Brokers using HNI demat accounts to invest in bonds, non convertible debentures

MUMBAI: In 2005, some operators used multiple demat accounts to corner stocks earmarked for retail investors in the initial public offerings. A similar game is being played in the bond market these days. Some brokerages are borrowing the demat account and Permanent Account Number of affluent clients to make a quick buck in companies’ non convertible debentures (NCD) and tax-free bond issuances.

Companies usually follow a differentiated commission structure for such debt issuances: they offer brokers higher fee for retail investor applications than the non-retail ones. These brokers have taken advantage of this disparity in fee structures.

While this has been a cosy arrangement between brokers and select high net worth investors, it attained scale in the recent NCD issuance by Shriram Transport Finance. At least two large brokerages, a few distributors and financial advisors in Maharashtra and Gujarat and a merchant bank specialising in bonds are said to have managed to get HNI clients to lend their PAN and demat accounts for this, said two persons aware of the development.

The arrangement works in two legs: the broker or distributor approaches the HNI to invest, say, Rs 10 crore, in the NCD issue. If the investor says he is unable to commit such a big sum to one issue, the broker would ask him to bring in as much as he can, while offering to lend the rest. Even if the investor is unable to cough up any money, the brokers would offer to fund the entire application. Brokers either borrow this money from the market or use their own money to fund this arrangement.

For ‘renting’ the demat and PAN account, the broker offers the HNI a small fee, which could even be a fraction of the application amount. The funds transferred to the investor are marked on lien to ensure the brokers’ funding money is not misused. Shriram raised close to Rs 2,000 crore in the recent NCD offering. The brokers also have an exit strategy ready. Once the units in the NCD issue are allotted and listed, brokers sell them to wholesale buyers such as mutual funds and insurance companies.

The broker is able to do this thanks to the Power of Attorney secured from the client. For these institutional investors, the incentive to buy these units is that they are offered at a discount to the coupon rate. For instance, if a company has collected money from investors at a yield of 9.9%, the units would be sold to the funds at a higher yield of, say 10.05%. The institutional investors benefit because they get the units at a higher yield (lower price).

The higher fee the broker receives from the NCD issuer for bringing in the retail money more than compensates for the loss it incurs in offloading the securities to mutual funds and other wholesale investors at discount. Even after factoring in the losses, kickbacks to the HNI and other expenses, the broker makes more than double the fees it would receive for selling it to an institutional client. Sources said close to half of the applications handled by the brokerage mentioned in the recent Shriram NCD issue above were through this arrangement. Shriram Transport Finance was not available for comments.