In 2020, Sebi introduced the new margin rules for day traders under which stock brokers were now mandated to collect minimum margins on leverage-based trade upfront as against the earlier practice of collecting it at the end of the day.
After intense discussion and deliberation with the stakeholders, the regulator decided to push forward with the reform in a phased manner.
What is the new rule?
Under the new peak margin funding rule, a stock broker will have to collect the minimum margin paid by a client for taking a leveraged position in the market upfront.
The peak margin rule has been brought to reduce the additional leverage that stock brokers often provided their clients over and above value at risk and extreme loss margin they charged because they could square off all positions at the end of the day to meet the minimum margin requirement.
Under the new rule, the clearing corporations will demand that minimum margin be maintained throughout the session, forcing brokers to demand additional margin from clients if they fall short or stock brokers will face a penalty.
The additional leverage will now be restricted and brokers will be penalized if leverage exceeded VaR plus ELM and standardised portfolio analysis risk for derivatives positions.
For example, if you wish to buy shares of Reliance Industries worth Rs 1 lakh and the margin charged by the stock broker is, say, 20 per cent then you will have to maintain the entire Rs 20,000 margin with your stock broker.
What happens from September 1?
The margin rule has been introduced in phases so far and from September 1, the last phase will go into effect.
In phase 1, brokers were to be penalised if the margin asked by broker from client was less than 25 per cent of 20 per cent of trade value in case of cash market stocks and an additional SPAN plus exposure for derivative trades.
In the third phase, which came into effect from June 1, brokers were penalised if margin was less than 75 per cent of trade value in case of cash market stocks and an additional SPAN plus exposure for derivative trades.
From September 1, brokers will be penalised if margin was less than 100 per cent of the above metric.
What does this mean?
The second order effect of the new Sebi rules is substantial for day traders in the market. The implementation of the peak margin rules curtails the leverage that traders can get from their brokers to execute a trade in the market.
The reduced leverage is likely to reduce liquidity in the market and in the worst case scenario disrupt the price discovery mechanism of the stock market.
Why has Sebi done this?
Sebi has introduced the new rules to protect retail investors from the troubles of leverage. Leverage is considered your friend when you trade is profitable, but can sink your trading account if your trade works against you.
Sebi’s intended goal is to reduce leverage in the market to avoid large swings that can happen in stock markets during times of extreme stress or extreme bullishness.