How does the SEBI circular on collection and reporting of margins in cash segment from Jan 1st 2020 affect me?

I saw this circular from SEBI and then read various versions of this on social media and the press. Do I really need money in my account to be able to sell stocks which I have in my holdings? This doesn’t seem right, can someone clarify?

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Let me start off with first explaining why SEBI may have put in this rule in place to collect margins from customers and report to exchanges.

Over the last couple of years, especially after the financial frauds at a few brokerage firms, SEBI has been working hard to fix a legacy issue of the broking industry which was a loophole that got misused by these firms. This is essentially a way to use one client’s balance (cash or margin from pledging securities) for another client, or by the brokerage firm itself.

We already have a rule in place for collecting and reporting margins in the derivative segments (Equity, Currency, & Commodity). All brokerage firms receive a file from the exchange at the end of the day detailing the margins required for positions taken by their clients (SPAN + Exposure). The brokerages are then required to upload back details of margins available in the client’s account. If the available margin is lesser than the exchange stipulated margin, a penalty is levied on the shortfall.

This circular, issued earlier this year now disallows brokerage firms to pledge client securities to any third party, even if the client hasn’t paid the entire money to purchase the security. Even so that clients aren’t allowed to do an off-market transfer for a loan anymore, it can be done only by marking a pledge to an NBFC directly from client demat, where funds from pledge get credited directly to the client’s bank account. This has ensured that client securities can’t be mis-utilized by the brokerage firm.

The last fix needed was for the equity (cash) segment. The traditional practice of brokers allowing clients to buy stocks for delivery without asking for upfront margins still exists. A client is asked to remit the purchase through a cheque after the execution of the purchase transaction. If the client takes longer than 2 days to remit, the broker earns additionally by charging interest on the debit balance. While this acts as an additional source of revenue for the broker, it increases the risk for the brokerage firm, as well as the capital market ecosystem as the stock price can go down and if no money/margin is collected from the client, the client could default.

The other issue here is that despite the fact that the client hasn’t paid for his purchase, a brokerage would still be required to pay the settlement obligation due to the exchange on T+2. The broker could potentially use unutilized credit balances belonging to other clients to fund such purchases of a different client. With this new circular of collecting and reporting margins for stocks, the equity (cash) segment becomes exactly like the derivative (F&O) segment. Instead of SPAN + Exposure, VaR+ELM margin is required to either buy or sell stocks. This not only reduces the overall risk, but the reporting mechanism ensures that one client’s funds can’t be used by another client or the brokerage firm itself going forward.

How does life change for you?

Nothing changes at Zerodha, or at most online brokerage firms for that matter, since we have always asked for accounts to be funded before placing a purchase order. It will definitely change for people trading with traditional brokers who are still working offline, where the practice was to pay money or deliver stocks only after taking a trade. Now they will have to maintain some margin with the broker (for purchase transactions) or transfer stocks to the broker in advance through DIS slips (for sale transactions).

For Intraday trading?

Online brokerage firms already charge margins to either buy or sell, so this practice will continue. What could change though is the intraday leverages provided by the firm. Check this exchange list for the minimum VaR+ELM margin for various stocks. A stock like Reliance requires 12.5% margin which equates to leverage of 8X. However, since all margin reporting is done at the end of the day, a brokerage firm could potentially continue to offer higher leverages. But the broker will have to do it from his own (clearing member) funds. This means that if a brokerage (clearing member) firm isn’t well-capitalised, they’ll be forced to reduce leverage for intraday trades.

For equity delivery based trades?

For buy delivery trades, the brokerage firm will have to now collect minimum VaR+ELM. So if clients got much higher leverage for this until now (Margin funded trades), it will be reduced to minimum VaR+ELM. Since currently at Zerodha, we insist on the entire delivery purchase value to be funded in advance, there’s no other requirement to bring in VaR+ELM. There could be stray cases where you may have bought a stock for Intraday and are forced to take delivery for any reason, in such cases, if you are short on the margins, a penalty will get levied for the shortfall amount.

For sell delivery trades, the brokerage firm continues to run the risk of the client not delivering the stock after selling. This can’t really happen in cases where the brokerage firm has the POA on demat to debit shares when the client sells a stock, as the firm can ensure the client can’t transfer stocks out. But wherever the brokerage firm doesn’t have the POA, they will have to collect margins before allowing clients to sell stocks to ensure that in case the client doesn’t deliver, there is margin available to make good of any potential auction settlement loss to the buyer.

Almost all online brokerage firms today have POA on demat, so ideally when selling shares, no margin will be required. But wherever POA is not there (all our new accounts are non-POA accounts and we will soon give an option for our POA accounts to switch to the non-POA as well) the brokerage firm can do an early pay-in of securities to avoid needing to ask margin from the customer selling stocks from holdings. By early pay-in I mean, the broker can move shares from client demat to the exchanges on the same day instead of on the settlement day i.e T+2.

So yeah, the above circular will only clean up the system and will most likely make no difference to the life of any retail equity investor/trader.

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Thanks @nithin for detailed post and clarifying most of the doubts.

However what about zerodha on this? Are you planning to continue 15x leverage on BO after this change?

We are very well capitalized, so nothing should change.

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Much appreciated to @nithin and zerodha team for the rules they applied and were running, even before the new sebi circular arrives.:+1:

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What SEBI has done here and earlier … adds insult to the injury. Exchange acted before SEBI on Karvys, and what SEBI now doing is … showing its presence by putting rules one after the another. If they really want, they can come up with a clear, simple and effective rules at once. Cannot they? They could have prevented Karvy kind of major things proactively. Why did not they?

SEBI has to change.

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Good to see SEBI is cleaning up it’s mess. It would be good if now SEBI lowers the exorbitant margins for option writing, for headed positions at least .

@nithin Thanks for the explanation. This gives some more comfort to clients in building a DP with Zerodha. Out of curiosity, could you post Zerodha’s financials for everyone’s perusal? It would give us more confidence if we are aware of your net worth and other financial details. Thanks.

I have been on record on broad numbers, Rs 300 crores+ PAT, and currently have around Rs 500 crores of own funds in the business and 0 debt. Until last year we were a partnership firm and didn’t need to make our records public. This year we converted to Public Ltd, so our financials will anyways be available next year for all (Post March).

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NSE has released FAQ on this issue. Here is the link

FAQ emphatically (Question 20 in Annexure A) says that upfront margin needs to be collected. @nithin Does this impact anything on intra day leverage offered in Zerodha in Cash or F&O segment?

Doesn’t this make MIS/BO/Co order pointless for fno orders. Zerodha should remove the option for it from the order box. It has no benefits except for the downside of possible extra charge of call and trade if he forgot to manually close his intraday trade.

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when it is coming to effect…Other Brokers still hasn’t updated it seems…Upstox 02 jan 19 margins for BO/CO showing with usual margins…

when zerodha will implement new margin for cash segment intraday?
I can see BO/CO margin is around 15X for cash today

Hi @nithin sir as you said nothing will change in zerodha!

Zerodha will continue offering the same margin system, as zerodha is well capitalise broker as it has own clearing membership it will utilize its own funds?

Now intraday leverage is reducing why?

@nithin @siva Are you implementing this immediately or at a later date? Though the blog clearly says margin of more than 1 lakh for one lot of nifty, I am still able to place order at ~15000/-
Please provide clarity on timeline of implementation. Thanks.

We have nothing to do, SEBI is asking to collect upfront, can check this for detailed info.

This may go live in some days, anyhow will update all our clients once this is taken live.

Mcx order as usual i can place without worring about penality right ?

Natural gas fut asking for 2% margin only in co

You can place on eq and fno also, once the leverages are reduced we will inform all our clients.

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