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Vivek Law
MUMBAI, NOV 8: The JR Verma panel appointed by SEBI has suggested a set of stringent guidelines for index-based futures trading. The group report on risk-containment measures for future trading has recommended that for the first six months of trading (until the futures market stabilises with a reasonable level of trading), the initial margin shall not be less than five per cent. The report also recommends a minimum Rs 50 lakh net worth in terms of "liquid assets" -- with the term liquid assets being defined very sharply.
During the initial six-month period of futures trading, the committee has said that margins should be set using volatility indicators derived from the cash market.
According to the group, even an accurate 99.99 per cent "value at risk" model would give rise to mark-to-market losses at the end of the day that would exceed the margin approximately once every six months.
"Obviously, the futures market should not be subject to a payments crisis every six months and this means that theremust be a second level of defence in the form of a broker's net worth.
The group is of the view that given the reality of the Indian situation, liquid net worth is a far more meaningful defence against market risk than book net worth", the panel has recommended.
Liquid net worth has been defined as total liquid assets deposited with the exchange towards initial margin and capital adequacy less initial margin applicable to gross open positions at any given point of time of all trades cleared through the clearing member.
The liquid net worth of a broker must satisfy the following conditions on a real-time basis: the liquid net worth shall not be less than Rs 50 lakh at any point of time and "not less than 33.33 times the mark-to-market value of gross open positions at any point of time of all trades cleared through the clearing member." In other words, a member's liquid net worth multiplied by 33.33 should exceed the total open position.
As to what should constitute liquid assets, the group hasrecommended that equity securities offered as part of new worth should mandatorily be in dematerialised form.
The acceptable securities would also have to be among the top 100 securities by market cap and the top 200 by trading value. All securities deposited for liquid assets will be be pledged in favour of the clearing corporation.
The total exposure of the clearing corporation to the debt or equity securities of any company shall not exceed 75 per cent of the trade guarantee fund or 15 per cent of the total liquid assets deposited with the clearing corporation. Debt securities shall be acceptable only if they are investment grade.
On bank guarantees, the group has recommended that the clearing corporation would set an exposure limit for each bank taking into account all relevant factors.
Not more than one per cent of the trade guarantee fund shall be exposed to any single bank which is not rated P1 or equivalent by an RBI-recognised credit rating agency and not more than 10 per cent of the TGFshall be exposed to all such banks put together.
The group has said that the clearing corporation should be required to disclose the details of incidence of failure in collection of margin or settlement dues on a quarterly basis. Failure for this purpose would mean a shortfall for three consecutive days of 50 per cent or more of the liquid net worth of the member.
The panel, which has gone into considerable detail in outlining the risk containment measures which need to be put in place in a derivatives market, has said that it does not make sense to have laxer risk containment measures in the cash market than in the derivatives market.
The group has, therefore, recommended that the basic ideas enshrined in the report should be extended to the cash market. The group has suggested that the margins in the cash market should be based on a 99 per cent value-at-risk model. As an interim measure, the margins could be twice that in an index futures market since individual securities are roughly twice asvolatile as the index. Exposure limits could also be commensurately lower than in the derivatives market.
The recommendations on the computation of liquid net worth and the up-front margins could be easily applied to the cash market, the panel has recommended.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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