Why ULIP mis-selling has become rampant ?

Come September 01 the last leg of capital market regulator Sebi (securities exchange board of India) peak margin rule will be implemented. To safeguard the interest of retail investors, Sebi in July 2020 notified the peak margin rules. The rationale behind the peak margins was to maintain some discipline in terms of trading, investment, brokers funding or taking leverage positions or intraday positions. As result, the said rule is expected to keep the markets and system strong as well as efficient.

As per SEBI’s notification, the peak margins rule was to be implemented in four stages. Between December 2020 and February 2021, traders were supposed to maintain at least 25% of the peak (maximum) margin. This margin was raised to 50% between March 2021 and May 2021 in phase two.

As a part of the phased adoption starting June 1, 2021, the 75% of the peak margin available with the broker i.e. intraday leverage provided for Equity Cash and F&O Intraday.

In the last and fourth phase by Sep 2021, clients should have 100% of the peak margin obligation available with the broker during the day.

What is peak margin?

Previously, margin reporting by brokers used to happen only at the end of the day for all the carry-forwarded trades executed by the customer on that trading day.

Because of this brokers were able to provide higher leverages in intraday (MIS), cover order (CO) and bracket order (BO).

Customers were able to trade with lower margins from the prescribed limit of VAR (Value-At-Risk) +

ELM (Extreme Loss Margin) for equities and SPAN + Exposure for F&O.

Leverages lead to risk at the broker’s end as there could be cases where the customers might not be able to provide the margins at the end of the day.

The working

For the sake of understanding let’s consider a trader takes already had exposure of Rs 10 lakhs worth in F&O securities and the exposure is further increased by another Rs 10 lakhs during the session.

In the earlier system traders were not required to pay any upfront margin for the additional exposure until the end of the session. So just in case if the trader squared off the additional exposure on the intraday basis he wouldn’t need to bring in additional margin rather he would take home in case of profit or would pay up only the quantum of losses incurred.

However, under the peak margin system, the margins are not calculated on the end of the day basis. Instead, exchanges will sample the price four times a day and the margins would be calculated based on that, thereby making it compulsory for traders to pay margin even for intraday trades.

What does it mean?

The peak margin actually enhances the risk at the individual level and at the aggregate market level. Sample this. If a trader knows that he has about 5% of the value of his trade as margin with his broker, he will probably limit his trading loss to 2-3% of the value of the trade. On the other hand, if the margin is now enhanced to, say 10%, the trader would probably be tempted not to incur more losses and cut the losses at 7-8%.