Sebi's risk management measures for derivatives likely to impact volumes

Market players attribute this to sharp drop in several F&O stocks

The Securities and Exchange Board of India’s (Sebi’s) additional risk management measures for the derivatives market are likely to impact volumes and increase trading costs.

According to brokers, the higher margin requirements could lead to up to a 30 per cent drop in volumes in certain segments, particularly option writing.

Increasing the margin or capital requirements for dealing in the derivatives segment, the market regulator in a circular on Wednesday asked brokers to mandatorily levy ‘initial margin’, ‘exposure margin’ and ‘calendar spread margins’ on their clients.

Brokers already charge initial margin, calculated using software called by Standard Portfolio Analysis of Risk (Span). However, exposure margin and calendar spread margins have been made mandatory as additional safeguards. The higher margin requirements come into effect from June 1. Sebi’s latest move comes on the heels of the decision to make physical settlement mandatory for certain stocks. 

“Although the concept of exposure margin is not new, Sebi has now made it mandatory. The move will impact returns, especially for option writers, as incidence of margin would be higher. This could also lead to a higher funding,” said Alok Churiwala, managing director, Churiwala Securities.
 

These additional margins have been introduced by Sebi to improve the risk management system amid implementation of physical settlement in the futures and options (F&O) segment. 

Market players attributed the sharp drop in several F&O stocks on Thursday to Sebi tightening. Shares of HCC fell 27 per cent, Jet Airways dropped 12 per cent, Ajanta Pharma and Reliance Communication declined 6 per cent each.

“We could see a drop in liquidity in the options segment. The effective returns to option writers will fall by 30 per cent. Earlier, traders could get a yield of 1 per cent on 5 per cent span margin, now they will effectively get only 0.6 per cent on 8 per cent margin for Nifty contracts,” said Jimit Modi, founder, Samco Securities.

“There would certainly be some drop in the trading volumes for the short term due to the new rules but they will also help investors, brokers and all other financial intermediaries by improving risk management in the derivatives markets,” said Achin Goel, head of wealth management, Bonanza Portfolio.

Further, Sebi has tweaked the criteria for computing ‘liquid net worth’, which will require brokers to infuse more capital into their business. The regulator has said the liquid net worth shall be arrived at by deducting initial margin and the exposure margin (extreme loss margin) from liquid assets of the broker.

“The increased capital requirements shall reduce systemic risk of broker defaults. But this could be an issue for several small brokers who are inadequately capitalised,” said Modi.

In the past, the market regulator has expressed concerns over high trading in the derivatives segment. The recent measures for the F&O segment are seen as measures to clamp down on speculation.

 

Tightening Rules

• Sebi has made it mandatory for brokers to charge exposure margins from their clients
• This would be over and above the initial margin which is already charged by brokers
• Sebi has decided to levy the additional margins to maintain a robust risk management system, especially after physical settlement becomes mandatory
• The move could lead to a sharp drop in the F&O volumes, say brokers
• The incremental margin requirements would reduce the asset turnover sharply, especially in the option writers segment