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Sell Today, Buy Only Two Days Later: Exchanges Change the Rules


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.

However, many brokers do not have an early pay-in mechanism, and some expect you to transfer stocks to their demat account. For such brokers, the following post applies!

From September 1, most 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:

  • If you sell a stock today, you’ll get the money two days later (T+2)
  • If you want to buy a stock today itself, you won’t have that money (since it’s coming on T+2)
  • The exchange now wants you – as in every retail client – to pay margins on the same day for trades taken that day.
  • You would have to pay a margin for the selling and the buying, in normal circumstances.
  • But the selling part has been handled by many brokers – they just transfer the securities earlier (same day or next day, rather than T+2)
  • The buying part will require margins of between 20% of 50% of the trade to have been taken upfront – but you cannot use the fact that you sold shares. Because that money is coming only on T+2, and the margin needs to be placed today.

We know you have a truckload of questions. First:

How has this been handled earlier? This has been running for ages!

First, let’s just say this is not new. All institutions – like mutual funds and even PMS providers (and we are one at 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:

  • The process has required margins, always. The difference now is about how margins are collected.
  • Till now, the exchange would demand margins at the brokers level. So if a broker saw 100 shares of a stock bought across all its clients, the exchange would say “Give me margins for 100 shares”.
  • This margin was handled via a common “margin” account of the broker – which included all the shares the clients had put in as margin. When you pledge shares, they are transferred to the margin account of the broker, and sit in one fat massive pool.
  • Many people may have pledged shares but not used the margin at all for trades, so there’s always going to be some “extra” margin available in this pool.
  • Brokers had used this margin, and any margined cash to fund the margin requirements. This ensured that you didn’t have to pay money on any purchases of stock when you had sold shares the same day.

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:

  • Pledging of shares will no longer involve transferring of your shares to the broker. This means there is no “one fat massive pool” in which unused margin can be shared.
  • Pledging will only mark a “lien” in your own demat account – so you can’t sell those shares, but they remain in your demat.
  • Exchanges will (from August 1) demand margins on a per-client basis. This means if you’ve bought shares, the broker will collect margin from you.

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.

Why this margin change?

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:

  • Futures position (long or short) – you need a margin to maintain the position.
  • Options position (short) – similar to the futures position.
  • Stock trade (intraday) – you need a margin on one leg, which is reversed when you close it, but the broker should have collected at least the margin from you in the beginning of the day.
  • Stock trade (delivery) – you need only margin at the end of day 1, but most online brokers will take the full amount.

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.

Impact: Cannot “Replace” Stocks Easily

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)

Impact: Can’t use LiquidBEES or such ETFs

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

Impact: Selling Stocks can’t provide F&O margins

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.

What can you do?

Here’s our suggestion:

  • If you only do stocks, then simply keep spare cash as cash only. If you don’t want to keep it with the broker, leave it in your savings bank account.
  • When you need to sell and buy (or rebalance) just move the money to the broker and take the trade. Unless it’s an unusually large position, you shouldn’t have a problem.
  • Some brokers may be able to offer a temporary loan (for just 2 days) which can meet your requirement. We believe most brokers will do this as a line of business, at very high interest rates.

Will this stay forever?

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.

Isn’t This Rule Going To Kill The Market?

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.

Also Read: Zerodha’s note on the change in the system and our tweet thread on the topic.


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