Personal Finance

Will upfront margins hurt investors?

Lokeshwarri SK | Updated on January 12, 2020 Published on January 12, 2020

No. But it turns the heat on brokers and intra-day traders in derivatives

There was a buzz created recently following the fresh guidelines on margin collections and reporting by stock brokers in the cash segment.

These rules, released on December 31, 2019, were perceived adversary by many stock brokers, who approached the Securities and Exchanges Board of India (SEBI) to review the rules. But the regulator has not yet agreed to backtrack on this.

The rules are primarily intended at the cash segment, since the need to deposit upfront margins is already prevalent in the derivative segment.

But the new guidelines have caused problems for intra-day traders in the derivative segment as well.

Such traders were so far allowed to trade without depositing upfront VaR (Value at Risk) and ELM (Extreme Loss Margin) by brokers since the margin status was being reported only towards the end of the day.

With the need for upfront margins for intra-day derivative trades, many traders are likely to be affected.

The impact on the cash segment is, however, likely to be limited since most traders use futures and options for intra-day trades.

The change

The guideline, issued by NSE, follows a directive issued by the SEBI on November 19, 2019.

The regulator has been worried that brokers are not collecting adequate margin from clients.

Besides, the recent Karvy episode has brought to the fore the issue of mismanagement of client securities and funds by some brokers.

The SEBI circular seeks to tighten the rules governing collection of trading margins from clients in the cash segment, and imposes penalties on brokers/clearing members for not following the rules.

Henceforth, brokers and clearing members have to compulsorily collect VaR margins and ELM from their clients upfront, before executing a transaction.

The extent of these margins vary according to the volatility in a scrip, but could be at least 12.5 per cent.

Other margins such as the mark-to-market (MTM) margin and special/additional margin shall be collected within the settlement cycle (T+2).

Upfront margins need not be collected in case of institutional clients or where the securities have been deposited with the brokers prior to the execution of the transaction. MTM margin need not be collected if adequate initial margins have been collected.

This requirement is seen as restricting the extent of leverage a trader can enjoy, with the leverage getting capped at eight times.

Onus on stock brokers

It’s obvious that brokers will have a tough time complying with these rules. Many brokers had been allowing their clients a leverage of up to 20 times on their margins to trade in the cash segment.

Further collection of upfront margins were not being followed strictly for intra-day derivative trades.

But brokers have now been told to report to exchanges about the actual collection, short collection or non-collection of margins in a prescribed format on the T+5th day. There are penalties for collecting inadequate margins or non-collection. False reporting can attract punitive actions.

The fine on brokers can be up to 100 per cent of such false/incorrect/non-reported amount of margin and/or suspension of trading for appropriate number of days.

While brokers and intra-day traders in derivatives are likely to face the heat, you may not be impacted too much if you are an investor who intends to take delivery of the shares purchased.

You will have to ensure that there is adequate amount in your trading account, to account for the VaR and ELM, prior to executing the transaction.

The remaining funds can be transferred within two days. Else you can use collaterals already with the broker to manage the upfront margins on your cash purchases.

As a retail investor, if you want to sell a share that was held for a long time, you are likely to have these shares in your demat account.

All you have to do is make an early pay-in of the shares, that is transfer the shares from your demat account to the broker, before executing the sale. In this case, you will not have to pay the VaR margin or the ELM.

If the broker is also a depository participant, and if the client has given the power of attorney (PoA) to the broker to transfer the securities in the client account for margin purpose, such securities can be allowed as collateral.

Similarly, funds in client bank accounts for which the power of attorney has been given to the broker can be utilised for margin purpose.

Impact on traders

If you trade intra-day in the derivative or the cash segment, you will have to ensure that you have deposited an adequate margin with the stock broker before executing any transaction.

The margins can be in the form of fund balances with the broker, across segments including commodities, bank guarantee in favour of the broker or clearing corporation, actively traded stocks or units of MFs in demat accounts, G-Secs and Treasury Bills, with appropriate hair-cuts.

Securities and funds for which a PoA has been given to the broker can be used as collateral for upfront margins.

Traders who were able to trade in futures and options without depositing upfront margins, due to the leeway provided by their broker, will be hurt.

Check margin statement

Your broker has to send you a daily margin statement, which will be issued by the end of the trading day. Do monitor this closely.

The margin statement will include client code and name, trade day, margin deposit available for the client on day T (with break-up in terms of cash, fixed deposit receipts, bank guarantees and securities).

The statement should show you margin adjustments (including MTM losses) for day T after adjusting MTM profit, if any.

The margin status, indicating if there is any balance available with the member or if any margin is due from the client, will also be shown in the statement.

Published on January 12, 2020
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