Liquid assets
The collateral a clearing member deposits with the clearing corporation, valued daily after haircuts, which must cover MTM losses, VaR margin, extreme loss margin and base minimum capital.
In plain language
A clearing corporation guarantees every trade, so it needs something to fall back on if a member cannot pay. That cushion is the member's liquid assets: cash and near-cash collateral deposited with the exchange or clearing corporation.
The workbook calls liquid assets the core of the risk management system. They must at all times cover four things: mark to market losses, VaR margins, extreme loss margins and base minimum capital. Every margin is blocked against them as trades happen, and a member that uses up too much of them is pushed into risk reduction mode.
Not every asset counts at full value. Each type carries a haircut, and there are limits on how much of the total can come from non-cash assets.
How it works
Acceptable liquid assets (Chapter 4, Table 4.2)
| Item | Haircut | Limit |
|---|---|---|
| Cash equivalents | ||
| Cash | 0 | No limit |
| Bank fixed deposits | 0 | See notes |
| Bank guarantees | 0 | Limit on exposure to a single bank |
| Central Government securities | Based on liquidity and tenor | No limit |
| Growth units of overnight MF schemes | 5% | No limit |
| Other overnight, liquid or gilt MF units | 10% | No limit |
| Other liquid assets (non-cash) | ||
| Equity shares: impact cost up to 0.1% for Rs 1 lakh, traded on at least 99% of days in 6 months | VaR based on 6 sigma, minimum 9% | Single-issuer limit |
| Other MF units | VaR based on 6 sigma, minimum 9% | No limit |
| Corporate bonds | Fixed or VaR-based, minimum 10% | Not above 10% of total liquid assets |
Key rules
- Valued daily, after haircuts.
- Cash equivalents must be at least 50% of liquid assets. Other liquid assets in excess of cash equivalents are not counted.
- MTM losses must be paid in cash or cash equivalents; other liquid assets cannot be used for them.
- A CC's daily exposure to a single bank (cash, FD, BG, equity and debt) through CM collateral cannot exceed 20% of total liquid assets.
- CCs do not accept FDs, BGs, equity or debt issued by the CM/TM itself or its group, nor collateral acquired through bespoke transactions.
- VaR margin is adjusted against total liquid assets at the time of trade and extreme loss margin in real time; MTM margin is adjusted against the cash/cash-equivalent component.
Derivatives. A clearing member's liquid net worth = liquid assets deposited towards initial margin and capital adequacy, less initial margin and extreme loss margin on gross open positions. It must never fall below Rs 50 lakh.
A worked example
Deposits and the 12% equity haircut are illustrative; the other haircuts and limits are the workbook's.
Ganga Securities, a clearing member, deposits:
| Asset | Market value | Haircut | Value after haircut |
|---|---|---|---|
| Cash | Rs 2.00 crore | 0 | Rs 2.00 crore |
| Bank FD | Rs 1.00 crore | 0 | Rs 1.00 crore |
| Liquid MF units | Rs 0.50 crore | 10% | Rs 0.45 crore |
| Group I equity shares | Rs 5.00 crore | 12% (VaR-based) | Rs 4.40 crore |
Step 1 – cash equivalents: 2.00 + 1.00 + 0.45 = Rs 3.45 crore.
Step 2 – other liquid assets: Rs 4.40 crore, but these cannot exceed cash equivalents, so only Rs 3.45 crore counts. Rs 0.95 crore of shares add nothing.
Step 3 – total liquid assets: 3.45 + 3.45 = Rs 6.90 crore. Cash equivalents are exactly 50%, as required.
Step 4 – usage: if the day's MTM loss is Rs 50 lakh, it must come out of the Rs 3.45 crore of cash equivalents, not the shares. To get value from the extra shares, Ganga would need to add more cash equivalents.
Why NISM asks about it
Chapter 4, section 4.1.1.2 (Liquid Assets) is the source: the four requirements liquid assets cover, Table 4.2 of haircuts and limits, and notes A to L. Section 4.1.1.1 ties VaR, ELM and MTM margins to liquid assets; section 4.1.2.2 defines liquid net worth for derivatives (minimum Rs 50 lakh). Expect numerical questions on the 50% cash-equivalent rule and recall questions on specific haircuts (5%, 10%, 9% minimum, 10% minimum for bonds).
Common exam traps
- At least 50% must be cash equivalents. Non-cash assets above the cash-equivalent total are simply ignored.
- MTM losses: cash or cash equivalents only.
- Bank FDs and BGs carry zero haircut but are subject to single-bank exposure limits; 20% is the overall single-bank cap.
- Growth-plan overnight fund units: 5%; other overnight/liquid/gilt fund units: 10%.
- Corporate bonds: minimum 10% haircut and at most 10% of total liquid assets. Two different 10s.
- Liquid assets are not liquid net worth. Liquid net worth deducts initial margin and ELM, and has a Rs 50 lakh floor.
- Own-group securities are not acceptable collateral.
Where this is taught
- Series VII · Chapter 4: Risk Managementintroduced here
- Series X-A · Chapter 3: Cash Flow Management and Budgetingintroduced here
Related terms
- HaircutThe percentage cut applied to the market value of collateral before it counts towards margin, so that a fall in its price does not leave the clearing corporation or broker under-covered.
- Base Minimum CapitalThe deposit every trading member must keep with the exchange purely to meet contingencies — it earns the member no trading exposure at all, and its size depends on what kind of trading the member does.
- Extreme Loss MarginA flat 3.5 per cent margin collected on cash-market positions to cover losses falling outside what the VaR margin is designed to capture.
- Liquid Net WorthThe part of a merchant banker's net worth deployed in unencumbered liquid assets, counted after a prescribed haircut on each asset type — a second capital test that net worth alone cannot satisfy.
- Risk reduction modeThe restricted state a stock broker is put into when 90% of its collateral is used up by margins: pending orders are cancelled, only IOC and margin-checked orders pass, until utilisation falls below 85%.
- Mark to MarketThe daily settlement of a futures position at that day's closing price, so gains and losses are paid in cash every evening instead of accumulating until expiry.
- Liquid assets to net worth ratioLiquid assets as a share of net worth — read against the timing of the household's goals, so a low figure is right when goals are distant and a higher one when they are near.
- Net Option ValueMarket value of a clearing member's long option positions minus its short option positions, added to (or subtracted from) its Liquid Net Worth so option gains and losses hit capital without cash settlement.
- UpstreamingThe SEBI framework requiring stock brokers and clearing members to transfer all client funds to the clearing corporation by end of day, as cash, a lien on a bank FD, or units of a Mutual Fund Overnight Scheme.
- Liquidity ratioLiquid assets divided by monthly expenses including loan repayments — the number of months a household could keep paying its bills from short-term assets if income stopped.