Thrust on risk containment

A GROUP under the chairmanship of Professor J. R. Varma, Member, SEBI -- comprising of Mr L. K. Singhvi, Senior Executive Director, Mr Pratip Kar, Executive Director and Mr P. K. Bindlish, Division Chief of SEBI -- was set up by SEBI to examine various issues related to the automated lending borrowing mechanism (ALBM) of the National Securities Clearing Corporation, in particular the risk containment measures. Based on the group's recommendations, SEBI decided:

The same position limits as in the modified carry forward system (MCFS), namely a limit per broker of Rs 40 crore in the aggregate and Rs 5 crore per scrip, would apply to trade positions netted against the ALBM position, and not to the standalone ALBM positions.

The stock exchanges desirous of implementing ALBM would need SEBI approval for the eligibility criteria for scrips to be included in the ALBM list, the process of choosing the scrips in the ALBM list, and disclosure and transparency provisions relating to ALBM.

Any exchange desirous of implementing ALBM has to demonstrate that it has a well-designed software for margin computation and well-established governance structures and administrative infrastructure to monitor and enforce the margining system.

The stock exchange or its clearing corporation implementing ALBM must be an approved intermediary under the stock lending scheme.

Receiving of charges by an uncovered short seller would be prohibited.

ALBM transactions, netted against trade positions, would be subject to gross margins, as in index futures and MCFS.

The margin on all trade positions that are to be netted against ALBM transactions should not be less than the limit of 10 per cent mandated for the MCFS. In cases where the position so netted by a member exceeds Rs 20 crore, the excess over Rs 20 crore would attract a margin of at least 15 per cent.

The financiers in the ALBM system would have the option of depositing the collateral with the clearing corporation. A financier who does so would not be subjected to the daily mark to market and other margins.

The incremental carry-forward margin would be equally applicable on the ALBM and MCFS.

The margins for the MCFS and ALBM transactions should be fully in cash or fixed deposits or government securities, or a combination of the three.

SEBI-NCAER survey

To help gauge the impact of the growth of the securities market on the households in the 1990s and analyse the quality of its growth, SEBI requested the National Council of Applied Economic Research (NCAER) to conduct a survey of Indian investor households. The objectives were to:

Estimate the number of households and the population of individual investors who invested in the equity market directly or indirectly through mutual funds;

X Draw a profile of the households and investors and describe their demographic, economic, financial and equity ownership characteristics;

Understand their investment preferences for equity and other savings instruments available in the market, their perceptions about market risks, their expectations from the market, the nature of their grievances and difficulties; and estimate the number of households which refrained from investing in the equity market, describe their demographic characteristics, and analyse the reasons for their reluctance to invest in equity.

The major findings of the survey are:

An estimated 12.8 million, or nearly 8 per cent, of all Indian households, representing 19 million individuals, directly invested in equity shares or debentures or both as at the end of fiscal 1998-99.

An estimated 15 million or nearly 9 per cent of all households invested in units of mutual funds. There are likely to be at least 23 million unitholders in mutual funds.

The investor households increased at a compounded growth rate of 22 per cent, between 1985-86 and 1998-99. Interestingly, the rural investor households increased at a compounded growth rate of 30 per cent compared to 19 per cent for urban investor households.

Of the 48 million urban households, an estimated 8.8 million households, or 18 per cent, representing approximately 13 million urban investor-owned equity shares or debentures or both. Of the 121 million rural households, only about 4 million households, or 3 per cent, representing nearly 6 million rural investors owned these instruments.

Low per capita income, apprehension of loss of capital, and economic insecurity which are interrelated factors, significantly influence the investment attitude of the households.

Ranked by an ascending order of risk perception, bank fixed deposits were considered very safe, that is, the least risky, followed by gold, units of UTI's US-64, and UTI's other schemes, fixed deposits of non-government companies, mutual fund equity shares and debentures. Debentures were perceived to be nearly as risky as equity.

Despite the expansion of the securities market, a very small percentage of households savings is channelled into the securities market

Despite their growth, the mutual funds have not yet become an attractive investment avenue for the low- and middle-income groups.

Of the 12.1 million equity investor households, 84 per cent invested in equity shares through the primary market, and 63 per cent bought equity shares in the secondary market.

Risk management for equity market

Mark-to-market margins should be collected separately from the daily/exposure margins as the purpose of these margins is different.

The equity markets must move towards margining on a gross basis, hence all the exchanges are to modify their software in such a way that the client code becomes mandatory at the broker level. This modification must be carried out by all the exchanges three months from the date of this circular.

All the clients excluding FIs/FIIs/MFs should maintain a deposit of minimum margin with a broker in the form of cash, bank guarantees, FDRs or approved securities. Such margin deposit should not be less than 10 per cent of the net open position of a client at any point of time. Actual delivery of shares sold or actual payment made for shares bought should be excluded from the net position.

The exchanges should disclose the daily net open position of top 500 scrips.

Modified carry-forward system: Based on the recommendations of the committee under the chairmanship of Professor J. R. Varma, Member, SEBI, reconvened by SEBI to review the existing MCFS and examine the introduction of the carry-forward system under rolling settlement, the SEBI modified some of conditions of the MCFS:

The overall carry-forward limit is enhanced from the existing limit of Rs 20 crore to Rs 40 per broker. The margin up to the present limit of Rs 20 crore would remain at the existing prescribed level and the incremental position would attract an additional 5 per cent margin. Further, there will be a scrip-wise broker-wise position limit of Rs 5 crore.

The maximum limit of 90 days for carry-forward of transactions is removed.

Based on the recommendations of the Risk Management Group constituted by SEBI, the following decision was taken: In case the carry-forward gross position in any exchange, in any scrip, exceeds the parameters mentioned below, the ICFM shall be levied, in addition to the carry forward margin, at a rate higher than the rates determined as per the tables below:

Investor Protection Fund: To promote investor education and create greater investor awareness, permission was given to all the stock exchanges to utilise interest income earned on the Investor Protection Fund for investor education, awareness and research. The Investor Protection Fund was formed to compensate the investors for loss in the event of the broker being declared defaulter. Over the period, there has been a sharp increase in the corpus of this fund in comparison to the disbursement from the fund due to improved risk management.

New derivatives products: A meeting of the Technical Group set up by SEBI to introduce new derivative products, held on August 4, laid down the broad framework for risk management of index options. It was decided to use a portfolio-based margining approach, which takes an integrated view of the risk involved in the positions of each individual client in various index futures and index options contracts. To cover the risk arising out of the changes in the value of the index and index volatility, the margining system would have the ability to compute the worst case loss under various scenarios of index and volatility changes and charge margins accordingly. Position limits mandated for future market would also apply to index options. Any short positions on options would be subject to stringent margining. Options on index would have maximum maturity of three months with minimum of three strikes (in the money, near the money and out of the money). The tentative target for the start of trading in index options was fixed for Diwali 2000.

(Edited-excerpts from NSE News published by the National Stock Exchange of India.)