Clearing, Settlement and Risk Management — novation, position limits, margins and the default waterfall

Where this chapter sits

Chapter 7 carries 10% of the paper. It is the heaviest chapter for numbers — position limits, margin percentages, spread charges and waterfall percentages all sit here.

Three things dominate: the position limit tables, the margin structure, and the default waterfall.

Introduction

The Clearing Corporation registered with SEBI is responsible for the clearing and settlement of all trades executed in Exchange-Traded Currency Derivatives. Clearing Corporation acts as a legal counterparty to all trades in the Currency Derivatives Segment of the Exchange and also guarantees their financial settlement.

The Clearing and Settlement process comprises of three main activities, viz., Clearing, Settlement and Risk Management. They are undertaken by the Clearing Corporation with the help of Clearing Members and Clearing Banks.

7.1 The mechanism

Clearing is the process of determining the obligations, after which the obligations are discharged by settlement.

A multilateral netting procedure is adopted to determine the net settlement obligations (delivery/receipt positions) of the clearing members.

Settlement is a two-way process which involves the transfer of funds and securities on the settlement date.

Pay-In is a process whereby a Clearing Member brings in money and/or securities to the Clearing House/Corporation. This forms the first phase of the settlement activity.

Pay-Out is a process where the Clearing House/Corporation pays money or delivers securities to the Clearing Member. This is the second phase of the settlement activity.

The timelines: the daily settlement of Exchange-Traded Currency Derivatives (ETCD) trades is done on a T+1 working day basis while the final settlement is done on a T+2 basis. The final settlement date is T+2 day from the last trading day of the contract.

And the timing within the day: the funds pay-in and pay-out of daily mark-to-market settlement, final settlement of futures contracts, premium settlement and the final exercise settlement of options contracts are typically effected before the start of market hours on the settlement day.

7.2 The entities

Clearing corporation

Defined by the Securities Contract (Regulation) (Stock Exchange and Clearing Corporations) Regulations 2018 as an entity that is established to undertake the activity of clearing and settlement of trades in securities or other instruments or products that are dealt with or traded on a recognized stock exchange and includes a clearing house and a limited purpose clearing corporation.

It acts as a central counterparty i.e., it provides financial guarantees for all transactions executed on the Exchange. It acts as a legal counterparty to all trades through the process called novation. Thus, the Clearing Corporation becomes the buyer to every seller and seller to every buyer.

Its work: the clearing corporation determines fund/security obligations and arranges for pay-in of the same. It collects and maintains margins, processes for shortages in funds and securities.

The three clearing members

Trading cum Self-clearing member: They have trading as well clearing rights. They clear and settle trades executed solely by themselves, either on their own account or on account of their clients but not for custodial participants.

Trading member–cum–clearing member: They have trading as well clearing rights. They clear and settle their own trades as well as trades of other trading members and custodial participants.

Professional clearing member: They have only clearing rights and do not have trading rights. They clear and settle trades executed by trading members and custodial participants. SEBI registered custodians and banks recognized by clearing corporations are eligible to become PCM.

Note the SCM's limitation — it cannot clear for custodial participants.

Clearing Members perform the following important functions: Clearing: Computing obligations of all their trading members · Settlement: Performing actual settlement · Risk Management: Setting position limits based on upfront deposits/margins for each trading member/client and monitoring positions on a continuous basis · Confirmation of the trades of custodial participants.

Clearing banks

Clearing Bank(s) acts as an important intermediary between a clearing member(s) and the clearing corporation. Every clearing member needs to maintain an account with any of the empaneled clearing banks at the designated clearing bank branches. The clearing accounts are to be used exclusively for clearing & settlement operations.

How the flow works: the pay-in obligation details are passed on to the clearing banks by clearing corporation, who then debit the clearing member account and based on pay-out instruction from clearing corporation the clearing bank credits the receiving member's clearing account.

Depositories

A "Depository" is an entity facilitating holding of securities in electronic form and enables transfer of securities by book entry.

And in this segment its role is narrow: in Exchange-Traded Currency Derivatives (ETCD), the role of the depository and DPs is mainly limited to the pledge and re-pledge of securities as collateral towards margin.

7.3 Interoperability

Inter-operability among Clearing Corporations (CC) has enabled a Clearing Member to select the Clearing Corporation of its choice to clear and settle trades executed in multiple exchanges. It allows market participants to consolidate their clearing and settlement functions at a single Clearing Corporation, irrespective of the stock exchange on which the trade is executed.

Its scope: the interoperability framework is applicable to all the recognised clearing corporations excluding those operating in International Financial Services Centre (IFSC) and all the products available for trading on stock exchanges, except commodity derivatives... Hence, interoperability is also applicable to the Currency Derivatives Segment.

Commodity derivatives are the one exclusion.

How it is built: the recognised clearing corporations are required to establish a peer-to-peer link for ensuring interoperability. A clearing corporation must maintain special arrangements with another clearing corporation and is not subjected to the normal participant (membership) rules.

And how the risk between them is covered: Clearing Corporations must maintain sufficient collateral with each other so that any default by one Clearing Corporation, in an interoperable arrangement, would be covered without any financial loss to the other non-defaulting Clearing Corporation.

The inter-Clearing Corporation collateral comprises two components, viz. (a) Margins as per the existing Risk Management Framework (initial margin, extreme loss margin, calendar spread margin, etc.) prescribed by SEBI; and (b) Additional capital, to be determined by each Clearing Corporation, based on the credit risk from the linked Clearing Corporation, on which no exposure is granted to the linked Clearing Corporation.

The benefits: choice to participants to choose the clearing corporation · better capital utilization · reduced trading disruption · reduced aggregate exposure · reduced operational complexity · enhanced market competition and lower cost of clearing · execution risk can be decoupled from settlement risk as there can be an 'arm's length' relationship between the exchange and adjunct clearing corporation.

7.4 The clearing mechanism — and the netting rule

The open positions of Clearing Members (CMs) are arrived at by aggregating the open positions of all the TMs and all custodial participants clearing through him. A TM's open position is arrived at as the summation of his proprietary open position and clients' open positions.

Proprietary positions are calculated on net basis (buy - sell) for each contract. Clients' positions are arrived at by summing together net (buy - sell) positions of each individual client.

And the crucial rule: positions are only netted for each client at the contract level and not netted across clients but are rather added up across clients.

A TM's open position is the sum of proprietary open positions, client open long positions and client open short positions.

The workbook's worked illustration. For trading member PQR in EURINR futures, the proprietary book is net (1000) short while client 1 is net 1000 long. These do not cancel:

While computing the open position of PQR, the long position of client 1 was not netted off against the short position of the proprietary book for EURINR futures. Further there is no netting between the long position in USDINR Futures and the short position in EURINR futures within the proprietary book.

So PQR shows Long 1000 and Short 1000 in EURINR simultaneously.

And the same discipline runs upward: similarly, no netting is allowed to clearing members for counter positions of trading members. The positions are summed up to compute the open position of clearing member A.

Hence, clearing member A's overall open position in March USDINR Futures is long 3000 and short 3000 lots while the open position in March EURINR futures is long 2000 and short 3000 lots.

Contracts are distinguished by futures and option, underlying instrument, expiry date, option type, strike price.

7.5 Settlement obligations

Custodial participants (CP) are those clients who are eligible for trading through multiple trading members and clearing and settling deals through single clearing member.

They register through their clearing member and avail a unique code (custodial participant code) which is linked to their clearing member. The trading member needs to enter the custodial participant code at the time of order entry.

And confirmation determines whose obligation it is: all trades which have been confirmed by clearing members are part of the obligations of clearing members concerned... Trades which have not been confirmed by clearing members of the custodial participants are considered as trades pertaining to the trading members entering such trades.

The five methods of determining obligations:

a) Daily mark to market settlement of futures contract — all open positions are marked to market at the settlement prices to determine mark-to-market obligations to be settled in cash. All open positions are carried forward at the latest daily settlement prices.

b) Final settlement for futures contract — all positions (brought forward, created during the day, closed out during the day)... at the close of trading hours on the last trading day of the contract, are marked to market at the final settlement price.

c) Premium settlement for option contracts — cash-settled by debit/credit of the clearing accounts... computed after netting the premium payable or receivable positions at the trading member/Custodial Participant level, for each option contract, at the end of each trading day.

d) Exercise settlement for option contracts — all in-the-money contracts are exercised automatically and are randomly assigned to short positions in option contracts with the same series.

e) Netted obligation — funds obligation is generated on a netted basis considering the obligations of a clearing member in the ETCD... and ETIRD (Exchange-Traded Interest Rate Derivatives) segments as both are part of the Currency Derivatives Segment.

7.6 Position limits

In order to avoid build-up of huge open positions, the regulator has specified the maximum allowable position limit at client level, member level, currency level etc.

A. Trading Members (banks and non-banks), DIIs, AD Cat-I banks, FPI Cat I & II (other than individuals, family offices and corporates)

And a special case: for Bank trading members as authorized by RBI: Gross open position across all contracts shall not exceed 15% of the total open interest or USD 1 billion, whichever is higher.

B. Domestic clients, NRIs and FPI Cat II (individuals, family offices and corporates)

C. Proprietary positions for a stock broker (other than a bank)

D. Consolidated proprietary limit across FCY-INR pairs

Single INR limit for proprietary position for bank stock brokers: Higher of 15% of total OI across all FCY-INR pairs or USD 200 million

Single INR limit for proprietary position for non-bank stock brokers: Higher of 15% of total OI across all FCY-INR pairs or USD 100 million

E. The single limit across currencies

Users may take positions (long or short), up to a single limit of USD 100 million equivalent across all currency pairs involving INR, put together, and combined across all exchanges.

Beyond that, a designation is required: exchanges... shall provide facility to users, intending to take position beyond USD 100 million (or equivalent) in contracts involving INR in all exchanges put together, to designate an Authorised Dealer/Custodian.

And the exchanges then report to that entity: the exchanges shall provide information on day-end open positions as well as intra-day highest position of the user to the designated Authorised Dealer/Custodian.

The responsibility is the user's: the onus of complying with the directions shall rest with the user. In case of any contravention, the user shall render itself liable to any action under the Foreign Exchange Management Act (FEMA), 1999.

F. Other guidelines

The previous day's open interest at the respective exchanges is considered for the purpose of computation of position limits.

The position limit linked to open interest is applicable at the time of opening a position. Such positions need not be unwound immediately in the event of a drop of total open interest.

However... the eligible market participants are not allowed to increase their existing positions or create new positions till they comply with the applicable position limits.

And the exchange retains a power: in view of risk management or surveillance concerns... stock exchanges may direct the market participants to bring down their positions to comply with the applicable position limits within the time period prescribed.

No separate position limit is prescribed at the level of clearing member. However, the clearing member must ensure that his own trading position and the positions of each trading member clearing through him are within the limits specified above.

The long/short convention for client gross open positions: long futures, long calls; and short puts are treated as long positions and short futures, short calls, and long puts are considered as short positions.

And conversion: the exchange provides the conversion ratio on a quarterly basis for the conversion to USD 100 million equivalent.

Monitoring

The position limits are always specified in number of lots.

The workbook's worked example. With total open interest of 4 million contracts in Exchange "A" and 0.5 million contracts in Exchange "B":

Category A on Exchange A: 15% of 4 million contract = 0.6 million contracts versus 0.10 million contracts (USD100 million = 0.10 million contracts as 1 contract =1000 USD) → Position limit = 0.60 million contracts i.e. 600 million USD.

Category A on Exchange B: 15% of 0.5 million contracts = 0.075 million versus 0.10 million contracts → Position limit = 0.10 million contracts i.e. 100 million USD.

Category B on Exchange A: 6% of 4 million contract = 0.24 million contracts versus 0.02 million contracts → Position limit = 0.24 million contracts i.e. 240 million USD.

Category B on Exchange B: 6% of 0.5 million contracts = 0.03 million versus 0.02 million → Position limit = 0.03 million contracts i.e. 30 million USD.

The percentage wins on a deep market; the absolute floor wins on a thin one.

On violations: when the open position of any trading member/client, exceeds the specified limit at any time, it is treated as a violation. The clearing member is accountable for the positions of all trading members and clients of trading members clearing through him.

The consequences: the Trading Member is restrained from taking any further positions in the contract in which there is a violation · the Trading member may use the existing close-out facility · a penalty can be levied for such violations.

7.7 Settlement

Currently all Exchange-Traded Currency Derivatives contracts are cash settled in Indian Rupees.

On what physical settlement would have meant: if USDINR future is physically settled, then buyer will pay INR and receive USD and seller will pay USD and receive INR on expiry. And physical settlement does not mean that every sell trade during contract's life results in physical delivery. The seller can always close ("square up") his position with an offsetting buy trade, but it must be done before the close of business on the last trading day.

Settlement prices

Daily MTM

All positions... at the close of trading hours on a day, are marked to market at the daily settlement price... and settled in cash. The settlement is done by debit/credit of the clearing accounts of clearing members with the respective clearing bank on T+1.

The workbook's worked table for a participant short 1 lot of USDINR futures @ Rs. 74.90 held to expiry shows daily spreads of +0.2075, +0.0700, −0.2200, −0.0125, +0.0350, −0.0250, +0.0783, with Net Effect 0.1333 and 133.30 rupees per contract.

Note how each day's sell price becomes the previous day's settlement price — all open positions are carried forward at the latest daily settlement prices.

For cross currency contracts: positions... are marked to market at the daily settlement price and the profit is arrived at in the quote currency. However, the settlement is in cash in Indian Rupee (INR).

To arrive at the settlement value of cross currency positions in INR for EUR-USD and GBP-USD contracts, the latest available FBIL reference rate for USD-INR is used. For USD-JPY contracts, the settlement value in INR is arrived at using the latest available exchange rate published by FBIL for JPY-INR.

Premium settlement

Premium... is settled in cash by debit/credit of the clearing accounts of clearing members with the respective clearing bank on T+1.

And a crucial difference from futures: the variation in premium is adjusted against the collateral placed and not settled in cash. Thus, unlike currency futures, there is no mark-to-market cash settlement of the changes in the premium value of the open option positions.

Final settlement

For futures: all positions at the close of trading hours on the last trading day of the contract, are marked to market at the final settlement price... and settled in cash on T+2 day. Open positions in a futures contract cease to exist after its expiration day.

For options: on the expiry date, all open long in-the-money contracts are automatically exercised at the final settlement price and randomly assigned to the open short positions of the same strike and series. Exercise settlement takes place in cash on T+2 day.

7.8 Funds settlement

Every clearing member is required to maintain and operate a separate and distinct primary clearing account for each segment with one of the designated clearing banks.

Clearing members can deposit funds into these accounts in any form and can withdraw funds from these accounts only in their own name.

On shortages: non-fulfilment of obligations towards settlement of contracts... by the scheduled date and time is treated as a violation. In the case of a settlement shortage, in additional to monetary penalty, the clearing corporation may advise the exchanges to withdraw any or all of the membership rights of the clearing member.

Running account settlement

With a view to prevent any misuse of a client's funds by the broker, SEBI has made it mandatory for brokers to settle the running account of client funds on a monthly or quarterly basis as per the mandate of the client.

And exchanges publish the dates: Stock exchanges shall, jointly, issue the annual calendar for the settlement of running account (quarterly and monthly) at the beginning of the financial year.

A special rule for dormant credit balances: for the clients having credit balance, who have not done any transaction in the 30 calendar days since the last transaction... 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 (irrespective of settlement cycle preferred by the client).

But if he returns to trading: if the client trades after 30 calendar days and before aforesaid upcoming settlement dates... the settlement of account of client shall continue to be done... as per the preference of quarterly/monthly as indicated by the client.

7.9 Risk management

A clearing corporation provides a settlement guarantee i.e., it ensures that the settlement of securities and funds takes place even if there is a failure by a broker/clearing member to fulfill their obligation.

The Risk Management framework mainly consists of the margins, liquid assets, base minimum capital, pre-trade risk controls, risk reduction mode, monitoring of position limits etc.

Salient features of the Clearing Corporation Risk Management System:

On-line real time risk management — including online monitoring of margins against liquid assets and on-line position limit monitoring Use of different kind of margins to cover all kinds of losses Intra-day and end of day mark-to-market margins Client-level margining Alerts to members on various levels of collateral utilization Risk reduction mode Automatic disablement from trading when limits are breached Cross margining facility Capital adequacy requirements for members Monitoring of member performance and track record

And the seven-point containment mechanism, of which these matter most:

The financial soundness of the members is the key to risk management. Therefore, the requirements for membership in terms of capital adequacy (net worth, security deposits) are quite stringent.

Upfront initial margin & extreme loss margin (ELM) are charged for all the open positions of a Clearing Member... It also follows a value-at-risk (VaR) based margining through SPAN® (Standard Portfolio Analysis of Risk).

The open positions of the members are marked to market based on the settlement price for each contract. The difference is settled in cash on a T+1 basis for futures contracts while it is adjusted against liquid assets in the case of option contracts.

Margin violations result in the withdrawal of the trading facility for all Trading Members of a Clearing Member in the case of a violation by the Clearing Member.

Separate settlement guarantee funds for this segment have been created by the clearing corporation.

7.9.1 Margins

Margining is a process by which a clearing corporation computes the potential loss that can occur to the open positions (both buy and sell) held by the members across all its clients.

And the netting rule again: the clearing corporation computes margins at the client-level positions and there is no netting of positions between clients/member etc.

Initial margin

Initial margin is payable on all open positions of clearing members, up to client level and is payable upfront by Clearing Members.

It includes SPAN margins, margin on consolidated crystallized obligations, delivery margins and such other additional margins.

The aggregation rule:

For client positions - It is netted at the level of individual client and grossed across all clients, at the trading/clearing member level, without any set-offs between clients. For proprietary positions - It is netted at the trading/clearing member level without any set-offs between client and proprietary positions.

The margins so computed are aggregated first at the trading member level and then aggregated at the clearing member level.

SPAN

The clearing corporations have adopted the SPAN system for the purpose of real-time initial margin computation. It is a product developed by Chicago Mercantile Exchange (CME) and uses scenario-based approach to arrive at margins. It generates a range of scenarios and highest loss scenario is used to calculate the SPAN margin.

Initial Margin requirement is based on a worst-case scenario loss of a portfolio of an individual client comprising his positions in options and futures contracts on the same underlying asset across different maturities and across various scenarios of price and volatility changes.

Initial margin requirements are based on 99% value at risk (VaR) over a one-day horizon.

With a futures exception: in the case of futures contracts, where it may not be possible to collect mark-to-market settlement before the commencement of trading on the next day, the initial margin is computed over a two-day horizon.

SPAN margining uses VaR to compute the initial margin but improves upon it with two modifications. It generates 16 "what-if" scenarios. The second and more important feature of SPAN margin is that it considers the entire portfolio of an investor for computing the portfolio-wide margin. The margin is not computed for each position separately.

Price Scan Range — the probable price change over a one-day period, based on 6σ subject to minimum percentage of underlying price:

Volatility is calculated using the Exponential Weighted Moving Average (EWMA), with the value of λ... currently fixed at 0.995.

Volatility Scan Range — for currency derivatives, the volatility scan range for generating the scenarios is fixed at 25% of annualized EWMA volatility subject to a minimum of 3%.

Updation: the parameters for computation of span margin are updated based on the prices at 11:00 a.m., 12:30 p.m., 2:00 p.m., 3:30 p.m., 5:00 p.m., 6:30 p.m., end of the day and begin of the day.

Net Option Value

Net Option Value is computed as the difference between the long option positions and the short option positions, valued at the last available closing price of the option contract... The Net Option Value is added to the Liquid Net Worth of the clearing member. Thus, mark-to-market gains and losses for options positions are not settled in cash.

Calendar spread charge

A futures position in one expiry month which is hedged by an offsetting position in a different expiry month is treated as a calendar spread.

For options: the margins for options calendar spread are the same as specified for futures calendar spread. The margins for option calendar spread are calculated on the basis of delta of the portfolio in each month.

And the benefit ends when the near leg does: the benefit for a calendar spread continues till the expiry of the near month contract.

Margin on consolidated crystallized obligation

On intraday basis it covers premium payable/receivable and futures crystallized profit or loss (calculated based on weighted average prices of trades executed).

At end-of-day it covers 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.

If the overall amount at the client level is payable, such amount is treated as the... consolidated crystallized obligation margin for the client. And it is released on the completion of settlement.

It replaced four earlier margins: the margin on consolidated crystallized obligations has replaced the net buy premium, intraday crystallized losses, assignment margin and futures final settlement margin levied.

For cross currency contracts, margins are collected in INR using the RBI reference rate of the previous day for USD-INR or JPY-INR, as applicable... till 02:00 p.m. and the latest available FBIL reference rate... post 02:00 p.m.

7.9.1.2 Extreme Loss Margin

Three notes:

In the case of calendar spread positions in currency futures contracts, extreme loss margin is levied on one third of the mark-to-market value of the open position of the far month contract.

The applicable extreme loss margin for futures is calculated on the mark-to-market value of the gross open positions.

The extreme loss margin for options is calculated on the notional value of the open short option position.

And the same client-gross, proprietary-net aggregation rule applies as for initial margin.

Additional margin

Exchanges/Clearing Corporations have the right to impose additional risk containment measures over and above the risk containment system mandated by SEBI.

7.9.2 Liquid assets and liquid net worth

Clearing member may deposit liquid assets in the form of cash, bank guarantees, fixed deposit receipts, approved securities and any other form of collateral.

Cash component includes cash, bank guarantees, fixed deposit receipts, units of money market mutual funds, Gilt funds, Government of India Securities. Non-cash component includes all other forms of collateral deposits like deposit of approved list of demat securities, units of the other mutual funds.

The 50% rule: the cash component must be at least 50% of the total liquid assets. This implies that the non-cash component in excess of the total cash component is not regarded as a part of liquid assets.

Haircuts:

Two restrictions worth noting: the clearing corporation does not accept Fixed Deposit Receipts (FDRs) from trading/clearing members as collateral, if these are issued by the trading/clearing member themselves or banks who are an associate. And only FPIs are permitted to offer foreign sovereign securities with AAA ratings.

Liquid Networth is computed as liquid assets less initial margin and extreme loss margin payable at any point in time.

And the floor: currently every clearing member in the Currency Derivatives segment is required to maintain a minimum liquid networth of Rs.50 lakhs.

7.9.3 Risk reduction mode

Stock brokers are mandatorily put in risk-reduction mode when a specific percent (currently 90%) of the stock broker's/clearing member collateral available for adjustment against margins gets utilized.

It applies at the level of the trading members as well as clearing members, and includes:

All unexecuted orders are cancelled once a stock broker breaches 90 percent collateral utilization level. Only orders with Immediate or Cancel attribute are permitted in this mode. All new orders are checked for sufficiency of margins. Fresh orders placed by members to reduce the open position are accepted, but orders that will result in an increase in the position are checked for the sufficiency of margin. Orders that are not supported by adequate margins are rejected. The stock-broker is moved back to the normal risk management mode only when the percentage of utilized collateral is lower than the utilization level specified by the clearing corporation from time to time (currently 85%).

Note the hysteresis — in at 90%, out only below 85%.

Additionally, when the member is in risk reduction mode: the member is not allowed to place orders with custodial participant code. Modification of Client and Custodial Participant code is not permitted.

7.10 Margin collection

The initial margin and extreme loss margins are payable upfront by the clearing members. Clearing/Trading members are required to collect initial margins and extreme loss margins from their client/constituents on an upfront basis.

The client-side timelines: it is mandatory for trading members to collect initial margin and extreme loss margins from their client on an upfront basis. It must be ensured that all upfront margins are collected in advance of trade. Margin on consolidated crystallized obligation must be collected from clients by T+1 day. The Trading Members/Clearing Members must report the actual short-collection/non-collection of all margins from clients to the Stock Exchange on T+5 day.

The penalties: all instances of non-reporting are regarded as 100% short collection and the applicable penalty in respect of short collection is charged. And for false reporting: the member is penalized to the extent of 100% of the falsely reported amount along with suspension of trading for 1 day in that segment.

Daily margin statements must include client code and name, Trade day (T) · margin deposit available for the client on day T (with break-up in terms of cash, FDRs, BGs and pledged/re-pledged securities) · margin adjustments (including MTM losses) for day T · margin status (balance with the member/due from the client) at the end of T day — issued on T-Day itself or within the specified timelines.

Client collateral

Collateral from clients in the form of securities is allowed only by way of 'margin pledge', created in the Depository system.

And a prohibition: an off-market transfer of securities leads to change in ownership and shall not be treated as pledge. Transfer of securities to the demat account of the TM/CM for margin purposes (i.e., title transfer collateral arrangements) is prohibited.

The chain: a client shall pledge securities with TM, and TM shall re-pledge the same with CM, and CM in turn shall re-pledge the same to Clearing Corporation (CC). The complete trail of such re-pledge shall be reflected in the de-mat account of the pledgor.

Held in a dedicated account: the TM/CM shall open a separate demat account for accepting such margin pledge, which shall be tagged as 'Client Securities Margin Pledge Account'.

And ring-fenced: the TM and CM shall ensure that the client's securities re-pledged to the CC shall be available to give exposure limit to that client only.

The blocking order under segregation of collateral: on receipt of a trade from a client account by the CC, the margin shall first be blocked from the value of the client collateral. If the client collateral is not sufficient, the residual margin shall be blocked from the TM proprietary collateral of the TM of such client. If the TM proprietary collateral is also not sufficient, then the residual margin shall be blocked from the CM proprietary collateral.

Client → TM proprietary → CM proprietary.

And for a CM's own trades: margins based on trades from proprietary account of the CM shall be blocked from the proprietary collateral of the CM only.

7.11 Core Settlement Guarantee Fund

Every recognized clearing corporation shall establish and maintain a Fund... for each segment, to guarantee the settlement of trades, and in the event of a clearing member failing to honour his settlement obligations, the Fund shall be utilized to complete the settlement.

The corpus... shall be adequate to meet the settlement obligations arising on account of failure of clearing member(s), and the sufficiency of the corpus of the Fund shall be tested by way of periodic stress tests.

There is a separate Core Settlement Guarantee Fund for Currency Derivatives Segment.

Minimum Required Corpus (MRC):

The MRC shall be fixed for a month. By 15th of every month, CC shall review and determine the MRC for next month based on the results of daily stress tests of the preceding month. For every day of the preceding month, uncovered loss numbers shall be estimated by the various stress tests for credit risk... and the highest of such numbers shall be taken as worst-case loss number for the day. Average of all the daily worst case loss numbers... shall be calculated. The MRC for next month shall be higher of the average arrived at... and the segment MRC as per previous review.

The contributions:

a) Clearing Corporation Contribution: CC contribution to Core SGF shall be at least 50 percent of the MRC which should be from its own funds. b) Stock Exchange Contribution: Stock Exchange contribution to Core SGF shall be at least 25 percent of the MRC. c) Clearing Member Primary Contribution: The total contribution from members to core SGF for each segment will not be more than 25% of MRC. And no exposure shall be available to CMs on their contribution to core SGF. d) Any penalties levied by CC shall be credited to Core SGF corpus. e) Interest on cash contribution to Core SGF shall also accrue to the Core SGF.

50% CC, 25% exchange, at most 25% members.

The default waterfall

In the event of a default, the utilization of the Settlement Guarantee Fund shall generally follow the following order:

a) Monies of defaulting member (including defaulting member's primary contribution to Core SGF(s) and excess monies of defaulter in other segments). b) Insurance, if any. c) CC resources (equal to 5% of the segment MRC). d) Core SGF of the segment in the following order: I. Penalties · II. CC contribution to the extent of at least 25% of the segment MRC · III. Remaining Core SGF: CC contribution, Stock Exchange contribution and non-defaulting members' primary contribution to Core SGF on pro-rata basis. e) Proportion of remaining CC resources (excluding CC contribution to core SGFs of other segments and Rs. 100 Crore) equal to ratio of segment MRC to sum of MRCs of all segments. f) CC/SE contribution to Core SGFs of other segments... and remaining CC resources to that extent as approved by SEBI. g) Capped additional contribution by non-defaulting members of the segment. h) Any remaining loss to be covered by way of pro-rata haircut to pay-outs.

The defaulter pays first, and non-defaulting members are near the end.

The cap on that contribution in derivatives: the maximum capped additional contribution by non-defaulting members shall be lower of 2 times of their primary contribution to Core SGF or 20% of the Core SGF of the segment on the date of default in case of derivatives segment (against 10% for equity and debt).

7.12 Cyber security and cyber resilience

Cyber security framework includes measures, tools and processes that are intended to prevent cyber-attacks and improve cyber resilience.

SEBI has recently notified a detailed CSCRF for the SEBI Regulated Entities (REs) that shall come into effect, in phased manner, starting from January 1, 2025 onwards.

The Market Infrastructure Institutions (MIIs): Stock Exchanges · Depositories · Clearing Corporations · KYC Registration Agencies (KRAs) · Qualified Registrars and Transfer Agents (QRTAs).

Cyber Resilience is an organization's ability to prepare and respond to a cyber-attack and to continue operation during, and recover from, a cyber-attack.

The five cyber resiliency goals:

1. Anticipate: Maintain a state of informed preparedness from adversary attacks. 2. Withstand: Continue essential business functions at times of adversary attacks. 3. Contain: In the event of cyber-attacks, localise containment of crisis and isolate trusted functions from untrusted ones to continue business operations. 4. Recover: Restore business functions to the maximum extent, subsequent to adversary attacks. 5. Evolve: To change business functions and its supporting cyber capabilities to minimize adverse impacts of adversary attacks (actual or predicted).