Brokers on a sticky wicket on upfront margin refunds

Brokers have reached out to the exchanges for clarity on the upfront margin shortfall issue, which may require them to refund penalties running into a few hundred crores.

A recent circular by the exchanges reiterated that brokers are not permitted to pass on the penalty levied by clearing corporations on account of short/ non-collection of upfront margins, to clients under any circumstances. Further, it advised brokers to refund the penalty levied on account of this shortfall after October 11, 2021, to clients on an immediate basis.

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Upfront margin is applied if there isn’t sufficient margin in a trader’s account at the time of entering a trade. For example, if a trader had Rs 1,00,000 in the account and the brokerage firm allowed the customer to enter a position with a minimum margin requirement of Rs 1,10,000, this would mean a shortfall of Rs 10,000, resulting in a penalty on the shortfall amount.

A non-upfront margin includes all such margins that need to be collected after the client enters a trade (after fulfilling the upfront margin requirement). When the client does not fund such additional margin requirements on time, it leads to a shortfall, where a penalty may be charged.

A broker should bear the penalty if they allow a customer to trade without sufficient upfront margins. Clients should pay if the customer doesn’t bring in additional margin requirements after taking a trade.

Zerodha has stopped passing on such post-trade upfront margin penalties to customers from August. “We have also been computing and refunding any upfront margin penalties from October 2021 that were passed on to customers. This process will take a few more weeks. However, differentiating between an upfront and non-upfront margin is not an easy calculation,” said Nithin Kamath, founder, Zerodha.

Peak margin penalties were introduced in October last year. A broker that collects sufficient upfront margin while entering a trade may see the margin requirements go up after entering a position due to unpredictable market conditions. This resulting shortfall is also considered an upfront margin shortfall, putting the obligation on the broker.

In these cases, most brokers had taken a stance that since sufficient pre-trade margins were available, penalty on shortfalls arising on account of market volatility or any other reason after taking a position is a non-upfront margin, which can be passed on to the customer who took the position.

Brokers have been consulting the exchanges and the regulator to understand why these post-trade scenarios ought to be considered as upfront margin shortfalls as it is difficult for brokers to ensure compliance in these scenarios.