New regs to mitigate margin trading risks: Proposals to rein in margin trading under consideration by the Financial Regulatory Authority (FRA) would introduce caps on how much stock investors can buy with borrowed funds, the regulator said (pdf) yesterday. The new regulations — drafted by the FRA’s advisory committee (pdf) — would curb how much a broker can lend to a single client to buy stock on margin. The measures could also include a cap on how much a single company’s shares can be exposed, FRA Deputy Chairman Islam Azzam said following a meeting between the advisory body, EGX representatives, and clearinghouse MCDR.

In detail: The current proposals would not permit any single investor to purchase on margin more than 1% of a company’s market cap or 2% of shares on freefloat. A single company would also not be permitted to have over 15% of its outstanding shares held on margin, or 25% of its publicly-traded shares, whichever is higher. Some 90% of public companies currently don’t exceed those limits, according to Azzam.

This comes after brokerages voiced concerns about the growth of margin trading on the EGX: The FRA invited several brokerage firms and custodians to meetings last week to discuss imposing a cap on the volume of margin trades permitted amid a surge in the value of EGX shares exposed to potential margin calls and the high concentration of borrowed funds in the hands of only a few investors. The value of shares traded on margin is currently at EGP 6.5 bn but could rise to as much as EGP 75 bn in the coming years, Azzam said yesterday.

WAIT A SECOND — haven’t policymakers been encouraging margin lending? In a word: Yes. The central bank last month earmarked EGP 1 bn to be lent out to brokerages in order to increase margin trading and boost liquidity on the bourse. The FRA is now allowing fund managers to trade using margin and recently agreed to allow non-bank lenders to get involved in margin lending.

SO WHAT DOES THIS MEAN? Our take is that the regulator is very comfortable with the growth of margin trading, but is taking the notion of risk management seriously. Look at the restrictions as akin to rules in the banking system on issues such as single obligor exposure and capital adequacy.

And remember: This is still a proposal, and while this is being put on the table by the advisory committee, the FRA’s board will have the final say. It remains unclear when the board will meet to decide on the way forward.

Whatever happens, a decision will have to be reached by the end of the year: Brokerages will have to start implementing the new regulations by the start of 2022, Azzam said.

How bad are the concentration risks? A regulatory official we spoke to estimates that out of the EGP 6.5 bn-worth of margins borrowed by equity investors from their brokers, nearly EGP 4.5 bn are given to 1% of clients, 10 of which have taken out margins of EGP 1 bn alone. A large part of those borrowed funds are also invested in a single constituent on the EGX70, which greatly increases both single-company and single-investor concentration risks.

Besides mitigating concentration risks, the limits would also help prevent back-to-back margin calls, which are usually bad news for equity prices, Prime Securities Managing Director Shawkat El Maraghy tells us. This can happen if the price of a share heavily traded on margin drops to a level that triggers a margin call and forces a broker to sell down the position, putting even more pressure on the price and triggering another margin call, creating a domino effect, he explains. This was at play earlier this week, when a drop in the EGX was made worse after an initial selloff triggered a series of margin calls that snowballed into more selling.

So, uh … what exactly is margin trading?

The short answer: It’s when a broker loans you money to allow you to buy more stocks.

Want the long answer? Stay tuned for our explainer in this afternoon’s EnterprisePM edition.