New margin norms imposed by NSE may hit mid, small cap segments hard

Norms on providing margins were issued by the National Stock Exchange of India last week

The new curbs imposed on leveraged trading is likely to hit hard mid-cap, small-cap, and penny stocks as the margin required for these is likely to shoot up after the clarification on margining issued by exchanges last week. 

According to the clarification issued last week, stockbrokers will have to collect margins from their clients upfront — both in cash as well as derivatives. 

“There was a lot of market making involved in small companies, especially penny stocks, to create artificial volumes as there was no system of upfront margining. These volumes will now dry up,” said a senior stockbroker. 

According to him, brokers allowed clients to leverage 15-20x based on their collateral and relationship with the latter. “Now, clients will be required to pay margin based on exchange calculations. This will create a level playing field among brokers.” 

Experts believe that more than 90 per cent of penny stocks that see a surge are run up by operators, who use the capital given by promoters of these firms, and not for fundamental reasons.

According to an exchange clarification issued last week, for the cash segment, value-at-risk (VaR) margin and extreme loss margin (ELM) have to be collected in advance of trade, and other margins have to be collected and paid as soon as margin calls are made by stock exchanges. 

In the futures and options (F&O) segment, it is now mandatory for members to collect initial margin, net buy premium, delivery margin, and exposure margin from clients upfront.

“Non-banking financial companies are not lending beyond the top 400-500 stocks. Now, the additional margin requirement will take away the liberty that brokers had to lend. This may especially impact mid- and small-cap stocks,” said Sandip Raichura, head-retail broking, Prabhudas Lilladher. “While the move may be good in the long run, we might see some pain in the short term,” added Raichura.

Mapping the move

The mid- and small-cap segment has been under pressure after the regulator’s classification of these stocks for mutual funds. Earlier, there was no standard definition to classify stocks as large-, mid- or small-cap. This changed after the Securities and Exchange Board of India brought out norms to classify these stocks based on market capitalisation. The top 100 companies in terms of market capitalisation are classified as large-cap, those ranked 101 to 250 are mid-cap, and from 251 onwards, small-cap.

“The circular says that the entire initial margin — standardised portfolio analysis of risk and exposure margins for F&O, and VaR and ELM for equity — has to be collected upfront before taking a trade, even if it is an intraday trade. These types of intraday products were being offered with additional leverage by the entire broking industry until now. This will have to stop going forward,” said Nithin Kamath, chief executive officer, Zerodha.

According to Kamath, for a stock like Reliance, you would need VAR+ELM margin (12.5 per cent) to take a trade. Hence, the maximum intraday leverage that can be provided by any broker is this requirement of 12.5 per cent or 8x. “Going forward, for all intraday products, the leverage will be the same, which is the VAR+ELM margin,” said Kamath.

The VaR margin is a margin intended to cover the largest loss that can be encountered on 99 per cent of days. ELM covers the expected loss in situations that go beyond those envisaged in the 99 per cent value at risk estimates used in the VaR margin.