The Hindu Business Line : When the market almost fell off the margin

With the market going into another tailspin, margin calls are under the scanner again. Some blame the broker-client nexus, while others point a finger at the banking system or the taxman. Whatever the real reason, strengthening the existing stock-lending mechanisms is the key to the health of the bourses, says D. MURALI.

PRAYING FOR deliverance? — Paul Noronha

Call it Black Monday or whatever, but the cuts and bruises inflicted on the market on May 22 are still too raw to turn black. "I must tell you friendly in your ear, sell when you can," tells Rosalind to Phoebe, in As You Like It. "You are not for all markets."

Monday, though, was not a day for friendly whispers. And everything that fell on the ears of traders sounded only ominous, whether the messages came in the form of assurances from those in authority, or contrived counsel from the Finance Minister, Mr P. Chidambaram. It was not a case of `sell when you can', as Rosalind says, but `run as you must', as always happens in panic situations, when the index plunged like a bungee-jumper. So much so, trading had to be halted with circuit breakers giving way.

Excitement was evident in the news reports that poured in. The market, therefore, tanked, slid, crashed, slipped into red, fell and tumbled. And all the synonyms of panic, such as fear, apprehension and alarm, added the necessary drama to news copies. To the angry, Mr Chidambaram became the favourite whipping boy. For instance, the CITU held him `responsible for the Sensex crash', and the BJP wished that he be gagged from making daily statements about the market.

Meanwhile, analysts are busy scribbling all over their worksheets to figure out the new P/Es, and fund managers are re-jigging their portfolios. Public sector financial institutions, perhaps like lambs to slaughter, are meekly obeying the diktats of their big boss, while small investors are nursing their wounds.

Not just a correction

To call the happenings of May 22 a `correction' would be as euphemistic as to label a large-scale massacre an `incident'. Which is why it may be tactless to say that the market has experienced a `healthy correction', especially to someone who has been hit by the recent tectonic shifts in the bourses.

So, too, the losers may not be amused to know that foreign institutional investors (FIIs) view the market's Humpty-Dumpty behaviour as normal adjustment; in fact, one learns that these biggies are waiting for the market to become `attractive' after a 10-20 per cent tweaking, on the minus side.

"What has happened is a certain amount of nervousness in the market. My advice to retail investors is to stay in the market," said the Finance Minister. Only, the cajoling did not seem to have much effect, because of several overpowering reasons — such as the `margin call'. The phrase means "a broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin," explains www.investopedia.com.

Pressure on brokerages

One of the reasons that Mr Chidambaram cited for the sharp fall was `the pressure on brokerages to sell because of margin calls,' as Associated Press reported on www.mercurynews.com in a story dated May 22. "A margin call is a demand made by a broker to an investor if the securities he bought with borrowed money fall in value beyond a certain point. The investor is either forced to deposit more money in the account or sell off some of his assets to meet the shortfall," explained the story, for those on the margin.

"According to experts the crash has occurred due to the vicious circle of margin call," postulated http://news.moneycontrol.com on Monday. It also quoted Mr Chidambaram as assuring that the fundamentals of the economy are sound, that margin pressure was expected, and that banks would give funds to meet margin calls.

"Normally, to buy and sell shares, you need to have the money to pay for your purchase, and shares in your demat account to deliver for your sale," explains http://content.icicidirect.com, in a page on the `concept of margin trading'. For novices, it may help to know how the system operates, through an example.

Margin trading

"Suppose you have Rs 1,00,000 with you in your bank account. You can use this amount to buy 10 shares of Infosys Ltd at Rs 10,000. In the normal course, you will pay the exchange for the shares on the settlement day and receive 10 shares from the exchange, which will get credited to your demat account," instructs the site.

The alternative is to use this money as `margin'. What happens then? Suppose the applicable margin rate is 25 per cent.

Your leverage is a factor of 4, since margin, as a percentage of the value of the transaction, is 25 per cent. Which means, you can now buy 40 Infy shares at Rs 10,000, for Rs 4 lakh. Obviously, since you don't have the money to take delivery of that many shares, "you have to cover (square) your purchase transaction by placing a sell order by end of the settlement cycle."

The trade is thus `squared off before the settlement cycle is over' and `there is no need to borrow money or shares', thus making margin `a leveraged position at the beginning of the settlement cycle.'

Looks catchy, but when margin trading facility was introduced in the Indian bourses from April 1, 2004, it did not become an instant hit. Even three months after its launch, financing of margin trading on the NSE was at Rs 16 crore, and on the BSE, a mere Rs 5 crore, because of many deterrents posed by the guidelines.

"Margin trading is an elegant mechanism through which modest levels of leverage are provided for users of the equity market with very high levels of safety," wrote Ajay Shah and Susan Thomas in a paper titled `Policy issues in India's capital markets in 2000 AD'.

Their suggestions to make margin trading a success in India included elimination or greatly enlarging of the limits on bank loans against shares as collateral and strengthening the existing stock-lending mechanisms.

Strict norms

The Reserve Bank of India has in place strict norms for banks financing margin trading. Banks are required to disclose the total finance extended for margin trading in the `notes on account' to their balance sheets. However, since this happens only at the end of the year, one may never know how much chipping-in banks were doing today, at the behest of the Finance Minister, to arrest the index fall.

On its part, the SEBI has norms, including that corporate brokers with a net worth of at least Rs 3 crore are eligible for providing margin-trading facility to their clients, subject to their entering into an agreement to that effect.

This is not the first time that margin calls have come under focus. Last week, too, when the charts went on a tailspin, badly mangling the Sensex, the reason was traced to brokers asking their clients to choose between squaring off their positions and paying up the margin.

Remember that when a broker is not able to pay the margin, the NSE has the power to throw the trading terminal off the hook, and also sell the shares in the broker's account.

Some blame the banking system for the time lost between depositing cheques and having the effects cleared; that could be an infrastructure issue to address.

Others point a finger at the taxman for the jitters that came in the form of draft instructions. In response, the Government may be quick to come up with the idea of an enquiry committee, as a typical knee-jerk reaction or a confidence-building measure.

However, it is only when the charts hit the screens tomorrow that we will know whether today's reasons still hold good.

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