Hedge Funds To Portfolio Managers Call New Margin Rules Operational Nightmare

Foreign corporate bodies, foreign individuals, hedge funds, domestic portfolio managers, alternative investment funds and non-bank lenders, together categorised as non-institutions, have seen transaction cost increase since the new rules kicked in.

Starting this month, the regulator banned pooling of client securities by brokers to prevent their misuse. This change followed after Karvy Stock Broking Ltd. allegedly transferred stocks of 95,000 clients to its own account illegally and then pledged these. Besides, all trades now require upfront margins before execution.

Prior to Sept. 1, for buy and sell transactions non-institutional investors had to provide instructions to custodians or clearing members to release the margin—or the minimum funds or securities to be provided to a broker to execute a trade—for trading in the cash market and derivatives, respectively. Until then, the broker was responsible for settling the trade.

The custodian or the clearing member had a day, or T+1, to confirm the trade; and payment or delivery happened on the second day after the trade or T+2.

From Sept. 1, non-institutions must provide upfront margin to the broker executing the trade. At the same time, they must instruct the custodian or the clearing member to block margin or shares for delivery. The custodian confirmation would happen only when they already have the money or securities with them.

Meaning, non-institutional investors now end up paying twice the margin at two different levels to execute the trade. As soon as the custodian confirms the trade to the exchange, which is now by evening of the transaction day, the bourse reverses the upfront payment.

But the requirement to provide margin at both ends at the time of the trade increases the cost of transaction, an exchange official told BloombergQuint.

Another problem is time, said a custodian who didn’t want to be named. From providing the confirmation on T+1 day, it has now been reduced to a few hours, he said, adding that they have to reconcile and confirm the trade and intimate the exchange within that window so that the margin paid earlier is reversed.

It is an operational nightmare, said another executive at an exchange on the condition of anonymity since the regulator is involved. A few representations have been made to find a solution, the executive said.

Asia Securities Industry and Financial Markets Association, a brokers’ lobby that manages trading for institutional and non-institutional investors, has also raised the issue with the regulator, according to one of exchange officials cited above.

ASIFMA spokesperson did not respond to BloombergQuint’s query. An emailed query to Securities and Exchange Board of India remained unanswered. The BSE declined to comment, while the NSE didn’t respond to an email.

Moreover, non-institutions contribute 5% of the total transactions on an overall trade basis, said another senior executive at a foreign brokerage providing custodian services on the condition of anonymity, indicating it is limited to a small class of investors. What increases the complexity is high volume of trades undertaken by non-institutional investors and the small time window to settle these transactions, he said.

Non-Institutions Vs Institutions

Qualified institutional buyers such as category-I foreign portfolio investors registered with SEBI, and domestic institutions including banks, insurance companies and mutual funds have been exempted from the upfront margin requirement. It’s only mandatory for non-institutional and retail investors.

QIBs are governed by regulators either in their home jurisdiction or SEBI, the Reserve Bank of India and the Insurance Regulatory and Development Authority of India.

These entities will rarely default on payments or delivery unlike other investors such as hedge funds, portfolio managers or alternate investment funds, said the custodian cited above. Moreover, he said, foreign mutual and pension funds don’t do leveraged trading, or trading on borrowed funds, while domestic institutions are not allowed to leverage their trades, he said.