SEBON’s another attempt at changing how stocks are traded in Nepal

Nepal is about to change how people buy stocks, and it could make the market riskier and more active at the same time.

The Securities Board of Nepal (SEBON) has approved a new Margin Trading Facility Directive that formally allows investors to borrow money from brokers to purchase shares. The new rules, which take effect from February 13, replace a 2017 directive and introduce a new set of eligibility requirements for both companies and brokers.

What is margin trading?

Margin trading is an investment strategy where stock investors can borrow money from a brokerage to buy more stocks or securities than their available cash allows, using their portfolio as collateral. It requires a special margin account, and interest is charged on the borrowed funds.

What’s in the new directive?

For a listed company to be qualified for margin trading, it must have at least 2.5 million shares listed on NEPSE, maintain a net worth per share equal to or higher than its paid-up capital, post profits in at least two of the last three years, and have been listed for at least two years since its IPO. In other words, only relatively stable and established companies will be eligible.

For investors, they must deposit at least 30% of the total investment upfront as an initial margin. They must maintain a minimum 20% margin as prices fluctuate. If share prices fall too much, brokers can issue a “margin call,” requiring investors to deposit more money or risk having their shares sold to recover the loan.

The directive also tightens rules for brokerage firms. Firms offering margin loans must have at least NRs 200 million in paid-up capital and operate as clearing and depository members. They can lend up to five times their net worth, but no single client (or their family) can receive more than 10% of the total margin facility.

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Since its inception, several firms have taken margin trading approvals but only one brokerage firm, NAASA Securities, implemented it. However, due to lack of resources and clarity in the legal framework, it halted its margin trading operations. 

According to Krishna Giri, Executive Chairman at Sun Securities, a brokerage firm, “This time margin trading will come into implementation. We are now waiting for a working procedure from NEPSE.”

Krishna however acknowledges that one issue is the source of funds required for lending, but adds that it will be gradually sorted out. According to the directive, a securities broker may use its own funds, obtain loans from banks and financial institutions, or secure unsecured loans from its shareholders or directors to provide margin trading facilities. The unsecured loans taken from shareholders or directors must comply with the applicable company laws. The directive has capped borrowing by brokers at 4.5 times the net worth of brokerage firms.

“Brokerage firms are prepared to implement margin trading and are confident it will be operational within a month,” Krishna adds. “Many processes will initially be manual, but digital integration with banks and payment service providers is expected to follow soon.”

To improve transparency, brokers must calculate margins daily using a mark-to-market system and report daily transactions to NEPSE, which will make the data public.

Here’s what that means in simple terms:

If an investor buys shares using margin (borrowed money), the value of those shares changes daily.

Under a mark-to-market system, brokers must:

• Revalue the shares at the closing market price each day
• Recalculate how much equity the investor has
• Determine whether the investor still meets the required margin level
• Issue a margin call if the value falls below the required threshold

If an investor fails to maintain the required maintenance margin, the directive permits the securities broker to accept, as collateral, shares of organised institutions listed under the ‘A’, ‘B’, and ‘G’ categories on the stock exchange, equivalent to the amount needed to restore the margin. In valuing such collateral, only 60% of the shares’ prevailing market price shall be taken into account.

Maintenance margin in margin trading is the minimum amount of equity an investor must continuously maintain in their margin account after purchasing securities with borrowed funds.

The directive further states that if the maintenance margin is restored due to fluctuations in the market price of the shares, any shares pledged as collateral under Sub-clause 5 must be released by the broker at the investor’s request.

Meanwhile, Nepal Stock Exchange has released its updated list of shares stock dealers can transact.  

A look back: Margin trading in 2017

Margin trading was first introduced in Nepal in 2017, when SEBON issued its initial directive to modernise the market and align it with international practices. At the time, it was seen as a major reform that would increase liquidity and deepen the capital market.

Under the directive, stockbrokers with a net asset of at least NRs 50 million were allowed to offer margin trading services to investors. Brokers could extend margin loans of up to 50% of the value of shares, calculated on the basis of the 180-day average price or the prevailing market price, whichever was lower.

The rules also set eligibility criteria for shares purchased through margin lending. Brokers were permitted to finance only those listed companies that had distributed a minimum 10% dividend in each of the previous two consecutive years and had more than 10,000 shareholders.

However, the rollout was limited. Only a handful of brokerage firms met the capital and operational requirements to offer margin loans. Strict compliance procedures, limited investor awareness, and conflict on who decides interest rates on the loans  meant that margin trading hardly enticed brokerage firms. The onset of the pandemic, and the subsequent bearish trend in the stock market also dampened appetite for leveraged investing.

The new directive appears designed to address some of those structural gaps while tightening risk controls after years of market volatility and lessons learned from previous bull and bear cycles. SEBON expects the new directive to boost liquidity, allow small and mid-sized investors to mobilise more capital, and create new income streams for brokers through interest earnings.

But margin trading cuts both ways. While it can increase market activity and returns in a rising market, it also amplifies losses when prices fall.