Regulatory Framework


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Brokerage

Margins From Clients

Margins to be collected from all clients/trading members
Daily margins to be further collected
Right of clearing member to close out positions of clients/TMs not paying daily margins
Losses if any to be charged to clients/TMs and adjusted against margins

Cash V/s Futures Market

J R Varma Committee Report

Constituted in June 1998
Submitted its report in Nov 1998
Objectives - recommend measures for risk containment in the Indian derivative market
Opertionalise the recommendations of the L C Gupta Committee

Background scenario

Statistics

Mean I.e. arithmetic average
Standard Deviation - a measure of dispersion
Variance = square of Standard Deviation
Normal Distribution - a probability distribution that can be adequately described/predicted based on the Mean and Standard Deviation

Margining System

Exponential weighted moving average method for estimating daily volatility
Variance at end of day t = ( 0.94 x variance at end of day (t-1)) + (0.06 x square of return of day t)
Logarithmic Returns
0.94 is recommended by Prof J R Varma
Model based on J P Morgan RiskMetrics
Margins for 99% VAR based on 3 sigma limits - theoretically the maximum amount a portfolio can lose (typically in a day)
During first 6 months, parallel estimation of cash and futures market
Margins to be higher of the two
Initial margins to be at least 5%
Initial calculations based on last 1 year of cash market
Futures volatility expected to be higher
The method attaches higher weights to more recent volatility
Trading software would provide volatility information on real-time basis
Volatility of day t will be used for margin calculations on day t evening

Margining for Calendar Spreads

Basis risk and no market risk
0.5% per month of spread (on far month contract)
Minimum 1% and maximum 3% margin
On expiry of near month contract, the far month would become an open position
Position to be treated as open over the last 4 days gradually
100% open on day of expiry, 80% open 1 day before, 60% open 2 days before, 40% open 3 days before and 20% open 4 days before expiry
Calendar spread open position = 1/3 of mark to market value of the far month contract

Periodic Reporting

Exchange to report to SEBI highlighting specific instances where price moves are beyond 99% VAR limits
Incidences of failure in collection of margin or settlement dues on quarterly basis
Failure defined as shortfall for 3 consecutive trading days of 50% or more of liquid net worth

Liquid Net Worth

Total liquid assets deposited with the exchange/cc less
Initial margin applicable to total gross open position
Liquid net worth shall be at least Rs 50 lakhs
Gross open positions shall not exceed 33.33 times liquid net worth
Back-testing over 8 years reveals that this level has been insufficient only twice on Nifty and never on Sensex
LNW includes cash, fixed deposits, bank guarantees, treasury bills, Govt securities, dematerialised securities
Securities to be marked to market at least on weekly basis
Only investment grade debt securities accepted - haircut 10%
Equity in demat form - 15% haircut
Acceptable equities - top 100 by market cap out of top 200 by market cap and trading value
All securities to pledged in favour of CC
At least 50% shall be cash, bank guarantees, FDs, T-bills and Govt sec

Position Limits

Customer level limits impractical
Persons acting in concert owning 15% or more of open interest to report this fact to the exchange
Trading member limit - 15% of open interest of Rs 100 crores whichever is higher
Clearing member should ensure that his own position and his TMs are within above limits

Back-testing Results

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