Standard Operating Procedure (SOP) on default

When a trading member or clearing member starts showing warning signs of trouble, the exchange cannot afford to wait and see what happens next. SEBI has laid down exactly what stock exchanges, clearing corporations and depositories must do the moment those signals appear.

This sequence is the Standard Operating Procedure (SOP) on default. Its purpose is to protect the non-defaulting clients of the member showing warning signs — not to wait until an actual default has already happened.

Chapter 8, section 8.6, sets out the SOP:

• On receiving warning signals of a possible default by a trading member (TM) or clearing member (CM), exchanges, clearing corporations and depositories must act as laid down in the SOP to protect the interests of the non-defaulting clients of the TM.
• The Clearing Member of the TM is also required to take the actions the SOP lays down.
• As an interim measure, exchanges and clearing corporations must settle the credit balances of small investors — those with balances of less than Rs 25 lakh — first, using unencumbered deposits already available with them.
• Investors with credit balances exceeding Rs 25 lakh are paid on a pro-rata basis from whatever funds remain after the small investors are settled.

A trading member starts showing warning signs of financial stress. The exchange activates the SOP before any formal default is declared.

Among its clients: Investor A has a credit balance of Rs 18 lakh, and Investor B has a credit balance of Rs 40 lakh. Under the interim measure, Investor A — below the Rs 25 lakh threshold — is settled in full first, from the unencumbered deposits on hand. Investor B, above the threshold, is paid only a pro-rata share of whatever funds remain once every small investor like A has been paid.

Chapter 8, section 8.6, sets out the SOP on default, its purpose of protecting non-defaulting clients, and the Rs 25 lakh threshold that separates full settlement from pro-rata settlement. Expect a question naming the Rs 25 lakh threshold or asking who is paid first.

• Small investors (under Rs 25 lakh) are settled first, and in full — this is not a pro-rata split applied equally to everyone.
• Only investors above Rs 25 lakh face pro-rata payment, from the funds left over.
• The SOP is triggered by warning signals of a possible default, not only after a default is formally declared — it is meant to act early.
• This SOP is distinct from the separate SOP for handling stock exchange technical outages (section 8.7), which covers system disruptions, not member default.