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General Manager

Secondary Market Department

e-mail : pkb@sebi.gov.in

SMD/Policy/ Cir – 9/2003

March 11, 2003

To Executive Directors/ Managing Directors Of all the Stock Exchanges

Dear Sir/Madam,

Sub:-Risk Management for T+2 rolling settlement

Please refer to our circular dated February 12, 2003, advising the time schedule for the implementation of the T+2 rolling settlement w.e.f April 01, 2003.

The SEBI constituted Group on Secondary Market Risk Management discussed the issue of the rationalisation of the margining structure in the shortened T+2 rolling settlement. The Group held various meetings and pursuant to the deliberations of the Group, the stock exchanges shall follow risk management structure given below w.e.f. April 01, 2003:-

Categorisation of stocks for imposition of margins

1.The risk containment measures for the scrips would be based on their volatility and liquidity. The scrips would be classified into three groups.

2.The stocks which have traded atleast 80% (+/-5%) of the days for the previous eighteen months from (1st July 2001) shall constitute the Group I and Group II.

3.  Out of the scrips identified above, the scrips having mean impact cost of less than or equal to 1% shall be categorised under Group I and the scrips where the impact cost is more than 1, shall be categorised under Group II.

4. The remaining stocks would fall into the Group III.

5. The impact cost shall be calculated at 15th of each month on a rolling basis considering the order book snapshots of the previous six months. On the basis of the impact cost so calculated, the scrips shall move from one group to another group from the 1st of the next month.

Calculation of mean impact cost

6.  The mean impact cost for the purposes of classification of the scrips in the two Groups viz. Group I&II would be calculated in the following manner :

i. Impact cost shall be calculated by taking four snapshots in a day from the order book in the past six months. These four snapshots shall be randomly chosen from within four fixed ten-minutes windows spread through the day.

ii. The impact cost shall be the percentage price movement caused by an order size of Rs.1 Lakh from the average of the best bid and offer price in the order book snapshot. The impact cost shall be calculated for both, the buy and the sell side in each order book snapshot.

iii.  The computation of the impact cost adopted by the Exchange would be disseminated on the website of the exchange.

iv. The Exchanges shall use a common methodology for carrying out the calculations for mean impact cost. The details of calculation methodology and relevant data shall be made available to the public at large through the website of the Exchanges. Any change in the methodology for the computation of impact cost would also be disseminated by the Exchange.

Risk containment measures

VaR based margins

7. For the stocks in Group I, the VaR margin will be scrip VaR (3.5 sigma) computed in a manner specified for the scrip on which stock futures are traded.

8.On the stocks in Group II where the impact cost is more than 1, the VaR margin shall be higher of scrip VaR (3.5 sigma) or three times the index VaR, and it shall be scaled up by root 3.

9.For the stocks in Group III, the VaR margin would be equal to five times the index VaR and scaled up by root 3.

10. For the purposes of determining the margins for Group II & Group III, the minimum Index VaR would continue to be taken as 5% as at present.

11. The volatility estimates for the scrips and the index for the VaR shall be computed on the price differential of 2 days. The VaR calculated by an exchange at the end of the previous day would be used for the purpose of margin calculations for the transactions carried out on the day.

Mark to market margin

12.In addition to the collection of the VaR based margins, the exchanges shall continue to collect mark-to-market margin.

Additional margin

13.  The existing 12% additional margin would be phased out progressively. With effect from April 01, 2003, this additional margin shall be reduced to 6%. This additional margin shall be further reduced on the implementation of advance collection of VaR based margins.

Collection of margins

14. All these margins would be collected on T+1 basis.

Adhoc / Special Margin

15.The exchanges should at their discretion may impose additional margin/adhoc margin/special margin on scrips wherever necessary to contain the risk in the market.

Gross Exposure Limits

16. the existing provision in respect of capital adequacy and the gross exposure limits shall continue to apply.

Dissemination to the market

17.The VaR calculations will be based either on BSE Sensex or S & P CNX Nifty and would be disseminated by the BSE and NSE daily on .their websites by 6:30 pm in a downloadable format.

18. Other stock exchanges could make their own VaR calculations or freely adopt the VaR calculations available on the sites of BSE and NSE. It will be mandatory for BSE/NSE to provide real time Sensex/Nifty/scrip data free. It will also be mandatory for all the stock exchanges to have real time information of Sensex/Nifty/ scrip data either from the respective exchange or through a vendor.

The stock exchanges should ensure that the above margin structure is implemented on April 01, 2003 and the exchanges have tested the software and remove any glitches in its operation well before the abovedeadline to avoid any problems in the live environment.

While the above risk management measures is expected to contain risk in the system, however, the efficacy of the same would be dependent on  monitoring, surveillance and timely collection of margin by the stock exchanges. For the risk containment measures to be successful, the exchanges must continue to strengthen their monitoring and surveillance of broker positions/ client positions vis-a-vis adequate capital/ margins and adherence to exposure limits and collection system and to take such timely actions as are expected of them in their functioning as public institutions and self-regulatory organisations.

The exchanges are advised to take steps to implement the above and confirm the same to SEBI before March 31, 2003.

Yours faithfully,

P K Bindlish

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