Commodity Derivatives - Contract Design, Trading, Surveillance, C&S - Lecture Notes PDF

Commodity Derivatives - Contract Design, Trading, Surveillance, C&S Session Outline Essential Components of a Commodity Futures Contract Principles of Commodity Futures Contract Design Key Parameters to be Considered Product Suitability Analysis – Score Card...

Commodity Derivatives - Contract Design, Trading, Surveillance, C&S Session Outline Essential Components of a Commodity Futures Contract Principles of Commodity Futures Contract Design Key Parameters to be Considered Product Suitability Analysis – Score Card Contract Approval and Modification Evaluation of Performance of a Product Modification of an Existing Contract SEBI Criteria for Eligibility, Retention and Reintroduction of Derivatives Contracts on Commodities Role of Independent Oversight Committee for Product Design Options – Product Design  Commodity Derivative Contracts in India Commodity Futures Contracts Price Discovery Commodity Derivative Contracts Price Risk Management in India Commodity Options on Futures Contracts Risk Management Price for Risk Management Delivery through Underlying Options Contracts on Commodities (Spot) Risk Management Price for Risk Management Delivery on Expiry 3 Session 14: Commodity Derivatives  Commodity Derivatives Contract Design - Perspectives Hedgers Hedgers Perspective Perspecti Efficient Price Discovery ve Risk Management Regulator( Regulator(s) s) Perspective Perspectiv Compliance Requirements Commodity e Derivative s Contract Market Design Perspective Market Requirements of Stakeholders Perspecti Efficient Price Discovery ve Competition Competiti Perspective on Arbitrage Opportunities Perspectiv Size of the Contract e 4 Session 14: Commodity Derivatives  Principles on Contract Design – IOSCO* Six Principles for Best Practice in Futures Contract Design: Accountabi Economic lity framework of Clear Utility and risk Price discovery design/review criteria and management procedures; Responsible entity held accountable for continuing compliance Correlation with Cash Responsive Market Reflect underlying physical ness Views of potential contract commodity; users should be taken into Conform to most common account in designing Contra commercial practices commodity contracts ct Design Promotion of Principles Transparen Convergence Cash and futures cy Rulebook and rule equivalence; changes available to Settlement reliability market authorities and participants in a timely manner * - International Organization of Securities Commissions (IOSCO) 5 Economic Utility For regulators, the chance of success or failure – or the potential to have contract performance issues – can be contingent upon whether the underlying commodity o Has a large and active cash market o Has risks dispersed across a wide range of producers, merchants and consumers o Experiences a considerable amount of cash price volatility o Is subject to regulatory treatment that can interrupt supply and demand. And the corresponding contract o Satisfies a hedging need o Tracks assets held by hedgers Correlation with the Cash Market Regulators need to observe whether the contract effectively reflects Size and structure of the market Historical patterns of production, consumption and supply, including seasonality, growth, market concentration, trade patterns Quality or grade of the underlying commodity Liquidity and cash pricing system (transparency, frequency) And accommodates for Vertical integration of production and consumption among producers, merchants & consumers Existence of price controls, embargoes or other regulations Promotion of Convergence Convergence is paramount to the price discovery and risk management functions of futures contracts and an important part of the regulator’s role in protecting the public interest Few deliveries actually occur, but the “credible threat” of delivery (and associated arbitrage opportunities) keeps cash/futures prices in line Contract terms and conditions should reflect the operation of the underlying cash market and avoid impediments to delivery Convergence is measured “basis” Basis = Cash – Futures Negative number, when cash is below futures, constitutes a “weak” basis Positive number, cash above futures, constitutes a “strong” basis Promotion of Convergence (Physical Delivery) Terms and Conditions (Physically-Delivered Commodities) o Contract size and trading unit o Trading months o Minimum price fluctuation (minimum “tick”) o Quality standards o Delivery pack o delivery facilities o last trading day and delivery period o delivery procedures o delivery points o delivery instrument Price limits Reportable levels Position limitations Position accountability Promotion of Convergence: Cash Settlement Guidance from the Commodity Exchange Act: “…[C]ash settlement of the contract is at a price reflecting the underlying cash market, will not be susceptible to manipulation or distortion, and is based on a cash price series that is reliable, acceptable, publicly available and timely.” Pricing basis Cash settlement procedure Determination of the index – reliability, availability and adequacy of sample size Third party information providers Information-sharing agreement when a contract settles to another market’s price  Post Launch Market Surveillance Large trader reporting and transaction reporting Familiarization with o cash market o product terms and conditions o market participants o delivery process and procedures o reporting requirements, as necessary Risk Review o Margin requirements o Incorporate into risk modeling for market participants and the exchange  Product Development - Process Stage #1 Stage #2 Stage #3 Stage #4 Stage #5 Internal Submission of Approval & Conceptualizat Feasibility Study Evaluation Proposal Launch ion Market Consultation Product Parameters Top Management Proposal Evaluation Observation Expert Opinion Clarifications Market Feedback Internal Evaluation Discussions with Contract Modification Stakeholders Product Potential – Key Parameters Standar dization Availabil ity of Price Supply Control Price Market Volatil Size ity Key Paramet ers Geograph Large ical no. of Coverage Buyers /Sellers No Market Existence Interventi of on by Global / Cash/Spot Policy Domesti Market Makers c Commod ity  Product Identification (Sample Scorecard) Parameters Weightage Production of the Product pa in India (US$) 10% Consumption/Demand of the Product pa in India (US$) 10% Trade (Surplus / Deficit) 10% Existence of organized spot market in India 5% Production Location (Globally) 5% Production Location (within India) 5% Standardization of the product 10% Spot Price information 10% Price volatility 10% Traded on any other Futures platform 5% Liquidity of the Futures contract on Global Futures platforms 5% Liquidity of the Futures contract on Indian Futures platforms 5% Recommended by market participants (Market feedback from 10% XX people) Total 100% Evaluation of Performance of a Product Parameters for Evaluation Market Feedback Stakeholders Participation Price Convergence with Spot Market Geographical Spread Traded Volume Liquidity in the Market  Parameters for Performance Review of Commodity Derivative Contract Goods Notified Under SCRA Eligibility Criteria for Allowing Derivative Contracts Risk Management Correlation with International 04 Market Ease-of- doing-Business Seasonality Price Volatility No Price Control 03 Non-applicability of other laws Trade Factors Global Value chain 02 Geographical coverage Commodity Fundamentals Size of the market / 01 Volume of the market Homogeneity/ Standardization Durable / Storable Template on Criteria for Eligibility of Commodity Derivative Products  Criteria for Retention and Reintroduction of Derivative Contracts on Commodities 01 03 Discontin 02 ued/ Not suspende satisfying d the No re- retention launching criteria contract Shall not re- 01 short position in futures – Short call -> short position in futures – Short put -> long position in futures Exercise Style – European Strikes – Minimum of Three in ITM and OTM and  Options on Goods Eligibility – – Exchange either is already trading the futures contracts or is proposing to launch the futures contracts on or before the day of launching option in those goods Commodity Futures Contracts of a Specified Month Settlement – On exercise: – delivery of goods Exercise Style – All exercise style are permitted (European / American style) Strikes – Minimum of Three in ITM and OTM and one ATM Exercise – ATM and 2 CTM – All ITM Trading Mechanism Trading Mechanism o Trading Features o Trading Workstation o Types of Orders o Order Validation o Order Matching o Order Management o Close Price o Bhavcopy 25  Trading Features Automated screen-based trading National reach Order driven trading system Transparent, Objective and Fair system of order matching Identity of the trader undisclosed Daily turnover limits for Buy and Sell for each User Flexibility in placing orders Trading Unit, lot or weight Complete Online Market Information Price tickers: – Flexible Speed and customised Portfolio – for Spot prices and Futures prices 26 Square-off facility Graphical Illustration 27 Trading Workstation Client-Server Architecture Server software (MCX - STRATUS) Fully Fault Tolerant System Delivers 99.999% uptime Client software runs under Windows on PC CTCL Facility Current resource utilization Data-Feed on a real-time basis Disaster Recovery Site o Primary site and DR site in different seismic zone o Online data replication to the DR site o No changes at the members end to connect to DR site 28  Types of Order Time related conditions – Day Order Available for execution during the Trading Day until executed or cancelled Unexecuted Day orders get cancelled at EOD – Good Till Cancelled (GTC) Available for execution till expiry of the contract or till it is cancelled, whichever is earlier – Immediate or Cancel (IOC) Order gets cancelled if not executed – Good Till Date (GTD) Available for execution till end of the specified date or till the last trading day of the contract month, whichever is earlier 29  Types of Order Price related conditions – Limit Order Specifying the price at which the trade should be executed. – Market Order To be executed at prevailing price. If there is no market order at that point of time, it takes the last traded price and remains in the system. – Stop Loss Order Remains in the system in inactive / abeyance mode and is activated only on trigger of the price, defined by member. 30 Order Validation Circuit filter (Price Range) Price steps (Tick size) Market Lot Minimum disclosed quantity [10%/25% or in multiple of trading unit, whichever is higher] Time conditions Order size 31 Order Matching Price Time priority Matching of Best Buy Order – Best Sell Order Quantity fields are in units Prices quotes in Indian Rupees Unique Order No. / Trade No. with Time Stamp 32 Order Matching - Snapshot 33 Order Management Modification and cancellation of orders – The order can be modified by effecting changes in the order input parameters. – Time priority on order modification will change except in case of decrease in quantity or disclosed quantity – An unexecuted / pending order can be cancelled Trades cannot be cancelled/modified 34 Order Modification If the price matches the sellers quote the order is executed Else the buyer has to wait for the seller to sell at his price Or the buyer can modify his order Suppose the buyer wish to modify his order – The person can ask his broker to do so Activity at exchange’s end – After the brokers frontend modification the system at exchange’s end Modified order for input parameters – price, quantity, type and client Time priority change except for decrease in quantity The successful modification is confirmed on real time basis through message on TWS Once the order is executed exchange send the obligation note to the member The margin will be deducted from the trading account 35 The member issues the client a contract note  Close Price * System generated at the end of the day * Formula – Close price is the weighted average price of all trades executed during last 30 minutes in a given contract. – If less than 10 trades during last 30 minutes, then last 10 trades executed during a trading day – If less than 10 trades during the day, then all trades. – If no trades is executed, last closing price. However, Session 16: Commodity Exchanges - Trading and the Exchange can modify such price36  Bhavcopy (Daily Price List) After every Trading Session: Open, High, Low and Close price of the day Previous close price No. of trades Volume Value Open Position Current Index sent to Members through Extranet (FTP) Server Media / Information Vendors through email Public at large through Exchange website 37 37  Price Circuit Filter (1/3) Pre-defined in the Contract Specifications Circuit Filter provides the maximum price range (% of variation) during a trading day Varies for different commodities Computed on the previous day’s Close Price In case of major fluctuations beyond the Price circuit filter, relaxation of circuit filter is required to facilitate better price discovery 38 38 Price Circuit Filter (2/3) Parameters considered before relaxing Circuit filter: Spot price and Market trend of the commodity LTP / close price of different contracts of the commodity No. of Trades till then No. of orders pending in the system Price movement in the contract Price movement in international market 39 39  Price Circuit Filter (3/3) Price Circuit Filter, approved by SEBI , if hit A cooling period of 15 minutes is observed Circuit Filter is relaxed by After informing the market, 50% and market receives Special Margin is levied an automated message online at client level  No further relaxation of Price Circuit filter  I n case of international commodities, the circuit filter is relaxed considering the international market and with prior approval of SEBI 40 40 Why Margins? Margins guarantee the price performance and eliminate risk of default on either side of the trade. Margin helps to ensure a clearing member can cover potential losses with his trading positions. All margins shall be collected upfront from the members and shall be grossed at the level of individual client and grossed across all clients at the member level. 41  Margins (1/3) The clients deposit this money with the members who in turn transfer it to the respective exchanges. The amount of initial margin is so fixed as to ensure that the probability of loss on account of worst possible price fluctuation (which cannot be met by the amount of ordinary/initial margin) is very low. The Exchanges fix rates of ordinary/initial margin keeping in view, need to balance high security of contract and low cost of entering into contract. The various scenarios of price changes would be so computed so as to cover a 99% VaR over a one day horizon. In addition to initial margin and extreme loss margin, additional margin, regulatory margin and long margin / short margin may be levied and changed time-to-time under the guidelines of SEBI. Levy of margins shall be intimated to the members through the circulars. Tender period and delivery period margin shall also be applicable during tender period and delivery period of the contracts. Margins shall be computed on gross positions of the clients i.e. no netting on margins for opposite positions across clients. 42  Margins (2/3) Initial Margin - Pre-defined in the Contract Specifications Special Margin - On relaxing price circuit filter Additional Margin - On continuous higher volatility Delivery Margin - During delivery period Margins at Client level Alert signals to Members at 60%, 75% and 90% utilization Automatic ‘Square-off’ mode if a member crosses the margin limits 43  Margins (3/3) Margin Deposit of a Member = Rs. 1 crore System generates alerts on Margin utilisation of - 60% - Rs. 60 lakh 75% - Rs. 75 lakh 90% - Rs. 90 lakh Member gets automatically in “Square Off” mode. Then he is I n case Margin utilisation restricted from taking fresh positions crosses 100% and is allowed only to Square off his existing positions build up by him. The member gets activated -  upon reducing existing position, or  by depositng Additional Margin with Exchange Member in ACTI VE MODE 44 Marked-To-Market (MTM) Loss (1/2) Monitoring of MTM loss, both notional and booked, incurred by member up to the last executed trade This is calculated on Real-time basis by way of computing the difference between actual traded price and last traded price Alert signals to Members at 60%, 75%, 90% of MTM Losses Automatic ‘Square off’ mode, if Member crosses the permitted MTM limit (75% of the total deposit) 45  Marked-to-Market (MTM) (2/2) Margin Deposit = Rs. 1 crore MTM limit ( 75% ) = Rs. 75 lakh System generates alerts on MTM loss of - 60% - Rs. 45 lakh 75% - Rs. 56.25 lakh 90% - Rs. 67.50 lakh Member gets automatically in “Square Off” mode. Then he is I n case MTM crosses 100% restricted from taking fresh positions and is allowed only to Square off his existing positions build up by him. The member gets activated -  by depositing Additional Margin with the Exchange, or  upon reducing existing position Member in ACTI VE MODE 46  Open Position In order to avoid building-up of huge open position in any commodity, SEBI has specified Maximum Allowable Open Position Limit for Member and his Client - * at Commodity level (all Contracts) * reduced limits for Near Month Contract Exchange, through a software utility, monitors breach of specified limits at periodic intervals during trading session both at Member and Client levels In case of violation, penalty is imposed 47 Position Limits General guidelines for Position Limits i. Numerical value of overall client level open position limits shall be applicable for each commodity. ii. The stock exchanges may prescribe limits lower than what is prescribed by SEBI by giving advance notice to the market under intimation to SEBI. iii. For the purpose of position limits, norms applicable on client level positions shall also be applicable to the proprietary positions of trading members and while calculating member’s open positions, his proprietary positions shall be treated and computed like a client’s positions. Clubbing of Open Positions Monitoring of Position Limits 48 Position Limits (Agri.) (1/3) General guidelines for Position Limits i. Numerical value of overall client level open position limits shall be applicable for each commodity. ii. The stock exchanges may prescribe limits lower than what is prescribed by SEBI by giving advance notice to the market under intimation to SEBI. iii. For the purpose of position limits, norms applicable on client level positions shall also be applicable to the proprietary positions of trading members and while calculating member’s open positions, his proprietary positions shall be treated and computed like a client’s positions. Clubbing of Open Positions Monitoring of Position Limits 49  Position Limits (Agri.) (2/3) Commodity Level i. For the purpose of calculating positions of a client, all long and short positions of the client across all contracts shall be added up separately and higher of the two shall be considered as his overall open position. ii. For determination of numerical value of overall client level open position limits, framework is prescribed for agricultural commodities iii. The overall member level position limits across all contracts shall be 10 times the numerical value of client level position limit or 15% of the market-wide open interest, whichever is higher. iv. Near Month Position Limits: a) Client level position limits shall be equivalent to the one fourth of the overall Client level position limit b) Member level position limits shall also be equivalent to the one fourth of the overall member level position limit. c) Client, higher of long and short positions of the client in near month contracts to be considered. d) Member – Adding positions of client level – No netting V. Exchange-wise Position Limits - VI. The overall Exchange-wide gross position limit on open interests shall be 50% of its ‘deliverable supply’ ‘Deliverable Supply’ determined for the relevant year, which shall also be jointly notified by the stock exchanges along with client level numerical limits 50  Position Limits (Agri.) (3/3) Framework for determination of numerical value of overall client level open position limits Categorization of commodities Sensitive – Prone to frequent Government/External interventions (stock limits, Export/import restrictions, Trade barriers) – Observed frequent instances of price manipulation in past 5 years of derivatives trading Broad – Average deliverable supply for past five year is at least 10 lakh Metric Ton (MT) in quantitative term and is at least INR 5,000 Crore in monetary term. Category of Position Limits Narrow Commodity – Not Sensitive or Broad Broad 1% of the deliverable supply 0.5% of the deliverable Narrow supply Revised limits (If >5%) shall become applicable Sensitive for of 0.25% allthe running deliverable supply contracts with effect from 1st of September of every year 51  Position Limits (Non-Agri.) Commodity Level i. For the purpose of calculating overall position of a client, all long and short positions of the client across all contracts shall be netted out. ii. Client level position limits shall be equivalent to the numerical level limit on Client Level Numerical Position Limits for Non-Agricultural Commodities or 5% of market- wide open interest, whichever is higher. iii. Member level position limits shall be 10 times of the numerical value of client level position limits or 20% of the market-wide open interest, whichever is higher. 52  Position Limits (Hedgers) Commodity Level i. Hedging limit non-transferable ii. Not applicable to near month contract (applicability of near month limit) iii. Case to case basis iv. Should not disturb the equilibrium of the derivatives market v. Hedge limit may also be made available in respect of the short open position acquired by an entity hedging against the stocks of commodities owned by it vi. Shall not exceed his/its actual/anticipated exposure in the physical market vii. Liable for expulsion from membership/prohibition from trading viii. Preserve relevant records for a period of min. 3 years for inspection ix. Approved hedge limit shall be valid for a period (approval letter) x. Stock exchanges shall disclose on their website the hedge position allocated to various hedgers 53  Position Limit (Hedgers) – SE Disclosure Format Stock exchanges shall disclose on their website the hedge position allocated to various hedgers, indicating the period for which approval is valid, in an anonymous manner. 54  Daily Price Limits (DPL) General guidelines for Daily Price Limits (DPL) DPL on First Trading Day of the Contract (For Agri/Non-Agri Commodity Derivatives): For fixing DPL slabs, base price shall be taken as previous day’s closing price of the contract For the first trading day (launch day) of each contract, the stock exchange shall determine base price as under: i. Volume Weighted Average Price (VWAP) of the first half an hour, subject to minimum of ten trades ii. If sufficient number of trades are not executed during the first half an hour, then the VWAP of first one-hour trade subject to minimum of ten trades. iii. If sufficient No. of trades are not executed even during the first hour of the day then VWAP of the first ten trades during the day For any commodity derivatives, the stock exchanges at their discretion may prescribe DPL narrower than the slabs prescribed by SEBI 55  DPL for Agricultural Commodity Derivatives DPL for Agricultural Commodity Derivatives Enhanced Commodity Initial Slab Total DPL Slab Broad 4% 2% 6% Narrow 4% 2% 6% Sensitive 3% 1% 4% After the DPL is enhanced, trades shall be permitted throughout the day within the enhanced total DPL of 4%. 56  DPL for Non- Agricultural Commodity Derivatives Trading Beyond Enhanced Aggregate Commodity Initial Slab Aggregate Slab DPL DPL Energy 6% 3% 9% Yes Metals and 6% 3% 9% Yes Alloys Precious 6% 3% 9% Yes Metals Gems and 3% 3% 6% No Stone Other Non-Agri 6% 3% 9% No Commodities In case price movement in referenceable international market is more than the aggregate DPL, the same may be further relaxed in steps of 3% by exchanges with cooling off period of 15 minutes. 57 Online Monitoring Price Volatility Trading pattern of Futures Market as compared to Spot Market Margin Utilisation by Members Marked-to-Market of Members Sudden rise / fall in Open Interest Sudden rise in turnover of a commodity Abnormal Trading 58 Exchange Surveillance Policy Restricted entry through Electronic Access Card Close Circuit Camera in Surveillance Room Restricted access to the Confidential information - Open Position, Trade Details, Margin Deposit etc. of Members / Clients No Direct Outgoing calls Recording of calls Mobiles not allowed 59 Risks to/from Derivatives market  Risk Management Framework The core of the risk management system of stock exchanges shall comprise of the following: Liquid Assets Initial Margins (IM) Extreme Loss Margins (ELM) Additional Margins Pre-expiry Margin Delivery Period Margin Concentration margins Minimum Liquid Net-worth Requirement MTM (Mark to Market) Settlement Base Minimum Capital Settlement Guarantee Fund (SGF) 61  Risk Management System (1/3) Liquid Assets: Liquid assets shall be deposited by members with the Exchanges in compliance with the norms specified herewith to cover various margin and deposit requirements. Initial Margins (IM): Value at Risk (VaR) Margins to cover potential future exposure for at least 99% of the days to participants in the interval between the last margin collection and the close out of positions following a participant default subject to minimum percentage floor value as prescribed by SEBI from time to time. Extreme Loss Margins (ELM): Margins to cover the loss in situations that lie outside the coverage of the VaR based initial margins. Additional Margins: Margins imposed on both long and short sides over and above the other margins, would be called additional margins. 62 Additional Ad-hoc Margins: Exchanges have the right to  Risk Management System (2/3) Pre-expiry Margin: Exchanges shall levy pre-expiry margin which may be increased gradually every day. 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. Minimum Liquid Net-worth Requirement: The clearing member’s liquid assets after adjusting for applicable margins shall be referred to as ‘Liquid Net-worth’ of the clearing member. Clearing Members shall maintain ‘Liquid Net-worth’ as specified by SEBI from time to time. MTM (Mark to Market) Settlement: Mark to market settlement of all open positions of clients/members shall be 63 done on daily basis.  Risk Management System (3/3) Concentration Margins: Margins to cover the risk of longer period required for liquidation of concentrated positions in any commodity derivatives contract. Base Minimum Capital: Exposure free deposit required from all members of exchanges. Settlement Guarantee Fund (SGF): Exchanges shall maintain SGF which shall be used by Exchanges only for the purpose of providing settlement guarantee. 64  Liquid Assets Liquid Assets - The types of liquid assets acceptable by Exchanges from their members and the applicable haircuts and concentration limits are listed below: Item Minimum Haircut Limits Cash Equivalent Cash, Bank fixed deposits, bank guarantees, 0 for first three, 10% for No Limit Securities of the Central Government, Units of remaining two liquid mutual funds Other Liquid Assets Liquid (Group-I) Equity Shares, Other Mutual Same as VAR margin / NAV Limit on exchange’s fund units exposure to a single issuer. Corporate Bonds having rating of AA or above Fixed percentage based or Not to exceed 10% VaR based Haircut (Min. 10%) Bullion, Gold ETF, Agricultural commodities, 20% (Bullion), 40% (Agri.) Total 30% (15% cap for Base Metals and alloys and Diamond and Diamond, 30% for non-bullion) base metals 65  Types of Margin Types of Margin Description Initial Margin Initial Margin / Var Margin is computed using “SPAN” (Standard Portfolio Analysis of Risk) Exponentially Weighted Moving Average (EWMA) methodology Based on a worst-case loss scenario of portfolio at client level to cover VaR (value at Risk) over a two day horizon Additional margins Margin levied as an Exchange / Regulatory Risk and/ or Special Management Levied whenever deemed necessary considering the margins volatility and price movement in the commodities Extreme Loss Levied to cover the tail end risk not covered by initial Margins margins Tender Period Levied on contracts nearing expiry to ensure non default margins and in commodity delivery Delivery Period Margins  Initial Margin (Futures) Volatility Minimum Initial Margin (IM) Minimum MPOR Category of Commodity Non-Agri. Agri. Non-Agri. Agri. Low (0-15%) 6% 8% 2 3 Medium (15- 8% 10% 2 3 20%) High (>20%) 10% 12% 3 4 Additional Lean Period Margin in Agri. Commodities – 2% (contracts expiring during lean period) Extreme Loss Margin (ELM): ELM of 1% on gross open positions 67  Margins (IM & ELM) Example CM A buys 140 Gold Futures Contracts expiring on December 5, 2020 on September 11, 2020. Futures price: Rs 50,000 / 10 gm. Contract size: 1 kg. Initial Margin: Minimum value of initial margin would be subject to commodity specific floor. Currently, in the case of Gold, its 4%. However, the MPOR for all commodity derivatives contracts shall be at least 2 days. Extreme Loss Margin (ELM): 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. Additional Pointers Initial Margin and ELM is applicable on both buy and sell side Initial Margin and ELM is collected on net open positions at Client level, grossed at TM and CM level Amount (INR Amount (INR) Particulars Percent Crore) (per Contract) (140 Contracts) Contract Value A 50,00,000 70 VAR Margin B = A*4% Minimum 4% 200,000 2.80 Extreme Loss C = A*1% 1% 50,000 0.70 Margin Total Initial D=B+C 250,000 3.5 68 Margin  Margin Imposition Additional and/or Special Margin In case of additional volatility, an additional margin (on both buy & sell side) and/ or special margin (on either buy or sell side) at such percentage, as deemed fit; will be imposed in respect of all outstanding positions. Tender Period Margin Tender Period/Pre-expiry margin is levied in addition to the Initial Margin for the last 5 (or predetermined number of days) calendar days including the expiry day based on the contract. Delivery Period Margin Delivery Margin is levied on the gross open positions that have been marked for delivery. For buyers, Delivery Period Margin is levied till the time the member makes pay-in of funds to collect delivery. For sellers, Delivery Period Margin is exempted if goods tendered during tender period with all the documentary evidence. Once delivery period margin is levied, all other applicable margins (including SPAN, ELM, Tender Margin, Calendar Spread Margin, Additional Margin, Concentration Margin and Special Margin) are released. However, delivery period margins shall be higher of 3% + 5 day 99% VaR of spot price volatility Or 20% 69  Tender Period Margin Example A: 2 Trading Holidays during the Tender Period The following assumes that the seller has not marked the positions for delivery Initial Margin Tender Period Applicable Tender Table A (SPAN + ELM) Margin Period Margin Friday, December 1, 5% 5% 8.66%* 2020 Saturday, December 2, 5% 10% 2020 Trading Holidays Sunday, December 3, 5% 15% 2020 *Since December Monday, December2-3, 4, are non-trading days, no additional margin will be levied. However, for December 1 (on the day immediately5% preceding the trading20% holiday(s)), CH will 20% scale up the 2020 Tender Period Tuesday, Margin December 5, to account for the risk faced on the open position. For the calculation of applicable Tender Period Margin on5% 2020 the subsequent trading 25% day, the two non- trading25% days will be considered. Example B: No Trading Holidays Initial during the Tender Margin Period Applicable Tender Period Table B (SPAN + ELM) Margin Monday, December 1, 2020 5% 5% Tuesday, December 2, 2020 5% 10% Wednesday, December 3, 2020 5% 15% Thursday, December 4, 2020 5% 20% Friday, December 5, 2020 5% 25% 70  Margin Imposition (IM, ELM & TPM) Example CM A buys 140 Gold Futures Contracts expiring on December 5, 2020 on September 11, 2020. Futures price: Rs 50,000 / 10 gm. Contract size: 1 kg. Initial Margin: Minimum value of initial margin would be subject to commodity specific floor. Currently, in the case of Gold, its 4%. However, the MPOR for all commodity derivatives contracts shall be at least 2 days. Extreme Loss Margin (ELM): 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. Tender Period Margin (TPM): Amount (INR Amount (INR) Crore) Particulars Percent (per Contract) (140 Contracts) Contract Value A 50,00,000 70 VAR Margin B = A*4% Minimum 4% 200,000 2.80 Extreme Loss C = A*1% 1% 50,000 0.70 Margin Total Initial D=B+C 250,000 3.5 Margin 71 Tender Period st  Risk Controls Risk Controls Description VaR based Margining – IM computed 10 times during the day On-line alerts at 60%, 75% and 90% utilisation of member’s Margin Margins Limit Upon 100% utilisation of the Margin Limit, member is shifted to square- off mode Members placed in RRM upon utilization of 90% of Margin Limit Risk Reduction Only orders with Immediate or Cancel (IOC) attribute permitted in RRM Mode (RRM) All new orders are checked for sufficiency of margins and orders that do not satisfy sufficiency of the margin are rejected by the system MTM Limit – 75% of the Margin Limit Monitoring of on-line MTM loss, both notional and booked, up to the last On-line Mark executed trade to Market Real time alerts in case of MTM loss (at 60%, 75% and 90%) (MTM) Loss On 100% utilization of the MTM limit, member is shifted to square-off mode Single Order Exchange level as per contract specifications Quantity/ Member level single order value limit based on Margin limit of member Value limit Terminal level limit – facility provided to member  Risk Controls Measures Description Commodity Level: Client level maximum open interest limit Member level maximum open interest limit Near Month Contract Level (for Agri Commodities): Monitoring Client level contract level open interest limit of Open Member level contract level open interest limit Interest On-line Alerts: Limits On client / Member breaching 60%, 75% and 90% of OI limits On-line alerts to Members – PAN level Violation message sent at 100% Penalties as per prescribed norms are levied for violation of OI limit SMPF restrict matching of orders originating from same PAN Self-match When an active buy/sell order gets potentially matched with a passive sell/buy order Prevention (where the PAN of both the orders is same), the active order shall be cancelled Functionality Self-Match Prevention Functionality shall be applicable for all order categories and clients (including *OWN* and INST clients) Members to obtain PAN details of clients before commencement of trading Member required to upload UCC details of the client System check to prevent orders from unregistered UCC. Orders for unregistered clients Unique are automatically rejected by the system Client Code System check to prevent issuance of duplicate UCCs for a client SMS and email sent to all end clients for trade information Trade verification facility through Exchange website  Risk Controls Measures Description Algo permitted only after prior approval “IOC” orders are not permitted “Market” orders are not permitted Mechanis For orderly trading in the market and fair usage, economic disincentives for m/ Checks Daily Order-to-Trade ratio with economic disincentive (Charges) are levied for Algo Trading In case of order to trade ratio exceeding 500, concerned member is not allowed to put orders for 15 minutes (except square off orders) on the next trading day As a safeguard measure, penalty is levied as per the prescribed norms for high order-per-second (OPS) Restricted Entities Debarred by SEBI Entities Employees & Directors of the Exchange (From Trading) WSPs and its associates Mark to Market (MTM) Settlement Mark to Market (MTM) Settlement: All open positions of a futures contract would be settled daily, only in cash, 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. Options on Commodity Futures Exchanges shall adopt risk management framework compliant with the CPMI-IOSCO Principles for Financial Market Infrastructures, including the following: Margining model and quantum of initial margins A. use a conservative estimate of the time horizons for close out of the positions (including in stressed market conditions), B. have an appropriate method for measuring credit exposure that accounts for relevant risk factors and portfolio effects, and C. to the extent practicable and prudent, limit the need for destabilizing, pro-cyclical changes. Options on Commodity Futures Initial margin requirement shall be adequate to cover 99% VaR (Value at Risk) and Margin Period of Risk (MPOR) shall be at least two days. Margining at client level Real time computation Mark to market Options on Commodity Futures Risks pertaining to options that devolve into futures on expiry: Specifically for long option positions (which are probable to be exercised) Exchanges shall start sensitizing the option holders of the impending increase in margins (along with the estimated increase) at least few days in advance, and/or, based on their risk perception, may also consider gradually collecting increased margins during the last few days so as to have adequate margins to cover the risk of futures position that will be created on devolvement of options into futures.  Other Margins Calendar Spread Margin Calendar Spread margin benefit is permitted between different expiry date contracts of the same underlying. No benefit in ELM is provided for spread positions, i.e. ELM is charged on both individual legs. Margin benefit on spread positions is entirely withdrawn latest by the start of tender period or the start of the expiry day, whichever is earlier. Inter spread Margin Inter Spread margin benefit is permitted between two contracts variants having the same underlying commodity. Minimum 25% of the initial margin is charged on each of the individual legs of the spread. No benefit in ELM is provided for spread positions i.e. ELM is charged on both individual legs. Margin benefit on spread positions is entirely withdrawn latest by the start  Other Margins Concentration Margins: Exchanges shall impose adequate concentration margins (only on concentrated positions) to cover the risk of longer period required for liquidation of concentrated positions in any commodity. o The quantum of concentration margins imposed may vary based on the level of concentration. Additional Ad-hoc Margins: Exchanges have the right to impose additional risk containment measures over and above the risk containment system mandated by SEBI. Margin Provisions for Intra-day crystallized losses: In order to mitigate the risk arising out of accumulation of crystallized obligations incurred on account of intra-day squaring off of positions.  Minimum Liquid Net-worth Minimum Liquid net-worth 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 Net-worth’ of the clearing member. Clearing Members shall maintain ‘Liquid Net-worth’ as specified by SEBI from time to time. Members of Clearing Corporations in CD segment shall maintain a minimum Liquid Net-worth of at least INR 50 Lakhs at all points of time.  Base Minimum Capital (BMC) Base Minimum Capital (BMC) i. Exchanges shall have BMC requirements for their members (Trading members) as given below: a. Members without Algo trading – INR 10 Lacs b. Members doing Algo trading – INR 50 Lacs ii. Clearing members who clear and settle only non-algo trades for other trading members shall have BMC requirement of INR 25 lakhs. Clearing members who clear and settle algo trades shall continue to have BMC requirement of INR 50 lakhs. iii. 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. iv. 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.  Risk Reduction Mode (RRM) Risk Reduction Mode Exchanges shall ensure that the TMs/CMs are mandatorily put in risk-reduction mode when 90% of the member’s Liquid Assets available for adjustment against margins/deposits gets utilized for margins/deposits. i. All unexecuted orders shall be cancelled once trading member himself or his clearing member breaches 90% collateral utilization level. ii. Only orders with Immediate or Cancel attribute shall be permitted in this mode. iii. All new orders shall be checked for sufficiency of margins and such potential margins shall be blocked while accepting the orders in the system. iv. 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%. Measures in case of repeated shortfall in margin/pay-in i. The member be put in square off mode and required to reduce positions. ii. The member be charged initial margins at a higher rate for the next one month, Or The member be subjected to a penal exposure free deposit equal to the cumulative funds/margin shortage over previous one month which could be kept with the exchange for the next month. iii. Exchange shall keep a close watch on such member.  Default Waterfall Defaulting member’s monies (including contribution to SGF) Insurance, if any Exchange resources equal to 5% of SGF SGF resources in the following order:  Penalties and investment income on SGF  25% of Exchange contribution to SGF  Remaining (non-defaulting members’ and exchange) contribution to SGF on pro-rata basis. Remaining exchange resources (excluding INR 100 crore*) Capped additional contribution by non-defaulting members (equal to their required contribution to SGF) Any remaining losses to be covered by way of pro-rata haircut to pay-outs. *INR 100 crore to be excluded only when remaining exchange resources are more than INR 100 crores. Settlement Guarantee Fund (SGF) Objective of Core SGF - Clearing Corporation (CC) shall have a fund called Core SGF for each segment of each Recognised Stock Exchange (SE) to guarantee the settlement of trades executed in respective segment of the SE. Corpus of Core SGF - The corpus of the fund should be adequate to meet out all the contingencies arising on account of failure of any member(s). Contribution to Core SGF a) Clearing Corporation contribution: CC contribution to Core SGF shall be at least 50% of the MRC. b) Stock Exchange contribution: Stock Exchange contribution to Core SGF shall be at least 25% of the MRC. c) Clearing Member primary contribution: If the CC wishes, it can seek risk based contribution from Clearing Members (CMs) of the segment (including custodial clearing members) to the Core SGF subject to the following conditions: o that total contribution from CMs shall not be more than 25% of the MRC, o that no exposure shall be available on Core SGF contribution of any CM and Settlement Guarantee Fund (SGF) Management of Core SGF - The Defaulter's Committee/SGF utilization Committee of the Clearing Corporation shall manage the Core SGF. Access to Core SGF - CC may utilise the Core SGF in the event of a failure of member(s) to honour settlement commitment. Further contribution to / Recoupment of Core SGF Review of Core SGF Default waterfall Stress testing and back testing Liquidity stress test and adequacy of liquidity arrangements  Penal Provisions for Non-delivery Violation Penalty References Buyer/ Seller Contract default in case of 2.5% of DDR + Replacement Cost @ 4% of specifications of Both Options DDR respective Contracts commodities. Buyer default in Buyer default is not permitted as per SEBI Contract case of Compulsory norms. specifications of Delivery contracts / respective Sellers Option Buyer attracts suspend-square off mode and commodities. Contract further disciplinary action 3% of DDR (Settlement Price) + Replacement cost* Replacement Cost computed as: For Agri Commodities Difference between SP and average of three MCX/C&S/ Seller Delivery highest of the last spot prices of 5 302/2016 dated Default in case of succeeding days after commodity pay-out. September 28, Compulsory Option (provided that the average so determined is 2016 & contract Contract greater than settlement price) specifications of respective For Non-Agri Commodities commodities. Difference between SP and higher of the last spot prices on the commodity pay-out date Thank You