What is the new margin rule on selling stocks

What is the new margin rule on selling stocks

Even those who do not regularly trade in the stock market are aware of how volatile it is. The uncertainty in the movement of share prices leads to a certain level of risk that all investors must undertake.

To ensure that the buyers and sellers take their promises (of buying and selling) seriously, and a safeguard against frauds, non-payment of dues and spiralling into debts, the regulatory body has established margin requirements.Is SEBI the sole market regulator in India? Are there others in the stock market that work towards smooth functioning, while protecting the interest of all players? Know more about the role of market regulators in our blog here.

Let us now see what margin is and what it means to trading.

What is a margin?

Margins come into play in intraday trading, also known as margin trading. Here, the investors can purchase more shares than they can afford by paying a part of the total share value, known as margin.

Margin also acts as a form of security that you must keep with your broker while trading in shares. This is a certain percentage of the share value that you must extend in cash as a trader. It is among the various other costs traders have to bear. Know more about other stock investing charges.

Both the sellers and buyers must adhere to the margin requirements. This is because, for every fluctuation in price, there may be a buyer unwilling to pay for the shares or a seller unwilling to deliver the shares.

As per the old margin requirements, if you wished to purchase 100 shares with a 20% margin, you had to pay Rs. 20, with the broker putting in the remaining amount. However, the brokers extended lucrative discounts on the basic margin requirements. They gave an offer where you only have to pay, say 10% of the margin, Rs. 2. Effectively, you could purchase the shares by using a lesser amount and get a higher amount of leverage on the shares. For the broker, they could pull in more investors by extending this offer, earning more brokerage as the volume of trade increased.

However, this practice put the brokers at significant risk of insolvency. Even though they willingly roped in more traders, a fluctuation in price could lead to default from the end of the buyers or sellers, emptying the reserves of the broking house.

To avoid such a situation, SEBI introduced new margin rules, which came fully into effect from 1 September 2021. Let us see what these are.

What are the new margin rules?

The new margin rules restrict the amount of leverage that the brokers can provide. Announcing the change in a circular regarding peak margin requirements, SEBI gave the new rules for the same. A notice with the FAQs to provide clarification on certain points was also released.

Let us see how these new margin rules work.

For sellers

After you sell your shares, then as per the new rules, you would be free to use only 80% of the sale proceeds on the same day, also known as ‘T day’. The remaining 20% will be frozen and will only be released on T+1 day, which is the next trading day.

This 20% is kept as margin, ensuring that the brokers have enough margin before more traders place a buy order.

For instance, you own 100 shares of X Ltd. You place a sell order on them, giving them away for Rs. 200 per share.

The total amount that you earn is: Rs. 200*100 = Rs. 20,000.

However, you will only receive 80% of this amount, which is Rs. 16,000, for immediate use. The remaining Rs. 4,000 will be available to you on the next trading day.

Similarly, there are new rules while buying shares. Let us understand them.

For buyers

If you wish to buy a certain amount of shares, you must pay the complete margin on it. For instance, if you want to buy 10 shares of Rs. 100 each, and there is a 20% margin on these shares.

The entire value of the transaction would be: 10*100 = Rs. 1,000.

The margin on this would amount to 20% of Rs. 1,000, which is Rs. 200. You must pay the entire margin amount upfront to purchase the shares.

However, to ensure a smooth transition into this new regime, the rollout was phased out over the course of a few months. Let us see how.

The rollout

SEBI laid out a certain percentage of the minimum 20% margin requirement upfront. The percentage amount required to be kept liquid of the 20% was gradually increased to 100%. The rollout was implemented as follows:

Phase 1: 1 December 2020 – 28 February 2021

You were required to keep 25% of the minimum 20% margin while trading stocks. This was based on the VaR+ELM margin in the cash market and SPAN+Exposure in the derivatives market.

Phase 2: 1 March 2021 – 31 May 2021

The requirement was increased to 50% of the minimum margin requirement of 20%.

Phase 3: 1 June 2021- 31 August 2021

The requirement was further increased to 75% of the 20% minimum margin.

Phase 4: 1 September 2021 onwards

Completing the gradual rollout, the entire margin requirement (100% of the 20% minimum margin) is now required upfront.

The implementation of the new margin rules in four phases allowed the investors to understand and comply with them easily. Let us see what changes it brought forward in the stock market.

What is the impact of the new margin rule?

There have been various impacts of this new margin rule. Some of them are as follows:

Trading volume

As explained previously, due to an increased margin requirement, the number of shares that a trader can purchase for a given amount would reduce. On the other hand, only 80% of the amount from selling shares will be available for investing immediately (with 20% available on the next day). Consequently, this will lower the overall trading volume.

Leverage

Another impact is on the leverage the brokers could offer to the traders. Assume that the price of a share is Rs. 100. On this, the minimum margin requirement is 20%, amounting to Rs. 20. In the first phase, 25% of this (Rs. 5) is required to trade, giving you 20 times leverage. During the second phase, the amount of margin increased to Rs. 10 (50%), reducing the leverage to 10 times. However, when the new rules were fully implemented, the entire margin (Rs. 20) had to be paid, reducing the leverage to just 5 times.

Investor protection

Because of the higher margin, the risk involved is reduced significantly, protecting the interests of investors. It also allows those who do not have enough experience in trading to learn the ways of the market as there is lower leverage involved. It let traders venture into newer trades and expand their knowledge.

In conclusion

As per the new margin rules declared by SEBI, traders must now pay the entire 20% minimum margin requirement while trading in the market. Moreover, traders can only use 80% of the selling amount for trading on the same day. This rule was rolled out in a phased manner, allowing the market participants to familiarise themselves with it.

Contact us at TejiMandi for more market updates, rules and regulations, and investing advice from experts!

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