Clearing, Settlement and Risk Management of IRD

Clearing, Settlement and Risk Management of IRD (Part 1)

• Definition: Clearing and settlement mechanism and entities involved in Exchange Traded Interest Rate Derivatives (ETIRD) are crucial for ensuring the smooth functioning of the securities market.
• Details: The clearing corporation, registered with SEBI, acts as a central counterparty to all trades in ETIRD, guaranteeing their financial settlement.

Key Concepts

• Clearing Mechanism: The process of working out open positions and obligations of clearing members, considering exposure and daily margin purposes.
• Settlement Mechanism: A two-way process involving the transfer of funds and securities on the settlement date, with pay-in and pay-out obligations for clearing members.
• Risk Management: The process of determining and managing the risks associated with clearing and settlement, including position limits and margining.

Entities Involved

• Clearing Corporation: An entity responsible for clearing and settlement of trades, acting as a central counterparty and providing financial guarantees.
• Clearing Members: Entities with clearing and settlement rights, helping in the clearing of trades of their clients, and performing functions such as clearing, settlement, and risk management.
• Clearing Banks: Intermediaries between clearing members and the clearing corporation, facilitating the transfer of funds for pay-in and pay-out obligations.
• Depository and Depository Participants: Entities facilitating the holding of securities in electronic form and enabling transfer of securities by book entry.

Important Terminologies

• Pay-In: The process of a clearing member bringing in money and/or securities to the clearing house/corporation.
• Pay-Out: The process of the clearing house/corporation paying money or delivering securities to the clearing member.
• Novation: The act of a clearing corporation interposing itself between both parties of every trade, becoming the legal counterparty to both.
• Interoperability: The concept of linking multiple clearing corporations, enabling a clearing member to select the clearing corporation of its choice to clear and settle trades executed in multiple exchanges.

Clearing, Settlement and Risk Management of IRD (Part 2)

• Participant Rules: The rules for participants, including membership, are crucial for clearing, settlement, and risk management of Interest Rate Derivatives (IRD).
• Risk Management Framework: A bilaterally approved framework ensures coverage of inter-clearing corporation exposures, with clearing corporations exchanging margins and financial resources on a reciprocal basis.
• Inter-Clearing Corporation Collateral: This comprises two components:
  • Margins: As per the existing Risk Management Framework, including initial margin, extreme loss margin, and calendar spread margin.
  • Additional Capital: Determined by each Clearing Corporation based on credit risk from the linked Clearing Corporation.
• Benefits of Interoperability: Among clearing corporations, these include:
  • Choice for participants to select a clearing corporation
  • Better capital utilization
  • Reduced trading disruption
  • Reduced aggregate exposure
  • Lower operational complexity
  • Enhanced market competition and lower clearing costs
  • Decoupling of execution risk from settlement risk

Clearing Mechanism

• Open Positions: The clearing mechanism involves working out open positions and obligations of clearing members, considering:
  • Proprietary Positions: Net positions (buy - sell) for each contract.
  • Client Positions: Net positions for each individual client, not netted across clients.
• Example: A clearing member's open position is the sum of proprietary and client positions, without netting between them.

Determination of Settlement Obligations

• Admitted Deals: Cleared on a netted basis, with settlement obligations arising for all clearing members.
• Confirmation of Trades: For custodial participants, trades are confirmed by clearing members, forming part of their obligations.
• Settlement Obligation Methods: Include:
  • Daily mark-to-market settlement for futures contracts
  • Final settlement for cash-settled futures contracts
  • Premium settlement for option contracts
  • Exercise settlement for cash-settled option contracts
  • Netted obligation computation for clearing members

Position Limits

• Definition: The maximum allowable open position limit at client, member, or market level to avoid huge open positions.
• Categories and Limits: Specified for trading members, institutions, and FPIs, with position limits for different year buckets (e.g., 8-11 years, 4-8 years, 11-15 years).

Clearing, Settlement and Risk Management of IRD (Part 3)

• Position Limits: Position limits are imposed on various categories of traders to prevent market manipulation and ensure fair trading practices. The limits are specified as a percentage of the total open interest or a fixed amount, whichever is higher.
• Category-wise Position Limits:
  • Non-Institutions in Category II FPIs: 3% of Open Interest or INR 400 crore (20,000 lots) for 8-11 year bucket, and 3% of Open Interest or INR 200 crore (10,000 lots) for 4-8 and 11-15 year buckets.
  • Trading Members: 15% of total open interest or Rs.1000 crores for 91 Day T-Bills Futures, and 15% of total open interest or Rs.1000 crores for Overnight MIBOR futures.
  • Institutions in Category I and II FPIs: 10% of total open interest or INR 1200 crores for Corporate Bond Index futures.
• Additional Limits for FPIs:
  • The total gross short position of each FPI in Interest Rate Derivatives contracts shall not exceed its long position in government securities and Interest Rate Futures.
  • The aggregate long position of all FPIs shall not exceed ₹ 5000 crore.
  • No FPI can acquire a net long position in excess of INR 1,800 crore.
• Monitoring of Position Limits: Exchanges and clearing corporations monitor position limits, and violations are treated as a breach of rules. Trading members and clients are accountable for their positions, and penalties can be levied for non-compliance.
• Settlement:
  • Cash Settlement: Most Interest Rate Derivatives contracts are cash settled, where the profit/loss is paid/received based on the final settlement price.
  • Physical Settlement: Not currently facilitated by exchanges, but can be done for notional GOI bond futures.
  • Settlement Price: Determined by the closing price of the futures contract, weighted average price of the underlying bond, or theoretical price computed using a formula.
• Settlement Schedule: Announced by Clearing Corporations, with funds pay-in and pay-out typically effected before market hours on the next day.

Clearing, Settlement and Risk Management of IRD (Part 4)

• Definition: Clearing, settlement, and risk management are crucial components of the IRD (Interest Rate Derivatives) market.
• Details: The process involves calculating daily settlement prices for interest rate futures contracts based on a specified methodology.

Key Concepts in Clearing and Settlement

• Yw (Futures Yield): Calculated as the volume-weighted average futures yield of traded futures contracts in the last 30 minutes of trading, subject to at least 5 trades.
• Daily Settlement: For certain products like Overnight MIBOR Futures, the daily settlement rate is the Volume Weighted Average Rate of trades done in the last 30 minutes of trading, subject to a minimum of 5 trades.
• Theoretical Daily Settlement Rate: For unexpired illiquid Overnight MIBOR Futures, a theoretical rate is calculated using the realized rate, number of days lapsed, and expected rate.
• Final Settlement: For Overnight MIBOR Futures, the final settlement price is the simple average of the Overnight Call Rate (MIBOR) applicable for the expiry month.

Cash Price Calculation

• Clean Price: The weighted average price (WAP) in the last 2 hours on NDS-OM, or the WAP of full-day trades if not traded in the last 2 hours.
• Accrued Interest: Added to the clean price to get the Cash Price.

Daily Mark to Market (MTM) Settlement

• Process: All positions in interest rate futures contracts are marked to market at the daily settlement price and settled in cash.
• Example: A participant sells 1 lot of 6.10% GOI 2031 bond futures and keeps it open till expiry, with daily settlement prices and mark-to-market spreads calculated accordingly.

Premium Settlement for Option Contracts

• Methodology: Premium payable or receivable is computed after netting positions at the trading member/custodial participant level, with premium variation adjusted against collateral.

Final Settlement for Futures and Option Contracts

• Futures Contracts: Marked to market at the final settlement price and settled in cash on T+1 day.
• Option Contracts: Automatically exercised at the final settlement price, with exercise settlement effected on T+1 day by debit/credit of clearing accounts.

Funds Settlement

• Primary Clearing Account: Each clearing member maintains a separate account with a designated clearing bank for each segment.
• Pay-in and Pay-out of Funds: Clearing members must have a clear balance of requisite funds in their clearing accounts, with pay-in and pay-out of funds advised by the Clearing Corporation to Clearing Banks.

Clearing, Settlement and Risk Management of IRD (Part 5)

• Broker Responsibilities: Brokers shall accept cheques drawn only by the clients and also issue cheques in favour of the clients only, for their transactions. Member shall maintain an audit trail of the funds received through electronic fund transfers to ensure that the funds are received from their clients only.
• SEBI Circulars: SEBI has issued circulars regarding the naming/tagging of demat accounts maintained by stock brokers. The key highlights are:
  • Bank accounts and Demat accounts maintained by all stock brokers shall have appropriate nomenclature to reflect the purpose for which those bank/demat accounts are being maintained.
  • The nomenclature for bank accounts and demat accounts to be followed is given as under:
    • Up Streaming Client Nodal Bank Account (USCNBA): SB/CM shall receive clients’ funds in USCNBA. The nomenclature for such accounts shall be “Name of the SB/CM –USCNB account”
    • Down Streaming Client Nodal Bank Account (DSCNBA): Payment to clients shall be done only from DSCNBA account. The nomenclature for such accounts shall be “Name of the SB/CM – DSCNB account”
    • Bank account(s) held for the purpose of settlement would be named as "Name of Stock Broker -Settlement Account".
  • Stock brokers are required to maintain demat accounts only under the following 6 categories specified by SEBI:
    1. Proprietary Account: Hold own securities
    2. Pool account: Settlement Purpose
    3. Client Unpaid Securities Pledgee Account: For pledging of Unpaid Securities of Clients
    4. Client Securities Margin Pledge Account: For Margin obligations to be given by way of Pledge/ Re-pledge
    5. Client Securities under Margin Funding Account: Hold funded securities in respect of margin funding
    6. Client Nodal MFOS Account: For subscription/ redemption of MFOS units
• Settlement of Accounts (Funds): SEBI has issued guidelines for the settlement of running account of client’s funds. The key highlights are:
  • The settlement of funds shall be done within 1 working day of the pay-out, unless client specifically authorizes the stock broker in writing to maintain a running account.
  • The actual settlement of funds shall be done by the member depending on the mandate of the client and there must be a gap of maximum 90 / 30 days (as per the choice of client viz. Quarterly / Monthly) between two settlements of running account.
  • While settling the account, the member should simultaneously send to the client a ‘statement of accounts’ containing an extract from the client ledger for funds and an extract from the register of securities displaying all receipts/deliveries of funds/securities.
• Handling of Client Securities: SEBI has given direction for handling of client securities by trading member/clearing member. The key highlights are:
  • The securities received in pay-out against which payment has been made by clients, shall be transferred to the demat account of the respective clients within one working day of the pay-out.
  • Unpaid securities shall be transferred to respective client’s demat account followed by creation of an auto-pledge in favor of a separate account titled –“client unpaid securities pledgee account”.
  • If the client does not fulfil its funds obligation, TM/CM shall dispose-off such unpaid securities in the market within five trading days after the pay-out.
• Recent SEBI Circulars: SEBI has issued recent circulars regarding the settlement of running account of client’s funds. The key highlights are:
  • The settlement of running account of funds of the client shall be done by the TM after considering the End of the day (EOD) obligation of funds as on the date of settlement across all the Exchanges, at least once within a gap of 30 / 90 days between two settlements of running account as per the preference of the client.
  • The required bank details for initiating electronic fund transfers shall be obtained from new clients and shall be updated for existing clients.
  • Client’s running account shall be considered settled only by making actual payment into client’s bank account and not by making any journal entries.
  • For the clients having credit balance, who have not done any transaction in the 30 calendar days since the last transaction and any amount of such client’s funds is lying with member for more than such 30 calendar days, the entire credit balance of client shall be returned to the client by TM, on the upcoming settlement dates of monthly running account settlement cycle.

Clearing, Settlement and Risk Management of IRD (Part 6)

• Account Statements: The stock broker shall send a complete `Statement of Accounts’ for both funds and securities in respect of each of its clients containing extract of from the client ledger for funds, an extract from the register of securities displaying all receipts and deliveries of securities and a statement explaining the retention of funds and / or securities.
• Annual Global Statement: SEBI has directed that all members shall issue an Annual Global Statement to their clients, which shall be issued within 30 days from the end of the financial year and shall contain details of all transactions executed by the client in the financial year, details of all charges etc.

Fund Shortages

• Settlement Obligation: Non-fulfilment of settlement obligation towards settlement of contracts traded on currency derivatives segment including ETIRD by the scheduled date and time shall be treated as a violation.
• Penalty: In case of a settlement shortages, in additional to monetary penalty, clearing corporation may advise the Exchanges to withdraw any or all of the membership rights of the clearing member including the withdrawal of trading facilities of all trading members and/ or clearing facility of custodial participants clearing through such clearing member.

Delivery Under Physical Settlement

• Deliverable Grade Securities: Exchanges shall select their own basket of securities from the eligible Deliverable Grade Securities, viz., GOI securities maturing at least 7.5 years but not more than 15 years from the first day of the delivery month with a minimum total outstanding stock of Rs 10,000 crore.
• Conversion Factor: The Conversion Factor for deliverable grade security would be equal to the price of the deliverable security (per rupee of the principal), on the first day (calendar day) of the delivery month, to yield 7% with semi-annual compounding.
• Invoice Price: Invoice Price of the respective deliverable grade security would be the futures settlement price times a conversion factor plus accrued interest.

Settlement Mechanism

• Physical Delivery: The contract would be settled by physical delivery of deliverable grade securities using the electronic book entry system of the existing Depositories (NSDL and CDSL) and Public Debt Office (PDO) of the RBI.
• Delivery Month: The delivery month shall be the last month of the expiring contract, i.e., March, June, September and December.
• Delivery Notice: It is the day when the selling Clearing Member (CM) sends a notice to the Clearing Corporation (CC) expressing his intention to deliver along with details of the security to be delivered.

Margins and Action on Deliverable Positions

• Margins on Physical Delivery Positions: For positions marked for delivery, a margin equal to VaR of the futures on the invoice price plus 5% of face value along with mark to market adjustments shall be charged both to the buying client and selling client.
• Action in Case No Intent to Deliver is Provided: In case no intent is provided by the selling CM till two business days prior to the last delivery date, it shall be presumed that selling CM has failed to deliver the security and the auction mechanism, as specified for security shortages, shall be activated.

Clearing, Settlement and Risk Management of IRD (Part 7)

• Definition: Clearing, settlement, and risk management are crucial components of the IRD (Interest Rate Derivatives) market, ensuring that transactions are processed efficiently and securely.
• Details: A comprehensive risk management framework is essential for the Clearing Corporation to provide settlement guarantees, even in cases of broker or clearing member failures.

Key Concept 1: Risk Management Framework

• Definition: The risk management framework consists of various measures, including margin requirements, liquid net worth, pre-trade risk control, risk reduction mode, and position limits.
• Details: The framework is designed to safeguard against potential losses and ensure the stability of the IRD market.

Key Concept 2: Margining

• Definition: Margining is the process of computing potential losses on open positions held by members across all clients.
• Details: The clearing corporation collects margins from members, who in turn collect margins from their clients, to cover potential losses.

Key Concept 3: Types of Margins

• Initial Margin: Payable on all open positions, computed using the SPAN (Standard Portfolio Analysis of Risk) methodology.
• Net Option Value: Computed as the difference between long and short option positions, valued at the last available closing price.
• Calendar Spread Charge: Levied on futures positions in one expiry month hedged by an offsetting position in a different expiry month.
• Margin on Consolidated Crystallized Obligation: Represents payable obligations based on closed-out futures positions and payable/receivable premium at the client level.

Key Concept 4: SPAN Margining

• Definition: SPAN margining uses a scenario-based approach to arrive at margins, generating 16 "what-if" scenarios to compute the potential loss.
• Details: SPAN margining considers the entire portfolio of an investor, not just individual positions, and uses value-at-risk (VaR) to compute initial margin requirements.

Key Concept 5: Risk Containment Mechanism

• Definition: The risk containment mechanism includes online real-time risk management, online monitoring of margin against liquid assets, and position limit monitoring.
• Details: The mechanism is designed to identify and manage potential risks in the IRD market, ensuring the stability of the market and protecting investors.

Clearing, Settlement and Risk Management of IRD (Part 8)

• Intraday Calculation: The net payable/receivable amount at client level is calculated using:
  • Premium Payable/Receivable
  • Futures Crystallized Profit or Loss (based on weighted average prices of trades executed)
• End-of-Day Calculation: The payable/receivable amount at client level is calculated using:
  • Futures Mark to Market Profit/Loss to be settled
  • Options Premium Payable/Receivable
  • Options Exercise/Assignment for expired contracts
  • Futures Final Settlement for expired contracts
• Consolidated Crystallized Obligation Margin: If the overall amount at client level is payable, it shall be the intraday/end-of-day consolidated crystallized obligation margin for the client
• Margin on Consolidated Crystallized Obligations: Replaces the net buy premium, intraday crystallized losses, assignment margin, and futures final settlement margin levied

Extreme Loss Margin

• Definition: Additional margin imposed on clearing members
• Calculation:
  • For client positions: netted at the level of individual client and grossed across all clients
  • For proprietary positions: netted at trading/clearing member level without set-offs between client and proprietary positions
• Applicable Extreme Loss Margin:
  • For futures: calculated on the mark to market value of the gross open positions
  • For options: calculated on the notional value of the open short option position
• Product-wise Extreme Loss Margin:
  • Cash Settled Interest Rate Derivatives: 0.25% for futures and options
  • Futures on 91 Day GOI T-bills: 0.015% for futures
  • Overnight Call Rate (MIBOR): 0.50% for futures

Additional Margin

• Definition: Risk containment measures imposed by exchanges/clearing corporations
• Calculation: In addition to initial margin and extreme loss margin
• Collateral: Clearing members shall provide margin in eligible collateral modes

Liquid Assets and Liquid Net Worth

• Liquid Net Worth: Total liquid assets deposited with the exchange/clearing corporation minus initial margin, extreme loss/exposure margin, and other deductions
• Liquid Assets: Cash, bank guarantees, fixed deposit receipts, approved securities, and other forms of collateral
• Cash Component: Cash, bank guarantees, fixed deposit receipts, units of money market mutual fund, and other forms of collateral
• Non-Cash Component: Deposit of approved list of demat securities, units of other mutual funds, and other forms of collateral
• Haircut: Applicable to liquid assets, with varying percentages for different types of assets
• Limits: Applicable to single bank exposure, with varying percentages for different types of assets

Haircut and Limits for Liquid Assets

• Cash Equivalents:
  • Cash: 0% haircut, no limit
  • Bank Fixed Deposits: 0% haircut, no limit
  • Bank Guarantees: 0% haircut, limit on exchange's/clearing corporation's exposure
• Securities of the Central Government: haircut based on type and tenor of securities
• Units of Mutual Fund Schemes: haircut based on type of scheme
• Foreign Sovereign Securities: haircut based on value of sovereign securities
• Other Liquid Assets (Non-Cash Component): cannot be used for mark to market losses, total cannot exceed total of cash equivalents

Notes

• Single Bank Exposure Limits: daily exposure to a single bank shall not exceed 15% for AAA-rated banks and 10% for AA-rated banks
• Mark to Market Losses: shall be paid by the member in the form of cash or cash equivalents
• Cash Equivalents: shall be at least 50% of liquid assets
• Exposure to Equity and Debt Instruments: shall be subject to well-defined criteria for acceptance of collateral
• Acceptance of Fixed Deposit Receipts: clearing corporations shall not accept FDRs from trading/clearing members as collateral if issued by the member themselves or associate banks
• Haircut on Securities of the Central Government: based on type and tenor of securities
• Exposure to Corporate Bonds: shall not exceed 10% of total liquid assets for AAA-rated issuers and 8% for AA-rated issuers

Clearing, Settlement and Risk Management of IRD (Part 9)

• Risk Reduction Mode: Stock Exchanges / Clearing Corporation shall ensure that the stock brokers are mandatorily put in risk-reduction mode when a specific percent (currently 90%) of the stock broker’s collateral available for adjustment against margins gets utilized.
• Key Features of Risk Reduction Mode:
  • All unexecuted orders shall be cancelled once the stock broker breaches the 90 percent collateral utilization level.
  • Only orders with Immediate or Cancel attribute shall be permitted in this mode.
  • All new orders shall be checked for sufficiency of margins.
  • The stock-broker shall be moved back to the normal risk management mode when the collateral utilization level falls below a specified percentage (currently 85%).
• Margin Collection by Clearing Corporation:
  • The initial margin and extreme loss margins shall be payable upfront by the clearing members.
  • Clearing members shall provide for margin in any one or more of the eligible collateral modes.
  • Clearing members can deposit liquid assets in combination, within limits specified by the clearing corporation.
  • Clearing members shall ensure sufficient collateral is allocated to cover margin requirements for Trading Members, Custodian Participants, and Clients.
• Margins from Client:
  • Trading Members/Clearing Members should have a prudent risk management system to protect against client defaults.
  • Margins constitute an important element of risk management systems and must be well-documented and accessible to clients and Stock Exchanges.
  • In the Currency Derivatives segment, it is mandatory for Trading Members to collect initial margin and extreme loss margins from clients on an upfront basis.
• Mechanism for Regular Monitoring of and Penalty for Short Collection/Non-Collection of Margins:
  • Clearing Corporations shall send minimum four snapshots of client-wise margin requirements to Trading Members/Clearing Members for them to know the intraday margin requirement per client in each segment.
  • The client-wise margin file provided by the Clearing Corporations shall contain the EOD margin requirements and peak margin requirements of the client.
  • Trading Members/Clearing Members shall report the margin collected from each client, and the higher shortfall in collection of margin obligations shall be considered for levying penalties.

Clearing, Settlement and Risk Management of IRD (Part 10)

• Margin Calculation: The margin from clients in derivatives segments, including commodity derivatives, shall be calculated based on fixed BOD margin parameters.
• Margin Related Information: Stock Brokers should send margin related information to their clients, including:
  • Client code and name
  • Trade day (T)
  • Margin deposit available for the client on day T
  • Margin adjustments for day T
  • Margin status at the end of T day
• Daily Margin Statement: Such margin related information should be issued by Stock Brokers to clients on T-Day itself or by specified timelines.
• Client Collateral Records: Brokers should maintain proper records of client collateral, including:
  • Receipt of collateral from client and acknowledgement issued to client
  • Client authorization for deposit of collateral with the exchange/clearing corporation
  • Record of deposit of collateral with exchange/clearing corporation
  • Record of return of collateral to client
  • Credit of corporate action benefits to clients
• Risk Management System: Stock-Broker/Clearing Members should have a prudent risk management system to protect themselves against client defaults, with margins being an important element.
• Mechanism for Client Collateral: SEBI has issued measures to strengthen the mechanism of protection of client collateral, including:
  • Margin Pledge: Collateral from clients in the form of securities is allowed only by way of ‘margin pledge’ in the Depository system.
  • Demat Debit and Pledge Instruction (DDPI): For transfer of securities towards deliveries/settlement obligations and pledging/re-pledging of securities.
  • Framework for Upfront Collection of Margins: To enable uniform verification of upfront collection of margins from clients by TM/CM and levy of penalty across segments.
  • Segregation and Monitoring of Collateral: At the client level, with a reporting mechanism covering both cash and non-cash collateral.

Clearing, Settlement and Risk Management of IRD (Part 11)

• Margin Blocking: In case of a trade from a client's account, the margin shall be blocked from the client collateral. If the client collateral is not sufficient, the residual margin shall be blocked from the Trading Member's (TM) proprietary collateral, and if the TM proprietary collateral is also not sufficient, then the residual margin shall be blocked from the Clearing Member's (CM) proprietary collateral.
• Proprietary Account Trades: For trades from the proprietary account of a TM, the margin shall first be blocked from the TM proprietary collateral, and in case such collateral is not sufficient, then the residual margin shall be blocked from the CM proprietary collateral.
• CM Proprietary Account Trades: Margins based on trades from the proprietary account of the CM shall be blocked from the proprietary collateral of the CM only.
• CP Trades: In case of CP trades executed by TMs, the margin shall be blocked in the following order: (i) CP collateral through the executing TM, if any, (ii) residual margin from the proprietary collateral of the executing TM, and (iii) residual margin from the proprietary collateral of the CM of the executing TM.

Upstreaming of Clients' Funds

• Upstreaming: SEBI has decided to upstream all client funds received by Stock Brokers (SBs)/Clearing Members (CMs) to the Clearing Corporations (CCs) to safeguard clients' funds.
• Client Funds: No clients' funds shall be retained by SBs/CMs on an End of Day (EoD) basis. Clients' funds shall all be upstreamed by SB/CMs to CCs only in the form of either cash, lien on FDR, or pledge of units of Mutual Fund Overnight Schemes (MFOS) created out of client funds.

Trading Supported by Blocked Amount

• Blocked Amount: SEBI has introduced a supplementary process for trading in the secondary market based on blocked funds in an investor's bank account, instead of transferring them upfront to the trading member.
• UPI Block Facility: The said facility shall be provided by integrating the Reserve Bank of India (RBI) approved Unified Payments Interface (UPI) mandate service of single-block-and-multiple-debits with the secondary market trading and settlement process.

Core Settlement Guarantee Fund

• Definition: Every recognized clearing corporation shall establish and maintain a Fund, known as the Core Settlement Guarantee Fund (Core SGF), to guarantee the settlement of trades executed in each segment of a recognized stock exchange.
• Purpose: The Core SGF shall be utilized to complete the settlement in the event of a clearing member failing to honour their settlement obligations.
• Corpus: The corpus of the Core SGF shall be adequate to meet the settlement obligations arising on account of the failure of a clearing member(s).
• Contribution: Contributions to the Core SGF shall be made by the Clearing Corporation, Stock Exchange, and Clearing Members.
• Minimum Required Corpus (MRC): The MRC of the Core SGF shall be fixed for a month and reviewed by the 15th of every month based on the results of daily stress tests of the preceding month.

Clearing, Settlement and Risk Management of IRD (Part 12)

• Definition: The process of clearing, settlement, and risk management of Interest Rate Derivatives (IRD) is specified by SEBI from time to time.
• Details: The SEBI Circular Ref. No. SEBI/HO/MRD2/DCAP/CIR/P/2020/01 Dated January 03, 2020, provides guidelines for the same.

Access to Core SGF

• Definition: The Regulatory Oversight Committee (“ROC”) of the Clearing Corporation (CC) manages the Core Settlement Guarantee Fund (SGF).
• Details: The CC may utilize the Core SGF in the event of a failure of member(s) to honour settlement commitment.

Default Waterfall

• Definition: A default waterfall is a sequence of steps to be followed in the event of a default.
• Details: The default waterfall for IRD includes:
  • Monies of defaulting member
  • Insurance, if any
  • CC resources (equal to 5% of the segment Margin Requirement Corpus (MRC))
  • Core SGF of the segment
  • Proportion of remaining CC resources
  • CC/SE contribution to Core SGFs of other segments
  • Capped additional contribution by non-defaulting members
  • Any remaining loss to be covered by way of pro-rata haircut to pay-outs

Stress Testing and Back Testing

• Definition: Stress testing and back testing are methods used to measure, monitor, and manage credit exposures.
• Details: The CC should:
  • Carry out daily stress testing for credit risk using standardized stress testing methodology
  • Develop own scenarios for extreme but plausible market conditions
  • Conduct liquidity stress tests and ensure adequacy of liquidity arrangements
  • Perform reverse stress tests to identify market conditions that could lead to insufficient financial resources
  • Conduct back testing of margins collected vis-à-vis actual price changes
  • Continuously monitor the adequacy of financial resources against uncovered loss estimated by stress tests

Key Concepts

• Core SGF: A fund managed by the ROC to provide a safety net in the event of a default.
• Default Waterfall: A sequence of steps to be followed in the event of a default.
• Stress Testing: A method used to measure, monitor, and manage credit exposures.
• Back Testing: A method used to assess the appropriateness of margining models.
• Liquidity Stress Test: A test to ensure the adequacy of liquidity arrangements.
• Reverse Stress Test: A test to identify market conditions that could lead to insufficient financial resources.