Equity Exchange Traded Funds Allowed As Eligible Security for MTF: SEBI

Nikhil Mogha

15 Dec, 2022

The SEBI, through circular “Inclusion of Equity Exchange Traded Funds as a list of eligible securities under MTC (Margin Trading Facility)” on 30^th November 2022, has allowed the Equity Exchange Traded Funds to be categorised as an eligible security or collateral for Margin trading facility. With effect from this circular, the SEBI, in furtherance to accommodate new provisions for Equity exchange traded funds, has modified circular No. CIR/MRD/DP/54/2017 dated 13^th June 2017. The present article will cover the modified provisions brought under the circular.

What is Equity Exchange Traded Funds and Margin Trading Facility?

The Equity Exchange Traded Funds is a pooled investment which operates similarly to Mutual Funds. It is a collection of securities that are traded on the stock exchange^[1] just like any other securities. The price of equity exchange traded funds fluctuates all day as it is purchased and sold throughout the day, which is different from the mutual fund as it is traded only once a day after the market close. The ETFs hold assets such as  bonds, stocks, currencies, futures, contracts and commodities. Most of the ETFs hold the same securities in the same proportions as a bond market index or stock market index. They are attractive to the investor as they offer low-cost and efficient trading.

The MTF or the Margin Trading Facility can be termed as when the trader increases its buying capacity of the securities by paying only a small or marginal amount.

What Are The Reasons For Treating Equity Exchange Traded Funds As Eligible Security?

Looking at the emergence of Equity Exchange traded funds as an investment product offering various advantages, including diversification, transparency, lower cost etc., in the market and based on the feedback received from market participants & the Secondary market Advisory Committee of SEBI, the SEBI decides to allow equity Exchange traded funds as eligible security under Margin trading facility.

What Are The Modifications Introduced Under The Article?

The SEBI, through its present circular on Equity Exchange Traded Funds, has modified the following provisions of SEBI circular No. CIR/MRD/DP/54/2017 dated 13^th June 2017:

Paragraph 3: Securities Eligible for Margin trading: The modified provisions now include units of Equity Exchange traded funds which are categorised as “Group I Security” under SEBI Circular on “Comprehensive Risk Management Framework for the cash market” dated 23^rd February 2005 along with the equity shares. Henceforth, the inclusion has made the equity ETFs eligible for the Margin Trading Facility.

Paragraph 4: Margin Requirement: the margin requirement for Equity Exchange Trade Funds on a Margin Trading facility shall be:

Paragraph 5: The modification in the circular has now allowed the client to pay the initial margin to the stock broker in the form of units of Group I Equity ETFs in addition to payment in the form of cash, cash equivalent and Group I Equity share.

Paragraph 6: The modified circular has allowed the units of:

• Equity ETFs that are deposited as collateral with the stockbroker for availing margin trading facility, and
• Equity ETFs that are purchased under the Margin trading facility

Shall be identified separately. Further, both types of Equity ETFs shall be distinct for computing the funding amount.

Paragraph 18(b): Leverage and Exposure Limits: The modified circular requires the stock broker to ensure that the exposure towards the units of Equity ETFs purchased under the MTF  or collateral kept in the form of Equity ETFs is well diversified while providing a Margin Trading Facility. Further, the stock brokers are required to have an approved board policy in regard to exposure.

Moreover, applicable haircuts for Equity ETFs shall be similar to the haircuts applicable to the Liquid Equity shares (Group I) as specified under SEBI Circular “Comprehensive Risk Management Framework for the cash market” dated 23^rd February 2005.

Paragraph 19: Disclosure Requirements: The modified circular has now required the stock broker to disclose information in regard to the Margin Trading Facility for units of Equity ETFs in the given format for disclosures by a stock broker to the stock exchange on gross exposure towards MTF.

Paragraph 14: Source of Funds: The present circular has modified paragraph 14 of the SEBI Circular “Comprehensive Risk-Management Framework for the cash market” dated 23^rd February 2005”. The modified provisions now allow the stock broker to use its own funds or borrow funds from the following for the purpose of providing a Margin Trading Facility:

1. Scheduled Commercial Banks.
2. NBFCs regulated by RBI.
3. Borrowing funds by way of issuance of commercial papers is subject to compliance under the relevant guidelines of RBI.
4. Borrowing funds by way of long-term unsecured loans from their promoters & directors are subject to compliance as per the relevant provisions of the Companies Act 2013.

Further, the stockbroker cannot borrow any funds apart from the abovementioned sources.

What Is The Applicability Date Of The Circular?

The modified provision of the present circular on Equity Exchange Traded Funds shall become e3nofracble on or after the 30^th day of the issuance of the present circular.

What Directions Are Given For Stock Exchanges?

The present circular has directed the stock exchange to:

1. Take an appropriate step for implementing the provision of the circular
2. Make relevant amendments to the bye-laws, rules & regulations
3. Inform the member broker about the stock exchange implementation of the decision.
4. Publishment of circular on the stock exchanges website.

Conclusion

The SEBI looking at the emergence of Equity Exchange Traded Funds as an Investment product in the market, has allowed the stock broker to use it as eligible securities under the Margin trading facility. The stock broker is required to diversify the Equity ETFs that are deposited as collateral and the Equity ETFs that are purchased under the Margin trading facility. Including Equity ETFs as eligible securities will enable the stock brokers to trade flexibility, portfolio diversification and risk management, and lower costs. The SEBI, while allowing the Equity ETFs to be used as eligible securities, has also maintained scrutiny over the stockbroker by requiring them to make disclosure of the exposure towards MTF in the units of Equity ETFs.

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