Beginning September 1, clients of stockbrokers will not be able to adjust margin commitments against the payout they will be receiving two days later for shares sold.

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Simply put, if a trader or investor is supposed to pay a margin of Rs 1 lakh on a trade and is to receive Rs 1 lakh against a sell order, he cannot adjust the margin due with the expected payout; he will have to put up Rs 1 lakh with his broker towards the margin.

This rule, brokers and high volume traders feel, will impact liquidity in the market.

Why has SEBI brought in this rule and how will it affect market participants? Here's an FAQ that explains this development, starting with the very basics.

What trading cycle does the Indian stock market follow?

Currently it follows a T+2 settlement cycle. This means that if you buy a stock on Monday, you will get the shares on Wednesday. Likewise, if you sell a share on Monday, you will get the money on Wednesday.

What are margins?

Margin is the amount a stockbroker’s client has to deposit with the broker before doing a trade. So, if a trader or investor plans to buy Rs 20 lakh worth of shares or futures, he will have to deposit a fraction of that amount with the broker, say Rs 5 lakh if he is being offered 4 times leverage by the broker.

Why do stock exchanges collect margins?

To ensure that the broker, and the settlement system is not at risk if the price moves against buyer. There is always the risk that the buyer may not honour the trade, if the prices fall sharply after the order has been executed. So if you put up a margin of Rs 2 lakh against an order of Rs 10 lakh, a Rs 1 lakh loss can be adjusted against this amount. At this point, you may also be asked to top up the margin to create the same cushion again, or your securities will be sold.

Are there margins on sell trades as well?

Yes. Because there is a risk that the seller may not deliver the shares, if the prices rise after the broker has executed the order to sell the shares.

Is the margin a standard one?

There are various kinds of margins, and the all the margins combined would be anywhere between 25 percent and 60 percent or even more, depending on how volatile the stock or future is. More volatile the stock, the higher the margin, because higher the chance of sharp price swings.

What are the benefits of high margins?

High margins help keep speculation in check. So, even if some clients default on their commitments, the settlement of trades—buyers getting shares and sellers the money—will happen smoothly because the clearing corporation will have adequate funds.

So why are brokers and high volume traders protesting?

That is because the big traders cannot rapidly buy and sell shares through the day without having a certain amount blocked towards margin commitments. An even trickier rule that comes into effect from September 1 is that brokers will be penalized if they are found to be not collecting margins from their clients before the trade is done.

Were margins not being collected regularly by brokers earlier?

Generally they are. But brokers could give some leeway to the clients they could trust. From September onwards, SEBI will be monitoring collection of margins by brokers from clients.

Big traders park their money in liquid funds, and any request for redemption is honoured only on the morning of the following day. Often brokers would fund the margins commitments of their large clients till the time the clients got their funds.

That is no longer possible. Because the stock exchange will have the details of the clients’ trades, and brokers will have to give proof of the margin collected from the clients.

To pay margins on time, the traders will now have to keep the money in their current accounts or with the brokers. That means they will lose on the interest they were earning by keeping the money in liquid funds

Will this have an impact on prices?

Market experts fear that initially volatility could increase if big traders cut back on their trading. High volume traders are key to providing liquidity in the market as they frequently buy and sell big blocks of shares. Higher the liquidity, less will be the impact cost for institutional investors. Meaning, institutional investors will be able to buy and sell large blocks of shares without the price deviating too much from the time they put in their order.

For instance, if there is not enough volumes in a stock, the market will quickly sense if a buyer wants to buy a big block of shares or a seller wants to sell a big block of shares. This will result in the big buyer or seller getting a poor price for their trade.

Will brokers be able to come up with a workaround?

Most broking firms have non-banking finance company arms (NBFC) arms. These arms may fund the traders for the margin requirements, for a cost of course. Ideally, the charge should be very low, because the risk for the broker is as good as zero. He is only funding the clients’ margin till such time the client receives the payout, which is two days later. The stock exchanges’ settlement guarantee fund will ensure that all payouts are honoured.