Margin in Cash Segment: The dilemma of new system

Ashish M. Shaji

07 May, 2021

SEBI had introduced certain requirements pertaining to collection and reporting of margins by trading member/clearing member in cash segment. In this, the client/investor should mandatorily deposit margin and (VaR and Extreme Loss Margin) with the trading member before execution of trades by the client/investor. Further, it should be reported to the exchanges on a daily basis.

SEBI, in its circular dated 31^st July 2020^[1], directed that there would be no penalty on account of short collection/non-collection of the margin in case where the TM/CM collects minimum of 20% upfront margin in lieu of VaR and Extreme Loss Margin from the client/investor. According to the circular, SEBI extended the date of applicability of the penal provisions.

Margin in Cash Segment: Position before the issuance of the SEBI circular

Before the circular was issued, the clients/investors used to issue a power of attorney in the broker’s name who could use the extant holdings of its clients to access margin for trade in derivatives and therefore, there was no need of any specific instructions from the clients. It is called the title transfer. It led to one clients’ securities being used to provide margin to client who had shortage of it.

Margin in Cash Segment: Impact of this SEBI circular

Under the trading practice before the issuance of the SEBI circular, the client/investor was not needed to deposit any upfront margin, which allowed the client/investor to freely trade while making intra-day trades. Intra-day trades means buying and selling or selling and buying of the same quantity of shares on the same day.

However, now the client/investor is required to deposit 20% upfront margin even in case of intra-day trades. This pre-condition is expected to limit the quantity purchased by a client/investor and can reduce the trading volumes at the stock exchanges.

Effect of pledge under the new circular vis-a-vis Power of Attorney

In SEBIs circular dated Feb 25, 2020, had called upon the CM/TM to accept collateral from its clients in the securities form only through margin pledge. It prohibited the practice of transfer of securities to the Demat account for margin purposes. Henceforth, the power of attorney, if any, given by the client to the TM/CM won’t be considered as equal to the margin collection and therefore has become null and void for the purpose of margin.

Power of Attorney is governed by the Power of Attorney Act 1882, as per which Power of Attorney includes an instrument allowing a person to act for in the name of the person executing it. It is always executed at the client’s discretion, and the trading member can’t force a client to execute a Power of Attorney.

Moreover, Power of Attorney, once executed, can be revoked by the principal only. Execution of this comes under the private ambit of the parties.

Execution of Power of Attorney didn’t restrict client from trading in the shares on which the authority was provided to the trading member, whereas under the new system after the shares are pledged by the client, it can’t be traded in the market. Further, under the new system, the TM/broker can levy charges for pledge of shares. Many clients/investors have faced difficulty in pledging their shares because of technological issues.

What is the dilemma?

If a client is having a holding in his demat account, then there is no requirement of having margin as there is no security requirement. However, under the new system, the client should deposit 20% upfront margin even when he is selling his shares. This is of no logic as the person should first deposit 20% upfront margin when he is going to be the net receiver on account of sale of his shares.

The deposit of 20% margin at sale appears to be contrary of the principles of the Indian constitution as it imposes a condition precedent on sale of individuals’ assets thereby denying such individual to dispose of his wealth and assets directly.

Further under the new system, the client/investor should wait for the transaction to get settled before using the proceeds out of it whereas earlier the sale proceeds were considered as notional proceeds and could be used for doing further trade.

Conclusion

Hence it can be concluded that there is a conundrum of margin in cash segment. The new system might cause hardship to the investors. The trading volumes at stock exchanges may suffer due to this change in the trading procedure.

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