Regulation T, or Reg T for short, is the Federal Reserve Board regulation governing the extension of credit from brokerage firms to investors. Also, financial regulators like the SEC and FINRA have also established rules regulating the extension of credit to investors. Brokerage firms can establish their own requirements as long as they are at least as restrictive as the Federal Reserve Board and FINRA rules. Below are key rules you should know:
Not all stocks qualify to be purchased or sold on margin. The Federal Reserve Board regulates which stocks are marginable. As a rule of thumb, Velocity will not allow customers to purchase penny stocks, over-the-counter Bulletin Board (OTCBB) securities, or initial public offerings (IPOs) on margin because of the day-to-day risks involved with these types of stocks. Velocity can also decide not to margin certain stocks, so check to see what restrictions may exist on new security purchases and sales.
Once the account is opened and operational, you can borrow up to 50% of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. Velocity may require you to deposit more than 50 percent of the purchase price.
Maintenance Margin and Margin Call
After you buy stock on margin, FINRA requires you to keep a minimum amount of equity in your margin account. The equity in your account is the value of your securities less how much you owe to your brokerage firm. The rules require you to have at least 25 percent of the total market value of the securities in your margin account at all times. The 25 percent is called the “maintenance requirement.” Velocity requires a higher maintenance requirement, typically between 30 to 40 percent, and sometimes higher depending on the type of stock purchased.
Here’s an example of how maintenance requirements work. Let’s say you purchase $16,000 worth of securities by borrowing $8,000 from your firm and paying $8,000 in cash or securities. If the market value of the securities drops to $12,000, the equity in your account will fall to $4,000 ($12,000 – $8,000 = $4,000). If Velocity has a 30 percent maintenance requirement, you must have $3,600 in equity in your account (30 percent of $12,000 = $3,600). In this case, you do have enough equity because the $4,000 in equity in your account is greater than the $3,600 maintenance requirement.
If your equity falls below the minimum account balance you must maintain, Velocity will request you to deposit more funds or sell stock to pay down your loan. When this happens, it’s known as a margin call. A margin call is effectively a demand from Velocity for you to add money to your account or close out positions to bring your account back to the required level. If you do not meet the margin call, Velocity can close out any open positions in order to bring the account back up to the minimum value. Velocity can do this without your approval and can choose which position(s) to liquidate.
House Maintenance Margin Requirements
For listed stocks, the House Maintenance requirement is the greater of 30% market value or $2.00 per share. Stocks priced less than $4.00 will be considered non-marginable and leveraged ETFs will have an increased requirement by the ETF multiplier. For stocks sold short that are priced at $5.00 or greater the House Maintenance requirement is $5.00 per share or the greater of 35% of market value.
FED-Req = Initial Margin Requirement 50%
House-Req = Maintenance Requirement 30% Longs and 35% Shorts
Exchange-Req = DT Buying Power 25%
-Farid Zainal, Head of Risk at Velocity Clearing