Risk Mngmt Ncdx
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Risk Management at NCDEX July 17, 2004 1
Risk faced by NCDEX The risk of a counter party (trading member, client, vendors etc) not fulfilling his obligations in full on due date or at any time thereafter
2
Risk vis a vis members
This risk is mitigated by collection of margins:
3
Initial Margins Exposure margins Market to market of positions on a daily basis Position Limits and Intra day price limits Surveillance
Initial Margins Initial margin is based on worst scenario loss to cover 99.9% VaR over one day horizon Daily volatility of the futures prices is considered for the computation of VAR Volatility is estimated using Exponentially Weighted Moving Average Method
Initial margins are collected upfront from the members
4
Initial Margins & Spread Positions
Minimum Initial margin is prescribed for each commodity
However, a benefit of calendar spread is given for Opposing positions taken on two different months in a 3month period
Calendar Spread 2% margin would be charged Calendar spread positions would be considered as a naked (uncovered) position in the far month contract three days before the expiry of the near month contract Gradual reduction by 33.33% per day for three days prior to that day
No credit for inter commodity spread
Calendar Spread benefits the members 5
Initial margin monitoring & collection
6
Margins are computed on gross positions of the clients i.e. no netting on margins for opposite positions across clients
The margins members
All the positions of the members and the margins are monitored by the Exchange on a real time basis.
are
collected
upfront
from
the
Margins collection from Clients
7
Member may: Charge same margin to his client Or charge a mark-up on the prescribed margin to his client, based on his perception of risk associated with that client Or recalculate margin for each individual client by using PCSPAN software.
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
8
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Exposure Limit
9
Gross open position for a member in all the futures contracts is limited to a multiple of member’s liquid net worth
Total deposit placed by a member gets bifurcated into initial margins and liquid net-worth
Exposure limit linked to exposure margin Exposure margin forms second line of defense Arrived at from back-testing of historical data
It is a fixed portion of margin Varies from 2.5% to 4% for different commodities
Effective deposits Effective Deposits (ED) Rs 30 lakhs
Initial margin (IM) Rs 15 lakhs
Minimum Liquid Net worth (MLNW)
Used for initial margin requirements
Used for exposure margin requirements
Rs 15 lakhs
If the member wants to increase his liquid net worth he has to bring in additional base capital 10
Minimum Margin percentages Symbol
11
Minimum Initial Margin%
Exposure Margin %
Minimum Total Margin %
Chana
3.00
3.00
6.00
Cotton J34
3.00
2.50
5.50
Cotton S06
3.00
2.50
5.50
Crude Palm Oil
4.00
4.00
8.00
Guar Seed
3.00
3.00
6.00
Gold
3.00
2.50
5.50
Jute
3.00
2.50
5.50
Pepper
3.00
3.00
6.00
RBD
4.00
4.00
8.00
Rubber
3.00
2.50
5.50
Rape / Mustard Oil
4.00
4.00
8.00
Rape / Mustard Seed
4.00
4.00
8.00
Silver
3.00
3.00
6.00
Soya Bean
4.00
4.00
8.00
Soya Oil
3.00
2.50
5.50
Real Time Monitoring
12
As soon as the member reaches 70% of Initial Margin Limit or his Exposure Limit message ’70% limit being reached’ is flashed on his terminal.
Once the member reaches 100% of the limit and he does not bring ABC, his terminal is disabled.
The terminal remains disabled till the member brings in additional funds to increase his base capital so that he can take further positions.
If the member is not able to bring in funds then the member positions may be squared up at the member’s request.
Risk faced vis-à-vis clients
Non-fulfilment of members obligation may be due to client default.
Hence the margins are charged at client level on NCDEX
SEBI too has started client level monitoring
13
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
14
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Marked to Market
15
All open positions in any contract are open to price risk
Open positions are defined as positions which have not been squared off.
The netting for open positions are at client level
Downward price movement will mean losses for clients with long open positions
Upward price movement will mean losses for clients with short open positions
Marked to Market
MTM profit is debited from one member and credited to another member
However, if one member defaults the Exchange will have to pay-up to the counter party
For calculating the MTM, all the open positions are marked to the Daily Settlement Price (DSP)
It is a zero sum game for the Exchange 16
Determination of DSP/FSP
All the open positions on the Exchange are closed at DSP
Pre-requisites of DSP / FSP There should be least intervention in the process of determination It should be representative of the market
DSP / FSP is very critical for the Exchange 17
Daily Settlement Price (DSP)
18
A closing session will be held daily for 15 minutes after trading hours
Single price call auction in the closing session
Daily settlement price is the consensus price that clears maximum volume of trade during this period
The consensus price is valid only if certain liquidity criteria are satisfied.
Alternative Methods for DSP
Value weighted Average Price (VWAP) of contracts during the last 30 minutes of trading. The price will be taken if the liquidity criteria is met.
VWAP of contracts during the last 1 hour of trading. The price will be taken if the liquidity criteria is met.
Value Weighted average price (VWAP) method will be applied for whole day’s trades. The price will be taken if the liquidity criteria is met.
We strive to ensure that there is least intervention 19
Illiquid contracts
The spreads that prevail between active contracts shall be used to determine the theoretical futures price
20
For example, Near month and Middle month contracts are active, The theoretical futures price for an illiquid far month contract shall be determined as a theoretical futures price using the spread between the near and middle month contract.
Previous day’s settlement price.
Theoretical Futures Price
Final Settlement Price (FSP)
The polled spot price of 4 O’clock on the date of expiry of contract shall be the final settlement price
Spot prices will be collected from different centers for different commodities across the country
Prices are bootstrapped to arrive at unbiased benchmarked price
Polled parties have positions & can influence the settlement price 21
MTM / Final Settlement shortage
22
In case of funds pay-in shortages
Pay-in shortage results in disablements of member.
If the members shortages are nearing Rs.15lacs (the initial margin portion of the liquid net worth amount) the Exchange will square-up the member positions.
The positions are square-up in consultation with the member
Default in Physical Delivery
In case of physical delivery not given or quality specification of commodity delivered is beyond the acceptable norms : Members positions are closed out The Close out rate along with a mark-up will be debited to the account of the Defaulting seller. The buyer get only financial settlement and not commodity settlement
23
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
24
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Position Limits
25
Position limits- limits on the percentage of gross open positions in a contract that a single member or single client can hold.
NCDEX would monitor all members' positions
NCDEX may insist on reductions in positions if they give rise to prudential concerns.
Member level Position Limits
15% of the Open Interest or the following value which ever is higher
Name of the Commodity
Amount (Rs)
Gold
200 crores
Silver
50 crores
All other Agri Commodities
40 crores
The limits have been arrived at considering the market potential and open interest that can be reached 26
Client level Position Limits
10% of the Open Interest or the following value which ever is higher Name of the Commodity Gold Silver All other Commodities
Amount
Agri
100 Crores 25 crores 20 crores
To ensure that the market is not controlled by a single member / client 27
Intra-day Price Limit
10% on the upper side and lower side
If the price hits the intra day price limit on the upper side/ lower side there would be a cooling period for 15 minutes
To avoid any panic reaction to any extreme price movements
No cooling period if the price crosses the intra day limit during last 30 minutes of trading
28
To limit the % of price movement on either side and To prevent erroneous order prices.
This will enable members to exit the market
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
29
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Surveillance-objectives
30
To monitor trading activity
To enforce the various trading limits that are specified by the Exchange
To detect and prevent manipulation and/or abusive trade practices
To build investor confidence
Surveillance system
Real-time surveillance Price monitoring Member Volume monitoring
31
End of the day alerts
Non- real time surveillance
Real time alerts - Price Alerts
Close against the intra day high/low
Consecutive Trade price movement
32
If the current trade price moves more than the percentages set from previous closing price This is to detect if any member is entering trades at a higher / lower prices.
Real time alerts - Price Alerts
33
Member Traded after a gap If the member has not been trading and suddenly starts trading an alert is generated
Contracts inactive in the day but active in the evening This gives an alert of the volume variation between morning and evening exceeds the percentage set.
Futures against SPOT/International prices This gives an alert if the variation in the Futures and the SPOT/International
End of Day Alert
Consecutive closing price movement
Member OI concentration alert Gives an alert if the member’s open position goes beyond a particular percentage set
Price Variation in session
34
If the difference between two consecutive closing prices is more than a certain percentage
Gives an alert if the gap in the price variation is the two sessions exceeds the set percentage
End of Day Alert
High price fluctuation but less quantity Traded
35
If the quantity traded drops below the past days average and the price fluctuation exceeds a percentage set an alert is generated.
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
36
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Other Risks Mitigation
37
Screening by Membership committee Members(or their key personnel) need to clear the exams stipulated by the exchange Net worth of Rs. 50 lacs Directors should be professionally qualified Minimum base capital requirements of Rs. 30 lacs Certificate on compliance with regulatory capital to be filed at periodic intervals NCDEX would conduct off line inspections of members' on an ongoing basis. Every member to take insurance prescribed by NCDEX
Mitigation of Risk vis-à-vis Market
38
Making ad hoc margin calls
Asking for early pay-ins
Asking members to square-up their open positions
Mitigation of Risk vis-à-vis Technology
39
NCDEX has established backup facilities for automation, communications and power sources.
Redundant power sources and communication lines are also provided
We have identified business continuity process and are working towards setting it
Cost Benefit Analysis –Member or Client of Member? Minimum cost of a membership Minimum Cash Deposit Collateral Deposits (Bank Guarantee / Fixed Deposits) Total one time fixed costs
= Rs. 1.5 mn. = Rs. 1.5 mn. =Rs. 3.0 mn.
Cost (Rs.) p.a. Interest Loss =Rs. 1.5 mn. @7%= Rs. 1.05 lacs Bank Guarantee Commission=Rs. 1.5 [email protected]%= Rs. 0.075 lacs Loss of Interest on Cash margin (say 40%)= Rs. 1.5 mn.* 40% *7 % = Rs. 0.42 lacs Total costs =Rs. 1.545 lacs p.a. Technology costs p.a.: VSAT Connection = Rs. 1.34 lacs (One time cost) Interest loss on VSAT connection = Rs. 1.34 lacs @7%= Rs. 0.09 lacs
40
Cost Benefit Analysis – (contd.) TOTAL COST INCURRED
Direct Membership
Through A Member
Financial Charges
Interest Loss on Cash Deposit Bank Commission Charges Interest Loss on Cash Margin Interest loss on VSAT Charges
1,05,000
NIL
7,500
NIL
42,000
NIL
9,380
9,380
NIL
50,000
3,000
NIL
Transaction Charges (On position of Rs.50 mn.)
Brokerage Charges ( 0.1%) Transaction Cost (0.006%) Interest & Commission charges on margins Deposited Margin
35,000
2,10,000
4%
6%
13,400
13,400
2,15,280
2,82,780
Technology Charges
VSAT Charges (Average Life of 10 Years)
41
Total
Thank You
42
Open Interest
43
Day
Trading clients
Day 1
A Buys 100 gms of Gold 100 gms B Sells 100 gms of Gold
A+100 B - 100
Day 2
B Buys 500 gms of Gold 500 gms C Sells 500 gms of Gold
A+100 B+ 400 C - 500
Day 3
B Buys 500 gms of Gold 900 gms D Sells 400 gms of Gold A Sells 100 gms of Gold
A- 0 B+900 C- 500 D- 400
Activity
of Open Interest
Client wise positions
Risk faced by NCDEX The risk of a counter party (trading member, client, vendors etc) not fulfilling his obligations in full on due date or at any time thereafter
2
Risk vis a vis members
This risk is mitigated by collection of margins:
3
Initial Margins Exposure margins Market to market of positions on a daily basis Position Limits and Intra day price limits Surveillance
Initial Margins Initial margin is based on worst scenario loss to cover 99.9% VaR over one day horizon Daily volatility of the futures prices is considered for the computation of VAR Volatility is estimated using Exponentially Weighted Moving Average Method
Initial margins are collected upfront from the members
4
Initial Margins & Spread Positions
Minimum Initial margin is prescribed for each commodity
However, a benefit of calendar spread is given for Opposing positions taken on two different months in a 3month period
Calendar Spread 2% margin would be charged Calendar spread positions would be considered as a naked (uncovered) position in the far month contract three days before the expiry of the near month contract Gradual reduction by 33.33% per day for three days prior to that day
No credit for inter commodity spread
Calendar Spread benefits the members 5
Initial margin monitoring & collection
6
Margins are computed on gross positions of the clients i.e. no netting on margins for opposite positions across clients
The margins members
All the positions of the members and the margins are monitored by the Exchange on a real time basis.
are
collected
upfront
from
the
Margins collection from Clients
7
Member may: Charge same margin to his client Or charge a mark-up on the prescribed margin to his client, based on his perception of risk associated with that client Or recalculate margin for each individual client by using PCSPAN software.
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
8
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Exposure Limit
9
Gross open position for a member in all the futures contracts is limited to a multiple of member’s liquid net worth
Total deposit placed by a member gets bifurcated into initial margins and liquid net-worth
Exposure limit linked to exposure margin Exposure margin forms second line of defense Arrived at from back-testing of historical data
It is a fixed portion of margin Varies from 2.5% to 4% for different commodities
Effective deposits Effective Deposits (ED) Rs 30 lakhs
Initial margin (IM) Rs 15 lakhs
Minimum Liquid Net worth (MLNW)
Used for initial margin requirements
Used for exposure margin requirements
Rs 15 lakhs
If the member wants to increase his liquid net worth he has to bring in additional base capital 10
Minimum Margin percentages Symbol
11
Minimum Initial Margin%
Exposure Margin %
Minimum Total Margin %
Chana
3.00
3.00
6.00
Cotton J34
3.00
2.50
5.50
Cotton S06
3.00
2.50
5.50
Crude Palm Oil
4.00
4.00
8.00
Guar Seed
3.00
3.00
6.00
Gold
3.00
2.50
5.50
Jute
3.00
2.50
5.50
Pepper
3.00
3.00
6.00
RBD
4.00
4.00
8.00
Rubber
3.00
2.50
5.50
Rape / Mustard Oil
4.00
4.00
8.00
Rape / Mustard Seed
4.00
4.00
8.00
Silver
3.00
3.00
6.00
Soya Bean
4.00
4.00
8.00
Soya Oil
3.00
2.50
5.50
Real Time Monitoring
12
As soon as the member reaches 70% of Initial Margin Limit or his Exposure Limit message ’70% limit being reached’ is flashed on his terminal.
Once the member reaches 100% of the limit and he does not bring ABC, his terminal is disabled.
The terminal remains disabled till the member brings in additional funds to increase his base capital so that he can take further positions.
If the member is not able to bring in funds then the member positions may be squared up at the member’s request.
Risk faced vis-à-vis clients
Non-fulfilment of members obligation may be due to client default.
Hence the margins are charged at client level on NCDEX
SEBI too has started client level monitoring
13
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
14
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Marked to Market
15
All open positions in any contract are open to price risk
Open positions are defined as positions which have not been squared off.
The netting for open positions are at client level
Downward price movement will mean losses for clients with long open positions
Upward price movement will mean losses for clients with short open positions
Marked to Market
MTM profit is debited from one member and credited to another member
However, if one member defaults the Exchange will have to pay-up to the counter party
For calculating the MTM, all the open positions are marked to the Daily Settlement Price (DSP)
It is a zero sum game for the Exchange 16
Determination of DSP/FSP
All the open positions on the Exchange are closed at DSP
Pre-requisites of DSP / FSP There should be least intervention in the process of determination It should be representative of the market
DSP / FSP is very critical for the Exchange 17
Daily Settlement Price (DSP)
18
A closing session will be held daily for 15 minutes after trading hours
Single price call auction in the closing session
Daily settlement price is the consensus price that clears maximum volume of trade during this period
The consensus price is valid only if certain liquidity criteria are satisfied.
Alternative Methods for DSP
Value weighted Average Price (VWAP) of contracts during the last 30 minutes of trading. The price will be taken if the liquidity criteria is met.
VWAP of contracts during the last 1 hour of trading. The price will be taken if the liquidity criteria is met.
Value Weighted average price (VWAP) method will be applied for whole day’s trades. The price will be taken if the liquidity criteria is met.
We strive to ensure that there is least intervention 19
Illiquid contracts
The spreads that prevail between active contracts shall be used to determine the theoretical futures price
20
For example, Near month and Middle month contracts are active, The theoretical futures price for an illiquid far month contract shall be determined as a theoretical futures price using the spread between the near and middle month contract.
Previous day’s settlement price.
Theoretical Futures Price
Final Settlement Price (FSP)
The polled spot price of 4 O’clock on the date of expiry of contract shall be the final settlement price
Spot prices will be collected from different centers for different commodities across the country
Prices are bootstrapped to arrive at unbiased benchmarked price
Polled parties have positions & can influence the settlement price 21
MTM / Final Settlement shortage
22
In case of funds pay-in shortages
Pay-in shortage results in disablements of member.
If the members shortages are nearing Rs.15lacs (the initial margin portion of the liquid net worth amount) the Exchange will square-up the member positions.
The positions are square-up in consultation with the member
Default in Physical Delivery
In case of physical delivery not given or quality specification of commodity delivered is beyond the acceptable norms : Members positions are closed out The Close out rate along with a mark-up will be debited to the account of the Defaulting seller. The buyer get only financial settlement and not commodity settlement
23
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
24
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Position Limits
25
Position limits- limits on the percentage of gross open positions in a contract that a single member or single client can hold.
NCDEX would monitor all members' positions
NCDEX may insist on reductions in positions if they give rise to prudential concerns.
Member level Position Limits
15% of the Open Interest or the following value which ever is higher
Name of the Commodity
Amount (Rs)
Gold
200 crores
Silver
50 crores
All other Agri Commodities
40 crores
The limits have been arrived at considering the market potential and open interest that can be reached 26
Client level Position Limits
10% of the Open Interest or the following value which ever is higher Name of the Commodity Gold Silver All other Commodities
Amount
Agri
100 Crores 25 crores 20 crores
To ensure that the market is not controlled by a single member / client 27
Intra-day Price Limit
10% on the upper side and lower side
If the price hits the intra day price limit on the upper side/ lower side there would be a cooling period for 15 minutes
To avoid any panic reaction to any extreme price movements
No cooling period if the price crosses the intra day limit during last 30 minutes of trading
28
To limit the % of price movement on either side and To prevent erroneous order prices.
This will enable members to exit the market
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
29
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Surveillance-objectives
30
To monitor trading activity
To enforce the various trading limits that are specified by the Exchange
To detect and prevent manipulation and/or abusive trade practices
To build investor confidence
Surveillance system
Real-time surveillance Price monitoring Member Volume monitoring
31
End of the day alerts
Non- real time surveillance
Real time alerts - Price Alerts
Close against the intra day high/low
Consecutive Trade price movement
32
If the current trade price moves more than the percentages set from previous closing price This is to detect if any member is entering trades at a higher / lower prices.
Real time alerts - Price Alerts
33
Member Traded after a gap If the member has not been trading and suddenly starts trading an alert is generated
Contracts inactive in the day but active in the evening This gives an alert of the volume variation between morning and evening exceeds the percentage set.
Futures against SPOT/International prices This gives an alert if the variation in the Futures and the SPOT/International
End of Day Alert
Consecutive closing price movement
Member OI concentration alert Gives an alert if the member’s open position goes beyond a particular percentage set
Price Variation in session
34
If the difference between two consecutive closing prices is more than a certain percentage
Gives an alert if the gap in the price variation is the two sessions exceeds the set percentage
End of Day Alert
High price fluctuation but less quantity Traded
35
If the quantity traded drops below the past days average and the price fluctuation exceeds a percentage set an alert is generated.
Risk vis-à-vis members
This risk is mitigated by
Collection of Initial Margins • Exposure margins •
36
Marked to market of positions on a daily basis Position Limits and Intra day price limits Surveillance Other measures
Other Risks Mitigation
37
Screening by Membership committee Members(or their key personnel) need to clear the exams stipulated by the exchange Net worth of Rs. 50 lacs Directors should be professionally qualified Minimum base capital requirements of Rs. 30 lacs Certificate on compliance with regulatory capital to be filed at periodic intervals NCDEX would conduct off line inspections of members' on an ongoing basis. Every member to take insurance prescribed by NCDEX
Mitigation of Risk vis-à-vis Market
38
Making ad hoc margin calls
Asking for early pay-ins
Asking members to square-up their open positions
Mitigation of Risk vis-à-vis Technology
39
NCDEX has established backup facilities for automation, communications and power sources.
Redundant power sources and communication lines are also provided
We have identified business continuity process and are working towards setting it
Cost Benefit Analysis –Member or Client of Member? Minimum cost of a membership Minimum Cash Deposit Collateral Deposits (Bank Guarantee / Fixed Deposits) Total one time fixed costs
= Rs. 1.5 mn. = Rs. 1.5 mn. =Rs. 3.0 mn.
Cost (Rs.) p.a. Interest Loss =Rs. 1.5 mn. @7%= Rs. 1.05 lacs Bank Guarantee Commission=Rs. 1.5 [email protected]%= Rs. 0.075 lacs Loss of Interest on Cash margin (say 40%)= Rs. 1.5 mn.* 40% *7 % = Rs. 0.42 lacs Total costs =Rs. 1.545 lacs p.a. Technology costs p.a.: VSAT Connection = Rs. 1.34 lacs (One time cost) Interest loss on VSAT connection = Rs. 1.34 lacs @7%= Rs. 0.09 lacs
40
Cost Benefit Analysis – (contd.) TOTAL COST INCURRED
Direct Membership
Through A Member
Financial Charges
Interest Loss on Cash Deposit Bank Commission Charges Interest Loss on Cash Margin Interest loss on VSAT Charges
1,05,000
NIL
7,500
NIL
42,000
NIL
9,380
9,380
NIL
50,000
3,000
NIL
Transaction Charges (On position of Rs.50 mn.)
Brokerage Charges ( 0.1%) Transaction Cost (0.006%) Interest & Commission charges on margins Deposited Margin
35,000
2,10,000
4%
6%
13,400
13,400
2,15,280
2,82,780
Technology Charges
VSAT Charges (Average Life of 10 Years)
41
Total
Thank You
42
Open Interest
43
Day
Trading clients
Day 1
A Buys 100 gms of Gold 100 gms B Sells 100 gms of Gold
A+100 B - 100
Day 2
B Buys 500 gms of Gold 500 gms C Sells 500 gms of Gold
A+100 B+ 400 C - 500
Day 3
B Buys 500 gms of Gold 900 gms D Sells 400 gms of Gold A Sells 100 gms of Gold
A- 0 B+900 C- 500 D- 400
Activity
of Open Interest
Client wise positions
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