Confusion reigns over Sebi margin rule 1.0: There is Version 2.0 too

NEW DELHI: Even as confusion reigns over the introduction of margin rules in the cash segment from September 1 as brokers claim unpreparedness at their level and that of the depositories, there is another deadline looming for the industry for Margin Norm 2.0. That has to do with changes in margin trading in derivatives, the segment that generates biggest volumes on Dalal Street .

The tweaks in margin rule for derivative trading will come into force from December 1. Under these rules, traders will be forced to progressively go towards keeping full margin based on peak positions during a day.

Market regulator Sebi says the decision was taken to reduce risk in financial markets, and curb the practice of excessive leverage. The changes will make it difficult to take a large position, if one does not have enough cash in the trading account.

ETMarkets did the legwork to try and understand the issues at hand, and more importantly, how the impending changes might affect investors one way or the other. The answers we found were based largely on our discussions with Venu Madhav, Chief of Operations at Zerodha. The first part dealt with the whats and whys and the second on penalty provisions. In the third and final part, we are trying to understand how the changes in the derivative segment are going to affect traders and brokers. Read on…

How does margin trading work in futures (derivative) markets?
To understand this, let’s take the example of Nifty futures. As of today, to buy or sell one lot of Nifty futures, you need around Rs 1.5 lakh in your trading account. This is called exchange-mandated margin required to take a position (taking a position means either buying or selling).

Now, suppose your trading account balance is just Rs 20,000. Theoretically, you shouldn’t be able to take any position in Nifty futures. In practice, many brokers allow you to take positions on the condition that you would square off at the end of the day.

How do brokers allow that?
They either use funds available in other clients’ accounts to make up for the shortfall, or take loans. In your case, your shortfall of Rs 1.3 lakh (Rs 1,50,000-Rs 20,000) is provided by your broker. At the end of the day, the position is squared off. And, after adjusting for gains or loss, the broker will return your money to you.

Currently, margin reporting is done at the end of the day. But since you have no position at the end of the day, the margin required is zero. This is a win-win game for both brokers and traders, but it creates risks for the financial system.

“Whatever you buy intraday, it is not checked. Suppose, you had taken a position of Rs 100 crore in the morning, but your position is squared off at the end of the day, no margin is required. This was identified as a risk, as brokers today give crazy amounts in margins. This puts other customers’ money at risk,” said Venu Madhav, Chief of Operations at Zerodha.

What is the change in rule proposed?
What Sebi is changing is, apart from the end-of-the-day margin check, there will also be a peak margin reporting, that is, what is the highest open position of the client in a given day. For example, in a day if you had bought five lots of Nifty futures at 11 am and five more at 12 noon before squaring off everything at 3 pm, it will be checked if you had Rs 15 lakh (peak margin required for the position) in your account or not. Brokers will be penalised if there is any shortfall. The rule will be implemented from Dec 1. This is to discourage the practice of over-leveraging, that creates risks in the financial market, said Madhav.

So, would I need to have the full amount in my account to take a position from Dec 1?
Yes, and no. Ideally, you should, but it may also depend on your broker. Sebi is implementing the margin requirement in a phased manner, so that market participants get used to the rule. From Dec 1, a trader needs to have 25 per cent of peak margin in her account. The quantum will be 50 per cent from March 1, 75 per cent in the next three months and 100 per cent from September 1, 2021.

“Ideally, brokers have to do 100 per cent collection. Sebi is saying you report just 25 per cent from Dec 1. This time has been given to brokers to streamline their systems and make it accurate enough in a year,” said Madhav.