4.3.1. Opening a Margin Account
Prior to opening a margin account, the customer must sign a margin agreement. The margin agreement sets the terms and conditions for enabling the client to borrow from the brokerage to buy securities. It identifies how much collateral will be placed in the margin account and the interest rate on the margin loan, and it permits (or does not permit) the customer’s broker to pledge the securities on margin as collateral for its own borrowing. Margin agreements typically contain three parts: the hypothecation agreement, the credit agreement, and the loan consent agreement.
Hypothecation agreement. Securing a debt by pledging securities as collateral for a loan is called hypothecation. This is because the pledged securities are “hypothetically” controlled by the creditor: the borrower retains ownership, but the creditor may seize possession if the borrower defaults. In a hypothecation agreement, the broker-dealer (the lender) agrees to a loan and the customer (the borrower) pledges collateral. The agreement also gives the lender the right to use the collateralized securities as collateral for a bank loan.
Credit Agreement. The second part of a margin agreement, the credit agreement, details the terms and conditions for the credit that the broker-dealer offers the customer. This agreement specifies the interest rate on the loan, which is set at the broker call rate, and it describes how the firm will calculate the interest.
Loan consent agreement. The loan consent agreement permits the broker-dealer to borrow the customer’s margined securities to cover short