Analysing Cross Margin in Commodity Index Futures and Its Underlying Constituent Futures or Its Variants: SEBI

A commodity market may be a place where raw materials or main goods are often bought, sold, and traded. Currently, there are over 50 major commodity markets throughout the globe that support trade about 100 primary commodities.

Commodities are frequently divided into two types:

hard and soft commodities. Natural resources that has got to be mined or exploited, like gold, rubber, and oil are considered hard commodities, whereas soft commodities are agricultural products or livestock—such as corn, wheat, coffee, sugar, soybeans, and other things.

Generally, the investing in companies that have a commodity exposure or directly investing in commodities via futures contracts are two ways for investors to possess exposure to commodities. Recently the Securities and Exchange Board of India (SEBI) , India’s capital and commodity exchange regulator, has decided to implement a cross margin benefit between commodity index futures and their underlying constituents’ futures.

The move is a component of SEBI’s endeavor to extend the efficiency of market participants’ usage of margin funds. this may help lower trading costs and increase liquidity in such products. When taking two mutually offsetting positions, cross margins allow market participants to lower the general margin payment necessary. Market players would be ready to transfer excess margin from one account to a different as a results of this.

The Cross Margin benefits which are allowed by SEBI for future traders-

Basically, the cross-margin benefits that has been stated by SEBI is that the qualifying offsetting positions of index futures and futures of its underlying constituents or variants could also be given a cross margin advantage of 75% on starting margin .SEBI has also levied the acute loss margin and market-to-market margin on the longer term traders. Cross margin benefit are going to be estimated at the client level and presented to the trading or clearing member in real-time online.

This benefit will then be passed on to the customer.

Clients are going to be ready to have two accounts with a trading or clearing member:

one for arbitrage (which holds a totally duplicated portfolio) and one for non-arbitrage. this is often to permit clients to show a partially replicated portfolio into a totally replicated portfolio by placing opposing positions in two different accounts. A fully replicated portfolio is one during which the index futures contracts and every one of its constituent futures contracts or variants have exact offsetting positions. However, for the needs of compliance and reporting, the positions in both accounts are going to be combined, and therefore the customer will retain his or her unique client code. To be eligible for the cross-margin benefit, the contracts belonging to index futures and underlying constituents, or its variants will belong to an equivalent expiry month or to the closest expiry month and will be from amongst the primary three expiring contracts only, SEBI said during a circular issued on Tuesday. The cross-margin benefit on qualified positions are going to be completely withdrawn by the beginning of the tender period for the index’s component futures or its variants, whichever comes first, or the beginning of the expiry day. After back testing for adequacy of cross margin to mitigate Mark to plug losses (MTM) for a minimum of six months, clearing corporations/exchanges can adopt cross margin benefit. consistent with back testing, the initial margin after cross margin benefit should be capable cover MTM on a minimum of 99 percent of the times. The clearing corporation will have the chance to stay holdings within the cross brokerage account until expiry in its own name if a trading member or clearing member whose clients have taken advantage of the cross margin benefit defaults, consistent with the regulator. According to the circular, the clearing organization also can liquidate positions or collateral and use the proceeds to pay the default obligation. Furthermore, exchanges or clearing businesses are going to be required to enter into an agreement with the trading or clearing member that clearly lays out the liability and responsibility distribution within the event of a default. The Clearing corporations must apply to the Securities and Exchange Board of India (SEBI) for permission to supply cross margin benefits on indices. the rear testing data must be included with the appliance. Hence, the Securities and Exchange Board of India (SEBI) has allowed exchanges to supply cross-margining benefits to clients arbitraging between commodity index futures and their underlies during a move to deepen the commodity derivatives segment (CDS). This  might reduce trade margins to only a fourth what they’re presently.

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