'Impact of upfront margin requirement to hit broking industry topline'

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Even though the upfront collection of margins reduces the risk to the investors & the markets, it will severely impact trading volumes. It is anticipated that the trading volumes in the cash segment may fall by 20-30 percent from the current level, Nilesh Sharma, Head of Broking Operations at Samco Securities said in an interview to Moneycontrol's Sunil Shankar Matkar.

Edited excerpt:

Q: SEBI released a framework to enable verification of upfront collection of margins from clients in the cash segment. What are key things to know by investor as well as broker, what is the exact process and what are your thoughts?

Due to the introduction of upfront collection of margin from clients & enabling its verification, the cash segment of stock markets in India will be affected in two major areas:

A) Delivery Trading

Before the introduction of SEBI Circular titled 'Collection and reporting of margins by Trading Member (TM) / Clearing Member (CM) in Cash Segment' dated November 19, 2019 which comes into effect from August 1, 2020, a large part of the Broking Industry, especially traditional brokers, used to follow the T+2 day system of billing & collection.

In the T+2 day system, brokers were required to keep margins upfront with the exchange, however collection from the Clients was left at the discretion of the Brokers.

Thus earlier, without having to put a single rupee as margin, a client could have entered into a trade in the Cash Segment for any amount, as allowed by the broker, and pay the amount to the broker till T+2 days. This is going to stop from August 1, 2020. Now, from August 1, investors will have to keep the exchange prescribed margin with the broker and only then they will be allowed to enter a trade, else margin penalty will be charged by the exchange to the Client.

B) Intraday Trading

For Intraday Trading the above-mentioned Circular proved ineffective as the Exchanges have been monitoring the margin collected by the broker on the net positions at the end of the day. This system was not adequate to ensure that the broker has collected margin on the intraday trades entered by the traders.

For eg: If one buys 1,000 Reliance & sells it during the same day, no margin was required to be paid as per the calculation on the end of the day. Due to this, the brokers were able to provide extra leverage for intraday trades to their clients.

With the introduction of framework to enable verification of upfront collection of margins from clients in the cash segment, the Clearing Corporations have been asked to provide the 'peak margin during the day' to the brokers which is required to be collected upfront from the traders / investors. And the above practice of levying margins only on the net positions at the end of the day will stop. However, this is going to be implemented in a phased manner and its impact will be felt from December 1, 2020 for intraday trades.

After full implementation of the Circular, leverage in intraday trading would still be prevalent as the trader will have to pay only a fraction of the total investment as margin (VAR + ELM) prescribed by the exchanges. However, the leverage would be far lesser and it would be regulated by the exchanges and the practice of giving virtually unlimited leverage by the brokers will stop.

Thus, with the above 2 changes, extra leverage being provided by the brokers for both delivery and intraday trades in the Cash Segment will be stopped.

Q: What is the major reason behind implementing upfront margin requirements in the cash segment as it was already in the derivative segment? Also is it a right step by Sebi?

The major reason for the introduction of upfront margin requirements is to curb the excessive leverage and funding being provided by the brokers to their clients. The brokers could have misused the non-collection of margins from clients by providing excessive leverage to only a few of their known clients. Also, the credit risk of one big customer can affect other clients of the broker thus preventing additional risk to the customers.

Besides, if the brokers wish they can continue to provide funding to the customers directly through the framework of Margin Trading Facility whereby exchange prescribed margin requirements are applicable.

Even though the upfront collection of margins reduces the risk to the investors & the markets, it will severely impact the trading volumes. It is anticipated that the trading volumes in the Cash Segment may fall by 20-30 percent of the current volumes. The reduction in trading volumes will also have an impact on the Market Depth, high volatility due to lesser participation by intraday speculators.

It will also not allow the optimum usage of money lying with the brokers whereby in 'intraday trades using stop losses' the risk is contained and thus blocking the full exchanged prescribed margins are not required.

Q: Do you see any impact of Sebi's upfront margin requirement in the cash segment, on new age investors (or retail investors) who joined the stock market during lockdown?

There will definitely be an impact on all sets of traders and investors. However, having said that, the impact of the upfront margin requirement will be a tad lower on the new age investors (or retail investors) as they are new to the markets and initially prefer to invest with the amount lying in their bank accounts. The retail traders who had come to the market on the hope of taking extra leverage and earning some quick bucks would be a bit disappointed.

Q: What is the impact on the broking industry in general or traditional brokers who allow traders to buy a stock and pay after, and online brokers?

The introduction of upfront collection of margins in the cash segment will impact the trading volumes for the whole broking industry and thus hit their topline.

However, the impact would be felt the highest by the traditional brokers. They used to charge brokerage to the customers based on a percent of turnover which is definitely very high as compared to the discount brokers who charge per order and generally have a fixed upper cap of say Rs 20. The traditional brokers were able to charge a higher brokerage rate mainly due to the option provided to their clients of paying the investment amount after 2 days without any interest. Thus, they used to provide this T+2 day payment system as an additional feature and charge higher brokerage to their clients in lieu of interest.

Also, as compared to the discount brokers the traditional brokers would be impacted more due to the direct relationship of their brokerage income (percent based system) with the turnover. Their revenue will be affected at the rate of decrease in turnover. However, since the discount brokers charge per order they won't be hit directly. For e.g. for a trader whose average trade size in intraday is say 10 lakh per order & post the implementation of the circular if it comes down to say 2 lakh per order. He would still be paying the fixed capped brokerage to the discount brokers.

Q: What could be the impact on intraday turnover and will it also impact arbitragers?

It will definitely have an impact on the intraday turnover of the whole market due to the reduced liquidity. The speculation activity will also reduce thus impacting the volumes, market depth and consequently the impact cost for trades. For arbitragers, the lower depth will reduce the chances and risk of arbitrage. Also, the margin requirement will drastically increase the capital requirement and thus impact their return on capital and may make it unviable for them to continue with the arbitrage business.

Q: Do you expect stringent rules from SEBI  in coming days to protect investors?

We expect SEBI to introduce more stringent rules in the coming days to avoid fraud or credit risk to a few of the brokers and thus protecting the interest of the investors. However, they should also focus on the impact of the rules to the whole market & its participants. In general awareness and investor education should be key focus to increase the market penetration in India.

Q: The market rallied 48 percent from its March lows and majority of leading sectors participated in the run. Do you think it could continue further?

After the knee-jerk reaction due to the COVID situation and the corresponding lockdown impacting economies and life of numerous people all over the world, the market has given a pull back rally from the March lows.

The current rally in the markets is driven by liquidity due to the stimulus packages announced by various countries globally, a better-than-expected performance by stocks of a few companies and also to some extent by the increased local participation by the new age investors.

We expect that it is time to be extremely cautious and the investors who were able to invest during the March lows should start booking profits.

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