Collateral Damage: Proprietary traders feel the squeeze under RBI's new rules

Mumbai: Proprietary trading desks are bracing for challenging times as the Reserve Bank of India's new rules requiring banks to collect 100% collateral against bank guarantees (BGs), effective July 1 is seen increasing funding costs and squeezing profitability.These firms, which trade with their own capital, use a bank guarantee to put them as collateral with exchanges or clearing corporations for margins. It allows them to meet part of that collateral requirement without parking the equivalent amount of cash with the clearing corporation.The new framework requires bank financing to capital market intermediaries for proprietary trading to be backed by 100% collateral. Before July 1, proprietary traders could obtain bank guarantees by providing margins covering about 50% of the guaranteed amount. The higher funding costs could not just impact these firms but also trading volumes, industry participants said."This is likely to have a dual effect of raising impact costs and reducing trading volumes," said Ketan Marwadi, managing director, Marwadi Shares and Finance.Marwadi said volumes have already started declining since the circular was introduced, and some traders have been laid off in anticipation of these norms.Proprietary traders accounted for 34.3% of cash market turnover and 27.9% and 49% of futures and options volumes, respectively, as of May 30, according to the NSE Market Pulse report.The RBI issued the circular in February and had initially planned to implement it from April 1 before deferring it to July 1.Since March this year, the share of proprietary traders across the NSE's cash, futures and options segments has declined marginally. Proprietary firms could access bank guarantees at a commission of roughly 1% per annum, said Amit Khurana, Group CEO at Dolat Capital.Under the new regime, if they go to NBFCs for funding at 10-11% interest and park those funds in bank fixed deposits, the net cost rises to about 4-5% after adjusting for the 6% earned on the deposit."In effect, the new framework could raise trading costs for prop firms by 300-500 basis points," said Khurana. "For props that were earlier generating post-tax returns in the high single digits, that could compress returns into the mid-single digit range."Several proprietary trading firms are expected to approach the Securities and Exchange Board of India (Sebi) to seek a review of their regulatory treatment to soften the impact of the new funding framework. In addition to NBFCs, prop trading firms could also tap commercial papers (CPs), debentures and market-linked debentures (MLDs) to meet their financing needs, though these alternatives are significantly more expensive.