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Sebi weighing margin trading introduction

Janaki Krishnan & Sangita Shah

The Securities and Exchange Board of India is learnt to be considering the possibility of introducing margin trading on the bourses in the aftermath of abolishing badla and rolling settlement now becoming an established fact in the stock markets.

Badla served as a means of financing for brokers, and in recent weeks there has been a backlash from the broker community for its reintroduction. Sebi is clear that it cannot backtrack on the reforms process it has set into motion in the stock markets - however, according to sources, margin trading, in line with overseas markets, is very much on the anvil.

In fact, the regulator is expected to go even further and might introduce some restrictions on short sales when the market is on the downtick.

In overseas markets, there is no concept of carry forward of trades but margin trading is permitted - that is investors can buy (or sell) on payment of a margin (depending on the risk perception in the stock) but the trades have to be squared within the same day). There are wider ramifications to margin trading, as in overseas markets the financing is usually provided by banks and financial institutions. Here, banks and FIs have a very limited role in markets sphere while lending to brokers is strictly prohibited.

Since the ban on deferral products, a need for loan-based trading has been felt like never before. The solution to such need is margin trading which is strictly a loan-based transaction and not a deferral product.

Margin trading will offer another avenue to the brokers for earning income on account of interest earned on such accounts. This will keep the brokers in business, who of late have been facing steadily declining income from brokerage fee.

Moreover, with restrictions on bank financing of equities, it becomes all the more important to have such a lending and borrowing mechanism in place.

An investor, purchasing securities, has to pay for them fully in cash. However, when only a part of the transaction value is paid by the investors and the rest borrowed from a brokerage firm, it is generally called margin-based transaction.

Purchasing securities by borrowing a portion of the transaction value and using the securities in the portfolio as a collateral is called margin trading.

Margin is the amount of money or equivalent value of eligible assets deposited by the investor with his brokerage firm. It enables the investor to borrow money to purchase more securities than he would have otherwise been able to do with his own money. The transaction is done on the expectation that the stock price will either rise or fall enabling him to make greater profits.

The part of the transaction value that the investor has to deposit with the broker is called margin, which is the initial equity in the margin account of the client or investor. The loan from the brokerage firm is secured by the securities purchased by the investor. Conversely, an investor can also short sale through a margin account, that is borrowing securities from the brokerage firm in order to sell it, hoping that the price will decline.

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