By David Adonri

At the mention of margin trading facility, many Nigerian investors become scared to their bone marrow because of the bitter experience from the so-called margin crisis during the global meltdown in 2008. That unfortunate event tarnished the good image of margin facility which was scarcely in use then but mistaken for the rampant shares purchase loan from banks. 

Worldwide, margin trading facility is an integral part of capital market resources designed to support maintenance of adequate liquidity and sustained credit flow to the market. Margin facility is a well established liquidity enhancer for investors and also an important credit outlet for banks. If you are temporarily short of cash amidst an enticing opportunity, a margin loan can be used to seize the opportunity while repayment is done later when your source of funds is replenished.

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Margin lending and securities lending are two sides of a coin. Both are necessary for continued liquidity of the capital market. While margin loan addresses liquidity from the cash end, securities lending addresses it from the stock end, thus balancing the market efficiency equation. The profitability of investment in financial assets and their derivatives can be magnified through the use of both leveraging resources.

Margin trading is a facility under which you buy stocks that you cannot afford. You are allowed to buy stocks by paying a marginal amount of the actual value, and borrowing the balance from your stockbroking firm or commodities brokerage firm. The marginal amount contributed by the investor/borrower to buy the marginable securities is called margin. Margin is, therefore, the collateral that an investor deposits with a brokerage firm or Central Counter-Party (CCP) to cover the credit risk the borrower/investor poses for the brokerage firm or CCP. Using margin to purchase securities is like using current cash or securities in your account as collateral for a loan. You pay interest on the collateralized loan. 

Margin is repaid either in cash or in shares. The margin loan can be settled later when you square off your position. You make a profit when the value of the marginable securities go above their purchase prices or a loss when they fall below.

MARGIN = MARKET VALUE OF SECURITIES PURCHASED – MARGIN LOAN FACILITY.

Assuming that:

1) Market value of securities purchased is N1,000

and:

2) Margin Loan facility is N600

then:

3) Margin is N400 or 40%.

Because the value of the marginable securities purchased is marked-to-market everyday by the stockbroker or CCP, if the value exceeds N1,000 in the illustration above, the excess is credited as profit to the investor. Conversely, if the value of the marginable securities purchased fall below N1,000, the brokerage firm or CCP will issue a Margin Call equivalent to the shortfall to the investor. 

The investor now either has to increase the margin that was deposited or close out his position by selling some of the marginable securities. If none of these is done, then, the brokerage firm or CCP can partly or wholly sell the marginable securities to meet the Margin Call. When you sell the assets in a margin account, the proceeds go to your brokerage firm against the repayment of the margin loan until it is fully paid.

To trade margin, you need to open a margin account with your brokerage firm. This account is different from a regular brokerage cash account. Through this account, you can access the margin trading facility. 

A minimum balance must be maintained in this account at all times, the purpose of which is to protect the brokerage firm against a fall in value of the marginable securities to the point that the investor can no longer cover the margin loan facility. When the initial margin falls below this minimum margin requirement, the brokerage firm makes a Margin Call on the investor. Maintenance margin is the additional amount of cash or security deposited by an investor, following a Margin Call in order to meet the minimum margin requirement.

Investors utilizing margin trading facilities must enter into a contract agreement with their brokerage firm and be aware of the benefits and risks involved. 

Prior to 2009 when the financial sector reforms to sanitize the entire finance industry began in Nigeria, margin lending/trading was one of the unregulated areas. As a reaction to the so-called margin loan crisis and it’s damaging effect on the financial market, CBN and SEC of Nigeria, acting jointly to forestall recurrence of the crisis, issued new guidelines and rules in 2010 to regulate margin lending/trading by banks and stockbroking firms. 

The rules cover profiles of investors that may participate in margin trading, describing them as sophisticated and knowledgeable investors whose net worth are over N20 million in securities, cash or real estate, or earn annually the sum of N5 million and have been investing actively for a minimum of three years. Under the rules, all Pension Fund Administrators (PFAs) are prohibited from owning and operating margin accounts. 

The regulations set the initial margin requirement for purchases into a margin account at not less than N1 million. The lender is authorized to increase the initial margin requirement subject to a maximum of N10 million. 

The regulations contain strict rules regarding marginable securities as not all securities may be purchased on margin except those on the list published monthly by SEC. IPOs do not qualify for margin trade.

Margin trading increases investor’s purchasing power. It is good for investors looking at cashing on price fluctuations over a short term but do not have sufficient cash. Margin facility is only used for short term investment to prevent accumulation of costs. The longer you hold an investment, the greater the return that is needed to break even. If you hold an investment on Margin for a long period of time, the odds that you will make a profit are stacked against you. Margin facility can enhance the rate of return on capital employed by magnifying profits. 

Despite these upsides, there are also downsides. You can win big or lose big. Borrowing on Margin is not appropriate for every investor. An investment strategy that includes trading on Margin exposes investors to additional costs, increased risk and potential losses in excess of the amount contributed. Therefore, carefully review your investment objectives, financial capacity and risk tolerance to determine whether it is right for you. As a good Margin trade practice, be extremely cautious and also have sufficient cash to withstand a momentary move against your position so as to timely meet any Margin Call.

Adonri is the MD/CEO of Highcap Securities Ltd