SEBI Brings Changes in Cash Collateral Rules in MTF

The Securities and Exchange Board of India (SEBI) has relaxed the margin trading requirements, allowing securities funded through cash collateral to be considered as part of the maintenance margin for margin trading facilities (MTF). This move is expected to reduce the operational burden on brokers and traders, promoting ease of doing business in the Indian capital markets. Let us look at the details and the impact it will have on the market participants.

Key Changes to Margin Trading

Previously, only securities held by the client could be used as maintenance margin. The new rule allows securities funded through cash collateral to be considered as part of the maintenance margin, reducing the need for additional collateral. Cash collateral can be used as maintenance margins but with the below conditions:

Group 1 Securities: Only securities from Group 1 (a list of high-quality stocks) can be used as maintenance margin in this case.
Margin Calculation: The margin requirement for these securities is calculated using a combination of Value at Risk (VaR) and Extreme Loss Margin. This means the margin will be higher than for other securities.
No F&O Requirement: The margin calculation for these securities is the same regardless of whether they are available for trading in the futures and options segment.

Further, SEBI clarified that stocks or units of Equity ETFs used as collateral with stock brokers for margin trading (referred to as collaterals) and the stocks or units of Equity ETFs acquired through margin trading (referred to as funded stocks) must be distinctly identifiable and must not be mixed when calculating the funding amount.

SEBI has strengthened reporting requirements for trading members. Brokers must now disclose their exposure under Margin Trading Facility (MTF) by 6:00 PM on the next business day after the trade. This ensures greater transparency and regulatory oversight.

Reasons behind the changes in cash collateral rules for margin trading facility

SEBI's relaxation of cash collateral rules for margin trading facilities (MTF) is likely driven by below factors:

To reduce the operational burden on brokers and traders: By allowing cash collateral to be used as maintenance margin, SEBI aims to simplify the margin trading process and reduce the administrative burden on market participants.
To promote ease of doing business: This move is part of SEBI's broader efforts to create a more conducive environment for businesses in the Indian capital markets.
To enhance market liquidity: By making it easier for investors to participate in margin trading, SEBI hopes to increase market liquidity and depth.
To align with international practices: The relaxation of cash collateral rules brings India's margin trading regulations in line with international standards.

What is cash collateral in margin trading?

Cash collateral in margin trading refers to the cash deposited by an investor as security to borrow funds from a broker for purchasing securities. The borrowed cash acts as a guarantee that the investor will fulfill their obligations, especially in the event of a loss. Margin trading allows investors to leverage their positions, enabling them to trade larger amounts of securities than they could with their available cash alone.

In margin trading, an investor borrows money from the broker to buy securities, using their own cash or other assets as collateral. The broker charges interest on the loan, and the securities purchased are held as collateral by the broker. If the value of the securities falls significantly, the broker may issue a margin call, requiring the investor to deposit more funds or sell some securities to maintain the minimum margin requirement.

Suppose an investor, Mr. X, has Rs 1,00,000 in cash and wants to invest Rs 2,00,000 in a stock. To do this, Mr. X engages in margin trading by borrowing an additional Rs 1,00,000 from his broker. The broker requires Mr. X to maintain 50% of the position value as collateral (a common margin requirement).

Total Investment in Stock: Rs 2,00,000
Mr. X’s Cash Collateral: Rs 1,00,000
Amount Borrowed from Broker: Rs 1,00,000

Mr. X has used leverage, meaning he has purchased Rs 2,00,000 worth of stock with only Rs 1,00,000 of his own money. The remaining Rs 1,00,000 is borrowed, and his cash collateral secures the loan.

Before you go

These changes will be effective from October 1, 2024, and will aim to streamline margin trading procedures. By addressing feedback from industry professionals, SEBI is making the process more efficient and user-friendly while maintaining market transparency.