Explained: How new rule tweak frees up stock brokers to invest beyond securities

Time of India

9 hours ago

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In a welcome step for the broking industry, the government has amended Rule 8 of the Securities Contracts (Regulation) Rules, 1957 ( SCRR ), providing long-awaited clarity on what does not constitute 'business' for a stockbroker. The amendment addresses a long-standing industry concern around regulatory restrictions that limited brokers from investing their own surplus funds in non-securities businesses.Rule 8 of the SCRR lays down the eligibility conditions for a person to act as a stockbroker or a member of a recognised stock exchange . Under sub-rules (1)(f) and (3)(f), brokers are prohibited from engaging in any business other than that of securities, unless such business is carried out without any personal financial liability. This essentially prevented brokers from exposing themselves to financial risks unrelated to their core broking activities.Over time, the National Stock Exchange and the Bombay Stock Exchange issued circulars that significantly widened the interpretation of 'business' under Rule 8 of the SCRR. These circulars clarified that even passive investments in group companies (subsidiary or associate) engaged in non-securities businesses (such as NBFCs, real estate or insurance) would be treated as 'business' and would be in violation of Rule 8. This interpretation created a regulatory overhang that discouraged brokers from investing their own profits outside the securities space.In practice, brokers were restricted from investing their retained earnings or surplus capital into group ventures operating outside the securities domain, even where such investments posed no financial risk to the broker or its clients. This created a significant operational constraint. If a broker wished to invest in a non-securities business, it first had to route profits to its parent, typically via dividends or buybacks, incurring additional tax liabilities before the funds could be redeployed by the parent. This structure was inefficient and deterred brokers from pursuing legitimate investment opportunities that could enhance their business offerings and growth.Recognising these industry concerns, the Ministry of Finance released a consultation paper in September 2024 proposing a more nuanced interpretation of Rule 8. It clarified that the original intent of the restriction was to protect client interests and ensure the financial soundness of the brokers, not to place undue limitations on the use of their own capital. Since stockbrokers are already subject to stringent SEBI regulations aimed at safeguarding client funds, further restricting them from investing in group companies engaged in non-securities businesses under the guise of protecting client funds seemed excessive and unwarranted.This position has now been codified through an amendment to Rule 8. It now clarifies that a broker's investment activity will not be treated as 'business', unless it involves client funds, client securities or creates a financial obligation for the broker. This empowers brokers to freely invest their retained earnings and surplus capital in group companies or unrelated ventures, so long as client interests remain unaffected. Brokers can now participate in broader financial services ecosystems such as lending or insurance through subsidiaries, allowing them to diversify revenue streams and build integrated financial platforms.While this amendment to Rule 8 is now effective and offers much-needed regulatory clarity, it is worth noting that the circulars issued by NSE and BSE interpreting the earlier position have not yet been formally withdrawn. This could create some ambiguity for brokers on how the exchanges will align with the amended Rule 8, particularly given that the validity of the NSE circular had been challenged before the Bombay High Court. Until the exchanges formally update their stance, brokers may continue to face uncertainty in practice despite the regulatory intent to liberalise.(The authors Prashanth Ramdas is Partner and Shivaang Maheshwari is Associate at Khaitan & Co. The views expressed are personal.)