SEBI's New Norm to Collect Margin for Cash Segment is A Step in Right Direction, Says Nithin Kamath of Zerodha
Market regulator SEBI has directed stock brokers to collect an initial margin of between 15-25%, even for simple buying and selling of shares, in the cash segment. As per a news report from The Hindu Businessline
, market experts are up in arms saying that SEBI’s new guidelines on margin requirement, even for ‘selling of shares,’ will act as a major entry and exit barrier for the retail investor.
Experts to who spoke to Hindu Businessline contend that the new rule will cause chaos in the share delivery system, which works on the issuance of demat delivery instruction slips, and is largely physical and not digital.
They claimed that maintaining a margin deposit with brokers for merely selling shares, is unheard of even globally. The other option is that the investor should maintain a demat account with the broker he or she is trading with so that the broker mark shares for early pay-in. But in order to safeguard against potential frauds, most retail investors keep their trading and demat accounts with separate entities so that the brokers do not take undue advantage of shares in their custody. The new rule could effectively mean that they need to sacrifice this safety net, they said to the paper.
SEBI is forcing investors to keep their demat and brokerage with the same entity. This is being touted as a brutal anti-investor move, as investors should have the right to choose their options.
Institutional investors who treat equity trades as business transactions, like foreign portfolio investors and mutual funds have been exempted from this rule.
Another person in the news report says, “SEBI is telling retail investors to go to mutual funds; direct trading is only for institutional players. One rule for the retail investor and another for institutional investors and foreign portfolio investors does not ensure a level playing field”.
Mr Kamath of Zerodha however gave credit to SEBI for working hard to fix a legacy issue of the broking industry - a misused loophole (essentially a way to use one client’s balance (cash or margin from pledging securities) for another client trades, or by the brokerage firm itself).
He hailed the new SEBI circular and said that it will only clean up the system. He claimed that it will most likely make no difference to the life of any retail equity investor or trader.
He pointed out that there is already a rule in place for collecting and reporting margins in the derivative segments (Equity, Currency, & Commodity). All brokerage firms receive a file from the exchange at the end of the day detailing the margins required for positions taken by their clients (SPAN + Exposure).
The brokerages are then required to upload back details of margins available in the client’s account. If the available margin is lesser than the exchange stipulated margin, a penalty is levied on the shortfall. This reporting ensures that a client can take positions only to the extent of margin in the account.
The SEBI circular issued earlier this year now bans brokerage from pledging client securities to any third party, even if the client has not paid the entire money to purchase the security.
Mr Kamath says the new rule means that even clients are not allowed to do an off-market transfer for a loan anymore, it can only be done by marking a pledge to an non-banking finance company (NBFC) directly from client demat, and funds from pledge get credited directly to the client’s bank account. This has ensured that client securities cannot be misused by the brokerage firm.
The equity (cash) segment was in dire need of a fix, he wrote. The traditional way of brokers allowing clients to buy stocks for delivery without asking for upfront margins still continues. A client is asked to remit the buy transaction through a cheque or online transfer after the execution of the buy transaction. If the client takes more than two days to remit, the broker earns additional income by charging interest on the debit balance.
This is an extra revenue stream for the broker but it increases the risk for the brokerage firm, as well as the capital market ecosystem as the stock price can go down and if no money / margin is collected from the client, chances of client default exist, Mr Kamath points out.
Even if the client does not fund the buy transaction, the brokerage firm would still be required to pay the settlement obligation due to the stock exchange on T+2. It is possible that the broker could use unutilized credit balances belonging to other clients to fund such purchases of a different client.
With this new circular of collecting and reporting margins for stocks, the equity (cash) segment becomes exactly like the derivative (F&O) segment. Instead of SPAN + Exposure, VaR+ELM margin is required to either buy or sell stocks, Kamath points out. This reduces the overall risk and the reporting mechanism ensures that one client’s funds cannot be used by another client or the brokerage firm from January 2020 onwards.
Seeking to dispel all the market experts’ objections, Mr Kamath reiterated that nothing would change at Zerodha, or at most online brokerage firms since clients have always been asked for accounts to be funded before placing a purchase order.
However he added that things would definitely change for people trading with traditional brokers where the practice was to pay money or deliver stocks only after taking a trade. Now they will have to maintain some margin with the broker (for purchase transactions) or transfer stocks to the broker in advance through DIS slips (for sale transactions).
For buy delivery trades, brokerage firms will have to now collect minimum VaR+ELM.
At brokerage firms which already insist on the entire delivery purchase value to be funded in advance, there would be no other requirement to bring in VaR+ELM. There could be one-off cases where one might have bought a stock for intraday and might be forced to take delivery for any reason, in such cases, if one is short on the margins, a penalty will get levied for the shortfall amount.
For sell delivery trades, the brokerage firm continues to run the risk of the client not delivering the stock after selling. This cannot really happen in cases where the brokerage firm has the POA on demat to debit shares when the client sells a stock, as the firm can ensure the client can’t transfer stocks out. But wherever the brokerage firm does not have the POA, they will have to collect margins before allowing clients to sell stocks to ensure that in case the client does not deliver, there is margin available to make good of any potential auction settlement loss to the buyer.