I meant they were doing it for their own prop trading books via third party NBFCs giving guarantee.
I am aware about the modus operandi for their clients.
Can a broker do this for himself? Is this grey area?
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Technically for Prop or Broker’s own trading account, it has been applicable for many years. Exchanges block entire money from brokers for all positions. If a broker was giving intraday leverage to his customers it was from his own funds. If a broker has to take positions in a prop or own account, the broker is required to have the full amount in any case.
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Prop or clients, there is nothing stopping either from borrowing money (taking into bank account and then transferring to trading account) and then trading in the markets. If the NBFC lends it is taking a risk by lending money to either the broker (prop) or customer without any collateral.
Any arrangement where the broker on behalf of NBFC blocks payouts etc in customer trading account is illegal. So if NBFC lends money without any collateral, it is taking extremely high risk (like personal loans).
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Generally how does this works. I mean I am not asking about recent changes, but as a industry standard joe does funding or bank guarantees work in the system. I mean if I am running prop desk of hundred crores,how much of exchange margin can a typical bank guarantee for me in exchange. I think you also took this facility in initial days of business when you were running your own propbook.
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Hypothetically, if the intra-day trading margins of combined positions of all traders go above the funds the broker has (before peak margin when brokers were giving 15X-20X leverage) then what used to happen?
Is the broker required to stop providing intra day leverage till the amount went lower than broker funds or did the broker have to pay some interest for the shortfall?
The way BG’s work is that you place a fixed deposit with the bank, and the bank gives you a BG for a value higher than your FD. So indirectly it is just another form of credit. How much more can the value of BG be compared to the FD parked, it depends like any other loan that you take from the bank - your creditworthiness. Today regulators have put in many restrictions around BGs as well, especially after few incidents where brokers went down (IL&FS clearing, BMA, Karvy, etc).
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If the margin required for all positions (prop & clients combined) at any time (intraday & overnight doesn’t make a difference) >90% of total margins placed by the broker with the clearing corporations, the broker is put in what is called a risk reduction mode (RRM). When in RRM a broker & the clients are allowed only to exit open positions and no new positions is allowed to be added. Apart from that there is also a penalty if you get into RRM mode.
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Can BGs work in client level too. For eg .I am running books worth ten cr . Can I ask my bank for BG and then pledge/block it with my broker who will block this in exchange and give me margin against that . I don’t know about it maybe full service broker might have this facility but still don’t have clue what will bank require to credit trading requirements.
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No, this is not possible. SEBI has blocked 3rd party BGs. Instead of a BG you could just take a loan from your bank/NBFC and fund the trading account.
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I remember producing BGs to the Central Taxes Dept to allow export without paying GST (in the initial days of GST implementation). Bank required that the BG be backed by FD and there was a fee for the BG too. And it made a case to do that for such.
But for collateral with stock broker, wouldn’t it be good enough to just purchase liquid mutual funds or money market mutual funds and pledge that? Or maybe you have a very high level of credit worthiness backed by different kinds of assets.
Actually the thing was BGs have low credit cost as o it doesn’t involve cash outflow as opposed to taking a normal loan.
But for the BG, doesn’t the bank ask for a FD lien or similar? Just an academic question if you have the time, as @nithin has already told us what’s possible currently.
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Yes but FD you pledge earns yield. So you might get 120₹ Bg against 100₹rupee Fd you pledged .
Okay.
Gilt Funds or Money Market Funds or SGB offer returns too. And as the value of the funds increase, so does the collateral.