Last Updated on Dec 9, 2022 by Aradhana Gotur
The Securities and Exchange Board of India (SEBI) has introduced a new margin system against securities, called margin pledging. From now on, margin trading will be accessible only via a revised pledging mechanism. In this article, we will discuss the many aspects of margin pledging in detail.
Table of Contents
Margin pledge meaning
- Under the new margin pledging system, unlike the old one, collateralized securities will continue to remain in traders’ own demat accounts. These securities will be marked as a pledge in favour of the concerning broker. Instead of getting access to a trader’s demat securities through a power of attorney (POA), the broker can access the collateralized securities only through a pledge.
- A pledge acts like a mortgage. It is the process of creating a lien on the demat stocks in favour of the broker and subject to liquidation on failure to pay margin. Based on this pledge, the broker allows trading at an extended limit. Suppose you have 350 shares of a company in your demat account; you can pledge all shares or a few shares in favour of your broker, and your broker will increase the limit of trading accordingly.
- Margin is the amount that a trader needs to deposit with a broker before placing a margin trade, which refers to the practice of using borrowed funds from a broker to trade a financial asset, either in cash or stocks. Traders can leverage their position without assuming the full risk initially.
With pledging, your risk exposure is limited to collateralized stocks. If you can not repay the margin, the broker can liquidate the collateralized stocks in the margin account in order to recover the debt.
Why is margin pledge required?
Here are the advantages of a margin pledge for investors:
A system in the interest of investors
The market regulator SEBI introduced the margin pledge policy as the safety net for investors and to prevent brokers from misusing the client’s demat securities.
No misuse of securities
Before introducing the pledging system, stockbrokers extended trading limits based on their client’s demat holdings, along with their trading account cash balances, and considered these as collateral for margins. Using a power of attorney (POA) signed by the trader at the time of account opening, a stockbroker could use stocks from the traders’ demat accounts rightfully, if required.
This system was very risky for traders as the broker can misuse the client’s funds and collateral. Therefore, the SEBI introduced a new system of pledging stocks to address such issues.
Client authorised pledge
Under the new system, the pledging process must be confirmed by the client with OTP authentication. The trader will initiate the pledging process with his broker, and the central depositories – NSDL/CDSL will execute it after OTP confirmation.
Why do investors buy margin pledge?
- Margin allows traders to leverage their positions and enables them to increase their returns within a short time frame. Using this tool, traders can deal in high-value trades without investing the full value.
- Many traders may have limited cash to be used as margins, due to which they may lose opportunities. But if they have enough stocks or ETFs in their demat accounts, they can pledge these securities as collateral margins.
- The margin received from pledging, also called collateral margin, can be used by equity day traders and Futures & Options (F&O) traders. They utilize the facility of pledging to receive margin funding from the broker as they trade with a huge amount.
Details of margin pledge
- Under the new frame, traders’ holdings will not get transferred to the broker’s collateral account. Instead, depositories will provide a separate pledge type, that is ‘margin pledge.’
- A power of attorney (POA) cannot be used for pledging anymore. A trader looking for margin trading has to produce a margin pledge separately.
- Intraday profits realized by margin traders cannot be used for new positions on the same trading day. It can be used after its settlement only, i.e., after T+1 days in the case of derivatives and after T+2 days for equity. However, the profits will continue to reflect in the account.
- Brokers maintain proper records of client collateral to ensure that it is not used for any other purposes than meeting the client’s margin requirements or pay-ins, which include:
- Receipt of collateral from the trader and acknowledgement issued to them
- Trader authorization for a collateral deposit towards margin with the exchange/clearinghouse
- Record of margin deposit with exchange/clearing corporation /clearinghouse
- Record of credit of corporate benefits to traders
- Record of return of collateral to the trader
Features of margin pledge
- Margin pledging is a fully digital and seamless process.
- Collateralized securities continue to remain in the traders’ demat account till they get sold.
- Traders have access to margins via the pledge.
- Stockholders continue to receive all corporate benefits like dividends and more on their pledged stocks.
- Margin pledge/unpledged involves charges to be paid by the investors.
- Before selling out the pledged stocks, it is mandatory to unpledged them through the prescribed process; otherwise, the trader will be penalized.
How does margin pledge work?
Below explained is the process for margin pledging:
Step 1: Make a request to your broker to pledge a specific number of securities
Step 2: Once your pledge request is submitted, the clearing corporation will send you a link to your registered mobile/email id
Step 3: Visit the link you have received on your registered mail ID or mobile number
Step 4: Once you click the link, the authentication process starts. The link will redirect you to the NSDL / CDSL webpage, where you are required to verify your PAN number or demat account number
Step 5: After verifying the details, click on generate OTP to authorise the pledge
Step 6: You will receive an OTP on your registered mail ID and mobile number
Step 7: Enter the OTP to authenticate your request on the NSDL / CDSL platform. You will receive a confirmation message for your pledging margin request, and the pledge request will take a couple of hours to be activated
New rules of margin pledging in 2020
- Stockbrokers have to collect upfront margins from traders for both buying and selling of securities. Failing to do so will attract a penalty
- The new system has put the power of attorney practice to an end. Traders can not give authority to the broker over their demat securities through POA, and it can’t be used for margin pledging anymore. A margin pledge is mandatory for traders to use the margin facility
- Besides the F&O segment, traders are required to pay margin upfront in the cash segment as well
Limitations and risks of margin pledge
- High-volume traders cannot quickly execute trades without a blocked amount towards margin commitments.
- One of the keys to providing liquidity in the market is big traders, as they trade big blocks of shares frequently. Volatility could increase in the stock market if high-volume traders cut back on their trading.
- In case a margin trader is unable to repay the margin, the stockbroker can sell the stocks to collect the debt.
The new margin pledging system does not leave any room for manipulation. Brokerages are the intermediaries between you and the stock exchanges and manage your funds and securities. Under the close monitoring system of SEBI and required reforms like margin pledges, stockbrokers can no longer misuse the ownership title of securities and margin funds.
Further, you are eligible to receive benefits from pledged stocks like bonuses, dividends, and rights, and so on. This way, the new pledging system benefits the interest of investors.