Sebi lays down more robust risk management framework for equity derivatives

Regulator Sebi Monday put in place a more robust risk management framework with regard to margin system for the equity derivatives segment.

The framework has been prepared on the basis of recommendation by Sebi's Risk Management Review Committee.

Now, the payment of mark to market margin (MTM) would mandatorily be made by all the members on T+0 basis -- before start of trading on the next day, as per a circular.

Currently, stock exchanges and clearing corporations offer a choice to the trading members to opt for payment of MTM either before the start of trading on the next day (T+0) or on the next day (T+1). This would be with scaled up margins to cover the potential for losses over the time elapsed in the collection of MTM.

To bring Margin Period of Risk (MPOR) in greater conformity with the principles for financial market infrastructures, Sebi has increased the margin period of risk to two days from one day at present.

Additionally, the regulator has asked stock exchanges and clearing corporations to estimate the appropriate MPOR, subject to a minimum of two days, for each equity derivative product based on liquidity and scale up the initial margins and exposure margins accordingly.

For initial margins, the revised MPOR would be given effect by way of scaling up the 'price scan range' used for computing the worst scenario loss.

Under the principles for financial market infrastructures, central counter-party identify and consider a number of elements, including margin period of risk or close-out period, when constructing an appropriate margin system to address risks that arise from the products cleared.

The assumed margin period of risk incorporates the market depth and characteristics of the products cleared.

Derivatives in financial markets typically refers to a forward, future, option or any other hybrid contract of pre-determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to an index of securities.

Broadly, there are two types of derivative contracts -- futures and options.

A futures contract means a legally binding agreement to buy or sell the underlying security on a future date, while options contract gives the buyer or holder of the contract the right (but not the obligation) to buy or sell the underlying asset at a predetermined price within or at end of a specified period.