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Risk Management Framework

The liquid assets

The liquid assets placed by the members with exchange /clearing corporation as collateral plays a significant role in risk management. All the liquid assets need to fulfill the below criteria laid down by SEBI at all point of time to qualify:

  • MTM (Mark to Market) Losses: Mark to market losses on outstanding settlement obligations of the member.
  • VaR Margins: Value at risk margins to cover potential losses for 99% of the days.
  • Extreme Loss Margins (ELM): Margins to cover the expected loss in situations that lie outside the coverage of the VaR margins.
  • Base Minimum Capital: The base minimum capital shall be blocked from the liquid assets placed by the member with the Exchange/Clearing Corporation.

Factors determining liquidity category of securities

Group (Parameter) Liquid Securities (Group I) Less Liquid Securities (Group II) Illiquid Securities (Group III)
Trading frequency for previous 6 months * At least 80% of the days At least 80% of the days Less than 80% of the days
Impact Cost for previous 6 months * Less than or equal to 1% More than 1% N/A

Note: For securities that have been listed for less than six months, the trading frequency and the impact cost shall be computed using the entire trading history of the scrip.

For the first month

For the first month and till the time of monthly review as mentioned in monthly review, a newly listed stock shall be categorized in that Group where the market capitalization of the newly listed stock exceeds or equals the market capitalization of 80% of the stocks in that particular group. Subsequently, after one month, whenever the next monthly review is carried out, the actual trading frequency and impact cost of the security shall be computed, to determine the liquidity categorization of the security.

In case any corporate action results in a change in ISIN, then the securities bearing the new ISIN shall be treated as newly listed scrip for group categorization.

Impact cost calculation method

  • Impact cost shall be calculated by taking four snapshots in a day from the order book in the past six months. These four snapshots shall be randomly chosen from within four fixed ten-minutes windows spread through the day.
  • The impact cost shall be the percentage price movement caused by an order size of Rs.1 Lakh from the average of the best bid and offer price in the order book snapshot. The impact cost shall be calculated for both, the buy and the sell side in each order book snapshot.
  • The computation of the impact cost adopted by the Exchange shall be disseminated on the website of the exchange.

The category for each security

The category for each security and applicable period is disseminated to members on the SFTP server and to the public at large through the Exchange website www.MSEI.in. The trading frequency and impact cost shall be calculated on the 15th of each month on a rolling basis considering the previous six months for impact cost and previous six months for trading frequency. On the basis of the trading frequency and impact cost so calculated, the securities shall move from one group to another group from the 1st of the next month.

Margins

Mark to Market (MTM) margin

MTM margins shall be collected from the members as a security towards their future settlement obligations. MTM margin is collected only wherein the transaction price is less than the end of the day close price of the security. If the security is not traded for the day, then close price would be latest available close price. Mark to Market Losses shall be collected in the following manner:

  • Mark to market margin (MTM) shall be collected from the member/broker before the start of the trading of the next day.
  • The MTM margin shall also be collected/adjusted from/against the cash/cash equivalent component of the liquid net worth deposited with the Exchange.
  • The MTM margin shall be collected on the gross open position of the member. The gross open position for this purpose would mean the gross of all net positions across all the clients of a member including his proprietary position. For this purpose, the position of a client would be netted across his various securities and the positions of all the clients of a broker would be grossed. Further, there would be no netting across two different settlements.
  • There would be no netting off the positions and setoff against MTM profits across 2 rolling settlements i.e. T day and T-1 day. However, for computation of MTM profits/losses for the day, netting or setoff against MTM profits would be permitted.
  • The margin so collected shall be released along with the pay-in, including early pay-in of securities.

VAR margin

The VaR Margin is a margin intended to cover the largest loss that can be encountered on 99% of the days (99% Value at Risk). For liquid stocks, the margin covers one-day losses while for illiquid stocks it covers three-day losses so as to allow the clearing corporation to liquidate the position over three days.This leads to a scaling factor of square root of three for illiquid stocks. For liquid stocks, the VaR margins are based only on the volatility of the stock while for other stocks, the volatility of the market index is also used in the computation. Computation of the VaR margin requires the following definitions:

  • Scrip sigma means the volatility of the security computed as at the end of the previous trading day. The computation uses the exponentially weighted moving average method applied to daily returns in the same manner as in the derivatives market.
  • Scrip VaR means the highest of 7.5% or 3.5 scrip sigma.
  • Index sigma means the daily volatility of the market index (S&P CNX Nifty or BSE Sensex) computed as at the end of the previous trading day. The computation uses the exponentially weighted moving average method applied to daily returns in the same manner as in the derivatives market.
  • Index VaR means the highest of 5% or 3 index sigma. The higher of the Sensex VaR or Nifty VaR would be used for this purpose.

The VaR Margins are specified as follows for different groups of securities:

Liquidity Categorization One-Day VaR Scaling factor for illiquidity VaR Margin
Liquid Securities (Group I) Security VaR 1 Security VaR
Less Liquid Securities (Group II) Higher of Security VaR and three times Index VaR 1.73 (square root of 3.00) Higher of 1.73 times Security VaR and 5.20 times Index VaR
Illiquid Securities (Group III) Five times Index VaR 1.73 (square root of 3.00) 8.66 times Index VaR

Collection of VaR Margin:

The VaR margin shall be collected on an upfront basis by adjusting against the total liquid assets of the member at the time of trade. Collection on T+1 day is not acceptable.

  • The VaR margin shall be collected on an upfront basis by adjusting against the total liquid assets of the member at the time of trade. Collection on T+1 day is not acceptable.
  • The VaR margin shall be collected on the gross open position of the member. The gross open position for this purpose would mean the gross of all net positions across all the clients of a member including his proprietary position.
  • For this purpose, there would be no netting of positions across different settlements.
  • The VaR margin so collected shall be released along with the pay-in, including early pay-in of securities.
  • The applicable VaR margin rates shall be updated at least 5 times in a day, which may be carried out by taking the closing price of the previous day at the start of trading and the prices at 11:00 a.m., 12:30 p.m., 2:00 p.m. and at the end of the trading session. End of Day and begin of the Day shall be provided along with the three intraday files.(As per SEBI Circular no. MRD/DoP/SE/Cir- 6 /2006 dated June 16, 2006)
  • The Var Margin details are disseminated to members on the SFTP server and to the public at large through the Exchange website www.MSEI.in.

Extreme Loss Margin (ELM)

ELM is used to tackle the situations where in the losses go beyond those envisaged in the 99% value at risk estimates used in the VaR margin. ELM is also popularly known as "exposure limits" and "second line of defence".

  • The Extreme Loss Margin for any stock shall be higher of:
    • 5%, and
    • 1.5 times the standard deviation of daily logarithmic returns of the stock price in the last six months. This computation shall be done at the end of each month by taking the price data on a rolling basis for the past six months and the resulting value shall be applicable for the next month.
  • The Extreme Loss Margin shall be collected/ adjusted against the total liquid assets of the member on a real time basis.
  • The Extreme Loss Margin shall be collected on the gross open position of the member. The gross open position for this purpose would mean the gross of all net positions across all the clients of a member including his proprietary position.
  • For this purpose, there would be no netting of positions across different settlements.
  • The Extreme Loss Margin so collected shall be released along with the pay-in.
  • The Extreme Loss Margin details are disseminated to members on the SFTP server and to the public at large through the Exchange website www.MSEI.in.

Margining of Institutional Trades

All Institutional trades in the cash market would be subject to payment of margins as applicable to transactions of other investors. For this purpose institutional investors shall include

  • Foreign Institutional Investors registered with SEBI.
  • Mutual Funds registered with SEBI.
  • Public Financial Institutions as defined under section 4A of the
  • Companies Act, 1956.
  • Banks, i.e., a banking company as defined under Section 5(1)(c) of the
  • Banking Regulations Act, 1949.
  • Insurance companies registered with IRDA.

All institutional trades in the cash market would be margined on a T+1 basis with the margin being collected from the custodian upon confirmation of trade. These trades would be identified by the use of Custodial Participant (CP) Code at the order entry.

Custodian has to confirm these trades if it is not confirmed then these trades shall be treated as normal trades and applicable margin shall be levied on these trades. Members can enter order by selecting order as INST and keeping Custodial Participant (CP) Code as blank at the time of entering orders on behalf of the institutional clients and they have to allocate these trades to the above categories.

Margins shall be levied on client level on the members who have executed Institutional Trades which have been not accepted or rejected.

Maximum margin

  • Buy: In case of a buy transaction in cash market, VaR margins, Extreme loss margins and mark to market losses together shall not exceed the purchase value of the transaction.
  • Sell: In case of a sale transaction in cash market, the existing practice shall continue viz., VaR margins and Extreme loss margins together shall not exceed the sale value of the transaction and mark to market losses shall also be levied.

Margin Exemption

A member can avail the margin exemption by choosing securities and funds early pay in option. The early pay in of securities and funds give an opportunity to member/clients to deliver the stock before the settlement date and release the blocked margin for utilization.

Early Pay-in of Securities

  • On the T Day EPI is allocated to clients having net deliverable position, on a random basis. However, members are required to ensure to pass on appropriate early pay-in benefit of margin to the relevant clients. However, at the End of Day if the member wishes to allocate benefit at the client level, the member is required to upload EPI File in FTP Folder .
  • Members shall provide the details of the clients to whom early pay-in benefit is to be provided through a file upload. However it will be subject to receipt of securities from depositories.
  • Members shall receive response file of successful and rejected records after the upload.
  • Members can make the Early Pay-in of Securities through either of the depositories(NSDL & CDSL)
  • In NSDL, members shall deliver the securities to their CM Pool Account and execute irreversible delivery out instructions through their Depository Participant, for the particular settlement.
  • In CDSL, members have to open separate early pay-in account with CDSL through MCCIL. Members shall be required to send a request for opening an early pay-in account to MCCIL.

Early Pay-in of Funds

  • Clearing Member will deposit the funds with the clearing bank and intimate the Settlement type and Settlement number for which it is deposited.
  • The clearing bank will provide confirmation to the clearing corporation that these funds will be paid as demanded in the next pay-in run along with the settlement type and settlement number.
  • The Member will also intimate to Clearing Corporation, the details of the Client to whom the EPI is to be applied.
  • The Member will be able to increase, decrease or cancel the allocation for a particular client and security. For this, the Member will always provide the full file for specific allocation.
  • It is possible for a Member to give the EPIF multiple times for the same Settlement type and settlement number. Thus, while allocating the EPIF, the total confirmation received from the bank will be considered.
  • Member can provide allocation details through the file upload mechanism.

Maintenance of Capital Cushion

For the purpose of monitoring members who have high capital utilizations, the methodology as specified hereunder shall be adopted, or such other methodology as may be specified by the relevant authority from time to time

  • At the end of each calendar month, clearing members who have exceeded 90% of utilisation of margin limits during the day for more than 7 days in the current month shall be identified
  • The capital required to bring the utilization of the clearing members to a level of 85% at the time of violating the trigger point of 90% on each of those occasions shall be noted. The highest of such amounts for the identified clearing members during the month shall be called for as additional capital.
  • The requirement of additional capital shall be communicated to the clearing members on the first day of the subsequent month.
  • The clearing members shall be required to provide the amount of additional capital in the form of Cash, FDRs or Bank Guarantees within three working days
  • No benefit including exposure, margin etc shall be available to the clearing member on the amount of additional capital so collected.
  • In case of non- payment of additional capital within the stipulated time limit a penalty as applicable for funds shortage shall be levied for the period of default.
  • The additional capital so collected shall be retained with the Clearing Corporation for a period of one calendar month
  • In case a clearing member is liable to provide additional capital in the subsequent month too, the amount of additional capital shall be recomputed and the excess /deficit shall be refunded /called for.
  • The amount of additional capital shall be informed to the clearing members on the first day of the subsequent month vide letter in the extranet directory.
  • The letter of intimation of additional capital shall be available to clearing members in their SFTP folder.
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The company was incorporated on November 7, 2008 and was permitted by SEBI to undertake clearing and settlement functions of trades done in MSE on January 2, 2009. The company commenced its operations on February 16, 2009.

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