If you have been investing or trading for quite a long time, you must have heard about the margin system for non-Future and Options (F&O) stocks. Recently, the Securities and Exchange Board of India (SEBI) has come up with a new set of rules regarding the margin requirement for non-F&O stock in the cash market.
SEBI has rejected the proposal to increase the margin requirement for non- F&O stocks in the cash market that was proposed on 20 March 2020, to increase the marginal requirement for outside F&O (Future and Options) stocks to 40% in a phased manner.
Before getting into the details of the new margin system, let us first understand non-F&O stocks and the margin system collectively.
Non-F&O (Future and Options) Stocks
Futures and options are two types of derivatives available for trading in the Indian stock markets.
Futures is a kind of a derivative future contract, wherein a buyer and seller mutually decide and agree to sell or buy a limited quantity of assets, at a specific fixed price at a future date. In simpler words, a futures contract facilitates the purchase or sale of a stock at a preset price for delivery on a later date.
In the Options contracts, the buyer or seller has the right but is not obligated to sell or buy stocks at a predetermined price or at a certain date.
SEBI has decided on a few criteria that need to be fulfilled to stay in the segment of the F&O stock. If these criteria are not fulfilled by the F&O stocks, then the exchange removes them from the F&O segment, and they will be then known as Non-F&O Stocks.
Margin is the borrowed money from the broker firm to purchase additional investment. It is the difference between the total values of the securities held in an investor’s account and the loan amount taken from the broker.
The margin system has mainly two components:
VAR (Value At Risk): VAR is a statistical measure that analyzes the financial risk of the firm.
ELM (Extreme Loss Margin): ELM is the fixed margin charge to cover the loss in situations that lies outside the coverage of VAR.
MTM (Mark to Margin):
As we know the futures price fluctuates daily, under which you either stand to make a profit or a loss. Marking to market, or Mark to Market is an accounting analysis process to adjust the profit/loss which is made by the investor for the day. As long as you hold a futures contract, MTM is applicable.
SPAN (Standard Portfolio Analysis of Risk), SPAN is the minimum margin required amount to initiate the trading.
Exposure margin is the charge on over and above SPAN margin.
For nearly 9 months, SEBI had imposed an increased margin on stocks, which can move 20 percent up or down in a day. All the outside F&O stocks are in the 20 percent price band.
In March, SEBI had said that if a stock moved over 10 percent for three or more days in the last one month, the minimum margin rate was increased systematically from 20 percent and higher. However, SEBI mentioned that measures that had been initiated in March will remain in full force, including the trading of derivatives and index derivatives.
Normally, traders are required to pay initial margin money between 10 to 15 percent.
However, from December 1, the broker will not be able to calculate the margin based on the end-of-day position required to use the intraday (Buying and Sellings of the stocks in the same trading day is called Intraday trading.) peak position.
From December 1, investors will see the new margin system in the market, the Peak margin system, that has been implemented by SEBI.
So, let’s understand the existing margin system and the new margin system collectively.
The Existing Margin System
Currently, according to the existing margin system, margins were collected upfront but were calculated based on end-of-day positions. The broker funds intraday positions as long as investors bring their outstanding by the end of the day, to below what they have already deposited as margin by the end of the day.
Suppose, you have Rs. 1000 as margin with your broker, you can trade multiple times with intraday trading with your broker’s funds. This is okay as long as, by the end of the day, your mark to market (MTM) doesn't wipe out your Rs.1000 in the margin.
The New Margin System (Applicable from December 1)
SEBI has introduced the concept of peak margin penalty, which will be in effect from December 1. In the way a margin penalty is calculated if the margin collection is lesser than the minimum for the end of the day position, the same way will now be used to calculate margin penalty if the available margin is lesser than the minimum Upfront margin at any point during the trading day (intraday).
Here are some key features of the New Margin System:
Equities will remain in the investor’s demat accounts and investors are liable to get all the corporate benefits of equity holdings.
Brokers will have to collect the upfront margin from the clients at the start of the day , else the penalty will be imposed.
The clients don't have to sign the Power of Attorney (POA) and brokers cannot sell client’s stocks without their permission.
From December 1, if clients want margin funding then they will have to pay a minimum of 30% of the upfront funding.
During intraday profit, investors will not be able to utilize the funds but they will be able to utilize it unless T+2 Days.
SEBI has given time to industries to make the required adjustment. The guidelines were introduced in August 2020 and from December 2020 to September 2021, SEBI is slowly going to increase the restrictions.
Penalties introduced by SEBI
Dec 2020 to Feb 2021 - If the margin blocked is less than 25% of the minimum 20% of trade value (VAR+ELM) for stocks or SPAN+Exposure for F&O.
March to May 2021 - If the margin blocked is less than 50% of the minimum margin required.
June to Aug 2021 - If the margin blocked is less than 75% of the minimum margin required.
From September 2021 - If the margin blocked is less than 100% of the minimum margin required.
How will this New Margin System affect Trading?
Intraday trading contributes significant liquidity to the markets. With restrictions on the intraday leverage, liquidity may fall and the potential impact will be on costs, which might go up.
Experts predict that intraday trading volume may shrink by 20%. These changes may disturb the market in the short run because investors require more capital to do intraday trading.
However, in the long run, these changes may show positive results by giving the authority of the stock to the investors to avoid the misuse of the POA.
Reasons behind introducing the New Margin System
A fund company named Karvy House came into the limelight in 2019 when the fund company used the investors’ funds worth Rs. 2000 Cr. for their purpose to finance their real estate business without any acknowledgment of the investors. As investors need to sign the Power of Attorney before investing in the market, that means the fund house has the authority to sell investor’s funds. And this how the Karvy fund house misused them.
This incident brought SEBI’s attention to the fact that POAs can also be misused by the brokers. Hence, the market regulator decided to introduce a new margin policy in which investors have all the authority over their stock and brokers can not sell investor's stocks without their permission.
The VAR+ELM or SPAN+Exposure margin computation doesn’t consider the difference in terms of risk-based on whether the market is open or closed. The overnight positions (Overnight positions refer to those trades that are placed after the exchange is closed and before it opens) are usually riskier because the market can move significantly overnight. Hence VAR+ELM and SPAN+Exposure are justified.
Brokers should be allowed to offer some additional intraday leverage (some cap so it isn’t misused) over and above SPAN+Exposure or VAR+ELM as long as it is funded by the broker’s capital.
However, while lower leverages may be negative in the short term for brokers & intraday traders, it can be positive for the long term as the probability of intraday traders winning will improve with lower leverages.