Shouldn’t SEC remove haircuts on debtors’ receivables with relaxation of credit rule?

Wednesday, 18 July 2012 00:23 - - {{hitsCtrl.values.hits}}

By R.M.B. Senanayake

The SEC has relaxed the credit restrictions on broker firms by extending its tenure for six months. Earlier the SEC, in order to check the dangerously escalating bubble fuelled by reckless broker credit, imposed a limit on broker credit extended to clients by the broker firms. This rationale no longer holds and the SEC decision is to be welcomed.

Margin credit extended by the banks or the broker firms is a form of overdraft subject to the 50% limit on the value of the portfolio. As long as the limit is not exceeded, there is no time limit for such credit. Of course the bank or the broker firm should charge interest on the outstanding balance. Several broker firms don’t seem to have done so and instead given free credit.

If the portfolio value falls owing to a decline in market prices, the bank or the broker requires the client to make good the difference and will force-sell the shares in the portfolio to bring up the balance within the reduced portfolio value. This is how the margin trading facility operates and there is no limit on the period of credit as far as I am aware.

In any case this gesture will not help the market unless the CSE and the SEC change the time periods for the haircuts imposed to enforce the rule. Where the tenure of the debt is 14-30 days, the CSE imposes a 50% haircut on the value when it computes the adjusted net capital. Where the tenure of the debt exceeds 30 days, there is a 100% haircut and the debt is treated as a broker liability rather than an asset in the calculation of the net adjusted capital by the CSE. Won’t these periods now require to be extended to say three to six months for the 50% haircut and over six months for the 100% haircut?

Unless these concessions are also made, the SEC relaxation is of no value to the trade. Actually, it is better to remove the haircuts for those debtors who have signed a margin trading agreement with the broker firm.

If at the end of the six months there is an excess of credit over the 50% limit, the debt should be treated as a bad debt and the excess written off. In fact this exercise may be done even before, say after 14 days. What is required is perhaps to enforce the normal margin trading rules with a margin trading agreement in force for those who borrow.