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20 September 2020

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Risk Management

Risk Management: The most critical component of a risk containment mechanism is the online position monitoring and margining system. The actual margining and position monitoring is done on-line, on an intra-day basis. Exchanges use the SPAN® (Standard Portfolio Analysis of Risk) system for the purpose of margining, which is a portfolio based system.

The Exchange levies initial margin and MTM (exposure) margin in derivative segment.

Initial Margin is calculated on a portfolio basis and not on individual scrip basis. The margin calculation is done using SPAN (Standard Portfolio Analysis of Risk) a product developed by Chicago Mercantile Exchange. The margin is levied at trade level on real-time basis. The rates are computed at 5 intervals one at the beginning of the day 3 during market hours and one at the end of the day. Initial margin requirements are based on 99% value at risk over a one-day time horizon. However, in the case of futures contracts (on index or individual securities), where it may not be possible to collect mark to market settlement value, before the commencement of trading on the next day, the initial margin may be computed over a two-day time horizon, applying the appropriate statistical formula. In case of option purchase the margin levied will be equivalent to the premium amount. This margin will be levied till the time premium settlement is complete.

Initial margin requirement = Total SPAN margin requirement + Net Buy Premium.

Exposure Margin is based on a single percentage on the value of the scrip determined at the beginning of every month for the following month by the exchange. This is charged over and above the initial margin and is popularly referred as second line of defense.
Assignment margin: Assignment margin is levied in addition to initial margin and premium margin. It is required to be paid on assigned positions of CMs towards exercise settlement obligations for option contracts, till such obligations are fulfilled. The margin is charged on the net exercise settlement value payable by a CM.
Cross Margining: Cross margining benefit is provided for off-setting positions at an individual client level in equity and equity derivatives segment.

Margining System :Clearing Corporation has developed a comprehensive risk containment mechanism for the Futures & Options segment. The most critical component of a risk containment mechanism is the online position

monitoring and margining system. The actual margining and position monitoring is done online, on an intra-day. The risk of each trading and clearing member is monitored on a real-time basis and alerts/disablement messages are generated if the member crosses the set limits.

SPAN approach of computing initial margins: The objective of SPAN is to identify overall risk in a portfolio of futures and options contracts for each member. The system treats futures and options contracts uniformly, while at the same time recognizing the unique exposures associated with options portfolios like extremely deep out-of-the-money short positions, inter-month risk and inter-commodity risk. SPAN constructs sixteen scenarios of probable changes in underlying prices and volatilities in order to identify the largest loss a portfolio might suffer from one day to the next. It then sets the margin requirement at a level sufficient to cover this one-day loss. The computation of worst scenario loss has two components. The first is the valuation of each contract under sixteen scenarios. The second is the application of these scenario contract values to the actual positions in a portfolio to compute the portfolio values and the worst scenario loss.

Calendar spread margin

A calendar spread is a position in an underlying with one maturity which is hedged by an offsetting position in the same underlying with a different maturity: for example, a short position in a July futures contract on Reliance and a long position in the August futures contract on Reliance is a calendar spread. Calendar spreads attract lower margins because they are not exposed to market risk of the underlying. If the underlying rises, the July contract would make a loss while the August contract would make a profit.

Overall portfolio margin requirement

The total margin requirements for a member for a portfolio of futures and options contract would be computed by SPAN as follows:
1. Adds up the scanning risk charges and the calendar spread charges.
2. Compares this figure to the short option minimum charge and selects the larger of the two. This is the SPAN risk requirement.
3. Total SPAN margin requirement is equal to SPAN risk requirement less the net option value, which is mark to market value of difference in long option positions and short option positions.
4. Initial margin requirement = Total SPAN margin requirement + Net Buy Premium.

Payment of margins

The initial and exposure margin shall be payable upfront by the clearing members. Members are required to collect initial margins from their client/constituents on an upfront basis. It is mandatory for all clearing /trading members to report details of such margins collected to the Clearing corporation.

Client Margin Reporting: The files are required to be uploaded to exchange as per the format specified. A return file shall be generated for all files uploaded by the members for client margin reporting. Members are allowed to upload client margin reporting file up to T+5 working days.

Penalty for short / non-reporting of client margin:

The following penalty shall be levied in case of short reporting by trading/clearing member per instance.
Short collection for each client Penalty percentage
(< Rs 1 lakh) And (< 10% of applicable margin) 0.50%
(≥ Rs 1 lakh) Or (≥ 10% of applicable margin) 1.00%
If short/non-collection of margins for a client continues for more than 3 consecutive days then penalty of 5% of the shortfall amount shall be levied for each day of continued shortfall beyond the 3rd day of shortfall.

If short/non-collection of margins for a client takes place for more than 5 days in a month, then penalty of 5% of the shortfall amount shall be levied for each day, during the month, beyond the 5th day of shortfall.

Notwithstanding the above, if short collection of margin from clients is caused due to movement of 3% or more in the Nifty (close to close) on a given day, (day T), then, the penalty for short collection shall be imposed only if the shortfall continues to T+2 day.

Market wide Position Limit violation:

At the end of each day during which the ban on fresh positions is in force for any security, when any member or client has increased his existing positions or has created a new position in that security the client/trading members shall be subject to a penalty 1% of the value of increased position subject to a minimum of Rs.5000 and maximum of Rs.100000. The positions, for this purpose, shall be valued at closing price of the security in the normal market of the Capital Market segment of the Exchange The penalty shall be recovered from the clearing member affiliated with such trading members/clients on a T+1 day basis along with pay-in. The amount of penalty shall be informed to the clearing member at the end of the day.

ADJUSTMENTS FOR CORPORATE ACTIONS: Adjustment for corporate actions shall be carried out on the last day on which a security is traded on cum basis in the underlying equities market, after the close of trading hours.
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