Guidelines on margin financing sought

KARACHI (February 10 2003) : The rate for margin financing should not be as fluctuating and variable as it is presently in badla. Either it should be correlated with some other benchmark, like the treasury bills rate or KIBOR (Karachi Inter Bank Offer Rate), or it should be subjected to some upper cap.

Shahnawaz Nadir, research analyst at WE Securities, said that the present upper limit of up to 50 percent interest rate in badla is too high. This should be made more realistic in margin financing.

The duration of financing on the part of the financier should be larger. The present situation of minimum availability of badla financing by the financier for ten days is too low. This leaves room for a sudden shrinkage in badla supply.

The badla financing rate is different for different companies. Under margin financing this variation would be reduced or removed altogether. Only the level of margin kept would differ.

The underlying idea of margin financing is to make the transaction safer. With the highly liquid position of banks and financial institutions, they should be willing to look into the idea of margin financing with greater interest.

It was in July 2002 that the SECP Chairman, Khalid Mirza, disclosed the regulator's intention of bringing in margin financing as an alternative to badla financing.

Even the then Finance Minister, Shaukat Aziz, had disclosed the intention of implementing margin financing as a suitable alternative to badla by the end of June 2003.

Under margin financing, the investor buying the shares would have to pay a part of the acquisition cost (say 10 percent), which would be kept as a 'margin' by the broker on part of the financier.

The rest of the cost would be borne by the financier. These financiers in this case would also be the same as those of badla ie banks, financial institutions, brokers and individuals.

The custody of the shares acquired would remain with the financier while the investor would have to keep the margin with the broker (who maintains it on behalf of the financier). If the share value goes up, the difference would be paid to the investor when the contract is closed, and not calculated on daily basis like that done in badla.

If there is a decline in the share value, the financier would give a “margin call” to the investor to provide additional security to bring the margin at the required level, or else close the contract.

Unlike badla, the difference between the prices would not have to be provided on daily basis. Thus margin financing is a combination of badla and futures trading, while reducing the risks involved.

Basically, margin financing is an improvement over the badla system.

Nadir said that margin financing has been implemented successfully in India last year.

Moreover, the SECP has made it clear that margin financing would run parallel to the futures trading and not affect it in any manner. So, investors need not be confused about any abolishment of futures trading along with the elimination of badla.

Unlike futures trading, where only 13 shares are traded, margin financing would be extended to all companies, as badla is extended. The applying margins may, however, differ from company to company.

Once the stakeholders understand the margin financing system, there may be no major hurdles.

Being a market in which most of the trades are of speculative nature, margin financing should further facilitate this speculative trend.

However, the risks would be lower this time. It is expected that there would be an overall increase in volumes and better control over the exposures / capital adequacy requirements of brokers by virtue of margin financing.

The essential benefit of margin financing would be that investments made through this form of financing would not count against the allowed exposures of the brokerage houses.

This would 'free' the exposures of brokerage houses from being tied up, as they are in badla and futures trading. This increases availability of exposure at brokerage houses and thus enhances trading limits. Any increase in trading volumes should be in the interest of a rising market.

CONCLUSION: Some of the facts mentioned above, like the exposure requirements in margin financing, are based on the understanding of margin financing and comparison with certain examples of other markets.

It is felt that the SECP would come up with a working paper on margin financing soon enough so as to give ample time for brokers, financiers and investors to learn about the new system. Additionally, it would be better if the SECP allows both badla and margin financing to run parallel for some time so as to bring a smoother transition.

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