The SEBI-appointed Risk Management Review Committee met on October 16 and agreed to most recommendations of the sub-working group. This group had proposed lower margins for hedged positions and status quo on unhedged derivative positions
Capital and commodities markets regulator Securities and Exchange Board of India (SEBI) plans to reduce margin requirements on certain trades done in the equity and currency derivative segments, sources told Moneycontrol.
The idea behind the reduction is to bring margins on derivative trades in India on par with those levied by global exchanges.
A recent study by EY showed that margins on derivative trades in India are up to 500 times higher compared to global exchanges.
The study had compared margins levied by Indian exchanges and those by bourses like Chicago Mercantile group, Osaka Securities Exchange, New York Stock Exchange, Singapore Stock Exchange, Euronext, Australian Stock Exchange and Hong Kong Stock Exchange.
SEBI-appointed Risk Management Review Committee (RMRC) met on October 16 and agreed to most recommendations of the sub-working group. This group had proposed lower margins for hedged positions and status quo on unhedged derivative positions.
A hedged position consists of two opposing trades in the same security. This reduces risk, but at the same time also limits profits.
For instance, in a put-call parity arbitrage trade, which involves buying the call option and selling a put option of the same strike price (say 11,500 on the Nifty) and selling the Nifty futures, a trader currently has to pay Rs 1.16 lakh as margin. Under the proposed margin structure, the margin applicable to this combined trade will fall to Rs 5,000.
If there is only one leg of the trade, then the present margin rules will apply.
Similarly, in a Nifty call spread, assuming buying a Nifty call of 11,500 and selling a Nifty call of 11,600, the margins based under the current structure work out to Rs 80,000. Under the new structure, it will fall to Rs 5,000.
The steep reduction in margins, while adhering to risk management rules, will benefit market participants immensely. That is because lower margins will improve the returns of traders as the amount of working capital blocked will be much less. That could help traders do transact more, which in turn could boost liquidity and reduce impact cost.
A source told Moneycontrol: "SEBI, clearing corporations, stock exchanges, and brokers have given in-principle approval to this new mechanism."
However, some trading and clearing members are opposing the move to reduce margins since they earn interest on margins their clients deposit with them.
Brokers say that the new margin structure if implemented, would be a major reform in the equity and currency derivatives segment.
The SEBI committee has backtested the new margin rules with some major downswings in the market in recent times. It concluded that the margins were sufficient even when a stock like DHFL fell 40 percent in a single trading session.
According to a report on the margin structure by consultancy firm EY: “India is the only country in the world where initial margin charged in the F&O (futures and options) segment consists of three margins -- SPAN (Standardised Portfolio Analysis for Risk), exposure and additional margin. The study also found out that if India followed only the SPAN margin system it would have been good enough to cover the risk for 99.44 percent instances of At-the-Money (ATM) and Out-of-the-Money (OTM) stock option contracts. Simply put, there is no need to burden traders with extra margins."
The report further says: "Higher margins result in a lower return on investment (RoI) for a trader. Ironically, an FII who has an option of trading both in India as well as in Singapore Stock Exchange (SGX) has to pay the complete margin in India, but only the SPAN margin, if he trades the Nifty derivatives on the SGX. With the same amount of money the FII can get better leverage and higher return if he trades abroad".
Apart from the margins, various statutory charges are imposed on traders. India has the highest transaction charges in the world and these do not include the taxes one has to pay if they are profitable despite these restrictions.
Correction: A previous version of this article wrongly described the put call parity arbitrage trade by failing to mention a third leg, i.e. shorting the future. This has been changed.