Call it the perils of a heated stock market rally, but the National Stock Exchange (NSE) has warned stock brokers against indulging in dubious ways of funding the ‘leverage hungry’ stock market traders.
Margins, which is initial money required for derivatives trading or even intra-day cash segment play, was hiked substantially from December last year. Piggy-backing on the recent market-mania, many stockbrokers act as conduits to arrange for higher leverage to fund their clients. The NSE believes this is illegal.
High-value margin funding
Often stock brokers facilitate the high-value margin funding deals between a non-banking finance company (NBFC) and a trader. Since brokers have an ongoing relationship with NBFCs, they act as guarantors to the client and the lender’s financing deal. Several large brokers have NBFCs as their subsidiaries, which makes financing easy. Many private bank-backed brokers and NBFCs are offering huge finances to high net-worth individuals.
“Trading members (brokers) will not entertain any instructions to trade in securities or transfer funds or securities, from any entity other than the clients, by prior arrangement or otherwise to facilitate financing of clients’ transactions or margin requirements in respect of the transactions. Any financing arrangement with a general authorization by the clients are not permitted,” the NSE said in its circular to brokers.
Warning against rules violation
The NSE said it had recently noticed that to fund clients’ peak margin requirement, brokers have entered into arrangements with NBFCs for facilitating loan/credit facilities to the clients by NBFCs, which were a violation of market rules.
NSE has also warned brokers against “financing or act as a conduit or front for financing any secondary market transactions, or margin requirements in respect of the transactions entered into by their clients, directly or indirectly except under the regulatory provisions of Margin Trading Facility and Securities Lending and Borrowing.”
The NSE has also said that brokers should not be party to any agreement directly or indirectly, entered into between their clients and any person including their subsidiary / holding company or group or associate company, to fund any secondary market transactions or margin requirements in respect of transactions executed on behalf of their clients or give recognition to any such agreements or arrangement entered by their clients.
The problem with such deals is that risk management goes for a toss. Recently, it came to light that a broker with a net worth of ₹20 crore had defaults worth nearly ₹150 crore, which was due to margin financing deals. More than two dozen stockbrokers have defaulted over the past couple of years, and several others are in the pipeline.
Brokers estimate that roughly more than ₹15,000 crore (over $2 billion) worth of such financing deals could be outstanding as on date given the huge amount of derivative positions. Futures position worth more than ₹25,000 crore (over $ 6 billion) is currently outstanding in index derivatives and more than ₹1 lakh crore (over $ 15 billion) in stock futures segment. New peak margin collections everyday are based on ‘peak’ theory. This has increased margin requirement, which in some cases could even be higher than 50 per cent, brokers said.
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