Penalties for brokers for not maintaining adequate working capital requirements kick in from today, 1st Aug. The second phase of the SEBI circular requiring brokers to provide a client-level allocation of funds to avoid one customer’s funds from being used by another goes into effect. This regulation was originally introduced in May 2022.
Brokers have to now start uploading client-level balances to the clearing corps (CC), based on which CCs will set client-wise limits. Until now, limits were set at the broker level or combined client levels, and not at individual client levels. The issue with this was that one customer’s funds could intentionally or inadvertently be used for another’s margin requirements.
If you think about it, globally, pooled funds are the norm in almost all financial services businesses—banks, deposit-taking NBFCs, brokers, etc. The Indian broking industry is probably among the first globally to implement fund allocation at the client level to ensure that one customer’s funds can’t be used by another. While the industry will become safer for customers, this will increase the working capital requirements significantly for brokerage firms. Let me explain with a few examples of working capital requirements going up and what changes at Zerodha.
Risk reduction mode at a client level
Until now, if the broker’s overall margin utilisation across all clients exceeded 90%, the broker would be put in a risk reduction mode (RRM) by the exchanges. That is if the total customer margin utilisation is over 90% of the total overall funds the broker has placed with a clearing corporation. When in RRM, the broker’s customers are only allowed to exit positions, but not take new positions. However, since all customers are highly unlikely to use all funds at the same time, brokers could easily avoid being in RRM mode.
Starting Aug 1st, RRM is at the client level. So either the broker will have to disallow the customer from utilising more than 90% of funds in the account or provide for the remaining 10% from the broker’s own capital. So, if a customer has Rs 1lk in the trading account, the broker should allow the customer to trade only up to a max of Rs 90,000 or provide Rs 10,000 from their funds, which means the working capital requirement goes up.
Allowing sale proceeds to be used immediately
If a stock is sold today, 80% of the proceeds are allowed for trading immediately if the broker debits the shares on the same day and provides them to the clearing corps (early payin). But our markets use the T+2 settlement cycle (we will transition to T+1 next year), which means that if shares are sold, the proceeds get credited to the account only after two days of the sell trade from the clearing corps. Until now, a broker could provide the customer pooled funds as a margin for new purchases from sell credits yet to be realised. But with the new regulations, if a customer is allowed to buy more, the margin has to be from the broker’s capital.
Allowing transactions before the payment gateway settles
When a customer transfers funds using NEFT, RTGS, or UPI, the funds are settled to the broker’s bank account on the same day. But if funds are transferred using a payment gateway (PG), the PG can take up to 2 days to settle the funds. So, if you transferred Rs 1lk using a PG to a brokerage account on Monday, and if the broker allowed you to trade with those funds, the broker typically receives the funds only after two days. But, the clearing corporations need the funds upfront before a client trades, so if it is not the customer’s funds, it could have been pooled customer funds until now. Now, brokers will have to allocate their own capital to allow customers to transact before the PG has settled the funds.
50% cash requirement for pledged positions
If stocks are pledged as a margin for trading F&O, the customer must provide 50% of the margins used in cash. If they don’t, the broker’s capital gets blocked from fulfilling the “cash component” requirement by the clearing corps from Aug 1st 2022.
Accounts with positions & insufficient margins
Customers can’t take F&O positions without sufficient upfront margins, but an account can go to a negative balance due to a change in margins of existing positions because margins are calculated at a portfolio level. This could be either because margins go up when a position that reduces the risk of the F&O portfolio is exited or if the margin goes up due to intraday volatility. While customers get time till the next trading day to transfer marked-to-market losses, any margin increase must be available in the account immediately. Now, if a customer’s account has insufficient margins, it will start blocking from the broker’s funds.
What changes at Zerodha?
We are well capitalised, and our funds are more than 25% of total customer funds, which must be among the highest in the industry. This will mean that we will be able to continue to offer the same services and user experience as earlier: allow trading with 100% of funds, allow trading instantly with funds transferred using PG or stock sold, and nothing changes with the pledging experience. The experience should continue to remain the same even post Feb 2023 when the 3rd and final phase of client level allocation of funds starts.
However, if a customer explicitly takes an F&O trade that causes their account to go into a debit resulting in a negative margin balance intraday or overnight, for example, exiting a hedged position, then the brokerage charges for orders placed during the duration where the account had negative margins, will be Rs 40 instead of Rs 20. This does not change anything for the vast majority of the customers. To ensure that this scenario doesn’t apply, simply ensure sufficient margin as always when taking trades.