NISM Series III A – SEBI (Foreign Portfolio Investors) Regulations 2019 and SEBI (Stock Brokers) Regulations 1992
Welcome to Part 8 of the NISM Series III A Short Notes series on PassNISM.in. This post covers two important chapters:
- Chapter XI: SEBI (Foreign Portfolio Investors) Regulations, 2019
- Chapter XII: SEBI (Stock Brokers) Regulations, 1992 — including client agreements, KYC, margin trading, DMA, and algorithmic trading
SEBI (Foreign Portfolio Investors) Regulations, 2019 Eligibility Criteria for Foreign Portfolio Investors (FPIs)
A designated depository participant (DDP) will not consider an application for FPI registration unless the applicant satisfies the eligibility conditions specified under the SEBI (Foreign Portfolio Investors) Regulations, 2019.
Categories of Foreign Portfolio Investors
Applicants must seek FPI registration in one of the prescribed categories — or any other category as SEBI specifies from time to time.
Designated Depository Participant (DDP) – Approval Process
- No person can act as a DDP without SEBI's approval
- Application for DDP approval is made to SEBI through the depository in which the applicant has an agreement to act as a participant
- The depository must forward the application to SEBI within 30 days of receiving it, along with its recommendations and confirmation that the applicant meets eligibility criteria
Investment Conditions and Restrictions
Regulation 20 of the SEBI (Foreign Portfolio Investors) Regulations, 2019 specifies the investment restrictions applicable to FPIs.
SEBI (Stock Brokers) Regulations, 1992
The SEBI (Stock Brokers and Sub-Brokers) Regulations, 1992 governs the registration and operations of stock brokers and sub-brokers in the securities market. All stock brokers and sub-brokers must comply with this regulation at all times.
Registration of Stock Brokers and Sub-Brokers
- Stock brokers must comply with all registration conditions under Regulation 9 at all times
- No separate registration is needed for a SEBI-registered stock broker to act as a clearing member in a clearing corporation, subject to the clearing corporation's approval
General Obligations and Responsibilities
A stock broker's general obligations and responsibilities are set out under Regulations 17 to 18B. These cover conduct of business, client dealings, and compliance requirements.
Procedure for Inspection by SEBI
Under Regulation 19, SEBI has the right to inspect. SEBI may appoint an inspecting authority to examine the books of accounts, records, and documents of stock brokers — with or without prior notice.
Action in Case of Default
A stock broker who contravenes any provision of the Act, rules, or regulations is liable for one or more of the actions provided under the regulation. Under Regulation 27, a stock broker is liable to enquiry proceedings under the SEBI (Intermediaries) Regulations under certain specified conditions.
Code of Conduct for Stock Brokers General Conduct
- Integrity
- Exercise of due skill and care
- No manipulation
- No malpractices
Duties to the Investor
- Timely execution of orders
- No breach of trust
- Fair business practices and commission
- Handling of defaulting clients
- Fairness to all clients
- Investment advice must be sound and appropriate
- Responsible investment advice in publicly accessible media
- Ensuring competence of sub-brokers
Dealing with Regulatory Authorities
- General conduct must be lawful and transparent
- No failure to provide required information
- No false or misleading returns
- No manipulation or malpractices
Regulation of Transactions Between Clients and Brokers
SEBI has mandated that:
- All member brokers must keep client funds in a separate account from their own funds
- No payment from transactions where the broker acts as principal can be made from the client's account
- Transfer from client account to broker's own account is allowed only in certain specified circumstances
Client Registration Documents
Client registration documents are split into mandatory and non-mandatory parts.
Mandatory Documents
- Client Agreement – defines the relationship and liabilities between the client and trading/clearing member
- Know Your Client (KYC) Form – mandatory per SEBI circular; must capture complete client information, bank and depository account details, financial details, investment/trading experience, and references
- Risk Disclosure Document (RDD) – mandatory for every client; informs them of risks associated with trading (especially derivatives); the exchange may prescribe additional disclosure requirements
Uniform Documentary Requirements for Trading
SEBI has prescribed uniform formats for client registration forms and broker-client agreements to bring uniformity across different market segments and exchanges, and to avoid duplication of documents.
Power of Attorney (PoA)
A PoA is executed by the client in favor of the stock broker/depository participant to authorize operations of the client's demat account and bank account. A PoA executed in favor of a stock broker must be limited to:
- Securities (demat account)
- Funds (bank account)
Unique Client Code and PAN
It is mandatory for brokers to use a Unique Client Code (UCC) for every client. The broker must collect and maintain the client's Permanent Account Number (PAN) in their back-office records.
Contract Notes
Contract notes must be issued to clients within 24 hours of trade execution. Contract notes must contain:
- Signature of the authorized person
- Unique Client Code (UCC) and PAN details
- Trade price and brokerage charged
Contract notes can be issued electronically, authenticated by digital signatures.
Direct Market Access (DMA)
Direct Market Access (DMA) is a facility that permits brokers to offer clients direct access to the exchange trading system through the broker's infrastructure — without manual intervention by the broker.
Advantages of DMA
- Direct control of clients over their orders
- Faster order execution
- Reduced risk of manual order entry errors
- Greater transparency and increased liquidity
- Lower impact costs for large orders
- Better audit trails
- Enhanced use of hedging and arbitrage opportunities through algorithmic tools
Key DMA Compliance Requirements
- Brokers must maintain a sound audit trail for all DMA orders and trades
- Audit trail data must be available for at least 5 years
- Clients must be specifically authorized for DMA after fulfilling KYC requirements and due diligence on creditworthiness, risk-taking ability, compliance track record, and financial soundness
- Brokers using DMA must not cross trades between their clients — all orders must be offered to the market for matching
- The broker remains fully responsible for all orders routed through DMA
Algorithmic Trading
Any order generated using automated execution logic is known as algorithmic (algo) trading. Key compliance requirements:
- Stock brokers can offer algo trading only with prior permission of the stock exchange
- Stock exchanges conduct initial conformance tests on the broker's systems before approval
- Risk controls that must be implemented include:
- Price check
- Quantity check
- Order value check
- Cumulative open order value check
- Automated execution check
Margin Trading
| Term | Definition |
|---|---|
| Initial Margin | Minimum amount (as a percentage of transaction value) the client must deposit with the broker before the actual purchase. The broker funds the balance. |
| Maintenance Margin | Minimum amount (as a percentage of market value of securities, based on previous day's closing price) that the client must maintain with the broker |
| Margin Trading Facility (MTF) | Facility where the broker pays part of the transaction value due to the stock exchange at the time of share purchase, on behalf of the client and per the client's request |
Authorized Persons
An Authorized Person is any individual, partnership firm, LLP, or body corporate appointed by a stock broker (including trading member) to provide access to the exchange's trading platform as an agent of the stock broker.
Frequently Asked Questions (FAQs) What is Direct Market Access (DMA)?
DMA is a facility that allows brokers to give clients direct access to the stock exchange trading system through the broker's infrastructure, without manual broker intervention. It enables faster order execution and better transparency.
Within how many hours must contract notes be issued?
Contract notes must be issued within 24 hours of the execution of trades on the exchange.
What is the Margin Trading Facility (MTF)?
MTF allows clients to purchase shares by paying only part of the transaction value, with the broker funding the remaining amount. The client must maintain an initial margin before the purchase and a maintenance margin thereafter.
What is an Authorized Person in the context of a stock broker?
An Authorized Person is appointed by a stock broker to provide clients access to the exchange's trading platform as the broker's agent. They can be individuals, firms, LLPs, or body corporates.
Continue to Part 9: SEBI (Alternative Investment Funds) Regulations 2012 and SEBI (Portfolio Managers) Regulations 2020.
NISM Series III A – SEBI (Alternative Investment Funds) Regulations 2012 and SEBI (Portfolio Managers) Regulations 2020
Welcome to Part 9 of the NISM Series III A Short Notes series on PassNISM.in. This post covers:
- SEBI (Alternative Investment Funds) Regulations, 2012
- SEBI (Portfolio Managers) Regulations, 2020
SEBI (Alternative Investment Funds) Regulations, 2012 What Is an Alternative Investment Fund (AIF)?
An AIF is any fund established or incorporated in India as a trust, company, limited liability partnership (LLP), or body corporate that:
- Is a privately pooled investment vehicle
- Collects funds from investors — whether Indian or foreign
- Invests in accordance with a defined investment policy for the benefit of its investors
- Is not covered under the SEBI (Mutual Funds) Regulations, 1996, the SEBI (Collective Investment Schemes) Regulations, 1999, or any other regulation for fund management activities
What Is NOT Considered an AIF?
The following are explicitly excluded from the AIF definition:
- Family trusts set up for the benefit of relatives as defined under the Companies Act, 1956
- ESOP Trusts under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 or as permitted under the Companies Act, 1956
- Employee welfare trusts or gratuity trusts for employee benefit
- Holding companies within the meaning of Section 4 of the Companies Act, 1956
- Other special purpose vehicles not established by fund managers, including securitization trusts regulated under a specific regulatory framework
- Funds managed by securitization companies or reconstruction companies registered with RBI under the SARFAESI Act, 2002
Categories of Alternative Investment Funds
| Category | Focus and Characteristics |
|---|---|
| Category I AIF | Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other sectors considered socially or economically desirable by the government or regulators. Includes venture capital funds, SME funds, social venture funds, and infrastructure funds. |
| Category II AIF | Does not fall in Category I or III. Does not undertake leverage or borrowing beyond day-to-day operational requirements. Examples: private equity funds, debt funds. |
| Category III AIF | Employs diverse or complex trading strategies. May employ leverage including through investment in listed or unlisted derivatives. Examples: hedge funds. |
SEBI (Portfolio Managers) Regulations, 2020 Who Is a Portfolio Manager?
A portfolio manager is a body corporate that, pursuant to a contract with a client, advises or directs or undertakes (on behalf of the client) the management or administration of:
- A portfolio of securities, or
- Goods, or
- Funds of the client
A portfolio manager may also deal in goods received as delivery against physical settlement of commodity derivatives.
Discretionary Portfolio Manager
A discretionary portfolio manager is one who, under a portfolio management contract, exercises discretion regarding the investment of funds or management of the client's securities portfolio.
Application for Grant of Certificate
A portfolio manager must apply to SEBI in the prescribed form, along with a non-refundable application fee. SEBI considers all relevant matters related to portfolio management activities when evaluating the application.
Conditions of Registration
The certificate of registration granted to a portfolio manager is subject to specified conditions laid out in the regulations.
Applicability of the Regulations
Regulation 16 of the SEBI (Portfolio Managers) Regulations, 2020 specifies the applicability of these regulations.
Key Differences – AIF Categories at a Glance
| Feature | Category I | Category II | Category III |
|---|---|---|---|
| Investment Focus | Start-ups, SMEs, social ventures, infrastructure | Private equity, debt funds | Hedge funds, complex strategies |
| Leverage Allowed | Restricted | Only for day-to-day operations | Allowed, including via derivatives |
| Government Support | Considered socially/economically desirable | None specifically | None specifically |
Frequently Asked Questions (FAQs) What is an Alternative Investment Fund (AIF)?
An AIF is a privately pooled investment vehicle established in India that collects funds from investors and invests them per a defined policy. AIFs are regulated by SEBI under the AIF Regulations, 2012, and are distinct from mutual funds and CIS.
What are the three categories of AIFs?
Category I AIFs invest in start-ups, SMEs, social ventures, and infrastructure. Category II AIFs include PE and debt funds, without leverage beyond operational needs. Category III AIFs employ complex trading strategies and may use leverage through derivatives.
What is a discretionary portfolio manager?
A discretionary portfolio manager exercises full discretion in making investment decisions for the client's securities portfolio under the portfolio management contract. The client does not direct individual investment decisions.
Is a family trust considered an AIF?
No. Family trusts set up for the benefit of relatives (as defined under the Companies Act) are explicitly excluded from the definition of AIF under the SEBI (AIF) Regulations, 2012.
Continue to Part 10: SEBI (Merchant Bankers) Regulations 1992, Takeovers, Delisting and ICDR Regulations.