Karvy one of three Indian brokers restricted after probe

Via Financial Times

Indian authorities have clamped down on a trio of brokerages after allegations of wrongdoing, feeding investor anxiety about the health of the country’s financial sector.

The Securities and Exchange Board of India, the market regulator, said last week that it would stop the brokerage arm of financial group Karvy from bringing in new clients after an investigation resulted in preliminary findings that it had pledged clients’ shares as collateral for loans.

The National Stock Exchange investigation found that the concerns extended to Rs23bn ($322m) worth of shares and involved almost 95,000 clients. Karvy allegedly pledged the shares to three private banks and another financial company in return for loans. SEBI also cited preliminary findings that the group had transferred funds worth Rs10.96bn from its broker to its real estate arm, and gave Karvy 21 days to respond to the interim order. 

The NSE has also suspended two smaller brokerages because of similar concerns. The alleged irregularities among financial middlemen have added to investor unease about India’s financial system. A severe liquidity squeeze over the past year, particularly in India’s troubled real estate industry, has left prominent financial groups struggling to raise funds and prompted higher regulatory scrutiny of their dealings. 

“It is a subset of the entire economic problem,” said Sumit Agrawal, founder of law firm RegStreet and a former SEBI official, referring to the allegations against Karvy. An economic slowdown has put financial groups under increased stress, he said: “These are the problems of doing business in these times.” 

Indian rating agency ICRA on Wednesday downgraded its rating on long-term bank credit for Karvy’s stock brokerage, pointing to the likelihood that SEBI’s order would affect its ability to repay debts. It also said that Karvy had stopped sharing information with the agency. “Despite repeated requests by ICRA, the entity’s management has remained non-cooperative,” ICRA said. 

Karvy, which services 70m investors across the group, said that the SEBI order was preliminary and that it planned to defend itself. It also contested the figures cited by the exchange and the regulator, denying that it had misused clients’ securities. “While we acknowledge delays in handling and resolution of certain cases, to characterise it as misutilisation is a travesty,” it said in a statement. 

The NSE has appointed EY to conduct a forensic audit of Karvy.

Confidence in India’s financial system has been eroded over the past year after a series of high-profile defaults at large financial groups led to a funding squeeze that sparked fears of contagion reaching other sectors. Groups like Karvy have interests spanning shadow lending, real estate and stockbroking

SR Srinivasan, an independent investment adviser, said the scandal risked scaring off retail investors in a country where millions have started participating in the financial system for the first time

“The question would be trust,” he said. “I trusted you to take care of my holdings. That’s broken, so there’s more concern among investors, which is understandable.”

Additional reporting by Andrea Rodrigues