What Is Regulation T?
Regulation T is a collection of provisions that govern investors' cash accounts and the amount of credit that brokerage firms and dealers may extend to customers for the purchase of securities. According to Regulation T, an investor may borrow up to 50% of the purchase price of securities that can be bought using a loan from a broker or dealer. The remaining 50% of the price must be funded with cash.
Key Takeaways
- Regulation T governs cash accounts and the amount of credit that broker-dealers can extend to investors for the purchase of securities.
- Investors who want to purchase securities using broker-dealer credit need to apply for a margin account.
- Reg T mandates that investors can borrow no more than 50% of the purchase price while the remaining balance must be paid in cash.
Understanding Regulation T (Reg T)
Buying securities with borrowed money is commonly referred to as buying on margin, which refers to assets that an investor must deposit with a broker-dealer to obtain a loan. Additionally, Regulation T promulgates payment rules on certain securities transactions made through cash accounts.
Regulation T, or Reg T, was established by the Board of Governors of the Federal Reserve System to provide rules for extensions of credit by brokers and dealers and to regulate cash accounts. An investor who has a cash account cannot borrow funds from a broker-dealer and must pay the purchase price of securities with cash.
Margin accounts, on the other hand, allow investors to obtain credit to fund a portion of their securities purchase. Because buying securities on credit can expose investors to sudden losses of a much larger magnitude compared to the same purchase using only cash, the Federal Reserve Board stepped in and promulgated a rule that limited the borrowing to be no greater than 50% of the securities purchase price.
The 50% requirement is called the initial margin because it establishes a minimum borrowing level at the time of purchase. Certain brokers may have stricter requirements, with levels above 50%.
Regulation T limits the amount of credit an investor can get from their broker to buy securities on margin.
Special Considerations
While the primary goal of Regulation T was to govern margin, it also introduced transaction rules for cash accounts. Because it takes up to two days for securities transactions to settle and the cash proceeds to be delivered to the seller of securities, a situation can arise when an investor buys and sells the same securities before paying for them from the cash account. This is called freeriding, and it is prohibited by Reg T.
In such cases, the investor's broker must freeze the cash account for 90 days, requiring the investor to fund their securities purchases with cash on the date of the trade.
Example of Reg T
An investor who wishes to purchase securities using broker-dealer credit must apply for a margin account that grants borrowing privileges. When investors borrow money in their margin account, they must pay interest based on the rate schedule established by the broker-dealer.
Suppose an investor wishes to obtain a loan from a brokerage firm to purchase 10 shares of a certain company with a price per share of $100, resulting in a total purchase of $1,000. Regulation T states that the investor can borrow no more than 50% of the purchase price, or $500, from the broker, while the remaining balance must be paid in cash.
FAQs
Example of Reg T
What is the Regulation T requirement? ›
Regulation T (Reg T) is a Federal Reserve Board provision that regulates extensions of credit and requires that investors have a minimum initial ownership interest of 50%.
What is the maintenance requirement for Reg T? ›
Once the stock has been purchased, the maintenance margin represents the amount of equity the investor must maintain in the margin account. Regulation T sets the minimum amount at 25 percent, but many brokerage firms will require a higher rate.
What's the Regulation T loan value for an eligible security? ›
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.
What is the Federal Reserve Regulation T? ›
The Federal Reserve Board's Regulation T and SEC Rule 15c3-3 provide for the possibility of extensions of credit by broker-dealers to investors when they have not promptly paid for a securities transaction.
What is requirement of regulation? ›
Regulatory requirements are rules that businesses must follow. They are invoked by designated regulators and compliance officers: those who make and enforce the rules. Also known simply as regulations, these obligations can specify different things.
What is the minimum deposit for Reg T? ›
For example, let's assume an investor wants to purchase $10,000 of stock in their new margin account. The standard Regulation T cash deposit requirement is 50%, or $5,000.
What is initial requirement and maintenance requirement? ›
Initial margin is the amount of funds required by CME Clearing to initiate a futures position. While CME Clearing sets the margin amount, your broker may be required to collect additional funds for deposit. Maintenance margin is the minimum amount that must be maintained at any given time in your account.
What is the minimum maintenance requirement? ›
The Bottom Line
A house maintenance requirement is the minimum equity an investor must hold in their margin account after making a purchase. Once a security is bought on margin, the requirement kicks in. Regulation T demands that at least 25% of the total market value of the securities be in the account at all times.
What is the maintenance requirement? ›
House maintenance requirement refers to the minimum amount of equity that a trader must have in their account to maintain a margin balance. The regulations are set out by Regulation T of the Federal Reserve as a way to protect brokerage firms from losses in the event that traders are unable to pay back the credit.
The securities exempt from Regulation T margin requirements but still subject to an initial margin requirement determined by the broker-dealer are exempt securities. These typically include U.S. Treasury and government securities, municipal bonds, and other high-quality instruments.
What is the difference between Reg T and Reg Way? ›
Regulation T settlement, which is different than regular-way settlement, occurs on the second business day after regular-way settlement. Stocks settle regular-way on the second business day after the trade, resulting in Regulation T settlement occurring two business days later (T+4).
How to meet a Regulation T call? ›
The customer must increase the equity in the account by depositing additional funds and/or marginable securities. If the necessary amount of cash or securities is not deposited into the account within the specified time period, securities may be sold to meet the call, and the account may become restricted.
What are the key requirements of Reg T? ›
Formally known as Regulation T, it's the initial margin requirement set by the Federal Reserve Board. According to Reg T requirements, an investor or trader may borrow up to 50% of marginable securities that can be purchased (such as most listed stocks).
What is an example of a Federal Reserve requirement? ›
As an example, assume a bank has $200 million in deposits and is required to hold 10%. The bank is now allowed to lend out $180 million, which drastically decreases bank credit—the amount of money the loans the bank can make to customers.
What is the payment period for Regulation T? ›
Section 220.2 of Regulation T defines a “payment period” as the number of business days in the standard securities-settlement cycle in the United States, as defined in paragraph (a) of SEA Rule 15c6-1 (17 CFR 240.15c6-1(a)), plus two business days.
Which transaction is subject to Regulation T? ›
Regulation T applies to transactions in non-exempt securities - these are the securities that are NOT exempt from the provisions of the Securities Act of 1933; and the Securities Exchange Act of 1934. U.S. Government bonds are exempt. Corporate bonds, American Depositary Receipts and warrants are non-exempt.
What is Regulation T versus Regulation U? ›
Reg T primarily governs the extension of credit to a margin customer by a broker dealer, while Reg U addresses the potential “loophole” of an investor utilizing commercial bank credit to finance trading activities.
What is the difference between Reg T and regular way settlement? ›
Stocks settle regular-way on the second business day after the trade, resulting in Regulation T settlement occurring two business days later (T+4). For example, assume an investor buys stock on a Monday. Regular-way settlement would occur on Wednesday (T+2) and Regulation T settlement would occur on Friday (T+4).
