New Delhi, May 19 -- Portfolio managers can allow their clients to pledge their securities to raise a loan, under certain circumstances, according to an informal guidance note issued by the Securities and Exchange Board of India (SEBI) on Tuesday.
Under SEBI regulations, managers of portfolio management services (PMS) are not allowed to borrow funds on behalf of their clients. But, according to SEBI's informal guidance note, if the managers are providing non-discretionary services, then their clients can pledge their securities to raise a loan.
The note was issued in response to a query raised by Geojit Financial Services, which provides non-discretionary portfolio management services (ND-PMS).
Portfolio management services can be provided as a discretionary service or a non-discretionary service. In discretionary services, the portfolio manager makes the investment decisions. In ND-PMS offerings, the portfolio manager recommends an investment and the client makes the final decision.
According to Geojit Financial, a prospective client had asked if they could pledge securities held in their demat account (purchased through the ND-PMS framework) to get a loan. The loan arrangement would be between the client and the lender and the portfolio manager would not be a party to the borrowing transaction.
In its query addressed to SEBI, Geojit stated: "Upon reviewing the PMS Regulations, 2020, and the related circulars, we could not trace any explicit regulatory guidance on the permissibility or treatment of client initiated pledging of such securities."
The company wanted to know if the PMS manager was allowed to permit such a pledge; and if such a pledge would be construed as a borrowing of funds or securities by the portfolio manager on behalf of the client, which is restricted under Regulation 23 (8) of the Portfolio Managers Regulations.
SEBI responded that in non-discretionary PMS service, the manager acts on the instructions of the client. "Thus, the final decision rests entirely with the client," said the SEBI note.
"Further, the client, as the beneficial owner of the securities, has the right to use its own assets, including those under PMS, as pledge for loans," it added.
The note also said that the restriction on borrowing of funds under the regulation cited does not prevent ND-PMS clients from initiating a pledge, "provided the pledge is initiated solely by or at the client's discretion".
Geojit also asked how such a transaction should be recorded in their regulatory reports.
The regulator responded, "[A] Pledge does not change the beneficial ownership from client (pledger) to lender (pledgee) unless such pledge is invoked. Since the pledged securities remain with the client, the market value of securities pledged by the client shall continue to be included in the portfolio manager's assets under management until the invocation of pledge and reflected in the regulatory reporting."
Published by HT Digital Content Services with permission from VC Circle.