After a meeting with brokers, depositories and clearing corporations on August 31, the capital market regulator Securities and Exchange Board of India (SEBI) decided to go ahead with its new margin pledge rules from September 1, 2020.
SEBI has introduced these measures to safeguard the interest of all investors and wants to have a higher degree of transparency in the stock market.
"The new pledge mechanism will bring much-needed transparency and will prevent brokerages from misusing clients' securities," Tejas Khoday, Co-Founder & CEO at FYERS told Moneycontrol.
Traditional brokerages with legacy systems will face huge operational challenges that can cause chaos and unintended consequences in the near future, he said.
The meeting was held to request SEBI to extend the deadline by a month as brokers were not ready with the system to implement new margin rules. The regulator sought a report from National Securities Depository Ltd (NSDL) and the Central Depository Services Ltd (CDSL) and both said they were ready and could go live from September 1, sources told Moneycontrol.
A smooth rollout will require stock exchanges to seed client codes in demat accounts, depositories to enable the pledge and re-pledge system, and clearing corporations to provide margin limits to members, who, in turn, could give them to clients.
The Association of National Exchange Members of India (ANMI) sought a month's extension from the regulator.
"In today's virtual meeting, Sebi declined to grant extension of further time in implementing margin pledge /repledge process. This came as a big surprise to ANMI and its 900 members. ANMI is holding consecutive meetings with all stakeholders and studying all options available to it in the matter," an ANMI spokesperson said.
Pledging refers to using stocks as securities to avail a loan. Traders in the futures and options (F&O) segment use pledging to receive margin funding from the broker to invest in large deals to earn maximum returns in a short time.
A popular tool worldwide, margin allows investors to leverage, invest in deals without assuming the full risk at the first stage. When you pledge, your risk exposure gets limited to the securities you have used as collateral. In case you can’t repay the margin, the broker sells the stocks to recover the debt.
The broker is the custodian of securities or funds in the margin account but there have been complaints of misuse. Some brokers were found guilty of misusing client funds and collaterals. The new margin pledge policy will help to address this problem.
Under the existing system, investors don’t have to pay upfront margin in the cash segment as cash margins are looked after by the broker. SEBI wants to implement it in the cash segment, too.
From September 1, brokers will have to collect margin from investors upfront for buying and selling securities. Failing to do so will attract a penalty. The securities in the demat account will not automatically become available to receive margins. The broker also has to report to the exchange the margins collected from investors.
Analysts say it is a good step in the long term but in the short term, there will definitely be a fall in trading volumes.
"On the immediate front, it will definitely hit volumes from September 1 and if the margins are not executed then you have to close your positions. Both way retail participation will see a big dip from September on the F&O side," Ajay Srivastava, CEO of Dimensions Corporate Financial Services told CNBC-TV18.
It would hit the unorganised sections of the brokerages badly. "We also reduced the positions per se due to pledged issue. Definitely it is going to cost dislocation, it is going to cost new volumes coming in the F&O front from the retail side, but in the long term it is a great positive for large companies like ICICI Securities, etc because of the safety of their portfolio and pledges, people will have to move to them and the whole advantage of having a flexible arrangement with small brokers is no more valid at this point of time in F&O segment," he said.
Deepak Shenoy of Capitalmind told CNBC-TV18 said a lot of brokers had started implementing some part of the new mechanism but it had unintended side effects.
"Earlier when shares were pledged, actually transferred to demat and into a margin pull account with your broker and this is where all shares of all customers of broker are co-linked and provided the margin. With this facility, sometimes it can be possible that some peoples who have given their shares for margin are not using margin and that margin can be provided to somebody else. This is a co-mingling problem, perhaps a problem that was seen in Karvy case and in couple of cases happened in the recent past," he said.
Now shares would remain in demat accounts and lien would be marked against them. "Without the co-mingling support, you might see volumes drop more in the coming days, after September 1 and not today. We could see a further complicated issue regarding unintended side-effects perhaps of this where these are unhealthy practices, you should not of course give margin to somebody else on the basis of somebody's shares," he said.
"But now that possibility has taken away and we want to see the impact of it but it will not happen today but will happen from September 1."
Shenoy, too, said volumes would go down. On August 31 volumes were at around Rs 74,000 crore in the cash segment, which was substantially higher than normal days "but volumes can fall starting tomorrow. I am worried in the short term but not in the long term", he added.
Deepak Jasani, Head of Retail Research at HDFC Securities told Moneycontrol that the change in margin system and securities pledge-repledging could undoubtedly bring disruptions in volumes of daily trading as there is insufficient preparation and validation by the participants in this system - viz Exchanges, Depositories, Depository participants, Clearing corporations, Brokers and clients.
"We could witness further polarization of stocks in the markets for some time with the top 200-300 stocks seeing the most depth and liquidity. The securities currently pledged with the brokers need to undergo the new process, which so far is not smooth going by the runs conducted so far. Hence large traders are unsure as to whether they will have limits to trade on September 1 which may lead to volume drop in both Cash and F&O segments that may last a few days/weeks," he said.Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.