Sebi tightens risk management for commodity derivatives

Exchanges shall take full responsibility on default; regulator doubles initial margin, introduce concentration margin and ends spread margin benefits

The Securities and Exchange Board of India (Sebi) announced a series of measures for strengthening and upgrading of risk management in commodity derivatives markets.

Some new concepts were also introduced to deal with liquidity problems in stressed situations. For instance, up to two days of risk coverage by initial margin, concentration margin, tools to regain matched book and 'default waterfall'. An exchange's accountability in a default has also been increased, to match those at equity exchanges.

So far, exchanges were not a counter-party to trades but ensured and responsibilities were met out of margins. The Sebi has now removed the five per cent cap of the gross revenue (net of income tax) for an exchange's contribution to the Settlement and Guarantee Fund (SGF). 

"Exchanges shall be required to meet the shortfall in full, as indicated in quarterly assessments," the Sebi circular states.

And, till clearing and settlement of trades in commodity derivatives are transferred to clearing corporations, the default waterfall of exchanges shall first use a defaulting member's monies (including contribution to SGF), then as needed by gap insurance, then exchange resources equal to five per cent of SGF and then penalties and investment income on the SGF. If a default could still not be met, the regulator has prescribed what is to be done to make good the loss. Commodity exchanges have been asked to form their clearing corporations for which they still have 18 months.

Apart from this, the minimum base capital for clearing members which clear and settle only non-algorithmic trades for other trading members has been prescribed at Rs 25 lakh. However, to avoid any additional volatility and default risk, the Sebi has asked exchanges to collect an initial margin covering two days of risk, double what is taken today, and the margin. The delivery period margin requirement has also been increased.

Exchanges have been asked to handle members where repeated margin/pay-in shortfalls beyond a threshold amount has been seen and steps have been prescribed for it. For the first time in the commodities segment, exchanges have been told to impose adequate concentration margins to cover the longer period risk required for liquidation of concentrated positions in any commodity.

The Sebi also said, margin benefit on spread positions — which was resulting in higher levarage — shall be entirely withdrawn latest by the start of tender period or expiry-sixth day, whichever is earlier. 

In the event of a member/client failing to honour pay-in/margin obligations, the Sebi has prescribed alternative tools to be used to liquidate the positions and regain a matched book, based on the conditions of market liquidity, volatility, size of position to be liquidated, etc.