Collateral Margins 101: Basics of Pledging Shares, Mutual Funds, FD, LIQUIDBEES & Financial Instruments
Introduction
‘Idle Brain is Devil’s Workshop’ is an old adage in human history that has not lost its lustre even today. Also a quote by Brandon Sanderson says — “A River is easier to channel than to stop”
These two quotes aptly suit Money or Wealth too, They cannot remain immobile for a long period. The currency gains value and momentum only through transactions in the market, isn’t it? Similarly the Shares you would have bought as long term investments (say for retirement gains) need not have to sit ‘Idle’ in your portfolio as assets not serving your immediate capital needs. In fact you can pledge these shares to Brokers or Exchange as collateral. The broker in return provides you a loan amount based on the value of your securities. The difference of your pledged shares value and the loan offered by brokers is called Margin. In today’s financial market collateral margin plays an important role in assisting Investors, Brokers and Exchanges to actively trade and make gains. This blog post is an effort to discuss the basics of Pledging shares, Mutual Funds, FD, Liquid Bees and other forms of financial instruments.
What is pledging and how does it work?
Pledging of shares or any other financial instrument means mortgaging a portion of the shares of an investor or promoter to a Broker or Exchange in exchange of money.Thus procured capital can be used for trading, personal use, or to meet daily expenses of investor’s company. The pledged shares are termed as Collateral. Following block diagram depicts the process of pledging with the two parties involved. The two parties are: Investors and Brokers/Exchange.
What is Collateral Margin and how it Works?
Collateral Margin concept can be understood by considering a simple example. Say you are an investor with 100 shares in your portfolio. You have long term investment plans with these shares and are not interested to sell them in urgency. But you are going through a capital crunch to trade in the market or to meet daily office expenses. The way out is to mortgage a portion of your shares to Brokers. Who will lend the loan with your shares as collateral. The difference between loan offered and the value of your pledged shares is termed as collateral margin.
The Equation:
Collateral Margin = Total Value of Your Stocks — Loan Received
What are Collateral Margin Rules?
New Rules have been introduced by SEBI for collateral margin trading to bring in
transparency in the operations. Important changes are:
1. The pledged shares remain in the investors demat account and the investors still enjoy all the corporate benefits on their shares. Earlier the Brokers used to have Power of Attorney (POA) to handle the investors shares or the clients had to transfer their shares to a Brokers account.
2. All the dividends are directly transferred to the investors account and not to the Brokers account.
3. Any sales or purchase of shares involves upfront fees. Investors who fail to pay fees will have to pay a penalty.
4. The POA is not applicable to transfer title of shares. It gives provision only to transfer shares to the exchange when a client sells the shares or in case the broker decides to sell it to recover debts.
5. Investors have to take up Margin Pledge in order to avail margin
6. In the new scheme investors are supposed to pay 20% margin upfront to avail trading facilities.
7. The margin obligations have to be fulfilled by the investors in the beginning of the deal but earlier it was more relaxed as they could wait until EOD
8. Now, Failure to pay 20% upfront margin is applicable even in cash segment also.
Let us Know ‘Haircut’ concept in Collateral….
In simple terms the percentage reduction in the value of the asset that is pledged by the investors is called Haircut. For example the value of pledged shares is Rs.1000 and a haircut of 10% means the borrower is given a loan of Rs. 900 and a haircut fee of Rs.100 is deducted. Haircut helps Lenders to play a safe game as the shares taken as security may get devalued and recovering debts from borrowers will be smoother. Following flow diagram illustrates Haircut concept with an example:
Risks in Collateral
Risk is an inevitable component of trading. Higher the Profit Margin Higher the Risk saying is applicable in collateral margin trading also. Usually Collateral trading offers you magnified profits at the same time it can push to a magnified loss cycle also. One simple rule is: Trading with Banks or Brokers both have their own stringent rules and regulations.
Important Risks that can be identified are:
● Obligation to maintain minimum balance in trading accounts
● Magnified Losses & Magnified Profits
● Brokers can take a call on liquidating your assets
Collaterals by Pledging Different Securities
Collateral Margin against Shares
Investors having shares in their demat account with long term goals needn’t have to keep those shares idle for long durations. Instead they can pledge a portion of those shares as collateral to the Brokers or Exchange and procure capital for trading. This is called Pledging Shares as collateral. Investors Pledging shares as collateral have to follow certain guidelines:
1. Only Approved shares by the regulatory bodies can be pledged as collateral
2. 50% of collateral margin has to be available as cash in the borrower’s account. For instance you as a borrower are having an intention of taking a position with Rs.1,00000 Lakh then Rs.50,000 has to be available as cash in your demat account.
3. Collateral Margin can be used only for Future buying and Selling activities.
4. In case of Option selling it is allowed but for option buying collateral cannot be used.
5. Collateral Margin can be employed for Intraday, E-margin and Equity trades not for cash trading.
Collateral by Pledging Mutual Funds
Primarily Collateral Margin based trading can be done by pledging Shares. But you can also pledge Mutual Funds as collateral for trading. Steps to be followed while pledging Mutual Funds as collateral are as follows:
1. Generally, Mutual Funds will be present with Asset Management Companies and are identified by a unique number called Folio Number.
2. Such Mutual Funds in possession of Asset Management Companies cannot be used as collateral.
3. Primarily it is necessary to transfer Mutual Funds with Folio Numbers your Demat account. Only, Mutual Funds in your Demat Accounts are eligible for collateral trading.
4. Usually Stock Brokers assist in the conversion of your Folio number based Mutual Funds to Demat Accounts.
5. Normally it takes 2–4 weeks for transferring Mutual Funds from Asset Management Companies to your Demat Account.
6. Moreover, If you already do not own Mutual Funds and are planning to buy them new, You can request authorities to transfer them directly to your demat account.
7. On collateral Margin a percentage of haircut is applied. The haircut percentage varies from stock to stock, Usually an haircut of 10%, 12% or 15% is applied. For instance your collateral margin fetches you Rs.1,00000 and haircut percentage is 10% then the lender will give you only Rs.90,000 by applying haircut percentage.
Collateral by Pledging LIQUIDBEES
The limitation of pledging shares is 50% cash rules have to be followed by the borrowers as already discussed. But LIQUID BEE is a financial instrument that offers borrowers 100% collateral margin.
LIQUID BEE features:
1. LIQUID BEES is an interesting financial instrument that always has a face value of Rs.1000. You can buy or sell LIQUID BEES for a constant price that is Rs.1000.
2. The unique feature of this instrument is it gives a dividend on a daily basis so that investors can reap the benefits even on non-trading days.
3. Usually a 6% rate of interest is offered by LIQUID BEES.
4. Most importantly LIQUID BEES can be pledged as collateral and 100% margin is available for them on contrary for shares it is mandatory to have 50% cash in the borrowers. In simple terms no need of cash to procure collateral margin with LIQUID BEES.
Conclusion
Collateral Margin is an instrument that enables investors to trade effectively by overcoming the drawbacks of holding their shares, mutual funds, fixed deposits and other financial instruments in a stagnant market. They can pledge shares or other securities without having to sell them to mobilize capital for their immediate needs. When big players in the stock market utilize the facilities offered by Collateral Margin why can’t small investors also use this offering to mobilize their otherwise stagnant financial assets.
About Zeva Trade
Zeva Trade is a subsidiary of Zeva group. Best trading positions are leveraged to our clients through four important parameters:
1. Abundance of financing resources
2. Broad trade networks
3. comprehensive market information
4. And with our excellent platform.
The motto of Zeva groups is: ‘Investments Made Simple,’ We are in the process of restructuring Indian Investment ecosystem by catering to the varied needs of different sections of the society that covers citizens:
● With High Net Portfolio
● With Fixed Income
● Who want to invest in Stock Market
● With long term Investment Vision.
● Who want to invest in Mutual Funds
References:
https://www.investopedia.com/terms/m/margin.asp
