The financial security of investors and market participants is essential for the expansion of activities and the entry of new investors. The Securities & Exchange Board of India’s new Stock Margin Pledge rule is a step in the right direction to ensure safety.
But first, let us understand margin pledging and then see how the new rules will impact retail investors.
What is Margin Pledging?
A margin pledging works just like any other mortgage programme. In margin pledging, you use your stocks assets as collateral to apply for a loan, similar to the mortgaging of real estate as collateral for a loan. Futures and options (F&O) traders often use Margin Pledging as collateral to obtain brokerage margin funds to invest in larger trades through initial investments.
Margin is a widely used tool in stock trading. Using this tool, investors can invest in commodities for a portion of their absolute value. By using margin pledging, you can save on investing real money by using an acceptable share price as collateral. This indicates that if you don’t reimburse the loss/depreciation, the broker holds the right to invoke and sell the shares of stock pledged for the margin for debt recovery.
Margin Pledging, by definition, refers to the process of using your stock as collateral for a loan. If you cannot pay the margin, brokers liquidate the stocks in the margin account to collect their debt.
What will the new rules prevent?
Before the introduction of the new stock margin pledge rule, a broker was promised the client’s shares utilising a power of attorney (PoA) signed by the client on the broker’s account. The broker then placed these shares in the clearing corporation.
The PoA used by some brokers was problematic. Some brokers often misuse PoAs to transfer their clients’ shares to other clients or utilise their shares as collateral and borrow money for themselves.
The new stock pledge rule abolished the PoA system and has introduced a new equity guarantee method. The pledged shares and promised promotions shall always remain in the customer’s Demat account under the new rules. The client would need to authorise a pledge request in favour of his broker. If the depositor takes responsibility, the broker can pledge shares to the corporation for the stake.
What are the changes in margin pledging rules?
Investors and brokers can no longer use a Power of Attorney (PoA) as proof of title transfer. They can, however, use it to transfer shares to the stock market in cases of debt recovery. It can also be used to initiate orders on behalf of clients, meet margin requirements, or provide trading limits to clients.
The shares need to be compulsorily put in the investor’s account. The stock can be directly pledged to the concerned person/authority, ensuring that investors continue to receive all the company’s benefits in their dealings.
The broker must invoice investors in advance for any trading margins. Any client who fails to do so is subject to penalisation.
A penalty on a short collection of 20% upfront margin and any other additional margin plus MTM loss within two days is required in the cash segment.
Under the new standard, investors must pay a minimum margin of 20% to use the trading system to buy and sell stocks.
Unlike the previous system’s end-of-day module, investors will have to fulfil their margin duties at the start of the deal.
Any investor looking to avail margin shall create a margin pledge.
Impact on the stock market and retail investors
The financial share of the trading volume may decrease due to the new margin norms. This is because SEBI has almost finished excessive leverage trades and directed brokers to collect higher margins from investors.
In addition, depositors must wait T+2 days before pledging newly bought shares. But it will not have a significant influence on ultra-short-term trading investors. However, active traders can increase the value of their business via trading costs as they will have to provide higher margins now.