Brokerages have more flexibility and fewer risks as regulations take shape two years after approval.
Fresh hope for liquidity in local markets
The Emirates Securities and Commodities Authority (SCA) has approved margin trading for brokerages, a long-awaited development that analysts say could inject badly needed liquidity into local markets.
In a statement sent to brokerages last week, the SCA said it "has opened the door for licensing of companies interested in engaging in margin trading". The regulator provided applications for brokerages that hope to provide margin trading for their clients.
It is expected to be introduced to retail investors next month. The law allowing margin trading was passed in 2008 but the regulator has only now finalised regulations regarding its implementation.
In margin trading, investors buy securities with cash borrowed from a broker, using other securities as collateral. Since this allows them to essentially buy securities using borrowed money, it is considered a risky form of investing that can result in sharp swings.
Many in the financial community hope the introduction of margin trading will improve the liquidity of local markets, which have suffered dwindling volumes in recent months. "It frees up the capital to do whatever you want and use the shares as collateral," said Jeff Singer, the chief executive of NASDAQ Dubai.
In order to offer margin trading, brokerages must provide the SCA with information such as the amount of commissions and other fees it will charge clients, a detailed description of the rights and obligations between the brokerage and the client, and the powers of the brokerage company should the client default. Brokerages will also have to demonstrate strong balance sheets and internal infrastructure to monitor and control margin lending facilities.
There are more than 100 stocks listed on the Abu Dhabi Securities Exchange and the Dubai Financial Market. However, not all stocks will be available on margin, under the regulations set by the SCA. "Stocks that are marginable are yet to be addressed. The criteria will be based on the historical liquidity and size of the stock," said Walid Shihabi, the chief executive of Shuaa Securities in Abu Dhabi.
Before the enactment of the regulation, brokerages used their own equity and other types of lending facilities that were risky for clients, sometimes providing them up to 300 per cent leverage. Brokers were expected to merely execute a trade, which left them unable to seek a legal framework for protection. Local markets took a dive during the global financial crisis, with Abu Dhabi's measure falling from a high of 5,148 points in June 2008 to a low of 2,136.64 points during the same month last year. In the same period Dubai's main measure fell from a high of 5,824 points to a low of 1,433.14, leaving brokerages exposed to big losses on investors' accounts that were not covered by securities or cash.
At present, brokers must place a guarantee with the exchanges to show they have money to pay for shares and often they must step forward with huge sums of money.
Margin trading is expected to provide guidance for securities firms to manage their risks more effectively. "Now that it is being regulated, which has now become a requirement, it will help many of the companies manage their risk better," said Mr Shihabi.