Markets regulator Sebi will put in place an early warning mechanism to prevent diversion of client securities, with stock exchanges, clearing corporations and depositories being directed to take requisite measures by early next year.

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Deterioration in financial health of the stock broker or depository participant such as significant reduction in net worth and delay in submitting any data related to its financial health to the stock exchanges or depositories, could be early warning signals, Sebi said in a circular on Monday.

Significant trading exposure or amount of loans or advances given to and investments made in related parties and sudden activation of significant number of dormant client's accounts could also be early warning signals.

According to the regulator, there have been instances where stock brokers had diverted clients' securities received as collaterals towards margin or settlement obligations, for raising loan against shares on their own account and for meeting securities shortages in settlement obligations on its own account. 

"However, such instances of diversion of securities come to light when stock broker failed in meeting the margin and/ or settlement obligations to stock exchange/ clearing corporation," the circular said.

Against this backdrop, the watchdog has decided to put in place an early warning mechanism and sharing of information between stock exchanges, depositories and clearing corporations to detect the diversion of client's securities by the stock broker at an early stage.

The threshold for such early warning signals would be decided by the stock exchanges, depositories and clearing corporations with mutual consultation, as per the circular.

They have been directed to implement the early warning mechanism and preventive actions, with effect from February 1, 2019. 

Among others, the regulator said that alerts triggered at one stock exchange, clearing corporation or depository through early warning mechanism should be immediately shared with others with respect to the stock broker or depository participant concerned.

"Stock exchanges and depositories shall frame internal policy/guidelines regarding non-cooperation by stock brokers and depository participants during inspections which shall lay down the time period, the type of documents critical for closing the inspections, which if not submitted, can be treated as non-cooperation," the circular said.