SEC temporarily relaxes margin and credit rules to prevent chaos

By Nishel Fernando
In an attempt to mitigate the pressure on forced selling and its impact on overall market performance when the market re-opens today, the Security and Exchange Commission (SEC) of Sri Lanka has relaxed regulatory margin levels on credit facilities extended by stockbroker firms and margin providers up until May 31. After considering recommendations submitted by the Colombo Stock Exchange (CSE), SEC on Friday decided to temporarily permit stockbroker firms to relax loan to value ratio which stands at 25 percent to 40 percent on existing credit facilities and to halt forced selling when investors fail to meet shortfalls within the relaxed threshold.

“The SEC deliberated on temporarily relaxing the said rules to permit all licensed stock brokers to allow the market value of securities pledged by the client to fall up to a maximum 40 percent from the current threshold of 25 percent at the discretion of the stock broker and with written consent of the client,” SEC announced.

Similarly, SEC has also relaxed the minimum maintenance margin standard applicable to margin providers from 30 percent to 20 percent until 31st of May.

“The discretion of the margin providers together with the written consent of the client, may permit the minimum maintenance margin to be at 20 percent, instead of 30 percent, before the margin providers inform the client to meet the shortfalls within three market days,” the SEC stated.

When stockbroker firms or margin providers decided to extend the relief measures to their clients, the SEC and the CSE emphasised that they are required to obtain the written consent of their clients after having clearly explained the risks associated with it.

The SEC reiterated that relaxation of regulatory standards can only be extended on existing credit facilities at the discretion of stockbroker firms and margin providers while stressing these relaxations, which are granted on temporary basis, should not be considered as an amendment to existing standards.

There are around Rs.14 billion worth broker credit extended to investors while margin credit extended by the banks is estimated at over three times of that.  The SEC closed the market entirely last week, based on the advice of CSE, citing the difficulties of conducting market operations in an orderly and fair manner following the announcement of a pre-emptive default on the country’s external sovereign debt.  The CSE defended the temporary market closure, citing concerns on sustainability and safeguarding investors under the current uncertain environment.

Although, the temporarily relaxation of regulatory measures is likely to reduce selling pressure to some extent, First Capital Research (FCR) Head of Research Dimantha Mathew cautioned that if there’s deep fall in the market today, it could lead to a large number of margin calls.  Commenting on expectations of market performance this week, he opined that the Colombo bourse is likely to experience shocks in the first few days.

“This is the risk that we have to face when following a market closure; otherwise we would have had a gradual fall instead of shocks. 

We feel that it could be similar to what we had when the market re-opened for trading during the pandemic in 2020. There were initial heavy losses followed by stabilisation. It will depend on how investors will react to this,” he added.