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The Effect of Margin Requirements on Portfolio Diversification

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Published Date: 23 Aug 2024Updated Date: 27 Dec 20246 mins readBy MOFSL

Introduction

A new circular on peak margin requirements has been released by the (SEBI) Securities and Exchange Board of India, the regulatory body overseeing the Indian securities market. This circular, supported by accompanying FAQs from exchanges, outlines a significant change in how to sell proceeds are handled, particularly regarding immediate availability for reinvestment. According to the new regulation, only 80% of the sale transaction proceeds will be available for reinvestment on the same trading day. The remaining 20% will be accessible only on the following trading day.

Under this new system, the 20% portion of the sale amount will not appear in your account balance on the day of the transaction. Instead, it will be reflected in the account balance on the subsequent trading day. This adjustment stems from SEBI's broader goal of improving market stability and reducing risk associated with excessive leverage provided by brokers.

Background and Rationale

SEBI's peak margin reporting requirement, which came into effect on December 1, 2020, aims to curb the provision of excessive leverage by brokers. Before this regulation, brokers could extend significant margins to investors, sometimes allowing margins below the minimum requirement. This situation posed risks to both the brokers and the market. To address this, SEBI mandated that brokers hold a sufficient margin before clients can place buy orders. Consequently, your broker can now only offer 80% of the sale proceeds for reinvestment on the same day. The remaining 20% must be held as a margin requirement.

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The goal of this regulation is to ensure brokers maintain adequate margins and reduce potential financial risks. However, this adjustment leads to the temporary unavailability of 20% of the sell proceeds for reinvestment on the same day.

Where Does the 20% Go?

For instance, you may have instant access to Rs 80 for reinvestment if you sell shares for Rs 100. The remaining Rs 20 will appear in the ‘20% Delivery Sell Amount Blocked’ section on the same day and move to the ‘Available to Invest’ section on the following trading day.

What is the Impact on Investors?

Intraday Trading

SEBI's regulations also affect intraday trading. Brokers are required to adhere to the Var+ELM (Value at Risk + Extreme Loss Margin) margin system. SEBI's phased approach to limiting intraday leverage began on December 1, 2020, and is being implemented in stages:

1. December 1, 2020 – February 28, 2021: Brokers must collect 25% of the minimum 20% margin required on trade value for stocks in the cash segment or SPAN + Exposure in derivatives.

2. March 1, 2021 – May 31, 2021: The margin requirement increases to 50% of the minimum 20% margin for stocks.

3. June 1, 2021 – August 31, 2021: Brokers are required to maintain 75% of the minimum 20% margin.

4. From September 1, 2021, the requirement reaches 100% of the minimum 20% margin.

Delivery Sell Orders

The revised rule stipulates that 80% of the sell amount is available for immediate reinvestment for delivery sell orders. The remaining 20% will be available the next trading day.

Example Scenario:

If you sell shares worth Rs 1,000, Rs 200 will be held back per the new regulation. Consequently, Rs 800 will be accessible for reinvestment on the same day. If you buy back the same shares on the same day, the Rs 200 held back is released as the transaction is considered intraday.

Practical Considerations

This new regulation also affects the handling of stocks from a Demat account. Brokers can perform Early Pay-In (EPI) of securities, which involves debiting the stocks from the Demat account and transferring them to the Clearing Corporation. This process helps cover margin requirements and prevents penalties due to margin shortfalls.

Example 1: If you sell ten stocks valued at Rs 100 each, you will receive Rs 1,000. Under the new rule, you will immediately get Rs 800. If you buy back eight stocks on the same day, your broker can perform EPI for the remaining two stocks.

Example 2: Selling shares worth Rs 1,000 will result in Rs 800 being available for same-day reinvestment, while Rs 200 will be held and then released for reinvestment on the next trading day.

Conclusion

Note that DP (Depository Participant) charges will apply for all sell orders from Demat accounts on a per ISIN per trading day basis.

 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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