Collateral Margin
Collateral margin is the credit extended by a broker to a trader or investor against shares, mutual fund units, or other approved securities pledged as collateral, subject to a haircut percentage applied by the exchange and clearing corporation to account for potential price decline in the pledged assets.
Indian traders frequently maintain positions in the derivatives segment that require substantial margin. Rather than keeping idle cash in their trading account, traders can utilise their existing equity portfolio as collateral to meet margin requirements. This collateral margin facility allows the economic value of the portfolio to work harder—simultaneously serving as a long-term investment and as margin support for other trading activity.
The process begins with the investor pledging approved securities (equity shares on the approved list, mutual fund units, ETFs, liquid funds) from their demat account in favour of the broker. The broker, after receiving the pledge, re-pledges these securities to the clearing corporation. The clearing corporation credits a 'collateral value' against these pledged securities, which can then be applied toward margin requirements for derivative positions.
The haircut is the critical parameter. A haircut is the discount applied to the market value of the pledged security to arrive at the collateral margin credited. For example, if a share is pledged with a 25% haircut, pledging shares worth Rs 1,00,000 in the market would yield only Rs 75,000 in collateral margin. Haircut percentages are prescribed by SEBI and exchanges, and they vary by the type and quality of security: liquid large-cap shares typically attract lower haircuts (10–15%), while mid-cap and small-cap shares carry higher haircuts (20–50%), and illiquid securities may not be accepted at all.
SEBI regulations also specify that cash margin requirements for derivatives cannot be fully met with non-cash collateral (securities). A minimum percentage—historically 50% of the total required margin for futures positions—must be in cash or cash equivalents. The remaining 50% can be met with approved non-cash collateral. This rule prevents excessive leverage via collateral chains.
For investors, using collateral margin creates a form of leverage on the portfolio—losses from derivative positions can erode the value of pledged assets if the positions are not managed carefully. Margin calls can trigger forced liquidation of both derivatives positions and the underlying pledged portfolio.