MC Exclusive: Brokerages avoid regulatory scrutiny of illegal prop-renting with an easy hack

 MC Exclusive: Brokerages avoid regulatory scrutiny of illegal prop-renting with an easy hack

Market sources say SEBI has started tracking these trades more closely and hence, brokers have found a solution.

Renting out prop accounts has become so lucrative that brokerage firms have set up pyramid-like schemes for their distribution.

Brokerage companies are finding new ways to continue their lucrative but illegal business of renting out their proprietary accounts to traders. According to market insiders, they are using easily available and affordable technology to dodge the regulator's monitoring mechanisms.

The Securities and Exchange Board of India (SEBI) is concerned about various illegal practices involving the use of proprietary accounts by brokerages, including brokerages 'renting out' their proprietary accounts for a fee. Therefore, market insiders told Moneycontrol, the regulator has started looking more closely at the location from where prop trades are being placed.

Brokerages are allowed to place proprietary orders only from specific locations. But the brokerages that leased their Prop accounts were allowing their tenant-traders to access the accounts from wherever they were located.

“People are trading prop books from different parts of the country, some even trade from their homes. But the regulator had never looked at it very closely until now,” said an industry insider.

Another said there has been an increase in testing, especially since October. Commenting on such practices, SEBI Chairperson Madhabi Puri Buch, in the press conference after the last board meeting, had said that these deserve scrutiny and the regulator is investigating them.

To avoid strict scrutiny, rogue brokerages are using Remote Desktop Protocol (RDP) to provide access to traders who are not operating from a specified or registered location. As insiders told Moneycontrol, brokerage companies are letting people trade from different locations across the country by giving them remote access to systems housed at registered locations/locations.

Why is this a matter of concern?

This allows brokerages to continue renting out their prop accounts to traders who are looking for additional profits, especially after meeting the upfront-margin collection criteria. SEBI issued a circular on May 10, 2022 mandating advance collection of margin, thereby eliminating the possibility of brokerages providing additional profits to traders.

Renting prop accounts is an illegal arrangement and brokerages are known to charge anywhere between 6 percent to 12 percent on the leverage provided.

This business did so well that brokers set up elaborate pyramid-like structures to deliver this service. That is, a trader who is registered as a sub-broker will first rent access to the prop book. It will then 'sublet' its credit limit to other merchants for a merchant fee. Anecdotal evidence gathered from insiders suggests that these intermediary traders can even expect to earn a few crores of rupees per month through such arrangements.

While people have been conducting such trades from various locations without much scrutiny, there were other ways to escape the regulator's attention.

“You can do it with a simple app,” the brokerage executive said. The trader feeds the trades he wants to place into the app and they are sent to the brokerage, which then places these trades from its system. In this case, the app works somewhat like a simple messaging solution.

“The interval for such trades will only be around 35 microseconds to 40 microseconds,” said an industry insider, adding that these intervals don’t really matter much to such traders because their strategies are based on price or time. Are not sensitive.

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One way to check whether prop accounts are not being abused is to use Static IDs to track the locations from which their trades are made.

That is, whenever a person logs in to the Internet from any location, a static ID is generated. This ID holds information about the location from where the person is logging in. If the regulator tracks this and sees that trades are being made from venues that do not have approval, it will be a red flag.

It will also flag other illegal practices such as traders who act as fund managers for various brokerages. That is, traders who manage prop accounts also manage brokerage accounts for a fee.

This practice can also be detected using IP addresses if trades for different prop books appear to be made from the same location. Again, static IDs can help here.

Therefore, the easiest way to avoid this IP-driven situation of trades is with the RDP protocol. As an insider told Moneycontrol, these systems can be installed in a brokerage office for anywhere between Rs 50,000 to Rs 70,000 per system.

“You just need a regular system to access a remote computer.” There is a possibility,” the trader said, adding that the brokerage has also added it to the charges.

Then a trader who is renting a prop book can place his order from a remote system located in the broker's office. Therefore, the static ID from which trades are sent will only reflect the office location of the broker and not the location of the trader.