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Margin funding: NSE hits hard on broker-NBFC deals

25 January 20235 mins read by Angel One
Margin funding: NSE hits hard on broker-NBFC deals
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The National Stock Exchange (NSE) has come down strongly on stock brokers who are looking at ways to fund margin needs of their clients through arrangements with non-banking financial companies (NBFCs) either in direct or indirect ways.

The markets have been on a bull run and on the back of this buoyancy, many brokers have found ways to enter into roundabout or dubious methods to ensure loans for clients of NBFCs / their subsidiary firms so that traders in need of leverage are funded.

Many stock brokers are known to organise greater leverage or margin funds for their clients as well which the NSE doesn’t approve of. The NSE has issued a circular to this effect warning brokers not to indulge in “financing or act as conduit or front for financing any secondary market transactions, or margin requirements”. The circular says exceptions are only made under the provisions of Margin Trading Facility and Securities Lending and Borrowing.

Margin funding is a short-term loan that a trader gets from the broker to buy shares even if the person doesn’t have the whole amount to pay for a transaction at hand. As share prices keep moving each day, margins make sure that buyers and sellers are able to fulfil obligations in spite of price changes.

Chronology of margin rule changes by SEBI

In June 2019, SEBI issued a circular which stipulated that broker firms could not pledge securities belonging to clients that were with brokers to banks or NBFCs.

SEBI has been aiming to bring in transparency and ensure that investor money is protected through its various norms. SEBI has brought in new margin rules that not only barred pooling securities but also ensured that trades can be carried out only against pledged shares or cash. Pledged shares would need to be in the client’s account and not with the broker, brought into effect from September 2020. Accordingly, clients need to wait for transactions to be settled before proceeds can be used for new trades.

Till September 1, 2020, investors didn’t have to pay margin upfront in the cash segment because margins in this segment were catered to by the broker. With effect from September 1, SEBI stipulated that margins would be collected upfront for buying/selling of securities. Upfront margins would be needed even in the cash segment. The broker would also have to report the margins collected to the exchange.

Peak margin rules

SEBI changed intraday margin norms from December 1, 2020, and has introduced a concept called peak margin reporting. Accordingly, stock brokers will not only have to calculate margin based on end-of-the-day position but also the intraday peak position. The highest margin out of a minimum of four snapshots sent by clearing corporations during a day will be the peak margin of that day.

The first phase of the adoption of these rules was between December and February wherein the client would need to have 25 per cent of the peak margin available with the broker. Between March and May (phase 2), the client would need to have 50 per cent peak margin with the broker, while between June and August (phase 3), SEBI has stipulated that clients need to have 75 per cent of peak margin with the broker. In the fourth phase, ie, by September 2021, clients would need to have 100 per cent of the peak margin with the broker during the day.

Thanks to peak margin calculations, there will be restrictions on the maximum leverages intraday that brokerage firms offer and 80 per cent of credit from the sale of holdings will be made available for other trades on the same day.

In order to circumvent SEBI norms on margin funding, many brokers had resorted to entering into a roundabout method to fund clients. They sought to enter into an indirect arrangement with NBFCs or subsidiaries of such companies to facilitate loans to clients. This meant that the NBFC had control over securities via subsidiaries. This in turn meant that the peak margin rules that were brought in from December 1 did not affect volumes on the cash and derivatives front. Also, the new peak margin rules did not have a huge impact on daily trading volumes because of the market rally that has brought in more stock market investors.

Impact on volumes?

The new NSE circular on margin funding combined with peak margin rules enter subsequent phases where margin needs rise, there is fear that volumes may begin to be impacted. However, this may be offset by stock market rallies and consequent investor interest. For instance, the NSE’s capital market segment’s average daily turnover saw a rise of 57 per cent in the year 2020 (CY), according to news reports. Also, the NSE’s investor base rose to 3.7 crore by the end of 2020 from just over 3 crore at the start of the year, reflective of a rejuvenated interest in the markets.

Conclusion

Over the long-term, margin funding rules by NSE and SEBI norms will infuse confidence among investors and may not have a bearing on volumes. From the investor perspective, the latest circular is expected to protect their interests, bring in accountability and transparency. Investor confidence and trust in the stock markets may end up having a positive impact on brokerages as well.

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