Moneycontrol Pro Panorama | SEBI’s margin move may make life hard for retail investor

Dear Reader,

Market regulator Securities and Exchange Board of India (SEBI) continues to tweak margin rules in the derivative segment, much to the annoyance of traders. SEBI’s margin requirement rule that was expected to be implemented from December 2021 is now likely to be implemented from February 28, 2022.

According to the changed rules, an individual trader will not be able to fund the margin requirements by using shares in the portfolio. Instead, 50 percent of the margin account has to be funded with cash. SEBI’s intention of doing this is to bring down volatility, but in reality, it may have the exact opposite effect.

Many clients, especially those in the retail, high net worth individuals (HNI) and proprietary book segment use their share portfolio as a margin. Changing the margin rule will hit market volumes in the derivative segment. Lower liquidity will increase market volatility, rather than lower it.

The changes in the margin rule suggested by SEBI go against the very definition of derivatives. When derivatives were introduced in India, they were marketed as hedging instruments. If an individual has a portfolio that has been held for a long time, the individual could protect against any fall in the market by either buying a put option or by selling a call option, or selling a futures contract. If there was a fall in the market, the profits from the derivative trades would protect the investor.

Many traders made a decent 1-2 percent return per month using a strategy called the covered call, where an out-of-the-money (OTM) call of the stocks in the portfolio or the index is sold. This trade will now stop because the investor will have to keep cash in the margin account. If one includes the cost of liquid cash lying in the client's account, then the return from a covered call trade would not be as lucrative as earlier.

The logic behind bringing in 50 percent margin in the form of cash makes little sense. Brokers and exchanges allow shares of only strong companies to be kept as margin. Further, there is a haircut system followed by the brokers where on average around 70 percent of the value of the shares is considered as margin. So, if an individual has shares worth Rs 50 lakh in the portfolio, only Rs 35 lakh (70 percent of Rs 50 lakh) will be treated as a margin. This way the brokers and exchanges are protected and can liquidate the shares the moment there is a margin shortfall.

If the value of these shares falls, the broker marks it to market and gives lower exposure to the client. At that point, the client has to either bring in extra margin by way of shares or cash if the client wants to continue with the same exposure. If the value of the portfolio increases, the broker increases the limit for the client. This is done automatically and the broker and client do not need to interact with each other.

As far as SEBI, exchanges and brokers are concerned, the client has provided security as a margin that is reasonably liquid and can be sold by the broker on the exchange regulated by SEBI. Where is the scope of default in such a case?

The system has been working well since derivatives were introduced in the country and did not require an unnecessary change such as this one. By bringing this change, the worst affected will be the retail trader who typically has a paucity of cash and prefers to use shares in the portfolio to make an extra buck. SEBI will once again be harming the very segment of retail participants it claims to protect.

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Moneycontrol Pro