New broker rule on client margins kicks off from 07th October

October 07th happens to be the first Friday of October and that would mean that the new rule of the Securities and Exchange Board of India (SEBI) pertaining to brokers squaring client accounts would kick in. Under this new rule, all registered brokers will have to mandatorily square up the accounts of their clients on the first Friday of every month. However, if the client so desires, they can choose to receive the squaring up of their accounts fixed once every quarter. On this date, there should be no credit balance in the trading account of the customer and it must be transferred to his / her bank account.

The idea is pretty good. It avoids the scope for misuse of funds since the broker would not be able to hold on to the funds of customers permanently. That allows them to play on float and as was learn from the Karvy case, when brokers are given the leeway of float, it could give rise to a host of other problems. Hence, SEBI has now suggested that on the first Friday of each month, all the brokers must square up their accounts with the customers and transfer funds back to the customers, except for the funds needed for pay-in. It is estimated that brokers hold about Rs25,000 crore of such retail funds in trading account float.

However, not all are too pleased with the new arrangement. The new rules would certainly ensure that funds of the clients are not misused by the broker and to that extent it is laudable. However, this move is likely to increase the working capital requirements of the brokers and that would eventually translate into higher brokerage charges. The costs will have to be charged to the customers and it is feared that it would translate into higher costs for the customers. Even people like Nithin Kamath of Zerodha, the largest broker by clients and volumes in India, broadly agrees that this move would lead to a rise in brokerage costs.

However, brokers point out other challenges that are a lot more practical in nature. For instance, when you place margins with the broker through a payment gateway, the broker gives the customer immediate credit to start trading. However, the broker actually gets the funds from the payment gateway on a T+1 basis. Effectively, the Friday pay-out would mean that on the Monday after the first Friday of a month, if the broker allows traders to immediately take positions, then the broker would have to fund the margin. That was possible in the past due to margin float, but now that could become a major issue.

In reality, the broker will have a situation wherein the positions have to be funded on the Monday after the first Friday without the payment gateway or the clearing corporation releasing the funds to the broker. This leaves the broker with only two options. They can either prevent fresh positions, but that would mean loss of business, which no broker would be willing to do. The other option would be for the broker to fund the positions for one day, but that would entail a cost. Eventually, the broker will pass the cost to the customer in the form of higher brokerage charges. That is inevitable.

According to Zerodha, the impact will felt by the brokers on 3 fronts. Firstly, we cannot ignore the fact that transferring Rs25,000 crore on the first Friday of each month is a huge operational risk for the brokers and the client. Secondly, indirectly, the broker will need to arrange for more working capital and that will entail a cost, which has to be passed on to the customers. Lastly, brokers will take a hit on float income, which is the money they earn from the idle balances of the customers lying with the broker. This would hit the lost cost brokers quite hard as many of them do rely on the float to supplement incomes.

Kamath has drawn some interesting parallels between the Indian low cost brokers and the US based low cost brokers like Robinhood. In the US it is normal for the broker to retain the float and that allows them to pass on more of these benefits to customers. That is why in the US you have genuine zero-cost brokerages whereas in India you only have low cost brokers. This is certainly a good move in that it brings more accountability on brokers and more transparency for customers. The only hope is that the implicit cost of this activity does not exceed the benefits accruing from this move.