On Friday, the National Stock Exchange transacted business worth Rs 1,116,155 crore. For a comparison, that figure is nearly double the central government’s annual expenditure budget. Close to 69 lakh deals took place on the exchange that day. Still there was not a payment problem. Thank the market’s robust payment system for that.
The government and the regulator, the Securities and Exchange Board of India, have used lessons from the earlier episodes to devise a payment system that did not buckle under a 58% fall in the equity markets this year and a 1071-point dip in bellwether Sensex last Friday.
How Sebi has transformed the landscape would become clear if we recall that just seven years ago, a single batch of payments coming unstuck at the Calcutta Stock Exchange had triggered the crisis of 2001.
When the tech bubble burst in the US, there was widespread selling in the market, and the payment crisis at CSE acted as the last straw. This, along with allegations of insider trading, led to the Bombay Stock Exchange board being reconstituted.
Similarly, In 1998, the BSE went through a huge payment crisis and a major bailout operation, with help from institutions like UTI, had to be carried out.
This time around, sound surveillance, capital requirements and margining systems have seen that a payment crisis has not occurred. “Apart from the odd client defaults, there has been no major payment crisis and while there is a concern over the speed and the extent of the market slide, there are no concerns about the system itself,” says Hasit Pandya, director with HPMG Shares & Securities, a broking company in Mumbai.
The regulations require the members to have a base minimum capital and additional capital with the exchanges and NSCCL for participation in the various categories. These capital requirements, ranging from Rs 2 crore to Rs 4 crore, include cash, bank guarantees and liquid assets. Even the qualitative scrutiny of allocating trading members has been stepped up and the introducer’s credentials are also checked.
On surveillance and margining, the exchanges have been extremely vigilant. “The surveillance is extremely strong and we keep getting regular updates during the day about our margins and we have to comply immediately. Non-compliance results in the trading terminals being shut off and fines and penalties later on,” adds Pandya.
Earlier, margins were simply based on positions and were largely marked to market; the volatility of the exposure and the risk taken by the member were not monitored. Now, shares are categorised according to liquidity, and liquid shares are placed in the Group I category and illiquid stocks in Group II. In this, impact costs calculated on the 15 th of each month are also used. Impact cost essentially captures the impact on the share price when ‘buy’ or ‘sell’ orders are placed. The more liquid the stock, the less is its impact cost.
Now, members have to pay margins based on the value at risk (VaR) margin, extreme loss margin and mark-to-market margin. The daily margin is a sum of these three components. “The concept of the margining system is more holistic, it covers the entire portfolio risk, more margining when there is volatility and also the regular mark to market margin that covers the daily trades and tells you where you stand on that day,” said a senior executive with a leading broking house.
VaR is a statistical technique used to estimate the probability of portfolio losses based on the analysis of historical price trends and volatilities. It measures potential loss from an unlikely adverse event in a normal market environment.
The VaR margin rate is charged on the net outstanding position (buy value-sell value) of the respective clients on the respective securities across all open settlements. There would be no netting off of positions across different settlements.
The net position at a client level for a member are arrived at and thereafter, it is grossed across all the clients, including proprietary position to arrive at the gross open position.
Now, suppose client A for a member has a Rs 100 ‘buy’ position in XYZ company and client B has a ‘sell’ position in XYZ for the same amount, then the members’ position will be Rs 200 and will not be ‘netted’ off for the purpose of margin calculation.
The extreme loss margin is usually a 5%, or 1.5 times the standard deviation of daily logarithmic returns of the security price in the last six months. In case of extreme volatility, Sebi could direct stock exchanges to change the margins from time to time.
And then there are the mark-to-market margins. Here, mark-to-market losses are calculated by marking each transaction in security to the closing price of the security at the end of trading. And, in case the security has not been traded on a particular day, the latest available closing price at the exchange shall be considered as the closing price.
If the net outstanding position in any security is nil, the difference between the buy and sell values shall be considered as a notional loss for calculating the mark-to-market margin payable. While, members cannot net margins between settlement periods, they can net the profit and loss for the day.
Essentially, these measures have ensured that even in a market meltdown, the market integrity is maintained.