SEBI’s New Rules for Direct Payout of Securities: What’s it All About?

Buying securities from a broker and getting those shares reflected in your demat account is a series of events. However, this process remains largely unobservable by investors and includes brokers, clearing corporations, and several intermediaries. Realizing the necessity to increase efficiency, transparency, and investor protection, SEBI has recently issued a completely new approach to the organization of securities payout.

The new rules suggest direct delivery of securities into the investor’s dematerialized accounts, thus eliminating the brokers’ involvement. This article discusses the shifts, their timeline, their effect on investors, and their general impact on the securities market.

Existing Settlement Process

Here’s how the current system works:

Purchase of Shares: When you need to acquire securities, your broker creates the order and transmits details pertaining to the order to the exchange.
Clearing Corporation’s Role: After the clearing of the transaction, the CC ensures that the securities are credited to the broker’s pool account from the settlement date of either T+1 or T + 2.
Transfer to Investor: The broker then transfers these securities to your demat account in which they are finally held.

It involves the brokers as the middle party and therefore may take more time or may reveal some of the weaknesses such as if the broker is in a financial crisis or has some issues regarding the operations.

Direct Payout for Net Settlements

NET Settlement could be defined as the procedure that helps match buyers and sellers in a way that the total amount of payments will be minimized.

Here’s how net settlement works today:

If a broker starts with 100 buyers and 50 sellers, then the system at this point directly matches 50 sellers with 50 buyers. For these matched buyers it issues the CC Credits securities.
The remaining 50 buyers source directly from the broker who buys shares from the market or through an auction.
If some of the sellers are unable to deliver the shares (short delivery), the broker is obliged to purchase the shares or offset the transaction at a close-out price.

Under this new direct payout system, the CC will do direct auction clearing whereby the ownership of the securities to the investors will be transferred with no brokers involved.

What Is the Direct Payout System?

Under the traditional system, the securities you purchase go first into the broker’s account and then are transferred into your demat account. There are certain risks associated with this intermediary step like delay or misuse of securities like stocks held by brokers.

The new Direct Payout System introduced by SEBI has done away with this process. However, securities will now be transferred directly to the demat account of the investor as cleared by the Clearing Corporation (CC). These changes reduce the general reliance on the brokers by quickening the settlement cycle which was a major concern in the present system.

Phased Implementation of the New System

SEBI has divided this into two phases, as follows:

Phase 1: 11th November 2024 to 13th January 2025

Scope: Equity cash and physical settlements are to be supported through direct payouts in this phase.
Process: In most of the transactions the Clearing Corporation will deliver securities through transfers to dematerialized accounts.
Exceptions: These securities will be held with the broker in the pool account when direct pay is not feasible (rejected pay, dormant demat trade, or pay excess).

Phase 2: 14th January 2025 onwards

Scope Expansion: This system will also incorporate all the security transactions like securities lending and borrowing and Offer For Sale transactions.
Auction Settlements: As for the shorts, the Clearing Corporation will perform the auctions and the settlement and the brokers will not need to buy the stocks in the market.

Changes to the Pledging Process

Securities can be purchased on margin or before the buyer pays the whole price to the seller. In such cases, brokers currently handle the pledging process:

The securities are recorded in the dematerialized account/trading account of the investors but they are noted as pledged until the full payment has been received by the investor.
It is the broker’s responsibility to make this pledge and it only reaches the beneficiary once the payment has been made.

Under SEBI’s new rules:

The pledging procedure will not be handled by brokers in the future.
However, the Clearing Corporation will directly credit these pledges into the demat account of the investor as per the instruction of the brokers.
When the investor has fully paid for the pledged securities, the Clearing Corporation will return the pledge.

This shift will reduce brokers’ involvement and enhance transparency because it will be conducted through a central structure.

Impact on Investors

Most of the changes will go unnoticed by the average investor since most of them will happen behind the scenes. However, the benefits are significant:

Faster Settlements: Securities will be credited to your demat account before T+1, thus reducing unnecessary holding periods.
Improved Safety: The exclusion of brokers in the transfers reduces the vulnerability of securities to abuse or improper handling.
Simpler Processes: Margin trading and pledging will not be so complex since it is understood that the processes will be fully administered by the Clearing Corporation.

Why Are These Changes Necessary?

The traditional system, while functional, has certain drawbacks:

Risk Exposure: It enhances the risk of such securities being manipulated or delayed given the fact that the brokers holding it become insolvent or engaged in malpractices.
Operational Complexity: This is because having more than one intermediary implies that there will be more barriers to address in the process of clearing the account.

All these issues are addressed by the new direct payout system that enables a faster, safer, and more transparent method of transferring securities.

Conclusion

SEBI’s new direct payout of securities can be seen as one of the most revolutionary changes in Indian financial markets. These changes in the settlement process and the reduction of the role of the brokers are expected to enhance the efficiency of the process, enhance investors’ protection, and increase their confidence in the system.

Even though these changes may not be immediately apparent to investors they shall be manifested in faster, safer, and far more efficient transactions. As the implementation unfolds, the Indian securities market will further align to the international standards for investor protection and transparency.

Frequently Asked Questions

1. Why is this change important?

The direct payout system is more effective and safe to use when it comes to the settlement processes. Since SEBI prevents brokers from holding securities custody for short periods it minimizes risks and facilitates faster credit to investors’ accounts.

2. How does this impact brokers?

Brokers will be less involved in the settlement process; however, they will be involved in some duties such as Managing client trade, directly payout confirmation, and tackling issues related to the settlement.

Their role will be more of a transactional nature rather than securities management.

3. What if I have more than one dematerialized account?

The Clearing Corporation will transfer securities to the main demat account tied to your trading account.

4. Does this affect margin trading?

Yes, the task does become easier. Importantly, you do not have to authorize pledges using OTP for Margin Trade Funding (MTF) anymore as pledging will be done through the Clearing Corporation.