Clients of brokers with unused balances in their trading accounts have their money automatically invested in liquid funds to comply with a SEBI rule. These clients might find themselves inadvertently caught in the crisis affecting liquid and other debt funds, triggered by the defaults and downgrades of IL&FS group companies.
SEBI formulated a set of rules on unused balances in 2009 to stop brokers from indefinitely enjoying interest income on them. This is because no interest is payable on the balance maintained in a stock broking account. These rules require brokers to credit unutilised funds back to the client’s account at least once in 90 days. Balances below Rs 10,000 are exempted. If you have a futures and options (F&O) position, a 125% of the margin money can be retained by the broker. The SEBI rules also apply to stocks which have to be moved to the client’s demat account at least once in 90 days.
Some brokers have found a way of avoiding the hassle of moving money back and forth between client accounts and their own. They have enabled a default purchase of liquid funds with the unutilized money. For instance, Zerodha had enabled the purchase of DHFL Instacash Fund with this type of unutilised money as we wrote here. Money invested in liquid funds is currently earning a return of 5-7% but this changes according to prevailing interest rates. No brokerage or Securities Transaction Tax (STT) applies to this type of investment.
As a result, clients of these brokers could find themselves taking losses due to the ongoing issues with debt mutual funds. As part of the recent crisis, Motilal Oswal Mutual Fund suspended inflows into the Motilal Oswal Ultra Short Term Fund. Principal Mutual Fund also suspended inflows into Principal Cash Management Fund, Principal Ultra Short Term Fund, Principal Low Duration Fund and Principal Arbitrage Fund and AMCs such as DSP Mutual Fund, BOI Axa Mutual Fund and Aditya Birla Sun Life Mutual Fund were also hit. Among these, Principal Cash Management is categorised as a liquid fund, punching a hole in the idea that liquid funds are virtually risk-free.
A move by DSP Mutual Fund to sell off its exposure to DHFL (Dewan Housing Finance Ltd), an NBFC, triggered a wider market sell-off with home lending oriented NBFCs like DHFC particularly hit. DHFL has lost 50% of its market capitalisation in the recent sell-off. It may be a pure coincidence, but Zerodha has changed its default liquid fund from DHFL Insta Cash Fund to Reliance Liquid Fund. The brokerage has also taken an additional precautionary measure – client funds are invested in liquid funds to comply with SEBI rules but are also immediately redeemed. However, this does not completely protect brokerage clients from being unwittingly caught up in the debt fund crisis. It is also unclear if other brokerages are taking similar measures.