Margin Requirements, Margin Loans, and Margin Rates: Practice and Principles - analysis of history of margin credit regulations - Statistical Data Included

New England Economic Review, Sept-Oct, 2000 by Peter Fortune

Table 1 summarizes the current requirements for several categories of securities. Nonexempt equity securities are those equities that come under Regulation T's requirements; the primary examples are common stocks traded on registered exchanges, convertible bonds, and equity or index options. Non-equity securities are all securities not classified as equity securities; the most prominent examples are nonconvertible corporate bonds, reverse repurchases on non-equity securities, and options on non-equity securities. Exempted securities are those exempted from any Regulation T requirements, primarily U.S. Treasury bonds and municipal bonds. At present, nonexempt equity securities have a 50 percent margin requirement. If the transaction is a short sale, the sales proceeds are set aside as collateral and are not available to the customer. The Federal Reserve System's regulations do not impose margin requirements for non-equity securities but require only that margins on these securities meet the "good faith" requir ements imposed by lending brokers, subject to any exchange requirements. There are no Regulation T requirements for exempted securities. While initial margin requirements limit the extension of credit at the time of a transaction, maintenance margin requirements limit a customer's debt against open positions. As a rule, broker-dealers set house margins for most common stocks above the required exchange margins. House margin policies also consider the characteristics of the individual accounts; house margins are higher for concentrated accounts (those with a disproportionately large position in a few stocks) and for high-volatility stocks. For example, until recently Charles Schwab had margin requirements as great as 100 percent (no loan value allowed) for a short list of stocks. At this writing, Schwab requires maintenance margins above 50 percent, and as high as 80 percent, for over 110 stocks, mostly in the Internet and technology sectors.

Implementation of Regulation T Margin Requirements

Regulation T implements margin requirements in two ways. The first is by defining "margin securities," those securities that can be used as collateral against broker loans. The second is through setting the margin requirement ratios for each class of margin securities, that is, the minimum equity required for newly purchased securities, expressed as a percentage of the acquisition's value.

While common stocks traded on registered exchanges have long been included in the definition of margin securities, foreign stocks and OTC stocks were not, until recently, margin securities under Regulation T definitions; the exceptions were stocks explicitly included on a List of Marginable OTC Stocks. Convertible bonds, non-investment-grade debt securities, and listed equity options were not margin securities until recent amendments.

Recent amendments have broadened the definition of margin securities. Amendments in 1996 extended margin security status to bonds that are convertible into a margin security, thereby adding convertible corporate bonds to margin status. Amendments in 1998 extended margin security status to non-investment-grade debt securities, and also allowed listed call options to be used as partial margin for short sales of the underlying security. The 1998 amendments also broadened the range of both over-the-counter (OTC) and foreign stocks that could be bought on margin; margin status was extended to all NASDAQ-traded stocks and to any foreign stocks included in a specified list of foreign stock price indices. Finally, the 1998 amendments created a "good faith" account for non-equity securities." Regulation T sets no margin requirements for non-equity securities, requiring that they meet the "good faith" margins required by the broker-dealers and the exchanges.