How NSE is preventing hard landing through collaterals

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Whenever some restrictions are imposed by exchanges or regulators, market participants, especially day traders and retail investors, turn uncomfortable and raise questions on such moves. All the more so, when the market is in a bullish phase, as it is currently.

A recent such move by the National Stock Exchange has raised a hullabaloo from frequent traders. The NSE has restricted securities to be accepted as a collateral for trading in the margin trading facility that allows investors or traders to buy shares for a fraction of the total trade value.

For instance, an investor needing to buy a share worth ₹1 lakh can actually pay just a part of the amount, say, up to ₹30,000 and the rest through a loan from the brokers. For that, investors need to pledge certain shares as collateral while brokers earn interest for the amount lent.

For the purpose of client margin collection and reporting, the broker should compute the value of securities as per the closing rate on T-1 day as reduced by the appropriate haircut at a rate not less than the VAR margin rate of the security on that day, according to the exchange’s rule.

Boosting risk management

SEBI, through various circulars issued from time to time, has prescribed norms for risk management of Clearing Corporations (CCs), including acceptable liquid assets by CCs with applicable haircuts to meet the requirements for initial margins, mark to market losses, value at risk margins, extreme loss margins, base minimum capital, etc.

To further strengthen the risk management framework of CCs, it has been felt necessary to review the existing collateral accepted by CCs and also to have prudential norms for exposure of CCs. These pledged securities are ‘collateral’ that investors use to secure their margin funding. If the value of collateral decreases, investors may need to add more collateral or sell positions to maintain the required margin.

In a recent circular, the premier bourse said that NCL (clearing corporation of the NSE) should only accept equity securities fulfilling following criteria: Equity shares with impact cost of up to 0.1 per cent for an order value of ₹1 lakh; and traded for at least 99 per cent of days over the period of previous six months.

“The list of approved securities, the acceptable quantity (market-wide limit and member-level limit) of the security and applicable hair cut for the respective security shall be informed through a circular issued by NCL for the respective month.” the bourse further said.

Prominent names in NSE list

Equity securities not fulfilling the above criteria should not be accepted from August 1, the NSE circular said. NSE came out with a tentative list of 1,010 securities that would not be eligible for margin trading facility if the above criteria are implemented.

Among them are some prominent and relatively higher market-cap stocks, such as Adani Power, Aditya Birla Money, Amrutanjan, Arvind SmartSpaces, Bajaj Healthcare, Bharat Dynamics, Butterfly Gandhimathi Appliances, CARE Ratings, Century Enka, Dalmia Bharat Sugar, Dhanlaxmi Bank, Dredging Corp, GE Power, Go Fashion, Greenlam Ind, Greenply, Heidelberg, IIFL Finance, ICRA, Inox Green Energy, Inox Wind, Jaiprakash Associates, Latent View Analytics, Ksolves India, LG Balakrishna Brothers, NBCC, PTC India Financial, Paytm, Puravankara, RPG Life Systems, SPARC, Sundaram Clayton, Sundaram Finance, Sundaram Brake Linings, Suzlon, Tata Investment Corp, Transport Corporation, Wockhardt, Yes Bank and Zaggle Prepaid and a host of exchange traded funds.

Significant step

This is a significant step. If one goes by history of stock market falls, whenever there is panic, the first thing brokerages resort to is selling the shares held as collateral due to margin pressure. From this perspective, the recent move by the NSE would ensure that the market doesn’t witness very sharp price declines caused by margin calls that could even lead to systemic failure.