The spate of reforms introduced by the market watchdog aims to safeguard the interests of investors, bring transparency and prevent brokerages from misusing the client's securities.
Recently, a lot of discussions have been going around regarding the new Margin Pledge rules implemented by SEBI. The new development came into effect on 1st September 2020 after SEBI refused to extend the deadline.
The spate of reforms introduced by the market watchdog aims to safeguard the interests of investors, bring transparency and prevent brokerages from misusing the client’s securities. These reforms came out in February and were initially scheduled to be implemented from June 1, 2020. The deadline was then extended to August 1, 2020 and thereafter to September 1, 2020. While the brokers still requested more time to make their systems ready, SEBI refused to extend the deadline any further.
The new rules are going to significantly impact the operations of the industry. Let’s see how.
Understanding Margin Pledging
Pledging functions like any other mortgage plan where you use your stocks as securities to avail a loan, similar to using an asset as collateral. Traders in the Futures and Options (F&O) segment often use pledging to receive margin funding from the broker to invest in large deals, involving sizeable initial investment.
Margin is a popular tool in the world of stock trading. Using this tool, investors can invest in deals without investing the full value. While you pledge, your cash investment can be saved upto the haircut / permissible value of the securities you have used as collateral i.e. if you fail to repay the losses/debits, the broker may invoke and sell the stocks pledged for the margin to recover the debt.
Further, the broker acts as a custodian for the securities in the margin account but many a time SEBI encountered the complaints regarding brokers misusing client funds and collaterals. The new norms will help to address this problem.
What changes are expected?
The new reforms will bring in some key changes to the existing system, affecting both investors as well as brokers, making margin laws more stringent.
Here are the key points:
# The stock will remain in investor’s account and can be directly pledged to the concerned person/authority which means investors will continue to enjoy all corporate benefits on their shares. Under the old system, investors either had to give Power of Attorney (POA) to the broker or transfer their shares to the brokers’ account.
# Brokers must collect margins from investors upfront for any purchase or sale of stocks. Any client failing to do so will attract a penalty. However, no penalty shall be applicable from 1st September, 2020 to 15th September, 2020.
# The Power of Attorney (POA) cannot be used for title transfer anymore. It can be used for transfer of shares to the exchanges against sale of shares by the client or by the broker sold to recover the debts. It can also be used to initiate the pledge on behalf of clients to fulfil the margin requirements or to provide the trading limits to the client.
# Any investor wanting to avail margin will have to create margin pledge.
# As per the new norms, investors will have to pay at least a 20% margin upfront to avail a trading facility for buying or selling of stocks.
# Under the old system, an investor could sell the shares today which were bought one day before (BTST – Buy Today Sell Tomorrow) . However, now, shares bought today can be sold tomorrow at double the margin.
# Investors will now have to fulfil their margin obligations at the beginning of the deal unlike the end of the day in the previous system.
# Now, penalty on Non/short collection of 20% upfront margin and any other additional margin plus MTM loss within 2 days is required in cash segment as well.
Impact on the Stock Market and Investors
Due to the new margin norms, we might see a decline in trading volumes in the cash segment. This is because SEBI has virtually put an end to excessive leverage trades and directed brokers to collect higher margins from investors. Moreover, investors will have to wait for T+2 days to pledge the newly-bought shares. Further, investors who do ultra-short term trading may not be impacted much. However, active traders might feel an increase in their trading costs as they will have to provide higher margins now.
Summing it All Up
The new norms have become a debatable topic among brokers and investors. There are apprehensions that the stock trading process might become cumbersome and discourage many day traders from trading aggressively. However, this might make the system more efficient.
(By Jashan Arora, Director, Master Capital Services)