Collateral margin

Collateral margin

Subject: Economy

Context: The Securities and Exchange Board of India (SEBI) came up with a fresh circular last week to strengthen the collateral margin reporting mechanism in the stock markets.

Concept:

Collateral margin is the extra funds received for trading or investing by pledging securities held in clients demat account.

• The collateral amount is essentially a loan offered by a stockbroker against the shares held in client’s demat account. The collateral amount is also referred to as the collateral margin. It can help client increase trading limit by increasing the amount of funds available in trading account.
• When the client avail this service, client basically pledge the shares held in client’s demat account with stockbroker. The stockbroker, in turn, provides client with a loan by enhancing client’s trading limit instead of disbursing cash
• In exchange for providing this service, the broker usually charges a fixed percentage of interest.
• When client pledge the securities available in client’s demat account, they are held as collateral and are temporarily blocked. This prevents client’s from selling the securities till the margin availed by client’s is repaid to stockbroker in full. Upon repayment of the margin along with the accrued interest, the collateral held is released.
• Clients are then free to either sell or transfer the shares as per the needs. In case client unable to repay the collateral amount, the stockbroker is free to sell the pledged shares and recover the loan amount.

Regulation

• The Securities and Exchange Board of India (SEBI) came up with a circular last week to strengthen the collateral margin reporting mechanism in the stock markets.
• According to it, Trading members, clearing members and clearing corporations now have to provide client-wise collateral information. The market intermediaries will need to report disaggregated information about client pledging through a web portal. This portal will have all the information on the value of securities pledged
• The facility is not restricted to shares and can be availed against mutual fund units, bonds, gold ETFs and fixed deposits
• According to SEBI’s new collateral margin reporting mechanism will come into effect on October 1, 2021,

Need for rules

• Reports of stock market investors losing access to the shares held in their demat account because their brokers had pledged their securities without their knowledge, to meet collateral requirements of other clients.
• It was common practise to hold client collateral in a shared pool which could be used at the broker’s discretion. Clients gave their brokers as power of attorney (POA) to deal with their demat on their behalf.
• The broker automatically appropriated shares of equivalent value from client’s demat account. But the rule implemented in September changed the mechanism so that the pledging process can only be initiated by client. Unless client avail of margin, the broker would simply say that the trade could not be executed because of insufficient margin.

Advantages

• SEBI’s new rules have added more steps to the once seamless process of availing collateral margin,
• It gives client the control over the securities held demat account, cannot transfer them even if client have given a POA. This also prevents the potential misuse of securities by brokers through pooling of collateral.
• If client’s shares are pledged, these will also not move out of client’s demat account. Instead, they will be tagged as pledged so that they cannot be sold unless the pledge is released.
• The details of the pledged shares will be available in the web portal.
• This move aims to increase the transparency of the decision of SEBI where it put in place a mechanism for pledging of securities.