What SEBI’s New Margin Trading Norms Mean

The market regulator’s changed rules covering margin collection in the cash segment are aimed at curbing risks and formalising leveraged trading. But the new norms are also expected to hurt small brokers the most.

The regulations look to prevent the potential misuse of client securities to borrow money by brokers, something that’s at the heart of the crisis at Karvy Stock Broking Ltd. The broker, using power of attorney given by clients, pledged their shares to raise money for its own purposes.

The Securities and Exchange Board of India made two key changes to curb such practices.

• From Oct. 1, it barred brokers from pledging such shares by creating pools of securities. SEBI asked them to transfer shares that are not fully paid in either of the three accounts: client unpaid shares, client margin trading demat and client collateral demat accounts.
• From Jan. 1, the regulator also made upfront margins payments mandatory.

What New Margin Trading Norms Require

Trading and clearing members in the capital market segment must collect upfront value at risk and extreme loss margins from clients, according to the new rules.

The VaR margin is intended to cover the largest loss that can be encountered on 99 percent of the days, according to details on the BSE. It’s calculated based on one-day losses for liquid stocks and three-day losses for illiquid stocks—allowing exchanges to liquidate positions over three days.

Extreme-loss margin covers the expected loss in situations that go beyond the 99 percent value-at-risk estimates. For any stock, it’s higher of 5 percent and 1.5 times the standard deviation of daily logarithmic returns of the stock price in the last six months.

Brokers and market participants BloombergQuint spoke with said these margins add up to anywhere between 15 and 40 percent of the total value of the trade.

What’s The Settlement Procedure

If trading and clearing members—entities that clear and settle trades—have collected adequate upfront margins to cover potential losses at the time of payment, they need not collect mark-to-market losses from clients, according to regulatory norms. Otherwise, they are required to collect the mark-to-market losses within two days of the trade (T+2).

And such entities have to report a single consolidated margin comprising VaR, extreme-loss, additional and mark-to-market loss margins collected.

Trading and clearing members have been given T+2 days taking into account practical difficulties they often face and it’s shouldn’t be construed as clients have been given two days to pay their margin dues, according to SEBI.

Why Small Brokers Could Suffer

According to Deven Choksey of KR Choksey Securities, SEBI’s objective to protect the market and investors by way of collecting upfront margin is appreciated but the mechanism can be simplified and made more effective. He suggested auto-debiting the bank account of the client for the purchase of shares and auto-debiting the depository account of the client for sale of shares. “This solution will prevent the cumbersome process of collecting the margin and in turn simplify the settlement process for the client and the clearing corporation.”

Jitendra Panda, head of business strategy at Yes Securities Ltd., said investors may be wary of giving the power of attorney to brokers who handle their demat accounts after the Karvy issue. Without that, seamless transactions may not happen, he said.

So the new margin norms are good as they discourage the practice of brokers using client shares as a collateral, Panda said. But the rules will marginalise small brokers, he said. Panda explained:

• A small trader having a broker account with one broker but the demat account with another outfit, say a bank, will have to first transfer the shares to the account of the broker before taking the trade.
• Alternatively, the trader must deposit the margins upfront. But for a lot of small traders, who may have some shares but not the capital for margins, making large sales or purchases simultaneously could become an issue, Panda said.