Regulation T, or Reg T for short, is a Federal Reserve Board regulation governing the extension of credit from brokerage firms to investors (also called margin accounts).
In margin trading, Regulation T is used to determine initial margin requirements. An investor who fails to meet the initial margin requirements may be subject to a Reg T call, which is one type of margin call.
Understanding Regulation T and Regulation T calls is important when trading securities on margin. Keep reading to learn more.
What Is Regulation T?
Regulation T is issued by the Federal Reserve Board, pursuant to the 1934 Securities Exchange Act. The purpose of Reg T is to regulate how brokerage firms and broker dealers extend credit to investors in margin trading transactions. Specifically, Regulation T governs initial margin requirements, as well as payment rules that apply to certain types of securities transactions.
Margin trading means an investor borrows money from a brokerage to make investments. This allows the investor to potentially increase their investment without putting up any additional money out of pocket. For example, an investor may be able to put up $10,000 to purchase 100 shares of stock and borrow another $10,000 on margin from their brokerage to double their investment to $20,000.
Regulation T is central to understanding the inner workings of margin accounts. When someone is buying on margin, the assets in their brokerage account serve as collateral for a line of credit from the broker.
The borrowed amount is repaid with interest. Interest rates charged on margin accounts vary according to the brokerage and the amount borrowed.
Trading on margin offers an opportunity to amplify returns, but poses the risk of steeper losses as well.
How Reg T Works
Regulation T works by establishing certain requirements for trading on margin. Specifically, there are three thresholds investors are required to observe when margin buying, one of which is directly determined by Regulation T.
Here’s a closer look at the various requirements to trade on margin:
• Minimum margin. Minimum margin represents the amount an investor must deposit with their brokerage before opening a margin account. Under FINRA rules, this amount must be $2,000 or 100% of the purchase price of the margin securities, whichever is less. Keep in mind that this is FINRA’s rule; some brokerages may require a higher minimum margin.
• Initial margin. Initial margin represents the amount an investor is allowed to borrow. Regulation T sets the maximum at 50% of the purchase price of margin securities. Again, though, brokerage firms may require investors to make a larger initial margin deposit.
• Maintenance margin. Maintenance margin represents the minimum amount of margin equity that must be held in the account at all times. If you don’t know what margin equity is, it’s the value of the securities held in your margin account less the amount you owe to the brokerage firm. FINRA sets the minimum maintenance margin at 25% of the total market value of margin securities though brokerages can establish higher limits.
Regulation T’s main function is to limit the amount of credit a brokerage can extend. It’s also used to regulate prohibited activity in cash accounts, which are separate from margin accounts. For example, an investor cannot use a cash account to buy a stock then sell it before the trade settles under Reg T rules. Here are more details about leveraged trading.
Why Regulation T Exists
Margin trading can be risky and Regulation T is intended to limit an investor’s potential for losses. If an investor were able to borrow an unlimited amount of credit from their brokerage account to trade, they could potentially realize much larger losses over time if their investments fail to pay off.
Regulation T also ensures that investors have some skin in the game, so to speak, by requiring them to use some of their own money to invest. This can be seen as an indirect means of risk management, since an investor who’s using at least some of their own money to trade on margin may be more likely to calculate risk/reward potential and avoid reckless decision-making.
Example of Reg T
Regulation T establishes a 50% baseline for the amount an investor is required to deposit with a brokerage before trading on margin. So, for example, say you want to open a margin account. You make the minimum margin deposit of $2,000, as required by FINRA. You want to purchase 100 shares of stock valued at $100 each, which result in a total purchase price of $10,000.
Under Regulation T, the most you’d be able to borrow from your brokerage to complete the trade is $5,000. You’d have to deposit another $5,000 of your own money into your brokerage account to meet the initial margin requirement. Or, if your brokerage sets the bar higher at 60% initial margin, you’d need to put up $6,000 in order to borrow the remaining $4,000.
Why You Might Receive a Regulation T Call
Understanding the initial margin requirements is important for avoiding a Regulation T margin call. In general, a margin call happens when you fail to meet your brokerage’s requirements for trading in a margin account. Reg T calls occur when you fall short of the initial margin requirements. This can happen, for instance, if you’re trading options on margin or if you have an ACH deposit transaction that’s later reversed.
Regulation T margin calls are problematic because you can’t make any additional trades in your account until you deposit money to meet the 50% initial margin requirement. If you don’t have cash on hand to deposit, then the brokerage can sell off securities in your account until the initial margin requirement is met.
Brokerages don’t always have to ask your permission to do this. They may not have to notify you first that they intend to sell your securities either. So that’s why it’s important to fully understand the Reg T requirements to ensure that your account is always in good standing with regard to initial margin limits.
Margin trading may be profitable for investors, though it’s important to understand the risks involved. Specifically, investors need to know what could trigger a Regulation T margin call, and what that might mean for their portfolios. Regulation T is used to determine initial margin requirements — i.e. the amount of cash an investor must keep available relative to the amount they’ve borrowed.
An investor who fails to meet the initial margin requirements may be subject to a Reg T call, which is problematic because they are restricted from making additional trades until they deposit the 50% initial margin requirement. If the investor doesn’t have cash on hand to deposit, then the brokerage can sell off securities in the account until the initial margin requirement is met.
Margin trading may increase the potential for gains, but it can also increase the risk of steeper losses. If you’re up for the risk, SoFi offers margin loans. When you open a SoFi Invest brokerage account, using margin can help you increase your buying power, take advantage of more investment opportunities, and potentially increase your returns while borrowing at one of the most competitive rates in the industry.* Once your account is set up, you can trade stocks and ETFs.
*Borrow at 10%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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