Risk containment measures, position limits and the broad eligibility criteria of Stocks and Index on which futures and options could be introduced. - SEBI - SEBI/DNPD/Cir-26/2004/07/16

DEPUTY GENERAL MANAGER SEBI/DNPD/Cir-26/2004/07/16 July 16, 2004 To, The Managing Director / Executive Director of Derivative Segment of NSE BSE and their Clearing House / Corporation. Dear Sir, Sub: Risk containment measures, position limits and the broad eligibility criteria of Stocks and Index on which futures and options could be introduced. This circular is being issued in exercise of powers conferred by section 11 (1) of the Securities and Exchange Board of India Act, 1992, read with section 10 of the Securities Contracts(regulation) Act 1956, to protect the interests of investors in securities and to promote the development of, and to regulate the securities market. This circular is in continuation of SEBI Circular No. IES/DC/CIR-4/99 dated July 28, 1999, Circular No. IES/DC/CIR-5/00 dated December 11, 2000, Circular No. SMDRP/DC/Cir-7/01 dated June 20, 2001, SEBI Circular No. SMDRP/DC/Cir-10/01 dated November 2, 2001, Circular No. SMDRP/DC/CIR 13/02 dated December 18, 2002, Circular No SEBI/SMDRP/DC/CIR-16/2003/04/19 dated April 19, 2003 and SEBI/SMDRP/DC/Cir-18/2004/01/05 dated January 5, 2004 for exchange traded Index Futures, Index Option, Stock Option, Stock Futures and Interest Rate Derivative Contracts issued to Derivative Exchange / Segment and their Clearing House / Corporation (hereinafter collectively referred to as Exchange). The existing eligibility criteria for stocks and indices, the position limits and the risk containment measures in the derivative markets were reviewed by the Advisory Committee on Derivatives and Market Risk Management (Advisory Committee). Based on the recommendations of the Advisory Committee, considered and approved by the SEBI Board, the eligibility criteria, the position limits and the risk containment measures in the derivative markets stand modified in the following manner. I. ELIGIBILITY CRITERIA OF STOCKS Clause I(1) and Clause I(5) of Circular No.SMDRP/DC/CIR-13/02 dated December 18, 2002 on the eligibility criteria of stocks and indices stand modified in the following manner:- 1. A stock on which stock option and single stock future contracts are proposed to be introduced shall conform to the following broad eligibility criteria:- The stock shall be chosen from amongst the top 500 stock in terms of average daily market capitalisation and average daily traded value in the previous six month on a rolling basis. The stock s median quarter-sigma order size over the last six months shall be not less than ₹ 1 Lakh (Rupees One Lakh). For this purpose, a stock s quarter-sigma order size shall mean the order size (in value terms) required to cause a change in the stock price equal to one-quarter of a standard deviation. The market wide position limit in the stock shall not be less than ₹ 50 crores (Rupees Fifty crores). Since market wide position limit for a stock is computed at the end of every month, the Exchange shall ensure that stocks comply with this criterion before introduction of new contracts. Further, the market wide position limit (which is in number of shares) shall be valued taking the closing prices of stocks in the underlying cash market on the date of expiry of contract in the month. The procedure for introducing and dropping stocks on which option and future contracts are traded shall continue to be in the manner specified in Circular No. SMDRP/DC/CIR-13/02 dated December 18, 2002. 2. The Exchange may consider introducing derivative contracts on an index if 80% of the index constituents are individually eligible for derivatives trading. However, no single ineligible stock in the index shall have a weightage of more than 5% in the index. The index on which futures and options contracts are permitted shall be required to comply with the eligibility criteria on a continuous basis. The Exchange shall check whether the index continues to meet the aforesaid eligibility criteria on a monthly basis. If the index fails to meet the eligibility criteria for three months consecutively, then no fresh month contract shall be issued on that index. However, the existing unexpired contracts shall be permitted to trade till expiry and new strikes may also be introduced in the existing contracts. II. RISK CONTAINMENT MEASURES The following risk containment measures are being specified in addition to those prescribed by SEBI from time to time. 1. Collection of Mark to Market Margin/Settlement It had been specified that if mark to market margin / settlements (MTM) for derivative contracts is not collected before the start of the next day s trading, the Exchange is required to collect correspondingly higher initial margins to cover the potential for losses over the time elapsed in the collection of MTM. Henceforth, the Exchange may offer a choice to the members to opt for payment of MTM i) either before the start of trading the next day i.e. T+0, or ii) on the next day i.e. T+1. If the member opts for payment of MTM by T+1, then correspondingly higher initial margin shall be collected, in the manner specified vide SEBI circular Ref. No. IES/DC/CIR-4/99 dated July 28, 1999 and circular Ref. No. SMDRP/DC/CIR- 10/01 dated November 2, 2001, to cover the potential for losses over the time elapsed in the collection of MTM. 2. It is clarified that for stocks which have a mean value of impact cost greater than 1%, in addition to the price scanning range, the minimum initial margin for single stock futures contracts and the short option minimum charge for stock option contracts shall also be scaled up by square root of three. 3. Liquid assets of Clearing Member Circular No-IES/DC/CIR-4/99 dated July 28, 1999 specifies the composition of liquid assets of a clearing member. In order to align the collateral requirements in the cash market and the derivative market, the following modifications in components of liquid asset are specifiedi) Cash equivalent component of liquid assets:- Units of money market mutual funds and units of gilt funds may be accepted towards cash equivalent component of the liquid assets of a clearing member. The unit shall be valued on the basis of its Net Asset Value after applying a hair cut of 10% on the NAV and any exit load charged by the mutual fund. The valuation or the marking to market of such units shall be carried out on a daily basis. ii) Securities component of liquid assets:- Clause 4 (v) (B) of Circular No. IES/DC/CIR-4/99 dated July 28, 1999 stands modified by this present circular in the following manner. a. Equity securities classified under Group I in the underlying cash market (as specified in SEBI Circular No.SMD/POLICY/CIR-9/2003 dated March 11, 2003) may be accepted towards liquid assets in the derivative markets. Securities classified under Group I shall be those which have traded atleast 80% (+/-5%) of the days for the previous eighteen months and which have a mean impact cost of less than or equal to 1%, for an order size of ₹ 1 Lakh. The equity securities shall be valued / marked to market on a daily basis after applying a haircut equivalent to the respective VAR of the equity security. The list of acceptable equity securities shall be updated on the basis of trading and mean impact cost on the 15th of each month. When a security is dropped from the list of acceptable equity securities, the existing deposits of that security shall continue to be counted towards liquid assets till the end of the month. b. Units of all mutual funds may also be accepted as the securities component of liquid assets. The unit shall be valued on the basis of its Net Asset Value (NAV) after applying a hair cut equivalent to the VAR of the units NAV and any exit load charged by the mutual fund. The valuation or the marking to market of such units shall be carried out on a daily basis. iii) The valuation / marking to market of all securities, including debt securities, dated government securities and T-bills, shall be carried out daily, with appropriate haircuts, specified vide SEBI circular Ref.No.IES/DC/CIR-4/99 dated July 28, 1999. 4. Position Limits i) Market wide position limits for single stock futures and stock option contracts Clause 6 H of Circular No-SMDRP/DC/CIR-7/01 dated June 20, 2001 and Clause 7 F of Circular No-SMDRP/DC/CIR-10/01 dated November 02, 2001 on Market wide position limits on Single Stock Derivative Contracts stand modified in the following manner: The market wide limit of open position (in terms of the number of underlying stock) on futures and option contracts on a particular underlying stock shall be lower of- - 30 times the average number of shares traded daily, during the previous calendar month, in the relevant underlying security in the underlying segment, Or - 20% of the number of shares held by non-promoters in the relevant underlying security i.e. free-float holding. This limit would be applicable on all open positions in all futures and option contracts on a particular underlying stock. The requirement for doubling the price scan range and volatility scan range, when the total open interest in a contract reaches 80% of the market wide limit in that contract, stands revoked. The Exchange is advised to enforce the market wide limits through administrative measures, in the manner detailed below: a. At the end of each day the Exchange shall test whether the market wide open interest for any scrip exceeds 95% of the market wide position limit for that scrip. If so, the Exchange shall take note of open position of all client/ TMs as at the end of that day in that scrip, and from next day onwards the members/ client shall trade only to decrease their positions through offsetting positions. While the Exchange will take this action only at end of day, they shall disclose real time information about the market wide open interest as a percentage of the market wide position limits. b. At the end of each day during which the ban on fresh positions is in force for any scrip, the Exchange shall test whether any member or client has increased his existing positions or has created a new position in that scrip. If so, that client shall be subject to a penalty equal to a specified percentage (or basis points) of the increase in the position (in terms of notional value). The penalty shall be recovered before trading begins next day. The Exchange shall specify the percentage or basis points, which shall be set high enough to deter violations of the ban on increasing positions. c. The normal trading in the scrip shall be resumed after the open outstanding position comes down to 80% or below of the market wide position limit. Further, the Exchange shall check on a monthly basis, whether a stock has remained subject to the ban on new position for a significant part of the month consistently for three months. If so, then the Exchange shall phase out derivative contracts on that underlying. The procedure for dropping stocks on which option and future contracts are traded shall be in the manner specified in Clause (3) of Circular No. SMDRP/DC/CIR-13/02 dated December 18, 2002. ii) Trading member position limits in index derivative contracts Clause 5 (ii) of Circular No-IES/DC/CIR-4/99 dated July 28, 1999 and Clause 7 H of Circular No-IES/DC/CIR-5/00 dated December 11, 2000 on trading member position limits in equity index derivative contracts stand modified in the following manner a. Trading Member Position limits in equity index option contracts: The trading member position limits in equity index option contracts shall be higher of: - ₹ 250 Crore or - 15% of the total open interest in the market in equity index option contracts. This limit would be applicable on open positions in all option contracts on a particular underlying index. b. Trading Member Position limits in equity index futures contracts: The trading member position limits in equity index futures contracts shall be higher of: - ₹ 250 Crore or - 15% of the total open interest in the market in equity index futures contracts. This limit would be applicable on open positions in all futures contracts on a particular underlying index. iii) Trading Member position limits in exchange traded interest rate derivative contracts Clause II( F) of Circular No-SEBI/SMDRP/DC/Cir-16/2003/04/19 dated April 19, 2003 and clause II of the Circular No-SEBI/SMDRP/DC/Cir-18/2004/01/05 dated January 5, 2004 on position limits in exchange traded interest rate derivative contracts stand modified as under Trading member position limit in exchange traded interest rate derivative contracts shall be higher of: - ₹ 500 Crore or - 15 % of the total open interest in the market in exchange traded interest rate derivative contracts. The Exchange shall implement the provisions of this circular w.e.f September 1, 2004. Yours faithfully, V.S.SUNDARESAN