Explained: SEBI's New Margin-pledge Process and the Rationale Behind It!

With effect from 31st August, 2020 there is going to be a tectonic shift in the way shares are used as collateral for margin or leverage trading. What’s the big deal?

Let’s assume:

-         You have shares in your demat account worth Rs. 10 lakhs.

-         Your broker provides a leverage of 4x [i.e. he will allow you to buy shares worth 4 lakhs if you provide collateral of Rs 1 lakhs].

Existing system – 

You place a buy order worth Rs 4 lakhs.

What happens in the background?

-         Broking platform checks whether you have enough margin. [In this case you need a margin of Rs 1 lakhs. Your Demat holding is worth Rs 10 lakhs which is more than enough.]

-         Your order goes through.

-         At the End of Day, broker checks whether you have added cash for the shares you have bought?

If Yes - Ok, all good.

If No - he will pull shares worth Rs 1 lakh from your demat account into broker’s common pool account. The shares will no longer remain in your demat account. [They will be returned to your demat only when the transaction is settled by adding cash or selling the shares.]

New System-

You place a buy order worth Rs 4 lakhs. – Your order will be rejected because of “Insufficient Margin”.

What you need to do?

-         Go to your DP holdings, select shares worth Rs 1 lakhs and pledge it to your broker. [In the initial days, it will take 30-60 minutes after which margin will reflect in your trading account. Once, the system matures it may happen on real-time basis.]

-         The transaction will have to authorised with the depository (CDSL/NSDL) using an OTP that you will receive on your registered mobile/email.

-         Shares will not be transferred to the broker’s pool account but will remain in your own demat account under the “Pledged” category.

Is it cumbersome? Yes.

Plus, there will be a charge levied per scrip by the depository for every time you pledge or un-pledge.

Then, why fix something that's not broken?

Heard of the name Karvy? Karvy group is a well-known name in the capital markets. Its broking arm, Karvy Stock Broking reportedly had 1.2 million clients out of which ~3 lac accounts were active (Source: ET). This is what the promoters did –

-         Pulled shares from client’s demat to their common pool account suo-moto. [~87% of the clients had paid fully for the shares yet these shares were pulled in collateral by Karvy by misusing the PoA - source:ET].

-         They took loans from banks against the shares in the pool account. [Taking a loan by pledging something which did not belong to them – so nice of them!]

-         And then they did not repay the loan! [Perfect!]

-         Banks wanted to recover their dues so they started selling the shares that were pledged to them by Karvy promoters. [But these shares belonged to the clients!]

Only when the banks started selling these shares did the entire matter come to light. Now the matter is with the courts and they have ordered the banks to not sell any shares which belong to the clients.

This Karvy fiasco is the reason for the new margin-pledge process. While cumbersome, it will increase safety for clients as shares will stay in their own demat account under the pledged category. On the flip side, it will increase costs for traders as they will have to pay pledging and un-pledging charges which will be an additional source of revenue for CDSL and NSDL [No wonder, CDSL stock price is soaring.]

#SEBInewMarginPledge #Markets #InvestorAwareness

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I have tried to keep it simple. If you want to go into more details [and if you like to torture yourself occasionally], then you may try to interpret the official SEBI circular. Link for the circular and the ET article in the first comment.