"No amount of margin collected from customers can cover risk": Nithin Kamath of Zerodha

Discussion in 'Must-Read Interviews, Articles & News Items' started by Arjun, Apr 25, 2020.

  1. Arjun

    Arjun Chief Executive Officer (CEO) Staff Member

    Mar 19, 2015
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    "No amount of margin collected from customers can cover risk" Nithin Kamath of Zerodha lamented, while increasing margins to 300% of contract value of commodity trades. Zerodha commodities lost 10% of its networth in the Crude Oil fiasco. A foreign broker lost Rs. 620 crore as its clients defaulted

    Height of buffoonery by punters

    It is unbelievable but true that the entire crude oil fiasco, which led to a mammoth loss of Rs. 300 crore for Indian brokers, was caused by the buffoonery of a few punters.

    Apparently, the punters went to SEBI and complained that they did not have laptops and could not trade from home.

    As their offices are shut due to the Covid-19 restrictions, the punters desired that the Commodities Exchanges should also be shut at 5.00 pm.

    The request, on the face of it, was preposterous because the International Commodities market starts at 7.00 pm IST and closes late at night.

    Yet, SEBI, without a moment’s reflection as to the consequences, acceded to the requests of the punters.

    Naturally, disaster followed because when the crude oil prices plunged like a stone and hit negative territory, the punters, who were lounging at home, had no way to square off their trades.

    Yesterday was probably the craziest day of my 25 years of being in the capital markets,” Nithin Kamath, the Billionaire founder of Zerodha said, recollecting the experience, his voice trembling.

    When the Indian markets closed at 5 pm, MCX crude was trading at Rs 965.

    By the EOD, MCX crude closed at (-) $37 equal to (-) Rs 2880.

    This means that a punter who had bought one lot of MCX Crude with margin money of Rs. 80,000 was staring at a loss of Rs. 3.8 lakhs.

    Some punters honoured their commitment and paid up the differential amount. However, many have absconded, leaving the brokers high and dry to face the music from SEBI.

    The onus is on the brokerage firm to make good the losses the next day and figure out ways to recover it from the customer. There were 11100 contracts open at 5 pm yesterday on MCX, which means a potential loss of over Rs 330 crores for the Commodity brokerage firms over and above the margins placed by customers,” Nithin Kamath said.

    He also disclosed that Zerodha Commodities had suffered a loss of Rs. 10 crore due to defaulting customers.

    We are currently looking at debits of around Rs 10 crores (9th March and 20th April incident combined) which we are trying to recover from the customers. While the loss seems big and does hurt us, it is only around 10% of our net worth, so we are okay,” he said, putting on a brave face.

    Interactive Brokers, a well-known brokerage, suffered a loss of $88 million equivalent to Rs. 620 crore.

    Several Interactive Brokers LLC (“IBLLC”) customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses in excess of the equity in their accounts. IBLLC has fulfilled the firm’s required variation margin settlements with the respective clearinghouses on behalf of its customers. As a result, the Company has recognized an aggregate provisionary loss of approximately $88 million,” it stated in a grim tone.

    SEBI restores MCX timings

    It is obvious that the fiasco would not have happened in the first place if the markets had remained open as usual.

    The RMS (risk management) team of the broker would have pounced on the punter and forced him to either cough up more margin money or square off the trade and book the loss.

    Thankfully, sense has now prevailed and the usual trade timings have been restored.

    Now, margins increased to 300%

    Brokers are now once-bitten-twice-shy. They are in no mood to take any more chances with defaulting punters.

    The margins have been hiked steeply and there are severe restrictions on MIS and CO orders.

    The margins at Zerodha are as follows:

    (i) An additional margin of 300% of the contract value will be required one day prior to expiry day on all open cash-settled commodity contracts expiring the next day. If a sufficient margin is not available, the positions will be squared off by our Risk management team.

    (2) No MIS or CO product types will be allowed the last two days of any expiry for cash-settled commodity contracts.

    No doubt, other brokers will also follow this sensible practice and insulate themselves from rampaging punters.

    End of the road for MCX?

    Now, the moot question is whether this will spell doom for MCX’s prospects.

    MCX’s claim to fame is the fact that the high volumes by the punters is contributing to its bottomline.

    However, if the punters are discouraged from punting by the steep margins, it may also spell doom for MCX.

    It is worth recalling that MCX was recently added to the portfolio of PPFAS Mutual Fund (see PPFAS Mutual Fund Adds MNC Stock + High Dividend Yield FMCG Stock + One Other High-Quality Stock To Portfolio)

    Markets can never be shut down

    Earlier, when the stock markets had plunged into the lower circuit, some intellectuals had clamoured for a closing down of the stock markets.

    This was vehemently opposed by other intellectuals.

    Thankfully, this preposterous idea was not paid attention to by the mandarins as otherwise disaster would have struck.

    Last edited: Apr 25, 2020