Integration of Equity and Commodity Broking Under a Single Entity — Compliance Checklist

A stock broker can now deal in commodity derivatives and other securities under a single entity, facilitating ease of doing business. This article provides a compliance checklist for integrating equity and commodity broking activities under a single legal entity.

The Regulatory Basis

SEBI Circular SEBI/HO/MIRSD/MIRSD1/CIR/P/2017/104 dated September 21, 2017 allowed a stock broker to deal in commodity derivatives and other securities under a single entity. Under the existing single registration mechanism, a one-time certificate of registration as stock broker / clearing member is granted by SEBI, and subsequent permissions to act as a stock broker / clearing member of other stock exchanges / clearing corporations are granted by the respective stock exchange / clearing corporation after proper due diligence.

Compliance Checklist

1. Registration and Approvals

• Obtain a single SEBI registration. A one-time certificate of registration as stock broker / clearing member is sufficient for both equity and commodity derivatives.
• Obtain exchange approvals. Apply to the respective commodity derivatives exchange for permission to act as a member.
• Obtain clearing corporation approvals. Apply to the respective clearing corporation for clearing rights.
• Prior approval for change in control. Prior approval from SEBI is required only in cases where integration leads to change in control of the stock broker / clearing member.

2. Client Account Transfer

• Obtain client consent. Client accounts may be transferred from one stock broker to another by taking the express consent of the client through a verifiable mode of communication.
• Maintain existing documentation. The existing set of documentation in respect of broker client relationship can continue.
• Update KYC. Ensure KYC is updated if the CKYC identifier changes.

3. Financial and Capital Adequacy

• Maintain net worth. The net worth requirement must be met for both equity and commodity derivatives segments. The net worth of the single entity must be at least ₹5 crore for a self-clearing member in both segments.
• Maintain deposits. The deposit requirements for equity and commodity derivatives must be met separately. Reference: SEBI Master Circular for Stock Brokers, Para 48 — Deposit Requirements
• Maintain separate accounts. Funds of equity clients and commodity clients must be kept in separate accounts. The accounts must be named as per the SEBI nomenclature requirements. Reference: SEBI Master Circular for Stock Brokers, Para 15.3 — Naming/Tagging of Bank and Demat Accounts

4. Risk Management

• Separate risk management systems. The entity must have separate risk management systems for equity and commodity derivatives, given the different margin requirements and settlement cycles.
• Report margins. Margins for equity and commodity derivatives must be reported separately to the respective exchanges.
• Collect upfront margins. TMs/CMs in cash segment must mandatorily collect upfront VaR margins and ELM from clients, similar to derivatives segment. Reference: SEBI Master Circular for Stock Brokers, Para 40 — Collection and reporting of margins

5. Compliance and Audit

• Appoint a compliance officer. The compliance officer must be responsible for both equity and commodity derivatives compliance.
• Conduct internal audit. Half-yearly internal audit must cover both equity and commodity derivatives operations. Reference: SEBI Master Circular for Stock Brokers, Para 13.2 — Internal Audit
• Submit financial statements. Financial statements must be submitted to stock exchanges in the same format as prescribed under the Companies Act, 2013.

6. Technology and Systems

• Separate systems for equity and commodity derivatives. The trading and risk management systems must be segregated, given the different settlement cycles and risk parameters.
• Cybersecurity. The entity must comply with the Cyber Security and Cyber Resilience framework for both equity and commodity derivatives. Reference: SEBI Master Circular for Stock Brokers, Para 62 — Cyber Security and Cyber Resilience Framework

7. Reporting

• Report to SEBI. The entity must communicate to SEBI the status of implementation of the provisions of integration through the Monthly Development Report.
• Report to exchanges. The entity must comply with the reporting requirements of both equity and commodity derivatives exchanges.

8. Outsourcing

• Follow outsourcing guidelines. The entity must adhere to the guidelines on outsourcing of activities specified in Circular CIR/MIRSD/24/2011 dated December 15, 2011. Reference: SEBI Master Circular for Stock Brokers, Para 86 — Guidelines on Outsourcing of Activities

Key Compliance Points

• Segregation of funds. Funds of equity and commodity clients must not be commingled. This is a major compliance risk.
• Separate systems. Failure to maintain separate systems for equity and commodity derivatives may lead to operational risks and regulatory action.
• Client consent. Client consent for transfer of accounts must be obtained promptly to avoid disruption of services.
• Net worth. The single entity must maintain net worth for both segments. If net worth falls short, the entity may be suspended.

Documents Required

• Application for exchange approval (commodity derivatives).
• Board resolution authorising the integration.
• Net worth certificate of the single entity.
• Client consent letters for transfer of accounts.
• Updated KYC documents.
• System audit reports for both equity and commodity derivatives.

Common Pitfalls

• Commingling of funds. This is the most common violation. Equity and commodity client funds must be kept separately.
• Delayed client consent. Client consent for transfer of accounts must be obtained promptly.
• Inadequate net worth. The single entity must maintain net worth for both segments.
• Failure to maintain separate systems. Separate trading and risk management systems must be maintained.

How We Help

At Anuj Desai & Associates, we assist in integrating equity and commodity broking activities under a single entity, preparing the applications for exchange approvals, ensuring compliance with all regulatory requirements, and implementing the risk management and reporting systems. If you are planning to integrate equity and commodity broking under a single entity, reach out to our capital markets desk.