Sebi liberalises spread margin benefit in commodity futures contracts

Sebi liberalises spread margin benefit in commodity futures contracts

Currently, margin benefit of 75 per cent in initial margins is given in spread trading

The Securities and Exchange Board of India (Sebi) has liberalised spread margin benefit in commodity futures contracts.So far, only calendar spreads or spreads consisting of two contract variants have the same underlying commodity.Sebi has now allowed spread contracts across futures contracts in a commodity complex or inter-commodity spreads, with margin benefits from July.

Currently, margin benefit of 75 per cent in initial margins is given in spread trading.From July, the benefit in initial margins for such spreads will be permitted when each individual contract in the spread is from the first three expiring contracts.Normally calendar spread takes place in near-month and far-month contracts.Usually, carry traders and financiers trade in spread contracts.

The difference in prices of two contracts gives them returns when they buy one and sell another contract. Such correlation breaks when a far-month contract enters in contango (when the futures price of a commodity is above the expected spot price). But, when margin benefits of 50 per cent — as proposed by Sebi — is given, this means they will pay less margin for one buy and another sell contracts considered together. Currently, when underlying commodities are different, buy and sell trades require separate margins.

“Spread margin benefit should help to get more liquidity in some of the same commodity group contracts and it can offer more leverage to large institution players to increase their inter-commodity exposure,” said Javed Malpura, vice-president, MSFL.Traders also see Sebi’s circular on Tuesday as preparation for more institutional players to enter commodity derivatives. Sebi is expected to soon permit mutual funds and portfolio management service providers in commodity derivatives.

Hedge funds which have been permitted may also be able to improve their participation with the spread margin benefit across commodity complexes because these benefits reduce their cost of carrying forward leverage positions.Tuesday’s move will help doing spread trades in commodities such as soybean and soya oil, kapas and cotton, guar gum and guar seeds where usually co-relation in futures prices of both contracts are higher.

The new move will help if one contract is less liquid while another is liquid, to improve liquidity in less-liquid contracts. Sebi has not confined spread contracts under the new circular to related commodities but prescribed some conditions.In the circular on Tuesday, Sebi has set a few conditions for spread margin benefits in commodity complexes. The most important among them is minimum coefficient of correlation between futures prices of the two commodities is 0.90.

Sebi has said in the circular that back-testing for adequacy of spread margin to cover mark-to-market (MTM) has been carried out for a minimum period of one year. Exchanges now have to do such back-testing of past one-year trading and they are likely to come out with results showing commodity-wise results where correlation is at least 90 per cent.

The initial margin after spread benefit should be able to cover MTM margin at least 99 per cent of the days, according to back-testing. The maximum benefit in initial margins on spread positions is restricted to 50 per cent.No benefit in extreme loss margin shall be provided for spread positions and loss margins shall be charged on both individual legs. Exchanges are free to charge higher margins, depending upon their risk perception.

The Business Standard, New Delhi, 21st March 2018