Upfront margins: Know your transaction maths

KS Badri Narayanan | Updated on September 11, 2020 Published on September 11, 2020

Early pay-in, enough margin could help trade smoothly

A good 10 days have gone by after the rollout of the SEBI-imposed new margin system. After initial hiccups in pay-in settlement, things seem to be settling down though some brokers and clients are still upset and complaining.

For selling

According to SEBI's new rules that bring the cash market on par with the derivatives segment, clients selling their shares in the cash market now need to fork out an upfront margin too. The logic behind the upfront margin for selling shares is that the regulator wants the seller to honour the commitment that he or she will deliver the shares within the settlement cycle. Under this system, brokerages are required to collect a system-generated margin for scrips upfront from clients that approximately works out to about 20 per cent of the deal value.

Exchanges, therefore, send system-generated details of the margins required for sell positions taken by their clients (SPAN + Exposure) to all brokerages on daily basis. In turn, brokerages are required to upload details of margins available in the client’s account; if the required margin is not available in the client account, a penalty is levied on the shortfall.

Earlier, brokerages invoked the power of attorney given by clients on their shares and used them to fulfil margin requirements by pledging their shares. This practice left clients open to fraud. SEBI has now disallowed brokerage firms from pledging client securities to any third party by invoking such PoAs. Therefore, pledging has to be done only by the client directly, wherein funds from pledge get credited directly to the client’s bank account. The idea is to ensure that client securities are not misused by the brokerages to do transactions for themselves or for some other close clients.

Early pay-in

Some brokers, however, continue to lure clients to create pledges on the existing shares so that they can do seamless buying and selling. According to market sources, already brokers have wooed a lot of traders to create a pledge in their favour and succeeded too to some extent, which is against the fundamental principle of the new rules. If one wants to avoid paying upfront margin, the client can sell the whole shares, marking it as a early pay-in. In this case, instead of T+2 settlement, the stocks would be debited in the clients account immediately and will be sent for delivery to depositories and custodians. However, the sale proceeds will come back to the client on T+2 basis only.

Clients now urge that at least for early pay-in transactions where shares are already debited from their account, they must be made eligible to buy new shares using the proceeds as margin.

As the system has already encashed their holding, there will not be any default risk and hence they should be allowed to use the proceeds as margin immediately for further purchases.

For buying

Similarly for buying, one has to pay upfront margins plus broking and other transaction charges to the brokerage. For those who wish to time the market, this mechanism will create a lot of pressure and risk as they will have to park their full amount with the brokerages. Some investors suggest that SEBI can instead insist on a ASBA type of mechanism, wherein the amount can be blocked in clients accounts until he or she wants to buy the shares.

ASBA or Applications Supported by Blocked Amount is the process currently applicable to IPOs, rights issue, FPOs etc wherein the IPO applicant's bank account does not get debited until shares are allotted to them. Similarly, the amount given to brokerages can be blocked till the actual purchase instruction is given. Or even better, brokerges can be asked to go for tie-ups with banks to do secondary market transactions through the ASBA mechanism.

Given the current situation, it’s best to either keep a certain amount of cash credit in your account or pledge a certain amount of shares in order to do seamless buying and selling.

As the intention of SEBI is to save gullible investors from unscrupulous brokerages, a further fine-tuning of the new rules will benefit all stakeholders.

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Published on September 11, 2020
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