3.2.2.2.3. Margin Agreements
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. Alongside the margin agreement, non-institutional customers must be given a disclosure document explaining the risks of margin trading. This disclosure must be delivered again annually.
A margin agreement typically contains 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. The margin account’s hypothecation agreement is where the customer pledges the securities in the account as collateral for the funds he borrows to buy on margin. The hypothecation agreement also gives the lender the right to use the customer’s securities as collateral for its own borrowing, within certain limits.
Credit agreement. This agreement details the terms and conditions for the credit that the broker-dealer offers the customer. This agreement specifies