Sebi’s cross-margining circular will lead to big margin benefits on derivative trade

Piyush Chourasia, Chief Risk Officer of Indian Clearing Corporation. has written an article in the ET in which he has explained the precise manner in which the SEBI circular on cross margining benefits will apply.

SEBI Circular on cross margining

Sebi issued a circular on November 8, 2019, on “Introduction of cross-margining facility in respect of offsetting positions in corelated equity indices,” laying down the criteria for the domestic equity indices to become eligible for cross-margining benefit of up to 70 per cent.

He has explained that cross margining is a concept whereby a trader can transfer excess margin from one account to another account to satisfy margin maintenance requirements to offset positions. Clearing Corporations provide this margin benefit on positions, which show a high degree of dependence or correlation.

It is pointed out that in India, cross-margining was earlier permitted only between index futures and underlying constituents/futures, stock futures and underlying stocks; and ETFs and their underlying constituents. However, this benefit was not available among the highly correlated indices.

Internationally, cross-margining is available on various products, including between Indices.



Derivative contracts will benefit

In India, index derivatives are the most traded contracts. Index derivatives on popular indices like Sensex and Nifty are available for trading on BSE and NSE, respectively.

It is stated that Sensex and Nifty are broadbased indices computed by BSE and NSE and move in tandem. These indices share a high level of overlap and positive correlation.

Till early this year, creating arbitrage positions in such contracts was inefficient and expensive, since trades on BSE were margined and settled separately than the trades done on NSE, through the exchanges’ own clearing corporations.

With the introduction of interoperability, members’ positions are margined and settled at the clearing corporation of their choice on a net basis for their trades across exchanges. However, even for arbitrage positions between such highly correlated indices, no margin offset was available, and members had to pay margin money equal to the sum of the two positions, as if they were independent.

The latest Sebi circular changed that and moved to a risk-based margining framework which allowed margin offset for opposite positions in such indices.

Extent of benefit

It is stated that if an investor has a portfolio consisting of a long Sensex futures position and a short Nifty futures position, one of those positions would typically be in profit and the other in loss, thus the overall mark-to-market settlement for the portfolio would be close to zero.

The margin requirement would now drop from approximately Rs 2.15 Lakh to Rs 0.65 lakh, resulting in a reduction of around Rs 1.5 Lakh or 70 per cent on the portfolio.


Source: Author handout
It is also pointed out that the circular came close on the heels of the implementation of interoperability of clearing corporations undertaken by Sebi to increase efficiency and access for market participants.

Currently, Sensex – Nifty and Bank Nifty – Bankex are some of the main index pairs that are likely to benefit from cross-margining circular, it is added.