BQ Explains | How SEBI’s New Margin Trading Rules Impact Investors
A new set of rules on margin trading came into effect on Sept. 1, aiming to bring transparency and prevent misuse of clients’ shares by brokers. This comes after market regulator SEBI banned the transfer of clients’ securities to demat accounts of trading and clearing members in February this year, following the Karvy Stock Broking Ltd. crisis.
BloombergQuint spoke to Prakarsh Gagdani, chief executive officer of 5Paisa.com; and Ashish Rathi, whole time director at HDFC Securities; to best understand the new regulations and how it changes life for the regular stock broker and investor.
1) What’s The New Margin Trading Rule?
So far if a client was buying shares, she would have to pay an upfront cash margin or pledge shares to cover the margin. The same applied to sale of shares, unless done as part of early pay-in.
Earlier, a client would give a power of attorney (authorisation) to the broker to use the client’s existing shareholdings to access margin for derivative trades. This led to some brokers pooling securities across clients, using one client’s assets as margin collateral for another client who was likely short of funds.
This went on till the Karvy Stock Broking Ltd. incident came into light where investments of 95,000 clients were illegally transferred by the broker to its own account and pledged without any authorisation. Immediately after, the Securities and Exchange Board of India banned pooling of securities and directed brokers to keep separate accounts for all clients.
The new margin rules are an extension of those changes that take away the need for separate accounts with the broker and mandates that the client’s trades be carried out directly with the Clearing Corporation from his/her own demat account.
It requires clients to pledge some of their shares, and use those as collateral to make trades in the market. It also brings in stricter regulations to minimise risk of fraud. This brings us to the second question.
2) What Are The Changes Under The New Rule?
- A trade can be carried out only against pledged shares or cash. Moreover, these shares have to be present in the client’s demat or trading account and cannot be with the broker.
- The client needs to authorise individual pledge requests using one-time-passwords sent to them by the clearing corporation, to ensure transparency, Gagdani said. The stock broker will re-pledge the shares with the clearing corporation for margin benefit.
- The pledged shares will remain in the client’s demat account, marked so.
- A client has to wait for a transaction to get settled (T+2 days) before using the proceeds from it, unlike before when the notional proceeds could be used as margin for a new trade instantly.
- Intraday profit can also not be used to enter new trades.
- Sale proceeds from holdings can be used to take new positions only after early pay-in.
- Option sell credit can be used only to buy options on the same trading day i.e you can exit a buy option and enter into fresh buy option the same day but cannot sell an option till T+1.
- Only 60% of the value of BTST trades sold will be available to take new positions in F&O
“For a customer who was doing seamless trading online, this is a huge change,” Gagdani said. “Most retail investors are new to capital markets and are trying to understand it. Trying to understand the new rules on top of it has acted as a disruption.”
Timing the market will become difficult now with the pledged system in place, Rathi said, in addition to the teething problems such as client education and getting accustomed to the new rules.
3) Should A Client Pledge His Entire Holding Upfront?
The process of pledging shares can take between 3 hours to a full working day. So brokers advise that those trading frequently should pledge all their shares so as to enable future trades easily. That’s what Gagdani from 5Paisa.com is advising his clients - to pledge 100% of the shares upfront because the benefit of pledging isn’t instant anymore.
If a client pledges shares partially, he will only get the benefit of it in a day or so, which could lead to missed opportunities. Even for incremental buys, Gagdani prefers if clients pledge shares as soon as they can so that when they spot an opportunity, they have pledged shares at hand.
The only danger to this is if a client exceeds leverage, the broker has the right to sell the pledged shares to recover the lost money, Rathi said. The probability of the event is a mere 0.1% because there are a number of other rules and checks by the regulator to prevent that from happening, Gagdani said.
4) Is There A Standard List Of Approved Pledged Shares?
The exchanges provide a standard list of approved companies whose shares can be pledged as collateral (usually these shares with high liquidity), but as a prudent practice brokers often apply their filters. These are individual risk management rules that may narrow the list of acceptable shares at the broker’s end.
5) What’s The Change In Margin Rules?
All buy and sell transactions require payment of margin, except in the case of transactions via early pay-in.
Earlier, often brokers gave longstanding clients the leeway to pay the margin amount by the end of the day.
No that is no longer acceptable. Margin has to be paid upfront for purchase and sale transactions. Other the broker is liable to be penalised by the stock exchange.
This means that clients will have to ensure adequate liquidity to back any transactions.
This shift to upfront margining, when done via share pledges will require the broker’s systems to be well synced with the depositories and clearing corporation to ensure seamless transactions.
The shift which was from a product perspective now is moving to operational efficiency of the broker, Rathi said.
6) How’s The Change Being Implemented?
Brokerages, including 5Paisa, are facing teething issues.
There is a delay in processing pay-in and pay-out. Normally on T+2 day of trading, settlement is completed by afternoon. That gives a clear picture of final shares which are bought, sold and delivered. As per regulations, the early pay-in needs to take place by the same evening. But now this process is stretching to midnight, and by then another trading day begins. This is creating confusion and leading to wrong holdings, positions being displayed to clients.
"Because of wrong holdings, we can't give margin. To top it all, we had to reduce margin as penalty was levied to brokers and not clients, so we are over cautious," Gagdani said.
HDFC Securities’ Rathi, too, said pay-in and pay-out timings have gone nearly 12-hours apart over the last two days. But things should stabilise from next week for the brokers and investors all over, he said.
7) Why Can’t I Use My Intraday Profits For New Trades On The Same Day?
Trading authorities—SEBI, exchanges and depositors—are of the view that the benefit of that settlement can’t be given before the settlement.
Till a few days ago, the brokers gave a limit on T-Day, the credit was given on T-Day, the profit arising was given on T-Day, the loss arising was deducted on T-Day etc. So, for the customers, everything was in real time. On the back-end, the settlement took two days.
Now that the rule has changed neither the credit nor the debit, neither the profit nor the losses can be taken out from the system on the T-Day. No new trades can now be made with a notional profit.
Watch the Broking Special AskBQ show here.
Read the edited excerpts here:
The thing that stood out for me is that holdings will now not be transferred to the broker account. They kind of stay in the account but customers have to pledge shares. One of the brokers that I spoke to off air was telling me that they are advising their clients to pledge all the shares that are there because it won’t make a difference and therefore they will have the margin requirement to trade as and when you start trying to do a fresh pledge when there is a need that arises. Can you tell us a bit about this and any other point that is important out here?
PRAKARSH GAGDANI: I’ll just take an example and explain this. I have one lakh worth of shares but till Sept. 1 all these one lakh-worth shares would have been approved and allowed to be taken as liability. Now, once it goes to the depository party and comes into the pledge system, I as a customer have an option of choosing Rs 1 lakh, full or partial. We’re also recommending all our customers to do 100%. The reason is that this pledging and getting the benefit, as Ashish mentioned, is not instant. So if today I see an opportunity in the market, I can’t use it because first I will have to pledge. It will take few hours to a day to reflect for me to avail the benefit. So if I want to reduce the time, it is important that I would choose the option of 100% at one go. It is not just for the shares that I already hold, it is also for incremental buying. If I bought something tomorrow, it is better that the moment the share comes and it is settled, it is better that I go and pledge it because as a customer I don’t know that when market will give me an opportunity to trade. So it is better that I do it 100% at once.
Is there any danger to this if I’m pledging the shares; because a lot of people feel that pledging is a taboo word. So, is there a danger to this and how should people approach this?
PRAKARSH GAGDANI: See, the only danger in this is that if at all I take leverage or faces a loss, then brokers, because it is pledged, then we have to sell those pledged shares and recover the money. Now, every other broker does it in absolutely 100% transparency while abiding by the rules and regulations. Now, in case a broker misuses that to sell it, then there can be a downside but it’s very rare right now because there are too many systems in control for regulators and exchanges and depositors to check whether this is being misused. So, I think that there is 0.1% danger but 99.9% it is absolutely safe and in the interest of customers.
Ashish you want to come in? Is there anything else that we have missed which you think one should add? Some people would have the opinion that the things that used to happen via the power of attorney which in a couple of cases could be misused etc., will now slowly cease to exist by virtue of the new pledging system because shares don’t leave the customer’s account in the first place. How would you react to that and of course if we’ve missed anything else, and then please speak about that too, as far as the pledging thing goes?
ASHISH RATHI: As far as the margin pledge goes, the concept is absolutely in favour of the customer ensuring customer safety or security. So the whole idea behind this pledge mechanism was that some of the brokers misuse it by power of attorney and cash customer shares thereby misusing the customer’s money. So that’s the whole genesis which happened initially. Now SEBI in an endeavour to ensure that these shares do not leak customers’ account and there is a clear-cut and transparent mechanism wherein the customer can actually go ahead and see yes it has been marked in favour of the broker but however the shares are lying in my demat account. So the system is absolutely transparent. There is no second thought on that. Yes, the customers can continue pledging but as said earlier, in case the customer leverages excess, then the broker will have a right to invoke the shares and obviously, he can sell those shares and get it. So, I don’t feel there is any harm in getting the pledge done but however the system is at its nascent stage and the time taken is higher. So you have to plan properly so you can get things. That’s the only thing which usually the customers have a problem with. I am sure that going ahead in maybe three-four months’ time; we’ll have a seamless system with the integration of APIs.
I wonder if there is a risk and there is a risk to avoid it. Somebody mentioned this that in the corporate action events, where in the existing pledge system stocks are held in the brokers’ collateral account, the broker was the recipient of the dividends, bonus, rights at the time they used to seamlessly transfer. Now that the shares don’t leave the account at all, that is also taken care of automatically. Would that be a valid point or you think that was anyway happening?
ASHISH RATHI: So, earlier what used to happen is, shares used to lie in the customers’ demat account only, which was held by the power of attorney so that some brokers used to keep it in their beneficiary. So over there the corporate action had to be transferred and typically, once this TDS on dividend has started, the problem is actually enhanced. Here the TDS was deducted, shares lying in brokers’ beneficiary, so how do you pass benefit up here? With the pledge system coming in, definitely all the corporate actions in favour of the customer, all the issues with respect to dividend, rights, any corporate action lies with the customer shares and the customer’s account so that would be taken care of.
For the pledge being allowed for all approved securities, now would this differ from brokerage to brokerage or would there be a standard list?
PRAKARSH GAGDANI: So, there is a standard list given by exchanges what are approved and what are not. But as a prudent risk management brokers also apply their logic and they filter it further. So, if exchanges are allowing approximately 1,000 stocks, then there is obviously some amount of risk management rules that we apply and reduce it. So, there will be different stocks in terms of approved and not approved at the brokers end sooner or later, it has to get aligned and be a common list of stocks which are both as a part of exchange list and as a part of the brokers.
We were reading one of the blogs and it says that the margin requirement would continue remain the same until Sept. 1 after that it changes. Can you tell us a bit about this?
PRAKARSH GAGDANI: See, the margin requirement has not changed because the margin required to take a derivative contract or a margin required to trade it in internet cash or wire delivery is absolutely the same there is no change there. What has changed is basically an upfront margin system in case of selling of shares, that too, in certain circumstances. Mostly the margin system remains absolutely the same at this point in time.
Can you simplify this for us because the biggest question mark in the minds of most people is what happens after I sell my shares? I believe that one change is of course and I don’t know what your view is. For a lot of people who are trading through the old time brokers, their view was ‘shares mera hai, toh bechne ke liye mai paisa kyu du?’ (these are my shares, do why do I have to give money to sell them?) Can you tell us a change in the efficacy or the reason for the same?
PRAKARSH GAGDANI: I’ll talk pre-Sept. 1. If I have to sell shares, it was a very seamless exercise, the customer just had to go on the platform and sell it or if you’re doing traditional brokers you call up your broker and the order is executed. You don’t even come to know at the back-end how the shares are moving from your DP account or from the brokers account. It was absolutely seamless. Now what has happened is that the credit of the shares sold can only be given if the paying is done on the T-Day. If there is a window of the same day for the paying to happen that window was earlier it around for 4:20 p.m., now it is extended up to 9 p.m. If a broker is able to do the same day paying, then he can give a benefit of the shares that are sold to a customer instantly. So, if I tell him that I wouldn’t be able to 100% do it on the T-Day, I will give the benefit of the shares sold for instance but because of any reason the broker is not able to do a T-Day paying, then what happens is that the penalty is charged on the broker. So, broker will normally not give the benefit of the shares sold to the customer the next day. They will wait for two days to happen. Now, in today’s environment, if at all your system and technology is absolutely proper, it is a no-brainer, it can happen but for the last three days, a lot of brokers are not able to do the T-Day paying because the normally what used to come at 1:30 p.m. is now coming at around three o’clock in the morning. So, right now there is a change but then after that, if a broker is able to do the T-Day paying, then the credit of the shares sold can instantly happen to the customers.
Are you able to do that right now or are you facing some teething issues as well at 5paisa?
PRAKARSH GAGDANI: We are facing teething issues and we have been not been able to do it for last two-three days because the entire load from CCL to brokers- all the cycles have disrupted. So, things like that just used to happen somewhere from 11 a.m. to 1:30 p.m. in the afternoon, now happening from 5 a.m. in the evening to 3 a.m. So, there is no visibility and right now, we are not able to do it.
Ashish what’s been your experience in these two days when it comes to this settlement and again that’s the same question that everybody asks for how long will this continue because most people are saying that ‘apne shares bechne ke liye, mai paisa kyu du?’
ASHISH RATHI: In terms of the last few days, there have been infrastructure issues. Across all brokers the same issue happens because there are dependencies on the repositories and there are dependencies on the clearing corporation. Now, from the first point which Prakarsh said, earlier what used to happen is margins were paid and there were three persons in the cycle -- the customer, the broker and the clearing corporation where the settlement or the margins are totaled. Earlier the broker used to pay and understand the margining system because they were professionals in this method but with the upfront margin coming in. Now the customer also has to understand how the margining system works which was actually not there until recently.
So that was the first change that happened wherein the buying or selling requires upfront margining. However, it clearly now depends on the operational efficiency of the broker. If he’s able to do T-Day paying to the clearing corporation and then after that whether he is able to do early paying also for the customer to buy any other shares against the share soon. So the shift which was from a product perspective now is moving to operational efficiency of the broker. So that was a drastic change.
Because you’re speaking on operational efficiency, do you guys believe, just speak for yourselves, maybe not for the industry. Do you guys believe that you will reach that stage wherein you will give the credit on T-Day?
ASHISH RATHI: Right now also in most of the cases we are giving credit to the customer because we are able to do early paying of these shares. In the last two days, the pay in, pay out timings have actually gone almost as you can say 12 hours apart what used to happen earlier.
Prakarsh, do you think that the T Day paying will happen?
PRAKARSH GAGDANI: Definitely, it will happen. Initially, when the entire system is getting changed and everyone is learning real time so there is always this structure. I feel a couple of days more and after this week passes by, I think from next week things will come back to normal because people and the customers would have understood the communication and the training. All of the brokers have done it and I’m sure that the systems, depositories and clearing corporations will also stabilise in next two-three days. So I think, barring some disruption right now, from the next week onwards, it should streamline.
Why am I not able to use the profits to trade intraday?
PRAKARSH GAGDANI: That is a very genuine question because all the profit arising out of my intraday trade are allowed to be a huge for sequential purchases either in derivative or cash. In the whole system what is changed is, something called as crystallised and uncrystallised. When you say crystallised, it means what the SEBI, exchanges and depositors are saying that till the time the settlement happens, the benefit of that settlement can’t be given before the settlement. So, today everything goes in on the T-Day and the settlement is not T+2. A few days ago, the brokers give a limit on T-Day, the credit is given on T-Day, the profit arising is given on T-Day, the loss arising is deducted on T-Day etc. So, for the customers, everything was in real time. On the backend, the settlement was for two days. Now what the rule has changed is, that neither the credit nor the debit, neither the profit nor the losses can be taken out from system on the T-Day and let the systems settle after T+2. If you’re getting a profit, that’s a notional profit. The profit will come to your ledger after the settlement is done. So once the settlement is done, then you can use it. That is the change right now. So, everything that is crystallised can’t be done and everything that is not crystallised, can be done.
What about the margin for selling shares and what does one do with those for the derivative positions? A lot of clarity is sought by people for the derivative positions as well as to what will happen. Can you kind of just briefly lay it out for us?
ASHISH RATHI: So for derivatives, we practically had an upturned margining reporting on derivatives initially too. So, from a derivative perspective, I don’t think many changes have happened. The upturned margin, similar to what has been introduced in the cash segment was earlier there in the derivatives segment too. So the only change that has probably happened from a derivative perspective which is very important is that now shares only mark this pledged can be used as margins and not otherwise. So, earlier, whether you had shares in your demat account or you had shares in the brokers demat account- that could be used as margins. Now, only shares which are in the margin pledge can be used. Other things in derivatives right now remain the same which was there earlier. So, nothing changes as of now in the margining systems and they are there in derivatives segment as earlier but yes, the margins in the form of shares can only be in the form of margins and not anything else.
A blog that I was reading said that while holdings can be used to trade F&O, new F&O positions can be taken after exiting the existing F&O positions. I mean, is there some new rule that has happened on or she said that there are no changes but is there something that I’m missing?
PRAKARSH GAGDANI: Today, if you sell an existing derivative position, either it is options that you’ve bought and you’re just squared off or the futures that you have squared off, the margins will immediately be released for you to buy anything else. The change that has happened is, if I have an options buying position and I square out the option buying position, then I can only use that money which is released, to buy another another option. I can’t use that money to take any other derivative contract or even any other edge position. That has changed.
PRAKARSH GAGDANI: That is what the rule says because it is again credited off the options cell and it is not crystallized because the settlement happens on T+1.
Ashish, using the proceeds from the BTST trades to trade derivatives now, have the norms changed because I think there was only 60% of the value now eligible? Can you just simplify the whole thing for us?
ASHISH RATHI: As long as you have given 40% margin because minimum margin which is specified by SEBI is 20%. So if you buy, you have to give 20% margin and if you sell, then you have to give 20% margin. So, total becomes 40%. As long as you have paid 40% margin, then you can buy today and sell tomorrow and the balance 60% if you have given margins, you can utilise towards F&O. However, there is a catch in this one wherein the which have additional margin or not up to market have to be bought in by T+2 basis. So now wherever there are shares which has additional margin or mark to market, this may soon have to be changed where margins might have to be slightly higher. However, given A-group security and also the better securities, this rule actually will play well wherein you give upfront 40% to the broker then you can do buy today sell tomorrow. Then it again depends on the internal risk management of the broker.
Can you explain this with an example that RIL’s price is Rs 2,000 and I have hundred shares?
ASHISH RATHI: So, we will go with buy today, sell tomorrow. Suppose Rs 2 lakh is the value. Now, as long as I give you a 40% upfront margin for buying this. Suppose I give you a cheque of 40% -- around Rs 80,000. As long as I’m able to give you Rs 80,000 rupees, then I am able to buy today and sell tomorrow, so 20% -- Rs 40,000 -- would be on the buy side and Rs 40,000 again would be on the sell side. So if I’m being offered 80,000, then buy today sell tomorrow will go as long as he doesn’t have an additional margin or mark to market.
Now, let’s assume RIL next day is Rs 2,100 rupees. So I bought stuff worth two lakhs and the next day I’m selling worth Rs 2,10,000 right? So what is the quantum of money that I can use for new trades that’s the question two or three people have?
ASHISH RATHI: It depends on the initial margin that you’ve given. So, like Prakarsh earlier said it becomes on settled pitches. Now, neither the buyer side is settled nor is the sell side settled because settlement happens on T+2. So if you have given 40% then only you can buy today and sell tomorrow. From selling tomorrow whatever proceeds you get, you may not be able to do anything because unless and until it is settled you will not be able to use that money. So if you have given 60% upfront margin hypothetically, then the balance 20% you can still be able to use to buy something else.
Is there some change on the intraday leverage is in any fashion whatsoever that people have to take for intraday trades?
PRAKARSH GAGDANI: As far as the leverage is concerned, there are absolutely no changes. The leverages are exactly same as it was earlier but the only thing is that today if you want to enjoy the leverage you’ll need to pledge.
Prakarsh, is there anything that we are missing out something that I haven’t asked you, I have a couple of other then broad brush questions after that. Is there’s something that we missing out something that is important?
PRAKARSH GAGDANI: Something that is important right now for all the customers is to go through these changes because as Ashish rightly said that it was earlier a broker who was supposed to understand all the rules and regulations but now, even customers will have to understand the new rules regulation.
So it is very important for investors and customers to go through all the literature which brokers have put on their on their website, on their platform and their blogs. There will be some scenarios which may not have been covered in the FAQs because a lot of scenarios are not there but I think it is very important for investors to go through these and understand how these changes would impact their trading.
A broker was messaging this to me Prakarsh, that when eight custodians do the clearing of trades for institutional customers, why not trust them to clear the trade for the non-institutional customers as well because that’s only about 15-20% of the overall volume. Is there merit to the argument can this be done, why is it not done?
PRAKARSH GAGDANI: Definitely. I am not from the institutional side so I don’t have the entire knowledge of how that custodian thing works but yes, from a third person perspective, definitely it can work. If they if they’re able to do a settlement for institutional clients, why can’t that be done for a retail client. The only difference between institutional retail is that of volume on the share side is higher and the number of customers is very less. Here, it is absolutely the opposite. So I don’t know whether custodians will be able to handle the large volumes of customers.