What is the whole issue about the so-called ‘Peak Margin’ system? How will it impact investors, day-traders and the overall trading volumes? Here are answers to some vital questions of the new framework.
What are margins?
Before understanding the ‘Peak Margin’ framework, it is necessary to understand what is meant by margin and why does the Securities and Exchange Board of India (SEBI) give it so much importance. Simply put, margin refers to the amount of leverage money that a broker can offer clients to trade in securities. For instance, if the transaction value is Rs 10,000 and a trader has put in 50 percent, then the balance 50 percent, or Rs 5,000, is the margin money. The quantum of margin that a broker is allowed depends on a combination of factors, including the various mandatory types of margins imposed by the exchange after factoring in the type of stock – liquid or illiquid.
What are the different types of margins?
Margins are of various types – VaR (value at risk), ELM (extreme loss margin), SPAN (standard portfolio analysis of risk), exposure margin, special margin and mark-to-market margin. While these may sound complicated and technical, each of the margins have been structured with a defined reason. For instance, VaR margin is computed to cover the largest loss that a particular stock could witness on 99 percent of the trading days and is computed based on the historical price movement data. Mark-to-market margins take into account the daily swing in the stock prices. The margin system has been put in place by the market regulator with a two-fold intent. One, investors trade as per their risk appetite and two, in case of an abrupt and huge fall in stock prices, there is some buffer for investors who can replenish the margins and not see holdings being auctioned due to total lack of required margins.
What is the new ‘Peak Margin’ system?
Earlier, brokers used to report margin details at the end of the day for all trades—except those squared off during the day—that were executed on a particular day. Since the margin computations happened only at the end of the day, at times, brokers were able to provide higher leverage to their clients. In other words, the intra-day swings were not captured in this mechanism.
Under the ‘Peak Margin’ framework, brokers have to report margin details multiple times during the trading session. The new framework requires clearing corporations to take a minimum of four random snapshots of all margin status during the trading session. The highest margin requirement that emerges from the different snapshots would become the ‘Peak Margin’ for the day. Thereafter, the peak margin requirement would be tallied against the available margin of the investor and any shortfall would attract a penalty.
Why this sudden switch to the new margining system?
The change in the margining system has not been done in an overnight manner. The capital market regulator brought in the new framework in phases. In the first phase between December 2020 and February 2021, it was mandated that clients should have at least 25 percent of the peak margin with a broker. In the second phase starting on March 1, the minimum requirement has been increased to 50 percent. The third phase (June to August) and the fourth phase (September onwards) would see the margin requirement being increased to 75 percent and 100 percent, respectively. Brokers who fail to adhere to the minimum peak margin requirement would be fined. Also, the new mechanism has in effect capped the maximum leverage that a broker can offer clients at around 20 percent.
How does it impact investors?
An active trader—one who trades in securities on a daily basis or may be every alternate day—would be affected by the new margining system. Before the new margining system was put in place, an investor or trader who sold shares today could buy securities worth the sale value immediately based on the available margin since it would be computed only at the end of the session.
Under the ‘Peak Margin’ mechanism however, the amount of funds available to buy shares on the same day post a sale transaction would be reduced. This is because the margin requirement would be computed during the session and any price fluctuations would impact the quantum of margin available for fresh transactions.
This assumes significance as intra-day trades constitute a large portion of the overall transactions in the stock markets and brokers would now be reluctant to offer higher leverage to avoid the risk of penalties.
Is the new margin system bad for the markets?
There is not a clear yes or no answer to this question. As mentioned earlier, since day trading accounts for a large chunk of the trading volume, there could be some amount of hit on the volumes in the initial days. However, the new framework would also strengthen the overall safety of the markets. A higher margin requirement ensures that the investor has enough funds to face any potential risk that could arise due to sudden and significant price swings.
Trading on leveraged funds is not a prudent thing to do and excess leverage could wipe off all the holdings on a highly volatile trading session – not a rarity anymore. There is empirical evidence to show that a new framework impacts volumes or trading frequency in the initial days but over a period of time, all market participants get used to the new system and volumes return to normal levels.