The Securities and Exchange Board of India (SEBI) has raised concerns over potential risks of tax evasion and market misuse linked to Client Code Modifications (CCMs) and Custodian Participant (CP) code allocations in the securities market. The regulator emphasized that while it aims to allow flexibility for correcting genuine trading errors, such relaxations must not compromise market integrity.
What Are Client Code Modifications?
In financial markets, Client Code Modifications (CCMs) refer to correcting a client's identification code after a trade has been executed, usually to fix punching errors or order-entry mistakes. This practice is common in the institutional segment, where brokers may execute trades on behalf of clients and later transfer securities to the correct account. Mutual funds also reallocate trades between schemes, necessitating client code changes.
However, SEBI has flagged that CCMs can be misused to facilitate:
- Tax evasion by shifting positions for artificial losses that offset capital gains.
- Circular trading or creation of artificial trading volumes when multiple client codes are linked to a single PAN.
- Intra-group reallocations by Foreign Portfolio Investors (FPIs), potentially altering beneficial ownership without transparency.
Concerns Around CP Codes
SEBI also noted that the allocation of Custodian Participant (CP) codes for banks, mutual funds, pension funds, insurers and public financial institutions is done at the clearing corporation level but lacks robust monitoring for changes in beneficial ownership.
Inconsistent Penalties
Sources indicated that SEBI has observed inconsistencies in the penalty framework at the exchange and clearing corporation levels. Currently, penalties of 1% of trade value may be disproportionate, especially for FPIs and institutional clients handling large volumes. Stakeholders have called for clearer guidelines on "genuine errors" and more proportionate penalties.
Possible Regulatory Measures
SEBI is exploring multiple reforms to address these concerns, including:
- Allowing multiple client codes per PAN for certain institutional categories under strict safeguards.
- Strengthening monitoring of CP code allocations to prevent misuse.
- Adopting uniform penalties for unauthorized modifications outside FPI families.
- Broadening the definition of genuine errors, especially for ETF market makers transferring trades to AMCs.
"Exchanges can decide which client categories may be allowed multiple client codes for operational reasons, but modifications must not compromise market integrity, such as facilitating tax evasion or circular trading," SEBI sources said.
SEBI favors a principle-based approach where client categories eligible for multiple codes are pre-approved by the Regulatory and Oversight Committee of exchanges. While operational corrections should be allowed without penalties, all measures must ensure transparency and prevent misuse in the securities market.
The regulator's initiative underscores its focus on balancing market flexibility for legitimate institutional operations with strict safeguards against tax evasion and trading malpractices.
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