The SEBI’s proposal last year to get stock market traders to eventually shell out the entire margin money upfront was widely expected to shrink trading volumes and make share prices volatile.
Nine months on, benchmark indices continue to make new highs even after the fourth and final phase—requiring clients to deposit 100 percent margins with brokers—became effective September 1.
So much so that deep pocketed stock market traders and brokers protesting the new margin rules are finding themselves marginalised in Dalal Street’s new pecking order.
So how come the market was able to take such a disruptive move in its stride?
An unprecedented bull run has helped, as has the rush of first time investors, and the market making peace with a determined regulator.
The driving force behind the market’s resilience to the margin rules has been a shift in the balance of power across various classes of investors.
Institutions continue to be dominant players, but big volume traders—high networth investors (HNIs) in market parlance—are no longer number two on the list.
Retail investors—directly putting money in stocks or investing through mutual funds—are a more potent force now, say brokers. In FY21 alone, around 14.2 million demat accounts were opened, nearly three times the average for the previous three financial years. An overwhelming majority of these investors trade online, which requires them to have the entire transaction value in their bank account, or trading account, before placing an order. And given that they are still trying to figure out the market, these investors don’t trade in derivatives, sparing them the headache of margin requirements.
Another set of retail investors, but with lower risk appetite, are tapping the stock market through the mutual fund route. Systematic investment plans (SIPs) are raking in close to Rs 8,000-9,000 crore every month, and these are acting as a cushion to the periodic bouts of heavy selling by foreign institutional investors.
The other factor driving this change is that the number of high volume day traders has not grown significantly over the years. Veteran brokers say the number is likely to be in the low thousands as the rapid growth in algorithm-based trading has ensured that only the serious players are now left in the game.
No more outsized leverage
With the market on an upswing since May, profitable trades have exceeded loss making ones for most investors. Officials at brokers’ back office say that this had led to many HNIs keeping their winnings with broking firms and using those as margin, taking up fresh positions.
With brokers now collecting adequate margins, the market has been less vulnerable to margin calls of late. Previously, when prices fell sharply, the second round of sell-off would be triggered by brokers squaring off positions of clients unable to meet margin requirements. Fewer shocks meant that winning days exceeded losing days for most investors.
In the past, brokers would allow clients to take up positions far in excess of what the margins allowed, by structuring clever products that helped sidestep rules.
Before December 2020, clients had to pay margins on outstanding positions only at the end of the day. Say, a client wanted to take a position worth Rs 1 crore in a stock with a 20 percent margin requirement. Ideally, he should have Rs 20 lakh on him. But a broker would allow him to take that position for as little at Rs 2.5 lakh, and then square off the trade five minutes before the market closed.
In short, the broker was allowing the client an exposure of 40 times the margin deposited, which was highly risky in the event of a sudden adverse move in prices.
With 100 percent peak margin norms in place, that is no longer possible. Brokers will be penalized if they are caught not collecting adequate margins from clients.
And the new SEBI rules make it harder for brokers to use the money lying in one client’s account to fund the margin requirement of another client. Also, previously, SEBI was tolerant of a shortfall in aggregate margin collection up to a certain limit. This allowed brokers to relax margin rules for some of their favoured clients. This flexibility too has gone.
“The influx of new investors too has helped,” said the back official at a domestic broking house. “These investors are starting on a clean slate and have no problems in accepting the new set of rules. It is the older clients who are finding it difficult to adjust,” the official said.
Not to say that the new SEBI rules have not affected trading volumes at all. Average daily cash market turnover on the NSE has been dipping for the last three months in a row, and on the BSE, it has fallen in July and August. It could be that players are getting a bit cautious with the market at such elevated levels.
But the pandemic effect seen across industries seems to be playing out in the stock market in reverse. In the real world, few big players have benefitted immensely from the misfortune of scores of smaller players. In the stock market, a few wealthy day traders may be hurting from the hike in margin requirements, but their grumblings have been drowned amid the shrieks of delight of small investors having the time of their lives as shares zoom to new highs.
And it is a fact that when there is good returns to be made, big traders find ways to come up with margin money. In the stock market, sentiment has a bigger bearing on prices than policy.
The market rallied through 2004 to 2008, and on heavy volumes, despite the securities transaction tax. It even shrugged off the curbs on overseas investment through the participatory notes (P-notes) route announced by SEBI in October 2007. Conversely, when the market was in a free fall during the latter half of 2008 and SEBI reversed the curbs on P-notes, it did nothing to improve sentiment.
Despite protests and lobbying by powerful brokers, SEBI stood pat on the new rules. Most importantly, it has managed to get the execution right. Through a phased roll out—starting with 25 percent margin payment upfront—it has managed to effect a behavioural change among both brokers and their wealthy clients, making the transition less painful.
At the same time, SEBI has been lucky in getting its timing right. But history has shown retail investors to disappear when the market turns bearish. The true test of the new rules will be when sentiment changes for the worse.