After a meeting with brokers, depositories and clearing corporations on Monday, the capital market regulator Securities and Exchange Board of India (SEBI) decided to go ahead with its new margin pledge rules from September 1, 2020.
What are the new margin pledge rules?
Under the framework, trading members or clearing members will be required to align their systems and accept client collateral and margin-funded stocks by way of creation of pledge and re-pledge in the depository system.
Depositories should provide "margin pledge" for pledging clients' securities as margin to the trading members or clearing members. The latter should open a separate demat account for accepting such margin pledge, which should be tagged as "client securities margin pledge account".
SEBI has introduced these measures to safeguard the interest of all investors and wants to have a higher degree of transparency in the stock market.
What are pledging and margin?
Margin is the amount a stockbroker’s client has to deposit with the broker before doing a trade.
Pledging refers to using stocks as securities to avail a loan. Traders in the futures and options (F&O) segment use pledging to receive margin funding from the broker to invest in large deals to earn maximum returns in a short time.
A popular tool worldwide, margin allows investors to leverage, invest in deals without assuming the full risk at the first stage. When you pledge, your risk exposure gets limited to the securities you have used as collateral. In case you can’t repay the margin, the broker sells the stocks to recover the debt.
The broker is the custodian of securities or funds in the margin account but there have been complaints of misuse. Some brokers were found guilty of misusing client funds and collaterals. The new margin pledge policy will help to address this problem.
How will margins change after implementation of the new rule?
Under the existing system, investors don’t have to pay upfront margin in the cash segment as cash margins are looked after by the broker. SEBI wants to implement it in the cash segment, too.
From September 1, brokers will have to collect margin from investors upfront for buying and selling securities. Failing to do so will attract a penalty. The securities in the demat account will not automatically become available to receive margins. The broker also has to report to the exchange the margins collected from investors.
Why is the stock market worried?
Traditional brokerages with legacy systems will face huge operational challenges that can cause chaos and unintended consequences in the near future. Also because the big traders cannot rapidly buy and sell shares through the day without having a certain amount blocked towards margin commitments. An even trickier rule that comes into effect from September 1 is that brokers will be penalized if they are found to be not collecting margins from their clients before the trade is done.
Were there irregularities in collection of margin?
At times, brokers could give some leeway to the clients they could trust. From September onwards, SEBI will be monitoring collection of margins by brokers from clients.
Big traders park their money in liquid funds, and any request for redemption is honoured only on the morning of the following day. Often brokers would fund the margins commitments of their large clients till the time the clients got their funds.
That is no longer possible. Because the stock exchange will have the details of the clients’ trades, and brokers will have to give proof of the margin collected from the clients.
To pay margins on time, the traders will now have to keep the money in their current accounts or with the brokers. That means they will lose on the interest they were earning by keeping the money in liquid funds
Will this have an impact on prices?
Market experts fear that initially volatility could increase if big traders cut back on their trading. High volume traders are key to providing liquidity in the market as they frequently buy and sell big blocks of shares. Higher the liquidity, less will be the impact cost for institutional investors. Meaning, institutional investors will be able to buy and sell large blocks of shares without the price deviating too much from the time they put in their order.
For instance, if there is not enough volumes in a stock, the market will quickly sense if a buyer wants to buy a big block of shares or a seller wants to sell a big block of shares. This will result in the big buyer or seller getting a poor price for their trade.