SEBI’S NEW FRAMEWORK ON MARGIN COLLECTION
Updated: Jul 23
Before we look at the new norms, let us first begin with understanding what a margin is. Simply put, a margin is the collateral that the holder of a financial instrument has to deposit with the broker. Margin buying refers to the buying of securities with cash borrowed from a broker, using other securities as collateral. This has the effect of magnifying any profit or loss made on the securities. They are calculated as a percentage of a trader’s total exposure in the market, which rises and falls with the prices in the market.
For example, a 20% margin requirement means by depositing Rs 20 lakh with the broker, the trader’s total market exposure could be up to Rs 1 crore. The purpose of minimum margin requirement is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan.
About the new SEBI framework:
The Securities and Exchange Board of India on 20th July 2020, released a new framework on upfront margins to streamline the risk of both cash and derivative segments. Currently, the rule of bringing in the entire upfront margins is only applicable to the derivatives segment.
The new framework will come into effect from December 1, 2020. The regulator in its circular has asked the brokers to collect upfront margins even for trading in the equity cash segment. These include the VaR Margin which is a margin intended to cover the largest loss that can be encountered on 99% of the days (99% Value at Risk) and the Extreme Loss Margin (ELM) which covers the expected loss in situations that go beyond those envisaged in the 99% value at risk estimates used in the VaR margin.
The clearing corporations are required to send at least four snapshots of client wise margin requirement to the trading member (TM) or clearing member (CM) for them to know the intra-day margin requirement per client in each segment. For commodity derivatives segment, SEBI said the last snapshot for commodity derivatives will be generated at 5 PM. The client wise margin file provided by the clearing corporations to trading or clearing member will contain the end of the day (EOD) margin requirements of the client as well as the peak margin requirement of the client, across each of the intra-day snapshots.
With regards to penalty, SEBI said higher of the shortfall in collection of the margin obligations at the two (Peak and EOD) will be considered for levying of fine.
SEBI stated that the peak margin obligation of the client across all snapshots will be adopted in a phased manner. For three months from the date of implementation, SEBI said 25 per cent of peak margin obligation of the client across the snapshots will be compared with respective client peak margin available with the TM/CM during the day. This will be 50% for subsequent three months and thereafter 75% for subsequent three months and finally 100%.
During the period of phased adoption, the member should be able to demonstrate that the balance peak margin obligation (1 minus 25/50/75%) should be funded by the member’s own funds and not from the funds of any other client.
In the current margin system, traders get an additional leverage intra-day because the margins are only required to be met at the end of the day. To give a perspective, the new norms can curtail as much as 50% on the leverage offered intra-day on stocks like Infosys, a source stated, failing which a broker can be levied a fine.
According to estimates, one third of the intra-day turnover is attributed to the additional leverage that is provided by the brokers. The total turnover is expected to fall by a staggering 20% following implementation. This also implies less liquidity, lesser volumes and in turn, an approximate 20% fall in broker revenues.
On the brighter side, however, with stricter checks on the margin systems, using one client’s margin for another client’s purpose will be curtailed and misuse of client securities as was the case in Karvy scandal will reduce.
Finally,as mentioned earlier, margins not only magnify profits but also magnify losses, and this has held especially true in the case of retail investors/ traders. So, an upfront margin is seen as an attempt to incorporate more prudence thus avoiding heavy cash burnouts.