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BSE begins work on new model for risk-based supervision of brokers

The new supervision model, derived from global best practices, would follow four steps to assess the risk posed by a market entity and then adopt a supervisory approach.

twitter-logoPTI | December 11, 2014 | Updated 13:12 IST
BSE begins work on risk-based supervision of brokers
(Photo: Reuters)

Bombay Stock Exchange (BSE), the leading domestic bourse, has initiated a process of putting in place a new risk-based model for supervision of market entities including brokers, taking forward a new model proposed by the Securities and Exchange Board of India (Sebi) in this regard.

Capital market regulator Sebi has decided to adopt this new supervision model, based on level of risks posed by a market entity, to help it better regulate the marketplace and strengthen its surveillance system.

In order to implement the model, based on the Risk Assessment template formulated by Sebi and exchanges, BSE has initiated the process of developing the system, which would comprise data generated by the bourse as well as those provided by the members.

The BSE added that it will provide an electronic interface to the members to enable them submit the data, which will be collated and analysed by the exchange system.

The risk assessment templates have been developed for various market intermediaries, such as stock brokers, depository participants, mutual funds, custodians, merchant bankers, portfolio managers, registrars and transfer agents, credit rating agencies and investment advisers.

The new model, derived from the global best practices, would follow four distinct steps assessing the risk posed by a market entity, assigning 'risk and impact rating' to it, determining supervisory risk rating score and then adopting a suitable supervisory approach.

Various market entities would be divided broadly into four groups - very low risk, low risk, medium risk and high risk - and the quantum of surveillance and number of inspections would increase as per the risk level.

Risk and impact ratings would be assigned to each entity on a scale of 0-4, with zero rating being for those with complete absence of any risk parameters. Meanwhile, a score of four would indicate very high risk or very low compliance.

The move would help the existing surveillance system take care of most of the smaller offences, so that the investigation resources are utilised more effectively to tackle serious violations in the market place.

The new model would follow four distinct steps - assessing the risk posed by a market entity, assigning 'risk and impact rating' to it, determine the supervisory risk rating score and then adopt a suitable supervisory approach.

The overall risk profile of an entity would be decided by two factors - business or activity specific risk and the impact risk arising out of default or failure. The risk-based supervisory approach is being implemented in a phased manner.

Earlier in September, Sebi Chairman UK Sinha had told PTI that the market watchdog was working on this risk-based supervision model while becoming the first financial sector regulator in the country to have done a study of its own regulatory impact.

Sinha had further said that specific metrics would be put in place to determine the risk that every firm poses to the system and based on which enforcement actions can also be initiated.

While the existing supervision model followed by Sebi has been very effective, it was found that the approach was 'loosely risk based', where no formal risk ratings were assigned to regulated intermediaries and the current resource allocation approach did not allow for an assessment of risk concentration across all regulated intermediaries.

While the new model provides for a combination of on-site and off-site monitoring of the intermediaries by the market regulator and its front-line regulators, the entities falling in the high-risk group will be subject to stricter monitoring (offsite) and comprehensive inspection.

Thematic inspections, as a supervisory tool, will be utilised for specific purposes such as verifying compliance with recently issued regulatory requirements on references received from departments within Sebi and other regulatory bodies or where a focused review of assessing compliance in a particular area of operations is needed.

The new guidelines also provides a procedure for determining the supervisory risk rating score for conglomerates and group companies that carry out multiple lines of regulated businesses. The overall risk score for them would take into account factors like significance of their businesses in capital markets and the sub-score for each type of business activity carried out by the entity.

The system would identify specific risks posed by different business of an entity, such as credit risk, market risk and operational risk. These 'risk parameters' will be accompanied by the corresponding risk mitigating measures, termed as 'control parameters', which are mainly systems or procedures put in place to minimise risk.

Similarly, the impact parameters will be identified to reflect risks associated with impact of default or failure of an intermediary on the basis of size of operations, number of active clients, turnover, market share, etc.

The credit risk would take into account loans to group entities or related parties, debt levels, margins-related defaults and other issues.

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