Upfront Margins Affecting Broking Revenues

The Securities and Exchange Board of India (SEBI) has announced new upfront margin norms in the cash segment of the stock market, which has triggered a debate on the impact of these norms on broking revenues. The new norms will be introduced in September. Even as brokers don’t seem to agree with the new rule, the market regulator has said that penalties for any shortage in collection/non-collection won’t be applicable if at least 20 per cent upfront margins are collected. This relaxed rule will be implemented from September 1.

The upfront margin regulations for intraday trading will be implemented in phases. During the first phase, ie, the initial three months post-implementation, only a quarter of the peak margin would need to be collected by the broker before a trade happens. The next phase would increase that to 50 per cent or half of the peak margin, and so on, till 100 per cent upfront margin is reached. This is said to provide adequate time for brokers to acclimatise their clients about the collection of margins.

Why is there fear over collection of upfront margins?

The fear among stock market brokers is that collecting an upfront margin will dent intraday trading itself. The reason upfront margin collection was introduced, according to experts and SEBI, was to put a check on excessive funding and leverage that brokers provided some of their clients. However, this is now a bone of contention among brokers because it is considered to negatively impact trading volumes.

Traders in the cash segment of the stock market pay a certain margin, which is the sum total of extreme loss margin or ELM, market-to-market or MTM and value-at-risk margin, which is VaR.

Currently, many brokers only collect a tiny amount of the overall trade, and provide a leverage that is several times higher. Extra margins are provided by the brokers so as to ensure that clients get an added advantage or as an additional service. It is this extra leverage that brings a sizable chunk of turnover, intraday, close to a third of all turnover.
Of course, if a client defaults, it is the broker who has to pay for the shortfall, and that is the practice among all brokers. However, as news reports suggest, the Association of National Exchanges Members, India (ANMI) has said that there have not been any major defaults over the last two and a half decades of the e-trading system.

Now, with the new norms in place, the whole margin will be needed upfront, which means the turnover could come down. To put it more simply, these new rules mean that traders need to pay margins to buy any stocks. A trader who is selling some of their shares to raise some cash also needs to pay a margin upfront before the trade is executed. Even if the broker is willing to bear the risk of not collecting margins upfront, the regulator will not allow such a thing.

Pledging of stocks, settlement cycle and title transfer: other norms

Earlier, the stocks that would stay in the demat account of the trader were deemed equal to margin will now be pledged with the broker. What’s more, the shares would have to be delivered on the very day or there will be a penalty.

The current settlement cycle is T+2 where T is the date of trading and the investor could deliver the securities till up to two days after that.

Yet another aspect of the new regulations is that the system of title transfer (TT) and power of attorney (PoA) have been barred. Thus far, brokers would use PoA to pull out shares from the demat account of the client to use as collateral. This was called title transfer and brokers would execute trade in the stock market for clients. This system will no longer be made available once the new norms are implemented.

This SEBI move to bring in regulations was first touted in November 2019. Till then, margins were needed compulsorily upfront only in the F&O segment (futures and options).

In conclusion

Brokers who took pride in taking on margin risks to build a special relationship with the clients they already trust will no longer be able to leverage such relationships. In a sense, the new norms aim to create a level playing field for traders. However, it will take time for the new system to fall in place and brokers to get used to the system and boost trading volumes. Till then, broker apprehension over the norms may remain. It remains to be seen how all the stakeholders on the intraday trading front will be affected by the new norms. It is the onus of the regulator to iron out any operational glitches that may arise and ensure that brokers and traders benefit from the new norms.