The Securities Exchange Board of India (SEBI) had issued Circular dated October 1, 2015, with an objective of aligning and streamlining the risk management framework across national commodity derivatives exchanges (hereinafter referred to as Exchanges). The present circular has been issued to pursuant to Central Government Notification F. No. 1/9/SM/2015 dated August 28, 2015, effective from September 28, 2015, where in all recognized associations under Forward Contract (Regulations) Act, 1952, are deemed to be recognized stock exchanges under the Securities Contracts (Regulation) Act, 1956.
The provisions of this Circular shall be implemented by all the Exchanges across the country latest by January 1, 2016 and communicate to SEBI the status of implementation of the provision of the circular. It is to be noted that the norms specified by Forward Markets Commission will in no way be understood to be modified by present circular.
As per the circular, the risk management system of national commodity derivatives exchanges (Exchanges) shall comprise of the following aspects:
1. Liquid Assets:
Liquid assets shall be deposited by members with the Exchanges in compliance with the norms specified in the circular to cover various margin and deposit requirements.
The types of liquid assets acceptable by Exchanges from their members and limits thereto have been specified in the circular itself.
2. Initial Margins (IM):
Value at risk (VaR) margins, to cover potential losses for at least 99% of the days subject to minimum percentage floor value, will be prescribed by SEBI from time to time.
Currently Exchanges are computing VaR based initial margins using Exponentially Weighted Moving Average (EWMA) method to obtain the volatility estimate and then calculating initial margin by multiplying the volatility estimate by scaling factor. SEBI has also laid down guidelines in the circular to bring uniformity in calculation of IM across all Exchanges.
3. Extreme Loss Margins (ELM):
ELM are the margins to cover the loss in situations that lie outside the coverage of the VaR based initial margins.
ELM of 1% on gross open positions shall be levied and shall be deducted from the liquid assets of the clearing member on an online, real time basis.
The ELM shall be implemented latest within six months of the date of this circular. Until the time any exchange starts charging ELM, the minimum value of initial margins shall be subject to following floor values:-
- Minimum IM For Nickel: 6%
- Minimum IM for other commodities:5%
4. Additional Margins:
Margins imposed on both long and short sides over and above the other margins, would be called additional margins. Exchanges may levy Additional Margins based on their evaluation in specific situations as may be necessary.
5. Tender Period Margin/Pre-expiry Margin:
Exchanges shall levy tender period/pre-expiry margin which may be increased gradually every day beginning from the pre-determined number of days before the expiry of the contract as applicable.
The Exchanges shall determine the quantum of tender period margin as appropriate based on the risk characteristics of the particular commodity.
6. Delivery Period Margin:
Appropriate delivery period margin shall be levied by Exchanges on the long and short positions marked for delivery till the pay-in is completed by the member. Once delivery period margin is levied, all other applicable margins may be released.
7. Minimum Liquid Networth Requirement:
Initial margins, ELM, Additional margins or any other margins as may be specified by SEBI from time to time shall be deducted from the liquid assets of a clearing member. The clearing member's liquid assets after adjusting for applicable margins shall be referred to as 'Liquid Networth' of the clearing member. Clearing Members shall maintain 'Liquid Networth' as specified by SEBI from time to time.
8. MTM (Mark to Market) Settlement:
Mark to market settlement on all open positions of clients/members shall be done on daily basis in cash. All open positions of a futures contract would be settled daily based on the Daily Settlement Price (DSP).
DSP shall be reckoned and disseminated by the Exchange at the end of every trading day. The mark to market gains and losses shall be settled in cash before the start of trading on T+1 day. If mark to market obligations are not collected before start of the next day's trading, the exchange shall collect correspondingly higher initial margin to cover the potential losses.
9. Base Minimum Capital:
Base minimum Exposure is the free deposit required from all members (Trading members/ Clearing members).
- Exchanges shall have BMC requirements for their members (Trading members/Clearing members) as given below (to be complied within six months from the date of this circular coming into effect):
a. Members without Algo trading – INR 10 Lacs
b. Members doing Algo trading – INR 50 Lacs
- Algorithmic or 'algo' trading refers to orders generated at super-fast speed by using advanced mathematical models that involve automated execution of trade, and is mostly used by large institutional investors.
- 25% of the above deposit shall be in the form of cash and balance 75% can be in the form of Fixed Deposit/Bank Guarantee. These funds would be kept in a separate account by the Exchange.
- BMC would be refunded to the members at the time of surrender of membership provided that there is no unsettled claim against member and no arbitration cases are pending against the member.
10. Settlement Guarantee Fund (SGF):
Exchanges shall maintain SGF which shall be used by Exchanges only for the purpose of providing settlement guarantee.
11. Margin Collection and Enforcement:
- All applicable margins shall be deducted by Exchanges from the Liquid Assets of the clearing members on an online, real time basis.
- Margins applicable on client positions have to be compulsorily collected from the clients and reported to the Exchange by the members.
- The members are required to collect Initial Margin and ELM upfront from their clients as applicable at the time of the trade.
- For other margins (MTM margin, Additional margin, delivery margin or any other margin as prescribed by the Exchange) members shall have time till 'T+2' working days to collect from their clients. The period of T+2 days has been allowed to members to collect margin from clients taking into account the practical difficulties often faced by them only for the purpose of levy of penalty and it should not be construed that clients have been allowed two days to pay margin due from them.
12. Risk Reduction Mode (RRM)
Exchanges shall ensure that the trading members/ clearing members are mandatorily put in riskreduction mode when 90% of the member's Liquid Assets available for adjustment against margins/ deposits gets utilized for margins/deposits (to be complied within six months from the date of this circular coming into effect). Such risk reduction mode shall include the following:
a. All unexecuted orders shall be cancelled once trading member himself or his clearing member breaches 90% collateral utilization level.
b. Only orders with Immediate or Cancel attribute shall be permitted in this mode.
c. All new orders shall be checked for sufficiency of margins and such potential margins shall be blocked while accepting the orders in the system.
d. The trading member shall be moved back to the normal risk management mode as and when the collateral utilization level of the trading member as well as his clearing member is lower than 90%.
13. Additional Ad-hoc Margins
Exchanges have the right to impose additional risk containment measures over and above the risk containment system mandated by SEBI. However, the Exchanges should keep the following three factors in mind while taking such action:
a. Additional risk management measures (like ad-hoc margins) would normally be required only to deal with circumstances that cannot be anticipated or were not anticipated while designing the risk management system. If ad-hoc margins are imposed with any degree of regularity, exchanges should examine whether the circumstances that give rise to such margins can be reasonably anticipated and can therefore be incorporated into the risk management system mandated by SEBI. Exchanges are encouraged to analyse these situations and bring the matter to the attention of SEBI for further action.
b. Any additional margins that the exchanges may impose shall be based on objective criteria and shall not discriminate between members on the basis of subjective criteria.
c. Transparency is an important regulatory goal and therefore every effort must be made to make the risk management systems fully transparent by disclosing their details to the public.
As per the circular, the Exchanges are advised to ensure that their risk management framework is in line with the provisions contained in the circular and take steps to make necessary amendments to the relevant bye laws, rules and regulations for the implementation of the same. Further the exchanges should bring the provisions of the circular in the notice of their members and publish such information on its website.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.