Who keeps the interest? Delhi HC to hear case on margin money in F&O trades

Mint

2 days ago

The Delhi High Court will on Wednesday hear a public interest litigation (PIL) that puts the spotlight on a contentious yet under-examined issue in India's ₹160-trillion futures and options (F&O) market: the fate of interest earned on margin money that traders deposit with brokers.
Investor funds in focus
Every day, millions of Indian traders participating in the fast-paced F&O market have to deposit 'margin money" as security against market risk. This capital—locked up for the entire period their position is open, ranging from a day to as long as two months—gets parked by stock brokers, often into fixed deposits or overnight mutual funds.
According to FY24 data from the National Stock Exchange annual report, traders collectively deposited over ₹160 trillion as margin, calculated as an average 20% margin on an F&O turnover of about ₹800 trillion.
While this capital remains blocked and generates substantial interest income, traders do not receive any compensation, the petition says. Brokers have traditionally pocketed this interest, despite the money not belonging to them.
Regulatory action by Sebi
In June 2023, the Securities and Exchange Board of India (Sebi) introduced rules to prevent misuse of client funds after a series of high-profile broker defaults. The so-called 'upstreaming framework" now requires brokers to transfer all client monies to designated clearing corporations (CC) at the end of each trading day.
Funds can only be held as cash, in specified fixed deposits, or in risk-free overnight mutual funds, and must be subject to tight liens and disclosures. However, Sebi's circulars remain silent on who is entitled to the interest income from margin funds kept in FDs or mutual funds.
This regulatory ambiguity forms the crux of the PIL filed by a Delhi-based lawyer, Virat Agarwal, who argues that while brokers act merely as intermediaries, it is the clients who deserve the return on their own capital.
The PIL seeks a clear directive from Sebi and the Central government to ensure that interest earned on traders' margin fixed deposits is passed back to the clients. 'After paying all taxes, duties, brokerage and fees, it is the legal right of the trader to get the interest on the margin money deposited," Agarwal argues.
The issue, he points out, impacts millions of retail and institutional investors who see no return on capital locked up as margins.
Legal lacunae and regulatory confusion
Legal experts universally agree that there is no statute or regulation in India that clearly prescribes who should rightfully receive the interest accrued on client margin fixed deposits.
'The upstreaming framework lays out stringent operational and safety norms to prevent the misuse of client money, but is silent on who benefits from the interest on these fixed deposits," said Alay Razvi, managing partner at Accord Juris.
The result, he emphasized, is that brokers retain this income by default, exposing a glaring regulatory gap that the PIL seeks to close.
On its part, on 5 July 2024, market regulator Sebi issued a draft circular and consultation paper proposing that clearing corporations should segregate their own funds from client money at all times and distribute interest income earned on invested collaterals to clearing members, who in turn should pass it on to their clients.
But these rules are still under consideration, and there is no formal adoption yet.
Brokerage business models on the line
Not surprisingly, the issue is contentious. Some brokers contend that interest on client float has become their sole major revenue stream, especially for low-cost or zero-fee platforms. 'Take away the interest, and brokers will be forced to increase trading fees or shut shop," warns one broker.
Financial advisors echo this view, noting that discount brokers—who have driven down commissions industry-wide—depend on this interest to subsidize their razor-thin margins.
Narinder Wadhwa, chief executive of SKI Capital Services, notes, 'For discount and zero-commission brokers, retaining interest on client margin is critical. Any regulatory shift could lead to fee hikes, business model overhauls, or even consolidation."
Globally, approaches to interest distribution vary. In the US, SEC and Finra demand strict segregation of client funds but do not require that brokers pass on interest. Some brokers voluntarily do so for high net worth clients as a competitive perk. In the UK, the FCA's rules on client money require segregation, but interest-sharing is a matter of contract, not regulation.
Experts warn that blanket Sebi orders would face formidable hurdles. One being the operational challenges of accurately allocating interest (after deducting costs and taxes) to each client in pooled accounts over shifting intraday balance, especially for high-volume brokers.
Wadhwa elaborates on a key regulatory obstacle of the broker not being a non-banking financial company. 'Under current financial regulation, brokers are not permitted to accept deposits or offer interest-bearing products in the manner that RBI-regulated financial institutions do."
He warns that Sebi requiring interest distribution could result in a jurisdictional conflict, blurring the lines between brokerages and regulated deposit-taking institutions. 'Any such step would likely require a coordinated policy effort between SEBI, RBI, clearing corporations, and exchanges, to ensure consistent treatment across the financial system."
He also mentions the tax and compliance implications, including questions around TDS, GST, and client-level tax reporting if interest is passed on. 'Most broker-client agreements today do not account for this scenario, and any retrospective application could trigger legal and contractual disputes",
Wadhwa says, adding that a more pragmatic approach could involve phased reform, including policy-level clarification on the role of clearing corporations in interest income distribution.
Looking ahead
Parth Contractor, founder of the Chamber of Parth Contractors, suggests a bigger story behind the PIL. 'The difference between Sebi's 2023 circulars and ground reality lies at the core of current litigation. Any change will surely disrupt brokers' economics and force compliance and technology upgrades."
As the High Court gears up for the hearing, Sebi has already replied to the court, arguing that the matter needs legislative and not judicial attention. The outcome could reshape investor compensation as well as business models across India's capital markets.