Badla - Financing the long in equity
Source : MakroIndia
Aug 27, 1999, 2:19:53 PM
The hold of badla over the stock market players has never been disputed. Today, with the markets once again on the up, the badla financier may be in for a very profitable time To understand its proceedure, the returns, the risks and more?. read on.
Before going into the details of badla, it is important to know the procedure for settlement of shares (trades). Badla, as of now, is prevalent only in the BSE. The BSE has a seven-day settlement period/trading period from Monday to Friday with Badla session on Saturdays, when "A" group share positions are carried forward to the next settlement. This brings an element of speculation, which is desirable from the viewpoint of imparting liquidity and inducing higher returns by injecting volatility in the market.
What leads to badla financing?
In the exchange, supposing a contract for a trade is entered into by two brokers. The clearing house acts as a middleman (guarantor) between the two brokers. All the trades executed by the brokers during the trading cycle week are registered with the clearing house. A contract entered between two brokers can be performed in any of the following manners:
* Shares can be delivered against a sale contract and in case of a purchase contract delivery of shares should be received and payment should be made for the same as per the contract rate.
* A purchase contract can be offset by a sale contract and a sale contract by a purchase contract during the settlement period and the difference in prices settled. That is the contracts in a week can be squared off against each other.
After end of trading period, the clearing house runs an algorithm which matches buy orders with sell orders. At times, there is a mismatch between the number of sellers who want to give deliveries and the number of buyers who want to take deliveries and vice versa. The badla financier fills this gap.
BADLA FINANCING
Badla financing is done in two ways -- by lending money or by lending short positions (shares). For the time being we will confine ourselves to lending money or Vyaj badla. Badla financing comes into play when the quantum of sellers wanting to give delivery exceeds the quantum of buyers planning to take deliveries.
If the quantum of sellers exceeds those of buyers desiring to take deliveries, we have financiers known as Vyaj Badlawalas coming into picture. They take the delivery in place of the buyers who were originally required to take the delivery in the current settlement from the sellers giving delivery. And they give delivery in the next settlement to the original buyer carrying forward the transactions.
The consideration for the financier is the difference between the settlement rate in the current settlement and the sales rate in the next settlement and this is known as the interest charges. This is known as contango or seedha badla and the transaction is known as vyaj badla or mandi badla.
If the quantum of buyers willing to take deliveries exceeds those of the sellers desiring to give deliveries we have Badla financiers known as MALBADLAWA-LAS emerging to give the delivery (in place of the sellers who were originally required to give the delivery), in the current settlement to the buyers wanting delivery.
The scrips that have been put in the badla list are all `A' group scrips, which have a good dividend paying record, high liquidity, and are actively traded.
An illustration of badla financing
For instance, in the settlement number 1, broker A has bought 1,000 shares of RIL at the rate of Rs 200 per share. He has to take delivery from another broker B who has a sold position in the said scrip. Broker A wants to carry forward his position to the next settlement.
But the broker B would like to give delivery of shares. This will lead to an unbalanced position, of more sellers wanting to give delivery against the buyers wanting to take delivery. In such a scenario, you as a badla financiers come into the picture. You give finance to another broker C to act on your behalf and take up the delivery for one settlement at the prevailing badla interest rate.
Broker C will take delivery of the 1,000 RIL shares from broker B at the rate of Rs 200 per share, in settlement no. 1. Broker C in turn will carry those shares for one week (i.e. for one settlement). Broker A the original buyer has to take delivery of 1,000 RIL shares from broker C, in the next settlement, i.e. settlement no. 2. Broker A will have to purchase the said shares at a higher price called the Hawala price. The badla rate for each scrip is predetermined by the exchange.
Say, in the settlement no. 1, badla rate for RIL was Rs 5 per share. Therefore, the broker A will have to buy the 1,000 RIL shares from the broker C at the rate of Rs 205 per share. The difference in purchase price in settlement no. 1 and the sale price in settlement no. 2 less commission charged by broker C is the earnings for you, the badla financier.
What kind of returns will you get as a badla financier?
Contrary to common perceptions, vyaj badla provides a flexible, low-risk investment avenue for parking both short-term and long-term funds. The rates of return, though variable, are relatively high. The return for the 52-week period beginning May 17, 1997, has been 22 per cent, and the weekly badla rates have varied between a high of nearly 54 per cent and a low of 6.5 per cent. On an average the investor gets a return of 14-16%. However such a return is not guaranteed. In a long bearish phase, the return could diminish to as less as 6-8%.
In each settlement the yield depends on the demand for and supply of funds. However, it is seen that over a 3-6 months period, vyaj badla has definitely out-performed other available comparative avenues of investment. Vyaj badla also offers unmatched liquidity. Investing in vyaj badla is, therefore, almost akin to lending money on call.
Badla also attracts capital gains tax. Since, badla is treated as a purchase and sale of shares, it would attract short-term capital gains tax depending upon the particular tax bracket you fall, with the highest rate applicable being 33%.
Would vyaj badla be considered speculation?
As the investor is not taking any investment position in the market it is generally not considered speculative. The investor's role is that of a financier and he steps into the shoes of the buyer only for funding the delivery at a pre-determined rate, that is, the standard rate. Simultaneously, the broker issues to him a sale contract, so that the shares he funded are deliverable in the ensuing settlement, that is, after seven days.
What security does an investor get as a badla financier?
The equivalent value of shares against the amount lent by the investor is the security. The shares are kept in safe custody at the clearing house, as stipulated by SEBI, to be retained until the vyaj badla is released and the investor wants his funds back.
BOI Share Holding, a subsidiary of the Bank of India and The Stock Exchange, Mumbai, manages the clearing house. It has an insurance cover of Rs. 800 crores to make good any loss that occurs due to fire, fraud, and so on.
It is also possible to open a sub- account in the investor's name in the clearing house so the shares remain in his name and cannot be misused. In fact, it is not necessary to have the shares in his sub-account. He can exercise his lien based on the contract given by the broker.
BSE has taken various measures to ensure that your broker conducting vyaj badla is not affected due to failure of another broker who is his counter party. These include collection of daily and marked to market margins on speculative transactions, setting stringent limits on the quantum of business that each broker can do and most important of all, creation of a trade guarantee fund (TGF) of Rs.375 Crore, which ensures that pay-outs take place as scheduled, even if some brokers are declared defaulters.
Simply put, if the broker through whom you have invested in vyaj badla becomes weak, you have recourse to the shares lying with BOI. There is a risk associated with this situation that the shares may plunge in value.
However, if your broker is strong and his counter party broker defaults, the BSE will pay the former from the TGF on the pay-out day. Thus with a reliable, trustworthy and financially sound broker, the badla transaction is risk free.
What are the risks involved as a badla financier?
The perceived risk in investing in vyaj badla is much higher than the actual risk involved. There are specifically two types of risks involved -
If your forward buyer defaults, you will be given the shares held in the clearing house against your broker's name and on which you have a lien through your badla bill. But the risk involved will be that of the share price moving in the time it takes to release the shares.
If your broker defaults If the broker defaults, the investor would be worse off. Other, than the FIs most brokers have net worth of a few crores. Some of them take on badla positions of 30 to 40 times their net worth. Even a 10% loss of their position would mean the broker pulling the investor into the red.
However there are a few safety measures. The Stock Exchange, Mumbai has a trade guarantee fund of Rs. 300 odd crores (as on March31, 1998) which can be used if a broker defaults. Moreover neither the Stock Exchange nor any other authority can touch the security in the investor's name. Further, the shares in the clearing house, paid for by the customer, cannot be dealt with by any other person.
However, if a single badla financier takes on a major chunk of badla financing and subsequently defaults, there will be widespread chaos in the clearing transactions but there have been no defaults from trading in the past 20 months.
How can you participate in Badla Financing?
Only type 1 brokers can finance badla transactions or do so on behalf of their client. Therefore a lay investor interested in badla financing has to go through one. Most of the time the stocks into which the investor's funds go is left to the discretion of the broker. Moreover you may have to pay a brokerage which can be anywhere between 0.5% to 1.50%.
There are a few caveats for you to keep in mind before venturing into badla financing -
Only a type one broker can finance your badla transactions
Always keep yourself abreast of the scrips in which your broker has financed a badla transaction as, most often than not, the broker does not inform the financier about the choice of his scrip.
It is always advisable to transact a badla transaction with a broker who has automated the process
Ask your broker specifically about the brokerage involved as it may cause a major dent on your returns.
Remember to know when to exit. If you do not inform your broker about your wish to exit the market, he will automatically roll your investment over to the next cycle. |
