6,40,000 to the custodian on Monday itself.

In India, settlement (delivery of shares by seller and the payment by buyer) is done on a T+2 basis,where T is the date of trade. This means the custodian needs to pay the cash to the exchange only on Wednesday.

The custodian bank enjoys the two days’ “float”, during which it can put the money into money market instruments and earn some quick interest.

Under the new rule, the client needs to pay only a fraction of this amount upfront, that, too, to the broker. Says a senior official with a private bank, which is a leading provider of custodial services: “Right now, the custodians space is very competitive with a number of players vying for a few big clients. The clients have negotiated dirtcheap rates often pointing out the “float” enjoyed by the custodians. Now, all that needs to be reworked.”

Pankaj Valia, an independent advisor to high networth individuals, says, apart from not getting their floats because institutions would now make payments on T+2 basis, they will face pressure operationalising the rule.

“The implementation of margin rule will see the number of operations of the custodian increase manifold. Systemic changes need to be made. With the stock lending and borrowing mechanism also coming up for implementation we are hardpressed for time.We are waiting for the final guidelines from the exchanges regarding the details of margins to be levied for such institutions,” said the bank official.

Institutions are not badly affected by the rule. Sources say the exchanges could determine around 10-12% margin for these trades.

Liquidity of institutions would be curtailed to that extent. This is because on settlement, they are required to settle trades on a gross basis and setting off the margin paid against the setteement is not allowed.

A discussion note published by Citi Securities and fund services says, “Institutional investors will need to settle their trades on T+2 on a gross basis and cannot net of the settlement amount against margin paid. The margin amount is treated distinct and separate from the settlement amount by the exchange /clearing corporation.”

Experts feel this would not make a big difference to the institutions. Valia feels more than the custodians and big institutions, it’s the small brokers who are not adequately capitalised, who will be worst hit. “They will be wiped out,” he says. “the foreign brokerages and top 5 Indian brokers, who are adequately capitalised will now garner all the institutional business.”

Small brokers will see their ability to trade go down considerably as a big institutional traders can block their exposure limits for whole trading sessions, say experts.

Also, when an institution wants to execute a big order, the broker may not have sufficient margin to cover for this trade. Thus, the client might be lost forever.

Currently, all cash equity trades entered into by institutional investors are exempt from margins.

Institutional investors will need to pay margins for their cash equity trades from the dates prescribed by Sebi — i.e. from April 21, 2008, on a T+1 basis and from April 16, 2008, on an upfront basis.

All trades, other than those entered into by institutional investors, are currently subject to margins.

Source : DNA