Additional Volatility Margin

 SECURITIES AND EXCHANGE BOARD OF INDIA
SECONDARY MARKET DEPARTMENT
Mittal Court, A Wing, Gr. Floor,
224, Nariman Point, Mumbai 400 021
  

To:

The Executive Directors/ Managing Directors
of all the Stock Exchanges

Sir,

Additional volatility margin

 

At the meeting of the Inter-exchange Co-ordination Group and Inter-Exchange Surveillance Group of the Stock Exchange which was held on June 25, 1998 to review the prevailing market situation it was agreed that the restrictions on short sales which was limited to a day should be removed with effect from July 6, 1998 and an additional margin system be put in place simultaneously. A small group under the IECG consisting of the representatives of the exchanges of Mumbai, Delhi, Calcutta, Ludhiana, Bangalore, National Stock Exchange and SEBI was set up to work out the details of the additional volatility margin. The details of such margin has been worked out in consultation with the group.

Need for Volatility Margins

It was noted that while the present margin system which included marked to market margin, daily carry forward margin, concentration margin, incremental carry forward margin, and also the exposure limits and intra-day and weekly price bands addressed market risks, there was a need to further strengthen the margin system to curb excessive volatility. It was also felt that weekly price bands coupled with different trading cycles across the exchanges and differential prices created situations in which if a scrip reached the boundaries of a price band during a trading period, the investors did not have any exit route in that scrip for the remaining days of the trading period. Taking these factors into account, the consensus among the stock exchanges was that the system of price bands calls for a review. It was felt that while daily scrip specific price band was necessary, the weekly price bands could be replaced by a graded margin system linked to price movements. Such a graded margin system would on the one hand contain volatility in securities while on the other keep open an exit route for investors. It was felt that this graded margin system should be in addition to the existing margin system. This would provide additional market safety and also act as a deterrent to building up of excessive outstanding positions in the market.

New Additional Volatility Margin System

The following is the system of the additional volatility margins which would be applicable to trading in all stock exchange with effect from July 6, 1998.

Price Bands

1. The daily price band would be reduced from the current level of 10% to 8%.

 
2. The existing weekly price band of 25% is being removed and a graded margin system as given below is put in place for volatile securities.

Definition of Volatility

1. A security would be considered as volatile if the price of the security varies by plus minus 16% or more in a single trading cycle. For the purpose of computing this price variation, the closing price at the end of each day of the security will be compared with the closing price at the end of the previous settlement. In other words, if Pn(T+1)is a price of a security on the nth day of trading period T+1 and Pl (T) is the price of the security on the last day of trading period ‘T’ then the security will be volatile if Pn(T+1)-Pl (T) ³ 16%.

Provided, however, price variations on account of calls, bonuses, rights, mergers, amalgamations, and scheme of arrangements would be excluded for determining volatile securities and adjustments in prices when securities traded ex benefits will have to be made for the purpose of computation of volatility.Margin Rates

1. The additional volatility margin will be as follows :

Price Variation	Margin Rates
16% or more	5%
24% or more	20%
32% or more	30%
40% or more	40%

1. Once a security attracts the volatility margin, the margin will continue on the security at the margin rate as of the last day of the previous trading period for the first two trading days in the subsequent trading cycle also. For the subsequent days of the trading period margins applicable shall be as per rates prescribed above based on price variation during the current week or 5% whichever is higher. If however, the direction of price variation has reversed in the current week and the price variation in the security has exceeded the threshold limits in the reverse direction, then the margins as per rates prescribed therefor shall apply.

Further, if prices have been volatile, say, upwards (or downwards) and are attracting margins on the buy side (or sell side), and if the price movement reverses and exhibits a decline (or increase) of 16% or more than the margins will now be applicable on sell side (buy side) as per rates prescribed.  Collection
 

1. The above margins would be paid in cash, bank guarantees, or bank fixed deposits. The margins collected will be due for release along with the other margins on completion of pay-in of securities. 

Applicability

1. The additional volatility margins will apply for all positions in the cash and carry forward markets.

 
2. The additional volatility margins would be applicable on the buy side when the prices rise and on the sell side when the prices fall. The margin would be payable on the outstanding buy/sell positions of the security at the end of each day.

 
3. The additional volatility margins are in addition to the existing marked to market margins, daily carry forward margin, incremental carry forward margin and concentration margin and special/ adhoc margin, if any, and will not be adjusted against any of these margins. However, in respect of carry forward trades the cumulative margin on a security on account of the above additional volatility margin and incremental carry forward margin will be subject to an upper limit of 50%.

 
4. The additional volatility margins would not be mandatory for securities whose prices are less than Rs.40. However, it would be upto the exchanges to consider applying the additional volatility margins in these securities also in case it is deemed necessary by the exchanges. If the price of a security increases to Rs.40 or more it will be eligible for consideration towards this margin. If price of a security reduces to below Rs.40 in a trading period it will still be eligible for consideration during that trading period.

 
5. The additional volatility margins will come into effect from the first trading period commencing on or after July 6, 1998. Simultaneously, the restrictions on short sales imposed on June 16, 1998 which came into effect on June 17, 1998and the 50% margin for securities in the no-delivery will be removed.

 
6. However, the additional margin of 10% levied on the end of the day sell position will continue to be levied till July 15, 1998.

While the imposition of aforementioned additional volatility margins is expected to contain price volatility, this cannot substitute the need for monitoring and surveillance by the exchanges. For the risk containment measures to be successful, the exchanges must continue to strengthen their monitoring, surveillance and the margin collection system and keep a constant close watch on the outstanding position of brokers and take such actions as are expected of them in their functioning as public institutions and self regulatory organisations.

Thanking you

Yours faithfully
 

PRATIP KAR
EXECUTIVE DIRECTOR
SMDRP DEPARTMENT