Client risk categorisation
Also written Client risk categorization
Classifying each client as Low, Medium or High risk under SEBI's AML Master Circular, based on location, business activity, turnover, nature of transactions and manner of payment, so monitoring can match the risk.
In plain language
A broker cannot watch every client with equal intensity, and should not try. The SEBI Master Circular on Anti Money Laundering (AML) dated 15 October 2019, as summarised in Chapter 10, tells members to categorise clients as Low Risk, Medium Risk and High Risk based on due diligence or KYC documents.
The point is stated plainly: by classifying the clients under various risk categories, effective monitoring and due diligence can be applied to thwart any illegal/unlawful transactions. Attention goes where the risk is.
The workbook describes each category in behavioural terms. Low risk clients have a respectable social and financial standing, and their dealings are satisfactory, with timely payment and delivery. Medium risk clients generally indulge in speculative transactions in excess of their known sources of income. High risk clients have a history of default and a suspect financial status.
Categorisation is not a one-time label. The member keeps the ultimate responsibility for the KYC of its clients, with enhanced measures commensurate with each client's risk profile.
How it works
The parameters a member considers: location of the client, nature of business activity, volume and value of turnover, nature of transactions, and manner of payments.
The three categories (Chapter 10):
| Category | Workbook description |
|---|---|
| Low risk | Respectable social and financial standing; satisfactory dealings with timely payment and delivery |
| Medium risk | Speculative transactions in excess of known sources of income |
| High risk | History of default; financial status suspect |
Onboarding that needs enhanced due diligence and close monitoring:
- Non-face-to-face clients
- Clients with multiple accounts in similar names, or many accounts sharing partners, directors, promoters, address, email, telephone numbers or authorised signatory
- Unexplained transfers between such accounts
- Unusual activity compared with past transactions, and alternating use of different accounts
- Sudden activity in dormant accounts
The list is not exhaustive; the member must have a robust framework to identify high-risk clients who need enhanced due diligence.
The evidence behind it. For clients who opt to deal in the derivatives segment, the stock broker must hold documentary evidence of financial details — for example an ITR acknowledgement, annual accounts, salary slip or Form 16, a net-worth certificate, a bank statement for the last 6 months, or a demat holding statement. That is what makes it possible to tell whether trading is in excess of known income.
A worked example
Illustrative. The clients and figures are hypothetical; the categories and triggers are the workbook's.
A broker reviews three clients who trade USDINR futures:
| Client | Financial proof on file | Activity | Category |
|---|---|---|---|
| Arvind, salaried engineer | Form 16: income Rs 24 lakh | Hedges an annual overseas education payment; margins always paid on time from his own account | Low |
| Bhavna, self-employed | ITR: income Rs 6 lakh | Speculative positions with Rs 18 lakh of margin in a quarter | Medium |
| Chetan & Co. | Net-worth certificate two years old | Two past payment defaults; a new cheque has bounced | High |
Bhavna's arithmetic.
Margin deployed ÷ declared annual income = 18,00,000 ÷ 6,00,000 = 3 times
Trading funded at three times her known yearly income is exactly speculative transactions in excess of known sources of income.
A trigger for enhanced due diligence. A fourth account, dormant for two years, suddenly deposits Rs 9,50,000 and trades heavily; the broker then finds it shares an address and phone number with two other accounts. That combines two listed red flags — sudden activity in a dormant account and multiple accounts with common parameters — whatever the account's earlier category.
Why NISM asks about it
Chapter 10 (Codes of Conduct and Investor Protection Measures) sets out client risk categorisation under the SEBI AML Master Circular, the three categories, the parameters and the five situations needing enhanced due diligence, just after the list of financial documents required for derivatives clients and before the KRA requirements. Expect a question matching a client description to Low, Medium or High risk, and one asking which situations call for enhanced due diligence.
Common exam traps
- Three categories: Low, Medium, High — no fourth.
- Medium risk = speculative trading beyond known sources of income. High risk = history of default and suspect finances. The two are easy to swap.
- Parameters include manner of payment and location, not only turnover.
- Non-face-to-face clients head the enhanced due diligence list.
- Sudden activity in a dormant account is a named trigger — even if the client was previously low risk.
- The list is not exhaustive; the member must build its own robust framework.
- The member keeps ultimate responsibility for KYC, even when the KYC data comes from a KRA.
Where this is taught
Free preparation for NISM Series IVRelated terms
- Enhanced Due DiligenceThe additional customer due diligence a Regulated Entity must perform where ML/TF risk is high — including source of wealth, Senior Management approval and enhanced ongoing monitoring.
- Money launderingTurning the proceeds of a crime into money that looks legitimate — classically in three stages, placement, layering and integration — and a standalone offence under section 3 of the PMLA.
- Client Due DiligenceScreening and verifying a client using reliable, independent sources — identity, beneficial owner, purpose of the relationship — and then continuing to scrutinise it for as long as it lasts.
- Suspicious Transaction ReportA report a SEBI intermediary must file with FIU-IND within 7 days of concluding that a transaction or connected series of transactions is suspicious — and must never disclose to the client.
- Know Your CustomerThe identity and address check every investor must clear before a bank, broker or depository participant will open an account — mandatory under the Prevention of Money Laundering Act, 2002.
- Risk Based ApproachApplying each due diligence measure in proportion to the money-laundering risk a client poses — enhanced diligence for higher-risk clients, simplified for lower-risk, never simplified where suspicion exists.