The exchanges (NSE and BSE) published these FAQs on margin collection & reporting yesterday. While we can live with most points on the FAQs, there is one big issue that will set the industry back by a couple of decades. According to the FAQs, you cannot use the proceeds from selling your stock holdings to buy other stocks for 2 days from when you sell them. While the broking community is trying to make representations and get the exchanges to reconsider this, we thought all of you should also be aware of this since this will potentially change the way you trade going forward. As things stand, this is applicable from Aug 1st 2020.
Settlement of stocks in India takes 2 days, which means that if you buy a stock, you’ll get it in your demat account after T+2 days. Similarly when you sell a stock, the credit from selling the shares reaches your account on T+2 days (This is T+1 for all F&O positions). Until now, unlike F&O, there was no margin collection and reporting for cash market transactions. But starting Aug 1st, like we need SPAN+Exposure for taking F&O positions, all clients will need to have VaR+ELM for cash/stock transactions.
With this minimum upfront requirement of VaR+ELM, intraday leverages offered by brokerage firms will only be to the extent of this margin. So to buy Rs 1 lakh of Reliance, all customers will need to have Rs 22,000 (VAR+ELM of 22%) in the account. I have explained here how this will result in intraday leverages in India being restricted going forward. Whether intraday leverages are good or not is debatable, this upfront margin requirement and this consequent FAQ from exchanges will I think have significant impact on the market activity.
Margin required to sell your stock holdings
VaR+ELM requirement is applicable even when you place a sell trade of your holdings on the exchange. If you hold Rs 1 lakh of Reliance in your demat, a margin requirement of Rs 22,000 is required to sell it. While this might seem weird, the reason for this is that Exchanges and Depositories (demat accounts where you hold stock) are different systems. When you place a sell order on the exchange, there is no way for the exchange to know if you actually hold the stock in your demat account or not. So exchanges will require an upfront margin even for the sell trade.
But thankfully, there is a way around this by using what is called Early Payin (EPI). So instead of waiting for 2 days, if the broker can debit the Rs 1 lakh of Reliance from your demat and give it to the exchange by the end of the same day you sold the shares, a broker can allow you to sell without asking for any upfront margin. At Zerodha, we currently debit the shares and give it to exchanges on T+1 day (it is still Early payin as we don’t wait for T+2). We are working on having our systems ready to do Early Payin on T day so that you don’t have to have the margin in your account to sell your stocks from Aug 1st 2020.
Margin for BTST trades
If the stock is sitting in your demat account, it can be debited from your demat and given to the exchanges on the same day you sell to avoid margin requirements as explained above. But when you buy today and sell tomorrow (BTST), you still don’t have the stock in your demat yet, as it takes two days to get credited. Which means that to sell a share the immediate next day after buying, you will now need VaR+ELM margin. So if you buy Reliance today for Rs 1 lakh, you will need Rs 22,000 in your account tomorrow to be able to sell it.
One workaround for brokers like us who collect full money upfront for equity delivery trades is that, on T day, even though we debit 100% of the money from your account upfront, we report only VaR+ELM to the exchange. The next day to sell, there will be sufficient VaR+ELM to allow you to sell. So for example, if you had Rs 1 lakh with which you bought Reliance, we block and report Rs 22,000 as VaR+ELM on T day. On T+1 day, to sell Rs 1 lakh of Reliance, we will report Rs 22,000 from the remaining Rs 78,000 in your account as margin available. What this means is that we can allow BTST trades (if you have no other money in your account) on stocks where VaR+ELM is less than 50%. Since the top 1500 stocks have VaR+ELM less than 50%, this also wouldn’t be a big deal for online brokers like us who collect full money for delivery trades when taking the trade.
The biggest issue with the FAQ is
You will not be able to use your sell proceeds to buy other stocks
The FAQ states that you can do away with the margin requirements to sell shares by doing an Early payin on T-day as explained above. But you will not be able to use the proceeds from selling that stock to buy anything until T+2 day. So if you held Rs 1 lakh of Reliance and you sold it on Monday, you can use this Rs 1 lakh to buy other stocks only on Wednesday.
Ideally, since the stock which is sold is going to be delivered to the exchange (Early Payin) on T-day and there is no risk. The customer should be able to immediately use the proceeds from the stock sold to buy some other stock or use it for F&O if required (hedging or trading), but you will not be able to.
This is how shopping happens everywhere today - I swipe the card at the showroom, the bank credits it to the merchant after 2 days, but since this is a guaranteed transaction, I can take the goods that I purchased along with me immediately. Similarly, I sold shares, the broker did Early Payin on the same day, funds are guaranteed to come on T+2, so maybe allow to purchase the same day, instead of saying come back after 2 days?
There are traders who sell shares and then buy back the shares the same day. Margins will be required even to buy back once peak margin reporting for the day starts from Oct 1st, 2020. So if you held Rs 1lk of Reliance in Demat, which you sold and bought back intraday, while the net position at the end of the day might be 0, your peak position for the day would be Rs 1lk short Reliance for which you’d require to have a margin. Since there would be no Early Payin since you bought back the stock, it will be treated for a short margin penalty.
By the way, the above rule also means that if you exit your long option positions, you will not be able to use that money to trade futures, short options, or buy stocks until T+1 day. You will be able to use it only to buy other options on T day. Everything remains the same for futures and short options positions and also remains the same for all intraday trading. By the way, the penalty for non-collection of upfront margin is now on the broker and not the client, which means brokerage firms will not be able to allow the customer to take such trades even if they’re willing to pay the short margin penalty.
I am hoping that this is a second-order effect of cash margin requirement which slipped through. Hopefully, gets clarified soon and clients will be allowed to use the sell proceeds immediately.
Update: The implementation of these rules has been postponed to September 1, 2020.