SEBI mulls ‘concentration margin’ in derivatives

To strengthen risk management norms to ensure that during excess volatility the risk of widespread default is minimised

Regulatory firewall: SEBI’s aim is to focus on those having large concentrated positions.

Traders with a very high or significant exposure to commodity and equity derivatives market may soon have to pay a higher margin compared with other traders as the Securities and Exchange Board of India (SEBI) is planning to create a structured framework for levying a ‘concentration margin,’ according to a person familiar with the development.

This is part of the regulator’s attempts to strengthen the risk management norms to ensure that during excess volatility or massive fall in the markets, the probability of a systemic risk in the form of widespread defaults is minimised with adequate margins, he said.

Simply put, a concentration margin would be levied on individuals and institutions whose exposure account for a major chunk of the total exposure in that respective equity or commodity derivative contract.

The issue was discussed recently during a meeting of the risk management review committee set up by SEBI. The regulator had sought the views of all the exchanges before deciding on the manner and structure in which the margin can be introduced, the person said.

Incidentally, ‘concentration margin’ is a normal practice in many exchanges globally, including the NASDAQ.

Global practice

“Concentration margin is a global practice with many exchanges levying it,” said Arun Kejriwal of Kejriwal Research & Investment Services. “A concentration risk is a bigger risk than normal volatility risk because that can bring down the individual or the institution concerned thereby affecting the market integrity as a whole,” he said. “There could be a short term impact on volume in the derivatives market,” he added.

“The aim is to strengthen the margining system by not increasing the overall margin requirements but focussing on those that have a large concentrated position,” said the person who spoke on the condition of anonymity.

“Stress tests have been done to evaluate the risks and the possible impact on the settlement guarantee fund in various scenarios. For instance, what happens if the top 10 or 20 clients default. The structure has not yet been formalised as SEBI has sought feedback in the form of data and suggestions from the exchanges,” he added.

Back-testing data

It is believed that the exchanges have back-tested the market data over the last 5-10 years with scenarios of default by large members and the potential impact on the overall market. Incidentally, commodity exchanges levy such additional margin in certain commodities during periods of excessive volatility but the regulator is looking at a formal structure that could be followed by both, equity and commodity exchanges. Further, the quantum of ‘concentration margin’ will be based on factors like total open interest position, individual concentration, time-to-expiry, overall liquidity in the contract and also the stress level in the overall market liquidity.

The risk management review committee, which is looking into this issue, has received representations from clearing corporations, exchanges and other market participants like banks and corporates.