As per SEBI’s Peak Margin circular (Collection of upfront margins), intraday leverages from Dec 1st 2020 is going to be capped at all brokerage firms, despite increased rumblings from the industry, SEBI is yet to show any signs of leniency .The cap on leverage offered will be increased in a phased manner between Dec 2020 and August 2021. The new norms prescribe a framework for verification of upfront margin collection in the cash and derivatives segments.
What is the circular about
SEBI has been grappling with some issues in recent years amongst which were of course broker corruption, network effects of one failure on others, and then there was the severe discomfort with the extremely high percentage of derivatives turnover versus cash.
Because of the way derivatives are- a synthetic instrument, it has attracted not only strategy based players but also heavy speculation by retail investors. To control this, SEBI has been increasingly raising margins and the size of the contracts but this effort was neutralized as brokers gave ever increasing multipliers to counter it. In effect , raising risk to their balance sheets in an era of decreasing brokerage and sources of funding.
Lets spend a minute on the existing margin system. Right now margins are collected upfront but they are calculated on the basis of end of day positions. Your broker funds intraday positions as long as you bring your outstanding by the end of the day to below what you have already deposited as margin by the end of the day.
Calculation of Peak Margin
Lets say you had Rs 100 in your account today – beginning of day – and you used lets say Rs 500 as margin (In cash it would mean Value at Risk (VaR) Margin & Extreme Loss Margin (ELM) and in derivatives, Initial Margin) to buy Rs 2000 worth of a derivative – some of which you did intraday and some you took delivery. Lets say you retained Rs 90 with the broker at end of day and your end of the day margin obligation for this derivative is Rs 80.
From December 2020, for such a trade, the formula would run something like this : The exchange would consider the higher of the two calculations below as your shortfall:
- 25% of your peak margin of Rs 500= Rs 125 was required but you had only Rs 100 during the day. So shortfall of Rs 25
- EOD margin of Rs 80 was required but you had Rs 90 at the end of the day DESPITE the cash withdrawal. So there is no shortfall as per the EOD formula. This is how it has worked so far.
- Higher of the two? Rs 25! So even if you had no obligation at end of day and you had fully paid for the position and the broker graciously returned Rs 10 to you at end of day because he was covered, there would be a shortfall! And a penalty!
So how would the broker cover this risk? He would not allow you in the above example to have more than Rs 400 (4x of 100) of margin leverage in Phase 1 – because then there cant be a shortfall as per 1 above. It was the extra Rs 100 that created the Rs 25 shortfall!
And by September 2021, the client would be required to have Rs 400 if he wishes to utilize Rs 400 of peak margin. Remember that even then, the leverage stays at 4x-5x as margins are 20%. So no big damage!
The second problem – how would the exchange communicate to the broker various peak margins of various clients – no such technology linkages exist today between the CPs and brokers. From 01 Dec Exchange will randomly select 4 times in the day to take snapshots of all margins and the highest margin of the 4 snapshots taken will become peak margin. This is applicable for both cash and F&O segments..Remember that your broker already pays this margin to the exchange. Now you will have to pay this too.
By its peak margining circular, SEBI has effectively capped the exposure that’s possible in Derivatives and CASH
Below will be the Margin from CASH
- Maximum of 20 X till Feb 2021
- 10X from Mar 21 to May 21
- 7X from Jun 21 to Aug 21
Max of 5X from Sep 2021
Derivatives(Equity FO, currency and commodity)
- 25%(4X) of the SPAN + Exposure margins until Feb 2021
- 50%(2X) of the SPAN + Exposure margins until from Mar to May
- 75%(1.33X) of the SPAN + Exposure margins until Jun to Aug
- Full SPAN + Exposure margins from Sep 2021 — From Sep 2021 you will need to pay full margin
Benifits of Peak Margin
- Option writers start looking at farther contracts or more out of money contracts to earn/save on margins thus possibly bringing liquidity into these sections of the market.
- For Rs 100, you can buy Rs 400 worth of a stock in derivatives and carry it for many days. This means you are leveraged anyways. So why have additional leverage on top of that. Example, a 10x leverage on margin means you could buy Rs 1000 worth of Reliance for just Rs 10(10% of Rs 25)- a big risk in derivatives as the contract could go either way till expiry!
- Lower leverages while it might be negative in the short term for brokers & intraday traders, it is positive for the long term as the probability of intraday traders winning will improve with lower leverages.
- Reduce risk to Financial System when we have a Big Crash as we seen in March 2020