It’s time for a reset in India’s quickly moving leverage trade. Under the terms of this new consultation, brokers will have more avenues for funding and more capital at their disposal, but the rules to keep wrong-way risk in check are being made stiffer. Investors might find it a little easier to get leverage, but the compliance side for brokers is going to be a bit more exacting.
The regulator put out a paper on June 18 saying the whole point of the overhaul is to put risk management on a firmer footing and make business a bit easier to do as MTF volumes go up. If you have something to say about it, you can until July 9.
Market impact and intent
One of the ideas is to let brokers put up some Non-Convertible Debentures and other forms of debt to back their MTF. That would take some of the pressure off of banks and NBFCs for funding, which in turn could mean better liquidity in margin finance and a different cost of capital for the broker.
SEBI also has its eye on having brokers put more of their own net worth into margin funding, while still setting aside a minimum for their core broking. The total exposure will be held to 5.5 times the net worth, so there is room to grow, but with a firm limit on it.
Funding, exposure, eligibility
The entry requirements are being raised. To offer MTF, a broker will now need a minimum of Rs 5 crore in net worth, up from the old Rs 3 crore mark. And in a move to widen the field, SEBI is on record for allowing Limited Liability Partnerships to be in on it, not just the usual corporate types.
There will be more to work with than the usual bank or NBFC loans and commercial paper. For an investor, that means a deeper well of broker capital and a more reliable supply of leverage no matter what the market is doing.
Risk controls and continuity
Wrong-way risk is something SEBI is watching. It won’t be putting up with any reduction in the maintenance margin if you’re using cash for pay-in and then putting up the same stock you just funded as collateral. The values could both head south, so the higher requirement is to stay.
And if a security gets downgraded, the broker has 30 days to rebalance. This applies when a position leaves Group I, goes to the trade-for-trade segment or is no longer tradable. It’s a buffer to avoid any kind of messy unwinding.
Then there is the matter of a client inadvertently going over the exposure limit because the broker’s overall MTF has come down. In that case, the broker has a month to put things right, and in the meantime, no new exposure for that client.
Collateral and operations
SEBI is of the view that any collateral the clearing house will have in the cash market should be good for MTF as well. They’re even open to EPI sell credits as collateral for new positions, provided certain conditions are met, to give you more options when you are in the thick of it.
On the operational side, they want to see one Rights and Obligations document for MTF clients on all exchanges to clear up any confusion. There is also talk of making MTF and non-MTF ledgers fungible, settling out extra cash on a regular basis and an auto-pledge for the shares you use as a margin.
Timelines for reporting are being tweaked too. The idea is to have a cleaner form of oversight that doesn’t get in the way of your day-to-day. Fewer bottlenecks, but we still want to see the risks.
What to watch next
These are proposals with teeth; they can alter the market. A steeper net-worth rule may see some of the smaller operators fold, while the new flexibility in funding and collateral could level the playing field for leverage. At the moment MTF is for Group I equities and ETFs only, and a look at how we classify securities is in the works.
Some of the numbers and dates to have on your radar:
– We’re out of time for comments on July 9.
– The new floor for net worth: Rs 5 crore.
– 5.5 times net worth is where the broker cap is set.
– More in the way of collateral, like EPI sell credits.
– NCDs are on the table for funding.
SEBI put this paper out on June 18 and is waiting for some input before they make a final call. But if they go ahead with it, the combination of higher bars, tighter limits and new ways to fund could very well put a new spin on the risk-reward equation for everyone involved in MTF.
