New SEBI Rules On Upfront Margin Collection: How Does It Impact You?

In the latest developments, security market regulator SEBI has issued a new set of rules and regulations on the stock settlement process and margin collection. It will completely change the way you carry out the buy and sell transactions on the stock market. According to the circular issued by SEBI on July 20th, 2020, trading members/clearing members in cash segments must mandatorily must collect upfront VaR (Value at Risk) margins and ELM (Extreme Loss Margin) from the clients. This is similar to the SPAN (Standard Portfolio Analysis of Risk) & exposure requirements for F&O. This rule will be applicable from 1st August 2020.

But before we get into the details of what is going to change from 1st August 2020, let’s understand how normal cash transactions work now :

Before the introduction of this rule, exchanges used to ask for upfront margins from brokers and collecting margins from clients was brokers’ job. Hence the investor could buy a stock in cash segment without any margin for amount allowed by the broker. In usual cases, these margin requirements used to get fulfilled by the end of the day.

If you buy new shares, they get credited in your demat account in T+2 days and similarly, if you sell your existing shares, the amount gets credited to your demat account in T+2 days. So, in current regime, if you sell any of your current stocks and wish to buy new stocks of same amount on the same day, it can be done without any margin payment. Because, the system captures the shares that your have sold and maps that amount to the new shares you have bought.

However, all of this is going to change from 1st August 2020. Here’s how the upfront margin requirements will work:

The first major change from this rule is that if you sell the shares on a particular day and want to buy the new shares of the same amount, you won’t be able to do that. Because the credit will only come in your account after T+2 days. If you want to buy the shares on the same day, you will have make the margin payment which changes everyday for every stock. So in simple terms, the margin requirements which were met at a broker’s level earlier will now have to be met at each client’s level before buying the stock.

Not only this, but the upfront margin will also be applicable on sell transactions. This is because when you buy a share, the records of the transactions are reported with the depositories. However, while you carry out a transaction on an exchange, they do not have access to depository’s database and hence they do not know whether you actually hold these shares. Hence, the upfront margin collection will also be done on sell transactions.

Another impact of this is also on the investors who keep the money in Liquid ETF Or Liquid Mutual Funds. The normal strategy used by a lot of investors is to park money in such funds for the short term. When the valuation is attractive, selling the mutual funds and buying the shares was easy. But now, since the credit from mutual funds will hit the account in T+2 days, this strategy will not work. Investors will either have to pay the upfront margin or wait two days to buy the stocks.

Why did Sebi come up with this change?

One of the important reasons for this move is to put a limit on the leverage provided by brokers to investors. As the upfront margin is now collected at each client’s level, brokers cannot provide extremely high leverage to any investors. This will reduce the credit risk for brokers and will protect the investors’ interest. Sebi is trying to ensure that Karvy–like events do not happen in the future and hence these new rules are now put in place.

What should Investors do now?

As of now, if you want to avoid paying the upfront margin, you should keep some cash in your saving account or in your demat account which you can use to buy the shares. Or you can have some shares / mutual funds pledged with the broker against which you can buy the new shares without paying the upfront margin.

If both these things are not possible, then you should be ready to pay the upfront margin while buying the shares.

This is all about the new rule on upfront margin by SEBI. In case of any further developments, we will update this space.