Special Services- Pledge and Hypothecation

Special Services- Pledge and Hypothecation (Part 1)

Definition: Pledge and hypothecation of securities refer to the process of using securities as collateral for a loan or other financial obligations.
Details: The creation of pledge and hypothecation against securities held in demat mode is permitted under section 12 of the Depositories Act, 1996.

Key Concepts

Pledge: A transaction where the lender (pledgee) has unilateral right to appropriate the securities to his account if the borrower (pledgor) defaults.
Hypothecation: A transaction where the lender needs concurrence of the borrower for appropriating securities to his account.
Pledge Sequence Number: A unique system-generated number in the DP system used to identify each pledge/hypothecation transaction.
Standing Instruction Indicator for Auto Pledge Confirmation: A flag in the NSDL system that allows for automatic confirmation of pledge requests.

Procedure for Pledge/Hypothecation

The pledgor initiates the creation of pledge/hypothecation through its DP.
The pledgee instructs its DP to confirm the creation of the pledge.
The pledge/hypothecation can be closed on repayment of loan or invoked if there is a default.
The following steps are involved in the creation of pledge/hypothecation:
1. Creation of Pledge/Hypothecation by Pledgor: The pledgor submits a request form to its DP with details of the securities to be pledged, agreement number, and pledgee's details.
2. Procedure for Confirmation of Creation of Pledge/Hypothecation by Pledgee: The pledgee submits a duly stamped and signed PRF to its DP, which verifies the details and confirms the pledge/hypothecation.
3. Closure (Unpledge) of a Pledge/Hypothecation by Pledgor: The pledgor submits an instruction to its DP to initiate the un-pledge/closure of pledge/hypothecation, which is then confirmed by the pledgee.

Benefits and Rejection Reasons

Benefits: Pledged securities are shown separately as "pledged balance" in the statement of holding.
Rejection Reasons: Un-pledge/closure date not accepted, pledged quantity not accepted, ISIN not accepted, security details not accepted, market value of pledged ISINs insufficient, ISIN delisted from trading, POA not received from all holders.

Special Services- Pledge and Hypothecation (Part 2)

Pledge Rejection Reasons: Rejection reasons are not present in the CDSL system, but the pledgee DP can enter the reason for rejection in a remark field.
Unilateral Closure (Unpledge) of Pledge: The pledgee can initiate unilateral closure of pledge/hypothecation by submitting an instruction to its DP.
Invocation of Pledge by Pledgee: The pledgee can invoke the pledge if the pledgor fails to discharge obligations, and claim beneficial ownership of securities after following necessary steps.
Invocation Request Form (IRF): The pledgee fills up the IRF to invoke the pledge, and the DP verifies the form for completeness and validity.
Pledge Invocation Process: The DP enters the invocation request details in the DP system, and the securities are transferred from the pledgor's account to the pledgee's account.
Corporate Benefits for Pledged/Hypothecated Securities: The pledgor (borrower) retains ownership of pledged/hypothecated securities and receives corporate benefits like dividends and bonus shares.
Checklist for Pledge/Hypothecation: The DP should ensure that the instruction form is submitted in duplicate, all compulsory fields are entered, and the request for confirmation of pledge is given before the closure date.
Recording of Non Disposal Undertaking (NDU) in the Depository System: The depository system allows recording of NDUs, which are undertakings given by a shareholder not to transfer or alienate securities.
Margin Obligations through Pledge/Re-pledge: SEBI allows margin obligations to be given by way of pledge/re-pledge in the depository system, and trading members/clearing members can accept collateral from clients in the form of securities only by way of margin pledge.
Margin Pledge Account: The trading member/clearing member is required to open a separate demat account for accepting margin pledge, tagged as 'Client Securities Margin Pledge Account'.
Re-pledge of Securities: The trading member can re-pledge securities with the clearing member, and the clearing member can re-pledge the same to the clearing corporation, with a complete trail reflected in the demat account of the pledger.
Pledge Release for Early Pay-in: The depositories provide a functionality for single instruction in the form of 'pledge release for early pay-in' to facilitate a smooth process without requiring physical or electronic instructions.

Special Services- Pledge and Hypothecation (Part 3)

Client Securities Margin Pledge Account: A functionality provided by depositories for mutual fund units not traded on the exchange, allowing invoked MF units to move into the TM/CM's Client Securities Margin Pledge Account and then be automatically redeemed.
Invocation-cum-Redemption: A process where invoked MF units are moved into the TM/CM's Client Securities Margin Pledge Account and then redeemed.
Frozen Trading Account: If a client's trading account is frozen or marked as 'not permitted to trade' after creation of pledge, the invoked securities shall move into the demat account of the TM/CM and be sold under the proprietary code.
Operational Mechanism for Margin Pledge: Provided in Annexure 3, outlining the framework for utilisation of pledged clients' securities for exposure and margin.
Framework for Utilisation of Pledged Clients' Securities: Provided in Annexure 4, detailing the guidelines for using pledged securities.

Key Terms:

Pledge: A transaction where the lender requires concurrence of the borrower for appropriating securities to his account.
Hypothecation: A transaction where the lender does not require concurrence of the borrower for appropriating securities to his account.
Depository: An entity that holds securities in electronic form, providing a platform for pledge and hypothecation transactions.

Review Questions:

Answer: (a) Pledge
Answer: (a) True
Answer: (c) When the confirmation advice is entered in the DP system
Answer: (a) Yes