How regulatory reforms likely to tighten margin loans

Infographic: TBS

The capital market reform taskforce is considering tightening regulations for margin loans as it appeared to be a big dragger for the stock market due to misuse and improper regulations, according to individuals involved with the taskforce and regulatory officials.

New regulations will not allow every investor to borrow from their brokers or merchant banks to buy more shares, if the taskforce plans emerged from expert focus group consultations are finalised through stakeholder opinion by April this year, they say.

Investors will not be allowed to use margin loans unless they have a six-month experience of secondary market investment with at least Tk10 lakh capital, several task force members, focus group experts and senior regulatory officials told TBS on condition of anonymity.

They said investors without regular income will not be allowed to use margin loans unless they have a disclosed wealth of Tk2 crore.

"Risk profiling of borrowers exists everywhere else, Bangladesh stock market should follow this," one of the individuals contributing to the future margin regulations told TBS.

Individuals with knowledge of the task force's considerations said the regulations would be tightened to limit the list of shares one can buy in leveraged accounts.

One-time profits not derived from a company's regular business activities will not be considered when calculating a share's margin loan eligibility, they say.

According to them, several problematic instances occurred where manufacturing firms struggling in their core business posted hefty earnings from investment activities and margin loans to buy their shares hurt investors and the market.

Additionally, profits from expiring project contracts will also be excluded from the previous two years leading up to expiration.

At present, a stock is marginable until its price exceeds 40 times its annual earnings per share and it does not belong to "Z category" in the stock exchanges. For companies paying at least 10% dividends for the past three consecutive years the threshold is at 50.

The taskforce is planning to reduce it to 30 and allow margin loans against only "A category" shares. It also plans to limit the threshold, called price to earnings or PE ratio, to 20 for shares of banks and non-bank financial institutions.

As marginable stocks should have enough buy and sell for easy entry and exit, the taskforce eyes at least Tk75 crore free-float market capitalisation of a company to get its shares marginable, as per the plan.

Free-float shares are the company shares that are readily available for selling without any regulatory announcement.

Sponsor-directors' shares, locked-in shares, blocked shares and shares already pledged somewhere else will not be treated as marginable, individuals with knowledge of the task force plans revealed.

There have been instances that sponsors used their locked-in shares as collateral borrowed for stock investments and later a market downturn did not let the lender trigger a forced selling of the sponsor shares due to regulatory restrictions.

The ceiling for margin loans is planned to remain at 100% of investors' equity. However, brokers or merchant banks can lend less based on their risk perception, according to the plan.

The draft proposals are yet to be communicated with the market stakeholders. However, some of them expressed their dissatisfaction with the lengthy process of the ongoing reforms.

"More than 100 days have passed since the taskforce started working on reforms and the slow progress is frustrating investors," said Dhaka Stock Exchange Brokers' Association President Saiful Islam.

"Margin loans have long been driven by faulty regulations and malpractices that turned it into a market dragger. We expect to see an end to it."

"Some restrictions are nothing but distractions from the actual points," he said.

For instance, he said, the unique regulations of company categorisation should not continue further.

"Better, let investors decide investment opportunities and the margin loan providers themselves calculate their risks."

Similarly, if a stock is marginable or not should not be decided based on regulatory dictation through PE ratio, he said.

"Those restrictions are outdated across the world," he opined, calling for a broader risk management framework and global best practices.

Huge margin loans were given to big clients in connivance with corrupt officials. Forced selling on time was the only solution during market downturns. But, the regulator's verbal orders several times did not let it happen, creating a toxic asset of negative equity in margin accounts already nearing Tk10,000 crore, said Saiful Islam.

"If the borrowers were considered as defaulters as per the global standard, they would not have let the negative equity mount to keep their creditworthiness alive," he added.