Up until now, brokerage firms had the liberty to offer any amount of intraday leverage to traders. Essentially, since margin reporting was only done at the end of the trading day until now, brokerage firms had been allowing customers to take intraday positions with margins that were much less than the required VAR+ELM or SPAN+Exposure.
For instance, say the VAR+ELM for Tata Power comes in at 20%. Now, brokerages had been allowing traders to engage in intraday trades with a far less margin, often as low as 5%. This means that for a trade of Tata Power’s shares worth Rs. 1,00,000, brokerages would only charge Rs. 5,000 as margin (at 5%) instead of Rs. 20,000 (at 20%, as required).
Or, in the F&O segment, say if a trade in NIFTY futures required the broker to charge Rs. 2,00,000 as SPAN+Exposure, they would charge only Rs. 75,000 or lower.
Why is this a problem?
From the customer/trader’s POV, since they’d been charged lower margins, they could afford to enter into trades of larger volumes. But the trouble is, if a broker collects lower margin than required, the burden to meet the difference falls on the said broker. So, if a broker charges a trader only 5% VAR+ELM instead of, say 20%, the difference of 15% used to be borne by the broker. Broking houses have been adopting this model to stay ahead of the competition. But ultimately, this is detrimental to the broker. In the light of recent issues at BMA Wealth Creators and Karvy, SEBI believed it best to introduce a peak margin penalty.
Change in peak margin requirements as per SEBI’s new regulations
The practice of charging lower margins, thereby offering additional leverage, has been around for a long time. So, to make it easier for broking houses to transition to the new system, SEBI issued a circular in August 2020, detailing a phased shift during which the penalties/restrictions will be increased gradually from December 2020 to September 2021.
These are the details.
- A maximum of 20 times until February 2021
- 10X from March 2021 to May 2021
- 7X from June 2021 to August 2021
- And a max of 5X from September 2021
Derivatives(Equity FO, currency and commodity)
- From December 2020 to February 2021: Penalty if the margin blocked is less than 25% of the minimum 20% of trade value (VAR+ELM) for stocks or SPAN+Exposure for F&O
- From March 2021 to May 2021: Penalty if margin blocked less than 50% of the minimum margin required
- From June 2021 to August 2021: Penalty if margin blocked less than 75% of the minimum margin required
- From September 2021: Penalty if margin blocked less than 100% of the minimum margin required
How does this regulation affect trading?
Intraday trading is one of the key contributors to liquidity in the financial markets. Naturally, these new restrictions on intraday leverage are bound to reduce the liquidity in the segment. However, on the other hand, high leverage also makes many traders lose large sums of money. So, with these new caps on the leverage offered, traders will likely find it easier to survive in the markets.
As per this SEBI circular dated July 20, 2020, Motilal Oswal is required to collect upfront margin as well as peak margin (that is, Intraday margin) from clients as per the predefined script-wise percentage of margin prescribed by the Clearing Corporations/Motilal Oswal, which are subject to change on a daily basis depending on parameters such as volatility in the scrip, overall market conditions and so on.