Overview of Margin Transactions

Purpose of Margin Transactions

In a normal stock transaction, the buyer prepares the full amount of the purchase consideration, and the seller prepares shares to sell. In cases where the price of a stock is likely to rise but the buyer does not have the funds on hand, or where the price of a stock is likely to fall but the seller does not have the stock on hand, securities companies will lend funds to buy or shares to sell to their customers to trade. These are referred to as “margin transactions.”

The purpose of the margin transaction system is to facilitate trading for investors, increase liquidity by introducing speculative supply and demand (i.e., lending shares and funds to those who do not have them on hand in order to promote their participation in the market), and ensure proper price formation by allowing additional supply and demand to enter the market when the stock price is too high or too low.

Mechanism of Margin Transactions

Collateral

As investors conduct margin transactions by borrowing funds or shares from securities companies, they must deposit the corresponding collateral with the securities companies. Therefore, if investors purchase shares with loans from securities companies, they will deposit purchased shares as collateral with the securities companies. If they borrow shares to sell from securities companies, they will deposit the sales proceeds as collateral with securities companies.

Security Deposit

When the price of a stock purchased on margin falls or that of a stock sold on margin rises, a loss will be incurred, and the value of the purchased shares or sales proceeds deposited with a securities company as collateral alone may be insufficient.
Therefore, in a margin transaction, an investor also deposits a certain amount of security deposit with a securities company to be prepared for a situation where collateral is insufficient.
The security deposit is required to be at least 30% of the purchase consideration or the sales proceeds (for leveraged and double-inverse ETFs and ETNs, at least 60%). In addition to cash, securities can be used.

Furthermore, if stock price fluctuations cause losses to grow to the point that the initial security deposit alone is insufficient to cover what has been required, the value of the collateral may become insufficient.
Therefore, when the amount obtained by deducting losses and expenses from the initial security deposit falls below 20% of the trading value, an additional security deposit (additional margin) will be required to be deposited to the securities company.

Premium Charges

In margin transactions, securities companies lend funds or shares to their customers to settle transactions. If they are unable to procure them on their own in standardized margin transactions (see Note 1 for settlement), they borrow funds or shares from a securities finance company (Note 2) to settle the transactions.
Transactions between securities companies and a securities finance company to complement these standardized margin transactions are referred to as loans for margin transactions.
In loans for margin transactions, a securities finance company receives shares to buy that have been deposited by a securities company’s customer as collateral from the securities company to which the securities finance company has provided a loan and lends these shares to the securities company that has applied for borrowing them.

However, if the value of outstanding loaned stocks exceeds that of outstanding loaned funds, resulting in a shortage of stocks, the securities finance company makes up for the shortfall by borrowing stocks from securities companies or institutional investors such as life and non-life insurance companies in the form of an auction. The rate determined through such an auction is referred to as a premium charge.

If a premium charge is levied, all the sellers of the issue on standardized margin transactions must pay the equivalent amount of money, while all the buyers of the issue will receive the equivalent amount.

Note 1: There are two types of margin transactions. The first are standardized margin transactions, in which TSE’s rules stipulate that the repayment deadline is within six months and that premium charges are given or received. TSE’ rules also determine eligible issues and other details. The second type are negotiable margin transactions, in which the repayment deadline and other details are agreed upon between the securities company and the customer.
Note 2: Licensed by the Prime Minister pursuant to the provisions of the Financial Instruments and Exchange Act, the securities finance company mainly conducts loans for margin transactions by lending securities or funds to securities companies that are TSE participants for settlements, etc. of standardized margin transactions.

Settlement

Loans on margin transactions must be repaid within six months. (See Note 1 under Premium Charges). There are two repayment methods.
One is settlement through offsetting transactions referred to as resale/repurchase.
The buyer in a margin transaction repays the loan using sales proceeds obtained by selling the purchased shares deposited with the securities company as collateral for the loaned funds, while the seller uses the sales proceeds deposited with the securities company as collateral for the loaned shares to purchase the same amount of shares as the loaned shares and repays them. The excess or deficiency incurred through the process will be profits or losses to the investors.

The other method is repayment against stocks with cash and repayment against cash with stocks.
The buyer repays loaned funds by providing itself with an amount of cash equivalent to the loan and takes back the shares deposited as collateral while the seller repays loaned shares by providing the same amount of shares as the shares to sell and receives the sales proceeds as collateral.

Note: To ensure safer and faster transactions of share certificates, paper share certificates of listed companies were abolished in January 2009, and shareholder rights are now electronically managed in accounts at Japan Securities Depository Center, Inc. and financial institutions such as securities companies. Therefore, shares are delivered between such accounts only through book-entry transfer.