Personal Finance

How new margin rules impact you

Akhil Nallamuthu | Updated on September 20, 2020

Investor safety is the focal point of SEBI’s new norms, but they make operations more complex

The Securities and Exchange Board of India (SEBI) has mandated upfront collection of margins in cash segment, like in the derivatives segment, and brought about changes in the way securities are being taken as margins.

In a circular issued last week, SEBI clarified that the upfront margin requirement includes ‘other margins’ in addition to value-at-risk (VaR) margin and extreme loss margin (ELM).

This means the applicable margin rate can at times be more than the 20 per cent that was announced earlier, depending on the security and its volatility.

And if investors opt to satisfy the margin obligation by offering securities they own, they should be pledged beforehand for expanded margin limit.

Upfront margins

Upfront margins are the minimum amount of fund or securities required to initiate a trade.

Now, the regulator has clarified that brokers should collect total margin upfront, ie, VaR, ELM plus other margins wherever applicable to penalties. Margin requirement can vary for each stock.

Consider this example. The applicable margin rate for the stock of HDFC Bank is 17.2 per cent (VaR 13.7 per cent, ELM 3.5 per cent, other margin is zero), whereas for the stock of Indiabulls Housing Finance, it is 61.5 per cent (VaR 43 per cent, ELM 3.5 per cent, other margin 15 per cent).

In the above scenario, even though the applicable margin rate for the stock of HDFC Bank is 17.2 per cent, investors should maintain 20 per cent if they wish to trade, ie, the margin obligation for the investor for a trade worth ₹1 lakh is ₹20,000. In the case of the Indiabulls stock, the required margin to execute a trade worth ₹1 lakh is 61.5 per cent, ie, ₹61,500.

In addition to the above, is the MTM (mark-to-market) margin, ie, margin to compensate unrealised loss, if any.

Margin pledge

Not only cash, investors can offer securities to fulfil the margin requirements. But under the new ‘margin pledge’ system, the limits will be increased only after the securities are pledged.

In the earlier system, prior pledging was not required.

The securities held by investors in their demat account were considered as margin by default, against which fresh trades could be executed.

Here, the brokers used the power of attorney (PoA) to move the shares as collateral from client demat account to their own demat account through title transfer.

The entire process was seamless and happened in the backend without the investor having to involve in the process. In the new system, in order to get additional margin against the securities they hold, the process should be initiated by investors through their demat account.

For instance, assume that an investor has funds worth ₹1 lakh and stock holdings worth ₹1 lakh in her demat account. Suppose if this investor wishes to initiate a trade which required an upfront margin of ₹1.5 lakh, in the earlier system — the trade will be executed as the broker will provide the margin by taking stocks worth ₹50,000 as collateral.

The whole process was done automatically. This has changed now. If the same investor wishes to execute a trade worth ₹1.5 lakh, the investor should pledge the shares worth ₹50,000 and enhance her limits to ₹1.5 lakh before initiating the trade.

Else, the new trade will not be executed.

Pledging process

Unlike in the earlier system wherein the pledging was initiated by brokers, the process is now initiated from the investor-end. That is, if an investor wishes to pledge securities to enhance the margin limit, it should be initiated from their own demat account. The investor will receive instructions from the depository (CDSL or NSDL).

Verification is done by following the instructions received, and the request for approval of pledging is made through an OTP (one-time password) verification.

If successful, the securities will be pledged, against which the investor will receive the additional margin facility. This margin can be used in cash as well as derivatives segment. Leading depository Central Depository Services (India) Ltd (CDSL) recently reduced the charges for margin pledge and unpledge. It has been reduced from ₹12 to ₹5 per request made by investors.

This cost, however small it may be, is additional burden for the market participants who opts to meet margin requirements by pledging.

Pros and cons

The upfront margin requirement rules will mean investors will now have to bring in more capital or increase margin limit for the same amount of transaction. This essentially brings down the return on investment.

And whenever the applicable margin rate is increased, investors will be required to provide additional funds or securities to satisfy the increased margin obligation.

However, more capital or margin requirement means lesser leverage and less room for over-trading, possibly bringing down losses and transaction costs.

Coming to the new pledging system, investor will have a greater control over leverage and can become more disciplined as prior planning of margin is required. And importantly, the prohibition of transfer of securities out of the investor demat account means there is no way of misuse which has been at the heart of the Karvy debacle.

Operational complexity has gone up as the investor need to follow certain procedures before the requested additional margin is made available. This can take time, and market participants looking for short-term opportunities might miss out on the trend.

And of course, there is a cost for pledging.

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Published on September 20, 2020
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