The Securities and Exchange Board of India (SEBI) has been very active throughout the lockdown period. It came out with many circulars which will have a direct impact on traders and investors.
For instance, from August 1 two major changes are being introduced.
Earlier, if a trader wished to utilise his shares as margins, only a Power of Attorney (POA) to the broker was required. But from August, he will be required to pledge securities with the broker to use the securities as margin.
Another big change is the introduction of upfront collection of margin in the equity segment, like derivatives, where the investor needs to provide margin before executing delivery trades.
This will thus end the concept of 'T+2 day' system where a client was allowed to pay the whole investment amount within 2 days of initiating trades.
While the market intermediaries were engaged in the implementation of the above two changes, SEBI came out with a new circular on July 20, 2020 on "Intraday Trading" laying down the framework for verification of upfront collection of margins from clients.
Currently, for intraday trades, the broker deposits upfront margin with the exchanges. However, at the investor level, the exchanges check the availability of margins post market closure on net positions. For e.g. If a trader buys 1000 qty of Reliance shares and sells them on the same day, net quantity at the end of the day being 0, no margin is required to be collected from the trader.
The brokers collect only a small fraction say 3% of total trade providing a leverage of 33x. The leverage can go as high as 100x if the margin collected is only 1%. Some of the full-service brokers collect margins after T+2 days virtually providing unlimited leverage.
A client can thus use excessive leverage and incur losses which may be more than his capacity to pay. This could also result in the broker defaulting and impacting his other clients. To safeguard investors from such a scenario, the circular has been introduced by SEBI.
Brokers cannot determine their own margins and will have to collect the "Peak Margin" as prescribed by the exchanges i.e. VAR + ELM Margin. This will spell doom for full-service brokers who provide additional margins as a service offering to their clients.
It is estimated that almost 30-35% of Intraday turnover of exchanges are based on additional leverage. Now assuming full margin is required, the total turnover would shrink by around 20% (since balance part margin was still being collected from clients).
Leverage is a double-edged sword
A 100% gain on your investment followed by a 100% loss will take your portfolio to 0.
Traders assume that they can earn higher profits using leverage. But it can also lead to an accelerated loss if the trade goes against them. Higher the leverage, higher the chance of blowing up your capital. Due to the increase in margin, the intraday leverage will decrease and thus help the traders sustain longer in the volatile markets.
Upfront margins will now become compulsory and failure to keep them will invite margin penalties by the exchanges. Thus, one may have to keep additional balance with the broker. A better option is to choose online payment transfers. Most discount brokers provide the option of paying through net banking via a payment gateway.
An increase in margin will reduce the return on capital. This will result in lesser speculation activity and thus reduce liquidity and market depth.
Execution is the Key!
Since the full-service brokers won't be able to provide additional leverage as an extra feature, it doesn't make sense to pay the higher % based brokerage and traders would start shifting to discount brokers. Thus, the brokers won't be competing on margins anymore and would be forced to provide better service.
The provisions of the circular will be implemented in a phased manner starting from December 1, 2020 and its full impact would be seen from September 1, 2021.
(The author is CEO & Founder, Samco Group)