Mumbai: In a bid to increase liquidity and trading volumes on India’s stock markets, capital markets regulator Securities and Exchange Board of India (Sebi) on Tuesday extended the existing facility of cross-margining across cash and derivative segments to all categories of market participants.
In May, Sebi had introduced the cross-margining facility to institutional investors for offsetting positions in cash and derivative segments.
Cross-margining, which is also known as “spread margin”, allows market participants to reduce the total margin payment required, if they are taking two mutually offsetting positions. This enables market participants to transfer excess margin from one account to another account.
Also Read Cross Margining across Exchange traded Equity (Cash) and Exchange traded Equity Derivatives (Derivatives) segments
In simple terms, if a trader buys Rs1 lakh worth of ICICI Bank Ltd stock from the cash market and sells an equal amount of ICICI Bank stock in the futures market, he doesn’t have to pay separate margins to the broker for both trades because they cancel out the credit risk on each other.
Margin is the collateral to cover the credit risk, paid by an investor when buying securities or taking a position in the futures and options (F&O) segment with borrowed funds.
Also See Spread Play (PDF)
Under the system, margin requirements in the derivatives market will reduce if an investor holds stock in the spot market, making efficient use of capital for brokers and investors. And, because it lowers the margin requirement, this also safeguards the trading system from defaults.
So far, cross-margining was allowed only to institutional investors and between spot market and F&O trade.
Now, this will be extended to all investors, between index futures position and constituent stock futures position; index futures position and constituent stock position in cash segment; and stock futures position and position in the cash segment.
The cross-margining between positions in single stock futures and index futures, however, will be eligible only for the same expiry month.
The head of derivatives at a large foreign brokerage said the introduction of this facility across other products such as index futures and stock futures would unlock tremendous capacity for foreign institutional investors (FIIs) and other domestic institutional investors. He did not wanted to be named as he is not authorized to speak to the media.
Cross-margining between index futures and single stock futures can be applied by computing the correlation between the two.
Simply put, if a fund house is going long on Reliance Industries Ltd (RIL) and short on Nifty futures, considering the large weightage of RIL in Nifty, some of the credit risk is offset with the opposite position taken on Reliance stock futures. Earlier, the fund house would have been required to pay up the entire margin for both trades.
“This move from Sebi could help bring more buying capacity in the stock markets and is, therefore, an important step,” said Anish Jhaveri, head of equities at Antique Stock Broking Ltd, a large local player in the F&O segment.
The combined daily trading volumes on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) have dropped at least 56% since the beginning of this year, when the BSE benchmark index was trading at its peak. Since then, the Sensex has slumped about 57%.
“This will increase liquidity in the markets; could result in a market rally,” said Madhavi Vora, managing director of ULJK Securities Pvt. Ltd, an old brokerage perched on the 18th floor of the BSE building.
According to Vora, who is also the head of the capital markets committee of industry lobby Indian Merchants’ Chamber, the cross-margining facility introduced earlier in May helped only FIIs and not other class of investors.
Currently, the margin risk in the derivatives segment is calculated using the standardized portfolio analysis of risk software, developed by the Chicago Mercantile Exchange. The software uses a set of algorithms that helps assess one-day risk for a trader.
The volatility index (VIX) is an important input for margin risk assessment. “Since VIX is extremely high now, the margin requirement for trading futures has gone up sharply, leading to stop losses being triggered,” Vora said.
Earlier this year, the margin requirement for Nifty futures was about 10-15%. Now, as a result of high volatility, it had gone up to 25%.