Executive Summary:
This circular revises the margin framework for commodity derivatives, categorizing commodities based on realized volatility to prescribe floor values for Initial Margin (IM) and Margin Period of Risk (MPOR). It addresses procyclicality in margin arrangements, aligning with CPSS-IOSCO principles. Clearing Corporations (CCs) must categorize commodities within 15 days and fully implement revised norms within three months from the circular date.
Key Points / Main Content:
* **Commodity Categorization:**
* Commodities are categorized into Low, Medium, and High volatility based on realized annualized volatility over the last three years (0-15, 15-20, Above 20 respectively).
* Realized volatility is calculated from daily log normal returns of near-month futures contracts, rolled over appropriately.
* The CC of the Lead Exchange (exchange with maximum average daily turnover) categorizes commodities, and other CCs must adopt the same categorization.
* **Minimum IM and MPOR:**
* Minimum IM and MPOR are prescribed based on volatility category, differing for Agri and Non-Agri commodities. The values are as follows:
| Volatility Category | Minimum IM (Non-Agri) | Minimum IM (Agri) | Minimum MPOR (Non-Agri) | Minimum MPOR (Agri) |
| :------------------ | :-------------------- | :----------------- | :---------------------- | :------------------ |
| Low | 6 | 8 | 2 | 3 |
| Medium | 8 | 10 | 2 | 3 |
| High | 10 | 12 | 3 | 4 |
* Floor values for IM are not scaled up by MPOR.
* **Review and Recategorization:**
* CCs must review commodity categories every six months based on the past three years' data.
* Movement from higher to lower category requires two consecutive reviews meeting the criteria, while movement from lower to higher requires only one review.
* Categorization is done on March 1st and September 1st each year, with changes applicable from April 1st and October 1st, respectively.
* **New Commodities:**
* New underlying commodities are initially categorized based on spot market prices, subject to a minimum of Medium volatility.
* Recategorization from higher to lower volatility can only occur after two consecutive reviews.
* **Lean Period Margin (Agri Commodities):**
* CCs shall levy an additional lean period margin of 2 on contracts expiring during the lean period.
* Lead exchanges determine the lean period in consultation with their Product Advisory Committee and disclose it on their websites.
* **Disclosures and Implementation:**
* CCs must disclose detailed breakups of applicable margins and volatility on their websites.
* Initial categorization must be done within 15 days of the circular.
* Revised norms for IM, MPOR, and lean period margin must be fully implemented within three months of the circular.
Impact Analysis
* **Clearing Corporations (CCs):**
* *Impact:* Required to categorize commodities, implement revised margin norms, and disclose margin details.
* *Action Required:* Categorize commodities within 15 days, implement revised norms within three months, update stress testing scenarios, and disclose margin details on their websites.
* **Exchanges (Especially Lead Exchanges):**
* *Impact:* Lead Exchanges are responsible for the categorization of commodities. Exchanges that handle Agri commodities are responsible for determining lean periods.
* *Action Required:* Lead Exchanges must categorize commodities and inform other CCs. Exchanges with Agri commodities must determine and disclose lean periods.
* **Market Participants/Traders:**
* *Impact:* Subject to revised margin requirements, potentially impacting trading costs and strategies.
* *Action Required:* Monitor changes in margin requirements and adjust trading strategies accordingly.
Key Entities Referenced
Securities and Exchange Board of India (SEBI): Regulatory body that issued the circular regarding the review of margin framework for commodity derivatives segment.
Commodity Derivatives Segment (CDS): The segment of the financial market to which the circular's margin framework review applies.
Clearing Corporations (CCs): Entities responsible for clearing and settling commodity derivatives transactions, and who are addressed in the circular.
Initial Margin (IM): The minimum margin required to cover potential losses on a commodity derivatives contract.
Margin Period of Risk (MPOR): The period of time it would take to liquidate a position in a commodity derivatives contract in the event of a default.
CPSSIOSCO Principles for Financial Market Infrastructure (PFMI): International standards for financial market infrastructures, including those related to margin requirements.
Securities and Exchange Board of India Act 1992: The act under which SEBI exercises its powers to protect investors and regulate the securities market.
Securities Contracts Regulation Act, 1956: The act under which SEBI exercises its powers to regulate the securities market.
CIRCULAR
SEBI/HO/CDMRD/DRMP/CIR/P/2020/15 January 27, 2020
To,
The Managing Directors / Chief Executive Officers,
All Clearing Corporations having Commodity Derivatives Segment
Sir / Madam,
Sub: Review of Margin Framework for Commodity Derivatives Segment
1. SEBI vide Circular CIR/CDMRD/DRMP/01/2015 dated October 01, 2015 and
SEBI/HO/CDMRD/DRMP/CIR/P/2016/77 dated September 01, 2016 prescribed
Risk Management Framework for the Commodity Derivatives Segment (CDS).
These circulars, inter alia, stipulated minimum value for Initial Margin(IM) and
Margin Period of Risk (MPOR).
2. CPSS-IOSCO Principles for Financial Market Infrastructure (PFMI) inter alia
prescribes under Key Considerations for Principle 6 on margin that margining
model should to the extent practicable and prudent, limit the need for destabilising,
pro-cyclical changes.
3. It is further explained under Clause 3.6.10 of PFMI that:
Limiting procyclicality: A CCP should appropriately address pro-cyclicality in its margin
arrangements. In this context, pro-cyclicality typically refers to changes in risk-
management practices that are positively correlated with market, business, or credit cycle
fluctuations and that may cause or exacerbate financial instability.
For example, in a period of rising price volatility or credit risk of participants, a CCP may
require additional initial margin for a given portfolio beyond the amount required by the
current margin model. This could exacerbate market stress and volatility further, resulting
in additional margin requirements. To support this objective, a CCP could consider
increasing the size of its prefunded default arrangements to limit the need and likelihood
of large or unexpected margin calls in times of market stress. These procedures may
create additional costs for CCPs and their participants in periods of low market volatility
due to higher margin or prefunded default arrangement contributions, but they may also
result in additional protection and potentially less costly and less disruptive adjustments in
periods of high market volatility.
4. In light of the above and given the wide variation of liquidity and volatility among
different commodity derivatives, it has been decided, in consultation with
Page 1 of 4stakeholders, to categorize commodities as per their realized volatility and to
prescribe floor values of IM and IMPOR depending upon their categories.
5. Accordingly, norms regarding Minimum IM and minimum MPOR for commodity
derivatives segment stands revised as per the framework mentioned below. The
norms on risk management prescribed vide circulars referred to at Para ‘1’ above,
which are not modified herewith, shall continue to prevail.
a. Clearing Corporations (CCs) shall categorise their commodities into three
categories of volatility based upon the realized volatility for last three years
as given below: -
Volatility Category Realized Annualized Volatility
of Commodity criteria
Low 0 to 15%
Medium Above 15 % to 20%
High Above 20%
b. Realized volatility shall be calculated from series of daily log normal return
of main near month future contracts of the respective commodity. The series
of daily log normal return shall be rolled over to next month contract on start
of staggered delivery period if it is applicable. If staggered delivery is not
applicable, then rollover shall be done on the day after the expiry of near
month contract.
c. Exchange having maximum average daily turnover across all derivative
contracts on the respective commodity based on last six months’ period
shall be termed as Lead Exchange. The CC of the Lead Exchange shall do
the categorisation of the respective commodities and same shall be
intimated to, and adopted by all other CCs
d. Based on volatility category, minimum initial margin (IM) and minimum
MPOR shall be as under:
Volatility Minimum IM Minimum MPOR
Category of
Non-Agri Agri Non-Agri Agri
Commodity
Low 6% 8% 2 3
Medium 8% 10% 2 3
High 10% 12% 3 4
Page 2 of 4e. It is also clarified that floor values prescribed for IM in table above need not
be scaled up by MPOR.
f. CCs shall review the categories of all commodities once in every six months’
period based upon past three years’ data. Commodity may be moved from
higher volatility category to lower category only if it satisfies criteria of the
revised category of volatility for two consecutive reviews. However,
movement from a lower to higher volatility category shall be done based
upon a single review.
g. The categorisation shall be done on 1st March and 1st September of each
year on rolling basis and changes if any shall be made applicable from 1st
April and 1st October respectively of each year.
h. In case derivatives are launched on any new underlying commodity for the
first time for which no reference futures prices are available, it shall be
initially categorised based upon prices available in the spot markets subject
to a minimum of Medium Category of volatility. Re-categorisation of such
commodity from higher to lower category of volatility can only be done after
two consecutive reviews.
6. Lean Period in Agri Commodities:
a. In case of Agri commodities, it has been observed that during lean period
(i.e. the period before the arrival of new crop) there is often uncertainty about
the arrivals of new crop. This may lead to higher volatility in prices of
commodities during this period. Therefore, CCs shall levy additional lean
period margin of 2% on contracts expiring during lean period.
b. Lead exchanges shall determine the lean period in consultation with their
relevant Product Advisory Committee and disclose the same on their
websites.
7. It is reiterated that risk management is primarily a responsibility of CCs and the
framework prescribed by SEBI is minimum framework. CCs are allowed to be more
conservative as per their own perception of risk.
8. CCs shall also disclose detailed break up of various applicable margins on
contracts cleared by them along with volatility on their websites.
9. Initial categorisation of commodities as prescribed under Para ‘5’ above shall be
done and notified by CCs within 15 days of the circular. The revised norms with
Page 3 of 4regard to IM, MPOR and lean period margin may be implemented by CCs in a
phased manner and shall be fully implemented within a period of three months from
the date of the circular. The corresponding update in stress testing scenarios, if
applicable, shall also be done by CCs immediately after the circular is fully
implemented.
10. This circular is issued in exercise of the powers conferred under Section 11(1) of
the Securities and Exchange Board of India Act 1992, read with Section 10 of the
Securities Contracts (Regulation) Act, 1956 to protect the interests of investors in
securities and to promote the development of, and to regulate the securities
market.
11. This circular is available on SEBI website at www.sebi.gov.in.
Yours faithfully,
Vishal V. Nair
Deputy General Manager
Division of Risk Management
Commodity Derivatives Market Regulation Department
vishaln@sebi.gov.in
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