There has been a lot of noise, especially from the broking fraternity, on SEBI’s proposal for traders and investors to maintain upfront margins even in the cash segment. Till now, clients needed to meet margin requirements in their accounts once at the end of the day. But, the new margin rules of SEBI will require them to fulfil their margin obligations before the execution of the deal.

Margins payable

Currently, investors or traders pay various margins. It is the total of the value at risk, famously known as VaR, extreme loss margin (ELM) and mark-to-market (MTM) in the cash segment, and SPAN (Standard Portfolio Analysis of Risk), MTM, exposure margin and ELM for derivatives.

VaR margin is calculated based on the liquidity of the stock. So, it varies from scrip to scrip. For instance, for stocks that are part of Group 1 (classified as liquid stocks), daily volatility (based on return) is calculated for each scrip using the exponentially weighted moving average methodology. The applicable daily VaR is 3.5 times the volatility or 7.5 per cent, whichever is higher.

For securities under Group II (less liquid securities), the VaR margin is the higher of the scrip VaR (3.5 times volatility) or three times the index VaR (calculated based on the index), and multiplied by 1.73 (i.e. root 3).For the securities listed in Group III (illiquid stocks), the VaR margin is equal to five times the index VaR, multiplied by 1.73 — this works out to 8.66 times the index VaR.

So, one has to pay at least 7.5 per cent as VaR on your trade.

Extreme loss margin is computed as 1.5 times the standard deviation (volatility) of daily logarithmic returns of the security price in the last six months. The computation will be done at the end of each month on a rolling basis for the past six months and the resulting value is applicable for the next month. However, ELM should be at least 5 per cent.

Mark-to-market loss is calculated by marking each transaction in the security to the closing price of the security at the end of trading.

SPAN and exposure margins

SPAN margin is calculated on a portfolio (a collection of futures and options positions) based approach. The SPAN margins are revised six times in a day — once at the beginning of the day, four times during market hours, and finally, at the end of the day. Higher the volatility, higher the margins. Besides SPAN, exchanges apply exposure margin on traders for Index options and Index futures contracts. It is 3 per cent of the notional value of a futures contract. In case of options, it is charged only on short positions and is 3 per cent of the notional value of open positions. For options and futures contracts of individual securities, it will be a minimum of 5 per cent or 1.5 standard deviation of the notional value of gross open position in futures on the individual security and gross short open positions in options on individual security, if it is higher.

Brokers’ fear

Brokers feel the new rule will significantly affect intraday trading activities that contribute almost 90 per cent of the total volume on the exchanges. According to market sources, currently, about 30-40 per cent of daily turnover depends on the additional margin extended by the broker. While on the one hand, it helps traders and investors to leverage with the broker’s loan, on the other, it helps the broker earn a steady income in the form of interest.

But under the new rule, clients will have to maintain a higher margin in their accounts to receive the same leverage amount as before and brokers would not be able to extend any higher-margin limit than prescribed. If the broker fails to collect the required margin, or the client fails to pay the required margin, clearing corporations will impose a penalty on the client.

The apparent aim of SEBI from this exercise is to check brokers from using margin money paid by one client for another and also to improve efficiency at brokerages levels.

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