What if i Receive Dividend on Collateral Stocks? (2024)

One of the popular ways of trading in the stock markets is by using stock as collateral margin. You can take a position in the market, more than you can afford with your current cash resources and get the position margin funded. Even the margin, you can give in the form of collateral shares rather than paying in cash. This is called offering shares as collateral or just pledging of shares.

What happens if the company pays dividends in the interim. Nowadays, most large companies pay interim dividends 3 to 4 times a year. You may have pledged shares and are entitled to receive dividends on pledged shares or dividends on collateral shares as they are also known. The question then is what happens to dividends on pledged shares? Does the dividend on collateral shares come to you or to the bank / NBFCs to whom the shares are pledged?

The answer to this question is quite clear. Dividends on collateral shares or dividends on pledged shares have to come to you. In case, the shares are still in your Demat account with just a pledge marked at NSDL / CDSL, there is no problem. The dividends will automatically come to you. However, in case there has been a movement of pledged shares from your Demat account to the financer’s Demat account then it is the job of the financer/broker who is syndicating the financing to ensure that the dividends are rightfully paid to you. to understand this aspect of dividend on collateral shares and dividend on pledged shares better, you need to understand the old and the new system of pledging.

Dividend on Pledged Shares

To understand the current pledging system, we need to understand that there was an old system of pledging that existed before 01 August 2020 and a new pledge system that now exists after that date. Let us look at the old system first. When you trade with your broker, you are statutorily required to maintain margins for your trades. That is defined by SEBI and there is no leeway on that. Now, these margins can be either in the form of cash or in the form of collateral pledging of stocks. While cash margins are easily understood, how did stock collateral margins work? Before 01 August 2020, whenever a client wanted to pledge stocks to obtain margins on collateral, these stocks had to be transferred from the client Demat account to the broker Demat account. Then the broker would pledge these very shares on behalf of the client with the clearing corporation of the stock exchange and get limits for the client.

The shortcoming in the old system was that there was an unnecessary movement of securities from the client Demat account to the broker Demat account. Since the shares were transferred, the title would also be transferred. Hence any corporate actions with a record date falling during the period of the pledge would accrue to the broker Demat account and not to the client Demat account. This was a major flat in the system as it opened up the entire system to misuse as we saw in several cases of brokers misusing the dividends that rightfully belonged to the client. Ideally, under the old system, the broker was obliged to transfer any dividends received during the interim period to the client's bank account. However, in practice, it was skipped if the client did not insist and follow up in the case of many brokers. This is the flaw that was largely addressed by the new system.

How the new pledge system makes dividend payment easier

Let us now turn to how the new pledge system is different from the dividend payment perspective. Under the new pledge system, the stocks will not leave the investor’s Demat account at all. Instead, there will be a pledge marked in favor of the broker but the shares will continue to remain in the Demat account of the client only. Under the new regulations stipulated by SEBI, the broker is required to open a separate Demat account labeled ‘TMCM – Client Securities Margin Pledge Account’ for this very specific purpose.

The TMCM refers to the trading member and clearing member for the transaction. The broker will just re-pledge these securities in favor of the Clearing Corporation and obtains margins. Hence, in this case, there is no question of how the dividend will be paid because the shares are not leaving the client Demat account at all. Since the shares will, therefore, be in the client's name on the record date, the dividends will automatically get credited to the mandated bank account of the client. That simplifies the process substantially.

In short, no misuse is just one of the benefits of the new pledging system. The other big benefit is that all corporate actions are automatically credited directly to the client account since the shares are only marked as pledged and not transferred. Therefore, in the new pledge system in existence from 01 August 2020, there is no question of the stocks being held in the broker’s collateral account. As a result, it is the client, not the broker, who is the recipient of all cash and non-cash corporate actions like dividends, bonuses, rights, etc. In the old system, the broker was required to voluntarily transfer these benefits to the investor, and many investors who were not so well informed missed out on claiming such credits if the broker did not do it voluntarily. In the new pledge system, that risk is obviated.

Other Corporate Actions on Pledged Shares

As stated earlier, in the new system of pledging, the shares never leave the Demat account of the client but are just marked as pledged. Hence dividends and all other corporate actions automatically accrue directly to the client since their name would now appear on the register of members on the record date.

What is Pledging of Shares?

Pledging is offering shares as collateral to raise a loan or to do margin trading by using the value of the pledged shares as collateral.