- Wealth PMS
Update August 1 2020: Looks like the regulatory system has decided not to do something this drastic. Exchanges have sent out a clarification that seems to indicate that brokers “where early pay-in of shares has been accepted by CC, since settlement of the trade is guaranteed by the CC, member may choose to give credit of the sale value of the shares in the ledger account of the client, which may be considered as margin towards subsequent trades”
This effectively means that brokers who do an early pay-in (take shares from your demat account the same day that you sell, versus T+1 currently) will be able to allow customers to buy other shares with that money. This frees up money and therefore, this post is no longer applicable. However we retain it for context.
From August 1, retail investors will not be able to buy stocks with the cash generated after selling stocks on the same day. Basically, it’s like this:
We know you have a truckload of questions. First:
First, let’s just say this is not new. All institutions – like mutual funds and even PMS providers (and we are one at https://capitalmindwealth.com) have had these restrictions. You need unencumbered cash to be able to buy. Period.
So when a mutual fund or PMS sells a stock, it has to wait for two days before the cash can be used to buy another stock. (Additionally, a mutual fund or PMS cannot trade intraday in stocks – that is, it cannot buy or sell unless it is for delivery, but this restriction hasn’t been applied on retail traders)
How has it run so far? Because of the margining system. What used to happen till now – and till August 1 – is:
That was till now.
As of August 1, that will change.
From August 1, the exchange demands margins at a per-client level. This means:
Now let’s see what happens if you sell shares and buy others on the same day. You will sell today for Rs. 50,000 – the broker will immediately transfer shares at the end of the day to the exchange. No margin required for the sell because of “Early Pay In” (EPI).
You also buy today for Rs. 50,000. For this, the broker should have collected money from you. Roughly 20% (it changes based on the stock, and changes every day). Which means you should have Rs. 10,000 in your account with the broker, or have that much pledged.
If you haven’t created a pledge, and you don’t have that much cash already in your account, the fact that you have sold Rs. 50,000 worth shares means nothing. You still need Rs. 10,000 to buy. And if you don’t have it, there’s a short margin penalty.
And here’s the rub: If the broker doesn’t collect this margin from you BEFORE you make the trade, the broker pays the short margin penalty. Not you. And he’s not allowed to charge you this penalty either.
Which is why you can’t sell shares and buy other shares on the same day.
The concept is called comingling. This is like an Osho-Rajneesh ashram for stocks, which people enjoy on the inside but others abhor from the outside.
Comingling here means you have shares of all clients in one place (the margin account) where clients have pledged them. The broker will know that roughly only 40% of the margin is actually used, and can offer a higher “leverage” to some other customers who will get the benefit of unused margins of some other clients. This, in Karvy’s case, created issues – when clients demanded their shares back, the broker couldn’t give them back because other clients’ margin positions would have been impacted.
To avoid comingling, the exchange has decided to push margins down to the client level.
Note: A “margin” trade is like this:
Margins are not usually payments made to the exchange. They can be in the form of stocks pledged against the requirement, or they can be mutual funds, or just plain cash. For a stock purchase by delivery, though, full money is paid to the exchange on day 2.
If you own one stock and would like to replace it with another, it’s going to take you two days to do the replacement. Or, you have to bring in enough money to do a buy separately.If you own one stock and would like to replace it with another, it's going to take you two days to do the replacement. Click To Tweet
This affects a number of strategies which tend to replace stocks frequently. We have one at Capitalmind – it’s our Momentum Strategy. (In that strategy, our view is that it’s just better to have an additional cash amount to be able to do the purchase, or you can do sells first and buys two days later)
Many traders will park money in a liquid ETF like LiquidBees, and when they need money to make a purchase, they will quickly sell the LiquidBEES and purchase a stock, say on a sudden dip in prices.
This can no longer happen, because the money from LiquidBEES can only be used to buy stocks.Parking money in LiquidBEES is of no use. If you sell it, you must wait two days to be able to buy stocks with the money. Click To Tweet
Sometimes you have a futures or options position that goes against you, and you need to give more margins or pay cash. This currently can be resolved by just selling some shares, which will free up the cash. However, going forward, selling shares won’t work – you’ll simply have to bring in additional money from your bank account.
This affects a number of arbitrage positions like covered calls or cash-future arbitrage, where a sudden cash mark-to-market requirement could happen because a stock moves up very fast. At this point, a trader usually sells shares and recovers the money to pay for a mark-to-market, but in this case, new cash will be needed for the interim two days.
Caveat: you can buy options on the same day that you sell stocks. This is an extreme case.
Here’s our suggestion:
Well, we believe SEBI will move to convert settlement into the same day. (T+0) At the end of the day, shares must be transferred, and so must funds. That means you may again be able to rebalance on the same day when that happens. But that will take time – it’s a much higher burden. However, with RBI making NEFT available round the clock and soon, RTGS too, perhaps, settlement times are likely to be shifted to around 9 pm and cash/funds can be exchanged.
Inherently, this will reduce some of the trades that happen in the market. This does not impact leverage yet; for that, a much bigger, complex and deleveraging system will come on December 1 (moved from Oct 1). That leverage circular limits how much intraday leverage can be given (will fall to roughly 5x) Given that even Bajaj Finance – a Nifty stock – has delivery of only 9% of the daily volume, most of the trading seems to be intra-day. That circular will really kill the volumes when it applies.
However, the current system of changing margin rules will have a much lower impact. It hurts the less regular trader, who may only want to come in once in a while and replace one position with another, or rebalance a portfolio. But such players will only be required to bring in some more cash, or wait a few days. We see this as an inconvenience, and may be specifically reversed soon. There’s hardly any danger of a systemic collapse if a person sells shares and buys other stocks with only that much money.
Even if it stays: Brokers might offer quick two day loans for a fee through an NBFC they link with, to avoid penalties.
A bigger gamechanger is this: without the comingling of client funds, how many traders and “operators” will die? Those people piggybacked on the margins provided by regular people, and in some brokerages, they don’t even know they are providing such comingled margins. When you take that away, you will take away the ability of all those traders and brokers to participate; they have to bring in their own funds.
Now that has the potentially to dramatically drop volume. If that happens, markets could also correct. But that would still be a good thing; piggybacking on other people’s shares is not a healthy practice anyhow.