Understanding the new margin pledge system — effective Aug 1, 2020
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The three principal objectives stated under SEBI’s preamble are:
- To protect the interests of investors in securities;
- To promote the development of the securities market; and
- To regulate the securities market.
If you’ve been following the actions of the market regulator closely, you’ll notice a spate of regulations introduced in recent years, all conscientiously aimed at protecting the interest of investors. From reporting of client level cash & bank account balance to standardising leverage across the industry, all steps culminate in achieving the three principal objectives listed above. The new pledging mechanism too is aimed to further safeguard investors.
A brokerage is the custodian of client funds & securities. When you transfer funds or stocks to your broker, you’re entrusting him/her with the responsibility of handling these assets without any prejudice. That said, there still are reports of brokers misusing client funds and/or securities entrusted to them. In the aftermath of these episodes, SEBI has taken further steps to strengthen the regulatory framework which has led to the genesis of the new pledge-unpledge system for stocks.
When you want to trade with your broker, you need to maintain margins for your trades. Margins can be in the form of cash or stocks. Transferring cash is straight forward. As far as stocks are concerned, today, when a client wants to pledge his stocks to obtain margins, he has to transfer securities from his account to the broker’s account. The broker then pledges these securities to the Clearing Corporation. This transfer of title (ownership) of the securities leaves a gaping hole in the system, allowing (certain] brokers to misuse these securities.This problem was addressed by introducing the new pledge system that will go live from August 01, 2020.
In the new pledge system, the stocks don’t leave the investor’s demat account, instead a pledge is marked in favor of the broker. The broker is required to open a separate demat account labelled ‘TMCM – Client Securities Margin Pledge Account’ for this purpose (TMCM stands for Trading Member Clearing Member). The broker then re-pledges these securities in favour of the Clearing Corporation and obtains margins.
Some of benefits of the new pledge system are as under:
- No misuse of securities: Since stocks don’t leave the investor’s account, there’s less chance of misuse of securities. Also, it wouldn’t be possible to pledge one client’s stocks to offer margin to a different client.
- Corporate actions: In the existing pledge system, since the stocks are held in the broker’s collateral account, the broker is the recipient of all cash and non-cash corporate actions like dividends, bonus, rights, etc. While the broker is required to voluntarily transfer these benefits to the investor, a non-savvy investor may miss out on claiming such credits in the event that the broker doesn’t.
- Pledge allowed for all approved securities: Some brokers (including Zerodha) don’t accept pledge of all instruments allowed by the Exchanges. For example, certain liquid funds pay dividends in the form of more units of the same fund. The operational nightmare around reconciling the dividends received and transferring them to the investors has held us back from accepting these instruments as margins. Going forward, since the stocks are all held in the client’s own account, any approved security will be accepted for pledge.
- Facility to sell pledged stocks: This is a feature we’re working on making available, allowing you to sell pledged stocks without having to request for unpledge and wait until they are received to your demat account. With the new pledge system it becomes much easier to deploy this. This covers the risk from market movements in the stocks you’ve pledged.
What will be the process at Zerodha going forward?
We’ve largely kept the process unchanged, except having to add a few additional steps whereby a client is required to authorise the pledge by entering an OTP on CDSL’s website, just like the TPIN based pre-authorisation for selling stocks. Since CDSL is still working on building full fledged APIs, the investors will have to access this link through an email sent to them to enter the OTP and authorise the pledge. The process is explained below:
- Log into Console.
- Go to the Holdings page. A list of stocks that can be pledged is displayed here.
- Select the stock you wish to pledge, enter the quantity, and click on pledge.
- CDSL sends an email to your registered email ID with a link to approve the pledge
- Upon visiting the link, an option to generate OTP is given. This then sends an OTP to the registered phone number & email ID. Enter the OTP on the CDSL page to approve the pledge.
- Once the pledge is approved, margins will be provided against the pledged stock from T+1. Once the full fledged APIs are available, we’ll work at providing near real-time margins against pledge.
- To unpledge, simply visit the holdings page and request an unpledge. The stocks will be unpledged from the Clearing Corporation (provided they aren’t blocked for margins) that is the lien on the stocks will be unmarked and the stocks become free securities in the demat.
The fee for pledging will continue to remain the same. This is because there’s a cost levied by the depository to create the pledge and re-pledge. Additionally, also note that as a client you’ll have to continue maintaining positions in the cash:collateral ratio of 50:50, failing which interest will be levied. If you fail to meet your margin obligations, the broker will have the right to invoke the pledge and sell them to revoke the dues.
All new pledges will have to be created through the new pledge system effective August 01, 2020. Brokers have been given time until the 31st of August to return all securities pledged using the existing framework and route them through the new pledge system. In due course, we’ll communicate the process of un-pledging to you. Please ensure to maintain sufficient margins for the positions you’ve taken.
Update: SEBI, vide this circular has allowed the present system of margin pledge to be available till the 31st August 2020. The new pledge system will be made live soon and in due course, we’ll communicate the process of un-pledging to you.