All you wanted to know about collateral margin

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. Trading members, clearing members and clearing corporations now have to provide client-wise collateral information. This move aims to increase the transparency of the September 2020 decision of SEBI where it put in place a mechanism for pledging of securities.

Collateral margin is the extra funds you receive for trading or investing by pledging securities held in your demat account. The facility is not restricted to shares and can be availed against mutual fund units, bonds, gold ETFs and fixed deposits too. The margin against each type of collateral however will be made available after a haircut, to mitigate the risk of a fall in the price of the asset you’ve pledged. The amount of haircut also varies within the asset type. For instance, you will generally receive more margin for large-cap stocks as opposed to small-cap stocks because of their lower volatility.

According to SEBI’s new collateral margin reporting mechanism that will come into effect on October 1, 2021, 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 you’ve pledged, with the segment-wise and asset-wise break-up.

Last year, we saw 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. Until then, 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 a power of attorney (POA) to deal with their demat on their behalf. But the misuse of this facility has led SEBI to introduce more steps in the pledging process.

Before September 2020, the process of using the shares lying in your demat account as collateral margin was automatic.

That is, if you entered a trade for which you were short of margin, the broker automatically appropriated shares of equivalent value from your demat account.

But the rule implemented in September changed the mechanism so that the pledging process can only be initiated by you. Unless you avail of margin, the broker would simply say that the trade could not be executed because of insufficient margin.

While SEBI’s new rules have added more steps to the once seamless process of availing collateral margin, control over the securities held in your demat account is now completely with you and your broker.

You cannot transfer them even if you have given a POA. This also prevents the potential misuse of securities by brokers through pooling of collateral.

If your shares are pledged, these will also not move out of your 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.

In short, measures that came into effect in September 2020 gave control of the pledging process to you. The new rules, set to be implemented in October 2021, allow you to verify the exact nature of securities that are pledged, improving transparency.

Margin trading is risky, but regulatory safeguards now ensure that your shares don’t double up as somebody’s collateral.

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