The recent SEBI guidelines issued on pledging of shares and upfront margin requirements are path-breaking changes in the Capital Markets – for investors these are exciting times ahead!
Pledging of shares has been made mandatory in the capital markets effective 1st of September 2020. Investors have been grappling with the significance of this move by the regulator, wondering what it means for them and how it will work.
What is Pledging of Shares?
A pledge involves creating a lien on the stocks you hold in your demat account in favour of your broker. So, for instance, if you have 200 shares of Coal India in your demat account, you can create a partial or full pledge in favour of your broker. Based on this pledge, the broker extends limits for trading.
Why is it the new buzz word?
Prior to this mandate, stockbrokers offered their clients trading limits based on their demat account holdings, in addition to their trading account cash balances. Effectively, the broker considered these as collateral for margins, since they had the right to swipe shares from the clients’ demat accounts, if necessary. This right was based on a POA signed by the client at the time of account opening.
The regulator considered this mechanism risky and has hence instituted the system of pledging of shares as a safety net for investors. Under the new system, the pledging process is initiated by the client via his broker and executed by the depositories (NSDL/CDSL) and the investor must confirm with OTP authentication
What are upfront margins?
The regulator has made it compulsory for investors to maintain a minimum margin of 20% before a trade is executed. Normally, the settlement of the trade is on a T+2 basis (2 days after the trading day). So, now, if you wish to buy stocks worth Rs 50,000, a compulsory margin of Rs 10,000 is necessary, even if you sell the same stock within the next two days.
There is, however, some relaxation in margins for shares sold and early pay-ins to the exchange on the same day.
How do these changes impact the trading ecosystem?
On the upside…
1) Shares continue to reside in the clients’ demat account, unless sold.
2) As long as clients have stocks in their demat account, they have access to margins via pledge.
3) The whole process of pledging is fully digital and seamless.
4) The investors continue to be eligible for all corporate actions, like dividends, etc. accruing on their pledged stocks as the stocks remain in their demat account.
On the downside…
Except for initial teething issues in implementation till the system stabilizes there is no disadvantage. In fact, this can be a bedrock for growth of the capital markets and its efficient functioning.
Every significant transition heralds a new beginning and the hope of better outcomes. Let us look forward to a safer and more transparent stock trading ecosystem for all stakeholders.
