Recently, SEBI published a new circular on margin that astonished the entire trading community along with the stockbrokers. Through this circular, SEBI announced tighter margin norms for the traders.
In this article, we are going to discuss what exactly is this new margin rule introduced by SEBI and how it will affect the people trading in share market.
What is Margin trading?
In terms of the financial market, Margin would be a direct synonym to leveraging. It simply gives you the power to buy/trade in stocks that we can’t afford to buy. Through Margin trading, one is allowed to buy the stocks by just paying the part of the actual value of shares.
The margin can be paid either in terms of cash or in shares as security. The balance amount of shares are funded by the brokers. In other words, Margin simply refers to the amount of money borrowed from the broker to buy the shares of a company. The broker acts as the lender of money and the securities in the investor’s trading account, are kept as collateral.
The margin is settled later when the positions are squared off. We receive profit if we sell the shares at profit or we stand to lose the margin if we make losses.
— How to trade using Margin?
To trade using a margin account, one must have a separate margin account and not the standard brokerage account. A margin account is a separate trading account in which the broker lends money to the investor to buy a security which otherwise he will not be able to buy. The loan or the margin money which is borrowed from the broker comes at a cost i.e., the interest. Therefore, one should use a margin account for short term trading as the interest on the margin money keeps accruing.
Say, if you deposit Rs. 1,00,000 in your margin account and you have a 50% margin in your account, which means buying power of Rs. 2,00,000. Now, if you buy stocks of Rs. 70,000, you still have the buying power of Rs. 1,30,000. And we have enough cash in our margin account to cover
Three steps in Margin trading
- We need to maintain the Minimum Margin (MM) throughout the trading session because volatility in the stocks can push the prices (up or down) more than one’s anticipation.
- The position needs to be squared off at the end of each session. If we have bought on margin, we need to sell it off before the end of the day (EOD) and vice-versa if we have sold using margin.
- If we want to carry the trade onto the next session, we need to convert it to the delivery trade. And for that, we need to keep the cash ready.
If any of the above three steps are missed then the broker automatically squares off the position in the market.
New Margin Trading Rule by SEBI
The Securities and Exchange Board of India (SEBI) gave out guidelines pertaining to Margin trading (which account for nearly 90% of the daily turnover of the stock market), which has not been welcomed by the brokerage firms with open arms. These rules will put an end to intraday trading and turnover generated out of it.
The brokers have been instructed to collect VaR (value at risk) and ELM (extreme loss margin) upfront from their clients. These rules will be implemented in a phased manner starting in December 2020.
- Phase 1: From December 2020, the brokers will be penalized if the margin is more than 25% of the sum of VaR and ELM.
- Phase 2: From March 2021 and June 21, brokers will be penalized if the margin exceeds 50% and 70% of the sum of VaR and ELM
- Phase 3: From August 2021, brokers will be penalized if the margin exceeds VaR and ELM
Reactions from the Brokerage community
The broking community feels that this will put an end to leverage based intra-day trading. Currently, some brokers collect as low as Re. 1 for every Rs. 100 worth of trade. Here are some of the reactions from Big brokerage houses:
Nithin Kamath, CEO of Zerodha Brokerage Tweeted, “Today’s SEBI circular says that all brokerage firms have to stop intraday leverage products by August 2021 in a phased manner”. In another tweet, he added:
“While many (even we) don’t like restriction on intraday leverages by SEBI, I don’t think any regulator in the world has done so much to protect retail investors. A lot of this slows brokerage business but what is good for the client eventually is good for the business as well.”
How Market Turnover is impacted by new SEBI rule?
On July 21, SEBI gave out a circular pertaining to new rules on Margin trading. And these rules are directly going to impact the market turnover both in the cash and derivatives segment. The cash segment on NSE recorded an average daily turnover of Rs. 50,322 cr (April), Rs. 52,656 cr (May), Rs. 61,395 cr (June). And the derivatives market is nearly 18-20 times of the cash market. NSE is the largest derivatives exchange in the world with an average daily turnover of more than rupees 11 lakh crore.
Some of the brokerage houses are of the view, with the new rules if VaR+ELM, the daily turnover may shrink by almost 20-30%. The clients will also have to maintain a higher margin in their account and which will also impact their return on investment. And these changes in rules will not only impact the brokers but will also impact the government, in the form of reduced Securities Transaction Tax (STT).